Sensical Gibberish

France is in trouble

2011-10-27T07:36:00.005-04:00

Rumors are swirling that China will be a major part of the Eurozone rescue by buying the debt of many of the troubled countries through the EFSF entity. Below is my understanding of such a move. It is clear the leaders pushing for funding by the BRIC countries are desperate. This leads me to believe that the country most in trouble is actually France with its President, Nicolas Sarkozy the main proponent of such an idea. From what I understand, it is actually France, with its high fiscal deficits and reliance on exports that could be most hurt by securing funding from China.

If the funding does take place not directly into the EFSF, but through an IMF led program, I am not sure how this will affect EU trade balances and capital flows. I hope to dig more into this as the information is released.

Global Warming

2011-09-27T11:48:00.003-04:00

I'm sure most of you have heard of global warming, but I propose a new type of warming. This warming takes place in the the ring of currency intervention that has caught fire around the globe. Whether countries are seeking to promote strength or weakness in their local currencies, the ring is heating up. Brazil, Swiss, Japan, and Poland have now all intervened in some way over the last 90 days.

My two questions are who is next and what are the implications as more and currencies go this route. My guess is that all this intervention will not lead to the stability in which officials are hoping...

Where are we?

2011-09-14T07:32:00.016-04:00

A book that I recently re-read (The Great Wave: Price Revolutions and the Rhythm of History by David Hackett Fischer). Fischer goes through history to determine commonalities in all price movements. Whether you know it or not, your everyday life is dominated by prices: the price of gas, food, soda, milk, public transport, and stocks.

Yesterday the US Census published its 2010 report. The report showcased something very clear: real wages (those adjusted for inflation) have contracted for 11 years at a total of 7% (SEE BELOW). Oddly enough, a marker of all price revolutions has included negative real wage growth. In addition, food and fuel has led the upward price movement. There are many other indications that confirm where we are in price stages. We have many of the markers of a stage 3 or 4: population growth in the developing world, money supply expansion, class inequality, real wage deflation, and the recognition phase that the price move is secular. At the same time we have some odd differences: social unrest in many parts of the world which would suggest a crisis phase and very low interest rates reminiscent of equilibrium times.

Over time price waves have changed in complexity due to technology and other factors, but its seems like one thing is clear, we are in fact in the midst of a price revolution. Daily news flow may suggest otherwise, but that is just noise. Focus on the bigger picture.

Volatility Selling

2011-09-09T12:09:00.002-04:00

The Swiss national Bank (SNB) recently announced it will seek defend the 1.20 level in the EURCHF to stem the strength of its currency by buying unlimited quantities. Upon further information, it seems has though they are selling options volatility as a means to defend that significant level. A central bank engaging in option vol selling sounds like a disaster to me. The question I have is what will happen when the plan backfires or they run out of bullets? Seems like to me that a BRIC country running surpluses and room for reserve growth will come to the rescue. The price; high. I bet it will be in the form of the SNB's 1,041 tons of gold as the continued wealth transfer to the eastern economies from the western accelerates.

This is not 2008...

2011-08-14T19:41:00.012-04:00

...it's a potential continuation of the events started in 2008 as the system continues to be sick and is seizing up again. Maybe the resolution is closer than we all think. With that said, some questions I am asking myself as we inch closer to fall:

1. Has the U.S entered a new recession?

a. Did oil over $115 or gas over $4.00/gallon get us there?

b. Was it the sovereign crisis in Europe that pushed us over the edge?

2. What effects will the "proposed" austerity in the U.S. have on global growth?

a. After a brief respite, has Washington D.C swung back to the epicenter of the crisis?

3. How much will recessions in the U.S and Eurozone effect demand for Chinese goods and in-turn Chinese accumulation for global assets (namely USD and UST's)?

4. If we have indeed entered a new recession or on the verge of one, can the U.S afford it?

a. Running approximate budget deficits of 8% of GDP (down from 11% in 2008) can the U.S step up and pump fiscal stimulus for the 3rd time in 12-years?

b. What happens if they can't?

I maybe early on this trade, but I think the gold/bond futures is the chart that will give us clues on the level stress in the system:

Cultural Trends

2011-06-11T11:05:00.002-04:00

In 2007, Tishman Speyer bought New York City's iconic Stuyvesant town for an ungodly price of $5.4B. Their plan was to take the former MetLife buildings built for returning servicemen from WW2, revamp them, and turn the residences into luxury condos.

Four years and a handful of heavyweight investors (Bill Ackman, etc) later, Stuytown remains the same grounds it has been for years. What these high-powered investors with the deepest pockets did not realize was that they were fighting one of the strongest cultural trends I have ever seen: New York City frugality.

From an investment perspective, fighting cultural trends must be considered. These trends can shift over time, but they are like the titanic heading towards an iceberg, they take time to turn. I don't know how Stuytown plays out, but I can guess 10 years from now, it will look very similar as it does today.

I enjoy thinking about the cultural implications of any situation. Whether it is geographic, demographic, or psychographic they all must be considered, especially when investing in new ideas and trends. I am keeping my eyes open for new cultural trends and will write as I see them.

Picture: Original 1947 Stuyvesant Town

Live Music's Turn

2011-05-30T16:18:00.006-04:00

I came across a new live music venue yesterday. It is the size of a living room, has the acoustics of Carnegie Hall, and can be seen by million of viewers (if not more). This location, TRI Studios, has been debuted by Bob Weir from The Greatful Dead. I've been told by a family member that there are more studio's like TRI around and there will be to come, but either way, the model has serious potential.

Traditional live concerts with finite seating capacity and old cost structures rely on cheap energy that allow consumers to travel long distances to see their favorite performer or group. Now, for a fraction of the price, music patrons can watch these live events from the comfort of their own home or office. Home audio and visual technology creates an even better experience. Listening to music on a computer or TV with HDTV or 3-D technology makes the whole live feed concert equation viable.

From an investors point of view, TRI has unlimited operating leverage built into its model. It seems as though the costs involved with putting on the show (booking the talent, operating the location, studio rental, data feed, etc.) will be incurred whether there is one subscriber or ten-million. Those are the kind of business models and numbers we like: each additional dollar in revenue is extremely high margin. Think about it, as the studio operator, how does 5 million $5 tickets sound vs. 20,000 $80 tickets? This setup means money will flow into the sector, most likely from big media starving for growth.

Everyone I talk to says live concerts will never go away, people want to experience the music and the atmosphere. Those people are probably right. Still, I think these live studio concert feeds have a chance of being a major disruptor. It hits on a few key macro themes: high energy prices, proliferation of high quality (cheap) home entertainment, and the growth of online video consumption. In 5 years will we see some of the worlds biggest acts going this route?

The Individual Producer

2010-12-27T16:03:00.038-05:00

Welcome back to Sensical Gibberish. I'm back with more gibberish and hope to post once a month going forward. To follow-up on my last post on the once quaint tradition of doling out gold Rolex's upon retirement, I'd like to develop the thought a little deeper: The Individual Producer.

Advances in technology along with the myriad of issues facing today's labor force are allowing (forcing) individuals to become productive. Quick example -- at one point in time if a journalist wanted to get their voice heard it entailed looking for a job at major newspaper and using that outlet to disseminate their work. Now, that same journalist can start blogging in a matter of minutes, distribute using social mediums, and generate income using advertising and subscriptions.

The theme: forget the days when individuals had to rely on large entities with deep pockets and technological know-how as portals to reach and acquire customers. The return to production is something I have been thinking about for a long time. Today someone passed this article on to me: How E-Books Are Changing the Economics of Writing. It demonstrates how technology is providing individuals amazing tools to harness their abilities.

The article quote from J. A. Konrath caught my attention:

"I have an acquaintance who is a New York Times bestseller," he notes. "She got a great advance. But I'm on track to earn $200,000 this year on e-books alone, and the e-book market is still in its infancy. If she'd kept the rights and self-published her e-book, I bet she would have earned more money in three years on her own than she will with her publisher."

There you have it. Technology is making it attractive for individuals to move away from big firm dependence and give it a shot on their own. As the article points out, there are some hurdles that face all individual producers (in this case self-published e-book authors) such as marketing and distribution to name a couple. Of course, when aren't there problems with a new business model?

I have faith in two things. One, entrepreneurs will continue to come along and enhance the individual producer ecosystem by providing individuals the tools to market, distribute, and solve any other future hurdles (think Etsy.com as a strong ecosystem for small artists and producers). Two, technology will continue to make it easier for individual producers to create and distribute whatever they are good at. I'm talking broad spectrum; from investing advice to farming -- harnessing any act using technology. It can only get more interesting and I'm excited to see whats next.

