The Big Picture | December 2003

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Productivity and unemployment: the Dark Side?

Wednesday, December 31, 2003 | 05:38 PM

A quick post before heading out for New Years (what type of wonk feels compelled to write about these things on New Years's Eve? I shudder to think about it).

Alex Tabarrok has an interesting post over at Marginal Revolution.

Alex notes he is "growing increasingly annoyed with people who argue that the dark side of productivity growth is unemployment:"

the "dark side" of productivity is merely another form of the Luddite fallacy - the idea that new technology destroys jobs. If the Luddite fallacy were true we would all be out of work because productivity has been increasing for two centuries. Sure, some say, that may be true in the long run but what about the short run? Even in the short run there is no necessary connection between productivity growth and job loss. In the computer industry, for example, productivity growth has led to falling prices and a bigger not smaller industry. If demand is inelastic then productivity growth can create short-term unemployment, especially at the level of the industry experiencing the growth - less likely but not impossible is that productivity growth leads to short-term economy-wide unemployment.

I think Alex draws a defendable -- but wrong -- conclusion about the hand wringing over productivity: It's not that some economists are wishing productivity growth were lower, so employment would be higher; Rather, its a recognition that it may take a substantial uptick in GDP to overcome the productivity hurdle and to lead to a sustained increase in hiring.

First off, we should all understand that productivity is a "good thing" -- higher productivity raises everybody's standard of living; it makes goods and services cost less, or in the alternative makes them more profitable to manufactur/sell.

Here is the flip side (what he called the "Dark Side") of productivity: If it used to take 10 workers to make 100 widgets, and now it takes 7 workers, thats 3 less employed people (at least as widget makers). Back in June 03, I termed this "The New Productivity Paradox.”

During normal economic recoveries, as companies see demand rise, they add to headcount in order to be able to meet those new orders. At least, that's what they used to do; Today, it seems there is so much elasticity in the manufacturing and/or service process via productivity improvements that there is little need to add an appreciable number of employees.

With the labor pool growing between 1-1.25% a year, and productivity somewhere north of 4%, a GDP of a minimum of 5% is needed just to not lose any additional jobs. Despite the scorching 3rd Quarter GDP of 8.2% (annualized), we saw only marginal improvements in employment situation.

Thus, its not a desire for weaker productivity to creeat more jobs -- that would be terribly inefficient. To the contrary, it is a recognition of reality, and a hope for higher than typical GDP growth in order to see the economy grow on a self sustainable basis.

As long as productivity stays at the present lofty levels -- and we maintain high levels of excess capacity -- we should be prepared to see anemic job gains. At least, until the economy is running at a much higher GDP. Its likely that, at some point in the future, productivity will naturally drift down a bit to a level number. But that's likely to occur much later in the cycle, when employment won't be an issue.

Happy New Year!

UPDATE (1/1/04 8:19am: Alex happens to be the author of a very interesting book, "Entrepreneurial Economics: Bright Ideas from the Dismal Science." I first stumbled across the book by accident in Huntington (The Book Revue) over the summer. I thumbed thru quite a few pages, and found it intriguing. I hadn't realized I was fisking a published author.

Source:
Marginal Revolution: Productivity and unemployment
Alex Tabarrok, December 31, 2003

Real Business Cycles: A Legacy of Countercyclical Policies
Satyajit Chatterjee, Senior Economist and Research Advisor
Federal Reserve Bank of Philadelphia, March 1999
http://minneapolisfed.org/pubs/region/99-03/cycles.cfm

Schwab's Year-End Moves to Reduce Your Taxes

Tuesday, December 30, 2003 | 11:16 AM

in Finance

Good advice from the nice folks at Charles Schwab online brokerage:

10 Year-End Moves to Reduce Your Taxes

1) Harvest your investment losses in taxable accounts by Dec. 31 to offset any capital gains;

2) Max out on contributions to your qualified employer retirement plan and IRA;

3) If you're self-employed, open a business retirement account such as a SEP-IRA, SIMPLE IRA or qualified retirement account (QRP)/Keogh;

4) Open and contribute to a Roth IRA;

5) If you make quarterly estimated tax payments to your state, make your fourth-quarter payment by Dec. 31 instead of waiting until the New Year;

6) Prepay the second installment of your property tax by Dec. 31;

7) Make January's mortgage payment in December;

8) Open and fund a 529 college savings account;

9) Donate appreciated securities you've held for more than one year to a qualified public charity;

10) Consider postponing the exercise of incentive stock options (ISOs) until January.

These are just the bullet points --each topic is given the full treatment at Schwab's site. Check it out . . .

via Schwab.com

Tracking Down the Malfeasants

Tuesday, December 30, 2003 | 04:08 AM

in Current Affairs | Finance

Apparently, Tom Toles of the Washington Post has views similar to my own regarding the veracity of government statistics . . .

Source:
Washington Post via Yahoo

K&C tonite!

Monday, December 29, 2003 | 03:10 PM

in Finance | Media

I am scheduled to appear tonite (Monday, December 29th) on Kudlow & Cramer's "year in preview."

That's on at 5pm, 8pm, 11pm and 2am.

I'm the reluctant Bull, which compared to some of the breathlessly fanatical table pounders, makes me look downright Bearish. In reality, I am a wary optimist, but always aware of where the exit is.

Should be fun . . .

2004: How The Pros See It

Monday, December 29, 2003 | 11:55 AM

in Finance | Media

2004: How The Pros See It

I participated in this year's survey, even though I do not really believe in forecasting one year out.

I'll eventually have a piece up on it -- "The Folly of Forecasting." Meanwhile, you can go over to B-week and laff at my predictions. . .

