Dollar Death $piral

SOPA/PIPA/DMCA

2012-01-24T07:49:00.001-08:00

Can't lose investing

2012-01-18T14:40:00.000-08:00

Against lukewarm data in the US, and feel good speculation about the Euro debt situation, the tide lifted all boats today except Treasuries.

DOW +0.78%
S&P 500 +1.11%
Nasdaq +1.53%
Gold +0.21%
Oil +0.44%

Even though Treasuries were down today, they are still up YTD. It seems you can't pick any bad investments in 2012. They all go up!

Let's see how things look at the end of March.

The Year in Gold: 2011

2011-12-31T15:32:00.000-08:00

2011 was a volatile, roller coaster ride for gold. It saw a price spike up to $1,900/oz, followed by a crash into the end of the year, finishing at $1,566/oz. The price change for the year was +10%. Despite the year end crash, gold outperformed all global stock markets by a wide margin, and beat the S&P 500 for the 11th year in a row. The S&P was essentially flat for the year, the FTSE was down over 5% and the Nikkei down 17%.

Gold vs. Money Supply

From the early 1980s until 2001, the monetary base grew faster than the gold price. That trend reversed when the gold bull market started in 2001 and continued until the US financial crises in 2008. After 2008, the monetary base grew at an even faster rate, but then leveled off in 2009. I find the comparison to the monetary base interesting because in the original Federal Reserve Act, the monetary base was limited by the amount of gold held by the Treasury. That legislative link was broken in 1971. The gold price has fared better against M1 and M2, nearly reaching their peak ratios from 1980 before easing back.

Gold vs. US Debt

I started modeling the gold price against US debt with surprisingly good results. The longest model I have is one going back to 1971 when the official link of the dollar to gold was broken by President Nixon. At that time, the official price was $35/oz.

Using a linear regression of the data back to 1971 (above), I get these predictions:
Two sigma below is $813.24
One sigma below is $1,035.33
The best fit price is $1,247.82
One sigma above is $1,460.30
Two sigma above is $1,682.40

These prices may be the best long term guides IF the United States can get control of its fiscal situation again, which requires control of its political situation again. Unending trillion dollar deficits is not the path to a stable currency and fiscal situation.

The more recent model that coincides with the gold bull market since 2001 has a higher correlation, for now. Using a linear regression of the data back to 2001 (above), I get these predictions:
Two sigma below is $1,423.85
One sigma below is $1,508.73
The best fit price is $1,592.00
One sigma above is $1,675.28
Two sigma above is $1,760.16

These numbers add some perspective to the $1,900 price seen in August, 2011. Of course, markets pay no attention to statistics or models in the short run or even the medium term. Humans don't work that way. I speak from experience. YMMV.

Gold: No More Love

2011-12-29T09:01:00.000-08:00

Gold prices, since peaking in August, have been dropping like a burst bubble, and maybe that is what is happening. I am still on the fence about that. After the momentous rise and crash, I was unsure of what was unfolding so I sold half at $1,654. This morning, we bounced off $1,530 again, the spike low from the initial crash.

My debt vs. gold model predicts a best fit gold price of $1,578. This is the first time since early 2009 that the spot price has been below my model price. One standard deviation below would be $1,409. I am content to sit in my physical position for now, until and unless it becomes clear that interest rates are rising and central bank money printing is over. Neither of those conditions is true today. What is true is that speculators have been destroyed and sentiment is in the toilet. Gold gets No More Love...

The Fickle Nickel

2011-12-27T22:49:00.000-08:00

More nickel weirdness at Kitco. Here is the Nickel chart I downloaded showing another 33% drop in the price of Nickel. I tried to confirm it at the London Metal Exchange, but the pricing there was showing roughly $8/lb.

I am puzzled about what is going on at Kitco with base metals. Is there a problem with Kitco, a problem with commodity futures markets, or both? A nickel in hand is worth 3/4 in the futures? I am able to make less of "markets" now than ever before. At least I have documented proof of my madness. I think there is an Edgar Allen Poe poem about this affliction.

A Dream within a Dream

I stand amid the roar
Of a surf-tormented shore,
And I hold within my hand
Grains of the golden sand-
How few! yet how they creep
Through my fingers to the deep,
While I weep- while I weep!
O God! can I not grasp
Them with a tighter clasp?
O God! can I not save
One from the pitiless [elliot] wave?
Is all that we see or seem
But a dream within a dream?

UPDATE: Nickel rockets up 55%!!!
More wild gyrations. What's up Kitco?

Land of the Rising Debt

2011-12-26T16:05:00.000-08:00

The spectacle of Japanese government debt continues to dazzle. Projections are for debt-to-GDP to reach 230% in 2012. The numbers just make me scratch my head. Japan will borrow half of all budget expenditures. With an average interest rate of around 1% on issued debt, they will still spend roughly half of all tax revenue on interest on their debt. Their debt will pass one quadrillion yen this year.
Here are some recent articles on the Japanese debt situation...
Japan Seeks to Market Record 145 Trillion Yen Bonds in 2012; Kicking the Can Japanese Style
The Endgame: Japan Makes Another Move

Last April, I tried to make some guesses about how the Japanese might make needed adjustments. I have no idea how it will resolve itself. Maybe Japanese debt, unlike Eurozone debt, can grow to the sky without limits. Maybe they can support a debt-to-GDP ratio of 1,000% or more without any problems. After all, yen are just electronic numbers, right?

I can't stop looking at Japanese debt with both a mix of both awe and terror.

UPDATE: another article on Japanese debt, one that has the same title as my blog entry!
Check the post dates, though, and you will see that mine was published first. My title was completely original, which doesn't mean the other guy didn't also have the same original thought. Or did he?!?? Haha.

In a Pickle with Nickels

2011-12-22T11:21:00.000-08:00

There is a distinct smell in the air. The pungent odor of deflation and a poorly timed trade.

In April, I suggested loading up on nickels since the metal value at that time exceeded the face value and I expected more QE interventions from the Fed to devalue the dollar even further. Since then, the prices of copper and nickel have plunged in a frightening way. This morning, nickel opened down about 35% and has lost more than 50% since my original article. I am still looking for news that would explain the 1/3 haircut in a single day, so far without success.

The good news is that there was almost no down side risk to hoarding nickels. Even though the metal value has dropped well below face value, they are still worth face value and there is no transaction cost to depositing them back into a bank or credit union.

I am still prepared to wait 10-15 years for a pay off, but I might trade some of them in for I-bonds or silver and to free up storage space. In the short run, it is clear that I was way off base on base metals. Doh!

UPDATE: FLASH CRASH! According to Kitco, the price of nickel is now back to pre-crash levels at $8.38/pound. The price anomaly lasted a good few hours, but has now been erased from existence. I should have taken a screenshot. While prices are still way down from a year ago, the puzzling 35% drop from this morning is gone without a trace. That explains the lack of news but raises a question about what happened to the price reporting.

Jonathon Livingston Siegel

2011-12-12T11:09:00.000-08:00

inspired by this post: Siegel's Island

From Wikipedia:
Jonathan Livingston Seagull, written by Richard Bach, is a fable in novella form about a seagull learning about life and flight, and a homily about self-perfection. The book tells the story of Jonathan Livingston Seagull, a seagull who is bored with the daily squabbles over food. Seized by a passion for flight, he pushes himself, learning everything he can about flying, until finally his unwillingness to conform results in his expulsion from his flock.

From Wharton:
Jonathon Livingston Siegel, is a story about a professor learning about life and stock markets, and a homily about the perception of self-perfection. The good professor is bored with the daily squabbles over bank consulting bonuses and tenure. Seized by a passion for equities, he pushes himself, misunderstanding everything he can about investing for the long run, until finally his unwillingness to conform to reality results in his expulsion from his flock.

Turns out, sometimes stocks are for the birds.

November, 2011 Employment situation internals

2011-12-02T11:39:00.001-08:00

Here are few internals from the BLS Employment Situation Report for October, 2011.

AVERAGE HOURLY EARNINGS: $23.18, -0.1% MoM

AVERAGE WEEKLY HOURS: 34.3 unchanged

PROFESSIONAL AND BUSINESS SERVICES
TEMPORARY HELP SERVICES
Oct 2011 15,800
Nov 2011 22,300

Go go Huntsman

2011-12-01T07:51:00.001-08:00

Simon Johnson covers the Huntsman approach to TBTF and is the only one ready to face them and make them smaller. He is the only candidate for President that seems to be saying rational things about the economy.

Pepper Spray Thanksgiving

2011-11-24T12:58:00.001-08:00

What has the USA become? What it is becoming? The National Police are serving up pepper spray as the main course for Thanksgiving.

The U.S. Government — in the name of Terrorism — has aggressively para-militarized the nation’s domestic police forces by lavishing them with countless military-style weapons and other war-like technologies, training them in war-zone military tactics, and generally imposing a war mentality on them. Arming domestic police forces with para-military weaponry will ensure their systematic use even in the absence of a Terrorist attack on U.S. soil… It’s a very small step to go from supporting the abuse of defenseless detainees (including one’s fellow citizens) to supporting the pepper-spraying and tasering of non-violent political protesters.
-- Glenn Greenwald
Salon

Nigel Farage: What Gives You the Right?

2011-11-17T13:45:00.001-08:00

Without comment...Link in case the embed doesn't work.

The Italian Job

2011-11-09T20:10:00.000-08:00

Over night, the Italian 10 year bond yield jumped over 500 basis points (a basis point is 1/100 of a percent).

It sent shudders through the entire global financial system, tanking equity markets everywhere and setting off a political firestorm in Italy and Euro centers of power. Italy is too big to save. It simply has too much debt and losses on that debt will devastate dozens of Eurozone banks. Emergency meetings are probably under way across Europe and Washington.

I have a hypothesis that the bankruptcy of MF Global forced a large liquidation of Italian bonds, causing big losses, stop loss triggers, followed by margin hikes on the bonds, and more panic selling. The loss of marked to market principal on Italian bonds alone was hundreds of billions of dollars in one night. I'm sure other factors came into play, but I think the death of MF Global was one of the matches that lit the fire.

I only see two ways this can now end. The ECB can start monetizing PIIGS bonds with massive buying, which is currently against the law. Or, each country can set the terms of their own restructuring, and each country will be responsible for recapitalizing their own banks. Either option might work out OK for Italy, but the second would be an ugly, chaotic event for Greece, which would probably be forced off the Euro and back to drachma. The same goes for Portugal and Ireland. Spain is much harder to call.

I've heard over the last few months how leaders need to restore "confidence to the markets". When I hear that, it gets translated in my head to "continue fooling you with lies and fake accounting". In 2008, deep seated corruption and lies came frothing to the surface. Scams and frauds have continued to wash up on the financial shores as they collapse. The missing $600 million in customer accounts at MF Global is just the latest.

However the Italian job plays out, major changes are coming to the Eurozone, maybe sooner than later.

Employment Situation Internals

2011-11-04T10:16:00.000-07:00

Here are few internals from the BLS Employment Situation Report for October, 2011.

AVERAGE HOURLY EARNINGS (YOY) Actual: 1.8%
Average hourly earnings YoY at 1.8% with CPI at 3.8% YoY mean a decrease in purchasing power of 2.0% YoY.

AVERAGE WEEKLY HOURS Actual: 34.3 unchanged
Not better, but not worse either.

PROFESSIONAL AND BUSINESS SERVICES
TEMPORARY HELP SERVICES
Oct 2010 27,200
Aug 2011 22,600
Sep 2011 21,100
Oct 2011 15,000

The drop and downtrend in temporary help services is not good. Generally, employers increase their temporary help before hiring new full time workers. This was a weak report but not disastrous.

$15 trillion on deck

2011-11-01T14:08:00.000-07:00

The Treasury debt to the penny page showed total US federal debt reached $14,993,709,044,140.78 on October 31, 2011.

The total is now on the cusp of passing $15 trillion. Astronomical.

California's unemployment insurance fund

2011-10-30T12:59:00.000-07:00

I've been tracking the California unemployment insurance fund for a couple of years. The fund ran out of money at the end of 2008. Since then, it has been insolvent and borrowing from the federal government to pay unemployment claims. The fund appeared to bottom at -$11.08 billion in April, 2011 and has since recovered to -$8.7 billion in August, 2011. Under the original agreement with the federal government, the state was supposed to start paying interest on borrowed funds in January, 2011, but that was deferred until September, 2011.

The first interest payment of $303 million was paid last month. The LA Times covered the unfolding disaster.

It will have to pony up at least a half-billion dollars in 2012 and even more in coming years. The state, which already is struggling to close a massive budget deficit, probably will be forced to make even deeper cuts to schools, law enforcement and other basic services. In the meantime, California employers in January will be hit with a mandatory surcharge of about $25 per employee to begin paying down the principal on the federal loan.

Surcharges for each employee are likely to slow hiring in an already weak employment environment. California is not the only state with an insolvent UI insurance fund. President Obama is proposing further suspensions of interest owed to the federal government and surcharges from the federal government on employers. There is a deep hole to fill to pay for all of the unemployment benefits paid out over the last few years that will be a drag on employers for many years into the future.

Side note: When I started my first business in 1993, I was surprised to learn that I had to pay unemployment insurance on myself as the single employee in my company. I remember talking to the state UI office to confirm that I could collect unemployment insurance if I laid myself off. It never came to that, thankfully.

