The Ordinary Blog

In April 2022 the U.S. Office of Management and Budget published a report estimating that climate change could cost the country $2 trillion per year by 2100.    In the same month, the U.N. issued a report warning that global greenhouse emissions must level off no later than 2025 to cap the increase in global temperature to 1.5* C, a level that many scientists consider critical to minimizing the effects of climate change.    Since many countries are still increasing greenhouse emissions, that threshold will likely be breached. 

At the same time, due to supply shortfalls, oil and natural gas prices in the U.S. have spiked, increasing costs to U.S. households and businesses.  In 2022 alone, the added cost of gas at the pump, home electricity, home heating, and prices of products and services dependent on fossil fuels could well exceed $1 trillion.   Based at least partly on the expectation that demand will shift to renewables, fossil fuel companies are not investing in new production capacity, so prices are not likely to return to historically low levels.   

The Federal Government recognizes the importance of reducing greenhouse gas emissions and therefore, the need for a new energy policy.  Based on public statements made by the Administration, the government appears to have a multi-pronged strategy with a focus on a few areas: 1. Accelerating the adoption of electric vehicles, 2. Reducing industrial emissions, 3. Shifting electric power generation from natural gas to solar and wind, 4. Transitioning home heating solutions from natural gas to electricity or hydrogen-based.  These changes will be highly disruptive to households, businesses, government, and the military in the U.S., causing major increases in costs and changes in operating procedures until the transition is complete. 

Climate change may also affect everyday aspects of life on planet earth.  Coastal regions at sea level will be underwater.  Some areas of the world may be uninhabitable for people and animal species due to higher temperatures and more violent weather patterns.   Ironically, higher temperatures will increase demand for air conditioning, creating more demand for natural gas.  Response to climate change may also shift the balance of political power in the world.  Nations that continue using fossil fuels will have an advantage in manufacturing and militarily.  As problems go, climate change is non-trivial, but most people (like me) have paid little attention to it until recently. 

Greenhouse Effect 101
Global temperature data show unambiguously that the temperature of the planet has been rising since about the 1940s.  Since scientists have identified this trend, the $64,000 question has been: what’s causing the higher temperatures?  Historically, looking back millions of years at the climate record found in the ice, soil, and fossils scientists know that temperatures on earth have cyclically fluctuated resulting in periods of abnormal cold and hot.  However, in evaluating the current heat wave, scientists point to evidence that the temperature increase since the 1940s is not a natural weather cycle but has been caused by human activities.     

As NASA explains on their website:

Ice cores drawn from Greenland, Antarctica, and tropical mountain glaciers show that Earth’s climate responds to changes in greenhouse gas levels. Ancient evidence can also be found in tree rings, ocean sediments, coral reefs, and layers of sedimentary rocks. This ancient, or paleoclimate, evidence reveals that current warming is occurring roughly 10 times faster than the average rate of warming after an ice age. Carbon dioxide from human activities is increasing about 250 times faster than it did from natural sources after the last Ice Age.

The planet’s average surface temperature has risen about 2 degrees Fahrenheit (1 degree Celsius) since the late 19th century, a change driven largely by increased carbon dioxide emissions into the atmosphere and other human activities. Most of the warming occurred in the past 40 years, with the seven most recent years being the warmest. The years 2016 and 2020 are tied for the warmest year on record.

As explained on the CalTech website:

…several lines of evidence show that current global warming cannot be explained by changes in energy from the Sun:

1. Since 1750, the average amount of energy from the Sun either remained constant or increased slightly.
2. If a more active Sun caused the warming, scientists would expect warmer temperatures in all layers of the atmosphere. Instead, they have observed a cooling in the upper atmosphere and a warming at the surface and lower parts of the atmosphere. That’s because greenhouse gases are slowing heat loss from the lower atmosphere.
3. Climate models that include solar irradiance changes can’t reproduce the observed temperature trend over the past century or more without including a rise in greenhouse gases.

We Don’t Want None of that Greenhouse Gas
Certain gases in the atmosphere absorb energy, slowing or preventing the loss of heat to space. Those gases are known as “greenhouse gases.” They act like a blanket, making the earth warmer than it would otherwise be. This process is natural and necessary to support life. However, the recent buildup of greenhouse gases in the atmosphere from human activities has changed the earth’s climate and resulted in dangerous effects on human health and welfare, and ecosystems.

Carbon Dioxide
The carbon cycle is the process by which carbon continually moves from the atmosphere to the earth and then back to the atmosphere. On the earth, carbon is stored in rocks, sediments, the ocean, and living organisms. Carbon is released back into the atmosphere when plants and animals die, as well as when fires burn, volcanoes erupt, and fossil fuels (such as coal, natural gas, and oil) are combusted. The carbon cycle ensures there is a balanced concentration of carbon in the different reservoirs on the planet. But a change in the amount of carbon in one reservoir affects all the others. Today, people are disturbing the carbon cycle by burning fossil fuels, which release large amounts of carbon dioxide into the atmosphere, and by deforestation, which reduces absorption of carbon from the atmosphere.

Methane
Atmospheric methane comes from both manmade and natural sources.  The main sources of methane emissions from human activity are agriculture (especially cattle and rice paddies) and fossil fuels (extraction, transport, and use).  Fossil methane is emitted from coal mines, fracking, gas leaks and venting of oil wells. 

Nitrous Oxide
Most nitrous oxide comes from agriculture, including microbes in fertilized soils and animal manure. It is a potent greenhouse gas with about 300 times the heat-trapping power of carbon dioxide.  Nitrous oxide also depletes the ozone layer (and is used by dentists as laughing gas). 

Fluorocarbons
Fluorocarbons come from coolants, foaming agents, fire extinguishers, solvents, pesticides, and aerosol propellants.  Fluorocarbons (FC) destroy the ozone layer of the atmosphere by increasing the amount of water vapor that gets into the ozone layer. It is the water vapor in the ozone layer that depletes ozone.

Feedback Loops
The earth is a very complex system.  Forecasting weather years in advance is fraught with pitfalls mainly because scientists don’t quite understand everything that’s going on.   The very sophisticated computer models used to forecast the effects of climate change have not been very accurate.  However, a few important feedback mechanisms are known and are fairly-well understood. 

One is the effect of vegetation.  Remember from Biology class that the photosynthesis process uses CO₂ and water to produce oxygen and sugar.  More vegetation will therefore reduce the amount of CO₂ in the atmosphere. The densest area of carbon-consuming vegetation on the planet is the Amazon rain forest in South America.   Unfortunately, the vegetation in parts of the rainforest is being razed so the land can be used for farming or grazing. 

Another feedback mechanism is the effect of warming oceans.  Unlike vegetation, which has a negative feedback effect, warming oceans have a positive feedback effect.  They add to global warming.  This includes the effect of the melting polar ice caps.   Melting ice caps cause the ocean levels to rise but also will cause the global temperature to increase.  The ice at the poles has a cooling effect on global temperatures. 

All else being equal, warmer air can hold more water vapor and that is the basis for another positive feedback effect. Scientists tell us that water vapor is the most important greenhouse gas.  Higher temperatures lead to more moisture content, and more moisture content leads to more heat retention.  Also, a negative side effect of more warm moisture in the air is more violent tropical storms and more precipitation.    This is especially a problem in the southeast and eastern seaboard U.S. The southwest U.S. is less affected because of the colder Pacific Ocean and the dry winds coming off the ocean.  The gulf coast has exactly the opposite situation.  And, unfortunately for the southwest, as the oceans warm, scientists predict that the southwest will also become more humid.

Population migration also affects climate change.   As millions of humans migrate from less-developed to more advanced areas of the world to escape the heat or for other reasons, their carbon footprints will increase, further accelerating global warming. 

Climate Deniers
If we were to poll the general public, a fairly large percentage would probably say they doubt the whole climate change narrative. That’s probably because the message has become politicized. After all, the main spokespeople have been Al Gore, AOC and Greta Thunberg, not exactly the team you’d pick for a convincing PR campaign. Videos of a Swedish high school student scolding the U.N. are a real turnoff to most people. Same with a wide-eyed former bartender warning that the world will end in 12 years. Then to top things off, President Trump decided to snub the Paris Climate Talks. That did not help. Putting all of that aside, what do the serious scientists have to say?

Multiple studies published in peer-reviewed scientific journals show that 97 percent or more of actively publishing climate scientists agree: Climate-warming trends over the past century are extremely likely due to human activities. (Caltech)

But the warming we’ve seen over the past few decades is too rapid to be linked to changes in Earth’s orbit and too large to be caused by solar activity.(Caltech)

Carbon dioxide from human activity is increasing more than 250 times faster than it did from natural sources after the last Ice Age. (Caltech)

In its Fifth Assessment Report, the Intergovernmental Panel on Climate Change (IPCC), a group of 1,300 independent scientific experts from countries all over the world under the auspices of the United Nations, concluded there’s a more than 95 percent probability that human activities over the past 50 years have warmed our planet.

But, wait a second.  The cost of discontinuing use of fossil fuels will be many trillions of dollars and will affect every household in the U.S.  If the science is so clear, why do only 97% of scientists agree and why do experts assign only a 95% probability that human activities are to blame?

Let’s examine the arguments made by the climate skeptics.  They say:

1. The changes in measured temperatures are part of the natural cycle. These skeptics are admitting that there is climate change, but not that it is caused on human activity. In response, climate scientists have gone to great lengths to develop methods that show how climate change rises above the natural signal (the so-called “fingerprinting” of climate change). Moreover, some of the more important natural cycles should be causing global cooling rather than warming at present.
2. Climate change and CO2 are good. Skeptics who take this line of argument are acknowledging that climate change is happening and that humans may be causing it. But, they extoll the virtues of climate change and are skeptical of potential negative impacts. For example, they claim that agriculture will benefit from higher temperatures, increased rainfall, expansion into northern latitudes, and the fertilization effect of CO2. Climate scientists, ecologists, and agronomists have shown that negative impacts far outweigh positive effects of climate change on agriculture. In fact, the weight of evidence suggests that negative impacts will swamp positive impacts in all sectors.
3. The scale of climate change is not sufficiently large to take action beyond sensible least-cost measures. This line of reasoning accepts that climate change is likely, that it is human-induced, and that most impacts are negative. Nonetheless, these skeptics do not believe that climate change will be as bad as mainstream science thinks it will be. A time goes by, however, observed climate changes are greater, and observed impacts are worse than originally projected by climate scientists. Although most experts agree that it is prudent to use least-cost measures when possible, they also agree that combating climate change cannot be cheap because the scope is so large.
4. The economic impact of making substantial cuts in greenhouse gas emissions on the scale suggested by the Intergovernmental Panel on Climate Change (IPCC) and other groups is too large. This final line of reasoning by skeptics accepts the conclusions of climate scientists, but says that society cannot afford to make the cuts needed to stave off the worst impacts of climate change. Numerous analyses, however, show that the ultimate cost of inaction or limited action to society will be far greater than the cost of robust responses to climate change and delaying action now necessitates more aggressive action in the future, which is likely to be more expensive.

In summary, the 97% of scientists who are climate change believers seem to provide credible counterarguments to those made by the 3% who are deniers.  However, recognizing that some scientists with Ph.D. degrees in climate science could analyze the data and come to a completely different conclusion should still be troubling. The problem is the complexity of the problem and the difficulty in forecasting its effects.

Skeptics say D.C. Braintrust Has Lights On, But Nobody Home
Some people are not “climate deniers” but would more accurately be called skeptics. Perhaps they are critical about how the transition from fossil fuels to green energy is being managed, (i.e., so far, not so good). The government apparently believes that limiting the supply of fossil fuels from U.S. sources and thereby causing higher prices will accelerate the adoption of renewable forms of energy. That may be true, but it’s a very clumsy and destructive way to promote the switch that will cost consumers and businesses multiple trillions of dollars in additional costs during the transition, enriching only the fossil fuel suppliers. So consumers and businesses are paying huge premiums for fuel while the federal government is passing multi-trillion dollar federal spending bills to promote green energy and in the process, triggering massive inflation. The same result could be accomplished in other less destructive ways. For example, why not keep fossil fuel prices low, apply an additional fuel tax and use the tax revenue to fund the transition? That would not be inflationary, would not wipe out savings and pension plans, or cause the stock market to crash. One gets the impression the government is not very smart or perhaps is corrupt and therefore anything they say should not be trusted.

This also provides fuel for other conspiracy theories. Aren’t the studies being done by climate scientists all funded by the federal government? University professors working on climate change grants have a perverse incentive to conclude that things are worse than they are. The bigger the threat, the greater the likelihood of follow-on grants. Likewise, government officials responsible for departments covering climate change have the same kind of incentive. Bigger problems lead to bigger budgets, more staffing, and possible promotions.

Skepticism may stem from doubt that science can accurately predict the results of rising temperatures. Perhaps the “climate industry” is manufacturing a crisis to encourage people and governments to change behavior or make investments faster. Or, maybe spokespeople are pitching climate change because they will benefit in some way. After all, Al Gore reportedly made over $100 million from his “An Inconvenient Truth” movie. Maybe relatives of D.C. politicians are heavily invested in alternative energy stocks.

Until the situation is managed better, the skepticism will likely continue.

Forecasting the Effects of Higher Global Temperatures or… Turn on the AC Please
The forecasts for climate change are categorized by average temperature increases of 1.5*C, 2.0*C, 2.5*C and 3.0*C. The accompanying figure shows that forecasts have been made for three scenarios – worst case, intermediate and best case – representing how well governments are able to reduce the upward temperature trajectory. Reading from the chart, we see that in the worst case scenario the average temperature is expected to rise by 1.5*C by 2027 and in the best case scenario not until 2032. Some scientists believe a temperature increase of 1.5*C will put low-lying island nations under water.

What do scientists have to say about how life will change in different areas around the planet? It’s not good:

Direct Effect of Higher Temperatures
In the next decade, heat waves in some parts of the world will make life unbearable. Tropical regions, the Middle East, India, Pakistan, Latin America, the southern regions of the U.S., and the eastern seaboard will all become less desirable locations because of the extreme heat.

This will reduce property values in these areas, cause a migration of people from these areas to cooler regions, and ironically, cause a spike in energy demand for air conditioning. If the trend continues, many regions of the world will be so hot as to be unlivable by the end of the decade.

Floods, Droughts, and Rising Ocean Levels
In some areas, the higher temperatures will cause the atmosphere to retain more water and then release the water causing cataclysmic floods. This will be the trend in the northeastern U.S. and the central parts of the continent.

Climate models forecast that northern California, Oregon, and Washington state will see less rainfall in the next decade. According to the models, over the next 30 years, the droughts will spread to southern California and Arizona, regions that have already experienced periodic droughts. What will happen to the Colorado River and the availability of water for consumption and irrigation? With this kind of uncertainty, one may want to think twice before investing in southern California real estate.

Cities like New Orleans and Miami that are at or close to sea level will be underwater by the end of the century. The U.S. will spend billions on flood walls and levies which will ultimately prove to be a waste of money. Island nations will be the first to be submerged, some even before the end of the decade.

Wildfires
California has already experienced massive wildfires but things will only get worse as temperatures rise. Over the next decade, more frequent fires will be experienced in Texas, Canada and parts of Mexico.

Crop Failure
Farmers like predictable weather. Either too much rain or too little is not good. Abnormal temperatures can also ruin a crop. Scientists predict that global warming will cause a third of the world’s food supply to be at risk. Famines and food shortages around the world will cause mass migrations, exacerbating the climate change problem.

The forecast sounds apocalyptic, but scientists warn that forecasting the effects of rapidly rising temperatures is not an exact science. There are many unknowns. For example, the effects may be non-linear. We may see change up to a point and then a leveling off. Or, change may take a upward hockey stick direction. No one knows for sure because such rapid temperature increases have never happened.

The Abatement Cost Curve
In 2009, McKinsey & Co., the strategy consulting firm, developed estimates of how much greenhouse gas emissions could be reduced by taking various steps globally and how much each step would cost in terms of Euros.   The result is an abatement cost curve shown here. 

On the vertical axis is Euros per billion tons of CO2 equivalents.  (A Euro is roughly equivalent to a US dollar.)

So, for example, looking at the left most bar we see the abatement cost to save one ton of C02 by switching from incandescent to LED lights is about 100 Euros per ton of CO2.  On the horizontal axis we see the amount of CO2 emissions that each action would save in terms of billion of tons of CO2 equivalents.  You can see that the bar for switching to LED lights is very narrow indicating that the emissions reduction is only slight.   Also note that the widest bars are related to switching to nuclear energy (which most countries probably will not do), adopting wind energy, and reforestation. 

What’s not clear is how deep the McKinsey analysis goes.  For example, when they measure the emissions reduction from switching from internal combustion to electric vehicles, do they consider greenhouse emissions related to mining required inputs (e.g., minerals for car batteries).  When the report was originally developed in 2007, this information was probably unknowable.   In fact, as if to correct this error, in 2021 McKinsey published another report which estimates the abatement cost for switching to electric vehicles considering the full supply chain effects.  

McKinsey concluded from their 2009 analysis that the cost to control greenhouse gas emissions globally would be about 800 billion euros upfront and an annual recurring cost of 200-350 billion euros by 2030, which is only about 1% of global GDP.  Although this number sounds quite doable, as already pointed out, the McKinsey analysis is flawed.

Unfortunately, the 2009 McKinsey analysis has been widely used by the U.N. and at the 2015 Paris Climate Accords.  A Google search yields no evidence that the curve has been updated since 2009.  Other consulting firms have jumped on the government funding bandwagon and produced their own estimates of the cost of emissions abatement.  For example, Deloitte estimates that inaction could cost the U.S. economy $14.5 Trillion over the next 50 years.  Surprising that anyone could be so precise (the .5) when estimating over 50 years.

One thing we do know is that this subject has become politicized.  For any consulting report, the most acceptable conclusion politically is that global warming must be mitigated as soon as possible, the cost of doing so is well within reach and the cost of doing nothing is unacceptable. 

