Mindless Austerity vs Mindless Irresponsibility

Some of the liberal press who favor the President’s new budget proposal’s spending increases are justifying the latter with a new term they have coined – Mindless Austerity (MA). What creativity! They definitely deserve an A+ in poetry. Apparently evil forces conspired to put us all through a time of MA and finally the President has been bold enough to stand against this harmful, debilitating process.

But I wonder about some things. First, consider the meanings of these words. Austerity is acting or doing without justification or concern for the consequences. It is authoritarian and severe. A synonym for mindless is stupid or idiotic.

What these commentators are saying is that MA that was the product of the same President’s past proposal that passed through Congress was done stupidly, without thought and with no consequences in mind. And these are the same press who supposedly think President Obama is both intelligent and a great leader. MA seems like a strange choice of words to me.

Along with MA is the idea of unnecessary suffering. Clearly the President believes that the middle class has suffered and his latest proposed policies are necessary to improve their lives. A corollary is that government needs to do more to improve their lots and so the additional government spending (and tax revenues) necessary to achieve these goals are absolutely necessary. The idea that economic growth is the only real sustained way to improve jobs and incomes for the middle class is not a major selling point of the President’s new budget proposal. Government to the rescue is. 

Another way to describe the President’s budget proposal is Mindless Irresponsibility or MI. The definition of irresponsibility is not having or showing maturity or good judgment. Adding Mindless to Irresponsible is redundant since the former means stupid. MI is stupidly not showing maturity or good judgment. It seems to me that MI is a better way to describe what the President and Congress did then and are contemplating doing now. Even though they know better they essentially put us in a no-win situation.

Notice what they did to us. First they punished a lot of people when they mindlessly put restraints on programs that might have helped people who needed help. Second, they let other programs grow and in some cases rapidly. Third, despite making some people suffer, the budget did nothing but put us in a worse condition financially.

And that’s what I mean by a no-win situation. The proper financial thing to do is to have a plan whose primary goal is to reduce national indebtedness. The proper economic thing to do is to have programs that support and enhance sustainable economic growth. But notice that while you will see bits and pieces serving those twin goals, the primary emphasis of both parties is to push for more spending and higher taxes.

This is bad for two reasons. Despite hopes and prayers about helping the middle class with “new and improved” government programs that broaden the scope of welfare and reliance on government, few of us really trust these guys to do anything that really works. It is all about them and not about us. Second, we know the President is pushing for higher taxes that are anti-growth.

Governments always promise that big expansions of government deemed necessary in recession will be removed when times get better. A quick check of the calendar shows the recession has been over since January of 2010 – a period of five years. Yet here we are in 2015 arguing about how much bigger spending and taxes have to be. No one seems to be the least bit concerned that the national debt level gets bigger each year and will get a whole bunch bigger when the next recession hits. Think Greece and by that I don’t mean Grecian Yogurt.

Do you see austerity in these tables below? Spending rose from $1.8 trillion in 2000 in $2.7 trillion in 2007 and then to $3.5 trillion in 2014. After rising by $940 billion in the first seven years spending rose by another $775 billion in the next seven. After rising by 53% total spending rose by another 28% in the second period. That is a reduction in rate but let’s face it – a 28% increase in seven years is not austerity by any definition.

Austerity was greatest with net interest. Thanks to the Fed keeping interest rates near zero since 2009, Federal net interest expense has remained stable. Estimates have this one category rising $600 billion in the future when interest rates reach normal levels. After rising by $253 billion between 2000 and 2007, discretionary military spending rose by $48 billion in the next seven years. So you might say that government spending on the military slowed considerably. The rest of the spending categories below showed increases from 2007 to 2014 ranging from $89 to $264 billion dollars. I wonder what the Greeks think of US austerity. 

Spending Levels  in billions
	2000	2007	2014
Discr. Military	295	548	596
Discr. NonMilitary	320	494	583
Social Security	406	581	845
Medicare	216	436	600
Medicaid	118	191	302
Income Security	134	203	311
Healthcare	313	567	831
Net Interest	223	237	229
Total	1,789*	2,729*	3,504*
Changes in Spending Levels in billions
	2000	2007	2014
Discr. Military	na	253	48
Discr. NonMilitary	na	174	89
Social Security	na	175	264
Medicare	na	220	164
Medicaid	na	73	111
Income Security	na	69	108
Healthcare	na	254	264
Net Interes	na	14	-8
Total	na	940	775
Percent Changes in Spending Levels in percents
	2000	2007	2014
Discr. Military	na	86	9
Discr. NonMilitary	na	54	18
Social Security	na	43	45
Medicare	na	102	38
Medicaid	na	62	58
Income Security	na	51	53
Healthcare	na	81	47
Net Interest	na	6	-3
Total	na	53	28

 * Categories do not sum to the totals since some categories are left out. 

