5/12/14

We are six-and-a-half years after the Democratic Party started wielding significant influence on economic policy, starting with the failed first stimulus attempt that not many people remember. Back in early 2008, at the behest of the then Speaker (Pelosi) and given the background of very bad economic conditions, although not yet a recession, President Bush on his last stretch and totally weakened by the war in Iraq, approved the totally useless $150 Billion one-off tax rebate.

We are six years after the official onset of the recession.

We are five-and-a-half years after President Obama has come to power.

We are five years after the recovery started.

So what does the U.S. economy look like after all these years?

The GDP growth for the 1st quarter of 2014 was 0.1% at an annual rate. Not much of a growth after five years of recovery. On the same day the Dow Jones index reached a new record high. Current expectations are that this GDP will be adjusted DOWNWARD! That is significant as if it does, it will be the first quarter of negative growth, contraction, since early 2009! After five years of the Obama administration, we are back where we started…

Some may think that the two indicators cannot be explained; some will say that the Dow is a leading indicator while the GDP is a lagging one. But the truth is much simpler and I explained it before in previous blogs. The Obama economy is as close to Crony Capitalism as one can get in a democratic country. All his policies favor big companies, those that have both the connections to get big government contracts and assistance as well as the wherewithal to handle the flood of regulations that continue to emanate from this most intrusive and non-free-market administration.

In addition, the Fed’s QE policy resulting in inundating the markets with liquidity also benefits the big guys—Wall Street—at a cost to “Main Street.” One more form of proof that this analysis is correct came just the other day from The Brookings Institution, a liberal think-tank, that published a survey showing for the first time ever in the U.S. more businesses are exiting the market (closing down) than entering it. This started in 2008 BUT remained so as of the last available information in 2011. True the trend began before but it picked up speed during Obama’s administration and is a clear result of his anti-business policies. Especially anti-SMALL-business. This is pro-BIG-business or Crony Capitalism!

So no surprise there.

The sad state of the U.S. economy and of the miserable growth we’ve had since Obama took office can be demonstrated by the actual numbers:

The growth in real GDP since the end of the recession in 6/2009 till today was 11%. As an example during the exact same period of four years and 9 months under Reagan, the GDP grew 21%, under Clinton by 18%, and even under the much maligned Bush with two wars it grew by 14.4%.

The difference is material. The U.S. economy is estimated to be approximately $16 trillion. If we had the Reagan-type growth since June 2009 we would be today at $17.4 trillion. Clinton-style expansion at $17 trillion and Bush expansion at $16.4 trillion. You may say the difference between Bush and Obama is not huge but it amounts to $1,300 per person per year, so that EVERY family in the country would have about $5,000 more in earnings every year. I think that it is material. Let alone a Reagan-type expansion which would have resulted in $19,000 MORE PER family EVERY year!

But even these numbers do not describe how bad the situation really is. Let’s look at U.S. debt:

  • Under Obama the debt grew from $10 trillion just before he came to power to an estimated $17 trillion by the end of fiscal 2014. As a % of U.S. economy it grew from 68% to OVER 100%!
  • Under Bush, during the correlating period the debt went from $5.7 trillion to $8.5 trillion and from 55% to 61%.
  • Under Clinton $4 Trillion went to $5.5 Trillion and REDUCED from 62% to 60% of the size of the economy (indicating that growth of the economy was faster than the growth of the debt)!
  • Under Reagan it went from 0.9 trillion to $2.1 trillion and from 32% to 46%.

Obama increased the debt by an unprecedented $7 Trillion. There are no comparisons; none even close enough. As a % of the U.S. economy he increased it by more than 50% and with the exception of Reagan (but at much lower level and with HUGE beneficial results), no one else comes even close to it. Think about it—aggregate GDP grew by about $4.5 trillion during Obama’s term in office to-date while the debt grew during the same period by $7 trillion. So in effect the government spent $7 trillion MORE than it collected and the resulting growth in the economy during that period in the aggregate was ONLY $4.5 Trillion.

Obama is the ONLY president EVER to increase debt more than the AGGREGATE growth in the size of the economy during his period.

