Top posts of 2012

Since it's that time of the year where everybody takes stock of things and mocks the Mayans and makes predictions for the next year and does whatever else it is that people like to do while nursing their egg nog hangovers, I thought I'd take a look back at The Year That Was here at the Crimson Cavalier, starting with a rundown of my most popular posts of the past 12 months.

So here are my Top 10 most-read pieces from 2012, which are, naturally, all over the map. None of these posts was anywhere close to becoming my most-read post of all time (that honor belongs to this post on globalization, followed closely by this George Carlin-inspired post and this post on discrimination), but a few of them definitely registered a bit of a rumble on the ol' Crimson Cavalier pageview seismometer.

Enjoy re-reading some of your favorites, and I'll do my best in the future to reproduce more of the good stuff you all like... whatever that is.

#1: Remembering the Dream Team (June 14)

It probably shouldn't be surprising that my most-read post of the year had to do with the (tape-delayed) Olympics, which dominated the news cycle for a few weeks back in the summer. On the 20th anniversary of the Dream Team, I shared some of my own memories while excerpting a GQ oral history of the squad.

#2: The changing business of education (May 9)

The runner-up post (with about half the pageviews of the champion, which means it's a distant second, but so be it) involved one of my favorite topics, education. Inspired by a very cool new program at Virginia Tech called the "Math Emporium", I shared some of my thoughts on the future of higher education in America.

#3: Eat More Chikin (at Wendy's?) (July 30)

I'm sure you all remember the flap surrounding Chik-Fil-A this summer, way back when Mitt Romney's Presidential campaign was just shifting from "suck" to "blow". I thought the controversy was incredibly overdone, and I thought that many people were far too self-congratulatory with respect to their boycotts of the fast food also-ran. I said so, in a pretty standard Crimson Cavalier rant.

#4: I'm too busy to write a blog post (July 16)

I'm too busy to write a blurb about this blog post. Just read it, alright? Or don't, if you're too busy. Either way, kudos to the Harvard Business Review for a well-written article, one that I briefly reviewed in this post.

#5: The carbon footprint of flowers (WTF??) (May 4)

With Mother's Day approaching, I decided to take a minute to make everybody think twice about sending flowers to their mothers. Why? Because I'm a jerk, obviously. Also, because it turns out that almost all of the flowers we buy in this country are shipped here from Latin America, and that therefore the flower industry has an incredibly large carbon footprint. How's THAT for irony? "Green" economics, indeed.

#6: Is it the weekend yet? (June 6)

I wrote this post on a Wednesday, so no, it most definitely was not the weekend. I might have had a drink that night anyway. Possibly.

#7: Bernanke's Terror Alert Scale (September 14)

I wrote this post in the immediate aftermath of the Fed's announcement of infinite "quantitative easing", a program that has had incredibly underwhelming results so far. That's about what I predicted on that day, and so I'm going to take a second here to pat myself on the back. While we're at it, keep your eye on this dynamic in 2013—I have a feeling it's going to have some serious economic relevance in the not-too-distant future.

#8: When hypocrisy is good business: "The Lorax" (March 2)

"The Lorax" could have been a cute little Dr. Seuss movie with a nice message about conservation, but instead it became a symbol of all that I hate about corporate hypocrisy. I borrowed from a delightfully vicious review of the movie by NY Times critic A.O. Scott, and I shared my own thoughts about the odd intersection (or clash) between morals and business.

#9: Clip of the Week (April 6)

I'd like to thank John O'Hurley (J. Peterman) for providing me with my most popular Clip of the Week ever—a promotional video for "Rangé" golf balls. Good stuff.

#10: The tail is still wagging the dog at UF (April 24)

Yes, another post on education, which makes two in my top 10. This one also involved collegiate athletics, another common topic here on the blog. The University of Florida made the incredibly bizarre decision to drop its ENTIRE computer science department, an area of education that should be expanding if anything. At the same time, they increased their athletics budget by more than $2 million, an increase that was greater than the entire C.S. department budget. Well played, UF. Well played. But next time, beat Georgia.

Quote of the Week

I'm going to keep things quick and simple with this week's Quote of the Week, because I think it largely speaks for itself. Let's get right to it, with blogger Karl Denninger's response to the recent revelation that over 47 million Americans (about 15% of the total population) are now receiving food stamps. That's an increase of nearly 50% just since 2009, which is costing our government an additional $25 billion annually. Yuck.

This week's QUOTE OF THE WEEK

"The last month for which data is available, September, shows over 600,000 people [began collecting food stamps] in that month alone, comprised of 290,000 households. In one month! The average handout is $278.89 per household, or $134.29 per person monthly. Note that there are only 143,549,000 people in the workforce -- that is, people earning a wage... To put this in perspective for every three people working one is collecting food stamps."
                                     - Karl Denninger, The Market Ticker

That is awful. Setting political issues of the "fiscal cliff" or the "welfare state" or whatever else aside, the simple fact is that this is a completely untenable economic situation. Far too many people are currently receiving food stamps, and this alone is a huge indication that our policy responses to the financial crisis of 2008-09 (deficit spending, Fed money-printing) have been an utter failure.

The debt-based financial games that we've played for the last several decades have gutted our nation's middle class (death by several trillion paper cuts), and yet many would suggest that more of the same is what we need to solve our problems. Believe me, they're wrong.

It is imperative that we stop lying to ourselves and pretending that these policies work. They don't. We need to clean up our fiscal house (starting with defense and Medicare), take the power away from the banks who continue to steal from the rest of society, and most importantly stop printing money. It won't be fun, and it won't be easy, but it really is the only option—things will only be worse in the future if we fail to act today. America is a country that has always strived for greatness, and 15% of the population on food stamps falls far short of "great".

[Market Ticker]

On housing and the low cost of money

I'm often writing about the perils of the Fed's monetary policy, but there are obviously some bright spots to be found out there. I'm sure by now that you've read at least one glowing article this year about the "housing recovery", and for the most part it's legitimate (even if there are some strange dynamics under the surface).

The question, of course, is whether this recovery is sustainable, and what will happen to housing prices if interest rates begin to rise from their freakishly low levels. That's a topic that Tim Iacono took on in a recent blog post, and I thought his findings were absolutely worth sharing (emphasis mine).

