Story here.Saturday, January 02, 2010
Why hold cash?
A couple of days ago, I looked at the housing market and mortgages, especially the US government-sponsored enterprises "Fannie Mae" and "Freddie Mac". The hook for the story was the news, slipped out on Christmas Eve, that the government is considering doubling its existing support for these two agencies, to maybe $800 billion. Some thought that the move might presage forgiving a proportion of the mortgage debt, though it seemed more likely to me that it was about making reassuringly generous provisions against loss from defaults.
One aspect I had overlooked was, who exactly might need this reassurance. The biggest holder of mortgage-backed bonds from Fannie Mae and Freddie Mac is and has been for a long time, reportedly, China. Back in 2008 when the credit crisis was under way, a Chinese commentator pointed out that China stood to lose heavily if those bonds decreased in value.
If bonds are perceived as having an increased risk of default, buyers in the market expect a higher income to compensate. Since bond income is fixed, the way that the yield increases is that the traded price of the bond falls. So, a potential capital loss for existing bondholders, including China.
The bigger picture is the need for governments to keep interest rates low, to prevent further collapse in the housing market for political-economic reasons, but also to keep down the cost of servicing the government's own debts. This is especially important because national debt has ballooned, not only because of official intervention in the markets but because there is more unemployment benefit paid out and less tax coming in. Damping the interest rate is forcing the government to take on further debt, which makes it even more vital to keep the rate down... it is a vicious circle.
Debt is either repaid or defaulted. But default would affect all owners of the bonds concerned, including US pension funds and other collective investments, so to some extent this would be cutting off one's nose to spite one's face. And cheating outsiders would be dangerous - a "credit strike" by foreigners (China alone probably owns $1 trillion-plus of Treasury debt, directly and indirectly) would cripple the debt-dependent US with rapidly-rising interest rates. The dangers might not be merely economic, either.
So debt is going to be paid off the hard way, and that means a long and painful period as people spend less and start to pay-off their loans, and pay more in taxes. The picture is much the same in many advanced economies - it's thought the UK is in an even worse situation - and developing economies are still greatly dependent on trade with us Western spendthrifts.
Is there anyone who won't be affected? Perhaps there is a country that balances its budget, does not let its economy be unsettled by flows in and out of international cash (see what happened to Iceland), and doesn't trade much with the rest of the world; but if such a place exists, it's probably a very poor country anyway.
One question that I think will be asked time and again in the coming years, is whether democracies can take action that is tough enough and quick enough to deal with the problem. Politicians seeking re-election will be tempted to apply the brakes too gently. But if they do not act decisively, especially in trimming public expenditure, those who still have money to lend will be the disciplinarians instead - interest rates will rise. Deferring the treatment will only mean nastier medicine later.
Unfortunately, that's what I think will happen, and so I believe we face a period when it will be very important to get out of debt, and quite rewarding to have cash savings. In fact, that has already been so when you look at the last decade; but I think it will continue to be so for some years yet. Yes, there are some who will use short-term trading to make good gains - look at how the market bounced in 2009 - but if we are in a "secular" (long-term) "bear market", there is more probability of loss than gain. "Bear market rallies" can and do break the fortunes of bold investors. For the more cautious, currently itchy to get a better income than the bank offers them, I suggest we are still in a phase where the return OF your cash matters more than the return ON it. The grass on the other side of the fence may be greener, but there are hidden predators concealed in that grass.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
One aspect I had overlooked was, who exactly might need this reassurance. The biggest holder of mortgage-backed bonds from Fannie Mae and Freddie Mac is and has been for a long time, reportedly, China. Back in 2008 when the credit crisis was under way, a Chinese commentator pointed out that China stood to lose heavily if those bonds decreased in value.
If bonds are perceived as having an increased risk of default, buyers in the market expect a higher income to compensate. Since bond income is fixed, the way that the yield increases is that the traded price of the bond falls. So, a potential capital loss for existing bondholders, including China.
The bigger picture is the need for governments to keep interest rates low, to prevent further collapse in the housing market for political-economic reasons, but also to keep down the cost of servicing the government's own debts. This is especially important because national debt has ballooned, not only because of official intervention in the markets but because there is more unemployment benefit paid out and less tax coming in. Damping the interest rate is forcing the government to take on further debt, which makes it even more vital to keep the rate down... it is a vicious circle.
Calculating total debt is difficult, but it's generally accepted that in the USA, the combination of public and private debt is higher than ever before, even when compared to GDP. Some will also factor-in a notional amount of debt, relating to the government's future obligations in terms of social security and medical care. One of those people is David Walker, formerly the US Comptroller-General, who toured the country from 2007 onwards to warn of coming economic difficulties. This commentator has estimated the debt at $57 trillion.
Debt is either repaid or defaulted. But default would affect all owners of the bonds concerned, including US pension funds and other collective investments, so to some extent this would be cutting off one's nose to spite one's face. And cheating outsiders would be dangerous - a "credit strike" by foreigners (China alone probably owns $1 trillion-plus of Treasury debt, directly and indirectly) would cripple the debt-dependent US with rapidly-rising interest rates. The dangers might not be merely economic, either.
So debt is going to be paid off the hard way, and that means a long and painful period as people spend less and start to pay-off their loans, and pay more in taxes. The picture is much the same in many advanced economies - it's thought the UK is in an even worse situation - and developing economies are still greatly dependent on trade with us Western spendthrifts.
Is there anyone who won't be affected? Perhaps there is a country that balances its budget, does not let its economy be unsettled by flows in and out of international cash (see what happened to Iceland), and doesn't trade much with the rest of the world; but if such a place exists, it's probably a very poor country anyway.
One question that I think will be asked time and again in the coming years, is whether democracies can take action that is tough enough and quick enough to deal with the problem. Politicians seeking re-election will be tempted to apply the brakes too gently. But if they do not act decisively, especially in trimming public expenditure, those who still have money to lend will be the disciplinarians instead - interest rates will rise. Deferring the treatment will only mean nastier medicine later.
Unfortunately, that's what I think will happen, and so I believe we face a period when it will be very important to get out of debt, and quite rewarding to have cash savings. In fact, that has already been so when you look at the last decade; but I think it will continue to be so for some years yet. Yes, there are some who will use short-term trading to make good gains - look at how the market bounced in 2009 - but if we are in a "secular" (long-term) "bear market", there is more probability of loss than gain. "Bear market rallies" can and do break the fortunes of bold investors. For the more cautious, currently itchy to get a better income than the bank offers them, I suggest we are still in a phase where the return OF your cash matters more than the return ON it. The grass on the other side of the fence may be greener, but there are hidden predators concealed in that grass.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Friday, January 01, 2010
Deflation and economic cycles
Experts are uncertain about the way the economy will go - will we return to normal, do we face inflation (plus recession) as in the 1970s, or is it to be a "deflationary depression"?
Deflation is when there is less money (including borrowed money) in the economy. In such a situation, "cash is king". In this article, James Wood argues that the large government financial stimulus will not work, because an even larger amount of money has been lost on the stockmarket and in the housing market. He's talking about the USA, but much the same could be said of the UK (though here on our crowded island, it may be that the housing market does not suffer from quite such an oversupply as in the United States.)
Thinking along the same lines, Robert Prechter offers some recommendations. Here are a few major "dont's":
• Generally speaking, don’t own stocks.
• Don’t own any but the most pristine bonds.
• Generally speaking, don’t invest in real estate.
• Generally speaking, don’t buy commodities.
Prechter is an advocate of the Elliot Wave theory, which tries to fit a pattern onto long-term stock market movements. According to this analysis, the current market recovery is merely a temporary upturn before a long drop to the lowest point in the cycle, when it all begins again.
