Wednesday, August 31, 2011

"Cooperative" or "Forced" Federalism? ... No Child Left Behind and ObamaCare

A heavily bipartisan congressional majority enacted No Child Left Behind (NCLB) legislation in 2001, and congressional Democrats passed ObamaCare in 2010.

These acts of Congress are similar in several important respects as each concerns the proper roles of the national and state governments concerning health care insurance and public education. Both of these areas traditionally have been viewed to be within the purview of individual states and not that of the national government.

So let's take a closer look at what this means in a broader sense for all of us. Under the Constitution, "We the People" delegated certain powers to the federal government. At the same time, we reserved to the states and the people (Tenth Amendment) all those powers not granted to the national government. At least that's what we wanted to do, and for a time that's pretty much the way it worked.

Of course, health care and education were not deemed to be among those powers granted to the federal government. Common sense and our country's long history would suggest that individual states and localities are the proper places for such governance. In this regard, most people understand intuitively that insurance and education are properly state and local matters. This is simply the organizational principle of subsidiarity being applied, meaning that decisions are best made at the lowest competent level of any organization, including government

If only it would have been kept as simple as it started out to be, NCLB and ObamaCare wouldn't exist. Sadly, it's developed over time into something else completely, so let's continue our discussion in order to better understand the issues involved.

Our Government and Economics class is currently studying federalism. One descriptive term under study is a concept called "cooperative federalism." In part, here's what the textbook says on page 75, "cooperative federalism is often used to describe the relationship between the state and national governments that developed to administer much of the reform legislation passed during the 1930s and the following decades. Cooperative federalism is based on the recognition that not all problems are best solved by concentrating authority in Washington. This new view of federalism also recognized that the states lacked the financial ability to pay for the social welfare programs that the public demanded."

My view is that his assessment is both incorrect and misleading. Neither the federal government nor the states has a blank check from the citizens to pay for unlimited federal programs. Or state programs either. Besides, the public wasn't "demanding" NCLB and/or ObamaCare.

In my opinion, what the textbook's author calls cooperative federalism would be better labeled "forced federalism." What the Congress has been doing ever since the Depression era, albeit in a most clever manner, has served to bribe or otherwise coerce the individual states into going along with the federal initiatives, regardless of whether the individual states wished to do so. If any individual state chooses not to "go along to get along" with the feds, the fiction of cooperative or forced federalism instead sends the federal subsidy money to those remaining states who do choose to "voluntarily participate." Some freedom of choice that is!

So let's more fully consider forced federalism using the specific examples of NCLB and ObamaCare. In order to avoid taking sides politically, we've chosen separate Republican and Democrat initiatives for our discussion.

NCLB was passed by Congress overwhelmingly with bipartisan support in 2001. President Bush sought and won approval to set standards and measurements to improve public school education and outcomes. The national legislation requires assessment in basic skills to be given to students in certain grades, and if the state doesn't "choose" to participate, it is ineligible to receive federal funding for public schools. The achievement standards are set by each individual state, and to my knowledge, while most states have "dumbed down" the meaning of test results, there has been no meaningful improvement in real student performance over the years. But the governments did succeed in one respect-- they spent the additional monies allocated to the program.

In a similar vein, Congress passed ObamaCare (aka the Patient Protection and Affordable Care Act of 2010), and its many provisions in 2010. Health Care Puts Governors in Pickle explains the rather huge dilemma now facing many Republican governors opposed to ObamaCare. That is, the salient question confronting each governor is the following: "Do they apply for millions of dollars in federal grants by September to begin establishing state-run health insurance exchanges, or let the deadline slide, lose the federal money and risk falling into a federally run exchange?"

{For a discussion of the law's constitutionality with respect to the individual mandate requiring the purchase of insurance by individuals, see our posting dated Tuesday, August 23.}

In other words, governors and states opposing ObamaCare are absolutely between a rock and the proverbial hard place. They certainly want the courts to declare the law unconstitutional, and they also want to elect a president in 2012 who would work to repeal ObamaCare if the courts decide the law is constitutional.

But what if neither happens? Should the states apply for and then take the federal subsidy money? Should they now proceed to adopt a state-run insurance exchange, or should they refuse the federal subsidy being offered because of the strings attached thereto? If any state opts not to take the federal money, it will then go to those states who do "choose" to establish the law's required state-run insurance exchanges.

As the editorial puts it,"The exchanges are the centerpiece of the 2010 health care law, designed to be government-run marketplaces where private insurers would compete to offer health plans to the uninsured and to small businesses at rates subsidized by the federal government. House Democrats and the White House wanted a single national exchange, but senators insisted they be operated by the states. The exchanges are to be running by 2014. But if a state has not made substantial progress by Jan. 1, 2013, the federal government will step in."

Here's what all this says to me.

Our Constitution established a dual government structure which became known as federalism. Some powers were delegated by the people to the national government, whereas others were reserved to the states and the people. However, cooperative federalism was created during the Depression years of the 1930s, and it has resulted in ever growing national government grants-in-aid to states and, therefore, an ever growing level of national and state spending.

Since we don't have the money that we spend, either at the national or state level, the result is that we borrow more and more, and our debt levels continue to climb.

My further view is that cooperative federalism is a fiction, and while perhaps an ingenious concept, it is contrary to the intention and plain meaning of the language of the Constitution. It's also inconsistent with the principle of federalism and subsidiarity, as well as sound financial management.

Perhaps the biggest lesson for us is that we elect the congress and the president. In the end, we'll get the government we deserve, and that government will bend to our political will. So will those who serve on the Supreme Court.

The powers of the national government have been allowed to expand greatly since the Depression years of the 1930s. But now it's time to reinstitute all those good ideas articulated so very well in the Constitution by the Founding Fathers. Pogo says it's time to speak up and speak out loudly, too.

Thanks. Bob.

Tuesday, August 30, 2011

More Tax Revenue for Government ... Raise the Gas Tax Dramatically

The Clear Case for the Gas Tax urges politicians to maintain and even increase gas taxes when current legislation expires at the end of September. Unlike most other ideas about raising taxes, this one actually makes sense.

{We'll set aside for now the "regressive" nature of gas taxation herein, even though raising gas taxes meaningfully would have a disproportionate impact on those who are poor. The underlying assumption being used is that the regressive impact of the additional gas tax would be offset by adjusting other taxes, such as income taxes, to achieve the desired equitable result.}

In fact, we should implement up to a $2 per gallon increase in the federal gas tax, which would in turn be offset in its entirety by income tax reductions. This rather extreme idea admittedly is not likely to be embraced by either Democrats or Republicans. Since I'm not running for elected office, however, please listen to the straightforward logic behind such an "outrageous" proposal.

As background information, gas taxes at the federal level of 18.4 cents-a-gallon haven't been increased since 1993. My proposal would be to increase them over time to $2.184 cents-a-gallon.

Simple common sense and elementary economics suggest that, all other things being equal, if we charge more for something, we'll buy less of it. And similarly, if we charge less, we'll buy more. That holds true for both taxes and consumption.

At the margin, accordingly, if we increase the tax on work and investing, we will get less of it. Thus, the higher we raise income taxes, the less people will be inclined to work and invest. The logic works equally in the other direction as well. The more we lower the income tax, the higher will be the work and investment.

Now let's apply the exact same logic to oil and gasoline pricing and consumption. Raising gasoline taxes would generate more government revenue and less oil consumption, resulting in fewer imports of foreign oil from our "friends" in the middle east and elsewhere.

The politicians don't seem to want to allow the oil companies to greatly expand drilling for more oil and gas domestically, so let's use less of it instead. Much less, in fact.

To offset the negative impact on this tax increase on the economy, any dollars generated from higher taxes on oil and gas consumption would be used to lower income tax rates. Thus, we'd end up with a clearly positive effect on the overall growth prospects for the U.S. economy.

As a separate but related matter, we could ask the taxpayers how they feel about more domestic drilling and the jobs and oil it would bring to our economy, too. There is no doubt in my mind that most people would vote to increase drilling if given a chance to do so.

So here are the top ten reasons behind the raise the gas tax dramatically proposal. Maybe you have others.

(1) Less oil and gas consumption resulting from (2) higher domestic drilling and (3) less foreign oil imports combined with (4) higher oil taxes of several dollars per gallon offset by (5) lower income taxes gets us a (6) faster growing economy that is less dependent on (7) buying oil from our "friends" in the middle east and elsewhere, thereby (8) making us less dependent on foreign oil and (9) enabling more Americans to stay home with their families and go to work rather than go to the middle east and (10) be in harm's way while there.

To recap, the idea is simply to do the following: Increase gas taxes by several dollars per gallon and offset that additional revenue with an income tax reduction, thereby encouraging more of what we want (work and investment) and less of what we don't want (foreign oil).

