Monday, May 31, 2010


I must've dreamed a thousand dreams
Been haunted by a million screams
But I can hear the marching feet
They're moving into the street

Mises observes that boom/bust cycles are not endogenous to capitalistic systems. Instead, business cycles are a consequence of government interference primarily geared toward lowering the rate of interest below free market levels.

When consumers are permitted to choose freely, it is the subsequent democratic process of the market that then produces the business cycle. When credit expansion comes to an end, consumers' choices reveal misallocations of capital driven by cheap credit, and those projects that should never have seen the light of day are wiped off the books during the bust phase.

One argument for centrally planned systems is that there is less boom/bust. But as Mises notes, if buyers are not permitted to vote with their wallets, then the capital misallocations made by the planners are less apparent in terms of changing business conditions. Instead, people live in a constant state of squalor. A permanent bust, if you will.

Sunday, May 30, 2010

Spill List

List from 2007 showing top 12 oil spills. A few things seem noteworthy. Most of the top spills are tanker spills--the Exxon  (XOM) Valdez tanker spill from '89 isn't even close to getting on the list. The only rig-related spill in the top 12 is the #2 Pemex incident in 1979-80 that spilled 140 million gallons.

It is currently estimated that the BP Deepwater rig in the Gulf has spilled between 500,000-1 million gal/day. At the high end of estimates and assuming 30 days of spill thus far, the BP spill should enter the top 10 soon.

Note also that most recent prior top spill occured in 1994 in Russian.

position in oil

Saturday, May 29, 2010

Crude Attititude

I don't know when to start or when to stop
My luck's like a button
I can't stop pushing it
--General Public

There is little doubt in my mind that we will regulate ourselves into $100+ crude. Supply is coming off the table in a commodity that's already dwindling in supply.

Standing between here and there, however, is the spectre of another economic slowdown, perhaps one that'll make the last one look pretty tame.

Should that occur, there's chance crude will retest its 2008 lows.

Because I think the probability of a double dip is pretty good, I'm reluctant to slap allota energy risk on right here. Perhaps I'm being too cute, but my sense is that there will be opportunity to buy oil at lower levels in the next 6 months.

Should that occur, it may be time to back up the truck, er, tanker.

position in oil

Friday, May 28, 2010

Oil Change

You're begging me to go, you're making me stay
Why do you hurt me so bad?
--Pat Benatar

Sold half of energy position into crude's mini spike higher this am. Planning to parse out additional commodity exposure into further liftage. Also looking for good setup to add to short equity position.

position in oil, commodities, SPX

Thursday, May 27, 2010

Fiat Folley

In violent times
You shouldn't have to sell your soul
In black and white
They really really ought to know
--Tears for Fears

Snippets from Russell:

"No man and no organization can create wealth with the click of a computer...Wealth is created by the sweat of man and the brains of man."

Government and its agencies are incapable of creating wealth. They can only redistribute it and, in many cases, discourage production (which as Russell notes above, is what creates wealth).

Wednesday, May 26, 2010

Regulatory Spillover

Substitution, mass confusion, clouds inside your head
--The Cars

Hirshleifer (2008) proposed a psychological attraction theory of regulation--that regulation is the result of psychological biases on the part of political participants (voters, politicians, media commentators). Let's see if we can't put a couple aspects of Hirshleifer's framework to work in light of calls to limit/regulate the energy sector in the wake of the British Petroleum (BP) oil spill.

Salience and vividness effects. Politics can be viewed as a struggle for attention. Constraints on information processing influence political debate. Political competitors seek mechanisms that will make their positions plausible, understandable, and memorable.

Research suggests factors that make stimuli easy to retrieve. Attention is drawn to salient stimuli, or those that stick out compared to others in the environment. Attention is also drawn to vivid stimuli, such as stories about personal experiences and emotionally arousing information (Nisbett & Ross, 1980). Moreover, people possess a 'negativity bias,' or a distaste for losses when measured from an arbitrary reference point (Kahneman & Tversky, 1979).

Disasters, of course, play right into the hands of political participants with an agenda. To my knowledge, we've never had a deep water oil spill like this before (which is likely the chief reason why no one has been able to stop it). Stories of tar balls on the beach and dead wildlife tug at emotions.

As such, voters are eager for politicians to 'do something' to at least create an illusion of initiative to correct the problem.

In-group bias and scapegoating. People tend to prefer members of their own group to outsiders, a phenomenon known as in-group bias. Moreover, people engage in self-serving attribution bias, the belief that in interactions with others we are right and they are wrong. Group serving interpretations of attribution bias can result in antagonism with other groups (Beck, 1999).

The animosity that various politically minded environmental groups hold for industries such Big Oil pretty apparent. Accidents provide a prime stage for the 'we're right; they're wrong' production.

BP becomes a scapegoat for those seeking sweeping reform. Scapegoating is blaming the visible, disliked, and relatively vulnerable--in this case to support regulation to avert future misconduct, regardless of whether there was any villanous behavior or not.

Overconfidence. It has been argued that the most robust finding in all of psychology is that people are overconfident. Overconfidence is belief that one's personal abilities are better than they really are (Hirshleifer, 2008: 864). People consistently express confidence that regulatory regimes can avert disaster. Yet disasters in heavily regulated processes persist. The Space Shuttle program, a government run initiative, has seen two catastrophic failures since its inception. Financial markets have experienced various meltdowns over the past couple of highly regulated decades.

Like all individuals, regulators think they are better than they really are. Can the oil industry be regulated by bureaucrats in a manner that reduces chances of an extreme event? Theory suggests that people think so ex anted but historical data suggest otherwise ex post.

Availability cascades. Extreme events such as disasters gain widespread public attention in intense bursts. Tversky and Kahneman's (1973) 'availability heuristic' suggests that people judge the importance of a phenomenon by their ability to recall examples of it. The more people talk about an event or problem, the more important it seems, creating a self-reinforcing cycle that can be labeled an 'availability cascade' (Kuran & Sunstein, 1999).

