2010: the year in review

The year is rapidly drawing to a close, and what a year it was. Many important issues came into the spotlight in 2010 -- too many in fact to cover in a short post, so we've selected three to discuss which we believe include some of the more important lessons investors can carry with them from 2010 into the years ahead.

• The world is waking up to the folly of endless taxpayer-funded pension systems. We called this "The question of our time" and it dominated headlines from Greece to California this year. After World War II, many governments instituted pension payments for retirees that were funded by the taxes levied on those still working. At the time, life expectancies were much shorter (men often worked past 62 and the average life expectancy was only 65), and as the Baby Boom of children born after the war grew up and entered the workforce, these pension ideas seemed to work. In some places, the benefits became more and more generous and the retirement ages at which retirees could draw them became younger and younger. This year was the year in which many around the world woke up to the fact that this system is unsustainable. See also "Greece and California."

• The "Unstoppable Wave" rolled on with a vengeance. The other half of the solution to foolish government entitlement programs is economic growth. While some pundits looked at the budget crisis in European countries such as Greece and in US states such as California and argued for an "austerity" solution of higher taxes and fewer entitlements, the real answer is higher economic growth rates and fewer entitlements. We've argued that the best recipe for economic growth is for government to ensure that it does not discourage innovation. We've also pointed out that the "Unstoppable Wave" paradigm shift taking place is so powerful that even ordinary-grade government ineptitude will be unable to derail it. The year 2010 provided all kinds of examples of the kind of transformative innovations that exponential increases in bandwidth can have on various industries, from the explosion of online retail shopping after Thanksgiving to the proliferation of smartphones and tablets, particularly their application to businesses but also even combat operations. Some of the best investment performance during the year came from businesses involved in this paradigm. See also "On the verge of something important" and "Another wake-up call."

• The "experts" who wrote off the economic recovery were as wrong as those who wrote off the San Francisco Giants. Conventional wisdom going into 2010, and during much of the year, was that the rebound after the crater of March 2009 was just a big head-fake, and that the economy would probably slide back into "years of treading water" or even replay the worst that had gone before with a "double dip." It was fashionable in the media to say we were still in a recession, long after the recession had officially ended. In July, the UK's Telegraph published a story entitled "With the US trapped in a depression, this is really starting to feel like 1932" and opened with a quotation from Robert Reich declaring that "The economy is still in the gravitational pull of the Great Recession. All the booster rockets for getting us beyond it are failing," despite the fact that the economy (as measured by Gross Domestic Product) had been showing steady expansion since June 2009. Since then, the economy has continued to expand, embarrassing the critics who had written off America's ability to grow. Incidentally, we've argued that it would have grown even more without the harmful and wasteful government "stimulus" plans. We pointed out the similarities between those who confidently wrote off the economy and those who confidently wrote off the World Champion San Francisco Giants, and cautioned investors to beware of the conventional wisdom they hear on the financial television shows, even if it is coming from the mouths of impressive-looking economists with PhD's. In fact, we think that the Giants victory might well be one of the most important things for investors to remember from 2010, and recommend that our readers (even those who aren't Giants fans) revisit this post on the subject!

And on that happy note, we'd like to wish all our readers a very Happy New Year and a prosperous 2011!

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Google and Groupon

P Morgan Brown has a noteworthy article discussing Groupon's decision to spurn Google's $6 billion buyout offer and raise more cash themselves to expand.*

Beyond the specifics of the Groupon story itself, the article provides plenty of food for thought on important subjects such as acquisitions, the importance of management teams, different management styles, paradigm shifts and the interchange between the "engineer viewpoint" and the "salesforce perspective."

We believe these are important topics for investors to consider, and would recommend readers also look at few of our past posts on related subjects, including "The koi pond analogy of investing" and "Capable, dynamic management operating in a fertile field for future growth."

* At the time of publication, the principals of Taylor Frigon Capital Management did not own securities issued by Google (GOOG).

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Seasons Greetings and Warm Wishes

Seasons Greetings and Warm Holiday Wishes from all of us here at Taylor Frigon Capital Management!

The photo above shows this year's wreath-laying ceremony at the General Grant sequoia in the Sequoia and King's Canyon National Park.

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Zombie economics

The New York Times recently published an op-ed by columnist Paul Krugman entitled "When Zombies Win," in which the author laments that the extension of lower tax rates are a puzzling example of the triumph of "free-market fundamentalists" (as an aside, we prefer the term "free enterprise") whom, he declares, "have been wrong about everything."

He goes on to say that such ideas (like the idea that lower tax-rates encourage growth) are "zombie economics" which he defines as "doctrines the crisis should have killed but didn't."

As evidence, he offers this startling sentence: "How, after the experiences of the Clinton and Bush administrations -- the first raised taxes and presided over spectacular job growth; the second cut taxes and presided over anemic growth even before the crisis -- did we end up with bipartisan agreement on even more tax cuts?"

