JasonC

'As GM Goes, So Goes the Nation': Let's Hope Iacocca Is Wrong

Look, it is terribly simple. GM and Ford between them have debts of a hair under $300 billion and they have annual sales of $300 billion. There is no reason they can't service their debts if they earn a fair margin on sales. The equity is gone and half the debt it going to turn into common. It will retain its value if and only if their margins instantly adjust to a profit of 5-7 cents on every dollar of sales --- without any change in those sales, because they are as likely to go down as up.

The average UAW line worker costs $146,000 a year. That is simply unsustainable, it is crazy, it is stark raving mad at a time when auto sales are dropping 40% in less than 6 months. There is no capital left to steal. If the unions won't let wages adjust with demand, then they will simply all be fired --- there is no capital to sustain crazy wages and benefits packages like that, in this environment. If the government tries to maintain $146,000 salaries and benefits for half a million sainted auto workers by taxing all the rest of us, there won't be any economy. It won't be the GM and Ford workers that will be fired in that case, but it will be everyone else, quite rapidly. There is no reason those people deserve $100 billion a year of our money just to maintain their ridiculously privileged union bloat lifestyles.

Cut the wages by half. Yes, by half - your sales just fell by nearly half, didn't they? Think equity can take the hit for you? There isn't any. The union owns what there is on the companies, so it takes the hit --- they already took everything else.

If these companies just paid ordinary wages instead of 3 times the national average, they'd be profitable immediately, their junior bondholders would be equity owners with real value behind them, and the senior stuff and everyone's pensions would be safe. The government can no more guarantee $150,000 a year jobs for everyone in the country even in declining and uncompetitive industries, than it can command mana to rain from heaven. Give it up, you are busted already.

Then save like everyone else if you want your standard of living to rise over time. Own a price of the company where you work, instead of trying to rob it blind with a union shakedown every five minutes.

Oil Breaks Below $60

In any sane world, the price would have peaked in early 2006 and retraced 50% of the long move, which would have put it back at $50 or so by the start of this year, instead of $100. We'd never have made the trip to $147. There was never any shortage, the entire move from mid 2006 to the top was pure bubble speculation driven by the apparent 25% a year uptrend in the rear view mirror. It destroyed demand completely.

As it is, instead, we will have volatility and continued downward pressure for some time. The long dated contracts have yet to join the near term ones, a sign that the diehard inflation thesis has not yet capitulated --- but it will. Those will all be priced at $40 within a year. Watch.

Be Very Afraid of Deflation

Econ 101 - you need a history lesson, instead.

The hyperinflation in Germany occurred in 1922, not the 1930s. And it wasn't after any deflation. It was, on the contrary, a release of money supply built up during WW I combined with a centralized effort by the government to support a miner's strike to prevent payment of reparations to France. France physically occupied the Ruhr and tried to take reparations in kind, by seizing trainloads of coal. The miners responded with a strike, and the government supported the strike with printed money handed to the miners to remain off the job. This continued until the French gave up and pulled their army out of the Ruhr. Hyperinflation set in, in the meantime, as everyone switched to using foreign currencies in daily transactions. No deflation of any kind had occurred.

After that, all the governments for the remainder of the 20s and into the great depression in the early 1930s, were rigorously deflationist, with punishingly high interest rates, balanced budgets or surpluses, and a continual export surplus meant to transfer reparations payments abroad. None of which remotely worked, once the source of external financing keeping it aloft - US lending - was cut off, first by the stock market boom in New York, and then by the crash and depression. But they were still deflating violently in 1932, until forced off gold by the banking crisis touched off by the failure of the largest bank in Austria in the summer of that year.

There was no hyperinflation after that. The mark became inconvertible, and the British pound followed rapidly with a violent 35% devaluation. Deflation spread to those countries that hadn't devalued, notably France and the US, giving the final spike down in the US real economy and stock market, which only halted when Roosevelt devalued. Germany was taken over by the Nazis and ran exchange controls, doling out all foreign currency to importers with an eyedropper and a military need focus. Importers financed themselves by buying defaulted German bonds abroad at discounts and selling them to the Reichsbank for more than they paid for them --- basically debt repudiation and distress put the losses on Germany's external creditors, allowing some imports to continue.

