Monday, December 31, 2007

Small is beautiful

J R Nyquist argues that internationalism is used as a cover for expansion by aggressive states, and the nation-state is our stoutest defence.

I think this links in with our domestic EU in-or-out debate, on which the allegedly Conservative British MP David Cameron has recently been making flirty noises. I say "flirty" because although the headline talks boldly of tearing up the un-referendum-ed Constitution, the leader of the Opposition says "We think the treaty is wrong because it passes too much power from Westminster to Brussels." How much is enough?

Perhaps some will say mine is a typical reaction from a little Englander, but originally that term meant an opponent of imperialism. Well, I'm used to ignorant brickbats. It was Philip Toynbee who - his son told me - called me a Colonel Blimp while I was still at school, I think because I had dared to ask him about the significance of colour in Lorca's poetry. What I gathered from this experience was: never ask a posh leftie for an explanation, he'll only look down his egalitarian nose at you. (I haven't met his daughter Polly, though.) Intriguingly, though the term "little Englander" is said to date from the 1899-1901 Second Boer War, there is an 1833 German dictionary-cum-phrasebook (published in Grunsberg) called "Der kleine Englander ober Sammlung". I do hope the title wasn't intended to have a pejorative tinge, but you can never be sure with the Germans - they do have a wry sense of humour.

The relevance of all this, aside from the asides? I think the themes of diversity, dispersion and disconnection will grow in importance over the coming years, in politics and economics. As with some mutually dependent Amazonian flowers and insects, efficiency and specialisation will have to be balanced against flexibility and long-term survival.

Sunday, December 30, 2007

Recession QED

In an educational (and mercifully profanity-free) essay, Karl Denninger builds up his case from first principles, explaining the processes of creating and destroying money. He expects house prices to fall back by 30 - 50% and notes that in a recession, equities typically lose 30%.

He says the media is not reporting the truth. I tend to agree: I now throw away the Sunday football and financial supplements at the same time. If you want to know what's really happening, he says, watch what is going on at the banks, the Federal Reserve and Goldman Sachs, all of whom are battening the hatches, while CNBS (also castigated by Jim Willie) plays a cheerful tune to the proles.

I've written before how in 1999, as a financial adviser, I sat through a presentation from a leading UK investment house about tech stocks, which were supposedly about to start a second and bigger boom. I suspected then, and even more so now, that they were looking for the fabled "bigger fool" to offload their more favoured clients' holdings. Denninger intimates the same:

Are these shows, newspapers, and others reporters on the financial markets, entertainers, or worse, puppets of those who know and who need someone – anyone – to unload their shares to before the markets take a huge plunge, lest they get stuck with them?

Then he gives his predictions - which are grim, but not apocalyptic. It's the fools who will get roasted, not everybody. (By the way, Denninger is another Kondratieff cycle follower.)

What to hold, in his opinion? Cash, definitely; anything else, check the soundness of the deposit-taker. If you want to gamble on hyperinflation, he thinks call options on the stockmarket index are likely to yield more than gains on gold, even if the gold bugs are right.

This is where I thought we were in 1999. Thanks to criminally reckless credit expansion in the interim, we're still there, only the results may be worse than I feared then.

Oh, and he thinks the dollar will recover to some extent, because the rest of the world is going to get it just as bad, and probably worse. (Interesting that the pound is now back under $2.)

Saturday, December 29, 2007

The answer to Olduvai?

I am most grateful for a comment by "APL" on the heroic "Burning Our Money" blog, which directs us to an article on the potential of radiation-free fusion energy.

There is an international project (ITER) in the south of France to develop this, and if it works...

UPDATE

Thanks to GMG for a link to this discussion of fusion power, which tends to the conclusion that a successful and economically viable fusion system is a very long way off, if feasible at all, and we'd do better to concentrate on fission, i.e. the present type of nuclear power station.

Spot the trends

The CIA World Factbook gives global GDP per capita as $10,200 (in purchasing power parity terms). This puts the average standard of living somewhere between Kazakhstan and Mexico. On the same basis, per capita income is $43,800 in the USA and $31,800 in the UK .

Generally, the poorer the country, the higher the income inequality as measured by the Gini Index (except for Azerbaijan, according to this from the ESRC).

The Factbook estimates 30% combined unemployment and underemployment in many non-industrialized countries; developed countries typically 4%-12% unemployment.

There are enormous fortunes to be made (by some) arbitraging the economic differences between countries.

In the USA and the UK, we are relentlessly spending more than we are earning.

What are our governments' plans for us to remain rich? And given the correlation between income and equality, do our business, media and political elites have much incentive to make and seek support for such plans?

