Author: sgstofka

Unemployment Insurance Extension

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The recent failure of the Senate to extend unemployment insurance (UI) benefits has sparked debate around the country.  This Senate report from the Joint Economic Committee focuses on the question of whether extending UI benefits causes the unemployed to be less aggressive in their job search or to be more discriminating, taking only those jobs similar in rank and experience to the job they lost.  This widely held notion is based on studies done in the 1970s and 1980s that found that unemployed workers found jobs just before their benefits ran out.  The committee heard testimony from authors of these decades old studies, who replied that those studies were no longer applicable because they were primarily concerned with temporary or cyclic layoffs in manufacturing industries. Manufacturing now comprises less than 20% of the economy. 

This Senate committee was chaired by a Democrat, leading some to respond that the report is biased in favor of extending benefits.  However, the report includes testimony from Alan Greenspan, former Federal Reserve chairman and a staunch conservative, who said “when you’re in period of job weakness where it is not a choice on the part of people whether or not they’re employed or unemployed, then, obviously, you want to be temporarily generous”.

It is the states have been largely responsible for the lack of funding for their unemployment reserves.  As this National Unemployment Law Project report shows on page 3, for the past four decades states have been lowering the wage base they collect UI taxes on from almost 50%  of taxable wages to less than 30% of taxable wages.  It is the states that have been unable to extend UI benefits simply because they have not prepared for the “rainy day” of a serious recession.  Many states and advocates for the unemployed then come crying to the Federal government to help them and their citizens who are suffering from the lack of planning by state politicians.

As a small employer, I strongly oppose the numerous burdens that states and the Federal government put on employers.  Under current law in most states, UI rates charged to employers are based on the experience ratings of each employer, which penalizes those employers with greater turnover.  Thus, employers are reluctant to hire a new employee if they are not sure that the increased business will be more or less permanent.  If they let that new employee go in 4 months, the employee will be able to collect unemployment insurance, which drives up the experience rating and UI rate of the employer and costs the employer more for all employees.

In my opinion, unemployment insurance should be paid for and based on the experience rating of a worker, not the employer.  If UI is to be part of the social contract, then collect it from the citizens who may benefit from that insurance, not the employers.  Some might counter that proposal with the argument that, once the burden of the insurance tax is shifted to the employee, there is the possibility of collusion between an employer and employee to defraud the system.  For example, an employee who wanted to quit a job – and would thus be unable to collect UI benefits – could ask the employer to fire him or her so that they could collect UI benefits.  Since the employer now has no “skin in the game”, the employer might agree to falsify the employee’s record to show that the employee was fired.  In the long run, however, it is the employee who will bear the cost in higher insurance premiums.

We are currently seeing the results of bad planning and policies that target and penalize employers.  Although some economic indicators show an uptick in spending and an increase in sales for some industries, businesses in general are reluctant to hire simply because the cost burden of a new employee requires such a commitment from the employer.

For now, solutions include extending UI benefits for now and dipping into federal stimulus funds for the money.  Why have the Democrats refused to touch the stimulus money to fund further extensions?  I have heard little of any substance from Democratic politicians explaining why they don’t want to pay for UI benefit extensions with stimulus funds.  If anyone has, please let me know.

The ultimate solution has to come at the state level where states need to keep adequate reserves for unemployment claims.  Secondly, states need to transition away from employer based unemployment insurance.

IRA Contributions On Sale

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In late March, I was speaking with someone about IRA contributions.  Both of us agreed that we were hoping that the market would come down a bit before the April 15th deadline to make a contribution for the 2009 tax year.  By April 15th, the market had gone even higher on early signs that a recovery was gaining steam. 

Recent data in this past month has cast doubt on hopes for a strong recovery and the market has declined 16% from its high on April 23rd.  Now might be a good time to think about making some part of a 2010 IRA contribution.  If you think the market could fall further into bear market territory, a 20% or greater correction, then stagger or dollar cost average your contributions.  Too often we make the mistake of not thinking about IRA contributions till a few months before the deadline.

