Paper Gold

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

Rick Santelli posits that securitization, primarily in the form of exchange traded funds (ETFs), has changed the dynamic of the gold market. Formerly, many buyers formerly took possession of physical gold as an insurance policy against a monetary meltdown, today's investors can easily get exposure to gold via ETFs like GLD without having to deal with the hassle of taking delivery and storage costs.

The problem, notes Rick, is that, should a meltdown actually occur, then those invested in gold ETFs don't have bullion. They have pieces of paper.

Those pieces of paper will likely not be convertible into gold. Not only do the gold ETF prospectuses indicate such, but the potential for re-hypothecation likely means that there is not enough physical bullion to fully back paper gold.

I share his concern. In the event of real financial market stress, the supply of physical gold is likely to dry up, which could render the value of paper gold worthless.

Imagine this scenario. The price of physical gold zoom...$2000...$3000 per oz. At the same time, the prices of GLD plummets...$100...$50 per share.

For me, paper gold is best owned in my retirement accounts that is full of paper securities anyway. Securities of all stripes could all be at risk in the event of an institutional crack-up. If I choose the right paper gold vehicle (I like CEF and its all gold cousin GTU), then I still might be able to salvage something from a gold insurance policy--even if it is of the paper variety.

positions in CEF, GTU

ABC Edits Away First Lady's Mistake

Jennifer Mack: Did you really give me a C?
David Lightman: No, I gave you an A.
--WarGames

Nice example of media bias as ABC edits out Michelle Obama's mistake during an inteview when she said that a Chicago teenager was killed by 'automatic weapons.' There were no automatic weapons involved in the shooting.

Gun control proponents frequently bring automatic weapons into the gun control debate, although automatic weapons, which fire multiple rounds with a single trigger pull, have been banned from manufacture and import for nearly 30 years.

Whether these people do so intentionally or out of ignorance is another issue.

In any event, an unbiased interviewer would have called out Ms Obama for her mistake and informed listeners of the facts. Instead, the ABC edit causes her mistake to disappear.

Slant city.

Law of Demand

Robbin' people with a...six gun
I fought the law and the...law won
--Bobby Fuller Four

In the context of minimum wage laws, Prof Walter E Williams discusses the law of demand. "It holds that the higher the price of something the less people will take and the lower the price the more people will take."

Proponents of minimum wage laws have yet to explain why the law of demand does not apply when the price of labor is fixed artificially high by government force.

They can't explain it, of course, because the law of demand is axiomatically grounded in natural law.

Raise the price of labor, and buyers of labor will purchase less of it.

To sellers of labor, the consequence is compulsory unemployment.

Sequester Requester

You see the signs
But you can't read
You're running at
A different speed
--Robert Palmer

Hand wringing is underway over the spectre of mandatory $85 billion in federal spending cuts if officials cannot come to an alternative agreement by Friday.

The cuts, strangely labeled a 'sequester,' are a consequence of the Summer 2011 compromise regarding raising the debt ceiling. The sequester has been postponed a few times already as politicians put off the unpleasantries of reducing their source of power.

That we are fretting over $85 billion in cuts on $3.5 trillion in annual spending (~2.5% of budget) demonstrates how addicted we have become.

Something or Nothing?

These changing years
They add to your confusion
Oh and you need to hear
The time that told the truth
--Level 42

Noteworthy market action today as the Euro was pounded for its biggest one day loss in some time. The stated reason was Italian election results that reportedly suggested to some that 'austerity' movements may be in jeapordy.

Not sure if that resonates with me but perhaps this is a signal that attention may be shifting back to the EU where nothing has been solved.

Meanwhile, Treasuries found a bid here with 10 yr yields declining big. Euro sold/Treasuries bought is reminiscent of the 'risk off' pattern common to the EU 'crisis' a yr or so back.

Whatever the driver, US stocks staged in a nasty reversal. After being up early, indexes flipped over by late morning and then sold all afternoon before closing on the lows. For the SPX the 50 day moving average is quickly approaching.

Tough reading much into one day's action. But the size of these intraday moves makes them stick out in light of recent history.

Time will tell whether this means something or nothing.

position in SPX

Discouraging Savings

There's a place 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

Over the past couple of months, I have been swapping cash for 'non-paper' assets and even some consumables. Given the current macro environment, I don't want to put away dollars here.

