Thursday, August 9th, 2012
by Peter Tchir, TF Market Advisors
Herding Cats and Obstinate Politicians
The mental image is so clear. Draghi, Hollande, and Obama, wiping the sweat from their brows with dust covered hands, having successfully corralled the Merkel. She’s still feisty and not happy about being in the pen, but they have managed it for now. Job well done, time for a well deserved refreshment after a long day.
It’s only then that they realize the Rajoy isn’t in the pen. They can’t believe their eyes. There is that damn Rajoy sitting on the other side of the river licking his paws preening himself. They cannot believe. They are stunned, flabbergasted, and about to go ballistic.
Seriously, after all the effort to cobble together something that they managed to convince the markets would turn into action is being derailed by the person who is most to benefit?
It is absolutely ridiculous, but it’s not as though they will just give up. They will corral Mr. Rajoy. It is inevitable and the real risk is whether Merkel is able to escape while their attention is focused on Rajoy.
So while it is concerning that Spain is not playing along, I think the pressure brought to bear will be great and Spain will accept something to keep the EU, ECB, and Obama happy.
Negativity Remains High
The markets have had a strong rally, and I am definitely seeing more bullish statements, and the media seems to be adopting a little more of a cheerleading stance than a week ago, but negativity remains high. As I wrote yesterday, I have continued to sell and am now by the smallest long position I have. I haven’t yet bought SPX 1,350 puts (I should have) but after yesterday’s sales, I have a small position. I think that is representative of many bulls. This is the underinvested bull rally, where very few, if any bulls have been aggressively positioned for the move from 1,380 to 1,400.
The perma-bears have grown angrier and louder. That makes perfect sense and doesn’t tell me much.
It is at the center that I still see a lot of bearishness. I read multiple reports today about how the ECB plan would create a problem for Spain and Italy because their average maturity would continue to decline. Serious analysts have taken the time to recommend selling the market because the average debt maturity will be too short. I saw this and had to think. I have been a proponent that the longer the better. Without a doubt getting Spain and Italy long dated, cheap money is far more beneficial than short dated money, but right now, let’s see them ACTUALLY GET SOME MONEY.
There is something about the need to write about the negative long term consequences of a plan that hasn’t been announced yet, that just makes me believe negativity remains too high.
Watch the financial news for a bit. How many people are getting set with an easy ball to spike down on the bull side (their normal tendency) yet refusing to take it? In some cases, they are going out of their way to find the bad side. In many ways that is an encouraging sign, as it is far more balanced than it has often been in the past, but it feels that the pendulum has swung and too much effort is being put into pointing out negatives. It isn’t as extreme as when the philosophy seemed to be to turn everything positive, but I think it is there.
So I remain convinced, that while the market has moved to a more balanced position, it is far from overly bullish.
Yesterday’s Credit Market Underperformance
IG18 actually finished ¼ bp wider yesterday. It had gotten down to 101.5 but finished the day 103 bid. This was in spite of equity strength and a reversal from the bidless market we had seen for several sessions. That is definitely something to watch, but the rally has been strong, and yesterday’s pause wasn’t met with much real pressure in single names as the basis is now only -2 bps. That is about the least rich that IG18 has been in awhile. This means that positioning here is becoming more balanced. It was getting hard to have a sustained rally while being 4 to 5 bps rich, but at a much more neutral valuation relative to fair value, it has room to tighten again, which remains my base case for CDS.
The high yield ETF’s both sold off a bit yesterday. HYG and JNK were both down about ¼%. That caught some attention. The first thing I look to for confirmation of weakness is HY18, the CDS index. That was higher by about 1/8. Not much, but not confirming weakness in the ETF’s. HY18 is a spread product, so that indicates spreads tightened. Then look at rates. Treasuries moved lower yesterday. That move was picked up by LQD and MUB which are very sensitive to treasury yields. High yield, as I’ve mentioned, now has a large segment of the market that is trading at such low yields, that it is more sensitive to treasuries than usual. Some of that will have impacted the market. Too many “high yield” bonds trade as low yield, so will track treasuries at least somewhat (why I have said repeatedly at these yields, individual credit, and individual bond selection is more important than the beta trade).
