On Economy



The Dow rose 288 points on Thursday, or 1.7%. Gold was flat, despite further dithering from the Fed on when it will raise interest rates.

Last night, we dined with the head of the SEC. Actually, Ms. White dined at the table next to us. But it made us feel as though we were among the movers and shakers in the zombie capital.

The Occidental Grill & Seafood is a landmark restaurant in D.C. For about $120, you can eat reasonably well and spot the powers that be in the room.


The Occidental GrilleThe Occidental Grill & Seafood – ideal powers-that-be spotting spot.

Photo credit: occidentaldc.com


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Is the Panic Low In?

Below is a daily chart of the Russian ruble. When we recently wrote about the currency’s collapse (see “The Russian Rubble”) we noted:


“It is a good bet that the ruble is by now egregiously undervalued, even in light of the oil price decline and economic sanctions”


We also opined that the Russian central bank may well feel forced to implement further rate hikes in the short term in order to halt speculation against the ruble. It appears that may actually not happen given the evolution of the chart picture over the past three trading days:


Russian Rubble-dailyThe Russian ruble vs. the USD, daily – click to enlarge.


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The days left to us in 2014 are dwindling to a precious few. It gets darker and darker. The Fed doesn’t seem to be able to do anything about it.

Less than a week from today: the shortest day in the Northern Hemisphere. Then Sol Invictus (“Unconquered Sun”) will have its day… growing day by day until June 21.

But today is the first day of the ancient Roman festival of Saturnalia; the sun fades.

In Rome, it was a time for free speech and role reversals. Masters served their slaves and all enjoyed gambling and drunkenness.


saturnalia-2Woo-hoo! Saturnalia!


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The Good, the Bad and the Plain Crazy

The EU Commissariat has just made an announcement that is both good and bad. Let us start with the good: According to European press reports, Chief Commissar Barroso left the commission with an inheritance of 452 legislative initiatives, including the “harmonization of standards of maternity protection”, “uniform energy taxation and environmental protection legislation” and “forcing all nations to implement waste recycling” (if you want to know why waste recycling, which superficially sounds like a great idea, is yet another complete etatiste charade, read this article in which Per Bylund deconstructs the recycling myth using socialist paradise Sweden as an example).

Anyway, the new commissariat under JC Juncker has decided to simply strike 83 of Barroso’s initiatives legacy completely, put a large part of it on hold, and instead concentrate only on a handful – 23 to start with. Also, among the things to be tackled is an endeavor to actually cut red tape (we will believe it when we see it). According to the commissariats own words:


“When laws are no longer fit for purpose, or impose too much burden, they will be reviewed and amended to make EU law lighter, simpler and less costly.”


So much for the “good”.

However, it is very unfortunate that many of the remaining initiatives they have decided to concentrate on (the bad) mainly consist of bureaucratic nonsense of the finest. Among the top initiatives we find for example: The “€315 billion investment offensive”, an “ambitious digital single market package” (under the leadership of the economically and technologically illiterate digital commissar Mr. Öttinger, whom we have profiled before), and “fair taxation” (the term “fair” in conjunction with the term taxation always means only one thing: higher taxes).


We want to once again focus on the bizarre “investment initiative” on this occasion. This project is one we would term both “bad” and “plain crazy”, although the political cronies who stand to be enriched by it would of course disagree.

Passenger stairs are seen in front of the airport in Lodz

The “ghost airport” at Lodz

Photo credit: Reuters

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From Ruble to Rubble in a Heartbeat

The Russian ruble has been in panicked free-fall, not unlike the oil price. Last night the Russian central bank reacted by hiking its interest rates, not in baby steps, but rather in giant strides. This was incidentally the second rate hike in just four days and the fifth this year. From the press release:


“From 16 December 2014 the Bank of Russia Board of Directors decided to raise the Bank of Russia key rate to 17.00 percent per annum. This decision is aimed at limiting substantially increased ruble depreciation risks and inflation risks.

