The Daily Reckoning February 15th

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Bond Bears Should Envy Broken Clocks

Broken clocks get a bad rap…at least they are right twice a day. Many are the objects, individuals and/or institutions who are lucky to be right once a day… or even once a year. Consider, for example, those poor souls who continuously predict rising interest rates. These “bond bears” have not been right once in the last 30 years.

The lesson is clear: Better to be a broken clock than a bond bear.

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But even if bond bears are not right even once-a-three-decades, perhaps they will prove to be right once-a-generation… and perhaps that moment is now, or almost now.

So says James Grant, editor of Grant’s Interest Rate Observer. In a recent issue of his esteemed newsletter, Grant observed, “Today’s stunted interest rates, though not exactly unprecedented, are rare and remarkable. The world over, creditors are living on the equivalent of birdseed. Investors who once disdained sky-high yields today settle for crumbs…What are they thinking today?”

Grant answers his own question. Today’s bond buyers believe that “in an overleveraged economy, inflation is unachievable. So is growth, they have lately begun to insist. As for us, we hold a candle for both growth and inflation — and, in consequence, for our long anticipated, long overdue bond bear market.”

Grant hangs most of his prediction on fifth-grade arithmetic…or maybe advanced fourth grade: Debts are rising a lot. Revenues, not so much.

“Like a well fed teenager,” says Grant, “the national debt keeps growing and growing. On December 31, it bumped its head against the statutory ceiling that never seems to contain it. That would be $16.394 trillion, or the cash equivalent of 360.7 million pounds of $100 bills.”

Meanwhile, as the national debt continuously inflates by millions of pounds of hundred dollar bills, the national tax receipts struggle to keep pace.

“In the past 10 years to fiscal 2012,” Grant observes, “the compound annual growth in federal receipts worked out to 2.8%, that of federal outlays, 5.8%. In as much as the growth in receipts was much below the historical median (which, since 1967, had been 6.75% a year), one might — just for argument’s sake — say that the country had an income problem.”

Rapidly growing debt, coupled with slowly growing revenue, often creates a toxic environment for bonds. Bottom line: Grant is bearish on long-dated US Treasurys.

Eric Fry
for The Daily Reckoning

Bond Bears Should Envy Broken Clocks appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

The Basement Beneath the Wage Floor

There are certain sounds that tend to make people crazy. Think of nails on a chalkboard. An infant screaming nonstop on a long flight. A piercing whistle that won’t go away.

Now we need to add another: a U.S. president who thinks he can legislate high wages into law. For anyone who knows the basics of economics — not distorted by a bogus central-planning mentality — hearing this is like torture. It’s painful. It makes you crazier and crazier until you finally want to yell, “Make it stop!”

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This is how I felt when President Obama said the following:

“Let’s declare that in the wealthiest nation on Earth, no one who works full time should have to live in poverty, and raise the federal minimum wage to $9.00 an hour. This single step would raise the incomes of millions of working families.”

Why stop there? Let’s also declare that everyone should make $9,000 or $9 million per hour. If all that stands between us and total riches is the word of a president and an action by Congress, let’s get on with it!

Does Obama really not get what’s wrong with this approach? I’ve long disagreed with him, but I’ve never really thought he was ignorant. But even from the earliest interviews I’ve read, he does seem to have a tin ear on economic topics. He doesn’t seem to get where wealth comes from. He doesn’t seem to understand how prices work. And now we can be certain that if he understands how wages work, he isn’t willing to let on.

Of course, he could also be lying. It wouldn’t be the first time a politician did that.

Much of the current problem with youth unemployment is due to the high minimum wage increases we’ve seen over the last five years. When the crisis hit in 2008, the minimum wage was $5.85. Lots of jobs got shaken up. Low-wage workers hit the road. When things settled down again, they went knocking on doors. The next year, they found that it was illegal to accept a wage less than $7.25. And we wonder why so many people are unemployed? It’s not a mystery. The huge increase in the wage floor is not the whole reason, but it is a contributing factor.

A wage floor of any sort traps people in the basement. The higher the floor, the larger the basement. Today, millions are rattling around down there, unable to find their way out. And now the U.S. president, in the name of creating jobs, wants to make more of the unemployed more permanently unemployed.

I feel a particular frustration with this issue, and it’s not because of the economics texts I’ve read alone.

My first real job was working maintenance at a department store. I was 15 (yes, I lied about my age; you could do that back then). My job was to clean toilets, crush boxes, pick pins out of the dressing room closets, wax the floors in the china shop, vacuum the place, and shine the glass.

It was a great job. I mean, truly great. I loved it because it was a hugely important job. If I didn’t clean the bathrooms well and replenish the toilet paper and towels, customers the next day might be grossed out and never come back. I played a big role in ensuring the profitability of this store.

