Fundmastery Blog

Kurt Brouwer November 6th, 2008

The State of California has to be one of the most badly-run in the nation.  We have the biggest population in the country, an economy that would be one of the biggest in the world if California was a nation, tremendous resources, a great climate and a position as the main port for Pacific Rim exports and imports.  California is the home to many of the world’s leading technology companies and it is famous around the world as the Golden State.

Despite all those advantages, this state is a fiscal basket case.

The state legislature has been unwilling to keep spending even within shouting distance of revenues, which until recently were climbing steadily. And, as many observers have been warning for years, the state has relied heavily on capital gains taxes, which are tax revenues from sales of real estate, businesses, stocks and other assets.  Obviously, capital gains are pretty scarce in 2008 and, as a result, capital gains tax revenues have fallen considerably.

Governor Schwarzenegger is proposing some spending cuts and some tax increases and he will probably soon find himself in the middle between the liberals who don’t want to cut spending and the conservatives who don’t want to raise taxes.  Nonetheless, that’s his proposal as this piece from AP indicates [emphasis added]:

Schwarzenegger: $4.4 Billion in Tax Hikes to End Deficit (Associated Press, November 7, 2008, Judy Lin)

Gov. Arnold Schwarzenegger on Thursday proposed $4.4 billion in new taxes and a similar amount in spending cuts to deal with California’s worsening fiscal crisis, saying, “We must stop the bleeding.”

Much of the new revenue would come from a 1.5-percentage-point increase in the sales tax; the Republican governor described the hike as temporary but did not say how long it would last.

“We have a dramatic situation here and it takes dramatic solutions … and immediate action,” Schwarzenegger said as he called the Legislature back into session to deal with the budget shortfall.

The governor said $4.5 billion in cuts will be necessary across all state programs, including education, social services, health care and prisons.

Just six weeks ago, Schwarzenegger signed an overdue state budget that was intended to close a $15.2 billion deficit. The rapid pace of decline in the national and state economies since then has reopened an $11.2 billion gap that threatens to widen even further.

Schwarzenegger’s call for tax increases puts him again at odds with legislators in his own party. Republicans, a minority in both houses but strong enough to block spending plans, were steadfastly against raising taxes in the last budget, and the state Senate’s GOP caucus chairman said that won’t change.

“The fact is that during this time of economic challenges is not the time to go back to California taxpayers and ask for more money from them,” said Sen. George Runner, of Lancaster.

The governor often has characterized California’s budget problems as being caused by runaway spending, rather than a lack of tax revenue, but he said Thursday that the severe financial crisis has flipped that.

“It is now a revenue problem rather than a spending problem,” Schwarzenegger said.

…California’s budget relies greatly on capital gains taxes, which have dropped precipitously in recent months as stock prices have plummeted. Sales and property taxes also have declined…

The state has belatedly realized it has a problem, yet many of our leaders in Sacramento fail to grasp that this is largely a spending problem brought on by years of overspending during good times.  In an ideal world, we would have a Constitutional amendment that would tie spending increases to population growth and cost-of-living increases.  With that in place, in good times, revenues would go up faster than spending.  The resulting budget surplus could be used to pay down state government debt and to give us some flexibility to either cut taxes or increase spending in times of economic hardship.

Unfortunately, profligacy has led to large budget deficits even in good times, followed by huge deficits in bad times.  Now, of course, we all will pay the price for that lack of foresight and leadership.

For more on this issue, see How to Squelch an Economic Recovery and California Taxes Going Up and State of California May Need Federal Cash.

• Business , Economy , Geopolitics , Personal Finance , income taxes
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Kurt Brouwer November 6th, 2008

There is plenty of evidence that this financial crisis has curtailed normal lending activity at banks.  For example, I know of creditworthy companies and individuals that had unused lines of credit which have been withdrawn and so on.  Nonetheless, the media accounts of an absolute credit freeze exaggerate things a bit as this chart from the always-excellent Carpe Diem blog illustrates:

Source: Carpe Diem

• Business , Economy , Money
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Kurt Brouwer October 31st, 2008

Economists and many other financial commentators have long decried the low rate of savings in America.  When you read laments about our ‘low’ savings rate, you should bear in mind that this is a statistical item rather than a commonsense use of the term savings.

The U.S. Commerce Department’s Bureau of Economic Analysis (BEA) compiles statistics on savings, but their calculations have little application in the real world in which we live because the BEA’s methodology of calculating savings does not include certain critical components that most of us think of as savings. For example, the BEA’s calculations of income and savings do not include capital gains even though capital gains on stocks, real estate, businesses and other investments are a significant part of what we would consider our savings or wealth. Also, the value of someone’s home equity and retirement plan holdings are also not fully-factored into this calculation of savings, so the published reports of national savings significantly understate the true savings that Americans are making.

Nonetheless, the savings rate as defined by the BEA has fallen for years, but now that may be changing.  In fact, it looks as though Americans are saving more due to concerns over economic and financial uncertainty.   So, that’s good isn’t it?  Apparently, not according to this post from the Real Time Economics blog [emphasis added]:

Good News for Stability, Bad News for Growth (Wall Street Journal-Real Time Economics, October 31, 2008, Phil Izzo)

Part of the reason that consumer cut back on spending in September is that Americans were putting more of their money into savings. That may not be good news for GDP growth in the short-term, but it’s a positive sign for the long-term stability of the economy.

