I am a bit confused why everybody is an uproar about the $160 million of bonuses given to AIG executives. AIG has received $173 billion from the government so far, so the bonuses make up just 0.09% of the total. Maybe we should be focusing on the other 99.91%?
By comparison, the recent budget bill included $8 billion in earmarks. Congress porks up 50 times as much money as the AIG execs, but Congress distracts us with AIG's "greed" and wants us to ignore Congress's waste and corruption.
Why aren't we hearing about the huge bonuses that Lehman executive are getting? Oh yea, because the government let Lehman go bankrupt and now we don't have to reward their incompetence.
UPDATE: We must not forget that the federal government will get back 35% of those bonuses through the income tax. So the bonuses account for just 0.06% of the total money given to AIG.
Wednesday, March 18, 2009
Friday, March 13, 2009
Preference to American Workers?
Recently, Senator Charles Grassley of Iowa said that Microsoft should give preference to American workers instead of foreigners when laying off employees. He said it was Microsoft's moral obligation.
Disregarding the argument about whether a company can have morals (they certainly should have ethics, but morals?), the question arises of whether this should apply to all US corporations.
How about Exxon Mobil, for example? Shouldn't Exxon give preference to American workers? Shouldn't Exxon expand production in the US with US workers rather than venture overseas? As such, shouldn't the US government make available all area with drillable petroleum, such as ANWR and the continental shelf, to help employ US workers? Isn't it a "moral obligation" to do so?
(Yes, I know Mr Grassley is in favor of increased oil production and drilling in ANWR. I'd like to hear him lecture his fellow Senators about their moral obligations instead of lecturing a company that has already created millions of new jobs.)
Disregarding the argument about whether a company can have morals (they certainly should have ethics, but morals?), the question arises of whether this should apply to all US corporations.
How about Exxon Mobil, for example? Shouldn't Exxon give preference to American workers? Shouldn't Exxon expand production in the US with US workers rather than venture overseas? As such, shouldn't the US government make available all area with drillable petroleum, such as ANWR and the continental shelf, to help employ US workers? Isn't it a "moral obligation" to do so?
(Yes, I know Mr Grassley is in favor of increased oil production and drilling in ANWR. I'd like to hear him lecture his fellow Senators about their moral obligations instead of lecturing a company that has already created millions of new jobs.)
Thursday, March 12, 2009
Monday, March 9, 2009
The Death of Capitalism
It is often hard to precisely date a transition from one era to another. In a previous post, I argue that the current crisis stems from the LTCM crisis in 1998 and the moral hazard and low interest rate that followed, but that is certainly up for argument.
These days, one often hears the refrain that capitalism in the US is dying. But in fact, America left free market capitalism way back in 1913.
The year 1913 is best known in the US as the year Woodrow Wilson became President. Woodrow Wilson, of course, was the US's first "modern liberal" President. Two other events, which the Progressives from both parties had been working on for years, finally occurred in 1913 that marked the end of American capitalism: the income tax and the Federal Reserve.
The Sixteenth American, giving Congress the "power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration" was ratified by the required number of states in 1913. As promised, the income tax at first affected very few people. From 1913 to 1915, most people paid no income tax, and the top income tax rate was a low 7% on incomes above $500,000 (a huge sum in those days). But then came World War I and the top tax rate jumped tenfold to 73%. The top tax rate would eventually fall back to 24% under President Coolidge, but the government had proven that it can and will increase taxes significantly if it "needs" to. Under FDR, the top tax rate would hit a whopping 94% and even the lowest rate was at 23%, about as high as the top tax rate under Coolidge.
The second act, which Progressives had been working on for years, was the Federal Reserve System, which was enacted by the Federal Reserve Act of 1913. Like the income tax, this act appeared to have little significance at first. The purpose of a Federal Reserve was to provide an "elastic currency," which would in theory help prevent panics like that of 1907. The obvious initial problem with the Federal Reserve System is incompetence. With such a system, we rely on the Federal Reserve member to decide when and by how much to expand or contract the money supply. Herein lies the fatal conceit that government agents can know what market participants do not know. Market participants take their cues from price signals to determine supply and demand (in the case of money, they look to interest rates). In order to be more effective than the market system, government agents must have some other vast source of knowledge to replace price signals. History and logic prove that they do not.
While the Federal Reserve System is certainly a statist system, it was initially constricted by the gold standard. The Federal Reserve could expand and contract money supply in the short term, but the long term money supply was determined by the amount of gold in the system As long as we had the gold standard, the Fed was limited in its inflationary abilities. The gold standard stayed around much longer than low income taxes. While England and most other countries left the gold standard in World War I, the US managed to maintain it until 1933, when gold coins were confiscated and the conversion rate was changed from $20.67 per ounce of gold to $35 per ounce. This standard, more or less, was maintained until 1971 when the US left the gold standard once and for all.
Not surprisingly, if one looks at the long term trend of inflation in the US, one sees a big spike during WWI, when Britain left the gold standard and the world's gold came into the US, another increase in inflation starting in 1933 and through WWII, when the US changed the dollar to gold ratio and made gold coin ownership illegal, and after 1971 when the US permanently left the gold standard.
These two acts spelled the death of the United States' long history as a capitalist country. With the income tax, and more so with income tax withholding, a person's income no long belonged to himself. Yes, the government is kind enough to let us keep 70% of our income. If you believe your income belong to you and you give the government a share, try not paying your taxes. Furthermore, the government can raise taxes to extreme levels (94% under FDR) and even do so retroactively (under Clinton). When the government can take as much of your future or even past income with threat of garnished wages and imprisonment, obviously your income no longer belongs to you.
