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Obama: America's Perón

I lived and worked in Argentina from 1975 to 1979, and I've been back there about every other year since. I began my economic career in 1980 with a lengthy study of the Argentine economy, and I spent lots of time understanding how and why it suffered hyperinflation for many years and why its economy has done so poorly. While I lived there, the inflation rate averaged about 7% a month, or 125% a year, as I recall. During one three-week visit in the mid-1980s, the price level doubled, and I saw supermarkets post prices on chalkboards and update them as many as two or three times a day. The only way the government could fund its enormous deficits was to order the central bank to print money so it could pay its bills—it's called an inflation tax because those who accept the funny money, which loses its value rapidly, are effectively forced to transfer some of their wealth to the government.

Aside from the ravages of inflation and periodic depressions—I recall calculating that industrial production per capita had declined almost 35% during one decade—the other thing that stands out in my memories of Argentina is seeing newspaper headlines report almost daily that the president had issued a decree: one day ordering some company to lower its prices, another day allowing another company to raise its prices, another day announcing the new price of gasoline, and yet another day declaring that all workers would receive a 10% increase in pay to compensate for the higher prices. The president spent most of his time managing the economy, and he did that by receiving an endless number of people in his office who petitioned for the right to raise prices, or who petitioned for relief from the fallout of one of his previous diktats. It was government by presidential decree, and it was the closest I hope I'll ever come to living in a socialist economy.

Argentines don't realize how bad things are because for most of the past 200 years they have lived in a country governed by caudillos, their term for a president with semi-dictatorial powers who solves everyone's problems. It's akin to Mafia Dons, only worse, and that in turn has a lot to do with Argentina's strong Italian roots. Juan Perón was the most famous example, and his influence is alive and well in the figure of Cristina Kirchner, Argentina's current president and a devout Peronist. She revels in pitting the rich against the poor, and handing out favors to unions, favored industries, and political cronies, all while living in grand style. Among the many curiosities of the Argentine economy, housewives are eligible for social security when they "retire," because after all, being a housewife is a job, isn't it? Trouble is, the government periodically runs out of money to pay for all the goodies, which is why a monthly social security check today won't buy even a month's worth of food. Legions of Argentines are dependent on and trapped by government handouts which effectively force them to live in a manner we would consider way below the poverty level. Spreading the wealth only ends up destroying a country's wealth, and Argentina is the best example of that I know.

So it is with great concern and sadness that I see a creeping Peronism happening in the U.S. economy under President Obama. Consider this latest headline: "Obama to Announce Contraception Rule ‘Accommodation’ for Religious Organizations." What business does our president have telling organizations and insurance companies how they should run their business, what kinds of healthcare policies they can offer, and whether or not they can charge for contraceptive services? This goes way beyond right-to-life issues, religious freedom, and the ObamaCare mandate, as John Cochrane so nicely explained in his WSJ article yesterday. It's all about whether we are going to have our economy and our personal decisions micro-managed in Washington. Are we ready to embrace Peronism? Do we really want bailouts that start with favored companies (e.g., General Motors) and trample the rights of bondholders? Should the government really be forcing banks to offer bailouts to homeowners who paid too much for their homes? It's a slippery slope we're on that knows no end, unless the voters rise up in protest this November. It's my fervent hope that they will.

Argentine President Cristina Kirchner is reported to have bragged that since Obama was copying many of her policies, he lent them great legitimacy. Two years ago I was on a plane in Argentina and was conversing with the fellow next to me about what was going on in the U.S. economy. I lamented that "Obama is the United States' Perón," and he replied "and what's wrong with that?" I immediately realized he was a Peronist, and he turned out to be the minister of education for the province that the Kirchners used to govern. Peronism has been the bane of Argentina's economy and its people, but it continues to thrive because it corrupts its politicians with unimaginable power and money.

I'm reminded once again of this memorable quote from Chip Mellor:

There continues to be the false premise that the problem in politics is too much money, when in fact the problem is too much government for sale ... these campaign finance laws are really treating only a symptom, not the disease. Until you get to the root cause, which is too much government, you are really not doing anything productive and in many cases you are doing harm.

Giving too much power to politicians (regardless of party affiliation) only ends up corrupting the entire process, because politicians end up selling favors, which in the end is an irresistible temptation. A tax hike here, a tax break there; higher prices here, lower prices there; a mandate here, an exemption from the mandate there. And so on, as we gradually lose our freedoms and our markets stop functioning efficiently. It's a very sad commentary on the state of the American economy and its politics. We really need to change; we really need less government, not more.