Then we could add to the foregoing the good sense of the voting public and increase domestic oil and gas drilling at the same time.

This would all tend to lower the overall price of imported oil considerably and maybe "sober up" our friends from the middle east at the same time. In turn we would provide more domestic jobs and a lesser need to send troops to the middle east to protect our so-called friends so OPEC can raise our gas prices, thus harming our national security and economic growth as well.

See how simple, if not easy, things like this could be if we had a little leadership in Washington?

Thanks. Bob.

Monday, August 29, 2011

Communal Resources ... The Rhinoceros

Rhino Horns Put Europe's Museums on Thieves' Must-Visit List is a timely and informative story about the rhinoceros and its very valuable horn. {For those studying economics with us, this very subject is covered in Chapter 2 of "Naked Economics."}

The broader subject deals with the unique problems associated with preserving "communal resources," meaning those resources not owned by anybody. Specifically, depletable resources such as ocean fish, gorillas in the wild, and the rhinoceroses of southern Africa present very real problems for preservationists.

Our general society may wish the soon-to-be-extinct-species to be a part of our world forever, but we don't act that way. The "communal resources" issue is our discussion topic for today.

The rhinoceros story says something meaningful about human nature, incentives, crime and free riders.

Communal resources present any society with special problems, especially if the resources are valuable, scarce and depletable. In this case, the rhino horns of southern Africa are also illegal to sell.

With respect to the question of value, the rhino clearly is worth much more dead than alive to the impoverished people of the area. Thus, there is no reason for the nearby citizens of southern Africa to help its government stop the poaching.

To the contrary, local citizens may have some incentive to see the rhinoceros both hunted and extinguished. This could be due to the citizens' safety concerns (would you want a rhino in your back yard?), and/or because the hunter may be willing to pay the villager a substantial sum of money to help hunt down the rhinoceros and its valuable horn.

As a result, the villagers' incentives favor the poachers taking horns instead of preserving the endangered rhinoceros. Similar to the sale of of many illegal drugs in our country, the horn of a rhino sells for a high price since it is valuable, illegal and scarce.

Of course, as with any such illegal activity, that means there is an economic argument for legalization. Legalizing the activity would bring down the price per horn and maybe enable to government to provide monetary incentives to villagers to protect the neighborhood rhinos from poachers, but that's another story.

Now let's discuss briefly the "free rider" problem. Many people will sympathize with the plight of the rhino but will sit passively on the sidelines, while hoping that somebody somewhere will do something to save the rhinos from extinction. If such a good deed is done by someone, then all of us roadside sympathizers will have achieved what economists call "free rider" status.

Being a free rider simply means that while we won't actively intervene to save the endangered species, if somebody else intervenes, then all people will benefit from those actions. Free riders get the benefit of another person's actions while incurring none of the costs. The costs are borne entirely by the one who intervenes on behalf of the community.

In such cases, all innocent and passive bystanders get a "free ride." However, if no such free ride presents itself, the illegal poaching and selling will go on until there are no more horns to hunt. Then the rhino will be no more, and the species will become extinct, even though that's not the desired outcome sought by anybody. Not even the poacher.

Obviously government has a legitimate role to play in these situations. If government effectively regulated or otherwise incentivized the villagers to help preserve the rhinoceros, the poachers would have an opponent.

But since the government may be without funds or its officials may be susceptible to bribes by the poacher community, all human incentives now seem to go against the rhino's preservation. And if no such human incentives are on the side of preservation of the species, the rhino doesn't have a chance.

In the above referenced story of Rosie the rhinoceros, the thieves didn't bother to go to southern Africa to replenish their supply of stolen rhino horns. They simply went to an English museum instead. While there, they stole a rhinoceros horn that had been on continuous display since 1907.

Why did they do it? They did it for the money, of course, and perhaps also because they believed a trip to the museum to be less risky than going to southern Africa.

And the value of an ever more scarce rhino's horn? Currently it's $200,000.

Thanks. Bob.

Saturday, August 27, 2011

Apple Computer, Steve Jobs and Creative Destruction

The presence of Adam Smith's "invisible hand" in free market based economies implies, even requires, that there will be "creative destruction," a term credited to Austrian-American economist Joseph Schumpeter.

Creative destruction simply confirms that innovation is an inherent part of capitalism, a process that rewards winners and crushes losers. Although the short term effects of competition are often brutal, creative destruction is a definite positive economic force for the long run.

Of course, the problem is that we live in the here and now. So when factories close and jobs are lost, Wal-Mart's arrival puts the local retail store out of business, cars replace the horse and buggy, typewriters are obsoleted by personal computers, cell phones replace land line phones, and so on, many very real people are affected immediately and negatively. But that's the way competition and innovation work.

Schumpeter taught that an integral feature of market based economies is change, or constant innovation. These improvements inevitably lead to an out-with-the-old-and-in-with-the-new effect, or the utter destruction of the status quo. Creative destruction not only does happen in a competitive market, but in fact it has to happen. Capitalism is sometimes brutal in the short term, especially for those on the losing end.

As an example, Sam Walton of Wal-Mart put lots of small and big retail competitors out of business. Similarly, Apple Computer and Steve Jobs have had a profound impact on the "losers" in the digital revolution with Macs, iPhones, iPads and iTunes, for instance.

The Importance of Jobs says this about what we can learn from entrepreneur Mr. Jobs, "One lesson here is that most successful business leaders often have many failures, large and small, along the way. The difference is that they learn as much from failure as they do from success. Another lesson is that the future belongs to risk-takers, who sense opportunities when others sense only folly or danger." See also Where Some Earn Enmity, Jobs Won Affection.

Later, it goes on, "Mr. Jobs's career is also proof of that classical economics concept known as Say's law--in distilled form, that supply can create its own demand. We live in a time when government, urged on by our most famous economists, has devoted trillions of dollars to reviving growth by conjuring consumer demand....But the real sources of prosperity are breakthroughs that create products or services for which there is no current demand....The current economic malaise has made Americans doubt our ability to grow and prosper as the country always has. As long as we remember that the source of that prosperity comes not from government managers but from restless, relentless individuals like Steve Jobs, we will."

Schumpeter long ago described the driven entrepreneur as possessing the impulse "to succeed for the sake, not for the fruits of success, but of success itself.... the joy of creating, of getting things done, or simply of exercising one's energy and ingenuity." Jobs fits that description well.

In a recent posting, we compared the competing views of Adam Smith the capitalist and Karl Marx the socialist. Smith would have identified closely with Steve Jobs, as would have Joseph Schumpeter.

Karl Marx would not have liked Mr. Jobs at all. Nor, I strongly suspect, would Jobs have thought much of Marx.

Thanks. Bob.

Friday, August 26, 2011

Government Fairy Tales and Keynesian Economics

In early September, President Obama is going to disclose to the nation and world his newest plan for getting our economy back on track. Again.

My guess is that the president's proposals will endorse new government spending initiatives in an effort to stimulate aggregate demand in the economy. Assuming his proposals are indeed based on this old style Keynesianism, they simply won't work. But let's continue.

Although at this time we can't know what he'll propose, of course, we can guess. We should reasonably expect that he'll tell us he's going to do everything possible to get people back to work and the economy growing. And that the Republicans should endorse his efforts. The president will further advise that this effort will also require some additional government "stimulus" or "investment" spending programs of some kind.

Haven't we already seen this movie? As I recall, the original stimulus program a few years ago was billed as necessary to keep unemployment from getting as high as 8%. Today it's more than 9%.

Of course, the Republicans will have their credibility issues, too. They'll insist that they are going to bring fiscal discipline to the table, but that they will not be able to seriously discuss, let alone address, our all-too-expensive entitlement programs and other initiatives until after they win next year's election.

And if in the end the two sides manage to reach some kind of deal, which they probably will, they'll all proudly say that they will "pay-for-it" by reducing other expenditures to make room for the additional short term "stimulus".

Here's the fundamental problem with all this happy talk.

Our government's financial condition gets worse with each passing day. We already borrow 40 cents of every dollar we spend at the federal level. Thus, even if we "pay" for the next program's expenditures by reducing other planned spending, we'll simply be borrowing money to spend on different things. All signs point to our national politicians continuing to spend too much in the years ahead (What Austerity?).

We will still have an enormously huge debt overhanging our society. The politicians won't talk much, if at all, about what they propose to do about that elephant in the room.

The statistics are stark and telling. As individuals we are much too heavily in debt. Our financially weakened states are dependent upon the federal government for 30% of their spending. Meanwhile, the federal government is getting 40% of what it spends by additional borrowings.

So the president's position will be this; we have no money of our own to spend, but we'll stimulate our economy by borrowing and then spending even more money in the form of what we'll call "stimulus" or "investment" funds.

