Previous Market Musings

7/29/2019 Previous Market Musings

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Previous Market Musings

Below are a series market musings pieces. There are also a number of attachments and you might notice my summ

and perspective on the topic in question or the subject being covered by the author of a given piece in the body of the em

below. As the topic of the various pieces may not be evident from the subject, Ive noted the dominant topic above each

piece. Also noted is the date of dissemination and any attachments that are associated with the piece. Note that Ive re-

disseminated certain items as they remain very relevant well beyond the time they were initially created.

Again, there is a plethora of information but if you would like to discuss any of these comments and perspectives, Im

happy to do so. You may recognize some of the authors I tend to follow and my personal favorites are Dr. Lacy Hunt of

Hoisington, Jeremy Grantham of GMO, John Mauldin, Hugh Hendry of Eclectica, Dave Rosenberg of Gluskin Sheff. As I havnot recently penned a musings piece, instead focusing on reading the work of others, Ive primarily included these papers

this email. I certainly look forward to more writing in the coming year and Ill add you to the distribution list if youre not

already included. Lately Ive sent a few short technical comments and unless there is a major event or some topic I feel

justifies a lengthy explanation, it seems that the shorter notes are easier to digest and lead to a healthy dialogue and/or

debate with those who find them of interest.

Note that four of the attachments are not noted below and these include the recent Mauldin pieces, a working pape

from Reinhart, Reinhart, and Rogoff (shown as nber), and the BTIG 2013 Outlook. Most of these authors works can b

easily accessed online but if you would like any further material from a particular author and are unable to find it, please l

me know.

While I havent included them here, I maintain a list of blogs and other websites that I find extremely useful and very

diverse. They cover a host of varying topics and provide a wide range of perspectives but can often be useful in identifyincounterpoint to a common perspective or personal opinion and the strength of these counterpoints (or supporting

information) is very useful. If there are specific topics or areas of the market you find most appealing, Im happy to see if

specific blogs may be of interest or alternatively I can send you those that are generally the most useful.

Dave Rosenbergs Charts and Outlook for 2013 (12/21/13)First, here is Rosie's Investment Outlook for 2013:

1. We remain in a classic post bubble 'fat-tailed' distribution curve, where the range of possible outcomes is much widthan in past recovery phases. This will remain the case in 2013, and until such time as all the major global debtimbalances have been fully resolved.

2. Near-6% U.S. output gap: 3%+ global gap. The world is still awash with excess capacity across labour and productmarkets. As such, disinflation themes will keep trumping inflation themes. This puts preservation not just of capitalbut of cash flows, front and centre in terms of core investment strategies.

3. Fed likely to keep rates near 0% through 2018 (according to our analysis): Interest rate volatility minimized; long-shcredit strategies should remain core to any bond strategy.

4. $1.7 trillion in cash on U.S. corporate balance sheets: Even though yields have plunged in the past year, corporatebonds remain a solid investment given prospective low default risks, especially given still-wide spreads relative to tgovernment sector

5. Fed to replace Operation Twist with outright bond buying: Treasury yields to head even lower, making dividend yiand 'bond proxies' in the equity market that much more alluring.

6. Real interest rates to remain negative: This is a very powerful positive thrust for the precious metals complex, andshould help establish a firmer floor under the stock market given the implications for "discounted' earnings growth(i.e. a lower cost of capital).

7. Stephen Harper around until April 2015 (at the least), Barack Oba ma around until .lanuary 2017: Along withdiverging monetary policies, the stark political divide is bullish for the Canadian dollar

8. Geopolitical tensionsMiddle East, China's political transition. Greek default risks. LS_ fiscal issues, high and risinyouth unemployment rates in Europe and9. Japan-China rift: Exposure to raw materials is a good hedge against these recurring flare-ups.10. U.S. energy self-sufficiency: Still a forecast, but this has positive implications for the manufacturing renaissance stor11. Malthuslan population dynamics: That two billion more people to feed in the next 35 years means we need 70% mor

food: an agrarian revolution is in its infancy stages.

Next, below are the 35 charts that best encapsulate Rosie's thoughts about 2012 and his view on 2013 and onward, but fihis overarching views:

The Fed has also completely altered the relationship between stocks and bonds by nurturing an environment of

ever deeper negative real interest rates. Therein lies the rub. The economy and earnings are weak, and getting weaker,

but the Interest rate used to discount the future earnings stream keeps getting more and more negative, and that lowers

the corporate cost of capital and in turn raises the present value of expected future profits. It's that simple.


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Beneath the veneer, there are opportunities. I accept the view that central bankers are your best friend if you are

uber-bullish on risk assets, especially since the Fed has basically come right out and said that it is targeting stock prices.

