Best Quotes of January 2007
Today's bubble in novelty and complexity is sure to blow up - if not in 2007, then all in good time. You might like to hold gold as insurance. For the "barbarous relic" - so beloved of apparently naive investors in the booming economies of India, China and the Middle East - is the ultimate antidote to "financial innovation". Nobody's promise, gold is also no one's to create.
But while Bartlett's ignored me completely, I notice that they had plenty of room for quite a few quotes from John Maynard Keynes, and, as is usual with crackpots, he sounds so good. He perfectly describes the state of affairs in the USA back when he was writing, vis-à-vis politics and the economic havoc they cause. The quote is that "Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back."
You can almost hear the contempt and sarcasm in his voice, echoing my own. Now, fast-forward to today. It is, unbelievably, even worse! Much worse! It is so bad (Audience shouts out "How bad, Mogambo?") that the chairman of the Federal Reserve himself IS a defunct academic scribbler! And the worst kind, too, as he was the head of the economics department of Princeton University, but nevertheless seems to have the insouciant opinion that the horrendous 18-year run of the disastrous, precedent-setting, unfettered monetary policies of the accursed Alan Greenspan is to be faulted only, I guess, in its restraint! Hahaha!
The life-span of the regime of irredeemable currency may be extended through machinations such as the artificial stifling of demand for gold, or trying to satisfy this demand with paper gold. Other stratagems serving the same end are: the manipulation of interest rates in order to boost demand for bonds artificially; the manipulation of interest-rate spreads to offer risk-free profit to the carry trade; allowing the derivative markets on bonds to grow beyond any conceivable limit. These manipulations, machinations and stratagems can certainly put off the day of reckoning. However, there is a cost: it makes the inevitable credit collapse, whenever it may come, a great deal more painful, and recovery ever more protracted. The one certain result is that the 'sudden death syndrome' will hit the currency when it is most vulnerable and disaster is least expected.
We should remember that every experiment in history with irredeemable currency has ended in a cataclysm unless the currency was stabilized in time by making it convertible into gold.
The managers of the present experiment betray extreme conceit when they pretend to know something that their predecessors, the managers of the continental currency, of the assignats, mandats, or of the Reichsmark did not know. The only difference between the present experiment and its historical precedents is a more highly refined web of disinformation.
This is the ugly secret about B rated bonds: if monetary conditions remain easy, then increased investor appetite allows potential defaulters to refinance instead of defaulting, which in turn keeps default rates low and increases investor appetite. This has particularly been the case in the last few years, when hedge funds have been able to raise almost unlimited capital from foolish institutional investors, leverage themselves to the hilt, possibly in yen, from foolish banks and then invest the gigantic proceeds in junk bonds, for their modest additional yield above U.S. Treasuries.
Provided the junk bond market doesn't crash, so refinancing of all but the worst rubbish is still readily available, hedge funds can in any given year achieve with almost complete certainty a satisfactory return, at least 20% of which will flow to the hedge fund managers personally. Thus the normal corrective mechanism of rising default rates ceases to work, and the market spirals towards bond-market nirvana. Essentially the safety valve on the engine of speculative financing has been jammed shut.
This is even more the case internationally. The only thing that ever causes countries to default is a refusal by the bond markets to finance their deficits. Since in an easy money period, with generally declining spreads, the bond market is open to all borrowers, no defaults ever occur. That's why there has not been a sovereign default since Argentina went in December 2001. The IMF and World Bank and the Bush administration can hold conference after conference congratulating themselves on their superb management of the international financial system, which has caused the world to be free from "crises" for half a decade.
In reality the lack of crises is nothing whatever to do with good management, but is simply a function of excess liquidity. The perverse incentives in emerging market junk bonds can be illustrated by the case of Argentina. Having defaulted on its international debt, forcing tens of thousands of middle class Italian savers (the main buyers of its bonds, presumably because of family connections) to accept only 30 cents on the dollar, having stiffed several foreign banks with local operations and a number of foreign utility companies foolish enough to invest there, Argentina is now living high on the hog. Four years of rapid economic growth, temporarily freed from onerous foreign obligations have produced a real estate boom so extreme that the government has ceased issuing construction permits, and have made the country one of the world's most attractive markets for luxury goods retailers.
This is the difference between corporate and national credits. If Enron had been a country, "Enronia, Queen of the Pampas" lenders and investors would be showering money on it today, and Jeff Skilling, rather than facing a 24 year jail sentence, would be seen, blonde on each arm, happily campaigning for triumphant re-election. The market for emerging market bonds is as distorted as any market in history. Both spreads and interest rates are low, so that the J.P. Morgan EMBI+ emerging market bond index yields well under 2% above Treasuries, thus providing investors in some of the world's dodgier credits with returns of a princely 6% or so. Oddly enough, emerging market stocks are not particularly overvalued; the Morgan Stanley Capital International Emerging Markets Index is on a price/earnings ratio of about 14.
