The Dodd Frank Wall Street Reform and Consumer Protection Act took a hit this week after the House passes a bill that guts many parts.
The House passed a bill called the Financial Choice Act that would allow banks to opt out of some regulations if they hold enough capital and would repeal the Volcker rule that barred banks from speculative trading.
One key component of the bill that I like is that banks will no longer be bailed out with tax payers funds as they will be forced to go through bankruptcy like any other industry.
Repeal the Dodd Frank Wall Street Reform and Consumer Protection Act
President Trump promised to repeal the Dodd Frank Wall Street Reform and Consumer Protection Act because it’s bad for business and in particular for small banks.
One of the original authors of the legislation, Jeb Hensarling (Republican from Texas) said Dodd Frank is a major factor in limiting GDP growth in the wake of the financial crisis.
Banking stocks are surging higher on news of the House bill but most see little chance of it passing in the Senate. Still, stock traders figure that even a watered down Senate version is better than what we currently have.
In an economic news report posted on YouTube (link above) by X22 Report, it cites how the average Millennial has less than $1,000 saved to buy a home. Not only do I think that’s true, I would add that the average Millennial has zero money saved for retirement.
Economic News Forecasts Recession
Most younger people have low paying service sector jobs like McDonald’s or Carl’s Junior, and most are dealing with student loan debt.
X22 Report says that the economy has already entered into a recession and is on the verge of a complete collapse.
Please keep in mind that the X22 Report is a perma-bear YouTube channel and they make money off of doomsday preppers and pitching gold and silver. They operate in the alternative news niche and so understand the alternative news industry. Don’t go bipolar and go out and short the market just yet. Nevertheless, it’s good to listen to the bearish perspective to balance against the bull perspective of the mainstream financial media.
A weekly Saturday night financial show that attempts to predict market direction for the week ahead by looking at a variety of technical and fundamental indicators. This week’s show includes commentary on the Fed’s first and only rate hike in 2016, Eli Lilly’s long-acting Basal Insulin that’s now available in the US, takeover rumors circulating about Qorvo, Protalix Biotherapeutics $24 million order to treat Gaucher patients in Brazil, the FDA approval of Vericel’s Maci for the repair of cartilage defects of the knee, Silicon Motion’s supplying of SSD solutions to the Alibaba Group, and more.
Pharmaceutical drug pricing is all over the mainstream financial media right now. Let’s examine the macroeconomics of what is happening.
The demand for pharmaceutical drugs is inelastic. People that need a pharmaceutical drug prescribed by their doctor will demand that drug regardless of price. As the price of the drug goes up, demand mostly stays the same.
Notice how steep the demand curve is. This steep drop-off represents the inelastic demand for pharmaceutical drugs. The increase in supply from S to S1 leads to a relatively large decline in the price, but not much of an increase in quantity demanded.
Companies like Valeant Pharmaceuticals and former CEO Michael Pearson abused the inelasticity of demand for pharmaceutical drugs for maximum profit. If demand for pharmaceutical drugs is hardly influenced at all by price changes, then raise the price of the drug to a level that maximizes shareholder profits. Sure the supply curve may shift up a little from a drop in demand from people on the margin, but most of the public with their large health insurance providers will pay the higher price.
The horizontal brown line on the supply and demand graph below represents a drug price ceiling.
The lower price of the drug shifts the demand curve up a little to point b. However, suppliers will rapidly stop supplying the drug when they are forced to sell it below market price at point a. The difference between the quantity of the drug demanded and the quantity of the drug supplied is a drug shortage as represented by the red shaded area. People will die from a drug shortage when there are no readily available substitutes, and so the government should not attempt to use price ceilings.
Make Pharmaceutical Drug Demand More Elastic
The way to control runaway drug prices is to make the demand for pharmaceutical drugs more elastic. If people have choices and substitute drugs they can use, the steepness of the demand curve will be flattened and represent a more healthy free market as illustrated below.
Notice that the demand curve is flatter and not so steep.
The US national debt just broke above $19.5 trillion. Both Democrats and Republicans are to blame, but it is important to note that President Obama and Democrats increased the national debt more than all President’s before combined.
