The Stimulus Package and the Prudent Man

President Bush’s new (and DOA at the House) $3.1 trillion dollar budget projects that, by September 30, 2008 — the end of the current Federal fiscal year — the shortfall over revenues will be $410 billion. The House majority party is salivating over the choice chops of political fodder this provides in an election year, while at the same time patting themselves on the back for delivering a $150 billion stimulus package to the economy, which does nothing to stimulate the economy. Because this stimulus spending is short term, the package outlay translates dollar for dollar directly to the deficit. (To be fair, the President has signed off on this package also in the spirit of true bipartisanship — lookout taxpayer!)

I consider myself somewhat prudent in that while I have a mortgage, the P&I seldom exceeds $1000 a month (it’s an ARM and thus varies with LIBOR); I don’t have any outstanding credit card debt — I am a transactor rather than a revolver; and I have some investments and savings.

The Federal Reserve has reduced interest rates in the last few months by almost 2 points. This is to bolster the economy (as perceived through the lens of the equities and bond markets). The markets have rallied, and then sunk as the impact is absorbed and evaluated. Democrats in Congress are talking about not being able to ‘afford extending the Bush tax cuts‘ and not being able to ‘afford the revocation of the AMT‘. They are also talking about expanding many programs.

What does this all mean to me?

My ARM resets every February based on the preceding six months LIBOR so the reduction of the Fed rate is likely to have little impact on my P&I. Additionally, since the LIBOR has lately decoupled from the Fed rate there is no guarantee that any Fed action will lower LIBOR. Credit card issuers adjust their loan rates monthly, usually based on 10-12% over the Fed rate, so that they can maintain a good net interest margin. However, since I am prudent and have no revolving card debt, I obtain no benefit from this. Since the rate goes down, so does the interest accrued to my meager savings and money market accounts. Current savings rates are less than the CPI so in terms of dollar denominated spending power, the value of my savings actually decreases.

One effect of the cuts manifests in the dollar’s value compared with other currencies. The dollar has achieved new lows. As a result, dollar denominated commodities such as oil and grain, have increased in terms of price. The value of a barrel of oil is the same or slightly rising (due to demand) but the value of the dollar is falling meaning that you need more of them to buy that barrel. Consequently, gasoline is hovering near $3.00 per gallon and can only rise as demand picks up again. Consequence to me: I have to pay more to get to work and back to buy fuel. I have to spend more of my pay to keep my house heated in the winter and to pay for electricity.

Policy decisions in Congress, particularly with the ethanol alternative fuel initiative, have also had their effect. These efforts are a derivative effect to mitigate the higher oil prices. Subsidies to ethanol producers — again an expense supported by taxes — have driven corn prices higher. Basic grain products have increased in price, cattle feed and thus meat has increased in price, and since corn syrup is used in about everything, most other processed foods have increased in price. Consequences to me: inflation.

One of the reasons that is used to support the package is that the liquidity of the financial markets is being reduced. The reason for that is simple — bankers don’t have a good feel anymore for what an asset is worth, and consequently are reluctant to lend money against that asset. Multiple levels of risk diversification haven’t quite worked out as planned. While I am a fan of and support securitization, the packaging of asset and mortgage backed securities with credit enhancements and credit default swaps constituted building a house of cards. Young financial engineers with little experience in the downside of things spun up an edifice of risk that is still in the process of toppling. But the Fed has already provided an answer to the liquidity problem through its discount window where banks are assured of obtaining the capital they need. The stimulus package doesn’t affect this. By viewing the economy entirely through the lens of the financial market, rate cuts only reinforces risky behavior. The Fed action is predicated on the premise (unsubstantiated) that whatever affects the markets eventually affects the general economy.

Finally, it seems as if Congress doesn’t learn anything. If anything was clearly demonstrated by the Bush tax cuts, it was Laffer’s theorem that there is an optimum taxation rate to provide maximum revenue. Since the stimulus package will increase the deficit, the inevitable result will be a call for an increase in taxes. The result of that will be a slowdown of the economy, a decrease in tax revenue, which will result is still higher deficits. Plus, the effect will flow down to the States and their revenue streams. All of the ‘good’ and ‘beneficial’ programs will be strained and States and Cities will attempt to make up the shortfall. Consequence to me: My take-home pay decreases as my fed taxes increase. My property tax component which is now slightly less than my P&I amount will exceed it and I will absorb more of the burden of government.