This limits the downside, to be sure, but as we have seen for the past five weeks, the earnings landscape will cap the

upside. I also think that we have to take into consideration why the central banks are behaving the way they are, and that

is the inherent 'fat tail' risks associated with deleveraging cycles that typically follow a global financial collapse. The

next phase, despite all efforts to kick the can down the road, is deleveraging among sovereign governments, primarily in

half the world's GDP called Europe and the U.S. Understanding political risk in this environment is critical.

With regard to global events, we continue to monitor the European situation closely. Euro zone finance ministers

have given Greece an additional two-year lifeline and the Greek parliament just passed another round of severe austerity

measures, which I think will only serve to make matters worse there from an economic standpoint, but I doubt that thecreditors are going to let Greece go just yet. So this never-ending saga remains a source of ongoing uncertainty, but at

the same time. Is a key reason why the Fed and the Bank of Canada will continue to keep short-term interest rates near

the floor, and all that means is to build even more conviction over income equity and corporate bond themes.

As for something new, after a rather significant slowdown in China for much of this year that put the commodity

complex in the penalty box for a period of time, we are seeing some early signs of visible improvement in the recent

economic data out of China and this actually has happened even in advance of any significant monetary and fiscal

stimulus. And while the Chinese stock market has been a laggard, if there is one country that does have the room to

stimulate, it is China (make no mistake, however, China's economic backdrop is still quite tenuous, especially as it

pertains to the corporate sector - excessive inventories, stagnant profits, rising costs and lingering excess capacity are all

challenges to overcome).

Keep in mind that much of this slowing in China was a lagged response to prior policy tightening measures to curb

heightened inflationary pressures - pressures that have since subsided sharply with the consumer inflation rate down to2% (near a three-year low) from the 6.5% peak in the summer of 2011 and producer prices are deflating outright. What is

providing a big assist to this sudden reversal of fortune in China is a re-acceleration in bank lending as a resumption of

credit growth and bond issuance has allowed previously- announced infrastructure projects out of Beijing (railways in

particular) to get incubated.

The nascent economic turnaround we are seeing in China, if sustained, is Positive news for the commodity complex

and in turn resource-sensitive currencies like the Canadian dollar, which I'm happy to report has hung in extremely well

this year even in the face of all the global economic and financial crosscurrents. Just consider that the low for the year for

the loonie was 96 cents - you have to go back to 1976 to see the last time intra-year lows happened at such a high level.

To reiterate, our primary strategy theme has been and remains S.I.R.P. - Safety and Income at a Reasonable Price -

because yield works in a deleveraging deflationary cycle. Not only is there substantial excess capacity in the global

economy, primarily in the U.S. where the "output gap" is close to 6%, but the more crucial story is the length of time it

will take to absorb the excess capacity. It could easily take five years or longer, depending of course on how far downpotential GDP growth goes in the intermediate term given reduced labour mobility, lack of capital deepening and higher

future tax rates. This is important because what it means is those disinflationary, even deflationary, pressures will be

dominant over the next several years. Moreover, with the median age of the boomer population turning 56 this year,

there is very strong demographic demand for income. Within the equity market, this implies a focus on squeezing as

much income out of the portfolio as possible so a reliance on reliable dividend yield and dividend growth makes perfect

sense.

Gold is also a hedge against financial instability and when the world is awash with over $200 trillion of household,

corporate and government liabilities, deflation works against debt servicing capabilities and calls into question the

integrity of the global financial system. This is why gold has so much allure today. It is a reflection of investor concern

over the monetary stability, and Ben Bernanke and other central bankers only have to step on the printing presses

whereas gold miners have to drill over two miles into the ground (gold production is lower today than it was a decade

ago - hardly the same can be said for fiat currency). Moreover, gold makes up a mere 0.05% share of global householdnet worth, and therefore, small incremental allocations into bullion or gold-type investments can exert a dramatic

impact. Gold cannot be printed by central banks and is a monetary metal that is no government's liability. It is malleable

and its supply curve is inelastic over the intermediate term. And central banks, who were selling during the higher

interest rate times of the 1980s and 1990s, are now reallocating their FX reserves towards gold, especially in Asia. With

the gold mining stocks trading at near record-low valuations relative to the underlying commodity and the group is so

out of favor right now that anyone with a hint of a contrarian instinct may want to consider building some exposure - as

we have begun to do.


