Financial Review

Wednesday, June 25, 2014 – Use Your Library Card at a Copy Shop for a Horseback Ride to the Moon

Use Your Library Card at a Copy Shop for a Horseback Ride to the Moon
by Sinclair Noe


DOW + 49 = 16,867
SPX + 9 = 1959
NAS + 29 = 4379
10 YR YLD – .02 = 2.56%
OIL + .74 = 106.77
GOLD – .60 = 1319.40
SILV + .09 = 21.12
One of the jobs of the Commerce Department is to calculate the gross domestic product of the country; clearly it is a difficult task to figure out the value of all the goods and services produced, and so they tend to revise the numbers as they gather information. In April the Commerce Department figured the economy grew, just barely, 0.1% in the first quarter; last month they revised their GDP numbers to negative1.0%; today they revised GDP even lower. The economy shrank by 2.9%.


To understand the big move, you first have to realize that the GDP number is supposed to measure everything; construction and demolition, marriages and divorces, broccoli sales and cigarette sales, yoga classes and cancer treatments. One of the big reasons for the negative number is that the cost of healthcare dropped significantly.


The US spent $6.4 billion less on health care in the first quarter than in the last quarter of 2013. Government statisticians initially forecast a 9.9% increase in health-care spending, and what we got was a 1.4% decline. Considering all the millions of previously uninsured people who are gaining access to health insurance under the Affordable Care Act, how can they be shrinking so dramatically?


Health-care costs overall have been increasing more slowly in recent years compared with the pace before the 2007-09 recession. Slow growth in the price of health-care services combined with a decline in the amount of health care people consumed in the first quarter. Still, health-care spending is expected to accelerate again in coming quarters as the millions of people who gained health insurance coverage during the Affordable Care Act’s first open enrollment period begin to use their new coverage. Most people who got coverage at the start of the year, are just now figuring out how to use the coverage. So, the idea that people are spending less on health care may hurt the GDP number but that doesn’t mean it’s a bad thing. This also means that the economists don’t really understand how Obamacare is affecting the economic data; and that means they don’t really know how long it will distort data. This is new territory.


A couple of other areas were also involved in shrinking the economy. Companies continue to hoard cash and shun investing in new equipment or new employees; and that will continue until demand picks up; we’ve been told demand will pick up, any day now…, it’ll pick up…., that’s what we’ve heard for a few years.


Another rough spot for GDP was in trade. The trade deficit widened in the first quarter, which would typically indicate growth, but in the first quarter both imports and exports dragged down growth. And then trade was disrupted by the weather, the excuse that keeps giving and giving.  And now that the winter has turned to spring and spring to summer, the economy will bounce back like a kangaroo on a trampoline. Maybe. Consider that when the economy shrank in the first quarter of 2009, the country lost 2.3 million jobs and the markets were in a free fall. Fast forward to first quarter 2014 and the markets are around record highs while the country added about 600,000 new jobs; hardly the stuff of gloom and doom.


Today’s GDP revision might give the Federal Reserve cause for pause, or more likely it will reinforce their dovish inclinations for monetary policy. On the fiscal side, if policymakers in Washington are concerned enough to give the economy a boost, they can consider straightforward measures that would promote growth and create jobs: invest in infrastructure, restore extended unemployment benefits, hire public-sector workers like teachers and first responders, and basically abandon austerity measures in general.


You may remember the gloom and doom days of 1973, when OPEC imposed an oil embargo; prices jumped, lines formed at gas stations to buy rationed gas. Lawmakers responded by limiting the export of oil from the US; we could still export gasoline and diesel but not oil. It didn’t make much common sense but that was the response to the embargo. Things have changed.


Now, oil drillers are tapping shale formations and so much oil is flooding out of the ground that prices for ultralight oil have dropped as much as $10 below the price of traditional crude oil. Which sounds good if you are a consumer, because you might think it would result in lower prices at the pump. But as you know, the price at the pump has been going up because of the crazies in Iraq, and Libya, and Ukraine. Rather than let the oil build up and let prices drop, the plan is to export that oil under a process known as a private ruling which would relax the export restrictions.


