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Goldman Sachs: The ECB Innovates With A ‘Creative New Policy Instrument’

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The ECB’s worst mistake is the lack of sensible PR. If the ECB were a regular company in the free market, it would quickly fire its PR agency and focus on solving its biggest problems. Even so, ECB’s policies are a lot better than its outdated, polit bureau-style PR strategies.
After all, the financial crisis started in the US with the subprime mortgage disaster. Moreover, it was Obama who got us embroiled in a stubborn and certainly avoidable political showdown with the GOP. As a result of President Obama’s strategic miscalculation, the U.S.–for the first time ever–lost its stellar AAA rating.
By now, the ECB seems to have learned its lesson. In today’s 24/7 news coverage, hyped up by the likes of Twitter and Facebook, slow ECB reactions—even smart ones—are always a tough sell. The next big effort to finally reign in interest rates may not occur in the sovereign bank or bank funding like most market analysts had predicted.

Instead, the ECB may tap the market for non-financial corporate bonds.
At least that is the opinion of the two renowned Goldman Sachs strategists Charles Himmelberg and Lofti Karoui. In an internal communication with clients they made the observation that obviously the ECB’s president Mario Draghi rejects the notion of a principle to deploy unlimited funds. After all, such a move would not only severely reduce the value of the Euro, but also mostly put the credibility of the Euro in question.
Hence, he and his team decided to deploy “creative new policy instruments” instead.

The ECB’s strategy—unlike its PR straight out of stone age–has already proven successful. The ECB’s long-term refinancing operations (a.k.a. LTRO) successfully strengthened the value of the Euro in the first quarter of 2012 by granting plenty of liquidity to Eurozone banks. They, in turn, re-invested these additional funds just in time to strategically drive down yields.

According to Goldman Sachs, the ECB could deploy the very same strategy to the non-financial private sector:

“The ECB could activate innovative policies that support the non-financial sector via direct purchases of corporate securities or possibly another LTRO modified in the direction of the Bank of England’s “funding for lending” scheme. Such policies would be consistent with a desire to support the private sector rather than encourage moral hazard by directly supporting sovereigns. Of course, like LTRO, but to a lesser degree, support for the non-financial private sector would flow back to the sovereigns via higher growth. But this is not the sort of sovereign support that runs a high risk of moral hazard.
President Draghi has not announced such policies, but in his remarks last week and again in yesterday’s press conference, he hinted that additional non-conventional measures are being considered. More importantly, we think, is the clear resistance – consistent with longstanding ECB policy – to providing any sort of unconditional support to sovereign markets.”

The takeaway from Goldman Sachs’ Charlie Himmelberg and Lofti Karoui is plain and simple: “we suspect that the market is under-pricing the possibility.”

According to Citibank, the LTRO is indeed efficient, but not without side effects. The most notable one is that “domestic banks, already heavily laden with domestic sovereign debt, make room to buy primary issuance by selling in the secondary market.” In plain English: LTRO yields may spike as result instead of dropping.

While Nouriel Roubini successfully keeps hitting the ECB for every real or perceived misstep, the reduction of red tape has not been an issue for the Obama administration. Ben Bernanke’s options are limited. As a self-proclaimed depression fighter, he will either keep the money supply steady or increase it. He is certainly in no hurry to reduce the money supply and let interest rates finally go up.

Well, unless Obama loses his re-election and Mitt Romney becomes President, that is. Ben Bernanke might then accidentally change the Fed’s ‘independent’ policy and follow Mitt Romney’s guidance to quit debasing the US Dollar. Do you really believe this can never happen? Think again. Alan Greenspan did the very same back in the early Bush years. Once his job was on the line, Greenspan was immediately willing to forget his own convictions and bow down to then-President G. W. Bush. Greenspan liked being the Chairman. This scenario could repeat itself.

Bernanke Claims the Fed Can Remove ‘Punch Bowl’ & Curb Inflation

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Federal Reserve Chairman Ben S. Bernanke was determined to assure lawmakers that the Fed can provide record stimulus and also limit inflation. He claimed that the Fed wouldn’t accept rising consumer prices in order to foster economic growth.

“It will be a similar pattern to what we’ve seen in previous episodes where the Fed cut rates, provided support for the recovery, and when the recovery reached a point of takeoff where it could support itself on its own, then the Fed pulled back, took away the punch bowl,” Bernanke told the House Financial Services Committee today in Washington.

