Disconnect

Hungry to touch
I'm eager to please
Out of control
And I hand you the keys
--Rick Springfield

Nice graphic that complements our previous post.

When you bail out bad decisions, you get _____ of them.

a) more

b) less

Student Loan Forgiveness

"Somebody's got to pay. Not gonna be me."
--Harry Lynch (Wall Street)

Ron Paul discusses the administration's plan to forgive college student loan debt. The plan is an overt attempt to buy votes, of course. Who is being bought?

Indebted college students, naturally. Plus all those who benefit from government subsidies to higher ed.

The plan can be viewed as a wealth transfer to the elite class. The working man is being forced to subsidize the 'educated.'

Moreover, the plan is inflationary. Loans that are forgiven don't just disappear. The liability must still be paid for. The money that can't be raised through taxes or borrowing will be...printed.

One more thing. Those who have actually paid for college now feel like suckers. In the future, more will borrow under the assumption that they won't have to pay.

Moral hazard writ large.

Undercover Hero?

My beacon's been moved
Under moon and star
Where am I to go
Now that I've gone too far?
--Golden Earring

I enjoy reading Tom Luongo's work. Thought provoking--even when his general premise is wrongheaded. 

In this recent piece, for example, Luongo gives the Fed entirely too much credit, arguing that the central bank is essentially the 'good guy'--battling inflation wrought by irresponsible fiscal policies that sent money to people in boxes during CV19. 

He fails to mention the Fed's long history of bailing out markets (and policymakers) when markets break, or of the central bank's $9 trillion of balance sheet assets purchased with money created at the click of a mouse. Because, as Friedman observed, inflation is always a creature of monetary policy, arguing that the Fed is somehow not the Dr Frankenstein that created our present monster seems a bit naive.

However, Luongo does make an interesting point toward the end of his article. He notes (correctly) that the Davos/World Economic Forum crowd would like to put an end to commercial banking, and put all monetary power in the hands of central banks--perhaps even in a one world central bank with digital currency-producing capacity.

He then suggests that, in the United States (and perhaps elsewhere), the Fed represents the interests of those commercial banks. As such, the Fed is motivated to break the EU-centric Davos/WEF threat to US commercial banks by raising rates, pounding the euro, and perhaps even driving the EU toward dissolution.

There's lots of holes in that argument--including the Fed's 'institutional obligations' both domestic and abroad--but interesting to ponder the 'undercover hero' thesis nonetheless.

How Low is High?

And there's some
Chance we could fail
But the last time
Someone's always there for bail
--Toad the Wet Sprocket

What is the max that the Fed can push its Fed funds rate before it stops? Judging from the downtrend line defined by previous cycle highs in the graph below, the ceiling appears to be about 1.5%.

Much lower, as we've said, than market participants seem to be forecasting.

Cornered

There's a storm on the loose

Sirens in my head

Wrapped up in silend

All circuits are dead
--Golden Earring

In addition to providing more perspective on the Fed's dilemma (recently discussed on these pages here, here), this article includes some nice historical perspective on the Fed's approach to managing its monetary policy cycles. The Fed responds to crises by easing rates. Once trouble has passed, the Fed begins to raise rates. 

But because the easing phases invites more risk taking (and leverage), new troubles arise as rates go higher. Consequently, the Fed begins easing again. 

The important thing to understand is that the tightening phase generally does not return rates to their previous levels, resulting in a downward sloping long term trend as denoted by the red dotted line.

It should not be surprising that the secular downtrend in rates has been accompanied by higher asset prices. The graph below shows how the SPX has responded.

This is how the Fed has cornered itself. By failing to raise rates back to previous levels at the end of a monetary policy cycle, it has invited massive risk taking in financial assets. Nearly 40 years of this behavior has hyper financialized the system.

Now, with rates near zero, along with $trillions of balance sheet assets (also known as monetization) to keep the wheels on the wagon with rates at the 'zero bound' for the past decade+, the Fed will find it difficult to engage in any substantial tightening of monetary policy (necessary to fight inflation) without tanking financial markets.

Inflation or asset prices? The answer seems obvious.

Mandated Arguments

Tell me your troubles and doubts
Giving me everything inside and out
--Simple Minds

Arguments for vaccine mandates usually assume at least one of the following positions.

Best way out. Vaccinating is the best scientifically-known way to end a pandemic. Therefore, everyone must be vaccinated.

Menace to society. Unvaccinated individuals can infect others. Because they put other people at risk, unvaccinated people are a danger to society--perhaps criminally so. 

