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We did get something – a gift – after the election. … It was a little cocker spaniel dog in a crate. … And our little girl – Tricia, the 6-year old – named it Checkers. And you know, the kids, like all kids, love the dog and I just want to say this right now, that regardless of what they say about it, we’re gonna keep it.
– Richard Nixon, “Checkers” speech after accepting illegal campaign contributions
Cory is here tonight. And like the Army he loves, like the America he serves, Sergeant First Class Cory Remsburg never gives up, and he does not quit. My fellow Americans, men and women like Cory remind us that America has never come easy.
– Barack Obama, 2014 State of the Union address
You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold.
– William Jennings Bryan, the Boy Orator of the Platte, 1896 Democratic nomination speech
Every man a king, but no one wears a crown.
– Huey Long, the Kingfish, slogan from 1928 Louisiana gubernatorial campaign
You didn’t build that.
– Elizabeth Warren, slogan from 2012 Massachusetts campaign for US Senate
The play’s the thing. Wherein I’ll capture the conscience of the king.
– Shakespeare, “Hamlet”
As usual, I was struck by the pageantry and sheer theatricality of this Tuesday’s State of the Union address. As usual, you had the props – human and otherwise – on full display. As usual, you had the rhetorical flourishes, the ritualized audience behavior, the talking head performances before and after. Unusual for me, though, was the professionally scripted and rehearsed television broadcast production, such that the cameras were trained on the human props before the President referred to them in his speech. A bravura technical performance, to be sure.
Last week’s note focused on the primal human behavior of dance. This week it’s the primal human behavior of theatre, of the representation of stories, particularly the play-within-a-play…a fundamental trope of human story-telling from Hamlet to The Simpsons.
There’s the ostensible meaning of the spoken words and the performance, and there’s the ostensible audience to whom the words and performance are addressed. But then there’s the real meaning of the words, and the real audience to whom the words are addressed. And then maybe there’s a meaning and an audience beyond that. This is the recursive, strategic nature of public communications. These multi-level games are the beating hearts of both politics and economics, and looking at these behaviors through the lens of game theory can help us both see the social world more clearly and call more things by their proper names.
We expect this sort of linguistic game-playing in politics. It’s what politicians DO, whether it’s Elizabeth Warren’s “You didn’t build that” speeches putting a modern slant on the same language and imagery of populism and class warfare used by William Jennings Bryan in the 1890’s and Huey “Kingfish” Long in the 1920’s, or whether it’s the entire Republican Party’s “Southern Strategy” of coded language to maintain racist voting blocs post the Civil Rights Act of 1964. If you’ve never read political operative extraordinaire Lee Atwater’s infamous interview on the subject, you really should. And yes, I know that Atwater’s point was that overt racist appeals were diminishing in the South as the language changed, but does anyone doubt that Atwater would use language straight from the KKK handbook if he thought it were still an effective campaign tool? It’s not that he thinks racism is wrong or even distasteful in the context of a political campaign, any more than Elizabeth Warren would be opposed to burning Jamie Dimon in effigy (or maybe in person) at her next campaign rally … it’s just an unpopular tactic today, at least in its unvarnished form. But if it works tomorrow? Sure, why not? In the immortal words of Al Davis, “Just win, baby.”
This sort of linguistic game-playing is not a modern phenomenon. It is a quintessential human phenomenon, played just as effectively by Pericles 2,500 years ago as it is by politicians today. My favorite example of a linguistic play-within-a-play was staged 150 years ago by an undisputed American political genius: Abraham Lincoln. We’re all familiar with the Lincoln-Douglas debates as some sort of shining example of civic participation and civil discourse, but few know the politics behind those debates. Lincoln lost that 1858 election to Stephen Douglas for the US Senate (well, he won the aggregate popular vote by a slim margin, but US Senators were still chosen by state legislatures back then, and the allocation of votes within the Illinois legislature gave Douglas a clear victory). But the way he lost that Senate race … the way Lincoln played the game … won him the Presidency in 1860.
Here was the central question of those debates, the way in which Lincoln framed the language of the debate to give himself the best chance of winning the larger political game: should the citizens of a Territory have the right to decide whether or not to allow slavery in that Territory? Every time Douglas tried to move the debate to some other topic (and seeing as how Illinois was, of course, a state rather than a Territory, you can understand why other topics might be of interest), Lincoln moved it right back. Every time the crowd’s attention seemed to wane in the subject, Lincoln would say something certain to inflame his opponents in the crowd, drawing Douglas back into the fight. Lincoln’s position on this question may surprise you. He was adamantly opposed to popular sovereignty in the Territories, even when the majority opposed slavery (like Kansas). Lincoln’s position was not only anti-slavery, but also (and perhaps more importantly to Lincoln from a political game perspective) anti-states’ rights and local sovereignty.
Why? Lincoln’s question was not really directed at Douglas, the immediate audience. Nor was it really directed at the crowds of voters in the various Illinois towns where they debated. Nor was it really directed at the Illinois newspaper reporters who carried the debates across the entire state of Illinois. It was really directed at a national audience of Republican voters, because Lincoln knew that the Illinois Senate race in 1858 was just a warm-up for the Presidential election of 1860. If Douglas agreed with Lincoln on the Territorial sovereignty question, then he would lose the only issue where he was more popular than Lincoln within Illinois … Douglas would lose the Senate race and fatally damage his chances in the national Democratic primary. If Douglas disagreed with Lincoln, then he would probably win the Illinois Senate race and put himself in a reasonable position to win the national Democratic primary, but not without splitting his own party (Southern Democrats wanted slavery legalized in Territories even if the majority voted it down). Lincoln was playing a game four layers deep! He didn’t care about “winning” the debate. He didn’t care about winning the crowd. He didn’t really care about winning the Illinois Senate election. All of those things would be nice, but it was the fourth level – winning the national Republican primary and the national Presidential election of 1860 – where Lincoln was focused.