While the income tax takes away your income, Federal Reserve induced inflation takes away your wealth. Since the creation of the Fed, the value of a dollar has declined to 5 cents. Of course, we all expect inflation and it is built into bond rates and expected returns for stocks. In "normal" times, the constant 2-3% rate of inflation is discounted and does not affect the value of our assets. But not all times are normal. In the late 70s and early 80s, inflation shot up to double digit rates. The government can easily run the printing press, pushing inflation higher to devalue US government debt, either on purpose or through incompetence. Now, anybody who has US dollar denominated assets, such as Treasury bonds, US bank or money market accounts, or US equities, will see their net worth shrink dramatically.
Starting in 1913, the government has the power to take away your US dollar denominated wealth through inflation and to take away your income through income taxes. All of a sudden, the US government, not the American citizen, became the economic judge, jury, and executioner. As a result, 1913 goes down in history as the year capitalism died in the United States.
BTW, 1913 also marked the death of states rights with the ratification of the Seventeenth Amendment, transferring Senator selection from each state's legislature to popular election by the people of each state. Prior to 1913, the state legislatures chose Senators, giving the states a powerful check on the federal government. But after 1913, with direct election of Senators, the Senate became little different than the House of Representatives and Senators became more interested in "national" legislation and no longer had to follow the advice of the state legislature to get re-elected. As U.S. Senator Zell Miller of Georgia said: "Direct elections of Senators … allowed Washington’s special interests to call the shots, whether it is filling judicial vacancies, passing laws, or issuing regulations." In 1913, the states lost their last check on federal power and the federalist system officially died.
These days, one often hears the refrain that capitalism in the US is dying. But in fact, America left free market capitalism way back in 1913.
The year 1913 is best known in the US as the year Woodrow Wilson became President. Woodrow Wilson, of course, was the US's first "modern liberal" President. Two other events, which the Progressives from both parties had been working on for years, finally occurred in 1913 that marked the end of American capitalism: the income tax and the Federal Reserve.
The Sixteenth American, giving Congress the "power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration" was ratified by the required number of states in 1913. As promised, the income tax at first affected very few people. From 1913 to 1915, most people paid no income tax, and the top income tax rate was a low 7% on incomes above $500,000 (a huge sum in those days). But then came World War I and the top tax rate jumped tenfold to 73%. The top tax rate would eventually fall back to 24% under President Coolidge, but the government had proven that it can and will increase taxes significantly if it "needs" to. Under FDR, the top tax rate would hit a whopping 94% and even the lowest rate was at 23%, about as high as the top tax rate under Coolidge.
The second act, which Progressives had been working on for years, was the Federal Reserve System, which was enacted by the Federal Reserve Act of 1913. Like the income tax, this act appeared to have little significance at first. The purpose of a Federal Reserve was to provide an "elastic currency," which would in theory help prevent panics like that of 1907. The obvious initial problem with the Federal Reserve System is incompetence. With such a system, we rely on the Federal Reserve member to decide when and by how much to expand or contract the money supply. Herein lies the fatal conceit that government agents can know what market participants do not know. Market participants take their cues from price signals to determine supply and demand (in the case of money, they look to interest rates). In order to be more effective than the market system, government agents must have some other vast source of knowledge to replace price signals. History and logic prove that they do not.
While the Federal Reserve System is certainly a statist system, it was initially constricted by the gold standard. The Federal Reserve could expand and contract money supply in the short term, but the long term money supply was determined by the amount of gold in the system As long as we had the gold standard, the Fed was limited in its inflationary abilities. The gold standard stayed around much longer than low income taxes. While England and most other countries left the gold standard in World War I, the US managed to maintain it until 1933, when gold coins were confiscated and the conversion rate was changed from $20.67 per ounce of gold to $35 per ounce. This standard, more or less, was maintained until 1971 when the US left the gold standard once and for all.
Not surprisingly, if one looks at the long term trend of inflation in the US, one sees a big spike during WWI, when Britain left the gold standard and the world's gold came into the US, another increase in inflation starting in 1933 and through WWII, when the US changed the dollar to gold ratio and made gold coin ownership illegal, and after 1971 when the US permanently left the gold standard.
These two acts spelled the death of the United States' long history as a capitalist country. With the income tax, and more so with income tax withholding, a person's income no long belonged to himself. Yes, the government is kind enough to let us keep 70% of our income. If you believe your income belong to you and you give the government a share, try not paying your taxes. Furthermore, the government can raise taxes to extreme levels (94% under FDR) and even do so retroactively (under Clinton). When the government can take as much of your future or even past income with threat of garnished wages and imprisonment, obviously your income no longer belongs to you.
While the income tax takes away your income, Federal Reserve induced inflation takes away your wealth. Since the creation of the Fed, the value of a dollar has declined to 5 cents. Of course, we all expect inflation and it is built into bond rates and expected returns for stocks. In "normal" times, the constant 2-3% rate of inflation is discounted and does not affect the value of our assets. But not all times are normal. In the late 70s and early 80s, inflation shot up to double digit rates. The government can easily run the printing press, pushing inflation higher to devalue US government debt, either on purpose or through incompetence. Now, anybody who has US dollar denominated assets, such as Treasury bonds, US bank or money market accounts, or US equities, will see their net worth shrink dramatically.
Starting in 1913, the government has the power to take away your US dollar denominated wealth through inflation and to take away your income through income taxes. All of a sudden, the US government, not the American citizen, became the economic judge, jury, and executioner. As a result, 1913 goes down in history as the year capitalism died in the United States.