The Nature of Transactions

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Conservatives are concerned about the moral behavior of individuals, but not about their economic behavior unless it is a transaction between two consenting adults which violates conservative moral sensibilities.  For that reason, many conservatives vote for laws banning prostitution, the use of drugs, and homosexuality, to name a few. 

Liberals are concerned about the moral behavior of companies, but less concerned about the moral behavior of individuals.  Conservatives and liberals have fundamental conflicting views of the nature of a transaction.

Conservatives tend to idealize process so they often view a transaction between two parties as a voluntary trade.  Liberals view a transaction as a process whereby one party gains some advantage, however slight, over another.  Because of their view, conservatives want little regulation of the economic behavior between people or between companies and people.  Liberals often mistake this view as a sympathy for companies but is a conservative reverence for the sanctity of transactions between parties that leads them to reject regulatory laws.

Because of their view of the nature of transactions, liberals want more regulations in an effort to reach a “fair” transaction where one party’s advantage over another is kept to a minimum.   What is the proper number of referees in a football game?  Conservatives want fewer referees, liberals want more.

World Trade Rising

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Each month the Bureau of Economic Policy Analysis, based in the Netherlands, releases a report on world trade.  The latest report for April, released June 24th, showed a month over month drop of 1.7% after a particularly strong increase of 4% in March.  The 3 month moving average is up about 5% with Japan, Asia and other emerging markets showing steady improvements in exports.

Liberalism

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Previously I discussed the contradictions in conservative philosophy.  Today I’ll examine contradictions in modern liberalism, which has borrowed aims, ideas and sentiments from classical liberalism but has evolved from those roots.

Liberalism claims a fundamental belief in the inherent goodness of people, that there is an implied social contract between people to treat each other fairly.  It professes commendable goals of equality and individual freedom but is less concerned with the process of attaining those goals.  The underlying morality of the means toward an end often conflicts with the morality of the goal.  To say that liberalism believes that the ends justify the means is a false oversimplification of the philosophy because liberalism is concerned with process, but that concern is subservient to the goal.  Principles compromised in the path toward a worthy goal are an acceptable trade off.

John Locke, regarded as the founder of classical liberalism, conceived of equality as a natural state that human beings are born into.   Each person is not inherently subject to another and all people in a political society have a right to be treated equally under the law.  Modern liberalism broadens that concept of equality to mean that all people in a society should have equal opportunity to further their economic station; that each person in a society should have at least a minimum amount of goods to survive.

In Locke’s view, each person has a right to own property – property of any sort, not just land – and it is the government’s chief role to protect that property. No person may be forced to give up their property unless that person chooses to do so by some sort of implied or explicit contract.  As modern liberalism expanded the idea of equality, a contradiction in principles arose.  If a society was to ensure some level of survival to all people in that society, it would have to take property from those who had it in order to give it to those who didn’t.

Equal opportunity is a utopian ideal.  Few modern liberals would reasonably assert that such an ideal is attainable.  What is attainable is more equal opportunity.  In pursuit of that goal, public educational institutions were founded – funded not by taxes apportioned equally among the citizens but by monies – property – taken from those who had property.  No one can reasonably question the immense value that a schooled citizenry has to society.  Over the past 150 to 200 years, the outcome of such a policy has been a great boon to society.  If the means of getting there has meant some compromise of the principle of protection of private property, that is an acceptable trade off, modern liberals would argue. 

Equality, or fairness, under the law is a core concept of classical liberalism.  No reasonable person would argue that it is fair that someone starve to death on the street while those with full bellies walk by.  Although modern liberalism professes a belief in the inherent goodness of people, it does not trust in the goodness of people to freely choose to help those in need.  This contradiction is so profound that, for some, it undermines the moral basis of modern liberalism.  Modern liberals assume that there are not enough people who will freely choose to help those in need that people must be made to help those in need.  Rather than passing the hat, liberals pass a tax.

Inequality of circumstance, of station, of living standard – is unavoidable.  That is the natural state that human beings – in fact, all creatures – are born to.  To minimize that inequality in pursuit of a vision of justice and fairness may be a laudable goal but the mission is sullied by a less than principled process in pursuit of a worthy aspiration.  Some people will doubt such noble intentions, others will fight confiscatory laws or hide their property – making it all the more difficult for modern liberals to attain their ends.  Process matters.