There are other theorists who have attempted to find cycles. One such is Nikolai Kondratiev (or Kondratieff), who thought he saw "long waves" in the economy, lasting a couple of generations. His followers think we are heading for the low point in that cycle - the Kondratieff Winter. In this time, deflation means that people try to store their money in whatever they consider safe - for example, government bonds, cash and gold. If the cycle is as regular as some would have it, "winter" will end somewhere around 2016-2018 - which is an interesting coincidence, because adjusted for inflation, the Dow Jones Index took 16 years to decline from its peak in 1966 to its bottom in 1982 (according to K's followers, that was the "summer" season). Here is a seductively attractive graphic summarising the Kondratieff cycle (please click on the image to enlarge it):
There are a couple of problems with all such attempts. Firstly, the human mind is wonderfully adapted to find patterns, and will find them even in randomness, which is why people once thought they could see a system of canals on Mars. Even if there is such a thing as a long-term economic cycle, there is the question of fit: exactly when will the change come? Once you think you see a pattern, there is the temptation to jam reality into the theory, like Cinderella's sisters trying on her slipper even at the cost of losing a toe or heel in the process.
The second problem is that we are dealing here with human behaviour, and unlike other things in Nature, this subject can take into account the theory that attempts to describe it - and change accordingly. For example, if I say I know what you are going to do next, and tell you, you may then alter your plan so as to prove me wrong. If all investors followed the Elliott Wave theory, they would presumably try to anticipate each other's reactions and that would alter the pattern.
However, these groups of theory-followers are, I think, still in a minority, so maybe the patterns will work, roughly. The contrarian instinctively feels that the way to win is not to follow the crowd - I remember the rich Yorkshire farmer in one of James Herriot's books whose principle was "When all the world goes one way, I go t'other".
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Deflation is when there is less money (including borrowed money) in the economy. In such a situation, "cash is king". In this article, James Wood argues that the large government financial stimulus will not work, because an even larger amount of money has been lost on the stockmarket and in the housing market. He's talking about the USA, but much the same could be said of the UK (though here on our crowded island, it may be that the housing market does not suffer from quite such an oversupply as in the United States.)
Thinking along the same lines, Robert Prechter offers some recommendations. Here are a few major "dont's":
• Generally speaking, don’t own stocks.
• Don’t own any but the most pristine bonds.
• Generally speaking, don’t invest in real estate.
• Generally speaking, don’t buy commodities.
Prechter is an advocate of the Elliot Wave theory, which tries to fit a pattern onto long-term stock market movements. According to this analysis, the current market recovery is merely a temporary upturn before a long drop to the lowest point in the cycle, when it all begins again.
There are other theorists who have attempted to find cycles. One such is Nikolai Kondratiev (or Kondratieff), who thought he saw "long waves" in the economy, lasting a couple of generations. His followers think we are heading for the low point in that cycle - the Kondratieff Winter. In this time, deflation means that people try to store their money in whatever they consider safe - for example, government bonds, cash and gold. If the cycle is as regular as some would have it, "winter" will end somewhere around 2016-2018 - which is an interesting coincidence, because adjusted for inflation, the Dow Jones Index took 16 years to decline from its peak in 1966 to its bottom in 1982 (according to K's followers, that was the "summer" season). Here is a seductively attractive graphic summarising the Kondratieff cycle (please click on the image to enlarge it):
There are a couple of problems with all such attempts. Firstly, the human mind is wonderfully adapted to find patterns, and will find them even in randomness, which is why people once thought they could see a system of canals on Mars. Even if there is such a thing as a long-term economic cycle, there is the question of fit: exactly when will the change come? Once you think you see a pattern, there is the temptation to jam reality into the theory, like Cinderella's sisters trying on her slipper even at the cost of losing a toe or heel in the process.The second problem is that we are dealing here with human behaviour, and unlike other things in Nature, this subject can take into account the theory that attempts to describe it - and change accordingly. For example, if I say I know what you are going to do next, and tell you, you may then alter your plan so as to prove me wrong. If all investors followed the Elliott Wave theory, they would presumably try to anticipate each other's reactions and that would alter the pattern.
However, these groups of theory-followers are, I think, still in a minority, so maybe the patterns will work, roughly. The contrarian instinctively feels that the way to win is not to follow the crowd - I remember the rich Yorkshire farmer in one of James Herriot's books whose principle was "When all the world goes one way, I go t'other".
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Wednesday, December 30, 2009
A straw in the wind reveals the changing direction of power
The public are gradually coming to realise that, within our countries, our institutions and businesses are not run fairly and for the general benefit of voters and investors.
Now, as the balance of economic power is shifting towards the East, we may discover that the rule of international law does not constrain the strongest. A straw in the wind is this story, about a small Chinese company that has defied a Goldman Sachs subsidiary, refusing to pay $80 million relating to derivatives contracts. The significant element is the reported preparedness of the Chinese government to support national businesses against foreign banks in the law courts.
Much more worrying, in my view, are the implications of this pugnacious stance if it is applied to copyrights and patents. Since the West cannot compete with the low labour costs of the developing world, it is placing its hope in its long-accumulated expertise and technology. Should mighty foreign nations begin to disregard intellectual property rights, we could find ourselves in a very difficult position. I raised this issue in 1997 - here, here and here. Please also see my review of James Kynge's "China Shakes the World", where Kynge is given the run-around when he tries to enquire into copyright theft in China.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Now, as the balance of economic power is shifting towards the East, we may discover that the rule of international law does not constrain the strongest. A straw in the wind is this story, about a small Chinese company that has defied a Goldman Sachs subsidiary, refusing to pay $80 million relating to derivatives contracts. The significant element is the reported preparedness of the Chinese government to support national businesses against foreign banks in the law courts.
Much more worrying, in my view, are the implications of this pugnacious stance if it is applied to copyrights and patents. Since the West cannot compete with the low labour costs of the developing world, it is placing its hope in its long-accumulated expertise and technology. Should mighty foreign nations begin to disregard intellectual property rights, we could find ourselves in a very difficult position. I raised this issue in 1997 - here, here and here. Please also see my review of James Kynge's "China Shakes the World", where Kynge is given the run-around when he tries to enquire into copyright theft in China.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Tuesday, December 29, 2009
The US (and UK) mortgage crisis continues
Update: China may now be experiencing a housing bubble
__________________________________________
Economist Mark Thoma comments on news (which was released on Christmas Eve - a "good time to bury bad news"?) that the US Treasury is considering doubling its line of credit to "Fannie Mae" and "Freddie Mac", from $400 billion to $800 billion. What does this mean?
Let's start with the background to these two "government-sponsored enterprises" (GSEs).
"Fannie Mae" is the familiar term for the Federal National Mortgage Association, set up in 1938 at the tail end of the American Great Depression to help make mortgages more easily available to low-income housebuyers, by buying the loans from mortgage lenders. Effectively, this was a way of guaranteeing poorer-quality loans and so it supported and encouraged lenders as well as borrowers.
In 1968, Fannie Mae was split into two companies; one private, doing the same job as before, but without an explicit guarantee against losses from defaults. The other part was a new public organisation, the Government National Mortgage Association, aka "Ginnie Mae"; this did guarantee mortgage-backed investments, but was originally intended to serve defined groups of borrowers, e.g. public employees and veterans (ex-military personnel).
In 1970, "Freddie Mac" (the Federal Home Loan Mortgage Corporation) was created to do much the same as Fannie Mae, so providing competition and helping to increase the supply of mortgages.
Given the quality of the loans that underpinned their products, Fannie Mae and Freddie Mac were particularly vulnerable to problems in the credit market and were so badly damaged in the "Credit Crunch" of 2008 that they were taken into public control, or "conservatorship". This helped maintain confidence in the banking system, but at a cost: the Treasury has, in effect, become the guarantor against losses, which now become the liability of the taxpayer. Some would say that a second cost is "moral hazard", in that reckless lenders have been shielded from the consequences of their actions, and so will not properly learn their lesson.
Returning to Mark Thoma, we find that mortgage defaults may eventually total $400 billion, which in inflation-adjusted terms is similar to the losses sustained in the Savings and Loan crisis of the late 1980s. (The root cause of the problem then was the same - treating houses as another type of speculative investment - and the trigger for the fallout was the Tax Reform Act of 1986, which (among many other changes) removed or reduced tax breaks relating to residential property investment.)
