Comments by Faber, Gross, Roach, and Grantham on the Political Economy

Over the past several days, I have caught some very good commentary by a number of well-known financial industry experts. I wanted to share my own thoughts with you on their commentary, especially in light of my last posts on Eisenhower’s Farewell Address and The New Monetary Consensus. I have featured two of the commentaries here in the past week, from Roach and Faber. I will add a bit from Gross and Grantham and try to unify them into a single theme.

Let’s start with Stephen Roach. He opined in an interview with CNBC last week that the Federal Reserve was a serial bubble blower which is creating the pre-conditions for yet another bubble right now. He believes that the Fed’s dual mandate of considering employment and price stability in monetary policy must be strengthened to include considerations of financial market excess. He thinks the Fed needs three mandates in order to be fully effective. I would prefer the Fed be stripped of its existing mandates and concentrate only on its role as lender of last resort. See my post, Stephen Roach on CNBC and the included video clip for more of Roach’s view.

Marc Faber takes a similarly sceptical view of the Fed and its bubble blowing. His view is that the Fed created a credit bubble through artificially low interest rates, much as Roach has said. But he also sees government as a whole implicated in similar policies to boost consumption artificially, ultimately leading to low quality growth. In his view, these policies will eventually destroy the dollar, which he already views as an invalid unit of account. See Marc Faber, what are you worrying about? for more on that score.

Now, Faber made his comments at the Barron’s Annual Roundtable with a bunch of other market followers like Fred Hickey, Meryl Witmer, Abby Joseph Cohen, and Felix Zulauf. Bill Gross has also recently joined the Roundtable group as its resident bond expert.  He too had some uncharitable words to say about government’s stimulative policies. But he also introduces the government capture issue aka crony capitalism. Get a subscription and see Attention, Stockpickers from Barron’s. Here’s an excerpt from early in the text:

Gross: Corporations are probably at the peak of their domination. They dominate versus labor in terms of their ability to export jobs and production overseas. They dominate now in terms of Washington, given the Republican electoral victory and the Obama administration’s moving toward the center.

They even dominate with regard to the Supreme Court, as evidenced by the recent ruling removing limits on corporate donations to election campaigns. This is all good for the market, but not for Main Street in the long run.

Just after the Faber commentary I quoted on Saturday, Gross then says:

Gross: I agree with Marc on many things, though not everything. I don’t know if the U.S. has reached a desperate point, but it is employing instruments and vehicles and policies that smack of desperation. We are not looking at a default here, but at years of accelerating inflation, which basically robs investors and labor of their real wages and earnings. We are looking at a currency that almost certainly will depreciate relative to other, stronger currencies in developing countries that have lower levels of debt and higher growth potential. And, on the short end of the yield curve, we are looking at creditors receiving negative real interest rates for a long, long time. That, in effect, is a default. Ultimately creditors and investors are at the behest of a central bank and policymakers that will rob them of their money.

Gross is speaking my language here.

Now, let’s round this out with Jeremy Grantham’s most recent newsletter. You can sign up to read it at GMO. Grantham also touches on the Eisenhower speech that I wrote about earlier today in a piece called "I Like Ike:  A Powerful Warning Ignored, January 17, 1961". He writes:

Historians may well look back on this period, say, from 1960 on, as the “Selfish Era” – a time when individualism and materialism steadily took precedence over social responsibility.  (To be fair, in the period from 1960 to 1980, the deterioration was slow, and the social contract dating back to the mid-1930s was more or less intact.)  Personal debt grew slowly at first but steadily accelerated, even though it can be easily demonstrated that consumers collectively are better off saving to buy and that the only beneficiary of a heavy debt society is the financial industry, whose growth throughout this period was massive, multiplying its share of a growing pie by a remarkable 2.2 times…

The financial industry, with its incestuous relationships with government agencies, runs a close second to the energy industry.  In the last 10 years or so, their machine, led by the famously failed economic consultant Alan Greenspan – one of the few businessmen ever to be laughed out of business – seemed perhaps the most effective.  It lacks, though, the multi-decadal attitude-changing propaganda of the oil industry.  Still, in finance they had the “regulators,” deregulating up a storm, to the enormous profit of their industry.  Even with the biggest-ever financial fiasco, entirely brought on by the collective incompetence they produced (“they” being the financial regulators and the financial industry leaders working together in some strange, would-be symbiotic relationship), reform is still difficult.  Even with everyone hating them, the financial industry comes out smelling like a rose with less competition, profits higher than ever, and not just too big to fail, but bigger still.

