See the Signs

Life is demanding
Without understanding
--Ace of Base

Article lays out five signs of recession currently flashing red:

1) Declining monetary base. As quantitative tightening proceeds, money supply should drop even more.

2) Inverted yield curve. Inverted yield curves are leading indicators of economic problems, and have preceded every recession for decades.

3) Tighter lending standards. Economic slowdowns increase risk aversion. Banks tighten credit standards to avoid losses during recessions. We're approaching tightness associated with past recessions.

4) Falling housing market prices. Mortgage rates have more than doubled over the past year. As prices and borrowing costs go up, demand for houses has gone down. Inventory is now above 10 months of supply--a threshold that has consistently been associated with past recessions.

5) Declining manufacturing and trade sales. Sales are down over one percent YOY. Declines below zero have coincided with every recession since the 1970s.

These indicators suggest that a recession is not imminent. Rather, it is likely already here.

Crack-Up Boom

"It's just money. It's made up--pieces of paper with pictures on it so we don't have to kill each other just to get something to eat."
--John Tuld (Margin Call)

Ludwig von Mises coined (!) the term 'crack up boom' to refer to people swapping out of money and into real goods out of fear that purchasing power was being destroyed by ever increasing monetary creation--either through expansion of bank credit or through monetization of debt. 

As supply of money ever increases, demand for money (i.e., desire to hold cash rather than spend it) collapses. People buy stuff even if they don't need it because anything tangible is better than holding cash which is deemed worthless.

Mises witnessed this phenomenon first-hand during the marquee hyperinflation of the 20th century in 1920s Weimar Germany. He saw children playing house with piles of worthless currency, and men pushing around infamous 'wheelbarrow wallets.'

Ron Paul wonders whether we're on the verge of another crack-up boom. Trillion$ in new money have been created with no end in sight. Inflation measures are printing multi-decade highs. Asset prices have followed suit.

He thinks that re-kindling the spirit of liberty would stop progress of a crack-up boom. Why? Because liberty-minded people do not tolerate massive government spending nor central bank intervention in financial (and social) affairs).

That's a worthy cause to pursue.

Bass Fishing

The trees are drawing me near
I need to find out why
Those gentle voices I hear
Explain it all with a sigh
--Moody Blues

Always interesting to hear what Kyle Bass has to say. Some points from this recent interview.

Fed monetization of debt will result in inflation. 

The 'official' numbers grossly understate the extent to which purchasing power is declining. He provides an example of the average car 30 yrs ago which cost $13,000 then marked at less than $15,000 in the inflation basket today--even though the average price of a new car is about $40,000. How can this be? The trick of hedonic adjustments. Even though a new car buyer's bank account goes down by $40K, the CPI number account for only a fraction of the actual price.

The Fed will be unable to taper much. Short rates higher than 1% would break the system. This means more monetization (inflation) pending in attempts to keep the wheels on the wagon.

The field position of government and central banks makes it unlikely that they will be able to intervene as Paul Volcker did in the late 70s/early 80s to 'break the back' of big inflation. Radically raising interest rates (and therefore borrowing costs) to curb inflation today would bankrupt the federal government (debt payments skyrocket) in addition to rendering leveraged entities across the globe insolvent.

He's not a Bitcoin/crypto fan.

Instead, he especially likes the prospects of rural real estate, particularly as populations migrate to states such as Texas, Tennessee, and Florida that are positioning themselves as business and consumer friendly with less regulatory burden. He likes land as a 'hard asset' play better than gold due to real estate's functionality.

Lots of discussion about China. Bass has been outspoken on what he feels is China's irresponsible, aggressive agenda. He believes that the country's move toward a national digital currency bodes poorly for global trading partners. He thinks the US should outlaw trading in it. He also believes that Taiwan faces imminent threat, and that markets have not seriously discounted the possible of Taiwan asset appropriation by the Chinese (e.g., TSM). Suggests strategic supply chain risk as well.

He thinks that the Chinese real estate problem will remain largely contained to the mainland, and that the PBOC will print yuan to keep the local economy afloat. He did NOT discuss what that money printing might mean to the global system.

Bass believes that fiduciaries should be fired if they buy Chinese stocks for their clients--due to their unaudited, manipulated nature.

Although he admits that he is a 'tree hugger' and believes in global warming, Bass thinks that under-investment in hydrocarbons over the past few years (due to widespread virtue signaling behavior) may take oil and gas prices to levels that we've never seen--particularly if we have a cold winter. The transition to cleaner energy will take decades and requires a far more measured approach than climate change zealots have been pushing. 