Lincoln’s multi-level game strategy worked perfectly. The Democratic party split into Northern and Southern factions (really into three factions if you count the Constitutional Union, which drew principally from former Southern Whigs), giving the Republicans a clean sweep of the Northern states and Electoral College domination even though Lincoln received less than 40% of the popular vote nation-wide. Douglas – the candidate of the (Northern) Democratic Party – finished second in the popular vote with 30% of the vote, but carried only one state (Missouri) and ended up with a mere 12 Electoral College votes, compared to Lincoln’s 180. Not bad for a former Congressman from a frontier state who couldn’t even win a Senate seat.
I’m always surprised when people who are quite aware of the linguistic game-playing that creates the fabric of politics are somehow blind to the same linguistic shaping of the fabric of economics and market behavior. I shouldn’t be surprised – as Upton Sinclair said, “it is difficult to get a man to understand something when his salary depends upon his not understanding it” – but still. We don’t expect our politics to be “scientific” or our politicians to be anything less than fallible humans, but somehow we expect Truth with a capital T when it comes to economics. There’s a tendency to treat economic communications and signals – whether it’s from a Famous CEO, a Famous Investor, a Famous Economist, a Famous TV Personality, or a Central Banker – as somehow less theatrical or less staged for a larger purpose than political speech. But this is a mistake. When Ben Bernanke said that the Fed would increasingly use its communications as a policy tool, he was declaring his intention to start playing a linguistic game. Or rather, his intention to play the game even harder than it had been played in the past. When Jean-Claude Juncker, former Luxembourg Prime Minister and head of the Eurogroup Council, said of European monetary policy “when it becomes serious you have to lie,” he was simply saying what every successful game-player knows: sometimes you have to bluff. Some Central Bankers are pretty good poker players (Draghi, for example); others … not so much. But they are all playing the Common Knowledge Game as hard as they can, they’re getting better at it, and they’re not going to stop. If you don’t understand the rules of this game, if you don’t listen to what is being said in the context of game-playing, then you are placed at a disadvantage versus those who do. You will not understand the WHY that exists behind the public statements.
There’s a slightly different linguistic game going on in the financial media, but no less important for understanding market outcomes. I’ll take CNBC as an example, but it’s just an example…you could make the same observations about any other media outlet. Within CNBC, Jim Cramer is everyone’s favorite whipping boy when it comes to complaints about media theatrics, but this is missing the forest for the trees. At least Cramer lets us in on the play-within-a-play conceit without constantly pretending that a daily price chart or a market “heat map” is anything other than a theatrical prop. If anything, Cramer’s performance is a paragon of honesty compared to the performances of the “news” hosts or the interchangeable “traders” on shows like “Fast Money.” XKCD published this cartoon in reference to ESPN and the like, but it’s even more applicable to CNBC and its ilk. Just to be clear, I’m not slamming these hosts and traders. I’m sure that they are overwhelmingly smart, honest people who believe that what they say are useful truths from their own perspectives. They are not hypocrites. But they are performers. And like any performer, there is a larger game being played with their words.
The larger meaning of the statements made on CNBC has absolutely nothing to do with specific investment advice or news. CNBC really could not care less about the actual content of what is being said. The purpose of CNBC’s game is not to tell you WHAT to think, but HOW to think, that thinking about investing in terms of some sell-side analyst’s anodyne story about fundamentals or some trader’s breathless story about open option interest is smart or wise or what all the cool kids are doing. Why? Because CNBC can create inexpensive content essentially at will to fill this demand, allowing them to sell advertisements and take cable carriage fees. Nothing evil or wrong about this. It’s what for-profit media companies DO. But the content they are producing is no less of a theatrical production than the State of the Union address, no less of a multi-level game, and it needs to be understood as such.
So what’s to be done if all of our leaders and all of our institutions are speaking past us, playing a larger game for power or money or whatever? Do we rage against the machine? Do we wander around like Diogenes, the founder of Cynic philosophy, holding to some absolutist standards of Honesty with a capital H and Truth with a capital T, living in rags and sleeping in a large clay jar? If that’s the price of being a Cynic and constantly fighting the innate fallibility of Man and his works…no thanks. There has to be a middle ground between being a Cynic and a Fool, some way of playing the game without losing one’s soul. Recognizing that all of us human animals, including me and including you, are playing multiple multi-level games … well, that seems like a good start to me. The Truths in life are still death and taxes (and maybe compounding returns). Everything else is theatre, where honesty (with a small h) and truth (with a small t) are probably the best we can achieve. And that’s not so bad.
While Europe, and the bulk of the Developed World is struggling to dig out of its unprecedented credit crunch (in which central banks are the only source of credit money which instead of entering the economy is stuck in the capital markets via the reserve pathway) and resulting deflation, the rest of the Emerging Market world is doing just fine. If by fine one means inflation at what Goldman calls, bordering on “extreme levels.” This is shown in the chart below which breaks down the Y/Y change in broad prices across the main DM and EM countries, and which shows that when talking about inflation there are two worlds: the Emerging, where inflation is scorching, and Developing, where inflation is in a state of deep freeze.
What is notable here is that despite hopes for a convergence between the inflationary trends in the Developed (downside extremes) and Emerging (upside extremes) world for the past year, what has happened instead is an acceleration of the process especially in recent weeks as EMs have been forced to devalue their currencies at an ever faster pace in order to offset the impact of the taper, leading to surging inflation as Turkey, Argentina, and Venezuela among many others, have found out the hard way in just the past month.
