Very Sad News

Posted on October 5, 2015 by tomdoerflinger

Thomas Doerflinger, the author of this blog, passed away suddenly and unexpectedly on August 23rd. We invite you to read his own account of his career here. A memorial service will be held in New York City on Oct 13. For more information, please email his wife, Janet, at jdoerflinger [at] comcast [dot] net.

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Our Wages Are Stagnant and Our Budget Is Tight—so Let’s Eat Out Tonight !

Posted on August 12, 2015 by tomdoerflinger

Who are you going to believe, the Bureau of Labor Statistics or your own lying eyes?

Based on wage data from the BLS, it has become a settled, uncontroversial, widely-recognized “fact” that wages have not increased in the U.S. for many decades. Consequently the great American middle class is imploding and living standards are, at best, stagnating. All the financial payoff from rising productivity has gone to greedy “millionaires and billionaires” such as Bill and Hillary Clinton. Thus a recent NYT column referred to “the fact that real wages have been flat for about four decades, while productivity has increased by 89 percent.” Paul Krugman wrote last year, “wages for ordinary workers have in fact been stagnant since the 1970s.” Bernie Sanders laments that “despite some improvement, the 40-year decline of the American middle class continues . . . . Nearly all of the new income growth since the recession has gone to the top 1 percent.”

There’s just one problem. If we leave the never-never land of economic statistics and take a look at the real world, it is obvious that middle-class consumers live much better today than their parents ever did. There’s all the free stuff on the Internet. Airbags and anti-lock brakes. Smart phones for the masses—Maria, the lady who cleans Donald Trump’s fantastic and exquisite and incredibly palatial executive suite, has a much better phone than The Donald had in his limo twenty-five years ago.

It’s not just electronics . . .

. . . . Consider restaurants, a superfluous luxury that people can easily do without if they are living on a tight budget. And rather than focus on national trends—the tens of thousands of Starbucks and Dunkin Donuts; the zillions of McDonalds and Burger Kings; the burgeoning gourmet burger category; the legions of middle-market “casual dining” establishments such as Appleby’s and Red Lobster; not to mention overpriced steakhouse chains such as Del Frisco’s and Morton’s—let’s look at a single town: Morristown, New Jersey, where I grew up.

It’s a middle class town in an affluent part of northern New Jersey. It’s hardly a boomtown like some parts of Florida or Texas, because Jersey’s economy has been systematically mismanaged–battered by the high taxes and over-regulation of a corrupt Democratic legislature and three incompetent governors prior to Chris Christie. Morristown’s affluence, relative to other towns in north Jersey, has declined in recent decades due to an influx of impecunious, hard-working Hispanic immigrants.

From Greasy Spoons to High-end Steakhouses

I returned to the “old neighborhood” to see how things have changed. When it comes to restaurants, they have changed a lot. Back in the 1970s there were a few small eateries—a couple of “greasy spoon” lunch counters, a few pizzerias, a diner, a forlorn little Chinese restaurant called The August Moon, and an Italian “bar and grill” featuring weak drinks and pasta drowning in red sauce.

Today, by contrast, Morristown has dozens of restaurants that on weekends attract thousands of diners from the surrounding area. I did a census using Google Maps. In the downtown area alone there are no less than 64 restaurants, of which 10-15 are very expensive or fairly expensive. Some of the 64 are big places that can accommodate well over a hundred diners. I count 11 Asian, 8 Italian, 1 French, 5 steak houses / upscale American, 12 casual American, 6 Mexican, and 6 pubs. Also 4 coffee shops, 2 ice cream parlors, 7 delis, and 2 pizza joints.

Sure, a few of these places mainly serve the weekday lunch crowd–but not too many, because Morristown has only one large office building. The number of downtown workers has not increased much since the 1970s. These restaurants mainly depend on dinner business, particularly on weekends when droves of suburbanites—both families and bar hoppers—come to Morristown to spend money, hang out, and have a good time. Crowds spill out onto the sidewalk in front of hot bars. These are normal middle class Americans, not Barack and Bernie’s “millionaires and billionaires.”

This is new. When I was a kid nothing much happened in Morristown on a Saturday night. Despite Democratic mismanagement of the state’s economy, living standards in northern New Jersey are far better than in the 1960s, which Paul Krugman naively hails as a time of unparalleled affluence. (By the way, if Krugman wandered down to Nassau and Witherspoon Streets he would notice a similar restaurant boom in his erstwhile hometown, Princeton, NJ.)

Never Mind

Bernie Sanders, Hillary Clinton, and the New York Times are out of touch with reality, operating on a false premise. Despite the inequality hysteria, the middle class is alive and well, somehow surviving the systematic economic malfeasance known as Obamanomics. The last thing the middle class needs is the Sanders solution—transferring funds from the private economy to Washington bureaucrats who already have much higher incomes than average Americans. As Scott Walker noted in the debate, six of the richest counties in the nation are in the DC area.

Copyright Thomas Doerflinger 2015. All Rights Reserved.

 

 

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Dumb SEC Rule and the “Land of Limitations”

Posted on August 10, 2015 by tomdoerflinger

Before 2009 wage stagnation and rising inequality were all the fault of George W. Bush and his “tax cuts for the rich.” Now that these problems have become much worse under Barack Obama, they are “America’s problem” and “a long-term structural problem” that has nothing to do with Obama’s policies. According to New York Times pundit Nick Kristoff the U.S. is now a “land of limitations” with less social mobility than Europe. Kristoff tells a sob story about his friend Rick Goff, an Oregon resident who had a hard life working in lumber mills and machine shops. Rick would have fared better in capitalist Texas than socialist Oregon, whose timber industry was killed off by environmentalists, along with many other industries. There’s not much commercial activity left in Portland, aside from coffee shops and strip clubs. Downtown Portland on a Tuesday in December feels like Seattle on a Sunday in August.

