Hunt For Inflation

July 15, 2018

by Steve Stofka

Saddle up your horses, readers, because we are going on the Hunt for Inflation. I promise you’ll be home for afternoon tea. During this recovery, Inflation has been a wily fox, a real dodger. It has not behaved according to a model of fox behavior. Has Inflation evolved a consciousness?

Inflation often behaves quite predictably. The central bank lowers interest rates and pumps money into the economy. Too much money and credit chasing too few goods and Inflation begins running amuck. Tally-ho! Unleash the bloodhounds! The central bank raises interest rates which curbs the lending enthusiasm of its member banks through monetary policy. Inflation is caught, or tamed; the bloodhounds get bored and take a nap.

Not this time. Every time we think we see the tail of Inflation wagging, it turns out to be an illusion. Knowing that Inflation must be out there, the central bank has cautiously bumped up interest rates in the past two years. Every few months another bump, as though unleashing one more bloodhound ready to pounce as soon as Inflation shows itself.

Yes, Inflation has evolved a consciousness – the composite actions of the players in the Hunt. These players come in three varieties. One variety is the private sector – you and me and the business down the street. The second variety is the federal government and its authorized money agent, the Federal Reserve, the country’s central bank. Finally, there is a player who is a hybrid of the two – banks. They are private but have super powers conferred on them by the federal government. The private sector is the economic engine. The federal government and banks have inputs, drains and reservoirs that control the running of the economy.

The three money inputs into the constrained (see end) economy are 1) Federal spending, 2) Credit growth, and 3) net exports. In the graph below, the blue line includes 1, 2, and 3. The red line includes only 1. The graph shows the dramatic collapse of credit growth in this country. Federal spending accounted for all the new money flows into the economy.

CreditNXFedSpendvsFedSpend

Before the financial crisis, money flows into the economy were just over 30% of GDP. In less than a year, those inputs collapsed by almost 25%.

CreditGrowthFedSpendPctGDP

When inflation is lower than target, as it has been for the past decade, too much money flow is being drained out for the amount that is flowing in. In the case of too high or out of control inflation, as in the case of Venezuela, the opposite is true. Too much is being pumped in and not enough is being drained out. That’s the short story that gets you back to the lodge in time for a cup-pa or a pint. Next week – the inputs, drains and reservoirs of the economy.

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  1. Constrained – the private economy, state and local governments who cannot create new credit.
  2. Net exports are the sum of imports (minus) and exports (plus).

The Line of the Idle

July 8, 2018

by Steve Stofka

It used to be easy for a horse to get a job. This week I’ll look at the workers who have been idled by a century of automation. As a counterpoint to the daily rhythms of being busy, a casual idleness helps us recharge our batteries. In an America whose moral foundations are the Protestant work ethic, a constant idleness taints a person’s character. Those who have retired after a lifetime of work are expected to stay active. Leisure time is a resource not be squandered.

The phrase “pull your weight” meant to act like a horse and contribute to the team effort. From the Revolutionary War for Independence to World War 1, horses fought bravely and earned a place of respect in American history. Many a statue portrays a general atop his brave steed. Horses helped turn America into the bread basket of the world. Then the gas engines came after their jobs. Motors took over the jobs of pulling horse drawn carriages, plows and work wagons. Thousands of horses joined the line of the idle.

Then the engines came for the jobs of the agricultural workers. In the first half of the 20th century, farm employment fell from 40% of the labor force to 20% in 1950, and is 2% today.

Then the robots came for the jobs of manufacturing workers. A 1987 BLS report found that “relatively few employees have been laid off because of technological change.” Thirty years later, the National Council on Compensation (NCCI) summarized data from several sources. “In 2016 the United States produced almost 72% more goods than in 1990, but with only about 70% of the workers.” This two-part report is a bit lengthy but a quick glance at the graphs on the first page tell the story of the decline in agricultural and manufacturing jobs. (Part 1 and Part 2) . As a percent of the labor force, agricultural jobs peaked in the late 1800s. Manufacturing employment peaked just after World War 2.

Robots help assemble the horseless carriages in the car factories. In businesses across the land, the robots now weld and lift, pick and sort, box and ship – jobs that humans had a monopoly on. The robots are now learning how to drive and to think. Almost 40% of adults, and 20% of adults in the prime of their lives now sit idle, joining the horses in pasture.

Electric motors, long chained by a cord to a wall, have broken free and are now taking the jobs of gas engines. Robots built by workers in other countries compete for the jobs of American-built robots. Now the machines are making other machines obsolete.

Forged by the Protestant work ethic, the retired generation of Boomers pursue their leisure in earnest. RV sales are at record levels and last year’s visits to national parks almost matched the record numbers of 2016. Each year there are more visits than there are people in the country (Nat’l Park Service link). This growth in recreation occurs at a time when continuing drought in the western states has put extraordinary pressure on plants and wildlife. Summer in the west is now the season of fire.

