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The Myth and Mistake of Quantitative Easing
Last week the Federal Reserve signaled its readiness to engage in further quantitative easing. This would be a colossal mistake. Quantitative easing does not boost real economic activity or inflation - it is not an injection of new money, like traditional monetary easing. During quantitative easing the Fed borrows money from banks and the Treasury to buy assets. All this does is shift what would have been held in the private sector onto the Fed's books. This does not create new money and therefore does not create inflation or lift aggregate demand.
Be Careful of the New Normal
The consensus is forecasting 2 percent real GDP growth for the remainder of the year, with some of the 'double-dip' crowd shifting to a forecast of a 'growth recession' - whatever that means. First Trust, by contrast, is predicting an average growth rate of 3 percent in the second half of 2010. This combines a tepid growth rate of 2 percent in the current quarter and a 4 percent rate in Q4.
Unfunded Liabilities and Cheap Stocks
Despite cries of 'uncertainty' that reverberate through the financial markets, U.S. equities remain grossly undervalued. Risk premiums are exceedingly high. Relative to bonds, stocks are undervalued by a considerable margin. And with profits expected to continue their upward climb, this gap is highly likely to increase even more in the next few quarters. So, what's holding investors back? Why are bond flows continuing to outpace equity flows?
President Obama's Best Gift to Labor
Under current law, companies that buy plant and equipment have to depreciate these expenses over several years. This depreciation makes investment look less attractive, as inflation and the time value of money erode the value of depreciation year by year. Under a new proposal leaked by the Obama Administration, however, companies would be able to fully expense capital investment. This proposal would make it more attractive for companies to buy capital goods, simplify bookkeeping and make taxable profits more equal to cash flow. It is President Obama's best economic policy idea so far.
Odds Brightening for Tax Cut Extension
On January 1, 2011, the top income tax rate on ordinary income and dividends will go back to 39.6 percent, the top tax rate on capital gains will revert to 20 percent, and the top tax rate on estates will go back to 55 percent. Some in Congress want to extend the tax cuts for everyone, some want to extend them but not for the 'rich,' and others want to hold the dividend tax rate to 20 percent. Ultimately, all the current tax rates on regular income, dividends, and capital gains will likely get extended for another year, but precisely when this will happen remains a mystery.
We Knew Reagan... And He's No Reagan
No matter how many of Obama's economists say that stimulus has a positive multiplier, it's simply not true. Stimulus spending does not stimulate, is de-stimulates, because it takes resources from growing sectors of the economy and pushes them to shrinking sectors of the economy. It taxes and borrows from good business models to support bad business models. It?s simple math. The larger the government's share of GDP, the higher the unemployment rate.
Politics and Pessimists
The forces underlying economic growth have turned positive. At the same time, the Fed is accommodative and unlikely to change its stance. These two factors alone will prove the pessimists wrong. In addition, the political winds are howling toward a divided government. The odds of putting off a tax hike in 2011, and possibly reversing healthcare legislation, cannot be ruled out. Add this to the mix, and the future could bring a sharp boost to the upside that makes short-sellers very uncomfortable.
The Fed Gives the Treasury a Gift
Tuesday's announcement from the Fed means that the U.S. Treasury will pay even lower interest rates to finance its burgeoning debt levels. By holding rates steady, the Fed will become more accommodative as the year progresses. As a result, Fed policy will cause both growth and inflation to accelerate throughout 2010 and into 2011. The bond market is stuck between a rock and a hard place. Fed policy on one hand is pulling rates down, while growth and inflation will push rates up. Easy monetary policy, however, eventually results in higher interest rates down the road.
Please - No More Stimulus
Canada has been cutting spending and tax rates for the past decade or so. If Keynesians are right, the U.S. economy should be outperforming the Canadian economy now and Canada should have done better back in the 1980s and 1990s, right? Wrong. It's the opposite. The unemployment rate in Canada is currently 8 percent and has been below the U.S. level since October 2008, when government spending started to go crazy. The lesson is clear: Less spending, less taxing and more freedom work. Let's not stimulate anymore. The U.S. economy just can't take it.
GDP Data - Better than the Spin Suggests
Even though the economy should be growing faster, to say it?s not growing at all is just wrong. Nor is it responsible to be overtly political about it and say it?s all Obama?s fault. Some are trying to say that the Bush stimulus and TARP were good, but what Democrats have done is bad. What a bunch of partisan malarkey! It's hard to do, but investors need to separate their politics from their economics. Staying positive is as important as fighting for what you believe in.