There was no great inflation thereafter, into the war and rationing - though of course there were high black market prices once the war itself was underway.

The whole script that somehow a huge deflationary smash can be or inevitably is succeeded by an inflationary repudiation of the currency, is pure historical ignorance and fantasy. The inflation was 10 years earlier, and not linked to any deflation in any way. The reparations and war debt tangle being involved in both, is the closest one can get to linking them.

Stocks vs. Bonds: An Update for the Current Market

The current yield on the SP500 is more like 3%, not 10%.

As for how to buy bonds, you can get a pro to manage a bond portfolio for you by investing in an open end mutual fund like Loomis Sayles. Many bond managers have fled risk into treasuries or agencies in the recent slide, not where you want to be. Instead the sweet spot is A rated or BBB rated corporates, and LS is a well managed fund aiming there.

That is the easy way. A harder way is to use some closed end funds trading at discounts sufficient to cover their generally higher management fees. Loan participation funds, high yield (junk) funds, distressed mortgage funds, and preferred stocks, are all ways to play the same spreads - but each is quite risky, and I'd only recommend 5% of a position in any one of them. With the bulk in something broader based and investment grade, like LS or Pimco.

Effects of the Long Dated Treasury Bubble

Is everyone here very stoned?

You do all realize, right, that exactly the brain trust making this same one-note idiotic prediction are the ones who blew all these bubbles, in real estate, in oil, in every commodity there is, in metals. Because if infinite inflation is just around the corner the right thing to do is get short dollar debt by borrowing to the hilt to carry real assets. Oops, everyone on earth just tried that. And it blew apart. Who'd pay them?

In fact, the Fed left spendable money - M1 - unchanged for 3 straight years, and all the debts are therefore real, and all the real-asset bets against them went smash. And will go right on going smash, until you-lot get this inflationary brainstorm out of your system. Everyone holding debt is getting paid, and everyone betting against it is being forced to give away every asset they own.

Will any of the johnny one-notes ever admit that it is precisely their hyperinflation prediction that just crashed and burned?

What We Don't Know about the Markets

Mostly sane advice, but you also ask "who wants to put in new money now, only to perhaps be underwater almost immediately, and then hope to get back to even?"

I do. I have no problem with it whatever. Someone coming along and offering a lower and lower bid for something I am not going to sell does not distress me. No one can own only monotonically increasing assets --- any such asset either returns only the risk free rate or can be instantly arbed up to a level where it goes unstable again. The whole notion that you can avoid ever holding anything declining in price is a complete delusion.

Who cares how insane the next few offers are? If they get whacky, take your next bond coupons and buy some more.

No one can call directions, anyone can call levels. Lend at the high rates on offer, and average into stocks with the coupons as you receive them.

Simple.

Don't Follow the Wall Street Crowd - Prepare for Market Rollover

"The real question is, medium term, where to put money?"

It is a deflation and spreads have already widened. So you should be putting money in long term corporate bonds, and a few other similar asset classes. The principle. Then as the coupons come in, use them to average in to common stock positions, to exploit the low prices on offer. Gradually, there is no great rush.

Finance corporates can be bought today with 10 to 30 year terms and double digits rates. Diversify by also having a 10-20% position in TIPS (yielding over 3% plus inflation adjustment), likewise in GMNAs (6%, both with no credit risk), and in floating rate bonds or preferreds (those can be bought today to yield 8% and up, and will return double short rates forever if they remain solvant). Keep a moderate position in insured CDs but don't hoard there.

The name of the game is simply to lend money when no one else will. Pick the credits, and go long on the terms, because spreads will tighten once this passes. Avoid "core" bond funds that right now will be stuffed full of short term treasuries bought by timid managers trying to get slightly less killed than the index.

If you are adventuresome, you can include small positions in loan participation funds, junk bond funds, and equity REITs or REIT funds, and distressed mortgage debt. All of which could get killed, still, so these are 5% positions at most. Only even look at them if you see 15-20% yields on offer - it will take half that figure to cover the loan losses.

