Phisix: The Implication of the US Boom Bust Cycle

We are big fans of fear, and in investing, it is clearly better to be scared than sorry. -Seth Klarman

Stock markets of the US and select developed countries continue with its melt-UP record smashing breakout streak.

This week, the Dow Industrials (not in chart) climbed 1.1% approaching a record while her peers at historic highs also posted gains, particularly, S&P 500 +.88% and the Nasdaq +.74%. The Russell 2000 small cap closed nearly unchanged +.003%.

Outperforming US stocks, this week, relative to emerging markets and against many other developed peers imply that the share of US stocks in terms of market capitalization to the world should be expanding.

However, the flagging US dollar has essentially offset nominal currency gains made by US equities.

Net foreign selling in US equities during the 2^nd quarter, which I cited two weeks back[1], represents the second largest in record since the 1990s.

Political bickering theatrics over government shutdown, debit ceiling and Obamacare reportedly prompted for net foreign selling of US assets in August. Net sales of U.S. equities by official holders abroad were a record $3.1 billion, according to a report from Bloomberg[2].

Rising stock markets amidst severe currency strains hardly represents signs of economic strength. Instead such dynamics are manifestations of an escalation of monetary ailment.

A good example of such extremes can be seen in the unfolding real time currency crisis in Venezuela. The Caracas Index or Venezuela’s stock market benchmark has been in a phenomenal vertiginous parabolic climb—up 347.5% (!!!) year-to-date, this adds to the 2012 gains at 302.81% for a total of 650.31% in one year and ten months (!!!)—as the collapse of the Venezuelan Bolivar[3] as shown via its black market rates steepen.

Ironically, in the face of massive goods shortages or an economic standstill, the increasingly desperate Venezuelan government decrees a Vice Ministry of Supreme Social Happiness[4]. Individual “happiness” will now be substituted for collective “happiness” as perceived and implemented by the political leaders[5].

I know the US is not Venezuela. Japan is not Venezuela too. But all three has exercised the same currency debasement programs, resulting to the same outcomes at varying degrees.

Venezuela which is at the advance stage of a currency crisis, serves as example of what may happen to the US or Japan if political leaders insist proceeding towards such trajectory.

And since the world still depends on the US dollar as main currency for foreign currency bank reserves and as the principal medium for payment and settlements for international financial transactions, despite actions by some nations to wean themselves from the US dollar via currency swaps, bilateral currency trade deals and barter[6], the fate of the US dollar will have significant influence on the direction of the global financial markets.

I would also add that aside from the US dollar, developments in the US financial markets—the largest in the world, for instance, the US stock markets, despite the fall of US market cap relative to the world, remains at 34.6% (as of October 13, 2013) according to Bespoke Invest[7]—will also have big sway on global markets. The meltdown from the perceived tapering by the Fed last May which intensified the actions of the bond vigilantes should be a noteworthy example.

In today’s globalization expect connectivity not just in the web, or telecoms but also in financial markets and economies.

Manipulating Earnings Guidance to Boost Share Prices

When market participants frenziedly bid up stock prices to astronomical levels, the unsustainability of such actions can be established by simple observations.

Again as I pointed out last week, zooming stocks has led to astonishing valuations. The small cap Russell[8] 2000’s PE ratio[9] has been valued at a fantastic 84.51 as of Friday’s close.

Given that the Forward PE has been estimated at 22.5, this means that earnings for the coming year have been expected to explode by a stunning 276%!

However if one were to weigh on the sentiment of small businesses to assess such potentials, a recent survey by small business (conservative lobbying[10]) organization the National Federation of Independent Business (NFIB)[11] seems barely sanguine to justify such valuations (bold mine)

Small-business owner optimism did not “crash “ in September, but it did fall, dropping 0.20 from August’s (corrected) reading of 94.1 and landing at 93.9. The largest contributing factor to the dip was the significant increase in pessimism about future business conditions, although this was somewhat offset by a notable increase in number of small-business owners expecting higher sales

So we have basically a neutral condition unsupportive of wild earnings growth expectations. 

The same hold true with Dow Utility. With a trailing PE at 30.89 and forward PE at 16.15 this means that priced at Friday’s close, the drop in forward PE will mean that earnings must jump by 92%!

Aside from bond based share buybacks discussed last week, publicly listed companies “beat earnings estimates” by resorting to lowering guidance[12] has been a major pillar in driving up US stocks.

As one would note, 62.6% of corporations recently beat earnings estimates. Although the positive surprise trend has been on a decline since 2006.