In 1900, people welcomed their idleness as a byproduct and hallmark of progress and prosperity. The idleness of prosperity looks very different from the idleness of poverty visible in many troubled countries around the world, including parts of America. Which line is longer and which line are we on?

Stocks and Tax Receipts

July 1, 2018

by Steve Stofka

There is a close correlation (see end) between the trend in equity prices and Federal tax receipts, as we can see in the chart below. Occasionally, the market gets too optimistic or pessimistic. When it does it inevitably corrects back to the trend in tax collections.

SP500VsTaxReceipts

Note the strong divergence between stock prices (blue line) and tax collections (red line) since the 2016 election. Tax collections grew modestly in the first year of the Trump administration; from $2.133 trillion in the first quarter of 2017 to $2.178 trillion in the fourth quarter of last year. Following the tax cuts passed at the end of last year, tax revenues in the first quarter of 2018 fell $150 billion to $2.033 trillion. In fifteen months, the trend is negative for tax collections. In that same time frame, the SP500 rose 20% on the hope – or for some, the faith – that Trump policy will spur economic activity. That greater growth should lead to greater tax collections. It hasn’t.

Some say that the taxes during the previous administrations were too high. “Lowering the rates will raise the revenue,” is the prayer of supply-siders and tax cutters. “Just wait, revenues will rise as strong economic growth kicks in,” they promise. But this correlation of equity prices and tax revenues transcends administrations: the Obama years, and the Bush years and the Clinton years and into the H.W. Bush presidency. We could go even further back. When equity prices mis-estimate future growth, they correct back to the hard trend of tax revenues. It doesn’t happen overnight. The market had been correcting for more than a year before September ‘s implosion of Lehman Brothers in 2008.

George Soros became one of the most successful traders by constructing a story in advance of his trades. The story is a prediction of what he thinks will result if event A happens. When event A doesn’t happen within a set time, or when event A does not lead to B result, he gets out of the trade. He doesn’t fall in love with his story as so many of us do. Economists and politicians fall in love with their theories and stories the way fans do a baseball or football team. This year we’re going to go all the way!

For the long-term investor, the important thing is an allocation commensurate with one’s risk tolerance, time horizon and income needs. Secondly, have patience.

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Since 1990, the correlation is .96. Since 1997, it is .91. Since 2008, it is .94. Since the 2016 election, it is -.45.

Who Owes and Who Owns

June 24, 2018

by Steve Stofka

Total debt levels are high relative to income, but the payments on that debt, the Debt to Income ratio, are at historic lows. Why? The absurdly low interest rates of the past decade play a significant role. What could happen as interest rates rise?

An explanation of terms first. The Debt to Income ratio (CFPB  page) measures the monthly flow of debt service payments to the flow of monthly income. Lenders use this ratio to judge the capacity of a borrower to repay a loan. Let’s call this ratio DTI.

The aggregate household debt to income ratio measures the pool of total debt to the flow of yearly income. Lenders and economists use this measure to assess the leverage of income, i.e. how much debt can the average income buy? Let’s call this ADTI.

As the DTI rose to historic highs before the recession, the average household was paying more than 13% of their disposable income to service their debt.  7.2% of that was mortgage payments. After the recession, the DTI has fallen to historic lows just above 10%. 4.4% of that was mortgage payments, which are near historic lows. Rock bottom interest rates have been the chief factor in that reduction. The percentage of disposable income going to non-mortgage debt payments have remained stable at 6%.

The ADTI shows the leverage of income to debt. Before the recession, each household had debt to income ratio of 1.2:1 (1.2 to 1), as shown in the chart below. (Federal Reserve paper).  The aggregate debt to income ratio is now 1:1. During and following the recession, some households reduced their debt voluntarily; some had their debt reduced involuntarily through home foreclosure and credit card debt write-offs. Although the current ADTI level is just about 1:1, this is far above the debt levels of the 1980s and 1990s when the ratio fell as low as .6:1. Households have transitioned from overleveraged before the recession to fully leveraged after the recession.

DebtToIncomeAgg

Households with higher incomes are more leveraged and raise the aggregate ratio of debt to income. Those with lower incomes have less credit available to them and less debt. They lower the aggregate ratio. Lower income households may not qualify for a mortgage, the greatest source of most household debt and a point of high leverage. The current mortgage leverage is more than 3-1; a $77K income is needed for a $260K mortgage at 4.5% for thirty years (calculator).

To reach the average 1:1 ratio of debt to income using the example above, there must be $183K of income with no debt. For one $77K household to get overleveraged to get that mortgage, there must be fifteen households with $50K incomes who are underleveraged (.25:1 debt to income). Where are those people? Many of them are in rural areas, particularly in the vertical middle of the country and several mountain states. See the 2006 county map of aggregate debt to income in the Federal Reserve paper linked above.

