Why Interest Rate Psychology Will Change By Late 2016

Wall Streeters disagree about when the Fed will start to tighten (September?, December?) but most agree that once it gets started the pace of tightening will be exceeeeeeedingly gradual. An overleveraged US in a weak world economy supposedly requires easy money for the foreseeable future.

But I predict . . .

. . . Wall Street will be singing a different tune 18 months from now. Word on the Street will be that the Fed has to tighten faster than people thought back in 2015. For a simple reason: the economy is adding ~210,000 jobs per month but only needs around 100,000 to keep up with population growth. So the unemployment rate is falling 90-100 bps per year. Over the last 12 months the jobless rate fell -0.8% (6.1% to 5.3%); this metric averaged -0.9% over the past six months. At this pace, the unemployment rate will be 3.9% by the end of 2016.

How low is 3.9%? Of the 546 months since the start of 1970, just six months were below 4% and the lowest figure was 3.8%. Even Larry “Secular Stagnation” Summers would agree a near–zero Fed funds rate is too low when unemployment is at record lows. Inflation is already approaching the Fed’s 2% target; the core CPI is rising 1.8% yr/yr. As wage metrics such as the Employment Cost Index accelerate and the debate shifts to how high rates must go to restrain job growth, investors will belatedly recognize the Fed is way behind the curve.

Four Reasons to Expect Rate Psychology to Change

Official Group Think. Central bankers in Europe, Japan, China and emerging markets (Madame Lagarde) are trying to nurture weak economies by pressuring the bankers of close-to-full-employment economies (the US and UK) to keep rates low. Lagarde explicitly instructed the Fed not to tighten until 2016. Yellen and Carney seem to be looking for reasons to maintain easy money. Yellen is a dove who loves to talk about the “slack” in the labor market, but in all her speeches and Congressional testimony I have never heard her address the simple fact that—as the Congressional Budget Office detailed—Obamacare will keep millions of people out of the labor force and increase part-time employment. Thus, much of Yellen’s “slack” is an optical delusion. Another problem, sadly, is that public schools are turning out semi-literate graduates who are not qualified for most jobs.

Bond Bears Have Cried “Wolf” for So Long that investors are complacent, oblivious of basic relationships involving inflation. Very early one morning I watched an eye-opening exchange on Bloomberg TV-Europe between a grizzled rates strategist who thought central bankers needed to tighten and a much younger FX strategist. “Weak UK productivity growth puts pressure on the Bank of England to tighten” said the bearish veteran, but the FX strategist denied low productivity growth was inflationary – it merely increased demand for low-wage workers. The veteran was incredulous; “Don’t you know that weak productivity growth means faster increases in unit labor costs?”

Deflationary Side-shows Obscure the Big Picture   Shenanigans in Greece and Chinese equities divert attention from a tightening labor market. So do weak gold and oil prices. Neither Greece nor China’s stock market matter much to the U.S. economy, and by 2016 the year/year change in oil prices will be flattish, as comparisons get easier.

Radio Daze I distrust official statistics, which are revised heavily and often rendered useless by structural change. If they were a trustworthy guide to the future the Fed, with its 10 million economists and unlimited access to proprietary information, would not have failed to predict the last three recessions. (Bernanke assured Congress in the spring of 2007 “the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”)

Conversely, I like anecdotal evidence such as radio commercials. Numerous ads for pets.com and drkoop.com pretty much rang the bell at the top of the tech mania in late1999; ditto all those ads for second mortgages in 2007 and gold funds in the summer of 2011.

So I think it is highly significant that Verizon—a big, solid employer that presumably offers good benefits—is advertising on New York City radio stations to recruit workers. And don’t forget that 26 states have lower unemployment rates than New York—in many cases, much lower. Earth to Dr. Yellen: Verizon would not be doing this if there were still plenty of “slack” in the labor market.

Investment Implications

Although much more bearish for bonds than stocks, rising short rates will keep a lid on PE ratios, which are already lofty for this point in the cycle, when profit margins are elevated and future earnings growth will be moderate. What would make stocks plunge is if investors sensed that rising rates could tip the U.S. economy into recession. I also wonder whether big losses in bond ETFs could spook investors and hurt consumer spending.


Two important items in the FT:

James Grant cites a study showing that an increasing number of companies are encouraging analysts to focus on “pro forma” EPS that excludes option expense, as opposed to GAAP earnings. Pro forma EPS is not all bad—it excludes exceptional gains as well as losses—but excluding option expense is ridiculous. My takeaway: where is the SEC on this issue? They were all over it in 2003, when everyone had sworn off tech stocks, but now that we have new mini-bubbles in some tech stocks and biotechs the SEC is nowhere to be seen. That’s the problem with regulators: like investors, they have short memories.

Dominic Rossi of Fidelity cites a big study based on Fido’s internal database of 2700 firms showing that – contrary to popular lore – capital spending is very healthy in most industries and substantially exceeds depreciation. This is consistent with my May 27 post showing that a WSJ article attacking hefty dividends and buy-backs was based on a crude misinterpretation of the charts that accompanied the article. The notion that dividends and buy-backs are starving capex is a fairy tale—but a dangerous one, because Hillary Clinton believes it.

Copyright Thomas Doerflinger 2015. All Rights Reserved.




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The Sowell Solution

Time:   1944

Place:   Junior High School 143 in uptown Manhattan, not far from Harlem

Action: Mrs. Sennett, a Guidance Counselor, is giving a classroom full of ninth graders advice about which NYC high school they should attend next year

She begins by telling the kids to be realistic; not everyone can go to the city’s elite high schools – Bronx High School of Science, Brooklyn Tech, and Stuyvesant. She goes on at excessive length so that they really get the message. Then she calls on each kid in turn and asks where they want to go. Eventually she calls on a black kid, slouching behind his desk, who looks rather bored as he sketches in a notebook.