A major reason why the U.S. is becoming a “land of limitations” is something economists tend to ignore because it is hard to measure: a huge increase in regulations, whereby DC elites spend unlimited amounts of other people’s money on projects that make no sense. Bureaucrats write a rule and companies spend billions to obey the rule, in order to avoid huge fines. Even if the expenditure has no discernible benefit, no one in DC is fired and the rule remains on the books. Exhibit A is the new SEC rule requiring companies to report the ratio of the compensation of the CEO to the median pay of all the employees. Companies will spend millions to generate data revealing that CEO’s make much, much more than the typical worker. Duh.

Even fans of this new rule admit it will have little or no effect. Regulatory guru Kenneth Feinberg confessed on Bloomberg radio, “I am not sure it will make any difference. I’m not [sure].” The Financial Times editorialized about the wonderful merits of the new rule, but half of the editorial explained why the results will be misleading. A company that outsources manufacturing to China will have a “better” ratio than one that runs its own factories. Wall Street firms will look “better” than retailers because top traders and bankers make as much as the CEOs.

Then there’s the redoubtable Gretchen Morgensen of the New York Times, who has made a good living over the years railing against excessive CEO pay. You would think she would love the SEC rule, but her praise has more hedges than an English garden. The rule “may actually do something to curb over-the-top pay,” and “may encourage other stakeholders” to pay attention to CEO pay, and “it’s possible” some consumers will care what the CEO makes. But she quotes a compensation consultant who “doesn’t think investors will pay much attention to the new law.”

It’s nice to hear that a rule that will cost millions of dollars to implement “may” not be a total waste of money, but there is absolutely no reason to think so. Even the liberal media could not find anyone who thinks it will make any difference. By siphoning off money from the real economy to the DC beltway, it simply helps to make the U.S. a “land of limitations.”

Addendum

The WSJ ran a piece analyzing why, “Sagging Productivity Vexes Economy.”  It fingers the usual suspects–“hangover from the recession,” “lackluster capital investment,” measurement problems–but fails to mention increased regulation.  Economists at the Business Roundtable and the Conference Board should weigh in, with some simple modeling.  Productivity is a fraction: output / worker.  When companies add workers without adding to output, in order to follow DC’s rules, it is obviously a big drag on this fraction and an even bigger drag on the increase of that fraction over time.

Copyright Thomas Doerflinger 2015. All Rights Reserved.

 

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The China Syndrome (Part II) . . . . and the Crumbling BRICs

Posted on July 31, 2015 by tomdoerflinger

Two years ago I wrote a bearish post on China titled “The China Syndrome: Will GDP Growth Top 5%?”.  I argued a “soft landing” was unlikely because: A) It would inevitably be tough to shift from export-and-investment driven growth to consumer-led growth, particularly when B) China had to manage this feat while shouldering a huge load of debt, much of which financed uneconomic boondoggle projects concocted by corrupt local governments.

And so it has come to pass. These days no one believes China’s GDP is really growing 7%, although economists at some banks with business interests in China still pretend to believe it. Weak electricity demand, declining auto sales, and the comments of U.S. multinationals tell a far more negative story. And there are some new elements to the bear story:

  • Xi Jinping’s purge of the party elite cannot help but disrupt economic activity. If you’re a top bureaucrat in Beijing, it’s hard to concentrate on managing the economy when you are plotting your escape to Vancouver or London.
  • Xi’s broad-based attack on freedom, including a free Internet, will severely retard development of the service economy. It puts most Chinese knowledge workers at a competitive disadvantage.
  • The stock market debacle reveals two things. China has yet to get off the debt bicycle—speculation was simply shifted from housing to stocks. And China won’t be able to “liberalize” its financial system because the government can’t stomach capital markets that go down as well as up.

Weak Chinese demand for commodities, corruption, and the strong dollar are hurting many other emerging markets, including Brazil, Russia, Venezuela, and South Africa. U.S. industrial firms are feeling the pain:

  • Eaton: “on the South American vehicle market . . . we just don’t see any recovery occurring in that marketplace during this year”
  • Praxair (industrial gasses are a good barometer of industrial activity): “[Global] Volumes declined 2% as new project contribution was more than offset by weaker underlying industrial activity in Brazil and China, as well as weaker energy, metals, and manufacturing end markets in the United States.
  • United Technologies: “In Asia, the China market has clearly slowed. Real estate investment, new construction starts, and floor space sold are all under pressure. Otis new equipment orders in China were down 10% in the quarter, and we also saw a slowdown in the rate of backlog conversion.”
  • 3M: “Organic growth was down 2% in China/Hong Kong in the second quarter. Healthcare delivered strong growth which was offset by declines in safety and graphics, electronics and energy, and consumer. We continue to see the Chinese economy adjusting to new growth levels . . . “
  • Mettler-Toledo, maker of precision instruments (including the scale your butcher uses). Sales dropped 11% in China, 30% in Russia, and 27% in Brazil.
  • BorgWarner, an auto parts maker, cut guidance due to “slower light vehicle production growth in China, unfavorable mix of light vehicle production in North America and weak commercial vehicle markets around the world.”

The news is not uniformly bad; Apple’s revenue in “greater China” soared 71%. Still, China’s economic and political problems are bad enough that they will be a drag on the industrial-and-commodity complex for the foreseeable future. Another risk is protracted strength in the dollar. On the plus side, Europe – a much more important market than China for most multinationals – is growing slowly; eventually European demand will benefit U.S. industrial multinationals.

