Wednesday, August 31, 2011

Real and imaginary threats to America

These are wild times and there are definitely things to worry about, but unfortunately the rains of misfortune are also bringing many crazy worms to the surface.

For instance, one story doing the rounds is that the 5.8 quake of 23 August 2011 (I was in Long Island at the time and it was mildly interesting) was caused by a nuclear explosion. For some, this segues into talk of a vast secret network of underground tunnels, stolen nuclear weapons and some kind of underground battle. Illuminati, aliens, the lot.

Worse, the excitable conspiracy theorists appear to be doctoring the data. See the alleged seismograph readout in the link above, which looks most odd because (unlike with normal earthquakes) there seem to be no p-wave tremors before the major shaking; then see the actual readouts from the Seismological Observatory at Virgina Tech. To save you the bother, here they are:


What are the nutters thinking when they do this? Are they like those mediaeval monks at St Denis, Naples and elsewhere, who created and manipulated effigies so that they appeared to speak to the faithful? Believers themselves (we must hope they were not simply cynical), they considered it their duty to perpetrate pious fraud in order to foster the faith in others. Is that what we have here, now?

Yet it seems there are more mundane, yet real, threats we should guard against. For example, according to this article (htp: Robert Wenzel) it seems that the United States government is choosing where to hold a trial for Julian Assange, according to vested local interests that may influence the kind of jury he will face. If true, this makes a mockery of justice - and my reading of John Grisham's fiction suggests that such manouevres are quite believable, perhaps common.

Meanwhile, Americans are thrown into a panic by the Islamic bogeyman, who in the worst atrocity on US soil ten years ago claimed under 3,000 lives. Every life counts, and we have New York fire and police in our extended family, so I don't for a moment undervalue the horror of what was done that day. Yet look at the year 2000 for comparison: the 9/11 toll is less than deaths ascribed to asbestos (3,750), medication errors (7,391), chewing tobacco and snuff (7,430), alcohol (85,000), infections acquired in hospitals and long-term care facilities (90,000), medical errors (98,000), adult obesity (111,909) and active smoking (389,290). Should the Patriot Act include provisions for hunting down and destroying brewers, tobacco companies, insulating firms, doctors, nurses and the makers of Twinkies?

The real threat to America is its own government, which uses fright tactics to cause its citizens to abandon their Constitutional safeguards against tyranny. The battle may be lost here in Britain, where our unwritten constitution has been so easily and quickly subverted; but I would urge my American friends to go back to those yellowing documents stored in Washington DC, so that "government of the people, by the people, for the people shall not perish from the earth." If you do not throw down your coat and stand to fight here and now, then where and when?

Who's bailing out Uncle Sam?

Just a couple of graphs to show which foreign countries have most increased their holdings of US Treasury securities.

The UK seems the odd man out, bearing in mind its own financial difficulties, but it is widely suspected that much of the UK's holdings are cat's-paw transactions on behalf of China.



INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

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, August 28, 2011

Is gold still fairly priced?

At the time I first accepted Richard Daughty's argument that gold represented a great buying opportunity, I didn't have the money available. So, seeing the phenomenal rise in the price over the last few years, have I missed the boat?

It depends. Yes, if what I want is the chance to buy in well below trend and "make a killing"; but perhaps not, even now, if I'm merely seeking something that may protect my savings against inflation.

There are so many ways to define inflation, especially if you are a government incentivised to keep the official figure low. But let's take a look at one monetarist measure, the Mises Institute's "True Money Supply", and compare that to the price of gold since 1971 (the year of the "Nixon shock"):



According to the above, gold is just about on its long-term trend line; not a bargain, but that's not the issue here. However, that trend does include the dramatic spike of 1980, from which peak it took some years to climb down. So let's re-do the line from 1985 onwards:





Seen this way, we're a little above average at the moment, which is perhaps why Marc Faber is hoping for a near-term pullback of $100 - $200; but it's not egregiously high, which doubtless explains why he still sees it as his favourite investment.

Another straw in the wind is a comment by an investment banker on a recent blog-piece of mine entitled "Cash: the investment of the century". "Wolfie" says (Aug. 17):

"I'm currently 100% cash but I think the time has come to break cover and take a 30-40% gold holding. A storm gathers."

