Inflation Reduction Act

I bought a novel, some perfume
A fortune all for you
But it's not my conscience
That hates to be untrue
I asked of my reflection,
"Tell me what is there to do?"
--Squeeze

As we've discussed, leftists are rarely honest with their rhetoric. They label things largely contrary of their actual effects.

Cast in point: the proposed Inflation Reduction Act. 

As Ron Paul discusses, the bill does the opposite. It increases government spending by hundreds of billions of dollars. It takes resources out of the hands of private citizens and puts them into the hands of bureaucrats.

Not only does this increase the risk of capital misallocation, but it must be funded. To the extent that citizens are taxed, it reduces economic resources available to people during an era of high price inflation and slowing economic activity.

It is a universal truth that slow economic activity motivates easier central bank monetary policy (read: inflation).

To the extent that taxes won't cover the spending, then those funds must either be a) borrowed, which taxes future incomes, or b) printed (the reason why inflation is called the 'invisible tax').

There is little doubt that the Inflation Reduction Act will ultimately result in more inflation, not less.

Public Health Philosophy

Sometimes you're better off dead
There's a gun in your hand 
And it's pointed at your head
--Pet Shop Boys

Robert Malone proposes that public health policy is built on two philosophies: utilitarianism and Malthusianism.

Utilitarianism posits that the morally right action is the action that does the most good. It is a form of consequentialism--the correct action is assessed solely in terms of results produced. 

Utilitarianism fosters what these pages have deemed 'greater good accounting.' If a program is deemed to help more people than it hurts, then it is deemed a winner.

Malthusianism springs from the writings of political economist Thomas Malthus, who believed that population growth would outstrip food supply and other scarce resources, consequently triggering global poverty and death. 

The central implication of Malthusianism is population control. Limit the number of births so that future standard of living won't be compromised by too many people walking the planet.

Two hundred plus years, and billions of people, later and the world has yet to hit Malthus' dreaded upper bound of population. Why? More people produce more, which alleviates the scarcity that worried Malthus. Moreover, those people innovate, applying capital in manners that improve productivity even more.

Meanwhile, countries that have seen birth rates decline significantly, such as Japan, face major demographic headwinds likely to restrain standard of living in the years ahead.

None of that matters to public health officials, or climate alarmists, or socialists in general. The ingenuity that flows from liberty must be restricted in favor of utilitarian and Malthusian central planning. 

Never mind the misery and chaos that such planning creates... 

Saving Rain

Here comes the rain again
Raining on my head like a tragedy
Tearing me apart like a new emotion
--Eurythmics

Nice graphic that shows that not only do Americans have no net savings, but that savings is negative after inflation.

As the Fed has suppressed interest rates over the past 30-40 yrs, people have had less incentive to save. Why put money into a savings account when there is little or no compensation to do so?

Now add inflation. As prices go higher, why put money away today when those dollars are expected to be worth less tomorrow?

Remember the saying 'Save it for a rainy day'?

No savings means no buffer against uncertainty (i.e., you'll get rained on). And, perhaps more importantly, no capital to fund productivity improvement.

Lower Hospital Capacity

It's been such a long time
I think I should be going
And time doesn't wait for me
It keeps on rolling
--Boston

One difference between manufacturing and service operations involves their composition of productive resources. In manufacturing processes, equipment serves as the primary factor of production. Equipment leverages the amount of output that workers can produce. Capacity, defined as the maximum amount of output possible from a production process, is generally determined by how much equipment has been installed to support labor.

In service-based operations, people are usually the primary factor of production. Although facilitating equipment may be employed, people generally control the pace and composition of output in service operations. Obtaining more output in service sector settings commonly requires hiring more workers.

With vaccine mandates now being imposed in many organizations, workers are being fired for non-compliance or leaving in advance of compliance deadlines. Several recent headlines have highlighted the situation in hospitals, where large groups of nurses and other workers are resigning or or threatening to resign in defiance of vaccine directives in their organizations.

Hospitals are prime examples of service sector operations that depend on people to produce output. The fewer doctors, nurses, and other staff personnel, the smaller the number of patients that hospitals can treat. By imposing vaccine mandates that cause workers to hit the silk, hospitals are essentially reducing their productive capacity.