[Read more…]

Breakup of the Euro? Germany Wants a Divorce

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After much initial hesitation, the Irish finally agreed on a “rescue package” over the previous weekend. At first glance it looks like the worst is behind them, but it’s not. Ireland’s public debt will now top out at 130%, so in plain English the fundamentals have not improved. Nonetheless, the ECB is trying to sell this latest “rescue package” as the ultimate solution, or “mission accomplished” if you will. The international loan which the ECB brokered grants Ireland an interest rate of 5.8%, but that’s only on the surface, since Ireland couldn’t repay the debt immediately without causing quite a stir of Irish discontent and frustration.
But well, Ireland’s generous lenders are anything but a good Samaritan driven by charitable motives. The international loan is first and foremost a good business deal for the international group of lenders.
The structure of the Irish deal has been cut out in a way that interest and principal payments the bondholders will add up to nearly 10% of the country’s national income.
This way, painful austerity measures across the board will become the ‘new normal’ for Ireland and this will translate at best to an anemic growth rate of near zero, or even worse, a harsh economic decline.
Without robust growth, the share of Ireland’s debt to GDP will keep growing and once the payments kick in, they will cripple the economy even further.
Also, drastic cost-cutting measures won’t be popular with the Irish constituency. The ECB and the German government have created a marketable “solution” driven by short-term populism instead of finding a sustainable and viable path to growth. The ink on the deal might not have yet dried when early next year the new Irish government could opt to reject the deal brokered by its predecessor.

A vicious cycle ahead for Ireland

In a pre-Euro era Ireland would go about devaluing its currency. But this option is no longer available to Ireland as a member of the Euro zone. The fact that the ECB, which is conveniently headquartered in Frankfurt, Germany, and the German government insisted on severe cuts is a clear sign of total ignorance of rather basic economic theory. Whoever is putting the Keynesian “paradox of thrift” to a test in the middle of the biggest recession in almost a century is in for a rude awakening. Austerity, while unavoidable in light of the current sentiment, will put a damper on the aggregate demand and choke off both consumption and economic growth. The more Ireland succeeds in cutting wages and costs the less the Irish will be able to spend (on German imports, too), the more Ireland’s GDP will fall. The more the GDP falls, the higher a share of it will be due bondholders. The higher the payments in relation to the national income, the more Ireland will have to tighten the belt to come up with the money, setting in motion a vicious cycle of ever more austerity.

Estland’s economy has recently shrunk by a whopping 30% following a similar self-imposed recipe for economic disaster. What makes the ECB think this scenario is not going to repeat itself and render the payment schedule all but obsolete?

Germany’s Chancellor Angela Merkel has reportedly announced that Germany was prepared to leave the Eurozone. So long as Germany keeps bankrolling the periphery, the periphery probably won’t mind.

Wal-Mart Restarts Growth Again: An Early Sign Of A Rebounding Economy?

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Wal-Mart (WMT) is among the most controversial U.S. companies.

Proudly American

Many American businesses fear Wal-Mart for its 10x force, to use Andrew S. Grove’s concept expressed in “Only the Paranoid Survive: How to Exploit the Crisis Points That Challenge Every Company”. Wal-Mart as a competitor is hard to beat and as a purchaser hard to swallow. Where a Wal-Mart is in business, foreign suppliers get a foot in the door while more pricey American companies frequently get the boot.

Wal-Mart is one of the very few American brick-and-mortar stores to have a shot at keeping successful e-commerce businesses like Amazon.com (AMZN) at bay. It is constantly driving down both prices and wages, its way of surviving the New Economy.

Wal-Mart was founded in 1962 by Sam Walton and, true to its beginnings, is still run as a thrifty family business. It is an American mainstay with a storied history, but why does it matter right now?

When the recession hit hard in the 3rd quarter of 2008, Wal-Mart was nearly the only safe haven for many Americans to lock in good deals and purchase those products they need at an all-time low price. The worse the recession got, the more Americans flooded Wal-Mart stores from coast to coast across the nation. An indicator that we have been through challenging times is the fact that Wal-Mart increased its sales by 4.7% annually on average since 2007. That’s a stunning and impressive performance because all the other competitors were hit hard by stinging and ever-growing losses since 2007.

Wal-Mart proved that conventional wisdom can be wrong and showed that investing in an U.S. retailer can actually be a rather prudent idea, if you get the timing right of course. Wal-Mart’s quarterly return rose from 20% to 22%. If it still doesn’t sound impressive please remember that the industry average is 18% and the S&P 500 average is laughable in comparison, just a meager 13%. On the plus side of Wal-Mart are three facts: WMT pays dividends, price-to-earnings is a reasonable 13, the cash flow multiple is 7.8 and its book value multiple is with 3.1 very much comparable with its industry peers.

The median price target for WMT is $60, which suggests that Wal-Mart is on track to return 9.5% over the next 12 months (excluding dividends). In general analysts are bullish about the Wal-Mart stock and a whopping 22, or 69% rate it a clear “buy”.

Where are the downsides for the WMT stock? Well, as WMT is very much a counter-cyclical stock in a case of very strong economic rebound this might lessen its appeal. but a strong rebound. But still, a strong economic rebound is most likely not yet in the cards by any stretch of imagination. But even in this unlikely scenario WMT could pull off healthy gains off the hat just by its sheer economies of scale.

