DUMB, DUMB, DUMB

Presidential candidates are apt to propose anything in hopes of getting elected. John Edwards, a former NC country boy, is a case in point. At the most recent Democratic debates, he and other hopefuls proposed raising the Social Security Tax dramatically. The idea is popular among those who hold the socialist idea that the primary purpose of taxes is to take from the rich while giving to the poor. There is a reasonable argument for a certain amount of this "income redistribution", there is also a powerful argument against killing the goose that lays the golden eggs.

The economic argument for income redistribution is that the marginal value of a dollar to a person who is hungry is much higher than the marginal value of a dollar to someone who is wealthy. On the other side of the issue, tax the heck out of wealth and several bad things happen. One is that the incentive to work more than a minimum goes away. Another is that the entire economic pie shrinks over time. The average size of each piece of pie goes down and down some more even while the pieces are closer and closer to the same size.

There are other "external effects" not seen immediately. A big one high US taxes results in a high loss of US jobs.

John likes to talk as if he would only raise taxes on the top 1% of Americans. In fact, by raising the tax on social security he would impose a significant extra burden on the small businesses of America. In particular, labor intensive businesses would see a significant increase in taxes. Adding an extra cost to American businesses is a good way to send more jobs over seas.

I am a strong support of free trade because in the long run, everyone wins by following the path directed by the law of comparative advantage. Under free trade, wheat will be grown in Nebraska, oranges in Chile, computers will be designed in silicon value and computers will be assembled in China. However, increase the tax on labor in America and less investment and economic activity will be performed in America relative to what is performed overseas and even those in Chile who trade oranges for wheat will see their costs go up. In particular America will be hurt by the confiscation of income. If it were true that the government used tax dollars more efficiently than those from whom the dollars are confiscated, the pie would not shrink. Surely you are not among the few who actually believe the government is efficient.

I encourage all of you to visit the blog written by Karl Fisch. The URL is www.thefischbowl.blogspot.com (a hat tip to Keith Hayes of HayesAdvisory for suggesting the site to me).

An interesting set of data is presented on this site and on several YouTube Videos. A couple of key points made that relate to the issue raised above is that if all the jobs in America were sent to China, there would still be millions of unemployed Chinese. And if you think that only the low skilled manufacturing jobs will leave for China, the number of people graduating from college in China is a much higher number than in America. Perhaps the most interesting point is that in about 10 years, there will be more English speaking people in China than there will be in all of North America.

The tax increase proposed by John would take the top marginal rate up to 47%. Of course, such a burden would result in lobbying for loop holes and the tax system would gradually become all the more complicated. The competitive position of America would be damaged. Ironically, countries all over the world have begun to understand that high taxes kill the golden goose. Other countries are lowering their taxes. Should the US raise its taxes at the same time that others are being lowered, the hit to the US economy would be extra severe.

Some like to argue that the increases in taxes during the Clinton years prove that taxes do not hurt as much as "economic libertarians" argue. The fact is that fiscal policies have a delayed effect. A business that has made huge capital investments in plant and equipment is not going to throw his investment away. He will continue to operate for as long as his marginal revenues exceed his marginal cost, however, he will look elsewhere when making new investments. By the end of the Clinton years, the boom had turned to bust.

Over the past few weeks, many have argued that the excessively low interest rates set by Greenspan in 2003 led to the sub prime mess. Monetary policy certainly played a roll but central bankers work within the framework established by the fiscal policies set by the President and the Congress. Extremes in interest rates are typically the result of mistakes made in fiscal policy and in monetary policy. Greenspan had to "row the boat" very hard, upstream, to counter the lagged effect of the tax increases made in the Clinton years. Latter, he had to start holding back the fast moving boat when the Bush tax cuts kicked-in. The wild ride did not need to be.

Life would be easier for all if tax policy were tweaked instead of jerked all over the place. The huge tax increases proposed by John Edwards and the similar increases proposed by his competitors are exactly the wrong policies needed.

Yes, an increase in taxes would raise revenue to the government and the budget might be balanced (of course it would not be balanced if most of the additional revenues were spent on health care or any other government programs), however, if you want to see a recession indicator, look at all the times the government came even close to balance. Nixon actually came close to balancing the budget before he left office. Yes he came close in 1973. Would you like to live through another recession as tough as the 1973-1974 recession. Bill Clinton balanced the budget before he left office but the recession was already baked into the cake when he left. The fact is that the budget never has to be balanced. The debt could possibly grow for ever and, as a result of growing less fast than the economy, it could remain at a law percentage relative to our total net worth.

By the way, one part of the explanation for the dramatic fall in the value of the dollar is the reaction to the probability of tax hikes in America. Markets look forward. When multi-national businesses see tax hikes being considered in America while they see tax cuts being considered in France, it is only natural for them to consider making their next investment in France.

The mind set that sends so many politicians down the wrong trail is that businesses set the price of their products or that the central bankers set the price of money. Markets are much more powerful than any business or any banker. Markets set prices. When taxes take a higher portion of profit margins in one country, the activity is encouraged to go elsewhere. Excessive taxes are simply a dumb, dumb, dumb idea!