I’ve about had it with how giddy a large portion of the U.S. population has become about rising home prices. 

Don’t get me wrong, when first thinking about this, I was about as happy as anyone else to learn that property values are now rising sharply again since, after renting for six years, my wife and I finally bought a house about two years ago. So, we stand to benefit as much as anyone else. 

But, when you look at what’s driving home prices higher and how unnatural and unsustainable those factors are, suddenly the headlines sound more ominous than optimistic...  

Yes, low inventory is a big factor behind the home price surge as the flood of foreclosures has slowed to a trickle while strong investor demand and growing confidence amongst American consumers have surely tipped the scales in favor of higher prices. But, it is today’s freakishly low interest rates – engineered by the Federal Reserve – that have clearly played the biggest role in pushing home prices higher, simply because most people buy a house based on the monthly mortgage payment, not the purchase price. 

And when you see the impact record low rates have on purchase prices, you might be as concerned as I am... 

Based on a constant mortgage payment of $1,100 per month (what seemed to be a good national average based on this story and others like it), today’s 3.31 percent 30-year mortgage rate will finance a house at almost double the price that the 40-year average mortgage rate would!

While there are clearly other factors involved, it is the Federal Reserve’s asset purchase program that is largely responsible for these freakishly low rates (it is one of their stated policy objectives) and, while the central bank has promised to keep rates low for a long time and to continue buying mortgage-backed securities indefinitely, those actions are by no means guaranteed. 

This is a dynamic that I've been well aware of for a long time now, but it's still striking to see it laid out graphically like in Tim's piece. In just the last 12 months, 30-year mortgage rates have come down from 4.2% to 3.4%. Using Tim's $1,100 monthly payment, that means that a buyer who waited a year can now afford to buy a $276,000 home, as opposed to a $250,000 home last year.

That's an increase of 10.4% year-over-year because of the low cost of money, and yet home prices are only reported to have increased by 5 or 6% over the last year, even according to the rosiest estimates. Therefore, in any realistic terms, the price of housing has continued to decline this year, rather than rebound sharply as the headlines would have you believe.

If interest rates are really going to stay this low forever, then you shouldn't have much to worry about, and you can go ahead and buy real estate to your heart's content (just don't read these three posts before you do so). But as Wells Fargo is always reminding me in their constant mailings, "Interest rates rarely stay put for long!"

And if Wells Fargo is indeed correct, well then... Tim's chart tells us that housing's got another pretty significant leg down (like, 30 or 40%) to get back to those historical average rates. And that likely won't be pretty for anybody hoping to sell property at any point in the next few decades. Good luck!

[Iacono Research]

Punishing bad predictions

I've been a little silent on here this week, in large part because I'm really trying hard to avoid talking about the election. That's not because I'm upset with the outcome or thrilled with the outcome or anything of the sort, but more because if nothing else, this election showed me just how deeply divided our nation has become. Our President was re-elected, yes, but re-elected with only 39% of the white vote nationally—Latinos and African-Americans carried the day for President Obama. As much as we may like to pretend that we inhabit a "post-racial America", that statistic would strongly suggest otherwise.

The fact is that there are entire segments of our population—gays, womens, blacks, Latinos—who largely felt that they had little choice in this election but to vote for the incumbent. Whether their feelings were correct or not is largely an immaterial matter—the feelings alone are indicative of just how ill our current political environment has become. Because of this bitter division, I feel that it's best not to weigh in with my personal opinions about the election, expecting that they would simply inflame some readers while being redundant to others. If you've read enough of my blog, you know my political leanings already, and I therefore feel no need to reiterate them at a time when nerves are a bit frayed. I'll revisit them in the not-too-distant future, to be sure. Now just doesn't seem to be the right time.

But what I would like to talk about is predictions, a topic I actually love discussing. As you may remember, I think that the incentive structure surrounding predictions and projections is badly out of whack, which leads us to be inundated with all manner of terrible prognostications. Italy, for one, decided that they'd finally had enough:

Six Italian scientists and an ex-government official have been sentenced to six years in prison over the 2009 deadly earthquake in L'Aquila. 

A regional court found them guilty of multiple manslaughter. 

Prosecutors said the defendants gave a falsely reassuring statement before the quake, while the defence maintained there was no way to predict major quakes. 

The 6.3 magnitude quake devastated the city and killed 309 people. 

Many smaller tremors had rattled the area in the months before the quake that destroyed much of the historic centre... 

The seven - all members of the National Commission for the Forecast and Prevention of Major Risks - were accused of having provided "inaccurate, incomplete and contradictory" information about the danger of the tremors felt ahead of 6 April 2009 quake, Italian media report. 

In addition to their sentences, all have been barred from ever holding public office again, La Repubblica reports. 

In the closing statement, the prosecution quoted one of its witnesses, whose father died in the earthquake. 

It described how Guido Fioravanti had called his mother at about 11:00 on the night of the earthquake - straight after the first tremor. 

"I remember the fear in her voice. On other occasions they would have fled but that night, with my father, they repeated to themselves what the risk commission had said. And they stayed."

Well, that's certainly one way to change the incentive structure surrounding predictions. Since I've often complained that pundits never face any real consequences when their predictions turn out to be wrong, this certainly provides a pretty strong counter-example. Whether or not it's a good thing is a different matter entirely.

Ultimately, if this sort of thing gained traction throughout the world, all that it would really do is give people an incentive to never make predictions of any kind, under any circumstances. That may or may not be a good thing, and it probably takes things too far in the opposite direction.

Ultimately what we all need to do is to take responsibility for our own decisions, rather than outsourcing them to "experts" and taking their predictions at face value. The more we ignore the expertise of the punditry and rely on our own research and intuition, the better off we all will be. We'll be a better-informed, better-prepared, and generally more capable populace, and that's inarguably a good thing. But the more we try to blame others for the bad outcomes that befall us, the further we're going down the wrong path.

Personal responsibility is paramount in the world, and while this ruling may help shift around the incentive structure surrounding predictions, it does absolutely nothing to promote personal responsibility. Therefore, I can't bring myself to support the move, no matter how much I might like certain elements of it. Although, maybe if we used this logic on Ben Bernanke.... nahhhhhhh.

