Mark Byron

The CTRL-ALT-DEL Economy?

Here's an interesting statement from Microsoft boss Steve Ballmer that has had my mind reeling a bit since I heard it Tuesday from, of all places, ESPN talker Collin Cowherd.

"I don't think we are in a recession, I think we have reset," he said. "A recession implies recovery [to pre-recession levels] and for planning purposes I don't think we will. We have reset and won't rebound and re-grow."

Ballmer may well be right; I was kicking this idea around with my Portfolio Analysis class last night, and it seems to make sense. Our financial system has got the jitters if not the DTs, used to using easy credit and free-wheeling derivatives and is now having to function without those financial greenies. The auto industry is undergoing an overhaul, as both Chrysler and GM go through government-shepherded Chapter 11s.

If we look to Washington, we shouldn't see too much help on the fiscal policy front. The massive stimulus package didn't do the trick and the Obama team is likely to move towards higher taxes in order to pay down the budget deficit; that might be good for long-term financial stability, but it won't be overly good for GDP growth

That's doubly true when you couple that with reforms that are likely to come out of Washington. Financial reform will likely lead to more expensive capital and more expensive credit for small businesses, as increased capital requirements for banks will likely lead to higher interest rates on bank loans; if banks need to have more equity on hand, they'll need to have a higher return on assets to offset the reduced leverage. Also, any unfunded mandates for health insurance put on businesses will lower profitability and economic growth.

So, Wall Street is looking for the Betty Ford Clinic (as one student put it last night) and Washington is doing stuff that, while helpful for the little guy, will slow the economy to a crawl.

That is, unless innovation paves the way for growth despite those downsides. Computers seem to have maxed out on their productivity-producing, but every time we think we've seen everything, we get a new ap that changes the game some more; Facebook and Twitter are two areas that have changed things as of late.

Nanotech seems to be just around the corner, but I'm not sure if the pure research we've seen to date is going to turn into real products anytime soon; if it does, it could offset the contractionary nature of our current situation much as improved logistics, the birth of the Web and other computer-generated productivity in the 1990 helped offset the Clinton tax increases and saw a growing economy despite higher taxes.

We may be in for a rather stagnant economy, where the 3% growth that we're used to might not be there until either the next big tech item comes along to boost the economy or our system digests all the financial and regulatory changes coming down the pike.

That's not all that encouraging, but that what we seem to be looking at for the near term.

Serving the Customer or the State?

It's been almost two week since GM CEO Rick Wagoner got forced out by the Obama administration and I haven't put in my $0.02 yet. One meme that has made the rounds is to compare what Obama's doing to the early days of Mussolini; Fascism (the actual ideology, not the all-purpose slur on anyone more authoritarian than you'd like) has a private sector but has it subservient to the needs of the state. Peter Sean Bradley kicks it around here and Glenn Beck has been on the theme heavy on his TV show.

This is the first time that I can think of that a president has forced out a corporate CEO. That's moving in some very heady territory that should make everyone a bit nervous. My general view of government in the marketplace is that it is an good referee, a mediocre coach and a poor player. Here, Obama is playing uberCEO, a dangerous spot.

I think it is the right move, albeit one that has ramifications galore. GM needs a serious overhaul if it is going to survive, and a GM lifer like Wagoner is not the person to dispassionately amputate the unsavable sections; you'd not be in a great position as a doctor to saw off your mom's legs even if you knew it medically needed to be done. Obama at least realizes that some sort of GM 2.0 needs to be created that will create more cutting that Wagoner can easily deliver.

Is this getting GM to serve the state? Not quite yet; a government-shepherded Chapter 11 trip should actually help GM to meet it's goals as a business.

I remember the basic mantra of my undergraduate Marketing class; the company needs to serve the customer and make a profit. If you don't do both, you're not going to stay in business long. If you don't serve the customer, you won't get any business, and if you don't make a profit, you won't stay in business for too long.

GM is making a decent stab at serving the customer; they might not be the most innovative bunch, but they do make solid cars. For instance I have very few complaints about the Pontiac Vibe I bought two years ago except that the Pontiac nameplate might not make the cut in the overhaul of GM.

What they aren't doing is making a profit. They have a truckload of fixed costs that only either a bankruptcy filing or Soviet-era level government support of money-losing businesses can fix; the latter is out of the question even for the flotilla-of-drunken-sailors in charge of spending at present.

Once the bond market takes its lumps and the UAW gets a sustainable contract, a GM 2.0 can emerge that can make a profit and continue to, in their somewhat homely way, of serving the customer.

Business can serve the public at large best by serving their customers. That's how they roll best. Government is well advised to place as few of barriers as possible in their way of doing so, regulating only where the red tape and disruption is worth the hassle of protecting the customer or the public at large. Yes, they will make money, but that's how we know they're doing a good job; if they aren't doing a good job, they go under and the economy moves the people and resources to other things.

In general, business serves the public by serving the customer. They're ill-equipped to help the government or take orders from Washington; doing what Washington wants isn't a good business model. By providing good products at fair prices, they help their customers and the public at large.

Even the Obama people likely understand that. Our scuffle is most likely over which regulations and laws are worth the hassle; they're going to place a higher value on intervention that most of the Peanut Gallery will.

In the case of GM, it seems that they are heading on the right path of a tough-love restructuring that will get multiple pounds of flesh from workers, bond-holders and other stakeholders, getting GM back to a point where it can "serve the customer and make a profit."

Does the UPS Whiteboard Guy Have Special Drawing Rights?

[Update 10:45PM-I'm getting some Google hits for the UPS Whiteboard guy-his name is Andy Azula, who works for the Martin Agency; he came up with the idea for the ad and his demo as the whiteboard guy worked better than any of the actors they brought in. It reminds me of Crush the turtle from Finding Nemo; it was voiced by director Andrew Stanton, who couldn't find anyone who did a better surfer dude voice for Crush]

One of the stories in finance that has gotten legs the last few weeks is a move to create a global super-currency based loosely on the IMF's Special Drawing Rights; here's a Motley Fool piece in the issue. Right now, an SDR is set to be worth 0.632 US dollars+0.41 Euros+18.4 Yen + 0.0903 British Pounds; they redo the weightings every five years, and this set is good through 2010; the percentages are 44% dollar, 33% Euro and 11% each for pound and yen; the yen's only worth roughly a penny, so they have a relatively big coefficient.

Would an SDR bank account be useful for firms to stash their cash him, if you could have a SDR-based account? Yes, for it would give you decent diversification across the four major players in international finance. You wouldn't need to have actually SDR coins and bills to do that; you had Euro-based bank accounts at the turn of the millennium when the old currencies were locked in to their exchange rates but before actual Euros were printed out in 2002.

The trick would be to have a monetary policy for such a critter. Right now, the IMF doesn't have to do macro monetary policy per se; they help out countries who are short on hard currency, but don't have to manage the supply of SDRs. You'd likely need some other sort of entity to be the central banker for the new currency, which might include a broader basket of currencies that the four in the SDRs.

