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Obama must realize he's in trouble, that's why he's becoming more centrist



As Obama continues to slide in the polls—the Rasmussen daily tracking poll today shows his Approval Index reaching another all-time low—he's being forced to move to the political center. This is very good news for the economy and the markets. Larry Kudlow recently noted Obama's embrace of the virtues of tax cuts here: "Is Obama Going Supply-Side?" Peggy Noonan has an excellent article in today's WSJ which explains the extent of Obama's political shift: "Obama Moves Toward Center Stage." Excerpts:

The political headline this week is that President Obama appears to be attempting to move toward the center, or what he believes is the center. We saw the big pivot in two major speeches, one on the economy and the other, in Oslo, on peace.

If it is real, ... it tells us White House internal polling is probably worse than the public polls. It tells us the mounting criticism from Republicans, conservatives and others has had a real effect. It tells us White House officials have concluded they were out on a cliff.
The economic speech took place Tuesday at the Brookings Institute, the generally left-leaning think tank in Washington. The president put unusual emphasis on—and showed unusual sympathy for—Americans in business, specifically small businesses. "Over the past 15 years, small businesses have created roughly 65% of all new jobs in America," he said. "These are companies formed around kitchen tables in family meetings, formed when an entrepreneur takes a chance on a dream, formed when a worker decides it's time she became her own boss." This is how Republicans, moderates and centrists think, and talk.

The president claimed success in reducing taxes—"This fall, I signed into law more than $30 billion in tax cuts for struggling businesses"—and announced a new cut: "We're proposing a complete elimination of capital gains taxes on small business investment along with an extension of write-offs to encourage small businesses to expand in the coming year." He called it "worthwhile" to create a new "tax incentive to encourage small businesses to add and keep employees."

All this was striking, and seemed an implicit concession that tax levels affect economic activity. It was as if he were waving his arms and saying, "Hey taxpayer, I'm not your enemy!" The only reason a president would find it necessary to deliver such a message is if he just found out taxpayers do think he's the enemy. The emphasis on what it takes to start and build a business, seemed if nothing else, a bowing to reality. And if you're going to bow to something, it might as well be reality.

Thursday, at his Nobel laureate speech in Oslo, the president used an audience of European leftists to place himself smack-dab in the American center. He said, essentially: War is bad but sometimes justified, America is good, and I am an American. He spoke of Afghanistan as "a conflict that America did not seek; one in which we are joined by 43 other countries—including Norway—in an effort to defend ourselves and all nations from further attacks." Adroit, that "including Norway." He said he had "an acute sense of the cost of armed conflict" and suggested America's efforts in Afghanistan fit the criterion of the concept of a "just war." It continues to be of great value that a modern, left-leaning American president speaks in this way to the world. "The world" didn't seem to enjoy it, and burst into applause a resounding once.

Retail sales are strong -- another V-sign



Here's yet another V-sign (and a very graphic one at that): the impressive strength in retail sales over the past six months. This, despite 10% unemployment and a significant amount of "resource slack" in the economy. What it means is that there are still an awful lot of people working; they have been working harder and more productively, and their incomes have been rising faster than inflation. In addition, their confidence in the future has risen, so some of what they are spending is money they had hoarded last year when the future looked disastrous.

Households' balance sheet repair continues



According to the Federal Reserve, in just six months following the low of last March, households' net worth has increased by almost $5 trillion, or 10%. Household debt fell by almost $60 billion, the value of household real estate holdings increased by over $600 billion (yes, increased!), and thanks to a strong stock market and increased savings, households' financial assets increased by $4.2 trillion since last March.

Moreover, in the six month period ending Sept. '09, household disposable personal income rose by $235 billion, owner's equity in household real estate rose by nearly $1 trillion (yes, one trillion!), and owner's equity as a percentage of household real estate rose by 12%. This is an impressive and across the board improvement in key indicators of households' well-being. 

We've still got a ways to go to get back to where we were in 2007, but we're making excellent progress. That's one more thing to be thankful for as we approach the holiday season.

Fiscal policy update










The federal budget numbers improved again in November (on a rolling 12-month basis), mainly because spending in recent months was less than the extraordinary levels of spending in October and November of last year. Nevertheless, it remains the case that both spending and tax revenues are "off the charts" for the post-war period. You have to go back to the early 1940s to find spending running at a higher share of GDP than today, and tax revenues running at a lower share of GDP. That was the time (WW II) that our debt/GDP ratio reached its highest point ever: almost 120%, whereas today it is about 54%. So today's figures are not actually unprecedented, but they are close.


