Turning around the US Economy:- My Top Recommendations for President elect Trump

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The people have finally spoken. Donald J. Trump has won and will be our next President for the next four years … and if things are done right, maybe the next eight too.

It is not going to be easy given the mess he inherited from President Obama which basically sums up as below.

  1. Total US debt, including private and business debt, is today $67 trillion, or just under 400% of GDP.
  2. We have 95 million people not in the labor force; 15 million of them not employed. That’s twice the number officially unemployed.
  3. We have almost 2 million prison inmates, 43 million people living in poverty, 43 million receiving food stamps, 57 million Medicare enrollees, 73 million Medicaid recipients and 31 million still without health insurance.
  4. The US federal government debt will be slightly north of $20 trillion before Obama leaves office in January. Local and state debt is another $3 trillion. That is a total of more than $23 trillion of government debt and a debt-to-GDP ratio of somewhat over 121%. That debt has risen roughly $10 trillion under Obama, in just eight years. This US debt total does not even take into account the over $100 trillion of unfunded liabilities at local, state, and federal levels that are going to have to be paid for at some point.

Bottom Line:  We are still witnessing a disaster in the making. The more we increase our debt, the more difficult it is going to be to grow our way out of our problem with the debt.

Something like $5.5 trillion is “intergovernmental debt.” And even if we did dismiss this internal debt, the government’s debt-to-GDP ratio would still be almost 100% when you include state and local debt….And after eight years of the slowest economic recovery in history, we are growing our debt dramatically faster than we are growing our country—even when we include inflation. Go figure.

My recommendations for President elect Trump

Cutting corporate and individual taxes, effecting significant regulatory rollback and fixing the Affordable Care Act may help stimulate growth but will not be a sufficient condition to stimulate growth. Significant regulatory rollback will help. It is also necessary but not sufficient.

Some more serious actions should include but not limited to:

  1. Reinstituting first and foremost the Glass-Steagall Act because Wall Street cannot be trusted to manage their risk properly. This would separate true banking activities from the high risk gambling that brought the economic system to its knees. Privatizing the profits and socializing the losses is unacceptable.
  2. Appointing the right next four people out of the seven governors to the Board of Governors of the Federal Reserve. People coming from the business world; neither economists nor academics please. Also having a Federal Reserve that is more neutral in its policy making and that realizes that the role of the Fed should be to provide liquidity in times of major crisis not to fine tune the economy, will do much to balance out the future.
  3. Putting the value of the dollar relative to the currencies of other countries under the purview of the Treasury Department, not the Fed. Too much power to the Fed already.
  4. Having the currency of the US backed by hard assets. A basket of gold, silver, platinum, uranium, and some other limited hard commodities would back the USD. If politicians attempted to spend too much, the price of this basket would reflect their inflationary schemes immediately.
  5. Directing to have the FASB to make all banks and financial corporations value their assets at their true market value. An orderly bankruptcy of all insolvent financial firms involving the sell-off of their legitimate assets to well-run risk adverse banks that didn’t screw up should ensue. Bondholders and stockholders would realize their losses for awful investment decisions. The economic system would be purged of its bad debt.
  6. Having the Social Security System completely overhauled. Anyone 50 or older would get exactly what they were promised. The age for collecting Social Security would be gradually raised to 72 over the next 15 years. Those between 25 and 50 would be given the option to opt out of Social Security. They would be given their contributions to invest as they see fit if they opt out. Anyone entering the workforce today would not pay in or receive any benefits. The wage limit for Social Security would be eliminated and the tax rate would be reduced from 6.2% to 3%.
  7. Dismantling Obamacare in its entirety and converting it from a government program to a private market based program. The Federal mandates, rules and regulations would be eliminated. Senior citizens would be given healthcare vouchers which they would be free to use with any insurance company or doctor based on price and quality. Insurance companies would compete for business on a national basis. Doctors would compete for business. The GAO would have their budget doubled and they would audit Medicare fraud & Medicaid fraud and prosecute the criminals without impunity.
  8. Repealing the healthcare bill. Insurance companies would be allowed to compete with each other on a national basis. Tort reform would be implemented so that doctors could do their jobs without fear of being destroyed by slimy personal injury lawyers. Doctors would need to post their costs for various procedures. Here again, price and quality would drive the healthcare market.
  9. Dismantling completely the entitlement state.  The criteria for collecting welfare, SSDI, food stamps and unemployment benefits would be made much stricter. Unemployed people collecting government payments would be required to clean up parks, volunteer at community charity organizations, pick up trash along highways, fix and paint houses in their neighborhoods and generally keep busy in a productive manner for society.
  10. We must make a serious effort to have a balanced budget and to fund healthcare and Social Security. I would propose some form of a value-added tax (VAT) that would specifically pay for Social Security and healthcare. I would also propose that we eliminate Social Security funding from both the individual and business side of the equation and take those costs from the VAT.
  11. We also need to get rid of the shackles on growth and get the incentive structure right with the proper tax mix. Then American entrepreneurs can probably get us out of the hole we’re in without it getting too much deeper. With the amazing new technologies that are coming along, we can probably get to a point where we can in fact grow our way out of our debt problem over the next 10 to 15 years.
  12. It is one thing to talk about unfair trade agreements—and we have certainly signed a few. But we also need to recognize that some 11.5 million jobs in the US are dependent upon exports (about 40% of which are services). If we drop our corporate tax to 15% and work on reducing the regulatory burden, I think we will be pleasantly surprised by how many jobs are created just by those steps alone.