Update: May 5, 2004:
I posted this in December, and for some reason it disappeared. (This is a repost)

Barrons picks up "The 3 Minute Mile"

Monday, December 29, 2003 | 05:27 AM

in Finance | Media

Our discussion on how silly so many economic releases are, Reality vs. Perception: The 3 Minute Mile, got picked up by Barron's.

Source:
MARKET WATCH: A Sampling of Advisory Opinion
Barron's, MONDAY, DECEMBER 29, 2003
http://online.wsj.com/barrons/article/0,,SB1072480440827600,00.html

2004: A test of Supply Side economics

Saturday, December 27, 2003 | 11:17 AM

in Finance

What are the Economic & Theoretical Ramifications of the 2003 Holiday Shopping Season?

The holiday shopping season of 2003 provided a fascinating glimpse into the goings on beneath the surface of the macro economy. It also provides a fresh opportunity to examine the validity of a specific economic theory -- Supply Side / Trickle Down Economics -- and to lay a fresh challenge to the proponents of that school of thought.

Our inquiry begins with this simple question: Why did the luxury sector do so smashingly well this Christmas, while the low end of the market -- in particular, the mass discounters -- performed below expectations? Contrast the year over year revenue gains for high end retailers Tiffanys, Coach, Nordstrom and others, with the performance reported by Wal-Mart, Target, CostCo, and the rest.

The explanation reads like an overview of 2003: The wealth effect from a rising stock market, along with a relatively healthy bonus pool this year, contributed to the surge in luxury goods sales following several years of pent up demand. But the true key to the 2003 holiday sales performance is found in the Bush economic plan. For higher income families, a holy trinity of tax cuts put a healthy serving of dollars into their pockets: Tax brackets were cut, capital gains taxes decreased, and an entirely new class of much lower dividend taxes created. The results from the retailers of higher end goods suggests that much of that money was spent on luxury items.

For middle and lower income families, the bulk of the tax benefits -- manifested in the form of $400 Treasury checks reflecting lessened federal witholding tax (due to the lowered tax rates and the larger standard deduction for married couples) -- were long spent prior to holiday shopping. This group may also have reined in their spending a bit, as they remain somewhat skittish about the employment situation. Bearing this out is the irregular gyrations of the monthly consumer confidence numbers. While middle income families will continue to see benefits from the Bush tax cut -- they will be rather modest. They will certainly not pay for many purchases from Nieman Marcus.

Viewing this phenomena through the lens of economic theory, the contrast between the luxury and discount retailers raises curious theoretical issues: Might some economists explain this discrepancy as an example of "Supply Side" economics in action? If the economy continues to strengthen going forward, will this school of thought finally be validated?

Long disparaged by classical econ scholars as the bastard stepchild of economics, the "Supply Side, Trickle Down Thesis" has been out of favor -- at least publicly -- since Ronald Reagan left the White House. While dedicated Supply Side proponents remained active in think tanks and media, they were at most influencing, but not pulling, the levers of power. Today, however, the Supply Side school of thought dominates the Bush Administration's economic policies as thoroughly as the NeoCons dominate its foreign policy.

In the 1980s, as Ronald Reagan's "Trickle Down" policies were put into effect, the top tax bracket was slashed in half, from 70% to 35%. That's the sort of meaningful change to the tax code which economists believe create significant changes in investor behavior. President Bush, on the other hand, made what many pundits (present company included) derided as an "incremental cut" -- less than 10% for the highest tax bracket. The assumption was that "incremental tax cuts for tax cuts sake" would not have all that profound of an impact.

What may have been overlooked at first blush was the cumulative effect of all the tax cuts discussed above. Capital gains taxes were sliced 25% (from 20% to 15%), and the new dividend tax cut -- at least for investors in the top bracket -- was more than chopped in half, (from 38.6% to 15%). Collectively, these three changes to the tax code seem to be having a meaningful effect on high end consumption. Whether it will have a trickle down effect on employment and business spending is as of yet unknown.

But we shall soon enough find out. Thus, Supply Side school of thought -- derided on the campaign trail by Bush the elder as "Voodoo economics" -- now has a golden opportunity to redeem itself. Failing to do so, however, may relegate it once and for all to the trash heap of economic theory.

The architects of President Bush's economic plans are former National Economic Council head Larry Lindsey, and former Council of Economic Advisers director Glenn Hubbard. Hubbard is widely credited as being the man behind the dividend tax cut -- he first proposed it while working for Bush I. Both are known as "strong supply-siders with conservative think tank roots." These advisers have since moved on. Lindsay resigned last December; Hubbard followed him out the door a few months later. These top bracket tax cutters were confident enough that their plan was irrevocably in motion that they retired to the worlds of think tanks and academia.

To us, here is where things get interesting: Harvard economics professor Gregory Mankiw replaced Hubbard at the Council of Economic Advisers. The Professor has been described as not a Supply Sider -- at least, according to Stephen Moore (Club for Growth President and NRO contributor).

Moore cites Mankiw's "Principles of Macroeconomics" textbook, where the professor disparingly refers to Ronald Reagan’s supply-side advisers as "charlatans and cranks." The obligatory excerpt:

An example of fad economics occurred in 1980, when a small group of economists advised Presidential candidate, Ronald Reagan, that an across the-board cut in income tax rates would raise tax revenue. They argued that if people could keep a higher fraction of their income, people would work harder to earn more income. Even though tax rates would be lower, income would rise by so much, they claimed, that tax revenues would rise. Almost all professional economists, including most of those who supported Reagan's proposal to cut taxes, viewed this outcome as far too optimistic. Lower tax rates might encourage people to work harder and this extra effort would offset the direct effects of lower tax rates to some extent, but there was no credible evidence that work effort would rise by enough to cause tax revenues to rise in the face of lower tax rates. . . .