As such, news media amplify the availability of threats selectively. In an availability cascade, as public opinion swings toward one position, evidence becomes increasingly one sided in favor of that position. Evidence suggests that people fail to account for the one sidedness of evidence, even when that one sidedness is explicit (Brenner, Koehler, & Tversky, 1996). Consequently, during an availability cascade based upon a perceived threat, political pressure for government to do something to mitigate the threat becomes irresistible.

All of this helps explain not just the regulatory regime sprouting from the current oil spill, but the larger phenomenon of why a people consistently cede power to political entities in the form of regulation--even when the cost of regulation is high and prone to failure.

position in oil


Beck, A.T. 1999. Prisoners of hate: The cognitive bias of anger, hostility, and violence. New York: HarperCollins.

Brenner, L., Koehler, D., & Tversky, A. 1996. On the evaluation of one-sided evidence. Journal of Behavioral Decision Making, 9: 59-70.

Hirshleifer, D. 2008. Psychological bias as a driver of financial regulation. European Financial Management, 14: 856-874.

Kahneman, D. & Tversky, A. 1979. Prospect theory: An analysis of decisions under risk. Econometrica, 47: 263-291.

Kuran, T. & Sunstein, C. 1999. Availability cascades and risk regulation. Stanford Law Review, 51: 683-768.

Nisbett, R. & Ross, L. 1980. Human inference: Strategies and shortcomings of social judgment. Englewood Cliffs, NJ: Prentice-Hall.

Tversky, A. & Kahneman, D. 1973. Availability: A heuristic for judging frequency and probability. Cognitive Psychology, 5: 207-232.

Tuesday, May 25, 2010

The Buck Stops Here

I'm sorry but
There's no one on the line

Put the below graph together using data from the BLS site.

By my calcs, $100 in 1916 is now worth about $3.50. And given the tortured state of our CPI statistics, this is likely a conservative estimate.

The Federal Reserve Act was passed in 1913, although the Fed didn't get active till 1916ish. The 16th Amendment was also ratified in 1913.

We should also note that, although CPI stats were not kept prior to the mid 1910s, estimates I've seen suggest relatively stable USD purchasing power during the pre-Fed 1800s.

Pavlov's Dog

The reflex is an only child, he's waiting in the park
The reflex is in charge of finding treasure in the dark
--Duran Duran

After proclaiming that its policies helped end the Great Recession, the Obama adminisatration is now seeking support for a new round of stimulus. Few things were more predictable, particularly given the fall midterm elections.

Size of the stock market pales in comparison to the size of the vote market.

Monday, May 24, 2010

Book Report

Last thing I remember I was running for the door
I had to find the passage back to the place I was before
'Relax,' said the nightman, 'We are programmed to receive.
 'You can check out any time you like, but you can never leave.'

In addition to professional endeavors, a personal goal during my sabbatical was to read up on the capitalism (a.k.a. market economy) socialism (a.k.a. planned economy) dyad. I was particularly interested in what smart folks had to say about the middle ground between the two poles. This middle ground, often referred to as managed capitalism, mixed economy, or interventionism, is where every modern economy is positioned to some degree.

"How stable is this middle ground?" was my primary research question. "Is a mixed economy a 'steady state' sort of design, or is it prone to migration toward one of the poles?"

I plowed thru some seminal books plus an article or two--some by economists, others by social commentators. Bibliography below. While certainly not an exhaustive reading list, there were some noteworthy findings nonetheless:
  • It was nearly unanimous that the middle ground is not a steady state position. The exception was Reinhart and Rogoff (2009) who seemed to believe that managed capitalism is the endgame. Hirshleifer (2008) offered an interesting counter argument against such regulatory regimes.
  • Most felt that the gravitational pull was away from capitalism and toward socialism. 
  • Some felt that a socialist endgame was inevitable (e.g., Marx & Engels, 1848; Marx, 1862; Schumpeter, 1942). Even Garrett (1953) seemed pretty fatalistic. 
  • Others felt that, while the pull favored socialism, intervention by liberty minded people could reverse the trajectory toward capitalism (e.g., Chodorov, 1959; Hayek, 1944). 
  • Rothbard's (1979) work was the only one suggesting a primary pull toward free markets--using US colonial context for his analysis. 
  • Mises (1951, 1998) concluded that the economics of socialism were inferior to capitalism. 
My key lessons learned? Many great thinkers think that mixed economies migrate toward socialism. This is, after all, what you get when governments get into the wealth redistribution business--currently a worldwide bureaucratic practice. However, the more an economic system moves in the socialistic direction, the weaker it becomes (think debt and lower standard of living as capital is misallocated and innovation extinguished). Before it ever reaches the pole, a socialistic system is likely to sink like a stone.

The old Soviet Union, the current EU situation offer real life examples in this regard.

While the Road To Serfdom points toward socialism, the journey appears difficult to complete.


Chodorov, F. 1959. The rise and fall of society. New York: The Devin-Adair Company. (see also here and here)

Garrett, G. 1932. The bubble that broke the world. Boston: Little, Brown, & Company.

Garrett, G. 1953. The people's pottage. Caldwell, ID: The Caxton Printers, Ltd.

Hayek, F. 1944. The road to serfdom. Chicago: The University of Chicago. (see also here)

Hirshleifer, D. 2008. Psychological bias as a driver of financial regulation. European Financial Management, 14: 856-874.

Lane, R.W. 1954. Give me liberty. Caldwell, ID: The Caxton Printers, Ltd.

Marx, K. 1867. Das kapital, Vol. 1. Hamburg: O. Meissner. (see also here)

Marx, K.H. & Engels, F. 1848. Manifest of the Communisty Party. London: Burghard.