Why, after all this official support, are we expecting heavy losses on the housing market?
The answer, as I understand it, is that the wrong problem has been solved. By bailing-out banks and other lenders, governments on both sides of the Atlantic have attempted to preserve "liquidity" - the availability of money. But this doesn't tackle the real problem, which is "insolvency" - i.e. when debts outweigh assets. Housing is overpriced - valuations swiftly doubled in the four years after 2002 - and when people perceive that the prices are unrealistic in the long term, the prices have to come down. However, home loans don't come down; they are fixed amounts of debt, that is either paid or defaulted. So as house valuations decline, more and more homeowners find themselves owing more than the resale value of their property. Behind them stand many others who fear that they may find themselves in the same situation, or who realize that renting would be even cheaper than paying their mortgage.
For although interest rates have dropped to historically low levels, the capital still has to be repaid, and so the total monthly cost can't be reduced much more. In an economic downturn, the weight of this obligation is unlikely to lighten because of quickly-rising wages, and until house prices rise significantly, they will also look like a poor capital investment to the borrower. For millions, a mortgage is now a useless millstone around the neck.
Back in September 2008, I floated the wild idea of paying off all US mortgages and making all such loans illegal in future; a comment by one reader, "Sobers", suggested the more moderate approach of partial debt forgiveness. Thoma speculates that one reason for the increased Treasury line of credit for Fannie Mae and Freddie Mac may indeed be a preparation for writing-off a proportion of mortgage debt.
This would be a radical step and maybe it's more likely that the US Treasury simply wishes to make enough money available to cover all likely defaults, with enough extra to prevent the spread of panic in the housing market. After all, people who bought their houses 10 years ago or earlier, are less likely to be in "negative equity" now; unless they took out extra property-backed loans for consumer spending (known as "secured loans" in the UK, and "home equity line of credit" - or HELOC - in the US). Paying off part of everyone's debt would give help to those who didn't need it as well as those who did; and might carry its own "moral hazard" by allowing future borrowers to hope that they might one day be bailed-out, too, so encouraging them to spend too much and get into unaffordable debt. Better, on the whole, to underwrite the losses of the worst cases and discipline the defaulting borrowers with the stigma of repossession, which is a warning to other borrowers, though sadly not so much of an object lesson to lenders.
Another strategy, since interest rates are so low, would be to reduce monthly costs of borrowing by extending the term of mortages and so cutting the amount of capital that has to be repaid each month. You can play with variants on interest rates and mortgage terms here - Yahoo offers some American versions here - and as you can see, extending the term offers some relief. However, there's only so long you're likely to want to have a mortgage, unless we descend to the 100-year mortgages of Japan.
There's also not much scope for cutting interest rates further. The banks loaned out far too much money in the good times and cut their reserves to a dangerous minimum. When the governments made more cash available to them, they kept a lot of it as a temporary buffer, so borrowing for housebuyers and businesses has continued to be on difficult terms. And the banks haven't passed on much of the drop in interest rates, because they are trying to rebuild their reserves. The central banks could cut the interest rate to zero and the banks that borrow from them would still be charging us something like 4%. Until the banks are solvent, we are going to remain hard up; unless there is debt forgiveness, and I don't think that will come for quite some time yet.
In short, I expect the current half-optimistic mood to evaporate gradually in the coming year, as people realize that the problems are enduring and begin to adjust their expectations and behaviour accordingly. I anticipate a longer-term reduction in the inflation-adjusted valuations of houses, though there may be temporary rallies from time to time, just as you get them in a "bear market" in stocks and shares.
I said years ago to friends and colleagues that whatever you treat like an investment will behave like one, and not for the first time, the housing market is copying the behaviour of equities, with the added disadvantages of being less easily and more expensively sold, and of being bought with borrowed money.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
__________________________________________
Economist Mark Thoma comments on news (which was released on Christmas Eve - a "good time to bury bad news"?) that the US Treasury is considering doubling its line of credit to "Fannie Mae" and "Freddie Mac", from $400 billion to $800 billion. What does this mean?
Let's start with the background to these two "government-sponsored enterprises" (GSEs).
"Fannie Mae" is the familiar term for the Federal National Mortgage Association, set up in 1938 at the tail end of the American Great Depression to help make mortgages more easily available to low-income housebuyers, by buying the loans from mortgage lenders. Effectively, this was a way of guaranteeing poorer-quality loans and so it supported and encouraged lenders as well as borrowers.
In 1968, Fannie Mae was split into two companies; one private, doing the same job as before, but without an explicit guarantee against losses from defaults. The other part was a new public organisation, the Government National Mortgage Association, aka "Ginnie Mae"; this did guarantee mortgage-backed investments, but was originally intended to serve defined groups of borrowers, e.g. public employees and veterans (ex-military personnel).
In 1970, "Freddie Mac" (the Federal Home Loan Mortgage Corporation) was created to do much the same as Fannie Mae, so providing competition and helping to increase the supply of mortgages.
Given the quality of the loans that underpinned their products, Fannie Mae and Freddie Mac were particularly vulnerable to problems in the credit market and were so badly damaged in the "Credit Crunch" of 2008 that they were taken into public control, or "conservatorship". This helped maintain confidence in the banking system, but at a cost: the Treasury has, in effect, become the guarantor against losses, which now become the liability of the taxpayer. Some would say that a second cost is "moral hazard", in that reckless lenders have been shielded from the consequences of their actions, and so will not properly learn their lesson.
Returning to Mark Thoma, we find that mortgage defaults may eventually total $400 billion, which in inflation-adjusted terms is similar to the losses sustained in the Savings and Loan crisis of the late 1980s. (The root cause of the problem then was the same - treating houses as another type of speculative investment - and the trigger for the fallout was the Tax Reform Act of 1986, which (among many other changes) removed or reduced tax breaks relating to residential property investment.)
Why, after all this official support, are we expecting heavy losses on the housing market?
The answer, as I understand it, is that the wrong problem has been solved. By bailing-out banks and other lenders, governments on both sides of the Atlantic have attempted to preserve "liquidity" - the availability of money. But this doesn't tackle the real problem, which is "insolvency" - i.e. when debts outweigh assets. Housing is overpriced - valuations swiftly doubled in the four years after 2002 - and when people perceive that the prices are unrealistic in the long term, the prices have to come down. However, home loans don't come down; they are fixed amounts of debt, that is either paid or defaulted. So as house valuations decline, more and more homeowners find themselves owing more than the resale value of their property. Behind them stand many others who fear that they may find themselves in the same situation, or who realize that renting would be even cheaper than paying their mortgage.
For although interest rates have dropped to historically low levels, the capital still has to be repaid, and so the total monthly cost can't be reduced much more. In an economic downturn, the weight of this obligation is unlikely to lighten because of quickly-rising wages, and until house prices rise significantly, they will also look like a poor capital investment to the borrower. For millions, a mortgage is now a useless millstone around the neck.
Back in September 2008, I floated the wild idea of paying off all US mortgages and making all such loans illegal in future; a comment by one reader, "Sobers", suggested the more moderate approach of partial debt forgiveness. Thoma speculates that one reason for the increased Treasury line of credit for Fannie Mae and Freddie Mac may indeed be a preparation for writing-off a proportion of mortgage debt.
This would be a radical step and maybe it's more likely that the US Treasury simply wishes to make enough money available to cover all likely defaults, with enough extra to prevent the spread of panic in the housing market. After all, people who bought their houses 10 years ago or earlier, are less likely to be in "negative equity" now; unless they took out extra property-backed loans for consumer spending (known as "secured loans" in the UK, and "home equity line of credit" - or HELOC - in the US). Paying off part of everyone's debt would give help to those who didn't need it as well as those who did; and might carry its own "moral hazard" by allowing future borrowers to hope that they might one day be bailed-out, too, so encouraging them to spend too much and get into unaffordable debt. Better, on the whole, to underwrite the losses of the worst cases and discipline the defaulting borrowers with the stigma of repossession, which is a warning to other borrowers, though sadly not so much of an object lesson to lenders.
