Tag Archives: gold

On Gold, Guns, Bread and Cadillacs…

Well, maybe not guns.  This isn’t that kind of post.  But I am going to talk about gold briefly.  One of the more interesting ways to think about the value of gold is its value in purchasing household items.  Because back in earlier times that was exactly how you paid for things.  Gold is money, after all.  Indeed, in the book “Hedgehogging” Barton Biggs refers to gold in such a manner:

The Old Testament recounts how, in 600 B.C., one ounce of gold bought 350 loaves of bread.  As of today, one ounce will still buy 350 loaves of bread in the United States.

Barton Biggs: Hedgehogging

In my area of the country in North Carolina, one ounce of gold will get you 446 loaves of bread.  So when measured in those terms, we’re overvalued even after the action we’ve seen over the past few months:

Today I heard it referred to in another way: gold vis-a-vis Cadillacs.  So first, I have to present to you the definitive video clip on Cadillacs…

And now back to the gold/Caddy ratio.  I stumbled across this post (hat tip: @hedgefundinvest and @FinanceTrends) that looked at the fact that in 1971 with gold pegged at $35 an ounce you needed about 11 pounds of gold to buy a ’71 Eldorado.  Take away the peg and it would’ve been much less gold (at $103 an ounce you need about 5 pounds).

Now?  You can get 2 Cadillac XLR-Vs for the same 11 pounds if you’re taking the $35 per ounce as your starting point.  If you used 5 pounds, well you’re out of luck because you won’t have enough based on Friday’s close at $1193.50.  So the starting point you choose is important.

But as for the overvaluation or lack thereof currently?  At these levels it may still be overbought even though we’ve seen a pretty sharp pullback from $1,250.  But I’d be wary about how much more of a decline we see here because volume has been higher even on up days and the revolt against central banks isn’t over by any stretch.

So in my mind, we’re in for more volatility not less.



Filed under finance, macro, Markets, risk management

At The Precipice: The Choices We Make vs. The Choices We’re Forced to Make

Author/Editor’s Note: You are about to embark on reading a post that is long, wonkish and meandering.  So while I admit it being this way, I will make no apologies for it.  This post is what it is.

This is a tough post for me to do.  Tough because so many discussions that seem disjointed and siloed, are in fact ones in which I see connections and I think the topics are interdependent: you can’t discuss X without discussing Y and Z.  So on that note, I’m going to talk about the inflation/deflation *and* the expansionist/austerian debates.  There’s a smattering of other things in here, too.  Like the unemployment conundrum.  Or Green technology.

Because while those topics are worthy of having separate discussions, you can’t come to any satisfying conclusions about any of them without looking at the first two debates, which are inextricably linked, and trying to tie them together with the other topics. It’s ambitious, I know, but I’m going to attempt it.  But with Jackson Pollack as a navigator and both Hunter S. Thompson and Jack Kerouac sitting in the back seat of this car, there’s no telling how this will come out.

I’ve read just about everything written over the past couple of weeks, discussed a lot of this stuff with folks on Twitter.  On blog comment forums.  And all I can say is I’m struggling to come to terms with this stuff, just like other folks I’ve discussed it with, and that has led me to come to some really profound – yet uneasy – conclusions which I’ll get to later on.

Inflation vs. Deflation

There’s been a lot of ink spilled on this.  Are we being confronted with one?  With both?  Let’s consider a few things in answering that.  First, a look at core CPI:

Not inflationary by any measure.  Prices are collapsing as a at least two effects I can think of are hitting the labor markets: persistence in long-term unemployment and under-employment: the folks who work part-time but are ready and willing to work full-time if a job is available.  Both of these effects are eventually reflected in GDP, personal income and last but not least, tax receipts.  Both of these effects are providing downward pressure to prices, plus they force people to choose products/retailers they wouldn’t choose before.  So the actual basket of stuff that’s getting sold now is different than the basket of stuff that was being sold before when people either had jobs or the jobs they had then paid them more.  Chalk that up as the choices we’re forced to make.

Another thing about inflation is the use of debt to fuel asset purchases and consumption.  Easy credit – and appetites that had been whetted by easy access to credit – had fueled a lot of purchases we had seen before the onset of the recession, and the levels of consumption we had seen conditioned others – such as auto manufacturers, strip mall developers, etc. – to expect those growth rates in consumption (and at that those nominal levels) going forward.  Well, this next chart shows that’s not happening:

About the only thing we can cheer about here is that the rate of decay is slower than it was the past year.  But it’s still declining as debt is shunned – a choice that can fall either in the camp of choices we can make or the camp of choices we’re forced to make.  A comment I saw on this struck me as being interesting, both right and wrong at the same time:

In one sense that’s true, and in another, it’s not.  I think in a macro, aggregate demand context, it’s very true.  Somehow we need to get back to the levels – think about the debate between growth rates and levels – we saw in that time frame.  But there has to be some product or some asset that would induce that kind of demand again.  Well, has that occurred?  Are securitized markets improving?  Well, you tell me.  Are they?

