Kudlow' Bad Predictions Not By Chance

Those familiar with Larry Kudlow know his poor track record in predicting the economy and stock market.  He was predicting the continued growth of tech stocks until the market crashed in 2001.  In December 2007 he wrote a column predicting that the "Bush Boom" would continue.  He criticized those who were predicting recession saying that they would have egg on their faces.  In 2009 he predicted a V-shaped recovery for the U.S. economy.  Then in 2010 he predicted high inflation and a stock market decline as a result of the Fed's QE2.

His most recent prediction provides a little insight into why his track record is so poor http://tinyurl.com/3gnsdml  In May of 2011 the stock market which had been rising since spring 2009 began to decline.  It declined about 7% from May 1 through mid-June.  Meanwhile negative economic news permeated the airwaves.  Economic growth has declined in the first quarter.  Disappointing jobs reports.  The unemployment rate increased.  The housing market had made a double dip.

But on June 14, the Dow Jones Industrial Average increased a little over 100 points.  Based on that one day fluctuation Kudlow predicted that the stock market correction was over.  He went fishing for some data to support his conclusion.  He found that retail sales increased a few tenths of a percent and that retail sales and production in China increased somewhat.  So based on that he's predicting a better economy and an end to the recent decline in the stock market.

We've got a slowly growing economy.  The unemployment rate has just increased.  The number of jobs created is anemic.  A large percentage of homes are in some state of foreclosure.  An even larger percentage of homes are behind in the mortgage payments and/or underwater.  The home construction industry has almost ground to a halt.  Plumbers, electricians and carpenters are out of work by the millions.  Consumer debt is near its all-time high.  And based on a one day fluctuation and one month's worth of retail sales data, Kudlow is predicting a reversal of a two month long stock market decline.

Jerry Bowyer is an Idiot

In a recent opinion column http://tinyurl.com/2az9y4b published by Forbes, Jerry Bowyer decries the value of a college education in the United States. He calls it a “higher education bubble”. Bowyer contends that “higher education shows every reasonable sign of having a completely unrealistic, astronomical price tag” and that those that argue the benefits of higher education are irrational.

The return on investment of a college degree varies by school, subject of study, gender, race, geographic location and other factors, and the value of a college degree is an ongoing debate. Unfortunately, Bowyer’s submission provides absolutely no valuable contribution to the debate.

First, rather than performing a cost/benefit analysis (i.e. computing the cost and comparing it to the expected benefits), Bowyer calculates a Price/Earnings ratio. The P/E ratio is one of many analytical tools used to evaluate securities whereby the price of the stock is compared to the corporation’s most recent earnings. It’s a simple calculation that can be used to compare stocks of many corporations. Up until now, no one has been stupid enough to think that P/E ratios are useful comparing the relative value of stock to a college education.

Second, Bowyer blatantly overestimates the “P”. In estimating the cost of college, Bowyer makes convenient assumptions that overstate the cost. A typical bachelor’s degree program is designed for four years of study. Bowyers claims that on average students take six years to complete a four year program. He claims he got this from a book entitled “The Five-Year Party”. He says this is because students increasingly drop classes late in the term to avoid failing grades.

And in calculating the “E” part of the equation, Bowyers is equally unfair. For the “E”, Bowyer uses the increase in earnings only for the first year out of college. He calculated that the increase in earnings due to a college degree is only $2,000 for the first year and that the P/E Ratio is 100. Coca-Cola stock P/E is around 20. Microsoft is less than that. Bowyer’s conclusion: An investment in a college degree “doesn’t look very attractive”.

Because one statistic is not sufficient to analyze an investment in a security, investors use dozens of statistics and trends in statistics and audited financial data. Bowyer uses manipulated inputs to one convenient statistic to draw his conclusion that it “doesn’t look very attractive”.

But a P/E Ratio is a stupid way to evaluate a long-term investment. When a business decides to invest in equipment, they don’t compare the cost to what the income would be for the first year. They compare the cost to the present value of the expected income stream and calculate the return on investment. For a college degree, that’s already been done.

Not only has it been done, but PayScale estimated the return on investment for hundreds of institutions http://tinyurl.com/29r7ah4 Using the same inputs used by Bowyer (only they used actual inputs, i.e. actual cost, actual earnings of graduates), they estimated returns on

investment for four-year college degrees. The returns vary from as high as 12.6% (How’s that, Jerry?) to 4.3%.  But not all college degrees are alike.  Not only do the returns vary by school, but they also vary by field of study.  Someone who studies accounting will get a higher return on their investment than someone who studies 18th century French poetry.  And the inputs are not just financial.  Someone who works hard will realize a better return than someone who parties and drops classes.

Figures can be manipulated. A clever hack can manipulate one statistic to support a pre-drawn conclusion. Jerry Bowyer seems to be in the habit of doing it. 