[BBC]

Reminder: there is no retirement

Even while our friends over in France continue to whistle past the graveyard and pretend that their official retirement age should in fact be lowered, rather than raised massively, Americans seem to be waking up to the obvious and inevitable. That is to say, for most Americans, retirement is now a pipe dream.

As they struggle to save for retirement, a growing number of middle-class Americans plan to postpone their golden years until they are in their 80's. 

Nearly one-third, or 30%, now plan to work until they are 80 or older -- up from 25% a year ago, according to a Wells Fargo survey of 1,000 adults with income less than $100,000. 

"It is so tough for Americans to save for retirement that the answer seems to be to work longer," said Joe Ready, director of Wells Fargo Institutional Retirement and Trust. 

Overall, 70% of respondents plan to work during retirement, many of whom plan to do so because they simply won't be able to afford to retire full time. 

But working well into your 70's, 80's or even 90's, isn't always realistic, said Ready. Nearly three-quarters of those who plan to work into their 80's say their employer won't want them working when they're that old, for example. Other roadblocks, like health issues, could arise as well.

Never mind the fact that many Americans won't even live until their 80s, this is an ugly statistic and trend. It's also terrible news for the next generation of college grads, who will emerge from school with mountains of debt and realize that there are no jobs for them because their parents (and grandparents?) are still holding them.

The simple fact is, we've convinced ourselves for decades now that low-interest rate policy and deficit spending gives us an economic free lunch, and that we'll therefore never have to endure another recession again. In reality, all low-interest rate policy has done is to pull forward years (if not decades) of economic growth into the current period, as workers spend now and cost themselves the ability to spend later (in retirement). Sooner or later we have to pay the price for those policies, and we're now seeing the side costs of all of that "prosperity" coming home to roost.

A devastatingly low number of 50-55 year olds in our country can currently afford to retire at anything approaching a reasonable age, and this problem will only get worse as our distressing gaps in pension and Social Security funding become more apparent (let's not even discuss their investment return assumptions right now). This is bad news for the older generation and the younger generation alike, and it all comes back to unrealistic monetary and interest rate policies. Thanks, Ben.

[CNN Money]
(h/t Tim Iacono)

Quote of the Week

A few months ago, I wrote a post about the Black-Scholes pricing model, its role in the financial crisis, and how economists continue to do themselves a terrible disservice by insisting that their discipline is a physical science like physics or biology, rather than the inexact social science that it is. I wrote:

We all use models in our daily lives, because they help us to make sense of what are often very complex problems. Models simplify, organize, and categorize the variables in an uncertain world so that we can better understand the impacts of our decisions. But they DO NOT, ever, have the power to tell us what to do. You don't even need to know a thing about Black-Scholes (and trust me, a lot of people who should know a lot about it... don't) in order to accept that assertion as fact. 

The intelligent person knows to use a model only as a guide to confirm (or refute) what our intuition tells us. Very often, our painfully simple heuristic models (which you can learn or hear more about from Gerd Gigerenzer's speech, if you're a nerd like me) actually outperform very elegant statistical models. How can this be? The answer lies in this brilliant polemic from economist Robert Wenzel (which is almost as great as a similar recent rant from Jim Grant).

In the science of physics, we know that water freezes at 32 degrees. We can predict with immense accuracy exactly how far a rocket ship will travel filled with 500 gallons of fuel. There is preciseness because there are constants, which do not change and upon which equations can be constructed. 

There are no such constants in the field of economics since the science of economics deals with human action, which can change at any time. If potato prices remain the same for 10 weeks, it does not mean they will be the same the following day. I defy anyone in this room to provide me with a constant in the field of economics that has the same unchanging constancy that exists in the fields of physics or chemistry.  

And yet, in paper after paper here at the Federal Reserve, I see equations built as though constants do exist.

Wenzel is dead on. We all know that models are useful, but they do not remove responsibility for rational risk management—only people have the power to do that. When callous risk managers at huge investment banks take another man's model on faith, and make huge bets with billions of dollars on the line without sanity-checking the model, that's nobody's fault but theirs.

While my points were correct, I took a little while to get the point across. For a more pithy take on things, we'll turn to Barry Ritholtz, for this week's Quote of the Week.

This week's QUOTE OF THE WEEK

"Economists are neither Engineers nor Scientists, as each of these fields has a significant degree of precision in what they do, and test their hypotheses in a lab. The better choice for Economists are 'Historian' or 'Sociologists.' The sooner the profession loses its 'physics penis-envy', the better off we all will be."
                                                  - Blogger Barry Ritholtz

I'll just let that "physics penis-envy" line stand on its own, because I think it's the single greatest takedown of modern economics that I've ever seen.

As our economy becomes more and more dependent on the fantasy-land models put together on Ben Bernanke's laptop, I sincerely hope that the damage done by these grand experiments isn't so grave that we all end up suffering for decades. But if we allow ourselves to entrust ever more of our lives to these "scientists", we're certainly running that risk.

Gas stations vs. department stores

I thought this chart here from the Illusion of Prosperity blog was pretty telling, and I think it says just about everything you need to know about what Fed policy has done for and to our economy over the last decade-plus (obviously the internet has a role to play here as well, but that dynamic alone cannot and does not account for a tripling of the ratio in a dozen years). Regardless of the reasons behind the spike in this chart, it's clear that inflationary monetary policy is powerless to restore lost retail jobs, but certainly ensures that we all spend more and more of our paychecks at the pump and the grocery store.

Pretty awesome, right? Hooray, Bernanke!

And hey, while we're at it, let's share another semi-terrifying chart from the same blogger.

Good times. Sooner or later, nobody will have any home equity at all, and then we'll all be living on Easy Street. Which will be good, because gas will be so expensive that we won't be able to afford to drive to any other streets. I can't wait.

Bernanke's Terror Alert Scale

Since I'm such a frequent critic of Federal Reserve policy, I'm pretty sure there's no way I can let yesterday's "aggressive", "unprecedented", "open-ended" announcement of what amounts to permanent quantitative easing ("QE") go by without comment. Indeed, I won't.

