More Re: The Obama Market Slump

The method of funded is of little importance compared with how the money is spent (Milton Friedman). The fellow who has a good job can afford to buy a car with his cash in the bank or his good credit at the bank. It is to the individuals benefit and to the benefit of society for our system to encourage the purchase of durable goods when they are needed. When individuals show that they are irresponsible, they lose their credit rating and are forced to ride a bike or a bus until they once again establish their good name. In the case of governments, one administration after another succumbs to the temptation of spending our collective money for the benefit of the few. One can come up with all sorts of good reasons to play Robin Hood but, while the politics of doing so often "wins", moral and economic laws are broken when the politically powerful confiscate assets. When is it OK to tell a white lie?


My favorite bipartisan example of government waste continues to be the ethanol boon doggle. The investments we made in ethanol have been poor ones. One after another, ethanol makers are going out of business, the US government borrowed some portion of the money that we "invested" in ethanol, but most of our "investment" came out of our most recent tax payments (assuming prorated allocation of debt to all government expenditures). Our ethanol "investments" were costly mistakes. We will have to use future tax revenues to pay off what was borrowed, but the tax money raised in the past is just as waisted as the tax money that must be used to pay off the debt. We will never recover the fat fees and campaign contributions that were funded by our tax dollars.



Had the investment been wise, there would have been high returns; 15% or more. Businesses do not routinely borrow capital unless they have expectations of 15% return or higher. The fact that the government only paid 1.7% or so to borrow the funds does not take away the sting of the 100% losses. One of the most simple truths, proven time and again, is that governments are not good at selecting which investments should be made. Investments by nature are speculations. The usual effect of involving government is to cause mistakes to be bigger.


While Warren Buffet is willing to pay more taxes, the reality is that he just keeps on paying more, year after year. In the past 40 years, the portion of total US taxes collected from Buffet has sky rocketed and the businesses he operates pay much more in other taxes than he pays in income taxes. His average return on investment has been better than 18% for decades. The tax revenues the government receives from Buffet have been growing at an average of 18% for these many decades. As citizens, we are all in partnership with Buffet.


It would be absolutely foolish for our government to take extra money from Buffet to invest in infrastructure; bridges that should have been built long ago with money raised for that purpose. If we really need many new bridges, we should instruct the Secretary of Treasury to borrow a billion dollars (or several or several hundred) at current t-bill rates of less than 1% and loan them to Buffet at the same rate. (It would even be profitable for us to give the money to Buffet, no strings attached.) Four years after making the loan, Buffet will have turned each 1 Billion investment into 2 Billion. For sake of simplicity, let's assume Buffet sold the investment at the end of 4 years and paid only 15% in capital gains. The profit to the government, per billion, would be 150 Million Dollars plus, plus, plus. We should even give Buffet the right to bid to build and own bridges with his money. If new technologies were used to eliminate gasoline taxes and to collect a fee for every mile traveled, there would be more good roads in the right places. A lot of dumb bridges would never be built.


To generate a Billion Dollars of profit, Buffet businesses would have generated sales of at least 10 Billion Dollars. Can you appreciate how massive the sum of the sales taxes, property taxes, payroll taxes and income taxes generated by the production and sale of 10 Billion Dollars worth of goods or services?


How Long Can the US Government Borrow to cover a significant portion of the services it provides?


Forever!


The above is not a recommendation but simply a fact.


Our governments borrowing costs, have always been very low. Today, it is unusually low. Short term t-bills currently trade for .5% or less, not 5% but five tenths of one percent. Over the past 50 years, government borrowing adjusted for inflation has cost us 1.28%, considerably less than our average productivity gains. Right now, in the middle of a tough recession, our most recent productivity gain was 1.1%, more than double the rates on our t-bills.


Your response implied that our SS Trust has been robbed liked the highway trust fund, but that is not the case. When our government needs to borrow money, it is absolutely proper for it to borrow from the Social Security Trust Fund. Just as the widow receives income on her savings by allowing her bank to loan her money, Social Security earns money for its beneficiaries by lending its reserves.


The bridge money was taken from the trust fund and spent elsewhere; the social security checks continue to go out every month and they will continue to go out when the fund balance swings from surplus to deficit.


Ironically, the most important reason to fund government spending with debt is to reduce government spending. The only way to keep the pressure on government officials to cut wasteful spending is to make sure they have to make the choice of more spending and more debt or no spending. Do we really want to replay the 1970's when wasteful spending resulted in hyper inflation?


In the "new global economy" the US dollar will be punished quickly if we waste our resources. Based on where we are in the investment cycle, the US Dollar should continue to rise, however, the rise has stalled. Will it continue? If Obama wants to lower the unemployment rate and boost the income for the average worker, he will cut the the US corporate tax rate.


