Notes on the Economy – 03/4/08

1. While the Fed fiddles with the debt discomfort of our largest banks, inflation burns on Main Street.  The latest report on the consumer price index showed that prices increased at a 7 percent annual rate over the last three months.  If you didn’t get a raise of at least 7 percent, you are losing ground!  The so-called core CPI inflation rate rose at a 3 percent rate so if you don’t use energy or eat, your cost of living is not going up as quickly.

But the Fed’s target for the core rate is much lower than 2 percent (we don’t have an official target like Europe or England), even excluding food and energy, inflation is headed out of bounds.  Someone needs to call a foul!  The Fed is busy lowering interest rates to help big financial institutions lend to each other and to encourage us to borrow more and spend to keep the economy out of recession.  It’s ironic, the cure for the problems created by easy credit such as mortgage defaults and reduced home building is more easy credit?  Hmmm.  As I have warned in the past, the biggest risk we face is a policy mistake in Washington.  That can cause a recession.

2.  “Financial markets remain under considerable stress, and credit has tightened further for some businesses and households.”  So said the Fed minutes after the last rate cut.  Of course, credit had to tighten, seems like there were no standards in mortgage markets in 2007.  Wall Street demanded mortgages and they were supplied.  Couldn’t get ’em fast enough.  And, “haste makes waste”, in this case, a lot of it.  Stress in financial markets?  Well, the Fed isn’t supposed to target asset prices, but I guess one can argue that well functioning financial markets are part of the Fed’s responsibility, guess that includes stock markets.  At this point, there is probably less disagreement about where the federal funds target is than over how we got there.

“We think that the market problem is a lack of confidence, not just regarding the direction of home prices, but, more broadly, in the direction of the overall economy and the state of the nation.”  (ft 2/7, page 18,  Bob Toll, Toll Brothers).  The cacophony of reports of a weakening economy is enough to scare anybody (meaning caution on hiring and spending).  The percent of small business owners expecting the economy to improve went from 24% (net of pessimists) just before the September rate cut to just 5% by the end of September, falling over 12 days with no other economic news other than the Fed action.  In an economy loaded with discretion, expectations matter.  Out on Main Street, it looks like we are being talked into a slowdown.  Small business owners cut back after each Fed action, leaving them as “depressed” in January as they were in January, 1991.  Let’s hope the “meds” being prescribed by Washington will be a sufficient bromide to cure the perceived ills.

3.  It’s an election year so bad political ideas will abound.  The latest is the 160 billion stimulus package to rescue the economy.  This is called discretionary fiscal policy.  Here’s the problem.  First, it takes Congress a long time to recognize that the economy is in trouble, the recognition lag.  Once Congress agrees there is a recession, it takes months more to debate and pass a bill, the policy lag.  Once passed, there is the implementation lag, the time it takes time to get the money into the economy.  The problem is that these three lags typically are longer than the average recession.  The money is too late and too little.

There is also help for housing.  But raising the minimum size of mortgages that can be considered conforming wont help – we have too many houses and even if lower rates are attractive, people have to sell a house to move into a new one, leaving the excess supply of houses unchanged.  Only population growth will solve the problem of too many houses.  The economy will be fine, the biggest risks are policy mistakes in Washington.

4.  GM, Ford and Chrysler continue to struggle, saddled with the uncompetitive labor contracts forced on the big three automakers over past decades, often with the heavy foot of government on the necks of the automakers.  In exchange for accepting these deals with labor, Congress often protected the steel and auto industries with import restrictions.  But, the chickens have come home to roost.  Firms need to adjust to competitive forces every day to stay sharp and competitive.  Protection weakens our domestic industries.

So, GM is now going to offer all of its union workers a buyout and is closing most of the offices of GMAC, it’s lending arm, to save money.  It has already sold 51 percent of GMAC to raise money to pay workers. This money is not invested in new car designs or modernization of plants.  They are just giving the money to union workers.  In simple terms, the big three automakers have been liquidating themselves and the process continues.  If our traditional automakers survive, they will be shadows of their former selves and hopefully a lesson to Congress – don’t interfere with markets by meddling with wages and prices or engaging in protectionism.  All that does is weaken our industries and make them easy prey for foreign competitors.

5.  Hedge fund managers have made more in a year that we could expect in a life time.  Still, they are sensitive to taxes and so many are looking to move out of New Jersey.  Gee, just because New Jersey is 41st highest on corporate taxes, 49th on property taxes, 44th highest on sales taxes, and most relevant, 49th highest on income taxes, is that a reason to move?  Of course it is.

And prospects don’t look good for tax relief.  In 1990, the state owed about $3 billion dollars.  Today, $32 billion is owed in addition to over $100 billion in unfunded retirement and health benefit obligations to public workers who have been allowed to retire as young as age 55 with 60 percent or more of their salary for retirement, indexed to inflation.

This is reason enough to move to lower tax environs.  With New Jersey the 49th worst tax state, almost any move is an improvement.   The governor hopes that taxing users of the toll roads will pony up enough to provide some relief.  But not if the toll road is used for a one way trip out of the state.

Senator Obama recently visited a green engineering business in Washington and declared that when he became President he would impose a carbon emission tax on businesses because they don’t own the air, the people do.  Hmmm, I guess this exempts the people from cleaning up their cars, after all, it’s their air.  Wait a minute!  Consumers own all businesses (stocks, 401k, proprietors and all that), so it isn’t businesses polluting, it is people whose companies are making stuff for them.  If we tax the businesses, there will be less stuff for people.

Hillary said the same day (2/9) that when she is President she would look after job creation south of the border (aka Mexico) so that fewer people would illegally come here.  OK, she’s running for president of all the Americas.

Related to Hillary’s idea, McCain said of the illegal immigrants “they are God’s children too.”  Meaning?  Maybe the McCain Kennedy bill?   Wonder what Huckabee will say about that?  Have a fun election season.  Tongue in cheek.