The reason that the market has blipped higher and then reset is that investors collectively know these things. This non-stimulus stimulus package offers no long term market or economic benefit. This package and the rate cut itself is a profligate renunciation of fiscal prudence. The current set of policies rewards the behavior the current Congress rails about: the lack of savings of US citizens; an excessive burden of credit card debt; highly leveraged mortgages; overreliance on oil.

Here is my table of consequences:

Result/Effect	Prudent Man	Profligate Consumer
Gasoline Prices	Screwed	Screwed
Leveraged Mortgage	Not Applicable	Bailout
Savings	Reduced Value	Say What?
Food Prices	Higher	Higher
Credit Card Payments	No Effect	Lower
Risky Financial Behavior	No Effect	Rewarded
Income Taxes	Increased	Likely Exempt
Property Taxes	Increased	Dude! I rent.

So!

Never one to bitch without offering a solution, here is what we need to do:

• Actually limit federal and state spending. Cut agency staff and eliminate costly programs which do not perform. Insure each agency has a performance metric upon which future funding is based.
• Stop adding new entitlement classes to existing entitlements of Medicare and Social Security. Take a close look at the implementation to insure that the program is not driving UP the cost of health care.
• Eliminate tax deductions on corporate contributions for employee health care.
• Increase the Fed Rate by 3 full points. The market will take a dive. So the next day …
• Announce the elimination of the AMT (and follow through) and make a permanent tax rate of 10% ($20,000 < Income < $250,000) and 22% (Income > $250,000).
• Completely eliminate capital gains tax.
• Eliminate corporate income tax. (This is just another tax on the consumer , since it’s passed through).

Basically, fix the tax problem and all other problems will fall into line. There is a reason why formerly Communist countries have gone to flat taxes and low rates.

 

Ron Paul: Libertarianism’s Latest Love Affair with Insanity

If you read Slashdot frequently, you’ll find that in the midst of the Windows bashing and Me > You flame fests, the name of Ron Paul is often mentioned in hushed tones as the Republican Libertarian messiah who will rescue Amerika America from The Great Satan (aka George W. Bush). From reading the comments of the barely literate masses, you’d think that Ron Paul inspires more interest than Natalie Portman, naked and petrified. His die-had partisans wet themselves off the fact that he raised $4 million off the internet. Combining that with the $4 million he raised in “meatspace,” that puts him on par with Joe Biden, and behind Chris Dodd and Bill Richardson in the fund raising race. Real impressive, Ron… you’re running neck-a-neck with three candidates who combine for less than 10% of likely primary voters. I’m impressed… NOT!

If I may for a moment piggy-back on the elitist sentiments often displayed by my colleagues, the “masses,” much like Mr. Paul’s partisans, who are rumored to groan “Brains!” during campaign rallies, are dead wrong. Ron Paul, though he has some attractive viewpoints, like being against the war in Iraq (though this is because he’s a rank isolationist, excuse me, noninterventionist) and pro-life (because even children in the womb have a right to property), Ron Paul firmly falls in to the ranks of the bat-shit insane. For those who’ve drunk the libertarian Kool-Aid, I’d like to convict Mr. Paul, not on so-called libertarian positions as espoused by the crazies, but on his own words and positions. “Real Libertarians” might not believe X, Y or Z, but Mr. Paul does, and a just condemnation will be his.

The Environment
Libertarianism, as a philosophy stands behind the oppression of the weak by the strong in the name of private property. The classic libertarian position on the environment falls along the lines — “It’s my f#@*ing property and I’ll do with it as I please.” Mr. Paul states his opposition to any sort of environmental protection law such as when he proposed a bill to repeal the clean water act. But Mr. Paul, unlike many of his libertarian counterparts, has left the pre-Sumerian age, and realized that what I do with my property can cause environmental harm to someone else’s. Thus, Mr. Paul, inherently distrustful of the evils of Big Government[TM] proposes his solution, which I quote: “If your property is being damaged, you have every right to sue the polluter.” That’s right, the answer to evil Big Government[TM] environmental law is lawyers, lots and lots of lawyers. Forget our elected representatives in Congress, the correct people to decide on the cost of the damage you cause to me by your polluting ways are the unelected judges in the judiciary. Mr. Paul’s stinging critiques of the UN and NAFTA for being “unelected” start to ring hollow. Imagine the look in the eyes of John Edwards’ trial lawyer buddies should this bit of Ron Paul insanity to come to pass — they’ll be seeing big, big, big bucks from all the litigation. Forget an honest day’s work, in Mr. Paul’s America, being an ambulance-chasing lawyer is the way to make it big… and you can help the environment too.

