The Capital Letter: Week of October 26

Global equities are on track for their worst week since the ructions in March, with Wall Street’s tech titans among the latest casualties in a sell-off attributed to caution over coronavirus and the US election.

Renewed virus-related lockdowns across much of Europe and the final stretch of the hotly contested US presidential campaign have contributed to an uptick in financial market volatility this week, with further losses on Friday.

The MSCI All World index of global equities fell 1.5 per cent, leaving it down 5.7 per cent since last Friday in its steepest weekly sell-off since concerns about coronavirus gripped markets in March.

Stocks fell on Friday, led by major tech shares, as Wall Street wrapped up a difficult week in which coronavirus cases rose, U.S. fiscal stimulus talks broke down and traders braced for next week’s presidential election.

The Dow Jones Industrial Average traded 451 points lower, or 1.7%. The S&P 500 dipped 2.1% and the Nasdaq Composite pulled back 3.1%.

The Dow and S&P 500 are down 7.5% and 6.4%, respectively, for the week and were on track for their biggest weekly losses since March. The Nasdaq has lost more than 6% over that time period and was also headed for its worst one-week performance since March.

The Federal Reserve announced Friday its latest round of changes to boost participation in its $600 billion lending effort targeting small and midsize businesses amid difficulty by Congress and the White House in reaching agreement on a new round of relief measures.

The Main Street Lending Program, which is jointly run with the Treasury Department, has seen muted demand from borrowers and banks and is designed to encourage more lending to businesses that were in a solid financial condition before the coronavirus pandemic hit this year. Under the program, the Fed will purchase 95% of eligible loans made by banks.

Friday’s changes reduced, for the third time, the minimum loan amount under the program—to $100,000, from $250,000. The loan amounts had earlier been lowered from $1 million to $500,000 and then from $500,000 to $250,000.

The changes also revamped the fees banks can charge borrowers to encourage greater production of smaller loans. For loans below $250,000, the Fed will waive the 1 percentage point fee it collects, and it will allow banks to double to 2 percentage points the fees it charges borrowers to make these smaller loans.

Shares of Apple fell 5.5% after the tech giant reported a 20% decline in iPhone sales and failed to offer investors any guidance for the quarter ahead. Amazon dropped 4.8% even after the e-commerce giant reported blowout third-quarter results with a big beat on the top line.

Meanwhile, Twitter lost more than 15% after the social media company reported user growth that fell short of expectations. Facebook was off by 6.6% amid a surprise decline in active users in Canada and the U.S.

Shares of Alphabet bucked the negative trend for tech stocks, rising 4.1% after the Google parent company posted quarterly results that topped Wall Street expectations.

The Vix index, a measure of expected volatility in the US stock market over the next month, climbed to almost 40 on Friday, double its long-run average. Analysts say the increase in the so-called “fear gauge” reflects uncertainty over the outcome of next week’s presidential election.

“As election week approaches, markets are now focused on what could go wrong,” said Joyce Chang, global research chair at JPMorgan, in a note to the Wall Street bank’s clients.

“The market has to prioritise its anxieties and right now it’s on overload,” added Quincy Krosby, chief market strategist at Prudential Financial. She pointed to Walmart’s decision on Thursday to remove guns and ammunition from sale as giving credence to concerns in the market that a contested election may lead to civil unrest.

“We could see pockets of civil disobedience. That has been feeding into an already jittery market,” Ms Krosby said.

U.S. government yields climbed Friday, lifted toward monthly gains by expectations that government spending will boom after the election. The yield on the 10-year U.S. Treasury, a benchmark for borrowing costs on everything from mortgages to student debt, traded at a recent 0.853%, according to Tradeweb, up from 0.834% on Thursday.

Near zero rates for potentially a decade raise the specter of financial stability risks. Fund managers are once again predicting asset bubbles and stock “melt-ups,” a debased U.S. dollar and a destabilizing acceleration in inflation, reigniting a debate about the dark side of easy monetary policy that raged after the 2008 crisis. There is already evidence that some of the risks are materializing with investors now questioning the classic 60/40 asset allocation strategy amid concerns that holders of long-term Treasuries could be in store for major pain.

