The Nature of Money

March 31, 2019

by Steve Stofka

Modern Monetary Theory (MMT) helps us understand the funding flows between a sovereign government and a nation’s economy. I’ve included some resources in the notes below (Note #1). This analysis focuses on the private sector to help readers put the federal debt in perspective. In short, some annual deficits are to be expected as the cost of running a nation.

What is money? It is a collection of  government IOUs that represent the exchange of real assets, either now or in the past. Wealth is either real assets or the accumulation of IOUs, i.e. the past exchanges of real assets. When a sovereign government – I’ll call it SovGov, the ‘o’ pronounced like the ‘o’ in love – borrows from the private sector, it entices the holders of IOUs to give up their wealth in exchange for an annuity, i.e. a portion of their wealth returned to them with a small amount of interest. A loan is the temporal transfer of real assets from the past to the present and future. This is one way that SovGovs reabsorb IOUs out of the private economy. In effect, they distribute the historical exchange of real assets into the present.

What is a government purchase? When a SovGov buys a widget from the ABC company, it also borrows wealth, a real asset that was produced in the past, even if that good was produced only yesterday. The SovGov never pays back the loan. It issues money, an IOU, to the ABC company who then uses that IOU to pay employees and buy other goods. A SovGov pays back its IOUs with more IOUs. That is an important point. In capitalist economies, a SovGov exchanges real goods for an IOU only when the government acts like a private party, i.e. an entrance fee to a national park. Real goods are produced by the private economy and loaned to the SovGov.

What is inflation? When an economy does not produce enough real goods to match the money it loans to the SovGov, inflation results. Imagine an economy that builds ten chairs, a representation of real goods. If a SovGov pays for ten people to sit in those ten chairs, the economy stays in equilibrium. When a SovGov pays for eleven people to sit in those ten chairs, and the economy does not have enough unemployed carpenters or wood to build an eleventh chair, then a game of musical chairs begins. In the competition for chairs, the IOUs that the private economy holds lose value. Inflation is a game of musical chairs, i.e. too much money competing for too few real resources.

A key component of MMT framework is a Job Guarantee program, ensuring that there are not eleven people competing for ten jobs (Note #2). Labor is a real resource. When the private economy cannot provide full employment, the SovGov offers a job to anyone wanting one. By fully utilizing labor capacity, the SovGov keeps inflation in check. The  idea that the government should fill any employment slack was developed and promoted by economist John Maynard Keynes in his 1936 book The General Theory of Employment, Money and Interest.

The first way a SovGov vacuums up past IOUs is by borrowing, i.e. issuing new IOUs. I discussed this earlier. A SovGov also reduces the number of IOUs outstanding through taxation, by which the private sector returns most of those IOUs to the SovGov.

Let’s compare these two methods of reducing IOUs. In Chapter 3 of The Wealth of Nations, Adam Smith wrote that government borrowing “destroys more old capital … and hinders less the accumulation or acquisition of new capital” (Note #3). Borrowing draws from the pool of past IOUs; taxation draws more from the current year’s stock of IOUs. Further, Smith noted that there is a social welfare component to government borrowing. By drawing from stocks of old capital it allows current producers to repair the inequalities and waste that allowed those holders of old capital to accumulate wealth. He wrote, “Under the system of funding [government borrowing], the frugality and industry of private people can more easily repair the breaches which the waste and extravagance of government may occasionally make in the general capital of the society.”

Borrowing draws IOUs from past production, while taxation vacuums up IOUs from current production. Since World War 2, the private sector has returned almost $96 in taxes for every $100 of federal IOUs. Since January 1947, the private sector has loaned the federal government $371 trillion dollars of real goods, the total of federal expenditures (Note #4). What does the federal government still owe out of that $371 trillion? $15.5 trillion, or 4.17% (Note #5). If the private sector were indeed a commercial bank, it would expect operating expenses of 3%, or $11.1 trillion (Note #6). What real assets does the private sector have for the difference of $4.4 trillion in the past 70 years? A national highway system and the best equipped military in the world are just two prominent assets.

The federal government spends about 17-20% of GDP, far lower than the average of OECD countries (Note #7). That is important because the accumulated Federal debt of $15.5 trillion is only .9% of the $1.7 quadrillion of GDP produced by the private sector since January 1947. Our grandchildren have not inherited a crushing debt, as some have called it. In the next forty years, the U.S. economy will produce about $2 quadrillion of GDP (Note #8). If tomorrow’s generations are as frugal as past generations, they will generate another $18 trillion of debt.

Adam Smith called a nation’s debt “unemployed capital,” a more apt term. The obligation of a productive nation is to put unemployed capital to work for the community. Under the current international system of national accounting, there is no way to account for the accumulated net value of real assets, or the communal operating expenses of the private economy. Without a proper accounting of those items, we engage in noisy arguments about the size of the debt.

In next week’s blog, I’ll examine the inflation pressures of government debt. I’ll review the Federal Reserve’s QE programs and why it has struggled to hit its target inflation rate of 2%. We’ll revisit a proposal by John Maynard Keynes that was discarded by later economists.


1. A video presentation of SovGov funding by Stephanie Kelton . For more in depth reading,  I suggest Modern Monetary Theory by L. Randall Wray, and Macroeconomics by William Mitchell, L. Randall Wray and Martin Watts.

2. L. Randall Wray wrote a short 7 page paper on the Job Guarantee program . A more comprehensive 56-page proposal can be found here 

3. Adam Smith’s The Wealth of Nations was published in 1776, the year that the U.S. declared independence from Britain. Smith invented the field of economics. The book runs 900 pages and is available on Kindle for $.99

4. Federal Expenditures FGEXPND series at FRED.

5. At the end of 1946, the Gross Federal Debt held by the public was $242 billion (FYGFDPUB series at FRED). Today, that debt total is $15,750 billion, or almost $16 trillion dollars. The difference is $15.5 trillion. The debt held by the public does not include debt that the Federal government owes itself for the Social Security and Medicare “funds.” Under these PayGo pension systems, those funds are nothing more than internal accounting entries.