On the other hand, the spread or the variance between positive and negative guidance by companies has been in a deficit since the 3^rd quarter of 2011.

In other words, listed firms set easier profit goals which they eventually outperform via “beat estimates”. The positive surprise then spurs higher prices.

In my view this looks like accounting prestidigitation.

Yet negative guidance according to the Factset has been at record levels[13]

For Q3 2013, 89 companies have issued negative EPS guidance while 19 companies have issued positive EPS guidance. If 89 is the final number of companies issuing negative EPS guidance for the quarter, it will mark the highest number of companies issuing negative EPS guidance since FactSet began tracking guidance data in 2006.

Managing earnings expectations in order to “beat the estimates” has usually been a bear market technique used by the management.

According to Investopedia.com[14] “It is one of the analyst's jobs to evaluate management expectations and determine if these expectations are too optimistic or too low, which may be an attempt at setting an easier target. Unfortunately, this is something that many analysts forgot to do during the dotcom bubble.”

The Factset graph also shows that Utilities and Telecoms have had 100% negative guidance changes. In short, these two industries expect materially LOWER profits thus the widespread downscaling of their estimates.

So how on earth will Utility earnings jump by 92%?!

Except for the energy sector, positive guidance has been a scarcity.

Since corporate profits represent a component of the income side of the National Income and Product Account (NIPA) [15], the lowering of profit guidance hardly reflects on a robust economy. This hardly justifies a sustainable upside run of stock market prices.

But again over the interim, rational irrationality may rule.

The other way to look at these: Management of many publicly listed corporations may have purposely been guiding “earnings” expectations down in order to generate “surprises”. Such positive surprise should extrapolate to an increase in (earnings performance based) compensation.

Rewarding executives based on earnings performance has been loaded with agency (conflict of interest) problems

According to an academic paper written by Lan Sun of UNE Business School, Faculty of the Professions[16] (bold mine)

In theory, a link between a CEO's compensation and a firm performance will promote better incentive alignment and higher firm values (Jensen & Meckling, 1976). However, executive compensation contract is an incentive where opportunistic earnings management behaviour is likely to be detected since CEOs are expected to have incentives to manipulate earnings if executive compensation is strongly linked to performance. A substantial literature has emerged to test the relationship between executive compensation and earnings management and has documented that compensation contracts create strong incentives for earnings management…When earnings management is driven by opportunistic management incentives, firms will ultimately pay a price and its negative impact on shareholders is economically significant.

So far, total corporate profits based on y-o-y changes inclusive of Inventory Valuations Adjustments (IVA) and Capital Consumption Adjustment (CCAdj)[17] have chimed with the trend of lowering of profit expectations.

Yet curiously bad news (negative trends), which represents the underlying largely overlooked or ignored real factor of declining trend of profitability or eps growth rate and net income as shown last week, has been seen as good news (by mainly focusing on beat estimates or nominal growth figures or Fed easing)

It’s all about selective perception or picking of information to fit one’s biases or beliefs.

Let’s Keep Dancing: The Intensifying Credit Orgy

In a manic phase of the boom-bust cycle, zooming stocks equals ballooning credit.

Back to the future with exploding leveraged loans and covenant lite bonds, from the Financial Times[18] (bold mine)

Neiman Marcus, the upscale US department store chain, is no stranger to fashion trends. But in the autumn of 2005 the luxury retailer started a very different kind of fad – this time for an unusual new bond structure known as a “payment-in-kind toggle”.

Pik-toggle notes, as they became known, gave Neiman Marcus the option to pay its lenders with more bonds instead of cash if the retailer ever ran into financial difficulty. For a company that was at the time being bought by private equity giants TPG and Warburg Pincus, in a leveraged buyout involving about $4.3bn worth of debt, that additional financial flexibility was considered a savvy move….

The average amount of debt used to finance LBOs has jumped from a low of 3.69 times earnings in 2009 to an average 5.37 so far this year, according to data from S&P Capital IQ. At the height of the LBO boom, average leverage was 6.05.

The $6bn sale of Neiman Marcus to Ares and a Canadian pension fund is expected to leave the retailer with a debt of about seven times earnings.

At the same time, more than $200bn of “cov-lite” loans have been sold so far this year, eclipsing the $100bn issued in 2007. That means 56 per cent of new leveraged loans now come with fewer protections for lenders than normal loans.

