Printing Presses

September 14, 2012

With the announcement of a much more aggressive round of quantitative easing than most expected, Ben Bernanke succeeded in continuing the inflation of financial assets, many of which reside in the shadow economy.

My first response which I have been telling people and as many pundits have exclaimed is that this is absolutely a political decision, even if the process to the decision was acutely rational and ethical. The only way to avoid a poeticized outcome would have been to pause any aggressive announcements until after the election. But as I am learning through the process of renovating a NYC co-op, if the decision making benefits the “decider”, without recourse then in hindsight the outcome should have been clear.

In this case the ensuing lift in financial asset prices, while likely to do nearly nothing for Obama’s middle class, will probably lead to strong PR and messaging trough the campaign trail from here to convince the vast majority of easily fooled Americans that they are better off today than they were when the S&P bottomed shortly after Bush left office.

The difference this time around however is that financial asset prices no longer respond primarily to the fundamentals of the economy but are now heavily linked to the actions of central banks who rightfully believe that lowering the probability of global financial collapse can be achieved by debasing currencies in the near term.

What they remain dangerously dogmatic about is their ability to remove excess liquidity in a systematic and orderly fashion. Hubris in Wall Street a decade ago led to its near demise. It is 100% probable at this point that the hubris among central bankers will lead us to another, far more gruesome edge. The question becomes who will finance the bailouts then?

Bernanke laid out a gauntlet yesterday and is now playing a massive game of chicken with the bond market that drives the global economy. He is betting that the threat of unlimited bond buying will be enough to scare the doomsayers out of the market keeping, now, all interest rates lower for longer, further punishing savers and rewarding borrowers who are generally afraid to take many risks.

If he is right, his brilliance now has a clock on it. Endless debasement of the worlds reserve currency will last only as long as it serves the needs of the largest foreign holders. This is not a sustainable move. For the moment it benefits China who remains loosely pegged to the dollar. However it puts the US in a precarious position should US-Sino relations falter.

Bernanke, sadly, is consciously or unconsciously using money printing as a substitute for good decision making in congress who remain practically useless to the democratic process. For a moment I can argue that this is somewhat thoughtful, but the outcome will be to enhance Obama’s reelection which will undoubtedly buy him at least one more appointment in 2014.

The analogy that came to mind this morning is that Bernanke is printing dollars to take the burden off of the house and senate to print meaningful tax and legislative reform. This is similar to building a house out paper. It may deflect the winds for a while, but it will not protect you from the vast majority of “elements”.

The medium term result of this decision, particularly in the US will creep into risk asset prices as the market digests the growing risks to sovereigns currently perceived as irrefutably sound financial hubs. We now know that a banking system can only remain stable with the threat of sovereign intervention. How long will the US Government remain a credible threat to interrupt another financial crisis.

No business leaders see the economy picking up more than it has from QE1 and QE2. In fact the downturn in transportation and materials probably in some part affected Bernanke’s decision. Adding even more liquidity will not have the desired effect without a major shift in lending practices by major banks.

Eventually equity risk premia will reflect the growing burden on US Taxpayers who by the vast majority remain under employed and less wealthy than they were 10 years ago. The irony is that continued debasement will ultimately lead more currency into safe low yielding investments.

If the US has not gotten its fiscal house in order before zombie investors wake up, the consequences will put us in uncharted territory.

When Obama makes his acceptance speech I wonder if he will thank Uncle Ben.


The Great Transgression

June 14, 2012

The United States Central Bank wether it likes it or not is ultimately responsible for global monetary policy either by controlling the default risk free rate or by nature of our reserve currency.

The current Fed has responded, with little precedent and arguably appropriately during the initial phase of the 2007-2009 crisis by printing money. They have set short term rates at zero and become the central banker to the world printing trillions of additional dollars that the world can’t seem to get enough of, particularly recently. But is this course sustainable?

Conscious capitalists argue our economy should be built and run in a sustainable fashion. This doesn’t mean just making us drink wheat grass shakes, limiting 16 oz soft drinks, or putting solar panels on our house. The point of the movement, however fragmented it is, is to design and build sustainable replacements for our unsustainable and brittle physical and economic infrastructure, products, services and systems. Sustainability is more than about feeling good about a single act or product which is selfishly individual. It’s about national security, economic development, job creation, creative destruction, and ultimately the disintermediation of unsustainable products, services and systems. Sustainability is built on a tenet of scarce resources and attacks flawed technology, flawed accounting, flawed assumptions and flawed systems-level thinking. The neo-classical economic model’s definition and treatment of externalities as costless and priceless losses to society is a failed systems-level paradigm.