What It Means for Investors

  • It is dangerous to “bottom-fish” in beat-up industrial and materials equities, some of which, alas, are to be found in my portfolio.
  • On the other hand, look for names that are being inaccurately tarnished as “energy plays” or “China plays” and will have better than expected earnings. Hopefully I own a couple of those as well.
  • Lower for longer energy costs, plus solid employment growth in the U.S. and improvement in Europe, are positive for domestic consumer companies. But many of these stocks are expensive.
  • At a more philosophical level, the problems of China and other Emerging Markets exemplify why I am no fan of direct investment in EM. Political stability, the rule of law, properly functioning capital markets (even in bear markets), and an unregulated Internet are taken for granted by U.S. investors but are pretty rare globally.

Copyright Thomas Doerflinger 2015. All Rights Reserved.

 

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Why Interest Rate Psychology Will Change By Late 2016

Posted on July 22, 2015 by tomdoerflinger

Wall Streeters disagree about when the Fed will start to tighten (September?, December?) but most agree that once it gets started the pace of tightening will be exceeeeeeedingly gradual. An overleveraged US in a weak world economy supposedly requires easy money for the foreseeable future.

But I predict . . .

. . . Wall Street will be singing a different tune 18 months from now. Word on the Street will be that the Fed has to tighten faster than people thought back in 2015. For a simple reason: the economy is adding ~210,000 jobs per month but only needs around 100,000 to keep up with population growth. So the unemployment rate is falling 90-100 bps per year. Over the last 12 months the jobless rate fell -0.8% (6.1% to 5.3%); this metric averaged -0.9% over the past six months. At this pace, the unemployment rate will be 3.9% by the end of 2016.

How low is 3.9%? Of the 546 months since the start of 1970, just six months were below 4% and the lowest figure was 3.8%. Even Larry “Secular Stagnation” Summers would agree a near–zero Fed funds rate is too low when unemployment is at record lows. Inflation is already approaching the Fed’s 2% target; the core CPI is rising 1.8% yr/yr. As wage metrics such as the Employment Cost Index accelerate and the debate shifts to how high rates must go to restrain job growth, investors will belatedly recognize the Fed is way behind the curve.

Four Reasons to Expect Rate Psychology to Change

Official Group Think. Central bankers in Europe, Japan, China and emerging markets (Madame Lagarde) are trying to nurture weak economies by pressuring the bankers of close-to-full-employment economies (the US and UK) to keep rates low. Lagarde explicitly instructed the Fed not to tighten until 2016. Yellen and Carney seem to be looking for reasons to maintain easy money. Yellen is a dove who loves to talk about the “slack” in the labor market, but in all her speeches and Congressional testimony I have never heard her address the simple fact that—as the Congressional Budget Office detailed—Obamacare will keep millions of people out of the labor force and increase part-time employment. Thus, much of Yellen’s “slack” is an optical delusion. Another problem, sadly, is that public schools are turning out semi-literate graduates who are not qualified for most jobs.

Bond Bears Have Cried “Wolf” for So Long that investors are complacent, oblivious of basic relationships involving inflation. Very early one morning I watched an eye-opening exchange on Bloomberg TV-Europe between a grizzled rates strategist who thought central bankers needed to tighten and a much younger FX strategist. “Weak UK productivity growth puts pressure on the Bank of England to tighten” said the bearish veteran, but the FX strategist denied low productivity growth was inflationary – it merely increased demand for low-wage workers. The veteran was incredulous; “Don’t you know that weak productivity growth means faster increases in unit labor costs?”

Deflationary Side-shows Obscure the Big Picture   Shenanigans in Greece and Chinese equities divert attention from a tightening labor market. So do weak gold and oil prices. Neither Greece nor China’s stock market matter much to the U.S. economy, and by 2016 the year/year change in oil prices will be flattish, as comparisons get easier.

Radio Daze I distrust official statistics, which are revised heavily and often rendered useless by structural change. If they were a trustworthy guide to the future the Fed, with its 10 million economists and unlimited access to proprietary information, would not have failed to predict the last three recessions. (Bernanke assured Congress in the spring of 2007 “the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”)

Conversely, I like anecdotal evidence such as radio commercials. Numerous ads for pets.com and drkoop.com pretty much rang the bell at the top of the tech mania in late1999; ditto all those ads for second mortgages in 2007 and gold funds in the summer of 2011.

So I think it is highly significant that Verizon—a big, solid employer that presumably offers good benefits—is advertising on New York City radio stations to recruit workers. And don’t forget that 26 states have lower unemployment rates than New York—in many cases, much lower. Earth to Dr. Yellen: Verizon would not be doing this if there were still plenty of “slack” in the labor market.

Investment Implications

Although much more bearish for bonds than stocks, rising short rates will keep a lid on PE ratios, which are already lofty for this point in the cycle, when profit margins are elevated and future earnings growth will be moderate. What would make stocks plunge is if investors sensed that rising rates could tip the U.S. economy into recession. I also wonder whether big losses in bond ETFs could spook investors and hurt consumer spending.

Addenda

Two important items in the FT:

James Grant cites a study showing that an increasing number of companies are encouraging analysts to focus on “pro forma” EPS that excludes option expense, as opposed to GAAP earnings. Pro forma EPS is not all bad—it excludes exceptional gains as well as losses—but excluding option expense is ridiculous. My takeaway: where is the SEC on this issue? They were all over it in 2003, when everyone had sworn off tech stocks, but now that we have new mini-bubbles in some tech stocks and biotechs the SEC is nowhere to be seen. That’s the problem with regulators: like investors, they have short memories.