Decision Analysis for the World – I’ll Take Door #1, Monty
As things stand, some countries like the U.S. are moving aggressively to reduce greenhouse gases and other countries are largely ignoring the threat of global warming or moving so slowly their efforts will have little effect.  Reports on China are mixed.  On the one hand, they are pushing the transition to electric vehicles but on the other, the country is still using coal as its primary power source. 

For purposes of our analysis let us assume that an individual global dictator could make a decision about climate change abatement for the entire world.  To make the analysis easier, let’s assume that the decision is binary – (Door #1) accept the hypothesis that global warming is an existential threat and take an aggressive path to reduce emissions, or (Door #2) accept the skeptics’ position and take only least cost measures. 

Assume that the cost of taking Door #1 over the next 15 years is $50 trillion worldwide. This includes the full supply chain costs and not just the costs to governments but also the costs to households and businesses. This is a huge number. By way of comparison, for the first nine months of 2022, the market capitalization of the U.S. stock market has declined by almost $10 trillion. Our estimate is much higher than McKinsey’s which does not include the full supply chain costs nor the full cost to households and businesses.

We estimate that the cost of taking Door #2 is $2-4 trillion. 

If the world takes Door #1 but their hypothesis is incorrect (i.e., global warming does not continue as predicted), the cost is $50 trillion.  In other words, the cost of being wrong is $50 trillion, a huge number. If the world takes Door #2 and is incorrect (i.e., global warming continues unabated) the cost to humanity is incalculable, probably many times more than $50 trillion. In either case, the cost of making the wrong decision is huge, almost unthinkable. 

If the decision were a simple binary choice, the world dictator would probably pick the less risky path.  Unfortunately, the situation is not that simple.  In a more realistic scenario, the decision is not binary and is not made by a single decision maker.  Each country will decide on a policy path and some countries like the U.S. and E.U. members will make every effort to reduce emissions while other countries will make only minimal efforts.  Unfortunately, this real-world, non-binary scenario may result in the worst possible outcome (worse than either Door #1 or Door #2) for the U.S. and perhaps the world overall.  In this scenario, the U.S. spends many trillions of dollars on climate abatement but its efforts are still not enough to halt the upward trajectory in global temperatures, ocean levels, and the intensity of tropical storms. It’s a double whammy.  We spend huge amounts of money on abatement but suffer almost as much as if we had spent nothing.

The bad news is this latter scenario appears to be most likely and this raises some interesting questions.  For example, is there any way to save the world from the worst scenario? Do I sound like Greta Thunberg? Would countries with limited coastlines like Russia and Germany fare better?  Or, would areas farther from the equator be less affected?  How would the balance of power in the world change? I’m not sure scientists know the answers to the first few questions (not even Greta) but we do have enough information to venture a wild guess about changes in the balance of power.

Implications for U.S. National Security and the Balance of World Power
To review, the U.S. appears to be moving aggressively to alternative renewable energy sources (wind and solar). Russia and China, our two main adversaries are moving more slowly. Russia is dependent on natural gas and oil as its largest sources of revenue and cheap energy supply. Given its economic situation, it will therefore be unlikely to move to solar or wind until absolutely necessary. China, although it will not reach peak greenhouse gas emissions until 2030, is investing heavily in renewable energy technology. China is trying to balance the move to renewables with the desire to continue on its fast economic growth trajectory. China’s move to green energy is motivated not so much by the desire to save humanity but more likely by the national security need to reduce energy dependence on suppliers in Russia, the Middle East, and the U.S. China is ever laser-focused on benefiting the homeland and generally very smart in the way they go about it.

Critics of the current U.S. energy strategy point out that it will result in a greater dependence on foreign supply of critical materials and components. As recently as 2020 the U.S. was in the enviable position of being energy independent based on its supply of fossil fuels. However, as the country moves from fossil fuels to green energy, it will become increasingly dependent on other countries, some of whom are adversaries, for critical supplies.

For example, today eight of the top ten solar panel manufacturers are located in China. Ten of the top fifteen wind turbine companies are also in China. The U.S. has a very small amount of lithium. China is a major source of this element required for EV batteries and possesses 60% of the processing capacity. Cobalt is another element required for EVs. The major sources of cobalt include the Democratic Republic of Congo (where China has established significant influence with the government), Cuba, and Russia.

Dependence on foreign countries for energy will give adversaries bargaining leverage not only in economic markets but also in world political negotiations. 

The move to green energy also results in a much greater reliance on the electrical grid to power not only heating/cooling/lighting/appliances but also transportation.  This will increase the potential cost of cyber or physical attacks on the grid.  In addition, as the oil and gas industry shifts away from fossil fuels, the question arises as to how this will affect the military readiness to defend the country or mount a military campaign, especially when potential adversaries are not shifting away from fossil fuels.  That’s not entirely clear.     

The message to the country from the Federal Government is to move full speed ahead to green energy and electrification.  However, as noted, this national strategy has some obvious pitfalls, especially with respect to the implications for national security. 

Conclusion
The summer of 2022 was one of the hottest on record in New Jersey and along the eastern seaboard. That was the nudge I needed to learn more about climate change. I suspect higher temperatures, along with the accompanying changes in rainfall and water availability will cause regional changes in property values and migrations to northern states. From a personal investing standpoint, the question is ‘when’. Alaska may well be the next retirement haven.

References

Causes | Facts – Climate Change: Vital Signs of the Planet (nasa.gov)
Basics of Climate Change | US EPA
What Is the Evidence that Human-Caused Climate Change is Happening? | Caltech Science Exchange
Deloitte Report: Inaction on Climate Change Could Cost the US Economy $14.5 Trillion by 2070 – Press release | Deloitte US
A cost curve for greenhouse gas reduction | McKinsey
How much will it cost to mitigate climate change? – Our World in Data
Beating the abatement cost curve for growth | McKinsey
U.S. Natural Gas Prices (eia.gov)
US natural gas prices spike to 14-year high. Here’s why – CNN
Frequently Asked Questions (FAQs) – U.S. Energy Information Administration (EIA)
The Case For Pivoting Into Renewable Energy (forbes.com)
The Business Case for Renewables: Obstacles and Opportunities – The One Brief
On the Business Case for Renewables (and Why It’s so Strong) – Union of Concerned Scientists (ucsusa.org)
Climate change could cost U.S. $2 trillion a year by 2100: White House (cnbc.com)
China’s Energy Strategy to 2030
China’s Daring Energy Strategy
American Institute of Physicists Forecast
The Climate Disaster Is Here – The Guardian

Remember when Bill Clinton was President and he placed a sign on his desk that read “it’s the economy, stupid”? He was right. It is all about the economy. Jobs, standard of living, a greater distribution of income, discretionary purchases, moving up, the American Dream, investment in new technology, foreign aid to poor countries…they all depend on the economy.

Unfortunately, today our economy appears to be headed for a recession and double-digit inflation and that is causing investors to panic and dump stocks. What’s driving this bad economy? Understanding may be helpful in devising an investment strategy.

1. At the top of the list is the price of energy. Energy prices contribute to just about everything else: transportation cost, heating, air conditioning, manufacturing, product inputs. Sanctions on Russia have reduced the worldwide supply of oil and gas, but the price of oil was over $100/barrel even before Russia invaded Ukraine. Part of the blame lies with the COVID virus, if one can blame a virus. The downturn in energy demand during the pandemic caused suppliers, including OPEC, to reduce production. Then, when the economy started picking up, we found ourselves with a supply shortage. Oil companies have started drilling new wells, but it takes time before new supply comes online.
   
   Another factor may be naive climate-change thinking: the idea that if we just make fossil fuel extremely expensive, that will accelerate the use of renewables. The idea is basically correct but making fossil fuels too expensive too fast could destroy the economy in the process, a fact that is overlooked by some zealots. It’s also not possible for consumers, businesses and governments to instantly switch to more renewables even if that were their greatest wish. The transition will take some time because of the availability and economics of the new technology and the embedded investment in existing infrastructure.
   
   Climate change concern has also influenced government policy. Stopping construction of the new Keystone pipeline, although it may not have affected energy prices in the U.S., was of symbolic importance. It signaled that the government was going to play hardball with fossil fuels. Same with the moratorium on drilling on Federal land. It may have had no effect on the spot price or futures market today, but it sent a message to the industry.
   
   Energy execs who testified before Congress said that clean energy sentiment in government has affected their willingness to risk new exploration. After all, exploration and drilling are expensive. Why would an oil company exec spend millions on a new well if they thought the government might place new regulations on it? At the very least, they’d be less likely to take a risk.
   
   Energy prices are expected to come down, but only after much more supply is available. OPEC members have not been willing to increase production much. We probably need to wait for U.S. and Canadian production to ramp up, which will take a while.
   
   
2. Next on the list would have to be our economic policy. Two aspects of our policy are inflationary: government spending and Federal Reserve actions.
   
   Deficit spending is inflationary and the greater the deficit, the greater the inflationary stimulus. In fiscal year 2021 the federal deficit was $2.8 trillion and in the prior fiscal year over $3 trillion. These deficits, caused by COVID and infrastructure spending programs and the downturn in tax receipts, are the highest ever.
   
   Both parties can be blamed for the deficits. They started under Trump and continued after Biden took office. Much of the spending was to help small businesses and households during COVID, but as usual the politicians loaded lots of pork onto each of the spending bills.
   
   We could conclude that our lawmakers have been irresponsible, but in their defense, COVID seemed to be very threatening at the time. What’s inexcusable now that COVID seems to have passed and the economy is in trouble, is to continue with more inflationary spending as some lawmakers continue to push.
   
   The Federal Reserve, whose charter is to control inflation, has also contributed to the current mess. The Fed has kept interest rates near zero, which stimulates business borrowing but hurts fixed income investors. They’ve also maintained a balance sheet of $9 trillion. That means they’ve purchased (and not yet sold) $9 trillion in government and non-government bonds and securities. These purchases stimulate the economy and are inflationary. By comparison, the U.S. GDP is about $21 trillion and the total U.S. debt is about $22 trillion, so the Fed balance sheet is very significant (huge).
   
   As a result of the current inflation, Chairman Powell (head of the Federal Reserve) said that the Fed will reduce its balance sheet by $3 trillion. In other words, they are going to sell $3 trillion in bonds and put that money out of circulation. That, of course, will have a highly contractionary effect on the economy. No wonder the stock market is crashing.
   
   The Fed also plans to raise the federal fund rate by a percentage point in half point increments over the next two months. This will cause all interest rates to rise and existing bond prices to decline. So, bond holders should take note.
   
   
3. A distant third place is the supply chain. COVID has caused supply shortages because of reduced production (e.g., in China) and delayed delivery (e.g., cargo ships lined up at U.S. ports). Both have contributed to higher prices.
   
   Also, Russia and Ukraine supply much of the world’s wheat and corn. This supply has been reduced by the war and sanctions against Russia.
   
   The commodities that are now in short supply could be good investments, at least in the short run.
   
   
4. The feedback from a lower stock market will also be a factor. When the stock market is booming, people feel rich and tend to spend more money. When it’s crashing, households tend to hunker down and tighten the purse strings. So, in either direction, there can be a spiral effect – recession expectation leading to lower stock market leading to contracting economy and so on.
   
   The stock market also has an effect on businesses. A dropping stock market tends to reduce the number of IPOs and also the amount of venture capital funding of start-ups. Moreover, lower stock prices and higher interest rates are the worst possible combination for financing business expansion.
   
   
5. Then, there’s the effect of higher wages. Somehow there’s a labor shortage in the U.S. It’s hard to understand exactly how that happened. Some say workers dropped out of the labor pool during COVID and never returned. In any event, the shortage has caused employers to raise wages hoping to attract workers. Higher wages lead to higher prices. Economists say that wages tend to be ratcheted upward, meaning they can go up but not down.
   
   

Those are the main factors that have contributed to our current economic situation. There may be other less significant contributors.

The economy affects the outlook for stocks, so understanding the factors contributing to the current economic situation may be helpful for investors.

What are investors to do in this situation? Here are a few possible basic strategies:

A. As Jim Cramer would say “sell, sell, sell”. You can sell now if you think the market will sink further. This would at least save you from further trauma. To minimize the damage, you can hope to sell on a day when the market rebounds from a relief rally. Of course, lots of people have the same idea, so that may not work.

A component of this strategy is to generate cash now and buy back when the market has reached a bottom and the economy is on the mend. The challenge is knowing when to buy back and distinguishing market head fakes from real changes in direction. This can be tricky. But, in general, selling now is not a completely irrational strategy. Obviously selling a few months ago would have been much better but that’s water under the bridge, over the dam or pick your favorite saying.

Long-term investors could also take advantage of the current depressed market to make small investments in alternative energy or other tech investments. Some may be good long-term bets at these prices and buying in some increments is better than all at once.

Of course, if the market rebounds much sooner than expected, you could end up with seller’s remorse. Everyone needs to be their own forecaster. The good news is that historically, the market tends to drop faster than it rebounds, so you may be given some early warning signs.

B. As every student learns in Investment 101, Diversify your investments. Normally this means spreading your money between stocks, bonds, and cash, but today bonds are paying very little and interest rates appear to be headed up, so (based on the information available today) investing in bonds seems a bad strategy. Even holding bond funds is probably not smart. Diversifying could mean selling your tech stocks and investing more in real estate, oil, natural gas, gold, dividend generators or particular stocks that will weather a stagflation environment the best. This seems like a reasonable thing to do. See chart below.

I would also want to keep some cash on the sidelines not only to invest in stocks when the market appears to turn, (see strategy A above), but also to invest in some bonds when interest rates have peaked.

C. Ride out the storm. Some of my friends have hired financial advisors to manage their money. The advisors charge .5 to 1% per year. I’m too cheap to do that and I don’t trust most advisors, but I ask my friends what their advisors are saying.

Based on the small sample size of my survey, professional financial advisors are telling their clients to stay the course.

Let’s examine the “stay the course” strategy a little. Like any investment strategy, there are pros and cons. One of the arguments against this strategy that sticks in my mind comes from my experience in year 2000. At that time, I was heavily invested in tech stocks and we all know what happened to tech stocks. I admit to being confused at the time. I thought tech stocks would recover. It was wishful thinking. I sold some, kept others and watched my portfolio tank. It took almost 10 years to recover. At age 50, while you’re still working, that ‘s not so bad although it was painful at the time. At age 70, when you’re mostly retired, it’s a riskier strategy.

On the other hand, our economists and Federal Reserve managers now have the experience of the 2000 and 2008 market collapses under their belts. Maybe they now know how to deal with this economy better. I have little confidence that this is true, but thought I would throw it out there.

Let’s also consider that we’ve just been through a 13-year bull market, the longest in history. Stock market performance following long bull markets in the past has not been good. Long bull markets are usually followed by periods of subpar performance. Of course, this information is of value only if one knows they’ve entered a bear market, a market that will perform poorly for an extended period. Otherwise, they could be experiencing a bull market correction, a market that will rebound within a quarter or two. Let’s assume for the sake of argument that we are now in a bear market. In that case, we should expect that a ‘stay the course’ strategy will lead to low equity returns for at least a few years and maybe longer.

We can also consider data showing the historical relationship between economic conditions and stock market performance. We need to do some amateur forecasting, but let’s assume we are headed to a period of stagflation. In that case, at least based on history, the best investments may be in gold and commodities. Nothing guarantees history will repeat itself, but we know that Wall Street investors at Goldman Sachs, Morgan Stanley, etc. are looking at the same data and trying to make good investment decisions for their firms or firm’s clients. So, if we are headed for stagflation or if we can assume that Goldman Sachs thinks we’re headed for stagflation, then this chart is of some value and should nudge us at least a little toward commodities (oil, gas, minerals, some foods, necessities) and precious metals.

A corollary to the Ride out the Storm approach is to generate income by trading options (puts and calls). That’s what I have been doing. Over the past two weeks it has felt like trying to extinguish a forest fire with a squirt gun, but I think it will be a helpful component of any of the above strategies.

Conclusion. Perhaps the best strategy would be some combination of A, B, and C. As your financial advisor would say “it depends on your risk tolerance” and other factors like whether you are depending on your nest egg for living expenses.

To be continued. Take with a truckload of salt and use at your own risk.

A Street With Character With a Few Characters

It was a street lined with multi-unit dwellings in a working-class section of Amsterdam, New York.  Back in the 1950s we would have called the houses two-family, three-family or four-families.   The street had them all.  In length it covered a rather short distance.  From Betz’s Funeral Home on the corner of Guy Park Avenue up the steep hill to Boice’s home at the corner of Major Lane, there were only about 20 houses. You wouldn’t exactly call the street treelined.  Front yards separating each house from the sidewalk were tiny, leaving little space for trees. Sidewalks ran on each side and because driveways and garages were in short supply, cars parked on both sides, wherever an available space could be found.  Jackson Street would not have won any House Beautiful awards, but it had character, or maybe it would be more accurate to say that there were a few characters who lived on the street. 

My Grandparents
I guess I’d have to admit that my grandparents, George and Ada Mae, were two of the many characters.  They had lived in the house at 13 Jackson St. for many years and had raised five children, one of whom was my mother.  George was a retired policeman who started a painting business after he retired.  He had run for Alderman, but, although everyone seemed to like George, he lost the election.   As it turned out, the painting business was his undoing.  He had a habit of cleaning the paint brushes in a solution that contained benzene and, according to the doctors at Albany Medical Center, that’s how he developed a blood cancer many years later.

Both George and Ada were nice people.  They helped the neighbors, looked after the kids on the street and during the Great Depression of the ‘30s they fed and sheltered homeless people on their back porch.  In fact, to this day, I think George may be the nicest man I’ve ever met.

George was of German descent.  Both of his parents were born in the U.S. but his grandparents immigrated to the U.S. in the 1870s-1880s.  Still, he knew some of the German language and used to speak German to the two dachshunds in the house and sometimes to his grandkids when they visited.  Although he had never been to Germany, he still liked strong mustard, awful-smelling cheese, blutwurst, and other foods from the old country.