Stated differently, the current policy regime discourages me from saving. Instead, I am motivated to convert what could be capital for investment into forms that preserve value or promote enjoyment of dollars at current prices.

This is a not a productive situation.

Durable recovery requires savings and capital accumulation. Current policies are doing the opposite. They are motivating more borrowing and spending.

Instead of capital formation, we are getting capital consumption.

There are few more foolish policies than those that discourage savings.

Rights and Wrongs

"It is the natural state of any man to want to live free."
--Guinevere (King Arthur)

GMU economist Walter E Williams discusses correct and incorrect definitions of rights. Correctly defined, a right is something that exists simultaneously among people and imposes no obligation on another--except that of non-interference.

This definition is correct because it is grounded in natural law. Although it is expressed in particular ways (e.g., right to self-defense, property rights, etc), the underlying right that each of us is born with is the right to freedom.

However, some people claim other rights--e.g., rights to health care, housing, food--regardless of whether the person can pay. However, if a person does not obtain these things through voluntary exchange with others (e.g., payment or charity), then the only way these things can be landed is by taking them from others.

Under this paradigm, the 'rights' of some people are achieved by compromising the rights of others.

As Williams observes, applying this arrangement to true rights would impose financial obligations on others to provide auditoriums (to support my freedom of speech), guns (to support my right to self-defense), etc.

Clearly, this is inconsistent with natural law as it requires the use of force on some for the benefit of others.

The only rights we can legitimately delegate to government are the ones that we possess. Thus, since each of us has a natural right to self-defense, we can delegate authority to government to protect us.

However, none of us has a natural right to forcefully take property from one person for the benefit of another. As such, we can not legitimately delegate this authority to government.

When people recruit the strong arm of government to forcefully take from others, they are not within their rights; they are doing wrong.

Planning vs Prices

There's a fire that's been burning
Right outside my door
I can't see but I feel it
And it helps to keep me warm
--Phil Collins

An axiom of human existence is that resources necessary for survival and prosperity are scarce, meaning that they need to be economized--a.k.a. rationed. There are two systems for rationing economic resources.

One system is central planning. People in a room decide what gets produced and who gets it. These people control productive assets, either through outright ownership or through regulation. The planners rule this system. Production and distribution decisions are at the discretion of the bureaucrats; consumers must live with the resource allocations made by the planners.

The other system is prices. Voluntary exchange among individuals establishes prices (i.e., what must be given up) for each economic resource. Prices ration scarce resources, as high prices reduce the draw on dear resources. Consumers, not producers or planners, rule this system. When prices increase, consumers are signalling producers that they are on the right track and that they should produce more. Entrepreneurs are motivated to improve productivity, which alleviates scarcity as more output is generated per unit of input.

Which system is more capable of rationing scarce economic resources?

Druckenmiller Comes Out

When you said goodbye
You were on the run
Tryin' to get away from the things you'd done
Now you're back again
And you're feeling strange
So much has happened, but nothing has changed
--Glenn Frey

Legendary (and now retired) fund manager Stanley Druckenmiller has generally shunned the public spotlight. However, he has "come out" on the issue of entitlements and government spending and how they are breaking the country. He says that current fiscal and monetary policies amount to robbing the young generation.

Druckenmiller recently co-wrote this WSJ editorial with a Harlem social entrepreneur and former Fed governor, and then sat for a rare CNBC interview with Maria.

His message is that escalating entitlements constitute generational theft. To live better today, the older generation is consuming resources that the younger generation will have to pay back. Because this will compromise standard of living of the young, what is going on right now amounts to robbing from the young to subsidize the lifestyles of the old.

From where I sit, slavery is the more appropriate term. Robbery is usually a one-off event, while slavery is the ongoing confiscation of an individual's production. When we borrow more than our income to elevate living standards today, the producers of the future become the slaves--forced to surrender a portion of their production to pay our debts.

If I borrow money with the promise to pay it back during my lifetime of production, then I am entering into a contract of voluntary servitude. But if I borrow money under the auspices that someone other than myself will have to produce in order to pay back the resources that I consume, then I am contracting someone else into conditions of involuntary servitude. I am enslaving someone else.

As such, government debt markets resemble slave markets.