Other industries, to be sure, are in there swinging: insurance and health care come to mind, but they seem like pikers in comparison.  No, it’s energy and finance in coequal first place, military-related companies an honorable third, and the rest of the field not even in contention.   And now, adding the icing to the corporate cake, we have the Supreme Court.  Formerly the jewel in the American Crown, they have managed to find five Justices capable of making Eisenhower’s worst nightmare come true.  They have put the seal of approval on corporate domination of politics, and done so in a way that can be kept secret.  The swing-vote Senator can now be sand-bagged by a vicious advertising program on television, financed by unknown parties, and approved by no stockholders at all!

All in all it appears that Eisenhower’s worst fears have been realized and his remarkable and unique warnings given for naught.  From now on, we should tread more carefully.  Honoring President Eisenhower’s unique warnings, we should perhaps not take this 50-year slide lying down.  Squawking loudly seems preferable. 

We have reviewed the last 50 years and compared 1960 with 2010 in every way we considered interesting, and present the results in Table 1.

Grantham Table 1960-2010

 

What are the unifying themes about the America of Today?

  1. The Financial Services sector is too large relative to the size of the economy. This is a de facto admission that the US economy is unbalanced, favouring a financial elite at the expense of the rest of American society.
  2. Government is a large part of the problem. In fact, it is the government’s desire to counteract cyclical downturns which not only has allowed debt to accumulate but has also taught industry to insinuate itself into Washington to benefit from these actions. Industries implicated are Big Oil, Big Bank, the military industrial complex, Big Pharma, and the Insurance Lobby.
  3. Deregulation as practiced now favours incumbent organizations at the expense of entrants, large companies at the expense of smaller companies and corporations at the expense of individuals.
  4. The Federal Reserve is part of the problem or even the main trouble maker through its asymmetric easy money policy geared to goosing aggregate demand after financial bubbles.
  5. US Economic policy is short-sighted and has no discernible longer-term objectives that can boost long-term economic growth.

I think that’s about as far as I can go in unifying these comments. Let me say a few things as well.  First, the comment by Tim Geithner I keep coming back to repeatedly is very much the problem. Just before Christmas 2009, when it looked as if the Obama Administration had beaten the first wave of the financial crisis, Geithner told Slate the following:

I spent most of my professional life in this building. Watching the politics of the things we did in the past financial crises in Mexico and Asia had a powerful effect on me. The surveys were 9-to-1 against almost everything that helped contain the damage. And I watched exceptionally capable people just get killed in the court of public opinion as they defended those policies on the Hill. This is a necessary part of the office, certainly in financial crises. I think this really says something important about the president, not about me. The test is whether you have people willing to do the things that are deeply unpopular, deeply hard to understand, knowing that they’re necessary to do and better than the alternatives. We’ll be judged on how we dealt with the things that were broken in the country. We broke the back of the worst financial panic in three generations, more effectively and at a much lower cost than I think anybody thought was possible.

Here’s what he is saying: I know Washington. I have been here for a long time and what I have seen tells me that the public often doesn’t have a clue. Sometimes, in the midst of crisis, I have seen people who actually do have a clue get pilloried by this public which doesn’t have a clue. Now, mind you, the people elect government so we have to put our ideas forward like this and take the beating. But, in the end, a real leader has to be willing to override the will of the people and have people around them who are also willing to resist the will of the people. This will be deeply unpopular, deeply hard to understand for people at the time. But when people realize that the policy making elite had it right and they had it wrong, we will be greeted as liberators from this awful mess.