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http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2012/12/Rosie%201.jpghttp://www.zerohedge.com/sites/default/files/images/user5/imageroot/2012/12/Rosie%204.jpghttp://www.zerohedge.com/sites/default/files/images/user5/imageroot/2012/12/Rosie%201.jpghttp://www.zerohedge.com/sites/default/files/images/user5/imageroot/2012/12/Rosie%204.jpg


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Source: Gluskin S
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Debt, Interest Rates and Fed Policy 9/11/12(Woodford vs. Bernanke and the Lacy Hunt Speech from 9/7/12)

Summary of the Speech by Dr. HuntDr. Hunt begins with a discussion of the Phillips Curve (highlighting the inverse relation between inflation and unemployme

noting that this activist Phillips Curve based policy approach has become dominant in the past few decades. The Misery Index m

be used as an effective and objective means of gauging the effectiveness of policy actions as the Misery Index is the sum of

inflation and unemployment (the U.S. Misery Index is shown over 2 time periods below). While the first 12-year chart shows th

this has clearly been on the rise since the late 90s, the second chart two major spikes in the Misery index that had occurred in

1975 and 1980. As Hunt notes, the index averaged just 6.7% in the 1950s, 7.3% in the 1960s, and 13.6% in the 1970s and thenpeaked above 20% in 1980. The recent peak was 13%, and though the trend is still to the upside, the index has recently subside

to the current level of 9.5% (due to subdued inflation).

Hunt goes on to discuss Milton Friedman (who often disagreed with Keynesian philosophy), later noted in a research repor

that though the Phillips Curve was observable over the short run, this was not true over longer periods (Hunt notes that this is a

fact weve learned the hard way). There is also growing evidence that activist monetary and fiscal policy may actually be hinder

economic growth over the long term while little or no benefits are evident even in the short run. Three studies he cites are De

Overhangs: Past and Present by Reinhart, Reinhart and Rogoff, Government Size and Growth: A Survey and Interpretation of t

Evidence by Bergh and Henrekson, and The Impact of High and Growing Government Debt on Economic Growth by Cheche

and Rother. All three studies confirm the same negative consequences of extreme government indebtedness and indicate that

while political and economic officials argue that government action is required for political reasons and public anxiety,

governments would be better off to admit

traditional tools only serve to compoundexisting problems.

As previously noted, the Misery inde

again on the rise and this is confirmed by

poverty index, the staggering 46 million

nearly 15% of Americans using the food sta

program (up from 8% in 1970), and the rec

41% of citizens paying no federal Income

(note other taxes are certainly impac

everyone). The current expansion after

recent crisis (though I contend were not

done) has shown the weakest growth of r

per-capita GDP in any post-WWII expansioonly 0.1% relative to the post-war averag

nearly 3%.

While Keynes argued for deficit spend

(Hunt notes this is improperly now referred

as stimulus), he failed to recognize the bang point or the point where government engages in such prolonged deficit spending

that it leads to a denial of credit as some point as creditors begin to fear they wont be repaid (think of the EU). Nor did Keynes

discuss the idea of many nations around

globe embarking on the same course of

action simultaneously, and at a time whe

the global economy is more interconnect

than ever. Friedman also failed to explic

consider these items but he did recognizethe risks and thus advocated balanced

budgets (required constitutionally). Thou

the view was rejected as inhumane, as w

the case more recently when the republi

party raised this notion, it could have

gathered support during better times

(potentially even during the surplus year

the 90s).

Hunt wraps up by noting that the m

sensible recognition of budget policy ca

neither from Keynes nor Friedman, but fr


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David Hume. Hume pushed for surpluses during the good times, which then enabled some stimulus spending during bad times

(using up those surpluses that were established). Clearly this would be politically unacceptable as politicians want and now see

to need the ability to spend in order to retain power, but Humes recommendation is exactly what we teach our children in

preparing them to manage their own personal finances You build up a nest egg that you can rely on when things get tough.

Another example is how the typical citizen prepares for retirement, by saving for when their incomes will ultimately drop.

Woodford vs. BernankeIn the article discussing the recent Woodford piece, the article notes that the U.S. is attempting the same failed policy

measures pursued in Japan. Woodford suggests that asset purchases actually have very little, if any impact, and that what impa

there may be is difficult to quantify. He suggests that a more useful action may be to verbally commit to target a certain economor financial outcome (specifically he suggests that central banks should target a nominal GDP level). While the article provides o

recent example of this in Canada, Woodfords full paper provides many more, all of which highlight that when we see a reductio

in a target rate coupled with explicit guidance about where that target should be expected to be in the future, there is an

instantaneous effect on market expectations about the future path of the policy rate. Not only does the yield curve fall in

response, but it also flattens. Woodfords primary point is that the forward looking statements do in fact matter is and they are

perhaps more important than the act of lowering the rate itself.

Woodford goes on to then rebut Friedmans notion that the Fed could expand its balance sheet, creating money that would

ultimately flow into the broader economy and boosting spending by highlighting that while the Fed has rapidly increased the siz

its balance sheet as of late, both nominal GDP and the GDP deflator (and the amount of money out there) have remained fairl

steady and subdued.