“The Fed is both the arsonist and fireman,” said James Athey, fund manager at Aberdeen Standard Investments, which oversees more than $500 billion. “It’s fixing the prices of the assets that would normally be used to express concern in the informed-investor community about what the Fed is doing.”

The Fed is “creating massive financial instability problems for the future,” Athey said.

A [Californian] state appeals court has ruled that app-based ride-sharing companies Uber and Lyft must comply with state law AB5 and classify all of their drivers as employees rather than contractors. The ruling raises the possibility that the companies will simply end operations in the state altogether, both having stated previously that their business model depends on the flexibility of using contractors.

An ill-conceived law can cause great damage. A good example can be found in the case of AB5 itself. In addition to scaring off many employers who use contractors, the law reined in contract work generally, strictly limiting what even traditional freelancers like photographers or musicians could do. State lawmakers were forced to amend the law and carve out exemptions for numerous professions. That’s clear proof that they had overreached. Freelancers still claim it’s too restrictive.

It may yet get worse for Californians. If the state ballot’s Proposition 22 to roll back AB5 fails and the panel’s ruling stands, the companies have said they’ll simply stop operating the state. Customers throughout the state will have limited transportation options — a potential public safety issue, as Mothers Against Drunk Driving has warned. Meanwhile, numerous drivers will be left without a way to make the additional money that ridesharing offers at a time when Californians need the opportunity. The national unemployment rate is 7.9 percent, but the Golden State’s rate is 11 percent. California’s unemployment has been consistently higher than the national average throughout the year, and the state’s effort to reign in gig-economy companies has likely been a factor.

“Do you ever see a McDonald’s worker just up and tell their boss, ‘No, I’m going to go across the street and work at Taco Bell and do maybe two hours there,’” she said. “It’s that flexibility that means everything to the majority of drivers.”

Even Kiarie, who is more reliant on his ride-share income than Krueger and Pyatt, said he may stop driving if Prop 22 fails, because at that point it would likely be just like any other regimented job. “It’s going to suck,” he said, adding that he could just find another job close to home.

“To me, it’s a new space in employment, it’s a new space in earning money,” he said. “And it should be treated that way.”

[W]e conclude that, in the long run, Biden’s full agenda reduces fulltime equivalent employment per person by about 3 percent, the capital stock per person by about 15 percent, real GDP per capita by more than 8 percent, and real consumption per household by about 7 percent.

President Trump can be forgiven, perhaps, for running on his record rather than a bold new policy agenda. But his challenger, Joe Biden, has barely made a peep about policy. During the Democratic primaries, he boldly supported far-left initiatives such as the Green New Deal, but backs away from those commitments now when queried about them. In 2009, when President Obama and Joe Biden took over the White House, they chose to drop the policy agenda that got them elected, even pushing an extension of the hated Bush tax cuts because a “recession is a bad time to raise taxes.” Biden’s proposals have likely received so little attention because markets expect him to use the current pandemic recession as an excuse to once again leave the radical Left at the altar.

The problem with this expectation, however, is that it fails to account for two important factors. First, big policy changes usually require legislation, which means that Congress has a big say about policy. Second, the Democratic Party has moved sharply to the left even since 2009. One has a hard time imagining that a Democrat-controlled Congress today would be able to extend the Bush tax cuts, even in a recession.

Given that, it seems that the most likely policy path following a Biden victory and Democratic congressional sweep would be that Congress passes sweeping policy changes with little care for the preferences of the executive branch, cognizant of the idea that Biden would be extremely unlikely to veto the Democrats’ own bills. And what type of legislation might they pursue? Exactly the proposals that were negotiated as part of a détente with Bernie Sanders and AOC as part of the “Unity Platform,” proposals that to this day are described in impressive detail on the Biden website.

Motivated by this, my coauthors and I spent the past few months doing a deep dive into the economic-policy proposals of the Biden campaign.

