Browsing the blog archives for February, 2013.

Obama phones and failed government

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The federal government spent over $2 billion last year as part of its Lifeline (AKA, Obama phone) program, which is designed to provide cell phones for low income Americans so they can “connect to jobs, family, and 911 services.” The Lifeline program is funded by the Universal Service Fund (USF), which fills its coffers through a tax on your phone bill. The fund supports several other government programs of questionable merit as well, but Lifeline is getting the most press at the moment.

Recent reports are suggesting widespread waste and fraud. Some companies have signed up clients in hospital rooms or by mailing them unsolicited phones. Others have simply signed up ineligible customers for the program. The companies are being blamed for their wrongdoing—and rightfully so—but attention should be placed on the program itself.

There are two obvious lesions here. First, government programs based on “good ideas” are rarely abolished when they are no longer needed. The USF has been in existence since 1997. Today, over 96% of the U.S. population has access to a phone, but the USF tax rate has increased to 3.32% of your telecommunications bill. This explanation for failed government programs is all about bureaucracy.

Second, when Washington hands out money to help those in need, some individuals and organizations will inevitably collude to game the system. When this occurs, the nefarious companies are tagged as greedy capitalists and criminals, while the consumers involved are labeled as an “exception to the rule” and the government is simply treated as an innocent bystander seeking to improve lives. This explanation for failed government programs is all about human nature.

Both explanations are entirely predictable. Consider the mortgage crisis. In short, Congress, the Fed, and Freddie/Fannie devised a system that effectively subsidizes housing, particularly for consumers who really can’t afford a home. Slack lenders that passed off the paperwork for marginal loans to Fannie and Freddie were vilified. Consumers who signed up for negative amortization loans and overextended themselves were treated as victims. The government is now suing S&P, the Fed is keeping rates as close to zero as possible, and the Democrats are talking about expanding government’s role in providing low-income housing.

The point here is that government programs—by definition—are inefficient and invite fraud. Whether it’s an $800 government hammer, an overpriced medical procedure, a subsidized cell phone, or section 8 housing, the lack of market discipline guarantees problems. Consumers tend to seek the most “bang for the buck” when they spend their own bucks. Likewise, sellers design their offerings to accommodate those who pay for the product. If government is paying, then the consumer loses both power and interest in the transaction.

In the case of the Lifeline program, many consumers get phones or phone plans they either don’t need or could have afforded on their own, aided and abetted by everyone else who pays the tax. If the $8+ billion USF tax were the only example of inefficient and ill-fated government intrusion, our economy would be in much better shape. Unfortunately it’s just the tip of the iceberg.

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Currency Wars

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Andrew Wilkow and I discussed currency wars on his radio show Friday. I received a couple of emails asking for more on how a currency war could affect the U.S., so I decided to post more info here.

Last month Japan’s central bank started buying Japanese bonds to devalue the yen; as with most devaluation schemes, they claim the intent is only to prevent deflation. In terms of currency exchange, the effect is already being felt. Compared to the dollar, the yen has declined about 10% since December, making anything produced in Japan 10% cheaper in the U.S. and American goods 10% more expensive in Japan. The Japanese are attempting to gain a comparative advantage in terms of production costs, and they will enjoy one in the short term if other countries don’t match them. Although the benefits of devaluation come with long term costs, Keynesians focus on the short term. Because most countries are run by Keynesians, its likely that others will counter the move in Japan, potentially igniting a currency war.

Left-leaning economists like Paul Krugman have made the case for a weak dollar for years, arguing that it boosts exports and deters imports. As with most Keynesian schemes, however, this argument is fraught with several problems:

  1. A weak dollar only makes exports less expensive when they are denominated in other currencies. About half of U.S. exports are denominated in U.S. dollars or currencies like the Chinese yuan tied to the U.S. dollar, so the effect on costs of these exports would be limited.
  2. A weak dollar is inflationary because imports cost more, thereby reducing real spending power. It resembles an indirect tax on Americans because their dollars won’t go as far in the marketplace.
  3. A weak dollar makes the U.S. currency less attractive and encourages U.S. and foreign investors to invest outside of the U.S. Remember, foreigners are funding much of our $16+ trillion debt. If we have to raise interest rates to attract foreign investors, our budget deficit will skyrocket. A 1% increase in interest paid on the debt would cost an additional $16+ billion annually.
  4. Strong economies compete more on quality and less on price/cost anyway, the logic behind promoting exports by cutting costs is questionable.
  5. Even if there are advantages to a weak dollar, there is no reason to believe that other countries will allow us to benefit at their expense.

