30 June 2009

End of Quarter

"We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.

That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed,

That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.

Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn that mankind are more disposed to suffer, while evils are sufferable than to right themselves by abolishing the forms to which they are accustomed.

But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security..."

The US markets will be closed on Friday July 3 in holiday observance of the anniversary of the American Declaration of Independence from the rule of England.

The rest of the world will somehow manage to muddle through on its own as best it can, and continue to consider its options and alternatives to the US Dollar as the prime measure of international trade and sovereign wealth.

29 June 2009

Premium to Net Asset Value of Certain Gold and Silver Trusts and ETFs

Government Bails Out General Electric

"But regulators soon loosened the eligibility requirements, in part because of behind-the-scenes appeals from GE...Public records show that GE Capital, the company's massive financing arm, has issued nearly a quarter of the $340 billion in debt backed by the program, which is known as the Temporary Liquidity Guarantee Program, or TLGP. The government's actions have been "powerful and helpful" to the company."
That fact that public money is being used to support General Electric, through their GE Credit group which chartered two small Utah banks raises several issues.

When people argue for state sovereignty in issues like banking and credit cards this is of course appealing to states rights people like this blogger. But when those regulations cross over the lines of interstate commerce and federal funds, the answer should always be 'no' as it merely opens the door to regulatory manipulation and state corruption. The experience with credit card debt limits and state regulation has been a blot on the regulatory landscape for many years.

There is nothing wrong with GE owning a financing operation. There was and needs to be the appropriate regulation of it, and that should include the ability to fail and take down part of General Electric shareholder value.

This 'behind the scenes' and 'under the table' decision-making has become far too common in Washington. And recent reports of Congressional 'insider trading' are alarming, not because of smoking guns discovered, but because of the official reluctance to speak out against even the appearance of such impropriety. Members of U.S. House Financial Services Committee traded bank stocks as bottom fell out of market

The banks must be restrained, and balance restored to the system, before there can be a sustained economic recovery.

Washington Post
How a Loophole Benefits GE in Bank Rescue
Industrial Giant Becomes Top Recipient in Debt-Guarantee Program
By Jeff Gerth and Brady Dennis
ProPublica and Washington Post Staff Writer
Monday, June 29, 2009

General Electric, the world's largest industrial company, has quietly become the biggest beneficiary of one of the government's key rescue programs for banks.

At the same time, GE has avoided many of the restrictions facing other financial giants getting help from the government.

The company did not initially qualify for the program, under which the government sought to unfreeze credit markets by guaranteeing debt sold by banking firms. But regulators soon loosened the eligibility requirements, in part because of behind-the-scenes appeals from GE.

As a result, GE has joined major banks collectively saving billions of dollars by raising money for their operations at lower interest rates. Public records show that GE Capital, the company's massive financing arm, has issued nearly a quarter of the $340 billion in debt backed by the program, which is known as the Temporary Liquidity Guarantee Program, or TLGP. The government's actions have been "powerful and helpful" to the company, GE chief executive Jeffrey Immelt acknowledged in December.

GE's finance arm is not classified as a bank. Rather, it worked its way into the rescue program by owning two relatively small Utah banking institutions, illustrating how the loopholes in the U.S. regulatory system are manifest in the government's historic intervention in the financial crisis.

The Obama administration now wants to close such loopholes as it works to overhaul the financial system. The plan would reaffirm and strengthen the wall between banking and commerce, forcing companies like GE to essentially choose one or the other.

"We'd like to regulate companies according to what they do, rather than what they call themselves or how they charter themselves," said Andrew Williams, a Treasury spokesman.

GE's ability to live in the best of both worlds -- capitalizing on the federal safety net while avoiding more rigorous regulation -- existed well before last year's crisis, because of its unusual corporate structure.

Banking companies are regulated by the Federal Reserve and not allowed to engage in commerce, but federal law has allowed a small number of commercial companies to engage in banking under the lighter hand of the Office of Thrift Supervision. GE falls in the latter group because of its ownership of a Utah savings and loan.

Unlike other major lenders participating in the debt guarantee program, including Bank of America, Citigroup and J.P. Morgan Chase, GE has never been subject to the Fed's stress tests or its rules for limiting risk. Also unlike firms that have received bailout money in the Troubled Assets Relief Program, or TARP, GE is not subject to restrictions such as limits on executive compensation.

The debt guarantee program that GE joined is administered by the Federal Deposit Insurance Corp., which was reluctant to take on the new mission, according to current and former officials who were not authorized to speak publicly. The FDIC also initially resisted expanding the pool of eligible companies, fearing it would add more risk to the program, the officials said.

Despite those misgivings, there have been no defaults in the loan guarantee program. It has helped buoy confidence in the credit markets and enabled vital financial firms to raise cash even during the darkest days of the economic crisis. In addition, the program has raised more than $8 billion in fees.

"The TGLP program has been a moneymaker for us," FDIC chairman Sheila C. Bair has said. "So I think there have been some benefits to the government and the FDIC."

For its part, GE said that it properly applied for and qualified for the program. "We were accepted on the merits of our application," company spokesman Russell Wilkerson said...

26 June 2009

The Particularity of Japan from an Economic and Demographic Perspective

Since Japan is so often, and as we think incorrectly, cited as a likely deflationary pattern for the US in monetary outcomes, and since so few who discuss this subject have an understanding of Japanese culture and social structures, I thought it would be timely to point out a basic fact that should be reasonably well known but is so often overlooked.

Japanese population growth is flat, and the percent of the population that is no longer economically productive is growing rather quickly.

So would we be so suprised that Japan's GDP is flat, and that their money supply growth is sluggish? One should not be, unless they are not bothering to look at the data.

America also has an aging population as do many countries, but Japan is unique because of its extraordinarily low rates of immmigration due to the very homogenous nature of Japanese society.

Japanese population is now estimated at about 127.7 million people with a very nominal immigration rate of about 20,000 people per year and a negative birth-death rate.

When one mixes a negative native birth-death rate and very low immigration due to a rigid approach to race and citizenship, it should be no suprise that Japan has an unusually high level of elderly citizens.

The charts seem to suggest that countries with significantly aging populations with low population growth will experience a natural slow growth in GDP.

As you know we tend to like to view money supply growth and GDP in relation with each other and to per capita variables.

When one adds to this demographic mix the Japanese cultural bias to low domestic consumption and a high savings rate, and a bureacratic bias to a mercantilist industrial policy, the reasons for Japan's economic status become rather obvious.

I am not suggesting that Japan must change. I have spent many happy moments in Japan, and spent a great deal of time to learn the language and understand the culture, albeit with results inadequate to my hopes.

I have had many Japanese friends, and find great enjoyment in their art and music and social personality. I regret that I have not been to visit there in some years, and have forgotten so much and miss so many old acquantances. And I am particularly at a loss for their wonderful cuisine which I find fascinating, uniquely refreshing and delightful.

It is important to understand a country in its context, and with some attention to detail and its particulars, if one is going to perform an economic analyis and then perform broad comparisons and construct models.

Demographically speaking, Japan is an outlier with some unique characteristics. If one does not consider this, it can be a source of false conclusions.

Tax Revenues Slump as the US Budget Deficit Soars

Income Tax revenue is taking a drop commensurate with the kind of slump which we are experiencing in domestic GDP.

But there is a bull market in government spending. This does not include much of the support being given to Wall Street banks and other 'off balance sheet' shenanigans.

Thanks to Escape From America Magazine for these charts.

25 June 2009

Jesse's Question for the Day

The expansion of credit in a fractional reserve banking system seems to be geometric.

The spending in the wage - price function, as captured by the velocity of money, seems to be more arithmetic, on the order of 2 or so.