Dishonest Kudlow

Sometimes in church you'll hear a preacher preach on a passage.  Romans chapter 8 is a good passage.  "Therefore, there is now no condemnation for those who are in Christ Jesus..."  It's a beautiful passage.  Sometimes a preacher will preach on a subject like wealth or something.  When they do it this way, you can take a verse out of context and/or twist it, and you can make it seem like the Bible supports almost anything you want to say.  It's not a new approach.  Peter spoke of it: "[Paul's] letters contain some things that are hard to understand, which ignorant and unstable people distort, as they do the other Scriptures, to their own destruction."

This deceitful tactic isn't limited to just scripture interpretation.  It's very common in politics and economics.  You can approach things in two ways: 1. Evaluate the information and draw conclusions based on said information, or 2. Start with a conclusion and then search the data for something that seems to reinforce your pre-drawn conclusion. Larry Kudlow commits this offense in a recent column: http://tinyurl.com/28ckp2g

For as long as I can remember, Kudlow has lauded the market.  The market consists of millions of investors who make decisions based on available information.  Millions of brains working together are smarter than a handful of government bureaucrats so Kudlow claims that the movement of the market is the best measure to evaluate economic and political news as well as government decisions.  For the past year or more, Kudlow has been criticizing the Fed's easy money policy claiming that it will result in high inflation which is detrimental to the economy despite the fact that the market has been increasing.

Last week the Fed announced that it will intensify its easy money policy buying hundreds of billions of dollars in bonds.  Investors were anticipating this announcement by the Fed which came Wednesday afternoon, but no one was sure about how much the Fed was going to put down.  The market showed little change during the first part of the week as investors awaited news of the Fed's decison.  Monday, Tuesday and Wednesday the markets barely moved.  The Fed announced its plans Wednesday after the market closed.  On Thursday morning, markets around the world shot up; the Dow gained nearly a hundred points right after opening.

An objective observer might tend to suspect that this sudden distinct rise in world markets was a result of the Fed's action.  But not Kudlow.

Kudlow had been lauding that the Fed's easy money policy was bad for the economy.  Intensifying this policy in Kudlow's eyes would be even more detrimental to the economy.  Kudlow's perfect market belief demands that the market would tank as a result of the Fed's Wednesday afternoon announcement.  When markets shot up immediately after the Fed's announcement, this conflicted with Kudlow's belief system.  But rather than evaluate his theories based on available information, Kudlow searched for something that would support his pre-conceived beliefs.

He found it in a White House press briefing on Thursday, November 4.  White House Press Secretary Robert Gibbs said that the Obama administration is “open” to negotiations on temporarily extending tax cuts for upper- income individuals to win extensions for middle-income families.  Kudlow used the White House's openness to negotiating tax cuts for the wealthy as the reason the market increased.

Kudlow's problem is that Gibbs' announcement came AFTER the markets shot up.  Gibbs' announcement was on the same day so Kudlow might have been able to convince himself and his ignorant fan base, but inquiring minds who investigated Kudlow's claims know that markets had already been rising significantly prior to Gibb's announcement.

Walter Williams Exploits Economic Ignorance: Tax Incidence

Walter Williams writes a column http://tinyurl.com/27yznyt on tax incidence and explains that politicians exploit the ignorance of the voters with respect to tax incidence. In the column, Williams commits the same offense that he decries.

Williams correctly explains that a tax is not necessarily borne by the entity on which it is levied. A tax on gasoline retailers is borne partially by consumers and partially by producers (i.e. employees or owners of the business). Either way, explains Williams, the tax is eventually borne by people, not corporations. Williams explains this to emphasize the point that President Obama's expressed intent to tax businesses will not be paid by said businesses but will be paid eventually by people, some rich and some not-so-rich.

Williams is correct in that a tax on business income ultimately is paid from the pockets of people. But he conveniently leaves out the rest of the story. What would be the result of not assessing a tax on business income? The result would be a subsidy. But that's good. Right? Shouldn't we be subsidizing business?

When the costs are not properly matched with an activity, it results in a subsidy to said activity thereby producing more of said activity than is best for society. It results in an inefficient allocation of resources. For example, there was a show on TV where a kid started a burrito business. He used his mom's credit to purchase the ingredients, prepared the burritos in his mom's kitchen and then sold them to his classmates. Without having to pay for the ingredients, the kid was making a good profit. The business was subsidized. The problem came when his mom noticed the charges. When the costs of the ingredients were considered, the boy's business was actually not profitable. In fact, the family lost money.

But taxes don't reflect a cost of a business. A tax is just the government taking what rightfully belongs to the business, people argue. Not so fast.

The purpose of tax is to provide funds for public goods. An example of a public good is a road. People drive on the road. Similar public goods are police, national defense and courts. It's possible to put up a toll booth at every intersection to pay for the upkeep of each road, but it's not practical. It's more efficient to get the money to pay for roads from taxes. Similarly, it's more efficient to pay for national defense through taxes. It's just not possible to calculate how much each person benefits from national defense and send them a bill.

