Thinking Things Over

Musings on the Markets from Inside the Beltway

By John L. Chapman, Ph.D.                                                                                                       Volume I, No. 8    091111

In this note:

  • A word about September 11
  • Addendum to last week’s comment on Solyndra
  • President Obama’s speech, and its portrayal of the seminal intellectual error that will likely end his Presidency
  • Ben Bernanke: that other speech on Thursday

I.     A Thought about September 11, 2001

Whatever one thinks of our current ground war in Asia, it must be said that today is an anniversary of acts of unspeakable evil.  We would be remiss if we did not pause to salute the memory of those who lost their lives or were severely injured ten years ago today, and equally so, the more than 6,000 Americans killed in action — and 30,000+ severely wounded in combat — as a result of what happened on September 11, 2001.  This is not the place to discuss the merits or strategic prosecution of our long-running conflicts across Asia; we will leave that to others.  But we will say, the interested investor (or citizen) would do well to read Seven Deadly Scenarios,  by Lt. Colonel Andrew Krepinevich (US Army-Ret), for excellent thinking on where we are headed, and the defense challenges before us.  The furies unleashed ten years ago today actually had their core origin long before — there is a straight line from the birth of Israel to Tehran in 1979 to New York and Washington in 2001 and beyond — and will be with us for a long time to come.   As investors, we have to take this reality as a given, and thus the threats Colonel Krepinevich deftly outlines are very real.  How the U.S. prepares for and responds to any such eventuality will of course bear large in terms of how the economy performs in the years ahead.

But regardless of what may or may not happen in the future, and how well or poorly U.S. foreign policy has been designed or executed in the past, we honor those who died ten years ago, and those who suffered then and still may be today.  And we thank the men and women in our military and naval forces who serve their fellow citizens voluntarily in harm’s way.  Whether or not the policies and strategy delineating their combat activity have been correct, these soldiers, sailors, Marines, and airmen are selflessly serving a country whose origins lie in the taproots of individual liberty: this is, it must never be forgotten, a wholly unique occurrence in recorded human history.  Indeed it is the birth and growth and defense of individual liberty in this constitutional republic — which these men and women have volunteered to defend — that have brought us the marvel of modern civilization, and the fruits of an enormously productive economy based on the accumulation of capital and protection of the natural right  to private property.

The other salient point to note on today’s anniversary is that, as expensive as foreign wars are, they are not a primary cause of the present economic calamity into which we have swerved.  To be sure, critics of the war itself or its prosecution may have valid points on all counts, and there have been wasted or poorly used funds, including those lost to corrupt governments abroad; again, we will bypass that discussion here.  But the total marginal costs of our current conflicts on the Asian landmass, roughly $1.2 trillion at the moment across ten years, are of course only a single-digit minority percentage of total U.S. indebtedness.  Not insignificant, but not wholly significant and certainly not causal.  Indeed, defense spending as a percentage of GDP is half of what it was when JFK was inaugurated; and, defense was 50% of the federal budget then, but less than 20% now.  It has been the growth in entitlements that have more than anything else ballooned the federal budget and level of federal debt, and these have been fueled by the central bank’s monopoly control of U.S. currency and indeed our entire monetary system.  In any case, to the fallen of ten years ago, we salute their memory, and as to the evil existent in the modern world — against which, at some level, a defense must be mounted — res ipsa loquitur.

II.     Update on Solyndra

Last week we noted that the federal government-backed solar panel manufacturer, Solyndra, Inc. of Fremont, CA, a recipient of $535 million in federal loan guarantees (most all of it will likely be lost to the U.S. taxpayer), had announced its intent to declare for a Chapter 11 bankruptcy, which it did this week.  In an irony of timing, on the very day President Obama was to address the nation in part to push for more “green energy” investments, the FBI raided Solyndra headquarters: FBI spokesman Peter Lee said the investigation commenced following a request by Energy Department inspector general Gregory Friedman, who alleged that the department’s clean-energy loan program lacks “transparency and accountability”.  We confess that both the raid itself, and the reason for it, are as unsettling as the U.S. government now so actively becoming involved in picking industry winners and losers, about which we will have more to say over time, given its impact on investment in this country.