Dominic Rossi of Fidelity cites a big study based on Fido’s internal database of 2700 firms showing that – contrary to popular lore – capital spending is very healthy in most industries and substantially exceeds depreciation. This is consistent with my May 27 post showing that a WSJ article attacking hefty dividends and buy-backs was based on a crude misinterpretation of the charts that accompanied the article. The notion that dividends and buy-backs are starving capex is a fairy tale—but a dangerous one, because Hillary Clinton believes it.

Copyright Thomas Doerflinger 2015. All Rights Reserved.

 

 

 

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The Sowell Solution

Posted on July 16, 2015 by tomdoerflinger

Time:   1944

Place:   Junior High School 143 in uptown Manhattan, not far from Harlem

Action: Mrs. Sennett, a Guidance Counselor, is giving a classroom full of ninth graders advice about which NYC high school they should attend next year

She begins by telling the kids to be realistic; not everyone can go to the city’s elite high schools – Bronx High School of Science, Brooklyn Tech, and Stuyvesant. She goes on at excessive length so that they really get the message. Then she calls on each kid in turn and asks where they want to go. Eventually she calls on a black kid, slouching behind his desk, who looks rather bored as he sketches in a notebook.

“Where do you want to go to high school?”

“Stuyvesant High School.”

“Haven’t you been listening to anything I said? What makes you think you can go to Stuyvesant High School?”

“I have a friend who goes there, and he has never seemed to be a better student than I am.”

“Oh really? Let me look at your IQ.”

Mrs. Sennett reaches for the student’s folder, which is in a pile on her desk. When she gets to the folder (the student later reported) “her sneering expression turned to cold resentment.”

That bored black kid, Tom Sowell–along with his two best friends in junior high school, Vegas and Rosen–scored 100 on the entrance exam. All three went to Stuyvesant High School, where the workload was extremely heavy—particularly for Tom, who had to commute an hour each way, changing trains twice as he traveled from Harlem to the Lower East Side. He came home exhausted, and slept before tackling hours of homework.

A Most Varied Career

Family problems forced Tom to quit high school and get a job at age 16. That marked the start of an incredibly tortuous, and sometimes torturous, career that included a short stint at the Home for Homeless Boys; a hazardous job in a machine shop; a job delivering telegrams for Western Union; a hitch in the Marines (but Tom’s expertise in photography kept him out of the Korean War); jobs in the Federal bureaucracy; courses at Howard University in DC.; getting a BA from Harvard University, an MA from Columbia, and a PhD in economics from the University of Chicago; and then teaching gigs at many colleges and universities, including Douglass College, Howard, Cornell, Brandeis, Amherst and UCLA. He also did research for some DC think tanks that were waging the “war on poverty.” Eventually Dr. Sowell settled at Stanford’s Hoover Institution, becoming one of America’s most influential economists and public intellectuals.

Brilliant though he was, Thomas Sowell still struggled with tough academic challenges at various points in his career. To keep up during his first year at Harvard he had to take “stay awake” pills and work non-stop. But eventually he learned how to succeed at an elite university and did fine.

Judging from his autobiography, Thomas Sowell’s modus operandi as a professor was to never, ever adhere to the maxim “To get along—go along.” He was as rigid as a crowbar. Instead of “going along” with academic standards that became increasingly lax during the 1960s and 1970s, Dr. Sowell stubbornly insisted on excellence in his economics classes from all his students, whether white or black, male or female. He never graded on a curve. So he was constantly at loggerheads with university bureaucrats who begged him to “make allowances” for poor performers.

Sliding Standards

Sowell’s autobiography is entertaining but depressing, because it shows—anecdote by anecdote, confrontation by confrontation—how racial paternalism subverted academic standards, to the detriment of black students. As education became increasingly politicized and racialized—more about racial integration of society than the education of individual students—it became harder for black kids to get a top-flight education. From first grade to ninth grade, all but one of Thomas Sowell’s teachers were white, but he did not believe that it hindered his education.   Partly because the student body was polyglot—there were so many minorities, no one was a minority—New York’s educational environment was relatively colorblind in the 1940s and 1950s. Smart black kids could get a good education at public universities such as City College, the “Harvard of the Working Class”; one of its graduates, Colin Powell, sings its praise in his autobiography. But beginning in the mid-1960s, educational standards steadily declined, thanks to:

  • A fixation on racial integration, to the detriment of education. The nadir was Boston’s “forced busing” crisis of the 1970s, when poor Irish kids were bused from crappy schools in South Boston to crappy schools in black Roxbury, while rich white liberals cheered from the suburban sidelines.
  • Affirmative action for university faculty, which tarnished the credibility of black academic stars like Dr. Sowell. Students were not fooled; they wondered whether a given black prof came in through the “front door” (as Dr. Sowell did) or the “back door.”
  • Elite universities such as Cornell scrambled to recruit black students, many of whom could not keep up. Dr. Sowell thinks they would have gotten a better education at a less difficult institution, where they would have had more time to master the material and gain self-confidence.
  • Universities admitted militant black students who were more interested in politics than education. They had little trouble intimidating university officials, as well as black students who were not politically radical.
  • Paternalistic white liberals hated to give a black student a bad grade, even when they deserved it. (Sowell believed many black students didn’t work hard enough.) A prominent victim of paternalism was City College, where high standards gave way to “open enrollment” – just about anyone could attend, but no one got a decent education. Eventually CCNY was rescued by politician Herman Badillo.

