Full employment - society must provide it.

There was an article in WSJ with some paragraphs trashing the people at the OccupySF. those paras copied below. It is a baseless statement. Here is my reply to it:

I don't think we can associate the bank's collapse and rescue with the inability to get a job. yes, the banks lied, sold toxic mortgages but when they collapsed, what can you do? Just because a judicial system becomes corrupt, you can't just throw away the institution. All you can do is try to reform the institution - put more regulations, checks and balances etc. same thing with the banks. we need the banks to run the society. you can get rid of the heads but not the institutions themselves.

If studying arts, humanities or gender studies won't get you a job to sustain yourselves, why then allow those degrees to be taught at univs here. how is it then any different from some religious madrasas in pakistan? just inculcating some useless knowledge? Then the society is lying to their children. they restrict the amount of MD degrees in the US based on the demand for those doctor specialities - do it for all other courses of study as well. make art univs have the students sign a beware stmt that their probability of landing a job is very low - like a warning on the tobacco label. The society is indebted to provide jobs to its every member - if not, you don't have a stable society. Unless you can prove all the unemployed are lazy bums, the society has to figure out a way to make them employed - it can't just say that you have got lousy degrees. well, the univs, the accreditation boards, and everybody else were in cahoots to market those useless degrees then.

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http://online.wsj.com/article/SB10001424052970204485304576640962366762204.html?grcc=c55cb65a12d38771ac008972b7e6dcb1Z3&mod=WSJ_hps_sections_opinion

Maybe this is all really about disappointment. I spoke to a young woman who had clearly bathed more recently than most. I asked her why she was at OccupySF. She told me she'd done all the right things. Studied hard. Graduated college. (She was an art major.) And now she can't get a job. It didn't matter. It's all messed up. She was lied to.

Of course she was. She's a member of the Trophy Generation. Win or lose, you get a trophy. We embraced mediocrity to an entire generation of kids during good times who are now finding themselves mediocre in bad times. There still is that American dream: Go to college, get a job, buy a Prius. But like it or not, studying art or humanities or gender studies won't get you there. Marissa Mayer at Google complains she can't find enough computer-science majors. Civil engineers are getting hired sight unseen.

Municipal Bonds and Fareed Zakaria

Two things I want to talk about in this blog - about a recent meltdown of municipal bonds prediction by Meredith Whitney (http://seekingalpha.com/article/243169-why-you-should-listen-to-meredith-whitney-s-municipal-bond-default-thesis?source=yahoo) and Fareed's TV interview with a bunch of CEOs on christmas day.

Meredith Whitney predicts a wave of municipal bond defaults that is about to hit the US municipal bonds. She thinks it will probably in the order of $100 to $150 billion. Again she argues based on the sagging revenue base of municipalities and their big pension obligations. But she doesn't take us thru a picture how exactly the municipalities would default. The recent experience of Vallejo,CA and Harrisburg, PA have provided a picture of how difficult, costly and messy it is to default. It is not like a homeowner defaulting on his/her home payments and the creditor can come in to foreclose and auction the property to the higher bidder. and also it is not a like a company that can be either taken over by a new management (after shedding liabilities in a bankruptcy court) or completely folded down in a organized sale of assets. A municipality is a local government entity that is there to provide services to its residents and it can't be liquidated. It is a non-profit entity. The reason they issue bonds is that they have to raise money to undertake big capital projects (like school buildings, sewer, water treatment etc) and they can pay the bondholders over a period of say 10 or 20 years thru assessing property taxes and local sales taxes. The municipalities are in a tough situation right now because their revenues are not enough to pay the annual bond payments plus the other obligations of the municipality (like salaries, pension payments, healthcare premiums, services maintenance etc. ). The economic slow down has affected their revenue base. Defaulting or renegotiating the bond payments is not easy. They have to go thru a court process to do this and it takes money to pay lawyers. The other big issue is that if a municipality does do the default, it will have a hard time raising money next time at good rates. Defaulting doesn't solve any problems for a municipality and it is much better for them to raise taxes or get support from the State govt. Which is why I believe that this wave of municipal defaults will not happen and I am slowly investing in municipal bonds (have a position in AKP that now pays 7.2% tax free yield). The bonds may go down because of default fear and I see it as a good investing opportunity to pick up some yields for the portfolio.

