The Great Government Mutual Fund Investment Opportuntiy

Imagine there was a new mutual fund with the following proposition. We want you to take money out of your current investments and give it to us. Here's our plan. First, we're going to impose a 20% load on your investment up front, so that you will have to take $1.20 out of your current portfolio for every dollar we invest. Then, we're going to invest your money in companies and projects that have such low return prospects that ordinary investment funds refuse to fund them.

Does that sound like something you'd be anxious to do? You're probably saying, "Why, the only way they could raise money for that fund would be to threaten to put you in jail if you didn't invest!" And you'd be right.

In fact this is a good approximation of the prospectus the Federal government should publish for it's spending operations.

1. Government raises the money it spends from taxes -- mostly income taxes. Compliance costs for administering this tax are about 20% of the revenue collected. That means that effectively the government takes $1.20 out of the economy for every $1 it plans to spend.
2. While in theory, government could spend most of it's money on things that have good economic returns, in practice it doesn't. It invests in things like Solyndra and Cash for Clunkers, but mostly it sends checks out to subsidize people who aren't producing much right now.

This is the fundamental reason why government spending is not, and really cannot be economically productive (or "stimulative") -- any more than the mutual fund we've described can produce better results than the ones in which you already invest.

Wealth Inequality Facts II

In a bit of rather good timing, just a week before President Obama will stand before Congress and declare there to be a crisis in income inequality and economic mobility, a group of economists led by Raj Chetty of Harvard University have published an extensive paper which concludes that "contrary to popular perception, economic mobility has not changed significantly over time".  This is a somewhat polite way of saying that the President has no factual support for his assertion.  He, understandably, desires to change the subject from the myriad failures of his administration to something that will sound good -- at least to those willing to ignore the facts. 

The chart below plots the difference in average income percentiles for children born to low vs. high-income parents in each year from 1971-1993. On average, children from the poorest families grow up to be 30 percentiles lower in the income distribution than children from the richest families, a gap that has been stable over time. 

The Wealth Inequality Facts

As if we needed more proof that the "Wealth Inequality" claptrap is simply a political gambit by Democrats and the media to divert attention from actual real problems like Obamacare. Why on earth would it suddenly be a crisis that the wealthiest 1% of Americans actually have a slightly smaller share of total wealth than they did 25 years ago? Once again, for the political class the level of noise is inversely related to the amount of supporting factual evidence.

The Magic of 50

Here's a quick intelligence quiz.

Q. Why does France have 2 1/2 times as many companies with 49 employees as with 50?

A. Because the French government commands that companies with 50 employees must create three worker councils and submit any employee terminations to those councils for approval. They must also create a formal profit sharing plan for employees.

Now the IQ quiz.

Q. What will happen in the US when Obamacare kicks in for companies with 50+ employees?

Does This Look Like We're Headed in the Right Direction?

The President is patting himself on the back for reducing the unemployment rate again. But only because he continues to  incent more people to drop out of the workforce. Does this really look like we're headed in the right direction?

Trickle On

In order to divert conversation from Obamacare, Democrats and the media (I repeat myself) have decided to latch on to some old buzzwords -- "Income inequality" and "Trickle Down economics" -- the idea being that we are somehow worse off when a relatively small number of high producers enjoy hugely disproportionate success.

At the risk of allowing economic facts to intrude on frothing rhetoric, consider this.

1. In 2010 companies launched by entrepreneurs backed by venture capital generated more than 20% of US GDP. 
2. In 2010 companies less than five years old generated more than 100% of all the new jobs that year (the older ones collectively lost jobs).

So if you're in the job market, you'd better hope that the activities of a very few productive people "trickle down" to you.

