40 Years of Pent Up Demand

I argued with the smartest person I know that the student loan crisis is a boon to the extent that it represents pent up demand. In eight to fourteen years, as the existing student debt burden becomes manageable, edumacated peeples will start to ping the bling, buying up timeshares, Mercs (as in Benzos, not camo-faced ex-Marines), Tag Heuer watches, commercial real estate, and fancyfancy children's clothing.

Reality check from the smartest person I know: Once the cadre of high earning debt slaves gets on grip on its scholastic debt pack, they will start saving for retirement. 

Good point. Ain't gonna be no Soshal Securitay. 

Euro Stuff

Just a quick note, mostly to self. You can't separate the fiscal from the financial. Given the differences, it's easy to see how the Europeans permitted the creation of a sovereign monetary union, without sovereign fiscal unity. Financial decisions are strategic, amoral, and are generally a lot of fun. Fiscal decisions are quotidian and hit at the moral fiber of the people and leaders. Will you set up a system that requires you to pay the bills? Or, will you live in pretend land where interest rate analysis substitutes for common sense. Fiscal decisions are painful.

Been a Long Time

I have not been posting anything here because I have a professional conflict. I cannot ethically or responsibly talk about banks, given my position. So, I won't.

So, I'll just posit a ramble.

Hyperinflation will not come. To step back a second and define terms, let's call hyperinflation something greater than 15% headline inflation (core inflation is basically meaningless to anyone who spends money, and only useful for Federal Reserve monetary policy). We're currently at about 3.6% headline inflation.

We are seeing headline inflation due to currency devaluation (back to Fed monetary policy), but the fundamentals of the American economy still support a deflationary trend. Economic activity is stalled, or still shrinking (if you take GDP minus headline inflation, you get a negative number, meaning we never left the recession except for maybe one or two quarters).

Forward, then, zero interest rate policy (ZIRP) will not trigger core inflation to spike. The reason is as follows. ZIRP encourages capital allocation to commodities or risk assets, but not to business investment. The only thing that encourages business investment (by that I am not referring buying NASDAQ stocks, but rather buying tractors, buildings, new ventures, etc.) is optimism. Optimism will only come after either a true bottom is hit, or after a period of stagnation so boring that business leaders and entrepreneurs start trying new things just to shake off their own doldrums.

Stagnation also will build its own form of inefficiencies to exploit, especially as the rest of the world continues to change.

Deflation would be more just, as it would cause some of the zombie entities to finally die. Deflation would be very painful, though. Wages would decrease. Unemployment would shoot upwards to 15% or so. Getting a loan would be nigh impossible on the downward trajectory, thus causing even greater economic malaise. Much of what we know in our world today would change due to cultural upheaval in the face of such a terrible condition for the average American. Doom and gloom would reign, even more so than in a period of prolonged stagnation.

On the flipside, deflation would benefit the dollar, meaning oil would be cheaper because a single dollar would buy more oil than it does now. At some point, energy would be so cheap that optimism would surge as investors realize the opportunity. Likewise, other assets would plunge to fire sale prices. Those with a cash stockpile (even a small one, say $10k) and those with nerve aplenty would become the leaders of change.

Creative destruction. With the dynamism and worldly interconnectedness of the modern economy (assuming the modern economy could survive American deflation), the greatest bull market ever would erupt.

Our fearful leaders will choose stagnation. That's their only hope for keeping their jobs. So, enjoy the wait. Eventually Baby Boomers will retire, which will give some relief to the labor market (opening up new positions) and to corporate earnings and government budgets (cost of labor will be reduced as younger, cheaper people fill the positions). Eventually the country will grow large enough that the excess labor pool will bring down wages sufficiently to make American exports competitive. Eventually Americans will deleverage and default on their debts to the point where banks might consider lending rather than hording their cash. Eventually weak core inflation and lack of demand will make housing prices look attractive again.

A lot of eventuallys. Welcome to the new normal.

Ups, Downs, Tops, Bottoms -- Who You Are

The rise and fall of financial voices. Cramer when the market's hot. Roubini when the depths of our sins are about to be laid bare. Krugman and DeLong when order jells with righteous anger. Paul and the Gold Bugs play a catchy tune of anarchic and revolutionary proportions. Jim Rogers when an escape seems the safest route. Liz Ann Sonders when common sense seems like a good plan.

These people are all absolutely correct -- some of the time. When, though? And how does one know when to tune in to whom?

To digress, I think sometimes about the fortunes of musicians. Some do their best work when no one knows who they are, or cares what they sound like. Metallica, Verve, Faith No More, Franz Ferdinand, Pink Floyd, Tori Amos. They all did their best work before deemed "successful" by the mainstream. Rising from nowhere they embodied the pure joy of musical expression, limitless and chaotic, driven by a single thread of beauty. Once they found success and fame, they lose that thread and become conservative, undifferentiated from their own impostors.