George used to tell stories about being a cop.  He and his fellow patrolmen often needed to deal with unruly patrons at the local bars.  The rules governing cop behavior were not so well-defined as they are today.  Jokingly, he said some men with really thick skulls were unphased by blows with the nightstick.  His stories of barroom brawls between the Irish, Italian and Polish immigrants in the city in the 1920s and 30s kept his grandchildren, at least the boys, quite fascinated.

My grandmother was born Ada Mae Duncan, a Scottish name.  Her mother, Ellen Kindon, had immigrated from England around 1890 and married a Scotsman she met in the new world.  Maurice Duncan owned a silk mill in the east end of the city but died of a heart attack when a fire destroyed the mill.  From old pictures, I see that my grandmother was pretty when she was young, but the years and the rearing of five children had taken a toll.  Growing up with British parents, Ada Mae’s life seemed to revolve around tea.  When anyone visited, her first question would be “Would you like a cup of tea?”  By the time I knew her she had been transformed into a somewhat chubby woman of about five feet in stature, perhaps at least partly due to the pastries and cookies that were always available to accompany the tea.  Still, she was an Aunt Bea-like prototype for a grandmother: jolly and kind, especially to her grandchildren. 

My grandparents lived on the first floor of a two-story house.  The upper floor was divided into two apartments.  My parents, my sister and I lived in one of the apartments and my uncle, aunt and cousin George lived in the other.  On the right side of the house was a driveway with a one-car garage at the end.  The garage was always full of my grandfather’s tools, painting ladders and other equipment.  The tools were moved in the winter so my grandfather’s blue Plymouth would fit in the garage.

The basement of the house was dark and cold. The wooden stairs leading to the basement creaked and were probably much too steep to meet building code standards today. At the bottom of the stairs was what would be considered a symbol of climate change apostasy today: about a half ton of coal piled in a coalbin and a coal-burning furnace. The coal was delivered through a window in the basement that opened to accommodate a chute from a coal delivery truck that parked in the driveway. Periodically my grandfather would make his way down the basement stairs to shovel coal into the furnace, stoke the fire or remove the old ashes, sometimes allowing one of the grandkids to accompany him. Many houses were heated with coal in the 1950s, but the furnaces were much larger than oil and natural gas units which required less attention from the homeowner and would become more popular in the next decade.

In the back of the house was a small yard and my grandfather’s chicken coop, complete with a rooster.  In the 1950s city residents were allowed to own chickens and to keep chicken coops.  My grandfather walked out to the coop every day to collect the eggs.  Sometimes he let the grandkids go with him, which was quite a thrill for a five-year old.  Scientists say that roosters crow to establish their territory or as a mating call, but our rooster had no competition and a harem of hens and nonetheless, he still crowed every morning.  Although I never knew for sure, I suspect that the rooster may have irritated some of the neighbors.  Adjoining my grandfather’s backyard was the backyard of a house on Brandt Place, the street that ran parallel and just east of Jackson.  When I got a little older, one of the kids who lived in the house on Brandt Place always wanted to fight me and I never knew why.  Years later the thought came to me that it may have had something to do with long-held bad feelings his family harbored about the rooster.   Guess I’ll never know.  The ‘kid’ from Brandt Place passed away many years ago, tragically choking to death in a restaurant.  Or, I guess technically, dying of asphyxiation.   

We lived on Jackson Street until my twin sister, Daryl and I were almost six years old.  We both attended kindergarten classes at West Spring Street School.  Our teacher, Mrs. Mau, was a taciturn old lady who had taught there for many years.  I think she probably taught my mother.  I don’t remember much about kindergarten, only that the cloak room was in the back and Mrs. Mau once slapped my hand and told me “No one plays the piano but Mrs. Mau”. 

In 1957, when we were almost six, my grandfather on my father’s side was transferred to Mexico City to help start a new carpet mill.  That was the beginning of corporate migration for cheaper foreign labor.  My grandfather Stahl offered to let us live in his house on Lily Street while he and my grandmother were in Mexico.  Lily St. was a few blocks away in a neighborhood where almost all of the houses were single family and had bigger yards, driveways and garages.  Unlike Jackson St. that always seemed to have kids in the street looking for fun, there were fewer kids around on Lily St.  My sister and I had to go looking for other kids on the neighboring streets.

Although we moved when I was young, I still remember Jackson Street because it was a fun place to live, at least partly because of families like the Redmonds.

The Redmonds
At 15 Jackson St., a little up the hill from us, lived the Redmonds.  The Redmonds had three kids – 2 girls, Bonnie and Paula, and a boy, Roger.  I think they had two other kids after we moved, but I never met them. Roger was a friend of the same age. As I remember, he was always outside looking for something to do.  That was good because I was too. Mrs. Redmond was a nurse and she once helped me when I had fallen head-first into a basement window well, striking my head and opening a deep gash.  Mrs. Redmond dressed the cut and advised my mother to keep me awake that night, so I remember sitting up for most of the night. 

Like some kids, Roger reserved much of his growing for his late teen years.  After high school he joined the Marines and grew about six inches, transforming himself into an impressive- looking specimen in his uniform.  In his later years he grew a prodigious beard and became an adventurous outdoorsman. Roger was very friendly and a good guy to have as a next-door neighbor.  Although I lost touch with him after I moved from Jackson, he stayed close to my cousin George even in high school.  I remember on one occasion in my high school years I was walking on Market Hill when a VW bug pulled up and offered me a ride.  It was my cousin George with Roger riding in the front passenger seat.  The two of them had been cruising around on this Saturday night, smoking menthol cigarettes and looking for something to do. 

I was sad to hear that Roger had passed away last year.  Although we had been out of touch for over 50 years, he was such a good soul I would have enjoyed reconnecting with him.  Perhaps in the next life.

The Four Family
On the other side of our house at 11 Jackson was a large four-family. 

In one of the four apartments lived the Bottomley family.  I did not really know them but they had an appropriate name for that neighborhood.  Although the families on the street were not at the very bottom of the economic ladder, we were pretty close.   Funny but at that young age kids were mostly unaware of their family’s economic status.  We were happy just to have a pair of sneakers and a ball to play catch.  Money was not an issue until we grew older and wanted more stuff that the richer kids had.

The most famous occupant of the four-family and most famous resident of the street no doubt was Dusty Miller (aka Elmer Rossi).   With his band, the Colorado Wranglers, Dusty played country music in local bars on weekends.  I’m betting that neither Dusty nor any member of his band had ever been to Colorado, but it was a good name.  Everyone in the neighborhood could tell when he had a gig because he would leave the house wearing a cowboy hat and carrying his guitar.  Yeeha!  Somehow his small stature and slight frame did not seem cowboy-like.  More like cowboy lite.

Dusty owned a vicious chihuahua that terrorized the kids in the neighborhood when allowed to run unleashed. Jackson Street had a large dog population. Besides Dusty’s chihuahua, old Mrs. Boice, who lived upstairs from Dusty had a three-legged dog named Twinkles. Mrs. Boice spent most days sitting on her second-story porch chain smoking cigarettes, petting Twinkles and watching people on the street. My Uncle Dunk had a Doberman named Blitzen and my grandfather owned the two aforementioned Dachshunds, Fritz and Hans. In those days, there were no leash laws. Dogs could run loose, but Fritz and Hans were housedogs. They’d surely get beaten up by the bigger neighborhood dogs if allowed to run unleashed. Same with Twinkles.

Next to the four-family lived another Italian family, the Izzos, in a single-family house.  Today the Izzo house has been transformed into a jerk chicken takeout restaurant.   

A couple doors down the street was a two-family house where Tony Dargush and his cousins, Charlie and Jimmy Kristie lived.  They were a year or two older than me.   After high school, Tony played basketball at SUNY Plattsburgh and came back to Amsterdam where he worked for the U.S. Postal Service.  An unconfirmed rumor on the street was that Charlie took steps to avoid being drafted into the military after high school.  That was the time when many 18-year-olds were being drafted and sent to Vietnam.  A few years later, Charlie had returned from Canada or wherever he had been and both Charlie and his brother Jimmy attended SUNY Oneonta along with Tim Selby who lived on Bayard St., the street that was just west of Jackson.  I never heard what Charlie or Jimmy did after college, but Tim Selby became a high school teacher and coach and passed away a few years ago. 

Juergen and Claudia’s and the Houses Down the Street
Across the street lived a family that had immigrated from Germany.  The mother spoke with a heavy accent.  She had two kids, Juergen and Claudia.   Poor Juergen was confined to a wheelchair.  He had been disabled from polio or muscular dystrophy, I don’t remember which.   I felt sorry for him.  As I remember, Claudia was pretty and kind of feisty.

In the same house as Juergen and Claudia lived the Beauchamps.   They had two kids, Alex and his younger sister.  Both were about my age, but I don’t remember seeing them much.

The house was owned by an old guy named Pop.  I don’t know Pop’s real name.  I don’t think anyone knew his name because no one talked to him.  He always seemed a little angry.  Pop spent much of his time in his pigeon coop in the backyard.   Some of the men who raised pigeons used to enter them in races, but I’m not sure what Pop did with his.   

In another house lived the Countermines.  They owned a bait, tackle and boat launch business on Mussel’s Harbor at Great Sacandaga Lake.  Their granddaughter, Michelle Pisarzyck used to visit frequently with her cat.  She and my sister were good friends. 

Next to them, at 16 Jackson, lived the Abballe family in a single-family house.   Tommy Abballe was a few years older and didn’t pay any attention to kids my age. The Abballe house was most famous for a murder that took place there in 1937. William G. Serviss, 45, had killed his elderly aunt Mary Enders, 81, in a dispute over money. Murder on Jackson Street

Down the street lived Danny Palmieri, who was about my age, and would sometimes come up the street to hang out with kids around us.  He was always welcome in our yard.  I think he lived in the same house as his cousins, the Ingalls.  My mother told me to stay away from Spike Ingalls.  He was a couple years older and Mrs. Redmond said he was a tough guy who would beat-up smaller kids.  The name Spike alone was enough to scare other kids.   

At the bottom of Jackson, on the corner of Jackson and Guy Park, was the Betz Funeral Home.  The funerals of my parents and grandparents were handled by Betz.  Mr. Betz knew our family well. 

The Local Candy and Grocery Stores
Around the corner from the Betz’s was Patterson’s Candy Store.  It was a tiny shop that looked like someone had converted their garage into a candy store.  Kids used to go there for penny candy and popsicles.  Across Guy Park was Butterfield’s, which was a small grocery store.  Today we’d call it a convenience store.  There was no parking for Patterson’s or Butterfield’s.  Customers lived in the neighborhood and walked there. 

To get a major order of groceries, other than just a few items, people in the neighborhood walked a few blocks west on Guy Park to the Grand Union.  It was a bigger grocery store with a parking lot.  Later, in the 1970s, it would be converted to an Off-Track Betting parlor.  My mother used to take my sister and me to Grand Union to go shopping.  I remember on one occasion when I was about 3 or 4 years old I asked my mother to buy me a pair of scissors for cutting out paper figures.  She refused and I put up a fuss.  Later after we had walked home I snuck out of our apartment and walked back to Grand Union to take the scissors.  When my mother realized I was gone she came looking for me and found me on my way home with the scissors. Of course, she made me bring them back to the store, but I remember she thought it was funny that I would want the scissors that badly.

The best candy store in the neighborhood was Hill’s, which was west on Guy Park and across the street from West Spring Street School.  Hills sold all of the normal penny candy and popsicles and fudgesicles but they also sold homemade candy.   My uncle especially liked their chocolate spiders.  Hill’s version of the recipe consisted of chocolates with shredded coconut that stuck out on the sides and looked like legs.

Sixty-Five to Seventy Years Later
Most of my memories are from the mid to late 1950s, but in 2022 things have changed.  My grandparents and parents have passed away.  My uncle, aunt and cousin George are gone.  George was only one year older than me, but he died while travelling Europe with his family a few years ago.  Roger and his sister Bonnie are gone. Juergen died in his late teen years and his sister Claudia, just a few years ago.    

Dusty Miller and the Bottomleys are gone. 

The survivors include the Kristie brothers (according to Google, one in California and the other in Connecticut), Tony Dargush (who lives near Amsterdam), Paula Redmond Sumigray (who also lives near Amsterdam), Danny Palmieri (who lives in Rochester) and Michelle Pisarzyck (who lives near the Great Sacandaga Lake).   And, my sister who lives in Arizona and me in New Jersey. 

The Betz Funeral Home is still at the corner, and it has expanded.  The Izzo’s house is now the Spice Island Caribbean takeout restaurant.   Patterson’s, Butterfield’s, and Hill’s are long gone.  West Spring Street School where we attended kindergarten was knocked down and replaced with a dental office many years ago. 

Someday Jackson Street may return to its former prominence but sadly without George, Ada Mae, Dusty Miller, Pop, Mrs. Boice, Twinkles or the rest of the old characters.  

Endnote: Thank you to Paula Redmond Sumigray and Danny Palmieri for helping me recall many of the details about Jackson Street in the 1950s and for supplying old photos and tips on finding former Jackson Street residents on Facebook.

Russia has now invaded Ukraine.  Soldiers and civilians have been killed and the human toll is not yet calculable. 

President Zelensky of Ukraine, a former stand-up comedian who turned to politics, has done an impressive job acting as the commander-in-chief during the crisis. The U.S. offered to provide transportation to evacuate Zelensky from Ukraine and in response Zelensky said, “I need ammunition, not a ride.” Bravo! Comedian Jon Stewart, impressed with Zelensky, said “We’re seeing the transformation of Shecky Green into Winston Churchill.” Of course, Zelensky never played the Catskills nor does he smoke cigars or have a pet bulldog, so the analogy has some imperfections. Let’s hope Zelensky hangs tough and Ukraine can hold off Russia.

Meantime, the invasion has affected U.S. and financial markets around the world.  Today, (Feb. 24) the DJIA was down over 500 points at noon but bounced back to end the day in the black.  There’s almost always a tendency to overreact to bad news, so we should expect more volatility.  Beyond that, this is a good time to think about what measurable effect the Russia invasion of Ukraine will have on U.S. markets.

* Assuming Russia stops in Ukraine and does not invade other countries, the effect will be felt most directly in energy markets.  Europe depends on Russia for oil and natural gas.  The U.S., which has cut back on drilling, also imports oil from Russia.  When the U.S. and Europe stop imports of Russian oil and natural gas, energy prices will increase.  The current price of West Texas Crude is $100+/barrel after hitting a low of about $17/barrel in April 2020.  Futures investors think WT crude will drop to $90 by July.

* Oil and natural gas account for 60% of the Russian GDP, but Russia may be able to continue exporting to China and other countries that don’t participate in sanctions.   With rising prices in the world market, Russia may not feel much pain from the U.S. and EU sanctions. 

* Frackers in Canada and the U.S. have already started reopening old wells and expanding exploration for new sources of oil and gas.  In general, fracking is profitable when the price of oil is $60/barrel or more.   New supply from frackers will bring down oil prices, but it will take a while (maybe 6-9 months?) for this supply to become available.

* All businesses use energy, so higher energy prices will contribute to more inflation and/or reduced business earnings. Lower earnings will tend to depress stock prices, so the market may be in correction mode until the full effect becomes clearer or more oil and gas becomes available. 

* Households will feel a budget pinch from the higher cost of gas at the pump and the cost of heating and cooling homes.   This will tend to reduce consumer discretionary spending which will affect businesses and possibly employment levels.

*Bottom line, from the Russia-Ukraine situation we can expect more price inflation, reduced consumer spending and possibly higher unemployment …trending toward 1970s stagflation.

*However, that’s assuming Russia is not able to successfully mount cyberattacks on important U.S. networks like the power grids, financial or government networks. Putin said that he would respond to economic sanctions “tit-for-tat”, yet he has no economic levers of any consequence. What he does have is some very good cyber hackers who could do great damage to the U.S. via ransomware attacks or simply by destroying data.

As negative as the Ukraine invasion may be, the U.S. would be hurt much more if China now decides to invade or annex Taiwan.   Taiwan is the world’s largest manufacturer of computer chips.  If this supply were cut off, the effect on the U.S. economy would be severe. 

What would the U.S. do in response to an attack on Taiwan?  Many of our products are manufactured in China as are many of the components used in our technical products.  A military conflict or a trade war in which imports from China were stopped would be an economic catastrophe for American business. Many U.S. companies with no alternate source of supply would have to cease operations, leading to unemployment and losses for equity holders. Not a pretty picture.

On PBS today, a China expert reasoned that China would never risk a war over Taiwan.  He argued that China would much prefer to annex Taiwan peacefully through a political process.  He explained that China already has support within Taiwan’s political hierarchy. 

In a Forbes magazine column, a computer industry analyst argued that the main reason China wants Taiwan is for the chip manufacturing plants.  He explained that because of the complexity of semiconductor fabrication, the chip plants require the expertise and experience of the Taiwanese workers.  China could not operate the plants without the help of the current Taiwanese companies and personnel.   Because of this, he reasoned, China will not take Taiwan by force.  

Taking the other side of the debate, a few commentators on CNBC and elsewhere have argued that an invasion of Taiwan is now almost a certainty. 

We’ll see who is correct.

Xi Jinping’s stated objective is for China to be the predominant economic superpower in the world.  The U.S. has helped China’s economy grow over the past 30 years but lately the U.S. government has become more suspicious of China.  Both the Trump and Biden administrations have expressed a desire to reduce U.S. dependence by moving manufacturing out of China or at least diversifying sources of supply. 

At present, China has the U.S. over a barrel, but that won’t be forever. This may be JinPing’s last chance to exercise China’s significant leverage. 

In a full-scale cold war with the U.S., China would lose its biggest customer, but would gain Taiwan’s semiconductor industry. China may suffer higher unemployment for a time, but JinPing and the CCP have the luxury of being able to take a longer view.  They may not care so much about short-term consequences.  Unlike politicians in the U.S., Jinping doesn’t have to worry about being voted out of office.   

