Image: President Reagan addresses the nation, July 1981 (Public Domain)

Lessons from How the Back of Inflation Finally Broke in 1982

 

by Tim Sablik – Federal Reserve Bank of Richmond

Prior to the 2007-09 recession, the 1981-82 recession was the worst economic downturn in the United States since the Great Depression. Indeed, the nearly 11 percent unemployment rate reached late in 1982 remains the apex of the post-World War II era (Federal Reserve Bank of St. Louis). Unemployment during the 1981-82 recession was widespread, but manufacturing, construction, and the auto industries were particularly affected. Although goods producers accounted for only 30 percent of total employment at the time, they suffered 90 percent of job losses in 1982. Three-fourths of all job losses in the goods-producing sector were in manufacturing, and the residential construction industry and auto manufacturers ended the year with 22 percent and 24 percent unemployment, respectively (Urquhart and Hewson 1983, 4-7).

 

The economy was already in weak shape coming into the downturn, as a recession in 1980 had left unemployment at about 7.5 percent. Both the 1980 and 1981-82 recessions were triggered by tight monetary policy in an effort to fight mounting inflation. During the 1960s and 1970s, economists and policymakers believed that they could lower unemployment through higher inflation, a tradeoff known as the Phillips Curve. In the 1970s, the Fed pursued what economists would call “stop-go” monetary policy, which alternated between fighting high unemployment and high inflation. During the “go” periods, the Fed lowered interest rates to loosen the money supply and target lower unemployment. During the “stop” periods, when inflation mounted, the Fed would raise interest rates to reduce inflationary pressure. However, the Phillips Curve tradeoff proved unstable in the long-run, as inflation and unemployment increased together in the mid-1970s. While unemployment trended down slightly by the end of the decade, inflation continued to rise, reaching 11 percent in June 1979 (Federal Reserve Bank of St. Louis).

 

Paul Volcker was appointed chairman of the Fed in August 1979 in large part because of his anti-inflation views. He had previously served as president of the New York Fed and had dissented from Fed policies he regarded as contributing to inflation expectations. He felt strongly that mounting inflation should be the primary concern for the Fed: “In terms of economic stability in the future, [inflation] is what is likely to give us the most problems and create the biggest recession” (FOMC transcript 1979, 16). He also believed that the Fed faced a credibility problem when it came to keeping inflation in check. During the previous decade, the Fed had demonstrated that it did not place much emphasis on maintaining low inflation, and public expectation of such continued behavior would make it increasingly difficult for the Fed to bring inflation down. “[F]ailure to carry through now in the fight on inflation will only make any subsequent effort more difficult,” he remarked (Volcker 1981b).

 

Chairman of the Federal Reserve Board of Governors Paul Volcker holds his head in his hand at a meeting in Washington, D.C.(Photo: Bettmann/Bettmann/Getty Images)

 

Volcker shifted Fed policy to aggressively target the money supply rather than interest rates. He took this approach for two reasons. First, mounting inflation made it difficult to know which interest rates targets were appropriately tight. While the nominal rates the Fed targeted could be quite high, the real interest rates (that is, the effective interest rates after adjusting for inflation) could still be quite low due to the expectation of inflation. Second, the new policy was meant to signal to the public that the Fed was serious about low inflation. The expectation of low inflation was important, as current inflation is driven in part by expectations of future inflation.

 

Volcker’s first attempt to lower inflation and inflationary expectations proved insufficient. The credit-control program initiated in March 1980 by the Carter administration precipitated a sharp recession (Schreft 1990). As unemployment mounted, the Fed eased up, an action reminiscent of the “stop-go” policies the public had come to expect. In late 1980 and early 1981, the Fed once again tightened the money supply, allowing the federal funds rate to approach 20 percent. Despite this, long-run interest rates continued to rise. The ten-year Treasury bond rate increased from about 11 percent in October 1980 to more than 15 percent a year later, possibly because the market believed the Fed would back down from its tight policy when unemployment rose (Goodfriend and King 2005). This time, however, Volcker was adamant that the Fed not back down: “We have set our course to restrain growth in money and credit. We mean to stick with it” (Volcker 1981a).

 

The economy officially entered a recession in the third quarter of 1981, as high interest rates put pressure on sectors of the economy reliant on borrowing, like manufacturing and construction. Unemployment grew from 7.4 percent at the start of the recession to nearly 10 percent a year later. As the recession worsened, Volcker faced repeated calls from Congress to loosen monetary policy, but he maintained that failing to bring down long-run inflation expectations now would result in “more serious economic circumstances over a much longer period of time” (Monetary Policy Report 1982, 67).

 

Ultimately, this persistence paid off. By October 1982, inflation had fallen to 5 percent and long-run interest rates began to decline. The Fed allowed the federal funds rate to fall back to 9 percent, and unemployment declined quickly from the peak of nearly 11 percent at the end to 1982 to 8 percent one year later (Federal Reserve Bank of St. Louis; Goodfriend and King 2005). The threat of inflation was not completely gone, as the Fed would face a number of “inflation scares” throughout the 1980s. However, the commitment of Volcker and his successors to aggressively targeting price stability helped ensure that the double-digit inflation of the 1970s would not return.

 

Suggested Reading:

CPI and PPI Both Suggests Persistent Inflation

Why the Most Conservative Investors Could Help Small Stock Performance

 

 

Sources:

https://www.federalreservehistory.org/essays/recession-of-1981-82

 

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	Image: President Reagan addresses the nation, July 1981 (Public Domain)

Lessons from How the Back of Inflation Finally Broke in 1982

 

by Tim Sablik – Federal Reserve Bank of Richmond

Prior to the 2007-09 recession, the 1981-82 recession was the worst economic downturn in the United States since the Great Depression. Indeed, the nearly 11 percent unemployment rate reached late in 1982 remains the apex of the post-World War II era (Federal Reserve Bank of St. Louis). Unemployment during the 1981-82 recession was widespread, but manufacturing, construction, and the auto industries were particularly affected. Although goods producers accounted for only 30 percent of total employment at the time, they suffered 90 percent of job losses in 1982. Three-fourths of all job losses in the goods-producing sector were in manufacturing, and the residential construction industry and auto manufacturers ended the year with 22 percent and 24 percent unemployment, respectively (Urquhart and Hewson 1983, 4-7).

 

The economy was already in weak shape coming into the downturn, as a recession in 1980 had left unemployment at about 7.5 percent. Both the 1980 and 1981-82 recessions were triggered by tight monetary policy in an effort to fight mounting inflation. During the 1960s and 1970s, economists and policymakers believed that they could lower unemployment through higher inflation, a tradeoff known as the Phillips Curve. In the 1970s, the Fed pursued what economists would call “stop-go” monetary policy, which alternated between fighting high unemployment and high inflation. During the “go” periods, the Fed lowered interest rates to loosen the money supply and target lower unemployment. During the “stop” periods, when inflation mounted, the Fed would raise interest rates to reduce inflationary pressure. However, the Phillips Curve tradeoff proved unstable in the long-run, as inflation and unemployment increased together in the mid-1970s. While unemployment trended down slightly by the end of the decade, inflation continued to rise, reaching 11 percent in June 1979 (Federal Reserve Bank of St. Louis).

 

Paul Volcker was appointed chairman of the Fed in August 1979 in large part because of his anti-inflation views. He had previously served as president of the New York Fed and had dissented from Fed policies he regarded as contributing to inflation expectations. He felt strongly that mounting inflation should be the primary concern for the Fed: “In terms of economic stability in the future, [inflation] is what is likely to give us the most problems and create the biggest recession” (FOMC transcript 1979, 16). He also believed that the Fed faced a credibility problem when it came to keeping inflation in check. During the previous decade, the Fed had demonstrated that it did not place much emphasis on maintaining low inflation, and public expectation of such continued behavior would make it increasingly difficult for the Fed to bring inflation down. “[F]ailure to carry through now in the fight on inflation will only make any subsequent effort more difficult,” he remarked (Volcker 1981b).

