Debasement vs. Technical Default

September 18, 2012

Debasement is a form of default. But it is not an event of default. This is critical to the path of risk assets from here. Many have termed printing money as debasement or financial repression.

A currency is debased as it is printed in order to pay off growing debts. Imagine you could simply photo copy 100 dollar bills and send them to your creditors and imagine that your creditors accepted those copies as payment to satisfy your bills. In this scenario as everyone pays their bills in copied currency, the amount of currency in circulation would grow. The value of all goods and services consumed grow much more slowly than we could photo copy bills (GDP growth is around 2%). I imagine if we were allowed to do this that we could grow our wealth by a whole lot more than 2% per year by photocopying. Therefore more money would be sloshing around chasing the same old goods and services. The richest person would become the person who could copy his money the fastest as each copied dollar would be worth less as it competes with more copied dollars and you in turn need more dollars to buy the same goods. Photo copiers would probably be worth a whole lot in this world!

Financial repression occurs as copied currency creates more demand for investments. Retirees and other savers living off of fixed (bond) income find that their income is fixed and tied to the interest rate on their bonds. So the retiree expecting $30k per year from investments and social security will get that, but what soon happens in the copied currency scenario is that he is penalized for not copying currency as the prices of essential items like milk and eggs goes from a few dollars to tens if not hundreds of dollars in our extremely imaginary scenario. In fact in this world the people who are rewarded are the borrowers because their interest payments are fixed in yesterday’s dollars but they can copy as much money as they need to in order to make interest payments and pay off their debts tomorrow.

Now consider this example in the context of a default. When a borrower defaults on a loan he is not able to pay back his lender the full amount he borrowed.

Assuming no imaginary scenario this amounts to your best buddy not paying you back all of the money he owes you.

In our imaginary scenario think of it this way. Your buddy borrows $500 when an iPhone costs $500 but he pays you back when an iPhone costs $2000. If he gives you the full $500 when an iPhone costs $2000, did he pay you back? The answer is tricky. Yes he gave you back your $500. But if you can’t buy the same things you could have when you lent it then your buddy has effectively defaulted on you.

Central banks around the world have drawn a guantlet. They have chosen to stealth fully default by paying off debts in devalued currencies. This will avert technical defaults but it won’t change the outcome if spending and revenues are not arrested and aligned to become sustainable.

Printing money to pay someone back is not making good on a promise, and it’s far less ethical than choosing not to pay someone back. It’s deceitful and deceptive and the vast majority of the worlds developed country citizens have no idea this is going on.


Is Ben Bernanke Finally Wrong?

September 18, 2012

Has anyone looked at the yield curve since QE3 was announced? Well the Fed published a paper within the last two years outlining the importance of immediate market moves as feedback for Fed policy. The rationale is that beyond the first 24-48 hours the impact of Fed announcements is less traceable due to other market news and events. Thus the Fed themselves observe interest rate impacts of major announcements and speeches to assess the efficacy of Fed Policy.

Interestingly enough, looking at Treasury Yield Curves for the 24 hour periods immediately following the announcement of QE1, QE2 and Operation Twist, term rates across the yield curve generally tightened (fell). However in the 24 hours after the announcement of QE3, all rates outside of 3 years actually increased.

I’m not claiming to know more than the next guy, but I’d be shocked if Uncle Ben thought he’d be kicking out the longer end of the curve. Granted the announcement was for MBS purchases and we can look at those curves, but widening treasury yields has negative implications throughout the bond market.

I’m not judging that the move was wrong, but I am questioning the strength of stocks and credit exposure which have both rallied since Thursday.

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.

Top Reasons Why the Market May Stumble

March 9, 2012

• Israel / Iran escalation explodes
• China’s slowdown stalls
• Syrian devotion creates collateral support on both sides increasing risk premia in stalemate
• Sovereign liquidity bazooka posturing has bluff called by bond market.
• Greek bond swap is a failure as new bonds plummet shortly, installing fear for efficacy of European control over the crisis.
• LIBOR fixing case escalates or gets more notable attention creating mistrust in credit markets
• Oil prices get squeezed by geopolitical events or surprisingly good data and trigger a new recession.
• Facebook IPO becomes symbol of the excess in this rally and seals the top of this market and it’s own fair in the bear market that follows. Irrational but practically fair guess.
• Obama’s GOP challengers fade and his tax policy surfaces into the election
• Major hedge fund blows up
• High frequency trading investigation roils liquidity providers creating another flash crash” as market makers unwind into these lower volumes markets with fewer retail clients buying.
• Credit rating downgrades surprise to the downside in magnitude and timing.
• European cooperation breaks down into elections as popular votes support protectionism, liquidity unexpectedly unwound.
• interest rates back up suddenly 50 bps causing shocking losses feeding the sell of in “safe assets” and spiking over more heavily into selling of “risk assets”. Dollar rallies again.
• US real estate recovery exposed as weaker than originally thought with inventory overhang growing with new sales activity much like unemployment may grow as more people reenter the workforce.
• Government enforcement of Dodd Frank puts new pressure on banks earlier than anticipated, forcing more derisking.
• Apple iPad debut falls short of lofty expectations stories turn to “after Steve jobs” and the company’s massive weighting in indexes roils markets as it corrects.
• Capacity utilization unexpectedly soars as obsolescence becomes apparent and prices rise squeezing demand already starved by higher oil and weaker borrowing by consumers.
• By weather or other natural disaster global food supplies are squeezed and prices for key commodities sky rocket crimping the global consumer.

