Monday, October 31, 2011

"The Market and Other Thoughts"

Sydney M. Williams

Thought of the Day
“The Market and Other Thoughts”
October 31, 2011

I pretend to no expertise as it pertains to calls regarding the market (nor to anything else, for that matter.) There are those in our office like Peter Zecca, Jeff Mondry and Steve Kroll who are students of the market and whose knowledge greatly exceeds mine. Unable to discern charts and made confused by myriad, conflicting opinions, it is my nature to try to look at markets over the longer term. That perspective suggests two conflicting conclusions. The first is that over the very long term, markets have generally risen, in the area of six or seven percent on an annual basis. The second is that our debt situation – and the culture that precipitated it – suggests that the historic long term positive bias to our market could be at risk.

As noted before in these pages, in my forty-four years on Wall Street, I have seen three broad markets: the markets decline (or flat-lining) from 1967 to 1982; a rise from 1982 to 2000 and the period in which we now find ourselves – a flat to declining market. Certainly, as Laszlo Birinyi has explained on numerous occasions, there are markets within markets. In his most recent issue of “Reminiscences”, Mr. Birinyi notes that we are in the 31st month of the seventh bull market over the past 35 years. But, for a broad sweep, I prefer my definition. In August 1982, the Averages were below where they had been fourteen years earlier. Over the next eighteen years those Averages rose sixteen fold. Today they are below where they had been eleven years ago. In each case, the results were a consequence of fiscal and political actions. President Johnson’s Vietnam policy and his “Great Society” program (“guns and butter”) in the mid and late 1960s proved unsustainable. The decision by President Nixon to exit the gold standard in 1972, followed by his observation “we are all Keynesians now” served as icing on the cake. In 1982, amidst a second recession and with soaring inflation, Fed Chairman Paul Volcker dramatically raised interest rates. A year earlier, President Reagan fired 11,345 air traffic controllers who refused an order to return to work – citing the Taft-Hartley Act that banned strikes by government unions. Reason and commonsense replaced the profligacy of Lyndon Johnson and the disgrace of Richard Nixon. Equity markets responded.

But too much of a good thing proved just that. “Irrational Exuberance” in markets was noted in December 1996 by Fed Chairman Alan Greenspan. March of 2000 marked the end of the tech-internet bubble that had sent those stocks to ridiculous multiples, lending veracity to the P.T. Barnum’s observation that “there’s a sucker born every minute.” Most stocks were selling at unsustainable multiples. President Bush’s decision to fight the War against Terror without making adequate plans to pay for it and the Fed’s decision to keep interest rates very low perpetuated the aura of speculation, transforming losses in equity markets to (momentary) gains in housing prices. Of course, a loss in equity prices had nowhere near the same impact on the broad populace as did declines in home prices. The first affected retirement plans – something American never seemed concerned about – the second their daily lives, as we are a nation of consumers, not savers. A bad situation was made worse. The ascendancy of Barack Obama did not help matters. He took Rahm Emanuel’s advice about a crisis to heart. With the country already entrenched with three entitlements we cannot afford, he decided to add a fourth – Obamacare. Additionally, he signed an $800 million stimulus bill which simply transferred federal tax obligations to state and local union workers, which served principally to stimulate his opposition. The result has been a dramatic rise in deficits, unemployment higher than it was when he took office and an economy that sputters along just above the break-even rate,

So, where does that lead us? In my opinion markets appear fairly valued, with some attractive dividend paying stocks. A lot depends on the outlook for corporate earnings in 2012. The strongest argument for stocks, in my opinion, is the richness of alternatives. The Ten-Year U.S. Treasury yields 150 basis points less than the current rate of inflation. Corporate bonds have been in a thirty-year bull market, with rates on corporate issues like Intel and Lockheed Martin yielding less than their common . Commodities have been in a ten-year bull market and incur a cost of carry. However, despite October looking to be the best month in a quarter of a century, we are only back to where we were in late June. In keeping interest rates at historic low levels, the Fed has benefited the borrowers of capital, notably government. The losers are creditors, be they elderly American savers or sovereign lenders. The situation is only exacerbated by creeping inflation. Keep in mind: Inflation benefits borrowers. The U.S. is the world’s largest borrower. The Federal Reserve (via interest rates) along with Congress and the President (by way of spending) are in the best position to affect inflation.

The risk to this otherwise somewhat tepid view of the market is if Washington maintains the trajectory they have been on for the past three years. Early in his recent book (a book which should be read by everyone who has a stake in our government and our capital markets) Keeping the Republic, Mitch Daniels lays out a scenario in which Americans awake on a Monday morning to cable television reports that the Chinese will no longer purchase U.S. Treasuries. Their decision is based on the unwillingness of Americans to confront the problem of trying to maintain a lifestyle, in terms of entitlements, they is no longer affordable. Governor Daniels lays out an ensuing scenario that will strike any unbiased reader as frightening in terms of potential consequences. (Let me make clear that this is not what the Governor expects will happen. He has faith in the American people to right what is wrong in Washington.) But this is his expectation if we persist on this path toward self destruction.

A study of history makes clear that one of democracies greatest hindrances is also its greatest preservative – a lack of efficiency. We have created a separate political class, in which too many seats are inherited or simply held too long. In the process, Washington seems no longer interested in the stewardship of government, but rather in enriching themselves and propagating their own careers. Just as the concept of the “Prudent Man” should be revived in the asset management business, the idea of the citizen politician should be returned to Washington and, in fact, to all our nation’s capitals. The only realistic way to do so is through term limits.

There are those who claim, perhaps reasonably, that the long term is nothing more than a series of short term periods strung together. That may well be, but the risk of error, when leverage is as high as it is and the inclination of government is to avoid making tough decisions, risk remains elevated.

Thursday, October 27, 2011

"Man and Machine"

Sydney M. Williams

Thought of the Day
“Man and Machine”
October 27, 2011

“Deniers” is a term generally associated with those who deny that climate change is largely due to man. But pessimists abound in all aspects of our lives. We have now reached a point where there are those who worry that any new jobs will be going to machines, not people. Such attitudes would seem to ignore the historical and natural trend toward increased automation and enhanced productivity. Time and again, man has demonstrated his ability to innovate.

Earlier this week, at a fund raiser in San Francisco, President Obama worried that we, as a nation, have “lost our ambition, our imagination.” This is a President, with his “Great Recession”, who wants to be compared to FDR and his Great Depression. Specifically, Mr. Obama was referring to the Golden Gate Bridge and the Hoover Dam, both federal projects built during the 1930s. He lamented that Congress will not let him build such monumental projects today. Like President Roosevelt, Mr. Obama has been attacking the investor class (the job creators), dividing the nation instead of unifying it, as had been his campaign promise. However, dissimilar to Mr. Roosevelt, it is unlikely that President Obama will have a world war to bail out the economy. (At least, we had better hope not.)

But in terms of aspiration and innovation, how does Mr. Obama explain Silicon Valley? Was not Steve Jobs and are not Eric Schmidt and Mark Zuckerberg examples of imaginative, ambitious entrepreneurs? The United States is replete with such men and women with ideas, and others with capital. Government should be encouraging them. They can simplify, lower and broaden the tax code. They can reduce and eliminate unnecessary regulation. The role of government should be to set the rules, umpire the game and then step back and let the players play. The fact is that machines have been replacing people since the advent of the Industrial Revolution in the early 19th century. Adjustment has never been easy. The Pony Express disappeared with the advent of the railroad. Carriages were replaced by cars. Ocean liners fell to transatlantic flights. Some people get left behind. But most people adapt, and my guess is that they will continue to do so.

The cause of this, perhaps, emotional reaction was an article in Monday’s New York Times, written by Steve Lohr featuring the economist Erik Brynjolfsson and the director of the MIT Center for Digital Business, Andrew McAfee. The two recently published an e-book, Race Against the Machine. The authors conclude: “Many workers, in short, are losing the race against the machine.” Mr. Lohr reports that originally the authors had been planning to write a paper entitled “The Digital Frontier”, but had changed their minds, as the “employment picture failed to brighten.”

Of course the picture hasn’t brightened. The ‘Great Recession’ was a result of de-leveraging. Consumers had feasted for two decades, placing themselves in hock to an extent hitherto unknown, using their homes as ATM machines. This house of cards collapsed when home prices retreated. Since the consumer represented 70% of the economy, manufacturing, exports and government have been unable to make up the shortfall. With the consumer now attempting to rebuild his balance sheet, with state governments perilously close to bankruptcies and with the federal government stretched near the breaking point the result is, unsurprisingly, modest economic growth at best. Growth is dependent on the expansion of credit. Today, the only sector of the economy expanding credit is the federal government, which is also the least efficient dispenser of capital. The problem has been made manifestly worse by Washington’s implementing regulatory policies that have hindered the unleashing of the private sector, the one area of the economy unencumbered with debt. And also the most efficient sector when it comes to investment, because it is motivated by profit.

There is no question that persistently high unemployment and even higher under-employment have caused a great deal of distress in the labor market. Compounding the employment situation are three factors. Most importantly, the internet has allowed people to work remotely, permitting skilled workers from all corners of the globe to compete for jobs. Second, while many jobs remain scarce, there is a shortage of skilled workers. A year ago, Manpower noted a shortage of electricians, carpenters and welders. Similarly, states such as North Dakota have reported a deficit of skilled job applicants in the energy sector. Trade schools and apprenticeships should be encouraged. Not everybody needs a four-year college education. And third, insufficient savings and depleted retirement accounts has meant that many older people must continue working, competing for scarce jobs.

The cause of the anemic growth in jobs we are experiencing is not machines replacing people – it is true that they are, but that is a phenomenon that dates back almost 200 years and one to which we have adjusted over the decades. The problem stems from the fact that over the last ten years the growth of debt has exceeded the growth in GDP by a factor of two. Slow growth can be seen as atonement for past excesses. Unfortunately, the consequence is high unemployment.