Also, recently JinPing and the CCP have taken a more anti-business position, attempting to reduce the power of large Chinese companies even at the expense of economic growth. This may provide a clue regarding their future policies.  

Let’s assume that China does invade Taiwan and the U.S. decides not to take military action, but to employ only economic sanctions. China would then respond in kind.

What weapons would each side employ? China would nationalize U.S. manufacturing assets in the country.  The U.S. would take possession of Chinese assets in the U.S., but most of these assets are real estate or financial related, not manufacturing or technology. China could sell its considerable holdings of U.S. Treasuries and terminate future purchases.  China may also sell its large reserve of dollars and stop use of the dollar as its reserve currency.   The CCP has stated that the Renminbi should be the world’s reserve currency.

U.S. equity markets would crash, wiping out savings for many individual investors and producing losses for institutional investors. This would have ripple effects on consumer spending and pension fund solvency.  The dollar would lose value and the Federal budget would be pushed to the breaking point.  The Federal Reserve would need to purchase the Treasuries that China sells and pick up any shortfalls in future Treasury auctions.

So, both sides would suffer economically with higher unemployment, business failures, stock market losses, and national budget issues, but because the CCP takes a long view and doesn’t care as much about short-term consequences, China could win an all-out economic sanctions war.   In the end, the U.S. would weakly acquiesce to an invasion of Taiwan.

If I’m right, it may be a good time to hedge on the possibility of a sanctions war with China.

In a recent interview, Jeremy Siegal, Ph.D., Professor of Finance at Wharton School of Business, said he thinks the market will continue on its historic uptrend during 2022 but at a slower pace than in recent years. Professor Siegel has been a market watcher since the 1970s. Many would call him a permabull, meaning his market outlook is always optimistic.

Other market analysts have different opinions. In fact, the forecasts range from a continuation of the historic uptrend on the bullish side to a cataclysmic market crash like the one in 2000 or maybe worse on the bearish side.

One of the bears, Greg Diamond, a Certified Market Technician, foresees a massive drop in markets that will wipe out pension funds and individual retirement accounts. Market technicians like Greg, look for patterns in stock price movements to make predictions. For example, if a stock peaks but then retreats only to peak a second time, if the second peak is lower than the first, technicians see that as a bad sign. Greg thinks the market will crash on February 11. It’s usually not a good idea for analysts to make such specific predictions. It’s like those prophets who forecast the end of the world in a particular year or, worse yet, on a specific day. Better for predictions to be a little vague, especially when they involve a market crash or the end of the world.

Greg’s prediction is based on market performance to date. Thus far, 2022 has not been kind to investors, especially tech investors. The NASDAQ is down 8% YTD (as of January 18). High-flying stocks like Tesla, NVIDIA, Google and the other FAANGs are doing especially poor. Even the stylish alternative energy and electric vehicle funds have fallen. All investors are wondering what’s causing the bearishness.

One of the contributing factors is inflation. Last week the front page of the WSJ featured a story on inflation. In December the CPI increased at an annualized rate of over 7%. Some CPI categories were up over double digits: household energy (11.6%), new vehicles (11.8%), meats, poultry, fish and eggs (12.5%). Those numbers are enough to make anxiety-prone retirees hide under their beds, but unfortunately the group affected the most is lower income people. Poor people need to buy eggs, gas for their cars and fuel to heat their homes. These kinds of price increases have got to hurt.

The Federal Reserve under the leadership of Jerome Powell has the mandate to control inflation or more accurately to find a sweet spot between inflation and unemployment. Generally during times of high inflation, unemployment is at its lowest because the economy is growing rapidly. And, conversely, when inflation is low, unemployment tends to be high. A goldilocks solution is to keep inflation below 2% and unemployment below 5%. During the 1970s stagflation period, inflation and unemployment were both very high. That period gets the booby prize for the worst managed economy during the later half of the 20th century, at least in the U.S.

During his last update, Chairman Powell said that the Fed would take measures to reduce inflation. The Fed will reduce its purchases of bonds and, at the same time, goose the Fed Funds rate to cause interest rates to increase. For the past few years, actually since 2008, the Fed’s accomodative policies have boosted the stock market. With interest rates at near zero, bonds were not competing for investors’ money, borrowing was cheap and the Fed’s money creation policies fueled the economy and security markets.

Shortly after Powell’s remarks, Mr. Market, the name sometimes given to the collective market, threw a hissy fit, dropping by triple digits day after day. To rub salt in Mr. Market’s wounds, Powell noted that the current inflation is probably not transitory as some analysts had hoped. The current labor shortage will cause wages to continue to increase and the massive federal spending related to COVID, infrastructure and social programs is gasoline on the fire.

What’s an investor to do with fixed income investments yielding close to zero and the stock market at an historic high and showing signs of weakness? Most financial advisors will tell their clients to sit tight, make sure their portfolios are diversified and ride out the storm. Those that are more action oriented will recommend trimming holdings perhaps by selling more volatile stocks in the portfolio. In fact, many investors are already doing that. There’s been a shift from NASDAQ stocks to stodgier dividend stocks. Analysts call this a market rotation.

Historically does sitting tight during bear markets work? Usually it does. During the most recent 20% drops in the market doing nothing was not a bad strategy. Of course, if you could have timed and sold at the peak and bought at the bottom, you would have done much better, but no one can really identify peaks and troughs with much accuracy. The exception to the ‘do nothing’ strategy was the drop in year 2000. During that crash, depending on your portfolio at the time, doing nothing would have been very painful. You would have watched tech stocks lose at least half of their value and then waited for 10-15 years to recover your losses. Ouch!

Financial advisors almost all say ‘do nothing’ at least partly because it’s not risky advice. If they all give the same advice then no one can be blamed for giving exceptionally bad advice. In 1996, during the historic Internet boom market, Elaine Garvarelli, a stock analyst who used an econometric model to predict changes in the market, issued an urgent “sell everything” alert to subscribers in her newsletter. Well, the market did not crash as her model predicted, but just kept rising. That was undoubtedly a career-limiting-prediction for Elaine. Her readers would have been much better off doing nothing than following her advice.

When the market is becoming very volatile, if there’s one group that may not be well served by doing nothing, it’s retirees. That’s because senior citizens have less time to wait for a recovery. Although, as we mentioned, markets usually recover within a few years, another crash like the one in 2000 could cause investors to lose half of their portfolios or more and take a decade or more to recover.

In past years, financial advisors recommended that retirees draw down no more than 4% of their portfolios per year to maintain their standard of living. In that case, assuming the portfolio is earning an average return, a retirement nest egg should last for at least 30 years. But, assume that the market drops by 50% immediately after a person retires and doesn’t recover for 10 years. In that case, the retiree may need to withdraw 8% of their portfolio for a few years and with drawdowns of that magnitude, their nest eggs would not last for 30 years or 25 or even 15. Granted, wealthier retirees don’t need to draw down their portfolios by 4% (or 8%) per year, but statistics show a high percentage of retirees are not well prepared for retirement. Those with less retirement savings would obviously be hurt the most by a market crash.

A big drop in the stock market would also affect pension funds, many of which are invested in stocks. The historic bull market bailed out many private and public pension funds that had been previously significantly underfunded. In that worst case scenario, a 50% decline would be a disaster for some pension funds, state and local governments, corporations offering defined benefit pensions and retirees.

What about the longer term, say the next 10 years? Is Jeremy Siegel right, will the market continue to chug along? Well, some indicators suggest Prof. Siegel may be right. For example, interest rates will probably continue to be low because the U.S. cannot afford to let rates rise by much. So, fixed income investments will continue to pose little competition for equity investments. That’s good for stocks. Also, new technologies like electric vehicles, artificial intelligence, virtual reality, alternative energy, and medical breakthroughs will provide fuel for a rising market.

On the other hand, markets tend to run in cycles and after a long bull run, historically markets tend to adjust or over adjust. Also, inflation is disruptive to many companies. Even if a company is able to increase prices along with the CPI, the timing of wage and price increases is difficult to manage and that affects earnings. Also, inflation affects discretionary spending especially for lower income households and that affects demand for many products.

Bottom line: obviously nobody knows what the next 10 years will hold, but if forced at gunpoint to make a bet, I would put some chips on a slower if not a lower stock market.

So, if I were a financial advisor, what advice would I give to my clients? Well, I’m not a financial advisor, but merely a humble blogger, but if I were, hmmm….I’d probably tell them to do nothing. 🙂

Janet Yellen, Secretary of the Treasury says that the escalating prices we’ve experienced lately are a temporary blip caused by the reopening of the economy.   Jerome Powell, Chairman of the Fed, more of less agrees but tends to hedge a bit more.  Jack Dorsey, multi-billionaire and CEO of Twitter, recently tweeted that he thinks we are headed for “hyperinflation”.  His tweet has created quite a stir. 

Both Yellen and Powell would like people to believe that inflation is temporary.  If many were to think we are headed for a period of hyperinflation that would trigger accelerated buying and hoarding, (even more than toilet paper) making the situation worse. Likewise, Dorsey’s prediction of hyperinflation may be based on no more than an attempt to generate more Twitter traffic.

There’s also been some quibbling about the meaning of the term “hyperinflation”.  That term makes us think of the Weimar Republic in the 1920’s when Germans needed a wheelbarrow of cash to buy a loaf of bread or the recent experience in Venezuela where in 2021 the inflation rate exceeds 5000%.  Currency becomes worthless.  Savings are wiped out. 

Is that what Dorsey is predicting?  My wild guess is that he’s thinking more in terms of double-digit inflation, but who knows?

And, who’s right, Dorsey or Yellen?

Many aspects of the current economic situation point to more price pressure.  For example,

Higher oil prices increase costs for businesses who then pass on the higher costs to their customers.  Exploration and drilling have declined in the U.S. over the past 2 years because of COVID and because of new regulations preventing drilling on Federal land and the northern tier of Alaska.  Oil companies have also scaled back because of the anti-fossil-fuel political climate. Recently oil companies have increased exploration and drilling so perhaps more supply will be available in 6-12 months, causing a reduction in gasoline and heating prices. On the other hand, OPEC and Russia are still limiting supply. 

Supply shortages of imported goods will also cause inflated prices to continue for at least a year.  The ports of LA and Long Beach will not catch up on the backlog of cargo ships for about 12 months.  Supply shortages of electronics will cause computer and other consumer electronic prices to remain high. 

Labor shortages cause wages to increase.  Increased labor costs get passed through to customers who feel the budget pinch and request higher wages of their employers.  It can spiral.

Higher real estate prices are pro inflationary.  If workers cannot afford housing, that could cause labor shortages in certain areas or longer commutes from lower cost areas. 

Increasing demand for certain goods and services as the economy opens is also inflationary. 

The government has the challenge of making sure these things don’t spiral out of control.  Higher costs lead to higher prices lead to greater wage demands lead to higher costs, etc.

The economic levers that government usually uses to control inflation include:

Higher taxes to reduce spending and therefore prices.  The higher taxes are coming.   They are supposed to be only on the very wealthy so that may have a minimal effect on consumer spending and therefore, prices.

Higher interest rates.  The Fed can cause interest rates to increase by increasing the federal funds rate (short term) and adjusting open market operations (long term).  Higher interest rates will cause less business and consumer spending which will reduce spending and investing.  On the other hand, the Sec. of the Treasury who holds some sway with the Fed does not want to see higher interest rates because that will make it more expensive to finance the huge Federal debt.  Therefore, significant increases in interest rates (initiated by the Fed) are unlikely.

Reduced government spending.  Generally, a key tool the government uses to reduce price inflation is to reduce deficit spending.  However, currently the Government is doing exactly the opposite and planning even more spending.    The effect of more spending can be offset with higher taxes, but history shows this is rarely as effective as expected.

So, is Dorsey right?   

Unless the Government changes its policies or something happens to change the supply-demand situation in markets, the deck is stacked on the side of more inflation, maybe not hyperinflation, but more than we want.

Those of us who are old enough to be Medicare-eligible grew up believing that the country was invincible.  After all, we were the country that accomplished impossible feats like storming the beach at Normandy and succeeding in defeating the Nazis.  We were the country that avenged the sneak attack on Pearl Harbor by crushing the Japanese army in the Pacific.  We were the country that built an industrial war machine at home and the same country that built the most successful economy in the world post-WWII.  We sent men to the moon and returned them safely to earth.  We had the best technology and the best universities.  We were the envy of the world. 

Yikes, what has changed?  If our withdrawal from Afghanistan is a fair indication, we have become not invincible but incompetent.  Whether we should have been in Afghanistan in the first place is a different question, but since we were there, one would have expected us to do a better job of withdrawal.  Instead, we pre-announced the date of withdrawal to give the enemy a heads up.  We picked a date when the Taliban fighters are in full summer attack mode, rather than in the winter when they are huddled around campfires in caves.

As the withdrawal date approached the Taliban advanced so fast that our President had to suffer the indignity of asking the Taliban leader for permission to evacuate the U.S. embassy in Kabul before it was overrun.  Our military left in such a hurry that the main air base was evacuated in the middle of the night without even informing the Afghan military.  Our military was evacuated leaving civilians and Afghani friends behind with no one to defend them.  

Instead of removing valuable equipment and armaments, we left them in place.  Some say the idea was to leave the Blackhawk helicopters to the Afghan military.  If that’s so, didn’t our intelligence tell us the Afghan military could be bribed by the Taliban or would flee without their big brothers from America?  Others say the equipment was supposed to be destroyed before the withdrawal and that some of it at the airport was destroyed.  Whatever the truth, the Taliban is now equipped with more modern military technology than most nations.

This isn’t the first time the U.S. has looked weak, stumbling and bumbling.  Remember the withdrawal from Saigon?  That was embarrassing too.  How about the Iran hostage situation?  Embarrassing.  Then there was the mother of all screw-ups, the report from our crack intelligence agencies that Iraq possessed WMDs.  That was a multi-trillion-dollar mistake.   

But the Afghanistan blunder was different.  It was somehow worse, more humiliating.  Everyone knew what would happen.  The Taliban had been advancing province by province.  The Afghan Army was retreating or fleeing province by province.  It was clear the Taliban would sweep the entire country including Kabul.  The media kept repeating “this won’t be another Saigon” and yet, it was even worse.    

The word “strategy” is derived from the Greek word “strategos” which means military leader or leadership, but we seemed to have no strategos in Afghanistan.   If we knew we were going to leave, wouldn’t it make sense to withdraw our most valuable equipment and arms first?  Of course, a West Point education wouldn’t be needed to reach such a simple conclusion. 

Heads should roll in D.C., but who will get the blame?  The President will need a scapegoat.  Maybe the feckless Secretary of State Anthony Blinken who seems to apologize to everyone he meets.  He would be a good candidate.  There’s Defense Secretary Lloyd Austin or Chairman of the Joint Chiefs, Gen. Mark Milley who only a month before the Afghanistan debacle testified before Congress about how important it is to educate troops on Critical Race Theory.   Or, maybe Biden will go lower on the totem pole and jettison the leader of Military Intelligence, Lieutenant General Scott D. Berrier.  Military Intelligence…hmm, that would seem warranted and have a nice ring to it.

We’ve been hearing the term “Jim Crow” a lot lately. Jim Crow this, Jim Crow that. Here a Crow, there a Crow, everywhere a Jim Crow.

President Biden said that a voting law passed in Georgia was like ‘Jim Eagle’. Eagles are bigger than Crows, get it? Others have used terms like Jim Crow 2.0 or Jim Crow on steroids.

Some of the less informed among us have heard the name Jim Crow and maybe knew the significance of the name at one time, but have long since forgotten the true meaning and origin of the term. Fear not. This vocab briefing will bring you up to speed and thereafter you may consider yourself cool again and be ready for any Jeopardy questions on the subject.

The name “Jim Crow” comes from a fictional character portrayed in a minstrel show and earlier from black slave folklore about a witty black trickster. The Jim Crow stage character was portrayed by Thomas Rice, a white man in black face, in his theater act in the 1820s and 1830s. The act was a negative, satirical, unsympathetic portrayal of black slaves. Was Jim Crow a Real Person? – HISTORY

When politicians use the name “Jim Crow” they’re not talking about the theater character but about segregation laws that were enacted by Democrat-controlled local and state legislatures in southern states mainly in the 1870s. These laws came to be known as “Jim Crow Laws”. Jim Crow laws mandated segregation in most of the states formerly part of the Confederacy and were intended to limit the political and economic gains made by blacks after the Civil War. Under Jim Crow, the races were to be “separate but equal” but, as a practical matter, that was not their true effect. Jim Crow laws also included poll taxes aimed at making voting more difficult for poor people, especially poor black people.

Jim Crow laws remained in effect well into the 20th Century. In 1954, school segregation was overturned by the Supreme Court in Brown vs. Board of Education. Then, the remaining Jim Crow laws including poll taxes were overruled by the Civil Rights Act of 1964 and the Voting Rights Act of 1965.

Today, Democrat politicians and even some large corporations are speaking out against a recent voting law passed in Georgia that requires some form of identification to vote and limits the time period prior to an election during which mail-in ballots can be accepted. In their view, this law is biased against black people which is why they use the term Jim Crow (or Eagle). However, the Georgia law is similar to the Jim Crow laws only in that it was enacted in Georgia (which had been part of the Confederacy), black people live in Georgia and the law involves voting. It’s quite a stretch.

So, President Biden, is the Georgia law really like “Jim Eagle”? C’mon man, it’s more like “Jim Mosquito”.

https://en.wikipedia.org/wiki/Jim_Crow_laws

Since the Bretton Woods Agreement in 1944 the U.S. dollar has been used as the world’s reserve currency.  When a company in Brazil wants to purchase goods from a company in Uruguay, they probably do the transaction in dollars.  Why?  Because both parties trust dollars.  They know that, unlike what’s happened to some banana-republic currencies in the past, the dollar will not lose half its value overnight. 