Would that be a slap in the face of the US? Yes, but if they keep something akin to the current weights, the US dollar would be 40% or so of the new currency. Better that they hang on to 40 cents than zero cents if they opt to go to a Euro or a not-so-free-world alternative; China and Russia are major sponsors of this alternative, which might be the beginnings of some sort of Second World movement.

More on that later.

Scared

I'm having a delayed reaction from last night's press conference, and it isn't pretty. The word "clueless" comes to mind regarding the president and economics.

That's a bit harsh, because he isn't unknowledgeable about economics. However, that knowledge comes with a paradigm that government knows more than the market does. He has faith that clean energy, better education and health care reform will get us out of this economic funk; either that or he's one slick and sick puppy.

None of those goals is bad in and of themselves. In the very long term, we'll need to find alternatives to coal and oil and natural gas, but a short-term crash course might be penny wise and pound foolish. We need to keep improving our education system, but a large part of the problem lies outside of the school walls in the attitudes of communities about education, problems that are ill-suited for a Washington solution. Health care could use some reform, but we may need to resign ourselves to spending more on health care as we get it to do more things for us.

However, none of those is going to be a medium-term growth engine. It's going to be changes in attitudes, not more money from Washington or state capitals, that will turn the education system around; even so, that well-trained workforce will be years away from changing GDP and productivity numbers. Health care reform could be a societal good but an economic wash at best; the lower cost from any reform package will be offset by the added costs of reaching the uninsured. Renewable energy could be a economic winner, but industrial policy is not something that government is generally good at.

What seems to be poised to be doing the damage is not the spending, but the higher taxes that will be needed to fund it. I don't have a dog in the fight personally, as a disgustingly middle class college professor with negative net worth, but those high taxes will tend to discourage further investment.

Keynesian econ looks at business investment as a given, but it isn't. You tax stuff more, you get less of it. You subsidize stuff less, like charitable giving, you get less of it; Obama assumed that the rich won't stop giving to charities if they only get a 20% break rather than a full 30-some-percent break, but that flies in the face of basic human nature.

I'm normally positive about the future. I'm not that way right now, at least not for the next few years. We're going to be OK for the very long term, but we're in for a bumpy ride the next bit if Obama means what he said last night. His heart seems to be in the right place, which is scary, for he'll be earnestly pulling things in the wrong direction.

Commie Edge

I'm expanding my intellectual horizons by helping out in the nursery area; Eileen and I have been looking after the two-year-olds during the Sunday School (a.k.a. Life Groups in Victoryese) hour this month (we get to help during the SS hour one month than the church hour the other) and have gotten reschooled in the fine art of PlayDoh.

One of the shapes we have at our disposal is some left-over cookie cutters from Arctic Edge VBS; that was Lifeway's summer critter of 2006, before we got their in 2007. It's out of stock now, but they did have a cookie-cutter set-

Arctic Edge cookies are sure to be a hit for VBS promotion, training, and kick-off events. Each set includes three cookie cutter shapes:

• moose
• polar bear
• tree

$3.99 (pkg. of 3)

The AE trees got used as we talked about God creating all the plants today; cookie cutters do well with PlayDoh as well as cookie dough.

However, I had some time on my hands last week and gave the cutters a once-over. They had a "made in China" sticker on them.

That's ironic, since it's unlikely that the powers that be in Beijing would be unlikely to let the Southern Baptists put on a Arctic Edge VBS in China, but are more than happy to make some not-so-holy hardware for them.

What does that say about Lifeway and the Southern Baptists? A lack of attention to detail, possibly? A tin ear about what their supply sourcing might mean to religous freedoms around the world?

Galting the Ground

I just got done grading a capital budgeting assignment for my Executive MBA finance class and was thinking about our current economic downturn. One of the catch-phrases that's making its way around the Blogosphere in the early Obama era is "going Galt", as in Atlas Shrugged protagonist John Galt; in the book, Galt led a strike of high-achievers.

Our economic downturn might not be a coherent strike from the American rich but the effects of the first 50 days of the Obama administration effectively salting the ground for economic growth.

Picture if you will a stock capital budgeting problem; we figure out the future cash flows from the project, then figure out what those cash flows are worth today by discounting them back using our cost of raising funds. If the present value of those expected future cash flows are bigger than what we're investing, we have a positive Net Present Value and we do the project.

The Obama team has created a double whammy (at least) for such projects.

Firstly, he has set the groundwork for higher taxes, both by promising to raise taxes on the well-off (or at least to allow the planned sunsetting of Bush tax cuts); the high deficits caused by the massive stimulus package and other projects will mean that tax cuts of any magnitude are unlikely and other tax increases may be forthcoming to pay for the expanded national debt. That will reduce the yearly cash flows from the projects being considered, since Uncle Sam will be getting a bigger chunk of the profits.

Secondly, the added deficit will tend to raise interest rates and required returns on stocks in the long term. The econ-speak term for that is the "crowding out effect"; as Uncle Sam borrows more money, there's less investable money to go into stocks, bonds and consumer loans, thus driving up interest rates and required returns. That will increase the cost of capital which we discount those future cash flows back at, making them less valuable to the investor.

So, thanks to BO and his buddies on Capital Hill, we have diminished cash flows for future investments and a decreased value for what cash flows we do get to keep. Some projects that might have made sense six months ago don't anymore.

On top of that, businesses that made sense six months ago might not make sense today; as people look at higher taxes, higher costs of capital and a weaker economy (not factored into the calculus above), they might decide to pull the plug on a marginal business, seeing that things won't be getting better any time soon. Note that the big drop in unemployment happened in December, as we saw the massive stimulus package taking shape and seeing Obama lurch more to the left on economics that the business community thought.

Could it be just the lousy economy in general. In part, yes, but part of it might be businesses looking at what Washington was sending their way and not wanting to try to send good money after bad.

Take this Shove and Job it

The unemployment numbers just out don't look promicing; we've lost just under 2 million jobs in the last three month, driving the unemployment rate up to 8.1%. 7.9% was the figure that was being batted around as an expectation, so the markets will not be happy.

"The unemployment rate has shot up 3.2 percent since the recession began and is higher now than at any time since December 1983." That's starting to inch us back to the stagflation era of the late 70s-early 80s, which, contrary to what history-challanged reporters might say, was the worst economic patch since the Great Depression.

Another quarter like the last one and they might be able to pull out the "worse-economy since the Depression" line without hyperbole.

Do We Need a Stimulus Package or Wellbutrin?

It's time to take a serious look at the d-word, depression. I've looked at it as a scare term used by folks who may not know better, like a conserative crying "socialist" at anyone significantly to their left or a liberal crying "fascist" or "theocrat" at anyone significantly to their right.

Until recently, I'd never seen a clear definition of an economic depression; this Robert Barro WSJ op-edder states it as "a decline in per-person GDP or consumption by 10% or more." His number crunching, looking at stock market downturns and economic depressions worldwide, put the odds at 20%.

Unfortunately, we can't go into the psychiatrist's toolbox and treat this looming depression.

We already had a 1% GDP drop in the 4th quarter, so we've got 9% to go. There's a lot of bad news that could get us a good chunk of the way there.

