Thursday, June 30, 2011

Obama and the Jets

Hey kids, shake it loose together
The spotlight's hitting something
That's been known to change the weather
We'll kill the fatted calf tonight
--Elton John

Wasn't aware that there was a 'corporate jet' class until yesterday's press conference. President Obama is cranking up the class warfare rhetoric in what appears to be a sprint toward his base. Not sure that's a good bet, but this is a masterful politician who continues to mesmerize people w/ his rhetorical skills.

Press conferences such as this one are so staged that they have a State apparatus feel. Should a questioner from 'the list' actually ask a tough question, then there is no opportunity for follow-up questions from others if the president says something that merits more probing. Of course, the very chance that the media at large would lob anything other than softballs and free passes at this president seems remote.

I did think two questions/ replies were noteworthy. Early on (~14 min) someone inquired about the Constititionality of several decisions/issues (War Powers Act, debt limit, gay marriage) that the president has recently been involved with or endorsed. The president deflected the question, saying that he was 'not a Supreme Court justice' and that he did not want put his Constitutional scholar hat on about the issues in question. The natural follow-up question would have been, "But Mr President, you swear to uphold the Constitution during your time in office. Shouldn't you therefore be prepared to make a convincing case for the constitutionality of any decision you support/make?"

The most interesting sequence came at the 53-54 min mark. Responding to a question that challenged the credibility of the Aug 2 debt ceiling deadline, the president appeared to go off script and address an "idea that's been floating around Republican circles." The 'idea' he refers to is to not raise the debt limit, and pay interest on debt to avoid default while cutting spending.

Parenthetically, this is clearly doable, btw. In 2010, interest payments amounted to about $200 billion--nearly 6% of outlays.

The president claimed that this would be analogous to him paying his mortgage but not his car note or student loan. No, Mr President, this is not analogous. The 'idea' you credit to 'republican circles' says service the debt with existing funds and cut spending in other areas to do so. Your example seems to equate govt spending programs with debt, which they are clearly not. The president's blunder here in and of itself should have sparked various challenges from the audience but did not.

A more appropriate analogy to our present situation is a Prodigal Son like scenario. The son spends lavishly and racks up big debts. The son then approaches his father saying, "Dad, I need more money from you. I owe my creditors plus I have expenses from my high lifestyle that I would like to maintain." Of course, if the president offered that type of analogy, he would not attract as many sympathizers.

After his failure at analogy, Mr Obama suggested that "for the US government to start picking and choosing is not going to inspire a lot of confidence. Moreover, which bills are we going to decide to pay?"

Unfortunately, the president could not be more wrong. Given our predicament, the only way to inspire confidence is to engage in the very 'picking and choosing' that the president abhors. We need to prioritize, Mr President, and begin tossing sizable govt spending programs onto the scrap heap of history. Return economic control to the people.

Refusal to do so will usher in the largest No Confidence vote in history.

Wednesday, June 29, 2011

Greece is the Word

We take the pressure and we throw away
Conventionality belongs to yesterday
--Frankie Valli

Greece is now set to receive a new tranche of bailout funds. More money being passed to a broke country in order to stave off default... Stocks have been lifting on the news.

Of course, other PIIGS (Portugal, Ireland, Italy, Greece, Spain) should soon be observed approaching the EU with hat in hand.

I'm adding to my short position around these levels as indexes approach resistance.

position in SPX

Competing Shapes of Monetary Collapse

Rise up, gather 'round
Rock this place down to the ground
Burn it up let's go for broke
Watch the night go up in smoke
--Def Leppard

Fine explanation of the fiat money/business cycle dynamic that fuels the 'crack up boom.' Not sure I quite concur w/ the conclusion, however.

Based on the work of Mises, the author notes that 'big' inflation and deflation are both viable outcomes of a fiat money collapse. Inflation would result if the govt tried to 'print its way out' of the problem. Deflation would occur if the bad projects built on a foundation of cheap credit would be permitted to collapse.

Yes, it seems a 'given' that govts will elect the former strategy and reach for the printing press to postpone pain. But could it turn out otherwise? For instance, some countries such as Germany have experienced hyperinflation before. Perhaps institutional memory will prohibit the re-creation of the hyperinflationary nightmare.

Then again, perhaps not. After all, the author happens to be a professor at a German university and he it not inclined to weight the deflationary scenario highly.

However, if Germany blinks and refuses to inflate away bad debt, then the EU comes apart...with global consequences.

The Folly of GDP Measurement

I think it's time to stop
Hey, what's that sound
Everybody look what's going down
--Buffalo Springfield

Most of us have come to accept the validity of GDP as a given. This article questions the usefulness of national output measures.

Arguments against GDP are not new. As the author notes, Mises was on the case years ago. GDP is hardly a measure of 'economic health' as many believe. One need only look at the components of GDP to understand why:

GDP = C + I + G + (X - M)

C = private consumption
I = gross private investment
G = government spending
X = exports
M = imports

As measured, GDP is largely a measure of consumption. In the spirit of 'what gets measured gets managed,' policymakers will likely intervene in markets in order to goose the numbers in their favor.

Interestingly enough, as noted by the author, GDP measurement didn't come about until the 1930s, when New Deal bureaucrats sought a measurement on which they could focus the public's attention on the need for planning to maintain national economic health.

A better argument can be made that long term economic health depends on savings and capital accumulation. Focus on a consumption oriented measure of national output like the one above is more likely to result in capital consumption in order to 'make the number.'

Secular declines in savings and secular increases in debt suggest that this is precisely what is going on.

Monday, June 27, 2011

The Political Landscape

And the parting on the Left, is now parting on the Right
And the beards have all grown longer overnight
--The Who

Political ideologies are often positioned on a unidimensional scale, with the ends of the scale commonly labeled Liberal vs Conservative, or simply Left vs Right.

This scale is sometimes called the 'political spectrum' where all ideologies can be located somewhere along the continuum.

But what is the single underlying dimension capable of ordering all political ideologies? It is sometimes proposed that Liberal reflects a 'big government' ideology while Conservative reflects a 'small government' ideology. However, in practice there seems to be little difference between the two sides in terms of installed government size.

The problem is likely due to the fact that political ideologies are multidimensional. Rather than using a spectrum model, politicial ideologies seem more accurately positioned on a 'landscape' model. Here's a proposal for a two dimensional model of the political landscape.

One dimension reflects belief in the sovereignty of the individual. A high value on this scale means that you believe individuals should be free to pursue their interests without interference from others. A low value on this scale means that you think individual interests should take a back seat to the interests of others.

The second dimension represents belief in government's role in society. Government is another name for force. A high value on this scale means that you think that a high level of government force is necessary in societal process. A low value on this scale means that you think that government force should be limited in scope.

Crossing these two dimensions offers a grid upon which we can plot various political idelogies. Modern day Liberals occupy the upper left space. Liberals view the pursuit of individual interests as less important than the interests of other people or groups (i.e., 'special interests'). While Liberals often profess to support 'social freedom' of individuals, most policies that Liberals push tend to restrict individual liberty. Private property is not highly valued. Liberals support a high level of force emanating from a central government authority to achieve ideological aims.

A bit down and to the right from Liberals (but not by much) are Conservatives. Although they profess to value individual freedom, Conservative frequently push policies that restrict individual choice. This is particuarly true in social issues (e.g., gay marriage). Famously, Conservatives are also willing to sacrifice individual freedom in the name of 'national security.' While they often say that they value small government, Conservatives push policies requiring a scope of government nearly equal to Liberal programs in their forceful content. 