When you hear that hospitals are being 'overrun' with patients, recognize that this may be due to self-imposed capacity limitations. Vaccine mandates may lead to fewer workers. Fewer workers mean fewer patients can be treated. Therefore, hospitals may reach capacity limitations when far fewer patients seek treatment than in the past. 

Afghan Unwind

There's a room where the light won't find you
Holding hands while the wall come tumbling down
When they do, I'll be right behind you
--Tears for Fears

The chaos that has erupted in Afghanistan following the abrupt removal of remaining American forces by Joe Biden has fostered no shortage of finger pointing. Republicans, especially, smell political blood in the water. Their howls range from "America has been completely embarrassed" to "Biden should resign."

These rants may be justified on some levels, particularly in light of what has transpired over the past year and a half. But, as Ron Paul notes in a more or less "I told you so" rant of his own, many of these same politicians created the Afghan mess to start with.

Meanwhile, most Democrats are predictably circling the wagons around Biden. He did the right thing, Dems claim, by taking us out of an unpopular war. And, indeed, prior to the chaos polls had suggested that nearly 70% of American opposed US presence in Afghanistan and wanted us out. 

As a matter of fact, I was one of them.

At the end of the day, I suspect the problem that most Americans, and perhaps many across the globe, have with what is going on is not the intent but the execution. As Ron Paul observes, the 20 year campaign of terrorist fighting and nation-building in Afghanistan had been counterproductive for years. Most people saw the writing on the wall.

The Trump administration seemed to understand this. Trump had begun the process of unwinding in-country military commitments but stopped short of complete withdrawal based on advice that it wasn't quite time to do so yet. 

Reports are circulating that the Biden Administration ignored similar advice. Rather than continuing a measured withdrawal, Biden decided to pull out cold turkey. Unfortunately, the political vacuum created by his hasty action has cost many lives, with more surely to come. It has also cost Biden a pile of political capital.

Which brings me to my main point. There was a time where I might have done things like Biden did here. I used to think that if I were in charge, then I would end every government-sponsored program--immediately. 

But now I know better.

When government intervenes anywhere--overseas in military ops such as Afghanistan, or in domestic affairs such as welfare and healthcare redistribution, it distorts human behavior and interaction. These distortions create dependencies and other commitments that cannot quickly be reversed should those interventionary policies no longer garner political support.

As Biden's actions have demonstrated, trying to reverse these dependencies quickly is likely to create considerable pain. Retrospectively, a more measured phase out may have been more sensible--and more humane. 

Biden might have told his administration, the media, and people in the US and Afghanistan, that the US would be out of Afghanistan in, say, two years. He could have demanded phased withdrawal plans from the military and other advisors in the early days of his administration, and then shared the plans with all stakeholders. Those plans could have included key dates, goals, measures of progress along the way.

And to be fair, Trump could have done the same thing.

Similar measured exits could be designed for every bloated government-sponsored program on the books. Social Security, Medicare, welfare, etc. For example, Social Security payments might be phased out over the course of four, eight, or ten years.

Do measured withdrawals from government programs cost more? Perhaps, but perhaps not given the potential cost associated with chaotic withdrawal. Is it possible that a measured withdrawal never happens--given the proclivity of institutionalized bureaucracies to stifle change? For sure. Will they be politically unpopular with large voting blocs that benefit from the largesse? Without question.

However, I can't help but think that the transparency of a well communicated gradual exit strategy executed by determined leadership would be an effective, and fair, way to back out of trillion$ in government largesse.

Let's also note this. If we don't proactively back out of commitments, particularly those with massively upside down economics, then market forces will do it for us at some point. And when they act, market forces are likely to do so quickly. 

Biden's handling of the Afghan situation therefore serves as a harbinger of the chaos likely to ensue in other domains if we do not learn from mistakes made here and initiate programs of measured reversal.