Poverty and Globalization

Mark Perry notes that economists Maxim Pinkovskiv and Xavier Sala-i-Martin published this paper at the National Bureau of Economic Research.  Using parametric methods to estimate the income distribution for 191 countries between 1970 and 2006 they show how dramatically the level of abject poverty ($1/day threshold in constant dollars) has declined since 1970. That's 250MM fewer people living on $1 per day. You may not see this too many places because it runs counter to the media mantra that free trade and globalization have hurt the poor. Does it look that way?  

Economic Questions for the New Year

If government spending is counted in GDP and financed by debt, what exactly is the meaning of the debt:GDP ratio?

If economic growth is achieved by producing more with fewer resources, how does devoting more and more land to producing energy from corn, wind-farms and solar-farms produce economic growth?

If the only manufacturing plants that are allowed to operate in the US are those that produce near-zero emissions and China has no such requirement, why is anyone surprised that manufacturing has moved to China? And what exactly should we expect if the US begins taxing carbon emissions?

Half the Country Doesn't Pay Income Tax-- Again

The Internal Revenue Service just released new 2011 data on individual income taxes. 

Once again, half the people in this country pay 97% of the income taxes, while the other half essentially pays nothing ( which Mitt Romney was pilloried for saying last year). Is it any wonder, then, that half the country thinks of government spending as a Free Lunch?

And just 5% of us pay over half the total tax bill. I can't recall . . . did the President bring that up in his rant about "income inequality"? 

Table 1. Summary of Federal Income Tax Data, 2011
	Number of Returns*	AGI ($ millions)	Income Taxes Paid ($ millions)	Group's Share of Total AGI (IRS)	Group's Share of Income Taxes	Income Split Point	Average Tax Rate
All Taxpayers	136,585,712	8,317,188	1,042,571	100%	100.0%
Top 1%	1,365,857	1,555,701	365,518	18.7%	35.1%	> $388,905	23.5%
1-5%	5,463,429	1,263,178	223,449	15.2%	21.4%		17.7%
Top 5%	6,829,286	2,818,879	588,967	33.9%	56.5%	> $167,728	20.9%
5-10%	6,829,285	956,099	122,696	11.5%	11.8%		12.8%
Top 10%	13,658,571	3,774,978	711,663	45.4%	68.3%	> $120,136	18.9%
10-25%	20,487,857	1,865,607	180,953	22.4%	17.4%		9.7%
Top 25%	34,146,428	5,640,585	892,616	67.8%	85.6%	> $70,492	15.8%
25-50%	34,146,428	1,716,042	119,844	20.6%	11.5%		7.0%
Top 50%	68,292,856	7,356,627	1,012,460	88.5%	97.1%	> $34,823	13.8%
Bottom 50%	68,292,856	960,561	30,109	11.55%	2.89%	< $34,823	3.13%
*Does not include dependent filers.

Public Pensions Increasing Risk Levels

Andrew Biggs writes in the Wall Street Journal about how defined benefit pension funds are taking bigger and bigger portfolio risks. These plans (mostly government employee pensions) were created using an assumption that portfolios would return around 8% annually. This certainly hasn't been the case, and is not likely to in the near future. One option would be for government to raise taxes to increase its contributions to the pensions. This is somewhere between unlikely and impossible. The only alternative for these funds is shift investments into much riskier assets in search of a higher returns.

A more prudent move would be for governments to convert pensions into defined contribution plans -- as almost the entire private sector has done. But given that most governments are controlled by public employee unions, that's not likely either. Historically, investment strategies that greatly expand risk have very unhappy endings. It may be that's what it will take to get government to face reality. Unfortunately that means that there are probably a lot more Detroit scenarios on the horizon.

Obama's Deceit Extends to Income Equality

The Congressional Budget Office's new report is especially timely in light of the President's rant last week about "income inequality".  As you can see from the table below, if you're talking about market income -- that which you actually earn -- the distribution is highly unequal. The highest household quintile earns almost 30 times what the bottom  one does (household income  can be very mislead itself because the household composition is very different between the upper and lower quintiles). But after tax and government payments? That ratio drops to less then 6x.