Can money creation then fail to overcome the output gap if monetization is permitted and government spending has been and continues to be robustly in excess of tax receipts?

A refusal of banks to lend would tend to dampen the geometric power of credit expansion and a potential source of money creation. It also would tend to dampen velocity of money.

An undeveloped thought which this blogger is just beginning to consider, offered in the hope that someone might offer some useful data or existing theory on the subject.

And on a separate but somewhat related topic, the flip side of deflation is not hyperinflation as it is an extreme. People who based their risk portfolio only for the extremes of an outcome cannot consider themselves hedged since they are likely to be killed in the middle, the most probable, over a reasonable investment horizon.

Our Current Bear Market in Context: Four Bad Bears and the Current Situation

From dshort.com

24 June 2009

A Final Word on Inflation and Deflation

A serious bout of inflation is rarely caused by normal business activity, such as commercial bank lending and private debt.

In almost every case that I have studied, a very serious monetary inflation is triggered by excessive government debt obligations, and not private debt, that can no longer be adequately serviced by a productive real economy and domestic taxation.

That unserviceable debt becomes 'monetized' and a serious inflation results. It is a form of debt default.

Devaluation of a currency is a form of inflation which specifically addresses external debt obligations, as well as default on bonds which is a form of selective national bankruptcy.

The reason that the output gap is no sure barrier to this type of inflation is that it ironically serves to feed it in the presence of profligate government spending, since it dampens tax revenues and domestic GDP.

Private debt bubbles, asset bubbles, stock bubbles all seem to be the symptoms, the side effects, of an over easy monetary policy from a central monetary authority. In some instances they have been caused by exogenous events, even in the face of a hard monetary standard, by events such as a precipitous decline of the population from disease, or a sudden influx of a new wealth from discovery, such as the influx of silver and gold to Spain from the New World.

But the notion that banks must always lend to create inflation, or employment must be at robust levels, absolutely flies in the face of all historical experience.

And it does raise the issue, despite his protestations of innocence, impotence, and confusion, that Fed chairman Greenspan and the Federal Reserve itself, owns a unique culpability in the creation of several bubbles, from tech to housing, and the eventual outcome.

Sucks to Your Asmar!

A Bank Holiday on Deck?

We've been hearing the same rumours about embassies buying foreign currencies for their own use as cited here, but have not been able to obtain enough confidence to comment on it before this public disclosure in a major news source.

Harry Schulz apparently thinks a bank holiday is in the offing.

We think that if something decisive like this happens it is more likely related to a de facto devaluation of the dollar, a market break, that would be very brief. The Banks would close in order to allow the markets to stabilize. The occasion is therefore likely to be a major failure of a household name in banking, or perhaps even the failure of the State of California. California is the size of a large national economy.

We struggle with the notion of a dollar devaluation. Against what? A continued weakness seems to be in the cards, with some major event precipitating a break in market confidence.

It is obvious that there is a campaign to undermine Ben Bernanke as the Fed Chairman, coming out of the Obama Administration. Bernanke is not willing to monetize debt as aggressively as Geithner and Summers would prefer.

A 'big event' appears to be more a long shot that a bet, but we'll keep an eye on it. It does explain some of the more obnoxious moves by insiders to grant themselves huge bonuses and sell their personal stock holdings now.

A number of people have asked us to comment on this, in addition to the Japanese bond smuggling story out of Switzerland which we suspected was just related to a private fraud of some sort.

A gradual and orderly devaluation of the Dollar is most probable but some exogenous event could trigger a loss of confidence and a slide which could provoke a bank holiday. A decline of 20 to 25% in the dollar index from here is what technical analysis seems to indicate, but the Dollar Index is hopelessly out of touch with the modern realities of global currency exchange.

We have taken some steps in our personal life to guard against this, but think it is unlikely given what we know today.

Latest Schultz Shock: a 'bank holiday'
by Peter Brimelow
Jun 24, 2009, 1:35 a.m. EST

NEW YORK (MarketWatch) -- The top-performing letter that predicted the Crash of 2008 now predicts a confiscatory Franklin D. Roosevelt-style "bank holiday." But it's surprisingly sanguine about stocks -- in the (very) short term...

In its current issue, HSL reports rumors that "Some U.S. embassies worldwide are being advised to purchase massive amounts of local currencies; enough to last them a year. Some embassies are being sent enormous amounts of U.S. cash to purchase currencies from those governments, quietly. But not pound sterling. Inside the State Dept., there is a sense of sadness and foreboding that 'something' is about to happen ... within 180 days, but could be 120-150 days."

Yes, yes, it's paranoid. But paranoids have enemies -- and the Crash of 2008 really did happen.

HSL's suspicion: "Another FDR-style 'bank holiday' of indefinite length, perhaps soon, to let the insiders sort out the bank mess, which (despite their rosy propaganda campaign) is getting more out of their control every day. Insiders want to impose new bank rules. Widespread nationalization could result, already underway. It could also lead to a formal U.S. dollar devaluation, as FDR did by revaluing gold (and then confiscating it)."

HSL is still sticking with its 20-year "V" formation forecast, but emphasizes that within the current 10-year downtrend phase there will be rallies that will "last 1-2 years." It attributes its current success to "successfully trading almost daily, especially in commodity stocks (coal/potash/energy/ fertilizer/gold). Take profits constantly and rebuy on mini pullbacks. Prefer non-U.S. dollar companies; many such companies are listed in U.S. & Canada or Australia."

HSL says: "The world is staggering today between stagflation and net deflation right now; it varies widely around globe. Net deflation is a maybe 35% risk, due to toxics and/or deepening depression. Bit more likely, we'll slowly creep up to a dangerous 4.5% inflation on average, medium-term. But the wild card is the currency risk, which has a 50% (?) chance of boiling over and causing literally overnight (i.e. 24 hours) mega inflation in the asset markets."

Nevertheless, in the very short term, HSL's charting leads it to say: "we MAY not get a new bear market decline that many bears are predicting. Likewise, DJIA & S&P500 may build a Head-and Shoulders right shoulder."

HSL's currently recommended allocation:

• 35%-45% Government notes, bills and bonds. (Not U.S.)

• 8%-10% Stocks (non-golds).

• 10%-30% Commodities, via futures, commodity stocks and/or physical assets.

• 35%-45% Gold stocks and bullion.

• 0-5% Bear stock protection via inverse ETFs like ProShares UltraShort QQQ ; ProShares UltraShort Dow30 ("Use to trade/hedge market downturns only.")

The Erosion of the Dollar and the Rise of the East

The outcome of the push for globalization is a severe decline in the median standard of living in the US and an erosion of those individual liberties and freedoms which has made the US somewhat unique on the vast historical sweep of world history.

Few understand this. One cannot be completely sovereign when the push for 'competitiveness' is used to consistently erode the commitment to individual freedom.

David Rockefeller, and Sam Walton, and Bill Gates, looked at the social and economic structure of the People's Republic of China and saw the new American paradigm. Not in the evolution of China to democracy and freedom, but in the subjugation of the United States to huddled masses docilely wearing the yoke of debt subservience to the ruling elite.

Too much speculation in this? The pattern of behaviour of those who promote this canard of globalism is too obvious to ignore.

The banks must be restrained and balance must be restored before a sustained economic recovery can be achieved.

The Korea Herald
'Dollar faces challenge as reserve currency'

Wednesday, June 24, 2009

A leading economist said in Seoul yesterday that the U.S. dollar's supremacy as the world's reserve currency is facing profound challenges as the balance of economic and financial power shifts East amid the current economic crisis.

"There is a slow-burning fuse underneath the dollar," Gerard Lyons, chief economist at Standard Chartered Bank, said in the World Economic Forum.

