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Auto sales surge

Economy bears say that auto sales are still at extremely low levels (11.8 million at a seasonally adjusted annual rate). Economy bulls prefer to point to the change on the margin: sales have surged some 30% from their low of Feb. '09. I'm in the camp that says this big rise in sales over the past year is another sign of a V-shaped recovery. Improvements like this, even though they are historically modest in size, reflect improving fundamentals in such things as the jobs market, the availability of bank financing, the increased liquidity in the financial markets, and the return of confidence (or should we say the decline of fear and panic). There is no reason to think that this kind of improvement can't continue. I view this as consistent with my expectations for 3-4% growth over the next year or so.

Slow money growth not necessarily bad (2)

This is a follow-up to my post last month on the same subject. The issue is that M2 money growth has been extremely slow in the past year, as the first chart shows.

As this chart also illustrates, the big slowdown in money growth has coincided almost exactly with the big rise in equity prices. I don't think this is a coincidence. Indeed, I think it is a story that makes perfect sense. This past recession was provoked by an extreme increase in the demand for money, which was expressed in a huge increase in money balances as people cut back their spending and did just about everything they could to increase their money balances. Now that the fear of an international banking collapse has passed, and evidence accumulates that the US and global economies are firmly in recovery mode, the public's desire to accumulate money has gone in reverse. Money is being spent that was hoarded, and money balances are declining.

Declining demand for money has reduced the growth rate of M2, but it has not slowed the economy because declining money demand means that money is being spent at a faster rate, and that is lifting nominal GDP. The next chart illustrates this point quite nicely, as we see that extreme swings in M2 growth tend to coincide with equally strong, but opposite, swings in nominal GDP growth.

Big increases in M2 tend to occur opposite big declines in nominal economic activity, and vice versa. What this means is that the big untold story underlying all this is the velocity of money. M2 velocity (the number of times a dollar of M2 is spent for a given amount of nominal GDP) has been increasing over the past nine months, because M2 growth has slowed way down and nominal GDP growth has picked way up.  That's illustrated in the next chart.

The rise in velocity has been significant, but it is only in its early stages. A better way of describing this is to say that over the past two years M2 increased by an unusually large amount. The money wasn't spent, however, it was stored. Now it is being released, and the stored-up M2 is sufficient to generate some very strong gains in nominal GDP over the next few years.

Regulations are very unlikely to reduce financial risk

Chris Dodd's financial reform bill would place severe new restrictions on startups and "angel" investing, and that is a very bad idea, as noted in this article from VentureBeat.

First, Dodd’s bill would require startups raising funding to register with the Securities and Exchange Commission, and then wait 120 days for the SEC to review their filing. A second provision raises the wealth requirements for an “accredited investor” who can invest in startups — if the bill passes, investors would need assets of more than $2.3 million (up from $1 million) or income of more than $450,000 (up from $250,000). The third restriction removes the federal pre-emption allowing angel and venture financing in the United States to follow federal regulations, rather than face different rules between states.

Several investors have written pointed critiques of the bill:

Fred Wilson of Union Square Ventures said startups will be “hit by shrapnel” from the bill. Robert E. Litan of the Kauffman Foundation, which researches entrepreneurship, wrote, “It is difficult to know why these provisions are in a much larger bill whose primary aim is to address the fundamental causes of the recent financial crisis.” Mike Masnick at tech policy site Techdirt described the restrictions as “somewhat horrifying.”
If the point of the bill is to ensure that the hapless public will be spared financial losses thanks to the oversight of government bureaucrats at the SEC, then it is worse than pointless. If bureaucrats could help people avoid risk and at the same time spot the obvious opportunities out there, then why wouldn't we just turn all innovation and risk-taking over to the state? Government was never to intended to protect the private sector from investment risks, and any attempts to do so will only stifle innovation, entrepreneurship and job creation.

As a corollary to this, I doubt very much that Dodd's bill will do anything constructive to limit the risk of future financial catastrophes. If the vast majority of the smart and formerly-rich guys on Wall Street couldn't see the subprime disaster coming, then why would we expect some piece of legislation or some group of regulators to prevent it the next time around? Financial catastrophes are best prevented by strictly limiting the degree to which government interferes in markets. This bill won't do that, unfortunately.

