Should Obama Nominate a New Supreme Court Justice?

When a really big controversy hits I usually like to give it a month or two to see where things settle. But for this one I couldn’t wait. This one is a beauty.

I watched TV news and saw two parties talking past each other. The Democrats were saying that of course the President should do his Constitutional duty and nominate a replacement for Judge Scalia. Republicans were saying that they have the power in the Senate and would definitely turn down an Obama appointee or simply won’t go to the trouble of acting since it is a fait accompli.

Instead of focusing on the obvious story talking heads have already wasted enough hours to write the definitive almanac on love. Experts continue to discuss and debate the meaning of the remaining months of Obama’s time in office. They debated if he is a lame duck or not. They went on endlessly about the difference between a vote and not having a vote. They talked about Senator Schumer and what he said in 2007 compared to what he said last week. We have heard people analyze court appointees who were denied hearings in the past. Then there is the issue of whether or not today's voters should determine the choice. 

All that discussion is juicy but meaningless for today’s question. What no one seems to want to say is the obvious – we have a President and a majority party that are driven by ideology. Hillary was saying that even if President Obama nominated a moderate and reasonable judge – those darned Republicans would not give her a hearing. But folks – let’s be realistic. Is there a snowball’s chance in Hell that he would nominate such a person? Obama has publicly hated many of the decisions of the current Supreme Court. Remember Citizens United? That case is always and everywhere lamented by Democrats who would love the chance to have it overturned. Obama is being sued by groups who want to overturn many of his presidential directives as well as his prize legislation, Obamacare. Are you telling me that Obama would nominate someone who would threaten liberal progressive values? 

Obama will nominate a justice who will turn the tide of opinion on the Supreme Court. This new justice will allow the liberals on the court to have their sway and by all means the new court will get many chances to support Obama and to tear apart anything those hated Republicans want done  or changed.

So what are good Republicans to do? Basically there is only one thing they can do. They can stall the process so that the next President might not have such clear ideological and political goals. It makes absolutely no sense for Republicans to not use their Constitutional prerogative to turn down anyone the President might nominate. But why waste everyone’s time? So they are just telling the president to hold off. 

This debate has nothing to do with the Constitution and nothing to do with what past presidents have done near the ends of their terms. It is not about democracy. This debate is like everything else going on now – it is about people at the ideological ends pointing fingers and yelling at each other. Us folks in the middle keep shaking our heads and wonder how we got to such a place. Obama and liberals want to preserve the Obama legacy or at least prevent conservative decisions later this year. Thus they want Obama to appoint a progressive friend.  Republicans want to tear apart Obama’s encroachments and move the court in a more conservative direction. They do not want Obama to appoint a progressive friend.

So now we have one more thing for the Democrats and Republicans to argue about in the coming election. Instead of admitting that the Court appointment is a political issue the Democrats will say the Republicans are obstructionists who won’t allow the President to fulfill his Constitutional responsibility. The Republicans will counter that the Senate has a Constitutional duty to not agree to Obama’s nominee.

Does this surprise anyone who lives in a bifurcated America these days? The extremes have taken over and EVERYTHING has become political. Compromise is seen by both sides as a cop out. Each side clings to "It is our way or the highway". Why would appointing someone to the Supreme Court be any different? Pretty soon I will have to choose between a Republican brand of JD and a competing Democratic brand. What a mess. 

2% Inflation -- A Fool's Quest

I wrote a piece on January 19^th about the Fed’s 2% inflation goal mostly saying that the 2% was a ruse – a way to take your eye off the ball. The Fed wants the unemployment rate lower and the economy stronger and the low recent inflation gives them the excuse to keep their pedal to the metal.

But there is more to the story. So let’s beat on the inflation goal again but in a different way. It seems clear why the Fed might want to adjust policy so as to reduce the unemployment rate. Higher unemployment hurts people. Lower unemployment is a sign of a healthier economy. I am not saying that the Fed is good at lowering the unemployment rate, but it seems to make sense that lower unemployment might be a desirable end.

During much of my lifetime, the Fed’s main goal was to reduce pesky inflation. That seemed reasonable too. Inflation is annoying. Ask folks who lived in any country ravaged by 100% inflation. Inflation hurts. Even when inflation hits 5-10% per year few of us like that. But the Fed tossed all that out lately. Their goal is to raise inflation. What? Why would they want to do that?

The answer has nothing to do with inflation or prices. The answer is that low prices might be an indicator of flagging or deficient national demand for goods and services. Influencing sagging spending makes sense but if you are concerned about low aggregate demand then why doesn’t the Fed come clean and say it is trying to raise AD? The answer is that AD is like love. Love is not directly measurable. Does she love me or does she not? We are always guessing about such things. If you want to know if someone loves you then you look at behavior. Apparently the Fed thinks it can look at measured prices to know what is happening to AD.

The problem with looking at inflation to gauge AD is that it simply is not very good for that purpose. For one thing, inflation reflects aggregate supply (AS) as well as AD.  When inflation falls because of increases in AS – then the Fed should not be reacting to that. So if the Fed has no direct measures of love or AD or AS, then inflation can be a dangerous and misleading indicator. When inflation falls is it because AD went down or because AS went up?  It is hard to know and reflexively presuming AD and inflation are the same thing has frequently led to grave policy errors and unnecessary economic suffering.

A second important problem with using inflation as a measure of AD is that inflation is like Steve Martin – wild and crazy. Inflation measures jump around like a kid on a red ant hill. Below I use some inflation data to make my point. The Fed might as well use lighting strikes to measure AD…it is a fool’s game to use inflation numbers.

My measures of inflation today are called implicit price deflators for GDP.  They are published by the Bureau of Economic Analysis and found at bea.gov with the various GDP statistics. Notice in the detailed table below there are inflation numbers for 2014 and 2015 for every component of GDP. This is a very comprehensive measure. It is broader than the consumer price index since it includes inflation rates of prices for things like plant, equipment, and exports. The closest thing to the CPI in this group is the deflator for personal consumption expenditures. 

