Helicopter Ben Should be Picking Up Dollars, Not Dropping them Down

May 11, 2012

The current economic policy has hinged upon the following equation:


Where P is the amount of productivity in the economy measured by GDP; M is the supply of money often measured by the M2 money supply, and V is the velocity if money (M2) or how often a dollar turns over each year.

In the simplest definition this equation represents the amount of value created by our economy (GDP) is equal to the amount of money in the system (M2) multiplied by how frequently that money “turns over” (V).

The faithful logic is that you can offset a decline in V by raising M to support P. Mathematically this makes sense and would be true if the equation followed only the rules of linear mathematics.

However, the problem is twofold: while M is the only lever that the Federal Reserve has any real control over; V is a value rooted in physics more than math and subject to inertia and indirect responses.

While M follows a linear progression (a $ in = a $ in and a $ out = a $ out) V is subject momentum where the rate of change is neither controllable or linear. The velocity of money tends to follow a trend which is partially fed by the supply of money but which is also fed by human behavior.

Consumption patterns are not linear and we don’t all necessarily start and stop consuming at the same time and the same rates. Moreover, the actions of one group can affect another and positive and negative momentum can drive how much of our paychecks we choose to spend. If our peers appear to be cutting spending we may choose to follow their lead if we presume their caution is correct. Vice versa in the hay days of the late 1980’s/early 1990’s our consumption patterns were heavily influenced by “keeping up with the jones'”.  The chart below illustrates the velocity of M2 in the US since 1950.

Quarterly, Seasonally Adjusted, Updated: 2012-04-27

In theory if V is falling faster and faster, neither a linear increase in nor an imaginable amount of M is going to support P for very long.  At some point the attention needs to move from how we support economic growth to how we arrest the falling velocity of money.

Solving for V, the equation turns to V=P/M.

Turning the equation around, the only method the Fed would have to arrest the current rapid continue decline in money velocity by attempting to make V larger, is actually to reduce M which in the new equation is now in the denominator.

While reducing the supply of money in anathema to growth, the problem is that the issue is no longer solvable until V is stabilized and the only way to stabilize money velocity is to effectively make cash more scarce so that more of the cash available gets used or put to work.  A dogmatic and long term agenda focused on increasing Velocity likely would have its own negative effects, but its clear that focusing on adding more liquidity to an economy awash in liquidity is no longer boosting output and is showing signs of growing impotence.  The best solution would probably at least be to pause on the quantitative easing and let interest rates rise modestly, if nothing else but to give some time for current cash to be circulated more effectively without the anticipation that more is on its way which creates a perception of falling prices.

As interest rates rise the cost of sitting (cost of waiting) on large piles of cash increases as depositors begin to feel the lost opportunity cost of at higher rates or simply consuming the cash.  At the very least it gets people out of the mindset that prices will continually be lower tomorrow and that there is no better alternative to cash.

What the right interest rate would be us as unknown as the grand experiment we are currently in the midst of, nonetheless it seems that our current path beyond being unsustainable may simply be wrong.



Food stamp use still rising despite good jobs news

February 19, 2012

This chart shows how food stamp participation has risen with the unemployment rate since 2005. The last peak in food stamp use occurred in the aftermath of Hurricane Katrina at the end of 2005, and the current peak has far surpassed that.

Source: http://www.csmonitor.com/Business/Paper-Economy/2012/0110/Food-stamp-use-still-rising-despite-good-jobs-news


What if Solar Energy was Subsidized like Fossil Fuels? [Infographic]

September 11, 2011

Self Explanitory


Punchline: Debt Ceiling Redux

September 2, 2011

The punch-line to the original August 2 2011 debt ceiling deadline: it’s September 2, 2011 and We’ve Already Hit the New Debt Ceiling!  Holy shite.

The Debt Subject to Limit is the maximum amount of money the Government is allowed to borrow without receiving additional authority from Congress. The current statutory limit is $14.694 trillion.

US Treasury Debt Subject to Limit Graph (The current statutory limit is $14.694 trillion.)

It’s 1938 all over again: Illusion of Recovery – Part I: Print and pray has officially failed by Eric Janszen

September 2, 2011

One of the most compelling and complete explanations of our economy over the last few years. Followed by a strong argument that both explains and continue to support the possibility for further parabolic moves in gold as it transforms into the world’s global reserve currency.

Well worth the time.  I particularly liked the call for further investment in domestic energy and communications infrastructure.  Far more important than bridges to nowhere.  Someone PLEASE send this to the current administration before Obama makes his speech next week.


Illusion of Recovery - Eric Janszen

“The incipient recession that the stock, bond, and gold markets smell is not a so-called “double dip” recession. It is a mid-gap recession, a recession that occurs in the midst of an output gap, a far more serious economic event than a recession that produces an output gap. The US has not experienced a recession inside of an output gap since 1938, except for one produced on purpose by the Volcker Fed in 1983 to squeeze the last breath of life out of an inflation spiral that was showing signs of resurgence in 1982. ”

Click here for the full story:  http://t.co/98THRVM

Thanks to Paul Kedrosky.

A Quick Look at Today’s Non-Farm Payrolls Data

September 2, 2011

The market seemed to wobble this morning in anticipation of the PMI data.  Upon the headline number surprising to the upside, the market rallied sharply, only to drift downwards and close at the lows of the day.  Many pundits were pointing to tomorrow Payroll data as a make or break moment.