Biden’s agenda is sweeping and far more complex than the debate discussion suggested. Take a deep breath. Here comes the highlight list. Biden calls for: restoring methane limits for oil and gas operations; ending federal leases for oil and gas drilling both onshore and offshore; ensuring that 100 percent of vehicles have zero emissions; eliminating carbon emissions from the power sector by 2035; making the entire economy net zero emissions by 2050; reparations to be paid by past polluters; $400 billion for clean energy research; rejoining the Paris agreement; reducing the carbon footprint of all buildings by 50 percent; and requiring firms to document and quantify the financial risk related to climate in their public reporting.

We estimate that the electrification of passenger vehicles would require a giant increase in power generation, since gasoline would no longer be the source of energy for passenger miles. Demand for power would rise by about 25 percent. Because 70 percent of power is currently generated by fossil fuels, the plan puts almost the entire grid on the table. If you assume that demand would be met by solar power, which is less efficient than power generated by fossil fuels, then the typical power bill would jump about $1,000 annually — not to mention that generating that much solar power would require a land mass about half the square footage of New England covered with solar panels.

[Biden’s] health-care proposal doubles down on the ACA, moving it very far to the left, and Biden himself has emphasized his main policies with admirable consistency. As one handicaps the policies that are likely to become law should the former vice president win, health care moves very close to the top of the list. The major reason why is Biden’s embrace of a public option for health insurance.

If the public option is attractive and takes over the health-insurance market, then the government will set the price for everything in that space, and presumably start to nickel and dime health-care providers. Almost all global health-care innovation starts in the U.S., so setting profits to zero here would have a major impact on the willingness of entrepreneurs to invest in risky new drugs. If you develop a cure for cancer, but have to negotiate its price with AOC, you probably will not come out ahead.

On the corporate tax side, Biden increases the top rate to 28 percent (from the 21 percent achieved by the Tax Cuts and Jobs Act), but also allows expensing of capital purchases to expire, and imposes steep new taxes on multinational income. On the individual side, the top individual rate will rise to 39.6 percent. Biden advocates other increases in the top marginal rate through some additional measures. First, he phases out itemized deductions, which lifts the rate by about 1.2 percent (taking us to 40.9 percent). Then he removes the cap on the 12.4 percent Social Security tax (lifting the rate to 53.3 percent), with the capital-gains rate rising to equal the ordinary tax rate. This Social Security tax trick was already used before when Democrats removed the cap on the Medicare tax, so add the 3.8 percent from that to our rate to get up to 57.1 percent.

The plan does not end there, of course. The capital-gains rate for wealthy individuals is lifted to 39.6 percent (so get ready to sell everything in December if Biden wins). Biden even hacks away at retirement savings, ending the deductibility of IRA contributions and replacing that with a fixed credit.

In the paper, we go on to show that these huge marginal tax-rate increases do not only affect a few rich people because small businesses tend to file as individuals and pay the top marginal tax rate. There are about 50 million workers in the U.S. working in these so-called pass-through businesses. Short-term cyclical factors are difficult to quantify, but perhaps as many as 10 percent of those workers could be expected to lose their jobs next year if these tax hikes are passed.

After a 50-year effort to diminish our reliance on Middle Eastern oil, which has miraculously happened at last, Biden would force the U.S. to transition to solar and wind, industries that currently depend on Chinese supply chains.

It’s a funny time to want to kneecap oil and gas. Proven reserves of natural gas in the U.S. are higher than ever before, thanks to American-made technological innovations. A couple of years ago, the U.S. surpassed Russia and Saudi Arabia in crude oil production. In recent years, petroleum and natural-gas exports have been increasing. And, of course, the rise of natural gas has cut U.S. carbon emissions.

This should be considered a national strength to build on, not a national shame to be put on a glide path to extinction. Fossil fuels are a tremendously useful source of energy, and no hype about renewables can obscure that reality.

