Paul Krugman Was Wrong

Paul Krugman, if you are not familiar with him, is a brilliant man. He is a Nobel Prize winner in economics. More important to me, he is a columnist for the New York Times, where his columns over the years have taught me almost everything I know about economics. That is a remarkable accomplishment for a writer, taking a complex topic and making it comprehensible to a lay reader such as myself. Having said that, in a recent column, Paul Krugman was wrong.

Krugman was offering an explanation for why the Republicans are finding that their tax bill, their only major accomplishment under Trump, is so unpopular. It is a terrible bill, but so were the Bush tax cuts, and they polled much better. Krugman said that the American people have finally woken up, and realized that this bill cheats them. He said that Americans understand that Donald Trump can not be trusted, and therefore they are feeling a healthy skepticism for anything related to him. I wish I could believe that. In Donald Trump, we have a man who employs a fixer to make problems go away. We expect mob bosses to do that, not presidents. But Americans, even when they tell pollsters that their dislike and even distrust of Congress is at an all time high, want to believe that their government is at least trying to act in their best interests. That is exactly why the Bush tax cuts were popular. The reason the Trump tax cuts are unpopular is much simpler than Krugman realizes. It has to do with a variation on a question once made famous by a Republican: are you better off than you were a year ago?

Krugman probably is better off than he was. He is, deservedly, well compensated for what he does, and so his tax cut probably gave him more cash on hand than he had last year. But Paul Krugman, for all of his brilliance, does not live in my world. I am not dirt poor. I have a good job that pays me well above the poverty level, even as the sole bread winner for a family of four. But I am not better off than I was a year ago, and neither are most Americans. There are two main reasons for this, both of which completely consumed my tax cut before I ever got it. First, I live in area that is very poorly served by public transportation, so gas prices are a key part of my budget. They are much higher than they were a year ago. On top of that, I have had medical benefits most of the time through my employer since 1999, and I have never seen the cost of them jump as much as they did this year. Even without the cost of gas, that consumed my tax cut and more. Most Americans are feeling the bite of these two issues, and they blame their government for their plight. In the face of this, they regard their tax cut as a cruel joke. They understand that the tax cut only helped people richer than themselves. They don’t own the tax cut, because they can not see that it helped.

In light of all of this, it is worth asking if Americans are being fair. Are the rises in gas prices and healthcare the Republicans’ fault? Are they Trump’s fault? Let’s talk about healthcare first. This one is pretty clear cut. Last year, Donald Trump tried to get the Republicans in Congress to keep a long standing promise to get rid of Obamacare. He failed, because voters let their Representatives and Senators know that they had come to depend on the protections embedded in the Affordable Care Act. But Trump, with the blessings of Republicans in both Houses, did everything he could to destabilize the insurance market. Premiums are higher this year because the uncertainty and instability this created, and that was the plan. Trump and his allies hoped to create enough pain to justify getting rid of the ACA at some point in the future. The tax cut bill itself also repealed the individual mandate in the ACA, which will only make things worse going forward.

Oil prices are harder to pin down. Barack Obama does not get enough credit for getting oil prices down to the levels they were at by the end of his presidency. He did this by continuing, and even expanding, a program started by George W Bush to promote domestic production. The Trump administration and its allies are, if anything, even friendlier to oil producers. Trump is willing to abandon any environmental concerns in the name of the all mighty dollar, and that certainly applies to the oil industry. But there were two other important reasons why gas prices fell so much under Obama. Obama did everything he could to pursue peace in the Middle East. Some specific conflicts were intractable, and they remain volatile now. But Obama used a shrewd combination of diplomacy and military force as a last resort, to get and keep oil flowing from places like Iraq and Syria. In contrast, Trump has not even hired ambassadors to some oil producing nations, and his bellicose manner in international affairs has threatened to jeopardize the flow of oil. Until last week, however, it was hard to point to anything specific that Trump had done that made oil more expensive. Breaking the nuclear treaty with Iran and threatening new economic sanctions changed that, and there was an immediate reaction in the price of oil futures worldwide. The other Obama initiative that helped tame gas prices was an aggressive push to promote alternative energy sources. Trump brought that to a screeching halt almost as soon as he took office.

