Relevant and even prescient commentary on news, politics and the economy.

7 years of the stock market

Earlier today Cactus posted on the real Dow over the past seven years.

Another comparison is to look at the alternative strategy, investing in cash or 3 month T bill.

If in January, 2001 you had placed your investments in 3 month T bills and reinvested the income in 3 month T bills, at the end of December, 2007 your total returns would have been
almost exactly the same as if you had invested in the S&P 500 with daily dividend reinvestment.
Way to go team Bush.

P.S. In looking at the current stock market and listening to strategist this chart is an important lesson to think about. You will hear from Wall Street analysts that if you do not go back into the market and miss the first leg off the bottom you are missing a great opportunity. Of course they are right. But if you miss that first bounce off the bottom and wait to go back into the market as long as you return while the market is below the cash line you are still better off than if you rode the market down and back up.

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The Fed and Elections

We are already starting to hear discussion about the point that this is an election year will influence Fed policy –either to ease or tighten more then it should because of the election.

The historic record is clearly that in election year the Fed does what economic fundamentals call for it to do and that the fact that it is an election year has no significant impact on Fed policy.

The chart compares actual fed funds with my version of the Taylor rule that gives inflation and unemployment equal weight. The vertical grey lines are Presidential elections. It shows that there is no significant difference between actual fed funds and the policy index in the period leading up to elections — if rising inflation calls for higher rates the Fed tightens or if economic weakness or a rising unemployment rate calls for lower rates it eases.

The historic record clearly demonstrates that Fed policy has not been influenced by elections beyond the standard belief that the Fed tried to avoid reversing policy in the last few weeks before presidential elections. Even under Volcker when actual fed funds were substantially above the policy index the direction of changes in actual fed funds was what the policy index implied it should be.

Yes, the recent jump in headline inflation implies that the Fed should not be easing now.

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In the previous OldVet comments I talked about the relationship between interest rates and the stock market. I just though I would but up one example of what I was talking about. Note how the fitted value has started rising in recent months but the market Pe has not moved up yet.



We’re starting to see a new campaign by the Republicans about a cut in the corporate tax rates.

There is a good case to be made for corporate tax cuts. This is especially true if the objective is to increase business fixed investment. After all corporations account for over 80% of business fixed investment as compared to only about 11% by partnerships, S-corps, etc that are subject to the individual tax code. ( non-profits account for the remainder) If you want to stimulate capital spending you should give the money to the economic sector that actually does the investments. But this is also the problem with the standard supply side argument that cutting taxes at the individual level really does not give you much bang for the buck.

In todays world of international competition there is also the problem of international competition to consider. For example KPMG did a big study of this last year that is getting a lot of attention. That study had this chart that compared US corporate tax rates to comparable tax rates in other countries.

You can find the study at:

The study shows that other countries have been lowering rates while the US rate has remained at 40%. They argue that the US needs to lower corporate rates to offset other countries cutting taxes to below the US rate.

But the problem with this comparison is that the US corporate tax rate is not really 40%. The
effective US corporate tax rate is really only 25%.

The US has a long record of cutting the effective tax rate and it is now only half of what it was in 1950.

My question is why do they have to be so dishonest about it? There is a valid argument for lower corporate taxes. Why do they feel they have to publish studies that are so fundamentally biased that if people knew the facts it would undercut their argument. I guess they have such a low opinion of the business press and other newspaper reporters that they are confident that reporters will never fact check the study.

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Some quick comments on the employment report.

Does not look good. I’m starting to have doubts about my forecast that we are just sliding into a stagnation, not a recession scenario. The household survey look especially worrisome.

But the hours worked data is not as weak. December hours worked were unchanged. The 4th quarter hours worked data is up at a 1.1% rate, about the same as the third quarter. It still implies that the second and third quarter rebound in productivity growth is probably continuing.

The new factor is weakness in finance. Employment growth in that sector just turned negative
and it will almost certainly remain negative for some time.

Finance employment is now about 6% of payroll employment as compared to about 10% for
manufacturing employment. But finance is a high wage area — average hourly earnings in fiance is $19.89 as compared to $17.66 for total private average hourly earnings. This has negative consequences for income and spending growth.

