The Capital Letter

The Capital Letter: Week of September 28

A U.S. Marine helicopter pilot waits at the controls of the Marine One helicopter for President Trump to depart the White House to fly to Walter Reed National Military Medical Center, where it was announced he will work for several days after testing positive for the coronavirus, Washington, D.C., October 2, 2020. (Leah Millis/Reuters)
Coronavirus and the election, new jobs numbers, the president's taxes, and more.

Well, 2020 is going to keep being 2020. The news that the president and first lady have both tested positive for COVID-19 adds yet more turbulence and uncertainty to a year that already has had too much of it.

While we should all (regardless of party affiliation) hope that the two make a speedy recovery, markets look at such news from a dispassionate, if not necessarily calm, perspective, as investors wonder what it will mean for them.

As I write (10:46 a.m.), the S&P 500 was down around 0.8 percent, up from the day’s lows, and the dollar had picked up slightly. A frequently recurring paradox is that uncertainty in the U.S. can boost the U.S. dollar, often seen as a safe haven, even under such circumstances.

The VIX was, unsurprisingly, up over 5 percent, to some 28, comparing with a long-term average of around 20.

Quite what the implications of the president’s diagnosis are for the election and the markets are, of course, unclear, although an article in the Financial Times gave a useful round-up of some reactions in the financial sector:

Analysts at Rabobank went through a list of questions running through their heads. “Does the fact that Trump will now spend half of the remaining time prior to the election in quarantine mean his odds of re-election have fallen? Does his testing positive give the lie to his repeated assertion that the virus is under control?” they wrote on Friday morning.

However, a rapid recovery ahead of the election could boost Mr Trump’s chances, for example if it precluded further fractious debates, or highlighted his self-professed strength, Rabobank analysts speculated.

“Such a development would [also] allow the president to claim that the Democrats have been overly alarmist as regards the virus and that the economy would be unnecessarily ruined in their hands,” Rabobank added. . . .

Nannette Hechler-Fayd’herbe, chief investment officer for Credit Suisse’s international wealth management division, said Mr Trump contracting the virus was a timely reminder to markets that a resurgence of the pandemic remained a major danger.

“While this move may reflect initial caution in the face of potential risks around the US president’s health, it more likely serves as a wake-up call for financial markets to expect a seasonal re-acceleration of Covid-19 infections around the world,” she said. “What can happen to the US president can happen to the population more broadly, with the potential disruptions to economic activity that this may entail.”

It is worth paying attention to this:

Highlighting how investors fret volatility will remain elevated, Vix futures contracts maturing in October — which cover the run-up to the election — climbed 2 points on Friday to nearly 33 points, and the contracts for November and December edged up 1 point to almost 34 and 32 points respectively.

As we have discussed in various editions of the Capital Letter, the focus here should not be expectations of increased volatility ahead of election day (that would be normal), but the market’s fears of trouble in its aftermath, stretching perhaps until the end of December. I discussed this at some length in an article here.

Meanwhile, today’s disappointing jobs number was a reminder that remaining hopes of a V-shaped recovery are looking increasingly forlorn.


The U.S. created 661,000 new jobs in September and the unemployment rate fell again to 7.9% to the lowest level of the pandemic, but the gain in hiring was the smallest since the economy reopened and pointed to deceleration in the recovery.

The increase in employment last month fell short of Wall Street’s estimate. Economists polled by MarketWatch had forecast an 800,000 gain.

Although this twist should not be overlooked:

Private-sector hiring was somewhat stronger with the creation of 877,000 new jobs, the Bureau of Labor Statistics said Friday. What dragged down employment in September was a decline in public-educations jobs at local schools and state colleges. Most have adopted forms of online learning.

This is because:

State and local governments need fewer bus drivers, cafeteria workers and teacher aides with so many schools opting for online learning.


The unemployment rate, meanwhile, fell for the fifth month in row to 7.9% from 8.4%, a new pandemic low. The official jobless rate had peaked at 14.7% in April before subsiding.

Yet the decline mostly reflected 700,000 people exiting the labor force because of a scarcity of new jobs. They aren’t counted in the unemployment rate.

Another caveat: The jobless rate would have been closer to 8.3% if households gave an accurate description of their employment status, the Bureau of Labor Statistics said. Some survey respondents have mistakenly referred to themselves as employed even though they aren’t actually working, a problem that’s bedeviled the BLS amid widespread furloughs.