BTW, 1913 also marked the death of states rights with the ratification of the Seventeenth Amendment, transferring Senator selection from each state's legislature to popular election by the people of each state. Prior to 1913, the state legislatures chose Senators, giving the states a powerful check on the federal government. But after 1913, with direct election of Senators, the Senate became little different than the House of Representatives and Senators became more interested in "national" legislation and no longer had to follow the advice of the state legislature to get re-elected. As U.S. Senator Zell Miller of Georgia said: "Direct elections of Senators … allowed Washington’s special interests to call the shots, whether it is filling judicial vacancies, passing laws, or issuing regulations." In 1913, the states lost their last check on federal power and the federalist system officially died.
Thursday, March 5, 2009
Banking moral hazard
Federal Deposit Insurance Corp. Chairman Sheila Bair said the fund it uses to protect customer deposits at U.S. banks could dry up amid a surge in bank failures. “Without these assessments, the deposit insurance fund could become insolvent this year,” Bair wrote in a March 2 letter to the industry. U.S. community banks plan to flood the FDIC with about 5,000 letters in protest of the fees, according to a trade group.
Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk.
When banks and their executives and insulated from the risks they are taking, yet they receive the rewards, they take on more risk than they would have in a free market environment. The government's "insurance" through the FDIC enabled banks to risk our deposits in by lending to high-risk businesses and home-owners or, even worse, by buying high yielding mortgage backed securities. Instead of acting prudently, banks gambled with our money.
Banks became like an option. Risk was limited (to the option holder) but reward was still huge. In reality, that risk was not limited, it was just shifted onto the government and the taxpayers.
Another successful government program...
UPDATE: Senate Banking Committee Chairman Christopher Dodd is moving to allow the Federal Deposit Insurance Corp. to temporarily borrow as much as $500 billion from the Treasury Department.
Now we have the government bailing out other parts of the government.
Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk.
When banks and their executives and insulated from the risks they are taking, yet they receive the rewards, they take on more risk than they would have in a free market environment. The government's "insurance" through the FDIC enabled banks to risk our deposits in by lending to high-risk businesses and home-owners or, even worse, by buying high yielding mortgage backed securities. Instead of acting prudently, banks gambled with our money.
Banks became like an option. Risk was limited (to the option holder) but reward was still huge. In reality, that risk was not limited, it was just shifted onto the government and the taxpayers.
Another successful government program...
UPDATE: Senate Banking Committee Chairman Christopher Dodd is moving to allow the Federal Deposit Insurance Corp. to temporarily borrow as much as $500 billion from the Treasury Department.
Now we have the government bailing out other parts of the government.
Tuesday, March 3, 2009
Geithner versus tax evaders
President Barack Obama's Treasury secretary says the administration will unveil a series of rules and measures in the coming months to limit the ability of international companies to avoid U.S. taxes. Treasury Secretary Timothy Geithner told the House Ways and Means Committee on Tuesday that Obama will propose legislation to limit U.S. companies' ability to shelter foreign earnings from taxation in the U.S. He also said the administration will try to limit wealthy Americans' ability to use tax havens to avoid taxation.
Geithner the tax evader will head up the attack on tax avoiders. As the old insult goes, it takes one to know one.
Geithner the tax evader will head up the attack on tax avoiders. As the old insult goes, it takes one to know one.
Trader Obama
President Barack Obama said Tuesday he's "absolutely confident" that the global economy will recover, and suggested that stocks might be a good buy now that prices have fallen so hard. "Profit and earning ratios are starting to get to the point where buying stocks is a potentially good deal if you've got a long-term perspective on it," Obama told reporters.
Maybe Obama should have become a trader or market analyst instead of President.
Maybe Obama should have become a trader or market analyst instead of President.
The European Union's top economy official said Tuesday that the 16 euro nations have a solution to rescue any member that risks economic collapse. EU Monetary Affairs Commissioner Joaquin Almunia said it would not be clever to give out details in public "but the solution exists." "Don't fear, we are equipped intellectually, politically, economically to face this crisis scenario," he said in a speech at an event organized by the European Policy Centre think tank. "But by definition this kind of things should not be explained in public."
I can rest easier now knowing that they have a super-secret solution to all our problems. I'll just ignore all their previous screw-ups, all the stuff they did to get us where we are today, and all the previous "solutions" that didn't work. This time, they have it figured it for sure!
I can rest easier now knowing that they have a super-secret solution to all our problems. I'll just ignore all their previous screw-ups, all the stuff they did to get us where we are today, and all the previous "solutions" that didn't work. This time, they have it figured it for sure!
Friday, February 27, 2009
Government solutions are killing us
Citigroup Inc. said Friday it reached a deal that will give the government up to a 36 percent stake in the struggling bank.
As a result of the government's help, Citigroup is down 43% in pre-market trading.
I am reminded of a famous sports cliche. When a great player on a losing team requests a larger salary, the owner replies "If we can lose with you, we can certainly lose without you."
As a result of the government's help, Citigroup is down 43% in pre-market trading.
I am reminded of a famous sports cliche. When a great player on a losing team requests a larger salary, the owner replies "If we can lose with you, we can certainly lose without you."
Thursday, February 26, 2009
Bye bye health care
Today's headline: Obama Wants $634 Billion for Health, Says More Needed
The result: XLV (health care ETF) down 5.0% today
Big losers include:
Abbott Labs (ABT) -5.7%
Amgen (AMGN) -9.4%
Bristol-Myers (BMY) -5.2%
Gilead Sciences (GILD) -5.0%
Medtronic (MDT) -6.1%
Merck (MRK) -6.7%
I must ask, is this man totally inept or is he trying to crash the stock market?
