Heading Towards Zero!

We are now heading towards a total loss in the stock market. The above is for the test portfolio of band aids, mac and cheese, soda and beer and a phone call. This is terrifying, it is approaching a 90% drop in the stock market by year's end if we continue at this unending rate. Add to that the taxes from cap and trade, add to it the bloated budget, the bloated stimulus, and the generally lack lustre performance of DC in general, well there may be no place to hide. Good Luck folks!

More Thoughts on Cap and Trade

We have calculated an estimate of what the Administrations proposed 100% Auction based cap and trade proposal will cost. The results are shown below and are based upon the model we have developed before. This uses the same data but now assumes that the Government runs an auction for credits with a strict cap. By strict cap we mean it sets a price, quite high, if you exceed the cap. The Auction sells or clears at 80% of the excess cap.




















The analysis above also assumes that a full compliance is made by deploying wind, nuclear and the like in a timely fashion. This is a highly optimistic plan. The above Figure shows several interesting results from the Administrations proposal. They are:

1. In constant dollars the tax per person goes from $310 to $1,650 per year. To get the number per household you multiply by 2.5 yielding $775 to $4125. This is just for electricity and does not include any additional costs for industrial pass through and the like.

2. This fee take $95 billion and growing to $600 billing per year out of the economy and places it in the Government coffers! This removes massive amounts of capital from productive sources and places them in the hands of Congress and the Executive!

In an early 2008 blog comment from the then CBO head Orszag, he wrote on the alternative CO2 control options:

"In this study, CBO examined a variety of incentive-based policies for reducing CO2 emissions, including a tax and a cap-and-trade system:

1. A tax would set an upper limit on the cost of emission reductions—firms would undertake reductions that cost less than the tax—but would leave the amount of emissions uncertain.

2. An inflexible cap-and-trade program would set an upper limit on the amount of emissions but would leave the cost of reducing emissions uncertain.

3. A flexible cap-and-trade program would maintain the structure of a cap-and-trade program, but would include features designed to limit the cost of meeting the cap. Specifically, a cap-and-trade program could include one or more of the following:

i. A price ceiling (often referred to as a safety-valve) and/or a price floor;
ii. Provisions that permit firms to “bank” unused allowances in one year for use in a future year
and/or “borrow” future allowances for use in an earlier year;
iii. Provisions to make the cap less stringent if the price of allowances rises beyond an agreed upon amount. A “circuit breaker” would directly modify the cap. Alternatively, the government could indirectly modify the cap by changing the terms under which firms could use borrowed allowances."

He then continues:

"The study finds that:

A tax could achieve a long-term emission reduction target at a much smaller economic cost than an inflexible cap. Provided that the tax was set equal to the expected benefit of reducing a ton of CO2, a tax could thus result in substantially greater net benefits (benefits minus costs) than a comparable cap-and-trade program. The advantage of a tax stems from the long-term nature of climate change (which depends on the build-up of emissions over many decades, but is not sensitive to the amount of emissions in any given year) and the uncertain and variable nature of the cost of reducing emissions (which will vary from year to year based on the weather, conditions in energy markets, and the availability of new technologies).

An inflexible cap-and-trade program would provide more certainty about annual emissions than would a tax; however, that certainty would come at a cost: The cap would require too many reductions when the cost of achieving them was high and would mandate too few reductions when the cost was low.

Flexible cap-and-trade programs could achieve some, but not all, of the efficiency improving/cost minimizing advantages of a tax:

Out of the flexible cap designs that CBO considered, a cap-and-trade program that included both a safety valve and either a price floor or banking provisions could offer the greatest potential to minimize the cost of meeting a given long-term target.

Including a circuit breaker, or altering the extent to which firms could use borrowed allowances, could help prevent the price of allowances from going higher than policymakers wanted. Either approach, however, would be less direct, and less effective than including a safety valve.