Conservatism

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Modern day conservatism and liberalism have several contradictions which make it difficult to forge pragmatic policy based logically on either theory.  Today I’ll look at the contradictions of the conservative philosophy.

Conservatism emphasizes individual freedom in a pro-forma manner but the philosophy particularly targets individual economic freedom.  Conservatism professes a support for moral freedom but herein lies one of many contradictions in the philosophy.  Advocating for tradition and the nuclear family, conservatives all too often prescribe moral values as part of their philosophy.  Politicians in the social conservative camp thus propose laws which aim to enforce certain moral choices – in effect, curtailing moral freedom.

Conservatism champions free market capitalism as the economic structure which will give the most individual economic freedom.  The haphazard to and fro of the marketplace does not promote social equality or deliver restorative justice and conservatives contend that government has no business intruding on an individual’s economic freedom in order to accomplish either of these goals.  Thus conservatism maintains that all government income redistribution schemes are baseless.  Here conservatism reveals its utopian roots.  While liberal philosophy has utopian aims, conservatism has utopian means.  In principle, free market capitalism is a sum of individual choices.  In practice, the participants in a free market try to gain an economic advantage through legal or political access, thus compromising the freedom of other individuals to make choices in their own self interest.  This inevitable contamination of the pure utopian model of capitalism transforms it to some degree into an income redistribution scheme.

Conservatives argue for limited government at the federal level but steadfastly propose a strong national defense, which requires more spending, more taxes and an increased intrusion by the federal government on both individuals and the separate states.  Despite their professed support for individual freedom, many conservatives have supported a military draft during the past century.  In addition to government’s role to protect its citizens from external threats, conservatism advocates a strong role for government to maintain an internal order.  Thus, conservatives support a strong police presence, a well funded judicial administration and penal system to dissuade and punish those who make moral choices which threaten the moral and social order.  Conservatives deny that any social benefits programs help maintain an internal civil order and so argue that the federal government should have no role in social welfare programs. 

Who shall determine the proper moral and social order?  Conservatism’s answer is majority rule but there lies another contradiction – a support for a populism which is antithetical to the founding principles of this country.  Conservatives hold a well deserved regard for the original text of the Constitution as they interpret it.  Yet the politicians who wrote the Constitution of this country were afraid of majority rule, regarding it as mob rule, and one of the most dangerous threats to a free people.  Accordingly, they enacted political institutions and processes designed to mitigate the danger of majority rule, creating a republican form of democracy. 

As an economic and political philosophy, conservatism is pro-forma anti-statist.  However, the practice of conservatism requires an intrusive statist framework to enforce traditional values.  In the U.S., these traditional values are based on Christian moral values as set forth in the Bible.  Since the Bible contains a set of rich, all-encompassing and deeply contradictory values subject to centuries of competing interpretations, it is not surprising that any politico-economic philosophy that embraces the Bible should embody contradictory aims.

These contradictions ensure disagreement not only between conservatives and liberals but also within the ranks of conservatives.

Banking Reform

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Stayed up way too late watching the Senate banking committee debate resolutions to correlate the language of the House and Senate banking bills.  Finally went to bed at 1:30 AM MDT, and they were still going at it in Washington, where it was 3:30 AM.  Although pundits like to describe political conflict as a disagreement along party lines, there are other subtler alliances that cross party lines.  Democratic members of the 12 person Senate conference who were on the Banking Committee would align with banking members of the Republican Party on an amendment vote, while Democratic members on the Agricultural (Ag) Committee would align with a ranking member of the Ag who was a Republican, thus creating a difference in approach between Banking members and Ag members, regardless of party.

CNN money has a good summary of the reform bill that will probably go before the full House and Senate before July 4th.   Although proprietary derivatives trading restrictions on Wall Street firms was included in the bill, a 3% provision was included in the language, allowing these firms to trade derivatives as long as it does not exceed 3% of their capital, which most firms except for Goldman Sachs will not exceed.

