Fellow
Shortrunners,
After a week of much needed vacation, I'm back to writing my newsletters. Today I'm joined by Alex Rothenberg, a senior economic analyst here at the Short Run, and hopefully in this issue we'll be able to tackle one of the most pressing issues of our day: financial misinformation.
This past fall, economists Joseph Stiglitz, George Ackerlof, and A. Michael Spence all shared the Nobel Prize for their work on the theory of asymmetric information. The prescience of the Nobel Committee in delivering their award is remarkable, as the very problems for which the economists won their awards now plague the American system of capitalism on an epic scale. Accountants of a small but growing number of firms have published systematic lies in the form of balance sheets and income statements, the principle methods of promulgating financial information.
These statements are designed not to present an accurate picture of a company's performance, but rather to inflate expectations over financial positions and earnings potential. When this misinformation becomes too difficult to accept, investors lose billions, workers lose their jobs and their retirement, and the financial markets suffer dramatically. There are some who feel that we may have only scratched the surface in uncovering the fraudulent behavior of corporations throughout the United States, and that more WorldComs and Enrons are yet to come.
Equity markets have already suffered heavily due to increased skepticisms of their credibility: this week alone, the S&P 500 index and the NASDAQ composite index hit their five year lows, as investors have become more and more afraid to put money into stocks whose fundamentals could be presented unreliably. The price of the dollar has also fallen sharply in recent months with respect to the Yen, the Pound, and the Euro, as international investors are motivated by the same fears.
Who's to blame for such catastrophes? The American standards of accounting, known as the Generally Accepted Accounting Principles (GAAP) are clearly an easy culprit. Like any system of laws, GAAP standards are not without their share of loopholes. Accounting, a profession long rumored to be dull and lifeless, has become a forum for creative number-crunchers to disguise expenses, inflate revenue expectations, and manipulate companies' balance sheets far beyond the realm of good policy.
Simplifying the corporate tax code is one means of discouraging corporate fraud from beginning in the first place. A simpler accounting structure would make underhanded activity easier to spot. Even more appealing is forcing greater financial disclosure for traded corporations. More available information should allow the financial community to appropriately value firms and to catch crooks before such serious damage can be done.
Moreover, the lack of corporate punishment decreases incentives for CEOs to achieve veracity in their reports: even with Bush's proposed doubling of maximum penalties, the problem remains that corporate scandals seldom ever go to trial, and while many chief financial officers and presidents of corporations probably deserve harsh penalties, they often avoid prosecution.
Arguably more important than our legal system's inability to identify and prosecute corporate fraud is the system's inability to deter the illegal activity in the first place. Having established and steep fines for corporate fraud is only one method of deterrence but it is by no means the only method. Often ignored in the political discussion of the issue is that criminals will factor in not only the dollar figure of being caught but the probability that they will be uncovered.
Sincerely,
Daniel Hicks and Alex Rothenberg
Economic Releases
The data section
provides charts and data for the most important economic indicators.
The data below represents releases over the past two weeks.
ISM Manufacturing Index: 56.2
Release Date: 7/1
- The Institute for Supply Management's Manufacturing Index rose to 56.2 in June, another sign that the manufacturing sector of the economy is continuing its healthy recovery. On a more positive note, measures of international trade were positive, with both export and imports rising. Global trade has been suffering of late, thanks largely to slower rates of growth.
ISM Non-Manufacturing Index: 57.2
Release Date: 7/3
- In another positive release, the non-manufacturing ISM index increased to 57.2, signaling that services activity in the US is picking back up even as price pressure remains mute.
Construction
Spending: -0.7%
Release Date: 7/1
- A large drop in non-residential construction spending helped contribute to an overall decrease in construction spending of 0.7%. This is good news for the housing market, as many analysts still believe that housing prices are inflated.
Unemployment:
5.9%
Release Date: 7/5
- According to the Bureau of Labor Statistics overall unemployment in the US climbed from 5.8% to 5.9% in June. The increase was due to growth in the labor force exceeding growth in new job creation which totaled 24,000 for the for the month. Despite the economy's lack of inflation, average hourly wages rose during the month.
Wholesale Inventories/Sales:
0.1%/-0.2%
Release Date: 7/10
- Wholesale inventories rose 0.1% in May as sluggish sales kept products on the shelves. Overall wholesale sales declined 0.2% during the same period.
Import/Export
Prices: -0.6%/0.0%
Release Date: 7/10
- Largely the consequence of a drastic decline in petroleum prices during June, overall terms of trade for the US improved. Import prices declined 0.6%, with petroleum measures declined more than 6%. Export prices remained unchanged.
ECRI Weekly Leading Index: 123.4
Release Date: 7/12
- The ECRI WLI continued to advance with its long-term growth rate rising to 6.4%.
Site News
Returned from vacation in time to send this newsletter. I'd like to apologize to Hotmail subscribers. For some reason hotmail blocks my emails. I've been working on the issue and hope to have it corrected soon. Thanks for the patience.
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Issue #110
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