 

Chairman of the Federal Reserve Board of Governors Paul Volcker holds his head in his hand at a meeting in Washington, D.C.(Photo: Bettmann/Bettmann/Getty Images)

 

Volcker shifted Fed policy to aggressively target the money supply rather than interest rates. He took this approach for two reasons. First, mounting inflation made it difficult to know which interest rates targets were appropriately tight. While the nominal rates the Fed targeted could be quite high, the real interest rates (that is, the effective interest rates after adjusting for inflation) could still be quite low due to the expectation of inflation. Second, the new policy was meant to signal to the public that the Fed was serious about low inflation. The expectation of low inflation was important, as current inflation is driven in part by expectations of future inflation.

 

Volcker’s first attempt to lower inflation and inflationary expectations proved insufficient. The credit-control program initiated in March 1980 by the Carter administration precipitated a sharp recession (Schreft 1990). As unemployment mounted, the Fed eased up, an action reminiscent of the “stop-go” policies the public had come to expect. In late 1980 and early 1981, the Fed once again tightened the money supply, allowing the federal funds rate to approach 20 percent. Despite this, long-run interest rates continued to rise. The ten-year Treasury bond rate increased from about 11 percent in October 1980 to more than 15 percent a year later, possibly because the market believed the Fed would back down from its tight policy when unemployment rose (Goodfriend and King 2005). This time, however, Volcker was adamant that the Fed not back down: “We have set our course to restrain growth in money and credit. We mean to stick with it” (Volcker 1981a).

 

The economy officially entered a recession in the third quarter of 1981, as high interest rates put pressure on sectors of the economy reliant on borrowing, like manufacturing and construction. Unemployment grew from 7.4 percent at the start of the recession to nearly 10 percent a year later. As the recession worsened, Volcker faced repeated calls from Congress to loosen monetary policy, but he maintained that failing to bring down long-run inflation expectations now would result in “more serious economic circumstances over a much longer period of time” (Monetary Policy Report 1982, 67).

 

Ultimately, this persistence paid off. By October 1982, inflation had fallen to 5 percent and long-run interest rates began to decline. The Fed allowed the federal funds rate to fall back to 9 percent, and unemployment declined quickly from the peak of nearly 11 percent at the end to 1982 to 8 percent one year later (Federal Reserve Bank of St. Louis; Goodfriend and King 2005). The threat of inflation was not completely gone, as the Fed would face a number of “inflation scares” throughout the 1980s. However, the commitment of Volcker and his successors to aggressively targeting price stability helped ensure that the double-digit inflation of the 1970s would not return.

 

Suggested Reading:

CPI and PPI Both Suggests Persistent Inflation

Why the Most Conservative Investors Could Help Small Stock Performance

 

 

Sources:

https://www.federalreservehistory.org/essays/recession-of-1981-82

 

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The Last Time Inflation Was This High Fed Funds Were 14.5%

 

The year-over-year inflation rate ending October, as measured by CPI-U, is 6.2%. During the month of October alone, prices rose nearly 1% (0.9%). This is the largest increase since July 1982. And yesterday’s PPI report suggests consumer inflation may be persistent. The question now is, will Fed Chairman Powell continue extending the length of time in his definition of “transitory,” and will the Fed move quicker than initially presented to pull in the price pressures that continue to surprise on the high side?

October CPI Data

• October Consumer Price Index (CPI-U): +0.9% vs. +0.5% consensus and +0.4% prior.
• +6.2% YOY vs. +5.8% consensus and +5.4% prior.
• Core CPI:
   +0.6% vs. +0.4% consensus and +0.2% prior.
• +4.6% YoY vs. +4.3% consensus and +4.0% prior.
• The increases are broad-based, with continued increases in energy, shelter, food, used cars, and new vehicles.

By itself, the rampant rise in prices does not necessarily argue against Chairman Powell’s expectations that what the U.S. is experiencing is the result of bottlenecks that will begin to fade. But, investors do have to stay aware of market expectations, even if they deviate from the Federal Reserve Bank chairman’s mindset – and with each new inflation report, market participants are questioning it more. 

The question for investors of all stripes (stocks, bonds, precious metals, real estate, crypto, etc.) is whether the Fed will show less patience than it has to date and act soon to tighten economic activity.

A Fed tightening in the form of targeting higher overnight bank rates and slowing the pace of bond purchases (tapering) would not necessarily be bad for stock investors but could signal the end of easy money, which many believe has been the tailwind behind the substantial growth in stocks. As for current bond portfolios, they would experience their bond values decline as newer investors would expect higher returns on their bond investments. Bond prices would be present-valued for the new rate environment, which mathematically pushes values down (rates up).

If Powell is wrong on inflation being transitory, or if the Fed keeps lengthening their definition of what that means, holding rates down could cause larger problems down the road. Recent indications are that the inflation growth we’re seeing now could stay in the manufacturing pipeline a while.

Manufacturing Pipeline Inflation

Yesterday the Producer Price Index (PPI) was reported for October. PPI measures the increases at the producer not consumer level. These are input costs at various stages of manufacturing that are part of the pipeline. These either work their way into consumer prices months later, or serve to hurt corporate profits. Part of the series of numbers in the PPI release is PPI Final Demand. This covers the input prices for consumer-facing industries whose prices go on to enter headline CPI. As reported yesterday (November 9), the PPI Final Demand jumped by 0.6% in October from September. This means the year-over-year increase is 8.6% (same as September). These are the biggest jumps in this data going back to eleven years.

This high PPI Final Demand number suggests future CPI releases could easily continue climbing into next year.

Take-Away

The one-year inflation rate for the period ending October 31, 2021, is 6.2%. Investors that did not earn 6.2% or more on their money will find they have lower purchasing power today. While the Federal Reserve stimulus is slowing, earlier this month, the Fed Chairman reiterated the term transitory in relation to his future price expectations. He also left the window open to act sooner if this expectation changes.

For perspective, the last time year-over-year inflation was this high was July of 1982; Fed Funds traded at 14.5%. By October of that year, inflation had fallen and was running at a 5% pace. With the new lower pace, then Chairman Volcker reduced the overnight Fed Funds rate to 9%.

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Paul Hoffman

Managing Editor, Channelchek

 

Suggested Reading:

Inflation Seems Persistent, What Now?

Deflation Not Inflation is Risk Says Cathie Wood

The Fed is Clear that they Intend to Hold Rates Down

The Limits of Government Economic Tinkering (July 2020)

 

Sources:

https://www.bls.gov/news.release/cpi.nr0.htm

https://www.providentmetals.com/knowledge-center/precious-metals-resources/inflation-precious-metals.html#:~:text=Unlike%20paper%20currency%20and%20stocks,general%20health%20of%20the%20economy.

https://www.bls.gov/ppi/

https://www.federalreservehistory.org/essays/recession-of-1981-82

 

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	IImage Credit: Payton Chung

Congress Passes $1 Trillion infrastructure bill – How Does the Government Go About Spending that Much Money?

 

The U.S. Congress passed an infrastructure bill that funds more than a trillion dollars in nationwide federal spending on Nov. 5, 2021.

The bill puts about US$240 billion toward building or rebuilding roads, bridges, public transit, airports and railways. More than $150 billion is slated for projects that address climate change, like building electric vehicle charging stations, upgrading energy grids and production to work better with renewables, and making public transit more environmentally sustainable.

There’s funding for cybersecurity, clean water and waste treatment systems, broadband internet connections and more.

The bill is the largest investment in the nation’s infrastructure in decades.