I especially loved my co-worker. His name was Tad. The department store would close, leaving just the two of us to have so much fun doing all this wonderful work. We would sing together, thrill to the danger of the wax machine, gross out at the mucky bathrooms, and just have that wonderful feeling that comes with having a real work partner.

You see, Tad was not a normal kid. He had some physical deformities. His face was oddly shaped and had what looked like a large stain on half of it. He couldn’t move around that well, really. I had to help him and assign tasks carefully. He was also mentally retarded. He spoke in a muffled way, and you had to be very clear about instructions.

But I tell you what, when he was happy, it made me happy. To see that big smile come across his face when I would praise the way he shined up a counter just gave me a huge lift.

One day, a poster appeared in the workroom. It was from the Department of Labor. The minimum wage was going up by 50 cents. Tad pointed the sign out to me. He said, “Look, we are getting a raise!” I was a bit suspicious. I was pretty sure that the boss was the one who set the wage, not some weird distant government thing. I didn’t quite believe it was true. Still, I was happy that he was happy.

The next day, I showed up at the usual time after school. I was getting the mop ready, running hot water in the pail and prepared to do the thing. Tad wasn’t there. I asked the boss, “Where’s Tad today?”

Well, he explained that he had hired Tad only because he was a boy he knew from church. He needed work. He knew that he would require a lot of help, which was one reason he was excited that I was able to work with him. In the end, he said, this was charity, because he knew that I could do the job by myself. It worked for us to be together so long as he could afford it, but this new minimum wage changed things. The store’s profit margins were very thin, and he had to make a hard decision.

The long and short of it: Tad had to be let go.

I was devastated. I stared at the Department of Labor sign again. Cursed thing! That sign just ruined a kid’s life. It stopped a great act of charity. And look what it did to me. I now had to work alone.

Management left, the lights dimmed, and I heard the familiar click of the doors leading to the outside. I would have to clean alone today. I did all the tasks I had to. But there was no more music, no more laughter, no more clowning around, and no more beautiful smiles. Tad was somewhere else, probably at home, confused and sad.

He died a few years later.

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This is what the minimum wage means to me. So you can say that I have a vendetta. When the president announces that he is raising wages to make everyone better off, I can’t help but think of the millions of Tads that will lose that opportunity to do wonderful things in this world and with their lives.

Sincerely,
Jeffrey Tucker

Original article posted on Laissez-Faire Today

The Basement Beneath the Wage Floor appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Bond Guru Still Likes Bonds

He has what seems like the easiest job in the world. He manages $4 billion of assets on which he earns fees. And all he does is buy US Treasuries.

His name is Van Hoisington. No man has been more right about interest rates in the last two decades. Van thought they would go down — and has thought so since 1990. So they have. As they fell, the value of Van’s bonds rose. Since he’s been right, his track record is ridiculously good. He has posted a 9.1% annualized return over the last ten years…in a bond fund!

You know those old Michael Jordan ads with the song “I Wanna Be Like Mike”? Forget it. I wanna be like Van.

So what does Van Hoisington think now? Will interest rates finally turn upward? They can’t possibly go lower, can they?

“Rates aren’t going up anytime soon,” he said, giving away his conclusion early. But the reason why is what makes the drink. Let’s look at why Hoisington thinks the way he does.

By way of introduction, let me say that Hoisington (born in 1940) is the top man at the eponymous money management firm, which he founded in 1980. He is, like me, an ex-banker. The firm operates out of Austin, and Van has a bit of a Texas drawl. With his twang, mane of silver hair, big gold ring, brass-buttoned blazer and folksy manner, he reminded me of an old college football coach at an alumni fundraiser.

Can Van be right again? I have seen him make this same essential presentation at least three times before over the past five years. Each time, I walk out shaking my head, thinking he can’t be right — much to my detriment.

His case is consistent and simple. “This is not a normal cycle,” Hoisington said. “The US is bogged down in debt. It takes a long time to correct.” He pointed to numerous studies that show debt overhangs translate into soggy interest rates and flaccid economic growth.

Moreover, such debt overhangs last an average of 23 years across the 26 episodes studied. Large governments, funded by massive indebtedness, usually crush economic vitality, such that the bond markets exhale interest rates that would barely fog a mirror.

Hoisington shared a good chart — “Historic Panic Years” — which showed three debt panics besides our own 2008 panic. He chose these particular debt panics because debt levels reached (or exceeded) what we have now. As you know, we live today with the aftermath of the housing bubble. As Hoisington wrote in his second-quarter letter:

Part of the problem was two federally sponsored housing agencies that openly encouraged massive extension of housing-related debt, just as governmental institutions played a central role in the creation of excessive railroad debt in the 1860s and 1870s. The debt disequilibrium panic years of 1873, 1929, 1989 and 2008 are uniquely important because each of these events resulted from extreme over-indebtedness, as opposed to lack of liquidity or some other narrower precipitating factors. [Italics added]

Look at the “US 2008” line in the chart. And look at how many years we have to live with low interest rates — if we should follow the historical pattern of prior debt panics.