Underscoring the strengthening role of Asia, Lyons said that the depth of the global downturn drove key emerging economies, such as China and Russia, to cite the possibility of a new global reserve currency.

The forum drew a group of leading figures from business, government and academic circles to discuss Asia's role in helping to overcome the current crisis and shaping a future paradigm for the global system.

"This is not just an economic crisis but also a social crisis," Rajat Nag, managing director-general of the Asian Development Bank in Manila, told participants of the convention, referring to the worsened social conditions stemming from a rise in unemployment. "Asia has to start on a different paradigm," the executive stressed.

He noted that the Asian economy, which enjoyed 9.5 percent growth in 2007, saw the rate fall to 6.3 percent in 2008, while this year it has spiraled further to 3.4 percent. Citing projections of 6 percent growth in 2010 for Asia, excluding Japan, Nag underlined the challenging times ahead.

About 400 of Asia's leading decision-makers from over 35 countries representing various public and private sectors from over 35 countries have gathered for this regional meeting themed "Implications of the Global Economic Crisis for East Asia."

The WEF said the event is designed to facilitate steps toward greater international and regional cooperation. They hope the discussions would inspire a clear direction for building a common agenda for reviving the global economy through new models of growth, technology and corporate practice.

According to the WEF, Asia's share of global GDP and its growing stake in international institutions point to the region's importance in restoring economic growth.

Reflecting the region's importance in rebalancing the international economic dynamics, participants stressed the greater leadership role of Asia's G20 members, as the United States focuses on strengthening trans-Pacific alliances.

Noting that the unprecedented economic crisis offers invaluable lessons, Peter Sands, chairman of the WEF on East Asia and group CEO of Standard Chartered Bank in the United Kingdom, cited the "huge need for coordination in regulation."

"I think it's very important for Asian countries to play a strong role in financial regulation architecture," Sands said, however, noting that proposals for global financial regulations still looked far-fetched.

The executive cited difficulties in striking a balance in tempering excesses of the market and continuing to use markets as a price-setting mechanism. But he also cautioned against too much regulation, stressing that more regulations was not necessary better.

23 June 2009

A Postscript on the Question of Inflation and Deflation

First, thanks to the many readers who mailed in a link to the book by Adam Fergusson at the Mises Institute. It is a good read, and free is much more attractive a price than $1,000 which is the price for a hard copy in good condition on Amazon. I purchased my own copy some years ago at a bookstall in Brighton. The online version is available here.

As to the discussion on inflation and deflation, I feel the need to make it clear that that inflation / deflation is a "policy decision" in a fiat currency regime with nothing preordained. In other words, either outcome is possible within a wide range of gradation. Most outcomes in the real world follow a similar pattern, not black and white but many shades of gray.

But not all things are equally possible. "Life is a school of probability."

If the Fed came out tomorrow and raised short term rates to 22% we would see a stronger dollar and the beginnings of a monetary deflation.

This arbitrariness of a fiat currency is intellectually difficult for most people because their domestic money has a natural patina of 'confidence' and objective value to it.

It is an assumption, one of those shorthand beliefs that help us through day to day life without having to intellectualize and analyze every aspect of every decision. It comes from using that currency as a store of wealth and medium of exchange, almost every day of our life (presumably even an American can take a day off shopping occasionally) and assuming that it will hold its value in the short term.

So we tend to invent 'rules' for the creation of money that preclude 'arbitrariness' and help us maintain our assumption set against 'black swan' thinking. When an assumption begins to conflict with the underlying reality it can become a 'prejudice.'

It is this very arbitrariness that is the goal of the central bank and statists whose preference is aggressive financial engineering. The limitation on the Treasury/Fed in a fiat regime is ultimately the value of the dollar and the sovereign debt. While people accept it, they can print it. This is a soft limitation with much more latitude than a hard external standard.

Having added the important caveat of possibility, given that the US is an enormous net debtor, it would be suicidal for the monetary authority to choose deflation as the Japanese did for their own particular reasons. We may experience a brief period of deflation as did the US in the early 1930's in which the money supply actually contracts, but this is much less likely now because the Fed has no external standards with which to contend.

There is a technically possible, rather conspiratorial line of thought that suggests that the wealthy elite who control the central government would opt for deflation in order to enhance their personal cash assets, driving the rest of the US into a form of debt serfdom. The probable response from the public would be in the tradition of the storming of the Bastille or the Winter Palace.

Almost all money issuing entities will choose inflation if they have the option. Sometimes they lose control of the process, the confidence game, and fall into a more serious and pernicious inflation and even hyperinflation. But this is not 'the norm.'

Our own Fed is rather arrogant these days, fully confident they know how to stop inflation given the Volcker experience. This may cause them to fall into a serious policy error on the inflationary side. In many ways our fate is no longer in their hands, but in those of our creditors, such as the Chinese and the Saudis.

Paul Volcker gave the odds of inflation in the current crisis as 99% for, allowing only for a serious policy blunder against it.

I wanted to highlight the Weimar experience to debunk the 'output gap' and the 'bank lending' restraints on the inflationary outcome. Much of what we hear on the financial channels smacks of propaganda, the 'confidence game.'

Yes the Fed faces the headwinds of slack demand and a very low velocity of money, which the Austrians will assert doesn't DO anything, but is rather of the nature of a economic speedometer. Speedometers don't' DO anything either, but their output is certain to be of some interest to the driver and their passengers.

This is less of an issue than one might think, keeping in mind that monetary inflation is the creation of money supply in EXCESS OF DEMAND. As the velocity decreases, so does demand for money, similarly the expansion of credit. So any monetization of existing debt, or government obligations by the Fed, becomes more potent so to speak.

As for the need to create more debt, let us just say that the Fed and Treasury would have yeoman's work to monetize the debt obligations the US already has, which recent estimates put at north of 40 trillions. Even with inflation at their backs, the government will be pressing the default button, selectively but surely, in the coming years.

The most probable outcome is stagflation, perhaps quite serious IF the economy and financial system is not reformed. This could have the vestiges of a monetary deflation were we not a net importer and net debtor.

This is an important distinction between the US experience and that of Japan whose industrial policy is well known to be in the bureaucratic clutches of MITI and the various kereitsu.

Japan sought to stimulate the economy and avoid deflation while aggressively exporting the fruits of their domestic productivity and consumption to support their long standing industrial policy. One cannot have their natto and eat it too. These were conflicting objectives and resulted in a decades long stagnation. This was a policy blunder of the first order.

So, deflation is possible, but not probable. If people understand that, I will feel that I have done a good job in raising the level of understanding about monetary economics.

But isn't all this debate and too often name-calling amongst the bloggers a distraction from the real problem facing the average person, in the same sense as Paris Hilton, Survivor, big time wrestling, the McLaughlin Group and American Idol?

The banks must be restrained, and the economy brought back into balance, before there can be any sustained recovery.

22 June 2009

The Harlot's Progress

Or should that be, The Progress of the Harlots?

Some Common Fallacies About Inflation and Deflation: the Weimar Nightmare in Review

There are several fallacies making the rounds of the economic community, often put forward by pundits on the infomercials for corporate America, and also on the internet among well-meaning but badly informed bloggers.

The first of these monetary fallacies is that 'the output gap will prevent inflation.' The second is that a lack of net bank lending or other 'debt destruction' will require a deflationary outcome. Let's deal with the output gap theory first.

Output gap is the economic measure of the difference between the actual output of an economy and the output it could achieve when it is most efficient, or at full capacity.

The theory is that when GDP underperforms its potential, with unemployment remaining high, there can be no inflation because demand is weak and median wages will be presumably stagnant. This idea comes from neoliberal monetarist economics, and a misunderstanding of the inflationary experience of the 1970s.