 

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It was written by and represents the research-based opinions of Ana Maria Dimand, Assistant Professor of Public Policy and Administration, Boise State University

 

So How Does the Government Go About Spending All That Money?

Officials are required to follow certain procedures, regulations and guidelines for advertising and gathering bids, reviewing them and then hiring contractors to do the work. This process is called “public procurement.”

What’s interesting to me and my colleagues who study public procurement policy is how this massive influx of spending can be used as an innovative policy tool to further the government’s social, economic and environmental goals.

Judging from President Joe Biden’s executive orders prioritizing action on climate change in contracting and procurement and ensuring equitable compensation for workers employed by federal government contractors, his administration will encourage the use of the power of procurement to achieve environmental, social and economic policy goals.

To understand how public procurement can be used to improve social equity or speed up climate action, it helps to know the basics of how it works.

 

How do Government Officials Buy Infrastructure?

The process starts with a formal demand from an agency like the Department of Transportation or Public Works and the selection of the best procedure for awarding the contract for a funded project.

For several decades, government infrastructure procurement processes have generally taken one of two forms: “design-bid-build” or “design-build.”

In the design-bid-build option, governments separate the contracts into two tracks – project design and project construction, one following the other. A major advantage of design-bid-build is that agencies are familiar with this traditional way of building things. The main disadvantage is that it requires a three-way relationship – with the government working with both the designer and the builder, and the designer and builder also working together – that heightens the potential for conflict during the project. And that can sometimes lead to increased costs.

An example of the design-bid-build method is the Virginia Department of Transportation’s I-95/Telegraph Road Interchange project, which involved building 11 new bridges and highway flyover ramps in Alexandria. A professional services firm named Dewberry designed the project – winning engineering awards as well as praise for avoiding negative impacts on local residents and businesses – and the separate construction firm was Corman Kokosing.

In the design-build procurement process, potential contractors bid to do both the design and construction of the infrastructure as a single package. The main advantage of this type of contract is the direct relationship between the contractor and the government. The designer and construction firm work together as a unified project team, which may significantly decrease project completion time.

However, design-build also requires a high level of expertise in drafting design and construction specifications from the government, because decisions need to be made early in the process, and changes may lead to an increase in costs.

With both of these infrastructure procurement options, the process is typically competitive among contractors, and the government owns, operates, finances and maintains the final bridge, roadway, mass transit line or other asset.

 

Public-Private Partnerships

The Biden administration has also proposed using another common type of procurement for infrastructure spending – public-private partnerships.

These partnerships divide the costs of designing, building, operating and maintaining a project between a private sector firm and the government over 25 or 30 years before the agreement phases out. The private firm may receive some or all of the revenues the project generates during that time.

Let’s say the infrastructure needed is a new toll road. The government enters into a contract with a private company to design, finance, construct, operate and maintain this new highway for a certain period of time. In exchange, the private company makes back its costs by collecting the revenues from the tolls.

The Capital Beltway High Occupancy Toll Lanes project in Fairfax County, Virginia, also called the 495 Express Lanes project, is just such a public-private partnership. The government agency is the Virginia Department of Transportation, and the private partner is a company formed specifically for this project called Capital Beltway Express LLC.

Proponents argue that public-private partnerships may help the government provide better infrastructure without increasing public debt.

Public policy researchers in the Netherlands have also found that by supporting the development of trust and commitment between the partners, public-private infrastructure partnerships can lead to better results in many ways, such as effective design solutions, reduced environmental impact, lower costs and better relations with and support from local communities or organizations.

But there are also critics. Policy scholars have noted that these partnerships may not really save governments money. Other scholars have raised concerns that these arrangements cede too much public control of infrastructure to the private sector, which may look out more avidly for its own financial interests than those of the public.

By inserting demands into government contracts, the new infrastructure spending could be used to promote fair wages, health care benefits, fair working conditions for people employed by government contractors and ensure that products are sourced in a sustainable and ethical manner. This approach can also be used to demand locally produced goods and services, support for veteran-, minority- and women-owned businesses and spur market innovation, environmentally friendly products and services.

  

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Wages Up as Americans are Encouraged Back to Work and Into the Office – Three Takeaways from the Latest Jobs Report

 

 

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It was written by and represents the research-based opinions of Christopher Decker, Professor of Economics, University of Nebraska Omaha.

 

After a lackluster jobs report in September 2021, the latest news on employment gives Americans plenty of cheer about ahead of the holiday season.

In total, 531,000 jobs were added in October – outstripping the already optimistic predictions of economists. This caused the unemployment rate to fall 0.2 percentage points to 4.6%.

Even with those gains, the U.S. is still below pre-pandemic employment levels. But as an economist, I see details in the latest jobs report that suggest the workforce is emerging from 18 months of what has been the “new normal” and getting back to, well, the “normal normal.”

Remote Working in the Rear-View
Mirror?

Americans are returning to offices after a year-and-a-half of Zoom meetings and digital water cooler moments. The pandemic had opened the eyes of many potential workers to the possibility that working from home might be preferable to on-site work.

But the jobs report shows that this may be passing. In October, 11.6% of employees worked remotely due to the pandemic, down from 13.2% in the previous month.

Working from home offered flexibility, especially to people who held down two jobs. A lot of people found they could get by with one job, work from home and save money on commuting and child care. The drop in remote working could indicate that some families came to realize that while this worked to cover a shorter-term period during the pandemic, it ate away at household savings, getting to a point where working on-site was necessary again.

It also signifies a change of attitude that may explain why employment in the leisure and hospitality sector has bounced back. One possible reason for lower-than-expected job gains in September was that people were hesitant to return to worksites where they would have to mix with people – such as at bars, restaurants and in stores – preferring to spend more time at home.

October’s jobs report – which saw strong gains in leisure and hospitality – suggests that peoples’ ability to delay returning to work may be coming to an end and potentially that they are more open to returning to on-site jobs, perhaps encouraged by vaccination rates and falling case numbers.

Wages Up, Workers Back … Time
for the Fed to Act?

There is some evidence that the “great resignation” – or more accurately, the great “not taking up low-paid jobs” – era was short-lived and winding down.

Many potential workers had seemingly been hesitant to return to lower-paid food service jobs as well as employment in the leisure and hospitality sector due to relative low wages and rigid work schedules.

But the latest report shows evidence of increases in wages and salaries. In October, average hourly earnings increased by 11 cents to US$30.96 – continuing the upward trend of recent months. It means that average earnings are almost 5% higher that they were a year ago.

 

 

Wage increases look set to continue for some time. The latest report shows that labor costs increased 8.3% year-on-year in the third quarter as job opening rates remained pretty high, putting further upward pressure on pay.

This is great for workers but does pose a challenge to the Federal Reserve, which must keep inflation in check.

On Nov. 3, the Fed said it would begin scaling down its pandemic-era policy of buying Treasury bonds and other assets, which has the effect of gently reducing the supply of money in the economy. The Fed has also said it might lift interest rates earlier than planned if necessary to tamp down inflation risks.

The stronger-than-expected jobs report and increases in employment costs may prompt it to act more quickly. That said, the Fed may still want to tread cautiously here. Supply chain concerns remain and will need to be worked out before central bankers can conclude that overall inflation is more than a short-term issue.

 

Not All American Workers Are Seeing the Bounce

There is no doubt that the October jobs report was encouraging. But public sector employment was down, and that is important. This is largely a result of the pandemic. Retail sales were down significantly in 2020 and as a result state budgets are tight – in short, they have suffered from lackluster tax revenue sources.

This might make it harder for public sector jobs – in local government and schools – to bounce back as robustly as the rest of the economy.