Mises, L. 1951. Socialism: An economic and sociological analysis. New Haven: Yale University Press. (see also here)

Mises, L. 1998. Interventionism: An economic analysis. Irving-on-the-Hudson, NY: The Foundation for Economic Education, Inc. (see also here)

Reinhart, C.M. & Rogoff, K.S. 2009. This time is different: Eight centuries of financial folly. Princeton, NJ: Princeton University Press.

Rothbard, M.N. 1979. Conceived in liberty, Vol. 4. New York: Arlington House, Publishers.

Rothbard, M.N. 1996. Origins of the welfare state in America. Journal of Libertarian Studies, 12(2): 193-232.

Schumpeter, J.A. 1942. Capitalism, socialism, and democracy. New York: Harper & Brothers.

Sunday, May 23, 2010

Open Containers

Here comes the rain again
Raining in my head like a tragedy
Tearing me apart like a new emotion

We spent the better part of 2007-2008 listening to bureaucrats claiming that debt blowups were isolated and contained. Little or no chance of a contagion, we heard.

The cascade then commenced.

Similar rhetoric is now building around the Europe story.

Of course, what choice do officials have? When you have a debt laden economic system that is levered many times, the only thing holding things together is confidence. If people become suspicious of the system's validity and simultaneously head for the exits en masse, then the game is up and the house of cards folds.

There will likely come a point, perhaps soon, where no amount of rhetoric will constrain market forces seeking to rebalance the system.

Saturday, May 22, 2010

Take the Long Way Home

You never see what you want to see
Forever playing to the gallery

Plucked the below chart from Barry Ritholtz's site.

If you believe in reversion to the mean, then this suggests that we have a ways to go.

position in SPX

Friday, May 21, 2010

Of Boots and Necks

Welcome to your life
There's no turning back
Even while we sleep
We will find you
--Tears for Fears

We've noted before that core tenants of the Tea Party movement (limited government, fiscal responsibility, free markets) are threats to both the Left and the Right. In true 'the enemy of my enemy is my friend' fashion, many Republicans are riding the Tea Party's coat tails as a means to bash Democrats, although they abhor the Tea Party philosophy themselves.

This week, we got a whiff of how this works in the political free-for-all that has followed US Senate candidate Rand Paul's comments on the appropriate scope of government's involvement in private enterprise operations. Such remarks were a layup to incite the Left's machine--particularly that part of the apparatus seeking to fill the KY seat w/ a Democrat.

But Republicans have been distancing from Paul's comments as well. Quite predictably, I might add, given their big government roots.

As observed last week, the real 'progressive' idea is liberty. Two hundred+ yrs after it drove this country's founding, the premise that people should be free to pursue their individual destinies unshackled from the control of others remains the most radical idea the world has ever known. 

Modern governments and the special interest groups that feed them will do what they can to keep their boot on the neck of freedom in suppressive authoritarian style.

Wide and Loose

I can't fight this feeling any longer
And yet I'm still afraid to let it flow
--REO Speedwagon

'Wide and loose.' That's the term my friend Don likes to use when describing the volatile action during selloffs. You can sure see it in the tape right now, with S&Ps moving in 1% clips.

The major contributor to increased volatility is leverage. When prices are going up, leverage is calm and happy to go with the flow. When prices go down, leverage gets nervous. And then it gets scared.

Leverage usually thinks it can get out near the top, when prices are high. But with so many levered participants, it should be readily apparent that all leverage can't possibly cash out on top. After a few fortunate sellers leave early, prices start falling.

Selling begets selling. And the action becomes wide and loose.

position in SPX

Thursday, May 20, 2010

Get Back

Jo Jo was a man who thought he was a loner
But he knew it couldn't last

Two wks ago, onlookers dismissed the 1000 pt intraday 'flash crash' as some anamoly of 'fat fingeredness.'

As it currently stands right, we're now only about 250 Dow pts away from getting back there 'for real.'

position in SPX

Hard Rain

Superman where are you now
When everything's gone wrong somehow?
The men of steel, the men of power
Are losing control by the hour

German Chancellor Angela Merkel is stepping up calls for regulation in what she calls "a battle of the politicians against the markets."

Jeff Cooper shared this Merkel quote although it is uncited:

"Governments must regain supremacy. It's a fight against the markets and I'm determinied to win this fight."

Consistent w/ yesterday's post, this is a battle that politicians think they can win. Overconfidence bias, availability cascades, et al.

Although markets around the world are not free, market forces persist nonetheless. Actions to restrain market forces do not negate them. Instead, restraints cause market forces to build (think trying to hold back rising water behind a dam that is springing leaks). At some point it is likely that the potential energy of market forces turns kinetic, and overpowers all attempts at restraint.

Politicians have been acting to restrain market forces for at least a century. One has to wonder how much longer this will continue.

position in SPX

Wednesday, May 19, 2010

Regulation Contagion

Well the years start coming and they don't stop coming
Fed to the rules and I hit the ground running
Didn't make sense not to live for fun
Your brain gets smart but your head gets dumb
--Smash Mouth

Just a quick missive to record the cite for future reference. Just chewed thru an outstanding paper by David Hirshleifer of Cal Irvine on the psychological biases of financial regulation. Can't link the pdf here but this is truly recommended reading for anyone seeking to understand the mechanisms of behavioral economics as they apply to government regulation of any kind.

Perhaps in a future post I'll summarize some of Prof Hirshleifer's key points here.


Hirshleifer, D. 2008. Psychological bias as a driver of financial regulation. European Financial Management, 14: 856-874.

Tuesday, May 18, 2010

Trouble Ahead

Think it's safe to say that Russell can be categorized as bearish.

Off Duty

I went away in the mud and the rain
The gang became snide and laughed
I was slayed and I smiled and the pain
Began to subside at last
--Pete Townshend

Not long after Minyan Peter suggested that we're running out of lifeguards w.r.t. transferring risk, chatter came out of Europe that regulators are going to curtail shortselling.