Before the dollar was king of the hill, other countries’ currencies had this position of esteem.  Before 1944 it was the British pound.  The pound had been top dog in the pound for over 100 years.  In earlier times the Dutch kroner, Spanish real and Portuguese escudo were in the pole position around the world.   Each held the top position for about 100 years give or take. 

It’s 2021, the dollar has held the position of reserve currency for 77 years.  This year the U.S. debt will top 100% of the GDP and the Federal Reserve has no plans to stop printing money.  Those who follow financial markets are starting to wonder just how much longer the world will keep faith in the dollar.  With each new dollar that rolls off the printing press, the value of the dollar is diluted a little and the risk of price inflation increases. 

Even if other world currencies are losing value faster than the dollar, eventually businesses and financial markets will catch on.

When that happens and the dollar loses its position as reserve currency what currency will take its place?  The Euro?  Nah.  Too much infighting in the EU and too many weak sister members.  The Renminbi?   Nope.  Most of the world does not trust China. 

More than likely it will be a universal digital currency not tied to any sovereign nation and designed to maintain its value.  Kind of like Bitcoin but without the restrictions of Bitcoin.  Such a currency could be created by hackers like Bitcoin and Ethereum or it could come from the IMF or U.N., who knows?

What’s an individual investor to do today?  Hedge your bets.  Don’t put all your eggs in the dollar basket.  Maybe make some investments in other currencies, in gold and in digital currencies. 

His hand will be against everyone, And everyone’s hand will be against him.  – Genesis 16:12

As Donald Trump is scheduled to leave office in a little over a week, Nancy Pelosi, other Democrats on Capitol Hill and many in the press are calling again for his impeachment.  His four years in office have been perhaps the most contentious of any President’s in the history of the country. 

How did so controversial an individual ever get elected in the first place?

Although it now seems like ancient history, Trump gained the GOP nomination and the Presidency in 2016 by promising to:

1. Stop illegal immigration at the southern border and build a wall
2. Bring back to the U.S. jobs that had been offshored to other countries
3. Reduce the national debt
4. Combat Islamic terrorism
5. Change the corrupt, entrenched system in D.C.  What he called “Draining the Swamp”
6. Stand-up to the biased media, or “fake news”
7. Instill a new national spirit as expressed in his slogan “Make America Great Again”

Like other elected Presidents in the past, some of his campaign promises were a direct reaction to the deficiencies of the prior administration.  President Obama was elected on a platform that was at least partly a reaction to the Bush Administration’s entry into the Iraq War.  Similarly, Trump’s platform was at least partly a reaction to Obama’s permissive view of illegal immigration and his globalist orientation. Trump got one thing right. He figured out the obvious: that the President’s job is to serve the citizens and taxpayers, not people in other countries.

Surprising to the press and pollsters at the time, most of the electorate resonated with Trump’s immigration, jobs and patriotism messages and he was elected.

To paraphrase Tina Turner, Trump did not campaign “nice and easy”. His style was more “not-so-nice and rough”.  He made disparaging remarks about his primary opponents, commenting on their height, weight, facial appearance, energy level, and any other attribute he could criticize.   Again, in the general election, he resorted to calling his opponent “Crooked Hillary”.

Most leadership consultants recommend not openly casting aspersions on opponents but attacking adversaries in more subtle ways.  Poking fun at physical attributes is especially bad form. The conventional wisdom says that directly belittling other people makes the belittler seem smaller.   Yet, somehow it worked for Trump. 

Another surprising aspect of Trump’s win is that most successful Presidential candidates are good speakers or at least reasonably competent.  Think of Obama, Reagan, Clinton and Kennedy.  Bush Jr. and Jimmy Carter were perhaps the weakest speakers since Truman, but they were at least passable.  Trump is not a polished public speaker.  He often speaks in short, chopped sentences. He tends to repeat phrases and add many superlatives.  Yet, again, somehow it worked.

Trump was the first President to use Twitter as a primary means of communication.  At first he said he did so to communicate directly with the American people and avoid the ‘fake news media’ and maybe that’s true.  But, even in his tweeting, Trump’s anger and combativeness came through.  He seemed to send out tweets without much thought or fact checking.  He made claims that were obviously not true.  He tweeted late, into the wee hours of the morning.  Like a lightning rod, his Twitter account attracted lots of heat.  Finally, at the end of his Presidency, Twitter, as if to pile-on, get in one last kick to the ribs and demonstrate its own “wokeness”, suspended his account.    

Although Trump’s rough, bullying style did not stop him from winning the primary and even the general election, it made him many enemies in his own party, in the media and especially in the Democrat Party.  

He made a point of declaring war with the media, never letting any slight go unanswered. Trump said he was a fighter who would back down from no one in the press or rival political party. During the Bush Jr. administration George W. was also repeatedly attacked by the mainstream media but he rarely responded and pretended not to care. Obama was rarely criticized by the media, except Fox News and he made a point of belittling Fox News at every opportunity. So, Trump was the first President to fight the media every day of his tenure. Most objective commentators would probably say he did not win the war. Fighters need to pick their battles too. Daily combat with so many reporters and news outlets must have taken its toll.

Trump’s combative style gave license to his enemies to use the same below-the-belt tactics against him and they did so in spades.  Trump perhaps did not realize that some of his physical attributes and frequent overdone spray-on tan made him an easy target for attacks.   He was brutalized by cable TV commentators, late-night talk show hosts and Saturday Night Live comics. His media detractors resorted to gutter language and mean-spirited talk. For example, actor Robert DeNiro has said multiple times that he wanted to punch Trump in the nose. Madonna once said she wanted to burn down the White House. Kathy Griffin created an online photo-shopped picture of herself holding the severed, bloody head of Trump. Politicians also got into the act. For example, Maxine Waters told her supporters to find Republicans in restaurants and in their homes and harass them. Make them pay for supporting Trump. Alexandria O-Cortez suggested making an enemies list, consisting of individuals who served in the Trump administration and those who supported him. The enemies list would ostensibly be used to seek retribution. And, that’s just a small sample of the overblown reactions from Hollywood and Washington.

Trump has been a very polarizing figure. During his Presidency, he was hated by almost all Democrats.  The hatred was not just dislike.  It was more deep rooted, pathological, and obsessive.  They hated him with a religious fervor. The media made a daily habit of feeding this hate machine with a constant stream of negative stories.  One media analyst estimated that during his Presidency over 98% of mainstream media stories about Trump were negative.  Obviously, viewers and readers are not able to fact check news.  They tend to be influenced by what they read and hear, especially when the stories told by the NY Times, Washington Post, CNN, ABC and other outlets are consistent.

So, at least partly from his own doing, Trump became a pariah for many.  Even among people who voted for him in 2020, many did so despite their dislike of his personality. There are many examples of Trump-hatred but perhaps the most visible was when Nancy Pelosi tore up Trump’s State of the Union Speech on national television.   That was a sign that the gloves were off, all rules of civility and decorum were to be abandoned. 

Despite the brutal beating he’s taken from the press and Hollywood celebrities, he’s not someone who engenders much sympathy. It’s hard to feel sorry for him for very long because he never learned how to rise above the situation and behave like a President. Instead, he made a habit of disappointing even those people who wanted to like him.

Some commentators have speculated that Trump’s behavior may have triggered the civil unrest of the BLM riots.  The rioters may have reasoned that if even the President does not follow any standard rules of civility and if his adversaries like Pelosi behave in kind, then rules no longer apply.  It’s a bit of a stretch to go from tearing up a speech to burning down buildings or occupying the Capitol but, who knows?  It may be partly true. 

Where did this combative non-politician come from? Trump’s professional background was as a real estate developer and later, reality television star.  Earlier in his career he had written “The Art of the Deal”, a book about negotiating.   He apparently considered himself a good negotiator and salesman.  Like any good salesman he thought he could charm his adversaries into seeing things his way.  Salesmanship was obvious in his public flattery of Xi JinPing, Putin and Kim Jong-un, but his ingratiation did not work.  He was able to get other leaders to smile, but never bend.  Oddly, especially for a salesman, Trump tended to alienate others.  He made enemies of people around the world and even in his own party with his occasional gratuitous snide remarks.

Trump had grown-up in a wealthy family.  He went to a military prep school and later to Wharton School of Business.  Trump’s father was a wealthy real estate developer in New York.  His father bankrolled Trump when he started out in his own real estate business and that fact has been used to paint Trump as a spoiled rich kid.

Trump’s real estate career was riddled with ups and downs.  His company declared bankruptcy several times as real estate markets in places like Atlantic City rose and then crashed.  Because of this Trump has been painted by his detractors as a poor business manager, but his net worth is still reportedly in the billions.

He also managed to accomplish many of his campaign promises. In 2020, before the COVID pandemic spread, unemployment among minorities, women and the general population was at an all-time low. He was able to impose effective controls on illegal immigration and built 500 miles of wall at the southern border. Trump was the first President to stand-up to China, something that should have been done 20 years earlier. He helped establish bilateral agreements between Israel and several Muslim countries in the Middle East. His ‘Make America Great Again’ did instill a new patriotic spirit at least among some element of the population.

He was not able to ‘Drain the Swamp’. In fact, it was more like the Swamp drained him. He also did not make any progress in changing the fake news media.

Also, in Trump’s defense, some of the criticism from the media and Democrats was unwarranted and just plain wrong.  For example, for three years of his Presidency he was under investigation for supposedly colluding with the Russian government during the 2016 Presidential Campaign.  Cable news outlets and leading newspapers reported daily that they were 100% certain Trump was guilty.  At the end of the three-year investigation, the Special Counsel, Robert Mueller, had to admit that there was no evidence that the Trump campaign broke any laws.  It was all a fabrication, a complete lie to get Trump out of office.   Even after he was cleared of the Russian hoax, he remained under constant attack by the opposition party and the media.  It was unprecedented.   

So, now Trump is about to leave office or possibly be impeached from office during his last two weeks.  Taking a step back from the emotionalism, what should we think about Trump’s Presidency?  Obviously, opinions vary widely.  At one extreme we have politicians and tech giants who want to punish and cancel anyone associated with Trump and at the other, loyal Trump supporters who probably want Trump to run again. Most of us are probably happy to see him leave the stage, but not seeking any kind of retribution.

Let’s hope we never have a President who behaves like Trump.  His behavior has been very disruptive and needlessly so.  He did not set a good example for the citizens of the country, especially young people. For many in the Democrat Party and the general population his behavior may have led to an implied change in the normal rules of civility. Leaders should lead by example, but Trump’s chaotic behavior was destructive.

On the other hand, he was treated unfairly by the press, which may have caused him to retaliate in kind. Hard to know who bears more blame.

The voters who liked Trump, i.e., the people who wore MAGA hats and went to his rallies, admired his fighting spirit, the way he called out the media and the entrenched interests in Washington, and even his direct, unstatesmanlike way of speaking. For many, he was a refreshing change from Washington politicians who consistently are the least admired of any profession in public opinion polls.

With luck, his policy positions, some of which are exactly right, will not be tainted by association.   Let’s see what the new government does about immigration, China, Iran, corruption in D.C. and putting America first. 

Imagine, if you will, a utopian land in which the needs of all residents are provided by the ruling authority. Consider further that the government of this land has at its disposal an unlimited supply of funds to serve its residents even without imposing taxes.

No, this isn’t an old episode of the Twilight Zone or a plot from a science fiction movie. It’s actually a scenario envisioned by a group of progressive economists. The theory underlying the vision is called Modern Monetary Theory (MMT), it’s gaining in popularity, and its leading proponent, Stephanie Kelton of Stonybrook University, has become somewhat of a celebrity. So, what’s MMT all about? To understand MMT, we need to review some basics about how the federal government operates today.

The Federal Budget
As most people are reminded every April 15th, the primary source of government funding is the tax revenue it collects from households and businesses. The government uses this money to fund its expenses including the military, the Washington bureaucracy, social welfare programs, safety net programs, and the interest on the debt. When spending exceeds revenue, like it did in 2019 by a whopping trillion dollars, the government sells bonds to cover the difference. As Figure 1 shows, bonds are purchased by foreign governments, other federal agencies, the Federal Reserve, commercial banks, corporations, mutual funds, and others.¹ About 43% of federal debt is currently owned either by the Federal Reserve or other federal agencies. Bonds sold by the U.S. Treasury are backed by the integrity and creditworthiness of the federal government and are generally considered zero risk or at least very close to it. Because of their low risk, interest on Treasury bonds is low compared to the interest paid on almost all corporate bonds.

How is the government doing in terms of managing its debt? Not so good. As shown in Figure 2, the government has been running budget deficits since 2001. During the years following the 2008 credit crisis, the deficit increased to over $1 trillion for four consecutive years. In 2019 the deficit fell just short of $1 trillion and in 2020, with the huge COVID-related expenditures, the deficit is expected to exceed a previously unthinkable amount – $4 trillion or more.

As the debt has increased, so have interest payments on the debt. The Brookings Institute reports “Even at current low rates, the government spent about $260 billion on interest in the first eight months of the fiscal year 2020, roughly equal to the combined spending of the Departments of Commerce, Education, Energy, Homeland Security, Housing and Urban Development, Interior, Justice, and State. And, of course, if interest rates rise, the government’s interest tab will go up.”²

Often when the subject of fiscal debt is discussed, John Maynard Keynes is remembered. He was a famous early 20th century British economist whose ideas fundamentally changed the field of macroeconomics. Among his many new ideas, Keynes taught that governments use deficit spending to stimulate economies during lean periods but then run budget surpluses during high-growth periods. Following Keynesian doctrine, the U.S. ran large deficits during WW2 but after the war had many years of budget surpluses to repay the debt. However, since the 1970’s the U.S. has experienced only one period of budget surpluses and that was during the Internet boom period of the late 1990’s – early 2000’s. Since then the second part of Keynes’ message (i.e., that economies run surpluses during high-growth periods) has largely been forgotten by most government politicians. Germany is about the only capitalist country in the world that still runs budget surpluses during strong economic times. In all other nations around the world politicians have become addicted to deficit spending across the entire business cycle. Keynes would not approve.

Should we be concerned about the growing debt? A partial answer to this question is provided by looking at the ratio of cumulative federal debt to GDP. This ratio is meaningful because a larger debt to GDP ratio translates to more difficulty repaying the debt. If the ratio becomes too high, even paying the interest on the debt may become problematic. Nobel laureate, Paul Krugman has often argued that if the GDP is growing as fast or faster than the debt, then debt poses no problem. In other words, Krugman is saying that the debt never has to be repaid, it can be rolled over when it comes due and the interest can be paid out of a growing budget each year. This is not a unique idea but a relatively new way of thinking about debt i.e., that it need never be repaid. However, unfortunately, as Figure 3 shows, the economy has not lived up to Krugman’s more permissive criteria for the past ten years. Over the past ten years the total debt has grown much faster than GDP. As of 2020, the ratio of debt to GDP is higher than it was at the end of WW2. Remember that WW2 was followed by a long period of fast economic growth and hence budget surpluses. There’s not much evidence to suggest that we are about to repeat that today. In this respect, the U.S. is in a unique situation in its history and not in a good way.

To see the current situation the U.S. faces relative to other countries, see Figure 4 which shows the Debt-to-GDP ratio by country for a select list of countries as of 2019.³ You can see that the U.S. is one of the most indebted countries on the list, exceeded only by Italy, Greece and Venezuela, (no surprises there) and Japan (I’ll be discussing Japan later). Notice that U.S. debt/GDP far exceeds that of Brazil and Argentina, two countries that have experienced debt crises and hyperinflation in the past.

So, how do we assess the situation the U.S. faces? I think anyone would have to agree that the current and rising debt poses a risk to the U.S. economy, currency and dominant position in the world.

This raises a most obvious question: Can the U.S. dig itself out of this debt hole? Studies show that countries with Debt/GDP ratios exceeding 130% do one of several things: restructure the debt (i.e., pay creditors a portion of what’s owed), devalue the currency to pay the debt in cheaper money, create lots of new money triggering high inflation, or outright default. What will the U.S. likely do? To answer this question, we need to discuss the Federal Reserve Bank of the U.S. which will play a key role in any strategy to address this problem.

The Federal Reserve Bank
The Federal Reserve Act of 1913 established the Federal Reserve Bank of the U.S. As provided for in the Act, the Board of Governors of the Fed are appointed by the President and confirmed by the Senate. Although the Chairman of the Fed is often asked to testify before Congress, the Fed operates independently and is not directly subordinate to the Executive or Legislative Branches. Of course, Congress could vote to abolish the Fed by overturning the Federal Reserve Act, but that’s rarely been discussed by anyone other than a few members of Congress, most notably former Congressman Ron Paul.

Some readers may be surprised to know the great influence the appointed (unelected) Fed Governors have over the economy. The Fed manages monetary policy with the dual objective of limiting consumer price inflation to a target of 2% and promoting job creation to achieve a target unemployment rate of 4-5%. They do this:
1. by setting the discount rate (the interest rate the Fed charges commercial banks for short-term loans),
2. by setting banks’ reserve requirements (the portion of deposits that banks must hold in cash, either in their vaults or on deposit at a Reserve Bank),
3. via open market operations (the buying and selling of government securities), and
4. by setting the interest rate paid by the Fed on excess reserves held for banks.⁴

The Fed can also fine tune an expansionary policy by implementing offsetting measures. For example, when the Fed makes bond purchases under open market operations, adding to the money supply, they can “sterilize” the purchases by taking money out of the economy at the same time. They may do this by having banks hold more reserves by requirement or enticement. They can also adjust bond maturities.

One of the most interesting aspects of Fed operations is their power to create money. In times past, new money was created by printing new paper bills. Today, in the day of digital transactions, the Fed produces new money simply by drafting an account on its books. In fact, the Fed can create as much money as it sees fit or, that is to say there are no legal restrictions on the amount of money it can create. The money the Fed creates is used for its “open market operations”, i.e., to purchase Treasury bonds or other securities.