What's even more remarkable is to examine the incentives for working. Those in the second quintile earn on average $46,700 more than those in the lowest quintile. Yet, after taxes and transfers those people are only $26,600 better off -- because they actually pay some tax, and they lose a lot of their government transfer payments. That's an effective marginal tax rate of 43% . Do you think the average middle class family really understands that the federal government is imposing a 43% tax on their work? I'd say about as well as they understood that they would be able to keep their health plan under Obamacare.

Stock Market Risk -- Reversion to the Mean

As the stock market reaches new highs and optimism grows, it is worth considering a couple of charts that should give caution. The first one is the ratio of corporate profits to GDP. It's currently at an all-time high of 10%. That isn't going to continue. At some point it will revert to more historically normal levels. Ultimately, share prices have to be related to earnings. 

The second is the Shiller PE Ratio between share prices and trailing 10 year inflation-adjusted earnings. The Shiller ten-year P/E Ratio also suggests the market is expensive. In 2000 the ratio was 44, the highest level on record. At the top of the market in 2007, the Shiller was 27. The long-term average is 16.5. By that estimate, the stock market was 63% overvalued in 2007. Right now the Index is at 25, which suggests an overvaluation of 50%.

Overvalued assets can become even more overvalued as we saw in the 90s, but the more expensive stocks become, the higher the risk of a big drop.  About the only thing you can say with any certainty is that over the next few years there’s more risk on the downside than on the upside. Of course, you could have said that in 1997 as well. Bob Shiller did, and he missed out on a couple more years of share price inflation. Investor psychology seems to fear losing out on a big upswing more than experiencing a big loss. Certainly that was what drove real estate in the mid-aughts. But history suggests that reversion to mean is an even more powerful force. 

Government vs. Private Sector Time Off

According to data from the Bureau of Labor Statistics here are the hours absent from work (for health or personal leave reasons) as a percent of the hours usually worked.

Private Sector               1.4
Federal Government      2.0
State Government          2.2
Local Government         2.0

Clearly this indicates that if you work for government you are about 50% more likely to be sick. Unless someone can think of another reason for this disparity?

If Amazon Operated Like Government. Mayday!

Amazon has a major technical initiative planned for its new Kindle Fire tablets next month. It's called Mayday, and it's a little button on the screen you can press at any time to get live onscreen help with whatever it is you're trying to do on the Kindle. The operator can even take over your Kindle and demonstrate how to solve the task. It's absolutely critical to Amazon that this service delivers as promised. Otherwise people will walk away from it pretty quickly and buy other tablets.

Imagine, though, that Amazon ran like government.

• Nobody's job would depend on whether this thing worked. If it didn't work, nobody would be fired.
• If it weren't operable in time for holiday sales, Amazon would simply declare that Christmas will be postponed this year.
• Amazon would charge some people $500 for the Kindle Fire so that other could buy it for $5. 
• Amazon would charge everybody who didn't buy a Kindle $100.
• Jeff Bezos would call a press conference and surround himself with ten people who actually got Mayday to work. He would then proudly announce that when Mayday wasn't working you could still call Amazon's 800 number and speak to an operator.
• When confidence in Amazon crashed and sales plummeted, Amazon would simply issue more bonds that the Federal Reserve would buy from it. 
• The Board of Directors would reelect Bezos as CEO because, well, he's really a pretty cool dude and knows how to use a TelePrompter. 

Waking Up to reality. The Obamacare Free Lunch.

The notion of the Free Lunch has always been a particularly popular myth with Americans. In fact there is an entire political party based on it's allure. Every now and then, though, believers come face to face with painful reality.  From today's LA Times comes a particularly poignant example.

Pam Kehaly, president of Anthem Blue Cross in California, said she received a recent letter from a young woman complaining about a 50% rate hike related to the healthcare law.

"She said, 'I was all for Obamacare until I found out I was paying for it,'" Kehaly said.

