Friday, October 30, 2009

Book Bubble

"Looks like the University of Illinois!"
--Joel Goodson (Risky Business)

Why do higher ed costs remain persistently high? Mike Shedlock hits it right on the nose. The reason is government subsidies. Loan programs like Sally Mae subsidize the market for higher ed. Subsidies always increase demand relative to supply. Consequentially, scarce resources are misallocated and prices rise.

Moreover, the 'cheap credit' structure of these subsidies has prompted borrowers to enter into larger commitments than they otherwise would. This should sound familiar, for it describe a process similar to the housing bubble.

How has this been operationalized on college campuses? Massive spending programs to build university capacity. Enrollment of students who would not have been admitted without subsidies--many of whom lack talent and motivation to do college level work. Diversion of resources away from those students with talent and motivation to do college level work. More debt. And, of course, higher prices.

Very few in the higher ed industry view this situation as bubblish. When reviewing the evidence, however, the familiar signs are there.

Which bids the question, what happens to these institutions and their stakeholders when the bubble pops, as bubbles always do?

Thursday, October 29, 2009

Credit, No Credit

With hours left time on our sides
Now it's fading fast
Every second every moment
We've got to--we've gotta make it last

Frank Shostak suggests that those equating a decrease in overall credit with deflation are wrong. He argues that only a decline in 'unbacked' credit reflects a deflationary condition.

While this may be true, the capacity of financial institutions to pyramid capital 10 to 1 or more suggests that the bulk of credit outstanding is indeed of the unbacked variety.

Indeed, bank leveraging lies at the heart of the inflation engine. When deleveraging occurs, the engine works in reverse.

Wednesday, October 28, 2009

Home Wrecker

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

Paul Wilham's fine blog has alerted me to concerns about the City of Cincinnati demolishing properties with little justification. To me, it seems criminal to be taking these properties down.

Now, it seems this may literally be true. The city appears guilty of negligence to say the least.

Certainly increases validity of the argument that city officials do not clearly think things thru before moving to demolish homes.

As Paul demonstrates, the economics of the current demolition policy makes no sense at all.

Tuesday, October 27, 2009

Fishing for Answers

"I miss the peace of fishing, like when I was a boy.
--Captain Marko Ramius

Great piece by Kevin Depew on the mechanism behind the debt crisis. In it, Pep cites work by economist Irving Fisher in the late 1930s published in Econometrica that outlines Fisher's 'debt-deflation' theory of a depression.

Fisher pinned the deflation dynamic primarily on the creation and destruction of debt, which certainly appears 'right' to me. Parenthetically, Fisher suggests early in his piece that his ideas were unique, although in my readings a number of others at the time were focused on similar thoughts.

Pep notes that the rising dollar step in Fisher's sequence is the one he's focused on. He sees DeMark trend exhaustion data lining up to support a major bottom in the USD in upcoming months.

Near the end of his piece, Kevin concludes that the debt-deflation phase will inevitably end in inflation, but that those positioning for that inflationary phase now are likely to feel significant pain.

I'm coming to a similar conclusion.

position in USD

Health Club

How will they hear
When will they learn
How will they know

Here is the smartest punch list for health care 'reform' that I've seen. The 4 elements that Professor Hoppe proposes are:

1) Eliminate all medical licensing requirements. Supply will rapidly increase and prices will fall. If buyers feel the need for some credentialing, then voluntary competing agencies will form.

This measure will increase search costs among health care consumers and drive more discerning choice.

2) Eliminate government restrictions on production and sale of health care products. No more FDA et al. Prices will fall and variety will increase.

Once again, this puts onus on the consumer to engage in more risk assessment. To the extent that consumer desire more information from producers, those sellers will be motivated to provide it in order to make sales.

3) De-regulate health insurance. Only private industry is capable of prudently insuring risk. Conditions that are not insurable will not be covered. Prices will fall; variety of insurance policies will increase.

4) Eliminate all subsidies to the sick and unhealthy. Subsidies create more of what is being subsidized. Eliminating subsidies increases motivation to live healthy lives.

The idea is to put market forces back in play. Despite what bureaucrats claim, our current health care system, and the system being proposed, is most certainly not market based.

Monday, October 26, 2009

Perspective Directive

Things could be different
But that'd be a shame, 'cause
I'm the one who could feel the sun
Right in the pouring rain
--Lou Gramm

This afternoon I read some comments on a sell off in bond land. I headed to the charts to see what was happening. Below is a daily chart of the 10 yr Treasury note yield (TNX). Sure enough, 10 yr yields have rallied more than 10% since the beginning of October. Not a good thing for things like mortgage rates.