While Mr. Krugman's own biases are so obvious to anyone who is familiar with his writing that such statements will probably come as no surprise, we believe it is worth pointing out that in this sentence he is completely and utterly wrong on his economic history.

It's true that the (also somewhat biased) Nobel prize committee awarded Paul Krugman a Nobel prize in economics, but he seems to have missed the fact that it was only after Bill Clinton and the first GOP-controlled Congress in forty years enacted spending restraint in 1996 enroute to a capital gains tax rate cut in 1997 that economic growth took off in the latter half of the 1990s! See the chart below, showing quarterly GDP growth as a percentage, and note the presence of GDP growth above 6% (in chained 2005 US dollars). Note that the roaring GDP growth rates began after the 1996-1997 changes (first red arrow on the left side of the X-axis).

















And, while we have several issues with some of the economic moves of the Bush administration, it is also true that US GDP went from around $11 trillion to over $13 trillion (in chained 2005 dollars) under the lower tax rates that George W. Bush enacted in his first term (see GDP chart in this previous post). Note also in the chart above that GDP growth of 6.9% was seen in Bush's term in 3Q2003, in conjunction with the enactment of his tax rate cuts (second red arrow on the right side of the X-axis). Growth rates of 3.0%, 3.5%, and 4.1% in 2004 and 2005, and of 5.4% in the first quarter of 2006 (which can also be seen in the chart above), can hardly be described as "anemic."

If we wanted to, we could also go back and look at growth after the JFK tax cuts (which he proposed in 1962 and which were enacted in 1964, after his death), when GDP grew at quarterly rates of 10.2% (1Q1965), then another 5.5% (2Q1965), then another 8.4% (3Q1965), then another 10.0% (4Q1965) and another 10.2% on top of all of that (1Q1966)!

Is Mr. Krugman ignorant of these simple facts of economic history, or is he trying so hard to prove that "free markets" are a failure that he can't let such trivial details get in the way of his larger argument?

We propose that it is Mr. Krugman's view of freedom as a failure that is the dead idea that should have been laid to rest long ago. Perhaps the issue was not settled yet in 1968, when the seminal zombie movie Night of the Living Dead was released, and the United States and the Soviet Union were involved in a space race to prove which economic system -- one based on free enterprise or one based on central government control -- was more viable, but four decades later it is inexcusable for an economist of Krugman's stature to pretend otherwise. We all know how the race to the moon turned out, as we wrote on the anniversary of Apollo 11 last year.

The question "Do lower tax rates and other economic policies that enhance the freedom of individuals to start businesses and employ their talents as they themselves see fit promote growth or not?" has been decisively settled by history as well -- we invite readers to view previous posts on that subject such as "Why can't we all just get along (on economic policy)?", "Growth is the answer: the primacy of human creativity," and "'Reducing taxes is the best way open to us to increase revenues."

Even better, we would recommend readers listen to another Nobel laureate economist, and one who had a much better grasp of history: Milton Friedman. For starters, we have linked to some of Milt Friedman's discussions on these important subjects in previous posts such as "A failure of government, not of private enterprise," and "The healthcare black hole."

Another excellent resource is the extensive interview of the late Professor Friedman from 1999 which was recently published on Youtube here.

It is amazing that the events of the twentieth century did not settle this issue once and for all, but as long as publications such as the New York Times continue to give a platform for the dissemination of arguments against free enterprise, the intellectual fight against zombie economics must continue.

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Andy Kessler: "Spectrum Scarcity? Hardly."

Andy Kessler has an excellent article on his website entitled "Spectrum Scarcity? Hardly." We've referenced his writings previously, such as in this post. In this article, as well as in a subsequent interview on Tech Crunch, he is discussing the concept of "net neutrality" -- or, more precisely, the role of government in regulating commercial practices on the internet.

We recommend listening to Mr. Kessler's views in conjunction with our previous posts on the subject, including this one.

We also recommend Bret Swanson's commentary on the recent developments at the FCC regarding this issue, which he published in RealClearMarkets here. Along with George Gilder, Bret Swanson is the author of "Unleashing the 'Exaflood,'" an important article we have referenced before and which we discussed here.

It is clear to Mr. Kessler (and to us) that the bandwidth paradigm shift currently underway is the most important economic development impacting businesses and future innovation today and for the coming decade. We also agree wholeheartedly with his arguments that government must not stifle competition and innovation in this critical field (and with his argument that incumbents typically lobby hard for legislators to preserve the status quo at the expense of potential newcomers).

However, we are also encouraged that recent developments, while not perfect, appear to reduce the chances for some of the most onerous initiatives proposed by those in favor of increased government regulation. We'll take that as a mild positive, while continuing to agree with Mr. Kessler that more competition for the delivery of bandwidth would be even better.

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