HT: Brian McCarthy and Don Luskin

Yields rise as the economic outlook improves

Yields on 10-yr Treasury bonds are now just 1 basis point shy of their highest level in the past year. As I've said before, these yields are best viewed as a barometer of the market's expectations for future economic growth, and I've indicated that with the shaded areas on the chart. At the end of 2008 yields plunged to 2% as the market priced in expectations for a deep depression and deflation. Today the market is pricing in some growth, probably on the order of the 2-2.5% growth forecasts that are common to those who believe in an extended "new-normal" period of sluggish growth.

It's my impression that most people worry that higher bond yields will choke off growth, but I thing it's the other way around. Growth fundamentals are improving, so bond yields are rising. That's only natural, since Treasury yields need to compete with the returns that can be generated by the economy, and those returns are, in turn, a function of the rate of economic growth. It would take bond yields of at least 6 or 7% and a concerted effort by the Fed to tighten before rising interest rates might prove harmful to growth.

The jobs growth we have seen so far this year is very welcome, but it does not yet signal that growth will be robust. It takes about 130K new jobs per month just to keep up with the normal expansion of the labor force, and more than that to bring about a decline in the unemployment rate. On the margin, the changes we are seeing are definitely positive, and there is likely to be further improvement in the pace of job creation later this year. On balance I think this adds up to a positive for the market, since I think the consensus is still somewhat pessimistic about the prospects for future growth.

400,000 new jobs and counting

The jobs news this morning can be summarized like this: in a welcome sign that the economy may finally be on the mend, jobs rose in March by 162K, but that was less than the 184K expected, and 48K of those jobs were new census workers; meanwhile the unemployment rate was unchanged at a very high 9.7%.

Or it could read like this: abstracting from census and other government workers, jobs rose in March for the third month in a row, as the private sector has now created a total of over 800K new jobs so far this year.

The difference between these two measures of jobs is the survey you look at. The first summary above came from the traditional survey of establishments, the second from the household survey. The latter has a good record over the years of picking up turning points in the economy ahead of the former. That's because it uses a telephone survey to get its data, whereas the establishment survey gathers data from existing businesses, and adds a guesstimate of how many new ones there might be. And as the chart shows, that makes a big difference. If the economy is turning up, the government is likely under-guesstimating the number of new businesses and new workers. (Both of the lines in the chart represent private sector workers only.)

But let's assume that even the household survey can have random blips, such as the 500K drop in private sector jobs in December, and the 550K jump in January. A conservative reading of the numbers would therefore conclude that new private sector jobs have increased by 400K so far this year, with 300K of those new jobs created in March alone. Any way you look at it, though, the number of jobs is clearly on the rise, so the outlook is likely to improve in the months to come.

The economy is now growing, and it's for real.

Brazil's super-V-shaped recovery

The top chart shows the level of Brazil's industrial production, which, in just over one year, managed to retrace almost all of its 2008 losses. Not surprisingly, Brazil's stock market is now within inches of its former all-time high. This has got to rank as one of the most amazing recoveries to date, a super-V. It's also a reminder that while we struggle with bad policies and high unemployment, many economies around the world are recovering rapidly. This fits with the very strong NAPM export orders number reported earlier today. The global economy is on a tear, and this can only help lift the prospects for the US economy.

Commodity prices continue to rise

Most major commodity indices are moving to new highs for the year. The top chart shows copper prices, which are now up 185% from their late-2008 lows, and up 485% from their late-2001 lows—a sextupling of prices. The second chart shows crude oil futures, which are now at a new high for the past year. Crude prices are now up 654% from their 1998 lows—that's a septupling of prices in just over 10 years! Gold prices have more than quadrupled since early 2001, and are up 55% from their late-2008 lows, which occurred just around the time the Fed started pumping over $1 trillion of reserves into the banking system.

It sure is a good thing that, according to the Fed, we don't have to worry about inflation, isn't it?

First glimmerings of new jobs

The Monster Index of online job postings (blue line in above chart) appears to be turning up, albeit only slightly, suggesting employers on average are seeking to boost hiring. The strength in mining is not surprising, given the huge gain in industrial commodity prices, and the strong demand that is driving it. 