If High Yield was really weak, IRM wouldn’t have been about to issue $1 billion of 5.75% coupon bonds. Those bonds only traded up ½ point (so not as much free money as you usually get from a new issue allocation, but still better than a kick in the teeth). For those who care about ratings, these are B1/B+ bonds.
So, yes, there was some weakness, but mainly in the cheapest hedge (IG18) and mostly a function of treasuries rather than spread, and the real key, the new issue side, remains strong.
I feel the need to point out that JPM closed at 37.01 yesterday, the highest close since the May 10th whale conference call. At one point, including the dividend paid since then, JPM hit 38. I am now virtually out of JPM. I will reload again, but above 37.50 just seemed far too good a selling opportunity to pass up. While the whale trade is out of the way (I remain convinced the residual is marked so conservatively and has so many reserves that even the worst summer intern could trade their way out of the residual and book a profit. There are signs that housing is stabilizing at these levels. Those are all good signs, but the risk of a nasty LIBOR headline concerns me at these levels. It has been a great trade for us, and we will continue to trade the name from the long end, and may add, but the main thesis is largely over now for me.
S&P 1,350 Puts, Could have, Should have, Would have, Won’t
All things considered, I will be looking to add back some risk here rather than continuing to sell. The amount of negativity still seems high. While it will be a pain to corral Rajoy, I find it hard to believe that after all the effort made, that Draghi, Hollande, and Obama will give up so easily. The credit market weakness that so many pointed out, seemed isolated to a couple things, relatively easy to explain and all part of a process that to me is as natural if it was preparing to break to new tights as much as it is a sign that it is about to turn around.
It still feels strange to be long, and feels even stranger to be looking to get longer as futures continue to drift lower, but the fact that so many people are happy to say how wrong I am, gives me comfort.
I am watching closely. It is possible that yesterday’s push through 1,400 and gap to 1,407 is all we get and I should have bought the puts, but for now I’m looking to replace what I sold and think we still push to a new high, largely because too many people are bearish and even the bulls are underweight.
Copyright © TF Market Advisors
Tags: Brows, Bull Rally, Bulls, Cheerleading, ECB, Herding Cats, Hollande, Market Weakness, Mental Image, Merkel, Negativity, Obama, Paws, Perfect Sense, Perma, Politicians, Refreshment, S Sales, Spx, Tf
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Friday, August 3rd, 2012
by Mark Gongloff, Huffington Post
People hate stocks more than at any time in the past quarter century. That could mean it’s a decent time to buy them. Wall Street’s optimism about the stock market is the lowest it has been since at least 1985, according to a research note on Wednesday by Bank of America’s stock strategist Savita Subramanian. The bank measures market agita by tallying how much stock strategists are recommending their clients buy stocks.
In the Bank of America chart at the bottom of this post, you can plainly see that sentiment has absolutely plunged this year. Stock-market strategists are almost always bullish on the stock market, in part because if nobody is buying stocks, then there’s not much point in having stock-market strategists, is there? They’d have to go home and sit on their couches. But today, these same strategists are so spooked by the European debt crisis and the fiscal cliff and whatever else — Obama, or something — that they are recommending clients sell stocks, more than they did even during the financial crisis or the dot-com bubble bursting or after the 9/11 terrorist attacks.
Typically, you’re going to get some pretty good bargains in stocks when you’ve got so little competition for them, Subramanian writes. She would be one of the dwindling breed of bullish strategists: “Given the contrarian nature of this indicator, we are encouraged by Wall Street’s lack of optimism.” Speaking of contrarian indicators, on Tuesday Pimco founder Bill Gross, manager of the world’s biggest bond mutual fund, declared, “The cult of equity is dying.” He warned that carnival barkers promising you annual returns of 6 percent to 7 percent every year in stocks were lying to you, that you should get those people out of your lives immediately. This is the same Bill Gross that predicted interest rates would soar last year (spoiler: they didn’t) and then put his money where his mouth was, taking a big hit to his fund’s performance and his reputation in the process.