I certainly have to take seriously an industry insider who is clearly as bearish and cash-based as myself, but wouldn't you know it, I've been in the USA for the last fortnight and unable to do anything about it up till now.

Perhaps it's "a sign" that I was in NY for Tuesday's 'quake and had to fly out of Newark two days early, just ahead of Hurricane Irene. In any case, I'm now considering following Wolfie's suit sometime soon, even though I don't like the price much. For in the mass of unused money in bank holdings lodged with the Federal Reserve, and also with the more fortunate of transnational corporations who have been fleecing the American consumer for decades and blaming the Chinese who get to see only 15% of the action, lies true storm force potential.

I think we have some time yet before the cloud of cash makes landfall - I've been eyeing 2016 as the approximate end of the real underlying recession - but I shan't delay my preparations quite that long. As the ancient Greek saying goes, there is no borrowing a sword in time of war.

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

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.

Nail that journo!


This site allows you to spot lazy journalists rehashing other people's news stories.

Htp: Autonomous Mind.

Tuesday, August 23, 2011

Monday, August 22, 2011

Don't tax the wealthy, use their wealth instead

There's a crisp and witty summation of the fiscal quandary we're in, from our man in San Marcos today.

I'm beginning to wonder whether simply taxing the elite is the best solution. That only means taking from A and giving to B, which A will resist and which turns B into a resentful and useless benefit recipient.

Little wonder that the rich are seeking some other way to spend their assets. The group of billionaires that have pledged half their wealth to global charity are, it seems to me, trying to buy God and our good opinion, but it doesn't quite work for me.

I'd have been more impressed if George Soros hadn't (quite legally, of course) swindled some of his fortune from the British public on Black Monday. I'd be pleased if Bill Gates spent some of his stack on ensuring that his software products work properly, instead of repeatedly launching them with multiple holes below the waterline: it's only a matter of time before my new Windows 7-equipped netbook has its working memory entirely filled with "critically important updates" and "service packs", and meantime it works jerkily as the machine juggles my use of it with behind-the-scenes internet downloads of these monster corrections.

So my suggestion, as I commented on Jim's piece, is to put the rich to work:

"I think the issues are productive employment, the over-concentration of wealth, and the parking of the latter in established (global and foreign) businesses instead of new (domestic) ones.

The wealthy need to start spending - investing in new factories and technologies and getting people back into decently-paid work."

Friday, August 12, 2011

Cash - the investment of the century

There's been comment recently about how the ordinary investor has been abandoning the market, in some cases with an undertone of contempt for the poor saps who are missing out on those incredible gains to be made just around the corner.

The banks who from time to time attempt to poach my clients often use past performance an an indicator of future returns, while of course covering themselves by the usual disclaimers. Typically they cherry-pick among terms of 1, 3, 5 and 10 years.

Let's see how the graph for the Dow would look over various time periods, and compare it with cash in your bedsock. To be fair, let's ignore the interest you could have earned on cash, and the dividends on stocks; as a special favour to the Dow, so being especially unfair to cash, let's also ignore the offer-bid spread and the fees and charges loaded onto the investor.

Over the last 12 months:, you could have made a good profit - well, you could if you'd got out a month early:
... over the last 3 years:
... over the last 5 years:
... and since January 2000:
"Mish" today points out that we are in deflation, if you are a monetarist, since credit and asset values have contracted. Inflation scares suit those who are running what some call a "wolf market" - come out, little pigs, it's all clear now.
What inflation? The consumer - and the inflation indices - may notice a rise in food and energy prices, but that's not what your nest-egg is for. Look at house prices - still going down in the UK and the USA - and all the other big-ticket items that in recent years were purchased with borrowed money.
I think Mish is right, for now. The concern I have - and it's reflected in the soaring price of gold - is what governments will do in their desperation once giving money to busted and corrupt banks (and governments) is finally seen as worse than useless. Can the bond market really dictate terms in an economic collapse, or will governments across the world break their currencies with the final splurge of money-printing that third-party control by central banks is designed to prevent?
Until that time, and despite the temptations of commodities, maybe cash-holders should hold the line while the enemy advances. A lot depends on your personal plans, of course; we're hoping to move house and such cash savings as we have may continue to appreciate against the thing we want. So really it's about relative values - comparing asset A with asset B - decided by you, not some index that doesn't reflect your priorities.
INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.
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, August 09, 2011

Where "should" the stock market be?

