Thursday, March 30, 2006

Is a 16th Rate Hike in the Cards?

On Tuesday afternoon the Federal Reserve Open Market Committee announced the fifteenth consecutive interest rate increase , just as expected by practically everyone on wall street. The latest increase of twenty five basis points(0.25%) raises the short term interest rate in the United States to 4.75%, a level not seen during this century. The Federal Reserve is not done yet raising rates. The future markets in Chicago are pricing in an 80% chance of a further rate hike during the next Fed meeting in May. A few economists are even predicting further rate hikes in the summer.

Those who support the current policy initiatives by the Federal Reserve are , as a general rule, worried about inflationary pressures. They tend to point to the low current unemployment rate of 4.8% in addition to the increase in manufacturing capacity utilization of over 81% and conclude that the economy is perilously close to its full employment potential. They argue that unless we start tapping on the brakes in order to slow down the economy then we run the risk of setting in motion a "demand pull inflation".

A small but vocal group of economists dismisses these fears as unfounded. They present the counter argument that such increases in the interest rate are unwarranted since the labour market has at least seven million officially unemployed persons, not to mention the millions of discouraged workers and those that are working involuntarily on a part time basis. Furthermore, this group believes that consistent improvements in productivity will ameliorate any upward pressure on wages.

Who is right and who is wrong? Probably the truth is somewhere in between.The fed should at a minimum stop after the next interest rate increase in May in order to observe and study objectively the new economic data.

Thursday, March 23, 2006

The Conservative Right Strikes Again

We have all seen the dire projections that demonstrate clearly that if we are to proceed with Business as Usual we have nothing to look forward to besides massive amounts of red ink as far as the eye can see. The expected shortfall is not limited to Social Security but the real big problem is the future cost of the Medicare/Medicaid complex. Add on top of that the cost of welfare and then you start to get an idea about the extent of the deficits that our current entitlements will subject us to in the not so distant future.

Charles Murray a resident scholar at the American Enterprise Institute (AEI) and the co author of the very controversial The Bell Curve has done it again. His new book “In Our Hands: A Plan to Replace the Welfare State” argues, obviously from a conservative perspective that we can eliminate poverty and reduce the size of governmental bureaucracy and enhance economic efficiency if we would eliminate all cash program payments at all levels of government; Federal, State and local.

Under this proposal there will no longer be any social security system or mecicare/medicaid or even welfare payments. The plan suggests replacing all of the above in addition to a few other subsidies with a single annual payment of $10,000.00 to each and every US citizen as of the time they turn 21 years old. His projections show that in the early years of this plan the deficit will expand but then will start to shrink and in short order generate a surplus. If this plan sounds too good to be true that is only because it is

Monday, March 20, 2006

Was it Really National Security?

What does buying groceries at Stop and Shop or A&P, filling the car tank at Amoco, going for a jog in Addidas running shoes, turning on your RCA television to watch your favorite soap or quenching your thirst with a 7UP have in common? If you guessed that all of the above mentioned companies are owned by non US firms then you have my admiration. But does that change anything? Of course not. But if so many of the most common corporate names are not American owned then what was all that hullabaloo about when Dubai Port World was to consummate a transaction of becoming the owner of the UK company O&P that is in charge of running six US ports? The short answer is racism, protectionism, partisan politics and short sightedness.

As we have discussed in an earlier post the United States runs on its current account an annual deficit of over $800 billion. This simply means that the US can go on running this deficit as long as we can generate a capital inflow of $2.5-3 billion each and every day. Our most two popular tools to accomplish this recycling of dollars are the sales of our treasury securities that carry a relatively low interest rate and the sale/export of equity in US based corporations. If that capital inflow is interrupted then we have no choice but to curtail our appetite for imported goods or else the excess dollars on the world market could trigger a major financial crisis. There you have it, was the move by the Congress to stop DPW from running six ports in the national interest or was it a move that is best characterized as killing the goose that lays the golden egg? You decide.

Thursday, March 16, 2006

National Debt vs GDP

The US Senate approved this afternoon by a vote of 51-49 a blueprint budget for 2007 that totals $2.8 trillion. This budget was not radically different from the one proposed by the White House last month. The Senators surprised the White House though, by adding a total of $18 billion in expenditures allocated along a number of programs that the administration had intended to either cut or at least freeze at last years level of expenditures.

The budget is predicated on the assumption that the federal deficit will amount to $350 billion in each of the current as well as the coming fiscal years. As a result the national debt ceiling was raised from the current $8.2 trillion to $9 trillion. This debt ceiling has gone up by $# trillion under George W Bush and the ceiling will have to be increased again next year and maybe even the year after. When the current administration was ushered into the White House in January 2001 the federal government was projecting budgetary surpluses as far as the eye can see.

As soon as the House passes its own version of the budget, sometime soon, the real horse trading begins. How many more years before the national debt surpasses the GDP?

Friday, March 10, 2006

Who is Working and Who is Not?

Official unemployment figures for the month of January 2006 reveal that the number of employed in the United States has increased by over 243,000. This figure is substantially larger than the 125,000-150,000 that is required each month to keep the rate of unemployment steady at 4.8% of the civilian labour force.