Copyright © Huffington Post
Tags: 9 11 Terrorist Attacks, Agita, Bank Of America, Barkers, Buying Stocks, Couches, Debt Crisis, Decent Time, Financial Crisis, Founder Bill, Good Bargains, Huffington Post, Market Strategists, Obama, Optimism, PIMCO, Quarter Century, Savita Subramanian, Stock Market, Strategist
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Wednesday, July 25th, 2012
It is not often we double-dip in the Sausalitan’s soliloquies but tonight’s glorious truthiness from Charles Biderman, CEO of TrimTabs, is worth the price of admission. After explaining that the only way he could be any more bearish is to be double-levered – and that he believes that besides “believing in miracles” this market will see the March 2009 lows once the market-rigging is fully exposed, he makes probably the most clarifying statement we have heard regarding our central-planners-in-chief. With regards to Messrs. Bernanke, Geithner, and Obama: “The most damage is caused by those who are not as smart as they think they are.” They continue to believe they are smart enough to fix all our financial problems (and Europe’s – if they would just listen to Timmay) by building a bridge over the recession – thanks to asset-buying and ZIRP. “The only problem is we are running out of bridge and are nowhere near recovery” is how he sees it and reflecting on the massive gains that have been made on short-dated Treasuries as the Fed (who is the one buying them) extends the ZIRP horizon – it is clear that this is nothing but a huge Ponzi scheme.
Tags: Bernanke, Building A Bridge, Central Planners, Ceo, Europe, Geithner, Horizon, Lows, Market Rigging, Massive Gains, Messrs, Miracles, Obama, Ponzi Scheme, Price Of Admission, Recession, Soliloquies, Treasuries, Trimtabs, Truthiness
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Monday, February 20th, 2012
TOP 15 Stories of February 2012, According to You
Tags: Austerity, Bill Gross, Bond Market, Business Insider, David Einhorn Greenlight, David Einhorn Greenlight Capital, David Rosenberg, Dividend Yield, Dreman, Insider Radio, Jeremy Siegel, Last Decade, Love Affair, O Neill, Obama, Puppetmaster, Radio Shack, Time David, Volatile Stocks, Warren Buffett
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Tuesday, January 24th, 2012
Just when one thinks American crony capitalism couldn’t hit new lows, here comes Warren Buffett and his personal puppet, the president, proving everyone wrong once more. Because if one thinks there is no (s)quid pro quo for all that “sage” advice that Buffett has been giving to Obama on extracting as much wealth as possible from future wealthy Americans (before they decide they have had enough with this crony s%*t and leave the country for good), one would be fatally wrong. As it turns out, it is not just natural resources and aquifer purity that Obama had in mind when sealing the fate of the Keystone XL pipeline.
No – it appears there were far more relevant numerial metrics that determined Obama’s decisions. Such as the bottom line number of Buffett’s Burlington Northern, which according to Bloomberg, is among U.S. and Canadian railroads that stand to benefit from the Obama administration’s decision to reject TransCanada Corp.’s Keystone XL oil pipeline permit. ‘“Whatever people bring to us, we’re ready to haul,” Krista York-Wooley, a spokeswoman for Burlington Northern, a unit of Buffett’s Omaha, Nebraska-based Berkshire Hathaway Inc. (BRK/A), said in an interview.
If Keystone XL “doesn’t happen, we’re here to haul.” And quite delighted to reap the windfalls of unfounded populist fears she forgot to add. Because while the whole “carbon-credit” multi-trillion top line expansion scheme for Goldman under the pretense of actually caring for the environment may have collapsed, it is not preventing others from trying and succeeding where even Goldman has failed.
Rail car production is already at a three-year high as manufacturers such as Greenbrier Cos Inc. (GBX) and American Railcar Industries Inc. (ARII) expand to meet demand for sand used in oil and gas exploration, according to Steve Barger, an analyst at Keybanc Capital Markets Inc. in Cleveland, citing Railway Supply Institute statistics.
Rail-car suppliers can add capacity, Hatch said.
“Railroads are not just a stopgap while we wait for a pipeline,” Hatch said in an interview. “They are potentially part of the long-term solution.”
Railroads are being used in North Dakota (STOND1), where oil producers have spurred a fivefold increase in output by using intensive drilling practices in the Bakken, a geologic formation that stretches from southern Alberta to the northern U.S. Great Plains. During 2011, rail capacity in the region tripled to almost 300,000 barrels a day as higher production exceeded what pipelines handle, according to the State Department report on Keystone XL.
