Special interests?

On the front page of today's New York Times, an article on 1031, "like-kind," exchanges says that the tax break is used by "everyone [emphasis mine[ from commercial real estate developers and art collectors to major corporations. It provides subsidies for rental truck fleets and investment property, vacation homes, oil wells and thoroughbred racehorses...."

Then the reporter writes: "The expansion of the tax break once intended to help farmers illustrates the challenges ahead and how special interests have learned to use the tax code to maximum effect."  Does he mean that farmers are not "special interests"? A bill written "to help farmers" is a classic special interest bill.  And the "expansion" of farmers' tax benefits to "everyone" may be a good or bad policy, but it's not a story about "special interests", it's the opposite.

Brad DeLong has a good phrase for this kind of thoughtlessness in journalism: why, oh why, can't we have a better press corps?

 

A Brazilian Anomaly

One nice thing about being retired is the freedom to spend an irresponsible amount of time looking into topics that catch my eye, without  feeling guilty about it.  For example, the chart below caught my eye during the week. On the right, it appears that the real yield on Brazil's 10-year is greater than the sum of the real yields on the 10 years of the US, China, Japan, Germany, France, the UK, Italy and Australia, not only individual comparisons, but combined, by a margin of about 2:1.



Source: Citi Equity Research:  QE Isn't Working: An Equity Perspective (Nov. 21, 2012) (h/t: Mebane Faber's Idea Farm).

The disparity seemed so anomalous I wanted to understand the reason for it.  Brazil in many respects has a stronger fiscal position than most nations in the sample.  And unlike Italy and the other PIIGS, it has control over its currency, which we have been told repeatedly, is the root cause of the PIIGS' financial problems.  So why does Brazil pay such a spread?

The report containing the chart implies that the reason is "financial repression", a term for government policies designed to repress financial returns to help highly indebted governments reduce their debts -- for example, the gigantic purchases by the Fed and ECB of their respective sovereigns' debt, keeping interest rates in those nations lower than would otherwise be the case as they run large fiscal deficits.  For a nation like Brazil that has a relatively low funded debt-to-GDP ratio of around 35%, presumably financial repression is not the order of the day that it is in more indebted nations.

While this sounded right, when I spent some time looking into the subject, I realized the chart is somewhat misleading regarding Brazil's debt.  In contrast to the other nations in the chart, Brazil's debt is denominated in multiple currencies.  The chart apparently portrays the real yield of its local currency debt (LCD), which is approximately 400 bps according to the chart, although more recently it's shrunk to about 370 bps (approx. 9.2% nominal yield less approx. 5.5% inflation).   But Brazil also has USD-denominated debt outstanding.  And that debt turns out to have a much lower yield, approx. 2.6%, or about 650 bps less than the nominal yield on the local currency debt.  If we subtract out the rate of depreciation of the USD, using the US inflation rate of around 2% as a proxy, we get a real yield on that paper in the 60-90 bps range, much more in line with the rest of the chart. 

But it did get me wondering: why is there such a disparity between the real yields on Brazil's two types of debt. 

It could well be that there are so many dollars slopping around the world and chasing yield that buyers have driven the USD-denominated paper up to an undeserved premium above the LCD, which is consistent with the "financial repression" explanation.  But a look at economies similar to Brazil, like Turkey and Mexico, gets in the way of that easy explanation.  They have inflation rates similar to Brazil, and their USD-denominated debt gives off a similar yield, but their LCD doesn't pay much of a premium to the local inflation rate at all.  Brazil is anomalous in that regard. Also, if it were just that, you would expect a carry trade to arise to arbitrage the two interest rate environments and reduce the disparity over time.

I thought it might be that Brazil just has a low savings rate, which would mean the government would have to pay up to obtain scarce funds.  They do have a low savings rate, but not any lower than Turkey  where yields are no higher than inflation.

I decided to look at whether there was a structural explanation in Brazil's financial sector, which does have some unusual aspects.  Brazilian credit availability is dominated by the state-owned development bank, BNDES, which holds a majority of all the long-term debt in the country.   Its loans are pegged to a different interest rate, designated the long-term rate, and known by the acronym of TJIP, than the central bank's policy rate, the SELIC.  But that long-term rate actually turns out to be lower than the short term rate (an inversion which is itself anomalous and probably  a topic for another day).  So that doesn't explain it either.