Regulators have sounded the alarm bells on covenant light loans but the industry group has pushed back saying that loan warnings will hurt the “neediest borrowers”[19]. Such characterizes the rationalization of the mania phase. Echoing the infamous words of ex-Citibank chair Charles Prince during the height of the US housing boom, “For as long as the music is playing, you’ve got to get up and dance. We’re still dancing[20].” 

Let’s keep dancing

And when it comes to yield chasing via increased leveraging, the absence of a stamp of approval by credit rating agencies has hardly become a factor to Wall Street’s peddling of Commercial Mortgage Bonds (CMBS). [note credit rating enthusiasts, credit rating warnings ignored by markets]

From the Bloomberg[21]: (bold mine)

Wall Street banks that package commercial mortgages into bonds are forgoing a ranking from Moody’s Investors Service on the riskier portions of the deals, a sign the credit grader isn’t willing to stamp the debt investment-grade amid deteriorating underwriting standards.

Moody’s didn’t grade the lower-ranking debt in 9 of the 14 commercial-mortgage bond transactions it’s rated since mid-July, according to Jefferies Group LLC. Deutsche Bank AG (DBK), Cantor Fitzgerald LP and UBS AG (UBSN) are selling a $1 billion transaction this week that doesn’t carry a Moody’s designation for a $64.3 million portion that Fitch Ratings and Kroll Bond Rating Agency ranked the lowest level of investment grade, said two people with knowledge of the deal.

Moody’s absence from the riskier securities in commercial-mortgage deals suggests the New York-based firm is taking a harsher view of the quality of some new loans as issuance surges in the $550 billion market, Jefferies analysts led by Lisa Pendergast said in a report last week. Credit Suisse Group AG’s forecast for $70 billion of offerings this year would be the most since issuance peaked at $232 billion in 2007.

Credit bacchanalia has gone global. Booming issuance of high yield (junk) bonds linked to M&A has reached 2007 highs. 

From the Financial Times[22]:

A burst of investor “animal spirits” has boosted the value of mergers and acquisitions-related bonds to the highest raised since the financial crisis.

Global acquisition-related bond issuance from non-investment grade, or high yield, companies has risen by 15 per cent to $62.9bn for the year to date compared with the same period in 2012.

This is the highest amount since 2007, according to Dealogic, the data provider.

The surge has been driven by purchases outside the US as non-US acquisition bond issuance nearly tripled to $14.1bn compared with last year, including deals such as Liberty Global ’s $2.7bn issue

High grade corporates likewise reveals of a debt issuance bonanza.

From the Wall Street Journal[23], (bold mine)

According to data provider Dealogic, the $884.3 billion of highly rated corporate bonds sold in the U.S. this year through Wednesday has been the most of any year at that point since 1995, when it began keeping records.

October’s rush of supply has helped put 2013 back on track to exceed the record $1.01 trillion issuance seen in 2012.

The accounts above validate my view on the transition process of companies from hedge financing to Ponzi financing.

As I wrote last week[24], (bold original)

So while most publicly listed US companies have yet to immerse themselves into Ponzi financing, sustained easy money policies have been motivating them towards such direction.

The greater the dependence on debt, the more Ponzi like dynamics will take shape.

The Fallacy of Little Screwy People

Record or near record issuance of high yield bonds, commercial-mortgage bonds, covenant lite bonds leverage buyout loans and investment grade bonds constitute signs of liquidity trap? To the contrary it would seem like a tidal wave of money.

Yet most central bankers and the consensus see the former (as if the world exists in some vacuum) to justify direct intervention via QE.

And thus far all these credit easing has failed to accomplish its end.

And we don’t need to heed on the former Fed chief Alan Greenspan’s view[25] about forecasting.

We really can't forecast all that well. We pretend that we can but we can't. And markets do really weird things sometimes because they react to the way people behave, and sometimes people are a little screwy.

And if officials can’t forecast on the consequences of their policies using their econometric models, then why experiment?

Yet it is hardly about people being a “little screwy” but more about people responding to daft experiments imposed on societies as economic policies (US and their multiplier effects worldwide) by ivory tower bureaucrats who hardly knows about real economic relationships except to see them as mechanistic mathematical models, and at the same time, have the impudence to undertake grand trials because they barely have skin on the game. 

Moreover policies which punish savings and simultaneously “nudge” the public to wantonly indulge in reckless risk activities leads people to become “screwy”. Bad ideas have bad consequences.

So the cost of their policies will be borne by the average citizenry via restrictions of economic opportunities, financial losses, assuming a bigger burden of financing pet projects of politicians and their bureaucracy, diminished purchasing power and many other non-pecuniary social costs (e.g. erosion of moral fiber, curtailment of civil liberties, social upheaval and etc...)

