Fundmastery Blog

Kurt Brouwer October 9th, 2009

We frequently are told by politicians that the only solution to our budget deficits at the Federal, state and local levels is to raise taxes.  I might buy this argument if those same politicians had made efforts to cut government spending that is not needed or is wasteful.  Unfortunately, those types of efforts get short shrift except when it is time to campaign.

From the Foundry blog, here are 10 examples of eggregious government waste:

50 Examples of Government Waste. (Foundry, October 6, 2009, Brian A. Riedl)

…Reducing wasteful spending is not easy. Even the most useless programs are passionately supported by the armies of recipients, administrators, and lobbyists that benefit from their existence. Identifying inefficiencies and abuses is much easier than devising a system to fix them. Many lawmakers focus more on bringing home earmarks than on performing the less exciting task of government oversight. Exasperated taxpayers see the cost of government rise with no end in sight.

Of course, eliminating waste cannot balance the budget. Lawmakers must also rein in spending by reforming Social Security and Medicare and by eliminating government activities that are no longer affordable. Yet government waste is the low-hanging fruit that lawmakers must clean up in order to build credibility with the public for larger reforms…

I have not cherrypicked these items, just took the first 10 from the Foundry’s list and added three bonus items from further down the list: [emphasis in the original]:

1. The federal government made at least $72 billion in improper payments in 2008.[1]

Okey dokey.  Has anyone thought of asking for these improper payments back?

2. Washington spends $92 billion on corporate welfare (excluding TARP) versus $71 billion on homeland security.[2]

We should be able to get to bipartisan agreement on this one.  Some don’t like waste, some don’t like welfare and some don’t like corporations.  It’s a match made in heaven.

3. Washington spends $25 billion annually maintaining unused or vacant federal properties.[3]

D’uh…Why not sell these properties?  We’d save $25 billion a year in maintenance savings alone plus the value of the properties, which are undoubtedly worth something.

4. Government auditors spent the past five years examining all federal programs and found that 22 percent of them–costing taxpayers a total of $123 billion annually–fail to show any positive impact on the populations they serve.[4]

Unfortunately, lawmakers do not seem to feel that positive impact from government spending is critical.  Witness the Cash for Clunkers program and many others.  Nonetheless, this is definitely low hanging fruit.  But still, $123 billion for programs that show no positive impact?

5. The Congressional Budget Office published a “Budget Options” series identifying more than $100 billion in potential spending cuts.[5]

This report from the CBO contains hundreds of recommendations to cut spending.  Again, we’re talking $100 billion per year.  $100 billion here and $100 billion there.  After a while, it adds up to real money.

6. Examples from multiple Government Accountability Office (GAO) reports of wasteful duplication include 342 economic development programs; 130 programs serving the disabled; 130 programs serving at-risk youth; 90 early childhood development programs; 75 programs funding international education, cultural, and training exchange activities; and 72 safe water programs.[6]

Do we really need 342 Federal economic development programs?

7. Washington will spend $2.6 million training Chinese prostitutes to drink more responsibly on the job.[7]

We previously said all we had to say on this one here: In this era of budgetary constraint and fiscal rectitude, we are pleased to report that our political leaders and bureaucratic chieftains have really gotten the message.  Otherwise, they would fund all kinds of crazy things.  Oops.

U.S. Will Pay $2.6 Million to Train Chinese Prostitutes to Drink Responsibly on the Job (CNS News, May 12, 2009, Edwin Mora)

The National Institute of Alcohol Abuse and Alcoholism (NIAA), a part of the National Institutes of Health (NIH), will pay $2.6 million in U.S. tax dollars to train Chinese prostitutes to drink responsibly on the job.

Dr. Xiaoming Li, the researcher conducting the program, is director of the Prevention Research Center at Wayne State University School of Medicine in Detroit.

The grant, made last November, refers to prostitutes as ”female sex workers”–or FSW–and their handlers as “gatekeepers.”

“Previous studies in Asia and Africa and our own data from FSWs [female sex workers] in China suggest that the social norms and institutional policy within commercial sex venues as well as agents overseeing the FSWs (i.e., the ‘gatekeepers’, defined as persons who manage the establishments and/or sex workers) are potentially of great importance in influencing alcohol use and sexual behavior among establishment-based FSWs,” says the NIH grant abstract submitted by Dr. Li…

This study certainly seems essential doesn’t it?  After all, what could be more important to people in Detroit, home of Wayne State University, than that Chinese prostitutes drink responsibly?  And, since this ’study’ is funded by the Federal government, it’s not as though we have any problems closer to home, right?