Burlington Northern carries about 25 percent of the oil from the Bakken, said Krista York-Wooley, the railroad spokeswoman. The company can carry higher volumes from North Dakota or Alberta, she said.
Canadian Pacific Railway Ltd. (CP)’s shipments from North Dakota climbed to more than 13,000 carloads last year from about 500 in 2009, Ed Greenberg, a spokesman, said in an e-mail. The Calgary- based company has a similar plan in western Canada.
“With an extensive rail network and proven expertise in moving energy, CP offers a flexible option for transporting crude oil and other energy-related products to and from key locations in North America,” Vice President Tracy Robinson said in an e-mail. “Rail is scalable, allowing CP to effectively keep pace with the shipping needs of producers.”
So those wondering how it is that AAR railroad statistics continue to be so very strong, it is not because the economy actually justifies it: it is because crony interests such as those of the Octogenarian of Omaha demand it as “payment” for their crony collegiality with the biggest dunce president since Carter.
In other news, it is truly amazing how with every new development, America is now becoming like one giant conspiracy theory, only this time it is actually not a theory as with every passing day we see it enacted in practice.
Tags: American Railcar Industries, American Railcar Industries Inc, Berkshire Hathaway, Berkshire Hathaway Inc, Burlington Northern, Canadian Railroads, Car Production, Crony Capitalism, Greenbrier Cos Inc, Keybanc Capital Markets, Keybanc Capital Markets Inc, Obama, Oil And Gas Exploration, Oil Pipeline, Puppetmaster, Transcanada Corp, Transcanada Pipeline, Warren Buffett, Wealthy Americans, Windfalls
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Sunday, January 22nd, 2012
I’d like to point out to readers a very good article in the New York Times on one of the major challenges for the new era economy. Unlike past eras, many of our major corporations are no longer major employers in the U.S. This story examines this trend via the lens of Apple. It also shows the challenges of competing with China, as armies of workers at companies like Foxconn have a very different perspective on working conditions than Americans. Where this is really striking Americans is the mid level jobs – we are seeing expansion of low level (paying) jobs in services, and to a smaller degree high level (paying) work. But many of the “rungs” Americans used to climb to get from low to high (or at least middle class) are now overseas.
- Not long ago, Apple boasted that its products were made in America. Today, few are. Almost all of the 70 million iPhones, 30 million iPads and 59 million other products Apple sold last year were manufactured overseas. Why can’t that work come home? Mr. Obama asked. Mr. Jobs’s reply was unambiguous. “Those jobs aren’t coming back,” he said, according to another dinner guest.
- The president’s question touched upon a central conviction at Apple. It isn’t just that workers are cheaper abroad. Rather, Apple’s executives believe the vast scale of overseas factories as well as the flexibility, diligence and industrial skills of foreign workers have so outpaced their American counterparts that “Made in the U.S.A.” is no longer a viable option for most Apple products.
- ….what has vexed Mr. Obama as well as economists and policy makers is that Apple — and many of its high-technology peers — are not nearly as avid in creating American jobs as other famous companies were in their heydays. Apple employs 43,000 people in the United States and 20,000 overseas, a small fraction of the over 400,000 American workers at General Motors in the 1950s, or the hundreds of thousands at General Electric in the 1980s. Many more people work for Apple’s contractors: an additional 700,000 people engineer, build and assemble iPads, iPhones and Apple’s other products. But almost none of them work in the United States. Instead, they work for foreign companies in Asia, Europe and elsewhere, at factories that almost all electronics designers rely upon to build their wares.
- Apple executives say that going overseas, at this point, is their only option. One former executive described how the company relied upon a Chinese factory to revamp iPhone manufacturing just weeks before the device was due on shelves. Apple had redesigned the iPhone’s screen at the last minute, forcing an assembly line overhaul. New screens began arriving at the plant near midnight. A foreman immediately roused 8,000 workers inside the company’s dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was producing over 10,000 iPhones a day. “The speed and flexibility is breathtaking,” the executive said. “There’s no American plant that can match that.”
- For Mr. Cook, the focus on Asia “came down to two things,” said one former high-ranking Apple executive. Factories in Asia “can scale up and down faster” and “Asian supply chains have surpassed what’s in the U.S.” The result is that “we can’t compete at this point,” the executive said.