Now, when you get coupons from all of the above, invest them in distressed equities. You don't want to be defensive, don't go looking for short term trades or try to hide in consumer non-cyclicals and health care etc. Let the mutual fund manager herd do all that. Instead buy financials, buy real estate related names, buy materials, buy retailers, the stuff smashed to heck and gone. Just don't invest any principal in them. Only your interest!

This will average you in to a 50-50 stock vs. bond position on the right 5 year time scale. Don't worry about inflation. One, there isn't going to be any for a short spell. Two, if there is, it will cause spreads to recover, your first stock purchases likewise. And three, because your TIPS and floating rate positions will benefit. Four, because you own a house (you do own a house, right?), and that is all the inflation bet exposure you require.

This is one of the best investing climates you will see in your lifetime. But that doesn't mean gun risk and jump in frantically, expecting it all to go straight up starting tomorrow. It won't, and you don't need it to, or even want it to, really. The longer prices stay cheap, the more stock you can buy with someone else's money (interest received, not borrowings).

I hope this helps.

Irving Fisher on Debt, Deflation, and Depression

"someone has to SAVE the money"

Suppose you say $10000 out of income, and invest it in some enterprise that fails and goes nowhere, earning a return of -100% in the first year. Does your having saved it first make it retain its book value as your savings? No.

Suppose you instead borrow $10000 at 3% and invest it at 10%, and the 10% investment actually pays the full 10%, and does so for 10 years as you fully repay the debt. Does the fact that you didn't first save it out of income mean its book value and true value and any other magic rabbit's foot value is "really" zero? No.

The value of an investment does not depend on where it came from, but on the success or failure of the investment to deliver the returns the investor envisioned when he made it.

Even if the investment returns exactly the same cash flows as the investor envisioned when he first made it, the value of the investment may be twice what he expected or half what he expected, depending on the level of interest rates used to discount a long stream of future cash flows back to the present.

Capital seeking better returns can go to worthwhile investments or to mistakes regardless of where it came from or how it was funded, likewise. Does an offer to lend to you at 3-5% - currently going begging, clearly - ensure you will invest only in projects earning 6%? Does it make projects earning 10-15% go away? No.

The earnings rate on the capital depends on the capital value of the capital. Leave the future cash flows unchanged but change the price, and the rate earned changes. A 10% investment is not one that ought to be engaged in while some other at 6 isn't, it is merely the same project with a lower price tag.

Price tags on bags of future cash flows are set by investor confidence and behaviors, not by a single interest rate on savings. There is no such interest rate. All the Austrians pretend there is, but this merely shows how busted their whole equilibrium model is and how far from reality. One can in fact prove that there must be a distinct rate of interest in every type of future claim and that the price system is overdetermined otherwise.

Another way of stating this is that no one can arb to equality all rates of return on capital. They are all changing, and the real capital is not fungible enough to switch from use to use faster than capital values fluctuate.

Borrowing at low rates to invest at high rates is capitalism. Saving out of income and expecting a guaranteed return from doing so, and assailing any force that interfers with collecting it, without running any risk, is instead an illusory fantasy. All it does it supply the credit at low rates wanted by the first sort.

No one is harmed in the slightest by such finance, because it is your free choice which side of it you stand on. If you think the rates on safer assets are so low one is a fool to accept them, then you can exploit that by borrowing at those rates instead of lending at them. If on the other hand you think leveraged investments are so insanely risky you'd never engage in them, then you cannot simultaneously castigate others for earning high returns running those risks for you.

The risks are there simply as a function of the real capital itself being entirely at hazard. Its value can all disappear tomorrow, even if every dime was supplied twice over out of real savings --- it is perfectly sufficient for demand to shift to some other commodity. No, you are not ensured by any economic law that you will still receive without fail some magical average rate of interest.

There are no safe investments, full stop. There are none even somewhat safe is calm times without others made less safe through leverage, standing ahead of them in claims and in losses. All investments derive their value from real services they perform for fickle consumers, and depend on their own unstable incomes and wealth. And no arrangement conceivable can change that, in the slightest.