Quantitative Easing During the Credit Crisis
During the 2007-2008 credit collapse, when the economy appeared to be on the precipice, the Fed implemented what Chairman Ben Bernanke called “credit easing” or what the press loosely referred to as quantitative easing (QE). The QE program consisted of three parts:
• Lending to financial institutions
• Providing liquidity to key credit markets (via loans and asset purchases)
• Purchasing longer-term securities (or, as they called it, “large-scale asset purchases”, LSAPs)
Although all parts of the program were important, we will discuss here large-scale asset purchases (LSAP), which received the most attention in the press and is most germane to this discussion. This program consisted of the Fed purchasing government bonds and other long-term securities with newly created money.⁵ The money was created with a snap of the fingers, a wave of a magic wand or actually a vote of a Fed committee. The Fed creates money and then records the bonds as an asset on their balance sheet. Astute accountants will at this point be saying to themselves “hold on just a second, what’s the offsetting entry on the balance sheet?” Well, indeed there is an offsetting liability. The amount spent on government bonds (the money creation part of the transaction) is recorded as commercial bank reserves, an amount owed to the commercial bank that sold the bonds.⁶ With more reserves, the bank is then able to loan more money to its customers. The net effect is the creation of money to increase the reserves of banks so they can loan more money to their customers. The transaction increases the supply of money and stimulates economic activity.

The original idea was to use QE as a stop-gap measure to help the economy recover from the credit crisis. The Fed’s plan was to unwind QE as the economy improved by selling the securities it had purchased. However, as fate would have it, the economic recovery was slower than expected, so the Fed continued the program for many years. QE, money creation by the Fed and near-zero interest rates became institutionalized.

The massive inflow of money into the financial sector from QE was supposed to spur business financing and consequently, business investment and new job creation. But, with weak consumer demand, businesses were reluctant to take on debt. What QE did instead was contribute to a huge boom in the stock market and markets for other financial assets. QE has also helped to keep Treasury rates low, which has helped the federal budget. Consumer prices have not been affected much because very little QE money trickled into the consumer economy.

Quantitative Easing During COVID
To counter the devastating economic effect of COVID, the Fed has expanded QE. Remember all of the hand wringing over the government bailout in 2008? The 2020 QE program makes 2008 look insignificant by comparison. At the end of 2007 the Fed owned about $745 billion in government securities⁷ but as of mid-August 2020, that number had increased to $4.3 trillion.⁸ That’s an increase of about 500% in 13 years. Fed bond purchases have helped the Treasury grow its debt to what is estimated to be 140% of GDP by the end of 2020 while maintaining very low interest rates on government bonds.

Japan and Abenomics 
The current situation in the U.S. (high debt and slow growth) resembles the situation that Japan has faced for many years. Referring back to Figure 4, we see that Japan is the most indebted country in the world in terms of Debt/GDP. Yet, Japan has not suffered any devastating economic consequences. Why is that?  In 2012 newly-elected Prime Minister Shinzo Abe championed a new economic policy to boost Japan’s economy.  Abe recognized that because of Japan’s aging and shrinking population, the after effects of the 2008 credit crisis and moribund economic growth, extraordinary measures were needed to stimulate growth.  Like the U.S., Japan has turned to quantitative easing and deficit spending to stimulate its economy.  “In 2014, the Bank of Japan (BOJ) started a large-scale asset purchase program that purchased assets worth $660 billion dollars annually. The goal was to continue the asset purchases until the country’s inflation rate hit the target rate of 2%. In 2016, the BOJ lowered interest rates past zero to increase lending and investment. As of 2018, the short-term interest target was at -0.1%.”  However, unlike the U.S., since 2014  70% of all Japanese government bonds have been purchased by the central Bank of Japan and the remainder by Japanese banks and trust funds.⁹ Huge deficits from stimulus programs over the past 20 years have caused Japan to run-up their debt to 250% of GDP. Like the U.S., money creation in Japan has not caused inflation in consumer prices. 

So, to some, the experience of Japan is empirical evidence that debt really doesn’t matter, however not everyone is convinced that Japan proves the point. The canary in the high debt coal mine would be loss of confidence in a country’s bonds, but since all of Japan’s bonds are purchased by Japan, it’s not a good test case. Another indicator would be a sharp decline in demand for the country’s currency.  Fortunately for Japan, it’s currency enjoys a steady demand to purchase its many exported products.   The Yen is also one of the “standard drawing rights” currencies as designated by the International Monetary Fund (along with the dollar, yuan, euro and pound) which gives it a special status as a chaos hedge. But, as shown in Figure 5,  the Yen has experienced about a 25% devaluation relative to the dollar since the end of 2012, (although the valuation of the Yen has recovered from a low point in 2015 and the Yen has not lost value against a basket of all other world currencies).   The devaluation of the Yen may be directly related to Abenomics (high debt, money creation, negative interest rates), but we don’t know to what extent.  

We asked earlier what the U.S. will likely do to deal with its huge and growing debt. One possible answer lies in the Japan example. The U.S. could become more like Japan; it could let its debt grow, create money to fund the debt and sell all debt to the Federal Reserve and other government agencies. To most economists that sounds like an unattractive solution.  But, another possibility exists.

Modern Monetary Theory
So far we have established that the U.S. is in deep debt, that countries that accumulate a high amount of debt relative to GDP generally face very bad economic outcomes (with the exception of Japan so far) and that QE programs have been one way the U.S. has been able to bail itself out of serious financial situations since 2008. Now let’s turn to Modern Monetary Theory (MMT)¹⁰ which has been presented as a possible solution to the current economic dilemma.

MMT is a new and different way of thinking about government budgets. The theory takes money creation and deficit spending a step beyond QE. Well, more than a step. More like a huge leap. According to MMT, government debt does not matter. That is to say the amount of government indebtedness is of no consequence. In contrast to Paul Krugman’s thinking that Debt/GDP is important, MMT proponents think the ratio is of little importance. Unlike households and businesses, as the theory goes, governments can incur an almost unlimited amount of debt because they can always create money to repay it. This idea is not only mind expanding but somewhat controversial. Almost all economists would agree that governments can incur debt and create money, but even the most other-worldly-minded would not agree that governments should create money without limit. The typical arguments made against unlimited money creation are that it can cause a loss of confidence in the currency, inflation or fear of inflation, and a rush to move dollars into hard assets or other currencies. Picture a Banana Republic outcome.

Politically speaking, the idea that “debt does not matter” has great appeal because, if true, it would solve a major source of conflict in U.S. politics i.e., how to obtain funds to meet all needs, those favored by liberals and conservatives alike. It’s easy to see how this idea would become popular amongst politicians who (not to be too cynical) need money to buy votes but don’t want to raise taxes which may cost them votes. In fact, the idea is spreading rapidly and “debt does not matter” has become a mantra amongst online devotees. Follow Twitter and you’ll see lots of tweets like “Ooomm, debt does not matter, Ooomm”.

Where did this idea get started? The genesis of the idea seems to have come from a school of thought called “functional finance” originally put forth by economist Abba Lerner.¹¹ At a very high level, functional finance is the idea that government economic policy (both monetary and fiscal) should be managed to achieve certain objectives – namely, economic welfare, full employment and price stability. Functional finance ideas were later adopted by hedge fund manager, Warren Mosler¹² and several university economics professors including Stephanie Kelton of Stony Brook.¹³ Functional finance teaches that economic and social objectives should be obtained by government borrowing, lending and money creation. This is not such a novel idea today. It’s not unlike the way the FOMC operates. The Fed adjusts policy to come as close as possible to its inflation and unemployment targets.

The proponents of functional finance take the idea of a managed economy a step (huge leap) further. They propose that the economic policy should aim for absolute employment i.e., 0% unemployment. During lean times and when dislocations occur in the private sector, the government should step-in and employ everyone who becomes unemployed. Or, if not employ everyone, at least provide them with a guaranteed income.

So, the two ideas: “government management of the economy to achieve welfare objectives” and “debt does not matter” are a perfect marriage. They complement one another in creating a government-centric model of the economy. The model is one in which the government has much more centralized control. Envision a group of government gnomes in Washington turning economic knobs to achieve the desired results.

But MMT thinking goes beyond “debt does not matter”. The primary reason debt does not matter is because governments can create money out of the ether to repay their debt. And, it follows at least in theory that because governments can create money, they need not incur any debt at all. According to MMT logic, governments need not issue bonds nor collect taxes but need only turn on the digital printing press to pay for expenditures. Government decides what objectives it wishes to achieve, creates money to accomplish those objectives and spends the newly created money accordingly.

The founders of the MMT theory issue one caveat. They say if printing too much money causes price inflation, they’ll control inflation by imposing taxes. In the world of MMT, taxes are needed only to reduce consumption and thus, control upward pressure on prices.

To summarize, the main elements of MMT:

• Unlike households and businesses, the indebtedness of sovereign governments does not matter. This is perhaps most true of governments like the U.S. whose currency is used as a reserve currency for much of the rest of the world.
• The primary reason debt does not matter is because sovereign nations can create money to pay for expenditures just like the U.S. has done with QE.
• Because nations can create money, they need not collect taxes or issue bonds to pay for expenses, they can (at least in theory) pay for all expenditures with newly created money.
• Monetary and fiscal policy should be managed to achieve certain social objectives employing created money.
• In response to critics who say that expanding the money supply by creating new money is inflationary, the MMT proponents reply that inflation can be controlled by taxing households and businesses.

It’s easy to see how MMT could be used at least in theory to solve the current problems faced by the U.S.  Newly created money could be used to repay all current creditors. Going forward either no new debt would be issued or like Japan, all debt would be purchased internally and most by the Fed. However, as in Japan, money creation on a large scale would eliminate the possibility of selling government bonds to foreign governments…because no one would buy them.

The Politics of MMT
The idea is mind boggling. Think of the political implications of MMT. Politicians could spend almost without limit. Today when politicians vote to spend money, we often hear political commentators saying things like “Is that a good use of taxpayer money?” Or, they may ask “Should we be mortgaging the future for our children?”

MMT has an answer to these kinds of objections: “Don’t worry about it.” In the utopian world of MMT, politicians need not answer to taxpayers because taxation is logically de-coupled from spending. Politicians would have no fiscal accountability to anyone. They could spend money as they pleased and answer to no one. Voters would have no reason to push back on the way the government spent money and there would be an unlimited amount of money to draw upon.

Imagine, with no concern for fiscal responsibility, the politicians who promised the greatest spending would be elected. MMT would be truly transformative. This kind of a system would surely attract huge numbers of new immigrants and with no concern for the economic effect of massive immigration, there would be no reason for any politician to oppose it.  In the most extreme case the U.S. digital printing press could produce an unlimited amount of new currency to support everyone in the world, all 8 billion of us.  Of course, that wouldn’t work, but the extreme case illustrates the folly of the less extreme cases. 

Would adoption of such a system lead to a decline in the U.S. relative to other nations that paid their debts without creating money? Yes, it would seem so. We would see increased confidence in currencies of governments that paid their bills with taxes or sovereign debt and decreased confidence in currencies of governments that paid their bills with a digital printing press. The dollar would gradually lose its position as a favored reserve currency which would reduce demand for dollars and lead to a devaluation.

Remember, U.S. currency was once backed by gold. Anyone who wanted to exchange their dollars for gold could do so. The U.S. changed this policy in the 1970’s and since then the dollar has been backed only by the good faith and integrity of the government. MMT would take the debasement yet one step further. The dollar would be backed only by the government’s ability to create one more digital dollar without creating a panic.

The MMT proponents point to the enigma of Japan as an evidence that MMT may work. Nonetheless, it’s probably hard even for believers to imagine how long MMT would work and to what kind of endgame it would lead.

At its core, MMT is more of a political philosophy than an economic theory. It is the set of economic assumptions and policies required to give a centralized government complete control over government spending without having to answer to anyone. So, is MMT a version of utopia? I suppose only if you fully trust the politicians and monetary gnomes who would be turning the economic knobs in Washington and only if you believe it could last forever. Markets tend to experience long periods of orderly, linear behavior punctuated by infrequent discontinuities (e.g., stock market crashes, a run on banks, the COVID virus). It’s one of those discontinuities (e.g., sudden loss of confidence in the dollar) that could be the eventual undoing of MMT.

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[1] https://www.fiscal.treasury.gov/reports-statements/treasury-bulletin/current.html

[2] https://www.brookings.edu/policy2020/votervital/how-worried-should-you-be-about-the-federal-deficit-and-debt/

[3] https://worldpopulationreview.com/countries/countries-by-national-debt

[4] https://www.stlouisfed.org/in-plain-english/how-monetary-policy-works#:~:text=The%20Fed%20can%20use%20four,funds%20in%20the%20banking%20system.&text=The%20discount%20rate%20is%20the,banks%20for%20short%2Dterm%20loans.

[5] https://www.investopedia.com/articles/investing/081415/understanding-how-federal-reserve-creates-money.asp

[6] Treasury bonds are assets on the Fed’s balance sheet and equivalent new bank reserves are the offsetting liability.

[7] https://www.federalreserve.gov/aboutthefed/files/BSTFRcombinedfinstmt20072008.pdf

[8] https://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1

[9] https://en.wikipedia.org/wiki/National_debt_of_Japan#:~:text=Around%2070%25%20of%20Japanese%20government,sensitivity%20to%20credit%20rating%20changes.

[10] https://www.investopedia.com/modern-monetary-theory-mmt-4588060

[11] https://en.wikipedia.org/wiki/Functional_finance

[12] https://en.wikipedia.org/wiki/Warren_Mosler

[13] https://stephaniekelton.com/

It was August 27, 1970, a hot, humid day in Amsterdam, a small, working-class manufacturing town that straddles the lazy Mohawk River, named after the Indian tribe that once inhabited the river valley in upstate New York.  The town was over two hundred and fifty years old and there were still families whose ancestors were the original Dutch and English settlers in the area, but the majority of the population now was comprised of Italian, Polish, Eastern European and Irish immigrants whose families had come to Amsterdam to work in the carpet factories.   In its center was a bridge that hung across the Mohawk and oversaw the barges headed west along the river to Lake Erie or east to the Hudson and then to the Atlantic.  The river was once a place for fishing and swimming, but those days were long past.  Parents told their kids to stay away from the river or they’d sure catch a disease of some sort.  It was still nice to look at.  The old Italian men still enjoyed watching the trains across the river as they played bocce at their river-front club on the south side. They were from the old country and they brought some of the ways from the old country. They ate dandelions and mushrooms that they picked at the bocce club, and some may have even fished in the river. 

It wasn’t just the Italians that had a club.  Every immigrant group in the town of thirty thousand had at least one club and church.   The Irish had the Hibernians and St. Mary’s; the Polish, Polish National Legion and St. Johns; the Ukrainians, the Ukrainian Club and St. Stanislaus; the Lithuanians, St. Casimir’s and the Lithuanian Club; and each club had its own softball team that competed in one of the city softball leagues.  Softball was an important part of summer in Amsterdam, just as bowling was in winter.  A man who hit home runs in the softball league or who was frequently listed on the sports page of the Amsterdam Recorder as having bowled three games totaling over 600, could become a home town hero.  Like most working-class towns, for Amsterdam, sports were a big part of life.

Unlike big cities where people lived with anonymity, in Amsterdam you were never far from someone who knew you or someone in your family.  But unlike small villages where folks tended to be friendly, Amsterdamians tended to be competitive. Folks in the city always seemed to be struggling to gain an edge over their neighbors in even the smallest of ways.  Maybe part of it was because there were so many different ethnic groups, or maybe it was just the natural behavior of people who felt frustrated by few real prospects to improve their lives much.  Whatever it was, kids had to be on their toes in Amsterdam or someone would most likely take advantage of them in some way.

During the summer, most folks in town spent weekend days at the lakes about thirty miles north of the city in the Adirondack Mountains.  There was a constant stream of cars on Route 30, the two-lane highway that ran north of town to the lakes.  Kids sitting in the backseats urged their parents to stop at the Tastee Freeze or Herm’s Charcoal Pit, two places on Route 30 that served the best ice cream in the area.  Teenagers revved their cars on Route 30 on their way to Vandenbergs, the beach where teens hung out.  Vandenbergs was an oasis from parents, a place to smoke cigarettes, have a six pack, and flirt.  It cost five dollars to park at Vandenbergs, but access to the beach was free.  So, the object was to pack as many kids in a car as possible to bring down the price.  Vandenbergs was at the end of a narrow winding road from Route 30.  Everybody in town knew that in 1966 a couple of teens died after missing one of the S-shaped turns in the road and smashing their new Jaguar XKE directly into a huge tree.  That story was told many times at the beach, especially after someone looked like they had too much beer to drink on a hot afternoon. 

But on this Saturday afternoon, in a white house on Summit Avenue in a nice middle-class tree-lined neighborhood, Tim “Kelso” Kelly wasn’t headed for the beach; he was just rising from his slumber.  Through his bedroom window he could hear the locusts buzzing, announcing that it would be a hot afternoon.   Kelso was a disorderly looking wiry young man of nineteen with thick brown nappy hair to his shoulders and a scraggly beard.  He looked like he’d be much more at home in Berkeley or Haight-Ashbury than Amsterdam, but that’s where he had always lived.  His father had been a physician in town, but passed away at an early age, leaving Tim and everyone in the Kelly family in mourning for many years to follow. 

Kelso had been out late the night before, mingling with the locals at Baia’s, a small tavern where college-age kids went to play darts, drink beer, talk with the locals or just sit and watch people.  Kelso had only two beers the night before – that wasn’t why he had slept so late.  It was because at that stage of his life he did not like mornings.  It was that simple.  There was nothing to do on a Saturday morning.  He had outgrown Saturday morning television, he didn’t really like breakfast or physical exercise, his white Irish skin was too pale for sunbathing at the beach, he didn’t have a girlfriend, and his chronic blepharitis bothered him in the morning.  So, Kelso tried to stay in bed as long as possible.  He kept the drapes in his bedroom permanently drawn to ease his eyes.  Better not to see the sun, at least until late in the afternoon when the real action started, he always thought.