Did that make you choke on something?  If so, you don’t want to see this one:

Forget about securitized credit for a second.  This is bigger than that.  These two charts are about debt revulsion and market illiquidity.  This is not coming back. The king is dead.  Long live the king.

Lastly, a y-o-y chart on total bank credit.  Note that on a y-o-y basis, we’ve gotten to a point where credit is just not falling as fast; that’s not the same as growth:

As Kevin Depew observed in a spectacular piece at Minyanville:

Make no mistake, there are the same underlying economic problems here that exist all across America in cities both small and large: too much real estate development, too few home buyers; too many cars, too few cars buyers; in short, too much malinvestment, thanks to decades of artificially cheap credit.

via Five Things You Need to Know: The Modern Stealth Depression Revisited | Markets | Minyanville.com.

So there you have it.  Artificially cheap credit and malinvestment, and fewer financial intermediares to give credit to us.  You could easily make parallels to agribusiness, where our food supply is controlled by a small number of national players, juiced on artificially cheap corn.  But that’s a whole other discussion, that can only be done after watching Food, Inc.

But with respect to the deflation in credit that is happening after seeing those two charts, frankly it doesn’t scare me.  Because as I had heard and read about in understanding addiction “the mind that brought you here will not be the mind that leads you out of here.”  We’ve got to find something else that can lead us out of this morass of corroding debt and overindulgent consumption.  That means giving up the ghost that more of the same will get us out of here.  It won’t.

But that won’t stop people from trying to go back to what was done before and try to make it work.  Charles Mackay’s classic is filled with such behavior, where people thought the road back to recovery was paved by the habits and assets that brought them to the brink the in the first place, only to see those efforts fail. Yet we try it over and over again.  In short, not only does this sort of behavior exemplify Albert Einstein’s definition of insanity, we want to repeat the definition to ourselves to make sure we get it right.

So that’s in favor of the case for deflation.  But what about inflation?  Also, what are to make of the run-up in the price of gold – the classic inflationary hedge?

This came up at Street Meet, which I had the privilege of attending.  Is this move an inflationary hedge?  Sure, by many it is.  But with all due respect, I offered that there was a second motivation, which is a real psychological shift: the move has nothing to do with inflation or deflation, but a move to store value in gold as a hedge against poor decisions made by central banks.  The fact of the matter is, central banks have lost the modicum of trust they had. Over the past three years, how many times have you read about something *good* a central banker has done?  Outside of the droning of some economists, not much.  The move to physical commodities as a store of value away from paper/fiat currency is a revolt against central banks.  Taken to its ultimate end, we won’t need an “End the Fed” bill to render them obsolete; just settle transactions in anything but paper money.  No potency cocktail of ginseng, Viagra or Cialis would help them at that point.

And meanwhile, yields head lower for Treasuries:

That’s a 20 year chart.  Here’s a 5 year:

Which is also having an unintended consequence, which factors into the austerity/expansionary debate.  Risky assets are also yielding less as well:

This is on a 20yr chart.  They want to head lower, and they will head lower.  One other thing to note: look at the sweeping parabolic nature of Baa rates from the last downturn in ’00 to the current one.  I bet if I found a parabola to fit that trend, the coefficients this time around would be bigger than the coefficients on the mini parabolas you see in the ’90s.  Why?  The convexity of yields.  Also, looking at the time periods between the cycles, I am starting to think that we’ve compressed economic cycles now with all of the cheap liquidity and stimulus.  That subject is probably more open for debate than the compression of market cycles, which is another topic we touched on at Street Meet and one where folks could easily agree that cycles in markets have compressed.

At any rate, here’s a 2 year chart:

The channel that had formed is breaking down, as 10yr yields head lower.  Another way to look at this?  Spreads between Baa bonds and 30yr Treasuries.  The Baa yields published daily are yields for bonds with more than 20 yrs left to maturity, so the spread to 30yr Treasuries can serve as a risk-free proxy:

As I, as well as others pointed out, defaults on high yield and leveraged loans/bonds are much lower than everyone has expected.  I’ve said it before, but I’ll say it again: we may be watching a new feedback loop form between rates and defaults.  Central banks pushed liquidity into the market, suppressing rates on, well,  everything.  High yield assets benefit as default rates head lower, thereby making them less risky compared to higher quality assets.  Risk compression is in play, and it may not end anytime soon.

But this is an important facet to the next debate.  A debate where the discussion of interest rates almost never gets discussed.

