Predictions for 2010

Following the tradition I started one year ago, in which my predictions for 2009 proved amazingly accurate, here’s what I think will happen to the economy and the markets in 2010. Caveat: last year’s accuracy provides no assurance whatsoever that this year’s predictions will be accurate or profitable.

Inflation: Inflation hit a low ebb one year ago, and has been trending slowly higher since. I think inflation will continue to trend slowly higher, because all of the key leading indicators of inflation are still saying that monetary policy is accommodative: the dollar is weak, gold is strong, the yield curve is very steep, commodities are strong, breakeven inflation rates on TIPS are rising, and credit spreads are declining. I don’t see significant inflation on the horizon, but I do believe that inflation will exceed the breakeven expectations implied in the pricing of TIPS, which are currently in the neighborhood of 2-2.5%.

Growth: Thanks to a return to more normal financial market conditions, an abundance of signs that economic fundamentals are improving on the margin, and the growing pushback that is emerging against Obama’s hard-left agenda (an important development that has helped the market for most of this year), I believe the economy will grow 3-4% over the course of the year. While this represents an above-average growth rate from an historical perspective, it will be a distinctly sub-par recovery given the depth of the recession which ended about six months ago. I think the main reason for sub-par performance will be the misguided and bloated Keynesian stimulus policies enacted earlier this year, coupled with a significant increase in government regulatory burdens and government spending (mostly in the form of transfer payments), and huge federal borrowing requirements. (Not surprisingly, this puts me at odds with most Keynesian forecasters, who generally believe that the winding down of stimulus spending will cause the economy to slump in the second half of the year. Where they see slower stimulus spending hurting the economy, I see stimulus spending acting all along as a obstacle to recovery.) If the economy manages to exceed 3-4% growth, it will likely be due to the fact that corporations and individuals have a strong incentive to accelerate the receipt of income this coming year, in order to avoid the higher tax rates that are slated to take effect at the beginning of 2011.

Fed: The market currently expects the Fed to begin raising short-term interest rates in June, and the current year-end expected Fed Funds rate is approximately 1.0%. Given my relatively optimistic outlook for the economy, and my belief that inflation is likely to trend higher, I think the Fed will end up raising rates sooner and/or somewhat more aggressively than the market currently expects.

Housing: Residential construction activity is likely to slowly but gradually improve over the course of the year. Housing prices on average are likely to post modest gains as well, thanks to improving economic activity, rising incomes, relatively low interest rates, and accommodative monetary policy. Prices could dip briefly as a result of increased foreclosure activity in the first half, but this should prove to be only a temporary setback. Rising mortgage rates, since they will still be relatively low from an historical perspective, should do more to encourage a "buy it now" mentality than to discourage would-be buyers who will see that in many areas homes are more affordable than ever.

Interest rates: Interest rates on Treasury bills, notes and bonds should rise significantly over the course of the year, with 10-yr T-bond yields exceeding 4.5%. The impetus for higher rates will be a stronger-than-expected economy, and higher-than-expected inflation. Higher rates will not threaten the recovery, however, since they will occur largely as a result of the recovery. Moreover, even though I see the Fed tightening sooner than expected, I nevertheless expect them to be “behind the curve” throughout the year, much as occurred with monetary policy in the 1970s (i.e., the Fed will wait too long to raise rates and is unlikely to raise them by enough to quickly dampen inflation pressures). There is very little risk that Fed policy will be anywhere near tight enough next year to threaten the economy.

MBS spreads: Since the Fed plans to cease its purchases of MBS by March, this could push MBS spreads wider over the next few months. Regardless, MBS spreads are likely to widen over the course of the year. The main impetus for wider MBS spreads next year is likely to come from an across-the-board increase in the extension risk of MBS as Treasury yields rise.

Credit spreads: Credit spreads are likely to decline gradually over the course of the year. Easy money and a strengthening economy add up to a perfect environment for spread tightening. Easy money that leads to higher inflation and improved cash flows is a boon to borrowers, especially the most indebted ones, and that means lenders will be rewarded by lower than expected default rates. High-yield bonds and emerging market debt should be the biggest beneficiaries of tighter spreads.

Equities: Equity prices are likely to experience a few dips along the way, but they should be at least 10-20% higher by the end of the year. The onset of Fed tightening may provoke a temporary selloff, but in the end a Fed tightening is just what the economy and the markets really need to build confidence in the dollar and in the future of the economy. The main impetus to higher equity prices will be an improving economy and improving corporate profits.

Commodities: Commodity prices will continue to work their way higher over the course of the year, buoyed by an ongoing improvement in global growth conditions and accommodative monetary policy.

Gold: Gold prices are likely to spike one more time to a new high this coming year. Gold speculators will be encouraged to see that the Fed is “behind the curve” and reluctant to tighten boldly and aggressively. However, gold is a highly speculative investment at these levels, and not for the faint of heart. In the long run, gold's downside potential now greatly exceeds its upside potential.

Dollar: The dollar is near enough to its all-time lows, both in nominal and in real terms, that it is likely to rise at least modestly against most major currencies, and it should be able to hold near its current levels against most emerging market and commodity currencies. The dollar will find support from Fed tightening, and from the growing realization that the economy is getting stronger despite all the concerns about the disturbing trends in fiscal policy and the ongoing defaults in the residential and commercial real estate markets.

Taxes don't lie

As far as I can tell, the debate over the U.S. economy's health and growth—or lack thereof—still rages. I've argued since late 2008 that the recovery would be a sub-par recovery, mainly due to excessive government spending and inflationary/uncertain monetary policy. (See more references to a sub-par recovery here.) I've consistently argued that even though the economy would likely experience a disappointingly slow recovery, it would nevertheless be a better recovery than the market was expecting, and that would be good for equities. Both of those forecasts have been vindicated, even though I thought we'd see growth of 3-4%, and instead we've seen growth of only 2.1% since the recovery began about 5 years ago.

Meanwhile, there is no shortage of (mostly Keynesian) economists, notably Paul Krugman, arguing that the recovery has been weak because government spending stimulus was insufficient. Lately, there have been a growing number of economists arguing that the recovery has been weak because of a significant decline in government spending. To me the Keynesian arguments are weak, because they all cheered the passage of the ARRA in early 2009, one of the most significant expansions of federal spending in generations. Yet regardless of whether federal spending increased or declined relative to GDP, real growth has been pretty steady at about 2-2.5% on average for the past 5 years. You can see this in the graphs above: despite a gigantic increase in federal spending relative to GDP in 2009, and a huge, subsequent decline in spending relative to GDP, real economic growth since 2009 has been a pokey 2-2.5% throughout. We had a similar decline in spending relative to GDP in the 1990s (though it never went so high as it did in 2009), yet economic growth averaged a solid 4% per year the latter half of the 1990s, thanks in part to lower tax rates.