6. In 2017, the Federal Reserve estimated interest and non-interest expenses for all commercial banks at 3% (Table 2, Column 3).

7. Germany’s government, the leading country in the European Union, spends 44% of its GDP Source

8. Assuming GDP growth averages 2.5% during the next forty years.

9. International Accounting Standards Board (IASB) sets standards for public sector accounting.



July 3, 2016

A week after crash-go-boom in the stock market following Brexit, the British vote to leave the European Union, the market recovered most of the 5 – 6% lost in the two days following the vote.  The reaction was a bit too intense, inappropriate to an exogenous shock, the vote, whose consequences would take several years to develop. In last week’s blog I had suggested that the market drop was a good time to put some IRA money to work for 2016.  This was not some kind of magic insight.  Each year’s IRA contribution amount is a small percentage of our accumulated  retirement portfolio.

Buying on market dips can be an alternative strategy to regular dollar cost averaging since the market recovers within a few months after most dips, although the recovery is at a slower pace than the fall.  Fear can cause stampedes out of equities; confidence grows slowly.  As an example of an abrupt price decline, the SP500 index fell almost 7% in five days last August, then took more than two months to regain the price level before the fall.  The 12% price drop at the beginning of this year was more gradual, occurring over six weeks.  The recovery to regain that lost ground also took two months, from mid-February to mid-April. In the latter quarter of 2012, the market also took two months to erase a 7% price decline from mid-October to mid-November.

The price level of the SP500 is near the high mark set in May 2015, more than a year earlier.  Only in the past year has the inflation-adjusted price of the SP500 surpassed its summer 2000 level (Chart and table).  Nope, I’m not making that up. The stock market has just barely kept up with inflation for the past 15 years. The inability of the stock market to move higher indicates that buyers are not attracted to the market at current price levels.  The absurdly low interest yields on bonds makes this caution especially puzzling.  As stock prices recovered this past week, prices on long term Treasury bonds should have fallen as traders moved into more risky assets.  Instead, bond prices have risen.  As the price of long term Treasuries (ETF: TLT) broke through its January 2015 high  on Friday, the last day of June, traders began betting against treasuries (ETF: TBF).

Those who are concerned about the return OF their money, the safety searchers buying bonds, are competing against those seeking a return ON their money.  VIG is a Vanguard ETF that focuses on company stocks with dividend appreciation, and is favored by those seeking some safety while investing in stocks. TLT is an ETF of Treasury bonds for those seeking safety and, as expected, pays more in dividends than VIG.  Rarely do we see a broad stock ETF like VIG have a yield, or interest rate, that is close to what a long term Treasury bond ETF like TLT has.  At the end of this week, VIG had a dividend yield of 2.15%, just slightly below TLT.  Why are investors/traders bidding up the price of Treasury bonds?  Some 10 year government bonds in the Eurozone have recently crossed a dividing line and now have negative interest rates.  The low, but positive, interest rates of U.S. Treasury bonds look like big open flowers to the busy bees of institutional investors around the world.

In a large group of investors, buy and sell decisions tend to counterbalance each other.  Occasionally there are periods when such decisions reinforce each other and create a precarious imbalance that all too often rights itself in an abrupt fashion.  Bubbles and – what’s the opposite of a bubble? – are iconic examples of this kind of self-reinforcing behavior.

In another week we will mark the middle of the summer season.  The All-Star game on July 12th occurs near the halfway mark in the baseball season and advises parents in many states that there are still five to six weeks before the kids head back to school.  Our mid-40s is about the midpoint of our working years, a reminder that we need to start saving for retirement if we have not done so already.  It has been seven years since the market trough in March 2009.  Let’s hope that this is the midpoint of a 14 year bull market but I don’t think so.

Next week will be chock full of data before the start of earnings season for the second quarter. We will get the June employment report as well as the Purchasing Managers Index.  In this time of short, sharp reactions to news events, we can expect continued volatility.



Pew Research just released a comparison of earnings by racial group and sex that is based on Census Bureau surveys, the same data that the BLS compiles into their monthly employment reports.  My initial criticism of the Pew Research comparison was that they used the earnings of full and part time workers.  Women tend to work more part time jobs so that would skew the earnings comparison, I thought. Thinking that a comparison of full time workers only would show different results, I pulled up the BLS report which groups the data by sex, only to find out that the differences between the earnings of men and women was about the same.  At the median, women earn 82% of men.

An even more depressing feature of the BLS report is that median weekly earnings have barely kept ahead of inflation during the past decade.  This wage stagnation provides a base of support for the criticisms voiced by former Presidential contender Bernie Sanders in a recent NY Times editorial.
Like a truck stuck in the mud, households are spinning their wheels without making much progress.  In the coming months, Donald Trump and Hillary Clinton will try to sell themselves as the tow truck that can pull average American families out of the mud. Well, it would be nice if they would conduct their campaigns in such a positive light.  The truth is that each candidate will try to convince voters that voting for the other candidate will get American families stuck deeper in the mud.  The conventions of both parties are later this month.  Expect the mud to start flying soon after they are over.  By election day in November, we will all be buried in mud.


