4 Worthwhile Articles to Read This Week

A few recent articles worth reading:

First, is it time to short oil and long natural gas? Bespoke Investment Group suggests in this article that when the current ratio between oil / natural gas is over 18 like it is now, that natural gas outperforms oil. Unfortunately, they do not provide the timeframe of this analysis or charts of the historical data, but if one was interested they could go long a natural gas ETF (UNG) and buy the short oil ETF (SZO). However, I would first suggest doing a little more research on this strategy / ratio since their analysis is nothing more then a teaser.

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Nice article from Trader Mark discussing the Real Green Shoot, my neighbors directly the west-the Dakotas.

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A very interesting factoid from David Rosenberg's 6/8/09 Economic Commentary(some good charts in the full pdf article):

Problem for equities may transcend just a weak economic backdrop: According to data compiled by Bloomberg, there has been so much in the way of secondary offerings that the share count in the S&P 500 is rising at a 3.4% annual rate so far this year. Tack on the fact that in this age of cash-conservation, companies are also slashing their dividend payouts by more than 20%, the sharpest decline since 1938, and the combination of these two effects is likely going to shave more than 4% from S&P 500 total returns this year. Considering that the S&P 500 total return has averaged 6% per year since 1900, the trimming impact from a higher share count and lower dividend yield looks to be rather significant.

He continues to make a cautious/bearish case in his comments:

Oil prices just below $70/barrel have more than doubled from their lows; and 10-year note yields approaching 4% (which are now pulling up mortgage rates — the 30-year fixed rate is all the way back to 5.45% — not to mention competing now with a near 4% earnings yield on the S&P 500) are starting to put a bit of a crimp in this rally. Once it becomes clear, before Labour Day, that the recession is not coming to an end quite so soon (as the National Bureau of Economic Research’s Robert Hall said Friday, it’s “way too early” to make that call), we would be looking for a corrective phase to start taking place....

What makes this cycle totally different is that it is coming off three shocks: 1) a housing shock; 2) a commodity shock, and; 3) a credit shock. The labor market is adjusting to all three shocks, whose effects are going to linger for years, in our view. In other words, there is a greater sense of permanency to the job losses this time around compared to the past. In fact, permanent job losses came to 287,000 in May and 3.9 million since the recession began. Around two-thirds of the employment decline this down-cycle has been permanent, which is unprecedented.

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For an opposing point of view to Rosenberg's deflation thesis (at least in the short/medium term), in a Financial Times article the historian Niall Ferguson sees inflation this year, or at least by next year (although he fails to say at what rate - there is a big difference between 1% and 10% inflation):

History lesson for economists in thrall to Keynes

By Niall Ferguson

On Wednesday last week, yields on 10-year US Treasuries -- generally seen as the benchmark for long-term interest rates -- rose above 3.73 per cent. Once upon a time that would have been considered rather low. But the financial crisis has changed all that: at the end of last year, the yield on the 10-year fell to 2.06 per cent. In other words, long-term rates have risen by 167 basis points in the space of five months. In relative terms, that represents an 81 per cent jump.

Most commentators were unnerved by this development, coinciding as it did with warnings about the fiscal health of the US. For me, however, it was good news. For it settled a rather public argument between me and the Princeton economist Paul Krugman.

It is a brave or foolhardy man who picks a fight with Mr Krugman, the most recent recipient of the Nobel Prize for Economics. Yet a cat may look at a king, and sometimes a historian can challenge an economist.

A month ago Mr Krugman and I sat on a panel convened in New York to discuss the financial crisis. I made the point that "the running of massive fiscal deficits in excess of 12 per cent of gross domestic product this year, and the issuance therefore of vast quantities of freshly-minted bonds" was likely to push long-term interest rates up, at a time when the Federal Reserve aims at keeping them down. I predicted a "painful tug-of-war between our monetary policy and our fiscal policy, as the markets realise just what a vast quantity of bonds are going to have to be absorbed by the financial system this year".

De haut en bas came the patronising response: I belonged to a "Dark Age" of economics. It was "really sad" that my knowledge of the dismal science had not even got up to 1937 (the year after Keynes's General Theory was published), much less its zenith in 2005 (the year Mr Krugman's macro-economics textbook appeared). Did I not grasp that the key to the crisis was "a vast excess of desired savings over willing investment"? "We have a global savings glut," explained Mr Krugman, "which is why there is, in fact, no upward pressure on interest rates."