Obama and his advisers are deeply religious in their belief in the Keynesian Multiplier theory, in spite of the debunking of this theory by Milton Friedman a long time ago and its consistent failure in practice all over the world time and time again in modern times. Looking at the above numbers, where is the Keynesian Multiplier? I see a negative multiplier here. We paid $1 for every 65 CENTS that the economy grew under Obama. Surely it would have been better to just do nothing, right?

Obama and his minions of defenders will try to explain and make excuses. It was a very deep recession they will say (correct), but generally as a rule in the past the deeper the recession, the higher and faster the recovery. So they say that it was a different kind of recession (financial assets and housing), which according to them is the excuse for everything. But how does that explain the clear lack of the Multiplier effect? In an FT article (5/5/2014) Lawrence Summers wrote a poisonous article aggressively attacking the UK economic recovery, which he begrudgingly had to admit is now the fastest growing economy amongst the G-7 countries. Summers, one of the main architects of the president’s economic plan and a staunch supporter of the Keynesian economic model, in his desperation to attack the UK success stated: “Historically, deeper recessions are followed by stronger recoveries.” I guess this works when you have to attack a non-Keynesian economic policy that is showing signs of success but is glossed over when analyzing the miserable state of the U.S. recovery. To be clear, the UK recession was much more due to financial assets and a housing bust than the U.S.’s.

So what happened to the “Keynesian Multiplier”? Most economists agree that the multiplier is about 1.4–1.5. So according to this theory the accumulated GDP growth generated by $7 trillion of deficit spending was supposed to be $10 trillion. In fact, it was less than half that. Where is the rest of the growth? Already forty years ago Milton Friedman debunked the theory itself pointing out that government spending is financed by taking resources via taxation or borrowing (which implies future taxation) from other parts of the economy. These resources could have been spent more productively in generating even bigger demand. That alone explains some of the $5 trillion of “missing” GDP. But with all due respect, and in my humble opinion (both phrases are meant VERY sincerely as Friedman is the greatest economist of modern times), I believe that there is even a better explanation and a bigger reason for the missing GDP. That explanation is rooted in a phenomenon called globalization that largely did not exist forty years ago and is really a product of the last 20 years.

When Keynes postulated his theory of the “Multiplier,” he was probably right. At that time funding government spending was done by printing money as opposed to borrowing, the effects of which on future taxation via inflation were not as well-known as they are today. Therefore it worked. It created an additional source of demand at a time when the economy needed that to be stimulated. The future effects on taxation/inflation could be spread over time and thus not reduce the immediate demand from other sources as Freidman points out. More importantly is the fact that each economy was very much a closed box on its own. This is clearly NOT the case today.

As I mentioned earlier government spending is concentrated with big companies to a much bigger percentage than their share of the economy. It is natural that government procurement will deal mostly with big companies, as these are generally big contracts. The problem is that today big companies rightly produce their products in the most efficient and cost-effective territories and as such, simplistically, a big part of the Keynesian Multiplier created by the U.S. government’s huge deficit spending stimulated the economy in China and other such countries! This is at best ironic and disturbing. The U.S. government went into bigger debt in order to stimulate the Chinese economy… What is shocking is that the “king” himself (Obama) and “all the king’s horses and all the king’s men” (in this case economists, experts, advisers, etc. to the president) did not understand this effect, did not predict it, and did not take it into account. The horrifying thing is that even today when the results are in for everyone to see, no one mentions that. No one is doing the simple math that proves that a big element of the “Multiplier” seeped overseas to other countries. No one is brave enough to come out and say, “We were wrong.” How will we ever learn and avoid doing the same mistake twice?