Resource hog. If an unvaccinated person gets infected and requires hospitalization, then that person is tying up scarce resources that other people would have available to them in the event that they fall ill. When hospitals are near capacity, deserving people may have to be turned away because of the imprudent choices of others.

Freedom robbers. Unvaccinated people rob freedom from others. People cannot live freely if they feel threatened by the behavior of unvaccinated individuals.

We'll discuss these arguments in future posts.

FDA Approved

I close my eyes
Oh God I think I'm falling
Out of the sky, eye close my eyes
Heaven help me
--Madonna

Approximately six months after operating under 'emergency use authorization' as an experimental drug ok for public distribution, Pfizer's (PFE) mRNA vaccine has been 'fully' approved by the FDA. The approval follows no where near the customary battery of evaluations required before agency approval.

Many folks seem to think that slapping an 'FDA Approved' sticker on the vaccine will reduce resistance or uncertainty among the skeptical. The truth, of course, is that we know no more about the efficacy and safety of this drug now than we did pre-approval. 

In reality, the hope is that 'FDA Approved' creates more blind trust in the 'experts.'

'FDA Approved' medications have killed lots of people in the past. How many of those deaths resulted from blind trust in the 'FDA Approved' endorsement may be unknowable.

Pray that blind trust in this FDA approval does not kill scores more in upcoming months and years.

no position

Paid Leisure

All I wanna do is have some fun
I got a feeling I'm not the only one
--Sheryl Crow

Several surveys suggest 1-2 million people are abstaining from work because they have been getting the extended and expanded CV19 unemployment checks.

Why should this be surprising?

People generally prefer leisure to work. If government is willing to pay people not to work, and compensation offers a subsistence deemed acceptable, then expect long lines at the unemployment benefits window--particularly for low-skilled workers.

When unproductive behavior is subsidized, you'll get more of it.

Heating Up

You can make or break
You can win or lose
That's a chance you take
When the heat's on you
And the heat is on
--Glenn Frey

The May consumer price number printed at a 5% year over year rate of increase. That's the fastest annual growth in prices since 2008.

Glass half full folks contend that this is just a transitory situation, reflecting an economy on a post CV19 rebound. One problem with this claim is that policymakers have signaled that they don't intend to reverse the trillion$ of stimulus meant to motivate the recovery. 

With millions of people out of work and sitting on their couches subsidized by money printed out of thin air by Uncle Sam, spreading enough new incremental output to sop up all those new dollars that policymakers plan to keep in the system seems a tall order.

Here's what I mean. Suppose in Period 1 there are 5 million dollars in circulation and 1 million units of production for consumer to buy. The average price = $5 million/1 million units = $5 per unit.

Now, suppose in Period 2, money in circulation increases to $10 million and production expands to 1.5 million units. The average price = $10 million/1.5 million units = $6.67 per unit.

The 'consumer price index' in this case increases by (6.67 - 5) * 100 = 33% from Period 1 to Period 2.

When the production of goods does not keep up with increases in money supply, prices heat up.

And the heat is on.

Silence Still

Hello darkness my old friend
I've come to talk with you again
--Simon & Garfunkel

The seasonal flu has historically killed tens of thousands annually in the US. Yet, no draconian measures have been taken to 'stop the spread' of seasonal flu and reduce the number of deaths.

CV19 has killed more people over the past year, although nowhere near the reported numbers. Draconian measures have been enacted to 'stop the spread' and reduce the number of deaths, with no conclusive evidence of their effectiveness. Meanwhile, the economic costs alone of these interventions number in the trillions of dollars.

Reasoning minds remain disturbed by the incoherence and inconsistency.

Why has it been ok to intervene in the case of CV19 but not with past years seasonal flu? The answer cannot simply be because CV19 is more lethal. At what level of lethality is intervention justified? Why?

Moreover, the economic and social consequences of lockdowns and other interventionary measures surely include hardship and death. 

How is it reasonable to kill others to save lives?

It's been a year and the questions remain unanswered. The silence is deafening. 

Public Mindlessness

Now did you read the news today?
They say the danger's gone away
But I can see the fire's still alight
Burning into the night
--Genesis

One month later and Ten Year rates still climbing. Why no allergic reaction in markets yet?

I suspect that market participants collectively believe that the Fed will not allow rates to continue to rise. They think the Fed heads will initiate yield curve control or some other monetization measure to buy down rates.

Has American belief in central planning ever been this high? In all policymaking areas. Monetary. Fiscal. Health. Perhaps only during the Great Depression has confidence in bureaucratic prowess matched current levels.