How Ethnic Minorities Build “Social Capital”

Dr. Sowell’s views on these matters is informed not only by his personal experience as an educator, but also his extensive research on the global history of ethnic minorities. He documents many cases of downtrodden minorities building “social capital” through “self improvement”— for example, Scots learning English to avail themselves of English literature and Jewish immigrants to the U.S. working hard to improve academically. (Jews from eastern Europe scored poorly on an intelligence test administered to more than 100,000 U.S. soldiers during World War I.) A precondition for “self-improvement” is recognition by minority groups that they really do need to improve academically—that, for example, bad scores on standardized tests are not merely the result of biased tests.

DeBlasio’s Victims

Of course, the main victims of lax educational standards are the putative beneficiaries. Why bother with “self-improvement” when guilt-ridden liberals will make excuses for you? Case in point: when New York Mayor Bill DeBlasio was asked recently why students’ failing grades on a Regent Exam were changed to passing grades, he simply replied, “This is something we have seen consistently over the years.” Given this attitude, it is not surprising that in 2014 only 3 percent of the students admitted to elite Stuyvesant High School were black and Hispanic, even though blacks and Hispanics make up 70 percent of the city’s public school student population. Which is why black parents are clamoring to send their kids to charter schools that provide a rigorous education. And why rich liberals like Barack and Michelle Obama refuse to send their own kids to public schools.

Thomas Sowell, A Personal Odyssey

Thomas Sowell, Intellectuals and Race

Copyright Thomas Doerflinger 2015. All Rights Reserved.

 

 

 

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A Flawed Framework for the AP U.S. History Curriculum

Posted on July 3, 2015 by tomdoerflinger

In a previous incarnation I was a professional historian, so I was intrigued by conservatives’ charge that the new AP History Framework for high school students has a leftist bias, depicting “a nation founded on oppression, privilege, racism, and heedless exploitation of the environment.” As it happens, a chief architect of the Framework is a former colleague of mine; in fact, I edited his first book. In a lengthy defense of the Framework, this gentleman makes these points (emphasis mine):

  • “At least as I teach my own introductory course . . . the goal is to produce students who understand that historical knowledge—whether of the American past or any other—depends on two absolute rules: first, that historians cannot make anything up; second, that they cannot leave anything out merely because it strikes them as inconvenient, embarrassing, or out of keeping with preconceived notions or conventional wisdom. . . .
  • “good history is that which offers both the most inclusive and the most coherent possible account of the past.
  • “My fellow members and I wanted to make the AP U.S. history course a more rigorous reflection of the current state of knowledge and practice in our discipline.”

My response:

  • Actually, historians today do leave out facts that are – to them at least – “inconvenient, embarrassing, or out of keeping with preconceived notions or conventional wisdom.” You won’t find many historians plainly stating that America’s capitalist economy, managed largely by acquisitive white males, reduced the poverty of millions of immigrants from Europe, Asia and Latin America (that’s why they came). Or that an important growth driver was effective “exploitation” of America’s abundant natural resources.
  • I, too, favor “inclusive” history; I have read many of the excellent new books on the slave trade and slavery. But in a survey course one wants to teach students, “how we got where we are today,” which requires understanding the actions of successful elites. Too much “inclusiveness” can be sub-optimal.
  • Basing the AP Framework on the “current state of knowledge and practice in our discipline” sounds commonsensical, but is actually problematic. Professional historians — unlike, say, investors or journalists, for whom every day brings something new and different—have to keep ploughing the same old ground, yet find something original and interesting to write about. So they rotate from one hot topic to another. In the 1970s, the hot topics for historians of 18th century America were the New England village and Republicanism. Later it was “consumerism.” Now it is slavery and Indians. That’s fine, but it is far from clear that a survey course should be heavily tilted toward a particular topic just because it is the current focus of historical research.

Framework Fractures

The Framework has 200 separate historical “concepts,” so it is not difficult to quantify its priorities. Of the 200, 28 refer to Indians and 27 to slavery and race, versus only 5 to the creation of America’s “founding documents,” the Declaration of Independence and the Constitution. Only one “concept” discusses the actual drafting of the Constitution; that is clearly inadequate.

 

On ante-bellum immigration, students are told:

“Substantial numbers of new international migrants — who often lived in ethnic communities and retained their religion, language, and customs — entered the country prior to the Civil War, giving rise to a major, often violent nativist movement that was strongly anti-Catholic and aimed at limiting immigrants’ cultural influence and political and economic power.”

A more even-handed formulation: “Despite its Protestant roots, the U.S. was willing to receive millions of indigent Irish Catholic immigrants who – notwithstanding sometimes violent nativist resistance – fared much better in the U.S. than they would have by remaining in Ireland or moving to England.”

 

Regarding World War II, students are told,

“Wartime experiences, such as the internment of Japanese Americans, challenges to civil liberties, debates over race and segregation, and the decision to drop the atomic bomb raised questions about American values.”

and

“The United States and its allies achieved victory over the Axis powers through a combination of factors, including allied political and military power, industrial production, technological and scientific advances, and popular commitment to advancing democratic ideals.”

So here we have a rather anodyne statement that the U.S. and its allies won the War, and a denigration of that extraordinary achievement on the grounds that the War “raised questions about American values.” No mention of the 407,000 American troops killed, which by the way was four times the number of Japanese Americans interned. Destroying the Nazi and Japanese empires, and rebuilding both nations along democratic lines, affirmed American values.