Mean vs Median unemployment

2011-10-28T15:38:00.000-07:00

source: St. Louis Fed (UEMPMEAN, UEMPMED)

The mean duration of unemployment set another new record in September of 40.5 weeks. The median has been in a tight range the last few months, but inched up in September to 22.2 weeks. While the median has dropped from the peak, it is still at levels much worse than the 1980s recessions and worse than any recession since tracking started in the 1960s.

The story is with the still rising mean. There are millions of people who want to work but had their livelihood destroyed in the 2008 recession. Many may never be employed again -- have become unemployable. Their long term benefits may have run out and they may be stuck trying to get by until they can collect Social Security. It cries out for a new Work Progress Administration. In general, I am not in favor of Keynesian policies, as practiced by D.C. (as opposed to my understanding of the original idea). However, in this case, I think it makes sense. An equivalent funding of a new WPA using the same percent of GDP as in 1939 would cost about 1 trillion a year. The devil would be in the details of executing such a program without horrific waste.

Another look at money supply vs gold

2011-10-22T14:24:00.000-07:00

Money Supply vs. Gold Price

I've added the Monetary Base (M0) to the charts. While the M1 and M2 charts show that the gold price has been increasing faster than the money supply, the opposite is shown in the monetary base, which has grown almost 4 times as fast as the gold price since the early 1980s. The Fed has been using the monetary base to execute two QE programs, purchasing well over two trillion dollars worth of MBS, ABS, and treasury bonds. Most of that new cash has ended up back at the Fed in the form of excess reserves, paying 0.25% interest to the banks that keep it there. If there was demand for that money as bank loans in the economy, it could create at least 18 trillion new dollars. Of course, there aren't a lot of credit worthy borrowers who want to take out new loans, and the banks need provisions for ongoing real estate loan losses. That inert money is likely to stay at the Fed until the real economy starts to improve, but the monetary base level is unusual and disturbing.

St. Louis Fed Financial Stress Index

2011-10-16T09:51:00.000-07:00

This index is relatively new and is similar to the longer running Kansas City Fed financial stress index. Both have been rising lately, but are not even close to the stress shown in 2008.

The St. Louis FSI is built from the following 18 weekly data series:

Interest Rates:

Effective federal funds rate
2-year Treasury
10-year Treasury
30-year Treasury
Baa-rated corporate
Merrill Lynch High-Yield Corporate Master II Index
Merrill Lynch Asset-Backed Master BBB-rated

Yield Spreads:

Yield curve: 10-year Treasury minus 3-month Treasury
Corporate Baa-rated bond minus 10-year Treasury
Merrill Lynch High-Yield Corporate Master II Index minus 10-year Treasury
3-month London Interbank Offering Rate–Overnight Index Swap (LIBOR-OIS) spread
3-month Treasury-Eurodollar (TED) spread
3-month commercial paper minus 3-month Treasury bill

Other Indicators:

J.P. Morgan Emerging Markets Bond Index Plus
Chicago Board Options Exchange Market Volatility Index (VIX)
Merrill Lynch Bond Market Volatility Index (1-month)
10-year nominal Treasury yield minus 10-year Treasury Inflation Protected Security yield (breakeven inflation rate)
Vanguard Financials Exchange-Traded Fund (equities)

I've added the FSI to the link list as a useful indicator to watch.

Punch the clown

2011-10-08T19:50:00.000-07:00

While reading an Illusion of Prosperity post on Oil and Wages, I was going to comment on how it was unsportsmanlike to beat up on Anthony Mirhaydari at MSN Money and his questionable ideas. I mean, how hard is it to punch a clown?

After reading the article, I decided instead to join in the clown punching fun. Here is what he wrote about the crisis in Europe on October 5, 2011:

As for Europe, leaders continue to make progress toward a definitive solution.

Maybe he is in on the latest weekly emergency meeting, but I have yet to see any progress toward a solution. I see lots of emergency meetings, lots of plans to make plans, lots of ideas tossed out by ministers who don't have the authority to do anything, but no solution. Wasn't this problem solved in the summer of 2010? No. Wasn't it solved by a second Greece bailout in July? No. Does Mr. Mirhaydari know that Dexia, a 500 billion dollar bank is being dismantled by the French and Belgium governments this weekend? No. How about that Italy and Spain were both downgraded two days after his article, or that Belgium is now under downgrade watch due to the Dexia bailout. Banks all across the EU were downgraded in the last few days because there is no solution forthcoming.

The Greek Cabinet approved a new budget with tough austerity measures -- including mass layoffs of public sector workers -- designed to return the country to a primary budget surplus (before interest payments), a necessary first step toward restoring fiscal sustainability.

Greece has been approving austerity measures for a year and a half resulting in a lower GDP and bigger budget deficits. They haven't hit a single target since they entered their death spiral. And as mentioned, they can't meet their budget even if they stopped making all interest payments on their bonds tomorrow. They are beyond bankrupt. How have things changed?

As for Greece's saviors, only Slovakia and the Netherlands need to approve the so-called "July 21" changes to the eurozone bailout fund -- which will give the fund more strength and flexibility. Moreover, ratification of the July 21 agreement is needed before European leaders can push ahead with plans to leverage up the bailout fund with private capital with the help of the European Central Bank, a plan that should be the final nail in the coffin of the crisis.

The latest from Slovakia is that the ruling party is against approving the EFSF, but negotiations are ongoing. It could pass, but lets not count the chickens before they hatch. Even if it is approved, they seems to be no taste in Germany for leveraging it up. It really makes no sense for bankrupt countries to borrow from each other, with leverage, to pay off the bonds they can't afford to pay. The whole thing is a circular cesspool.

Whew, clown punching can be exhausting.

S&P 500 vs. Net Capital Inflow (Z1)

2011-10-07T21:38:00.000-07:00

The 2nd quarter of 2011 showed a shocking drop in net capital inflow from the Treasury Department Flow of Funds (Z1). The drop was from 478 billion to 2 billion, a net change of -476 billion or almost half a trillion dollars that fled the US. The last time a drop like that happened was the 2nd quarter of 2008 when the net change was -475 billion. Does S&P history rhyme? We are about to find out.

Steve Jobs RIP

2011-10-06T09:56:00.000-07:00

Steve Jobs RIP

A Decade of Rough Sledding

2011-10-04T20:23:00.000-07:00

CNN has an article called "Face it, tough times are ahead".

President Obama has repeatedly stated, "We are tougher than the times we live in." Although the president may not have intended to signal a whole new approach to our future, the line has Churchillian implications. Speaking of tough times, he could call on Americans to recognize we face at least a decade of rough sledding, ask us to face the challenges and express confidence that we shall prevail.

The problem with asking Americans to suck it up is that the government is really asking the weak, poor, and least connected to suck it up, shoving the burden of the crimes and mistakes of the financial elite onto everyone else. It won't work. This is not an external enemy that bombed us at Pearl Harbor. These are the white collar confidence men running the banks, insurance companies, and the Federal Reserve. Today, I watched Bernanke give the nod to usurious 30% interest rates charged by banks when asked point blank by the Honorable Senator Bernie Sanders. He doesn't see any problem loaning banks money at 0.25% so they can turn around and lend it to consumers at 30%.

Harvard economist Kenneth Rogoff argues that intentionally inflating the dollar is the "the only practical way to shorten the coming period of painful deleveraging and slow growth."

If only it were so easy. Inflation is a disjointed, asymmetric process. Those with first access to new money spend it at full value. Then it cheapens all existing money as moves through the system. That's the way it works unless you drop it equally and on everyone at once.

I am hardly the only one who foresees a "lost decade." A recent Atlantic magazine article argues that even by 2011, 2012, even 2014, the employment rate may decline very little and describes the current economic climate as "a trauma that will remain heavy for quite some time."

Foresee? I see a lost decade looking back to 2000. I also foresee our second lost decade going forward. And maybe a third if we keep kicking the can.

We've avoided the violent demonstrations seen in Greece, the massive demonstrations against inequality seen in Tel Aviv and the random torching of cars common in riots in Germany, France or Britain. If Obama can speak candidly about the coming tough times and the shortfalls we all will have to accept as part of the cure, he may do better; we most assuredly will.

I disagree that Obama can charm the masses by speaking candidly. Obama either doesn't understand what happened, or more likely does understand, but up to now hasn't wanted to confront the money trust the way Andrew Jackson did. He is an insider, groomed to maintain the status quo. He would not have packed his administration with cronies like Geithner and Summers if wanted to address the real issues.

Updated Gold Price vs. Debt statistics

2011-10-01T08:52:00.000-07:00

The monthly model (R-squared = 0.95) going back to 2001, shows some major froth on the upside. The intra-month highs in August and September approached 1900 and reached more than 4 sigma above the linear regression. The closing price on 9/30/2011 was $1,620. Here are the prices predicted by the model:
Two sigma below: $1,335.27
One sigma below: $1,417.52
Best fit: $1,498.20
One sigma above: $1,578.87
Two sigma above: $1,661.13

Expanding the model to yearly prices back to 1971 (R-squared = 0.64), prices are well above trend (predicted best fit price = $1,126.52). The long bull market periods are marked by extreme stress in the financial system. I could be wrong, but the nature of the stress in banks and sovereigns seems much more severe than it did in the 1970s and 1980s. European countries were not going bankrupt in the 1970s while tied to a Euro wide currency. The private debt levels, financial sector debt levels, and sovereign debt levels were not close to what we have now, and no resolution seems to be near. Instead, every effort is being made to sustain the unsustainable. A lot of paper promises are going to be broken. That doesn't mean the gold price hasn't already discounted all of the turmoil to come.

Whether the big gold sell off in September was the start of a bubble collapse or just a correction in an ongoing bull market, I don't know. I think we will know within six months. While I made some good trades during the August and September froth, I also gave some back. Until I have a better understanding of what story gold is telling, I am going to back to the discipline of my statistical models.

Subjective Invective v.8

2011-09-09T16:21:00.000-07:00

The G-7 Finance Ministers and Central Bank Governors issued a statement to calm the troubled markets today.

We reaffirmed our shared interest in a strong and stable international financial system, and our support for market-determined exchange rates.

Market-determined exchange rates like pegging the Swiss Franc to the Euro.

Market-determined exchange rates like multiple interventions by the Bank of Japan.

Bank Of Japan Intervention Leaves Trail Of Blood And Gore.

Bank of Japan Ponders Further Intervention

In recent weeks, many central banks have taken aggressive actions to control the values of their own currencies.

If the Bank of Japan continues to follow its precedent of supporting exporters though, the yen may depreciate from here. Yet, if other central bankers (who themselves may be pursuing weak currencies) have their say, the Bank of Japan may be unable to really weaken the yen.

If anything is market-determined in this day and age, it surely is currency exchange rates. Pursuing weak currencies is the hallmark of market-determined exchange rates, or something. I forgot where I was going with this.Oh, right. Forex trading is so easy that an E*Trade baby can do it! Can you feel the sarcasm?

Why $2K - M1 and M2 vs gold price

2011-09-05T13:09:00.000-07:00

(Hat tip JD from Calculated Risk for the Why $2K title hilarious)
It has been a while since I compared M1 and M2 to the gold price.

M1 has started to go vertical. I can only speculate why. Maybe people are cashing in investments to have more ready cash available. The vertical nature of M2 supports that idea. A surge in both measurements could be explained by liquidation of stocks, bonds, and other investments, but I am only guessing what is happening.

The historic low for M1/gold price was 0.45 that occurred at the peak gold price on January 21, 1980.
The current M1 ratio is 1.16.
The historic low (in my spreadsheet) for M2/gold price was 2.40 in July 1980.
The current M2 ratio is 5.24.

I expected the current ratios to be lower due to the rise in gold prices, but I did not expect the dramatic rise in M1 and M2.

Since money supply is not tied to anything tangible and money is created mostly by typing into computer accounts at commercial banks and the Fed, does it even make sense to call it money supply? I've heard suggestions that "Number Supply" is a more accurate term for dollars in existence instead of money supply. Perhaps the Fed will create more numbers in their computers after their September meeting. Are you ready for Why $2K?

Consumer Metrics Moonshot

2011-09-01T20:46:00.000-07:00

One interesting site I follow sometimes is the Consumer Metrics Institute data on Internet purchases of durable goods. When I first discovered Consumer Metrics, I thought their near real-time methodology was unique and might off deeper insight into what was happening in the broader economy. Over time, the demographics of Internet users turned out to be skewed in some ways and diverged from other broad indices. Still, whatever is going on now with Internet purchases is showing an incredible upward rate of change and deserves some brain cycles for reflection.

There are a couple of possibilities that come to mind. One, Internet consumers on a large scale decided to spend a lot of money online all at the same time because they all came into some new money (tax refunds, raises at work, inheritances). Maybe they all had appliances break over the summer and are replacing them. Anyway, that is one possible theme. A darker idea might be that they are nearly tapped out and decided to buy a bunch of new stuff on credit before declaring bankruptcy within the next six months. There could also be another explanation like the data feed is invalid for some reason or is reporting different information. Consumer Metrics itself seems to take the more positive view that this is a spending phenomenon that will reflect a stronger recovery in the government reported numbers in about 6 months.

Europe Don't Want No Short People

2011-08-21T08:56:00.000-07:00

The short sale ban on banks instituted by many EuroZone countries is scheduled to end on Friday, August 26, 2011. The ban has not saved banking shares from being mauled and may have created artificial air pockets under the share prices since there are no shorts to cover as the prices drop. We'll know more next week.

That ban ends of the same day as the Fed Jackson Hole meeting concludes and Ben Bernanke speaks. Maybe Europe is expecting a miracle announcement from Ben.