Now, I do not need lessons about the General Theory. But I think perhaps Mr Krugman would benefit from a refresher course about that work's historical context. Having reissued his book The Return of Depression Economics, he clearly has an interest in representing the current crisis as a repeat of the 1930s. But it is not. US real GDP is forecast by the International Monetary Fund to fall by 2.8 per cent this year and to stagnate next year. This is a far cry from the early 1930s, when real output collapsed by 30 per cent. So far this is a big recession, comparable in scale with 1973-1975. Nor has globalisation collapsed the way it did in the 1930s.

Credit for averting a second Great Depression should principally go to Fed chairman Ben Bernanke, whose knowledge of the early 1930s banking crisis is second to none, and whose double dose of near-zero short-term rates and quantitative easing -- a doubling of the Fed's balance sheet since September -- has averted a pandemic of bank failures. No doubt, too, the $787bn stimulus package is also boosting US GDP this quarter.

But the stimulus package only accounts for a part of the massive deficit the US federal government is projected to run this year. Borrowing is forecast to be $1,840bn -- equivalent to around half of all federal outlays and 13 per cent of GDP. A deficit this size has not been seen in the US since the second world war. A further $10,000bn will need to be borrowed in the decade ahead, according to the Congressional Budget Office. Even if the White House's over-optimistic growth forecasts are correct, that will still take the gross federal debt above 100 per cent of GDP by 2017. And this ignores the vast off-balance-sheet liabilities of the Medicare and Social Security systems.

It is hardly surprising, then, that the bond market is quailing. For only on Planet Econ-101 (the standard macroeconomics course drummed into every US undergraduate) could such a tidal wave of debt issuance exert "no upward pressure on interest rates".

Of course, Mr Krugman knew what I meant. "The only thing that might drive up interest rates," he acknowledged during our debate, "is that people may grow dubious about the financial solvency of governments." Might? May? The fact is that people -- not least the Chinese government -- are already distinctly dubious. They understand that US fiscal policy implies big purchases of government bonds by the Fed this year, since neither foreign nor private domestic purchases will suffice to fund the deficit. This policy is known as printing money and it is what many governments tried in the 1970s, with inflationary consequences you do not need to be a historian to recall.

No doubt there are powerful deflationary headwinds blowing in the other direction today. There is surplus capacity in world manufacturing. But the price of key commodities has surged since February. Monetary expansion in the US, where M2 is growing at an annual rate of 9 per cent, well above its post-1960 average, seems likely to lead to inflation if not this year, then next. In the words of the Chinese central bank's latest quarterly report: "A policy mistake ... may bring inflation risks to the whole world."

The policy mistake has already been made -- to adopt the fiscal policy of a world war to fight a recession. In the absence of credible commitments to end the chronic US structural deficit, there will be further upward pressure on interest rates, despite the glut of global savings. It was Keynes who noted that "even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist". Today the long-dead economist is Keynes, and it is professors of economics, not practical men, who are in thrall to his ideas.

The writer is Laurence A. Tisch professor of history at Harvard University and author of The Ascent of Money (Penguin)

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Comments

[Bruce Krasting]

Nice piece Prof. Tisch. I am glad you gave it to Krugman.

My thoughts on Keynes/Geithner:


brucekrasting.blogspot...

2009 Jun 10 08:24 AM

[Alphameister]

Good to see Krugman diminished, but I'm not sure Tisch has it right either. The surge in long-term rates is less a matter of the market reacting to huge supplies related to deficit spending than it is of the market shifting from a Krugman mentality (another great depression) to a Tisch mentality, an expectation of economic recovery rather than a plunge into a black hole.

2009 Jun 10 10:04 AM

[isurfmb]

Two points come to mind. 1. I didn't see any warnings of accuracy from the Krugman camp back in 05-07 for this credit/ fraud/ fiasco. So his forecasts and solutions at this point will be stop-gap at best, and not that of a preventitive master economist accurately seeing the future. 2. Since the inception of our Federal Reserve in 1913, one sage who got it right while experiencing the G-Dep, and rings loud and clear today with 90% plus accuracy is Will Rodgers when he phropesized, "invest in inflation, it's the only thing I know that's guaranteed to go up!"
With a currency that loses 95% of it's purchasing power in 96 years and current M1 increases of 16% yoy, who in their right mind would voluntarily hang in that currency for 30 years under the greatest hyperbolic long-UStreasury bubble in our lifetime?
Could it be that Mr. Krugman hasn't had the experience of creating income from risking his own capital?

2009 Jun 10 02:15 PM