UPDATE: XLV down another 4.0% today. Financials (XLF) down 6.5% as Citigroup falls 39.0% thanks to the government giving them more help. With friends like these, who needs enemies.
The result: XLV (health care ETF) down 5.0% today
Big losers include:
Abbott Labs (ABT) -5.7%
Amgen (AMGN) -9.4%
Bristol-Myers (BMY) -5.2%
Gilead Sciences (GILD) -5.0%
Medtronic (MDT) -6.1%
Merck (MRK) -6.7%
I must ask, is this man totally inept or is he trying to crash the stock market?
UPDATE: XLV down another 4.0% today. Financials (XLF) down 6.5% as Citigroup falls 39.0% thanks to the government giving them more help. With friends like these, who needs enemies.
Hoover
The other day when talking to a friend about the stimulus bill, another friend interrupted saying that we can't do nothing like Hoover did. I quickly replied that Hoover raised taxes and started a trade war (I didn't get into Hoover's pro-union pro-minimum wage stance since it is a bit more complicated entire books have been written on that subject). I am amazed that people still don't understand that important part of our history.
This reminds me of what Ronald Reagan said: "The trouble with our liberal friends is not that they're ignorant: It's just that they know so much that isn't so."
I just read this on Wikipedia: "Franklin D. Roosevelt blasted the Republican incumbent for spending and taxing too much, increasing national debt, raising tariffs and blocking trade, as well as placing millions on the dole of the government. Roosevelt attacked Hoover for "reckless and extravagant" spending, of thinking "that we ought to center control of everything in Washington as rapidly as possible," and of leading "the greatest spending administration in peacetime in all of history." Roosevelt's running mate, John Nance Garner, accused the Republican of "leading the country down the path of socialism"."
We are repeating history here. The Democrats, led by Barack Obama, attacked Bush and the Republican for spending too much and increasing the deficit and debt (which is true). Immediately upon taking power, just like FDR and the Democrats of those, Obama and the Democrats drastically increase spending and the size of the deficit, making Bush and the Republicans look "conservative" next to them.
This reminds me of what Ronald Reagan said: "The trouble with our liberal friends is not that they're ignorant: It's just that they know so much that isn't so."
I just read this on Wikipedia: "Franklin D. Roosevelt blasted the Republican incumbent for spending and taxing too much, increasing national debt, raising tariffs and blocking trade, as well as placing millions on the dole of the government. Roosevelt attacked Hoover for "reckless and extravagant" spending, of thinking "that we ought to center control of everything in Washington as rapidly as possible," and of leading "the greatest spending administration in peacetime in all of history." Roosevelt's running mate, John Nance Garner, accused the Republican of "leading the country down the path of socialism"."
We are repeating history here. The Democrats, led by Barack Obama, attacked Bush and the Republican for spending too much and increasing the deficit and debt (which is true). Immediately upon taking power, just like FDR and the Democrats of those, Obama and the Democrats drastically increase spending and the size of the deficit, making Bush and the Republicans look "conservative" next to them.
Why Government Stimulus Doesn't Work
Everybody is talking about the government stimulus plan. When asked about it, I normally respond "I hope it doesn't do too much damage." While the vast majority of people oppose the stimulus, they do so because they see the costs outweighing the benefits. On the other hand, I see no benefits and only costs.
In a private business transactions, both the buyer and seller benefit. If I go to the store and purchase a product, I the customer receive something I value more greatly than the money I spend, otherwise I would not enter the transaction. Even though I end up with no money, which really represents units of labor I have already performed, I actually profit from the transaction since, to me, the value of what I receive exceeds the value of what I give away. And the seller also books a profit, obviously, since that is a business's purpose for existing and his revenue exceeds his expenses. With both the buyer and seller profiting from the transaction, wealth increases.
On the other hand, government transactions have no profit motive for either the buyer or the seller. The government stimulus plan is really a government spending plan with a very small amount of tax cuts. When the government spends money, neither the government nor the taxpayers profits. The government generally spends taxpayer money on projects that would not otherwise get done. But why wouldn't these projects get done without the government? Because they are not profitable, of course! If the government does a project at a profit (where benefits outweigh costs), maybe a road or a stadium, that means that a project that would have been done privately has been usurped by the government, where the government will most likely execute the project much less profitably than private business. And to do these projects, the government amasses huge deficits each year, which a private business would call a loss. Without any motive for profits, which modern liberals claim to be a good thing, taxpayers lose money with each dollar they send to the government and the government makes losses on top of that instead of profits. With losses accrued by both the buyer (taxpayer) and seller (government), wealth is being destroyed.
As Winston Churchill said, "It is a socialist idea that making profits is a vice; I consider the real vice is making losses." As this "stimulus" package takes hard earned money from taxpayers and government bureaucrats waste the money away on unprofitable projects, remember that any plan which destroys wealth, as this plan does, is full of costs and has no benefits.
In a private business transactions, both the buyer and seller benefit. If I go to the store and purchase a product, I the customer receive something I value more greatly than the money I spend, otherwise I would not enter the transaction. Even though I end up with no money, which really represents units of labor I have already performed, I actually profit from the transaction since, to me, the value of what I receive exceeds the value of what I give away. And the seller also books a profit, obviously, since that is a business's purpose for existing and his revenue exceeds his expenses. With both the buyer and seller profiting from the transaction, wealth increases.