Greece: The Tail Wagging the Dog

Human beings do not have tails but we do have animals that do. We are quite used to our pet wagging its tail especially right after we poured a large JD on the rocks and put it on the edge of the cocktail table. We are NOT used to the tail sitting motionless as it wags our dog. That would be weird and perhaps even dangerous.

All of this is relevant because in 2015 Greece has become the tail that wagged the dog.  The stories floating around this week about Greece and the Syriza Party prove it. Syriza is a left-wing radical political party in Greece. I tried to find a generic definition for Syriza but the word appears to mean nothing except for radical left-wing party in Greece. So I will make up my own definition and say it can be defined as a state of emotional chaos and intellectual vacuity.

This Syriza Party is amazing. Not even a majority of Greek voters it has done the impossible. Like David slaying Goliath, Syriza has brought the entire European Union to its knees. Syriza is threatening to not pay what it owes to the EU and has already suggested it might align itself with countries like Russia, China, and Cuba. Amazing. It is one thing for a country to use its veto in the United Nations – but for a European country to align itself with places like Russia and China is beyond imagination. As one of the smallest members of the 29 country EU, Greece is threatening to use it veto power to sway a huge economic union. If this isn’t the tail wagging the dog I don’t know what is.

If that isn’t bad enough for you, let’s say Syrzia is also evidence that a very long historical wave has peaked and is in decline. It’s like when your best friend and companion Bogie can no longer catch Frisbees in mid-air and instead retrieves the missile from the ground and limps back with catch in mouth and tail weakly wagging. You know the best is over. You fear for what is to come. You feel terrible and sad.

I am not exaggerating when I say that Greece shows that we have hit a sad turning point. The people of Greece spoke. They are tired of unfair austerity and want to move on with a new government that will restructure their debts. It seems unfair to Greek voters that they would have to pay their debts. Keep in mind that the Greeks entered into this mountain of debt willingly. Greeks were not deceived by Payday Lenders or by loan sharks in shiny suits.

Even before the crisis hit in 2007, Greece’s government deficit had reached around 10% of GDP. At that time the overall Euro area had a deficit of about 2.4%. During the crisis things got worse for all governments but in Greece the problem was catastrophic with debt to GDP reaching 19.1%.

No one made Greece join the EU. And no whips were involved when they gave up the drachma in favor of the euro. In joining this club they knowingly and willingly signed up to hundreds of agreements. Among them they agreed to keep their deficits no higher than 3% of GDP and debts no greater than 60% of GDP. The Greeks have done neither. One of the reasons for joining was to give Greece a more solid economic reputation. Being a successful member of the Eurozone gave them instant credibility and better interest rates for borrowing. But despite continued and repeated efforts to ask Greece to own up to its obligations, the Greeks made excuse after excuse and now find themselves in an impossible mess.

Austerity is too hard. Paying off honest debt is unfair. Restructuring the economy so it can compete and changing the government so taxes are normal and bribes are illegal is too much. Now the media says that other countries are watching the Greek case and will follow if they are successful in getting a huge portion of their debts written off. That anyone in the Eurozone would even listen to this nonsense is beyond credibility. 

When the Greeks threaten to not change and to not pay their debts, someone is harmed. Some of the money is owed to individual countries. If the Greeks don’t pay their taxes will have to increase in those countries. The Greeks also owe the EU government, the ECB, and the IMF. When Greece does not pay a loan,  other countries have to pay it. But the critics argue that it is still unfair. The IMF is rich. The EU is not popular among many Europeans who call themselves Eurosceptics. The ECB can print money.

But all this is nonsense.  The Greeks have to change. They have horrible habits that will devastate them in a global economy whether they are inside or outside of the EU. Sure they can get out of the EU and Eurozone. But they are still a member of the world economy. You can kick a drunk out of your club but he or she is still part of your community or town. The Greeks have to change their ways and this crisis just proves it. Okay so austerity is rough. But this is not just about austerity. It is about common-sense reforms that many European countries have already taken to make their economies more efficient and competitive.