The private rulings by the Commerce Department define some ultralight oil as fuel after it has been minimally processed, making the oil eligible for sale outside the US. Export could start in August, and could increase to more than 700,000 barrels a day by next year. The Commerce Department has given permission to two companies to ship ultralight oil: Pioneer Natural Resources and Enterprise Products Partners.


So if you were hoping that all that domestic oil drilling would lead to lower prices for America, yea, that’s not going to happen.


Have you ever been on the floor of one of the commodity exchanges, or maybe seen pictures of the commodities traders? Thirty years ago, the scene was a violent confrontation of traders battling it out in the pits. Nowadays, the trading is much more subdued. Traders walk around with a portable computer that calculates the price in real time. That formula that is on every commodity trader’s computer is a continuous time option pricing model known as the Black-Scholes-Merton formula. Robert Merton and Myron Scholes won the 1997 Nobel Prize in Economics for their formula; Fisher Black passed away in 1995.


Robert Merton went on to create computerized arbitrage trading formulas and he advised hedge funds for a while, including the Arbitrage Management Company and Long Term Capital Management. He then settled down to work as a professor at MIT, where his current academic include financial innovation, controlling macro financial risk, and managing sovereign risk.


Bob Merton says your 401K is dangerous. In an article published in the Harvard Business Review, Merton writes: “The only way to avoid a catastrophe is for plan participants, professionals, and regulators to shift the mind-set and metrics from asset value to income.”


Instead of telling you how much you’ve accumulated in your 401K, the plan administrators should be telling you the amount of sustainable income an employee can expect to receive in retirement. The “risk is retirement income uncertainty, not portfolio value.” That’s not to say that 401k money shouldn’t be invested in stocks. In fact, Merton says, 401k investment managers should invest participants’ savings in a mixture of “risky assets,” including equities, and “risk-free assets,” such as long-term US Treasurys and deferred annuities. Merton says the solution  for employees who want to lock in retirement income, “the obvious decision is to buy the annuity.”


By disclosing annual income, Merton says, employers would help employees quickly and easily calculate how much of their annual salary they can expect to replace in retirement, together with Social Security. As a result, employees would be better able to take action to ensure they are on track to retire as planned.


The Supremes are in session and handing down decisions on a daily basis. Let’s start with American Broadcasting Company v Aereo; the Supremes delivered a major victory to the nation’s television networks, ruling that an upstart Internet company was violating copyright laws by transmitting their programs without paying for them. It was a 6-3 vote; in the majority, Justice Breyer said Aereo’s use of modern technology to stream broadcast television was not much different than cable systems that must pay the networks for its content. Meanwhile, in the minority, Justice Scalia said that Aereo is a copy shop that gives its customers a library card. I’m not sure how you might use a library card at a copy shop, but anyway, Kinko’s is out of business and so is Aero.


Today the Supremes also ruled on a couple of fourth amendment cases. The Fourth reads, in part: “The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause…” and apparently your smartphone falls under the category of “papers and effects”.


Riley v. California and United States v. Wurie featured similar facts. Defendants were detained validly, one for driving with expired tags and the other for a hand-to-hand drug sale. Police searched them, as they had every right to do, and seized their phones. Without getting a warrant, they looked at the contents of each phone and found evidence that led, eventually, to much more serious charges: gang-related attempted murder in the first case and drug distribution and weapons violations in the other.


California state courts refused to overturn Riley’s conviction when he appealed the attempted murder charge, but the 1st Circuit Court of Appeals reversed Wurie’s conviction and ordered a new trial on the grounds that the warrantless search violated the Fourth Amendment’s prohibition against “unreasonable searches and seizures.”


Police can search a suspect’s pockets, or briefcase, or car when making a valid arrest because there may be weapons nearby or evidence of crime that could be lost. In addition, officers can search when there are “exigent circumstances,” meaning when there is no time to lose, in order, say, to stop a crime in progress, prevent suspects from destroying evidence, or rescue a kidnap victim. Prosecutors in both cases argued that searching a cell phone is really just the same thing as the valid search of personal items. Chief Justice Roberts didn’t buy it, replying, “That is like saying a ride on horseback is materially indistinguishable from a flight to the moon.”


Roberts wrote the opinion for the unanimous decision and concluded: “We cannot deny that our decision today will have an impact on the ability of law enforcement to combat crime… Privacy comes at a cost.”



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