 

Suggested Reading:

Study Says Investors Would Benefit if Weren’t so Confident

Bill Ackman Says ESG Investing Contributes to Inflation

Deflation Not Inflation is Risk Says Cathie Wood

Index Funds Still May Fall Apart Over Time

 

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Bill Ackman is Hedging Against Higher Rates and Inflation, Here’s Why

 

Bill Ackman is the most recent fund manager to weigh in on inflation. Not-unlike when Cathie Wood shared her views last month, Ackman’s read on the question of future price moves approaches the question from in an unconventional way. Ackman, the founder, and owner of Pershing Square Capital is worth listening to as he has made some very profitable calls in the past, including his betting against municipal bond insurer MBIA some years ago. Whether his current expectations play out remains to be seen.

Background

In an October 20, 2021 presentation to the Federal Reserve, Ackman laid out a case for them to immediately taper bond purchases and raise interest rates. Part of his case is the belief that the Fed is blind to how ESG investing is contributing to the recent surge in inflation. Ackman says the portfolio managed by his firm is hedged to protect against and therefore benefit from higher interest rates, as his evaluation sees this risk as imminent.

 

 

In a Tweet this week (November 3) he said the costs of ESG (Environmental, Social, and Governance) initiatives “is not transitory, but persistent and growing.” Later that day, the November FOMC meeting adjourned and Fed Chairman Powell, indicating that inflation isn’t expected to be persistent, said that the central bank doesn’t expect to raise interest rates until 2023.

Argument
for Higher Rates

Ackman’s reasoning is corporate America’s focus on traditional ESG inputs has shifted investment away from lower-cost fuels and towards higher cost renewables. This argument has been echoed by others on Wall Street that warn energy prices are climbing now because of lagging supplies as the result of underinvestment in natural gas, oil, and coal.

On the flip side of this argument is the founder of Ark Invest, Cathie Wood. Wood has carried the banner for ESG based investing through her investments in “green” companies like Tesla. She has been very outspoken that she expects technological innovation to not only reduce inflationary pressures in the future but perhaps so much so that deflation becomes the real concern.

A third of all assets under management, or $35 trillion are now invested in what has been categorized as sustainable or ESG investments.

 

 

Powell did indicate after the Fed meeting that the Fed stands ready to alter its policy as conditions indicate. While he did say he considers inflation to be transitory, he did leave the door open to change his mind before 2023.

 

Take-Away

Markets are made by people looking at the same facts and drawing two different conclusions. Ackman’s discussion of ESG and inflationary pressures did draw some attacks and some support under his Twitter posts. His past success suggests his expectations and actions are worth watching. Paying attention to the experience-based stance of the founder of Ark Invest is also worth weighing against our own analysis.

Suggested Reading:

Deflation, Not Inflation is Risk Says Cathie Wood

Inflation Seems Persistent, Now What?

Where Investors Should Turn if Spiking Oil Prices Feed Stagflation

Positive Outlook for Metals and Miners in 2022

 

Sources:

https://fortune.com/2021/11/04/bill-ackman-stakeholder-capitalism-hight-inflation-elon-musk-cathie-wood

https://www.newyorkfed.org/medialibrary/media/aboutthefed/pdf/IACFM-presentation-Oct-2021

https://markets.businessinsider.com/news/stocks/bill-ackman-pershing-square-federal-reserve-stimulus-taper-interest-rates-2021-11?utm_source=markets&utm_medium=ingest

https://twitter.com/BillAckman/status/1456107116654120967

https://twitter.com/BillAckman/status/145412

https://markets.businessinsider.com/news/stocks/bill-ackman-federal-reserve-ignores-esg-investing-contributing-surging-inflation-2021-11?utm_campaign=browser_notification&utm_source=desktop

https://markets.businessinsider.com/news/stocks/global-sustainable-investment-alliance-report-esg-assets-responsible-investing-2021-7?utm_source=markets&utm_medium=ingest

 

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	Image Credit: Medill DC (Flickr)

What Rising Interest-Rates Has Meant for Small and Large-Cap Stocks

 

Interest rates, as measured by the US Treasury 10-year note have been below 4% since 2008. The 10-year is an important rate in many homeowners’ lives as it is the benchmark rate for many conventional 30-year mortgages. Rates are currently being held well below most measures of inflation as a part of the Fed’s efforts to maintain a healthy economy. Rates on bonds would naturally have a positive spread over inflation, inflation rates either have to come down, or bond rates should rise.

 

Source: Macrotrends

 

Stock market participants are concerned that the current easy money environment is unsustainable and are concerned about what may happen to the markets as the Fed begins to taper and siphon money back out of the banking system. Channelchek’s focus remains on smallcap and microcap stocks. Below we look at what has occurred in the broader small-cap and large-cap sectors during the 12-months following the Fed indicated they’d be more hawkish.

 

Background

Keeping in mind that the past is not a perfect indicator of the future, let’s look back and see what has occurred to smallcap stocks during each of the 12 month periods after the Fed started reducing economic stimulus.

 Absent another surprise shock, the Fed is expected to begin to taper their support of the banking system via reduced bond purchases. They announced today (November 3) that they’d reduce bond purchases by $10 billion per month. The markets have been anticipating this reduction in stimulus since at least the first Covid-19 vaccines were given earlier this year. The stock markets continued to rise despite the threat of tighter money.

 

 

The chart above shows each time the Fed has overtly begun to remove stimulus from the banking system. Specifically, over the past four periods, there has been only one (February 1994) that has been negative for the Russell 2000, and that is the only period that has underperformed the S&P 500 (-2.9% vs +2.41%). The following date the Fed began to be less accommodative was June 1999. Small caps as measured by the Russell index grew 14.32%, large caps as measured by the S&P 500 also rose, but only 5.97%. In June 2004, when the Fed began to tighten, small caps saw a 9.45% return over the following 12 months. During the same period, large caps returned a little less than half at 4.43%. More recently, in December 2015, small caps shot up 22.63% afterwards the Fed began a more hawkish stance; again the large-cap index was also positive but returned less than half at 10.70%

With only one exception, since 1994, each time the Fed began removing stimulus, these two major indexes were positive, small caps returned on average 10.93% over the following year while the large-cap index returned on average 5.88%.

 

Take-Away

Each time the Fed talks of tightening, the stock market is concerned. Historically stocks are not impacted the way bonds are, and small-cap stocks tend to outshine. We don’t know what will occur over the next year, but looking back, we may not need to be concerned at all.

 

 

Sources:

https://www.ajmc.com/view/a-timeline-of-covid-19-vaccine-developments-in-2021

www.koyfin.com

https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=longtermrate

https://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart

	Image Credit: Francois de Halleux (Flickr)

The Fed is in a Box, Any of Its Options Could Create Problems

 

What does transitory mean? It means fleeting and temporary.  The “inflation is transitory” expectation has, over the past two months, become less probable. The last time we had economic weakness and inflation, was in the ’80s when the Fed (FOMC) found themselves needing to stimulate the economy by lowering rates while at the same time needing to stave off inflation with higher rates, back then we said, “the Fed is in a box.” Well, for those of us that have forty-plus years of economic memories, it feels like we’ve been here before.

Background

Officials at the U.S. Federal Reserve Bank are poised to begin withdrawing the liquidity in the system (economy) that was added in response to the reaction to the pandemic. Wall Street economists expect the Fed to announce a $15 billion reduction in monthly Treasury and mortgage-backed securities purchases beginning this month (November).  If $15 billion per month is withdrawn, all tapering will be out of the system by July of 2022.

The Fed has been using the “transitory” description when discussing inflation. If they continue to suggest it is temporary, the markets, stock and bond, may lose all confidence and could crumble. So the voting members may feel they have no choice but to become more hawkish at a time when U.S. economic growth is less than satisfactory.  Uncertainty as to fiscal spending plans adds another degree of difficulty for the Fed as they have incomplete information related to tax rates and government spending plans. Monetary and fiscal policy should work in conjunction with each other. Fiscal policy is up in the air. The Fed is, in a box, or boxed in. No matter what action or inaction they announce tomorrow, it will likely draw a negative (and positive) response on different fronts.