Another strategy, since interest rates are so low, would be to reduce monthly costs of borrowing by extending the term of mortages and so cutting the amount of capital that has to be repaid each month. You can play with variants on interest rates and mortgage terms here - Yahoo offers some American versions here - and as you can see, extending the term offers some relief. However, there's only so long you're likely to want to have a mortgage, unless we descend to the 100-year mortgages of Japan.
There's also not much scope for cutting interest rates further. The banks loaned out far too much money in the good times and cut their reserves to a dangerous minimum. When the governments made more cash available to them, they kept a lot of it as a temporary buffer, so borrowing for housebuyers and businesses has continued to be on difficult terms. And the banks haven't passed on much of the drop in interest rates, because they are trying to rebuild their reserves. The central banks could cut the interest rate to zero and the banks that borrow from them would still be charging us something like 4%. Until the banks are solvent, we are going to remain hard up; unless there is debt forgiveness, and I don't think that will come for quite some time yet.
In short, I expect the current half-optimistic mood to evaporate gradually in the coming year, as people realize that the problems are enduring and begin to adjust their expectations and behaviour accordingly. I anticipate a longer-term reduction in the inflation-adjusted valuations of houses, though there may be temporary rallies from time to time, just as you get them in a "bear market" in stocks and shares.
I said years ago to friends and colleagues that whatever you treat like an investment will behave like one, and not for the first time, the housing market is copying the behaviour of equities, with the added disadvantages of being less easily and more expensively sold, and of being bought with borrowed money.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Monday, December 21, 2009
When to invest?
This interactive resource from the Wall Street Journal (hat-tip to the Wall Street Pit blog) looks at 10-year returns from investing in the NYSE (companies listed on the New York Stock Exchange) and the S&P (Standard & Poor's) 500, i.e. the top 500 US companies. The last 10 years look like the worst decade since records began.
Now, some may say that it's a great time to get back in. But if you look at the S&P 500 graph at bottom right, you'll see that returns are calculated in both nominal and inflation-adjusted terms. Sometimes you get an apparent gain which is really much less so, or even a loss, once you take inflation into account.
This is exactly what happened in 1970-79. My fear is that all the current monetary pumping will stoke inflation and the market will rise in nominal terms, but these gains will be undermined by a general increase in consumer prices.
If we have a re-run of the 1970s, it could be years before the market yields real returns.I've covered this topic quite a few times on my old blog - in this post for example, I show that in nominal terms, the worst point was in September 1974; but adjusted for inflation, the real bottom came in July 1982:
It's said that history doesn't repeat itself, but it rhymes. If anything, that has worse implications for us, because by any measure, the levels of debt in the US and UK economies are much higher than they have ever been in history.
I can quite believe that the market will zoom up a bit more, but my feeling is that we are in what is known as a "bear market rally" - a temporary upward twist before a slump. Gamblers may make fortunes in the current rise, but the reversals in a bear market can be unpredictable, sudden and savage, just like the creature after which such a market is named.
Personally, I'm in favour of diversifying investments, and building up emergency supplies of cash and the things you need for daily life. I don't expect things to run smoothly in the next few years.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Now, some may say that it's a great time to get back in. But if you look at the S&P 500 graph at bottom right, you'll see that returns are calculated in both nominal and inflation-adjusted terms. Sometimes you get an apparent gain which is really much less so, or even a loss, once you take inflation into account.
This is exactly what happened in 1970-79. My fear is that all the current monetary pumping will stoke inflation and the market will rise in nominal terms, but these gains will be undermined by a general increase in consumer prices.
If we have a re-run of the 1970s, it could be years before the market yields real returns.I've covered this topic quite a few times on my old blog - in this post for example, I show that in nominal terms, the worst point was in September 1974; but adjusted for inflation, the real bottom came in July 1982:
It's said that history doesn't repeat itself, but it rhymes. If anything, that has worse implications for us, because by any measure, the levels of debt in the US and UK economies are much higher than they have ever been in history.I can quite believe that the market will zoom up a bit more, but my feeling is that we are in what is known as a "bear market rally" - a temporary upward twist before a slump. Gamblers may make fortunes in the current rise, but the reversals in a bear market can be unpredictable, sudden and savage, just like the creature after which such a market is named.
Personally, I'm in favour of diversifying investments, and building up emergency supplies of cash and the things you need for daily life. I don't expect things to run smoothly in the next few years.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Sunday, December 20, 2009
More on gold
During this crisis, we hear more from the "gold bugs" - people who are convinced that most modern currencies will become worthless, because they are "fiat money", i.e. the government can make unlimited amounts of them since they are not related to anything in fixed supply, such as gold (or land, when the Nazis restructured the mark).
One such is an American called Jim Willie. He reminds us of debt problems, not only in the USA and Britain, but Spain, Greece etc. Even Swiss banks are under pressure, because of loans to small European countires whose currencies have since devalued. Willie thinks the Euro will unravel because of the difficulties of a number of its member economies, and that Germany will reintroduce the mark, perhaps under some reassuringly Euro-like pseudonym.
Germany happens to have the world's second-largest official holding of gold - 3,400 tonnes compared to the USA's 8,100 (assuming we are being told the truth about how much the USA actually has in its vaults, and that is a matter of serious debate). This article reports China's ambition to increase its own holding of gold, from around 1,000 tonnes now to perhaps as much as 10,000 tonnes in 10 years' time.
The gold mania is not universal. Writing in the Daily Telegraph, Ambrose Evans-Pritchard predicts that the price of gold will actually fall next year - among other bad things such as the collapse of America's social security pension fund. He may be right. In a panic, people want ready money, so maybe cash will (for a time) be king. But when an economy is in dire straits, its government will do whatever it can to ease the pain, and many think that the strategy will be to increase the money supply, or even introduce a new form of the currency, as has just happened in North Korea.
The attraction of gold is for pessimists. It doesn't earn any interest, so mainly it is seen as a last-resort store of value when the money system breaks down (and it's nice to wear and show off). It is perfectly possible that you could make a loss on gold, but it will never be worth nothing at all, unlike the old US Continentals, or Confederate money after the North won the Civil War. In this context, it's worth noting that Reuters news agency reported back in September that Hong Kong moved its gold reserves out of London and into the gold depository at its Chek Lap Kok international airport. A sign of something, but what?
Gold is not the only tangible store of value, of course. Agricultural land, houses, food, medicines etc all have intrinsic value, i.e. they are worth something because of what they can do for you themselves, not just because they can be exchanged for something else.
Inflation remains a serious long-term threat. Comparing the past and present value of cash is difficult, because the economy has increased in size and changed in nature; but depending on the measure you use and looking at what has happened since 1971 (when I started at college), the British pound has lost 90% - 96% of its buying power. It's still (until April next year) possible to retire at age 50 in this country, so if history repeats itself, you could see a similar devaluation during a long retirement.
In short, it's not about the value of gold, but the unreliability of money.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
One such is an American called Jim Willie. He reminds us of debt problems, not only in the USA and Britain, but Spain, Greece etc. Even Swiss banks are under pressure, because of loans to small European countires whose currencies have since devalued. Willie thinks the Euro will unravel because of the difficulties of a number of its member economies, and that Germany will reintroduce the mark, perhaps under some reassuringly Euro-like pseudonym.
Germany happens to have the world's second-largest official holding of gold - 3,400 tonnes compared to the USA's 8,100 (assuming we are being told the truth about how much the USA actually has in its vaults, and that is a matter of serious debate). This article reports China's ambition to increase its own holding of gold, from around 1,000 tonnes now to perhaps as much as 10,000 tonnes in 10 years' time.