On the other hand, government transactions have no profit motive for either the buyer or the seller. The government stimulus plan is really a government spending plan with a very small amount of tax cuts. When the government spends money, neither the government nor the taxpayers profits. The government generally spends taxpayer money on projects that would not otherwise get done. But why wouldn't these projects get done without the government? Because they are not profitable, of course! If the government does a project at a profit (where benefits outweigh costs), maybe a road or a stadium, that means that a project that would have been done privately has been usurped by the government, where the government will most likely execute the project much less profitably than private business. And to do these projects, the government amasses huge deficits each year, which a private business would call a loss. Without any motive for profits, which modern liberals claim to be a good thing, taxpayers lose money with each dollar they send to the government and the government makes losses on top of that instead of profits. With losses accrued by both the buyer (taxpayer) and seller (government), wealth is being destroyed.
As Winston Churchill said, "It is a socialist idea that making profits is a vice; I consider the real vice is making losses." As this "stimulus" package takes hard earned money from taxpayers and government bureaucrats waste the money away on unprofitable projects, remember that any plan which destroys wealth, as this plan does, is full of costs and has no benefits.
Wednesday, February 25, 2009
Spendthrift
First Obama gets his $787 billion stimulus bill. Then he adds $250 billion for his foreclosure plan. After spending all that money, he promises to halve the deficit. But then today, Obama announces a 10-year, $634 billion health-care plan.
My calculator must be broken. It tells me that Obama is raising the deficit, not reducing it.
In this deep recession, how many people believe that our current government is too small and taxes are too low?
My calculator must be broken. It tells me that Obama is raising the deficit, not reducing it.
In this deep recession, how many people believe that our current government is too small and taxes are too low?
Sunday, February 22, 2009
Corporate Bond Deception Point
I never really understood the allure of corporate bonds. To me, it seems that corporate are simply a hybrid of equity and Treasury bonds. If Treasuries yield 6% and stocks grow at a 10% rate, corporates will yield something in between. Where in between depended on how much extra risk you were taking.
For years, corporate performed fabulously well. Investors got their above Treasury rate return with very few defaults. But this false sense of security did not last long. In the 18 months, many highly rated companies, such as the major financial institutions have seen their bond value sink as the risk of default surges. As a result, corporate bonds acted more like equities than Treasuries.
Let us look at LQD, the iShares iBoxx Investment Grade Corporate Bond ETF. The LQD has an effective duration of 7.16. By comparison, the IEF, which is the iShares Barclays 7-10 Year Treasury ETF, has an effective duration of 6.98. Nearly the same so a very good comparison.
Let's start by looking at the chart since LQD started trading 2002.
As you see, LQD rises pretty steadily for the first five years, outpacing the steady rise in the IEF, as expected. But when the stock market starts falling in late 2007, the LQD stops rising while the Treasury rally picks up steam. In the fall of 2008, corporate bonds crash nearly 20% before recovering most of the losses whereas Treasuries surged higher. All of a sudden, corporate bonds were acting more like stocks than Treasury bonds.
I think we can break this up into two periods. The first, July 2002 to June 2007, the LQD tracked the IEF very closely. In this period, LQD has a 93% correlation with the IEF but a negative 10% correlation to the SPY.
But from July 2007 to January 2009, the LQD shifted away from tracking Treasuries and towards stocks. In this second period, the correlation between LQD and IEF dropped to 56% while the correlation with the SPY rose to 38%.
Looking at that first period, we see that IEF had a total return of 32% while the IEF returned 21% and SPY rose 79%. To mimic the LQD, one could have put 80% of their portfolio in the IEF and 20% in the SPY. In the second period, the LQD fell 0.7%, not bad at all. But the 80/20 portfolio would have actually gained 9.3%.
During the entire period, LQD had an average annual return of 4.7% with a 9.3% standard deviation. On the other hand, the 80/20 portfolio returned a larger 5.3% with a standard deviation of just 5.9%.
Seems to me, that corporates are a bad deal for long term investors or for people relying on them for retirement income. The LQD though may be a great trading device for those who can predict when and how the correlations will change.
For years, corporate performed fabulously well. Investors got their above Treasury rate return with very few defaults. But this false sense of security did not last long. In the 18 months, many highly rated companies, such as the major financial institutions have seen their bond value sink as the risk of default surges. As a result, corporate bonds acted more like equities than Treasuries.
Let us look at LQD, the iShares iBoxx Investment Grade Corporate Bond ETF. The LQD has an effective duration of 7.16. By comparison, the IEF, which is the iShares Barclays 7-10 Year Treasury ETF, has an effective duration of 6.98. Nearly the same so a very good comparison.
Let's start by looking at the chart since LQD started trading 2002.
As you see, LQD rises pretty steadily for the first five years, outpacing the steady rise in the IEF, as expected. But when the stock market starts falling in late 2007, the LQD stops rising while the Treasury rally picks up steam. In the fall of 2008, corporate bonds crash nearly 20% before recovering most of the losses whereas Treasuries surged higher. All of a sudden, corporate bonds were acting more like stocks than Treasury bonds.
I think we can break this up into two periods. The first, July 2002 to June 2007, the LQD tracked the IEF very closely. In this period, LQD has a 93% correlation with the IEF but a negative 10% correlation to the SPY.
But from July 2007 to January 2009, the LQD shifted away from tracking Treasuries and towards stocks. In this second period, the correlation between LQD and IEF dropped to 56% while the correlation with the SPY rose to 38%.
Looking at that first period, we see that IEF had a total return of 32% while the IEF returned 21% and SPY rose 79%. To mimic the LQD, one could have put 80% of their portfolio in the IEF and 20% in the SPY. In the second period, the LQD fell 0.7%, not bad at all. But the 80/20 portfolio would have actually gained 9.3%.