“Where do you want to go to high school?”

“Stuyvesant High School.”

Haven’t you been listening to anything I said? What makes you think you can go to Stuyvesant High School?”

“I have a friend who goes there, and he has never seemed to be a better student than I am.”

“Oh really? Let me look at your IQ.”

Mrs. Sennett reaches for the student’s folder, which is in a pile on her desk. When she gets to the folder (the student later reported) “her sneering expression turned to cold resentment.”

That bored black kid, Tom Sowell–along with his two best friends in junior high school, Vegas and Rosen–scored 100 on the entrance exam. All three went to Stuyvesant High School, where the workload was extremely heavy—particularly for Tom, who had to commute an hour each way, changing trains twice as he traveled from Harlem to the Lower East Side. He came home exhausted, and slept before tackling hours of homework.

A Most Varied Career

Family problems forced Tom to quit high school and get a job at age 16. That marked the start of an incredibly tortuous, and sometimes torturous, career that included a short stint at the Home for Homeless Boys; a hazardous job in a machine shop; a job delivering telegrams for Western Union; a hitch in the Marines (but Tom’s expertise in photography kept him out of the Korean War); jobs in the Federal bureaucracy; courses at Howard University in DC.; getting a BA from Harvard University, an MA from Columbia, and a PhD in economics from the University of Chicago; and then teaching gigs at many colleges and universities, including Douglass College, Howard, Cornell, Brandeis, Amherst and UCLA. He also did research for some DC think tanks that were waging the “war on poverty.” Eventually Dr. Sowell settled at Stanford’s Hoover Institution, becoming one of America’s most influential economists and public intellectuals.

Brilliant though he was, Thomas Sowell still struggled with tough academic challenges at various points in his career. To keep up during his first year at Harvard he had to take “stay awake” pills and work non-stop. But eventually he learned how to succeed at an elite university and did fine.

Judging from his autobiography, Thomas Sowell’s modus operandi as a professor was to never, ever adhere to the maxim “To get along—go along.” He was as rigid as a crowbar. Instead of “going along” with academic standards that became increasingly lax during the 1960s and 1970s, Dr. Sowell stubbornly insisted on excellence in his economics classes from all his students, whether white or black, male or female. He never graded on a curve. So he was constantly at loggerheads with university bureaucrats who begged him to “make allowances” for poor performers.

Sliding Standards

Sowell’s autobiography is entertaining but depressing, because it shows—anecdote by anecdote, confrontation by confrontation—how racial paternalism subverted academic standards, to the detriment of black students. As education became increasingly politicized and racialized—more about racial integration of society than the education of individual students—it became harder for black kids to get a top-flight education. From first grade to ninth grade, all but one of Thomas Sowell’s teachers were white, but he did not believe that it hindered his education.   Partly because the student body was polyglot—there were so many minorities, no one was a minority—New York’s educational environment was relatively colorblind in the 1940s and 1950s. Smart black kids could get a good education at public universities such as City College, the “Harvard of the Working Class”; one of its graduates, Colin Powell, sings its praise in his autobiography. But beginning in the mid-1960s, educational standards steadily declined, thanks to:

  • A fixation on racial integration, to the detriment of education. The nadir was Boston’s “forced busing” crisis of the 1970s, when poor Irish kids were bused from crappy schools in South Boston to crappy schools in black Roxbury, while rich white liberals cheered from the suburban sidelines.
  • Affirmative action for university faculty, which tarnished the credibility of black academic stars like Dr. Sowell. Students were not fooled; they wondered whether a given black prof came in through the “front door” (as Dr. Sowell did) or the “back door.”
  • Elite universities such as Cornell scrambled to recruit black students, many of whom could not keep up. Dr. Sowell thinks they would have gotten a better education at a less difficult institution, where they would have had more time to master the material and gain self-confidence.
  • Universities admitted militant black students who were more interested in politics than education. They had little trouble intimidating university officials, as well as black students who were not politically radical.
  • Paternalistic white liberals hated to give a black student a bad grade, even when they deserved it. (Sowell believed many black students didn’t work hard enough.) A prominent victim of paternalism was City College, where high standards gave way to “open enrollment” – just about anyone could attend, but no one got a decent education. Eventually CCNY was rescued by politician Herman Badillo.

How Ethnic Minorities Build “Social Capital”

Dr. Sowell’s views on these matters is informed not only by his personal experience as an educator, but also his extensive research on the global history of ethnic minorities. He documents many cases of downtrodden minorities building “social capital” through “self improvement”— for example, Scots learning English to avail themselves of English literature and Jewish immigrants to the U.S. working hard to improve academically. (Jews from eastern Europe scored poorly on an intelligence test administered to more than 100,000 U.S. soldiers during World War I.) A precondition for “self-improvement” is recognition by minority groups that they really do need to improve academically—that, for example, bad scores on standardized tests are not merely the result of biased tests.

DeBlasio’s Victims

Of course, the main victims of lax educational standards are the putative beneficiaries. Why bother with “self-improvement” when guilt-ridden liberals will make excuses for you? Case in point: when New York Mayor Bill DeBlasio was asked recently why students’ failing grades on a Regent Exam were changed to passing grades, he simply replied, “This is something we have seen consistently over the years.” Given this attitude, it is not surprising that in 2014 only 3 percent of the students admitted to elite Stuyvesant High School were black and Hispanic, even though blacks and Hispanics make up 70 percent of the city’s public school student population. Which is why black parents are clamoring to send their kids to charter schools that provide a rigorous education. And why rich liberals like Barack and Michelle Obama refuse to send their own kids to public schools.

Thomas Sowell, A Personal Odyssey

Thomas Sowell, Intellectuals and Race

Copyright Thomas Doerflinger 2015. All Rights Reserved.