What to Listen For

On the top of Fed-watcher’s minds is whether the FOMC will continue its “transitory” description with respect to inflation.  Price increases are prevalent in everyone’s daily lives and have proved more persistent than central bankers had suggested they’d be. Fed Chairman Powell has remained consistent in his public expressions that rising prices are the result of the economy reopening and won’t be long-lived.  Investors will be listening for this same language, particularly those in more interest-sensitive sectors.  Eliminating all “transitory” language may perpetuate a bond market sell-off that could carry over into stocks.

Recent Economic Numbers

Fed watchers are beginning to have a more difficult time making the inflation-is-transitory case. They are looking at, for example,  the quarterly Employment Cost Index (ECI) released on Friday (October 29), which is the preferred wage cost measurement release of many economists. It includes full compensation costs rather than just payroll data.  The larger-than-expected rise in the third quarter ECI was the fastest pace of increase since they started measuring this almost 40 years ago. Labor costs, as a percentage of business expenses,  are often a companies’ highest expense. The ECI shows these costs are increasing rapidly as employers raise pay to attract workers. 

The labor shortage is helping to promulgate the “everything-shortage,” this scarcity of things is also providing inflationary fuel. Labor numbers will be reported this Friday when the Labor Department releases its October employment situation report.  Economists expect sporadic hiring and wages that are rising at an increased pace as millions of workers remain on the sidelines for reasons that are less understood. From a supply/demand standpoint,  if true labor-force participation is lower than Fed policymakers are accounting for, the U.S. economy is much closer to full employment than they thought and wage inflation as competition for employees continues will spiral upward. 

Against that potentiality, what if the Fed decides they can risk spooking the markets by eliminating the word “transitory” in their statement? After all, Powell recently said the Fed could accelerate the tapering process.  So it may. What is important for all investors to understand is that much of the Fed’s control over the economy is done outside of actual monetary policy and instead falls in setting expectations and providing confidence. For example, their words and promises.

Based on bond market movements, investors are already expecting that the Fed will raise rates sooner than the central bank has indicated. Economists at Goldman Sachs last week said, “We now expect core PCE inflation to remain above 3%—and core CPI inflation above 4%—when the taper concludes.” The PCE index is considered the Fed’s most worthwhile inflation gauge.

Can monetary policy impact supply shortages that have been caused by supply-chain issues? The trillions that consumers have in savings amounts to approximately 10% of GDP. The shortage problem is also being exacerbated by high demand. Monetary policy is meant to affect demand. Reducing demand by pulling cash out of the system and making money more expensive could help the supply chain catch up while slowing demand price pressures. But, this is where the Fed is in a box. Demand is already falling. Last week’s third-quarter GDP report reflected the slowest rate of growth since the pandemic inspired lockdowns.  As consumers retrenched, government spending fell, exports fell and business spending on plant and equipment declined. The increased prices are one cause of slowing consumption. It is conceivable that if rising rates and less liquidity through tapering further slows demand and price pressures decline, demand returns. This is possible, but a weak argument as consumers tend to buy when they believe products will cost more in the future.

Take-Away

For the FOMC voting members, they may feel “damned if they do, damned if they don’t,” as it relates to increased tapering and including the “transitory” language. While the future is always uncertain, market participants have eyes and can conduct their own analysis. If they lose confidence in the Fed having a steady and capable hand, they may panic. If they have confidence in the Fed’s words and actions, and those words are not pro-growth, they may also sell. This places the Fed in a box. Although the Fed’s mission isn’t market-related, severe reactions by the stock and bond markets reverberate through all sectors of the economy.

Paul Hoffman

Managing Editor, Channelchek

 

Suggested Reading:

Trimmed PCE Inflation vs the PCE Deflator

Inflation is No Baloney

Will Inflation be Transitory or Persistent?

Inflation’s Impact on Stocks, Four Scenarios

 

Sources:

https://www.ig.com/en-ch/financial-events/fomc-meeting-announcement
https://fred.stlouisfed.org/series/GDP

https://www.barrons.com/articles/federal-reserve-meeting-economic-growth-investors-51635839198?mod=hp_LEAD_1

https://www.barrons.com/articles/growth-slowdown-beyond-delta-variant-51631307629?mod=article_inline

https://www.reuters.com/business/goldman-sachs-brings-forward-us-rate-hike-projection-by-year-2021-11-01/

 

Stay up to date. Follow us:

	Image Credit: Francois de Halleux (Flickr)

The Fed is in a Box, Any of Its Options Could Create Problems

 

What does transitory mean? It means fleeting and temporary.  The “inflation is transitory” expectation has, over the past two months, become less probable. The last time we had economic weakness and inflation, was in the ’80s when the Fed (FOMC) found themselves needing to stimulate the economy by lowering rates while at the same time needing to stave off inflation with higher rates, back then we said, “the Fed is in a box.” Well, for those of us that have forty-plus years of economic memories, it feels like we’ve been here before.

Background

Officials at the U.S. Federal Reserve Bank are poised to begin withdrawing the liquidity in the system (economy) that was added in response to the reaction to the pandemic. Wall Street economists expect the Fed to announce a $15 billion reduction in monthly Treasury and mortgage-backed securities purchases beginning this month (November).  If $15 billion per month is withdrawn, all tapering will be out of the system by July of 2022.

The Fed has been using the “transitory” description when discussing inflation. If they continue to suggest it is temporary, the markets, stock and bond, may lose all confidence and could crumble. So the voting members may feel they have no choice but to become more hawkish at a time when U.S. economic growth is less than satisfactory.  Uncertainty as to fiscal spending plans adds another degree of difficulty for the Fed as they have incomplete information related to tax rates and government spending plans. Monetary and fiscal policy should work in conjunction with each other. Fiscal policy is up in the air. The Fed is, in a box, or boxed in. No matter what action or inaction they announce tomorrow, it will likely draw a negative (and positive) response on different fronts.

What to Listen For

On the top of Fed-watcher’s minds is whether the FOMC will continue its “transitory” description with respect to inflation.  Price increases are prevalent in everyone’s daily lives and have proved more persistent than central bankers had suggested they’d be. Fed Chairman Powell has remained consistent in his public expressions that rising prices are the result of the economy reopening and won’t be long-lived.  Investors will be listening for this same language, particularly those in more interest-sensitive sectors.  Eliminating all “transitory” language may perpetuate a bond market sell-off that could carry over into stocks.

Recent Economic Numbers

Fed watchers are beginning to have a more difficult time making the inflation-is-transitory case. They are looking at, for example,  the quarterly Employment Cost Index (ECI) released on Friday (October 29), which is the preferred wage cost measurement release of many economists. It includes full compensation costs rather than just payroll data.  The larger-than-expected rise in the third quarter ECI was the fastest pace of increase since they started measuring this almost 40 years ago. Labor costs, as a percentage of business expenses,  are often a companies’ highest expense. The ECI shows these costs are increasing rapidly as employers raise pay to attract workers. 

The labor shortage is helping to promulgate the “everything-shortage,” this scarcity of things is also providing inflationary fuel. Labor numbers will be reported this Friday when the Labor Department releases its October employment situation report.  Economists expect sporadic hiring and wages that are rising at an increased pace as millions of workers remain on the sidelines for reasons that are less understood. From a supply/demand standpoint,  if true labor-force participation is lower than Fed policymakers are accounting for, the U.S. economy is much closer to full employment than they thought and wage inflation as competition for employees continues will spiral upward. 