Construction update

No surprises here. Residential construction has been flat for most of the past year, confirming once again that the housing sector has stabilized. Nonresidential construction has been declining for the past year, after peaking almost three years after residential construction peaked. This lag suggests we could see further weakness in nonresidential construction for another year or two. That's a grim prospect, but there's a good chance that residential construction could start to pick up before too long, thus mitigating the overall decline in construction activity. This is the sector of the economy that is going to take the longest to recover, because it was the sector that boomed the most. But there's no reason that weakness in construction should keep the broad economy from expanding; there are lots of empty offices and commercial space just waiting to be occupied, at very attractive prices, by new and growing businesses.

Unemployment claims continue to fall

Weekly unemployment claims peaked exactly one year ago and have been declining ever since. They are still almost  50% above normal, but the trend is moving in the right direction.

Obamacare is here

This is the sign that my sister-in-law made that my brother (the best chiropractor west of the Mississippi) declined to post in his office today:

ISM manufacturing data very strong

You couldn't ask for a more positive, stronger set of numbers than those released today by the Institute for Supply Management. Their members collectively reported a huge gain in overall manufacturing conditions (top chart), a number so strong that it suggests 1st quarter GDP growth could come in as high as 6%. 61% of its members reported seeing stronger export orders (second chart), the most since 1989, during the booming export years of 1985-92. In a direct challenge to prevailing concerns over deflation, 75% of its members reported paying higher prices (third chart). The employment index slipped to 55%, but it continues to reflect expansion, and it remains higher than at any time during the 2006-09 period.

If these numbers don't paint a picture of a V-shaped recovery in manufacturing, then I'm at a loss for how to describe it. Plus, numbers like these very likely reflect similar strength in other areas of the economy. We see here a very strong, robust recovery, coupled with a sharp rebound in pricing power. This is NOT your "new normal" economy, not by any stretch.

It is a testament to the persistence and depth of investor skepticism that in spite of the strength of these numbers, and in spite of all the other signs of recovery (e.g., higher commodity prices, tighter credit spreads, declining unemployment claims, a steep yield curve, declining implied volatility, strong corporate profits, the bottoming in real estate, strong global demand, increasing business investment, and the return of liquidity to corporate bond market, to name a few), the stock market is still 25% below its 2007 high, 10-yr Treasury yields are still below 4%, 2-yr Treasury yields are only 1%, and the market expects the Fed to raise the funds rate to a mere 1% in April or May of next year.

Watch out bears, you're about to be run over by a freight train. Hello, Bernanke, wake up and smell the coffee! We don't need zero interest rates any longer.

Corporate layoffs back to normal

Corporate layoff announcements are firmly in "normal" territory, according to the latest data from Challenger, Gray & Christmas. The awful national nightmare that began in late 2008 is over.

Banks are stepping up their lending efforts

This morning I received an email from Charles Schwab offering to reduce my margin interest by up to 30%, depending on my willingness to borrow. It strikes me as unusual, but also very interesting, because this represents an aggressive attempt to increase lending activity. Perhaps banks are finally realizing that the very steep yield curve gives them a fabulous opportunity to make money by lending more. Their prior reluctance to lend was undoubtedly driven in part by concerns that the economy was fragile and credit risks were high, but those concerns are likely beginning to fade.

Once a recovery gets underway, it becomes self-perpetuating as confidence rises and risk-taking resumes.

The danger of American Peronism

Here is a short editorial from the Washington Examiner titled "United States of Argentina." I reprint it because it does a good job of comparing the worst of what is going on in the US with what those same policies did to Argentina. The parallels between Obamanomics and Peronism are chilling.

I know a lot about Argentina, having lived there for four years in the late 1970s. I've been following the economy closely ever since, and have traveled there extensively. This article does not exaggerate in the least how much Argentina has suffered from Big Government.

I believe strongly that the US electorate does not want to follow in Argentina's footsteps, even though our current ruling class apparently does. This is going to be the central issue in the upcoming November elections. If we say "NO" to American Peronism, as I think we will, our future will brighten considerably.