Though many have warned of hyper-inflation, we see no signs of this as of yet, and this does not support the theory of pu

quantitative easing. Woodford goes after Bernankes notion that by limiting the availability of less-risky Treasury assets, he isforcing investors into riskier and more productive investments. Woodford suggests the composition of assets shouldnt change

their price if markets are remotely efficient, highlighting that no data demonstrates a sustained impact on prices. The question

asks is what moves the market? Is it the asset purchases or the forward looking statements? Yields have actually gone up durin

periods of QE though they have fallen on the days the programs are announced. However, on the day of the announcement the

Fed has also released forward looking statements, calling into question whether the cause of the shift was the asset purchases o

the commentary.

Woodford ultimately suggests the Fed should say We are going to keep rates low until nominal GDP reaches nominal

potential GDP. This would imply that they would keep rates low and wouldnt ease up until the economy is functioning at full

capacity rather than potentially dialing back when unemployment falls, inflation begins to rise, or the recovery begins to beco

clear in the economic data. Woodfords suggestion would imply that the fed would keep their foot on the gas even after the

economy starts gaining speed and if youre in the game then, youre going to make huge profits. This eliminates all uncertaint

and it also implies that if the economy gets weaker, the stronger the implied promise of future easing becomes. It is precisely

when the interest-rate lower bound is expected to be a binding constraint for some time to come that expectations about the

conduct of policy after the constraint ceases to bind should have a particularly large effect on current economic conditions

One great example provided is to consider youre determining whether to borrow money to build an apartment building. T

key issues are the interest rate and how much you expect people to spend on rent. If you believe that real incomes will rise, the

project may appear more attractive, but this would also put upward pressure on rates, diminishing the positive impact. If youre

told that this is a special case where rates will remain low even after real incomes begin to pick up, this has a huge impact. A

since the very act of building the apartment tends to increase real incomes (youll hire people to build and then operate the

building) the commitment serves to supercharge the impact of any good news. On a side note, making a credible promise not

raise rates until a clear goal is met (though we dont always see this behavior) may also be one reason that historically we have o

seen rates increase by 50 basis points or 0.5% a full 25-years after debt crises.

This is not a new idea and other economists have also suggested similar methods. As the article mentions, even Goldman

Sachs recently suggested the Fed should set a target for Nominal GDP. Woodfords ultimate points are clear. Communication i

key and this is consistent with how the Fed minutes have been characterizing the internal debate. Though the markets are

interested in only QE, the Fed is clearly focused on refining their communication tools. His second point is that communicatio

is more effective when they conditionally commit to a certain path. Finally, though he is critical of extreme balance sheet

increases at the central bank level, he does not fully rule out the use of asset purchases.

While a paper such as this would have caused many to view the author as crazy only a short time ago, this view is now

increasingly more mainstream. Even recent internal Fed research supports this notion (as does their focus on communication),

suggesting that lowering the path of ST rates will do more to stimulate the economy than lowering LT rates. While Woodford do

not outright appose asset purchases, it is clear that he sees the foundation of any Fed strategy being the conditional nature of t

commitment on interest rates.

--AC


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Lessons from Previous Credit Crises - 9/10/12Mauldin is a great writer and you are able to sign up for his weekly economics emails and thoughts from the frontline for free. This one was of

particular interest and Ive attached more recent writings of his as well.

Debt Be Not ProudBy John Mauldin | Sep 08, 2012

"In the financial markets, the current economic cycle is still often viewed as if it is comparable to the

far shorter cycles we have experienced since World War II. If that was indeed the case, the solution would

be to implement fiscal and monetary stimuli now until lending to the private sector and thereby growth rise substantially.

However, what is being overlooked is that the total debt/GDP ratio has risen so sharply over the past 75 years that the limit has

probably been reached.

"That would mean that the governments and central banks can no longer create high growth; at best they can prevent grow

from sliding fast. In addition, the drawbacks for central banks of opening the liquidity taps further are growing, while the

effectiveness of the action is waning. Therefore, although we anticipate the Fed to embark on additional easing measures, we

believe they will be disappointing in scope and effectiveness. For the ECB, maintaining the EMU and the euro is more important

achieve that, interest rates in Italy and Spain have to be rapidly reduced. Nevertheless, the measures the ECB recently announce

will achieve no more than creating a degree of calm in the financial markets, unless Spain and Italy make substantial structural

reforms to their economies. However, there is great resistance to those reforms." - ECR Research

The unemployment numbers came out yesterday, and the drums for more quantitative easing are beating ever louder. The

numbers were not all that good, but certainly not disastrous. But any reason will do, if what you want is more stimuli to boost th

markets ever higher. Today we will look first at the employment numbers, because deeper within the data is a real story. Then w

look at how effective any monetary stimulus is likely to be.

How Down Can Be Up If You Create the RulesThe nonfarm payroll numbers showed an increase of just 96,000 jobs in August. This was almost dead on the average for th

last six months, which is 97,000, down from 205,000 the previous six months, echoing the pattern of last year and suggesting th

numbers for the next two months will be soft as well, just prior to the election.