Stock may be the best tool for average investors trying to weather inflationary periods. Bass's work suggest stocks keep up with about 85% of general price increases. Investors will still lose, but stocks mitigate the losses.

position in gold

Homesteading

"Do you mean to tell me, Katie Scarlett O'Hara, that Tara, that land, doesn't mean anything to you? Why, land is the only thing in the world worth working for. Worth fighting for. Worth dying for. Because it's the only thing that lasts."
--Gerald O'Hara (Gone With the Wind)

Today, if you want to own some land, then you generally have to buy it from someone who already owns it. But how did it work back in the day when land was not yet owned? Could you be like Christopher Columbus and just claim it? Finders, keepers?

That's often how it starts--claiming ownership of large tracts of land in your own name or in the name of someone else if you're that someone else's agent.

But claiming ownership by fiat is difficult to sustain for long periods of time. You have to defend the land against intruders. You have to maintain it. Most importantly, you'll likely want to elevate your standard of living by production on that land. 

You'll need guards, workers. You'll need tools and other resources. How to fund it? You'll probably have to peel off property to fund your interests. Those who receive land in payment have similar goals and needs. They undertake a similar process.

It may take a bit of time, buy hopefully you see where this leads. Gradually, apportionment of land approximates the ability to use it productively. Owners with too much unproductive land have to surrender some until they reach a scale that they can manage efficiently. The allures of specialization and trade drives even finer apportionment.

This early process is called homesteading. Land is apportioned according to productive capacity of the owners.

After the primary markets of homesteading wane, land begins to trade in secondary markets (like today).

However, in unhampered markets, the relationship between productivity and land ownership remains. The amount of real estate owned tends to be proportional to the owner's productivity.

Out of Place

"Some of your fingers are out of place. I have to push them back. If I don't do this, there's a chance you may never use them again."
--Arthur Castus (King Arthur)

Which one of these pictures is out of place?

1. S&P 500, Dow, Nasdaq: All-Time High
2. Home Prices: All-Time High
3. Expansion: longest in history (126 months)
4. Unemployment: 50-yr low (3.5%)
5. Job growth: longest in history (111 months)
6. Fed: expected to cut rates for 4th time in '20, growing balance sheet $100 bil/mo pic.twitter.com/Pc5lKL12zY

— Charlie Bilello (@charliebilello) January 18, 2020

Radical monetary policy is supposed to be reserved for bad times, not good.

Earnings and Stock Returns

I walk along the city streets
You used to walk along with me
And every step I take reminds me
Of just how we used to be
--Naked Eyes

Simple but interesting scatter plot of sector earnings growth over the past decade vs sector returns over the same period.

Strong correlation between earnings & returns by sector@biancoresearch pic.twitter.com/N2CdSElBpr

— Liz Ann Sonders (@LizAnnSonders) January 8, 2020

Pretty good R-squared associated with this relationship, me thinks.

Note lagging performance of energy. My sense is that low valuation placed on this sector as a result of this historical performance offers opportunity going forward.

New Year's AA

Sometimes you picture me
I'm walking too far ahead
You're calling to me
I can't hear what you've said
Then you say, "go slow"
And I fall behind
The second hand unwinds
--Cyndi Lauper

Every now and then I like to estimate my asset allocation (AA) across all financial accounts. Helps keep me aware of where I stand.  Here's my current AA as we usher in the new year:

Equities   40.3%
Fixed income   1.0%
Cash   48.0%
Alternative assets   10.7%

Note that this breakdown is for securitized (i.e., paper) assets only. It does not factor in physical assets such as my house.

Fixed income portion would be higher if my work 401(k) would make certificates of deposit (CDs) available. Instead, I have to settle for money market funds that currently yield close to CD rates (although they do not provide FDIC protection). If CD's were available in the 401(k) account then I would be targeting an asset allocation of ~ 40 equities/30 fixed income/20 cash /10 alt assets.

Top stock holdings include D, INTC, JNJ, MRK, PAAS, WFC, XOM. Alternative assets consist largely of closed end gold and silver funds CEF and PHYS.

Asset allocation should evolve this year as funds from pension fund buyout are allocated primarily toward dividend paying stocks and precious metal proxies.