One thing about Kelso that everyone agreed: although there were few things that interested him, what did interest him he pursued with a passion.  His favorite pastime was lying on his bed listening to music, like his collection of records by Captain Beefheart and His Magic Band, an avant garde band that appealed to only the most cynical of rock fans.   He also coveted his collection of Frank Zappa records, which were of the same genre.   He sometimes played his guitar to the music and imagined himself a Zappa bandmember.  His mother didn’t like him staying in his room so much and she was especially concerned about the kind of music he liked.   “Tim, you should go out and do something. Isn’t there anything you want to get done today?  Get some exercise.  You’re starting to get a potbelly and you’re not even twenty.  Get out of the house and go with your friends.”  she used to say.  “Ah, but Mrs. Kelly, you don’t understand.  Tim is an artiste”, Kelso’s friend Tates Black would say between Yahtzee plays at the kitchen table.  Tates was a huge young man with wild hair, but a gentle, playful manner.  During the summer college break he worked for his father’s refrigeration and cooling business, carrying air conditioners and refrigerators. It was rumored that Tates had lifted a Volkswagen out of a ditch all by himself.   “Artiste, schmartiste”, Mrs. Kelly would retort as she rolled the dice.  “Yes, but he thinks very deeply, like an artiste and he has the heart of a musician,” Tates liked to say. 

Kelso did have the heart of a musician.  He’d sit in his bedroom for hours playing his guitar along with Captain Beefheart.  Perhaps he was dreaming of becoming a professional musician during those many hours.  He never discussed it.   But despite the many hours of practice, his guitar playing was not a match for Eric Clapton, Jimi Hendrix or even the Captain Beefheart band and his singing voice was very average, so he must have realized that he was not destined for stardom as a musician.  However, as if God had given him some consolation, Kelso did have an exceptional talent in one musical instrument — the hand flute.  In fact, Kelso played the hand flute better than anyone in Amsterdam and, some people said, better than anyone in all of New York.  People pointed him out and said, “That’s the guy who plays the hand flute so well.”  This made Tim feel proud and whenever he heard such a comment he threw his shoulders back, cupped his hands, brought both thumbs to his mouth and blew through his thumbs to produce a flute –like sound.  He could produce very loud sounds with the hand flute and had quite a range of different pitches, which astonished listeners.  He knew that he had an unusual gift and although he realized that it wasn’t really all that significant a gift, he did feel good when listeners gave him praise and, at least for now, he felt at peace when he played the hand flute.  He knew that in a town like Amsterdam you could become a celebrity for bowling 600 or doing something like playing the hand flute. 

On his good days Kelso ventured down Summit Avenue, past the home of the Gavry’s. The Gavry’s were a Lithuanian family whose name when they came to Amsterdam was Gavrilchuk. As they used to say about their name, “What’s the big deal? We just decided to chuck the ‘ilchuk’.”

At the intersection with Glen Ave., Kelso took a right and walked down the hill, past Grant Avenue, under the low hanging Maple and Elm trees, past the home of Dutch Howland, the Bishop Scully high school basketball coach, and across Romeyn Avenue to Mac’s Confectionery.  Young children were sometimes in front of the store with their bicycles.  Some would be sitting on the low cement wall at one end of the one-story yellow wooden building looking at baseball cards, talking about the local softball games or eating popsicles; others were sometimes in the vacant lot next to the store playing catch or throwing a frisbee.  The confectionery owners, Mac and Virginia Riano, a couple in their sixties, greeted Kelso as he closed the front door causing the bells attached to the back of the door to jingle.  As he walked past the cash register to the booth area Kelso made a point of stealing a glance at Sally Valar’s legs while she served customers from behind the soda counter.  Sally, a Bishop Scully sophomore, was a few years younger than Kelso.  “Legs to die for”, he’d say to himself.  He secretly fantasized about lots of girls that frequented Mac’s, old acquaintances from high school, just about anyone.   Fantasizing was one of his favorite pastimes and when he sat in the red vinyl booth at Mac’s he’d watch the girls who’d walk in the store and imagine that they secretly desired him. 

When Kelso wanted to get the attention of girls in Mac’s, he’d play the hand flute very loud.   Mac and Virginia sometimes commented to the customers standing near the cash register or sitting at the counter, “I don’t especially like that sound, but isn’t he good at it?”  When he heard such praise, Tim flared his left hand out to change the pitch, demonstrating his range.  When friendly girls were sitting on the red swivel stools at the soda counter, Tim took extra time away from his cherry Coke and Mad Magazine to entertain them.  “Hey girls, listen to this”, he’d say.  The girls, most of them no more than twelve or thirteen years old, shook their heads in acknowledgement and giggled.

There were many Kelso wanna-bes in town, inferior hand flute players, who came to Mac’s to match skills or challenge Kelso.  There was Chris Gavry, (Gavrilchuk) who played a mediocre hand flute at best.  Chris liked to chew bubble gum and smoke Merits.  This gave his hand flute an unusual cavernous sound and a smoky smell.  Then there was Tim McKnight, a former high school football star, who now was more interested in emulating Stephen Stills, his favorite singer, than in catching touchdown passes.  McKnight liked to sing in public, play air guitar and would occasionally play hand flute. There was Tates, who had huge hands, a definite asset for hand flute playing, but who was limited to only two notes – high and low.  And, finally there was Paul Gavry, Chris’ older brother.  He may have been the best of the Kelso followers, but he was still learning the finer points. 

Kelso was very polite and patient when it came to hand flute contenders.  He never directly discussed their failings in the art, nor did he give direct instruction or discuss his hand flute skill.  When the subject came up or when someone made a poor attempt at imitation, Kelso would patiently demonstrate the proper technique.  If the truth be told, he liked following his imitators’ weak attempts with a demonstration of the real thing.  This seemed to be the right compromise between instructing the imitators, which seemed inconsistent with his light-hearted attitude toward life, and ignoring them, which seemed either too arrogant or too humble, he couldn’t decide which.  Usually his demonstrations produced silence and almost reverence.  For example, McKnight and Paul understood their inferiority and would shake their heads in amazement.  But, there were also those like Tates and Chris who were so uncultivated they were unable to recognize their own shortcomings.   Sometimes after giving a lesson to the “contenders” Kelso would smirk to himself before returning to his Mad Magazine.  He knew he was the best and he allowed himself just a little bit of pride every so often.

There were also Kelso protégés in the neighborhood, young neighborhood kids who stood outside of Mac’s practicing the hand flute.   When Kelso wasn’t around, you would hear them say things like, “Here’s how he does it”, or “I saw him do it this way.”  One time a youngster was overheard saying, “You know how they sing that song about the Pinball Wizard?  They ought to sing a song about him called the Hand Flute Wizard.”  When the kids saw Kelso walking down Glen Ave. they stopped playing, stopped talking and watched “the master” as he strolled by into the store.  Then they tried to peek through the window, around the many ads taped to the glass.  As misfortune would have it, Kelso’s favorite booth was directly behind a big yellow and black ad that read “Develop Your Film Here, 24 Pics for $1.99”, but they’d still find a way to catch a glimpse of him and sometimes they could hear him play the flute.

On some days the traffic was very light at Mac’s.  Only a few neighborhood people stopped in to buy bread or milk.  An older neighborhood man named Bob Kroller was there every day.  He nodded at Kelso in the booth and sometimes said hello.  There were lots of rumors about Bob because he was a single man who lived alone and wasn’t very friendly.   He was not especially impressed with Kelso’s hand flute, probably because he didn’t know how the sound was produced or maybe because he was planning strategy for his next softball game.  Sometimes Jimmy “Pie” Sheridan stopped in after visiting his cousins, the Quiris.  Pie was a good-looking, friendly guy who was sent away to prep school in Worcester, Massachusetts because his father wanted him to improve his grades.  Pie always wanted Kelso to teach him to play the hand flute, but Pie never really got the hang of it.  Buster Schuster, sometimes stopped over to the store to buy groceries for his mother.  Buster was a few years younger than Kelso, but big for his age.  For some reason Buster called Kelso “Top”.   “Hi Top, you see anything good in that magazine?  You think it’s goin’ to rain today?  I hope not, I have a baseball game tonight.  My mother told me to drink some milk so that’s what I am goin’ ta buy.” Buster might say.

It was on August 27, 1970, near the end of the summer, that a group of the regulars had met at Mac’s on a lazy Sunday afternoon.  There was Kelso and Tates Black, Chris Gavry, McKnight, Scott Merrow (fellow Irish Summit Ave. resident), Tim Blanchfield (the sweet but feral weight lifter from McClellan Ave.) and Paul Gavry.  Sally Valar and Marie Labate were behind the counter.  Mac and Virginia were at the register, talking to customers and stocking shelves.  Marie had a radio behind the counter tuned to 1540 AM, WPTR which was playing “I Am Woman” by Helen Reddy.  “Hey Marie, switch it to a different station, will ya?”, Paul yelled.  “It’s almost over”, Marie replied. 

Mercifully, the song ended.  “Let’s go take a drive to Vandenbergs, it’s so hot”, Tates suggested.  “Yeah, let’s go” agreed Blanch, “We can grab some beer on the way.  What do ya say Timbo?”

Kelso didn’t answer, he was intent on the next tune that had already started on the radio.  From the first few notes he and everyone else in Mac’s recognized it.  Bumm-bumm-bababa-bumm-bumm-bummm-bumm groaned the electric guitars.  Kelso cupped his hands, put his thumbs together, and raised his hands to his mouth.  The Gavrys took their cue from Kelso, both Paul and Chris raised their hands into hand flute position.  McKnight, who was talking with Marie at the counter, could see the others in the mirror behind the counter and turned to come back to the booth.  Kelso started playing lead hand flute to the unmistakable In-A-Gadda-Da-Vita by Iron Butterfly, the number one rock song at the time.  A very difficult tune for the hand flute, but not beyond Kelso’s considerable reach.  Kelso belted out the tune.  The Gavrys joined-in with bass hand flute and harmony.  Scott started beating out the drums on the tabletop.  McKnight played an imaginary guitar with his right hand and imitated the sound of a heavy steel guitar.  Blanch was dancing in the aisle next to the booth making guitar sounds too.   Paul stopped playing hand flute to sing the lyrics with McKnight and Tates, “In-A-Gadda-Da-Vida, honey, don’t you know that I love you?” they sang while holding imaginary microphones.  Blanch strutted his stuff in the aisle, Paul and Chris kept singing and imitated the typical pained rock star countenance.  Kelso continued on lead flute and Scott kept beating out the drums, “In-A-Gadda-Da-Vida, baby, don’t you know that I’ll always be truuuhuue?”  The guitars whined and all of the by-standers tried to make guitar sounds to accompany Kelso on the flute. The group bellowed out “Oh, won’t you come with me-hee-hee anda take my haahaa-haand? …Oh, won’t you come with me-hee-hee anda walk this laaa-haa-haa-haaaaaand?”  On Kelso’s signal everyone joined in for the chorus with “Pleeeeease take my haa-HAAA-haaa-haaanndddd”.  Then everyone tried to imitate the familiar thundering guitar piece, but Kelso returned to the flute and belted out the rest of the tune so loud, so well and with such style and panache that everyone else stopped and listened.   Marie and Sally stopped serving cherry Cokes, Mac and Virginia stopped what they were doing and came into the booth area, the Kelso sycophants who were peering in the window came in the store, the customers at the counter spun around on their stools.  Everyone watched and listened.  Kelso was at his best, he was in a zone, he was at the top of his game, he was playing with the heart of an artist, he belted out the tune with precision, with flair, with style.  Everyone at the counter was tapping out the beat, Mac and Virginia were clapping their hands to the beat, Blanch and Tates kept dancing wildly in the aisles, and Paul, Chris, McKnight and Scott were making sounds to try to harmonize with Kelso’s lead.  It was a defining, once-in-a-lifetime moment, a surreal moment, one of those moments when everything seems right with the world.  As Kelso finished the song the entire group burst into applause and whistles.  Kelso got hand slaps from everyone around, Blanch yelled out “Tim Kelly, you are the big cheese, you are the big kahuna.”  Marie had a tear in her eye.  “That was beautiful Tim”, she said.  “Yeah, Tim that was real good”, said Sally.  “You know how to play that thing Top,” Buster added.  Virginia turned to one of the customers and said, “I have known him since he was a little boy.  He’s been coming in here for years.  He’s always been such a good boy and so talented.”  It was a real celebration for everyone, a celebration of Kelso’s special hand flute talent.  It was a day in 1970 that will live in the memory of everyone who was at Mac’s Confectionary that special Sunday afternoon.

The gang broke up after that.  Everyone went their separate ways.  Mac’s was closed shortly thereafter.  Mac and Virginia have long since retired and both have passed on.  Bob Kroller passed away many years ago.  Paul married Marie and they now have grown kids, McKnight and Blanch are teachers, and Scott, after 30 years as a Colonel in the Air Force, passed away.  Kelso lives in Ohio and is a lawyer.  The rest have migrated to parts unknown.  Wherever they happen to be, whenever they hear In-A-Gadda-Da-Vita they will always remember that magical day at Mac’s and remember Kelso’s performance of a lifetime on the hand flute.

And, yes, rumors from a small town in Ohio are that Kelso still plays the hand flute but only on special occasions.

In the 1985 movie “Lost in America” Albert Brooks plays David Howard, a yuppie advertising executive who saves $180,000, quits his job and buys a Winnebago to tour the country with his wife.  When they visit Las Vegas, his wife loses all of their money playing roulette.   In the funniest scene in the movie, a distraught Howard lectures his wife on the “Nest Egg Principle”.   “The nest egg is sacred.  We must never touch the nest egg.  The egg is our protector and keeps us safe.  Without the egg we have no protection.”  At the conclusion of his lecture, Howard asks his wife to write “I lost the nest egg” one thousand times.

Baby Boomers should pay attention to Howard’s lecture about the Nest Egg Principle.  In the coming years your nest egg may be in jeopardy. 

Why?

The explanation starts with demographics.  The U.S. is divided politically by race, gender, sexual preference, immigration status and religion.  Soon we will see another major political division emerge – a division by age.  Baby Boomers, born from 1946 to 1964, have long been the largest age group, influencing social trends and controlling most elections, but that is about to change.   Demographic data now show for the first time that Millennials outnumber Baby Boomers.

Millennials and GenZ
Millennials are those born from 1981 to 1996, so today they range in age from 24 to 39.    Gen Z, the group that follows Millennials, includes those born from 1996 to 2020, so voting-age members of the Gen Z group are between 18 and 24. 

Millennials and Gen Z together comprise 37% of eligible voters and this number will only grow as Boomers die off and more of Gen Z reaches age 18.

Shockingly to many Boomers, surveys show that unlike previous generations, Millennials and Gen Z have a favorable view of socialism.   One poll shows that 70% would vote for a socialist.  In another, more than half said they preferred “socialism” to “capitalism”[i]. 

Commentators have debated the reasons for this shift of opinion.[ii]  One view has it that growing inequality in wealth and income is a leading cause.   A shrinking middle class is another possible explanation.  Similarly, underemployment due to offshoring and automation has also been a source of dissatisfaction.  America has long been a place where each succeeding generation has surpassed the prior generation economically and this has set high expectations for Millennials.  Unfortunately, those expectations are not being met by a significant percentage of the group. In fact, almost a quarter of Millennials still live with their parents.  Many Millennials agree with Bernie Sanders that “the system is rigged.

What do Millennials and Gen Z want?  

Since this block of voters will likely hold sway if not in the 2020 election, certainly in future elections, what will they demand of their elected representatives?  That seems pretty clear.  Let’s take a look at the platforms of the politicians who represent their interests — Bernie Sanders, Elizabeth Warren, and AOC, among others.  Their platforms include proposals like:

• Expanded government health insurance,
• Free college tuition,
• Forgiveness of existing college loans,
• Universal guaranteed income,
• Government-funding of alternative energy sources.

These spending programs together will be very expensive, costing many trillions of dollars.  The COVID-19 bailout has already cost a previously unthinkable sum, but the price tag for the Millennial/Gen Z programs will be many times larger.  Even before the pandemic, in fiscal year 2019, the federal deficit was $1 T and the federal debt stood at about 120% of GDP.  In fiscal year 2020, the deficit may reach $4T or more.  

The developing scenario – very large deficits and demands by an increasing portion of the electorate to dramatically increase spending – leads to the inevitable conclusion that the federal government will need to find new and creative ways to increase tax revenue or somehow pull a rabbit from their hat.   

Modern Monetary Theory – A Rabbit from the Hat?
 A possible solution to this dilemma has been offered by economists following the school of thought called Modern Monetary Theory (MMT).   According to this “have-your-cake-and-eat-it -too” theory, the size of the federal debt doesn’t really matter.  One of the leading advocates of MMT, Prof. Stephanie Kelton of Stonybrook University, argues that unlike a business or a household which must repay its debts, the Federal Reserve can “print” large amounts of money to fund initiatives such as a guaranteed income program or public infrastructure projects. And, because the United States can borrow in its own currency, the logic goes, the increase in public sector debt poses no real danger to the economy[iii].   Any debt can be repaid by “digitally printing” more money and furthermore, because of the government’s ability to create money, debt is not even necessary.    

Would MMT actually work?  Most leading economists argue that implementing MMT would lead to a debasing of the currency and, as a result, inflation.  Supporters of MMT sometimes point to Japan which has a debt/GDP ratio of 250% and has been employing a monetary policy that might be described as MMT Lite.  Despite its high debt, the Japanese economy still grows, albeit very slowly over the past 30 years.  Other economists say that what really counts is not the absolute debt but the net debt (debt minus public assets).  According to Koichi Hamada, professor of economics at Yale University, “unlike the U.S., the Japanese government owns very valuable public corporations.  So, by that measure (net debt/GDP) Japan and the U.S. are currently at parity”[iv].   