Austerity vs. Expansionism

This discussion and the inflation/deflation one are linked.  If inflation is the issue, austerity is will correct it.  Deflation on the other hand, is different.  In a deflationary environment, consumption and/or investment is encouraged as the capital inflows kick-start economic activity.  But when there are charts like this…

and this…

It’s bothersome.  The debt keeps increasing and to listen to the expansionists, it needs to keep expanding.  Because governments are the only ones that can fill the void and consume while the private sector repairs their balance sheets, for which there’s no guessing how long that can take.  Indeed, this is one of the basic tenets to Richard Koo’s framework for dealing with balance sheet recessions.  Plus, looking at Japanese bond yields, they’ve only gone lower as inflation has become a distant memory.  And that was 20 years ago.  Indeed, the biggest takeaway in my mind from Koo is that instead of bemoaning the Japanese experience, we should be embracing it.  Sure there are some things that they did wrong (lack of structural reform, banks not charging off losses, big banks that got bigger – gee why does this all sound so familiar), but by and large,  the policy of governments taking on ever larger deficits to stop deflation is something to be accepted, not fought.  I can see in one sense that is true.  As I read and re-read posts and comments on this debate, there are a couple of things I see as true: there is no magic debt/GDP percentage where everything goes bust and as interest rates head lower, the interest burden is lessened, which allows more debt to be taken on.  Indeed, it’s like a feedback loop sprouts up out of nowhere as a result.  Like a weed staring at you in your driveway which forces you to ask “how did this get here?”

But is that how we want our government to operate?  Taking on debt so we don’t have to?  I realize the comparison to Japan is not a perfect one, for at least two reasons: the difference in savings rates and the composition of their debt market: practically all domestic investors.  Indeed the sovereign default question is puzzling when one looks at Japan, because while their debt/GDP keeps rising, the only talk of default comes from outside of their borders – not within.  This chart is as of end of last year, but it still gets the point across:

But GDP growth has not resumed in a robust manner, it has languished and continues to do so.  Personally, in Japan I see an economy that has spent a lot of public bucks and gotten very little bang for it all.  It just seems to me there has to be a better use of all of that money.

And then I read this (emphasis, mine):

What we haven’t yet experienced—at least in a sustained manner—is deflation. That, combined with the enormous fiscal stimulus, may explain why unemployment has stabilized to some degree now despite sustained private sector deleveraging, whereas it rose consistently in the 1930s….

Whether this success can continue is now a moot point: the most recent inflation data suggests that the success of “the logic of the printing press” may be short-lived. The stubborn failure of the “V-shaped recovery” to display itself also reiterates the message of Figure 7: there has not been a sustained recovery in economic growth and unemployment since 1970 without an increase in private debt relative to GDP. For that unlikely revival to occur today, the economy would need to take a productive turn for the better at a time that its debt burden is the greatest it has ever been..

via Steve Keen’s Scary Minsky Model « naked capitalism.

Here’s the figure:

Keynesians and MMTers beware.  This speaks to secular deflation: a large, demographic and psychological shift away from the use of debt. Debt-induced growth won’t work if there’s no appetite to take it on and there’s no productive use for it that has a greater benefit than the costs of servicing it.  Maybe Keynes got it wrong.  Perhaps it should be the Paradox of Debt instead of the Paradox of Thrift: societies resist taking on debt just as they should take it on, because they already took on so much beforehand.  I’ve heard the argument before that that shouldn’t matter because a government can always print more money to cover the interest.  And risk inducing hyperinflation as a result?  Because governments don’t know what the optimal quantity of money is better than any one of us do.  Plus, taken to its extreme, that kind of outcome can be viewed as a technical default.  The political risk of being the next Zimbabwe or Wiemar Republic is very real, currency standards (fiat vs. gold) notwithstanding.

And it might actually be worse.  If you can’t trust a government to act prudently with respect to fiscal matters, how can you trust that rules that are made by that body are fair?  That they are enforced fairly?  Or interpreted reasonably? Again, these are conversations that are thought of in isolation, but can only be treated in a satisfying way when discussed concurrently.  Chalk this up as a choice we can make – for now.

But the austerity argument has its own warts.  Cutting safety nets is largely out of the question, because as Andy Grove wrote in Bloomberg Businessweek:

I fled Hungary as a young man in 1956 to come to the U.S. Growing up in the Soviet bloc, I witnessed first-hand the perils of both government overreach and a stratified population. Most Americans probably aren’t aware that there was a time in this country when tanks and cavalry were massed on Pennsylvania Avenue to chase away the unemployed. It was 1932; thousands of jobless veterans were demonstrating outside the White House. Soldiers with fixed bayonets and live ammunition moved in on them, and herded them away from the White House. In America! Unemployment is corrosive.

via Andy Grove: How America Can Create Jobs – BusinessWeek.