There's a flap on about market declines. I think it's because the traders are kids.

Take a look at the graph below, which shows the Dow since the end of WWII. Bearing in mind that in real terms, a thousand points on the Dow was worth more in the past than today, where do you think we ought to be, if the market was "normal", or better yet "sane"?

Adjusting for inflation (CPI-U), and looking at the Dow's progress from August 1945 to August 1980 (around when the Great Inflation really started), then extrapolating, I figure the Dow should be a shade under 3,000 points today.

The rest is, effectively, monetary bubble - which is not to say it can't continue.



INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

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, August 08, 2011

China downgrades American credit to "A"

Half a world away from the USA, China's Dagong credit rating agency can afford to be blunter than Standard & Poor.

Their view, shared by many in the West, is that the problems have not been solved but damagingly deferred; $4 trillion needs to be cut from the public budget within 5 years; QE3 is inevitable and "will throw the world economy into an overall crisis". Accordingly, on August 3 Dagong downgraded the US rating further, to "A, with a negative outlook".

If the Western rating agencies dare to echo that view (and some see last week's S&P's re-rating to AA+ as an attempt to break the news gently), it could be the trigger for a more serious selloff in the stock and bond markets. Disaster for many, opportunity for some - perhaps.

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

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 a nutshell - the investment crisis

A bear market is one where the odds of losing are greater than the odds of winning; they built Las Vegas on the back of it. So the gambling will continue, a few will do well and most will lose their wad. The difference is, Wall Street won't serve you drinks.

Sunday, August 07, 2011

Crash? What crash?

The hackneyed news media deadlines are trotted out again: "x billion wiped off shares". How quickly we forget.

Below are the charts for the FTSE and the Dow from their recent low points in March 2009:

The FTSE closed Friday 49.4% higher than 29 months ago; the Dow, 74.8% higher.

I think that ultimately, both will (in real terms) plumb depths significantly deeper than they did in 2009, but it will not happen in one go, and it will take a long time.

The stockmarket is not a store of money: A has already paid B for ownership of the shares, and the money went into B's bank account. The money is not parked on Wall Street or Paternoster Square, it merely passes through it.

On the way, it's purchased either the promise of a future income stream (and how reasonable is that hope in an unravelling world economy?) or the chance to sell on to a bigger fool (in the hope that it hasn't already happened).

Remember, you don't have to be in this game. I should like to know where the traders' and bankers' bonuses are invested at the moment: do they eat where they cook?

INVESTMENT DISCLOSURE: None. Still in cash (and index-linked National Savings Certificates), and missing all those day-trading opportunities.

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, August 01, 2011

Gold and its correlation to debt and GDP - updated

Jesse offers a chart showing an apparently close relationship with the price of gold and the growth of US official debt, thus:


He wonders how this might look in relation to debt/GDP, and I give below gold's correlation with GDP and with debt in its broadest sense (TCMDO, ignoring intragovernmental lending) in the period 1952 - 2010:



I would suggest that gold's basic correlation is with GDP, but with wild swings reflecting debt-fuelled manias and financial crises. On this showing, and despite what looks like a meteoric rise over the last few years, gold is merely coming home and is not yet overpriced in the long view. This, as I understand him, is what Dr Marc Faber also thinks.

Not having had the money at the right time, I missed the opportunity to climb aboard gold when it was severely underpriced; but may do so soon, merely to preserve some of the value of our savings.

I'm not so much a gold bug as a most-everything-else bear. When the system stops lending cheap money to the riverboat gamblers with dusty top cards on Wall Street, I'll be interested in genuine investment.

