Wednesday, October 12, 2011

Big and welcome reversal

This chart shows the fairly significant reversal in two indicators of fear that has occurred this month: the Vix Index (orange), and the 10-yr Treasury yield (white). The chart bellow combines these two into one, the Vix/10-yr ratio:

Obviously, something big has happened since Oct. 3rd, which marked the peak in the Vix/10-yr ratio and the recent low in the S&P 500. The Eurozone sovereign debt crisis has not been resolved, not by a long stretch, so what is it? Two things: 1) economic data that show the U.S. economy is still growing, and in fact might be picking up a bit after a very depressed first half (e.g., unemployment claims, private sector payrolls, rail shipments, capital goods orders), and 2) indications that the Eurozone debt crisis is not getting worse and might possibly have a solution down the road. Reason #2 might not sound very convincing, but I think it does mark an important inflection point. After all, as I have been noting for awhile, since markets were priced to an "end-of-the-world-as-we-know-it" scenario, then anything short of that, even just a hint that conditions might be sort of stabilizing or improving just a tiny bit, would have to be very good news in a relative sense.

In short, markets were braced for an outright catastrophe, and now that seems doubtful. That's not to say the future looks rosy—on the contrary, we still face strong headwinds and likely setbacks on the road to a painfully slow recovery. To really get optimistic, we'll need to see real austerity measures (such as those adopted by Ireland), tax reform (lower and flatter tax rates, coupled with fewer deductions and a broadening of the tax base), entitlement reform (e.g., a privatization of social security, higher retirement ages, and market-based healthcare reform), and central banks willing and able to take bold steps to reverse their quantitative easing as the demand for money falls back to its pre-2008 levels. That comprises my wish list of things to hope for over the next 2 years, and I think they are doable.


Benjamin Cole said...

We also need to see cuts on federal agency outlays, for Defense, USDA, Homeland Security and VA *the latter better as a voucher system).

The Defense-Homeland Security-VA megaplex consumes $3,333 every year for every man, woman and child n the United States. A family of four sits down, and the dead hand of the federal government takes $13k off the table, just for the three agencies mentioned. That is a huge structural impediment. No other nation spends as much, per GDP or per capita nor faces so little real defense threats.

About 70 percent of federal outlays financed by income taxes go to defense, homeland security, VA, USDA, Interior and Commerce.

Why right-wingers simply refuse to even acknowledge these necessary cuts (besides Ron Paul) is beyond me.

It is one reason why the modern GOP has never even come close to balancing the federal budget.

Employment by agency--and think about pensions coming.

Department of Defense 3,000,000
Veterans Affairs 275,000
Homeland Security 250,000
Treasury 115,000
Justice 112,000
Energy 109,000
USDA 109,000
Interior 71,000

Labor 17,000
HUD 10,000
Education 4,487

Where to cut?

Frozen in the North said...

No offence CBP but your solutions always involve cutting taxed and widening the tax base to lower income, and never, ever looking at the higher tax brackets...I understand, you like every other American want everyone but themselves to pay higher taxes.

In 2010, the US government borrowed 40% of its entire budget. A flat tax may work, but it's is not going to be Cain's 999 solution, more like 15/15/15 -- and no deductible for any one (mortgage or corporations, no more off shoring of revenues either). Not sure the Rich and famous will be so happy about that -- imagine if GE actually paid 15% taxes!

Scott Grannis said...

Our deficit problem needs to be fixed, that's clear. But raising taxes on the rich won't help anybody. Making the tax code more progressive than it already is is a very bad idea. Flat tax rates are far more efficient, and they don't distort incentives. A very steeply progressive tax code, on the other hand, creates huge marginal tax rate increases for all those trying to climb the income ladder.

The only real solution to our deficit problem will come from a) a stronger and bigger economy (via permanent changes in the incentives to work and invest) and b) a serious reduction in the size and scope of government (e.g., a cut in spending as a % of GDP).

And happily, both of those solutions will reinforce each other.

Benjamin Cole said...

We can cut federal outlays to below 20 percent of GDP, and I would like to see even 16 percent of GDP.

We need to trim entitlement, and radically downscale defense-homeland security-VA programs.

Did you know that federal income taxpayers have given $32 billion to cotton farmers since 1995?

If the GOP and Tea Party are fine with handing over $32 billion to pinko cotton farmers, then how can we expect serious fiscal medicine from that quarter?

BTW, bothy the Bachmann and Perry families are recipients of federal pink lard, for "farming."

Ron Paul does look better all the time.

randy said...

It's frustrating that it's so difficult to separate tax policy from spending policy. They are of course intimately related, but the appropriate level of spending is NOT AT ALL dependent on determining the optimum tax policy. In the debate last night, Bachman attacked the 999 plan, arguing that it just opened another tax pipeline that could be raised at will. Cain's response was that he would insure raising it would require 2/3 vote. I think the right answer is that we should institute a spending cap as a percent of GDP. Then, as an entirely separate issue, tax policy would seek optimum method of meeting spending needs. I don't like the "balanced budget" talk - it's too limiting, but a cap on spending as percent of GDP makes a lot of sense. Sure there's a ton of details - identifying what constitutes "spending" (cash of course, but what about tax incentives, allocations to future entitlements, etc), providing mechanisms for smoothing over years, etc. Economists may debate at what level, but any economist not dedicated to full blown socialism would agree that at some point govt spending undermines future prosperity.

djakel said...

Scott's conclusion is right on as to what SHOULD happen over the next 2 years. It is impossible to achieve with this crew in D.C. We must vote out most of the progressives and RINOs that have gotten us into this fine mess and replace them with more constitutionalists like the Pauls, Amash, Chaffetz, Lee, Johnson (WI), Toomey, DeMint, etc. Look for vetted and endorsed candidates in 2012.

Tom said...

Further to Benjamin's comment about federal workers. The government's current system of defined benefit retirements where you receive XX% of your salary has to go. Almost every company in America has abandoned these plans as unsustainable. Apparently the government didn't get the memo.

Public Library said...

When taxes were 90%, America kept producing and the entrepreneurial spirit thrived.

Not advocating either side, but high taxes only discourage paying taxes (ie loopholes), not investment and entrepreneurial spirit. Anything to the contrary is basically garbage.

If anything, the marginal person will work harder and we are nowhere near a tipping point with higher rates.

Case in point about incentives: reading Wine Spectator last night and an article covered the crazy prices paid recently for 12 acres of cabernet producing land.

The purchases essentially price out young wine makers from sourcing cabernet grapes and the possibly of ever owning land in the area.

However, none of this stops them from wanting to source high quality (yet affordable) cab grapes or hinders their desire to make a 100pt cab.

What kind of person says, well since my taxes went from 35% - 45% (or whatever), I am going to tell my boss I want to work less and lay around more.

Really? Is that the argument we are making here? I need to pinch myself to see if I am in a dream or still living in America.

If this was even a possibility, a billionaire would quit making more money long before the 10th digit regardless of tax rates.

Total baloney and why we are at a standstill in this country.