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.

Nipponification?

To pick up on a theme, is American going to go the way of Japan? By this I don't mean xenophobic and robot-obsessed. Rather, will we see continued economic stagnation, zero interest rates, employment only held together through wasteful and purposeless government spending, and long term declines in asset values (i.e., Dow 1000, home values declining another 50-70%, etc.)?

The answer hinges on the following question: what can we do to differentiate our path from Japan's? If you go back to Bernanke's deflation speech (2002), it becomes clear that we have done nearly the exact same things that Japan did to combat their asset catastrophe. As of today, we are in the same liquidity trap that has mired Japan for a decade. To be honest, I do not know what exactly would accelerate economic growth to the point where we could reach escape velocity. We need four things simultaneously: better employment figures, confidence in the market, assets to be priced attractively, and inflation. These four cannot be had at the same time -- or at least, they cannot be engineered by the Federal Reserve to occur in simultaneity.

For now, I would be content if policy makers would just pursue job growth.

For the Record

Just for the record, I gave up on the Administration when they pursued cap-and-trade and health care reform while ignoring the unabated bloodletting of geographically pervasive layoffs.

You can pick your principles and form your own ideals in life, but you don't usually get to pick your challenges and crises.

I really and truly cannot fathom how the Administration failed to see the unemployment crisis as the biggest threat to 1) American prosperity, 2) economic and financial recovery, and 3) Democratic reelection.

More on Deflation - Daniel Gross

I like reading Daniel Gross, but he's been mailing it in for about five months now. Probably fatigue from peddling his book. But, now he's just getting sloppy.

Economists generally agree that deflation is a widespread fall in prices, as measured by the consumer price index (CPI).

That economists generally agree on anything is news to me. Deflation has many definitions. Some would argue that there are multiple species of deflation.

For example, there is the phenomenon of debt deflation -- where credit was extended far and wide without proper risk assessment. Always this leads to creditors chasing too many debtors who cannot pay. Always this chokes the supply of money from lenders to borrowers.

There is also the type of deflation referenced by Gross, whereby prices of things go down in a domestic market. Price deflation can result from innovation (things being made cheaper) or from oversupply. Price declines from innovation are different from price declines from oversupply. For example, precision machining may lead to fewer error rates in a manufacturing process, which benefits the manufacturer's bottom line by reducing the cost of production. Some of that savings is passed on to consumers. Some is gobbled up as profit, depending on the level of competition in the industry. Suppliers to the manufacturer see no net change, unless the lowered price leads to greater demand -- in which case suppliers may see a benefit to the innovation-driven price decline. Maybe jobs will be created.

Price declines from oversupply are a bad deal for the companies selling the product. For example, many areas have too many houses right now. This means homes can be bought for cheap (especially with interest rates set to prevent a worsening of the depression). It also means many sellers are taking a loss. It also means home builders have to build fewer homes than planned. This means the suppliers to the builders will take a hit. People will get laid off.

There are other forms of deflation, too, such as an insufficient level of money printing. Or the decline of derivatives creation.

My guess is that we are in a state of multiple layers of deflation. Debt deflation, price declines from oversupply, and a complete derivatives Armageddon. One could make the case that the printing presses are not running at capacity, either. I know DeLong and Krugman would agree. So would Martin Wolf.

As for price declines from innovation, this is where it gets tricky. A lot of the innovation we have seen in the past fifteen years has actually been a political and economic innovation: globalism. Really, shunting off manufacturing to Asia to take advantage of the low cost of labor. This will reverse itself to some extent as Asian populations demand a chunk of the consumer pie, which will send some portion of their colossal aggregate savings into merchants’ pockets. This increase in demand will lead to price increases for everyone. These price increases, given the tendency for things to fall to shit all at the right time, will hit us just as our debt deflation is the worst. Meaning, just when we can afford it the least.

Indeflation, or Indigestion?

Deflation is still real, thanks to European banks holding sketchy sovereign debt. The poor stock markets are getting battered as the carry trade reverses. How this works is simple: European banks borrow dollars or yen, then trade stocks with the borrowed money. Basically, the banks are playing with free money because the borrowing rates that big players enjoy are close to zero. Well, now the European banks don't trust each other's collateral so they need to be back in cash to fulfill their capital requirements and pay their bills. So, they sell their stocks, using the cash to make payroll or to buy safe US Treasurys (used for collateral for overnight borrowing). Plus, Treasurys and other US guarantees are trading for higher than book value, so banks can trade them out for a greater rate of return than they'd see in this stock market anyway.