- ….nothing like Foxconn City exists in the United States. The facility has 230,000 employees, many working six days a week, often spending up to 12 hours a day at the plant. Over a quarter of Foxconn’s work force lives in company barracks and many workers earn less than $17 a day.
- “They could hire 3,000 people overnight,” said Jennifer Rigoni, who was Apple’s worldwide supply demand manager until 2010, but declined to discuss specifics of her work. “What U.S. plant can find 3,000 people overnight and convince them to live in dorms?”
- Another critical advantage for Apple was that China provided engineers at a scale the United States could not match. Apple’s executives had estimated that about 8,700 industrial engineers were needed to oversee and guide the 200,000 assembly-line workers eventually involved in manufacturing iPhones. The company’s analysts had forecast it would take as long as nine months to find that many qualified engineers in the United States. In China, it took 15 days.
Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog
Tags: 30 Million, American Counterparts, Apple Products, Different Perspective, Dinner Guest, Eras, General Electric, General Motors, High Technology, Ipads, Iphone, Mid Level, Middle Class, New Era, New York Times, Obama, Overseas Factories, Rungs, Viable Option, Working Conditions
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Thursday, December 1st, 2011
Leon Cooperman, Chairman & CEO of Omega Advisors, says he is very alarmed at the direction President Obama is taking the country. Click here for the open letter he wrote to Obama.
Source: CNBC, November 30, 2011.
Wednesday, September 28th, 2011
by Trader Mark, Fund My Mutual Fund
Richard Koo is a well respected economist, but he does not get much play on the major U.S. business infotainment channels. He is probably considered the foremost expert on the malaise that has been Japan the past 2 decades. Money magazine just published an interview with the man, and his comments are quite interesting. Warning for those leaning right: on first glance, he sounds like Krugman-lite, although his framework is a bit different.
- There’s no shortage of debate as to whether the Obama administration and Congress have done the right things in attempting to avert a debt crisis and revive the stalled economy. Richard Koo, the chief economist for the Nomura Research Institute, a Japanese think tank, says that government spending is the key to getting the economy back on track — and that 2009′s massive stimulus package didn’t go far enough.
- While Koo’s kind of thinking is decidedly unfashionable, there are good reasons to listen to him. A Japanese-born Taiwanese-American, he worked at the Federal Reserve Bank of New York in the 1980s. For the past 27 years he’s lived in Japan, studying its economy in depth and writing what many consider the definitive analysis of Japan’s “lost decade” – “The Holy Grail of Macroeconomics: Lessons From Japan’s Great Recession.” Koo, 57, recently spoke with MONEY senior writer Kim Clark; their conversation has been edited.
Why do you say that this recession is different from others the U.S. has had?
Typical recessions are part of normal business cycles, when overconfident businesses overproduce and then have to cut back. This is what I call a balance-sheet recession. It’s caused by an overload of debt. It’s a very rare type of recession that happens only after the bursting of a nationwide asset bubble, like a real estate bubble. Once the bubble bursts, the debt remains. The assets, in this case homes, are underwater; their prices are way down, but all the consumers’ original debt remains.
The Federal Reserve recently said it won’t raise interest rates for two years. Won’t that help?
No. Monetary stimulus doesn’t work until balance sheets are repaired. Right now consumers are using their cash to pay down their debt. The economy is depressed because no one is borrowing or spending. Consumers don’t want to borrow, even at [very low] interest rates. And lenders don’t want to make loans to consumers who will struggle to pay them back. You need fiscal stimulus. That means the government should borrow and spend the money in the private sector.
When Japan fell into recession about 20 years ago, we had no idea what was happening. Interest rates were lowered to zero, but the economy still did poorly. Every time the government stimulated the economy, it rebounded nicely. Then when they pulled back, it lost steam again.
Some people look at Japan and say the government spent huge sums on public projects and there was no real growth, so spending didn’t really cure the economy.
The early ’90s recession in Japan was far worse than people realize. Commercial real estate prices nationwide in Japan fell 87% from the peak. Imagine U.S. housing prices down 87%. The fact that the Japanese government halted what could have been an enormous drop in GDP in the early ’90s speaks to the success of its economic policies.