And these booming credit markets have largely undergirded the financing of the housing or the stock markets bubbles rather than channelled to the real economy for productive activities. The opportunity cost for monetary policy-induced speculation has been the productive sectors, thus the real economy’s growth remains muted or sluggish relative to asset markets.

Monetary inflation has essentially been absorbed by the asset markets. Monetary inflation has spurred massive risk taking, speculative splurge, blatant momentum yield chasing, having been financed by exponential credit growth that has resulted to severe misallocation of resources, blatant mispricing of assets and maladjusted economies.

And such asset bubbles have become international. Thus risks from any unhinging of the bubbles from the US or from any developed economies or even from big emerging markets may likely have a domino effect.

We don’t really need to forecast. All we need is to understand the real economic relationships applied to instituted policies to appreciate the risks.

As the great dean of Austrian economics Murray Rothbard explained[26]: (bold mine)

Economics provides us with true laws, of the type if A, then B, then C, etc. Some of these laws are true all the time, i.e., A always holds (the law of diminishing marginal utility, time preference, etc.). Others require A to be established as true before the consequents can be affirmed in practice. The person who identifies economic laws in practice and uses them to explain complex economic fact is, then, acting as an economic historian rather than as an economic theorist. He is an historian when he seeks the casual explanation of past facts; he is a forecaster when he attempts to predict future facts. In either case, he uses absolutely true laws, but must determine when any particular law applies to a given situation. Furthermore, the laws are necessarily qualitative rather than quantitative, and hence, when the forecaster attempts to make quantitative predictions, he is going beyond the knowledge provided by economic science

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[1] See Phisix: Rising Systemic Debt Erodes the Margin of Safety October 14, 2013

[2] Bloomberg.com Foreigners Sold U.S. Assets as China Reduces Treasuries October 22, 2013

[3] Steve Hanke Venezuela The Troubled Currencies Project Cato Institute

[4] Telegraph Venezuela creates Social Happiness ministry October 26, 2013

[5] Happiness See Amidst Hyperinflation, Venezuelan Government Decrees a ‘Happiness’ Ministry, October 27, 2013

[6] See Has the Fed’s Taper Talk induced foreign selling, swap and bilateral currency deals? October 23, 2013

[7] Bespoke Invest US Loses Share to Rest of World October 14, 2013

[8] Russell Investments Russell 2000® Index The Russell 2000 is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.

[9] Wall Street Journal P/Es & Yields on Major Indexes Market Data Center

[10] Wikipedia.org National Federation of Independent Business

[11] National Federation of Independent Business October Report Small Business Economic Trends

[12] Bespoke Invest Guidance Remains Weak October 24, 2013

[13] Factset Guidance S&P 500 September 30,2013

[14] Investopedia.com Earnings Guidance: Can It Accurately Predict The Future?

[15] Bureau of Economic Analysis Corporate Profits: Profits Before Tax, Profits Tax Liability, and Dividends

[16] Lan Sun EXECUTIVE COMPENSATION AND CONTRACT-DRIVEN EARNINGS MANAGEMENT ASIAN ACADEMY of MANAGEMENT JOURNAL of ACCOUNTING and FINANCE 2012

[17] Yardeni.com US Economic Indicators: Corporate Profits in GDP, October 26, 2013

[18] Tracy Alloway and Vivianne Rodrigues Boom-era credit deals raise fears of overheating Financial Times October 22, 2013

[19] Bloomberg.com Fed Loan Warning May Hurt Riskiest Borrowers, Trade Group Says October 26, 2013

[20] Deal Book Citi Chief on Buyouts: ‘We’re Still Dancing’ July 10, 2007

[21] Bloomberg.com Wall Street Skips Moody’s as CMBS Standards Slip: Credit Markets October 25, 2013

[22] Financial Times M&A bonds surge to highest in six years October 21, 2013

[23] Wall Street Journal Latest Headlines Low Rates Bring Bond Bonanza October 25, 2012

[24] see Phisix: US Debt Ceiling Deal and UNTaper Spurs a Global Melt UP October 21, 2013

[25] BusinessInsider.com 'YOU JUST LEARNED THIS?!?' — Jon Stewart Struggles To Understand How Former Fed Head Greenspan Missed Wall Street 'Screwiness' October 22, 2013

[26] Murray N. Rothbard, 1. Economics: Its Nature and Its Uses CONCLUSION: ECONOMICS AND PUBLIC POLICY Man, Economy & State

While Wall Street Cheers, US Small Businesses Frowns

Today’s financial markets has been hardwired to see price movements of securities as having only one direction: up up and away! 