While Wal-Mart is a truly American company from the heartland, it now stands to benefit from growth through small stores in countless new locations around the world. Wal-Mart now grows by being present in emerging markets such as Mexico, Brazil and of course China. Wal-Mart’s international sales rose an 7.3% and its operating income jumped by an impressive 17%. As the growth in our nation is predicted to stagnate for the foreseeable future, Wal-Mart is prepared to continue growing at a healthy rate due to its activities in emerging markets.

In a nutshell: Wal-Mart’s performance is a muted sign of a rebounding U.S. economy at best, because it derives most of its growth from emerging economies such as Mexico, Brazil and–you guessed it–China.

You can certainly chose to agree or disagree with Sam Walton, but the legacy of Sam Walton: Made In America still lives on, if mostly overseas.


How Rigid German Economic Policy Threatens The Stability of The Euro Zone And Scares Investors

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Back when initial plans for the common European currency were being drawn up, the United Kingdom was eager to be a part of it. However, it turned out rather differently. George Soros’s legendary speculative bet against the British Pound back in 1992 succeeded beyond his wildest expectations and forced Her Majesty’s government to leave the currency basket, dashing all hopes for a participation in the euro project. Today, both the British and the Europeans are living with the consequences.

Among the most fateful effects of Soros’ raid on the Bank of England is the fact that the European Union is not just dominated but practically controlled by the German-French axis. Today’s politicians in charge, German Chancellor Angela Merkel (once a physical chemistry researcher in the Communist-ruled Eastern Germany, who rose to power after re-unification on the heels of her political friendship with former Chancellor Helmut Kohl) and French President Nicolas Sarkozy, play nicely hand in hand. None understands the Keynesian paradox of thrift and no one in their entourage would dare to explain to them the sheer senslessness of their rough austerity prescription for PIIGS. Keynes was, after all, neither a German nor a Frenchman. He was British.

Since even the British cabinet of David Cameron has contracted the austerity virus, the European Union is committing a collective economic suicide.

The European Central Bank could provide some counterbalance, but it too is dominated by the French and the Germans with their chronic Mercantilism and acute austerity, courtesy of Soros’ successful speculation (you can read his account of it in Soros on Soros: Staying Ahead of the Curve).

There are a few brilliant economists who could pitch in and fix the mess in Europe, but they happen to be British-educated and you know how well that goes over in Frankfurt nowadays. If they can’t talk some reason into the Cameron cabinet how can they make any difference across the channel. Without a formal role at the ECB by the virtue of having a common currency, they can’t.

Take for example Willem Buiter (Professor of European Political Economy, London School of Economics and Political Science). He served on the Monetary Policy Committee of the Bank of England in the good ol’ days between 1997 and 2000, then he went on to work as Chief Economist and Special Counsellor to the President of the European Bank for Reconstruction and Development (2000 through 2005). You may have read his fascinating articles which used to be a highlight of the Financial Times. The Eurocrats should be bending backwards to have him run their economic affairs or sit on the monetary policy committee of the ECB. Instead he was hired by Citi in January 2010 and serves as Chief Economist from his office overlooking Canary Warf in London (at what is deemed a safe distance from Germany’s punitive tax laws).

Courtesy of the successful bet against the pound by George Soros back in 1992, British-educated economists and bankers are as welcome in Frankfurt as Greece is welcome to spend.

But British-educated economists are the ones who grasp the merits of a Keynesian intervention, something you cannot say about French or German educated ones. Thus a crude mix of Austrian School of Economics and Mercantilism is the only prescription the current breed of Eurocrats know how to write.

German Finance Minister Wolfgang Schäuble Hijacks European Economic Policy

In its latest power grab at an European summit in late October 2010, Germany managed to convince fellow members of the European Union to accept a rather imprudent new economic strategy, rushed through by Germany’s Finance Minister Wolfgang Schäuble. Members of the European Union decided to force investors in sovereign bonds to take losses as a precondition of future government bailouts. Bonds tanked immediately on the news.

The implications of this new policy are profound and won’t just hit countries like Portugal, Italy, Ireland, Greece and Spain (PIIGS). In the long run it will come back to haunt core EU members, including Germany and France. The problem is that at the time when Germany and France start to feel the effects of their own ill-conceived monetary and fiscal policies, they will have pushed the European Union into a lost decade of low growth to no growth or an outright economic decline.

Portugal might be forced to leave the Euro-Zone

Germany’s rough prescriptions for austerity will lead to a sharp rise in borrowing costs for weaker peripheral euro-zone governments (PIIGS). The biggest danger right now is Portugal’s political inability to push through the highly unpopular austerity cuts through the Portuguese Parliament. According to the Portuguese Foreign Minister Luis Amado, budget cuts of the magnitude ECB officials are demanding may force his country to leave the Eurozone.