Either a tax or a cap-and-trade program could be relatively easy to implement. Some flexible design features, such as banking, borrowing or a safety valve, would be straightforward to implement. In contrast, price volatility in the allowance market could make it difficult for the government to know when to implement a circuit breaker (or to change the terms associated with borrowing allowances). Minimizing the cost of reaching a global emissions target would entail undertaking the lowest-cost emission reductions regardless of where in the world they were located. If coordinated among emitting countries, a tax would help minimize the cost of achieving any given target. Linking the cap-and-trade programs of various countries could help minimize global costs, but could create some significant concerns:

• Countries would give up sovereignty over the price of allowances traded in their programs.
• Poor monitoring or enforcement in any one country could undermine the integrity of the
• allowances traded throughout the whole system.
• Flexible design features, such as a safety valve, banking, or borrowing, would become
• available to all regulated entities in the linked system.
• Major emitting countries could help minimize global cost of reducing emissions by establishing
• national cap-and-trade programs that each included a safety valve set at roughly the same level."

In our recent White Paper we presented a cap and trade with strict caps but with a Government free Exchange for the credits. We assumed that the transaction costs were cleared in an open market manner. However this is NOT what the Administration seems to be proposing. From the Administration's overview of the 2010 Budget they state:

"Begin a Comprehensive Approach to Transform Our Energy Supply and Slow Global Warming.

The Administration is developing a comprehensive energy and climate change plan to invest in clean energy, end our addiction to oil, address the global climate crisis, and create new American jobs that cannot be outsourced. After enactment of the Budget, the Administration will work expeditiously with key stakeholders and the Congress to develop an economy-wide emissions reduction program to reduce greenhouse gas emissions approximately 14 percent below 2005 levels by 2020, and approximately 83 percent below 2005 levels by 2050. This program will be implemented through a cap-and-trade system, a policy approach that dramatically reduced acid rain at much lower costs than the traditional government regulations and mandates of the past. Through a 100 percent auction to ensure that the biggest polluters do not enjoy windfall profits, this program will fund vital investments in a clean energy future totaling $150 billion over 10 years, starting in Fy 2012. The balance of the auction revenues will be returned to the people, especially vulnerable families, communities, and businesses to help the transition to a clean energy economy."

Now this implies the following:

1. The Government will auction off rights to generate CO2 emissions to the highest bidder. This will be akin to the FCC spectrum auctions. he have had major problems and have been dominated by the largest carriers. This means that the proposed national 100% auction will generate massive industry consolidation and massive monopolization of the power industry as well as of industrial production. The Administration continually fails to understand the unintended consequences which will flow from their actions.

2. The Government will maximize its returns on ALL CO2 emissions. In our model the intent was to cap emissions. In the Government model it is to cap emissions as well as collecting a massive amount of tax by having a monopoly on the auction process.

3. Government auctions are inefficient and time consuming and tend to either maximize prices, thus becoming a highly regressive tax, or result in people just walking away. The FCC spectrum auctions give many examples. Fraud also has been rampant in these auctions.

4. The tax collected in this process will just be handed down to the consumer and business. This is a massive tax and will draw capital from the US economy and destroy massive amount of entrepreneurial efforts. It appears that the current Administration is bent on destroying the American entrepreneur at all costs. They seem to believe that they and they alone have the insight to "invest in America" and "to make the right choices" in what is to be done, the market be damned. The more one looks at this cap and trade scheme the more Americans should be terrified that their future shall disappear in the smoke that contains less CO2.

5. The CBO just a year ago supported a tax plan if any were required. Yet the Administration's proposal is a 100% Auction hard cap plan. This then allows the Administration to effectively take over the power companies, drive out the industrial base and destroy any creativity. Frankly this goes from Socialism to, well, I think we may have seen this before.

Type 2 Diabetes: An Example of an Economically Controllabe Disease

Type 2 Diabetes is predominantly caused by obesity. Obesity is defined as a body mass index, BMI, in excess of 30. Type 2 Diabetes currently affects 5.9% of the population and this is increasing at the rate of 6% per year. In 2008 we estimate that it costs $275 billion in fully loaded health care costs and this was 12% of the total. By 2030 we estimate that it will take 20% of all health care costs if left unabated.

We have prepared a White Paper detailing how this can be turned around by taxing at the source. As was done in tobacco tax, thus reducing male cancers by almost half in twenty five years, we believe the same if not more can be accomplished in the area of Type 2 Diabetes.

We conclude in the paper the following.

1. Type 2 Diabetes is a disease caused by the person having it. It is a self induced disease for almost all. A very few have a massive as yet identified genetic flaw, but that is de minimis. It is obesity as the main and almost sole cause.

2. The prevalence of Type 2 Diabetes is growing exponentially and the term of epidemic is not unjustly employed. It is an epidemic resulting from childhood lack of food control, lack of exercise, and lack of recognition that the problem is moving downward in age and becoming explosive as that population itself ages.