I very much value what others who have fled oppression in such countries as Hungary in the 1950s have to say because they’ve seen what oppressive, overreaching governments are capable of.  Are we there yet?  No, but when you see things like this – on Independence Day no less – it makes me wonder how close we are.

But back to the safety net issue and what to cut.  There’s obviously little wiggle room on one side of the equation – the safety nets.  They’ve become interwoven into the fabric of our society and the best thing we can do is strive to ensure fraud, waste and abuse are minimized.  Eliminating it is a joke so when politicians talk in such absolute terms, I just laugh.  Or holding up unemployment extensions for the sake of the deficit?  Please.  Nevermind the fact we’ve got whole departments of the Federal government where  nobody knows what they do, how effectively they do it or what it costs to keep all those folks in their “jobs.”  Talk is the most inflated currency out there.

But then you read things like this:

President Barack Obama Friday signed a law giving consumers already in the process of buying a home three extra months to close the deal and still get a popular tax credit from the government.

Homebuyers that signed the contract by April 30 but failed to go to closing by the original June 30 deadline have until September 30 to finish their purchases.

Homebuyers with contracts signed by April 30 who failed to go to closing by the original June 30 deadline will now have until September 30 to complete their purchases.

via Housing Fix: Obama Signs 3-Month Extension of Homebuyer Credit – CNBC.

You just can’t help but feel, well, deflated.  The old saying of “good money chasing after bad” applies.  Just as it did with TARP.  With Bear Stearns.  With AIG.  Pork-barreled projects stuffed into legislation at the 11th hour, 59th minute.  Need I pile on?  So when folks tell me it doesn’t matter how it gets spent, just as long as it does get spent, I have to disagree.  Throwing money at the things that got us into this situation will not be the things that get us out of it.  Nor will wasteful pork-barrel spending.

Also to the austerians’ credit, there is a valid case to be made for government and entitlement restructuring.  The current way healthcare benefits like Medicare are collected and distributed is one area ripe for restructuring.  Social Security is another.

True market reforms are what’s needed, not just debating about levels and amounts of stuff to increase or decrease.  I like the way Joe Wiesenthal expressed it:

Lost in this debate is any discussion of what actually goes into a competitive or dynamic economy. There are so many factors that go into this. Let’s just rattle off a few that could have an effect:

  • Immigration
  • Education
  • Tax fairness
  • Labor mobility
  • Labor flexibility
  • Environmental policy
  • Demographics
  • Family planning policy
  • Health policy
  • Agricultural policy
  • The weather
  • Corruption

We could probably go on forever, listing factors that would help determine whether a given economy was competitive or not. And yet this stimulus vs. austerity debate ignores all these things, as both sides pretend that these are secondary, as opposed to foundational, aspects of what makes the economy hum.

via Why It’s Time To End The Whole “Stimulus Vs. Austerity” Debate.

And I couldn’t agree more.  Rather than take this time to really sit down and think what it’s going to take to move us forward, we’re mired in squabbling and posturing.  It’s easy to do because it’s lazy.  Most people would rather argue about throwing money – or not throwing money – at a problem because these topics make most people’s heads hurt.  But in reality it just sets the table for the last two things I’m going to look at.

Jobs and Green Tech

By now, we all know that unemployment has basically held steady, at 9.5%.  And the participation rate continues to be a negative on the economy.  So I took a look at both of them, together in this chart:

Looking at this chart, we can see that unemployment – when compared to labor force participation – hasn’t been this bad since the recessions of the ’80s.  The ’80s marked another transformational period in this country as we saw the decline of manufacturing and the rise of the service-based and information-based economies.  This becomes very clear when you see capacity utilization:

The lower lows are a sign of technological innovation taking root in each phase of the economy.  Automated manufacturing uprooted people from working in manufacturing several decades ago and we’re seeing something similar in our current economy as we’re able to produce more with less.  This presents us with a couple of problems.  First, as we get more efficient, we have to find better uses for capital that give us returns we want.  This is a huge issue as Keen pointed out earlier: we need better returns on capital to fund our debt.  We’re not finding it now and we need something – an innovation – a radical breakthrough in something from somewhere, anywhere – to get us there.  Second, there’s this issue :

Over the past couple of weeks I have been fascinated with the topic of overpopulation as I explained in my last post that “overpopulation was the greatest threat to sustainability in my book.”

Long story short he believed that the two classes capitalists and landlords (where Labor was considered equipment of the land) a typical feudalistic setup, population unchecked would grow at an exponential rate or geometric ratio.

via BankrChick (Tonight I do).

So overpopulation while we get more efficient and yet at the same time, we need to conserve more of our resources.  Not an easy task.