“It’s the economy, stupid!” read the banner that James Carville posted in Bill Clinton’s campaign office during the 1992 election race. In a series of articles published in 2004, journalist Bill Bishop coined the term “the big sort” and published a book by that name in 2009. This is one more example of the sorting that is taking place in this country.

Many people in rural areas live a penny-wise life because they don’t like to be in debt. Some are living frugally because credit is not available to them. In either case, their low levels of debt relative to income are enabling those in urban and suburban areas to maximize their debt leverage. Those living in urban areas may complain – quite rightly – that they must borrow more than they would like because the cost of living in some cities is so high. Regardless, people in one set of circumstances and making do with less are effectively enabling the income to debt leverage of another set of people who are enjoying more. That dissonance adds to the cacophony of the current debate in this country.

Less Bang For The Buck

June 17, 20918

by Steve Stofka

There are two types of inputs into production, human and non-human. Over a hundred years ago, Henry Ford realized that he had to invest in his human inputs as well as his equipment, land and factories. Once he started paying his employees a decent wage, they were able to buy the very cars they were producing on Ford’s assembly line.

The total return on our stock investments depends on two inputs: dividends and capital gains, which is the increase in the stock price. Both are dependent on profits. Dividends are a share of the profits that a company returns to its shareholders. Capital gains arise from the profits/savings of other investors who are willing to buy the shares we own (see end for explanation of mutual funds).

In the past three decades, a growing share of total return has come from capital gains. Because of that shift from dividend income to capital gains, market corrections are harsh and swift.

In the 1970s, stocks paid twice the dividend rate that they do today. It took an oil embargo and escalating oil prices, a continuing war in Vietnam, the impeachment of President Nixon, a long recession and growing inflation to sink the market by 50% beginning in early 1973 to the middle of 1974.

In 2000, the dividend rate or yield was a third of what it was in 1973. Total return was much more dependent on the willingness of other investors to buy stocks. In 2-1/2 years, the market lost 45% because of a lack of investor confidence in the new internet industry, a mild recession and 9-11. Dividends act as a safety net for falling stock prices and dividends were weak.

In 2008, the dividend yield was about the same as in 2000. In 1-1/2 years, the market again lost 45% of its value because of a lack of confidence brought on by a financial crisis and a long and deep recession.

Other bedrock shifts have occurred in the past three decades. Corporate debt is an input to production. In the post-WW2 period until 1980, corporate debt as a percent of GDP was a stable 10-15%. $1 of debt generated $7 to $10 of GDP. Following the back-to-back recessions of the early 1980s until the height of the dot-com boom in 2000, that percentage almost doubled to 27%. Each $1 of corporate debt generated less than $4 of GDP.

CorpDebtPctGDP

Today $1 of corporate debt generates just $3 of GDP. Debt is a liability pool. GDP is a flow. That pool of debt is generating less flow. It is less efficient. In 1973, $1 of corporate debt generated 46 cents in profit. Now it generates just 30 cents.

To hide that inefficiency and make their stocks appealing to investors, companies have used some of that debt to buy back their own stock. This reduces the P/E ratio many investors use to gauge value, and it increases the leverage of profit flows.

Here’s a simple example to show how a stock buyback influences the P/E ratio. If a company makes a $10 profit and has 10 shares of stock outstanding, the profit per share is $1. If the company’s stock is priced at $20, then Price-Earnings (P/E) ratio is $20/$1 or 20. If that company borrows money and buys back a share of stock, then a $10 profit is divided among 9 shares for a per-share profit of $1.11. The P/E ratio has declined to 18. When the company buys stock back from existing shareholders, that often drives up the price, and thus lowers the P/E ratio further.

The P/E ratio values a company based on the flow of annual profits. A company’s Price to Book (P/B) ratio values the company based on a pool of value, the equity or liquidation value of the firm. If we divide one by the other, we get an estimate of how much profit is generated by each $1 of a company’s equity, or Return On Equity (ROE).

1982 was the worst recession since the Great Depression. Stocks were out of favor with investors and were at a 13 year low. In 1983, $8.70 of equity generated $1 of profit for companies in the SP500. Seventeen years later, at the height of the dot-com boom in 2000, companies had become more efficient at generating profits. $6 of equity generated $1 in profit. In the last quarter of 2017, companies have become less efficient. $7.30 of equity generated $1 of profit.

Let’s look at another flow ratio, one based on the flow of dividends. It’s called the dividend yield, and the current yield is 1.80, about the same as a money market account. I can put my $100 in a money market account or savings account and earn $1.80. If I need that $100 a year from now, it will still be there. I could use that same $100 and buy a fraction of a share of SPY, an ETF that represents the SP500. I could earn the same $1.80. However, if I wanted my $100 back in a year, it might be worth $120 or $50. A stock’s value can be very volatile over a short time like a year, and the current dividend rate does not compensate me for that extra risk.

