Crocodilian

Inflation by Stealth

author writes:
"So for now, inflation is like a ninja stalking our economy. It's lurking in the shadows but can't easily be seen."
----------------------...

Yes, because we're busy fighting off the far more pressing danger of a deflationary depression. Is there a risk of inflation from the measures taken to keep our economy from imploding? Sure there is: but we have good tools for fighting inflation if it occurs., and right now, we have a much more pressing problem.

The world is generally beset with too much industrial capacity, too much debt, asset prices that still look too high, and end user demand that's very suspect.

In that circumstance, the immediate risks of inflation are quite low-- what's going to drive it?

Remember, its not just money supply that determines the risk of inflation, its (money supply)*(velocity of money), which stands equal to (price of goods)*(quantity of goods). This is called the "Exchange Equation" in economics, and what it tells you is that if velocity of money has collapsed (and it has), even a large increase in money supply won't have an impact on prices.

Jim Rogers on the Next 10 Years

"1. The Chinese want to live like we do;"

Unfortunately, they can't.

The US, with %5 of the world's population, requires about %25 of the world's energy to live as we do. China has about %18 of the world's population . . . there simply is no way that China can come anywhere near the US consumes.

US energy consumption (2006)
334 million BTU per capita

China energy consumption (2006)
56 million BTU per capita

Because of China's giant population even small increases in per capita energy consumption will crash into supply/price constraints.

Analyzing Strange Volume on the NYSE

On Aug 27 05:12 PM James Davis wrote:

> You say its an arb? Then what instrument are they shorting as they
> bid up AIG?
>
> I await an example.

The AIG story has so many complex overhangs of potential offsets that you can't catalog them all. But lets start with the obvious: there's a massive US Government position. Then there's a very large Hank Greenburg/Starr International position.

"They" may not be shorting AIG; they may be long another security or contract which is affected by the price of AIG.

Remember, the common is a tiny stub here-- AIG common is a rounding error next to the value of outstanding swaps and other instruments issued by AIG. AIG wrote something like $600 Billion in credit default swaps, for example.

One could imagine all kinds of exotic trades where you'd bid up the common. You could buy a CDS on a lousy CDO written by AIG (would have sold for next to zero in March or June), for example, and then have a very strong incentive to bid up the common (the more likely AIG is to survive, the higher the price on a CDO written by them).

Not saying that that precise trade is taking place-- there's no way to know who's got what trades on. But this kind of thing is made for paired trades.

What you can say with certainty is that the common in all these entities is a tiny fraction of the total capital structure, so to say something meaningful about trading you have to look at the whole.

Analyzing Strange Volume on the NYSE

The massive volumes here have a fairly straightforward explanation: arbitrage. To look at these common stocks without considering the size and complexity of the capital structures of these companies is very misleading.

Quantitative investors love these kinds of stocks,because there's an enormously deep pool of related instruments to trade. One need not assume that there's some dark or nefarious scheme going on-- hi speed quant strategies are employed in other markets too.

A true investor should look at all four of the entities listed as speculative -- how much they're worth is more a function of government policy choices than underlying business. But a quantitative trader has very different objectives and is trading not just the common, but many other instruments related to the issuer.

Why Do Equity Markets Disagree with the Data?

Equity markets discounted the end of the world.

Turns out that the world isn't ending, and for firms which survive, they have the prospect of diminished competition and much greater profitability when the cycle does turn

What Will Happen If America Returns to an Historical Savings Rate?

A thoughtful article, with good data and something rarely found on SA, intellectual modesty. Would be good for others to learn from author and say "I don't know" more often . . .

As to author's points, one compelling one has to be retail space. There's a good argument that a good part of it is obsolete; a friend of mine who works at Amazon refers to malls as "Amazon's showrooms".

When you think about it, the entire retail experience infrastructure came into existence before online shopping; some retailers have a distinctive niche (the very expensive, the very cheap)-- but the vast middle has a problem. That said, a shrinking sector can actually add to the profitability of the survivors-- Best Buy certainly has benefited from Circuit City's liquidation.

But here's a point which I haven't seen mentioned: a huge amount of discretionary consumer spending -- the part now being channeled into savings-- was spent on imports.

If an American consumer chooses to put $1500 into the bank, instead of buying a television made in China, or clothing made in Thailand, the loss to the US economy is the profit made by the US retailer-- but much of the value-add was always overseas.

Savings which result in decreased demand for imports have a lot of effects. One notable one would be a stronger dollar . . .

No One Saw This Economic Crisis Coming?

Saw "it" coming? Really depends on what the "it" is.