DANCING AROUND THE INEVITABLE.

The congress continues to dance around the FAA funding bill. One idea after another has been discussed. Ideas like having government officials set the flight schedules. All of the ideas being floated by the congress are attempts to "fix the problem" without agreeing to fairly fund the system. It takes money to buy bread and money to provide air traffic control, there is no free lunch, someone has to pay.

The congress faces this problem because its past attempt to tax the rich and give to the "poor" has caused massive pain. In this case, the extra tax on the major carriers was partially to blame for sending these companies into bankruptcy and now it is partially to blame for forcing passengers to circle airports or to sit on tarmacs for hours. Of course, pointing fingers is not the way to correct the problem but a basic understanding of economics would help.

If the congress is going to continue to insist that the owners of small planes get "90% off" then small planes are going to consume the bulk of the service. Under the current system it is like the US government is operating a Starbucks where coffee is sold to all who do not have a job at 30 cents per cup. Those with jobs hate to go buy coffee because they must stand in line behind hoards of "free loaders". The big difference in this Starbucks and the FAA funding is that the government operates the only "store" for miles around. If you want coffee, you must stand in line or go the long way around. The really bad news is that your cost per cup is not the standard $3 but $8 because someone has to pay for the money lost on all the 30 cent cups! Even more bad news: the projected growth in the purchase of 30 cent cups is off the chart. In 2008, there will be more than 1,400 small jets added to the fleets of those who are enjoying the 90 percent subsidies. This is great for small plane manufacturers and for those who can make use of the small planes but it means millions of more delays for the passengers on commercial flights.

You see, even the $8 coffee is not enough to make up for the many cups of 30 cent coffee sold at a loss. The result is that the coffee must be rationed. There is demand to build many more stores to offer much more of this 30 cent coffee but there is a limit to what the traveling public will pay. The end of the John Edwards story above is that the "rich" small business must leave the USA or suffer and the end of the airline story is that the public must buy their own small plan or perhaps participate in protest marches in Washington. When planes loaded with hundreds of passengers sometimes sit on the tarmac for hours, while 20 million dollar private jets take off and land for pennies on the dollar, something has to be done and something will be done.

I don't believe the congress is willing to allow the airports to be partially closed even for a day or two. At some point, they must reach a workable compromise. The demand for air travel is growing rapidly, even while the horror stories created by congress are in the news daily. For a while, the finger of blame can be pointed at the carrier of the day that has had a problem. Sooner or later, the public will realize that the funding system is the problem and not the individual carriers.

Congressional leaders have tried to use health care for poor children as a foil to win sympathy votes. The congress has passed a bill to throw $35 Billion on top of a $5 Billion Dollar program. In terms of government spending the extra $30 Billion is small potatoes. Even so the congress has not been able to put together a veto proof majority. A continuing resolution has been passed. The government can continue to operate even though none of the 12 annual budget bills has been passed. Over the next several weeks, bills will be passed and the FAA will be funded. The big subsidy to "small jet owners" will not be eliminated but it will be reduced dramatically.

WHAT INFLATION?

One reader believes that his increase in his cost for food and gas have been far more significant than his savings from the Internet. As I mentioned yesterday, each of us has an individual inflation rate that is a little bit different from all others. Besides, while the Internet and other information technologies provide great examples of savings, lower prices are in products every where. The savings that a business achieves though the use of the Internet shows up in all sorts of products and services.

One of the problems we have in seeing the lower prices is that we often choose to pay more for a new product that is then compared to the price of the old product. For example, the price of TV's have fallen and fallen and fallen. The real cost of a black and white TV that offers a great picture relative to the one I started watching more than 50 years ago is a tiny fraction of the cost of that old TV; the price has dropped in real terms by more than 90%. The price of color TV's have gone through the same process and in recent years the price of digital high definition TV's has been falling like a rock. In like manner, in real terms our monthly phone bills average much less than the phone bills of the past but this is for a mobile phone; a phone that has given us huge savings in other costs but that by itself is seen as an expensive toy by many people.

If you want to see savings, productivity and dis-inflation, take a look at the cost of data storage. In 1981, electronic data storage cost $700 per megabyte. The latest designs bring the price down to $.002 per megabyte. Go back further in time and you find that the price of an IBM 5MB drive in 1956 was $50,000. Even at $10,000 per megabyte, savings were realized over the "old system". The huge savings comes in the time spent retrieving the data when needed and the electronic method would not have been adopted at all if it was not cheaper than the old paper and file cabinet system. So, the cost of data storage during my life has fallen from $10,000 to $.002, a factor of 5 million times! My friend will probably respond that he does not buy data storage and that he does not understand what data storage has to do with the cost of his food and gas. In reality, he does consume large amounts of data storage and he does benefit greatly from the decline in the price. When he goes to the hospital to get a heart operation to save his life, he will benefit from data storage. Neither the hear operation or the data storage even existed some years ago.