Keynesianism emphasizes the stimulus of aggregate demand. It's a fairy tale story which says that we can borrow and spend money to drive demand, which will then return to our economy more money than we borrowed and spent in the first place.

The political argument is that performing this Keynesian magic trick will drive our economy forward and deliver needed economic growth. But, of course, it will do no such thing!

Keynesian Economics vs. Regular Economics by Robert Barro, a Harvard economics professor, exposes this too-good-to-be-true fairy tale for what it is. He talks about the so-called economic "multiplier" effect of food stamp spending programs and concludes that this Keynesian "miracle" is pure nonsense.

Specifically, Agriculture Secretary Tom Vilsack asserts food stamps are an "economic stimulus" and that every dollar spent on food stamps will magically increase overall economic activity by $1.84. In other words, government borrows $1 for food stamps, and the economy benefits by $1.84. We can call this fiction the "no pain, all gain" plan.

Unfortunately, free lunch programs (aka Keynesian economics) will likely be a significant part of what the president will be selling us in September.

In comparison, here's the counterpoint. Self-described "regular economics" proponent Professor Barro sees it a bit differently, "The overall prediction from regular economics is that an expansion of transfers, such as food stamps, decreases employment and, hence, gross domestic product. In regular economics the central ideas involve incentives as the drivers of economic activity. Additional transfers to people with earnings below designated levels motivate less work effort by reducing the reward from working."

He goes on, "In addition, the financing of a transfer program requires more taxes--today or in the future in the case of deficit financing. These added levies likely further reduce work effort--in this instance by taxpayers expected to finance the transfer--and also lower investment because the return after taxes is diminished."

Then he adopts a somewhat conciliatory and normative approach, "This result does not mean that food stamps and other transfers are necessarily bad ideas in the world of regular economics. But there is an acknowledged tradeoff: Greater provision of social insurance and redistribution of income reduces the overall GDP pie." { It makes complete sense to separate normative from positive economics when discussing food stamps or similar programs.}

Later Professor Barro offers another example of "perverse incentives", or the law of unintended consequences, at work, "Ironically, the administration created one informative data point by dramatically raising unemployment insurance eligibility to 99 weeks in 2009--a much bigger expansion than in previous recessions. Interestingly, the fraction of the unemployed who are long term (more than 26 weeks) has jumped since 2009-- to over 44% today, whereas the previous peak had been only 26% during the 1982-83 recession. This pattern suggests that the dramatically longer unemployment-insurance eligibility period adversely affected the labor market."

Barro then wraps up his attack on Keynesianism, "There are two ways to view Keynesian stimulus through transfer programs. It's either a divine miracle--where one gets back more than one puts in--or else it's the macroeconomic equivalent of bloodletting."

Thus, when the president's new economic plan is revealed in September, let's listen carefully. Even if we choose to believe that his intentions are good, and not in any way based on politics or with an eye toward the 2012 election, it behooves us to understand the logic behind his proposals.

In the interim, here's hoping that not one of his proposals is based on fairy tale Keynesian macroeconomics and the free lunch syndrome. That wouldn't help us out of this mess. Not at all.

Thanks. Bob.

Thursday, August 25, 2011

The Competing Views of Adam Smith and Karl Marx

Let's compare the competing views of Adam Smith and Karl Marx. Each urged different paths to a society's prosperity.

(1) Smith embraced the idea of the freedom of each individual acting in his own self interest as the path to general prosperity.

(2) Marx endorsed the authority of the collective whole as the way to general prosperity.

An Englishman, Adam Smith wrote "The Wealth of Nations" in 1776. This classic book marked the beginning of what is now known as the school of classical economics. Smith has influenced the movements of free market societies worldwide, and especially ours.

A German, Karl Marx was a socialist and is generally acknowledged as the father of communism. Along with Friedrich Engels, he co-authored "The Communist Manifesto" in 1848. His teachings have influenced socialist movements worldwide.

Suffice it to say that in a very fundamental way they saw things differently.

Smith's views were the ideological foundation for modern capitalism, individual freedoms and market based economies, whereas Marxism stands for socialism and communism.

We'll begin with Smith.

An important contribution of his is the example of the dramatic productivity effects associated with the division of labor in a pin factory (click here). This is a classic and is worth reading.

Although mentioned only once in "The Wealth of Nations", perhaps Smith's greatest contribution to our understanding of economics resulted from his description of the "invisible hand" at work. Smith described the invisible hand thusly:

"....every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good."

Today something much more general is known by the words "invisible hand". It's the result of a process where the outcome is produced in a decentralized way with no explicit agreements between the acting agents. In addition, the process is not intentional. The actors' aims are neither coordinated nor identical with the outcome, which is a byproduct of the actors' aims.The process works even without the agents having any knowledge of it. That's why it's called invisible.

In another place, Smith offered another example of the invisible hand at work, "It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest."

To sum up Smith's thinking, the system in which the invisible hand works best is based on free individuals operating in a free market. Consumers want the lowest price, and entrepreneurs want the greatest profit. Thus, by making their excess or insufficient demand known through market prices, consumers "direct" entrepreneurs to invest in the most profitable industry.

Self-interested market participants make the world go around, and free markets make the world a better and more prosperous place for freedom loving individuals.

Now let's turn to Marx.

At the other end of the ideological spectrum from Smith, Marx is known as the father of socialism and advocated the collective ownership of society. He believed that the following economic system would best serve any society, "From each according to his ability, to each according to his need." His view was that an abundance of goods will be the result of a developed communist society. Therefore, the idea is that a collectivist approach or system of socialism will produce more than enough to satisfy everyone's needs.

Marx believed that capitalism will inevitably be replaced by socialism, thus leading to communism. In his view, private property ownership will be superceded by the cooperative and collective ownership of property. Marxism teaches that capitalism is oppressive, and workers will unite in revolution against it, thereby leading to a workers' paradise in the end.

The reality; Marxism never has gotten past the dictatorship stage, which supposedly precedes and leads to the promised workers' paradise.

The reason Marxism wouldn't work, even if ever tried, isn't very complicated. It's due to human nature. Simply stated, a person won't work hard and to his full ability if he will receive no reward for having done so.

To put it in personal terms, if you just sit there, I won't work harder than you do just so you can have everything that I have. Neither will you do the same for me. We're just too human, I guess.

Although socialism and communism are abject failures, capitalism clearly isn't perfect either. Not by a long shot.

Winston Churchill described the differences between the two competing systems as follows, "The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries."

That sums it up nicely.

Thanks. Bob.

Wednesday, August 24, 2011

Taxes and the Principal-Agent Problem


Government gets its revenues by taxing its citizens. Nothing complicated about that.

As individual citizens we are likely to spend our money (MOM) more wisely and with more care than government officials will spend what starts out as our money, but after being transferred to government, then in effect becomes other people's money (OPM). Nothing complicated about that either.

Through its taxing power, the government takes our money away from us and spends it as it sees fit. To repeat, this OPM will be spent more ineffectively, inefficiently and with more waste than had we kept it and spent it ourselves.

When we then factor in the intermediary costs (commission or handling costs) of government acting in its capacity as middleman, the cost of spending the original MOM, which next becomes OPM, and then is ultimately spent by the "middleman", becomes quite high indeed.


As an example, in economics the principal-agent problem arises when the individual employee's interests aren't properly aligned with those of the owner, the owner being the principal and the employee being the agent. Thus, a principal is always well advised to see to it that the interests of his employees are aligned with his own.

Here are a few illustrations of the principal-agent problem at work. When employees don't work harder than the minimum required, or retail workers are tempted to steal from the cash register, or CEOs don't act in the long term best interests of the company's owners, or officials of various organizations don't act in a fiduciary or stewardship manner with the resources and funds entrusted to them, these all serve as good examples of the principal-agent problem. Of course, there are countless others as well.

As a simple matter of fact, whenever there is a principal and an agent, there is a potential problem of not properly aligning their interests. If such a misalignment occurs, the result will generally be ineffective and inefficient (let alone optimal) results for the costs incurred, whether those costs be stated in terms of money, time, effort or judgment.


Now let's move back to two specific questions concerning taxes. (1) Should the so-called "millionaires and billionaires", aka the 3% of the people earning more than $200,000 and who pay ~50% of the total income taxes already, pay even more in income taxes, as advocated by our president and Warren Buffett? (2) Or is that even the right question to ask, at least initially?

My Response To Buffett And Obama is an editorial commentary by the retired CEO of American Express. Therein he disagrees strongly with Buffett's and Obama's assertion that taxes on him or any other citizens should be raised any time soon.

In the editorial, Mr. Golub makes some broader points about taxation and asks some pointed questions as well. I hope you will take the time to read and reflect on what he has to say about taxes, government and citizenship.