During the entire period, LQD had an average annual return of 4.7% with a 9.3% standard deviation. On the other hand, the 80/20 portfolio returned a larger 5.3% with a standard deviation of just 5.9%.
Seems to me, that corporates are a bad deal for long term investors or for people relying on them for retirement income. The LQD though may be a great trading device for those who can predict when and how the correlations will change.
Friday, February 20, 2009
The Lost Decade
Everybody is trying to figure out what caused our current financial crisis. There are in fact many factors that led us to this place, including lack of private savings, high government spending and debt, and loose monetary policy.
But those factors have been around quite a while before we fell off the edge of this cliff. Many will argue that those factors alone are enough given enough time. While I agree with that, we did in fact have a moment in our recent history which led to the acceleration of our wasteful ways and made our current crisis a reality.
In 1998, Long Term Capital Management was sitting on top of the world. That is, until they got hit by huge losses. To avoid a total market collapse, or so we were told, the Fed organized the major banks to put in billions of dollars (now considered pocket change) and take over LTCM. To help the financial system and the new owners of LTCM, the Fed dramatically lowered interest rates, even though the economy was performing well and did not justify lower rates. It also created a moral hazard, whereby failing companies will get bailed out, encouraging risky bets knowing that the rewards will be huge but the risks will be limited as the government eventually bails out those that are "too big to fail." This combination of monetary inflation and moral hazard led to a rampant wave of speculation, first in the stock market with Internet stocks creating a bubble that ended in 2000, followed by a bubble in real estate, followed by yet another bubble in commodities.
Thanks to the government's loose money and the moral hazard, the economy over-leveraged itself and speculated on get rich quick schemes (options on Internet stocks, buying multiple houses with nothing down no interest loans) instead of saving and investing in solid profitable business ventures.
Today, the Dow hit its lowest point since October 1997. Back in 1998, the government supposedly saved the day with its actions. But the wave of speculation, bubbles, and crashes that resulted have created a lost decade for American equity investors.
But those factors have been around quite a while before we fell off the edge of this cliff. Many will argue that those factors alone are enough given enough time. While I agree with that, we did in fact have a moment in our recent history which led to the acceleration of our wasteful ways and made our current crisis a reality.
In 1998, Long Term Capital Management was sitting on top of the world. That is, until they got hit by huge losses. To avoid a total market collapse, or so we were told, the Fed organized the major banks to put in billions of dollars (now considered pocket change) and take over LTCM. To help the financial system and the new owners of LTCM, the Fed dramatically lowered interest rates, even though the economy was performing well and did not justify lower rates. It also created a moral hazard, whereby failing companies will get bailed out, encouraging risky bets knowing that the rewards will be huge but the risks will be limited as the government eventually bails out those that are "too big to fail." This combination of monetary inflation and moral hazard led to a rampant wave of speculation, first in the stock market with Internet stocks creating a bubble that ended in 2000, followed by a bubble in real estate, followed by yet another bubble in commodities.
Thanks to the government's loose money and the moral hazard, the economy over-leveraged itself and speculated on get rich quick schemes (options on Internet stocks, buying multiple houses with nothing down no interest loans) instead of saving and investing in solid profitable business ventures.
Today, the Dow hit its lowest point since October 1997. Back in 1998, the government supposedly saved the day with its actions. But the wave of speculation, bubbles, and crashes that resulted have created a lost decade for American equity investors.
Tuesday, February 17, 2009
The five political economic systems
Since so many are confused by what are the different economic systems, here are my five political economic systems based on the three factors of production: land, labor, and capital.
Aristocratic: The economic system favoring land owners is one I call the aristocratic system. In this system, the legal system and government are created and administered by the land-owners. The laws are obviously crafted to benefit them and used to keep the vast majority of people working the land for a very small share of the production. One example, from which the name is derived, is pre-Revolution France where land owners were exceeding wealthy and granted titles while the general populous were peasants living to work the aristocrat's land. The early 19th century Southern US economy with the plantation owners and slave is another example, as it Czarist Russia with the lord-serf relationship.
Socialism: Socialism is the economic system where all factors of production are controlled by "the people," thus eliminating any specific land or capital owners and, therefore, all economic benefit goes to the labor component. Additionally, since all land and capital are now owned by everybody and everybody, in theory, works to their full ability, all production is split evenly between the people regardless of the job or effort put in.
Mercantilism: When the government creates laws benefiting owners of capital, such as factories, this is called mercantilism. Mercantilist systems have protective tariffs to discourage cheaper imports from competing with local production. They will also have export duties on raw materials to keep manufacturing costs low. Obviously helping producers, it hurts consumers through higher prices for goods.
Capitalism: Capitalism is the system whereby the government avoids any economic intervention and allows the three factors to compete freely. The term capitalism implies that this system benefits capitalists, exactly what Marx wanted when he invented the term. Now, we often call it laissez faire or free market capitalism to ensure that the listener understands that what is meant is a government that does not interfere with the economy.
Interventionism: Sometimes, the government will interfere in the economy with the goal of maintaining equilibrium between the three factors. This can come about in one of two ways. In the first way, political parties will each push their programs which counter each other. Party A passes a law benefiting land owners while Party B passes a law benefiting workers, thus offsetting each other. The second way is through sudden action. In the early 20th century, in order to combat socialism, the fascists gained control of many government. They created big government, not necessarily to benefit one party over another, but to stop the socialists from benefiting labor over all others. With intervention, we get a complicated system that generally evens out, though the result is a big cumbersome government. The government bureaucracy makes the economy less productive and the people worse off.
