Yes, The Economy Is Fragilistic 

Steven Colbert, the brilliant political & economic satirist of Comedy Central's, Colbert Report, used the term "Supercalifragilistic-expiali-zillion" to describe an alternate sum of money Hank Paulson could have requested for the bailout in late 2008.  The original namesake "Supercalifragilistic...expialidocious" was performed to umbrella twirling perfection by Julie Andrews in the Disney classic Mary Poppins.  Much the way our politicians and economic gurus are now twisting, twirling and machinating on how to best obfuscate the practical reality of what is, is really happening, the song's writers, Richard and Robert Sherman, defined the long syllable 5 part word as follows:  Super (above) - Cali (beauty) - Fragilistic (delicate) - Expiali (atoning) - Docious (educable). According to the film, Mary Poppins, it is defined as "what you say when you don't know what to say". If that sounds familiar, just turn on the television, tune into C-SPAN or CNBC and turn up the volume. 

Well, here's a fog horn alert.  We are heading towards a major bump in the road ahead.  A bell curve of sorts that is fairly predictive now that monetary expansion has taken its position in the alleged rescue of the U.S. economy.

There's Nothing Like a Good Refund

There is a massive refunding underway at the Treasury that was started, likely in covert terms last October 2008, but more prominently, by pronouncement, March 18, 2009 (my 15th wedding anniversary and last if I don't find a job).  This is a day of incredible history.  The day was filled with sweeping measures and anti-gravitational forces that seem to run in parallel to my wife's evolving marital dedication of "for better or worse, and worser, and now worsest..." - the U.S. Federal Reserve and Treasury's jet packs of re-inflationary measures to pull the U.S. out of a deflationary spiral. 

The Federal Reserve's balance sheet has exploded from $900 billion to $2 trillion with the potential of getting doubled from here. As for my wedding anniversary gift from the Fed? It's called hope for tomorrow.  Another musical fantasy on the heels of a freshly minted $300 billion in longer term Treasury security purchases and $1.45 trillion in federal agency debt and MBS (mortgage backed securities). 

Here's the tale of the tape...

In the Blue corner, weighing in at infinite levels of elastic currency, successor to the First Bank of the United States and trained by Ben Bernanke, the reigning heavyweight champion of the financial world since 1913... the Federal Reserve. 

In the Red corner, weighing in at a svelte $2 trillion, a champion fighter in its own right, having beaten congress with TARP, TALF an an assortment of fun house smoke and mirrors, trained by Timothy Geithner... the United States Department of the Treasury.  

Touch gloves and come out dancing.  Maestro, start the music.

There are theorists out there that say the overstimulation was needed to avoid a Great Depression style economic collapse.  Keep in mind that there were many problems with the governance in the 30's rescue package, most notably the Smoot-Hawley Tariff Act.  Then, there was a six year abstenance by FDR to exact Keynesian style supply-side stimulus.  It should be noted that the ineptitude of harsh surplus side protectionism (something China may not fully understand today) buttressed by a very slow hand in supply-side stimulus led to a protracted depression (this much, our current administration and fed policy makers decry they have a good handle on). 

However, there still remains stark fundamental differences in the U.S. economy between then and now and its relation to the global economy.

Pointed out on Capital Markets Live! and in several articles over the past year, the world has modern technology and globalization programs that by all calculations will speed up recovery and expansion - much the way President Obama indicated on 60 Minutes on March 22, 2009. The speed to which declines come, they respond in speed to recovery by virtue of technology and more of a balanced global economy. This is a fair certainty.

However, in the 30's and 40's there was yet another balancing element. Between the U.S. and the U.K., World War II, following another World War but 25 years earlier, brought the loss of a million or so lives out of a global 25 million. The loss of life and the lack of emerging markets and technology were capping forces, preventing any runaway inflation in a post-stimulus/post-WWII economy. That becomes central to the balances of outstripping of finite resources, creating jobs and filling gaps of unemployment.

In the 70's with population growth on the rise globally, a punchy domestic recession and oil shock on the ground, we did see the effects of a parabolic move on inflation.  The recession of the mid 70's was part of a normal business cycle.  The inflation in the late 70's and early 80's, for the most part, was the result of monetary policy, the effects of decoupling of the USD from gold, the birth of OPEC, and in the emerging market model of credit failure in the throes of a peak in a highly inflated industrial economic hegemony - the U.S. 

