the social scientist.

Looking at Our Present Crisis Through the Lens of 'The Fourth Turning'

I think Basehitz is referring to the Coming Great Depression of 1990 by Ravi Batra. I read that one before 1990, and his arguments about income equality were good, and then he went into this long cycle thing about certain kinds of social classes displacing each other in power. So there was a recession in 1990, and I made good money in both 1990 and 1991, by being long.

Batra's error again was categorizing past societies based on social attributes of his choosing. That is, it was all interpretive. There was no measurement of these social groupings. I have engaged in categorization of phenomena using cluster analysis. It requires good data, and no mathematical technique can tell you whether an individual observation should be in this group or that group, and how diverse the group memberships should be, and which attributes you should choose to define the group. Your classification is only meaningful if it is predictive in some way - so you have to wait.

I agree that there is plenty of energy out there, but we are near peak oil, and replacing it or substituting for it is more expensive than oil at $100 a barrel given current technologies. It's not the dollar cost of energy that is a problem, it's the energy efficiency of energy production. Ethanol produces very little net energy, if any, because of industrial agriculture that uses great amounts of energy to fertilize, plant, manage pests, and harvest corn. Then there is the energy used in conversion of the corn to alcohol.

It takes oil to build nuclear reactors. It takes oil to build synthetic fuel plants that make oil out of coal. We're talking about huge capital and energy investments to get alternative energy production started up, at a time that both cheap capital and energy are scarce.

Necessity is NOT the mother of invention. Most inventions come out of the blue and then spur a demand for them. I'm not waiting for nuclear fusion. Viagra was a side effect of testing the stuff as a cardiac drug.

Looking at Our Present Crisis Through the Lens of 'The Fourth Turning'

Anyone remember the Greening of America? Came out in the early 1970's I think. He argued that America for most of its years had been in a frontier mentality. I forget what other stages there were that we were going to proceed into, but it was an excellent book, except in 1980 we elected Reagan, and reverted to a frontier mentality.

Classification of the past into various sociological or psychological eras is a descriptive tool. It has no predictive value. I am a baby boomer. I do not recognize myself in the psychological attributes of the boomers. We are not a great uniformity. Besides, the psychological attributes are not predictive of future events, nor of our reactions to future events.

Cycles are also a description of the past. They are in no way predictive of cycles in the future, just as trends are not predictive of a trend continuing or discontinuing. This is an astrological mentality - that there are cyclical forces afoot, and these cycles have a regular periodicity.

We are faced with depleting oil and no cheaper alternative that can quickly be put in place to replace it (unlike oil replacing coal 75 years ago). We are faced with an aging population that would like to live a retirement at the same comfort level that they enjoyed in their working years. We are faced with a debt burden of historic proportions both at the individual and government level, and having government assume some of that private debt doesn't solve anything. For credit to flow again, for economic growth to occur again (and there are no guarantees that it must), that debt must be deleveraged.

Where are the cycles in these three headwinds? Two of them are completely new. When we deleveraged and came out of the Great Depression, resources were plentiful, and there was no immediate threat of an aging population. Quite the opposite. Things ARE different this time. Some things are always different. And things don't look good for some time to come based on historical relationships that are likely to continue. And then there are Black Swan events, some of which could have benefits to society.

The certainty of history is that no one knows the future. Thanks for wasting my time.

Evidence That Big Inflation Is Coming

That's about the best discussion I've seen on seekingalpha.

Let's distill - the comments in particular. Inflation is a general increase in the level of prices of things that we consume. Asset price inflation refers to the change in price of productive resources (or non-productive, like collectibles) that last for some time. Residential real estate then is an asset, but it's shelter services are priced as consumption inflation. When Friedman hypothesized that inflation is a monetary phenomenon he was encapsulating a theory, that inflation is the result of an increase in the money supply. He was not redefining inflation. In his argument he of course engaged in modeling, in which we assume that a lot of other influences (causes) do not vary, and so the independent effect (by itself) of an increase in the money supply will produce inflation. That is, if nothing else changes, including no change in the production of goods and services that money buys.

