Notes from Robert Kaplan’s Presentation to Rice Alumni (19-Feb-2019)

On February 19, 2019, I went to a Rice Alumni event at the Federal Reserve Bank in Dallas.  The Dallas Fed is one of twelve Federal Reserve Banks in the United States.  The CEO’s of the Fed banks meet every six weeks or so to set national monetary policy.

Robert Kaplan, the CEO of the Dallas Fed was speaking about the state of the economy.  Peter Rodriguez, the Dean of the Jones School of Business at Rice University, was asking Dr. Kaplan questions.  Late in the presentation, Rice Alumni and their guests asked questions.

Here are some key points that I took away:

  1. Business Pricing Power:  In the current market, consumers have real-time access to prices of products.  They have never had such comprehensive access before.  Because of this, price competition is extremely stiff and businesses are not able to pass on cost increases to consumers.  Dr. Kaplan specifically mentioned the recent steel and aluminum tariffs as costs that businesses are not able to pass on to consumers.
  2. The number of people in the labor force and productivity are the primary drivers of GDP growth.  More people in the labor force yields higher GDP growth.  Likewise, higher productivity yields higher GDP growth.  Technology and education drive productivity increases.  Education is a big problem for Texas because Texas lags the US in general.  And, likewise, the US lags many countries in the developed world.  (More on this below.) Texas’ growth looks positive for at least the short and medium term, however, because Texas is experiencing large population growth.  This is dampening the education disadvantage that Texas has.  Likewise, Texas’ population growth – which results in higher GDP – allows Texas to solve its education problem in the future easier than states with stagnant or declining populations.  Dr. Kaplan specifically mentioned Kansas, where he is originally from, and Illinois.Dr. Kaplan mentioned immigration as a component of population growth in Texas.  But, he did not explore the subject.
  3. Technology helps people with post-secondary educations or specialized training in the trades.  It hurts those with a high school (or less) education.  This is the biggest driver of the growing divide between the wealthy and the poor.  Dr. Kaplan mentioned STEM many times as the path to growth.
  4. Dr. Kaplan specifically mentioned Khan Academy and edX as potentially disruptive forces in the post-secondary education arena.  He stated that education delivery needs to be significantly revamped.  He believes this should be done with steps such as busting teachers’ unions, eliminating tenure for college professors, and financially separating teaching from research at the university level.
  5. The media concentrates on the U3 unemployment rate.  However, the Fed primarily looks like the U6 unemployment rate which considers people who have given up looking for work and part-time workers who would prefer to be full-time.  The U6 unemployment rate is about 8%.  This paints a much less positive picture of the economy than the U3 rate that the media reports.
  6. The US owes $54 Trillion in unfunded entitlements such as social security, medicare, and retiree pensions.  This is a ticking time bomb.  It does not show up in the deficit or national debt numbers that we hear.
  7. 2018 saw GDP grow at a rate of 3%.  That was largely due to the tax overhaul and increases in government spending.  The effects of the tax overhaul are likely over for individuals.  The effects of the tax overhaul for businesses may be longer lasting.  But, that is not clear.  The effects of increases in government spending last year are probably over.  Therefore, GDP will likely grow at 2% or less in 2019.
  8. Dr. Kaplan believes that education spending will yield productivity increases (which will yield GDP increases).  He specifically mentioned early childhood education and that 60% of children who enter 1st Grade behind will never catch up.  He also believes that college prep should have more emphasis at the high school level.
  9. Shale oil/fracking:   The petroleum yield from this kind of oil production is short-lived.  That likely means that the US’ production levels will struggle to maintain their historic high levels and that the oil industry will profit from high oil prices in the future.

Short Commentary

During the question and answer session from Rice Alumni and their guests, one gentleman told Dr. Kaplan that there is either no correlation, or negative correlation, between spending on education and educational achievement levels.  If you think about it, such an assertion is absurd because, if true, the best thing for society (including individuals) would be to spend absolutely nothing on literacy.  Obviously, Dr. Kaplan disagreed.

After the presentation, I spoke with Dr. Rodriguez, the Jones Business School Dean.  I told Dr. Rodriguez that I was surprised by this question and was also surprised that Robert Kaplan did not point out that much of the spending labeled as “education” spending really goes for athletic programs which do not increase literacy.  Dr. Rodriguez agreed and mentioned the huge high school stadium in Allen as a great example.

I told Dr. Rodriguez that I would like to understand the research about the relative effect of employment growth and productivity on GDP.  For example, immigration increases the number of workers in the workforce.  But, immigrants come with various educational levels depending on their circumstances.  So, more immigrants cause GDP to grow.  And highly educated immigrants increase productively and that causes GDP to grow too.  But, illiterate immigrants have the opposite effect on productivity – at least initially.  That means that the positive effects of increased workers are dampened if those workers have lower than average productivity.  Unfortunately, Dr. Rodriguez seemed to take this as a political question and brushed it aside.  It was not meant to be.  I am sure that the Fed has data on this question.  I would love to see it.


No Longer Funding 401K?

On May 23, 2012, Yahoo Finance posted an article  by K. W. Callahan explaining why he is no longer funding his retirement account.  Here is a snapshot of Mr. Callahan’s article.


Mr. Callahan has a business degree from the Indiana University Kelley School of Business.  Unfortunately, he seems to have forgotten much of what he learned in business school.  There are many misconceptions about the way the equity markets work.  But, this post concentrates on the power of dollar cost averaging and how Mr. Callahan has missed out on a significant opportunity to grow his retirement savings.

Mr. Callahan explains that he stopped contributing to his 401K in late 2007.  At that time, his retirement account balance was about $38000.  He correctly points out that his balance was only $33000 in late 2011 – almost 5 years later.

Assuming he makes about $50000 per year, a 3% contribution would have amounted to $125 per month.  If he had saved $125 per month in a non-interest bearing account, he would have added $7500 to his savings over the course of 5 years.  That would have brought his retirement savings today up to around $40000.

But, a better strategy would have been to invest his 401K in a diversified basket of securities reflecting the total market value, such as the iShares Russell 3000 Index Fund (IWV), and keep contributing.  If Mr. Callahan had done this, he would have had around $45000 as of June 1, 2012.

The reason is simple.  With regular contributions at set intervals, investors are able take advantage of low points in the market.  For example, purchasing $125 could have bought 3.15 shares of  (IWV) on February 2, 2009 — at the low point of the market.  A similar investment of $125 on April 1, 2011,  would have purchased only 1.56 shares.  Catching the up’s and down’s of the market by purchasing set amounts at regular intervals allows investors to accumulate more shares when prices are low and less shares when prices are high.   This is dollar cost averaging.

Obviously, there were months that such a strategy would have left Mr. Callahan’s account with less than $38000.   But, over a reasonably long period of time (years, or decades),  dollar cost averaging using a diversified basket of securities has historically produced much better yields than buying securities all at once and then holding them.  And it has produced better results than government bonds, real estate, gold, or other investments.

Dollar Cost Averaging
Mr. Callahan's Investment Alternatives

The lesson is to keep investing a set amount regularly in a broad range of investments.  Never give up.