And as inflation in EM nations continues to roil ever higher not only does the implicit exporting of deflation to the DM accelerate, but it means that their societies approach ever closert to the tipping point when the citizens decide they have had just about enough with their government and/or their currency and decide to change one and/or the other. Hopefully, in a peaceful matter.
The rot moves from the margins to the center, but the disease moves from the center to the margins. That is what has happened in the realm of money in recent weeks due to the sustained mispricing of the cost of credit by central banks, led by the US Federal Reserve. Along the way, that outfit has managed to misprice just about everything else — stocks, houses, exotic securities, food commodities, precious metals, fine art. Oil is mispriced as well, on the low side, since oil production only gets more expensive and complex these days while it depends more on mispriced borrowed money. That situation will be corrected by scarcity, as oil companies discover that real capital is unavailable. And then the oil will become scarce. The “capital” circulating around the globe now is a squishy, gelatinous substance called “liquidity.” All it does is gum up markets. But eventually things do get unstuck.
Meanwhile, the rot of epic mispricing expresses itself in collapsing currencies and the economies they are supposed to represent: India, Turkey, Argentina, Hungary so far. Italy, Spain, and Greece would be in that club if they had currencies of their own. For now, they just do without driving their cars and burn furniture to stay warm this winter. Automobile use in Italy is back to 1970s levels of annual miles-driven. That’s quite a drop.
Before too long, the people will be out in the streets engaging with the riot police, as in Ukraine. This is long overdue, of course, and probably cannot be explained rationally since extreme changes in public sentiment are subject to murmurations, the same unseen forces that direct flocks of birds and schools of fish that all at once suddenly turn in a new direction without any detectable communication.
Who can otherwise explain the amazing placidity of the sore beset American public, beyond the standard trope about bread, circuses, and superbowls? Last night they were insulted with TV commercials hawking Maserati cars. Behold, you miserable nation of overfed SNAP card swipers, the fruits of wealth and celebrity! Savor your unworthiness while you await the imminent spectacles of the Sochi Olympics and Oscar Night! Things at the margins may yet interrupt the trance at the center. My guess is that true wickedness brews unseen in the hidden, unregulated markets of currency and interest rate swaps.
The big banks are so deep in this derivative ca-ca that eyeballs are turning brown in the upper level executive suites. Notable bankers are even jumping out of windows, hanging themselves in back rooms, and blowing their brains out in roadside ditches. Is it not strange that there are no reports on the contents of their suicide notes, if they troubled to leave one? (And is it not unlikely that they would all exit the scene without a word of explanation?) One of these, William Broeksmit, a risk manager for Deutsche Bank, was reportedly engaged in “unwinding positions” for that that outfit, which holds over $70 trillion in swap paper. For scale, compare that number with Germany’s gross domestic product of about $3.4 trillion and you could get a glimmer of the mischief in motion out there. Did poor Mr. Broeksmit despair of his task?
Physicist Stephen Hawking declared last week that black holes are not exactly what people thought they were. Stuff does leak back out of them. This will soon be proven in the unwinding derivatives trades when most of the putative wealth associated with swaps and such disappears across the event horizon of bad faith, and little dribbles of their prior existence leak back out in bankruptcy proceedings and political upheaval.
The event horizon of bad faith is the exact point where the credulous folk of this modern age, from high to low, discover that their central banks only pretend to be regulating agencies, that they ride a juggernaut of which nobody is really in control. The illusion of control has been the governing myth since the Lehman moment in 2008. We needed desperately to believe that the authorities had our backs. They don’t even have their own fronts.
Is the money world at that threshold right now? One thing seems clear: nobody is able to turn back the plummeting currencies. They go where they will and their failures must be infectious as the greater engine of world trade seizes up. Who will write the letters of credit that make international commerce possible? Who will trust whom? When do people seriously start to starve and reach for the pitchforks? When does the action move from Kiev to London, New York, Frankfurt, and Paris?
“The ‘Recovery’ Is A Mirage” Mark Spitznagel Warns, “With As Much Monetary Distortion As In 1929” | Zero Hedge
“Today there is a tremendous amount of monetary distortion, on par with the 1929 stock market and certainly the peak of 2007, and many others,” warns Universa’s Mark Spitznagel.
At these levels, he suggests (as The Dao of Capital author previously told Maria B, “subsequent large stock market losses and even crashes become perfectly expected events.”
Post-Bernanke it will be more of the same, he adds, and investors need to know how to navigate such a world full of “monetary distortions in the economy and the creation of malinvestments.” The reality is, Spitznagel concludes that the ‘recovery is a Fed distortion-driven mirage‘ and the only way out is to let the natural homeostasis take over – “the purge that occurs after massive distortion is painful, but ultimately, it’s far better and healthier for the system.”
Via Investments & Wealth Monitor:
On the “recovery” in the United States…
Spitznagel: The somewhat improved economic activity that we’re seeing is based on a mirage—that is, the illusion created by artificial zero-interest rates.
When central banks lower interest rates in hopes of stimulating the economy, that intervention is not the same as a natural move in interest rates.
A genuine drop in interest rates is in response to an increase in savings, as consumers defer consumption now in order to consume later. In a high-savings environment, entrepreneurs put their capital to work to become more roundabout,1 layering their tools and intermediate stages of production to become increasingly productive. The time to make these investments is when consumers are saving, so that entrepreneurs can be in an even better position to make the products that consumers want, when they want them.
In an artificial rate environment, however, that’s not what’s happening. Instead of consumers saving now to spend later, they are spending now.
But because interest rates are artificially lower, entrepreneurs are being fooled into investing in something now that they will have to back out of later—building up what the Austrians call “malinvestment.” Therefore, the illusion is unsustainable, by definition. The Fed can’t keep interest rates low forever.