The thought is that sustained inflation is due to a 'wage-price' spiral. Higher wages amongst workers cause prices to rise, prompting workers to demand higher wages, thereby fueling inflation. If workers do not have the ability to demand higher wages there can be no inflation.

While this is in part true, it tends to confuse cause and effect.

The cause of a monetary inflation, which is a broadly based inflation across most products and services relatively independent of demand, is often based in a monetary expansion of the currency resulting in a debasement and devaluation.

A monetary expansion is relatively difficult to achieve under an external standard since it must be overt and often deliberative. A gradual inflation is an almost natural outcome under a fiat currency regime because policy-makers can almost never resist the temptation of cheap growth and the personal enrichment that comes with it.

There can be short term non-monetary inflation-deflation cycles that tend to be more product specific in a market that is not under government price controls. But this is not the same as a broad monetary inflation or deflation.

The key difference is the value of the dollar which has little or nothing to do with a business cycle or product demand/supply induced inflation/deflation.

In the modern era the Federal Reserve can increase the money supply independent of demand by the monetization of debt, with the only restrictions on their ability to increase supply being the value of the dollar and the acceptability of US sovereign debt. This requires the acquiescence of the Treasury and the cooperation of at least one major money center bank.

People tend to invent 'rules' about how the money supply is able to increase, and confuse financial wagers and credit with money. This is in part because the average mind rebels at the reality behind modern currency and the ease at which it can be created. Further, people often invent facts to support theories that they embrace in an a priori manner.

In a pure fiat currency regime, the swings between inflation and deflation are almost always the result of policy decisions, with the occasional exogenous shock. A government decides to inflate or strengthen their money supply relative to productivity as a policy decision regarding spending, central bank credit expansions, banking requirements and regulations, among other things.

As a prime example of a rapid inflation despite a severe economic slump, what one might call uber-stagflation, is the Weimar experience.

Since pictures are worth 1000 words, let me be brief by showing you a few important charts.

The basic ingredients of the Weimar experience are...

A high level of official debt issuance relative to economic growth

High unemployment with a slumping real GDP

Wage Stagnation

I should stop here and note that although the statistics at hand involve union workers, in fact unemployment was widespread in the Weimar economy. The saving grace of being in the union was that one was more often able to retain their jobs and some level of nominal wage increases.

Anyone who has read the history of the times knows that unemployment, underemployment and slack demand was rampant, and that hoarding was commonplace as people refused to trade real goods for a rapidly devaluing currency.

Rapidly Rising Prices Despite Slack Demand and High Unemployment

So much for the wage price spiral and the output gap.

A Booming Stock Market, at Least in Nominal Terms

Booming Price of Precious Metals as a Safe Haven Even While Basic Material Prices Slumped

Notice the plunge in the price of copper as the economy collapsed and gold and silver soared.

If one can obtain a copy, as it is out of print, one of the best descriptions of the German inflation experience is When Money Dies: the Nightmare of the Weimar Collapse by Adam Fergusson. There is a copy of the book available online for free here.

From my own readings in this area, the people who tended to survive the Weimar stagflation the best were those who:
1. Owned independent supplies of essentials including food and shelter and were reasonably self-sufficient.
2. Had savings in foreign currencies that were backed by gold such as the US dollar and the Swiss Franc
3. Possessed precious metals
4. Belonged to a trade union and/or had essential skills or government position which guaranteed a wage
5. Were invested in foreign equity markets, and even in the domestic German stock market for a time

People will argue now that the Fed understands that inflation is caused by perceptions, and that by managing those perceptions inflation can be avoided because even those prices are rising and the currency is being devalued, if they ignore it the inflation cannot reach harmful levels.

This is what I call the "psychosis school" of behavioral economics.

Granted, perception is important, and managing perception may delay outcomes for a period of time. But unless the underlying cause of the problem is remedied during what is at best is an extended interlude, the resulting break in perception will ignite a firestorm of cognitive dissonance, loss of confidence, and social unrest.

In summary, in a purely fiat currency regime a sustained monetary inflation or deflation is an outcome of policy decisions regarding fiscal policy, monetary policy, and economic balance and output.

As long as the government is able to generate debt, deflation is a highly unlikely outcome. And when the government reaches the practical limits of debt creation, the underpinnings of the currency give way and the economy tends to collapse in a stagflationary slump.

There are no predetermined outcomes in a fiat monetary regime. Deflation, stagflation and hyperinflation are not 'normal' but are certainly possible if the central authority is permitted to abuse the real economy and the money supply for protracted periods of time.

What about Japan? Japan is the perfect example of a policy decision made by a fiat currency regime in what was decidedly NOT a free market, but under the de facto control of a highly entrenched bureaucracy, a single political party, and large corporate giants in pursuit of an industrial policy that favored exports and domestic deflation.

The difference between the Japan of the 1980s and the US of today could not be more stark. Choosing a deflationary policy and high interest rates as a debtor nation is economic and political suicide. It would be interesting to see what happens if the US elites try to take that path.

We will know if there is a true monetary deflation in the US because the value of the dollar will start increasing dramatically with regard to other hard assets, other currencies, goods and services, and precious metals and commodities. Prices will decline especially for imports as the dollar gains in purchasing power.

Remember that a true monetary inflation and deflation would only show up over time. Even in the Great Depression in the US, as demand slumped and prices fell, the stage was set for a significant devaluation of the US dollar and a rise in consumer prices well in advance of the eventual recovery of the economy that caused the Fed to tighten prematurely. As I recall the actual contraction in money supply lasted two years. This again highlights was an amazing piece of bad policy that Japan represents in its 'lost decade.'

People embrace beliefs for many motivations. So often I find they are not 'rational' and based on a scientific study of the facts, even on the most cursory level. Fear and greed and prejudice are often motivations that are surprisingly resilient, even in the face of overwhelming evidence against them. Leadership understands this well.

There are often appeals to private judgement. I do not care what you say, this is what I believe, what I think, what I feel. This is appropriate in the supra-natural realm, but in the natural realm there may be private judgement but the facts are public, and the outcomes are well beyond the complete control of the most fully-managed perceptual campaigns, at least so far in human experience.

"The lie can be maintained only for such time as the State can shield the people from the political, economic and or military consequences of the lie. It thus becomes vitally important for the State to use all of its powers to repress dissent, for the truth is the mortal enemy of the lie, and thus by extension, the truth is the greatest enemy of the State." Joseph Goebbels, of the perception modification school of economic thought

What is truth? It is difficult to estimate but not completely out of reach.

Our own view is that a serious stagflation with further devaluation of the US dollar as it is replaced as the world's reserve currency is very likely, after a period of slackening demand and high unemployment. A military conflict is also a probable outcome as countries often go to war when they fail at peace.

Weimar was not an anomaly although the level of inflation was indeed legendary. Argentina, post Soviet Russia, and most recently Zimbabwe are all similar examples. Serious Instances of Monetary Inflation Since World War II

There are many, many variables in play here, and policy decisions yet to be made. It is highly discouraging to see Obama's Administration fail so miserably to do the right things, but there is always room for hope, less so today than six months ago however.

Argue and shout grave oaths and wave our hands though we might, we are in God's hands now.

Let's see what happens.

A very special thanks to our friend Bart at Now and Futures who makes these charts, among other things, available on his highly informative web site for public review. If you are not familiar with his work you might do well to view it. We do not always agree, but he demands attention because of the rigor which he applies to his work for which we are grateful, always.

NAVs of Several Precious Metals Funds and ETFs

21 June 2009

Goldman Sachs Set for Record Profits, Largest Bonuses Ever

As they say in the States, "in your face."

Or just some 'getting out of town money' ahead of a financial collapse?

The outsized financial sector, with its exorbitant fees, represents a serious tax and a growing threat to the real economy.