CNN reacted to the news with a characteristically balanced headline: “Trump has the worst job losses on record heading into the election.”

CNN’s report itself was (low bar) rather more balanced, and this was an interesting detail:

This [7.9 %] is the highest the unemployment rate has been ahead of a presidential election since the government started tracking the monthly rate in 1948.

In 2012, when the country re-elected President Barack Obama, the pre-election unemployment rate was initially also reported at 7.9%, before getting revised down to 7.8%.

I’ve thought for quite a while that a K-shaped recovery was plausible, but looking at Twitter today, I saw that the coffee pot had been added to the repertoire of recovery shapes. Spoiler, it’s not a good thing.

Finally, in what will, I suspect, be a preview of major trouble ahead, there was this today, reported in The Wall StreeJournal:

Moody’s Investors Service downgraded the credit ratings of both New York City and New York state on Thursday, a consequence of the coronavirus pandemic’s mounting toll on the New York economy.

The general obligation bond ratings of both the city and state fell one level, to Aa2 from Aa1, though they remain high investment grade. Moody’s kept the city’s outlook “negative,” saying its rating could drop further if the city relies heavily on borrowing for cash flow.

A spokeswoman for Mayor Bill de Blasio’s office expressed disappointment with the downgrade and said his administration has a “track record of strong fiscal management.”

Frankly, I am surprised that the rating (even now) is as high as it is, but de Blasio is to be congratulated in having kept his sense of humor in these trying times.

These problems will not be confined to New York. 2021 seems likely to become a year of the states, and not in a pleasant way.

Opening up for Capital Matters on Monday, Joe Sullivan, our chart guy, had reassuring words about the status of the dollar’s reserve status: it shows no signs of slipping:

Foreign governments do not stockpile dollars because of fuzzy feelings towards the United States. They plow reserves into U.S. dollars because their own citizens and businesses use them. As a result, to support their own domestic economies, foreign central banks and foreign governments need to stockpile U.S. dollars. Why do foreign citizens and businesses use U.S. dollars? For the same reason many of them speak English: in a world where everyone else is already doing something, it makes sense to do so yourself. Like languages, currencies exhibit what economists call “network effects” –the value of adopting English or the U.S. dollar over French or the euro stems, in part, from the size of the existing network it allows you to access and transact with. Sure, the story of how the financial system first came to revolve around the U.S. dollar, in the ashes of World War II, is rich fodder for historians. But it’s as irrelevant to a business’s choice of currency as is the history of the English language’s spread around the world to a child’s decision to study Shakespeare’s mother tongue rather than French as a second language.

Pronouncements about America’s decline may be trendy. It’s not hard to see why: Many things in the world today seem as novel as they are worrying. Premature predictions of the demise of America’s dollar, however, are as familiar as the fall foliage in New England. Past performance may be no guarantor of future returns. But if you’re holding your breath until the dollar’s reign crumbles, your health (or sanity) may be next to tumble.

Alexander William Salter was unconvinced by the Fed’s new stance:

The bottom line is that markets are telling the Fed, “We don’t believe you.” In truth, the Fed hasn’t done anything worth believing. They announced a policy change, but without an accompanying procedural change, it’s just cheap talk. If the Fed wanted to convince markets it was serious about its average inflation target, it would formally abandon the floor system, reestablishing the link between the volume of reserves in the banking system and overall macroeconomic variables, like inflation and unemployment. It would also retire its foolish experiments with credit allocation, such as direct loans to small- and medium-sized businesses, large corporations, and state and local governments. These policiesblurred the line between fiscal and monetary policy, diminishing the Fed’s effectiveness.

But the Fed hasn’t done any of these things — or anything else that convinces markets it means business. That’s bad for the American economy. Until and unless the Fed makes a credible commitment to an average inflation target, the Fed will continue to let down the American public.

Robert Verbruggen wasn’t too bent out of shape by the Trump tax revelations:

Trump sometimes tries to reduce his tax bills in borderline ways that may or may not be kosher. This isn’t really a surprise either, though of course if he’s actually flouting tax laws the IRS should call him on it. The biggest item here, a huge refund of past taxes he claimed when he later lost money, is the subject of an audit — though it’s an unremarkable feature of the tax code that businesspeople can “carry” losses from one year to reduce tax liability in another. (This avoids overtaxing businesses with more volatile revenue streams.)

