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   A Republic Off The Rails



There are so many great quotes attributed to Sir Winston Churchill. Here is a favorite; “The greatest argument against Democracy is a five minute conversation with the average voter”. Wow! That quote is credited to a man who dedicated his life to the defeat of fascism and the defense of freedom on his island nation and for the rest of the world. 

There is great responsibility in being a citizen of a democratic republic. We must be informed about a myriad of complicated issues both domestic and international. In the age of mass media and particularly television, we voters are presented well crafted and even better funded sales pitches aimed at influencing our interpretation of those complicated issues. Joe McGinnis’ book, The Selling of the President, 1968, opened America ’s eyes to the marketing strategies used by the Nixon campaign to defeat Hubert Humphrey in a race for the highest office in the land. It has been difficult not to see candidates as packaged products positioned for public consumption since reading Joe’s book. In present day politics attack ads have become ever present because they work. It seems we like to have somebody to blame for the hard knocks we encounter. Blame is always easier to assign when we can first demonize our target. We are all too often subject to the politics of scarcity, fear and blame. Is it not the responsibility of citizens of democratic republics to see through and beyond the maze of propaganda and get to the heart of issues that determine the fate of nations?

We must occasionally have the foresight to choose between our immediate self-interests and the long term wellbeing of our country. Societies that participate in the free enterprise system must accept its rough and tumble, imperfect nature to reap its cyclical rewards. Expansion, contraction, boom and bust, evolution and revolution are part of the landscape. There are winners and losers and companies add and shed workers as economic conditions demand. From this reshuffling of the deck come growth, efficiency and new sources of national wealth. It follows that to promote this natural selection we must engender competition, encourage innovation and yet maintain social continuity. The winners have got to be rewarded but the losers should not be unduly penalized. The private accumulation of wealth ought to reward success but cannot progress in the extreme to the detriment of a healthy economy and society. And when there is failure and or evolution in business models there should be an orderly transition when possible. This transition should include retraining for the displaced and a viable social safety net that discourages unrest to assure continuity.

 What becomes of free enterprise and democracy when those who fail are also rich, politically powerful and reluctant to accept the consequences of competitive capitalism? What becomes of a nation when its plutocrats are shareholders in a global enterprise rather than stakeholders in a society? What becomes of the free enterprise social contract that binds a nation when poverty and inequality grow unchecked and too many feel their aspirations and opportunities are vanishing?

I have often pondered the compatibility of capitalism and democracy. While the benefits of self determination that characterize the economic and political ideals seem to travel hand in glove it is the flaws of both systems, when left unconstrained, that combine to weaken the very society they thrust to greatness.


More Winston Please


“Some see private enterprise as a target to be shot, others as a cow to be milked, but few are those who see it as a sturdy horse pulling the wagon.” Well that about sums it up.

There will always be malcontents who find no comfort in a particular social or economic order. They will not rest until their brand of justice has been done and a perceived wrong set right. The founding brothers of our great nation chaffed under the yoke of mercantile colonialism and chose revolution over subjugation. It was not free enterprise they scorned but instead the heavy hand of the British Empire that limited opportunity for financial reward in the colonies.

In an unfortunate turn of events too much of American Capitalism has been replaced by a bastard form that promotes socialized loss and privatized gain. This abrogation of the free enterprise social contract is fomented by the institutionalization of moral hazard so devious and destructive that it not only perpetuates but rewards risks great enough to threaten the stability and future of the nation. We have learned that the finance sector can be a valuable tool of industry but it should not be mistaken for industry. Nor can finance fill the role of a sustainable driver of economic growth. The financial sector as currently structured is prone to frequent crisis and occasional failure- all at public expense. In this manner Wall Street’s extravagance and misdeeds are a tax on free enterprise and society.  Moo!

Optimism springs from the few bold voices that recognize that free enterprise must be nurtured through fairness and honest competition that provides proportionate reward for the superstar and the more humble achiever and assures the powerful plutocrats do not exchange the financial future of America for the short term gains of today’s global economy. Warren Buffet, Mohamed El Arian and Bill Gross to name a few wealthy, successful capitalists recognize the need for a recalibration of the free enterprise machine that has grown far too top heavy and tilted toward finance. If the horse is to remain sturdy and reliable a greater balance must be restored.


Chanos Knows


James Chanos is a capitalist in every sense of the word. Jim runs a very successful hedge fund and is the president of Kynikos Associates Ltd, his baby since 1985. Kynikos is the Greek word for cynic and true to form Jim made his mark shorting the stock of Enron after pouring over the fictitious financial statements of this historically corrupt energy company. Jim not only calls them like he sees them but puts his and his client’s money where his analysis takes him. He is currently looking at two trends he believes could end badly. The first is a property bubble in China that he sees mirroring the US experience and the second is the increased vulnerability of the US economy due to the widening income gap. “Income inequality in this country is just getting worse and worse and worse,” said Chanos in a recent interview with Bloomberg Radio. “And this is not a recipe for stable economic growth when the rich are getting richer and everybody else is being left behind.”