As a supply sider, I don't see the logic behind the theory that more government spending is stimulative and less is restrictive. How can taking money from those who are working and giving it to those who aren't create a bigger economic pie? It creates perverse incentives, for one thing. And it also channels the economy's scarce resources into the less-productive sectors of the economy. True economic growth only comes about when scarce resources are utilized in a more productive manner. I think the massive amounts of deficit-funded spending we've seen since 2008 are one of the main reasons the economy has been so weak. Bigger government is not better. With spending now having shrunk to historic norms relative to GDP, I'm tempted to say that growth has a chance of picking up.

Be that as it may, it still appears that the debate today centers around the question, Is the economy growing? I think the evidence of growth is significant, even though growth is sub-par. But one sure way to tell if we're growing and prospering is to look at tax receipts. Tax receipts don't lie: they are driven by incomes and profits and the number of people working.

As the graph above shows, federal revenues have been rising for over 4½ years. Annual federal revenues are up by almost $1 trillion from their recession lows. They are up $365 billion from their pre-recession high, for a gain of 13.7%. Most of the gain has come from individual income taxes (including capital gains taxes) and payroll taxes. That is powerful testimony to the fact that the economy is generating more jobs, higher incomes, and higher profits. Corporate taxes probably would have contributed a lot more if our corporate profits tax weren't so high, since more and more companies appear to be avoiding the repatriation of their foreign profits. These days the government is earning 35% on lots of nothing, when instead it could be earning, say, 10-15% on $500 billion or more (of repatriated profits) per year if we had the wisdom to reduce our corporate tax rate.

And in any event, as the graph above shows, federal revenues today as a % of GDP are almost exactly equal to their post-war average. Imagine how much higher they might be if this had been a robust recovery with lower and flatter tax rates!

It's the weakest recovery ever, but it is nevertheless a recovery. Taxes don't lie. And it could be a much stronger recovery if tax rates and transfer payments were reined in.

How I see things

A quick recap of how I see the current state of markets and the economy:

Inflation: Contrary to the expectations of many monetarists, including myself, inflation remains subdued. This can only mean that monetary policy has not, contrary to what most believe, been "stimulative." Inflation happens when the supply of money exceeds the demand for it; that we haven't seen higher inflation is proof that the Fed has not been printing money, as I've long argued. Quantitative Easing has been all about swapping bank reserves (T-bill substitutes) for notes and bonds. Demand for safe assets like T-bills and short-term notes has been intense, and the Fed has effectively accommodated the market's demand for safe assets. It's been a very risk-averse recovery, and had the Fed not engaged in QE, there would have been a severe shortage of the things the market has most wanted.

Growth: It's been a sub-par recovery, despite massive fiscal "stimulus." Actually, it's more correct to say that it's been a sub-par recovery because of too much government spending. Government spending, which has been dominated by transfer payments, wastes money and creates perverse incentives. It's also been a sub-par recovery because the world has been so risk-averse. Corporate profits have been abundant, but businesses have been reluctant to invest those profits due to persistent risk aversion. The U.S. economy has grown mainly because of its inherent dynamism and ability to overcome adversity, and because most people here naturally want to improve their lot in life by working harder, saving, investing, and taking risk.

The dollar: Until recently, the dollar has been very weak against virtually all currencies. This was the by-product of 1) the Fed's QE policy (which many thought would severely debase the dollar), 2) the government's massive deficit-financed spending (which increased expected tax burdens, thus depressing investment and growth), and 3) the huge increase in regulatory burdens (think Obamacare and Dodd-Frank) which have also depressed growth and investment. The dollar has improved of late because 1) the economy has done better than dismal expectations, 2) the U.S. economy is outperforming the Eurozone economy, and 3) the policy outlook is improving as elections approach and the Obama administration's agenda (which consists of a relentless effort to expand government's power and influence over the economy, which in turn dims the prospects for healthy growth) shrinks to near-nothingness.

Interest rates: It should now be abundantly clear that QE was not about lowering interest rates, and low interest rates do not stimulate growth. Interest rates have actually risen during each episode of QE. Monetary policy cannot fine-tune economic growth, and it cannot create growth out of thin air. Low interest rates may be good for borrowers, but not for lenders; in a sense, the Fed's attempts to manipulate interest rates proved to be a zero-sum game (at best). Today's low interest rates are symptomatic of the persistence of risk aversion: zero interest rates on high-quality risk-free securities reflect intense demand for those securities and that safety. In a booming economy, cash is a drag; in today's economy, cash is a refuge from uncertainty.

Equities: The stock market is not artificially inflated. Prices are up because the economy has consistently exceeded expectations, and because corporate profits are at near-record levels, both nominally and relative to GDP. The current level of PE ratios is only modestly higher than their long-term average. The earnings yield on stocks compares very favorably to the yield on corporate bonds, which is again symptomatic of a market that is risk averse.

Gold: Gold prices are still quite elevated relative to their long-term inflation-adjusted average, which I calculate to be roughly $600/oz. Gold rose because investors feared a host of potential calamities: a global financial collapse, a Middle East meltdown, and a QE-fueled explosion of inflation. Gold has fallen in recent years because those fears have been largely unrealized. Gold is still very expensive, however, because investors are still very risk averse, only somewhat less so than a few years ago. Commodity prices have tended to follow gold prices, but they are not as overextended as gold prices today.

The future: There are abundant signs that the U.S. economy continues to grow, albeit relatively slowly. This is likely to continue, and it is possible that growth could improve somewhat in the foreseeable future because: 1) government spending as a % of GDP has shrunk dramatically, thus reducing the drag of spending on growth, and 2) the policy outlook should improve in the wake of next week's elections, as policy is likely to become more business- and growth-friendly.