Gold Rolex?

2010-05-08T17:31:00.005-04:00

The monthly US employment report was released yesterday (Friday May 7th) and two internals continue to catch my attention. The first, U-6 measure of unemployment. Some regard U-6 as the true rate of unemployment as it accounts for the unemployed looking for work, those working part-time that would accept at full-time position, and finally those unemployed whom are discouraged and no longer looking for work. This broad unemployment measure is stubbornly high at 17.1%, resisting to come down even though we have now seen four months of positive jobs gains. The second internal, duration of unemployment continues to suggest the long-term unemployed are not finding new jobs. The average duration in weeks rose from 31.2 in March 2010 to 33.0 in April 2010. Seasonally adjusted, those unemployed for 27 weeks or more is 46% of the total 15.3 million jobless Americans.

These two statistics signal that the US unemployment situation is structural by nature. By defining unemployment as a structural issue, this means who lost jobs in the financial, insurance and real estate industries are now without the proper skills or opportunities to find new work. This will keep the unemployment rate stubbornly high.

What I would like to focus on is that new trends will be born out of such a structural problem, not the problem itself. Will work be redefined in such a way that Americans will be forced to occupy multiple jobs? Maybe these jobs will target productivity as opposed to the paper shifting industries which have become so prevalent over the last 30 years. At the same time, inadvertently such a shift would, in my mind, target the psychological multitasking nature of our society.

At one point in America's corporate history, employees with a certain duration of service to one company received a gold Rolex upon retirement, now they may receive a more productive fulfilling lifestyle.

Where does all the dough go?

2010-03-25T09:51:00.006-04:00

As the US bond market struggles to find a bid, it's time to ask where does all that money go once it has fled from the risk free asset known as US Treasuries. Conventional thought would say yield chasers find their way into various other bonds (i.e safer sovereign debt or US corporates) and/or dividend yielding equities.

But, what if unconventional is the way to go? What if that income producing capital finds its way into assets that do not produce any income, assets necessary for daily life such as oil and foods? Oh, and lets not forget gold and silver.

TV's and Automobiles

2010-02-02T23:07:00.021-05:00

Post World War II a seismic shift within the American economy was taking hold. Two innovations forced this shift from what we knew as the industrial economy to a new vibrant economy based on the consumer. Televisions and automobiles made it possible for consumers (a new term at the time for the American population) to live a life of prosperity coupled with convenience.

The growth of the personal television took strength away from the manufacturers and placed the power in the hands of the Madison Avenue's of the world focusing on advertising and marketing products to consumers.

The implications of the automobile led to shifts in geography as suburbs in new parts the country became widely populated as convenient, cheap, and viable places to live. The quality of life for American's was booming unlike ever before. The television created a desire to buy goods and the automobile led to a means of transportation to buy those goods, thus the rise of malls and shopping centers.

Now it seems like the foundations of these two great innovations have peaked along with the economy they built. Cars are not as cheap as they once were and neither are the products we see on television. What future innovations and themes will spark the next growth phase in the American economy, as cars and TVs once achieved in the post WWII period?

2010 -- The Year of the Tiger

2009-12-21T11:11:00.012-05:00

According to the Chinese Zodiac, the Year of 2010 is the Year of the Tiger. I see two things occurring:

1. The correlation of equity markets and the bond market will break. When equities fall, bonds will not be bought as flight to safety trade.

2. Gold stocks will, for the first time in 9 years, trade with the metal on the upside and less so with the overall market.

Call me crazy, but I am not sure we want to see upside economic growth (relative growth vs. expectations on global basis) here in the US. Excess money floating around coupled with real demand overseas will spike the prices of the things we need and rely on (energy, food, and interest rates). Add those to the structurally high unemployment and the deficits we currently face both of which resulting in the goods we own (dollars, houses, and cars) continuing to depreciate. Not something to cheer for.

Goldmember

2009-10-27T15:09:00.008-04:00

I try to refrain from using the term "bubble" but since its so widely excepted, I decided to use it just this one time to convey my point.

Gold, contrary to popular opinion, has many uses such as jewelery, medicine, electronics, and as a form of money. Today I would like to focus on the topic of gold in its monetary form. It is hard to ignore the price action of gold over the past 9 years, rising from around $300 to over $1000 an ounce. Although the price appreciation has been steady and consistent, there are constant calls for a gold "top" or identifying it as a "bubble." I am on the other side of the aisle in that gold, in its current state is not a bubble, but in a secular bull market that has a lot of room to run.

Bull markets are very difficult to ride in their entirety because the percentage gain from start to finish is sickening, but the best method is to be part of the bull market and walk away, looking from time to time. By "walk away", I mean to the point you forget you own gold.

I do actually think gold will become a bubble or mania, but again I believe that is far off. I don't have a price in mind, but sentiment will guide me. During the technology mania peak of 1999 and 2000, respectable businesspeople were quitting their jobs to become day traders. They believed this was the future. I believe we will know when gold is in the process of topping when, again these same respectable people will quit their day jobs to be gold dealers or brokers. That will be my sign, but until then the fundamental and technical picture remains in tact. Will you become a Goldmember?

The green push

2009-10-03T18:06:00.003-04:00

As September has come and gone, news flow started to pick up in what seemed like a frantic pace in much of the “stuff” I follow. To my interest, Hong Kong called their gold back from London, Tiger Woods is now the first billionaire athlete at age 33, and Shaq is still hilarious .

Outside of news, I also have had some questions recently. Again, they touch on some of my favorite themes that I have written here many times: green technology, Asian-US relations, and the wars in the Middle East. I will start my comeback with the first, and I will try and keep things brief.

Do we actually want to become “green” or is China, along with other foreign countries pushing it upon us?

I started thinking about this question and have come up with three points. First, I am in the camp that the easy, inexpensive oil has been found. Going forward, this will continue to keep energy prices high thus making expensive, hard to find oil projects worthwhile. Also, one must consider the time lag it takes to drill deeper. With this in mind, alternative sources of energy make sense, but I have to think there is another reason outside of high-energy prices that green technologies have caught fire globally.

America is broke and the only way it can expand is raising money via debt issuance or printing dollars. As our #1 creditor, both scenarios must include China in the discussions. There is a train of thought that alternative energy is going to be the new frontier in the American economy, employing millions and carrying us forward. I have to think that China is behind this massive marketing campaign in an effort to promote its own growth as an exporter (even if exports will play a smaller role in their economy going forward). China has and continues to build out its alternative energy capabilities in batteries, wind technologies, and solar both to make its massive country more sustainable and to keep up with its expansionary boom, but also to provide the American business and consumer cheap, energy efficient products. Americans are no longer buying sneakers and extravagant electronics, but they will spend on solar panels for their roofs or wind turbines for a new source of energy.

I believe higher energy prices going forward, but more importantly China are behind the push for America to go green, and I don’t think we have a choice in the matter. China and the rest of the US creditors, ones with an interest in exporting alternative energy technologies are forcing the American government to pursue possibly the largest marketing campaign of all time.

A shout out to my editor, thank you.

Cash for what?

2009-08-02T10:14:00.008-04:00

It has been a while since my last post, due in part to summer and also that there has not been much to write about. Finally, something to write about.

Cash for Clunkers

I'm sure many of you have read about this government subsidized program that has gained media attention over the last week due to its widespread adoption, lack of funding, and eventual re-ante of extra capital. Some may think that this is a well thought out strategy that reinvigorates the American economy, but I have a few thoughts. First, a well respected person in the energy policy space brought up an interesting point, which is that the net energy gain from this strategy is not a gain at all, but in fact yields a loss. When you add in energy loss due to production variables, the average mile per gallon savings disappears. Second, with the backlash of government bailouts of financially unstable sectors using taxpayer money, the government has found a new way to handout the cash, via programs like this. In reality, the $3500-4500 off retail price is a way to hand the auto sector money in a sly, under the radar fashion.

Third, the way you cure an over- indebted consumer based economy is through debt service and savings. U.S governing bodies understand this and realize why this particular recession is "different". Yet, if the cash for clunkers program is any indication of their solution, it proves that they have no interest in actually creating a sustainable lasting recovery. Revving up the consumer to spend, and in some cases take on more debt to pay for their new automobile only provides a short-term gain. Isn't the idea to come up with solutions to cure the problems of the last 30 years- not prolong them?

In addition, if you look into the details of the program, the "clunker" must be drivable and the new car must be under $45,000. Who does this target? To me, this plan is focusing on the vulnerable middle class, the same ones who struggle to pay their mortgage and have been trying building up savings to pay down debt. Why do we want these folks to go out and spend more, taking on more debt?