Incidentally, the rules on loss-carrying have gone back and forth a lot recently. Obama’s stimulus law extended the “carryback” period, allowing Trump to attempt this at the time he did; the recent GOP tax bill eliminated the ability to carry losses backward in time for a refund of past taxes (while removing the 20-year limit on carrying losses forward); and then the CARES Act brought carrybacks back for the 2018–2020 tax years to inject some money into businesses during COVID.

Anyhow. Politically, none of this is going to help the president, but I don’t see it swaying many votes against him either.

Dan Mclaughlin saw some irony in the position that Democrats were taking on this matter:

These rules have changed over the years. In 2009, the Obama-Biden stimulus bill changed the rules to allow carrying back losses four years into the past, rather than two. The stimulus was written by Democrats and passed essentially on party-line votes. As Kyle Smith has discussed, the Times story admits that Trump claimed a $73 million windfall refund of past taxes from Obama’s expansion of carry-back rules:

“Mr. Trump had paid no income taxes in 2008. But the change meant that when he filed his taxes for 2009, he could seek a refund of not just the $13.3 million he had paid in 2007, but also the combined $56.9 million paid in 2005 and 2006, when “The Apprentice” created what was likely the biggest income tax bite of his life.”

That $73 million (including interest) refund is still being contested eleven years later. The bipartisan Congressional Joint Committee on Taxation has to offer a recommended opinion on refunds that large, and it has dragged its feet. The committee’s opinion is advisory, because the Constitution could not empower a committee of parts of both houses of Congress to carry out an executive or judicial function, but the process becomes more problematic when the taxpayer is the president and the committee simply doesn’t act.

Still, the entire windfall was the direct result of Democrats giving a big handout. It is hard to blame Trump, or Republicans, for that policy decision. In fact, the 2017 Tax Cuts and Jobs Act passed by the Republican Congress and signed by Trump eliminated carry-back provisions. (On the other hand, it eliminated the already-generous 20-year limit on how far losses could be carried forward). But the bipartisan CARES Act passed this year reversed course again, allowing a five-year carry-back not only for losses in 2020 but also in 2018 and 2019.

On the broader point, if you dislike the spectacle of some very rich people and businesses paying a lot less in taxes than you’d expect from their tax rates, the solution should be a flatter, simpler tax code. And that is the last thing that Trump’s Democratic critics want.

But Kevin Williamson noted that this was not something that could just be blamed on Democrats:

The truth is that almost no one in either party wants to simplify the tax code or — here is the perverse part — to make it more effective. The Republicans have a pretty straightforward position on this: They want (at least they say they want) less spending and lower taxes. (Just don’t ask them what they want to cut.)

The Democrats have, in a way, a bigger challenge: The left wing of the Democratic Party wants to build a U.S. version of a Scandinavian welfare state, but very, very few Democrats are willing to speak honestly about what that means — a huge tax increase on the middle class. In the Scandinavian countries (and in much of Europe) people with middle-range incomes pay relatively high tax rates: If your household earns $100,000 a year in Sweden, you pay an effective tax rate of 40 percent. In the United States, your effective rate would be about 15 percent — just over a third the tax burden. (Insert here the usual caveats about the complexities that make straightforward comparisons . . . not straightforward.) “But they get lots of good stuff for their taxes in Sweden,” progressives say. Indeed, they do. But Democrats rarely if ever acknowledge just how big a tax increase on the non-gazillionaire would be required to fund the welfare state they imagine, preferring to pretend that it could be paid for by raising taxes on the likes of Donald Trump.

If the tax story doesn’t undo the Trump campaign, it will be in part because many Americans do not think highly enough of our tax system to chafe at somebody’s getting over on it. And Howard Kurtz is right: This is on Congress.

Ahead of the audits coming his way for the next fifty years, David Harsanyi argued that avoiding taxes (a very different thing from evading them, as too few commentators seemed willing to acknowledge) was patriotic:

The ideal amount any American should pay in taxes is “the absolute bare minimum.” Because doing everything within the bounds of the law to avoid handing your money to the wasteful, bloated, and intrusive state is an act of patriotism. Every extra dollar denied the Treasury Department is more productively spent in the stock market or the supermarket or your local corner Gas and Cigarette market on slices of stale microwaved pizza and Red Bulls.

