Random thought of the day:
My biggest monthly expense, outstripping rent, food, and even beer… is federal tax. Maybe we should all look at the bright side of this financial mess. By losing our jobs we will also lose our biggest expense.
In that vein, something like 10% of famous quotes go like this:
“We don’t stop playing because we grow old; we grow old because we stop playing.”
I was thinking about writing some software that would autogenerate these things.
We don’t X (for, because, to) Y, we Y (for, because, to) X.
Some completely nonsensical examples:
We don’t eat because we’re hungry, we’re hungry because we eat.
We don’t strive for greatness, greatness strives for us.
We shouldn’t exercise to get in shape, we should get in shape so that we might exercise more.
I think this is where Horatio Caine from CSI Miami gets his quotes:
“When you have everything, sometimes it feels like nothing”
Quick thought on Black Friday sales being ugly but better than expected. All of the people who decided to forgo car and truck purchases due to the recession are likely to spend some the money they saved on holiday shopping.
This looks like a shift from big ticket items (cars) to small ticket (gifts). Those looking for any sign of the bottom are quick to latch on to these stats. I’m not convinced that we’re through the woods yet in spite of economic deforestation / bailouts.
For next time. The graying of credentials. Degrees are losing their luster as employers learn to ask the right questions and interpret online reputation.
Part 1> The Injustice of the Correlation Between Ignorance and Pulpit
Part 2> Inflation vs. Deflation
Part 3> Investment Strategy
Part I – The Injustice of the Correlation Between Ignorance and Pulpit
“The fundamentals are strong”
“Debt is irrelevant”
“Whatever you do, don’t touch your 401k”.
“Ride it out”
“Nobody could have seen this coming”
I’m not frustrated about the economy melting down. In my eyes this was absolutely inevitable. I’m frustrated because of the horrible financial advice people are receiving on TV every day. Markets cannot work without good information and it is in short supply.
To prove that the saying “Nobody could have seen this coming” is completely without merit, here is one of the people I’ve been reading for the last few years. This is from 2006.
The older optimist in that video is likely to be on TV these days, calling the bottom and advising retirees that they should be investing in financials. Why he’s still on TV remains a mystery.
Oh, and here are the people in charge of fixing this mess:
Another blind optimist, Larry Kudlow, is watching his show slowing slip from his grasp. Jim Cramer’s ‘Mad Money’ is alive and well but Kudlow & Company has been turned into a generic roundtable of discussion about the economy. A few months ago, if the market was down, Kudlow would devote his show to the evils of the Democratic party (I’m not a Dem nor Repub). The evidence for his incompetence is now so overwhelming that CNBC had to do something. Kudlow wasn’t lying, he was simply unable to grasp reality.
Part II – Inflation vs. Deflation
Even before I knew the details of credit default swaps and commercial paper I knew that we were going into a nasty housing led recession and that the outcome would be either inflation or deflation. It is the only real question at this point. Over the next year stocks will trend down regardless (punctuated by insane rallies if history is any guide).
As I’ve been focusing more on this problem of inflation vs. deflation the issue of timing is key. It’s not a question at this point of which will we see. The outcomes are these:
1) Deflation followed by rapid inflation
2) Deflation followed by more deflation
I’ve always been in the deflation camp but I’m starting to turn. The Fed has a can of starch now. Pushing on a string to prevent deflation is no longer impossible. Bernanke may be ignorant but nobody will argue that he’s not crafty. I’m now more confident that he can destroy our economy using inflation. He referred to the printing press as a “technology”. The man is fiscal technologist.
The following paragraphs are the most important I’ve read in a very long time. Someone at the Council on Foreign Relations turned on a microphone and transcribed a discussion between some of the best minds thinking about these problems.
QUESTIONER: Thank you. I’m Jeffrey Rosen from Lazard. What you suggest for fiscal policy and monetary policy, massive stimulous deficits, low interest rates, implies an inflationary risk in the future. What you described for the asset market, a real estate market, commercial real estate market perhaps, certainly the residential real estate market, suggests an asset deflation risk. And I’m just curious which of the two you think is more serious and whether you think there are implications for what’s happening now, for asset deflation in the future which brings back to mind the Japanese type of scenarios. And if I’m allowed and he’ll take a minute, I’m just curious what Mort’s views are on the impact of all of this on the political season.
STEIL: I think both of them are serious, and the RTC fund I put forward with Mark Fisch in December was meant to address precisely that problem. But the inflation risk is also serious and we know that we can experience the two together in some combination. And the 1970s was a particularly bad period. I think in many senses the next five to 10 years are going to look like the 1970s; in other words we’re going to have at best very sluggish growth, we’re going to have elevated real interest rates, elevated inflation rates, elevated commodity prices. It’s going to be a painful period that’s going to involve both asset depreciation and an element of higher inflation.