Finally, the supposed goal of this plan is to save energy. I am all for saving energy, but in the proper way. Investing $3 billion and possibly more in the future to subsidize the auto sector while at the same time costing the consumer thousands of dollars is not a long term solution. A long term solution would be to take that $3 billion and focus on energy saving public transport initiatives such as rail and conversions of buses and taxis to compressed natural gas (CNG). As a side note this would also create the must needed jobs as it takes people to build out public transport. These plans would not yield immediate short- term results, but would actually accomplish what the government claims the cash for clunkers sets out to do, which is to save energy.

The new financial center v.2

2009-07-02T09:31:00.005-04:00

Here is a follow-up to my New York City post a few weeks ago, just focusing on a different city, Boston, MA. These are not my words, they are from a well known site Itulip, which is run by Eric Janszen. Eric begins by discussing the consumer psychology in a depression and continues into some examples that he is seeing.

"What impresses us most is how unimpressed many appear to be about the seriousness of this depression. They ask why many restaurants are still busy and why many malls are still busy, even if apparently the shoppers in them are buying less. Where are soup lines? Where is the high crime rate?

We remind them that we are only one year in to a multi-year process.

The average man or woman does not change his or her behavior until years after an economy has changed around them. No one likes change, even positive change but especially negative change. The tendency is to ignore change as long as possible, and hope it goes away and "normalcy" returns. Meanwhile, change goes on.

This depression is transforming the world around us. If you don't think so, I encourage you to take a closer look. On the surface much appears to be the same as two years ago, but under the surface much has changed and is changing, shifting relationships among friends, families, and colleagues. Changes in circumstances effect the range of choices people can make. They make different decisions than before. Different decisions produce different results. Those results impact someone else's decisions. Collections of decisions combine in unexpected ways. One of the most obvious is that consumers buy less. As they do, after a lag, they will find that they have less to buy.

The Great Depression is taught in American schools as a market crash on a Monday in October 1929 with soup lines forming shortly thereafter. Blurred over are years of failed trial and error policies by politicians who desperately wanted to undo the damage caused by the preceding decade of credit excess. But as time went on, the damage that started off as abstract data on output and debt and incomes began to show up unmistakably in the physiognomy of economic depression. That itself will later to have consequences, feeding back into changes in behavior.

To get a street level view of this process, I brought my camera with me on my latest bike ride into Boston from the western suburbs where I live. On the usually pristine Minuteman Bike Trail that I ride on as far as Arlington, not seen on previous trips over the past ten years are now graffiti, piles of burned trash, groups of teenagers hanging out, and police cars parked on the side of the trail. Nothing says “things are not going well at home with Mom and Dad” like graffiti on the side of a boutique grocery store.

Riding down Newbury Street, Boston’s posh shopping district, I took 15 pictures of retailers that had gone out of business, eight of them side by side. So desirable is the location that even during the 1980s recessions a single vacant Newbury Street shop was a rare sight."

I will again come back to the idea that the U.S cities that decided to base their underlying economic strength on financial and retail sectors will have a hard time regaining their dominance. Again I ask, what will be the next great financial center of the United States?

Nice problem to have, but still a good read

2009-06-22T21:56:00.002-04:00

Good article in Newsweek

Too Big To Make Sense (To Me)

2009-06-21T14:37:00.006-04:00

Talk of too big to fail has heated up recently as the Obama Administration proposes sweeping regulatory initiatives. Many believe that much of the problems in the U.S. banking sector were driven by the theory that institutions that are too big are also unable to manage risk properly. I will not argue this, but it makes sense. I have seen from a small level perspective that hedge funds that take massive positions in small, micro-cap names face issues upon liquidating that said position. That is the only first hand experience in which I can relate.

Here is an
article about too big to fail from the New York Times.

What baffles me with all this talk about too big to fail from government officials and market commentators, an interesting fact has been overlooked. The government has found a way to promote getting bigger and badder. Lets take a look at the deals in the banking sector over the last two years. JP Morgan bought Bear Stearns and Washington Mutual, Well Fargo bought Wachovia, PNC bought National City, and Bank of America bought Merrill Lynch. Somehow the largest U.S banks got larger and more difficult to manage. Sounds like "regulators" are not practicing what they preach.

Lets Make A Deal

2009-06-13T14:25:00.027-04:00

I recently was fortunate to witness a sales pitch at a local retail outfit. Located at a nearby golf course, about a half-dozen South Korean gentlemen walked into the pro-shop looking for golf clubs. After some information swapping which included club specifications and price, the men convened amongst themselves for 15 minutes and walked over to the pro-shop attendant. It was obvious that English was not their first language, but they knew one word very well- "Deal". They had come to this particular shop in search of a great deal.

The haggling went on for about an hour, during which time the Korean men were able to negotiate the price down by close to 25%. It was amazing, they knew what they wanted and knew what they were willing to pay. I have seen many people attempt to talk price with this salesman, but nothing like this. They had with them a piece of paper and pointed to it incessantly as their bargaining chip, until the pro-shop employee broke down and gave them the price they were looking for.

In my mind, this experience occurred at an opportune time. It just so happens that the U.S. faces a similar situation to that of my local golf shop. Treasury Secretary Geithner recently made a trip to China to discuss monetary policy. Asia, and more specifically China and Japan, are the top two creditors to America. They have a vested interest in the policy decisions made by our leaders. Tim Geithner went to Asia with his hat in his hand. Much like the men looking for new clubs, our Asian creditors are in search of a deal. They know America is on weak footing and without their support of the bond market; America is in a tough spot.

I have now decided what is in order regarding foreign ownership of U.S. debt. With lax policies being put into place by top officials, concessions will need to be made in order to keep the bond market functioning. I believe these two concessions will entail America parting ways with its gold reserves and the relaxing of antitrust regulations to foreign (Asian) companies. We will come to find out one day that America has depleted its gold reserves in order to keep the country going, by way of conceding gold for continued foreign debt support in a sub par growth period. In addition, Asia, particularly China, would love the opportunity to come on U.S. shores and take major stakes in companies, from the banking to resource sectors. Deals must be struck.

The golf shop experience opened by eyes to how the foreign frugality and sentiment towards deal making will drive future relations with the U.S. The two key words going forward are deal and concession. My bets are on gold and foreign M&A, let's hope Bob Barker is correct and the price IS right.

Cuff Em

2009-06-08T07:06:00.003-04:00

Friday’s slight improvement in the jobs number has found a way to quickly make a mockery of US monetary policy. The less bad headline number of -345,000 jobs lost in the month of May 2009 has prompted the expectations of the Federal Funds rate, set by the Federal Reserve Committee, to sky rocket. With short terms rates at 0% and talk of it staying that way for a long time to come from Chairman Bernanke, the FED now faces an interesting quandary. Expectations on what the FED will do during the upcoming meetings based on FED Funds Futures are as follows: 33% possibility of a 50-basis-point interest rate hike by September, a 40%-plus chance of a Sept hike and a 100% possibility by December. This after a report of a contraction of over 300k jobs!

If we think back to a similar situation where the FED was faced with this predicament, it can be last seen in the 1931-1934 period during The Great Depression. The FED saw the economic data improving and decided to raise rates prematurely. This backfired and sent the economy back into a downturn. As we all know, Ben Bernanke has dedicated his life to studying the Depression, so in my estimation, this policy action will be avoided (Fed Fund Futures are wrong in my opinion).

Leaving the question of whether we should currently be at 0% in the first place aside, this is where the FED has to make some decisions. Do they want to disappoint the American people and send us back into a depression they worked so hard to avoid, or will they continue to inflate the economy through low interest rates and liquidity programs? Inflation vs. Deflation, we have seen that the FED has chosen inflation, why will it change?

Now, the interesting part. The elephant in the room is foreign ownership of US Treasuries and T-Bills. Because the FED policy thus far has been one of ZIRP (Zero Interest Rate Policy) everyone and their mother has shortened duration in the treasuries they hold. For example, if I owned 10-year treasuries, I have decided to swap those in for 2–years as we know they are “safe” and tied to short term rates by the FED, who has told us time and time again they are on hold for “an extended period of time.”

So, two roads. Fed Funds Futures market is correct, and the FED decides to raise rates by the September 2009 meeting. OR, they stay on hold as implied by the last eight months of statements. Some believe the FED does not control the short end, the market does, which is quite possibility true. Either way, raising rates will cause a catastrophe in the short end of the curve due to enormous over crowding and will send us back on depression watch. Due to FED policy, banks have had the opportunity to make obscene profits from the record steep yield curve; this will go away. If they stay on hold, long-term rates will continue to climb, but this time at faster speeds thus squashing any housing recovery due to exploding mortgage rates. In addition, by upsetting what the market wants will create a dollar debacle, something our creditors have been staunch opponents of as they hold immense dollar assets.