A post-2020 government may use MMT logic to justify the higher deficits required to fund the Millennial wish list, but it will be only part of the solution.  Deficit spending or money creation alone do not accomplish another one of the Millennial/GenZ objectives: to reduce inequality in income and wealth.  Tax increases would be needed to accomplish this objective. 

What taxes are most likely?
As Yogi Berra once said, “predictions are difficult, especially those about the future”.   Instead of predicting, let’s review a list of the kinds of tax increases the government may impose.

Some politicians tell us that all future bills can be paid by increasing taxes on the top 1% of income earners, but that’s just not true.  The top 1% earn an aggregate annual income of just over $2 trillion.[v]   If the Government were to take an additional 20% of their income, that’s only $400 billion a year, a mere drop in the bucket compared to the size of the anticipated debt.  What if the top 5% were the target?  The combined income of the top 5% is approximately $5 trillion per year, so taking 20% of the total would yield $1.0 trillion in additional tax revenue.  That would help, but it’s still not enough.  Also, there’s the issue of whether such a tax program could actually be successful.  Would people like Bill Gates, Jeff Bezos and Mike Bloomberg stand by and watch the government take 20% more of their income?  I doubt it.  As very large political contributors, they can seek favors from politicians and, because of their vast resources, they can hide their income in countless ways.   

New spending programs cannot be fully funded with personal income taxes because the debt is large compared to the amount of income that could be taxed, the ultra-wealthy would find ways to avoid taxes and imposing very high tax rates may actually cause tax receipts to decline.  Other tax programs would be needed in addition to raising personal income tax rates.

Taxes on Business
Business income taxes include taxes on corporations (C corporations) as well as pass-through entities (S corporations, LLCs, partnerships and sole proprietorships).  Income from the latter group passes through to the owners who must include it as part of their personal income for tax purposes.  The ‘Tax Cuts and Jobs Act of 2017’ (TCJA) allows pass through entities to deduct 20% of qualified business income.  The TCJA also cut the statutory corporate tax rate from 35% to 21%.  This reduced corporate tax receipts by almost $100 billion in 2018 as compared to 2017.   In recent years corporate income taxes have totaled only 15-20% of personal income taxes. 

Candidate Joe Biden has proposed reversing the TCJA, eliminating the 20% deduction for pass-through entities and increasing the corporate statutory rate back to 35%.  This would probably increase tax revenue by $100 to $200 billion, assuming it did not trigger layoffs which it very well may.  This tax would also help to reduce income inequality because many in the top income categories receive much of their income from private businesses.

Unrealized Capital Gains
Elizabeth Warren proposed during her 2020 Presidential Campaign, a “mark-to-market” tax on unrealized capital gains, i.e., appreciation in stock portfolios, real estate or other assets.  With the run-up in stock market and real estate values over the past 10 years, taxing unrealized gains would certainly give the Government access to a huge new tax stream, but fully implementing this kind of a tax would be difficult.   It would require that the cost basis and fair market value of all assets be estimated and verified.  This may be fairly straightforward for financial assets but would be more difficult for other kinds of assets.  Even if the tax were limited to financial assets, taxing unrealized gains would not only generate tax revenue but would also serve to reduce the wealth of more affluent households.   However, a problem with such a tax from the government’s perspective is that the revenue yield would be very unpredictable from year-to-year. In the first year the tax is implemented it would produce a huge windfall, but in subsequent years tax receipts would rise and fall with the stock market. For that reason, a tax on unrealized capital gains may not be the government’s first choice for raising additional revenue.

Estate Tax
According to the IRS, “The Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death. The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. “

Currently estates are taxed 40% by the federal government for amounts in excess of $10.58 million.   Sen. Bernie Sanders has proposed raising this rate to 77% and reducing the dollar threshold.  This is a hot button topic for Sanders and others who believe wealth should not be passed from one generation to the next.  Expect to see this kind of change in the tax code.

Wealth Tax
Another proposal Sen. Warren put forth is to tax wealth. 

What’s included in “wealth”?  Wealth is an individual’s or couple’s net worth, their assets minus their liabilities.  Assets include savings, brokerage accounts, retirement accounts, real estate, vehicles, art, precious metals, and private businesses.  Liabilities include mortgages, home equity loans, business loans, and any other debt

The distribution of wealth, like income, is very skewed toward a small group of the most affluent.  The richest 10% of households own 70% of the wealth.[vi]  And, a very large portion of aggregate wealth is held by Baby Boomers, those over 55 years old who have accumulated savings over many years. 

Herein lies the future battle between Baby Boomers who have accumulated wealth and Millennials/ GenZ who feel cheated and entitled to more. The most direct way for politicians to redistribute wealth is to tax it.  And, this is the biggest threat to Baby Boomer Nest Eggs.   The Boomers have the money and the Millennials want it. 

Current household wealth in the U.S. is about $100 trillion[vii].  Sen. Warren suggested taxing wealth at 2% per year for wealth above $50 million and an additional 1% for wealth above $1 billion during her 2020 bid for the Democrat nomination.  Billionaires, Michael Bloomberg and Howard Schultz, criticized the proposal as unconstitutional, but many legal scholars disagree.  Independent economists estimated that Sen. Warren’s proposal would generate about $275 billion in tax revenue each year.  That’s obviously not enough.  To make a big difference in the federal budget the wealth tax would need to be broadened to include households with less than $50 million in assets.  In the worst (or best) case, if the tax were applied to all household wealth, that would generate $2 trillion in tax revenue per year, enough to fund many of the Millennial/GenZ programs. 

Household wealth could be the pot of gold that politicians need to get elected with Millennial/GenZ votes in the future.  After all, Boomers are dying off; they’re not going to be determining election outcomes in the future.  It’s Millennials and GenZ who will hold sway in elections from now on.  

Source:  www.dqydj.com

Has a Wealth Tax Ever Been Tried?
Fifteen other countries have tried wealth taxes and four countries (Switzerland, Norway, Spain, and Belgium) still have wealth tax programs in place.

In France the wealth tax was repealed because too many wealthy taxpayers fled the country, reducing the tax base.  In 2017 it was replaced with a national property tax. [viii]

In Switzerland, Norway and Spain the wealth tax covers real estate and financial assets.  The taxes affect not just the wealthiest, but also households of more modest means.  For example, in Switzerland the tax is graduated and affects the top 34%.  Anyone with a net worth above the equivalent of US$102,000 is taxed.   In Norway the tax affects anyone with assets above the equivalent of US$181,000.  .[ix]   And, in Spain, the tax is levied on net worth in excess of US$774,000.  The wealth tax in Belgium is imposed only on financial accounts above US$550,000. 

In Switzerland net worth is self-reported and enforcement is lax.  Academic studies show that wealth tax avoidance in countries where it has been tried is common.  One study found that for each 1% increase in the wealth tax, the amount of reported wealth declined by 34%.

Besides taxpayer flight and tax avoidance, another challenge in implementing a wealth tax is valuation of assets.  Valuing financial assets is straightforward and valuing real estate, although there is more leeway, is not difficult.  But, valuing private businesses is not straightforward and it has been a source of conflict between taxpayers and European governments that have imposed wealth taxes.  This is a non-trivial problem since it’s reported that the 1% wealthiest households in the U.S. have 40% of their wealth in private businesses. [x]

Support for Wealth Taxes in Academia

In 2014, French economist Thomas Piketty published a widely-discussed but controversial book entitled Capital in the Twenty-First Century.  He starts with the observation that economic inequality is worsening and proposes wealth taxes as a solution. The central thesis of the book is that inequality is not an accident, but rather a feature of capitalism, and can only be reversed through state intervention.

Emmanuel Saez and Gabriel Zucman, two Economics professors from Berkeley, worked on the “Ultra-Millionaire Tax” proposed by Senator Elizabeth Warren. In their paper, “Progressive Wealth Taxation,” they present arguments for a wealth tax as a way to redistribute wealth.[xi]

Of course, these ideas have been taught in every university in the country, so it’s probably not surprising that recent grads may hold the same beliefs.  As the surveys show, a high percentage of younger generations favor socialism or social programs like those put forth by the 2020 Dem candidates.   And, they believe that wealth is unfairly distributed in the U.S. and indeed around the world. 

So, a tax on wealth could very well gain support of the majority of voters.   Millennials and GenZ will demand bigger social programs and wealth redistribution and politicians will need to deliver the goods to get re-elected.

What Can Baby Boomers Do?

Baby Boomers are in a vulnerable position.  They’ve accumulated assets over a lifetime of work.  They’ve already paid income taxes on at least part of their assets.  If they were to lose their entire nest eggs in Las Vegas playing roulette or part of their nest eggs to a wealth tax, they would have little chance of recovering.  

A wealth tax could be passed as soon as 2021, but because of the need for administrative changes and new IRS auditors to manage such a program, the Government may need to wait until tax year 2022 to make it effective.

What can Boomers do?  Obviously, if you don’t want to be a sitting duck target for a wealth tax, start moving or redistributing assets.  Of course, without knowing the provisions of the tax, that is easier said than done.  Will the tax be levied on all assets, just financial accounts (like the tax in Belgium) or financial accounts and real estate (like Switzerland, Norway and Spain)?  Will the IRS turn a blind eye to accounts held overseas (as Switzerland does and France apparently did)?   No one knows.   The politicians will consider factors like revenue generation, ease of implementation, backlash from political contributors, and flight of the wealthy.  Without knowing the details of the tax, we cannot know exactly what we should do now, but again, let’s review the possibilities.

In the past, the wealthy commonly parked funds in overseas accounts in Switzerland, the Cayman Islands or other tax havens.  Indeed, a Financial Secrecy Index produced by the Tax Justice Network ranks Switzerland and the Cayman Islands as two of the top places for hiding private wealth. The same report estimates that $21 trillion to $32 trillion worth of private wealth is located in what it calls “secrecy jurisdictions” around the world where the money is lightly or entirely untaxed.[xii]  The old tax dodge was to minimize income taxes.  That still exists, but the U.S. government is going to great lengths to clamp down on tax havens and this will affect taxpayers’ options for avoiding a wealth tax.  

In 2010 Congress passed the Foreign Account Tax Compliance Act (FATCA) which requires all non-U.S. foreign financial institutions (FFIs) to search their records for customers with a connection to the U.S., including indications in records of birth or prior residency in the U.S., or the like, and to report the assets and identities of such persons to the U.S. Department of the Treasury.[xiii] FATCA also requires such persons to report their non-U.S. financial assets annually to the Internal Revenue Service (IRS).  As a result of FATCA, the U.S. has signed compliance agreements not only with the Swiss government, but also with the governments of other once-favored tax havens like the Cayman Islands, Bermuda and Mauritius.   Currently, Monaco and many African and Asian nations have not agreed to comply with FATCA.[xiv] 

In addition to FATCA, under Bank Secrecy Act regulations issued by the Financial Crimes Enforcement Network, U.S. tax filers are required to report on foreign financial accounts exceeding US$10,000 on their tax returns.[xv]   Therefore, to comply with current regulations, if cash or other assets were moved offshore, the assets would need to be moved outside of the international banking system.

What about overseas real estate?  As of the 2019 tax year, the IRS does not require individuals to report international real estate holdings.  Property taxes on international real estate can be itemized as a deduction and rental income must be reported, but the holdings and value of the holdings need not be reported.  If the real estate is owned by a corporation and not the individual, then the foreign corporation must be disclosed on the individual’s tax return. 

In February 2014, the Organization for Economic Development (OECD), also known as the G20, first presented a new global standard for information exchange, the Common Reporting Standard (CRS), a broad system of automatic information exchange between nations. The CRS does not include any provision for exchanging information regarding real estate holdings.  It’s possible that owning international real estate in the right country may be a way to free assets from taxation. 

A few years ago, some financial advisors were touting cryptocurrencies as a way to place funds out of reach from the government, but the IRS, (presumably fearing that crypto is a way for drug cartels to launder money or for terrorist organizations to secretly exchange funds), is clamping down on that strategy.  They have recently asked Coinbase for a list of all of their account holders and for buy and sell data.[xvi]  Also, 2019 is the first tax year in which filers must report on their crypto investment gains, but buying cryptocurrencies from an international exchange may still be a good way to secure assets and stay within the law.  The CRS does not cover cryptocurrencies.

Another strategy would be to liquidate brokerage accounts, IRAs, and real estate investments and store cash in a home safe or other secure location.  One could also invest in precious metals, art work or collectables.  To comply with the Patriot Act, financial institutions must report any account withdrawals above $10,000 to the IRS[xvii], so withdrawing the money in small increments may be a good idea.

Baby Boomers could transfer assets to children to reduce net worth, but transfers above $15,000 are subject to gift tax.  Also, the IRS sets an $11.4 million tax-free lifetime limit on gifts. 

One could also take a low-interest loan to reduce net worth and shield assets from taxation.  With interest rates so low, that may not be a crazy idea.

Historically, the very wealthy have sheltered income by setting up shell companies overseas or sometimes networks of interlocking foreign corporations, making it very difficult for the IRS to untangle the web to find funds.  With the help of the best accountants and tax attorneys, the wealthiest will find ways to avoid a wealth tax using similar schemes.  For all but the top .1% these kinds of strategies are currently not as attractive because of the cost, but clever, entrepreneurial law and accounting firms may start offering these services as a wealth-tax shelter to those in the 90 to 95 percentile categories.

The bottom line is if a wealth tax becomes law, it will be too late to secure assets.   We obviously don’t yet know the tax rates that will be imposed, the wealth levels that will be affected, the loopholes that will be left open, or how vigilant the IRS will be in enforcing the law.  To avoid taxpayers fleeing the country, like what happened in France, the IRS may take more of a lax-enforcement approach, as Switzerland does. 

However, in a worst-case scenario, many retirees may be faced with an awful choice– to pay the wealth tax and sacrifice much of their nest egg savings or renounce their U.S. citizenship and move to another country.   Renouncing U.S. citizenship would mean Baby Boomers would need to forego all future social security and Medicare benefits (and possibly even private pension benefits), after having paid into these programs for many years, but that may still be cheaper than sacrificing 2% of net worth every year.   Those owning private businesses would obviously need to sell their businesses before the tax becomes effective.

Foreseeing the possibility of taxpayer flight, Sen. Warren’s plan would place a 40 percent exit tax on any U.S. taxpayer who renounces their citizenship and flees the country.  This tells us that the politicians are willing to play hardball with Baby Boomers to achieve their objectives.  To avoid such an exit tax, one would need to leave the country and move all assets before such a tax would take effect.[xviii] 

The Nest Egg Principle Revisited
A strong case can be made that a wealth tax will be imposed and, because of the need to raise huge sums, will affect not just the ultra-wealthy but also perhaps those in the top 10%.   Taxing the top 10% (those with a net worth of $1.2 million, based on 2017 wealth data) would give the IRS access to 70% of household wealth.[xix]. 

A wealth tax would hurt billionaires and other ultra-high net worth individuals less, not only because of their much bigger financial cushions but also, as mentioned, because they would be able to find many more ways to avoid taxes by: finding loopholes in the law and cleverly engineering their finances.  Billionaires may also lose less by leaving the U.S. and moving to another country.  As mentioned, for the ultra-wealthy, losing Medicare and Social Security benefits would be trivial in comparison to losing 2% of their wealth each year.  

This is a good time for individuals who are 55+ to remember the Nest Egg Principle.  For retirees, “the nest egg is sacred.”  Many Baby Boomers need their nest eggs to maintain their standards of living during retirement and some, to pay for necessary expenses.   Boomers should start making plans now to protect their nest eggs in case a wealth tax is imposed.  After the tax becomes law, it will be too late. 


About the author:  David Stahl is a baby boomer and vigilant nest-egg watcher.  He is retired from 25 years of investing venture capital in technology start-up companies and currently teaches MBA classes part-time.  He has been to Las Vegas a number of times to attend trade shows, but has never played roulette.

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[i] https://www.salon.com/2019/10/29/new-poll-finds-70-of-millennials-say-theyre-likely-to-vote-for-a-socialist/

[ii] https://www.businessinsider.com/millennials-would-vote-socialist-bernie-sanders-elizabeth-warren-debt-2019-10

[iii] https://www.weforum.org/agenda/2019/07/japans-answer-to-economic-deficit/

[iv] ibid.

[v] https://taxfoundation.org/summary-latest-federal-income-tax-data-2018-update/#:~:text=In%202016%2C%20the%20top%201,percent%20of%20all%20income%20taxes.

[vi] https://www.marketwatch.com/story/the-richest-10-of-households-now-represent-70-of-all-us-wealth-2019-05-24

[vii] https://www.brookings.edu/blog/up-front/2019/06/25/six-facts-about-wealth-in-the-united-states/#:~:text=1.,total%20assets%20minus%20total%20liabilities.

[viii] https://en.wikipedia.org/wiki/Wealth_tax#cite_note-49

[ix] https://en.wikipedia.org/wiki/Wealth_tax

[x] The Problem with a Wealth tax, Wall Street Journal January 11, 2012

[xi] https://en.wikipedia.org/wiki/wealth_tax

[xii] https://fsi.taxjustice.net/en/methodology/secrecy-indicators

[xiii]  “Sec ii B 1 Agreement between the government of the United States of American and the government of the United Kingdom of Great Britain and Northern Ireland to improve international tax compliance and to implement FATCA” (PDF).

[xiv] https://www.ustaxhelp.com/which-nations-have-igas-with-the-united-states/

[xv] https://en.wikipedia.org/wiki/Bank_Secrecy_Act

[xvi] https://www.coinbase.com/bitcoin-taxes#paytaxes

[xvii] https://www.reedsmith.com/en/perspectives/2001/12/banking-aspects-of-the-usa-patriot-act#:~:text=5311%20et%20seq.%2C%20and%20related,reported%20on%20suspicious%20activity%20reports.

[xviii] https://www.accountingtoday.com/articles/democrats-love-a-wealth-tax-but-europeans-are-ditching-the-idea

[xix] https://equitablegrowth.org/the-distribution-of-wealth-in-the-united-states-and-implications-for-a-net-worth-tax/