The Debt Deal’s Failure

Just read an interesting article in Time magazine on the “debt deal” – here are some highlights from the article:

In narrow economic terms, the debt deal is actually not a big deal, neither as good as its advocates claim nor as terrifying as its opponents fear. The actual cut to the 2012 budget, the only budget over which this Congress has control, is $21 billion out of total expenditures of $3.7 trillion–a pittance. Everything else can and will be changed by future Congresses. What the deal does is kick tough choices down the road, this time to a congressional supercommission that will have to come up with a larger plan to reduce debt. And it does nothing to spur growth, without which the debt will expand well above projections. That’s why the usually circumspect Mohamed El-Erian, head of Pimco, the world’s largest bond fund, grades the deal somewhere between an incomplete and a fail. “Other than eliminating default risk emanating from a self-manufactured crisis,” he writes, “there is nothing good about America’s debt ceiling debacle.”

The deal’s largest impact will be political, and there it has been a disaster. The manner in which it was produced added poison to an already toxic atmosphere in Washington, making compromise even more difficult. Democrats now feel they need to mirror the Tea Party’s tactics and are becoming unyielding on any cuts to entitlement programs like Medicare. Republicans, emboldened by the success of their bullying, have closed ranks more solidly around a no-tax agenda. But the only solution to America’s debt dilemma will need to involve both cuts to entitlement programs and higher tax revenues. Even if the besmirched ratings agencies don’t downgrade America, we’ve downgraded ourselves. The system did not work.

We couldn’t be grappling with this at a worse time. Many economists believe that the economy is fragile and that it would be better not to cut spending or raise taxes at this point. It’s true. The sensible economic policy would be more stimulus now and major deficit reduction in a few years. But that kind of smart, sequenced public policy is simply beyond the reach of the American system today.

So far, the national debate has been built around the fantasy that we do not have to choose between big government and low taxes–that we can get both by cutting waste, fraud and abuse. But the money is in the big middle-class items, from Medicare to the mortgage-interest deduction. With federal taxes at 15% of GDP, a historic low, and spending at 24% of GDP, there is really no conceivable way to close the gap without increasing taxes–either raising rates or eliminating deductions and loopholes. And Republicans might find to their dismay that when forced to choose, Americans will decide that they like their government programs after all. Polls show that the public would rather raise taxes than, for example, cut Medicare. (In fact, we would have to do both.) The public may hate government in theory, but it has warm feelings about most individual government programs, from the space shuttle to Head Start to Pell Grants.

Whatever the outcome of the ideological debate, that outcome has to then be translated into public policy. For that to happen, we need a government that works. What the debt crisis has highlighted is that Congress–the heart of day-to-day government–is utterly and completely broken. Countries from Canada to Australia to Singapore implement smart policies and copy best practices from around the world. We bicker and remain paralyzed.

Some of those best practices used to be American. The world once looked at America with awe as we built the interstate highway system, created the best public education in the world, put a man on the moon and invested in the frontiers of knowledge. That is not how the world sees America today. People watched what happened over the past month and could not comprehend it. We have taken something that the world never doubted–the credibility of the U.S.–and put it into question. From now on, every time the debt ceiling has to be debated, the world will wonder, Will America honor its commitments? Will it keep its word? Will the system break down? We have taken our most precious resource, the trust of the world, and gambled with it. If, as a result of these congressional antics, interest rates on America’s debt rise by 1% –in other words, if the world asks for just a little bit more interest to lend us money–the budget deficit will rise by $1.3 trillion over 10 years. That would more than wipe out the entire 10 years of cuts proposed in the debt deal. That’s the American system at work these days.

Climbing a Wall of Worry

What Does Wall Of Worry Mean?
It is a phrase used to describe a condition where a bullish market trend exits even in the face of negative uncertainties.

I thought of this phrase a couple of days ago when I watched a video of Alex Honnold free solo climbing Moonlight Buttress in Zion’s National Park. As my family and I watched the video we decided that this guy Alex is either 1) totally crazy or 2) the most mentally tough guy on the planet.

Even though the stock markets are known to sometimes climb a wall of worry and move up in the face of negative conditions I think right now we are content to stick with our defensive approach that includes ropes, safety nets, etc and leave the climbing of walls without protection to Mr. Alex Honnold. I don’t want our portfolios falling and getting hurt.