What Tim Geithner is saying is that it is OK to bail out huge corporations with taxpayer money because, in the end, we shall all see this was the right solution, the least cost solution. I don’t know about you, but I find this statement very undemocratic and, indeed, deeply hard to understand. Of course, what Geithner is implying is that the US is a republic, which is really a representative democracy, and, as such, it affords policy makers wide latitude to govern as they see fit; that’s why they were elected. And if people don’t like it, vote them out.  Fair enough.

But, again, we are living in a world of asymmetries and privatised gain and socialised loss of an incestuous and intermingled corporate and inside the beltway culture. The very reason people like Faber, Gross, Roach and Grantham are all saying this is wrong is because of the very attitude Geithner displays. When you have executives from mega corporations like Citigroup advising the President-elect while captured regulators are bailing out that same mega corporation, only to have top White House officials depart for that same organization for a multiple of their government salary, how can one not see the whole thing as deeply unpopular, deeply hard to understand?

Second, what’s striking for me is how both Grantham and Gross mention the Citizens United case when talking about crony capitalism. You might already know that out-of-state money flooded into districts like Gabrielle Giffords’ after it was targeted as a pivotal electoral swing district. This is a direct result of Citizens United. You can expect it to get much worse going forward.  But, top US courts have made other very pro-corporate eminent domain verdicts that trample on property rights but are supported by government officials.

The United States is an out of control corporatocracy. On this score, things are no different under Barack Obama than under George W. Bush or Bill Clinton. This is why real wages have not increased in 40 years. This is why the male labour participation rate is at post-WWII all-time lows. This is why so many jobs are being outsourced. Yet corporate profits are now again at records despite the 16% U-6 rate of unemployment and record foreclosures.

I am cautiously optimistic about the outcome for 2011. Apparently, so is every single one of the financial experts mentioned in this article. But, given the foregoing, there is little reason to think that this GDP growth will either be long-lasting or particularly advantageous for the middle classes in the United States. I hope I am wrong and that the U.S. turns toward policies which foster long-term economic growth. But, clearly there is a reason Grantham, Gross, Faber and Roach are all saying the same thing.

8 Comments
  1. fresnodan says

    agree 100%. If we take free market and capitalism theory seriously, than the job of the financial sector is to allocate capital to where it will get the greatest TRUE return to the economy. These guys managed to get a great return for themselves by making loans that couldn’t get paid back. I believed they were either stupid, venal, or most likely, venal and stupid. Now I believe TBTF was the scheme right from the start – and apparently our Fed regulators think that is a good way to run an economy.

    1. Edward Harrison says

      It does seem that way, Dan. People have short memories and Obama’s calculus in 2009 was that this would benefit him if he was successful in helping reflate the economy by 2012, if not 2010.

      Right now, judging from Obama’s poll numbers, he is slowly getting the benefit of the doubt. If the economy stays on a modest uptick through the election a lot of people will forget about his first two years and the bailouts. I was on a TV program last night and was talking to another guest who is a Republican strategist. I asked him what the grass roots says about bailouts. And his response suggested that they don’t like them but that the issue is off the radar screen.

  2. fresno dan says

    agree 100%. If we take free market and capitalism theory seriously, than the job of the financial sector is to allocate capital to where it will get the greatest TRUE return to the economy. These guys managed to get a great return for themselves by making loans that couldn’t get paid back. I believed they were either stupid, venal, or most likely, venal and stupid. Now I believe TBTF was the scheme right from the start – and apparently our Fed regulators think that is a good way to run an economy.

    1. Edward Harrison says

      It does seem that way, Dan. People have short memories and Obama’s calculus in 2009 was that this would benefit him if he was successful in helping reflate the economy by 2012, if not 2010.