The Good, Bad and Ugly of Austerity
It doesn't matter where we look: National, state and local government budgets are in crisis. This cannot continue. Major policy shifts are underway. The time for austerity has come. The only question is what form that austerity will take. There are three types of austerity: Good, bad, and ugly. Good austerity puts the pain on the government sector. Bad austerity tries to spread the pain across the public and private sectors. Ugly austerity tries to put all the pain on the private sector.
'New Normal' Nowhere in Sight
With GDP scheduled for release next week, Brian Wesbury and Robert Stein's estimate for annualized second quarter real GDP growth is 3.5 percent. While this is a significant reduction from their 5.5 percent forecast made in March, it is still higher than what the 'new normal' camp is predicting. Productivity growth is strong, monetary policy is (and will continue to be) easy, inventories are razor-thin, and corporate profits are growing rapidly. For the next four quarters, ending in mid-2011, Wesbury and Stein thus again anticipate growth at around a 4 percent rate.
Trade Deficits As Far As the Eye Can See
As the trade deficit increases again in the next few years, and as manufacturing jobs disappear because of productivity increases, protectionism will once again become an issue. This fear about the deficit, however, ignores a major reason for it. Ultimately, the U.S. trade deficit is a by-product of an attractive investment climate. Foreigners, with assets to invest, often need to worry about the risks of exposing those assets to a local banking system that makes ours look like a pillar of strength.
Get Real - This is Not 1932
Want to be invited to 'A' list parties? Want people to think you are smart? Then don't smile and don't say anything positive - especially about the economy. Pessimism has become so pervasive that people will believe just about anything, as long as it is negative. The truth is that the U.S. is creating jobs, even if the rate of growth is slower than in previous recoveries. Profits are still rising. In fact, analysts are still raising earnings estimates. The market has so much negativity priced in that it is cheap on just about any basis.
Feds Spin Wheels on Financial Regulation
'Later this week, President Obama will sign an overhaul of the financial industry, the biggest change required by law since the Great Depression. For all the legal change it brings, it won?t prevent the next crisis but also won?t do much harm. This bill will force existing firms to restructure their operations in order to comply, which may hit profits.' Wesbury and Stein point out the many shortcomings of this bill to fully address certain issues which include monetary policy, Fannie or Freddie, and 'too big to fail.'
China just decided it will once again let its currency - the yuan - get stronger against the U.S. dollar. Yuan appreciation will do two things. First, it will lower Chinese inflation relative to U.S. inflation. Second, it will raise the living standards of Chinese citizens. Where previously the Chinese government might have wanted the peg in order to encourage export growth, now the political calculus is starting to favor expanding the purchasing power of its workers. This is a sign of maturity for both the economy and Chinese policymakers.
Disagreeing with Laffer About 2011
Economist Arthur Laffer recently fretted about the economic impact of the expiring 2003 Bush tax cuts, writing that the tax hikes would lift growth in 2010, but cause a double-dip recession in 2011 when the rates actually went up. The problem with economics, however, is that there are always multiple things happening at once. Back in 1993, the Federal Reserve was holding the federal funds rate at 3 percent - a clear policy of easy money. This helped offset the impact of the tax hikes and kept the economy growing.
Has America Forgotten the Fruits of Freedom?
Between 1970 and 1979, there were an average of 25 oil spills per year of 700 tons or greater. Between 2000 and 2009, there were just 3 per year on average. Oil companies lose money and soil their image if oil spills. They therefore have a huge incentive to invest in better safety controls. There is no way to take the risk out of life. When government tries, all it really does is transfer that risk elsewhere. And without the growth and advancement that freedom brings, the system breaks down and wealth creation is undermined.
FASB Fanatics At It Again
The Financial Accounting Standards Board wants to force banks to use 'fair value or 'mark-to-market' rules not only for the securities they own, but also the loans they make. The number one problem with fair value accounting is that market prices for assets are forward-looking. In good times, prices reflect a positive outlook. In bad times, they reflect a negative outlook. And when markets freeze up, financial institutions must use prices that do not reflect actual cash flow. This creates a vicious downward cycle of losses, bank failures, more fear and lower 'observable' prices.
Dr. Copper and the Pessimists
Government is too big and too intrusive and it will harm the economy over time. But it will not kill the economy today, or even next year. Productivity is booming. New technology is lifting wealth, and living standards are rising. Some might say that it is not the Great Depression we should worry about, but the 1970s all over again. This, Wesbury and Stein can agree with. However, during certain periods of that decade, particularly during 1975-76, the economy and the stock market both boomed. That?s what we are experiencing right now ? a boom amidst an uncertain future.