I recall when martial law against shorts was similarly declared in US markets in September 2008. After an initial short covering pop, markets came to rest about 30% lower six months later.

Bans on short selling never work. First, shorts are not the 'problem' when prices are declining. Market forces are merely punishing poor decisions made in the past. Second, shorts provide a layer of liquidity and support for prices when projects are covered. That buying power disappears when shorts are removed from the game. We noted as much back in Sept 08.

Just another in the long line of unintended consequences spawned by bureaucratic intervention.

Would 'think' we'd get a pop somewhere around here (although US markets went south on the chatter this afternoon). If they do pop, then I would think that bears might want to express their bearishness in markets where shorting is (still) allowed (for now).

position in SPX

AA Update

Is there any just cause for feeling like this?
On the surface I'm a name on a list
I try to be discreet, but then blow it again
--Cutting Crew

Updated asset allocation:

cash   45%
commodities   2%
fixed income   3%
precious metals   14%
real estate   31%
short equity   5%

Compared to beginning of year, cash has come down in favor of paying off home mortgage and bumping metals position.

Pretty comfortable with how the pie's divided. Might add to commodity exposure. And if stocks rally, might use price to my advantage to bump short position closer to 10%.

Monday, May 17, 2010

Crude Mood

We mention the time we were together
So long ago, well I don't remember
All I know is that it makes me feel good now
--The Motels

Initiated a position in crude today. Getting pretty oversold and at technical support. The bearish argument (and one I'm admittedly sympathetic to) is that the selloff in crude and other industrial commodities signals global slowdown ahead.

On the bullish side, however, is that oil supplies continue to dwindle, and the political backlash stemming from the recent oil spill is likely to restrict supply further.

So I'm willing to hedge my bearish views with a lil crude. Have also initiated a position in ags based on same general thought process.

positions in DBO, DBA

Sunday, May 16, 2010

Specs in Black Hats

We can dance if we want to
We can leave your friends behind
Cause your friends don't dance and if they don't dance
Well they're no friends of mine
--Men Without Hats

Not sure why I was surprised to read this. Whenever markets move against them, politicians, managers, and pundits that have skin in the game are quick to point fingers at 'speculators' for pushing prices in the 'wrong' direction.

The UK blamed George Soros, Tyco blamed David Tice, O'Reilly blamed oil traders. The list goes on and on.

Such claims are always prepostererous. If speculators truly made prices 'wrong', then those who think so could make a boat load of money by simply taking the other of the trade. In the case of Greece, politicians and other advocates should welcome the lower prices of their outstanding bonds, buy back a ton of it, and make a killing. Greece would thereby retire debt at depressed prices. Kind of like settling your credit card debt at pennies on the dollar.

They won't do that, of course, because in reality they either see no value in it, or their past actions leave them broke and unable to take action--which of course in Greece's case is the gist of things.

It may take a while but market forces, however constrained, seek fair value.

More often than not, pointing fingers at 'speculators' for self-created problems preceeds a death spiral in the related securities.

position in SPX

Saturday, May 15, 2010

Sinking Feeling

"You hear that Mr Anderson? That is the sound of inevitability."
--Agent Smith (The Matrix)

The most surprising thing to many market watchers over the last week is the euro's ongoing weakness in the face of the EU's huge sovereign debt bailout announcement.

After an initial pop, the euro resumed sinking like a stone, easily slicing thru the 124 cross rate on Fri. Some pundits are amazed that the ECB hasn't stepped in with a massive currency intervention to stem the decline.

It's hard not to wonder about the effectiveness of such action should it unfold (and it may unfold this wkend). Perhaps more folks are catching on to the folly of fiat currency and the inevitable end game.

That's one way to interpret the strong action in gold.

position in gold

Friday, May 14, 2010

Progressivism: New and Modern?

"I guess you guys aren't ready for that. But your kids are gonna love it."
--Marty McFly (Back to the Future)

When Progressivism was gathering momentum a century ago, the movement's ' dominant logic was that changing times demanded a new view of the world. The relevance of the Constitution had largely passed and those who still supported it were out of date. In order to adapt to the times, the scope of government needed to be broadened beyond the scope specified by the Founders. Progressivism was new and modern; allegiance to the Constitution was old and stuffy.

That marketing message persists to this day.

The fact is that the mechanism behind Progressivism--employing authoritarian government to coercively achieve some group's agenda--is as old as time. Indeed, authoritarian government has been the dominant design of civilized history.

The truly fresh idea is that of liberty and limited government. Individuals pursuing their destinies powered by their own free will. This design has been a rarity throughout civilized history, which has facilitated belief that governance structures grounded in liberty can not persist.

While it may not seem so to this generation of Americans, rest assured that when our country threw off its authoritarian shackles more than 200 yrs ago, the concept of freedom looked pretty radical to the rest of the world. Indeed, that was precisely the label slapped on early Americans: 'radicals,', 'revolutionaries.'

The Progressive movement is nothing new. It's merely a flavor of traditional authoritarian rule that pervades history.

Thursday, May 13, 2010

Oil Slick

Out where the river broke
The blood wood and the desert oak
Holden wrecks and boiling diesels
Steam in forty five degrees
--Midnight Oil

A couple wks back when crude really started streaming into the Gulf from the British Petroleum (BP) rig, I ran across a snippet claiming that the maximum non-cleanup liability for an oil spill had been set by the US government at $75 million. Surely this was a typo. Damages relating to an oil spill could easily mount into the $billions and will certainly do so in this instance.

But nope. In 1990 the Oil Pollution Act was passed which indeed limited corporate liability to $75 million.

In typical reactive fashion, bureaucrats are now scrambling to raise the limit. I've heard proposals for up to $10 billion in order to 'minimize taxpayer liability'--maybe even retroactive to the present spill.

