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Hoisington Q1 Letter


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observation:

 

Our GDP was growing at 4.8% ten years ago, and today we are staggering out of recession.

 

conclusion:

 

Thus, contrary to conventional wisdom, monumental government spending produced less growth,

 

 

His analysis begs the question:  

Did the bursting of a massive bubble of overinvestment slow GDP growth, or was it the government spending that slowed GDP growth?  In other words, did the 4.8% GDP growth of 10 years ago... did that in any way reflect the bubble?  So as the bubble unwinds and GDP growth slows, should we ignore that and instead conclude that GDP growth is slowing down because of the government spending?

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He supports his argument with Japan beginning at 1989 -- another terminal point where a massive bubble collapse could instead be the cause of the slower GDP growth.

 

He would be more convincing if he used an example that involved an increase in government spending but did not use a massive bubble collapse as it's terminal point.

 

Otherwise he muddies the issue.

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Why are we surprised with the conclusion that more government spending produces some growth but leads to more taxation which causes the economy to shrink. Isn't it because almost all of us unquestionly accept Keynesian theory despite massive evidence that the theory is mistaken? Keynesian is like communism. It sounds great in theory but when human nature is taken into account they both fail miserably.

 

What is most government monies spent on? War, Homeland Security, Prisons and Anti-Drug and Anti-Terrorist War, expanding Bureaucracy and regulation all destroy resources, weaken society and erode confidence. Vast resources are wasted on phoney tax privileged foundations that push phoney theories causing massive waste in government spending. Even good spending like education causes harm when meritocracies are replaced by rent seeking, seniority based bureaucracies where increasing numbers are paid not to work.

 

Economic growth used to be less than 0.25% per annum for centuries until the British stumbled upon the sources of growth. You need easy transportation and communication, scientific rationalism, access to capital and the efficient deployment of capital, and property rights. (Birth of Plenty http://www.efficientfrontier.com/ef/404/CH1.HTM) How much government spends is less important than whether their activities foster or inhibit the sources of growth. The US is currently failing miserably while Canada, especially western Canada is doing well. We need less and better government spending such as better rule of law (http://www.economist.com/culture/displaystory.cfm?story_id=15495776).

 

 

 

 

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I love how economists like Hoisington and John Taylor refuse to even consider the counterfactual, which is that without the policy response that was implemented, we would have gotten another Great Depression.  Hoisington loves to set up the policy response as spending our way to prosperity when it's really spending to prevent economic collapse. 

 

Note that it would be impossible to really rely on econometric data in this recession because balance sheet recessions do not occur with the same frequency as normal recessions.

 

Below is a link to a recent Richard Koo presentation.  I would love to hear a direct rebuttal to this presentation from Hoisington, which I believe is the most compelling, nonconventional argument for the US policy response.  It's total BS to say that this is standard economic thought.  The Friedmanites have been running amok for years. 

 

http://www.scribd.com/doc/29914022/Koo-April-2010

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Thanks for the Koo article.  He's someone I need to start keeping an eye on for new material.

 

Two parts really disappoint me about this Hoisington letter.  One was already mentioned: that he references GDP growth of one bubble era and compares it to today's era to conclude that presto, government spending is bad.  Second, he totally misunderstands Keynes.  You can't point to studies on the effectiveness of government spending done in periods of prosperity and high private sector investment.  In these periods, it is inefficient for government to take resources and use it on public spending.

 

But when fear is prevalent and private sector investment drops off a cliff (and so idle saving is everywhere) (which is the situation where Keyne's whole book is about), to let fear rule and let this money sit idly is the worst thing possible.  Government has a situation: a ton of money is risk averse and is willing to be lent to them at next to nothing.  Meanwhile unemployment is high.  Combine the use of the two resources to produce something productive in the interim, until the private sector is willing to step in.  Then and only then, should the government step back.

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The Hoisington letter effectively assumes that the spend & benefit are in the same 'period', & that both private & public spend for largely the same reason. Within that framework it's right

 

But ... A government borrowing today to fund investments in 'green' energy infrastructure (ie: direct investments, & paying well above market rate for 'green' energy) is essentially building its future industrial base to create 'green' jobs, new markets, green energy exports, etc. Todays cost does not reflect the future GDP growth, or the revenue from the sale of future carbon credits. The 'collective' corporate world is just rolling over & deleveraging existing debt; its not actually investing.

 

Koo is correct overall, but doesn't recognize that companies will not just delever - they'll also exploit the opportunity to extend maturities & refinance at much lower rates. Companies get a lot healthier & quicker, but there's no benefit to individuals as nobody other than the sovereign wants to borrow.

 

Net result if you believe it, is minimal cost pressure as interest savings offset higher input costs from FX devaluation. But ... if you think global QE cannot be safely unwound, we get higher rates and higher input costs, & every other company going bankrupt as they can't deleverage quickly enough.

 

Once in a lifetime opportunities.....

 

SD

 

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I am a little surprised that the board members are taking the authors to the shed. As we have been discussing Hoisington's letters for several years now, this is just the same theme as in the past. Nothing really new, as the same points of no pricing power, Irving Fisher Debt Deflation, lower interest rates heading our way, quarterly commentary.