Theory and history suggest that the public mind is in for a big let down.

COVID Relief and Moral Hazard

"You're getting a free ride on my tail, mate."
--Sir Lawrence Wildman (Wall Street)

In case you've heard the term 'moral hazard' before but are fuzzy on what it means, the recently passed $1.9 trillion 'COVID relief'' bill provides a textbook example. Several states were prudent in their virus countermeasures--no lockdowns, limited restrictions on movement, etc. As a result, their economies remained just as healthy as their people.

Many states did just the opposite--draconian countermeasures that cratered their economies and tossed millions out of work.

Facing depressionary conditions, those states that implemented totalitarian policies are now looking to the prudent states for a bailout. Those states with vibrant economies are being forced to surrender production to those states that chose not to produce.

Bad behavior is being subsidized. Precisely as predicted.

This is the essence of moral hazard. Taking more risk than you otherwise would because you believe that you ill-advised behavior is insured.

Why This and Not That?

It's poetry in motion
She turned her tender eyes to me
As deep as any ocean
As sweet as any harmony
--Thomas Dolby

In an age where work is increasingly specialized and societies are increasingly politicized, people have been conned into thinking that they must leave scientific thinking to so-called experts. Of course, those heavily credentialed 'scientists' are subject to political influence--and are often retained by political factions who benefit from a particular 'scientific' viewpoint.

The simple truth is that anyone can think scientifically. At its core, scientific thought is reasoned thought. Reasoning requires considering alternative explanations of a phenomenon (sometimes referred to in scientific circles as 'propositions' or 'hypotheses'), and then selecting the one that makes the most sense. Selecting the most sensible alternative is done by using a combination of logic, previous theory, and empirical evidence.

Consider, for example, the well-publicized proposition that face masks help 'stop the spread' of viruses COVID-19. Proponents of this proposition claim that it is grounded in 'science.' However, instead of presenting the various arguments in favor of and against masks, and why their arguments are superior, mask proponents merely defer to the recommendations of the so-called 'scientific community' in this regard. 

This blind deferral makes any reasoning mind suspicious. 

A truly scientific explanation considers the various theories of masking and outcomes. The prevailing theory in favor of masks is some variation of: face masks filter out virus particles in inbound and outbound airflow, thus reducing viral transmission. Let's call this hypothesis H0.

But what are some plausible rival theories? Let's list a few, primarily grounded in filtration theory when applied to masking:

H1: CV19-laden particles are too small to be effectively filtered by face mask substrates.

H2: Inbound and outbound air escapes between the mask and the face allowing virus-laden particulates to circumvent the filtration process.

H3: Covering the nose and mouth with a filter obstructs normal respiration (e.g., reduced oxygen intake, increased CO2 in local air mixtures, and breathing contaminants lodged in dirty masks), which can lead to health risks more significant than the risk of the virus itself.

The duty of true 'science' is to evaluate all plausible rival hypotheses in search of truth. If H0 is to be true, then the scientific mind not only has to explain the validity of H0, but also why H1, H2, and H3 are not valid.

It should be noted that plucking one published research study out of the literature that supports H0 does not necessarily suffice--particularly if there are other studies available that favor H1, H2, or H3. 

To the reasoning mind, science is rarely if ever settled. True science is obligated to consider what else could it be? Why this and not that?

Wear Mask, Get Virus

Soldier in gas mask: Are you ok, sir?
Roy Neary: Yeah, I'm fine. And the only gas around here is from you guys farting around!
--Close Encounters of the Third Kind

Study recently posted on CDC site reports that masks are not effective at preventing positive CV19 cases, even among those who consistently wear masks. The July study conducted in the US compared the reported habits of 154 patients who tested positive for CV19 to a control group of 160 non CV19 patients from the same health care facility.

Over 70% of the case patients tested positive despite reporting that they 'always' wore a mask in public. About the same percentage of control patients also reports that they always wore a mask in public.

An additional 14% of CV19 positive patients reported that they 'often' wore a mask in public, implying that about 85% of positive case patients wore masks all or most of the time.

Only 4% of the case positive patients reported that they 'never' wore a mask. As shown in the table above, the p-value associated with the difference in reported face mask use between CV positive patients and control group is insignificant (p = 0.86).

Relatively small sample at a single facility to be sure, but another brick in the wall of evidence against mask efficacy.

Unfortunately, most who favor superstition over science certainly will.