Against that potentiality, what if the Fed decides they can risk spooking the markets by eliminating the word “transitory” in their statement? After all, Powell recently said the Fed could accelerate the tapering process.  So it may. What is important for all investors to understand is that much of the Fed’s control over the economy is done outside of actual monetary policy and instead falls in setting expectations and providing confidence. For example, their words and promises.

Based on bond market movements, investors are already expecting that the Fed will raise rates sooner than the central bank has indicated. Economists at Goldman Sachs last week said, “We now expect core PCE inflation to remain above 3%—and core CPI inflation above 4%—when the taper concludes.” The PCE index is considered the Fed’s most worthwhile inflation gauge.

Can monetary policy impact supply shortages that have been caused by supply-chain issues? The trillions that consumers have in savings amounts to approximately 10% of GDP. The shortage problem is also being exacerbated by high demand. Monetary policy is meant to affect demand. Reducing demand by pulling cash out of the system and making money more expensive could help the supply chain catch up while slowing demand price pressures. But, this is where the Fed is in a box. Demand is already falling. Last week’s third-quarter GDP report reflected the slowest rate of growth since the pandemic inspired lockdowns.  As consumers retrenched, government spending fell, exports fell and business spending on plant and equipment declined. The increased prices are one cause of slowing consumption. It is conceivable that if rising rates and less liquidity through tapering further slows demand and price pressures decline, demand returns. This is possible, but a weak argument as consumers tend to buy when they believe products will cost more in the future.

Take-Away

For the FOMC voting members, they may feel “damned if they do, damned if they don’t,” as it relates to increased tapering and including the “transitory” language. While the future is always uncertain, market participants have eyes and can conduct their own analysis. If they lose confidence in the Fed having a steady and capable hand, they may panic. If they have confidence in the Fed’s words and actions, and those words are not pro-growth, they may also sell. This places the Fed in a box. Although the Fed’s mission isn’t market-related, severe reactions by the stock and bond markets reverberate through all sectors of the economy.

Paul Hoffman

Managing Editor, Channelchek

 

Suggested Reading:

Trimmed PCE Inflation vs the PCE Deflator

Inflation is No Baloney

Will Inflation be Transitory or Persistent?

Inflation’s Impact on Stocks, Four Scenarios

 

Sources:

https://www.ig.com/en-ch/financial-events/fomc-meeting-announcement
https://fred.stlouisfed.org/series/GDP

https://www.barrons.com/articles/federal-reserve-meeting-economic-growth-investors-51635839198?mod=hp_LEAD_1

https://www.barrons.com/articles/growth-slowdown-beyond-delta-variant-51631307629?mod=article_inline

https://www.reuters.com/business/goldman-sachs-brings-forward-us-rate-hike-projection-by-year-2021-11-01/

 

Stay up to date. Follow us:

College Cost Calculators Aren’t Precise, but They Could Easily be Made Better

 

The best way to figure out how much you have to pay for college is not to go by the sticker price. Instead, it’s to go by a college’s net price, which is often much lower. That’s because the net price tells you how much you have to pay to attend a particular school after you get your financial aid.

So why would anyone go by the sticker price when they could go by the more accurate net price? The main reason is that the net price is often unknown until after you get a college offer letter. These offer letters spell out how much financial aid you can expect.

One way to speed up how fast you can calculate the net price for a school is to use an online tool called a net price calculator. As its name suggests, a net price calculator is meant to give you a better sense of the actual price you have to pay to go to a particular college. The net price calculator does this by providing a more individualized price estimate based on you or your family’s financial circumstances.

You might think all net price calculators are created equal. As researchers who study the economics of higher education, we can tell you they are not.

 

This article was republished with permission from  The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of  Aaron Anthony, Director of Operations, Institute for Learning, University of Pittsburgh and Lindsay Page, Adjunct associate, Brown University.

 

In a 2021 peer-reviewed study, we found that the prices determined by net price calculators vary by an average of US$5,700 per student for students from families with the same or similar economic situations. That means the price determined by a net price calculator can be off by plus or minus $5,700. That’s pretty significant because – over the course of four years – that adds up to $22,800 and can determine whether and how much you need to borrow in student loans.

 

Differences in Calculators

Some net price calculators are more user-friendly than others.

Some of them ask students to provide financial information that is hard to access. For others, the calculators might provide cost of attendance information – as well as grant aid information – that could be outdated.

Since all net price calculators don’t work the same way, it can also be hard to compare prices from different schools.

The U.S. Department of Education provides a free net price calculator template. It doesn’t require that much information, and most student users can provide the information on their own.

 

Proposed Improvements

There’s a bill in Congress that aims to improve net price calculators. It’s called the Net Price Calculator Improvement Act.

Introduced in April 2021 by Sen. Charles “Chuck” Grassley, a Republican from Iowa, the bill would create a minimum set of requirements for net price calculators. It would also allow for the U.S. Department of Education to create a universal net price calculator that would have students answer one set of questions and get net price estimates for several schools.

The bill has only a 3% chance of becoming law, according to a website that scores bills based on their chances of being passed.

The federal net price calculator template requests information about a student’s household income. This is reportable in increments of $10,000 that range from $30,000 to $99,999. It also asks what your family size is, whether you plan to live in a college dorm or off-campus and how many family members are in college. This in turn allows the federal template net price calculator to generate identical financial aid estimates for similar students attending the same postsecondary institution. However, actual aid awards may be very different.

 

In Search of a Fix

Since figuring out financial aid is not easy to do, we identified three simple changes that would make the federal net price calculator template more accurate.

 

1. High school GPA

Even though a lot of colleges and universities award merit-based aid – basically scholarships – the current template does not request any academic information. A simple change like asking students for their high school GPA could help better predict merit-based grants. On the user-facing side of the calculator, students would just enter their GPA. On the back end, where colleges enter their aid information, colleges could set up GPA requirements for students to get various scholarships offered through the school.

 

2. Anticipated financial aid application timing

Different colleges have different deadlines for financial aid from within. If net price calculators could capture the date when a student plans to apply for financial aid, the calculator could include only aid the student would be eligible to receive. For example, if a student submits an application after a college’s institutional aid deadline but before a state or federal deadline, then the school’s calculator would include only state and federal aid in the net price estimate.

 

3. Expanded income bracket

The current income categories top out at $99,999, meaning that a family earning $100,000 is treated identically to a family earning 10 times that amount. An additional option of $100,000-$150,000 would help to distinguish upper-middle-income families from upper-income families. According to table A-2 on this Census website, 15.3% of the 129.9 million households in the U.S. – or 19.9 million households – have incomes between $100,000 and $150,000.

 

The average undergraduate student from a family with a household income between $100,000 and $150,000 receives more than $4,400 in grant aid. This is according to a National Postsecondary Student Aid Study from 2016 – the most recent data available.

 

Better Estimates

Our study included 7,600 students at 900 different colleges and universities. We had an even mix of public and private colleges.

We found that information collected on the current version of the federal template net price calculator accounts for 70% of the variation in actual aid awards for students attending the same university. In other words, the inputs these calculators require can account for 70 cents of every dollar in aid awarded.

Our proposed changes can help net price calculators do a better job of estimating aid for similar students. With these additions, we found that the information that net price calculators use would predict 86 cents of each dollar in aid awarded.

Even if these changes were adopted, there would still be a lot of variation in the prices determined by net price calculators. The variation changes based on the type of college in question. For instance, at private, four-year institutions, amounts varied by nearly $11,000. By contrast, within community colleges, it was about $2,400.

Taking these figures into account, a federal net price calculator template could also help prospective students estimate high and low ends of their expected grant awards.

Our proposed modifications are straightforward to implement and require only basic information from student users. They also allow for a universal federal template that colleges and universities can adapt to their own financial aid award processes.