In the pre-Euro era, the handling of a financial crisis would have been a lot easier for Portugal and the other PIIGS. At a time of economic upheaval troubled countries would devalue their currencies by printing more money and thus restore their competitiveness through lower labor costs in real terms (in Bernanke speak you might call it “quantative easing”; we are so good at it here in the U.S. that we have started round two already).

What To Expect: The Way Ahead

How Will The Portugal-Ireland-Crisis Play Out? There are three possible scenarios.

Scenario 1: A Quick Solution.

The best-case scenario: A swift and generous intervention. Don’t celebrate just yet, it won’t happen due to the lack of political backbone.

The best-case scenario–the ECB rushing to the rescue of Portugal–is getting increasingly unlikely. Even if the ECB were able and willing to quickly contain the Euro crisis created by Portugal’s budget problems, German and French politicians would derail it by resuming the usual bickering in order to gain political points. They frequently seem to compete for the title of best actor in the never-ending Greek tragedy of a common currency without a common bond market.

A quick solution of the Portugal-inflicted euro crisis is highly unlikely at this point and this means that the Euro will keep loosing value for now. This is a perfect opportunity for hedge funds to shorten the Euro big time.

Scenario 2: A Long Drawn-out Drama will be Averted At The Last Minute

The most likely scenario: A repeat of the Greek crisis.

The most likely scenario is the total escalation of the Portugal-Euro-Crisis until even the very last German or French citizen is fearing for the value of his or her euros so that German and French politicians finally feel compelled to rush to the rescue and push the ECB to intervene at the last moment. This represents an awesome chance for hedge funds, institutional investors and high-rolling speculators to make a quick buck.

Scenario 3: The Euro spins out of control

The worst-case scenario: European politicians and the ECB fail to avert the Euro crisis and Portugal leaves the Euro zone in disgrace.

The worst-case scenario would be a precedent of a euro zone member leaving the common currency. The Portuguese Parliament may not be able to agree–due to internal political pressure from its own constituency–to the demands of the white knight (the ECB) and is forced to leave the euro. While Portugal as a single country is initially too small to make a difference for the stability of the euro zone, it is certainly relevant enough to question the resolve of the ECB to promote a viable and trustworthy currency. Should this scenario unfold, the euro will never be the same again.

The European Complacency in Full Swing

In June 2010 Timothy Geithner had to complain about the European complacency in containing the crisis and had to push hard for European stress tests. After incurring big and most of all avoidable losses, European officials finally came around to implementing stress tests, but it took them far too long both for the taste of financial markets and rating agencies (and then the tests turned out to be meaningless). This time it’s not going to be any faster if at all.

In the worst-case scenario there would be no quick end in sight for the turbulent slide of the euro (one reason why this scenario is very unlikely), so speculators–unlike in the first and the second scenario–needn’t be concerned about when to quit their euro shortening. They will have plenty of time to head for the exits.

The Punch Line

You may remember the CIA video conference with top MI6 top brasses in James Bond: The World Is Not Enough, when M was told by her U.S. colleague rather bluntly:

“Bring your house in order… or we will do it for’ya.”

The reality is much more thrilling than what a Hollywood scriptwriter could dream up. The US Secretary of the Treasury, Timothy Geithner, will probably soon have another opportunity to tell his European counterparts not to sleep on the job.

In a nutshell: Speculators will have ample opportunity to shorten the Euro, again. It begets the question whether Europe intends to learn from past mistakes at all. And the answer is: Not if they can help it.

Please comment below.

The Writing Is On The Wall: Apple Is About To Terminate Pro Products And Loose Out To Android

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When Apple Computer Inc. renamed itself to Apple Inc. (AAPL), the majority of investors and users didn’t think much about it. Analysts quickly dismissed the idea that the new name would actually signify a change in strategy which would have profound implications as the events of the following years unfolded.

Apple used to make the very best professional Macs in its entire history back in the late 90’s, at a time when the company’s prospects were dire and the threat of disappearing into oblivion was still looming large over its Cupertino headquarters. But with the growing success of its consumer product line during the first decade of the new millenium, the days of Apple products geared at IT pros were counted.

A Case Of Think Different Gone Bad

In order to improve its public image and lay a claim to uniqueness, Apple created the rebellious ‘Think different’ campaign at the turn of the century. But the company did not see fit to walk the walk. It did the exact opposite: it introduced uniform compliance.

With the release of Mac OS X 10.5, the days of the brilliant Mac OS X creator Avadis Tevenian at Apple were counted. Soon after the OS hit the market, Tevenian was shown the door.

