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The End of the Status Quo: aka. Mass Consumption
Japan: Locus of the Next Crisis?
The past five year rally in global credit was driven by liquidity flows and carry trades. Zero percent interest rates subsidized highly leveraged lending to the riskiest of sovereign borrowers. As long as the liquidity flows continued, the underlying solvency was never put into question. When liquidity flows inevitably reverse due to risk aversion, pricing of debt/credit/bonds will be based solely upon ongoing solvency of the underlying borrower. At that point in time, the Minksy Moment will arrive seemingly out of nowhere.
History’s Largest Circle Jerk
Third World wage slaves produce the goods. Over-leveraged Western consumers borrow from the wage slaves (via recurring trade deficits) to buy the goods, billionaires capture the arbitrage profits between rich and poor which they then lend to sovereign governments to service non-amortizing debts. Central Banks provide 0% liquidity to paper over the latent insolvency. All while policy-makers and the dunces at large pretend that this can go on indefinitely.
Borrowed Time and Money
(Un)Paving Our Way To Nirvana
The citizens who do recognize their own discomfort in this geography of nowhere generally articulate it as a response to “ugliness.” This is only part of the story. The effects actually run much deeper. The aggressive and immersive ugliness of the built landscape is entropy made visible. It is composed of elements that move us in the direction of death, and the apprehension of this dynamic is what really makes people uncomfortable. It spreads a vacuum of lost meaning and purpose wherever it reaches. It is worse than nothing, worse than if it had never existed. As such, it qualifies under St. Augustine’s conception of “evil” in the sense that it represents antagonism to the forces of life.
We find ourselves now in a strange slough of history. Circumstances gathering in the home economics of mankind ought to inform us that we can’t keep living this way and need to make plans for living differently. But our sunk costs in this infrastructure for daily life with no future prevent us from making better choices. At least for the moment. In large part this is because the “development” of all this ghastly crap — the vinyl-and-strandboard housing subdivisions, the highway strips, malls, and “lifestyle centers,” the “Darth Vader” office parks, the infinity of asphalt pavements — became, for a while, our replacement for an economy of ecological sanity. The housing bubble was all about building more stuff with no future, and that is why the attempt to re-start it is evil.
Sooner rather than later we’ll have to make better choices. We’ll have to redesign the human habitat in America because our current environs will become uninhabitable. The means and modes for doing this are already understood. They do not require heroic “innovation” or great leaps of “new technology.” Mostly they require a decent respect for easily referenced history and a readjustment of our values in the general direction of promoting life over death. This means for accomplishing this will be the subject of Part II of this essay, but it is necessary to review a pathology report of the damage done.
I have a new theory of history: things happen in human affairs because they seem like a good idea at the time. This helps explain events that otherwise defy understanding, for example the causes of the First World War. England, France, Russia, Germany, and Italy joined that war because it seemed like a good idea at the time, namely August of 1914. There hadn’t been a real good dust-up on the continent since Waterloo in 1814. Old grievances were stewing. Empires were both rising and falling, contracting and reaching out. The “players” seemed to go into the war thinking it would be a short, redemptive, and rather glorious adventure, complete with cavalry charges and evenings in ballrooms. The “deciders” failed to take into account the effects of newly mechanized warfare. The result was the staggering industrial slaughter of the trenches. Poison gas attacks did not inspire picturesque heroism. And what started the whole thing? Ostensibly the assassination of an unpopular Hapsburg prince in Serbia. Was Franz Ferdinand an important figure? Not really. Was Austria a threat to France and England? It was in steep decline, a sclerotic empire held together with whipped cream and waltz music. Did Russia really care about little Serbia? Was Germany insane to attack on two fronts? Starting the fight seemed like a good idea at the time — and then, of course, the unintended consequences bit back like a mad dog from hell.
Likewise America’s war against its own landscape, which got underway in earnest just as the First World War ended (1918). The preceding years had seen Henry Ford perfect, first, the Model T (1908), and then the assembly line method of production (1915), and when WW I was out of the way, America embarked on its romance with democratic motoring. First, the cities were retrofitted for cars. This seemed like a good idea at the time, but the streets were soon overwhelmed by them. By the mid-1920s the temptation to motorize the countryside beyond the cities was irresistible, as were the potential profits to be reaped. What’s more, automobilizing the cities made them more unpleasant places to live, and reinforced the established American animus against city life in general, while supporting and enabling the fantasy that everyone ought to live in some approximation to a country squire, preferably in some kind of frontier.