•  GM is seriously contemplating Chapter 11 (about time) as part of their 10-K annual report they have to file with the SEC.
• The stock market is hitting lows not seen since the last century; the Dow is down to 1997 levels. So much for saying that the stock market doesn't have bad decades. Barro mentions that the Samuelson quip that "the stock market has predicted nine of the past five recessions", but the bad news is that a near-50% tumble is predicting a depression and they have a shot of being half-right if the old Samuelson saw is correct.
• As we go to press, Citigroup is at $1.03/share and was down in penny-stock land for a time earlier today. Not good news for one of the linchpins of the banking industry.
• The European Central Bank cut interest rates from 2% to 1.5%; that's the lowest rate in the young history of the Euro. When the ECB cuts rates by a half percent (quarter-percent moves are the norm), they are spooked. Historically, they've been inflation hawks, as the Germans strive to avoid the megainflation that hit them between the world wars, so when they're cutting rates, they see the Eurozone economy seriously tanking.

Does that and other bad news add up to a 10% GDP drop? I hope not. There seems to be a solid residual strength in the economy and the American people to make that big of a drop unlikely.

However, if housing values plummet, and GDP includes implied rent on owner-occupied homes (essentilly, GDP assumes you rent your own house to yourself), then that portion of GDP will drop big time. Housing is about 10% of GDP, and if real estate values drop 30%, GDP will drop 3%, all else being equal.

Even if economic activitity doesn't fall 10%, GDP might, if the real estate market continues to suck bilge water.

Thankfully, I'm a college professor and my wife is about to start a job working at a doctor's office. Colleges do well in recessions ("the job market sucks; why not go back to school?") and people get sick regardless. However, it's going to be a bumpy ride for a lot of people.

Not Fonda Honda Anymore?

This is a headline I never thought I'd see anytime soon-

Japan's exports plunged more than 45% in January compared with a year ago to hit the lowest figure recorded, official figures have shown.

Japan's trade deficit hit 952.6bn yen ($9.9bn; £6.8bn) in January, the largest since records began in 1979. The demand for Japanese cars in particular dropped by 69%.

Well, the demand for Japanese cars made in Japan did, at least. We have a Toyota plant in Georgetown, a semi-suburb of Lexington. Those seem to be going well.

You normally don't think of Japan running a trade deficit, but if people stop buying cars and electronics, it can and does happen

"Dr. Hayek, what milestone are we on?"

Here's an interesting statement-

In his weekly address, President Obama praised Congress for passing the $787 billion economic stimulus package Friday, saying its efforts "delivered a real and tangible progress for the American people."

Obama, who lobbied House and Senate members of both parties, said in his address released Saturday that the bill passage marks a "major milestone on our road to recovery."

The president might be a letter off from the truth. If the critics are right, this is a major millstone around the economy as opposed to a major milestone on the road to recovery.

While the various parts of the stim-ulus package might goose the economy in the short term, the added debt load and tax burden needed to pay for this bad boy (both now and in the future, as many items become permanent) may well slow the economy for years if not decades to come.

Or, if I can bring Hayek into the mix, it's a major milestone on the road to serfdom. I can recall one poster in the late-90s NRO protoblog GIGO who'd close posts on days when the left was winning with "Dr. Hayek, what milepost are we on?"

Indeed. Let's see if we can find an off ramp.... soon.

The Fall of '08, Part I: Root Causes

Richard Heyduck of Bandits No More has a set of questions that could pass for a good doctoral comps in macroeconomics. Here's his setup and the first two of his question set-

Since everyone is an economist now, I figured that since I’ve had at least one course in economics and that I have no debt, I’m at least as qualified as others to ask some questions about the stimulus.

1. Do we know both the originating cause and the maintaining causes of the current economic downturn? This is an epistemological question: do we have real knowledge in this area or are we still at the stage of robust competing theories?
2. To what degree do the originating and maintaining causes feedback on each other? We hear of several aspects of the economy being involved: Housing, Lending, Finance, Employment, Consumer purchases, Government spending and non-spending. I mention the last because some believe that government non-spending will contribute more to continued economic decline than will government spending.

Here's my reply to #1 from earlier in his comment section-

Let me take a quick stab at #1. High oil prices, too many sub-prime mortgages and too much risk-taking at big financial institutions were among the originating causes. The poor stock market, tightening lending practices and media-and-politician generated fear are the maintaining causes.

We have some real knowledge, but you also will have a lot of competing economic theories; even when the facts are known, different paradigms will often produce different conclusions. Remember, if you laid all the economists end to end, you wouldn’t reach a conclusion ;-).

High oil prices were the first culprit, along with lax lending practices and a housing market that encouraged people to get into get-rich-quick flip-this-house mode. You had people buying more house than they could afford, cheered on by lenders who were counting on a strong housing market to backstop them if borrowers defaulted and a low-interest rate milieu that allowed for very cheap financing through adjustable rate mortgages.

Then, as high oil price forced inflationary pressures up, short-term interest rates went up with them. People want to get their buying power back and a bit extra (what economist call the real rate) so when inflation goes up, so do short term interest rates.

Were the home buyers above in old-school fixed-rate mortgages, we'd have not been in too much trouble. However, 2007 saw a spike in short-term interest rates, as T-bills went from under 1% in 2004 to around 5% in early '07. That meant that ARMs that were based on, say, the 3M T-bill plus 3% went from being a 4% loan to a 8% loan. A $100K mortgage that required a $477/month payment jumped to being a $733/month payment.

Folks that went into a cheap 4% ARM seeing an affordable $477 payment now has the sticker shock of seeing their mortgage payment jump $250/month once the loan refinances itself at the new higher rate. Add that to the number of junk (politely known as sub-prime) mortgages that had less money down and lesser income than a conventional mortgage, and the housing market went in the toilet.

Many investment banks like Bear Stearns and Lehman Brothers had tried to do for the sub-prime market what Fannie Mae and Freddie Mac do for the conventional mortgage market; buy mortgages off of banks and package them to investors. As the housing market went in the tank and defaults rose, the value of the mortgage packages fell. The loans that Freddie and Fannie worked with were less risky, but the increase in defaults had them nearly insolvent, requiring an investment from the Treasury department to keep themselves afloat in the summer of 2008.

The sub-prime market was even harder hit, and institutions that had portfolios of these junk mortgages saw their values plummet. The financial chaos that resulted coupled with high energy prices coupled to pull a shaky economy into a recession.

That's my one-page summary of what went down. I'll get to question two later this week, God willing.

One Percent

That's all the economy contracted in the fall of 2008... or should that be The Fall of 2008? If I can borrow from Mars Attacks, we still have 99% of the economy working for us, and that ain't bad.

The fourth quarter stats are in, and GDP shrunk at a 3.8% annual clip. Divide that by 4 and it dropped by a smidge under 1%, 0.95% if you want to get pedantic.

That's not to say that those losses aren't real; we're getting layoffs at Lexmark here in town and we have friends working their. However, life is still going on despite the bad news, doggone close to normal.

Think about that before getting Washington or your state government to go gonzo.