Perhaps I'm missing something here, but why should there be a limit at all? If a corporation or any other entity violates the property rights of others, then they should be fully liable. If an operator wishes to buy insurance from a private carrier to lay off the risk to another private party, then that is permissible as long as the insurer is capitalized well enough to handle the claim--otherwise liability reverts back to the violator.

But government has no business granting put options that decrease risk for private entities and increase risk for public taxpayers. As in so many other realms, this does nothing but create condtions of moral hazard, where an entity is likely to take more risk because their actions have been insured.

The proper role of government is to enforce property rights to their fullest extent in an uninterested manner.

Ironically, by writing insurance policies in so many different contexts (e.g., banking, unemployment, healthcare, and in the present case environmental), government elevates the very risks that we want to minimize.

no positions

Wednesday, May 12, 2010

Lobby Lizard

So glad we've almost made it
So sad they had to fade it
Everybody wants to rule the world
--Tears for Fears

For the first time since its establishment in 1913, the Federal Reserve has hired a lobbyist. The objective of this lobbyist is to influence Congress to reject the 'audit the Fed' bill, thereby keeping the central bank shrouded in secrecy. It looks like the Fed is getting its money's worth as the Senate watered down the bill at the last minute.

One argument for limited government is that it is easier to monitor and understand--i.e., it is more 'transparent.'

Authoritarian regimes crave just the opposite. As demonstrated by these actions to suppress audits of the Fed, bureaucrats naturally seek opacity in their dealings to reduce accountability and to strip power from the people.

Rainy Day Feeling

Here comes the rain again
Falling on my head like a memory
Falling on my head like a new emotion

Commentary from Jim Rogers w.r.t. the EU bailout. The meat of the matter is around 2:20 in the interview, where he marvels that adults could really believe that more debt and spending can solve a debt and spending problem.

Amen brother.

It has often been said that future generations will be the ones on the hook for our foolishness. But as Jim notes near the end of the talk, the size of the problem now suggests that we'll paying in present time.

Also interesting to learn the he's been putting out shorts over the last month or so--for the first time in nearly two yrs.

position in SPX

Tuesday, May 11, 2010

The Heat is On

You can make a breath
You can win or lose
That's a chance you take when the heat's on you
And the heat is on
--Glenn Frye

One of the purported rationales behind the EU's bailout actions over the weekend was to defend the euro against 'speculators.'

Well, it took less than two trading days for the euro to fall back to pre-bailout levels. One way to read this is that a whole lotta euros will have to be printed in the bailout process.

Another interpretation is that the bailout effort will fall apart.

no positions

Three More

A thousand skeptic hands
Won't keep us from the things we plan
Unless we're clinging to the things we prize
--Howard Jones

My top personal financial goals this year included paying off the mortgage and increasing my gold holdings. On the gold front, I originally intended a 10-20% increase in bullion by weight. However, the crazy state of the world prompted me to increase my uptake. Thus far, I've increased my gold stock by over 50% and am anticipating more.

On the mortgage front, I've retired all but ~$20K of a $194.1K mortgage. Although gold purchases have resulted in larger cash draw down than originally planned, I'm hoping to snuff out the remaining mortage in three more payments.

God willing, I'll be debt free by the end of summer.

position in gold

Monday, May 10, 2010

Paper Late

It's too easy to talk about rocking the boat
Making changes and changing track
But you better not lock that door
'Cause you'll be coming back

I remember 9/19/2008 well. I recall the jovial happy b-day greeting sung by my mom and brother when I walked thru their door. It was grandparent's day at St Columban, and I proudly escorted Mom as my niece and nephew showed us their hallowed halls. We were still reeling from an inland hurricane the weekend before, and many homes were still without power.

It was also the day that the US government declared martial law on financial markets. Among other things, this entailed banning short sales on financial stocks--to curb the actions of 'speculators.' The Dow was at about 8000 at the time. After a voracious multi-day short covering rally that took the Dow to 9500ish, the selling returned with a vengeance. The Dow bottomed six months later at 6500 in the midst of an additional Shock and Awe campaign of stimulus.

This past weekend, the EU rolled out its own version of Shock and Awe in the form of a $1 trillion bailout package of Greece and other week EU members. Essentially, this involves Germany, France, and the IMF (read: the US) tossing in funds and printing money to prop up the debt of other EU members. The rhetoric included rationale aimed to curb 'speculators' against the euro and EU sovereign paper. Markets around the world are partying today, with world indices up anywhere from 4-12%.

Once again, the world is trying to paper over a debt problem w/ more debt.

Perhaps the end game is pushed out once more. But my sense is growing that the paper chase is getting long in the tooth.

position in SPX

Sunday, May 9, 2010

Circus Circus

"I don't want to do this anymore."
--Jason Bourne (The Bourne Identity)

The EU is organizing a 'stabilization fund' to defend the Euro against 'speculators.' The idea is to borrow money with loans 'guaranteed' by participating governments to buy Euros.

We've seen this movie before. British pound, Thai Baht, etc. Currencies get sold when the underlying fiat systems face intractable problems.

Borrowing more to defend the Euro compounds the fundamental debt problem. The correct solution to this situation involves implementing austerity measures (read: debt reduction and savings) to reverse the real problem.

While a 'Euro defense fund' action might motivate a temporary reprieve in Euro weakness, hard to see how this doesn't increase the chances of outright monetary failure for the bloc.

no positions

Saturday, May 8, 2010

Is This It?

But you don't understand my point of view
I suppose there's nothing I can do
--The Clash

It's hard not to wonder whether we're witnessing the end of the debt Ponzi. A couple years back the world began transferring private debt and leverage to an already overleveraged public sector. The private sector doesn't appear to want the debt back, as evidenced by Iceland and now Greece (and Spain, Ireland, Italy, et al). The State has no one to hand the debt to.

If this game's over, then can bureaucrats devise another one to extend the fantasy? The only one that comes to mind involves a printing press and a whole lot of confetti.