UPDATE:

Here's the price of gold compared to the growth in Total Public Debt Outstanding since fiscal year 1929 - this includes intragovernmental debt (please click to enlarge):









INVESTMENT DISCLOSURE: None - YET. Still in cash (and some inflation-linked government savings certificates), and missing all those day-trading opportunities.

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, July 29, 2011

Banks' final grab: the land

UPDATE: It's happening! Unbelievable!

_________________________________________

Robert Wenzel comments approvingly on a course of action mooted in a meeting of primary dealers and the US Treasury held at midday today. The idea:



"Dealers suggested that the Treasury might be able to repo their MBS portfolio to raise cash."



Yes, I should think banks would like to suggest that: have the government that bailed them out, now sell the MBS (mortgage-backed securities) back to them at fire-sale prices. 31 million mortgages - about half of all the mortgages in the USA - delivered into the hands of the swindlers.



What daring. It is almost Biblical in the scale of its impudence.



For the record, let's list these players:



BNP Paribas Securities Corp.

Barclays Capital Inc.

Cantor Fitzgerald & Co.

Citigroup Global Markets Inc.

Credit Suisse Securities (USA) LLC

Daiwa Capital Markets America Inc.

Deutsche Bank Securities Inc.

Goldman, Sachs & Co.

HSBC Securities (USA) Inc.

Jefferies & Company, Inc.

J.P. Morgan Securities LLC

MF Global Inc.

Merrill Lynch, Pierce, Fenner & Smith Incorporated

Mizuho Securities USA Inc.

Morgan Stanley & Co. LLC

Nomura Securities International, Inc.

RBC Capital Markets, LLC

RBS Securities Inc.

SG Americas Securities, LLC

UBS Securities LLC.



You'll note that six of them are now Limited Liability Companies (LLC), the latest to convert being Morgan Stanley (as of May 31, 2011). Apparently, this has a tax advantage for derivatives dealers; but I wonder whether not having shareholders while also avoiding personal liability is an equally important consideration, as we approach the endgame, when bank shares may finally burn up.



Imagine what Thomas Jefferson and Andrew Jackson would say, if they could see how in the Land of the Free a tiny elite not only owns most of the cash, bonds and shares, but now aspires to seize the real estate. America is approaching a peak of wealth inequality and mass servitude comparable to the condition of England in the eighteenth century, but without the hopes offered by the Industrial Revolution.



INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

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, July 28, 2011

When investing, remember inflation

The lowest point (so far) in the above monthly sequence was February 2009. But we've still lost a third in real terms overall since the start of the Millennium.

And what does this shape suggest to you about future returns?


INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.



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, July 27, 2011

The Stock Market made simple?

A correspondent on Usenet took umbrage recently when I referred to traders as (possibly necessary) parasites on the economic system. That he used to be one probably had something to do with his outrage, but I meant the term in the biological sense, in that traders generate no wealth, nor provide any real service, at least in my simplistic understanding.

Perhaps the illuminati here can shed light on my misunderstanding by considering the following simple scenario:

1. MomandPopCo decide to expand, and so release an IPO of 2,001 shares. They keep 1001 to have majority control, and sell the rest for $100 per share. With a 1% fee charged by the brokers, they realize $99,000, and the latter get $1,000
2. A short time later, Amy sells her 100 shares for $105 per share to Bob. She gets $395 in profit, and the brokers get $105 for their service.

Questions:

1. Where does all of the money come from?
2. Why does Bob pay more for the shares than Amy did?
3. Why was Amy able to charge more than she paid?

The answers are clearly(?):

1. From the investors.
2. Unless Bob is an idiot, he assumes that the stock price will either further increase, or the dividends will cover his costs.
3. Amy must be taking the discounted value of the future dividends of the company, or we are starting yet another bubble. This is easier to see if the company is buying and raising cows for sale, being a transaction of finite duration.

Notice that the company does not benefit at all from the second transaction. Even if their stock goes up, they cannot sell any more without losing control.

Hedge fund titans admit they don't know what's going to happen

George Soros is retiring, closing his fund to outside investors and returning their money.

Some say it's because he's become old (81) and cautious, other suggest it's to avoid being regulated by the Securities and Exchange Commission, but he himself has said “I find the current situation much more baffling and much less predictable than I did at the time of the height of the financial crisis.”