The last chart puts the current budget picture into vivid relief. Spending is out of control due to bailouts, stimulus spending, and a robust increase in ongoing government spending and involvement in the economy. Revenues are extraordinarily weak thanks to the sharp economic downturn and only a few months of modest recovery.

From a supply-side perspective, what I would like to see is a cancellation of the stimulus spending, since it has already proved itself ineffective, and the application of the recovered funds to increase the private sector's incentives to work and invest. At the very least we should have a lower corporate tax rate to allow our businesses to compete in the world, and we should not allow the Bush tax cuts to expire at the end of next year. I think these two simple steps—calling off the stimulus, freezing tax rates at current levels, and reducing the corporate tax rate—would be a tremendous boost to confidence and investment, and would thus give the economy the "kick-start" that everybody seems to want.

Unemployment claims still support a recovery



Weekly unemployment claims ticked up a bit last week, but the 4-week moving average is still trending decisively down. In fact, if the recent pace of improvement continues, claims could be back to "normal" levels in 3-4 months.

Export growth surges -- another V-sign



U.S. exports of goods have rebounded very strongly this year, rising at a 37% annualized rate in the six months ending October. This is yet one more item on the growing list of V-signs. I've been highlighting this chart for a long time, initially because it showed a very strong rebound in outbound container shipments from the Ports of Los Angeles and Long Beach, and I thought that argued for similar growth in subsequent months in the government's official tallies of exports. Contain shipments, in other words, were probably good leading indicators of overall export performance. The data is finally in, and this looks to have been a correct assumption.

Of course, exports are still well below their best levels of last year, so we are still in the recovery phase of this new business cycle. But it still represents a fairly impressive recovery, which is not surprising given the sudden collapse of confidence and spending last year; all we needed to recover was a return of confidence, and that is the story that has been playing out over the course of this year. There is every reason to expect continued improvement in exports in the months to come.

100 Quick and Easy Ways to Waste Your Money

A huge hat tip to my good friend Don Luskin for pointing me to Senator Tom Coburn's compilation of 100 ways in which the $787 billion American Recovery and Reinvestment Act is wasting taxpayers' money. Here is a random sampling of the things that your hard-earned dollars are being spent on:
“Almost Empty” Mall Awarded Energy Grant ($5 million)

Renovations for Federal Building as Expensive as New Building ($133 million)

DTV Advertising Agency Generates Three Jobs ($5.9 million)

Research to Develop Supersonic Corporate Jets ($4.7 Million)

Water Pipeline to a Money-Losing Golf Course ($2.2 million)

Program to Control Home Appliances From a Remote Location ($787,250)

Dinner Cruise Company Gets Terrorism Prevention Money ($943,190)

Broadband Map That May be Obsolete by the Time It’s Complete ($350 million)

Grant to Fund Search for Fossils . . . In Argentina ($1.57 million)

Study on "Hookup" Behavior of Female College Coeds ($219,000)

Money to Airport Authority Cited for Having Problems Managing Federal Money ($9.6 million)

Buffalo Residents Paid to Keep Daily Journal of Malt Liquor and Marijuana Use ($389,357)

California Gets Money to Upgrade Computer System . . . Twice ($60 million)

Obsolete Bridge Converted to Bike Path ($5.6 million)

If you don't refer everyone on your mailing list to Coburn's document listing 100 government boondoggles disguised as economic stimulus, then you are remiss in your civic duties.

Yes, these are the "shovel ready" projects that were absolutely vital in order to keep the economy from falling down a black hole. It's. Simply. Amazing. And downright infuriating!