From an investor perspective, people are trying to extract as much as they can right now. Consider the naïve dividend investment argument: “I can’t afford to be in cash right now.” Investment managers have to provide returns today.
Whenever investors sell a low dividend-paying stock to buy a higher-dividend stock, some piece of progress is sapped from our economy. (The cash needed to pay that higher dividend isn’t going to capital investment in the company.)
This is the exact opposite of entrepreneurial thinking that advances the economy. Consider the example of Henry Ford, who didn’t care about paying dividends today. He wanted to plow as much capital as possible back into making production more efficient for the benefit of the consumer who would pay less for a higher-quality product.
In summary, a major message of my recent book, The Dao of Capital, is recognizing the distortions that come from central bank intervention. Because of the Fed’s actions, interest rates are no longer a real piece of economic information. If you treat them like they are, you will simply do the wrong thing.
After all, when the government tries to manipulate things, the inverse of what was intended usually happens. On that point, history is entirely on my side.
On The Government & Federal Reserve’s “Interventions”…
Spitznagel: The reality is, when distortion is created, the only way out is to let the natural homeostasis take over. The purge that occurs after massive distortion is painful, but ultimately, it’s far better and healthier for the system. While that may sound rather heartless, it’s actually the best and least destructive in the long run.
Look what happened in the 1930s, when the actions of the government prolonged what should have been a quick purge. Instead, the government prevented the natural rebuilding process from working, which made matters so much worse.
I draw a parallel to forest wildfires. Fire suppression prevents small, naturally occurring wildfires from error-correcting the inappropriate growth, and thus prevents the system from seeking its natural homeostatic balance—its natural temporal structure of production, if you will. Instead, everything is allowed to grow at once, as if more resources exist than actually do, and the forest actually gradually consumes itself. When fire inevitably does break out, it is catastrophic. This is a perfect analogy for the market process. We simply do not understand the great homeostasis at work in markets that are allowed to correct their mistakes.
Suppression that makes the cure that much worse than the initial ill, until exponentially more damage is done, calls to mind the wry observation made by the great Austrian economist Ludwig von Mises: “If a man has been hurt by being run over by an automobile, it is no remedy to let the car go back over him in the [opposite] direction.”
As the Mises protégé Murray Rothbard would say, the catharsis needed to return to homeostatic balance “is the ‘recovery’ process,” and, “far from being an evil scourge, is the necessary and beneficial return” to healthier growth and “optimum efficiency.”
It is unfair to call the Austrians heartless because of these views. The Keynesians are the ones who got us into this mess in the first place—just like those who advocated for the suppression of natural forest fires are the ones who created the tinder box that puts the forest at risk.
On The Yellen Fed… (hint – no change)
Spitznagel: Post-Bernanke it will be more of the same. Therefore, investors need to know how to navigate a distorted world—and post-Bernanke the world is likely to get even more distorted—until the markets, ultimately and inevitably, flush out that distortion. This is why I rely on the Austrian school so much.
Austrian business cycle theory (ABCT) shows us what is really happening behind the curtain, so to speak, from monetary distortions in the economy and the creation of malinvestment. When the economy is subject to top-down intervention from the government and especially the central bank, investors need to read the signs in order to protect themselves—as well as still find a way to own productive assets.
People can avoid becoming trapped into chasing immediate returns along with the rest of the ill-fated crowd.
A far better approach is to wait for the return to homeostasis that will prevail even in the midst of pervasive distortion. In that way, investors can embrace roundabout investing by avoiding the distortion and, thus, have all the more resources later for opportunistic investing.
On investing (for retail inevstors)…
Another option for investors is a very simplistic, “mom-and-pop” strategy that starts with recognizing when you are in a distorted environment. For this I use what I call the Misesian stationarity index, which describes the amount of distortion in the economy.
This simple, back-of-the-envelope strategy would be to buy when the index is low and sell when it is high. In other words, people should stay out of the market when it is distorted and thus preserve their capital to deploy after the inevitable purge and correction, when productive assets become bargain-priced. Such an approach has resulted historically in an annualized 2-percent outperformance of stocks. Logically it makes sense, and when you look at it empirically, it’s incontrovertible.
Yet, admittedly, in the world of investing, sitting with one’s arms folded and not taking advantage of a rising market pumped up with distortion, is difficult—even though avoiding the enticement leads to better intermediate means for positional advantage to be exploited later.
It is difficult to do and may even feel anticlimactic. Nonetheless, the disciplined Misesian approach is healthier for one’s portfolio.
On the worst case scenario…
the Fed keeps winning and the illusion continues. The equity markets keep ripping along.
On extreme monetary distrortion and the Q-Ratio…
In simplest terms, the equity Q ratio is the total corporate equity in the United States divided by the replacement cost. Another way to think about it is the appraised value of existing capital in the United States divided by what it would cost to replace or accumulate all that capital.
This ratio has tremendous meaning from an Austrian standpoint, as it reflects what the markets are saying about the state of distortion in the economy.
This aptly illustrates Mises’s concept of “stationarity.” (In a stationary economy, in the aggregate, balance is achieved between the return and replacement costs.) The farther the ratio moves above “1,” the more monetary distortion there is in the economy. For this reason, and as a tip of the hat to the man who gave us the Austrian business cycle theory, I call this ratio the Misesian stationarity index, or MS index for short. When the MS index is high, subsequent large stock market losses and even crashes become perfectly expected events.
Today there is a tremendous amount of monetary distortion, on par with the 1929 stock market and certainly the peak of 2007, and many others (except the 2000 peak, which got a bit more ahead of itself). And all were caused by monetary distortion. As the Austrians show us, the business cycle is a Fed-induced phenomenon.