Druckenmiller observes that the problem is compounded by central banks that are buying interest rates down across the world. This has deadened market signals that would otherwise alert us that current policies are problematic. He notes that he can't think of any political system in the world where policymakers have not substantially acted until interest rates head north.

But intervention in the money markets won't restrain interest rates forever. "Eventually the hamster can't move on the wheel anymore."

Moreover, when exactly interest rate markets decide to get concerned is not knowable. But the change is often sudden and without warning. "The bond market," Druckenmiller observes, "is a funny thing. In Greece the bond market was perfectly fine until February of 2010. Not moving, not doing anything. And then in two weeks it was over."

Druckenmiller is coming out on this issue thinking that we still have time to be proactive and reverse course ahead of a cataclysmic wipe out.

Surely Druckenmiller realizes that, human nature being what it is, such a proactive reversal is a long shot.

Monthly Firearm Background Checks

"He's going vertical, so am I."
--Maverick (Top Gun)

Following up on the previous post, my buddy Don pointed me toward monthly firearm background check data. Monthly checks since Jan 1999 appear below.

The series is stationary (with obvious intra-year seasonal patterns) until 2008 when it began trending higher. This time period corresponds to the credit market meltdown and the onset of "The Great Recession" along with the election of President Obama.

The uptrend went ballistic (!) late last year. This time period corresponds to the re-election of President Obama and the Newtown massacre.

The Dec 2012 and Jan 2013 totals of 2.5+ million checks/month are about double the average of the past four years and 3-4x the average from 1999 thru 2007.

Record Firearm Background Checks

First class and fancy free
She's high society 
She's got the best of everything
--Tau Bachman

Interesting data from the FBI National Instant Criminal Background Check System (NCIS). Top 10 days and weeks for firearm background checks (program started in late 1998) have all occurred in the last two months. So far in 2013, every week has placed in the top 10 all time.

I would like to plot monthly data since NCIS inception, but thus far have not been able to find such data.

Economic Organization and Adaptation

We chased our pleasures here
Dug our treasures there
But can you still recall
The time we cried
Break on through to the other side
--The Doors

It is often proposed that the primary objective of economic organization is profit maximization. A more institutional view is that the central goal of organization is adaptation. We organize economically in order to survive and prosper in the face of a changing world.

Adaptation can be autonomous in nature. Adaptation can be implemented spontaneously in response to changes in prices on the market.

Adaptation can be also be coordinated in nature. Adaptation can be facilitated through use of administration and heirarchy.

Markets and hierarchies are institutional responses to the adaptation goal. Both have distinctive roles to play in a functioning economy.

The question is under what situations markets might be preferred over hierarchies, or vice versa.

Weak Hand Wringing

You don't need no diamond rings
Or eighteen karat gold
Fancy cars that go very fast
You know they never last, no, no
--Madonna

Russell's big 'clean out' in gold is clearly upon us, with the yellow metal gapping lower this morning by another $25. Those with weak hands are crying uncle.

Stochastics are starting to twist low. We're also getting close to support levels marked last June.

Doesn't mean that prices can't continue to sink, but feels like we're close to a tradeable bounce.

I'm not tradin' 'em, however. Instead, am spreading buys with the goal of stacking metal in the long term vault.

position in gold

Red-lining

Revvin' up your engine

Listen to her howl and roar

Metal under tension

Begging you to touch and go

--Kenny Loggins

When markets detach from reality, buyers relentlessly march prices higher unfazed by the altitude. For those who choose not to play the fool's game, emotions can start to red-line. "There's no way prices should be here! How long can this madness go on?" they exclaim. 

And then prices squirt even higher.

My last red-line experience was mid 2007. The SPX was touching all-time highs. Housing prices had already flipped over, and early signs of chaos were already evident in the credit markets (New Century Financial, anyone?).

Crazy becomes crazier to the point where you start to wonder if madness permanently trumps sanity.

That red-line feeling is returning. The SPX is once again within spitting distance of all time highs against a backdrop of a feeble economy propped up by money-printing.

How long can the madness go on? 'When' is not knowable. 'What' is much easier to foresee.

The challenge is to endure the red-line phase and make it to the other side.

position in SPX

Price Ceilings

I went down to the demonstration
To get my fair share of abuse
Singing, "We're gonna vent our frustration
If we don't, we're gonna blow a fifty amp fuse"
--The Rolling Stones

The opposite of a price floor is a price ceiling. A price ceiling is a maximum price set by law. Trade at prices above the maximum is prohibited.