So why don’t more people see it this way? I think it is because we have gone too far. Too many people hate markets. Too many people raise so called fairness above competitiveness. Too many people don’t see simple universal truths and instead see complex and complicated layers of excuses. We don’t care if Greece does the right thing. Our hearts ache for Greeks who will have to change their ways. Our hearts similarly pound when someone suggests we get tough on Russia in Ukraine or Bashar in Syria. 

Russia has invaded the Ukraine. Period. Bashar used gas on his own people. Period. Greece is a mess. Period. Doing the right thing will be painful. So we excuse inaction by talking about time, and layers, and complications.  This is not a one-time change in attitude. It will be hard to undo. Democracy makes it too easy for the heart to rule the head – or for the tail to wag the dog. 

Size Matters in Employment

It is always fun to check on the recent validity of eternal truths. For example, I was shocked to learn one day that if a tree fell in the forest you could not hear it if you were talking on your cell phone. I was also surprised to learn that JD is not an elixir and will not prolong my life past 100 years.

So I decided to check up on another truth – that small businesses are responsible for all or most new jobs in America. I hear people make that claim all the time. For example, I was having a JD on ice at a local tiki bar when the lady sitting next to me whispered in my ear – hey fella what do you think about the proper size of an NFL football? Not knowing the correct answer I whispered back – most jobs in the US are created by small businesses. She toddled off shortly thereafter.

Now that I have your attention, I can move ahead. Who really cares whether jobs are created by your local dry cleaner or by Amazon.com? A job is a job. In fact the job at Amazon probably has better benefits and security. I know that some of you think that bigness creates meanness and that AT&T and GM have it in for workers. But those of you who think that way probably never had a job at one of these small companies. I recall one summer working for a landscaper who yelled at me when I accidently almost cut my arm off with his power saw.  I am not sure if the guy was ever sober one time we worked together.

My point  today, however, is not to irritate small business or to argue with the zillions of fine people who believe that small businesses were invented by God and are the sole source of all good things including JD. My goal in writing this blog post is simply to look at some data that measure recent job change in the USA by size of company. And doing that I have to admit was almost as fun as teaching a three hour class at 9 am  at Big Arts.

Below is a table of numbers I constructed after visiting the Bureau of Labor Statistics web page (http://www.bls.gov/news.release/cewbd.t04.htm ). I take no responsibility for the definition of small or large or what is in between. I will also refrain from any jokes about the meaning of small or large since I know that my readership is above such things. But I do recall a joke about relativity and women’s technical skills in which a man holds his fingers one inch apart and explains to the woman that the distance between those two fingers is exactly six inches.

The BLS has decided to divide private sector companies into three size groups – 49 or less employees; 50-249 employees; and 250 or more employees. They published data for each size cohort for the years 2004 to 2013. Their data is by quarter so I added the quarters to get yearly totals. Their data set has employment gains and losses for each quarter for each size cohort. I have netted the losses from the gains to get the net increase or decrease in each year for each size cohort.

The numbers are pretty interesting. The first set of sums in the table below show how many jobs were created in those 10 years. Below the sums are the averages per year. Roughly 330,000 jobs were created each year. Small companies created 103,000 per year (31%); Medium firms 171,000 per year (52%) ; large companies 55,000 per year (17%).

So you might conclude from these past 10 years that small companies were responsible for about a third of the net jobs created in private companies. That is a nice hunk of jobs buy clearly is nowhere near even a majority.

But let’s take this another step. The years 2008 and 2009 were unusual. While large companies typically account for a minority of the jobs gained in expansionary years notice that the larger companies accounted for nearly 7 million job reductions in 2008 and 2009. Small business lost less than half that amount. So let’s remove those two years and look at the 8 remaining years in which there were net job gains. If we believe those 8 years are more typical for accessing job gains – then the picture changes radically. The average increased employment of the larger firms was about 927,000 jobs per year. Small firms accounted for about 563,000 jobs per year.

Whoa Nellie you say. Larry – you can’t throw out the numbers you don’t like. That’s true. But it is also true that neither set of averages is perfect. Leaving in two very atypical years distorts our conclusions. Removing those two years equally taints the data. Without any easy or obvious third way, I think it is safe to say that both sets of data inform us. Weighing both together suggests that we not discriminate against the bigger firms when it comes to finding ways to expand US employment. It just ain’t true that small firms are the only sources of job growth.