Those who voiced concern about the strength of the economy and the above expected growth in the labour market are in effect implying that the economy is perilously close to its natural rate of unemployment, NRU. Any growth from this point runs the risk of setting loose the inflationary genie. On the other hand there is a group of economists who believe that this will not happen as long as productivity continues to increase

Even though the total number of the unemployed is 7,700,000 ( 7,300,000 officially counted as unemployed plus 400,000 that are ready to work but have not looked for a job in the last four weeks) only less than half of this number represents a drag on the economy. In a vibrant, dynamic economy up to 3% of its civilian labour force could be classified as in between jobs. Since the civilian labour force in the US is estimated to number 150,000,000 workers then this means that 4,500,000 of our unemployed are voluntarily so. This however leaves over 3,200,000 people that are involuntarily without jobs in addition to those that have been discouraged, those that can be enticed to enter the labour market and those that are currently working part time.

As you can see from the above the argument that we should sacrifice employment for the sake of a lower rate of inflation rests on shaky grounds, at least in the short run.

Thursday, March 09, 2006

Another Month Another Record Deficit

The US trade deficit for the month of January 2006 did not disappoint. It was another record deficit of over $68 billion, that is over $2 billion a day. If this rate is to persist for the rest of the year, and it is expected to, then 2006 will record a trade deficit of around $800 billion. As a result many in the Congress have escalated their attacks on the Bush administration for its liberal trade policies and are threatening to introduce measures that will insulate the American economy. It should be clear that these protectionist measures will not address the major cause for the deficit but will merely politicize the issue without delivering any relief, if relief is needed.

Trade deficit, in a free market economy is not set by the government but is a direct outcome of consumer behaviour. Just under 70 % of the trade deficit for the month of January is accounted for by only two items. Imported oil bill totaled $24.6 billion during the month of January 2006 while the total value of the imported automotive goods added another staggering $22.7 billion. I am sure you will agree that Washington did not actively promote the sales of either Lexus or Honda neither did it encourage the purchases of Mercedes or BMW for that matter. I am equally confident that very few would approve of any efforts by the government to dictate the brand of vehicles that is to be purchased.

The goal of eliminating the trade deficit in the foreseeable future is as unrealistic as the goal of "Energy Independence" and just as misguided. If a country, any country, cannot afford its level of imports then the value of its currency will plummet, foreigners will cease to provide it with credit and its domestic producers will become more competitive. These adjustments will continue until a working balance is restored to the supply and demand of its currency on the foreign exchange market.

So, in light of the above, what does the evidence show? Surprisingly enough, the US dollar has not moved much against the euro one way or the other. When the Euro was launched on January 1, 2002 its exchange rate was $1.17= 1Euro, currently the rate is $1.22=1Euro. The same is practically true of the Japanese Yen which was trading around $=120 Yens in early 2002 and is currently exchanging hands at about $1=118 Yens. So what gives? Most of the excess US dollars supplied on the world markets as a result of the American consumers current fascination with things imported have been recycled back to the US through the equity markets. Foreign investors have shown a voracious appetite for US corporate securities and have thus been more than satisfied to supply us with the variety of wines, cloths,cars and energy in exchange for an equity position in various US corporate enterprises.

In the final analysis international trade is nothing else but a process of exchange. And when that process is not inhibited by governmental rules and regulations then the parties to the exchange will agree to it only if they deem it to be mutually beneficial. In the case at hand, the US pays for its net imports through exporting equity positions to the rest of the world. If we decide that it is not in our interest to sell major US based operations to nonresident enterprises then we must reduce our level of imports from the rest of the world. It is as simple as that.

Saturday, March 04, 2006

Copyrights never die!!!

Copyrighted material has been biven a twenty year extension in a recent bill that memorializes Congressman Sonny Bono of the Sonny ans Cher fame. As a result of the new bill his popular hit "I got you Babe" will be under copyright protection untill the year 2061!!!
I doubt whether such a lengthy period of intellectual property rights is needed to enhance the output of creative people. Mickey Mouse is already more than sixty years old but yet he enjoys world wide protection!!!

Friday, March 03, 2006

The Savings Conundrum

We are all familiar , if not with the figures, at least with the notion that indebtedness forms a major challenge to prosperity in the United States. We are often reminded that the consumers have been using their homes as ATM machines and charging everything in sight. Total consumer indebtedness is estimated to be slightly over $2.2 trillion. That is right $2,200,000,000,000.00!!! This figure pails in comparison to the total Federal debt of an astounding $8.2 trillion and growing at the rate of almost half a trillion every year.

If the above figures are a cause for concern, and they should be, then some of the largest and most trusted names in corporate America should be commended for eschewing the above mentioned trend. Such household names as Microsoft, Intel, Cisco and Genentech do not carry any debt on their balance sheet and when they do the cash hoards that they have amassed is much larger than the miniscule amount of debt . Such corporations have what is known as a negative debt. Many think that since debt is not so good to consumers and government then it should be bad also for corporate America. Not so fast.

Corporate capital structure has two components; (1) equity and (2) debt. Many business executives, financial analysts and economists have spent a good portion of their time researching the optimal corporate capital mix of debt and equity. Recent research on the subject matter has shown that equity is at least fifty percent more expensive than capital. This suggests that the capital structure of some of the largest corporate giants in the US is not competitive when compared to the much more highly leveraged international competitors.

As you can see from the above conventional wisdom is wrong in this case. Corporate America can increase its borrowings and yet improve its profitability. Who says that there ain't no such thing as a free lunch?