The shockingly bad performance of the economy is even worse if you take two more elements into consideration:

  • The Federal Reserve accommodating policy: Never in history have the Feds made such a huge effort to accommodate the federal government and try to help (and failed miserably) the economy by PRINTING money at such quantities. Like everything else such a policy has benefits of course but also costs and risks. The benefits are already built into the economic numbers. So in addition to explaining how bad the growth is, one has to take into account that however miserable the growth is, it has been achieved in the most extremely accommodating conditions created by the Federal Reserve. The RISKS and COSTS of such an accommodating policy are in the future and they can NOT be avoided. Those costs will manifest themselves either in very high interest rates, which will cause a severe recession, or in a debilitating inflation. So having had the benefits, small as they are, under our belt—are they worth the costs that are still to come? Of course not. The benefits are so insignificant and minimal that they are not worth any costs, let alone the very large costs that we will unavoidably pay.
  • Oil & Gas Revolution: In a stroke of luck, typical of this president (whom I said many times is the luckiest politician ever), the very sector of the economy that he despises and attacks all the time has generated, during his term, the fastest and most significant growth ever. I do not have exact figures but I estimate that the oil & gas revolution contributed at least 10% of the GDP growth under Obama. Without the technological breakthrough in the oil & gas industry (Fracking and horizontal drilling) that came to age during his administration, the performance of the economy would have been significantly worse. How ironic is that?

Another economic data point published in the last few days shows the productivity rate in the U.S. economy fell in the last quarter at an annual rate of 1.7% and that Unit Labor Costs grew by 4.2%, so not only did productivity fall but wages grew. That is very significant. This is the first harbinger of inflationary pressure, which I will discuss a bit more below. Productivity is probably the most important factor in creating wealth and allowing the economy to grow. Without improving productivity the individual standard of living cannot rise and the growth in the economy is muted. Over the last three years the rate of growth of productivity was on average .8% per year. That is an historical low for the U.S. AND is even more serious due to the fact that normally at the beginning of recovery, productivity rises very fast and above average. Under Obama, during the so-called recovery, productivity grew BELOW average.

Why? There are two very obvious trends that are causing this significant under performance:

  • Slow rate of business investment. Technology and capital investment are the keys to improving productivity. Unless businesses invest in both, productivity will not grow. The underperformance of business investment is the core of the economic underperformance under Obama. The fact that business investment predicates economic growth makes sense, is proven by the past recoveries, and is as close to unanimously agreed upon as you can get economists to be.
  • Slowdown in creation of new business. As mentioned above in the Brookings Institution research, the rate of business creation is negative. Why is that detrimental to productivity? Generally speaking it is accepted that startups have better productivity than larger companies. Ultimately a one-man business produces the biggest GDP per person.

Unfortunately the Obama administration’s “biggest” achievement in the domestic arena is to create an environment where businesses do not want to invest in the U.S. and entrepreneurs do not want to risk creating a new business here.

Why and how? There are five main reasons for this dubious achievement:

  1. Regulation: ObamaCare, EPA, Dodd-Frank and multitude of other agencies and acts that create a flood of new regulations simply increase the cost of doing business, deter smaller business from starting, or prompt them to close and reduce competition. The devastating cost of these regulations and bureaucracy is very hard to quantify but cannot be overemphasized. It is huge.
  2. Taxation: New taxes reduce the returns on capital investment and the incentives to start new businesses. The U.S. tax code was bad even before Obama. The fact that he not only added new taxes but did nothing to simplify it at a time when many of the U.S. competitors did simplify and reduce their tax rates is causing many non-U.S. investors to choose to start their business elsewhere, and many U.S. companies are choosing to make their capital investments elsewhere.
  3. Socialization: At the same time as putting so many hurdles on new businesses, this administration makes it easier and thus incentivizes not working. The number of people leaving the employment ranks is at a record high, workforce participation rate is at a record low, and all that is possible due to various Federal programs that are being offered to people as an alternative to work. In the margins there are always people who would choose to live on Federal assistance rather than work and their effect on the GDP growth or lack thereof is significant.
  4. Litigation: The propensity of this administration to sue big business, irrespective of the law, is legendary. Starting from the bankruptcy proceedings of the car industry, to BP, to big banks, to big Pharma, all businesses have been attacked by this administration and paid off tens of billions of U.S. $ just because they are afraid to fight the hand that feeds them—another aspect of crony capitalism. The case of S&P who was threatened by the Administration (Tim Geithner then Treasury Secretary) and went on to downgrade the credit rating of the U.S. nevertheless, only to find itself being sued by the Federal government, is just one example of how egregious this administration is in abusing its prosecutorial powers. Trampling on the law and extracting money from companies who are too afraid to fight may seem a good idea in the short-term but that too cerates disincentive for companies to invest in the U.S., both U.S. and foreign companies. Not surprisingly FDI levels over the last few years are at a low compared to the years preceding and given that FDI is a long-term decision the “best is still to come.” In this case, worst is a better description.
  5. Persuasion: Probably the most malevolent of all the above reasons is the president’s general hostility to business. Obama has about him an aura of disdain and spite toward private business. Be it his famous preposterous “you did not build that” speech, his frequent harsh attacks on many business sectors, and his constant pointing at “millionaires and billionaires” as undeserving and immoral people. On top of all the above reasons, this simply seals the fate for business investment and business creation.