Wednesday, October 26, 2011


Sydney M. Williams

Thought of the Day
October 26, 2011

As regular as Halloween ghosts, and with the effrontery of Al Gore lamenting the melting of ice floes, every few years a new crop of Malthusians appears, frightening the populace with fears of overcrowding and a coming shortage of food and fresh water. Recent Cassandras have included Joel E. Cohen, a mathematical biologist from Rockefeller University who wrote an op-ed in Monday’s New York Times and Professor Jeffrey Sachs of Columbia who noted, regarding the seven billionth baby, “the consequences for humanity could be grim.” The New Yorker, according to William McGurn of the Wall Street Journal, has thrown gasoline on this fire, concluding recently that Malthus was not wrong, just early.

What prompted the New York Times to print this op-ed is the significance of an enormous sign outside the United Nations with a number on it – 7,000,000,000 – the number of people the earth is expected to reach sometime next week. The adamancy of the anti-natalists appears to know no bounds. That poor child, who starts the world on the path toward eight billion, risks growing up under the cloud that he or she bears sole responsibility for tipping the scales toward annihilation by starvation and drought.

In 1798, with the earth housing less than a billion people, Thomas Malthus published An Essay on the Principle of Population in which he predicted that the world’s population would outstrip its food supply by the middle of the 19th Century. In using static analysis, he failed to anticipate the industrial revolution. A hundred and seventy years later, in 1968, Paul Ehrlich wrote a best-seller, The Population Bomb , in which he predicted mass starvation in the 1970s. Four years later, with the world population approaching four billion, the Club of Rome commissioned The Limits to Growth, which raised awareness as to the interdependency between natural resources (limited) and population growth (potentially unlimited.) Again, their warnings proved to be more hype than real. Since then the earth has accumulated another three billion people, as overall living standards improved. While it is certainly true that millions are still starving, that is more due to dysfunctional governments than a question of agriculture, as can be seen in places like Somalia and Ethiopia.

Ironically, two years earlier, in 1970, Norman Borlaug, an agronomist, received the Nobel Peace Prize. In the 1940s, with the spectre of starvation a real possibility, Professor Borlaug developed genetically unique strains of “semidwarf” wheat and later rice, that raised food yields as much as six fold. In granting the prize, the Nobel Committee stated that “more than any other person of this age he has helped provide bread for a hungry world.” The Wall Street Journal, at the time of his death in 2009, noted: “Borlaug showed that nature is no match for human ingenuity in setting the real limits to growth.” According to Wikipedia, Norman Borlaug was credited with saving more than a billion people. Instead of deploring population growth, he did something about it.

The world, as Joel Cohen points out in his op-ed in the Times, has become bifurcated, with the developed world – the U.S. being a notable exception – exhibiting declining populations. Meanwhile, the developing world – in this case with China being the most notable exception – continues to show positive population growth. The net result, as Professor Cohen notes, is that the average number of children per woman has fallen to 2.5 today from 5 in 1950. Wealth, education and birth control are distinctly having an impact on birth rates, and that trend is likely to persist.

Much is made by Joel Cohen at the increasing rate with which the world keeps adding another billion. The first billion took tens of thousands of years until about 1810 – the second, 120 years; the third 29 years and the fourth 16 years. The most recent increase, a 17% gain, took 13 years. Each time we add a billion the percent gain declines, making adjustment for people easier. Of course there is a maximum. The earth is not expanding, so predictions of an apocalyptical end to humankind, at some point, will be proven correct. But that point is likely to be thousands of years into the future. Thus far man’s ingenuity in finding better and less expensive ways of feeding himself has exceeded his ability, or willingness, to procreate.

The bigger and far more immediate problem is the one of aging, a subject I have written on frequently . At the end of his op-ed, Professor Cohen does comment on this looming problem. He writes, “In 1950, for each person 65 and older, there were six children under 15. By 2070, elderly people will outnumber children under 15.”

If one looks to the immediate past, one should conclude that economic development will likely result in continued declining birthrates and that scientific development, in terms of genetically modified seeds and improved fertilizers, will continue to improve the productivity of arable land. Desalinization plants will help with water shortages. But just as it was impossible to anticipate the changes that have occurred over the past two hundred years, my guess is that human creativity will continue to surprise. As William McGurn wrote in yesterday’s Wall Street Journal: “Instead of looking for ways to reduce the number of people at the banquet of life, we would do better to look for ways to lay a better and more bounteous table.” That is exactly what markets have been doing since the advent of the Industrial Revolution. As long as man is permitted to be creative and innovative, there is no reason to expect the trend not to continue.

Overpopulation may prove to be a problem. On the other hand, an aging population is a problem, one that needs to be addressed very soon.

Tuesday, October 25, 2011

"The Death of a Friend"

                                                                                                 Sydney M. Williams
                                                                                                 October 25, 2011
Note from Old Lyme
“The Death of a Friend”

“When a great man dies, for years the light he leaves behind him, lies on the path of men.”
                                                       Henry Wadsworth Longfellow (1807-1882)

Our firm lost a good friend when Fred Stein died suddenly Sunday evening. He was just shy of his 85th birthday. Fred’s greatest success was the collecting of friends; he was a “people person.” Along the way he also amassed considerable wealth. In the world of finance, he was a giant and he knew and was known, loved and respected by thousands of all ages.

His death causes us to pause and reflect on our own mortality – the importance of family and friends, and to consider: by what legacy will we be remembered?

So busy are we in our daily lives, with our concerns for the immediate future that we rarely (and fortunately) do not think of the fact that this will all end one day – fortunately in the sense that if we were to pass our lives in reflection nothing would ever get done. His death makes us realize the value of time. It becomes crystal clear that each moment that passes is one that has disappeared forever.

Retrospection, in small doses, is healthy. Death is a natural and inevitable consequence of life. Shakespeare wrote: “All that live must die, passing through nature to eternity.” A giant sequoia might live more than half a millennium; an insect, perhaps a day or less. According to Joel Cohen, a mathematical biologist at Rockefeller University, the global average age for man is 70. By that measure, Fred lived a full life. But death always arrives too early. On learning of one’s death our minds immediately turn to words unspoken, of deeds undone. It serves as a reminder to do the things we want to do, and to speak and be with those we cherish.

The greatest gift of life is a sense of wonder and curiosity – traits natural to children and too often sloughed off by adults. Those gifts presuppose a belief in the future. Fred embodied that attitude. It was what drew him to young people. It is what made him so knowledgeable about fields as diverse as art, literature and opera. Instinctively or knowingly, Fred recognized that life is a continuum, with no knowable beginning and no knowable end. He knew that the value the elderly bring to the young is not so much wisdom as a link to the past – a past they otherwise know only through books. And the value the young bring to those of us who are older is a glimpse into the future – a future we will never see.

At the risk of being overly sentimental, Fred’s death is a reminder that there is nothing so valuable as family and friendships; those relationships should be nurtured, so that the rewards they provide can be shared and enjoyed.

Above all else, we should remember Fred for his friendship, for his wisdom and for the curiosity that kept him forever young. He enriched our lives and we are all the better for knowing him.

"Irony in the 'Occupy Wall Street' Protests"

Sydney M. Williams

Thought of the Day
“Irony in the ‘Occupy Wall Street’ Protests”
October 25, 2011

There is among Washington Democrats a sense of desperation when it comes to defending the odd mixture of jobless, youth, anti-Semites; druggies; union workers; professional protest types, and rich Hollywood people like Michael Moore, all who have come to inhabit Zucotti Park – a partially privately owned park – in lower Manhattan. The protesters chant simple slogans, like ‘Down with Capitalism’, ‘We are the 99’, ‘End the Fed’, ‘Jobs, not Wars’ and ‘Tax the Rich.’ Democrats envision their response to the Tea Party, the people they (the Democrats) blame for their defeat in 2010. But there is a significant difference. The Tea Party stands for empowering the people; the “Occupiers” want to empower the state.

It is true that over the past couple of decades, wealth has accrued to a minority. But that has always been the case. In every society it is always a small number of people who combine talent with drive and initiative. It is they who reap the bulk of the nation’s wealth. Democracy is different than other forms in that it promises equality of opportunity, not equality of outcomes. “Progressive” politicians use the disenchantment of people to divide them between the “haves” and “have-nots,” to seduce them down the path toward Socialism, a trail that too often terminates in Totalitarianism. For the young people in Zucotti Park it becomes a case of being careful what you wish for.

This is not to argue that capitalism or even the system is pristine. There are always abusers, some of whom are greedy or crooked. But abuse also stems from unintended consequences of government interference. For example, in early 1993, the Clinton administration, wanting to rein in corporate excess decided to limit the deductibility of executive compensation to a million dollars. Corporations could pay their executives more, but amounts exceeding a million dollars would not be tax deductible. The consequence was an enormous rise in the use of options, which were excluded from the restrictions; pay packages thus soared to multiples of what they had been under the old rules. The blatant use of options reached its peak in the 1990s and, as usage has declined, the gap between CEO compensation and average worker pay has narrowed – from 525X in 2000 to 411 times in 2005 and 369 times in 2007 – but remains substantially above where it was in 1960, when it stood closer to 50 times.

In 2008, it was critical that banks be saved. Commerce relies on banks and the credit they offer. Had the banking system collapsed in 2008, the world would have experienced a global depression of harrowing proportions. The Occupy Wall Street crowd would not have been able to gather in Zucotti Park. It would already have been filled with the homeless and destitute. Banks weren’t saved because the Bush administration loved bankers. (Keep in mind that Barack Obama received two times the amount of money from Wall Street than did John McCain.) The banking system was preserved so that commerce could continue. Were there bankers who took advantage of the bailouts? Absolutely! Larceny is certainly not unknown in the financial world, and the perpetrators should be punished. The principal of failure is necessary to the success of capitalism, but the failure of the system would be disastrous.

