Hot Summer Mailbag
Perhaps the best part of being a writer is the chance to interact
with readers. I can’t tell you how much I’ve learned from you over the years.
Whether it’s through our online comment threads or emails or conversations in
the hallway at a conference, nothing pleases me more than to share thoughts
with you. The exchanges are always stimulating, even when we disagree. Believe
it or not, I make a special point to read those who disagree with me if they
come armed with cogent thoughts. And I will admit to changing my mind at times.
Or at least softening my position. I know many of you think I have too much
going on to take time to read your comments, but I make it a priority.
Today I am at Camp Kotok in a remote area of Maine where
connectivity (the electronic kind) is limited. Rather than try to write a
regular letter, I decided to hand the keyboard over to you – or at least to a
few readers like you. I went through the feedback to my last few letters and
picked some comments to share and respond to. These are a small fraction of the
feedback we received, so forgive me if I omitted your brilliant submission! And
because I want to get to the Camp Kotok opening reception in a bit, this letter
will be shorter than usual.
Photo: Kevin Baird via Flickr
But first, a quick request. I had a visit with an ear specialist
(ENT) about three years ago, a doctor whose office is near Baylor Hospital. I
have lost track of his name, but I really need to see him again. I know he was
a long-time reader. If you recognize yourself here, would you please get in
touch with me? Thanks. Now to the comments.
First, a follow-up to last week’s note about Google email
delivery. Reader Thomas
Hurley sent this advice for other Gmail users:
Dealing with Gmail is not extremely hard.
First, decide that you are smarter than Google and only have one category:
PRIMARY. I never, ever let Google decide where to put my email except for Spam,
which I do review because they make mistakes. But if I tell them that something
is NOT SPAM, then that mail goes into the Inbox in the future.
Under SETTINGS set INBOX TYPE to DEFAULT. Under
CATEGORIES check PRIMARY and uncheck all the rest so that there is only one
Inbox except for SPAM. Final optional step is to open a Mauldin Economics email
and then click on the Labels icon at the top of the page and create an icon.
All future emails will still go into the Inbox but will also show up under that
label for quicker identification. Additionally, one might sort for Mauldin
Economics, and in that case I can add the Label MAULDIN ECONOMICS to 100 past
emails at a time.
I hope that advice helps. Our Mauldin Economics tech team tells me
that email delivery is a never-ending battle. Email providers constantly tweak
their algorithms to screen out junk, and we occasionally get caught in their
dragnets. You can always point your browser to mauldineconomics.com,
where you will see links to our last few articles on the home page to see if
you are missing the letters we send. If you find that you are, just resubmit
your name, and the team will get you back on the list. And check your filters
and firewalls – you may be missing a lot of things you would prefer to have.
Now, on with the mail.
This comment came in response to my July 22 “Three
Black Swans“ letter:
Gas prices – what role has this played in the
economy? Seems to me that inflation for the masses is good and bad for the
government. Deflation is good for those who save and bad for those who spend.
What person wants to pay more for goods? What I see in my household budget is
inflation, yet they tell me we have deflation. It’s all so confusing – or is
it? – Glenn De Vries
John: Thanks for writing, Glenn. The problem with understanding price
inflation is that not every price rises the same amount at the same time. That
means your perceived (or, if you could calculate it, even your actual)
inflation rate can be quite different from someone else’s, simply because we
all spend our money differently. Healthy young people don’t notice that
prescription drug prices are rising. Retirees may not be aware that video game
prices are dropping.
Benchmarks like the Consumer Price Index try to reflect the
experience of an “average” family, but few families are actually average. We
all have our own preferences and priorities.
And I want to clear up a common misconception. Deflation is
actually good for your household budget in that it means that you have to spend
less to get the same goods and services. Inflation, in contrast, means that you
have to pay more. Governments like to have inflation because they want to
inflate away their large debts.
I find it passing strange that economists think 2% inflation is
the right number to target. First, 2% inflation means that in 36 years you will
have lost 50% of the buying power of the dollars you save today. It also means
you need to earn at least 2% on your savings just to stay even on buying power;
and if you want to grow your future buying power, you have to make more than
2% – not easily done when interest rates are 1% – unless you want to take
on some extra risk.