The fatal flaw in healthcare reform (2)

I mentioned one fatal flaw here, which is that by prohibiting insurance companies from denying insurance to people with pre-existing conditions, but failing to impose a sufficient penalty on those who refuse to buy insurance, Congress was all but ensuring the financial failure of healthcare reform. I also referenced an article that said that a healthcare mandate was unconstitutional here. Now Randy Barnett has jumped into the fray with yet more—and very compelling—reasons why a health insurance mandate is unconstitutional:


Can Congress require all Americans to buy a new Buick every year or pay a tax equivalent to the price of a used LeSabre? Some members of Congress claim that power in the health care debate. Indeed, all the leading health care bills being debated in Congress require Americans to either secure or purchase health insurance with a particular threshold of coverage, estimated to cost up to $15,000/year for a typical family. Such a purchase mandate has never been attempted. The purpose of this forced purchase, coupled with the arbitrary price ratios and controls, is to require many people to buy artificially high-priced policies to subsidize the coverage for others. Sponsors of the current bills are attempting, through the personal mandate, to keep the transfers entirely off budget or through the gimmick of unconstitutional tax penalties. The sponsors have struggled to analogize and justify the mandate under existing federal laws and court decisions, but those efforts all fail under serious scrutiny. Senator Orrin Hatch and a growing number of Congressmen argue the mandate is unconstitutional as a matter of first principles and under any reasonable reading of constitutional precedents, and it is very unlikely the Supreme Court would devise or extend current constitutional doctrines to save them.

Read the whole thing, plus this article.

A VIX Xmas Card



Inspired by Mark Perry, here is my version of the stock market's VIX Christmas Card: the gift of implied volatility that has returned to almost-normal levels. We couldn't ask for much more at this time of the year. One year ago the world celebrated Christmas and New Year's with Great Fear and Trembling, whereas today we are getting ready to celebrate the return of conditions that are much closer to normal. That's a really big deal.

Markets are still pessimistic





These two charts record the most dramatic rally in the corporate bond market in modern history, and it's far from being over. Earlier this year, when spreads were at their peak, the market was effectively forecasting that a deep depression and a global deflation would wipe out a huge percentage of the world's companies. Now, as spreads have come back down to the worst levels we saw during the 2001 recession and the subsequent corporate credit crisis (second chart), the market is effectively saying that what the future holds in store for us is a garden-variety, but still rather nasty recession.

My takeaway from this is that the rally we have seen in corporate bonds and equities this year has been more about the market becoming less fearful of the future than it has been about a market that has turned optimistic. Stocks and bonds are still priced to some fearsome assumptions, and this is hardly the stuff of an overbought or overextended market.

Bernanke's belief system not encouraging

Fed Chairman Bernanke this morning attempted to answer everyone's most pressing concerns about monetary policy, the economy, and inflation. His answers revealed a lot about his belief system, and from my perspective he has some problems. There's really nothing new here, but it's worth repeating because this is a subject that has enormous importance for just about everyone in the world, given the Fed's power and influence.

Bernanke is fundamentally a Keynesian when it comes to the economy: "a sustainable recovery requires renewed growth in final sales," he notes. Not a word about how the economy is going to produce and earn more in order to purchase more. No mention of how tax or regulatory burdens might discourage new business startups. For Keynesians, economic growth is all about demand; if demand materializes, then growth will follow.

Bernanke is in charge of the Fed, and the Fed is charged with keeping inflation low and stable. Only the Fed has the power to print money and thus to create inflation. But to hear Bernanke speak, inflation depends on a variety of things that have nothing to do with the Fed:

Inflation is affected by a number of crosscurrents. High rates of resource slack are contributing to a slowing in underlying wage and price trends, and longer-run inflation expectations are stable. Commodities prices have risen lately, likely reflecting the pickup in global economic activity and the depreciation of the dollar. Although we will continue to monitor inflation closely, on net it appears likely to remain subdued for some time.
Here he reveals yet again his Keynesian roots. When the economy is weak (i.e., when there is lots of "resource slack"), then inflation tends to decline. This view, however, ignores the fact that while a weak economy may result in some price declines, the only thing that can generate a decline in the overall price level is a shortage of money. I know firsthand, from my four years of living in Argentina in the late 1970s, that a very weak economy can coexist with very rapid inflation. Indeed, rapid inflation is a major reason why hyperinflationary economies are generally very weak. Bernanke also notes that a weak dollar can boost commodity prices, and that can contribute to inflationary pressures. But why is the dollar weak? He never answers that question. If the Fed controls the supply of dollars, then surely a decline in the value of the dollar must be the consequence of the Fed either oversupplying dollars to the world, or failing to restrict the supply of dollars in order to offset a decline in the demand for dollars.