You cannot solve recurring problems with larger versions of the same solution. This idea is no different than asking your two year old not to throw food on the floor. When that fails some people tell then not to do it, and then yell, scream and even resort to physical intimidation or violence. Even if the physically violent response “works” what do we think we’ve imparted to that child? Does the toddler learn manners and social graces, both of which would be sustainable lessons that they would use and pass on with adults and peers? No, violence only teaches fear. Think of any bully. A toddler raised in fear grows up to be angry, you don’t need to believe in psychology at this point to have observed it. But I digress.

The Fed, in it’s early and appropriate response to the liquidity crisis after Lehman failed has created a system of free money, and worse, a systems-level thinking of free money which at its core-no text book needed-is unsustainable.

If money is free, it is worthless. If the currency is worthless then the entire economic system is broken as we are seeing in some form in Greece right now.

This is the purpose of the Fed, in their own words from their website:

“The Federal Reserve System, often referred to as the Federal Reserve or simply “the Fed,” is the central bank of the United States. It was created by the Congress to provide the nation with a safer, more flexible, and more stable monetary and financial system. The Federal Reserve was created on December 23, 1913, when President Woodrow Wilson signed the Federal Reserve Act into law.”

The Fed is failing its own mandate. Endless ZIRP policy and and unabashed money printing is NEITHER making us safer NOR creating more flexibility. Quite the contrary. The fed at the very least is digging us into an unsustainable trajectory that will ultimately end with even harder decisions than were made in 2008. I don’t believe the current Fed is evil, stupid or purely politically motivated, although I have my doubts on the last one. The biggest problem, which is similar to problems of the Bush administration is hubris and dogma.

The only way to create a safe and flexible backdrop for economic activity is to have the ability to move levers in multiple directions. This requires an extreme bias for moderate policies in any direction, something like steering an oil tanker in a narrow channel. An oil tanker responds too slowly to know exactly how far the captain is correcting the direction so he uses extreme caution and slight movements to stay centered and nimble. This philosophy and centeredness is completely lacking at the Fed today.

As we dig ourselves deeper into a position of sovereign indebtedness and take steps closer to eliminating the value of currency altogether we put ourselves closer to the patsy seat at the global poker table leaving little room for flexible strategy. A strategy defined by faith and hope is better suited for men of God, not leaders of the free world.

Obama ran on a platform of Hope. It was a powerful campaign, but Hope is not an economic strategy nor a sustainable model for success.

Bernanke is convinced that the depression could have been avoided using policy tools he has unsheathed since 2008. Let’s assume he is right. If not the Great Depression then what would we have ended up with instead?

A Great Repression? As noted by many others our current system of penalizing savers in favor of borrowers is a form of financial repression.

A Great Decession? The current status quo has seen the US slowly erode once dominant positions in global economic policy, trade policy, foreign policy, global defense policies and a host of once untouchable pole position of global power. A weak economy and a weak currency is a recipe for a slow fall from grace. A strong economy AND a strong currency make for an unusual bargaining position, just look at Germany in the context of broader Europe.

A Great Egression? The numbers of US Citizens renouncing their citizenship while small in absolute numbers is beginning to balloon in relative numbers. More and more wealthy Americans have lost interest in or confidence in an American future.

A Great Oppression? When wealth becomes concentrated by the few, regardless of their benevolence, there ensues a form of economic oppression where it grows increasingly harder for “just anyone” to amass great wealth. Simply put the super rich spend a small
fraction of their wealth and that slows the velocity of money in the system, limiting how often dollars change hands.

When all this plays out, and we look back in 80 years it would not surprise me that this difficult period is reflected upon as The Great Transgression. A period of time where the economic rules of law were totally and unilaterally transgressed at the expense of “saving the system”. A period where credit seniority only held weight IF the government or some other supra national entity did not intervene. A period where the many were led by the few further from their goals and dreams guided by fear of harder outcomes. A period of time where multiple transgressions were made possible through the growing frequency of global panics.

Bernanke may successfully lead us away from the known path of a Great Depression. But does he know where we end up if we maintain the current unsustainable course?

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.


Income Inequality is a Deadly Misdirection

January 26, 2012

Income inequality has caused wealth inequality. In fact the latter is a natural result and we should not be surprised or angered by this. These are some of the reasons America has been great. Neither issue would be a problem if that income & wealth were redistributed naturally through healthy economic activity. If every billionaire found a way to live paycheck to paycheck the dollars spent would fuel corporate profits and more growth. Unfortunately for society there is a great correlation to savings rates and wealth creation. The guy who make $10mm per year can easily afford to save 50% of his take home pay whereas the guy making 50k has very little room to save anything at all. If the first guy lived more like the second, his spent dollars would find their way through the tax system via sales tax and further wage tax. Economic activity would be supported and companies would hire to fill demand.