Moreover a portfolio of emerging market stocks that matches the MSCI Index gets you largely Asia, with particular concentrations in the rapidly growing economies of South Korea and Taiwan. Conversely an EMBI+ portfolio of emerging markets bonds dumps more than half your assets in the dodgy kleptocracies of Latin America, with another sixth subjected to the tender mercies of Vladimir Putin's Russia. If ever a market was subject to extraordinary popular delusions and the madness of hedge fund crowds, it's this one.
One day, the Fed will notice that inflation hasn't disappeared, and will raise the Federal Funds rate, probably by a wimpy ¼%. At that point, panic will ensue in the junk bond markets, domestic and international. With higher interest rates and tighter money, junk borrowers will find all their comforting arithmetic thrown out of whack, as their cash drains increase in size, and the bond markets begin to close for them. At this point, a wave of defaults worse than we have ever seen will sweep over these markets. It will probably be worse than the 1930s in terms of percentage defaulting, even if any economic downturn is initially mild. The worst classes of 1930s debt issuance, those of 1930-32, lost 4.72% of principal for AAA credits and 12.25% of principal for AA. However this time very few of the defaulters will be AA credits, let alone AAA. The actual loss rates on the 42% of companies with B ratings, or even the 25% with BB ratings is likely to be a substantial multiple of 12.25%, in the B case possibly more than half.
Doug Noland, Prudent
Credit Insurance: As much as the markets are determined to reckon otherwise, Credit losses are not insurable risks. Losses are categorically non-random and non-independent (as opposed to auto and fire accidents). By their very nature, they come and go in waves, and that infrequent Tidal Wave of Destruction can be expected to come precisely when it is least expected. Boom-time exuberance, with its intoxicating run of inflated financial profits and minimal Credit problems, propagates the crescendo, reversal and dismal downside of the Credit Cycle.
The current Credit Derivatives Mania is putting the finishing touches on a Credit system and economy distorted to the point where there is no applicable history that might offer guidance as to downside cycle risks and expected Credit losses. Certainly, forecasting future losses based upon recent (cycle "blow-off") Credit performance - as derivative models do - lays the foundation for some very ugly surprises when the cycle reverses.
I simply have a difficult time getting on board with the view that our housing markets will be this year's major Issue. And, actually, I'll be surprised if the U.S., Chinese or the global economy takes center stage. When it comes to Issues 2007, I fully expect developments in and around finance and the financial markets to overshadow economic issues, concerns and risks. I'll even go out on the analytical limb and predict it will be one captivating, historic and, likely, fateful year - and very much All About Finance.
Bull! Not Bull
Take a look at this quote, which can be found all over the internet:
If the American people ever allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered.
This quote is attributed to Thomas Jefferson, though it is most certainly apocryphal. However I use it because it is instructive in many ways. First, don't believe anything just because you read it, even if you've read it many times. You can find this quote on a hundred web pages attributed to Jefferson. Second, even though Jefferson didn't say it, there is still wisdom in whoever did: "First by inflation, and then by deflation..."
As I already pointed out, we've already had the inflation. Most everyone is in debt up to his eyeballs, and the dollar has been inflated to within 5% of its life. There's not much more room to go before it is completely dead. These are hard times for many individuals, corporations, and the government itself. Ben Bernanke even told the government so recently -- that this is the "calm before the financial storm."
But pretend for a moment that YOU are a Federal Reserve bank, and all these entities owe YOU the money. When you look at the problem from this point of view, something quite amazing happens. Why, there is no problem at all! Those poor consumers, businesses and the Federal government have all gone and gotten themselves into debt, haven't they? Well now they are just going to have to pay it all back. End of story. What is the problem now?
As the Bank, your power comes from 1) your monopoly on the issuance of legal tender, 2) your ability to create it out of thin air and 3) your willingness to loan it out and charge interest on it. In fact, deflation wouldn't be such a bad thing at all, since it increases the value the currency you have a monopoly on creating. During deflation it is best to have a mountain of cash and a positive cash flow to ride it out. The only problem is if folks start defaulting on you. But that has already been taken care of with the Bankruptcy Reform Act of 2005. That law was written by the credit card companies, i.e. the banks, i.e Federal Reserve members, to keep working people on a treadmill of perpetual debt. This reminds me of the stories of economic colonialism John Perkins told in his book, confessions of an Economic Hit Man. First the World Bank would go to some natural-resource-rich third world country and offer it a fat loan to "develop" its resources. The loan would be bigger than necessary, and certainly more than the country could ever afford to pay back - but the bank would say, "with your new refinery/mine/port/whatever, you'll have enough revenue to pay it back." When the country eventually did default, the IMF would sweep in with "fiscal austerity measures" for the people and the government. All the revenue from the new development would be siphoned to the banks in order to pay off the huge loan. Tsk tsk.
Sound familiar? Anyone who bought a house in the last five years knows that mortgage bankers rarely advocated financial prudence when buying a house, but instead pushed the idea to "buy as much house as you can (or can't) afford!" And now with prices coming down, many of those buyers are stuck right where those third world countries got stuck. Looks like a fiscal austerity plan is coming down the pike for many consumers so they can stay on the financial treadmill while the productive fruits their life - their labor - are siphoned off by the bank. Because the banks still know that as much money as they make trading and manipulating paper and financial "products," there is still only one true source of wealth, and that is human labor.