Now you might think that things can’t possibly be as bad as I say. After all, the economy continues to expand. Unemployment is at a historic low. Where are the signs of the distress that I allege makes people dislike the tax cut bill so much? Actually, the signs are there for any who care to read them, and they are getting clearer. Yes, the April jobs report showed that unemployment fell below 4% for the first time since 2000. But job creation was actually pretty weak; unemployment fell because 236,000 people dropped out of the workforce. In addition, the stocks of casual dining companies have been down all year, because people are eating out less. And there have been 11 bankruptcies in the retail sector this year. That is a record for this time of year, and includes the demise of Toys R Us. All of this will translate over time into job losses, and will further strain the economy. The stock market can continue to defy gravity for some time, as corporations continue to use their tax cuts to buy back shares, instead of raising wages as the Republicans promised. Wealthy individuals will continue to need someplace to put their tax cut loot to work, and it won’t be any place that increases consumer spending or creates jobs. But the stock market is not the economy, and there will have to be a reckoning at some point.

So there you have it. Americans reject the tax cut bill not because of some great awakening in consciousness, but simply because they have less money now than before they got their tax cut. I wish Paul Krugman was right, but I don’t see it.

The Fun House Mirror

I often see people using the performance of the stock market as a way of evaluating the success the political climate of the time. A meme made the rounds last year that included the rise of the S & P stock index during his presidency as a measure of Barack Obama’s success. If that is an accomplishment that one should be proud of, then Donald Trump must be the best president we ever had. You only need to look at how the stock market has performed since Election Day to see this. There are indeed some people who believe this. Even the sharp drop in the stock market last Wednesday does not dissuade them. That drop came as a special counsel was appointed to investigate the Trump campaign and the possibility of obstruction of justice within the administration, but the market has rallied in the following four sessions and regained most of what it lost as the news cycle quieted. This is a fine example of what I like to call a “just kidding rally”, and it points out how the stock market is not reality.

That said, Wall Street does mirror our political scene in bizarre ways. There is a battle of two different ideologies that mirrors our partisan divide. One side has more real world facts on its side, but the other has the better marketing for its positions. There is a blurring of who is on which side that serves to confuse matters, and strengthen those who eschew real world evidence. The two schools of thought combine in ways that do not always stand up to close inspection or analysis.

Wall Street is divorced from the real world in the first place because it is a game for the wealthy. You have to be able to afford the buying and selling of individual stocks, as well as more esoteric and speculative investments, to have an influence on how the market moves. You live in a world where your personal spending is not affected by increases at the pump in the price of gas. The jobs that are lost in mergers and acquisitions are not real to you. Drastic cuts in programs for the poor are seen in the light of deficit reduction, while the impact on consumer spending, and therefore ultimately on jobs, is conveniently ignored. The majority of the members of the House and Senate also live in this world, which makes it easier for them to evaluate the laws they pass in terms of how the market responds. Massive tax cuts for the rich do not go into the economy and create jobs; instead, they are invested for long- and short-term profits in the market, boosting the portfolios of many who voted for them. Market growth is not economic growth, and eventually even investors pay the price for this dichotomy, but too many policy makers can not see this. I just referred to “investors”, and thereby illustrated part of the problem. Wall Street is actually divided into investors and traders, and this is also reflected in our politics. Traders are looking to buy and sell stocks and other financial instruments rapidly, a year being a long time frame for them. They are looking for positions they can take for short term gains. Real world reasons why a stock should do well over time, such as the viability of the product or the soundness of the company, do not interest them. Instead, traders have developed an esoteric method of analyzing price charts to predict near term price movements of a given financial instrument. This type of analysis has become so involved that there is a tendency to lose track of the real world reasons for these price movements. Often, these reasons come down to mob psychology. A stock may have already risen to a level that is appropriate to the company’s worth by the time an analyst recommends it, but a trader’s charts measure the effects of new buyers piling in as the price of the stock rises to unsupportable levels. Traders hope to take advantage of this rise, and get out before the inevitable return to hard reality. Traders also know that their approach often fails, but they seek to balance their losses with a few big wins, so they need to exit their losing positions quickly. Donald Trump is a trader. His bankruptcies do not matter; they were just him monetizing the quick losses, while pursuing the next big win. In this game, it does not matter who gets hurt on the other side of a trade.