The Fed: Members of the FOMC are overly-impressed with their ability to "guide" the U.S. economy, and overly-concerned with the relatively low level of current inflation. Monetary policy was never meant to be an instrument for fine-tuning growth, much less creating or promoting growth. Monetary policy that is good and proper can facilitate growth, but it cannot create growth. Growth comes only from working harder, investing, and taking risk, and low interest rates do nothing in that regard. Massive changes in the way monetary policy is conducted only create uncertainty which depresses investment and growth. One key source of risk going forward is that, because of the Fed's hubris, FOMC members may fail to react in a timely fashion to signs of improving confidence and declining money demand: a failure to reverse QE in response to a decline in the demand for safe assets could result in an unwelcome abundance of money and higher inflation. At today's levels, Treasury yields offer hardly any cushion at all for this risk and are thus very unattractive. Deflation, contrary to widespread claims in the punditocracy, is not a threat to growth, and is not a black hole that captures and annihilates slow-growing economies.

All of these themes have appeared in my posts over the past 5-6 years. If anything has changed of late, it is that risk aversion appears to be on a slow decline, and the outlook for fiscal policy is improving, if only because the misguided policies of the past 5-6 years have failed so miserably. One long-enduring theme has been that the equities were likely to do well because the economy was likely to exceed expectations, which were dismal because of all the risk aversion, fears, and uncertainties that have existed.

The world doesn't change on a dime, and so many of these same themes are likely to survive for another few years at least.

Dissecting the faux-stimulus fiasco

This analysis of the House stimulus bill was put together by the Washington Post, and it is a great public service. (HT: Mark Perry) It's not exactly representative of the final bill that will be voted on this week, but it's good enough to give you an idea of the absurdity of this whole enterprise. This is what jumps out at me: very little of the bill involves immediate stimulus or anything that might be actually stimulative; only a little over 10% of the money gets spent this fiscal year, and about 30% gets spent next fiscal year (so much for the argument that we needed to pass this thing urgently); about 30% of the money goes to transfer payments (taking from one person and giving to another); only $20 billion would be spent over the next 18 months on highway construction; and about 20% of the bill doesn't get spent until 2012-19.

This means the bill amounts to a gigantic spending spree, and has very little to do with providing immediate stimulus to an economy that, in Obama's words, would face a catastrophe if it weren't passed. And I'm not making this up. When asked about "... GOP criticism that the stimulus had turned into a spending plan, (Obama) replied, 'That's the point. Seriously, that's the point.'"

The bill is just a gigantic Democratic wish list and will do more to permanently expand the size of government than to stimulate the economy. The real tragedy will be that a permanently larger government will require permanently higher taxes, and an increased tax burden will almost surely mean less growth and a slower advance in our living standards. This bill should be called an "Economic Destruction Bill" because it will end up hurting the economy much more than it helps.

President Obama has started out his administration in the worst way imaginable. His stimulus is not a a stimulus. His calls for bipartisanship in crafting the bill were phony. His understanding of economics is zero. Instead of hope, he used fear of disaster to promote his bill. He has squandered much of his credibility in just two weeks. If this bill emerges from Congress in anything like the form represented in this chart, I predict it will go down in history as one of the most egregious examples of government waste in history.

Does this mean that investors should turn pessmistic and sell their stocks? I don't think so, because I believe that the market has already factored in a future that is absolutely miserable. This bill won't give us a depression, but it will reduce the chances of a sharp or quick recovery, and it will mean sub-par growth for the foreseeable future.

The bad news is why I'm optimistic

In the seven and a half years that I've been doing this blog, I've been accused by many readers of being relentlessly and even dangerously optimistic (e.g., "do you ever seen any negatives?"). It's true that I have been reliably optimistic, even in the face of a series of selloffs and corrections. However, I've explained that my optimism is not optimism per se, but optimism relative to a market that has been generally pessimistic. Ever since early 2009 I've predicted that, while the economy was likely to grow, it would be a disappointingly sub-par recovery, mainly because of headwinds like high marginal tax rates, "stimulus" spending, increasing regulatory burdens, Obamacare, anti-business sentiment, and uncertainty surrounding the Fed's monetary policies. Even though I foresaw sub-par growth, I thought that it made sense to be bullish because the market expected even less (remember all the "double-dip recession" calls and ECRI's recession call in 2012?). So far, my optimism has been warranted.

Now, let me be specific about all the negatives I see out there, especially the relatively new ones. There are LOTS of negatives, but I'll try to be brief.

The biggest negative of them all is that the US economy is not nearly as large and as healthy as it could or should have been, had policies been better designed. This has been the weakest recovery in post-war history, and by a lot. If the economy had rebounded from the Great Recession with the same vigor it displayed in every post-war recovery, national income would be almost $3 trillion higher than it is today, as the chart above illustrates. Per capita income would be almost $9000 higher, and a family of four would be making $35K more every year. That's real money, and it explains why the electorate is so upset these days with the establishment.

As I noted some years ago, all the spending and borrowing that was supposed to "stimulate" the economy was essentially flushed down the toilet. Since 2009 we've conducted a laboratory experiment in the power of government spending to grow the economy by stimulating demand, and the result is proof that Keynesian theories are destructive, not stimulative. Neither government spending nor easy money has the power to create growth out of thin air, but politicians want to convince you that they do. The economy is weak today because we have wasted many trillions of dollars on transfer payments that only create perverse incentives to work less.

A few days ago, Treasury Secretary Jack Lew unleashed a regulatory broadside against large corporations seeking to become more competitive in an economy with an absurdly burdensome tax code. As Pfizer's Ian Read noted in today's WSJ:

This week’s Treasury action interprets the tax laws in ways never done before. This ad hoc and arbitrary attempt to single out and damage the growth opportunities of companies operating within the current law is unprecedented, unproductive and harmful to the U.S. economy. 

The action was accompanied by much unfortunate rhetoric about tax avoidance. No one was shirking their U.S. tax bills. In a merger with Allergan PLC, an Irish company, we would have continued to pay all federal, state and local taxes on our U.S. income. All that these new rules will do is create a permanent competitive advantage for foreign acquirers. Simply put, there will be more foreign acquisitions of U.S. companies resulting in fewer jobs for American workers.

If the rules can be changed arbitrarily and applied retroactively, how can any U.S. company engage in the long-term investment planning necessary to compete? The new “rules” show that there are no set rules. Political dogma is the only rule. 

Why punish our most successful companies, when it would be so much more reasonable to simply revise our tax code so that U.S. businesses are not double-taxed on their foreign income, and are not taxed at the highest rate in the developed world? If the objective is to have more money to redistribute to the "poor" it's doubly stupid, because income redistribution only creates perverse incentives. Unfortunately, we've been seeing a lot of stupid policies out of Washington, for about as long as I can remember.