Examples of price ceilings are the anti-gouging laws on gasoline imposed by some jurisdictions in the aftermath of Hurricane Sandy last fall. Such laws raise prices to the ceiling and drive supply out of the market. Shortages occur.

Rationing is often considered to be something that occurs only during difficult times when supplies are scarce. By definition, however, all economic resources are scarce--meaning that all economic resources must be rationed.

In unhampered markets, rationing is done by the price mechanism. High price signals elevated demand relative to supply. Resources are increasingly rationed as fewer people purchase at higher prices. Entrepreneurs are challenged to increase productivity in order to bring more supply to market.

In hampered markets, government intervenes to cap the price producers can charge. Productivity improvements are discouraged, and producers leave the market.

Price ceilings, like price floors, reduce general standard of living.

Halting Gun Sales to Government

"And while the biggest arms dealer in the world is your boss - the president of the United States, who ships more merchandise in a day than I do in a year - sometimes it's embarrasing to have his fingerprints on the guns. Sometimes he needs a freelancer like me to supply forces he can't be seen supplying."
--Yuri Orlov (Lord of War)

In the wake of various government efforts to increase gun control, various arms makers are curbing sales to various government agencies.

If enough gun and ammo producers ceased selling weaponry to the federal government, is there any doubt that the government would commence gun and ammo production (or expropriate productive assets from private hands)?

Without guns, government has no authority.

Cleaning Out the Gold Market

"Ain't nobody clean. Be nice to get clean, though."
--Trip (Glory)

Richard Russell discusses the likelihood of one more 'clean out' in gold. We seem to be getting it now. Clean outs shake off the weak hands before bullish moves higher.

He recalls the big move down in gold prior to 1979-1980 surge.

Russell also asserts that the bear market in US stocks began in 2007. Many like to say it began with the tech bubble pop of 2000-2001. Russell the technician thinks otherwise. After all, the Dow and SPX made marginal new highs in 2007 before the credit crisis.

The implication is that cycle theorists proclaiming that the bear market is over because it has exceeded its average its 10-15 year time period are premature, as their frame of reference is mistaken.

The bear is only 5 years old by RR's measure and still hungry.

position in gold, SPX

Melting Gold

You talk about things that nobody cares
You're wearing out things that nobody wears
--Aerosmith

Gold continues to take it on the chin, down another $20+ to end the week. Seems a gift, given the state of the world.

Buy program continues. Started a position in GTU, the all gold cousin of CEF.

position in CEF, GTU

Ten Year Yields North of 2%

Eve Kendell: Roger O. Thornhill. What does the O stand for?
Roger Thornhill: Nothing.
--North by Northwest

Yesterday 10 yr Treasury yields closed decisively above 2%. Today we are seeing from follow thru. Long bond yields are up almost 50% in 6 months.

Currently markets are drinking this pretty. Rates are rising because the economy is strengthening...

At some point the reality of higher interest rates in a leveraged economy is likely to set in. Particularly because it is occurring in the face of a massive QE program by the Fed to buy rates down.

At that point pretty morphs into pretty ugly.

no positions

Freedom is Trending

Always searching for the real thing
Living like it's far away
Just leave all the madness in yesterday
You're holding the key
When you believe it
--Michael McDonald

Following the president's state of the union address, a designate from the opposing political party responds. Last night, there were two responses.

One came from Senator Marco Rubio who delivered the 'official' GOP response. The other came from Senator Rand Paul who delivered the Tea Party response (here is a side-by-side comparison of Obama, Rubio, Paul comments).

Symbolic, it seems, of the divide inside the Republican party. Old Schoolers view the strife as a nuisance and figure that, with some co-opting, the Big Government Right will be unified in time for the mid terms.

Awareness is building, however, that the traditional GOP is not much different than the Democrats. Demand is growing for different political representation--representation grounded in liberty.

The political landscape is changing because freedom is trending.

Blind Bias

Any place is better
Starting from zero got nothing to lose
Maybe we'll make something
But me myself I've got nothing to prove
--Tracy Chapman

Bias is stubborn preference or dislike that impairs objective judgment.