Better Balance

Miyagi: You remember lesson about balance?
Daniel LaRusso: Yeah.
Miyagi: Lesson not just karate only. Lesson for whole life. Whole life have balance...everything be better. Understand?
--The Karate Kid

As an investor, I used to bet on one macro scenario. Even if I reasoned that several outcomes were possible, I'd put all my chips on the one I thought most likely.

I've come to learn that isn't a good idea. My most likely scenario might not materialize. And even if it does, it might take much longer than expected. Meanwhile the underweighted scenarios dominate.

So now I spread it around. If I envision three possible scenarios, then I allocate capital more or less equally among those three. I might adjust them a bit based how I suspect things might unfold, but I retain material exposure to all of the possibilities.

Although I won't kill it if my preferred scenario happens to play out, my performance is more balanced.

I no longer worry about having to be exactly right in both direction and timing. And I sleep better.

Capex and Institutional Uncertainty

"Just one chance in a hundred to make one improvement in a hundred."
--Don Walling (Executive Suite)

Classic example of organizational response to institutional uncertainty. US Steel (X) decided to shelve a job creating plant expansion in the face of a hostile regulatory environment. Perhaps the company will play wait-and-see. Maybe it will pursue a similar project in a region of the world friendlier to capital investment. 

Of course, the project may be gone for good.

Any way you slice it, an opportunity for domestic productivity improvement has been squandered by a hostile regulatory regime.

Who Will Pay?

"I'm here for one reason and one reason alone. I'm here to guess what the music might do a week, a month, a year from now. That's it. Nothing more. And standing here tonight, I'm afraid that I don't...hear...a thing. Just...silence."
--John Tuld (Margin Call)

Judge Nap provides constitutional context for the federal government's spend now, pay later policies. This year the Feds have already spent $1.9 trillion in CV19 relief (although only a fraction of this spending actually went for relief. The Biden Administration is now proposing $2.3 trillion in infrastructure spending. Plus there is the annual $2 trillion in borrowing just to make ends meet.

The judge wonders who will pay for this? Corporate tax increases will be mean less workers with income to tax. This is on top of the unemployment from lockdown/shutdown policies. Moreover, the 'near certain' inflation that the judge (correctly, in my view) suggests is pending will raise borrowing costs. 

The tired old answer seems to be that future generations will be the one's paying for today's profligacy. 

However, if there are no savings/no capital for investment (how can there be when we owe?), then where will future incomes come from to pay the bills? 

Increasingly, my fear is that future generations will be paying for our mistakes by having to endure a massive depression that we designed just for them.

Degrowth

Christy Wills: Just tell me one more time what your solution is to this crisis.
Brantley Foster: We don't cut, we expand.
Sheila the waitress: I agree. Expansion is a positive reaction to the universe. While retraction, or cutting back, or pulling off...those are all negative forces.
--The Secret of My Success

Degrowth? I had never heard the term until a couple days ago. Degrowth is grounded in belief that economic growth and prosperity are central causes of environmental and social decline. Fixing the situation requires 'degrowth,' or curtailing industrial activity and consumer behavior--particularly w.r.t. to industries that employ fossil fuels.

Reasoning minds might have to read that a few times just to make sure they've accurately grasped the central propositions. As absurd as it is, the degrowth idea is organized enough to have its own website, and enough of a following to be discussed among the cosmopolitan intellectual set.

While the label may be new, degrowth is really just a brand of watermelon socialism. In order to save the planet from capitalism, central planning must be substituted for voluntary production and trade.

What is new is that COVID-19 lockdowns have provided a glimpse of what degrowth policy might look like in practice. Such a 'test-run' offers degrowth proponents an opportunity to observe just how far they might be able to push their policies on the public.

Of course, the poverty and all of its associated problems brought on by 'degrowth' will also vividly demonstrate to millions just wrong headed the idea is.

Poverty and Health

Mae Braddock: Howard's fever was getting worse and then Rosy started to sneeze.
Jim Braddock: Where are they, Mae?
Mae Braddock: Jim, we can't even keep them warm.
Jim Braddock: Where are the kids?
Mae Braddock: The boys will sleep on the sofa at my father's in Brooklyn. And Rosy will stay at my sister's. Jimmy, we can't keep them.
Jim Braddock: You don't make decisions about our children without me.
Mae Braddock: What if they really get sick? We already owe Dr McDonald...
--Cinderella Man

It does not take an 'expert' to understand that the most important factor in explaining collective health of a population is standard of living. Standard of living improves from voluntary production and trade (capitalism). As production and trade increase, more resources are generated that enable greater prosperity and healthier lifestyles.