June 26, 2016

“Should I Stay Or Should I Go?” was a 1982 song by the Clash.  For months, Brits have debated the question of whether to stay in the European Union (EU) ahead of a referendum vote held just this past week and nicknamed “Brexit,” a mashup of British Exit.  Germany and Britain are the two strongest members of the EU and the loss of either from the union would weaken it’s political and economic ties. In the U.K., the campaigns turned vicious and sparked the murder of an MP (story) earlier this month.  In the British Parliamentary system, an MP is similar to a Congressperson in the U.S. House.

In recent polling the advocates of separation, or Leave, appeared to be gaining momentum so that the outcome of the referendum vote seemed deadlocked at 50-50.  A poll in the last days before Thursday’s vote reassured many that cooler heads would prevail and Britain would remain with the EU. Leaders from both the right and left belonged to this coalition, appropriately named “Remain.”

At about 3-4 AM London time, 11 PM New York City time on Thrusday night, a third of the vote had been counted and it was eerily close, with the Leave group having a teensy-weensy lead.  Then half of the vote was counted and the Leavers were up 1% over the Remainers.  As the vote tally continued, it became apparent that – surprise, surprise – the Remainers had won the vote.

Asian markets were active at that time and responded with a severe sell off of risky assets like stocks and rushed into the safe haven of bonds, cash and gold.  Stocks were down as much as 12% initially on some Asian exchanges.  Gold shot up 6%. Neither the U.S. or European markets were open but the Futures markets in the U.S. sank 6% and European futures plunged 9%.

While most Americans were sleeping European markets opened about 8- 9% down. Market makers in Italy could not establish an opening price for a number of Italian bank stocks, which had already been under pressure in recent weeks.  When they did, these stocks had lost a third of their value.  Everyone was selling, few were buying.

The referendum vote still needs to be codified into law before the Brits formally notify the EU that the country is leaving. After that negotiations begin over the trade and diplomatic terms of exit, a process that could take two years.  A rational person might wonder why the panicked selling?  The worry is that this vote may provoke similar votes in other EU countries, which might lead to the eventual dissolution of the EU.  When in doubt, get out.  Traders did.

Earlier this month the WSJ reported that legendary (and semi-retired) investor and billionaire George Soros had returned to his trading desk to make a series of bearish bets on global markets in anticipation of both political and economic turmoil.  Soros became a household name when he made a $1 billion on a bet against the British pound in 1992.  In several hours Thursday night/Friday morning, the British pound lost 10% of its value.  Was this also another killing for Soros?  Soros thinks the break-up of the EU is inevitable (Story)

What should the long term investor do?  January’s dip of 5% was a good time to make an IRA investment.  This may be an equally good opportunity.

The Active and the Inactive

October 4, 2015

A disappointing September jobs report capped off a third week of losses a rescue from a third week of losses in the stock market.  The initial reaction on Friday morning was a 1.5% drop in the SP500. Over the past several weeks, the stock (SPY) and long term Treasury market (TLT) have become little more than speculative gambles on when the Fed will raise interest rates.  Until Friday’s jobs report, the choices were mainly restricted to October or December 2015. Janet Yellen voiced a commitment to raising interest rates this year in comments (see last week’s blog) at the U. of Massachusetts.  However, the lackluster jobs report ushered in another choice – March of 2016.  By the closing bell on Friday, the SP500 had gained 1.5%, a reversal of 3% on the day and a gain of 1% in the index for the week.

Emerging markets bounced up almost 5% this week, showing that there are enough buyers who are willing to invest at these low price levels.  The Vanguard ETF VWO formed a “W” pattern on a weekly chart and strong volume.

Despite the tepid job growth of 142,000, the unemployment rate remained steady because more than 300,000 left the work force.  Probably the biggest surprise was that July and August’s job gains were revised downward as well.  I had been expecting an upward revision in August’s numbers.

The Labor Force Participation Rate (CLF) declined .2% to 62.4%.  The CLF rate measures the (number of people working or looking for a job) / (number of people who can legally work).  There is another measurement that I have used before on this blog: the ratio of (people not working or looking for a job) / (the number of people working).  Let’s call it the Inactive Active ratio, or IARATIO.

Visually, the blue CLF rate doesn’t show us much; it is a relatively monotonic data series.  In contrast, the decades long fluctuations in the red IARATIO present some useful information.  We can see a simple answer for the federal budget surplus at the end of the 1990s, when the ratio of inactive to active workers was very low. Although politicians like to claim and blame for every data point, the simple truth is that there were almost as many adults working as not working in the late ’90s. Working people tend to put in more than they take out of the kitty.  For two decades there was a striking correlation between the Federal Surplus/Deficit and the IARATIO.

At about .75, the ratio of this past recovery was similar to that of the first half of the 1980s.  In the past two years, the IARATIO has dropped to .72, a good sign,  similar to the readings of 1986, a time of economic growth.

The ever greater number of Boomers retiring over the next decade will put upward pressure on this IARATIO.  The fix?  More jobs. Jobs solve a lot of problems, both for families and government budgets.


January 11, 2015

Price movement continued to be volatile in this second week of the year.  Despite all the price gyration, the SP500 is down only 1% since the first of the year.  On Monday, light crude oil broke below the $50 price barrier, helping to usher in a rush to safety, namely U.S. government debt.  As the prices of long term Treasuries climb upwards, who is buying this Federal debt?  As the chart below shows, foreigners already hold the majority of Federal Debt.

As the dollar continues to strengthen, institutional investors around the world buy Federal Debt to enhance the return on their savings. Let’s say a European investor bought $132 of Treasury debt on September 1, 2014 for €100. Now that same investor cashed in that U.S. Treasury bill this past Friday.  What does the investor get back?  €111.46, without any accrued interest or fees included. In a little over 3 months, they have made almost 11-1/2% return, an annual rate of more than 40%.