What is frightening to those who believe in traditional liberal principles of individual freedom is the encouraging of and then the succumbing to mob rule. The excesses in our economy that have led to this state stem from the overuse of leverage, mostly by individuals for homes. Bankers are certainly not free of fault, but the real blame lies with a system that encouraged consumption, that gave no encouragement to savings or investment. As consumers, we were at fault. We live for today, the Hell with tomorrow. If there is one institution to blame, it is government which encouraged such behavior. The unwinding of that debt definitionally means a slow economic recovery. To hide from that truth in vitriolic rhetoric, as the President has been doing with his divisive attacks on the “1 percent,” is highly risky and potentially dangerous. Remember, this is a man who three years ago promised to unify and heal what he told us was a troubled nation. From trashing bankers, to bashing the Chinese we risk a ride down a slope too slippery to easily evacuate.

The irony comes from a failure of the protesters either deliberately, or, more likely, through ignorance to understand that capitalism and democracy are inextricably linked – one is not possible without the other. The very fact that the protesters have been able to assemble and to vent their frustration is due to the success of our democratic-capitalist system. Those who would suppress capitalism also rein in democracy, for when rights are denied individuals they are assumed by the state. The fact of the matter is that individual rights are better protected when government retreats to its traditional role. When a state deems it important to secure additional powers, to cause people to become dependent on the benignity of the state, or when the state decides equality of outcome justifies a re-distribution of wealth, power shifts away from the people and toward those who run the state. The ‘99’ would remain; the one percent would become the government leaders who would dictate terms.

In my opinion, the basic problem that led to this mess has its origins in a cultural shift abetted by government that encouraged people to live for today, for tomorrow would take care of itself. In the 1990s, the Clinton administration, with HUD Secretary Andrew Cuomo at the helm, encouraged banks to lend to low-income families with poor credit histories. The Bush administration continued the process, bragging in early 2005 that home ownership had reached a record 69.2 percent. (As of the second quarter of 2011, home ownership had fallen to 65.9 percent, the lowest since 1998.

Democracy is being challenged and no one should underestimate what that means. Congressman Jesse Jackson recently suggested that the President suspend the campaign and the election. I have listened to people who should know better that democracy is no longer up to the task at hand, that we would be better with some sort of benevolent dictator. There are those who suggest we emulate the more efficient and supposedly better managed Chinese economy. Certainly, democracy suffers from a lack of efficiency, but that is also its strength, for that implies it is the people who wield power. Mussolini was noted for making the trains run on time, but that only meant that Jews could be more quickly expedited to concentration camps.

A problem we do have is that fewer people have an axe in our system. Almost half of all workers pay no federal income tax. To them, Washington is a source of income, not a government to which they contribute. Two suggestions, in my opinion, would improve our country and would benefit those young unemployed who are hanging out smoking dope and defecating on doorsteps in and around Wall Street. One would be the reinstitution of the draft, or some form of national service. Giving something back to the country while learning a skill would benefit both themselves and the rest of us. The second recommendation is to broaden the tax code, so that everyone pays something. It is not the amount paid that is important; it is the principal.

In the meantime, this movement does have legs, with offshoots showing up in Asia, Europe and Australia. Their messages too often reflect ignorance and hate. From what I can see it is largely comprised of youths with no unified message or complaint. And there is also irony in that they are being used by those who purport to side with them – politicians and Hollywood who have adopted them for their own, selfish purposes.

Monday, October 24, 2011

"Dancing on the Titanic"

Sydney M. Williams

Thought of the Day
“Dancing on the Titanic”
October 24, 2011

“You can run, but you cannot hide.” I first heard that old saying almost forty years ago from an old friend, the actor Brian Dennehey. Reality ultimately triumphs over wishful thinking.

It is not uncommon to ignore unpleasant truths. Blanche DuBois, Tennessee Williams iconic character in A Streetcar Named Desire, imagined herself a southern belle, yet disappointment with a homosexual husband (and his suicide) sent her, an aging and fading beauty, into the arms of multiple men. As it relates to German citizens in the 1930s the question of reality versus fiction has been discussed ad nauseum. Why did so many ordinary people choose to ignore and excuse the persistent disappearance of their Jewish neighbors, and why were so many willing to accept a Socialist state that gradually dispensed with their individual freedoms? Thomas Paine answered those questions in his pamphlet, “Common Sense”: “It is natural for man to indulge in the illusion of hope. We are apt to shut our eyes against a painful truth, and listen to the song of that siren till she transforms us into beasts.” Psychiatrists refer to this phenomenon as delusional.

This tendency to ignore reality despite – to stay with the Titanic metaphor – the iceberg dead ahead can be seen in both Europe and the United States today. Like ostriches, Europeans with heads in the sand fail to acknowledge the reality of a bankrupt Greece and the failure of the Euro. Seventy-nine cents on the dollar does not adequately discount the value of Greece’s debt. A single currency without full fiscal and political integration is impossible. Despite persistent last minute meetings, the unwillingness to give up national sovereignty will doom the experiment to failure .

Likewise, in the United States, promises to constituents, whether by government or by unions, are beyond the ability of the guarantor to keep. Promises were made, perhaps in good faith, but were based on unrealistic expectations and faulty math . For example, Michael Lewis writes in Boomerang of California spending $6 billion on fewer than 30,000 prison guards, while investing $4.7 billion in higher education for 670,000 students – a case of misplaced priorities and an obvious case of robbing the future to pay for today. The strikes in Greece and the Occupy Wall Street movement reflect the frustration people have in seeing dreams dashed, because reality has exposed the fraud of the promises. Greece is bankrupt; in the U.S. we have witnessed a few municipal bankruptcies. We can expect more strikes and bankruptcies. A University of Vienna employee told me last week of his recent encounter with reality. Historically, professors had been able to retire at 70 percent of their three best years. That is being changed to 40 percent of an average of their past ten years – a lower percentage of a lower base. In the West, we are experiencing the end of an era when all things seemed possible. Optimism will return, but it will have to be based on a more realistic version of markets and economies. No longer will we be able to hide behind promises based on faith, not reason.

Meredith Whitney has been ridiculed in the U.S. Press and by politicians for her call a year ago suggesting the pending bankruptcy of 100 municipal entities; yet the fault may be only that she was early, not wrong. The municipal market is a $3.7 trillion market. Thus far, in the present cycle, there have been four municipalities that have filed for bankruptcy – Jefferson County, Alabama; Harrisburg, Pennsylvania; Vallejo, California, and Central Falls, Rhode Island . Kicking the bucket down the road has proven to have been the most appealing course of action for politicians whose desire for reelection exceeds the more difficult one of doing what is right for their community. But the bucket is getting heavier and the road is coming to an end. Operating in one’s self interest is a legitimate aspect of free capital markets, but it does no good for society when it is practiced by those hired to serve the public – politicians; yet that is too often the case.

The current situation has been compared to the world-wide depression of the 1930s; so it was appropriate that this pending collision between fact and fiction was a subject discussed at a round-table I was fortunate to attend last week in Vienna. The symposium was sponsored by the Liberty Fund, Inc. (, an organization based in Indianapolis dedicated to encouraging the study of the ideal of a society of free and responsible individuals. The conference was put on in conjunction with the Hayek Institute of Vienna ( Friedrich Hayek, along with his mentor and teacher Ludwig von Mises, was the founder of the Austrian School of Economics. Simply put, it is their belief that economic freedom is prerequisite for all other freedoms, and that the interference of government to promote or to retard events can have unintended consequences. The School had its roots in the 19th century, but gained prominence in the 1920s and 1930s when much of the world turned to Socialism in response to the devastating consequences of World War I reparations, hyperinflation in Germany and an ensuing global depression.

Like inflation, Socialism is insidious, sneaking in on “little cat’s feet.” The early promises of Lenin and Stalin, and Hitler and Mussolini were as populist progressives. They needed someone to blame for the uncomfortable (and “unfair”) conditions in which they found themselves. With the aristocracy gone, they turned, not unlike those occupying Wall Street, to the monied classes, a euphemism, at that time, for the Jewish people. Around the world, “socially responsible” politicians have hopped aboard this train hoping it will lead, at least in the U.S., to reelection in 2012. The quickness with which they joined the “blame game” is disconcerting and makes the message of personal freedom, the focus of the Liberty Fund, more imperative than ever.

The search for someone to blame for one’s ills is endemic to the human condition. In Travels with Charlie, John Steinbeck wrote of how 1950s Americans found it easy to blame the Soviets for all our woes. Growing up in New Hampshire, when our neighbor’s cows weren’t milking it was somehow the fault of the “Russkies.” The Jewish people have been blamed for financial disruptions for centuries, thus the anti-Semitic signs carried by even a small number of ‘Occupy Wall Streeters’ are chilling reminders of a past some of us remember and all should never forget. Others want a redistribution of wealth, which implies a redistribution of power from the electorate to the state. There is no society in which equality of outcomes is a given. What protesters should demand is an equal access to opportunities – the promise of a democratic state. Over the decades the attractions of Socialism seduced both those on the left and the right. John Reed, a Harvard educated journalist and poet, along with thousands of other prominent Americans like Walter Lippmann, in the early 1930s fell for the lure of Soviet Communism. Anne Morrow Lindberg and Joseph Kennedy found their sympathies lying with Hitler’s Nazis in the late 1930s. The author, Sinclair Lewis in the 1930s, was worried enough to write of his fear that ordinary Americans might unwittingly accept a version of Nazi Socialism. In 1935, he wrote It Can’t Happen Here, which of course was why it could. When people become afraid they often become xenophobic; they look for someone to blame. When government endorses such behavior, risks accelerate.