Almost all of the growth is in the birth/death number, which this month was 87,000 new jobs. For new readers, this is the

number that the Bureau of Labor Statistics creates to account for new businesses created that were not part of the employment

survey. The BLS surveys established businesses to get the employment data (thus this survey is called the establishment survey)

Since, almost by definition, they can't survey new businesses, and net new businesses are one of the more important parts of th

employment picture, BLS makes an estimate based on historical data. Then over time they revise the overall numbers. The

direction of the revisions is very important, as it tells us much about the underlying employment trends.

The revisions were all negative this time. That suggests to me that this month's birth/death number is probably higher thanshould be, and over time it will get revised down as well. Ugh. Looking at the data, we find that 28,000 jobs were created in the

and restaurant business. Those are not exactly high-paying jobs. My anecdotal observation is that more than a few college

graduates are taking those jobs.

The average earnings data was flat for the month, as the year-over-year number fell to a +1.7%, which is below inflation.

Workers are falling behind. Worse, hours worked fell by one-tenth of an hour. That doesn't seem like a lot, but when you add th

hours up, that one-tenth is the equivalent of several hundred thousand jobs, in terms of actual pay, which is of course a drag on

consumer spending.

We are down 4.7 million jobs from the pre-recession peak. At less than 100,000 jobs added per month, it would take four

more years just to get back to where we were five years ago. This would not appreciably reduce the unemployment rate, due to

the growth in population. All that was disappointing, but not anything we should be surprised by. No, the thing that caused me

do a double-take was the drop in the unemployment rate from 8.3% to 8.1%. How can only 96,000 new jobs cause a drop in the

unemployment rate of 0.2%? That is really a rather large number and should have required closer to 250-300,000 new jobs. In

addition, the population actually grew by 213,000.

"The number of unemployed fell by 250,000, and the unemployment rate fell by 0.2 to 8.1%. But those declines were large

the function of labor force withdrawal. Flows data confirm this suspicion: 195,000 went from employed to not in labor force, an

226,000 from unemployed to not in labor force, both very high numbers by historical standards. The number classed as not in la

force but wanting a job rose by 437,000 to 7.0 million, or 2.9% of the population, the highest of the Great Recession/Tepid

Recovery cycle." (The Liscio Report) The U3 unemployment rate has dropped from 9.1% last August to 8.1% this August. How do

that square with numbers in the real world? The working-age population has risen by 3.7 million people, and the number of

employed people (including part-time) has increased by 2.3 million. How can an increase in the number of people that logically

seem unemployed translate into a reduction in the unemployment rate? To reduce the unemployment rate, the trick is to redu

the number of people in the work force by significantly more than the number of new jobs. Under the rules, 368,000 people we

removed this month from the labor force. The labor force is made up of those who are either employed or unemployed, but you


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are not considered unemployed if you have not looked for a job in the last four weeks, or are in school or

Now, here is something Lacy told me today in a private conversation, as we were talking about the rather large drop in the

labor force, and it surprised me. He noted that you are not considered to be in the labor force is you have not been considered

unemployed during the last year. (I must admit I cannot find that on the BLS website. And at 3 AM in the morning, it would be ru

to call his room. I will confirm this later today and note that to you next week if I got the details wrong.)

Here is the interesting thing. It usedto be that you were in the labor force if you had been looking for work sometime in the

last four years, but that was changed to one year in the latter Clinton years. If we used that older and to my mind more reasona

standard, the unemployment rate would be

least 1% higher and perhaps a lot more. I cal

the old standard more reasonable because it

counts discouraged workers who would take

job if they thought they could find one. Look

this graph from the St. Louis Fed FRED

database. The labor force participation rate

red and the employment-to-population ratio

in blue. The employment-to-population ratio

down to where it was in the late '70s. The

participation rate is down to 63.5%, roughly

where it was some 30 years ago.

Note that if you are on disability you arnot considered to be in the labor force. As of

April we have added 5.4 million people to th

disability rolls since the beginning of 2009. T

is several million above the previous trend. There are now almost 9 million on disability. There are many who drop off each year

but many of them are going from disability to Social Security.

"As the Congressional Budget Office explains: "When

opportunities for employment are plentiful, some people who co

quality for [disability insurance] benefits find working more

attractive ... when employment opportunities are scarce, some o

these people participate in the DI program instead." "The explos

growth in disability enrollment also 'helps explain some of the dro

in the labor force participation rate,' noted economist Ed Yarden(IBD) In 1992, there was one person on disability for every 35

workers. It is now about one for every 16 workers. If disability ha

stayed at the pre-recession growth trend, unemployment would

at least 1% higher, and perhaps as much as 2%.