On the other hand, the “carry trade” is getting squeezed.  The carry trade involves borrowing money in a country with a low interest rate, or borrowing low, and buying debt in another country with a higher interest rate, or loaning high.  This is a great deal – easy money – IF the currency of the country where an investor borrowed the money doesn’t start rising in value as the U.S. dollar has done recently. The problem is particularly acute in emerging countries which have higher interest rates to attract capital.

To keep the example simple, let’s use the euro again.  On September 1st, a European investor bought €100 of  French BTFs paying 5%.  Because interest rates are so low in the U.S., the  European investor was able to borrow the money in the U.S. for 1/2%, making 4.5% for doing nothing.  The investor borrowed $131.30, converted it to €100 and bought the BTFs.

This past Friday, the U.S. bank calls the investor’s loan so the investor cashes in her €100 BTF and gets only $118.42 at the current exchange rate.  They are short $12.88, an annualized loss of almost 36%.  What makes this simple scenario even more dangerous is that, in the real world, the investor has often leveraged their money, multiplying the losses.

The problem becomes particularly acute for companies headquartered in an emerging market (EM) country but which have a U.S. subsidiary.  The subsidiary borrows money at a low interest rate in the U.S., much lower than the prevailing rate in the EM country, then converts those dollars to the currency of the EM country to fund expansion.  If the EM currency loses value against the dollar, the company finds it increasing difficult to make payments on their loan because each time they convert their EM currency to U.S. dollars, the EM currency buys fewer dollars.  This is another kind of squeeze that may cause the bank to call the loan, or escalate the loan to a higher interest rate, creating even more financial pressure on the company.

This is the first time in fifteen years that the U.S. dollar has gained in strength against all major currencies.


Purchasing Manager’s Index 

As expected a few months ago, a composite of employment and new orders in the services sector continued to moderate in December.  In September, these two key factors of production were at the highest levels in 17 years, so some decline was anticipated toward the end of the year.

The CWPI, a composite of manufacturing and services sector activity in the country, continues to run strong, although it has also moderated from the higher peak set in October 2014.  The wave like pattern of economic activity is getting stronger over the past several years.  The peaks are coming closer together and now the strength of activity has quickened.

Despite these strong economic indicators, investors are worrying again (see October blog)  that the rest of the global economy is faltering. Why investors showed less concern about the global economy in November and December remains a puzzle. To longer term investors, the market seems to have the attention span – and frenetic activity – of a three year old.



In December, employment rose 2.1% year over year, almost besting the high set in March 2006 for yearly growth.

There were several positives in this report.  Job gains for October and November were revised up 50,000 total.  The core work force, those aged 25 – 54, continued a steady rise. The number of people employed at part time jobs because they couldn’t find full time work fell again in December by 60,000 and is down 13% over the past year.  However, there are still 50% more involuntary part-timers than during the 2000s.

The number of long term unemployed people has fallen 28% in the past year but – that word “but” rears its ugly head again – are still high.

Investors tended to focus on the negatives in this month’s report.  The number of discouraged workers, those who are available for work but haven’t looked in the past month, was up 42,000.

As a percent of the labor force, the long term unemployed and discouraged are still at historically high levels – more than five years after the official end of the recession.

Hourly wages declined by .05 to $24.57 but the influx of seasonal and part time jobs at the holidays and year end may have had some impact.  Last month’s slight increase in hourly wages sparked hope that employees might be gaining some pricing power, indicating an underlying strong demand from employers.  This month’s data suggests that lower gasoline prices will have to substitute for wage growth in the near term.

The Labor Force Participation rate edged down .2 and seems to be stuck in a range just under 63% for the past year.  If the labor market were really growing strongly, we would expect to see some upward movement as more people tried to enter or re-enter the job market.


Social Security Calculator

Last year the Wall St. Journal reviewed several social security claiming calculators.  Social Security (SSA) has some very complex rules, particularly for married couples.  Remember that this is a system designed by politicians and the Washington bureaucracy, the same people who, after 9-11, designed the multi-colored terror threat warning system that seemed permanently stuck on yellow, or elevated threat.
Given the complexity of the Social Security rules, noted economist Lawrence Kotlikoff heads a team that designed an online calculator  to help people maximize their benefit.  The program has a fee of $40 and looks very easy to use.  An 11 minute video demonstrates using the tool for a married couple born in 1958 and 1952.  Curl up on the couch and get out the popcorn.

The mutual fund giant Fidelity has a good discussion of various claiming options for married couples.  The third example is rather interesting.  The younger person in a married couple files early and receives a reduced benefit. The older person files and suspends his own benefits at full retirement age (FRA) but takes a spousal benefit based on the fact that his wife has already retired.  Here’s the kicker: his spousal benefit is based on what her benefit would have been at FRA, not the reduced benefit she receives because she retired early.



We learned about allocation while playing Monopoly.  It is better to put up a few houses on both the Green and Purple property groups than put all of our money into hotels on the pricey Green group only.

Vanguard has a questionnaire to help investors determine an appropriate allocation mix of stocks, bonds and cash.  You don’t need to be a Vanguard customer to answer the questionnaire.


Final Word

The price of oil is unusually low.  The U.S. dollar is unusually strong.  Interest rates have been unusually low for several years.  Central banks around the world have provided an unusual level of support for their economies.  A confluence of unusualness, a new word, leads to greater price swings.  Market volatility (VIX) has been low – below 20 – for most of the past two years and this relative calm tends to bring more people into the market, helping to lift stock prices.  We may see a return to higher volatility levels similar to early 2012 and late 2011.

New Year, No Fear

January 4th, 2015

As the calendar flips from December to January, some favorite activities are predictions for the coming year and reviews of the past year.  Here are a few predictions I’ve heard in the past few weeks:

“We think oil will continue to drift downwards as global demand slackens.”