Either way, their hands are tied.

The new financial center?

2009-06-04T11:42:00.003-04:00

In the 1700's New York City gained prominence as THE financial center of America. It established itself as a major trading port due to the Hudson River availability and for a brief time was the capitol of the US. As time went on, it grew in importance as a financial, cultural, fashion and entertainment mecca. In the financial realm, it is best known for Wall Street. Wall Street has been a key driver for the local economy in Manhattan fueling real estate, retail, fine dining, and nightlife. I believe this is changing. Manhattan will always be a cultural and entertainment hotbed, but the demise of finance will bear great strains on the city. You can see it walking around the streets. New Yorkers don't march up and down 5th Ave. shopping, it's foreign buyers here on vacation. Much of the real estate boom in New York was driven by lofty bonuses and a foreign buyer. What happens to a city that is reliant on one industry, a city that is not self sustaining?

The real question is what will be the next great financial center of the United States?

GM vs. Wall Street

2009-06-01T11:09:00.002-04:00

The news stories you read regarding General Motors and Wall Street proclaim hedge funds are evil for demanding liquidation. The are viewed as un-American for pushing GM into bankruptcy, all to profit for themselves and their investors. This story may be all well and good, but I think the real GM vs. Wall St. story is being missed here. Here is how I see it. GM, the ultimate blue-collar American business is forced to fess up to its own fate as an insolvent, unprofitable company that made mistakes in its business strategy. Much like failures before it, GM goes belly-up, attempts to solve its problems then re-emerges. This is the evolution of business that we have come to expect in free market America. Now keep this in mind and think about what is going on with our financial sector. Persistent handouts to financial firms such as AIG, Bear Stearns, and the rest of Wall St. sounds more un-American then anything. The government has decided financial firms, disregard the systematic risk element which we really have no idea if its true or not, and their rich employee's are more important than the common man working at GM in Detroit. Weird dynamic if you ask me, I would like to know who is running the show in DC because doesn't seem like the pro-blue collar democratic party. Seems like a continuation of the previous eight years.

The rebuild

2009-05-17T10:20:00.011-04:00

Quick quote from Peter Schiff. He mentions a point I discussed in my output gap post. An economy based on finance, insurance, and real estate must be transformed into a production based economy, where paper pushing industries are not the drivers of domestic growth.

"In America we need to figure out how to convert all of our malls and shopping centers into factories. We have to figure out how to make stuff for ourselves, now that we cannot import it from everyone else. We must also rebuild our savings because the rest of the world will not be providing us with their savings... fundamentally our economy is flawed, the worlds economy is not flawed."

The U.S. has long been thought of as the preeminent economic power. Therefore, during a time of crisis it has been a store of value. But what happens if this store of value status disappears?

The rebuild

I think to return to this preeminence, we must focus inward and build an economy that actually produces "stuff". Weaning off the FIRE economy will be a long and painful road, but the sooner people realize that former drivers such as finance and real estate need to take a back seat to goods-producing industries, the quicker the pain will end. America has the most innovative, educated, and driven population in the world, but none of this matters if our governing bodies and general population cannot get their hands around the real problem at hand, which is that our economy must be revamped.

This is why I am so opposed to persistent handouts from the U.S. government to the former economic leaders. Trillions of dollars (some of which is/was necessary) have been thrown at financial, insurance, and real estate firms to quell their past and future mistakes, but this is not the answer. In a free market economy, businesses are meant to fail due to strategic mistakes. Then, the competition and innovation picks up the slack and the surviving firms will be stronger and rewarded for their ability to avoid making those same mistakes. Employment shifts from these once high flying sectors to the new growth arenas. This has been the evolution of business for thousands of years, and it must continue.

The old way of thinking, the thinking that we are invincible and former economic leading sectors will drive future success must be abandoned. We need to rebuild and re-organize from the ground up.

The Truth

2009-05-14T10:59:00.003-04:00

Being from Boston, the truth holds a near and dear place in my heart. For those of you who are not in tune with Boston sports or basketball in general, Paul Pierce's nickname is the truth. Shaquille O'Neal gave him the nickname after a Lakers' victory over the Celtics in 2001, Shaq pulled a Boston reporter over and gestured toward his notepad. "Take this down," said O'Neal. "My name is Shaquille O'Neal and Paul Pierce is the truth. Quote me on that and don't take nothing out. I knew he could play, but I didn't know he could play like this. Paul Pierce is the truth."

Speaking of the truth here are two links that speak volumes on what is going on. Here is an article from the UK Telegraph discussing the TARP sham.

US 'sham' bank bail-outs enrich speculators

Also, here is another link from a prominent blogger detailing the pressure the government put on banks last fall.

FOIA disclosure busts Paulson, Geither and Bair

I am not sure the government is doing the right or wrong things here, but I will tell you something, the US is the largest economic and military power in the world and this news does not paint us in a good light. With 60-70% of our debt being owned by foreigners, this kind of news is disastrous. To me, creditors to this entity should be very concerned. Hearing this kind of scandal and upfront lying by your debtors would make me question whether to lend to this institution at all.

Deflation? What deflation?

2009-05-11T09:26:00.002-04:00

The US government raises stamp prices by $.02. Doesn't sound like price deflation to me...

Quick follow up

2009-05-10T13:38:00.000-04:00

Based on a comment from my last post I decided to write a quick follow up.

I think they key to take away from the below post is that we never had deflation nor will we have it. Since going off the gold standard in the 1920’s and closing the gold window in the 70's, governments can "create" money as they please. The government and media will force deflation down your throat by telling the public that the US is in a deflationary spiral not seen since the 1930's.

Since you cannot trust economic indicators, we have to use the real time indicators, asset prices. I look at grains, metals, and energy. The last recession in 2001-2003 was a mini downturn from the tech bubble, nothing entirely serious like the banking crisis of 2008. Since 2001 (the ho-hum small downturn) my inflation/deflation indicators are:

Corn - 2001 price -$2.00. Current price -- $4.25
Oil - 2001 price $20. Current price -- $58
Platinum - 2001 price $450. Current price -- $1200
Copper – 2001 price $98. Current price -- $220

None of this tells me we have price deflation, does it? Comments are welcome...

Prepare for a wild ride

2009-05-09T20:07:00.015-04:00

Peter Schiff is often times very emotional and likes to "pound the table" on his ideas. Below is a passage from his blog and I think it is a timely article. In addition, I have posted a chart below that describes what exactly he means by loss of purchasing power because of inflation. As the stock market rallies, citizens of that country feel better about the economy as economic data is stabilizing, but inflation adjusted stock market returns are in fact negative. Their cost of living is skyrocketing due to price inflation in consumable goods like food and energy.

Don’t Be Fooled by Inflation By Peter Schiff

"Strike up the band, boys, happy days are here again! Recently released short-term economic data, including unemployment claims, non-farm payrolls, home sales, and business spending, which had been so unambiguously horrific in February and March, are now just garden-variety awful. With the Wicked Witch of Depression now apparently crushed under the house of Obamanomics, the Munchkins of Wall Street have sounded the all clear, pushing the Dow Jones up 25% from its lows. But the premature conclusion of their Lollipop Guild economists, that the crash of 2008/2009 is now a fading memory, is just as delusional as their failure to see it coming in the first place.

Once again, the facts do not support the euphoria. Over the past few months, the government has literally blasted the economy with trillions of new dollars conjured from the ether. The fact that this “stimulus” has blown some air back into our deflating consumer-based bubble economy, and given a boost to an oversold stock market, is hardly evidence that the problems have been solved. It is simply an illusion, and not a very good one at that. By throwing money at the problem, all the government is creating is inflation. Although this can often look like growth, it is no more capable of creating wealth than a hall of mirrors is capable of creating people.

We are currently suffering from an overdose of past stimulus. A larger dose now will only worsen the condition. The Greenspan/Bush stimulus of 2001 prevented a much needed recession and bought us seven years of artificial growth. The multi-trillion dollar tab for that episode of federally-engineered economic bullet-dodging came due in 2008. The 2001 stimulus had kicked off a debt-fueled consumption binge that resulted in economic weakness, not strength. So now, even though the recent stimulus administered a much larger dose, we will likely experience a much smaller bounce. One can only speculate as to how much time this stimulus will buy and what it will cost when the bill arrives.

My guess is that, at most, the Bernanke/Obama stimulus will buy two years before the hangover sets in. However, since this dose is so massive, the comedown will be equally horrific. My fear is that when the drug wears off, we will reach for that monetary syringe one last time. At that point, the dosage may be lethal, and the economy will die of hyperinflation.