George Bush exploded the national debt by $3 trillion in response to an imploding economy and 911. Obama exploded the national debt by $10 trillion in response to an imploding economy.
Debt increases are a function of the government not being able to pay its bills because it has too little revenue (taxes) compared to costs (spending). When spending exceeds revenue you have a deficit. Since 2002, this is what quarterly deficits (or surpluses) have looked like.
The last time we have a surplus was back in 2001, some 16 years ago. That’s sad.
The interest on the $19.5 trillion dollar debt is about $482 billion a year or more than $60,000 per US citizen.
How does the US government finance the deficit?
The Crowding Out Effect
The U.S. Treasury sells IOUs in the form of bonds or treasury bills directly to the private capital markets and uses the proceeds of the sales to finance the deficit.
The US Treasury is competing directly in the capital markets with private corporations, which may also be seeking to sell bonds and stocks to raise money to invest in new plant equipment. To compete for these scarce investment dollars, the Treasury typically must increase the interest rate it is offering to attract enough funds. Running a huge deficit is largely a zero sum game because funds to finance the deficit would otherwise be spent on private sector investment (the I variable in the GDP formula).
Money used to finance the deficit is money that would otherwise have been borrowed and spent by corporations and businesses on private investment. Deficit spending by the government is said to crowd out private investment. Crowding out is the offsetting effect on private expenditures caused by the government’s sale of bonds to finance the deficit. The larger the deficit and the more government needs to spend on financing that deficit, the more crowding out occurs.
The crowding out effect, which is one of the most important concepts in macroeconomics, is illustrated below.
The initial equilibrium is at Y, where the aggregate expenditure curve AE, crosses the aggregate production curve AP. However, expansionary fiscal policy shifts the aggregated expenditure curve up to AE1. This leads to a new equilibrium of Y1. However, because the government has had to borrow money from the private capital markets to finance these expenditures, interest rates rise. This reduces investment and a resulting contractionary effect shifts the aggregate expenditure curve back down from AE1 to AE2.
The final equilibrium is now at Y2 as the net economic expansion equals Y2 minus Y. At the same time, the partial crowding out of private investment may be measured by Y1 minus Y2. The level of partial crowding out rises the more government borrows from the private sector.
It is my opinion that government deficits are a weak fiscal policy tool at best, and I think the last eight years of President Obama increasing the national debt and running the largest deficits in US history has proven that point.
A few readers have asked me if crowding out can be reduced by printing money. The idea is to avoid crowding out by printing money and here is how that scheme works. The Federal Reserve accommodates the Treasury’s expansionary fiscal policy by buying Treasury’s securities itself rather than letting the securities be sold in the open capital markets. In essence, the Federal Reserve simply prints new money.
The problem with this option is that the increase in the money supply can cause inflation. Moreover, if such inflation drives interest rates up and private investment down, as it is likely to do, the result of the print money option will be a crowding out effect as well. In other words, there is no escaping the crowding out effect when it comes to financing the deficit. Again, look at the last eight years of President Obama and look out how much he has put this country in debt and ask yourself has it really benefited the U.S. economy that much? Perhaps some, but ultimately crowding out took away much of the initial gains from Democrat’s expansionary fiscal policy.
Deficits Impact On International Trade
Deficits and a rising government debt is a serious threat to the US. Chronic budget deficits have not only been responsible for crowding out private investment, but also for America’s huge trade deficits over the last several decades. The macroeconomic relationship between deficits and international trade is illustrated below.
As government deficits drive interest rates up in boxes 1 and 2, we observe crowding out in box 3. Now look at box 4. Higher US interest rates attract foreign investors but, for these investors to invest, they must exchange their foreign currencies for dollars. This not only leads to an increase of US external debt in box 5, but it also drives up the value of the dollar in box 6. A stronger U.S. dollar makes U.S. exports less competitive, and exports decrease in box 7 even as imports increase in box 8. The result is a larger trade deficit in box 9, and that’s why economists refer to budget and trade deficits as the “twin deficits.”
A trade deficit means a country is not exporting enough to pay for its imports. The difference can be paid by either borrowing from abroad or by selling US assets.