They got grubby little fingers
And dirty little minds
They're gonna get you every time
Well, I don't want no short people
Don't want no short people
Don't want no short people
'Round here

Boat of Gloat v.1

2011-08-19T18:23:00.000-07:00

Bank of America Plans Big Layoffs to Cut Costs

The boat of gloat, the sloop of Schadenfreude, sets sail to Charlotte, NC. It sails to the port of call most deserving and docks to find a large, evil, organization. Evil at the top, mind you, and there is a measure of empathy for the pain the generals are going to inflict on thousands of innocent foot soldiers.

With its stock down more than 50 percent since January, the job cuts by Bank of America may be only the start of a broader restructuring at the company, which is the nation’s largest bank. Brian T. Moynihan, the chief executive of the bank, has said that he hopes to trim quarterly expenses by $1.5 billion. Thousands more job cuts are likely in the months ahead.

But this zombie bank, being propped up at horrific costs to the country by the government, needs to finally be killed. Nationalized, unwound, sold off in chunks. For the safety of the US and the world. The list of criminal and civil violations perpetrated by this organization is too long to list.

UPDATED 9/2/2011:
Looks like the layoffs may now reach 30,000.
Bank of America was also sued today by the FHFA for $30 billion dollars (counting BofA and Merrill Lynch).

UPDATED 9/9/2011:
Looks like the layoffs may not reach 40,000.

This boat's for you!

Producer prices hitting the ceiling?

2011-08-17T10:57:00.000-07:00

The producer price index inched up today, led by food and energy. Looking at the long term chart, could we be hitting the ceiling on producer prices where the economy rolls over and dies? This set up looks ominously like 2008 except that oil is currently much lower than in 2008.

I am not saying prices will necessarily fall. The Fed has been very diligent about keeping the dollar going down and prices going up, but the economy may only be able to absorb price increases at a certain rate before tipping back into recession.

Subjective Invective v.7

2011-08-13T19:45:00.000-07:00

After a wild week for stocks, what to do?

What to do, indeed.

The article gives two pieces of sage advice from Robert Shiller. First...

Though he believes the stock market is still overvalued by historical averages, he says it is closer to fairly valued than before. He suggests investors move their money "modestly" into stocks.

I get it. If stocks are overvalued, invest modestly. As the saying goes, buy overvalued and sell high. Then, at the end, we get another piece of advice from Shiller...

"I'd be wary of putting too much in the market," says Shiller. "There's a good chance they'll fall. It's hard to predict the market."

Invest modestly, but be wary of putting too much in the market because there is a good chance it will fall. Now, I'm really confused. To be fair to Professor Shiller, he was probably misquoted and taken out of context. At least CNBC is consistent. It's always time to buy stocks!

I found this chart from an article by Charles Hughes Smith comparing the DOW from the 1907 panic (the one that spawned the Federal Reserve) to the 2008 crash. Yowza. Quoting Shiller: "there is a good chance it will fall."

Disclosure: I am not a certified financial anything. This is not investment advice. No stock positions.

Real GDP vs. Real GDP ex-deficit

2011-08-12T06:05:00.001-07:00

This is my own twist on the size of deficit spending and what it means. By subtracting the GDP deflated deficit from the real GDP, you can see the huge gap being filled by current deficit spending. Some of the causes are well known: spending on unfunded wars and entitlements is too high, taxes are too low, and the Wall Street created financial crisis. Private and financial debt reached a saturation point in 2007 which was the trigger. What led consumers and financial firms to accumulate so much debt is more complex.

If you agree with the general causes, the solutions should be obvious. But what stands in the way is the political courage to address the issues leading me to name the difference in the lines the Political Fantasy Gap. The gulf between reality and sustainable government revenue is so large that the political body can't cope with it. Instead, the aim is to reduce the growth of the gap by 10% over the next 10 years. America is likely to run out of credit before then, which will be the crisis that forces the gap closed in an uncontrolled way.

Falling Down Exter's Pyramid

2011-08-11T04:38:00.001-07:00

John Exter was a member of the Board of Governors of the United States Federal Reserve System. This is a modern version of Exter's Pyramid. From Wikipedia...

In Exter's scheme, gold forms the small base of most reliable value, and asset classes on progressively higher levels are more risky. The larger size of asset classes at higher levels is representative of the higher total worldwide notional value of those assets.

For people wondering why big money is flowing into gold, this is one possible explanation. When the financial system starting falling apart in 2008, (you could argue 2000), there was a sudden realization that mortgage and asset backed securities, the highest level of derivatives on the pyramid, were not money good. They defaulted en mass. To prevent losses, money fled down the pyramid to stocks, bonds, and cash.

The crash of mortgage derivatives and general debt saturation led to falling real estate values which led to more capital fleeing down the pyramid in search of stable returns and preservation. As the bust affected the broader economy, it led to lower profits, layoffs, and a stock market crash. At this point, a lot of big money had fled into treasury bonds. Now, the US has been downgraded, many sovereign countries are on the verge of default, and there is only one place left to go.

Update: The size of the top layer of the pyramid, financial derivatives, is estimated to have a notional value from 500 trillion to 1 quadrillion. A lot of that is supposed to be netted out, but the problem, as we saw with AIG, is that if one counter party can't meet its obligations, one side of a big net position blows up, and the whole chain detonates. A lot of that phantom money just disappears.

Liar Liar

2011-08-07T10:17:00.000-07:00

From Zerohedge...

S&P on the verge of crossing 1200 for the 26th time

2011-08-05T13:58:00.000-07:00

Stagflationary Mark has been documenting how many times the S&P 500 has crossed the magical 1,200 mark.

With the close today at 1,199, it only needs one small up day to finish above that mystical level for the 26th time.

The first time it closed above 1,200 was on 12/21/1998.

It seems much more special in 2011 than it did 13 years ago. Now, it is true that if you bought and held since 1998, you collected some dividends along the way, but this pesky thing called inflation ate it.

Stocks for the long run! (or not)

Awww, SNAP! (updated thru 5/2011)

2011-08-02T19:09:00.001-07:00

The Food Stamp program participation is in a powerful uptrend. Here is the latest raw data as of May, 2011:
Total Participation: 45,753,078
Total as Percent of the US Population: 14.7%

There were about 800,000 new people added to SNAP this month in the state of Alabama.

The GDP Revisions

2011-07-30T12:35:00.000-07:00

The most recent BEA GDP release not only was disappointing for 2Q2011 (1.3%), but the revisions were deep and way down, including an 80% downward revision for 1Q2011. Invictus at The Big Picture blog presented this Fed graph showing the shocking changes.

How can the BEA data be that far off over such a long period of time?

CoreLogic Snapshot: One City

2011-07-23T07:52:00.001-07:00

I compiled a few very basic statistics from the CoreLogic data of one mid-sized city with about 50,000 parcels of land. This was my first pass at the data and it can be compiled in a more fine grained way. For now, here are couple of quick charts on the assessed values and mortgages. Note this includes both residential and commercial properties which are usually segregated. I was going to include mean and median negative equity values but they aren't meaningful with commercial properties in the mix.

Percentage of parcels with no mortgage: 65%
Percentage of parcels with a mortgage: 35%

Mortgages with positive equity: 80%
Mortgages with negative equity: 20%
Percentage of all properties with negative equity: 6%

Subjective Invective v.6

2011-07-22T06:08:00.000-07:00

The Lesser Depression

When the bubble burst, home construction plunged, and so did consumer spending as debt-burdened families cut back.
Everything might still have been O.K. if other major economic players had stepped up their spending
...
In particular, cash-rich corporations see no reason to invest that cash in the face of weak consumer demand.
Nor did governments do much to help.

Except for the massive coordinated monetary policies of all central banks, including about 16 trillion in programs from the Federal Reserve alone. Followed by the massive fiscal stimulus by the US and one by China. Followed by two rounds and 2 trillion more in QE by the Federal Reserve.

The disappearance of unemployment from elite policy discourse and its replacement by deficit panic has been truly remarkable. It’s not a response to public opinion. Nor is it a response to market pressure. Interest rates on U.S. debt remain near historic lows.

Take a look at the historic lows Greek debt enjoyed until, within a short span, it was game over. The problem is no one can predict when the market will turn against a debtor nation with a structural trade deficit. The US might have low rates for the next 10 years, or it might have a bond market meltdown next year.

For those who know their 1930s history, this is all too familiar. If either of the current debt negotiations fails, we could be about to replay 1931, the global banking collapse that made the Great Depression great. But, if the negotiations succeed, we will be set to replay the great mistake of 1937: the premature turn to fiscal contraction that derailed economic recovery and ensured that the Depression would last until World War II finally provided the boost the economy needed.

When banks create too much credit, to the point of debt saturation, the inevitable bust is going to be painful and no amount of trickery can fix it. The answer is not more debt, it is the elimination of debt through payment and default. If you don't allow the debt to deflate, organic growth can't return. More fiscal stimulus won't jump start the economy. Another big world war can eliminate a lot of the work force and create the missing demand you seek, but that is an ugly solution. Kill the debts, not the people.

Autumn of the Empire

2011-07-19T14:39:00.000-07:00

A fantastic and sweeping essay offering several viewpoints, sourced books, and themes to explain three recurring phases of empire. An examination of past empires and the final financialized stage of the current US empire. You may or may not agree, but you won't be disappointed.

Most striking and most dramatic is the discovery that each of these long centuries has itself been divided into three phases, choreographically consistent: a merchant phase based on trade, followed by a phase of industrial expansion, and finally a period of financialization, in which economic vitality moves to the banking sector. It is a febrile vitality indeed, burning hot and fading away; the shift to finance is always, in Braudel’s lovely phrase, “a sign of autumn.” And when the finance era runs its course, so does the empire.

This spiral grows, with China possibly in the middle phase of industrialization. Will the 21st century see an ascendant China?

How Investors Use Stories to Tame Uncertainty

2011-07-14T15:30:00.000-07:00

In the book, The Soros Lectures: At the Central European University, Soros mentioned funding a new project called the Institute for New Economic Thinking (INET). To see if he followed through with his pledge, I searched and discovered that the Institute was indeed active and providing grants for research.

One of the grants went to David Tuckett, with a background in psychoanalysis and sociology, who conducted interviews of hedge fund managers to learn how they made investment decisions. The research focuses on the use of emotion and "stories about investments". The idea that an emotional experience is inextricably tied to each financial investment decision is fascinating, and also the idea that a rational investor would never make investments in financial assets.

Watch the brief video for an explanation.

Fiat Money Distribution of Power and Wealth

2011-07-03T10:20:00.001-07:00

This diagram shows the advantages of being close to the money creation power in a fiat system. The banks and government benefit the most by having the ability to create money and control interest rates. With first access to new money, those nearest to the source of creation are harmed the least by inflation, while those on the other end lose the most purchasing power.

Trade Surplus/Deficit vs. Foreign Owned Securities

2011-06-26T10:17:00.000-07:00

Sources:
Census Foreign Trade (http://www.census.gov/foreign-trade/statistics/historical/)
Treasury International Capital (http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/shlhistdat.txt)

Trade surplus/deficit data from the Census shows a very disturbing trend with the US balance of payments showing a strong trend of increasing deficits. The first thought I had was that an increasing reliance on foreign oil imports was the main driver. However, digging into the details, I found that in 1994, oil accounted for 93% of the cost of imported goods. In 2010, oil accounted for only 29% of the cost of imported goods. The US is still a net exporter of services but it doesn't come close to the amount of goods we import.

My next thought was what happens to all of those dollars sent outside the US? There are two main places they can go. They can be used to buy Treasury securities (bills, notes, bonds) and they can buy US assets (land, companies, corporate bonds and stocks). I tracked down the foreign owned US securities form the Treasury International Capital system and found a steady accumulation of US debt and assets by foreigners recycling their dollars (shocker!).

It's not just US jobs that are moving overseas, it is ownership of the US itself. The growth of foreign held US federal debt is one dimension of concern, but more troubling to me is the increasing ownership of US corporations by foreigners (e.g., Anheiser-Busch bought by Belgium based InBev). The US has denied sales of "strategic" companies to foreign interests (e.g. Union Oil), but eventually those dollars have to come back in the form of either debt or equity ownership. The trend is not our friend.

Update: Here is Real Surplus/Trade (inverted) vs. Real Foreign Owned US Securities as suggested:

Yanis Varoufakis

2011-06-19T09:22:00.000-07:00

Yanis Varoufakis is a Greek economist from the University of Athens. His blog is packed with media interviews, articles, papers, and what he calls the "Modest Proposal" for a solution to the Eurozone crisis.

I found his interviews and writing refreshing, entertaining, and deadly accurate. I haven't had time to absorb the sweeping changes in the Modest Proposal, but I agree with the starting point, which is that the Euro currency structure as originally conceived has fatal design flaws that are now manifesting now as systemic threats to the currency union. He claims (and I agree) that the sovereign debt problems are rooted in insolvency and not liquidity, and that the Euro banking system is also insolvent.

I found his web site by a link provided on Calculated Risk by commentator Haralambos.

UCLA Anderson Forecast June 2011

2011-06-15T14:07:00.001-07:00

I was fortunate enough to attend the UCLA Anderson Forecast this morning. This was the second Forecast event I have attended. The mood was noticeably more subdued compared to a generally upbeat tone at the previous one.