The other issue I want to talk about is the interview of Fareed Zakaria with some CEOs on christmas day on CNN. At the end of the interview, Fareed gave his view on why the US is stuck in this slowdown and high unemployment. His take was that our economy is powered by 70% consumer consumption and we are not investing much in the economy. We need to invest a lot more in R&D and other infrastructure. GDP of an economy powered by 70% consumption is not in and of itself a bad thing. This happens in mature economies where the need to build roads, electric grids is not that great as in developing economies. When consumer consumption is only say 40% of the economic activity, the other 60% is coming from infrastructure investments and net exports. Infrastructure investments like road building is an economic exchange between businesses and the govt and so is not part of end consumer consumption. and yes, the exports driven economy require less internal consumer consumption but as I have said before, all countries in the world cannot run a net export surplus. For long-run growth, we have to improve the skills of our people and that requires a cultural change among the population to see the importance of a high school and graduate education. It is not just building more schools and more universities - the population has to be coaxed to believe that education is a must for living. It is more the soft campaign and marketing stuff. A 70% consumption driven economy is not the problem that is dogging our economy - it is the lack of skills among the population compared to the world that is dogging it. Globalization has allowed Companies to shop around the world for the skills and that has made life a lot more difficult - the competition is not regional but global now.

Should the Fed buy more bonds or not

There were two interesting articles on Barrons this weekend - one arguing for why the Fed should shop till it drops and the other on Lessons of History about hyperinflation due to excessive borrowing. John Hatzius of Goldman Sachs argues that a relatively large percentage gain in the growth of the economy (or GDP) is required to induce a decline in the unemployment rate (Okun's Law). Quantitative easing can release the animal spirits to get the economy going again (even if it is a blunt instrument right now). For him, deflation is a much bigger threat than inflation. On the other side, Victor Sperandeo asks if a nation financing 50% of its budget expenditures in the debt market grow itself out of a collapse? He has some good data. US govt debt is now over $13.7 trillion (not including state's debt of $2.8 trillion and agencies debt of $3.0 trillion). The average rollover period for the debt is 49 months. With recent deficits running over $1 trillion a year, the Treasury issues new debt and refunds old debt at a rate of about $4.3 trillion a year. He thinks investors in US debt will begin something similar to a run on the bank, selling Treasuries, even at severe losses. The break point occurs when a government borrows an amount equal to 40% of its expenditures over an extended period of time. and when this happens, it triggers a hyperinflationary spiral. He uses the example of Zimbabwe currently and France in 1790s as an example. The US still owes most of its debt to its own citizens.

Both these guys just use numbers to justify their stance without looking at the productive capacity of the US economy. Why did Zimbabwe get into hyperinflationary situation - nobody wanted to trade with them anymore and they had killed their agricultural economy due to the land seizure program. The agricultural products and mining products was what Zimbabwe used to trade with the outside world to get other things that they couldn't make internally. Hyperinflation is more a result of losing productivity rather than just printing more money. As I have mentioned in my previous blogs, china is buying US Treasuries not to earn a good return but they have no other avenue to put the dollars to work. Yes, they can buy assets around the world but buying assets in other countries (including the US) is not easy and buying a physical asset requires active management. China could stop trading with us to reduce the flow of dollars to it and it would be more bad to China than the US. Feds buying US Treasuries is not going to trigger inflation unless the banks lend the money and the consumers trigger a demand greater than the installed capacity. The unions at manufacturing companies have a lot less leverage these days to demand big pay raises.

What are the avenues an investor has in putting saved money to work - buy into the stock market or the bond market around the world. If the economy is not growing, then the stock market is not going to give a decent return. Then the main avenue to put the money to work for a greater than zero return is to invest in govt securities and the US Treasuries still offer more protection than other govt securities around the world. If the economy did grow, then the deficit issue of the US govt will get solved and so does the unemployment issue.