As a conclusion, let me be very clear. If we don’t get the debt and deficit under control—and by that I mean that at a minimum we bring the annual increase in the national debt to below the level of nominal GDP growth—we will simply postpone an inevitable crisis. We have $100 trillion of unfunded liabilities that are going to come due in the next few decades. We have to get the entitlement problem figured out and we must do it without blowing out the debt. If we don’t, I am afraid we will have a financial crisis that will rival the Great Depression and maybe worse.

We’re in a world where most major economies are also in trouble. If the US starts printing again money merely to service its debt because people don’t buy its debt, then I foresee total global debt in the $500 trillion range and global GDP topping $100 trillion. A total global economic disaster.

I have tremendous faith in President elect Trump and his team and just hope all those prescriptions will not go unheeded although they certainly go far, long-term, in fixing a system which is quite dysfunctional and broken.

“Draining the swamp” of our present economic morass will certainly require drastic action tantamount to a real revolution in both thought and practice.

The Old Order has gotten us into this mess, and cannot, or is unwilling, to get us out. It is past time for them to go.

Nothing much in a positive, productive sense can be accomplished under our government, as presently constituted, as it has devolved into a Fascistic, crony-corporatist construct.

Until those who govern are forced to experience outcomes consistent with those experienced by the governed, I am afraid the Republic will drift ever further away from the establishment principles envisioned by those rebellious Founding Fathers, who were intoxicated upon the fumes of liberty, fraternity, and equality of opportunity.

God bless our new President elect Trump and the United States of America…. Time to roll up our sleeves and start making America great again.

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Financial Impacts of Foreign Events

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Events around the world have an impact on financial policy, investment strategy, trade and commerce, and each of these has an impact on the others. It is time to do another review of global events and their financial impact. This article contains both analysis and my own editorial opinion. It does not necessarily reflect the opinions of whoever publishes it.

One issue that has attracted a great deal of interest in news reports is the issue of internal and external security threats to Europe. Much of this has to do with the mass immigration of refugees from the tumult in the Middle East, and Islamist Jihadist extremists in their midst. However, in my opinion, the greatest threat at present is the deepening fragmentation within Europe of public opinion camps – and policymaking camps – over policies and policy-making of the European Union. Three factors are influencing this: the rising power of Germany within the EU; the apparent inability of the regions minorities – and particularly the recently-arrived Islamic minorities – to integrate into European society; and the threat of terrorism, largely from Islamist Jihadist cells within the immigrant population. These threaten to stall the region’s efforts at greater integration and enhanced common security. External factors that are affecting this are: the collapse of previously stable states in North Africa and the Middle East into failed states; the retreat of the United States from the world stage, both militarily and from its historic leadership role; and the resurgence of Russian State military ambitions and its apparent efforts to resume the empire-building of Peter the Great. Middle Eastern events have produced the flood of refugees that provides internal instability; the retreat of the United States leads to increased instability world-wide, and a fragmented Europe has difficulty in dealing with this without US leadership; and Russia provides threats to the eastern frontiers of Europe. Unfortunately, all of these factors are likely to intensify in the near future rather than to wane.