At the bottom right are Libertarians. Libertarians see the freedom of individuals to purse their interests as a natural right. By logical extension, the only restriction to this pursuit is that individuals cannot infringe on the rights of others pursuing their own interests. Libertarians believe that the role of government should be limited to helping people protect their individual interests (i.e., life, liberty, property) from appropriation by others.

The lower left is occupied by Anarchists. While Anarchists sometimes profess to value individual liberty, it is difficult see that in practice. Conditions of anarchy are commonly characterized by lawless mob rule with little respect for private property. It is nearly impossible for individuals to pursue their self interests under anarchy because their days are occupied protecting their interests from infringement by others. Anarchists believe in conditions of limited or no government force.

This landscape provides one explanation as to why Conservatives and Libertarians are often viewed as 'close' to one another. The distance on the above grid between Conservatives and Libertarians is a bit smaller than the distance between Liberals and Libertarians. As drawn, however, Conservatives have less ideologically in common with Libertarians than they have with Liberals. Empirically, that seems correct.

Other political ideologies (e.g., facism, communism, monarchy) can be plotted on the landscape as well. Nearly all of them have a tendency to be 'up and to the left.' The crowd in the upper left hand quadrant reflects a dominant belief in government style.

Commonly, heavy authoritarian hands restrict individual freedom.

Sunday, June 26, 2011

Class Dismissed

I'm the innocent bystander
Somehow I got stuck
Between the rock and the hard place
And I'm down on my luck
--Warren Zevon

Lew Rockwell discusses the notion of 'class' based on the recent class action lawsuit vs Wal-mart (WMT) that was dismissed by the Supreme Court.

The notion of class in this context pertains to the view made widespread by the publication of the Communist Manifesto (Marx & Engels, 1848). It posits that the world is composed of various social groups and that these groups are constantly battling each other to gain the upper hand.

Economically, Marx (1867) centered the contest between 'labor' and 'capitalists.' He theorized that capitalists, i.e., those who own the means of production, exploit workers by extracting 'surplus value' from production in a manner that makes capitalists increasingly richer and labor increasingly poorer. (In Marx's theory, this continues until the working class revolts and appropriates the capitalists' property. After a 'dictatorship of the proletariat' phase, then society settles into the Communist version of socialism whereby all are content and earn equal incomes.)

As Rockwell notes, the traction that this theory has gained over the years is strange because it is obviously untrue. There are no homogeneous 'classes' of people acting as monolithic units. Instead there are individuals acting in their own best interests. The class notion is a construct of the mind.

Moreover, when an individual agrees to work for someone else, that individual is not being exploited. Both parties are engaging in mutually beneficial exchange. The exchange is voluntary, and both are free to negotiate the terms of the deal. Both parties can decline to trade, and they are free to associate with whomever they wish.

If a worker was being exploited by an employer, then that worker can walk away and associate with a different employer. If the employer was, say, discriminating against a worker because of age, skin color, gender, et al, then another employer would step in and capitalize on the bigotry by hiring the talent. The bigoted employer therefore operates at a competitive disadvantage.

In unhampered markets, bigoted discrimination is penalized. Bigotry can only persist in hampered markets which, by definition, are created by government intervention.

Rockwell suggests that class action lawsuits are a product of lawyers exploiting a group of people in order to pick deep corporate pockets. Perhaps, but one cannot dismiss the motives of the individuals who sign on as plaintiffs in the 'class.' Because people prefer to satisfy their needs using the least effort possible (a.k.a. the law of parsimony), then they will be prone to engage in activities such as class action lawsuits that allow them to 'get something for nothing.'

The Marxist concept of class can only exist by legislation that pits one group against another. It is a classic example of the State creating a problem that is purports to solve.

no positions


Marx, K.H. 1867. Das kapital, Vol 1. Hamburg: O. Meissner.

Marx, K.H. & Engels, F. 1848. The manifest of the Communist Party. London: Burghard.

Saturday, June 25, 2011

The Fed's Misdirection

Confusion never stops
Closing walls and ticking clocks

Another talking head that appears utterly clueless about Jim Grant's remarks on monetary policy. Grant notes that the Fed is now trying to 'enforce the symptoms of prosperity,' such as higher assets prices, without the underlying commensurate productivity.

Grant also astutely responds to the interviewer's comment about not giving the Fed enough credit for warding off deflation. The Fed's definition of deflation, notes Grant, is falling prices. Falling prices are in fact a natural outcome of a more productive society, and people spend large parts of their economic lives seeking to better their economic situation by buying goods and services at lower prices.

Central banks have fingered lower prices as the enemy, one that must be vigorously fought. The opposite is true. Falling prices are a gateway to higher standard of living. Our incomes can buy more so that we can satisfy our needs to a greater extent.

Of course, what the Fed is really concerned about is falling asset prices. This concerns the Fed for at least two reasons. Falling prices of things like stocks and real estate reduce what's known as the 'wealth effect,' a theory that posits people will spend more when their asset account balances are higher (btw, empirical evidence suggests that the strength of this relationship is quite weak). When consumption represents 2/3 of the economy as it currently does here in the US, then anything that weighs on consumption alarms bureaucrats who think that they need strong GDP numbers to win elections.

The larger concern about falling asset prices is that they stress leveraged systems toward insolvency. Leverage is using borrowed funds (a.k.a. debt) to magnify potential returns in the here and now. In investment contexts, leverage could drive higher returns on capital. In everyday life situations, leverage can promote higher standard of living today. An individual who borrows to buy a house is leveraged; this leverage is often assumed because the person wants comfort, privacy, et al that a house can provide.

But leverage works both ways. When asset prices decline, then losses decline. If there is much debt in the system, i.e. when systemic leverage is high, then it does not take much of a drop in prices to drive the value of assets below the value of liabilities, thereby creating a condition of insolvency.

This is what took out Bear Stearns and Lehman, and what brought the financial system nearly to a stop in 2008. If markets were left in their natural state, then market forces would have driven prices, debt, and leverage lower while driving savings rates higher until a certain balance was restored.

The Fed has been doing all it can to keep those market forces at bay. It has been printing $trillions to keep asset prices higher, buying distressed debt so that the debt does not get liquidated at lower prices, and fixing the price of credit near zero to encourage borrowing (certainly by the US govt) and keep leverage high. As Grant eloquently notes, 'The problem with the Fed generally is that it is imposing false values on a range of markets.'

At some point market forces, which continue to build potential energy as they are held back by monetary and fiscal intervention, will not no longer be able to be checked by the Fed and other central planners. Interestingly, this week Fed chair Bernanke confessed that he couldn't quite explain why economic 'headwinds' remain strong, which helped send his public approval ratings to all time lows. Not long ago this man held Man of the Year and superhero status).

When all of that potential energy finally turns kinetic, we may suddenly realize that it would have been much better to let the system balance out long ago.

position in SPX

Friday, June 24, 2011

The Correlation of Contagion

What do you do when you get lonely?
No one is waiting by your side
You've been running and hiding much too long
You know it's just your foolish pride
--Derek & the Dominos

Interesting discussion by Conor Sen on the set-up for a EU-based contagion now vs the housing/credit market contagion we experienced in 2008.

An important difference, he notes, is that in 2008 there was leverage across the board. Debt was piled high on consumer, corporate, and government balance sheets. He suggest that since then, corporate balance sheets have improved dramatically making them more capable of withstanding a credit event.