Professor Leamer kicked things off with a "No Recovery" slide. Most of his charts we comparing not against pre-recession highs but against where trend growth would have put the economy today. We are 11% below trend growth on both GDP and employment and it looks increasing difficult to ever get back to trend. In a normal cycle, all lost jobs are recovered after 2 years. This time, we are two years out and millions of jobs have not returned. Dr. Leamer said that over 5 million jobs are permanent displacements, never to return. Permanently lost jobs by his figures:
Manufacturing - 2.5 million jobs
Construction - 2 million jobs
Retail - 800 thousand jobs

The California economy is doing slightly better than many other states. Most job growth has been in hospitality and health care, while most job losses were in government and construction. The government job loss cycle should peak next year, then stabilize, but will be a drag on the economy for the next couple of years.

The focus of this conference was commercial real estate. In general, AAA properties are hot and within 10% of their 2006 highs. Lesser commercial property is slumping. There is a lot of investment money chasing real estate returns. The economists mentioned that pension funds need 7-9% returns to stay sound and can't get there with Treasury bonds that yield 3%. [comment: that might not end well]. Multi-family is expected to boom the next two years as people move out or are kicked out of single family homes. Office space is expected to be weak for years, until employment recovers.

During the first Q&A, a question was asked about the Greek debt. Professor Leamer and panelists agreed that Greece would default, and probably soon. He went on to say that "Uncle Sam was not much better than Uncle Dmitrious" and that after the market dealt with PIIGS, it might turn attention to the US bond market. [comment: While bad, I don't think the US situation is near as bad as Greece]. Professor Shulman stated that Greece would restructure, and that at some point, the US might need to restructure. [comment: I was surprised to hear these comments from the ivory tower].

Keynote speaker was Sam Zell of Equity Residential. Highlights from Mr. Zell:

Consumer over leveraged. Banks over leveraged. Corporate sector strong but unwilling to spend due to uncertainty.
Called Obamacare destabilizing.
Dodd-Frank worse because it did not create any new rules, only directions to make new rules in the future that are not happening.
Called NRLB action against Boeing in South Caroline "shameful".
Deficits unsustainable and unsolvable without growth.
US dollar on verge of losing reserve currency status.
Lots of zombie owners of office space. Way overbuilt.
Lodging - first to fall, first to recover. Said REVPAR was almost back.
Called Western Europe a demographic time bomb. No growth, bad place for RE investment.
Called Asia a tough place to invest. They don't need money, and locals have advantage.
Best real estate investments in Latin America.
Very bullish on Brazil. Reminds him of America in the 1950s.

This was my first time on the UCLA campus. Very beautiful. A really fun time.

Total Credit Market Debt

2011-06-10T18:31:00.000-07:00

Thanks to the magic of economagic.com, I spent some time investigating the Total Credit Market Debt (TCMD) from the Fed Flow of Funds report (Z.1).

The first chart shows the TCMD as a percentage of GDP and also the annual percentage changes in TCMD with recession bars shown. It appears that when the annual change in credit rolls over, perhaps a debt/credit saturation point, the economy goes into recession. This is hardly an original idea.

The second chart highlights the exceptions when the annual change in credit rolled over but did not manifest in an official recession. The exceptions were all relatively minor dips and most did not dip into negative territory. In other words, credit was still growing, just at a slower pace. The 1960s dips did enter negative territory but no recession was called. The 1987 event coincided with a massive stock market crash.

The 2008 financial crisis coincided with debt saturation and the steepest plunge in percentage terms for the change in credit seen since at least 1952. It was nearly a 10 full percentage point drop. Also, the change in credit is still negative. People are still de-levering. Myself included. It is hard to quantify how pervasive this change in attitudes is.

I have completely changed my attitude toward banks and debt. It's not like I had a lot of debt to begin with, but now I am anti-debt other than the very few times it can be used productively. In my opinion, the Fed is encouraging credit destruction by squashing rates to 0%. This reduces interest rates across the curve and on interest bearing accounts. It was 0% interest rates that made me pay off my car loan. Where else could I get an immediate guaranteed 3% return?

The change in credit growth, the shear amount of debt to GDP (still around 350%), and perhaps permanent change in attitudes leads me to believe the recovery will be very slow and take a long time.

Subjective Invective v.5

2011-06-08T16:45:00.000-07:00

The Magic of Financial Repression

I'm glad I had not eaten recently when I read these words of wisdom from President Obama:

“Save a little bit out of whatever you’re earning, and the magic of compound interest applies,” Obama said.

Just wow. Because the Fed is artificially sitting on short term rates (0 to 0.25%), the rate on my savings account at the Credit Union is 0.10%. Now that is a really magic number. If I saved $1,000 in that savings account, it would earn a cool $1 per year, or 8.3 cents a month.

But it gets better because I have to pay taxes on that $1. After paying state and federal income taxes, that leaves me about 75 cents at the end of the year for loaning the Credit Union $1,000. I don't know, 75 cents doesn't sound like such a great return.

But it gets better because of inflation. With headline CPI inflation running a little over 3% a year, by saving and using the magic of compound interest, I have lost about $29.25 a year in purchasing power.

I haven't done the math, but my guess is that the numbers don't get better after 10 years unless something truly magical happens.

See: Financial Repression

Apprentice to a Failed Philosopher

2011-06-02T16:43:00.000-07:00

I've taken a great interest in George Soros recently, and especially his theories on Reflexivity and the Open Society ideas he adopted from Karl Popper. Soros has had an extraordinary life and reading his bio is interesting and entertaining in itself. I am currently reading The Soros Lectures that he gave at the Central European University.

The title of this post is a reference to Soros' self described failure as a philosopher during a certain period of his life. Part of what Soros writes that resonates with me is that I consider myself something of a philosopher, having done a great deal of studying and reading in college. Whether the subject is programming computers (my ostensible profession), investing, or playing chess, I am more of a strategist than a tactician. I have to work at tactics to enjoy success, while strategy comes more naturally.

Whatever you think of the politics of George Soros, I think he offers a lot of food for thought with both his general philosophy and in its application to investing. If I am diligent, I hope to eventually rise to the rank of failed philosopher.

ZSL teaching some investors harsh lessons

2011-05-14T08:01:00.001-07:00

While cruising around the Yahoo Finance message boards, I read many posts similar to this one:

I learned a painful lesson with this POS. After making a small gain in SLV calls a few weeks ago, lost it all in 2 days. Turned to this and managed to turn $4k into $0 within 3 days with useless calls. I have to agree this is totally rigged, down big when silver is down, but not last week....up big when silver was down....WTF?!!!! I'll be interested if a class action lawsuit is forthcoming.

ZSL is a double inverse ETF based on the silver price. In other words, it is a way to short silver with leverage. From the ProShares web site:

This ETF invests substantially in financial instruments linked to the performance of commodities and currencies, such as swap agreements, forward contracts, and futures and options contracts, which may be subject to greater volatility than investments in traditional securities.

A derivative monster on steroids. If you hold it for more than one day, the transaction and roll costs will eat you alive. ZSL has usually tracked the double inverse of the silver price pretty well for one day periods. But what really changed this past week is that the short silver trade got very crowded. Everyone wanted to short silver on the way down and bid up the price of ZSL far beyond it's net asset value. That premium gets wrung out through resets in derivative prices and from arbs coming in to take the eager short sellers' money.

Even after the horrendous performance last week, the NAV of ZSL is $18.76 while the closing price was $19.70, a 5% premium. I made a little on ZSL early in the week but got out when the premium started getting too high. You can see an outrageous premium in the Sprott Physical Silver Fund (PSLV) as well, something close to 15%. That is not likely to end well. These premiums can build up for a number of reasons, but Reflexivity is probably the best explanation.

This poor investor thinks the ZSL tracking error is due to fraud.

I called proshares about this fraud, they soooo fawked up, gave some bull@#$% explanation, what ever. But people lost lot of money. When silver 5% down ZSL also down too doesn't make any sence at all. This morning SLV up 2% but this turd is down 10%. Play this POS if you just want to loose money. Total fraud, people have to file class actions about proshares doing too much looting with these 2x and 3x scams. SEC should get rid of all these fancy etfs and toss em into toilet.

While there is plenty of fraud in the operation of stock markets, investment companies, and the SEC, this case is not one of them. This investor is probably making investment decisions with the same expertise shown in his grammar and spelling.

Possible end game gold price targets

2011-05-06T19:10:00.001-07:00

Note: This post inspired by Eric Janszen articles at iTulip.com.

There are a number of possible resolutions to the world debt crisis and to the titanic debt of the USA. Going through the political calculations and game theory of the timing and final resolution is frankly beyond my ability. However, with the dollar index and trade weighted dollar near all time lows, one possible resolution to prevent the dollar from an eventual collapse would be for the US to reopen the gold window for foreign creditors to allow them to exchange dollars for gold.

This would simultaneously impose (again) some kind of limit on the trade deficits that can be run by the US. The simplest way to accomplish this is to revalue the gold on the Fed balance sheet. The Federal Reserve Act of 1913 put a limit on the total amount of credit and currency that could be issued by the Federal Reserve. Here is the pertinent part of section 16 of the Federal Reserve Act:

Every Federal reserve bank shall maintain reserves in gold or lawful money of not less than thirty-five per centum against its deposits and reserves in gold of not less than forty per centum against its Federal reserve notes in actual circulation, and not offset by gold or lawful money deposited with the Federal reserve agent.

There may be some argument over the best measure of notes in circulation. The most conservative measure might be M1 which includes currency and checking accounts. But since the FDIC insures savings accounts and CDs, M2 might be a better measure. Wikipedia has common definitions of money supply. I've read arguments that the Fed balance sheet, the total liabilities of the Fed, could be used but that doesn't seem to come close to the definition in the Act.

If the US wanted to stick with the letter of the original act and limit redemption to M1 money stock, which was $1,908,900,000,000 as of May 5, 2011. Restrictions on redemption to M1 would force creditors to wait for their treasury bonds to mature before making claims on US gold. Here is where gold would need to be priced to restore the dollar link to gold based on M1:

$1,908,900,000,000 / 261,499,000 oz (US gold reserves) = $7,299.84 / oz
Apply the 40% reserve to get a current target of $2,919.94 / oz.

However, the thesis is that the purpose of reopening the gold window would be to keep foreign creditors from dumping the dollar. Most foreign reserves are stored in treasury bonds. Treasury bonds are simply frozen dollars that pay interest -- dollars that thaw on a specific date in the future. Total US debt is over $14 trillion, but not all of that debt needs to be redeemable in gold.

I think it is safe to exclude Intragovernmental Debt, primarily the Social Security Trust fund, because those bonds are not marketable and will be paid out as dollar benefits (or legislated away). That leaves the debt held by the public, made up of both foreign and domestic creditors. The number we are looking for is the number for foreign creditors.

For that, we need to look into the Treasury International Capital System (TIC). The total debt held by foreigners as of February, 2011 was $4,474,300,000,000.

$4,474,300,000,000 / 261,499,000 oz (US gold reserves) = $17,110.20 / oz
Apply the 40% reserve to get a current target of $6,844.08 / oz.

But does the US really need to give gold to foreign private citizens that hold treasury bonds? Maybe not. The point is to keep international commerce flowing smoothly. To that end, we can look at only the debt held by foreign sovereigns. The total official foreign holdings as of February, 2011 was $3,186,300,000,000.

$3,186,300,000,000 / 261,499,000 oz (US gold reserves) = $12,184.75 / oz
Apply the 40% reserve to get a current target of $4,873.90 / oz.

The Fog of Currency War

If all of the above conjecture is correct, it will still be a murky and twisty path to arrive at the destination. I don't believe the US will reopen the gold window until and unless it is forced to do so. It would be an admission of the failure of the US and Federal Reserve to manage the dollar. It would discredit the theory of a workable pure fiat currency. It would discredit a couple of generations of academic economists, including Nobel Laureates, and the economics profession. Not that being consistently wrong hurts the career of economists in general, but they might have o amend a few textbooks. It would also come as a shock to the general population who for the most part has little or no understanding of monetary history or the current money system.

If gold was remonetized preemptively at a price higher than the market price, the transition might be made without any major disruption. If it happens in a disorderly way, the market price may overshoot the remonetized price and come back down to a permanently higher and managed level. In that scenario, the US may not have as much control of the final price.

Dual mandate: Inflation expectations, Unemployment, Fed Funds Rate

2011-05-01T12:25:00.000-07:00

Sources:
Fed H15 http://www.federalreserve.gov/releases/h15/data.htm
NY Fed http://www.newyorkfed.org/markets/statistics/dlyrates/fedrate.html
BLS

The Fed's dual mandate is theoretically stable prices and low unemployment. There are many different measures of inflation, but one that can be reasonably argued as market based is the difference between the 10 year treasury yield and the 10 year TIPS yield. In the above chart, the difference in yields is labelled inflation expectations. That data is only available back to 2003.

Inflation expectations appear to have completely recovered from the 2008 crash after plunging to depression levels. What has not recovered is the unemployment rate. Based on the recent comments by Bernanke, the Fed is not worried about inflation.

The employment numbers look even more terrible if you look at the raw job numbers that don't ignore people whose benefits have expired. Based on the dual mandate, it is unlikely the Fed will raise rates any time soon. However, if inflation expectations continue to rise, say into the 3-4 percent range, the Fed will have a tough choice to make regarding interest rates.

At the beginning of the graph, you can see the end of the 1% reflation rate set to recover from the 2001 recession. The low rate, held for about 2 years, helped fuel the housing bubble. The even lower rate set by Bernanke has now been in place for over 3 years and I wonder how and where that latent inflation will pop up. We have partial answers right now: stocks, commodities, and metals. Whether those assets will continue to benefit over the next 3 years is an open question.