The ousting of Avadis Tevenian, the creator of Mac OS X, was the first sign of the ongoing disruptive changes behind the curtains. A cultural revolution, if you will, occurred at the company with the departure of a few other brilliant nonconformists. Then a new bread of totally compliant top brasses climbed to the helm of Apple (all eleven Apple executives are, purely coincidentally, Caucasian males) with the likes of Tim Cook and Bertrand Serle. Then they embarked on decision making to appease.

In case you wondered, at Cupertino headquarters there is only one valid opinion: the one of its admittedly brilliant and nonetheless human CEO Steve Jobs. Whoever managed to stay employed at the company could get ISO certified for compatibility withe the opinions of the Supreme Leader and compliance. So much for Think Different.

In public Apple may never admit, but inside the company, a total reorganization was going on beginning around the time of Tevenian’s departure. The first visible sign of a product strategy heavily skewed in favor of consumers was delivered by Apple on February 19th, 2008, when the Apple Xserve RAID was axed. Apple’s loyal customers were told to the Promise Vtrak instead.

Then on July 30 2009 Apple finally discontinued Apple Shake 4.1, a powerful motion effects software, after having lowered the price of the product in June 2006 to just $499 to silence protests.

The reality distortion field around Steve Jobs spinned in a way that there where no reasons at all to be concerned with the future of the company. As the sales of the iPod, iPad and finally iPhone went through the roof and money poured in, the company became all the more arrogant.

On A Mission To Perdition

Obviously, Apple is on a radical mission to terminate Apple Pro products and the next step has been announced already. According to Apple’s website, the company decided to discontinue sales of Apple Xserve on January 31 2011.

In the spirit of full disclosure: this post was written and edited on an Apple Mac Pro.


It’s not about reviving flame wars between Apple and Windows users. Let there be peace. But it is high time someone finally shed some light on the direction Apple is headed and most of all how it might impact your investments in AAPL.

There have been a couple of tactical decisions Apple made in designing its product line which point to a clear intent: not integrating a Blu-ray player into any Mac, refusing to include the mainstream display and the HDTV connection standard HDMI in any Mac (except for the Mac mini), dismissing other popular standards such as eSATA and USB 3.0 as irrelevant. But that’s not all.

You may still remember when Apple was selling Mac OS X 10.5 (a.k.a. Leopard), ZFS (the Zetabyte file system) was touted as one of the major new features of the upcoming Mac OS X 10.6 (Snow Leopard). This state-of-art file system, developed by Sun Microsystems, was supposed usher in a new era of data storage for Apple’s customers. In the meantime, Sun Microsystems was acquired by its former arch rival Oracle Inc. (ORCL). Did Oracle demand license fees for the use of its intellectual property? We don’t know for sure, but what we do know is that Apple axed the project.

But how do these rejectionist and obstructionist policies add up for Apple? Well, HDMI is for Apple of course a ‘bad’ standard simply because Apple would have to pay about 4 cents per connector in license fees. Besides whenever you attempt the futile task of connecting a non-Apple branded display to a Mac, Apple cashes in again: $29,95 (plus shipping and taxes) per each DVI-to-mini-DisplayPort adapter. The same goes for Blu-ray, adopting Blu-ray would mean Apple would have to pay license fees to the arch rival and Blu-ray inventor Sony and to the Blu-ray consortium. Steve Jobs reportedly referred to Blu-ray as a “bag of hurt” presumably due to these license fees.

Apple wants you to shop for music and videos in the Apple iTunes Store and not for Blu-rays at Walmart. This is understandable, but what about professionals in in the business of non-linear video editing and post production, how are they supposed to handle Blu-rays? Without ZFS, it is not clear how Apple intends to make the archaic Mac OS file system, HFS+ Extended Journaled, fit to handle the kind of data storage requirements which are the hallmark of digital media production. Without the Xserve, products such as Final Cut Server make little sense and users of Apple’s flagship video editing suite, Final Cut Studio, will be left in limbo without nodes for their Compressor clusters.

The biggest cash cow for Apple so far has been the iPhone 4. The neglect of all pro products by Apple was a direct consequence of the smashing success Apple has experienced with mobile devices. But that success, at least in the cell phone market, might prove short-lived.

According to Garner, Android has been gaining momentum aggressively over the course of the last few months. A lasting success of the Android platform would undermine Apple’s dominance in the mobile sector. But while Microsoft’s Windows 7 Phone is a long shot at best, and a desperate attempt to play catch up with Apple and Google, the Android platform is a serious contender which can challenge Apple successfully. Over the long run, Android has the potential to displace Apple’s iPhone from the pole position Apple believes it is entitled to. If you think this scenario can’t happen, think again. According to Gartner, Android and Symbian are poised to lead the mobile OS market in 2012.