However, prominent Supply Side commentators strongly dispute Moore's cranky assessment; Mankiw, we are assured, has both feet solidly planted in the Supply Side camp.

So is there a split within the economic apparatchiks of the Administration? Bush continues to maintain prominent Supply Side/Trickle Down theorists, the most prominent of which is VP Dick Cheney. This group remains extremely influential with the President.

The present team seems to have more fiscal conservatives -- including budget balancers and otherwise traditional economists -- and self-described "responsible adults." Should the President win a second term, these budget balancers expect to be the "clean up team" -- imposing fiscal discipline on a White House and Congress that has yet to meet a spending increase they didn't love.

The rest of the President's term may play out as a fascinating economics drama between two schools of thought. We will be witnesses to a trial of the trickle down school of thought. The large disparity between the two end points of the retail sector that materialized suggests a real time, live test of the Supply Side economics.

Indeed, the key to which wing of Bush's economic team will win subsequent budget and tax battles is likely to be determined by how the economy behaves between now and Inauguration Day 2005.

Is Supply Side Already Working?
The recent economy has something for every school of economics: There's been enough deficit spending too keep the Keynesians happy; Money supply increases (at least, up until recently) were sure to warm the hearts of Monetarists. Yet the economy seemed not to respond to either of these stimulants -- not until the 2nd Quarter of 2003, when the second round of tax cuts kicked in. Indeed, supply siders might even argue that a test in 2004 is unnecessary, as the recovery in 2003 more than proves the case.

Perhaps that assessment is premature. As Ned Davis said, "give me a trillion dollars and I'll throw you one hell of a party." The proof of Supply Side success will come once the economy demonstrates it is on a self sustaining path - that includes robust job creation. That's something notably absent in this post recession recovery cycle, and which the Supply Side team expects to occur in the first half of 2004.

If the economy is in full recovery by this time next year, that will go a long way towards rehabilitating the supply side school amongst traditional economists. If on the other hand, the economy slips back into a slow growth mode without much in the way of job creation, or (gasp!) a contraction, that may very well spell the death knell of trickle down as a credible economic thesis.

As an economic agnostic -- I believe in the "smorgasbord approach" of taking a little of what works from each school of thought -- I simply can't wait until next year to see how this plays out.

Redemption or repudiation awaits . . .

Sources
Hail Hubbard
by Bruce Bartlett
National Review, January 13, 2003, 8:00 a.m.
http://www.nationalreview.com/nrof_bartlett/bartlett011303.asp

Think Twice About Gregory Mankiw
This Harvard economist does not belong on the Bush economic team.
By Stephen Moore
National Review, February 28, 2003 11:30 a.m.
http://www.nationalreview.com/moore/moore022803b.asp

Principles of Macroeconomics
by N. Gregory Mankiw
International Thomson Publishing; 2nd edition (June 2000)

Cheney the Supply-Sider
Cheney the Supply-Sider
Larry Kudlow,
National Review, 7/24/00 6:45 p.m.
http://www.nationalreview.com/kudlow/kudlow072400.html

David Stockman, The Triumph of Politics: Why the Reagan Revolution Failed
(New York: Harper & Row, 1986), p. 56.

The Education of David Stockman
William Greider
Atlantic Monthly, December 1981, pp. 46-47.
http://www.theatlantic.com/politics/budget/stockman.htm

Q&A Gregory Mankiw
Top economic adviser to George Bush
By JYOTI THOTTAM;
Time, Monday, Oct. 06, 2003
http://www.time.com/time/insidebiz/article/0,9171,1101031013-493318,00.html

Secondary Resources:

Trickle-Down Economics: Four Reasons Why It Just Doesn't Work
By Mehrun Etebari
July 17, 2003
http://www.ufenet.org/research/TrickleDown.html

The Rise of Supply-Side Economics
www.huppi.com/kangaroo/23More.htm

Trickle Down Economics and corporations: How corporate taxes cost jobs
By Brad Wardell
Posted Wednesday, September 03, 2003
http://www.joeuser.com/articlecomments.asp?AID=89&s=1

Trickle down economics comes of age
By: Tim Wood
Posted : 2002/06/14 Fri 04:00 | © Moneyweb 1997-2003
http://m1.mny.co.za/MNBTalk.nsf/0/C2256A2A002030FD42256BD60028F633?OpenDocument

Trickle-down Economics and Ronald Reagan
Jim Blair
http://www.bigissueground.com/politics/blair-trickledownreagan.shtml

The "Trickle Down" Economics Straw Man
by Thomas Sowell
September 27, 2001, Capitalism Magazine
http://capmag.com/article.asp?ID=1115

Trickle Down Economics in Full Flow (PDF)
Center for Impact Research, April 2003
http://www.impactresearch.org/documents/newsletterarticle403.pdf

Supply-side Economics has Supporters in Academia
Monday, September 29, 2003
by Bruce Bartlett
http://www.ncpa.org/edo/bb/2003/bb092903.html

A Supply-Side History And The Road Ahead Part I
By Wayne Jett, August 1, 2003 Part I
http://www.wanniski.com/showarticle.asp?articleid=2803
and Part II:
A Supply-Side History And The Road Ahead Part II
http://www.wanniski.com/showarticle.asp?articleid=2821

Fox Xmas Retail Discussion

Thursday, December 25, 2003 | 09:20 AM

in Finance

Today's discussion about 2003 holiday retail sales on Fox (what I jokingly refer to as the "Christmas Calvacade of Jews") will be on between 3 and 4pm. The discussion is tentatively titled "Whether the retail Grinch really stole Christmas."

