"The President's Budget and Other People's Money"

Sydney M. Williams

swtotd.blogspot.com

Thought of the Day

“The President’s Budget and Other People’s Money”

March 27, 2017

“The proof of liberal virtue is generosity with other people’s money.”

                                                                                                            George Will (1941-)

                                                                                                            Political Commentator

Spending other people’s money dates back centuries. It was Aristotle who allegedly said, “Three groups spend other people’s money: children, thieves and politicians. All need supervision.” John Randolph, a Virginian planter and Congressman between 1799 and 1833, once wrote: “…that most delicious of all privileges – spending other people’s money.”

This attitude is common to both political parties, but more so for Democrats, the party of ‘big’ government, than Republicans. In his 2007 book “Who Really Cares: The Surprising Truth About Compassionate Conservativism,” Arthur Brooks noted that liberals are less likely to give to charity than conservatives, despite average incomes 6% higher. They claim to be generous, but with tax payers’ money – not their own.

Nobody denies the right of government’s need to spend. A nation must defend itself. It must ease commerce through roads, bridges, tunnels and ports. It educates its youth. It has a moral obligation to ensure the well-being of its poor, elderly and those unable to care for themselves. Citizens understand, so pay taxes…willingly in most cases. But politicians should keep in mind the enormity of the responsibility that is theirs, and remember they are servants to the people. They must acknowledge the labor that went into taxes paid, to treat the money they spend with respect. (Total government spending, including federal, state and local, represents about 36% of GDP.) In the modern welfare state, the line between capitalism and socialism has become blurred, reminding us of Margaret Thatcher’s wisdom: “The problem with socialism is that eventually you run out of other people’s money.”

The President’s recently submitted $1.065 trillion budget is a blueprint of where he would like the country to go. The 2018 budget proposed by Mr. Trump was limited to “discretionary” items. He did not address the 70% of the budget represented by mandatory spending, which includes Social Security, Medicare, Medicaid, unemployment compensation, earned income and child tax credits, SNAP and certain expenses in Defense, Agriculture, Education and Veterans Affairs – safety nets mislabeled “entitlements.” To place Mr. Trump’s 2018 proposal in perspective, President Obama’s 2016 budget totaled $4.1 trillion, of which $1.15 trillion (28%) was discretionary. If one included, as one should, interest expense of $283 billion as a mandatory item, then “true” discretionary spending represented just 21% of the 2016 budget – not a lot of wriggle room, when the goal is to increase defense spending (a discretionary expense) by ten percent.

To listen to howls coming from Democrats over Trump’s budget one would have thought he was the Grinch determined to starve and make homeless the poor and the elderly. President Trump’s proposal, as stated above, does not touch entitlements. It neither raises taxes nor increases the deficit. It keeps spending at the same level, diverting funds from the EPA, the State Department (USAID and Treasury International Programs), Agriculture, Labor and Commerce to Defense and Veteran’s Affairs.

As expected, reactions were hyperbolic.  Nancy Pelosi: “…President Trump has shown he does not value the future of children and working families.”  Senate Minority Leader Chuck Schumer: “Once again, the Trump Administration is showing its true colors: talk like a populist, but govern like a special interest zealot.”  Representative Jim Hines (D-CT): “…all kinds of pain will be felt around the country…”

On January 20, 2009, federal debt was $10.6 trillion. Eight years later, it was $19.9 trillion. In other words, Mr. Obama, during an eight-year stretch without a recession and with a stock market up 148%, almost doubled the national debt. The cost of this borrowing has been masked by eight years of artificially low interest rates, a situation that is only now changing. Higher interest rates will add to costs, pressuring deficits and debt. In the fiscal year ending last September, the deficit rose to $587 billion, the highest in five years. Despite favorable economic tail winds, Mr. Obama did not leave the nation in good fiscal shape.

These deficits, of course, do not include the unfunded liabilities of welfare programs, for which we, as taxpayers, have responsibility. Determining the absolute level is not easy; but estimates range, from an “official” $55 trillion up to $222 trillion. Whatever number is right, it is crushingly large.

Over the past eight years, we saw an increase in spending on social welfare programs, including the Affordable Care Act, yet poverty increased. During those years and keeping in mind that a nation’s first responsibility is to protect its citizens, we saw defense spending, as a percent of GDP, decline from 5.5% to 4.4%. And global tensions rose. Consider: Chinese aggression and Russian belligerence increased. Islamic extremism persists, and the Korean Peninsula gets more dangerous by the day. Iran has become more truculent. Ukraine has been invaded. Democracies in South Korea, Japan and Israel are vulnerable, as are the Baltic States and those within the reach of China. Time moves forward, but human nature remains unchanged.