In September, personal saving - disposable personal income less spending - was $140.3 billion, compared with $82.5 billion in August. That raised the savings rate to 1.3% from 0.8% in the previous month. The savings rate spiked from May to July on the back of the government’s stimulus payments, but averaged below 1% for a number of years. It was just 0.2% in April before the stimulus payments went out, and has been nearly flat for years, not rising more than 1.5% in any month since 2004. The rate was in double digits in the 1970s and early 80s, but began a steady decline to the historic lows reached in recent years.

Many experts wrote off the decline, saying that the measures of savings only looked at income, and didn’t include assets such as a house or capital gains. Justin Fox recently recounted some of the history on his Curious Capitalist blog. Now it appears to be a warning sign that went largely ignored.

…It’s also worth noting that even as job losses intensified, home prices declined and other economic concerns stressed household balance sheets last month, consumers managed to put sock more money away than the previous month.

…It’s a bit early to say so, but the American consumer may have finally learned a lesson and is moving toward a more sustainable level of spending. However much this move may benefit individuals, it could prove difficult for the economy…

What I take away from this piece is that individuals are acting rationally at a time of financial crisis — cutting expenses and saving more cash.  These actions make sense in a given economic environment for an individual, but they may not result in a positive outcome in the event that millions of Americans immediately change their behavior by spending less and saving more.  In other words, if you save a bit more money and spend less, that’s probably a good move.  But, if everyone does it, then economic activity slows down considerably, which means more unemployment and so on.

So, the American consumer may have to ride into the breach once more by shopping hard as part of a noble effort to save the economy…or something like that.

• Business , Economy , Geopolitics , Investing , Money , Personal Finance
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Kurt Brouwer October 25th, 2008

The dollar continues its strength versus most currencies (other than the Japanese yen) as investors seek the safety and stability of U.S. dollar-denominated securities.  This represents a remarkable turnaround for the dollar, which was was not receiving much love as recently as June.  Now, that has changed in dramatic fashion as this Bloomberg piece [emphasis added] indicates:

Dollar Gains Most Since 1992 On Concern Global Slump Deepening (Bloomberg, October 25, 2008, Ye Xie)

The dollar gained the most in 16 years against the currencies of six major U.S. trading partners as a global economic slowdown spurred demand for the greenback as a haven from losses in emerging markets.

“The foreign-exchange market is basically saying we are in a global recession and perhaps a very, very deep one,” Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York, said in an interview on Bloomberg Radio.  “Any sense of rationality and fundamentals is thrown out the window.”

Japan’s yen also benefited as investors fled high-risk assets and used the proceeds to pay back low-cost loans taken out in the currency. The yen climbed to a 13-year high against the dollar this week and surged to its strongest level against the euro in six years. The pound fell below $1.53 in its biggest weekly drop since investor George Soros drove sterling out of Europe’s system of linked exchange rates in 1992.

The dollar appreciated 6 percent to $1.2623 per euro this week, from $1.3410 on Oct. 17. The currency touched $1.2497 per euro yesterday, the strongest since October 2006. The yen rallied 7.8 percent to 94.32 per dollar from 101.69, and touched 90.93 yesterday, its highest level since August 1995. Against the euro, the yen climbed 12.7 percent to 118.96 from 136.21. It touched 113.81 yesterday, the strongest since May 2002.

This week’s decline in the euro was its biggest against the dollar and the yen since the 15-nation currency’s inception in January 1999. The yen’s gain versus the dollar was the biggest since October 1998.

…”We are in a financial crisis,” said Richard Clarida, a global strategist at Newport Beach, California-based Pacific Investment Management Co., which oversees $830 billion in assets, including the world’s biggest bond fund. “The flight to quality is boosting the dollar and the yen.”

Emerging-market currencies tumbled as Argentina seized private pension funds, and Belarus, Ukraine, Hungary and Iceland joined Pakistan in requesting at least $20 billion of emergency loans from the International Monetary Fund. Brazil’s real dropped 8.2 percent to 2.3075 against the dollar, the South African rand decreased 10.4 percent to 11.18 and the Russian ruble fell 3.2 percent to 27.1991…

One of the most fascinating aspects of this financial crunch is how rapidly changes are occurring.  It takes $1.25 to buy one Euro now and it was not long ago that it took $1.60.  This rapid rise in the dollar will probably begin hurting U.S. exports, but it should help make the cost of imported goods much more affordable for U.S. consumers.  For more on this, please see Dollar Soars Versus Euro and Dollar Rallies Against Euro — Flight to Quality.

• Business , Economy , Geopolitics , Money
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Kurt Brouwer October 16th, 2008

This is an interesting chart in that it illustrates the inflation-adjusted price for a gallon of since 1980.

Source: Carpe Diem

On a related note, we all remember that, earlier this year, the news was full of stories about the inevitable trend towards higher and higher gas prices. Yet now, gasoline prices are falling and from this chart we can see that we are paying the same cost for gas that we were paying 28 years, once inflation has been factored in.  Actually, our gas bills are probably lower because cars generally have better mileage today than they did back then.

The fact that one ‘inevitable’ trend has turned around so dramatically should give us a little pause as we read the daily dose of negative news on the financial markets and the economy.  If the trend towards higher and higher energy prices was wrong, is it possible that the drumbeat of negative news on finance is also overdone?

• Business , Economy , Geopolitics , Personal Finance , inflation
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