We may have, at best, the illusion of a recovery based on the increasing monetary inflation and monetization of debt as shown in the money supply figures, as compared to real GDP growth. Price, Demand and Money Supply

It will be a selective recovery at best, and damaging to the political fabric of the United States. It is a drain on the world economy while the US dollar is the reserve currency.

It is seigniorage on a grand scale, unprecedented tax on productivity not seen since the decline of colonialism, perhaps even feudalism.

Until the financial system is reformed there can be no sustainable recovery.

The Guardian
Goldman to make record bonus payout
Surviving banks accused of undermining stability

Phillip Inman
The Observer
Sunday 21 June 2009

Staff at Goldman Sachs staff can look forward to the biggest bonus payouts in the firm's 140-year history after a spectacular first half of the year, sparking concern that the big investment banks which survived the credit crunch will derail financial regulation reforms.

A lack of competition and a surge in revenues from trading foreign currency, bonds and fixed-income products has sent profits at Goldman Sachs soaring, according to insiders at the firm.

Staff in London were briefed last week on the banking and securities company's prospects and told they could look forward to bumper bonuses if, as predicted, it completed its most profitable year ever. Figures next month detailing the firm's second-quarter earnings are expected to show a further jump in profits. Warren Buffett, who bought $5bn of the company's shares in January, has already made a $1bn gain on his investment.

Goldman is expected to be the biggest winner in the race for revenues that, in 2006, reached £186bn across the entire industry. While this figure is expected to fall to £160bn in 2009, it will be split among a smaller number of firms.

Barclays Capital, Credit Suisse and Deutsche Bank are among the European firms expected to register bumper profits, along with US banks JP Morgan and Morgan Stanley following the near collapse and government rescue of major trading houses including Citigroup, Merrill Lynch, UBS and Royal Bank of Scotland.

In April, Goldman said it would set aside half of its £1.2bn first-quarter profit to reward staff, much of it in bonuses. It is believed to have paid 973 bankers $1m or more last year, while this year's payouts are on track to be the highest for most of the bank's 28,000 staff, including about 5,400 in London.

Critics of the bonus culture in the City said the dominance of a few risk-taking investment banks is undermining the efforts of regulators to stabilise the financial system.

Vince Cable, the Liberal Democrat treasury spokesman, said: "The investment banks more than any other institutions created the culture of excessive leverage, excessive risk and excessive bonuses that led to the downfall of the financial system. Now they are cashing in and the same bonus culture has returned. The result must be that we are being pushed to the edge of another crash."

Goldman Sachs said it reviewed its bonus scheme last year and switched from a system of guaranteed rewards that were paid over three years to variable payments that tied staff to the firm. It told employees last year that profit-related bonuses would be delayed by 12 months.

Until the release of its first quarter profits in April, it seemed inconceivable that a firm owing the US government $10bn would be looking to break all-time records in 2009.

David Williams, an investment banking analyst at Fox Pitt Kelton, said: "This year is shaping up to be the best year ever for investment banks, or at least those that have emerged relatively unscathed from the credit crisis.

"These banks are intermediaries in the bond markets where governments and companies are raising billions of pounds of new money. There is also a lack of competition that means they can charge huge sums for doing business."

Last week, the firm predicted that President Barack Obama's government could issue $3.25tn of debt before September, almost four times last year's sum. Goldman, a prime broker of US government bonds, is expected to make hundreds of millions of dollars in profits from selling and dealing in the bonds.

16 June 2009

The Alternatives to Uncle Buck Being Considered

China Stakes
BRIC, SCO Discuss "Super-Sovereignty" Currency, USD Alternatives

By Scott Zhou
June 16,2009

China continued to consider a “super-sovereignty” currency among the countries of Shanghai Cooperation Organization (SCO), an intergovernmental mutual-security organization that met today in the Russian city of Yekaterinburg, in the Urals at the division of Asia and Europe. Members include China, Kazakhstan, Kyrgyzstan, Russia, Tajikistan, and Uzbekistan, with India as one of its four observers.

Right after the SCO meeting, the BRIC country (Brazil, Russia, India and China) leaders met formally for the first time. It is not merely coincident that three of them have expressed a desire to adjust their foreign exchange reserve portfolios by reducing the share or volume of US dollar assets.

China has just halted the increase its holding of US Treasury debt. By the end of April, China held $763.5 billion of it, a fall of $4.4 billion, month on month, the first time China has reduced its Treasury holdings. Since May, 2008, China has increased its holding by $260 billion.

Inside China, USD is a hate-more-than-love story. Analysts have long argued that China should be very cautious on buying US government bonds since dollar is bound to weaken. Others hold that US treasury debts are still the best and first choice for China's near $2 trillion foreign exchange reserve.

In March, Madam Hu Xiaolian, the chief of China's State Administration of Foreign Exchange and a deputy governor of the People's Bank of China, China's central bank, said that investing in US national debt is an essential part of China's reserve management. But while continuing to buy US national debt, China is concerned about the risk of the fluctuation in value of its assets.

China has announced that it would buy up to $50 billion in bonds issued by the International Monetary Fund (IMF). Meanwhile, Russia and Brazil have said they are planning to buy up to $10 billion in IMF bonds, which would mean selling Treasury bonds. India has expressed the same interest. In April, China, Russia, and Brazil all reduced their holdings of US treasury debt.

China now believes that a long-term dollar decline is inevitable, and the risk to the value of its $2 trillion foreign exchange reserve has become realistic, if not imminent.

China has been a huge beneficiary of the order of the world economy and a monetary system with the US dollar as the reserve currency. China's economy has been anchored by a stable dollar exchange pegged by China's currency, RMB.

But the financial crisis has given China a wake up call that the present monetary system is not sustainable, and neither is China's foreign exchange regime and mode of economic growth, which has been largely based on relentless exporting.

What, then, is the role RMB can play in the future? Russia has been urging China for years to settle their bi-lateral trade in their respective currencies. Brazil intends to trade with China by RMB and the real. Recently Russia suggested making RMB convertible to become an international reserve currency.

China can not challenge US directly. The BRIC summit is a convenient platform for China and the other BRIC powers, set to become the 4 of the 6 largest economic entities by 2050, to put a bit of pressure on the US. Held before the first China-US Strategic and Economic Dialogue in late July in Washington DC, the BRIC summit may give China some leverage in dealing with the US.

Russia is ready to use its exchange reserve to buy securities issued by BRIC countries. In return, Russia hopes the others will be willing to buy financial instruments issued by Russia. The leaders discussed increasing of the share of settlement currencies for trade among them. They also discussed adjusting their reserve assets portfolio in a coordinated way.

At the SCO meeting held just before the BRIC summit and attended by China, Russia and India, China proposed to research the feasibility of using a super-sovereignty currency among SCO member countries.

Kazakhstan president Nursultan Nazarbayev proposed that trade among SCO countries be settled by currencies of member countries. He also suggested that a super-sovereignty currency used inside the SCO eventually become a SCO reserve currency. Russian President Dmitry Medvedev also supported the idea.

SP Futures Hourly Chart

This is a quad witch option expiry week. The futures front month is rolling over but we have not yet made the change to September futures.

Volumes remain remarkably light even for June.

Support is obvious.

Keep a close eye on the VIX volatility.

And the Winner Is.... the SDR?

This is a significant development.

It appears clear now that the preferred alternative to the US dollar reserve currency regime for international transactions is going to be the Special Drawing Rights (SDR) units from the International Monetary Fund. We have seen indications that this was going to be the alternative, as compared to the euro, but it was not so confident a probability as it seems today.

Now it seems to be. And those SDR units will be an adjusted basket of commodities and currencies that will be more reflective of the current global economic picture. This may be phased in over time if the US and its political supporters have their way.