Repo Madness

All our times have come
Here but now they're gone
--Blue Oyster Cult

As we've noted, the Fed has embarked on another monetization program. A primary focus of this intervention is the repo market, where short term financing rates have skyrocketed over the past few weeks, surpassing highs during last decade's credit market freeze.

We've written about repos before, and speculated that they could potentially lie at the epicenter of the next financial system meltdown (here, here, here).

The question, however, is why now? What is causing the repo market to crack at this moment?

The regulatory backdrop has been ripe for some time. Post-crises revisions to banking regulations have forced banks to set aside more than $1 trillion in reserves. Repo rates are rising in part not because of a scarcity of cash in the banking system, but because that cash cannot be used to fund repo loans. Regulations are also constraining the return creditors can realize on large lending positions in short term money markets.

The Fed's sell down of QE program assets has exacerbated the stress. Until the Fed (predictably) suspended its QE unwind a couple months back, it was draining tens of billion$ monthly from the system as it sold back the bonds that it had previously purchased during QE (with money created out of thin air, of course). Those sell backs took cash off the repo market, perhaps to a tipping point. Now, the Fed's recent monetization program is once again sending cash (created out of thin air) in exchange for bonds (as shown above).

Peter Schiff adds that ever more federal debt coupled with shorter maturities on that debt means that record levels of debt need to be financed daily. Banks have dutifully bought those bonds--as they in part are required to do by recapitalization laws put in place since 2008. Once again, this leaves less cash available to fund repos.

Perhaps it has just been the confluence of these factors that have cracked the repo market, although I can't help but think that something more acute is pushing this situation overboard. We'll likely know soon enough.

Also not hard to think back to the early days of the credit collapse. Early tremors (e.g., New Century Financial) before the dominos starting hitting each other in the mortgage markets. Is the repo market an early tremor this time around?

Fortune Teller

No more broken hearts
We're better off apart
Let's give it a try
Tell me, tell me, tell me lies
--Fleetwood Mac

In summer 2007 I was in NYC helping a friend with his fledgling business. You could feel early tremors of the pending credit crisis. Dining at BLT Steak one night with several friends, I noticed the grim look on many money managers' faces after a particularly ugly day on Wall Street. Those steaks were becoming much easier to stomach than those market downdrafts and those $1000 dinner tabs.

After dinner, my buddies decided to hit the club scene while I elected to walk back to my apartment on a warm evening in the city. A couple of things stood out during that stroll. Lots of boom cranes lifting new residential high rises out of the ground. Also, lots of For Sale and For Rent signs in existing units.

I bring this up because high end NYC real estate is softening anew. Large fractions of new units remain on the market and prices are softening. More capacity is pending.

An noteworthy tell prior to the last credit market meltdown may be telling us something again.

Banking and the Business Cycle

"Never had my house pushed over before. Never had my family stuck out on the road. Never had to lose everything I had in life."
--Ma Joad (The Grapes of Wrath)

Ten years ago I began a book about the causes of the Great Depression called Banking and the Business Cycle (Phillips, McManus & Nelson, 1937). With my renewed reading campaign about the 1920s and 1930s this summer, I recently finished this insightful work.

The backdrop is compelling for several reasons. The authors are three professors who conduct their analysis with requisite academic rigor. Footnotes and data abound. The analysis focuses on monetary-related causes of depression. Findings are integrated to formulate a general theory of business cycles that goes beyond the Depressionary period. Finally, the book was written while the Depression was still at work. Similar to the recently completed Allen (1931) work, publication inside the period adds freshness and validity that later work can't replicate.

Their analysis points directly at that policies of the Federal Reserve--policies enacted during WWI and in the following decade--as causing the depth and length of economic malaise that characterized the Depression. The Federal Reserve Act was passed in 1913, a couple of years before WWI began. Relaxed parameters of the newly created central banking system (e.g., lower reserve ratios, member banks needed to deposit all reserves with Federal banks, low Federal Reserve bank reserve ratios, lower reserves required for time deposits) expanded credit creation capacity orders of magnitude greater than what was possible pre-Fed. This enabled US WWI operations to be funded primarily through the sale of government bonds that were purchased primarily by the banks. As is usually the case when war is funded by inflationary policies, prices generally increased during this period

Following the war, market forces naturally worked to correct the systemic distortions. A general deflation commenced to destroy excess credit and decrease prices. (The authors present interesting data indicating that during the two prior US wars--the war of 1812 and the Civil War), prices generally returned all the way to their pre-war levels and then some). Much of this deflation occurred during the deep but relatively brief Depression of 1920-1921.