8. A GAO audit classified nearly half of all purchases on government credit cards as improper, fraudulent, or embezzled. Examples of taxpayer-funded purchases include gambling, mortgage payments, liquor, lingerie, iPods, Xboxes, jewelry, Internet dating services, and Hawaiian vacations. In one extraordinary example, the Postal Service spent $13,500 on one dinner at a Ruth’s Chris Steakhouse, including “over 200 appetizers and over $3,000 of alcohol, including more than 40 bottles of wine costing more than $50 each and brand-name liquor such as Courvoisier, Belvedere and Johnny Walker Gold.” The 81 guests consumed an average of $167 worth of food and drink apiece.[8]

It has been found over and over again that government employees abuse credit cards to the point where they really should be given out sparingly.  No doubt there are plenty of responsible bureaucrats who do not abuse cards, but nearly half of all purchases are either improper, fraudulent or embezzled?  C’mon.  Cut up the cards.

9. Federal agencies are delinquent on nearly 20 percent of employee travel charge cards, costing taxpayers hundreds of millions of dollars annually.[9]

Apparently, Federal employee not only abuse credit cards, but their agencies are also frequently delinquent in paying the bill.  From the link for this item #9, we read:

The most stunning revelation concerns not how the cards are used but rather how long it takes the government to pay its bill — and what those delays are costing taxpayers.

According to the most recent data from the Office of Management and Budget, in January 2009, governmentwide delinquency rate for centrally billed card accounts — those paid by an agency rather than an employee — was 19.23 percent. The average delinquency rate for individually billed cards was 6.25 percent, data showed.

A card is considered delinquent if a bill is outstanding for more than 60 days.

“A private travel agency would be out of business running this kind of operation,” said Scott Amey, POGO’s general counsel. “This report summarizes problems with individual transactions and, more important, with government agencies that aren’t safeguarding taxpayer dollars.”…

10. The Securities and Exchange Commission spent $3.9 million rearranging desks and offices at its Washington, D.C., headquarters.[10]

Now, in all fairness, the SEC has been given some new responsibilities, but that is still a lot of dough for a pretty modest task.

And, here are three bonus items:

12.  Over half of all farm subsidies go to commercial farms, which report average household incomes of $200,000.[12]

I have never understood this farm subsidy concept in which we pay well-to-do folks not to do something.  What does it take to kill off something as silly as this?

13.  Health care fraud is estimated to cost taxpayers more than $60 billion annually.[13]

Much has been made of this as a source of ‘found’ money to help pay the cost of health insurance reform.  OK, fine.  Why not just fix this problem first, if it’s so easy.  See this post, Why Not Fix Medicare First? for more on this issue.

And, finally, the Pentagon’s procurement group should be summarily fired. Of course, Congress shares some of the blame for this one because Congressional leaders have frequently put great pressure on the Pentagon to allow wasteful cost overruns.

14.  GAO audit found that 95 Pentagon weapons systems suffered from a combined $295 billion in cost overruns.[14]

This should also be a Congressional ‘no brainer’ because some in Congress don’t like waste and some don’t like the Pentagon.  I don’t want to undercut our military men and women at all.  They do a difficult and often dangerous job and I would like to make sure they have adequate resources.  Yet, cost overruns on big projects do no one any good.

It looks to me as though savings in just these 13 items would be in the hundreds of billions per year.

That’s enough to give insurance tax credits or vouchers to all those who do not have health insurance, with some spare change left over.  No need to do more deficit spending or to raise taxes.  Just cut the waste and do it first.  What’s not to like?

• Blogging , Business , Geopolitics , Money , debt , deficit , income taxes
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Kurt Brouwer October 6th, 2009

The absolute size of our Federal government stuns me.  It was big — really big — before, but in the past few years it has been supersized.  Check out these charts from a new website and blog called Downsizing Government.

Chart 1: Federal Spending in Dollars

Source: Downsizing Government

Since the year 2000, Federal government spending has doubled.  Doubled.  And, the growth in spending is accelerating.  The increase in this fiscal year, 2009, that just ended was around $670 billion.  That’s just the increase.