Funny I said jokingly to someone last week to go long after Bernanke speaks and precisely short after Obama talks next week. We will see if this data point changes that and accelerates the decline.  There were a number of stories today of Goldman and others lowering their estimate for NFP.  Those calls might be political gesturing as much as fundamental analysis.  We are going into a long weekend, and there are a lot of unknowns out there.  As of this evening Wikileaks is back in the news for having released the entire trove, unedited and un-redacted.  Meanwhile a potentially massive attack on the banks for mortgage fraud by the Federal Government is also going to be in the Zeitgeist tomorrow.  All more reasons why people may choose to de risk into the weekend.  And with the VIX starting above 30 at the open, its anyone’s guess which way the market will move, but it certainly has potential to be large in either direction.

Below are the current employment estimates for NFP.  The gloomiest predictions were sorted to the top of the list.

Bloomberg: Non-Farm Payrolls Estimates

Oh, and in case you forgot, the headline unemployment rate currently just above 9% is mostly politics and media white washing. The real percentage of unemployed Americans is plotted below and is north of 16%.  Hard to imagine it could get worse, but it surely hasn’t really gotten any better.  Per my last blog post, doing more of the same seems like insanity at this point.

Bloomberg: U6 The Real Unemployment Rate

How to Create Jobs? Raise Interest Rates?

September 2, 2011

I have written about this subject before, purely from an abstract thought, but using fairly rational economic reasoning.  The concept is not new, nor my own I’m sure, but it goes something like this.

As long as interest rates are kept artificially low, capital becomes misallocated, and does not end up being used for the greatest societal benefit.  Imagine if you had two investment choices to choose from.  The first might be able to produce a 20% annual return, but it would take you a year of research and due diligence and some out of pocket expenses if not a large up front investment for R&D.  Another opportunity will provide a 3% annual return, with good certainty and without much effort.  If you were lazy you might be hard pressed to decide between the two.  However most money that moves markets is in the hands of pure capitalists.  The difference between them and you is that they can borrow enormous amounts of money at obscenely low interest rates.  From their point of view, if they can borrow 8 times the value of the lower yielding investment for say, 1%, then they can leverage the 3% investment eight times and earn a 17% annual return (8*3%=24% but they are going to pay interest of 1% on 7x the original investment so they would net 17%) without the year of due diligence or out of pocket expense.  In one sense this is precisely what a great number of credit funds do.  They buy low yielding securities, apply leverage and create higher yielding securities (today you can do this through a USD carry trade; you sell 5 year treasuries and buy longer maturity bonds).  If that market place had existed in the first half of the 20th century we’d likely never have invented the Integrated Circuit, the World Wide Web, The Personal Computer, vaccines, and a host of other capital intensive initiatives that created enormous returns for the original investors.

While the vast majority of the world is contemplating QE3 and praying that interest rates remain low for extended periods, ought we reconsider what types of industries we will be adversely selecting to succeed with a cost of capital (hurdle rate) as low as it currently is?  The best inventions are expensive to develop, take a lot of time, effort and ingenuity.  None of that hard work is worthwhile to investors when their cost of capital is as low as it currently is.  The obvious outcome to all of this is going to be massive inflation, most likely after a terrible bout of deflation.  Must we wait for 1970’s type inflation again to begin to raise rates?  Sure it will be painful to do this now, no doubt.  But our only choices are to do it now or do it later.  In my experience its best to get shitty things done as soon as possible so you can move on and then begin to enjoy life again.

If you want a little extra encouragement, take the chart below to heart.  Its a comparison of US Unemployment (seasonally adjusted) all the way back to 1970 side by side with the 10 Year Treasury Yield.  Notice first that the two lines have moved mostly together up until recently.  Notice that the gap between the two is currently at the widest over the entire period.  The old relationship of lowering interest rates to lower unemployment has broken down.  Now see how the “pain” endured from 1980-1983 also saw interest rates jump from 8% to 11% and unemployment from 6% to nearly 11%.  However, the speed with which unemployment then began to decline was much faster than we have experienced from our most recent recession.  Loosening capital by lowering interest rates is not currently creating new industries nor new jobs.  Instead most of this liquidity is being stored in cash, in anticipation of the next crisis and with apprehension towards Washington who remains anti business.  Note that the pain felt in the early 1980’s paved the way for two decades of job creation.

Besides when rates are too low, we’ve all now learned that people who really can’t afford debt seem to get it, and those least equipped at managing debt end up with a whole shit ton of it.  (Greece, sub-prime borrowers, small over-leveraged poorly run companies, etc…)

Bloomberg: USURTOT vs USGG10YR Unemployment vs 10-Year Treasury Yields 1970-2011

We are at the precipice of another stagflationary environment, likely to be far worse than what happened in that period since our government finances are not in order.  The stimulus and policy responses undertaken from 2008 to now have been appropriate, but they will no longer work.  I don’t want to see the government creating jobs and industries, I want to see inventors and entrepreneurs do it.  In driving to Washington DC last month I saw first hand what happens when the President funds “shovel ready” projects.  Every schmo with a shovel gets a check to build a bridge to nowhere. I literally saw multiple bridges crossing I-95 that seemed to literally be going to no where.  There were no roads to meet the new bridges on other side, and in most cases they were cutting through fields and farmland.

There may be intelligent places the government can invest in rebuilding our economy (i.e. energy security), but I have lost all confidence that the current staffers have any bit of a clue of how to do that appropriately. If we take away the free money, capital providers will need to do more work to make good risk adjusted returns. And governments will be forced to reign in deficits and not just borrow more at lower rates to finance old debt that supported wasteful spending.  Paul Volker was the right man at the right time during that period.  He was also the right man at the right time when Obama took office.  Unfortunately Obama let him go at precisely the time he needed him most.