Why don’t investors demand more dividends? After the early 1980s, economists at the Minneapolis Federal Reserve noted (PDF) that, on a global scale, companies’ profits grew at a faster rate than the dividends they paid to shareholders. The dividend yield of the SP500 companies fell from 6% in the early 1980s to 1% in 2000 (chart).

Those extra profits are counted as corporate savings. The same paper showed that global corporate savings as a percent of global GDP increased from 10% in the early 1980s to 15% this decade. Each year companies were adding on debt at a faster pace than during the post-war decades, but undistributed profits were growing even faster. The net result was an increase of 5% in the rate of corporate saving. Companies around the world were able to shift dividends from the savings accounts of shareholders to the savings of the companies themselves.

From the early 1980s to the height of the dot-com boom, stock prices increased more than ten-fold. Investors that had depended on company dividends for income in previous decades now depended on other investors to keep buying stocks and driving up the price. The source of an investor’s income shifted slightly from the pocketbooks of corporations to the pocketbooks of other investors. Investors adopted a shorter time horizon and now look to other investors to read the mood of the market.

The bottom line? If investors rely on each other for a greater part of their total return, price corrections will be dramatic.

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Notes: Price to Book (P/B) ratio was 1.5 in 1983 (article).
P/B graph since 2000
When mutual funds sell some of their holdings, they assign any capital gains earned to their fund holders. This amount appears on the mutual fund statements and the yearly 1099-DIV tax form.

A November 2017 article on share buybacks at the accounting firm DeLoitte

 

Study Dollars

June 10, 2018

by Steve Stofka

In the past forty years, inflation-adjusted per student spending on higher education has increased by 40%. Despite this, the number of tenured professors has fallen by half. Two-thirds of instruction is now carried out by adjunct faculty with no job security and few benefits. State and federal dollars subsidize workers training for the banking and insurance industries, but not those entering the construction and manufacturing industries. No wonder people express their grievances at government for a lack of funding (Alternet article) . Where is the money going? Maybe the question is: who is the money going to?

In 1940, just 5% of Americans had a four-year college degree (NCES, Dept. of Ed).  In 2015, 75 years later, a third of Americans reported having a college degree.

CollegeDegreePct

A few years after WW2 and the enactment of the GI Bill’s education benefits, 2.7 million were enrolled in a two or four-year degree granting institution. By 1959, enrollment had grown 33% to 3.6 million students (NCES). About 60% were enrolled in a public institution. According to the Bureau of Economic Analysis (BEA), total Federal, State and Local spending in 1959 was $12.4B, about $3400 per student in 2016 dollars.

In 2016, there were 20.2 million students enrolled in college, a third of them in two-year programs. They were sharing a pot of $241B federal and state dollars, about $12,000 per student. That’s inflation-adjusted dollars: apples to apples. Here is a chart covering the past 50 years.

EdSpendPerStudentReal

Confronted by escalating Medicaid costs and uncooperative taxpayers, the state portion of higher education spending has fallen over the past two decades.

StateLocalEdSpendPerStudent2016$

In Colorado, the taxpayer rebellion started in the 1990s when the Denver Post reported that a University of Colorado (UC) faculty member was retiring with an annual pension almost eight times the average yearly income in Colorado. The abuse has not stopped. Last year, the L.A. Times reported that UC continued to hand out generous pensions to faculty members.

In the 1990s, UC and other public and private universities planned that the future annual investment returns on their endowment funds would continue to be generous. They stopped making contributions to meet the future obligations of the equally generous pensions they promised to faculty. “Our accountants told us we would be all right,” was the lament of one city official in California. After a decade of rock bottom interest rates and single digit returns for college endowments, students, parents and taxpayers must now pick up the tab for the Polyanna thinking of politicians and college administrators.

In 1959, state and local governments spent 98% of higher education funding. In 2016, they spent less than 60%. Because public and private institutions are tax-exempt, state and local governments provide billions in forgone tax revenue that is not counted.

StateLocalPctEdSpend

About 9% of total spending goes to private for-profit institutions (NCES). Because the for-profit institutions grab headlines, some might think that they receive a greater percentage of education dollars than they do. I did.

Inflation-adjusted per student spending has risen 27% in the past twenty years. Where is all that money going? Not to today’s instructors. Less than a third of spending goes to instruction (NCES). About 40% goes to administration and student support.

Public and private non-profit institutions do not detail the expenses for maintenance and operation of their buildings and grounds, nor their interest and depreciation expenses. This gap is about 28-30% of spending, so we can conservatively estimate that they spend at least 25% of their budget on these items. As buildings continue to age, operations expenses will grow faster than the rate of inflation and eat up more education dollars. Each year, colleges and universities spend more time and dollars in their outreach to a growing cohort of “non-traditional” students.