 

Regarding Ronald Reagan and the Winning the Cold War:

“President Ronald Reagan, who initially rejected détente with increased defense spending, military action, and bellicose rhetoric, later developed a friendly relationship with Mikhail Gorbachev, leading to arms reductions by both countries.”

Actually, it was Reagan’s military buildup, in the face of strenuous liberal opposition, that ultimately led to the demise of the Soviet Empire – not his “friendly relationship” with Gorbachev.

The Framework’s Not so Gilded Age

The Framework misconstrues the relationship between capitalism, economic growth, immigration and poverty reduction. Students are told:

“Following the Civil War, government subsidies for transportation and communications systems opened new markets in North America, while technological innovations and redesigned financial and management structures such as monopolies sought to maximize the exploitation of natural resources and a growing labor force.”

If I were grading this and in a good mood, I would still give it a “D.” There are at least three problems. First, “government subsidies” did not open new markets; people did – entrepreneurs and their employees, encouraged by subsidies. Second, monopolies are not “management structures;” they are market structures and were quite rare in the gilded age. Third, “maximize the exploitation of natural resources and a growing labor force” is tendentiously pejorative.   A “growing labor force” did not willingly cross the Atlantic in order to be “exploited.“

Next,

“The industrial workforce expanded through migration across national borders and internal migration, leading to a more diverse workforce, lower wages, and increase in child labor.”

Wages did not decline in the late 19th century; in real terms they rose 130% between 1865 and 1898. Living standards were boosted by a host of technological breakthroughs that go unmentioned in the Framework – telephony, electricity, elevators, phonographs, light bulbs, indoor plumbing, packaged foods, catalogue stores, interstate shipment of frozen meat, and (a few years later) autos and airplanes.

LBJ’s Not So Great Society

The Framework sidesteps the abject failure of Washington’s “War on Poverty,” obliquely noting that “public confidence and trust in government declined in the 1970s in the wake of economic challenges….” The accelerating inflation of the 1970s was more than a “challenge;” it was a protracted disaster for ordinary Americans engendered by the statist policies of LBJ, Nixon, and a Democratic Congress. Real median household income declined between 1969 and 1982 despite a huge increase in the number of working wives (female labor force participation rose from 42.7% to 52.6%). The Framework notes that “economic inequality increased after 1980” but ignores the broad prosperity engendered by the Reagan / Volcker program of monetary restraint, tax cuts, and deregulation; median household income rose 12% from 1982 to 1989.

Bottom Line

The product of a great deal of thoughtful effort, the Framework is well intentioned and a pretty good start. However, it inevitably reflects the scholarly priorities and political biases of professional historians and should be substantially revised to meet the needs of high school students who wish to take a college-level American history survey course.

Copyright Thomas Doerflinger 2015. All Rights Reserved.

 

 

 

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U.S. Stocks: Look for Stronger Performance in Second Half of 2015

Posted on June 26, 2015 by tomdoerflinger

At the end of 2014 we explained why “stocks are expensive, offer mediocre risk / reward.” The weak 2.5% price rise so far this year is consistent with that call. But stocks should be stronger in the second half because profit growth will improve.

Profit dynamics are poorly understood—and not just by the media. Goldman Sachs and JP Morgan could use a tutorial as well (from the folks Deutsche Bank). When oil prices collapsed, some strategists claimed this would boost S&P profits, because energy costs would decline. That was dead wrong. The huge decline in profits of oil producers was not offset by energy cost savings in other sectors for the simple reason that energy costs are just not that important—far smaller, in most industries, than such items as labor, R&D, rent, taxes, depreciation, etc.

Because of this energy confusion, as well as the surprising strength of the U.S. dollar, Q1 2015 earnings were surprisingly weak, as was earnings guidance for Q2. With stocks trading at high valuations, weak earnings growth led to weak price performance.

Three Reasons Why Profit Performance Will Improve

  1. The Missing Metric

Although Street strategists do a good job of slicing and dicing S&P profits, one useful metric is being neglected: median EPS growth. S&P EPS is an index number reflecting aggregate profits of 500 companies. When giants like Exxon, Chevron, Citi, etc. post huge profit drops, it slashes overall S&P earnings. But this weakness hides decent growth at many companies that, frankly, are of more interest to investors than “big uglies” such as XOM. I don’t have the median EPS growth rate for the index, but I do have a decent proxy—the median yr / yr EPS growth rate for 40 big companies spread across most industries. Here are the figures for the past eight quarters:

  • Q2 2013         5.7%
  • Q3 2013      12.3%
  • Q4 2013      15.0%
  • Q1 2014       10.6%
  • Q2 2014      12. 0%
  • Q3 2014      12. 2%
  • Q4 2014       11.7%
  • Q1 2015        7.0%

Owing mainly to the strong dollar and weak oil prices, median EPS growth rate was much weaker in Q1 than the six prior quarters. But 7% is still a lot better than the 2% growth for the index as a whole. So the typical stock is becoming cheaper in the “sideways correction” we have had so far in 2015.

  1. Higher Oil Price, Stabilizing Dollar Are Positive for Profits . . .

The two key headwinds to profit growth—weak energy prices and the strong dollar—are becoming more profit friendly. Oil prices have climbed 27% since January; the dollar has declined from $1.05 / Euro to $1.11. If WTI oil stays at $60 / barrel, the yr/yr change in oil prices will improve from -53% in Q1 2015 to -44% in Q2, -39% in Q3 and +1% by the fourth quarter of this year. Similarly, if the dollar stabilizes companies will quit slashing guidance for earnings and revenues. The dollar could be up modestly yr/yr by Q1 2016.