When White House Chief of Staff Rahm Emanuel last year advised "never waste a good crisis," he likely was thinking ahead to President Obama's economic stimulus program and health care plan. After swelling the federal deficit by passing the stimulus at a cost of nearly $1 trillion, Democrats in Congress signed off on Obamacare, with a price tag, according to Rep. Paul Ryan, R-Wis., of $2.3 trillion in its first decade alone. With federal spending exploding at such a rate, it's no wonder that Moody's Investor Service recently warned that it would downgrade the U.S. government's credit rating if it concludes "the government was unable and/or unwilling to quickly reverse the deterioration it has incurred."

What the United States government will do in the future may be in question, but we need not look far to find past examples of countries unwilling to get their finances in order. Consider Argentina. In 1914, it was one of the wealthiest countries in the world, and its living standard exceeded that of Western Europe until the late 1950s. Then President Juan Peron squandered his nation's prosperity by introducing a host of redistributionist economic and regulatory policies, nationalizing utilities and foreign investments, and pumping up the national debt. What followed was three decades of political instability, growing dependency, and economic stagnation.

There was a brief period of privatization and booming foreign investment in what the American Enterprise Institute's Mark Falcoff called Argentina's "go go" 1990s. But that was negated by the return of political leaders espousing Peronist principles who created a downward economic spiral by breaking contracts with foreign utility companies that had invested heavily in Argentina. Today, the country has lost its international credit standing and an estimated 10 percent of the population has moved abroad to escape the stifling taxes, regulation and inefficiency. To make matters worse, President Cristina Kirchner recently attracted attention for firing the president of the country's central bank. His sin was refusing to go along with her inflationary spending policies (Argentina's inflation is 17 percent) and challenging her demand that he hand over $6.6 billion in bank reserves.

Besides sending federal spending skyrocketing, Obama has, like so many of the politicians who ruined Argentina, dramatically increased government regulation of business, nationalized major sectors of the economy, and imposed a lengthy list of tax increases. America today is no more exempt from economic reality than Argentina was in years past. Make no mistake, these actions will eventually drain the life from this nation's economic vitality, just as they did in Argentina.
 HT: Glenn Reynolds

Factory orders--another V-shaped recovery

This chart shows New Orders for U.S. Manufacturers. The chart follows the pattern that characterizes nearly all recoveries: the steeper the recession, the stronger the recovery. The pattern has been confirmed empirically, and it was first conceptualized in 1964 by Milton Friedman as the "Plucking Model" of growth. New orders in the past year are up over 10%, and that marks a faster pace of recovery than the one that followed the relatively mild 2001 recession. Of course we are still well below the previous highs, but a rapid recovery such as we are seeing here and in many other areas of the economy all fit together. Importantly, this is all likely to have a synergistic effect, continuing to push the broad economy higher despite the fierce headwinds of faux-stimulus policies and aggressively accommodative monetary policy. At the very least, the economy wants very much to return to its former level of activity, and to accomplish that requires a lot more growth, more profits, and more jobs; all of which we are likely to see in the next year or so.

Job market is poised for growth

The ADP employment report released today was a bit softer than the market expected (-23K vs. +40K), but it's within shouting distance of an inflection point in which the jobs market stops shedding jobs and starts adding. Expectations for this Friday's payroll number are for a healthly gain of 180K, but most of this would probably come from the hiring of census workers. Regardless, it's clear that the jobs market is at or near the point at which growth replaces decline. Soon we'll be worrying about how fast the economy is adding jobs. It's still very unlikely that enough jobs will be added between now and the November elections to make the electorate feel like it received good value for the $1 trillion we borrowed to "stimulate" the economy. This could be one of the most exciting, important, and divisive elections in memory.

Thinking about confidence

Here's a conundrum: consumer confidence is still at very depressed levels, yet there is no shortage of pundits calling for a double-dip recession and/or another major stock market decline.

Market bears cite evidence of overvaluation in stock prices and overbought conditions, while economy bears point to another wave of residential and commercial mortgage defaults, high unemployment, massive deleveraging, trillion-dollar deficits, and rising tax burdens, among other things.

A quick look at this chart, however, tells you that consumers are always worried about an economic relapse in the wake of a recession (once burned, twice shy, as the saying goes), but they are never worried about the future in the months just before a recession. I would wager that the same holds true for most pundits.