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5% unemployment rate

WOW — in seven year team Bush managed to raise the unemployment rate from under 4% when they took office to 5%.

Way to go team Bush!!

P.S. Note that in modern times only one Republican President managed to leave office with a lower unemployment rate then they inherited. Every Democratic President achieved this feat.

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Outsourcing – This takes outsourcing to a new level….

I was depressed last night so I called Lifeline. Got a call center in Pakistan. I told them I was suicidal.

They got all excited and asked if I could drive a truck.

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Oil Price

The price of oil touched $100 today.

The new record is being accompanied by all kinds of analysis and comments relating this new record to developments in the US economy.

But, US real oil imports, including both crude and refined products have been flat to down since early in the decade.

Looking at it from the OPEC and other international suppliers of oil, US imports represent US oil demand. This chart clearly shows that the run up in oil prices to $100 had little or nothing to do with demand from the US. The rise in oil prices is being driven by demand from the rest of the world like China and India.

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Wal-Mart and Disaster Supplies

A few days ago I commented on an article about how Wal-Mart provides emergency supplies to disaster areas at their regular everyday low prices. I pointed out that libertarians like those at Café Hayek should note these developments and see that some guy in the back of a pick-up truck selling supplies at high prices was not the only way to provide disaster victims additional supplies.

Russ Roberts took exception to what I said and we went though a long discussion of it over at his blog. He started out claiming that Wal-Mart had to face higher costs because of the higher cost of carrying inventories. He finally conceded that my explanation of how Wal-Mart had revolutionized inventory management and that when you looked at how the computer revolution had altered the way big-box retailers managed inventories that I was right in arguing that the cost of inventory management did not mean that Wal-Mart had to charge higher prices.

But he was still unwilling to concede that Wal-Mart did not have to raise prices, claiming that this is what theory shows and we have a long history of the world working this way.

I think the difference stems from the way academic economist view supply curves. They look at supply – demand diagrams and see supply curves as continuous curves rising from the lower left to the upper right of the diagram. It is a beautiful theory and is a great tool for explaining to students how the system works in the long run, especially when suppliers have to create new capacity to increase supply. Moreover, continuous curves are required to do the advance math modern academic economist do. So someone seeped in this methodology obviously and correctly believes that higher prices are needed to attract additional supply. If this is always true the guy in his pick up truck charging storm victims very high prices is doing a good thing.

But in the real world in the short to intermediate run supply curve are not always continuous curves sloping from the lower left to the upper right – especially in the short run. In the short run most industries do not operate a full capacity and do not have to bring new capacity on line to increase supply – they normally have excess capacity.

Because of this most businesses in the US economy typically operate on some form of posted price approach. For example if you want to buy a pizza you call the pizza shop and they tell you the price of a pizza is $10. Moreover, the price will be $10 per pizza if you want to buy one pizza or ten pizzas or anything in between . Over this portion of the supply curve it is flat, it is not a continuous curve with an upward slope. If you said to the pizza owner next Wednesday I am having a kids party and want 20 pizzas delivered at three in the afternoon, what kind of a discount would you give me. The owner would think, at that time most of my ovens are sitting unused and my employees are idle. So sure, I’ll give you a discount and sell you 20 pizzas at $8 each. Just don’t try this for the pizzas to be delivered at half-time of the Super Bowl. Actually, if might even work then because Super Bowl Sunday is one of the worse days of the year for restaurants. But anyway, what we have here is a supply curve that actually slopes downward over portions of the curve.

Think of the typical small retailer. They look at the catalog or price list the vendor provides and finds that if they want one or two cases of something the price is set at one level. But normally, if they buys 20 or thirty cases they will get a volume discount. So again, we typically have a supply curve that over certain portions of the curve actually slopes downward. It is not a continuous curve with a constant upward slope.