I have been in the room with Nobel laureates conversing under the
Chatham House Rule (which means that I cannot name names), when they have
argued that the Fed should actually, surreptitiously, target 4%
inflation, or let the economy run “hot,” because that is the only way that we can
“grow” our way out of the massive debt we have accumulated. There is a certain
twisted logic to that. If you could have 4% inflation and 2% actual growth,
that combination would increase the nominal size of the economy by 6%. If you
were increasing total debt by only 3%, then your debt-to-GDP ratio would
decline by 3% a year. No one in the room argued that we should actually balance
the budget.
And no one spoke up for the little guys (that would be you and me,
Glenn) who at 4% inflation would see a 50% loss of their buying power in 18
years. Inflation is a destroyer of capital and purchasing power.
The following two comments were posted in response to “Prepare
for Turbulence.”
John wrote: “It doesn’t make sense to cover
over a problem for years, let it get bigger and bigger, and postpone
acknowledging it until the worst possible time.”
I believe mankind, and especially the Western
democracies, are guilty of this for at least 150 years. Think of the financial
crises in the late 1800s. Then there are all those in the 1900s. Then 2000 and
2008. The core problem is that we do not learn. Politics blinds us to the
correct way forward. Wealth buys Congress and the bureaucrats.
On a larger front, the West dithered until we
had WW I. Then it dithered again, and we got WW II. Now we are dithering on
three fronts at once – the Middle East, N. Korea, and the South China Sea. The
West seems incapable of taking the needed action in a timely manner. If not us,
who? If not now, when? We fail to ask those questions. WW II cost tens of
millions dead and trillions in wealth destroyed. Watch and learn, folks. Even
bigger things are coming that are not financial. There will be no place to
hide. – Paul Everett
John: This is indeed frustrating, Paul. Societies make the same mistakes
over and over – the cycle goes back much further than the 150 years you
mention. The limitations of our human nature have been with us from the
beginning.
Part of the problem is communication. Societies have evolved with
leaders who make decisions for everyone and observers like me who comment from
the sidelines. I notice things are happening but have little power to change
them. Those who do have that power don’t notice what is actually happening. We
don’t have very good feedback loops.
Further, what you and I might believe to be the necessary actions
will not be what others think we should do. The lack of consensus – until
action is actually required and it’s too late – ultimately means a bigger
crisis when things finally come to a head.
Here’s another comment from “Prepare for Turbulence”:
John wrote, “For instance, with a glut of more
than 7 million previously leased cars clogging the auto market, new-car
production is projected to continue to fall.”
That is only half the auto industry problem.
The mix of cars has changed quite dramatically over the last decade. Sedans are
out and SUV’s are in. So, if you have a used SUV you’re going to do quite well
at trade-in time. However, if you have a sedan to trade in, you are going to be
very disappointed. The used car volumes swamp new car sales. There were about
40 million used cars sold last year. A lot of sedan owners are going to be
underwater on their car loans because of the low resale value of their car. – Michael Yaffe
John: I was aware of the rather large number of cars coming off lease
and affecting future sales volume, but you have given me a new fact that I
absolutely love. All of the promotions based on low rates and six- and
seven-year loans have pulled consumption forward. Although these promotions
make this quarter’s and this year’s sales look good, they exert a drag on
future sales as people are lured into greater debt.
This effect is going to be a big problem, and soon. Generous
vendor financing by the auto manufacturers has put people in deeper debt than
many realize. It will not take much of an economic downturn to throw many of
those loans into arrears. And what will the lenders do, repossess vehicles no
one wants to buy? I suspect we’ll see a miniature version of the
extend-and-pretend game that mortgage lenders played in the last recession. If
that is not the case, then those lenders are going to take large losses. In
many cases the lenders are the very car companies that will be seeing lower
sales.
Here’s a comment responding to “Trade
War Games” and my concerns about rising protectionism.
Much of America’s trade deficit stems from our
refusal to adopt a Value Added Tax when virtually all of our trading partners
have one. To review, VAT is added to the cost of everything purchased inside a
country, including imports, but does not apply to export sales. So, if the
total tax burden in two countries is equal and the actual manufacturing cost is
equal but one uses VAT and the other does not, you can expect that the total
cost to produce, ship, and sell goods in BOTH countries will be lower for the
company located in the country with the VAT. Those who wish to challenge this notion
are welcome to sit down with paper and work it out.
Companies in the non-VAT country pay both the
full tax in their own country plus the VAT when they try to export to the VAT
country against competition from the locals who pay only the full tax. Meanwhile,
in the non-VAT country, imports enjoy a tax reduction equal to the VAT
percentage while local makers pay full tax.
