The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

University of Chicago Behavioral Economist Richard Thaler drops some hard analysis on the tax-cut-at-any-price crowd in his NYT column this week:

“Want to give affluent households a present worth $700 billion over the next decade? In a period of high unemployment and fiscal austerity, this idea may seem laughable. Amazingly, though, it is getting traction in Washington.

I am referring, of course, to the current debate about whether to extend all, or just some, of the tax cuts of President George W. Bush — cuts that are due to expire at year-end. They’re expiring because the only way they could be enacted initially was by pretending that they were temporary.

In this situation, it’s not clear what should be called a tax “cut.” If the temporary law is allowed to expire as planned, does that represent a return to normal, or a tax increase? Conversely, if some parts of the current rates are extended, should those count as a tax cut?

Psychologists call these descriptive choices “framing.” No one is proposing that tax rates be lower than they are now, so the question is whether some people should pay more, and, if so, who.”

The rest of the column is well worth reading. Warning: Many of you will not be happy with what he says (but I think his math is spot on) . . .

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Source:
What the Rich Don’t Need
RICHARD H. THALER
NYT, September 25, 2010
http://www.nytimes.com/2010/09/26/business/26view.html

James Randi is a leader in the skeptical community who has been debunking paranormal and supernatural claims for most of his life. A magician himself James Randi is excellent at exposing the frauds that make up the paranormal and psychic communities. He offers a one million prize to anyone who can prove a paranormal claim scientifically and to this day nobody has won the money. Sylvia Browne has been ducking him for quite some time.

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Michael Steinhardt was one of the most successful hedge fund managers of all time. A dollar invested with Steinhardt Partners LP in 1967 was worth $481 when Steinhardt retired in 1995.

The following six rules were pulled out from a speech he gave:

1. Make all your mistakes early in life: The more tough lessons you learn early on, the fewer (bigger) errors you make later. A common mistake of all young investors is to be too trusting with brokers, analysts, and newsletters who are trying to sell you something.

2. Always make your living doing something you enjoy: Devote your full intensity for success over the long-term.

3. Be intellectually competitive: Do constant research on subjects that make you money. Plow through the data so as to be able to sense a major change coming in the macro situation.

4. Make good decisions even with incomplete information: Investors never have all the data they need before they put their money at risk. Investing is all about decision-making with imperfect information. You will never have all the info you need. What matters is what you do with the information you have. Do your homework and focus on the facts that matter most in any investing situation.

5. Always trust your intuition:  Intuition is more than just a hunch — it resembles a hidden supercomputer in the mind that you’re not even aware is there. It can help you do the right thing at the right time if you give it a chance. Over time, your own trading experience will help develop your intuition so that major pitfalls can be avoided.

6. Don’t make small investments: You only have so much time and energy so when you put your money in play. So, if you’re going to put money at risk, make sure the reward is high enough to justify it.

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This report was originally published by The Kirk Report on June 2, 2004.

Pushing on a String
September 24, 2010
By John Mauldin

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Pushing on a String
Let’s Shift the Focus
An Invitation to an Inflation Party
Ten Years and Counting

This week the Fed altered their end-of-meeting statement by just a few words, but those words have a lot of meaning. It seems they are paving the way to a new round of quantitative easing (QE2), if in their opinion the situation warrants it. A trillion dollars of new money could soon be injected into the system. Tonight we explore some of the implications of a new round of QE. Let’s put our speculation hats on, gentle reader, as we are moving into uncharted territory. There are no maps, just theories, and they don’t all agree. (Note: this letter may print a little long, as there are a lot of charts.)

But first, as a reminder, next Wednesday, September 29 (9:00 AM PST/12:00 PM EST), I will be doing a special “webinar” with Jon Sundt, President & CEO of Altegris Investments, where we’ll discuss the forces that are shaping today’s economy and their potential influence on financial markets (the very things I write about in this week’s letter and in my new book!). This is an excellent opportunity to learn about alternative investment strategies designed to provide noncorrelated diversification for your investment portfolio in the “new normal” economy. We’ll set aside a lot of time to answer your questions.

A replay of the call will be available for two weeks starting Thursday, September 30, for . Even if you can’t make it at this specific time, I recommend you still register so you can listen to the replay at your convenience after the event.