Look at the violence inherent in the system
Unfortunately, four of these political economic system lead to violence, as we have seen throughout history.
The aristocratic system creates an environment where land-owners fight for control over more land. More land equals more wealth and more production, so the competition to own as much land as possible is intense. Furthermore, if a land-owner gains enough land, he can become a lord or king, ruling over both the land in his possession and the people who live and work on it. Eventually, two or more kings will fight to create their own empire.
Socialism results in war wherever it appears. Right from the start, socialism requires the confiscation of land and capital from their owners. The owners of land and capital, not willing to give up their possessions, are thrown in jail, banished, or killed. Furthermore, this oppressive system must be maintained forever to prevent an intelligent and industrious worker from saving money and starting his own business. History has proven that socialism also results in international wars. Given that socialism requires internal violence, it is no stretch for that violence to applied internationally. The goal of socialism is the overthrow of the capitalists and to impose shared ownership of property by the working class. This goal knows no borders. Polish workers have just as much right to equality as the Russians and the Russian socialists will use their strength to help the Poles achieve that goal, whether they want to or not.
Most of the wars fought between the early 16th century and mid 19th century were fought over mercantilist policies, including the imperialist desire for colonies. The Spanish empire established colonies in the new world to get their precious natural resources, especially gold and silver. But more common, such as with the British and Dutch empires, was to establish colonies for which to trade. The colonies were forced to trade only with the home country, thus benefiting the home country. The famous war between England and the Spanish armada was fought over trade. Most of the wars between England and France were as well. The Spanish-American war was fought for the right to trade with the Philippines and West Indies. But mercantilist wars are not just between two competing countries. In the mid-1800s, the North outgrew the South in both population and economy. Gaining seats in Congress and the Presidency, the North imposed high protective tariffs on finished good imports and duties on raw material exports. Thus, the North made finished goods more expensive for the South and Southern crops, such as cotton and tobacco, went down in price. The result was the Civil War.
Interventionism, being a mix of the previous three systems, can cause wars in any of the above mentioned way. But interventionism also creates an ongoing internal war for control of the government. With a large government precariously balanced evenly between the three factors, a single party gaining enough power can quickly change the laws to its own benefit. In the US, the political system was designed to make it extremely difficult for any single faction to gain complete control. When the mercantilists gained control in the mid-1800s, full scale civil war broke out. Most of the time, people live peacefully in the interventionist system, but it must always result in war when one faction eventually gains too much control. Obviously, when a single faction gains majority control of government, international war also becomes more likely as they advance their policies. As mentioned above, the mercantilist wants to conquer colonies, the socialist wants to spread socialism, and aristocrats want more land. And each will pursue that through war if they gain control of the government. In fact, it is not necessarily required for one faction to gain total control. If two factions agree, even if for different reasons, that the invasion of a foreign country is beneficial and those two factions combine make up a majority, the war will occur as those two factions will outvote the third faction and any capitalists in government.
Capitalism is the only system designed to bring lasting peace. In a capitalist system, the government has just four goals: to protect our life, liberty, property, and peace. Without a government that influences everything we do, political factions have little reason to exist. Gaining control of the government will not enable one faction to benefit themselves as the government has very limited power. There will still be crime, as there is in any system, but two capitalist countries simply want to trade freely with each other and have no reason to fight each other. In fact, the capitalist country has no desire to make war on any country, even socialist, mercantilist, interventionist, or aristocratic countries. The capitalist realizes that free trade is the best method, but also that a war to open up trade with an unfree country is unproductive. Not only will the war most likely cost more than the benefits accrued, the capitalist country must in fact give up capitalism to fight this "pro-capitalist" war. In order to fight a war, the government must raise taxes to pay for it, employ soldiers to fight, and buy equipment. Thus, any war requires the government to infringe upon the people's life (dead soldiers), liberty (draft, taxes), property (taxes, military equipment), and peace (war). War is therefore impossible in a truly capitalist system.
However, countries based on the other economic systems may attempt to conquer the capitalist country to benefit themselves. As mentioned above, one of the four goals of the capitalist system is peace. Capitalist countries need some method of defending their life, liberty, and property from foreign attack in order to maintain peace. Primarily, having a method of defense acts a deterrent, causing enemies to think twice before breaking the peace. Secondly, the defense must be used to repel any attack that would make the conquered less free.
Aristocratic: The economic system favoring land owners is one I call the aristocratic system. In this system, the legal system and government are created and administered by the land-owners. The laws are obviously crafted to benefit them and used to keep the vast majority of people working the land for a very small share of the production. One example, from which the name is derived, is pre-Revolution France where land owners were exceeding wealthy and granted titles while the general populous were peasants living to work the aristocrat's land. The early 19th century Southern US economy with the plantation owners and slave is another example, as it Czarist Russia with the lord-serf relationship.
Socialism: Socialism is the economic system where all factors of production are controlled by "the people," thus eliminating any specific land or capital owners and, therefore, all economic benefit goes to the labor component. Additionally, since all land and capital are now owned by everybody and everybody, in theory, works to their full ability, all production is split evenly between the people regardless of the job or effort put in.
Mercantilism: When the government creates laws benefiting owners of capital, such as factories, this is called mercantilism. Mercantilist systems have protective tariffs to discourage cheaper imports from competing with local production. They will also have export duties on raw materials to keep manufacturing costs low. Obviously helping producers, it hurts consumers through higher prices for goods.