Chart 2: Federal Spending as Percentage of GDP

Source: Downsizing Government

In Chart 2, we see Federal spending as a percentage of Gross Domestic Product (GDP) or total economic activity.  Chart 2 shows steady growth in the size of government, with a huge jump from 1970-76 and an enormous jump in the past two years or so.

Surprisingly, two spending categories — defense and net interest costs — are not contributing to the increased size and scope of government.  I shudder to think what will happen if interest rates go up substantially.

See also:

Households Cut Back; Government Debt Grows

Don’t Tell Congress What Comes After Trillion

Government: It ain’t broke yet, but just wait

• Economy , Geopolitics , debt , deficit
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Kurt Brouwer October 5th, 2009

As you know, the dollar has been falling against the Euro and other currencies lately. But, it is sometimes hard to put that in an actual historic perspective. Also, it’s hard to understand why the dollar is falling. With this post, the goal is to give you answers on both questions — How far has the dollar fallen? And why is it falling? And, we also want to discuss what is likely to be ahead for the declining dollar.

Declining the dollar

Do you remember hearing that the Euro fell to historic lows versus the dollar in 2001? In fact, the Euro fell steadily versus the dollar for the first five years of its existence, beginning in January 1999. It did not get back to even until mid-November, 2003. At the low point for the Euro you could have bought one for 84 cents. Now, it takes a $1.46 to buy one Euro.

Here is a chart showing the fluctuations of the Euro versus the dollar since inception in 1999. This shows how many dollars it takes to buy one Euro. When the blue line is heading down, the dollar is getting stronger. When the line heads up, the dollar is getting weaker.

U.S. Dollar / Euro

Source: St. Louis Federal Reserve Bank

The gray bars in the charts indicates the relatively brief recession we experienced in 2001 and the longer recession we are experiencing now. You might notice that the 2001 recession coincided with the low point for the Euro (or conversely, the strongest point for the dollar during this time period). Why? The very strong dollar and the recession went hand in hand because the Federal Reserve raised interest rates beginning in 1999 and that led to the recession. Higher rates cause the dollar to strengthen, but they also inevitably slow down the economy. On the other hand, lower interest rates are positive for the economy, but often not for the dollar.

After the 2001 recession ended, our economy strengthened for years and the dollar fell, more or less continuously during that economic upturn. Coincidence? No. Here is a chart showing the Federal Funds target rate.

Federal Funds Rate

Source: St. Louis Federal Reserve Bank

As you can see from this chart, the Federal Reserve began raising interest rates (blue line going up) to slow down the technology bubble in 1999. By comparing this chart to the first one, you can see that when U.S. interest rates went up, the dollar rose versus the Euro. When the economy fell into recession in 2001 (the first area in gray), the Fed began slashing interest rates and the Euro finally began strengthening versus the dollar. The Fed began raising rates again in 2004 due to inflation concerns and the Euro stabilized versus the dollar until the Fed stopped raising rates in 2006. At that point, the Euro began climbing and the process accelerated when U.S interest rates were cut significantly in 2007 as the economy began to weaken.

Flight to the dollar during financial panic

During the financial panic at the end of 2008 and early in 2009, the dollar strengthened considerably.  This chart is the same data as in chart number one, the dollar versus the Euro, but for the period of 2008 and so far in 2009.  I also took off the recession bar.  Remember that the blue line going down means the dollar is strengthening versus the Euro, while the blue line going up means the dollar is weakening.

Source: St. Louis Federal Reserve Bank

The flight to the dollar during the panic began in the Summer of 2008 and ended in early 2009.  As the panic subsided, other considerations such as interest rates took hold again and the dollar again began to weaken against the Euro.  At the low point, it took nearly $1.60 to buy one Euro.  Then, during the depths of the financial panic, it took only $1.25 to buy one Euro, but now that same Euro would cost $1.46 or so.

What’s Next?

The big difficulty we face now is that the economy is weak and the Fed likes to have low interest rates to help the economy begin to grow again.  Low interest rates are helpful to overall economic activity, but, as you have seen, lower rates generally hurt the dollar.  If we wanted to help out the weak dollar, the response would ideally be to raise interest rates.  However, due to serious weakness in the economy, the Fed is hampered in its ability to respond to this situation and I believe it will opt to keep very low interest rates in order to promote economic growth.

