Alan Moore Commentary 10-1-2011           

   The Financial Accounting Standards Board waived the mark to market requirement for banks about a year ago, and now they allow "mark to make believe"; so a house that is valued at $350k today is recorded on the bank's books at the $625k paid in 2005. That is another reason the banking system can’t afford more write-offs due to a Greek default. Those potential hits to capital are why banks aren’t aggressively making loans and choose to hold on to their excess reserves instead. However, the stock market rose last week because Congress finally agreed on something and the EU appears to have a Greek funding deal approved by the German Parliament. But, a Trojan horse lurks: The Germans will have to vote again in December on upping the bailout fund because Greece can’t cut it; the deficit that is. The Greeks are continuing to strike against austerity as their GDP has fallen to a negative 5% YTD; the lesson here is that you can’t buy growth with austerity, and Euripides couldn’t have said it any better (he was a Republican by the way). The whole world is cutting back, which spells global recession not recovery.

    As you can surmise, contagion, confluence and volatility are three phenomenon that crosslink different asset classes making them all susceptible to black swans landing anywhere in the world; they also debunk the old “buy and hold” and “asset allocation” investment strategies. The tsunami in Japan shaved a half point off of our GDP because of the parts shortage in the auto and electronic industries; The “Arab Spring” created an oil premium that continues to hurt consumer spending everywhere. With Europe heading down and China slowing, there is nowhere for the American economy to go but down----- it is only a question of who goes down the most. You cannot cut taxes and cut spending at the same time and decrease the deficit; that is fourth grade arithmetic---one minus cancels out the other minus leaving no gain (despite what Republicans say). Neither can raising taxes to cover feckless stimulus spending reduce the deficit, as Democrats propose. Government budget projections are not based on real math; they are schemes to achieve political objectives in the so-called class war. However, a fight between the top 2% of incomes and the other 98% is a mauling, not a war---- if most of the 98% just vote for their self interests.

     Here are some classy facts for political war-mongers: the top 1%-of- incomes-class owns $16 trillion of this country’s $57 Trillion in total net assets. The bottom half own only 2.5% of the assets, or $1.7 trillion dollars. If we took half of everything the bottom-half owns it would only pay ½ of this year’s budget deficit.  If we took half of the top 1%-people’s assets, it would cut the national debt in half and restore our AAA rating. So you can see, in Nancy Pelosi’s eyes,  the only viable solution to paying down the national debt is to confiscate ½  the property of the rich-------- given there is no way to cut $1.3 trillion (amount of the deficit) out of government spending anytime soon without causing a GDP decline tantamount to a depression. A depression would mean more socialism not less, as Congress would launch stimulus after stimulus via the Democrats, and very few jobs would come out of it; The Republicans would be voted out of office for twiddling their thumbs and not helping, waiting for tax-cuts and free-market forces to fix the problem. One thing about the rich: when the going gets tough, they don’t get going into new business ventures; they close their wallets and wait it out; no new jobs will be created by them during a crunch. Hence, our problems will remain unfixed until the deleveraging is complete: no matter which class stays on top. I just know that “we the people” cannot continue to run such large deficits and expect to be continually bailed out by foreigners buying our debt.

    Unfixed, we are headed for more stagnation caused by high unemployment which is now structurally embedded in the American economy. Capitalism has its weakness: Capitalism cannot resurrect demand if most of the discretionary income flows to the top 2%, because the top won’t invest in business and create jobs without seeing an increase in sales first, which can only come from the pockets and credit cards of the other 98%. To boot, when corporations do invest in this country, it is in machinery and technology that reduces the need for labor, because our labor costs too much versus Asian labor. It is a catch-22 situation and free-market economic theory breaks down in a global economy. The only way out of the mess is a dramatic fall in asset prices to the point demand is initiated from solvent investors with capital to spare; this is the exact phenomenon Bernanke is fighting with quantitative easing and low interest rates. At this juncture, his efforts are a finger in the dike.

     Long-term, besides controlling the deficits, there is only one economic fix: education. Currently in the world, American students rank 31^st in Math and 17^th in science(Economist magazine); China is ranked first. In the long-run we are dead in the world market if we don’t raise our education standards. In the global economy, Jobs are created by science, technology, patents and low-cost, non-union manufacturing------- the top 2%-people always chose to invest in those things, no matter what the tax rates are. The problem is, new technologies are slipping from our grasp as we dumb down education to make sure “no child is left behind” and that every teacher has tenure. Most math and science teachers in our high schools ranked in the bottom-half GPAs in their college graduating classes, because the top half got chosen by industry which pays more. By default, the poorest students in math and science go into teaching even though the pay is low. China does the opposite, the top college graduates get paid as well to teach, as working in industry. Their test scores say it all. On the other hand, the best teachers in American schools tend to be in English and History, because top college graduates in those subjects can’t get a job in business. Another startling thing, it has been proven in studies that class size has very little to do with student test scores (China and Singapore average 40 students per class), neither does teacher-pay as doled out by our school systems: the bad teachers get the same pay raises as the good ones, due to control by the teacher’s union---- and the union wants to do away with standardized tests; guess why!  I think if we awarded pay based on merit and were allowed to fire the bad teachers, student test scores would sky-rocket. Unions in all facets of our lives are destroying the American economy; and if unions are the foundation of the middle class like they claim, then the middle needs some new blood: a highly educated and technically trained workforce. 