Last night, in a meeting of several local business owners, accountants, executives and investors, the consensus was reached that Obama will not attempt to pass significant tax increases until the Bush tax cuts are set to expire. The general feeling in the room was that while Libor spreads and other indicators are being rapidly healed through the (almost) Trillion Dollar flood of new reserves, the number of trouble spots is large. The group initially supported the belief that the bankruptcy of GM would be bad news but came to realize the company would continue to operate during bankruptcy while getting rid of decades old hand cuffs. Employment growth in the US auto industry just might resume after decades of declines.


To Obama's credit, his most recent position on the autos is to speed the previously approved funding to the autos without necessarily doing anything else. The government fuel economy mandate (a complicated mess of a bill) included a $25 Billion loan to the autos. Once again, government mandates have proven to be a huge mistake (except for those who have held onto to the power they grave). Once again the government created a crisis and the people once again voted to elect those who created the crisis to use even more government to fix the crisis.



Cast all your anxiety on him because he cares for you. I Peter 5:7

Jack Miller
1825 Curraghmore Road
Clemmons, NC 27012

On Sat, Nov 8, 2008 at 8:55 AM, Al wrote:

As you stated before, we agree on many things. Unfortunately it is not only the highway trust fund that has been robbed. THE BIGGEST HOLDER OF US TREASURY PAPER IS SOCIAL SECURIY. In reality, one must wonder, "How much of the proposed increases are needed to fund current non Social Security debt?"

Re: The Obama Market Slump

While we have made the economic mistake of having progressive income tax rates (a flat rate consumption tax would create an unheralded economic boom), we have at least kept the social security program in the ball park of a retirement program. Once it becomes purely a welfare program, it will have lost its purpose for being and should be canceled. Taxing the successful to refund Joe's retirement savings is bad "medicine" for the successful and for Joe.


The situation reminds me of our "highway trust funds". Taxes on gasoline were deposited to these trusts as "user fees"; those who bought gas paid for the roads; fair enough. Later, politicians misappropriated these funds and used them for more and more "other things". In NC transfers gasoline tax revenues were by hook and crook used to pay for preschools.



I support government funding for every child to attend preschool but I do not support taking the money out of the highway trust fund. Doing so is a breech of public trust. In all things we need honesty. History well demonstrates that governments typically fail due to corruption. Having the votes to misappropriate funds does not make the act moral.


As a result of the theft of funds from the NC highway trust fund, this state that accesses high gasoline taxes can no longer maintain good roads; indeed, this state is now in a scramble, trying to keep new promises made to parents of preschool kids. Had the money not been misappropriated, the sharp decline in road tax revenue would have had little effect on the rest of the state budget. If the trust fund was still low, the problem would be easy to fix as the public would understand that increasing the gasoline tax is necessary for good roads.


Across the US, local and state governments are begging for an infrastructure bail out bill to rebuild decrepit bridges. The reason is that the misappropriation of highway funds has become a common occurrence.


The facts are clear, republican and democrat administrations and legislatures have fallen into the routine practice of purposely spending more money than is available. Most of the time, these politicians are bailed out by revenue growth. When tough times hit, we all pay a steep price.


The current tax structure is an abomination. It subsidizes wasteful spending on monster homes, monster cars, polluted air, stupid investments, .... (add a few dozen more items to the list if you like). Cliches become cliches because there is truth therein. The conservative mantra that the problem is not too little taxes but too much spending is true.


As far as Joe Six Pack is concerned, the worst thing the government can do to him is to teach him that he can leave work early to have a six pack because the government will pick up the tab. It is vitally important that he or at least his children learn that higher paying jobs are available to those who seek them earnestly.


Yes, in America, people do wish they could earn $350,000 per year and, yes, in America they can. However, the combination of higher income tax rates, higher social security tax limits, higher capital gains taxes and higher estate taxes will literally cause millions of Americans to cut their education short, to work fewer hours or both.


The data are clear, in the years after the Bush tax cuts, the revenues to the government went up substantially. The sharp increase happened even though low income earners got the bigger percentage breaks. Despite the constant false telling by liberal politicians and their media friends, the Bush tax cuts cut taxes to the working class more than to the upper income class. It is also true that total revenues went up because total earnings went up sharply. The Laffer curve is fundamental, until the maximum is reached, lower taxes increase incomes enough to increase total tax revenues even at the lower rates.


One of many fundamental truths ignored by liberals is that if we tax $350,000 incomes more, we will have fewer $350,000 incomes (in real dollars) and if we subsidize Joe Six Pack income levels we will have more people earning at Joe Six Pack levels (again in inflation adjusted dollars). Is that really what you want for your children and grand children?


