Reappoint Ben Bernanke

The Senate is likely to reappoint Ben Bernanke as Fed chairman. But there is a cabal of senators on both the left and right that want him ousted. And some want the Fed’s powers restricted, a course of action that would only end up politicizing policy, which would be a disastrous turn.

His opponents are making noise and made him mighty uncomfortable in his confirmation hearings today. They feel he and his predecessor have been the source of many of our problems with monetary policy that has been far too loose for far too long, encouraging risk and baiting inflation. The price of gold has them apoplectic as a sign that inflation is just around the corner.

Bernanke is taking the heat for his policies of quantitative easing, in which he has purchased debt instruments to effectively take real interest rates below zero. As we learned in the 1930’s and Japan learned in the 1990’s, bursting financial bubbles are deflationary events. And once deflation takes hold it is difficult to arrest. The value of assets collapse and the economy essentially folds.

The process of turning on the liquidity spigots has had the effect of fighting off deflation and its pernicious economic effects. Unemployment might be 10% and growth without stimulus barely positive, but these numbers would be a lot worse without these policies. In case you’re in doubt consult your history books.

Yes, the dollar is weak and likely to weaken further. And gold is on fire. But we view this as more a vote of no confidence in the dollar than in nascent inflation. The following comparison chart uses ETFs to show gold (GLD), the dollar (UUP), oil (USO), the euro (FXE), the Commodity Research Bureau Index (DBC) and the Australian dollar, with all charts starting at 100 on March 9th of this year, the day the NASDAQ bottomed and started its impressive advance. We selected this date because the dollar was at a three year high at that point and has steadily declined as stocks and other assets have rallied.

(If you click on this particular chart to enlarge it, in order to best view it you might have to adjust your screen size by pressing CTRL and the [-] sign.)

The results are clear. All assets are higher – much higher – against the dollar, but not so much against one another. In fact the commodities are bracketed by two currencies with gold smack in the middle. This isn’t inflation. It’s a sign of severe illness in the United States.

Would higher interest rates repair the damage? To an extent, yes. But they would choke off whatever signs of life are percolating in our economy and only fuel the deflation impulse.

If members of Congress want to place blame for our malaise on someone they need only point their fingers at themselves. The dollar isn’t sick because of interest rate policy. It is sick because of nearly nine years of profligate spending under two administrations and a welfare state that is coming unhinged and, incredibly, set to expand by an unfathomable order of magnitude.

Whoever the Fed chairman will be in the years to come there is a difficult task ahead. A healing economy will need to have quantitative easing artfully withdrawn. And we believe Ben Bernanke is the proper artist for this job. He should be reconfirmed forthwith.

The Real Message of the Election

On Tuesday voters in Virginia, a national swing state, and New Jersey, a solidly blue one, voted overwhelmingly for Republican candidates. Across the country races of lesser standing went for Republicans far more than for Democrats. In Westchester County, New York, one of the country’s most affluent counties that is solidly Democratic, the two term Democrat incumbent County Executive was routed from office.

Twelve months after turning the Federal government over to the Democrats in resounding fashion the nation voted for an abrupt about face.

Republicans are painting this as a precursor to a comeback by their party in off year Congressional elections next year, but that could be reading too much into these results. We don’t believe this election was necessarily about health care reform, which most Americans do not grasp and whose policy effects they do not yet feel. Rather, voters vote their pocketbooks.

As President George H. W. Bush (41) found out in his unsuccessful run for reelection in 1992, an economy just out of recession, similar to our current situation, is often a hostile environment for incumbents. Employment is the last indicator to turn and voters are not interested that GDP has resumed expansion when an inordinate percentage of them remain out of work, stoking fears of the employed that they could be vulnerable. Democrats can be thankful that they have another year of recovery before they must face the electorate again.

The real message of the election is that the president and his party now own the economy. This might seem elementary. After all, presidents tend to get far too much credit when the economy is performing well and too much blame when it’s not. But President Obama has been unique in this regard by routinely reminding the public that any problem on his plate is one for which his predecessor bears responsibility.

With their votes on Tuesday the electorate has sent him a clear message: blaming his predecessor is a dog that will no longer hunt. He now officially has ownership of the nation’s economic performance and a year to improve it sufficiently to keep off year elections losses, which are typical for the party that holds the White House, to a minimum.

Ironically for Republicans last nights results are more likely to help the Democrats. Moderate Democrats will now be emboldened to resist the agenda set by the White House and liberal Congressional leadership. This agenda includes, among other growth crushing initiatives, raising the top federal income tax rate to 45% on the class that starts the most businesses that yield the most jobs, and Cap and Trade climate legislation that would vastly increase the price of energy.