An educational system designed for the children of the landed elite in the 19th century is trying to catch up to the needs of a diverse student population in the 21st century. That earlier system wasn’t much good to start with. That’s a topic for another time.  Entrenched political and financial interests now hinder any substantive changes in these institutions as they prepare the students of today for the world of tomorrow.

About 3 million students are graduating high school this year. Two thirds of those graduates are enrolled in a two or four-year college (BLS), and the majority are female. Out of every 100 college students, 56 are female (NCES). There are not enough state or federal educational programs to meet the skills training for the million students who will not go on to college this year, or the million who may drop out before getting a degree.

Discrimination – Education policy in this country subsidizes the training of workers employed by a large bank like J.P. Morgan Chase, but has little support for the workers in the construction and manufacturing industries. The subsidized workers at Chase are more likely to lose their jobs to automation than the unsubsidized workers at a large homebuilder like Pulte.

Fifteen percent of all employees are in the BLS category of Professional and Business Services. This percentage has grown from 8% of the work force in 1980. Employees work for private companies and government, enjoy lower unemployment rates and much higher incomes. (BLS profile ) The great majority have college degrees. College enrollees are attracted by these numbers, but the numbers are changing. The growth of this category in the 1990s lessened during the 2000s and has lessened again since the Great Recession. I’ve highlighted the trend changes in the graph above.

ProfBusSvcPctPayems

In the past year growth is relatively flat. The number of institutions with job growth has offset those with declining job growth.

ProfBusSvcEstablish
The world is changing rapidly, and for some the changes are too much and too quick. That reaction against change underlies the support for Donald Trump in the rust belt states.

Current college enrollees and graduates may find that they have prepared for a world that existed a decade ago, and will be materially changed a decade hence. The college debt is permanent but not the state of the job market. Be versatile, be flexible, be prepared.

 

Building A Peak

June 3, 2018

by Steve Stofka

First I will look at May’s employment report before expanding the scope to include some decades long trends that are great and potentially destructive at the same time. In the plains states of Texas, Oklahoma, Kansas, and Nebraska, summer rain clouds are a welcome sign of needed moisture for crops. That’s the good. As those clouds get heavy and dark and temperatures peak, that’s bad. Destruction is near.

May’s employment survey was better than expected. The average of the BLS and ADP employment surveys was 203K job gains. The headline unemployment rate fell to an 18 year low. African-American unemployment is the lowest recorded since the BLS started including that metric in their surveys more than thirty years ago. As a percent of employment, new unemployment claims were near a 50-year low when Obama left office and are now setting records each month.

During Obama’s tenure, Mr. Trump routinely called the headline unemployment rate “fake.” It’s one of many rates, each with its own methodology. Now that Mr. Trump is President, he takes credit for the very statistic that he formerly called fake. The contradiction, so typical of a veteran politician, shows that Mr. Trump has innate political instincts. A President has little influence on the economy but the public likes to keep things simple, and pins the praise or blame on the President’s head.

The wider U-6 unemployment rate includes discouraged and other marginally attached workers who are not included in the headline unemployment rate. Included also are involuntary part-time workers who would like a full-time job but can’t find one. Mr. Trump can be proud that this rate is now better than at the height of the housing boom. Only the 2000 peak of the dot com boom had a better rate.

Let’s look at a key ratio whose current value is both terrific and portentous, like a summer’s rain clouds. First, some terms. The Civilian Labor Force includes those who are working and those who are actively seeking work. The adult Civilian Population are those that can legally work. This would include an 89-year old retiree and a 17-year old high school student. Both could work if they wanted and could find a job, so they are part of the Civilian Population, but are not counted in the Labor Force because they are not actively seeking a job. The Civilian Labor Force Participation Rate is the ratio of the Civilian Labor Force to the Civilian Population. Out of every 100 people in this country, almost 63 are in the Labor Force.

While that is often regarded as a key ratio, I’m looking at a ratio of two rates mentioned above: the Labor Force Participation Rate divided by the U-3, or headline, Unemployment Rate. That ratio is the 3rd highest since the Korean War more, ranking with the peak years of 1969 and 2000. That is terrific. Let’s look at the chart of this ratio to understand the portentous part.

CLFUIRatio
Whenever this ratio gets this high, the labor economy is very imbalanced. Let’s look at some previous peaks. After the 1969 peak, the stock market endured what is called a secular bear market for 13 years. The price finally crossed above its 1969 beginning peak in 1982. In inflation-adjusted prices, the bear market lasted till 1992 (SP500 prices). Imagine retiring at 65 in 1969 and the purchasing power of your stock funds never recovers for the rest of your life. Let’s think more pleasant thoughts!

For those in the accumulation phase of their lives, who are saving for retirement, a secular bear market of steadily lower  asset prices is a boon. Unfortunately, bear markets are accompanied by higher unemployment rates. The loss of a job may force some savers to cash in part of their retirement funds to support themselves and their families. Boy, I’m just full of cheery thoughts this week!