Europe is beset by some of its most serious threats internally since the collapse of the Soviet Union. The European Union has failed to achieve the unity of purpose and policy needed to handle the complex issues it faces. National policies tend to take precedent over pan-European issues in the stronger European countries. Economic uncertainties and failures have awoken the struggles between left and right that had remained largely submerged when Europe was facing the threat of Soviet invasion. Ethnic and religious minorities that remained relatively quiet during the Cold War are now asserting themselves, in large part either in opposition to, or emboldened by, the influx of Muslims. This threatens to balkanize Europe politically, even as national boundaries and states remain as they were. High levels of joblessness and financial insecurity among many of these minority populations produce demands that the State “do something.” Germany, Sweden, Greece, France, Italy, and Belgium are particularly affected by this. Recent terrorist attacks in France and Belgium have highlighted the problems resulting from uncontrolled immigration and the failure to screen out dangerous immigrants from those simply seeking a better life.

Externally, the situation is worsening as well. The unprecedented period of peace along the eastern periphery that followed the ending of the wars in the former Yugoslavia enabled Europe and the European nations to focus on internal issues, downsize their militaries, and further subsidize and adjust their social subsidies. The resulting decrease in levels of military, security and intelligence activity paved the way not only for internal attacks by terrorists but for Russia’s expansionist imperialism. When Europe needs her most, the United States is “leading from behind,” which means not leading. There are even calls by US politicians to reconsider whether NATO is even useful.

Internal and external political and security risks to Europe and its nations are at their highest levels in decades, and rising. The resulting instability depresses legitimate trade, encourages smuggling, increases illegal arms trade and distribution, and produces demands on central banks to “do something.” From the standpoint of central banks, there is little that can be done financially without cooperation from the political sphere. Trade and commerce need these things in order to prosper: the rule of law; stable currency; lack of barriers to trade; low levels of regulation; societal security and prosperity; and government policy that aids all of these. These things can be summed up as small government, economic freedom, and stable currency. Many politicians (and their followers), however, are headed left, which will only make the situation worse. A central bank can only do so much. All it can do is to stabilize its currency. This causes profligate governments to fail financially, and leftist politicians don’t like that. A resurgence of capitalism is needed, and the world needs the US to lead that resurgence.

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The World In a (Cracked) Nutshell: Things Happen

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Picture used with permission from William Reid of www.northernpecans.blogspot.com

Investors and people in the business world need to be aware of world events and the impact they have on their business outcomes. Recent events of which we should all be aware are:

  • The Russian-Turkish Rivalry
  • The Apparent Steadying of the European Economy
  • The Death of Supreme Court Justice Antonin Scalia
  • Prison Riot in Mexico City
  • The Northwards Spread of the Vika Virus
  • Trade Dispute between Russia and Ukraine
  • Rapid Changes in the Syrian Civil War
  • Economic, Security and Political Developments in Central Africa
  • Growing Civilian Casualties in Afghanistan
  • The Weakening of the Indian Rupee
  • Growing Stresses between North and South Korea
  • Poor Performance of Japan’s Economy
  • The Persistent Decline of Oil and Gas Prices
  • American Political Chaos

Some of these are of more concern to some of us than others – it all depends on the nature of our investments and business interests. Let’s look at these and their impacts. It is through politics that events will have their greatest impact on business and investment clients.

American Political Chaos

American politics is becoming increasingly chaotic because fewer and fewer people identify with either of the two, dominant political parties, but are now “independents.” These “Independents,” however, cover the entire spectrum of politics from far right to far left. In my neighborhood alone, which is majority Democrat by voter registration, I know voters who are not affiliated with either the Democratic Party nor with the Republican Party who have not registered as members of a party because (1) the Republican party is too far to the left for them; (2) the Democratic Party is too far to the right for them; (3) The Republican Party is too far to the right and the Democratic Party is too far to the Left; (4) the Republican party and the Democratic Party are both too far to the right; and (5) The Republican Party and the Democratic Party are both too far to the left. Many of these “Independents” are not registered to vote at all, because they don’t think they should have to declare their party preferences when registering. At the same time, they say they are angry because they have no voice in the selection of candidates. Many of the Independents, many of the Republicans, and Many of the Democrats are angry at both major parties, are angry at the government in Washington because they feel it does not represent them or serve their interests, and so they’re “Mad as Hell and aren’t going to take it any more.”

