Friday Five

1. Yesterday I wrote about the positive aspects of the Chinese revaluation of the Yuan, today let me highlight the bad side of the deal for US investors.

The Chinese have a massive current account surplus, they had a peg to the dollar so they used to buy massive amounts of US Treasury bonds, this depressed interest rates in the US and allowed debt ridden US consumers to borrow more and buy more at cheap interest rates. A lot of these US consumers buy based on the monthly payment the debt requires, as the interest rate goes down, so does the payment allowing the balance of the debt consumers can handle to grow. Consumers took this extra debt and bought the asset they though would always go up: real estate.

If the Chinese don't buy US debt, interest rates have to go up to entice investors to buy the debt, if this happens real estate becomes less affordable to consumers, putting pressure on real estate prices. In short, the revaluation of the Yuan could be the catalyst that moves interest rates up and real estate prices down.

2. Yesterday UPS reported earnings up 21% from last year, Union Pacific's earnings were up 47%. Both were based in part on higher shipping volume. Strong evidence the economy continues to grow.

3. At all levels of government tax receipts are up surprising government officials and improving the budget picture.

This reminds us of two things: governments generally don't understand business (in part because many of the people in government have never worked in a business) and that most taxes are paid by rich people.

Tax receipts from payroll withholdings have been stable, it is higher quarterly filings (generally filed by the richest American) that have driven increased tax receipts higher at the federal level. It is the growth of the economy, stimulated by lower tax rates, that have increased tax receipts.

4. Most people now consider the Kansas education funding "crisis" over. However the real crisis is the fact that, like their counterparts in other states, Kansas students have a rather dismal academic record when compared to their counterparts in other nations, especially Asian nations.

Now is the time for legislators, and leaders who care about quality of the education our children receive to lead a meaningful debate about how to improve education. Unfortunately the issue is often reduced to a funding debate, when the real problem is much more.

I will be happy to publish a guest column or details of any plan anyone wants to put forward.

5. In an attempt to morph into a party of "values" Democrat Senator Hillary Clinton will be investigating sex scenes in Take-Two Interactive's Rock Star Games' Grand Theft Auto: San Andreas. This officially makes Hillary Clinton the biggest sucker since Tipper Gore.

GTASA has been on the market for about a year, sold more than 5 million copies and has recently seen sales falling. If you ran a video game publisher that made a living publishing edgy games, how would you stimulate sales? Leak a surprise modifcation? Get a New York Senator in a fit? Get every mom in America wound up about it? Make your game must have, adult only, forbidden fruit for every 12 year old with a PlayStation? Yeah, you would consider that plan, and it would work.


Timothy Burger
timothyb {at} timothyburger.com

China Revalues Yuan

This morning the Chinese government announced that they would no longer peg their currency, the Yuan, to the US dollar. Instead the Chinese will peg the Yuan to a basket of currencies, allowing the value of the Yuan to fluctuate in relation to other currencies.

This is a good move. Moving away from a fixed exchange rate allows the market to price the Chinese currency. This removes an artificial barrier and no longer requires the Chinese to intervene in currency markets to preserve an artificially low value for their currency, although they may still choose to like the Japanese do.

The Yuan will no doubt appreciate in relation to the dollar, which is the news US investors in China have been waiting for. The appreciation of the Yuan increases the value of any Chinese holdings in dollar terms.

However, the revaluation is not the cure all that US manufacturers think it is. If you listen to a number of protectionist Democrats, Chuck Schumer for one, you would think that the drop in US manufacturing employment is solely based on Chinese currency prices. Unfortunately the causes of the changes in the US economy are much deeper.

Chinese workers earn something like $2 per hour (in purchasing parity terms) while US workers on average earn a little under $20 per hour, while US workers are much more productive than their Chinese counterparts, but they are also about ten times as expensive. So far it appears that the Yuan will not have a huge initial move since it is now pegged to a basket of currency, not just the dollar. However, even a 10 or 20% move would not fundamentally change the balance between Chinese and US workers.

Other Thoughts

AMGN reported huge earnings numbers two days ago. If you would have bought the biotech giant a month ago, it would be up 30 some percent now.

PFE reported yesterday. Everybody thinks big pharma is dead, pipelines look weak, biotech seems to be the next big thing. While pipeline and patent expiration issues are real, the biotech vs. pharma rivalry is not. Biotech may be the wave of the future, but big pharma still has tens of thousands of scientists doing billions and billions of dollars of research. I need to revise some work I did this spring, but it seems like the market is pricing some of these stocks like they will never have another big drug discovery, a potential opportunity for patient investors.