The world is dynamic. No perfect system has been devised. Yet democracy, as Winston Churchill once said, remains the best governing system that man has yet devised. However, implicit in democracy is the fact that people must accept responsibility and they must recognize our unequal talents. Some are smarter; others are more athletic or better looking. Still others work harder, or have greater aspirations. But the yearning for freedom is universal. There is a need for a state to ensure that, via a basic education, opportunity remains a universal right and that equality under the law is preserved. The state provides protection from those who would do us harm. It must help the indigent, the elderly and those incapable of looking after themselves. It provides structure and aids in commerce. But government cannot guaranty equality of outcomes without depriving us of our individual rights, including the right to succeed or to fail. A people who become overly reliant on “Big Brother” are doomed to a poorer future – a fact the Greeks and the “occupiers of Wall Street” should consider.

In the meantime, governments in Europe and in America seem to be assuming that the iceberg in front of us is nothing more than a mirage, and that our luck will hold one more time. In times of distress, many look to government for sustenance, but that path is indeed a slippery slope. None of this is unknown to markets, as they have been flat to down for more than ten years. Nevertheless, prudence would suggest we know the location of the nearest lifeboat. And somebody, please turn down the music.

Thursday, October 13, 2011

"Pension Liabilities - The Piper Must be Paid"

Sydney M. Williams

Thought of the Day
“Pension Liabilities – The Piper Must be Paid”
October 13, 2011

Lost amid the Tsunami of concerns emanating from the European sovereign debt crisis and the continuing mortgage debt problems in the U.S. is the growing deficits accruing to both public and private pension funds. It would be my guess that an implicit deficit of even greater magnitude exists in the self-managed 401K and IRA world. The losses in the former are a consequence of over-the-top promises, along with underperforming markets. In the latter, insufficient funds in self-managed funds are due to ignorance as to future needs, inadequate savings and poorly performing markets. This shortfall in assets, in my opinion, is likely to become the direst problem confronting our country over the next few decades.

According to a report in the January 18, 2011 issue of the Financial Times, the shortfall among public pension funds was $2.5 trillion. Mercer Financial Strategy Group puts the shortfall for corporate defined benefit plans for the S&P 1500 companies at $512 billion as of the end of September 2011. But, as indicated above, those numbers understate the scope of the problem, especially the problem for those working in the private sector. Eighty-eight percent of public employees participate in defined benefit programs. However, only 15% of private sector workers participate in employee-based defined benefit plans, according to the Employees Benefit Retirement Institute (EBRI.) One could easily assume, therefore, that the real unfunded liability for those who self-fund in the private sector is closer to 6.7 times that number, or closer to $3.5 trillion. The combined shortfall of about $6.5 trillion (a little more than 10% of total U.S. capital markets) provides some sense of the problem facing this country over the next few decades. In fact, in a piece I wrote last January it was suggested that the needs over the next twenty years could approach $27 trillion . As a country, we must become far friendlier towards capital and its formation.

While personally I question both the spontaneity and the motivation (if there is one) behind the Occupy Wall Street protests, I do believe there are deep-seeded frustrations with the seeming inability of our country to provide opportunities for millions of people. Most of the protesters – the ones not displaying hate-filled anti Semitic signs, or selling drugs – believe the fault lies with the capital system. My personal belief is that the fault lies more with government, and specifically with those programs that did so much to encourage sub-prime borrowers to buy homes they could not afford, and with the Federal Reserve keeping interest rates so low that it encouraged borrowing and discouraged savings. The fact is that, as a nation, we are capital poor, not rich. That is seen in the need to reach out to China for funds. Obviously, the first need is to provide jobs; but the second is to encourage Americans to invest capital. The economy only works when both labor and capital are growing. To demonize one is to forsake the other, and to ignore the goal of a growing economy.

Shortfalls in corporate defined benefit programs will have to be made up by shareholders. In a piece out on Tuesday, Credit Suisse writes: “Higher pension costs could cause an earnings headwind for 244 companies going into 2012; as a result earnings estimates may have to come down.” In aggregate, according to an October 5 report in the Wall Street Journal, American companies are holding $2 trillion in cash. Thus corporations, or at least most, would appear to have adequate means to repair their pension liabilities. But cash spent on pensions is cash that cannot be spent on dividends, acquisitions or buybacks. The Credit Suisse report estimates that S&P companies will have to contribute $91 billion in 2012, an increase of 76% over the expected 2011 contributions. Coming off the recession earnings have been surprisingly strong; nevertheless markets are nervous, so any shortfalls may not be received well.

The more critical questions are those facing public unions and the millions of people who have inadequately prepared for their own retirements. States such as New Jersey and Wisconsin have visibly and vocally prepared their constituents, including their public employees, as to the magnitude of the problem. Accepting reality, however, is far from a slam-dunk, as we have seen in those two states and others. Additionally, the contagion of bankruptcy which began in Central Falls, Rhode Island in July has now spread to Harrisville, Pennsylvania, which, according to an article in today’s Journal, filed for bankruptcy yesterday under Chapter IX of the bankruptcy code. The fact is that municipal and state unions over the years promised their members benefits that will be impossible to fulfill. The debate will be determining who is at risk – bond holders, the beneficiaries of unrealistic promises, or both?

The more worrisome concern is the one that receives little mention and that is the needs of the 85 million working Americans who rely principally for their retirement on some form of a defined contribution plan. The people in these plans are dependent for retirement upon voluntary contributions and the performance of their investments. A report out last month from EBRI suggested that 67% of early Boomer households without defined benefit plans (and 59% of late Boomers) are at risk of having insufficient retirement income. We live in a country that encourages consumption, not savings and for almost a dozen years we have been in what I would term a secular bear market. Neither factor is promising of a comfortable retirement. An estimated 55 million people will reach retirement age over the next seventeen years. The funds they will require to retire without worry, coupled with the size of our capital markets, suggest that needs dwarf availability.

Next week I will be out of the country, so your inbox should be alleviated from inundation of my Thoughts of the Day, at least for a few days.

Wednesday, October 12, 2011

"Egypt - The Promise of Spring Becomes an Autumn of Anguish"

Sydney M. Williams

Thought of the Day
“Egypt – The Promise of Spring Becomes an Autumn of Anguish”
October 12, 2011

“If you want to move people, you look for a point of sensitivity, and in Egypt nothing moves people as much as religion.” Those words of Naguib Mahfouz, Egyptian writer and Nobel Prize winner for literature were prescient in terms of Sunday’s clash between Coptic Christians, the Egyptian military and Muslim extremists. Mr. Mahfouz, who died in 2006 at the age of 95, was a devout Muslim who believed in freedom of expression. For example, while he criticized Salman Rushdie’s Satanic Verses as being insulting to Islam, he defended Mr. Rushdie’s right to publish. For his troubles, Arab extremists, in 1996, attempted to assassinate him by stabbing him in the neck. He survived, but the injuries affected his writings.

While religion may not have been as instrumental as economies and politics as a cause of war, it certainly has played (and is playing) a central role in terrorism that has been sweeping across the Middle East and the globe. We in the West assumed that it was the sole desire for freedom and democracy that drove youthful demonstrators into Cairo’s Tahrir Square last February when, in fact, the protests may have been orchestrated by the Muslim Brotherhood. Stability is a hallmark of tyrants and Hosni Mubarak was no different from others. The army kept the Brotherhood under control and Coptic Christians – about ten percent of Egypt’s population – were provided freedom of worship. It was a situation that suited the West, as its principal manifestation was stability. However, like a covered pot brought to boil, the underlying tensions needed release.

Democracy is difficult in part because success demands compromise and respect – conditions unfamiliar to extremists everywhere. Democracy relies on trust and shared responsibility. No one gets everything they want. Benjamin Franklin spoke of that at the time of the Revolution when he defined democracy: “Democracy is two wolves and a lamb voting on what to have for lunch.”

Since Mubarak’s ouster, Egypt has been run by the Supreme Council of the Armed Forces (SCAF.) In fact, some would argue that the military has been the mainstay of stability in Egypt for years. The difference is that Hosni Mubarak had the strength and the means to keep warring factions separated. Reva Bhalla of Stratfor wrote yesterday: “What most of the media have failed to discern in covering the Egyptian uprising is the centrality of the military in the conflict.” Many of the military elite shared the goal of dislodging the Egyptian ruler. In Ms. Bhalla’s view, the main purpose of the elections is to provide the impression of transitioning to democracy.

Under Mubarak, according to Ms. Bhalla, “…members of the Egyptian Muslim Brotherhood would shuffle from apartment to apartment in the poorer districts of Cairo trying to dodge arrest while stressing to me in the privacy of their offices that patience was their best weapon against the regime.” During the Mubarak years, Coptic Christians stuck together freely, if nervously, worshipping at their churches. However, in the nine months since the ouster of Mubarak, the military has tried some 12,000 Egyptians in military courts, “more than the authoritarian ruler did in thirty years,” according to Laura Meckler of the Wall Street Journal. Despite the omnipresence of the military, forces opposed to SCAF have become increasingly vocal in their discontent. State-run media has been supporting the interim military dictatorship and, according to Stratfor, appear to have deliberately fomented dissension between Islamic extremists and the Christian community.

Egypt, with 83 million people, is the largest Arab nation in the world; it appears to be disintegrating into anarchical chaos. It remains to be seen as to whether SCAF will permit the start of parliamentary elections last month as promised. Last Sunday, the Maspero Youth Union, an extremist Coptic group, marched on the headquarters of the Egyptian state television. They did so in protest over the burning of a church in Aswan and against the failure of the army to protect Coptic interests. The response was fast and furious. While a lot of misinformation was passed around by Twitter feeds, what we do know is that shots were fired and the army responded with tear gas and the use of armored vehicles. Pictures of armored vehicles charging into protesters at high rates of speed were chilling and reminiscent of those of Nazis moving into Poland in 1939 – a total disregard for human life. Purportedly twenty-six have been killed, including three Egyptian soldiers, but it is hard to believe that that number will not rise.