Coming out of that depression, however, prices had only retraced about 50% of their wartime increase. This is when the Fed began a multi-year campaign to intervene in the name of 'price stability.' In 1922 the Federal Reserve embarked on the first of three rounds (they did similar in 1924 and 1927) of lowering what today we call the 'Fed Funds rate' and engaging in 'open market operations' (read: bond buying) that, coupled with the central banking system's newfound capacity for pyramiding credit through the system, created the leveraged fuel that funded several rounds of speculative investment--first in productive capacity, then in real estate, and finally in stocks--that inflated the bubble that ultimately popped with the market crash of 1929.

It is interesting to note that prices of goods and services did indeed stabilize. Despite all of the credit creation, prices of consumer goods did not change much and never reclaimed pre-WWI levels. However, prices of speculative assets such as real estate and stocks went through the roof. Although the authors did not call it such, they explain this phenomenon as if it were the Cantillon Effect. The newly created credit largely remained within the financial system, and the first users of the newly created credit bid up the prices of financial assets accordingly.

Those who cannot recognize the parallels to our present situation are not engaging their brains.

Post crash, the authors considered why economic activity persisted at such depressed levels. Their explanation centered on New Deal policies, many initiated during the Hoover administration, that extended the previous decade's price stability motive via additional rounds of monetary and fiscal policy. They make a particularly compelling argument that restricting layoffs and legislating minimum wage rates essentially institutionalized widespread unemployment. Letting labor markets clear at much lower wage rates, in authors' view, was the quickest way to end the Depression.

I was longing for a deeper dive into the effects on savings during the period. What happened to savings rates during the 1920s? And if savings were sharply lowered during the boom, then how could the economy expand significantly until those savings had been replenished? A rigorous discussion of the interaction between credit creation and real savings would have been icing on the cake.

That said, this is a superior analysis with few peers. An amazing work from individuals who were still living the times.

Reference

Phillips, C.A., McManus, C.F. & Nelson, R.W. (1937). Banking and the business cycle. New York: The Macmillan Company.

Only Yesterday

"He used to be a big shot."
--Panama Smith (The Roaring Twenties)

Just completed Only Yesterday, a book by Frederick Lewis Allen that chronicled life during the 1920s. Allen was a journalist and magazine editor. When this book was published in 1931, he was writing for Harper's magazine.

The 1920-1930 period of US history interests me. Although I have read several books on this era already, Allen’s work promised to be an attractive read. As a mainstream journalist, Allen offers relaxed social perspective that differs from the rigorous analysis of academic economists that dominate literature about this period. Because the book was published soon after the decade ended, Allen's perceptions were still fresh in his mind and less subject to loss of accuracy from time decay. The quick turnaround also reduces the chance that the fidelity of his analysis was influenced by conclusion reached by future 'authorities' of the subject.

1922 $20 PCGS MS65+ CAC

The primary strength of this book is the analysis of social trends during the 1920s. The effect of WWI and Wilsonian regime on behavior (live for the day, less idealism, less tolerance for long, drawn out issues and news events). Women's fashion (skirts shorter, less frills, flat profiles, short hair, helmet hats). Youth rebellion and disillusionment (discarding customs and ethics, freedom facilitated by automobile, sex over love, alcohol consumption). Unfolding technologies (radio, car, airplanes). Fascination with 'ballyhoo' (Linbergh, murder cases, sports). Prohibition (going thru the rigorous process of passing a law by Constitutional amendment and then collectively ignoring and/or breaking it).

Several times I found myself tingling with a sense of deja vu. During Allen’s recount of the Red Scare in the early part of the 1920s, for instance, the rush to judgment and denial of rights toward those deemed communists or communist sympathizers seemed mirrors other targeted groups experience today.

1923-S $1 PCGS MS65 CAC

The most eye-brow raising 'never knew that before' data point? The theory that President Warren Harding didn't die from illness in 1923. Rather he either a) committed suicide upon learning of  Teapot Dome and other scandals committed by people in his administration, or b) was murdered (likely poisoned) by his wife when she learned of his extra-marital affairs which allegedly produced at least one child.

Allen focuses on the market bubbles toward the end of the book. Real estate comes first, primarily because the excitement came and went a bit earlier in the decade. The housing bubble in Florida and elsewhere was inflating by 1925 and had largely popped three years later.