It is painful and expensive to be "right" too soon. In fact, its so painful and expensive that its little different from being wrong. So the temporal aspect of the calculation is critical; particularly for a policy maker.

A second aspect of "it" is that so far as I'm aware, no one saw clearly the web of derivative products that had increased implicit leverage far higher than we understood-- I'm thinking specifically of AIG. One reason that we didn't see AIG coming, was that like Enron, they'd structured their business to make it hard to see the parts that were contributing risk.

The FIRE sector didn't get modeled as Brezmer notes-- but not because people didn't want to. It couldn't modeled because AIG had purposefully established AIG Financial Products in a domicile outside of the Fed's ambit, and as such the Fed simply didn't have data to model their exposures. If you don't have AIG CDS exposure (and the similar exposures of counterparties) in your model, how _could_ you see "this" coming?

This is what is famously called the "shadow banking system". The essence of the shadow banking system is that it represents the movement of capital -- and leverage -- from the traditional, observable, regulated financial institutions to an alphabet soup of opaque entities.

We created a perverse set of incentives for the FIRE entities to move their risks to precisely the place where we couldn't see them clearly.

The Coming Economic Collapse, Part 2

Author writes:
"The massive drop in US incomes"
----------------------...

There has been no "massive drop in US incomes"

Neither in this essay nor in your prior one do you offer any data to support this contention.

Very straightforward data makes this clear: payroll tax receipts. These are actual dollars coming out of actual paychecks. These receipts have gone up in per capita, rate adjusted, inflation adjusted terms in the period you describe.

The increase in payroll taxes --adjusted for rates-- gives clear evidence that incomes has been no "massive drop" in US incomes. Some sectors have lost high paying jobs. Other sectors have gained them. Union steel and autoworkers have clearly lost. On the other hand, Kentucky rural folks who've gone to work for Toyota now earn much _more_ than they did.

You have to look at real numbers if you want to say anything meaningful on this subject: where do your numbers come from? Do you have any?

You can consult payroll statistics at:
www.taxpolicycenter.or...

Poisoning the Green Shoots

Author writes:
"The soaring debt is the greatest poison. It is one thing to have a large debt in a rapidly growing and young country, it is another to have a large and growing debt in a maturing country facing an aging population "
----------------------...

yes, that's correct. Demographics are important, but few people talk about them. At an individual household level, it makes perfect sense to take out a mortgage and buy a house when you're thirty . . . it makes very little sense to do so when you're 65.

Nations face similar choices-- and the US is aging very rapidly. Not only does an older population have little ability to produce more, they necessarily consume more expensive healthcare services.

The US median age is about 37 years, and is on its way to the 40s.

PIMCO's Bill Gross Sees a Bleak Future

Its really striking to see people treat Bill Gross' and Mohammed el-Arian's comments as though these were some kind of dispassionate analysts: they're not, they managing a massive portfolio . . . $150 _Billion_ in the Pimco Total Return Fund.

That's staggering in size, and whenever they talk, they are effectively negotiating with the Treasury and the Federal Reserve: "If you do X, I'll do Y"

I don't think they're bad guys, but they're talking their book-- it would be irresponsible of them _not_ to do so, but its equally irresponsible to presume that their comments as disinterested.

The Worst Case Scenario (Someone Has to Say It)

On May 20 08:21 AM Big Jake wrote:

> Again my friend, I say very respectfully, that I am not impressed
> with your just-finished-my-MBA-a... crib-notes data dumps.

One more time: you come to all kinds of conclusions, having done zero research. Zero.

You conclude that a Google liquidation would result in shareholder's obtaining

AM Big Jake wrote:
>"What tangible assets would they be able
> to liquidate? A few office buildings divided by how many millions
> of shareholders?

when the most trivial research reveals that the company has $56 a share in cash, and zero debt! How someone posts an opinion about the value of a company without doing even the simplest research on its balance sheet is really a mystery to me.

If you're posting on a bulletin board dedicated to economics and finance, you ought to know what a balance sheet is, and look at it, before coming to some conclusion about what a company's liquidating value would be.

I post negative comments about sloppy, ill-researched -- or in your case, unresearched-- pieces here, because as your title says "someone has to say it".

Can you show one single claim made in your original post that you supported with data?

The Worst Case Scenario (Someone Has to Say It)

On May 19 07:17 PM Big Jake wrote:

> ... This is actually quite funny. I would sure like to see someone
> walk away from a liquidation of Google with anything more than a
> stack of office supplies. What tangible assets would they be able
> to liquidate? A few office buildings divided by how many millions
> of shareholders?