UPDATE: This is almost too good to be true. Apparently, Occupiers were paid to protest the CPAC (the Conservative Political Action Conference). This is exactly the strategy that the Kirchners have used in Argentina. If you travel to Argentina you are quite likely to run into a street protest that disrupts traffic, and the protest is almost certainly going to be some variation on the theme of how "the rich" are taking advantage of the poor. Three years ago I documented one such protest in Argentina. The parallels between Obama and the Peronists are too numerous to ignore. Protesters paid by unions and Peronist crony friends of the Kirchners have become so prevalent that the government has even come up with an official job designation for what they do: piqueteros. There are people in Argentina who actually make a living protesting against the supposed evils of capitalism. Believe it or not.

HT: Glenn Reynolds

Upward pressure on bond yields is becoming intense

As this chart suggests, long-term bond yields have a strong tendency to track the strength of the economy (as reflected in equity prices). Except for the past four months, that is, as equity prices have surged 23% but long bond yields have barely budged. You can almost feel the tension in the bond market building. Something is going to have to give—either equity prices and budding economic optimism have to collapse, or bond yields have to surge. It just doesn't make sense for the economy to be doing better while bond yields languish near all-time lows. My money is on higher yields, since the evidence of continued economic improvement is pervasive.

The Fed may hold a significant amount of long-term Treasury bonds, but they can't control long bond prices, and there are gobs of them that are held by investors all over the world. Those investors face the prospect of massive losses should bond yields once again sync up with equity prices. With the duration of the current 30-yr bond now 19, the price of the long bond could fall by 25% or so if 30-yr yields return to the levels of early last year. And that would still leave 30-yr yields very close to the low end of their range over the past three decades. Bond buyers beware.

Continued improvement in the labor market

The economy may be struggling to grow and suffering from a huge output gap, but the labor market is undeniably improving, and in a relatively impressive fashion. First time claims for unemployment continue to decline, and by more than expected.

Claims as a percent of the workforce have fallen by almost half, and are now lower than at any time during the 1970-1997 period. That's impressive, and it's likely to continue to improve. The only thing missing, of course, if new jobs, but that should come with time and with improved fiscal and monetary policies.

As this chart suggests, the ongoing decline in weekly claims (shown inverted in the chart above) supports continued gains in equity prices. It's got to be a good thing that companies are firing fewer and fewer workers.

The definition of what is "fair"

Whenever politicians use words like "it's only fair," you need to automatically grab your wallet, because they are planning to take money from one person in order to buy the vote of others. Taxes should be based on very simple and objective measures, and calibrated so as to influence economic decisions as little as possible. That usually means that tax rates should be as low and as flat as possible, with few if any deductions, otherwise they create distortions, inefficiencies, and perverse outcomes. Unfortunately, our current tax system is extremely progressive and riddled with exemptions and loopholes—all in the name of fairness—rendering it extremely "unfair" to many, especially to those who can't afford to pay lobbyists to look after their interests. In his op-ed in yesterday's WSJ, the always-excellent Steve Moore poses "A Fairness Quiz for the President" which merits wide distribution, because he lays bare the inequities that have accumulated in our economy that are unfair to so many of our citizens. Here are some excerpts, but do read the whole thing and pass it along:

Is it fair that the richest 1% of Americans pay nearly 40% of all federal income taxes, and the richest 10% pay two-thirds of the tax?
Is it fair that the richest 10% of Americans shoulder a higher share of their country's income-tax burden than do the richest 10% in every other industrialized nation, including socialist Sweden?
Is it fair that American corporations pay the highest statutory corporate tax rate of all other industrialized nations but Japan, which cuts its rate on April 1?
Is it fair that the three counties with America's highest median family income just happen to be located in the Washington, D.C., metro area?
Is it fair that soon almost half the federal budget will take income from young working people and redistribute it to old non-working people, even though those over age 65 are already among the wealthiest Americans?
Is it fair that wind, solar and ethanol producers get billions of dollars of subsidies each year and pay virtually no taxes, while the oil and gas industry—which provides at least 10 times as much energy—pays tens of billions of dollars of taxes while the president complains that it is "subsidized"?
Is it fair that in 27 states workers can be compelled to join a union in order to keep their jobs?

Putting Apple in perspective

Apple stock hit a new high of $477 today: that's up 50% from its recent low last June, up 510% from its low in January 2009, and up 14,800% from its all-time low in July 1997. Apple is now the most expensive company in the world, having eclipsed Exxon by $40 billion, and it is worth $190 billion more than Microsoft, which was once valued at $586 billion in early 2000. Wow. People worry that Apple is really expensive, but Apple is still 25% short of where Microsoft was 12 years ago.

And to think that this company with its absolutely stellar, world-busting growth, has a trailing PE ex-cash of only 11.3, and a forward-looking PE ex-cash of only 9.4! It just boggles the mind. If anything demonstrates how cheap this market is, Apple does. Investors today are getting paid very handsomely to assume the risk of a calamity. Anything short of a calamity, and prices could continue to rise.

Full disclosure: at the time of this writing I am long AAPL.