1926 $20 PCGS MS65 CAC

Rather than dying there, the speculative juices of America then turned toward to stocks. Although equity markets had been rising steadily through much of the decade, it was not until 1928 that the real stock market action kicked in. Despite big time volatility that included at least four white knuckling pullbacks, stocks commenced an epic rise over the better part of the next two years.

Allen does well in capturing the accompanying sentiment. Stories of cab drivers and waitresses speculating in Steel (US Steel) and Radio (RCA). Bullish prognostications of Wall Street gurus and many academics.

1927-S $1 PCGS MS65 CAC

He also emphasizes the impact of margin loans. People everywhere were buying stock on margin. Even when the Fed announced in 1928 that it would not lend to entities supporting 'speculation,' margin loans continued to grow. Where did this credit come from if it was not facilitated by central bank credit? Perhaps it still did but in a roundabout way. Much capital for margin loans came from corporations that saw opportunity to make a tidy sum by lending cash to banks for the margin crowd at 10% or more.

As hoped, Allen zeros in on the panic during the fall of 1929. In late October he offers a day-by-day synopsis of what occurred around Black Tuesday. The most insightful aspect of his account: how far behind information systems were at generating data that today we take for granted--such as real time stock quotes. During the height of the panic, quotes were hopelessly behind--3-4 hours minimum. Imagine trying to decide whether to hold onto a margined position when you have no idea where prices are. Clerks settling trades burned the midnight oil for weeks to complete the accounting. Margin calls went out sometimes days late.

1928 $20 PCGS MS66+ CAC

What Allen doesn't address, and frankly I did'nt expect him to, was the role of monetary policy during the decade (and earlier) in facilitating the speculative fervor of the Roaring Twenties. People are always looking for a quick buck but they don't always have access to the means (read: easy credit) to satisfy their speculative urges. Where did those means come from during the 1920s? Allen is silent in that regard.

At the end Allen recounts the aftermath. In his view, the Hoover administration's efforts to get 'prosperity' back on track weren't working. Optimism was turning to pessimism. Business investment was falling. Unemployment was rising. Thoughts about the benefits of socialism that had waned with the Red Scare ten years earlier was gaining traction once again. Considering that the election of 1932 was still a year or so away, the picture that Allen paints in the year or so following the Crash suggests an interesting (and accurate) trajectory.

It turns out that Allen followed this work up with a chronicle of the 1930s, Since Yesterday. I've just opened it.

Reference

Allen, F.L. (1931). Only yesterday. New York: Harper & Row

Rate Cuts at Market Highs

'Cause she's so high
High above me
She's so lovely
--Tal Bachman

Major US equity indexes are marking all time highs after Fed chair Jerome Powell's dovish speech in front of Congress yesterday seemed to guarantee that the FOMC will cut rates at its upcoming July meeting. That the Fed plans to lower interest rates with markets at all time highs has raised more than a few eyebrows.

But such a move is not unprecedented. In the fall of 2007 the Fed cut rates three times to bring down the Fed Funds Rate a full percent from 5.25% to to 4.25%. Stock markets proceeded to rally to all time highs during this period.

The euphoria was short-lived, of course. The following year saw markets absorbing the full effects of the credit crisis. The SPX would fall more than 50% from those rate cut highs. In fact, the Fed furiously cut rates in 2008, lowering the Fed Funds all the way down to an astonishing 0.25% by December.

By that time, markets  no longer celebrated the cuts. Instead, they plummeted lower.

History suggests that caution, not euphoria, is sometimes warranted when the Fed cuts rates at all time stock market highs.

Tax Absurdity

And if you knew how much I need you
Oh and I need you like the air
If someone should take you from me
I would run, run, run, runaway
--Jefferson Starship

Amusing post by Dan Mitchell on two absurd statements about taxes made by political officials. One comes from the governor of Illinois who claims that higher income taxes are needed to keep people from leaving the state (!). Theory and data show the opposite of course. As Illinois has raised its taxes, people are voting with their feet--as they are doing in other high tax regimes like New York and California.

The other statement comes from a German bureaucrat. He claims that, while he respects the sovereign rights of states to set their own tax rates, sovereignty of some states depends on being able to impose taxes on the people of other states. Mitchell suggests this is like having the right to own a house while neighbors have the right to set it on fire.