Even paying the bare minimum should be an obligation met with begrudging acquiescence — akin to registering your car at the DMV. Americans remain the most tax-averse people in the western world. We should keep it that way.

Now, if Donald Trump broke tax law, he should pay the penalty. But, judging from the breathless New York Times account of his finances, as far as we know now, that isn’t the case . . .

Liberals such as Biden have long attempted to cast paying higher taxes as an act of patriotism. The government has accepted such gifts since 1843 — viewing them as “bequests” from “individuals wishing to express their patriotism to the United States.” You probably won’t be surprised to learn that there are extraordinarily few confused souls who express their love of country by paying extra in taxes. Not even Biden, who has become quite wealthy on a government paycheck, has ever participated in this program. Democrats take their tax cuts like everyone else.

I noted new efforts to push the EU closer to a transfer union and Jimmy Quinn cast a skeptical eye over some of TikTok’s claims.

Abby McCloskey found a silver lining in the way that the coronavirus pandemic has highlighted the inefficacies of existing state-run unemployment-insurance (UI) systems. Could it lead to reforms that would pave the way for UI to serve as the administrative vehicle for paid [parental] leave?

In many ways, UI is naturally suited to play that role. It is designed to deliver temporary benefits to those out of work for short periods who have an expectation of re-employment, just as paid family leave delivers temporary benefits to new parents who expect to eventually return to work. The hybrid federal–state model of UI allows for considerable state flexibility in determining benefit levels, instead of a one-size-fits-all federal approach. This makes it an especially appealing match for paid leave, given that benefit and taxation levels vary widely across the patchwork of existing state paid-leave programs. (By comparison, benefits that flow through the Social Security Administration such as disability insurance and old-age payments are delivered over the long-term without an expectation of returning to work and thus the administration for paid leave is less comparable, at least in this regard.)

Thomas Koenig joined in a debate over the administrative state:

The real battle over the growth of the administrative state is not over whether the rules are clear, but over who makes the rules. Transparency and comprehensibility are necessary, but they are not sufficient to promote “the values of legality, accountability and liberty.” To actually do so, they must be paired with representative democracy — with the structures of self-government. The Framers recognized this in drafting the Constitution, which explicitly vests “all legislative Powers herein granted . . . in a Congress of the United States” — a body of citizens elected on a regular basis by their fellow citizens, not a body of unelected technocrats and experts.

Why did they do this? Because under a republican form of government, one “in which the scheme of representation takes place,” as James Madison put it in Federalist No. 10, lawmakers are ultimately accountable to their constituents — to the citizenry. Legislators are empowered to refine the public views and passions, and they are equipped with the time and resources to deliberate with one another about the common good. And crucially, thanks to regular elections, they are dissuaded from running roughshod over the people’s liberties. In the end, the people are in charge.

This is the genius, straightforward way in which the Framers designed our government to uphold the values of accountability and liberty. Unfortunately, under our present governing scenario, when many executive agencies and the bureaucrats who staff them are effectively promulgating laws, however well-intentioned they may be, they simply don’t face the same electoral constraints that their elected counterparts do; the causes of liberty and accountability inevitably stand to suffer no matter how clear and transparent and consistent the rules may be.

Steve Hanke dug into the trade balance mystery. Spoiler: it’s not a mystery:

The cumulative current account deficit the U.S. has racked up since 1973 matches the amount by which total savings has fallen short of investment. But, that is not the end of the story. Disaggregated U.S. data are available that allow us to calculate both the private and government contributions to the U.S. current account deficit. The U.S. private sector generates a savings surplus — that is to say, private savings exceed private domestic investment — so it actually reduces (makes a negative contribution to) the current account deficit. The government stands in sharp contrast to the private sector, with the government accounting for a cumulative savings deficiency — that is to say, government domestic investment exceeds government savings, resulting in fiscal deficits — that is almost twice the size of the private-sector surplus. Clearly, then, the U.S. current account deficit is driven by the government’s (federal, plus state and local) fiscal deficits. Without the large cumulative private-sector surplus, the cumulative U.S. current account deficit since 1973 would be almost twice as large as the one that has been recorded.

