Tag Archives: Economic

Warren Buffett is wrong because he doesn’t understand economics. Support the Fair Tax.

Warren Buffett recently remarked:

The rich are always going to say that, you know, just give us more money and we’ll go out and spend more and then it will all trickle down to the rest of you. But that has not worked the last 10 years, and I hope the American public is catching on.

Technically, what Mr. Buffett said may be true but only because he is looking at the wrong thing. I’m sorry that this supposed capitalist and businessman has never learned that spending money is not what creates wealth. To create wealth, one must save, invest, and produce items that had not existed before or items that do exist but of higher quality or at a lower cost.

Instead of encouraging spending, as the current and past Presidents have done, we should be encouraging investment. That means lower taxes on investments (capital gain, interest, and dividends) and, to offset that loss of revenue, either lower government spending (my preference) or higher taxes on spending. Until 1913, with a few rare exceptions (Civil War), all federal taxes were collected on spending while income, both earned and from investments, were non-taxable. During that time, the United States economy grew like nothing the world had ever seen before. Since the income tax has replaced tariffs as the primary source of government revenue, the United States has saved and invested less money and the economy has grown more slowly.

Mr. Buffett argues that we’ve tried trickle-down economics and it has failed. We have also tried trickle-up economics (in the late 1960s) and it too failed. Let’s try something that has succeeded: consumption taxes instead of income taxes.

Currency devaluation’s effect on the markets and the importance of diversification

With commodities rallying across the board this year (most are up between 20% and 100%), copper is at an all-time high, palladium at a 10-year high, oil near its two-year highs, and the Treasuries falling, traders are obviously look for real assets.

The realest assets are commodities, but behind those are shares in companies that produce real goods and earn real profits. We tend to look at those profits in Dollar terms, but they really aren’t. A company making a 10% margin is making a 10% margin in the goods it sells, not in Dollars. In other words, a company could sell 90% of its goods to breakeven and hold the other 10% of the goods produced as profit instead of converting it into Dollars. Or that extra 10% could be converted into gold, silver, or whatever it wants, as long as it has a place to store the profits. Therefore, as long as a company continues to sell, the devaluation of currencies should affect it less than non-performing assets, such as Treasuries which will get hit by rising interest rates and inflation.

Actually, stocks tend to do well during periods of inflation, as long as the economy does well too. If a company’s costs rise, it simply passes along all or most of that to its customers. So if costs rise 10%, a company raises its selling price by the same amount to maintain its margin. As long as all countries experience the same inflation, there will little effect on the company. If we are seeing a worldwide currency devaluation, as I believe, stocks should rise as long as the economy holds up. Of course, commodities will likely do best, but stocks won’t be far behind. They’ll continue to earn a real rate of return of 4% to 7% or so. Bonds though will get double hit by rising interest rates and devaluation. Buying a bond yielding 4% today will yield a negative return if inflation exceeds that amount. And rising interest rates will reduce the Present Value of the bond too.

I would add a major caveat to all this: there is a chance of a major economic decline. With government’s deep in debt and many cutting back, the economy could suffer. Whether we see sub-par growth for the next generation or a double-dip recession remains to be seen. But if this economic decline occurs, stocks will get hit, of course. Commodities will also fall. Industrial commodities, such as copper and oil, may do even worse than stocks while precious metals will hold up better, but they too are likely to decline as they did during the 2008 market crash.

I’m not an economic adviser, but I always recommend diversification. Unless you have a lot of time to spend analyzing the market and become very good at it, chances are you won’t be able to “beat the market.” In fact, even the experts have a hard doing so and, statistically speaking, it has not been proven that anybody can beat the market (those that appear to do so may just be black swans). So own some stocks, some bonds, some commodities, and hold some cash. How much in each depends on your age and risk tolerance. You will not make a killing by diversifying, but in this political and economic environment, protecting your money is paramount. And with the future so uncertain, diversification is the only way to be sure your wealth won’t disappear in a market crash or rally, if governments go bankrupt or become solvent, or if the economy strengthens or weakens. No single investment will perform well in all the possible situations. Remember gold’s decline in 2008 or the larger decline from 1981 to 1998. Cash could be eaten up by inflation. Treasuries by rising interest rates. Stocks by an economic decline. But it is very unlikely that all four will decline together.