“We think long term Treasuries will continue to show strong gains in the coming year.”

“Output remains strong, and the labor market continues to strengthen.  We expect further gains in the stock market this year.”

“We expect gold to find a bottom in the $900 to $1000 range and we will be initiating a long position at that time.”

Predictions are foolish, of course.  They are too certain.  An expectation is a bit more sober, a pronouncement of a probability.  Did anyone hear these expectations at the beginning of 2014?

“Oil prices will decline by 40% this year.”

“We expect long term Treasuries to gain 25% in 2014.”

“We expect the euro to fall to a 4-1/2 year low against the dollar.”

I don’t remember any of those predictions at the beginning of 2014.  So here’s my expectation – er, prediction: in 2015, I will be surprised by some of the events that will unfold.

If that doesn’t satisfy your prediction craving, here are several – let’s call them guesstimates – of SP500 earnings and price predictions in 2015.


Blue Light Specials

As I mentioned a few weeks ago, there are a few stock sectors that are “on sale,” selling below their 200 week, or 4 year average.  Falling gas prices in the last half of 2014 have had a negative impact on energy stocks (XLE, VDE).  Selling below their 200 week averages in December, both ETFs are hovering at their 200 week average.  The 50 week average is above the 200 week average, indicating that this is, so far, a relatively short term trend.

Emerging markets have been in the doldrums for a year and a half.  The 50 week average is just about to cross above the 200 week, signalling that the downturn may have exhausted itself.

The mining sector (XME) is down – way down.  The 50 week average is below the 200 week average and current prices of this ETF are below the 50 week average.  The mining sector can be quite cyclical but could be quite profitable in the next six months.

In the summer of 2011, the oil commodity ETF USO lost a third of its value.  In the melt down of 2008, it lost 75% of its value, falling from $115 down to near $30.  This week USO broke below $20, losing half of its value since July.  Since September 2009, shortly after the official end of the recession, the 50 week average has been trading in a range of $34 to $38, and is currently at the low point of that five year range.  While this may not be appropriate for a casual investor, it might be worth a look for those with some play money.

Other sectors – industrials, materials, finance, health, technology, consumer staples, consumer discretionary, retail and utilities – are above both their 50 and 200 week averages.


Happiness Is An Open Wallet

The Conference Board’s Consumer Confidence gauge rose still further above 90 in December.  At some time in the distant past, in a year called 1985, all the people were happier than they are today.  That long ago time became the benchmark 100 for this index.  The index number is less important than the trend of confidence – whether it is rising, falling or staying the same.

The Case Shiller 20 City Home Price Index for October showed a 4.5% yearly gain.  The double digit gains of last year and the first six months of 2014 were unsustainable.  However, I would be concerned if this continues to fall toward zero, indicating a serious softening of demand, or a lack of affordability or both.


The non-SP500 World

The SP500 index, composed of the 500 largest companies in the U.S., was up 11.4% for 2014. An index of mid, small and micro-cap companies was up a more modest 7.1% (Standard Poors) for the year.  An index of REITs was up 25.6% in 2014 after stalling during much of 2011, 2012 and 2013. I was surprised to learn that during the past twenty years, REITs outperformed the SP500.

Conventional wisdom holds that rising interest rates are bad for REIT stocks.  A study of REIT performance shows that the impact is less than most investors think. In addition, the income growth generated by REITs has outpaced inflation in all but one out the past 15 years. VNQ and RWR are two ETFs in this market space.  VNQ has a 10 year return of about 9%, RWR a bit less.


Social Security

The Social Security program depends on current taxes to pay current beneficiaries.  In per person inflation adjusted dollars, the federal government collects twice the amount of money it did forty years ago.  Per person revenues have almost caught up to the levels of 2006.

The problem is that there are a lot of people starting to retire.  Politicians of both parties have spent the excess social security taxes collected in the past decades.  Last week I asked what you would do if the stock market lost 30% of its value.

This week’s sobering question for those in or near retirement:  what would you do if social security payments were reduced, or means tested?  With the stroke of a pen, Congress could reduce the maximum monthly benefit from $2533 to say $2100.  This would affect a relatively small percentage of voters, those with higher incomes, a favorite target for benefit cuts.  Perhaps you are taking care of an ailing child or parent and need the income.  You might submit a 4 page form listing your pensions, IRAs, the assessed value of your home and any mortgage you had against the house, your mutual funds, stocks and bonds.  Using a complex formula to factor in your age, special circumstances, the cost of living index in your area and the total of your assets, the Social Security Administration would calculate your monthly benefit.  Can’t happen here in the land of the free, home of the brave?

Merry Christmas

December 21, 2014

In preparation for today’s solstice, the market partied on in a week long saturnalia.  The week started off on a positive note.  Industrial production increased 1.3% in November, gaining more than 5% over November of 2013.

Capacity utilization of factories broke above 80%, a sign of strong production.  Production takes energy.  I’ll come to the energy part in a bit.

The Housing Market Index remained strong at 57, indicating that builders remain confident.  Tuesday’s report of Housing Starts was a bit of a head scratcher.  After a strong October, single family starts fell almost 6%.  Multi-family starts fell almost 10% in October, then rebounded almost 7% in November.  Combined housing starts fell 7% from November 2013.

The market continued to react to the change in oil prices.  For the big picture, let’s go back a few years and compare the SP500 (SPY) to an oil commodity index (USO).  For the past five years, USO has traded in a range of $30 to $40, a cyclical pattern typical of a commodity.  In October, the oil index broke below the lower point of that trading range.

On Tuesday, oil seemed to have found a bottom in the high $50 range.  USO found a floor at $21, about a third below its five year trading range.  Beaten down for the past three weeks, energy stocks began to show some life (see note below).