I said above that inflation numbers are wild and crazy and could not possibly be good proxies for what is happening to AD or anything else. The overall index for inflation (for GDP) was 1.6% in 2014 and then 1.0% in 2015. The Fed would say that the national inflation rate fell and might be a problem if AD fell in 2015 and worsens in 2016. So far so good. But let’s look inside the wrapping of that sausage.

While the prices of consumer goods were falling by 2.9% in 2015 notice that the prices of consumer services rose by 1.9% after increasing by 2.3% in the year before. Note that the inflation of consumer services averaged those two years around 2%. Thus consumer services prices are at the Fed’s spoken limit. By the way, consumer services were approximately 65% of all consumer spending and 45% of GDP. In contrast, wild and crazy durable goods are only 13% of consumer spending and 9 % of GDP.  The durability of future inflation rates are much more associated with the heavyweight consumer services and much less influenced by wildly gyrating prices of consumer durable goods.

The GDP component we call investment includes purchases of capital goods – plant, equipment, software, buildings, and more. While consumers buy residential investment, the rest of these items are generally purchased by businesses. Notice the behavior of prices in this category. While the prices of the nonresidential portion of investment goods barely budged in 2015 (0.2%), prices of newly produced residences rose by 2% after rising by 6% the year before. Finally look at the behavior of both import and export goods.  Prices fell in those categories by 7-8% in 2015 after being pretty flat in 2014.

When you read the first line of the table and see that the US inflation rate fell to 1% in 2015 one might get the impression that the prices of most or all goods and services followed in lock step and somehow national AD must be on the decline. But this could be very misleading since the average masks a lot of different and conflicting changes – each one having a very different implication for AD or AS. Clearly spending on the biggest part of GDP, consumer services, was strong enough to put inflation of consumer prices at the Fed’s goal value. If you add prices of new residences, you get the same result – healthy enough spending to put inflation at 2%.

So what causes the impression that inflation is falling? Clearly sectoral issues that may or may not be AD in origin make the results very muddy. For example, prices of consumer nondurable goods retreated because of gasoline prices. Lower gasoline prices, however, should give consumers more money to spend on other items. Prices of imports and exports figured into much lower prices of those categories. Again, how much do these international changes reflect ongoing AD issues that our within our sphere of influence?

A closer look at inflation numbers suggests a mixture of temporary changes in highly volatile sectors and a mixture of AD and AS impacts. They paint a very unclear picture of how national AD is changing and a poor clue as to what will happen to inflation and AD in the future. The Fed should stop talking about inflation and be more honest about its true goal. The Fed has become Supergirl of modern times. Even the tiniest worry about unemployment or economic weakness sends the Fed into action. This was never the intention of the framers of the Federal Reserve Act and ignores all of the unintended negative impacts and imbalances that such policies have shown time and again.

Table. Inflation as measured by changes in

implicit price deflators of GDP

                                     2014  2015

Gross domestic product	1.6	1.0
Personal consumption	1.4	0.3
Goods	-0.4	-2.9
Durable goods	-2.3	-2.1
Nondurable goods	0.6	-3.3
Services	2.3	1.9
Investment	1.8	0.6
Fixed investment	1.9	0.6
Nonresidential	1.0	0.2
Structures	1.5	-0.5
Equipment	0.7	0.7
IP products	0.9	0.0
Residential	6.1	2.0
Net exports	na	na
Exports	0.1	-4.9
Goods	-0.7	-6.8
Services	1.9	-0.6
Imports	-0.2	-7.7
Goods	-0.5	-8.9
Services	1.2	-1.7
Government	1.8	0.2
Federal	1.6	0.7
National defense	1.4	0.2
Nondefense	2.0	1.4
State and local	1.9	0.0

Spending Spending Spending

Last week I spouted profusely about Federal government deficits and debt. I likened the government to the pepperoni pizza addict who ate the whole thing last week and this week not only ate his own large pie but also finished his wife’s left over clams with linguine (with a hint of hot red peppers).

It makes no sense to me that a government that goes into debt during a national and world emergency should plan to go even further into debt after the threat is well over. This is exactly how a nation flirts with becoming the next Greece or Venezuela. I show below how it might be possible do better than we are presently doing. It won’t be easy but it is possible. Waiting will only make it much harder.

For example, the results below show that with the spending and tax revenue projected for the next 10 years we could begin to chip away at the problem of deficits and debts. But it would take a decline in benefits of major mandatory spending programs of around 20% of the 2025 estimate. Of course spreading the pain among tax revenues and other spending would reduce that amount somewhat but it gives you a feel for what already must be done to get us back to anything approximating normal. If we add even more to debt in 2016 the difficulty explodes.

One of my alert readers who awakened from a thirty year slumber asked me off line to go a little deeper into the details behind the debt numbers. So for the sake of my huge (did I say huge?) and growing cadre of faithful followers I decided to strain my eyes and crane my neck over the reams of data published by the Congressional Budget Office. The most pertinent of those data are found neatly packaged by me below.

Before boring into the numbers, let’s do a little review of government budgeting. The government loves us and therefore deems it possible and legal to take money from the mouths of our children and distribute it over Iowa from helicopters. No I am just kidding. The government has the power to tax. In America the biggest federal taxes are imposed on income of persons and corporations. They also collect something confusingly called the payroll tax when in reality it should be called the let’s be nice to old folks tax. But naming these things is not my quibble today. The government also levies about 10 million other little taxes that are often collectively named “other”. Many of you are familiar with the gasoline tax that you happily pay each time you go to the pump and then buy a lottery ticket and a Twinkie.