ZUCKERMAN: Anybody else want to — ?
SETSER: I guess both of us.
ZUCKERMAN: Go ahead.
SETSER: I would put slightly more emphasis on the risk of asset deflation in large part because I think the process by which loose U.S. monetary policy was producing, super loose monetary policy in places like China and the Gulf that were pegging to the dollar and generating globally loose monetary policy, I think that process is about to go into reverse and that you’ll see a much stronger contractionary element from the global economy from the emerging world which will take some of the inflationary pressure off.
ZUCKERMAN: Nouriel?
ROUBINI: I don’t know. I think like in the cycle of 2001, 2003 in six months we’re going to start worrying about deflation, where suddenly asset deflation, slacking good labor and commodity market means inflation’s going to be the least of the problems the Fed has to worry.
You’re right about one point, if you’re going to essentially monetize all the fiscal deficit, that’s going to be made eventually inflationary. But I think that the way it’s going to be financed is going to be by public debt which is going to increase interest rates, but it’s not going to be monetized. Of the liquidity injection in the short run are satisfying a demand for liquidity that you can take away once the demand for liquidity goes away, so that’s not inflationary. And most of the — what the Fed does with the swap line doesn’t increase the money supplies, that’s the swap of bad assets for good assets.
So if we were to monetize, reduce the fiscal problem, absolutely, we’ll have a massive inflation problem down the line. But even–(inaudible)–said what Bernanke cannot afford essentially is throwing the inflation kind of expectation rise then because if inflation expectation comes out of the bottle then to bring it back you’re going to need a nasty bulk of this inflation, and we have a severe inflation. And even a–(inaudible)–Fed cannot afford to essentially monetize this problem. Then if we’re going to fiscalize it, we’ll have to raise taxes, cut spending, pass them onto the next generation. I think that’s the way that this crisis is going to be resolved, not with inflation.
ZUCKERMAN: I’ll just make a brief comment about the last part of your question. I believe if the election had been held two weeks ago, that McCain would’ve won. He was ahead in all of the key battle ground states as a quota. It’s amazing to me how close the election — the polls are to this moment. And since I don’t believe that the polls accurately reflect where the votes are going to come out and that votes will be much more than the polls indicated in McCain’s favor, it’s still a close election.
I cannot imagine that the impact of this crisis, which is going to make the economy the dominant issue from now until the end, unless there was some enormous gaffe or differential effect of the first debate, I just don’t see how Obama loses. If he does, it will really say something very, very serious about race relations, I have to say, because I think that’s the only issue that would defeat him if it were a generic poll. If it were any other Democrat, I think it would be a walk-away.
Part III – Investment Strategy
I’ve been advising all cash and 5 to 10% gold since the beginning of ’08. I think 5% gold is a good bet until the Fed Funds Rate hits zero, which could happen soon. At that point the Fed will have to get really creative in propping up markets using inflation.
This is almost unknowable. If inflation gets out of hand interest rates go through the roof (thanks to China selling dollars). That kills housing and bad mortgages are the cause of our problems. This is a hard problem because hyperinflation is a real threat but we’re the world’s reserve currency. I’m pretty sure nothing like this has happened in the history of human kind.
For the first time the Fed has the tools to actually fight deflation. Whether or not they will risk it remains to be seen. Bottom line – In my opinion now is a horrible time to buy stocks or housing. This ain’t the bottom. I really hope I’m wrong.
Just another recession? Bear Stearns is almost dead, stocks are off because of it. Bear is one of the ten biggest securities firms.
The people in charge aren’t saying that this is the worst financial crisis since the great depression. They prefer “since WWII”. I don’t like to write about depressing news because not many people like to read about it, but this is fascinating and terrifying at the same time. I’m just glad I can write about this now without sounding like a permabear.
For some reason, when I read news articles weird analogous cartoons appear in my head. In this case I’m picturing a bunch of crusty old bankers, crammed into a shopping cart, headed down a perfectly smooth slope, picking up speed. The average person on the street knows we’re in a recession. But if you watch Bloomberg (live feed – much better than CNBC but not as good as some blogs) and read the best finance blogs you know that what is happening right now is basically a 100 year financial storm. It’s really really bad.
Why doesn’t the guy on the street know what’s going on? Because if Ben Bernanke said what some know there would be panic. Bernanke keeps referring to this as a sub prime problem. That’s not the whole story. These loans are going bad because of one simple reason: Home prices were too high. Homes bought with subprime loans were too expensive and homes bought with prime loans were too expensive. The loans were a means to an over priced end. Bernanke is shooting the messenger because the messenger is expendable. Now he’s just about out of messengers to shoot and things are still falling apart. His credibility is the only thing holding things together at this point which might explain why people are applauding during his live speech in DC right now. It’s a bit like a laugh track.