This is where Green tech could fill the void.  The theory being that Green tech would allow us to make something again and put people back to work while at the same time, if we export our products (not the technology and there’s a big difference between the two in terms of exporting), we can solve it all.  Mr. Birds 1 & 2, you’ve just been killed by one green, eco-friendly stone.

But in my mind, it won’t in its current state, for two reasons.  First, let’s start with the job creation issue.  I went back to Andy Grove on this:

Such is the case with advanced batteries. It has taken years and many false starts, but finally we are about to witness mass-produced electric cars and trucks. They all rely on lithium-ion batteries. What microprocessors are to computing, batteries are to electric vehicles. Unlike with microprocessors, the U.S. share of lithium-ion battery production is tiny (figure-E).

That’s a problem. A new industry needs an effective ecosystem in which technology knowhow accumulates, experience builds on experience, and close relationships develop between supplier and customer. The U.S. lost its lead in batteries 30 years ago when it stopped making consumer electronics devices. Whoever made batteries then gained the exposure and relationships needed to learn to supply batteries for the more demanding laptop PC market, and after that, for the even more demanding automobile market. U.S. companies did not participate in the first phase and consequently were not in the running for all that followed. I doubt they will ever catch up.

via Andy Grove: How America Can Create Jobs – BusinessWeek.

He’s saying we’ve been out of the game for so long we may not be able to compete in this new area.  I don’t necessarily agree.  We’re at a disadvantage yes.  But in my mind, Green tech isn’t good enough yet.  Ethanol cars?  Please, you’re harvesting an ag crop to turn it into fuel, plus you have to burn billions of BTUs to turn it from starchy sugary food into something you can use in a car.  Yes, cellulosic ethanol may be better because there’s less refining that has to be done, but you’re still faced with the fact that you’re using a fuel that will 1) not be as efficient as gasoline (your vehicle’s range is diminished) and 2) is actually corrosive to the engine since ethanol is a form of alcohol and it burns quickly and dryly.  Electric cars?  After watching this review by the guys at Top Gear and reading this rebuttal from Tesla (note the charging time and compare that to the time it takes to fill up a petrol car), it’s clear to me that electrics aren’t ready for primetime, Tesla’s IPO be damned.

There are other cars that might be though, and in comparing the two, it raises a point I want to make: green tech, to be palatable,  needs to raise the bar.  Planting a solar farm 20 football fields wide and 20 football fields long of solar panels out in the middle of nowhere isn’t going to help us if there’s a better use for the land and we tear up miles more of land to get the power from the solar farm to a generation station that can put that power on the grid.  There has to be a better way to do this that fits the lives we live today or offers us something better than we already have.  Otherwise it will fail.

Which leads me back to the austerity/expansionist debate: why isn’t the government investing more in this?  High speed rail could substitute air travel as it’s cleaner and can be more efficient (and possibly more convenient), but nobody is talking about setting up an incubator to research it.  Government can step in there.  What about other alternative energy sources and investing in more R&D in the other issues like making power transmission more efficient – so things like wind and solar power make more sense?  Instead we’re bailing out car manufacturers that are slaves to fossil fuel technology, but our economy as a whole has moved past volume production in this manner for at least 3 decades.  The things that got us to this precipice will not be the things that will lead us away from it.  The government has the opportunity to be the biggest angel investor ever and they’re not taking the chance to do it.  That’s disappointing.

So What Do We Do Now?

But I’m hopeful.  Maybe we should realize, as Kevin Depew says “the time for preparations and battening down the hatches has passed. It’s here.”

Which echoes Joe Wiesenthal’s sentiment.  We need to focus on the bigger picture issues.  Education for our children is still going to be an issue that will still be there.  Care for an aging population is still going to be with us, as well as figuring out what our economy can produce as those of us who follow the Baby Boom have to keep things moving somehow.  These are all things we can still choose to do something about, even as other things we can’t do anything about (the trajectory of real estate prices, for example) head along their own paths.  We don’t have to let our actions or even our lives be governed by that stuff.

I don’t know about you, but I’m glad that we don’t have to let those things dictate outcomes.  Because on this Independence Day weekend, I’ll take the power of choice – the freedom to choose, in fact – any day of the week over the alternative.


Filed under finance, government, macro, Way Forward

The 6.30 Libor Earthquake, Aftershocks and Tsunamis

First, let’s update our Dollar/Euro Libor spread chart.  That’s the one that really matters now because looking at the Libor curves in isolation won’t help us understand what’s going on:

Across all maturities, we saw rates increase about 1bp from Wednesday into Thursday.  Not a healthy sign.  Indeed, I along with others were wondering about the €310bn that didn’t settle and it’s looking more and more like the liquidity it provided is gone and now there’s a mad scramble – a tsunami of buying, if you will – for Euros:

But if you’re watching the Euro-Yen cross like I am, you still need to use the Dollar-Yen as a crossing pair to get a Euro-Yen quote. The last time I checked, the Euro-Yen cross was at 110.039. In a word, ugly.  That cross has been the great carry trade cross for years, so any movements in this cross should be noted and heeded.