The video of Honnold climbing Moonlight Buttress is no longer available but this video will give you an idea of what he does:

Between a Rock and a Hard Spot

So the United States like Greece and several other countries are between a rock and a hard spot – a situation that it is difficult to find an answer to that doesn’t hurt – maybe pretty badly.

The only ways to get some debt paid off is to:

1)      Raise taxes,

2)      Cut spending

Neither of those two things has ever been good for the economy. Any time money has to be sent to payoff creditors it is money that is no longer available to be spent and circulated through the economy.  So we are currently a bit bearish about the health of the economy in the near future.

Another interesting thought is how people are going to handle spending cuts if /when they come. “You’ve got just a huge number of people who, in one way or another, interact with the federal government,” President Obama said last Friday night when he announced that House Republicans had pulled out of the debt talks.

An unprecedented number of Americans now depend on the government for assistance. Roughly one in six people are receiving public aid, with Medicaid and food stamps straining in the wake of the Great Recession.

Data shows that the only way to really get things in control is to cut entitlement programs, which means the large number of people that “interact with the government” are not going to be very happy about it. We saw what happened in Greece– people rioting in the streets protesting government austerity measures.

According to a CNNMoney money article by Tami Luhby – Social Security payments aren’t the only federal lifeline payments that may have to be cut to get our federal debt under control.

The federal government supports myriad safety net programs, such as unemployment insurance, tuition grants, food stamps, child care subsidies and housing assistance. That’s not to mention the nation’s massive health insurance programs: Medicare and Medicaid.

All told, the federal government should distribute nearly $145 billion in lifeline funds this month, according to theBipartisanPolicyCenter.

A record 44.6 million people — or one in seven Americans — received food stamps in April. That’s up nearly 10% from the year before. The government is scheduled to send out $6.7 billion in food and nutrition support, which includes aid for children, pregnant women and new mothers, in August.

Medicaid, the nation’s largest safety net program, serves more than 60 million people. It not only provides health insurance for low-income Americans, but it is also the primary payer for two-thirds of the country’s nursing home residents. Some $50 billion in Medicaid and Medicare payments are set to go out in August.

Nearly 5 million low-income families depend on vouchers or other assistance from the Department of Housing and Urban Development to keep a roof over their heads. But the $6.7 billion in payments in August could be at risk.

And some 3.8 million of the long-term jobless are receiving federal unemployment benefits, which could be halted if the impasse isn’t resolved. They are scheduled to collect $12.8 billion in August.

“If the federal government cuts, people who depend on assistance for food and housing and other basic needs could find themselves in a crisis,” said Jodie Levin-Epstein, deputy director at the Center for Law and Social Policy, an advocacy group for low-income Americans.

Hmmm – things are going to get interesting!

Apple vs U.S. Government

According to the latest daily statement from the U.S. Treasury, the government had an operating cash balance of $73.8 billion at the end of the day yesterday.

Apple’s last earnings report (PDF here) showed that the company had $76.2 billion in cash and marketable securities at the end of June.

The world’s largest tech company has more cash than the world’s largest sovereign government. That’s because Apple collects more money than it spends, while the U.S. government does not.

How would Apple solve the US debt crisis? According to David Weidner’s recent MarketWatch article he says:

 “I’ve been covering Wall Street and corporate America for going on two decades, and if there’s anything I’ve learned it’s that there are really only two kinds of companies: those growing and those shrinking.

The U.S. government today has officially become the latter.

The difference between a growing business like Apple Inc. (NASDAQ:AAPL)  and a shrinking one such as Eastman Kodak (NYSE:EK)  has less to do with spending and revenue and than with psychology. Growing companies go through tough times. They adapt, and they’re poised to strike when conditions are right. They don’t stop innovating.

Defeated companies may be producing steady profits. But they lose their entrepreneurial spirit. They stop looking at the future. They get intimidated. They quit fighting. They look for a sale. They try to buy growth. They play not to lose — and end up losing anyway.

Which of those does Washington sound like?

So, what would happen if Apple had to tackle the debt crisis? First, it would eliminate spending that’s not working. Then it would make a commitment to spend if necessary. Third, it would look for ideas to spend on. Finally, it would call customers’ bluff. How much are you willing to pay for what the government gives you?

Ultimately, what’s happened to our government, lawmakers, elected officials and ourselves is that we’ve have taken on a mind-set of defeat. It doesn’t seem to matter that the business model — taxing for revenue, spending for growth — isn’t broken. After all, it’s working in Germany, Canada, India and China.”