Capitalism: Capitalism is the system whereby the government avoids any economic intervention and allows the three factors to compete freely. The term capitalism implies that this system benefits capitalists, exactly what Marx wanted when he invented the term. Now, we often call it laissez faire or free market capitalism to ensure that the listener understands that what is meant is a government that does not interfere with the economy.
Interventionism: Sometimes, the government will interfere in the economy with the goal of maintaining equilibrium between the three factors. This can come about in one of two ways. In the first way, political parties will each push their programs which counter each other. Party A passes a law benefiting land owners while Party B passes a law benefiting workers, thus offsetting each other. The second way is through sudden action. In the early 20th century, in order to combat socialism, the fascists gained control of many government. They created big government, not necessarily to benefit one party over another, but to stop the socialists from benefiting labor over all others. With intervention, we get a complicated system that generally evens out, though the result is a big cumbersome government. The government bureaucracy makes the economy less productive and the people worse off.
Look at the violence inherent in the system
Unfortunately, four of these political economic system lead to violence, as we have seen throughout history.
The aristocratic system creates an environment where land-owners fight for control over more land. More land equals more wealth and more production, so the competition to own as much land as possible is intense. Furthermore, if a land-owner gains enough land, he can become a lord or king, ruling over both the land in his possession and the people who live and work on it. Eventually, two or more kings will fight to create their own empire.
Socialism results in war wherever it appears. Right from the start, socialism requires the confiscation of land and capital from their owners. The owners of land and capital, not willing to give up their possessions, are thrown in jail, banished, or killed. Furthermore, this oppressive system must be maintained forever to prevent an intelligent and industrious worker from saving money and starting his own business. History has proven that socialism also results in international wars. Given that socialism requires internal violence, it is no stretch for that violence to applied internationally. The goal of socialism is the overthrow of the capitalists and to impose shared ownership of property by the working class. This goal knows no borders. Polish workers have just as much right to equality as the Russians and the Russian socialists will use their strength to help the Poles achieve that goal, whether they want to or not.
Most of the wars fought between the early 16th century and mid 19th century were fought over mercantilist policies, including the imperialist desire for colonies. The Spanish empire established colonies in the new world to get their precious natural resources, especially gold and silver. But more common, such as with the British and Dutch empires, was to establish colonies for which to trade. The colonies were forced to trade only with the home country, thus benefiting the home country. The famous war between England and the Spanish armada was fought over trade. Most of the wars between England and France were as well. The Spanish-American war was fought for the right to trade with the Philippines and West Indies. But mercantilist wars are not just between two competing countries. In the mid-1800s, the North outgrew the South in both population and economy. Gaining seats in Congress and the Presidency, the North imposed high protective tariffs on finished good imports and duties on raw material exports. Thus, the North made finished goods more expensive for the South and Southern crops, such as cotton and tobacco, went down in price. The result was the Civil War.
Interventionism, being a mix of the previous three systems, can cause wars in any of the above mentioned way. But interventionism also creates an ongoing internal war for control of the government. With a large government precariously balanced evenly between the three factors, a single party gaining enough power can quickly change the laws to its own benefit. In the US, the political system was designed to make it extremely difficult for any single faction to gain complete control. When the mercantilists gained control in the mid-1800s, full scale civil war broke out. Most of the time, people live peacefully in the interventionist system, but it must always result in war when one faction eventually gains too much control. Obviously, when a single faction gains majority control of government, international war also becomes more likely as they advance their policies. As mentioned above, the mercantilist wants to conquer colonies, the socialist wants to spread socialism, and aristocrats want more land. And each will pursue that through war if they gain control of the government. In fact, it is not necessarily required for one faction to gain total control. If two factions agree, even if for different reasons, that the invasion of a foreign country is beneficial and those two factions combine make up a majority, the war will occur as those two factions will outvote the third faction and any capitalists in government.
Capitalism is the only system designed to bring lasting peace. In a capitalist system, the government has just four goals: to protect our life, liberty, property, and peace. Without a government that influences everything we do, political factions have little reason to exist. Gaining control of the government will not enable one faction to benefit themselves as the government has very limited power. There will still be crime, as there is in any system, but two capitalist countries simply want to trade freely with each other and have no reason to fight each other. In fact, the capitalist country has no desire to make war on any country, even socialist, mercantilist, interventionist, or aristocratic countries. The capitalist realizes that free trade is the best method, but also that a war to open up trade with an unfree country is unproductive. Not only will the war most likely cost more than the benefits accrued, the capitalist country must in fact give up capitalism to fight this "pro-capitalist" war. In order to fight a war, the government must raise taxes to pay for it, employ soldiers to fight, and buy equipment. Thus, any war requires the government to infringe upon the people's life (dead soldiers), liberty (draft, taxes), property (taxes, military equipment), and peace (war). War is therefore impossible in a truly capitalist system.
However, countries based on the other economic systems may attempt to conquer the capitalist country to benefit themselves. As mentioned above, one of the four goals of the capitalist system is peace. Capitalist countries need some method of defending their life, liberty, and property from foreign attack in order to maintain peace. Primarily, having a method of defense acts a deterrent, causing enemies to think twice before breaking the peace. Secondly, the defense must be used to repel any attack that would make the conquered less free.
Friday, February 13, 2009
Laws and sausages
As Congress votes on the stimulus bill today, without even having read it, I am reminded of this quote disputedly attributed to Otto von Bismarck: "If you like laws and sausages, you should never watch either one being made."
Thursday, February 12, 2009
Government math
So how much will the $789 billion stimulus plan actually cost?
According to the Congressional Budget Office, $3.27 trillion over the next 10 years.
Ouch!
According to the Congressional Budget Office, $3.27 trillion over the next 10 years.
Ouch!
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