China is already retaliating to Japan and other nations seem to be following suit. If the U.S. gets involved in the fray, then we’ll have a full blown currency war with most economies attempting to weaken the relative value of their currencies. Because such attempts tend to cancel each other out, a global currency war would yield no significant cost advantage to any country and would ultimately have the same effect as a coordinated global currency devaluation. Some economists might like to see this occur, as it serves as an huge indirect tax and would lessen the value of government debt at the expense of cash holdings, including those at corporations and in retirement accounts. I’m convinced Obama wouldn’t mind it either.

This could be a serious problem, but–like many others–it’s only getting back page coverage in the mainstream media.

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DoJ sues S&P

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As anticipated, the Department of Justice is now suing S&P over its alleged contribution to the mortgage crisis.

http://online.wsj.com/article/SB10001424127887324445904578284064003795142.html

The details surrounding the mortgage debacle has been well chronicled in previous posts. While it’s obvious that S&P’s risk assessment models were flawed, there is no evidence to suggest that the rating agency deliberately misled anyone. The real issue is is political, and the point here is to establish corporate America–not Washington–as the villain, and send a message to anyone who might challenge governmental authority. Unfortunately, S&P will probably negotiate a settlement rather than fight, which will further underscore the threat.

If the DoJ is going to due S&P, there are some other culprits Eric Holder could consider as well…

1. Congress–for passing the Community Reinvestment Act.

2. Freddie & Fannie–for exacerbating the subprime problem.

3. Barney Frank and Chris Dodd–for misrepresenting the financial integrity of Freddie & Fannie.

4. Obama–for expanding the national debt at an unprecedented pace.

5. The Fed–for instigating the entire problem from the outset by, among other things, pushing people into houses and bigger houses by keeping mortgage rates artificially low.

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The Stock Market and the Economy

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Whenever the stock market has a good run the mainstream media always cite it as evidence that Obamanomics is actually working, the $16 trillion national debt isn’t all that bad, and that Keynesian economics really makes sense. When it declines, they refer to it as a readjustment, or a response to the European crisis or some other elusive, non-controllable event. The stock market is an interesting economic indicator, but not always a reliable reflector of economic growth. While I’m not disseminating any investment advice, here are a few things to keep in mind when watching moves in the market:

1. The DJIA does not always correlate with economic progress. In fact, the last three decades is replete with stock market increases during bad economies and drops during economic expansions. Over the long term, the stock market is a reliable indicator of economic activity, but you have to look at years of data to make sense of this.

2. Stock prices are a function of supply and demand, especially over the short run. The more people invest in the market–regardless of the reason–the higher prices will go. This is why stock prices decline when there is global uncertainty, with many investors moving funds to cash or gold, lowering demand for stocks and thereby triggering an overall decline. This is also part of the reason why the Fed keeps interest rates artificially low. By guaranteeing that ordinary investors cannot receive a reasonable rate of return for cash deposits in savings accounts and CDs, the Fed pushes average investors into stocks. Ask yourself, how much money would leave the market immediately if returns on one-year certificates of deposit rose to 5%? Enough to send the Dow into a tailspin.

3. Few individual or institutional investors purchase a stock at a certain price because they believe a company’s future earnings justify that price. Instead, they purchase a stock because they think the price will rise, even if the increase is irrational. I can’t tell you the number of investors I’ve spoken with over the last few years who are convinced that fiscal problems will drive the U.S. economy to ruin but are still heavily invested in the stock market. Their reasoning is simple. They believe the day of reckoning is still a few years away. With cash returns in the 1% rate–below inflation–they are hoping to ride the market for a while longer and dump their holdings when the next financial crisis hits. Investors call this the greater fool theory because it assumes that a fool is always waiting around the corner to pay more for your shares of a given stock that you did. Keynes referred to this phenomenon as the beauty contest principle of investing because investors are often less concerned with what a stock is really worth and more concerned with what they think others think it is worth.

Most left-leaning pundits ignore these realities because they don’t fit in the pro-Obama narrative. They seek to use the stock market’s rise or fall to reinforce their claims that an expanding, far-reaching and intrusive government is actually good for business and economic growth. Sometimes market moves can be largely attributed to simple drivers, but more times than not they can’t.

BTW, you might be surprised that I cited Keynes favorably in this post. Keynes offered a number of sage observations about the economy and we should be willing to consider each on its own merits. Even Paul Krugman is right once in a while, although such instances are not very common these days. Arguments from Keynes, Krugman, and other misguided economists typically open with a few legitimate insights before drifting astray. There’s nothing wrong with giving each of them a fair hearing. It’s a shame that those on the left won’t give Hayek, Mises, and Hazlitt the same consideration.

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