Encouraging economic news helped lift investor sentiment on Tuesday morning. Some bearish investors who had shorted the market went long to close out their short positions. Growth in China was slowing down, Japan was in recession, much of Europe was at stall speed if not recession and the continued strength of the U.S. dollar was making emerging markets more frail.  While the rest of the world was going to hell in a hand basket, the U.S. economy was getting stronger.  Thee Open Market Committee at the Federal Reserve, FOMC, began its two day meeting and traders began to worry that the committee might react to the strengthening U.S. economy with the hint at an interest rate increase in the spring of 2015.  This helped sent the market down about 2% by Tuesday’s close.

Wednesday’s report on the Consumer Price Index (CPI) was heartening.  Falling gas prices were responsible for a .3% fall in the index in November, lowering inflation pressures on the Fed’s decision making about the timing of interest rate hikes.  The core CPI, which excludes the more volatile energy and food prices, had risen 1.7% over the past year, slightly below the Fed’s 2% target inflation rate.  Traders piled back into the market on Wednesday ahead of the Fed announcement Wednesday afternoon.  Back and forth, up and down, is the typical behavior when investors are uncertain about the short term direction of both interest rates and economic growth.

The Fed’s announcement that they would almost certainly leave interest rates alone till mid-2015 gave a further 1% boost upwards on Wednesday afternoon.  Twelve hours later, the German market opened  up at 3 A.M. New York time.  Early Thursday morning, the price of SP500 futures began to climb, indicating that European investors were reacting to the Fed’s decision by putting their money in the U.S. stock market.  Those of you living in the mountain and pacific time zones of the U.S. might have caught the news on Bloomberg TV before going to bed.  Maybe you got your buy orders in before brushing your teeth and putting your nightgown on. Very difficult for an individual to compete in a global market on a 24 hour time frame.  On Thursday, the market rose up as high as 5% above Wednesday’s close, before falling back to a 2.5% gain.

Still, a word of caution.  Both long term Treasuries, TLT, and the SP500, SPY, have been rising since October 2013.

As long as inflation remains low and the Fed continues its zero interest rate policy (ZIRP), long term Treasuries and stocks will remain attractive.   Something has to break eventually.  ZIRP  helps recovery from the aftermath of the last crisis but helps create the next crisis.  Abnormally low interest rates over an extended period are bad for the long term stability of both the markets and the economy.

Sale – Energy Stocks – Limited Time Only

(Note: this was sent out to a reader this past Tuesday.  Energy stocks popped up 4 – 5% the following day, a bit more of rebound than I expected. The week’s gain was almost 9% and the ETF closed above its 200 week average.)

As oil continues its downward slide, the prices of energy stocks sink.  XLE, a widely traded ETF that tracks energy stocks,  has dropped below the 200 week (four years!) average.  (A Vanguard ETF equivalent is VDE).  Historically, this has been a good buying opportunity. In the market meltdown of October 2008, this ETF crashed through the 200 week average.  A year later, the stock was up 38% and paid an additional 2% dividend to boot.  Let’s go further back in time to highlight the uncertainty in any strategy. The 2000 – 2003 downturn in the market was particularly notable because it took almost three years for the market to hit bottom before rising up again.  The 2007 – 2009 decline was more severe but took only 18 months. In June 2002, XLE sank below its 200 week average.  A year later, the stock had neither gained nor lost value. While this is not a sure fire strategy – nothing is – an investor  is more likely to enjoy some gains by buying at these lows.


Emerging Markets Stocks

Also selling below the 200 week average are emerging market (EM) stocks.  These include the BRICs (Brazil, Russia, India, China) as well as other countries like Mexico, Vietnam, Turkey, Indonesia and the Philipines. When a basket of stocks is trading below its four year average, there are usually a number of good reasons. Several money managers note the negatives  for EM.   Also included are a few voices of cautious optimism.  Sometimes the best time to buy is when everyone is pretty sure that this is not the right time to buy.  Another blog author recounts two strategies for emerging markets: a long term ten year horizon and a short term watchful stance.  The long term investor would take advantage of the low price and the prospect for higher growth rates in emerging economies.  The short term investor should be cognizant of the fickleness of capital flows into and out of these countries and be ready to pull the sell trigger if those flows reverse in the coming months.



What are the characteristics of TANF families?  When the traditional welfare program was revised in the 1990s, lawmakers coined a new name, Temporary Assistance to Needy Families, to more accurately describe the program.  The old term carried a lot of negative connotations as well. Two years ago Health and Human Services (HHS) published their analysis of a sample of 300,000 recipients of TANF income in 2010.  Although the recession had officially ended in 2009, the unemployment rate in 2010 was still very high, above 9%.  It is less than 6% today.

There were 4.3 million recipients, three-quarters of them children, about 1.4% of the population. By household, the percentage was also the same 1.4% (1.8 million families out of 132 million households).  In 2013, the number of recipients had dropped to 4.0 million, the number of families to 1.7 million (Congressional Research Service)

In 2010, average non-TANF income was $720 per month, or about $170 a week.  To put this in perspective, this was about the average daily wage at that time The average monthly income from TANF averaged $392. Recipients were split evenly across race or ethnic background: 32% were white, 32% black, and 30% Hispanic. For adult recipients only, 37% were white, 33% black, and 24% Hispanic.

Rather surprising was how concentrated the recipients were. 31% of all TANF recipients in 2010 lived in California.  43.3% of all recipients lived in either New York, California or Ohio.  The three states have 22% of the U.S. population and almost 44% of TANF cases.

HHS data refutes the notion that welfare families are big.  50% of TANF families had only one child.  Less than 8% of TANF families had more than 3 children.  82% of TANF families also receive SNAP benefits averaging $378 per month.