This is important because it is feasible, a realistic alternative, much more practical than the complete replacement of the US dollar by something else like the euro for example. We may also see more bilateral agreements based on local currencies.

Achieving the concurrence of the Saudis and other US client states will be important, because the dollar reserve strength has been largely based on its political connection to oil and military power. Most commentators and analysts miss this, but it is essentially at the heart of the matter. History may look back on this as a period of neo-colonialism since it has been so pervasive and uneven in its geopolitical relationships, especially since the 1970's: a Pax Americana.

This is not to say that the IMF's SDRs will be THE solution. They may very well falter. But if one is looking for a politically and financially palatable alternative to break the Big Dollar cartel, this looks likely to us. If it falters, it will be replaced with something else, most likely after some 'tinkering' with the basket composition first.

Let's keep an eye on this. But it is our judgement that the US dollar will continue to decline in signficance, in a relatively orderly fashion for the forseeable future, looking out perhaps over the next ten years, barring a major exogenous event, most likely of a geopolitical or military nature.

Russia calls for revision of SDR currency basket
By Gleb Bryanski
Tue Jun 16, 2009 3:58pm IST

YEKATERINBURG, Russia (Reuters) - The International Monetary Fund (IMF) should expand the basket of Special Drawing Rights to include the Chinese yuan, commodity currencies and gold, a senior Kremlin official said on Tuesday.

The SDR is an international reserve asset allocated to member countries with its exchange rate determined by a basket of currencies, at the moment including dollar, euro, yen and sterling. A review of the basket is due in November 2010.

"The rouble, yuan deserve to be included in the SDR basket," Kremlin economy aide Arkady Dvorkovich told a news conference ahead of the first summit of Brazil, Russia, India and China, known as BRIC, in the Russian city of Yekaterinburg.

"It is important that the composition of the basket also reflects the role of commodities in the global economy," Dvorkovich said, naming Australian and Canadian dollars as possible candidates.

"We also think that gold has a potential as a possible participant. The price of gold has a negative correlation to the dollar. Therefore it is beneficial to tie these two instruments into one so that investors feel safer," he said.

Dvorkovich said he doubted Russia would complete its transition to an inflation-targeting regime which implies a freely floating exchange rate for the rouble next year when the IMF basket's review takes place, as announced by the central bank.

Dvorkovich said BRIC leaders will discuss new reserve currencies at the summit but called for caution in the currency debate, saying it was in no-one's interest to ruin the dollar.

Russia rattled financial markets last week when a central bank official said Moscow will cut the share of U.S. Treasuries in its forex reserves in favour of IMF bonds and bank deposits.

Finance Minister Alexei Kudrin played down this statement over the weekend saying the dollar's status as the world's main reserve currency would unlikely change in the near term. Dvorkovich said new reserve currencies were inevitable.

"The world economy will grow... In the future we are sure growth will resume. This growing pie should be divided in a fairer way. We are not talking about excluding the dollar but the share of other currencies should increase," he said.

He said BRIC leaders will discuss investing their reserves, which are among the seven largest in the world, in each other's currencies, settling bilateral trade in domestic currencies and striking currency swap agreements.

"It would make sense for us if our partners agreed to place some of their reserves in Russian roubles," Dvorkovich said.

He said BRIC countries had a common position regarding the reform of the International Monetary Fund while a decision by China, Brazil and Russia to purchase SDR-denominated bonds issued by the IMF would boost the role of SDRs.

"Any expansion of the IMF's resource base implies ... strengthening of SDRs' role in the international currency system," Dvorkovich said.

15 June 2009


Although the Cafe is open, the proprietor is temporarily overcome by a state of ennui regarding the financial markets.

From the volume today it appears to be a more widespread condition than those managing this distribution rally would have preferred.

No positions taken into the close except of course those very long term ones so firm as to be not worth discussing.

"Notre ennui, nos mœurs fades sont le résultat du système politique." Balzac La Femme de Trente Ans 1832

(Our boredom, our insipid customs, are the result of the political system.)

12 June 2009

Wall Street's Toxic Message Carried in the Winds of Change

Joe Stiglitz writes an important essay, and it is suggested that you take the time to read it. It helps to explain many of the things we have been saying, including the forecast that 'a new school of economics will rise from the ashes of this crisis, as Keynesianism rose from the Great Depression.'

These are changes of an historic nature, and as such they will progress slowly, and be largely unnoticed by those going about their daily business.

But the tides of change have been loosed, and what we have known, and relied upon, and expected will be shaken to its foundations.

Wall Street's Toxic Message by Joseph Stiglitz - Vanity Fair (pdf)

09 June 2009

US Dollar Long Term Chart

Price, Demand, and Money Supply as They Relate to Inflation and Deflation

There are three basic inputs to the market price of something:

1. Level of Aggregate Supply
2. Level of Aggregate Demand
3. Relative Value (purchasing power) of the Medium of Exchange

Let's consider supply and demand first, since they are the most intuitively obvious.

The market presents an overall demand, and within that demand for individual products in particular.

Supply is the second key component to price. We are not going to go into more detail on it since what we are facing now is a decrease in Aggregate Demand.

It can seem a little confusing perhaps. Just keep in mind that if the aggregate demand decreases for goods and services for whatever reasons, such as severe unemployment, and supply remains available then prices will drop overall, with some variance across products because of their differing elasticity to price changes.

This is known as the Law of Supply and Demand.

How we do know when aggregate Demand is decreasing?

Gross Domestic Product = Consumption + Investment + Government spending + (exports − imports),
or the famous economic equation GDP = C + I + G + (X − M).

Consumption, or Aggregate Demand, is a measurable and key component of our GDP figures.

Given the huge slump in GDP, it should be obvious that we are in a demand driven price deflation on many goods and services. People are saving more and consuming less.

Now, that covers supply and demand as components of price, but what about money?


Notice in the above examples we talk about Price as a value without a label.

Money is a medium of exchange. It is the label which we apply to give a meaning to our economic transactions.

If you are in England, or France, or Argentina, or China, the value label you apply to Price is going to be different according to local laws and customs.

Money is the predominant medium of exchange that a group of people have agreed to use when engaging in economic transactions that are not based on pure trading of goods, known as barter.

The source and store of wealth are the 'credits' within the system which one uses to exchange for products. The money is the medium of exchange.

If you work for a living, you are exchanging your time and your talent, which is your source of wealth, for products. The way in which this is labeled and facilitated in the United States is through the US dollar. I n Russia and China is it something else completely.

The Value of Money

How do we know what some unit of money is worth? Try not to think about your domestic currency. Since we use it so often every day, we tend to think of it with a set of assumptions and biases. Most Americans have little practical exposure to foreign exchange, and tend to think of themselves as living in a dollar-centric world.

Let's use the Chinese yuan. What is the yuan worth? What if I offered you a roll of yuan in exchange for a day's work? How would you know if it was a 'fair trade?"

Since there is no fixed standard for money in our world, you would most likely inquire in the markets what you could obtain for those yuan I offered to you in an accessible market.

But what sets the rate at which yuan are exchanged for a given product?

In a free market system, it is a very dynamic system of barter. When you offer something for money, I know how much of my source or store of wealth I must exchange for the yuan to provide for the product offered.

Money is just a placeholder. We hold it because we expect to be able to trade it for something else which we really desire. You don't eat or wear money; you exchange it for things which you wish to eat or wear.

If the value of money changes, the price of all the things to which you have been applying that label changes. This is why it is important to distinguish between price changes because of changes in demand, and changes because of money supply. They are different, and require very different responses.

Money supply

In a very real sense, there is a relationship between how many goods and services are available, and how much money exists.