The gold mania is not universal. Writing in the Daily Telegraph, Ambrose Evans-Pritchard predicts that the price of gold will actually fall next year - among other bad things such as the collapse of America's social security pension fund. He may be right. In a panic, people want ready money, so maybe cash will (for a time) be king. But when an economy is in dire straits, its government will do whatever it can to ease the pain, and many think that the strategy will be to increase the money supply, or even introduce a new form of the currency, as has just happened in North Korea.
The attraction of gold is for pessimists. It doesn't earn any interest, so mainly it is seen as a last-resort store of value when the money system breaks down (and it's nice to wear and show off). It is perfectly possible that you could make a loss on gold, but it will never be worth nothing at all, unlike the old US Continentals, or Confederate money after the North won the Civil War. In this context, it's worth noting that Reuters news agency reported back in September that Hong Kong moved its gold reserves out of London and into the gold depository at its Chek Lap Kok international airport. A sign of something, but what?
Gold is not the only tangible store of value, of course. Agricultural land, houses, food, medicines etc all have intrinsic value, i.e. they are worth something because of what they can do for you themselves, not just because they can be exchanged for something else.
Inflation remains a serious long-term threat. Comparing the past and present value of cash is difficult, because the economy has increased in size and changed in nature; but depending on the measure you use and looking at what has happened since 1971 (when I started at college), the British pound has lost 90% - 96% of its buying power. It's still (until April next year) possible to retire at age 50 in this country, so if history repeats itself, you could see a similar devaluation during a long retirement.
In short, it's not about the value of gold, but the unreliability of money.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Saturday, December 19, 2009
House prices: the second wave down?
Edward Harrison looks at statistics for US housing and quotes Frank Veneroso*, who guesses that, on average, houses with mortgages have almost no equity left in them:
"... the flow of funds accounts tell us that the total value of residential real estate is $16.53 trillion. The share owned by households with a mortgage is probably $10 trillion to $11 trillion. Total mortgage household debt now stands at $10.3 trillion. In effect, for all households with a mortgage taken in the aggregate, their loan-to-value ratio is now close to 100% and perhaps close to half of them have a zero to negative equity."
For some US housebuyers (especially if they haven't taken out a second mortgage or secured loan on the property), the law relating to their loans says that they can return the house to the mortgage lender and if there is any debt left over after selling the house, that's the lender's hard luck - there's no pursuing the buyer. So if a homeowner is in negative equity and interest rates rise, the easy thing to do is strip the house, rent a van to move the stuff, and mail the house keys to the mortgage company (this is jocularly known as "jingle mail").
In some cases, the paperwork on the mortgage (written in haste in boom times) is so sloppy that mortgage lenders may not even be able to legally foreclose and seize the house.
I have also seen graphs (like this one) to show the large number of low-initial-fixed-rate mortgages that are going to return to variable rate in the next year or two, just as (it seems) interest rates may be on the increase.
So there are a number of reasons why banks, the housing market and the economy generally may still face very testing times.
*Veneroso also believes that for years, central banks have held far less gold than they would like us to believe. If this is correct and the currency comes under pressure, there may be a steep rise in the price of gold as the Federal Reserve and others buy back hastily, to reassure us that the currency does indeed have some kind of backing. But please remember (a) this is speculation and (b) gold has already appreciated very considerably in the last couple of years.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
"... the flow of funds accounts tell us that the total value of residential real estate is $16.53 trillion. The share owned by households with a mortgage is probably $10 trillion to $11 trillion. Total mortgage household debt now stands at $10.3 trillion. In effect, for all households with a mortgage taken in the aggregate, their loan-to-value ratio is now close to 100% and perhaps close to half of them have a zero to negative equity."
For some US housebuyers (especially if they haven't taken out a second mortgage or secured loan on the property), the law relating to their loans says that they can return the house to the mortgage lender and if there is any debt left over after selling the house, that's the lender's hard luck - there's no pursuing the buyer. So if a homeowner is in negative equity and interest rates rise, the easy thing to do is strip the house, rent a van to move the stuff, and mail the house keys to the mortgage company (this is jocularly known as "jingle mail").
In some cases, the paperwork on the mortgage (written in haste in boom times) is so sloppy that mortgage lenders may not even be able to legally foreclose and seize the house.
Others, suspecting that the market will go down further, may wish to sell to get out what equity they can while there still is any. And actual or imminent unemployment may force still others to leave - the official US unemployment rate is around 10%, but some say that if looked at properly the true rate is more like 17%. (Update: John Williams says 22%)
I have also seen graphs (like this one) to show the large number of low-initial-fixed-rate mortgages that are going to return to variable rate in the next year or two, just as (it seems) interest rates may be on the increase.
So there are a number of reasons why banks, the housing market and the economy generally may still face very testing times.
*Veneroso also believes that for years, central banks have held far less gold than they would like us to believe. If this is correct and the currency comes under pressure, there may be a steep rise in the price of gold as the Federal Reserve and others buy back hastily, to reassure us that the currency does indeed have some kind of backing. But please remember (a) this is speculation and (b) gold has already appreciated very considerably in the last couple of years.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
'Tis a gift to be simple
Via Lifehacker, I find a sane blog to counter my (and possibly your) OCD: Small Notebook. One of the principles it stresses is knowing when to stop.
I'm adding it to my sidebar as a still, small voice of calm. Maybe you should do the same.
I'm adding it to my sidebar as a still, small voice of calm. Maybe you should do the same.
How should we invest if we're back to "boom and bust?"
Edward Harrison analyses the current financial situation, and thinks that governments will continue to try to stimulate their economies by increasing public debt. This will increase (or support) asset prices, but you can't rack up all your expenses on your credit card forever: another crisis will come and then it's time to pay the bill. The money base will shrink and asset prices will decline again.
The gamblers will try to buy into the false boom and sell before the bust, but this is a risky strategy. I haven't the nerve for it, though some would say you should be prepared to speculate with 10% of your investment money.
For the ordinary investor, it's a difficult time: holding cash will seem like a losing strategy, and he/she may be tempted back into the market at exactly the wrong moment - the moment when everybody thinks that "you can't lose". We saw this in the technology boom of the 90s, and the house price boom a few years ago.
What is clear is that the system is unstable. In these wild times, fortunes will be won by some, lost by others; but the prudent saver looking for secure and steady rewards will have to diversify and consider all sorts of safety measures. Let's look at common investment options, in what used to be thought of as ascending risk order.
If governments try to counter the downturn by producing too much new cash and credit, the result may be inflation and that will punish bank and building society accounts. The insurance company I started with in the late 80s used to have a handout on the effects of inflation: it showed the real purchasing power of money placed in a bank account for 10 years from the mid-70s to the mid-80s - even letting the interest accumulate in the account, your cash had lost 50% of its buying power in a decade. And the events of October 2008 have alerted savers to the fact that money in the bank is not a risk-free option - thank goodness for the limited (up to £50,000) protection of the Financial Services Compensation Scheme.
Government bonds (or gilts) are a problem, too - their yield (their annual income as a percentage of their current traded price) is very low, but when interest rates rise the capital value of gilts will fall correspondingly. There is also mounting concern about national credit ratings and the growing risk of default. For those who still have faith in the UK government's promises, National Savings and Investments claims to offer "100% security for your money" (actually, there is no such thing, but you know what they mean). For example, it is still possible to buy National Savings Index-Linked Certificates, to guard against inflation.
I suspect that with-profits funds will continue to face huge challenges in the coming years. They were set up to deliver modest but (most importantly) reassuringly steady growth; but the volatility of modern markets has stood up in their boat and is rocking it violently. Look out for further occasions when with-profits managers have to impose "Market Value Adjusters" (MVAs) - temporary discounts on the face value of your holding if you're trying to cash-out at a turbulent period. They're trying to preserve balance in an unbalanced time, and I fear they may not succeed.
Higher interest rates (maybe higher taxes, too) and increasing unemployment will tend to affect house prices. In a recession / depression, much commercial property will stand empty and so that market will decline, too.