Gold may be sniffing this out.

position in gold

Friday, May 7, 2010

Regulation and Risk

"I know that vibration was not normal."
--Jack Godell (The China Syndrome)

Many fine pieces today on Minyanville discussing yesterday's intraday crash. After reading this one, it struck me that confidence in regulatory oversight induces widespread moral hazard which increases systemic risk. stated formally:

Proposition: The greater the market regulation and oversight, the higher the systemic risk.

Ponder the irony of that. The more we regulate markets, the greater the chance of a broad failure. To the extent that this proposition is true, then this situation has to rank up there w.r.t. the Law of Unintended Consequences.

This also has ramifications for models of regulatory failure or regulatory drift. Perhaps it's not a 'breakdown' of the regulatory system per se. Maybe the regulatory system merely becomes 'undersized' to handle the increased risk as moral hazard builds.

European Disunion

There's a room where the light won't find you
Holding hands while
The walls come tumbling down
When they do, we'll be right behind you
--Tears for Fears

Columbia professor Joseph Stiglitz is among the more vocal US economists with a socialist bent (I rank him up there with Paul Krugman of Harvard and Brad DeLong of Cal Berkeley). Stiglitz has long been an admirer of the 'social democracy' approach of Europe and, like many US 'intellectuals,' seems to think that we should move toward a similar model.

It appears that the problems now facing the European Union are even giving Dr Stiglitz cause for pause.

In past missives we've suggested the headwinds facing the EU. Expecting durable monetary and fiscal unity among sovereign nations with diverse needs and interests seems horribly flawed from the outset on a natural law basis. Blend in the underlying producitivity lowering and debt generating socialistic economic models of the sovereigns and you have a recipe for down-the-road fracture.

A decade or so later, it appears that we may be down the road.

Thursday, May 6, 2010


"The problem with manipulation is that people can turn on you."
--Horatio Caine (CSI Miami)

Today was a rare day, featuring an intraday 1000 pt move lower in the Dow. After leaking thru the morning and the early afternoon, US financial markets lost it. In the span of a few minutes the Dow went from -300 to -1000, bottoming near the early Feb lows of about 9800.

Those quick triggered folks who bought Spoos down there were soon rewarded, as markets soon rebounded back toward being down 'only' 3% or so.

Rumors are circulating that this was mostly anomoly. Theories include: a trader at Citi fat fingered a billion share trade rather than a million share trade; black boxes of high frequency traders went wild; those trading naked credit default swaps put things in motion. etc.

While I wouldn't rule out any of those, particularly as a potential contributor to exacerbating short term volatility, the bigger picture concerns the leveraged state of the world.

The nature of leverage is this. When things are perceived as fine, leverage tends to depress volatility because of all of the liquidity that narrows bid/ask spreads and keeps uptrends neatly in place. But when things are perceived as not fine, that liquidity leaves the system as folks seek to cover their leveraged bets, leaving 'bid wanted' types of situations.

I have little doubt that this accounted for much of the action. And as long as the world continues in its leveraged condition, behavior similar in nature if not magnitude should be expected.

Heck, it was the way of the world less than two years ago. And since then overall leverage is higher rather than lower thx to socialization of risk.

What happens in the near term is anyone's guess. It's admittedly hard for me not to feel bearish here; I'm having trouble shaking the down-up-DOWN patterns that characterized the 1987 and 1929 daily charts. At the same time, one can't dismissed the power of the press--the monetary printing press, that is--that major central banks have at their disposal. You can bet there will be some big conference calls tonite between the ECB/Greece bailout contingent and central banks around the world.

As it currently stands, I'd be inclined to view a lower opening tomorrow as bullish, and a higher open tomorrow as bearish--at least for a trade. In the intermediate/longer term, my sense is that the path of least resistance may now be lower.

btw, what was the port in the storm today? Gold. It was moving higher today against nearly everything. Perhaps more folks are connecting the dots--that the only way out of this debt problem is to print our way out. Which, of course, is not a real 'way out' at all.

position in SPX, gold

For the Duration

It was a shakedown cruise
I guess I just was born to lose
They tell you life is going cheap
I got myself in pretty deep
--Jay Ferguson

Seems to me that many folks don't understand the difference between printing 'paper money' and printing 'credit money.' Major inflationary events burned into people's heads involve the printing of paper money. The spectre of kids playing house with worthless Weimar marks, or the recent paper blizzard in Zimbabwe, seems to dominate current mindset.

In today's 'advanced' monetary monetary systems, however, money is created primarily in the form of credit. Central banks such as the Federal Reserve reduce borrowing costs in hopes that banks will pyramid credit money thru the system.

This adds, I think, a few counterintuitive dynamics to the system. One relates to the perverse behavior of interest rates during early periods of deflationary conditions. It goes something like this. People become risk averse in droves after a secular borrowing binge. Risk aversion leads to paying down debt and debt defaults. As debt-related projects are retired, folks pour into cash and short term fixed income because they are risk averse and trying to preserve capital. The Fed intervenes and drives interest rates to zero to encourage risk taking. As long as risk aversion has folks moving into fixed income as a 'flight to safety', then the Fed does not have to worry about market forces winning the upper hand and forcing interest rates higher. In fact, people will be willing to buy all the 0% yield paper offered by the Fed in return for the guarantee that it will be 'safe.' Therefore it can be posited that:

Proposition 1a: In early stages of deflationary periods, interest rates will decline and remain at low levels despite high levels of central bank stimulus.

Proposition 1b: In early stages of deflationary periods, demand will be high for near 0% yield paper that is 'guaranteed.'

