A Tad More Mulder

Yesterday, we claimed to be feeling more-Scully-than-Mulder about Obamanomics following his weekend speech. In fact, we felt that the likelihood of a significant market rally had been taken off the table — wrong! Today, after hearing the appointments to Obama’s economic team, and some positive leaks regarding his plans for taxes, we feel a bit better (equity markets have been feeling better since Friday afternoon, though we suspect that much of today’s rally was due to the government’s announced rescue of Citi). We’re not raging bulls on the economy or the stock market, but today’s developments indicate that things could turn out ‘less bad’ than markets feared as recently as last week. From an AP summary (underlining added):

At the news conference, he said he wanted to create 2.5 million jobs by the end of 2010. He also said he wants the legislation to incorporate his campaign ideas for new jobs in environmentally friendly technologies — the "green economy."

As a candidate, Obama also said he wanted to eliminate Bush-era tax cuts on the wealthy. Many economists caution that raising taxes can make a recession worse, and the president-elect said he would await a recommendation from his advisers on whether to follow through on his earlier pledge.

If his "green economy" plank is incorporated into an overall economic recovery plan without dictating terms, that’s positive. And if the worst that he does on taxes is allow some of the Bush rates to expire as scheduled, that’s not as bad as it could have been; it’s also an outcome that has probably been discounted in the markets for some time, ever since it became clear that the Democrats were likely to control Congress and the Executive branch. 

The AP article continues: 

…there were no plans to balance the tax cuts with an immediate tax increase on the wealthy. During the campaign, Obama said he would pay for increased tax relief by raising taxes on people making more than $250,000.

"There won’t be any tax increases in the January package," said one Obama aide, who spoke on condition of anonymity because the details of the Obama package have not been fleshed out.

Obama could delay any tax increase to 2011, when current Bush administration tax cuts expire.

That’s an important leak, and hopefully it will prove true. Obama also appointed Berkely economist Christina Romer to chair of the President’s Council of Economic Advisers. She and her husband David have done some very important empirical work on taxes and economic performance, and she could be the most bullish CEA chair for financial markets and the economy since Glenn Hubbard circa 2003. Overall, Obama’s economic appointments — Geithner, Romer, Larry Summers, and Melody Barnes — are all left leaning, but reasonably diverse in their views. How much influence Romer will have in shaping tax policy is unclear, but at the very least, the new President will have a voice of reason in his cabinet when it comes to tax policy. Her presence might also improve the odds of positive corporate tax reform, which would be very positive for U.S. financial markets and — if well designed — domestic employment. It’s too early to know, and the sausage making is just getting started, but we’ll be keeping our ear to the ground.

In the meantime, if you own an S&P 500 index fund, it’s worth roughly 13% more than it was at mid day on Friday. Enjoy it. The economy still stinks, credit growth is moribund and will be for some time, and there’s plenty of economic pain still to come. But today it looks like we’re in for less pain than seemed likely just a few days ago, and in the cold, harsh world of financial markets, less pain is seen as a good thing.

URLs:

http://www.symmetrycapital.net/newsandviews/newsandviews/2008112443.html 

http://news.yahoo.com/s/ap/20081124/ap_on_go_pr_wh/obama_economy 

Bullish Developments in the Beltway?

I’ll preface this post with an admission that the economy is not going to suddenly turn the corner  as a result of the following developments. There’s still massive deleveraging and rising unemployment ahead. But there are some interesting political news bites relating to Congress over the past week that maybe — just maybe — signify a marginally better future for the performance and value of financial assets in the year ahead.

First, House Speaker Pelosi recently talked about enacting permanent tax cuts, preferably before the end of the current session. We suspect that the cuts she has in mind, which sound like lower payroll tax withholding for certain income levels, are simply another way to reallocate the burden of social security and FICA taxes, similar to President-elect Obama’s proposed ‘tax cuts’. While fairness and distribution are legitimate issues in taxation, the productive incentives of such a move would be minimal. On the other hand, her proposal does sound more immediate and efficient than the tax rebates of 2008.

Second, it’s rumored that Sen. Clinton may seek to wrest the role of Senate Majority Leader from Sen. Harry Reid. That could be bullish, as Sen. Clinton strikes us as more of a centralist on economic issues, and is rumored to be open to the idea that our corporate tax code is increasingly uncompetitive (despite her red meat rhetoric of the primary season). And if the WSJ op-ed page is correct in its assertion that PAYGO rules will be suspended (if not forgotten) in the next Congress, it will give pro-growth policies a better chance of passing — albeit at the risk of worsening public finances.