To finance its trade deficit, the US has had to sell off assets such as factories, shopping centers, hotels, golf courses, and farms to foreign investors. This mortgaging of America has reduced both the rate of economic growth and the level of real income of Americans.
Deficit Doves Say Don’t Worry
Deficit dove economists that work for Democrats and the Obama Administration say don’t worry about the national debt because most of that debt is internal debt owned by the country to its citizens. Obviously, that argument by Democrat economists is not so good as evidenced by the broken US economy some eight years after Democrats and Obama took office. I list four reasons below why this “don’t worry be happy” argument is wrong and how it has hurt the US economy.
#1: Internal Debt Leads to Higher Taxes
Internal debt requires payments of interest to bondholders. This, in turn, means higher taxes which distort the allocation of national resources and lead to an efficiency loss.
#2: Internal Debt Redistributes Income From Poor To Rich
Paying interest on the internal debt unfairly redistributes income from the poor and middle class to the rich. This happens because government bondholders as a group tend to be wealthier than taxpayers as a group.
#3: Servicing The Debt Cuts Government Services
Paying interest on the debt uses $482 billion each year, and this money could otherwise be spent on providing taxpayers with more education, health care, and other government services. The size of the interest payments to service the debt, relative to total tax revenues, has been rising every year. If nothing is done, we will eventually wind up using all available tax revenues simply to service the debt.
#4: A Burden On Future Generations
The accumulation of such a large debt places an unreasonable burden on future generations, which must pay this debt off. I don’t know what to even tell my daughters about the $19.5 trillion national debt, so I choose to say nothing. I could say I voted for Obama because I wanted to vote for the first African-American President and I thought he would save our household money on medical care. Then say, oops, my bad, now here’s the $9 trillion he added to the national debt during his Presidency that you have to pay off when you’re old enough to work. Thank you and have a nice day.
Niall Ferguson thinks that the “age of debt” is coming to an end. Apologies for the sub-titles but this Hard Talk interview has an important message.
With a growing crowding out effect, it may be impossible to increase GDP in a meaningful way until the national debt and deficit spending is reduced.
The velocity of money has hit the lowest level ever recorded as I wrote about here. I believe the crowding out effect is at least partially to blame for the slowdown in the velocity of money.
President Obama has run the national debt up to nearly $20 trillion, more than all President’s before him combined. This expansionary fiscal policy has crowded out private sector investment.
Crowding out is the offsetting effect on private expenditures caused by the government’s sale of bonds to finance expansionary fiscal policy. When the Federal government borrows money to finance a budget deficit, the U.S. Treasury sells IOU’s in the form of bonds or treasury bills directly to the private capital markets and uses the proceeds from the sales to finance the deficit. The Federal Reserve is out of the loop as the U.S. Treasury is competing directly in the capital markets with private corporations, which may also be seeking to sell bonds and stocks to raise money to invest in new plant and equipment.
To compete for these scarce investment dollars, the Treasury typically must raise the interest rate it is offering in order to attract enough funds. This means that running a deficit is largely a zero sum game. The money used to finance the deficit is money that would otherwise have been borrowed and spent by corporations and businesses on private investment. This is how deficit spending by the government is said to crowd out private investment. This crowding out effect is illustrated by these two figures.
On the left-hand figure, an increase in investment demand by the government shifts the investment demand curve from Id1 to Id2. This raises the interest rate and reduces private investment as is made clear by the right-hand figure. Note that in this figure, if the economy starts at point a and moves to point b, crowding out will be equal to h1 minus h2; however, if the economy starts at point C in a recession and moves to point B, crowding out need not occur.
I believe that substantial crowding out has occurred during the Obama Administration and their expansionary fiscal policy which has reduced the velocity of money.
Banks don’t need savers money because they have large surpluses of cash and can borrow money cheaply from the Federal Reserve; thus savers are penalized as they are paid very low-interest rates on their savings.
The next President of the United States needs to reverse course in my opinion and reduce the crowding out effect to get the velocity of money going up again. The way to do that is to stop using fiscal policy and government spending to drive economic growth. In the GDP formula: GDP = C + I + G + (Exports – Imports), the reliance on fiscal policy should be reduced because increases in G (government spending) are largely being offset by declines in I (investment by businesses).