Stanley Druckenmiller, one of Soros' former fund managers, also threw in the towel last year, and he's only 58.

Closing hedge funds is a trend, and the issue now even has its own website: The Hedge Fund Implode-O-Meter. I see this as further confirmation that it is no longer "business as usual" in the investment world. It is, perhaps, like that stage in WWII when senior officials on the losing side prepared fake IDs and packed gold and art treasures for their flight; that is, it's no longer about gain, but about hanging on to what you've taken.

This, I think, is part of what's behind the current US budget crisis. Agreed, public spending is out of control, but that has been so for a very long time. What's forcing us towards disaster is the overall level of debt, of which much the greater part is private credit. Players in finance and politics colluded to encourage the housing and credit bubbles, which disguised the failure to nurture domestic production and balance imports with exports. Fees, interest and selling securitised debt, plus capital gains on inflated assets in a booming economy, made many people rich, and some super-rich; and they bought the government and regulators.

The ordinary Joe's real wages stalled for 30 years and more, but loading him with easy credit (and sending his wife out to work) kept the show on the road. Now, it seems, the objective is to get him to pay for everything, without asking his masters for any of the money they made out of the game.

If the elite succeed, they keep their extraordinary wealth and Joe suffers. Actually, it looks as though they cannot lose, since most cash, bonds and equities are owned by the top 1% of the population. Even their houses will tend to retain most of their value, since the only people who can aspire to buy them are other people with lots of money.

Inflation would hit cash and bonds, but the rich also have most of the equities and nice houses. Deflation would amplify the power of cash and (provided there is no default) attractiveness of bonds, and the rich have most of that, too.

So why do we feel that we're at some break point? I think it's because the balance of opportunity and threat has altered significantly.

Firstly, there's nothing much more to steal; expansion is no longer a prospect.

Second, the economy may not rebalance without an increase in taxation, and I should think some of the wealthy are on the lookout for the possible imposition of capital controls that would prevent them from fleeing abroad with their money. The more far-sighted are already renouncing their US citizenship.

Third, if the system cannot survive without some redistribution of wealth, but those who have it hold on too hard, there may be a breakdown in the social order. Last year, Marc Faber and Ron Paul were each predicting such problems, Faber recommending moving out of cities because they are such easy targets for attack.

I agree with them. I think that when irrational greed and resentful desperation meet, there can be no good outcome. We are planning to move soon to somewhere pleasanter, but also, we hope, safer. We are beyond knowing what to do with our savings, other than to diversify so that we don't lose everything, and not to entrust it all to third parties.

Looks like the super-rich hedge fund managers think the same way.

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

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, July 19, 2011

Gambling on sovereign default may seriously disrupt equity and bond markets

IMPORTANT: Please note the disclaimer below before continuing!

Matters are coming to a head in the financial markets.

The yields on Spanish and Italian government bonds recently exceeded 6% for a while; at 7%, it is estimated, Italian public borrowing becomes unsustainable and Italy then joins Greece in the category of countries doomed to at least partially default on their obligations.

On the other hand, it's possible that the 7% point will not be reached, or if it is, not for long. So much depends on market confidence and as is well known, fear may trigger a crisis that is otherwise avoidable.

But so can the greed of speculators. While Britain's 1992 "Black Wednesday" made George Soros a reported USD $1 billion, the cost to the UK of its attempts to support the pound against his and others' shorting is estimated at over £3 billion sterling. He has since developed a reputation as a philanthropist; we could wish for a less expensive way to fund a benefactor. *

The difficulties in Europe come at a most unfortunate time for the USA, since there is now a showdown between President Obama and Congress over raising the debt ceiling for American public borrowing. The President has indicated that a deal needs to be struck by this Friday to give time for enactment by the August 2 deadline, which I guess will really mean more last-minute hard negotiating over this weekend. Brinkmanship is a dangerous game to play: it nearly blew up the world in the Cuban Missile Crisis of 1962, and then as now, everything depends on both sides remaining sane.