Try PhantAids, Your Pro-Growth Economic Relief

I'm still getting my mind around the "stimulus package" gearing up on Capital Hill. Here are a few early thoughts and contrathoughts

Sen. Arlen Specter (Pa.), who gave Vice President Biden a 17-page list of spending requests, said he opposes the proposed increase in funding for Pell Grants for college students because it would do little to spur short-term economic growth.

I resemble that remark as a college prof; college spending is a long-term proposition, since it gives us a better-equipped workforce if we're doing our jobs. Having people go to school less and work more would increase GDP... in the short term.

However, encouraging going to college in a recession is a good idea, since that will give the unemployed and underemployed something constructive to do. In finance, we preach looking at the long-term, focusing on maximizing shareholder value/wealth rather than this quarter's net income, for there are numerous ways (cutting R&D, cutting advertising, cutting quality control) to help the bottom line in the short term that trash the firm in the long term.

True, you won't get as good of a multiplier effect on the Pell Grants, since most of the money will go to schools who are on fixed budgets that will be slow to change. However, it might be a good long term-move for maximizing national value (if I could conjure up such a critter, but as a semi-pro economist, I can conjure up a lot) even if it the help comes years rather than months off.

House Minority Leader John A. Boehner (Ohio) said the plan lacks enough "fast-acting tax relief," such as a temporary halt to payroll taxes and more relief for businesses.

 Is The Onion writing your scripts? Here's my modest ad proposal-

Try PhantAids, your pro-growth economic relief. Unlike Democratic econ-antacids that take years to take effect and leave you bloated, PhantAids goes straight to the bottom line in seconds. PhantAids, long memory, fast relief.

A payroll tax cut would help most businesses, even ones that aren't making money at present and have the advantage of encouraging job creation. When you tax something, you get less of it all else being equal, and taxing wages means you get less wages. I'd make it ongoing rather than temporary, so as to encourage job creation rather than give businesses a one-shot cash infusion, but that makes more sense than a corporate income tax cut if the goal is to increase jobs.

Why? Income tax cuts only help if you have income. For instance, an income tax cut will help someone like GM very little, since they have a huge amount of losses to carry forward and won't get to see any added cash flow from the tax cuts for years. Likewise, other struggling firms that are either barely breaking even or losing money will only benefit if they can hang in there long enough to turn a profit. There would be a mild stimulative effect on struggling firms if successful firms have lower taxes and start plowing the savings into extra investments, but if lower taxes translate into lower prices for those firms, it might make it harder for the struggling firms to hang in there.

For some reason, corporate income tax cuts now seem a bit like social Darwinism, giving the successful firms a boost while letting the struggling firms fend for themselves. Creative destruction, I hear the guy in the back right say. Right said, but could we get by with a bit less destruction.

Turning Japanese-Part I-Monetary Policy, RIP.

If you want to partake in the title earwig, here you go.

Deflation, stangnant growth, and near-zero interest rates. That's something we've seen in Japan for the last decade or two. Could that be what awaits the US in the '10s?

We currently have the three-month T-bill rate at 0.12%. It had been at 0.06% earlier in the week when I was discussing the issue with my FIN 324 class. People are so spooked, that they're letting Uncle Sam hang on to their money just about for free.

Normally, we talk about the T-bill rate including a modest "real" interest rate plus expected inflation. That real rate is usually around 1 or 2%, the money needed to compensate us for putting off enjoying our goodies. We then tack on inflation to that real rate in order to keep our purchasing power.

What does a near-zero interest rate say about expected inflation? Try expected deflation. Our model starts to fall apart when deflation is bigger than our real rate and the model would call for negative interest rates.

We had deflation last month, 0.7% worth. It was the third straight month of declines, almost moving 2008 into net deflation; we had a 0.1% inflation figure for the year overall. Dropping oil prices and stagnant consumer demand have given us declining prices for the fourth quarter of 2008.

What that means is that the Fed has just about shot its monetary policy wad. The Fed Funds rate is at a quarter-percent, as low as it can go without giving money away for free, as least if they keep the custom of moving in quarter-percent increments.

Ben Bernanke just became moot. He's like the general in the creature feature who has fired everything in the arsenal at the approaching leviathan and can't slow it down.

Can you say "Liquidity Trap", boys and girls? I thought you could.

"What do we do now?!?", the president screams in the creature feature. Good question.

The mad scientist hero now takes center stage.

Are Big Macs an Inferior Good?

Not that inferior; I skorfed one down on my way back from a doctor's appointment this afternoon. The good news on that front is that I may have been fending off migraines all this time and have new medication that seems to help so far.

For the non-econ people in the Peanut Gallery, the title's not a put down. Inferior goods in econ-speak are stuff you spend more on the poorer you get, like Mac and Cheese or Ramon noodles. One of the more positive news items on the business page was McDonald's sales going up 8% in October.

The results were a bright spot in what was a dismal month for most restaurant operators. Many sit-down chains have reported steep declines in same-store sales during October as consumers grew more anxious about the possibility of a prolonged recession.

But U.S. consumers kept spending at McDonald's, even as Congress passed a bill to bail out the economy and credit markets froze.

One would think that McDonald's would be somewhat counter-cyclical, as one set of downscale customers would eat out less but another set of upscale customer might round down to fast food from "sit-down" chains (I'm glad I'm not the only one that uses that term as the antithesis of fast fooders).

However, an 8% jump could be a good response to their Chick-fil-A knock-off sandwich and dollar menus, or people rounding down to fast food. It will be interesting to see how the other fast fooders like Wendys and Yum do.

__________

One store that I've viewed as just plain inferior is Circuit City. I've always been more comfortable in a Best Buy for some reason; pushy sales reps at CC might be one reason. They're writing a new chapter in their history; Chapter 11.

Right before the Christmas shopping season; that has to hurt. It will get a lot harder for them to do business, as consumers will try and steer clear from gift cards that could become useless if their local stores go the way of the dodo.

They'll also steer clear of what one of my MBA students called the "cheese" of extended warranties that are big money-makers for electronics and appliance stores; his manager's line on a sale was "Did you get cheese on that?" That's not unique to his store, for this CBS piece had this line-

According to reports, in online forums a good sale without a warranty is a "hot dog" but a good sale with an extended warranty is a "chili dog with cheese."

Speaking of inferior goods, that usage got into the Urban Dictionary under mac-and-cheese.

_________

Another interesting casualty of the bumpy economy is DHL; they are pulling out of the US domestic market in January. As Sherrif Justice once put it, "The [gosh-darn] Germans got nothin' to do with it!" Not any more, as they leave the market to FedEx and UPS. That ought to make people in Memphis and Louisville (their respective hubs) happy.

Liberals are Conservative and Conservatives are Aggressive

Here's an interesting MSN Money piece on the retirement portfolios of the VP nominees.

Their retirement nest eggs -- which for both candidates are almost their entire net worth -- are modest in the extreme, amounting to somewhere between $300,000 and $400,000 for each family.

They are also, on the liberal-conservative scale, upside down. Democrat Biden has most of his money in a tax-sheltered annuity, that most timid of investment vehicles. The Republican Palins (husband Todd is the investor) are much bolder, venturing into individual stocks and exotic exchange-traded funds, or ETFs.