Here's part of what bothers him about our current tax collection system and the way our taxes are subsequently spent, "....the unfair way taxes are collected, and the violation of the implicit social contract between me and my government that my taxes will be spent---effectively and efficiently---on purposes that support the general needs of the country."

Here are additional problems that he has with our present chaotic mess of a tax system: (1) Gifts to charities are deductible but gifts to grandchildren are not. (2) Mortgage interest deductions support the private housing industry at the expense of renters. (3) Generous fringe benefits are not taxed at all, in order to support union and government workers at the expense of people who buy their own insurance with after-tax dollars. He describes many others of a similar nature.

With respect to taxes, Golub defines both the duty and track record of government this way, "Governments have an obligation to spend our tax money on programs that work. They fail at this fundamental task."


As citizens who pay taxes, what exactly is the nature of our relationship with the government? Should we be willing to pay more in taxes, based on how these monies are currently managed and spent? That brings us directly to the principal-agent problem.

The principal-agent problem is front and center in the tax and spend relationship between citizens and our elected representatives. We citizens are the principals and government officials are the agents.

Here's my exact point. If we individually are likely to do a better job when deciding how to spend our own money than government officials will, we should be reluctant to turn it over to government without compelling evidence that it's the right thing to do.

Why give our money to our agents to spend as they see fit? In my opinion, MOM thinking trumps OPM wasting every time. All taxes begin as MOM and end up as OPM, with a government commission in the middle.

So let's be careful about what we do with our money. In the case of taxes, how much government are we all willing to pay for, regardless of where the money comes from? And how much money are we willing to waste? And how willing are we to substitute the judgment of OPM thinking for MOM?

Can't we be a little more self-reliant? Can't we trust ourselves to try to do the right thing?

So we should always require the government to commit to act responsibly with what we entrust to them. And even with such a commitment, we need a strong monitoring device to ensure that promises made are in fact promises kept. After all, their track record isn't so good.

If we adopt a starve the beast attitude and approach toward government spending, thereby requiring our "stewards" or "agents" in government to spend both wisely and transparently, we will begin to reverse the ever growing tendency toward government growth.

That would be a great start toward sanity and fiscal responsibility. MOMs everywhere would like the result.

We hear a lot about how much more we need in taxes. Why not discuss instead how much federal government spending has grown since the Depression years? In that regard, here's something you may not know and which the politicians aren't likely to volunteer anytime soon.

Government spending was ~4% of our GDP (gross domestic product) in 1930 and grew to ~10% by 1940 by the end of the Depression years. Now it's ~25%.

Republicans want to bring it down to what they call a "historical and normal" ~18%-20%, but why stop there? Why not something closer to 15% over time? That would be a 40% reduction from current levels. MOM advocates would really like that.

Admittedly, moving methodically along the way toward fiscal sanity would require a radical change in our entitlement programs and related spending. Medicare, medicaid and social security, deductibility of charitable contributions, mortgage interest deductibility and other subsidies would all come under scrutiny, for sure.

But all that government spending starts out as MOM. It makes no sense, at least to me, to willingly convert MOM into OPM without a very good reason. History teaches that we have no such reason to perpetuate our wasteful OPM ways of today.

Thanks. Bob.

Tuesday, August 23, 2011

Patient Protection and Affordable Care Act of 2010 (Obamacare); Constitutional?

Is the Patient Protection and Affordable Care Act of 2010, aka ObamaCare, constitutional?

Here's one very specific constitutional question ruled upon recently by the Atlanta based U.S. Court of Appeals: Can Congress compel Americans to buy and maintain health insurance? The appeals court answered no.

That straightforward "individual mandate" question, perhaps among others, is what is likely to be ultimately decided by the Supreme Court.

How are we to know whether the various provisions of the health care law are going to be upheld or struck down by the Supreme Court? First, we look to the Constitution.

The Constitution is the "supreme Law of the Land" as specified in Article VI, Section 2. As such, the interpretation of its provisions will be dispositive with respect to the constitutionality of the national health care legislation enacted in 2010.

But who decides what the Constitution means with respect to whether the actions of the Congress in enacting the health care law will pass constitutional muster? The Supreme Court decides on matters of constitutionality. That authority was clearly spelled out long ago in the case of Marbury vs. Madison in 1803 and is known as the doctrine of judicial review.

Now that it's clear that the current ObamaCare case and the constitutionality thereof is likely to be decided by the Supreme Court, what constitutional language is relevant to the case at hand? The relevant language is found in Article I, Section 8 and grants Congress the power regarding "regulating commerce .... among the several States". The court's interpretation of these six words as applied to the health care law will determine that law's constitutionality.

Hence, the issue to be decided is simply this: do those six words empower Congress to require Americans to buy health insurance as part of its authority to regulate interstate commerce?

Or is that power to decide whether to buy or not to buy health insurance beyond the powers belonging to the federal government? Does it instead reside within the states or the people as provided in the Tenth Amendment?

During the past 223 years the U.S. Constitution has been a much analyzed and interpreted document. It stands as the longest standing written Constitution in the world today. As such, its basic contents are worth knowing.

The recent decision by the U.S. Court of Appeals in Atlanta (ObamaCare's Latest Judicial Defeat) rejected the constitutionality of the "individual mandate" provision of the new national health care law. The case will almost certainly be appealed to the Supreme Court for a final decision.

In addition to ObamaCare's importance to Americans generally, the court case has all the necessary ingredients for a good lesson in both constitutional law and the workings of government.

As in any judicial dispute, there are differing points of view which will be argued by the respective parties, fully considered and then decided by the nation's Supreme Court. In brief, these are the basic competing arguments.

(1) The lawyers on the side representing 26 states argue that Congress does not have the power to force people to buy insurance. In part, they argue, "In fact, the individual insurance mandate does not regulate commerce. It imposes a freestanding obligation that must be satisfied regardless of whether one is engaged in commerce." Thus, they argue the law is unconstitutional. The U.S. Court of Appeals in Atlanta agreed.

(2) Government lawyers on the other side take the position that Congress does indeed have such authority and that "the failure to have congressionally prescribed insurance is the result of an "economic decision" (whether or not to purchase the required insurance). Accordingly, Congress can regulate that decision making by individuals because such "economic" decisions affect commerce." The Atlanta court disagreed.

Now the Supreme Court will decide, assuming it takes the case, and I believe it will. But whether the Supreme Court will render its decision prior to or after the 2012 presidential election is very much an open question. That's for them to decide.

Before looking at the actual case more closely, let's first review some relevant background.

We have had a constitutional form of government since the Constitution's ratification in 1788. The Constitution followed the Articles of Confederation which were in effect from 1781-1788.

Our constitutional system of government provides for a national government and fifty state governments as well. 51 sovereigns in all.

Because the Founding Fathers embraced a system of popular sovereignty (We the People), all governmental power flows from the people. The Tenth Amendment provides that any legislative power which isn't delegated to the national government (aka enumerated or express powers) in Article I is either "reserved" to the various states or to the people, respectively.

Thus, if the power is not given to the legislature, it's reserved to, or retained by, the states or the people.

To repeat, one such express or enumerated power delegated or granted to the legislative branch involves the regulation of interstate commerce. Article I, section 8 gives the Congress the power to regulate interstate commerce.

In another place, the Tenth Amendment states in its entirety, "The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the People."

Thus, unless the power is granted to the national legislature, it's retained by either the states or the people. Period.

The Constitution also separates the powers of the three distinct branches of government and provides checks and balances between those branches as well. While the legislative, executive and judicial departments are each independent, their various powers are checked by the other departments.

Now let's put this all together.

Congress enacted a health care law of historic proportions in 2010, and the President signed it into law. Both believed its passage to be within the constitutional powers of Congress.

However, at least 26 states believe the entire law, or portions thereof, is not among the legitimate powers granted by the people to Congress in the Constitution. These states are now challenging the constitutionality of ObamaCare in the federal courts.

Using the very same document that has been the supreme Law of the Land since 1788, we will get a decision by the third branch of government, the judicial branch, as to who's right about the new health care law and its enforceability. Congress and the President, or the states and the people.

The national government and many individual states are on different sides of this dispute. In the end, the Supreme Court will provide the answer. (Thereafter, of course, the legislative branch could choose to enact further legislation, but let's stay with the present situation today.)

{There is a fundamental economic aspect to this individual mandate provision, too. To add even more complexity to the case, without the individual mandate, the economics of affordability would be difficult, to say the least. In that instance, the new health care finances would hardly be "affordable", due to adverse selection. That is, if people elect not to buy insurance unless and until they get sick, premiums collected from those covered will be considerably less than otherwise. Without receiving those ongoing premiums from the healthy young who are mandated to buy whether they want to or not, the total costs of ObamaCare will likely be much higher than predicted when the law was passed.}

In the end, the Supreme Court will ultimately rule. Let's all hope that in the future the Congress is more careful about using the "commerce clause" to do whatever it wishes with respect to usurping both the constitutionally protected rights of individuals and the various states as well.