After the 2000 peak, stock market prices recovered in 2007, thanks to low interest rates, mortgage and securities fraud. Just as soon as the price rose to the 2000 peak, it fell precipitously during the 2008 Financial Crisis. Finally, in the first months of 2013, stock market prices broke out of the 13-year bear market.

We have seen two peaks, followed by two secular bear markets that lasted thirteen years. The economy is still in the process of building a third peak. Will history repeat itself? Let’s hope not.

May’s annual growth of wages was 2.7%, strengthening but still below the desirable rate of 3%. The work force, and the economy, is only as strong as the core work force aged 25-54. This age group raises families, starts companies, and buys homes. For most of 2017, annual employment growth of the core fell below 1%. It crossed above that level in November 2017 and continues to stay above that benchmark.

Overall, this was a strong report with job gains spread broadly across most sectors of the economy. Mr. Trump, go ahead and take your bow, but put your MAGA hat on first so you don’t mess up your hair.

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Executive Clemency

This week President Trump pardoned the filmmaker Dinesh D’Souza, serving a five-year probation after a 2014 conviction for breaking election finance laws. He helped fund a friend’s 2012 Senate campaign by using “straw” contributions. D’Souza complains that he was targeted by then President Obama and General Attorney Holder for being critical of the administration. A judge found no evidence for the claim but if he didn’t see the conspiracy against D’Souza, then he was part of the conspiracy, no doubt. I reviewed the 2016 movie in which D’Souza unveiled the perfidious history of the Democratic Party and its high priestess, Hillary Clinton.

Grandma’s Kids

May 27, 2018

by Steve Stofka

The birth rate has touched a 30-year low, repeating a cycle of generational boom and bust since World War 2. The first boom was the Boomer generation born in the years 1946-1964 (approx). They were followed by the baby bust Generation X, born 1964-1982. The Millennials, sometimes called Generation Y and born 1982 – 2001, surpassed even the Boomers in numbers. Based on the latest census data, Generation Z, born 2002- 2020, will be another low birth rate cohort.

These numbers matter. They form the population tide that keeps the entitlement system afloat. Social Security and Medicare are “pay as you go” systems. Older generations who receive the benefits depend on taxes from younger generations for those benefits. As the population surge of Boomers draws benefits, the surge of Millennials is entering their peak earning years.

To maintain a steady population level, each woman needs to average 2.1 births. During the Great Recession, the birth rate for native-born Hispanic and Black women fell below that replacement level. White and Asian women fell below that level during the recession following the dot-com boom in the early 2000s. Foreign born Hispanic and Black women are averaging a bit more than 2-1/2 births. The average of foreign born White and Asian women is just about replacement rate.

Around the world, birth rates are falling. Social welfare programs depend on inter-generational transfers of income. When a smaller and younger generation must pay for a larger and older cohort, there is an inevitable stress.

I will distinguish between social welfare programs and socialist welfare programs with one rule: the former require that a person pay into the program before being entitled to the benefits from the program. In this regard, they are like insurance programs except that private insurance policies are funded by asset reserves held by an insurance company. Government “insurance” programs are “pay as you go” systems. Current taxes pay for current benefits. The Social Security “reserve” is an accounting fiction that the Federal government uses to track how much it has borrowed from itself.

Examples of social welfare programs that require the previous payment of dues are: Social Security, Medicare, Unemployment and Workmen’s Compensation Insurance. Although the latter two are paid directly by employers, they are effectively taken out of an employee’s pay by reducing the wage or salary that the employer pays the employee. Employers who fail to understand this go out of business early in the life of the business. I have known some.

Examples of socialist welfare programs that are based on income, or need: Medicaid, TANF (Welfare), WIC, Food Stamps, Housing and Education Subsidies. There is no requirement that a person pays “dues” into a specific program before receiving benefits.

Health care in America is primarily a social welfare program with socialist elements. The Federal government does subsidize all employer provided health insurance and most private insurance through the tax system or the Affordable Care Act. However, most beneficiaries must pay some kind of insurance to access benefits. Under the 1986 EMTALA act, emergency rooms are notable exceptions to this policy. They are required to treat, or medically stabilize, all patients insured or not.

As Grandma begins to draw benefits from Social Security and Medicare, she relies on the earnings of her kids who form the core work force aged 25 – 54. Grandma has paid a lifetime of dues into the social welfare programs and wants her benefits. Grandma votes.

Her grandkids want government subsidies for educational needs and job training. They depend on socialist welfare programs with no dues. The grandkids don’t vote.

The kids are caught in a generational squeeze.  Their taxes are paying for both their parent’s benefits and their kid’s benefits.