Gold: War of Attrition

How does a gold short who sold at $1000 wind up under anything, water or otherwise, when it is down at $750?

Irving Fisher on Debt, Deflation, and Depression

Fisher had is right, and reflation can prevent an increase in the weight of debt caused merely by changes in the exchange value of money as velocity falls. But that alone does not redress the real misallocations that brought on the crisis in the first place, which are not caused merely by how the investments made in the boom where financed (a mere division of their nominal cash flows among those owning claims on them), but on those cash flows themselves proving insufficient to justify the expenditure first made on them, at the new prevailing rates of commodity interest.

The critical line in the quoted text is that the resulting movement of interest rates in the smash are not simply downward, but instead downward for contract interest and upward for commodity rates of interest. There is such a thing as a commodity rate of interest, and it doesn't restrict itself to "commodities" in the modern financial sense of that term. It means the rate of return on real capital invested in any line of business. This rate *rises* in the smash --- but this is barely noticed, because the rate on an existing claim rising corresponds to a capital loss to the holder of that claim the instant the rise takes place.

In other words, instead of loan offers at 5% chasing prospective returns at 5.5%, with tons of takers, one sees loan offers at 1-3% chasing prospective returns of 15-20%, with no takers to speak of.

The Mises-ean Austrian analysis has no room for this development. The error underlying that whole view is its accounting for capital as a uniform factor of production and its belief that the rate of return on capital will be arbed to equality across all possible uses of capital. It can be formally shown that this results in an overdetermined price system --- one with many more equations than unknowns. It is completely unsurprising that it fails to be seen in actual practice.

Where the Mises-ean, Austrian view is basically correct is in seeing the attempt to lower the rate of return on capital as being behind the cycle; where it is incorrect is in failing to see that this failing, the uniformity of the concept "capital" breaks up. At bottom, Mises too readily equates capital with a historical value (or book), and expects the rate of change in that value to be governed by savings out of income. This isn't what happens and it is plainly an error, a priori. The dominant factor in changes in the value of capital through time is the change in the value of existing capital resources, not net savings being added to a fund thought of as having some natural tendency to precisely preserve its invested value. There is no such tendency.

From a rational actor point of view, the queer thing about depressions is that men pass on loan offers at tiny demanded rates at the same moment the spreads available on riskier investments and their expected future value therefore, have soared. The reason is pavlovian training - men fear what has just hurt them.

The solution is also well known by now - counter-cyclical investment even if it means borrowing to do it. And that has been hardwired into the financing of modern welfare states. It was Minsky who pointed this out in detail.

By the middle of next year, tax receipts are going to plummet. Transfer payments will automatically rise. Stimulus packages and bailout packages and open market operations will add to this. And as a result, government will run massive short term deficits, borrowing from risk averse investors at near zero rates to do so. All of those funds will wind up in the hands of households and businesses.

Those households will desire some increase in their savings rate, and some reduction in their debts, respectively. There will therefore be some lag during which the normal deflationary forces described in the article will operate. But once those one-off adjustments have occurred, there will be massive additional cash flows into their hands at the expense of government (accounting) and risk averse savers (cash flows --- the acquirers of all the new government securities and new bank money created).

Final demand in nominal terms therefore cannot stay down. Just as happened in the 1974 bear market period, it will surprise almost everyone with the speed of its recovery. There will be no great depression in reruns. Keynesian automatic stabilizers will see to it.

Monetarist ideologues and Austrians hate to admit this, because it violates their white-hat and black-hat view of things. But that is entirely in their own minds anyway, purely normative, and has nothing to do with practical economic reality.

Mark my words - in six to nine months, nominal GDP will be growing not sliding, and the whole thing reverses. And borrowing at 3 to lend at 10-15 is going to look in restrospect like a no-brainer trade. Men will wonder that anyone could have failed to see it and act on it, promptly.

AIG and the Free Lunch Myth

Put writing is popular in stable uptrending markets.

CDS contracts on credits that looked sound were put writing.