Its tough to cover so broad a subject in only 5-7 minutes, here's what I hope to touch upon:

First, this has been the best Christmas season for retailers since 1999.

The final numbers may have disappointed some overoptimistic analysts, but they really were quite respectable. I think some observers got carried away by a few data points, and set their expectations way too high. Mostly, this was due to the 3rd Quarter GDP data, and they way people extrapolated it.

Looking at the actual sales and shopping habits of consumers in 2003, we take note of these three trends:

1) Luxury goods were far and away 2003's best performers:
The reasons? Luxury shoppers are feeling particularly flush in '03: The stock market rally has a wealth effect, holiday bonuses were respectable this year, and, of course, the tax cuts this year all put alot of money into the hands of the luxury goods shopper.

The flip side of this was the weaker than expected performance from the Discounters. Two reasons for this: Price sensitive shoppers are not feeling as flush; Their tax rebate checks from the summer has long been spent, and as a group, they are still a little nervous employment wise.

Additionally, too many stores played a game of chicken -- and lost. They waited too long to cut prices. They did eventually cry Uncle. Between WalMart, Target and the outlet centers, and of course, comparison price shopping engines on line, we've become a nation of very price savvy shoppers.

Finally there's a trend towards New American Luxury -- i.e., "Trading Up". A couple of marketing guys from Boston wrote a book that focuses on the middle market -- why buy mediocre? If it matters, buy the best, and pay for it by buying the cheapest you can find in everything else. Perfect example: The NYTimes had an article about how rear projection TVs ($2,000 - 5,000) are sold out across the nation. From Sears down to local chains, the retailers and manufacturers completely underestimated demand.

Believe it or not, in this category, its not the premium item. The flat panel Plasma screens -- at $10 - $20,000 -- are the luxury item in his category.

2) Gift Card purchases increased:
Last year's trend toward Gift Card purchases has accelerated. Solves a lot of gift selection issues, and avoids the dreaded Seinfeldian problem of "regifting."

Retailers expect to sell $45 billion worth of gift cards -- more than 5 percent of total retail sales this season. Recipients often spend 15 to 20 percent more than the face value of the card, another 10% -- $4.5 billion worth -- are never redeemed.

From a corporate accounting perspective, stores can not record sales of gift cards until they are redeemed for goods. (Recall how a few years ago, software companies got into trouble for treating new contracts as revenue --- before the goods shipped; That's improper). So this trend somewhat understates holiday sales -- And, it also creates a nice spillover effect into January. It extends the holiday retail season somewhat.

3) On line stores continue to grow rapidly (more so for the "non pure-plays"):
37 of the 50 largest internet stores are also Brick & Mortar retailers. Wal-Mart, Sears, Best Buy, Target, Radio Shack, J.C.Penneys, Starbucks, William Sonoma, all did a brisk business on line.

We saw a continued increase in online sales this year; That's part of the reason we weren't put off by the Snow on 2 consecutive weekends in the North East . . .

Bull!

Wednesday, December 24, 2003 | 04:31 PM

in Finance

I caught Maggie Mahar on K&C last nite (never heard of her before). She was discussing her new book: Bull: A History of the Boom, 1982-1999: What drove the Breakneck Market--and What Every Investor Needs to Know About Financial Cycles.

Her thesis is right up my alley -- its a fascinating study of longer term bull and bear cyles. Her concepts are very similar to the study "Looking at the Very Very Long Term" we did earlier this Fall.

Good stuff; I haven't read Mahar's book yet, but from what I skimmed of it, its looks like a keeper . . .

Upcoming Media Appearances

Tuesday, December 23, 2003 | 03:41 PM

in Media

I just got tagged for 2 TV appearences over the next few days (set your TiVo)

On Christmas Day, between 3 and 4pm, I'll be discussing the Economy on FoxNews with Sheppard Smith. The discussion will cover "Whether the retail Grinch really stole Christmas."

Then on Monday, December 29th, I'm scheduled to appear on Kudlow & Cramer's year end review. Thats on at 5pm, 8pm and 11pm. I'm the reluctant Bull, which compared to some of the breathlessly fanatical bulls, makes me one the more bearish people on the show.

Reality vs. Perception: The 3 Minute Mile

Tuesday, December 23, 2003 | 12:20 PM

in Finance

I was quite the runner back in High School. My mile times were a little over 3 minutes. Indeed, I ran the marathon in just under an hour and a half. Now that I’m in my 40s, it takes me longer to finish the 26 mile run - a touch over two hours.

Still, those are pretty respectable numbers.

Of course, those are my seasonally adjusted, inflation bracketed, annualized numbers -- not my actual track times. I simply applied the same governmental methodologies used to calculate economic statistics to my lap times.

Take this morning’s revised GDP numbers, for example: 8.2% annualized GDP growth sure sounds impressive. But that number’s fictional. GDP growth for the 3rd Quarter was 2.05%, which is then multiplied by four to derive an annual number (4 Qs= 1 year).

GDP is no more 8.2% per year than I am a 3-minute miler.

What’s so amazing about these illusions is how the markets react to them. Each week, we get treated to seasonal adjustments, revised estimates, subsequent revisions to the revisions. There’s hedonic pricing (which, trust me, you really don’t want to know about). There are nominal numbers, inflation adjusted data, and on occasion, “real” numbers.