People the world over want to know the secret to American success. And it is simply this. Our political system was designed in such a way that power is sufficiently diffused so that it is nearly impossible to veer too far from the center. Nowhere is that principal more on display than in the likely effect of these elections.

Upon taking office the president’s chief of staff, Rahm Emmanuel, noted that the administration would take far reaching steps to remake the American system using the financial crisis as cover to get things done that could not be accomplished under more normal circumstances. “You never want a serious crisis to go to waste,” he said at that time. Yet in the months ahead he is likely to find that Tuesday’s election laid his opportunity to waste.

The Obama Recovery

After the last recession Democrats demonized Republicans for laying the foundation for a “jobless” recovery. We were told that tax cuts, the traditional fiscal policy medicine used successfully by presidents as disparate as Kennedy and Reagan to spur growth, were suddenly not valid, skewing incentives toward the wealthy and accelerating income disparity. Democrats would restore fairness and produce better results.

Eight years later the jury is in and they have done neither.

Nine months into his administration, after demanding and receiving from an obeisant Congress a pork laden stimulus package that didn’t stimulate much but was sufficient to feed all the pigs at the party in power’s trough, President Obama owns the current economy. And yet, we are told by the New York Times in a front page article this past Sunday, “Americans now confront a job market that is bleaker than ever in the current recession and employment prospects are still getting worse. Job seekers now outnumber openings six to one, the worst ratio since the government began tracking open positions in 2000.”

That would be worse than the heretofore unprecedentedly “horrid” Bush recovery.

So this is what an Obama recovery looks like.

In fairness economies are self healing if left to their own devices. And indeed the economy has begun showing signs of awakening. Leading indicators have been up at least 5 months in a row. And although it is uneven there are clearly signs of growth.

And we know that unemployment is a lagging indicator. Employers won’t hire until they are more certain that a nascent recovery has staying power. Until then they will drive their current staff as hard as they can, piling on overtime before they dare begin rehiring.

Yet even with this knowledge The Times tells us that “prospects are still getting worse.” Can we identify the reasons that escape the brilliant policy makers in the White House and Congress?

Lost on the Administration and their minions in Congress are the effects their policies or the threat of their policy changes are having on business.

Health care reform will no doubt feature higher insurance costs to be borne by businesses. Even if a public option isn’t part of the package Congress will increase mandates that policies must cover to new levels and that will only mean higher premiums for employers. And for those businesses that can’t or won’t shoulder health benefits there will be a tax, perhaps as much as 8% of payroll, to insure the cost to the taxpayer for their employees’ healthcare will be borne as much as possible by the employer.

Can’t you just imagine how eager employers are to hire more people while these increases, still undefined, are shortly to become a significant part of the cost of employment?

And if this weren’t enough businessmen of all stripes, who take risks with their own capital and create most of the jobs in America, are facing huge tax increases by 2011. The expiration of the Bush cuts will increase capital gains taxes back to 28%. And income taxes will increase to over 39%. But that’s not all. With massive social welfare spending about to become a part of an expanding deficit baseline Democrats have discussed the possibility of even higher taxes. Paired with state income tax increases that have already taken effect in many states across the country the employment producing class could face tax rates of nearly 60%.

Have no doubt that just the threat of these levels is causing capital to become risk averse. And as long as the calculus regarding rates remains open and undefined business owners will err on the side of caution when it comes to expanding employment. Businessmen are less eager to expand when government becomes the majority owner in their ventures.

President Bush cut taxes and got the economy growing again. After lagging early during the heart of the cycle employment expanded at healthy levels.

Now President Obama’s policy to retard business expansion and hiring is in full gear. And the New York Times and their fellow travelers are stunned that the pace of layoffs has yet to bottom even as the economy begins to recover.

Sometime next year we’re certain they’ll start talking about the need for another stimulus. That won’t help matters any but that will be beside the point. The pigs, as always, will line up at the trough.

The Unintended Consequences of Empathy in the Markets

We were struck by the front page of the New York Times business section this past Saturday, September 5th. On display were two examples of how well meaning price subsidies help to distort markets and create conditions exactly the opposite of what they intend to accomplish. Yet the author of neither piece was able to understand this basic economic fact.

We don’t mean to single out the Times. Journalists often don’t grasp the consequences of market interference. Instead they focus on the impulses for fairness that exists inside all of us and thus fail to see the larger picture.