Instead the Great Accumulation of the last 30 years has created a conundrum of sleeping capital. The top 1% of wealthy Americans control 40% of the nations wealth. They are rich beyond their capacity to spend (recycle) those dollars. They have built investment portfolios comprised predominantly of investment assets as opposed to operating assets. Many of those investments (I.e. treasuries paying 2%) are simply unproductive to economic activity.

What this country needs to do is to wake up from the dream that some utopia exists if the highest earners are “justly” taxed. This might help mitigate inequality in the future, bit it will not solve the current problem of 1% controlling 40% of wealth. While there may be a need to alter the tax code, most don’t realize that a dramatic overhaul of our current tax system to raise taxes on the new 1% would serve an ulterior if even an unintended consequence.

If you make it harder for new individuals to create substantial wealth then you will seal the doors to a socio economic class of people who will enjoy added protection of their current status. In short taxing the guy like me who aspires to be in the 1% in a manner that the current 1% has not previously been taxed helps ensure that I will not be able to join their ranks. Doing this would close the doors to the American Aristocracy, sealing the entry for would-be wannabes, and ultimately robbing America of one of its best features, the motivation for creativity, innovation, and visionary thinking.

Let’s not forget that no one has asked what we would do with all the hypothetical tax revenue if the Buffet Rule were put into effect. What would happen to the excess revenues into the Treasury’s coffers? Are we to believe that any future politician when faced with the option of implementing austerity or buying votes will not choose to buy votes? Do we need an even larger entitlement system? Do we need government to continue to step into private industry?

My suggestion is that we leave the rules of the game mostly in tact. Don’t penalize the guy who is at the cusp of massive financial success. Sure, maybe make it a little harder for the wealth gap to grow but after all, most people who have made millions or billions have more than likely created jobs. What needs to be done is we need to address the massive amounts of unproductive sleeping capital: wealth that is not getting recycled and will never get recycled until generational dilution forces a fixed pool of wealth into the hands of many generations of offspring.

Personally a major change to the estate tax would hurt me. However, the privilege of being an American is not the result of my winning the “ovarian lottery” as Warren Buffet likes to call it, but rather the opportunity to create and do anything I want to do. The American Privilege is one of being able to dream and execute your own vision regardless if your original circumstances.

An estate tax policy built upon a “you can’t take it with you” philosophy accomplishes a few things. First, it forces more of that first generation wealth to be consumed rather than saved. Second it ensures that the incentives to “win the game” don’t change so much that we alter the great American Experiment of entrepreneurship, capitalism and democracy. Third it will help mitigate the proliferation of an elite dynasty class that could permanently subvert power from the 99% by controlling the vast majority of American wealth. Fourth it helps rebalance the American opportunity with the true cost of the American economic ecosystem. Defense spending, education, public works, science and technology breakthroughs and a host of other foundations for American success need to be funded with the wealth our system currently creates AND that it HAS ALREADY created.

We also ought to rethink our current philanthropic landscape that enables tremendous amounts of capital to be separated from its highest and best use. Tax exempt endowments and foundations often support worthwhile causes and constituencies. However, left unchecked we have parked trillions of dollars with asset managers looking to earn no less than 5% but often times no more either. 5% is the required
Distribution amount for a non profit to keep their tax status, they must spend 5% of their corpus every year. They typically try to earn more to grow the asset base but their boards are generally risk averse focused first on capital preservation. In a country where wealth preservation is the driving motivation for a substantial amount of the capital base it becomes nearly impossible to reinvigorate wealth creation because risk becomes something that is controlled by the few and no longer taken by the many. This may in part explain the growing popularity of crowd sourcing and micro venture funding. Most of those who have “won the game” are now in a “risk-off” mode.

The US is at a crossroads. We must face the reality that the future can no longer mimic the past. Change is going to happen and somehow everyone will be worse off, at least for a period of time. I implore our leaders to think above the policy and above the zeitgeist so that what sits past the pain is a new utopia with new rules and new limits but with the same general sense of opportunity and patriotism that got us this far. If we continue to debate the pain, we are not ensuring that our future can be better. In order to do that we need to first debate the utopia we want to create. From there the changes and sacrifices will be clearer, more palatable to the many, and ultimately the right sacrifices to make.