The U.S. government’s fiscal policies, which promise ever-widening fiscal deficits, simply mean that the trade deficit will continue to balloon as far as the eye can see, particularly in the COVID-19 era. Protectionists in the While House, whomever they may be, can bully countries they identify as unfair traders and can impose all the restrictions on trading partners that their hearts desire, but it won’t change the current account balance. The U.S. current account deficit is solely a function of the savings deficiency in the U.S., in which the government’s fiscal deficit is the proverbial elephant in the room.

Maxford Nelsen looked at Joe Biden’s plans for unions. Spoiler: they will like them:

The heart of Biden’s policy platform for private-sector unions calls for adoption of the PRO Act, an expansive union wish-list that would end any pretense of allowing workers to make up their own minds about unions. Among other things, the law would require employers to allow their internal communications systems to be used for union organizing and force them to turn over employees’ personal information — including home addresses, cell phone numbers and personal emails — to union organizers. At the same time, the bill would restrict employers’ ability to speak with employees about the implications of unionization.

Perhaps most concerning, the PRO Act would ban right-to-work laws, which have so far been adopted by 28 states and which protect the rights of workers to choose for themselves whether to surrender part of their paychecks to unions.

Thankfully, the U.S. Supreme Court’s 2018 decision in Janus v. AFSCME recognized that unionized public employees have a constitutionally protected right to refrain from union payments without losing their job, but, under the PRO Act, millions of private-sector American workers would be stripped of similar protections.

In several respects, Biden promises to go even further than the brave new world envisioned by the PRO Act.

Whereas the PRO Act would sharply increase civil and monetary penalties for employers found to violate employees’ union rights, Biden proposes “[holding] company executives . . . criminally liable” for such violations.

Tomas Phillipson examined continued government failures on drug pricing:

In an effort to lower U.S. drug prices, President Trump has signed an executive order tying Medicare’s payments for drugs to the prices paid in other nations. Under this “most favored nation” rule, Medicare’s payments under Part B, which covers medicines typically administered in doctors’ offices, along with Part D, which covers self-administered medicines mostly obtained from pharmacies, could not exceed the lowest price paid in any developed country.

Trump’s gut instinct on drug prices is right: They are too high in the United States and too low abroad, but his advisers led him down the wrong path in addressing this disparity. The pricing disparity stems from government failures preventing price competition, among sellers here and buyers abroad. And the proposed “solution” adds additional layers of government controls that would do little to lower U.S. prices and could actually increase the foreign freeriding that understandably riles the president.

And I looked at the disaster now engulfing New York City’s restaurants, a disaster that is symptomatic of wider policy failures:

Dealing with COVID-19, a highly infectious, and dangerous disease (particularly to certain categories of patient) –and certainly no “flu” — was never going to be straightforward. But that was no excuse for failing to find a way to live alongside the virus in a fashion that avoided shutting down so much of the economy for so long a time, even in a hotspot such as New York City.

Intelligent management of the pandemic was always going to involve restrictions, but the resort to the heavy-handed command-and-control of Cuomo and de Blasio showed few signs of intelligence and revealed a management style notable mainly for its crudity. What we saw was a reflex fueled by panic and ideological habit, made even more damaging by a seeming inability to realize that risk and reward shift over time: What might have been sensible in March was close to madness in May.

And the bill for that failure is rising by the day.

Meanwhile, if anyone can explain the risk-reward calculation that went into capping indoor dining at 25 percent of capacity rather than, say, fifty percent, I’d be interested to hear it. Restaurants run on very thin margins. Finding the right balance between necessary health precautions and giving large numbers of restaurants at least a chance of survival was never going to be easy. But opting for 25 percent was a sign of political leaders who were not even pretending to try.

Finally, we produced the Capital Note (our “daily” — well, Monday-Thursday, anyway). Topics covered included election trades, troubles ahead in the CMBS market, Argentina’s woes, exponential growth bias, a new SPAC fund, Palantir’s IPO, conflicts of interest among economists, a spike in new-business formation, a reevaluation of exchange rates and international trade, another new SPAC fund, the ‘green’ investment ecosystem, stimulus (or not) and the man who launched the cola wars.

To sign up for the Capital Letter, follow this link.


The Latest