It is for the fundamental rationale and comparison from the 30's to the 70's and now, inclusive of the speed of technology and productivity born from the same, quick fixes to the high rate of unemployment and the surplus economies of China and India - that the likelihood remains of the U.S. catching a spell of hyperinflationary influenza. 

Some joke that the U.S. has become a third world nation. Joke as you will regarding its current economic state. The U.S. is hardly Zimbabwe and will undoubtably never get to that point.  However, it's no joke that it does looks more and more like Brazil of the 80's.  Perhaps by this comparison, one would describe the United States as a re-emerging market, rather than an economic super-power. 

Inflation in Brazil accelerated as a result of a combination of factors - the exchange-rate devaluations of the austerity program (an IMF blunder); a growing public deficit; and an increasing indexation of financial balances, wages, and other values for inflation. The first two factors are classical causes of inflation - the last became an important mechanism for propagating inflation and in preventing the usual instruments of inflation control from operating.  The 80's in Brazil ended with high and accelerating inflation and a stagnant economy, which never recovered after the demise of the Cruzado Plan. The public debt was enormous, and the government was required to pay very high interest rates to persuade the public to continue to buy government debt instruments.

Is the U.S. Cruzado-ing for a Super-Sov Reserve Currency? 

Be careful what you ask for...

Globe Mongering, part of the U.S. laissez-faire economic policy of decades gone by, seems to have run its course.  Last week, China's version of Ben Bernanke, the People's Bank of China Governor, Zhou Xiaochuan, called for a new super-sovereign reserve currency, a super-califragilistic-sovereign-reserve-a-dough-shift. Indubitably, it will be  exchanged all over the world.  For soon-to-be travelers from the U.S. to Ireland looking to kiss the Blarney Stone, you can toss an unknown quantity of U.S. dollars in the air and receive in return an odd currency that has a minted picture of Ayn Rand shaking hands with Mao Zedong. On it you will see the term inscribed over glowing black coal - "In Us We Trust".

If the geniuses who thought up the ten trillion dollar emerging markets boondoggle, and a 4:1 trade ratio favoring China thought it was a good idea for the U.S. economy, please stand up.  America want to salu... shoot you. Yes, shoot you. Of course there's going to be a new world order currency. It can do all of the things that the USD can do and more, including being used as a snorting tool and an tightly wound apple coring implement.  What will you snort? My drug of choice will be the powdery ashes from a pile of debt that is being built up without prospect of intermediation on trade and taxation.

Expect and Unexpected Response to Unexpected Inputs 

As for the immediate future, the Fed policy on inflation and the need to have an itch trigger finger on Treasury Repos should be measured accordingly, and most importantly, by watching China, India and the emerging markets. 

The only saving grace on overstimulation here in the short run is the absolute and monumental gravity of the negative GDP gap in the U.S.  This Japan like deflation that has brought the best and brightest minds together to create a multi-trillion dollar triage does however have the potential to become a gigantic fiscal atomic bomb of the future. 

And Now... Where's The Money? 

Clara Peller, the brilliant cameo spokeswoman for Wendy's Hamburgers in the 80's quipped and coined the phrase, "Where's The Beef? It won't much matter without the money.

I haven't quite figured out the exact conditional probability of emerging market protectionism on steriods (surplus) and the corollary to the effects of the high potential U.S. hyperinflationary tail developing - but I can see one in the horizon developing in twelve to eighteen months, much the way of the late 70's early 80's. From there it's Paul Volcker's Fed redux.

There is a good chance that hard right edge monetary policies will be needed to offset the tangential rise in hyperbolic monetary policy in the U.S.  The problem will become, where will they get the surplus or reserves for it once Congress is through fleecing the American Taxpayer. Never before, or at least once in an ancient civilization that lived through what we now refer to as the Great Depression, has there been a need to break free from any form of laissez-faire economic policies.  Such policies championed by Alan Greenspan, should be examined for failure to properly target and for getting too high on Globalization crack.  It is paramount to avoid such policies in the future, when by the recognition of extremes (i.e. - Irrational Exuberance or  Pessimism) should foster anything but laissez-faire dynamics or its rival antithesis - highly restrictive, massive and continuous Benthanistic type government intervention.