    Here is an interesting statistic unrelated to the anything relevant: A recent study found that the average American walks about 900 miles a year. Another study found that Americans drink, on average, 22 gallons of alcohol a year. That means that, on average, Americans get about 41 miles to the gallon. Literally, America could walk its way out of the energy problem.

Operation Twist:

    Of the $1.3 trillion of Treasury bonds held by the Federal Reserve Bank, only $150 billion of them mature in over 20 years, the bulk averages  4.5 years in duration. The Fed has announced Operation Twist to designate their strategy to rollover the short-term bonds into long-term bonds, in order to hold down mortgage rates as higher inflation threatens to push them higher. Even though this new policy  is part of an overall easing by the Fed, it is always more desirable to lock in interest payments for 20 or 30 years versus being vulnerable to short term increases; but Operation Twist will have negligible effect on the economy and it is a waste of Fed credibility.

    Two embedded myths in the Republican and Democrat’s messages that are repeated over and over are: the Repub’s chant, “regulations and taxation are killing small business and job creation”, and Dem’s, “big-business and fat-cats are making huge profits on the backs of workers” (unions, per se). My take is that both sound bites are dead wrong. First, I own part of a small business with 50 employees and there is no new regulation that I can think of that has set us back---- I can also remember the 49% top tax rate under Ronald Reagan. Unequivocally, competition is always a threat, but Obama-care only affects a business that pays less than 65% of health premiums for employees; most pay at least 75%; so that is not a significant problem(under 50-employee companies are exempt anyway). The Frank-Dodd bill has nothing to do with small business, it has to do with regulating banks, and I prefer them to be better capitalized and not engage in leveraged, robo-signing, no-doc loans and credit swaps. In my thinking, there is no new regulation in the last 30 years that has cost small business a lot of money to comply with----it is a Republican myth; and, it isn’t a factor in creating jobs---getting new customers is the only thing that counts in that regard.

    On the other hand, the average net profit margin of the large corporations listed on the stock exchange is only 6%----even EXXON doesn’t do much better. I guess the Democrats could extract that 6% through taxation and then mandate wage increases to sop of all the profits, but then who would want to own a large business in America? Wouldn’t that just push big business and jobs out of the country, to other places with lower corporate tax rates, Mexico, Brazil and China (all have lower corporate tax rates than the USA, even France beats us)? Hasn’t that happened already? Isn’t there a trillion dollars locked in foreign subsidiaries that won’t come home because of the 35% corporate tax rate in America and the double tax on dividends? Corporations aren’t making huge profits on the backs of labor: labor unions are riding on the backs of business----- pushing them to foreign ground, where new factories are opened (Boeing can’t even open a plant in South Carolina without being sued by the union). The big-business, bad-guy-thing is a Democrat’s myth and there is another side to the consumer led 70%-of-GDP thing: it is the other 30% of spending that causes the economy to swing up and down. The 70-percenters include the bottom half of incomes and the unemployed; the other 30% of total spending is comprised of items like: plant, equipment, housing and investment. Both segments need stimulus at the same time to be effective because they are interdependent.    

    As an investor, there are only two kinds of losses possible: the loss of your capital that is already committed to investment, or the loss of opportunity to invest the capital in the future. I say, if you can protect the capital, there will always be another opportunity-------- you can afford to miss a bargain or two, but if the capital is lost, your future is over; at least financially speaking---- and greed often overshadows this reality. I think it is always more important to put risk ahead of profit when determining whether to invest or not; and today, the risk is all macro. That is a simple message that requires a healthy amount of skepticism to work.   

  One investment theme you could have been sucked into is solar energy. Obama heavily subsidized the development of “green energy” in the stimulus package of 2009, not to mention the huge ethanol tax credits for corn farmers and refiners put into effect by George Bush. Both programs are a bust; Evergreen Inc., the largest solar producer, went bankrupt in July, and now this: NEW YORK (MarketWatch) – “Solyndra, the solar panel maker that has filed for bankruptcy despite a $535 million federal loan guarantee, is the target of a search warrant from the Federal Bureau of Investigation, according to a report on Thursday. Earlier this week, Solyndra shut its doors and filed for Chapter 11 protection from creditors under the U.S. Bankruptcy Code, throwing 1,000 people out of work.”

   The Chinese are selling solar panels for ½ the price of American manufacturers. We can’t take the heat from the “rising sun” only shielded by Obama’s green stimulus; it will take American know-how and patents. By the way, where have all our engineers gone? I predict every solar panel producer in America will go bankrupt or quit, even as solar energy becomes a more cost effective alternative. Until it does, the only thing green about “green” is carbon envy.