What we didn’t know at the time of our writing last week was that Tulsa billionaire investor George Kaiser, a backer of Solyndra, happens to be a major Democrat contributor who was an Obama “bundler” in 2008. And further, Mr. Kaiser made multiple visits to the White House in the months prior to Solyndra’s obtaining the $535 million loan from the Obama Administration in 2009.  This was the latest example of rent-seeking and cronyism out of Washington (certainly not confined to the present administration) that, as we have noted before, can only be deleterious to job creation and chilling in terms of corporate investment (we say “was the latest”, because just hours later Mr. Obama took to the airwaves and demanded still more of the same type of payments to favored constituencies and political allies, from teachers’ union members to more “green energy” companies).   What Mr. Obama and his advisors cannot seem to understand is how such actions affect entrepreneurial incentives for the large majority of firms who do not care to participate in the rent-seeking activities of the likes of Mr. Kaiser.  Perhaps this lack of discernment is at least remotely related to the fact that, as J.P Morgan & Co. has noted, so few of Mr. Obama’s advisors have much in the way of private sector or profit & loss management experience.  Regardless of the reason for the policy, however, it is yet another manifestation of the evils attendant upon government intervention in the form of taking from some and bestowing favors on others, who are hardly needy — who indeed often are so benefited because of the bought-and-paid-for connections they can leverage, as exemplified by Solyndra’s Mr. Kaiser.   And we use the term evil descriptively here, because the result is more unemployed and more hardship for those who may well be truly needy in a way Solyndra’s billionaire investor and other wealthy managers and backers are not.  One lodestar for a strong and sustainable recovery in the United States is when these terribly wrong (from the perspective of engendering economic growth) — and immoral — crony investments have met their end.  Because Solyndra, more than a poster-boy example of the failures of government stimulus, is a perfect exemplar of the sclerotic European welfare state economy that the U.S. government now seems so determined to import here.

III.     President Obama’s Speech to a Congressional Joint Session on September 8

President Obama spoke to the nation from Capitol Hill Thursday night, in a much ballyhooed address introducing his “American Jobs Act” legislation.  Mr. Obama introduced a $450 billion package of new spending programs, on new “infrastructure” ($105 billion for new “roads, bridges, and schools”), more teachers in classrooms, more investments in green energy, payroll tax cut extensions, extension of unemployment benefits, and cash incentives for businesses to hire unemployed workers (e.g., if a business hires a worker unemployed more than six months, a $4,000 one time tax credit is proffered to the hiring firm), along with the same if this firm decides to give pay raises to existing workers.  This latter plank, if it became law, would be tantamount to a direct give-away of taxpayer money to recipients who are already employed, yet who’d receive this one-time windfall thanks to the tax credit going to their employer — and it would be very hard to police any fraud with this, as the pay raise could easily be rescinded next year for, ostensibly, legitimate economic reasons.

Because the details of the proposed legislation will not be made available for at least another week, we were treated only to the general outlines Thursday night, along with the proviso that “every dime of this should be paid for” by the debt “supercommittee” now meeting, and due to report by Thanksgiving.  That is, Mr. Obama is counting on them finding an additional $450 billion in “savings” on top of their mandated $1.5 trillion;  or, in theory, a similar structure of mandated future cuts, set forth in the most recent debt ceiling legislation, could be made operative.

But in spite of the details, the much-anticipated speech earned “Bronx cheers” on Wall Street on Friday, with US equity markets off 2.7%.  It is true that news out of Germany, with the resignation of the European Central Bank’s chief economist (and sound money hawk) Juergen Stark, had led to a broad sell-off in Europe that portended the same, by degrees, in the U.S. on Friday.  And it is impossible to separate the two major news items, along with Ben Bernanke’s speech to the Economic Club of Minnesota (see below).  But we think the Obama speech was a major inflection point in any case, for what was not said more than what was.  In short:

  • For this writer, the Obama speech was a last chance for Mr. Obama to turn to an explicit pro-growth policy stance before electioneering hardens his political moves and strategy with respect to policy.  The U.S. economy is in an “underemployment equilibrium”, as it were, in the exact sense in which Keynes once famously described it: corporate America has achieved record profit growth and strong productivity gains without hiring idle labor, and in a situation where final consumer demand has settled at a level below where it would be if all resources were fully employed.  Thus there is, as Keynes said, “deficient aggregate demand”.  And to simplify it in Keynesian terms, firms do not want to hire workers because they see no marginal demand extant now or in the future, and workers do not want to buy the firms’ products because their income is down, or they fear for their jobs themselves, if they have one.  Further, both firms and workers are repairing their overly-leveraged balance sheets.
  • Mr. Obama had a primal opportunity Thursday night to break this sub-optimal equilibrium of inertia.  How best to do this?  How about elimination of the corporate income tax, which will only bring in $300 billion this year, coupled with a deep cut in marginal income rates to total another $200 billion — and couple this with $500 billion in immediate budget cuts?  For one thing, a $300 billion corporate tax elimination might be close to double the stimulant, because it would of course eliminate all compliance costs, said to be in the $300 billion range now.  And the profit explosion would have led to a soaring stock market and stronger dollar beginning immediately on Friday, instead of sharp losses.  This happy event, borne of new circumstances, would also have turned the U.S. into a magnet for foreign capital seeking a safe haven in an uncertain world.
  • But Mr. Obama cannot, for almost congenital reasons borne of deep intellectual commitment to an anti-capitalistic mentality, offer up a new policy mix which would in essence repudiate his entire term in office.  His proposals Thursday night, to the degree they see any light of day legislatively, are of course doomed to failure.  Why?  Because they repeat the ongoing policy error of engendering consumption and government spending and their necessary concomitant, the destruction of capital.   These funds, which have gone to government-mandated (and wasteful) programming such as Solyndra, Inc. are taken directly from entrepreneurs and business investors responding to the real identified needs of customers and markets in which for-profit operators are incited to discern opportunities to produce and sell.   As economist Robert Higgs has taken pains to repeatedly point out, personal consumption expenditures surpassed their pre-recession peak almost a year ago, and of course government spending on consumption and investment items is at an all time high.   So lack of spending is not the problem: to paraphrase James Carville, it’s the investment, stupid.  
  • Indeed, it is worth quoting Mr. Higgs at length, because this highlights the seminal error of the Obama economic policy set, and is one which will now likely doom his re-election chances:

“Gross private domestic fixed investment fell steeply after the second quarter of 2007, and in the second quarter of 2011 it remained 19 percent below its pre-recession peak (emphasis ours).  This figure fails to show how bad the investment situation really is, however, because the bulk of the investment spending now taking place is for what the accountants call the ”capital consumption allowance,” the amount estimated as necessary to compensate for the wear and tear and obsolescence of the existing capital stock.

“The key variable is net private domestic fixed investment—the investment that builds the productive private capital stock. Quarterly data through this year are not currently available…. but the annual data show that an index of its real amount peaked in 2006, fell substantially in each of the following three years, and recovered only slightly in 2010, when the index showed net private domestic fixed investment was running about 78 percent below its level in 2005 and 2006 (emphasis ours).  Here is the true reason for the recession’s persistence.”

  • Thus, as Higgs goes on to point out, private investors, despite the full recovery of real consumer spending and the dramatic increase of real government spending for final goods and services, obviously remain apprehensive about the future of new investments, especially new long-term investments.  And why are they apprehensive?  Clearly, the policies out of Washington in recent years have almost uniformly fostered this climate of fear: out of control spending (that ensures higher taxes and inflation), an out of control Federal Reserve, repeated threats of higher taxation, Obamacare, Dodd-Frank financial reform that has raised costs, environmental regulation, ignoring trade agreements promulgated years ago, and many other areas that have scared off investors from income-generating capital investment.

This was thus a major inflection point and high moment for the Obama Presidency: the chance to return to a pro-capitalistic, or better said, pro-capital formation, policy mix.  And the build-up of the speech in recent weeks led some to believe that there would be elements of pro-investment and pro-job creation policies announced, perhaps along the lines of the Simpson-Bowles Commission recommendations which the President had heretofore ignored.  Alas, it was not to be.  Mr. Obama persists in making a crucial error first pointed out long ago by the great French essayist and expert in political economy, Jean-Baptiste Say: spending is an effect, and not a cause, of economic growth and prosperity, in the main. Indeed, we produce, in order to consume.  The key to revivifying the American economy is to encourage production and output that supplies the incomes that in turn will lead to higher spending.  As Say himself said succinctly: production is the source of demand — and not spending, as Keynesian acolytes are wont to say.  Increasing production and output carry with them the source for incomes that in turn generate demand and spending.

This is why it is so maddening to hear voices from within this Administration, from the President on down, talk about, say, unemployment benefits as being a “major source of maintaining aggregate demand”.   And this is the origin for such wrong-headed policies as paying firms $4000 to in turn increase the pay of existing employees.   Because of this fundamental misunderstanding of the source of increased wealth and job creation, the U.S. economy will per force remain in a moribund state next year, and along with it, in high unemployment.   This refusal to change course, for one final time Thursday night, has likely guaranteed Mr. Obama’s exit on January 20, 2013.   We say this wistfully because we have rooted for Mr. Obama’s success in turning the economy around, albeit knowing it could only come from the President undergoing a “Nixon-to-China” moment on economic policy.  In closing on this point, we warn our readers to expect much more from us, ad nauseam, in the months ahead, on the policies and philosophy of Jean-Baptiste Say.  Say’s Law and its proper understanding and application hold the secret to our recovery today — and we take it as a sublime mission to have all of Washington one day chanting, Production is the source of demand. We produce in order to consume.  Spending is an effect, not a cause, of economic growth. Capital investment holds the key to sustainable recovery.   These, and other such mantras on policy, will be our constant refrain in the near term.

