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Hitting the Economic Wall


from In Search of Fixes for a Fossilized Economy by Victor Davis Hansen at National Review

Historically, 2016 is one of the least expensive years in memory to finance a house, car, or major appliance. Or, put another way, regular savings accounts are earning almost no interest. Hundreds of billions of dollars usually paid to savers have in a sense been transferred to borrowers in the form of lower interest rates.

Given annual U.S. gas consumption of about 140 billion gallons, American consumers are enjoying a collective fuel savings windfall of well over $200 billion per year — in addition to reductions in home heating expenses.

All the new technology and innovations, the near-zero interest rates, the printed new money, the record number of college-educated youth, the massive government borrowing and the cheap energy have not brought millions back into the labor force or increased annual family income and purchasing power.

In sum, the U.S. has been stimulated to death with cheap fuel, near-zero interest rates, massive borrowing, and cheap money. Yet its economy is ossifying.


The regulatory state has accumulated friction costs for decades, and the Fed is no longer able to bail them out. Rather than acknowledge this a new realm of books and explanations are coming forth about structural changes in the economy that avoids any accountability of the government and its never ending pursuit of the welfare state and regulatory state.  You can not raise taxes high enough to fix this and it will likely only make it worse.  Much worse.

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Interest Rates and Piketty’s Data

from Project Syndicate,  The Invention of Inequality by Antonio Foglia

Piketty observes a rising wealth-to-income ratio from 1970 to 2010 – a period divided by a significant change in the monetary environment. From 1970 to 1980, the Western economies experienced rising inflation, accompanied by interest-rate hikes. During that period, the wealth-to-income ratio increased only modestly, if at all, in these countries.

From 1980 on, nominal interest rates fell dramatically. Not surprisingly, the value of wealth rose much faster than that of income during this period, because the value of the assets that comprise wealth amounts essentially to the net present value of their expected future cash flows, discounted at the current interest rate.

What impact do lower interest rates have on measured inequality? If I own one house and my neighbor owns two, and falling interest rates cause the value of those houses to double, the monetary inequality between us also doubles, affecting a variety of statistical indicators and triggering much well-intended concern. But the reality is that I still own one house and my neighbor still owns two. Even the relative affordability of houses doesn’t change much, because lower interest rates make larger mortgages possible.

For further evidence of this phenomenon, consider Piketty’s own data. In Europe, Piketty singles out Italy as the country where the wealth-to-income ratio rose the most, to about 680% in 2010, compared to 230% in 1970. Germany appears to be a more “virtuous” country, with a wealth-to-income ratio of 400%, up from 210% in 1970. What Piketty fails to highlight is that, over this period, interest rates fell much more in Italy (from 20% to 4%) than in Germany (from 10% to 2%).

The real-world impact of this dynamic on inequality is precisely the opposite of what Piketty would expect. Indeed, not only are Italians, on average, much richer than Germans; Italy’s overall wealth distribution is much more balanced.

Clearly, economic inequality is a highly complex phenomenon, affected by a wide variety of factors – many of which we do not fully understand, much less control. Given this, we should be wary of the kinds of radical policies that some politicians are promoting today. Their impact is unpredictable, and that may end up doing more harm than good.


I have covered several aspects of inequality and the difficulty of measuring it, but this article shows how the dramatic fluctuations in interest rates in the 1980s influenced Piketty’s data, durin gthe time period he noted.

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Extorting the Producers


From Bret Stephens at The WSJ, Bernie’s Wall Street Slander

But the reason Mr. Sanders is drawing his big crowds is neither his fanatical sincerity nor his avuncular charm. It’s that he’s preaching class hatred to people besotted by the politics of envy. Barack Obama, running for president eight years ago, famously suggested to Samuel “Joe the Plumber” Wurzelbacher that “when you spread the wealth around it’s good for everybody.”

Mr. Sanders dispenses with the niceties. “I do not have millionaire or billionaire friends,” he boasts, as if there’s an income ceiling on virtue. That’s telling the 10,100,000 American households with a net worth of at least $1 million (excluding the value of their homes) to buzz off.

It is also telling any intellectually sentient voter that the drift of the modern Democratic Party runs in the same illiberal direction as the Trumpian right, only with a different set of targets. Mr. Sanders thinks Wall Street’s guilt is proved by its capitulation to the demands of a government that could barely prove a single case of banker fraud in court.

Another interpretation is that a government with almost unlimited powers to break, sue, micromanage or otherwise ruin an unpopular institution is not a government banks are eager to fight. The problem with capitalism isn’t that it concentrates excessive economic power in the hands of the few. It’s that it gives political power ever-tastier treats on which to feast. Covering for that weakness is the reason Wall Street plows money into the pockets of pliable Democrats like Chuck Schumer, Cory Booker—and Mrs. Clinton.

That’s something Mr. Sanders will never understand, being the sort of man whose notion of wisdom is to hold fast to the angry convictions of his adolescence. That may be why he connects with so many younger voters. But it’s also why his moral judgments are so sweeping and juvenile. Wall Street remains one of America’s crowning glories. To insinuate that the people who make it work are swindlers is no less a slur than to tag immigrants as criminals and moochers.

My colleague Holman Jenkins once cracked that some plausible ideas vanish in the presence of thought. I would add that some widespread beliefs vanish in the presence of decency. That goes as much for Bernie Sanders’s economic prejudices as it does forDonald Trump’s ethnic ones, a thought that ought to trouble the placid consciences of this column’s more liberal readers.