Totalitarian states that harbor terrorism are dangerous to the world, as we learned on 9/11 and was made clear yesterday when the Justice department foiled an Iranian attempt to assassinate the Saudi Ambassador to the United States in a Washington restaurant, a location frequented by members of Congress. There is little question that the choice of venue was deliberately aimed at the United States. The United States has long supported repressive regimes in the Mideast, as well as other places, on the basis that stability trumps anarchy. However, as hope coursed through the region on the back of the Arab Spring, expectations for democracy rose. Twitter and YouTube put words and faces to young protesters; those in the West who wanted this to be a grassroots response to tyrannical leaders ignored the role played by those such as the Muslim Brotherhood.

Democracy is the best antidote to terrorism and the desire to export democracy is a noble goal, but its implementation is difficult. It is all well and good for the United States to call for such change and to lend verbal support for those who demand such change. But for democracy to succeed it requires more than just words, as we have learned in Iraq and Afghanistan. The words of Edmund Burke resonate: “All that is necessary for the triumph of evil is that good men do nothing.”

On June 4, 2009, newly elected President Obama spoke at Cairo University. He said: “I have come here to seek a new beginning between the United States and Muslims around the world.” He spoke of how we “share common principles – principles of justice and progress; tolerance and the dignity of all human beings.” But President Bush had made clear in the days after 9/11 that the war against terrorism was not a war on Muslims. Speaking to airline employees at Chicago’s O’Hare airport on September 27, 2001 he said: “Americans understand we fight not a religion; ours is not a campaign against the Muslim faith. Ours is a campaign against evil.” Too many Muslim regimes do not share democracy’s principles of justice and tolerance.

Evil knows no boundaries or religion, and certainly is not limited to Muslims, as we who lived through the times of Hitler and Stalin know full well. However, Mahmoud Ahmadinejad is evil incarnate, as his regime’s recent assassination attempt shows. The attempt is also a visible reminder of the consequences of letting Iran develop a nuclear weapon. And the risk that is emerging from the chaos in Egypt is the possibility of either a newly strengthened military, or an empowered Muslim Brotherhood – neither one will advance the demands of pro-democracy forces and both, should Iran get their nuclear weapon, will seek one for Egypt.

It is not so much a “new beginning” we should be seeking, but a reaffirmation of the principles of liberty for which so many have died over the centuries, and which was so well understood by that exemplary Egyptian author, Naguib Mahfouz.

Tuesday, October 11, 2011

"A Double-Dip Recession?"

Sydney M. Williams

Thought of the Day
“A Double-Dip Recession?”
October 11, 2011

In 1982, the U.S. economy fell into a double-dip recession. The first quarter of 1980 experienced a decline in GDP of 7.8%, the worst decline in quarterly GDP since the Great Depression. However, the recession proved short-lived, lasting for six months. A second recession – the double-dip - lasted sixteen months, from July 1981 through November 1982. That recession saw unemployment rise to 10.8%, another post-War record.

Both recessions had their origins in a rising inflation that had begun in 1966, a result of the “guns and butter” policy of President Lyndon Johnson – the Great Society and the Vietnam War. President Nixon then severed the Dollar from its ties to gold and instituted wage and price controls in 1972. The consequences of Mr. Nixon’s actions saw prices go higher, demand stifled and wages that were too high, so forced employers to lay off workers. The first oil embargo, in the fall of 1973, then helped tilt a weakened economy into recession. The third and fourth quarters of 1974 and the first quarter of 1975 saw GDP declines of 3.8%, 1.6% and 4.8% respectively. With its double, and at times contradictory, mandates of controlling inflation and maintaining full employment, the Federal Reserve under Chairman Arthur Burns opted to focus on employment. The Fed’s expansionary policies had the unintended consequence of businesses simply raising prices – in anticipation of rising inflation – instead of hiring additional workers . That resulted in inflation rising from 3.2% in 1972 to 9.1% in 1975, while unemployment also rose, over the same years, from 5.6% to 8.5%.

The short, sharp recession of 1980, which was generally blamed on increases in inflation driven by the second oil embargo and global food harvest failures, was in fact “man made”, as Paul Volcker who replaced Mr. Burns at the start of 1979 drove Fed Funds sharply higher. Mr. Volker had been appointed by President Carter to be Chairman of the Federal Reserve to address the growing inflationary concerns that were destroying confidence. Between June and December of 1980, the Fed raised Fed Funds from 8.5% to 20%. In early 1981 with recovery under way, Mr. Volcker lowered rates to 16%; but inflation remained stubbornly high. So the Fed Chairman acted again. By mid October, he had again raised rates to 20%. The cost was the double-dip recession mentioned above, but this time it worked. Inflation declined from 13.5% in 1980 to 3.2% in 1983. Unemployment, which had peaked in the fourth quarter of 1982 also declined to 7.5% in 1984. The market, anticipating the economic growth that would follow, began rising in August 1982 leading to what would become the longest and strongest bull market in New York Stock Exchange history – eighteen years during which the Dow Jones Industrial Averages compounded at 16.2%.

Today, the question is, are we headed into another double dip recession? The Economic Cycle Research Institute (ECRI), which has had the most accurate record of predicting recessions of any major research group, seems to think so. The Economist recently reported that ECRI has “never issued” a false alarm. Of course, there is always a first time for everything and perhaps this will be ECRI’s time in the penalty box. Regardless, one should not take their warnings lightly. In late September, co-founder of ECRI, Lakshman Achuthan stated: “The vicious cycle is starting where lower sales, lower production, lower employment and lower income leads back to lower sales.” A study released yesterday by the Sentier Research and reported in Monday’s New York Times indicated that household income has declined 6.7% since the end of the recession in June 2009, more than double the decline in household income during the recession! On the other hand, anecdotal evidence from among companies we follow does not indicate an economy tipping into recession. Similarly, Ken Prewitt of Bloomberg on Monday noted that economists from Goldman Sachs and Macroeconomic Advisors recently revised their third quarter GDP numbers from 2.2% to 2.5%. “We may have,” he said, “dodged a double-dip.”

Not being an economist, so not one who spends his weekends pouring over data from the Federal Reserve or from the Bureau of Labor Statistics, I have no idea as to whether or not we will experience a double-dip recession. But I also know that two experts looking at the same data can come to two different conclusions. President Truman once said “give me a one-handed economist,” so they wouldn’t be able to say “on the one hand…on the other hand.” John Kenneth Galbraith said: “Economics is extremely useful as a form of employment for economists.” Peter Lynch, in response to George Bernard Shaw’s famous observation on the inability of economists to form a consensus, was more helpful: “If all the economists in the world were laid end to end it wouldn’t be a bad thing.”

What I do know is that there is no confidence in politicians around the world, or in the economies for which they are stewards. And there is no confidence in markets. Capitalism has too often been trashed by the Administration and others in Washington. Confidence is an illusive sense and difficult to define, but we know it when it’s missing. It brings to mind Supreme Court Justice Potter Stewart’s famous riposte in 1964 when asked to describe pornography: “I know it when I see it.” Today’s lack of confidence can be laid at the feet of the President and Congress. Neither has done much to address its absence. Each side has blamed the other, with neither being honest about the fact it was a cultural issue, abetted by Washington, that had come to permeate our society, and which allowed all of us to assume debt irresponsibly – to ignore the future for the pleasure of living well today. But government is not solely responsible for the current environment. A lack of confidence is also the fault of those who labor on Wall Street, as they never treated the money that was used to bail them out three years ago with the respect it deserved. As Ayn Rand said, in a quote sent me yesterday by my friend Alan Rivoir, “We can evade reality, but we cannot evade the consequences of evading reality.”

In 1982, it took an effort by the Federal Reserve to slay the beast that was inflation. In doing so, they catapulted the economy into recession – the medicine necessary to right the ship. Today’s problems stem from too much leverage. Reducing leverage will not necessarily send the economy back into recession. What it does imply, though, is a far more sluggish recovery, which is exactly what we have been experiencing. In the U.S., it has been necessary for banks to write down mortgages that are no longer “in the money”, or those loans on which the mortgagor is no longer current. Banks which use their capital to write down existing loans definitionally have less money to lend. And economic growth relies on the availability of credit. If I had to wager a guess, it would be that sluggish growth will persist and that we will skirt recession, but that advice plus $2.50 will get you uptown on the subway.

As a guide to where we might be, a Swiss friend of mine offered some advice. You know that things are bad when:

          * Exxon-Mobil lays off twenty-five Congressmen.
          * A truckload of Americans gets caught sneaking into Mexico.
          * Angelina Jolie adopts a child from America.

We have not reached that point, and perhaps we will not. However, the fact that the ECRI has declared that we are in (or entering) a recession is a warning not to be taken lightly. I worry about the lack of confidence and suspect it will take a change in administrations to correct that situation, which may not happen until 2016. So be forewarned; the world is a surprising place; what seems obvious today may not seem so tomorrow.

Monday, October 10, 2011


Sydney M. Williams

Thought of the Day
October 10, 2011

In spite of the President’s policies, protectionists in Congress and efforts of organized labor, manufacturing appears to be returning to our shores. At least that is the conclusion of a study performed by the Boston Consulting Group (BCG) that was released last Friday. Scott Paul, executive director of the Alliance for American Manufacturing, says, “It’s a trickle, not a trend – but clearly companies are thinking more about it.”