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A Flawed Framework for the AP U.S. History Curriculum

In a previous incarnation I was a professional historian, so I was intrigued by conservatives’ charge that the new AP History Framework for high school students has a leftist bias, depicting “a nation founded on oppression, privilege, racism, and heedless exploitation of the environment.” As it happens, a chief architect of the Framework is a former colleague of mine; in fact, I edited his first book. In a lengthy defense of the Framework, this gentleman makes these points (emphasis mine):

  • “At least as I teach my own introductory course . . . the goal is to produce students who understand that historical knowledge—whether of the American past or any other—depends on two absolute rules: first, that historians cannot make anything up; second, that they cannot leave anything out merely because it strikes them as inconvenient, embarrassing, or out of keeping with preconceived notions or conventional wisdom. . . .
  • “good history is that which offers both the most inclusive and the most coherent possible account of the past.
  • “My fellow members and I wanted to make the AP U.S. history course a more rigorous reflection of the current state of knowledge and practice in our discipline.”

My response:

  • Actually, historians today do leave out facts that are – to them at least – “inconvenient, embarrassing, or out of keeping with preconceived notions or conventional wisdom.” You won’t find many historians plainly stating that America’s capitalist economy, managed largely by acquisitive white males, reduced the poverty of millions of immigrants from Europe, Asia and Latin America (that’s why they came). Or that an important growth driver was effective “exploitation” of America’s abundant natural resources.
  • I, too, favor “inclusive” history; I have read many of the excellent new books on the slave trade and slavery. But in a survey course one wants to teach students, “how we got where we are today,” which requires understanding the actions of successful elites. Too much “inclusiveness” can be sub-optimal.
  • Basing the AP Framework on the “current state of knowledge and practice in our discipline” sounds commonsensical, but is actually problematic. Professional historians — unlike, say, investors or journalists, for whom every day brings something new and different—have to keep ploughing the same old ground, yet find something original and interesting to write about. So they rotate from one hot topic to another. In the 1970s, the hot topics for historians of 18th century America were the New England village and Republicanism. Later it was “consumerism.” Now it is slavery and Indians. That’s fine, but it is far from clear that a survey course should be heavily tilted toward a particular topic just because it is the current focus of historical research.

Framework Fractures

The Framework has 200 separate historical “concepts,” so it is not difficult to quantify its priorities. Of the 200, 28 refer to Indians and 27 to slavery and race, versus only 5 to the creation of America’s “founding documents,” the Declaration of Independence and the Constitution. Only one “concept” discusses the actual drafting of the Constitution; that is clearly inadequate.


On ante-bellum immigration, students are told:

“Substantial numbers of new international migrants — who often lived in ethnic communities and retained their religion, language, and customs — entered the country prior to the Civil War, giving rise to a major, often violent nativist movement that was strongly anti-Catholic and aimed at limiting immigrants’ cultural influence and political and economic power.”

A more even-handed formulation: “Despite its Protestant roots, the U.S. was willing to receive millions of indigent Irish Catholic immigrants who – notwithstanding sometimes violent nativist resistance – fared much better in the U.S. than they would have by remaining in Ireland or moving to England.”


Regarding World War II, students are told,

“Wartime experiences, such as the internment of Japanese Americans, challenges to civil liberties, debates over race and segregation, and the decision to drop the atomic bomb raised questions about American values.”


“The United States and its allies achieved victory over the Axis powers through a combination of factors, including allied political and military power, industrial production, technological and scientific advances, and popular commitment to advancing democratic ideals.”

So here we have a rather anodyne statement that the U.S. and its allies won the War, and a denigration of that extraordinary achievement on the grounds that the War “raised questions about American values.” No mention of the 407,000 American troops killed, which by the way was four times the number of Japanese Americans interned. Destroying the Nazi and Japanese empires, and rebuilding both nations along democratic lines, affirmed American values.


Regarding Ronald Reagan and the Winning the Cold War:

“President Ronald Reagan, who initially rejected détente with increased defense spending, military action, and bellicose rhetoric, later developed a friendly relationship with Mikhail Gorbachev, leading to arms reductions by both countries.”

Actually, it was Reagan’s military buildup, in the face of strenuous liberal opposition, that ultimately led to the demise of the Soviet Empire – not his “friendly relationship” with Gorbachev.

The Framework’s Not so Gilded Age

The Framework misconstrues the relationship between capitalism, economic growth, immigration and poverty reduction. Students are told:

“Following the Civil War, government subsidies for transportation and communications systems opened new markets in North America, while technological innovations and redesigned financial and management structures such as monopolies sought to maximize the exploitation of natural resources and a growing labor force.”

If I were grading this and in a good mood, I would still give it a “D.” There are at least three problems. First, “government subsidies” did not open new markets; people did – entrepreneurs and their employees, encouraged by subsidies. Second, monopolies are not “management structures;” they are market structures and were quite rare in the gilded age. Third, “maximize the exploitation of natural resources and a growing labor force” is tendentiously pejorative.   A “growing labor force” did not willingly cross the Atlantic in order to be “exploited.“


“The industrial workforce expanded through migration across national borders and internal migration, leading to a more diverse workforce, lower wages, and increase in child labor.”

Wages did not decline in the late 19th century; in real terms they rose 130% between 1865 and 1898. Living standards were boosted by a host of technological breakthroughs that go unmentioned in the Framework – telephony, electricity, elevators, phonographs, light bulbs, indoor plumbing, packaged foods, catalogue stores, interstate shipment of frozen meat, and (a few years later) autos and airplanes.