In fact, the situation is more akin to what we actually have. People 'own' houses, but other people can vote to tax that property. If people can forcibly take your property by law, then do you really own it?

The scary thing is that people actually believe these statements of tax absurdity.

Net Worth

Don't you try to pretend
It's my feeling we'll win in the end
--Simple Minds

"Where do I stand financially?" One way to answer that question is to periodically estimate your net worth. Simply defined, net worth is the difference between what you own and what you owe. The more you own and the less you owe, the greater your net worth.

In financial accounting, the instrument for measuring net worth is called a balance sheet. When companies report their financial results, they include a balance sheet so that shareholders can understand the capital structure of the business and their underlying net worth (a.k.a. shareholder equity). Individuals can similarly employ the balance sheet approach to get an idea of their net worth.

Assets

First comes what you own, a.k.a. 'assets.' Record them, then add them up. Here's a list of typical assets, beginning with the most liquid:

Cash and cash equivalents. Value of checking accounts, savings accounts, CDs held in banks. Don't worry about physical cash on hand unless it's substantial.

Investments. Value of brokerage accounts, mutual funds, IRAs, 401(k)'s.

Alternative assets held in physical form. Precious metals, collectibles, other real estate besides personal dwelling. Value of alternative assets can be harder to estimate because they are less liquid. Be conservative with your estimates.

Home. If you own a house, include the property's estimated value. A conservative reference is often the county assessment done every few years for property tax purposes.

Car. Estimated selling price of a car if you have one. Remember that car values depreciate quickly, so be conservative.

Other personal property. For the most part, ignore possessions like clothes, electronics, etc. They usually have little 'salvage value' if you have to sell them.

Liabilities

Next comes what you owe, a.k.a. 'liabilities.' For the most part liabilities are various forms of debt. Record them, then add them up. Here's a list of typical liabilities.

Credit card debt if balance not paid off monthly.

Student loan debt--remaining balance that you owe.

Car loan debt--remaining balance.

Home mortgage debt--remaining balance.

Other debt. Rare but could include personal loans (money you've borrowed from another person) and other unusual obligations.

Don't include monthly bills like phone, cable, gas and electric as long as they are paid when due.

Net Worth

Once you've summed up your assets and liabilities, find the difference:

Net Worth = Assets - Liabilities

You want the number to be positive and growing over time. When you are just starting out, you net worth will be small. It may even be negative. The way to stay out of negative territory is to avoid debt. Stated differently, owning tons of assets matters little from a net worth standpoint if those assets have been funded by a mountain of debt.

The smaller your debt load, the quicker that you can build your financial net worth.

Personally, I estimate my net worth quarterly using a spreadsheet. Nothing to obsess over. Just a way to track progress along the way.

Prices

Maybe it's change
Or the time of the year
Or is it the way 
That you hold me so near
I swear it's the price of love
--Roger Daltrey

Prices reflect the current exchange rates between trading partners. Prices are usually set in monetary terms. The price of admission to a movie, for example, might be $10.

Without prices, markets could not function. Imagine trying to buy dinner at Chipotle if prices for various entrees were not available.

How are prices determined? In unhampered markets, prices are not set by mandate. Instead, they are determined by discovery. A seller might offer a cell phone model for $500, but if no one buys it, then there is no 'market' at that price. The seller will likely have to lower the phone's price in order to discover where to 'make a market.'

In financial markets, securities are often priced on a 'bid/ask' basis. Consider this recent price quote for Merck & Co (MRK) stock:

Bid: $74.60
Ask: $74.61
Last: $74.60

The 'bid' is the price where marginal buyers currently indicate that they are willing to purchase the security, while the 'ask' price indicates the price where marginal sellers are currently willing to part with the stock. Note that the difference between the bid and ask, also known as the 'spread,' is very narrow--only a penny. When spreads are narrow like this, markets are said to be 'liquid.' In liquid markets, buyers and sellers can do transactions very close to the bid/ask prices. Note that the 'last' price indicated above, i.e., the most recent transaction of MRK stock to be recorded, occurred at $74.60--the same as the current bid price and only a penny less than the ask price.

Liquid markets typically occur when there are lots of buyers and sellers looking to trade. The more buyers and sellers, the narrower the spread. Conversely, when there are few buyers and sellers in a market, spreads typically 'widen.' In housing markets, for instance, one seller and only a couple prospective buyers might result in very wide bid/ask spreads. The seller might offer a house for $300,000 while prospective buyers may only be willing to pay $250,000. Unless the seller is willing to come down in price or the buyer is willing to come up, then the house is likely to remain unpurchased for some time.

