The President and gas prices, on the same page as Krauthammer

In his column today, Charles Krauthammer touches on the some of the same points I made in my post yesterday, starting with:

"Yes, of course, presidents have no direct control over gas prices. But the American people know something about this president and his disdain for oil. The “fuel of the past,” he contemptuously calls it. To the American worker who doesn’t commute by government motorcade and is getting fleeced every week at the pump, oil seems very much a fuel of the present — and of the foreseeable future."

The whole column is here http://www.nationalreview.com/articles/293617/seaweed-your-gas-tank-charles-krauthammer

More on the Fed

Way back in August http://porcupinehuddle.blogspot.com/2011/08/federal-reserve-policy.html,  I posted something on Federal Reserve policy, suggesting that what was missing from the discussion of Fed policy was the importance of velocity.  Critics of Bernanke’s easing seemed to be arguing that any increase in the money supply would lead to inflation, but that isn’t the case if the velocity of money decreases and it seemed to me very likely that the velocity of money had declined.

Along similar lines is this article on the misuse of Milton Friedman: http://www.theatlantic.com/business/archive/2012/03/what-gop-economists-dont-understand-about-milton-friedman/254405/

UPDATE:  There is a related post on the Powerline website.  It includes this from a reader:

"Yes, base money has been cranked up from ~$800B to about $2.8T. But the velocity has crashed so hard (and with it, the multiplier) that M2 hasn’t really shown a hiccup at all."

http://www.powerlineblog.com/archives/2012/03/what-would-milton-say.php

Contraception and insurance, tellingly written & posted on a Saturday night

Overlooked in the controversy over the mandatory nature of supplying contraceptive services by way of employer health insurance is the question of why it is a part of insurance in the first place.  You insure against financial losses of a chance nature which would be otherwise difficult to absorb.  Much to my regret, I’m all too familiar with the chance need for contraception, but even if I had something approaching charm, any seductive ability at all, I still wouldn’t see the need or merit to buy insurance to cover contraception. 

Consider the numbers.  I pay $56 a month for internet service, $58 for my phone, and the current price of a condom is approximately $2.25 per pop (or non-pop if that is the focus of your attention). My math gets me 30.42 days or 4.35 weeks in an average month, so if I calculate further my birth control costs would equal my internet/phone costs if I had sex 25 – 26 times a month, or about 5.75 days every week: a) I should be so blessed b) why would this not be a perfectly ordinary expense which has no place in the scheme of insurance?

In large part the answer has to do with taxes.  If my contraception costs are included as part of my health insurance then I’m paying for them with tax free income as opposed to after tax income, so it makes sense to pack as much expense as you can get away with into your health “insurance”.  Then to, if I don’t think about it, I can easily believe that it is free since I’m not paying for it out of my own pocket (as if the employer pays you a salary and then tacks on the benefit costs out of the goodness of his/her heart). 

In short, to a considerable degree we have a issue of liberty and social controversy instigated by the government, on a matter also brought about by government.  I know, I know, what a surprise.

Obama's budget and finance's M&M theorem

One of the notable changes in the President’s entirely symbolic budget is the proposed adjustment in tax on dividends from the current capital gains rate of 15% to the personal rate of 39.6% for those with incomes above $250,000.  It should be noted that this is a change of 24.6 percentage points, and perhaps more revealingly, a 164% percent change.  Without knowing how the expected revenues from this change were derived I’d feel very confident in the prediction that actual revenues will be less.  Change something by more than 100% for people who have financial means, and you are likely to get rather dramatic changes in behavior.

Which brings me to one of the central tenets of modern finance; the M&M or Modigliani-Miller, theorem.  What M&M posits is that in absence of taxes and bankruptcy costs, capital structure—that is a company’s mix between equity and debt—doesn’t matter.  Bankruptcy costs obviously tilt the field towards equity since debt costs are a financial, legal obligation. 

Taxes enter into it because interest expense is a deductible expense for the corporation.  The money going to debt holders is before tax, the money in the form of dividends to equity holders is after tax.  And here it is worth bringing up a point made by finance professor Harold Bierman: “if a company is 100% debt financed, the debt holders own the company.”  In other words, the distinction between debt and equity isn’t as concrete, as absolute as it would appear on first thought.  What, for example, is a convertible bond?  Thus, following M&M you have investors who put money into a company in the expectation of a financial return, absent the conditions discussed, they and the company proper are indifferent whether that is in the form of debt or equity.