A Shift in Our Fed Rate Outlook
Early this year, it seemed that the Federal Reserve would start lifting interest rates from their current level of near zero by mid-year 2010. It seemed that zero percent interest rates would be too low, that the economy would be in recovery and that inflationary pressures would continue to increase. Even though all of this is still true, the Fed has made it clear in recent months that they are willing to hold interest rates down for a period of time that is much more 'extended' than people realized. Indeed, the Fed could continue holding rates at current levels through the end of 2010.
Wall Street Dips, Main Street Turns the Corner
We may never know exactly what caused last week's Wall Street drop, but the lack of an uptick rule didn't help. Nonetheless, at the bottom on Thursday, the market experienced its first true 10 percent correction in 14 months. Short-sellers were basically gleeful and many politically motivated pundits took the drop as a sign of economic trouble. This correction, however, came just when economic data took a very visible turn for the better. Friday's employment report provided a huge 'thumbs up' for the V-shaped recovery. The fundamentals of Main Street are improving.
Triumph of the Euro?
Because Greece uses the euro, devaluation is not an option to solve the country's budget problems. As a result, Greece?s pain will be concentrated in the sector that is causing most of the problem: government. The conditions of the bailout, decided by the EU and IMF, require Greece to freeze government salaries, eliminate bonuses, and lift the retirement age to 60 for government workers, as well as raise value-added and excises taxes. While the tax hikes are disappointing, the focus on restraining government spending, rather than using devaluation, represents a triumph of the euro.
Fed Twiddles its Thumbs
The Federal Reserve made no direct changes to monetary policy yesterday, leaving the target range for the federal funds rate at 0 percent to 0.25 percent. Minor changes to the Federal Reserve's statement on Monday, however, show that the central bank is continuing to gain confidence in the economy. These include comments that the labor market is 'beginning to improve,' rather than 'stabilizing;' household spending is 'picking up' rather than 'growing at a moderate rate;' and housing starts have 'edged up' rather than staying 'flat.'
Steep Auto Sector Recovery to Continue
Both auto sales and auto production have rebounded substantially in the past year. We expect these trends to continue as a major feature of the V-shaped economic recovery. In the first half of 2009, cars and light trucks were sold at a 9.5 million annual rate, the slowest pace for any six-month period since 1974-75, when the US population was about one-third smaller. Then, along came cash for clunkers in July/August 2009 and sales temporarily surged to a 12.6 million annual rate.
The Danger of Zero Percent Interest Rates
The Fed has become overly involved in financial markets and it is losing sight of its number one job - maintaining price stability. Zero percent interest rates are becoming more dangerous every day. The economy is outperforming the Fed?s forecast, creating a dilemma. Before massive snowstorms, the Fed projected that real GDP would grow 3.1 percent in 2010. First Trust's forecast for Q1 real GDP is 3.4 percent, despite record-breaking storms. And we expect Q2 real GDP growth to approach 6 percent.
Higher Inflation, Not Hyperinflation
Some analysts have proposed inflating/devaluing our way out of this debt crisis. The theory is that with deficits already so large and no immediate prospects for spending control, the US government may have to resort to an Argentina-style monetary policy to pay for its largesse. Hyperinflation with a side order of devaluation, however, is not a free lunch. That was a lesson learned all too well in the 1970s. And now, with future entitlement spending making the current securitized debt small by comparison, it makes even less sense for the government to pursue.
All Aboard the V-Train
As the economic data clearly traces out a V-shaped recovery, some previously skeptical pundits are standing on the V-train platform shouting 'all aboard' as often as they can. Others are slowly raising their forecasts of growth, even job growth. Unfortunately, there is a group of people who still haven't arrived at the station. But they will be wrong. Government spending has hindered, but not killed, the recovery. Recoveries happen. This one would indeed be stronger if the government had not wasted so many resources. Nonetheless, the V-train is on the tracks.
No Double-Dip For Housing
While the end of the Federal Reserve's massive mortgage purchasing program will certainly not help the housing market, it probably will not result in a double dip for housing of the economy. Instead, home building, home sales and home prices should all be up nationwide a year from now versus today. Perhaps the most important reason for this is that the labor market, the last of the lagging economic indicators, has finally turned positive.