Wow, you really can't be troubled to look at data. There's this thing called a "balance sheet" -- do you know what that is? Google has $17 Billion in cash, on hand. Zero debt. That's something more than a "painted rock"

However, Google would not be valued on a liquidating basis, because its business is so profitable-- a purchase of Google (or any other fast growing, highly profitable company) would be done on a discounted value of future cash flows. EBITDA is the standard metric -- do you know what that is?


> Anyway bro, I won't be lectured in quote-unquote "basic finance"
> by someone who claims that <Dividends are neither "rents" nor "returns"
> in an economic sense>. I mean, were you trying to be funny?

No, I'm being accurate. "Rent" is a term that is used with precision by economists, and while it has two rather different meanings, one thing that it does _not_ mean is "dividends". Your use of the term interchangeably with dividends is incorrect.

A brief definition, from
www.economist.com/rese...

Rent

Confusingly, rent has two different meanings for economists. The first is the commonplace definition: the INCOME from hiring out LAND or other durable goods. The second, also known as economic rent, is a measure of MARKET POWER: the difference between what a FACTOR OF PRODUCTION is paid and how much it would need to be paid to remain in its current use. A soccer star may be paid $50,000 a week to play for his team when he would be willing to turn out for only $10,000, so his economic rent is $40,000 a week. In PERFECT COMPETITION, there are no economic rents, as new FIRMS enter a market and compete until PRICES fall and all rent is eliminated. Reducing rent does not change production decisions, so economic rent can be taxed without any adverse impact on the real economy, assuming that it really is rent.

The Worst Case Scenario (Someone Has to Say It)

> A share that does not pay dividends is nothing but a painted
> rock that a fool will buy in the hopes of selling it to a greater
> fool. It has no intrinsic value.

You're wrong on so many things, but this is the easiest to correct briefly.

Stock represent ownership of a company, which owns assets; an equity stake is thus a percentage claim on the assets of a corporation. Google pays no dividends, but you can be quite sure that it is not a "painted rock". In the event of a sale or liquidation, shareholders would receive quite a lot of money for those "painted rocks" called Google shares. It is the claim on liquidating or takeover values for non-dividend paying stocks which sets their value in the market.

This is very basic finance.

Really, you ought to do some actual research before saying things. You have written a tremendously long apocalyptic scenario, without having troubled yourself to look up a _single_ statistic! That's extraordinary. In a world that's knee deep in economic data, you've got precisely zero data.

The only numbers you use, you make up.

The informational content of the essay is nicely summarized in your prediction:
"This may or may not lead to hyperinflation."

Sure, Nostradamus, great call there.

The Worst Case Scenario (Someone Has to Say It)

On May 18 07:03 PM Big Jake wrote:

> You misunderstand. The 25-year equities bubble has not popped yet.
> Dividend yields in relation to stock prices are still miserable,
> not to mention at historic lows. A very high proportion of stocks
> still pay no dividends at all (and I'm not just talking about recent
> IPOs). The perverse, greater-fool logic of paying top dollar for
> an asset that provides no "rent" is still going strong.

Two errors in that one:
First: Whatever bull market there was ended more than a year ago-- the indexes have fallen more than %50 peak to trough since then. That's a bear market by anyone's definition. So your "prediction" is of something that's already happened. If you're suggesting that stocks will fall to erase the entire 25 years since 1984, you're looking at a SPX of 200 (its at 900 today). Is that your "prediction"?

Second: Dividend yield is a dubious indicator, given a tax system that makes dividends so tax-inefficient. I'm not sure what you mean by "rent": Dividends are neither "rents" nor "returns" in an economic sense. Any CFO looking to deliver profits from operations to stakeholders in a tax efficient way would prefer, in order:
1) pay interest on debt
2) share repurchase
3) and last dividends

The exception to this would be MLPs and REITs, whose structures allow them to pass on income without paying corporate tax-- you will note that these entities pay much higher dividends (more properly "distributions") than C corporations, fairly clear evidence that what's at work here is a tax issue.

The Worst Case Scenario (Someone Has to Say It)

More disaster-porn? Good, that's just what we need. Lots of crackpot opinions, but don't bother doing anything so mundane as "research" -- you know, that's that thing where you look up data

Oh, and one more thing:
"Prediction one. The twenty-five-year equities bubble pops in 2009."

Um . . . in English, the prefix "pre" means "before". For it to be a "prediction" you'd have had to have said it _before_ the market dropped %50. Being a "retrospective Nostradamus" isn't hard.

In that vein, my prediction for 2009: The Allies win World War II.