He does not discuss the changes in consumer and government balance sheets. Consumer balanced sheets have improved marginally as individuals begin to save and pay down debt. But governments have levered up as risk has shifted from private to public hands over the past few years. Systemic leverage has gone up.

The similarities between then and now include the persistent run-up in risk spreads despite interventionary efforts to put down problems. For example, sovereign yields of Greek, Spanish, and Italian sovereign bonds have been rising over the past year or so in the face of ECB interventions. Similar to 2008, Conor notes, stock markets have been basically chugging higher, basically ignoring problems in the credit markets.

The other similarity is interlinked and leveraged exposure to smoldering credit problems. Some institutions are long sovereign debt while others are short sovereign credit default swaps in a complex, levered manner that is difficult to figure out. The exposure reaches the US, including risk to cash assets. Approximately 40% of domestic prime money market funds are parked in unsecured European bank debt.

You would think domestic institutions would have sold off their Euro exposure by now in order to manage risk. Well, it so happens that in 2008-2009 we changed the accounting rules so that institutions could mark distressed securities as 'held to maturity' rather than having to market them to market in the 'assets for sale' category. Marking them to market would have meant lower values. When you're highly leveraged as banks are, lower values to balance sheet assets drive you toward insolvency. By designating securities as 'held to maturity,' institutions only need to recognize losses if cash flow issues drive them to sell.

It was this fun with numbers, extend-and-pretend approach that helped stave off a more severe decline two years ago. Consequences of that manipulation may now be coming home to roost, however.

Should an institution elect to sell 'held to maturity' securities before they mature, the accounting rules require that other assets in the 'held to maturity' category must be moved back to the 'held for sale' bucket, meaning that they must be marked to market once again.

Because marking them to market would require significant write-downs and threaten solvency, Conor suggests that institutions are 'not going to sell sovereign debt until they can't.' (nicely put) The important consequence of this is that banks seeking to reduce risk will instead sell correlated assets. This means that they might sell anything from corporate bonds to stocks in order to avoid a margin call or outright failure.

This is what a 'contagion' is about. Investors selling anything that isn't nailed down in order to stay solvent. Contagions cannot occur without leverage, or debt. The more debt that's in the system, the higher the chance that a deleveraging contagion will occur at some point.

As we noted above, while debt has been shifted around, the overall systemic leverage is high. The potential for contagion, thus, is also high.

position in SPX

Thursday, June 23, 2011

Blindness to Media Bias

We tried to speak between lines of oration
You could only repeat what we told you
--The Who

Juan Williams posted an interesting comment yesterday on his Facebook page. He said that after viewing the recent Jon Stewart/Fox interview and discussing it on a radio show, "it's just so clear that people who listen to one side or the other have trouble seeing political slant on their own side."

His comment builds on a recent post to these pages. The phenomenon is not peculiar to Stewart, nor to others in the media, nor to people in general. Psychologists have long recognized that humans selectively pursue information that confirms/validates their personal points of view. This tendency is known as 'confirmation bias,' or 'selective reasoning.'

A constant back-and-forth is evident today among media channels--one that volleys claims of 'our media outlet is the source of balance and truth while theirs is the source of bias and dishonesty.' Williams' observation above, that all seem blind to their own political slants, is wholly consistent with the volley. We should expect this behavior to be particularly evident in politics, where strongly held emotional beliefs tend to manifest. Emotion impairs reason and facilitates bias.

A few months back, we proposed that the media industry can be viewed as a market for biased information. People draw on media sources such as TV, radio, printed pubs, and web sources for information. Theory suggests that we will search for outlets that provide information that fits our view of the world. Because supply follows demand, various media outlets should arise to serve segments of consumers and their information preferences. 

Once we locate suppliers that tailor information to our comfort zone, then we will likely remain with those providers rather than engage in further search. In fact, consuming information delivered by alternative outlets may make us physically uncomfortable. Because humans generally favor pleasure over pain when filling their needs, we will be predisposed to stick with outlets that deliver information that confirms our views.

Perhaps the most robust finding in psychology is that people are generally overconfident and rate their capacity for judgment highly. This leads to an interesting irony. Although we are prone to engage in unbalanced, biased thought, we're liable to view ourselves as unbiased, critical thinkers! As such, we are likely to accuse others of biased thinking while not seeing it in ourselves (Juan's point above). We are also likely to belittle the media sources of others while elevating our own.

The theorizing above assumes that there is differentiation among media providers. In an industry with monopolistic tendencies, there will be less choice of information sources. In such a case, bias in others may be less evident because all are consuming similar sources of information.

It has been suggested that we're seeing more biased media today. If such a claim has validity, perhaps it is due to a freer, more differentiated media market. Cable television, the internet, and other innovations have broadened the spectrum of choice available to media consumers. For example, Fox News offers a source of information framed in conservative tones that was not available on TV fifteen years ago. This brand of information has attracted a large audience, to the point where Fox is now a dominant media force.

The quick rise of Fox suggests large pent up demand for conservative programming that was previously underserved. (Precisely why that market was underserved for so long is an interesting issue that we'll consider in a future missive.) Now, a media product with a conservative bias provides more contrast against media products with a liberal bias.

Stated differently, it is easier to recognize the bias in others more readily today.

Previously I've noted my respect for Juan Williams and his candid demeanor and insight. Snaps again in his direction...

Wednesday, June 22, 2011

More Fudge in the CPI Numbers

"You've been living in a dream world, Neo."
--The Matrix

As part of the federal budget talks, there is a proposal on the table to alter the way that the consumer price index (CPI) is calculated. Essentially, the proposed method would try to take into account the fact that consumers often trade down (e.g., go from steak to hamburger) when prices rise.

If passed, the alteration would make the 'headline' inflation number smaller.

Why is this on the table as part of the budget debate? Because a smaller inflation number would lower federal payouts (such as social security) that include cost of living adjustments. Viola! An instant $200 billion in budget savings.

This would not be the first time that the CPI has been dumbed down. There have been multiple changes to the methodology over the past couple of decades. The weird (criminal) thing is that when the goverment changes the method, they do not go back and alter the historical series. Those looking at historical CPI data are not comparing apples to apples (the same is true for unemployment, GDP, and other measures). If we were measuring the CPI the same way as in 1980, the headline inflation number would be nearly triple the currently reported level.

How such a practice is viewed as legitimate and is tolerated is beyond me. If I had tried to manage measurement systems like this during my industry days, then I would surely have been fired.

Make sure you understand the dynamic here. The federal government is printing money, which undermines the value of the dollar. Government officials are then supressing the metric that is supposed to reflect the dollar's value, effectively under-reporting reporting the inflationary consequences of their activities.

I continue to shake my head in disbelief at those people who see the widening income/wealth chasm as driven by 'big bad business', the private sector rich, et al. They fail or refuse to recognize the impact of government policies such devaluing the currency on real income inequality. Inflation guts the wealth of savers, and transfers it to those with political interests. Those at the bottom of the economic pyramid are hit especially hard in this regard...and the divide widens.

Greece Fire

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

Mises observed that debating the long term benefits of capitalism vs socialism was a waste of time, because socialism as a concept could never be reached in reality. Long before reaching a socialist endpoint, the system would plunge into chaos resulting from economic squalor.

Greece provides a real time example of a socialist system coming apart at the seams. The almost comical efforts of EU bureaucrats to keep the wheels on the wagon symbolize the utter folly of the concept of socialism.