Subsidizing Lockdowns

Jacob Moore: You know what moral hazard is, Ma? You know what that means?
Sylvia Moore: No.
Jacob Moore: It means that once you get bailed out, what's to stop you from taking another shot.
--Wall Street: Money Never Sleeps

Why would so many blue states and localities push for long term lockdowns when these measures would surely crush their main stream of resources: tax revenues? The answer seems obvious. They calculate that their behavior will be subsidized.

And now House Democrats are trying to make it happen.

Textbook moral hazard.

Disengaged and Indifferent

Charlotte Selton: You have done nothing for which you should be ashamed.
Benjamin Martin: I have done nothing. And for that I am ashamed.
--The Patriot

Thomas Massie with some back-of-the-envelope math on the cost that the multi-trillion dollar stimulus plan will levy on US citizens. The longer the economic lock-down drags on, the larger the costs of a collective bailout will be.

$2 trillion (Congress)
+$4 trillion (Fed & Treasury)
———————————
$6 trillion stimulus

$6 trillion divided by 350 million citizens = $17,000 per citizen

times a family of 4

=$68,000 per family of new national debt and dollar devaluation in this stimulus.

not a good deal

— Thomas Massie (@RepThomasMassie) March 26, 2020

But does the average citizen care anymore? Perhaps they have come to expect government to have their backs whenever times get tough. Or maybe the numbers have just gotten so large that people figure there's nothing they can do. Just go with it...

Prospects of losing ever more liberty seems to find many people disengaged and indifferent.

Unlimited QE

"Those are not Mulligan's mortars anymore. Those are German eighty-eights!"
--Little Joe (Kelly's Heroes)

With bonds tanking and credit spreads blowing out, the Fed has announced several new programs with alphabet soup titles reminiscent of 2008 aimed at 'supporting the economy.' These programs amount to unlimited QE with the twist that corporate bonds, including bond ETFs, are fair game this time around.

This is monetization of debt like we have never seen before.

Inquiring minds wonder when the scope of Fed buys will be extended to stocks.

Holding the Gains

Just hold on loosely
And don't let go
If you cling too tightly
You're gonna lose control
--38 Special

After yesterday's historic day that saw the Dow down about 1800 pts and oil down 25%, chatter of monetary and fiscal bail outs (naturally) got loud. President Trump did not disappoint. In an evening press conference he sought to soothe market nerves with specters of tax roll backs and other stimuli.

Those positive presidential vibes, coupled with extremely oversold near term conditions, ignited big rallies overnight and we woke up to domestic futes gapping higher 3-4%.

Some of the initial bloom has come off the rose, however, as indexes are significantly off their highs. Purists might argue that a more bullish set-up would have been a whoosh lower pre-market to strike more fear into investors before a tradeable bottom was put in.

Now it seems imperative that bulls hold their gains here. If markets should happen to reverse lower intraday, then the bears will be surely be emboldened.

Lagged Effects and Uncertainty

"Why can't they invent a shot that keeps time from passing?"
--Jory Emhoff (Contagion)

The CoronaVirus situation presents good examples of lagged effects. It takes at least 10 days, perhaps longer, to diagnose someone with the virus. That means that infected individuals can unknowingly spread the illness for days before exposure is quarantined.

Similarly, the economic consequences of the virus are also lagged. Chinese suppliers are situated at the upstream end of many global supply chains. Many of these suppliers have severely curtailed operations in order to prevent local contagion to the virus. Reports are now surfacing that many container ships moving Chinese-produced goods are either a) sailing from ports with loads far below capacity or b) not leaving port at all.

Because it takes at least a month for many upstream shipments from China to make their way to downstream US retailers, the material consequences of these disruptions won't be visible for several weeks here in the states. Meanwhile, the time lags involved add uncertainty that make ultimate outcomes more difficult to forecast.

I wonder whether market discounting mechanisms that have been mucked up with so much easy money will be able to cut thru the fog of uncertainty and accurately foresee the lagged effects in this case.

Underfunded Pensions and Systemic Risk

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

Managing a pension fund is similar to saving for retirement. Just like each of us needs to determine how much money to set aside for when we're no longer working, pension fund managers must determine how much to set aside for all of those payments to retirees down the road.

Naturally, when you put money into a retirement account, you're unlikely to let it sit there idle. You'll try to grow those funds through investment vehicles like stocks, bonds, etc. It follows, then, that determining how much to contribute to your retirement account is influenced by the return that you expect on your investments in the account.

The basic rule is this: The higher the expected return on investment, the less you have to set aside in order to achieve your retirement goals. A simple example helps demonstrate. Suppose that you'd like to have a million dollars available to fund your retirement beginning 40 years from now. If you expected no return on your savings, then you would need to set aside $25,000 for each of the next forty years to obtain $1 million. However, if you're able to realize annual growth of 7% on retirement fund investments, then you would only need to contribute about $5,000 annually to meet the $1 million goal in forty years.