When the money base shrinks and interest rates increase, businesses will suffer and many stocks and shares (aka "equities") will be hit. Already, professional investors have increased their holding of "defensive" stocks - shares in companies providing things we always need, such as energy and reasonably-priced food and clothing. You can reduce investment risk further by holding shares in more than one company and in more than one type of business; you can also diversify by including foreign equities.
Which brings us to another topic: currency depreciation. The British pound has lost some of its buying power abroad, in part a response by foreign investors to our problems with debt and a weakening economy. The pound has lost ground against the US dollar (not because the US economy is strong, but because the US dollar is still - for now - the world's trading currency) and the Euro over the last couple of years, so even if prices here in the UK seem stable, you might have gained by investment in other countries, or even just holding some money in foreign currency. Of course, the key questions are, which investments, which currencies, when to get in and out?
For the adventurous, there are commodities (everything from pork bellies to agricultural land, oil and gold), emerging markets (developing economies - remember the saying, "an emerging market is one from which it may be difficult to emerge") and specialist funds/shares, such as in technology and medical research.
Further up (or off) the scale are the outright financial gambles - futures and options, derivatives etc. These things - supposedly originally designed to cover and so reduce risk - are now the instruments that threaten our security. I think the main cause of the problem is that there seems to be no notion of "insurable interest", as with life insurance. Prior to the UK's Life assurance Act of 1774, it was possible to take out insurance on a complete stranger, whereas now you can insure only against the loss you might suffer if someone dies. If modern options trading was regulated in the same way, the market would be far smaller and much more secure. Perhaps that will come, one day.
This not the place for any recommendations, but if you are lucky enough to have any investments or savings, perhaps it's a good time to review them, maybe in consultation with your financial adviser. If you don't know which horse to back, then at least you can try to bet on a wider selection, or even all of them; for unlike racecourse betting, there is (most unfortunately) no option to stay out altogether; not unless you have nothing.
UPDATE
Z. O. Greenberg looks at ideas for diversifying investments out of the dollar. This would apply similarly to those who are chary of the British pound. But beware - some say the US dollar may strengthen soon.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
The gamblers will try to buy into the false boom and sell before the bust, but this is a risky strategy. I haven't the nerve for it, though some would say you should be prepared to speculate with 10% of your investment money.
For the ordinary investor, it's a difficult time: holding cash will seem like a losing strategy, and he/she may be tempted back into the market at exactly the wrong moment - the moment when everybody thinks that "you can't lose". We saw this in the technology boom of the 90s, and the house price boom a few years ago.
What is clear is that the system is unstable. In these wild times, fortunes will be won by some, lost by others; but the prudent saver looking for secure and steady rewards will have to diversify and consider all sorts of safety measures. Let's look at common investment options, in what used to be thought of as ascending risk order.
If governments try to counter the downturn by producing too much new cash and credit, the result may be inflation and that will punish bank and building society accounts. The insurance company I started with in the late 80s used to have a handout on the effects of inflation: it showed the real purchasing power of money placed in a bank account for 10 years from the mid-70s to the mid-80s - even letting the interest accumulate in the account, your cash had lost 50% of its buying power in a decade. And the events of October 2008 have alerted savers to the fact that money in the bank is not a risk-free option - thank goodness for the limited (up to £50,000) protection of the Financial Services Compensation Scheme.
Government bonds (or gilts) are a problem, too - their yield (their annual income as a percentage of their current traded price) is very low, but when interest rates rise the capital value of gilts will fall correspondingly. There is also mounting concern about national credit ratings and the growing risk of default. For those who still have faith in the UK government's promises, National Savings and Investments claims to offer "100% security for your money" (actually, there is no such thing, but you know what they mean). For example, it is still possible to buy National Savings Index-Linked Certificates, to guard against inflation.
I suspect that with-profits funds will continue to face huge challenges in the coming years. They were set up to deliver modest but (most importantly) reassuringly steady growth; but the volatility of modern markets has stood up in their boat and is rocking it violently. Look out for further occasions when with-profits managers have to impose "Market Value Adjusters" (MVAs) - temporary discounts on the face value of your holding if you're trying to cash-out at a turbulent period. They're trying to preserve balance in an unbalanced time, and I fear they may not succeed.
Higher interest rates (maybe higher taxes, too) and increasing unemployment will tend to affect house prices. In a recession / depression, much commercial property will stand empty and so that market will decline, too.
When the money base shrinks and interest rates increase, businesses will suffer and many stocks and shares (aka "equities") will be hit. Already, professional investors have increased their holding of "defensive" stocks - shares in companies providing things we always need, such as energy and reasonably-priced food and clothing. You can reduce investment risk further by holding shares in more than one company and in more than one type of business; you can also diversify by including foreign equities.
Which brings us to another topic: currency depreciation. The British pound has lost some of its buying power abroad, in part a response by foreign investors to our problems with debt and a weakening economy. The pound has lost ground against the US dollar (not because the US economy is strong, but because the US dollar is still - for now - the world's trading currency) and the Euro over the last couple of years, so even if prices here in the UK seem stable, you might have gained by investment in other countries, or even just holding some money in foreign currency. Of course, the key questions are, which investments, which currencies, when to get in and out?
For the adventurous, there are commodities (everything from pork bellies to agricultural land, oil and gold), emerging markets (developing economies - remember the saying, "an emerging market is one from which it may be difficult to emerge") and specialist funds/shares, such as in technology and medical research.
Further up (or off) the scale are the outright financial gambles - futures and options, derivatives etc. These things - supposedly originally designed to cover and so reduce risk - are now the instruments that threaten our security. I think the main cause of the problem is that there seems to be no notion of "insurable interest", as with life insurance. Prior to the UK's Life assurance Act of 1774, it was possible to take out insurance on a complete stranger, whereas now you can insure only against the loss you might suffer if someone dies. If modern options trading was regulated in the same way, the market would be far smaller and much more secure. Perhaps that will come, one day.
This not the place for any recommendations, but if you are lucky enough to have any investments or savings, perhaps it's a good time to review them, maybe in consultation with your financial adviser. If you don't know which horse to back, then at least you can try to bet on a wider selection, or even all of them; for unlike racecourse betting, there is (most unfortunately) no option to stay out altogether; not unless you have nothing.
UPDATE
Z. O. Greenberg looks at ideas for diversifying investments out of the dollar. This would apply similarly to those who are chary of the British pound. But beware - some say the US dollar may strengthen soon.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Thursday, December 17, 2009
Time for a radical rethink
Warren Pollock considers ideas of Buckminster Fuller in relation to the economy and the real world. This is a most interesting video article and quite short (under 10 minutes). One point he makes is how vulnerable city-dwellers are, to dislocation of supplies. Click here to view the article.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Not time to get out of the market?
USA-based Chris Puplava at Financial Sense looks at indicators and thinks that although the market could suffer a downturn, that doesn't seem to be imminent.
This kind of analysis is for the active, more risk-taking investor: market timing is notoriously unpredictable.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
This kind of analysis is for the active, more risk-taking investor: market timing is notoriously unpredictable.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
The inflation-deflation debate
Sheffield-based analyst Nadeem Walayat demonstrates that, apart from a blip a few months ago, the long-term inflationary trend in prices continues. Whether you look at CPI or RPI (the latter includes mortgage costs), household bills are rising.
He also examines the trend in UK public debt, which again seems to be rising unstoppably. The Chancellor has predicted growth for the UK economy, but that growth is more than paid for by borrowing, so overall we will be worse off. Controversially, Walayat suggests that the motive is political: deliberate damage to the economy in order to leave the next (presumably Conservative) government "scorched earth". We must hope that British governments do not really operate so irresponsibly.
Walayat concludes with a look at some commodities that investors may choose as hedges against inflation: energy (natural gas), gold and silver. He offers some technical comments on fund charges and whether the way the fund invests is likely to track the real progress of the commodity's price. He feels that gold and silver funds correlate better with actual prices in these markets, though he warns that theft and fraud are always possible.