      Right now, judging from Obama’s poll numbers, he is slowly getting the benefit of the doubt. If the economy stays on a modest uptick through the election a lot of people will forget about his first two years and the bailouts. I was on a TV program last night and was talking to another guest who is a Republican strategist. I asked him what the grass roots says about bailouts. And his response suggested that they don’t like them but that the issue is off the radar screen.

  3. Jim R Mcgovern says

    Edward, I read a lot of financial blogs and find your analysis thought provoking and among the most insightful. However I am frustrated that even after reading so much analysis (here and elsewhere), I am still mostly perplexed with what to DO with my money.

    It would appear that bond yields likely will rise (so bond prices will fall). And that the US dollar, though it may strengthen a bit short term, will likely continue to weaken over time against most currencies as the Fed continues to print money and as we continue to run a significant trade deficit. And that most stocks, worldwide, are likely over-valued when looked at on a 10 year PE basis. etc etc. So I’m left thinking where the hell do I put my money that will generate a positive real return with an acceptable level of risk?

    Any chance you could focus a bit more on the “what to do” with one’s money? It seems to me that the value of analysis ultimately needs to be on prudent strategies going forward, not just on understanding what went wrong and why.

    Thanks,

    Jim McG.

    1. Edward Harrison says

      Jim,

      I just posted the first half of John Mauldin’s review for 2011, which I think is actionable. In my forecast, I made some calls on investing but had said I might flesh them out in a later post. My general view, though, is that we are in a mid-to-late cycle upturn. That means we still have a way before the cyclical factors that spell recession re-appear. How long isn’t yet clear and won’t be until the housing, muni, and European questions are answered and until we see what commodity price inflation means in terms of demand destruction.

      But in anticipation of election in the US and with this upswing, I am moderately bullish. Stocks are still overpriced on a secular basis and they have doubled from their lows in 2009. So I can’t see how we get a powerful rally here in US equities. There are markets that have done poorly which could rally like China or Brazil. There are a lot of high quality large cap, corporate bond and emerging-market plays that look good as well if you believe in cautious optimism.

  4. Jim R Mcgovern says

    Edward, I read a lot of financial blogs and find your analysis thought provoking and among the most insightful. However I am frustrated that even after reading so much analysis (here and elsewhere), I am still mostly perplexed with what to DO with my money.

    It would appear that bond yields likely will rise (so bond prices will fall). And that the US dollar, though it may strengthen a bit short term, will likely continue to weaken over time against most currencies as the Fed continues to print money and as we continue to run a significant trade deficit. And that most stocks, worldwide, are likely over-valued when looked at on a 10 year PE basis. etc etc. So I’m left thinking where the hell do I put my money that will generate a positive real return with an acceptable level of risk?

    Any chance you could focus a bit more on the “what to do” with one’s money? It seems to me that the value of analysis ultimately needs to be on prudent strategies going forward, not just on understanding what went wrong and why.

    Thanks,

    Jim McG.

    1. Edward Harrison says

      Jim,

      I just posted the first half of John Mauldin’s review for 2011, which I think is actionable. In my forecast, I made some calls on investing but had said I might flesh them out in a later post. My general view, though, is that we are in a mid-to-late cycle upturn. That means we still have a way before the cyclical factors that spell recession re-appear. How long isn’t yet clear and won’t be until the housing, muni, and European questions are answered and until we see what commodity price inflation means in terms of demand destruction.

      But in anticipation of election in the US and with this upswing, I am moderately bullish. Stocks are still overpriced on a secular basis and they have doubled from their lows in 2009. So I can’t see how we get a powerful rally here in US equities. There are markets that have done poorly which could rally like China or Brazil. There are a lot of high quality large cap, corporate bond and emerging-market plays that look good as well if you believe in cautious optimism.

  5. Stevie b. says

    Hi Ed
    Based on your excellent analysis, seems to me that someone with none should be buying gold in 1/3rds – at around $1275, $1175 and $1075 if they get the chance. Co-incidentally I think at least 1/3rd of one’s total liquid assets should be in coins in one’s own safe. I just pray the price falls to the lowest figure above as i’d add to my position first established over 35 years ago and never regretted.
    By the way, if it’s not a secret, how much gold do YOU have as a percent of your liquid assets, and are you happy with that percentage?