So what does all of this have to do with the change in dividend rates?  Well financial returns are always calculated as after tax cash flows and it should be noted that the value of a stock is, at least theoretically, the discounted value of future dividends [the capital gains benefit derives from your selling the right to a future cash flow stream, i.e. the future dividends].  Increase the tax on dividends and you’ve made it more attractive to invest via debt rather than as a shareholder.  Further, by reducing the benefit of receiving dividends you’ve increased the benefit of the company holding on to and using cash rather than distributing its profits.  In short, the financial implications of the change in dividend treatment being proposed by a Democratic administration is a tilt towards greater debt finance, and larger companies!

One final, relevant point: when a company engages in a stock buy back it is often derided in the press as an action to prop up the stock price.  While reducing the number of shares will have the effect of raising the share price—the same pie being divided into fewer slices equals larger portions—that isn’t really what is going on.  A stock buy back is just another method open to a company to distribute money back to investors, with the advantage of being able to delineate who wants to receive those funds and who doesn’t at a certain time (as opposed to a dividend which goes out to every shareholder), and to distinguish between equity holders in different tax situations.  A significant increase in the tax rate on dividends should lead to more companies opting to buy back shares, a kind of dividend masquerading as a capital gain.

The politics of economics

"Unfortunately, it is seldom possible to insulate economic judgments from political ones, or to expect complicated economic ‘truths’ to be accepted ‘on their merits’.  Some parts of the argument have gone over the heads of the electorate while others, in the form in which they are adopted…, have been adopted within an egalitarianising framework which makes nonsense of the rest."

Maurice Cowling, Conservative Essays, The Present Position, 1978

Bain Capital and finance - an NRO discussion

There is an interesting discussion at NRO and the Weekly Standard regarding the attacks on Bain Capital, and by extension Mitt Romney, by a few of the other candidates, most notably Newt Gingrich.  The point being discussed is the alleged compulsion on the part of conservatives to defend finance by way of defending capitalism. Yuval Levin states it thus:

“But it has revealed two problems that conservatives who have risen to Romney’s defense and the Romney team itself will need to address. The former have too easily treated finance as the entirety of capitalism, and so have needlessly made both the defense of finance and the defense of capitalism more difficult.” http://www.nationalreview.com/corner/287698/romney-and-bain-yuval-levin

Levin is usually very sound, but I think his contention that conservatives have treated finance and capitalism as being one in the same is absurd.  To be sure a defense of finance has been prominent lately, but then we are in recession caused by dislocations in the financial markets and the occupy wall street protests are, if targeted at all, a protest against finance so one would hope a defense of finance has been mounted by those who believe in capitalism.  But where is the evidence that the two have been conflated as being one in the same by conservatives?

Prompted by Levin’s post Michael Walsh added his own supporting argument drawing a contrast between finance and production of goods and services.

“A bestselling author creates wealth for himself and others by sitting alone at his desk and then producing something the public wants to read and buy. George Eastman basically invented the photography industry (now fallen on hard times), Henry Ford, the modern automobile industry. A screenwriter or two, even if they’re sitting poolside in Beverly Hills, create out of whole cloth a movie script that sells to a studio and then provides employment for hundreds or even thousands of people — employment that did not exist until they started typing with one simple question in their minds: ‘What if . . . ?’ All of these folks deserve the rewards they get, and ought to be able to keep most of them.

But the public — after decades of enduring pixel-pushing Masters of the Universe, corporate crooks engaged in liar’s poker as they loot the suckers, convicted felons who try to manipulate the American political system, and other assorted enemies of the people — is rightfully suspicious of men who make millions off the lives and fortunes of others and then act as if they’ve accomplished something unique and original.” http://www.nationalreview.com/corner/287707/battle-bain-capital-michael-walsh

This is terribly confused, and only in part because it makes a similar mistake to what Yuval Levin has warned against by treating one practice or aspect of finance as its entirety.  But more fundamentally it glides over the central contribution of finance and what Bain Capital was doing.  Walsh’s example loses sight of the sequence in which a screenplay becomes a movie and employs thousands in the process, and fails to grasp that the receipts or in-flow of cash comes after the movie has been made, marketed, and released.  The screenplay, no matter how creative, doesn’t become a ‘product’ doesn’t put anyone to work, unless someone is willing to fund it.  Moreover the writer and workers all get paid whether the final product finds an audience or not.   It’s only the financier who really loses if the venture doesn’t turn a profit (and that he doesn’t share in the creative reward only extends the point).