But the readers' comments are worth looking at, too. "Raleigh" points to an estimated $6 trillion reduction in the value of US housing, which more than offsets the recent $1 trillion increase in US government borrowing as a result of the banking crisis. His view, if I understand it correctly, is that such net deflation will put a downward pressure on prices and wages.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
He also examines the trend in UK public debt, which again seems to be rising unstoppably. The Chancellor has predicted growth for the UK economy, but that growth is more than paid for by borrowing, so overall we will be worse off. Controversially, Walayat suggests that the motive is political: deliberate damage to the economy in order to leave the next (presumably Conservative) government "scorched earth". We must hope that British governments do not really operate so irresponsibly.
Walayat concludes with a look at some commodities that investors may choose as hedges against inflation: energy (natural gas), gold and silver. He offers some technical comments on fund charges and whether the way the fund invests is likely to track the real progress of the commodity's price. He feels that gold and silver funds correlate better with actual prices in these markets, though he warns that theft and fraud are always possible.
But the readers' comments are worth looking at, too. "Raleigh" points to an estimated $6 trillion reduction in the value of US housing, which more than offsets the recent $1 trillion increase in US government borrowing as a result of the banking crisis. His view, if I understand it correctly, is that such net deflation will put a downward pressure on prices and wages.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
The inflation-deflation debate
Sheffield-based analyst Nadeem Walayat demonstrates that, apart from a blip a few months ago, the long-term inflationary trend in prices continues. Whether you look at CPI or RPI (the latter includes mortgage costs), household bills are rising.
He also examines the trend in UK public debt, which again seems to be rising unstoppably. The Chancellor has predicted growth for the UK economy, but that growth is more than paid for by borrowing, so overall we will be worse off. Controversially, Walayat suggests that the motive is political: deliberate damage to the economy in order to leave the next (presumably Conservative) government "scorched earth". We must hope that British governments do not really operate so irresponsibly.
Walayat concludes with a look at some commodities that investors may choose as hedges against inflation: energy (natural gas), gold and silver. He offers some technical comments on fund charges and whether the way the fund invests is likely to track the real progress of the commodity's price. He feels that gold and silver funds correlate better with actual prices in these markets, though he warns that theft and fraud are always possible.
But the readers' comments are worth looking at, too. "Raleigh" points to an estimated $6 trillion reduction in the value of US housing, which more than offsets the recent $1 trillion increase in US government borrowing as a result of the banking crisis. His view, if I understand it correctly, is that such net deflation will put a downward pressure on prices and wages.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
He also examines the trend in UK public debt, which again seems to be rising unstoppably. The Chancellor has predicted growth for the UK economy, but that growth is more than paid for by borrowing, so overall we will be worse off. Controversially, Walayat suggests that the motive is political: deliberate damage to the economy in order to leave the next (presumably Conservative) government "scorched earth". We must hope that British governments do not really operate so irresponsibly.
Walayat concludes with a look at some commodities that investors may choose as hedges against inflation: energy (natural gas), gold and silver. He offers some technical comments on fund charges and whether the way the fund invests is likely to track the real progress of the commodity's price. He feels that gold and silver funds correlate better with actual prices in these markets, though he warns that theft and fraud are always possible.
But the readers' comments are worth looking at, too. "Raleigh" points to an estimated $6 trillion reduction in the value of US housing, which more than offsets the recent $1 trillion increase in US government borrowing as a result of the banking crisis. His view, if I understand it correctly, is that such net deflation will put a downward pressure on prices and wages.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Tuesday, December 15, 2009
Janszen: Gold is not overpriced
"Gold ads bug us from the TV and radio. To the new gold experts this means gold sentiment is now too bullish. We’re due for a crash.
Have they noticed that the gold ads are about selling not buying gold?"
In a long but well-worth-reading article, Eric Janszen of iTulip maintains that despite eight years of rising prices, gold is not undervalued, because the economic system is unstable. He points out that, for the first time in many years, central banks have started to buy gold.
Unlike many commentators, he doesn't support the notion that the dollar will collapse, because other major economies (e.g. China and Japan) have become dependent on the USA to buy their exports. Global inter-linking means that the coming bust will not take the same form as previous ones.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Have they noticed that the gold ads are about selling not buying gold?"
In a long but well-worth-reading article, Eric Janszen of iTulip maintains that despite eight years of rising prices, gold is not undervalued, because the economic system is unstable. He points out that, for the first time in many years, central banks have started to buy gold.
Unlike many commentators, he doesn't support the notion that the dollar will collapse, because other major economies (e.g. China and Japan) have become dependent on the USA to buy their exports. Global inter-linking means that the coming bust will not take the same form as previous ones.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Sunday, December 13, 2009
Inflation and then a bust, by 2012, says Andy Xie
Andy Xie, a respected former Morgan Stanley economic analyst says that low interest rates (cheap money) will lead to increasing asset prices until the game simply cannot continue, whereupon there will be a massive, world-wide breakdown, which he expects in 2012.
But Xie's ex-employer thinks the credit crisis may hit Britain as early as next year (hat-tip to "Jesse").
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
But Xie's ex-employer thinks the credit crisis may hit Britain as early as next year (hat-tip to "Jesse").
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Saturday, December 12, 2009
Could Britain go bust?
Britain's debtor weaknesses
Update: PIMCO has announced that it will be a net seller of UK bonds this year. The European portfolio manager is Andrew Balls, brother of UK government minister Ed Balls, so one wonders what the siblings may have to tell each other.
This week's Spectator includes an article by Irwin Stelzer, a noted economic commentator, entitled "Who would lend to a bankrupt Britain?"
Stelzer's comments follow recent developments in the market for "credit default swaps" (CDS) - insurance contracts that pay out if a business or government defaults on its debt. The premium (price) of the insurance reflects the degree of concern, and in the case of the UK, that concern has deepened.
CMA DataVision supplies information on the CDS market. Its third-quarter report on sovereign (national) debt assesses each country for the chances of a default within the next five years (CPD, or "Cumulative Probability of Default"), the cost of default insurance and what that means about creditworthiness. In this report (see page 14), the UK is rated as having a 4% CPD, with an implied credit rating at "aa+".
The top "aaa" credit rating is enjoyed by the USA, Australia and a small handful of European countries including ourselves, but things have moved on and it looks as though we are heading for a downgrading. The CMA report linked above covered the market for CDS contracts between July and September. On 7 December, the average CDS risk premium for the UK reportedly increased to 0.74% p.a. (85% higher than in the third quarter), which compares very unfavourably with the USA's premium at 0.32% p.a. This insurance repricing suggests that the UK's risk of default within 5 years may have risen to around 5.5%.
Are we going broke? Not yet, but our economy is not as strong as it used to be, and this is reflected in the price of gilts (government bonds, or Treasury securities). Gilts offer a fixed income for a fixed period, but can be bought and sold many times before their maturity date. Factors influencing their price include interest rates available elsewhere and the chance of default.
If gilts become cheaper, their fixed income is higher in comparison. The relationship of income to the traded price is called the "yield" - effectively, an interest rate. Immediately after British Chancellor Alistair Darling delivered his Pre-Budget Report to Parliament on 9 December, 10-year gilt prices fell and their yield rose from 3.81% to 3.85%.
The bond markets are, so to speak, the judges on Strictly Come Borrowing, and they are not impressed by the proposals they have seen. This, not bankruptcy, is the implication of CDS premiums, gilt yields and national credit ratings: we can expect to pay more for access to extra funds.
Since we are already so indebted, personally and nationally, an increase in interest rates will add to our burdens, at the same time that (in a recession) profits and tax revenues are decreasing; so Britain could have to borrow even more just to keep going. Spiralling debt and the growing reluctance of lenders could eventually force us to call in the International Monetary Fund as a lender of last resort, which we last did in 1976. That was bitter medicine, but still better than what would happen if we defaulted altogether and credit markets shunned us completely (or imposed loan-shark rates and terms).