Let's say we are in China. I give you 100 yuan. Tomorrow the Chinese government triples the amount of yuan in the economy by giving each of its citizens ten thousand yuan for essentially doing nothing, for not producing anything more or less.

Do you think the 100 yuan will be worth as much as they were the day before? No, obviously not.

In real economies these changes tend to happen with a time lag, or gradually, between the action and the reaction. This is necessary because people can only adjust their daily habits, their economic transactions, gradually. Otherwise it becomes too stressful, since our daily routines and decisions are based so heavily on habits and assumptions of value and consequences.

But in general, if the supply of money is increasing faster than real per capita GDP over a longer term average the money supply is inflating, that is, losing real purchasing power.

Seems simple? Well its a bit more complicated than that unfortunately since these things relate to free markets, and if there is any other thing you need to remember, we do not have free markets, only free to varying degrees.

The logical question at this point is to ask, "What is the money supply?" That is, what is money and what is not?

We dealt with this at some length, and suggest you look at this Money Supply: A Primer in order to gain more knowledge of what is money and money supply.

We would like to note here though, that there is a difference between money supply and credit, between real money and potential money.

If I have 100 Yuan in my pocket, there is a real difference between that money, and my ability to work at some job tomorrow and be paid 100 yuan, or have you repay 100 yuan to me which I gave to you yesterday, or my hopes that I can borrow 100 yuan from some third party.

If you do not understand this, you will not understand money. It is one of the great charades of our time that risk has been so badly distorted out of our calculations. We cannot help but think that some future generation will look at us as though we had all gone barking mad.

The subject becomes even more complicated these days because we are in what is called a fiat regime. Fiat means 'let it be done' as we will it, and we are if anything in a very relativistic age in which we think we can will just about anything.

The major nations of the world get together and attempt to manage the value of their currencies relative to one another, primarily through their finance ministries and central banks.

Countries will interfere in the markets, much more than they will admit, to attempt to maintain certain relationships among currencies of importance to them. Sometimes they are overt about it, as when nations 'peg' one currency to another, and at other times they are more subtle and merely influence other currencies through mass purchases of debt and other forms of persuasion and the molding of perception.

I hope this helps. I don't intend to answer loads of questions on this, particularly from those who immediately start inventing complex examples to try and disprove this. Most of the time the examples betray a bias that person has that defies patience and a stubborn belief that everything is relative. In the longer term it is most assuredly not.

Each will learn at their own pace what is real and what is not. But they will not be able to say that they have not been warned that sometimes appearance is different than reality.

Here are some examples of money supply growth in the US. If you read our Primer you will know that MZM is by far the most important now that M3 is no longer reliably available.

Is money supply growing faster than real per capita GDP? Yes, decidedly so. And unless this trend changes significantly we will face a whopping monetary inflation.

Here is a chart that shows the buying of US debt that other countries have been doing through the NY Fed Custodial Accounts for a variety of motivations. Without this absorption of US money supply the value of the dollar would be greatly diminished relative to several other currencies. This is probably not a sustainable relationship but it has had a good long run because it is supported by the US as the world's superpower.

Other countries are essentially exchanging their productivity, their per capita GDP, for our excess money supply. This is why a US monetary inflation has remained manageable. Other countries are providing an artificial Demand for US debt at non-market prices.

One of the great errors of our generation has been the gradual and erroneous mispricing of risk through a variety of bad assumptions and convenient fallacies. Without the appropriate allowance for risk, there is no ability to discover valid pricing and allocation of capital.

The consequences of this abuse of reason are going to be enormous.

I do not see this improving quickly because the manipulation of risk for the benefit of the few, and the transfer of that risk to the public and the rest of the world, has tremendous value to the powerful status quo.

But the day of reckoning and settlement of accounts is coming, and as it approaches it will accelerate and come with a vengeance. For after all,

"Life is a school of probability." Walter Bagehot

School is almost out.

08 June 2009

SP Futures Hourly Chart at 2:30 PM

The volumes remain thin, and the market appears to be in the control of the big trading desks, flush with TARP money, and the demimonde of hedge funds and daytraders.

Be in this market for the short term only, or not at all. The manipulation of certain funds, options and indices makes this a 'professionals only' market.

Let's see if any serious support breaks, ahead of the second quarter earnings. The mainstream media is preoccupied with bread and circuses, and the financial news media is an extended informercial, if not propaganda machine.

There is no economic recovery, only a paper chase. The Obama Administration is failing to take the next steps of creating an industrial policy that places the US labor force and economy on an equal footing with the rest of the world, and reforming the financial system which is unbalanced to the point of deformity and inefficient to say the least.

06 June 2009

Is the USO Oil Fund "Like a Pyramid Scheme?"

Some very hard words being said about the USO Oil Fund ETF, sparked by comments from the Schork Report.

Certainly the USO oil fund has not been tracking the performance of the commodity it attempts to represent, and has severely lagged the recent rally in West Texas Intermediate Crude.

This is in contrast to ETFs which target a percentage of the continuous commodity contract such as GLD or SLV. However, one should never mistake the commodity for what is essentially a derivative position, with little or no underlying guarantee of taking delivery of the commodity, as opposed to the futures markets.

This is different from the issue with levered ETFs which we reported on back in December, which reset their basis every day. But we think they also are contributing to volatility particularly in the last hour of trade.

Here is the information on USO. We do not believe in holding the ETFs for long periods of time, which in our lexicon is more than a couple of weeks. We understand that the CFTC is setting revised rules for "commodity pool operators."

"So how is this like a pyramid scheme? A pyramid scheme is funded by a constant flow of dollars into the venture by new investors. The second investor knowingly and willingly pays the first investor on the assumption he will get paid by the third investor… and so on. It’s similar to a Ponzi/Madoff scheme, with the key difference, investors don’t know (or don’t want to know as long as those alleged returns keep rolling in) they are being scammed.

The USO is being funded by a proliferation of new retail investors looking to diversify into “alternative investments” (which as far as we have been able to ascertain, alternative investment is a euphemism for Las Vegas style bets on commodities by retail investors tired of watching their 401Ks drop). More importantly, these investors are obviously out of their league, i.e. taking buy-and-hold positions in a contango which raises their cost basis every month they roll into the higher priced deferred contract.

We assume they are buying the USO because they are bullish. But in a peculiar way, their actions could be helping to prevent the market from rallying. These new investors are not funding a pyramid per se, but they are helping to fund storage. That is to say, with global demand in the doldrums, the contango will persist. And, as long as it lasts, traders will continue to front-run the rolls, which in turn will exacerbate the contango, which will then incentivize storage builds further, which will then ultimately weigh..."

USO: A Self-Propelled Pyramid? - Financial Times

USO Oil Fund or Just a Pyramid Scheme? Stockmaster.com

USO Oil Fund: All of the Drop and Some of the Gain - Phil's Stock World

Special thanks to Ilene over at Phil's Stock World for the comparison chart. We also enjoyed this quote from their article.
"In fact, it’s very possible that if you did an proper investigation (perhaps a Congressional one) you would find that MOST of the oil traded on the NYMEX has nothing to do with real demand at all but is pure speculation that is sold to retail investors as "commodity investing" or "inflation hedging" but what kind of inflation hedging loses 33% a year PLUS TRANSACTION FEES before a profit can be made? Oh and a funny note - who handles USOs cash and places trades on the ICE and NYMEX for them? Aw, you guessed it - Goldman Sachs!