El-Erian Agrees


Mohamed El-Erian is the CEO and Co-Chief Investment Officer of PIMCO, the world’s largest bond fund. El-Erian is concerned with both the economic and political divergence caused by the growing income divide. “The large and growing gap between the haves and have-nots will tend to undermine growth, both directly and indirectly by reducing the marginal propensity to consume and by amplifying the political polarization that has already contributed to poor economic policymaking.”  

The Organization for Economic Cooperation and Development concluded in a 2008 study that among the world’s 30 developed nations only Turkey and Mexico have more unequal societies than America . The rich-poor gap widened by 20% in the U.S. since the mid 1980s, “Nowhere has this trend been so stark as in the United States ” claims the report. Between 1993 and 2008 in the US the top 1% of families captured 52% of total income gains according to a 2010 analysis of IRS tax data by economist Emmanuel Saez at UC Berkeley.  According to Census Bureau data analyzed by David Lynch in a recent Bloomberg article, since 1980 about 5% of annual national income has shifted from the middle class to the nation’s richest households. “That means the wealthiest 5,934 households last year enjoyed an additional $650 billion--about $109 million apiece-- beyond what they would have if the economic pie had been divided as it was in 1980.”

Meanwhile, at year end 2010 the typical American household enjoyed a median income of $49,445, below the level reached in 1997. Corporate profits stand at a record $1.5 trillion, 6.5% above their 2006 peak.


World Bank Economists Says...


In a September article, World Bank economist Branko Milanovic, attributed America’s gap to the following, “Economic gains in the U.S. have been spread less equally in recent years as a result of factors including globalization, technological change, the decline of labor unions, changing social norms and government trade and tax policies.” Milanovic concludes. “Widespread education has become the secret to growth. And broadly accessible education is difficult to achieve unless a society has a relatively even income distribution.”


Buffet's Baby Boy Bays

PEW Raises a Stink

Bernanke Buys In


Warren ’s bouncing baby boy Howard, the Director of Berkshire Hathaway Inc. told Bloomberg News in an interview where he defends Wall Street protesters, “There has never been a larger gap between earnings in this country, there has never been a time in my lifetime when government is going to cut an incredible amount of programs that support poor people and feed them.” While Howard lacks his dad’s folksy eloquence his point is clear. A PEW Research poll released on September 29th showed an increase to 45% from 35% since 2009 in the percentage of Americans who believe that the country is divided between haves and have-nots. The largest increase occurred among those describing themselves as political independents.  Last year gentle Ben Bernanke, the Chairman of the Federal Reserve, told 60 Minutes that rising inequality was leading to “a society which doesn’t have the cohesiveness that we’d like to see.” The fraying of social fabric begins at the margins, impacting those least able to defend their turf. If left unaddressed the fabric’s integrity and resilience become compromised, weakness spreads and distress intensifies. The Tea Party and Wall Street protestors are symbols to the trained eye that something is amiss in America .

The most egregious form of government relies upon the politics of scarcity, fear and blame and seeks to divide a nation for partisan gain .In the vacuum left by the failure of true leadership we sow the seeds of radical division that is currently packaged on the left and right in the dangerous terms of class warfare. There are few things more damaging than pitting citizens against one another when a cohesive society is required for self preservation. It is time for America to admit its mistakes and craft a focused long term solution of shared sacrifice and a commitment to competitive capitalism for all.

It is glaringly clear that our political class was unprepared for the consequences of the Techno-Global Revolution. It was obvious that conditions were ripe for massive, sustained job loss. An unprecedented supply of cheap capital, technological innovation and international labor cost differentials set the stage for disaster. Taking advantage of labor cost arbitrage was no overnight decision. Overseas infrastructures were built, workers trained, equipment bought, financing arranged, plant closures and human resource decisions were made. In times of job market uncertainty most folks cut expenditures and increase savings to weather a storm. They prepare for a number of scenarios. As my favorite mentor, John Wooden said to each young man in his charge, “Failing to plan is planning to fail”.

American leaders failed to show the required understanding of global labor markets and the vision to prepare for the coming storm. These are the same folks who failed to see   the financial crisis coming. Somewhere in this decade long story of ineptitude and imbalance there is a message for voters that cannot be obscured by multi-million dollar TV spots.


