The Skeptical Optimist

Move over, Hoover

I try to avoid long-term forecasts, but this one is as close to a sure thing as I've ever encountered... so here it is:

The US national debt accumulated between 2001 and 2017 will go down in the history books as George W. Bush's fault -- all 16 years of it.

Reason I'm so sure of it: Political message-crafting can be so powerful that it trumps economics, critical thinking, and any explanation that won't fit on a bumper sticker.

[Note: What follows is not a defense of George W. Bush; it's a defense of economics and critical thinking. I, for one, am very much looking forward to having a president who is talented at communicating with us and with the rest of the world; we've suffered an eight-year void in that department. In fact, we haven't had a really good one since Reagan, and Barack Obama strikes me as having Reagan-like potential in that regard. That will be very good for us and for posterity. However, I fully expect him to play the "Bush Card" every time he needs it to shore up his political capital. Although it won't fool me, the Bush Card should be extremely effective for years to come with the millions of devoutly religious members of The Church of Obama's-The-One, Bishop Keith Olbermann presiding.]

Yes, the debt nearly doubled in eight years. Never mind that the underlying premise is a lie (...that an increase in the national debt is undesirable). Never mind that the long-run growth of our economy is much more important than the long-run growth of our debt. In politics, those facts just don't matter. Politicians on the left just hammer away at one simple, easy-to-remember charge: "Bush added five trillion to the debt." Sadly, politicians on the right have no idea how to counter that quarter-truth.

Yes, the debt nearly doubled in eight years. Never mind that it's easier today for the federal government to service its debt than it was ten years ago (...it now takes a smaller portion of tax receipts to pay the interest.) That fact won't make it into the history books. Never mind the two expensive wars precipitated by 911, and never mind our 1990s preference for cashing in the "peace dividend"  instead of investing it in preventing 911-like attacks. That missed opportunity won't make it into the history books, either.

No, the political message is this: the whole 5 trillion extra debt is a travesty, and it's all Bush's fault. Before him, we had our wonderful, beloved surplus; but all because of him, the debt almost doubled in 8 years.

And that summarizes the Democrats' number one talking point leading up to the 2008 election.

But wait, that only explains 8 years of my 16-year prediction.  So, here's the rest of it:

The day after we elect the Democrats to "save us" from the Bush debt runup, their top political talking point will switch to "My god, look what we inherited from Bush; this is much worse than we'd thought!" An exact repeat of the Clinton '92 theme -- and we'll hear it for eight years, if not longer.

Never mind the implicit Obama promise of $10 billion per month savings from pulling out of Iraq. Never mind the implicit windfall we are supposed to get from hiking taxes on the rich (who make unfair incomes), or on the domestic oil companies (who make unfair 10% after-tax profit margins). Never mind the cost of subsidizing new green jobs, the cost of protecting old, obsolete union jobs, or the cost of creating lower-cost, lower-quality universal health care. No, never mind those promises and programs, because...

...every dollar of deficits from 2009-2017 will turn out to be the unavoidable aftermath of the Bush deficits and debt.

Yes, I feel good about this prediction. It will all be Bush's fault -- all sixteen years from 2001-2017, according to the politicians who will be crafting the story for posterity.

Move over, Herbert Hoover.

Four unanswered questions: two for McCain, two for Obama

Some of us aren't yet sure whom we should vote for, and there's not much time left. If I could get the answers to four questions (two for each side), it would help me a great deal.

Anyone who has made up their mind, and knows the answers to your side's questions below, should feel free to enlighten me by posting a comment.

McCain question #1.
You have promised big cuts in government spending, starting with across-the-board spending freezes (or cuts), and have criticized Obama's "investments" as just a code word for more spending.  But spending money effectively on such things as improving our infrastructure, or educating returning GIs, have always been, and always will be, good investments; in fact, because they increase aggregate supply, they fall under the heading "Supply-side economics." Why is it so difficult for you to admit that at least some government "spending" might just be a good investment in our future, and why on earth are you yielding that portion of the supply-side economics agenda to your opponent?