Pension managers go through a similar process. When many pension funds were created in the 20th century, returns on investment portfolios consistently averaged 8-12% annually. Pension managers began to bake those return assumptions into their decision-making processes for determining how much new money to put into the pot. Because they assumed 8-12% returns in the future, pension managers contributed less new funds than they would have added in anticipation of lower return scenarios.

Then the unexpected happened. Realized returns on pension fund investments began dropping. Interest rates on long term government bonds fell into a secular decline. Because pension funds traditionally over-weighted their asset allocations toward fixed income instruments, as bond yields fell, so did portfolio yields and annual returns.

In an effort to win back some of the returns lost in fixed income, pension fund managers shifted asset allocations toward more stock exposure. Stocks, of course, are generally riskier, and, under normal conditions, throw off less income, than bonds. Moreover, because every time stock markets take a dive, funds with large equity exposure lose a big chunk of value, funds carrying significant stock exposure are more subject to capital loss.

The last 30 years have seen a steady decline in pension fund investment returns. Today's returns are far lower than the assumptions used by pension managers years ago when they were determining how much new cash to sink into theirs funds to cover future payouts to pensioners.

What that means is that many pension funds today are chronically underfunded. Investment returns are lower than expected, and not enough new cash has been injected into pension funds to make up for the shortfall. This is similar to individuals who did not contribute enough to their retirement nest eggs over the years because they assumed that the returns on their investment positions would be higher than they turned out to be.

How to deal with underfunded pension situations? Ideally, pension fund sponsors would simply raise a bunch of cash and dump it into the fund the plan adequately. But think about it. If you as an individual have not saved enough for retirement over the course of many years, then how realistic is it for you to make up the difference when you are older? Many organizations with pension obligations face a similar problem. They simply don't have the resources to allow them to make up ground lost from years of chronic underfunding.

To reduce some future liabilities, some pension plans are offering lump sum buyouts to prospective pensioners. By dangling one time cash payments in front of some participants in exchange for them agreeing to exit the plan, pension managers hope that many of these people, using 'a bird in the hand is worth two in the bush' line of thinking, take the money and run. The managers' hope is that, by buying some participants out of the plan, the monetary resources remaining will be more capable of fulfilling monthly payment obligations to pensioners still in the plan. At best, however, buyouts more likely offer a way to reduce the degree of underfunding rather than to eliminate it.

Another option is for pension plans to default on their future obligations. Cease payments to pensioners. Or pay only a fraction of what was initially promised. Some of this is already occurring in chronically underfunded pension plans in the public sector involving teachers and government workers.

In the private sector, most corporate pensions are insured by the Pension Benefit Guaranty Company. The PBGC is a federally chartered corporation designed to take over private sector pension plans that go bust and cover monthly payouts to pensioners up to a certain amount. Unfortunately, the PBGC itself is thinly capitalized, meaning that it would not take many pensions defaulting at the same time to bankrupt the insurer.

It is here, I think, where serious risk lurks. A pension insurer that is essentially an agency of the federal government carries an implicit promise that the government will make pensioners whole--even in the event of a systemic crack-up that drains the PBGC's capital reserves. With so many pensions so chronically underfunded, the chances of such a systemic event cannot be ignored.

Where would the federal government get the resources to make pensioners whole? Taxing and/or borrowing are possibilities but politically unpopular. Federal tax rates are near the upper bound of political expedience, and federal debt levels are at $23 trillion and growing by the minute.

More likely is that the federal government would opt to monetize (i.e., print money) to pay pensioners. Send pensioners monthly checks for monetary sums created at the click of a mouse. Such a policy would create a form of 'helicopter money' infamously suggested by former Fed chair Ben Bernanke.

The inflationary implications of such a bail out policy are obvious. Specifically for pensioners, these people would be getting the nominal monthly paychecks originally promised them, but each dollar paid would be worth less due to the increasing supply of dollars in the system. The effect, from a purchasing power standpoint, would be as if the original pension plan defaulted on a fraction of the original promised payments. The systemic consequences could be far worse. As history indicates, once inflation toothpaste is out of the tube, it is difficult to put back in.

The bottom line is this. If you believe that pensions are chronically underfunded, then there is a significant likelihood that pensioners will not receive anything close to their promised monthly payments in real purchasing power terms. Inflationary bailouts designed to make pensioners whole are likely to do anything but.