My last point is that my purpose for getting into the numbers was to show that in many cases it makes sense for individuals to withdraw funds from 401-K plans before their tax rates go up. Your response reminded me of something that I left out, which is that the tax increases will prove to be much higher than the bounce from 25% to 28%, from 28% to 31% or even from 35% to 39.6%. As I mentioned the tax code is an abomination. Many of us support getting rid of thousands of loopholes. Obama supports getting ride of some of these loopholes. The combination of raising rates and eliminating tax deductions or credits will be a bitter pill for high income earners to swallow. Believe it or not, in today's mobile society, some folk who make their $350,000 off Internet pursuits will choose to move elsewhere.


Instead of shrinking the economic pie and making the pieces more equal, we should grow the economic pie so that everyone gets a larger piece. We should eliminate the interest deduction on massive homes. We should not even consider bailing out GM or Ford. (The pundits keep talking about the massive job losses if GM goes bankrupt when the exact opposite is true.) We should stop subsidizing scores of government solutions. We should stop telling lies (such as energy supplies are running out) just to advance our political agenda. We should stop taking money from highway trust funds to start preschools. We should not tax the creation of wealth but we should encourage it.




Cast all your anxiety on him because he cares for you. I Peter 5:7

Jack Miller
1825 Curraghmore Road
Clemmons, NC 27012

On Fri, Nov 7, 2008 at 1:16 PM, Al wrote:

Income tax has, from its first inception, been a way to spread the wealth. It has always been progressive, only the rates have changed in its nearly 100 year existence and these changes have been to make it include more and more income.See http://www.ustreas.gov/education/fact-sheets/taxes/ustax.shtml for a brief history on all types of taxes the federal has used.

Let's look at someone who pays the 35% rate. It starts at $357,700 This is almost six times the median male wages of $45,113. The first man currently pays $125,195 in income taxes and $6,324 in SS for a total of $131,519. With a tax rate increase to 39.6% and no SS cap, he now pays $141, 649 in income tax and $22177.40 for a total of $163,826. This is a reduction in his net income of $22177 or 6.2%.

Now let's look at Joe Six Pack, who at the median male 2007 US income of $45,113 is paying a 25% income tax rate ($11,278) and SS of $2,797 for a total of 31.1% or $14,065. Under the new rate Joe would get a $1,024 tax reduction and his rate would drop to 28.9%.
Tax brackets are based on IRS tables for net income and Joe Six Packs salary is really a gross number from census estimates. I can't speak for anyone else, but if I were Joe, I'd be happy to trade places with the person making a $357,700 annual income.

Make Money Off the Historical Rhyme

In the early 1980's, when US car companies faced mandates to increase fuel efficiency, high energy prices and, Chrysler, faced certain bankruptcy. A silly mistake was made. The US government bailed out Chrysler. I took advantage, buying shares in Chrysler for $2.37 each. The shares went to $80 each in just a few years. But, the bail out was a disservice to the auto industry and to America.


Some 25 years later, history rhymes. The remains of Chrysler are all but bankrupted and Ford and GM are bleeding profusely. Auto executives and union leaders are arm twisting legislators, begging for bail outs. The companies should be forced to file bankruptcy, but will it happen?



The market cap of GM is now $2.7 Billion, chump change for moneyed investors such as Warren Buffet. The market cap of Toyota, that only sells a few more cars, is $106 Billion. Is Toyota really worth 39 times the value of GM? (Numbers provided by 24/7)


Ford has about 18 Billion in cash but it is burning cash rapidly. It has sold Land Rover and Jaguar and it may sell Volvo. Ford can survive without having to file bankruptcy but bankruptcy would allow Ford to get out from under mistakes made more than 25 years ago.


Those who like swinging for home runs should consider buying shares of Ford or GM before Obama's crowd makes bail out decisions. It is likely that Obama will allow Ford and GM to get their hands on some of the bank bail out money. In negotiations with Hank Paulson, GM was unsuccessful. GM wanted to have GMAC registered as a bank holding company, after all it makes car loans, mortgage loans and offers credit cards. Chances are that democrats will go along with bail outs because it will be the union contracts that will be saved.


Those who do not swing for home runs should stand ready to buy Ford and GM as soon as the shares jump off the bottom. Those who wait until after the ink is dry on the deal, assuming there is one, will pay at least 100% more than those who do not.


This morning government officials in England paid visits to banks that were not passing on the 1.5% rate cuts announced yesterday. Since the government there has taken stakes in these banks, it was an easy argument to win. Consumers in the UK can borrow money today at the lowest cost in 53 years. Some of those people will buy cars.