For now, the decision by the Atlanta based U.S. Court of Appeals is a victory for those believing that the enumerated powers provision of Article I, Section 8 still stand for something, and that the Tenth Amendment does as well.

And in any event, this is a good lesson in how our governmental powers are granted, restricted and adjudicated, all in accordance with a 223 year old document, as interpreted from time to time.

Thanks. Bob.

Monday, August 22, 2011

Sustainable Economic Growth is the Only Way Forward

The single biggest issue facing us as a nation is achieving sustainable economic growth. For a good refresher of why this must become THE focus of all Americans, A New Strategy for Economic Growth is worthwhile reading.

Try as we may, we simply can't cut or save our way to prosperity. That said, we must reduce wasteful and unnecessary government spending as much and as fast as possible, too. This applies to both the long and short run as well.

First, let's remind ourselves of the completely obvious, because as newscaster Edward R. Murrow once said, "The obscure we see eventually. The completely obvious, it seems, takes longer."

Speaking of the adverse effects of taxation, here's in part what the father of legendary investor Warren Buffett had to say in 1956 (Notable & Quotable), "The part of his production taken from the producer cumulatively increases the power of the federal government proportionately with the increase in its income. This power is not created; it is simply taken away from the people...."

Thus, the "completely obvious" is merely that the private sector provides all the economic growth. Not the public sector. The less the amount of money the government removes from the private sector, the more the economy will grow and the more our citizens will prosper.

Today the private sector has enormous issues to overcome in order to achieve "normal" economic growth. For the good of all Americans, our government officials must stop demonizing the private economy and instead support it in every conceivable way. We all need to get back to the business of business, while encouraging individuals to reduce household debt levels at the same time.

This walk and chew gum approach in the short term will be somewhat difficult, but it is vitally necessary to restore much needed strength to our American economy.

What is referred to as the paradox of thrift means that acting to reduce the excessive household debt levels of today will constrain economic activity in the future. Even though this deleveraging process will take several years, it's imperative that it gets done. When completed, economic growth can then resume at historical or even higher rates. How Far Should Consumers Unwind Debt? is a good discussion of where we are and how far we have to go.

To repeat, the household sector has meaningful future spending constraints due to today's historically large debt burden. This excessive debt is primarily but not exclusively related to real estate. To make a bad situation worse, the debt is often greater than the current value of the house that was purchased with the borrowed money. Thus, underwater mortgages are the new normal for millions of our fellow citizens. But it's even worse than that.

As so many of us have borrowed from the future to spend today, something called "reversion to the mean" is now underway. A simple illustration is that if we assume we earn $100 and spend $80, we will increase savings by $20. But if we earn that same $100 and spend $125, we will need to borrow $25. What that means for future economic growth is profound.

In the first instance, we had acquired $20 to invest in productive assets. In the second, we end up with a debt of $25. In turn that debt needs to be repaid, and that debt will incur interest charges until repaid. That's pretty much where too many of us are today.

In this context, reversion to the mean simply acknowledges that we will spend no more than we earn over time. If we've been spending $80 of our $100 in earnings, we're saving and investing for the future. But if we're spending $125 of our $100 in earnings, we're developing a big problem with respect to future spending capability.

In addition to limiting spending to what we earn going forward, as debtors we would then have to reduce spending much more in order to pay back the money, plus interest, that we borrowed for our past spending spree. The math for our $100 per year earner works thusly; if in year one we spend $125, we need to reduce spending in year two to $75 from $125. That's a year-over-year 40% reduction in spending.

Of course, we won't reduce spending by 40% or more in any one year, but we will need to cumulatively reduce spending by that amount over time. In the interim we have to pay the ongoing interest charges, too.

In simple terms, the foregoing example tells us why consumer spending isn't going to be much help with achieving strong economic growth for several more years at least. Since historically consumer spending accounts for ~70% of our nation's economic activity, that makes the get-more-growth objective even more difficult.

This pretty much summarizes the probable slow to no growth scenario for a long time to come.

We have the effects of many years of bad habits to overcome. The accumulated government debt and deficits will need our attention, but we also need to remind ourselves of one straightforward fact. The only realistic way to solve this debt driven dilemma is to do everything possible to foster economic growth in the private sector.

Since our economy depends largely (much too much, I would argue) on consumer spending, lower than "normal" consumer spending levels will result in a subpar economy for the foreseeable future. This household deleveraging process is necessary, but it will take time. Lots of time.

Accordingly, we'd be well advised to get started right now on this do-all-we-can-to-get-the-private-sector-to-grow-the-economy goal. Time's a wasting.

Thanks. Bob.

Sunday, August 21, 2011

The European Problem

The United States is a sovereign nation with a dollar currency.

The euro zone is not a sovereign nation, but it has a common currency. Thus, there are many sovereign-states in the euro zone with one common currency, the euro.

Therein lies one big European problem. The European single currency, multi-sovereign approach simply isn't logical. That said, an immediately effective solution will be difficult to achieve, if not impossible. That's because there is no fiscal or political union within Europe, and therefore no European political decision making body.

So it's a mess. While the finances, debts and obligations of each sovereign are its own, the currency is a shared one. Although each country (Germany, France, Italy, Spain, Greece, Portugal, Ireland and so on) is responsible for its own spending and taxation, none has the power to alter the price of its currency. It's an untenable situation.

Typically when a sovereign country can't pay its bills, it doesn't go bankrupt, as do individuals and companies. Unless the sovereign chooses the path of outright default, it can accomplish the same thing as bankruptcy by debasing or otherwise inflating its currency. However, this method of currency devaluation is not an option for countries having the euro as their common currency.

Now let's bring the multi-national banks into the story. When there are sovereign-debt problems, there are always going to be related bank solvency problems as well. The banks are the ones holding the debt of the sovereigns (and each other, too) that borrowed the money which they now can't repay.

And when and if the sovereign defaults on its bank loans outstanding, the banks get stuck with the losses. That in turn means the banks will be less able to service their own debts. As a result, their solvency is often at risk, too. This is called counterparty or default risk, and it's now a huge one for the banks, especially European banks, who loaned to the financially weak sovereigns.

Here's what then can happen. A race for the exits ensues as all of the banks try to rid themselves of this sovereign debt as well as the debt of other banks who hold sovereign debt as well. In other words, all bank swimmers try to get out of the pool at the same time. It amounts to a simple and widespread run on the sovereign and many of the multi-national banks as well. When such a "run" occurs, the result is instability and chaos. This can then turn into a nasty global recession. Not a pretty picture and one to avoided, for sure.

As an example, we'll use Greece, one of the weakened European PIIGS (Portugal, Ireland, Italy, Greece and Spain). For self inflicted wounds, Greece is financially now a dead man walking, being insolvent with no realistic hopes of getting back on track economically. It needs rescuing in a big way. But who will rescue Greece and then the other PIIGS, should the dominoes start to fall in a widespread manner?

How about Germany coming to the rescue? It is relatively strong compared to all other European countries, but the German citizens don't want to bail out the Greeks (would you?). Still, Germany doesn't want the euro to implode and chaos and a serious continent wide recession to occur either. That would likely end up in financial chaos and a recession throughout Europe and perhaps the rest of the world, too. It's between a rock and a hard place.

In sum, the power to tax and spend belongs to individual nations or sovereigns. No European institution has the ability to stop spending by any single nation.

Financially what is needed, of course, is some kind of euro bond or continent wide fiscal authority. However, that would inevitably lead to more than making each nation responsible for the finances of the others. The logical next step would be some kind of overall fiscal or political union.

But as it stands today, most countries don't trust each other, and they sure don't trust Germany based on its long history, if nothing else.

So since the strong don't want to assume the obligations of the weak, and the weak don't want to relinquish their sovereign rights to tax and spend, currently it's a stalemate. Sadly, until this impasse is broken, the situation will remain an ongoing threat to global financial stability, and the various financial markets, too. Thus, look for the markets to force action by the sovereigns sometime during the next several weeks. The sooner the better.

Lessons for Europe's Crisis From U.S. and Brazil concerns this sovereign-debt dilemma, and includes a discussion of relevant lessons from our early American history. The story is told of how our first Treasury Secretary, Alexander Hamilton, persuaded Thomas Jefferson and James Madison to agree to the U.S. government assuming the various state debts in 1789. Although perhaps not widely appreciated, Hamilton did much to make America into potentially a great nation with this single act. In exchange for an agreement with the Virginians for the U.S. to assume all of the states' outstanding debts, our nation's capitol was built in Washington, D. C..