Very low consumer confidence has traditionally been one of the best buy signals for stocks. Why should it be any different now?

Industrial metals prices signal strong global recovery

More signs of a V-shaped recovery: industrial metals prices are now up 110% from their late 2008 lows. The global economy must be doing quite well, and accommodative monetary policies from most of the world's central banks are not interfering with the ongoing rise in prices or the expansion of activity. So far I have seen no signs in sensitive asset prices of a slowdown in economic activity anywhere. How much more evidence does the Fed want to see before they take the "daring" step of raising short-term interest rates by a few notches?

Housing market stabilizes

The evidence continues to suggest that the housing market has stabilized, and may even be improving. The Case Shiller Home Price Index for 20 major metropolitan markets hit bottom in the second quarter of last year and has been rising gradually ever since. Given the lags used in constructing the index, this means that prices likely hit bottom around March of last year. Even after adjusting for inflation, as this chart shows, home prices are up at a 3% annualized rate over the past 8 months.

We're now seeing the dimensions of the housing "bubble" with more clarity: in real terms, prices rose about 54% more than they should have, from 2002 through 2006, but now that they have fallen by 35% we have returned to some semblance of normality. Markets have found their new clearing price. Excess home inventories are being rapidly reduced due to an unprecedented decline in new housing starts. Since the rate of new household formation is still way above the current pace of construction, we should expect to see a pretty impressive increase in new construction over the next year or two.

This is excellent news all around, but the market still seems very reluctant to buy into the notion that the housing market might actually be improving. In typical bull market fashion, the market continues to climb walls of worry.

How bureaucrats deal with budget crises

This is a true story from almost 40 years ago, but it may be subject to some memory lapses and faulty recollections of facts on my part. I tell the story now because I think people need to understand why it is that government is so bad at controlling spending, especially now that spending is so out of control and deficits are approaching unimaginable levels.

Background: I was a young LTJG in the Coast Guard from 1972-75, and I was stationed in San Francisco as the Deputy Director of the 12th District Coast Guard Auxiliary. Sometime during that period, I can't remember exactly when, there was a federal budget crisis and the solution was to cut all federal budgets by 10% or so across the board. As it happened, when the 12th District command called a meeting of all division heads to develop a plan to implement this sizeable budget cut, I was the stand-in for my commanding officer because he was out of town.

Perhaps it was the Admiral who addressed the meeting, but I can't be sure. Nevertheless, his plan was straightforward. Instead of asking each division head to shoulder their share of the budget cut burden, the plan was to take the entire cut out of the Search and Rescue division's budget, leaving them with almost nothing. As of a certain date, the Coast Guard would suspend all search and rescue operations due to the budget cut.

The plan had an unspoken assumption that was explained to those of us present at the meeting: the public hue and cry that would result from such a draconian cut to emergency services would be huge, and it would likely persuade Congress to exempt the Coast Guard from the across-the-board budget cuts. And so it was. The Coast Guard never had to take that 10% cut, even though my budget had plenty of room to cut, and I imagine that many other departments and divisions could have taken a cut as well.

From that experience as well as others, I came to understand the difference between the public and the private sector. The private sector is all about survival: if your revenues drop, you have to cut your spending. The public sector is all about politics: your survival and prestige is a function of the size of your budget, so you never consent to a cut. Instead, you always ask for more and more spending authority, no matter what.

Why healthcare reform bill will eventually go down to defeat

The bill is full of fatal flaws, as I and many others have emphasized. Mandating the purchase of anything just because you're alive is unconstitutional. Prohibiting insurance companies from refusing policies to those with pre-existing conditions will bankrupt the industry, because the penalties for noncompliance with the purchase mandate will be much less than the cost of insurance. Regulating the price that insurance companies charge, in addition to their profit margins, is also unconstitutional. Perhaps most important of all, the collapse of the Soviet Union proved once and for all that governments are utterly incapable of restructuring and efficiently managing industries, much less economies; it's simply too complex a job for mere mortals. And then there's that old economic maxim that says you can't impose price controls and hand out subsidies in a market without eventually facing the need to ration the product or service in question.