For example, learn more about Harry Browne’s Permanent Portfolio. I don’t necessarily recommend his portfolio as is. Much depends on your age and risk tolerance and ability to purchase these funds/instruments. But it certainly gives you a clearer picture of the importance of diversification.

Dollar holding steady, so why are commodity prices way up? And where’s the inflation?

The US Dollar Index is up three percent this year. On the surface, it appears as if we have not experienced a Dollar devaluation this year. But that is not so. Looking at the US Dollar Index or the Dollar against other currencies gives you a false sense of what is happening. The Dollar is being devalued, but so it the Euro, Yen, and most other currencies. All currencies are falling together, but that means they aren’t changing against each other.

How is the Dollar doing against other things, like commodities. Most people look at gold and silver as a currency substitute. Adam Smith looked at wheat prices to measure the value of one’s labor. In today’s global economy, oil may be even more important. So how are the metals, oil, and agriculture doing compared to the Dollar?

Gold is up 28 percent so far this year. Silver is up 79 percent. Platinum is up 19 percent. Palladium is up 92 percent. Copper is up 29 percent.
Crude oil is up 12 percent. Wheat is up 91 percent. Corn is up 56 percent. Soybeans are up 32 percent. Cotton is up 97 percent. Sugar is up 40 percent.

No matter how you measure it, commodity prices are up. Another way of looking at it: the Dollar buys less of each of the above items. Inflation or Dollar devaluation. Whatever you call it, it is happening right now.

So why aren’t we feeling the effects of this falling wage rate or, from the other perspective, this inflation? In fact, we are to a small degree. Just ask anybody around you about their financial situation. Times are tough. But why aren’t we feeling it to the extent the statistics imply? Simply because raw materials make up just a small percentage of the total cost of the things we buy. Personal income, whether it be wages, benefits, capital gains, or corporate profits flowing to individuals, makes up 86 percent of GDP. Raw materials is somewhere around 10 percent of GDP. So it should come as no surprise that rising commodity prices have not, for the most part, not found their way into the CPI statistics. In fact, I’d guess that rising health-care costs have been a bigger contributor to inflation than commodities. On the other hand, falling housing prices are keeping inflation in check.

But what if commodity prices not risen so much? What if the Dollar had not been devalued? In that case, we would either see rising wages or deflation. One is seen as good and the other evil, but they are really the same thing. Either we’d earn more and be able to buy more good with our earnings or we’d have the same wages but lower prices would allow us to buy more with our earnings. Just look at how much we’ve benefited from deflation in the technology area. Don’t we all wish other goods would fall in price as well?

While we have inflation in some areas, such as commodities and health care, we have deflation in other areas, such as housing. Even though the Dollar is being devalued in comparison to non-currency money like gold and silver, it is holding steady against other currencies that are devaluing at similar rates. But we’d be much better off if the United States didn’t devalue: we’d benefit from rising wages or falling prices, either of which would enable us to buy more goods. But the government fears deflation, not for our sakes, but for its own. Deflation makes the real value of the government debt rise. Inflation though makes the real value of that debt smaller, enabling the government to hide its incompetence, that is until interest rates rise. If the government doesn’t right its ship soon, inflation or deflation will become a secondary issues. Interest rates will rise and the government won’t be able to hide its debt and deficit with inflation.

Tax and intervention uncertainty killing the economy.

Everybody is talking about the impending largest tax increase in history due on January 1, 2011. In addition to the cost this imposes on the economy, there is the uncertainty this creates. The Giant Wakes writes:

The Bottom Line: Until the uncertainty surrounding the future Federal tax rates is resolved, it will remain yet another factor conspiring to keep businesses sitting in the economic sidelines, waiting for clear signals before committing capital to growth – and, the uncertainty had better be resolved in favor of sustaining the current rates rather than increasing them, if we hope to see an end to the ‘jobless recovery’ and any kind of broad-based improvement in consumer economic circumstances any time soon.

While The Giant Wakes may write about government intervention in a future post within his ten-part series called “Ten Tyrants of Uncertainty,” I thought I’ll jump ahead and add to the discussion.