Unfortunately, most modern Keynesian economists recognize the possibility of crowding out, but they do not think it is a major problem when business borrowing is depressed because that’s what usually happens in a recession; therefore, an activist expansionary fiscal policy is appropriate.
Watch out for investing in high yield corporate debt. U.S. default rates are surging higher and breaking away from the rest of the world.
The U.S. has more oil and gas firms that are financed by the high yield bond market than anywhere else on the planet. The S&P calls these oil and gas companies the “weakest links.”
Accommodative Federal Reserve policy (ultra-low interest rates and lower lending standards) caused a lot of borrowing by smaller oil and gas companies profiting from the shale oil boom. When the price of oil crashed, S&P downgraded the credit rating on lots of that debt to B- and lower.
Now you see why many oil and gas executives are using the mainstream financial media to disseminate fantastic stories of oil production cuts by OPEC members. The goal is to jawbone the price of oil higher. No one is going to cut production when oil prices are this low because they have to produce more to make up for the budget shortfalls caused by the lower price of oil. Remember the law of man: when things get bad enough, it’s every man/country for himself.
I just can’t get behind the idea that consumers are saving so much money at the pump that it’s going to be a boom for consumer spending. Savings at the pump boosting consumer spending is the same claim that the mainstream financial media has made for the last two years. The Wall Street Journal writes…
Regular gasoline averaged $2.15 a gallon on Monday versus $2.72 a year earlier, according to the Energy Information Administration. With gasoline prices persistently lower on the year, American households are set to have poured about $12 billion less into the tank since Memorial Day than over the same period last summer.
The $0.57 a gallon is not going to make any difference in consumer spending and the monthly retail sales report. I use about 10 gallons of gas a month to get to work and back in my 30 MPG car. The $2.72 versus $2.15 a gallon saves me $5.70 a month. No big deal. I use my car almost exclusive to get to work and back. Let’s say that someone drives ten times more than I do, and so they use about 100 gallons of gas a month. That’s a savings of only $57 a month. Folks, $57 a month is not going to make people go out and shop more. Lower gas prices boosting consumer spending is just the same sort of media hype we had in 2014 and 2015.
Every penny that gas prices decline puts about a billion dollars into Americans’ pockets, according to Stephen Stanley, Chief Economist of Amherst Pierpont.
What a bunch of baloney that statistic turned out to be. I remember counting all the pennies oil dropped then multiplying each by $1 billion and thought consumer spending was going to explode higher, LOL. I think what these mainstream financial media publishers do is that they look at the stories people clicked on during August of last year, and they re-write the story and run it again in the current year. Shame on the mainstream media once, shame on me twice. I can’t afford to buy the hype this time around.
Traders continue to pile into stocks on the jobs report for June that showed 287,000 jobs created. The mainstream financial media is running with the 287,000 jobs created headline number, but is this the entire jobs market picture?
Below is the 3-month rolling average of non-farm payrolls.
In other words, when we zoom out and look at the larger time frame trend, job creation is slowing. Does that single uptick in the 3-month rolling average chart above really justify a breakout of SPX to new all-time highs? Of course not.
Another chart that shows a big problem with the labor market is the number of Americans who are not in the labor force but want a job.
Notice that the number of Americans who are not in the labor force but want a job remains at a historically high level.
The mainstream media asserts that there are lots of job openings and employers are having trouble finding the labor to fill those open positions. The chart below adds some much-needed context to that assertion.
The chart above shows that the average duration of unemployment is very high relative to historical averages. In other words, it’s taking people an incredibly long time to find a job because there are not many jobs available.
For years, some of the best paying jobs were in the energy sector. The next chart shows employment in the US oil & gas industry plunging lower thanks to Saudi Arabia.
We also hear from the mainstream media that Amazon and online shopping is why the Retail sector is in so much trouble. If that were true, we would expect jobs in the trucking industry to be rising as all that online stuff people bought was shipped around the country. In reality, we have just the opposite.
As stock traders, we have to question everything we hear and read in the mainstream financial media because they will lead us right off a cliff.