McCain question #2.
Ignorance on Capitol Hill cost us a precious week before our politicians would act to relieve the economy's credit freeze. Did you yourself understand that willing bond buyers, not unwilling taxpayers, would be the ones funding the $700 billion rescue package -- and if so, why do you think so many House members failed to pick up on that important point in time to prevent a deeper recession? 



Obama question #1.
What percentage of federal tax receipts would the rich (those making over $250,000) have to pay in order for you to say, "Stop! That percentage of total tax receipts is just the right amount for the rich to be paying; any more than that would be unfair"?

Obama question #2.
If middle and low income workers deserve relief from the payroll taxes they pay into the social security system without any reduction in their SS retirement benefits, but high-income workers deserve to pay more without any increase in their benefits, isn't that, in effect, your historic veto of FDR's original intent that SS contributions and benefits go hand-in-hand?

=================

[Commenters, please specify which question(s) you are providing the answers to.]

LIBOR explained

Recently, most heads have been turned toward the Dow Jones Industrial Average; but a few others have been closely watching the "LIBOR spread." [A notable exception is the U.S. House of Representatives, whose heads were in a completely different place -- and that includes my congressman's.]

The so-called LIBOR spread is the credit-freeze indicator. The bigger the spread, the closer we are to shutting down main-street commerce, just because of the business equivalent of a lack of pocket change. (Shutting down main-street commerce is like shutting down a big factory: it takes quite a while to get it going again.)

LIBOR is the rate at which banks are willing to lend to each other. When they are afraid to do that, they tend to park their money in risk-free, short-term US Treasuries (which usually track closely with the target fed funds rate). The "spread" is the difference between those rates. The chart above, which I clipped from the Bloomberg link below, compares LIBOR to the Fed Funds target. Many watch LIBOR vs short-term US Treasuries. In both cases, a big spread indicates a preference for parking money in a safe place instead of risking it on lending pocket change to businesses and other banks. 

Bloomberg's explanatory graphic is at this page...

...and they publish the LIBOR rates, and others, at this page.

LIBOR has been taking baby steps downward in recent days; short-term treasuries remain steady at around one-quarter percent.

Who will modulate capitalism: business, or government?

I'll make an educated guess that whatever popular sentiment remained for laissez-faire capitalism is now dead and buried. Anyone who disagrees is free to post a comment. My judgment: the free-market is in for some new controls, like it or not.

To me, the big question is not whether it will happen, but:

How will capitalism be modulated, going forward?

Below is how I picture the problem. The business cycle is a given (...economists don't argue about its existence, or whether it will continue). But society has a limited tolerance for the joblessness and bankruptcies that go along with downturns in the business cycle — and when the downturns surpass that tolerance limit, the people get really, really upset. No surprise.   

The people have now had it with the previous form of capitalism on Wall Street. (Whether or not Wall Street deserves more blame than incompetent regulators and politicians is a valid question, but my guess is that the people will assign the lion's share of the blame to Wall Street.) 

So, the question is not whether, but how capitalism will be modulated differently than it was before. If business cannot figure out how to better-modulate the business cycle, then the public will turn that job over to the government. I hope the former is still possible, but fear the latter may now be inevitable. 

Here's the modulated version:

Too much government intervention will stifle innovation, and therefore long-run growth (blue line). That's why I hope the government's intervention can be limited to "stimuli" that push private business into better practices.

One idea I've mentioned previously ("What shall we do about the board of directors?") is at least a quarter-century old. It's former ITT chairman Harold Geneen's solution to the fox-guarding-henhouse situation in our top 500 corporations (i.e., employees "representing" the owners — the most common example being the CEO's membership on the board of directors, frequently as the chariman). Should there be a new law banning corporate employees from board membership? Geneen thought so, but few if any corporations did anything about it.

One result of that inaction: almost nobody in corporate America who bought into the ponzi scheme of mortgage-backed securities asked the question (...on behalf of their bosses, the stockholders), "What if housing prices went down? What would that do to the risk in these securities, in our portfolio, and on our balance sheet?"

If questions like that had been asked in more companies than just Wells Fargo and (Warren Buffett's) Berkshire Hathaway, we probably wouldn't have moved anywhere near this close to the brink of financial collapse.