Meanwhile the printing presses continue to work overtime. Why would they do that? Again, for a simple reason. Politicians have decided that is is more palatable to inject blood into zombie banks than to let them fail. The story is getting old, but we're not writing any new chapters. So we have simultaneous inflation and deflation. Indeflation.

Bilderberg Update

The Bilderberg Brahmins released their "agenda":

The Conference will deal mainly with Financial Reform, Security, Cyber
Technology, Energy, Pakistan, Afghanistan, World Food Problem, Global Cooling,
Social Networking, Medical Science, EU-US relations.

Here is what I expected they would discuss:

• Debt deflation
• Spain
• Greece
• Turkey
• Maintaining European competitive advantage against emerging economies
• Social decline of the west

I imagine "financial reform" is actually a cover for fiscal reform. Financial reform can be discussed openly. Fiscal reform, however, is a fertile soil for popular anger. "Security" is code for the ongoing conflict between the West and Islam. "Cyber technology" can only refer to China and its army brigades of hackers -- or perhaps the loose band of Russian nationalist hacktivists. And so forth.

The two topics that surprise me are "medical science" and "global cooling." To be honest, seeing these listed made my skin crawl. Why in the hell would these people want to discuss about medical science? I don't see it, unless it's in the context of health care costs and the untenable welfare state. And, global cooling? Is there something we should know?

I wonder who's job it was to explain Twitter to Henry Kissinger . . .

Bilderburg 2010

I'm not into the Alex Jones scene, believe me, but Bilderburg always gets me thinking. Based on the leaked attendees list, here is my take on the themes:

• Debt deflation
• Spain
• Greece
• Turkey
• Maintaining European competitive advantage against emerging economies
• Social decline of the west

Think I'm wrong? Then why did Niall Ferguson get the invite, but Krugman didn't? If I was in charge, I would arrange the agenda as follows:

• Debt deflation
• Russian integration into the European economy (you know, because the failure to do so allowed WWI to happen)
• Alternative energy, i.e., anything but Middle Eastern oil
• Finding buyers for European and American goods, i.e., JOBS!

PIMCO

Am I the only one who thinks that PIMCO is behind all the public debt hysteria? Like the the Rothschilds before them, PIMCO will make a fortune by convincing everyone that public debt must be reduced -- which would decrease the supply of bonds, which would increase their market price.

Two Simple Thoughts

If the economy is going to lag, then seeking dividends is the only sensible way to allocate capital.

If employment stays low, then interest rates will, too. That's how the Fed works. Thus, assets will re-inflate (cheap money is too tempting to pass up), which will set the stage for yet another burst bubble (a bank failure in Austria was the spark that ignited the Great Depression). If that's the case, the only risk-approved way to allocate capital is to invest in blue chip companies that have the power and resilience to weather another broad decline. If those companies have been shown to be favored by the government (ahem, big finance, automobiles, GE), so much the safer, right?

And one less simple thought. The economy has found its footing. The housing market has found its bottom nationwide (more or less, regions and neighborhoods have decoupled, which is a sign of fundamental strength). Greece and the other PIGS will find a bailout. China will allow its currency to float a bit. These are all very good signs, but the question remains as to whether the skeleton has healed. A human body in traction is fragile, even if you dress it in Armani. I still believe that America faces a necessary step backwards in its standard of living. My reasons for this are not motivated by envy of the uber-rich, or a loathing of materialism. My gut math just doesn't add up. I can't help but think that the American consumer has been the victim of a macro version of a pump-and-dump scheme. Multinational corporations invest in facilities where labor is cheap, then sell the manufactured crap to Americans. Once the cost of money stabilizes (in part the dollar's relative strength is a result of a lack of confidence in other people's money -- increasing lack of trust in the American system and the American fisc will bring the dollar down), the dollar will find itself extremely overbought. Then multinationals will dump their junk on the next round of suckers (India, Brasil, China?).

And what will Americans do for a living? Build more houses?