The cash conundrum revisited

I began getting very bullish back in December 2008, having observed numerous signs of improvement, most notably declining swap spreads and the Fed's aggressive expansion of the monetary base. In one post around mid-December, "The coming cash conundrum and the return of the carry trade," I wondered how long it would take people to realize that holding lots of cash (a very popular idea at the time, given how fearful people were that the end of the world as we know it was approaching) would be embarrassing. After all, holding cash that pays zero interest only makes sense if the prices of riskier assets decline; if they just hold steady, riskier assets beat cash due to their higher intrinsic yield. If, as I thought, a recovery was in sight, then the deleveraging that characterized 2008 would soon reverse and releveraging would return to fashion. I was a little early calling the low in the stock market, and the return to releveraging took a lot longer than I thought (see my post yesterday on this subject), but with the benefit of hindsight, dumping cash at the end of 2008 and buying stocks was a very profitable strategy: the total return on the S&P 500 since late December has been about 65%, vs. almost nothing for cash.

So, more than three years later I ask the question again, amazed that it still needs asking: how much longer will the public be content to sit on a mountain of cash? Especially now that the economy has been growing for the past two and a half years, swap spreads are back to normal, corporate default rates have plunged, corporate profits are at record highs, residential construction is beginning to turn up, job growth has picked up, and cash still yields zero? Can the economy's prospects be so dismal that it still makes sense to hold zero-yielding cash in the belief that most other assets will decline in price?

According to ISI, domestic equity mutual funds have suffered net outflows of some $355 billion since Sep. '08, with $155 billion of that occurring since last April, and $6 billion so far this year. While investors have shunned the equity market, the demand for safe-haven cash has been intense. Since September '08, households have socked away just over $2 trillion in bank savings deposits that pay next to nothing (see chart above). Moreover, the banking system has been content to sit on $1.5 trillion of excess bank reserves (see chart below) that pay only 0.25% per year (i.e., the proceeds from the sale of MBS and Treasury notes and bonds to the Fed). Apparently, there is still lots of fear out there, and there seems to be no shortage of gloom and doom predictions.

But turning a blind eye to the alternatives to cash requires a deep conviction that the future is going to be miserable. Consider: the average yield on investment grade corporate bonds is over 4%; REITS are yielding 4%; the average yield on BAA corporate bonds is over 5%; the average yield on junk bonds is over 7%; and the earnings yield on the S&P 500 is over 7%.

Ignoring those very attractive yields in favor of zero-yielding cash also means paying no attention to the Fed's very explicit desire to convince the public that holding cash makes no sense at all, and it's only a small logical leap to the corollary that borrowing money makes lots of sense. It rarely pays to fight the Fed.

Deleveraging is history

These two charts may look pretty similar, but they represent two very different things. The top chart shows total outstanding Commercial & Industrial Loans (a proxy for bank lending to small and intermediate-sized businesses), while the bottom chart shows total outstanding consumer credit. Both started to decline in late 2008 as the economy cratered, the financial system was virtually paralyzed, and consumers were clobbered by collapsing home and equity prices. Consumers and businesses struggled valiantly to deleverage and de-risk, and banks were happy to oblige, not anxious at all to increase their lending at a time when every borrower was suspect and most banks were teetering on the verge of insolvency.

Things started to change about a year ago. C&I Loans are now rising at an 11% annual rate, and although consumer credit is up only 3.7% in the past year, it was up at an annualized rate of 7.8% in the final three months of last year. (Both series are seasonally adjusted)

One important thing about the releveraging activity that we see here is not that it will directly boost the economy, because more credit does not necessarily equate to more growth. More credit today means that everyone—businesses, consumers, and banks—feels more comfortable about taking on additional risk. It's a measure of rising confidence, and that bodes well for future growth. It's also important because it means that financial markets are functioning more normally. Credit expansion can't create growth per se, but it can facilitate growth by more efficiently distributing the economy's resources from savers to investors.

Of course, credit expansion in the context of the banking system's $1.5 trillion in excess reserves could also be the canary in the inflation coal mine—the first sign that banks are starting to use their reserves to create new deposits and thus expand the money supply. M2 has increased by $568 billion in the past seven months, for an annualized growth rate of 11%, which is about double the rate that M2 has averaged over the past 15 years. Too much of this sort of credit expansion could eventually be a bad thing. So far, however, we are only in the early stages, and I see it more as a harbinger of a healthier economy than of any significant near-term rise in inflation.

For now, these charts are additions to the long and growing list of signs that the U.S. economy is slowly and gradually improving.

Calafia Beach winter

This photo was taken a few hours ago as we set off for a walk along the beach. Dana Point is in the upper right, and a piece of Catalina Island can be see in the upper left. Water temp is only 58º, but the air was close to 70º with a light breeze. This is arguably the most beautiful time of the year at the beach.