The sum of these annoying federal taxes is labelled as Total Revenue below. You also pay taxes to your state and local governments but we will ignore those today. The table tells you that these Total Revenues amounted to almost $2.2 trillion in 2005. And no, Donald Trump did not pay your taxes or mine that year. Below those government revenues in the table are found the expenditures or outlays which are the ways the government gives us our money back. Yes, they take with one hand and give back with the other. Well – they actually give us back more than we pay in and that is the rub because when that happens and it usually does, the government goes deeper into debt. But I get ahead of myself.

Government spending is often divided into three main categories – mandatory, discretionary, and net interest. Mandatory spending means that these categories of spending are very difficult to change because if you change them Jimmy Hoffa will get you. Discretionary spending refers to items that are usually negotiated each year by Congress, while mandatory spending is set out in laws that extend payments into the future. You might say the future amounts are contractual. Notable mandatory items in the US budget include Social Security, Medicaid, Medicare, disability insurance, and more.  Surprisingly defense and many poverty programs are included in discretionary spending. Notice that since much of mandatory spending relates to people of my age – young people have a keen interest in how these spending totals are shaping up.

Last week I wailed about alarming increases in future government deficits and debt. This week I look into how spending and tax revenues generate those scary statistics. My comments come from the table directly below. The table divides and compares budget information for ten years into the past (2005 to 2015) and ten years into the future (2015 to 2025). The first three columns give you the budget numbers for 2005, 2015, and 2025. The next four columns focus on the 10 year changes (in dollars and in percents).

The time period from 2005 to 2015 starts with a strong economy, endures a recession in 2008 and 2009, and then recovers slowly from the recession. The future from 2015 to 2025 is unknown but the CBO estimates these future numbers based on relatively slow growth but without a recession.

First, debt is rising despite large increases in tax revenues. Tax revenues will rise by $1.5 trillion in the future after rising by a little more than a trillion in the past. Revenues will increase by 48% after rising by 51%. I am sure folks in the middle class would love to experience that kind of growth in their personal incomes.  Tax revenues will reach almost $5 trillion in 2025.

Second, the big generator of total revenue is income taxes. The future will see a rise of $988 billion or about 64%. Total income taxes will rise from $1.5 trillion to $2.5 trillion from 2015 to 2025.

Third, despite huge increases in government revenue – we are planning to increase spending even more – from $3.7 trillion in 2015 to $6 trillion in 2025. Wowee – that's an increase of 64%. That increase of $2.4 trillion in the future doubles the past increase of $1.2 trillion. DOUBLES!

Fourth, in 2005 federal spending on mandatory categories at $968 billion was less than discretionary spending of $1.3 trillion. But that was about to change. Mandatory spending is the big spending hog. Notice that while spending on mandatory items will rise in the future by $1.6 trillion (69%), spending on discretionary items will increase by $232 billion or by about 20%. Notice also that these discretionary future increases come after a decade of decline (-$154 billion or -12%). As of 2025 mandatory spending will be $3.9 trillion compared to discretionary spending of $1.4 trillion.

Fifth, notice that net interest spending increased by only $39 billion in the past but is expected to rise by $545 billion in the future. This is no surprise given how long the 

Fed has kept interest rates so low. This shows you the importance of the national debt. If the debt was to return to normal we might save a lot of money on interest. 

Finally, notice the last line of the chart. This shows you that we have gone from an excess of past spending over revenues of $319 to $438 billion to a future amount equal to $1.2 trillion. If we knocked the $1.2 trillion down to something more normal like $400 billion we would reduce the excess by $800 billion. $800 billion amounts to 21% of mandatory spending in 2025. But even this change does not stop debt from rising. 

	2005	2015	2025	Chg	Chg	% Chg	%Chg
Revenues				Past	Future	Past	Future
Income tax	927	1541	2529	614	988	66	64
Payroll tax	794	1065	1531	271	466	34	44
Corp. Inc tax	278	344	421	66	77	24	22
Other tax	154	299	337	145	38	94	13
Total Revenues	2153	3249	4818	1096	1569	51	48
Spending
Mandatory	968	2299	3875	1331	1576	138	69
Discretionary	1319	1165	1397	-154	232	-12	20
Net Interest	184	223	772	39	549	21	246
Total Spending	2472	3687	6044	1215	2357	49	64
Spending minus	319	438	1226	119	788	37	180
Revenue
CBO.gov

Ticking Time Bomb: National Debt

If I had a cartoon for this post today it would show the leaders of both parties smiling merrily with gifts extended in right hands while the left hands were plunging a dagger into our collective backs.

Recall last December when champagne corks flew and Congress declared it had come together in a great spirit of compromise to save the nation? Despite years of acrimony and accusations, these folks came together on the eve of the next presidential election and selflessly compromised by removing lids on spending while keeping most temporary tax cuts in place. Selfless? Ha ha. These elected officials realized that voters are not buying government standoff and they basically made Santa looks like a piker when it comes to distributing brightly wrapped gifts for all. On Dasher. On Dancer. Ho Ho Ho.

Well, the Congressional Budget Office (CBO) got around to estimating the budgetary implications of the 2016 Compromise Bill and they are not pleasant. In fact I think it is safe to say that we have finally arrived. We have finally arrived at the point of no return, the proverbial rock and hard place. We are out of bullets, yet our emboldened leaders are bribing and drugging us as they take us to the brink

Let’s suppose you go to Bank 1 and get a loan for a car. Then you go to Bank 2 and get a loan for another car. Bank 3 helps you buy a house and Bank 4 lends you money for your education. At some point it becomes pretty clear that even if you graduate at the top of your class with your coveted degree in Tiddlywinks, you will never have enough money to pay back these loans. Then you get sick and need to borrow money for expensive medicine.The next Bank says no way Jose. And your name is not even Jose. 

You explain to Mr Banker how much you need the money and he says no again. So you decide to reduce your spending on guava jelly and even with relatively large cutbacks on Jiffs Extra Crunchy Peanut Butter, you still can’t pay your existing loans much less the new one. So you ask your boss for a raise and he gives you 10% more. Hmmm…still not enough. Not nearly enough.