The urban hinterlands presented just such a simulacrum of a frontier. It wasn’t a true frontier anymore in the sense of civilization meeting wilderness, but it was a real estate frontier and that was good enough for the moment. Developing it with houses seemed like a good idea. Indeed, it proved to be an excellent way to make money. The first iteration of 1920s car suburbs bloomed in the rural ring around every city in the land. An expanding middle class could “move to the country” but still have easy access to the city, with all its business and cultural amenities. What a wonderful thing! And so suburban real estate development became embedded in the national economic psychology as a pillar of “progress” and “growth.”
This activity contributed hugely to the fabled boom of the 1920s. Alas, the financial shenanigans arising out of all this new wealth, along with other disorders of capital, such as the saturation of markets, blew up the banking system and the Great Depression was on. The construction industry was hardest it. Very little private real estate development happened in the 1930s. And as that decade segued right into the Second World War, the dearth continued.
When the soldiers came home, the economic climate had shifted. America was the only industrial economy left standing, with all the advantages implied by that, plus military control over the loser lands. We already possessed the world’s biggest oil industry. But after two decades of depression, war, and neglect, American cities were less appealing than ever. The dominant image of city life in 1952 was Ralph Kramden’s apartment inThe Honeymooners TV show. Yccchhh. America was a large nation, with a lot of agricultural land just beyond the city limits. Hence, the mushrooming middle class, including now well-paid factory workers, could easily be sold on “country living.” The suburban project, languishing since 1930, resumed with a vengeance. The interstate highway program accelerated it.
The Broken Promises of Suburbia
It seemed like a good idea at the time. Country life for everybody in the world’s savior democracy! Fresh air! Light! Play space for the little ones! Nothing in world history had been easier to sell. Interestingly, in a nation newly-addicted to television viewing, the suburban expansion of the 1950s took on a cartoon flavor. It was soon apparent that the emergent “product” was not “country living” but rather a cartoon of a country house in a cartoon of the country. Yet it still sold. Americans were quite satisfied to live in a cartoon environment. It was uncomplicated. It could be purchased on installment loans. We had plenty of cheap energy to run it.
It took decades of accreting suburbia for its more insidious deficiencies to become apparent. Most noticeable was the disappearance of the rural edge as the subdivisions quickly fanned outward, dissolving the adjacent pastures, cornfields, and forests that served as reminder of the original promise of “country living.” Next was the parallel problem of accreting car traffic. Soon, that negated the promise of spacious country living in other ways. The hated urban “congestion” of living among too many people became an even more obnoxious congestion of cars. That problem was aggravated by the idiocies of single-use zoning, which mandated the strictest possible separation of activities and forced every denizen of the suburbs into driving for every little task. Under those codes (no mixed use!), the corner store was outlawed, as well as the café, the bistro, indeed any sort of gathering place within a short walk that is normal in one form or another in virtually every other culture.
This lack of public amenity drove the movement to make every household a self-contained, hermetically-sealed social unit. Instead of mixing with other people outside the family on a regular basis, Americans had TV and developed more meaningful relations with the characters on it than with the real people around them. Television was also the perfect medium for selling redundant “consumer” products: every house had to have its own lawnmower, washing machine, and pretty soon a separate TV for each family member. The result of all that was the corrosion of civic life (a.k.a “community”) until just about every civic association except for school oversight (the fabled PTA) dwindled and faded. And the net effect of all that was the stupendous loneliness, monotony, atomization, superficiality, and boredom of suburbia’s social vacuum. It was especially hard on the supposed greatest beneficiaries, children, who, having outgrown the play space of the yard by age eight, could not easily navigate the matrix of freeways and highways outside the subdivision without the aid of the “family chauffeur,” (i.e. Mom).