End the deficit in 5 Minutes

I could end the deficit in 5 minutes. You just pass a law that says that anytime there is a deficit of more than 3% of GDP all sitting members of congress are ineligible for reelection.

Warren Buffet

A Visualization of United States Debt

Click the link below for a helpful visual of the level of US Debt:

http://usdebt.kleptocracy.us/

Grade Inflation

I recently read an interesting article in the New York Times about College Grade Inflation by Catherine Rampell.

Take a look at the red line in the chart below, which refers to the share of grades given that are A’s: 

What accounts for the higher G.P.A.’s over the last few decades?

I’d like to think that my own kids are just smarter than me, but the authors don’t attribute steep grade inflation to higher-quality or harder-working students. In fact, one recent study found that students spend significantly less time studying today than they did in the past.

Rather, the researchers argue that grade inflation began picking in the 1960s and 1970s probably because professors were reluctant to give students D’s and F’s. After all, poor grades could land young men inVietnam.

They then attribute the rapid rise in grade inflation in the last couple of decades to a more “consumer-based approach” to education, which they say “has created both external and internal incentives for the faculty to grade more generously.” More generous grading can produce better instructor reviews, for example, and can help students be more competitive candidates for graduate schools and the job market.

The authors argue that grading standards may become even looser in the coming years, making it increasingly more difficult for graduate schools and employers to distinguish between excellent, good and mediocre students. More disturbing, they argue, are the potential effects on educational outcomes.

I’m wondering if this is just another result of the growing entitlement attitude in our world? I hope not, I hope it is because our kids really are smarter.

The Sky is Falling – or wait, is the Ceiling Moving?

I expect that, like me, most of you grew up hearing the story of Chicken Little.

“Chicken Little was in the woods one day when an acorn fell on her head. It scared her so much she trembled all over. She shook so hard, half her feathers fell out. ‘Help! Help!’, she cried. ‘The sky is falling! I have to go tell the king!’

Pretty soon, Chicken Little was joined by Henny Penny, Goosey Loosey, Ducky Lucky and Turkey Lurkey who were all impressed with her explanation for her apparent fear; ‘I saw it with my own eyes, and heard it with my own ears, and part of it fell on my head.’

Of course when this fearful band ran into Foxy Loxy he agreed to take them to the King, which turned out to be his den, and they were heard from no more.”

Sound familiar? Unfortunately, this time it is the King, those in his court and even many representatives of the people, who are crying “The sky is falling!”, and who warn of “Economic Armageddon” in the face of the debt ceiling debate.

Here are some interesting points:

1) The debt ceiling is no ceiling at all. Rather, past Congresses and Presidents have treated it more like a retractable dome on a stadium, which once reached, can be pushed out of the way so that once again the sky’s the limit.

2) Even after the August 2nd deadline, the Federal Government has enough revenues to keep all of the essential government services up and running. From its $172.4 billion in August revenues, Washington could pay interest on the Federal debt ($29 billion), Social Security payments ($49.2 billion), Medicare/Medicaid ($50 billion), unemployment benefits ($12.8 billion), keep paying its soldiers ($2.9 billion) and keep up the salaries of the one-third of the federal work force deemed essential ($4.5 billion) and still have about $24 billion left for any other programs it considers vital (figures are from the Bipartisan Policy Center). When the government was shut down in 1995, the Policy Center found that the effects on the economy were “modest.”

The debt ceiling is an artificial creation of Washington politicos to show that they are being fiscally responsible. However, in the past it has not delivered on its promise of being a restraint on spending. It’s been a paper tiger, easily caged by a Congressional resolution every few years that merely increased the allowable debt number yet again.

So if the debt ceiling isn’t all it’s made out to be, what’s so important about the current negotiations? It appears that both Republicans and Democrats are merely trying to put themselves in the best light for the 2012 elections.

The Democrats believe that a crisis will give them an advantage with their more government-dependent constituencies like it did in 1995. They seek to paint the Republicans into a corner where they can be labeled extreme and uncaring.

The Republicans, after being willing compromisers in the spending increases with the Democrat Congresses under President Bush, believe they just got a new lease on life with their landslide victories in the 2010 elections. They don’t want to turn their backs on the voters that put them back in charge of the House of Representatives.