And part of that programming has been to view bad news as good news. The reason for this schadenfreude outlook has been that bad news in the real economy extrapolates to more injections of government steroids. So Wall Street tacitly cheers and wishes for bad news, which they sell on the surface as good for the economy.

Aside from the depraved sense of ethics from bad news is good news, Wall Street’s benefiting from the massive transfers via government steroids has real effects on the economy. 

One victim has been Small Businesses.

Small businesses, the largest employers or job providers in the US, has been lackluster, despite the statistical so-called economic recovery.

August’s Optimism survey report from National Federation of Independent Business (NFIB) chief economist Bill Dunkelberg (bold original)

Small business optimism remained flat in August, dropping 0.1 points from July for a final reading of 94.0. While the total reading showed essentially no change over the month prior, a look at the individual indicators reveals incongruent details. Job creation plans leapt to a level not seen since before the recession and sales expectations improved; but this optimism would appear to contravene the dramatic deterioration in quarter to quarter sales and profit trends. The favorable employment plans also contrasted sharply with the increasingly negative expectations for improved general business conditions. The month's performance proved poor, but expectations, pre-Syria, were looking up.

So buoyant financial markets have spurred a jump in job creation plans but real actions via sales and profit trends “contravene” this outlook. What people say and what people actually do are different (demonstrated preference). 

Aside from the invisible transfers, lethargic activities of small businesses have been imputed to mostly taxes and government regulations.

In short the real economy suffers from uncertainty brought about by the trifecta of government induced factors: inflationism, taxes and regulation.

The so-called rising inequality has really been due to instituting policies favoring Wall Street at the expense of main street where the latter has been a recipient of transfers via Bernanke Put, zirp and QE channeled through higher asset prices.

And such dynamic reinforces the ongoing sentimental rotation from the tepid growth in the real economy and the selloffs in bond markets into the property and stock markets; The Wile E Coyote Moment

US Part Time Jobs: Obamacare and Regime Uncertainty

Dr. Ben Bernanke and his team at the US Federal Reserve appears to be in a quandary over the surge of part time jobs.

From the Bloomberg:

The number of workers holding full-time positions fell in the U.S. in June as part-timers hit a record after rising for three straight months, according to the Bureau of Labor Statistics household data. Part-time employment has been outpacing full-time job growth since 2008. Economists cite still-tough economic conditions as the root cause, with some saying President Barack Obama’s 2010 health-care law exacerbates the trend.

U.S. Federal Reserve Chairman Ben Bernanke told a House committee July 17 that policy makers consider underemployment, which includes part-time workers who want full-time jobs, one of the gauges of labor-market strength…

The number of part-time employees in June rose by 360,000, the Bureau of Labor Statistics reported, based on its survey of households. Full-time workers fell by 240,000, erasing much of the gains from April and May. The share of Americans who work part-time for economic reasons, meaning they can’t find full-time jobs or because their hours have been cut, is 78 percent higher than in December 2007, when the 18-month recession began.

So what the mainstream sees as “strong” economic growth has been founded by part time jobs.

The charts above from Zero Hedge shows of how part time jobs came at the expense of full time jobs last June.

Importantly, much of the new jobs comes from the low wage segments of the service industry, particularly leisure and hospitality, retail trade and education,  health and other temp jobs, as observed by  the Zero Hedge.

Talk about economic "vigor".

Asked whether Obamacare has contributed to the part time jobs, from the same Bloomberg article (bold mine)

“It’s hard to make any judgment,” Bernanke said when Stutzman asked if the Patient Protection and Affordable Care Act’s mandates are slowing the economy. Bernanke said that it has been cited in the economic outlook survey known as the Beige Book, which the Federal Open Market Committee considers in assessing the economy.

“One thing that we hear in the commentary that we get at the FOMC is that some employers are hiring part-time in order to avoid the mandate,” Bernanke said. He added that “the very high level of part-time employment has been around since the beginning of the recovery, and we don’t fully understand it.”

For the official whose opinions and decisions moves the global financial markets and likewise plays a significant role in influencing activities on the main street and on the global economy, “we don’t fully understand it” looks really very reassuring. This means that “we don’t fully understand it” has been the basis of all grand experimental policies being conducted by the FED.