Adjustment scenarios for JGBs

2011-04-24T07:12:00.000-07:00

Reuters reports Japan GPIF to withdraw $78 bln from assets.

The GPIF is likely to raise cash by selling JGBs and other assets in its portfolio as pension contributions and tax income continue to fall short of pension payouts which are growing as Japan's population ages, the newspaper said.

The largest buyer of JGBs, is not just reducing purchases, or failing to roll over maturing bonds, but will be a net seller this year. That is a watershed moment. The Japanese government, with astronomical debt-to-GDP over 200% may be a harbinger of things to come for western governments with heavy debt loads. We've seen bond market failures already for Greece, Ireland, and Portugal at much lower debt levels.

Japan has been given a great deal of slack because it has large net exports, and the unusual fact that it's government bonds are 90% funded internally through pension funds and private purchases. It appears the time is fast approaching when private purchases are no longer sufficient to fund bond issuance. I've been trying to think through possible ways Japan and/or market forces will adjust to this change. How will JGBs be funded in a future where private funding slows down?

Foreign purchases might surge

The shortfall could be met with increased foreign purchases of JGBs, from sovereign wealth funds, hedge funds, or central banks. At current interest rates, the lowest in the western world, it is hard to imagine any large buyer would think Japanese bonds were a good investment. It is possible that foreign central banks might agree to support Japan and purchase some with the goal of averting a global crisis. The Fed in particular has been accommodating of most any request for dollars.

Japanese bond issuance slows due to voluntary austerity

The government of Japan may decide to dramatically reduce spending and reduce deficits. Where spending cuts are made is likely to be a heated political battle, much as in the US.

The BoJ monetizes JGBs

Following a standard operating practice since the 1990s, the BoJ may increase their purchase of bonds in another round of quantitative easing. While events may include elements of each policy and market response to the JGB problem, I view BoJ QE as the most likely and to make up the bulk of any shortfall from private purchases.

The danger of unlimited QE is that the amount monetized becomes absurd at some point. Whether that is 250% debt to GDP, 400%, or when the total tax revenues no longer cover the interest due on outstanding bonds. Something will be a trigger point where either the Japanese people or Japan's trading partners lose faith in the yen. An extreme currency crisis can be only be met with extreme policy choices.

Extreme policy choices

Once a currency crisis has begun, Japan can choose to default on outstanding debt due and preserve some value in the currency, or print money to cover every bad debt leading to hyperinflation. Both choices are painful for the citizens and country and may lead to unknown political consequences. Despite all the advantages accrued to Japan, it may be the first major advanced economy to go over the Keynesian cliff.

Subjective Invective v.4

2011-04-22T18:42:00.000-07:00

NPR Planet Money on Gold

A recent story on NPR Planet Money, Why We Left the Gold Standard, is an amazing mixture of misunderstanding and tangential anecdotes without ever managing to answer the question in the title.

In the early part of the 20th century, all the world's key economies were on the gold standard.
But in 1931, the system began to unravel in the most powerful country in the world: England. When the Great Depression hit, the people in England panicked, and started trading in their paper money for gold. It got to the point where the Bank of England was in danger of running out of gold.

The article never tries to explain why the people wanted gold instead of paper, or why the Bank of England was in danger of running out of gold. It was because the Bank of England was on a fractional reserve gold standard and they issued too much paper to be supported by the gold reserves. Banking, as it grew out of original goldsmiths issuing paper receipts for gold deposits, was a fraud from the start. The goldsmiths could issue more receipts than the gold they had on deposits and as long as not too many people redeemed their receipts at the same time, no one was the wiser. Modern bankers lend out deposits while pretending that all their deposits are available to all depositors all the time. But just like the goldsmiths, if too many depositors want to redeem their paper money receipts, the bank fraud is exposed and the bank fails.

"Because of undermined confidence on the part of the public there was a general rush by a large portion of our population to turn bank deposits into currency or gold," Roosevelt said.
When he gave this speech, Roosevelt knew the gold standard was a problem. But he wasn't sure what to do about it.

The undermined confidence grew after large numbers of banks failed (eventually about half of all banks) and people lost their deposits. There was no FDIC insurance and people, at least some people, knew that banks didn't have enough gold or reserves to pay all depositors. Fractional reserve banking is inherently unstable by design.

"Most economists now agree 90% of the reason why the U.S. got out of the Great Depression was the break with gold," Ahamed says.
Going off the gold standard gave the government new tools to steer the economy. If you're not tied to gold, you can adjust the amount of money in the economy if you need to. You can adjust interest rates.

Most economists have been wrong about most everything, from the Great Depression through the Great Recession. The break with gold happened in 1933 and Depression raged on until after World War II. There was a powerful segment in "Inside Job" showing the duplicitous nature of academic economists. Their opinions and services are for sale and they are happy to offer up some kind of defense of any policy for which they are paid, without, of course, disclosing their financial arrangement. The U.S. got out of the Great Depression only when World War II created massive demand, 400,000 Americans were killed and the productive capacity of the rest of the world was destroyed, creating even more demand.

Being able to issue unlimited unbacked credit and change interest rates to benefit your friends is indeed a powerful tool. The Federal Reserve had all those tools long before the Great Depression, with the exception that their ability to issue credit was restricted by a 40% fractional reserve limit, part of the original Federal Reserve Act.

The author does not discuss why the banks were running out of gold, why FDR confiscated gold from citizens in 1933 then devalued the paper notes he forced them to take -- against the gold he took from them -- and made it illegal to own gold, which remained in effect until 1975. The author does not talk about the fact that the U.S. only went off the gold standard domestically, but continued to redeem dollars for gold with foreign governments until 1971 when Nixon broke the final ties between the dollar and gold. Gold was used to settle international trade balances at the IMF until 1978. The author seems to imply that the US went off the gold standard because it gave the government new tools for central planning of the economy. In fact the only new tool it gave the government was the ability to issue unlimited unbacked credit. The government could devalue people's savings at will. The author seems to have no understanding of monetary history.

U.S. Senate Report on the Financial Crisis

2011-04-16T17:41:00.000-07:00

On April 13, 2011, the PERMANENT SUBCOMMITTEE ON INVESTIGATIONS in the US Senate released a report called WALL STREET AND THE FINANCIAL CRISIS: Anatomy of a Financial Collapse (pdf).

It is a massive report with plenty of damning evidence, implicating Goldman Sachs and Duetche Bank among others. The net of blame is cast wide, with good reason, citing failures of OTS regulators and the rating agencies.

I haven't had time to dig into too many details, but I read the overview and the 19 recommendations for reform included in the summary. The recommendations are broken into 4 areas, High Risk Lending, Regulatory Failures, Inflated Credit Ratings, and Investment Bank Abuses.

My initial reaction is that all of the recommendations are good and would improve the financial system, but none address one of the root causes identified in the collapse. No provision is made to dismantle Too Big to Fail institutions. There is a suggestion to make banks hold higher reserves against high risk investments, but nothing to address size and scope issues of TBTF.

A second glaring omission, I believe, is a better way to incentivize rating agencies. Instead of the issuer paying the agency, I think a much better model is for investors to pay the agency for an honest opinion. Kind of a consumer reports for financial investments. The Senate report suggests that the SEC rate the rating agencies on their accuracy, but this seems like a poorly thought out half-measure to me.

If any of the suggested reforms are enacted, it will be an improvement, but I believe it will leave the system vulnerable to a similar kind of collapse in the not too distant future.

Twilight's last metal gleaming

2011-04-11T16:41:00.000-07:00

Starting in 1965, the US began to actively debase metal coins in circulation by removing silver from the dime, quarter, and half dollar. The half dollar went from 90% silver to 40% silver, then 0% silver by 1971. In 1983, the penny went from 95% copper to 97.5% zinc and 2.5% copper. Both copper and silver became worth much more than the face value of the coins. Monetary debasement has been common throughout history as inflation eats into the value of the "official money". Consequently, governments require greater seigniorage and taxes to keep overextended empires going.

Today, there is one US metal coin remaining with a metal value greater than the face value: the lowly nickel. The nickel composition is 75% copper and 25% nickel. According to Coinflation.com, it has a metal value of roughly 7.1 cents or about 42% above face value.

There was a brief period during World War II when the composition was changed to 56% copper, 35% silver and 9% manganese to preserve the nickel for war needs. It was a rare period when the nickel had no nickel in it. It went back to the copper-nickel alloy after the war.

Don't take any ~~wooden~~ zinc nickels

Straight from Wikipedia...

Gresham's law is an economic principle "which states that when government compulsorily overvalues one money and undervalues another, the undervalued money will leave the country or disappear into hoards, while the overvalued money will flood into circulation."[1] It is commonly stated as: "Bad money drives out good", but is more accurately stated: "Bad money drives out good if their exchange rate is set by law."

With the nickel undervalued and other coins and paper overvalued by fiat, it is only a matter of time before either nickels start disappearing from circulation as they are hoarded, or the US Mint decides that paying more than double the face value for the current nickel alloy doesn't make sense and will change it something like the new penny, 97.5% zinc. That action may also cause the copper-nickel version to be hoarded.

Trying to stay only one step ahead of the crowd, I have started collecting nickels. The risk is that I will miss out on 0.1% interest in my money market fund, but there is no acquisition cost or deflation risk. I started with a humble request for 10 nickel rolls from my credit union. Sadly, they only had 7 rolls in the entire brach. I was able to double that from the loose change jars of two friends. I've added copper and nickel charts to the blog.

I am prepared to wait 10-15 years on my nickel speculation. The 1964 silver coins didn't become a big win until 1979 or 1980. I'd rather be wrong about the active and earnest debasement of the dollar, and will happily return my nickels to the bank when I am convinced it is safe to do so.

Real Per Capita Income and Debt

2011-04-05T16:47:00.001-07:00

sources:
http://research.stlouisfed.org/fred2/series/NICUR
http://www.treasurydirect.gov/NP/BPDLogin?application=np
http://www.census.gov/popest/states/NST-ann-est.html
http://www.bls.gov/data/inflation_calculator.htm

This chart shows the last 10 years of national income and national debt per capita, adjusted to 2010 dollars. Per capita income rose slightly, while per capita debt rose very sharply, on a trajectory to double within the next few years.

Despite the comparison of a stock vs. a flow, I find it ominous that the debt crossed the income line around the beginning of 2010. The debt shown is only federal debt. It does not include private debt, state or local government debt. The chart also doesn't address the distribution of that income which is becoming more concentrated in the top quintile.

Subjective Invective v.3

2011-04-02T16:14:00.000-07:00

source: OMB Table 1.1—Summary of Receipts, Outlays, and Surpluses or Deficits (-): 1789–2016

The federal budget debate and potential shut down have been in the news lately. I started reading the overview of the budget from the President's Office of Management and Budget and found the expected double talk and misdirection.

The Budget includes more than $1 trillion in deficit reduction – two-thirds of it from cuts -- and puts the nation on a path toward fiscal sustainability

If you read a little further, you find out that the the $1 trillion deficit reduction is projected over a 10 year period. The President is claiming that a 6.6% reduction in the current year $1.5 trillion deficit is sustainable. It's not. The OMB makes optimistic projections for the next 5 years of job and wage growth and assumes no new recession will appear. Even in that case, the deficit never gets smaller than $500 billion.

Five-year non-security discretionary spending freeze will reduce the deficit by over $400 billion over the next decade and bring this spending to the lowest level since President Eisenhower sat in the Oval Office.

Non-security discretionary spending is less than 15% of the budget, and the part that is not growing. What is growing automatically every year are Social Security, Medicare, and Medicaid, accounting for over half of the budget. The other large outlay, the MIC, is also deemed untouchable. To mention Eisenhower in the same sentence as making defense spending off limits is the height of hypocrisy, like putting Jackson on the $20 Federal Reserve Note.

Pays for a three-year patch to prevent an increase in taxes on middle-class families through the Alternative Minimum Tax (AMT) by limiting the rate at which high-income earners can itemize tax deductions.

Why does Congress insist on patching the AMT every year? Here is my permanent fix: index the AMT amounts to the CPI and forget about it. Inflation is why the AMT is hitting so much of the middle class now. Full disclosure: I had to pay about $800 extra in AMT this year, the first year I ever had to pay it. The only reason I can imagine why they don't want a permanent fix is because they plan to stop patching it at some point when it applies to everyone and just becomes the base line for higher taxes.

The whole thing is further evidence that the US is politically incapable of fixing the budget and deficit problems that face the country.

Earthquakes and Tsunamis

2011-03-13T08:50:00.000-07:00

My heart goes out to all of Japan, suffering through a terrible natural disaster.

Reflecting on events, I could not help but think about parallels in the international monetary system. The stresses and imbalances in the dollar reserve system, sometimes called Bretton Woods II, have been building up since 1971.

Like the stresses on a fault line, sometimes you feel rumblings, sometimes you get small tremors, but the big changes tend to come unannounced and all at once as the pressure is relieved. The final event itself may not even cause the most damage, but may set in motion destructive forces greater than anyone can imagine. The financial tsunami that follows the end of the dollar reserve system may destroy many economic and political foundations long thought safe from harm.

Unlike a real earthquake, the financial one to come is man made, the result of a system designed to benefit the central planners and bankers for whom it was constructed.