Then there’s the GDP deflator. No one I spoke with is able to explain to me what this does or how it works. (That includes Nobel Laureates). There is some complicated applied mathematics involved; NASA’s Jet Propulsion Laboratory had some engineers figure out how the deflator functions for their website (really). But no one else actually understands how this works. That should be a red flag that we have become overly reliant on estimates and false data.

But intelligent economists admonish us to understand the limitations of data, and place it into the framework of a larger perspective of trend. See the forest and the trees.

What should matter most to market watchers, however, are the changes in underlying trends and how they impact perception versus reality. Example: Before the 3rd Quarter, the general perception of the economy was that it was worse than it actually was. After the 8.2% GDP number came out, expectations got raised so high they overshot the reality. Now, the general perception is that the economy is much better than it actually is.

That gets reflected in the disappointment in holiday retail sales - despite the fact they are going to be the best in 3 years.

Reality trumped by perception once again.

Chart of the Week: S&P500 Barra Value/S&P600 Barra Growth Ratio

Tuesday, December 23, 2003 | 12:15 PM

in Finance | Media | Politics

The long awaited rotation from small cap stocks to large cap, from to value from growth, is well underway. This can also be described as a rotation from speculative low quality names into higher quality issues.

S&P500 Barra Value/S&P600 Barra Growth Ratio

Source: StockCharts.com

Technician John Murphy notes “the most notable gain is seen in large value, while the most notable drop is seen in small growth.” That suggests to us that the most recent shift has been a move to quality.

Random Items:
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Why the U.S. Treasury Market Just Won't Go Down
Hey, big spender
Beyond Red and Blue in the 2004 Election
10 reasons why investors prefer being ignorant
Abby Joseph Cohen Looks to the Future

Quote of the Day:
"I am part of the networks and the networks are part of me. I am visible to Google. I link, therefore I am." -William Mitchell, author of "Me++"

Music Sales Rise on Aggressive Discounting, Price Competition and an Improving Economy

Sunday, December 21, 2003 | 02:58 PM

in Finance | Music | Web/Tech

In the most under-reported story this year, music sales rose this past quarter. For the first time in nearly 3 years, pre-recorded music sales saw a bump up in total units and revenues.

The Recording Industry Association of America (RIAA), the industry's usually vocal mouthpiece, has been notably silent on this development. Given their typical penchant for publicity, one would have assumed the RIAA would be crowing about the sales improvement, claiming their much criticized litigation strategy was paying off in spades.

Their silence speaks volume.

I suspect the reason the RIAA has been so hushed on this issue is that the increase in sales has nothing to do with their aggressive litigation tactics. In fact, there are three unrelated and verifiable reasons why the industry is enjoying a strong sales uptick:

1) Lowered suggested retail prices, combined with aggressive discounting, has made CDs a reasonable value;
2) The improving U.S. economy is putting more discretionary money into consumers hands;
3) A slew of new legitimate on-line music services are attracting music fans.

This economic led revival is a good thing, too. The RIAA’s plan to sue as many of their customers as possible was dealt a fatal blow Friday (See “Court to RIAA: Drop Dead”). Specifically, the U.S. Court of Appeals for the District of Columbia said a lower court had "incorrectly approved enforcement of subpoenas under the Digital Millennium Copyright Act".

This decision came at a rather inopportune moment for the RIAA, who just launched their latest litigation salvo. This time, however, the RIAA may have overplayed their hand.

Typically, the RIAA has been masters at garnering publicity for the slightest new development. Why the sudden radio silence? The answer may surprise you: The group does not want to publicize the recent upswing in music sales.

The convicted price fixers of the music industry have schemed long and hard to prevent market forces from bringing true competition to the retail market place. The major labels have illegally conspired to maintain prices far in excess of what market conditions would bear, to the tune of some half a ~~trillion~~ billion dollars over the past 5 years:

"Former FTC chairman Robert Pitofsky said at the time that consumers had been overcharged by $480 million since 1997 and that CD prices would soon drop by as much as $5 a CD as a result."

The pre-holiday upswing in sales reveals what many critics have been saying all along: the main culprit behind slumping music sales has been the ~~inexplicably~~ inexcusably high prices of CDs.

Consider that the Big 5 Labels -- the aforementioned price-fixing cartel -- "have engaged in acts and practices that have unreasonably restrained competition in the market for prerecorded music in the United States through their adoption, implementation and enforcement of Minimum Advertised Price ('MAP') provisions of their Cooperative Advertising Programs "). That was the determination of an anti-trust case brought by several state governments (led by Eliot Spitzer of NY), as well as a successful civil class action suit.

But what broke the cartel's price fixing scheme, however, was not litigation. Just as the members of that other price fixing cartel, OPEC defect (releasing more supply and thus effectively lowering prices), the music cartel was finally broken by the defection of the biggest label of them all: Universal. Since October 1, they announced a new program of lowering the suggested retail selling price of CDs by 30%" in attempt to win back customers downloading songs."

This breakthrough led to the first genuine price competition in the retail music space in decades. On Black Friday (the day after Thanksgiving), adverts from Best Buy offered new releases for sale at $7.99. Note that these were not old titles or budget lines discs, but new releases from artists such as Sting and Mary J. Blige. This past weekend, I picked up recent releases by Jet ("Get Born") and Kings of Leon ("Youth & Young Manhood") on sale for $7.99 each at Best Buy.

With the Minimum Advertised Price restrictions removed, widespread sale prices (i.e., John Mayer's new disc at $9.99) were very much in evidence at all the major retailers:= such as Best Buy, Target, Wal-Mart, and others. (Long live market forces).