Bottom line is that true unemployment is closer to 10% and

perhaps significantly more. We just don't know. Underemployme

is still in the range of 16%. And that does not count people who h

a job for which they are far overqualified and who are making mu

less money than they would if they could find a job in their chose

field. I should note to all those people who think I am being overl

pessimistic that John Williams at Shadow Stats, who uses the USgovernment methodology from 30 years ago, tells us that U-6

unemployment is around 23%.(http://www.shadowstats.com/ th

is a great website that I would highly recommend. Ironically, I on

got in a bit of hot water for going to the site on a work computer f

a large bank but this story is for another time. The difference is in

how you create the model. The feds keep changing the rules, and it should be no surprise that with each new rule the number o

people officially counted as unemployed drops. And if you can't find a job, whether you are officially unemployed or not, it's no

fun.

The Fed to the Rescue?This ongoing unemployment problem is increasing the pressure on the Fed to "do something." But is more quantitative eas


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the answer? I am going to quote from three pieces of research brought to my attention by Lacy Hunt this afternoon (directly fro

his PowerPoint). This all fits hand in glove with the report I highlighted last week from William White, which was on the Dallas

Federal Reserve website. The upshot of these difficulties is that Fed QE policy has lost its effectiveness and may start to be part

the problem. And that the solution should focus on controlling government debt.

The Correlation Between Government Size and Growth"Government Size and Growth: A Survey and Interpretation of the Evidence." Andreas Bergh, Research Institute of Industri

Economics (IFN) Lund University and Magnus Henrekson, Research Institute of Industrial Economics (IFN) Lund University.Journ

of Economic Surveys, April 2011. Page 2, http://journalistsresource.org/wp-content/uploads/2011/08/Govt-Size-and-Growth.pd

The first study we'll look at shows a clear inverse correlation between the size of government and growth. This really confircommon sense, as government only takes from private production to fund its spending. And while one can make a case that som

government spending is productive, much of government spending, including transfer payments, does not contribute to that ca

That is not the same as arguing that those transfer payments should not be made. It simply points out that there is a cost to soc

to increase the size of government. And that cost is in jobs, hence the ugly employment numbers. That being said, the authors

note that correlation is not causation and that there are other explanations for countries with high taxes and higher growth rate

provide a link to the study for those who are interested, and we may explore those questions in depth in a later letter. Quoting:

"Any conflict between the size of government and economic growth is largely explained by variations in definitions and the

countries studied. Bergh and Henrekson write, 'An alternative approach of limiting the focus to studies of the relationship in ri

countries, measuring government size as total taxes or total expenditure relative to GDP and relying on panel data estimations w

variation over time reveals a more consistent picture...' Bergh and Henrekson find a 'significant negative correlation.' Specifica

'an increase in government size by 10 percentage points is associated with a 0.5% to 1% lower annual growth rate.'"

Debt Be Not ProudCristina Checherita and Philipp Rother, "The Impact of High and Growing Government Debt on Economic Growth, An Empir

Investigation for The Euro Area," European Central Bank working paper no. 1237, August 2010.

http://www.ecb.int/pub/pdf/scpwps/ecbwp1237.pdfThis ECB paper suggests that governments need to get their fiscal houses

order. "Checherita and Rother investigated the average effect of government debt on per capita GDP growth in twelve euro are

countries over a period of about four decades beginning in 1970. They confirm and extend the finding by Reinhart and Rogoff in

their 2010 NBER paper. A government debt to GDP ratio above the turning point of 90-100% has a 'deleterious' impact on long-

term growth. In addition, they find that there is a non-linear impact of debt on growth beyond this turning point. A non-linear

relationship means that as the government debt rises to higher and higher levels, the adverse growth consequences accelerate.

Results across all models 'show a highly statistically significant non-linear relationship between the government debt ratio and p

capita GDP for the 12 pooled euro area countries included in their sample.'

"Moreover, confidence intervals for the debt turning point suggest that the negative growth rate effect of high debt may stfrom levels of around 70-80% of GDP. (Consider where we in the U.S. are currently at) Due to these findings, Checherita and

Rother write this 'calls for even more prudent indebtedness policies.' Checherita and Rother make a substantial further

contribution by identifying the channels through which the level and change of government debt is found to have an impact on

economic growth: (1) private saving, (2) public investment, (3) total factor productivity and (4) sovereign long-term nominal and

real interest rates."

Debt Overhangs: Past and PresentCarmen M. Reinhart, Vincent R. Reinhart, Kenneth S. Rogoff, National Bureau of Economic Research, working paper 18015.

http://www.nber.org/papers/w18015 Then Lacy reviews recent work by our old friends Ken Rogoff and Carmen Reinhart (who

wrote the seminal work This Time Is Different). It is further acknowledgement that excessive government debt will retard growth

Again quoting from his PowerPoint:

"Post 1800 Episodes Characterized by Public Debt to GDP Levels Exceeding 90% for At Least Five Years."Consistent with other more recent research, the authors confirm that public debt overhang episodes are associated with growt

over one percent lower than during other periods. ... duration of the average debt overhang episode across all 26 episodes last

an average of 23 years.... Growth effects are significant even in the many episodes where debtor countries were able to secure

continual access to capital markets at relatively low real interst rates. That is, growth-reducing effects of high public debt are

apparently not transmitted exclusively through high real interest rates.