This has resulted in a primary campaign in which the front-runner in the Republican Party is an outsider to the political process, Donald Trump, who, until recently, was a Democrat and espoused Liberal positions, but who now has the backing of a large swath of the conservative Republican voters. On the Democrat side, the establishment candidate, Hillary Clinton, has the vast majority of convention delegates so far but is running neck and neck with “Democratic Socialist” Bernie Sanders, who is supported by the leftists in the party and the young voters in the party. For much of his political career, Bernie Sanders was a card-carrying official of the Trotskyite Marxist (with overtones of Maoism) Socialist Workers’ Party, but he then became a Democrat and proclaims himself a “Democratic Socialist.” It seems that the younger generation of voters has given up on capitalism, thinks Socialism is the most equitable economic system, and hates banks and big business. We will not know for sure how the Independents will vote until the November elections, but it is not impossible that the election will be between Trump and Sanders.

How does this affect investment and business? If Sanders wins, but the House and Senate remain Republican-controlled, there will likely be a standoff between the White House and Congress and the government will do very little. This means that business can proceed to do its own thing, and investors can invest without fearing a change in the regulatory environment. If Trump wins, and Republicans retain control of the House and Senate, there is likely to be a reform of regulation to promote business and investment. In either case, investors and businesses will likely not suffer at the hands of the US government, despite the present political chaos in America.

The death of Justice Scalia foretells a standoff in the Supreme Court, now evenly divided between liberals and conservatives. Republicans in the Senate seem poised to prevent President Obama from being able to appoint a successor to Scalia, saving the seat to be filled by an appointee of the next president.

In Mexico prison riots were sparked by battles between the Zetas cartel and the Gulf Cartel. The resulting fires spread to a number of areas of the prison. 49 people were killed. Conditions in other prisons in Mexico’s overpopulated prison system threaten to spark more unrest. The inability of the Mexican federal and state governments to reduce the influence and control of drug gangs over broad swaths of territory causes increasing concern. Continuing flows of migrants from south of Mexico through Mexico into the United States continue to raise flags, particularly political flags, in the US, where Republican candidates pledge to stop illegal immigration and Democrat candidates pledge to legalize it.

Middle East (West Asia)

Tensions between Turkey, which seeks the ouster of the regime in Syria, and Russia, which is actively supporting the regime with a military presence and military action in Syria, remain one of the major flashpoints in the world and the one flashpoint that could bring two nations to war with each other. Syria has already shot down a Russian jet that strayed over Turkish territory (but they shot it down over Syria). For the immediate future, Syria will remain the front line between Turkey and Russia.

Russia has desired for centuries to establish control over the Bosporus, which has been under Turkish control since the Turkish Sultan conquered Constantinople and renamed it Istanbul. Turkey has the ability to close the strait and keep a significant Russian fleet bottled up in the Black Sea. Turkey and Russia have fought wars against each other periodically for the past 300 years. The current tensions between Turkey and Syria are much deeper than just the issues involving Syria, but are not likely to provoke a conflict. If they come into conflict over Syria, however, each might take advantage of that to try to make gains in the Black Sea and Baltic areas. Russia’s entry into the Syrian conflict seems to have taken Turkey (and a number of other interested countries) by surprise. We all seem to have forgotten that nature abhors a (power) vacuum – and that when one exists, someone will fill it. Turkey has a number of potential conflicts along its borders other than Syria. Within its borders is ISIS, definitively an enemy of the regime. The Kurds in northeastern Syria and northern Iraq are seen by the Turks as enemies. Refugees streaming across Turkish borders from Syria and Iraq are a problem for Turkey if Europe will not let them go from Turkey into Europe. Because of the myriad crises along Turkey’s borders, Turkey is not in a strong position to intervene decisively in the Syrian conflict. Russia is likely to bog down in Syria, finding itself unable to withdraw without its withdrawal causing the collapse of the Assad regime. If other Middle Eastern States start to take an active role in Syria, the conflict could widen dramatically. Jordan, Saudi Arabia, Egypt and Israel are all affected by the Syrian Crisis and might be tempted to take an active role. Russia and the US have agreed to a cease fire, but must convince the various rebel and Islamist groups in Syria, and the other interested parties, to engage in a cease fire for it to become real. If a cease fire is not achievable, an active conflict between Russia and Turkey, or between either and other states in the Middle East, could have profound impact on investors and businesses around the world.