Because similar socialist designs are scattered throughout the EU, it is also folly to think that Greece is an isolated problem. The Greeks are merely the lead traveler on the Road to Serfdom.

no positions

Tuesday, June 21, 2011

Courting the Jester

Clowns to the left of me, jokers to the right
Here I am, stuck in the middle with you
--Stealers Wheel

Yesterday, my sister posted a Washington Post blog about a recent interview between Jon Stewart and some interviewer on Fox. It was interesting to me because the discussion centered on the topic of media bias, a topic that occaisionally colors these pages (e.g., here, here).

When asked whether he thought outlets like ABC, NYT et al were biased, Stewart responded that he thought so, but that the bias was not 'towards a liberal agenda.' Instead, he said the bias was toward sensationalism and laziness.

Moreover, when it was suggested that material on his show seemed to reflect political commentary, Stewart responded that the interviewer was 'insane,' claiming that he was a 'comedian first.' He did admit that his 'comedy is informed by an idealogical background,' but insinuating that this makes him a 'political player' is 'dead wrong.'

I found it amusing that even though JS acknowledges that his professional output is influenced by his political ideology, he does not view his product as politically biased. Were I asking the questions, I would have probed just how Stewart thought that this could reasonably be concluded as true. I would think that a straightforward content analysis of Stewart's show material would indicate a significant volume of content geared toward political topics, and that the lion's share of the show's political content favors the Left at the expense of the Right. His claims of not being a 'political player' also seem funny in light of his involvement in a major political rally in DC last fall.

Then again, JS is a self-professed comedian, so me finding these things amusing and funny must mean that he's doing his job.

One other noteworthy portion of this interview was Stewart's reference to Fox as a 'relentless, agenda driven, 24-hour news opinion propaganda delivery system' while implying that the other outlets in question, including his own show, were nothing of the sort.

Seemingly, he is suggesting to the interviewer that 'you and your organization are politically biased, but I myself and my affiliations are not.'

Which qualifies as the funniest line I've ever experienced from this jester.

Break Dancing

When it feels like the world is on your shoulders
And all of the madness has got you going crazy

Learned via Bill Fleckenstein today that Jim Grant, in his most recent newsletter, has observed that US money market funds have substantial fractions of their assets invested in European bank debt. Many money fund managers have been extending themselves abroad in search of yield, given the Fed's suppression of short rates to essentially zero.

The five largest domestic money market funds (three at Fidelity, one at Vanguard, one at Blackrock) with about $400 billion under management have about 45% of their assets in Euro bank paper.

If a credit crisis commences in Europe on the back of sovereign debt probs, then the spectre is raised that collapsing Euro bank paper could pressure net asset values of US money market funds to the point where they could 'break the buck' (fall below the $1 unit value). This occured to a small degree two years ago here in the US.

The implication is that US investors should make sure that they understand the nature of their cash holdings. Some funds may be FDIC insured. Current insurance amount, which was raised during the recent credit crisis, is $250,000 per depositor per insured bank.

For cash holdings that exceed the insurance limit or that are not covered, then the strategy should be locating the safest principal preserving vehicle possible. For those who are capable, this might mean parking cash in 1 to 3 month T-bills. They yield next to nothing but likely reflect the surest bet on preservation of principal.

Some believe that the US government would intervene should US money market funds begin to feel stress. Based on history, that may be a good bet. It is also one of the reasons why moral hazard is so high among bank depositors. As a class, depositors are largely clueless of the issues discussed here since they figure that the government has their back.

Monday, June 20, 2011

Past is Present

"Everyone is drinking the same Kool Aid."
--Gordon Gekko (Wall Street II)

This has to be today's headline of the obvious. Greece's probs could result in contagion? Really?

Peter Atwater writes this morning that it seems more like 2008 each day. The risk from 2008 has not gone away. In fact, it is bigger. And it has largely been transformed from private to public hands.

Risk has been socialized.

This is why we're now seeing stress at the country level. By socializing risk, we bought some time. But socialized risk has no place to turn for relief when the bills come due. And they are starting to come due.

There are two basic choices. Dial back on standard of living and start living within (or below) one's means while paying off debt. Or default--either thru refusing to pay debt, or in the case of countries that own a printing press, by paying off debts thru freshly printed paper.

I've watched Wall Street II a few times over the past couple of months. The movie does a nice job of capturing how it felt when credit markets were melting down in '08. I want to remember what it feels like so that my brain doesn't freeze should things start coming apart again.

position in SPX

Sunday, June 19, 2011

A Look at Federal Taxes

Let me tell you how it will be
That's one for your nineteen for me
--The Beatles

The federal government has two primary ways to obtain economic resources. It can print money, thereby obtaining instant claims to resources that it did not create. Or it can appropriate economic resources directly from the people in the form of taxes.

For the first century or so of the country's existence, the federal government's capacity to tax was Constitutionally limited. Article 1, Section 9 restricted the central government from levying taxes directly on the people except for a head tax. Through the 1800s government inflows were confined mostly to ad valorem taxes and asset sales.

That all changed with the 16th Amendment, which permitted the federal government to tax income at its discretion.

Once the feds knew what they had, spending and debt have never looked back. (Source for the following data is the OMB website.)

Receipts and outlays exploded almost overnight, and helped fund a world war:

Of course, those early increases don't even show up as blips on a graph of the past 100 yrs given the massive increases in receipts and outlays over the past few decades:

Observe the widening chasm between receipts and outlays (about $1.3 trillion in 2010). The difference must be funded by either debt or money printing. We've been doing both.

There are many who think that the difference should be closed by increasing the tax burden. In 2010, federal government receipts totaled about $2.1 trillion, about 15% of GDP. Inflows on both an absolute and relative level are down slightly over the past two years--presumably because of a slower economy and less income to tax.

Individual income taxes and social security taxes each constitute about 40% of total receipts with corporate taxes composing another 10%. The remaining 10% is a blend of excise taxes and other revenue sources.

Since 1944, total government receipts as a fraction of GDP have been relatively stable, varying between 14% and 21% of GDP. The average is during this period is 17.8%.

Individual income taxes have largely varied between 6% and 9% of GDP, averaging 8.0% for the period. Social security taxes have trended up during the period while corporate taxes have trended down.

It is also readily visible in the above graph that the variance in overall inflows mirrors changes in individual income taxes. This is because of the gradual and opposite trends in social security and corporate receipts, along with income tax's major 40% role in overall inflows.

One final note before doing some math. The data above reflect federal government inflows only. If we add state and local receipts, the tax burden almost doubles. In 2010, total government inflows at all levels amounted to about $4.2 trillion, or about 29% of GDP.

Sourced from this nice analysis, here is a graph of overall government receipts:

Once again, note the step up after ratification of the 16th Amendment in 1913. It's been an uphill trip since, with only the occaisional economic slowdown slowing the ascent.
OK. The thesis by some is to close the federal government deficit by increasing individual income taxes. The federal deficit in 2011 is projected to be about $1.6 trillion. In 2010, individual income tax receipts totaled just about $900 billion. Eliminating the estimated 2011 federal deficit soley thru higher income taxes would require collection of $2.5 trillion from the people--about a 180% increase.

Tea stained Boston Harbor for lower tax hikes.

Which raises an interesting question. Just how much more could the federal government raise taxes if it wanted to? A theory often credited to economist Arthur Laffer posits that government tax rates pass through a maximum that is neither economically nor politically expedient to exceed.