Imagine you are the regional manager for Wal-Mart and as you do your planning you estimate that next year you should sell 1,000 crates of six-ounce bottled water each week. So you go to the manufacturer and negotiate a contract. But you do not negotiate a contract to buy 1,000 bottles a week. What you do is negotiate a contract with minimum and maximums. You commit to buying at least 800 bottles per week and up to potentially 1,200 bottles per week at the agreed on price. The contract provides a great deal of detail about exact specifications and how the contract can be changed. But it will also call on Wal-Mart to tell the bottler each Tuesday how many bottles from 800 to 1,200 they want next week and calls for them to ship about 20% of the order each day from Monday to Friday. The manufacturer now has several days to arrange his supplies and production schedule. Wal-Mart is not the vendors only customer and typically Wal-Mart will buy from multiple vendors. So it is a good deal for both. But it means that between a volume of 800 to 1,200 bottles a week Wal-Mart faces a flat supply curve. It is not upward sloping.

If you are a academic economist and long accustomed to thinking about supply curves having a continuous upward slope and you see that a natural disaster creates a temporary surge in the demand for bottled water at some location it is perfectly natural to apply your theory and believe that it will take higher prices to attract the additional supply. The big retail chains like Wal-Mart, Home Depot, 7-11, CVS Drug, etc, sell several hundred thousand bottles of water around the country every day and they each have contracts similar to the one Wal-Mart has with bottled water manufacturers . Compared to this total national supply the few thousand bottles needed at a natural disaster site is insignificant. And the amount the proverbial guy in the pick-up truck could supply is infinitesimal . It is very easy for big-box retailers to redirect a small portion of their supply and remain well within their existing contracts where they face a flat supply curve.

When you look at the world like this and realize that supply curves can be flat or actually downward sloping over certain portions of the curve it is very easy to understand why and how modern retailers can quickly increase supplies to a disaster area at regular every day low prices. This does not mean there is anything wrong with the economic theory. It is a good first approximation of how the world works. In the next year if Wal-Mart wanted to sell 1,500 six ounce bottles of water rather then 1,000 bottles the theory based on an continuously upward sloping supply curves should work very well.

Well, maybe not. Ever year since 1992, retailers like Wal-Mart, Home Depot, etc, have actually experienced deflation. The deflator for GAO type products – think department store products or roughly what Wal-Mart sells – has been falling at a 2% to 3% annual rate every year since 1992 . So actually, there is a very good chance that the per bottle price for 1,500 bottles of water may be cheaper next year. So even the long run supply curve may be downward sloping.

So what evidence do I have that this is the way the world works? Experience is the best evidence I have. But there is also a body of research that finds that most firms tend to change prices only once a year. Firms do work on a posted and/or contract price approach and find that in a low inflation world it does not pay to frequently change prices. Most firms have the flexibility built into their systems to moderately change their supplies in the short to intermediate run without changing prices. In the short run the overwhelming bulk of the items sold and the vast majority of firms in the US economy face a flat supply curve. This is not inconsistent with economic theory. Upward sloping supply curves are a long run phenomenon, not a short run phenomenon.

So I will stick with my argument that modern retail chains like Wal-Mart can and do quickly and easily provide extra supplies to disaster areas at regular every day low prices. Consequently, the proverbial guy in his pick-up truck charging the victims higher prices is not doing them a favor. Academics teaching this to college undergraduates are teaching both bad economics and bad morality.

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Jarad Berstein at just reported that the

The Congressional Budget Office (CBO) just updated their invaluable data series on income inequality.

In looking at them I came up with a couple of very interesting charts.

In recent years there has been one big factor in this redistribution of income that
has not been discussed much. That is the massive increase in profits share of GDP
that happened this cycle.

The primary factor behind this large increase in profits has been firms ability to
capture the large productivity gains this cycle in higher profit margins rather
than in labor compensation.

Standard economic theory says this large gain in profits should be reflected in higher
savings and/or higher capital spending. But we have not seen either response.
However, the much higher income inequality and large cyclical increase in profits
have generated somewhat higher tax receipts than we had at the bottom of the cycle.
So through these mechanisms we do seem to be getting something of a supply side
impact on tax receipts, but given these other developments it is amazingly small.

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