Complications arise when prices are set by force rather than through voluntary price discovery. We'll discuss this situation in a subsequent post.

position in MRK

Primary Asset Classes

"The most valuable commodity I know of is information. Wouldn't you agree?"
--Gordon Gekko (Wall Street)

Investors generally choose from four primary asset classes:

1) Cash. Cash is the fundamental asset class upon which other asset classes are based. It is denominated in units of currency (e.g., dollars). Cash is liquid, meaning that it is easily exchanged at its nominal value (e.g, 'one dollar'). It carries low short-term risk, meaning that its value is unlikely to decrease over the next few days or weeks. Over longer periods of time, however, the value of cash can decline in inflationary environments when the creation of additional money (typically by government) causes the purchasing power of cash to go down.

That said, the primary objective of cash is capital preservation. In uncertain times, or as a parking place for investment capital until better opportunities arise, cash can be an attractive asset class.

2) Fixed income. Fixed income includes a variety of investment vehicles ranging from bonds (both government and corporates) to certificates of deposit (CDs). Fixed income securities usually pay predetermined streams of income to their owners over the life of the investment. The timing of these payments is nearly always pre-set as well (e.g., monthly, semi-annually, annually, at maturity). This predictability is an attractive feature of fixed income instruments. A primary risk for owners of fixed income is 'credit risk,' meaning that it is possible that the borrower who sold the debt may default on some or all payments. To compensate, investors demand higher interest rates from debtors deemed to be riskier.

The primary objective of fixed income is predictable income or cash flow.

3). Equities. Equities, also known as stocks, are investments in for-profit companies. Partial ownership of a company is obtained by purchasing its shares either directly or via funds (mutual funds or exchange traded funds (ETFs)) that hold its shares. Equity shares can commonly be purchased on a stock exchange such as the New York Stock Exchange (NYSE) or the National Association of Securities Dealers Automated Quotations (commonly called the 'NASDAQ').

Stocks entitle the owner to participate in future wealth-building activities of the company that can result in share price appreciation (a.k.a. 'capital gains') or dividend payouts. Of course, owners also face risk that the company may not perform well in the future, thereby causing share prices to drop or dividend payouts to decline/terminate. The risks associated with stock ownership generally exceed those associated with either cash or fixed income. However, the rewards are generally greater as well. (Remember that risk and reward are related: the higher the risk, the higher the prospective reward, and vice versa. If that was not the general rule, then markets would have trouble functioning)

The primary objectives of equity ownership are capital appreciation and dividend income.

4) Alternative assets. The three asset classes discussed above--cash, fixed income, and equities-- are considered 'conventional' asset classes and comprise the bulk of investment portfolios. However, over the past few decades, financial market innovations have enabled investors to gain exposure to another group of assets called alternative assets. Alternative assets, sometimes termed 'hard assets' because they typically involve tangible goods, include commodities (such as oil, farm products, and gold), real estate, and even collectibles such as art. In the old days investors wishing to own alternative assets had to buy the tangible property and hold it in physical form. Today, many alternative assets have been 'securitized,' meaning that investors can readily buy exposure to them through ETFs and related vehicles. Many of these securities carry idiosyncratic risks, however, and investors must understand these risks before getting involved with this group.

Alternative assets can be attractive from two standpoints. Owning hard assets such as real estate or gold can be an effective way to hedge against inflation and other forms of financial or social disorder. If the value of the dollar goes down, for example, then the price of land or gold typically goes up. Another feature of alternative assets is that their value often moves up and down in a manner that is weakly or even negatively correlated to stocks and bonds--making this asset class an attractive way to diversify an investment portfolio.

The primary objectives of alternative assets, then, are inflation/disorder protection and diversification.


One of the major decisions facing investors involves 'asset allocation,' or how to divide their capital among the four above asset classes. We'll discuss in a future post.

position in gold

(Un)Affordable Housing

Our house
It has a crowd
There's always something happening
And it's usually quite loud
--Madness

As Ryan McMaken and Tom Woods observe, the most straightforward way to make housing more affordable is to build more of it (ECON 101). Instead, policymakers want to subsidize housing.