It's ironic that a financial elite, having looted the economy for decades and left it pretty much unworkable, then blames the losers and expects them to pay all the costs of putting things right, and that without delay. What nonsense: America's problem is private debt, which over the last 30 years has so enriched some of these born-again pecuniary Puritans. Yes, public sector workers have enjoyed great salaries and pensions compared to the People of Walmart (though please, say nothing about the top 10 hedge fund managers whose average earnings are $1.75 billion); but what fortunes have been made on the back of arranging mortgages on their increasingly crazily-priced houses? It takes two to tango; and the same number to quarrel, as we now see.

Well, the reckoning is coming, even if some won't pay their fair share of the bill. As "Mish" reported yesterday, the yield on the US Treasury 30-year bond is increasing and he is predicting a bond market revolt "sooner than anyone thinks".

And, scarcely believably, here come the speculators again. They made money packaging debt, making sausages with as much old roadkill as fresh meat in them; then they made governments pay for the consequences; now they gamble on which countries will go bust as a result. Last month, Martin Hutchinson reminded us that he'd warned in 2008 about credit default swaps, especially the ones that are "naked", i.e. insure events that would not in themselves result in any loss to the investor. This simply gambling, and it makes a bad situation worse; it did so, he argues, with Lehman Brothers and others, and will do so with Greek debt, where the loss on default will have added to it the cost of an estimated $100 billion in side bets.

Now there are those who will argue that the CDS market, though enormous ($60 trillion in 2008, half that now), isn't a dangerous one, exactly because it's a gambling operation. Loser pays winner, so it's a zero-sum game.

But it's not.

Firstly, there's the question of mispriced risk. Hutchinson explains: "Wall Street's risk management looks at normal price fluctuations and then assesses the maximum possible risk as a modest multiple of the daily fluctuation, it was completely inadequate in measuring the risk of a CDS book. That, in a nutshell, is why AIG went bust and had to be bailed out with $170 billion of taxpayer money."

Then there's the interaction between the speculators and the authorities. Goldmans Sachs was compensated by the taxpayer for losses on AIG debt, in addition to claiming on its CDS on the same. It's like getting paid twice on an auto repair job. Rather questionable, that.

And there's the risk of outright fraud, which is how rogue trader Nick Leeson destroyed Barings, Britain's oldest investment bank: he hid his losses in a secret account and increased his bets to try to recoup them. That put Barings' capital at stake in a way that the naive, old-fashioned management failed to foresee.

Which leads us to the problem of contagion. Banks can go bust, but their depositors are protected (subject to limits) by the FDIC. Not only does that puts the taxpayer on the hook, but the FDIC, being a corporation with limited assets, may itself become insolvent if the scale of losses is too great (in fact, that was the position only two years ago). We then have either partially-busted depositors, or (if politics forces it) a further burden on what under the circumstances is likely to be an already-distressed public budget.

And what if insurance and pension funds have to pay out on CDS contracts? As Hutchinson points out, banks have limited balance sheets, but the funds that represent security for the nation's savers have much more to place at risk in contracts that many of the fund managers won't properly understand or calculate - which made them such suckers for packaged debt (CDOs and variants). "Fool me once, shame on you; fool me twice, shame on me." Hutchinson, who ran a derivatives desk in the 1980s, assessed CDS as a "sophisticated scam". So I should like to know the total downside of CDS for pension and life companies. Could this result in massive extra welfare support for retirees?

Derivatives are the fourth horseman in Michael Panzner's apocalypse, or "Financial Armageddon" as his March 2007 book titled it (reviewed here in May of that year). The market, recently estimated at $601 trillion, is worth some 8.75 times the world's GDP (or nearly 40 times that of the US), so a relatively small percentage imbalance as per some of the ways illustrated above, represents a huge potential problem. The subsector including interest rate and CD swaps is expected to grow by 10% within a couple of years, according to Citigroup (itself a name to conjure with, in the light of recent history).

Will the Dodd-Frank Act prevent all problems in future? Not, I'd have thought, with many of the nation's brightest brains employed on Wall Street and perpetually looking for ways to game the system. I don't know the loopholes and weaknesses, but I'm betting on that talent, human nature and the fabulous scale of the incentives involved, to find them out.