All in all, it’s a kind of a Deja-vu. Back in the 1980s, Apple was the most admired computer maker, mainly because of the original Mac OS, well until Windows 3.11 challenged Apple and by the time Windows 95 (and the subsequent Windows editions 98/ME/2000/XP) hit the market, Apple was fighting for its survival. A very similar scenario seems to be unfolding before our eyes.

Like with Microsoft DOS/Windows and the PC revolution, Google’s Android OS has created an open eco-system for cell phones, which is populated by multiple device makers. Unlike the iOS, the Android OS does support Adobe Flash.

With Android Apple has a formidable challenger. After all, what made Microsoft Windows a smashing hit wasn’t its superior quality but a thriving Windows eco-system. It certainly looks like Apple Inc. is repeating its mistakes of the past by deliberately excluding everyone else from the playing field it invented and is poised to suffer the consequences. Again.

What it means for investors in a nutshell: AAPL might be overvalued and a decline could be in the cards.


Markets Expect Political Gridlock And Why It Could Actually Be A Good Thing

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Stocks priced in the Republican takeover in the House in the midterm elections. In the meantime, the results are nearly final.

 

In the light of the overreaching economic policies by team Obama, the sweeping losses of the Democrats and the stunning tsunami wave of the “dynamic duo” of TEA/GOP were clearly to be expected (if not long overdue). Whichever party warms their seats for too long at a time tends to get accustomed to the perks and corrupted by power. Unlike in 1994, this time around voters exercised restraint by rejecting some extremists in the Senate.

The Midterms in Numbers

Bi-Partisan Bickering Resumes

Why the Obama Stimulus Did Not Live Up To Its Economic Potential

Reverse Keynesianism (Or How to Bribe the Voter Base)

First Things First

On the Upside: We Will Not Become A Second Europe

The Midterms in Numbers

In the House, the Republicans gained a record 60 seats (with 11 seats still undecided). This gives the GOP 239 seats. That’s 21 above the majority threshold of 218. House Democrats had to accept a humbling defeat. They lost the gavel and 60 seats in the House (as of today). They will have to make do with just 185 votes.

 

The outcome in the Senate looks slightly better for the Democrats. Thanks to the victory of the Majority Leader, Senator Harry Reid (D-NV) and Senator Barbara Boxer (D-CA), the Democrats managed to hold on to their slim majority, albeit a razor-thin one. A majority of 52 Democratic seats in the Senate puts them barely above the threshold of 50. It is a majority only on paper. Anything less than 60 is not filibuster-proof.

Bi-Partisan Bickering Resumes

President Obama pledged to work with the Republicans, but why should they want to work with him now? Paying lip service to bipartisanship has no practical implications. It certainly simplifies the blame-game if you can pin failures on the “ruling” party. President Obama will face the choice between rejecting GOP bills–which have a free pass at least in the GOP-controlled House–only to be seen as an obstructionist. Or he can sign them into law and be seen as though he betrayed his Democratic base.

The GOP is in a far more comfortable position. The sweeping tidal wave of the midterms can be portrayed as a clear mandate to govern. The GOP will certainly pursue its vision of a much smaller government with lower spending. Whether they will retaliate by cutting Democratic pet causes or attempt a lasting reform remains to be seen.

On the economic front, the Republicans believe in Reagonomics, trickle-down-economics, and supply-side economics. They subscribe to tax cuts the main instrument of stimulating the economy.

Democrats used to have a clear agenda during the Bill Clinton years. Clinton enacted his own edition of Keynesian economics, championed today by the likes of Paul Krugman (the 2008 sole Nobel Price winner in Economic Sciences) and Joseph Stiglitz (a 2001 Nobel Price winner in Economic Sciences), but not by the current White House.

Why the Obama Stimulus Did Not Live Up To Its Economic Potential

John M. Keynes’ Depression-era General Theory of Employment, Interest and Money was aligned with the policies of the New Deal and delivered results, but is largely misunderstood today. It is not about big government mindlessly going on a spending spree with borrowed money. Keynes actually suggested that the government should run a surplus in good times to pay off the debt acquired in bad times. He also suggested the government should borrow and redistribute money in bad times to stimulate the economy by increasing aggregate demand. It should channel the spending through the hands of consumers who have the highest propensity to spend so that they actually do spend and prop up demand in the process.

Instead, we have been doing the exact opposite. We let the government borrow and wastefully spend on our behalf in fairly good economic times only to begin exercising demand-killing austerity in hard times. We let the government borrow and spend a mind-boggling amount of stimulus money on all things not “Keynesian” such as, ultimately, bank(st)er’s bonuses. As a result, banks don’t lend and consumers don’t spend.

We didn’t follow the Keynesian model but we like to criticize it for “not working”.

Reverse Keynesianism (Or How to Bribe the Voters)

We didn’t follow the Keynesian model, but honestly, we have yet to find a country which did. Not that it is not politically viable (exhibit A: the Clinton presidency).