As always, the bulls fail to understand that investors can lose wealth even as nominal stock prices rise. As a corollary, the bearish case is not discredited by rising stock prices. While there are some bears that mistakenly cling to the idea that deflation will cause the dollar to rise, those of us in the inflation camp understand that the opposite will occur.

In the meantime, stocks are not rising because the long-term fundamentals of our economy are improving. If anything, the rise in global stock prices is due to investors realizing that cash is even riskier then stocks. The massive inflation that is the source of the stimulus is essentially punishment for those holding cash. To preserve purchasing power, investors must seek alternative stores of value, such as common stock.

It is important to point out that despite an impressive rally, U.S. stocks have substantially underperformed foreign stocks. In the past two months, while the Dow Jones has risen 30%, the Hang Seng and the German DAX have risen by over 50% in U.S. dollars. Commodity prices are also rising, with oil hitting a five-month high. And gold is shining as well, with the HUI index of gold stocks up 30% during the past two months, and 2/3 of those gains occurring in the past month. If this rally really were about improving economic fundamentals, gold stocks would not be among the leaders. Further, during those two months, the U.S. dollar index fell by 7%, with commodity-sensitive currencies such as the Australian and New Zealand dollars surging 20%.

To me, the relative strength of foreign stocks and currencies indicates that perhaps the global economy is not as impaired as many have feared. It has been my view all along that after the initial shock wears off, the world will be better off – once it no longer subsidizes the American economy. The shrinking U.S. current account deficit is evidence of this trend in action. Renewed strength in foreign stocks and weakness in the dollar may indicate that not only is the world decoupling from the U.S., but benefitting as a result.

So let the Munchkins dance for now. But remember, the Witch is not dead; only temporarily stunned by an avalanche of fake money."
--------------------------------------------------------------------------------------------------

The circled region on the chart is exactly what Peter is referencing. The last period of nasty inflation in the US came in the 1970's. We made lows in 1974, as shown by point 1 on the chart. In unadjusted inflationary terms, that was THE low of the bear market. We rallied to point 2 and then stagflation kicked in. Not until 1982 was THE low was seen (inflation adjusted terms) with Paul Volcker taking a stand and fighting inflation with raising rates, as seen by point 3.

I happen to think the environment seen in 1970-1982 is very similar to the current situation. We can and may continue to rally in equities, but this will not account for the decrease in Americans' standard of living. I happen to believe that the 1970's will make this trip around look like a joyride. In today's market we have a far more vulnerable consumer and the wild card is OIL. Some may argue this point, but I am in the camp that the easy oil has been depleted. Since world oil production may have peaked in 2008, we face a far more dire environment that raising rates may not cure; the diminishing of the world most crucial resource. These are fragile times making this run around far more scary. Get ready for a wild ride.

Worth its weight in gold

2009-05-05T23:31:00.002-04:00

Everyone loves to hate gold. Dennis Gartman, author of the widely followed Gartman Letter, often claims he “hates himself when he is long gold.”

With this in mind, what’s going on in the gold market the last two days? It has become extremely volatile with persistent spikes pre-pit opening (COMEX pit opens at 8:20am). This leads me to believe that there is a buyer- a very large buyer. The only problem is that the buyer spikes the market around 7:30am and then disappears. My estimation is that this action can be attributed to foreign buying. Some of these potential buyers could be China, which reported two weeks ago that it added 66% to its gold reserves in the last 5 years. India has also been a long standing buyer in the form of jewelry. Finally, Russia and various other central banks or institutions could be potential buyers as well.

Therefore, once these buyers walk away (or their local markets close) and the volume dries up, the upward momentum is met with sellers. These are large sellers, especially seen by today’s $15 reversal. I believe these sellers to be of the domestic variety in the form of the US government, the IMF, and other entities that have been convinced to weigh on gold prices for whatever reason. We know the IMF is being summoned to sell its gold to pay for its aid to weaker emerging market countries, but the real question is why the US would actively want to depress the gold market. I have some ideas which may seem radical to some.

First, the US wants to keep the dollar strong. Therefore, foreign holders will not panic out of US debt, forcing long term interest rates to skyrocket and further slowing down economic recovery. Second, gold is an inflationary barometer. The FED wants the global markets to believe that inflation is anchored and making their money supply expansion actions warranted. Finally, gold is a gauge of crisis and in this case, a bank crisis. The governing bodies desperately seek to prove the bank insolvency concerns are over, so they cap gold prices.

These theories may be entirely off base. However, IF the U.S government is actually depleting its gold reserves for short term price action in order to justify policy and keep foreign flows in the country, I am scared. They should know better than to intervene in the free markets as shown by the results of the disastrous bank short ban of 2008 and soon- to- be- mess of a US treasury market.

One caveat to this is that I am very bullish of gold, which I believe to be the only current bull market. I will leave you with one thought- no matter how much one wants to interrupt a price move short term, I happen to believe that true price discovery will win out in the end.

I would also like to point out a news story that hasn’t gotten much play since it broke the night of Sunday, May 3rd. Wealthy Asia, Japan, China, and South Korea (JCSK) is offering up aid to emerging market Asia, much like the IMF would normally provide to the emerging world. In my opinion, the aid will be used to drum up demand in emerging Asia for JCSK’s goods now that the US consumption is falling off a cliff. Also, it continues to show that foreigners are weaning off the US dollars as fast as they can due to the devaluing policies implemented by the FED. Therefore, this is all very bullish for gold. But only time will tell.

Calm before the storm

2009-05-02T10:45:00.029-04:00

So I have discussed Sudden Stop in previous posts, but essentially it is an abrupt halt in flows of capital by foreigners into a country that tips the balance of payments into the negative, in theory eliminating the ability for a country to fund its operations beyond old faithful, the printing press. It has been most commonly seen in emerging market economies of South America, and various other cases in Asia and Europe. But never has it occurred in a developed economy such as the US. It is hard to visualize, but here are three charts showing what sudden stop looks like. The first is foreign flows of agency debt (Fannie Mae, Freddie Mac bonds for example), which until 2007 was heavily invested by foreigners. These investors, mostly central banks were made to believe these bonds were safe, though not officially guaranteed by the U.S. government like Treasuries. The rise in demand for these bonds was due in part to yield chasers; entities/people that wanted a superior yield return over U.S. Treasuries.

As you can see, the light grey line, shows what sudden stop looks like. When the sudden stop of flows begin, it is unnoticeable, feeling like an orderly drop in demand, but that catches fire and becomes an all out collapse, ending in pure outflows of capital. The result of the agency debt market collapse is, as we know, FannieMae and FreddieMac becoming full faith US govt guaranteed entities. They have entered receivership and their bonds are still being bought hand over fist with newly printed money by the Federal Reserve in an attempt to re-start the market, economy, and faith of foreign investors. Also, in this chart you can see as the light grey line collapses, the dark grey line, Treasuries, is the beneficiary of the flows. These holders don't necessary want to be in any form of US assets, but US Treasury market is the largest and most liquid market in the world, making it an easy swap into or out of at the right time.

Now this brings us to our current state of affairs. A similar setup of the agency market collapse of 2007 is playing out in the US Treasury market as we speak. Currently, 60-70% of our bonds are owned by foreigners, either through trade imbalances or pure play investments. They have funded our operations for years, paying for our wars, updating our infrastructure, and so forth. In return we consume their goods and provide a liquid and stable market. As trade imbalances crash across the world and Treasuries become less liquid and more volatile everyday, what good are we to these foreign holders?

There have been rumblings amongst some market participants that the US Treasury market could face a sudden stop scenario as aggressive FED policies create rampant inflation down the road, foreign nations need their capital back to improve domestic economies, and the viability of the US to be able to honor these debts in the future. It is impossible to know when or IF foreigners withdraw funds in the real time, all we can use is price action of the underlying asset (US Treasuries) and lagging TIC data, released monthly. Another real time clue could be FED actions. Watching the activity levels of treasury buybacks could provide insight into foreign flows, as the FED tries to get ahead of the problem with printed money ($300 billion in buybacks so far). Either way, whether the FED is there to provide a bid for these sellers to plug the system or not, the collapse in the agency market will seem like a cakewalk compared to the possible situation that lies ahead in treasuries. Treasury yield levels are the glue that holds our economy together. Housing via refinancing and new mortgage loans, business and consumer credit, and so forth are all based off of the long end of the treasury market. With high yields and a slow moving economy, it could be a dangerous storm.