One way or the other, the money looks as though it's going to run short. This will lead to increased reluctance on the part of lenders, and so raise interest rates and tank the market in existing bonds. Coming back to Martin Hutchinson, he wrote on Seeking Alpha at the beginning of this month, predicting an "epic" crash in September or December, though if things go wrong in current budget negotiations that date could come sharply forward. It seems inevitable that such a crash would also impact on equities, what with deleveraging and the depressing effect on demand of a severe deflation.

Will a mooted QE3 help? I'm not sure. What did QE2 do? The banks got a raft of money from government, couldn't find anyone who they wanted to lend it to and parked it at the Fed to get safe interest. In effect, the State is rebuilding the banks' reserves for them, on the drip. But as real estate continues to dwindle in price, the bank reserve ratios may actually worsen despite all this help. And whatever the outcome of current budget negotiations, the private debt ceiling seems to have been reached already, so the frightened consumer is hardly likely to shore up the economy with extra demand.

I cannot envisage how this can continue for much longer*, unless the government takes back from the Federal Reserve the right to issue money, in which case rip-roaring inflation is a possibility, followed by a total reset, as in Germany in 1923. But avoiding that is surely the point of a central banking system: not to have a Chancellor Havenstein operating 2,000 presses 24/7 printing currency with face values in the billions, truckloads of which were still waiting to move out on the day he died. Dropping dollars by helicopter might work in this terrible way (though C-5s would be more commodious); shoving money into the banks hasn't done so.

Perhaps the strategy will be debt default, but again I can't somehow picture the virtuous depositors being allowed to keep their dollars and see them multiply in spending power, even though at least one New Yorker appears to hold $100 million in a checking account. Is that a vote for cash as the best asset?*

Hutchinson's latest post advocates gold (an each way bet if you think deflation ends with a currency crisis), buying a house (even though he thinks it'll go down in value) and finally, a put option on Treasuries. Like me, he's struggling, really: gold is above its long-term inflation-adjusted trend, houses seems to be a bad investment for ready cash (unless you're one of the growing number of bottom-fishers snapping up distressed properties at 40% off) and options carry counterparty risk, which is where we came in.

In the event of a full-scale disaster, all bets are off. All I can suggest is diversification among all assets, plus holding some away from banks and other fiduciary institutions. And, of course, hope. ________________________

*Though I'm confused, it seems I'm in good company here:

"...even such "legendary" hedge funds as Soros' $25 billion Quantum are about as clueless as everyone else. Bloomberg reports that "the fund is about 75 percent in cash as it waits for better opportunities, said the people, who asked not to be identified because the firm is private."

The reason: "“I find the current situation much more baffling and much less predictable than I did at the time of the height of the financial crisis,” Soros, 80, said in April at a conference at Bretton Woods organized by his Institute for New Economic Thinking. “The markets are inherently unstable. There is no immediate collapse, nor no immediate solution."

- Zero Hedge
____________________________

INVESTMENT DISCLOSURE: None, except for (UK) NS&I Index-Linked Savings Certificates (similar to US TIPS). Otherwise, still in cash, and missing all those day-trading opportunities.

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, July 16, 2011

A reply from Mr Allister Heath, and my attempted rebuttal

Following my recent needling of Mr Allister Heath at City AM in response to his article calling for a new Ronald Reagan, he has kindly responded thus:

I agree with you that monetary policy was too loose in the US and in the UK (disastrously so under Lord Lawson in particular). However, I was focusing on Reagan's fiscal policies and didn't mention his monetary policy in my piece. While the latter was bad, it was no worse than what we have seen later and still see today - so I don't think it's an especially anti-Reagan point (we also saw far worse prior to him; in fact, the history of modern monetary policy has been one of failure in almost all economies). In fact, it is simply wrong for you to claim that monetary over-expansion started in the 1980s - we have been plagued by it ever since fiat money (and even before, for example when gold was brought back in large quantities to Europe by Latin American explorers).