LBJ’s Not So Great Society

The Framework sidesteps the abject failure of Washington’s “War on Poverty,” obliquely noting that “public confidence and trust in government declined in the 1970s in the wake of economic challenges….” The accelerating inflation of the 1970s was more than a “challenge;” it was a protracted disaster for ordinary Americans engendered by the statist policies of LBJ, Nixon, and a Democratic Congress. Real median household income declined between 1969 and 1982 despite a huge increase in the number of working wives (female labor force participation rose from 42.7% to 52.6%). The Framework notes that “economic inequality increased after 1980” but ignores the broad prosperity engendered by the Reagan / Volcker program of monetary restraint, tax cuts, and deregulation; median household income rose 12% from 1982 to 1989.

Bottom Line

The product of a great deal of thoughtful effort, the Framework is well intentioned and a pretty good start. However, it inevitably reflects the scholarly priorities and political biases of professional historians and should be substantially revised to meet the needs of high school students who wish to take a college-level American history survey course.

Copyright Thomas Doerflinger 2015. All Rights Reserved.




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U.S. Stock: Look for Stronger Performance in Second Half of 2015

At the end of 2014 we explained why “stocks are expensive, offer mediocre risk / reward.” The weak 2.5% price rise so far this year is consistent with that call. But stocks should be stronger in the second half because profit growth will improve.

Profit dynamics are poorly understood—and not just by the media. Goldman Sachs and JP Morgan could use a tutorial as well (from the folks Deutsche Bank). When oil prices collapsed, some strategists claimed this would boost S&P profits, because energy costs would decline. That was dead wrong. The huge decline in profits of oil producers was not offset by energy cost savings in other sectors for the simple reason that energy costs are just not that important—far smaller, in most industries, than such items as labor, R&D, rent, taxes, depreciation, etc.

Because of this energy confusion, as well as the surprising strength of the U.S. dollar, Q1 2015 earnings were surprisingly weak, as was earnings guidance for Q2. With stocks trading at high valuations, weak earnings growth led to weak price performance.

Three Reasons Why Profit Performance Will Improve

  1. The Missing Metric

Although Street strategists do a good job of slicing and dicing S&P profits, one useful metric is being neglected: median EPS growth. S&P EPS is an index number reflecting aggregate profits of 500 companies. When giants like Exxon, Chevron, Citi, etc. post huge profit drops, it slashes overall S&P earnings. But this weakness hides decent growth at many companies that, frankly, are of more interest to investors than “big uglies” such as XOM. I don’t have the median EPS growth rate for the index, but I do have a decent proxy—the median yr / yr EPS growth rate for 40 big companies spread across most industries. Here are the figures for the past eight quarters:

  • Q2 2013         5.7%
  • Q3 2013      12.3%
  • Q4 2013      15.0%
  • Q1 2014       10.6%
  • Q2 2014      12. 0%
  • Q3 2014      12. 2%
  • Q4 2014       11.7%
  • Q1 2015        7.0%

Owing mainly to the strong dollar and weak oil prices, median EPS growth rate was much weaker in Q1 than the six prior quarters. But 7% is still a lot better than the 2% growth for the index as a whole. So the typical stock is becoming cheaper in the “sideways correction” we have had so far in 2015.

  1. Higher Oil Price, Stabilizing Dollar Are Positive for Profits . . .

The two key headwinds to profit growth—weak energy prices and the strong dollar—are becoming more profit friendly. Oil prices have climbed 27% since January; the dollar has declined from $1.05 / Euro to $1.11. If WTI oil stays at $60 / barrel, the yr/yr change in oil prices will improve from -53% in Q1 2015 to -44% in Q2, -39% in Q3 and +1% by the fourth quarter of this year. Similarly, if the dollar stabilizes companies will quit slashing guidance for earnings and revenues. The dollar could be up modestly yr/yr by Q1 2016.

  1. . . . and so Is Strengthening Growth in Europe

Europe is by far the most important foreign market for U.S. multinationals, accounting for around 15% of S&P profits. Economists expect GDP growth to accelerate from 0.9% in 2014 to 1.6% this year and 2% in 2016. This is a significant positive for profits. Arguably Grexit would be positive, not negative, for Europe’s growth; it has been a huge distraction for policy makers.  It looks like the Greeks will get the depression they voted for.

As confidence in profit growth improves, so should stock prices. Using a forward PE of 17x and 2016 S&P profits of $131, look for 2200 on the S&P 500 by the end of this year, up 5% from current levels.

Skip Ip – Monetary Hubris Is the Big Risk for Equities

For the time being investors still expect low inflation which justifies high PE ratios. I don’t expect this to change in the next six months, but risks are rising. Much of the econ fraternity is in the “secular stagnation” / “debt deflation” camp, which supposedly justifies zero Fed funds seven years into an economic expansion. Exhibit A was the WSJ article by Greg Ip, “Memo to Fed: Allow the Economy to Overheat.” Mr. Ip thinks overheating would be beneficial because “it would help nudge inflation back to more normal levels, restore some of the long-term growth potential lost since the financial crisis, and boost ordinary workers’ wages more effectively than a minimum wage.” This is a great example of monetary hubris—the notion that central bankers can skillfully steer the global economy, even though the Fed’s forecasts have been wrong for the past six years. There are a few good reasons to skip Ip:

  • Inflation is already moving to “more normal levels.” In the three months through May the Core PCE Deflator rose at a 1.7% annual rate, close to the Fed’s arbitrary 2% target. (CPI inflation since 1815 averaged just 1.4%).
  • Weirdly, Ip forgets that inflation reduces real wages, so overheating would not “boost ordinary workers’ wages.” Commodity speculators would fare much better than workers.
  • The real driver of wage growth is productivity growth, which would be hurt by higher inflation, as it was in the 1970s. It is much easier for companies to raise prices than increase efficiency.
  • Overheating will cut short the expansion through A) rising inflation and bond yields, B) belated tightening by a behind-the-curve Fed, which would spook markets., C) popping of asset bubbles in venture capital, junk bonds, and elsewhere.