Table. Net Job Change Private Sector Companies

2004 to 2013 by Size of Company

Thousands of jobs

Year	0 to 49	50 to 249	more
2004	684	467	1048
2005	696	373	1076
2006	554	433	666
2007	3	217	418
2008	-1479	-580	-1647
2009	-1993	-1054	-5211
2010	346	379	633
2011	591	502	923
2012	776	519	1003
2013	853	458	1645
Sum	1031	1714	554
Average	103	171	55
Sum2	4503	3348	7412
Average2	563	419	927

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The Ghost of Christmas Future: If Scrooge Can Change Why Can’t We?

Dickens’s Scrooge woke up and was relieved to know it was all just a dream. And he had time to change his ways before a very ugly future unfolded. Aren’t Christmas tales fun? You get a second chance.

Our government and our Fed will get a chance to save us from an ugly future. Let’s hope they are as salient as Scrooge. But then Scrooge didn’t have to be re-elected or face the press each day.

Larry stop cracking your knuckles in the living room. My mom often warned me that if I kept up that annoying habit that someday my hands would be a mess. I should have listened to mom.

I took a look at the bi-partisan budget outlook published by the Congressional Budget Office last August (cbo.gov). It amazes me how little attention it is getting. The warning could not be any clearer but alas our elected leaders will spend their time on a prison Cuba, arguing the correct name for terrorists, and giving young people free Community College experiences. Not that these issues are unimportant but it is pretty clear that we are putting ourselves in extreme financial jeopardy by ignoring or papering over what our government is doing to us—and our progeny.

I have moaned about the concept of jeopardy in this space before. I am not speaking of Alex Trebeck. Jeopardy is a state of being that opens you up to consequences. When you try to scale a vertical cliff, you put your health into jeopardy. When you wear last year’s trousers that are a bit too tight, you put yourself into social jeopardy. When the government creates too much debt it puts our economy and millions of jobs into jeopardy.

Many of my blue friends are saying – Larry quit your whining. The unemployment rate is down and the economy is growing. Roses are blooming and young women are wearing yoga pants. What could be better! I can think of a lot of things that could be better but I will try to stick to my message. Jeopardy means that today the cool breezes are flowing through your ample locks – but that also means you might land on your head tomorrow.

When things are good is the only time you can prepare for the future. So if you miss that opportunity then things will only get worse. When you are young and your income is ample and rising, that is when you save for the future. If you do the saving, then when misfortune hits, you can take care of yourself. It is pretty simple. You DON’T wait until after the loss of employment to decide it is a good time to save money.

And that is what we threaten to do now with our country. Go to cbo.gov and look at the tables in the August report cited above. Before the last recession our net national debt held by the public (the gross debt is much bigger) was $5 trillion and about 35% of the economy. By 2014 it had risen to almost $13 trillion or 74% of the economy. It is expected to rise to almost $21 trillion by 2024.  It will then be 77% of the economy.

Some of you will say that 70+% net debt is sustainable – at least for a while. The debt exploded during a recession and the following slow growth time period. But notice that it is getting even bigger during a future time characterized as at least moderate if not strong economic growth. So if our representatives do not make major strides to fix the debt, it isn’t going to fix itself. The economy is not going to fix it either.

But that story is too optimistic. The recession lasted through 2009. That means it has been almost six years since the last recession. Which means another recession is coming.  I won’t quote the average time between recessions but clearly it is highly unlikely that we won’t get a recession in the next few years. If you look around at what is happening in China, Japan, Greece and so on…you realize that the chances of a US recession are improving all the time.

If we do enter a recession or a very slow growth period what do you think is going to happen to the US budget? Correctomundo– tax revenues will fall, expenditures will rise, the deficit will widen and the debt will grow. If you were comfortable with a net debt of 77% then how about a debt of 100%? How about 150%? Is there a point at which you will admit that something needs to be done? Why not do it now before we reach than unenviable rock and hard place?

Some of you will puff out your chests and note that our deficit came down to $0.5 trillion in 2014. But that doesn’t help. The CBO report projects a deficit every year through 2024 rising each year to an amount equal to $1 trillion in 2024. I hate to tell you but that is not progress. That is like the 240 pound guy who gains 5 pounds a month and reaches 300 pounds during the year saying he is going to start gaining only 3 pounds a month as a way to lose weight. He is going to weigh 336 next year!

That’s what we are doing with the nation’s deficit and debt. Current projections say it will go from about $13 trillion in 2014 to almost $21 trillion in 2024. It won’t be easy to get this country on a real empowering diet. The main problem is that we are already hemmed in by so-called mandatory spending and net interest growing by about $2 trillion over the next 10 years. If we don’t stop mandatory spending, then we don’t have much else to work with!