One way to get more affordable housing is by building more housing. But most policymakers seem more interested in schemes for subsidizing housing instead. https://t.co/2tYoTW0l4u

— Ryan McMaken (@ryanmcmaken) February 5, 2019

Housing subsidies discourage supply and increase demand. Consequently, prices will ____. (Put on your ECON 101 hats)

Wall's Biggest Problem

Borderline
Feels like I'm going to lose my mind
--Madonna

Most arguments against construction of a barrier wall across the southern border are weak. The most popular one, that 'walls don't work,' is among the weakest. As discussed on these pages, humans have been building walls as effective deterrents for thousands of years. While they do not eliminate intruders, particularly those who are highly motivated, walls certainly reduce them.

However, there is one argument against the wall that is difficult to ignore. In order to build a comprehensive walls across the southern border, the government would have to expropriate property from hundreds if not thousands of private landowners. Commonly known as 'eminent domain,' the process is justified under the auspices that it is being done for the 'common good' or for purposes of 'national security.'

Now, to be sure, many of the president's political opponents, particularly those on the left, who have voiced opposition to the eminent domain approach can hardly be taken seriously. After all, these same people generally have no problem with government confiscating property in other contexts for the 'common good.' Their motivation is purely political. They are desperate to employ any means necessary, no matter how inconsistent with their beliefs and past actions, to defeat this president's agenda.

However, opposition to the eminent domain approach is not coming solely from the left. Several congressional representatives and thousands of citizens, particularly from the state of Texas where much of the eminent domain process would likely be employed, have voiced their objections as well.

And their argument is a strong one, as these pages have made clear in the past (here, here, here, here).

To be fair, though, I do sense that there may be a couple of arguments that may have some merit from the pro-wall side. One might be called the 'airline emergency door' argument. If you are a passenger on a flight and you are sitting next to an emergency exit, then you are asked whether you are willing to operate the door in the event of an emergency. If you say 'no,' then you are asked to move in favor of someone who is willing to be responsible for 'securing the border' for travel.

A similar argument might be made for land owners whose property buts up against a national border. Because the border is subject to policies such as those related to national security, property owners adjacent to that border may be viewed as being obligated to secure their properties' boundaries, or be open to the government doing so, so that national security policies can be realized. If those property owners choose not to do so, then they would have to move--similar to those unwilling airline passengers seated next to emergency doors.

The other argument might be called the 'outside the fort' policy. As settlers moved west, forts were often erected so that those living behind those walls would be safer. Some settlers, however, chose to live outside of the fort's walls. By doing so, those settlers could live on their own land as they saw fit with greater freedom. However, they were also more exposed to unwanted invasion by intruders.

For border line property owners in Texas and elsewhere who do not want a wall erected on their land, then perhaps the government should look inland until it finds land owners who will voluntarily cooperate with wall construction. That would simply leave landowners who do not want the wall erected on their property 'outside the fort' by their own choosing.

Those are two arguments that I can think of that might hold some water against those who oppose the wall on eminent domain grounds.

Free Range Humans

"You think you're free? You're not."
--Nathan 'Diamond Dog' Jones (Con Air)

John Lott reminds us that, although many people believe that they are free, they're not.

So is the US still a free country? This is only a very partial list of things people can no longer do without gov approval. pic.twitter.com/cVQNynixDv

— John R Lott Jr. (@JohnRLottJr) January 5, 2019

Freedom has become a positive substitute symbol for government regulation and control.

Not a bad way to put it at the bottom of the graphic. Increasingly, we're living on a tax farm as free range humans.

Distinction Without Difference

"Nice thing about you, Joe, is that you can sound like a liberal, but at heart you're an American."--T.T. Claypoole (The Best Man)

Pundits are promoting next week's election as the most important midterm ever. We've heard this before, of course. And there is some merit to the notion that, as stakes escalate ever higher in winner-take-all democratic votes, every election becomes more important than those before.

 Yet despite the campaign ads claiming the superiority of one political policy over another, Ron Paul reminds us just how close the two warring factions are.

Republicans are the party of WAR...But so are the Democrats.

Democrats are the party of WELFARE...But so are the Republicans.

Democrats are BIG SPENDING SOCIALISTS...But so are the Republicans.

Government Power vs. Individual Liberty

That's the game.

The rest is theatre. pic.twitter.com/mD7QO1Mjgq

— Ron Paul (@RonPaul) October 24, 2018

When it comes to destruction of liberty, the policies of both sides condone it.

Distinction between these parties amounts to little real difference.