You may hear various members of the Federal Reserve or politicians or pundits decrying the weak dollar.  However, for decades, our government’s philosophy during recessions has been to publicly espouse a strong dollar while, at the same time, cutting interest rates to strengthen the economy and give unemployment a boost.  This has traditionally been done despite the fact that lower interest rates generally lead to a weaker dollar.  I don’t see anything in the cards that appears to have changed that policy.   Therefore, I expect continued pressure on the dollar as the Fed seeks to get economic activity going again.

• Economy , Geopolitics , Investing , Money , debt , deficit
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Kurt Brouwer October 1st, 2009

Though we did correctly call Cash for Clunkers a bad program, I still hate to see the entirely predictable end result.  The government handout just induced buyers to move up car and truck purchases a bit so we saw a temporary blip in sales.  This chart tells the tale:

Source: Clusterstock

CRASH: Was Cash for Clunkers a success?

I suspect Congress would say yes, however I would say no.

Let’s review the scoring here.  First, Joe Consumer turns in a decent car, which gets destroyed.  Not sold to a family that needs a decent used car.  Not even given to needy families.  Not even broken up for parts.  Destroyed!

Joe Consumer then buys a new car for, let’s say $25,000.  Government borrows $4,500 from investors, both at home and abroad, and pays car dealer the dough, which offsets that portion of the cost of Joe’s car.  However, Joe Consumer has to come up with the balance of $20,500 which has to come from his savings or from a loan.  Of course, when Joe drives the car off the lot, the value drops by 20% or so.

Joe Consumer: Loses older car that was paid off.  Now, he’s making payments on a loan of $20,500 on a car worth $20,500.

U.S. Government: Now owes another $4,500 to bondholders.

New car company: One new car sale

Other consumer product retailer: One less sale

Environment: One more scrapped car plus environmental costs of making new car

Environment: Slightly higher average mileage for gasoline

Charities: Fewer folks donate old cars to needy charities

Used Car Buyers: With used car costs soaring, those who need a decent car end up paying more

U.S. Taxpayer: Grab your wallet

Update:  ABC News’ John Stossel does a very good job of pointing out the economic fallacy in government programs at his blog:

…Now it appears that Congress will ask not just for another billion, but another TWO billion. Look how generous Congress is with your money!

The idea is that by destroying used cars, people will buy new cars, which creates jobs. But this commits the “broken window fallacy”. That $3 billion taken from taxpayers to, essentially, destroy used cars now cannot be put towards college, or a new home, or new clothes, or anything else. Some used cars are no longer available for poor consumers to buy. If the “new car” market is helped by “Cash for Clunkers”, every other market is hurt because that $3 billion cannot be spent on anything else…

The government cannot just make up the billions needed for Cash for Clunkers out of thin air.  That money has to come, ultimately, from us as taxpayers.  Government spends more; we spend less.  Result: no net benefit. If you are interested in more on this topic, go to Stossel’s link above on the ‘broken window’ fallacy as put forth originally by a 19th century French economist, Frederic Bastiat.

If you want to see how much actual environmental benefit we have accrued under Cash for Clunkers, go to the Political Calculations blog right here.  They have a handy online tool that helps you do the calculations.  Here is a summary of the findings:

…Using the default numbers, we find that it takes a very long time for taxpayers to get their money’s worth for what they were required to spend to support the “Cash for Clunkers” program. At 26.5 years, the time needed to obtain the perceived benefits of reduced CO₂ emissions will very likely outstrip the useful life of the new “green” vehicle, suggesting that taxpayers will never realize a positive environmental return on the $4,500 they provided to subsidize the new car sale…

The cost for the unintended consequences and the collateral damage from Cash for Clunkers is rising. As is quite common, Congress never really did its homework on this issue and they have wasted money on a program that did very little, if any, economic good and clearly has had a net, negative environmental impact.

You’ve seen us drive, now watch us heal…

What’s next from those brilliant minds in Congress?

Source: Economists Do It With Models

Our government cannot properly manage a pretty simple $1 billion car rebate program, but the fearless folks in Congress are willing to give it a go with healthcare and health insurance, which together comprise about 17% of our economic activity.  What could go wrong?