The agreement reached last week by Saudi Arabia, Russia, Venezuela and Qatar to freeze oil production at current levels helps to prevent further declines in oil prices, but will not reverse the trend because the current global oversupply in oil is partly the result of those levels of oil production. Of course, the dramatic increase in American oil production is also a significant contributor to global oil price declines, but the “free market” in the US will cure that factor by causing a reduction in US oil production. Oil drilling in the US is now dramatically reduced, with fewer than 10% as many rigs operating now compared with a year ago. While oil will remain at low levels until the surplus of stored oil is absorbed, eventually the market will right itself. In the mean time, there may be buying opportunities for investors interested in buying shares of companies whose share prices are depressed below the real value of the companies. It is also an opportunity for oil speculators who are positioned to buy oil and hold it until prices recover. This will have the effect of removing oil from the market and hastening the recovery of the oil market.

South America

The Venezuelan opposition is stepping up its efforts to oust President Nicolas Maduro from office. Possible conflict between the opposition and Maduro’s supporters could impact oil production in this important contributor to the world’s supply of oil. Until recently, it was difficult to determine the state of Venezuela’s economy because Venezuela has no independent official statistical agencies, but it is clear that Venezuela’s Socialist economy is in full collapse, having shrunk by 10% this year alone with inflation threatening to reach 700%.

Argentina, similarly, has been a significant unknown, with the official statistical agencies controlled by allies of the previous Argentinian government, skewing the results of their analysis to support the positions of the previous government. Now that President Mauricio Macri has taken office, he has moved to restore the independence of these statistical agencies. This has led to statistics that reveal the true inflation afflicting the Argentinian economy.

Bolivians are voting in a referendum on lifting term limits for the Bolivian presidency, which could risk the rise of a Marxist dictatorship in that country.

In the midst of all of this the Zika outbreak is moving northward. However, the fear of microcephaly may be overblown, because not all areas infected with Zika have similar rates of microcephaly. Scientists suspect that the combination of the Zika virus with certain insecticides used in certain areas may be causing local epidemics of microcephaly.

Central and South Asia

In Afghanistan, civilian casualties are continuing to rise even as Afghan forces, led by US Special Operations forces make gains against the Taliban and ISIS in Afghanistan. The level of civilian deaths was the same in 2015 as in 2014, but the level of civilians injured was the highest since civilian casualty records began in 2009. The Afghan government says that in areas of fighting, an increasing number of civilians is choosing to flee their homes, and that both death and casualty levels would be higher if they had not “chosen” to do so. This could affect the economies of other nations if the current conflict spreads into Pakistan.

In India, the Rupee is weakening, despite having been a much stronger currency than many of its emerging market rivals over the past two years. Last week, the Rupee approached an all-time low against the US dollar. The drop in the Rupee seems to be the result of falling levels of investor confidence in the global economy, as well as a response to some troubling economic data that emerged recently in India. India’s economy may continue to slow in the first quarter of the year, providing risky buying opportunity for adventurous investors.

East Asia and Pacific

Increasing tensions between North and South Korea, bolstered by the largest joint military and naval exercise by South Korean and US forces, give rise to concern. In the South China Sea, rising tensions between the conflicting territorial claims of the nations bordering that sea are primarily due to the expansive claims by China over virtually the entire sea. China has been building islands on which it places military-capable runways in the middle of the South China Sea, in order to bolster (and defend) its territorial claims. This risks increasing nationalism on the part of Japan, the Philippines, and South Korea, all of which are increasing their investments in their military forces, in particular in their navies. While actual conflict appears only a remote possibility, the increasing militarization gives rise to concern. Here again, is the operation of the vacuum principle. In the face of military weakness on the part of the United States, local powers are seeking to fill the power vacuum. In the meantime, Japan’s economy continues to struggle to generate growth. In the fourth quarter of 2014, it expanded just 0.5%, but shrank by 0.4% in comparison with the fourth quarter of the previous year. Domestic factors were the largest reasons for the poor performance of the economy. The real estate sector remained weak and consumer spending levels were disappointing. Export markets remained weak in the face of weak external demand. This places more pressure on Prime Minister Shinzo Abe to undertake more stimulus measures. While there may be buying opportunities in Japanese shares, it may be some time before they recover value. The Chinese Yuan will remain highly visible. Despite concerns over China’s economy, the Yuan is stronger than most of its emerging market rivals. This encourages Chinese companies to outsource rather than to build new capacity in China, which further stalls the Chinese economy.