As Congress considers legislation to improve how net price calculators look and function, keeping the tool simple to use is one of the most important aspects to consider. Choosing a college is among the most consequential financial decisions that students and their families will ever make. More accurate and easy-to-use tools should make the decision easier than it would otherwise be.

One More Thing

Do you know a student with an interest in the investment markets? Tell them about the Channelchek College
Challenge.  

Are you that student? Think about how being awarded $5,000 to $7,500 will help your studies.

 

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	Image Source: Mobilus in Mobil (Flickr)

Will the Definition of Income be Changed to Collect More Income Taxes?

 

Can one be expected to pay income tax on capital gains when there has not been a realized gain?  Senator Ron Wyden of Oregon is the top-ranking member of the Senate’s tax committee; today (October 27), he proposed to tax unrealized capital gains. This places a legislative heavyweight behind getting this dramatic change implemented. Back in February, and again this week, the Secretary of the Treasury, Janet Yellen, proposed this idea. Open opposition to this idea comes from some notable businesspeople, including Elon Musk, who wonders if it is a slippery slope that will eventually impact everyone. Others question how can one properly appraise non-market-oriented investments each year?

 

Background

In the U.S., capital-gains tax works this way; one purchases a capital asset such as a stock or real estate, the purchase price then becomes the “cost basis.” After it’s sold, the change in value between this cost basis and the sale price is the realized capital gain.  In cases where the asset was held for a year or more, its gain is taxed at a 15 to 20 percent rate (depending on the taxpayer’s income). An additional 3.8 percent surtax is added for taxpayers making over $250,000.  In effect, the U.S. has a capital-gains tax imposition of between 15 percent and 23.8 percent when an asset is sold at a profit after one year. The rate is higher if it’s sold within a year. Under a year, it is taxed at the owner’s ordinary income tax rate.

If the value of a capital asset increases, but that gain was not realized by a sale, there is no tax event. For assets that are inherited and never sold by the original purchaser, they are valued at the current market at the time of inheritance. Although there is an inheritance tax on large estates, many assets are reset at the current market or replacement value, thus reducing the beneficiary’s cost basis and reducing the magnitude of any potential tax from the pre-inheritance valuation.

 

Current Proposals

The Secretary of the Treasury who is also a former Chair of the US Federal Reserve Bank, Janet Yellen,  proposed a tax on capital gains. She wants investors to pay a tax on the increase in the value of stock every year, even if it is not sold. In an appearance on CNN this week she said, “It would help get at capital gains, which are an extraordinarily large part of the incomes of the wealthiest individuals, and right now escape taxation.” Details of where the lines would be drawn and who the tax would impact were not clear. She was, however, discussing what she refers to as the wealthiest of individuals.

In a Senate Finance Committee news release, Senator Ron Wyden (Oregon) presented what he calls The Billionaires
Income Tax. The release has the tag line:

“Billionaires Income Tax would
ensure billionaires pay tax every year, like working Americans”

Key points of the proposal are, tradable assets like stocks would be marked-to-market every year. Billionaires would pay tax on any gain and take deductions for losses on these assets each year for tax purposes. Those affected would be able to carry losses forward and, in certain circumstances, carry back losses for three years. 

Non-tradable assets like real estate or business interests would not be taxed annually. When someone of high net worth sells non-tradable assets, they would pay capital gains tax, plus an interest charge. The interest charge, or “deferral recapture amount,” is the amount of interest that would be due on the tax owed if the asset had been marked to market each year and the tax had been deferred until sale. The interest rate is the applicable federal short-term rate plus one point. The AFR is currently 0.22 percent, so the interest rate applied would be 1.22 percent.

The proposal contains rules to transition to the changed income tax. For example, the first time those impacted have their tradable assets marked-to-market, they may elect to pay the newly incurred tax over five years. They may also elect to treat up to $1 billion of tradable stock in a single corporation as a non-tradable asset. This will ensure that the proposal does not affect the ability of an individual who founds a successful company to maintain their controlling interest because they’d be forced to sell a portion to pay taxes.

 

Source: U.S. Senate Committee on Finance Bulletin, October 27, 2021

 

Opposition

Those opposed argue that a declining market could potentially reduce taxes collected. Others wonder how non-tradeable assets can appropriately be marked-to-market, and question if an entire industry of appraisers will be born in order to serve accountants and the IRS needs.

The richest man in the world, U.S. Citizen and immigrant businessman Elon Musk would surely be included and taxed differently. He showed his opposition when he tweeted his thoughts in response to a tweet directed at him along with the second richest man, Jeff Bezos.

 

 

 

Musk seems to believe that although it’s called the “Billionaires Income Tax” those without as many zeros after their net worth may also be impacted if the idea of taxing unrealized gains becomes accepted.

There is also concern over how this could impact stock prices. Taxing a non-cash asset leaves the challenge of where the cash will come from. It also reduces the incentive to hold stocks for very long periods of time. The combination of these two, if the proposal becomes a reality, could weigh on the stocks with the greatest gains.

Why Now?

There are a number of expensive proposals coming out of the nation’s capital. These include the Social Spending Bill, converting our energy grid to something less dependent on fossil fuels, infrastructure spending, and funding for stimulus and other projects. 

The question is paying for these enormously expensive projects. The richest 400 families in the country have become thought of as a source for various reasons; chief among them is the average voter is indifferent to taxes that don’t directly impact them.

Take-Away

In an attempt to find a means to pay for expensive projects, there are proposals coming from Washington to increase taxes. One proposal that is being brought to the forefront, separate from a “wealth tax,” is the idea of collecting taxes based on the change in the market value of assets rather than realized capital gains. If implemented, this would have implications far beyond the few hundred families directly impacted. The financial markets and real estate may feel some weight.  The reasons are that money would have to come from the liquidation of something to pay the required taxes, also the attractiveness of long holding times is lowered, and alternative investments, perhaps offshore, may become more tax efficient.

Suggested Reading:

Is Biden Tightening the Reins on Large Companies?

Federal Marijuana Laws are Half-In/Half-Out Says Justice Clarence Thomas

Paying for Infrastructure Spending

The Era of Flying Cars May Have Just Dawned

Sources:

https://www.finance.senate.gov/chairmans-news/wyden-unveils-billionaires-income-tax

https://www.finance.senate.gov/imo/media/doc/Billionaires%20Income%20Tax%20-%20One%20Pager.pdf

https://www.whitehouse.gov/omb/briefing-room/2021/09/23/new-omb-cea-report-billionaires-pay-an-average-federal-individual-income-tax-rate-of-just-8-2/

https://www.politico.com/newsletters/weekly-tax/2021/10/25/will-wydens-new-wealth-tax-survive-the-courts-798431

https://www.nytimes.com/2021/10/26/us/politics/democrats-billionaires-tax.html

https://www.businessinsider.in/international/news/heres-how-janet-yellens-proposed-tax-on-unrealised-capital-gains-may-work/articleshow/87249423.cms

 

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	Image Credit: World Bank Photo Collection (flickr)

Scandal Involving World Bank’s ‘Doing Business’ Index Exposes Problems in Using Sports-like Rankings to Guide Development Goals

The World Bank, a behemoth of an organization that provides tens of billions of dollars in aid to mostly developing countries, is in the middle of one of its biggest scandals since being founded in 1944.

The crux of the crisis relates to its Doing Business Index, which ranks the ease of opening and operating companies in 190 countries. In September 2021, an investigation alleged that senior leadership at the bank manipulated the index’s data in response to pressure from China and Saudi Arabia.

The scandal has already caused the bank to suspend publication of the index and prompted calls for further investigations. Some have also demanded the resignations of officials identified in the report, such as Kristalina Georgieva, who was formerly CEO at the World Bank and now heads the International Monetary Fund.