{At the time of the states' debt assumption by the nation, Virginia had relatively few debts, and Massachusetts was heavily indebted after the Revolutionary War. In our modern European dilemma, Greece is Massachusetts and Germany is Virginia. We'll soon see how it all turns out, and if the Europeans have learned any worthwhile lessons in the past 222 years.}

Sovereign debt is different than other debt. When a sovereign can't pay its bills, no matter what the weak sovereign does or doesn't do, its creditors are at risk of losing most or all of their investment unless some stronger sovereign body comes to the rescue. Today Greece is the prime example of a nation that is insolvent, meaning that it's broke, but it is also a member of the euro zone.

Let's recap.

The euro zone is a monetary union but not a fiscal or political union. If that sounds unworkable, in my opinion it is, at least for the long haul.

Total European debt is the sum total of the various sovereign debt levels. But Greece can't pay what it owes, and other countries, specifically Germany, don't want to assume the financial obligations of Greece or any other financially weak countries. Some of the other countries that are also in a weakened financial condition are Portugal, Ireland, Italy and Spain. Europe as a total is in relatively good shape, but there is no total Europe.

So Europe has its own Alexander Hamilton and Thomas Jefferson moment of truth ahead of it. What will they do, and especially the Germans? As little as possible for as long as possible, I predict. But as much as required to avoid a complete debacle throughout the continent and world. Somehow in the end we'll probably have to play a role here, too, as will China and perhaps others.

We're all connected, but it would be nice if the Europeans engaged in a little self help from time to time.

Thanks. Bob.

Saturday, August 20, 2011

Why Americans Hate Economics

Why Americans Hate Economics clearly reveals, among other things, many of the fallacies associated with conventional macroeconomic thinking. Macroeconomics is the field of economics that studies the behavior of the aggregate economy.

The article debunks both Keynesianism and its demand based logic, the government's usual formula for solving our short term economic problems these past eighty years.

As an example, Keynesians believe that the problems associated with weak economies can be addressed by creating demand through government spending programs. In their view, when times are tough, things such as government stimulus spending programs, additional unemployment benefits and minimum wage raises will increase consumer spending. As a result, the programs will essentially pay for themselves by increasing employment, taxes, economic growth and so forth. If only that were true.

After eighty years of trying, the results are in for all to see, assuming people are willing to face reality. This fantasy island approach of new demand creation by government spending isn't the way the world works.

That's because government doesn't create anything. It first gets its money to spend from people outside the government, such as taxpayers or lenders. In simple words, government takes money from person A, deducts its "government operating commission", and then gives the remainder to person B. No new money or wealth is created in the process of getting money from A to B; in fact it's subtracted. The money is merely taken from A and then redistributed to B. At least most of it is.

That's pretty simple stuff for most of us real citizens to understand. However, we citizen taxpayer simpletons are not elite and sophisticated politicians, so we probably don't intuitively (or otherwise) understand the logic behind macroeconomic based policy making.

As the article says, "Economic bimboism is rampant in Washington." Or as a professor from George Mason University said about this approach, "Macroeconomics was nothing more than a dismissal of the rules of economics." That dismissal began in the 1930s with the rise of Keynesianism, and its pervasiveness continues today, unfortunately.

In another statement the question's answer is given, "How did modern economics fly off the rails? The answer is that the "invisible hand" of the free market system, first explained in 1776 by Adam Smith, got tossed aside for the new "macroeconomics," a witchcraft that began to flourish in the 1930s during the rise of Keynes. Macroeconomics simply took basic laws of economics we know to be true for the firm or family--i.e., that demand curves are downward sloping; that when you tax something you get less of it; that debts have to be repaid-- and turned them on their head as national policy."

{NOTE: "demand curves are downward sloping" simply means that there is an inverse relationship between price and the quantity demanded. Thus, higher price = lower quantity demanded and vice versa.}

Supply side advocate Arthur Laffer sums up as follows, "All economic problems are about removing impediments to supply, not demand." And he's right.

But the article doesn't tell the whole story. Unfortunately, there's another reason why Americans hate economics. At least that's what I believe. Human nature plays a role, too.

What we'll call the simple but not easy rule applies here. We humans prefer things to be both simple and easy. But economic decisions, while simple, are usually not easy ones to make. They always should require us to make choices in the face of scarcity. We can't have it all, and even if we could have it all, we couldn't always have it now. Thus, difficult choices require us to make tradeoffs among various alternatives. That's simple but not always easy.

Our two political parties have done a genuinely awful job of forcing us to make these choices over the years. {We invariably chose the "easy way out" by taking on huge chunks of debt instead of making tradeoffs by deciding what we'd have and pay for as a society. But that's another story.}

Republicans tell us they'll reduce taxes and give us smaller government. But they don't tell us how we'll manage to pay for existing levels of medicare, medicaid, tax breaks on houses, charitable deductions, social security and so forth without raising our taxes. They don't talk about such unpleasantries, and we don't require them to do so. Shame on us.

A good discussion of the Tea Party and its role, past and future, is worthwhile reading in The Tea Party's Achilles' Heel. The jury's still out on whether the Tea Party will be prove to great for America or just another special interest.

Similarly, will the various Republicans seeking the presidential nomination seriously discuss the entitlements issue as part of the call for fiscal responsibility, or will each of them be just another loud but empty voice in the end? The Tea Party and its supporters could be helpful here, but we'll just have to wait and see what happens. Hopefully, they will surprise us all by advocating that we pay fully for the entitlement programs we choose for ourselves and our descendants.

Of course, Democrats always feel our pain and will fight to the bitter end to protect our entitlement benefits, old and new. They also will battle tooth and nail to keep everybody employed or if unemployed, then paid until employed, and at a high wage, along with world class medical care and related niceties, too.

But they won't tell us how much we'll have to pay for all this stuff. And they certainly won't admit that everybody's taxes, and not just those of the millionaires and billionaires, will have to be raised in dramatic fashion if we choose all these feel good results. Nor will they tell us how much economic growth will be adversely affected by the bigger and bigger government they always seem to embrace, in fact if not in word.

In sum, our two political parties each have promised us the impossible, and we humans have liked to hear those simple and easy feel good solutions, regardless of our political persuasion. A fantasy world for one and all.

But the fantasy will now end, because it must. If something can't go on forever, it won't.

As a society we're now faced with making simple but non-easy choices and tradeoffs. That results from decades of accumulating debt and deficits that now demand our attention.

We can call this simple, if not easy, economics. But not macroeconomics, please.

Thanks. Bob.

Friday, August 19, 2011

Basketball Shooters and Presidential Approval

Rajon Rondo of the Boston Celtics is a poor shooter, for certain, but has President Obama made him an even worse one?

That's what Shaquille O'Neal believes.

See for yourself by looking at Notable & Quotable.

Having confidence, or believing in oneself, is always an important element of success.

Thanks. Bob.

Basketball In China

In case you missed the basketball action, Georgetown played a prominent Chinese team in a "goodwill" game the other night in Beijing.

The game ended prematurely in a tie and a brawl. Evidently the Chinese team has done this more than once. Not much is being said in the media, there or here.

To read about it and see the brawl, please see After U.S.-China Basketball Fracas in Beijing, the Sound of Silence.

Thanks. Bob.

Defining America's Future .... A Standalone Michigan Looks Too Much Like Europe

The future will never be precisely like the present, only later. Change is continuous.

In the U.S., our system of federalism consists of a central government coupled with fifty state governments. That approach has brought us the world's highest standard of living and the world's strongest military power as well. Our individual freedoms are the basis for this strength. In important part, states such as Michigan and Texas are aligned as critical parts of what is intended to be a limited national government.

Because of this federalism, if Michigan is troubled, the resources of Texas and others can be used to help. And vice versa, of course.

In Europe, however, there is no center. If Spain, Italy or France is in trouble financially or otherwise, they have no political allies who will stand by them as a matter of right. Each is a sovereign and each stands or falls on its own. That's why Europe is pretty much falling apart today. That and the fact that most European states are like Michigan and unlike Texas, for example. We'll explain hereinbelow. For now, let's look closely at our American future.

Several game-changers will profoundly impact our American future (and that of the rest of the world, too). How we elect to deal with these issues will move us closer to socialism or back to a free market capitalistic society. Future generations will pay the price or reap the benefits of what we choose for them to inherit.

Three fundamental American game-changing issues are (1) economic growth, (2) demographics and (3) entitlements.

(1) For years to come, our economic growth will be adversely affected by the size of government as well as the huge debt levels we now have and the future deficits we will incur. Unless we focus on private sector growth in a way we never have, our problems will linger for years and years. In any event, there will be huge "headwinds" limiting growth for the foreseeable future.