Suppose we had a scale where we can plot people's preference for driving slow versus the speed limit versus preference for driving fast versus the speed limit. Some people are biased toward the slow side of scale, perhaps because they doubt their driving skills or fear an accident.

Slow<------------------------>Fast

Other people are biased toward the fast side of the scale, perhaps because they are impatient or hurried.

The smaller the distance between two people on the scale, the harder it is for one to detect bias in the other. To the drivers of two cars going the same speed side-by-side, it appears that both cars are standing still.

So it is with our biases. We tend to view ourselves as correct and objective. And if we are unbiased, then people close to us in preferences and dislikes must be unbiased as well.

However, we can readily detect drivers going slower or faster than us. The greater the distance between two drivers on the scale, the easier it is to recognize difference. From our reference point, we are standing still while the other person is moving. We anchor ourselves on a reference point, and view the other person as biased versus that reference point.

Bias is much easier to see in others than in ourselves.

Do Machines Make Us Poor?

Where does the answer lie
Living from day to day
If it's something we can't buy
There must be another way
--The Police

Nice discussion by Gary North on the flawed thinking that machines make us poor. Sometimes called the Luddite Fallacy, the premise is that employing machines in production processes makes us worse off, because those machines often do the work of much manual labor. Those who lose their jobs to productivity-enhancing machinery must somehow be protected or compensated.

The premise is obviously false because, taken to its logical conclusion, it requires scrapping all machines and tools in favor of manual labor. Such action would reverse hundreds of years of progress, returning us to widespread poverty. The population of the world would shrink to a fraction of its current size as economic resources that support standard of living disappear.

As GN observes, anything that can be done profitably by machine should be done by machine. This frees up labor, the most flexible of all productive resources, for more productive use.

Permanent unemployment due to the use of tools in production can only occur when a) there is no additional demand to be satisfied after the implementation of machines, or b) some other factor of production runs dry, thus restraining further production with labor.

Because human desires are insatiable, a) seems forever unlikely. Currently, there is need in the world that can be satisfied by more production.

Because economic resources are scarce and some of them (e.g., fossil fuel) not easily replaceable, b) seems a more plausible scenario. But in free markets, higher prices of increasingly scarce resources drive entrepreneurs to bring new technologies to market that alleviate resource restraints.

Thus, if markets are allowed to work (yes, increasingly a bigger 'if'), then b) seems unlikely as well.

Viewed thru this lens, what we face in this world is not a labor glut, but a labor shortage--a shortage that machines help us manage.

Price Floors

I'm all out of faith
This is how I feel
I'm cold and I'm ashamed
Bound and broken on the floor
--Natalie Imbruglia

A price floor is a minimum price set by law. Trade at prices below the minimum is prohibited.

An example of a price floor is a minimum wage law. Currently, the US federal minimum wage is $7.25/hr although it is higher in some states.

Buyers of labor at prices below the legal minimum are prohibited from trading with people willing to sell their labor at rates less than $7.25.

For marginal workers, minimum wage laws constitute compulsory unemployment for people willing to work for less than the legal minimum.

For organizations, minimum wage laws drive employers to hire fewer people than they would otherwise. Moreover, employers are likely to search for alternative environments where labor markets are less restrained.

Price floors infringe on freedom of contract. Moreover, price floors set on any commodity result in a reduction in demand for that commodity.

Pro Government, Pro Gun

Now and then when I see her face
She takes me away to that special place
And if I stare too long, I'd probably break down and cry
--Guns 'N Roses

Any government program requires force, or threat of force, to implement. Government must use guns to be effective.

In a free society, the use of guns by government is limited to helping individuals defend their person and property from invasion by others. Government does not initiate force; it uses guns for defensive purposes.

When the scope of government expands beyond helping people defend against attack, then the guns of government are used to take person and property. Government initiates force; it uses its guns for offensive purposes.

If you are pro government, then you are pro gun. The question is whether you support using guns for defensive or offensive purposes.

If you side with limited government, then you support using guns for defense only.

If you side with expansive government, then you support using guns to initiate violence on others. Employing the strong arm of government to get your way makes you the gun-toting aggressor.

Out of Stock

We are passengers in time
Lost in motion, locked together
Day and night by trick of light
I must take another journey
--The Fixx

Have jettisoned nearly all remaining equity exposure today, keeping just a sliver of CSCO on the books (which will likely be for sale should we march higher). May be way wrong but, as I see it, 'quack count' increasing for a meaningful pullback.