There's about a million different angles from which I could attack this latest policy announcement (it's desperate, it's ill-timed, it's dangerous, it fans the flames of inflation at a time when the economy can ill afford it, it jacks up the Fed's balance sheet leverage to astonishing and terrifying levels, it makes me wonder just how freaking bad things are out there if the Fed feels like this is a "reasonable" step, and it therefore isn't exactly confidence-inspiring), but I'm not even going to bother with any of those approaches. Instead, I'm actually going to celebrate (yes, you heard me), because this means that the end of the era of Fed-manipulated markets is now imminent. The Fed fired its last meaningful bullet yesterday, and now the endgame is at hand. Let me explain what I mean.

In the immediate aftermath of 9/11, the newly-created Department of Homeland Security unveiled its "Homeland Security Advisory System" (better known to most as the "terror alert level" or "terror alert scale"), a color-coded, semi-ambiguous chart indicating just how scared we all should be of a terrorist attack at any given moment. The intent of the program was in large part to impact the psychology of citizens, making them more vigilant and aware of their surroundings when times warranted.
 
Unfortunately, the terror alert scale was an utter failure. Since the level was essentially always set to either "yellow" or "orange", nobody ever really paid any attention to it. It simply became a part of the background noise, consistently ignored because of its ubiquity. People are able to remain vigilant and aware only for short periods of time—when they're asked to do so for years at a time, they simply become complacent. Not surprisingly, the terror alert scale was eventually retired, presumably still set to "orange".

The Fed's latest QE program similarly attempts to impact the psychology of the American citizens—if consumers and investors know that the Fed is committed to always printing money, they'll be more likely to step out on the risk scale and start spending and investing money (while it's still worth something) rather than waiting around until tomorrow. It theoretically creates a certain sense of urgency that the Fed has been laughably unable to instill up until now.

Unfortunately, perma-QE is likely to fail in the same manner that the DHS terror alert scale ultimately failed. Sure, QE-∞ will cause a Pavlovian short-term rally in the markets, just like the terror alert scale caused us all to be super-vigilant at airports for about 3 months. But sooner or later, this perma-QE will just fade into the background like the "orange alert" that we all ritualistically ignored after a while.

The simple fact is, "QE always" is "QE never", just like anything else that was once rare but then became ubiquitous (like, say, a college education). Once a new baseline expectation has been set and adjusted to, this "easing" simply becomes part of the landscape, and it will become increasingly difficult—if not impossible—for the Fed to effect incremental change. In all areas of life, ubiquity brings along with it an ironically increased invisibility—call it the paradox of ubiquity. Ubiquity breeds irrelevance, for Fed policy just like anything else.

To date, previous QE programs have been effective because they have been sudden, strong, and powerful—like a quick shot of cold air on a hot summer day. But once we've turned the AC on full blast and left it there for months at a time, does anybody even notice it anymore? Or do they only notice when it's taken away? I'd argue the latter, which means that the days of the Fed influencing the market with incremental policy proposals are largely in the past.

So as I said to lead off this rant, the Fed has now fired its last meaningful bullet (some intrepid journalists in fact called it a bazooka), and it sure as hell better work and work quickly. Because if it doesn't, they're going to have to do something far beyond drastic to ever have any impact on the economy (or markets) again, now that they've made permanent QE the baseline.

At some point in the not-too-distant future, the market will experience another correction, and the economy will tilt into another recession. The question is, what will the Fed do then, and will it have any impact whatsoever? The Bernanke Terror Alert Scale is now definitively set to "red"—to have any future effect, Bernanke will have to invent a new color, and I for one don't think that's possible.

So congratulations, Chairman. You've seemingly pulled off the impossible and printed yourself into irrelevance. Enjoy these next few weeks or months of Fed-fueled market rallies while you can—I'm betting this may be the last time you'll ever see them.

David Einhorn on the Fed and The Simpsons

I don't always agree with hedge fund manager David Einhorn, but the piece that he wrote for The Huffington Post regarding Fed policy is one of the better pieces I've read this year.

It's not easy to take a complex subject and make it easy to understand (not to mention entertaining), but I think Einhorn's pulled it off here. And the fact that he brings The Simpsons into it just makes it all that more appealing to me. I'm easy.

I'll excerpt a couple of sections of it here (basically the beginning and the end), but I seriously suggest that you take a few minutes and read the whole thing. At the very least, it'll help you understand just why the economy can't seem to get out of its own way.

A Jelly Donut is a yummy mid-afternoon energy boost. 

Two Jelly Donuts are an indulgent breakfast. 

Three Jelly Donuts may induce a tummy ache. 

Six Jelly Donuts -- that's an eating disorder. 

Twelve Jelly Donuts is fraternity pledge hazing. 

My point is that you can have too much of a good thing and overdoses are destructive. Chairman Bernanke is presently force-feeding us what seems like the 36th Jelly Donut of easy money and wondering why it isn't giving us energy or making us feel better. Instead of a robust recovery, the economy continues to be sluggish. Last year, when asked why his measures weren't working, he suggested it was "bad luck." 

I don't think luck has anything to do with it. The blame lies in his misunderstanding of human nature. The textbooks presume that easier money will always result in a stronger economy, but that's a bad assumption... 

I think we've reached the point where even Homer can see that the last thing he needs is another Jelly Donut, but the Fed Chairman is oblivious. 

We can all say "D'oh!"

Since I left out the entire guts of the argument, you'll have to go to the full article to see what he's saying. I like the analogy, and I definitely agree with Einhorn's conclusions. The Fed needs to get out of the way, allow the market's price mechanism to work properly (even if that means significant short-term pain), and let the economy begin to heal itself. Doing otherwise will only prolong the pain, and could even create the next crisis--I might in fact argue that it already has.

[Huffington Post]

Paul Ryan gets it?

I've had my disagreements with Paul Ryan's decisions in the past (namely, voting for TARP and voting for Medicare Part D), but today he issued some incredibly sensible analysis in his questioning of Fed Chairman Ben Bernanke.



The highlight, as I see it: "The Federal Reserve, whose primary goal is to manage our money, is involving itself in fiscal policy--is sort of bailing out fiscal policy, because the branch of government in charge of fiscal policy, this branch, is not doing its job. I mean, a budget hasn't passed Congress in two years."