    1. Edward Harrison says

      I try to leave the precious metals stuff to the Casey Research guys Steve. But there’s no reason not to have as much as 15 or 20% in alternative assets. I think asset allocators suggest 5%.

  6. Stevie b. says

    Hi Ed
    Based on your excellent analysis, seems to me that someone with none should be buying gold in 1/3rds – at around $1275, $1175 and $1075 if they get the chance. Co-incidentally I think at least 1/3rd of one’s total liquid assets should be in coins in one’s own safe. I just pray the price falls to the lowest figure above as i’d add to my position first established over 35 years ago and never regretted.
    By the way, if it’s not a secret, how much gold do YOU have as a percent of your liquid assets, and are you happy with that percentage?

    1. Edward Harrison says

      I try to leave the precious metals stuff to the Casey Research guys Steve. But there’s no reason not to have as much as 15 or 20% in alternative assets. I think asset allocators suggest 5%.

  7. Philip Pilkington says

    One more thing – and I think this should have attention called to it, so I’m going to post it on both blogs, if you don’t mind.

    That table you ran is fascinating – I could spend hours discussing it – but one thing in particular struck me: the corporate profit rate which, according to the chart, has risen from 9.9% of GDP in 1960 to 11.1% in 2010. Now look at the financial corporation profit rate – its risen from 1.6% to 2.5% in the same period.

    These figures – in my opinion – are deeply misleading. They give a fudged impression of the real situation today – which is far more ominous. Why? Because more and more corporate profits come from… you guessed it: the financial sector.

    This graph is taken from Great Krippner’s paper on ‘Financialization’. She takes into account the overall contribution of the entire FIRE sector (finance, insurance and real estate) on the corporate profit rate:

    http://fixingtheeconomists.files.wordpress.com/2010/11/graph-3.jpg

    This, it would seem to me, is particularly important to consider today in light of what has been causing the economic problems – i.e. finance.

    For a short and fast summary of Krippner’s paper – and a link to the paper itself – have a look at my own article here (PLUG!!!):

    http://fixingtheeconomists.wordpress.com/2010/11/14/busted-the-fall-in-profits-and-the-rise-in-finance-part-iii/

    1. Edward Harrison says

      Thanks, Philip, that is a good catch, especially when estimates are that financial firms have contributed a large plurality of profits to the S&P500 as we have moved from the March 2009 lows.

  8. Philip Pilkington says

    One more thing – and I think this should have attention called to it, so I’m going to post it on both blogs, if you don’t mind.

    That table you ran is fascinating – I could spend hours discussing it – but one thing in particular struck me: the corporate profit rate which, according to the chart, has risen from 9.9% of GDP in 1960 to 11.1% in 2010. Now look at the financial corporation profit rate – its risen from 1.6% to 2.5% in the same period.

    These figures – in my opinion – are deeply misleading. They give a fudged impression of the real situation today – which is far more ominous. Why? Because more and more corporate profits come from… you guessed it: the financial sector.

    This graph is taken from Great Krippner’s paper on ‘Financialization’. She takes into account the overall contribution of the entire FIRE sector (finance, insurance and real estate) on the corporate profit rate:

    http://fixingtheeconomists.files.wordpress.com/2010/11/graph-3.jpg

    This, it would seem to me, is particularly important to consider today in light of what has been causing the economic problems – i.e. finance.

    For a short and fast summary of Krippner’s paper – and a link to the paper itself – have a look at my own article here (PLUG!!!):

    http://fixingtheeconomists.wordpress.com/2010/11/14/busted-the-fall-in-profits-and-the-rise-in-finance-part-iii/

    1. Edward Harrison says

      Thanks, Philip, that is a good catch, especially when estimates are that financial firms have contributed a large plurality of profits to the S&P500 as we have moved from the March 2009 lows.

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