Perhaps this reader does an occasional "Internet Search"; since there will be 2.7 Billion Google Searches done this month and since 57% of all searches will be done on Google, lets assume the search is a "Google Search". Google did not exist 10 years ago. Before Google came along, how would my friend have gotten the information? Would he have driven to the public library, done a free search in a card catalog to discover the location of a source, visited the stacks to locate the source and then searched the table of contents to find the section, etc? Compare the cost of one data search and one can surely see that costs are going down not up. Inflation is really about productivity. What can we do today that will substitute a cheaper resource for a wasteful expenditure?

We are living in a time of accelerating innovation. We keep doing more and more while spending less and less. In the short term, care must be taken to not "jump ahead of ourselves". With massive numbers of citizens of the world just now able to afford the "good life", again due to the deflation of costs, we must try to maintain a reasonable speed limit. We cannot expect billions of more goods to be produced until infrastructures are in place to support the production and delivery of those goods.

Yesterday, the government of China made a few more tweaks to try to slow growth. The interest rate on second homes in China was raised to 10% higher than the rate for first homes. The projected slow down in growth from 11% to 7% in China would help the "capital markets catch up". Time is needed for resource capacity to be increased or diverted.

The markets are forcing resources that have been being devoted to building residential housing to business "housing". It would be inflationary to try to build homes at the pace of the past several years and to manufacture the 1,400 "small jets" and all the rest of the new capacity needs in our growing economy. So far, believe it or not, the switchover has been relatively smooth. New house sales figures have fallen sharply in America but the rate of sales is still in the area of 800,000 homes! We live the "good life" and find it hard to appreciate how good we have "it". We have plenty of houses available for a while. As the "business side" gathers speed, incomes will continue to rise and houses will become affordable for many more people but the emphasis of the market will remain on the "business side" for the next several years.

ONE MORE BRIEF ATTEMPT TO EXPLAIN OIL PRICES

Your answer to a question might help explain the current action in the oil futures market. If you were an institutional money manager and you found yourself holding billions of dollars worth of energy stocks and if you decided to reduce your holdings only to find that none of your fellow institutional investors had an appetite to buy shares, how would you go about making the reduction? Chances are you would negotiate a deal with one or more of the major retail brokerage houses. You would sell shares to the brokers "for distribution" to the public. With billions of dollars involved, the selling of these shares would take many months. To get the "job done", the brokerage houses would crank up their publicity machines. One of the ways to make news would be to bid up the price of oil futures.

In the long run, markets set prices, however, in the short run markets can be pushed around a little. The action in the coal yards and the natural gas caverns tells the story. It is an amazing story. Coal trains are having to suspend service because utilities are over stocked with coal. Natural gas production is being slowed or stopped because storage caverns are full. The prices of coal and gas have fallen. The BTU equivalent price of natural gas is in the neighborhood of $47 per barrel of oil. Because the coming decline in oil price is so obvious, people in the business of suppling oil are not purchasing supplies for inventory; they are waiting for prices to fall. Ironically, the publicity machines have been able to use the fall in inventories as a "fact in support" of higher prices. The overwhelming majority of individual investors do not buy futures contracts but they do buy oil stocks and mutual funds that own oil stocks. By losing a relatively small sum on futures contracts, the "big boys" are talking the public into holding and buying billions of dollars worth of oil stocks.

Yes, some would dismiss this theory as the "conspiracy theory of a kook". No matter. I am a patriot and I believe in free enterprise. This means I also believe in "buyer beware". I do not believe that the price of oil shares are going to suddenly drop. Large institutional investors have a hard time in beating the market because they are the market, like the Captain of a battle ship, they must turn slowly and they do not even try to dock the boat, or hit the exact peak in the market price. They must sell and sell and sell at an average high price, some shares way too early and some too late but few at the exact top.

Warren Buffet has said time and again that making above average returns becomes more and more difficult the greater the size of the investment. My favorite analogy is the story of "The Cincinnati Kid". The Kid was a fantastic poker player. He could beat the pants off all the local players. He even showed that he was good enough to play against the top professionals but he still went broke. The top player simply had the resources to out last him and the willingness to lose a lot of money on a bad play in order to set up a big win. It is a very old Steve McQueen movie that you should watch.

It is virtually impossible for the largest of the mutual funds to sell all their energy stocks if they wanted to do so. On the other hand it is easy for individuals to go to a zero weighting. The ability to make such bold moves gives the small investor a huge advantage but it also opens the door to the possibilities of making huge mistakes. Learn to make such moves with confidence based on sound knowledge and you will have Warren Buffets problem one day!

History tells us that it is DUMB, DUMB, DUMB, to run too long with the crowd. The crowd is convinced that energy prices still have momentum. The data tell a different story. The USA uses more coal than oil and the price of coal has fallen. Given time to convert and coal will be used to produce the electricity that will be used to fuel cars. Don't believe the "news" when the "facts" tell a totally different story! Big money is going to be spent on products that help us avoid wasting money on oil. BUY, BUY, BUY, GROWTH STOCKS; SELL, SELL, SELL OIL STOCKS!