[As a side note: Dr. Bernanke applies the same concept on gold prices, stating that “Nobody really understands gold prices and I don’t pretend to understand them either” but curiously has the audacity to make conclusions on gold prices based on his “non-understanding”]

I believe that the crucial changes in the character of US employment has been related to the record cash pileup by US non-financial corporations

As the Wall Street Journal noted in June, (chart from creditwritedowns.com)

The Federal Reserve reported Thursday that nonfinancial companies had socked away $1.84 trillion in cash and other liquid assets as of the end of March, up 26% from a year earlier and the largest-ever increase in records going back to 1952. Cash made up about 7% of all company assets, including factories and financial investments, the highest level since 1963.

Both variables, the reluctance to invest (as expressed by huge cash holdings) and the change in the character of the US labor force, have been products of regime uncertainty. 

Regime uncertainty as defined by Austrian economics professor Robert Higgs represents the “pervasive lack of confidence among investors in their ability to foresee the extent to which future government actions will alter their private-property rights”

On whether Obamacare has been responsible for such trend changes, Dr. Bernanke’s adroitly fudges the issue by referring to “the beginning of the recovery”.

The reality is that the Patient Protection and Affordable Care Act (PPACA) or the Affordable Care Act(ACA), popularly known as Obamacare was signed into law in March of 2010, basically “the beginning of the recovery”. 

Some provisions of the said law has been slated for January 2014 and the rest in 2020 according to Wikipedia.org  [Update: The US house of representatives has just voted to delay the implementation of the Individual mandate]

As I pointed out in the past, Obamacare comes with 21 new or higher taxes.

And small businesses are the main sector that appear to be hardly affected.

Small businesses have been the heart of the US economy. According to the National Small Business Association, 

-Small business represents 99.7 percent of all employer firms.

-In 2010, there were an estimated 27.9 million small businesses in the U.S.—5.9 million with employees and 21.4 million without employees.

-Small businesses employ about half of the country’s private sector workforce.

- Small firms accounted for 64 percent or 9.8 million of the 15 million net new jobs created between 1993 and 2011.

Yet from a recent survey conducted by the US Chamber of Commerce, “unease around Obamacare appears to be increasing among small businesses” according to the Huffington Post.

In a survey conducted by National Federation of Independent Business (NFIB) last June, small business optimism continues to be plagued by taxes and government regulations and red tape

As the NFIB chief economist William Dunkelburg wrote (bold highlights mine)

The economy remains “bifurcated”, with the big firms producing most of the GDP growth with little help from small business. That balance is shifting, but unfortunately because larger firms are losing ground, not because small business is growing faster. Housing and energy are helping, and that does involve a lot of small businesses but the rout in housing was so severe that there are now supply constraints developing in new home construction due to lost capacity that cannot be easily reconstituted. Home prices are now increasing at double digit rates. Consumer net worth is allegedly doing well due to stock prices and house prices rising. But the quantity of items held, real wealth (houses, cars, fractions of a company owned), is not increasing that fast, just the prices. Been there, done that.

While US government sponsored surveys or the US Federal Reserve of Philadelphia and Minneapolis says that only a small portion has been affected by Obamacare, circumstantial developments (part time jobs and high cash by non-financial corporations due to reluctance to invest) says otherwise.

Nonetheless, “Big firms producing most of the GDP growth with little help from small business” has been a common feature in today’s QE-ZIRP based global financial economy where monetary policies have been engineered to buoy asset markets (stocks, real estate) via credit fueled destabilizing speculations (bubbles).

The reality is that the Dr. Bernanke's policies has substantially been responsible for these. FED easing policies combined with Obamacare and the increased regulatory mandates (the Federal Register is now over 81,000 pages long. Obamacare has 906 pages, Dodd Frank has 849 pages) and aside from a surge in taxes (US tax code now 72,000 pages) all contributes to the uncertainty over the investor’s property rights, hence the lack of commitment to invest and the corresponding changes in the hiring and employment dynamic.

Are Taxes and Regulations as Primary Business Obstacles a Myth?

The McKinsey Quarterly writes to supposedly debunk the myth where taxes and regulations poses as key obstacles to small businesses:

Many business leaders will tell you that taxes and regulation are the biggest barriers to starting up and enlarging small businesses. It’s true that some regulations and laws have inhibited the growth of small businesses; the Sarbanes–Oxley Act, for instance, had the unexpected consequence of discouraging some companies from making initial public offerings, a step typically followed by a burst of hiring. But taxes and government oversight are not the primary barriers to stimulating the growth of small businesses. In the latest recession, their owners pointed to a lack of market demand as the primary problem, as well as an inability to obtain financing

In reality, the alleged inadequacy of consumer demand are no less than symptoms of invisible but real underlying causes.