You may dislike Trump the man. You may believe the cartoon caricature that the media has created. But you cannot deny the dilemma we face – that we are living beyond our means in a dangerous and fractious world. We need to increase spending on defense. And we must rein in the administrative state, and the unprecedented powers it has given to agencies like the EPA. Unnecessary regulations have sapped the vitality of our economy, the engine that allows us to live well, securely, and to do the good we want.

The President’s budget speaks to his desire to beef-up defense and provide better for veterans, but without raising taxes or incurring higher deficits. It addresses fraud and waste in agencies where funds have been cut. It does not touch entitlements. Despite the fear-mongering, it is, in fact, modest and perhaps a bit timid given the forces we face. We cannot dismiss the spreading of violence abroad as not being our problem, nor is it compassionate to provide false expectations as to benefits that we may never be able to afford. There are consequences to living beyond our means – increased deficits and higher taxes. The first will bring higher interest rates and, ultimately, a declining currency; the second will result in decreased liberties and impediments to economic growth.

If you think the howling is loud now, wait ‘til we tackle – as at some point we must – entitlements. However, there are things we can do now to ease the burden that will become our children’s: We can raise the age of eligibility for Social Security and Medicare. We can means-test. We can encourage savings for retirement and health care by granting larger exemptions. What we need are serious conversations and debates, not the Ostrich-like behavior of politicians who place their childish partisan bickering above needs of the nation; nor does it help when a sycophantic media puts loyalty to favored causes and friends above real news.

"Markets in the Trump Era"

Sydney M. Williams

Thought of the Day

“Markets in the Trump Era”

February 13, 2017

“Wall Street people learn nothing and forget everything.”

                                                                                                Benjamin Graham (1894-1976)

“It has become appallingly obvious that our technology has exceeded our humanity.”

                                                                                                Albert Einstein (1879-1955)

Investors get what they want (deserve?) from market pundits. If one is bullish, an expert is found who concurs. If one is bearish, a market seer will be uncovered. But the future is, at best, a guess. We can look to the past for guidance, but none of us are clairvoyants, especially in this “brave new world.”

The two decades that ended in 2000 were some of the best in stock market history, with the Dow Jones Industrial Average compounding at 14.0% over those twenty years. Since, the Average has compounded at 3%, a consequence of a difficult first nine years, followed by a big bounce off the 2009 lows. Multiples are high, but the euphoria of the late 1990s is gone.

Markets are deciphering what is happening globally, geopolitically, economically and technologically. One thing we do know is that the past few decades have not been good for large segments of the population. Since 1970, on an inflation adjusted basis, stocks, including dividends, have compounded at 4.3% and home prices at 2%. However, median incomes have compounded at only 0.5%. In the past ten years, these variances have widened. Since 2007, stock prices are up 60%, median house prices are up 30%, while median incomes are unchanged. Incidentally, over the last decade college tuitions have risen 40%. Labor force participation, over the last decade, declined four percentage points – a cost of six and a half million fewer jobs. Working Americans, who find dignity in what they do, are understandably upset.

There are many reasons for their angst: Immigration policies have let in cheap labor. Globalization has provided benefits to consumers, but at a cost of jobs. Politicians have provided entitlements to the nation’s poor and have focused on pet projects for the wealthy (like solar panels and Teslas), but have ignored the plight of the American worker. A politically-driven fixation with environmental issues has come at the expense of economic growth. Complex tax and regulatory rules have helped rich individuals and big businesses, but have hurt small companies and caused a net decline in new-business start-ups for the first time ever. And a technology boom, equal to the Industrial Revolution in impact, has obsoleted jobs.

There are still other reasons for their concern: Social Security and Medicare are at risk; an absence of defined benefit retirement plans and an aging population mean that millions are retiring without the ability to support themselves. The moral values that most Middle-American families grew up with are dismissed by coastal elites. Public schools cater to unions, not students and parents. Low interest rates have helped speculators, but have hampered savers. And, of course, 9/11 exposed a vicious and and different enemy – Islamic extremism – an enemy Obama’s Washington was unwilling to call by name.