Stop crying Charlie. It is just an example. This example is silly Larry stuff but it makes a simple point. It is possible for a person or a country to have so much debt that there are no good solutions to their problems. Greece, Venezuela, Argentina, and dozens of other countries now and in the past have hit those limits and the results are both clear and tragic. At the point that the tragedy becomes known we all get very interested. We start asking questions – how did we get ourselves into this situation? What can we do to make things better?

The sad thing is that it is too late to ask those questions. The time for those questions was BEFORE things got so bad. BEFORE is when you can make adjustments. Those BEFORE adjustments are painful but they are nothing like the harsh boot on your neck when the creditors come after you…and then desert you.

Many of you are betting on just how many JDs I consumed tonight. But I am pretty sober and I am not exaggerating this mess.  What is so bazaar is that the US is now in a tragic budgetary position and these people running for office do not even have a clue. I will show you CBO projections below that are alarming. But the sad thing is that no one has picked up on it. No one and no party is debating this issue. Worse – many of these government folks want to legislate even more spending when they get back together later in 2016. Wow.

Here are some facts from the CBOs latest budget projections (cbo.gov):

·        From 2000 to 2007 government debt held by the public averaged around 34% of GDP. Let’s call that normal. In dollar terms the debt averaged around $4.2 trillion.

·        Largely because of the recession of 2008/2009, the debt increased to $13.1 trillion or to 74% of GDP by 2015. Let’s call that a huge increase but partly explainable by tough times.

·        After the 2015 Budget Compromise the debt is projected to rise to $16.9 trillion in 2020 or 78% of GDP. By 2026 the corresponding projections are $23.8 trillion and 86% of GDP. Let's call that criminal neglect.

·        If I am doing my math right, in 20 years, US government debt held by the public will have grown from about $4 trillion to more than $23 trillion. That’s a roughly six-fold increase. Notice it grew much faster than the economy as the share of debt will have gone from 34% of GDP to 86%. 

How do we get debt back down to something normal like 34% of GDP? How do I fit into my wedding suit? Not easily!  In the meantime, what happens if we have another recession and the debt goes to more than 100%? What happens to interest expense and debt when interest rates return to normal levels? How do we get back to something even approximating “normal” debt? Our so-called don't even talk about it. Instead they are boldly advancing plans to increase spending (free schools, more free healthcare, more submarines, etc) or looking for the lucky beans that will raise revenues (on the other guy) or magically increase output. 

Why isn’t hell already breaking out? There is a simple answer. For the time being problems elsewhere make us look okay by comparison. We survived the world recession better than most countries but part of the reason we did so well is that we went deeply into debt. Other countries had their own pluses and minuses – but right now many are in trouble. They won’t always be in trouble. And when they return to more normal conditions we will look much less good in comparison.

Japan and Europe will gradually improve. China will bottom and recover. Many developing countries will get pulled along when the developed world improves. As all this happens, our politicians will hope nobody looks too closely at US debt. As US debt pushes toward 100% of GDP or more and as better alternative investments arise, you can bet that US and global investors will shift their money to where in the world it seems safest. At that point there will be no easy fixes. We will feel the stupidity of policymakers who make us more and more vulnerable. It will be a mess. But our current batch of policymakers today is whistling their way to the bank. How do we get their attention? 

Iran, Climate Change and Prediction Error

Mark Twain is famous for saying that "it is difficult to make predictions, especially about the future." My mother often predicted that I would become a bum.  She was right. As a happily retired guy I am sure that Betty would agree with my mom’s vision. 

Predicting the future is both necessary and humbling. Squirrels don’t have spreadsheets and mathematical models, but they gather nuts in anticipation of the coming winter. The playboy squirrels who don’t predict so well lose a lot of weight after winter arrives.  Clearly we learn from squirrels and we predict lots of things that improve our lives. But predicting the future is not an easy thing since the future by definition is unknowable. Those who take actions in anticipation of a specific future often make mistakes – sometimes very damaging ones.

Yet we predict and forecast. I grew up in Florida. During hurricane season we all become forecasters. Will that storm turn into a hurricane? Will that hurricane hit land? If so when will it hit? Where will it bring the most disastrous winds and lightning? Weather forecasters are almost always wrong when it comes to predicting these critical facts about hurricanes.Maybe that is an extreme example but I don’t think so. We modern folks with our math and models forecast a lot of things. It is important to do so. And we do so knowing that we are often wrong.

If you are still awake your mind might be wondering and thinking about all the ways we predict the future. My reason for writing today arises because of what I see as a very inconsistent approach by our present leaders with respect to forecasting some very important things.

The Obama administration is VERY sure that climate change is coming and that without major policy changes and a lot of investment, we and the rest of the world will be threatened. I think he said that climate change is our most important future challenge. There are some very important people and very sophisticated models supporting the urgent need to spend trillions of dollars to change and prepare for things that will happen in the distant future – some expected to arrive more than 50 years from now.

Despite the fact that the future is hard to predict and despite the huge sums of money involved, the president is laser focused on attending to these challenges immediately. In his and his supporters’ minds, this expenditure is worth the risk. His policy makes us all invested bettors on future climate.

Compare this aggressive approach to another important future challenge – nuclear weapons. The world is already in accord that countries will not produce more nuclear weapons. And that accord is for good reasons. While it seems highly irrational that any nation, even a rogue nation, would fire nuclear weapons at another country, we worry that all nations are not always rational. It is like the idea of someone yelling fire in a crowded movie theater. It seems quite irrational to yell those words – yet we have laws to prevent crazy or mean people from doing such things. The world has agreed to control nuclear weapons for similar reasons.