(2) Demographics are facts. We've gotten older as a nation, and we're getting older each year. That creates a big strain on the economy and its resources, adding to the woes of financing our entitlement programs.

(3) Those entitlement programs present some hard-to-face facts, too. We've made promises to ourselves that future generations should not be asked to keep. How, when and whether we reform these programs will impact future economic growth. As will what we spend for public education as well.

Creating sustainable economic growth, dealing with demography's effects and amending entitlement promises are completely within our ability to resolve in a satisfactory manner. We simply need to muster the will to do so. That said, having the required political will requires our collective and serious attention as citizens of a free society. We must make choices about our overall priorities and what government will do compared to what will be the responsibilities of individual citizens.

Let's compare our overall national situation to that of a European sovereign nation. We'll also look to Midwest America, and specifically the state of Michigan, for historical guidance as well. My conclusion is that we must stop looking to both Europe and our Midwest as models. Europe and the American Midwest are formulas for failure.

Let's begin with Europe.

Economic growth in Europe has long lagged behind ours. Unemployment rates have been higher, too. My view is that this is essentially attributable to the social democratic governments European sovereigns have adopted since World War ll. They are the home of entitlements, and "progressive" Americans have long wanted for us to follow Europe's welfare state model. Unfortunately for the Europeans, they are so far down the path of socialism that adopting a genuinely free market system and therefore strong economic growth in the future is not a realistic option.

Lesson From Europe (Take 2) represents a less-than-optimistic view of what's ahead for the European sovereign states. Quoting from the editorial, "For the past four decades, "Europeanism" has been an amalgam of Keynesian economics, bureaucratic centralization, and welfarism, corporate and social. Even now, the ideology remains unshaken by events. Though there is plenty of talk about getting spending under control and balancing budgets (typically by way of tax increases), nobody in Europe is proposing a serious growth agenda."

Meanwhile, in the U.S. The Fall of the Midwest Economic Model attributes the historical reliance on big companies and big unions as the cause of its now largely insoluble woes. Using Michigan and the auto industry as a Midwest proxy, the article states, "The Michigan model was based on the Progressive/New Deal assumption that, after the transition from farm to factory, the best way to secure growth was through big companies and big labor unions."

The Big Three auto companies ... could create endless demand for their products through manipulative advertising and planned obsolescence. The United Auto Workers would ensure that productivity gains would be shared by workers and the assembly line would never be speeded up. In those days, 40% of Michigan voters lived in union (mostly UAW) households, the base vote of a liberal Democratic Party that pushed for ever larger governments at the local, state and federal levels. You found similar alignments in most Midwestern states."

Later the author notes how government and public employee unions switched positions with the auto companies and the UAW, "Michigan is an extreme example of what has afflicted the industrial Midwest. Big corporations were replaced by big government as the leading employer, and public-employee unions replaced industrial unions as the chief financiers of the Democratic Party. In effect, public-employee unions have been a mechanism by which taxpayer money, in the form of union dues, permanently finances a lobby with a vested interest in higher spending and less accountability."

Finally, he comments, "The idea that the wave of the future is an ever-larger public sector financed by a more or less stagnant private sector looks increasingly absurd. The Midwest's public sector has, as Margaret Thatcher put it, run on "other people's money"."

Sadly, Michigan today looks a lot like a typical sick European sovereign. So do Illinois and several other Midwest states, for that matter.

Our overall American reaction to the global competitive situation will determine how successful our future America will be. We have to choose to compete with everybody in the world, both educationally and industrially. To do that we must tear down our welfare state and mindset, and we must embrace the private sector as the only path to sustainable economic growth and general prosperity.

Our American competitiveness issues are many and difficult. But I'm betting on enough, if not all, of my fellow Americans to choose to compete, and then we'll win, as we've always done.

Thanks. Bob.

Thursday, August 18, 2011

The Benefits of Retirement Planning

West vs. East: How Our Views on Retirement Differ compares the expectations and savings habits of citizens of various countries throughout the world.

The article cites one important piece of the benefits of retirement planning this way, "The people who said that they have a financial plan for retirement save 2.5 times more toward retirement that those who don't."

Be that as it may, 50% of those surveyed have no such plan.

Still, these same people expect government and employer retirement benefits to be less generous in the future than they are currently.

The clear message is start saving, "since saving small amounts each month can make a big difference in the long run."

Thanks. Bob.

Incentives Matter .... Housing and Government

White Picket Fence? Not So Fast argues for cutting back the various incentives offered by government to individuals to encourage home ownership. The cost in tax revenues foregone is estimated to be $100 billion annually, and government needs the money, so the reasoning goes.

Things such as mortgage interest deductions, property tax deductions, gains on sales and government subsidies for loans make up the $100 billion.

Here's an entirely different take on the matter. As a government, are we helping or hurting people by incentivizing them to borrow money to buy on speculation things that they perhaps can't afford?

While it's true, as the article notes, that government incentives do in fact encourage home buying, the question is, in my opinion, are these "perverse incentives" or do they represent good policy? Perverse incentives are the inadvertent incentives which can be created when we set out to do something completely different. These inadvertent results are also known as the "law of unintended consequences".

My view is that government subsidies to encourage home ownership have been by far the biggest contributor to our current economic mess. Non-government debt is at all time highs because of real estate related loans which were made widely available by lenders due to government incentives. In fact, we added insult to injury when we offered home buyer rebates during the recession to get more people to buy. All that did was make things worse.

In part, here's what the article says, "Until recently, support for home ownership was untouchable because the programs were popular with voters and because of unrelenting lobbying efforts. The political right sold them as part of its "ownership society," whereas the left used them to fight rising income inequality. But the policies have turned into a major disappointment for both sides."

Later it hits the nail on the head again, ".... a comparison of home ownership among economically advanced countries shows that the United States is in the middle of the pack, which suggests that subsidizing housing with tax breaks is neither a necessary nor a sufficient condition for a flourishing housing market. Rather, these subsidies enabled people to borrow more than they could afford so they could buy houses bigger than they needed, leading to a house price bubble. The policies encouraged homeowners to make highly leveraged bets on real estate that turned sour and wiped out nearly $8 trillion in household net worth."

Losing $8 trillion is both a whole lot of money and an unintended consequence, for sure. But since voters liked the incentives, real estate special interests lobbied for them and both political parties thought they were great ideas as well, what more could we ask for $8 trillion?

Well, in the future we could ask of our fellow citizens some Emersonian Self Reliance and a basic knowledge of personal finance.

Homes are places to live. They are also speculative as investments and not one way bets to a sure thing, no matter what anybody says.

As with all speculation, when prices are going up and we've used leverage or borrowed lots of money to fund the speculative purchase, we will make money when we sell. But that's only if we sell before the fever breaks.

Asset inflation induced by an abundance of readily available cheap credit pushes up demand and therefore prices. Until it doesn't. These non-government debt induced asset inflation cycles always end badly, just as happened this time.

Let's look a little closer at what can happen when we're buying houses with lots of borrowed money. We'll assume that we make the home purchase "investment" for $150,000 by borrowing all or most of that sum. We borrow the money at 5% or interest charges of $7,500 annually. If prices go up, we win. But what happens when prices go down?

Normally home prices don't exceed three times a person's annual income (Linkage in Income, Home Prices Shifts). Thus, we are deemed to be able to "afford" a home costing $150,000 if we make $50,000 annually. And during the recent period, we could buy a house that cost five times income. Hence, we could have bought the $150,000 home above with an income somewhere between $30,000 and $50,000. Now we owe $150,000 and must pay $7,500 in interest charges annually as well, not considering the other costs of home ownership such as insurance, property taxes and such.

Home prices have declined by one third the past few years, and brokerage commissions will cost another ~6% or so. Our totally leveraged $150,000 buy-at-the-top "investment" is illiquid, meaning we can't decide to sell it today and receive the money therefor anytime soon.

To sell we first have to find a willing buyer, and it's now very much a buyer's market. Lots of supply but not much demand. We have an asset worth perhaps $94,000 net, but we owe $150,000. And the economy stinks.

Here's the point. Had we not bought the home with $150,000 of borrowed money, we wouldn't owe the $150,000 and also have on our hands an illiquid investment worth perhaps less than $94,000. And we wouldn't have to pay $7,500 in interest annually. For those counting, that 5% rate of interest is now more like ~8% based on the current net asset value of the home.

If in addition we are earning $40,000 annually and setting aside 10% of that for rainy day needs, retirement funding and such, that's the equivalent of our next 14 years in savings going just to make up for the loss of the value of the home we bought. In other words, we unwittingly bet the farm with borrowed money for a very illiquid purchase. And that asset isn't worth much, having declined in market value.