DRUS02-15-13-1

The actual starting and ending points for interest rates are also instructive. Take a look at this table:

DRUS02-15-13-2

Again, by these lights, we have years of piddly interest rates to look forward to. What about all that money printing? Like pumping blood into a corpse. Hoisington says it isn’t going anywhere. It sits, cowered by debt. No circulation, no rise in interest rates. And bonds — yes, Treasury bonds — still offer value. As Hoisington sums up, if high debt levels limit growth, then “a prolonged state of debt-induced coma may so limit the returns on other riskier assets that a 30-year Treasury bond with a 2% yield would be a highly desirable asset to hold.”

I realize this is a controversial point of view. In part, this is why I think it is important enough to write about. I don’t totally agree with him, but he has been right for so long; you should know about his work.

If he is right again, there is good and bad news. The good news is that low interest rates could prop up stocks generally, because returns will be hard to dig up elsewhere. The bad news is that we’ll all make squat on our savings. All the retired people trying to live on accumulated savings suffer. Besides this, history suggests such debt-laden economies shrink over time in real terms (or adjusted for inflation). We may be seeing this already, as household incomes are now the lowest they’ve been since 1995. We’re marching backward and it could continue.

As for me, I have been wrong for a long time in thinking that interest rates would go up. They haven’t. For once, though, I wasn’t shaking my head incredulously after a Hoisington presentation. This time, I fear he may be right — again.

Regards,

Chris Mayer
for The Daily Reckoning

Bond Guru Still Likes Bonds appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Buying the Bourbon Bull

We’re just hours away from a 3-day weekend. So why not treat yourself to a bourbon on the rocks?

Apparently, that’s what everyone else is doing…

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Bourbon sales have gone through the roof. In order to meet sales demands, one label is doing the unthinkable. Just this week, Maker’s Mark announced it will water down its bourbon from 90 proof to 84 proof in order to meet sales demands.

Forbes says the decision could be “brand suicide” for Maker’s Mark, which is owned by Beam Inc. But if you look beyond the bad publicity, you’ll see a major trend developing in the beverage sector…

Per Capita Beer Consumption

Liquor consumption is quickly gaining on beer — which has found itself in a steady downtrend since 2008. Leading the way is bourbon, accounting for 35% of all domestic spirit sales, according to The Atlantic. But overseas demand is the real kicker. Bourbon is currently experiencing triple-digit sales growth outside the US. Japan, Australia and even emerging markets are becoming major growth hotbeds for this distinctly American beverage.

I suspect bourbon shortages and rising prices will become the norm. You can’t outsource bourbon production (it’s not bourbon unless it’s made in the States). And there’s no way to quickly increase supply (bourbon has to age in barrels before it can be bottled and sold).

Then there’s beer. Microbrews have gained in popularity recently, yet the market feels saturated. Bigger brands are seeing their market shares dwindle as consumer preferences evolve…

The decision here is obvious:

Sell beer. Buy bourbon.

Greg Guenthner
for The Daily Reckoning

Buying the Bourbon Bull appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Don’t Get Suckered Into The “Austerity” Argument

“Recovery Shows a Soft Spot,” declared a banner headline of a recent edition of the Wall Street Journal. “Soft spot” pretty much sums up the Journal’s explanation for a reported 0.1% contraction in gross domestic product (GDP) in the fourth quarter of 2012.

Viewing things from further west on 8th Avenue and 41st Street, The New York Times spun the same story differently, toward its chronic, Krugman-esque view of trickle-down government. The Times encapsulated the tale of a 0.1% GDP decline in a front-page headline, declaring that “Growth Halted in 4th Quarter on U.S. Cuts.”

Which angle should you trust? How about neither! Instead, let’s take our own look behind the curtain…

U.S. cuts? Huh? What cuts? Has Congress cut spending and not told anyone? Are fewer people receiving lower entitlement payouts? Do we have fewer people on Social Security? Fewer on food stamps? Less Medicare? Are government agencies laying off personnel down in Washington? Are we shutting off military aid to, say, Egypt?

Cuts? What is The New York Times talking about? Has U.K. Prime Minister David Cameron secretly been advising President Obama and setting U.S. spending policy? Nope.

Digging into details of the Q4 contraction, the key component is a 22.5% decline in military spending at the end of last year. Other than that, business spending, consumer spending and housing were all slightly positive. In other words, the civilian economy muddled along and did OK — but not great — during the last three months of 2012.