You can register by going to www.accreditedinvestor.ws and signing up for my free accredited letter, and a representative from Altegris will call you to give you the details. Sadly, this is available only to accredited investors ($1.5 million net worth and up) and/or registered financial professionals, due to current regulations. I will be giving a preview of the conclusions from my new book, The End Game, which I think you will find interesting. (In this regard, I am president and a registered representative of Millennium Wave Securities, LLC, member FINRA.)

Let’s Shift the Focus

The Fed issued the usual statement at the end of their meeting this week, and Fed watchers poured over the words, looking carefully for any sign of change in Fed policy. The consensus seems to be that the most important change was the statement concerning inflation, the first such change in over a year.

“Measures of inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.”

The next (and only other real) change was:

“The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if neededto support the economic recovery and to return inflation, over time, to levels consistent with its mandate.” (my emphasis)

Translation: inflation may be getting too low, but don’t worry, we are on the job.

One of my laugh lines in my speeches (I don’t have that many) is: “When you are appointed to the Federal Reserve they take you into a back room and do a DNA change on you. After that, you are viscerally and genetically opposed to deflation.”

Bernanke made his famous helicopter speech about not allowing deflation to happen back in 2002. He happily assured us that the Fed has many tools to fight deflation and that it won’t happen here. Of course, he also told us the subprime problem would be contained, but I am sure that we have to give him a bit of slack – we all miss a few, including your humble analyst. (Well, I didn’t miss the subprime thingie. Nailed that one.)

Anyway, the Fed seems to be setting us up for another round of quantitative easing. That is Fed speak for buying a few trillion or so dollars of government debt and injecting said cash into the economy.

Before we get into the wisdom of such a move, let’s look at what might prompt them to do so. This is where we get into speculation.

Recessions are by definition deflationary, but if we go into recession when inflation is already as low as it is, the Fed will be behind the curve. But telling us they are going to start easing because they are worried about a recession is not a good recipe for a positive market reaction.

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Bruce Bartlett takes issue with the all-tax-cuts-all-the-time wing of the GOP.

He argues essentially that Reagan was a good Keynsian, passing huge tax cuts during a recession, then taking (half of) them back as the economy expanded:

“It may come as a surprise to some people that once upon a time in the not-too-distant past Republicans actually cared enough about budget deficits that they thought raising taxes was necessary to bring them down. Today, Republicans believe that deficits are nothing more than something to ignore when they are in power and to bludgeon Democrats with when they are out of power.”

Here is his chart of Reagan era tax revenue and costs; Turns out RR was only one half Supply Sider — he was also one half Keynseian, taking back almost 50% of the tax cuts during an expansion:

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Legislated Tax Changes by Ronald Reagan as of 1988

Source: Office of Management and Budget, Budget of the United States Government, Fiscal Year 1990 (Washington: U.S. Government Printing Office, 1989), p. 4-4.

From Bruce Bartlett's blog

via boingboing

For some perspective on the Great Recession, the chart of the day (below) illustrates the duration of all US recessions since 1900. There are a couple points of interest.

Of the 22 recessions that occurred over the past 110 years, the most recent recession is tied for fifth in terms of duration. It is also worth noting that the recession just passed was above average in duration and the longest since the Great Depression.

Chairman Ben S. Bernanke
At the Conference Co-sponsored by the Center for Economic Policy Studies and the Bendheim Center for Finance, Princeton University, Princeton, New Jersey
September 24, 2010

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Implications of the Financial Crisis for Economics

Thank you for giving me this opportunity to return to Princeton. It is good to be able to catch up with old friends and colleagues and to see both the changes and the continuities on campus. I am particularly pleased to see that the Bendheim Center for Finance is thriving. When my colleagues and I founded the center a decade ago, we intended it to be a place where students would learn about not only the technicalities of modern financial theory and practice but also about the broader economic context of financial activities. Recent events have made clear that understanding the role of financial markets and institutions in the economy, and of the effects of economic developments on finance, is more important than ever.

The financial crisis that began more than three years ago has indeed proved to be among the most difficult challenges for economic policymakers since the Great Depression. The policy response to this challenge has included important successes, most notably the concerted international effort to stabilize the global financial system after the crisis reached its worst point in the fall of 2008. For its part, the Federal Reserve worked closely with other policymakers, both domestically and internationally, to help develop the collective response to the crisis, and it played a key role in that response by providing backstop liquidity to a range of financial institutions as needed to stem the panic. The Fed also developed special lending facilities that helped to restore normal functioning to critical financial markets, including the commercial paper market and the market for asset-backed securities; led the bank stress tests in the spring of 2009 that significantly improved confidence in the U.S. banking system; and, in the area of monetary policy, took aggressive and innovative actions that helped to stabilize the economy and lay the groundwork for recovery.