Yet the same administration that worries about climate change wrecking our countries is willing to predict that Iran and North Korea can be trusted to not yell fire in a crowded movie theater – or to not unload a nuclear weapon on one of the rest of us. Obama can vividly see water levels rising and shorelines being over run despite knowing that all this future information is model-driven and about the future 50 years from now. Yet the same Obama cannot imagine a religious zealot or a desperate dictator shooting a nuclear weapon. He cannot see those countries most threatened by nuclear Iran and North Korea arming themselves. He seems to minimize any real threat from a world with increasing amounts of nuclear weapons in the most unstable places. 

Kerry and Obama repeatedly say that the recent accord with Iran will prevent them from obtaining a nuclear weapon yet they also agree that within 10 years Iran will be able to manufacture such weapons freely. They publicly agree that after those 10 years it will take only one year to be ready to aim and fire. So why are we not aggressively trying to prevent that outcome? My grandson Nolan will not be 13 yet in 10 years. I am not particularly crazy about him having to worry about Iran or North Korea or some other despotic place. Clearly this is at least as important as the impacts of climate change on him. Right? 

So here is my question. In the case of global warming, President Obama is willing to forecast the absolute worst. In the case of Iran and North Korea his “models” assume the absolute best. Most economic forecasters that I know (who are not ideologically motivated) bring a “show me” attitude to forecasts. They are always skeptical about their model’s predictions. They always discount the certainty of what we think we know. They always follow their forecasts with a list of caveats longer than a drug company’s list of side-effects in a television commercial.

Why is Obama so sure about the intensity of climate change and so sure that Iran and North Korea will turn into the cutest and sweetest puppies? Why can't we apply conservative and consistent forecast approaches to policies related to climate and national defense? 

2% Inflation and the Fed

The Fed seems to have a thing about 2% milk. Or was that 2% inflation? It has become a passion with them. It’s like your mom when you were a kid. Honey, if you are good we will take you to Legoland. What is good Mom? To start with clean up your room. And then you should get straight Bs. Straight Bs? Why do I need straight Bs to be good – good enough to go to Legoland?

Mom knew that I would never get straight Bs. I could hardly sit in my school desk for five minutes let alone concentrate long enough to get a B on anything. The Fed has been singing this 2% inflation song for quite a while – and all during that time the chance of inflation reaching 2% was about the same as my getting straight Bs.

Why is the Fed so disingenuous? Mostly to take our collective eye off the ball. There used to be a time when the proper role of the Fed was to provide just the right amount of liquidity to the economy and restrain inflation. But then the Keynesians messed things up and suggested that since the government is totally inept, the only organization besides Donald Trump left to control the economy is the Fed. So instead of humbly trying to  dampen inflation and inflation expectations the Fed has turned into this multi-headed hydra doing everything from dunking basketballs to fine tuning the unemployment rate.

Janet has no troubling dunking so she and her fine fellows at the Fed (notice all the Fs) have spent the last 8 years or so telling us bedtime stories about monetary policy and the unemployment rate. Janet will not rest until every last legal and illegal fast-food server has a full time job with rapidly growing wages. She is still a long way from reaching that goal so she is even more dedicated. But here’s the rub. Aged economists like myself keep reminding her that at some point after she has poured enough money onto the smoldering economy she will have created enough economic and financial imbalances to sink a manatee.

Janet wants to please even old guys like me so she gives what we might call “lip service” to the idea of inflation. Janet wants unemployment much lower (and wages much higher) and will say just about anything so she can say she slayed the employment dragon. One thing she can say is – look dudes. I poured enough money on the economy to drown China and look – no inflation. Well – there is some inflation so she had to come up with a number for the perfect amount of inflation and that number is 2%. She keeps pointing out that inflation is less than 2% and she acts as if that is a bad thing. Is it a bad thing when your money buys more? Instead of saying she wants the unemployment rate lower – she chides us with this silly statement that inflation is less than 2% and that is a bad thing! Worse – she says – we must keep stimulating the economy until we can get inflation up to 2%. 

Up to 2%!!! Am I yelling? I spent my whole 169 year career thinking the Fed is supposed to REDUCE inflation. Where did we get this raise inflation crap??? It is just like those straight Bs. Mom didn’t want to take me to Legoland. Janet does not want to raise inflation to 2%. What Janet really wants is a gold star for employment achievement.

You say – but Larry – the Fed just raised the interest rate. Are you never happy? Did you never get to Legoland? Yes, I did get to Legoland and it was wonderful. As the Fed announced its miniscule increase in the interest rate it spent more words reassuring us that the future increases will be so gradual that no one will even notice. But even that tiny little interest rate increase isn't guaranteed. If ANYTHING comes up this year that has even the tiniest possibility of slowing growth in the US economy you can be sure that the Fed will end their attempt to restore a bit of normalcy to monetary and financial conditions.

2% inflation is a gimmick and it means nothing. What matters is the Fed’s progressive agenda and that it is riveted on the unemployment rate and economic growth. Mark my words. If the inflation rate rises close to or above 2% while the employment situation is not sufficiently solved – the Fed will explain why 2% was never a rigid target. The Fed will then explain why 3% makes more sense. Hey guys, is 4% really so bad? 

Why am I so mean about the Fed? The answer is that they don't read the handwriting on the wall. First, remaining issues with employment have nothing to do with monetary policy and everything to do with long-term structural issues. Loose money and low interest rates are doing little for growth and everything to increase imbalances. Second, we already see the worrisome bubbles developing that arise from near-zero interest rates. Third, if inflation does begin to rise despite little progress on employment, the Fed will likely ignore the inflation and will end up creating a very unstable stagflationary environment. Those of you who experienced all that in the 1970s know why that is not a desirable end. 

The Fed should stop this charade about wanting a higher inflation rate and just tell the truth. They are not going to stop this abnormal monetary policy until every last one of us has a full time job and wages are growing faster than kudzu. Domestic and global imbalances be damned. 

