Sunday, April 17, 2011

Raising Lazarus From the Dead?

Today is Palm Sunday, marking the beginning of Holy Week for the Orthodox Church. I'm not particularly religious but decided to stop off St-George church this afternoon to light a candle. Nobody was there; it was so peaceful and serene, just the way I like it when praying.

This morning I watched the American political shows, and then reflected on how mainstream media presents certain topics on the economy. Bear with me as I take you through some topics.

First, ABC's this Week discussed the Ryan budget, proposing $6 trillion in federal government spending cuts. I think Republicans are dreaming if they think they can pass these cuts. As far as all the fear mongering on raising the debt ceiling, I will bet with all the doomsayers out there that the US won't ever default on its debt.

And as far as raising US government revenues, there is any easy solution, it's called a value-added tax, better know as a goods and services tax (GST). Canadians and Europeans know all about it. It hasn't crimped Canada or Germany's growth. It's a fair tax because it's a consumption tax, therefore non-regressive. The rich are back, spending more than ever on luxury goods, so it's easier to tax what they're spending on than introduce more income taxes. (The smartest thing the Conservatives did in Canada was tax free savings accounts, TFSAs, and the dumbest was cut the GST by 2%).

I then watched Indra Nooyi, whom Fortune Magazine has listed as the most powerful businesswoman in the world for several years running, discuss her thoughts on a "blueprint" that brings manufacturing jobs back to the United States:

"We need to start somewhere. I think the first step is, create a blueprint for the country," Nooyi told CNN's "Fareed Zakaria GPS" in an interview that aired Sunday.

"I don't think worrying about the re-industrialization of America is a Republican issue or a Democratic issue. It's the country's issue," she added.

"There is an extremely qualified cadre of recently retired CEOs and C-suite (top-level) executives who can all be co-opted to help author this blueprint for the future."

Obama's Democrats have been sparring with opposition Republicans over how much government spending to slash this fiscal year, as part of a broader budget war and debate over how to rein in a runaway deficit.

The president, Nooyi said, should "forge these coalitions" that would lay out an economic framework for the coming decades that would highlight energy efficiency.

"I don't know if they can do it with an election year coming up (in 2012), but I think people can put their differences aside and worry about the country."

She acknowledged that such a project would take years, but said there were several short-term measures that could revitalize job creation in America, including slashing taxes on US subsidiaries that bring foreign profits back to the United States.

Some US firms are "trapped in overseas countries, because the tax rate to bring them back is extremely high," Nooyi said.

She suggested taxing repatriated money at 15 percent, compared to the top corporate rate of 35 percent -- a move she described as "a creative way to address unemployment without adding to the deficit."

In a report this year, the Association for Financial Professionals estimated that US firms had a total of $1 trillion in overseas cash and investments.

Should Washington lower the tax on repatriated profits, "the likely inflow of capital into the US would stimulate capital investment and hiring, contributing to economic recovery in the short run and economic growth in the long-term," according to the association.

I don't buy the argument that US corporate taxes are too high "trapping" profits abroad. As far as those retired CEOs and C-suite executives, bring them on, anything is better that that shameless self-promoter called Donald Trump (if he runs for office, it will be a gift to Obama).

Ms. Nooyi also talked about how Pepsico is now focusing on health conscious food. While I welcome this shift, it's too little too late. There will be a revolution in health conscious diets over the next decade in the US and elsewhere and if the Pepsicos and Coca Colas of this world aren't part of it, they will lose big.

But Ms. Nooyi is an impressive woman and she didn't get to where she is by being behind the curve. She is in a minority among Fortune 500 CEOs. She told Fareed Zakaria that she worked "her tail off" to get to where she is and her accomplishments should be a source of inspiration for all women.

On the economy, she said that "Bill Sixpack" is back, saying things are better but too many Americans feel uneasy with their economic prospects. As I stated above, things are great for the rich invested in stocks, not so great for the millions of unemployed or underemployed struggling to get by as food and energy prices keep creeping up.

This brings me to my other topic, inflation. Zero Hedge posted an interview with Jim Grant saying "there will be a lot of it suddenly". I got blasted for commenting that I don't see how inflation can take hold without wage inflation.

In an environment where corporate America has destroyed unions, kept wages low, cut jobs to shift them abroad, it's hard to see major inflation "all of a sudden". I know that inflation is rising in emerging markets, spurred by the Fed's aggressive policies, but let me share with you a comment from one of the smartest pension fund managers I know (we were discussing the Shadowstats figure pegging inflation in the US at 10%):

The guy from shadowstats may have some micro points, but he’s just plain nuts on the CPI. He added up every single potential adjustment to CPI, and says that all of them add up to a 6% (?) understatement. Thus his “True CPI” is (reported CPI + 6%).

Unfortunately, if CPI is “really” 8% per year for the past 10 years, vs. 2%, that compounds up to a huge gap. For example, that roughly implies that if you deflate nominal GDP by CPI, it’s been falling in “real terms”. Also, consumption would have to be contracting 3—4% on average over that period. But that flies in the face of actual volume data, which rose over the period. The only way his numbers make sense it that every other stat is being manipulated in a consistent manner to be in line with the CPI.

I have no worries about imported inflation, other than on oil/gasoline/food prices, but that’s still a relative price story. Oil prices fell in nominal terms from 1980-1998, but that did not stop inflation from rising steadily over the period. You cannot ignore wages, which are 70% of the cost of production. Unless wages rise, you can’t see price hikes sticking – by definition, volumes fall, and that will crush the price hikes. The only places you see imported inflation are countries like Iceland, where they import practically everything other than cod.

This pension fund manager is a sharp cookie. He reminded me in the late 1990s, everyone was short JGBs, waiting for the implosion of the Japanese bond market. There were back-up in yields, but over the next decade, JGBs beat out not only the Japanese stock market but the S&P 500 too. In other words, just because yields are low, doesn't mean that Treasuries can't outperform stocks on a risk-adjusted basis over the next decade.

The Fed is doing everything it can to reflate risk assets and introduce inflation back in the system. I've been writing about this ever since Operation AIG ("All In Goddammit"). There is only one thing that petrifies corporate America and bankers, a long protracted period of deflation. Demographics are terrible in Europe and Japan, and while growth is strong in emerging markets, the risks of deflation have not subsided. That's why I expect more liquidity to be pumped into the system. And with more liquidity will come more warnings from Inflationistas that we are doomed but all that will happen is more volatility in the financial markets which will benefit the financial oligarchs and the ultra wealthy. Hopefully some of that "wealth" will trickle down and start sustaining job growth.

That's the Fed's game plan and it hasn't changed. The big question is will the Fed succeed? Will it "raise Lazarus from the dead" and resuscitate the US economy? I honestly don't know, but I will tell you this much, they'll do whatever it takes to avoid debt deflation. That much I can guarantee you. Below, part of Fareed Zakaria's interview with Indra Nooyi.

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