Some believe that the federal government has already reached its taxation capacity. For example, Hauser's Law (named for some consultant in the 1990s who observed the phenomenon), says that the stable overall inflows as a % of GDP is empirical proof positive that that the federal government has reached the upper bound for taxation. This upper bound might reflect lower economic productivity as tax rates rise, tax payers exploiting loopholes in the tax code, and/or political fear of angering the taxpayers who are also voters.

Perhaps politicians are keenly aware that higher taxes and revolution are in this country's formative DNA.

Friday, June 17, 2011

Cooking the Goose

It happened one summer
It happened one time
It happened forever
For a short time
--The Motels

Insightful piece by Frank Shostak. He observes that economists, politicians, et al. who are elevating 'job creation' as the number one priority in getting the economy moving misidentify the key driver of economic growth. The main driver of economic growth is not reducing the number of unemployed. Economies grow in sustainable fashion through an expanding pool of real savings.

Savings is income that is set aside rather than consumed. When projects to create or improve new products and processes appear to offer an attractive risk/reward profile, then people will invest some of their saved economic resources toward these projects. This fraction of savings is called capital. Capital expands and enhances the infrastructure used to produce the goods and services linked to standard of living.

The chain goes like this: real savings --> capital for investment --> enhanced productive infrastructure --> better goods and services --> higher standard of living.

Please note that stimulus programs, tax increases, money printing, et al are not part of this chain.

Jobs that enhance individual purchasing power come from the expanded industrial infrastructure. The better the infrastructure, the more output an individual can generate. Higher productivity commands higher wages in terms of purchasing power.

It is saving, therefore, that creates jobs.

Our problem, of course, is that savings in the US have been in secular decline. There is a dearth of real savings to deploy in capital investment projects.

Yet, Washington bureaucrats and their economic advisors continue to enact monetary and fiscal policies that discourage rather than promote savings. A glaring example of this is the Fed's zero interest rate policy (ZIRP). ZIRP's expression at the retail level is yields on savings vehicles near zero percent. Prospective savers are motivated to do something else with their income--namely spend (consume) it or take risk with it even if the risk/reward profile appears unattractive.

Loose monetary and fiscal policies divert real savings away from wealth generating activities. Money-printing, taxation, and government spending programs confiscate remaining pockets of real savings from their owners. This wealth is transferred into the hands of bureaucrats and their interests, where it is spent under the guise of 'economic stimulus.'

What these programs constitute is capital consumption. When savings is spent, economic recovery (and job creation) is pushed farther out into the future.

As kids we learn the story of the goose that lays the golden eggs. If you cook the goose because you are hungry today, then there is no wealth tomorrow.

Savings is the goose, and it is being cooked.

Thursday, June 16, 2011

Socialism and the Pathology of Resentment

Well a good man pays his debt
But you ain't paid yours yet

There are two general ways of economic organizing. Capitalism (a.k.a. free or unhampered markets) puts ownership and control of production in private hands. Producers take signals from the market to determine the best approach for converting inputs into outputs.

The other way is socialism (also known as central planning or planned economy). In this system, ownership and control of production is in public hands (it is 'socialized'). A group of people, the 'central planners,' draw from their own resources (knowledge, experience, special interests, etc) to determine what should be produced, how much should be produced, and for whom.

When socialism began attracting serious attention in the mid-late 1800s, proponents claimed that this approach to economic organizing would elevate standard of living beyond the capacity of capitalism. Not only would resources be distributed more evenly (a.k.a. 'social justice' in today's parlance), but on average all would be better off.

During the next few decades, serious thinkers, particularly those of the Austrian economic school, tossed that theory onto the intellectual scrap head of history. A critical problem with socialism is that there are no price signals by which producers can effectively allocate resources. Moreover, bureaucratic planners are unlikely to match the speed with which capitalist systems, with its myriad actors each acting in their own self interest, correct for error and adapt to environmental change.

Socialism, concluded the thinkers, is more likely to result in squalor because economic resources would be grossly and persistently misallocated. Mises concluded that achieving the socialist ideal would not even be possible before the system dissolved into chaos. Empirical observations drawn from actual socialist systems (e.g., USSR, North Korea) provide confirmatory evidence in this direction.

Proponents of socialism have thus had to change their tune. Perhaps standard of living w.r.t. material goods will not be higher under socialism, they admit. But because those on the lower end of economic pyramid will be elevated and those at the higher end will be lowerd, then the system is justified. Besides, when people realize that they are no better off than their neighbors, then demand for economic goods will likely decline anyway.

Such claims, of course, do not square with basic axioms of human behavior.

Mises also suggested that proponents of the socialist argument may suffer from a pathological mental attitude of resentment. They resent, and perhaps envy, those who are better off. Socialism provides a mechanism for pathological resenters to obtain emotional satisfaction as they observe the rich suffer in an outsized fashion.

Mises may have a point. After all, it is easy to amass a mountain of 'journalistic' evidence that paints wealthier people as enjoying excessive or unfair advantage. I found these three examples (here, here, here) in about 30 seconds. The tone/one sidedness of the commentary is consistent with a resentful, envious tone.

As sagely observed by Mises, the reason why such resentment and envy may be pathological is that the socialist's prescribed solution for those who are less well off is to worsen the position of better situated people. A well reasoned person is more likely to conclude that the most effective way to deal with this situation is not to worsen the position of those better off, but to proactively improve one's own position.

On the other hand, because people are naturally attracted toward getting something for nothing, there may be no pathology in wanting to the soak the rich. Instead, it is perhaps a sensible approach for getting more wealth at the expense of less effort.

Of course, those who take this path are condoning the use of force to acquire the wealth of others. Justifying (rationalizing) such action once again suggests the possibility of a resentment-oriented pathology.

Wednesday, June 15, 2011

All the King's Horses

I watched you suffer a dull aching pain
Now you decided to show me the same
--Rolling Stones

In the summer of 2007, stock markets showed early warning signs that something was going on in the credit markets. Led by the banks, we had a few big down days in July/Aug.

I happened to be in NYC at the time and recall that, while there was some palpable concern among traders, many viewed the bearish action as a minor, necessary correction to relieve overbought conditions in what had been a strong multi-year uptrend. A stroll thru Midtown certainly did not suggest that luxurious lifestyles had taken much of a hit yet. Excess was still visible everywhere.

One rationale offered by the bulls was that it was the year before an election year, and that the Bush/GOP political machine would pull out all stops to keep markets from falling. After the summer swoon, markets indeed reversed higher. In fact, the S&P 500 (SPX) notched a marginal all time high in early fall.

After that, however, things came unglued. For most of the following 18 months, stocks cratered alongside the credit markets, lopping more than 50% off the value of the SPX.

It is safe to say that maneuvers employed by politicians to keep things 'contained' (and they used that word alot) were not very effective.

So here we are four years later. Markets softened back in March and then ralled to marginal highs for the move off the early 2009 lows. Prices have given back more than 7%. From a macro standpoint, we have the end of QE2, data suggesting a softening domestic economy, a sovereign debt crisis in Europe, and stress cracks in the Chinese machine. As a whole, this constitutes a big stinking mass of bear fodder that could/should propel markets much lower.

Yet, similar to four years ago, many have been trotting out the year-before-the-election-year rationale once again. Obama can see his poll numbers sliding w/ the weaking economic picture, the thinking goes. He and his political machine will therefore pull out all stops to keep things afloat into next year's election.