3. The current means of managing Type 2 Diabetes with drugs such as metformin, insulin, sulfonylureas, and others mask the true problems and in many ways exacerbate the secondary disease states.

4. Type 2 Diabetes is now at 12% of the total health care costs and with its current growth rate combined with costs and population may reach 25% of the total health care budget. This disease has the sole potential for collapsing the health care system.

5. Type 2 Diabetes is a disease which can be controlled and possibly eliminated by purely open market means. By pricing carbohydrates at a point that exceed the propensity to buy, then there will be a reduction in carbohydrate driven obesity. This is akin to taxing the use of tobacco in cigarettes.

6. The use of combined drugs such as statins and the existing insulin modulating drugs oftentimes create additional tertiary health problems that add to the overall burden while also costing a great deal in the use of the drugs themselves.

Cap and Trade: Unintended consequences

We have just published a White Paper on the cap and trade issue. The intent was two fold: first, develop a simple analytical model to understand how it works and what are its consequences. It appears that no one has present such an approach. Second, to consider the unintended consequences of this proposal. We have found that it is essential to study these otherwise you find yourself back in the same mess we have in the financial markets. The Administration is so hell bent to institute this that they are totally neglecting the downside risks! We summarize a few here.

The law of unintended consequences plays an ongoing role in all Government programs. Whenever the Government acts there are reactions to avoid the actions. The unintended consequences are critical to understand and hopefully anticipate and if necessary avoid. It is akin to flying an F‐16 having had one lesson in a WW‐I bi‐plane. If you enter a dog fight you best have some skills.

Leakage from Mexico and Canada

Why not just set up coal power along the Mexican border. It would employ hundreds of thousands of Mexicans, and then send it across the border. Likewise Canada could use shale oil and do the same on the North. Then watch the trade deficit sky‐rocket. The cap and trade proposal is a national first mover approach. Yet Canada and other nations have already moved. Thus what the US does is not followed by other countries.

Inherent Instabilities in Deployment of Alternatives by Environmentalists

As we have seen in so many prior cases, the environmental lobby, for reasons often known to only themselves, oppose anything. The use of wind has seen objection after objection. The deployment of large wind turbines across the mid country would be in the path of many migrating birds. Thus they cannot go there. Or the environmental impact statements would go on forever. Delay is often the deadliest form of denial. Delay can occur at the Federal, State, and local level, and the delay adds costs directly and derivatively.

Failure to Deploy Grid; Environmental and Other Delays

You cannot get wind and solar or even nuclear unless you have a national grid. This is in and of itself a major task. What is an intelligent grid? It is an evolving and learned process just as was the Internet. The Internet did not spring forth fully formed. It began in the late 1960s and slowly evolved assisted by thousands of highly intelligent and collaborative systems and development engineers. The power industry has been a backwater for the past fifty years. Thus the competence set is just not there. IBM had developed SNA, something that one may now find in history books. A handful of very smart people developed TCP/IP and its progeny. GE will not develop the smart grid. It will take the same group. However the problem is that they just do not exist. Thus the essential first step is at best problematic. Ironically many of those who could do this have H1B visas and are soon to be shipped out of the US! Who is forcing this? The
Unions. They want all Americans. The H1Bs want to become Americans and yet we throw them away. The system seems to devour itself in an endless fashion.

Stability Problems and Cycles

As I recalled about my involvement of the Black‐Scholes model, my parting comment was beware of the instabilities. They seemed to have forgotten that admonition in Long Term Capital Management. This is not a static system, year upon year. It is a random dynamic process with nonlinearities. By definition they become unstable and they oscillate. However we can model and monitor them. They may be controllable and than can be observable. It just means that you fully understand this and have people looking at it as a system. Economists are poor at this since economists never have to design something that works. They are not engineers, scientists, or physicians. They are at best abstract conjurers.

Massive Job Loss and Displacement

Coal is the livelihood for hundreds of thousands in the United States. Wheeling, WV is a lynch pin in this world, and in the hollers of that region mining of coal has been centuries of existence. We will drive them totally into the stone age. The technological solution is a clean coal which seems to be dismissed out of hand by the Administration. Technologically ignorant people assume if it has not been done it cannot be accomplished. Roosevelt was not a luddite; the atomic bomb was a glimmer in the eye as late as 1943. It took really just over two years to deploy. The same effort could be applied to coal. But for some almost religious reason it has been defaulted. Add to this the industrial collapse because of dislocations of Industries and we would expect massive unemployment. The recovery would take generations. It would be costly beyond any trillion dollar Stimulus we have yet to see.