Geithner, Bernanke and the king's court must now be more vigilant and proactive than ever and assure themselves that while they may not see any near term inflation from the effects of the stimulus in rescuing a biafran like economy, they must be quick to tighten at a measured and corresponding pace to the projected slope of recovery.  Economies and business cycles run in degrees of change and variances in a unit circle.

Today, with George Stephanopoulos on "This Week", Secretary of Treasury Geithner told Stephanopoulos that the Treasury has "roughly $135 billion in uncommitted money left over in the TARP plan." That's good because he's going to need it now that tax revenues and reductions to trade deficits (vis-a-vis income) are going to be running in a trough.    

As The Unit Circle Turns 

It's a global daytime/nightime soap opera. That much is certain.

Olivier J. Blanchard and Charles Milton Kahn, reknown economists, noted that the existence and uniqueness of a solution depends fundamentally on the position of the eigenvalues relative to the unit circle.  Pronounced "eye-ghen-values", the term is derived from the German word "eigen" which means "characteristic".  In the world of linear algebra, the computations for a monetary solution will incorporate Blanchard / Kahn theory. Mr. Blanchard is currently the Chief Economist of the International Monetary Fund. 

As for Geithner and Bernanke, their jobs are cut out for them, bigtime. How they target rates and effectuate monetary policy after the money bomb that went off on March 18th and throughout the month of March might best be fixed on rational expectations, Blanchard / Kahn computations and the Cagan-Sargent-Wallace model of inflation dynamics. The rational expectation is that emerging markets will heat up their own engines to fuel their own growth and it will need to be factored into how quickly they will need to pull the trigger on Repos and the relation of the U.S. economic recovery to emerging market inflation.

On that note, I'm sure glad we have just found $135 billion or so in unused TARP money. What a relief!

The solution of the rational expectations model is unique if the number of unstable eigenvectors of the system is exactly equal to the number of forward-looking (control) variables.

Fire Up Those Engines

As a new-world-ordered protectionism begins to take hold around the world, and soon-to-be refired up emerging market engines (of high population and growth) start chugging massive quantities of oil again, even at depressed at +6.5 to +8% GDP targets (see: last week's emerging market indicies MSCI-EM & EEM), our modern day monetarists will feel like they're walking the Wallenda high wire on a windy day. One thing is for certain, it won't be a short jaunt.

Granted that the U.S. was cruising at 3.1% and now is in a -6.2% ditch, the early estimates for 2002 are a whopping 4.1% GDP.  Factor in the already increased food and energy prices of the last two years, with a floor in place on oil at $40 (translating to $2.00 per gallon of unleaded gas), a loaf of bread, up 7% from 2006 to 2008.  Somehow, this defies a deflation.  On the unit circle the parabola may not be from a negative fixed point but rather from a zero baseline considering the inclusion of a 2007-2008 growth rate in what are now sticky prices (excluding asset classes like real estate and stock prices, still falling although not as steeply as before).

Re-Balancing The Act 

Economic stability and the health of the U.S. balance sheet and income statement is going to be front and center in the short run.  The elements that make up revenue for the U.S. and participate in towing a negative GDP growth rate out of the abyss are going to have to include a more liberal tax policy and a more conservative trade policy, truly a bi-partisan responsibility.

Assuming what now looks like a shift in risk failure and hopefully an ongoing occurrence, as the credit markets stabilize and banks are able to sidestep the write-downs of their toxic junk into a "bad-bank" now run by PIMCO and Blackrock, the Fed's stimulus will become more transparent and results more predictive.  It will need resources to start shrinking its bloated balance sheet and drain excesses from the system. We all know that over stimulation with low inflation is a bad thing - Greenspan's laissez-faire, CDO-CDS mania, and extension of oodles of credit on a monetary policy that led to ponzi schemes and false American dreams.  Post 9/11 fear is a powerfully intoxicating force that should never have been assessed by the Federal Reserve in broad sweeping continous laissez-faire brush strokes without careful consideration of the internals and normal business cycle which formed a hard right recession in 2000-2003. 