But Japan did suffer a major recession again in 1997.
The Japanese made a horrendous mistake in 1997. The Organization for Economic Cooperation and Development and the International Monetary Fund said to Japan, “You are running a huge fiscal deficit with an aging population. You’d better reduce your deficit.”
When the government cut spending and raised taxes, the whole economy came crashing down.
I see exactly the same pattern in the U.S. today. If the government acts to cut the deficit while people are continuing to pay down their debts, then we could have a second leg of decline that could be very, very ugly.
Since 2008 the Fed has been trying to boost the economy — and prevent price deflation — by buying Treasury bonds. What has that done?
The Fed’s so-called quantitative easing has failed to contribute to economic growth. By taking the new Treasury supply away, it forced the private sector to put its money into equities, commodities, or real estate.
With real estate in a tailspin, the money went to commodities and equities on the assumption that the economy or profits would pick up. The effect was to push stock prices to higher levels than could be justified by genuine cash flow or corporate growth. Now, with fiscal stimulus disappearing and GDP growth slowing, people have realized that equity prices are essentially overvalued, and that is the correction we are currently seeing.
So are you saying that the stimulus package didn’t go far enough?
Obama kept the economy from falling into a Great Depression. But you never become a hero avoiding a crisis. The economy is still struggling, so people say that money must have been wasted. Not true. The expiration of that package is behind the economy’s weakness right now. Yes, the Bush tax cuts were extended last year, but tax cuts are the least efficient way to support the economy during a balance-sheet recession because a large portion of the cut will be saved or used to pay down consumer debt. Government spending is much more effective.
MONEY recently interviewed Carmen Reinhart, an author of what’s now thought of as the authoritative history of financial crisis. She warned that economies that build up gross deficits in excess of 90% of GDP weaken significantly. The U.S. recently passed that mark.
Before the next balance-sheet recession comes, you’ll have plenty of time to cut the deficit. (Mark’s note – in theory the government should cut back in good times, and spend in bad times. The reality is the government never cuts back during good times, because everyone is drinking Kool Aid and wants to get re-elected)
Of course, Congress recently committed to slash our deficit by $2.5 trillion as part of the agreement to avoid default.
It is good that Congress managed to avoid default. But they should keep in mind that Japan’s deficit actually increased when the government tried to cut the budget while the private sector was paying down debts. The cutback caused a second recession.
Think about the Great Depression; war spending is what finally pulled the economy out.
The Japanese government didn’t do enough spending in the early 1990s and added another 10 years to the problem. If the U.S. avoids that mistake, maybe in a couple of years you will be out of this mess.
Tags: Bank Of New York, Bonds, Business Cycles, Chief Economist, Commodities, Debt Crisis, Definitive Analysis, Federal Reserve Bank, Federal Reserve Bank Of New York, First Glance, Foremost Expert, government spending, Holy Grail, Kim Clark, Money Magazine, Nomura Research Institute, Obama, Rare Type, Real Estate Bubble, Recessions, Richard Koo, Stimulus Package
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Tuesday, September 20th, 2011
There are those who watch quietly from the sidelines as month after month, year after year, decade after decade, the Keynesians among us (especially those who only focus on the upswing in the business cycle and always ignore the downswing) announce that the only thing the economy needs to grow is a just a little more debt… more debt…. much more debt…. And for the most part it worked: for years every dollar in additional debt generated a little less than a dollar of economic growth, or GDP. Alas, slowly but surely, we have been pushed to the point where incremental debt generates no incremental growth: an event that if it were to be recognized for the debt-stimulus dead end it is, would put an end to years of flawed economic thought taught in the world’s most prestigious universities. Yet there is more to it, and as always it goes to the age-old question of capital allocation efficiency, and specifically how with time, any centrally-planned attempt to allocate capital effectively always fails, usually accompanied by incurring insurmountable leverage. Probably one of the best and most succinct summary of this core quandary facing the entire developed world and the voodoo economics profession in general, was done by UBS’s Andy Lees today, who in one note, deconstructed the primary flaws, and outright lies, at the base of the last ditch economic rescue effort planned by Obama, by the world’s army of “fiscal stimulants” and by the western world in general.