The result, while political, is an honest deadlock that has both parties doing what they should have always done — represent the interest of the voters that elected them. Still, sometimes representatives must be leaders, and now with President Obama failing to generate sufficient credibility to make a deal and having yet to put a public, congressionally scorable plan on the table, the primary responsibility for leadership moves back into Congress’ hands. I appears that Congress will step up and work out a deal in time to avoid President Obama’s Treasury Department prioritization of how to spend the $172.4 billion in August without adding to the deficit. Of more concern to the markets, I believe, is whether the plan for, or actual reductions in, spending that accompanies any debt ceiling deal are significant and meaningful. Many fiscally conservative commentators of both political stripes (yes, skeptics, there are still numerous fiscally conservative Democrats) have been saying for a long time that if Washington doesn’t impose some fiscal discipline, then the bond markets will.

Traditionally, this has meant that interest rates will rise and the threat of an economic slowdown and increased borrowing costs will rein in our public officials. Today, a third party has arisen that creates a step before the pressure from the bond market. No, I’m not talking about the Tea Party. Today, we have the credit rating agencies (S&P, Moody’s and Fitch) getting into the act. They threaten a downgrade even if, or should I say, especially if, a debt ceiling increase is approved.

Any downgrade by the credit agencies could have serious repercussions. While the economy is probably still weak enough to provide protection against a substantial increase in interest rates that some fear, the psychological blow to the American psyche would be substantial. This subsequent “crisis of confidence” and a downgrade to our credit rating could require some time for recovery. Since an economic recovery is normally based on rising, rather than declining, confidence, this could have real costs.

So what do the agencies want in order to avoid a downgrade? As I said, raising the debt ceiling isn’t the answer. Instead, they say they want reductions in spending, or a meaningful procedure to attain them. The Democrats are shopping their solution: $2.7 trillion in cuts in spending, and an extension of the debt ceiling debate until after the elections. A few reports say they also want tax increases, but since the Senate Democrats have failed throughout the year to put any plan in writing, we don’t know the details for sure.

Although the Republicans in the House have proposed budgets, ten-year plans, and actually passed legislation, those have all been rejected by the Democrats (who just can’t say yes?) and they are floating a new two-step approach. It raises the debt ceiling $900 billion into 2012 with an equal amount of spending reductions, then requires another $1.9 trillion in cuts to further extend the ceiling into 2013.

It would seem to any reasonable person that if the Democrats require an extension past the 2012 elections and are willing to do so that, the Republicans should jump on the offer as long as it does not contain tax hikes in a fragile economy. They would do this, it is supposed, because about the same amount of spending reductions as they desire could be accomplished in one fell swoop.

Of course, the devil is in the details. Over a trillion dollars of the Democrat “spending cuts” (cutbacks already announced for the wars in Iran and Afghanistan) are not new, but rather were already being counted on as budget reductions. And while the Republicans have focused on spending, they also want to see entitlement and tax reform. Their two-step approach contemplates that along with a permanent debt solution, while the Democrat proposal just attempts to plug the hole in the dike.

It appears that an amalgamation of the two plans may yet emerge. Perhaps a move to make those Democrat cuts “real, and additional cuts” will satisfy both the Republicans and the credit agencies, if accompanied by a framework for addressing entitlements and tax reform — like the second step of the Republican plan. But who really knows?

Until this fog of uncertainty is lifted, financial markets are likely to stumble. Over the last nine trading sessions, every one-day price advance has been met with a price decline the next. Good news cannot overcome the omnipresent crisis atmosphere over the debt ceiling hike.

That’s the way it’s likely to continue. After all, while Chicken Little may have been wrong when she said that the sky was falling… she was hit by something!

We remain very flexible and unbiased in our portfolios and anxiously await some decisions to be made so we know which way to proceed.

(thanks to our good friends at Flexible Plan Investments for this insightful material)

Squirrel!!

Did you ever see the movie “UP!”? There’s a dog in it, Dug the Talking Dog, whose focus is continually interrupted, signaled by his shout of “Squirrel!” (need a refresher on Dug? See here:)

This video best captures the environment in all the financial markets so far this year. All year long, the markets will start a trend only a short time later to change course with the shout of “Squirrel!”

Some of the things causing so many “squirrels” running around this year are poor job creation, good earnings, mixed signals in all economic data, (see blog posts below on some of those), earthquakes, tsunamis, nuclear crises, Egypt, Libya, Greece, Spain, Italy, US debt ceiling, etc, etc.