While many lament the power of money to bribe politicians it is more accurate to lament the power of politicians to extort the producers.

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Risk Horizons


There are a lot of ways to lose money in the stock market, but far fewer effective ways to make money.

Looking at two managed accounts over the same time period, one was far more profitable than the other.  One had far less turnover than the other, one had no mutual fund positions, and was far less diversified.  The one with fewer stocks, less turnover and no positons in funds or alternative investments showed much better returns- even in most down markets.

The account with much less turnover also had a far larger amount in unrealized gains. This means that the growth was tax deferred. The lower turnover meant less was eaten up in taxes.

If you have enough money for a managed account- at least a half million dollars, then there are few reasons to own mutual funds in that account. You are paying a management fee already. Mutual funds have another layer of expenses  that should be unnecessary.  In the current era of single digit returns these fees greatly hobble your return.  An index fund will beat most managed mutual funds. Funds used by managers are usually specialty funds with singular purposes and high hidden fees, often with an intent to diversify into areas that the manager has no expertise of his own.

The poorer performer was much more focused on risk avoidance. They largely missed the 6 year bull market by under allocating to stocks.  This led to the subject of the best way to avoid excessive risk.

While it is a common theme that index funds will outperform most money managers, it is worth knowing why.  If the managers have much more than 25 to 30 stocks they are likely to mirror an index fund anyway.  Mistimed allocation and increased friction costs as noted will underperform the index.

Wealth in equities is built by carefully selecting companies that compound their capital on a continuous long term basis. Such selection takes focus and discipline.  And even when such companies are discovered you want to buy them when they are undervalued.    I have found that few equity managers do this and if you are not one of them or currently being managed by them then yes you are much wiser to be in an index fund.

The risk profile of such companies is very low DEPENDING ON YOUR TIME HORIZON. Even in a flat market a company that continues to compound capital will show little risk on a ten year time horizon.  In any two year period any of the stocks can sell off substantially or market PEs can drop due to monetary issues or alternative investment options.

Instead of risk profile questionaires your allocation should be dependent on your time horizon.  This may or may not be dependent on your age.  If you are 70 and you have money in a trust that you do not plan to spend then the horizon is not limited to your mortality.

Decide how much of your investment you want to access in two years and keep most of it in cash with the highest safe yield you can find. Today that number is probably less than 50 basis points.  How much do you think you may need in 5 years?  Perhaps – depending on where you start- that portion should be a 50/50 equity cash split. This cash may be in bonds purchased at par or less that mature in that time period.

With a ten year horizon you have a chance to build wealth with an 80/20 mix of equity and bonds. You can even get more aggressive.

Warren Buffett recommends selecting a stock that you would be comfortable holding if the market shuts down for ten years.  He buys companies like an owner, not a trader. He does not panic if the stock market has a selloff and his market value declines.  Usually he is sitting on billions in cash and sees such period as buying opportunities.

If you do not have access to equity managers who do their homework or if you are not so inclined yourself then definitely go with the index funds. Even if you think you have the gift put a portion of your funds in the index and compare it to your results. If you don’t beat the index over a period of at least five years then admit your shortcoming and put the rest in the index.

You can adjust your risk by keeping a portion in cash to match your risk profile.

A tip to gin up your index returns- decide what portion you want in the market. Say 60%. If the market is toppy allocate your investment over three years to avoid buying all at the top. If the market is down maybe allocate over a much shorter period. Don’t try to find a bottom, but avoid the top.  Once you reach your allocated amount, just keep the rest in cash, get the most secure return without capital risk. This is boring but if you want excitement look elsewhere.

Then set a parameter of return, for example 3% per quarter (you can go higher , but no higher than 5% per quarter).  If the return is between 0% and 3% in a quarter, do nothing and watch your money grow. If the market falls and your return is less than 0% then buy half the difference from your cash portion.  If the gain is in excess of your top return parameter then sell half the difference and save it in cash.

Most quarters you will not make a trade, but you will improve your returns buying some when it is down and selling some amount into the up market. Most fo the time the market will fluctuate within your parameters and will just regularly compound.

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A Poor Guide to The Future


A NYT article, The Debate About America’s Best Days  about Robert Gordon’s The Rise and Fall of American Growth sounds like another academic pontificating how our best days are behind us.  Reminds me of economists from the 1970s and early 80s who made the same claim- I just cannot remember their names- neither can anybody else. (wait… just came to me….  Lester Thurow)

 “For reasons I have never understood, people like to hear that the world is going to hell,” the economic historian Deirdre N. McCloskey  of the University of Illinois, Chicago, wrote in an essay about “Capital in the Twenty-First Century,” the blockbuster about income inequality by the French economist Thomas Piketty. “Yet pessimism has consistently been a poor guide to the modern economic world.”

While reading the article I thought of the term for my economic outlook- ‘cynical optimism’- I am optimistic sbout the future and man’s potential, but I have little faith in those who predict or worse, pretend they can influence or control it.

While reading Rove’s book The Triumph of  William McKinley, about his  campaign it was clear  that after major recessions in 1873 and 1893 (and the doozy still to come in 1907), they were pretty pessimistic then as well.  It appears that eras of great economic growth coincide with eras of great economic and political turmoil. I would not assume that either is a cause of the other or predict accordingly.

It would seem that economists,  of all professions,  would understand the danger of predicting the future based on the past or even the current trend.