The bill, which amounts to the biggest restructuring of the American economy in history—of any economy, for that matter—and which promises to deeply impact the lives of every single one of its 300 million residents, was passed against the will of the people. Not a single vote from the opposition; every major poll prior to its passage showed that a majority of people were against it. Even today, the majority of people believe it should be repealed. Never before has anything this big passed in such an undemocratic, partisan manner.

It will almost certainly be a budget buster, at a time when we are already staggering under the burden of $1.5 trillion dollar deficits for as far as the eye can see, and a rapidly rising debt/GDP ratio that will soon take us to the lofty heights previously occupied by such economic titans as Japan and Italy. Never before has a major government program not ended up costing significantly more than projected, and this is one of the biggest to come along.

Arnold Kling has some pithy observations that bear repeating. Excerpts follow:

The health care legislation represents a culmination of a sequence of unpopular major initiatives from Washington. First, there was Henry Paulson’s massive transfer of wealth from the people most hurt by the financial crisis to some of the people most responsible for it. Next, came the massive, ill-conceived stimulus bill, which was not timely, targeted, or temporary but instead a pure power grab by Washington. Health care legislation is merely the latest straw.

The American people are watching their country being transformed from an exceptional, vibrant free economy to a broken European welfare state, and many of us do not like the direction of change. We may not know exactly what is in the health care legislation (does anyone?), but we know its intent to assert government authority over health insurance. We know that it creates a large entitlement, paid for in large part by unspecified future cuts in Medicare.

Thanks to the projected Medicare cuts, the Congressional Budget Office scores the health care legislation as deficit-reducing relative to current law. However, current law is unsustainable. Medicare spending will have to be cut in the future in order to avoid national bankruptcy. By diverting projected Medicare cuts into a new entitlement, this legislation makes the impending budget crisis in Medicare loom sooner and deeper.

The public probably does not understand this budgetary legerdemain, but their instinct is to distrust Congress. In this case, the populist instinct is valid, and the elitist contempt for ordinary citizens is quite unjustified.

The Tax Foundation has put together a summary of how the healthcare bill is to be financed. Note the huge portion (44%) that is paid for by cutting Medicare spending. How many are gullible enough to think these cuts will actually occur? And won't they just make the Medicare deficit even worse than it already is? There is some really serious, runaway deficit spending lurking inside this bill, and it's way too big and ugly to keep hidden for long.

This whole thing is so outrageous that it simply cannot survive. There is plenty of time for the people to look inside this healthcare box of surprises and come away horrified. Spread the word.

UPDATE: Here is an excellent paper written by Barnett, Stewart, and Gaziano that makes a very strong case for why the individual mandate is unconstitutional.

Dissecting inflation

This chart shows the rate of inflation according to the Personal Consumption Deflator (green line), as compared to two of its three components: services and durable goods. (The third component, nondurable goods, is for some reason not available to me at the moment.)

The next chart shows the behavior of the price indices for services and durable goods since they began to part ways in 1994 (prior to that they both moved only in an upward direction). This price divergence has now grown to sizeable proportions. Put it this way: over the past 16 years, the average price of services has risen almost 60%, while the average price of durable goods has fallen almost 25%. Service sector prices therefore have doubled relative to durable goods prices in just 16 years. You might say we have had a whole lot of inflation in the service sector which has been offset to a significant degree by a lot of deflation in the durable goods sector. That might explain why there is so much disagreement these days about how much inflation there is. It all depends on what sector of the economy you're talking about.

Measured inflation is still benign

I've been worrying about rising inflation for most of the past year, mainly because of the Fed's extremely accommodative monetary policy (e.g., zero interest rates, plus the injection of over $1 trillion of reserves to the banking system in exchange for mortgage-backed securities). My concerns have not been unfounded. When I look at sensitive indicators of the net effect of monetary policy, I see abundant evidence that there is an excess supply of dollars in the world: the dollar is within 5% or so of its all-time lows against other currencies; gold prices have risen from $260 to $1100/oz.; TIPS 5-yr forward breakeven spreads have risen from almost zero to 2.7%; the Treasury yield curve is as steep as it's ever been; credit spreads have narrowed significantly across the board; and commodity prices are up steeply across the board.