Africa

Boco Haram, Al Qaeda, ISIS and affiliated groups in Africa continue to provide a source of political and economic instability. Nigeria faces significant economic and security problems. After taking office last year, President Muhammadu Buhari has taken significant steps to revive Nigeria’s economic and political stability, and to reduce the levels of unrest and corruption. Oil prices have fallen dramatically, which has harmed the oil-dependent national economy and dramatically reduced government revenues. Although Nigeria has mounted a strong military campaign against Boko Haram in the northeast, this has failed so far to bring an end to the Boko Haram threat to Nigeria.

The Central African Republic recently underwent the second round of voting in its presidential election. This round pitted former CAR prime ministers Faustin Touadera and Anicet Dologuele against one another. Both candidates promise to bring peace and stability to the republic and to restore the economy, but their ability to do so in the face of the Boco Haram regional threat is questionable. Boko Haram has mounted attacks in a number of central and western African countries, making foreign investment keep its distance.

In northern Africa, the failed nation-state of Libya dominates the area by spreading instability, terrorism and uncertainty. Libyan oil, once a significant supplier of Europe’s fuel needs, flows only intermittently, with ports often controlled by terrorists. No solution for Libya in particular (and northern Africa in general) appears in the offing. Egypt is taking a stronger role, but likely lacks the ability to exert power to bring ISIS and related groups in northern Africa to heel, despite having largely quelled the Muslim Brotherhood within its own borders. Islamist extremism is still strong in Egypt, and stronger in pockets of northern Africa like Libya. This is unlikely to change in the absence of any likelihood of a defeat for ISIS in the near future in Syria and Iraq.

Europe

We look at Europe last, because Europe is on the receiving end of the consequences of what is going on elsewhere in the world. The United States is as well, but it is a player of little influence as long as it tries to “lead from behind” and so it is a contributor to the instabilities that are impacting the Europeans rather than simply being a recipient of their consequences.

A major trade spat has developed between Russia and Ukraine. Two weeks ago, Russia prevented more than 150 trucks from Ukraine from travelling through Russia on their way to Kazakhstan. The Ukrainian government responded by banning Russian trucks from crossing Ukraine on their way to other countries. Economic ties between Russia and Ukraine have become significantly worse since the free trade deal between Ukraine and Europe took effect last month.

Despite the troubles between Russia and Ukraine, the economies of Central Europe in general have continued to grow, driven by high domestic demand and growing demand for exports from Central Europe in West Europe. Poland, the regions largest economy, grew by 3.6% year-on-year in the fourth quarter, continuing its impressive rates of economic growth. Hungary Slovakia and Romania also experienced impressive rates of growth in the fourth quarter, thanks to those countries strong manufacturing sectors. Poland has backed Ukraine in its recent trade dispute with Russia, which could inflame tensions between Poland and Russia.

The European economy in general remains stable. It is not known how it will respond to a possible (but unlikely) withdrawal from the European Union by the United Kingdom. What is more likely is a weakening of the voice of Europe in British affairs. All in all, we can expect a steadier European economy. The domino-effect crises that have occurred over the last six years have dominated the picture, ranging from the Greek economic collapse to the struggles of all the southern European economies. Despite the continuing problems in Greece, most of the news out of Europe over the past year has concentrated on the region’s slow and steady recovery from the struggles. Although the results from Europe have been unspectacular, they are much better than previous years and give the impression of steadiness, if not growth. The four largest economies outside of Eastern Europe grew by between 1% and 2% on a year-on-year basis, ranging from 1% in Italy (a good performance compared with recent history) to 1.9% in Britain. Countries that have taken steps to boost competitiveness (Spain and Eastern Europe) show growth rates in excess of 3%. This news is dampened somewhat by the fact that Greece and Finland remain in recession that are likely to continue in 2016. Overall growth in the European Union in 2015 was 1.8%, a better performance than in recent years. The British “motto” of World War II comes to mine: “Keep calm and carry on.”

Summary

So, we have just described the State of the World in a nutshell – a cracked nutshell. Nuts in cracked nutshells can leak crumbs out, reducing the size of the nut, and the nut itself is more likely to spoil. Our nations’ leaders need to concentrating on un-cracking the nut rather than on saving the contents, because they can’t save the contents while the nut remains cracked. Without global security (a coherent nutshell), the global economy itself cracks up. While there will always be trouble spots in the world, the task of the world’s leaders is to keep them contained so they don’t spread. In the absence of American exercise of power, the wildfires are spreading rapidly, and the global economy threatens to crack up along with the nutshell. Many are the times I have cracked the kernel of a walnut when attempting to crack only the shell and extract the kernel whole. It is time to restore security to broad swaths of the world, and there is no one capable of doing it but the United States. If we do not do it, we will suffer along with the rest of the world.