Why tear down the rule of law upon which our country was built? As an aside: if Hillary escapes prosecution for what are almost certainly serial and willful violations of U.S. intelligence and secrecy laws, while the Clinton Foundation has every appearance of being massively corrupt, think of the example this sets. When rules are only for the little people, trust in government goes down the toilet almost as fast as government "stimulus" spending. Even Hillary acknowledged this when she said "There’s no daylight on the basic premise that there should be no bank too big to fail, and no individual too powerful to jail."

And then you have the problem that there is way too much ignorance of the fundamental laws of economics these days, especially among the political class. How else to explain Trump's vow to impose huge tariffs on Chinese imports? Or California's decision to raise the minimum wage to $15/hour? Or the $370 billion of M&A deals aborted on Obama's watch? These policies are virtually guaranteed to lead to perverse outcomes. It takes magical thinking to believe that a $15 minimum wage will do anything but shrink job opportunities for youth. At its worst, this exercise in hubris will lower living standards for all Californians, by sending jobs elsewhere and increasing poverty among the young. Raising the prices of Chinese imports will certainly be a negative for all consumers, but won't provide any guarantee of creating new domestic jobs.

And then you have the failure of our educational system, which has allowed a generation to grow up thinking that socialism is the wave of the future. How else to explain the huge popularity of Bernie Sanders?

I won't dwell on the Dept. of Labor's new rules which will place more onerous requirements on private sector financial advisors and push more people into government-run savings plans. (Who in their right mind would trust the government to invest your money?) Or the ongoing failure of Obamacare, which has only pushed up healthcare costs for everyone while restricting choice, all but ensuring that we will have a growing shortage of doctors in the future. Is it any wonder that the only two institutions that affect most everyone in the country and which provoke the most concern and frustrations—education and healthcare—are almost entirely under the control of government? If a private sector business delivered the miserable results that we find in education and healthcare it would have gone out of business a long time ago.

Then of course you have the problems of the slowdown in the Chinese economy and the collapse of oil prices, but these are problems which can presumably be solved if market forces are allowed to operate, as I've argued in numerous posts of late.

Now, of course none of this is a secret. The market is fully aware of all these problems, and anyone paying attention to quality news outlets and scouring the internet should not be surprised to hear it. There's lots of bad news out there, and that's why I think the market is still dominated by pessimism. The chart above makes my point: 5-yr real yields on TIPS are trading at levels which suggest that the market expects real GDP growth in the U.S. to be somewhere in the neighborhood of 1-2% per year for the foreseeable future. The market has been underestimating growth for years, and it continues to see weak growth ahead.

But it's not enough to be worried about the future, or to be optimistic. You have to match your knowledge and expectations against the expectations that are built into market prices. If you think the market is too pessimistic, as I do, then you should be optimistic, even though you don't expect real GDP growth to be more than 3% a year for the foreseeable future, and you fully expect the economy to be stuck in a slow-growth rut until policies change for the better.

I'm still optimistic, mainly because there are so many problems out there and because expectations are so dismal. But here's the kicker: if we could just fix a few things that are so easily fixable (e.g., the tax code, burdensome regulations), the potential for an upside growth surprise could be gigantic. How hard can it be to do the right thing?

Let's De-Stimulate!

Way back in June I called for recalling the Stimulus. It was poorly designed, and probably worse than just flushing the money down the toilet. Since then nothing good has come of it. Larry Kudlow today revives this notion, saying we should De-Stimulate. We've all had more than enough government intervention and taxes and wasteful spending. And who is Obama to decide that having the federal government spend $2.3 on Green Energy programs is better than letting the private sector do it? If it were so profitable and job-creating, surely some enterprising firm out there would already be pursuing this. Here's a slightly edited version of Larry's column:

After the arrival of a disappointing December jobs report, my thought on putting America back to work is simple: de-stimulate. Get rid of the Obama stimulus monster, including the government takeover of health care, cap-and-trade, and all this nonsensical talk of creating green jobs. Get rid of the increase in marginal personal tax rates and capital-gains tax rates. Get rid of the payroll tax hike from the health-care talks. Get rid of the spending that is a counterweight to growth. It’s creating so much uncertainty that even profitable businesses are afraid to hire new workers and expand.

On Friday, the day of the sub-par jobs release, President Obama comes out with a new green-jobs program that will cost taxpayers $2.3 billion. He predicts targeted tax credits for all of his faddish “energy savers” -- presumably determined by hoards of EPA bureaucrats -- will create 17,000 new jobs. This is out of a total workforce of 153 million.

And wait, it gets better. The average cost of these alleged new green jobs will be $135,000 per job. It’s sorta like the $780 billion stimulus plan, half of which has supposedly saved 1 million jobs at roughly $200,000 per job.

And on the subject of energy-related jobs, the EPA is now going to penalize manufacturing America -- or what’s left of it -- with tougher standards to reduce smog. Of course, smog has already fallen 25 percent in the last three decades. And the EPA’s projected smog savings are so miniscule compared to the new costs for business that the National Association of Manufacturers, the petrochemical makers, and others are screaming bloody murder.

Interior Secretary Ken Salazar recently announced that he is closing down federal lands for oil and gas drilling. This with the price of oil hovering around $83 a barrel and retail gas at the pump moving in the direction of $3 per gallon. Does anybody in Washington have any common sense at all?

Steve Moore of the Wall Street Journal just wrote a good column about tax chaos in the new year, with small-business write-offs for capital purchases expiring, the alternative minimum tax (AMT) un-indexed for inflation, and no fix in place for the estate tax, which is set to rocket from zero back to 55 percent.

So my point is this: Get rid of all this government spending, taxing, regulating, and meddling. De-stimulate. Let us keep our own money as workers, small-business owners, and corporate employees. Stop any future tax hikes. Stop them. And bring down business tax rates for large and small companies, from 40 percent (federal, state, and local) to something around 25 percent. And take a cue from FedEx CEO Fred Smith, who wants to revive the manufacturing and transportation industries with immediate cash-expensing tax write-offs for investment in new equipment.

President Obama has talked about a zero cap-gains tax for small investors. But why not provide more capital access for everybody, small- and large-business investors?

In light of all the tax-and-regulatory threats, it’s too expensive to hire right now. So get rid of all the so-called stimulus plans and social policies to transform the government’s relation to the private economy. Remove these obstacles.