On the fallacy of “GDP”:
Economists and politicians tell us that if we try to cut the level of debt the economy will slow and it will become self-defeating; debt will rise relative to GDP. Whilst this is sounds fair enough, how does this fit in with the truism that if debt is rising relative to GDP then by definition we are allocating capital unproductively and therefore unsustainably?
The answer is simple definitions. Clearly over the last few years vast amounts of capital have been written off and yet we have not revised previous estimates of GDP. We have effectively ignored that some element of the economic activity was unproductive and unsustainable. If debt rises by 10% relative to GDP, then only 90% of the stated GDP is actually sustainable. The 10% balance is made up of non-jobs that are dependent on debt accumulation. They are either consuming down our productive balance sheet, and thereby borrowing from our future level of economic activity, or alternatively borrowing from another country’s either present consumption level or their productive balance sheet. Either way, unless we are going to default, we are again borrowing from our future level of economic activity. We are putting the balance sheet through the P&L account and accounting for that as profit or GDP but without an offsetting liability.
Realistically therefore we should not look at debt-to-stated GDP, but rather debt-to-“sustainable” GDP. Taking the example where debt-to-stated GDP has risen over the course the last year from 190% to 200%, then we know that 10% of the factors of production are misallocated and unsustainable, and therefore sustainable GDP is just 90% of the stated level. This means that debt-to-sustainable GDP is not 200% but rather 222.2% (ie. 200/90). Imposing austerity simply recognises that fact, slowing the economy to the sustainable level of output and thereby recognising the level of debt against this truer measure of GDP. Take Greece for example; clearly the country has been living way beyond its means, and its sustainable level of GDP is significantly lower than the stated level. Recognising and accepting this reality is extremely difficult, but we cannot clear Greece’s debt without at the same time “clearing” the level of economic output to a true level.
If we allocate resources correctly, then debt-to-sustainable GDP will start to fall immediately. The confusion and the pain comes from having to recognise what that sustainable level is, ie to own up to what is our true economic worth. Taking the above example, we know that debt-to-sustainable GDP is not 200% as recorded but actually 222.2%, so if we allocate resources efficiently, all other things being equal, GDP will fall back to the sustainable 90% level and debt-to-sustainable GDP will remain at 222.2%. Given the painful acceptance that is necessary, if we make the adjustment over time, then the total debt will continue to rise in both absolute and relative terms, but by incrementally less each year relative to sustainable GDP.
On the toxic feedback loop of why ever more central planning (such as what is happening in the US and the entire developed world) means fiscal stimulus becomes self-defeating. The irony is that as those “planners” locked up in a room “plan” and issue more and more debt, all that debt goes for failed projects, until all of it ultimately serves non-productive purposes.
Whilst differentiating economic output as either productive or unproductive may sound sterile and ignore hidden values from work that are not obviously measured in conventional GDP calculations, the reality is that these “externalities” are included in GDP as they feedback into the calculations indirectly in just the same way that loss-leaders do with corporates. There will be both productive and unproductive externalities, and the best measure of whether we are misallocating capital or not will be whether debt is rising relative to GDP or not. Pursuing a Keynesian stimulus can only make sense if the capital reallocation results in a reduced debt-to- sustainable GDP ratio. This does not factor in inter-temporal investments where the pay-off may not be immediate, but easy adjustments can be made for this.
And the interlinking continues: the biggest culprit for the failure of fiscal stimulus? Why the monetary stimulus authority itself, the Federal Reserve.
The only meaningful reduction in debt throughout this crisis has been the forced deleveraging of households in the US through foreclosure, and in Europe through job losses. Total debt has increased throughout the crisis as the public sector initially socialised the private sector debt, whilst running large fiscal deficits. The zero interest rate policy also continues to misallocate capital, supporting unsustainable consumption levels at the expense of productive investment. QE2 and the hotly anticipated QE3 will drive a speculative bubble in risk assets and give cheer to the financial markets but will not support or drive sustainable investment. As you can see below, the continued misallocation of capital in Japan from similar policies has not only lifted the debt to frightening levels, but has also raised the cost of servicing that debt as it strangles the productive assets, despite the zero rate policy. Far from lowering the cost of business, the printing of money by central banks sustains this misallocation of capital and thereby adds to the costs of business. Governments are simply crowding out the only part of the economy that can get us out of this mess, and thereby killing the overall economy with their supposed kindness.