The US unemployment rate jumped again. Unemployment is up to 6.5%. During the 1980 debacle US unemployment was in double digits (as I recall). The important point is that central bankers are loath to stand firm in the face of dramatic job loss. Four months ago, central bankers around the world were joined in battle, fighting inflation. Yesterday, the Bank of England dropped rates not .25% or .5% or even .75%, but 1.50%! The new fight is against recession and investors should never fight the FED! If you are short something, you should cover. If you are sitting on cash, you should employ it. You should be especially concerned if you hold long bonds hidden inside mutual funds.


It is amazing but true that the US Central Bank is behind the curve. The market has taken US short rates to .25%. The FOMC will have to cut .75% to catch-up. As the years go by, with one Fed Chairman after another failing to follow the market 99% of the time, like it should, the arguments for doing away with the FOMC make all the more sense. The power hungry find the way to make their jobs more important than they are. As my friend Lamar says, we should go back to the system in the days of George Washington, when part-time legislators went home for most of the year. A couple of months ago, the Bush administration could have loosened the screws on the banks with the stroke of a pen. Instead, thousands of banks are still being squeezed. The little guys ears are being pinned back. The bluest of blue bloods do not want to let others join their private club.


With the powerful allow GM and Ford to go bankrupt? Not likely. Buy now and you will probably hit more than a four bagger. You will hit a grand slam with 10 bases loaded!

England is Rocking and Rolling

This morning, the lowest BOE interest rates in 53 years are having an effect. Some UK banks passed the 1.5% cut along to their customers and some are using the cut to help restore balance sheets. The ones who did not pass the full cut along are betting that the others will not aggressively go after new customers during these difficult times. Of course, sooner or later, competition will force the full cut to be given to customers.


British Airways is up 15% this morning. It does not take much to give a beaten down stock a good rise. The news does not look so good but the price of the stock indicates that short sellers are covering. In the USA, short interest fell from 17 Billion to 13 Billion Dollars last month. Airlines are reducing ticket prices by eliminating fuel surcharges. Just 4 months ago, the largest expense of airlines was the fuel costs, but that cost has been cut in half!


The huge leap in short to long interest rate spreads is the most positive thing of all. The best indicator of future GDP growth is the yield spread and this forecast of growth in England just jumped straight up. It is no surprise that BAY would soar when the prospects for growth soar. The UK is rocking and rolling and the move is broad based. Stocks of all sorts are so depressed than one can throw a dart at the stock page and consistently hit a big one year winner.

The Obama Market Slump

The stock market has fallen 12% in two days; a regular reader wants to know if this is "The Obama Slump".


In the short run, markets are driven by emotion; in the long run, markets are driven by math. Discerning what part of a market move is fear or greed and what part is math is virtually impossible, but people are certainly making irrational decisions right now. Last month, after huge declines in stock values, the public withdrew $56 Billion from equity mutual funds. Rational people add money when prices are low. Since the 12% decline in the past two days was only a retraction of most of the gains of the prior week, the public has sold at prices well below those of last year, when they were still adding money to equity investments.



A good friend has calculated that the combination of the bump in tax rates from 35 to 39.6 and the removal of the cap on social security will consume 45% of his net disposable income. Ouch! This fellow has performed a rational calculation in order to make an informed decision. By the law of rational expectations, we know that many people look ahead and make informed decisions based on planned "changes in the math". One of the important things to remember is that "changes to the math" often have different effects in the short and long term. If you are going to have to pay more taxes on gains next year, you want to sell winners to take gains this year. By selling and paying unnecessary taxes, the fearful are helping the government to raise extra revenue. The extra selling being done in the past couple of days just might be a function of the "Obama slump" but for every share that was sold, a share was bought!


Besides, Obama is not likely to attempt to push through the higher tax brackets this year or next. His first move will more likely be to pass the populist tax breaks he has proposed. Without taking any action, the Bush tax cuts will expire in 2010 and the tax brackets will go up automatically. This automatic tax increase raises will result in higher tax collections prior to the rate increase. The higher tax rates scheduled for 2010 raise big questions in regard to 401-K accounts.


With the exception of the company match, the 401-K account is a bad deal. The net tax benefit is to the US Government. Regular withdrawals from 401-K accounts are taxed at ordinary rates; the capital gains tax savings is given as a gift to the government. Therefore, while values are low, it may make much sense to withdraw funds. Of course, those who are retired and above the age of 59.5 benefit the most from early withdrawals as they do not pay a 10% penalty.


Suppose a retired investor withdraws $10,000, pays $3,500 in taxes and invests the $6,500 in a beach house. Had he waited until 2010, he would have owed $3,950 in taxes and would only have $6,050 to invest in a beach house. With beach houses currently available at deeply discounted prices, by waiting, he will have lost a lot more than the extra $450 in taxes. Lets say that this investor borrows most of the money for the beach house and uses the full $10,000 to pay the interest cost on the house. Since the interest cost is tax deductible, he will have withdrawn $10,000 from his 401-K and paid no net increase in taxes. He may ultimately pay the taxes when he sells the beach house but even Obama offers a tax break to those who convert ordinary income into capital gains.