I have no doubt that many political stops will be pulled--some perhaps more extreme than we've seen already (and that's saying something). Whether those stops will 'stop' the bleeding is another question entirely, as our analog four years ago suggests.

Can't shake the sense that all the king's horses and all the king's men will once again prove ineffective in parrying the corrective forces of markets seeking balance.

position in SPX

Default by Default

Well if you don't have the answer
Why are you still standing here?
Hey, hey, hey, hey
Just walk away
--Kelly Clarkson

When you have borrowed more than your income will allow you to comfortably pay back, you face three choices. One is to borrow even more, assuming that creditors are stilling willing to lend to you. A secone choice is to lower your standard of living so that you can allocate more of your income to debt service. The third choice is to default on your loan.

In the first case, you are merely kicking the can down the road while facing larger payback obligations. In the second case, your standard of living falls. In the third case, the creditor's standard of living falls. In all cases, there is likely to be a drag on economic progress. In fact, collective standard of living will probably fall.

These choices now confront much of the world. Greece is a microcosm of the situation. The people of Greece have borrowed extensively to elevate their standard of living far beyond that which income from productive effort would permit. The Greeks want to borrow even more to sustain their condition. Unfortunately, the bond market no longer believes that the Greek condition is indeed sustainable and has effectively shut the country off from further credit.

To frame it in terms that we in the US might currently relate to, Greece would like to 'raise its debt ceiling.' Unfortunately, lenders refuse to offer any more loans.

As such, the first choice elaborated above is unavailable to Greece.

The Greeks do not appear to want to lower their living standards, as demonstrated once again yesterday by yesterday's riots. The second choice therefore seems unlikely either.

Quite appropriately, by default (!) this leaves the third choice: default.

no positions

Tuesday, June 14, 2011

Sentimental Journey

'Cause, you're emotion in motion
My magical potion
You're emotion in motion
To me
--Ric Ocasek

Anyone looking at a chart of stock prices can see that markets move in ebb-and-flow cycle patterns. In fractal-like fashion, cyclical patterns reveals themselves across various time frames--from granular minute-to-minute action to secular decade-long swings.

The nascent field of socionomics equates cycles with changes in 'social mood'--alternating periods of collective optimism and pessimism that cause investors to run with the pack (a.k.a. 'herd behavior').

Here is an interesting diagram that reflects various emotional states as a market cycle progresses. Note that extreme optimism is associated high risk. This is because euphoria has driven investors to bid up prices. At some point, extreme optimism reverses as do prices.

This model suggests that best value is obtained at lows in the sentimental cycle. Extreme pessimism drives investors to sell and to stay away from assets marked way down.

I personally find it useful to overlay these concepts on my fundamental analyses. For example, a question that I've been asking myself over the past couple of weeks is where on the diagram is general stock market sentiment currently?

We entered a bullish uptrend off the March 2009 lows. Since then, markets have been rising on increasing optimism. This has been a strong bull run, with major indexes like the S&P 500 (SPX) up nearly 100% off the lows. Now, however, the uptrend is more than 24 months old and general market valuations are extremely rich. Technically, we're approaching a level (SPX 1250) which, if decisively pierced, would reflect a trend change.

From where I sit, collective sentiment may have topped out at 'Euphoria' at the end of April (approx SPX 1370). Investors are currently at 'Anxiety' after a 7% decline from the highs. If correct, then we have more work to do on the downside. Stages of fear, panic, capitulation (e.g., 'forced selling') lie somewhere ahead. I have been trying to position accordlingly.

I'm not totally pessimistic, however, as some individual names have been beaten down to the point where the negative sentiment coupled with interesting fundamentals suggests value. Cisco Systems (CSCO) is one of those names.

Over the past few months, CSCO has reversed nearly all of its gains off the 2009 lows as recent quarters have fallen short of expectations. Sentiment in this name is horrid, and portfolio managers have been busy unwinding positions in CSCO as prices go down.

Our diagram, of course, suggests that extremely negative sentiment is likely to wring risk out of a security. Pessimism encourages selling over buying. All else equal, the lower the price of a security, the better the value.

I happen to believe that CSCO's competitive advantage is still intact and durable. Using similar reasoning to my entry into this name, I now think I can buy a large multinational company with a durable franchise, strong balance sheet, and $9 billion in free cash flow, that I conservatively value at $90 billion, for a market price of about $60 billion.

The risk, of course, is that the fundamentals of the company have been permanently impaired, and markets are in the process of revaluing the franchise.

Could be, but the current disparity (market says it's worth $60 billion; I think it's worth $90 billion), gives me a decent margin for error in my assessment.

position in CSCO, SPX

Monday, June 13, 2011

Fading Bonds

So glad we've almost made it
So sad they had to fade it
--Tears for Fears

Just a note for future reference. While speaking to my buddy Jeff Macke, Jim Rogers noted that he began shorting US govt bonds today.

He's definitely trying to fade near term strength.

no positions

Credit Default Swap Round II

Look around everywhere you turn is heartache
It's everywhere that you go
You try everything you can to escape
The pain of life that you know

John Mauldin shares analysis suggesting that, while Euro banks stand to lose big time in the event of sovereign debt defaults in the EU, US financial institutions are likely to fare just as poorly. This is because US institutions have been primary sellers of credit default swaps on EU sovereign debt.

Of the approximate $1.2 trillion in sovereign debt issued by Greece, Ireland, and Portugal, US institutions have indirect exposure via CDS of about $120 billion.

Hopefully you can connect the dots. Big EU bond 'restructurings' (a.k.a. defaults). CDS owners files claims w/ US insurers. US insurers lack capital to cover claims. FDIC steps in. US citizens fund another bailout--this one arguably on foreign soil.

position in SPX

Saturday, June 11, 2011

Implied Power

Drawn into the stream of undefined illusion
Those diamond dreams, they can't disguise the truth
--Level 42

In his monologue, Judge Nap notes that almost as soon as the Constitution was ratified, big government proponents such as Alexander Hamilton began suggesting that the federal government had 'implied powers'--powers that were not written in the Constitution yet somehow there.

It is upon the agument of 'implied power' that snippets of language from the Constitution, such as the 'clauses' of Article 1 Section 8 (e.g., the Commerce clause, the General Welfare clause), have been evoked by lawmakers and judges to justify the expansion of federal government scope.

Such a justification could make sense only to people with no reasoning power whatsoever (or, of course, to those who stand to benefit from more government power).

The Constitutional Convention lasted four months, during which time the framers debated and carefully specified the limitations to central government power. The subsequent ratification process took close to another debate-filled year.

It is likely that the Constitution would not have been ratified if there was not an agreement to amend the Constitution with even more specification of individual rights and the limits of government power. The last of these ten amendments states that powers not delegated to the federal government by the Constitution go to the individual states and their people.

How could a process that meticulously focused on limiting central government power produce a framework that can legitimately be interpreted as being open ended--granting government powers that heretofore had been unspecified? Stated differently, why would those involved in the Constitutional development and ratification process waste their time? Why debate and limit if the intent was to subsequently permit arbitrary expansion of power?

It makes no sense, of course. The Constitution was written and ratified because the people wanted hard restrictions on central government power.

Once this situation is thought thru, only those who reap windfalls from increased government power will be prone to conclude that 'implied powers' are valid.