Final observations:

  • Crisis: A crisis is inevitable and the longer it is delayed by all kinds of conjuring tricks by the Treasury and mostly by the Federal Reserve, the more painful it will be. It will start when inflation rears its ugly head. The current benign low inflation, low interest, and unlimited supply of money cannot continue forever. True, in Japan it has now lasted TWENTY-FIVE years and counting. For twenty-five years Japan has been in a no-growth, slow decline, mode. This is horrendous; I hope and pray that either the political circumstances in the U.S. will change and a new executive will force the U.S. to take the bitter medicine before the decline becomes unstoppable, or that the markets will do that.

The U.S. is much more dependent on markets than Japan is, although already four years ago I expected that the market would not allow a Japan type slow death and as of now I was obviously wrong. I underestimated the conviction of this president in the face of facts and the collaboration of the Federal Reserve and crony markets in the scheme to make America the next Japan, all in the sincere belief that if they can delay the inevitable they can solve it later. I believe that the crisis will start with inflation and move swiftly into a deep recession triggered by very high interest rates employed to counter inflation. I believe that it will come sometime in the next 3–5 years.

  • Cowards: Obama and his team are guilty of having the wrong vision. But they are doing what they believe is right and good for America. They stand up for their convictions and fight for them, some times ferociously. They are courageous; they employ the goals-justifies-the-means type of attitude (which I condemn), but you cannot fault them for trying and doing their best to achieve what they believe in. In contrast to them stand the business leaders in the U.S. These so-called “captains of industry” know better than I that everything that I wrote here is correct and more. Yet basically not one of them has the courage to stand up and call out loud and publicly: the emperor has no clothes. They prefer to tend to their own very narrow short-term interests in working with the government and never standing up to it, lest they will be sued like S&P or lest they will lose this government contract or that government subsidy or tax break. They are allowing themselves to be bribed by “big government”— Crony capitalism.

While I understand why they are afraid, that does not justify the fact that none of them or even more so many of them band together to do their civic duty and stand up and shout in the public square. They are allowing the president to harm America in ways that will take very serious undoing, if it can be undone. It will be costly to everyone and for them and their companies too. Many people are afraid of many things. Conquering those fears is what bravery and heroism are made of. Those who have the power and duty to do something but are shirking it for short-term gain or fear are simply cowards.

  • Chicken comes first: The jury is in! The old adage of what comes first, the chicken or the egg has been resoundingly solved. The chicken comes first, at least when it comes to economy. The slow level of business’s capital investment has material adverse effects on hiring and on the economy.  Thus SUPPLY (business investment) must be first before demand, contrary to what instinctive and simplistic intuition may indicate, and contrary to what Democrats keep drumming all the time.

I explained in detail in one of my previous blogs the exact mechanics of why it is that the EXPECTATION of additional demand CREATES the need for additional supply, which causes firms to invest and to hire, which then INDEED creates the additional demand. You cannot create the demand by government fiat. It has to be convincing and long-term for businesses to want to invest. The government can only shift resources from one type of demand to another. Therefore, supply-side economics is the winning theory.