That is correct. I vehemently disagree with Bernanke and his inflationary policies, as I've made clear here on several occasions. But as I pointed out in my post earlier this week, Bernanke is merely raising taxes (effectively, at least) where Congress has refused to do so. His constant purchases of U.S. debt have kept the federal government solvent where it otherwise would not be (by artificially depressing borrowing costs), and it is therefore disingenuous at best to see elected officials hurling barbs at Bernanke without also acknowledging their own shortcomings.

With his analysis today, Rep. Ryan showed that he at least seems to understand the dynamics at play--Bernanke may be the devil, but he's a devil of Congress' own creation. One cannot exist without the other.


(h/t The Mess That Greenspan Made)

Quote of the Week

This week's Quote comes courtesy of Karl Denninger, who has inspired more than a couple of my rants here in the past. It stems from the Congressional Budget Office's projections released yesterday, which are absolutely chock full of ugly numbers and statistics (ignore them at your own peril). Let's get right to it:

This week's QUOTE OF THE WEEK

"Government spending for Medicare, Medicaid and other healthcare programs will more than double over the next decade to $1.8 trillion, or 7.3 percent of the country's total economic output, congressional researchers said on Tuesday.


In its annual budget and economic outlook, the non-partisan Congressional Budget Office said that even under its most conservative projections, healthcare spending would rise by 8 percent a year from 2012 to 2022, mainly as a result of an aging U.S. population and rising treatment costs. It will continue to be a key driver of the U.S. budget deficit."
                                           - David Morgan, Reuters

Look at that first paragraph: that's 7.3 percent OF THE COUNTRY'S TOTAL ECONOMIC OUTPUT! Not of tax revenues, not of total government spending, of the ENTIRE ECONOMIC OUTPUT. In case you were wondering, total federal tax receipts in 2011 were approximately $2.3 trillion, on total economic output (GDP) of $14.6 trillion--about 15.8% of total economic output. That means that our expected expenditure on health care programs would be a full HALF of everything that we currently bring in from tax revenues.

That is, in a word, untenable. There's absolutely no way to make these programs solvent, and we need to stop pretending that there is. We can't grow our way out of this problem, we can't inflate our way out of this problem (hi, Ben), and we certainly can't default our way out of it (although that's where we're heading).

Oh yeah, and just repealing Obamacare doesn't do anything to help matters either, in case any of you Republican-lovers were wondering.

This country is bumping up against fundamental problems with respect to how it cares for its elderly, and it's clear that we've made promises that we mathematically cannot keep. A millionaire tax or a wealth tax or an inflation tax or whatever other tax can't compensate for the fact that there's just simply not enough money to go around. We need to admit that we've made promises that we can't keep, and begin the ugly and unpleasant process of reneging on those promises. The longer we wait, the worse the problem will get--procrastination is an expensive vice that we simply cannot afford.

[Reuters]
(h/t Karl Denninger)

The inflation tax

With all the idle campaign rhetoric surrounding millionaire taxes and wealth taxes (read that wealth tax article, by the way, it's a good one), you might have missed the massive tax increase that was passed last week without any fanfare at all. Oh, you did miss it? Don't worry, I've got your back.

The Federal Reserve took the historic step on Wednesday of setting an inflation target, a victory for Chairman Ben Bernanke that brings the Fed in line with many of the world's other major central banks.

The U.S. central bank, in its first ever "longer-run goals and policy strategy" statement, said an inflation rate of 2 percent best aligned with its congressionally mandated goals of price stability and full employment.

First of all, generally speaking, anything that can be considered "a victory for Chairman Ben Bernanke" should also be recognized as a loss for working Americans. Furthermore, the article's nonchalant assertion that inflation targeting is okay because it "brings the Fed in line with many of the world's other major central banks" is offensive, in a "if all your friends jumped off the Brooklyn Bridge, would you do it too?" kind of way. We've all seen the mess that Europe has created for itself, and so far we've comforted ourselves by nodding in agreement that "things are different here". Nope. Not anymore. Ben Bernanke just dealt the final death blow to "American exceptionalism".

But all that aside, what comparatively few people recognize is that inflation--especially inflation as an explicitly defined policy goal--is effectively a tax levied without Congressional approval. By decreasing the purchasing power of the dollars that people earn, we're essentially confiscating a larger chunk of their earnings--that's no different from doing so more directly via taxation, and the same parties benefit from the policy in the end.

Sure, 2% a year may not sound like much to us, but it's a hell of a lot over the course of a working lifetime--with compounding, 2% annually over a 45-year time horizon amounts to a 144% increase in prices. A loaf of bread that costs 3 bucks today, then, would be expected to cost $7.32 in 2057, when today's college graduates (not to mention those who didn't go to college, screw them, right?) would be looking to retire. That's a pretty big failure with regards to the "price stability" half of the Fed's famous dual mandate.

Of course, this cost inflation isn't as big of a deal for those of us with investable assets who have a realistic method of hedging against cost increases. But it's definitely a huge problem for the poorest Americans, who live paycheck to paycheck and for whom a 2% shift one way or the other can make or break a budget. And if you think those workers' wages are likely to increase in order to keep pace with inflation, you're insane--they'll be lucky to increase at 1% a year, even if their productivity increases measurably.

Inflation, effectively, is the ultimate regressive tax. We fund our deficits and debt by printing money, and the effects of that money printing disproportionately impact the poor. I've discussed this dynamic at length before, but it's vital to remember that the way we calculate our "inflation rate"--as a one-size-fits-all statistic that includes prices of electronics, food, gas, housing, insurance, clothing, and more, and assumes that all consumers have the same relative breakdown between those expense categories--in incredibly flawed in practice.

This chart (an old favorite) shows that the poorest 20% of Americans spend nearly 60% of their income on food and energy, while the richest 20% spend only about 10%. This disparity matters significantly, as it means that different people will be experiencing different "effective" inflation rates, regardless of what the Fed's catch-all measurement declares. Without getting too deep into the mathematical weeds, it should be clear that an environment in which electronics and housing prices are decreasing and food and energy prices are skyrocketing (which is our current reality) will devastate a poor American, be roughly neutral to an "average" American, and matter little to a rich American.