But I also wanted to take a look at some other trading activities in futures:

Surely with the correlations we’ve grown accustomed to, a rise in the EURUSD should mean stocks, commodities and well, everything that is not cash is headed higher.  But right now, it doesn’t because of the banking issues in Europe.  Gold collapsing the way it did was rather stunning, frankly.  And the fact that crude oil, in the midst of the summer vacation/driving season coupled with a natural disaster of epic proportions, couldn’t maintain the trend line on the daily chart that would imply $80/bbl, is telling.  And the message seems rather ominous and foreboding:

Meanwhile, two Treasury ETFs, SHY (iShares 1-3 yr Treasuries) and TLT (iShares 20+ yr Treasuries) have benefited from the safe haven bid.  If you executed a bear flattener by shorting the SHY and going long  the TLT, you would’ve had a very nice 6 months, in spite of the gains in the SHY:

My point in showing all of these charts?  It’s to try and present/describe a macro level picture that shows one simple message: the problems in Europe can’t – and shouldn’t – be underestimated and the spillover/contagion/whatever buzzword you want to use that means “spreading” are the worst kinds of scenarios you can think of: higher probability and high severity.  I characterize them as “higher probability” for two reasons:

  1. Never underestimate people’s ability to underestimate tail events.
  2. The probability of a spooky tail event occurring  is increasing.

I don’t know how long the EURUSD “rally” lasts.  It will last as long as banks in Europe are afraid their balance sheets are too illiquid.  It could be over in days, weeks or months.  I don’t know.  But I do know that trade is not acting the same way it would have in the past for a reason.

This will be an interesting month…

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Filed under finance, International, macro, Markets, risk management, Way Forward, You're kidding

Looks Like There’s More To Say. Lots More…

In one of my recent posts, I got a comment from Pedro Nicolaci da Costa at Reuters.  Turns out the comment was an article Pedro wrote May 19th.  Now, without psychoanalyzing things too much, I could only conclude there are three reasons why an article would be left as a comment on a post.  Especially a post of mine that may have had 5 people read it:

  • Something was done right, let’s extend the conversation.
  • You’re a total tool.  Read this and the STHU memo that’s attached.
  • Too little, too late.  Thanks for playing, but you can go back to sleep.

I’m going to assume it’s the first but I know the second and third (as well as others) reasons can’t be ruled out.  So let’s start out with a quote found in the post:

“The recent trend in inflation has been swiftly to the downside,” said Eric Green, chief U.S. rates strategist at TD Securities in New York. “All measures of inflation are decelerating.”

I’d concur, if your objective is to measure inflation based on price levels, which is the normal economic definition:

That was looking at PCE, on a continuously compounded annual rate of change.    The average over the 5yr period in this chart is 2.18 percent.  In April, it was 0.2 percent.

The next one is CPI excluding food & energy, looked at the same way:

The CPI view gives you a more distinct trend, and it’s easier to see prices are falling.  Here the average over the same 5yr period was 1.93 percent.  In April, it was 0.6 percent.

Two measures of prices, both telling the same story.

Here’s the way the Reuters article looked at it:

One of the U.S. central bank’s favored inflation measures, the core consumer price index, rose just 0.9 percent in the year to April, the smallest gain since 1966. Most Fed officials would like to see that number closer to 2 percent.

Now let’s look at a chart I constructed of this:

That’s a well-defined trend lower.  But why?

This probably has something to do with it:

I think a breakdown in the velocity of money explains a good bit.  Fewer transactions pointing to lower demand which drags prices lower in turn.

But let’s continue…

And with Europe mired in a worsening debt crisis that threatens a flashback to the credit-impaired days of late 2008, the possibility of an unwelcome decline in prices begs the question of what Fed officials might do if deflation sets in.

There’s no question it has already set in.  To me, deflation is as much a mind set as it is a data point.  One can make the argument that Greenspan, Bernanke, et. al. were right in seeing some of the signs in ’01 and ’02.  The devastation brought on by the turn from .com to .bomb was as much a psychological trauma as it was a financial one.  But the financial impact was muted.  Why?  That was a destruction primarily of savings & investment.  The amount of leverage involved in .com investing was relatively small when compared to real estate, where most of the money – if not all of it – was borrowed.  There’s an asymmetry when leverage is used in an investment or purchase.  Think about the use of margin in stock investing.  Yes, it can boost returns but too much can put you under in a hurry.  And it doesn’t take big price moves to do it when big amounts of leverage are employed.