It also can't be that Brazil's central bank is trying harder than the rest of the world to fight inflation because  it's actually cut policy rates by 500 bps in the past year, and just cut reserve requirements on top of that, because the economy was basically stagnant last year.  

It's possible that holders of Brazil's LCD just don't fully trust Brazil's official inflation rate - or, more charitably, fear the inflation rate will be even higher in the future, and are charging a premium to hold LCD, which is a garden variety inflation risk / currency depreciation explanation with even some capital flight maybe going on.  Although with the US, European and Japan;s central banks all monetizing debt like mad, is Brazil the biggest risk in that regard?

I didn't find any explanation completely satisfactory, so maybe it is a combination of them all or there are some other local factors at work. If it were just an anomaly, it would be a great carry trade but somehow I doubt such an opportunity has been missed by the investing world 

Along the research trail, I came upon a pretty interesting website, http://brazilianbubble.com/ , which maintains that Brazil is in the final stages of a credit and housing bubble, a thesis that it marshals a good deal of analysis to support; some readers might find it of interest and possible something to keep an eye on in the next year or two.

"Dance With You" by Eugene "Hideaway" Bridges

I was driving along, listening to the "Bluesville" channel on SiriusXM, when they played a song, "Dance With You" by an unfamiliar artist named Eugene Bridges.  It sounded so retro that I figured it was just a cover of something turned out in the 60's by an R&B artist like Solomon Burke or even Sam Cooke.  But when I looked it up online, it appears to be an original.  I can't believe anyone is still creating songs like this anymore.  I couldn't find a file of the song itself to embed, but the song can be sampled and purchased on Amazon  ( http://www.amazon.com/Dance-With-You/dp/B004YFC9FQ ), iTunes, etc. Since the artist is somewhat obscure, I thought he deserved a little shout-out for helping to keep a genre alive.

Constitutional Disobedience?

I had planned to start this blog with a different topic, but since the blog takes its title from a clause in the Constitution, when I read Louis Seidman's op-ed piece in the December 31 New York Times, "Let's Give Up on the Constitution", I thought it would be appropriate to start off with a post about that instead.

In pretty outrageous language -- describing Constitutional provisions as "downright evil" --  Seidman, a professor at Georgetown, argues that the Constitution (1) causes political dysfunction, (2) keeps us "from debating the merits of divisive issues" and  3) "inflames our public discourse".  I gather the Times does not edit op-ed submissions, as no one seems to have asked Seidman  to explain how "public discourse" is "inflamed" if the public is not "debating  the merits of divisive issues", or how he identified "divisive" issues if they are not being debated.  In any case, I can't find anything in his op-ed that explains any of those bombastic accusations.

A blurb at the bottom of the column says that Seidman  has written a book about to be published titled "On Constitutional Disobedience".  The title, I suspect, harks back to Thoreau's essay "On Civil Disobedience".  But unlike Thoreau's essay, in which one introverted guy sitting in the woods advocated disobedience by individual citizens on matters of conscience, Seidman argues for federal officials to disobey the Constitution whenever they think it's in the best interest of the nation.  Which they wouldn't ever possibly confuse with their continued employment at taxpayers' expense.

Seidman offers up several historical anecdotes to support his argument that the Constitution gets in the way of getting good things done and should be merely "aspirational".  On casual inspection, the anecdotes prove to be, in most cases, mere statements of personal opinion by famous government officials:  Jefferson thought this, FDR said that, Justice Jackson believed such and such.  But this is just an ad hominem argument; the remarks he quotes never triggered an overthrow of the role of the Constitution as the supreme law of the land, which for 225 years has remained the case.  The small handful of occasions when a consensus formed around a particular deviation from the then-prevailing interpretation of the Constitution -- the Louisiana Purchase; the addition of the post-Civil War amendments notwithstanding their somewhat coercive ratification; and the New Deal -- are too rare to lead to the conclusion that ignoring the Constitution should be a routine practice.  By way of analogy, policemen have to shoot people on rare occasions, and many of those occasions resolve significant problems, but that fact doesn't mean it should become routine for policemen to shoot people.