For longer term perspective I pulled up the TNX chart on a weekly basis spread over nearly 4 yrs. This chart looks a lot less 'urgent.' A small countertrend rally in a multi-year downtrend. Technically, there's nothing to get excited about unless the TNX rises thru about 38 (or 3.8% yield). That level what suggest a change in longer term trend.

The lesson here? Time frame, cookie. What appears true in one horizon may look different in others. Varying time horizons improves perspective.

no positions

Low Return World

Have we become a habit
Do we distort the facts
Now there's no looking forward
Now there's no turning back
--Pat Benatar

My sense is that the next few years are likely to offer pretty low investment returns. Sure, there may be some special situations, and intra-period volatility may permit catching a nice trend if you're saavy enough to trade 'em. But I doubt I'll be smart enough to do that in a meaningful way.

As such, I want to shed risk and hold lots of cash.

With the tiny returns on cash balances, the other thing that makes sense to me is to pay down debt. Taking my mortgage debt for example, I'm paying 4 5/8% which, after tax, seems pretty low. But if cash is earning 0 to 1% in a money market fund, then I'm actually better off 'investing' this cash in paying down by mortgage, as my real return will be a coupla percent--which beats nearly everything else in my investing universe as I'm seeing it.

Doing some what-if planning suggests that I could pay down my entire mortgage, originated at $194,100 K this past May, by the end of next summer. As it stands right now, this will be my primary personal finance goal for 2010. Debt free by the end of 2010.

position in USD

Marginal Thought

With a little perserverence you can get things done
Without a blind adherence that has conquered some
--Corey Hart

Last week, President Obama spoke at MIT about his energy policy. During the speech, he spoke of the 'opponents' to his policy as being 'marginalized.' He claimed these opponents are making 'cynical claims that contradict the overwhelming scientific evidence when it comes to climate change.'

He goes on to suggest that the largest obstacle in the way of getting his policy done is cynicism and pessimism. He argues that what we need is optimism that his policy is correct.

Well reasoned thought processes know that there's plenty to contest w.r.t. the validity of the 'science' of global warming. It's easy to view the president's plea as one to switch off critical thought and blindly follow the 'smart ones.' A rhetoric of compliance.

Hopefully individuals will engage their brains and carefully think this issue thru on their own.

Sunday, October 25, 2009

Rose Colored Glasses

Now, the mist across the window hides the lines
But nothing hides the color of the lights that shine
Electricity so fine
Look and dry your eyes
--Joe Jackson

Interesting article on Charlie Rose. Am not a huge fan but the way he weirdly leans over that table when chatting with guests catches my attention.

During the meltdown last fall, the way he softballed questions to Warren Buffett, Tim Geithner, Hank Paulson et al in a manner that leads me to believe he has a core belief in the value of central planning and intervention.

I do like how he relies on private donations for his show. Although he operates on PBS, he refuses public sources of funds. So perhaps he's more market driven than I had suspected.

GM and Them

If you let them do it to you
You've got yourself to blame
It's you who feels the pain
It's you who feels ashamed
--The Who

Classic example of government intervention gone awry. When GM wanted to build a Cadillac plant that would straddle Detroit and the municipality of Hamtramck in the early 1980s, it approached local government for help in clearing out local residences.

Politicians were happy to oblige in the name of 'jobs' (read: votes). They wound up evicting protesting residents of Poletown to make way for the factory.

Det-Ham went down as one of the biggest disasters in facility layout and automation gone awry. Today it operates at a fraction of original capacity, and is tooling up for a big bet on the hybrid Chevy Volt.

Government intervenes in the name of big business. Big business bombs but persists. Citizens get hosed. Sound familiar?

btw, a picture of GMs Michigan area capacity, then and now.

no positions

Friday, October 23, 2009

Dream On

Every time I look in the mirror
All these lines on my face gettin' clearer
The past is gone
It went by like dust to dawn

Changing homes earlier this year has elevated my interest in local real estate. I'm an old house guy and I find myself canvassing my local neighborhood looking for the 'perfect' old house. You know, the kind of house you dream about if you won the lottery.

Here's my current dream house list, from highest to lowest price (per the county auditor).

1242 Edwards Rd. I altered my usual jogging route yesterday due to road construction and ran past this 100+ yr old beauty. As you'll surmise from my picks, I'm partial to brick and the colonial style. This one's so pretty that I can look at this picture all day. Inheriting a million dollars won't quite permit writing a check for this one though. Currently appraised at $1.3 million. Fun to dream, tho.

2750 Baker Pl. Baker Place is a private gaslit cul de sac off Madison in East Walnut Hills. White brick with interesting rounded sides. Very elegant. Sports a nice solarium and patio to the right side. This one is actually for sale, altho current list price at $1.8 million is quite a bit higher than the current appraised $1 million.