No, the Fed is not stupid. Not stupid at all. There will always be booms and busts, and the best way to position oneself is to take advantage of both sides of the trade. Or as one responder to my last article put it so eloquently:
I am fascinated by the common perception that the Federal Reserve is a proven non-stop inflation machine. Inherently, the Federal Reserve uses inflation and deflation to whipsaw the average bystander out of their savings. I don't see how one economic machination is more favored over the other when the goal is to ensure that the public's savings ends up in the accounts of the shareholders of the Federal Reserve System.
I couldn't have said it better myself. Don't count deflation out just yet.
Ron Paul, Texas
As the war in Iraq surges forward, and the administration ponders military action against Iran, it's important to ask ourselves an overlooked question: Can we really afford it? If every American taxpayer had to submit an extra five or ten thousand dollars to the IRS this April to pay for the war, I'm quite certain it would end very quickly. The problem is that government finances war by borrowing and printing money, rather than presenting a bill directly in the form of higher taxes. When the costs are obscured, the question of whether any war is worth it becomes distorted.
Congress and the Federal Reserve Bank have a cozy, unspoken arrangement that makes war easier to finance. Congress has an insatiable appetite for new spending, but raising taxes is politically unpopular. The Federal Reserve, however, is happy to accommodate deficit spending by creating new money through the Treasury Department. In exchange, Congress leaves the Fed alone to operate free of pesky oversight and free of political scrutiny. Monetary policy is utterly ignored in Washington, even though the Federal Reserve system is a creation of Congress.
The result of this arrangement is inflation. And inflation finances war.
This year complacency reigns everywhere. You can see it in the rise in margin debt, the takeover of mortgage sub prime lenders by investment banks, and the narrowing of premiums on credit default swaps and the VIX. The effects of the one-off events that seemed to give strength to the economy last year I believe will soon fade. Rising complacency, low volatility and obliviousness to all forms of risk are usually the status quo right at the time when some catalyzing event appears out of nowhere to take the markets by surprise.
The assumption that oil prices will continue to fall at a time when geo-political tensions with oil-producing countries are rising and major oil fields are peaking indicates that these negative factors are being completely ignored by markets all around the globe.
There is some degree of speculation that the reason the oil markets have been attacked the way they have since the latter part of December is a prelude to an attack [on Iran] coming in late spring. We know the markets and the economy can handle $80 oil. Oil at $100 is another story. Clearly the recent drop in oil goes beyond weather.
Some may think the talk of attack is nothing other than conspiracy. However, I regard the markets to be far too complacent on this issue. It is not as if we haven't been warned by both warring factions. Iran has stepped up its violence in Iraq as we witness the bombings of the last few days. President Ahmadinejad has provoked Israel by his repeated speeches threatening to annihilate the country as soon as it is able. The U.S. is escalating economic pressure on Iran as well as building up its military forces in the region. The Middle East is clearly the most volatile and unstable part of the world. It is the world's largest gas station where you have madmen running around lighting matches. Given the sequence of recent events and the increase in provocation by both sides the markets could be in for a major shock.
The rapid simultaneous devaluation of all fiat currencies via inflation improves the long-term investment case for gold. Gold will eventually become widely recognized for what it already is: the only viable alternative to the dollar.
Shedlock, Mish's Global Economic Trend Analysis
In Kondratieff Autumn, cash is trash and gold (like all currencies) is of little use. Asset prices like stocks and houses soar and everyone is spending every cent they have and then some, as fast as they can. A similar thing happened in the Roaring 20's and probably every other crack-up boom in history as well.
In the credit crunch of Winter deflation, gold and currencies are hoarded and the purchasing power of both rises. If anything, the CPI adjusted price during the Great Depression does not really do justice to the mammoth increase in assets such as land or stocks that gold could buy. Instead it reflects purchasing power on a general basket of goods and services. The same thing is likely to happen again.
Sam Zell, CEO Equity Office Properties
To the tune of "Raindrops Keep Falling on My Head"
Capital is raining on my head
everything is liquid, we're awash with cash to spend
the flood has drowned returns
because assets keep liquefying, monetizing, raining…
So I just did me some Econ 101
seems like we've gotten out of equilibrium
but relative yields keep falling as more capital keeps raining
What lies ahead: we're old
the western world is aging, we'll need income
from our pension funds
where's it coming from?
the yields we see won't fuel no party
Tho' capital is raining on my head
interest and inflation rates are narrowing their spread
to half what textbooks said
the ratios that we're used to
have been squeezed by so much cash flow
The world is monetizing faster every day
illiquid assets alchemized
to currency in play
competing for return
black gold prices rising, still more money chasing assets…
And there's one thing I know
to get things back to normal
it's a long haul
yields won't improve 'til growth soaks up this liquid freefall
Capital keeps raining on my head
so much is out there that the world is out of whack
when will we see balance back?
it's gonna be a long time 'til returns meet expectations/p>
We need to be
prepared for slim annuities...