This unfairness has persisted since the 1950s
when the VAT was invented. It was, long ago, “justified” in Europe by the need
to rebuild their destroyed in World War II economies. I humbly suggest that the
need for America to subsidize manufacturing in Europe [and China] via refusing
to adopt a VAT is long since past and that using a VAT here, possibly as an
exchange for lower or no income taxes, would right our trade situation in
multiple industries at once.
And, since most of our trade partners already
have a VAT, their “bully pulpit” to complain about the US starting a trade war
doesn’t exist ... they started it, as the saying goes, long ago. – Rolf Parta
John: Regular readers know I would like to see a VAT system in the US.
I think it could eliminate or greatly reduce both income and payroll taxes. For
some reason, though, the politicians who could make this happen refuse to
consider the idea. They fear – perhaps reasonably – that we would end with both
a VAT and existing taxes on top of it. There are ways to prevent that from
happening, but it would take more vision and dedication than the current
congressional leadership seems to possess.
And let me make a further point. Today’s deficits will grow even
larger because of entitlement programs. The only way to get serious money, and
by that I mean the trillions it will take to balance the budget or even come
close, is a VAT. Let’s face it: We are going to get a VAT sooner or later –
probably under a Democratic Congress and administration, but Democrats are not
going to look kindly upon lowering income tax rates. A Republican
administration, on the other hand, could use a VAT to completely eliminate
Social Security taxes and deeply cut corporate and income taxes.
The Republican leaders in Congress currently believe that they’re
going to be able to make cuts in programs and reform entitlement spending such
that they can handle future deficits. Yet they can’t pass even a simple tax
reform package or healthcare reform. This is the Gang That Can’t Shoot
Straight.
At the beginning of the year I was really encouraged that
Republicans could act and we would get major tax reform and healthcare reform
and bureaucratic reform that would push out a potential business-cycle
recession or worse at least three or four years. Now, they are likely to pass
something they will call tax reform, but it will actually be just tinkering
around the edges. Real change requires real change. Real tax reform requires
real tax reform. I will openly admit that “my team” talked a good game but just
hasn’t been able to move the ball down the field. I’m extremely disappointed.
This comment is in response to “The
Wedge Goes Deeper.” That letter was written by my associate Patrick Watson,
who filled in while I was away on honeymoon. He wrote that Amazon’s pending
Whole Foods Market takeover, combined with the arrival on the scene of
deep-discount grocers like Aldi, would lead to further class separation in the
US. Reader Ron Miller responded:
I’ll apologize for what is probably a trivial
comment, but the reason for the growing success of the Aldi supermarket chain
is not just that it’s “spartan” while prices are low. That growing popularity
is mainly attributable to the fact that customers are learning that, very
contrary to the Dollar-General experience, they need not sacrifice a whit of
quality at these low prices.
The quality is as good or better than the big
chains (not including Whole Foods, which sells Mercedes-priced groceries), and
the reduced prices seem to be achieved because they sacrifice a very few
amenities (bag boys), they prepackage all produce, and they carry only one
brand — i.e., there is seldom any choice other than the Aldi brand which must
lead to significant savings in shelf stocking, warehousing, and wholesale
prices.
Were these Aldi brands not top-notch in
quality, the chain would have failed, but the products are just as good or
better than the stuff at Kroger for 50% higher prices. I’m not sure what to
compare them to – perhaps they are to groceries what Ikea is to furniture…
minus all the self-assembly jokes.
John: Ron, the relationship of price and quality is actually a burning
debate among economists. Sometimes the price of a good remains the same but its
quality increases. That change ought to be deflationary. Each dollar you spend
is buying more utility for you. But making this effect show up in CPI and other
stats is difficult. Economists make “hedonic adjustments” for that very reason,
but the methodology is still imperfect. And, the aggregate impact could be
significant when you consider the rapidly increasing capabilities of
electronics products, just to name one category.
Only an economist can say that selling one barrel of oil for $100
is equivalent in terms of GDP to buying two barrels for $50 each. GDP, as
measured by dollars spent, may not be the best way to actually measure growth
of the economy.
My friend Dr. Woody Brock (one of the smartest economists
anywhere) argues that the current CPI numbers significantly overstate inflation
because of the way they are calculated. My friend John Williams at Shadow Stats
argues, conversely, that inflation is massively understated. Your conclusion basically comes
down to the assumptions you make.
Your missing his son Trey at Camp Kotok analyst,
John Mauldin
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