The counter argument, of course, is that stocks are floating higher on an ocean of liquidity that likely won't end soon.

As such, I've rolled some of the proceeds into CEF, my current 'paper precious metals' vehicle of choice. Will continue to do so.

Relative value of gold versus stocks appears pretty attractive right here given the situation.

positions in CSCO, CEF, SPX

Progressivism and Progress

Sometimes I think it's a sin
When I feel like I'm winning when I'm losing again
--Gordon Lightfoot

The Progressive Movement began in the US more than 100 years ago. The administration of Theodore Roosevelt was among the early presidential tenures to exhibit progressive tendencies, although the Movement burst into full bloom under the administration of Woodrow Wilson beginning in 1913.

A central tenet of progressivism is that government should be used as an instrument of progress. Laws established in the past are seen as outdated and should be torn up or simply ignored by the present regime if the old laws stand in way of progress.

By employing the strong arm of government to achieve their goals, progressives become despots seeking to force others to comply with a particular vision of the world. There is nothing new or modern about this approach. Tyrannical rule is as old as civilized man.

Rather than being forward looking, progressivism constitutes a return to the past of discretionary rule. The rule of one man over another.

By forcefully restraining the pursuits of people, progress is discouraged rather than encouraged.

Progress is truly realized when free people engage in voluntary exchange in pursuit of their interests. Because such exchange is mutually beneficial (otherwise it would not take place), things are better than they were prior to the exchange. This is the essence of progress.

We cannot predict with precision what the future looks like under systems of voluntary cooperation, but we can confidently predict that the future will be better.

True progress is realized when people freely cooperate, not when government forcefully intervenes in free pursuits.

Fed Balance Sheet Expansion and Stock Market Performance

Oh, but her love is cold
It wouldn't hurt her if she didn't know, 'cause
When it gets too much
I need to feel your touch
--Bryan Adams

Wanted to follow up on previous comments about Fed balance sheet changes and stock market performance. I went to the Fed's website and downloaded a data package of weekly assets and capital from the consolidated Federal Reserve balance sheet (can be found in Table 8 of the weekly release, which is done each Wednesday). The data are available since December 2002.

I also grabbed corresponding weekly S&P 500 Index (SPX) data.

Fig 1 plots weekly Fed balance sheet assets and weekly SPX values across the entire time frame since late 2002. Note the slow-but-steady increase in Fed balance sheet assets (the blue series) from 2002 until late summer 2008. Balance sheet assets increased from $7.2 trillion in late 2002 to $9.3 trillion in September, 2008 (+28%). While such balance sheet expansion is not trivial, it reflects a straight line, 'non crisis' approach to inflating the money supply.

Beginning with the 9/17/08 report, the Fed began increasing balance sheet assets greater than trend. Over the course of the next six weeks, Fed assets more than doubled to over $2 trillion. That's a trillion dollars in just over a month. This was the beginning of the Fed's famed Troubled Asset Relief Program (TARP), when the Fed began buying mortgage backed securities et al off of bank balance sheets.

In case you don't know how this works, the Fed essentially gives the banks cash (generated out of thin air at the click of a mouse) in exchange for their securities. The purchased securities go onto the Fed's balance sheet as assets. Unless the Fed someday unloads all of these assets at the acquired price (highly unlikely), then what the Fed has done via these operations is inject newly minted cash into the system, which is inflationary.

You can see that since late 2008, the Fed has added another $1 trillion in assets thru its various 'quantitative easing' (QE) programs--such that its balance sheet assets now top $3 trillion.

As part of its latest asset pruchase program, affectionately labeled QE-Infinity, the Fed has pledged to buy about $90 billion/month of securities from the banks. In Ponzi-like circular fashion, the banks initially purchased many of these assets with credit created by the Fed out of thin air. At a $90 billion/month run rate, the Fed's balance sheet will be north of $4 trillion one year from now.

Fig 2 plots the same series as Fig 1, but focuses on the time period since July, 2008. You can see that the square wave increase in the Fed's balance sheet in late 2008 corresponded to the end of the decline in stock prices. The SPX marked its low in March, 2009.