I have punished you enough today. The President plans to punish you even more tonight. Tell him it is time to address the national debt. 

Potpourri from Guest Blogger Buck Klemkosky

The U.S. Economy Accelerates

The Buck’s at an 11-Year High

The U.S. Baby Bust

TARP Ends With a Profit

Less Liquidity = Bond Market Turbulence

The U.S. Economy Accelerates

The Great Recession ended in June 2009. The 5.5 years of economic recovery and expansion since has been slow and uneven until 2014. The year started off with negative economic growth of 1.9 percent in the first quarter but GDP growth accelerated to 4.6 percent annualized growth in the second quarter and 5 percent in the third quarter of 2014. These are the best two quarters of GDP growth since 2003 and the 5 percent third-quarter growth was the first since the recession ended.  The third-quarter growth was driven by personal consumption expenditures, especially for services, government expenditures and manufacturing output.

Recent consumer confidence surveys are at the highest levels since the recession ended. This increased confidence can be attributed to the 2.7 million jobs growth in the first 11 months of 2014, plunging energy prices, low inflation and interest rates, household finances in better shape and a stronger financial system. The consensus forecast of 2015 GDP growth is 3 percent, which is the average U.S. growth rate since 1965. After subpar 2.3 growth since 2009, the average looks pretty good.

But there are headwinds, especially from abroad as the U.S. stands alone among the developed countries of the world in economic growth; Europe is barely growing; Russia is headed for a recession, and Japan is already in one. China’s growth is down to 7.0-7.5 percent in 2014 and lower growth is expected in 2015 as it tries to transition from an investment to a consumption-driven economy. Any global economy that is dependent upon energy production or commodities will have difficulty achieving positive economic growth in 2015. A stronger dollar could also slow U.S. economic growth in 2015.

The Buck’s at an 11-Year High

2014 has been the year of the U.S. dollar. It has strengthened (appreciated) 13 percent against a basket of global currencies to its highest level since 2003; 12 percent against the Euro and Japanese yen, and 9.4 percent against the Canadian dollar, and 14.7 percent again the Mexican peso. About the only countries not to have their currencies depreciate against the dollar were those that peg their currency to the dollar; that would include China, Singapore, Saudi Arabia and a few others.

Why the strength in the U.S. dollar? The U.S. economy is accelerating relative to a stagnant Europe and slowing Asia. Plus the U.S. appears to be about the only developed country ready to raise short-term interest rates in 2015. A combination of better economic growth and higher interest rates makes the U.S. a more attractive place to invest. So capital flows from abroad have been somewhat responsible for the surging dollar, helping to lower U.S. long-term interest rates and inflation.

The risk of a strengthened dollar to the U.S. is that exports will be less competitive in global trade and may affect economic growth. But the risks are much greater for those countries that are exporters of oil and other commodities, as reflected in the dramatic fall in the value of the Russian ruble and Venezuelan bolivar. The risks to any foreign country or company that have borrowed in U.S. dollars will be particularly severe as it will take more local currency to pay back a dollar of interest or principal. Another concern is that the currency realignments may lead to competitive devaluations, which used to be called currency wars. Japan has already used this to kick start their economy and inflation. Others may follow.

The U.S. Baby Bust

The Great Recession and financial crisis of 2008-2009 has impacted the fertility rate in the U.S., resulting in one of the lowest on record. In 2007, the U.S. had 69.3 babies born per 1000 women of child-bearing age; in 2013 that had fallen to 62.5 babies per 1000 women. The fertility rate has fallen to 1.86 in 2013; a rate of 2.1 is needed to stability the population. If 2007 fertility rates had prevailed, there would have been 2.3 million more births than actually occurred from 2007 to 2013.

There has been a long-term structural decline in the U.S. fertility rate from 3.7 in the 1950s to 1.8 in the late 1970s. This decline can be attributed to later marriages, increased college attendance and labor-force participation by women, advances in birth control, the higher costs of raising a family and the higher divorce rate. There was then a gradual increase in the fertility rate from the 1970s low to 2.1 in 2007.

The decline in the fertility rate since 2007 is a result of the Great Recession. More than half the decline in births since 1970 can be explained by a one-third decline in the birth rate of Hispanic women. In 2007, Hispanic females accounted for 17 percent of the women in the 15 to 44 age group but had 25 percent of the babies. Their birth rate of 2.4 today is slightly above the replacement rate. The other half of the decline in births is due to white and black women having a slightly lower fertility rate, again a result of the recession.