Lending on mortgages backed by houses with rapidly rising prices were put writing.

Asset backed lending at razor thin spreads differs from straight lending on risk free assets by the implicit put being written on the value of the collateral.

All lending on terms that involve no upside if things go well but plenty of downside if they don't is put writing.

All leveraged positions in risky assets that have someone else apparently or actually on the hook if things go wrong, while the whole leveraged upside belongs to the risk-taker if they do not, are call positions, and call positions can only be created by someone else willingly engaging in put writing.

All assets are owned and owned exactly once. The net change to all market participants is therefore always the change in the value of everything, without financing or leverage or hedging of any kind. Those activities never control risk, they simply shift it to someone who does not know he is taking it and therefore misprices it.

When a lender sees no risk in a CD loan to a bank, he is rational because he sees an underwriter's guarantee from the authorities. That too is put writing - the authorities promise to take all the losses once they reach the point where they might endanger a bank depositer.

That underwriting can be rational - the authorities do own upside after all, in the form of taxation of every profit. They haven't thrown away all upside in underwriting against downside risks. They did agree to finance the smash phase of the cycle by doing so, and now they are called on to make that good.

One can moan about how horrible it is that someone else may profit from a bet made with borrowed money, but until savers give up the desire for safer forms of investment there will always be a demand for the speculative, junior, call positions --- because those are inseparable from the senior and put writing positions.

It is always possible to fund things with a higher portion of equity, or to blend holdings across all asset classes in a way that captures the total average returns instead of slicing it up and betting on specific positions. The second always amounts to calling the specific range in which future returns will lie, instead of their average or overall direction.

Nobody should be remotely surprised that it is harder and therefore that more bets made that way blow up and wreck the plans of those engaged in them.

Long run average returns across entire capital markets are always going to be easier to predict than narrow bits deliberately made as volatile as possible. But will men be satisfied with them? That is the question.

When capital is not paid to be conducted safely, it does not go away or initially succeed in demanding greater rewards. Instead, risk will be gunned and concentrated instead. This used to be a proverb - "John Bull can stand many things, but he cannot stand 2%".

Gold: War of Attrition

My house maintains its value regardless of what money authorities do, as well. It is more useful than a bar of pretty metal. It remains just as useful to me whether someone quotes a price four times as high for it or four times as low.

And no, the Fed wasn't inflating all along, that was pure slander and reckless betting by precisely you-lot of inflationary brainstormers. Then the Fed *tightened*. Did everyone forget? Raised rates to around 6%? The yield curve inverted? Anyone remotely remember the actual sequence of events?

M1 was utterly flat from the spring of 2005 to the spring of 2008. Here's the thing, you can't spend a CD. Banks don't have to have any reserves against one, so they can make loans against them all day --- but they do need to reserve against currency or checking accounts. Which the Fed wouldn't let move an inch, for 3 straight years.

That is *why* all the bubble prices didn't stick. The Fed didn't allow *spendable* forms of money to grow, and as a result, nominal spending didn't double or quadruple like all the insane bets you-lot were making, did. Without 2-4 times the spendable money chasing all your gossamer bubbles, the high prices just destroyed demand. And went smash. And continue to go smash, because all the debts issues against them now (1) own the assets and (2) are worth only 50 cents apiece on the dollar, themselves.

Everything the Fed has done since has merely kept the entire price level from falling the same 50-95% that all the bubbles are falling. It will still fall, just not much or for very long. If they left the money supply unchanged right now, prices starting with wages would fall half or more, just like the great depression. But they aren't going to. They will simply let people who want to hold money balances instead of everything else you can think of, do so.

In an actual inflation, people don't want to hold money balances, they are trying to get out of money. In a deflation, everyone is trying to get out of everything else and into money. We are in the second - transparently, beyond dispute, beyond spin.

The world bet on a hyperinflation but someone forgot to tell the Fed and it did not allow it. As a result, dollars remain entirely valuable, and all your ridiculous slander-driven schemes are dead as doornails.

Gold: War of Attrition

"In economics 101."