Gary Becker's Optimism
The commentary responds to a recent Wall Street Journal interview with Nobel prize-winning economist Gary Becker. Becker is the founder, with Milton Friedman, of the Chicago school of economics. Becker said the financial crisis did not undermine his belief in free markets, and that he remained hopeful that competing interest groups would protect the country in the long run from a systematic bias toward bad policy. While Becker primarily blames new financial instruments for the economic crisis, however, Wesbury and Stein blame mark-to-market accounting rules.
Health Care Fallout
The health care bill is no reason to run for the hills. In the short term, there are no policy changes that will derail or noticeably slow the V-shaped economic recovery slowly underway. There are harmful policy shifts, including extra fees on health insurers and the makers of medical devices, but these are sector and not macroeconomic issues, at least in the short term. The biggest macroeconomic effects will stem from tax hikes scheduled to go into effect in 2013. In the meantime, however, Wesbury and Stein retain their bullish stance.
Fed Still Clinging to Extremely Loose Money
The Federal Reserve made no direct changes to monetary policy, leaving the target federal funds rate at 0 percent to 0.25 percent. Changes to the Fed's statement with regards to the labor market, business investment and housing starts, however, suggest that the central bank is gaining confidence in financial markets and the economy. One member even strengthened his dissent toward keeping interest rates exceptionally for an 'extended period' of time. The Fed also strengthened its commitment to ending special lending facilities for the mortgage market.
More Solid Growth Ahead
The consensus is forecasting a growth rate of 2.7 percent for the first half of 2010. In contrast, we are predicting 4.5 percent, with faster growth in the second quarter than the first. The tilt toward Q2 is due to unusually harsh winter weather across much of the country. The consensus is still underestimating the resilience and robustness of the US economy and remains stuck on expectations of a 'new normal.' But, productivity is strong, monetary policy is (and will continue to be) easy, inventories are razor-thin, and corporate profits are growing rapidly.
More on that Federal Pay Cut
Last week, Wesbury and Stein proposed a 10 percent pay cut for all civilian federal workers in order to send a signal to creditors that policymakers were concerned about the deficit. That article generated more responses than any article the two have published. Many comments were supportive, but most were negative. Many critics of the proposed pay cut pointed to the relatively low wages of younger federal workers, while others argued that a pay cut would blunt the multiplier effect. This latter argument is fallacious, because every dollar the government spends must come from somewhere else.
Bernanke Finally Fingers Mark-To-Market
Mark-to-market ideology is affecting the ability of the Federal Reserve to exit its quantitative easing. The mark-to-market rule uses bids, or exit prices, to value assets. Chairman Bernanke signaled that he recognized the problem in February when he said commercial real estate loans should be valued on income from their property, rather than their collateral value. As long as mark-to-market valuation continues to drag on securitization, the Fed will remain hesitant to withdraw its support of the system.
Getting Serious About the Deficit
President Obama's proposed 2 percent federal worker pay hikes, unveiled amidst a 9.7 unemployment rate and widespread private sector pay cuts, send a clear signal: The U.S. is not yet serious about the deficit. A 10 percent across-the-board federal worker pay cut would net just $15 billion in net outlay savings, but would permanently shift future wages onto a lower path.
Don't Be An Economic Hypochondriac
There are always things to worry about in the economy. With an accommodative monetary policy and the end of the panic, however, the economy is heading upward. The consensus forecast for economic growth has grown from 2 percent of real GDP to roughly 3 percent. This forecast may continue to grow to 4 percent or more.
The Fed Tests the Waters
The Federal Reserve took a big first psychological step toward a tighter monetary policy yesterday when it raised the discount rate to 0.75 percent, from 0.50 percent. The Fed wants to make sure, however, that markets understand that a rising discount rate does not necessarily entail higher federal funds rate.
Greece is Not Lehman Brothers
Sovereign debt defaults are the most recent fears plaguing investors. If governments refuse to cut spending and markets refuse to finance excess outlays, debt defaults could spread worldwide one-by-one. The current sovereign debt crisis in Greece is more likely to lead policymakers to reduce spending to reasonable levels, however, than to kick off a new financial panic.
The (Relatively) Bullish Case for Consumer
Wesbury and Stein justify their 4-4.5% forecast for growth in real GDP in 2010 with five factors: rising consumer incomes; deleveraging; higher savings; a pickup in home building; and pent-up demand for autos.
"Extended Period" of Low Rates Starting to Lose Support
The Federal Reserve made no direct changes to the stance of monetary policy today, leaving the target range for the federal funds rate at 0% to 0.25%. However, one member dissented from the Fed?s comm
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