GOP Victory in 2016 Could Lengthen the Recovery

The economic expansion has labored under Obama’s anti-capitalistic, anti-worker, pro-DC policies. A Republican President who reforms corporate taxes, Obamacare, energy policy, etc. would boost business confidence, increase investment, and reduce inflationary pressures by expanding the supply side of the economy.

Copyright Thomas Doerflinger 2015. All Rights Reserved




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The Wright Stuff

On May 30, 1899 an impecunious 32-year-old man who, along with his brother, ran a small bicycle shop in Dayton Ohio wrote to the Smithsonian Institution, with a request:

“I have ben interested in the problem of mechanical and human flight ever since as a boy I constructed a number of bats of various sizes . . . . .I am about to begin a systematic study of the subject in preparation for practical work to which I expect to devote what time I can spare from my regular business. I wish to obtain such papers as the Smithsonian Institution has published on this subject . . . .”

Four and a half years later, toward the end of 1903, Wilbur and Orville Wright completed their first flight in a “flying machine” at Kitty Hawk, a windy, isolated, desolate expanse of sand dunes on North Carolina’s outer banks. By 1906 the Wright Brothers were global celebrities. They took up residence in the luxurious Hotel Meurice in Paris, where they consulted with military officials and cut deals with European capitalists.

The Wright Brothers’ historic triumph, we learn in David McCullough’s superb new book, was the result of concentrated effort by exceptionally smart, determined, resourceful, courageous and yet humble Americans. To crack the code of manned flight, they intently studied birds in flight, built increasingly sophisticated “flyers,” created their own wind tunnel, devised a gasoline engine for their flying machine, developed a weight-driven catapult to launch the flyer, and methodically overcame a host of other technical, practical, and theoretical challenges. They did all this while running their bicycle shop. While camping at Kitty Hawk they braved at various times clouds of voracious mosquitoes, hurricane-force winds, frigid temperatures and a near shipwreck while traveling to Kitty Hawk. Theirs was dangerous work; a crash in 1908 permanently disabled Orville and killed the soldier who was flying with him. The one thing these unlikely capitalists lacked was capital; their project cost all of $1,000, versus $70,000 spent by Samuel Pierpont Langley in a failed attempt at manned flight.

The Wright Lessons

  • Interestingly, many auto pioneers also started their careers in the bicycle business, which was booming in the 1890s after a long gestation period. Don’t dismiss the bicycle as just an “intermediate technology;” it sill provides millions of people with comparatively fast, clean transportation. (If you cross a Shanghai street during the morning commute, watch out for clouds of cyclists; they don’t stop for pedestrians.)
  • Like Henry Ford, Bill Gates, and Steve Jobs, Wilbur and Orville remind us that very smart and determined entrepreneurs can work wonders on a slender budget, beating out competitors with copious funding from Wall Street, Washington, or corporate coffers. Focused smarts and lack of bureaucracy are big advantages.
  • Hey, you liberals: don’t forget that often the best antidote for capitalism is more capitalism. While autos and airplanes were—pardon the pun—getting off the ground in the first decade of the 20th century, “monopolistic” railroads seemed to rule the economy, which is why Teddy Roosevelt in 1904 brought an anti-trust suit against railroad conglomerate Northern Securities. Two palatial new train stations (Penn Station and Grand Central) were built in New York in the first decade of the 20th century, just as railroads’ dominance was cresting. Which is one reason why Obama’s decision to use the FCC to impose “net neutrality” on Internet infrastructure is absurd.
  • Give the government its due; the Wright brothers received valuable information from the Smithsonian institution in Washington. Today the Library of Congress could provide similar assistance to citizens, but it is being mismanaged by politicians. Following a senseless tradition that Librarian of Congress is a lifetime appointment, it is now run by an 86-year-old historian, James Billington, who is a nice man (I once took a course from him) but utterly clueless about digitizing information; he does not even use e-mail.


Copyright Thomas Doerflinger 2015. All Rights Reserved.

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Princeton University’s ATO Breakthrough

“Our research demonstrates conclusively that as a liberal education becomes more expensive it is also becoming less liberal and less educational.”

T.J. Maxx PhD


I would have to respectfully disagree with Dr. Maxx. America’s great universities are pushing back the frontiers of knowledge by developing important new academic disciplines—novel ways of understanding the world. My alma mater, for example, is on the verge of granting degrees in a path-breaking new field of study, colloquially known as ATO (Art of Taking Offense). After they receive their ATO degrees, Princeton graduates will be able to discern every sleight (however slight), every offense (real or imagined), every subtle hint of distaste or disapproval. Their SQ (Sensitivity Quotient) will have been permanently elevated.

To appreciate just how rapidly the science of ATO has advanced at Princeton, consider the EDP / UC dichotomy.


Just forty years ago, in elections for Class President, there was one jokey candidate who called himself El Deuco Perverto (EDP). Along with several sidekicks, El Deuco Perverto showed up at campaign events wearing dark glasses, a trench coat, and no pants. The potential OTQ (Offense Taken Quotient) of El Deuco Perverto was extremely high –- El Paso, El Salvador, Eldorado, Eloise, El Capitan and Chicago’s El train had all been viciously slandered. But such was the undeveloped state of ATO that El Deuco Perverto was merely viewed by the Princeton Community as a silly, amusing, inane, clever campaign gambit. Nothing more. Clearly a lost opportunity for injured outrage.