In 2014, Federal and State spending on the TANF program was less than $30 billion, about 1/2% of the $6 trillion dollars in total government spending.  The Federal government spends a greater percentage on foreign aid (1%) than the TANF program. Yet people consistently overestimate the percentage of spending on both programs (Washington Post article).  The average estimate for foreign aid? A whopping 28%.  Cynical politicians take advantage of these public misperceptions.



Aiming to overhaul the health care insurance programs throughout the country, the Affordable Care Act (ACA) was a big bill.  No, it wasn’t 2700 pages as often quoted by those who didn’t like it.  The final, or Reconciled, version of the bill was “only” 900 pages.  The House and Senate versions were also about 900 pages each; hence, the 2700 pages.

At 1600 pages in its final form, the recently passed Omnibus Spending bill makes the ACA look like a pamphlet.  As  specified in the Constitution, all spending bills originate in the House.  Past procedure has been to pass a series of 12 spending bills.  Majority leader John Boehner has found it difficult to get his fractious members to agree on anything in this Congress so all 12 bills were crammed into this behemoth bill just in time to avoid a government shutdown.  Just as with the ACA, most members of the House and Senate did not have adequate time to digest the details of the bill.  The bill is sure to hold many surprises for those who signed it and we, the people, who must live under the farcical law-making of this Congress.  Here is a primer on the budget and spending process.


Home Appraisals

They’re back!  A review of 200,000 mortgages between 2011 and 2014 showed that 14% of homes had “generous” appraisals, inflating the value of the home by 20% or more.  Loan officers and real estate agents are putting increasing pressure on appraisers to adjust values upwards.


Personal Income

You may have read that household income has been rather stagnant for the past ten years or more.  In the past fifty years household formation has increased 78%, far more than the 50% increase in population.  The nation’s total income is thus divided by more households, skewing the per household figure lower.  During the past thirty years, per person income has actually grown 1.7% above inflation each year.  Inflation adjusted income is now 66% higher than what it was in 1985.

In 2013, the Bureau of Economic Analysis released median income data for the past two decades. Median is the middle; half were higher; half were lower.  This is the actual dollars not adjusted for inflation.  Except for the recession around the time of 9-11 and the great recession of 2008 – 2009, incomes have risen steadily.

The 3.7% yearly growth in median incomes has outpaced inflation by almost 25%.

Why then does household income get more attention?  A superficial review of household data paints a negative picture of the American economy. Negative news in general tugs at our eyeballs, gets our attention.  The majority of the evening news is devoted to negative news for a reason. News providers sell advertising in some form or another.  They are in the business of capturing our attention, not providing a balanced summary of the news.  In addition, a story of stagnating incomes helps promote the agenda of some political groups.


Merry Christmas and Happy Chanukah!

Oil, oil, retail, and oil

December 14, 2014

The market seemed to wake up Monday morning on the wrong side of the bed.  The Federal Reserve updated their Labor Market Conditions Index, scoring the month of November with a tepid 2.9, a sobering counter punch to the previous Friday’s report of 321,000 job gains in November.  Too many part time workers, too many long term unemployed, a rate of unemployment that was too high among minorities, those in their twenties and those without a college education.

ISM’s monthly reports showed continued strength in both manufacturing and the services sector. The composite CWPI eased just a bit from the historic highs of the past two months.

The key components of the manufacturing index, new orders and employment, remained strong or robust.  The prices component showed a steep dive from expansion to contraction, 53.5 to 44.5.  George wondered if the falling price of oil had anything to do with this change.  New orders in the services sector grew even stronger while employment eased just a bit and was also continuing a strong expansion.

On his way to Home Depot on Tuesday morning, George filled up his SUV for just under $50.  When had that happened last he wondered.  2009, maybe?  George remembered the lead up to the 2012 elections. “Gas was $1.50 when Obama came into office,” he would hear on a conservative talk show, “and now it’s more than double that. Obama is hurting working families.”  As though Obama, or any President for that matter, had much to do with the price of gas.  Most talk show hosts counted on the fact that their audience was, well not stupid, as Jonathan Gruber had quipped when talking about Obamacare at a conference, but poorly informed.

The market had opened up that morning in a particularly foul mood after China tightened lending criteria so that Chinese investors could no longer use low-grade corporate debt as collateral for loans.  Overnight the Shanghai market lost more than 5% (WSJ ).

The EIA projected that U.S. oil production would rise in 2015 even as oil prices went lower.  Lower prices might curb new drilling but once the wells were drilled, the cost of production was fairly low.  The drop in gas prices put some extra money in most people’s pockets.  The EIA estimated that a gallon of gas would average about $2.60 in 2015, almost a $1 lower than the $3.51 average in 2013.

The continuing fall in oil prices contributed to another drop in the market on Wednesday, erasing the gains of the past month.  To sell or not to sell, that is the question, George thought as the volatility in the market continued to climb, rising more than 50% in the past week.  But he hemmed and hawed, then decided to replace the fence post in the back yard as the antidote to his indecision.

In an economy dominated by consumer spending, the monthly retail sales report and the employment report are probably the two most influential gauges of the strength of the economy.  Thursday’s report on retail sales was a huge positive, showing a rise of .7%.  On an annualized basis, that was an increase of more than 8%.  People were evidently spending the money they were saving at the pump.  The market opened higher and climbed up above Wednesday’s opening price.  Great stuff, George thought, then watched as the positive mood vanished and the market started sinking.  He must have made some sound because Mabel called out asking him if he was OK.  George realized that the early morning run up in prices was traders covering their short bets.  The underlying sentiment was still negative.  A strong employment report last Friday and now a strong retail sales report was having little effect on the mood of the market.  George decided to get out of the way of the darkening mood and sold the equity index he’d bought in mid-October.