The IMF’s woeful forecasting record, chronicled extensively before, has just taken yet another hit, following the latest flip flop on emerging markets. Try to spot the common theme of these assessments by the IMF.
IMF Chief economist Olivier Blanchard, April 11, 2011 (source):
“In emerging market economies, by contrast, the crisis left no lasting wounds. Their initial fiscal and financial positions were typically stronger, and the adverse effects of the crisis were more muted. High underlying growth and low interest rates are making fiscal adjustment much easier. Exports have recovered, and whatever shortfall in external demand they experienced has typically been made up through increases in domestic demand. Capital outflows have turned into capital inflows, due to both better growth prospects and higher interest rates than in the advanced economies. The challenge for most emerging market economies is thus quite different from that of the advanced economies—namely, how to avoid overheating in the face of closing output gaps and higher capital flows.”
IMF Chief economist Olivier Blanchard, July 9, 2013 (source):
“If you look country by country it seems to be specific . . . so in China it looks like unproductive investment, in Brazil it looks like low investment and in India it looks like policy and administrative uncertainty. But you wonder whether there is not something behind. I think behind this is a slowdown in underlying growth – not the cyclical component but just the average rate. It’s clear that these countries are not going to grow as fast as they did before the crisis.”
IMF Chief economist Olivier Blanchard, January 23, 2014 (source)
“Finally, we forecast that both emerging market and developing economies will sustain strong growth“
A few days later, EMs around the globe crashed, and central banks virtually everywhere had to step in to bail out their crashing currencies, and hit the tape with even more impressive verbal intervention every several hours.
Finally, today we get IMF economist Alejandro Werner, January 30, 2014 (source)
“Conditions in global financial markets will stay tighter than they were before the U.S. central bank’s “taper talk” in the first half of 2013, translating into higher international borrowing costs,particularly with the recent volatility in emerging markets…. sustained turbulence in emerging markets could tighten global financial conditions further…. Rebuilding fiscal buffers, and using monetary policy and flexible exchange rates to absorb shocks where possible, remains the order of the day.”
In other words, going from a forecast of “high underlying growth”, to “not going to grow as fast as they did”, to “sustain strong growth”, to violent EM crash, to “turbulence”, “volatility”, and urging EMs to “using monetary policy to absorb shocks”, what is clear is that nobody knows what is going on, nobody has any handle on the future of Emerging Markets, but let’s all just pretend that the MIT central-planners in control, are in control, and all shall be well.
It’s deliciously ironic that emerging market (EM) problems have flared so soon after the meeting of the rich and powerful in Davos. According to the central bankers at Davos, the financial crisis is behind us and brighter days lay ahead. According to these bankers, the EM issues which have since arisen are confined to a handful of developing countries and they won’t impact the West.
If only were that so. What the eruptions of the past week really show is that the system based on easy money created by these bankers remains deeply flawed and these flaws have been exposed by moves to tighten liquidity in the U.S. and China. The system broke down in 2008, and again in Europe in 2011 and now in EM in 2013-2014.
The market reaction to the latest events has been abrupt and violent, particularly in the currency world. In my experience, markets generally cope well when there is one crisis. If the current issue was isolated to Turkey, markets outside of this country would probably shrug their shoulders and move on. But when there are multiple spot fires like the last week, markets don’t cope as well.
What are investors supposed to do now? Well, going into this year, Asia Confidential suggested (here, here and here) being cautious on stocks given increasing deflationary risks from U.S. tapering and a China slowdown. And to go long government bonds in developed markets (the U.S) given these risks and junior gold miners due to the extraordinarily cheap valuations on offer. These recommendations have performed well year-to-date and should continue to out-perform for the remainder of 2014.
Simple explanations for the crisis
Much ink has been spilled (or keyboards worn, in this day and age) trying to make sense of the past week’s event. China’s economic slowdown has copped much of the blame. As has QE tapering. And idiosyncratic issues in Turkey and Argentina have received their fair share of attention.
There have also been more sophisticated explanations such as this one from Kit Juckes at Societe Generale:
“There has been a shift in the balance of growth as Chinese demand for raw material wanes, and as higher wages and strong currencies make many EM economies less competitive. Meanwhile, the Fed policy cycle IS turning, and 4 years of capital being pushed out in a quest for less derisory yields, are ending. This isn’t a repeat of the 1990s Asian crises, because domestic conditions are completely different but it is a turn in the global market cycle. We need to transition from a world where investment is pushed out of the US/Europe/Japan to one where it is pulled in by attractive prospects. When that happens, flows will be differentiated much more from one country (EM or otherwise) to another. But for now, we’re just waiting for global capital flows to calm down.”
Now I have a large issue with the purported attractive prospects of the US, Europe and Japan, but let’s put that aside. The bigger issue is that the explanation here appears to be addressing the symptoms of the crisis (global capital flows) rather than the disease (excess credit and an unstable global economic system).
A more nuanced view
Let me elaborate on this. In a previous post, I echoed the thoughts of India’s new central bank chief in suggesting that there were four main causes for the 2008 financial crisis:
- Rising inequality and the push for housing credit in the U.S.. Growing income inequality in America, exacerbated by technology replacing low-wage jobs and an inadequate education system which failed to re-skill people, led to politicians allowing easier credit conditions to boost asset prices and make people feel wealthier. That resulted in the subprime and housing crisis.
- Export-led growth and dependency of several countries including China, Japan and Germany. The debt-fueled consumption in the U.S. would have been inflationary were it not for these countries not meeting the consumption needs of Americans. In other words, they aided and abetted the consumption binge in the U.S.