By the way, the decision by the Bureau of Economic Analysis to create a new measure for the economy—the Gross Output (in addition to the traditional GDP) proves the significance and importance of supply. In GDP close to 70% is represented by DEMAND (consumer demand). In the new measure, which more correctly reflects the real power equation in the economy, the roles are reversed and investment demand (the creation of supply) is bigger than consumer demand.

  • Correction: Is there anything that can be done to change the trajectory to avoid the crisis? Of course there is. But it will not happen as long as Obama is president. I do not think that one can totally avoid the pain needed to extricate ourselves from Obama’s eight years of bad and damaging economic policies, but a massive change in the direction of U.S. economic policy can make the pain very short lived. I am not going to repeat my entire economic platform that has been discussed at length in prior blogs but whatever is done, it needs to be revolutionary. One cannot continue with evolutionary, small-step increments. These are not working any more. A good place to start the revolution is by abolishing the tax code and starting from a blank page. I strongly believe that a nationwide sales tax is the way to go REPLACING all, I repeat ALL other forms of Federal taxation.

As I mentioned in prior blogs, the defining issue of our time is the tug of war between big/benevolent government advocates such as the president, his administration, and Democrats on the one hand, and small/inefficient/bad for the economy government, which is the belief of conservatives and free market followers mostly in the Republican party. Analyzing “big government” initiatives over the last 50 years, we see failure to achieve stated goals and inefficiency in every one of those initiatives. The war on poverty declared 50 years ago has not moved the needle on poverty in the U.S. The tons of money being poured by the Federal government on education in the last 40 years at a growing pace has failed to arrest the decline in U.S. education ranking in the world. The devastating failure of “big government” as shown in the flawed ObamaCare web site is a prime example of the inability of government to EXECUTE. The current scandal surrounding the VA health care system is just another example of that.

When will these people stop hiding behind their grand ideas and altruistic motives and face the reality that the only PRACTICAL way to achieve at least some of their goals is by unleashing the power of the free market? It is not ideal; we will not create Utopia but we will get better results than their poor track record. When will they stop behaving on the basis of: “I made up my mind, do not confuse me with facts”?

One of the more annoying traits of this president and his Democrat cohorts is that when there is credit to be taken, it is always his; yet when things go bad, the president is never to blame. His media defenders will always deploy the notion that either everything is normal and the fault is with the amorphous Washington DC (i.e., BOTH parties are to blame), or alternatively there is nothing that the president can do to influence the problem.

Here is something that the NEXT president CAN do to make a HUGE difference with no cost. Reagan understood that and was effective in doing it, as was Clinton. Bush understood it but was bad at it. Obama is simply terrible at it—he does the exact opposite. It is called psychology—the clever use of the power of the bully pulpit that the president of the U.S. commands. So much of the economic viability of this country is based on our optimism. If firms BELIEVE that the immediate future will be good and positive they will INVEST and start the virtuous cycle that will MAKE things good. The phenomenon of the Paradox of Thrift is well researched and I discussed it in prior blogs but its effect on investment and supply is less researched, if at all. Kick starting the economy MUST come by changing the atmosphere, by convincing businesses that the America IS, again, the best place to do business. It of course requires some actual measures, such as the one I mentioned above on taxation but changing the atmosphere from anti-business to pro-business, from doom and gloom/America is not exceptional and is on the decline to the “shining city on the hill” attitude will make a HUGE change in the economic decisions of multitudes of people and the aggregate of these economic decisions will generate the recovery.

Unfortunately, Obama’s economic policy seems to run along the Louis XV famous guideline: “Après moi, le deluge.” He is going to leave the country with:

  • An empty treasury, in the sense that by 2016, we will have around $18.5 Trillion of debt being well above 100% of the economy.
  • Weakened Federal Reserve having overplayed its money-printing ability (they are already “tapering” that) and that cannot easily raise interest rates due to the burden of the debt on the budget.
  • A depleted military that will require a huge investment to recover—all from empty coffers.
  • A deeply divided and partisan country—the one he was supposed to unite so there would be “no red states, no blue states, but the UNITED states.”
  • Severe damage to the animal, entrepreneurial, spirits of the people.

The task facing whoever is the new president is both colossal and critical. Eight more years of this type of nonsensical polices will ruin this country.