Home Prices: Or, Why We Hate Economists

Here is probably the most ridiculous evaluation of home prices I have ever seen. Seriously, I read better analysis in the comments below Tech Ticker postings on Yahoo! finance.

http://economix.blogs.nytimes.com/2010/04/06/why-your-houses-value-probably-wont-rise/

Of all the things that factor into a home's price, cost of construction is ridiculously inconsequential.

economy bottom

About a year ago I accurately called the stock market bottom. Today I am making the same claim about the economy as a whole. One caveat, it will be a slog. Deflation is still a very real threat as banks continue to write down loan losses.

Fail

So, health care reform is going to fail because the President has failed to express an underlying principle (is it cost reduction, or is it expansion of coverage -- the message is mixed up). Meanwhile, he has committed to a surge strategy in Afghanistan and we remain forever in Iraq. And the TARP banks are repaying despite the fact that they haven't shrunk enough to cease posing systemic threats to the entire world economy.

Oh, and new jobless claims were up again.

Fail.

Interviews

I hate job interviews. I believe I could sell anything, but when it comes to marketing myself, I have a full blown panic attack. The reasons for this remain elusive, but I am certain about one thing. If the goal was to be as self-critical as possible, I think I would be the best interviewee ever.

Intentional Ambiguity in Heraclitus

I have been pondering Heraclitus' first fragment all weekend. Commentary beginning with Aristotle points out the ambiguity in the first line: "Of this Word which holds forever men prove uncomprehending." Is forever modifying holds or men? The meaning is altered slightly depending on how you approach the grammar.

Yet, there is another ambiguity that puzzles me. Word, or Logos, can have two meanings. Logos has a metaphysical and an epistemological meaning. Metaphysically, Logos refers to the power of creation or to the act of creation. It also may refer to the power of the creator enduring into perpetuity. Epistemologically, Logos means science and reason. It can also mean prophecy and revelation.

The metaphysical and the epistemological meanings are almost inimical to one another. Creation becomes a subject of materialism, externality, and sensory perception. The epistemological meanings are about uncovering the hidden, transcendental knowledge, and abstract thought.

All weekend I have been asking myself, does Heraclitus mean Reason or Creation? Heraclitus is big on reconciliation of opposites. In the first sententence of the fragment, the philosopher uses a universal (Logos) and a particular (men). A universal is a type of extreme, so it must be reconciled with the particular. Likewise, a human is a discrete unit, and must be reconciled with the whole.

The fragment seems to express despair about human cognition. Some humans understand and thereby divide and classify (form particulars for understanding the Logos). Other humans experience life with the same transcience and Lethe-ward slackness of sleeping.

Though this Word is true evermore, yet men are as unable to understand it when
they hear it for the first time as before they have heard it at all. For, though
all things come to pass in accordance with this Word, men seem as if they had no
experience of them, when they make trial of words and deeds such as I set forth,
dividing each thing according to its kind and showing how it is what it is. But
other men know not what they are doing when awake, even as they forget what they
do in sleep. (from heraclitusfragments.com)

If Heraclitus is making a social commentary, then he is expressing a pro-science outlook. The world should be inspected and understood through a trial of words and deeds. This is a reasonable interpretation. But, this is the first fragment, and such a banal criticism would not befit the beginning of a book (now lost, of course) concerning metaphysics and logical paradoxes.

Rather, Heraclitus is laying the groundwork for understanding understanding, and for understanding the universe. Logos can be heard, but will not understood despite its manifest truth. In fragment two, Heraclitus argues that the Logos is universal, but people live as if each had her own received wisdom. Even those who attempt understand the Logos through inspection, argument, and experiment will fall short of total comprehension.

The great mass of humanity represents the particularity of the created world. The world is not created to understand itself. Men do not understand when they hear. Science and argument will not reveal the truth of creation. Passivity of thought will not naturally bring you to the origins of truth.

Like the Bhakti saints and Sikh Gurus two thousand years later, Heraclitus endorses understanding through introspection. The created world will not reveal the highest truth. How does Heraclitus know Logos: He sought the oracle inside himself (fragment 101). What he does not tell us, however, is whether his Logos is everyone's Logos or if he is trapped in the same folly as every other man, unknowing of the Words that endure forever.