Corporations use these public goods when conducting business. Corporations benefit from roads. Trucks transport goods on public roads. Workers commute on said public roads. Businesses benefit from public education by having an educated workforce. Thanks to Social Security and Medicare workers don't demand as much pay or retirement benefits thereby resulting in the government picking up the tab for a portion of worker compensation. Safe shipping lanes exist courtesy of our armed forces. Courts enforce contracts. Police provide safe neighborhoods thereby facilitating business.

The free market matches expenses with actions. If you want an ice cream cone, then you pay for an ice cream cone. A decision is made. I want that ice cream cone more than I want that money. With government provided goods, that decision is not made. The road is there. It's free. I can drive on it, and my action of using that road does not result in any additional cost to me.

In an ideal situation, the costs of something would be paid for by those benefiting. Because corporations and other businesses benefit from public goods, a tax is levied on their income. Theoretically the higher the income the more the entity benefits from the public goods. Thus, the higher their income, then the higher tax they pay.

But what's so bad about subsidizing business? It's still good to subsidize business, isn't it? A business that is not profitable, that is propped up by taxpayers is a drain on society. Subsidies for steel manufacturers sucked blood out of consumers and taxpayers for decades. The unprofitable steel companies avoided making necessary changes to make their businesses more efficient. Those that couldn't survive went bankrupt anyway leaving creditors holding millions in unpaid debt, leaving employees without jobs and retirees without their pensions.

Look at the auto companies. Bailout after subsidy after preferential tax treatment permitted the auto companies to overpay workers and fold to pressure from unions and make promises of post-retirement benefits that they had no way of paying. They've been struggling for decades, and subsidies have permitted them to continue their inefficient ways of doing business.

Another example is the homebuilding industry. The mortgage interest deduction provided a tax incentive, and there have been and still are plenty of other artificial government subsidies to the homebuilding industry. It created a bubble, artificially inflated home prices and profits for homebuilders, and allocated resources towards building houses that could have been allocated to more efficient uses (like building apartments).

Walter Williams wants his readers to believe that it doesn't matter who pays the tax. Individuals ultimately pay the tax anyway. But the absence of a tax directly on corporate income exaggerates corporate income thereby permitting unprofitable businesses to continue to suck blood out of society thereby resulting in an inefficient allocation of resources. 

Supply Side Ignorance

“It” Is a Fiscal Problem

http://tinyurl.com/2dgo3qm
In Kudlow’s analysis of “the problem”, he is unable to look beyond the government. If it’s not a monetary problem, then it must be fiscal problem, concludes Kudlow. It never occurred to him that “the problem” might not be with the government. Maybe the worldwide recession isn’t a result of U.S. government tax rates but an imbalance that had been growing for decades. Maybe the fact that consumers are swamped in consumer debt has something to do with it. Maybe the fact that many homeowners are underwater in their mortgages has something to do with the sluggish recovery.

Kudlow calls himself a “supply-sider”. Like many supply-siders, Kudlow believes that the only engine of the economy is the supply side. Supply-Side Godfather Arthur Laffer writes in a recent book that demand is not a problem. There is never any lack of demand even in poor countries like Bangladesh. The problem is supply. I’d like to see Laffer open up a BMW dealership in a Bangladesh slum and see how high the demand is there.

Whether it fits your pre-drawn conclusions about economic growth or not, consumer demand has been a major engine in not just the U.S. economy but the world economy over the past decade. Look at China. Its double-digit economic growth over the past decade is a result primarily of producing products to be sold in the U.S. and European markets. In the past couple of years as U.S. consumers reduced consumption so much due to high debt levels that China’s economic growth has decreased considerably.

Back in 2002 after September 11 the Fed reduced interest rates to spur the economy. Consumers were able to borrow at extremely low interest rates to fund consumption. Auto dealerships were providing loans at zero percent interest rates. Then housing boomed. Low interest mortgages permitted people to buy more house for less monthly payments. The construction industry boomed as a result of this along with real estate brokers, mortgage brokers, the lending industry and title attorneys. This was all spurred by high demand. As housing values increased, homeowners were able to get low interest home equity loans to finance even more spending thereby fueling electronic, travel and tourism and other industries. President Bush reducing the top personal income tax bracket from 39% to 36% probably had very little to do with the booming economy of the mid-00s.

Then it crashed starting with home values. Those who has low interest adjustable mortgages saw the interest rates on their mortgages adjust upwards. People were able to refinance until real estate values tanked. Then they were stuck with high monthly payments. As real estate values tanked nationwide, consumers lost trillions in wealth. They reduced consumer spending considerably. No more new cars. No more big screen TVs. No expensive cruises or vacations. No new decks or new bathrooms or remodeling.

This is what caused the current depression, and the same parameters exist today. Millions of homeowners are underwater in their mortgages. Millions of people are unemployed. People who are employed are saving just in case they lose their jobs as business and local governments are strapped and looking for areas to cut.

The problem is not monetary. The problem was not caused or worsened by government fiscal inputs. The problem was and is a demand side problem and requires a demand side solution. It’s basically a hole, a deep, wide hole that’s going to take years to turn around and decades to recover from. Those that think that the economy rises and falls based on supply side factors only are only seeing half the picture.