Collective measures of health, such as average life expectancy, are strongly correlated to per capita income over time.

And, although I am not a researcher in the public health space, I'm certain that there voluminous studies that focus on the bottom end of the relationship--that people with lower incomes are generally less healthy. The higher the poverty level of a society, the lower the collective health.

One of the many ironies arising from the COVID situation is that leftists digging in their heels in favor of extended lockdowns--regulations that reduce prosperity because they restrict voluntary production and trade--are the same people who, at other times, claim that income redistribution policies are necessary to improve the health of the poor.

By extending lockdown periods, leftists are creating poverty that they claim to despise.

Today, the headline unemployment rate hit nearly 15%, while the U6 number (which includes discouraged workers) ticked 23%. These levels, which likely under-report true degree of unemployment, were last touched in the Great Depression.

US Unemployment Rate moves up to 14.7%.

The peak % in prior recessions...
2007-09: 10.0%
2001: 6.3%
1990-1991: 7.8%
1981-1982: 10.8%
1973-75: 9.0%
1969-70: 6.1%
1960-61: 7.1%
1957-58: 7.5%
1953-54: 6.1%
1948-49: 7.9% pic.twitter.com/5VuZB958WV

— Charlie Bilello (@charliebilello) May 8, 2020

The adverse effects associated with forcing (literally) people into conditions of economic weakness will surely dwarf the near term ill effects of the coronavirus itself.

Less Trade, Higher Prices

We stand to lose all time
A thousand answers by 
In our hand
--Yes

To answer your question, Liz, yes. Two natural forces in particular have been keeping price increases at bay over the past couple of decades--despite escalating inflationary policies of central banks seeking to do otherwise. One has been the broad integration of several powerful innovations, particularly with respect to info tech, into production processes. Small computers, the internet, wireless, et al have dramatically improved worker productivity. As output/hr goes up, there is downward pressure on prices.

For those who believe globalization has been a significant force bringing and keeping inflation down globally ... do you believe deglobalization could represent upside inflation risk (if not near-term, longer term)?

— Liz Ann Sonders (@LizAnnSonders) February 27, 2020

The second natural force has been expansion of global trade, which allows world economies to realize gains from specialized production. When division of labor increases, learning effects and lower switching costs boost productivity. When specialized producers exchange their output, those productivity gains are collectively shared. Those shared productivity gains exert downward pressure on prices.

Restraints on global trade, whether those restraints come from protectionist tariffs, bans to quell the spread of illness, or other sources, eliminate a big source of downward price pressure.

As such, a big wind in the face of aggressive central bankers seeking to 'create inflation' ceases to blow, and higher prices of goods and service become more likely.   

Uncertainty and Real Options

Can you see the real me?
Can you? Can you?
--The Who

Investment is the act of incurring immediate cost in expectation of future rewards. Investment decisions generally share three characteristics (Dixit & Pindyck, 1994). First, the investment is irreversible to some degree. Should you change your mind and want to unwind the investment, its initial cost cannot be completely recovered. It is at least partially sunk.

Second, the future rewards associated with the investment are uncertain. Alternative outcomes associated with higher or lower rewards might be identifiable, but the best you can do ex ante is estimate probabilities of those various alternatives to guide your decision.

Finally, latitude exists about when the decision can be made. You can postpone action to get more information in order to reduce--although never completely eliminate--uncertainty about the future.

The possibility of delaying an irreversible investment decision creates an option--i.e., the right, but not the obligation--to buy an asset at some future time. Analogous with options in financial assets, opportunities to acquire real assets under such flexible arrangements are sometimes called 'real options.'

Reference

Dixit, A.K. & Pindyck, R.S. (1994). Investment under uncertainty. Princeton, NJ: Princeton University Press.