So here you are giving your money to an ETF that gives its money to the biggest shark in the ocean, who chews off your legs in transaction fees and contango spreads BEFORE they even bother to circle around for the kill by gaming the market. NOT ONLY THAT, but the idiotic rules of the fund lead them to PUBLISH THE DAYS THEY ARE ROLLING IN ADVANCE so every little shark in the sea knows exactly when and where to feast on your bloody, bobbing carcas this month - and the next and the next and the next. Don’t worry though, once you are chewed up and digested, there will be a fresh round of suckers herded back into commodities and the commodity pushing stocks and ETFs every time GS, MS or Cramer need another payday. "

Should a bank guaranteed by public funds and the FDIC be active operators in speculative markets? Or should they be confined to the more conservative realms of commercial banks as they were under the Glass - Steagall regime?

We think the answer is obvious, especially given the fact that a great deal of the problems we face today are a direct result of the repeal of Glass-Steagall and the mixing of public funds with private greed in a coopted political and regulatory regime.

05 June 2009

SP Weekly Chart

Natural Gas and Crude Oil: An Interesting Spread to Watch

The spread between Natural Gas and Crude Oil is now at an 18 year record low.

Nat gas has fallen from $13 to $3 while Crude Oil soared to $70.

Either crude is incredibly frothy, or natural gas represents an outstanding bargain.

A few years or so ago I published a fairly comprehensive study of the seasonality of natural gas, and some relative relationships with demand and supply. I will look for it, and see if I can update it. Since I no longer trade the futures I have not looked at this in some time. But I do remember the spreads and saw this one grown shockingly wide.

My first thought is that oil has been driven higher by monetary inflation and speculation, which are in some ways the same thing. Hot money craves beta and drives the prices of real assets to extremes.

Keep in mind that if enough people get in on this trade, the market makers who can see your aggregate holdings will use it to skin the speculators, without regard to fundamentals in the short term.

It's never easy.

SP Hourly Futures Chart at 2:30 PM

The SP futures are climbing the trellis of a reflationary ramp on thin volumes.

Although we would not suggest stepping in front of it, and certainly not seriously shorting it until the trend is broken, nevertheless the move has all the feel of artificiality and will meet its test when earnings start coming out for Q2.

From what we have seen on the fundamentals of earnings, stocks seems very fully valued here, and would not be looking for a great deal of upside, particularly when the banks finish their price manipulation to support their equity offerings to pay back their TARP funds.

"There is something wonderful in seeing a wrong-headed majority assailed by truth." John Kenneth Galbraith

Non-Farm Payrolls Trend Mismatch

Here is our usual chart comparing the seasonally adjusted and actual payroll numbers from the Bureau of Labor Statistics.

Two things are worth noting.

The first is that the recent uptrend in the seasonally adjusted 'headline' number is conspicuously at odds with the actual numbers, which are still in the same downtrend.

The second is the usual observation we make, and that is to remind people that the adjustments that are made to the actual numbers for seasonality are enormous, and subject to significant revisions after the fact.

About 220,000 of those jobs in the actual number are due to the birth death model 'plug' which is a real howler when you look at the specifics that the BLS attributes growth in the new / small business segement of the economy.

We will get a little more optimistic when the longer term trend turns higher. Granted, it will miss the bottom by a few months, but it is an important signal to confirm any uptrend in the economy that seems to be highly reliable.

The level of unemployment is still a major impediment to the economy despite hopes for a bottom to the economic contraction. Economists will say that this is a lagging indicator, and we will say yes, but we would say that it is the standard by which a bottom will be judged.

Our take on these numbers is that they are at best a short term uptick in response to historically unprecedented monetary stimulus and at worst a false recovery fueled by dangerous levels of monetization and some disappointing short term statistical razzle dazzle.

04 June 2009

Can the Non-Farm Payrolls Report Show the Market Some Green Shoots on Friday'?

Ben and Timmy will be providing the Ho - Ho - Ho...

The Stock Market in Context with the Great Crash of 1929 - 1932

The US Stock Market Crash of 2007 - 2010 expressed in percent decline from the market top in October 2007.

A trading day by trading day comparison of the Great Crash of 1929 - 1932 with the current market decline from its October 2007 top.

The classic profile of a collapsing bubble.

The economic policy of the early post-Crash period was heavily influenced by what was later called Liquidationism epitomized by prevailing views of the Hoover Administration. The idea was that allowing companies and banks to fail as quickly as possible, in a relatively uncontrolled manner, was the appropriate response. This view is still held by the Austrian School of economics.

The flaw in this theory would seem to be that the decline of a crash is not like a natural decline in a business cycle or a severe demand contraction, but the result of a precipitous collapse from a Ponzi-like monetary and credit expansion.

One can argue this point, endlessly if they wish to ignore history and economic reality, but again we need to remember that the outcome in several other nations embracing this theory was the rise of militant, fascist political regimes in response to societal dislocations.

Obviously the best cure is prevention, in not allowing monetary bubbles in the first place. Duh. But one has to play with the cards in one's hand, and not the hand they wish to have.

But there is a lesson in this for our current 'cure' in that blowing yet another asset bubble from a monetary expansion, and little else, will not work. We ought to have learned this from the Fed's policy responses in 2003-2006 which led to the US housing bubble.

Systemic reform and rebalancing is absolutely essential to a sustained economy recovery, and needs to be measured by an increasing median wage and a reversion to manageable income - debt ratios.

The headwinds against this remedy from an outsized financial sector that in many cases has coopted the political process makes a sustained economic recovery less probable without a significant shock to the political and economic structures of the US at least.

Bernanke's wager

Being a student of economic history, Ben Bernanke believes that he can inflate the currency subtly without a formal devaluation, and avoid a second leg down to a deeper bottom.

The Fed is now confident, with the Volcker era inflation experience under their belts, that they do not need to replicate the NY Fed policy error of the 1931 by increasing nominal interest rates prematurely out of inflationary concerns.

Things ARE somewhat different today, in that there is no gold standard, and the world has relatively free flows of fiat capital under a US dollar reserve currency schema.

It should be noted, with no mistake, that the limiting factor on the Fed is the valuation of the US dollar and its sovereign. In 1931 the limiting factor was the gold standard which severely limited the Fed's options, and eventually caused a significant formal devaluation of the US dollar in a step-wise function.

In a fiat regime the devaluation can be done gradually without fanfare.

It is also easy to forget that in 1931 the business community and the leading economists were convinced that the worst was over and that a recovery was underway. Their concerns shifted to inflation, and dealing with the then unprecedented expansion of narrow money in the adjusted monetary base to ease short term credit problems.

The 'risk' is obviously that the analog with the Fed's experiment with subduing inflation in the 1970's under Volcker are not completely consistent to the environmental context today.

The levels of US debt to be absorbed by the rest of the World are without known precedent. And the degrees of freedom in the Fed's calculation are significantly impacted by the policy actions of countries that may be sympathetic but not completely consistent with their own national self-interest or inclinations.

From our own viewpoint, without signficant structural reforms to the US economy and political process, which at this time seem unlikely to overcome the resistance of the status quo, the Fed's actions will most likely result in another type of bubble, less obvious than the last two perhaps, and a stagflationary economic recovery of a sort combing some of the nastier aspects of the Japanese experience, but with a nasty dose of the post-Soviet / Argentinian slumps.

A deflationary envionrment with a stronger US dollar appears to be a fantasy in our opinion, although we have always held it to be possible. Of course it is possible. If the Fed raised short term rates to 22 percent tomorrow, we would see a serious deflation and a stronger dollar.

We would also see riots and civil insurrection in response. This is another limiting factor on the policy decisions of the Fed and the Administration, which people tend to underappreciate, again ignoring many of the social and political events of the 1930's.

The US dollar will continue to decline until there is a precipitating currency crisis that clears the market for US debt. Things will not be able to continue on this way forever. We estimate that the next bubble, if the Fed is able to get the rest of the world behind it, will be decisive.

However, we continue to degrade the probability of this happening as the weeks go by, and the rest of the world appears to be asserting its financial sovereignty from the Anglo-American banking cartel.