As to the statistical dispersion of post-tax incomes you refer to, I agree that it has increased since the 1980s - but I do not believe inequality of outcomes as a goal, evidently unlike you. I do not believe that this kind of inequality causes crime. I'm much more worried bythe fact that some groups and individuals in society lack opportunity, for example because of poor state schools or because of perverse incentives created by the benefits system. But I think that low marginal tax rates maximise opportunities and economic growth, and hence welcome what Reagan did on that front.

To which I have framed a reply, as follows:

Dear Mr Heath

Thank you for responding. I am sorry to reply late but must plead pressure of work. May I perhaps take up a couple of your points?

1. I accept that Reagan's successors tended to permit the same disastrous over-expansion (I said "acceleration") of the money supply that, I must insist, did indeed begin on his watch. I shan't bore you with the graphs but the facts are undeniable. Yes, the money supply has had previous bursts - e.g. in the lead up to the 1929 debacle (and I'm familiar with the gold-supply-boosted inflation of the 16th century) - but 1980-ish was definitely a watershed in the postwar era. It's reaching a bit too far back to make tu quoque an excuse. However, I certainly don't exonerate his successors, either.

2. I also accept that when tax rates are high, tax cutting does help increase tax revenue as well as stimulating enterprise. But I'm not sure how much more tax rates should be cut from the 15% or so that effectively the American rich are currently paying. At the other end, I seem to recall research by - was it the IFS? - that shows the poorer sort are paying proportionately nearly as much tax as the middle class (something like 40%), thanks to indirect taxation.

3. You don't have to be a socialist - and I am certainly not - to query how (for example) the top ten US hedge fund managers can now be averaging $1.75 billion earnings p.a. This sort of thing is hardly the only alternative to "equality of outcome", a phrase whose implications are somewhat mischievously deployed by you in a discussion that ought really to be rather more nuanced.

4. Fiscal policy that focuses solely on State spending and debt is what has led us to this pretty pass. The Flow of Funds data shows that US local and national government debt declined from 52% of total credit market debt in 1952, to under 15% in 2007. That is not what has blown up the economy. Australian economist Steve Keen maintains, plausibly in my view, that what we have seen is a private debt crisis, not a public one. And this was stoked by the ability of banks to inflate asset prices through reckless lending; as well as government interference in the housing market, on both sides of the Atlantic. The failure to control the egregious greed of bankers must be laid at the door of governments, who doubtless saw votes for themselves in an overstimulated financial environment.

5. As the late Sir James Goldsmith (no slapstick socialist he, either) observed as long ago as 1993 when GATT was under way, it is globalisation that is destroying opportunities for those sectors of society for which you express some concern. Indeed he foresaw the breakdown of social cohesion in the West which we are now beginning to witness, and which the extremely high and growing disparities of wealth and income are doing nothing to heal. Certain clever and unscrupulous individuals have exploited the massively enriching (to themselves) opportunities latent in this situation, so I think it's fair to suggest that there is a causal relation between the prosperity of the super-wealthy in the modern financialized economies, and the impoverishment and social decay in the same.

6. You say that poverty does not cause crime (though recent UK statistics are showing a significant increase in burglaries). I would suggest that the underclass has, to some extent, been bought off by the payment of various kinds of social benefits, although there has been a concomitant deterioration in morale and behaviour, the effects of which are becoming increasingly difficult to manage and which is breeding a growing number of angry and confused children. Schools are doing what they can, but people must have hope of a better life and the prospects of meaningful employment and self-determination. This is unlikely to be achieved when our government exploits economic migration to hold down wage rates. More exam passes (inflated grades or no) may merely create a class of Eliza Doolittles with attitude.

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

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, July 12, 2011

Some European debt ratings



CMA Datavision reports on credit default swaps for sovereign debt and so its information, based on market rates, is not quite so compromised as that of some major rating agencies. The global rankings are for 67 countries. The eurozone includes 4 of the 6 best, and 3 of the 4 worst. It is not surprising that the euro garment cannot fit all sizes in this range and the problem was identified by some commentators over a decade ago when the Euro was introduced.

Note: Spain is the 21st worst - consider it deep orange!

INVESTMENT DISCLOSURE: None. Still in cash, and missing all those day-trading opportunities.

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.