If you think $300K is "modest in the extreme", then my nest egg's got a friggin' burqua on; it got about 10% more modest yesterday.

Before I tackle the inversion, ETFs aren't all that exotic as a beast. They're a form of mutual fund that trades like a stock with the advantage that larger investors can cash their shares in for their share of the porfolio of the fund; that keeps the stock price of the ETF from getting too far away from the Net Asset Value of the ETF.

That inversion isn't surprising. Political liberals tend to be skittish about the economy; that's why they want to regulate it and compensate for its excesses and shortcomings. That skittishness can translate into a more risk-adverse investor, so the annuity (a guaranteed set of payments, generally from an insurance company) is a prudent choice for such a skittish investor. "Not taking risks" translates to conservative in investment-speak.

On the other hand, economic conservatives tend to be bullish on the economy, understanding the benefits of the creative destruction of the market. We'll get the occasional crash-and-burns like Lehman but we'll also get success stories, like the Google search engine that you might have gotten here by or the Movable Type software that this post is composed on.

Thus, economic conservatives need not be financial conservative. With a decade or two before retirement, the Palins have the wiggle-room to suffer through bad days on Wall Street like we had yesterday, for there should be plenty of good days to offset yesterday's stinker. They also have the confidence in the market to know that things will get better in the long haul.

That's not to say that economic conservatives can't be financial conservatives; get close to retirement or close to when you'll need that college fund, and the investment mix will shift from stocks and into lower-risk bonds and savings accounts. However, economic conservatives will tend to be more aggressive in their investing.

So, liberals are conservative, conservatives aren't conservative, and I Don't Know's on third.

Think Globally, Eat Locally

One of the thoughts that was going through my mind when thinking through the meatless-day-for-Gaea this morning is that veggies are a more liberal diet than meat; at least they are a less corporate diet.

How many brand-names from the meat section can you name? Tyson, Perdue, Hormel, Armour, Oscar Meyer, et cetera. Lots of corporate names getting their money off of processing meat and chicken. Quite a bit of generic meat and chicken as well, but a lot of branded meats as well.

How many brand names can you name from the produce section? Dole, Chiquita and..... and...[cricket chirps in the background]. If you hit the right store, you may not even see those. You're much more likely to get your stuff from mom-and-pop growers in the produce section. Your local farmer's market, the great anti-corporate cut-out-the-middle-man tool, will have tons of fruits and veggies but typically little in the way of meats.

We'd be using less fuel and eating better with a more-veggie diet; this is one where we could all use a bit more crunchy-con in us. Easier said than done for the meat-starch-and-veggie-plate raised kid.

Putting the Lid on the Punchbowl, Euro-style

Interesting news out of Europe, where the European Central Bank raised its main lending rate 25 basis points (or a quarter-percent for the non-finance-geeks) from 4% to 4.25%. The ECB is the analog to the Federal Reserve for the countries using the Euro. They're having to fight off inflation, which is at an Euro-era record of 4%.

In the short term, that will put pressure on the dollar, as short-term investors will tend to move money out of the US and into higher-yielding Euro-denominated stuff. However, the high inflation in the Eurozone will tend to help the dollar regain its footing, if the US can keep its inflation below European levels.

The problem with raising interest rates is that it tend to slow down the economy. In a era where the EU elites are trying to push through the current Lisbon Treaty round of reforms, having the ECB be an economic bogey-man if Europe goes into a recession might not be great for EU integration.

Catch a Falling Starbucks

Interesting news from yesterday; Starbucks is slated to shutter 600 stores, just under 10% of its total 7100 stores. Starbucks may well have over-expanded, as many growing retailers will sometimes grow too fast and have to retrench.

However, $4/gallon gas makes $3.50/cup lattes problematic in people's budgets. The econ prof keeps screaming that Starbucks' joe is a luxury good that people with reduced buying power will look to do without. The rise in gas prices has put a modest squeeze on budgets, a previous post posited that a 31% rise in gas prices would make buying power go down 1.6%. Methinks that the average Starbucks denizen would be even more sensitive than average, being in their cars more (I have no good data on that, but the stereotypical white-collar java junkie is on the road more than blue-collar folks), so the buying power recession may hit a soccer mom or salesman harder than the rest of us.

Is that enough to shutter 600 Starbucks? Probably not. Overexpansion probably did quite a bit, as did McDonald's move to have their own line of upscale brews. However, the buying power recession (not in GDP mind you, it's still mildly positive) caused by those high gas prices causing us to trim budgets elsewhere may have helped push a few Starbucks over the edge.

Buying Power Recession

My stock response as of late for people who cry "recession" is that we still have positive GDP growth; the first quarter figures got revised up to 0.9% last week from an initial reading of 0.6%.

The problem with that is that buying power didn't go up with it. In that first quarter, gas prices went up 7% from $3.16 a gallon in January to $3.38 a gallon in April. Since the GDP figures assume a yearly growth rate, let's compound that 7% figure for four quarters and get a 31.2% yearly rate ((1+7%)⁴-1).

Gasoline makes up 5.2% of the CPI, so that buying power in the first quarter went down at a 1.6% annual rate (31.2%*0.052). That's roughly twice the rate of economic growth. So, even if the economy was growing at just under a 1% clip, the high gas prices was draining our pocketbooks at a 1.6% clip, making us 0.7% poorer.

Well, we all have to cut back some. Suck it up, feline friend.

We're having to cut spending in other areas, like squeaky toys or durable goods, in order to finance the increasing cost of gas. I'm just working on the 5% cost of gasoline in that math above, since the CPI is 9% energy and quite a bit of the non-gasoline energy budget is oil-based, that 1.6% hit could be more like 2% when oil-based energy costs are factored in.

It may not meet the textbook definition of recession, but our buying power is taking a beating. To our LOLcat friend, it if wokz like a reseshon, and quakz like a reseshon.... itz a reseshon .

We may not have had two quarters of negative GDP growth, but we've had at least one quarter of negative buying power growth and are hot on the heels of two, given our $4/gallon  (or just under here in Lexington) gas as of late. That's going to be on people's minds as they go to the ballot box in November.

The Weeble Economy

The first quarter GDP figures came in today; it was up a very modest 0.6% (at an annualized rate, so it was up just 0.15% from the end of last year), the same growth as the fourth quarter of 2007.

It's not great news, but it beats the heck of a negative figure. However, it's sluggish enough to prompt the Fed into another Fed Funds rate cut, 25 basis points down to 2% even.

The economy has taken the hit of $3/gallon gas and $100/barrel oil and only staggered a little; compare that with the stagflation of the 70s when we saw a comparable spike in oil prices. Even the problems of a reeling financial sector hasn't caused a negative quarter of GDP growth.

I was talking about that with my Managerial Econ students last week. The reason that came to mind for our ability to fend off massive inflation is that the long term is a lot shorter than it used to be; businesses have more leases, more temp workers and can get new equipment on-line in days and weeks rather than months and years. An adaptive economy can make changes quicker than they used to, shifting resources to more profitable endeavors quicker than in years past.

It's not as stable as the economy of the 70s, but it's a lot more nimble and resilient. Or, if I can hearken back to an old toy, we have the Weeble economy, which wobbles but doesn't fall down.