Chart Courtesy of Professor Amy Macy

Indeed, many consumers have been astounded at how new DVDs of recent films sell for less than comparable CDs -- sometimes even the film's soundtracks on CD! Popular retailer J&R Music is advertising the DVDs of "Seabiscuit" and "Pirates of the Caribbean" for $17.99, while the soundtracks to those films go for similar prices. At Best Buy (both the store and the website), for example, the DVD the film "High Fidelity" (with of John Cusack) was $9.99; the CD soundtrack to the film is $15.99; At Amazon.com, both the DVD and the CD are the same $14.99. (Incidentally, the Jack Black cover of Marvin Gaye's "Let's Get It On" is much better on the DVD than the watered down, candy ass version released on the soundtrack CD).

How is it that a movie which costs $100 million to make sells for the same price -- or less! -- than the soundtrack of the same film. Which costs 1/1000th of the film to produce? Something is very wrong with the price mechanism. Its no wonder that sales have off.

These aren't isolated instances, they are the norm. If you like James Taylor, you can get a DVD of his most recent tour, or a more intimate show at the Beacon Theatre. Either DVD is at Best Buy for $9.99. Both discs contain nearly 2 hours of music, plus audio commentary and other special features. Or you could buy "The Best of James Taylor" for 35% more, but why would you? It is completely irrational for a consumer to spend more money on the 45 minute, audio only CD, rather than purchase the less expensive, audio/video/special feature multi media 120 minute long DVD.

I've long believed that the entire P2P brouhaha, including the litigation and legislative initiative of the RIAA, was a red herring of sorts. These tactics are not about fighting sharing or downloading (RIAA newspeak: piracy); Rather, its all about maintaining monopoly/cartel pricing power. Downloading has been a direct response to price fixing.

But the labels should be -- and are, to some degree -- aware of two much greater threats: The first is illegal CD duplication; Its a real problem, and its a form of physical copyright theft that the industry must continue to confront. I see much of the Billboard 100 on my way to the office every day on the streets of New York for $5 apiece (3 for $10). Mass re-production is definitely eating into sales.

Fighting this form of theft is no fun. It requires close logistical coordination with local law enforcement. It is a time consuming, thankless task doesn't generate big headlines. Indeed, like battling cockroaches, its a never ending task. This is, in my opinion, the most significant and costly form of piracy, but it doesn't seem to recieve nearly the same focus from the RIAA as other, sexier issues.

Perhaps there's a bit of ego involved in the choices made by the RIAA; (Ego? In the entertainment business? You must be kidding!) Otherwise, we'd be hearing more about the illegal physical disc knockoffs, and less about 12 year old girls and grandmothers without PCs getting sued for "Piracy."

The more dangerous long term challenge facing the labels is "disintermediation." The internet allows for the labels to be removed as the middle man between the consumer and the artist. Networked technology, not free MP3s, may very well be the meteor that eventually destroys the dinosaur (i.e., big 5 labels). That's an entirely different discussion which we will save for a later date.

For now, it all comes back down to allowing the marketplace to set prices: By synthetically overpricing CDs, and then using illegal means to maintain those artificially high prices, the industry created a yawning void and unfulfilled demand. CD duplicators would not be able to fill the demand at that price point if the industry let the marketplace work to set prices. One even imagines the arguments made at some late night meeting at Universal HQ: "Hey, maybe this Capitalism thing works!"

Universal may have accidentally saved the music industry from its own worst enemy -- itself -- by breaking away from the price fixing cartel, and allowing the marketplace to function.

The uptick in sales is likely to get even better as the economy continues to strengthen, and price competition takes root in the retail space. Unless the industry and the RIAA manages to find someway roll back the price cuts. Then it will be back to the street vendors for many incremental buyers.

Goodbye price cuts, hello oblivion.

Sources:
U.S. Music Sales Up as Positive Trend Rolls On
By Sue Zeidler
Reuters Wed Nov 19, 9:56 PM ET
http://www.forbes.com/home_europe/newswire/2003/11/19/rtr1154432.html

Five Consent Agreements Concerning the Market for Prerecorded Music in the United States
FTC File No. 971 0070:
http://www.ftc.gov/os/2000/05/index.htm#10

Hit Charade: The music industry's self-inflicted wounds
By Mark Jenkins
Slate, Aug. 20, 2002, at 8:19 AM PT
http://slate.msn.com/?id=2069732

EMI halts fall in music sales
By Saeed Shah
Independent Digital (UK), 20 November 2003
http://news.independent.co.uk/business/news/story.jsp?story=465472

How much is digital music worth?
http://zdnet.com.com/2100-1104_2-5117275.html
http://news.com.com/2100-1027_3-5117275.html

Swappers Buy Music, Too
May 7, 2003, 8:25 PM PDT
By Reuters
http://news.com.com/2100-1027_3-1000420.html?tag=fd_top

RIAA lawsuits yield mixed results
http://news.com.com/2100-1027_3-5113188.html?tag=st_pop

Online music on center stage
Conference grapples with new digital world
http://www.sfgate.com/cgi bin/article.cgi?f=/c/a/2003/12/09/BUG7K3IR7E20.DTL

Barron's Picks up on the "Retail Snow Job"

Saturday, December 20, 2003 | 04:00 PM

in Current Affairs | Finance | Media

I must have missed this earlier in the week, but Barrons' picked up the "Retail Snow Job" we discussed last week.

Here's what they ran:

DECEMBER 17 -- Some analysts and CFOs have taken to blaming sluggish sales on the two snowstorms that have recently hit the Northeast. You can already hear the rumblings and excuses being trotted out. This is, for the most part, nonsense. Here's a news flash: It snows in the winter, especially in the northern parts of the country. People who live in the North are used to it . . . So should retailers, and they must learn to plan accordingly.