Both of the NRO posts reference an earlier post by Jonathan Last at the Weekly Standard. http://www.weeklystandard.com/blogs/how-many-cheers-bain_616558.html?nopager=1  Like the others, Last suffers from the same confusion on what constitutes a successful company or product writing “When people think “job creation,” they typically think about an enterprise that builds something” as if finance and what Bain Capital did isn’t connected to things being produced.  But at least Last (least Last?) gets around to the heart of the matter when in the 5^th of six points he notes: “You could make a sophisticated economic argument that access to capital is even more important than entrepreneurial genius in the grand scheme of things.”  Indeed.  Having been involved in a start-up company I can testify that funding is no mere after thought and I’d be willing to bet that a significant number of otherwise ‘good’ companies die on the vine because they are for whatever reason under-capitalized. 

Like capitalism finance in all its forms isn’t without fault.  Like any idea of practice it has been perhaps extended at the very least to areas of diminishing returns.  Irving Kristol was correct in giving capitalism two but not three cheers.  The same as true of finance, even if it isn’t the same thing as capitalism.

Weak field argument isn't about the field collectively

Over at Commentary/Contentions Peter Wehner makes the point that it is the nominee not the field that matters in regard to current discussions over a weak Republican field.  http://www.commentarymagazine.com/2011/10/28/weak-gop-candidates/   Wehner is being far too literal here.  The weak field complaint isn’t anything like a collective score measurement or even an average. 

Earlier in the day on the same site an upcoming column by George Will was brought out.  In it Will says of Romney:

“Romney, supposedly the Republican most electable next November, is a recidivist reviser of his principles who is not only becoming less electable, he might damage GOP chances of capturing the Senate: Republican successes down the ticket will depend on the energies of the Tea Party and other conservatives, who will be deflated by a nominee whose blurry profile in caution communicates only calculated trimming. Republicans may have found their Michael Dukakis, a technocratic Massachusetts governor who takes his bearings from “data” … Has conservatism come so far, surmounting so many obstacles, to settle, at a moment of economic crisis, for THIS?”

http://www.commentarymagazine.com/2011/10/28/george-will-romney/

That neatly sums up Romney, but when you a look for an alternative to him among the other candidates you come up empty.  If there were a viable alternative Romney would be getting blown out, instead he looks inevitable. That’s what’s driving the weak field meme, not whatever it is that Wehner is addressing.

Finally, one of those false choices

At the Wall Street Journal this week, Peter Wallison had an interesting editorial on the financial collapse.  Wallison’s main point is that the anger being expressed towards Wall Street is the result of a false narrative which has blamed the meltdown on bankers rather than the government policies that produced the housing bubble that collapsed resulting in Wall Street’s losses. http://online.wsj.com/article/SB10001424052970203633104576623083437396142.html?mod=WSJ_Opinion_LEADTop

Among the interesting items that Wallison brings out is a) the requirement from HUD that 55% of mortgage loan originations should be to borrowers below the median income and b) that according to Edward Pinto half of all mortgage loans by 2008 were either sub-prime or otherwise weak.  The 55% requirement is especially eye opening for as Wallison points out this requires a lowering of loan standards which is bad enough, but by artificially increasing demand it creates a bubble which accentuates the problem.  The particulars aside it shouldn’t surprise us that when government gets involved in financial decisions it is going to be political considerations not sound credit that will be in the lead.

But what I find truly interesting and perplexing about this opinion piece is the other or nature of the argument.  At one point Wallison remarks: “this bubble, which lasted from 1997 to 2007, also created a huge private market for mortgage-backed securities (MBS) based on pools of subprime loans.” And so, seemingly without Wallison’s acknowledgement we are back to looking at the banks and Wall Street, for you can’t have a huge market in mortgage backed securities without investors.  What Wallison doesn’t seem to want to ask is if government mandated requirements like 55% of loans below the median are so ill thought out—and they are—then why were supposedly savvy investors, the masters of the universe, backing them with their money instead of putting the brakes on by staying away from them?  HUD directives can’t explain AIG’s credit default swaps.

I agree that the narrative has been one-sided, that the government’s involvement in this debacle were deep and probably more decisive, at least as the proximate cause, than the failures of the banks.  But the liberal insistence that it was the banks and the conservative retort that it was government involvement via Fannie and Freddie is a false choice.  It was both.  However misguided government policy, it still required buyers to keep it going.  The cliché it takes two to tango is applicable here and for some reason missing from the story that both sides want and willing to tell.