However, we are very far from the worst case globally. The same third-quarter report by CMA DataVision named three countries that had a five-year default risk of over 50%: the Ukraine, Venezuela and Argentina. The annual CDS risk premiums for the first two were 12% and 11.25% respectively; both have since increased to over 13% per annum. Closer to home, Ireland's risk premium is 1.55%, Greece's 2%, , Lithuania's 3.2% and Iceland's 4.4%.
Although the USA is still regarded as a safe borrower, individual States are not: California's annual CDS premium is about 2.5%, reflecting an estimated 20% risk of default within 5 years.
British banks themselves now have a significant CDS premium, ranging from about 0.9% p.a. for Barclays to 1.4% p.a. for the Royal Bank of Scotland - the latter implies about a 10% risk of defaulting within 5 years.
So, no panic yet, but grounds for considerable concern.
Derivatives: a bigger worry?
A second worry is the state of credit default swaps themselves, and other "derivatives". The total amounts insured in this hard-to-understand market are vast, much bigger than any country's GDP. The USA's GDP is something like $14 trillion, but the CDS market is worth about $36 trillion - down from $62 trillion in 2008.
The derivatives market as a whole is much larger - an estimated $1,400 trillion in April 2009, many times the entire world's annual GDP. It's a mammoth global insurance/betting game, and if a major player comes unstuck it could destabilise finance, just as the collapse of Lehman Brothers and others threatened to do not long ago.
We think of insurance as reducing risk, but actually it's about transferring risk. Promises can turn out to be very expensive: the world's oldest mutual insurer, Equitable Life, suffered a major crisis because of a guarantee it made regarding minimum annuity rates for some of its pension investors; Barings, the oldest merchant bank in London, was destroyed by derivatives traded by its employee Nick Leeson.
The derivatives market is huge, interconnected and inadequately regulated. It is the fourth threat identified by Michael Panzner in his prescient book, "Financial Armageddon," which I reviewed in May 2007. Let us hope that this one can be neutralized in time.
______________________________________________
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Update: PIMCO has announced that it will be a net seller of UK bonds this year. The European portfolio manager is Andrew Balls, brother of UK government minister Ed Balls, so one wonders what the siblings may have to tell each other.
This week's Spectator includes an article by Irwin Stelzer, a noted economic commentator, entitled "Who would lend to a bankrupt Britain?"
Stelzer's comments follow recent developments in the market for "credit default swaps" (CDS) - insurance contracts that pay out if a business or government defaults on its debt. The premium (price) of the insurance reflects the degree of concern, and in the case of the UK, that concern has deepened.
CMA DataVision supplies information on the CDS market. Its third-quarter report on sovereign (national) debt assesses each country for the chances of a default within the next five years (CPD, or "Cumulative Probability of Default"), the cost of default insurance and what that means about creditworthiness. In this report (see page 14), the UK is rated as having a 4% CPD, with an implied credit rating at "aa+".
The top "aaa" credit rating is enjoyed by the USA, Australia and a small handful of European countries including ourselves, but things have moved on and it looks as though we are heading for a downgrading. The CMA report linked above covered the market for CDS contracts between July and September. On 7 December, the average CDS risk premium for the UK reportedly increased to 0.74% p.a. (85% higher than in the third quarter), which compares very unfavourably with the USA's premium at 0.32% p.a. This insurance repricing suggests that the UK's risk of default within 5 years may have risen to around 5.5%.
Are we going broke? Not yet, but our economy is not as strong as it used to be, and this is reflected in the price of gilts (government bonds, or Treasury securities). Gilts offer a fixed income for a fixed period, but can be bought and sold many times before their maturity date. Factors influencing their price include interest rates available elsewhere and the chance of default.
If gilts become cheaper, their fixed income is higher in comparison. The relationship of income to the traded price is called the "yield" - effectively, an interest rate. Immediately after British Chancellor Alistair Darling delivered his Pre-Budget Report to Parliament on 9 December, 10-year gilt prices fell and their yield rose from 3.81% to 3.85%.
The bond markets are, so to speak, the judges on Strictly Come Borrowing, and they are not impressed by the proposals they have seen. This, not bankruptcy, is the implication of CDS premiums, gilt yields and national credit ratings: we can expect to pay more for access to extra funds.
Since we are already so indebted, personally and nationally, an increase in interest rates will add to our burdens, at the same time that (in a recession) profits and tax revenues are decreasing; so Britain could have to borrow even more just to keep going. Spiralling debt and the growing reluctance of lenders could eventually force us to call in the International Monetary Fund as a lender of last resort, which we last did in 1976. That was bitter medicine, but still better than what would happen if we defaulted altogether and credit markets shunned us completely (or imposed loan-shark rates and terms).
However, we are very far from the worst case globally. The same third-quarter report by CMA DataVision named three countries that had a five-year default risk of over 50%: the Ukraine, Venezuela and Argentina. The annual CDS risk premiums for the first two were 12% and 11.25% respectively; both have since increased to over 13% per annum. Closer to home, Ireland's risk premium is 1.55%, Greece's 2%, , Lithuania's 3.2% and Iceland's 4.4%.
Although the USA is still regarded as a safe borrower, individual States are not: California's annual CDS premium is about 2.5%, reflecting an estimated 20% risk of default within 5 years.
British banks themselves now have a significant CDS premium, ranging from about 0.9% p.a. for Barclays to 1.4% p.a. for the Royal Bank of Scotland - the latter implies about a 10% risk of defaulting within 5 years.
So, no panic yet, but grounds for considerable concern.
Derivatives: a bigger worry?
A second worry is the state of credit default swaps themselves, and other "derivatives". The total amounts insured in this hard-to-understand market are vast, much bigger than any country's GDP. The USA's GDP is something like $14 trillion, but the CDS market is worth about $36 trillion - down from $62 trillion in 2008.
The derivatives market as a whole is much larger - an estimated $1,400 trillion in April 2009, many times the entire world's annual GDP. It's a mammoth global insurance/betting game, and if a major player comes unstuck it could destabilise finance, just as the collapse of Lehman Brothers and others threatened to do not long ago.
We think of insurance as reducing risk, but actually it's about transferring risk. Promises can turn out to be very expensive: the world's oldest mutual insurer, Equitable Life, suffered a major crisis because of a guarantee it made regarding minimum annuity rates for some of its pension investors; Barings, the oldest merchant bank in London, was destroyed by derivatives traded by its employee Nick Leeson.
The derivatives market is huge, interconnected and inadequately regulated. It is the fourth threat identified by Michael Panzner in his prescient book, "Financial Armageddon," which I reviewed in May 2007. Let us hope that this one can be neutralized in time.
______________________________________________
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Friday, December 11, 2009
The end of the dollar? But where else can we go?
The market is inherently unpredictable: if you think an accident is bound to happen, that still doesn't tell you when it will happen. However, this article by Paco Ahlgren takes the long view and maintains that the dollar must one day become worthless.
In the short term, who knows? In times of panic, many investors could run back to holding the dollar and temporarily boost its value.
Other countries are also weakening their currencies. Even the Euro suffers from flaws in the economies of some of its member countries, so although it may seem strong now against the pound and dollar, it too may be overvalued.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
In the short term, who knows? In times of panic, many investors could run back to holding the dollar and temporarily boost its value.
Other countries are also weakening their currencies. Even the Euro suffers from flaws in the economies of some of its member countries, so although it may seem strong now against the pound and dollar, it too may be overvalued.
DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.
Thursday, December 10, 2009
Education or Indoctrination?
Sackerson directed me to the following article: http://www.overcomingbias.com/2009/12/school-is-propaganda.html
In response, I argue that we have public schools because (based on the data):
a) they are cheaper than private schools;
b) they out-perform private schools, on average;
c) it is better to educate than imprison;
d) education is the only modern means for social mobility.
In response, I argue that we have public schools because (based on the data):
a) they are cheaper than private schools;
b) they out-perform private schools, on average;
c) it is better to educate than imprison;
d) education is the only modern means for social mobility.
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