Not only did Fed intervention bail out insolvent banks by lifting declining assets off their books, but the Fed also bailed out stock investors from further price declines as well.

Since then, stocks have been rising in accordance with increases in the Fed's balance sheet. Since the early March, 2009 lows, I get a correlation coefficient of .854 between Federal Reserve assets and the SPX.

Fig 2 may tell you all you need to know about why stocks have been marching upward over the past few years. Rather than being driven by fundamental improvements in the economy, there is a compelling case to be made that stocks have been floating higher on an ocean of liquidity courtesy of the Fed.

Fig 3 shows the ratio of Federal Reserve balance sheet assets to underlying capital. This is a measure of leverage. In 2007-2008, many banks that failed were levered 20-30 to 1. Currently, the Fed is levered much more than that. Current Fed leverage stands at about 55:1.

When an institution is highly levered, it takes only a small decline in the value of assets to render the institution insolvent. Indeed, John Hussman estimates that the decline in bond prices over the past few months hasalready mede the Fed technically insolvent.

No economically motivated entity would engage in such reckless behavior. The risk of catastrophic loss is too great to be borne by decision makers with their own wealth on the line.

But Fed bureaucrats are not risking their wealth. Through their recklessness, they are risking yours.

position in SPX

Cover Story Indicator Alert

This whole world out there is 
Just trying to score
I've seen enough I don't want to 
See anymore
--Bruce Springsteen

Hard not to raise an eyebrow (or two) at this week's Barron's cover.

Whether we're looking at another classic example of the contrarian cover story indicator remains to be seen. The cover does appear amidst growing evidence of extreme sentiment.

Hindsight, of course, will be the final arbiter.

position in SPX

Durable Law

"None of us took this city from the Muslims. No Muslim of the great army coming against us was born when this city was lost. We fight over an offence we did not give, against those who were not alive to be offended. What is Jerusalem? Your holy places lie over the Jewish temple that the Romans pulled down. The Muslim places of worship lie over yours. Which is more holy? The wall? The Mosque? The Sepulchre? No one has claim...All have claim!"
--Balian of Ibelin (Kingdom of Heaven)

The Constitution was developed as the supreme law of the land. Some people who oppose it today argue that the Constitution, being developed over 200 years ago, does not apply to them because they were not around to agree to it.

Indeed, in order to be just or legitimate, law requires the consent of the governed.

But how can consent of the governed be achieved in practice? Any law passed today does not have the consent of someone born tomorrow. Moreover, for laws passed by democratic vote, those who vote against the law do not consent either.

It is impossible that any law gains explicit consent of the governed. That being the case, how it it possible that any law can be viewed as legitimate over any length of time?

A law can be legitmately durable if it carries implicit consent. Consent is implied if we can assume that any and all people can agree on a law's legitimacy at any point in time.

The only laws that meet this condition are those grounded in the natural rights of individuals. Natural rights involve the freedom to pursue one's interests without being forced to do otherwise by someone else. All must respect this right, meaning that I can't initiate force to interfere in your pursuits just as you can't violently intervene in mine. Laws based on natural rights are inalienable, meaning that they cannot be legitimately revoked by government.

Laws grounded in natural law prohibit people from initiating force on others. The only legitimate use of force is for self-defense purposes.

It is reasonable to assume that good people, regardless of their position in time, would consent to such a law--i.e., a pledge not to initiate violence on others, and to face legal consequences if violence is initiated on others. Only bad people would not consent to such.

Laws grounded in natural rights form the basis for durable law since they are the only laws to which we can assume that good people would consent to--even if they were not alive when the laws were developed.

Rotten Tomatoes

Mick: You know what you are?

Rocky: No, what?

Mick: A tomato.

Rocky: A tomato?

Mick: Yeah, and I'm running a business here, not a goddamn soup kitchen."

--Rocky

Classic example of Bastiat's "That which is seen, and that which is not seen." What the reader 'sees' is assistance to US farmers who are less efficient than Mexican tomato growers, as well as claims about less chance of a 'trade war' with Mexico.

But this is a trade war--a war on free trade. And US farmers are lining their pockets with prices fixed above market rates. US consumers lose.

Note also that this 'factual' piece from the Chicago Tribune completely ignores that side of the story. For example, a straightforward question any balanced reporter would ask is, "How much more will American consumers have to pay for tomatoes as a result of this trade agreement?" Or, "How much business will Mexican farmers lose because of the price supports?"