Thus, the recession-mongers have another quarter to wait for a downturn and two quarters to wait before a classic recession call of back-to-back bad quarters could be first made. There are micro problems galore, like mortgage issues and high gas prices, but we have a rather resilient Weeble economy with which to work those problems out in. Automation, logistics and a well-run Fed have helped to make this economy nearly recession-proof.

Kobe Slumps-Only Scores 20 a Game

I was thumbing through the dead-tree Wall Street Journal at the school library before class today and found this interesting headline-"U.S. Slump Takes Toll Across Globe."

So far we haven't been in a recession; we've yet to see a single quarter of negative GDP growth, although all bets are off as to what the first quarter numbers will be. Ben Bernanke made headlines by just acknowledging the possibility of a recession.

The US economy is still growing, despite all the sub-prime mortgage headaches and $3/gallon gas. We're still the most potent economy on the planet.

Let me go back to that headline. If the largest economy on the planet is growing, albeit slowly, how does that equate to a slump? If everyone is expecting more, modest growth is a "slump."

Twenty points a game is a very good average for an NBA player. Only 28 players are at or above that figure as I go to press; Detroit manages to have the #2 record without any of them. Currently, LeBron James leads the league with 30.3 PPG followed by Kobe Bryant with 28.7.

Were Kobe to have his scoring average drop to 20PPG, he'd still likely be an All-Star. He'd still be one of the more feared players in the league. However, since we're used to seeing him in the general vicinity of 30, a 20PPG average would be a slump; he hasn't scored that low in almost a decade, when he was college-aged and just coming into his own.

Likewise, when the US economy merely slows down to a 1% growth rate rather than the 3-4% that is expected, everyone starts to worry. Even a modest downtick in the economy is a modest downtick from a doggone big economy; that's cold comfort to someone getting laid off at a mortgage firm or someone who's out of a house due to an ARM gone sour, but it's something to remember as a citizen and consumer.

Beyond the headlines, we have a very solid economy. Not perfect and not without pockets of inequality and poverty, to be sure, but still very solid. Just like most of the NBA would be happy to "slump" to 20PPG, the rest of the world wouldn't mind slumping to US levels.

Thus, things probably need more tweaking that overhauling.

GDH-Gross Domestic Happiness

Bhutan isn't a country I recall blogging on before, but they had their first elections as a constitutional monarchy. It's enough of a democracy where the king's brother-in-law was allowed to get thumped in the polls.

However, it wasn't the nascent democracy that pulled my chatty ring when I read this piece earlier today, but this paragraph on the ruling philosophy of the country-

The monarchy remains popular in Bhutan partly because of its focus on promoting what it calls "gross national happiness" - based on the idea that economic growth should be balanced by respect for traditions and the environment.

I've discussed my ideal macroeconomic policy as seeking to maximize the commonweal, looking for a peak on a modified Laffer curve that maximizes the collective well-being of the country rather than tax revenue.

Since commonweal is a very highbrow term, might the Bhutanese concept of Gross Domestic Happiness be a better phrase? Since we tend to use Gross Domestic Product these days rather than Gross National Product in macroeconomics (GDP looks at where something's produced rather than GNP, where it measures which country owns the company producing it; the Toyota plant in Georgetown counts on US GDP but Japanese GNP), I'd rather go with GDH rather than GNH for our mythical measure of commonweal.

There are a number of things that are good for GDP but aren't good for the country; we all can rattle off a number of vices that we'd be better off without. There are also some things that are bad for GDP but are good for the country; stay-at-home moms are a great example.

• They aren't earning an income, reducing GDP.
• They do more cooking from scratch, reducing the grocery bill, reducing GDP; the value added from their labor doesn't count towards GDP.
• They don't use as much daycare services, reducing GDP; the care they give their own kids at home isn't sold, so it doesn't count as GDP.
• They don't use as much gas or buy as much business attire, reducing GDP
• Their families tend to eat in more, further reducing GDP
• If they're home-schooling, there will be less need for teachers, reducing GDP.

In addition, we can look at the ideas of tradition and the environment as the piece does. Economic development can have a lot of negative externalities that may reduce GDH while increasing GDP.

For instance, one discussion here in Lexington revolves around building a big hotel-condo-retail space skyscraper downtown. The development would take out some nightclubs and do a number on the skyline, but it sure would add to the tax base, and many mayors and city councils start to drool when they see the extra property tax dollars from such a project.

As a suburban newcomer (I have a Lexington address, but live well away from downtown) who has no attachment to the existing skyline and who goes downtown only when I have to, I don't have a dog in the aesthetic fight. However, there are lots of folks who would have their quality of life impacted by having their bohemian part of downtown torn down to put up a hotel for the big-shots who come to town for the Keeneland meets, UK games and major events at the Kentucky Horse Park like the world equestrian championships slated for 2010.

Would the hotel increase Gross Civic Product? Yes. Will it increase Gross Civic Happiness? Good question; the powers that be say yes, but a lot of activists say no.

Gross Domestic Happiness. You can't quantify it, but it's something we need to focus on.

What sayeth the Peanut Gallery?

Acceleration≠Speed

Here's an untrue headline-"Economy Skids to Near Halt." No it didn't. GDP growth for the fourth quarter of 2007 was a bit anemic, to be sure, at a meager 0.6%, but the economy was still growing and still going on roughly as normal. After 9/11, you could say that the economy came to a near-halt, but even then, business was being done; I recall getting gas on the way home that afternoon just before the price spiked up.

If you're going along the expressway on cruise control, your speed is stable and your acceleration is zero, the change in the rate of movement is zero, yet you are moving at a good clip. You're not slowing to a halt, you're just not speeding up any or slowing down.

Likewise, the economy is still chugging along, producing goods at a slightly faster rate than it did earlier in 2007; it's rate of production is still high and even growing, but the change in the rate of production has decreased. In car speak, you're still accelerating, just not as much as before, going from 60 to 61 rather than from 30 to 60.

However, mathematical illiteracy isn't uncommon in certain circles. For instance, if people are expecting a government program to grow at a 20% clip and is adjusted to grow at only a 5% clip, it's viewed as a cut by the fans of the program. No, it's still growing, but not as fast as you'd like.

The same's true with the economy. We're used to about a 3% yearly growth rate in GDP, and anything less seems like a drop, or is cast as such by the media. The observers feel entitled to a normal growth rate and feel shorted if they don't get it.

We're on the verge of an Orwellian shift in language where a recession becomes where where growth is merely less than average.

Not Quite Voodoo

We've got an interesting back-and-forth between Joe Carter and Josh Claybourn on taxes; Joe is defending John McCain's deficit hawk side and systematically trashing supply-siders, while Josh ably picks up the gauntlet and throws the reality of the Laffer Curve back at him.

I think they both have some flaws in their arguments. First, to Joe, who seems to have slid over into the Bull Moose's camp now that Huckabee's campaign has (regrettably) jumped the shark.

Contrary to what some might claim to be a "real fiscal conservative" requires adherence to fiscal disciple and recognition of economic realties. Almost all conservatives pay lip service to the first, yet many today seem to ignore the latter. To my mind, there appear to be only three reasons not to tie tax cuts to spending reductions--and all appear to defy reality.