Junk Bond Bust by Guest Blogger Buck Klemkosky

There are problems in the junkyard. Liquidation of the largest mutual fund since 2008, Third Avenue’s $800b Focused Credit Fund, has intensified concerns about the health of the high-yield bond market.  Third Avenue had invested in high-risk illiquid bonds and as redemptions poured in the fund sold liquid bonds first but at the end could not sell the $800b of illiquid bonds and halted redemptions until assets can be sold. 

Another high-yield fund also stopped redemptions and one other liquidated. This was a wake-up call for investors who had been chasing yield without assessing the potential risk of high-yield bonds. The amount of money invested in high-yield bond funds has quadrupled since 2009.

High-yield, high-risk bonds are commonly referred to as junk bonds. People who work and invest in this area of the bond market would prefer the high-yield label but junk is used as often as not. Bonds are rated investment grade or speculative. Investment-grade bonds are further categorized into high-grade (AAA and AA ratings) and medium-grade (A and BBB ratings). High-yield bonds (rated BB or B or CCC) are considered speculative with only moderate protection of principal and interest. Bonds can be rated lower than CCC but usually not at issuance.

There are only three AAA-rated corporations left in the U.S.: Johnson & Johnson, Exxon-Mobile and Microsoft. Twenty-five years ago there were nearly 100 U.S. companies with AAA ratings so they are a dying breed. There has been a long-term downgrading of corporate bonds globally; for example, in 2015 more than $1t of corporate bonds have been downgraded and less than $500 B upgraded in the U.S. alone.

Prior to the 1980s, only investment-grade bonds could be issued. Any bonds rated lower than BBB had been downgraded. Mike Milken of Drexel Burnham fame started the junk-bond revolution by convincing investors to buy high-yield bonds at issuance. He has long since departed the industry as has Drexel Burnham but the high-yield bond market continues to thrive. High-yield bond issuance has set records the past five years as has the issuance of investment-grade corporate bonds.

One result of the record amount of high-yield bond issuance and consistent downgrading of investment-grade bonds is today $2t of global corporate bonds are rated speculative or junk. Corporations have been motivated to issue bonds because of low interest rates and tax advantages while investors have chased yield because high-yield bonds provide 4-5% annual yield more than investment-grade bonds. Recently AA-rated bonds yielded 2.61%, BBB-rated 4.27% and high-yield 8.5-8.8%, up from 5.8% earlier in 2015. In the bond markets, the higher the risk, the higher the return. If you really have an appetite for risk, the CCC-rated bonds yield over 18%. However, as junk-bond yields have increased and prices declined, they will suffer negative returns for the first time since 2008. A popular high-yield bond index has fallen 13.6% since mid-April 2015, prompting investor selling.

What is the downside of having $2t of corporate bonds rated junk? Evidence shows that the probability of default is much higher for junk bonds; over a 30-year period, 3.8% of these bonds defaulted annually. In 2015, the default rate was 2.6% versus 2.1% in 2014. The default rate is expected to be above 4% in 2016. During periods of crisis such as 2007-2009, the default rate skyrocketed to 15%. About 25% of high-yield bonds have been issued by energy, mining and commodity-based companies which are now experiencing financial stress. 111 companies have defaulted on $80b of debt in 2015, the highest number since 2009. High-yield promised returns look appealing in a low-interest rate world; returns after default don’t look nearly as attractive as promised yields. Unfortunately many investors have chased yields without fully understanding the risk that entails.

Sunny Davidsons: Glass Half-Full?

Happy New Year!

I spout a lot and spouting can sometimes have a negative tone. So I thought I would start the year off on the right foot. Glass half-full? Of course the glass is always half-full but in 2016 and the year of a Presidential election in the USA – we are going to constantly hear about everything that is wrong with this country and the world. The good things will easily get lost in all this negativity.

I am not saying that there is anything wrong with pointing out our drawbacks and challenges. This is the way we learn. Mrs. Montgomery my fourth grade teacher was pretty clear that punching and otherwise touching my classmates was not appropriate behavior. Today I am pretty much punch-less and I should thank Mrs. Montgomery for her constant help including the water-boarding. 

But we also know that too much emphasis on the negative can be counterproductive. My father’s name was Sonny Davidson.  Born in 1915 he was a young teen when the Great Depression hit and he decided he already had enough schooling and hit the streets. Later during World War II he passed himself off to the Merchant Marines as an electrician. After the war he was selling cigarettes on the Staten Island Ferry where he met my mom. Sonny was an eternal optimist despite being beaten back time and time again. He fought hard to put the food on the table and had at least the following occupations – taxi driver, entertainer with a stage name (Zonn Murray was a hypnotist, mind reader, magician), Miami Beach strip club manager, bar manager in Key West and then Havana, appliance salesman, appliance store owner, and then gift wholesaler. Both his appliance store start-ups ended in bankruptcy.

But if Sonny Davidson was optimistic his dear wife Marge was Mother Teresa.  Marge was born in Budapest and came to the US in 1929 – great timing mom! She met Sonny one day on the Staten Island Ferry and that was that. They moved to Miami after World War II and happily raised two sons there. They were the classical good cop bad cop when it came to raising children but always they were optimistic and forward looking. No wall was too high to climb. Thus my title today is Sunny Davidsons.

Inasmuch you see why it is so easy and natural for me to advance the glass half-full philosophy. As we march through the battlefield of 2016 it does not hurt to think about some things….

            If you are reading this you are alive. Smile.

            Thanks to innovation we have things available to us that we never even dreamed of 20 years ago. If mom was alive she would not be using something called a wash tub and ringer.

            While Russia is no pussycat, I am not a pimply teen walking around Miami waiting for a violent reaction by the Soviets over Kennedy’s Cuban Missile Standoff.

            While we are contemplating ground troops in Syria, we are not learning daily of casualties in a far-off place called Vietnam. Most people today do not even know the word napalm.

            Non-profits and charities are everywhere serving the needs of the less-fortunate and many of us are proud to serve on their boards and committees.