2766 Baker Pl. This one is right next door to the white brick noted above and, strangely enough, it's also currently for sale (asking $1.05 million). This may be the ultimate set-up as seen thru my rose colored glasses. Fantastic foyer, covered porch on left, solarium on the right, 3 car attached garage to rear, awesome slate roof. If I had a spare $800-900K or so, I'd be tempted to make a run at this one.

1854 Keys Crescent Ln. Keys Crescent is one street up from Baker Place off of Madison in East Walnut Hills. Some huge mansions face the river valley on the sout side of the U-shaped street. One of the north side parcels is occupied by this elegant center hall brick (do you see a pattern developing?). Auditor indicates current owner has been there since 1985. Perhaps she'll be looking to sell right at about the time my ship comes in...

3268 Observatory Ave. Observatory is my favorite street in Cincy. And my favorite part of Observatory is the climb up the hill from Delta toward Ault Park. Great house, great location.

2924 Erie Ave. For nearly 14 years I've walked past this house admiring it from the outside. Less than two weeks before I was scheduled to close on my house, it came for sale. If I wasn't under contract, this would have been an interesting situation. Was able to walk thru it and I liked what I saw. The owner, a PG exec, had been leasing it and was apparently testing the market between tenants. Three months went by and the for sale sign came down. Appears he has a new tenant now.

As you can see, I'm a brick colonial type of guy. Seeing as I've promised myself to never take on debt again after I pay down my present mortgage, the likelihood of legging into one of these beauties is pretty small.

But, hey, dare to dream...

no positions

Loose Change

The waiting is the hardest part
Every day you see one more card
You take it on faith, you take it to the heart
The waiting is the hardest part
--Tom Petty

This week saw many stocks gap higher after beating expectations only to fill the gap and keep on sinking. Previously, stock were going up an good and bad news. Now it appears they're having trouble heading higher on good news.

Perhaps an early sign of tenor change w/ the tape.

No Thanks

Congressman Sam Albert: "We knew that we had to monitor our enemies. We've also come to realize that we need to monitor the people who are monitoring them."
Carla Dean: "So who's gonna monitor the monitors of the monitors?"
--Enemy of the State

Yesterday the Obama administration wanted to exclude Fox from a White House pool interview with pay czar Ken Feinberg. The four other networks in the pool said "No thanks" to the White House.

Well done!

As noted the other day, perhaps the press is waking up and deciding they will no longer be manipulated by political machines.

Am very hopeful that this trend will continue.

Thursday, October 22, 2009

Escape Hatch

Tell you straight - no intervention
To your face - no deception
You're the biggest fake
That much is true
Had all I can take
Now I'm leaving you

The 'Necessary and Proper' clause, along with two other sweeping clauses in Article 1, Section 8 of the Constitution (those being the 'General Welfare' and 'Commerce' clauses), are often evoked by politiciaions to justify increased government intervention. It is currently being cited by bureaucrats as Constitutional justification for health care legislation.

At first glance, these clauses indeed appear to be loopholes that offer license for ever increasing government intervention with Constitutional backing.

Careful reason, however, suggests this a non sequitur.

Had the Framers truly desired to offer politicians this loophole, then why carefully write the rest of the Constitution in a manner that specified and restricted the Federal government's power? Why not just permit the State to expand its scope when it feels that it is 'necessary and proper' to do so?

Clearly the intent of the Framers was limitation, not expansion.

Viewed thru such a lens, the Section 8 clauses lose their influence.

Sell The News

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

The upside earning beats by Pfizer (PFE), Merck (MRK), and nearly all big pharma this week appeared to be classic sell-the-news events. Nearly all have given back a coupla percent since their announcements.

After the runup many of these names have had, Hoofy will argue that this is healthy action.

Did ditch a small position in Eli Lilly (LLY) and a little PFE, but I'm sticking w/ the Hoofster for awhile.

positions in MRK, PFE

Wednesday, October 21, 2009

Wolf Pack

In touch with the ground
I'm on the hunt I'm after you
Smell like I sound, I'm lost in a crowd
And I'm hungry like the wolf
--Duran Duran

More often that not, CNN, like most mainstream media outlets, has given the current administration free passes on tough issues. But I have to give Wolf Blitzer credit for staying on point with Obama advisor David Axelrod on the notion of introducing more private sector competition in healthcare reform.

Despite Mr Axelrod's repeated attempt to dodge a question about deregulating health insurance markets so that competition could be broadened nationally, Blitzer kept coming back to his question.