Thursday, June 9, 2011

Rogers Rounds

Dr Peter Venkman: This city is headed for a disaster of biblical proportions.
The Mayor: What exactly do you mean, 'biblical?'
Dr Ray Stantz: What he means is Old Testament, Mr Mayor. Real wrath of God type stuff.
Dr Peter Venkman: Exactly.
Dr Ray Stantz: Fire and brimstone coming down fromt he skies! River and seas boiling!
Dr Egon Spengler: Forty years of darkness! Earthquakes, volcanoes...
Winston Zeddemore: The dead rising from the grave!
Dr Peter Venkman: Human sacrifice, dogs and cats living together...mass hysteria!

The alway interesting Jim Rogers has been making the rounds recently, here at WSJ and here w/ a raspy Maria. JR has little doubt that the US is headed for crisis much larger than the 2008 edition. His time window for arrival seems to be between 'this fall' and 'the next 5 years.'

He's offsetting his longs in commodities, Chinese stocks, and select currencies (including the USD for a trade) with shorts in emergining markets and US tech.

When speaking w/ Maria, JR also revealed that he's short 'one major American financial company.' When pressed for more details, he admitted that 'it's the bank that hasn't gone down as much as the others.'

Any guesses on which bank he's short? I have mine...

position in commodities, SPX

Wednesday, June 8, 2011

Point of Know Return

Today I found a message floating
In the sea from you to me
You wrote that when you could see it
You cried with fear, the point was near

The below chart, taken from this article, shows total US debt among select countries. Total debt is broken down into categories of government, non-financial business, households, and financial institutions.

In 2009, total US debt amounted to nearly 3x GDP. Since then, government debt has probably gone up relative to other categories as we increasingly socialize risk.

According to the author, the pink line at 260% represents the all time record for debt repayment, accomplished by England between 1815 and 1900. Can't substantiate the source, but the notion that there is a level of debt that constitutes a point of no return is certainly consistent with the recent work of Reinhart of Rogoff (2009).

The author observes that these debt numbers do not include entitlement liabilities (e.g., Medicare, Social Security). Were these liabilities factored in, then total liabilities to GDP shoots to 6-7x or higher.


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

Fed Leverage

The less we say about it the better
Make it up as we go along
--Talking Heads

Since 2007, assets on the Federal Reserve's balance sheet have expanded from $850 billion to $2.8 trillion. At the end of April, the Fed reported assets of $2.695 trillion against capital of $53 billion.

That's a 50:1 leverage ratio. Bears Stearns and Lehman were leveraged about 30x before they imploded.

At 50x leverage, prices need only go against you by 2% before equity is wiped out.

Of course, the Fed does not have to worry about insolvency risk. That risk has been transferred to us.

no positions

Tuesday, June 7, 2011

Distortion in Large Portions

Out of the blue and into the black
You pay for this and they give you that
And once you're gone, you can't come back
When you're out of the blue and into the black
--Neil Young

In unhampered (a.k.a. free) markets, interest rates signal the state of savings supply and demand. Low interest rates reflect high supply of savings available for investment relative to demand. Borrowers are motivated to borrow at attractive rates. Entrepreneurs use these borrowed funds to lengthen the capital structure of industries.

Individuals are less motivated to save when interest rates are low. The market's 'invisible hand' diverts economic resources away from savings channels when the returns associated with savings are perceived as small. 

Over time, fewer resources allocated toward investment pressures interest rates upward. After all, savings have become more scarce--less inflows from savers, more outflows from borrowers. On the demand side, fewer projects are likely to look attractive from a risk/reward standpoint because the cost of funds is higher. Demand is likely to be limited to only the most attractive projects.

High interest rates signal a low supply of savings relative to demand. The invisible hand is at work once again, this time encouraging individuals to allocate more economic resources toward savings channels.

Because standard of living is directly tied to level of saving and investment over time, interest rates constitute one of the most important price signals on the market. In order to ensure the most effective allocation of economic resources possible, then the interest rate signal needs to be as true as possible.

In today's hampered system, however, it is difficult to imagine how much more distorted the interest rate signal can be. Central banks have been manipulating money markets for decades, primarily by suppressing interest rates below 'free market' levels.

The low interest rate signals have had predictable effects. Borrowers have borrowed $trillions at low borrowing costs. Capacity in many sectors has exploded higher.

Savings, meanwhile, have been in secular decline, as individuals have little incentive to set economic resources aside.

We now face a situation where there is little or no savings to support real capital investment for the future. And our incomes are not large enough to service payments on what we have borrowed.

Default seems immenent. And with it, collectively lower standard of living.

A sad state largely attributable to senseless distortion of the interest rate signal.

Monday, June 6, 2011

Magnet and Steel

Now I told you so you ought to know
It takes some time for a feeling to grow
--Walter Egan

A few days back we wondered whether the major indexes might not have a date with the uptrend line off the Spring 2009 lows. For the S&P 500 (SPX), that uptrend line marks at about 1250 currently.

Since then, markets have continued to trade heavy, putting that 1250 level all the more in play.

Shorter term technical analysis provides more suggestive evidence. Multi-month horizontal support highlighted by the lows last March and the 200 day moving average intersect at ~1250.

While many short term indicators suggest an oversold tape, 1250 may be the magnet for a steely SPX.

position in SPX

Farmers Market Mechanism

Happy ever after in the market place
Desmond lets the childern lend a hand
Molly stays at home and does her pretty face
And in the evening she still sings it with the band
--The Beatles

For the past couple of years, my neighborhood has sponsored a farmers market on Sundays. This year, the weekly market will be set up in the town square.

Markets are often explained in terms of sellers and buyers. For instance, markets are often defined as places where sellers and buyers come together.

In the farmers market case, the sellers are customarily considered to be the farmers with their produce. The buyers are viewed as the neighborhood folks heading to the square with cash (broadly defined) in hand.

Generally, then, sellers are typically seen as those who bring goods and service to the market; buyers are those who bring the money.

But what exactly is money? It's often defined as a medium of exchange. But corn or apples are also mediums of exchange.

At its essence, money in the form of paper or coins is meant to represent a portion of income from productive effort. One dollar might represent 4 ears of corn from a farmers' production, or a fraction of a customer service representative's phone conversation assisting a client. It is the fungibility of paper or coins money that makes it a desirable proxy for income in social situations.

Typically, then, a farmer is seen as 'selling' 4 ears of corn to the customer service rep, who 'buys' them with a dollar bill. Just as accurately, however, the CSR can be seen as 'selling' the fraction of a service call to the farmer, who 'buys' the call with 4 ears of corn.

Precisely who is the seller and who is the buyer seems a subjective matter.

More accurately, then, markets are places of trade or exchange. In market exchanges, people trade portions of their income or (when the paper or coin money used in trade is created by fiat) claims on other people's income.

Viewed thru this lens, sellers and buyers do not populate markets. Traders do.

Sunday, June 5, 2011

Student Union

Richard Vernon: Now this is the thought that wakes me up in the middle of the night. That when I get older, these kids are going to take care of me.
Carl the Janitor: I wouldn't count on it.
--The Breakfast Club

Last week in one of my summer classes, I offered an impromptu extra credit assignment on the definition of a market bubble and its causes. The following session, discussion of student findings morphed into an interesting back and forth on our current economic situation and the role of policy decisions such as QE2 in helping or hurting the situation.

Once engaged, students asked thoughtful questions and voiced viewpoints that, if permitted, would easily have chewed thru our entire 2.5 hr class session. Some samples:

"How can the actions of QE2 be legal?"
"Can't we just keep borrowing and live in a situation of ever increasing debt?"
"Why can't we just raise taxes to pay off the national debt?"
"How can I protect my personal situation in case things get really bad?"
"Because banks are not lending, why can't we just give money directly to small businesses and job creators?"