US Debt vs. Gold Price linear regression update

2011-03-02T11:30:00.000-08:00

One of my favorite models is US Debt vs. Gold. There has been a strong correlation between the debt and gold prices since 2001. Here was the original post. The correlation gets a little weaker, but is still significant all the way back to 1971. As with any market, there are gyrations on either side of the regression line.

The first chart shows monthly debt and gold prices starting in January 2002 through March 2011 with the linear regression line.

The second chart plots them together. Notice the deep drop in prices when it looked like "this sucker was going down" in 2008. That would have been an unprecedented deflationary event, with perhaps only a handful of banks surviving. When that didn't happen, both the debt and gold started moving up a steeper slope.

The R² of the regression is 0.95. Predicted gold prices based on the March 1, 2011 debt level of 14,172 billion are as follows:

One sigma (68% confidence):
low: 1304.92
best fit: 1375.35
high: 1445.79

Two sigma (95% confidence):
low: 1233.04
best fit: 1375.35
high: 1517.66

Since I started tracking the gold price, I haven't seen a price, even intraday, get close to a two sigma deviation.

PHYS vs. GTU vs. GLD vs. GDX

2011-02-27T13:09:00.000-08:00

I am currently long the Sprott physical gold fund, which trades on the NYSE under the symbol PHYS. On Friday, gold gained about 0.66% in price while PHYS traded lower at the end of the day. This is the second time I've seen this happen in the last month and I started to become a little concerned about the correlation of PHYS to the metal.

This motivated me to make a closer comparison of the physical metal funds and ETFs and gold stocks to see if there was a better way to leverage gold in a trading account.

PHYS and GTU are both Canadian bullion trusts that store physical gold, while the giant GLD ETF also stores physical gold, but the audits and conversion features are much less desirable. Because PHYS lets you take possession of the metal at a much lower threshold than GLD, it tends to carry a higher premium. It may also carry a trust premium. The GDX is an ETF made of gold miner stocks.

Looking back six months, I was a little alarmed to find that PHYS underperformed all the gold vehicles I was researching. It was a full 10% below the GLD, which does seem to track spot price movements reliably.

Looking back a full year, I found the results a bit more comforting. Over the full year, PHYS outperformed everything except gold stocks, which benefited from a rising QE2 fueled stock market. Over the full year, GTU was the laggard.

There are several dynamics that might explain the inconsistent performance. First, PHYS has a market cap only about 2% of GLD. It takes much less money moving in and out of PHYS to move it away from the spot price. Some people don't trust that GLD has all the gold they claim to have, but I don't have a strong opinion on that either way. The fact is that large players, hedge funds, banks, pension funds, can shove the price of PHYS up or down by accumulating or distributing shares. Over time, arbitrageurs should make the necessary adjustments, but over the short and even intermediate term, it may be more volatile than GLD.

CFNAI-MA3 on 8 month losing streak

2011-02-24T07:54:00.000-08:00

The 3-month moving average of the Chicago Fed National Activity Index (CFNAI) came in at -0.10. This is the 8th consecutive negative reading going back to June, 2010.

The numbers are not in recession territory, but they also don't show much strength or momentum in the recovery. More like treading water.

Doug Short has some great charts on the CFNAI showing the long term trend line is still down.

Subjective Invective v.2

2011-02-23T09:50:00.000-08:00

Geithner Says World in Better Position to Handle Oil-Price Jump

“The economy is in a much stronger position to handle” rising oil prices, Geithner said today during a Bloomberg Breakfast in Washington. “Central banks have a lot of experience in managing these things.”

I wonder what he ate at that Bloomberg Breakfast? Geithner believes our economic Central Planners can handle whatever happens with oil prices.

“The core of the American financial system is in a much stronger position than it was before the crisis,” he said. “We’re way ahead of any other major economy.”

That statement is a head scratcher. Let's look at a few macro readings to compare the before and after picture. For the before, I'll November 2007 since the recession officially began in December 2007.

Unemployment (from bls.gov)
Nov 2007: 4.7%, unemployed persons 7.2 million
Jan 2011: 9.0%, unemployed persons 13.9 million

Oil Price
Nov 2007: 95.93
Feb 2011: 99.67

Real GDP (annual rate, 2011 dollars, bea.gov, bls.gov)
Nov 2007: $14,834
Feb 2011: $14,870

Federal Debt (treasurydirect.gov)
Nov 2007: $9.080 trillion
Feb 2011: $14.124 trillion

Dollar Index
Nov 2007: 76.80
Feb 2011: 77.77

Fed Funds Rate (newyorkfed.org)
Nov 2007: 4.59%
Feb 2011: 0.15%

Case-Schiller House Price Index
Nov 2007: 179
Dec 2010: 131

Which of the above indicators shows that the "core of the American financial system is in a much stronger position"?

Maybe he means that hundreds of banks have failed each year since 2007 with almost 1,000 more on the FDIC watch list?

Maybe he means that two of the big three automakers already have their bankruptcy behind them?

Maybe he is talking about the nearly 10% (of GDP) structural deficit the government is running each year?

Maybe by "core" he means his personal friends.

iTulip link, long overdue

2011-02-17T19:01:00.000-08:00

Eric Janszen, founder of iTulip.com is one of the most thorough, thoughtful analysts on the political economy I have read. I first discovered him in 2008 through this seminal Harper's Magazine article, The next bubble: Priming the markets for tomorrow's big crash.

It was the first time I remember seeing the acronym, FIRE (Financial Insurance and Real Estate) to describe the economy from the early 1980s through 2008. Since then, I've seen FIRE turn up in dozens of places.

My reluctance to link to it was simply because of the pay wall. Eric posts half of his analysis for free, and the other half behind a pay wall. I have paid for subscriptions in the past and plan to in the future. I think the content is worthwhile, but even if you choose not to subscribe, the free parts are still worth the visit.

FD: I have no relationship with Mr. Janszen and he will likely never be aware of my endorsement.

Subjective Invective v.1

2011-02-13T10:16:00.000-08:00

Obama plans to cut deficit by $1.1 trillion

"We have a responsible budget that will cut in half the deficit by the end of the president's first term."

Really? The headline doesn't make sense then, because cutting $1.1 trillion over 10 years would not cut the deficit in half over the next 18 months. The CBO estimates that the deficit will grow this year, shrink to just under $800 billion in a couple of years, then explode again to $1.2 trillion by 2020.

"The challenge we have is to live within our means but also invest in the future," Lew said, adding "tough tradeoffs" would have to be made to achieve that goal.

All of these budget cutting proposals seem like a joke to me unless they target the largest budget items: Medicare, Medicaid, Social Security (non-discretionary) and Defense. I don't see any tough tradeoffs in the proposals.

A Democratic aide said the budget would reduce Pentagon spending by $78 billion over five years. Pentagon cuts would include the C-17 aircraft, the alternate engine to the Joint Strike Fighter and the Marine Expeditionary Vehicle that the Defense Department says it does not need.

How dare they cut something that the Defense Dept. doesn't need? Ike is rolling over in his grave. That $78 billion over 5 years is a whopping 1.5% of the projected deficits. Way to make a dent in the defense budget.

I wonder what would happen to the deficit if we had another recession before 2020, something I would wager heavily on (and have)? It would not surprise me to see a $4 trillion deficit before 2020.

note: subjective invective was inspired by Stagflationary Mark's sarcasm reports. The format fits my personality too much not to copy it. Thanks, Mark.

Consumer Credit Crucible

2011-02-05T13:36:00.000-08:00

Here is a closer look at the details of the Federal Reserve G.19 Release on Consumer Credit (all amounts NSA). Since the financial system reckoning in October 2008, total consumer credit began declining and only stopped on a quarterly basis in August, 2010. The steep and sustained credit contraction is unprecedented since World War II. Non-revolving credit has been close to flat since the crash, while revolving credit continued to contract until December, 2010 as households repaired their balance sheets.

Total non-revolving credit started showing growth again in July, 2010, but the composition of that growth has been lopsided. Commercial banks and finance companies had a short-lived spike in 2009 loans, probably due to the Cash for Clunkers program, but since then, both have continued to contract. December 2010 showed an increase in commercial bank lending. We'll have to watch to see if this is a trend reversal. Securitized consumer loans fell down and can't get up, down more than 50%. The only sustained growth, which went parabolic after the crash and made up for contraction in all other categories by adding over $200 billion, was Federal Government/Sallie Mae student loans. That's a lot of money and a lot of people feeding the higher education bubble.

Total revolving credit peaked in July 2008 and is down about 18% through December, 2010. The last two months showed some signs of life. Whether this was one time holiday spending or a new trend is to be determined. An interesting footnote is the accounting change in March, 2010 that moved all securitized revolving credit back on to the balance sheets of banks. The net change of those two categories during the month of the accounting change was -$41.7 billion. How much of that was from pay offs vs. write downs is unknown.

While total consumer credit has stopped declining, the composition is unbalanced. Until December, 2010, households in general were still paying down debt faster than they are taking out new loans. The big exception is student loans, which have been growing at about 75% YoY since October, 2008.

Maybe the rapid growth in student loans corresponds to the rapid growth in unemployed people attempting to retool for a new career after the reckoning. I hope it works out for these new students because student loans, unlike other kinds of consumer credit, cannot be discharged in bankruptcy.

The Financial Triad

2011-01-26T17:07:00.000-08:00

I have been thinking about personal cash flows lately, and where spending energy has the best odds of producing good results. It seemed to break naturally into three areas (in order of decreasing importance):

Earning a good income (by working)
Being a good consumer
Being a good investor

Once people reach retirement, number one drops off, although having a steady income stream in retirement is important. There is a lot of time and energy spent by people to improve their work skills, and there is a glut of information on investing, but probably not enough good information on being a good consumer. Spending wisely can pay off a lot better and more consistently than searching for the ideal trade.

With that in mind, I've added a link to Clark Howard, a popular consumer advocate who has a radio program and pretty good web site. I certainly have big disagreements with his conventional investment advice, but I think he does a great job discussing consumer issues, quality, deals, and more. I certainly find him sincere and earnest in providing advice.

Abstract Purchasing Power of Investments

2011-01-22T17:23:00.000-08:00

A friend of mine made a comment this weekend about his deferred compensation retirement statement. A new statement arrives quarterly showing profits and losses in the retirement account denominated in US dollars. This got me thinking about the differences between the dollar amounts shown on a retirement statement, brokerage statement, or the value of any investment compared to the purchasing power of dollars spent today.

This post is mostly rambling hypothesis and conjecture, but it puts purchasing power at a particular point in time in some kind of perspective. It seemed somewhat interesting rolling around in my head and writing it down helps flesh out the idea.

Purchasing Power in Time

The purchasing power of a US dollar fluctuates continuously based on many factors. For any given product or service, the current price is the intersection of the supply of and demand for dollars with the supply of and demand for the product or service. Since that intersection moves continuously, it can vary over time, and it can vary immensely over a long period of time. Note that part of the supply and demand profile for dollars is reflected in foreign exchange rates. For humans, a long period of time can be the 30 years that retirement funds are locked up (severe penalty if withdrawn) before retirement.

Here are a few consumer prices from the BLS from 30 years ago (US City Average):

Bread, white, pan, per lb. (453.6 gm)
1981 0.53
2010 1.38

Electricity per KWH
1981 0.063
2010 0.125

Gasoline, unleaded regular, per gallon/3.785 liters
1981 1.298
2010 2.985

Prices of some items have roughly doubled over 30 years, and some have more than doubled. On the other hand, prices of things like computers have come down by orders of magnitude.

Liquidity and Taxes

Going back to the retirement account statement, what is the purchasing power of those dollars today? That money is not liquid, it must be extracted with penalties from the account and taxes paid on it (unless it is a Roth IRA), then adjusted for inflation (zero inflation if you spend it today). For a traditional retirement account, a rough estimate is 40% of the purchasing power is destroyed through penalties, state, and federal taxes. So the purchasing power today is about 40% less than what appears on the statement. After some period of time, the penalties go away, but the taxes remain, perhaps at a lower rate if your income is lower during retirement. Over that time, inflation has probably eaten some purchasing power. The point is that the purchasing power of retirement account dollars are very abstracted from the purchasing power of dollars today.

Inflation, Productivity, and Technology

Let's turn our attention to the forces operating on the purchasing power of dollars over time. Inflation and deflation are the source of many misunderstandings and issues, mainly due to different definitions and ways to measure it. I prefer to think of inflation as the net effect of changes in money supply and velocity, one result of which is higher or lower prices. Higher prices mean lower purchasing power. Inflation is always working against you, while always working for governments.

Fortunately, there are forces working in everyone's favor to increase purchasing power. Those forces are productivity and technology. Both tend to increase output per labor hour and/or reduce operating expenses, creating downward pressure on prices. Computers are a perfect example. Moore's law suggests that microprocessor power doubles every 18 months. That is equivalent to a 48% deflation rate (or negative 48% inflation)! Massive increases in productivity and technology are what keeps inflation at bay. It creates the illusion that the Fed is doing a good job managing inflation and the dollar, when in fact, it is all the deflation created by entrepreneurs and technology that lets people flourish.

Thinking back on the retirement dollars, if productivity and technology can outpace inflation over 30 years, those dollars become more valuable later. But since inflation has no upper limit in a pure fiat system, I would bet on inflation winning in the long run.