IV.     The Other Speech Last Thursday (Mr. Bernanke’s)

Fed Chairman Ben Bernanke spoke to the Economic Club of Minnesota  on Thursday, and while his careful remarks did not explicitly signal any new policy moves, he nonetheless, we believe, did exactly that implicitly.  Said Mr. Bernanke:

“There is ample room for debate about the appropriate size and role for the government in the longer term, but — in the absence of adequate demand from the private sector ­— a substantial fiscal consolidation in the shorter term could add to the headwinds facing economic growth and hiring (emphasis ours). ….I do not expect the long-run growth potential of the U.S. economy to be materially affected by the financial crisis and the recession if — and I stress, if — our country takes the necessary steps to secure the outcome.

“We have to do this in a way that is not disruptive to our financial markets; ….. [and we can, since] the United States is still a very rich country that has the money to pay its debts…. We need to work together to find solutions.”

What is the translation of this Bernanke-speak?  Sadly, Mr. Bernanke has signalled that he does not want to see spending cuts at the present time because, similar to the Keynesian blinders Mr. Obama wears per the above, the Fed Chairman believes (erroneously) that spending is a cause of demand and growth.  Further, he wants everyone in Washington “to work together” to create a path to long term fiscal sustainability, and this is an unambiguous endorsement of increasing taxes on the productive class in the United States, to be coupled by the Left’s agreeing to some budget reforms and spending cuts.    Mr. Bernanke went on to add:

“U.S. households seem ‘especially cautious’ in the present environment'”, and “are not helped by the continued slump in the housing sector….. Depressed construction has hurt providers of a wide range of goods and services related to housing and homebuilding, such as the household appliance and home furnishing industries”, a key part of any economic recovery.

Mr. Bernanke went on to hint that a “wide range of policy tools” still exists to help this fitful recovery with respect to housing, and hence there is perhaps no coincidence that there has been talk of more mortgage abatement programming in Washington in recent weeks, concurrent with the Fed’s purchase of more mortgage bond portfolios.

Finally, in response to a question after his speech about his definition of a “strong dollar”,  Chairman Bernanke reminded the questioner that dollar policy was the purview of the US Treasury, but that “stable consumer prices” were the main feature of a strong dollar.  U.S. equity markets ended the day down over 1% after absorbing this speech.

Why does all this cause us angst?  Very simply, because in the great divide between the “Reagan paradigm”  (of low marginal tax rates in income an capital, sound money that encourages long horizon investment, and less federal spending that can sap resources out of the productive private sector) and the “Obama paradigm” (of higher taxes on producers and entrepreneurs, higher federal spending that crowds out private investment, and a politically-managed currency that manipulates interest rates for short term reasons but distorts relative prices and investment patterns in the long run, to great harm), Mr. Bernanke reaffirmed his preference for the latter.

At a time when the U.S. debt rating has just been downgraded; Greece is on the road to a highly likely near-term default, taking (perhaps) Spain, Italy, Ireland, and Portugal along with it or close to same — thus throwing the Eurozone into further turmoil and extended recession, as well as affecting U.S. banks with Eurozone exposure to the tune of up to $1.2 trillion; U.S. productivity growth has slowed dramatically, meaning corporate profits in the U.S. seem likely to fall; and China and Japan have evinced cause for concern in recent weeks, it is imperative that the U.S. once again take the mantle of global economic leadership.  What is needed from the U.S. — and signalled as such from the Fed Chairman — is a strong dollar once again in which global investors have great faith, and more than anything else, will also lead to (and materially aid) a de facto recapitalization of the entire U.S. economy, whose households are $12 trillion poorer than they were just four years ago.    Instead, we heard two speeches Thursday afternoon and evening from the two most powerful economic figures in the world — and both essentially signalled, more of the same of recent policy.   As we have stated many times in recent months, there can be no recovery in the U.S. economy until there is a big shift in policy, as only these two men can most effectively and directly induce.  With Mr. Obama having in our view now passed a point of no return, we will look to his likely successor in 2013 for  needed changes — that might include, frankly, new leadership at the Federal Reserve.

Dr. Chapman is chief economist at Alhambra Investment Partners, and director of research at Hill & Cutler Company in Washington, D.C.  He and Alhambra founder Joe Calhoun are writing a book on investing and capital preservation in the current turbulent era. Chapman can be reached at  


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