Timothy Burger
timothyb {at} timothyburger.com

Follow the Money

Our friends at Fire Dennis Moore have a Dennis Moore fundraising update today. As you might expect, Moore has a huge lead on any Republican opposition right now. Moore will be a tough opponent to beat in 2006 after a convincing win in 2004.

Timothy Burger

Dean, Lance, Dick

--In a surprise announcement this afternoon, State Representative Dean Newton
announced that he is resigning from the State Legislature. From my
perspective Newton was one of the few true "moderate" Republicans. In a
party often torn between vocal minorities on the religious right, and equally
vocal (and even more minor) pro-choice Republicans, Dean Newton seemed to be the
moderate middle ground. Fiscally conservative, socially a reasonable human
being, and in person charming, Newton was what a Republican legislator should
be.

Dean Newton will be stepping down to spend more time with his family, this makes a lot of sense with young children at home.

If we needed a reason to get the party all stirred up again, we have just found it. By this afternoon there were reportedly already cerebral people already staking out a position in the 21st legislative district.

--In other news, Lance Armstrong is holding onto the lead in the Tour de France. Armstrong is an inspiration to all cancer patients and survivors. It is a testament to the scientists and doctors, as well as the determined patients who have made cancer a disease that can be overcome, a disease that can be beaten, and then a disease whose conquest can be motivation for a more powerful life after cancer.

Good Luck Lance, we are all cheering for you.

--In financial news, I just finished an analysis of Dick's Sporting Goods. I will publish a full report later, but here is the quick and dirty. Dick's is a nice regional retailer, with a great regional going national story. Currently the company has 236 stores, and plans to grow its store base by 15% per year.

The company trades at a P/E around 38, more than a little rich compared to other retailers. Dick's doesn't seem to manage inventory as well as some other retailers, but generally seems to match up pretty well with the retail industry.

The growth story is attractive until you really start to run the numbers. Taking into account the capital expenditures Dick's expansion plans will require, the stock would seem fairly valued at about $25 per share. The stock currently trades at $38 per share, substantially over valued.

However, there doesn't seem to be a clear catalyst to bring down the share price. The company will continue to grow it's store base, and Dick's has some vocal fans in the media. Stay away from the short, but don't add this one to your portfolio either.

Timothy Burger

timothyb {at} timothyburger.com

"America's Rotten Public Schools"

An except from today's Economist:

"America fixed its class problem in the Gilded Age by becoming more meritocratic: money was poured into education, and ladders were created for young bright children to ease past the robber barons' doltish offspring. America's “problem” nowadays—and it is really a triumph—is that this meritocracy is working almost too well. Put crudely, educated people are marrying each other and pouring money into their children's education to make sure they go to the same universities. That helps explain why American universities are so much better than their peers; but only one in 30 students at the most selective ones come from the poorest quarter of households.

A new deal for schools

So the challenge is different. But the solution once again is to be found in the education system—particularly America's rotten public schools. Republicans are, generally speaking, reluctant to spend more money—partly because they represent people in richer school districts and partly because so much cash has already been wasted (America spends much more than other countries). Meanwhile Democrats, enslaved to the teachers' unions, are generally unwilling to countenance reforms such as school vouchers and testing; and they are also keener on affirmative action, the system of race-based preferences which makes universities less competitive and keeps the poison of race in a debate which is best focused on income.

This is depressing. But a political solution of sorts is going begging. Republicans should be willing to spend more cash on schools in poor areas (including on teachers' salaries) in exchange for the Democrats accepting structural reform. The No Child Left Behind Act, which introduced some forms of testing and the daring possibility of shutting down some bad schools, was an important step forward. But more is needed. Otherwise two Americas really will start to jump out off the map."

Interesting how different a perspective you get from a non-US source on this one. The solution seems clear, develop a system that works and then give it the money to function, not one without the other.

As a side note: I am half way through Ron Chernow's excellent book, The House of Morgan. One of the most striking things about JP Morgan in the early to mid 20th century was the decision to generally hire men based on merit, not based on connections. While there was certainly some nepotism at the bank, in general men were hired and promoted based on intelligence and education, not on the business their family ties could bring the bank Undoubtedly, one of the factors behind Morgan's success.

Timothy Burger