The economy has more than enough monetary stimulus, and corporations are profitable. The stock market rose nearly 3 percent in the first week of the new year, and is up 70 percent from the March 2009 low. The recession is over. But America must go back to work to truly get the country moving again. Unfortunately, Washington is standing in the way.

There’s a populist wave coming, but it’s from the right, not the left. Free-market populism emanating from the tea-party movement wants government out of our businesses and out of our pockets. These folks are right.

Right now, Washington is completely wrong.

Weekly claims point to a sub-par recovery

The weight of the evidence continues to suggest that the recession has ended (probably in June) and the economy is again growing. There are some serious headwinds, however, which are likely to make this recovery less-than-satisfying. If the political winds were blowing in a more favorable direction (i.e., with true fiscal stimulus focused on increasing the incentives to work, invest, and take risk, rather than bulked-up spending, increased regulatory burdens, and tax rebates) we might expected a fairly dramatic V-shaped recovery, with growth in the range of 6-8% in the coming year. Growth of that magnitude would be a natural result of the degree to which the economy has slowed relative to its trend growth. Instead, it's looking like growth will be on the order of 3-4%, and that will leave the economy below trend and the recovery sub-par, because it will be a long time before firms need to build new capacity.

The progress of the labor market seems to be confirming this. The pace of firings has slowed, but we are still a long way from the point at which which firms begin adding jobs and firings fall to "normal" levels. Recessions can and do end when the pace of firings is still high, as this chart shows, but they don't really feel healthy and satisfying until the recovery sparks demand for new capacity and lots of new jobs. At this rate it could a few years before enough new jobs are added to relieve some of the pressures that still afflict many millions of families, even though the economy will be growing.

GDP from 30,000 feet

Quarterly GDP readings are notoriously volatile, and they are subject to substantial revision after the fact, so it doesn't pay to read too much into any one quarter's number. Third quarter GDP, released today, was in line with expectations, but it was disappointingly slow: a mere 1.5% annualized rate. Did the economy really take a nose dive, considering it grew at a 3.9% rate in the second quarter? Most likely not.

Given the vagaries of the quarterly numbers (see the first chart above), I've found it makes more sense to look at the rolling 2-yr annualized rate of growth of GDP, as shown in the second chart. Think of it as looking down on the economy from 30,000 feet, getting the big picture rather than the street-level map. It's clear this is a weak recovery, but notice how the pace of growth has actually picked up somewhat over the past year or so.

I'm not alone in making this observation: the bond market has figured it out too. The real yield on 5-yr TIPS has been trending higher over the past two years, tracking the rising trend in growth. The market senses that the economy is on somewhat firmer footing—even though growth is still sub-par—and thus the market is coming to accept the fact that the Fed is getting ready to raise short-term real interest rates.

In another sign that the economy is on firmer footing, weekly unemployment claims have fallen to their lowest level since 1973, and to the lowest level relative to total jobs on record (which goes back to 1967).

As the chart above suggests, the REAL big picture is one of an economy that has been growing at a sub-par pace (2.15% annualized) since the recovery began in mid-2009). If the economy had bounced back as it always did in the past, real GDP would be about 15% bigger: that translates into $2.6 trillion in "lost" income this year alone. That's arguably the measure of the cost of increased regulatory burdens, marginal tax rates that are too high, and years of Keynesian-inspired "stimulus" spending. This chart should make it painfully obvious that our highest priority should be to bend fiscal, tax, and regulatory policy in a more growth-friendly direction.

Tracking the recovery: pessimism still pervasive

For the past three years this blog has been steadfastly of the belief that while the economy was likely to improve, the recovery would be sub-par because of too much fiscal stimulus and too much uncertainty surrounding monetary policy. At the same time, I have repeatedly observed that the market's implied outlook for the economy was overly pessimistic, thus making equities very attractive. And indeed, the economy has been steadily improving, but the recovery has been definitely sub-par. As for the market, I still see signs that it is priced to overly pessimistic assumptions about the future, and therefore still attractive. What follows is a quick recap of some important indicators and how they are evolving:

The ratio of the Vix index to the 10-year Treasury yield is one way of judging how much fear (Vix) is priced into the market, and how much optimism about the future (10-yr) is priced in. Last October this ratio hit a peak as the market braced for a wave of Eurozone defaults, a financial market meltdown, and a double-dip recession. Fear was intense, and the market's outlook for future growth was dreadful. Things have since improved, but there's still a lot of concern expressed in this ratio. The Vix index is still some 40% higher than it would be if the market were calm and relaxed, and the 10-yr yield, at 2%, is still at a level which implies dismal prospects for economic growth. The 10-yr Treasury yield is equivalent to the market's guess for what the Federal funds rate will average over the next 10 years, and it will only average 2% if the Fed keeps the funds rate at or near zero for at least the next several years. And that, in turn, will only happen if the economy remains very sluggish for years to come. If the market believed that today's jobs report marked the beginning of a significantly stronger economy, then it would be pricing in a much more aggressive Fed posture, and that would imply a much higher 10-yr yield.

This chart shows how the ups and downs of fear have been important drivers of equity market performance. On balance, the story of the last three years is simple: the market started out with the expectation that the future was going to be catastrophically bad: years of depression and years of deflation. When the economy started to grow instead of collapsing, the market began to be less fearful, and equity prices rose. We've seen two waves of fear push the market down in the past few years, both caused by concerns over a Eurozone sovereign debt crisis. Yet each time the fears have proved to be overdone, and as fear subsided, equity prices rose.

This chart shows how the relatively steady improvement in the economic fundamentals (i.e., declining weekly jobless claims) has guided the equity market higher. It's hard to argue with improvement in the current fundamentals, even if you remain concerned about the future.

Corporate profits according to the National Income and Product Accounts have never been stronger, yet PE ratios remain very depressed by historical standards, and hugely depressed considering the very low level of Treasury yields (the 7.3% earnings yield of the S&P 500 compared to the 2% yield on 10-yr Treasuries implies a huge equity risk premium). This points to only one conclusion: the market is convinced that profits are set to collapse, perhaps because of a global recession sparked by a Eurozone disaster, and/or because our enormous and growing federal debt burden will crush the economy via a mega-increase in future tax burdens.

