by Paul Woods.
Most of us have been taught that the path to success involves getting a good education, working hard, and providing a product or service that others need. However, in 1993, a UCLA economist named Jack Hirshleifer outlined an alternative path to success. From his observation of democracies, he argued that an equally effective approach was to organize politically, use the ballot box, and vote to take more of what successful people had earned. His term for this was expropriation.
As I was digesting this idea last year, the Occupy Wall St. movement was spreading across the country and proving Hirshleiferís point. Most of their demands were incoherent but the occupiers did agree they wanted more free goodies from the top 1% of wage earners. That movement received fawning coverage from the old media and appears to have been the prelude to a barrage of articles Iíve been reading recently about the need to close the gap between the rich and poor in the U.S.
Predictably, none of these articles want to close this gap the old fashioned way by unleashing the economy and letting it create jobs for the poor. Instead, they appear to be written by people that never got over the story of Robin Hood and want to steal (the polite term for this in democracies is redistribute) more from the rich and give it to the poor. They even have a way to measure the gap in incomes, the Gini Index. This produces a range of values from zero to one. A reading of zero means all incomes are the same (utopia) while a measure of one means that one person in the country earns all the income.
John Maynard Keynes had a knack for coming up with really bad economic ideas and this is no exception. He believed the rich saved too much of their money, so "redistributing" it to the poor would lead to more consumer spending and boost economic growth. To see how this has worked out, keep in mind the countries that have taken redistribution to an absurd extreme (a Gini coefficient of less than .3) are all in Europe. Growth forecasts there are the lowest in the world and have just been revised downward again. The graph above makes it pretty clear that punishing people for being productive and successful by redistributing an increasing share of their income takes a major toll on economic growth.
In the second quarter, the stock market was hit by sluggish growth in the U.S. economy and continuing problems in Europe. There was the usual flight to large companies during this downdraft and value finally outperformed growth. Midcap stocks were the hardest hit.
Source: Telemet Orion
Winners in the second quarter included utilities and biotech as these are less sensitive to the economy. Energy and financials brought up the rear.
Source: Telemet Orion.
Itís getting comical watching the bond lemmings rush into and out of Treasury Bonds on an almost monthly basis even though thereís very little change in the outlook for Europe or the rest of the world. In May, there was a rush back into Treasuries because of lousy growth in the U.S and Greece, Spain, Italy, etc. We find even less value in Treasuries this quarter than we did before, and are maintaining positions in the sovereign debt of countries with strong balance sheets along with attractive muni and corporate debt.
Source: Federal Reserve Bank of St. Louis
Internationally, the usual group of problem children in Europe tried to find increasingly creative ways to keep living beyond their means and get Germany to pay for it. Apparently, the European fondness for redistribution applies to wealthy countries also. In addition, we examined country data for 2011 that included revenues, spending, debt, and taxes. As a result, we removed Malaysian equities from our foreign portfolios in the second quarter. With an election approaching, spending there is out of control and debt levels are already at a troublesome level. In the 1990s, many countries in Asia learned a painful lesson about the consequences of trying to borrow and spend their way to prosperity. Ever since, the vast majority of Asian economies have been models of fiscal restraint with robust growth. Only India, Japan, and Malaysia appear to have skipped class when that lesson was being learned.
In the U.S., the Supremes created a ticking time bomb when they upheld Obamacare, as 75% of the taxes to pay for it will hit the middle class. When this goes off in a few years, nothing good will happen to the economy. Meanwhile, in the name of avoiding risk, investors flocked to a country that just experienced a major 3-year decline in living standards and is piling up debt at a record rate. To do this, they sold securities in countries with stronger balance sheets, better prospects, and more attractive yields. We were happy to be on the other side of that trade and took advantage of the opportunity to move more money to parts of the world where living standards are rising and a healthy gap between rich and poor is being maintained.
About Paul Woods