Is there a way forward? Yes. There are things government should let alone, but there are steps they can take. Among the former is: Don’t impede technology, even though change is taxing, especially to the age-challenged. When Einstein uttered his famous quote, he was thinking of the Atomic bomb, but his words apply today. Robots have replaced factory workers and algorithms have replaced Wall Street traders. Doctors in Houston, using robots, can perform surgeries in remote New Hampshire towns. Hoteliers can deliver room service using robots. During the holidays, as many shoppers bought gifts online as went into stores – good for consumers and a blessing for truckers, but bad news for store clerks. And, when Drones and/or self-driving vehicles drop packages on our doorsteps, delivery drivers will be affected. Wireless communication has had a negative impact on copper producers and linesmen. Approximately 30% of the roughly $100 trillion in U.S. equity and bond markets are now managed passively, reducing management fees by perhaps $150 billion. MOOCs (Massive Open Online Courses) are changing the way we learn. Joseph Schumpeter’s “creative destruction” is affecting multiple sectors of the economy. And, such changes have a draconian impact on labor. Snapchat, Instagram and other forms of social media mean that we are, for good or bad, continuously connected. In the military, Drones are doing the jobs of manned aircraft and “boots on the ground.” Through our smart phones, we are trackable. But the internet also allows terrorist organizations to recruit and plan operations anonymously. Do we understand the full consequences of this revolution? I would guess not, but we cannot discourage innovation.

We must also be careful not to raise barriers to trade, a critical ingredient to global growth. We cannot retreat into a shell, to quit the world of which we are its most integral part. We must not lose sight of our responsibilities as a compassionate nation, but we must not be so naïve as to ignore evil that lurks. We have a responsibility to ourselves and our allies to be militarily strong. We should be the principal proponent of global trade that is fair to our workers.

But we can make this disruptive transition easier. We can ease regulation for those willing to start new businesses. We can reduce red tape, without forfeiting safety. We can make our tax code less complex and more competitive. We can legislate tort reform, without harming plaintiffs. We can improve schools by giving parents and students choice. We can limit government spending, by fixing run-away entitlements, which should allow moneys to be spent on infrastructure without ballooning debt.

As for markets, the Dow Jones Averages are up 10.5% since Mr. Trump’s election last November – a significant down payment on future policies. Despite protesters and the ridicule Mr. Trump receives from mainstream media and his Democrat opponents, risk markets seem unworried[1]. The spread between investment grade corporates and high-yield bonds has narrowed since the end of 2016’s third quarter from 284 basis points to 216 basis points. The VIX, a measurement of volatility, closed at 18.74 on November 8, and at 10.85 on February 10. And, during only one day out of the 67 trading days since the election has the market moved up or down more than 1.5 percent. There is, however to this oldster, something unsettling about complacency in markets, which brings to mind Benjamin Graham’s warning.

Mr. Trump, regulatory and tax reform should be first on the agenda.

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[1] Investors have exchanged riskless for risk, with the yield on the US Ten-Year having risen 25% since November 8.

"Negative Interest Rates: An Uncharted Land"

Sydney M. Williams

Thought of the Day

“Negative Interest Rates: An Uncharted Land”

September 15, 2016

“No pessimist ever discovered the secret of the stars,

or sailed to unchartered land, or opened a new doorway for the human spirit.”

                                                                                                            Helen Keller (1880-1968)

Uncharted lands are not always doorways to a better life. While I believe that confidence is essential to success, I also feel that Ambrose Bierce was onto something when he defined optimism in The Devil’s Dictionary: “It is held most firmly by those most accustomed to the mischance of falling into adversity…”

I am not an economist and profess no real knowledge of that dismal science; however, when I think of the Federal Reserve over the past several years I am reminded of the Apostle Paul writing to the Romans: “Professing to be wise, they became fools.” In the years since the end of recession in 2009, central bankers have marched into Robert Lewis Stevenson’s “Land of Nod:” “The strangest things are there for me, both things to eat and things to see, and many frightening sights abroad till morning in the Land of Nod.” Was it morning that brought today’s ‘new normal,’ with its pitiful economic results?

Since 2006, the balance sheets of central banks have risen from just under $5 trillion to almost $17 trillion. Two weeks ago Mario Draghi, Chairman of the European Central Bank suggested they were running out of assets to buy. When central banks borrow reserves from the banking system, they are, in effect, removing credit from the private economy. Asset prices have increased, but growth has been feeble.

Two weeks ago, Sanofi, the French pharmaceutical company borrowed €1,000,000,000 for three and a half years with an interest rate of minus 0.5 percent. On the same day, the German consumer goods company Henkel borrowed €500,000,000 of two-year debt at the same rate. According to Grant’s Interest Rate Observer, there are outstanding about $13 trillion worth of negative yielding bonds – most of it sovereign debt issued by governments of Germany, Japan and Switzerland. Think about that for a minute. An investor willing to lend $1,000,000 for two to three years would receive back a mere $950,000! That’s an easy way to run out of money. Is Hans Christian Anderson’s Emperor naked?