Steeped in Aggression

All in all
It's just another brick in the wall
--Pink Floyd

Some claim that the current ESG movement, where investment decisions are being made according to the environmental, sustainability, and governance profiles of target corporations, is 'market driven.' After all, fund managers are allocating capital out of their own volition driven by their own ideals.

However, these ideals have not been formed freely. They flow from particular political ideologies. Government has funded programs that promote, for example, global warming and climate change, and public schools been indoctrinating young minds to these notions for years.

Because resources to fund these initiatives have been sourced from taxpayers, the ESG movement can be seen as an outcome stemming from another in a long line of government-sponsored propaganda campaigns. Rather than being peacefully driven, it is a movement steeped in aggression.

Interest Rate Decline

It's been such a long time
I think I should be going
And time doesn't wait for me
It keeps on rolling
--Boston

Interesting graph of interest rates over many centuries courtesy of Visual Capitalist. Obviously, the trend over the past eight centuries has been down.

Several theories are proposed to explain long term interest rate decline. Productivity growth should influence interest rates. As productivity increases, scarcity declines. More capital should be available to borrow, thereby lowering borrowing costs.

The article takes a different view, however. Focusing on the continued decline in rates over the past 30-40 yrs, the author proposes that lower productivity leads to less business investment and therefore less demand for capital. The opposite should be true. Lower productivity means that capital will be more scarce. Less supply means higher prices, all things equal.

The author also proposes aging demographics and slowing economic growth as driving rates lower recently. Of course, this does little to explain the longer term down trend, as there were many periods over the past few centuries where populations grew dramatically and economies boomed.

It is also noted that bond yields have been falling coincident with declining rates--as if bond yields are supposed to trend independent of interest rates. Let's clear up the confusion. Interest rates constitute a price--the price associated with borrowing money. Bonds are a vehicle for borrowing money. Bond 'yield' coincides with the borrowing price. The real news would be if interest rates and bond yields were not highly correlated.

What the article completely ignores is the work of central banks over the past 100+ years to interfere with the natural rate of interest. Slowdown in productivity growth should have caused rates to level out or perhaps to rise. However, central bank intervention has continued to force rates lower, thereby keeping the eight century downtrend in place.

If central banks lose control of rates, then they will surely rise and jeopardize the long term downtrend.

Fossil Fuel Fossils?

Here I am in silence
Looking 'round without a clue
I find myself alone again
All alone with you
--Information Society

Is it possible to find value in markets that mark all time highs seemingly every day? With thousands of stocks to choose from, it is likely that investors overlook some attractive names here and there--no matter how 'efficient' markets behave.

While diligent investors will likely stumble upon an attractive situation on occasion, it seems less probable that an entire sector remains undervalued after the run we've had. My sense, however, is that energy may offer an exception. This sector has under-performed now for some time.

I get the bear story. With green narratives and ESG (environmental, sustainable, governance) agendas echoing in fund managers heads, 'carbonated' energy producers' days are numbered. Fossil fuel makers are, well, fossils.

Perhaps, but even if the 'common wisdom' turns out to be true in this case, it will likely take decades to play out. Meanwhile, daily life demands energy of the old fashioned variety.

I like the integrated oils--particularly the two big US players, Exxon (XOM) and Chevron (CVX). Both have strong internal cultures and exemplary management. Because they are headquartered in the US, I can keep an eye on them and their operating/institutional environments far better than I can their international peers.

XOM appears to be resolving a near term triangle pattern to the downside (bearish) but as a long term investor this presents opportunity. Here is a company with a dominant worldwide production footprint with a capex plan to make it even larger, strong culture with a long track record of execution, and a 5% dividend yield.

CVX has a more benign technical pattern. Also well managed, CVX is dialing back on capex a bit after some big spending. The stocks yields just above 4% here.

I also view these names as inflation hedges in an environment that, increasingly, is being shaped by monetization policies of central banks.