The birth rate has declined in past recessions, but not to the extent of the last six years. If the birth rate permanently stays below the replacement rate of 2.1, it means less population growth, slower economic growth, and less consumer spending. It also means the U.S. is following the Eurozone countries, Russia, China and Japan in demographic trends. The economic consequences will be noticeable and long lasting.

TARP Ends With a Profit

Remember TARP, the Troubled Asset Relief Program, which was passed by Congress in October 2008 in the depths of the financial crisis? It was just after the Lehman Brothers bankruptcy and the financial system was on the verge of collapse. It was and still is a controversial bailout package that never won public support. In fact, the first TARP bill was rejected by Congress but a second version passed a week later. The U.S. government approved $800 billion of bailout funds including about $426 billion of TARP funds.

TARP bailed out banks, including Citigroup and Bank of America, American International Group, General Motors, Chrysler and hundreds of other firms with debt and equity support. The government also took over two major mortgage firms, Fannie Mae and Freddie Mac, which purchase mortgages from originators. In total, the government funded almost $700 billion of bailouts including the $426 billion of TARP funds. The takeover of Fannie Mae and Freddie Mac required $187 billion of government funding but was not part of TARP.

In December 2014, The U.S. government closed the books on TARP when it sold its remaining shares of Ally financial, the former General Motors Acceptance Corp. After six years, TARP was closed with a profit of $15.3 billion, a return of 3.6 percent. Probably not a sufficient return given the risk involved, but most had not expected any profit at the time. The U.S. government made money on the bank bailouts and AIG. It lost money on the auto bailouts and the takeover of the two mortgage companies. About 35 small community banks remain in the program, down from 700 financial institutions at the height of the program. For all intents and purposes, the TARP books are closed with a profit. The government still owns Fannie Mae and Freddie Mac, both of which are profitable and will soon repay their $187 billion of bailout funds in full.

The major criticism of TARP and other bailout funds is that it put Wall Street ahead of Main Street by not helping troubled homeowners who have received about $15 billion of assistance out of $75 billion promised. But TARP and the whole bailout program has to be considered a success in terms of stabilizing the financial system and the economy. The complete collapse of several large banks, General Motors, Chrysler, AIG and others would have been catastrophic and ended up costing taxpayers hundreds of billions of dollars more than the cost of TARP and other bailout funds. Think trillions.

Less Liquidity = Bond Market Turbulence

October 15, 2014 will be a date long remembered in financial markets similar to the May 10, 2010 flash crash when the Dow Jones Industrial Average lost 1000 points in a few minutes and October 19, 1987, when stock markets of the world declined 20 percent or more in a single day. Maybe not a day of infamy, but an important day.

On the morning of October 15, 2014, the benchmark U.S. 10-year Treasury bond had been trading at a 2.2 percent yield to maturity. As U.S. trading opened, the yield started to drop and within minutes it tumbled to 1.86 percent, a drop of one-third of a percentage point. This drop in yield was of historical proportions and was considered a 7 standard deviation event; to put that in perspective, this is something that should happen every million years or so, given the historical volatility of U.S. 10-year Treasury bond yields. By the end of the day, nearly $1 trillion of Treasury bonds had traded and billions more in the derivative markets and the yield on the U.S. 10-year Treasury bond had recovered to 2.14 percent. Bond yields are inversely related to bond prices, so U.S. Treasury bond prices rose initially and then settled back as yields rose. What had prompted the rush into treasuries was disappointing economic news and a flight to safety because of geopolitical events.

The Treasury bond market is the deepest and most liquid of all markets in the world as $12.5 trillion of Treasury bonds are in public hands. What bothers investors and regulators alike is that this October experience in the Treasury bond market may foretell the future volatility in the U.S. corporate bond market. The U.S. corporate bond market has about $9 trillion of bonds outstanding, an increase of about 50 percent since the Fed started to lower interest rates in 2008. In the U.S. there are about 5,000 different common stocks that are publicly traded; however, there are 47,000 different corporate bonds outstanding. So the liquidity and ease of trading a particular bond issue is not like trading a stock; it’s riskier on average.

This risk has become accentuated by an unintended consequence of the Dodd-Frank law passed in 2011. Under the co-called “Volcker Rule,” banks are prohibited from proprietary trading, trading for their account, and new capital rules make it more costly for banks to hold assets and securities needed to ensure liquid markets. So banks have dramatically reduced the amount of capital devoted to bond trading; one estimate has dealers’ inventory of corporate bonds declining 75 percent from $200 billion to $50 billion since the financial crisis. Thus liquidity in the bond markets has been dramatically reduced.