Monopoly power on the producer side

I didn't know how to frame this title but still want to capture my thoughts about recent changes we see in monopolistic behaviour. The govt has usually looked at the monopolies in industries serving the consumers and they use a HHI index to assess the competitiveness of an industry and approve/disapprove mergers based on the projected HHI index after the merger. Monopolies are bad because they hold too much market share, have high pricing power and can stifle innovation in their industries because of their power. Compared to a competitive industry, a Monopoly would produce less of a product and charge a higher price for the product. and we break up Monopolies to make the industry more competitive. Basic Microecon classes at universities teaches us all this. This is not the point of my blog.

But Microeconomic theories (atleast the ones I know) have always looked at Monopolies serving the end consumer - like AT&T, Standard Oil, Microsoft etc. but what about those companies that act as monopolies to manufacturing companies - like a Walmart. Walmart almost dictates pricing terms to its suppliers and the suppliers don't have much of a say or choice to go somewhere else to sell their wares. If they don't sell to Walmart, they pretty have to shut down a large portion of their production capacity. This pressure from Walmart then pushes these companies at first to seek efficiencies in production in the US and after that they can only get those costs down by moving to a lower-cost overseas operation. But this causes these companies to lay off employees in the US. So are we increasing unemployment in the country by having these kind of Monopolies like Walmart - they may not be charging a high price to a consumer but extract low prices from their suppliers. Google is another example. They hardly charge anything from a user for e-mail or its search function from a consumer but it has almost 65% of the market share in the search space. They can dictate terms to the companies seeking to advertise on its search pages. I am just raising a question whether Monopolies should strictly be looked at from the point of view of how they behave with a consumer. Is there a potential fallout for an economy by having companies with monopolistic power with their suppliers? What we pay for something is earnings for another. Porters five forces does look at all the sources of power for an industry - should the govt only look improving the bargaining powers of a consumer in a Monopolistic industry - should they also not look at improving the bargaining power of suppliers?

exchange rate wars - continued part 2

Let me get more of my thoughts on this before I get overly influenced by the rightists or leftists views on the QE2. There was an interesting article in Barrons a few weeks back with the title 'Monetary Steroids' by Randall Forsyth. I quote a few sentences from the article. "The trade deficit is a symptom, not the cause of a complex of economic problems. To target a trade deficit is lunatic", Goldman writes on his Inner workings blog at www.atimes.com. "Roberty Mundell shoed in his Nobel Prize-winning work that trade deficits arise from an excess or deficiency of savings in a national economy; if the chinese want to save 50% of GDP, they can only do so by exporting goods, because there aren't sufficient outlets for savings inside China". For the US to increase its savings rate and stop importing goods from Japan and China would mean the US economy would have collapsed, adds Goldman.

I have made this point before in my other blogs - every country in the world can't be net exporters unless we start trading with some outer space aliens. and add to that a corollary, every country can't have a positive savings rate. The desirable equilibrium is to have minor trade deficits/surpluses and average savings rate close to zero. If the chinese or indians have a 40 ro 50% savings rate, it is unsustainable. They can only sustain it by being big net exporters, causing trade frictions and currency exchange rate wars. The govts of the big savings countries need to get their citizens to spend money internally on goods and services. That can be done by providing safety nets like social security, unemployment benefits, universal health care coverage, disability protection etc so that every citizen doesn't see the need to save a big cushion of cash for some unforseen calamity in their life. By saving a big percentage of their income, they are not driving demand for internally produced products and services and so those products & services have to be exported to keep people employed. and these countries initially have a cost advantage to export these goods but then try to sustain the same export advantage using currency manipulation. The country that is losing jobs because of this will retaliate - one tool of easy retaliation is to try to devalue their own currency, which is what the US is trying right now. This is not a solution to the problem but just a response to what the other party is doing. will talk about some solutions in my next blog.