Investors are different. The real world matters to them, even if they don’t exactly live in it. They seek to find investments that are worth more than their current market price, and then hold them for as long as it takes for reality to catch up. The viability of a product and the financial health of a company are important to them. Peter Lynch once made investors in his Fidelity Magellan fund very happy with this approach, and Warren Buffet has become very wealthy this way. In politics, investors understand that safety net programs are vital to the long term health of the country. Where a trader sees the people of this country as competitors for a finite set of resources, investors see each person as representing a long term value to the nation, even if it takes a generation or more to unlock that value.

In a political campaign, traders offer short term solutions that may seem wonderful if you don’t look at them too closely. They can vilify political investors, knowing that they offer an easily visible quick fix, in contrast to a slow developing investing approach that solves nothing in the near term. In eight years, the full benefits to society of Obamacare had not had time to play out, making it easy for the Republicans to run against it. Political investors such as Hillary Clinton can also lose track of the fact that most Americans do not and can not actively participate in the market at all. To her, the status quo established under Obama was fine, just needing more time to play out. She could not appeal to those who needed not just health insurance but health insurance they could actually afford to use. She was asking for patience, while Trump was offering someone to blame for the time things were taking to get better.

It comes down to this. Would you rather buy a stock that should be worth twice its current price, but may take years to get there? Or would you rather buy a stock that a star analyst says will double in six months, even if it currently sells for more than the company is worth? It is the job of corporate Democrats to sell us the first stock instead of the second. It is the job of Republicans like Paul Ryan to get us to ignore any misgivings and buy the first stock. There is hardly anyone in Washington who will speak for those who can’t afford to actively play the market at all. That is actually most of us, and our laws would look very different if we were also considered. Ironically, the times when we have been considered, with policies such as the New Deal and the Great Society, have been very good times for the stock market. There many good reasons for this, but they may be the subject of a future post.

I really could only see one choice for this week’s song:

The Trump Bubble

Something very strange happened in the 24 hours following the election. Going in, everyone on Wall Street “knew” that Hillary Clinton would win. It is an old adage that Wall Street hates surprises, so everyone also “knew” that the stock market would get clobbered if Trump somehow won by mistake. Indeed, as the results became known, markets in first Asia and then Europe plunged. Futures for the US stock market began to predict a brutal day for American stocks as well. But, as 9:30 AM November 9 approached, (which marked the opening of the US stock market), European markets and US futures began to recover strongly. In fact, US stocks as measured by the S&P 500 index not only rose strongly that day, but they have gone on a tear ever since, in what has come to be called “the Trump rally”. Literally overnight, the market went from fear and despair to euphoria. Euphoria is something Wall Street is very good at, but it usually ends badly. So call this my year end forecast edition.

Before I look forward, however, I should provide some background. It is vital to keep in mind that the stock market is not the economy. In the best example of this, when companies merge or lay off workers for any reason at all, unemployment increases, which then reduces consumer spending and thereby hurts the economy over a longer period of time than most people appreciate. But an announcement of a merger or layoffs almost always boosts the price of a stock, because profits increase. What is good for stocks more broadly can also be bad for the nation, so a new law or president that greatly weakens the EPA for example increases the profits of companies that pollute, but it means poisonous air and water for the rest of us. Given this, you might expect that voters would reject any candidate that Wall Street liked, and indeed there are some progressives who vote that way. But that ignores that fact that Wall Street is not monolithic. Individuals like George Soros may be hedge fund billionaires, but they recognize that, over time, progressive causes are good for the country and the markets.