Well done, Wolf. Keep it up. Hopefully others will pick up on your example.

Tuesday, October 20, 2009

New World Dictionary

Howard Prescott: "Let me get this straight. Brantley is Whitfield?"
Brantley Foster: "That's right. Brantley is Whitfield. Whitfield is Brantley."
Vera Prescott: "And Christy is the bimbo. Well, now that we've all had Mouseketeer roll call, I'm just going to call my lawyer."
--The Secret of My Success

Mises observes that politicians, in classic Orwellian fashion, often seek to twist the meaning of words 180 degrees.

Over time, for example, the term liberal went from describing someone who was grounded in the principles of individual liberty to one grounded in big government and interventionism. Indeed, Schumpeter thought this particular turn around one of the more classic literary coups in political history.

Mises was particularly intrigued by bureaucratic efforts to convince people that more government intervention increases freedom.

More than half a century after Mises' comments, various strains of this argument persist. Check out the emperor's new clothes...

Broadcast News

You don't really need to find out what's going on
You don't really want to know just how far it's gone
Just leave well enough alone
Eat your dirty laundry
--Don Henley

When so many in the mainstream media--and a presidential administration--howl about a particular news outlet, you can be pretty confident that outlet is doing something right.

While pundits argue about how 'fair and balanced' Fox News is (btw, they'd appear less biased themselves if they would be questioning the same about other networks), the real measure of the value of an information outlet is demand. Market share and financial data for general network and particular programs suggest superior, and growing, demand for content generated by Fox relative to other news networks.

Meanwhile, mainstream newspaper and television institutions continue to lose eyeballs and face difficult financial situations.

Their solution is to pile on the leader. School yard stuff: condemn, discredit, regulate. Everything but provide better customer value.

All the while, Fox turns over rocks other networks refuse to touch.

The market is speaking, and mainstream media and its dependents are having trouble coping with what they're hearing.

Given the current set up, it's hard not to wonder whether we'll be testing the strength of the First Amendment in the near future.

Monday, October 19, 2009

High and Dry

Living easy, living free
Season ticket on a one-way ride

Another day, another 1% higher for the SPX. Sold placholder in Eli Lilly (LLY) and a bit of Pfizer as it creased $18 today (discipline).

Pharma continues to act well. Merck (MRK) reports Thurs and PFE reports tomorrow.

Additional jig will likely find me materially smaller in these names by end of week.

Had a bid on more USD exposure today but did not get filled.

positions in MRK, PFE, SPX, USD

Duration Station

So fun time is over
And I guess it's enough
But just for the record
It was a little too rough
--Til Tuesday

This nifty chart posted by Prof Zucchi shows that the US government has been funding increasing debt levels with instruments of decreasing maturity. This suggest a possible 'duration' problem in the future.

Imagine funding payments on a 30 yr mortgage with those cheap 'teaser rate' loans that credit card companies used to offer (remember those?). Each month, you find a different '6 months @ 0%' offer. You use the proceeds to pay your mortgage and other bills. Seems pretty nice as long as those low rate loans are available.

But what if those cheap sources of credit vanish (as they largely did w/ those teaser offers)? You may only be able to fund your mortgage payments with high cost dollars perhaps much higher than your actual mortgage rate. The underlying cause is that you tried to finance a long term obligation with short term funds. If the conditions surrounding the cost of those short term funds change, then you may have a big problem on your hands.

The US government has been doing this because short term interest rates are so cheap. The Fed has been making this so by buying down short rates (can you say Ponzi?).

The risk of a duration problem surfacing here in the US at some point is rising. If you've been following the Iceland story, you likely know that duration mismatch has been a key factor in this country's financial turmoil.

position in USD

Saturday, October 17, 2009

Answer Key

You and I in a little toy shop
Buy a bag of balloons
With the money we've got
Set them free at the break of dawn
'Till one by one, they're all gone

Peter Schiff provides answers to questions posed a few posts back. Essentially, the answers are:

Q1: credit contraction following a binge of excessive spending, debt, and leverage
Q2: nothing

Friday, October 16, 2009

Check Please

Heavy hearts token words
All the hopes I ever had
Fade like footprints in the sand
--Level 42

This is an example of doing an end around the broken credit system. Simply mail people checks.

Perhaps this is what gold is sniffing out.

Of course, the president's proposal could also be viewed as a bribe to garner favor from a meaty voting class.

position in gold

Bringing Bad Things to Light

When the mirror crashed I called you
And turned to hear you say
If only for today
I am unafraid

Some nice thoughts toward the end of this piece on GE, such as:

"The best way to think of GE is as a finance company masquerading as a manufacturing company. This was essentially the business model of General Motors as well, except GE is better at it.