I would argue that the Fed's attempts to flatten the Treasury yield curve (by promising to keep short rates near zero for at least 3 years and by selling short-maturity bonds and buying longer-maturity bonds) have very little impact on 30-yr bond yields, because the Fed owns only a very small portion of outstanding, marketable Treasury debt. 30-yr Treasury yields are determined by the market's outlook for growth and inflation, and they are as low as they are today because the market's outlook for growth is still dismal and inflation expectations are unremarkable. However, as the chart above shows, there is a huge and growing disconnect between the rise in equity prices over the past several months, and the continued low level of bond yields. The equity market is grudgingly accepting the view that the economy is doing better than expected, but the bond market is still in the grips of fear. Domestic and foreign investors are still very worried about Eurozone defaults and a financial meltdown, and so the demand for the safety of Treasury bonds is still intense.

The bond market has experienced a rather significant change of late, however, and it shows up in the spread between 10- and 30-yr Treasury yields (the blue line in the above chart). Fed expectations haven't changed much, and that is reflected in 10-yr yields that are still below 2%. But Fed expectations can't keep 30-yr yields from rising as the economy beats dismal expectations. Since early October, 10-yr yields are up 20 bps, whereas 30-yr yields are up over 40 bps. Over the same period, forward-looking inflation expectations have risen from 2.0% to 2.5%, as the market figures that the risk of very low or negative inflation has declined because the economy has proved stronger/less weak than expected.

The market can't be considered to be optimistic about the future until we see that expectations for Fed policy have been radically revised, and that change, if and when it occurs, will show up in a dramatically higher 10-yr Treasury yield. As long as the 10-yr bounces along around 2% (see chart above), we know that the market's outlook for the future remains pessimistic.

Government is shrinking, and that's good

The U.S. economy grew at a somewhat disappointing 2.5% annualized rate in the first quarter. However, if we exclude the first quarter decline in government spending (mostly related to cuts in defense spending), the increase was a more respectable 4%. This is an under-appreciated story: the private sector is doing reasonably well (much better than the GDP number suggests), even though the public sector is shrinking. In fact, it's probably more accurate to say that the private sector is doing OK because the public sector is shrinking.

The advance estimate of GDP growth for the first quarter was less than the economy's long-term average growth rate of about 3%. As the chart above shows, the economy is thus slipping further and further below its trend. This continues to be by far the weakest recovery in modern history. 

As this next chart above shows, federal government spending has been flat for the past several years, and it has declined in the past several months, mainly due to declining defense spending. This has contributed to  reported GDP growth coming in below expectations, but is that really a bad thing?

The first of the two charts above shows how much federal spending relative to GDP has declined in the past 3-4 years.  The second chart shows the dramatic reduction in the federal deficit that has resulted from flat to lower spending and increasing tax revenues: the federal deficit has collapsed, from a high of 10.5% of GDP to only 5.75% today. These are arguably the biggest under-appreciated economic facts of recent years. Since federal spending is not growing, the federal government is shrinking relative to the economy at a fairly rapid pace. Since the economy is growing, especially the private sector, tax revenues are rising much faster than overall economic growth. Combined, these two developments have resulted in a major decline in the burden of the federal deficit.

Four years ago, no one forecast that this would happen, much less to this extent. What we see here is not only unprecedented but totally unexpected, and that is a big—and very positive—change on the margin.

There are more lessons here. The huge increase in spending that began in late 2008 and continued through 2009 utterly failed to stimulate economic growth. As I've pointed out before, that's because the stimulus spending was all about income redistribution:

Fully 63% of the "stimulus" spending was income redistribution in disguise (i.e., tax benefits and entitlements). And if you reclassify things such as education, housing assistance, and health as transfer payments, then over 75% of the $840 billion allocated to "stimulus" was essentially income redistribution. Only 8%—$65.5 billion—went for transportation and infrastructure (i.e., the "shovel-ready" projects that would put American back to work). Not a dime went to increase anyone's incentive to work harder or invest more.

Since spending all that extra money failed to stimulate growth, it should not be surprising that the reduction in government spending relative to the size of the economy in the past few years has failed to materially weaken growth. We've been on a growth path of roughly 2% per year for the past several years, despite the big swings in spending relative to GDP:

Why the slow growth? I think the recovery has been very sub-par for a variety of reasons. For one, government transfer payments and government spending in general do little if anything to grow the economy. The government is an inefficient allocator of economic resources, and big spending inevitably entails crony capitalism (e.g., Solyndra), corruption, and waste. Transfer payments create perverse incentives, rewarding those who don't work and penalizing those who do. In other words, one reason the economy has been expanding slowly is because we've been wasting scarce resources in a big way, starting with the big "stimulus" spending of 2009. Two, the expansion of the size and scope of government has also entailed huge new regulatory burdens (e.g., Frank-Dodd), and the looming introduction of Obamacare has created great uncertainty among many small businesses since it threatens to significantly increase their costs. For example, small businesses with fewer than 50 employees face huge marginal cost increases if they expand, since they would be forced to either pay a stiff penalty or provide costly insurance to their employees. With businesses unwilling to expand, millions of the unemployed have confronted the dearth of new jobs and decided to drop out of the labor force, hence the relatively high level of unemployment.

Unfortunately, even though the burden of government (i.e., spending relative to GDP) is declining—thus giving more breathing room to the more productive private sector—government-induced headwinds are scheduled to increase significantly next year if Obamacare is fully implemented, and that has already been holding the economy back. Also, it's likely that entitlement spending will increase in the next several years due to aging baby-boomers. So while the recent and ongoing decline in the burden of government spending augurs well for future economic growth, the gains are likely to be muted unless regulatory burdens are reduced and entitlement programs are reformed.

If there is a silver lining to this big-government cloud, it's the growing realization that Obamacare is not going to work as advertised. Max Baucus' decision to not run for re-election in Montana next year is likely due at least in part to his fear that Obamacare will be a train wreck. Since I don't see how Obamacare can work well, much less be implemented on time, I think there is a reasonable chance that before the end of this year Congress could decide to postpone its implementation for at least a year. That could be a very positive development.

Global bull market reflections

The market capitalization of global equity markets has recovered $14.3 trillion (with valuations up 56% from the March 9th low) of the $36 trillion that was lost last year and earlier this year. Not bad for less than 5 months' work! Mark Perry has some other charts and comments on this same subject.

I'm breathing easier these days, but there is a lot of work yet to be done before valuations—and the global economy—get back to something approaching normal. To understand what needs to be done, I keep thinking there are two parts to this drama, financial and political.