For those who do not want to buy beach houses, they can take the money out of the 401-K and invest the balance in low priced stocks or mutual funds, save the initial $450 in taxes and save future taxes on the gains. Again, the gains on the stocks outside of the 401-K will get the benefit of capital gains tax treatment. Of course, Obama's plan for the government to take 45% of estates over 3.5 million creates another tax trap.


Still, if substantial numbers of people make the rational decision to withdraw money from 401-K accounts, before tax rates go up, the tax revenues to the government will soar over the next couple of years. Then, in the years after the tax laws go into effect, tax revenues will fall. The fall may be surprisingly large as the incentive to work is reduced by excessive tax rates.


OBAMA IS NOT AS BIG AS PEOPLE SEEM TO THINK


One of the frequent talking points has been that the next stimulus package will include massive infrastructure spending. Even if the government passes a massive bill, we must remember that construction is taking a break after a multi-year run. For example, the Chinese consumed a massive percentage of the world's total consumption of concrete and steel in the 5 years leading up to the Olympics. The Chinese Interstate Highway Program made Eisenhower's program look like a game of tinker toys. Right now, the factory utilization rate is at a multi-year low and a number of firms are cutting back on office space leases. There have already been decisions not to build everything from coal mines to super tankers. The most massive of government programs will not replace the reductions in the private market place. In addition, the dramatic reduction in gasoline consumption has dramatically lowered the cash flow to the highway trust fund, many a planned project has already been delayed or stretched.


The US government, is monstrous but it is still only about 20% of our economy and most of that 20% is automatic stuff. The money flows in from taxes and flows back out to stuff like medicaid. Obama and the congress cannot possibly change most of the government policies in the short run. Indeed, even the loss of the Oregon Senate seat does not give democrats a filibuster proof majority. Obama supporters are in for great disappointments. Obama will not leave Iraq quickly, he will not increase taxes on the rich quickly and there are a few hundred thousand or maybe a few million who would like to grab one of the 14,000 government jobs he will fill.


The Obama slump of the past two days was really just a continuation of the housing slump. The best way to think of the current situation is that banks are under water on billions of dollars worth of home mortgages. These banks are trying to keep their heads above water just like the many individuals who "own these houses jointly" with the banks.


The USA is much closer to the big economic up-turn than are many nations. Even so, after a long pause, the FOMC is once again lowering US short rates. By the time the latest cut was made, the market had gotten even further ahead of the FOMC. Market rates suggest that the Fed Funds Rate should be at .25%! This is consistent with market forecast of inflation. The best news in this area is that rates for loans between banks are dropping quickly. Frozen credit markets are thawing quickly.


Other good news is that the government does not appear ready to pass another silly rebate law. The irony is that the idea behind the last $600 check scheme was from Keynesian Economics, but Keynes was well aware of the "savings paradox". Based on consumer spending reports, it appears that many scared consumers saved their rebates or used it to pay down debt. Thus, we ended up with new debt on the government books and a negative stimulus to the economy. The savings paradox is that it takes savings to produce long term growth but savings in the short run is the same as stealing the punch bowl from the party.


What we need is gridlock. If we are lucky, Pelosi and Reid will over-reach and even moderates will refuse to go along. Since our economic problems will be largely solved when the rebound in the real estate market becomes clear, the main thing we need is for natural rules to work. Here again, the irony is thick. Of all the most recent economic numbers, the housing numbers are among the few that are in the positive column. New home sales rose from 460,000 in September to 464,000 in October and existing home sales rose from 491,000 in September to 518,000 in October. The fact that housing prices fell was emphasized by the media but the consistent pattern at turns is for sales to rise first and then for prices to follow.


There have been other signs of strength: short interest fell by 4 Billion Dollars, the US Dollar gained ground and productivity rose 1.1%. The 1.1% was down but it is a great number to hit during a tough recession, a rebound of industrial production will cause productivity to rise sharply. The wholesale of gasoline is down to $1.33, implying an average retail of $1.93 within weeks.


Obama is to be admired for running a great campaign. He did not cloud the uninformed with unnecessary knowledge. A Rasmussen poll of democratic voters suggest that 30% do not even know who Harry Reid is! Democrats and republicans tend to agree that Clinton was a better president than Carter. The reality is that Clinton was elected just after a tough real estate recession when the economy was likely to grow no matter what and that Carter was elected just after price controls had artificially held down prices. Not to diminish the good deeds done by Reagan but to some extent Regan was simply lucky to come to power after Paul Volcker did a job on inflation that Arthur Miller had been unwilling to do.