The perception of the lack of consumer demand as the main culprit to business or even economic deficiencies represents a populist Keynesian fallacy.  As the great Friedrich A. von Hayek explained  (Unemployment and Monetary policies, p.40; hat tip Professor Don Boudreaux) [bold mine]

The conquest of opinion by Keynesian economics is due mainly to the fact that its argument conformed to the age-old belief of the businessman that his prosperity depended on consumer demand.  This plausible but erroneous conclusion was derived from his individual experience in business, namely, that general prosperity could be maintained by keeping general demand high.  Economic theory had been rejecting this conclusion for generations, but it was suddenly made respectable by Keynes.  And since the 1930s it has been embraced as obvious good sense by a whole generation of economists brought up on the teaching of his school.  Thus for a quarter of a century we have systematically employed all available methods of increasing money expenditure, which in the short run creates additional employment but at the same time leads to a misdirection of labor that must ultimately result in extensive unemployment

The policies of inflationism, aimed at increasing “money expenditures”, that has prompted for the large scale or clusters of “misdirection of labor” and resources that “must ultimately result” in capital consumption which gets to be manifested as “extensive unemployment” and consequently, the dearth of consumer demand.

In short, boom bust cycles fosters what mainstream sees as lack of demand.

Additionally, regulations that prevent markets from “clearing” or allowing markets to coordinate resources and labor towards consumer preferences also poses as unseen but real hindrance to additional consumer demand.

High taxes divert resources from production to consumption, thereby decreasing capital investments that suppresses income and eventual demand.

 

Bailouts and subsidies too or the transference of resources from productive to politically preferred unproductive areas (e.g. Obama’s green energy projects) also results to wasted resources, high costs to taxpayers, crowding out, diminished capital investments and subsequently a paucity of demand

Lastly, arbitrary regulations have been the major obstacles to business creation or expansion.

Some real life examples: In Georgia, policemen shut down a child’s lemonade stand (due to lack of permit) and in Chattanooga City Tennessee, a pedicab project has been shelved simply because state officials didn’t like it. 

Of course, there are many more instances of economic repression from political agents. Deprivation of livelihood from political interference, signifies as a source of the lack of demand. No income, No spending.

Bottom line: The world does not operate on a vacuum. People just don’t act because they wake on one side of the bed and feel either confident or anxious. People’s actions are driven by incentives (and not by moods or by animal spirits). 

Lastly, effects must not mistaken as the cause.  

Regime Uncertainty and US Employment Woes

Dr. Ed Yardeni’s noteworthy perspective on the recent ‘conspiracy theory’ controversy over US employment data: (bold added) 

The employment gain was attributable to an increase of 838,000 in full-time employment, while part-time employment fell 26,000. What’s odd is that among those working part-time (which edged down slightly), there was a 582,000 increase in those working part-time for economic reasons. In other words, lots of people found full-time jobs, and lots of people who wanted to work full time could only find part-time jobs. Got that? Even odder is that the payroll survey showed that employment in the temporary help industry edged down by 2,000 in September.

While I doubt that anyone at BLS tampered with the household data for political motives, I’m certain no one even thought to bother with the payroll employment numbers. September’s increase was a measly 114,000. I give much more weight to the revisions to the previous two months, which tend to be upwards when the economy is expanding. They totaled 86,000 during July and August, raising their monthly average gain to 161,500. The oddity here was that upward revisions occurred at the local-government level--mainly the hiring of school teachers (up 77,000)--which nearly matched the revision to overall payrolls…

The debatable question is whether the Obama administration’s policies are creating jobs. The answer, of course, is they didn’t create them. Mitt Romney says he’ll create 12 million jobs if he is elected to be the next president. Presidents don’t create jobs. Profitable companies expand and create jobs, especially small ones that turn into big ones.

So politics could have played a sleight of hand trick in the statistical improvements of US employment conditions.

Well, the real reason for the sluggish job conditions can be traced to concerns of small business which makes up the kernel of employment: growing political uncertainty, as I earlier pointed out here.