These low interest rates facilitate government borrowing on the cheap for social programs to stem the pain from the deflationary decline (unemployment insurance, other safety nets). However, the government will be tempted to borrow at shorter durations, because short rates are subject to the greatest degree of central bank influence (longer term rates are subject to drift higher as some bond investor sense longer term inflationary consequences of all the stimulus). As government borrowing increases, a mismatch grows between the funds borrowed (e.g., at 0.1% for three month T-bills), and the obligations that they are supposed to fund (say, 12 months of unemployment payments or infrastructure projects with 5-10 yrs timelines). This creates a mismatch in duration--long term projects are being funded with short term debt.

Proposition 2a: Lower interest rates during deflationary periods, particularly on the short end of the yield curve, will drive governments to increase their borrowing for social programs.

Proposition 2b: Higher levels of government borrowing during deflationary periods will increase duration mismatch.

These actions could precipitate profound down-the-road consequences. For instance, what happens if/when market forces drive interest rates (a.k.a. borrowing costs) higher (kinda like what's happening in Greece now)?

position in SPX

Wednesday, May 5, 2010

Greece Fire

"You go. We go."
--Lt Steven McCaffrey (Backdraft)

Can't help but wonder whether Greece is a microcosm of things to come. A country that spent lavishly on gov't programs w/ no productivity to support it. Had to borrow to keep it going. Now there's no way to pay debt back. And people riot at the notion that their entitlements will be cut.

Of course, big diff between Greece and US is that we own the monetary printing press.

What we're seeing is market forces/natural law coming to bear on a centrally planned, socialist system.

Set of factors surrounding Greece mirror the general world situation.

Risk Shifting

Hands across the water
Heads across the sky
--Paul McCartney and Wings

Toddo considers the rising angst stemming from the Greece/EU situation.

One of the feathers in the bull's cap has been narrowing credit spreads, more specifically corporate credit spreads. But in a world where governments are socializing risk, isn't a reduction in the odds of business failure (which is what corporate credit spreads reflect) intuitive--at least in the near term?

The credit spreads that are rising are sovereign credit spreads. This should also be intuitive as governments assume more default risk.

Over the past couple of years, levels of debt and leverage haven't gone away. The risk has simply changed hands.

As the EU situation demonstrates, we're running out of hands.

Tuesday, May 4, 2010

Shake & Bake

Somethin's happenin' here
What it is ain't exactly clear
--Buffalo Springfield

When inter-day volatility rises following an uptrend period, something's usually up. That's what we've seen the last few days.

Increasing volume too.

Should this downside move get traction and slice thru the 50 day moving avg (blue line), then the intuitive next stop is the Jan highs of 1150ish.

position in SPX

Fiat Fraud

All that glitters is gold
Only shooting stars break the mold
--Smash Mouth

Market sage Dick Russell suggests that the primary thesis for gold is waning confidence in the 'greatest fraud ever perpetrated on the people of the world:' fiat money of all stripes. An argument (I think a good one) can be made against fiat money from a moral, ethical perspective, but these arguments ultimately rest on value judgements which are never decisive.

More decisive are economic arguments against fiat money because they are based on laws of nature and human behavior. The proof is in the pudding, of course, as we know that never in the history of the world has a fiat currency endured.

Consider Russell's example here. Cost of a one oz gold coin in 1970 = $35. Cost of a one oz gold coin in 2010 = nearly $1200. That's a 33x increase in forty yrs for those keeping score.

Some claim the gold market is bubbly. This graph compares gold to other mkts regarded as bubbles (missing here is the recent housing mkt).

The froth still seems a ways off.

position in gold

Monday, May 3, 2010

Buying Time

Confusion that never stops
Closing walls and ticking clocks

Opponents of free markets often claim that market participants are too short term oriented. Because they care about profits today, capitalists avoid, for example, investments in technologies that could benefit society down the road (e.g., alt energy). It is therefore necessary for government to intervene to provide longer term perspective.

This argument is ludicrous, of course. Capitalists, like all people, act in their own self interest (2.1 here). If it is perceived that long horizon investments have a suitable payoff, even if that payoff is years off, then chances are that such investments will be made.

The poster children for decision-making mypopia are politicians. Politicians, like all people, act in their own self-interest. In the case of politicians, however, the payback period for their actions is limited to their time in office. Moreover, the basis for their decisions is political calculation rather than economic calculation. The present election cycle constitutes their typical horizon.

An excellent example of the stunted political time horizon can be found in the past two yrs worth of stimulus programs. We've taken on a massive amount of incremental risk (more debt, inflation, etc) because politicians choose not to deal with problems today. This weekend's Greece bailout is merely the most recent example of pushing out the pain.

Buying time while creating ever greater risk is consummate short sightedness.

no positions

Carry Out

All the Japanese with their yen
The party boys call the Kremlin
The Chinese know (Oh-Ay-Oh)
They walk around like Egyptians

Marc Faber thinks chances of a dramatic slowdown in China, perhaps even a crash, are rising. We've been noodling such prospects for a while.

Faber joins hedgie Jim Chanos and prof Ken Rogoff among recent bears. Chanos in particular focuses on China's dependence of real estate, citing that as much as 60% of China GDP depends on construction.

Chinese stocks have been lagging other world markets recently. Whether this represents canary in the coal mine stuff remains to be seen.

no positions

Sunday, May 2, 2010

Goldman Walking

The heat is on
On the Street
Inside your head, on every beat
And the beat's alive
Deep inside
The pressure's high
Just to stay alive
'Cause the heat is on
--Glenn Fry

Wanted to share an excerpt from John Mauldin's letter this week re the Goldman Sachs (GS) roasting in DC. This letter also includes an important discussion of a recent Bank for International Settlements paper on public debt in select countries including the US, which we'll circle back to. A must read letter, imo.

I'm cutting and pasting here. Emphasis below is mine:

There Had to Be a Short

Somebody needs to brief Senators before they get on TV and ask irate questions which demonstrate they have no idea what they are talking about. Expressing shock that someone was short on the trade in question shows you don't understand the trade. Let me see if I can offer some clarity.