We have been and are in a real estate induced slump. The primary thing that will turn this slump around will be naturally lower interest rates, in the US and in other parts of the world. One can take away currency distortions by computing 30 year T-Bond and other rates in terms of SDR's (special drawing rights). Using SDR's, US Bond rates hit 3% in June of 2003, when rates hit their long term low in terms of US Dollars. The SDR rate is currently at a 70 year low of 2.7%! Low interest rates stimulate economies.


The way to look at this is that the world rate to buy US real estate is based on a 2.7% base. In other words, the US Dollar is still cheap. It makes sense for citizens of other countries to diversify their investments and to buy real estate in the USA.


If I am wrong and Pelosi and Reid get all the stuff passed they want, then union wages will rise, inflation will jump and long rates will soar. But, everyone but Pelosi and Reid realize that the country cannot afford everything Pelosi and Reid want. Again, what we need is a stalemate or a good compromise between republican senators and Obama. If Obama governs as the moderate that ran in the general election (he won 21% of the voters who describe themselves as moderates compared to 9% by Kerry), then the compromise will be somewhat reasonable.


Mike Huckabee made the excellent point tonight that Obama needs to adopt policies that fit the reality of a global economy. The staffs of legislators and the staff of the new president will understand that we cannot afford to raise taxes on businesses or people who can take their assets elsewhere. Americans are loyal when only a few bucks are involved, but they buy Toyota's when the price is right. Toyota, the largest car maker in the world, can move production to where ever it wants as loyalty to the US is not the question.


As an American, I support my President. He is our commander in chief. We want and need him to succeed. Tomorrow, he will hold his first news conference. The US congress will hold a lame duck session starting in 10 days. Moderate and encouraging words tomorrow should serve to ease the fears of many. It would only take a small boost in confidence to get the market headed in the right direction.

A Fast Train Over Runs the Station

Learning the details of the big turn being made in the markets is worse than watching sausage being made. The good news is that the sausage is ready and central bankers are scrambling the eggs. Breakfast is all but ready.


Today, the EU Central Bank lowered interest rates by 50 basis points, the EU Bankers are have turned on the stove. The Bank of England realized that it was behind and in a frantic catch-up move, it lowered short rates by 150 basis points, today! The yield curve in England is more positive than it has been for a very long time.


The first lesson new investors learn is not to fight the FED. In the current battle, the FED has been joined in battle by Central Bankers from around the world. In the USA, one has to go back to 1982 to find such massive percentage declines in interest rates. The data for the world is not as handy as we would like but a 150 basis point move against a 4% base is a rare event indeed.


Last week, we experienced the reflation trade "hook". I hope you did not get caught. Some readers have been inquiring about inflation plays such as CAT and Siemens. Those who are stuck on the idea that "oil prices are going right back up" were given support for a week. Yesterday, they were smacked on the fanny again. The best way to explain what happened is to use examples.


An index of Russian stocks, Russia being one of the countries that makes its money off the sale of natural resources, has fallen 62% in the last 52 weeks. This drop of 62% includes the 47% gain made last week! It does not include yesterday's 12% drop! Since it takes a 24% gain to make up for a 12% loss, it is silly to try to catch "falling knives".


For simplification let's put the above moves in terms of $1 invested in the Russian Index one year and one day ago. The value that dollar fell to 25 cents before bouncing 47% to 38 cents. Yesterday the value of that 38 cents fell to 33 cents. The one year and one day decline from $1 to 33 cents is a decline of 67%, up from the 51 week decline of 75%. The guys who bought solar energy 13 weeks ago have lost lost 61%. The solar reflation bounce of last week was 14%. The clean energy fund, PBW lost 60 percent in the past year which includes last weeks 14% bounce. (HT: to QVM Group).


AN ARGUMENT THAT WORKS


Those who have been brainwashed into believing in the "end of oil" tend to fall into the "world is about to end" crowd. They believe that the current drop in oil prices is temporary and the world as we know it will die when more "oil wars" break out. This belief will cause them to miss one of the best stock market bull markets of all time.


A few days ago, I found the argument that seems to break through. These "peak oil -- global warming" people tend to be supportive of the new government CAFE standards. They believe it is the government that must force the people to save fuel. The imposition of laws requiring auto companies to sell high mileage fleets fits their view of the world that it is government that must "save the day".


The mandate, put on the books last year, is that US fleets, including light trucks, must get 35 miles to the gallon by 2020. Honda, for one, has said that making the targets all along the way is going to be a challenge. Obviously the market believes that Ford and GM will have great trouble in meeting the challenge. The mandated average increase in fuel efficiency per mile is triple the historic average of 1.1% annually!