It's not at all unreasonable to assert that a poor person's effective inflation rate could be closer to 3% or 4% (or higher--in developing nations, a disparity of 3% between rich and poor is not uncommon), as opposed to the summary "2%" statistic that the Fed is targeting. Too bad, then, that the poor person has no investable assets with which to hedge against those price increases.

In every way, inflation is a regressive tax that devastates the poor and working class to the benefit of the richest. Not only do the poor have no way to protect themselves against inflation, they also have the distinction of having a higher-than-average "effective" inflation rate. Sucks, huh?

If you want to know why income and wealth inequality is at such lofty levels in the United States, don't blame "capitalism" or our education system or any of a million social dynamics that politicians try to hide behind. Inflation--persistent, intentional inflation--is what keeps the lower class down, and somebody needs to tell them that. This crap has to stop some time. 

[Reuters] 

"Loss allocation" as government policy

This is usually the sort of thing that I just post on my Twitter feed and let pass, but given my past rants against the Fed, I can't let their most recent acts of political activism go unmentioned. Rather than do my own ranting, though, I'll let the king of blog ranting (Karl Denninger) take over. He absolutely goes after the Fed here (mimicking the Wall Street Journal), and deservedly so.

There's a point at which The Fed's actions reach into the realm of rank politicking and attempts to protect their "chosen many" from their own foibles; we've certainly seen plenty of games played in the last three years.

But this paper, sent to Congress unsolicited, apparently went too far for even the Journal's bankster-crank-stroking reflexes.  Among other things it said:

In this report, we provide a framework for thinking about directions policymakers might take to help the housing market. Our goal is not to provide a detailed blueprint, but rather to outline issues and tradeoffs that policymakers might consider. We caution, however, that although policy action in these areas could facilitate the recovery of the housing market, economic losses will remain, and these losses must ultimately be allocated among homeowners, lenders, guarantors, investors, and taxpayers.

This is where the problem is, of course.  Where does the government get the right to "allocate losses" through interventions?  The dirty little secret about the housing mess is that:

• The Fed was largely complicit in causing the housing bubble.  In fact, Greenspan intentionally stoked this speculative orgy and further, both he and Bernanke intentionally averted their eyes from the monstrous credit expansion that "maintained" economic output and which was utterly unsustainable -- a mathematical fact that was obvious to anyone who bothered to look at the very data The Fed maintains!  In other words The Fed is now trying to find ways to evade responsibility for what it did. 

• The losses are real but being hidden by further Fed actions!  Just one example is the hundreds of billions of dollars of second lines (Home Equity and "Silent Second" mortgages) that are behind underwater, non-performing first line mortgages.  These have an actual net present value in a foreclosure of zero, as they're not entitled to one penny of recovery until every dollar of the first is satisfied, and the first is underwater and thus will not be fully recovered.  All of our large banks have monstrous exposures in this regard -- almost none of these loans were securitized and thus they are all sitting on bank balance sheets, most at nearly 100 cents on the dollar.  These accounting values are fictions.

The reason that The Fed and our Government are desperate to hide these losses, praying for a miracle to somehow keep them from being recognized, is quite simple -- these long-duration investments are typically held by insurance companies and pension funds.  Recognition of these losses will cause the allegedly "healthy" firms and funds that hold this paper to be shown to be severely impaired or worse.

Denninger is absolutely dead on here, and I really have little to add. Our federal government (along with the Fed) has increasingly decided that it is their job to determine winners and losers in the economy. "Loss allocation" is not a central government function, nor should it be. The potential for unintended consequences and conflicts of interest is simply too high, a fact that some people in government still recognize and appreciate.

We can hide these losses as long as we want, but sooner or later it's clear where they will end up--on the backs of taxpayers, those who are paying the least attention. If you don't explicitly refuse to take these losses, you're going to end up with them by default. Therefore, ignore these games that the Fed is playing at your own peril--it's your money that's at stake.

[Market Ticker]

Quote of the Week

This one probably wouldn't be Quote-of-the-Week-worthy if it was coming from a different source, but since it's coming from CNBC, it's noteworthy.

If you've been reading me long, you know how I feel about the Fed's easy-money policies and what they do to the economy. But CNBC isn't quite the cynic I am, and the network in fact tends to be a heavy apologist for government policies and for big business in general (Rick Santelli is a notable exception, but Steve Liesman is a hack through and through). That's not necessarily surprising giving that their ultimate parent company is one of the biggest corporations around, but it's nonetheless worth knowing.

That's what made this article so striking when I came across it yesterday. The topic of the article was the Fed's insistence on focusing on "core" inflation measures which ignore the impacts of food and energy prices, which are deemed "volatile" and therefore too noisy to consider. The problem, which I first mentioned in this blog post, is that food and energy comprise the majority of American's budgets--especially for the poorest Americans.

Ultimately, the cost of fuel and food is basically all that matters to most Americans. Ignoring it is very dangerous, especially when you note the broader trend--and that broader trend is the subject of this week's quote.

This week's QUOTE OF THE WEEK

"Since 1987, there has never been a five-year period where food and energy prices declined on an annualized basis... Only four years in the last 24 have seen a decline in combined food and energy prices."
                           - John Melloy, CNBC Executive Producer

Yeah, it's hard to make a case that inflationary pressures are "temporary" or "transitory" when 25 years of history suggest otherwise. We need to stop pretending that government policies aren't creating this phenomenon, or that it's somehow going to magically reverse itself now that our planet is welcoming its 7 billionth human. Keep that in mind with this week's Fed meeting ongoing--whatever Bernanke says, it's what he's not saying (or conveniently ignoring) that's arguably most important.

[CNBC]

Amusing

Sure, this is standard online poll ballot-stuffing, but given my previous rants on this blog, I found the results of this CNBC poll to be humorous.

Yup, that's about how I feel.

[CNBC]  
(h/t Mish Shedlock)

The uneven economic recovery

I've certainly written here before about my belief that the policies which have been enacted--both by Congress and by the Fed--in response to our economic crisis have disproportionately benefited the interests of the rich and the corporate, at the expense of the poor (and the retired on fixed incomes).