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.

Rick Perry and All People Undereducated

September 29, 2011

I’m still not sure who listens to Rick Perry and believes he has half a clue. That said, I’ve only spent limited time in Texas and I suppose one could easily argue that Sarah Palin garnered more votes than I could.

I am reminded of a panel I watched a couple of years ago where two honorable representatives from the US Congress reflected on the state of economic affairs and their own understanding of them.

What hit home was that one of these representatives lamented at the amazing amount of information and data he had access to in his privileged position. He talked about how “cool” his morning briefings were which connected him to the audience. He then went on to say that when he first took office, he quickly realized his understanding of economics was rusty and his understanding of financial markets was about nil given the advent of modern financial products. Thus with all these amazing reports and classified data on his desk, none of it really told him very much.

He then went on to say that he took it upon himself to go back to school to better equip himself to understand and ultimately impact the information he was reading. After all, as member of the finance committee, that was his job.

I was stunned to hear one our representatives express his own lack of knowledge and astounded that he took it upon himself to educate himself to be a better leader.

What really blew me off my seat, however, was when he described the lack of understanding shared by his peers in the House and Senate and went on to say that among them all, he was the only one he was aware of to go back to school to learn about the things he was tasked to oversee.

Reading the growing circus that is Rick Perry’s campaign I was inspired to consider a new rule that ought to be imposed on all of our political representatives, particularly those with specific domain responsibility.

Simply, we ought to keep our 4 year election cycle but move to a 5 year service cycle in which upon election all public leaders spend one year in school learning everything from the basics of flawed public finance, to leadership, ethics and markets and to take electives related to any committees they may need to serve on.

We spend a lot of oxygen touting the importance of education in the US. We talk about educating our children, have requirements of higher education for most highly skilled professions, but yet any schmo from Texas with an affable personality and some financial backing can grab a soap box and lead our country. I think we’ve seen the dangers of that before and I don’t think the US just needs a rinse and repeat.

After all, the political vacuum is great at dishing out rules for everyone else to follow. Why not at least require they have half a clue of what the fuck they are talking about?

Ben Bernanke, ‘Money-Printing’ Would Be Out at Fed: Perry | September 29, 2011 | 08:28 AM EDT
Ben Bernanke no longer would be the Federal Reserve chairman and the central bank would be out of the money-printing business under a Rick-Perry-run White House, the Texas governor told CNBC.

The Republican presidential candidate has not hid his disdain for Bernanke, and he reiterated during a live interview that someone else would be in charge of monetary policy should Perry unseat President Barack Obama in the 2012 election.

“The statement towards Chairman Bernanke needs to be very clear to him, that making monetary policy to cover up bad fiscal policy is just bad public policy,” Perry said. “What we’re seeing is a Fed that is getting involved in things that frankly it does not need to be involved with. Printing money doesn’t do anything at this particular juncture except make the dollars in our pocket worth less money, plus it puts us in jeopardy of greater inflation in the future.”

Perry’s star has faded somewhat over the past week or so after turning in less-than-stellar performances in Republican candidate debates.

The fiery Texas governor has found himself criticized on the right for his immigration stance, and the left for his hard-line stances on social issues.

He has been especially rough on Bernanke, drawing criticism at one point for suggesting that if the central bank chief ever came to Texas he would face retribution for this actions.