Sluggish hiring has been an outcome of lethargic business fixed investment…

…which can be traced to REGIME UNCERTAINTY

As Professor Robert Higgs writes, 

I have argued for years that this anemic investment recovery evinces, at least in part, the prevailing regime uncertainty brought about by the Fed’s and the Bush and Obama administrations’ massive, ill-advised, and counter-productive interventions in the economy during the past five years. These interventions are continuing, however, and continuing to prolong the recovery. The idea that these actions will ultimately succeed if only the authorities persist in them long enough and on a sufficiently great scale was a bad idea from the start, and its bankruptcy became fairly evident a long time ago even to many observers wedded to mainstream economics and conventional economic policy making.

Policy makers have cost the U.S. economy a decade or more of normal economic growth. How long will people in their capacities as political and financial actors continue to tolerate this foolish, destructive policy making? I do not know, but I believe I know what the result of these misguided ongoing experiments will be—economic stagnation at best, relapse or another bust at worst.

The bottom line is that in contrast to the quack idea that Presidents "create" jobs, the reality is Presidents “unmake” or “destroy” jobs from repeated interventionism-inflationism which only engenders regime uncertainties or from a political environment which have been antagonistic or hostile to businesses.

Philadelphia Fed’s Charles Plosser Warns of Risks from QE Forever

In addition to Richmond Federal Reserve’s Jeffrey Lacker, the Fed’s recent QE ‘forever’ has elicited another dissenting insider opinion.

Federal Reserve Bank Bank of Philadelphia President Charles Plosser says that the FED’s measures will not only miss attaining the targeted economic goals but would lead to hefty unforeseen risks.

Here is why employment goals won’t be reached, from SFGate/ Bloomberg, (Bold emphasis mine)

Federal Reserve Bank of Philadelphia President Charles Plosser said new bond buying announced by the Fed this month probably won’t boost growth or hiring and may jeopardize the central bank’s credibility.

“We are unlikely to see much benefit to growth or to employment from further asset purchases,” Plosser said in a speech today at the district bank in Philadelphia. “Conveying the idea that such action will have a substantive impact on labor markets and the speed of the recovery risks the Fed’s credibility.”…

Plosser said today that central banks can’t effectively target employment levels the same way they can guide inflation rates because hiring also depends on variables unrelated to monetary policy, such as technology, education and tax rates.

“It doesn’t make sense to say that there is a particular unemployment rate that we can achieve,” Plosser told reporters after his speech. “The problem with the labor markets is there are many things that affect employment and unemployment that are beyond the control of the Fed.”

Mr. Plosser acknowledges that in a highly complex world, oversimplified centralized or political solutions can lead to unintended consequences.

Mr. Plosser fails to add that policies such as added taxes and regulations impact investments (aside from monetary policies) and thereby employment levels. The mainstream's favorite indicator, employment, represents an effect from business spending and not the cause.

Small businesses which make up the bulk of the source of US employment has been suffering from tax and regulatory policies (chart from advisor perspectives).

I would like to point out that while poor sales has also been an important concern, poor sales are symptoms of an underlying disease.

Relative economic freedom, the US has been on a decline since 2000 or when the FED began to massively inflate the system (chart from Cato Institute)

Mr. Plosser also believes that the Fed’s latest QE will lead to significant risk of consumer price inflation…

“I opposed the Committee’s actions in September because I believe that increasing monetary policy accommodation is neither appropriate nor likely to be effective in the current environment,” Plosser said. “Every monetary policy action has costs and benefits, and my assessment is that the potential costs and risks associated with these actions outweigh the potential meager benefits.”…

The Fed’s “hard-won credibility” is crucial because if the public doesn’t have confidence in policy makers, their ability to set effective monetary policy will be harmed, hurting households and businesses, Plosser said. If people believe the central bank will delay raising rates, they may “infer that the Fed is willing to tolerate considerably higher inflation,” spurring an increase in inflation expectations that would require a response from the FOMC, Plosser said.

“The Fed’s most recent actions carry with them significant risks,” Plosser said. “I am not forecasting that those risks will necessarily materialize and I hope they will not. But if they do, they could prove quite costly to the economy.”

And Mr. Plosser suggests that the Fed has been trapped, where exiting from current measures would likely be highly disruptive.

Plosser said in response to audience questions that he’s “worried that the actions we are taking to make our balance sheet bigger entail risks and those risks could be quite substantial.”

The central bank may “be forced into selling assets in the open market” when it needs to reduce stimulus, he said. Policy makers “must be aware of the consequences,” from their decisions.

In short, Mr. Plosser warns of two possible consequences from current the policy of QE forever: massive inflation or boom bust cycles, both of which would only destabilize the US and global economies.

Mr. Plosser’s warning eerily resonates with the admonitions of the great Professor Ludwig von Mises

The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.