What got everything started was the unraveling of the housing boom, which then undermined the value of complex securities, when then undermined the capital structure of banks and cast great uncertainty on all financial counterparty risk, which then led to panic selling and collapsing prices which further undermined balance sheets, all the while the financial collapse led consumers and businesses to slash spending and build up precautionary balances.

The second part was the fear (beginning in late September last year when Obama started moving ahead in the polls, but reaching a peak with the passage of the stimulus bill last February) of the consequences of a massive shift in fiscal policy. It started with the trillions of dollars of bailout money thrown at the markets in October and November, not only in the U.S. but also overseas. Then it took the form of the Democrat's $800 billion stimulus bill which contained hardly any stimulus but lots of new spending, and then Obama's trillion-dollar-deficits budget projections. Anyone looking at the numbers quickly realized that government was poised to grow by 20-25%, and that would require an almost unthinkable increase in tax burdens. Then came the massive costs that would be inflicted on the economy by cap and trade legislation, as well as the likelihood that tariff barriers would be required to deal with China and India's refusal to self-inflict higher costs for carbon-based fuels. All of this would have been enough to leave markets reeling, but then Obama demanded that a compliant Congress pass legislation—before the August recess—that would result in a government takeover of the U.S. healthcare system.

The financial part of the drama is well on its way to being resolved. As the recent GDP figures show, the economy has experienced a massive readjustment in the past year and is now on the road to recovery, even though it will be licking its wounds (e.g., all the defaults and foreclosures yet to come) for another year or two. The resolution of the financial part of the drama has been evident for months now, as I've been pointing out, and can be seen in the dramatic narrowing of swap and credit spreads, and the decline in fear and the restoration of confidence, among other things. With financial health returning to the markets, the fears that drove money under mattresses all over the world are abating, and the money is being returned to the economy. Signs of growth show up in rising commodity prices, rising shipping rates, and higher-than-expected profits at many companies, among other things.

The political part of the drama may not be resolved, but it does appear that the U.S. is not going to blindly embrace a massive expansion of government and equally massive tax increases. The cap and trade bill is sidelined, and healthcare legislation is being attacked from all sides. Obama's approval ratings are headed straight down, and public discomfort with his agenda is growing daily. The roadblocks to Obama's legislative progress must have contributed substantially to the new bull market.

The economy may well be recovering, but there are still many uncertainties out there, plus the almost certain threat of higher taxes after 2010. So the recovery is not likely to be as robust as it otherwise could have been. Instead of the 6-8% growth that might have occurred had this been simply a financially-caused recession, perhaps we'll see only 3-4% growth. That will leave the economy in sub-par status for a number of years, and that means unemployment will remain stubbornly high for some time to come. And that takes us to the 2010 election season, when public dissatisfaction with Obama's agenda could result in big losses for the Democrats in the congressional elections, and that could be the best deja vu for the markets since the Democrats lost Congress in the 1994 elections.

In short, it could take another year or two before global equity markets recover all that was lost.

Onward and upward

This is still the weakest recovery ever, but the economy continues to grow and conditions continue to improve. It's a sub-par recovery, as I've been predicting for the past 5 years, mainly because the private sector has been smothered by too much government spending and too many new regulatory burdens. Things could be a whole lot better, but that is no reason to be pessimistic about the future. Indeed, there are so many things that could be fixed for the better (e.g., major reform of the tax code, the reversal of Obamacare) that the case for optimism is still compelling. As I've said many times in recent years, the economy is growing in spite of all the "help" it has received from "stimulative" fiscal and monetary policy. Pessimists see it the other way around, of course, believing that if it weren't for all the government-sponsored stimulus the economy would be a total wreck.

What follows is a series of charts which make some important points about the ongoing improvement in the economy and the financial markets.

Capital goods orders have been lackluster for over a year, but today's release of April data contained some significant upward revisions to past data. A month ago, orders appeared to be essentially flat over the past year, but they now have a modest upward tilt. As the chart above shows, orders in real terms are still substantially below their 2000 high, but they are now at a new high in nominal terms. It's still the case that businesses are very reluctant to invest—despite record-setting profits—but at least we can say that investment in productivity-enhancing capital goods is expanding, albeit slowly. As an optimist, I look at this as a glass half-full: imagine how much stronger new investment could be if taxes on capital and regulatory burdens could be reduced. The November elections hold great promise for the future if they can tip the balance of policies in a more growth- and capital-favorable direction.

According to the Case Shiller data, housing prices have recovered almost half of what they lost from their pre-recession highs. The same goes for housing starts. The recovery is more modest in real terms, but it nevertheless continues. Every day the number of households suffering from negative equity declines. There is still plenty of upside potential in the housing market.

The market capitalization of global equity markets is now at a new all-time high, having gained $38 trillion from the March 2009 low. These are huge numbers, considering that the total market cap of the U.S. equity market is currently almost $23 trillion according to Bloomberg.

Pessimists don't get excited by the above chart, which shows that the implied volatility of equity options is very close to its historic lows. They worry that because the market is not very worried these days about something going wrong, it is vulnerable to bad news. As an optimistic, I prefer to think that the market is "vulnerable" to unexpected good news. Long-time readers may remember my post from August 2012, in which I posed the question "What if something goes right?" In retrospect it was quite prescient. I still think that is the right question to ask today.

The above chart of the PE ratio of the S&P 500 shows that multiples are only slightly higher than their long-term average (according to Bloomberg calculations). That lends strong support to the view that the market is far from being overly optimistic. There is still plenty of room for multiples to expand.

Consumer confidence is at a post-recession high, but as the chart above shows, it is still far below levels associated with healthy growth and widespread prosperity, such as we had in the late 1990s. Indeed, confidence today is at levels that in the past have been associated with the onset of recessions. There is still lots of room for improvement.

As the chart above shows, Eurozone equities have been rising in line with the ongoing recovery in  U.S. equities for the past two years. In fact, Eurozone equities have recorded outsized gains over the past two years: the total return on the S&P 500 is 51%, while the Euro Stoxx 50 index has posted a total return of 77%. The Eurozone may be lagging, but it is definitely improving. 

As an aside, I couldn't help but notice the proliferation of construction cranes and road repairs as we drove through almost 2,000 miles and 5 countries' worth of European countryside earlier this month. Things are definitely improving in Europe.

There will undoubtedly be setbacks along the way, but I see little reason to doubt that things can continue to improve, albeit slowly. Onward and upward.