"In reference to the sale of NBC entertainment, Immelt said GE has no need for cash. Of course GE has a need for cash. GE has a total debt of more than $500 billion.

"Instead of buying back shares at totally ridiculous prices over the years, GE could have and should have been retiring debt. The panic low earlier this year below $6 was on concerns that GE wouldn't be able to finance that debt."

It's been my experience that so many folks are in this stock without any idea of the debt carried by the company. A peek at the balance sheet offers cause for pause.

no positions

Thursday, October 15, 2009

Pharmer's Fields

After all the jacks are in their boxes and the clowns have all gone to bed
You can hear happiness staggering on down the street
Footprints dressed in red
And the wind whispers Mary
--Jimi Hendrix

Seeing some nice technical action in the pharma space. Merck (MRK) has broken to fresh 52 wk highs after resolving a pennant like pattern to the upside.

Pfizer (PFE) also vaulted higher over the past couple of days on big volume. Currently it's right at its 52 wk high.

Interestingly, these moves come on the back of the proposed health care reform bill. If you're noodling over cause and effect, one argument is that market participants are betting that the health care bill will die on the vine, thus freeing the druggies from more regulatory shackles. Another argument is that market participants are betting that the health care bill will pass, and that the regulatory environment would actually be a big win for pharma.

I've heard smart people argue both sides. Personally, I'm hoping it's the former for the sake of our country but my strategic mgt side is whispering in my ear that it's the later.

How could a government controlled environment possibly be good for the pharma folks? Because regulated industries tend to preserve the franchises of incumbents and squelch new entry. Efficiency and innovation (read: future standard of living) suffer.

Never thought about it this way when I put these positions on, but this pharma trade may turn out to be a decent hedge against the collective stupidity of our elected officials in Washington.

positions in MRK, PFE

Cross Walk

After two days in the desert sun
My skin began to turn red
After three days in the desert fun
I was looking at a river bed

The Dow's lift thru 10,000 yesterday had the headliners out in force. Was amused to see FBN pushed aside Dave Ramsey last nite in lieu of a special Dow 10,000 show.

I can construct various scenarios that 'explain' the big market lift off the March lows.

1) We were due. Markets don't move in a straight line. Instead, prices cycle between periods of optimism and pessimism--even when trending up or down. After one of the most dramatic waterfall collapses in market history, it stood to reason that we'd see an equally historic rally off the lows at some point. Should this scenario prove 'correct,' then once the oversold pressure is adequately relieved, then the primary trend lower, driven by the deflationary phase of the credit cycle, will reexert itself.

2) It's all about inflation. Market are levitating higher on an ocean of liquidity created by central bank policy and government intervention. Following this line of thinking, historic levels of intervention may lead to historic market price increases. Should this scenario prove 'correct,' then prices may continue higher. In fact, all this new money and credit may help us blow another bubble. Indeed, some smart folks I know are wondering where that next bubble might be, and how to participate as it expands.

3) The fundies are all good. Bad credit and bad actors have been wrung out of the system and the forward fundamentals are looking up. There's a new world order that promises smarter decision-making and innovation that will raise standards of living around the globe. Should this scenario prove 'correct,' then prices will move to levels never before seen--based on increased returns on productive capital.

Before 'choosing' a particular scenario of blend of scenarios as a basis for investment decisions, the prudent individual should seek answers to two questions. First, what precisely was it that drove stock prices lower? Second, what has transpired to eliminate those causes in order to prevent recurrence?

position in SPX

Wednesday, October 14, 2009

Unhealthy Practice

You had me down, 21 to zip
Smile of Judas on your lip
Shake my fist, knock on wood
I've got it bad, and I've got it good
--Robert Palmer

Jammin' today w/ mid term exams, but a quick thought. Headlines read that health care 'bill' cleared hurdle yesterday via Senate Finance Committee vote.

But we don't have a bill. We have a scribbled over concept draft. The SFC gave it a thumbs up without having the proposed legislation in hand.

At some point people must call Congress on the carpet for blatant (and escalating) disregard to the Constitution.

Tuesday, October 13, 2009

In and Out Burger

"I shall serve no fries before their time."
--Brad Hamilton (Fast Times at Ridgemont High)

Closed a very small trading project in GLD today. Initially entered the position this week with intentions to pyramid higher. But data inflow today (TD sell signals in gold, lopside COT reports w.r.t. spec longs) had me bookin' 'em, Dano.

Still have on a little SLV, as well as small amount of commodity ETFs in energy (DBE) and ags (DBA).

All of these are on the move today, particularly DBA.