- A clash of cultures between developed and developing countries. This relates back to 1997 when the Asian crisis force countries in the region to go from being net importers to substantial net exporters, thereby creating the conditions for a global glut in goods.
- U.S central bank policy pandering to political considerations by focusing on jobs and inflation at any cost. The bank acted in accordance with the wishes of politicians by keeping interest rates too low for too long. They did this to maintain high employment, one of the bank’s two central mandates.
It’s important to note that none of these issues has been resolved. In fact, many of them have worsened. And any hint of adjustments to one or more of these problems results in further crises (like Europe in 2011 and in EM mid-last year and today).
This isn’t to excuse the governance issues in the likes of Argentina and Turkey. But it is to suggest that they are merely symptoms of a deeper malaise.
Deflation is winning battle over inflation
If these adjustments were to happen in full, it would result in plunging global asset prices as excessive debt loads are unwound. De-leveraging, in economic terms. This deflationary action is anathema to the world’s central bankers as deflation is enemy number one. Hence, they’ll do “whatever it takes” to produce inflation. And if that means flushing currencies down the urinal, so be it. The battle between inflation and deflation is ongoing, though the latter has the upper hand right now.
The weapons of choice for central bankers to fight off deflation are QE and zero interest rates. Central bankers tell us that these policies are necessary for economies to heal. I’d suggest this is baloney and they’re exacerbating the aforementioned problems.
To see why, it’s important to understand that interest rates are the central price signal off which all assets are priced. If central banks keep rates artificially low, it distorts these asset prices. And if you keep rates low for long enough, it distorts prices to such an extent that it’s impossible to know what the real value of certain assets are.
Another issue is that by keeping rates low, businesses which should go bankrupt stay alive. That’s why government bail-outs of almost any private company are a bad idea. Keeping zombies businesses alive means economies become less competitive over time. Witness Japan since 1990.
These are but a few of the unintended consequences of the current policies.
There are three possible endgames to the current situation:
- There’s a global deflationary shock where all asset prices fall and fall hard. A la 2008. In this instance, central banks would go in all guns blazing with more money printing on an even grander scale. This would risk inflation if not hyperinflation as faith in currencies is diminished, if not lost.
- You have a gradual global recovery and inflation stays tame enough for a smooth exit from current policies.
- There’s a recovery but central banks are slow to raise rates and inflation gallops, which forces tightening and a subsequent economic slowdown.
My bet remains on the first scenario given intensifying deflationary forces from a China economic slowdown and Japan currency debasement (which aids exporters in being more price competitive).
If I’m right, there may be deflation followed by extreme inflation (or one quickly followed by the other). That makes investing a tough game. Under both of those scenarios, stocks and bonds would under-perform in a big way (my current call to own developed market government bonds is a 6-12 month one, not long-term). That’s why cash (which would out-perform in deflation), gold (which would prosper under extreme inflation) and select property and other tangible assets such as agriculture (which may out-perform under extreme inflation on a relative rather than absolute basis) should be part of any diverse investment portfolio.
This post was originally published at Asia Confidential:
Marc Faber Warns “Insiders Are Selling Like Crazy… Short US Stocks, Buy Treasuries & Gold” | Zero Hedge
Beginning by disavowing Mario Gabelli of any belief that rising stock prices help ‘most’ people (“Fed data suggests half the US population has seen a 40% drop in wealth since 2007“), Marc Faber discusses his increasingly imminent fears of the markets in this recent Barron’s interview.
Quoting Hussman as a caveat, “The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak. There’s no calling the top,” Faber warns there are a lot of questions about the quality of earnings (from buybacks to unfunded pensions) but “statistics show that company insiders are selling their shares like crazy.”
His first recommendation – short the Russell 2000, buy 10-year US Treasuries (“there will be no magnificent US recovery”), and miners and adds “own physical gold because the old system will implode. Those who own paper assets are doomed.”
Faber: This morning, I said most people don’t benefit from rising stock prices. This handsome young man on my left said I was incorrect. [Gabelli starts preening.] Yet, here are some statistics from Gallup’s annual economy and personal-finance survey on the percentage of U.S. adults invested in the market. The survey, whose results were published in May, asks whether respondents personally or jointly with a spouse have any money invested in the market, either in individual stock accounts, stock mutual funds, self-directed 401(k) retirement accounts, or individual retirement accounts.Only 52% responded positively.
Gabelli: They didn’t ask about company-sponsored 401(k)s, so it is a faulty question.
Faber: An analysis of Federal Reserve data suggests that half the U.S. population has seen a 40% decrease in wealth since 2007.
In Reminiscences of a Stock Operator [a fictionalized account of the trader Jesse Livermore that has become a Wall Street classic], Livermore said, “It never was my thinking that made the big money for me. It was always my sitting. Got that? My sitting tight.” Here’s another thought from John Hussmann of the Hussmann Funds: “The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak. There’s no calling the top, and most of the signals that have been most historically useful for that purpose have been blaring red since late 2011.”
I am negative about U.S. stocks, and the Russell 2000 in particular. Regarding Abby’s energy recommendation, this is one of the few sectors with insider buying. In other sectors, statistics show that company insiders are selling their shares like crazy, and companies are buying like crazy.
Zulauf: These are the same people.
Faber: Precisely. Looking at 10-year annualized returns for U.S. stocks, the Value Line arithmetic index has risen 11% a year. The Standard & Poor’s 600 and the Nasdaq 100 have each risen 9.4% a year. In other words, the market hasn’t done badly. Sentiment figures are extremely bullish, and valuations are on the high side.
But there are a lot of questions about earnings, both because of stock buybacks and unfunded pension liabilities. How can companies have rising earnings, yet not provision sufficiently for their pension funds?
Good question. Where are you leading us with your musings?