The rules are complex (bureaucrats relish making rules that must be interpreted by bureaucrats). The new standards include both cars and light trucks but they give pickups a break with a sliding scale for the footprint of the vehicle. By the same token, the standards are automatically raised if the average size of vehicles goes down.


The most obvious "technology" available to help meet the standards is weight reduction. The easiest way to achieve weight reduction is to make smaller cars, but, due to lobbying by GM and Ford, small car fleets will be penalized by even tougher standards.


When I do a non scientific survey of my friends and neighbors, I find that many people think that tiny smart cars are a fluke. The public does not believe that a high percentage of cars will be of Honda FIT size or smaller any time soon. The average person surveyed is hardly aware that the CAFE standards were jacked up, last year, to go into effect in 2011.


The first move will be from the current 27.5 miles per gallon standard to about 29 in 2011. The curve slopes up sharply and the standard will reach 31.6 by 2015. While the different ways of measuring mileage and the combination of the light truck and car standards make comparisons difficult, the move from 27.5 to 35 represents a mandated decrease in fuel usage of 27%. The demand for oil is going down just as investments to produce more are "paying-off".


I doubt if many of my readers have even heard of the Grosmont Formation in Canada, but Shell Oil has spent 465 million dollars to lease a portion of this massive reserve. Oops, I should not have used the word reserve because the estimated 485 Billion Barrels of oil in this formation are not included in reserves because there has not been technology available to recover this oil. After years of testing new methods, Shell is making a bet, one that will reach trillions of dollars, that it can profitably produce oil from Grosmont.


Shell plans to "cook", cook is another word for refine, this thick slurry of oil in situ (where it sits). At 50 dollars per barrel Grosmont is worth 24 Trillion Dollars. When there is talk about spending 4 Billion Dollars to build one nuclear power plant, the citizens of many a community automatically start wondering if wind mills are not a better answer. Many folk simply do not want to understand that it cost double to build wind mills with the capacity to produce power equal to that of one nuclear power plant. They certainly do not want to know that wind mill runs only about 20% as much as nuclear power. Since the product of 2 times 5 is 10, a nuclear power plant is about 10 times more economical than a wind mill.


But what if 100 billion dollars worth of nuclear power would be enough to recover all 24 Trillion Dollars worth of oil from Grosmont? Those who say that we cannot drill our way out of the energy crisis should be told that we cannot make the wind blow.


The combination of higher fuel standards with abundant supplies of oil means that the price of oil is not "going right back up". The records we have of the past two thousand years consistently support the fact that wages rise faster than commodities over long periods of time. Commodities only "win" the price battle during relatively short cycles. The prices of commodities come down in the long run because we constantly learn how to do more with less. The process will never be smooth but mandates from the government only serves to make the process much more volatile.


If you want confirmation that car manufacturers plan to reduce vehicle weight, take a look at the price of nickel, a metal used in making steel. Scientist have learned to use nano technology to make carbon (graphite) panels that are stronger than steel but much lighter than aluminum. It has taken Boeing many years to design and produce aircraft in which aluminum panels and millions of stainless steel rivets are replaced with light weight graphite panels. The collapse in the price of nickel shows how the law of substitution has once again done its magic act.


The inflation adjusted cost of cars continues to fall. The drop in prices has been hidden by the addition of air conditioning, cruise control, power windows, GPS and much more, but the average person works fewer hours to buy a basic car than ever before. Gasoline priced in hours of work is not far from all time lows.


A fast Russian train, hauling oil, fertilizer, corn, grain, nickel, cars and much more was going so fast two weeks ago that it ran right past the midway station. The train engineer received warnings from central bankers to slow the train down. Last week, the engineer backed the train to the station but it left again yesterday. The load of oil has bounced around; at the midway station the oil had fallen from $147 to $60 before it bounced back to $70. The price is down $8 over the past two days and is currently around $62. If it falls no more, US consumers will save about 300 Billion Dollars per year on energy and much greater amounts on the sum of purchases of other commodities.


The election of Obama will have less effect on the price of oil than is commonly believed. Government subsidized ethanol plants are going bankrupt. Wind mill builders who collected 30 cents of the construction costs from the government are having trouble operating profitably. Shell is not going to leave its $465 Million in Canada just because Obama is president. Perhaps the investment was made in Canada in anticipation of higher taxes in America!


The public has been bombarded with the lie that we have been transferring 700 Billion Dollars of wealth to foreigners through the purchase of oil. The fact is that we got fair value for our 700 Billion Dollars (I guess you have noticed that I like to make the B's T's and D's capitals when I talk about Billions or Trillions of Dollars). What we have not been bombarded with is the amount of dollars consumers will be able to divert to other purposes as those 700 Billion Dollars fall to 200 Billion Dollars.