Runaway Teen Unemployment

The headline story was about teen unemployment being over 25%. Since statistics have been kept in 1948 this is the highest teen unemployment has ever been. That arc of over 60 years encompasses the harsh recessions of 1973-4 and the “double dip” of 1981-2.

In an attempt to grasp why the reading is so outsized as compared to other groups the article correctly noted that this is an unskilled group and the last in line to be hired. With little leverage they command low wages and few opportunities.

And the poor state of the economy has narrowed the number of jobs available. The article sites many seasonal jobs as not being filled this year. And with older, more qualified individuals having employment difficulties of their own many are “stepping down” the employment ladder to take positions that are well beneath their skill level to simply have some kind of job. Recent college graduates were specifically cited.

But the author proceeds to twist logic into a pretzel to explain the outsized number by postulating that many qualified older teenagers are attending college to boost their chances of landing a job and younger qualified teens are relying on their well to do parents allowing them to literally turn their noses up at work they’d rather not do, thus leaving the least desirable prospects in the job pool. Employers, she suggests, are balking at hiring them.

The Best Minimum Wage is None at All

The article devotes one sentence to the possibility that the recent rise in the minimum wage might have something to do with the high teen jobless rate. But clearly the author isn’t enamored of this idea. It is included almost as an afterthought with no elaboration or explanation as if an editor insisted it needed to be mentioned.

And indeed it does. The convoluted thinking the author goes through in order to explain high teen unemployment defies the basic law that the shortest distance between two points is a straight line, whether in mathematics or in logic.

There is no doubt a recession would have an outsized impact on employment of the low skilled and the number of jobs available. But raising the price of that labor can only magnify these outcomes.

It’s all the more troubling when you consider that for the most part minimum wage jobs are not lifetime destinations but stepping stones to better opportunities for older unqualified workers and first work experience jobs for teenagers. Few people truly capable of functioning as self sufficient individuals in the society spend any real length of time in these positions. No less than the largest employer in the country, Wal-Mart, the king of low paying jobs, encourages entry level employees to acquire skills on the job, making them more valuable to the company and thus subject to promotion.

Raising the cost to the employer for hiring workers at the margin is a clear disincentive to hire. And doing so in the midst of a significant recession is the work of politicians more worried about their images than the deleterious effects of this policy. It’s easy to brag about increasing the minimum wage but more complicated to explain why the best minimum wage is to not have one at all. This from a political class supposedly so worried about jobs they passed an economically back breaking stimulus.

The minimum wage increased only on July 24th but employers have known for a long time that it was coming and have no doubt factored it into their plans. With the cost of entry level work increasing by over 10% it’s no wonder employers would think twice about expanding their hiring in the most challenging of times.

Why is the best minimum wage none at all? The author unwittingly answers this question in part. If, as she postulates, teenagers will go to college to avoid low skilled work and others simply will refuse to do it, the pool of available workers isn’t as large as she suggests. That means there is a happy medium that will maximize the number of jobs available at a price employers are willing to pay and the unemployed are willing to accept for a job that is a stepping stone to something better if a worker is reliable and willing to learn.

Look first and foremost to a higher minimum wage for the record high 25+% teenage unemployment rate.

The Dizzying Rise of College Tuition Even in “The Great Recession”

Elsewhere on the front business page another author seeks the reasons for the rising cost of college even in a recession but in this instance doesn’t consider a major factor behind the rise.

He consults the president of Lafayette College, who has an MBA and private sector experience, giving him a business perspective that is largely lacking in the academic world. Lafayette, the author feels, is an excellent college to discuss because it is not a “top tier” institution yet it charges $50,000 a year for its programs.

The president suggests they are not good at cutting costs when they increase spending. And why should they be when they have successfully raised tuition at will for decades?

He also suggests a tenured faculty cannot be crossed and thus costly but unpopular majors cannot be trimmed. In addition sabbaticals are offered every seven years to give faculty a chance to further their research and recharge their offerings, although it is not at all clear that a pedestrian institution like Lafayette requires the same type of approach as the cutting edge universities.

He defends the university’s burgeoning administrative staff as necessary for the school to be competitive with others that offer career counseling and other services.

Ultimately the president defends Lafayette’s policies by pointing out the importance of a well rounded liberal arts education and the fact that it is costly in a world where skilled labor, such as professors, only gets more expensive.

And indeed he is correct in that regard. But he misses the point.

Higher Education Isn't The Magic Potion For a Better Life

Politicians are convinced that college is the entry point to a better life for the entire population. They are as convinced of this as they were that everyone should own there own home. The latter was a clearly misconceived idea. We’d argue so is the former.