Fast forward to 2015, when the Princeton Community – having made dramatic advances in ATO – was torn asunder by a sophomoric student gambit quite similar to El Deuco Perverto’s. At two talent shows the swimming and diving team – exclusively comprised, not incidentally, of white males – styled themselves “Urban Congo” and trooped out on stage wearing only their speedos to perform a slightly amusing drumming, chanting and dancing routine. No reference to a specific ethnic group or region. No nasty lyrics. No demeaning innuendo or hint of threat toward anyone. The Offense Taken Quotient was actually pretty low, as these comments from YouTube viewers demonstrate:

  • “How is that offensive? It is not even a satire, just a parody. Jesus Christ, people, grow a thicker skin.
  • Not offensive. Just weird!
  • I don’t get why ppl find this offensive
  • Yo peeps, as an African I can assure you that nothing of this video offends us.
  • That’s not racist, just stupid.
  • This is not offensive. AT ALL. WHAT is offensive about this?”

Concocted Campus Crisis

Sadly, none of these commentators have mastered ATO, but such is not the case for many Princeton students and professors, who were greatly offended by Urban Congo’s antics. The leafy campus was plunged into a week-long period of angst and anguish about the horrid, hurtful, hateful performance. The head of Urban Congo was forced to recant; he assured one and all that he recognized his error and had been thoroughly reeducated by Princeton’s diversity police. The crisis culminated in a convocation at the university chapel where Princeton’s President and a few faculty members expressed their pain, their sorrow, their outrage.

Princeton’s president: “On our campus and in our society, members of minority groups too often find themselves hurt, excluded, or diminished by stereotypes, by ignorance, by thoughtlessness, and by hostility” — including, one presumes, Urban Congo’s clearly non-racist performance. Translation: to stay out of trouble, you should only tell black / brown / Hispanic / female / LGBT students what they want to hear; don’t challenge them with ideas outside their comfort zone, or you will be accused of racism / sexism / homophobia. Of course, this is the opposite of a liberal education, but Princeton’s President wants to keep his job.

One professor reported that black students felt Urban Congo “crossed the line” of free speech because the black students were “negatively impacted.” . . . . “they are tired of the idea that in America, generations of people, deemed educated, can have effectively no knowledge of Native American or African cultures and history.”   So black students can shut down a performance that does not conform to their own values or world view. Again, the opposite of a liberal education.

Another professor said, “We’re opting to wake up each morning and swallow a colorblind hallucinogen, numbing ourselves to the racial reality. . . . We’re playing dumb about the fact that humor and entertainment always have been the handmaidens of racism and sexism. . . . [there are] devastating inequities in education, health, and incarceration that continue to damage our body politic [that must be addressed].” In other words, this professor’s outrage over Urban Congo was overtly political; the performance simply did not set the proper cultural tone for the Progressive reforms she believes Princeton should pursue. I wonder how this Professor would react to an outside lecturer who explained why Barack Obama’s tax/spend/over-regulate agenda has been a disaster for African Americans, whose median household income was 9.2% lower in 2013 than 2007.

Official Princeton’s week-long freak-out about a sophomoric talent show routine that probably took a half hour for students to prepare shows that the University is effectively banning any speech or cultural display that offends hyper-sensitive minority students and liberal professors. I must apologize to the aforementioned Dr. Maxx; he was indeed correct that “liberal education” is becoming less liberal and less educational.

Copyright Thomas Doerflinger 2015. All Rights Reserved.


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Urban Inequality – the Paris Syndrome, U.S. Style

After stepping off an Amtrak train in Washington DC, you drag your luggage down a ramp into a nice, modern, well-organized space with waiting areas, newsstands and mid-priced eateries, plus a few retailers such as H&M. Overhead signs instruct you to keep walking through this space to reach taxies and busses; you find yourself in a huge hall with marble floors and soaring coffered ceilings, where there are a couple of nice restaurants and, on a lower level, a food court. But you still haven’t reached the taxi line. Keep going and you will find yourself in the officially branded “Great Hall,” which has no discernible function but sure is impressive with its polished floor and yet another soaring, barrel-vaulted ceiling. Finally, on the other side of the Great Hall, you find the taxi line.

While Washington’s Union Station has three giant halls, other major Amtrak stations on the northeast corridor – Baltimore, Wilmington, Philadelphia, Newark, New York, New Haven, Providence, Boston – barely have one between them. Their stations are all, to a greater or lesser degree, dumps. Philadelphia’s is the best of the lot, with a spacious art deco waiting area that, unfortunately, appears not to have been cleaned since it was opened in 1933. New York’s Penn Station may well be the worst major train station north of the equator—a crowded, dirty, cacophonous multi-level catacomb of unsightly corridors and passageways.

The same goes for subways—immaculate platforms and sky-high ceilings in the DC Metro versus cramped, decrepit, claustrophobic, outmoded transit systems in Philly, New York and Boston.

The Protection Racket

Of course, this transit dichotomy is symptomatic of a larger reality. In Obama’s Washington, bureaucrats and politicians multiply taxes and fines and regulations and rules and guidelines and mandates with the stated aim of reducing inequality. In reality they are retarding economic growth and dramatically increasing inequality by burdening America’s private economy with excessive regulation, even as Washington’s regulatory economy booms. The city is brimming with lawyers and lobbyists who, for a stiff fee, will stretch the tax code or “improve” a piece of legislation. (How do you think Denny Hastert got the $1.7 million he allegedly paid to a blackmailer?) Whereas the business districts of Baltimore and Philadelphia are shrinking into a pathetic, dilapidated core of banks and government offices, downtown Washington has block upon block of gleaming 10-story office buildings; interspersed among them are innumerable luxury hotels and fancy restaurants, not to mention ornate embassies and high-rent apartment buildings. And DC’s booming suburbs claim six of the ten richest counties in the U.S.

Rich Regulators

The 2013 median household income of the Washington-Arlington-Alexandria metro area was $90,149, far higher than other cities; next highest was San Francisco at $79,624. Boston was $72,907, New York $67,194, and Philadelphia $60,482. So incomes were fully 50% higher in Washington than Philadelphia. Talk about “inequality.”

Call It the Paris Syndrome . . .