                                                                                                                 The first is the "starve the beast" strategy...The second reason is a modified version of the first: conservatives believe that we can take the tax cut now and force spending reductions in the future. While history has shown the "starve the beast" strategy to be nonsensical, the "Cut now, Spend less later" is plausible, though politically untenable.

While I agree with McCain's take that it would be an insult to say that Congress spends like a bunch of drunken sailors, since he never saw a sailor with that much creativity in blowing cash, there is a bit of truth to the second premise; liberals are somewhat constrained in new spending due to the fact that the deficit is rather large to begin with. They either have to trim elsewhere or raise taxes significantly in order to fund any major new project like a national health care plan.

Unfortunately, a lot of minor (and not so minor, like Medicare prescription coverage) new spending stuff has gone through over the last few years. Moderate Republicans, when unable to say no to a new extension of a current program, are also unable to say yes to a tax increase to pay for it, and wind up running up the deficit.

On that point, Joe is largely correct; the put-Leviathan-on-a-diet strategy doesn't work, since Levvie always seems to sneak a run into Cheezyburger on his way home from work.

However, he seems to go somewhat off the tracks on part three-

The third and most common reason people think tax cuts and spending reductions can be untethered is because they have a faulty understanding of supply-side theory. Rather than supply-side theory, some conservatives believe in supply-side magic: Cut taxes and you'll get more tax revenue than before! This, of course, is nonsense, as any supply-side economist will admit.

I'm not sure I qualify as a "supply-side economist," but I do play one on occasion in the classroom when I teach macroeconomics. My Ph.D. is in Finance, but my doctoral minor is in International Economics and have 27 graduate semester hours in economics. I am currently teaching Managerial Economics at Sullivan University, so I think I have enough credentials to call B.S. on that last sentence.

The key to his argument is how high the taxes are before getting cut. Josh's piece trots out the construct of the Laffer Curve, which is the now-classic idea that at some point, an increase in tax rates will actually decrease revenues. If the tax rate is high enough, people start getting more interested in tax avoidance or trading income for leisure, and taxable income falls faster than the tax rate rises, creating a drop in tax revenue. At such a point, a cut in the tax rate would increase tax revenues, since taxable income would rise more than the tax rate fell.

When the Laffer Curve was being first promulgated in the late 70s, the top marginal tax bracket was 70%; the Reagan tax cuts of the early 80s brought that down to 50% and later to 28% in 1986. In the early going, one could make the case that 70% was on the downslope of the Laffer Curve and the paradoxical idea that a tax-cut could raise revenue might actually have been legit.

That being said, I don't think we're on the right side of the Laffer Curve today; Joe should hold his fire for the folks who think we're still on the right side, for those would be the folks that would be in the supply-side-magic camp. Current tax cuts would be unlikely to be fully self-financing via growth, but they might be partly self-financing to the extent that the lower taxes will encourage more work and more investments.

This is where this passage from Joe's piece runs aground a bit-

According to supply-siders, the beneficial effect of lowering tax rates is that it expands the tax base. The more people paying taxes or more people moving up into a higher tax rate, the more the revenue lost from the tax cut will be offset. But rarely--if ever--does a tax cut pay for itself. That is why it is essential to reduce spending.

This should be obvious to anyone who gives it a moment's reflection. Consider an example on the microeconomic level: Imagine you make $100 a week and are in credit card debt. You decide that you can't live on such a measly salary and so continuously borrow $1 a week from your credit card. Are you better off financially? Maybe in the short run, since you have an extra dollar to spend or invest. Eventually, though, you have to pay back the dollar (plus interest) that you borrowed. You are penalizing your future self to improve your present condition.

I have two issues with his scenario. The first is that the assumption that the extra cash from the borrowing will be spent; some of it could be invested. If it is invested at a rate higher than our interest rate, we'll be rewarding our future self. We will have to pay back the dollar with interest, but if we're earning 15% and only paying 5% in interest, we'll be ahead of the game.

Secondly, the federal government will borrow at a lot lower interest rate than the credit card.

Tax cuts will help draw more investment into the economy, which will help generate more taxable income in the future. True, deficit spending in the short term will create a "crowding out effect" that will raise interest rates and have government taking capital that could have been used for private-sector purposes, but the lower taxes will have a crowding-in effect of people looking to invest more, given that the take-home pay of investment will have increased.

Granted, the increase in revenues that Bush cites might be due to a sound economy growing rather than his tax cuts, but part of that economic growth was likely due to the tax cuts. How much is open to debate.

                           

The Benefits of a Deficit Hawk

I just got done with my International Finance class this evening, and I gave them the following question to kick around-

Group question 4: Deficit hawk John McCain does well on Super Tuesday February 5th; world financial markets think that he’ll do a better job at reigning in the US deficit than his more supply-side inclined GOP foes.

How should the dollar react to that electoral news?

All else being equal, and assuming that the statement above is true (and I think that it is a fair statement), the dollar would tend to rise, since markets would be expecting that we'd have a better chance of reigning in the budget deficit. That would mean that we'd need to raise less funds overseas, driving down the supply of dollars in the foreign exchange markets and raising the value of the greenback.

We could use the help, since about that time, those drunken sailors of the Potomac Navy (as McCain might put it) will be passing some sort of stimulus package. While such deficit spending may help the economy if spent (the consensus in my class tonight was that it will be either saved or used to pay bills), deficits will require more debt, which means more borrowing, some of which will be by foreigners, which will drive the value of the dollar down.

The postive McCain effect would be expectational, while the stimulus effect would be real; the irony would be the markets would be seeing the expectation of future deficit decreases along with the reality of mad spenders inside the Beltway. One can only hope that they cancel each other out and the dollar doesn't continue down the crapper.

Talk of tax cuts on the Republican side of the aisle may be good long-term economics, but it isn't good short term geopolitics, especially in the currency markets. So as the right side of the Peanut Gallery trashes the Bull Moose, note that he might make gas a tad bit cheaper if he does well next month.

The 0.7% Solution

Well, it was actually 0.75%, but it didn't make as as good of a headline. That was the amount of the cut in the Fed Funds rates announced earlier today. That is bigger than it sounds to the non-finance person, since the Fed generally moves in quarter-percent increments; a half-percent change is a radical move, so a three-quarters percent move is all but hitting the eject button.

The financial markets think that there is a problem, but I'm not sure how big of a problem we really have.  On the macro level, the economy is moving along nicely, having gone up at a 4.9% clip in the third quarter of 2007. Yet one AP report printed in the Herald Leader is talking recession. The traditional definition of recession is two quarters of declining GDP, and we've yet to have even one confirmed, although I wouldn't be surprised if we were in the hole for the fourth quarter.

Increased oil prices, the larger-than-normal number of mortgage defaults and the resulting write-downs at banks and a nasty trade deficit has left financial markets nervous. Monday was a big meltdown day in financial markets, where European stocks were down around 5%. In Asia and Australia, where they had their Tuesday trading in our overnight hours, they were down by 6-7%. The Fed action calmed British markets, which went from down 3% to up 3% on the news.