Unloved, strong competitive positions, strong dividend yields, inflation hedge. I'm happy to take the other side of the fossil fuel fossil trade here.

position in CVX, XOM

Government and Prices

You could have a big dipper
Going up and down, around the bends
You could have a bumper car, bumping
This amusement never ends
--Peter Gabriel

Proposition 1: The more that an industry is regulated by government, the higher the prices of output produced by the industry.

Proposition 2: The more resources that an industry receives from government, the higher the prices of output produced by the industry.

Proposition 3: The more that an industry competes in markets unhampered by government intervention, the lower the prices of output produced by that industry.

Lower Corporate Taxes

Oh sweet freedom
Carry me along
We'll keep the spirit alive
On and on
--Michael McDonald

Many are waiting for record high profit margins of US corporations to revert back toward the mean. They might, but to the extent that lower corporate tax rates stay in place, the mean may be higher than before.

Global effective tax rates by S&P 500 sector (pre- and post-tax cut) pic.twitter.com/Y2qQb7vksz

— Liz Ann Sonders (@LizAnnSonders) January 7, 2020

This has been a big contribution of the Trump administration. Lower taxes (to any entity) increases freedom. Capital is freed for other endeavors that in the long run benefit standard of living.

Ideas Held Hostage

"Spread the word. Get on the wire to every squadron around the world. Tell them how to bring those sons of bitches down."--General William Gray

God made physical resources scarce. What isn't scarce is the creativity that springs forth from our minds. By combining those scarce resources with our abundant ideas we can alleviate some of that scarcity thru productivity improvement.

When we restrain ideas and our ability to use them in production, as we do thru 'intellectual property' laws, then we restrain prosperity.

When we hold ideas hostage, the world is a more barren place than it would be otherwise.

Fallacy of We

Leo Getz: You hungry? I'll call for anything you want. See this silk robe? Free.
Sgt Roger Murtaugh: It's not free. 
Leo Getz: Yes it is.
Sgt Roger Murtaugh: It's taxpayer's money.
Leo Getz: Same thing.
--Lethal Weapon 2

Article discusses the absurd claim that federal debt is not a problem because it is money that we owe to ourselves. The 'we owe it to ourselves' crowd argues that because government debt can be passed on to future generations, the debt can persist into perpetuity so long as people are willing to lend and government is able to service the debt. Moreover, because federal debt is owned by domestic citizens, the money used to repay debt doesn't leave the economy.

But, as the article points out, about 1/3 of federal debt is in fact owned by outsiders. In other words, we don't owe a substantial portion of federal debt to ourselves. We owe it to others.

A larger problem can be called 'the fallacy of us, we, and our.'  Individuals lend and borrow, not collectives. Individuals who incur federal debt are different from individuals who bear the burden of repaying the debt. The beneficiaries are people today who enjoy the borrowed funds and what they can purchase. However, future taxpayers are hurt, as they must repay the debt borrowed by previous generations.

However, the most fundamental problem is one not directly addressed in the article. Government debt constitutes borrowing by force. Sovereign debt is a contract between governments and private lenders with the promise that bond principal and interest will be repaid by citizens under threat of force. Confiscating economic resources by force distorts how those resources would have been allocated by individuals engaging freely in production and trade.

Moreover, when government knows that it can take resources at gunpoint, it will surely 'borrow' more, which leads to lower saving and, ultimately, to capital consumption over time.

The result is fewer resources available for investment and productivity improvement down the road. Prosperity, consequently, is restrained.

Decline in Job Quality

Hey, I'm not complaining
'Cause I really need the work
Hitting up my buddy's 
Got me feeling like a jerk
--Huey Lewis & The News

Article indicates that, while unemployment is near record lows, quality of work has been declining. The Job Quality Index, a product of Cornell Law School, factors in hourly wage growth, hours worked (higher deemed better), labor force participation rate, and rates of core economic growth to reflect to find a ratio of 'high quality' to 'low quality' jobs. A number less than 100 indicates more low quality jobs.

Notice that the index has been trending down since its inception in 1991. Why might this be? The best jobs come from capital investment. But real capital investment has been dwindling as savings have declined. We are now engaging in capital consumption. High quality jobs are unlikely when there is little real capital to create them.

Until we borrow less and save more, job quality should continue to deteriorate.