Contradicting the contrarians

Cash is king for now, but later next year it'll be equities up, dollar up, bonds down, according to the round table on Safe Haven.

UPDATE

But Tim Wood expects the market to hit a low - "The straw that finally breaks the camel’s back may be closer than you think."

Friday, December 28, 2007

Desperate hope

"Desperate hope" is an oxymoron, which sounds like a dumb bull: mine is that we will have a tough landing rather than a complete crash. Goading the dumb bulls is The Mogambo Guru (Richard Daughty), who delivers another comical end-of-the-world sermon on inflation. He thinks dropping interest rates will encourage borrowers to take on still more debt.

However, many have already pointed out that (a) lending criteria are tightening and (b) not all of the interest rate cut is being passed on to the borrower. So lenders are trying to reduce their exposure and are also being paid more for the risk they have already assumed. And we see from this Christmas shopping season that (c) the consumer is becoming more reluctant to spend.

That's not to say that we won't get inflation (in some sectors, not housing), since falling interest rates tend to depreciate the currencies of debtor countries relative to their cash-rich trading partners. On the other hand, the latter will continue trying to hold down their currencies, in an attempt to keep the show on the road - the show being the osmosis of wealth from the lazy, spendthrift West to the hard-working, hard-saving developing world.

We're going to be buying less, but I don't know how fast the Eastern co-prosperity sphere will take up the slack. In his book "The Dollar Crisis", Richard Duncan argues for a worldwide minimum wage to stimulate demand; but maybe events have overtaken him. Certainly, China aims to expand its middle class, rapidly.

But there's another way for China to stave off depression while waiting for the sun to rise in the East. According to James Kynge, manufacturing and transportation costs account for only about 15% of the end-price of Chinese exports to the US. Some of the expanding Chinese middle class will surely go into advertising, marketing, sales, distribution and finance. As China develops its own version of Wal-Mart, Omnicom and banking, credit card and financing operations, it'll own more of the total profit in the supply chain - some of which it can sacrifice to retain market share. And they're motivated to do so by the fact that domestic consumption yields very little profit for their companies: the money's in exports. The longer this game goes on, the more the decline of capital and skilled labour at our end.

So let's worry about the effects at home first. Yes, for investors inflation may be a worry, but perhaps they should extend their concern to include the stability of the society in which they live, as unemployment and insolvency stalk through the West. The issues are no longer financial, but political and social.

And we'd better hope that we don't go for the wrong solutions. Daughty quotes Ambrose Evans-Pritchard's 12 December article in The Daily Telegraph, which concludes (amazingly), "... it may now take a strong draught of socialism to save the Western democracies." I do not think Mr Evans-Pritchard is very old. Or maybe he's just saying that to bug the squares, an expression I'll wager he's too young to remember.

Anatomy of a CDO

The Wall Street Journal provides a grisly visual dissection of a subprime mortgage package - thanks to The Contrarian Investor for the lead.

If I follow correctly, the trickery seems to come in step 4, where a CDO largely composed of middling-rated mortgage risk sells bits of itself with unreasonably optimistic ratings attached. "Skimmed milk masquerades as cream".

Thursday, December 27, 2007

Some interesting correlations

Greg Silberman reveals the results of some interesting research:

1. Since 2003, if the dollar falls, all other asset classes rise; and conversely, if the dollar rises, the rest drops.

2. The "real" (adjusted for the price of gold) interest rate on 3-month Treasury bills predicts movements in the exchange rate of the dollar a year later.

Since the "real" interest rate has fallen sharply, he therefore expects a strengthening in other assets next year.

Modestly, Silberman adds, "Correlations are never perfect and tend to fail just when you need them most."

I think he's right there. To me, there seems to be a lot of jiggery-pokery in the gold market (speculators vs. central banks), and the predominance of "fiduciary money" (credit) in the economy means that we're measuring sizes with elastic bands.

In times of stress, the normal predictors don't hold, so currently I view all investments as speculative. My first priority is to reduce my vulnerability with respect to creditors, and my second is building cash to take advantage of emerging opportunities.

Defensive investing

Michael Panzner's latest is lucidly entitled "Today's Lesson: Bad Economy = Bad Stock Market". At last, financial analysis I can understand.

I've never understood why the stockmarket seems serenely unrelated to the dire state of the economy. Supposedly the market "looks ahead" around a year, but it can't be seeing what I'm looking at.

Anyhow, Panzner reproduces Dan Dorfman's article in the New York Sun, which reviews what's happened to the market in past recessions and gives tips on strong defensive areas - booze, cigs and "household products". I can understand that, too - or the first two, at least.