Earlier this week, I came across an interesting item (and graphic) from the New York Times which gave a further indication of the impact of these policies.

Americans are becoming more optimistic about the prospects for the economy, but are still concerned about their own financial situation.

For the first time in six years, at least half of Americans questioned for the Thomson Reuters/University of Michigan consumer sentiment index said they believed that business conditions had improved over the previous year, according to the preliminary results from the February survey...

Before the recent downturn, only once — in early 1980, during a sharp recession accompanied by high inflation — has a majority said their families were worse off financially than they had been a year earlier. But a majority felt that way for all but one of 18 consecutive months beginning in mid-2008, as the financial crisis took hold.

Even now, 37 percent say they are worse off, compared with just 28 percent who think they are doing better.

In the past, there were only a few times when an absolute majority of people thought they would not be able to keep up with inflation over the next year, and before the financial crisis, all of those times came when inflation was high. But now, 53 percent feel that way, while a record-low 8 percent think their income will rise faster than prices.

The reason for that seems to be largely based on worries about income rather than prices. Although expected inflation rates have been rising, a majority still expect prices to rise by 4 percent or less.

Regardless of what Ben Bernanke says about inflation, it's clear that the impact on the typical American family has been devastating. Despite the steady improvement in summary economic statistics, the gains simply have not been equally shared. That's why you see charts like these, and persistent pessimism in polls like these even when people see the general situation improving.

Economic "recoveries" that are built on inflationary policies will always leave the majority of Americans behind, while disproportionately benefiting a very small subset of the richest of the rich. One of the only reasons that we are not seeing widespread riots in America (like we saw in Egypt, where inequality and inflation were primary driving factors behind the rebellion) is that so many Americans are in fact delusional--they don't realize how unequal we really are, as this post expertly points out.

Sooner or later, as already happened in 2008, the majority of Americans will realize that they have been scammed by Bernanke, et al. GDP statistics may be improving, but the reality--that more and more Americans seem to be waking up to--is that most Americans are getting effectively poorer, not richer. And those who really are getting richer certainly aren't sharing.

[New York Times]

New York Times on Ron Paul

There's an interesting article by Floyd Norris in today's New York Times about Ron Paul and his upcoming chairmanship of the House Monetary Policy Subcommittee, which I previously wrote about here. It's an interesting and important read, and I suggest you give it a look if you have the time.

The article does a fantastic job not only of laying out the history of the Fed and its relationship with the Federal Government at large, but also of setting up the imminent debate between Ron Paul and Ben Bernanke. I personally think that this debate/showdown will be one of the most important stories to watch in 2011, as the Fed's seemingly unchecked power comes under ever further scrutiny.

A congressman from Texas, long a dissident critic of the Federal Reserve, is scheduled to become the chairman of a House panel with jurisdiction over the central bank. It promises to be a miserable time for the Fed chairman as he is peppered with hostile questions at oversight hearings and with legislation to force complete audits of Fed operations.

So it is now, with Representative Ron Paul about to take over as chairman of the Domestic Monetary Policy Subcommittee of the House Financial Services Committee. Mr. Paul campaigned against big banks, arguing that concentrated financial power goes hand in hand with concentrated political power.

If the Fed were abolished, he wrote last year, “the national wealth would no longer be hostage to the whims of a handful of appointed bureaucrats whose interests are equally divided between serving the banking cartel and serving the most powerful politicians in Washington.”

It is not hard to imagine Mr. Paul lecturing the president of the Federal Reserve Bank of New York in a committee room: “You can absolutely veto everything the president does. You have the power to veto what the Congress does, and the fact is that you have done it. You are going too far.”

And so it was back in 1964, when that lecture was actually given by the then-new chairman of the House Banking Committee, a Texas congressman named Wright Patman. As Time magazine then wrote: “For three decades, Wright Patman has fumed and fussed that the Federal Reserve system is too secretive, too independent, too insensitive to the hopes of small borrowers. A sharecropper’s son, he often charges that it is a tool of Wall Street bankers.”

A joke during Mr. Patman’s tenure was that the reason he chose a bright red carpet for his office was to hide the blood stains after William McChesney Martin Jr., then the Fed chairman, emerged from private meetings.

The apparent cyclicality of American history and politics is certainly eye-opening; what's even more notable is that even when faced with certain obvious truths, we can be painlessly slow to do anything about them.

The Fed's power has grown incrementally over a period of decades, so gradually as to be imperceptible to most citizens (especially those who do not pay close attention to finance and the markets). But as is often the case, the public seems to be waking up rather suddenly to the truth of the matter--that the Fed has become significantly more powerful than the elected officials we obsess over daily, without being subject to any of the same Constitutional checks and balances.

Time will tell if the Paul/Bernanke debate creates the lasting change that I believe we need (or at least a wider conversation about the role of the Fed), or if it becomes a mere footnote in American history like the Patman/Martin battle decades ago. It is my sincere hope that the former is the case.


[New York Times]

Quote of the Week

Alright. I'm cheating here. This week's Quote of the Week isn't really a quote, so much as it is a clip, with a quote that I pulled as an excuse to post the clip. But so be it. This is entertaining.

This week's Quote of the Week

"The printing money is the last refuge of failed economic empires and banana republics, and the Fed doesn't want to admit this is their only idea." -Little cartoon dude



The whole thing isn't totally fair, but it's amusing. The Fed is taking a lot of heat lately, deservedly so. That a clip like this has gone viral shows just how far the Fed's credibility has fallen.

Why you should ignore "core inflation" measures (and Paul Krugman)

My old punching bag Paul Krugman is back at it again, with a somewhat condescending blog post imploring us all to mimic the Fed and focus only on "core inflation" measures (which do not consider food and energy prices). I'll repost the whole thing here:

Just a quick illustration of why I — along with the Fed and everyone else who’s serious about these things — use core inflation rather than headline inflation to measure trends. Here’s core versus headline CPI growth for the past decade:

So, do you believe we faced runaway inflation in early 2008, which had turned into runaway deflation by the middle of 2009, then miraculously stabilized? I don’t; I think volatile prices were volatizing, but that underlying inflation was trending steadily downward.