Seidman also references the Emancipation Proclamation as an example of extra-Constitutional action by the executive.  But as everyone who has seen the movie "Lincoln" knows, (a) there was a plausible Constitutional basis for the Proclamation as a "war power" (indeed, separating slaves from their masters had been justified under the law of war in the military theater by General Butler at Hampton Roads in the first month of war); and (b) more importantly, the Constitution was amended in 1865 to incorporate the result.  So, after 148 years of undisputed Constitutional resolution of the power of states to allow slavery, it seems pedantic to base an argument for overthrowing the Constitution on an ambiguity that existed during 2 prior years. 

To illustrate his argument that the Constitution causes "political dysfunction" and thus should be disregarded, Seidman identifies the requirement of Article I that all revenue bills must originate in the House.  This requirement  has little practical significance today, because, if the House wants to get behind a Senate tax measure, it can simply adopt that measure as an "amendment" to one of its own prior revenue bills, as occurred just this past week; Seidman does not mention that.  To offer something so insignificant  as proof that the Constitution as a whole should be disregarded is like deciding that, because you can't start your car until you put your foot on the brake, you should really just set your car on fire.

Seidman next asks the reader to "Imagine that after careful study a government official — say, the president or one of the party leaders in Congress — reaches a considered judgment that a particular course of action is best for the country. Suddenly, someone bursts into the room with new information: a group of white propertied men who have been dead for two centuries, knew nothing of our present situation, acted illegally under existing law and thought it was fine to own slaves might have disagreed with this course of action. Is it even remotely rational that the official should change his or her mind because of this divination?"

There is an awful lot wrong with this caricature, which emanates often from the academy, post-critical legal studies.  First, while the Constitution may have been drafted by DWM in 1787, it hasn't sat in a DWM museum since then.  Dozens of states with live voters subsequently chose to accede to it, including, within living memory, Alaska and Hawaii, states with sizable non-white voting populations.  Should Puerto Rico be afforded the opportunity to become the 51st state and accept, the point will be reinforced.  Similarly, nine separate amendments have been ratified since women began voting, including the poll tax ban, which removed an impediment on African-Americans voting, and the amendment extending the franchise to persons between 18 and 21, many of whom are still living.  

Second, in order to become a "government official", one has to take an oath that says something about upholding the Constitution.  So, unless Seidman means for "Constitutional disobedience" to extend to lying to the people who elected you, it's "remotely rational" to expect the official to live up to that oath, especially since the only reason he or she gets to become "a government official" in the first place is a process set up by that "downright evil" Constitution.   

But let's suppose Seidman solves that problem by dispensing with any oath, or reference to the Constitution in it; let's suppose that, instead,  government officials just have to swear to engage in "careful study", which is the only other requirement he seems to envision for government action.  Well, it isn't just "white, propertied men who have been dead for two centuries " who "might disagree" with the particular decision of a particular government official (and I'll ignore the ad hominem argument that "they liked slavery too" because, however revealing it is of his lack of intellectual rigor, it's too tangential to the point).  Because, if dead people were the only opponents, his hypothetical government official could easily get the Constitution amended to approve the desired course of action.  The problem is that there are likely lots of other government officials, and equally likely lots of ordinary citizens, who don't agree with the course of action.  And there needs to be a mechanism for resolving that disagreement. 

Seidman doesn't offer any guidance on what that mechanism should be.  In fact, his op-ed is completely incoherent on mechanisms, which are much of what the Constitution is about.  In his second paragraph, he scorns the role of the legislative branch in fiscal matters:  "Why should a lame-duck House, 27 members of which were defeated for re-election, have a stranglehold on our economy? Why does a grotesquely malapportioned Senate get to decide the nation’s fate?" But, in the middle of his piece he allows not only that " ... Congress should consist of two houses. Some matters are better left settled, even if not in exactly the way we favor” but also that "Congress might well retain the power of the purse, but this power would have to be defended on contemporary policy grounds, not abstruse constitutional doctrine.".   So is it OK or not for a "lame duck House" and a "grotesquely malapportioned Senate" to control the fisc on "contemporary policy grounds"? (Which, as far as I can tell, are the principal grounds they've been debating). His view seems to vary from paragraph to paragraph.  But if it is OK, then it's his snarks about "lame duck" status and apportionment that are the "abstruse points". 