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The Activist Investor: A True Ally of Corporate Governance

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Activist investors: Publicly listed companies fear them. Corporate governance pundits generally do not trust them. Retail investors quietly applaud them, and most laymen do not understand them. However, it is clear that in today’s complex corporate world, we need them. Activist investors may be the only players in the game that can effectively “Occupy Wall Street”.

We have entered the twilight zone when it comes to corporate governance. The zone where many Boards bury their head in the sand when it comes to breaches in compliance, as in the case of HSBC and the tax evasion scandal of February 2015. Certain Boards passively bow to the dictates of executive management, throwing all accountability on the corporation-as-entity, with no individual responsibility. All other stakeholders, from shareholders, to suppliers, to workers, to humble taxpayers are left to peck at what is left of net worth after the share price dives, and are left to fork out money for regulation and reconstruction.

To be fair, in the recent past activist investors have been noted for short-termism. Short-termism is the process by which an activist fund may coerce target companies to conduct strategies that may yield high profit in the short term, but that may be detrimental to company performance in the long term. For instance, it is common practice for activist funds to demand significant reduction in Research & Development activities; yet, R&D is needed for long term competitive and innovative advancement. Most activist fund activity increases the stock market price of the target company. However, best practice professionals argue that the temporary increase in share price is misleading and cannot offset long term business hazards that occur if the activist investors short the target company’s stock. There is truth in this belief. However, we need to take a closer look at activist investors’ strengths when it comes to financial strategies and business growth.

Bernard S. Sharfman in his Columbia Business Law Review article Activist Hedge Funds in a World of Board Independence: Creators or Destroyers of Long-Term Value does an excellent job of delineating the benefits of shareholder activism and Board governance. The author’s main premise calls for an integral approach to investor activism in Board decision making, as opposed to the present “Authority Model” that exists within Board and executive management’s line of communication, a model that excludes shareholder participation and creates a passive acceptance of managerial decision making as ultimate, without proper analysis and foresight. Poignant highlights from Sharfman are as follows:

  • Shareholder activism can be defined as “any action(s) of any shareholder or shareholder group with the purpose of bringing about change within a public company without trying to gain control.” – In its essence, shareholder activism is more inclined to correct core business discrepancies before the market reads any sign of trouble via share volatility.
  • Value investors such as Warren Buffett are lauded in the industry while activist investors such as Carl Icahn and the Vanguard Group are called out for short-termism. However, Sharfman clarifies that while value investors cannot practice activism based on their own long holding period strategies. In reverse, activist funds impede their own shareholder wealth creation if they have long holding periods, since their strategies are based on intervention.
  • Since most activist fund strategies are based on intervention, activist investors can be viewed as financial engineers that can offer very timely and effective financial restructuring advice to a Board. Such advice may not come from executive management caught in day to day operations and so may not have an adequate view of the broad financial picture. It sounds humbling, but in reality it may work to a company’s advantage to have a short-termism in financial engineering from an actual shareholder.
  • The threat of a proxy contest may be the most important weapon the activist hedge fund has in its arsenal to effect change. While activist investors have become notorious for proxy contests, the authors found that only 13% of hedge fund activism resulted in proxy contests. Thus, the simple idea of a proxy contest may be enough to spark strategy change at the Board level.
  • The Board of Directors must have a strong outside director composition to allow investor activism to work in a positive fashion for long term company performance. A non-executive director stronghold on a public board gives the Board more authority to listen to both the dictates of activist investors and executive management, and so allows broader decision making for company strategic direction.

Consider activist investors as the best devil’s advocate. A company can hire an independent consultant to assist the Board in setting strategic direction; however, an activist investor literally has more to lose with company profit at stake! And these investors are the savviest investors in the industry – as bullying as their tactics may seem, they are top financial engineers that can truly structure profitable companies. Many companies are embracing the activist investor style of C-Suite leadership. The Vanguard CEO William McNabb has advocated forming a “Shareholder-Director Exchange” to have clearer communication between activist investors and Boards, to facilitate such financial engineering and prevent negative market reads in a proactive manner. Former Texaco CEO and Director of Abbot Laboratories Glenn Tilton further encourages public boards to be one step ahead of shareholder activists in terms of strategy and risk management expertise. Prevention is better than cure.