An emailer suggested a second possible way for government to stimulate self-modulation in business: Employee-owned stock in major corporations automatically becomes non-voting stock. Employee-stockholders get the owners' upside of success, and downside of failure — but they don't get rubber-stamp approval authority over the way they propose to run their companies for the rest of the stockholders.

I'm sure there are more ideas to kick around regarding better self-modulation by business, but there might not be much time (if any) left for figuring it out. If it can't happen that way, then government will get too big a role. That would definitely gum up the works. Not only would 5% long-run growth become a polyanna fantasy, our track record of 3% growth (blue line above) could easily become a thing of the past — as would the incentive behind this blog.

The business cycle will be modulated differently, that's a certainty. The question is, Who will do the modulating?

An ancient letter to my congressman (11 days ago)

Eleven days ago, I faxed the letter below to my congressman. What's really a weird feeling is that it seems like ancient history now.

This was a few days after the House idiotically rejected the first version of the $700 billion rescue package intended to help unfreeze the credit markets. I had been hoping there was still time to prevent a deep recession. Time may or may not tell whether that first mistake did in fact blow it for our economy.

By the way, this letter didn't do any good. He voted against it again.

Here it is, for what it's worth:
========================
Congressman:

I noticed that you were one of the members who voted against the inaccurately-named "bailout" bill yesterday.

The American people were misinformed by the administration’s leaders; they botched the explanation of the package. Taxpayers will NOT have to come up with $700 billion; in fact, it might not require one dime of taxpayer funds, and might not end up increasing the national debt by even one dime. Please read an article at my blog that explains why, and diagrams the money flows in simple-to-understand pictures. Here is a link to it:

“It's not funded by taxpayers"
http://tinyurl.com/4m2pyj

To verify the accuracy of what I've depicted, feel free to call someone at the Treasury (or the Fed) who is up to speed on the package as it was proposed.

Now I'll tell you my reaction to your vote: I am highly disappointed. You may, in effect, have voted in favor of the next Great Depression. The credit freeze could trigger it, if something isn't done quickly. (The credit freeze can be identified by a skyrocketing difference between the LIBOR rate and short-term Treasuries; that's what it has been doing in recent days.)

I sincerely hope it will make you and your colleagues feel better to know that preventing a depression might not cost the taxpayers a single dime. Whoever is responsible for permitting the general public to think the taxpayers needed to come up with $700 billion, on short notice, deserves to be fired or turned out of office.

Please vote in favor of the package when it comes up again. It might not be too late to prevent widespread bankruptcies and joblessness.

Thank you,
Steve Conover
Sept. 30, 2008
========================

Household Income brain teaser

Below are two households. Even though the overall economy grows 5% from year 1 to year 2, household 1 takes a big hit: its income drops by nearly 50%. 

Brain teaser:
Income distribution started off at equality. (a) Did unfair economic policy cause the huge disparity in income distribution between the two households in year 2? (b) Which is more indicative of the fairness of the "sharing" of economic growth: household income, or income per earner?

For a more detailed discussion of this problem, go down two articles.

Please listen to Warren Buffett

All readers here should invest 54 minutes to hear Warren Buffett explain the economic crisis and the steps being taken to fix it. 

Here's the link.

Thanks to commenter Larry D'anna for alerting me to this.

Return on investment: Two million percent

The stock market's recent performance has cost a lot of people a lot of money in their retirement accounts... except for one individual I know, who has made a return of somewhere between one and two million percent on an investment she made a year ago.

Most people follow the conventional advice for portfolio management: diversify, diversify, diversify. Choose an array of index funds: some stocks, some bonds; the percent you should allocate to bonds should be about the same as your age.

It just has to be a good strategy: it's the result of decades of work by really smart people such as Markowitz, Sharpe, Bachelier, Black, Merton, and Scholes. They developed modern portfolio theory, the Capital Asset Pricing Model, option pricing models, and other sophisticated tools. Some won Nobel prizes for their work, and then started hedge funds to parlay their nest eggs.

Their theories work well almost all of the time. In the long run, they said, one can expect an average annual return of 8%, 10%, even 12% or more using the new, smart strategies. [Micro-quiz: What's the most important word in the first sentence?]