We’ve been able to make money this year despite the constant whipsaws in the markets, but not as much as we could if we could get some trends to develop that will last a little longer than a week or two. The indecisiveness of the markets and constant changing of feelings in the world has had the markets yelling “Squirrel” very often so far this year. All the fits and starts the market has experienced this year have been frustrating. Every time a trend begins to develop, some news item diverts the market’s attention and a reversal begins and the trend and strength indicators all have to reset again.

Our investment strategies are built on keeping the money always invested in the areas with the most strength. We don’t much care where that is, we just let the markets move as they will and we follow the strongest asset classes until they weaken and dictate a change to stronger areas.

Here are some charts that show the volatility I’m talking about:

First:  S&P 500 Index

As you can see from the chart, there have been quick, violent moves in both directions with an overall positive return as of today.

Second:  Oil

Oil is actually negative as of today, which we all don’t mind paying less at the gas pumps.

Third:  Agriculturals (Wheat, corn, cattle, cocoa, coffee, cotton, soybeans, sugar, etc..)

Slightly positive with some big volatility.

Fourth:  US Dollar since May

All kinds of indecision continues in the U.S. Dollar vs. The Euro.

It’s impossible to capture gains from every quick up or down  More solid and longer lasting trends will develop over time so we will have the opportunity to profit more from those moves.  We are excited for the future and hope the markets pick a direction sooner rather than later so we may all benefit from the trend – whichever direction it may be!

June Unemployment is Grim: A Look at Employment-to-Population Ratio

A disappointing increase of only 18,000 jobs was accompanied by a June unemployment rate of 9.2%, up from the previous month’s 9.1%. The briefing.com consensus was for 9.1% and their own estimate was spot-on at 9.2%. The employment-to-population ratio is hovering around levels first seen in March 1953.

Here is the lead paragraph from the Employment Situation Summary released this morning by the Bureau of Labor Statistics:

Nonfarm payroll employment was essentially unchanged in June (+18,000), and the unemployment rate was little changed at 9.2 percent, the U.S. Bureau of Labor Statistics reported today. Employment in most major private-sector industries changed little over the month. Government employment continued to trend down.

The unemployment peak for the current cycle was 10.2% in October 2009. The chart here shows the pattern of unemployment, recessions and both the nominal and real (inflation-adjusted) price of the S&P Composite since 1948.

Unemployment is usually a lagging indicator that moves inversely with equity prices (top chart). Note the increasing peaks in unemployment in 1971, 1975 and 1982. The inverse pattern becomes clearer when viewed against real (inflation-adjusted) S&P Composite, with its successively lower bear market bottoms. The mirror relationship seems to be repeating itself with the current and previous bear markets.

 

 

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The second chart shows the unemployment rate for the civilian population unemployed 27 weeks and over. The June number is 4.1% — up from May’s 4.0%. This measure gives an alternate perspective on the relative severity of economic conditions. As we readily see, this metric is significantly higher than the peak in 1983, which came six months after the broader measure topped out at 10.8%.

 

 

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The next chart is an overlay of the unemployment rate and the employment-to-population ratio (age 16 and over).

 

 

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The inverse correlation between the two series is obvious. We can also see the accelerating growth of two-income households in the early 1980′s. The June ratio is back to the ratio low of 58.2% in November 2010 and December 2009 — a level not seen since August 1983. In fact, the current level puts us virtually back to the 58.1% ratio of March 1953, when Eisenhower was president, the Korean War was still underway, and rumors were circulating that soft drinks would soon be sold in cans.

The employment-population ratio will be interesting to watch going forward. The first wave of Boomers will be a downward force on this ratio. The oldest of them were eligible for early retirement when the Great Recession began, and the Boomer transition to the retirement will accelerate over the next several years.

What is the average length of unemployment? As the next chart illustrates, are perhaps seeing a paradigm shift — the result of global outsourcing and efficiencies of technology. The post-recession duration of unemployment continues to rise. It has approached a level nearly double the peak in 1983 following the 1981-82 recession.

 

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The last chart is one of my favorites from CalculatedRisk. It shows the job losses from the peak employment month since World War II. Note the addition of the dotted-line alternative for the current cycle, which shows unemployment excluding the temporary census hiring.

 

 

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 The start date of 1948 was determined by the earliest monthly unemployment figures collected by the Bureau of Labor Statistics. The best source for the historic data is the Federal Reserve Bank of St. Louis.

Big thanks to Doug Short at www.dshort.com for compiling such great data.