Others thrive at the top. They seem perennially capable of churning out hits. Fame and success seem to justify their existence, rather than cast doubt upon their purpose. Jay Z, The Rolling Stones, AC/DC, Madonna.

Some musicians find a way to thrive even after the fame and success fade. No longer in the spotlight, they are free to just make music. Their way. Maybe without expanding their creative impulse into new sounds. Maybe just playing the same old songs they love to play. Some of these acts become staples at weddings, bar mitzvahs, and proms. Others dwell in a land of perpetual expression. Jimmy Buffett, The Grateful Dead, De La Soul.

Rarest of all are the artists who start off with a bang, but continue to evolve and change unfazed by the stultifying effects of fame and money. The Beatles, Led Zeppelin, Damon Albarn. (are there any Americans who can do this?) I wonder what enables these types to do what they do. How strong must one's ego be to withstand the hangers-on, the sycophants, the pressure to produce an expected result?

The last are those who never made it, never will. And that's ok. I think this is what Kurt Cobain wanted. Maybe they desperately want to be heard. Maybe they enjoy being the barracuda in the kiddie pool.

Back to the financial realm.

The reason why technical analysis works -- and also why fundamental investors like myself are so suspicious of it -- is because people listen to the voices they feel like hearing. They want to be reinforced in their opinion of today. They want comfort. They want to feel the pleasure of a good tune, as befits the mood. Fundamentally, we're talking about chord progressions, harmonies, rhythms. The elements of song. Industrial demand, price to earnings, projected sales, debt load. Really, we're talking about the heart and soul of what it means to be a person in the world. Let It Be?

Not Just Me

And so we've cycled back. We killed the Joneses. Not in the sense that we bested them at materialist poker.

We're poor. When I say we I mean it's not just me.

http://www.washingtonpost.com/wp-dyn/content/article/2010/09/16/AR2010091602698_pf.html

Smart money will realize this.

There's no free money to let us play pretend rich. We're really hurting. How do the pitchfork tines feel, Joneses?

Numbers

Just for fun, let's throw out some numbers.

2% -- the amount of GDP growth needed to stave off deflation.

3% -- the amount of GDP growth needed to stave off further unemployment.

4% -- the amount of GDP growth needed to convince sideline money that recovery is actually in full swing.

6% -- the amount of GDP growth needed to make a dent in unemployment.

10% -- the amount of reduction yet needed in housing prices in order to be attractive to the remaining potential buyers.

2010 -- the year Social Security goes in the red.

1:1 -- the ratio of new borrowing to debt payments by the Federal government in the month of June 2010.

65 -- the number of wins by the Miami Heat in the 2010-11 season.

0 -- the number of championship rings on LeBron's fingers this time next year.

Deflationary Cold Sore Cream -- Rock Bottom Prices

I keep reading about all the wrong reasons to fear deflation. Deflation, in itself, will naturally find a bottom. Risk takers and fools will see to it. At some point, risk takers and fools simply cannot help themselves. They will buy stuff, and lots of it, whether it be stocks, raw materials, or cheapened labor.

The problem with our deflation is not the falling prices, per se. It's the deal making that drives the prices downward. Viz: Bank A has debts coming due soon, for which Bank A needs liquid capital. Plus, it also must satisfy its regulatory capital requirements. Bank A has two options, sell good assets for below market, or sell bad assets for way below market. The due date on the debt is a real constraint. The Bank needs the money now. So it sells assets at a loss.

This means Bank A has less money to pay down the same debt. Think of it this way, Bank A probably took on the leverage with a measure of comfort. It held all these assets. In a pinch, Bank A could sell some off without hurting its overall position. But, what if there are more sellers than buyers?

There is a cascading effect on the price of assets. Meaning all debtors have less money to pay an unchanged amount of debt. So, despite making a debt payment, banks' debts are actually growing relative to their ability to pay.

As cash positions shrink, more liquidation ensues. Prices drive down further. Now, bear in mind that this is all occurring in the rarefied air of Wall Street. M3, M4, and M5 in monetary terms. Nothing you or I would ever touch.

But, as banks' lose money and shave down their assets, they have less to lend with. This means diminishing revenues, which also means the top line is smaller -- thus hitting the bottom line. And so their share prices should also drop.

And because they aren't lending, that means businesses can't obtain credit. One of the biggest reasons for use of credit by corporations is simply to make payroll. Corporations go into the money market (repos and other short term commercial paper deals -- big banks and investment houses are the counterparties, and many of these transactions are leveraged), or they take out short term loans (like one week long) so that their employees' checks don't bounce. Without these credit options, corporations will continue to shed jobs.

That's when Wall Street's V.D. spreads to the rest of us.

Now on sale: deflationary cold sore cream. Always at a discount.