As much as not everyone is capable of owning their own home a greater percentage of the population is not capable of true college level work. And we’d argue that for many it isn’t necessary. The idea of a liberal arts education is to learn how to think and problem solve, skills necessary to secure many higher paying jobs.

But there are many well paying jobs that can ensconce their holder firmly in the middle class that only require artisan training. You will no doubt be a better rounded person if you read Shakespeare and study the Roman Empire, but you don’t need this knowledge to be a plumber or a dental technician.

Yet our system is designed to subsidize as many people into higher education as possible through government loans. We have a friend that accumulated $50,000 in loans and is paying it off at 2 ½% interest over a 30 year period. And the loan is forgivable upon death. Loans like these make it easier for students to pay college tuitions. But most economists will tell you that prices tend to rise as much as the subsidy that is extended. In other words, these programs are politically popular but tend to be self defeating.

If the government would get out of the subsidy business two things would happen, and rather quickly. First, tuition increases at all but the finest universities would slow as fewer students would venture to pay prevailing prices. Second, second tier institutions like Lafayette would quickly make the hard decisions their business savvy president would rather resist, suddenly preferring to take on overpaid faculty and a bloated bureaucracy than to hike tuition. Tuition levels at a wide variety of schools would become more affordable as colleges try to meet the market rather than meet their fate.

Conclusions

Market subsidies are politically popular but have unintended consequences that ultimately defeat their purpose. The mirage that government can bring things the population covets within reach is a powerful aphrodisiac and the fatal flaw of popularly elected governments.

Defeat of the Entrepreneurial Spirit

Maybe they want to spend more time with their families. Maybe they are enduring mid-life crises and are leaving their posts for greater fulfillment. But this morning two key executives of Amedisys Inc have resigned. They were responsible for much of the company’s tremendous growth and abruptly they are leaving.

Could there be a dark secret inside the company that is causing these executives to leave before the storm breaks? That’s certainly possible. Indeed the market is rattled with shares down over 30% at one point during today’s trading.

But we’d venture another cause: defeat of the entrepreneurial spirit.

Amedisys is a home health care provider. They have profited handsomely from the trend to limit expensive hospital stays. For a fraction of what a day in the hospital costs Amedisys can provide care in a patient’s home.

If this sounds exactly like what our health care system needs to cut costs and become more competitive you’d be sadly mistaken. Amedisys and its competitors are targets rather than solutions because they make fat profits in the health care field.

Over a year ago on August 12, 2008 Citron Research, a short seller that makes bearish arguments against companies it has bets against, issued a detailed report that essentially made the point that Medicare reimbursement would be severely cut stemming the company’s growth. That day the stock priced collapsed 18% on 11MM shares. Consider that at the time the company traded far less than 1MM on any given day. Selling of this magnitude generally sends the stock in question into a significant correction. Amedisys has been no exception.

While the share price has had rallies since that fateful day the trajectory of the stock price has been down. This in spite of the company beating analyst estimates in all four subsequent quarters and raising earnings guidance in three of those four reports. These reports attested to 46 – 64% year over year profit growth.

We can only conclude that the stock price has not been under pressure these last 13 months due to performance, but rather to fear of the future.

We won’t pretend that Amedisys competes in a free market. Rather their market has the hands of the government all over it and lives and dies by arbitrary reimbursement rates the government sets. And we won’t argue that Amedisys’ reimbursement rates shouldn’t be cut. We also won’t argue that the nation’s health care system could use an evaluation.

But clearly Amedisys responded to a need in the system and built a profitable business based on the rules in effect. It is something the government could not have done on its own.

Now, clearly, the prospects for that business have been diminished. No matter the fate of “health care reform” it seems fairly clear that reimbursement rates will be curbed and the company’s growth curve severely curtailed.

With the propects for continuing to build the company compromised we believe key executives are simply leaving in disgust, likely intent on finding fresher opportunities perhaps in a sector where the market rather than the capricious arm of government will dictate their success.

And herein lays the gravest potential impact of “health care reform.”

Contrary to prevailing belief in Washington the amount of money spent on health care cannot be limited while expanding care at the same time. Rather limiting spending will result in less availability of services. More importantly, because the ability to profit will be curtailed it will lead to less innovation. And over time it will lead to more resignations of bright, innovative executives in companies that drive one of the most dynamic sectors of our economy. They will resign out of frustration to pursue “other opportunities.” Worse, they won’t be attracted to the field at all.