If you made it to the next class, they explained to you that the demand for money is not a constant. If you paid attention even in Econ 101, you noticed that all assets have 2 curves determining their price, not one.

"in the end will result in high, if not hyper, inflation"

Um, where do you think the real estate crisis came from? It consisted in everyone making that bet together until the prices were ridiculous. Being short a nominal mortgage and long a real house was the inflation bet everyone was making. And it crashed.

Right now if you believe in future inflation and don't want to take risks, you can buy a 20 year TIP for a 3% real return. If you believe in future inflation and are willing to take risks, you can buy property REITs yielding I kid you not 33% (some hit 67% yields at last week's lows) and PEs of 3 or 4. Their prices have fallen 95% from the highs and no one will look at them, because they carry real estate (aaaaggghh not real estate! ) with debt (aggggh, not debt), sometimes as significant levels of leverage (aggggh, not leverage).

If your inflation thesis is true, one none of those would have crashed in the first place, and two at current smashed to heck prices all of those would return 10-50 times what bullion can ever promise to return.

It is a deflation. Look it up.

Bond Expert: Wednesday Outlook

whidbey - everyone on earth still has that same silly inflationary brainstorm that eventually all currencies will be worthless. Even though the last couple years have proved to a demonstration that view is false, as those holding the money claims instead of being short them, will own all the real assets bet to the moon by the inflationary brainstormers.

But here is the little problem - a trade entered recklessly by everyone in the world cannot be correct and pay them. Who'd pay them off?

All the inflationary brainstorms go smash. And prices will not soar back up to revive any of the busted bubbles. Not a one. Until you-lot get the inflationary brainstorm out of your system, all the holders of debt have to do is remain on strike, and you will be forced to give them everything, for a nominal song. Money will be insanely bid and valuable, until you get rid of the idea that it "must" all be worthless tomorrow.

Gold: War of Attrition

Um, you can buy all the gold you please at the stated prices. Just buy a gold future on the exchange, and take delivery at expiration date.

What are we supposed to be stupid, here?

Oh, and manic selling of *what*?

There are two items traded for each other in every trade, not one. There is no manic selling of anything without manic buying of something else. And none of it clears unless someone has the opposite opinion.

The reason gold isn't soaring is obvious - there is a money panic and deflation due to an infinitely expanded demand for money as a form of safe short term investment - not for spending. All the quantity theories assume demand is a constant, it isn't, it is a variable. Variables vary. Welcome to reality.

Because all the commodity bubbles based on overcrowded bets that everything real would appreciate in terms of currencies, are going smash and will continue to go smash, and because gold is just another such bubble, no different from the one in houses or oil or potash or anything else you please, it is perfectly understandable that the bubble in gold is going smash just like all the rest.

And no, everyone isn't scrambling to get out of everything else on the planet into gold. There is no reason why they should. And no way they could succeed if they tried.

Standing around waiting for the manic stampede into your favorite asset class is irrational. Are there manic stampedes into an out of asset classes? Sure. Do they benefit anyone? No, other than a few charlatans acting on them early and fading what everyone else does. But why on earth would everyone else on earth pick exactly the same item you have?

If I want to be in real items instead of financial claims, what is better in any way about a bar of pretty metal, compared to a nice house in the southwest? Both can and do have manias. One I can live in in the meantime. Or thnt oil? Both can and do have manias. One is in constant industrial demand and gets burned up continually, the other accumulates from every mine on earth indefinitely.

Or than tulip bulbs, kumquats, widgits, gimcracks, old masters, office buildings, classic cars, stamp collections, etc, etc.

"Gold is money". Oh, where does it function as a medium of exchange? What evidence is there that it is the most liquid possible asset to hold, because men everywhere are ready to accept it as immediate payment for anything and non-existence bid-ask spreads or markups? It isn't money. It is merely another collectible that once was. So are seashells and cigarettes and printed ration cards and Czarist bonds.

Forgive me for trying to reason with conspiracy theory nonsense, occasionally the first duty of a rational man is to state the obvious.

Gold is a commodity bet bubble like all the others that just went smash, and with a bit of a delay for the diehards, it goes smash just like all the rest.