Applying Keynesian theory in the good years and in bad would have worked so much better, but obviously that ship has sailed.

Instead, we squandered borrowed money on supposedly patriotic but rather pointless wars overseas. Some liberal Democrats argue (privately) that the most patriotic course of action would have been saving thousands of American lives and investing in the education of the next generation of Americans.

It would have been the right thing to do, but it’s such a hard sell. Instead many of us Americans were sold on the rather crude and simple ideas of G.W.Bush to save the (f)ailing economy through tax cuts. But the biggest expense of all are the costly wars we are fighting overseas. Obama has thankfully very much scaled down our engagement in Iraq, but it is still ongoing and draining our budget. On top of that, we kicked into higher gear in the war in Afghanistan and can’t really avoid going after terrorists in the nearby Pakistan. So we have three wars now.

Most Americans who voted for then-Senator and now President Barack Obama had three wishes in mind:

1) fixing the economy by creating an economic green energy boom (just like Bill Clinton did it with the dot.com boom in the 90’s)

2) ending all wars overseas, not just merely shifting the war from Iraq to Afghanistan/Pakistan; for parents and families of our men and women in uniform it does not make much of a difference whether their loved ones die in Iraq or in Afghanistan, they just want them safely here back home

3) ensuring that the U.S.A. remains the economic super power number one

In the light of a continuing economic slump–well technically were are not in a recession because two percent growth already qualifies as recovery– Americans of all political stripes and almost all walks of life are rightly disappointed with the state of the Union.

Former President Bill Clinton fixed the economy first. He created a sustainable recovery and a swinging boom but had to sacrifice his health care reform.

President Obama succeeded in what no US President has ever done: he did pass a “comprehensive health care reform”. But without money to pay for it, it is just paper and if it is enforced it will become yet another burden on the ailing economy. So, President Obama entered history books at the speed of light not only as the first President to win the Nobel Peace Price in 2009, he was also the first to sign a sweeping health care reform and a Financial Regulation bill (a.k.a FinReg or Frank-Dodd-Bill). But is he doing the job we hired him to do? You have to wonder whether ending the wars and restoring American economic greatness is anywhere on his agenda right now.

Many political analysts argue that the Nobel Price so early in his Presidency was more of a decisive vote against G.W. Bush then a vote in favor of Obama. Even so, the Nobel Price didn’t make Middle East negotiations between Israel and Palestine any easier. We can only hope for peace in this difficult conflict regardless.

One thing is for sure, a health care reform which covers an additional 30 millions of Americans is certainly laudable even though in its current form it is an economic suicide. Former President Bill Clinton managed to pull off an economic recovery (made possible by the dot com boom) because he put it first, ahead of everything else. President Barack Obama hired his economic team and then pretty much left it up to them while he himself hurried to do too much in too little time on other fronts.

First Things First

Pay-as-you-go was one of the pillars of Bill Clinton’s economic policies. Picking the very same economic advisors as Bill Clinton did has two downsides: it doesn’t qualify as change (unless you compare it to former President Bush’s team) and it creates fertile ground for unfavorable comparisons.

Hammering the Clintons on lack of judgment was a short-lived popularity stunt. It would have worked if the one who claimed superior judgement had actually succeeded in re-starting the economic engine. Nearly 10% unemployment is certainly not what voters expected.

And what about the Stimulus Bill (and Bush’s tax cuts)? Well, for starters, tax cuts are quite pointless so long as people are unemployed. There is nothing to cut for jobless Americans! Is there?
Obama’s stimulus bill wasn’t such a bad idea in general, but the practical implementation was “above his pay grade” as even many Democrats argue behind closed doors.

Saving the banks and preventing the Great Recession from turning into Great Depression 2.0 was no doubt the right course of action, but–now comes the caveat–most of the money went straight to the banks without any requirements to lend it. The upside was the banks were able to pay TARP loans back quickly with interest, but the downside was that banks don’t lend right now and won’t lend in the foreseeable future. This defies the very idea of the Stimulus Bill.

Keynesians point out that in order to get “the biggest bang for the buck” (in Obama speak) requires that the money flows to those consumers who have the highest propensity to spend (which is another way of saying that people with low income have no choice but to spend nearly all the money which goes through their hands; there is obviously no way around paying for these people and address their basic needs like shelter and food to avoid a spike in crime).

The biggest returns–or shall we say in Obama speak “the biggest bang for the buck”–delivered programs such as “Cash for Clunkers” and the Federal Housing Tax Credit ($8,000 for first-time home buyers).

If most of the $767 Billion of stimulus spending had gone through the hands of the middle class instead of filling bank vaults and gathering dust there, the very same amount of stimulus would have created a sustainable recovery. But instead, we went the route of saving the banks and nobody but the banks.

