The Second Great Economic Experiment: An Update by Ron Muhlenkamp At our June 3, 2014 investment seminar, I addressed The Second Great Economic Experiment: How’s It Going?
(A seminar archive is available at www.muhlenkamp.com).
Ron Muhlenkamp: Current fiscal policies
In October 2009, I first voiced my opinions on current fiscal policies in my Quarterly Letter:
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In the area of rules and regulations, I don’t believe anyone can state what the tax rules will be a year from now, or what the regulations will be on companies providing health insurance or carbon dioxide emissions. I do suspect that people will be reluctant to start or expand a business, at least until the rules are known—and not just business people. As a result of proposed rules, we know doctors who are considering retiring and others who are discouraging their kids from becoming doctors.1
I have continued to express my thoughts on this topic (some think it’s become a rant) in Quarterly Letters, conference calls, and investment seminars over the past five years. We are now seeing data that confirm my fear:
- When it was begun 40 years ago (1974), the Wilshire 5000 Total Market Index comprised the stocks of about 5,000 companies. The number grew to 7,500 in 1998. Currently, that list of companies is more like 3,700. (We’re trying to fill in the gaps in the data; we will report to you when we do.)
- In 2013, the fraction of families that owned a privately held business fell to 11.7%, the lowest level recorded in the Fed’s triennial Survey of Consumer Finances, dating back to the 1989 survey. While the mean value of family-owned businesses increased from $844,800 in 2010 to $973,900 in 2013, it remained below the 2007 level.2 (The businesses included in this category are sole proprietors, limited partnerships, S corporations, and other types of corporations that are not publicly traded.)
Bottom line: Today there are fewer businesses, including both publicly and privately owned companies, and, therefore, fewer employers. Some argue this is the result of aging baby boomers selling their business, but they sell to someone. And, of course, corporate mergers and acquisitions always lower the number of companies outstanding, but in the past these combinations were more than offset by new companies being formed.
When do you expect it to be easier to find a job: when the number of businesses is expanding or contracting?
Ron Muhlenkamp: Increased costs of regulations
In last quarter’s newsletter [Muhlenkamp Memorandum #111], we showed the increased costs of regulations to our mutual fund since 2001. The rise in regulations to the financial services industry began with Eliot Spitzer, who was Attorney General of New York state from 1999-2006 and spread to other industries with Sarbanes-Oxley in 2002. Dodd-Frank was passed in 2010, but only half the regulations have been published to date. (If you are interested in reading Alan Greenspan’s comments on “regulatory over-reach,” )
We are not alone.
While the Federal Reserve has a dual mandate (stable prices and maximum employment), its tools are limited and not always beneficial. Allan Meltzer, author of A History of the Federal Reserve and professor of political economy at Carnegie Mellon University, sums it up nicely in a July 2012 “op-ed” in The Wall Street Journal:
Today’s economic problems are serious, but the Fed can’t do much about them if these problems are not monetary. Very expansive monetary policies did help during the crisis of 2008-09, but they’re not what is needed now. To get out of our bad economic situation, we need coherent long-term fiscal policy, especially entitlement reform.
With mortgage rates lower than ever and housing showing very sluggish recovery, what can be gained by dropping the mortgage rate another small fraction? Business investment is held back by uncertainty. No one can reliably calculate tax rates, health-care costs, and the regulatory burden until after the election, if then. How can corporate officers calculate expected return when they cannot know these future costs? How is more monetary stimulus today supposed to help? 3
It’s long past the November 2012 elections and nothing has improved. At her Semiannual Monetary Policy Report to the Congress on July 15, 2014, Janet Yellen, Federal Reserve Chairwoman, acknowledges using monetary policy to compensate for the inaction of Congress:
Fiscal policy for a number of years has been a drag on growth. We can translate that into a factor that has necessitated lower-than-normal interest rates to get the economy moving back on track.
Ron Muhlenkamp: Fed’s offset bad fiscal policy with monetary policy
So the Fed is trying to offset bad fiscal policy with monetary policy. In my opinion, it can’t be done. If I read Professor Meltzer correctly, he said it can’t be done. And we can find no evidence that the Fed’s policy is working. Low interest rates have not served to boost the economy or employment. The economy is growing at the lowest sustained rate since at least WW II and employment continues to decline as a percent of the work force. (The unemployment rate is declining because the calculation of the number ignores those who quit looking for work; refer to Figure 1.)
Low interest rates have not reflated the housing market, business investment, or employment—all of which require a measure of long-term faith by individuals and/or company executives. Low interest rates have encouraged short-term financial engineering by hedge funds and company executives, resulting in increases in borrowing and in mergers, acquisitions, and stock repurchases. But that does not create additional production capacity.
Wilshire 5000 Total Market Index is a market capitalization-weighted index composed of publicly-traded companies that meet the following criteria:
- The companies are headquartered in the United States.
- The stocks are actively traded on an American stock exchange.
- The stocks have pricing information that is widely available to the public.
One cannot invest directly in an Index.
Stay tuned for the next update on The Second Great Economic Experiment in our next quarterly newsletter.
Figure 1 Labor Participation Chart, 1948 – Present
1 Muhlenkamp Memorandum, #92; Ron Muhlenkamp’s Quarterly Letter; October 2009
2 Source: Federal Reserve Bulletin; September 2014; Vol. 100, No. 4
3 What’s Wrong with the Federal Reserve?; The Wall Street Journal; July 9, 2012