Of course, the Home Depots of the world sold a lot more shovels and snow blowers that weekend, which may leads to cries of "broken window" thesis, but when applied to Christmas shopping, that theory is a fallacy. A hardy and determined lot, holiday shoppers are hardly dissuaded by their 'finite' resources. The key underlying flaw of all economics -- the theoretical "rational consumer" -- is nonplussed by mere lack of cash. Social and familial obligations of gift exchanges reduce the elasticity of "the Xmas list" by a large measure.

Thus, everyone you know will get everything on their X-mas shopping list by December 25th, come sleet, snow, debt, gloom of night, etc. If the snow kept them from the mall, than they shopped online. If they run out of cash, then they will charge their purchases. It's always dangerous to rely on anecdotal evidence, but this is a query into the fundamental nature of the American consumer. Will a little snow -- or a lot, for that matter -- prevent grandma from getting her grandkids their gifts? "Susy and Bobby, here are your Christmas gifts sorry little Debbie, but it snowed. Maybe next year . "

Last I checked, the Internet does not close for "snow." Whether that means Wal-Mart's and Sears' loss becomes Amazon's and eBay's gain, we have yet to see. Last I checked, Wal-Mart and Best Buy had web sites. Suffice it say that a determined shopper can get whatever they want delivered by December 25th -- online or off.

May we please retire the pathetic snow canard now? Thank you.

Source
Retail Snow Job
Market Watch Today
December 18, 2003 2:28 p.m. EST
http://online.wsj.com/barrons/article/0,,SB107170172249997000,00.html

Court to RIAA: Drop Dead

Friday, December 19, 2003 | 01:21 PM

in Current Affairs | Media | Music | Web/Tech

Here's the best overview on the legal situation, from the always interesting GMSV:

"Silly." That's how a U.S. appeals court described the Recording Industry Association of America's efforts to use the subpoena provisions of the Digital Millenium Copyright Act to compel Verizon Internet Services to identify subscribers accused of illegally distributing music over its network. In a blistering ruling a three-judge panel from the U.S. Court of Appeals for the District of Columbia overturned a prior ruling forcing Verizon to hand over the personal information of at least four its customers and flat out rejected the RIAA's claim that Verizon was responsible for the illegally downloaded music files that traverse its network.

"We are not unsympathetic either to the RIAA's concern regarding the widespread infringement of its members' copyrights, or to the need for legal tools to protect those rights," the court wrote in its opinion. "It is not the province of the courts, however, to rewrite the DMCA in order to make it fit a new and unforeseen Internet architecture, no matter how damaging that development has been to the music industry or threatens being to the motion picture and software industries. The plight of copyrightholders must be addressed in the first instance by the Congress; only the Congress has the constitutional authority and the institutional ability to accommodate fully the varied permutations of competing interests that are inevitably implicated by such new technology." The ruling is a huge setback for the RIAA, whose campaign against file-sharing earlier this year morphed into an orgy of lawsuits (see "Music industry to recoup alleged file-sharing losses one 12-year-old at a time").

Source: Appeals panel to RIAA: "Ha, ha, ha, ha ... but seriously, no"
Good Morning Silicon Valley, By John Paczkowski, Dec. 19, 2003
http://www.siliconvalley.com/mld/siliconvalley/business/columnists/gmsv/7532166.htm

Other Sources:
Recording Industry Is Dealt a Blow By Court's Take on Copyright Law
By JOSEPH SCHUMAN
http://online.wsj.com/article_print/0,,SB107184050465849600,00.html
WSJ, December 19, 2003 12:37 p.m. EST

RIAA legal tactic unconstitutional, appeals court says
http://www.hollywoodreporter.com/thr/article_display.jsp?vnu_content_id=2056164
By Brooks Boliek
Hollywood Reporter. Dec. 20, 2003

Court Says Net Music Subpoenas Not Allowed
By Andy Sullivan
Reuters Fri 19 December, 2003 17:44
http://www.reuters.co.uk/newsArticle.jhtml?type=technologyNews&storyID=4023626§ion=news

Record Industry May Not Subpoena Providers
AP News
http://apnews.myway.com/article/20031219/D7VHHPHO0.html

Jobless Claims Data Gyrate Due To Seasonal Adjustment Difficulties

Friday, December 19, 2003 | 10:57 AM

in Finance

Jobless Claims: -22,000 to 353,000 in 12/13/03 Week

I took yesterday off, saw the headline above, and was pleasantly surprised. This data point was well below the 365,000 consensus. Then today I came across this interesting take from Joshua Shapiro, Chief U.S. Economist for MFR, an independent research house:

"We continue to maintain that the claims data are too dependent on questionable seasonal adjustment at this time of the year to be of much if any use in detecting underlying labor market trends. While other sources of information (survey evidence, the monthly employment report, etc.) point to an incipient labor market recovery, we will need to wait until after the New Year to see if the claims data corroborate this.

Over the past 6 weeks, we have seen NSA changes of +51,453, -49,282, +50,143, -40,404, +129,108, and now -75,048. SA changes have been +16,000, -7,000, -8,000, +11,000, +10,000, and now -22,000. The NSA increase 5 weeks ago was due to normal layoffs in construction as weather turned colder, the NSA decline 4 weeks ago was due to the Veteran's Day Holiday, the NSA increase 3 weeks ago was due to a bounce-back effect from the holiday-shortened week, the NSA decline 2 weeks ago was due to the Thanksgiving Day holiday, the very large NSA increase 1 week ago is the NORMAL bounce-back effect from the Thanksgiving Day holiday and the NSA decline this week is the NORMAL drop-off after that very large increase. There is NOTHING unusual in the underlying NSA data, but the seasonals are once again unable to account adequately for the weekly changes."