From 16 December 2014 in order to strengthen the efficiency of monetary policy loans secured by non-marketable assets or guarantees for 2 to 549 days will be provided at a floating interest rate, set at the Bank of Russia key rate level, increased by 1.75 percentage points (up to the present these loans for 2 to 90 days were provided at fixed rate).

Moreover, for further expanse of credit institution ability to manage their foreign exchange liquidity it was decided to increase maximum allotment amount for28-day FX REPO auctions from 1.5 to 5.0 billion USD and to conduct 12-month FX REPO auctions on weekly basis.”


To help readers to appreciate what a giant move in rates this was, here is a table showing the rates after the last rate hike on December 12 compared with those instituted yesterday:


Bank of RussiaOvernight liquidity provision goes from 11.5% to 18%, 3 month rates go from 10.75% to 17.25% – click to enlarge.

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Regulators Are Getting Worried About their Own Handiwork

Readers may recall a remark we made when we discussed the dangerous boom in low grade corporate debt. This was in connection with one of the weak links in the chain, if you will. We noted among other things in passing that:


“…new regulations have forced the banks to vastly reduce their proprietary trading activities. They have essentially withdrawn from the function of “market makers” in these securities.”


The question we pondered was actually whether banks, by virtue of having removed themselves from a lot of proprietary trading and market making, would be less exposed to a putative credit crisis as a result. Certainly it could be argued that the growth in excess reserves has made banks far less vulnerable to “bank run” type situations, but as we pointed out, one cannot simply ignore the interconnectedness of financial markets. In this particular case, other entities have intensified their trading activities, and these others receive funding from banks. In essence, some types of risk are now merely one step removed, but they have not disappeared.

However, there is another reason why the above should be seen as potentially quite worrisome. That is the fact that the new regulatory hurdles leave certain market segments – especially corporate bond markets – far less liquid than they once used to be. We were reminded of this when Bill Fleckenstein mentioned in a missive a few weeks ago that one of his contacts in the fixed income trading universe had warned of the risks posed by mutual funds investing in various grades of corporate debt (and we presume, by extension, other funds active in these areas, as well as certain ETFs). The specific worry expressed by this investor was that if these funds were ever hit by a wave of redemptions, they would be forced to sell into what would essentially be a vacuum.


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Sticking with the Game Plan

The Dow lost 315 points on Friday – a nearly 2% decline. It is bound to happen sooner or later: US stocks will enter a bear market. Nothing can stop it. Nature and the gods command it. The Dow will fall as much as 1,000 points in a day.

Then we’ll see if our analysis is correct…

We believe the Fed will be unwilling to stand back and let markets be markets. We believe it will step in with more stimulus… and probably bring on the wildest, craziest stock market extravaganza we’ve ever seen.

Whether that happens sooner or later, we don’t know. So let’s continue our discussion of the big picture… and why we think the Fed must stick with its game plan.



The game plan is always the same …

Photo credit: howitcouldbedifferent.org

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Weidmann the Strict

BuBa chief Jens Weidmann is complaining about the EU Commission’s decision to eschew confrontation with France over its repeated inability to deliver on its debt and deficit targets, and rightly so.

Some people may argue that the French government’s recent willingness to implement some long-overdue, if halfhearted reforms, should be taken into account as a sign of goodwill. Perhaps, but it was precisely the “original Maastricht sin” of 2002-2003, when neither France nor Germany were taken to task for violating the treaty with their deficit overshoots that created the preconditions that later made it seem normal for many others to violate these limits as well (admittedly, this has to be brought into context with the artificial boom of 2002-2007 and the subsequent bust).

Nevertheless, the fiscal compact strikes as one of the more sensible EU regulations (although it is obviously difficult to enforce it against a big member nation). Not only because the euro’s survival essentially depends on it, but also because keeping government spending under control is good for the economy at large in any event.

If we have a gripe in this context, it is mainly that European governments are often inclined to raise taxes rather than cutting their spending. Both France and Italy currently stand as monuments to the folly of this approach.


weidmannJens Weidmann shortly after learning that France’s government will get away with a slap on the wrist.