Think of the decline in prices the way a bond trader thinks. The lower the interest yield on a bond goes, the higher the climb in the value of the bond. The lower the price of oil, nickel and cars, the higher the value of ones income.


At some point, the fast trains carrying the price of commodities (including the massive reduction in the price of English money that hit today) will lose its momentum, stop and gradually turn around. A year or more after this train stops, consumers will reach their peak in real disposable income. While Obama will take a chunk of this disposable income, Milton Friedman taught us that even government spending will serve as an economic multiplier. The initial loss to the "government rake" will not reduce the number of times the "surviving dollars" will be multiplied.


Don't let tears cloud your vision. The relative value of real estate, airlines and shares of all sorts have reached levels well below historical averages. Prices can go lower but the odds that share prices will go up dramatically is greater and greater the longer your time horizon. The odds are great that the powerful decline of 150 basis points in England will be a ripple felt around the world. This ripple will help to slow the decline in commodities but it will not take away the gains already made.

Re: The Big Y

As always, thank you for your response. I would like to do some digging before responding but have a meeting to attend. Under the circumstances, I will make a couple of assertions that I believe to be true.


If we add the payroll tax to the income tax and then compare the totals to the net amounts paid by the bottom 10% of our population, especially after we also throw in welfare payments at their peak, and I think you will find that we are less socialistic today than in the days of the LBJ Great Society programs. Certainly during the Great Depression, we reached higher levels of socialism. While I understand that Obama's term is just beginning, if the great danger is in a boost of the top bracket from 35% to 39%, I can live with that.



One of the big differences today is that we are so much wealthier. Back in those rough days, men often worked two jobs, grew a garden and plumbed the pipes when needed. Today the average man works 34 hours per week.


As far as going bankrupt, even after the downturn in asset values, the US balance sheet is pretty darn strong. We tend to rail against the size of our debt in nominal terms without comparing it to our income and assets.


Capitalism did not fail during the great depression. Governments slammed capitalism time and time again and capitalism ultimately came out limping but strong.


Right now, democrats are quickly lining up to propose another silly Keynesian style stimulus plan. If another stimulus package passes or if it does not, will not make a hill of beans. The last $600 checks went in a circle. We shifted money from one pocket to the other. We borrowed $600 per taxpayer and we increased our debt. Yes, the bottom third of those who received it will not have to pay it back but these kind of hand outs are understood by the most liberal to be limited to times of recession. The recession will be over soon.


These silly payments give the people comfort that something is being done. They may even result in the retired, living off of SSN, to take part time jobs just to qualify for the checks.


My final point is that the power hungry desire to remain in power. If they try to run over the 43 to 46 votes in the senate, they know they will lose some of that power in 2 years. Again, the congress, the Fed, the president and our international trading partners all made dumb moves that created or prolonged the great depression. No one is proposing great tariffs today, the fed is not restricting money but pumping it in and we have just watched the most liberal voting member of the senate run a very successful centrist campaign for president. He won votes from former supporters of Jesse Helms! Conservatives see him as a wolf in sheep clothing but perhaps it will be Barney Frank who sees him as a wolf in sheep clothing within a few months.

On Wed, Nov 5, 2008 at 11:00 AM, Lamar wrote:

I agree with your theoretical economic argument but differ with the realities of the body politic of the depression era. From what I have read, the world was viewing with greater skepticism the great experiment of capitalism and democracy. Many countries had already converted to communistic rule or were eying the shift. The US was no different with communism gaining support. No better argument for the failures of capitalism than the economic times of the 30's. The depression was caused by ill guided policies and actions but the average American neither understands nor believes those facts.


Fast forward to financial collapse of 2008. In my opinion the most egregious action taken recently was the imposition on the financial system that Americans had a right to own their own home. By most definitions a person that offers no or very little equity to purchase this home, that person does not actually own the home. And yet our politicians have forced us to swallow that outrageous pill.


This is another great example of the incompatibility of economic theory and political action. In hindsight it made no economic sense to allow lower credit quality buyers purchase homes with no money down. The politicians forced this great idea on the country and now we are enjoying the result. On a purely economic argument the solution was probably not the correct one. Our politicians had to answer with the 850 billion bailout. Surely not the best economic answer but the ones they decided upon.


My outlook on the economy is less sanguine than yours and many others. If the stat of 40% of Americans pay no taxes is correct, that is an alarming number. I cannot imagine that number decreasing over time. Combine that with the rush to court the hispanic vote, the union vote and others and I can only imagine what level of socialism the country will have in 40 years. I won't even go into the moral decay of the population.


Just apply the Hemingway quote about bankruptcy here. Q-"How did you go bankrupt? A-Slowly at first"