Massive Industrial Movement from the US

The Industrial sector is a major user of energy in the United States. One approach of controlling the CO2 emissions at the source would be to have the Industrial sector be controlled like the electricity sector. If we look at the Table below the sector relies heavily on oil, gas and even coal. Coal is used for aluminum and concrete, it is a cheap energy source for creating these and also concrete as a chemical process also produces CO2. Thus is we were to apply the same restriction here we would inevitably drive these industries from the US totally. The IT industry is a heavy user of electricity and it too would find itself drive elsewhere. Thus one of the unintended and totally un‐thought about consequences is this driving of industrial entities, the residual one at that, from the US to countries which have available and affordable power.

Dramatic Inflation and Inflationary Pressure

The problem of inflation is pandemic in this approach. Taxes will drive up demand which drive up costs of the energy sources which drive up energy which drives up costs and on and on. The cap and trade proposal may very well set in motion a whole cycle of such inflationary pressure. Also like Gresham's Law, it may drive out "good fuels" and leave bad. For example as coal becomes non‐existent in electric power plants, there may be created a "Black market" for coal and wood may replace coal in certain markets. It will be akin to prohibition, the demand will be intensified because of the inflationary pressures. As one begins to know this Administration, the home still will be replaced by the home coal burning stove and a new massive Federal police force will likely be formed to strike down the down trodden pollution violators.

Destruction of Entrepreneurial Innovation

One of the things which seems to be coming out of this Administration is a total lack of understanding of the entrepreneur. As we have written before the entrepreneur is the engine of innovation and commerce in the US since the Dutch settled in Manhattan.

Back to the Restaurant at the End of the Universe

In the tale of the Restaurant at the End of the Universe a planet expels its middlemen keeping its thinkers and doers. Of course the middlemen survive and the thinkers and doers implode upon themselves. Then there is the Obama meeting on healthcare as reviewed by the Washington Post.

I have spent a few minutes looking at the list and it is composed of legislators, lobbyist and lawyers! The deadly three Ls. At least Hillary collected a group who had been thinking and analyzing the problem for some time before assembling. Imagine if you will, for but a brief moment, in a room with Jimmy Hoffa, Marian Wright Edelman, Donna Shalala, John Dingell, and Larry Summers. Even Dante could never have imagined such a collection! And from this we will get a new Healthcare Plan!

To gain credibility, one first needs to assemble those who bring value to the process. In a conversation with a good friend and highly successful and technically advanced physician, we discussed electronic medical records, and he said it will never work because Physicians are just "stupid". I took that in the sense of accepting technology. However anyone who has ever taken a patient history clearly knows that this is not a table checking process, it is not always linear, you don't start from the head and work your way to the toes. There are interjections, deflections along differing paths and the like. The problem is to diagnose and if at all possible cure. Diagnosis requires first listening to the patient, and sometimes that can be a lengthy and circuitous process.

Thus the almost childlike simplicity of the new Healthcare Plan, yet to be formed, needs the 3 Ls only after it had been developed and digested. Otherwise it becomes just another fire hydrant exercise with all of the dogs in the neighborhood.

DoL Numbers, The Winter May Just be Beginning

The Department of Labor just issued the unemployment numbers. They are shown below:


















Unemployment has reached 8.1% and the market is falling at an annualized rate of 80%. As we said almost three months ago, we anticipate this going well into 2010, a DOW at well below 6000, unemployment exceeding 12.5% and then a swing in inflation approaching 20% as a way to "pay off the massive debt". The major problem is that the current Administration is attempting to do everything at once and not accomplishing anything. Again as we said, focus, focus, focus, and the primary focus in the economy.

The US is going into the G20 with no cards. Perhaps the exchange of gifts between the Prime Minister and the President were most telling, the Prime Minister gave the President items of great historic value, stressing the nexus between the US and Great Britain. The President gave a bunch of DVDs! Really, you can't make this stuff up! Even the Chicago Tribune says that Obama may do what no one else could, make Bill Clinton look great.