Further jig will likely find me flatter than a sat on a hat w.r.t. 'stuff.'

positions in DBA, DBE, SLV

Monday, October 12, 2009

Cold As Ice

I've seen it before, it happens all the time
You're closing the door, you leave the world behind
You're digging for gold, you're throwing away
A fortune in feelings, but someday you'll pay

Iceland's problems continue to escalate. On the surface, you'd think that the U.S. is headed down the same path. Massive borrowing destined to end in a bust with a currency that gets destroyed.
Not so fast. I haven't wrapped my head around the situation totally, but studying some of the data suggests a couple of salient differences between Iceland and the US right off the bat.

One is that Iceland had literally been printing money for years as narrow money aggregates had been (and still are) growing nearly 20% annually for a decade.

More importantly, however, is that Iceland banks took on a ton of debt denominated in other currencies. By borrowing dollars, yen, et al, Iceland investors were short foreign currencies big time. When their carry trades went bad, no short squeeze developed in the domestic currency as investors didn't need to buy back krona. Instead, the short squeezes developed in the foreign currencies themselves.

This squeeze occured not from Iceland's short covering, but from a worldwide margin call on risky asset trades last year. As folks around the world, not just Iceland, scrambled to close $trillions of dollar denominated debt projects last year, the rip higher in the USD smoked the krona.

The US, however, has been in a situation where it has been able to borrow money from other countries in its own currency. We're short dollars in huge size. When we want to cover our massive carry trade liabilities, we need to buy back dollars. This demand puts a floor under the USD that the krona does not enjoy.

Iceland is certainly experiencing characteristics of deflation similar to other countries. Contracting debt/credit, falling asset prices, reduced consumption. The one divergence is the currency.

The moral seems to be if you're gonna borrow big, make sure you get your foreign creditors to denominate the debt in your own currency. That way, when you go bust, your currency doesn't instantly turn to dust.

position in gold, USD

Saturday, October 10, 2009

The Great Debate

"I guess it comes down to a simple choice, really. Get busy livin', or get busy dyin'."
--Andy Dufresne (The Shawshank Redemption)

A heated debate currently involves whether we will experience inflation or deflation down the road. This debate is of high interest to market participants because conditions of inflation or deflation require different, perhaps diametrically opposed positioning (e.g., buy General Electric (GE) versus sell General Electric) in order to effectively navigate the situation from a financial standpoint.

This debate finds some very sharp cookies on opposite sides of the fence. A great number of intelligent thinkers are steadfast in their belief that inflation of a great magnitude is pending, while another large group strongly believes that deflation awaits.

How can so many smart people with very respectable thought processes be so diametrically opposed? One reason relates to differences in the definition of inflation and deflation. Some people define inflation/deflation in popular terms of price while others select a definition grounded in classic terms of money supply. Changes in money supply do not necessarily influence prices of all categories (i.e., goods, services, stocks, real estate, etc) in the same manner. Thus, grounding an argument in a price-based definition of inflation or deflation may not be comparable to an argument grounded in a money-supply-based definition.

Differences in time horizon may also be cause for separation. Some folks see only inflation or deflation for the foreseeable future. Others, however, view the future in phases. Some die hard inflationists envision a near term period of deflation before inflation really kicks in. Similarly, some in the deflation camp see a near term inflationary burst higher before lights out deflation.

That said, a great many individuals who possess similar conceptual definitions and time horizons still operate at different ends of the inflation/deflation spectrum. In studying the many arguments on both sides of this debate, I've concluded that differences of opinion seem to hinge on at least three underlying factors.

1) Paper money vs credit money. Inflationists assume fiat money systems permit governments to literally 'print' money at will. Because bureaucrats have a 'printing press' at their disposal, they will indeed print money in attempt to bail the system out during difficult periods.

Deflationists argue that expansion of supply in modern monetary systems does not depend on literal money printing but rather on the creation of credit. The dynamic of credit money creation is different from paper money in that it ultimately depends not on government's willingness to provide a large credit supply, but on credit demand. If demand for credit is low, then money supply may not rapidly expand.

2) Limits on money creation. Inflationists believe that, lacking the political will to do otherwise, bureaucrats will always resort to printing more money during difficult times. A landscape covered in dollar confetti is the logical outcome.

Deflationists argue that there is a limit to how much credit money can be created. More credit means more debt and increased risk. Creditors (in our particular case other countries such as China) will raise the cost of borrowing to offset risk. Facing the specter of higher interest rates, bureaucrats will be forced to let the system deleverage.

3) Monetary vs social phenomenon. Inflationists generally concur with economist Milton Friedman who once stated that inflation is ultimately a monetary phenomenon. Essentially, inflation is a function of the printing press and those who control supply.