Which is a bigger deterrent to economic activity: tax uncertainty or the uncertainty of government intervention? When government steps in to bail out one company at the expense of another, economic calculation is thrown out the window. And this does not just apply to corporations where our government may bail out GM thus hurting Ford or give billions to large banks while letting small banks fail. It also applies to each of us an individual. Those of us who are responsible, paying our mortgages each month or not buying a house knowing we cannot afford one, are now paying for those who irresponsibly bought more house than they could afford but whose mortgages have been “modified” by the government.

As a result, we now have a bipolar economy. We have those who have abandoned all risk taking, not knowing what the government will do. And we have those who take extreme risks, believing the government will bail them out if they fail. In the mean time, nobody is taking the reasonable calculated risks that are essential to a productive and profitable economy.

Second Fed official opposes Quantitative Easing.

In a follow-up to my previous blog post Fed planning trillion dollar Quantitative Easing. Fed official admits it won’t work, another Fed official announced his opposition to the planned trillion Dollar quantitative easing:

Dallas Fed President Richard Fisher, who will get a vote on the policy setting Federal Open Market Committee next year, on Friday made his case against a new round of bond purchases, saying it is not clear the benefits of further quantitative easing outweigh the costs. Fisher, according to a copy of prepared remarks he’s due to deliver in Vancouver, made the case that removing or reducing the tax and regulatory uncertainties is the best way to promote business spending and have firms “release the liquidity they are hoarding and invest it robustly in hiring and training a workforce that will propel the American economy to new levels of prosperity, rendering moot the argument for QE2,” he said. “I consider this to be a far more desirable outcome than being saddled with a bloated Fed balance sheet.”


Doesn’t this seem to the motto of our current government? Purchase mortgages, expand the Fed’s balance sheet, and print more money even if there is no evidence that this helps the economy. Enact a trillion Dollar stimulus bill, pass a TARP bill, extend unemployment benefits to two-years and drop the requirement to look for work, and raise taxes on the rich even though logic and history prove that this things also do nothing for the economy.

Fed planning trillion dollar Quantitative Easing. Fed official admits it won’t work.

The Fed is currently planning a one trillion dollar quantitative easing program. As Jonathon Trugman of the NY Post reports:

The Fed will likely undertake a very large quantitative easing program sooner rather than later, if the economic data doesn’t get markedly better in the very near future.

This QE2 will need to be far more aggressive than most expect, for there is not going to be a QE3. It is essentially the last chance the Fed has. It will want to eradicate any doubt about its ability to work; it is, in essence, the nuclear option.

The measure could be as much as $750 billion to $1.5 trillion. And expect far more aggressive purchases than in QE1.

Mortgage-backed securities, the root cause of the economic collapse, will be the cornerstone of the purchases, thereby allowing a possible 10 percent to 15 percent increase in home prices, which would do wonders for the flat-lined economy.

Credit card-backed paper will be on the tab as well as some auto loans to keep the administration happy.

Sadly, with credit still unavailable to the “middle class” due primarily to poor fiscal policy and economic leadership, the Fed will have to dramatically increase the money supply in order to spur spending. It will work, but it’s going to be complicated.

So Mr. Trugman believes this quantitative easing will work, but that it has to be huge to spur spending. He fails to ask the simple question: will such an aggressive program be worth the benefit?

But others are arguing that the quantitative easing will have no effect at all. Marketwatch reports:

A new round of Federal Reserve purchases of bonds would have little impact on markets or the economy, Minneapolis Fed President Narayana Kocherlakota said in a speech on Wednesday.

Speaking in London, Kocherlakota on Wednesday outlined several reasons why buying government bonds wouldn’t make a major impact. For one, banks already have nearly $1 trillion in excess reserves. “QE gives them new licenses to create money, but I do not see why they would suddenly start to use the new ones if they weren’t using the old ones,” he said, according to a copy of the text he was due to deliver.

As to the first round of quantitative easing by the Fed, Kocherlakota cited an academic study showing that the $1.5 trillion purchase of agency debt, agency mortgage-backed securities and Treasuries by the Fed between Jan. 2009 and March 2010 reduced the term premium on 10-year Treasurys relative to 2-year Treasurys by about 40 to 80 basis points, which in turn led to a slightly smaller fall in the term premia of corporate bonds.