Faber: What I recommend to clients and what I do with my own portfolio aren’t always the same. That said, my first recommendation is to short the Russell 2000. You can use the iShares Russell 2000 exchange-traded fund [IWM]. Small stocks have outperformed large stocks significantly in the past few years.
Next, I would buy 10-year Treasury notes, because I don’t believe in this magnificent U.S. economic recovery. The U.S. is going to turn down, and bond yields are going to fall. Abby just gave me a good idea. She is long the iShares MSCI Mexico Capped ETF, so I will go short.
What are you doing with your own money?
Faber: I have a lot of cash, and I bought Treasury bonds.
Faber: I have no faith in paper money, period. Next, insider buying is also high in gold shares. Gold has massively underperformed relative to the S&P 500 and the Russell 2000. Maybe the price will go down some from here, but individual investors and my fellow panelists and Barron’s editors ought to own some gold. About 20% of my net worth is in gold. I don’t even value it in my portfolio. What goes down, I don’t value.
Which stocks are you recommending?
Faber: I recommend the Market Vectors Junior Gold Miners ETF [GDXJ], although I don’t own it. I own physical gold because the old system will implode. Those who own paper assets are doomed.
Zulauf: Can you put the time frame on the implosion?
Faber: Let’s enjoy dinner tonight. Maybe it will happen tomorrow.
There is a colossal bubble in assets. When central banks print money, all assets go up. When they pull back, we could see deflation in asset prices but a pickup in consumer prices and the cost of living. Still, you have to own some assets. Hutchison Port Holdings Trust yields about 7%. It owns several ports in Hong Kong and China, which isn’t a good business right now. When the economy slows, the dividend might be cut to 5% or so. Many Singapore real-estate investment trusts have corrected meaningfully, and now yield 5% to 6%. They aren’t terrific investments because property prices could fall. But if you have a negative view of the world, and you think trade will contract, property prices will fall, and the yield on the 10-year Treasury will drop, a REIT like Hutchison is a relatively attractive investment.
Faber: The outlook for property in Asia isn’t bad because a lot of Europeans realize they will need to leave Europe for tax reasons. They can live in Singapore and be taxed at a much lower rate. Even if China grows by only 3% or 4%, it is better than Europe. People are moving up the economic ladder in Asia and into the middle class.
Are you bullish on India?
Faber: I am on the board of the oldest India fund [the India Capital fund]. The macroeconomic outlook for India isn’t good, but an election is coming, and the market always rallies into elections.The leading candidate is pro-business. He is speaking before huge crowds.
In dollar terms, the Indian market is still down about 40% from the peak, because the currency has weakened. In the 1970s, stock market indexes performed poorly and stock-picking came to the fore. Asia could be like that now. It is a huge region, and you have to invest by company. Some Indian companies will do well, and others poorly. Some people made 40% on their investments in China last year, but the benchmark index did poorly.
I like Vietnam. The economy has had its troubles, and the market has seen a big decline. I want you to visualize Vietnam. [Stands up, walks to a nearby wall, and begins to draw a map of Vietnam with his hands.] Here’s Saigon, or Ho Chi Minh City, the border with China, and the Mekong River. And here in the middle, on the coast, is Da Nang.
Faber: I recommend shorting the Turkish lira. I had an experience in Turkey that led me to believe that some families are above the law. When I see that in an emerging economy, it makes me careful about investing.
Here is how Reuters summarized the soaring price expectations in the country under its first day with “relaxed” controls:
Argentina’s sudden relaxation of currency controls, long touted by the government as essential to the country’s financial health, has left investors wondering what’s next for Latin America’s crisis-prone No. 3 economy. Shopkeepers around the country hurriedly placed new price tags over the weekend on imported items from Cuban cigars to Asia-made televisions, reflecting a more than 20 percent drop in the official peso rate over recent days.
The consumer price surge came after the government said on Friday it would lift a two-year-old ban on Argentines buying foreign currency, allowing savers access to coveted U.S. dollars while the peso was left to plummet. Friday’s relaxation of controls came as central bank reserves fell beneath $30 billion, a level suggesting its interventions in support of the anemic peso had become unsustainable.
But allowing average wage-earners to access U.S. dollars was sure to pressure reserves as well, because the central bank is the main source of foreign exchange. The announcement on Friday ended a two-year ban on saving in the greenback.
So far inflation has been in check, mostly thanks to a price freeze imposed this month on staple foods which has kept a lid on basic supermarket items. Reuters says that “no one knows how long those prices can hold while labor unions prepare wage demands based on one of the world’s highest inflation rates.” For now, they are holding. They won’t for long, and if Argentina reports 30 percent inflation this year, as private analysts expect, it would mark the fastest rate since the 2002 crisis, when inflation reached 41 percent.
However, one thing is certain: dollar demand by the general population is sure to flood the central banks, and force reserve depletion, which have been declining at a pace of over $100MM per day and were last at $29.1 billion, at the central bank to really pick up pace. To wit:
Conditioned by previous crises to save in dollars, Argentines are obsessed with the greenback. The currency control regime ending on Monday forced people to go to the black market for dollars needed to protect them from the weak peso and fast-rising consumer prices.
Luckily for the central bank, as Bloomberg calculates, at most 20% of the population will actually be able to take advantage of the “relaxed” capital controls, because only Argentines who earn at least 7,200 pesos ($901) per month will be allowed to buy dollars, Cabinet Chief Jorge Capitanich told reporters today. And since only 20% of Argentines earned 7,000 pesos or more as of 3Q 2013,according to the National Statistics and Census Institute, it means that 80% of the population will get all the “benefits” of inflation with zero benefits from dollar purchase price protection.