Despite these and other policy successes, the episode as a whole has not been kind to the reputation of economic and economists, and understandably so. Almost universally, economists failed to predict the nature, timing, or severity of the crisis; and those few who issued early warnings generally identified only isolated weaknesses in the system, not anything approaching the full set of complex linkages and mechanisms that amplified the initial shocks and ultimately resulted in a devastating global crisis and recession. Moreover, although financial markets are for the most part functioning normally now, a concerted policy effort has so far not produced an economic recovery of sufficient vigor to significantly reduce the high level of unemployment. As a result of these developments, some observers have suggested the need for an overhaul of economics as a discipline, arguing that much of the research in macroeconomics and finance in recent decades has been of little value or even counterproductive.

Although economists have much to learn from this crisis, as I will discuss, I think that calls for a radical reworking of the field go too far. In particular, it seems to me that current critiques of economics sometimes conflate three overlapping yet separate enterprises, which, for the purposes of my remarks today, I will call economic science, economic engineering, and economic management. Economic science concerns itself primarily with theoretical and empirical generalizations about the behavior of individuals, institutions, markets, and national economies. Most academic research falls in this category. Economic engineering is about the design and analysis of frameworks for achieving specific economic objectives. Examples of such frameworks are the risk-management systems of financial institutions and the financial regulatory systems of the United States and other countries. Economic management involves the operation of economic frameworks in real time–for example, in the private sector, the management of complex financial institutions or, in the public sector, the day-to-day supervision of those institutions.

As you may have already guessed, my terminology is intended to invoke a loose analogy with science and engineering. Underpinning any practical scientific or engineering endeavor, such as a moon shot, a heart transplant, or the construction of a skyscraper are: first, fundamental scientific knowledge; second, principles of design and engineering, derived from experience and the application of fundamental knowledge; and third, the management of the particular endeavor, often including the coordination of the efforts of many people in a complex enterprise while dealing with myriad uncertainties. Success in any practical undertaking requires all three components. For example, the fight to control AIDS requires scientific knowledge about the causes and mechanisms of the disease (the scientific component), the development of medical technologies and public health strategies (the engineering applications), and the implementation of those technologies and strategies in specific communities and for individual patients (the management aspect). Twenty years ago, AIDS mortality rates mostly reflected gaps in scientific understanding and in the design of drugs and treatment technologies; today, the problem is more likely to be a lack of funding or trained personnel to carry out programs or to apply treatments.

With that taxonomy in hand, I would argue that the recent financial crisis was more a failure of economic engineering and economic management than of what I have called economic science. The economic engineering problems were reflected in a number of structural weaknesses in our financial system. In the private sector, these weaknesses included inadequate risk-measurement and risk-management systems at many financial firms as well as shortcomings in some firms’ business models, such as overreliance on unstable short-term funding and excessive leverage. In the public sector, gaps and blind spots in the financial regulatory structures of the United States and most other countries proved particularly damaging. These regulatory structures were designed for earlier eras and did not adequately adapt to rapid change and innovation in the financial sector, such as the increasing financial intermediation taking place outside of regulated depository institutions through the so-called shadow banking system. In the realm of economic management, the leaders of financial firms, market participants, and government policymakers either did not recognize important structural problems and emerging risks or, when they identified them, did not respond sufficiently quickly or forcefully to address them. Shortcomings of what I have called economic science, in contrast, were for the most part less central to the crisis; indeed, although the great majority of economists did not foresee the near-collapse of the financial system, economic analysis has proven and will continue to prove critical in understanding the crisis, in developing policies to contain it, and in designing longer-term solutions to prevent its recurrence.

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I love that he lifted RSI’s animated approach:

Beginning with Charles Darwin’s first encounter with the teeming ecosystem of the coral reef and drawing connections to the intellectual hyperproductivity of modern megacities and to the instant success of YouTube, Johnson shows us that the question we need to ask is, What kind of environment fosters the development of good ideas? His answers are never less than revelatory, convincing, and inspiring as Johnson identifies the seven key principles to the genesis of such ideas, and traces them across time and disciplines.