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Why Policy Has Failed
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Upon re-thinking what I have written, I am now starting where I originally ended because itcreates some context:I will certainly admit there are things I may be wrong about. I am not an economist. I am aninvestor by background. Despite my cynicism the economists are all really bright guys and have put a lot of thought into the issues. What I can say with absolute certainty is that I have lost a lotof faith and trust in the system. And I am not the only one. This sentiment is running at all-timehighs amongst business leaders (their collective in-actions prove it) and guys on the street. It is both sides of the barbell and middle that are up
set. Often it’s
one or the other, but not all three.T
his time it’s not at an external state, it’s directed inward
s. That is a tough problem to solve.Jingoism is not the answer either as we already tried that.If any of my commentary is wrong in fact, it is not wrong in principle. I am exhibit A when itcomes to lost faith, and as I said this sentiment is not unique to me. If there is no faith in thesystem, it has a really hard time working. And I mean real underlying faith and trust in thesystem, as opposed to the confidence born from economic steroid injections or entitlements.These are valid notions, but as a point of clarity I am talking about a something different. Therealso is a subtle but important distinction between faith and trust versus confidence. Faith andtrust are longer term and more powerful concepts.For example, common wisdom tells us it was all the government spending in World War II thatgot things turned around. This notion is far from factual, and any argument that portrays it assuch should be taken with a grain of salt. And it is insufficient as the primary evidence for policy decisions. There is a big difference between coincident and causal. How did all the war related spending work out for the Axis powers? The Soviet Union? Truth is nobody reallyknows what got the flywheel spinning in the right and sustainable direction for the U.S. after WWII. I believe all the WWII government spending would have been meaningless without people finally feeling really good for obvious reasons when the Allied powers won the war, after about 20 years of misery post the great depression. And the system cleansed for a long time prior to this all happening. There were pre- and post-conditions in place for a rebound then thatare not in place now. A happy and invigorated population is very powerful for any economy.Oftentimes
it’s impossible to know what is the chicken and what is the egg
, governmentinvestment catalyzing corporate and consumer spend or a rare positive exogenous event resultingin a suddenly happy consumer pulling investment through the system, or if neither can occur without the other and with sound economic policy in place at the same time as well.And even if the spending was the final lynchpin then, it does not mean the economy and thenature of risk aversion today is of the same nature. That is what the collective inaction of business leaders with their muted response to policy for many years is telling us. There is moregoing on than a temporary lull in animal spirits that current fiscal and monetary policy will cure.If that was the case, it would be working already.It may be I have focused too much domestically, as this notion of belief could now extendglobally, and the economy is also much more global now than at any point in the past. By
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extension business leaders think of countries like they do customers. No CEO would rely oncustomers or suppliers with the balance sheets a lot of countries have. In the back of their mindsthey must be wondering how exactly this all hangs together (as do many individuals who readthe Wall Street Journal and have a ton of money in cash). Now, something has to happen to restore our collective faith. And more short term fixes andempty promises during campaign speeches and the State of the Union addresses are not what doit. It may start with a new leader (Democrat or Republican) after the next election. Or it may just start under current leadership with something as simple as people feeling the system isrunning well again. Or maybe the Fed starts showing more restraint and markets becomemarkets again. It may be the notion that issues in other countries around the globe start toresolve. Or it just may be time. It is impossible to know, but I hope faith is restored and that theAmerican spirit ultimately prevails over the impediments in place.
Killing Me Softly
At any rate, on to the details. I pulled together the following chart to illustrate the historicalrelationship between corporate profits (red) and employed Americans (blue). As you can see it began to diverge in the ~2003 and ~2009 corporate profit cycles, when corporate profits startedto fare much better than the number of working Americans. I also included total public debt(green).
DebtEmployedProfits
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Here is my thinking about what has happened and some other related points. Think about it fromthe perspective of a CEO. First some interesting facts which if one had a-priori, one would probably not think there would be an explosion in corporate profits under these conditions:When the stock market was at this price in 2007: Consumer Confidence: then 99.5, now69.6; Americans on Food Stamps: then 26.9 million, now 47.69 million. Also real medianannual household income (using what is an understated CPI in my opinion) in January of 2013was $51,584
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or 92.7% of the level in January 2000 and it remains well below the $54,008 levelseen at the start of the recovery in ~2009. But at the same time counter-intuitively corporateearnings and margins have skyrocketed to a new peak which is the primary reason the equitymarket has rallied.Despite all the chatter about QE driving the stock market up, from the moveoff the bottom most of it has to have been profit driven (profit margins being un-natural andfunded by the government which I will explain next), whether profits account for 70% or 90% or 99% of the move I cannot tell you although I have some guesses.Profits are the question at hand. The chart shows corporate profits have generally trackedemployed Americans. Makes sense. Jobs = income = consumer spend = corporate revenue=profits. Fewer jobs = less revenue = less profits. Economics 101.However as the chart shows, things clearly changed in the ~2003 and ~2009 profit cycles ascorporate profits surged while employment did not. My explanations:Starting with the ~2009 cycle first. In the 2008 downturn companies eliminated a lot of jobs.The depth of the downturn forced them to make the tough decision. Normally that killsconsumer spend due to wage loss. But the government plugged the revenue gap with transfer payments and direct investment. See the green line go nearly vertical and it is fascinating how profit growth has mirrored the trajectory of debt growth. The consumer has started to dis-saveagain as well. Thus corporations kept the revenue, lost the labor, and voila record margins. Youcould argue unemployment is being subsidized. Like anything else, when something issubsidized, you tend to get a lot of it. Normally corporates would take the excess profits and re-invest in capacity and labor, drivingmargins back down to mean levels or even into an excess capacity situation (normal businesscycle). Certainly at this level of profits the return on investing idle cash in capacity (capital andlabor) should be much higher than having it accumulate and earn 0% interest. When businessesinvest and hire to take share because share and growth is profitable, that competition pushes profits to consumers (wage earners) through higher employment, higher wages and lower real prices. Competition and risk-taking often hurt investors over the short term. It's risky andsometimes unprofitable or profit margin lowering, but is great for the economy over the longterm. The economy needs risk taking and competition to grow and sustain itself.But now there is greatly subdued competition because CEOs are scared to take risk. Investmentsin capital and labor are long lived and expensive if wrong (even labor as there is a high frictionalcost of firing employees). Other forms of regulation and things like Obamacare and lack of faithin the government lead to further risk aversion by employers. Thus low growth, but high profits.
Investors for the time being seem to love this condition, especially when it is hard to find yieldelsewhere. Now high profits are discounted with low interest rates because nobody sees any
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