My take is that this housing correction, by itself, would cause a pretty nasty recession. But we’re adding on super leveraged derivatives, unregulated hedge funds, over extended consumers, inflation, and the death of dollar hegemony as BRIC emerges and competes for jobs and resources. My tech brain tells me that IT automation(onshore outsourcing) is probably a bigger concern for balanced wage growth than China or India.
In other words, housing is the trigger that’s allowing all of these other painful inevitabilities to unravel at the same time. Housing never would have been allowed to get so out of hand by the Fed if they weren’t trying to delay the inevitable. A look at the home price to income/rent ratios back in ’04 was enough to know that we were in a classic bubble and the Fed had to know this. The fact that they did nothing lends credence to the notion that they were aware of the systemic problems now rearing their heads.
My guess is that rates go to zero and the Fed loses a tool to “stimulate” the economy. Odds of a 1% rate cut are at 50% right now so we’re not far off from ZIRP (zero interest rate policy). Japan ran into the same problem almost 20 years ago and couldn’t stop deflation.
So the only question remaining, assuming things continue to deteriorate (which looks likely): Will US ZIRP lead to inflation or deflation? If we see deflation the Austrians win. From Mises’ Human Action:
There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved. (p. 572)
Mises was probably a bigger contributor to the Austrian School than Hayek but he never won a Nobel Prize.
Economics, and specifically the economy, will be the dominant issue in the ’08 race. I believe that because I’m aware of the toxic waste keeping the economy afloat that nobody seems to want to talk about. I’m a long term optimist due to the effect of accelerating change on productivity but here is my list of facts that bode ill for ’08.
The housing correction is just getting started. Trillions of dollars of homeowner wealth will vanish.
The economy is 70% consumer spending. Home ownership is 70%.
Opacity of derivatives markets. Things are now so complicated that nobody really knows what sort of dysfunction lies beneath the surface.
Consumer indebtedness. People have been spending more than they earn for quite a while. That is not sustainable.
Monolines – Insurance companies that back bonds are starting to flail due to unprecedented foreclosures. If they go down ratings on munies fall and pension funds are forced to sell (bad for stocks)
Credit bubble which we’ve been blowing for 20+ years is about to pop and if you believe Hayek/Mises things are about to get ugly. This explains the housing bubble and current credit squeeze.
Government spending (state and local is 10% of the economy) is going to fall as tax revenues fall in a recession.
Commercial real estate is starting to fall. This was a bright spot until recently.
Even if the Fed can bail out financial markets it will do so using inflation (hence my preference for gold). Higher prices mean less discretionary spending which bodes ill for the economy.
Recessions are a natural part of the business cycle and we’re way overdue
Home equity lines of credit and loans are evaporating
Credit card delinquencies are rising.
I could go on but you get the picture
I’m going to predict an Obama victory for the sake of argument. Here is his problem: We’re probably going to be in an unusually nasty recession when he’s being inaugurated next year and presidential approval ratings are roughly equal to consumer sentiment. Of course the president doesn’t have much of an effect on business (credit?) cycles in a $14 Trillion economy but that is the way the cookie crumbles.
Obama is probably going to make the economy a huge part of his campaign as the economy slides which will give Americans hope that everything will be puppies and roses as soon as he takes the helm of this rusty ship. Assuming this isn’t a repeat of the ’70s (or, dare I say it, 30s) we should be well on the road to recovery which bodes well for a 2nd Obama term, all things equal.
Optimism:
I said that I’m an optimist due to the effect of accelerating change on productivity. Accelerating change is a branch of future studies that nobody is really looking at in terms of economics yet. Kurzweil has a good chapter on it but it deserves a entire book. My take is that accelerating change will start to seriously ramp up productivity. The problem is that we don’t have the ability to train workers fast enough to take advantage of what should be a wealth boom for more than just the privileged few. The growing wealth divide is currently blamed on tax cuts. That may be the case but I think it is also due to the accelerating economic changes we’re witnessing due to the internet and off shore outsourcing.
Gold:
Nearly every time we see a sell off in the markets (DOW is off 2% as I write this) Gold goes down with it. But gold seems to go down about half as much as equities, the assumption is that the smaller decline is due to the belief that the Fed is now cutting rates (using inflation) to prop up the stock market and maybe because it’s a destination in a flight to safety.
Asia Times has a good multi-part series on the inflation/deflation debate here. They’re in the hyperinflation camp. For the deflationary angle check out this post from Mish at Global Economic Analysis.
Random thought of the day:
Part 1> The Injustice of the Correlation Between Ignorance and Pulpit