Note that last week's claims had to be adjusted up. Does this decline of 22,000 (seasonally adjusted) represent a positive data point or not? Its hard to tell, but Joshua Shapiro notes that "the CUMULATIVE effect of poor seasonal adjustment has likely left SA claims at a lower level than the trend in NSA [non seasonal adjustment] data would suggest."

Wouldn't it be nice if we just got clean, unspun data?

Source:
Maria Fiorini Ramirez, Inc. (MFR).

Cherry Picking: The Weapon of Choice for Price-conscious Consumers

Thursday, December 18, 2003 | 08:27 AM

in Finance

A quick follow up to our ongoing retail discussions on discounting and shopping: Knowledge@Wharton, a publication of the Wharton School of Business, referenced an interesting paper: Cherry Picking: The Weapon of Choice for Price-conscious Consumers.

Obligatory excerpt:

"Do cherry pickers – those consumers who are extremely sensitive to price and go from store to store to pick the best-priced items and leave the rest – really save a lot of money? A recent paper by Wharton marketing professor Stephen J. Hoch and Edward J. Fox, a marketing professor at the Cox School of Business at Southern Methodist University, found that consumers not only save money but that the savings are enough to offset the time it takes to do the extra shopping. In addition, the researchers found, a substantial number of shoppers exist who are savvy and diligent enough to make cherry picking pay off.

“What we discovered was a big surprise to me,” says Hoch, noting that more than a few marketing experts and consumers consider cherry picking a “perverse” kind of shopping behavior and doubt that all the effort required to be a consummate cherry picker is economically worthwhile.

According to Hoch, the findings hold implications for retailers who are the targets of cherry pickers: Don’t fight cherry-picking and risk alienating customers; instead, try to entice cherry pickers into buying higher-margin items."

Source:
Cherry Picking: The Weapon of Choice for Price-conscious Consumers
http://knowledge.wharton.upenn.edu/index.cfm?fa=viewArticle&ID=912

VIX Signal Redux?

Thursday, December 18, 2003 | 12:03 AM

in Finance

Back in mid-October, we noted that a significant slide in the VIX to the 16s was signaling an imminent short-term correction. That call saw the Dow drop nearly 5% over the next 10 days, and the Nasdaq give up well over 100 points. So you may imagine our excitement on Tuesday and Wednesday as we watched the VIX break 16, and continue south to 15.52, making a fresh 52 week-low.

Unfortunately, we cannot make the same call on either the VIX or QQV, the volatility index for the NDX (See charts nearby). The VIX move in October, from 23.26 to about 16.19 represented a drop of over 30%. The recent VIX drop began from just over 18, and poked beneath 15.52 for a 15% move - half of the prior signal. This is not enough to get us excited that massive complacency has set into the market. While there is some lack of fear, it is not yet at levels that reliably signal an imminent reversal or sell off.

Seasonality fights complacency?
Additionally, there are two unrelated factors working against a late December VIX call: Seasonality, and deferrable taxes. Seasonality includes the “Santa Claus Rally” and so called “January Effect.” According to the ’Stock Traders Almanac http://www.stocktradersalmanac.com/, the Santa Claus rally includes the last 6 days of the year, and the first 2 days in January. The January Effect typically starts mid-December, and runs through the first week of January. A variety of reasons underlie why this period is typically positive; space does not permit a full exposition here. Suffice it to say that the markets have historically enjoyed positive returns near the end of the year.

Not only Cub’s fans say “Wait ‘til Next Year”
As we head into year’s end, another element working in favor of equities is the reappearance of our old friend, Capital Gains Taxes. This being the first winning year in three, investors’ thoughts are turning to our ever-present dependent, dear old Uncle Sam. I’ve been hearing from a variety of institutions and individuals that are delaying ‘hitting the bid’ until January 2004. A profitable sale made in December 2003 has a tax bill due in a mere 4 months; Waiting until January to make that sale gives the seller a full 16 months, until April 2005.

This is reminiscent of ’99, as I recall seeing so many charts gone vertical late in the year, all of which were technically begging to be sold that December. Time and again, all manners of investors insisted on waiting until 2000 to make the sale - for the same tax deferral reasons. Given how 2000 turned out, this crafty strategy worked well. By the end of the year, most people had losses sufficient to offset their taxable gains that calendar year. Compare this with offsetting a mere $3,000 per year in losses, forever.

Taxes delayed are not taxes denied, but . . .

Productivity and unemployment: the Dark Side?

Schwab's Year-End Moves to Reduce Your Taxes

Tracking Down the Malfeasants

K&C tonite!

2004: How The Pros See It

Barrons picks up "The 3 Minute Mile"

Top Business Stories of 2003

2004: A test of Supply Side economics

Fox Xmas Retail Discussion

Bull!

Upcoming Media Appearances

Reality vs. Perception: The 3 Minute Mile

Chart of the Week: S&P500 Barra Value/S&P600 Barra Growth Ratio

Music Sales Rise on Aggressive Discounting, Price Competition and an Improving Economy

Barron's Picks up on the "Retail Snow Job"

Court to RIAA: Drop Dead

Jobless Claims Data Gyrate Due To Seasonal Adjustment Difficulties

Cherry Picking: The Weapon of Choice for Price-conscious Consumers

VIX Signal Redux?