Photo credit: Eric Piermont / AFP 


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An Update on a few Obscure and Not-So Obscure Indicators

We recently discussed the market with our friend T.R. (inventor of the proprietary Au-Ag ratio adjusted VIX indicator) and he sent us a few charts of the things he is watching. While he’s not a long term bear, he does think there is sufficient evidence to warrant caution – i.e., a bigger correction may be about to get underway. This jibes with what we have been seeing lately in terms of sentiment extremes.

Note that these charts are by now three trading days old, but that doesn’t make a big difference – although the stock market has had a few bad hair days last week, it hasn’t really made a big move yet. The annotations on the charts are T.R.’s, and mainly serve as orientation. Regular readers may recall that we showed some of these charts fairly regularly at the time of the euro area debt crisis. Many of them haven’t really been all that interesting up until recently, but that has now changed.

The first chart shows the SPX, the Junk/Investment grade debt ratio and the SPX adjusted by volatility and the gold-silver ratio. The vertical white lines show the historical peaks of the margin debt/GDP ratio


1-spxvixauagSPX in green, junk-investment grade debt ratio in yellow, VIX/Au-Ag ratio adjusted SPX in orange. The white vertical lines show margin debt/GDP peaks, which tend to lead market peaks (the current lead time has been historically quite extended) – click to enlarge.


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The Peach Eaters

A conversation in the hotel lobby …

Woman – tall, thin, attractive:

“Hey, you must be a writer. You look like a writer.”

Your editor, hunched over his laptop writing …

“Good guess.”

Woman, putting her arm around his shoulders …

“I’m Rebecca. What’s your name?”

“Bill …”

“What are you writing about?”

“A subject so boring I wanna slit my wrists every day.”

“What’s that?”





Photo credit: StockMonkeys.com / Flickr


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Clear Winners

Today, we’re going to ignore the news. Instead, we will be giving you a crash course on money. Over the next few days, we’ll talk about what we know… or think we know… on the subject.

Money has its digital side. In one sense, it is pure numbers… as boring and as predictable as long division. But there’s a snakier side to it… and an underbelly as nuanced and subtle as humanity itself.

Few subjects – save perhaps religion and politics – are as full of puerile balderdash and self-serving claptrap.

But neither religion nor politics produces such clear winners. When it comes to wealth, just look at who has the most money!



Photo credit: TaxCredits.net


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Only Number Two?

A story has been echoing around the financial news for a few weeks. One article about it, It’s official: America is now No. 2 by Brett Arends at MarketWatch, came to my attention. Arends asserts that the Chinese economy is now larger than the economy in the US. Here’s what he said.


“We’re no longer No. 1. Today, we’re No. 2. Yes, it’s official. The Chinese economy just overtook the United States economy to become the largest in the world.”


With GDP data from the IMF, we can easily see that the US economy is bigger than China’s. The IMF estimates 2014 GDP at $10.4T for China and $17.4T for the USA. So how does Arends claim the contrary? He uses different data that IMF adjusts. By this methodology, the Chinese economy is “really” $17.6T.


china-gross-national-productChina’s GDP in hundreds of million yuan


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Sometimes It Doesn’t Pay to Catch a Falling Knife …

We like to think that a contrarian investment approach works best in the long term. Contrarian does not necessarily mean that one simply tries to fight every trend. It is more about attempting to recognize when a trend has gone too far. In practice this is often more difficult than in theory. The theory is simple enough: buy low, sell high. However, it is nigh impossible to recognize turning points with precision. So a contrarian style often forces one to be patient, and to accept that one will frequently both buy and sell too early.

One way of dealing with this problem is to spread one’s purchases and sales out over time. We did this with Japan, to name an example. In “Reconsidering Japan”, which turned out to be a well-timed post, we made the case for Japanese stocks (warning: we have our share of decidedly less well-timed posts). We didn’t know at the time that a bull market would be set into motion by what we ultimately consider a catastrophic economic policy, we only knew that the market was cheap. Our own approach was to buy in small sizes over a long time period. It took a lot of patience, as the market simply sat and sat there – the rallies never amounted to much. We felt though that the market represented a contrarian opportunity. We have occasionally mentioned similar opportunities in the past, such as e.g. Greece and even China. As we have pointed out a few times, economic fundamentals and stock market performance are often two different cups of tea. Usually we tend to be “early”, but this doesn’t matter if an idea ultimately pans out (gold investors take heart).