Unfortunately, other things do change, and the changes in the other causal variables are all inter-related. The key variable omitted by the first author is the velocity of money. If the new money just sits locked up and is unavailable to create an increased demand for goods and services, it isn't going to engender inflation (think globally here). I'm with Mish, for the most part. The bad debt has to unravel. There won't be credit expansion until a lot of that debt is simply written off. There won't be economic growth until credit expands again, or people have saved a lot of money, and then dip into those savings. There won't be inflation until you get economic growth. Don't hold your breath waiting for it.

How does that square with stagflation - inflation with no economic growth? It's mostly a question of time lags I expect. Inflation did ease when the recessions of 1974-75, and 1982-83 bottomed. And, during those recessions, there was no destruction of asset values or credit contraction as now.

This is the 1930's, and Japan in the 1990's. Can the government and central banks save the day? Nobody knows, including them, because this experiment hasn't be tried before. Consider that the 1930's was the control group, and now we are the experimental group. So far the experiment isn't going well is it? Who knew that recapitalizing the banks was not going to improve credit availability for the consumer Who would have thought that people would not want to borrow? Actually quite a few.

When inflation returns there will be plenty of forewarning - we will have signs of economic growth, such as new unemployment claims falling. Remember though, that in the past deflation, or lack of inflation, hung around for a long time.

I do own some GLD - it's a trade.

Deflation Is Mostly Behind Us

No one has mentioned the velocity of money. the quantity of money means little until it is spent or lent out (to be spent). If gold were the only money and you mine lots of extra gold and just store it, you have increased the money supply (or the quantity of money), but the economy does not expand, and there is no inflation. (BTW, the Vikings then helped the economic development of Europe by spending the plundered gold.) This principle applies to paper money also. A lot of that bailout money is sitting at the Federal Reserve as bank reserves. It's not entering the economy. Also, most of that bailout money has not been 'created' as yet. It has been borrowed.

Yes, inflation will return some day, but nobody knows when. I think TIPs are a good buy, but so does everybody, which scares me. Everybody thinks municipal bonds are a great buy, and have done so for 2-3 months. So why haven't they risen? Could it be because many cities may default on this stuff? And if they do, there is no collateral - only default swaps. Can the mono-lines cover a wave of defaults?

Remember in 2007, that 'everybody' said we should diversify into uncorrelated assets like foreign stocks and commodities, especially because 'everybody' knew that the dollar had nowhere to go but down. that worked well in 2008, didn't it?

In 2000, 'everybody' thought that this time was different, and stocks would go up forever. Now in 2008 we are getting a consensus that this time things are not different, that the government and technology will save us, that economic growth will return fairly soon (God's law of capitalism), and so will inflation. The stock market will recover, because it always has. Did Rome have a stock exchange?

Think independently people. The last year really has been different from the post- WWII era. It looks a lot like the 1930's and post-1990 Japan with new wrinkles that matter. The debt bubble this time was worse than the 1930's. It's global. The populations of the developed economies (and China) are aging rapidly. Oil really is running out, and there are alternatives, but this time there are no cheaper alternatives. (The beauty of oil was that it required so little human energy input to produce vast amounts of energy that we could utilize to our benefit.) Global warming cannot be stopped, and can only be slowed by the immediate cessation of fossil fuel consumption. Of course, we don't know the consequences of warming, but it will require expensive adjustments. It's the rainfall consequences that matter most, although we may lose a few coastal cities.

So, beware of conventional opinion. Entertain the possibility that economic growth is not God-given. Large areas of the world in the past have experienced economic decline (and population decline) for centuries. Sustainable economic growth in the form that we have known it is logically not possible. There are no guarantees that innovation will always provide cheaper alternatives to the resources that we have used up and can't recycle. We don't have to worry too much about innovation increasing food production to keep up with population growth, because world population growth will probably cease by the middle of the century - that's not good for economic growth either.

Humans are evolved to be optimistic by nature, because if you're not, you don't survive long enough to ensure the continuation of your pessimism genes. But look at both sides of reality, and look back further in history than the last 200 years, and you must admit to the possibility that things won't get better, at least for quite a long time. So don't buy-and-hold. Trade to survive, lower your living standards while you can make the choice, and don't expect a comfortable/wealthy retirement. Hell, have a good time now, and forget about retirement. I've been retired for 7 years, and would be content to be poor, except I still have a teenager at home, and a wife who would not be content to be poor.