What surprised me is the lucidity of members of the Senate at that time in the early morning, having spent 18 hours debating various language and amendments.  To pull an “all-nighter” at 20 years old is one thing – many of these Senators are in their fifties, sixties and seventies.  Very impressive.  What befuddles an ordinary person like myself is why, after 18 months of wrangling over the development of the bills’ language, does it have to come down to an endurance test?  The lawmaking process in a democratic republic is messy, almost as ugly as open abdominal surgery – and many of these lawmakers probably felt like MASH surgeons this morning as the sun came up.

Federal Reserve for Kids

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Eight times a year, the Federal Reserve Bank publishes its Beige Book, a summary of economic conditions around the country. The Federal Reserve branch at St. Louis publishes a lot of current and historical information on the economy for adults but they also provide some educational tools for grade schoolers.

Our grandchildren will look back on these years as the “old days” and this past decade has had some memorable events – an election decided by the Supreme Court, 9/11, two wars, Katrina, the banking meltdown, the oil spill.  The St. Louis Fed features a timeline of banking, credit and policy events for the past three years.  You can also download a PDF of the timeline so that, 10 years from now, you’ll have notes when you tell your stories.  The grandkids will think you know everything.

Small Cap Breakout

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From a March 6, 2010 WSJ article: “Finance professors Eugene Fama and Kenneth French have found that one in eight small growth stocks typically becomes large each year—and that these small stocks on the cusp of becoming big generate giant annual returns of as much as 62% on average.”

What’s a small cap stock?  Investopedia gives these approximations:
Mega Cap – Market cap of $200 billion and greater
Big Cap – $10 billion and greater
Mid Cap – $2 billion to $10 billion
Small Cap – $300 million to $2 billion
Micro Cap – $50 million to $300 million
Nano Cap – Under $50 million

The Russell 2000 index of small cap stocks uses the same range, $300M to $2B.  However, AOL’s stock screener classifies small cap as $250M to $1B.  Market Watch’s screener is one of the few that allows a precise range of values, rather than selecting from a list of values, but does not have as much screening criteria as some sites.  The screening tool at Yahoo Finance lists values for market cap  which apparently follow AOL’s criteria for small screen stocks, with market cap gradations at $500M,$1B, then jumping to $10B.

At Yahoo, I ran a screen for stocks with a market cap between $500M and $1B, sales greater than $500M, a P/E ratio of 10 to 20 and a 5 year estimated EPS growth rate greater than 50%, or 10% a year.  That criteria produced some companies just under $1B market cap that I wish I had invested in several months ago.  While small cap stocks have risen a few percent this year, some of these stocks have risen 20 to 50%.   Small cap stocks usually lead the way out of a recession and even though they have had a good run the past twelve months, there is probably more to come.

There seems to be an eternal debate and much research into this question: do growth funds and ETFs produce better returns than value funds and ETFs?  It depends on the time period that one looks at.  Here is a short 2007 article on the small cap value vs. growth.  

Non-Manufacturing Index

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Each month, the Institute for Supply Management (ISM) surveys purchasing managers around the country about changes in inventories, orders, sales and employment.  If there is no change from the previous month, the index reads 50.  Anything greater than 50 is a positive.  ISM publishes two composite indexes each month, one for manufacturing (PMI) and one for non-manufacturing (NMI), which represents more than 80% of the economy.

In January of this year, the non-manufacturing index squeaked into the positive zone with a 50.5 reading, followed by a 53 reading in February. In May, the NMI rose to 55.4, and a key component of that composite, the Business Activity Index, rose to 61, a level not seen since 2006.  The indexes are calculated in such a way that they reflect the dispersal of either positive or negative activity throughout the economy, so a reading of 61 indicates that improvement is spreading ever wider through a variety of companies.

Employment is usually the last horse out of the gate when coming out of a recession and this time is no different.  However, for the first time in 28 months, the Employment Index portion of the composite index broke into positive territory at 50.4.

This recession has a greater gravitational pull than the more recent ones at the beginning of this decade and the early nineties.  Pulling against this recovery are home foreclosures, commercial real estate debt coming due, European sovereign debt problems, China’s monetary support of its own exports and a lack of lending to small businesses.  But the rockets are firing.