Carl Icahn has defended his position as activist investor, saying “I look at companies as businesses, while Wall Street analysts look for quarterly earnings performance. I buy assets and potential productivity. Wall Street buys earnings, so they miss a lot of things that I see in certain situations.” Activist investors challenge companies’ core competencies. However, they challenge Wall Street’s investing myopia as well. Devil’s advocates they may be, yet the activist investor may well be the true change catalyst for practical, no frills, efficient corporate governance.

Bebchuk et al. 2015. “The Long Term Effects of Hedge Fund Activism.” Harvard Business Law Discussion Paper. Columbia Law Review. Pages 1064 – 1154.

Harvard Business Review. 2015. “Your Board Should Think Like Activists.”

Sharfman, Bernard S. 2015 “Activist Hedge Funds in a World of Board Independence: Creators or Destroyers of Long-Term Value.” Columbia Business Law Review. Pages 103-139.

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Central Banks: A Question of Governance

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Fiscal year 2015 is upon us, and is fast becoming the year of historic monetary policy changes in light of an appreciating US currency and, in turn, a blanket decrease in European and Asian economic growth.  Since late 2014 and in full swing 2015, the Danish central bank, the Swiss National Bank, and  the Bank of Russia cut key interest rates, with probable Turkish Central Bank short term rate cuts to follow. The Bank of China has recently reduced its requirement ratio as well to encourage growth. In the US it is expected that the Federal Reserve raise short term rates by mid-year 2015, a policy change that has not been effectuated for over three years. It is apparent that governments are depending heavily on central banking to modify economic growth patterns as a short term solution.
While the spotlight is fixed firmly on central bank monetary policy to control the global economy, should central banks be fully responsible for financial stability? From a governance perspective, central banks act first and foremost as an independent or fully state-run agency to ensure adequate capital liquidity.  The gist of central banking is to control the effects of growth expansion or decline, and not necessarily to be the institution to structure economic growth itself. In addition, one of the tenets of central banking is to oversee a sovereign’s commercial banking system, and be thus supported simultaneously by government legislature.
If this foundation of central banking was kept constant, we would not have had such financial turmoil in 2008. However, lack of commercial bank corporate governance due to lobbying influence has vastly undermined central banking effectiveness in the long term.
In layman’s terms:

  1.  Short term upon short term upon short term monetary rate fixes does not equal proper long term decisions. Decisions that should be made with no biased influence from legislature.
  2. The global monetary system has moved from fully secured to almost totally unsecured asset-backing over the past 40 years. Most world currencies are much less asset-backed than ever before.

Both very simple reasons listed above explain why at anytime an industry receiving the most ‘creative’ cash flow (derivative upon derivative) will experience the dreaded bubble. And, while it is natural in the scheme of a global economic cycle to have peaks and troughs, the mass non-collateralization of currencies, followed by a now endemic financial culture of sophisticated derivative creation leads to unsustainable growth. It’s less long term growth and more adrenaline rush. We have more monetary policy magicians at work than real doctors of the art.
The Bank for International Settlements examined the central bank’s role in being the overseer of global financial stability in its May 2009 publication, Issues In The Governance Of Central Banks. The article points out that while central banks are needed for monetary stability, having the central bank be the main institution for overall financial stability gives unwarranted responsibility, and unnecessarily overlaps with government functions:
Governance arrangements for the financial stability function are generally less settled than for the monetary stability function…apart from the lender of last resort function and various regulatory powers, there are no central bank policy instruments that are uniquely suited to ensuring systemic financial stability. Instruments that might influence financial stability have other primary roles…Using such instruments for ends other than their primary purpose inevitably involves trade-offs.
It is therefore ill-advised policy to depend solely on the central banking model for ongoing global financial stability. Yet, from a governance perspective can individual banks be allowed full deregulation? Deregulation makes sense in a free market economy. However, judging from the shenanigans of 2008, we need checks and balances in our global banking system. In the US, bank regulation took a dive in December 2014: Section 716 of Dodd-Frank financial law, which would have forced big banks to keep their derivatives mostly separated from their insured deposits, was repealed by the U.S. Congress, with planned repeals to follow in FY2015. Can a global economy with rampant recession afford the repercussions of a huge financial crisis within the next two years? Probably not: short term policy issued by a sovereign’s central bank cannot fully override financial policy decisions made by legislature, based on corporate influence.

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