"The long duration belies the view that the correlation is caused mainly by debt buildups during business cycle recessions. T

long duration also implies that cumulative shortfall in output from debt overhang is potentially massive. "At the end of 23 years

Real GDP is 24 percent lower than for the baseline. It is not exactly what T.S. Eliot had in mind when he wrote 'This is the way th

world ends, Not with a bang but a whimper' but the general thrust appears to be applicable to the debt-without-drama damage

"This research documents the first systematic evidence on the association between high public debt and real interest rates. They

write: 'Contrary to popular perception, we find that in 11 of the 26 debt overhang cases, real interest rates were either lower or

about the same as during the lower debt/GDP years. Those waiting for financial markets to send the warning signal through
http://email.mauldineconomics.com/wf/click?upn=DdQTzhAUMB03KSYvpasuzwQweQAs4ND2gsLyX8UN7-2BScoG22iOftuPJkpHcRw67z2eOdKzUSLrt6TTfzOfiagsP7Zsuj-2BpuevhZHdaZVhA-2BLyq08qhhbhwkUfYooxctN_biTJWLvEQqhpJW8shpiJJT-2BYTKhulCDnnr0lavZIxnQ2DYG-2BPj87pVRb-2F1O-2FRmR0QRiL7jWzO5IyZn2eiTr4ZD6Lw-2BeHZjYPum4HcYlja4ik7yHw5WOu3ZncxelH9dwEe9gD1PqN1tHhIOVOIT8UN1fgH9k1b-2BOLFlSgyK3oETfVlkQFiPPeTblX02wt1vjoD6RdeaXV-2BZfmuKZy0-2FM-2F5g-3D-3Dhttp://email.mauldineconomics.com/wf/click?upn=U8GusXYvzQrI-2BTfpBInOi5lsH4oGiYTfmtQqA0oyikHf9lrin1SQoWCDXk0aVyJUyyZ7D4kMX25gdOkrbwP0UA-3D-3D_biTJWLvEQqhpJW8shpiJJT-2BYTKhulCDnnr0lavZIxnQ2DYG-2BPj87pVRb-2F1O-2FRmR0aWVxaIVXaaUFHKBrvEARI7RgBdjDr3fowsywvTUgN-2FGbMxjX6IppdQpN1LNOWbJrp9eZCnuAKpWNDaEMX9uK317xmqEp00cfkKEjLVJEgT72IDHQaUrUNhItTX43vrGUdVL9zA4EJwR6pNaqh-2B67fA-3D-3Dhttp://email.mauldineconomics.com/wf/click?upn=U8GusXYvzQrI-2BTfpBInOi5lsH4oGiYTfmtQqA0oyikHf9lrin1SQoWCDXk0aVyJUyyZ7D4kMX25gdOkrbwP0UA-3D-3D_biTJWLvEQqhpJW8shpiJJT-2BYTKhulCDnnr0lavZIxnQ2DYG-2BPj87pVRb-2F1O-2FRmR0aWVxaIVXaaUFHKBrvEARI7RgBdjDr3fowsywvTUgN-2FGbMxjX6IppdQpN1LNOWbJrp9eZCnuAKpWNDaEMX9uK317xmqEp00cfkKEjLVJEgT72IDHQaUrUNhItTX43vrGUdVL9zA4EJwR6pNaqh-2B67fA-3D-3Dhttp://email.mauldineconomics.com/wf/click?upn=U8GusXYvzQrI-2BTfpBInOi1VcFEHAPNo1eDDARh5-2FMzFkAUNE3qnFjpwc5eoTv8dK_biTJWLvEQqhpJW8shpiJJT-2BYTKhulCDnnr0lavZIxnQ2DYG-2BPj87pVRb-2F1O-2FRmR0eSaTZmCwZphvpiY2vQKbOZky79tl60zWJlzrLmYC7y8M9xguCj7-2FU74Mf37VnkRVztUeF6LZ0b5SXA-2BSr456IJNy1pyqyW7ERSAUg-2FBy3XDjKxYuqYtw-2BXj-2FPEj2Q69mgyGD3yle4G0bX-2B2IDPuZFA-3D-3Dhttp://email.mauldineconomics.com/wf/click?upn=U8GusXYvzQrI-2BTfpBInOi1VcFEHAPNo1eDDARh5-2FMzFkAUNE3qnFjpwc5eoTv8dK_biTJWLvEQqhpJW8shpiJJT-2BYTKhulCDnnr0lavZIxnQ2DYG-2BPj87pVRb-2F1O-2FRmR0eSaTZmCwZphvpiY2vQKbOZky79tl60zWJlzrLmYC7y8M9xguCj7-2FU74Mf37VnkRVztUeF6LZ0b5SXA-2BSr456IJNy1pyqyW7ERSAUg-2FBy3XDjKxYuqYtw-2BXj-2FPEj2Q69mgyGD3yle4G0bX-2B2IDPuZFA-3D-3Dhttp://email.mauldineconomics.com/wf/click?upn=U8GusXYvzQrI-2BTfpBInOi1VcFEHAPNo1eDDARh5-2FMzFkAUNE3qnFjpwc5eoTv8dK_biTJWLvEQqhpJW8shpiJJT-2BYTKhulCDnnr0lavZIxnQ2DYG-2BPj87pVRb-2F1O-2FRmR0eSaTZmCwZphvpiY2vQKbOZky79tl60zWJlzrLmYC7y8M9xguCj7-2FU74Mf37VnkRVztUeF6LZ0b5SXA-2BSr456IJNy1pyqyW7ERSAUg-2FBy3XDjKxYuqYtw-2BXj-2FPEj2Q69mgyGD3yle4G0bX-2B2IDPuZFA-3D-3Dhttp://email.mauldineconomics.com/wf/click?upn=U8GusXYvzQrI-2BTfpBInOi5lsH4oGiYTfmtQqA0oyikHf9lrin1SQoWCDXk0aVyJUyyZ7D4kMX25gdOkrbwP0UA-3D-3D_biTJWLvEQqhpJW8shpiJJT-2BYTKhulCDnnr0lavZIxnQ2DYG-2BPj87pVRb-2F1O-2FRmR0aWVxaIVXaaUFHKBrvEARI7RgBdjDr3fowsywvTUgN-2FGbMxjX6IppdQpN1LNOWbJrp9eZCnuAKpWNDaEMX9uK317xmqEp00cfkKEjLVJEgT72IDHQaUrUNhItTX43vrGUdVL9zA4EJwR6pNaqh-2B67fA-3D-3Dhttp://email.mauldineconomics.com/wf/click?upn=DdQTzhAUMB03KSYvpasuzwQweQAs4ND2gsLyX8UN7-2BScoG22iOftuPJkpHcRw67z2eOdKzUSLrt6TTfzOfiagsP7Zsuj-2BpuevhZHdaZVhA-2BLyq08qhhbhwkUfYooxctN_biTJWLvEQqhpJW8shpiJJT-2BYTKhulCDnnr0lavZIxnQ2DYG-2BPj87pVRb-2F1O-2FRmR0QRiL7jWzO5IyZn2eiTr4ZD6Lw-2BeHZjYPum4HcYlja4ik7yHw5WOu3ZncxelH9dwEe9gD1PqN1tHhIOVOIT8UN1fgH9k1b-2BOLFlSgyK3oETfVlkQFiPPeTblX02wt1vjoD6RdeaXV-2BZfmuKZy0-2FM-2F5g-3D-3D