Lessons from Solyndra

September 6, 2011
There has been a lot of press around Solyndra, most of it has been creating more noise than anything else.  I don’t have time to research the statistics of how many companies fail each day, nor do I know how many alternative energy companies have failed since the initial boom in the mid 2000’s, but there is nothing new about dead bodies on the road to innovation and the creation of new industries.
Of course what is selling this newsprint is that the government was counted as a large investor in the company, and the failure of Solyndra has become a touchstone for failed Keynesian spending.
I take a bit of offense to those seeking click-through for the easy “headline” story here.  True this is a good example of wasteful spending, I will not argue that this was terribly wasteful.  However, I do not think the lesson should be that the government has wasted money on “solar energy”.  I think the lesson should be the government has no business making direct investments in any private corporation.
What the government does need to do, is to appropriate taxpayer money in a manner that is in line with possible public benefits rather than private ones.  Any business student can tell you that among Porter’s Five Forces is a satellite force often noted as missing from Porter’s original approach.  The sixth (or five and a half) “force”, after buyer power, supplier power, barriers to entry, substitution and rivalry is government.  Two of the ways governments exert influence on the competitive dynamics of industries are through regulation, subsidies.  There is plenty of literature to support the thesis that sovereign industry winners (i.e. home country advantages) are often a function of sovereign investment and support for those industries either due to national security concerns, or economic importance.  Consider nuclear energy in Japan, oil in the middle east, automobiles of defense in the United States, airlines in almost every country, etc….  These are all areas where at the end of the day, the sovereign will support (or bail out) an entire industry because of perceived importance to the domestic economy (jobs) or national security.  Anywhere you see close government support or intervention in an industry you generally have competitive advantages.  At its core this is due to lower costs of capital for companies nurtured by sovereign support for their industry.
The boondoggled Solyndra investment is the result of Obama’s “shovel ready” approach which I have commented on before.  Whenever the government makes “shovel ready” a requirement, you are going to see a lot of wasteful spending on every halfwit with a political connection and a shiny new shovel.
Our country does need to make new investments in energy infrastructure.  I am sure someone has done more recent math, but I know that for a fraction of the trillions of dollars we have spent in Afghanistan and Iraq, and even possibly Afghanistan OR Iraq, we would currently be entirely energy independent.  It’s absurd that we have waged two decade long wars over oil which has finite capacity, and which we do not have much jurisdiction over.  Moreover, as has often been said, when we convert US Dollars into Petro Dollars we increase our trade deficit, subsidize directly or indirectly our enemies, export jobs,  and further entrench deteriorating legacy infrastructure.  What the government does need to do is to use money it would have spent on individual projects to support entire new industries, not individual new companies. Rookie mistake I guess.
Government spending in the space program resulted in a proliferation of technological advancement that inspired entirely new industries, including computing and telecommunications.  No one company is large enough to make that kind of investment.  No one company can think big enough to take on that kind of challenge.  Additionally, no one company would probably have turned a profit developing our original space program.  I’m sure the direct accounting resulted in billions of “wasteful” spending.  The endeavor was one of national security and during the cold war the space program was also about national pride.  Nonetheless every American could get their hands around the common benefit (even if they did not conceive of the actual outcomes) of putting a man on the moon.
China just a year ago offered to provide $80 billion dollars to backstop their domestic solar industry.  This lowered the cost of capital for all participants, and helped lead to the massive cost savings that Chinese manufacturers have developed, and which in turn have put companies like Solyndra out of business.  I don’t want to point to China’s model as a best practice, because they still allocate capital along socialist lines, and not by free markets.  However, many advanced economies have created subsidy programs to incentivize alternative energy development, which is what truly catalyzed the industry in the first place.  Europe was on the forefront of solar and wind technologies, and Germany in particular with its large energy intensive manufacturing base heavily subsidized the development of alternative energy.  Q-Cells was the original large solar panel manufacturer, not coincidentally from Germany.  However with the massive sovereign investment from China in domestic solar industries, and the rapid rise in the Euro further exacerbating Q-Cells cost issues for buyers, the company now teeters on the brink of insolvency.   China is well aware that alternative energy is the future for the global economy and China has had both the political authority and capital to see that they “win” the great solar race.  In the future oil will inevitably rise again to levels that make alternatives even more attractive than they are today.  At that time our US Dollars will no longer be converted to Petro Dollars, but will eventually be supporting China’s Red Solar Dollars.
Ironically I am totally for the development of US leadership in alternative energy infrastructure, and while I do think that we should probably siphon big oil support into scalable alternative energy industries (to include natural gas and nuclear to some extent), I am not totally opposed to carbon solutions in the medium term.  We need to take a portfolio approach to domestic energy needs, based on domestic supply considerations and topographical opportunities.  Every part of the US has unique advantages and disadvantages, and the clear winner for domestic energy will be a safer more independent grid and energy network, not an individual company or technology.
It’s not the government’s role in a capitalistic democracy to pick the winners and losers within an industry, but to the extent that new technologies can advance the local economy, aid national security and create spillover benefits to other industries (lower energy costs), it is the government’s role to see that those technologies are incubated and succeed at home.
Article from the New York Times
September 6, 2011

A Third Solar Company Files for Bankruptcy


WILMINGTON, Del. (Reuters) — Solyndra, a solar panel maker that received $535 million in federal loan guarantees, filed for bankruptcy on Tuesday.

Solyndra, which also received more than $700 million in venture capital financing, said it would try to find a buyer quickly to avoid a fire sale liquidation.

The solar industry has been in turmoil this year as a glut of panels has sent prices plummeting 25 percent. Manufacturing capacity expanded just as government austerity measures in Europe eliminated subsidies and undercut demand.

Solyndra cut prices to try to compete but said in court papers that it had been unable to match the extended payment terms offered by foreign competitors.

The company, based in Fremont, Calif., said last week it had suspended operations and laid off 1,100 workers.

Solyndra’s bankruptcy filing followed similar filings by Evergreen Solar and SpectraWatt, a private company that was backed by the Intel Corporation.

Solyndra said in documents filed in Delaware’s bankruptcy court that it planned to spend the next four weeks trying to drum up interest among potential buyers to avoid shutting down permanently and selling its assets piecemeal to repay its creditors.

If it finds a buyer, it could lead to the rehiring of some of its laid-off workers. One of those workers filed a class-action lawsuit against the company in the bankruptcy court, accusing Solyndra of violating the federal law that requires larger companies to give 60 days’ notice of layoffs.

Solyndra did not return a call seeking comment.