There is however one market that has defied contrarians to such an extent that one wonders what the hell happened. Shortly after the bail-out, when we first wrote about the enormous decline in the Cyprus General Index, we did so because at the time it represented the greatest stock market crash in history by far (see: “The Greatest Collapse in History” for details). We also noted that Cyprus was in a very bad position, referring to it as “Iceland without the fish” and a “disaster zone” (which it was/is). The 98% decline in its stock market at the time might have led one to suspect that the place had been hit by an asteroid. Instead it had been hit by the EU, which turned out to be almost as bad, at least financially. We later posted a brief update on the Cypriot disaster area and noted that the market had apparently simply perished (see: “Cyprus – A Stock Market Dies”).

Believe it or not, Cyprus as such still seems to be standing. Here is a recent photograph of the Limassol sea front in Southern Cyprus:


Limassol seaside

Limassol – nope, no signs of an asteroid strike or a nuclear explosion visible.

Photo credit: P. Matanski


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Begging the Question on Minimum Wages

The battle over minimum wages is raging. Emotions are running hot. Some cities are setting the bar very high. For example, Seattle is mandating a $15/hour wage.

Economically, the issue is very simple. Minimum wage laws do not raise anyone’s wage. This is because it’s not sustainable to overpay.

Suppose you run a small tailor shop. Customers are willing to pay $20 to repair a pair of slacks. Why are they willing to pay that, and no more? It’s not just their budget, but also the relative value of fixing their old trousers compared to buying new ones. A higher wage for your employees will have no effect on customer willingness to pay.

You have rent, utilities, insurance, wear and tear on your sewing machines, etc. that add up to $10. Therefore your maximum gross profit is $10. You cannot pay someone $11, much less $15, to do this work. If the law attempts to force you to overpay, then you have to lay off workers or even close your doors. Going out of business is no fun, but it beats losing more money.

This is black and white. Minimum wage law can destroy jobs and businesses but it cannot raise wages. However, many people become very emotional on this issue. So let’s look at the issue from a different angle.

There is an endless outpouring of sympathy and support for the unskilled laborer. How is this poor downtrodden helpless victim supposed to feed a family, cover medical expenses, and save for retirement earning only $7.25 per hour?

I don’t know.

My lack of an answer to this question is no justification for minimum wage laws. This is not even the right question. It is an example of the logical fallacy known as begging the question—when you presume what you should be asking. We should ask if one man’s need creates a duty for anyone else. Then the answer is a lot clearer.

The last time I checked, we had not adopted the Communist Manifesto as our new constitution. There is no law saying that each is to be given according to his need.


manifesto1Not quite adopted just yet: the communist manifesto by Marx and Engels.

(Amazingly, they actually charged 40 cents for this)


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The Upside of Error and Misfortune

We are here in Lower Manhattan. It does not seem much like an “urban jungle.” It is too cold and rainy. After a brief excursion outside, you have to warm yourself by an artificial fire, with a coffee.

Or, after 7 p.m., with a glass of Jameson. Then the fog of the outside world clears long enough to think about “the hurtin’” and other philosophical puzzles. Nobody wants to be a-hurtin’. And nobody wants to own an asset in a sector that has the hurtin’ on it. But that is usually the best thing to buy.

Man is not cut out to be a good investor. It goes against his basic instincts. At the end of a battle he wants to be still standing, like Caravaggio’s David – a bloody sword in one hand and the head of Goliath in the other.

He wants to win. And he wants to own the team that just won the Super Bowl. The alternative, at least in his atavistic race memory, is death. But going with the winners is a recipe for losing in the perverse world of Wall Street, near where we pen these words.

The winners soon get as fat, stupid and overbought as a senator. The losers, meanwhile, are leaner, wiser and oversold. Error and misfortune are what you look for in a good investment.



Photo credit: PAULINO MORAN / flickr


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