But after investing in the two books pictured here (and reading them), the individual I know decided those theories weren't convincing enough. The books:

• Fooled by Randomness, by N. N. Taleb, and
• The (Mis)Behavior of Markets, by Benoit Mandelbrot.

Here are eight excerpts from those two books:

[In economics,] you can disguise charlatanism under the weight of equations, and nobody can catch you since there is no such thing as a controlled experiment.

...the precision of the language of mathematics could lead people to believe that they had solutions when in fact they had none.

Harry Markowitz received something called the Nobel Memorial Prize in Economics. What is his achievement? Creating an elaborate method of computing future risk if one knows future uncertainty... An immediate result of Dr. Markowitz's theory was the near collapse of the financial system in the summer of 1998.

Economics is a science of fashion... The profession burns through new theories the way a teenager hops from one new date to another.

The market is very risky — far more risky than if you blithely assume that prices meander around a polite Gaussian average [i.e., the bell-shaped curve].

Anywhere the bell-curve assumption enters the financial calculations, an error can come out.

In 1993, [Scholes and Merton] joined some heavyweight Wall Street bond traders in the creation of a new hedge fund, Long-Term Capital Management... The had at one point twenty-five PhD's on the payroll... In August 1998 the Russian government defaulted on its bonds, triggering a market meltdown. LTCM... was stuck without buyers... In the end, several banks reluctantly agreed to bail out the fund... only at the behest of the Federal Reserve Board, which was concerned about a wave of bankruptcies if LTCM went under.

[Merton and Scholes] made absolutely no allowance in the LTCM episode for the possibility of their not understanding markets and their methods being wrong. That was not a hypothesis to be considered... The fact that these "scientists" pronounced the catastrophic losses a "ten sigma" event reveals a Wittgenstein's ruler problem: Someone saying this is a ten-sigma either (a) knows what he is talking about with near perfection... or (b) just does not know what he is talking about... and it is an event that has a probability higher than once every several times the history of the universe. I will let the reader pick from these two mutually exclusive interpretations which one is more plausible.

Passages like those prompted a switch away from trusting the smart people armed with their bell curves, to a different, non-Nobel-prizewinning strategy: Move 80% of one's funds into safe, short-term Treasury securities; do whatever you want with the remaining 20%.

Result of that strategy switch after 12 months: Avoidance of the 30% drop in equity index fund values. Almost a two million percent return on her two-book investment in just one short year.

A lot better than a hedge fund, don't you think?

[ps- I read both books, too. Wish I'd paid closer attention.]

Dora the Explorer to the Rescue?

I've been watching C-SPAN. House members have been taking turns at the mike.  THEY STILL DON'T UNDERSTAND THAT TAXPAYERS WILL NOT BE THE SOURCE OF THE RESCUE FUNDS. This is NOT a good omen. This is an emergency. Maybe we need some help from Dora the Explorer.

Most of the Congress members still think the bill would give the Treasury Secretary "the power to spend $700 billion of the taxpayers money."

Not one of them understands that the bill would, instead, give the Treasury Secretary the power to sell T-bonds a few billion at a time to BOND BUYERS WORLDWIDE -- then BUY THE BONDS BACK a few months later. Taxpayers would not be involved; buying bonds is a voluntary action on the part of the buyer; selling bonds is also voluntary.

ANY taxpayer who would choose not to be involved in that process would remain free to opt out, by simply DOING NOTHING. The federal government is NOT going to send out the army to collect money from ANYONE who chooses not to buy a T-bond.

After the rescue, the Treasury Secretary would be able to buy bonds back from BOND SELLERS WORLDWIDE. If the Treasury "makes a profit" on its rescue of the private sector, it would be able to buy back more bonds than it sold originally; if it "incurs a loss" it would be able to buy back fewer bonds than it sold originally. AGAIN, THE TAXPAYERS ARE NOT INVOLVED IN THAT PROCESS.

Why is that such a difficult message to communicate to the members of Congress?

I bet Dora the Explorer could explain it to our kids, something like this...

1: Sell a bond;
2: Use the money to prevent a deep recession (if there's still time);
3: Buy the bond back.
WE DID IT, WE DID IT, WE DID IT!

(I'm running out of ideas, and we are running out of time, if we haven't already.)