The toxic spiral then moves away from the sovereign state and its debt printing apparatus and migrates to every state that has a monetary authority: read a central bank.
The paper The real effects of debt –(http://www.bis.org/publ/othp16.pdf) – by Cecchetti, Mohanty and Zampolli highlights that debt is supposed to improve the efficiency of capital allocation across its various possible uses in the economy by shifting the risk to those most able to bear it, but of course that very statement reinforces what I am saying; if debt is causing a better allocation of capital, then debt will fall, not rise, relative to GDP. Modelling the stock of non-financial sector debt against GDP per capita for 18 OECD countries over the period 1980 – 2006, the authors found that every 10% increase in corporate debt resulted in a 20bpt reduction in growth per capita, and every 10% increase in household debt resulted in a 25bpt reduction in growth per capita. The authors found this somewhat surprising as they did not believe that debt was uniformly bad for growth, but of course during that period debt was rising relative to GDP. A second regression found that a 10% increase in the ratio of public debt to GDP is associated with a 17 – 18bpt reduction in subsequent average annual growth.
The paper concludes by saying that the clear implication of these results is that the debt problems facing advanced economies are even worse than we thought as the benefits that governments have promised to their ageing populations will not only sharply raise debt but will thereby sharply lower GDP growth. As growth falls, debt rises even more, reinforcing the downward impact on already low growth. “The only possible conclusion is that the advanced countries with high debt must act quickly and decisively to address their looming fiscal problems. The longer they wait, the bigger the negative impact will be on growth, and the harder it will be to adjust”.
Andy’s conclusion: the current approach to fixing problems is dead wrong. At this point issuing more debt merely compound the problems in an exponential fashion.
What return per unit of additional debt will we get today? The idea that we should slow austerity and grow our way out of this with further debt, or increase our ability to service our debt by taking on more, seems disingenuous at best. Why should the same cheap money policies used by central banks to avoid the occasional cleansing of debt via a recession, now succeed in allocating capital productively and sustainably when they have clearly failed in the past? Perhaps politicians and the press can be excused for taking a different view as their individual priorities are not necessarily aligned with the good of the economy as a whole, but what I don’t understand is why the wider economics profession also seems unable to come to a comprehensive conclusion; to establish data that presents the facts accurately and thereby establishes policy agreement.
Alas, the world will be engulfed in mushroom clouds before economic Nobel peace prize winners finally admit their lunacy and that the false cause they have spent their lives defending, has been a lie. In the meantime, everyone else will continue to suffer. That is the only thing that is guaranteed: after all, it is the definition of insanity. And those in the status quo doing all they can to preserve their, well, status, are now all insane.
Tags: Business Cycle, Capital Allocation, Downswing, Economic Thought, Economics Profession, Fallacy, GDP, Incremental Growth, Keynesians, Obama, Prestigious Universities, Quandary, Rescue Effort, Sidelines, Stimulants, Stimulus, Succinct Summary, Truism, Upswing, Voodoo Economics
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Sunday, September 18th, 2011
September 15, 2011 (11 minutes)
This online video features Craig Alexander, Senior Vice President and Chief Economist, TD Bank Group in conversation with MaryAnn Matthews.
This summer once again has showed us that there is no such thing as decoupling in economies or financial markets. Craig discusses the Euro zone sovereign debt crisis and the lack luster growth in the US economy and what it will mean for Canada and the financial markets.
During this interview, Craig Alexander addresses the following questions/topics:
- What are the factors that have prompted you to downgrade the global economic outlook?
- What is the likely endgame in the Euro zone sovereign debt crisis?
- Can President Obama’s Jobs Bill help the US economy and what will it mean for Canada?
- What will this mean for financial markets?
Click here or on image below to view:
Tags: Addresses, Alexander, Bank Group, Canadian Market, Chief Economist, Craig Alexander, Debt Crisis, Decoupling, Endgame, Euro Zone, Financial Markets, Global Economic Outlook, Global Economy, Jobs, Lack Luster, Maryann, Obama, Online Video, Outlook, Senior Vice President, Sovereign Debt
Posted in Canadian Market, Markets, Outlook | Comments Off