Indicator Update

You are probably familiar with Fosback's high/low Logic Index. He took the number of weekly 52-week highs and lows on the NYSE (all issues traded I think), and calculated the lowest of the highs or lows as a percentage of total issues traded. If the 10 week average of these percentages fell below 1% that was a bullish signal. It didn't matter if the low number was highs or lows. At the beginning of a bull market the percentage of stocks making new highs is extremely low, and when the bull market lifts off, the percentage of stocks making new 52 week lows is very low. He wasn't publishing in 2002; so I don't how the indicator did in forecasting the bottom of that bear.

I have calculated the indicator for myself since 2004, and it is getting close to a bull signal, although I suspect it is wise to wait until there are very few new lows.

If the 10 week average is above 5% that is a bearish signal. The Hindenburg omen seems to be a variant of Fosback's indicator. The sell signal failed at the end of 2005, but forewarned of weakness in May 2006. It issued a sell on 8/17/07 at the intermediate bottom. It has not come to signaling a buy until this month. As of Friday the 10 week average was at 1.62% and falling.

What the High-Yield Corporate Bond Market Is Telling Us

Brett:

I too have been monitoring the high yield bond funds, especially HYG. Do you know if the bonds in such funds are insured? That is, were CDS bought on them when put in the fund? Also, is a CDS good for the entire term of the bond, or do they expire after a certain period of time like puts. I read a lot, but I've never seen these questions posed or answered. If they are insured then an 18% yield is very attractive, even in the face of a possible 20%+ default rate.

This Recession Will Be Anything but Deep

I tend to agree with pretzel logic. I don't know of any significant occurrences of asset price deflation that didn't also have product price deflation succeed it.

As for Peng's idea that the financial losses are not as bad as they appear because the prices of the debt instruments may go up, I would point out that US financial firms are understating their losses, because as the price of their debt drops below par, they record that price drop as profit. The accounting principle is that they can buy the debt back cheaper than they sold it for.

There are also a lot of companies with defined benefit pension plans, who assume an annual profit on those plans, even in a year like this, which are in their earning statements. And finally, the companies that are losing money, get to record future tax credits as profit now, even though they have to make a profit to collect that tax savings. Remember GM? They finally had to write those imaginary profits off, because they weren't going to make a real profit in time to collect the tax credit.

My point - the reported losses are actually much bigger than reported.

The Most Dangerous Place to Get Investing Advice

I too caught the irony of your title. However, good stuff. I did retire at 54 using technical trading, but I haven't done very well for 5 years now, and I will never make the Forbes 400 or 1 million list. Only down 2% YTD, however.

May I add another wrinkle on other people's investment advice? When the conventional opinion is fairly uniform, go the other way. And this includes advice on some sound value companies. For years, Washington Mutual showed up on lists of most recommended stocks. Of course, following your advice above to avoid stocks with more than 40% debt, you would avoid all financials, right?

Another example - last year investment advisers were uniform in recommending diversification into international stocks (and commodities), probably because of the declining dollar which was destined to decline further because that was the chart trend. That worked well, didn't it?

Right now, Walmart is the most recommended stock. That would presumably mean it has a lot of support from institutional buyers, but it's not going to be a good long-term prospect. Too big to grow much, and it's a retailer, a sector like airlines. They come, they go.

On Board the 'U.S.S. Titanic'

Nice Titanic metaphor. But, metaphors just provide another perspective. They do not explain, nor do they predict, nor do they provide solutions. The ship should have slowed down to not hit the iceberg. But it's hit the iceberg. Whether you put the band leader in charge or not does not affect whether the ship will sink or not. Paulson as band leader is not a good fit anyway, because as CEO of GS he was a player, and helping decide how fast the ship should go.

I have seen no mention of Marx's crisis of capitalism. This is a theory, and therefore an explanation, which produces predictions. The main prediction, which caused the theory to fall into disfavor was he predicted the collapse of capitalism followed by revolution of the workers. It didn't happen in the 1930's when we had the last crisis of capitalism.