Both Sanofi and Henkel have good balance sheets. (We cannot say the same for governments, but they have the power to tax.) Neither company needed the money. They were not looking for investment opportunities. The money was raised because they could. In his A History of Interest Rates, which covers 5,000 years of lending, Sidney Homer does not mention any period of extended negative interest rates. During the 1930s some U.S. Treasury Bills were issued with rates close to zero, but at that time the world was in a world-wide Depression, Fascism and Communism were on the rise and a world war was in the offing. Today, despite aggressive and innovative tactics by central banks, global growth has been anemic. Last week, in the U.S., the Administration proudly promoted last year’s household wage increase of 5.2%, but only noted in whispers that the number was still below inflation adjusted income for 2007. We are in an uncharted land, and have been led there by creative central bankers and deceptive politicians!

Consider the consequences of near-zero and negative rates in just four areas: personal savings; national debt; pension and entitlement accounting, and life and long-term care insurance.

My generation was the first to live in an age of abundance. We came to maturity in the years after Depression and War. For most of the fifty-five years after 1945 the economy did well – unemployment was low, consumer products became ubiquitous and ever-cheaper, stocks rose, credit became common and, if one worked for a large company, pensions were provided. Sometime in the late 1970s and early 1980s businesses began to abandon defined benefit pension plans due to costs, and turned to defined contribution plans. That meant workers had to save for retirement. The single biggest victim of the Fed’s policy of pursuing low interest rates has been the nation’s savers and elderly. Reduced rates hinder savings, which has had a fundamental impact on the economy. As John Tamny writes in his recent book, Who Needs the Fed?: “True economic advantage results from entrepreneurial ideas being matched with savings.”[1]   

U.S. federal debt exceeds U.S. GDP by a trillion dollars. As a percent of GDP, it is at record levels for peacetime. Mitch Daniels, in last Wednesday’s Wall Street Journal, wrote, “Our national debt…is heading for territory where other nations have spiraled into default...” Low rates make borrowing less painful, and therefore easier for prodigal politicians. Interest expense, as a percent of the federal budget (roughly 6%), is no higher than it was ten years ago, but when rates normalize, which they will at some point, interest expense will be three times larger. Entitlement spending, plus other safety-net programs and benefits for federal workers and the VA, along with interest expenses consume 73% of the budget. When (not if) interest costs rise to normal levels, 85% of the budget will go to those two areas, leaving little for defense, education, infrastructure, research and national parks. Is this where we want to be?    

Besides having the obvious consequence of deterring those saving for retirement, negative rates effect the way pension liabilities are calculated. When calculating pension obligations (the same math is used for determining entitlement obligations) a “risk-free” rate of return is assumed – historically the yield on the U.S. Ten-year, currently 1.7 percent. The problem is most acute in the public arena, as most companies have abandoned defined benefit plans. Public pension plans, which cover roughly 20 million workers, have reduced assumed returns to 7.68%, a rate four times that of “risk-free” returns. Any shortfall – as the mayors and governors responsible for these plans well know – will have to be made up by taxpayers. The hope of these ‘fiduciaries’ is that the problem will not surface on their watch. It is the same math that informs us that unfunded liabilities of myriad entitlement programs are a problem of growing intensity – that Americans have been misled about the promises of our fundamental social welfare programs.  

Life and long-term care insurance rates are rising – another consequence of central bank’s policies of keeping interest rates at sub-normal levels. Insurance companies take in premiums, invest them and then pay out obligations. Actuaries are employed to determine investment returns, as well as life expectancies and myriad health risks; premiums are priced accordingly.  Obligations, while fixed in life insurance, are a moving target in long-term health plans. Policies that were sold a few years ago, when interest rates were five or six percent, are now at risk. When profits disappear, so do companies.   

It is the abandonment of free market principles that is concerning – letting markets set interest rates. The motives may be honorable – hoping to prevent economic hardships and to smooth out inequalities – but the unintended consequences of penalizing savers, minimizing the effect of our national debt, ignoring pension accounting discounting rules, and increasing insurance premiums is devastating. Just as universities cannot protect students against language they find disagreeable, no system can protect all investors and employees, but free-markets, with their accountability and self-discipline, have been the most beneficial to the greatest number. The path we are on leads to an uncharted land where tears outdo smiles.

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[1] While I disagree with Mr. Tamny’s conclusion that the Fed should be abolished. The Fed was founded in the aftermath of the Panic of 1907; it has and it should continue to serve as lender of last resort.