"Everyone else who's serious about these things?"--oh, you smug sonofabitch... Okay, that aside, the Wall Street Journal immediately posted a rebuttal (imagine that).

As you can see, the headline CPI item is incredibly volatile, but seems to hew to the core measure over time.

But that isn’t the entire story. Here’s another chart showing the cumulative change in the headline and core CPIs since the end of 1999:

The core has risen 24.1%, the headline has risen 29.4%. So except for those supermodels who don’t drive or eat, prices have risen more over the past decade than the core measure suggests.

That’s not to say the core isn’t generally a better guide to understanding what’s going on with underlying inflation; rather that there may be something going on with those noncore measures that is worth paying attention to. For example, rapid growth in developing markets may be bringing about a shift in global demand for commodities such as oil and grain that makes it unlikely that their prices will revert to the mean.

The line about supermodels, while snarky, is an important one. It dovetails nicely with an e-mail response that I sent to a reader (my mother-in-law) this morning, after she had sent me a link to this New York Times article.

As I wrote in my e-mail, my greatest fear is of "biflation", which is EXACTLY what the Journal's graph is showing. What Krugman chooses to refer to as "underlying inflation" is realistically durable good inflation--autos, technology, etc. This portion of goods represents 90% of income for the richest 20% of Americans, but only 40% for the poorest 20% (refer to the chart in this post for a stunning graphical representation).

So for the poorest Americans (Princeton professors need not apply), which is realistically the more important measure of inflation? The one that tracks their ability to eat and heat their homes, or the one that tracks their ability to buy iPods and Chevy Volts? Yeah, I thought so...

So, Krugman, you're right. If we don't care about poor people (or anybody but the very rich), we should absolutely mimic the Fed and focus only on core inflation. How a self-described "liberal" can espouse a policy that so clearly favors the richest of the rich is absolutely baffling to me.

Here's my full e-mail response, if you're interested to learn more about biflation and why I don't trust the Fed or quantitative easing.

What worries me most (and what I think these Fed policies are likely to cause) is "biflation"--where the costs of vital goods (food, energy, clothing) increase fairly rapidly, while deflation persists elsewhere (technology--where it's considered perfectly normal, autos, housing, other durable goods). Essentially, earnings-based assets (commodities) increase in price, while debt-based assets decrease. This is already occurring in the markets, where commodities prices are shooting through the roof, while "core inflation" measures--which include durable goods--have remained stagnant (low levels of "core inflation" are a large part of Bernanke's justification for his policies).

Biflation creates a particularly dangerous situation because it severely harms the poor, while not promoting their employment. Recall that the poorest 20% of Americans spend roughly 60% of their income on food and energy, whereas that proportion for the richest 20% is closer to 10%.

Furthermore, the increase in the cost of staple goods will cause margin pressure on almost all corporations as their input costs rise, which will put pressure on profits and make them reticent to begin hiring. Biflation is particularly dangerous when you consider that nearly all of our most important businesses in America are in the provision of durable goods rather than vital goods (exceptions include ExxonMobil, Chevron, etc., but it's clear to see how biflation would hurt banks, technology companies, and not least of all Wal-Mart, our nation's largest employer by a long shot).

Bernanke has claimed that his policies will create a "wealth effect" as stock prices rise--the wealthy will spend their new money on all sorts of goods, creating traditional trickle-down economic growth. I'm skeptical. I think that few investors are comfortable that stock prices will remain at their current levels, and they won't begin spending that "wealth" until they are comfortable that it's here to stay. The longer they do not, the more time higher input costs will have to flow through to corporate earnings. As earnings decrease, so too will stock prices, possibly creating a self-fulfilling prophecy for investors--as stock prices correct, they'll have even less reason to spend their newfound wealth.

It's not a rosy picture, but I think it's fairly clear what overly aggressive Fed policies have created in the past. Asset bubbles are essentially unsustainable, and incredibly ugly when they burst. The Fed has determined that the best way to save the economy is to create a new asset bubble. I think that's foolhardy. Our economy has significant structural problems that will take time to work out--I'd take a Japanese-style lost decade any day if my other option is a decade of relentless bubble-blowing and bursting. I especially feel that way since we've already essentially HAD a lost decade--since 2001, we've seen an increase in unemployment and national debt, a decrease in the dollar's purchasing power, and no increase in the stock market (in fact, the S&P is about 8% lower than it was in Jan. 2001). That's what these Fed policies do.

We need to be patient and work the bad debt out of the system, not panic and flood the market with easy money so as to encourage more risky debt-fueled behavior.

[New York Times]
[Wall Street Journal]

Quote of the Week

Though I already awarded Scott Adams with an honorary (and well-deserved) "Quote of the Week" yesterday, I didn't want to let a Tuesday pass without an official Quote of the Week.

If you've been reading me consistently, you'll remember my rant against the Fed last Thursday. Didn't wanna do it... felt I... owed it to them.

At any rate, it seems like a few people around the world have agreed with my rant, and chimed in as well. The Germans always do a great job of cutting through the B.S., so I thought I'd give them the honor of this week's semi-self-congratulatory Quote of the Week.

This week's QUOTE OF THE WEEK

"With all due respect, U.S. policy is clueless." -German Finance Minister Wolfgang Schäuble

To be fair, some translations of Schäuble's comments ("Bei allem Respekt, mein Eindruck ist, die Vereinigten Staaten von Amerika sind ratlos") are a bit more charitable. The key word, "ratlos", could more directly be construed to mean "helpless", "at a loss", or "stumped".

With my background in German, I'll agree that the popular translation is a little shaky, and definitely more direct and damning than Schäuble's untranslated phrase. But nevertheless, his remarks in combination with China's perturbed response (and this morning's downgrade of U.S. sovereign debt by a prominent Chinese rating agency) makes it clear that the world is not exactly on board with Mr. Bernanke's experimental policies.

Remember, the whole world owns U.S. debt, and they won't stand idly by as we try to inflate our way out of it. What began as mild annoyance among the global community this week could easily morph into something entirely different and much more damaging. I hate to be the bearer of bad news, but this is decidedly bad news.


[CNBC]