Third, the WSJ editorial staff has endorsed Rep. Paul Ryan as House Minority Leader which, although unlikely to happen, is encouraging because we feel that Ryan is a critically important and literate voice regarding the long term fiscal and economic policy challenges facing the country. It’s also likely that Rep. Eric Cantor, who authored a 2008 bill to lower corporate tax rates, will step into the Minority Whip post which Roy Blount vacated last week.

It also seems to us that President-elect Obama may be more flexible than Presidents Clinton and Carter were, and that the corporate tax issue could thus get some traction, perhaps sooner than thought. It might be wishful thinking, but it wouldn’t surprise us. He’s clearly been able to assess and assimilate differing viewpoints on important issues. And on a related note, the WSJ reported this weekend that John Rogers of Ariel Capital Management, who played a key role in Sen. Obama’s presidential campaign, is expected to be a behind-the-scenes advisor to the new president. We were surprised that the WSJ described Rogers as an "obscure money manager" — he’s a fairly well known value investor, and a smart guy — and it’s encouraging to see him playing a role.

Attention to the corporate tax code — as long as it’s not reminiscent of Rep. Rangel’s harmful utterances of 2007-2008 — would be bullish for asset values. Although again, fiscal prudence shouldn’t be left by the wayside, and the inevitable compromises must be well thought out and designed — in fact, tax cutting in general needs to be better designed than it has been in the past.

URLs:

http://online.wsj.com/article/SB122600310456906045.html?mod=googlenews_wsj 

http://www.clusterstock.com/2008/11/fear-of-a-hillary-coup 

http://online.wsj.com/article/SB122628143512612399.html 

http://cantor.house.gov/061208.htm 

http://online.wsj.com/article/SB122610559597910247.html 

China, Interest Rates, Commodities

China has unveiled a massive fiscal stimulus plan that, according to the WSJ, "includes spending in housing, infrastructure, agriculture, health care and social welfare, and…a tax deduction for capital spending by companies." The plan, at $586B, would equal 16% of China’s output in the prior year; for comparison, the previous U.S. package of $168B was about 1% of last year’s output (though it leaves out the much larger funds being made available through Treasury’s TARP and other programs).

This raises some important questions about long term interest rates, commodity prices, and inflation. First, it is likely to mean lower demand for U.S. Treasury debt, and (perhaps) selling of existing Treasury debt, both of which would raise interest rates, all else equal. As Tony Crescenzi of Miller Tabak put it:

China’s need for money will collide with the ramp up of U.S. borrowing, expected to be between $1.5 trillion and $2.0 trillion because of the massive U.S. budget deficit. This brings back the larger question which I would call the question of our age: Can the U.S. borrow its way out of a debt problem…?

Another concern is the impact that these moves could have on commodity prices, given the Federal Reserve’s extremely easy stance at the moment. As the WSJ points out, Beijing feels it needs at least 8% growth in GDP to maintain social and political stability; with the U.S. economy likely contracting, what appears to be a sensible monetary policy at home could end up financing inflationary pressures abroad, causing commodity prices to resume their upward climb, and creating renewed inflationary pressures here at home in 2009. News of rapid commodity ’supply destruction’ in the wake of this summer’s demand destruction and the global credit contraction seems to support this possibility. Such an outcome would line up well with our thesis that the current decade is very similar to the 1970s. While we we admit that there are shades of the early 1980s and even the early 1930s, we believe this is a result of the massive financial leverage that was carried into this slowdown. More importantly, we still believe that the risk of long term inflation is more significant than is widely believed. Consider that several of the world’s most important countries (China, Japan, and Germany according to the WSJ), with historically high savings rates, are now embarking on programs that entail significant dissaving. The U.S. is doing the same thing, but lacks the domestic savings base (and rate) of those countries. And if the interplay between monetary and fiscal policies diminishes incentives to save at the margin, as we expect, then at some point central banks will simply end up monetizing a significant portion of public and/or private debt, a measure that is inevitably inflationary and has negative impacts on standards of living. 

There is a scenario that could prove us wrong, however, and it would arise if ‘fiscal stimulus’ becomes analogous to trade barriers in the 1930s. In that respect, it’s somewhat disconcerting that both China and the U.S. are considering stimulus measures that are largely inward looking.

Another anti-inflationary scenario would be that key central banks, including the Fed, enact policy measures that prevent ‘inflating away’ the value of public or private debt, much as Paul Volcker did in the early 1980s. We think the probability of this is virtually nil, as people and politicians simply don’t seem to have the stomach for it. However, if countries enacted fiscal, trade, and regulatory policies designed to incentivize productive and lasting investment, employment, and output, then anti-inflationary measures would be a much more palatable prescription. As we wrote in September, it’s all about the policy mix. 

URLs:

http://online.wsj.com/article/SB122623724868611327.html?mod=testMod 

http://www.symmetrycapital.net/idlespeculation/20080925_policy_mix.pdf