  1. . . . and so Is Strengthening Growth in Europe

Europe is by far the most important foreign market for U.S. multinationals, accounting for around 15% of S&P profits. Economists expect GDP growth to accelerate from 0.9% in 2014 to 1.6% this year and 2% in 2016. This is a significant positive for profits. Arguably Grexit would be positive, not negative, for Europe’s growth; it has been a huge distraction for policy makers.  It looks like the Greeks will get the depression they voted for.

As confidence in profit growth improves, so should stock prices. Using a forward PE of 17x and 2016 S&P profits of $131, look for 2200 on the S&P 500 by the end of this year, up 5% from current levels.

Skip Ip – Monetary Hubris Is the Big Risk for Equities

For the time being investors still expect low inflation which justifies high PE ratios. I don’t expect this to change in the next six months, but risks are rising. Much of the econ fraternity is in the “secular stagnation” / “debt deflation” camp, which supposedly justifies zero Fed funds seven years into an economic expansion. Exhibit A was the WSJ article by Greg Ip, “Memo to Fed: Allow the Economy to Overheat.” Mr. Ip thinks overheating would be beneficial because “it would help nudge inflation back to more normal levels, restore some of the long-term growth potential lost since the financial crisis, and boost ordinary workers’ wages more effectively than a minimum wage.” This is a great example of monetary hubris—the notion that central bankers can skillfully steer the global economy, even though the Fed’s forecasts have been wrong for the past six years. There are a few good reasons to skip Ip:

  • Inflation is already moving to “more normal levels.” In the three months through May the Core PCE Deflator rose at a 1.7% annual rate, close to the Fed’s arbitrary 2% target. (CPI inflation since 1815 averaged just 1.4%).
  • Weirdly, Ip forgets that inflation reduces real wages, so overheating would not “boost ordinary workers’ wages.” Commodity speculators would fare much better than workers.
  • The real driver of wage growth is productivity growth, which would be hurt by higher inflation, as it was in the 1970s. It is much easier for companies to raise prices than increase efficiency.
  • Overheating will cut short the expansion through A) rising inflation and bond yields, B) belated tightening by a behind-the-curve Fed, which would spook markets., C) popping of asset bubbles in venture capital, junk bonds, and elsewhere.

GOP Victory in 2016 Could Lengthen the Recovery

The economic expansion has labored under Obama’s anti-capitalistic, anti-worker, pro-DC policies. A Republican President who reforms corporate taxes, Obamacare, energy policy, etc. would boost business confidence, increase investment, and reduce inflationary pressures by expanding the supply side of the economy.

Copyright Thomas Doerflinger 2015. All Rights Reserved

 

 

 

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The Wright Stuff

Posted on June 19, 2015 by tomdoerflinger

On May 30, 1899 an impecunious 32-year-old man who, along with his brother, ran a small bicycle shop in Dayton Ohio wrote to the Smithsonian Institution, with a request:

“I have ben interested in the problem of mechanical and human flight ever since as a boy I constructed a number of bats of various sizes . . . . .I am about to begin a systematic study of the subject in preparation for practical work to which I expect to devote what time I can spare from my regular business. I wish to obtain such papers as the Smithsonian Institution has published on this subject . . . .”

Four and a half years later, toward the end of 1903, Wilbur and Orville Wright completed their first flight in a “flying machine” at Kitty Hawk, a windy, isolated, desolate expanse of sand dunes on North Carolina’s outer banks. By 1906 the Wright Brothers were global celebrities. They took up residence in the luxurious Hotel Meurice in Paris, where they consulted with military officials and cut deals with European capitalists.

The Wright Brothers’ historic triumph, we learn in David McCullough’s superb new book, was the result of concentrated effort by exceptionally smart, determined, resourceful, courageous and yet humble Americans. To crack the code of manned flight, they intently studied birds in flight, built increasingly sophisticated “flyers,” created their own wind tunnel, devised a gasoline engine for their flying machine, developed a weight-driven catapult to launch the flyer, and methodically overcame a host of other technical, practical, and theoretical challenges. They did all this while running their bicycle shop. While camping at Kitty Hawk they braved at various times clouds of voracious mosquitoes, hurricane-force winds, frigid temperatures and a near shipwreck while traveling to Kitty Hawk. Theirs was dangerous work; a crash in 1908 permanently disabled Orville and killed the soldier who was flying with him. The one thing these unlikely capitalists lacked was capital; their project cost all of $1,000, versus $70,000 spent by Samuel Pierpont Langley in a failed attempt at manned flight.

The Wright Lessons

  • Interestingly, many auto pioneers also started their careers in the bicycle business, which was booming in the 1890s after a long gestation period. Don’t dismiss the bicycle as just an “intermediate technology;” it sill provides millions of people with comparatively fast, clean transportation. (If you cross a Shanghai street during the morning commute, watch out for clouds of cyclists; they don’t stop for pedestrians.)
  • Like Henry Ford, Bill Gates, and Steve Jobs, Wilbur and Orville remind us that very smart and determined entrepreneurs can work wonders on a slender budget, beating out competitors with copious funding from Wall Street, Washington, or corporate coffers. Focused smarts and lack of bureaucracy are big advantages.
  • Hey, you liberals: don’t forget that often the best antidote for capitalism is more capitalism. While autos and airplanes were—pardon the pun—getting off the ground in the first decade of the 20th century, “monopolistic” railroads seemed to rule the economy, which is why Teddy Roosevelt in 1904 brought an anti-trust suit against railroad conglomerate Northern Securities. Two palatial new train stations (Penn Station and Grand Central) were built in New York in the first decade of the 20th century, just as railroads’ dominance was cresting. Which is one reason why Obama’s decision to use the FCC to impose “net neutrality” on Internet infrastructure is absurd.
  • Give the government its due; the Wright brothers received valuable information from the Smithsonian institution in Washington. Today the Library of Congress could provide similar assistance to citizens, but it is being mismanaged by politicians. Following a senseless tradition that Librarian of Congress is a lifetime appointment, it is now run by an 86-year-old historian, James Billington, who is a nice man (I once took a course from him) but utterly clueless about digitizing information; he does not even use e-mail.