Deflationists believe that inflation is ultimately a social phenomenon. Inflation depends on credit creation which depends on willingness to borrow which depends on an appetite for risk. Appetite for risk is a social, not financial, variable. Should collective risk appetite for risk be low, then those wishing to inflate the system are 'pushing on a string.' Essentially, inflation (and deflation) is a function of those who control demand rather than supply.

As I see it, which side of the fence you fall in terms of the above factors suggests whether you'll land in the inflation or deflation camp.

position in USD

Friday, October 9, 2009

Collect Call

"Tenth grade biology. Brachial artery...pumps 30 liters of blood a minute. There's only five in the human body. I'm sorry."
--Jessica Martin (Cellular)

It is important to differentiate between paper money printed and distributed by fiat, and credit money. If the government prints $1000 dollars and gives it to me as a gift, then the primary worry is the devaluation of these pieces of paper over time, prompting a decision of whether to spend them now or wait till later. But the holder does not owe anyone anything for the right to hold the paper and make the spending decision.

The dynamic is different with credit money. If the government creates $1000 worth of credit and I borrow it, then I still have $1000 in hand. But I owe someone for the right to hold/use this money. I have to pay the lender back and (usually) add some interest. Now, I not only have to decide whether/when to spend these funds, but I also have to worry about repayment.

Should my capacity for repayment become less certain, then I'm less prone to borrow credit money. If I've already spent credit money funds, then I'm essentially 'short' some or all of the loan, and need to acquire dollars in order to cover my short position.

It should be clear that the fiat gift situation tends to be inflationary. Money supply expands and each dollar falls in value, prompting folks to spend them rapidly.

It should also be clear the the credit money situation is deflationary. Money supply contracts as folks avoid borrowing and work instead on paying off debt. The value of remaining dollars tends to rise.

Now, connect this with the fact that 95%+ of current money supply is credit money, and what is the conclusion?

position in USD

Thursday, October 8, 2009

Cuts Like a Knife

I took it all for granted
But how was I to know
That you'd be letting go
--Bryan Adams

As stock markets chug higher, the under performance anxiety is getting pretty palpable. Increasingly, professionals and retail investors feel the need to get there.

Two scenarios are plausible. One is that more folks jump on the train and higher prices become a self-fulfilling prophecy.

The other is that with sentiment getting giddy, Ms Market is ready to lop some heads.

No edge from where I stand on how to play it. Although today I was tempted to slap on some upside exposure just because it feels like they're going higher.

But chasin' 'em's not my bag.

Wednesday, October 7, 2009

Dealing Propaganda

Been away so long I hardly knew the place
Gee it's good to be back home
Leave it till tomorrow to unpack my case
Honey disconnect the phone
--The Beatles

My friend Vitaliy discusses the new Michael Moore 'Capitalism' movie thru his lens of a former citizen of the Soviet Union. He proposes that successful propaganda efforts share three characteristics:

1) influencing attitudes rather than providing information
2) selectively presenting facts (what he calls 'lying by omission')
3) eliciting emotional rather than rational response

The short story is that, if people engage their brains and employ their capacity to reason, then propaganda is rendered useless.

Contraction Action

Look up on the wall, there on the floor
Under the pillow, behind the door
Theres a crack in the mirror
Somewhere theres a hole in a window-pane

The observations of 'money printing' by the Federal Reserve continue. Such money printing is thought to be a primary driving force behind the recent rise in gold. Spectres of 1920s Weimar or modern Zimbabwe come to mind.

For the most part, however, the Fed is not printing currency via a 'printing press.' Instead, it is trying to create credit. It is offering cheap credit supply to the banks. However, to pyramid this initial credit supply thru the monetary system requires credit demand by banks and, ultimately, from borrowers.

When the monetary system is functioning 'normally', $1 of Fed credit might be pyramided into anywhere from $10 to $100 of credit via the banking system. Currently, demand for credit is low, resulting in a much lower leverage ratio.

Moreover, money 'velocity' data suggest a marked decline in funds actually being used in transactions. Money is being hoarded by both lenders and borrowers alike.

This is classic deflationary, not inflationary, action.

position in gold

Tuesday, October 6, 2009

Out of Bounds

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

Hard not to like the picturesque breakout in gold today. Nice pop from the mini pennant formation on good volume.

Futes hit a record high today and finished closed strong above 1040/oz.

One news item driving the dollar lower, and thus gold higher, has been growing chatter that nations plan to switch out of USDs when paying for oil.

There's been considerable debate over whether sentiment towards the yellow metal is overly bullish or bearish. On one hand, many gold newsletter writers report that die hard gold bugs expect a sizeable correction pending--suggesting that the gold trade isn't very crowded. On the other hand, commitment of traders numbers indicate large short positions for commercial hedgers (the alleged 'smart money').