Get Real On Real Estate 

I hear a lot of noise regarding real estate and the toxics that caused the problem now going into a newly created riskless black box of sorts.  The the reality is that this black box maybe another black hole and the 97% taxpayer guarantee on the bad bank model will only go so far before it becomes a super nova.  It's no wonder why PIMCO and Blackrock are running to the trough to cook up a model ETF of sorts and are engendered to participate.  It seems warranted, in the same corkscrewy way that the ebbs and flows of policy that brought us here have inversions to policies that are reflective of times past and yet to come.  Should this be true, perhaps unscrewing the counter-intuitive dynamics of former fiscal, monetary and tax policies that have become legacy are now needed in addition to the one sided approach in the tax and stimulus plan currently under agenda.  For example, if the Tax Reform Act of 1986 immediately fulfilled a timely purpose and resulted in an untimely departure from normal private investment utility, that needs to be reviewed, clarified and amended. Another example is the Glass-Steagall Act.  This Act, right before the American public's eyes, was being modified and slowly repealed to allow for commercial bank participation in the coveted and profitable investment banking arena during the late 80's and 90's.  But it's complete death under Gramm-Leach-Bliley should have never happened.  Now it needs to be re-enacted as too big to fail is symptomatic of how you got to big in the first place.

As for The Tax Reform Act of 1986, it sought to choke off unbridled gains and tax incentives in real estate investing, but should now, with the inventory problem and tight credit system, be peeled back to allow for more private participation.  If Lawrence Summers, Director of the White House Economic Council was serious about a two year tax holiday, then President Obama and Congress should make it ubiquitous through owner occupied and real estate held for investment purposes.  

I believe whole heartedly that since the crisis began, an effort to immediately roll back the Tax Reform Act of '86, which took away all of the incentives, tax credits and breaks for investors to own properties should have been instituted.  It takes care of an inventory problem and a potential rental market solution versus wholesale abandonments.  I guess they already made up their minds on the issue and the taxpayer is picking up the private party tab, again. And possibly, again in the near future.

With banks no where near healthy by any stretch, a commercial real estate crisis is brewing and it too will likely need some relief as banks, insurance companies and REITs, have balance sheet exposure on concentrated risks of corporate debt and property mortgages secured by long term income producing leases for big and medium sized box retailers.  The list is growing and there will be another "bad-bank" asset class that will emerge as large footprint landlords begin to crumble from the effects of Chapter 11 & Chapter 7 tenant vacancies (i.e. - Fortunoff; Circuit City; Bombay; Domain; Linens n' Things and downsizings and consolidations from Office Max; Office Depot and Toys R Us). 

The U.S. real estate market presents a mixture of inventory gluts in both the residential and commercial real estate space combined with a lack of available credit to purchase the excesses and a lack of tax benefit in acquiring property for investment purposes. At the same time, the government is taking deductibility away, a counter-intuitive measure that will do anything but provide for greater private participation.   

A roll back of the '86 Act would reverse a policy that decreased the value of investment related properties which had been held for their tax advantaged status rather than proforma profitability.  Now, with values in the toilet, perhaps a more rational tax policy is needed.  If the administration is now seeking to remove or dramatically decrease the mortgage interest deduction for owner occupants (increased under the '86 Act), then it seems to warrant an unwinding of the elimination of the passive activity losses and passive activity credits and restore them into a chaotic system badly in need of private capital participation.  The '86 Act was the brainchild of Democratic Senators Richard Gephardt and Bill Bradley. 

Prior to 1986, a large portion of real estate investment in the United States was done by passive investors on an individual or syndicate basis, both on commercial and residential real estate properties. More often than not, real estate property management companies were formed to manage investment properties which, in turn, became deductions as  expenses on the investor's profit and loss statement. These losses (passive losses) were often used in a tax advantaged way to offset other sizeable income in the investor's portfolio. 

The '86 Act reduced the value of these investments by limiting the extent to which losses associated with them could be deducted from the investor's gross income. This, in turn, encouraged the holders of loss-generating properties to try and unload them, which contributed further to the problem of sinking real estate values. Hence, it is argued that the crater formed by the '86 Act and the dumping of break even and losing properties was not a market condition response but that directly pinned to regulatory myopia.

It seems that we have a crater to come out of today and market forces will have some impact. A liberal tax policy with a sunset window can be a major force in dealing with the crisis in real estate which is only going to extend from further increases in the unemployment rate and a commercial real estate crisis that is on the horizon.