Sound familiar?  It should.  Interest rate convexity works very much the same way.  Which is why the uptick in Libor is so disturbing…

This is a good quote from a good economist, David Rosenberg:

“What is going on in Greece, and the Club Med countries in general, must be seen as a significant deflationary shock — underscored by the fact that U.S. dollars are in such huge demand as was the case after the Lehman collapse,” said David Rosenberg, chief economist at Gluskin Sheff.

Far from being a perma-bear (and I’ve read him for more than 6 years, so that includes when he was at Merrill), I just think he’s a very cogent macroeconomist.  I have the utmost respect for him.  And he’s right: ECB/EU guarantees don’t mean a thing when they’re denominated in Euros.  Plus, when assets are bought on credit and balance sheets expand via credit, asset price declines are the last thing anyone wants to see.  Because as the assets fall in value, equity evaporates and debt gets destroyed.  And that debt is an asset to someone.  So it just cycles through the system that way, destroying almost everything in its path.

Then there’s this:

In his 2002 speech, entitled “Deflation: Making Sure It Doesn’t Happen Here,” Bernanke outlined what the Fed could do if faced with a deflationary .

But the Fed has already put into play a number of the ideas Bernanke discussed, including buying up government and private debts and committing to holding short-term rates low for a long time to pull down long-term borrowing costs.

Now, its room for maneuver is limited. The Fed’s relatively modest purchase of $300 billion in longer-term Treasury securities sparked fears the central bank was “monetizing” government deficits by printing money.

I think many of us would agree the Fed has very little left in the way of magic tricks to pull rabbits out of a hat.  And the purchases of Treasuries is something to think about, but it pales in comparison to the MBS purchases the Fed has undertaken.  Securities with deteriorating credit characteristics and they were the only buyer.  That means what once were highly liquid securities aren’t so liquid anymore, which presents all sorts of problems for the Fed since they stopped buying them and now have to figure out how to offload them.

And it ends with this:

John Canally, economist for LPL Financial, said that while inflation expectations, which the Fed sees as a harbinger of inflation itself, are relatively stable, anxiety is showing up in certain places. Just look at the price of gold, he says. The price of the yellow metal, seen as an inflation hedge, has continued to hit new records despite the prospect of renewed economic weakness.

The price of gold is being depicted as an inflation hedge, when really people are buying it now because political risk – in the gold buyer’s mind – is unforgivably too high.  People are worried and in some cases just flat out mad at what governments are doing – forestalling losses and bailing out bad actors/agents (to use the economic parlance) – and they’re not going to take it.  Are they willing to move back to barter?  Because that’s the ultimate revolt against our current fiat-based, electronic payment networked world.  Our system is set up to facilitate electronic, instantaneous movements of little pieces of paper and coins.  Not physical gold nuggets.  We used to do that and I don’t think many people want to go back.

So the point is simple: folks should realize deflation is here, it’s not going anywhere and the Fed has probably spent most of (perhaps all) its bullets trying to fight deflation and doesn’t have much else left.

To the folks at the Fed: good luck with that.


Filed under finance, macro, Markets, Monetary, Way Forward

As the Sovereign Enron Turns… Actually, it’s Greece

The Enron (Sovereign Edition) story continues to unfold:

BRUSSELS (MNI) – EU finance ministers will urge the Greek government to make its statistics office independent and to address methodology weaknesses in its data collection when they meet next Tuesday.

The move comes on the back of a European Commission report which showed that the Greek statistics agency revised its data many times in the period 2005-2008 and concluded that, unless the quality of the data is improved, the reliability of the information remained in question.

Commission sources say it is only a matter of time before legal proceedings are launched to force Greece to improve the quality of the information it provides.

via EU Finance Ministers To Urge Greece To Improve Statistics | iMarketNews.com.

I have not had a chance to see or understand what the Greeks were doing to manipulate their data, but the fact that a government even resorted to such tactics is absurd.

Meanwhile, Jean-Claude Juncker is going “all-in” on fiscal reform because he says two things will not happen, according to Bloomberg:

“Two things won’t happen: Greece won’t go bankrupt; but it has to make enormous efforts,” Juncker said at a press conference in Luxembourg today. “The second point is that the hypothesis that a country will leave the eurogroup or euro zone is not a question. It’s absurd.”

So he’s leaving it squarely on the Greeks to get fiscal reform right. This from the gang that can’t report straight.