Normally, you think of a Collateralized Debt Obligation (CDO) as a pool of mortgages. This pool is broken into anywhere from 6 to 15 tranches. The highest-rated tranches get their money back first, and the rating agencies made them AAA. While the lowest level would be called the equity portion and be first in line to lose, in theory it paid a very high yield. It was usually not rated. But the level just above that is BBB (just barely investment-grade), and that was typically about 4% of the total deal, but paid a much higher yield than the "safe" AAA portion.

Now, here is where it gets interesting. Investment banks would take the BBB portions of these Residential Mortgage-Backed Securities, which were not as easy to sell, and combine them in a CDO, which the rating agencies then rated using models based on data provided by the investment banks themselves. Since this combining of BBB tranches supposedly created diversification that the rating firms' models indicated would drastically limit delinquencies and defaults, the AAA tranche of the CDO was jacked up to 75% of the total capital structure, with 12% rated AA. Only 4% was typically considered BBB. So pools of mortgages that probably should have been rated below BBB were miraculously turned into a CDO with 87% of its capital structure rated AAA and AA and only 4% rated BBB, with a chunk as equity. (I wrote about this in January of 2007, based on material from Gary Shilling and others, plus my own research, although I think I wrote about it in an earlier letter as well.)

Who would buy this stuff? Mostly institutions that were reaching for yield in what was, in 2007, a very low-yield world. Yield hogs. And institutions that trusted the rating agencies.

But the CDO in the Goldman case was not this type of CDO. It was hard to find enough BBB pieces to put together a CDO of the type described above, and the demand was high. Remember, everyone knew that housing could only go up. So, what's an investment bank to do? They create a synthetic CDO. Follow this closely. The various investment banks - it was way more than just Goldman; rumors are it was up to 16 of them - would construct an artificial CDO fund based on the performance of BBB tranches in other deals.

Let me see if I can simplify this. It is as if I had a very negative view about a particular industry for which there was no future or index or liquid security. We could go to an investment bank and ask them to create a "hypothetical" index that would mirror the performance of this industry. I would be willing to short that index. But unless the bank wanted to be long that index, they would have to find a buyer who would take the long position. Presumably the buyer would have a different view than me.

Now, by definition there has to be a short for the long, and vice versa. This is a synthetic index. It exists only as a spreadsheet and performs in conjunction with the components it's modeled upon.

Numerous hedge funds did not think the rating agencies knew what they were talking about when it came to the mortgage ratings. They also believed we were in a housing bubble. So they went to a number of investment banks and asked them to construct synthetic (derivative) CDOs that they could short. And there were buyers on the other side who wanted the yield, who trusted the agencies, and who believed that housing could only go up.

As to the Goldman deal, the buyers had to know there was someone short on the other side. By definition there was a short. Besides, they had a guarantee from ACA on the AAA portion (which of course went bad, as I wrote about later that year) - there was a guaranteed AAA yield a few points higher than with normal AAA debt. What could be better? Except of course that it was too good to be true. Learn a lesson, gentle reader. Don't reach for yield.

The hedge funds that shorted the synthetic CDOs took real risk. They had to pay the interest on the underlying tranches to the investors who were long. And if the housing market continued to rise, and the bubble did not burst, they could easily lose a lot, if not all, of their money. No one knows when a bubble will burst. The markets can be irrational longer than you can remain solvent.

Let's be very clear. This was purely gambling. No money was invested in mortgages or any productive enterprise. This was one group betting against another, and a LOT of these deals were done all over New York and London.

The SEC alleges that there was material lack of disclosure. I must admit that I would want to know that the person who was taking the short position had a hand in the creation of the pool of BBB paper I was buying. And if Fabrice Tourre told someone that Paulson was $200 million long when they were actually net short, that could be problematic. Now, if he just said that Paulson bought the equity portion of the synthetic CDO (there has to be one), that will be a different matter.

The prosecutor for the SEC is by all accounts a very solid and serious person who would not move this case forward if he did not think they would win. This is not one the SEC will want to lose. On the other hand, I hope that Goldman takes this to the Second Circuit Court of Appeals (the final decision maker in a long and arduous process), as there are some very interesting aspects to this case that I would like to see resolved, as an individual in the industry. On someone else's legal bill.

I wonder why Goldman's witnesses seemed ill-prepared. Did their lawyers tell them to keep it simple and not get into a spirited defense? My instinct says that a lot more will come out about this case. If it was just this one deal, then Goldman should pay the fine and walk away. Done all the time. I suspect there is more here. Or maybe it was just that they didn't want to explain why they were doing a synthetic CDO. We'll see when someone writes the book.

How Should Our Institutions Invest?

However, the larger and far more critical question is, why were institutions buying synthetic CDOs in the first place? This is an investment that had no productive capital at work and no remotely socially redeeming value. It did not go to fund mortgages or buy capital equipment or build malls or office buildings. It seems to me there is a certain social responsibility when you have institutional capital and manage pensions. It's one thing to buy a gambling stock; it's quite another to be the gambler, especially if it is not your capital at risk, and by being a yield hog you increase your bonuses. The hedge funds were risking their capital. The institutions were risking other people's money. And let's be clear, the counterparties in the Goldman deal, at least, were very knowledgeable players. They knew exactly what they were buying.
John's final paragraph asks a fine question: who are the real bad guys here? Hedgies risking their own capital betting on the housing bubble popping, or institutions (e.g., pension funds) risking other people's money reaching for yield with a bet for the housing bubble?
The sad thing to me is that, surely out of fear of reprisal, the GS folks have to refrain from lambasting the politicians for their idiocy--altho it would be a public service to do so.
Back about the time these synthetic CDOs were being created, about the only thing more certain than the housing bubble popping was bureaucrats slithering thru the rubble post-pop with the obligatory "We're SHOCKED and OUTRAGED!" tirades.
Justice would be more rightly served if it were the American people grilling the Hill.

no positions