Cutting Our Losses & Moving On
A couple of points about the current situation in suburbia ought to be self-evident. One is that our predicament vis-à-vis oil, along with cratering middle class incomes, suggests that we won’t be able to run this arrangement of things on the landscape a whole lot longer. The circulatory system of suburbia depends on cars which run on liquid hydrocarbon fuels. Despite the current propaganda (“drill, baby drill”), we have poor prospects of continuing an affordable supply of those things, and poorer prospects of running the US motor vehicle fleet by other means, despite the share price of Tesla, Inc. The second point is how poorly all suburbia’s components are aging — the vinyl-clad houses, the tilt-up strip malls, the countless chicken shacks, burger stands, and muffler shops, all the generic accessories and furnishings that litter the terrain from sea to shining sea. There are a lot of reasons these things now look bad (and lose value) but the chief one is that most of them are things nobody really cares about.
In Part II: A Better Human Habitat for the Next Economy, we explore the necessary behaviors we’ll need to adopt if we hope to have any prosperity in the years ahead. What seemed like a good idea at the time — through the 20th century and a little beyond — is looking more like an experiment that failed. Our sunk costs in it promote a tendency to agonize over it. I propose that we just give up the hand-wringing and prepare to cut our losses and move on. The reality of the situation is that the response to all this will arise emergently as circumstances compel us to change our behavior and make different (and we should hope) better choices. That is to say, don’t expect programmatic political action to change this, especially from remote authorities like federal or state governments. We will reorganize life on the ground because we will have to.
A few days ago, when GMO released its quarterly thoughts, most focused immediately on the claim that the market is 75% overvalued. However perhaps an even more important analysis by author Ben Inker, and one which was largely ignored by most, is what front-loading so much market gains thanks to the Bernanke surge in the S&P means for future returns especially as it pertains to pension funds the bulk of which are already underfunded. GMO’s conclusion was not a happy one.
If equity returns for the next hundred years were only going to be 3.5% real or so, today’s prices are about right. We would be wrong about how overvalued the U.S. stock market is, but every pension fund, foundation, and endowment – not to mention every individual saving for retirement – would be in dire straits, as every investors’ portfolio return assumptions build in far more return. Over the standard course of a 40-year working life, a savings rate that is currently assumed to lead to an accumulation of 10 times final salary would wind up 40% short of that goal if today’s valuations are the new equilibrium. Every endowment and foundation will find itself wasting away instead of maintaining itself for future generations. And the plight of public pension funds is probably not even worth calculating, as we would simply find ourselves in a world where retirement as we now know it is fundamentally unaffordable, however we pretend we may have funded it so far.
One person who read this part of Inker’s paper and did do the calculation is none other than Bridgewater’s Ray Dalio. His conclusion is terrifying.
The reason why public and all other pension funds are the least discussed aspect of modern finance, is that while Bernanke has done his best to plug the hole in the asset side of the ledger resulting from poor asset returns, it is nowhere near sufficient since the liabilities have been compounding throughout the financial crisis since the two grow independently. Which means that anyone who does the analysis sees a very disturbing picture.
Indeed, while the asset side can and has suffered massively as a result of the great financial crisis, the liabilities are compounding on a base that has grown steadily. As Dalio notes, each year a growing percentage of assets are paid out in the form of distributions, leaving less assets to compound at a given return.
This dynamic is shown in the chart below, which shows the change of pension fund assets over the past decade relative to the present value of liabilities discounted at a rate that has been roughly constant at around 7.5%, and rising to reflect the growth in future liabilities. Obviously, if the assets equal the value of liabilities, then the fund would be able to make its payments at a 7.5% asset return. The problem is that even with the Bernanke rally of the past five years, public pension assets are now at about the same level as in 2007 while commitments have grown. Sadly, this means that recent good returns have barely closed the gap. Needless to say, the gap grows much faster in the coming years if the future returns are less than the assumed 7.5%, something that was the basis for the GMO observations.
A key component of the pension fund calculation is the increasing portion of annual distributions less contributions as a percentage of assets. Since each year public pensions distribute about 5% of the future value of their liabilities, and these liabilities have been growing at a compounded rate of about 4%, the net cash out as a percentage of flat and/or declining assets has been progressively rising. Today, annual cash outflows amount to roughly 9% of total assets which contributions are a paltry 5% of assets, which has led to a 4% cash flow drag. This increase in net cash outflows from 1.5% of assets in 2000 to 4% most recently is shown in the second chart below. The take home from this chart is that funds need to return 4% a year
in the near term just to avoid losing assets, and thanks to compounding,
over time the rising amount of NPVed liabilities raises the required
return even further.