Meanwhile, the market doesn’t share Mr. Juncker’s thinking. The two charts (courtesy of FT Alphaville) show: 1) the increase in the cost of protection and 2) the term structure of those protection costs:

As worrisome as the first chart is, the second is positively harrowing. The fact that credit protection at the front-end of the curve costs more than at the back end of the curve is a ‘tell’ the market is fearful – indeed frightened – that the possibility of a Greek default will occur much sooner rather than later. Is it within the next week? The next month? Or the next year? Regardless, it looks like it could happen soon, which makes Juncker’s statement about fiscal reform being the only course of action Brussels will see through an ‘all-in’ call on ‘the River.’ Alright, I’ve exceeded my quota for Texas Hold’em analogies for one post. I get it.

But Juncker’s statement tells me the EU has no idea what their contingency plan will be, because they have no contingency plan. But when you let countries adopt the currency and throw your own requirements for usage overboard, your inviting yourself nothing but trouble.

Whatever happens to Greece, the ramifications will hit the other PIIGS hard and fast. Which will bring the sustainability of the Euro further into doubt than it is already. I, for one, am expecting to see weakness both in the Euro & Yen with the dollar being the beneficiary along with commodities like oil and gold. It’s important to keep track of these other moving parts because if you’re just watching the Euro/Yen cross, there’s a lot of context you’ll miss in the markets going on around you.

At any rate, I wonder who is going to come in and do the top-to-bottom review of Greece’s statistical collection methods because they need one if anyone is going to trust their economic data ever again.

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God, Gold, Guns & Butter, and Cold Hard Cash

Tamela Rich, who is a brilliant talent, wrote a thought-provoking blog recently. Part memory lane stroll, part analysis of the symbolism of “The Wizard of Oz” with a smattering of finger-wagging at Glenn Beck (who is a total tool, in my view), it’s a great post. I’d encourage you to read it yourself.

I commented on her post there, saying that I’d have more to talk about here on my blog. Because her post was so rich, there’s so much to talk about so it can be kind of hard to whittle things down and focus on some key ideas. But one thing I want to delve into is one of the things we’ve all seen on TV by now: those ads imploring you to sell your gold for cash. She used one with Glenn Beck, so I’m going to up the ante by using an ad with not one, but two has-been celebrities. Actually, one washed-up celebrity and one that’s deceased:

Not to be outdone, there’s the Mr. T Gold Indicator, courtesy of Minyanville and one of their chief Minyans, Kevin Depew. It has all of the things I look for in a technical indicator: it’s easy to use and even easier to laugh at.

But what should we make of all of the talk about gold? It’s clearly been on a tear over the past year, recent pullback notwithstanding.

As Tamela points out in her blog post, gold has historically been used as a hedge against inflation. Plus, as gold as always been used as a currency unto itself, it’s safe to use as a payment/settlement mechanism all on its own.

The problem with gold, or any other commodity for that matter, is that settlement of a transaction can be unwieldy. I mean, can you envision paying for your house with 200 ounces of gold ($240,000 purchase price with gold at $1200/oz)? That’s walking around with 12 and a 1/2 pounds of gold.

As I pointed out in a recent post, the real reason for fiat currency’s existence is the ability to settle transactions with a  mechanism that is easy to carry, easy to account for. Until the ideas of fiat currency and credit had taken hold, we lived very much in a barter-based world. Where we have gotten ourselves into trouble – and brought the rest of the world into this mess because the dollar is the world’s reserve currency – has been in the overextension of credit. We have gone completely apeshit with the idea of borrowing from the future to pay for the present, largely on the belief that we would always grow our way out the debt obligation.

Here’s the problem: how can anyone expect us to grow our way out our debt obligations, when debt is growing faster than the long run average growth rate of GDP? The long-run average growth rate is about 3.5%.

Meanwhile, debt growth has been at a much higher rate.

What needs to change is our spending. GDP growth will be what it’s going to be. We can’t change that. But we can sure change how we think of borrowing and the use of credit. And that’s the real secular trend to be focused on. Because through tighter control of credit, control of inflation/hyperinflation risks we see before us will be greatly reduced.

But this is all being juxtaposed against a deflationary backdrop. All you need to look at is the latest Flow of Funds release from the Fed to see that even though we have benefited from a sharp rally in equity values from March ’09, the net worth of households is still a good deal lower than 2 to 3 years ago:

With such a deflationary context, gold loses its luster as a hedge against inflation, simply because there’s no inflation in the prices of goods and services to hedge against. In such a scenario, gold loses some purchasing power while cold, hard cash makes gains in its purchasing power.

Which explains why there are so many commercials out there trying to get people to sell their gold for cash. For them, the current situation is about raising liquidity – not about holding onto assets that are illiquid.

This presents us a ‘wishbone world:’ two scenarios, with plenty of pulling and tugging on both sides, all to see which side gets the bigger half of the wishbone.

Let’s just hope someone doesn’t lose an eye in the tug o’ war.


Filed under finance, government, macro, Markets, Way Forward

Wordless Wednesday 01-06-10

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