In 2019, petroleum, natural gas, and coal accounted for 80 percent of overall energy consumption in the United States, according to U.S. Energy Information Administration. Renewables made up only 11 percent, and the bulk of that came from biomass (wood and biofuels) and hydroelectric. Despite being heavily subsidized, wind and solar, combined, were responsible for only about a third of our renewable energy.

As [Danish] economist Bjorn Lomborg points out, the share of U.S. energy that comes from renewables actually declined over the past century. The rise of fossil fuels was a boon to humanity, a major advance over those old renewables, wood and dung. “Over a century and a half,” Lomborg writes, “we shed our reliance on renewable energy and powered the industrial revolution with fossil fuels.”

Many cults demand a degree of performative asceticism and quite a few of them find virtue in the simplicity of a more natural, supposedly prelapsarian past, which, luckily for them, they never had to endure. And while many of those preoccupied by climate change, whether out of genuine scientific concern or cynical self-interest, are perfectly rational (even if the same cannot always be said for their conclusions), some climate warriors exhibit behavioral characteristics more akin to those of medieval flagellants or, in their more light-hearted moments, back-to-nature types in the early 20th century, wearing shorts, eating nuts, and (shudder) “hiking.”

Zimbabwe and Puerto Rico . . . provide models for what we might call pause-full electricity. Admittedly, neither Zimbabweans nor Puerto Ricans chose to accept this rationing. And in Zimbabwe, official incompetence has reduced electricity to a nearly unbearable degree. Still, Zimbabwe’s past and Puerto Rico’s potential indicate just and feasible ways of living amid intermittency. With a pause, life goes on. By abiding that interlude—by shedding their load—people can preserve life near and far. If my town’s blackout will lessen, say, the force of Puerto Rico’s next hurricane, then, please, shed us half a day per week.

Somewhere the manager of a coal-fired power plant in China laughed.

A faction on the American right, typified by [ahem] Oren Cass of American Compass, also wants to increase the power of Big Labor to “represent” more unwilling workers by importing European models of workplace relations. While conservatives should ensure that Americans have a voice in their workplaces, the plan of the redistributionist Right to give more power to Richard Trumka, Mary Kay Henry, and other national union bosses will hurt, not help, workers who are more open than ever to supporting conservatism.

Watson uses the phrase “redistributionist Right” to describe conservatives interested in revitalizing the American labor movement. This descriptor is backward. Strengthening workers’ position in the labor market is an alternative to redistribution that allows them to earn their own success through their productive efforts. It is in the absence of worker leverage, where wages are low and conditions poor, that redistribution becomes more necessary — or at least more likely.

The standard (and entirely valid) resistance on the right-of-center to regulation and redistribution is precisely why organized labor deserves another look.

Of course, to endorse the concepts of a strong labor movement, worker representation, and collective bargaining is not to endorse dysfunctional labor unions as they operate in America today. This is a point on which I, and many other conservatives eager to advance these conversations, have been very clear. To quote from American Compass’s Labor Day statement signed by Senator Marco Rubio, former attorney general Jeff Sessions, J.D. Vance, Yuval Levin, and others: “Many unions have become unresponsive to workers’ needs and some outright corrupt, and membership has fallen to just 6 percent of the private-sector workforce. Rather than cheer the demise of a once-valuable institution, conservatives should seek reform and reinvigoration of the laws that govern organizing and collective bargaining.” As I argued in the Wall Street Journal, “America’s dysfunctional labor unions, creatures of Great Depression-era legislation and decades of political polarization, are neither inevitable nor typical of their counterparts elsewhere.” When Watson accuses us of wanting to “give more power to Richard Trumka, Mary Kay Henry, and other national union bosses,” he badly misunderstands our case.

There are many alternative models to consider and, at least in my view, separating political activism out from the economic core of labor’s role must be a non-negotiable starting point. One model that I find particularly appealing is called “sectoral bargaining,” in which unions and employers, rather than fighting workplace-by-workplace, negotiate terms and conditions that will apply industry-wide. No employer would have to fear that unionization of their own firm would place them at a competitive disadvantage, and within the workplace labor and management could adopt a more cooperative relationship — which is exactly what workers say they want.