An article in Friday’s Wall Street Journal, mentioned that Otis Elevator was moving production from Nogales, Mexico to a new plant in Florence, South Carolina. The article also mentioned that Master Lock Co. of Milwaukee is moving some production back to the U.S. from China, as is Ford. Even General Electric, the scourge of the Tea Party for paying no income tax and for moving a few executives in its X-Ray Division to China, is opening an “appliance park” in Lexington, Kentucky where it plans to produce energy-efficient electric water heaters that it used to assemble in China. In 2009, NCR moved its ATM manufacturing facility from China to Columbus, Georgia. The retired CEO of GF AgieCharmilles, Harry Moser, has formed a group named “Re-shoring Initiative” to wean companies from reflexively sending manufacturing operations overseas.

The weekend edition of the Financial Times reported that over the past decade, the United States’ share of global manufacturing declined from 27% to 19%, while that of China rose from 7% to 19.7%. According to the Boston Consulting Group about 5.7 million manufacturing jobs have been lost over the past decade to off-shoring. Their report suggests that approximately 3 million jobs could potentially be created by 2020 because of re-shoring. The BCG report identifies seven industries where rising costs in China, along with the increased competitiveness of the U.S., make it economically rewarding to operate plants in North America: electrical appliances, furniture, car parts, electronics, basic metals, machinery and plastics. One common factor in those seven industries is that labor has become a diminishing percent of total costs.

Over the past two or three decades, significantly lower labor costs in emerging countries caused labor-intensive industries to move manufacturing facilities overseas. As technology proliferated, leading to enhanced productivity, and as labor costs differentials narrowed, a few companies have begun returning home. Factors influencing this trend, according to the BCG report, include a narrowing of the wage gap; a stronger Yuan; delivery responsiveness, which is a reflection of just-in-time delivery requests on the part of wholesalers and retailers, and the proximity to engineering staff making design revisions simpler.

Augmenting this development has been the growing number of states that have implemented “right to work” legislation. There are now twenty-two such states, with Indiana and Ohio now considering such legislation. The legislation is opposed by unions for the obvious reason that it deprives their leadership of dues. In a non right-to-work state, workers may choose not to join a union, but they still can be required to pay union dues, a violation of their civil rights, as much of the money is used to support political candidates friendly to unions.

Free market capitalism does resolve issues, perhaps not always on the timeline preferred by government interventionists, but it works. The movement toward right-to-work legislation is a direct response of the globalization of the workforce. There are those who argue that mercantilist states, such as China or Brazil, have an advantage over their capitalist competitors. Certainly their governments provide financial support and serve up protectionist barriers, but no bureaucratic-ridden business is as efficient as the market place. Businesses in capitalist societies are owned by their equity holders; so they will find a way or they will fail.

Unions, which played a critical role in organizing labor in the dark days of the 1930s and ‘40s by demanding improved wages, benefits and safety provisions, were in part responsible for the off-shoring of manufacturing. Their entreaties, especially for healthcare and retirement benefits became unrealistic in a world in which the workforce was global. They failed to recognize that competition was no longer between the Midwest and the Sunbelt, but was between Mexico, China, India and Brazil and the United States. Their blindness to a changing world, abetted by a federal government equally blind, bankrupted the steel and auto businesses – or nearly so. Many workers, companies and a growing number of right-to-work states are now addressing that self-inflicted wound.

What the BCG report shows is that the world is constantly in motion. Schumpeter’s theory of creative destruction does work, at times against us and at other times to our advantage. The twenty-two right-to-work states have been creating jobs at a far faster pace than those that provide no such rights and have been the principal beneficiaries of re-shoring. According to the Bureau of Economic Analysis (BEA), eight of the ten states that showed the greatest percentage of growth in GDP between 2000 and 2010 were right-to-work states. Conversely, eight of the ten states that showed the smallest percentage of growth in GDP were compulsory union states. But it is beyond just jobs. According to a CNBC survey, when it comes to a quality workforce in 2011, eighteen of the top twenty states were right-to-work states. All twenty-two of right-to-work states were in the top twenty-five. That fact has not gone unnoticed by voters. Indiana has become much more business friendly under Governor Mitch Daniels and looks to become the twenty-third right-to-work state. In two heavily unionized industrial states, Ohio and Michigan, Republicans were elected as governors in 2010. Even Illinois, home of the President, had a close election with the Democrat, Pat Quinn just nosing out Republican Bill Brady by about 8000 votes.

Free trade encourages the relatively free flow of money and goods to those areas where money can earn the highest risk adjusted return and where goods, on a quality-adjusted basis, can be produced most inexpensively. NAFTA greatly increased the export (as well as the import) of goods and services to Canada and Mexico. All three countries have benefited. Trade will be enhanced once Congress passes the three trade bills recently sent them by President Obama. On the other hand, should Senators Schumer and Graham be successful in pushing through their Currency Exchange Rate Oversight Act, the consequences could well be a trade war with China, deleterious to our trade with that nation and to American jobs.

The irony is that this trend toward “re-shoring” is happening despite President Obama’s attempts to shore up unions and funnel more federal money into the economy. Should this re-shoring “trickle become a trend” the President will likely adopt it as his own. We will all benefit, but such an outcome will be despite the President and his policies, not because of them.

Thursday, October 6, 2011

"The 'Occupy Wall Street' Protests"

Sydney M. Williams

Thought of the Day
“The ‘Occupy Wall Street’ Protests”
October 6, 2011

Civil disobedience is an honored means of protest. Henry David Thoreau, the author of a speech entitled, “Resistance to Civil Governments” (later published as “Civil Disobedience”) is considered the father of civil disobedience. Mahatma Gandhi said of Thoreau’s pamphlet, “…it is written for all time. Its incisive logic is unanswerable.” Martin Luther King wrote of Thoreau: “As a result of his writings and personal witness, we are the legacy of a creative protest.” Throughout history, protesters were often treated terribly. During World War I, pacifists in England were hounded, jailed, physically forced into the army and, when they refused to carry a weapon, shot.

As one who came of age in the 1950s, I was witness to marches across the south for civil rights, many of them ugly and too many that ended in death and destruction. (Yesterday’s Wall Street Journal carried the review of a book, Elizabeth and Hazel, which tells the sad story of two women, one white and the other black, who were captured in a photograph that became an iconic emblem of 1957 Little Rock.) In the end civil rights prevailed, but not before the assassination of Martin Luther King and the deaths of hundreds of blacks, many murdered in horrendous ways. Fifty years later the wounds are still healing; but the appointment by George Bush of Colin Powell and Condoleezza Rice as Secretaries of State, the election in 2008 of Barack Obama and the fact that Herman Cain has become a Republican Presidential candidate speak to the distance we have traveled over the past fifty years. Civil disobedience changed the country for the better.

But not all protests have such honorable origins, or such noble goals. Many protests are “unserious.” Who, when in college, did not march in protest? I certainly did. Looking back fifty years, I generally remember the demonstrating, but not the cause. The goal was to be outrageous, to appear incensed, but in truth to have fun. Even when one is involved with sports, time hangs heavily over most college students. Classes, homework and athletics consume a lot of time, but not all of it. Youth is both blessed and cursed with energy – blessed in the sense that they are imbued with the belief that there is nothing they cannot do, but cursed in the sense that that energy can be expended in destructive ways.

Occupy Wall Street fits neither mold, but leans toward the unserious. The demonstration stems from a sense of frustration that people were left to hang while Wall Street was bailed out. There is an element of truth in their complaints. Banks were bailed out. They had to be. And it proved too difficult, even for glib politicians, to explain simply and clearly why banks had to be bailed out – that if they were not, the entire financial system was at risk of collapse. On the other hand, banks had no excuse for taking some of the money and using it to pay exorbitant bonuses. The fact that they did is a manifestation that on Wall Street returns on labor greatly exceed returns on capital. When capital and labor were the same, as they were in private partnerships, capital was treated with the respect it deserves. But when capital and labor became divorced, as happened when Wall Street firms went public, capital began being treated cavalierly. For many traders, it became a time of “heads I win; tails, I don’t lose.” It is little wonder that so many on Main Street became incensed with Wall Street. Capital provided to banks that was not needed for operations should have been returned to the owners, in this case the taxpayers – not paid out in bonuses.

Initially, the protesters were comprised of unemployed youth. Following the highly publicized arrests over the past weekend, a number of labor unions chose to join the fray, bringing a level of adulthood (but not much maturity) to what had, for the most part, been youthful demonstrations. Matt Miller of Bloomberg yesterday described some of the youth as wanting “to change the conscience of the nation,” a goal of every college sophomore. Others have jumped aboard the cause, eager to be seen as enemies of ‘greedy’ Wall Streeters. Why else would Susan Sarandon make an appearance? Why would that billionaire “King of Hedge Funds,” George Soros make public his support for their goals? The cause, frankly, is less important to them than the cameras and publicity, which to them are as slop is to pigs.

Not to be outdone and never a good person to have in your corner, comedienne Roseanne Barr, best known for not being very funny, articulated with a straight face her reasonable solution to the protests: “I first would allow the guilty bankers to pay, you know, the ability to pay back anything over $100 million [of] personal wealth because I believe in a maximum wage of $100 million. And if they are unable to live on that amount of that amount then they should, you know, go to the reeducation camps and if that doesn’t help, then being beheaded.” Not being able to completely unscramble Ms. Barr’s elocution, it seems she does not like rich bankers.

The list of demands issued by Occupy Wall Street protests smacks of silliness and socialism, peppered with items from the liberal agenda of the Obama administration – guaranteed living wages, free college, a universal single payer healthcare system, ending dependency on fossil fuels, spending a trillion dollars on infrastructure and another trillion on ecological restoration, and forgiveness of debt for all. Indicating truth to the old maxim that things never change, and apropos of today’s Wall Street protests, a 1934 political cartoon from the Chicago Tribune was sent me by a friend. The cartoon depicts a horse-drawn cart carrying “young pinkies from Columbia and Harvard.” They are shoveling bags of money to the street. Their desire is to “bust” the government, “blame the capitalists for the failure – junk the Constitution and declare a dictatorship.”