 

However, I guess you are either in their camp, or not. I would suspect that nearly 80% of the investment community is on the other side of this theme. Time will tell.

 

 

Cheers

JEast

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More like a seesaw.

 

One end has 80% of the people out a short distance (market view), the other has the remaining 20% of people out a far distance (Hoisington). A small change in the 20% generates a disproportionate effect; hence the once in a lifetime impacts.

 

There's also an element of denial to it. If you grew up in the US & all you've ever experienced over the last 50 years is inflation; deflation, & the US as anything other than the 'center-of-the-universe' is a very alien concept.

 

SD

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Koo is correct overall, but doesn't recognize that companies will not just delever - they'll also exploit the opportunity to extend maturities & refinance at much lower rates. Companies get a lot healthier & quicker, but there's no benefit to individuals as nobody other than the sovereign wants to borrow.

 

Koo's thinking is colored by his experience with Japan.  I agree that in the US and certain other countries, companies will get healthier quicker, which could potentially lead to a Japanese lost decade speeded up. 

 

Hoisington is correct to criticize the effectiveness of government spending in normal times, but these are not normal times, and he always fails to consider the counterfactual situation, which is what Koo's thinking is all about.  We have Keynesian spending policies not because that is always the right thing to do, which is how many "conservatives" characterize the policy response (it fits very well with a political narrative about profligate "liberals" who always want to throw money at a problem), but because this is an unusual situation where the government must borrow and spend money in order to prevent an economic equilibrium where GDP is much lower and where unemployment is much higher.  The next step is to ween the country off of life support and let the private sector replace the government as borrower and spender.

 

Also, there's a big distinction between QE and fiscal stimulus, which people don't seem to get.  They think it's all one and the same thing, but it's not.  Koo is very explicit about his distaste for bringing down interest rates and implementing extraordinary measures (QE) as the solution to our problems.

 

Note that if you believe Koo or David Rosenberg, you believe that interest rates will remain surprisingly low for a long time.  This comports with Hoisington's forecast of deflation and low interest rates. 

 

It is Hoisington's insistence that the US government is trying to spend our way to prosperity that is maddening.  That's not what is happening, despite what politicians might say.  The writing has been on the wall for a long time, and now the US is implementing reactive policies that are necessary due to the lack of foresight on the part of our policymakers in the last couple of decades.

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I am a little surprised that the board members are taking the authors to the shed. As we have been discussing Hoisington's letters for several years now, this is just the same theme as in the past. Nothing really new, as the same points of no pricing power, Irving Fisher Debt Deflation, lower interest rates heading our way, quarterly commentary.

 

However, I guess you are either in their camp, or not. I would suspect that nearly 80% of the investment community is on the other side of this theme. Time will tell.

 

 

Cheers

JEast

 

 

Hoisington does point out that government action will work to cure debt deflation so long as the government starts a massive war that encourages people to put an unprecedented amount of their savings into war bonds, put 30 million people into uniform (a huge make work project) and send enormous amounts of munitions to our allies.  Meanwhile, the public sector debt skyrockets in the process.

 

http://www.hoisingtonmgt.com/pdf/HIM2009Q1NP.pdf

 

However, the dynamics during the War were much different than from those of 1929 through 1941 and today. The U.S. ran huge trade surpluses as we supplied military and other goods to allies, which served to lift the U.S. economy through a massive multiplier effect. Additionally, 10% of our population, or 12 million persons, were moved into military services. This is equivalent to 30 million people today. Also, mandatory rationing of goods was instituted and people were essentially forced to use an unprecedented portion of their income to buy U.S. bonds or other saving instruments. This unparalleled saving permitted the U.S. economy to recover from the massive debt acquired prior to 1929.

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This makes me wonder.  Hoisington thinks that would work, so why don't we just do it?  Put 30 million people into make-work projects, suck enormous amounts of money from the private sector (sell war bonds), finance the whole thing with huge government debt...  we could just skip the shooting war though.

 

We could make lots of tanks and airplance, ships, grenades, food, etc...  we can put them on huge convoys and just throw it all overboard before we get to England.

 

Why does Hoisington think government programs won't work, yet he argues that such programs are exactly what cured the Depression during the WWII years?

 

He says that sending all the war supplies to allies had a massive multiplier effect.  We weren't paid for those items, it was lend-lease (is that really a trade "surplus" if your trading partners are broke and issue IOUs?).  Or am I wrong... did we get substantially repaid?

 

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Here is the answer:

http://en.wikipedia.org/wiki/Lend_lease

 

America was repaid for the lend-lease program 10 cents on the dollar.

 

Hoisington's conclusions that a massive trade surplus with a huge multiplier then are interesting to debate.  He is contradicting himself when he says government spending can't work, then he also maintains that it has a huge spending multiplier.

 

He calls it a trade surplus when we're getting paid with IOUs that get settled for 10 cents on the dollar.

 

It undermines much of what he argues about in the current letter.

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