This recent rise in income inequality within the Electoral College is likely a symptom of a new tendency among state economies, in the United States, to disunite. “The convergence in per capita incomes across U.S. states from 1880 to 1980 is one of the most striking patterns in macroeconomics,” according to economists at Harvard and the University of Chicago. But they continue, “over the past thirty years, this relationship has weakened dramatically.” By the time their sample stops, in 2010, “virtually zero” convergence occurs, they report.

America’s own history underscores the potential for divergences of fortune between states to rip it apart. Whatever story of the Civil War’s origins you want to tell, the chasm between the North and South’s economic trajectories is likely to at least be a part of it. Today, it seems, America has returned to a political environment as polarized as what existed on the eve of the Civil War. Many are vexed by this turn of events. The chart above, however, suggests an answer: We may be living through a reboot of the national politics that greets America whenever the electors of its President represent states with increasingly divergent economic interests. “It’s the economy, stupid” may apply, ominously, even to today’s fraught partisan vortex.

Inequality, then, may well be what’s ripping America apart as its political seams. But it’s not the type of inequality familiar to familiar gripes about the global rise of a top 1 percent. If any inequality is the culprit, this exceptionally American vintage is a likely suspect.

It took the Obama-Biden administration over six years to produce the job growth and retail-sales gains the Trump administration produced in five months. Industrial production, durable goods, and housing starts all grew much more rapidly under Trump than Obama-Biden.

Trump critics blame the pandemic recession on his administration’s mishandling of the virus. Whatever missteps there might have been, the U.S. economy is performing better than peer economies that may, to a greater or lesser extent, have responded differently to the coronavirus. The International Monetary Fund predicts that from 2019 to 2021, the U.S. will have grown over 3 percent faster than the euro zone and Japan.

To be sure, the two great recessions, similar in many respects, also have differences, so their courses may not be entirely comparable, but they don’t need to be precisely compared. The sluggish first five months of the Obama-Biden recovery led to the slowest recovery in U.S. history. While there remains a long distance to full recovery from the pandemic (and the implications of a second wave remain, for now, unknowable) the Trump administration’s first five months of recovery are the nation’s fastest ever.

In two recent reports (see here and here), I made the case that Trump administration policies very likely account for much of the slowdown in immigration, even in the face of a strong economy. As for the improvement in labor-force participation, three key observations can be made: First, declining labor-force participation is not inexorable. Some American workers who are on the sidelines can, in fact, be drawn back into jobs. Second, things clearly improved for American workers even as immigration slowed. So the idea that very high levels of immigration are required to increase opportunities for Americans is invalid. Third, recent trends in labor-force participation are consistent with the possibility that American workers benefit when there is less immigration. In sum, the strong economy coupled with lower levels of immigration that characterized the first years of the Trump administration seems to be the best of all worlds for American workers, at least with regard to labor-force participation. Perhaps policy-makers should strive for this situation in the future.

Recently, one expression of corporatism, “stakeholder capitalism” has won powerful support on both sides of the Atlantic. This might be expected in Europe, but that it has been taken up by the Business Roundtable and many leading firms in the U.S., supposedly a bastion of both free enterprise and democracy, is depressing. Looked at trustingly, the BRT and its C-suite cheerleaders are useful idiots. Looked at realistically, they are representatives of a managerial class grubbing for the power that flows from other people’s money.

[T]he apostles of stakeholder capitalism. They want to enforce the principle that a company’s shareholders — its owners — are just one category of “stakeholder.” This transfers the power that capital should confer away from its owners and into the hands of those who administer it. They are then responsible to, well, it’s not quite clear who. It’s not difficult to grasp why so many corporate managements are enthused by stakeholder capitalism.

But stakeholder capitalism is a betrayal of democracy as well as of shareholders. The power it gives to managers is used to support an agenda influenced by a cabal of activists, NGOs, representatives of the “international community,” and politicians too arrogant to go through the usual legislative channels.