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Housing Trends

In the spring of 2008, there was an eleven month supply of existing homes on the market.
2010 – 8-1/2 months
2012 – 6-1/2 months
2014 – 5-1/2 months
2016 – 4-1/2 months
2018 – 4 months

In some cities, a median priced home stays on the market less than 24 hours.

Here is another generational shift.  Grandma and Grandpa now own 40% percent of home equity, up from 24% in 2006. Their kids, the age cohort 45 – 60, own 45%. Those under 45 have only 14% of home equity, down from 24% in 2006.

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Brave New World

E-Commerce is now 9.5% of all retail sales, almost triple the percentage ten years ago. (Fed Reserve series ECOMPCTSA). In 2000, the percentage was less than 1%.

The Big Picture

May 19, 2018

by Steve Stofka

Here is a simple and elegant animation model of the economy in a thirty-minute video from Bridgewater Associates, the world’s largest hedge fund. The video illustrates the spending – income – credit cycle in easy to understand terms. The video includes an insight first noted eighty years ago by the economist John Maynard Keynes, who pointed out that one person’s spending is another person’s income. Sounds obvious, doesn’t it?  I spend money on a pizza which increases the income of the pizza store.

When Keynes explored this simple idea, he revealed a glitch in the traditional model of savings and investment. In a simplified version, money not spent is saved in a bank. The bank loans out those savings to a business.  A business invests that loan into production for future spending. When economists model the whole economy, Savings = Investment. It is an accounting identity like a mathematical definition. The financial industry transforms one into the other.

During the Depression, something was obviously broken, and economists debated various aspects of their models. Keynes asked a question: what happens to the merchant where the money was not spent? Let’s say the Jones family decides not to buy a new TV and puts the money in a savings account at the Acme Bank.  The local Bigg TV store sells one less TV and has a corresponding decline in its income. Because Bigg had less income, they must withdraw money from their Acme Bank savings account to meet payroll. The money that the family saves is withdrawn by the business. The money Saved never makes it to the Investment side of the equation.  There is no increase in investment.

Most of the time, those who are saving and those who are spending funds from saving balances out. But there were times, Keynes proposed, when everyone is saving. Keynes attributed the phenomenon to “animal spirits.” As incomes fall, people start using up their savings to make up for the lost income.

During a crisis like this, Keynes proposed that government increase its spending, even if it needed to borrow, to boost incomes and break the vicious cycle. When the crisis was over, the government could raise taxes to pay back the money it borrowed. In Keynes’ model, government spending acted as a balancing force to the animal spirits of the capitalist economy. In the real world, politicians win votes by spending money but find that raising taxes does not win them favor with voters. Without legislative debt controls, government borrowing to counterbalance declines in income only produces greater government debt.

Turning from government debt to personal debt, the average credit card rate has risen to 15.3%, an eighteen year record. As an economy continues to expand and credit is extended to those with marginal creditworthiness, the default rate grows. The percent of credit card balances that have been charged off in default has risen from 1.5% several years ago to 3.6% in the 4th quarter of 2017.

Mortgage rates have risen to about 4.9% on thirty-year loans, and about a half percent less on fifteen-year loans. That half percent difference is close to the average for the past twenty-five years and adds up to an extra $1.60 in interest paid during the life of the loan on every $100 of mortgage principal. The graph below shows the difference between the two rates.

MortRatesDiff

Because shorter-term mortgages require higher monthly payments, they are more feasible for those with stable financial situations and above average incomes. When the difference in rates is less than average, there is a smaller advantage to getting a short-term mortgage.  At such times, the mortgage industry is reaching out to expand home ownership to lower income homeowners. When the difference is more than average, as it has been since the recession, the finance industry is cautious and not actively reaching out to lower income families.

Mortgages are secured by a physical asset, the house. U.S. Treasury bonds are secured by an intangible asset, the full faith and credit of the country. Just like us, the Treasury usually pays a higher interest rate for a longer-term loan.

A benchmark is the difference between a 10-year Treasury bond and a 2-year bond. As this difference declines toward zero, economists call it a “flattening of the yield curve.” At zero, there is no reward for loaning the government money for a longer term. Knowing only that, a casual investor would sense that something is wrong, and they are right. Periods when this difference falls below zero usually occur about a year before a recession starts. In the graph below, I’ve shaded in pink those negative periods. In gray are the ensuing recessions.

10YRLess2Yr

Before that negative pink period comes another phenomenon. Above was the 10 year – 2 year difference in interest rates. Let’s call that the medium difference. There’s also the difference between two long term periods, the 20-year minus 10-year difference. I’ll call that the long difference. When we subtract the medium difference from the long, we get a difference in long term outlook. In a healthy economy, that difference should be positive, meaning that investors are being paid for taking risks over a longer period. When that difference turns negative, it shows that there are underlying distortions in the risks and rewards of loaning money. That distortion will show first before the flattening of the yield curve.

DiffRates1995-2018

As you can see, the difference today is positive, a welcome sign that a recession is not likely within the year.