But it's not only his perspective on the legislative branch that is incoherent.  Regarding the Supreme Court, he tells us that one benefit of ignoring the Constitution is that "The Supreme Court could stop pretending that its decisions protecting same-sex intimacy or limiting affirmative action were rooted in constitutional text."  Ignoring for the moment the "have you stopped beating your wife" frame-up of the Court's decisions, the larger fallacy in this statement is: if you've eliminated a requirement that government officials obey the Constitution, what would bring any of those questions before the Supreme Court in the first place?  They only come before the Court because someone makes a claim that the Constitution limits what government officials can do. If it doesn't, the Court has no role to play.

And when he gets to the executive branch, Seidman pulls off a triple play of incoherence, stating on the one hand that "Nor, finally, should we have an all-powerful president free to do whatever he wants. Even without constitutional fealty, the president would still be checked by Congress and by the states" and on the other that "The president would have to justify military action ... solely on the merits, without shutting down the debate with a claim of unchallengeable constitutional power as commander in chief."  As a matter of historical record, I can't recall an occasion when a President (a) failed to claim that his military action was justified on the merits, but (b) "shut down debate" with a claim of unchallengeable power.  Seriously, how far could a President get in the court of public opinion saying "I don't have to convince you this is the right decision, I can do this whether you or not it is."  This is just another straw-man.  But even as a matter of logic, it's as incoherent as anything else.  Without "Constitutional fealty", what enables Congress to "check" the President?  The predicate assumes away the source for their power to "check" the President.  

And, even within the Constitution, I don't know what he is talking about when he suggests "the states" check the exercise of Presidential power. I can't think of a single government action that requires states to act as a predicate to Presidential action, or give states a veto over Presidential action.  The whole subject of resolving federal  / state conflicts, a gigantic aspect of the Constitution, goes unmentioned.

Seidman urges that the Constitution should be "aspirational" without much explanation of what that means.  For example, he doesn't explain how doing so would result in less "inflamed public discourse".  When politicians debate alternative courses of action that are clearly Constitutional, such as different bills on tax policy, the "public discourse" is hardly less inflamed.  And he totally ignores how government officials would resolve conflicts between two opposite "aspirations".  Often the response from Constitutional scholars who share his viewpoint is "the electoral process".  But that would produce outcomes that many would find intolerable.  For example, in the civil rights era, duly elected state officials strenuously resisted the desegregation orders of unelected federal judges.  So if "the electoral process" were the tie-breaker between competing aspirations about the Constitution, the South might well have remained segregated; indeed, there would be no basis for the federal courts to have become involved at all if the Constitution were not binding on elected state officials.

Seidman might respond by positing that certain provisions of the Constitution, such as those that limit racism, should remain in force.  But then his position boils down to a rationalization of his personal preferences as opposed to something more comprehensive template for running a government, as an enduring nation requires.

Seidman also notes that other countries do not maintain a written Constitution, for example, the UK.  But the UK also has a monarchy and, while he clearly wants to repudiate the actions of 1787, I don't sense he wants to go back even further and restore a monarchical regime in the US.  That may sound flip, but I think there is an important point to be made.  To maintain the social cohesion that is essential to have a nation, nations tend to have a central reference point for their particular identity, what defines what it means to be that nation as opposed to something different.  That identity almost always derives from the nation's founding or some other epochal event in its history.  In the UK, the monarchy serves that purpose, even if its government has defined itself by its separation from the monarchy over the past millenium.  France,  Russia and China have their revolutions and the rhetoric of the revolutionary leaders.  These are very similar to how the major religions define themselves, harking back to a single historical moment, when something divine or quasi-divine happened, to which both the leaders of the religion and its many members refer to establish a coherent religious identity.  In the highly secular and ethnically diverse US, the Constitution serves a similar purpose as a principal point of reference for national identity and cohesion. 

Seidman winds up his op-ed with a lament that if we continue to be bound by the Constitution, "we have to give up on the claim that we are a self-governing people who can settle our disagreements through mature and tolerant debate"  which is pretty sanctimonious from a guy who calls the Constitution "downright evil".  While there is plenty of immature and intolerant debate in the nation, it's hard to think of a more "mature and tolerant debate" than a Supreme Court argument on a Constitutional issue. If anything, arguing about the Constitution implies a common bond to it. 

I wouldn't write a Constitution today as the Constitution is written.  I imagine few would.  But I doubt my or anyone else's vision of a perfect replacement will ever take its place. As a practical matter, what Churchill said of democracy, that it is the worst form of government except for all the others, is probably fairly applicable to the Constitution as well.