            Despite continuing worries about the future of the Social Security System, the baby boom is retiring in scores and receiving checks that make life easier for boomers.

            Radio stations continue to play Party Doll and other favorites from the 1950s.

            Despite lingering two-way racism and ensuing unrest, minorities are succeeding in education, work, and are no longer subject to obnoxious insults like sitting in the backs of buses.

            While many of us dislike a swollen national debt our government is not teetering on the brink of collapse as in Greece, Brazil, Russia, Venezuela, and several other countries.

            No one likes sub-par economic growth but if one looks around the world today a 2% growth rate is not bad. Consumer spending rose 3% last quarter.

            Gays can marry and are mostly treated as regular folk.

            While politics and elections are important and colorful – most of our days and hours are  filled with both frustrating and wonderful friends, family and neighbors.

Have an absolutely wonderful 2016. 

Predictions for 2016

I offered no predictions last year and therefore I can honestly say that none of my predictions failed. But I knew that your holiday would be spoiled if I did not add a few tantalizing forecasts to those you will be hearing from real experts during the next week. So I am giving you 11 predictions for the price of 10.

1.     President Obama will announce a new directive in which Michelle his wife will become Queen for life of America. Congress and the Supreme Court are unnecessary obstacles under her regime so those pesky institutions will be disbanded.

2.     Marco Rubio will grow a whole foot next year and will tower over the other candidates at the debates at 6’6”.

3.     Iran, Cuba, and North Korea will form a new country named Korcuran. After their first practice shot with a nuclear tipped ballistic missile they will explain to western friends that they have no nuclear tipped missiles and would never aim them at Israel.

4.     Vice President Kerry will be scammed by third graders posing as fifth graders at a Kool-Aid stand.

5.     Carly Fiorina will be named most congenial from among the Republican presidential candidates.  Despite constant rumors she will not marry Matt Lauer or Hoda.

6.     Bernie Sanders will lose the Democratic nomination for President but will be among the top five candidates for emperor of Korcuran.

7.     Late starters, Dennis Rodman and Charlie Sheen, will win the Presidential election next November. Both are considered to be outsiders who will stand up for the little guy while being totally unintelligible. And possibly drunk. Queen Michele Obama will protest the election. 

8.     Delta and United Airlines will soon be marketing new standing areas on their international flights. While paying for all the usual amenities (baggage, JD, etc) flyers will now have to Pee for Pay in the lavatory. If a passenger cannot remain standing during the full 18 hour flight to Australia, he or she can pay flight attendants a little extra to tie them to their poles. Let’s not stand for that!

9.     The Indiana University football team will not play anyone in the defensive backfield next year. They have brokered a deal to have 15 players on the offense and only 7 on the defense.

10.  Net Neutrality will become the law of the land next year but most people do not have a net and are not remotely neutral. In a poll taken earlier this year 14 out of 10 people did not know what net neutrality means.

11. Obamacare will not be repealed. It will be renamed Rodmancare. Among the many new benefits will be a free week with unlimited healthcare in Korcuran and a discounted round trip airfare in Delta’s new Standing Zone.

I think I am running out of steam.

I hope you had a nice Christmas and 2016 brings you everything you ever dreamed of and more. And yes, send money if you can.

Santa, Trump, and Climate Change

That time of the year has rolled around again. Despite a mountain of evidence that Rudolph is really an ISIS spy using Santa’s sleigh to collect reams of personal information, we cut down perfectly good trees, decorate them, and go deep into debt so our children will carry on these traditions.

So naturally I was thinking about Santa when I read Bloomington's Sunday (a week ago) newspaper and came upon the column by notable left-wing columnist Eugene Robinson. The last time Robinson wrote a nice thing about a Republican candidate was when….hmm….I guess I can’t remember. Robinson, like about 2 million other nationally syndicated columnists, likes to write about Donald Trump. Articles about Trump now exceed the number of emails I receive purporting to help me enlarge my male part.

Here is what Robinson says about two-thirds through his article – “It’s not that Trump will do the impossible, it’s that he might do something.” It was this statement that got me thinking and that isn’t easy on a Sunday morning after the annual Christmas tree decorating party that included a brand new half-gallon bottle of JD. This statement by Robinson made me see the glowing connections between Santa, Trump, and Climate Change.

Let’s begin with Santa. We adults, except for Jason, all know that Santa brings no gifts with Rudolph and his sleigh.  As Robinson says, Trump won’t do the crazy stuff he yells about. But we love it when Trump reams the big guys. It’s like we all love it when IU almost beat Ohio State in football. We cheered like crazy knowing that our IU guys would not really win. We’d like to think that we might have won. That’s enough for Hoosiers. We love to tell our kids about Santa and Mrs. Santa and his workshop and shimmying down chimneys drinking milk and eating cookies. We love it because it makes us feel good. We love Trump because he say's things that most people would not say. 

That leaves us with another article that was published Sunday December 13 about climate change. President Obama was quoted in this article as saying, “The climate pact offers the best chance to save the planet we have.” I am not sure about you but the minute I saw that statement the first thing that came to mind was Supergirl. Don’t tell me I am not liberated!

There is a photo in that newspaper article with several key players of the United Nations with thumbs up and hands clapping. The title of the article is, “Historic pact to slow global warming is celebrated in Paris.” Ban Ki-Moon, not related to the infamous Reverend Moon said, “The Paris Agreement on climate change is a monumental success for the planet and its people.”

You would have thought that the representatives of 190+ countries had found a way to stop comets from intersecting with the Earth – or they had eradicated Aids or Pancreatic Cancer. Or maybe they agreed that Iran should name Christmas as an official holiday.

No, these representatives apparently did something monumental to save the plant from climate change. Already you are labeling me a climate change denier. That way you can dispense with me as just another fruitcake from the right. Never mind that. I am saying that you folks who are not climate change deniers have been duped in the usual ways by the usual people. If you care about climate change you were sold down the river by the 190+ smiling government officials.