Demographics of Conventional Investments

One final thread to this idea. That is the effect of the baby boomer generation on conventional investment vehicle prices. Since the 1970s, conventional wisdom has been to invest primarily in stocks and bonds through IRAs and 401k type plans. Without trying to calculate the effect of the majority of boomers buying stocks and bonds, sheer numbers say there should be an upward price movement due to increased demand. All things being equal, as boomers begin to liquidate their stocks and bonds during retirement, there should be downward price pressure as sellers outnumber buyers. One caveat is that foreign buyers could step in to fill the demand. If not, then lower prices for financial assets mean lower purchasing power during retirement. That doesn't mean you should necessarily stay away from stocks and bonds, but it is a factor to consider in any kind of long term planning.

Purchasing Power Pressures

Pulling it all together, the purchasing power of retirement account dollars in the distant future are very hard to measure. Inflation and taxes will eat away at it, productivity and technology improvements will increase its value over time, and demographic effects for conventional investments may decrease purchasing power over time. Whether the numbers on a retirement statement today have a strong correlation to their purchasing power many years in the future is difficult to say.

Fiat money exposes human flaws

2011-01-09T08:35:00.000-08:00

An idea emerged for me recently from the collision of themes in two books: This Time is Different by Reinhart and Rogoff, and When Money Dies by Adam Fergusson. I am afraid this will come across as a gold bug rant, but it is not about gold, more about humans and human systems.

Table 1.1 in This Time is Different documents different financial crisis types by time period going as far back as the year 1258. In every kind of crisis, fiat money proves far more disastrous than metal backed money. Here are the highlights showing the annual maximum % of currency change:

Inflation
1500-1913
173%

Inflation
1914-2008
9.73 E+26% (Hungary 1946)

Currency Debasement
1258-1913
-56.8%

Currency Debasement
1914-2008
-1.0 E+11% (Zimbabwe 2008)

The message of the table is clear. Before the rise of fiat currencies, financial crisis, inflation, and currency debasement occurred, but were much less severe. Currency debasement before paper currencies required physical debasement of metallic coins. That is both a slow and difficult process for kings, queens, and governments to perform. Hyperinflation never happened when physical metal was used as money. It is just not feasible. Modern debasement is often performed by simply lopping zeros from the end of currencies.

Human Flaws

Humans and human systems are flawed. Fiat currencies can work in theory, but where there is potential for abuse, that potential will be exercised. For a fiat currency to work over time, the people running the system must execute it perfectly. With a metal backed currency, the potential for abuse and therefore the actual abuse is less severe. That is one of the lessons from history in This Time is Different.

Most financial crisis have been caused by over expansion of credit, political crisis, war, or some combination. None of those goes away with a metal backed currency, but the aftermath of each is almost guaranteed to be less traumatic.

California UI Fund Balance update

2011-01-06T16:44:00.000-08:00

The California unemployment insurance fund ran out of money in 2009 and the state started borrowing money from the Federal government to pay unemployment insurance claims. Money borrowed was interest free until January 1, 2011 and all money borrowed is due, with interest, on September 30, 2011.

The red line in the chart shows the actual balance, the latest data for October, 2010. The black line is a simple extension of the 2010 experience. If 2011 unemployment claims are similar to 2010, the ending balance on September 30, 2011 will be about -$12 billion.

The state employment development department estimates the interest due on September 20, 2011 will be $362.3 million. Worse, the state is forecasting a worse experience and a fund balance of -$26 billion at the end of 2012. Details here.

Oh, SNAP!

2011-01-02T15:17:00.000-08:00

The number of people on food stamps, now called SNAP, exceeded 40 million in 2010. To qualify for SNAP, you must fall below gross income, net income, and resources thresholds. There are quite a few exclusions from resources (home, vehicles used for income), but otherwise, you can't have more than $2,000 in the bank. Gross income limits for a family of 4 is $2,389 and net income is $1,838. The formula for meeting the net income threshold also has quite a few deductions, but is considered the poverty level. Full details are here:
SNAP eligibility

The SNAP participation rate as a percent of US population has rocketed to a record 13.1%. Even without the rise from the 2008 crash, the trend line (dashed line) has been up since the program began.

CFNAI-MA3 vs. S&P 500

2010-12-20T20:03:00.000-08:00

Here is a chart of the last six years of the Chicago Fed National Activity Index (3 month moving average) vs. the S&P 500 closing price.

The Chicago Fed National Activity Index (CFNAI) is a monthly index designed to gauge overall economic activity and related inflationary pressure. The CFNAI is released at 8:30 a.m. ET on scheduled days, normally toward the end of each calendar month.

A linear regression on the data over the last six years found little correlation (R-squared = 0.27) between the CFNAI and the S&P 500. The CFNAI is a trailing indicator that has a pretty good track record of marking recessions, but does not appear predictive of market movements.

99ers in the Shade

2010-10-22T14:29:00.001-07:00

This is a quick chart I put together from the BLS private and government employment totals. This shows the month over month change in total employment and when roughly 99 weeks of unemployment benefits expire.

For people who have been out of work that long and are still looking, this is when all unemployment benefits expire. The next five months may be the toughest unless Congress extends benefits.

Added Propublica Bailout List

2010-08-24T14:59:00.000-07:00

I added a Link List section after the blog roll. Some of the blog roll links should probably be moved down to the link list.

The lead off batter for the link list is the Propublica bailout list that covers not only TARP, but Fannie and Freddie. A few black holes in that list from which no money ever escapes.

The shape of the elephant

2010-06-17T15:20:00.000-07:00

The story of the blind men and an elephant is apropos of economics and markets.

The story of the blind men and an elephant originated in India. In various versions of the tale, a group of blind men (or men in the dark) touch an elephant to learn what it is like. Each one touches a different part, but only one part, such as the side or the tusk. They then compare notes on what they felt, and learn they are in complete disagreement. The story is used to indicate that reality may be viewed differently depending upon one's perspective, suggesting that what seems an absolute truth may be relative due to the deceptive nature of half-truths.

Several years ago, I began an intensive, focused (my wife says this is the only way I know how to do things) examination of money, economics, and markets. Only in the last few months have I begun to feel like I can see the silhouette of elephant.

It will always be a little fuzzy because it never sits still, always moving. The strategy I have evolved combines my own reading, research, and statistics with the opinions, research, and statistics or many other blind men whose opinions I trust.

Unfortunately, the blind men in power, who have the best vantage point -- those in the Federal Reserve, the Department of Treasury, some academics, the mainstream press, and Wall Street analysts -- are so often wrong that they are not reliable.

There are very good reasons why they are so often wrong, some innocent, some not. I did not come to this conclusion quickly or intentionally, but through countless hours of study and comparing ideas, statements, and predictions with unfolding events.

The blind men and women I rely on to help me see the elephant are scattered throughout history and the world. Some are living and some are not. The truth is out there, just not in plain sight.

Six impossible things

2010-05-29T08:11:00.000-07:00

This is a great post from John Mauldin on the impossibility of every nation becoming net exporters and reducing deficits at the same time.

http://www.ritholtz.com/blog/2010/05/six-impossible-things/

RIP RJD

2010-05-16T14:37:00.001-07:00

The Last in Line

Stock market is broken

2010-05-06T14:20:00.000-07:00

While I was at lunch today, the DOW took a thousand point plunge, then recovered about 600 points within about 30 minutes. Meanwhile, gold was up over 2.5%. The stock market mechanism is broken and fraudulent due to HFT trading, front running, and a host of other reasons.

Google finance was showing 30,110 shares of Accenture stock (ACN) traded at 1 penny, while it closed at 41.09. Any system where this is normal is not a place to put hard earned money, or pension fund money.

MASSIVE SYSTEMIC FRAUD.

California Unemployment Insurance Fund Balance

2010-05-01T08:21:00.001-07:00

The following chart shows the California UI Fund balance and Month-over-Month changes since the recession began in December, 2007. The balance went negative at the end of 2008 and has had a growing negative balance since then.

US Debt vs. Gold Price linear regression

2010-04-19T19:41:00.001-07:00

WARNING: This is not financial advice, just a fun project for me.

A chart at Jesse's Cafe Americain inspired me to crunch the debt numbers on my own. That chart compares US debt to the gold price and showed a very high correlation (R-squared of 0.93).

I downloaded monthly public debt data from the Treasury starting in 2001 and historical gold prices from Kitco, then ran my own linear regression using the open source R program. The R-squared was was 0.9288, confirming the value from the chart at Jesse's site. This is the regression chart for the 2001-2010 data:

The linear regression formula (without the error term) is:
GOLD PRICE (nominal) = -522.86 + (.1334 * US-debt-in-billions)

If we take the Obama administration estimates of $1 trillion dollar deficits for the foreseeable future, the model makes this prediction (with 95% confidence):

June 1, 2016: US debt = $19 trillion
price of gold (nominal) = 1849.42 (low), 2011.84 (best fit), 2174.27 (high)

Now, some caveats. Below is an annual regression from 1971 which still has a good correlation (0.5564), but predicts lower prices. Correlation is not causation, and I suspect there are many other factors that weigh on the gold price, both positive and negative.

After confirming the original chart, I went back to Treasury and gathered annual debt numbers as back to 1971 when the final dollar link to gold was broken. The R-squared for the larger data set is 0.5564. This is the regression chart for the 1971-2010 data:

The linear regression formula (without the error term) is:
GOLD PRICE (nominal) = 181.46 + (0.0518 * US-debt-in-billions)

And this is what the updated model predicts (with 95% confidence):

June 1, 2016: US debt = $19 trillion
price of gold (nominal) = 780.95 (low), 1165.66 (best fit), 1549.94 (high)

Gold charts 4/1/2010

2010-04-09T08:32:00.001-07:00

Gold charts 3/1/2010

2010-03-16T09:15:00.000-07:00

In all charts, money stock values come from the St. Louis Fed. Gold stocks come from the Gold Council and gold prices from Kitco. These comparisons are for US money stock vs. World gold supply.

Starting with the 1/1/2010 data, I adjusted the estimated gold supply to reflect mining output for 2009 based on data from the Gold Council. This affects the M2/oz chart but does not affect the M2/price chart.

Charts do not start at zero to better show changes.

They Pay Bonuses

2010-03-13T10:11:00.001-08:00

Consumer credit up in January, 2010

2010-03-06T08:38:00.000-08:00

Total consumer credit was up (+2.4%) for first time since August, 2009. Before that, you have to go back to December 2008 for an uptick in total consumer credit. Despite the uptick in total credit, revolving credit (credit cards) continued down. We will have to wait for future releases to see if the down trend has changed.

Total Credit Dec 2009: 2451.3 Billion
Total Credit Jan 2010: 2456.3 Billion

The Minsky view of Keynes

2010-02-20T15:47:00.000-08:00

I just finished the book John Maynard Keynes by Hyman Minsky. It is a fresh look (circa 1975) at the revolutionary ideas from Keynes' major works, including but not limited to The General Theory.

Minsky believes that the work of Keynes was watered down and absorbed into the classical economic mainstream and the revolutionary ideas were mostly ignored. He thinks a heart attack shortly after The General Theory was published prevented Keynes from defending his work as vigilantly as he would have otherwise.

One of the big ideas in the book is an examination of how Keynes viewed investment decision making in times of uncertainty, and direct relationship between investment, growth, and employment. In A Treatise on Probability, Keynes stressed the difference between risk, which can calculated and assigned a numerical value, and uncertainty, which is incalculable. Uncertainty leads to money hoarding, leading to lower investment and employment.

Minsky fleshed out the ideas in Keynes' work related to lending, interest rates, financial investment and speculation, looking at the psychology that develops in various stages of the business cycle. Combined with the effect of increasing debts and rising asset prices, Minsky was able to tell a story about disequilibrium. The seeds of the destruction of each phase of the business cycle can be explained in terms of the psychology of financial investment and speculation, leading to the Financial Instability Hypothesis.

The book ends with an interesting discussion of Keynes' social philosophy and political aspirations. For Keynes, the trick was to achieve three goals:

economic efficiency

social justice

individual liberty

He believed he had found a way to balance these goals with policy modifications of government action, without going the way of Socialism or Communism. I have great empathy for these goals, though the implementation of the policy prescriptions have not proven to work as Keynes expected.

An epiphany for me was the connection between the work of Minsky and Keynes, and the Kondratiev long wave theory. Kondratiev had described long waves in Capitalism, but did not define the mechanism -- how or why long waves occurred. Minsky's Financial Instability Hypothesis, described how long waves between boom and bust could happen in a system of financial Capitalism. Rational and irrational actors play their parts, with banks, speculators, and workers interacting in fundamental ways. I need to spend some time assembling all the steps into a more coherent whole, but that connection hit me like a sledgehammer.

Gold charts 2/1/2010

2010-02-17T17:05:00.000-08:00

In all charts, money stock values come from the St. Louis Fed. Gold stocks come from the Gold Council and gold prices from Kitco. These comparisons are for US money stock vs. World gold supply.

Starting with the 1/1/2010 data, I adjusted the estimated gold supply up by 2% to reflect mining output for 2009. This affects the M2/oz chart but does not affect the M2/price chart. I will make further adjustments when I receive updated supply figures from the Gold Council.

Charts do not start at zero to better show changes.

The beginning of February was a slightly better time to buy than January or December.

Some Krugerrand trivia

2010-02-13T08:50:00.000-08:00

The South African Krugerrand was the world's first 1 oz gold bullion investment coin. For a while, it was the most popular gold bullion coin, but has since been eclipsed by the Canadian Maple.

The obverse side has a picture of Paul Kruger, while the reverse side has a picture of a springbok antelope, one of South Africa's national symbols. The rand is the unit of South African currency, hence Kruger-rand. It is minted with no face value, but is legal tender in South Africa, taking on the current market value of spot gold.