And it’s not like even the rich will be able to truly benefit: he limit for FX purchases will be $2,000/month and will be taxed at 20% unless deposited with bank for at least a year.
So in other words, Argentina’s capital control “fix” was largely a sham, designed to hide the real motive behind last week’s announcement – push inflation far higher, perhaps under some persistent external influence, which in turn would lead to even more social instability. This could be a problem.
Consumer prices are a big worry on the street, but the issue has not sparked mass protests lately. Tensions could rise over the weeks ahead as labor demands pay increases in line with private economists’ 2014 inflation estimates. Fernandez has mentioned neither consumer prices nor the peso’s plight in recent speeches, leaving her cabinet to announce policy changes. The next presidential election is next year, with Fernandez unable to seek a third term.
Possible candidates from the main parties offer policies that lean in a more pro-investment direction that Fernandez’s, as the outgoing leader tucks into her last two years in power.
“If the government fails to prevent inflation from accelerating it will probably hurt the chances of presidential aspirants who are aligned with the administration,” said Ignacio Labaqui, an analyst with Medley Global Advisors.
“A deeper economic crisis could provide a window of opportunity for candidates who are more business friendly.”
Such as technocrats from… Goldman Sachs?
In what is sure to be met with cries of derision across the European Union, in line with what the IMF had previously recommended (and we had previously warned as inevitable), the Bundesbank said on Monday that countries about to go bankrupt should draw on the private wealth of their citizens through a one-off capital levy before asking other states for help. As Reuters reports, the Bundesbank states, “(A capital levy) corresponds to the principle of national responsibility, according to which tax payers are responsible for their government’s obligations before solidarity of other states is required.” However, they note that they will not support an implementation of a recurrent wealth tax in Germany, saying it would harm growth. We await the refutation (or Draghi’s jawbone solution to this line in the sand.)
Germany’s Bundesbank said on Monday that countries about to go bankrupt should draw on the private wealth of their citizens through a one-off capital levy before asking other states for help.
The Bundesbank’s tough stance comes after years of euro zone crisis that saw five government bailouts. There have also bond market interventions by the European Central Bank in, for example, Italy where households’ average net wealth is higher than in Germany.
“(A capital levy) corresponds to the principle of national responsibility, according to which tax payers are responsible for their government’s obligations before solidarity of other states is required,” the Bundesbank said in its monthly report.
It warned that such a levy carried significant risks and its implementation would not be easy, adding it should only be considered in absolute exceptional cases, for example to avert a looming sovereign insolvency.
The German Institute for Economic Research calculated in 2012 that in Germany a 10-percent levy on a tax base derived from a personal allowance of 250,000 euros would add up to around 230 billion euros. It did not give a figure for crisis countries due to lack of sufficient data.
Greece has been granted bailout funds of 240 billion euros from the euro area, its national central banks and IMF to protect it from a chaotic default and possible exit from the euro zone. Not all funds have been paid out yet.
In Germany, however, the Bundesbank said it would not support an implementation of a recurrent wealth tax, saying it would harm growth.
“It is not the purpose of European monetary policy to ensure solvency of national banking systems or governments and it cannot replace necessary economic adjustments or bank balance sheet clean ups,” the Bundesbank said.
In considering some of the potential measures likely to be required, the reader may be struck by the essential problem facing politicians: there may be only painful ways out of the crisis.
There is one thing we would like to bring to our readers’ attention because we are confident, that one way or another, sooner or later, it will be implemented. Namely a one-time wealth tax: in other words, instead of stealth inflation, the government will be forced to proceed with over transfer of wealth. According to BCG, the amount of developed world debt between household, corporate and government that needs to be eliminated is just over $21 trillion. Which unfortunately means that there is an equity shortfall that will have to be funded with incremental cash which will have to come from somewhere. That somewhere is tax of the middle and upper classes, which are in possession of $74 trillion in financial assets, which in turn will have to be taxed at a blended rate of 28.7%.
The programs BCG (and the Bundesbank) described would be drastic. They would not be popular, and they would require broad political coordinate and leadership – something that politicians have replaced up til now with playing for time, in spite of a deteriorating outlook. Acknowledgment of the facts may be the biggest hurdle. Politicians and central bankers still do not agree on the full scale of the crisis and are therefore placing too much hope on easy solutions. We need to understand that balance sheet recessions are very different from normal recessions. The longer the politicians and bankers wait, the more necessary will be the response outlined in this paper. Unfortunately, reaching consensus on such tough action might requiring an environment last seen in the 1930s
Whether we will admit it or not, a lot of us engage in gang member-like thinking that destroys our ability to divergently think, critically think and even consider the truth when the truth challenges the group-think of the “gang”.
Ishmael Cisneros, a member of the notorious global crime syndicate, the Mara Salvatrucha, better known as MS-13, says that once you join a gang, “your mind closes off to the rest of the world and you’re capable of doing anything for the gang…don’t get caught up in the world of gangs, especially for those that think there’s something good in it. It’s all lies.”
Yet many of us that deny we ever engage in the vapid and counter-productive gang mentality that Cisneros describes above unintentionally allow ourselves to be bound by this gang mentality by TPTB that deliberately shuttle people into adopting gang mentality through divide and conquer tactics based upon religious, political, and racial affiliations.
If we are truly honest with ourselves, we will all admit to having engaged in “gang-think” at one point in our lives, and perhaps of still engaging in these counter-productive thought patterns today. It’s time to deconstruct this type of mentality so that we can awaken to the truth and always choose what is best for the greater good of humanity over what is best for our gang only as we move forward. Separating ourselves from gang think will be essential for not only survival but also for a positive mental health state in coming years as Central Banks keep destroying the purchasing power of fiat currencies and people’s struggles all over the world consequently intensify.