The Gold Standard
Mr. Paul’s long-standing dislike of the federal reserve is well noted in his diatribe on the gold standard. Mr. Paul rants about the evils of so-called “fiat currency” and sees the only solution in the gold standard. Unfortunately for Mr. Paul, all of his fancy education has left him educated stupid on the issue. There are two fundamental problems with Mr. Paul’s logic: a fundamental misunderstanding of currency exchange and a fundamental misunderstanding of the value of gold.

First, we must understand that money is subject to the same laws of economics as anything else, from soup to nuts. This means that if more people want to sell dollars than want to buy dollars, the price of dollars go down. This is why the current account balance is one of the two major contributors to the underlying value of a currency. The United States has a large negative current account balance, aka we import much more than we export. The importers want to sell dollars, to buy the local currencies where they produce goods, while exporters want to buy dollars and get rid of the local currencies where they sell goods. Since there’s more importing and exporting, more people want to sell dollars than buy them. This means that the price of the US dollar decreases. This problem is (in the long term) self-correcting (imports cost more and exports cost less) but that doesn’t mean a negative current-account balance won’t wreck havoc in the short term.

The second major contributor to the underlying value of a currency is the money supply. The more money there is, the less it’s worth in a certain sense. This “cheapening” of money can be crudely approximated using the inflation rate (more sophisticated measures, like M1 are available, but for our purposes today, inflation suffices). If the money supply is being printed to the point of worthlessness (like Robert Mugabe‘s Zimbabwe), inflation number should be high. In the US inflation numbers are low (and have been in the 1-5% range since the early 1980’s). This means that the money supply, about the Fed’s control of which Mr. Paul complains constantly, isn’t the cause of the weakness of the US Dollar. The cause is the current account balance, which the Fed has no control over.

Second, Mr. Paul’s understanding of gold is fundamentally flawed. Unlike wheat (which is edible), gold has almost no inherent value to a human person. Barring a few uses in high-end electronics, gold is exclusively used in jewelry. Translation: We don’t really need gold, we want it because it is pretty. It has a high value because the demand for pretty exceeds the supply of it. If I could perform alchemy and turn lead into gold, gold would be worthless. This means that the big difference between gold and a “fiat currency” like the dollar is in supply. Neither has any (meaningful) intrinsic value. The scarier problem with gold is who control’s the supply. Unlike the Fed, which is part of the US gov’t, the supply of gold is controlled by mining companies, like Anglo-American, historically the gold arm of the DeBeers cartel. In Mr. Paul’s opinion, allowing a foreign cartel to control America’s money supply is the superior choice for America. This seems to clash mightily with Mr. Paul’s isolationist non-interventionist tendencies. But Mr. Paul doesn’t need to double-think this one, because he hasn’t bothered to think things through in the first place. History is pretty damning. If you look at the 1850’s the gold rush in America (which then had a gold/silver standard) caused a 30% increase in wholesale prices in five years. A switch to a strict gold standard in the “Crime of 1873” lead to a depression so great its like would not be seen again until 1932. But Mr. Paul’s short-sighted version of history neglects both of these calamities.

Conclusions
I could go on and on about Mr. Paul being a few cards short of 52, if you catch my drift, but these sites have done the job pretty well. My favorite gems from Mr. Paul’s legislative record include trying to ban flag burning (what a libertarian proposal!) and abolishing basically every form of federal tax (which would allow us to pay for our military, how exactly?). All told, Mr. Paul is the latest example of the sorry mental state of America’s Libertarian movement. It’s a shame they have to take civil liberties down with them.