Spending and Spending On Creating More and More Poverty

Over the last five years, the federal government has spent a total $3.7 trillion on approximately 80 different means-tested poverty and welfare programs. And yet the government tells us that poverty is increasing, Usually if you spend a lot of money on projects to reduce something and that something keeps increasing, it's called a FAILURE. In Washington that's grounds for spending even more money.  Because in Washington, doing the same thing over and over and expecting different results is the norm. Everywhere outside the Beltway it's called insanity. 

America's Bridges Are Falling Down?

How many times have you heard a story like this one: “America’s road to recovery may face a costly detour due to a fraying transportation network. One in nine of the country’s 607,380 bridges are structurally deficient …”  This is immediately followed by a call for higher taxes and more Government Spending (remember the Stimulus?). Just another case of those mean Republicans cutting spending at the expense of your safety. Except . . .  here's an inconvenient chart. 




Whatever those dastardly Republicans have been doing, it seems to be working. Or maybe the call for more government spending is like a broken record that just plays over and over and over.

The Fed's Infinite Do-Loop

In 2008, the Federal Reserve sharply increased it's bond buying in the face of severe liquidity problems and a major recession. What was supposed to be a temporary, radical monetary policy has now become a permanent one. 

Ben Bernanke recently said that the reason they would hold off on reducing bond buying was that “the Fed has some concern that the rapid tightening in financial conditions in recent months could have the effect of slowing growth…a concern that would be exacerbated if conditions tighten further.”

I think I've identified what computer programmers used to call an “infinite do-loop”.  

Step 1: The Fed announces that they are considering reducing bond buying.

Step 2: The markets respond by driving interest rates up

Step 3: The Fed cites this“tightening in financial conditions” as a reason to hold off their bond buying

Step 4: The Fed increases its purchase of Treasuries for its balance sheet,

Step 5: Go to Step 1

Prostitution Pays

Paul Krugman, economist, wrote the following in 1998:

So what are the effects of increasing minimum wages? Any Econ 101 student can tell you the answer: The higher wage reduces the quantity of labor demanded, and hence leads to unemployment. [Those who advocate for higher minimum wages]  very much want to believe that the price of labor--unlike that of gasoline, or Manhattan apartments--can be set based on considerations of justice, not supply and demand, without unpleasant side effects. 


Fast forward 15 years. Paul Krugman, now a lapdog at the NY Times, wrote in support of a minimum wage increase:

 . . . .workers aren’t bushels of wheat or even Manhattan apartments; they’re human beings, and the human relationships involved in hiring and firing are inevitably more complex than markets for mere commodities. And one byproduct of this human complexity seems to be that modest increases in wages for the least-paid don’t necessarily reduce the number of jobs.

All of which simply demonstrates that Mr. Krugman discovered that being a prostitute pays more than being an economist

Hat tip to William Occam  

That's not how we do things in America

President Obama had this to say today.

Consider that just a couple of weeks ago, Apple rolled out a new mobile operating system, and within days, they found a glitch, so they fixed it. I don't remember anybody suggesting Apple should stop selling iPhones or iPads or threatening to shut down the company if they didn't. That's not how we do things in America. 

I can't think of anything that is more revealing of the President's utter economic ignorance as to how market choices are made among products (as opposed to government products where you have no choices). 

First of all, Mr. President. When Apple released OS7, 99.9% of it actually worked.  More importantly it was something people voluntarily chose to do. Nobody forced them to use OS7 -- or even an Apple phone. There weren't any fines levied if you didn't buy an Apple.  In fact you have other choices in phones, and, Mr. President, if Apple phones worked as well as the government does, people would run to those other phones in droves and Apple would be out of business. Apple cannot simply tax their customers to make up for their incompetence. 

Mr. President, with all due respect, on what planet did you learn about economics? 

You're right about one thing, though.  That's not how we do things in America. At least the part of America that continually produces things that people want at lower and lower costs every year.