The Tax Receipt Conundrum & Irrational Expectation

It is patently clear that the Administration is about to play its next hand in the shell game of tax revenue for support of a stimulus package.  And the American Taxpayer is the benefactor here without any reward. Bad bank programs that put a near 100% burden on the taxpayer for what return? They don't even have a means to price the bad assets yet and the ICE (the Intercontinental Exchange) has yet to set up the system to act as a pricing medium for these assets.  Yet, it took this much of a liberal approach to bring a fiscally conservative giants like PIMCO and Wilbur Ross to the table with high profile hedge funds like Blackrock and others to the table. They all have little to nothing to lose in the process and everything to gain in establishing the pass through pool paid for by the American Taxpayer.  

But if suggesting, instead that it should be policy measures that need to be more more tax liberal than direct taxpayer sponsored stimulus with a gun to everyone's head - or at the very least an unscrewed equivalent in balancing tax incentives with a collections policy (i.e. - rolling back the '86 Act on investment real estate to reflect the Administration's new limitations on owner occupied mortgage interest deductions) at a time when the receipts become so vital to effectuating the Administration's stimulus plan, then the American Taxpayer could never be taken hostage in this lopsided corkscrewy process. 

By raising taxes later on (in two years, according to Summers) and by taking more money from the taxpayer now (limiting owner occupied mortgage interest tax deductions), the Government has enacted a policy of a type of moral hazard and adverse selection equal to a shell game or three card monty.  And for what? To entice the private sector to participate in a rigged game paid for by the American Taxpayer, who for the most part, did nothing but follow the leaders. 

That is a rational expectation and a problem of new sorts that will be difficult to target in a taxpayer revolt.  No new taxes hikes for anyone making less than $250,000 but no repeal to the AMT, and a carve out of traditional mortgage interest tax dedutions that are as bad as raising taxes. 

So Where Will The Money Come From In The End? 

Mike Huckabee and Ron Paul, and oddly Steve Forbes (who by some measure of amnesia supported John McCain) all had it right. A fair tax to consumption system that fills the Federal coffers and eliminates the IRS personal income tax.  The practical end-all beginning of all economic theory is that there is "no free lunch".  Hence in today's system, while somewhere along the line there is a cost to someone, nobody knows who, including themselves of what the actual cost is. 

Gov. Huckabee and Congressman Paul, well respected for their authorities on fiscal policy and the constitution support FairTax.org,  the organization that supports the institution of The FairTax Act (HR 25, S 296) is nonpartisan legislation. It abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax  administered primarily by existing state sales tax authorities.

A fair consumption tax based system is the only way this thing is going to end. That this mairsey-doats carousel of government sponsored fraud upon the American Taxpayer is ever going to end and lead to better targeting through a rational behavior model far more efficient in means.  A means that suggests that the same person may make different choices under different circumstances.  That John/Jane Doe might decide to buy a burger at All-American versus McDonald's were they'll save a dollar on a combined meal.  Or that rational behavior is defined by choices that vary where John buys a Mercedes and Jane takes a world tour.

People's economic wants are too numerous to mention and replaced by new products, services, innovations, etc. every day.  That is the expanding universe of consumption to tax revenue.  It also puts the impetus on the government to continue to fund FTTR programs insuring a continuous expansion of the aggregate supply/demand model and long term GDP growth so as to feed into consumer's expanding economic wants.  Now the better news. Biologically, we humans need only clean air, clean water, nutritious food, adaptive clothing, and shelter to survive.  If we keep more of what we earn, we have more control over what we seek and buy of the goods and services that please us.  It is a stark reality that our economic wants far exceed the productive capacity of our limited and scarce resources.  Hence complete satisfaction of society's economic wants is impossible.

Tax everything at a standard rate with a redistribution to the State (i.e. - in a 30% consumption tax, the Fed gets a 70/30 split).  I don't care if my lunch date jumps from $30 to $39.  If we have it, it's up to us under a rational self-interest model that is formed by "no free lunch" and "we can't have it all anyway" where we decide what we will have and what we must forgo.  This is the fragility of economics at its core.  For those that can't find the means to spend at all or can't afford the marginal cost of quality of life improvements from a Chevy Volt to a BMW Hydrogen 7 series car, the entrepreneural spirit and forced savings will take care of that want over time.  A fair tax policy can only help make it a certainty.

If you want proof, the current democratic capitalist system is miserably broken and in tandem with a highly regressive tax system has served to wipe out decades of stored wealth effect in the U.S. while riling up the ranks of tea tossing Americans.