In the lens of recent discussion on the 50th anniversary of Milton Friedman’s New York Times essay on shareholder primacy, which I’ve recently written on, I’ve been thinking about a strange decision made by expense-management-software company Expensify to email all 10 million of its customers (who are likely divided roughly evenly on politics) urging them to support Vice President Joe Biden and further criticizing any customer who would think otherwise, saying that “anything less than a vote for Biden is a vote against democracy.”

What makes it particularly strange is not that it’s related to Biden but how rare it is to see a sizable company with significant institutional shareholders and lenders make such a brazenly political move that could potentially jeopardize half of its customer base.

To be sure, this isn’t just another boilerplate statement in support of woke capitalism. Those public-relations moves in many ways seek to benefit shareholders by attempting to retain and help win new socially aware customers (consistent with Friedman’s shareholder primacy).

It also would be different if Expensify were solely owned by its founder and CEO David Barrett, in which case a political endorsement would arguably improve the sole shareholder’s utility (even if revenue were lost), still conforming to the Friedman model of shareholder primacy.

But Expensify has received millions from venture-capital firms. The question is whether Expensify shareholders such as Travis Kalanick, Redpoint Ventures, PJC, OpenView, Hillsven Capital, who have invested a sum total of $38.2 million (according to TechCrunch)in the company, all approve of this decision?

That doesn’t appear to be the case.

The trickiest remaining point of contention is how to establish a mechanism to resolve any disputes arising out of the implementation of a future EU–UK deal. This is dubbed “governance” in Brexit lingo, and serious talks on the issue haven’t begun in earnest.

One way out, which I support, might be to entrust the resolution of disputes arising out of any EU–UK agreement to the only non-EU court that has been cleared by the ECJ to interpret elements of EU law. This is the “EFTA Court,” which has been given the task of adjudicating disputes between the EU and the three non-EU member states — Norway, Iceland, and Liechtenstein — who are part of the “European Economic Area,” whereby they enjoy almost complete market access to the EU in return for regulatory alignment in relevant areas. This solution, to use the jargon, would involve the UK’s “docking” (i.e., delegating judges) at this court. Interestingly, the EU’s top negotiator has also floated this idea, and even if the UK government dismissed it in 2018, it may well come back as the only option to avoid serious trouble on January 1, when much of the trade between the EU and the UK will become legally unsustainable, if no deal has been agreed, something that industrial leaders in both Europe and Britain do not want to see.

What to expect now? In the end, Boris Johnson may simply fold and accept that the UK judiciary, like its counterpart in Ukraine, subjects itself in this respect to the ECJ. An alternative is that, as with the EU–Swiss relationship, no governance arrangement is agreed to between the EU and the UK, and that, as a result, the EU does not grant as much market access to the UK as it would have otherwise, resulting in quite a lot of economic damage. And that would be on top of all the mayhem that the COVID-19 crisis has caused. Neither this nor the “Ukrainian” outcome would be sustainable for long. Trade between the EU and the UK is too important for that, and the UK would not accept being bound to the EU’s top court for long. My best guess is that both sides would quickly return to the negotiating table in an effort to restore trade to something closer to the old status quo.

The upshot is that some types of establishments, especially restaurants, are in deep trouble. The silver lining is that because other industries haven’t been hit as hard and the businesses closing are disproportionately small, the closures thus far probably represent a tiny share of total U.S. employment.

There’s nothing unusual about an American business, especially a small business, closing. Every year, we lose about 8.5 percent of all establishments, representing 3.5 percent of total employment. (When we count “establishments” rather than “firms,” we include situations where a company stays in business but closes some locations.) That’s the “creative destruction” that makes capitalism work: When one business can’t operate profitably, it’s replaced by another that can, putting both its employees and its capital to more productive use.

But with COVID-19, it’s not creative destruction so much as plain old destructive destruction. We’re losing businesses that have been profitable in the past and could be profitable again, post-pandemic, if they could hold on.