You also can not say that voters are going against their own economic interests without thinking about the 401(k). Today, it is easy to think that 401(k)s have always existed. In fact, however, they are named for a section of the tax code in a 1978 law, and they only took off after a rule interpretation in 1981. Look at a graph of income inequality, and you will see that our current situation has its roots around this time. Yes, Reagan’s tax policies also made a big difference, but 401(k)s have made a big difference in our politics. Before the 401(k), companies provided retirement benefits through defined benefit plans. This meant that you were guaranteed a pension that grew predictably over time, no matter what the stock market did. The 401(k) is another matter, and it has replaced completely the old defined benefit plans for most workers. With a 401(k), you contribute to the plan with an employee match, but how it grows is entirely based on how the stock market performs. I’m simplifying somewhat, since most 401(k)s also offer money market and bond options, but the big gains are to be had in the stock funds offered. The greater risk is also to be found in these funds, but too few people appreciate that. What’s important is that 30 years on, voters now have to weigh the health of the nation against the possible impact on their retirement funds. The Trump rally is good for Wall Street traders, but it is also good for your 401(k).

This, of course, is short term thinking, but that is how many people vote. Retirement planning done properly however involves thinking in the long term. Policies that provide a social safety net and help share the wealth throughout society boost consumer spending over time, thereby creating jobs, which create more consumer spending. On the other hand, policies such as tax cuts for the rich and assaults on safety net programs concentrate wealth in the hands of a few, reducing both employment and consumer spending over time. This is ultimately bad for stocks and corporate profits, which is why the market consistently performs better during Democratic presidencies than Republican ones. And the difference is not small.

The Trump rally is short term thinking at its finest. After the initial panic, analysts began drool of the prospect that expensive regulations would be swept away by the new president and the Republican congress. Healthcare companies and insurers expect increased profits as the Affordable Care Act gets kneecapped. That means they will pay less and we will pay more for healthcare. The demise of environmental regulations is expected to be profitable for polluters in raw material industries. Military contractors look forward to a new arms race with Russia. Investing in general and the mortgage industry in particular will see a return to the casino environment that preceded the 2008 financial crisis. But the most absurd part of the Trump rally is the idea that Trump’s infrastructure plans will mean a huge increase in government spending. In fact, Hillary Clinton’s infrastructure proposals would have had that effect, but Trump is talking about tax incentives and privatizing things like toll roads and bridges, many of which are currently free. Initially, companies will reclassify existing projects wherever they can to get the tax benefit, diluting the power of these programs to create jobs. Over time, the new toll roads and bridges will be a burden on drivers, and therefore a drain on consumer spending. So, once again, your 401(k) may benefit in the short term, but the economy will suffer in the long term. Actual infrastructure spending by the government would never pass in this congress, even if that was what Trump had in mind.

So, here is my stock market prediction for the Trump presidency. In 2017, we will be operating under the last Obama budget, and many of our current laws will still be in effect. The economy will continue to create jobs for which Trump will try to take credit, but in reality job growth will slow as Trump’s changes begin to take effect. The stock market will drop somewhat in January as the current rally stalls, but the market will be up slightly at year end. In 2018, we will begin to see the full effect of Trump’s policies. From that point to the end of his presidency, the market will fall. We will see a new recession by 2020, the severity of which will depend on whether the Democrats can gain control of the Senate in 2018 and curb some of Trump’s worst impulses. The market will also fall if Trump finds a way to get himself impeached. That seems likely when you consider his contempt for our system of laws and the Constitution. So over all, voters can look forward to four lost years for their 401(k) plans.