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:

Thanks to Paul Kedrosky.

Monitoring the Precipice

August 31, 2011

As the month of August has ended, on a suspiciously positive note, lets take a look at some recent undertow, and expectations for tomorrow’s PMI data.  The real story looks quite gloomy, particularly since some much economic data has been falling, quickly.

The chart below illustrates T-Bill rates intraday yesterday as the market was continuing a low volume rally post Bernanke’s comments on Friday.  Note that both the 4W and the 3M T-Bill rates posted negative prints.  Hmmm, I don’t know about you but I find it hard to believe that the stock market is such a good value when so many people are willing to lose 1 bps to own a US T-Bill for a month or two.  Historically this happens just before we go off a cliff.

Bloomberg BTMM 8-30-11 US Money Market Rates

Note the chart below offers a general perspective on sovereign currency risks as measured by the Option Adjusted Spread of the G-8 currencies.  Story seems to be short the Euro and go long everything else.  Guess we can confirm where this disaster is about to emanate from.  Makes sense if the European banks are in as bad shape as many have been reporting.  Funny though, I don’t recall a time where banks distinguished their risks by borders.  I don’t see how the European banking system would not take down the US.

Bloomberg LOIS Currency 8-31-11

And then there is the widely anticipate Manufacturing PMI number due tomorrow.  This will be the first data point to illustrate how much the tail has wagged the dog, and how much real damage the August roller coaster did to the US economy.  I’m also surmising that Bernanke in his infinite wisdom chose to punt to the September meeting to avoid taking action and then have the data come in so anemic.  Note that the Consensus estimate will mean that the economy actually CONTRACTED in August. Any number below 50 represents a contraction.  Also interesting to note that only a handful of economists think we will print a number above 50.  Certainly at least worth a hedge, ay?  Might mean the recession has already begun.  Crazy stuff.

Bloomberg NAPMPMI Estimates Manufacturing PMI 8-31-11

Note that the last time this data came in with estimates this low we were watching the aftermath of Lehman’s failure.

Bloomberg NAPMPMI Estimates and Actual Manufacturing PMI 8-29-11

While the Manufacturing PMI is not as important as its half-brother the Non Manufacturing PMI due next week, it has often been a leading indicator preceding both economic contractions and expansions.  This chart illustrates periods when the two data points were at their widest.  Make your own judgements.  Orange line is tomorrows Manufacturing PMI series.  The white line is next week’s Non-Manufacturing PMI series.  The crossover we are seeing is indicative of past recessions. Since the market is up about 10% from its recent lows, and the DOW is about even to positive for the year, for the market to price a recession in, we need to drop at least about 20%.  And that would be a mild one.  September will be a very long month on Wall Street.  I think we will know better next year how it all has affected Main Street.

Bloomberg NAPMPMI vs NAPMNMI Actual Manufacturing & Non-Manufacturing PMI 8-29-11

No matter how pricy puts look, they are cheap if you are on a precipice.

Bond Market is Pricing a Recession, 10-Year Treasury Breaks 2% Yield Intraday

August 18, 2011

Two charts below show a rather alarming and decisive signal from the bond market.  The signal is the stock market is about to crash.  Today the 10-Year Treasury Yield broke 2%.  This follows a 5-Year note below 1% and the 1-Year note below 20 basis points.  Bond holders are not being rewarded much in nominal terms, which generally indicates that deflation is on its way.  The only thing I cannot reconcile is the recent strong performance in TIPs, or Treasury Inflation Protected Securities.  That said the bond market is pricing in a recession, and last time this happened, it took about 6 months for the equity markets to bottom.  Since we are going into an election year next year, which is traditionally bad for markets, and since the world is totally upside down anyway, odds of this being a dramatically terrible selloff in equities is quite high.

A saving grace could be how cheap it is to short US Treasuries.  One would think the carry trade would support asset prices, but we are not seeing that.  Although anecdotally one could guess the strength in the 10-Year and the 30-Year is being supported by a long-short treasury trade. where traders are short the front of the curve and long the mid and long ends, picking up a fairly risk free spread.  When Ben Bernanke committed to keeping short term rates low for two years, he effectively gave carte blanche for the market to arb the spread between the short and and the long end.  I suppose when risk assets get cheap enough, we will see a dramatic selloff on the long bond, as people run back into equity and credit risk.

There may be no better time in our lifetimes to refinance or take out a mortgage!

Bloomberg: 10-Year Treasury Yields vs S&P 500 Index, August 18, 2011

Bloomberg: 10-Year Treasury Intraday Yields, August 18, 2011