So, who will fund our huge deficit and massive spending over the next few years? Who will buy the huge treasury issuance set for 2009 (calendar year 2009 we will see the biggest funding effort in America's history)? One possible saving grace as foreigner flock out of US debt is a pick up in domestic demand to offset the potential outflows. Based on the current uptick in US savings rates (reaching decade highs of 4.2%), some may argue this is possible. I happen to believe that Americans are more well informed about the potential risks with treasuries, and in reality the asset class is not providing much of an attractive yield with rates so low. So in my mind, the slack left behind by foreigners will not be able to soaked up by the American consumer in its dire financial position.

What happens if yields skyrocket because of sudden stop? Who will be there to pickup the pieces if sudden stop does occur? Unlike FannieMae and FreddieMac, who will put the US government into receivership? Printing money is not the answer, it only creates more problems down the road. Its like drinking more after a hangover, it helps the short term headache, but you still feel twice as bad when you wake up the next morning. Maybe the problems built up over the last 15 years are coming to an inflection point and nothing can be done to stop them, the best anyone can do is prepare, as laid out in my previous All major credit cards accepted post:

"Most Americans think of savings as cash that sits in a bank account or CD/money market account bearing some rate of interest. I think this conventional definition must change. In my mind, cash must be diversified into a basket of goods and currencies*. Everyone must do their own research, but I like resources such as oil, grains (food), gold, silver, and currencies of resource rich nations as well as some dollars (since you must be able to function day-to-day).*

I hope this provides some insight what MAY lay ahead. It is hard to fathom that America can be in such a predicament as we still are the preeminent economic and military power, but watching the financial events over the last three years has taught me to never rule out any outcome.

Here are two more charts below of forms of US sudden stop. Flows of equities and corporate bonds by foreign investors resulting, as we know, in the collapse of US equity/corporate bond markets over the last year and a half .

* Charts provided by Brad Setser at http://blogs.cfr.org/setser/. Great site check it out.
*I don't like to offer up specific investment advice here, again you must take everything I say with a grain of salt and keep in mind I know nothing about everything.

Update on China

2009-05-01T09:08:00.002-04:00

China has long been a nation of closed gates and financial secrecy. Here are some recent stories from China that tell me they are opening up as a financial hub with the former powers (UK and US) on the decline.

1) As of yesterday, on a trial basis, foreign companies will be allowed to list on the Shanghai Exchange. Here is a link describing the developments.

http://www.china-briefing.com/news/2009/04/30/foreign-businesses-permitted-to-list-in-shanghai.html

2) As I described as few weeks ago, China is also opening up its corporate bond market to non-China based companies to raise capital. The flow of Yuan denominated bonds with further supplant its economy and local currency as a financial power for years to come.

http://www.bloomberg.com/apps/news?pid=20601109&sid=amTdk4Eb4Zu4&refer=home

3) China is been buying gold, tripling its reserves over the last 6 years. Its growing place in the financial world, ever increasing dollar holdings, and goals to put Yuan as a real global currency make these reserve additions important to watch.

http://www.reuters.com/article/ousivMolt/idUSTRE53N18T20090424

4) Finally, China's Yuan-denominated swaps and its stockpiling of commodity related assets just bolster its financial situation. As a new form of policy, it is helping its weaker counterparts, displaying its attempts to place itself atop the global landscape of trade.

http://www.reuters.com/article/newsOne/idUSTRE52T1FB20090330?sp=true

To me, these actions are part of a larger agenda China has going forward to supplant itself as the dominate global power. Maybe they should have started this agenda a few years back, distancing themselves from the US and its faulty economy, but its hard to stop eating the cookies when your hand is already in the bag.

As they continue to boost the domestic economy and wein off of a US export driven economy, it will be very interesting to see how things play out both on an international and domestic scale. Some have their doubts, but I continue to believe Asia, and China specifically is where the growth is going forward.

Impressive

2009-04-30T13:17:00.003-04:00

Reminds me of one of my favorite movies Blankman, played by Damon Wayans

Volcker

2009-04-27T11:08:00.006-04:00

This is a portion of a Paul Volcker address from 2002 discussing among other things the relevance of central banks going forward and a new reserve currency. This comes from a guy who has been involved in FED policy since the 1950's and fought the vicious inflation of the 70's and 80's that sprouted a new bull market lasting 20 years. So, I like to listen when he speaks. I have italicized the parts I think are relevant.

"When I think about what the central bank ultimately controls, I am led to thinking about what function of the central bank cannot and will not be taken over by the other operators in the financial markets, either individually or collectively. Market participants certainly sit around ingeniously thinking of how to intermediate and satisfy every possible demand for liquidity and credit at the lowest possible cost. So it seems to me – and I say this with some tentativeness – that the market is going to try to minimize the use of base money, the one thing the Fed controls. If no interest is paid on base money, market participants will try to minimize the need to hold reserves or currency, or develop other payment systems, once again trying to work around any constraint set up by the central bank.

So what is left for the central bank to control? I think the market is still a long way from doing away with currency or reserves as a means of interbank payments. At the end of the day, it is only the central bank as an institution that can satisfy our demand for currency and create or withdraw reserves and therefore provide a sense of liquidity in the markets. In the extreme case, it can create liquidity without end, since there will be no question about its credit status. In most circumstance, that power does give the central bank special influence, both through its actions and through its potential influence; markets respect this, and will therefore respond to the intention of policy.

This seems to me to be the last strand of permanence in central banking. Of course, influence over liquidity does not provide any assurance that you will use that influence wisely or that the transmission belt to the economy is going to be obvious and direct. Operating monetary policy in open, liquid markets means that the transmission belt will inevitably be unstable: the market in effect is competing with you, and the central bank will find it necessary to adjust. All of the history I have recounted suggests that this will be a continuing struggle. A fixed rule cannot solve the problem. I think that is the lesson of the past fifty years. Those fifty years also offer some hope that central banks will not be inconsequential, even if they have to adapt their modi operandi constantly.

I want to leave you with one other thought, which may make some central banks inconsequential. What is the endgame in all of this, of open markets: the free flow of capital around the world, a couple of hundred independent countries, some big, some small? I think the logical long-term result – extending far beyond my living horizon, but perhaps not yours – is a world currency. With a world currency, we will not have a lot of independent central banks. What I have not quite figured out is what the one remaining central bank will do, what instrument it will use, and how it will be controlled. But I think that is the direction in which economic and financial logic guides us.

I suspect there will be a lot of way stations along the road to a world currency. For example, I am pretty sure we are going to go to some regional currencies, and we will almost certainly have many fewer currencies. In such an environment, will we have a few large central banks centered around big countries and monetary centers, each with some influence, but with their interrelationships guided, influenced, and affected by the exchange rate between them? Such a structure leaves open a lot of questions about the organization of the world economy in ways unrelated to central banking. Nevertheless I think that if the net result of that kind of a world is very widely fluctuating exchange rates between major centers, then it will not be a world conducive to the kind of multilateral open trading system and political harmony that we like to associate with the benign leadership of the United States and its partners during the postwar period.

So I will leave you with that thought, confident that you will not be able to disprove it to me, in my lifetime anyway. That is the safest kind of projection to make."

Full Text: http://wfhummel.net/VolckerAddress.html

Just a thought

2009-04-24T12:49:00.002-04:00

Just thought of interesting comparison and once again inflation based.

Banks knew the rise of structured products they were creating and holding would come to an end, but times were too good. They felt that they would be able to time the market and flip the script, get out a the top and walk away. Everyone was in the same boat, everyone knew it was unsustainable and thought they could escape at the perfect time. There was talk on investment bank conference calls, major hedge fund managers taking the other side of trades, etc. Now we have the same talk about FED/Treasury intervention and inflationary seeds going forward. People know it will be there in the future (just as they knew the end of structured products would come) and are acknowledging it (some preparing for it), but to think FED/Treasury can walk away or prevent it from running its course is about as delusional as the bank notions that they could walk away at the perfect time from credit products. I am reading about how the collapse of the roman empire, and like all empires ended in an inflationary spiral. Just a thought...

Follow-up

2009-04-22T12:38:00.015-04:00

I would like to follow-up yesterdays post with some excerpts from Dying of Money: Lessons of the Great German and American Inflations by Jens O. Parsson. It was written in 1974, in the midst of America's 1970's period of stagflation and had Germany inflation of the late 1910's and early 1920's in its rear view mirror. The portions I am including chronicle the America's boom of 1962-1968, where government induced stimuli created an embedded inflation period lasting into the early 1980's. I would like you to draw your own conclusions as you see fit with the excerpts. I find that the parallels are pretty great.