Jim Willie goes bowling

Bowling is fun - some would say, too much fun. Apparently, Connecticut passed a law in 1841 banning "ninepin lanes" and so fostered the invention of tenpin. In the old game, still played in England, you set them up manually - it gives you something to do while downing your beer and waiting your turn. The uneven boards of the alley add a pleasantly unpredictable element, too.

Jim Willie stands up nine reassuring statements about the US economy and smashes the lot down. He goes to the back of his mule for material to throw at Greenspan, Wall Street, CNBC etc and concludes that nothing is going to stop the financial melt. So he recommends gold.

He may be right, since on both sides of the Atlantic the authorities have decided to bail out lenders, instead of following Marc Faber's advice to let some of the players be taken out of the game.

However, as Faber has also pointed out recently, gold is an item everyone thinks everyone else supports, without committing themselves (elections have been lost that way). Is it not possible that we could see a continuing uptrend in the (relatively small) gold market, simply because of increased demand from existing fans? In which case, don't come late to the party - you'll have brought fresh beer but missed the fun.

Wednesday, December 26, 2007

Uncertainty

A trio of articles from Safe Haven: Paul Tustain thinks that inflation, and even hyperinflation are indeed possible, because of support operations for the banking system; Michael Swanson reads the charts and thinks the stockmarket could be teetering on the edge; Adam Oliensis of The Agile Trader is man enough to admit he's baffled:

A couple of things seem pretty clear to me: first, that I haven't lived long enough to have enough experience to know whether the bulls or bears are right about just how far the ripples will spread from the credit market problem; second, that there's never been an economic cycle just like this one, so even the people who have lived long enough to know who's right are speculating at best. (highlight mine.)

So it's not just me that's confused. And we're in distinguished company: Marc Faber also says we are in a new situation, with the possibility of a first-time-ever worldwide bust.

If we're into guesswork, then mine is that for a while, the monetary inflation will offset the credit (or "fiduciary money", as I'm learning to call it) deflation.

And then? Here's what worries me, in my amateurish, hunchy fashion: balance can be achieved in different ways (an empty seesaw is not the same as one with an elephant at each end). There's been a massive buildup of energy within the system, and the question is, can the Xbox take it?

Can democracy resist the hyperinflation route?

The Contrarian Investor thinks that rather than face economic depression, voters will force the US government to destroy wealth by hyperinflation. The arguments are therefore not economic but political.

I'm not so pessimistic; and if I were, investing in gold would be of less concern than physical survival.

Marc Faber: profile and views

Here's a profile of Marc Faber from 18 months ago, describing him as an ace, though I'd say he's a wild card: a hedonist whose philosophy is non-attachment, a lover of life who festoons his website with images of mortality. It's a cavalier, death-spiced duality that women tend to find very seductive.

And here's an interview he gave to Resource Investor 5 days ago. Some snippets:

it’s clear that in the U.S. we are already at some kind of a stage of stagflation where say retail sales are strong because grocery prices are rising very strongly. So that boosts essentially grocery sales whereas sales of discretionary items are sluggish...

the whole credit bubble that we’ve built over the last 25 years, I have to point it out, has now basically come to an end. We will have lower credit growth... that leads to poor economic conditions... the Fed will eventually win because they can print an unlimited amount of money, and they can essentially expand their balance sheet by not only acquiring treasury securities, but also lower quality paper... at that point I suppose that inflation will become a problem. And so in real terms you will have no economic growth, and you have a real kind of stagflationary environment...

whenever ... you have relative tightening of international liquidity ... you have a period of dollar strength... I think that we may have for the next three months at least a rebound in the U.S. dollar... I think long-term the dollar is a doomed currency because you have a money printer at the Fed and you have basically Hank Paulson at the Treasury who comes straight out of Wall Street and who has more interest in stabilizing the price of Goldman-Sachs stock than of having a strong dollar...

the global economy will slow down very considerably over the next six to 12 months...

I’m not very bullish about commodities right now. I think the price of gold will also come under some pressure... But long-term I think that having Mr. Bernanke at the Fed, you have essentially a friend of gold at the Federal Reserve because he will print money...

I would like to add to your comments that so many people are bullish about gold... people have actually very little gold in their portfolio... the gold bugs are bullish about gold, but the other 95% of the world, they have no gold exposure at all.

If he's right, my guesses (23 December) aren't too far off the mark.

Tuesday, December 25, 2007

Liberty Dollar Update

A news item here about a bill introduced by Ron Paul, to stop the government misusing its power to kill-off rival currencies.