. . . . elites clustered in the capital, ruminating about inequality while making a mint taxing and regulating the real economy to death. Of course the national media are oblivious to the Paris Syndrome because they live in Washington and are out of touch with the real world beyond the Beltway. To them Georgetown – with its quaint tree-lined streets and immaculate ivy-clad townhouses – is a typical urban neighborhood. But nothing similar is to be found in Baltimore, Philadelphia, Wilmington, or Newark, whose impoverished citizens are supposedly benefiting from the torrent of regulation pouring out of DC.

Copyright Thomas Doerflinger 2015. All Rights Reserved.




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The Winner of the 2015 Ig-Nobel Prize, for the Worst Book by a Nobel Prize Winner Is . . .

Ignoble   adjective 1. Not honorable in character or purpose

Synonyms: dishonorable, unworthy, base, shameful, contemptible, despicable, vile, degenerate, shabby, sordid, mean, dastardly

Ladies and Gentlemen, thank you for attending our Annual Gala, where we present the Ig-Nobel Prize, our humble effort to identify the worst books written by the smartest people. This year was particularly challenging for the Prize Committee. The Committee was torn. The book that eventually won the prize as the Worst Book by a Nobel Prize Winner was actually deemed, by 6 of the 13 committee members, to be the best book because it broke new ground in literary technology. It used sophisticated algorithms to produce a complete 52-chapter book—admittedly a terrible book, but you have to start somewhere—by producing 51 chapters that merely re-ordered the key words and hackneyed concepts presented in Chapter I, including:

  • Inequality
  • Rising inequality
  • Shrinking middle class
  • 1%
  • .1%
  • financialization
  • speculation
  • deregulation
  • too big to fail
  • rent seeking (wealth appropriation)
  • rent seeking (taking a bigger piece of the pie)
  • excessive leverage
  • monopoly profits
  • talented tax lawyers
  • pollution tax
  • carbon tax
  • financial transaction tax
  • higher income tax
  • essential public investments

Ultimately, however, the Prize Committee concluded technological innovation was not exculpatory. A terrible book is a terrible book, even if ghost-written by a computer. Therefore, the 2015 Ig-Nobel Prize goes to . . .

. . . the envelope please . . .

. . . . Joseph Stiglitz for his latest “book,” The Great Divide. It says pretty much the same thing in every chapter, with little documentation and no consideration of conflicting evidence or alternative points of view. Nevertheless the book (which is a compendium of previously published articles) does have merit as a window into the mind of a doctrinaire socialist who throughout an illustrious career has had no hands-on contact with the private economy he hates. Here, for example, are . . .

. . . Six Stiglitz Bloopers

Regarding the 2008 financial crisis, JS claims “for the preceding three years I, together with a small band of other economists, had been warning of the impending implosion.” Hold the self-congratulation, JS. You actually failed to predict the financial crisis even after it started. In a Vanity Fair article published in December 2007 (four months after the crisis began) you lament the Bush tax cuts, shrinking budget surplus, and Iraq War but failed to predict a housing bust or banking crisis. The big challenge of the “next president,” you wrote, will be moving the economy from a savings rate of zero to a more normal 4%. No mention of a banking collapse.

JS’s hobby horse is “rent seeking” (grabbing wealth via monopoly rather than creating it) which supposedly is how the notorious 1% gets its money. He forgets that the biggest rent seekers are governments and non-profits such as the Federal government, teachers unions, universities, the UN, the IMF, and the World Bank. Of the ten richest counties in the U.S., six are in the Washington DC area. Universities comprise a credentialing cartel that kills competition and uses its market power to jack up tuitions.

JS believes financial deregulation produced rising income inequality as Wall Street vampires sucked the blood out of the real economy. But why, then, has financial re-regulation—Dodd-Frank, giant bank fines, etc.—failed to reduce inequality?

JS opines, “there is no begrudging the wealth accrued by those who have transformed our economy—the inventors of the computer, the pioneers of biotechnology. But, for the most part, these are not the people at the top of our economic pyramid. Rather, to a large extent, it’s people who have excelled at rent seeking in one form or another.” As usual, he provides no evidence; here is some. Of the top 50 people on the Forbes 400 list, 41 possess wealth generated in the “real economy” and only 9 are in finance; 37 are self-made men (sic) and 13 are second generation wealth. Financiers are resourceful entrepreneurs, not parasitic rent seekers. One reason for faster GDP growth in the U.S. than Europe and Japan is wider and deeper financial markets, as well as shareholder pressure on companies to become more efficient.

JS largely ignores big government’s central role in creating the housing bubble. Based on the myth (since disproven) that mortgage lenders, contrary to their own self-interest, were discriminating against credit-worth minorities, Clinton and Cuomo pressured Fannie, Freddie and private banks to make risky, low-down-payment loans to marginal borrowers–most of which were later re-labeled “predatory loans.” It was the Federal bureaucracy and pressure groups such as ACORN—not Wall Street—that destroyed the credit culture of the mortgage market.

JS claims “growing inequality is the flip side of something else: shrinking opportunity.” History suggests otherwise. In a buoyant economy such as the 1920s or 1990s the rich get richer and inequality rises, but living standards also improve for other income groups. Median household incomes rose 10% in the tech-frothy 1990s. Conversely, in troubled economies (1930s, 1970s) inequality declines as companies and financial markets stagnate, but the middle class struggles as well. Between 1970 and 1983 median household income fell 1% despite a huge increase in the number of women in the workforce. Perversely, Obama’s anti-capitalist agenda has produced the worst of both worlds: rising inequality and declining opportunity. Median household income was 8% lower in 2013 than 2007. Faced with anemic 2% GDP growth (bad for the poor and middle class) the Federal Reserve has tried to stimulate growth by pumping financial liquidity into the economy (great for investors, speculators, and Wall Street deal makers).