You will have to click on the text and read each part separately, sorry

As you can hopefully see, sorry the font is pretty small, false booms created by loose monetary policy have occurred before. The results of the fiscal leniency of the late mid-late 60's in the US wasn't nearly as catastrophic as Germany post WWI but had the potential to be if Paul Volcker hadn't raised interest rates so quickly in 1981. Some may argue that the underlying seeds have been planted over the last 10 years and the collapse in the global economy of the last two years, led by the US, will just make the inflationary concerns that much greater down the road. The question is will we have the bullets to fight it off this time?

Thrown out the door...

2009-04-21T15:55:00.002-04:00

From one of my favorite shows, Fresh Prince of Bel Air. All wasteful things need to be thrown out the door...

I hate to harp on monetary policy/inflation and its consequences so often, but they are the main contributors to what has happened in America and what it will take for us to rebuild. Today I want to focus on what many classical economists call the output gap and how I believe it needs to be thrown out, like Jazz. Here is the classical definition:

“An economic measure of the difference between the actual output of an economy and the output it could achieve when it is most efficient, or at full capacity. There are two types of output gaps: positive and negative. A positive output gap occurs when actual output is more than the full-capacity output. Negative output gap occurs when actual output is less than full-capacity output.”

-Investopedia

So as you might guess, we are currently running a negative output gap and as many deflationists will tell you is the sole reason we cannot have inflation in the foreseeable future. When a negative gap exists, typical of slowdowns, production runs under capacity. Thus, money velocity, a key determinant of inflation grinds to a halt. This is why the Federal Reserve will do anything to pump money into the system to make up for any shortfalls.

I believe the output gap in its classical sense is faulty. In addition, based on this theory and contrary to popular belief we can have severe inflation in the foreseeable future. Output gap theorists are children of a production based economy, one where productive labor, such as factory or farm work dominate GDP. Due to the policy actions by the FED over the last 10 years, we no longer have an economy of production. Our country has been built upon unproductive sectors with unproductive “paper-pushing” jobs that really didn’t need to exist in the first place. Some call this a FIRE economy (financial, insurance, real estate) and now that it is gone our economy is running under its potential (negative output gap). But, if you think about it, the initial FIRE economy growth was not real in the first place, a complete monetary policy engineered figment of imagination. Thus, the positive output gap during FIRE times was not real either.

A fellow output gap theorist and I were discussing this post and he put it simply as such “core to your idea is that there is not the kind of idle machinery and factory floor space, typical of a classical output gap in a balanced economy. Instead, there is just a ton of office space and retail/shopping mall space.” Because we have built a FIRE economy of unproductiveness, where we are currently running is probably not too far off our potential max output. Only when we return to a sound production based economy, which will take years of working towards, can the output gap be considered. In the meantime, the FED tries to fix a "broken stick" by dumping inordinate amounts of money into the system, there are far too many dollars chasing too few goods (inflation with no growth), which I believe will be seen soon. The output gap, though it may be useful in many situations, I believe is an outdated form of economic data and should be thrown out when discussing our current state.

Deflation vs Inflation - Does it matter?

2009-04-17T11:10:00.004-04:00

I think the argument between inflation and deflation in our current state is somewhat of a moot point. The debate is part of classical economic thought, the same thought that has proved wrong over the last 10 years. I would like to introduce a thought. Deflation will to lead inflation and monetary efforts are just an outcome, not a cause.

"Under deflation, government tax revenues would drop, and governments would no longer be in a position to roll over their debt falling due, let alone increase their debt... I may add a political consideration here: public opinion, massaged by government preservers, will presumably see inflation — the increase in the money stock — as the lesser evil. The total destruction of the currency would presumably be within reach... It is in this context that we should remind ourselves of the (most prominent) German experience in the early 1920s. It was a democratically elected government which decided, in view of reparation payment obligations and depleted funds, to take recourse to the printing press, which ended in hyperinflation, unspeakable hardship for the people and paved the way towards totalitarianism."

-Austrian School of Economics

After tax revenues collapse, a direct outcome of deflation, the next step is the revulsion of government debt. This step is called sudden stop where countries with high debt-GDP ratios and huge budget deficits face the reality that no more foreign capital inflows will flood into the countries debt. This chain of events is crucial in the shift from deflation to inflation. As the money flows out of government debt interest rates climb not because of inflation, but because of deflation that led to sudden stop. Think of it as a self fulfilling prophecy. Once a government realizes that sudden stop is here, they will turn on the printing press to combat the outflows of money; this is what feeds fuel to the fire and a hyperinflationary state will upon us. I am on the lookout, as tax day has come and gone for warning signs, but in reality it can happen one day without any notice, that is the scary part.

Gold

2009-04-16T10:24:00.004-04:00

Two charts of gold. The first, a 30 year monthly chart. People love to hate gold, but it has been the only asset to perform over the last 10 years while all over assets are in the red. Oh, by the way, its the oldest form of monetary value in existence.

The second chart is Gold/S&P 500. Yes, it has come a long way since the 1999 bottom, but look where it has been. FYI -- that spike was in 1980, a period of high inflation, or stagflation. This picture to me says the trend is just beginning, just my opinion.

Banks - The bar is set too high

2009-04-16T08:16:00.005-04:00

My problem with the US banks going forward is as such. The rise of risky fixed income products was in part due to interest rates being too low for too long, thus banks looked to create higher yielding products for investors with the appetite for "risk". Now that the fallout has occurred, risk is no longer a term most investors are willing to use.

The record bank earnings the street has become accustomed to over the last four years can be attributed to the originating and selling of these securitized products. That is now over; banks for the most part do not exist in these businesses as the only marginal buyer is the US Government along with some distressed investors that will only invest with the use of the FED’s balance sheet access to leverage. So, again today like in 2002 rates are so low, but the securitized market is no longer a revenue driver for the banks because of its dislocation and lack of investor risk appetite. They can still make money doing what banks were meant to do - take deposits, borrow at 0% and lend to creditworthy entities, underwrite bond and equity deals, and when M&A comes back advise deals. But the expansion over the last 7 years in terms of revenue growth and hiring, I believe is over. The street does not like decelerating growth and margin compression. The boom years are over and the bar is set too high.

Another thought from a fellow blogger when fighting inflation becomes a serious concern -- "Our economy has become more addicted than ever to low interest rates. But because bank assets will now be collecting income at record low rates, when and if the Fed tries to raise rates it will only be able to do so on the margin. If Bernanke raises rates substantially to fight inflation, banks will be paying out more on deposits than they collect on their income streams. Couple that with their already distressed balances sheets and look out!"

Links 4/15

2009-04-15T08:52:00.004-04:00

Here is a link worth reading...

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aNMQDysdnKRc

Here are three non-current event driven pieces. More economic theory based, but very well laid out and simple to understand. They will also give you some background on my post in the next few days...

http://www.itulip.com/forums/showthread.php?t=5403

http://www.itulip.com/forums/showthread.php?t=8160

http://gregor.us/crisis/paths-to-repudiation/

http://gregor.us/oil/the-seigniorage-curse/

http://gregor.us/ng/rock-scissors-paper-recession-vs-collapse/

All major credit cards accepted

2009-04-13T20:01:00.009-04:00

Everywhere you turn you hear about saving. I am a believer that now is the time to take on as much debt as your creditors will allow. Also at the same time, save, just not the conventional way. By the way, the government does not want you to save one bit.

Some people may ask why doesn't the government want you to save, how can they control what I do with my hard earned money? Lets look at both short term and longer term rates here in the U.S. First, Fed Funds is essentially zero making saving short term unyielding. That being said, lets say you wanted to stick your cash in longer term bonds, 10-year treasuries are 2.8% and 30-year bonds are pushing 3.7%. Not entirely attractive considering the creditworthiness of US debt.

The funny thing about this is the FED is buying treasuries in the open market, in an attempt to keep yields low. There are number of reasons for this which I wont go into, but most importantly they want investors to go out the risk spectrum and NOT be invested in commonly-known safe assets like bonds and cash (not saying this is a good investment over a 10 or 30 year time horizon anyway). In the end they want consumers to spend, stimulate the economy and get us back on track, also known as reflation.

So now that I have explained why the government doesn't want you in cash, lets figure out why you should fill out those credit card applications. I am in the camp that we have no deflation, or none yet in our current economic environment. CPI has yet to show a year-over-year negative reading (we will see on Wednesday April 15th when we get our most recent numbers) but deflation has not set in. Actually there is a term for what has occurred, its known as disinflation.

With the monetary policy enacted by the Federal Reserve over the last 10 years (print money short term to fend off long term structural issues), we have a built up a fair amount of inflation embedded in our system (oil prices soared to $150 as corn and soybean prices skyrocketed last summer). As this trend continues and more money is printed, dollars will be worth less in the future, also known as inflation. So if you think about it, $10 saved now could quite possibly lose its purchasing power in say one, three or five years from now. Based on this theory, debt levels will be worth less over the long term as compared to current prices, again inflation. With inflation expectations currently tempered and the media telling you to save, I try and be contrarian. As the value of the dollar rises your debts grow in value, and conversely, as dollars fall due to inflation, the net value of your dollar denominated debts will fall as well. Now, more than ever, I believe is the time to rack up the debt!