Forgetting about any added dollars in home equity loans that we may also have added to our financial burden, we own something that is worth nowhere near what we paid for it. And we borrowed the money to buy it.

Here are the two questions du jour: (1) Did the government do us any favors? (2) Did we do ourselves any favors?

Will we acknowledge, as Pogo would argue, that we did this to ourselves by following the herd? Or will we search for someone else to blame, such as the evil bankers, who were also encouraged by the government to make the loan in the first place? Or will we blame the politicians for creating these popular but financially lethal "perverse incentives" to enable us to become happy homeowners, even though now we're not happy at all?

Thanks. Bob.

Wednesday, August 17, 2011

Civics Literacy

A good friend sent me a brief 33 question test by the Intercollegiate Studies Institute about our civics knowledge. Click here to take the exam online. It takes less than ten minutes, and I believe you will find it to be a worthwhile exercise.

The only bothersome thing, at least to me, is the survey's finding that "The average score for all 2,508 Americans taking the following test was 49%; college educators scored 55%."

My hope and strong belief is that those students who studied American History with me last year would do much, much better than the average score cited hereinabove.

But even if not, we'll keep trying to improve our performance as we study Government and Economics this academic year.

For the rest of you, I hope that you will choose to take the test and learn something concerning your knowledge of civics as well.

Thanks for forwarding the exam, Sid. Bob.

Investing = Faith!???

To Those Who Have Lost Faith in Investing is a timely commentary about the faith in the future that is required to be a long term investor in the shares of stock in American companies. As for the required faith, it's about faith in America's future, to be specific.

The article's final paragraph puts it this way: "In some regard, investing based on the weighty evidence of history is the most prudent thing we can do. So far it has always proven to be correct. Every time someone has predicted the death of the stock market, they have been wrong. Given this record, isn't it reasonable to assume that stocks will continue to be better than bonds, and that bonds will continue to be better than cash?"

As you may already know, my answer to the question of stocks for the long run versus bonds versus cash is to own stocks of solid companies.

Yesterday we wrote about the logic behind staying the course when investing for the long term. Many people obviously question that belief, and they are certainly entitled to their own opinion on this highly personal matter. But so am I.

After thinking over why I strongly believe that stocks for the long haul is the proper way to invest, it seemed necessary to acknowledge that historical results are no absolute guarantee of future results. As one sage put it long ago, predictions are dangerous; especially those about the future.

In other words, nobody knows with certainty what will happen in the future. In that respect, it's simply unknowable. That said, Mark Twain reminded us that "History doesn't repeat itself, but it does rhyme." Or as President Truman said, "The only thing new in the world is the history you don't know."

So while we can't know for sure what will happen with respect to the future performance of the market or anything else, that doesn't mean we can't make an informed judgment and be guided accordingly.

My belief in long term stock investing is based on both past results and my faith in our American future. The past results speak for themselves. As the saying goes, we can have our own opinion, but we're not entitled to our own facts. Historically, investing in stocks has beaten all alternative investments by a long shot.

One simple story comparing stocks to the current hottest investment in gold rings true for me. In 1980 gold sold for a then record ~$800 per ounce. The market price of stocks (as measured by the DJIA) was essentially ~$800 as well. A virtual dead heat.

Today gold sells for ~$1,800 per ounce, and the DJIA sells for ~$11,400. Compared to ten years ago, however, gold has done dramatically better than stocks. The fact is that gold is selling at a record high price today, while the DJIA is down a few thousand dollars from its record high a few years ago. People today wish they owned more gold and less stock, because gold has recently outperformed stocks. So our investing timeframe is important when comparing different investment alternatives. I say own stocks.

Most important to me is that the difference between owning gold, or land, for that matter, and stocks is this; solid companies produce and sell things that people want to buy, and they earn profits doing so. They generate cash through their daily operations. Of course, gold and land do not. In fact, it costs money to continue to own them.

Wal-Mart, Exxon, IBM, Apple, Microsoft, Pfizer, Caterpillar, GE, JPMorgan, Wells Fargo, Pepsi and Coke are examples of cash generating companies. Just as they have been for many years, my guess is that these types of companies will be successful performers for decades to come. Some of their profits are mine, too, since as a shareholder I own a piece, albeit a very small piece indeed, of each of these and similar companies. And in addition to the price of their shares rising over time, they generally pay increasing cash dividends as well.

I cast my vote for stock ownership several decades ago, and I firmly believe that America's best days lie ahead. Thus, my continuing faith in our political system of self government combined with our free market system of capitalism makes stock ownership the best investment vehicle for me. If you believe similarly, owning a basket of diversified stocks is probably the right answer for you as well.

Thanks. Bob.

Tuesday, August 16, 2011

Government and Economics - Writing Assignment (optional)

Government and Economics Students:

Yesterday, I described to you the "minimum" requirements for membership in the Government and Economics course:  reading the assigned chapters and understanding the reading, or alerting Bob or me well in advance of class when you don't understand portions of the reading so we can help you.  I also told you that we will help eager students do more than the minimum.

Investing versus Trading .... Stock Market Gyrations

My view is that investing, as opposed to trading, in the shares of quality companies is the really prudent thing to do with our long term patient money.

That said, if we can't hang in there when the market swings wildly from time to time, as it will, we probably shouldn't own stocks at all. Not for trading and not for investing either. That's because we will not achieve good trading results over time. In simple terms, if we aren't able to stomach the ups and downs of the market, we should stay away from the market entirely, since the stomach churning won't be worth the incremental rewards of stocks over bonds. Even worse is buying high and then panicking and selling out at a much lower point.

Hence, the basic idea is straightforward for individual investors; either invest for the long haul or stay away from stocks. Don't be a trader, unless that's what you do for a living, and somebody pays you well to do it.

For individual investors, the rewards associated with owning shares of solid companies for long periods will invariably prove to be the proper course. The unintended but quite predictable, albeit largely unnoticed, consequences of trading frequently, on the other hand, will almost always be the wrong path to take.

As a reminder of this boring but prudent approach, several current articles on investing versus trading are worth your time. In sum, each makes the case for buying and holding shares in good solid companies over long periods of time.

In contrast, they point out that the interests of most financial intermediaries, including brokers and mutual fund managers, are not aligned with those of the individual investor. We're on our own, in other words. But we can help each other along the way, too. It's simply not that hard to learn how to be a good investor, and we can do it in our spare time.

Accordingly, I recommend that you review each referenced article in this present uncertain and volatile time. The Mutual Fund Merry-Go-Round by David Swensen, the highly successful chief investment officer of Yale University, tells us why we need to figure out our own way to successful investing. In that regard, Swensen details how most brokers and actively managed mutual funds don't serve the interests of individual investors.

Short term "performance chasing" by selling losers and buying winners frequently is a common way of losing money or considerably underperforming the market indices over time. By buying high and selling low, which is what happens most often with active traders, the individual investor loses as his broker or mutual fund manager wins. To cut to the chase, the performance of the individual investor is harmed measurably by following the frequent trading herd. Listening to what Swensen has to say is definitely worth the time.

Don't Panic About the Stock Market offers timely advice from another investing pro. He advises us to stay the course, despite today's turbulence, and look to the long term future instead of focusing on the wild and volatile time we're in today. What he says is also sage advice worth hearing.

Finally, How investors can handle the market's turmoil and Be an investor or a trader, but not both advise the long term investor to stay the course, and make a genuine effort to ignore the daily onslaught of market moving emotional news items.

Good companies will perform well over time, and their earnings will be shared with their shareholders. We must never confuse a company's short term operating performance with its stock's daily, weekly, monthly, quarterly or annual gains or losses.

As Warren Buffett puts it, the market in the short term is a voting machine, but in the long term it's a weighing machine. We simply need to know that we own pieces of good solid companies (or as a proxy therefor a low cost passive S&P 500 index fund). We do not own pieces of the stock market, but we invest in companies whose shares are traded on the market. There's a huge difference between the two ways of looking at the same thing.

As individuals we are not qualified full time and professional traders; instead we are long term investors. We're in it for the long haul. Accordingly, we play a different game than the traders, stock brokers and mutual fund salesmen.

We investors know that owning shares of good companies is a long term winning strategy, and we adopt a patient approach. We minimize transaction and other intermediary costs associated with frequent buying and selling, including taxes on gains. And we employ a dollar cost averaging buying technique as well. We like to buy when things are on sale, including stocks of good companies.

That said, if we are going to panic when the market falls rapidly and substantially, which it certainly will from time to time, we should do ourselves a favor and just stay away from stocks entirely.

My considered advice is to focus on the long term picture of investing, and if that means turning off or otherwise tuning out the daily news, by all means turn it off and tune it out.

Thanks. Bob.