After the financial crisis of 2007-2008, investors placed more than $1 trillion into bond mutual funds, exchange traded funds and other institutional money managers. The money was invested in bonds because of low Fed-induced short-term interest rates and stock market losses in 2008-2009. It was deemed a safer investment and investors were chasing yields. Given the combination of a much larger corporate bond market and less liquidity available for trading corporate bonds, many worry about what happens when interest rates start to rise and bond investors head for the exit. The big question is whether the exit door is wide enough to let everyone out without causing major disruptions in the market. 

*Buck is Market Strategist at Wallington Asset Management.

Ghost of Christmas Past: Looking Behind to Look Ahead

Stock markets are up then down. The value of the dollar is soaring while the ruble and many other currency values plummet. Are we going back to another recession? Didn’t we just get out of a recession? Are we doomed to decades of slow growth? Was Elvis a transsexual? These are just some of the questions being asked these days.

To oversimplify what is going on now is risky but why have a blog if you aren’t willing to stick your neck out? It seems to me that what is going on today reflects an ongoing evolution of the global economy. In the rich places of the world we are playing out a dramatic financial evolution. In the wanna-be-rich places of the world we are seeing the results of logical but unfortunately dangerous economic development policies.

Whether we focus on Russia or Venezuela there are similarities. These countries are trying to catch up to their richer neighbors. Impoverished by rigid autocratic and socialist policies before the 1990s, these and other so-called emerging or developing countries plunged into less regulated and more market-oriented systems. Just as when an old man tries to learn to play the guitar, the physical, cerebral, and other transitions required in such a transition are slow and painful. No country found transition easy and no country did it the same way. But by the dawn of the 21^st century many were finding success in global capitalist markets. And some of the ones with the most startling successes were those that chose to specialize – or build their new economies around one or a few industries often featuring the exportation of commodities like oil, copper, and aluminum.

And so it was in 2007 when the signs of economic slowdown first became apparent, a catchword was "decoupling". That is, the developing countries had advanced so far that even if the US or other rich countries experienced recessions – the developing countries would be fine. They had decoupled their economic growth from industrial world. Well—that was optimistic and mostly wrong. Just as a one-handed juggler of flaming knives finds out – when the going gets rough it helps to have two hands! Building your economy on only a few sectors means you have nothing to fall back on when those sectors experience difficult times.

Human nature and politics suggest that we should not be too critical of developing nations. It is not easy to dig from the ruble of failed socialism and build a broad, dynamic for-profit economy. And once you get a few sectors humming, it is tough to divert resources away from the successful ones to build the lagging parts. Critical or not, as the world languishes in slow growth, these one horse countries are not going to quickly or easily return to the heady days. One reason is that world growth may take awhile to recover. The other reason is that bad policy seems to follow bad policy. 

Excessive debt and inflation hamper what can be done with traditional Keynesian policies. Most of these countries are raising interest rates to defend against currency depreciation and inflation. Many are going through fiscal contraction because of excessive debt. They are between the proverbial rock and hard place.

This brings us to a JD break and a brief discussion of the other countries – the rich ones. These countries might be richer but they are not necessarily smarter and are not immune from historical evolution. They may not have one-horse economies, but as Brian Westbury often writes, they have created plow horse economies. Perhaps in the name of “progress” or because of sophisticated caring for people and resources – the richer countries have saddled capitalistic engines with more regulations, higher taxes, higher government debts, and uncertain business environments. It is interesting that while an energy revolution has finally strengthened the US in economic and security terms – there are those in politics who want to throw even more regulations, costs, and uncertainty on US firms.

To bring this all together, it is unexplainable that the rich and not-so-rich cannot learn from each other. The rich should vividly see that too much debt and regulation can virtually destroy a country’s economy and leave it with no good policy alternatives.  The less-rich need to see that reforms to widen the economic base are necessary for future growth.  The past should inform us.

Is There Ever Enough Regulation?

In the Wall Street Journal last week (12/24/14, Page A15, Good Medicine for Bad Bankers) Alan Blinder laid out his plans for more government regulation of banks. While seeking more regulation is not unexpected coming from a liberal like Blinder, it is the increased intrusion and non-stop zeal that is so frightening. 