The theory is essentially quite simple. If the owners of capital don't pay their workers the fair rewards of their labor, then those workers won't be able to consume all of the production (unless you lend them the money - my addition). There is an oversupply of production. Profits then fall. The capitalists look for new profit opportunities, i.e. new markets and colonies, now called globalization. The same problems occur again. Marx never thought of raw material supplies being limited, but their scarcity is clearly adding to the cost of business and lowering profits also.

We were there in the 1930's, but there was no revolution. We are there again, and there will be no revolution, because most people, including me, are sheep. Don't separate from the mob, because you will be culled. How do you like that metaphor? Here's another, inspired by Mel Brook's History of the World - the meek shall inherit the earth - 6 feet under.

Another Depression, no matter what politicians do? Quite possible. Even if they make credit available again, those who can afford to borrow don't want to. The others who need credit can't borrow. It doesn't look good. Can China save the day? Probably not. I figured out long ago that if China and India were to emulate the western growth path, the world would quickly run into Malthusian supply constraints. If the world can resume economic growth oil prices will go through the roof. Although there are many alternatives to oil, none are cheaper than oil, and they are all take lots of capital and time to put in place. The capital is cheap, but there isn't much available. This paradox is about the only new thing under the sun in this situation.

We live in interesting times.

Do Paulson and Bernanke Really Understand What's Going On?

Excellent stuff Jason.

Perhaps you can clarify where credit default swaps enter into all this. Wasn't all this bad paper insured against default? Who, other than AIG sold the insurance? How is it possible that the notional value of the insurance far exceeds the total amount of debt? Does a seller of the debt keep the insurance, and then the buyer buys a new insurance on it? Or when they repackage the loans do the buyers of the loan package buy new insurance? Or? Do insurance sellers know they are selling more than one insurance coverage on a loan?

Did you see Krugman's take on Paulson's plan? Krugman says we should demand equity ownership in the institutions from which we buy the debt. Makes perfect sense. If the intent is to free up credit, by improving the equity positions of the lending institutions, then pour equity capital into them. This also does more to resolve the deleveraging paradox (where everyone is deleveraging, which deflates asset prices, which worsens everyone's debt to equity ratios).

Will rescuing the financial institutions help the housing problem? I don't see how. Those who are qualified to get home mortgages already can through Fannie Mae etc.

Did you see where Microsoft is going to borrow, using commercial paper, to help fund the purchase of $40 billion worth of their shares? That really helps the credit crunch and the economy, doesn't it? So they don't see any avenues for expansion? Worried about the value of management's stock options are they?

It's Only the End of the Beginning

This is not about whether you were caught leaning the wrong way (I'm in yuan, and bought and sold an index ETF for a nice gain thursday, but missed most of the rally.) And it's not about whether the Republicans or Democrats caused the problem. It's about the fact that Bernanke and Paulsen (Bush got lucky by putting these guys in charge) are both very conscious of the fact that they are on the cusp of a depression, the big one. Bernanke in particular has studied the Great Depression, and come to the conclusion that it was the credit crunch that caused it. So they have to relieve the credit crunch. It wasn't addressed in the 1930's. Will their actions work this time? We/they don't know, because it hasn't been done before. If they succeed, we still don't know if there would have been a depression without their actions. They want to liquefy the economy without taking over these financial institutions. They've already acquired three, and don't want anymore. So this is not about ideology (socialism vs capitalism) either. The risk of inflation and a lower a dollar don't matter. In fact, if the dollar drops and we have inflation that will be an indicator of their success in preventing depression. And inflation will diminish the real debt that the government incurs. Inflation is much better than deflation.

Will they succeed? They might succeed in turning a depression into a protracted recession. Prospects for growth in this economy are dim, because those that need to borrow (and I'm talking consumers) can't afford to or won't qualify, even if there is money to borrow. Even if consumption can be increased, then resource costs (oil) will rise and kill it. In 3 years time the boomers will start retiring, reducing consumption, and withdrawing money from equities and from their retirement accounts (I retired when I was 54 and have been doing exactly that). It's going to be tough to make unearned money from here on people.