Nobel Prize to Thomas Sargent

I’ve been familiar with Thomas Sargent--at least his reputation--since he taught at the Univ. of Minnesota.  Sargent who along with Robert Lucas was a leader of the rational expectations school of economics has now won the Nobel Prize.  That school of economics can be summarized as the belief that “policymakers can’t manipulate the economy by systematically tricking’ people with policy surprises.”  No surprise then to see that Sargent wasn’t a fan of the stimulus program. http://www.nysun.com/national/new-nobel-laureat-warned-against-stimulus-package/87512

Keeping in mind the rational expectations view consider the current economic situation and the Obama economic program:

Ø      Wealthy defined as $250K per year in income, above that is money you don’t need.

Ø      Calls for dramatically increasing taxes on “the rich.”

Ø      Extremely high debt levels with no signs that it will be dealt with by decreasing spending.  Proposed spending cuts when offered have all been pushed into the out years.

If Thomas Sargent’s work has any validity why would a person with money risk it investing in startups and the like?  As it currently stands a rational view of the future includes singly or in some combination: a) much higher taxes on wealth b) inflation c) severe fiscal stress.   

Winston's turn of phrase

Over on the Powerline blog Steven Hayward has a post warning Obama about class warfare via a warning from Winston Churchill to FDR on the subject. Beyond the basic point what stands out is the writing.  Not least how Winston brings it to a close:

"To hunt wealth is not to capture commonwealth."

The entire--pretty short-- post is here: http://www.powerlineblog.com/archives/2011/10/winstons-warning-for-obama.php

Occupy Wall Street - Demands

I haven't been paying any attention to Occupy Wall Street except for Iowahawk's twitter comments.  But I noted that Fox Special Report tonight Juan Williams likened it to the Tea Party and a clip had former Obama admin. official Van Jones cheerleading for the protests.

So this list of demands from one of the protesters is interesting (yes, it's unfair to draw conclusions from one person). http://www.nationalreview.com/corner/279011/oh-all-daniel-foster  Of the thirteen demands I think this is my favorite:

"Demand eleven: Immediate across the board debt forgiveness for all. Debt forgiveness of sovereign debt, commercial loans, home mortgages, home equity loans, credit card debt, student loans and personal loans now! All debt must be stricken from the “Books.” World Bank Loans to all Nations, Bank to Bank Debt and all Bonds and Margin Call Debt in the stock market including all Derivatives or Credit Default Swaps, all 65 trillion dollars of them must also be stricken from the “Books.” And I don’t mean debt that is in default, I mean all debt on the entire planet period."

The shorter version of this demand is no financial system.

Then there is "demand three: Guaranteed living wage income regardless of employment" which might be tough to institute after you've destroyed the financial system and has the other problem of running into
"demand nine: Open borders migration. anyone can travel anywhere to work and live."

Wrapping up our author concludes with "these demands will create so many jobs it will be completely impossible to fill them without an open borders policy." 

The only thing I can add is that when you post something like this you should have to state where received your education,to provide the public with a suitable warning.

More Keynes/stimulus spending

For those of you following at home, you may have noticed that while I think Keynes' basic prescription for getting out of a recession makes sense in certain circumstances, I question whether it applies to current circumstances.  As I've pointed out our problems aren't due to too much savings but rather over-spending.

So a current post over at Reason.com http://reason.com/blog/2011/09/07/one-reason-why-keynesian-stimu
should sound familiar:

"I think John Maynard Keynes would be horrified at the slavish adherence to this simplistic strategy by so many policymakers and economic thinkers, as his theory was much more complex. This thinking might be correct under circumstances other than those in which we find ourselves. If the ratio of our national debt to gross domestic product was low - say 25 percent - and the federal government had run surpluses before the downturn, this college freshman-level Keynesian analysis would have great weight. Put another way, if Uncle Sam were a rock-solid financial entity with low debt to value and he had judiciously used debt for capital improvements that were accretive in value, as the biggest dog on the porch, a stimulus might work.

But with a national debt of more than $14 trillion and unfunded, future “off the books” debt of Social Security and Medicare combined at $104 trillion in present value, according to the Dallas Federal Reserve, Uncle Sam ain’t the man he used to be. This in turn makes American businesses that are sitting on a pile of cash focus on deleveraging. The American consumer is doing the same. In fact, from where I sit, it appears as though everyone except Uncle Sam is working like mad to strengthen his balance sheets. The legitimate fear across the country is that Washington’s refusal to join our common-sense parade will result in higher taxes, more regulations, more inflation and Japanese-style stagflation. In other words, Washington’s attempts at stimulus through spending are having the opposite effect. Businesses and consumers stay hunkered down."