For both Bernanke and his predecessor Greenspan, the Fed never controls inflation directly. They see the Fed's job as monitoring the things that do create inflation (e.g., the health of the economy, the degree of resource slack, and inflation expectations) and then taking action if required. In this view, the Fed controls inflation indirectly by taking measures (e.g., raising or lowering interest rates, adding or subtracting liquidity to the banking system) which are ultimately designed to boost or retard economic growth or reduce inflation expectations. It's a convenient way of describing the Fed's job, since if inflation ends up being too high, the Fed can conveniently blame it on things beyond its control: inflation expectations became unanchored, commodity prices rose too much, the dollar fell too much, demand was too strong, etc.

The real problem with this worldview—the Fed's model of how inflation works—is that it doesn't focus on the monetary roots of inflation. It puts too much emphasis on non-monetary factors, and this in turn leads to Fed errors. We've seen several examples of this in the past decade. From 1995 through 2000, the Fed thought the economy was too strong, and so they tightened policy even as inflation was low and declining, gold and commodity prices were plunging, and the dollar was rising. That helped tip the economy into recession in 2001, and it created deflationary pressures which dogged the economy through 2003. The Fed then thought the economy was too weak and deflation was a threat, so they pursued a multi-year period of excessive ease in 2002-2005, even though inflation, gold, and commodity prices were rising, and the dollar was falling. That in turn helped fuel the housing bubble, the popping of which set in motion the financial crisis which precipitated the recent recession. Today the Fed is once again concerned about how weak the economy is, so they are extremely accommodative even though gold and commodity prices are rising and the dollar is falling.

As long as the Fed persists with this view of the world, they will likely err on the side of monetary ease, and that will give an upward bias to inflation. It will also likely result in asset price bubbles, one of which appears to be forming in the gold market—where, not coincidentally, prices jumped in the wake of Bernanke's speech this morning. 

Badly informed monetary policy on the part of the Fed has been an important source of the very headwinds that Bernanke today blames for creating a dismal economic outlook. It's a shame, because the Fed could have done a better job and we all could have been better off. I for one would like to see some new and better-informed blood at the Fed.

Too many people pay no income tax

To sum up the facts put together by The Tax Foundation and TaxProf Blog:

One third of those filing tax returns in 2007 paid zero income tax, while about half of those received money from the government. Since 15 million workers did not earn enough to be required to file a return, almost 62 million workers paid zero income tax in 2007. In rough terms, almost 45% of the those who worked in 2007 paid zero income tax, and one third of those paying zero tax ended up receiving substantial money from the government (in the form of earned income tax credit and other subsidies).

Here's a chart of the data:



Note the dramatic and unprecedented increase during the Bush II years in the percentage of workers who pay no tax. To make matters worse, consider this comment from The Tax Foundation:

"The number of 'nonpayers' can be expected to soar due to programs such as President Obama's 'Making Work Pay' tax credit," Tax Foundation President Scott Hodge said. "We now have an enormous class of Americans who are disconnected from the cost of government and have no skin in the game, and that is not good for democracy."

Nuni, a very good friend of mine, made a similar comment to me this morning:

If we talk about the unfairness of those making a lot of money and not sharing enough with those who don't make a lot of money, how about the unfairness of those who don't pay any taxes asking to increase taxes on the rich? The fair thing to do would be to say that only those who pay taxes should be able to give an opinion about raising taxes. The rest are just going along for a free ride. And that's definitively unfair.

Financial conditions are almost back to normal



Here's an updated chart of financial conditions as measured by Bloomberg. (See more background for this here.) Note the spectacular improvement in this index over the past year. Financial conditions (e.g., credit spreads, implied volatility, interest rates) today are almost back to what might be considered "normal." The financial markets have undergone a great healing process this past year, thanks in part to the Fed's quantitative easing, but thanks also to the natural processes of adjustment that follow any crisis. The recent recession was unique in that it was largely caused by a financial crisis—the prospect of a global financial meltdown, which in turn caused a dramatic decline in economic activity around the world. So to the extent that financial conditions have reverted to normal, the source of the economy's slump has been removed and things should get materially better.

Obama approval update



Obama's approval ratings continue to slide. Importantly, the percentage of those who "strongly approve" of his performance in office has hit a new low of 25%, after being as high as 45% right after he assumed office in January. The change on the margin in the past several months has been the ongoing decline in the number of people who feel strongly that he is doing a good job.