So quit bitching about the morality or ideological purity of the government's actions. Bernanke and Paulson are much smarter than us. If they avert depression people will give them hell. If they fail people will give them hell. But there is no doubt in my mind that they are doing their best, and their strategy has the best chance of succeeding without nationalizing the financial institutions of this country. And again, inflation would be a good thing.

I've always been a Democrat, by the way. If you want to cast blame, blame Reagan and his Keynesian economics, and blame Greenspan for compounding the problem. Remember when he told Congress it would be ok to could cut taxes?

RTC: Creating a Big Bad Bank

I think the previous RTC came about because the FSLIC didn't have the money to cover the insured deposits at the bankrupt savings and loans. When the S&L's went under the RTC ended up with all those bad loans. They presumably got the money from the foreclosed properties that were sold, and they sold the outstanding notes on commercial property for pennies on the dollar. Why it cost them $400 billion beats me.

So would a new RTC be intended to bail out the FDIC, and take over the loans of bankrupt banks? or would it be along the lines of what Cramer suggests - that they enter the market and buy the bad paper at market rates? Either would take an Act of Congress, but they would go along. The risk then is, since since they're replacing those loans with Treasury debt, will foreigners still buy Treasury debt? And will my yuan go up or down?

Depressionary Tales

The problem with trying to analyze why a depression occurred is that we only had one with reasonable data to analyze. You can't therefore investigate it scientifically. Science is based on variables. You vary something and see what happens to a response variable. This can't be done in the case of a one time historical event.

Prior to the last depression there was no consumer price inflation. Technology was creating productivity gains where there was actually excess production capacity in the US holding down prices. There was asset price inflation but nothing like the current housing bubble. The Feds raised interest rates in 1929 to slow the asset price inflation. That worked well. Deflation in all prices became very apparent in 1930, and was at its worst in 1931 and 1932.

The economists today figure you provide liquidity to prevent this (helicopter Ben), to make people spend (better to spend than save when interest rates are low and there is inflation), and to relieve a credit crunch. But, how do they know that it would have worked then? They don't. How do they know that it will work this time, with a fundamentally different financial structure that provides credit to the economy? We don't know if it will work. So we try it, and see if it will work this time. The fact that interest rates are so low with the CPI at 5%, and that the Fed and Treasury are doing their utmost to relieve the credit crunch by providing it to more than just the banks, is an indicator that they truly fear a Depression. On the other hand, are they really doing what it takes to provide liquidity? The interest rate on the loans to AIG are really steep, and the government gets 80% of the equity in the company. And interest rates could be reduced to zero now. Inflation is not a worry. The danger is deflation.

The politicians on both sides can do little, except to keep the stimulus coming, but the government has to borrow that money they give to us and so place further demands on credit. In turn, if we spend it, which is what they want, a lot gets spent on imports benefitting other countries. No problem - they lend it back to us. Our government increases it debt; the common folk don't decrease there's. Nothing is solved. We just stay on the treadmill, the dollar drops and there is severe inflation or there is a depression, or both. In the both scenario, the inflation precedes the deflationary depression, or has that happened already?

I don't think there is a way out, until most of this debt is unwound, by way of bankruptcies or high inflation. So root for high inflation policies. Incidentally this is all began with the Reagan administration - cut taxes on the rich; so they have the capital to lend it back to the government, to lend it to the not so rich so they can consume all that unnecessary crap, and to build factories in other countries. They invested that money really well didn't they.

Too Much Fiddling with the GDP

Since import prices and export prices plunged in August, and will do so again in September, third quarter GDP should drop, ceteris paribus. Am I right?

The Death of Consumption?

The drop in import prices in August, which should continue in September, will greatly reduce reported GDP for the third quarter also. That's right - reduce. The drop in export prices will also reduce GDP, I think.

The markets will probably react positively to a contraction in GDP. It's the old lore, that when the recession is announced, the market looks forward to recovery. Can't see how economic recovery could occur, myself. If it does occur, oil prices will go back up, and kill it.