These people punted every possible real issue. Folks there ain’t no Santa Claus and this agreement has done absolutely nothing to save the planet earth.

Your mom says "go do your homework". But she does not tell you when you have to do your homework. Nor does she tell you how much homework you have to do. Your mom says you have to self-report how much time you spent on your homework. But there are no penalties if you don’t do your homework. Maybe she will frown at you. You agree to do your homework when your friends do their homework but there is no mechanism for your friends to do their homework until they are 45 years old. Even then there are no penalties if they don’t.

No, I am not going to do the boring work of repeating all of the silly things in the agreement that are making so many people pop their corks. But here are a few examples of the silliness as expressed with the words of the contract:

By “some point” somewhere around 2050 emissions need to be reduced to low levels. I checked my calendar and Grandson Nolan will be almost 38 years old then. He is 2.5 now.

Countries are “expected” but not required to meet any targets

Since the agreed targets are insufficient, countries are asked to review them in four years to “see if they can update them.”

There are no penalties for missing targets

Richer countries “should” continue to support the poorer countries. China is “encouraged to pitch in on a voluntary basis.”

I think representatives of those 190+ countries should be asked to sign a statement that says that Santa is real and that Trump has nice hair.  We will then all feel a lot better.

Adam Smith and Prudent Man

Last week on December 8 the Wall Street Journal had two articles on page A15. In their Notable & Quotable column is a quote from Adam Smith from his “The Theory of Moral Sentiments” (1759). The second article is titled “Dissensus, the Spirit of our Age” by Joseph Epstein.

So today I am taking a departure from my usual Macro-paranoia to discuss the ways we speak to each other. My spell-checker does not like the word Dissensus but we all know what that means. It means we don’t agree. And when we disagree we are often emotional if not violent. I suspect that dissensus has always been around but to me it seems a lot worse today.

Perhaps our problems are more severe now – but I doubt that is the case. I recall too well being at Coral Gables High School and wondering before his horrible assassination if President Kennedy was going to start a war over missiles in Cuba. I remember the draft and Vietnam. I remember that blacks drank from separate drinking fountains and were required to sit in the back section of city buses. None of that was fun or good. We had plenty to argue about.

Yet despite the extreme and seeming intransigent problems we faced, many of us were able to find less strident ways to disagree. The Epstein and Smith articles ask us to think about this issue. Epstein emphasizes that people – even people with strongly held views – thought it more prudent to look at both sides of a question before leaping to vote for a candidate. Today many of us seem to have reflexively made-up our minds. Epstein thinks that we used to cogitate more and only decided after much weighing of facts.

Smith is copied below. His wording seems a little archaic and his descriptions of prudent man might be considered by some old-fashioned. But the father of the free market and the “invisible hand” says things we probably should not forget. Among the gems below are that the prudent man:

            studies seriously and earnestly

  may not be brilliant but they are always perfectly genuine

            is not ostentatious

            is simple and modest

            does not always think of cultivating the favor of those little clubs and cabals

 neither endeavors to impose upon you by the cunning devices of an artful imposter, nor by the arrogant airs of an assuming pedant nor by the confident assertions of a superficial and imprudent pretender.

More of Smith is at the bottom below.

Should we not passionately disagree? Of course we should. That is not my point today. My point is that we seem to rush judgment. We share with some others a complete and well-outlined ideology that has its own dos and don’ts. Am I saying you should not have an ideology? No. But what I am saying is that perhaps there are some important things that fall between the cracks.

One example is abortion. That topic has some of you already taking deep breaths. But in a democratic nation with divided views it is hard to  imagine moving to an extreme state in which we had either no abortion or totally free choice for abortion.  Today we have laws that allow it but regulate it. Realistically the laws will bounce around over time. Sometimes we will make it harder to get abortions for good reasons. Other times we will do the opposite – for good reasons. This is where the thinking comes in. If we are never going to move to either ideological extreme then it seems that knowledge and analysis ought to be used by both sides to decide on the best current solution. That hardly ever seems to be the case today. 

The same goes for income distribution or poverty programs. Extreme ideology supports widely divergent policies – virtually no social programs or greatly expanded state public assistance. Reality finds us between those ends. We can shout ugly epithets at each other – or we can be more like Smith’s prudent man. Would not a left-winger be willing to discuss waste in current programs? Might not the conservative believe that society could gain by assisting some families? The idea that knowledge and common sense can be brought together for our mutual gain seems valuable. The more important the policy topic the more important that we arrive at good decisions.

If we continue to go down the path of dissensus we will live by reality TV. Instead of prudent man we will live by the dictates of finger-pointing. It is hard for me to believe that we would continue to choose the latter.

Adam Smith, “The Theory of Moral Sentiments” (1759):

The prudent man always studies seriously and earnestly to understand whatever he professes to understand, and not merely to persuade other people that he understands it; and though his talents may not always be very brilliant, they are always perfectly genuine. He neither endeavours to impose upon you by the cunning devices of an artful impostor, nor by the arrogant airs of an assuming pedant, nor by the confident assertions of a superficial and impudent pretender. He is not ostentatious even of the abilities which he really possesses. His conversation is simple and modest, and he is averse to all the quackish arts by which other people so frequently thrust themselves into public notice and reputation. For reputation in his profession he is naturally disposed to rely a good deal upon the solidity of his knowledge and abilities; and he does not always think of cultivating the favour of those little clubs and cabals, who, in the superior arts and sciences, so often erect themselves into the supreme judges of merit; and who make it their business to celebrate the talents and virtues of one another, and to decry whatever can come into competition with them. If he ever connects himself with any society of this kind, it is merely in self-defence, not with a view to impose upon the public, but to hinder the public from being imposed upon, to his disadvantage, by the clamours, the whispers, or the intrigues, either of that particular society, or of some others of the same kind.