The Economic Impact of Growing Inequality


Most Americans would agree that it is the natural course of free enterprise for the gifted capitalist to reap rewards in proportion to his or her contribution to an industry, an economy and ultimately society at large.  The invisible hand of laissez faire capitalism provides for an equitable distribution of income and an optimum benefit for capital and labor alike. Translated this means that while the capitalist may reap a larger financial reward than workers, in the end everyone gets what they need to perpetuate the system and its prosperity. The capitalist is rewarded for his expertise and the financial risk he absorbs. The worker obtains a market wage for the labor he provides. What happens to an economy when a market wage and a living wage diverge?

For the past seven years ICM has argued that the Techno-Global Revolution has altered the relationship between capital and labor and has produced a leveling of global standards of living. U.S. workers have seen the market level of wages for many low skilled manufacturing jobs reset from those prevalent in America to those of Asia .

The initial rush of “every day low prices” lost its luster when “every day low wages” became the obvious reciprocal cost in a global economy. American jobs and wages were in steep decline even as faulty credit structures were dished up to stem the ebbing tide of U.S. consumption. Strapped American consumers devoured the equity in their homes in a futile effort to supplement stagnant or falling wages with borrowed dough. Surely some consumed with reckless abandon and deserve their insolvent fate but for most can we deny the impact of stalled wages in the face of ever rising costs of energy, food, college and housing?


The Economy Struggles and Poverty Grows


Adam Smith described the health of a nation’s economy as measured not in metals, raw materials or gold but in the household standard of living. Smith measured the success of an economy from the perspective of its consumers rather than its monarchs and merchants. Smith noted that economic prosperity is born of self motivation, competition and innovation rather than monopoly and privilege. What becomes of an economy when the distribution of wealth and privilege becomes skewed?

"Tangible Consequences"

  Research conducted by the International Monetary Fund economists Jonathan Ostry and Andrew Berg suggest that economic expansions erode more quickly in less equal societies. Unbalanced societies are more vulnerable to financial crisis and political instability. When such societies are hit by external shocks they often stumble in to gridlock rather than make tough choices to prolong growth. The IMF study also suggests that future U.S. expansions may last only one third as long as those in the 1960s, before the income divide began widening.

The average post war expansion in America lasted 4.8 years according to the National Bureau of Economic Research. The current expansion is a mere 27 months old, anemic, and characterized as on the edge of recession by Goldman Sachs. JPMorgan Chase & Company chief U.S. economist Mike Feroli relays that “Very high levels of inequality seem to be associated with slower growth.”

While recoveries may be growing shorter fewer Americans are sharing in the benefits. In fact during the recent period of “expansion” dated 2002 through 2007 America saw poverty rise and median incomes fall. 


Seeds of the Next Crisis

Some economists advocate that rising inequality contributed to the onset of previous financial crisis and may be laying the groundwork for the next one. During the 1920s and in the most recent decade the wealthy reaped large income gains that enhanced purchasing power and helped keep pace with inflation. As working poor and middle class wages lost ground they kept pace by increasing debt. This debt took off with the advent of increasingly risky credit offerings. In his book, Fault Lines, Raghuram Rajan, former IMF economist and now finance professor at the University of Chicago ’s Booth School of Business points out that politicians encouraged risky credit solutions as a bridge for those struggling to maintain their standard of living. Household debt nearly doubled in the 1920s and 2000s. Rajan concludes that as rich and poor drift apart the constituency for restributive tax and spending policies grows. “The guys falling behind don’t see much hope of getting ahead and are therefore more focused on redistribution.”

In the end debt is a toxic solution to income inequality.


Pain at the Top


A quick check of financial market history reminds us that there may be a price to pay for income inequality that will impact high rollers. After the crash of 1929 many middle class investors abandoned the stock market, seeing it for the rigged game it had become. In September 1929 the DOW stood at 355.95, a level it would not see again until September 1954. A 25 year bear market may again be the price paid if Americans question economic justice on a wholesale level.

Modern global capitalists would be foolish to trade the health of the American consumer for reliance on the Asian Economic Miracle. The glut of cheap workers and global manufacturing overcapacity carry the risk of nasty deflation that threatens rich and poor. China is an untested engine of global growth. If it sputters or worse, blows a gasket the progressing hand off of global consumer power from west to east could come to a swerving stop. Today’s global economy suffers from a lack of aggregate demand- in other words, weak consumers.

Shareholders in the global economy should not be confused with stakeholders in American society. The free enterprise system in a global economy produces wrenching realignments for the labor pool of high income nations and perhaps for equity investors.