That’s where we stand now, but where are we headed? Assuming a 4% return and a steady growth of the liabilities means the financial gap will grow at an accelerating pace, making it more and more difficult to close the funding gap. It also means that with every passing year the required rate of return to plug the gap will grow even faster. Today, for example, the required return is 8.9%. In the future, once again assuming a 4% return on assets, means the required rate of return grows to 13% in ten years and 16% in fifteen years. Naturally, if a fund has a larger funding gap, the required return is even larger and the funding gap blows out much faster. As Bridgewater summarizes this feedback mechanism, “the dynamics of compounding cause this case machine to operate like the event horizon of a black hole: the pressures rise exponentially until it is virtually impossible to recovery.”
But the scariest chart of all is the following simulation of the underfunding process over time and total fund assets held, assuming a 4% return on assets, which shows the accelerating decline in the value of asset holdings due to an increasingly negative cash flow yield, causing virtually all pension funds to run out of money. In the case of a 4% return, a pension fund that is assumed to be fully-funded today will run out of cash in 30 years; pensions that are 80% funded run out of money in 25 year, and so on. A fund with just a 20% funding ratio will have no money left in just over 5 years!
Curious what the current distribution of funds that match these criteria is? The chart below shows the percentage of current pension funds at each funding bracket. Nearly 50% of all fund are funded 80% or less.
The charts and simplistic calculations above show not only why virtually all pension funds are set for extinction in the not too distant future, but why Bernanke is stuck artificially reflating asset values if only to preserve the myth of the public pension funded welfare state. Because the biggest threat to Keynesians and monetarists everywhere is the social instability that would result once the myth of the Bismarckian welfare state unwinds.
But wait, there’s more.
Bridgewater next proceeds to calculate what the economic impact is in a world in which a generous, consistent 4% return on assets is assumed. As Dalio’s fund notes, in such a case the path to public pension sustainability will require some combination of benefit cuts or increased contributions to net out the liabilities and assets and close the funding gap. “Any way you cut it this will reduce someone’s income, with a likely impact on their spending. Higher taxes will reduce the disposable income of workers, although the impact will be different depending on whose taxes are raised; less government spending on other things will hurt growth directly; lower benefits will reduce the disposable income of retirees who have a high propensity to spend; borrowing to finance the deficit will hurt growth less directly and over the longer term.”
Bridgewater concludes that if public pensions don’t delay and start plugging the hole now, they will need to contribute just under $200 billion per year over the next 30 years, amounting to 1.2% of GDP and 8.8% of state and local tax revenues. If funds wait a decade, the impact per year explodes to $325 billion over 30 years and will “cost” 1.2% of GDP and 12.2% of tax revenues. But the most likely, and worst case scenario, is if pension funds do nothing at all, “let the machine run its course”, then the economic damage is unquantifiable as low asset returns inevitably cause lower income through benefits after assets are fully depleted.
And that in a nutshell is why the pension system, erected on an asset-liability mismatch gone horribly wrong, is doomed: a fact well known by the Fed chairman, and whose only countermeasure is to keep doing more of what has been done to date: inflating asset value while monetizing massive amounts of debt in the hope that the higher asset return will offset the funding gap. In principle this is great assuming the Fed can keep doing QE for the foreseeable future. However here, as everywhere else, we run into the fundamental problem with QE – the Fed is currently monetizing 0.3% of all private sector 10 Year equivalents per week, or about 15% per year. Since the Fed already holds about a third of the total, it has one, at best two years of QE left, before it is in control of an unprecedented two thirds of the entire bond market, and before the complete lack of market liquidity from central-planning gone wild, grinds Bernanke’s experiment to a halt.
It is at that point that the entire flawed economic system of the past century will finally be on its last legs, as one of the core pillars of the biggest lie of all, the welfare state, resting on the flawed assumption that asset grow at a faster compounded rate than liabilities, will have no choice but to look into the abyss.