When considering the situation we currently face, it is easy to slip into a state of despair. However, witnessing the level of engagement and concern exhibited by these college students is evidence that the situation is not as hopeless as it seems.

Multiply the energy of this group and you get social power. Social power is man's conquest of nature, with abundance achieved thru productive means. Its antithesis is political power, where the coercive power of the State is employed to acquire wealth.

Social power is amassed through a free thinking people. It is based on thinking thru a situation and arriving at one's own conclusions. It is not dependent on what others are thinking. Leaning on the views of others generates conditions of dependency--just what political power wants.

As such, I urged students to seek out all perspectives on our economic and fiscal situation. If they find a certain viewpoint, seek or argue the opposite. Process all info against capacity for reason.
Because we had other things to do during the session, I promised that I would post some additional charts related to our discussion. I've done that here.

Saturday, June 4, 2011

Defensive Posture

Ooh a storm is threatening our very lives today
If I don't get some shelter, oh I'm gonna fade away
--Rolling Stones

The last couple of weeks has found me selling strength in pursuit of a more defensive posture. Current asset allocation is:

stocks  18%
fixed income  4%
alternative assets  18%
cash  60%

Alternative assets are composed of 8% commodities and 10% short equity. Because my fixed income is in short duration insured instruments (i.e., 'risk free'), then I estimate my net risk or net market exposure at about 16% (18% stocks + 8% commodities - 10% short equity).

Am increasingly watching the Greece/EU situation with a certain sense of deja vu toward 2007. Massive debt, intertwined banks, and unknown but likely large derivatives exposure. While some markets have been flashing warning signals (e.g., 10 yr Treasury yields, swiss franc), most markets have been trading in a benign state of denial.

From where I sit, probability of a deflationary downdraft is increasing, and the time horizon is dead ahead.

As such, I would like to reduce my net market exposure even more. I might do this by selling strength should stock/equity markets rally further, or by increasing my short position.

Friday, June 3, 2011

Consent of the Governed

"Knights, the gift of freedom is yours by right. But the home we seek is not in some distant land. It's in us, and in our actions on this day! If this be our destiny, then so be it. But let history remember that, as free men, we chose to make it so!"
--Arthur Castus (King Arthur)

As the judge explains, each of us has been endowed with a set of unalienable rights. Among them, as famously noted by Jefferson, are life, liberty, and the pursuit of happiness.

These rights can be broadly construed as property rights. Each of us owns our lives, our wherewithall to produce, and the income from our productive endeavors.

Whether using a theological or biological explanation for their existence, these rights come from within us--they are 'natural.' They are not given to us by government or by other people.

When people try to rob us of our rights, we are justified in using force to defend our property. However, because the force of perpetrators can exceed our defensive capabilities, we may designate some individuals to serve as our agents to help us, as Jefferson noted, 'secure' our individual rights. We lawfully transfer some of our power to these agents so that they can help us better protect our natural rights.

Collectively, these agents are 'government.' These agents operate, per Jefferson, with our consent. This consent is reflected by the Constitution, which represents a social contract between the people and the government populated with our agents

The judge's commentary poses an interesting question. If the government claims its authority through the social contract which is the Constitution, and this contract reflects the consent of the governed, then how can the Constitutional contract be valid today? After all, none of us were around when the contract was originally ratified.

By my way of thinking, a broad social contract like the Constitution can only be considered valid from one generation to the next if the contract confines government to upholding natural laws that cannot be contested. For instance, just as none of us has the right to lawfully steal from each other, government does not have the lawful right to take property from individuals under threat of force.

There is no way that a social contract that specifies government to forcefully advance the wealth of some at the expense of others to be valid over long periods of time, since some people would surely not consent to such a contract.

The Constitution as originally written respected the natural rights of individuals and limited the scope of government to protecting these rights. Not consenting to these terms reflects a desire to infringe on the rights of others which, of course, is unlawful. Thus, the Constitutional contract can be seen as perpetually valid through the eyes of lawful individuals.

However, there is a case to be made that changes made to the original Constitutional contract since its inception are indeed invalid. The Sixteenth Amendment, for example, appears wholly inconsistent with the natural rights framework upon which the original consent of the people was based. It is hard to believe that the original Constitution would have been ratified by all states had the federal government been authorized to tax income.

When government agents violate the terms of the agreement, then the social contract has been breached. It is then morally and ethically justified for the people, using Jefferson's magnificent words, 'to throw off such Government, and to provide new Guards for the future security.'

In such a case, the contract does not change. The agents do.

Missing Work

Every time I think of you
I always catch my breath
And I'm standing here, and you're miles away
And I'm wondering why you left
--John Waite

Big miss in the jobs number this am. And it should be noted (because most mainstream media won't), that the 54,000 number includes 206,000 estimated jobs created using the laughable 'birth/death' model of the BLS.

Over the past 3 years, government has borrowed and spent $trillions, and printed and spent $trillions more largely in the name of 'creating jobs.' Yet, anemic employment persists despite the federal government's best efforts to paint the data pretty.

Those who have put themselves in charge of 'creating jobs' (a charge, btw, that is not granted by the Constitution), seemingly face one of two courses of action from here. One is to conclude that this intervention is not working and that government should step back and do less. Let people and the markets they create work things out.

The other course is to conclude that the $trillions in intervention is simply not enough and that government needs to escalate its involvement in the economy. Increase bureaucratic influence on the economic relative to people and markets.

Which course do you suppose government officials will select?

Thursday, June 2, 2011

Moody's Blues

A thousand miles can lead so many ways
Just to know who is driving
What a help it would be
--Moody Blues

Today Moody's indicated that it will put the Aaa credit rating of the US under review unless there is progress on increasing the federal debt limit by mid July.

I actually had to re-read the article to make sure that I was grasping this correctly. Unless I am still not getting the gist, Moody's is saying the credit rating of the United States may go down if the country does not borrow more.


At least the 'negative outlook' issued by S&P back in April was more correctly centered on rationale that the US needs to reduce debt.

It's tempting to view Moody's statement as politically motivated, as it surely is not grounded in reason.

Wednesday, June 1, 2011

Melting Yields

I saw the world thrashing all around your face
Never really knowing it was always mesh and lace
--Modern English

Related to the previous post, what is the Treasury market telling us here? 10 yr yields have been falling, and today gapped lower south of 3%.

On the surface, this suggests an intensifying 'risk off' deflationary context.

Then again, this market is so manipulated that any signal may be drowned in noise...

no positions


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

After yesterday's nice move higher, domestic equity markets revealed their bipolar side w/ a nasty drop today. The Dow was down about 280, which is the largest single day point drop in some time.

Am starting to wonder whether the major indexes might not have a date with their respective uptrend lines stretching from the Spring 2009 lows.

For the S&P, that would correspond to about SPX 1250 which is also where the 200 day moving average currently resides.

What in the fundamental or macro environment might drive weakness from here? There are many possibilities, cookie. But given how heavy the banks are trading (the BKX was down over 4% today), it 'feels' like markets may be worried about contagion from the ongoing Greece/Spain/etc EU saga.

Over the past couple of weeks, I've been selling strength to get more liquid. Cash level is now at 60%. Wouldn't mind more, as the market action is increasingly taking on a deflationary feel.

position in SH