Kocherlakota estimates a new round of QE would have a more muted effect, because financial markets are functioning much better than they were in early 2009. “As a result, the relevant spreads are lower, and I suspect that it will be somewhat more challenging for the Fed to impact them,” he said.

So Trugman says this aggressive quantitative easing will work, but Kocherlakota says it won’t. In reality, who knows? The real problem is that there is so little discussion of the risks and costs involed. Marketwatch explains the risk in one sentence:

Kocherlakota also said that the impact of quantitative easing is to shift the interest rate risk on bonds from investors to taxpayers.

So the real impact of this quantitative easing will be to socialize risk. The Fed risks creating further moral hazard. The Fed risks producing interest rates that are too low, which will create more bubbles. The Fed is going to create distortions in the market system. But despite these risks, there is no guarantee of success.

I applaud Minneapolis Fed President Narayana Kocherlakota’s efforts to restore reason and common sense to our ineffective and inefficient monetary policy.

Stimulus spending: the new perpetual motion machine.

Stimulus spending is like a perpetual motion machine. Sounds great in theory, but it doesn’t work. Just as machines must use up more power than they output, so too stimulus costs more than it produces.

If stimulus spending really creates jobs and improves the economy, the government could just stimulate the economy all the time and we’ll never have recessions or unemployment. We can achieve perpetual motion through big government! Or so they tell us.

Eighty years ago, Ludwig von Mises wrote:

It is obviously futile to attempt to eliminate unemployment by embarking upon a program of public works that would otherwise not have been undertaken. The necessary resources for such projects must be withdrawn by taxes or loans from the application they would otherwise have found. Unemployment in one industry can, in this way, be mitigated only to the extent that it is increased in another. From whichever side we consider interventionism, it becomes evident that this system leads to a result that its originators and advocates did not intend and that, even from their standpoint, it must appear as a senseless, self-defeating, absurd policy.

It is not just economists like Mises that predict the failure of stimulus projects. History predicts it as well.

Stimulus spending didn’t prevent the Great Depression. It didn’t prevent any recession since then. And I have yet to see proof that stimulus spending produced a net economic benefit when the costs of the government programs were weighed against the economic gains, if there were any at all. Which leads us to one of two conclusions: either (1) stimulus spending cannot work or (2) it can work in theory but government is simply incapable of applying the correct amount of stimulus at the correct time.

In reality, stimulus does have some short-term effect. The “cash for clunkers” program boosted auto sales briefly. The tax credit for home purchases boosted home sales briefly. Construction spending from the Recovery Act did help the economy slightly. The census lifted employment for a few months. But all these programs do is borrow from the future. In the case of “cash for clunkers” and home tax credit, it brought future sales into the present. In the cases of jobs programs and construction projects, the government takes money from the future (debt) and spends it today. That leaves the government with less money in the future and it will either need to reduce future spending or raise taxes, either way harming our economic future.

The Keynesian argument is that this stimulus spending during a recession and cutting back in the future will smooth out the volatility of the economy. First, the government is great at the spending during the recession part, but terrible at cutting back during the recovery. Keynes’ idea was to run a budget deficit during recessions and a surplus during booms. Instead, government runs a deficit during booms and an even larger deficit during recessions. Second, the government has no idea how much to spend on stimulus during a recession and when to cut back on that spending. The government can only guess at how deep the recession will be, when it will start, when it will end, and how strong the recovery will be.

But the government will not let economics or history stand in the way of its grandiose ideas. As Stalin used to say, “We are bound by no laws. There are no fortresses which Bolsheviks cannot storm.”

History has proven that stimulus spending does not work, just as the great economists explained. Yet, time and again voters fall for the same trick and beg our “benevolent leaders” in Washington to take our hard-earned money from us to spend for us.

God willing, voters this November will learn to say NO to Washington and the politicians. “Fool me once, shame on you. Fool me twice, shame on me!” As those great political thinkers from The Who sang, “Won’t Get Fooled Again.”