Perhaps my tone is too glib. I do not mean to suggest that the protests on Wall Street should be ignored or belittled. They are indicative of dissatisfaction with the economy, a distrust of our political classes; they reflect a growing awareness of disparities in wealth and a sense that some of the young feel they are trapped in a downward spiral. This year has been a season of protests: from uprisings in the Arab world, allegedly fueled by a desire for democratic reform, but in fact often encouraged by the Muslim Brotherhood; to government strikers in Greece who object to paying taxes and to the unfair demand that the retirement age should be raised to fifty-five, and now to New York and other cities, where the young ventilate their frustrations by taking to the streets, disrupting traffic and commerce.

It is difficult to tell how Occupy Wall Street will end, but my guess is that it just peters out. While their frustration is real, their goals are unrealistic to warrant serious reaction. When the cameras go away, so will the celebrities and when that happens, so will the protesters.

Wednesday, October 5, 2011

"Is Our Democracy Becoming Illiberal?"

Sydney M. Williams

Thought of the Day
“Is Our Democracy Becoming Illiberal?”
October 5, 2011

One of the more misleading myths of our political world – and one perpetuated by the mainstream liberal press – is that the Democratic Party represents hardworking laborers and the needy. And that the Republican Party represents “Fat Cats” in urban and suburban America. An analysis done by the New York Times (but never used to my knowledge on their editorial pages) shows that in the 2008 election the richest counties in America, those with median incomes around $100,000, went for Obama 55% to 44%, while those with incomes under $40,000 went for McCain. Two counties in New York State serve as a proxy. Westchester County, where the median income was $71,472, voted 62.9% for Obama with McCain taking 36.2%. In the upstate county of Hamilton, where the median income was $36,413 the results were almost precisely inverted, with McCain taking 63.7% of the vote to Obama’s 35.5%.

Over the past couple of decades, economic growth in the U.S. was dependent on the consumer and his willingness to assume increasingly ridiculous levels of debt. He was aided and abetted by a Congress intent on permitting our least credit worthy citizens before the feeding trough and a Wall Street whose sense of morals went no further than their pocketbooks. The consumer, as a percent of the economy, grew from 66.7% in 1990 to 70% in 2008. Between 2000 and 2007, total consumer debt doubled to $13.8 trillion (an annual compounded rate of 10 percent,) while GDP compounded at an annual rate of 5.2% to $14 trillion. That world of “Wonderland” came crashing down, as housing prices began deflating in early 2006. The punch bowl was empty and all that remained was the stomach ache. Deleveraging definitionally results in less economic growth. It is the way the math works. To offset declining consumer spending an $800 billion stimulus bill was passed; but then Mr. Obama, in an attempt “to not let the crisis go to waste” immediately followed that bill with an idiotic decision to push through Congress, in a partisan fashion, the Affordable Care Act. He also attempted, and fortunately failed, to pass a climate change bill and card-check – all three job killers. The three bills were advertised as liberal, but, in reality, would deprive individuals of basic rights. Why Mr. Obama chose that moment to remake the country, when a lack of jobs was the problem, could cost him a second term.

When government intercedes for moral (prohibition) or economic (healthcare) reasons, it consumes capital by borrowing money or raising taxes, thereby increasing the cost of capital for the private sector. In the introduction to his book, Liberalism, Ludwig von Mises wrote: “Antiliberal policy is a policy of capital consumption. It recommends that the present be more abundantly provided for at the expense of the future.” That reads like the United States over the past couple of decades.

Hard times make for even odder statements. Peter Orszag, Mr. Obama’s former budget director, wrote recently in the New Republic that, “we need to counter the gridlock of our political institutions by making them a bit less democratic.” Governor Bev Perdue of North Carolina suggested last week to a Rotary Club audience that perhaps Congressional elections be suspended. “I think we ought to suspend, perhaps, elections for Congress and just tell them we won’t hold it against them, whatever decisions they make, to just let them help this country recover.” She now claims she was being funny. Nevertheless, she added at the end of her speech: “I hope that someone can agree with me on that.” That does not sound like an attempt at humor.

Dana Milbank, a columnist for the Washington Post, in an op-ed in this weekend’s Investor’s Business Daily, sounded fatalistic about the future of Presidential politics. He wrote: “Washington’s problems are beyond the ability of one man to repair.” The comment reeks of cynicism and ignores the positive effect individuals from FDR to Churchill to Reagan have had on the course of events. On Thursday, the President suggested the people had become soft and less competitive over the past couple of decades. I am not sure exactly what he meant, but words like those do little to restore confidence. Reducing regulation and reforming the tax code would certainly help, as should his sending to Congress, as he did on Monday, the three trade bills that he has been keeping on his desk. Of course, the value of those three trade pacts will be more than offset by the Yuan-bashing and protectionist bill (The Currency Exchange Rate Oversight Reform Act) proposed by Senators Chuck Schumer and Lindsay Graham that amazingly cleared the Senate yesterday with a 79-19 procedural vote.

A story in this past weekend’s edition of the Wall Street Journal told of an African-American mother of two young girls from Ohio. She had been sentenced to jail because she used her father’s address to enroll her daughters in a better public school. Fortunately, she was granted clemency by Governor John Kasich, but not until she had spent nine days behind bars. Poor families, unable to afford private schools and who live in districts with no access to vouchers or charter schools, are left without choice. Michael Flaherty puts it well in his Journal article: “Only in a world where irony is dead could people not marvel at concerned parents being prosecuted for stealing a free public education for their children.” So much for the liberality of the America Federation of Teachers! Civil disobedience has a long history in the U.S. and is a hallmark of our democracy. This case certainly fits that definition.

Classical western liberalism stems from John Locke and his belief in the natural rights of man. Of course, he was writing at a time when hereditary or divine rights held sway and the church was an organ of the state. Today those laws and traditions, like primogeniture, have been relegated to the dusty bin of history. Locke’s “natural rights” assumed the right to assemble, to speak and write; to elect their own leaders, and to worship as they chose. However, Locke’s “natural rights” were also based on the concept of constitutionalism, capitalism and free trade, all functioning under the rule of law.

Too often today’s “liberals” equate a more powerful, benevolent government that grants entitlements as being liberal. Classical liberalism would object to a government whose very expansion, definitionally, diminishes the role of the individual. A man like Herman Cain far better fits the classical definition of liberal than does Barack Obama. The ongoing debate over the budget, deficits, entitlements and taxes is in essence a debate over what kind of a society do we prefer – how intrusive a government will we allow. The more power government assumes the less available to individuals. The spectrum ranges from anarchy to authoritarianism. The people must decide where on that grid they choose to reside.

Tuesday, October 4, 2011

"The Market - Nearing a Sea Change?"

Sydney M. Williams

Thought of the Day
“The Market – Nearing a Sea Change?”
October 4, 2011

More than anything the markets need a strong dose of confidence. The problems in Europe are incalculable, not because they are incapable of being resolved, but because everything in finance and the capital markets are constantly in motion. A snapshot of any bank’s balance sheet is meaningless when markets are moving as quickly as they are. For the past eighteen months the ECB and the IMF have been trying to buy time, time that should have allowed banks to improve their balance sheets. That Greece will have to renege on its loans seems a given. What is unknown is to what extent the loans held by European and U.S. banks have been written down.

In 2008, the United States faced not just a liquidity problem, but a solvency crisis as well. Bear Stearns had been saved from bankruptcy in a last minute deal with J.P. Morgan. A few months later Lehman did go bankrupt. Congress, at the urging of Treasury Secretary Henry Paulson, created the Troubled Asset Relief Program (TARP.) AIG would have gone bankrupt had the government not stepped in; the same fate would have been Merrill Lynch’s had not Bank America, with government urging, come to the rescue. Equity investments were made by TARP in dozens of banks and financial institutions. General Motors and Chrysler were restructured, screwing the bondholders, but saving the companies and thousands of jobs.

Regardless, everyone, including Republicans, has back-pedaled from any association with TARP. Yet, Douglas Elliott of the left-leaning Brookings Institute said: “The TARP is probably the most effective (my emphasis) large-scale government program that the public has decided was a bad idea.” A year ago, Bloomberg estimated that $309 billion in TARP funds invested in banks and insurance companies had returned $25.2 billion, or 8.2%. Most importantly what TARP did was inject confidence into frightened markets.

We can all Monday-morning quarterback and criticize specifics of the federal government’s dealings in the fall of 2008; nevertheless, the worst of that fear in September-October 2008 was dissipated in a matter of weeks. The TED spread, which had been running around 50 basis points in July of that year, spiked to 480 basis points in early October. By year-end 2008, the TED spread had declined to 131 basis points. The yield on Three-month Treasury Bills, which had had a negative yield at the worst of the crisis, was returning 11 basis points by year-end. The spread between Investment Grade Corporates and the 10-Year Treasury declined from 419 basis points to 411 basis points between September 30 and December 31. The stock market continued to decline in early March of 2009, but the High Yield market began recovering in December of 2008. The Bloomberg-FINRA Index had the yield on High Yield bonds peaking over 25% in late November 2008. A month later, the yield had declined to 17.4%.

Fear again grips investors. Each crisis is unique. The current one centers on Europe, their sovereign debt crisis, the question of bond ownership and what the impact of this crisis will be on their economies and ours. The situation begs analysis, because the seventeen nations that share a common currency have no common fiscal authority. The ECB can raise or lower rates, but there is no central treasury authority that can effect tax policy.

Because the future is unknowable, we can only speculate as to what the outcome might be. But most people are nervous and fear the worst; ergo the money pouring into Treasuries, with returns that do not match inflation.