 

This article was republished with permission from  The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of   Fernanda G Nicola, Professor of Law, American University

 

I’m a comparative legal scholar who studies the rule of law in multilateral institutions like the World Bank. As I show in my forthcoming book on the topic, I believe the real problem here is less about whether or not officials meddled, and more about the problematic role the Doing Business Index and similar indicators play in aid to developing countries.

 

Everyone
Wants to Win

The World Bank’s Doing Business Index ranks countries around the world across 11 different economic indicators, such as registering property and paying taxes, and has become an authoritative source for international business and funding decisions since its inception in 2002. It’s akin to U.S. News and World Report’s rankings of colleges, countries and other categories.

A change in a country’s rankings can have a huge impact on how much money it receives from foreign investors. The World Bank has found that a 1 percentage point improvement in a country’s overall Doing Business score correlates with US$250 million to $500 million in additional foreign direct investment.

The main idea behind the ranking system was that it would be very simple for politicians, journalists and others to use, and therefore publicity surrounding it would prompt reforms.

“The main advantage of showing a single rank,” according to a 2005 World Bank staff report, is “as in sports, once you start keeping score everyone wants to win.”

And in effect, even though the World Bank technically has no mandate to guide countries’ regulatory regimes, in practice its index has had significant influence on how governments behave. For example, countries in Latin America and Africa have restructured their entire corporate governance regimes to fit Doing Business’ one-size-fits-all reforms.

But this wide influence has a negative side, as it serves as an incentive for governments to try to “game the system – or corrupt it,” as The Washington Post editorial board put it recently.

 

 

Problems
with Doing Business

The most recent Doing Business scandal began around June 2020, when employees began spotting data irregularities in two recent reports.

In January 2021, the law firm WilmerHale was asked to investigate. On Sept. 15, Wilmerhale said it found that senior World Bank leadership pressured employees to improve China’s Doing Business ranking in the 2018 report as it sought Beijing’s support for a major capital injection. The law firm also found problems with changes to rankings of Saudi Arabia, the United Arab Emirates and Azerbaijan in the 2020 report but didn’t blame senior leaders directly.

But a big part of the problem here is that the rankings incentivize this kind of behavior, often because not all countries can enact the market-friendly legal reforms required to rise up.

One way they can do this is by paying the World Bank fees for “reimbursable advisory services,” such as advice on how to better implement the kinds of reforms it favors. Of course, it is not hard to see the potential for institutional conflict of interest and corruption here. The report noted that both China and Saudi Arabia made extensive use of these contracts while pressuring bank officials to change their rankings.

The bigger concerns about the Doing Business Index is more fundamental. Comparative legal scholars, including me, have found that the legal reforms favored by the index always appear biased in favor of systems based on common law followed by countries such as the U.S. and U.K.

For instance, France, one of the world’s largest economies operating under a civil legal code, has performed rather poorly in the initial rankings because of low scores on the “registering property” and “getting credit” metrics. And, in turn, that means countries such as Algeria, Lebanon and Indonesia that built legal systems based on France or other non-Anglo legal traditions are also unfairly hurt by the rankings.

The rankings have been controversial since their very launch. Joseph Stiglitz, who was chief economist at the World Bank in the late 1990s, said in a recent op-ed that he thought it was a “terrible product” from the beginning.

“Countries received good ratings for low corporate taxes and weak labor regulations,” he wrote. “The numbers were always squishy, with small changes in the data having potentially large effects on the rankings. Countries were inevitably upset when seemingly arbitrary decisions caused them to slide in the rankings.”

In other words, the Doing Business Index ends up pushing countries toward a shareholder-focused corporate and business model molded on U.S.-style capitalism. This is at odds with many other models, such as those in Japan and Germany, that put more emphasis on workers and social goals like gender equality. Corporate governance scholars have found these may be better models for some countries than U.S.-style capitalism.

 

Does it
Deserve to Die?

The recent scandal underscores the degree to which the index doesn’t square with the bank’s wider purpose.

 

The World Bank’s stated mission is to “end extreme poverty and promote shared prosperity.” It was set up in the wake of the Second World War to achieve this mission through financing agreements with developing countries.

The Doing Business Index fails in this purpose because it compels governments to commit to “transplanted” legal reforms that may not be right for those countries, and in fact may end up backfiring and delivering bad outcomes for residents.

I’m not sure whether the index “deserves to die” or should be reformed and shifted to another institution, such as a university, but I do believe its time at the World Bank is likely coming to an end.

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	Image Credit: RODNAE Productions (Pexels)

What Investors Get from the COLA Increase in 2022

 

Roughly $75.6 billion of new money will be distributed to a specific demographic beginning next year ($6.3 billion per month). How seniors spend their newfound 5.9% Social Security COLA increase could impact a number of industries. Seniors are known to spend disposable income on eating out, travel, gifts for family, etc. They may also find they can withdraw less from savings and investment accounts, keeping more in the markets. Although tens of billions won’t alter investment sectors in the same way a multi-trillion-dollar infrastructure bill would, as we saw with stimulus checks, it can be quite impactful.

 

  Source: ssa.gov

Background:

Inflation data released yesterday (October 13) included the Consumer Price Index for All Urban Wage Earners and Clerical Workers (CPI-W). This is the index on which Cost of Living Adjustment (COLA) for Social Security benefits is calculated. The “raise” COLA provides 69.1 million Social Security recipients will start begin January 2022.  The percentage increase, calculated by the average of July, August, and September CPI-W is 5.9%. Every penny of this near 6% increase is money that was not previously in circulation.

Although we often imagine a retired person as someone barely scraping by on a limited fixed income, conserving because they can barely make ends meet, the reality is those now in retirement own more property, have greater pensions, and are worth ten times more than millennials. 

 

 

The info-graphic above by the Visual Capitalist demonstrates how successful, on average, the generation now of retirement age has been in providing for their future. And while many rising costs like healthcare and food impact those receiving social security, housing expenses often don’t vary much from one year to the next. Much of the new payments, although individually may not seem impactful, combined with almost 70 million people, all in a specific demographic, will have an impact. As an example, when $1400 in stimulus checks were sent to 137 million people last March, it contributed to driving the stock market gains (S&P up 7.16%), housing, and technology purchases.

 

 

Expectations

The question is, where will this newfound cash flow be spent or invested. According to the U.S. Bureau of Labor Statistics, those 65-74 spend 2.4% more than the overall population on food. Presumably, much of this difference is prepared food at restaurants. More compelling, entertainment has an even wider gap over the total population as seniors (65-74) spend 19.6% more on entertainment. Although it isn’t included in the BLS data, travel and gifts for grandchildren are included on most lists of where seniors are spending after all other costs are covered.

Take-Away

Does the COLA increase impact you? If you aren’t in a position to receive one, you may ask, is this bullish for stocks? And, what stocks may benefit the most? While headlines of other spending work their way into investment analysis, this use inflow, so far, has been largely overlooked.

Paul Hoffman

Managing Editor, Channelchek

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In Nine Years, Nearly All Boomers Will Have Retired, Is This Good for Stock Pickers?

COLA Increases for Seniors in 2022 Will Likely Top $68 Billion

IRA Investments and Small Cap Stocks

Is it Smart to Avoid Brokers that Sell Order Flow

 

Sources:

https://www.ssa.gov/oact/cola/colaseries.html

https://crr.bc.edu/wp-content/uploads/2005/02/ib_28_508.pdf

https://www.aarp.org/content/dam/aarp/research/surveys_statistics/life-leisure/2019/aarp-grandparenting-study-money-fact-sheet.doi.10.26419-2Fres.00289.017.pdf

https://www.visualcapitalist.com/visualizing-net-worth-by-age-in-america/

https://www.bls.gov/opub/btn/volume-5/spending-patterns-of-older-americans.htm

 

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