The Department of Defense (DOD), however, tightened the screws. Procurement officers and defense contractors, up and down the supply chain, cut back outlays, anticipating the fiscal cliff originally scheduled to kick in on Jan. 1, but now rescheduled to March 1. (In this sense, el precipicio still looms for DOD.)

The bottom line is that the private U.S. economy is holding its own. Businesses and consumers are writing checks. Autos are doing OK. Technology is holding up well — Apple’s loss is Samsung’s gain. Housing is moving — depending on location, location and location, of course.

Economywise across the U.S., things are not super-hot, by any means. There’s plenty of room for things to get better. (Or not, perhaps. Taxes are up this month. Obamacare looms.) Still, the private economy is not evidently throttling back.

But down at the Pentagon? Times are tough. Purse strings are tight. Here’s an example. In mid-January, the French government requested U.S. aerial tankers to assist with that nation’s military expedition into Mali. The first reaction from the U.S. side was to ask who was going to pay for the fuel. In the olden days, in case you don’t know, the tankers would fly first and the accountants would settle up for the gas later on. No longer, apparently.

Don’t Be Fooled by Raw Numbers

Why dwell on the New York Times “U.S. Cuts” headline? It’s part of the run-of-the-mill, Times style of journalism, right? (Yes, right! It’s their headline, not mine.)

Well, I don’t want you to get suckered into the “austerity” argument that we frequently see in the Times, in both the news and opinion sections. That austerity idea is geared to championing government spending as a creator of domestic prosperity.

Indeed, according to the logic embodied in the Times’ analysis, the American economy is now contracting — despite the business, consumer, auto, tech and housing sectors — because we’re not shoveling enough money into our big, gray military machine.

The counterargument is that this isn’t the 1930s, when the feds spent immense sums to pump the economy. Back then, massive projects built, say, the Hoover Dam, Grand Coulee Dam or Tennessee Valley Authority (TVA) dams. And at least when these capital projects were completed, the country had a bunch of dams, impounding water and generating electric power.

So in the 1930s, the feds spent big money on concrete and steel. That’s unlike today, when the bulk of federal spending, and its seemingly endless growth, goes for income redistribution, entitlements like Medicare and salaries to bureaucrats — none of whom are building dams.

The takeaway point is don’t confuse raw GDP numbers with the “real” economy. GDP is simply a metric that people use to gauge the size of the U.S. economy. But GDP is NOT the actual U.S. economy. If GDP really contracted by 0.1% in Q4, did the “real” economy decline too?

For example, what if we moved the GDP numbers around? What if the government were spending immense sums on military procurement, while, say, private investment were totally stalled? By cooking the macro-books just a little bit, government spending could appear to show that GDP is strong, and growing. Yet in reality, lacking private investment, the overall economy would be much worse.

Back in the USSR

An example of these fake economics would be the former Soviet Union, with its massive, government-directed capital investment, year after year, in heavy industry and military production. Sure, Soviet capex numbers looked strong, but the economy was hollow.

When I was in Moscow a while back, I had a long talk with a Russian economist trained in the Soviet era. Her view was that basically, Communism was a system of false bookkeeping.

Soviet planners made countless bad investments, which never paid off to the nation. But politics within the Soviet system prevented the overall economy from ever truly booking the loss, because every expenditure showed up in the books as a positive element to the economy.

Now looking back, the landscape of Russia and former Soviet states is littered with white-elephant projects that never had any economic justification — roads to nowhere, bridges to nowhere, factories in the middle of nowhere.

The Russian economist summed up 75 years of history by saying, “Communism died in the USSR by the early 1970s, but political inertia kept it going. Communism outlived itself, until everything collapsed suddenly in 1991.”

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A Different Story (For Some)

Today, though, the story has changed. “Putin Turns Black Gold to Bullion as Russia Outbuys World” cries a headline from Bloomberg. In a way only history can, the storyline is changing. Russia’s economy is gearing up as Vladimir Putin stresses the need for energy and hard currency.

Russia is stocking up on gold? At a time when the U.S. is cooking the GDP numbers one way or another? What does Vlad know that Obama, Biden, Geithner, Bernanke, Reid, Pelosi…And most politicians don’t? Probably, a lot.

Indeed, don’t be fooled by the U.S. austerity talk. So far nothing behind the government curtain has changed.

Likewise, let’s not change our thesis on holding hard assets. Keep an eye on gold, silver, oil and all the other “stuff” that can hold more value than government paper.

Thanks for reading.

Byron King

Original article posted on Daily Resource Hunter

Don’t Get Suckered Into The “Austerity” Argument appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

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