The market continued to follow oil prices down on Friday.  George was pleased to find that the long term Treasuries that he had bought last week were up a few percent.  Glancing back at the beginning of the year, he saw that long term Treasuries (TLT) were up an unbelievable 20% so far this year.  Back in January many had projected higher interest rates toward the end of 2014, making long term Treasuries less attractive.  The equity market was up 10% for the year despite the recent change in mood.  Two types of investment that often moved opposite each other had moved in the same direction.  George smiled as he remembered something his  childhood baseball coach would say, “If it ain’t one thing, it’s the other, and sometimes it’s both.”  Which was just another way of saying not to put all your eggs in one basket.

Summer Signs

July 13, 2014

Small Business

Optimism has been on the rise among small business owners surveyed monthly by the National Federal of Independent Businesses (NFIB).  Anticipating a growing confidence, consensus estimates were for a reading of 97 to 98, topping May’s reading of 96.8.  Tuesday’s disappointing report of 95 dampened spirits.  The fallback was primarily in expectations for an improving economy.  Mitigating that reversal of sentiment was a mildly positive uptick in hiring plans. The majority of job growth comes from small and medium sized companies.

Job Openings and Labor Turnover Survey (JOLTS)

Speaking of job growth…There is a one month lag in the JOLTS report from the Bureau of Labor Statistics so this week’s report summarized May’s data.  The number of job openings continues to climb as does the number of people who feel confident enough to voluntarily quit their job.  Job openings have surpassed 2007 levels. If I were President, I would greet everyone with a hand shake and “Hi, job openings have surpassed 2007 levels.  Nice to meet you.”

Still, the number of voluntary quits is barely above the low point of the early 2000s downturn.  Let’s not mention that.

We can look at the number of job quits to unemployment, or the ratio of voluntary to involuntary unemployment.  This metric reveals a certain level of confidence among workers as well as the availability of jobs.  That confidence among workers is relatively low.  The early 2000s look like a nirvana compared to the sentiment now.  The country looks positively depressed using this metric.

If I were President, if I were a Congressman or Senator, I would post this chart on the wall in my office and on the chambers of Congress where it would remind myself and every other person in that chamber that part of my job is to help that confidence level rise.  Instead, most of our elected representatives are voicing or crafting a position on immigration ahead of the midterm elections.  Washington is the site of the largest Punch and Judy show on earth.  Like the little train, I will keep repeating to myself “I think I can, I think I can…stay optimistic.”


Government Programs

Most social benefit programs are on autopilot, leaving Congress with little discretion in determining the amount of money that flows out of the U.S. Treasury.  These programs include Social Security, Temporary Assistance to Needy Families, Food Stamps, Unemployment Benefits, etc.   Enacted over the past eighty years, the ghosts of Congresses past are ever present in the many Federal agencies that administer these programs.

During the recent recession, payments under social programs shot up, consuming more than 70% of all revenues to the government.  Political acrimony in this country switched into high gear as the U.S. government became the largest insurance agency in the world. As the economy improved, spending fell below the 60% threshold but has hovered around that level.

 That percentage will surely rise as the boomer generation retires, taking an ever increasing share of revenues to pay out Social Security, Medicare and Medicaid benefits.  As the percentage rises again toward the levels of the recession, we can expect that social benefit spending will take center stage in the 2016 Presidential election.


Back in ye olden days, soothsayers used chicken bones and tea leaves to foretell the future.  We now have powerful computers, sophisticated algorithms and statistical techniques to look through the foggy glass of our crystal ball.  Less sophisticated algorithms are called rules of thumb.  In the board game Monopoly, a good rule of thumb is that it is wiser to build hotels on St. James, Tennessee and New York Ave than on the marquee properties Park Place and Boardwalk.

I heard a guy mention a negative correlation between early summer oil prices and stock market direction for the rest of the year. In other words, if one goes up the other goes down. I have a healthy skepticism of indicators but this one intrigued me since it made sense.  Oil is essentially a tax on our pocketbooks, on the economy.  If oil goes up, it is going to drive up supplier prices, hurt the profits of many companies, reduce discretionary income and drag down economic growth. The market will react to that upward or downward pressure in the next few quarters. But a correlation between six weeks of trading in summer and the market’s direction the rest of the year? Is that backed up by data, I wondered, or is that just an old saw?   I used the SP500 (SPY) as a proxy for the stock market, the U.S. Oil Fund (USO) as a proxy for the oil market and threw in Long Term Treasuries (TLT) into the mix.  I’ll explain why the treasuries in a minute.

A chart of recent history shows that there is some truth to that rule of thumb.  When oil (gray bars) has dropped in price in the first six weeks of summer trading, the stock market has gained (yellow bars) during the rest of the year in five out of the past seven years.   A flip of a coin will come up heads 50% of the time, tails 50% of the time. An investor who can beat those 50/50 chances by a margin of 5 wins to 2 losses will do very well.

Whether this negative correlation is anything but happenstance is anyone’s guess.  If you look at the chart again, you’ll see that there is also a negative correlation between long term Treasuries (TLT) and oil the the first half of summer trading. When one is up, the other is down.  The last year these two moved in tandem was – gulp! – in the summer of 2008.  Oh, and this year.  We know what happened in the fall of 2008.  So, is this the sign of an impending financial catastrophe?  Let me go throw some chicken bones and I’ll let you know.



Small business sentiment eased back from its recent optimism.  Spending on government social programs exacerbates political tensions and aging boomers will add fuel to the fire.  Job openings and confidence continue to rise from historically low levels.  Do summer oil prices signal market sentiment?