Copyright Thomas Doerflinger 2015. All Rights Reserved.



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WSJ Misinterprets Its Own Data to Demonstrate Companies Are Spending Too Little on Capex, too much on Dividends & Buy-backs

To its credit, the WSJ did some serious quantitative work in an effort to determine whether Blackrock’s Larry Fink is correct that companies are paying out too much money to shareholders while starving capital investment. Fink is right, the Journal concluded. However, scrutiny of the WSJ’s own data points toward the opposite conclusion. Capex is not, in fact, being starved, and the relationship between capital spending and capital payout is similar to the 2003-2008 business cycle. Which is not at all surprising, if we think about the “real world” out there. We had a capital spending boom in the energy sector over the past few years; pharma companies big and small are spending heavily to develop new drugs; giant tech companies such as AMZN, FB, AAPL, MSFT, IBM and GOOG are spending heavily on server farms, warehouses, and R&D.  Not exactly a capex drought.

The Conclusion . . .

The article, titled “FIRMS SEND MORE CASH BACK TO SHAREHOLDERS,” opens with its conclusion: “U.S. businesses, feeling heat from activist investors, are slashing long-term spending and returning billions of dollars to shareholders, a fundamental shift in the way they are deploying capital. Data show a broad array of companies have been plowing more cash into dividends and stock buybacks, while spending less on investments such as new factories and research and development.”

The WSJ Data . . .

“An analysis conducted for the Wall Street Journal shows that companies in the S&P 500 Index sharply increased their spending on dividends and buybacks to a median 36% of operating cash flow in 2013, from 18% in 2003. Over that same decade, those companies cut spending on plants and equipment to 29% of operating cash flow from 33% in 2003.”

What Really Happened . . .

That sounds pretty bad: a “fundamental shift” as capex is “slashed” while companies are “plowing more” into dividends & buy-backs. But there are a couple of problems:

  • The data presented are based on shares of cash flow rather than absolute levels, so they simply cannot support the flat statement that firms are “slashing long-term spending.” If the share of cash flow spent on capex falls modestly while cash flow rises capex may increase, perhaps substantially. That is what actually occurred.
  • The WSJ focuses on the end points (2003, 2013) while ignoring the business cycle, which drives capital payouts. The recent rise in payouts is cyclical not secular; a similar pattern occurred from 2003 to 2008. Said differently, the big rise in payouts trumpeted by the Journal comes from comparing a cyclical trough (2003) and cyclical peak (2013).

A Closer Look at the WSJ Data

 Capital spending as a share of cash flow for the median firm: The 2013 figure of 28.7% is not particularly low—modestly below the 2003-2013 average of 29.5%. As noted, this metric is share of operating cash flow, so it may decline not because capex is weak but because cash flow is strong. Profits were, in fact, strong in 2013 at 117% above the cyclical low in 2009. Conversely, the 2003 figure was probably inflated by weak profits at the beginning of the economic expansion; 2003 S&P 500 profits were only 26% above the cyclical low in 2001.

Capital payout as a share of cash flow for the median firm: This metric was 17.7% in 2003, soared to 44% by 2008 as companies increased buy-backs and dividends, and then collapsed to 18% in 2010 as companies hoarded cash during the financial crisis. It has since climbed to 36.1% as dividends and buy-backs have increased, in normal cyclical fashion. But this metric is still below the 2007-2008 level, belying Larry Fink’s claim that activist investors are forcing companies to pay out too much capital.

If schools of journalism, like some business schools, had “case studies” this one would be titled, “Critically Scrutinize and Analyze your Data Before you Write About It.”

Copyright Thomas Doerflinger 2015. All Rights Reserved.


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“The Policy Environment”—Bloomberg’s No-go Zone

A few days ago on Bloomberg Radio Tom Keene and Barry Ritholtz interviewed Stephen Stanley of Amherst Pierpont Securities, focusing on his gloomy outlook for GDP growth. Twice Stanley stated that the “policy environment” was holding back growth. First he observed that “Some of the reasons potential growth has slowed are not permanent reasons. The policy environment has been very unfavorable toward business investment and that is something that obviously could change over time.” A couple of minutes later, in response to a question from Tom Keene about weak capital spending, Stanley said, “Investment has been the biggest disappointment relative to expectations for several years now. A lot of that has to do with the hostile backdrop. Corporate tax reform just sits there, and never happens. The regulatory environment has been difficult for a lot of industries. Firms are only doing what they have to do. They replace machines that break down . . .”

So how did Messrs. Keene and Ritholtz—ever eager to elucidate future economic developments for their thousands of listeners—follow up on Stephen Stanley’s dour assessment of the “policy environment?” Did they ask for more specifics? Challenge his assumptions? Find out what policy changes Stanley hoped to see out of Washington?

Not a chance. Nothing. Nada. Rien. You see, in BloombergLand, the wretched “policy environment” crafted by Obama Administration is off limits. Whether because of the network’s obvious liberal bias or the myopia of Wall Streeters obsessed with the Fed, the broader “policy environment” is a no-go zone. Bloomberg reporters and pundits would rather spend a month at the Chernobyl Nuclear Exclusion Zone than explore how Obama has stunted economic growth and killed jobs, thereby increasing inequality and hurting the poor. (The affluent Washington bureaucrats who live in suburban Maryland are doing just fine; Baltimore’s poor blacks, not so much. Let’s blame the police and Fox News.)

Why does this matter to investors? Because, as Stephen Stanley clearly implied, a new Republican administration with pro-growth policies could jump-start economic growth, proving Larry Summers and fellow Secular Stagnationists wrong. With the torrent of revelations about Hillary and Bill starting to make the Corleone Family look like amateurs, a Republican administration appears increasingly possible. This would be much more positive for equities than for bonds.

Copyright Thomas Doerflinger 2015. All Rights Reserved.

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