I've certainly been among the skeptics. For some reason, I haven't liked the action during the past couple of months. Perhaps my deflationary bent has tainted my view.

I've been out of 'paper' gold and silver since mid summer. However, my bullion position, a permanent holding, keeps me exposed to further upside should gold rip higher from here.

Meanwhile, surveying the post-close headlines, it does seem that gold's new highs are not grabbing much fanfare. Should my perception persist, it may prompt me to buy some GLD for a trade. The 'easy' entry would be GLD 100-101, should prices pull back and test the gap.

positions in gold, silver, USD

Why Ask Why

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

Minyan Peter observes that a recent NYT reporter writing does not pursue the underlying causes of the Simmons Mattress bankruptcy.


People seem far too willing to assimilate a situation without asking why it is occurring. Viewing the empirical world as-is is known as induction. Animals can do this.

Humans differ from animals in that they possess the power to reason. Reason permits the analysis of a situation in order to understand why things are as they are. This is known as deduction.

Unless deductive skills are employed, past problems are certain to resurface, since we fail to grasp their root causes and implement solutions to prevent recurrence.

Without reason, repeating the past is our destiny.

Monday, October 5, 2009

New Deal Reasoning

Hey I'm not complaining 'cause I really need the work
Hitting up my buddy's got me feeling like a jerk
Hundred dollar car note, two hundred rent
I get a check on Friday, but it's all ready spent
--Huey Lewis & The News

Robert Reich engages in another piece of 'make work' drivel. The argument is that government needs to increase spending (beyond the trillion$ of stimulus already in motion) to get more people working.

As for issue of ladeling on even more debt to pay for the make work programs, well, according to Mr Reich we'll have to deal with that later.

I suppose this is what passes for well reasoned thought at Berkeley, eh Professor?

Stabilizing Influence

I tried so hard to rearrange your mind
But after while I realized you were disarranging mine
--Rolling Stones

Although I can't relate to Nobel laureate Hyman Minsky's Keynesian roots, his theories on financial market instability certainly resonate.

The basic idea is that periods of stability sow seeds for subsequent periods of instability. Stability causes folks to take on more risk and become complacent about the chances that the risks will be realized.

When policymakers seek to 'calm' markets down, the resulting moral hazard creates even more risk taking as decision makers perceive that someone has their back if things turn out poorly.

Intervention that is stabilizing in nature pushes out, and likely increases, the degree of instability in the future.

Friday, October 2, 2009

Greenback & Co

And it goes running all through the night
Until it ends there is no end
--Cyndi Lauper

In his posts today, Fleck dismissed the 'proposed' inverse relationship between the dollar and stocks as 'silly.'

The data suggest otherwise.

Comparing the SPX to the USD over the past 3 yrs reveals a pretty strong relationship. When the dollar goes down, stocks go up and vice versa.

While this relationship may not hold for all of history, it 'works' right now because of the leverage in the system. Many folks have borrowed lots of US dollars while owning risk assets like stocks at the same time. Stated another way, people sell dollars (USD price goes down) in order to buy stocks (SPX goes up).

When they want to shed risk, people sell stock and then buy dollars to pay back their loans.

As long as there's lots of dollar denominated debt out there, this relationship promises to hold to a signficant degree.

positions in SPX, USD

Thursday, October 1, 2009

Cool Down

Fire and ice
You come on like a flame
Then you turn a cold shoulder
--Pat Benatar

Decent sized sell off today ahead of tomorrow's payroll numbers. Technically, the ball is still in Hoofy's court. Our bovine buddy would argue that we're merely taking pressure off of overbought conditions. And the picture suggests that he's correct.

A near term sign that Boo might be taking control of the helm would be a break below the 50 day MA at about SPX 1020, which also roughly corresponds to support from the uptrend line defined by the March lows.

Stochastic oscillators suggest more downside room before things get too oversold in the near term. This is another feather in Boo's cap.

A repeat of today's action in the next coupla days would also raise eyebrows.

position in SPX


Nobody on the road
Nobody on the beach
I feel it in the air
The summer's out of reach
--Don Henley

Overall asset allocation breakdown thru Q3 2009:

cash 45%
stocks 29%
real estate 15%
precious metals 10%
commodities 2%
short equity 2%
currencies 1%

My sense is that probabilities of another deflationary wave will increase in the months ahead. As such, I'm looking to reduce stock exposure in favor of additional cash. If I'm fortunate enough to 'see' the right opportunity, I may also take on more short side exposure and increase my position in USD.

positions in gold, USD