• Business , Economy , Geopolitics , debt , deficit , income taxes
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Kurt Brouwer September 29th, 2009

Though inflation fears are popping up all over the place — particularly in ads for inflation-hedging investments such as gold — Pimco’s Bill Gross still believes economic activity is weak and he is warning of deflation ahead, not inflation.  This Bloomberg pieces gives his thoughts [emphasis added]. Be wary though of the headline because I believe it is incorrect as I point out below:

Pimco’s Gross Buys Treasuries Amid Deflation Concern (Bloomberg, September 29, 2009, Thomas R. Keene and Susanne Walker)

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said he’s been buying longer maturity Treasuries in recent weeks as protection against deflation.

“There has been significant flattening on the long end of the [yield] curve,” Gross said in an interview from Newport Beach, California, with Bloomberg Radio. “This reflects the re-emergence of deflationary fears. The U.S. is at the center of de-levering as opposed to accelerating growth.”

...He boosted the $177.5 billion Total Return Fund’s investment in government-related bonds to 44 percent of assets, the most since August 2004, from 25 percent in July, according data released earlier this month on Pimco’s Web site. The fund cut mortgage debt to 38 percent from 47 percent…

This piece is a good example of why you should be wary of headlines and media reports in general.  The reporters were probably correct that Pimco bought a modest amount of Treasury securities opportunistically when rates hit an attractive level, but they gave the impression that a major move into Treasuries was underway.  And, the headline writer added to that erroneous (I believe) impression.

The piece got it right in the final paragraph above when it pointed out that Pimco is putting more emphasis on government-backed securities (such as Fannie Mae bonds or other government agency bonds) and interest rate swaps and other similar instruments tied to government-backed securities. Government agency bonds are guaranteed by the Treasury, but they are very different from Treasury bonds or notes.

Getting back to the main theme, like Gross, I too wonder and worry about deflation.  It’s not that I do not see a threat from inflation in the future because I do see inflation ahead.  But, inflation is not much of a factor right now whereas deflationary forces are still quite strong.  With the potential for deflation, we also have a higher likelihood of lower interest rates.  Whereas, in an inflationary environment, we would typically have higher interest rates for most fixed income securities.

What is inflation and what is deflation?

Inflation means that we are experiencing a general increase in the price of goods we buy.  Deflation is the opposite, that is, a general decline in the prices of various assets and the goods we buy. Inflation is very common in most developed countries, but deflation is rare.  The last time we had protracted deflation was in the Great Depression of the 1930s.  Now, the slumping economy has weakened demand enough that, at least, most goods and services are under some pricing pressure. Overall, the cost of living (Consumer Price Index) is still up a bit, but that is primarily due to recent increases in the cost of energy.

Why is general deflation so scary to our government?

Falling consumer prices are a good thing, but there are concerns about generalized falling prices, i.e. deflation.  A generalized state of deflation is viewed with fear and loathing by the government because it can be very disruptive.  Falling prices for goods and services mean companies struggle financially and are forced to cut spending and employment.  Falling prices for assets such as real estate means that homeowners see their equity vanish and that leads to lower levels of consumer spending.  As real estate prices fall, banks and mortgage holders also suffer.  This leads to a hoarding of capital and decreased lending activity.  And, as economic activity under a deflationary environment falls, more unemployment results, thus leading to yet further reductions in consumer spending.

In short, deflation can become a downward spiral and our government will use every tool it has to quickly root out deflation and prevent it from taking hold because, to paraphrase Sun Tzu from The Art of War:

If the deflation is protracted, the resources of the State will not bear the strain.

As Gross pointed out in his September Investment Outlook,

As of now, PIMCO observes that the highest probabilities favor the following strategic conclusions:

1. Global policy rates will remain low for extended periods of time.
2. The extent and duration of quantitative easing, term financing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories, both domestically and globally.
3. Investors should continue to anticipate and, if necessary, shake hands with government policies, utilizing leverage and/or guarantees to their benefit.
4. Asia and Asian-connected economies (Australia, Brazil) will dominate future global growth.
5. The dollar is vulnerable on a long-term basis.

The Feds are fighting deflation very hard for the reasons noted above, but the deflationary pressures are such that we are not likely to see inflation for some time.  That’s good. Unfortunately, deflationary pressures also mean that we will probably have a modest, rather than robust, economic recovery in 2010.

See also:

Burgeoning Bond Funds

Economy Turning — slow growth ahead

Full Disclosure:  Kurt Brouwer owns Pimco Total Return (pttrx)

• Economy , Geopolitics , Investing , Mutual Funds , debt , deficit , inflation
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