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Tidbits

The actuaries for Social Security and Medicare use an assumption that our average life expectancy will increase .77% per year (Reuters article)  If you are expected to live till 85 this year, then that expectation will grow to 85 years and eight months next year. That’s a nice birthday present!

U.S. lumber mills can supply only two-thirds of the lumber needed by homebuilders. The other third comes from Canada. Recent import tariffs now add about $6300 to the price of a new home (Albuquerque Journal).

Optical Illusions

May 12, 2018

by Steve Stofka

I have long enjoyed optical illusions. Is that a picture of a rabbit or a duck? Which way is the cube facing, right or left? (Some examples) Is that two people facing each other, or a vase? (Image page) These can be even more fun when shared with a friend or sibling. Can’t you see the rabbit? No, it’s a duck!!!

Moving images present a selective attention deception. When asked to count the number of basketball passes, we may not see the gorilla that walks across our field of view. (Video)

These examples excite our curiosity and fascination as children and carry important lessons for us as adults. We sometimes misinterpret the data our senses receive. Those with a strong ideological bent may focus narrowly on only that data that supports their view of the world, or that makes them feel comfortable.

Let’s look at an example. Real (inflation-adjusted) median (middle of the pack) household income peaked in 1999 at $58,665. In 2016, income climbed to $59,039. However, personal income did not peak till 2007, at $30,821. Like household income, personal income finally rose above that peak in 2016.

PersVsHouseholdIncome

In the household series, the past twenty years have been especially tough. In the personal series, only the past ten years have been that difficult. What accounts for the difference in the two series? Households have grown faster than the population. Population Income / Households will be lower when households increase.

But what is income? Household income is money income received and does not include employer-provided benefits and retirement contributions (Census Bureau Defs). The BLS does track total compensation costs which do include these benefits, and those costs are 67% higher today than they were in 2001.

Benefits

If an employer gave an employee $500 a month for health care expenses and the employee sent the money to the health insurance company, that would be counted as income in the data. But because the employer sends the money directly to the insurance company, that income is not counted. Because of World War 2 wage and price controls, and to avoid being taxed under the income tax system, most employee benefits never touch the employee’s pocket, and are not counted as income. This becomes important when something not counted, benefits, grows much quicker than the income that is counted, or money received.

Since 1970, real hourly wages have grown only 3%. Bernie Sanders and other Democrats use a similar figure to press for more social welfare programs. Total hourly compensation has grown 60% (Fed Reserve blog) and most of that is not included in household income.

HourlyWagesVsTotalComp

Is it a rabbit or a duck?

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Do Millennials have it worse than Boomers did at this age?

I’ll call them the Mills and the Booms, so I don’t wear out my fingers. The Mills were born about 1982-2001 so they are 17 – 36 years old today.  A decade after the worst recession since the Great Depression, home and apartment prices are rising fast in many urban areas.  Mills are now the largest generation alive and are at an age when a majority of  them are independent and increasing the demand for housing.

Some Mills are trying to provide shelter for their families when the competition for housing puts constant upward pressure on prices. Some Mills are paying off student loans, while paying $800 to $1000, or more in California, to share a 3 bedroom house with  two other people. It is stressful.

The Booms were born approximately 1946 – 1964. The youngest are 54; the oldest are 72. When the Booms were 17-36, the year was 1982, and oh, what a year it was. The Booms had just endured a decade of double-digit inflation rates (it is now less than 2%), four recessions, mortgage rates that were considered a “bargain” at 9% (4% today), and high housing and apartment prices because there was so much demand for living space from this post war baby boom.

Oh, and tax increases. Tax rates were not indexed for inflation till 1985, so higher wages each year to keep up with that double-digit inflation meant that many workers were kicked up into a higher tax bracket each year. One of Ronald Reagan’s campaign promises was to stop the sneaky practice of dipping deeper into worker’s pockets every year. He got elected President, beating President Jimmy Carter who had told workers to turn the heat down and put a sweater on.

How do today’s monthly debt payments compare? Household Debt Service Payments as a percent of disposable personal income are 5.8% today compared to 5.6% in 1982. The 37-year average is 5.7% (Federal Reserve).

What are those average debt service payments buying? Better cars, more education, more square footage of housing space per person, and computers and electronics that didn’t exist in the 1980s. People are paying more for housing but are enjoying 30% more square footage per person (Bloomberg). In 1982, 17% of the population 25 years and older had a college degree. Today, it is double that percentage (Census Bureau table A-1), an achievement that the Mills can be proud of.

The Mills do have it better than the Booms, who had it better than the generations before them. That “good old days” talk that we heard from Bernie Sanders on the campaign trail are based on some foggy memories. The reality was way tougher than Sanders remembers or talks about because his perception is clouded by his ideology. He only sees the data that tells him it’s a rabbit. He doesn’t see the duck.