On The Upside: We Will Not Become A Second Europe

As President Barack Obama’s economic policy is turning into an utter failure and disintegrating as we speak, we are about to swiftly shift–under the leadership of the GOP–from a bad economic policy to a worse one: austerity. Harsh austerity is a misguided idea of the Austrian School of Economics, widely practiced in Europe under Germany’s “leadership”. It didn’t work in over-regulated and over-taxed Europe, why should it work here in the USA? It won’t.

But political gridlock may actually turn out to be a good thing.

High taxes in Europe and the U.K. did not result in more economic prosperity but to two dreaded B-words: “barter & bribery”. In this environment, deals are made behind closed doors where money does not change hands and favors are “tax-free”. In the UK, Belgium, France, Germany and Scandinavia up to one in four individuals in the workforce either don’t work at all or they only work as little as possible in order to still qualify for government hand-outs. And the few businesses which still thrive pay a flat wage of 400 Euros per month. This is about 565 US Dollars per month. Many bigger corporations abuse students as low-cost labor because they can employ them without social security contributions and with minimal contributions to the health care system. They only have to fire them before they acquire protection after a two year employment. Barter deals among befriended corporations are widespread as a means of dodging high taxes. They range from swapping ads in a print magazine in exchange for services to sophisticated accounting gimmicks.

VAT tax rates in Europe were initially introduced at a seemingly harmless rate of slightly above 10 percent. Give the government a finger and it will take the whole hand and ask for the leg. VAT tax rates have been hiked across Europe many times over the years. Now a VAT tax between 20 and 25% is no exception.

Some countries such as Poland adopted mechanisms for fully automated VAT tax increases which are triggered whenever the deficit exceeds a predefined quota. This ensures that no one has the slightest incentive to make any corrections. And only few people have any incentive to work.

The Austrian School of Economics, peppered with a lot of red tape straight out of Brussels, is a toxic cocktail which made Europe the laughing stock of developed countries.

Between 40% and 50% of the budget of the European Union is earmarked as government subsidies for agriculture, but only one in four Euros trickle all the way through to the actual farmers. But even so, this is a lot of money given that farmers constitute only a mere 3% of the population. What happens with the remainder of agricultural subsidies? The rest of the subsidies is swallowed by red tape and other inefficiencies. E.U.’s disastrous CAP policy (Common Agricultural Policy) has given China a head-start as an economic powerhouse. Only recently did European nations decide to pull the plug on subsidies for China. (This is not a typo. The Europeans used to subsidize the growth of China through direct donations.)

So all in all, the midterms may well prove to have been worth the hassle of casting a vote, even though voters clearly took chances with some more radical newcomers to the House and the Senate. If by doing so we averted a VAT tax and prevented the country we love from becoming a second Europe, then it was certainly worth it.

Please comment below.

Why The Fed’s Adventures With U.S. Government Debt and China’s Interest In Natural Resources Could Flare Up Inflation

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The Fed has recently announced QEII (quantitative easing two, named like this in fond memory of QEI, which has saved us from a re-run of the Great Depression at the onset of this financial crisis). Could this be a hint at China’s growing reluctance towards investing in U.S. treasuries? Given current low yields, it seems reasonable to assume the Chinese aren’t thrilled.

Our biggest trading partner China has been by far the biggest investor in long-term U.S. government debt, as it needed a safe haven to bank its mounting trade surpluses. Should China seriously shift its focus towards buying up natural resources such as energy, rare metals (needed to manufacture technology products) and commodities, we would be looking at inflation at some point down the road.

If we do contract inflation, the Fed will be forced to resort to a contractionary monetary policy with higher interest rates.

This would bring the stuttering U.S. economy to an instant halt.


Midterm Elections 2010: Is It A Time to Buy Stocks?

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The midterm elections will set the the stage for a major power redistribution in Washington. Now that Democrats and Republicans are in the final stretch of the midterms, a much-anticipated Wall Street rally is in the air.

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The Balance Of Power Is About to Shift And With it The Economic Policy

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On Friday, Chairman Ben Bernanke reassured investors that the FED is prepared to take new action in order to stimulate the economy. According to Bernanke the economy is still too weak, inflation is too low and worst of all the unemployment rate is stubbornly high. But Bernanke also expressed some unease about too much quantitative easing in round two (dubbed QEII), that it might prove counterproductive, but he also noted that QEII is for the time being the way to go.

While no one doubts Ben Bernanke’s personal conviction as to the apparent unavoidability of QEII at this point, the question is not whether there will be some QE but how much QE is in the best interest of our country. While the markets are up mostly because Ben Bernanke’s positive attitude fired investors up, for real action investors will have to wait until the next policy meeting of the FED on Nov. 2nd and 3rd. By the latter date we will know the outcome of the midterm elections. This is the real joker.

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