Sunday, December 23, 2007

Visions of 2008

Following Dearieme's comment on the previous post*, I'm going to try to visualise a chain of events over the next year - guesswork, of course, with plenty of obvious ones:

USA

a marked deflation in property prices
a reduced demand for luxury goods and services
reduced imports of the above
consequent recession abroad
further interest rate cuts
higher unemployment
higher taxes
higher State and Federal budget deficits
a sell-off in equities
increased demand for bonds
a weakening currency
higher prices for food, fuel and clothing

increase in the price of good-quality agricultural land
consumer price inflation indices will not be able to continue to mask the real increases in costs of living, and this will have further consequences for public finances
public enquiries, leading eventually to a thorough reform of the financial system

UK

much the same as above, except I don't think our house prices will fall so far - the US subprime mess will hit investments, but we will drop our interest rates to devalue the pound to maintain stability against the dollar

Gold

will continue to fluctuate interestingly, but although some smart money is after it, there will be less spare money around generally, and other commodities will offer interesting opportunities for inflation-beaters. It's already above its inflation-adjusted long-term trend, and lenders will make sure that the real value of their loans is not destroyed by hyperinflation

... in short, slumpflation.

UPDATE

*and, by way of comparison, here is Karl Denninger's outlook in his Dec 24 post.
... plus a more sanguine assessment by Nadeem Walayat.

A Merry Christmas to all, and thanks for your visits and comments.

Saturday, December 22, 2007

IN, not DE

Peter Schiff argues the opposite way to Karl Denninger, pointing to the large amounts of US currency held abroad. In paper-money terms, he foresees continuing consumer price inflation, faster than for the assets you hold, so you're going to get poorer. If assets also inflate, we're into hyperinflation. Reasoning this way, he is, of course, a gold supporter.

Righteous wrath

Karl Denninger comments angrily on the failure of authorities to grasp the nettle - issuing warnings instead of downgrading credit ratings, holding back from forcing off-book liabilities back onto the balance sheet.

I've been looking for one of those famous photographs from China's "Great Leap Forward", showing children standing on a field of wheat, such is the success of the Party's new agricultural techniques. Can anyone help me find it on the Net?

For it's certainly a bit like the official-fudged miracle economy we've got now. Except even the peasants have stopped believing in it, to judge by what's happening in the retail outlets.

Green screens

The traders seem to be filling their boots with annual bonuses, as I guessed on 20 November (Red Screens) - or is it just the cyclical winter upswing in the market, as Joseph Dancy shows?

Thursday, December 20, 2007

Hark what discord follows

David Galland rehearses the argument for gold. He points out that, relative to stocks, the gold market is so small that a small shift into it from stocks would massively inflate demand. Against that is the fact that it hasn't happened yet, and that a small market can also be manipulated downwards by suppliers, particularly the central banks. Besides, in a real panic, Joe Average isn't looking to make a killing in commodities, he's trying to pay bills in cash and buy food and fuel ditto. Nice area for speculators with quick reflexes, though.

What is inflation, anyway? Ronald Cooke looks at the damned lies and self-serving statistics that underpin the official Consumer Price Index.

Jim Patterson reads the stockmarket runes and concludes:

Sub-Prime issues have been discounted. With overall market returns compressed the downside is limited. We expect a better market in the weeks and months ahead.

In his slightly starchy prose, The Contrarian Investor agrees with Patterson, up to a point, but also gives a serious warning:

1. In today’s market, the probability of the market going up is higher than the probability of it coming down. Hence, it is rightly called a bull market.

2. But should it come down (which is unlikely), it can collapse at extremely great speed and magnitude.

Hence, the stronger and longer this uptrend continues, the greater in magnitude and speed (as in volatility, not timing) the Great Crash III will be. Hence, the coming Great Crash III is a Black Swan event—an improbable but colossal impact event.

The importance of a particular event is the likelihood of it multiplied by its consequences. Black Swan events are events that are (1) highly unlikely and (2) colossal impact/consequences. One common mistake investors (and many professionals) make is to look at the former and forget about the latter i.e. ignore highly unlikely but impactful events.

Therefore, when contrarians are preparing for a crash, it does not necessary mean that they are predicting doom and gloom. Rather, they see the vulnerability of Black Swans and prepare for them.

Credit default swaps - a line of dominoes, one falls

Karl Denninger reports on the savage downgrading of a credit default insurer from "A" to "CCC" (junk) in one move - essentially a collapse in creditworthiness - and explains the implications for credit and investment markets. His conclusion is crystal clear:

If you're long stocks, bail now.