Most conservatives understand that companies and their employees can be dishonest and will break legal and ethical standards. Conservatives understand that free markets don't solve all our problems. While most of us could debate until the cows come in just how much regulation and government spending is warranted or beneficial -- most of us would settle on something well north of zero. We get it Mr. Blinder. 

But at what point is enough enough? At what point do we ease into the Nanny State? Let's get back to banking. DF goes a long way to regulate banks. Some of us think it goes too far in some ways but we understand that banking is complicated these days and it doesn't hurt for government to put some curbs or brakes on riskier banking activities. After all, if government is going to subsidize or insure some bank deposits backed up by our tax money, then it makes sense that society should have some say so about banks. DF has a lot of say so. DF went through Congress and was signed by the president. There are also international accords that regulate bank risk exposure. 

Some might think that enforcing criminal statutes and DF would be enough -- at least for a while. But not so for Blinder. He wants to muck things up even more. His article quotes a Fed Official William Dudley as saying that there are just too many bad bankers these days. They do some really awful things apparently and are not being harassed enough by people in government who apparently never do anything wrong and are much better at banking than are the bankers. So what does Blinder recommend.

First, he wants whistle blowers to be encouraged and treated more kindly by their companies. Perhaps they should post photos of the "whistle blower of the month" on the company's Facebook Page. Then we can count all the Likes they receive. The ones with the most Likes get free tickets to an IU football game. Second he wants to regulate the pay of bankers so that they focus less on the short-run. 

Everyone loves to get paid for today's work when hell freezes over. Right?  Third, anyone caught doing something wrong would be not only convicted but would be barred from banking for life. I wonder how the unions would go for that one? Fourth, each bank would have a point total score -- sort of like airline frequent flyers points. These totals would accrue each time a bank was caught doing a no-no and would somehow be published so that all of us dummies would know exactly which banks were repeat offenders. Maybe a weekly tweet of bad bank scores would get the word out. Finally, when a bank was fined or otherwise punished -- it would not be enough to whip the CEO in public. Instead the government would require everyone in the offending part of the bank to be spanked in the town center by the principal. 

So Mr. Blinder. ARE YOU KIDDING? Why not do these same things to Pharmaceutical companies? How about all those companies who advertise great deals buying gold today? Then there are those wonderful firms who heavily advertise reverse-mortgages? Why stop there? I am sure there are evil and mean-spirited owners, managers, and employees in EVERY INDUSTRY who stay up all night conjuring up ways to deceive the public. 

This is nuts for a couple of reasons. First, we spent a lot of time and energy passing legislation over the last 50 years -- are you kidding about these suggestions? Did you copy this crap from one of your student's freshman exams? Second, are you sure you want our government to have regulators who tell business people how to run their companies? Do you want them to institutionalize whistle-blowers? Do you want to regulate pay? Do you  want to have government employees infringing on the rights of union employees to keep their jobs? Do you really want a government that often has strong ideological goals deciding which companies are the bad guys? 

Some of you are saying cool. You love the idea of government controlling these bad actors. To you I say -- just wait until the government thinks your company is one of the bad guys. Or maybe just take a peak at Cuba or China and see what it's like when liberals get their wish. 

Christmas 2014

My good friend Ron, a reader of this blog suggested that publishing on December 23rd might be a little ballsy. After all, you important folks have a lot to do to get ready for Christmas and archery practice. So I decided to follow his advice and post something whimsical, though highly meaningful.And by that I mean I am posting my 2014 Christmas list. For those of you who do not celebrate Christmas you may substitute another word for Christmas or for list or for any other word above if you want. This is a free country you know.

In reading this list you will notice that I did not include JD. I figured that would be sort of err redundant. There are only 18 items because I am not greedy and I forgot the other ones.

1. Cuban Cigar
2. Free popcorn and flack jacket with ticket to  “The Interview”
3. Elizabeth Warren Jockstrap
4. A one-pee night
5. One channel that has news
6. Fed Impatient about Interest Rate above Zero
7. Honest politician
8. Mung Bean Bindaettoek at Gwangjang Market
9. Putin and Bieber in the rear view mirror
10. Sing one song live with the Temptations or Four Tops or Justin Bieber
11. Ribeye Steak as big as my head
12. Cash
13. A liberal/progressive who will write a guest blog for me
14. Another grandson
15. Wearable Camera for the Back Door
16. Paul Krugman's speaking fee
17. An Uber gift certificate
18. Another daughter named Ashley

I hope you have a great Christmas and a very Happy New Year.