The key to this equation is borrow and save at the same time. I have explained the debt element above, based on my views of the dollar, money will be worth less in the future. Now savings. Most Americans think of savings as cash that sits in a bank account or CD/money market account bearing some rate of interest. I think this conventional definition must change. In my mind, cash must be diversified into a basket of goods and currencies*. Everyone must do their own research, but I like resources such as oil, grains (food), gold, silver, and currencies of resource rich nations as well as some dollars (since you must be able to function day-to-day)*. I may sound gloom and doom, but I think it is a reality. The monetary policies til now, although they may change going forward (I don't think they will) have set the stage for individuals to take preventative measures going forward.

This is my roadmap over the next few years, now the tough part -- find a creditor to lend me some money...

Side note: Based on the US govt propensity to bailout everyone and everything out, an interesting thought has been brought to my attention. Load up your debt and be irresponsible because the government will come along and and pay your bad debts and clear out your previous credit history. The clean credit history allows consumers to spend and even qualify for home loans, another print money to stimulate short term demand. Just a thought.

*I don't like to offer up specific investment advice here, again you must take everything I say with a grain of salt and keep in mind I know nothing about everything.

The charts don't lie

2009-04-10T10:59:00.016-04:00

Who will grow in the coming years?

Below are the one-year charts from selected Asian countries and Brazil. As you can see, after the October global "crash" none of these indices have made new lows. They can be described as on the path to recovery.

Taiwan

Malaysia

Japan

Hang Sang (Hong Kong)

China

Brazil

Now below are the one-year charts of the S&P 500 and Dow Jones Industrial Average.

As you can see, both indices have made significant new lows in 11/08 and 03/09 after the October global crash. Here in the U.S, we face a banking crisis, that seems to have subsided for the time being. On the other hand in 1998, Asia was hit with a similar "financial crisis". Having lived through it, Asian bank balance sheets are currently considered to be in a healthier state. One caveat, many foreign indices were hit harder than the U.S. in 2008, so maybe their outperformance in 2009 "just gets them back in-line".

America is the worlds largest economy and largest importer, so its effects are felt worldwide, but it seems to me that Asia is where the growth is going forward. The charts don't lie

Stuff

2009-04-09T09:13:00.003-04:00

The world is good again: Wells Fargo pre-announces and is up 35%, go figure. I am still not a believer, but it feels good while its here.

I came across this energy post from a well informed blog. I know some energy policy and its nuances, but will heed to those far more knowledgeable. Here is the link:

http://www.getreallist.com/how-to-profit-from-energy-illiteracy.html

Also, here is an article showing China's growing importance in the global economy. Foreign companies are selling yuan denominated bonds. China, a once closed country to outsiders is beginning to open up...

http://www.bloomberg.com/apps/news?pid=20601109&sid=amTdk4Eb4Zu4&refer=home

What China Should Do...

2009-04-08T11:26:00.000-04:00

This post will chronicle what I THINK China should do to ensure long term prosperity. There are five key points:

1) Stockpile natural resources/natural resource producers
2) Diversify out of its long end US paper
3) Buy its own government debt
4) Take the hit now and promote domestic demand
5) Prosper

1) If you didn't already know, China has been stockpiling all the necessary resources it needs at depressed levels (commodities minus gold have crashed from their peak in summer 2008). China has been on the open market buying copper, crude, among other resources as well as entering into swap agreements with resource producing nations such as Brazil, Australia, and Russia. They are swapping their dollar reserves for hard assets, because they NEED the goods for its vastly growing population and really need to rid themselves of excess dollars due to the disastrous policy efforts from the US. China has also showed interest for Canadian oil-sands producer Suncor Energy, but will face strict government regulation.

2) As you may know, China is the biggest holder of US government debt and that is where they find themselves in a predicament. The US economy is in serious trouble, debt deflation has set in and the Federal Reserve is doing all it can to avoid the Great Depression v. 2. The US economy has abandoned all producing industries over the last 15 years for unproductive “paper pushing” industries such as finance and the like. The US has shipped all production capacity to the foreign nations such as China.

Due to these serious concerns here in the US, the FED has reverted to attempts to viciously debase its currency via numerous unconventional actions. China has expressed concern about the US policies being implemented, but find their "hands are tied." Since the Yuan is pegged to the dollar and the two countries are such important trading partners, China has relied on a weak Yuan/strong dollar to export much of its goods to the US. Plus, as explained above, China is the biggest US treasury holder and as the FED attempts to debase the dollar China’s UST holdings are worth less. This is why China is so concerned with the US monetary policies and has expressed much concern. The double whammy loss is not what China wants to see especially since many feel its on the verge of coming out of its recession (its stock market has crashed 70% from peak to trough). So, at all costs it must diversify.

3) What will China do with this excess capital from the selling of UST’s? It cannot bring it all back onshore because of concerns of the Yuan appreciating, which is in essence deflationary. My solution is two part. First, they need to continue to buy resources with the excess dollars, but more importantly I think they must buy their own government debt. This action is viewed as extremely inflationary when the said country is running a budget surplus along with an increase in money supply (which China has been implementing since November 2008). Also this is why the Federal Reserve is engaged in buying debt across the curve along with agency debt, it is trying to ignite inflation and possibly give foreign holders a “bid” to sell into. Some will say that buying ones own debt is asking for hyperinflation, but I beg to differ in this situation. With the economy growing at a 6+% hyperinflation is not a scenario worth considering in my mind. To boot, who says China doesn’t want SOME inflation in their economy? In my step by step process, the first step was to stockpile the world’s resources. Because they are averaged in at low levels and have excess commodity reserves, the fact that the government CONTROLS consumer prices on many essential goods is a crucial piece of the puzzle. With wage inflation rising as the economy recovers and complete control over price inflation due to gov't stockpiling resources efforts, China will be best positioned to come out of the global recession.

4) To ensure the Chinese economy continues to grow, it must decide: suffer now or suffer later? I believe they must take the hit now to ensure prosperity down the road. China as a nation is the best of historians. It has had the chance to see the rise and failure of developing-to-industrial nations; this is the knowledge they will use as the road map for their future. The shift away from the US dependence will not be easy, but I feel is necessary for long term growth. The US economy over the last 10 years is a perfect example of creating short term fixes to long term structural problems. In 1998, Long Term Capital Management posed systemic risk, so they were bailed out with printed money. In 2002, rates were left too low for too long thus breeding the rise of the real estate bubble/credit boom. We are now paying for the short term fixes of our past and once again, firms are being bailed out with printed money because they pose systematic risk such as AIG, Bear Stearns, GM, and Chrysler. And the last straw: the government monetizing its own debt. China needs to realize these short term fixes only breed long term disasters (I believe the US will pay dearly for the actions by our government over the last 10 years for a long time to come). China must take the hit now for future growth. They must also focus on improving the domestic economy by implementing stimuli for its citizens, which it is already doing. Improving the standard of living today will have far reaching effects down the road.

5) Prosper. I may be off base with all of these actions; again my saying is sensical words from someone who knows nothing about everything. But, I do feel Asia and more specifically China is where the growth will be for the coming years. The key will be to take the necessary steps now to ensure that they can grow into the future. Below are some links on China. Enjoy

http://gregor.us/oil/as-america-frets-china-buys-stuff/

http://jimrogers-investments.blogspot.com/2009/04/where-to-live.html

http://marcfaberblog.blogspot.com/2009/04/treasuries-bear-market-will-extend-for.html

http://blogs.cfr.org/setser/2009/02/26/who-bought-all-the-treasuries-the-us-issued-in-2008-and-who-will-be-the-big-buyers-in-2009/

http://blogs.cfr.org/setser/2009/03/31/foreign-central-banks-arent-going-to-finance-the-us-fiscal-deficit-their-reserves-arent-growing-the-q4-2008-cofer-data/

Bank Stress Tests...

2009-04-08T07:49:00.000-04:00

http://www.nypost.com/seven/04082009/business/fdic_bair_s__teeth_163380.htm

Is Sheila Bair the only one in DC not spewing nonsensical gibberish? Over the last year, she has been the one to stand up to opposition. Now she is calling out the bank stress test. Oh yea, Treasury Secretary Geither and Bair have been at odds for a while now. Geither even tried to oust her as FDIC chair as part of his signing on with the Obama Administration. Lets see if this rev's some engines even more...