Inflation picks up

The August rise in consumer prices exceeded expectations. The headline CPI rose 0.4%, vs. an expected 0.2%, while the 0.2% rise in the core rate was a tad higher than expected. As the first chart above shows, core inflation over the past six months is running at an annualized rate of 2.7%, while overall inflation is 3.6%. As the second chart shows, the rise in core inflation has been quite pronounced, and apparently owes a lot of its strength to the Fed's second round of Quantitative Easing which began almost a year ago.

What is most impressive about the rise in core inflation is that it has happened at a time when the economy has been demonstrably weak and the output gap has been gigantic (10-12% by my estimation). The main reason the Fed was so anxious to engage in QE2 was that it feared the output gap posed a serious risk of deflation. The bond market has been willing to ignore signs of rising inflation because of the pervasive belief that a large output gap provides an insurance policy against rising inflation. Yet these beliefs are being challenged almost daily. Thus, the Treasury market is perched very precariously on the edge of acceptable valuations, as real 10-yr Treasury yields are now clearly in negative territory.

Here's a Big Picture thought: what we see happening over the past year or so is the gradual undermining of widely-held theories about how the economy and inflation work. Keynesian economic theory is taking a beating, because it was used to justify a $1 trillion government spending stimulus package that not only failed to stimulate the economy as predicted, but most likely helped to weaken the economy. The Phillips Curve theory of inflation is also taking a beating, because inflation is much stronger than it has been predicting, given that unemployment is still very high.

The bad news for Keynesians and Phillips Curvers, however, is good news for supply-siders like me. Supply-side theory has been predicting relatively slow growth and a tepid recovery for over two years, since it recognizes that deficit-financed spending has no power to generate growth, and big increases in the deficit inhibit risk-taking because they tell the market to expect big increases in tax burdens in the future. (Two consistent themes of my predictions since early 2009 have been that the economy was likely to grow, but at a sub-par pace, and that inflation was likely to rise.) Rising tax burdens reduce the after-tax rewards to work and investment, so you end up getting less of both.

Monetarists and supply-siders have been predicting rising inflation for over two years, since they recognize that accommodative monetary policy, when fortified by a very weak currency, rising gold and commodity prices, a steep yield curve and low to negative real yields, will inevitably lead to higher inflation regardless of how weak the economy is. Indeed, in the supply-side framework, a weak economy is to be expected when monetary policy is inflationary. That's because easy money weakens a currency, and that increases the rewards to speculative activity while reducing the rewards to investment, and with weakened investment you get weak growth.

Along with the decline of Keynesian theories and the rise of supply-side theories, we are seeing a powerful realignment of political power in Washington. Obama, a dyed-in-the-wool Keynesian, is still insisting that what we need is more spending and more government control over the economy. But he is fighting a losing battle as more and more people begin to realize that Big Government is antithetical to prosperity. Keynesianism is all about giving power to politicians so they can pull the levers that supposedly will create growth, but now we see that politicians are fallible just like anyone and spending other people's money is never a very productive enterprise. Indeed, giving a handful of individuals who happen to inhabit Congress the power to spend a trillion dollars they don't have is so foolish as to be dangerous to our economic health.

What we can expect to see more of, fortunately, is policies that return power to the private sector, while also increasing the after-tax rewards to work and investment. Even if it takes a year or so for policies to make a clear shift in a more pro-growth direction, the prospect of improvement and the fact that in the meantime the economy is likely to continue to grow, should be enough to push equity valuations and Treasury yields higher.

A comment on the ECRI leading indicator

This chart shows the Economic Cycle Research Institute's Weekly Leading Indicator. The pronounced drop in the index which began in early May has been the subject of much concern, since some have taken it to imply the imminent onset of a double-dip recession. Business Insider has a nice summary of the controversy here. The key point is that outsiders have misused or misunderstood this index: "ECRI itself has never used WLI growth going negative as as a recession signal." In short, the concerns are much ado about nothing. ECRI further explains that a decline in the WLI would have to be accompanied by a "pronounced, pervasive and persistent decline" in their Long Leading Index before they would predict the onset of a recession. While I have not seen the LLI, presumably it has not given such a signal yet. I think the main message of the current decline in the WLI is that economic growth going forward may be a bit weaker than it has been in the past several months, but that is not at all the same as saying we are headed for a double-dip recession.

I do not follow the ECRI indices religiously, but I do hold them in great respect, since in my experience their economic calls have tended to be similar to my own. I would be surprised if they were to predict a recession that was not obvious to me. They have a good record of predicting recessions and recoveries, and in fact, they predicted the current recovery in April '09, in advance of the consensus. I would note that I also predicted the recovery, but even earlier, in this post dated Dec. 31, '08.

I would reiterate here that I do not see any signs in the economic or financial market data that would lead me to expect a double-dip recession. I continue to believe, as I have since my 12/31/08 prediction, that we are in a recovery that will be sub-par "due to the drag of increased fiscal spending and slowly rising inflation." The economy would be growing much faster, in other words, if it weren't for all the so-called "stimulus" spending that has made the economy less efficient by redistributing nearly one trillion dollars from the productive sectors of the economy to the non-productive sectors. And if monetary policy weren't so accommodative and potentially inflationary, the economy would be stronger today because investors would have more confidence in the future and companies would be more willing to make productive (and risky) investments.

Another V-sign: Chicago Purchasing Managers' Index

I don't ordinarily pay much attention to the regional components of the Purchasing Manager's index (published by the Institute for Supply Management on the first day of each month), but the Chicago index published today was such a great example of how dramatically things have changed over the past year that I couldn't resist adding it to the list of V-shaped recovery signs. It's not surprising at all that GDP grew at a 5.7% annualized pace in the fourth quarter. The recession is definitely over, and the only issue going forward is how strong the recovery will be. I'm in the camp that says we'll see 3-4% on average this year and next, but the consensus (the "new normal") seems to be calling for 2-2.5%. I think the consensus is too pessimistic; even my 3-4% represents a fairly anemic recovery, given the depth of the downturn we've just lived through.

I'm calling for a sub-par recovery because of all the wasteful government spending that is going to drain productive resources from the economy. You can't just take money from the bond market and hand it out to people in the form of subsidies and expect that to stimulate the economy. Economies grow only when people are working harder and/or producing more. True real growth thus requires hard work and investment, not just handing out money and putting people to work on projects that the private sector has already decided aren't very productive. If we want a truly impressive recovery, we'll need to cancel the stimulus spending, restructure and reduce entitlement programs, shrink government programs in general, and lower tax rates across the board.