The political class in Washington has failed to reach a deal. They are effectively playing a game of chicken with the markets to see who blinks first. As usual, there are plenty of lies and spin swirling around this situation.
The US Treasury has stated it will run out of cash on October 17.
This in of itself is a strange claim as technically we hit the debt limit back in May and have been resorting to “extraordinary” measures since then. I don’t recall anyone in at the Treasury talking about the importance of the “debt ceiling” then, do you?
Secondly, the Government has effectively been running a Ponzi scheme with our debt for the greater part of 20 years. Over $5.7 trillion of our debt is owned by the Federal Government, ($2.1 trillion is owned by the Fed, $2.6 trillion is owned by Social Security, and over $1 trillion is owned by various Federal Retirement entities).
Indeed, the single largest owner of US debt is not in fact China, but our own Government. We’ve been running this kind of scheme for over 20 years.
Now this is not to say that a debt ceiling breach or a possible default on some payments are NOT huge issues. What I am saying is that the US Government can shuffle money around just as it has for the last 20 years to insure that we meet our debt obligations….
- Ponzi Scheme National Debt? (billlawrencedittos.com)
- Lew’s Testimony on Debt Mirrors SEC’s Definition of Ponzi Scheme (cnsnews.com)
- The Biggest Ponzi Scheme In The History Of The World (thehovistrader.wordpress.com)
Be it BBQ judging, investing, picking out an outfit, or even choosing whether or not you’re going to show up for work tomorrow – ConvergEx’s Nick Colas notes that there’s a decision making process occurring. Quite simply, decision making is the cognitive process resulting in the selection of a final choice among several alternative scenarios. Final choices can be opinions (as in “This brisket is an 8”) or actions (such as “I will invest in tech stocks”), and decisions are both conscious and unconscious. For investors, financial decisions and how we tend to arrive at them are of particular importance. The following is a cautionary tale of the ‘Top 10’ common biases that creep into the decision making process. Recognizing and eliminating these biases from your financial choices will make you a sharper and smarter investor… or BBQ judge… or whatever it is that you do…
- Ponzi schemes proliferate (bostonherald.com)
- When an SEC Equity Receiver may, and may not, Use the “Ponzi Presumption” in Fraudulent Transfer Cases (thecreditorsrightsblog.com)
- Bitcoins Are Money, Judge Rules in Bitcoin Ponzi Scheme Investigation (news.softpedia.com)
- This Ponzi Scheme of Government Financing Will Not Continue Forever (goldsilverworlds.com)
- The Scam Of Zero Interest Rate Policy (planet.infowars.com)
- The Reality of Gold and the Nightmare of Paper (safehaven.com)
- Political Extremism in the 1920s and 1930s: Do German Lessons Generalize? (delong.typepad.com)
- The Economic Parallels Of Today And The 20′s Are All In Place (planet.infowars.com)
- Life in the 1920s (amandabonin.wordpress.com)
- Interventionism & Panic of 1919 (armstrongeconomics.com)
- consumerism=epic failure (lunaticoutpost.com)
- The Big Issues Part 1: Consumerism (tobeandnottobuy.wordpress.com)
- Capitalism VS Consumerism (jovanidelmas.wordpress.com)
- Consumerism and Keynesianism (coordinationproblem.org)
- Our Global Ponzi Scheme (resilience.org)
- 77 Years Of Being Wrong About Social Security Just Hasn’t Been Enough (businessinsider.com)
- Abenomics: The Biggest Ponzi Scheme in History? (business2community.com)
- Osborne’s Housing Ponzi Scheme (think-left.org)
- The Federal Reserve – A Study In Fraud (economicnoise.com)
- Regulatory strategy for savings/investment schemes, that would address ponzi schemes (citizeneconomists.com)
- Funds guru accused of NZ’s biggest Ponzi scheme (gulfnews.com)
- Further Thoughts on Whether or Not Social Security is Ponzi Scheme (cafehayek.com)
- Bernie Madoff And The Best Ponzi Scheme Of All Time (thepoliticalpixie.wordpress.com)
- Court Tries to Reach Deals With NC Ponzi ‘Winners’ (abcnews.go.com)
- New Zealand charges man over $317m Ponzi scheme (arunbabyveranakunnel.wordpress.com)