Yet as the chart above shows, measured inflation is within the Fed's target zone of 1-2%, as measured by the Personal Consumption deflator (February figures, included in the chart, were just released today). Am I wrong to worry about rising inflation?

I must admit that I thought inflation would be higher by now, but then I've never called for anything more than a "gradual rise in inflation," so I'm not off by too much. As Milton Friedman counseled, the lags between monetary policy and inflation are long and variable, so I take some comfort from that and am content to wait longer before throwing in the towel.

UPDATE: I would dearly love to be wrong on my rising inflation call. I really hope the Fed will not again make the mistake of keeping interest rates too low for too long, as they did from 2003-2005. Inflation is very unkind to the poor, the innocent, the trusting, and the naive, and it has wreaked havoc in most of the world's economies from time to time. Given the beating the economy is taking from Obama's wanton spending proclivities (which unfortunately greatly overshadow the Bush administration's excesses), higher inflation is the last thing we need right now.

Why I still like AAPL (2)

Go here to watch a just-released series of videos/guided tours which show Apple's new iPad in action. It's simply amazing. I ordered mine awhile ago and expect to receive it this Saturday. I can't wait! I haven't seen anything this slick, fast, and beautiful in my life. Apple has a real winner here. Watch the iBook video and you'll quickly realize that the iPad makes the Kindle utterly obsolete.

10-yr Treasury yield update

As 10-yr Treasury yields work their way slowly higher (first chart), I thought it would be appropriate to revisit the long-term context (second chart). Yields are up almost 200 bps from their lows, but they are still very low by historical standards. To think that yields of 4% or even 5% pose a threat to the economy seems rather farfetched, when you consider that the economy grew strongly in the 1980s despite yields of 8% and higher, and despite yields being significantly higher than inflation. Similarly, it's hard to see how the recent emergence of trillion-and-a-half dollar deficits has had any meaningful upward impact on yields.

Yields are primarily driven by inflation, as the third chart shows. Secondarily, yields are driven by growth expectations, since this in turn suggests the direction and level of rates that the Fed seeks to target via the Fed funds rate. For now, yields remain historically low because the market believes that inflation is going to be low for many years (witness TIPS breakeven spreads of 2-2.5%), and the economy is going to be stuck in a "new normal" rut, with growth of 2-2.5% per year and a huge amount of economic "slack." That in turn suggests that the Fed is going to keep short-term interest rates very low for a considerable period (witness Fed funds futures and eurodollar futures which are priced to a 1% funds rate one year from now, and a 2.25% funds rate two years from now).

Yields will move higher if these critical assumptions about inflation, growth, and Fed policy are challenged. For example, yields are likely to move higher if economic growth proves stronger than expected, even though stronger growth would reduce the deficit.

The fatal flaws in healthcare reform (6)

The Joint Committee on Taxation has just discovered another fatal flaw in the just-passed healthcare reform bill: the government has no ability to enforce the mandate that all must purchase a healthcare policy. You can find the full explanation here. (HT: Glenn Reynolds)

This discovery modifies the first of my list of four fatal flaws that I summarized last December. I indicated then that the penalty for not purchasing a policy was likely to be less than the cost of the policy for a great number of people. When coupled with the ability of anyone to buy a policy despite any pre-existing conditions, this would mean that large numbers of people would simply opt to pay the penalty, thus saving money, and buy a policy only after they got sick. Unless this error is fixed, it is now almost certain that vast numbers of people would choose to buy a policy only after they discovered they had a serious illness. Revenues from policy premiums would thus fail to match costs and eventually bankrupt the insurers, leaving the taxpayer to pick up the tab. This would hasten the arrival of the single payer system that Obama and leading Democrats have wanted all along. (Perhaps this fatal flaw was intentional?)

I suspect we'll find many more such errors, omissions, and oversights in the legislation passed. I can only begin to imagine the unintended consequences of this legislation that are likely to arise in the future. It's a great reminder that governments cannot run industries, much less economies. Even the smartest of bureaucrats and politicians have only a fraction of the intelligence of free markets.

I continue to believe that the defects of this legislation are so massive and pervasive that it will never see the light of day.