As written, this story belongs on the editorial page rather than in the business section.

Intentional or not, this is a prime example of media slant likely to influence reader thought. A one sided story factually presented as 'news.'

The Moral Hazard Epic

The mountain is high
The valley is low
And you're confused on which way to go
So I've come here to give you a hand
And lead you to the promised land
--Edgar Winter

Marc Faber observes that "You need to buy stocks when there is no reason to buy them. And I will be careful about stocks when you can't see why they can go down."

The 'why they can't go down' relates to the Federal Reserve's interventionary might. It is becoming common wisdom that as long as the Fed is pouring money into the system, stocks will continue to levitate.

David Rosenberg has cited a .86 correlation between movements in the Fed's balance sheet and the SPX since the onset of QE. Here's a portion of that relationship:

Needs updating--something I hope to do shortly. The relationship is clear nonetheless.

The moral hazard in the market is truly epic, as the Fed emboldens more people to catch a free ride.

A familiar script, though, as we've seen this movie before.

Velocity of Money

I bought a toothbrush, some toothpaste
A flannel for my face
Pajamas, a hairbrush
New shoes and a case
I said to my reflection
Let's get out of this place
--Squeeze

Might the velocity of money become one of the more important metrics in upcoming periods? Conceptually, money velocity is the amount of economic activity associated with a particular money supply.

When velocity is high, much of the money supply is being used in transactions. When it is low, money is staying in wallets and bank accounts instead of being spent.

Money velocity is operationalized by taking GDP and dividing it by money supply. The chart below shows money velocity for the M2 measure of money supply. It is readily apparent that money velocity has been slowing down.

Many people view this as bad. The thinking is that if people aren't spending, then that is bad for the economy.

But money velocity has been declining since 1995. It has been declining in periods of reported economic expansions as well as contractions.

Let's think about what is going on here. Velocity can fall either by a decline in the numerator (GDP) or by an increase in the denominator (M2). GDP typically declines only during recessions, which doesn't fit the 15+ year trend. In fact, M2 related velocity currently sits at its lowest level in the last 50 years despite us currently being in a purported expansion.

What has been happening during this entire period is that M2 money supply has been expanding. Since 1995 is has roughly tripled. This has made the denominator larger and calculated money velocity smaller.

Moreover, because M2 does not include institutional deposits, money market funds, repos, and the like, the decline in money velocity due to expansion of the money supply is likely understated.

The takeaway is that massive quantities of money have been created over the past few years. When that money becomes employed in economic transactions, money velocity may not even have to turn up--it may just decline at a slower rate--in order to exert significant upward pressure on prices.

By then, it will be difficult to put the inflation toothpaste back in the tube.

Tuning Out

"Clear the mechanism."
--Billy Chapel (For the Love of the Game)

Financial markets occasionally get 'loud' for me. While trying to stay focused on the 'signal' (the information that really matters w.r.t. the direction of the tape), I am bothered by the 'noise' (trivial information that obscures the signal or sends false signals).

When I don't sense a strong signal, the noise is welcome. Noise drowns out false signals and keeps me from acting when I shouldn't.

However, when I sense a strong signal, lots of noise is bothersome. I don't want the signal to be lost in the noise, lest I don't act when I should or lose my conviction to previous actions.

Now is one of those times. The signal seems strong--we are headed toward an inflationary crackup. But the noise is getting loud too--stocks hitting 5 yrs highs, sharp cookies suggesting that we're beginning a melt-up period, various economic reports with positive tones...

In the past, I have let the noise get to me. I have reduced or reversed commitments aligned with the signal just to reduce the deafening pitch of the noise.

In all cases, this was the wrong thing to do. Given time, the signal trumps the noise.

What I have come to understand is that high signal, high noise situations are characteristic of extremes and of turning points. The signal is change, the noise is status quo. Unfortunately, the status quo emits a siren song that resonates with our herding instinct.

As such, my evolving approach for coping with situations like the current one is to unplug. Turn off the streamer. Quit watching the P&L. Leave the news flow. Do other things.

Yes, I want to keep an open mind. But when I perceive a signal to be strong, more than anything else I want to trust my judgment.

position in SPX