Below the antelope image on the right side are the small initials CLS for Coert L. Steynberg, the South African artist who designed the image.

One of the unique features of the Krugerrand is that it is an alloy of only gold and copper, giving a darker, redder tone than other bullion coins, that are usually pure gold or are alloyed with silver in addition to copper. I happen to like the color, but it is purely a matter of personal taste.

One point that confuses some people new to gold investing is that 1 oz bullion coins contain a full ounce of gold despite being alloyed, so a 1 oz 22 karat Krugerrand contains the same amount of gold as a 1 oz 24 karat Maple. It actually weighs a little more than the Maple due to the copper content.

Specifications
Diameter 32.69mm
Thickness 2.74/2.84mm
Weight 33.931 g
Fineness Au 916.67/Cu 83.33
Gold 31.1035g
Reed edge 220

The most frequently counterfeited US gold coin

2010-02-10T10:54:00.000-08:00

"The single most counterfeited series of U.S. gold coins is the Indian Head Quarter Eagle. This series accounts for approximately 40% of all counterfeit gold coins received by PCGS."

Read the full article at PCGS...

Debunking Economics

2010-02-06T10:57:00.000-08:00

Debunking Economics, by Steve Keen, is perhaps a seminal work for bringing economics out of the 19th century. Building on the work of Keynes and Hyman Minsky, Keen makes a strong case for leaving static, equilibrium based neoclassical economics behind.

The flaws in classical economic axioms are so obvious, and the predictions so poor, that they are indefensible. Yet, their ideas still dominate academic and practicing economists, with policies that are not just misguided, but harmful to the well being of the world political economy.

The new dynamic models Keen has developed show great promise as a new way to approach an understanding of modern credit based economies. This book ranks near the top of all economic books on my bookshelf.

I was particularly impressed with chapters 10 and 11, which cover financial markets, the efficient markets hypothesis, Irving Fisher's theories before and after the Depression, and Minsky's financial instability hypothesis.

Great money supply primer

2010-02-02T12:56:00.000-08:00

I stumbled on a great money supply primer on Jesse's Cafe Americain.

In my gold charts, I mainly use M2 for comparisons against gold supply and gold price.

The use of pools of water is an excellent metaphor, and can be applied to money flows more broadly than just money supply (e.g. stocks and other assets).

Oompa Loompa Bankers

2010-01-26T05:45:00.000-08:00

Oompa Loompa Bankerdee doo
I've got another puzzle for you
Oompa Loompa Bankerdah dee
If you are wise you'll listen to me

What do you get from a Ben Bernanke?
A flood of reserves and spreads greater than three
Why don't you try simply cooking your books?
Regulators would not dare to look

You'll get no
You'll get no
You'll get no subpoenas

Oompa Loompa Bankerdee Dah
If you are greedy you will go far
You will live in happiness too
Like the Nineteen
Oompa Loompa Bankerdee do

Added Steve Keen's Debtwatch

2010-01-23T09:57:00.000-08:00

Steve Keen is an Australian economist, who is a luminary in a more advanced school of economic thought, post neoclassical. He is extending the work of Hyman Minsky through dynamic system models and shows compelling data on the effects of too much debt.

I am about half way through his Debunking Economics book, gaining better insights into neoclassical theory and why much of it doesn't work in the real world.

There is a treasure trove of lectures, models, and articles at his Debtwatch site.

Q4 Hoisington Economic Review and Outlook

2010-01-15T13:32:00.001-08:00

The Hoisington Investment Group publishes a quarterly review and outlook.

The outlook has not changed much from Q32009, with a strong case made for continued drops in money supply, credit, and asset prices. They recommend US long bonds to take advantage of disinflation (or even deflation).

What remains a mystery is under what circumstances a lack of foreign buyers would create a huge interest rate spike. Treasury rates, especially long rates seem particularly vulnerable.

On the other hand, the dynamic that seems to be at work presently is Fed monetization that is feeding banks, who recycle that money not into loans, but into stocks, bonds, and commodities. The Fed is threatening to withdraw support of the mortgage market, which could pull a lot of money and leverage out of the system. This would tend to push rates up, but could also spur a flight to safety in Treasuries. I'm not sure how the dynamic is going to play out.

Gold charts 1/1/2010

2010-01-13T13:06:00.000-08:00

All charts start from a number greater than zero to better show monthly changes.

M2/World Gold Supply (oz)

M2/Gold Price

In all charts, money stock values come from the St. Louis Fed. Gold stocks come from the Gold Council and gold prices from Kitco. These comparisons are for US money stock vs. World gold supply. Starting this month, I removed the MZM charts since they really told the same story as M2 vs. gold.

After peaking in December, gold pulled back more than $100 to start the new year at $1,121.50. The pull back, along with an increased M2 for the month, made it [relatively] more affordable than December 1.

At the beginning of the month, the M2/Price ratio was 7.49. During the stagflation crisis in 1980, the ratio went under 3.

One of these things is not like the other

2010-01-09T09:13:00.000-08:00

Can you spot the broken promise in the picture?

This is a picture of a 1957 silver certificate and the reverse side of an 1879 Morgan silver dollar. Both are US legal tender with face values of 1 dollar. The silver certificate is supposed to be backed by silver in the US Treasury and convertible to silver on demand.

In 1965, the US Mint began debasing silver coinage and circulating coins contain no silver today. After 1968, the US Treasury reneged on its promise to honor conversion and the purchasing power of the silver certificate steadily declined while the purchasing power of the Morgan silver dollar increased. The Treasury has sold off all 16 million ounces of silver it once held as reserves. The Mint must purchase silver on the open market in order to create silver Eagle bullion and other collectible coins.

This scenario has played out time and again throughout the history of government issued money. Do not believe for a moment that the US government won't break its monetary promises. It has done so in the recent past.

Taxes for Revenue are Obsolete

2009-12-18T07:54:00.000-08:00

At some point within the last two years, as I devoted more and more time to understanding economics (some might say obsessively), I realized the Federal government was not constrained to spending based on tax revenue. The Treasury can issue as many bonds as needed, either borrowing from purchasers or as we saw in 2009, having the Federal Reserve Banks create money out of thin air to purchase bonds, something Bernanke said he would not do, then did in the amount of $300 billion.

Congress spends like tax revenue doesn't matter, and as Dick Cheney has been famously quoted "deficits don't matter". That is true, of course, until it is not.

But I don't want to get side tracked on Triffin's dilemma. This week, I stumbled on a 1946 speech by Beardsley Ruml, Chairman of the Federal Reserve Bank of New York titled:

"TAXES FOR REVENUE ARE OBSOLETE".

The first half of the speech discusses using the tax code to implement public policy. The second (less interesting) half focuses on the "evils" of the corporate income tax.

Clearly, the Federal Reserve has been thinking this way since the original Bretton Woods agreement. I think many people would be surprised or shocked to learn that governments and central banks operate this way, since leaders never [AFAIK] make the point explicit.

The Ascent of Money - part 3

2009-12-17T07:52:00.000-08:00

More fascinating tidbits from Niall Ferguson's The Ascent of Money. Can you tell I like this book?

The Failure of LTCM and the Quants

The Nobel prize winning economists and rocket scientists employing the Black-Scholes formula for pricing options found out the hard way in 1998 that humans aren't easily modeled.

Meriwether himself, born in 1947, ruefully observed: 'If I had lived through the Depression, I would have been in a better position to understand events'. To put it bluntly, the Nobel prize winners had known plenty of mathematics, but not enough history. They had understood the beautiful theory of Planet Finance, but overlooked the messy past of Planet Earth.

And later...

As we have seen repeatedly, the really big crisis come just seldom enough to be beyond the living memory of today's bank executives, fund managers, and traders.

Reversal of Capital Flows

For centuries, the capital flow was generally from West to East, but has reversed over the last 20 years.

And it is a mighty flow. In 2007, the United States needed to borrow around $800 billion from the rest of the world; more than $4 billion every working day. China, by contrast, ran a current account surplus of $262 billion.

A Modern Classic

There is so much wisdom in this book that I don't feel I have even touched on a fraction of it. It puts into perspective the disorienting chaos of global financial markets. Highly, highly recommended.

The Ascent of Money, part 2

2009-12-15T12:46:00.000-08:00

The New Deal and Housing

More fascinating tidbits from Niall Ferguson's The Ascent of Money. A long stream of legislation was born out of the Great Depression that reinvented the U.S. housing market, and particularly, the mortgage market.

Prior to federal government involvement, home mortgages were typically 5-year interest only loans with a balloon payment due at the end. If you were unable to pay off or roll over the balloon payment, you were foreclosed. Home ownership was at about 40%. After FHA was established, mortgages were typically 20-year, amortizing, at 80% loan-to-value. FHA mortgages were also federally insured -- safe as houses.

The Public Works Administration spent 15% of its budget on low-cost homes and slum clearance. New agencies created included the Home Owners' Loan Corp to refinance mortgages on longer terms, the Federal Home Loan Bank Board, and the Federal National Mortgage Association (FNMA). By 1960, home ownership was up to about 60%.

Mortgage interest has always been tax deductible, since the inception of the federal income tax in 1913. Ronald Reagan defended the deduction while president stating that mortgage interest relief was "part of the American dream".

Restructuring in 1968

To broaden home ownership in wake of the Civil Rights movement, Fannie Mae was split in two: the Government National Mortgage Association (Ginnie Mae), which was to cater to poor borrowers like military veterans, and a rechartered Fannie Mae, now a privately owned government sponsored enterprise (GSE), ...was permitted to buy conventional mortgages creating a secondary market. Two years later, to provide some competition in the secondary market, the Federal Home Loan Mortgage Corporation (Freddie Mac) was set up.

All of the key government institutions were now in place to support home ownership. My first home loan for $95,000, was through FHA, whose standards in 1992 required only a 3.5% down payment, with a loan limit in Texas of $120,000. I made a small gain when I sold it 4 years later for $108,000. Safe as houses.

The Ascent of Money - part 1

2009-12-13T10:04:00.000-08:00

I just finished reading Niall Ferguson's The Ascent of Money. This book is a financial history of the world and is fantastic on many levels. The subject matter is highly relevant to today's malaise. It will take a few posts to highlight some of the juicy bits. The scope of this book is stunning, interleaving the rise of various financial innovations and their relationship to geopolitics.

The first noteworthy passage I found was in the introduction:

...poverty is not the result of rapacious financiers exploiting the poor. It has much more to do with the lack of financial institutions, with the absence of banks, not their presence. Only when borrowers have access to efficient credit networks can they escape from the clutches of loan sharks.

In light of the widespread fraud and moral hazard of the current era, this is a profound insight. With reflection, it holds up. Finance and credit do perform a vital role in society, but it can, and has, gotten off track.

The Government Bond Market

Following the history of the bond market, which grew out of transferable bonds in Italy, it was surprising to find that bonds financed war more than public works. War bonds issued by city-states, then nation-states, have been used mostly to initiate or defend against aggression. Ferguson covers the rise of the Rothschilds and the incredible fortune made buying and selling British bonds during the Napoleonic wars.

He covers the American Civil War from the perspective of the Union and Confederate bond market. As the value of Confederate bonds fell, their ability to finance the war crumbled.

There is also a nice piece on the German hyperinflation after World War I:

Inflation is a monetary phenomenon, as Milton Friedman said. But hyperinflation is always and everywhere a political phenomenon, in the sense that it cannot occur without a fundamental malfunction of a country's political economy.

The Germans apparently miscalculated the French response to their money printing and after the French invaded to force collections, the political situation got out of hand. We can see evidence of Ferguson's assertion by looking at the political situation in Argentina over the last couple of decades and Zimbabwae today. Hyperinflation flourishes in the midst of political breakdown.

Gold Charts 12/1/2009

2009-12-13T08:05:00.000-08:00

In all charts, money stock values come from the St. Louis Fed. Gold stocks come from the Gold Council and gold prices from Kitco. These comparisons are for US money stock vs. World gold supply.

All charts start from a number greater than zero to better show monthly changes.

M2/World Gold Supply (oz) in 2009

MZM/World Gold Supply (oz) in 2009

M2/Gold Price in 2009

MZM/Gold Price in 2009

For the second month in a row, M2 and MZM continued to rise. However, the gold price rose much faster. I expected economic conditions, particularly housing, to deteriorate in November, but the numbers were more moderate. The first time homebuyer tax credit, foreclosure moratoriums, and Federal modification programs have slowed the housing correction and artificially limited supply at the low end.

Looking at the money supply to gold price ratios, it is the most expensive time in 2009 to buy gold. Inflation adjusted gold prices are still not near the peaks of 1980.

The first part of December saw a long overdue dollar rally. If it continues, gold prices will be under pressure.

Nordegren Woods (This Bird Has Flown)

2009-12-09T08:42:00.000-08:00

I once had ten girls, or should I say, they once had me...
She scratched up my face, isn't it good Nordegren Woods.

She asked me to go and she told me to split anywhere,
So I looked around and I noticed my phone on a chair.

I ran to the car, biding my time, drinking her wine,
We fought until two and then she said: "It's time you're dead"

She smashed out my glass with a wedge and started to laugh.
I told her I'm sorry, and crawled off to sleep in the path

And when I awoke, I was alone, this bird had flown
So I may retire, isn't it good Nordegren Woods.

-- The Beatles
http://www.youtube.com/watch?v=KkcRZSdc8us