Caught in the Cycle of Entrepreneurship


In addition to identifying the importance of a healthy consumer class in evaluating an economy Adam Smith also opened the world’s eye to the important yet sometimes destructive role of entrepreneurs. Smith tells us that entrepreneurs are called to arms by the alarm of high profits and high wages. In today’s Techno-Global Revolution the normal evolution of entrepreneurship has taken place in the emerging economies and particularly in the BRIC nations. Emerging nation entrepreneurs hear mostly the siren of high wages and grow their business on small innovations and large labor cost differentials. In America it is the CEO’s of global companies assuming the unlikely role of entrepreneur. They too are being called by the tolling bell of high wages. Labor arbitrage and the mechanization of the production process have displaced many a U.S. worker while producing record profits.

In this cycle of entrepreneurship companies have enhanced profits by cutting labor costs, a practice that will continue to squeeze the lemon. To date the Techno-Global revolution has been detrimental to American workers and a booming success for the wealthiest among us. As American household incomes suffer our BRIC nation counterparts enjoy a rising standard of living. Labor arbitrage is leaving American workers behind, with many workers now facing big adjustments in their American Dreams.


We Need More Jobs


BusinessWeek reported that at age 12 Steve Jobs placed a call to the home of William Hewlett the co-founder of Hewlett-Packard Co. The adolescent Jobs engaged Hewlett in a 20 minute conversation looking for parts for his latest gadget.  To say that Jobs was an entrepreneur is an understatement. He started Apple in his parent’s garage on April Fools Day, 1976- seeking to create a “bicycle for the mind”. Jobs’ all too short walk on Earth took him from adoption to techno-hippie start up to the leadership of the world’s second most valuable company. As an executive he was a demanding virtuoso. As a visionary he was unrivaled. His creativity knew no bounds. If you are a football fan over 40 you likely remember the 1984 Super Bowl ad depicting an Orwellian world of drab conformity. A woman tosses a hammer through a giant screen smashing the façade of Big Brother (read IBM) introducing the age of the Macintosh.

To ease the pain of the cycle of entrepreneurship that is sucking the life out of the American middle class we need more Jobs- Steve Jobs. It is clear that labor arbitrage is here to stay. The market value of labor is being determined by nations early in their industrial revolutions. America needs a cluster of innovations that will lead to the next technological revolution and the jobs and wealth that follow. We often shout about the importance of producing scientist, mathematicians and engineers but let us remember that Jobs and Bill Gates and Michael Dell were all dropouts from college. These men helped create an industry, employment and wealth for Americans. America needs the next generation of free thinkers to help sculpt our future and break the grip of this race to the bottom that is the signature byproduct of the current cycle of entrepreneurship.

Steve Job’s commencement speech to Stanford’s graduating class of 2005 is pure magic! Share it with your favorite young people. Bring the Kleenex.


Why Should You Care?


For as long as the cycle of entrepreneurship is the defining standard of the global business model we can look for slow growth, stagnant wages, high unemployment and flat revenues here in the U.S. In a political environment of scarcity, fear and blame, local government will be caught between federal austerity measures and the needs of your community. You, dear clients, are on the front lines.

World markets will remain volatile as long as the Euro-Zone fumbles and bumbles its way through the Mediterranean debt crisis. Interest rates should stay low for most of next year as per Fed monetary policy directive and the ongoing flight to safety in U.S. Treasuries.

In short, look for the economic malaise to persist and bond yields to bounce along historic bottoms unless something big happens.


Investing in a time of Slow Growth


ICM will continue to monitor the markets for low risk options to boost yield. Agency spreads have widened over Treasuries providing some yield pick up with comparable safety and liquidity. Some clients may choose corporate bonds for additional yield spread over both Treasury and Agency securities. LIBOR Floaters remain attractive. Three month LIBOR has risen to 41 basis points at the time of this writing. High grade corporate floaters add another 100 basis point spread to LIBOR producing yields competitive with 5 year Treasuries but with the advantage of shorter maturities a three month coupon reset.




ICM was born on October 1, 1997 in Boulder, Colorado . Our oldest clients may recall our overpriced offices were located on Pearl Street in the center of town. Boulder was buzzing with the chatter of high tech entrepreneurs and creative artists determined to change the world. It was an exciting time of innovation, promise and excess. The dot com bubble burst separating the pretenders from the real capitalists but the world of innovation never seemed to miss a beat. 


Today’s America seems a bit tired, less enthusiastic than it did in those days. Too many of us seem to be looking to the past for our futures. Our contemporary leaders are so poorly miscast their ineptitude would be comical if the circumstances weren’t so dire.

I would like to pass along some wisdom shared by a young friend. “A man is not old until regrets take the place of dreams.”  The words of John Barrymore can just as easily apply to our weary nation as it does a man worn down by life’s struggle.