As I wrote at the start of this piece, more than anything, the markets and the economy need a strong dose of confidence. Consumers have been reducing their leverage and there is no reason to believe they will not continue to do so. The federal government has increased its debt enormously in the wake of the financial crisis, but the problem is not debt; the problem is growth, or the lack thereof. Economic growth is dependent on the private sector. Fundamentally, the corporate sector (ex the banks, which are too difficult for me to determine; though I suspect they are in better shape than three years ago) is in good shape. They have adequate liquid resources, but have been reluctant to invest because of unknowns surrounding tax policy and regulatory concerns, especially those relevant to healthcare. Of course, therein lie the opportunities for improving confidence.

Bill Gross, in his “Investment Outlook” suggests that the United States requires “enhanced safety nets of benefits for the unemployed” until the economy recovers and job growth flourishes. He also urges protectionism, in recommending “buy American.” He argues that since China and Brazil do it, “why not us?”

No one wants to see people suffer. There is already too much suffering here and abroad. Welfare is a reflection of a compassionate nation. It is also a bi-product of wealth. While a small number of people have accumulated vast amounts of wealth over the past few years, the vast majority has made little progress. That fact, in combination with high levels of existing debt and an economy negatively impacted by deleveraging, limits our options. Fiscal and monetary policies should have one goal – generate economic growth, for that is the only way to put people back to work and to raise needed federal revenues. Our nation must rebuild its wealth.

When one looks at the three principal sectors of the economy – consumer, private business and government – the only one that has the means to invest and to hire is the private sector. A bold, radical redesign of the corporate tax code, with permanent, not temporary, changes would go a long way toward restoring confidence. Removing the tax consequences of repatriating money held offshore would encourage investment back home. Stimulus does not necessarily mean that government must control the spending; government can simply make it easier for the private sector to invest.

But private capital is not considered as compassionate as government, for it demands a return on investment, whereas government’s motives are deemed to be more benevolent. Nevertheless, the unintended consequences of government’s actions can produce pain, as the last two years have demonstrated. With the private sector in charge, pain may well come faster, but so will recovery. The consumer knows the answer is deleveraging, and that is what he has been doing over the past two or three years. He has made headway, but still has a ways to go. An abundance of capital and very low interest rates may be marginally important, but the consumer realizes his first priority is to reorganize his balance sheet, not to take on additional debt.

The most obvious way out of the economic morass is to focus on exports and, in that regard, it is a good thing that the President is sending the three trade bills to the Senate. But it is a bad sign that China bashing persists with Senators Chuck Schumer (D-NY) and Lindsay Graham (R-SC) urging passage of the Currency Exchange Rate Oversight Reform Act. The bill is based on the premise that China has not allowed its currency to appreciate adequately, despite the Yuan having risen 30% against the Dollar over the past six years. China is our second largest trading partner and our third largest export market. It is the second largest economy in the world. Even recognizing that countries like China, Brazil and Russia are mercantilist and so therefore they have an edge in terms of pricing, does it really make sense to pick a fight with China? Besides being our third largest export market, they are also our largest creditor. The returns they receive on their Treasury investments to date are not offsetting the decline of their currency versus the Dollar. Do we really want to chase them away from our markets? Is not that Schumer-Graham bill reminiscent of that great trade blunder of 1930, the Smoot-Hawley Tariff? Protectionism has a populist appeal, making it attractive during times of economic turmoil, but once started, trade wars are hard to stop.

The answer to the question in the title depends greatly on policy action taken by the President and Congress over the next several weeks. It is possible they can restore confidence, but it will take a seismic shift in both words and action – not, in my opinion, a high probability, but, also, not impossible.

Monday, October 3, 2011

"The Rust Belt Comes to Wall Street"

Sydney M. Williams

Thought of the Day
“The Rust Belt Comes to Wall Street”
October 3, 2011

Technology has been changing Wall Street for most of my forty-four year career. Machines have been replacing people, not dissimilar to what happened in the industrial Midwest decades earlier. There is no better example of machines replacing man than in the arena of high-frequency trading (HFT.) Wikipedia estimates that HFT firms represent two percent of the approximately 20,000 firms operating today, but account for over 70% of all trading volume. But this changing dynamic began long before the advent of high-frequency traders.

Wall Street had always been a relationship business – and that certainly remains true for smaller firms like ours and for many of those on the “buy side” of the Street who rely on personal contact. Nevertheless, rising volume on the Exchange demanded increasingly sophisticated computers to handle trades. When I entered the business in September of 1967, daily volume was approaching 10 million shares a day, double what it had been a year earlier. By June of 1968, daily volume was approaching 15 million shares, causing the Exchange to close on Wednesdays, so as to deal with the growing paperwork problem. Those Wednesday closings continued through the end of that year, when declining volume (and stock prices,) along with faster computers, allowed the Exchange to re-open on Wednesdays.

Interestingly, On “Black Tuesday,” October 29, 1929, over 16 million shares traded hands on the NYSE and the tape ran until 7:45PM. It would take thirty-nine years before that many shares traded on the Exchange – in May 1968. Volumes increased as negotiated commissions replaced fixed commissions on May 1, 1975. On August 19, 1982, about a week after the great bull market began more than 100 million shares traded and on October 28, 1997, a day during which the DJIA traded up 4.7% marked the first time more than a billion shares traded. Since those days in the late 1960s, technology has generally allowed the tape to keep pace. According to the March 2007, Quarterly Report from the Bank for International Settlements, trading in U.S. equity markets grew from $136 billion or 13.1% of GDP in 1970 to $14.2 trillion or 144.9% of GDP in 2000. Increases in volumes did not necessitate a corresponding increase in the number of traders.

About the same time technology was allowing faster trading, John Bogle of Vanguard Funds created the nation’s first index fund. That fund, now the Vanguard S&P 500 Index Fund, is the largest equity mutual fund in the country. The concept of indexing meant that larger pools of money could be managed at lower costs and with fewer people. Index products required neither analysts nor high-priced portfolio managers. The creation of equity derivative products, a symbiotic product, caused indexes to further proliferate. But it did mean Wall Street had a need to hire mathematicians capable of understanding and producing complex algorithmic trading platforms. Those employees were more technocratic in nature with little need to interact with clients. The owner of money was further distanced from any sense of real corporate ownership.

An article in Friday’s papers reported that McGraw-Hill, owner of Standard & Poor’s is in advanced talk with the CME Group, which owns the Dow Jones Indexes, about forming a joint venture. Those two benchmarks, the S&P 500 and the DJIA, are, as the New York Times reported, “just the tip of a huge business. The companies own hundreds of thousands of indexes that track stocks, commodities and more exotic investments.” There are 56 regulated exchanges around the world that, according to data from Bloomberg, list more than 46,000 companies. Additionally, exchange traded funds (ETFs,) which act similarly to an index fund, now account for about a trillion dollars in assets. The net effect is that increasingly the owners of company shares are index funds who care little for the fundamentals of the underlying business.

New funds and ETFs are constantly being created, and they are fluid – stocks get dropped and added to ETFs and index funds, often for reasons having to do with fundamentals. That creates an advantage (and opportunity for mischief) for the sponsor of such funds. The creator of an ETF has the capacity to combine an understanding of the fundamentals of the underlying stocks with an access to flows into and out of the specific ETF. That knowledge could be used for spurious purposes – the gruel on which regulators feed.

As technology improved and derivative products proliferated, the financial industry generated larger percentages of GDP, rising from 4% when I entered the business to 8% in 2006. According to an article on “Financialization” in Wikipedia, the notional value of all derivative trading in 2006 reached $1.2 quadrillion, or roughly 100 times the value of that year’s U.S. GDP of $12.5 trillion. During those years, the consumers’ role in the economy increased from about 66% to 70%, suggesting that manufacturing, trade and commodity production declined proportionately.

Technology has increased productivity in our industry enormously. With a five man trading desk, our firm trades in a day what the entire Street was doing in early 1967. Trillions of dollars are managed for investors in a variety of index products using proportionately fewer people. Obviously, there has been an increase in programmers and software engineers, but the trend is not unlike what happened earlier in the automobile or steel industries. Thirty years ago I recall visiting the Anheuser Busch facilities in St. Louis and being amazed at the size of the vats and the acres of floors on which they were located, and at the dearth of visible human labor.

No industry is immune from the advances of technology. It is part of the natural process of what Joseph Schumpeter called creative destruction. It explains, in part, the advent of hedge funds, independent money management firms and private equity partnerships; it is what has allowed smaller firms like ours to survive and to thrive; because, for all the efficiency of machine over man, their very existence allowed opportunities for creative individuals. Owners of money will always seek out those few managers who can consistently outperform markets. And those managers have a need for analytical input and judgment. In the steel and auto industries, specialized, creative manufacturers were able to add value. The same has been and will be true in the financial industry.

The Dodd-Frank Bill left glaring gaps. “Too big to fail” banks have become even bigger. Derivative products that provide insurance, such as credit default swaps, remain unregulated. If all investment banking firms were to revert to private partnerships, the growth of derivatives and “financialization” would slow markedly, for what people do when their own money is at risk is quite different than when they have access to other people’s money. In 2008, Merrill Lynch lost $28 billion, probably as much as they had made cumulatively in their thirty-eight years as a public company. Nevertheless, the general trend of machine replacing people on Wall Street is likely to persist – more indices and derivative, higher trading volumes, decreasing commission costs, and larger amounts of assets, all requiring fewer people. The asset management business, in particular, faces enormous hurdles, as the ten-year performance for most money managers hardly justifies today’s fees, and proliferating ETFs and indexes provide cheaper alternatives. Nevertheless (and ever the optimist,) from today’s problems will arise tomorrow’s opportunities.