I hope that that will soothe the market's jitters and get conversation away from a stimulus package. I wouldn't mind a $1600 check, but it would merely pay down the credit card tab for the engine work in Sparkle (Eileen's car) from November, not get us to go out and buy a new big-screen TV or some other big-ticket economically-stimulating item.

From a long-term perspective, the most stimulating thing Washington can do is sit on their tookus for a few months (or let themselves do gridlock) and let the Fed do its thing.  Do we really want to have another 1% of GDP hit to the national debt when we're merely going through a rough patch? Not that I couldn't use the money, but I don't like the precedent. What happens when we have a real recession and we want to goose things?

Ramifications of the "Fair Tax"

Here's my assignment to my FIN542 class for next week. As part of the on-line class, we have a discussion question each week where they post a reply, then comment on each other's answers; it's almost like blogging, and I get paid to orchestrate it.

I'm going to hold my tongue on the issue until after they post their replies on Thursday night, but it worth posting here for the Peanut Gallery's consideration. You're free to put in your two cents worth here, but I'm largely going to lie low until Friday.

One of the interesting topics that has flowed out of the 2008 presidential campaign is that of moving to a national sales tax which would replace federal income tax, payroll taxes (including the FICA taxes for Social Security and Medicare) and inheritance taxes; former Arkansas governor Mike Huckabee, who won the Iowa Republican caucuses on Thursday, is a supporter of such a national sales tax.

The common proposal from "Fair Tax" supporters would tax sellers 23% of their sales to final users; since the tax is on the seller, it is the equivalent of a 30% tax on the buyer, since prices would likely be raised by 30% to offset the 23% tax. 1.3*(1-0.23)=1.001. If they raise prices by 30% and then pay a 23% tax on that new price, they'll net the old price.

That's steep, but you'd have all your paycheck given to you, save any state income taxes that might survive (and there likely would be pressure to have a state sales tax in order to put tax accountants in state out of business), so you'll have more take home pay to absorb those sales taxes.

In addition, each household would get a rebate equal to the amount equal to what a family of their size at the poverty line would pay in sales tax, so only the amount spent above the poverty level would be affected; that helps offset the normal critique of a sales tax that it's regressive, taking a bigger percentage of a poor person's income than a rich person. When that "prebate" is coupled with getting rid of the FICA payroll taxes, which take a 7.65% hit from dollar 1, the working poor are winners in this system, unless they qualified for a big Earned Income Tax Credit.

Here's a Wikipedia write-up on the Fair Tax, a "thumbnail sketch" of the plan from the Fair Tax web site and a critique of the plan from FactCheck.org. Also, here's a critical piece on Huckabee and the Fair Tax from the Washington Post.

The discussion question revolves around the financial impact of moving from the current income and payroll tax system to a sales-tax based system.

(1) What would such a change do to the bond market?

(2) What would such a change do to the stock market?

(3) What would such a change do to financial institutions?

(4) What would such a change do to where you work?

Spend a paragraph or two on each question, more if you feel talkative.

It's a neat bunch of folks; we met in person this afternoon, but will be on-line only until mid-February. I'll be interested to see what they come up with.

Putting the Spurs to It

This is good news; the Fed's Open Market Committee cut the Fed Funds rate by 50 basis points (that's half a percent for those of you in Wachula) earlier this afternoon. Normally, the Fed moves in quarter-percent increments, so a half-percent move means business. They had cut the discount rate (what the Fed lends to troubled banks) earlier, but it is the Fed Funds rate (the rate that banks lend Fed deposits amongst each other) that the rest of the money market takes its cue from.

The Fed move will mean many, if not most, money-market rates, like bank prime lending rates, will go down, as will any adjustable-rate mortgages and credit cards that are based on short-term money-market rates. That should have a positive effect on the economy, as it will be easier to borrow to buy stuff.

The Fed has a dual task of keeping inflation in check while encouraging economic growth. The good news of today is that the Fed thinks that the oil-driven inflation has been managed sufficiently where they can lower interest rates and help the economy out of a mortgage-foreclosure induced funk.

$2.65/gallon gas isn't any fun, but the economy seems to have adjusted to it. Wal-Mart has even eluded to it in its recent ads, pitching the idea of saving where you can to make up for the high gas prices; they probably get an inferior-good kick out of people rounding down to the simpler stuff.

A rate cut is generally a sign of weakness, but in this case, it may be designed to head off any weakness before it become endemic in the larger economy. We had 4% growth in the second quarter of 2007, and the Fed wants to keep the number on the positive side for the third quarter. This will help end the third quarter on a good note.

Discouraging Borrowing

Fed chairman Ben Bernanke was using his bully pulpit to jawbone the trade deficit down during a Berlin speech earlier today. I'm not quite sure if this paragraph isn't misleading;

The United States' larger current account deficit, which includes not only monthly trade figures but also investment flows, would be helped if the country boosts savings and continues to trim its federal budget deficit, Bernanke said.

I'm not sure if that part I italicized is Bernanke's or the AP's Jeannine Aversa's, but it confuses what the current account is, at least to Joe WaPo reader. The Wikipedia for current account has this definition-

The current account of the balance of payments is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid).

It does include some investment flows, but only interest and dividends. Any investments go into the capital account. The current account covers trade in goods and services, investment revenues and transfer payments, which also includes people sending money back to the "old country," be it a US worker in Dubai sending back cash to Ohio or a Mexican worker sending money back from Orlando to Aguascalientes.

A current account deficit is always offset by a capital account surplus; people are opting to invest in the US more than Americans are investing internationally. Unless we want to start a savings war, we're going to be at a disadvantage in lowering the current account deficit.

Part of the problem is that foreigners save more than Americans do. That is partly due to American spendthrift-streak but also due to more pessimistic foreign views of the future. If you're not expecting your income to go up in the future, you'll need to save more now to provide for your future needs. If you're expecting you're income to go up in the future, you can spend more now, knowing that you'll be able to save more later (or pay back what you borrowed later, then start saving).

There's not much an American politician can do to change that, unless he wants to go deep into the doom-and-gloom swamp and discourage people's views of the future. Thankfully, such folks tend not to get elected.

What an American politician could do is change our financial system that discourages saving and encourages borrowing. We give government guarantees and interest-deductibility on student loans and interest deductibility to home mortgages and some government guarantees for FHA and VA loans. If people save to put their kids through college, they're taxed on the income unless in a IRA-style 529 college savings plan and then get less help with student aid. If they save up for a down payment on a house, they're taxed on the interest.

We've made some strides to make saving and investment less taxing; you can use an IRA to save for a home down payment and the 529 plans can help cut taxes on college savings. However, little has been done to discourage borrowing in two decades, since the 1986 tax reforms took away the tax deductibility of non-mortgage debt like credit cards and car loans.

One advantage of a consumption-based tax is that it would chuck all the subsidies of interest; 1040 will just mean a good time to take a mid-morning break. It would be an uphill fight, since the current tax system has many vested interests.

That's what we'd need to do if we were to get serious about trimming our trade balance; stop borrowing as much. The way to do that is to stop encouraging borrowing.