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higher interest rates that government policy will be detrimental to economic performance may be waiting a long time.'"

Should the Fed Give Us QE3?There seems to be a clear consensus (from the dozen or so items I have read) that the Fed will now give us QE3 at its meeti

next week. I do not doubt that more QE is in the works, but I sincerely hope they wait until after the election. To my mind, anoth

round of QE will not produce all that much, though it may possibly make the stock market happy. It will not stimulate spending

increase the need for more loans or make it easier to buy a house. Rates are already low, and there is excess liquidity in the

system. While I acknowledge that the propensity of a central banker is to do something (God forbid that a recovery should happ

while they did nothing, so they couldn't take credit for it!), it is unseemly to do so right before a presidential election. There is

nothing in this employment report that is any different from what we knew months ago. I can see no reason not to wait untilNovember. The building is not on fire. Additional QE today is like pouring water on a drowning man.

Please note: I have been consistent on this issue for decades. The Fed must not be seen to be political in any way prior to

presidential election. Caesar's wife and all that stuff. I would be fine with QE after a Lehman-type incident if it happened right

before an election, but we do not have a Lehman issue. The economy is still growing, if slowly. The problem is not a monetary

problem and cannot be solved by the Fed. The future direction of the country and the shape of the fiscal deficit will be decided i

November. Next week we'll take a look at the election itself, after some time to assess the convention bounces and what this

election really means. Let me give you a teaser. I am not worried at all that either the Obama budget or the Romney budget will

enacted as proposed, because the chances are about zero of either being passed. The issue is the direction of the compromise, a

on that seeming nuance, the economic future of the republic hangs. Stay tuned.

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