 

Copyright Thomas Doerflinger 2015. All Rights Reserved.

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Princeton University’s ATO Breakthrough

Posted on June 12, 2015 by tomdoerflinger

“Our research demonstrates conclusively that as a liberal education becomes more expensive it is also becoming less liberal and less educational.”

T.J. Maxx PhD

 

I would have to respectfully disagree with Dr. Maxx. America’s great universities are pushing back the frontiers of knowledge by developing important new academic disciplines—novel ways of understanding the world. My alma mater, for example, is on the verge of granting degrees in a path-breaking new field of study, colloquially known as ATO (Art of Taking Offense). After they receive their ATO degrees, Princeton graduates will be able to discern every sleight (however slight), every offense (real or imagined), every subtle hint of distaste or disapproval. Their SQ (Sensitivity Quotient) will have been permanently elevated.

To appreciate just how rapidly the science of ATO has advanced at Princeton, consider the EDP / UC dichotomy.

E D P

Just forty years ago, in elections for Class President, there was one jokey candidate who called himself El Deuco Perverto (EDP). Along with several sidekicks, El Deuco Perverto showed up at campaign events wearing dark glasses, a trench coat, and no pants. The potential OTQ (Offense Taken Quotient) of El Deuco Perverto was extremely high –- El Paso, El Salvador, Eldorado, Eloise, El Capitan and Chicago’s El train had all been viciously slandered. But such was the undeveloped state of ATO that El Deuco Perverto was merely viewed by the Princeton Community as a silly, amusing, inane, clever campaign gambit. Nothing more. Clearly a lost opportunity for injured outrage.

U C

Fast forward to 2015, when the Princeton Community – having made dramatic advances in ATO – was torn asunder by a sophomoric student gambit quite similar to El Deuco Perverto’s. At two talent shows the swimming and diving team – exclusively comprised, not incidentally, of white males – styled themselves “Urban Congo” and trooped out on stage wearing only their speedos to perform a slightly amusing drumming, chanting and dancing routine. No reference to a specific ethnic group or region. No nasty lyrics. No demeaning innuendo or hint of threat toward anyone. The Offense Taken Quotient was actually pretty low, as these comments from YouTube viewers demonstrate:

  • “How is that offensive? It is not even a satire, just a parody. Jesus Christ, people, grow a thicker skin.
  • Not offensive. Just weird!
  • I don’t get why ppl find this offensive
  • Yo peeps, as an African I can assure you that nothing of this video offends us.
  • That’s not racist, just stupid.
  • This is not offensive. AT ALL. WHAT is offensive about this?”

Concocted Campus Crisis

Sadly, none of these commentators have mastered ATO, but such is not the case for many Princeton students and professors, who were greatly offended by Urban Congo’s antics. The leafy campus was plunged into a week-long period of angst and anguish about the horrid, hurtful, hateful performance. The head of Urban Congo was forced to recant; he assured one and all that he recognized his error and had been thoroughly reeducated by Princeton’s diversity police. The crisis culminated in a convocation at the university chapel where Princeton’s President and a few faculty members expressed their pain, their sorrow, their outrage.

Princeton’s president: “On our campus and in our society, members of minority groups too often find themselves hurt, excluded, or diminished by stereotypes, by ignorance, by thoughtlessness, and by hostility” — including, one presumes, Urban Congo’s clearly non-racist performance. Translation: to stay out of trouble, you should only tell black / brown / Hispanic / female / LGBT students what they want to hear; don’t challenge them with ideas outside their comfort zone, or you will be accused of racism / sexism / homophobia. Of course, this is the opposite of a liberal education, but Princeton’s President wants to keep his job.

One professor reported that black students felt Urban Congo “crossed the line” of free speech because the black students were “negatively impacted.” . . . . “they are tired of the idea that in America, generations of people, deemed educated, can have effectively no knowledge of Native American or African cultures and history.”   So black students can shut down a performance that does not conform to their own values or world view. Again, the opposite of a liberal education.

Another professor said, “We’re opting to wake up each morning and swallow a colorblind hallucinogen, numbing ourselves to the racial reality. . . . We’re playing dumb about the fact that humor and entertainment always have been the handmaidens of racism and sexism. . . . [there are] devastating inequities in education, health, and incarceration that continue to damage our body politic [that must be addressed].” In other words, this professor’s outrage over Urban Congo was overtly political; the performance simply did not set the proper cultural tone for the Progressive reforms she believes Princeton should pursue. I wonder how this Professor would react to an outside lecturer who explained why Barack Obama’s tax/spend/over-regulate agenda has been a disaster for African Americans, whose median household income was 9.2% lower in 2013 than 2007.

Official Princeton’s week-long freak-out about a sophomoric talent show routine that probably took a half hour for students to prepare shows that the University is effectively banning any speech or cultural display that offends hyper-sensitive minority students and liberal professors. I must apologize to the aforementioned Dr. Maxx; he was indeed correct that “liberal education” is becoming less liberal and less educational.

Copyright Thomas Doerflinger 2015. All Rights Reserved.

 

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