Recovery?

QE

We have enough data and David Stockman nails it on the head here…

Q4 Obliterates The Case For QE And ZIRP

by  • February 27, 2015

The most important number in today’s Q4 GDP update was 2.3%. That’s the year/year change in real final sales from Q4 2013. As an analytical matter it means that the Great Slog continues with no sign of acceleration whatsoever.

Indeed, the statistical truth of the matter is that this year’s result amounted to a slight deceleration—–since the Y/Y gain in real final sales for Q4 2013 was 2.6%.  But beyond the decimal point variation the larger point is this: Take out the somewhat jerky quarterly impacts of inventory stocking and destocking, and view things on a year/year basis to eliminate seasonal maladjustments and data collection and timing quirks, such as the double digit gain in defense spending during Q3 and the negative rate for Q4, and what you get is a straight line slog since the recession ended in 2009.

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Currency Wars (and more…)

QE Forever

This article explains in greater detail a subject I addressed in a recent comment in the Wall St. Journal:

“…our macroeconomic models are wholly incapable of incorporating operational measures of uncertainty and risk as variables that affect human decision-making under loss aversion. We’ve created this unmeasurable sense of uncertainty by allowing exchange rates to float, leading to price volatility in asset markets because credit policy is unrestrained.

The idea of floating exchange rates was that currency markets would discipline fiscal policy across trading partners. But exchange rates don’t directly signal domestic voters in favor of policy reform and instead permit fiscal irresponsibility to flourish. Lax credit policy merely accommodates this fiscal fecklessness. The euro and ECB were tasked with reining in fiscal policy in the EU, but that has also failed with the fudging of budget deficits and the lack of a fiscal federalism mechanism.

The bottom line is that we do NOT have a rebalancing mechanism for the global economy beyond the historic business cycles of frequent corrections that are politically painful. The danger is we now may be amplifying those cycles.”

From Barron’s:

Currency Wars: Central Banks Play a Dangerous Game

As nations race to reduce the value of their money, the global economy takes a hit.”

Feb. 13, 2015
It’s the central banks’ world, and we’re just living in it. Never in history have their monetary machinations so dominated financial markets and economies. And as in Star Trek, they have gone boldly where no central banks have gone before—pushing interest rates below zero, once thought to be a practical impossibility.At the same time, central bankers have resumed their use of a tactic from an earlier, more primitive time that was supposed to be eschewed in this more enlightened age—currency wars.
The signal accomplishment of these policies can be encapsulated in this one result: The U.S. stock market reached a record high last week. That would be unremarkable if central bankers had created true prosperity.
But, according to the estimate of one major bank, the world’s economy will shrink in 2015, in the biggest contraction since 2009, during the aftermath of the financial crisis. That is, if it’s measured in current dollars, not after adjusting for inflation, which the central bankers have been trying desperately to create, and have failed to accomplish thus far.
Not since the 1930s have central banks of countries around the globe so actively, and desperately, tried to stimulate their domestic economies. Confronted by a lack of domestic demand, which has been constrained by a massive debt load taken on during the boom times, they instead have sought to grab a bigger slice of the global economic pie.Unfortunately, not everybody can gain a larger share of a whole that isn’t growing—or may even be shrinking. That was the lesson of the “beggar thy neighbor” policies of the Great Depression, which mainly served to export deflation and contraction across borders. For that reason, such policies were forsworn in the post–World War II order, which aimed for stable exchange rates to prevent competitive devaluations.

Almost three generations after the Great Depression, that lesson has been unlearned. In the years leading up to the Depression, and even after the contraction began, the Victorian and Edwardian propriety of the gold standard was maintained until the painful steps needed to deflate wages and prices to maintain exchange rates became politically untenable, as the eminent economic historian Barry Eichengreen of the University of California, Berkeley, has written. The countries that were the earliest to throw off what he dubbed “golden fetters” recovered the fastest, starting with Britain, which terminated sterling’s link to gold in 1931.

This, however, is the lesson being relearned. The last vestiges of fixed exchange rates died when the Nixon administration ended the dollar’s convertibility into gold at $35 an ounce in August 1971. Since then, the world has essentially had floating exchange rates. That means they have risen and fallen like a floating dock with the tides. But unlike tides that are determined by nature, the rise and fall of currencies has been driven largely by human policy makers.

Central banks have used flexible exchange rates, rather than more politically problematic structural, supply-side reforms, as the expedient means to stimulate their debt-burdened economies. In an insightful report last week, Morgan Stanley global strategists Manoj Pradhan, Chetan Ahya, and Patryk Drozdzik counted 12 central banks around the globe that recently eased policy, including the European Central Bank and its counterparts in Switzerland, Denmark, Canada, Australia, Russia, India, and Singapore. These were joined by Sweden after the note went to press.

In total, there have been some 514 monetary easing moves by central banks over the past three years, by Evercore ISI’s count. And that easy money has been supporting global stock markets (more of which later).

As for the real economy, the Morgan Stanley analysts write that while currency devaluation is a zero-sum game in a world that isn’t growing, the early movers are the biggest beneficiaries at the expense of the late movers.

The U.S. was the first mover with the Federal Reserve’s quantitative-easing program. Indeed, it was the initiation of QE2 in 2010 that provoked Brazil’s finance minister to make the first accusation that the U.S. was starting a currency war by driving down the value of the dollar—and by necessary extension, driving up exchange rates of other currencies, such as the real, thus hurting the competitiveness of export-dependent economies, such as Brazil.

Since then, the Morgan Stanley team continues, there has been a torrent of easings (as tallied by Evercore ISI) to pass the proverbial hot potato by exporting deflation. That has left just two importers of deflation—the U.S. and China.

The Fed ended QE last year and, according to conventional wisdom, is set to raise its federal-funds target from nearly nil (0% to 0.25%) some time this year. That has sent the dollar sharply higher, resulting in imported deflation. U.S. import prices plunged 2.8% in January, albeit largely because of petroleum. But over the past 12 months, overall import prices slid 8%, with nonpetroleum imports down 1.2%.

China is the other importer of deflation, they continue, owing to the renminbi’s relatively tight peg to the dollar. The RMB’s appreciation has been among the highest since 2005 and since the second quarter of last year. As a result, China has lagged the Bank of Japan, the ECB, and much of the developed and emerging-market economies in using currency depreciation to ease domestic deflation.

The bad news, according to the Morgan Stanley trio, is that not everyone can depreciate their currency at once. “Of particular concern is China, which has done less than others and hence stands to import deflation exactly when it doesn’t need to add to domestic deflationary pressures,” they write.

But they see central bankers around the globe being “fully engaged” in the battle against “lowflation,” generating monetary expansion at home and ultralow or even negative interest rates to generate growth.

The question is: When? Bank of America Merrill Lynch global economists Ethan Harris and Gustavo Reis estimate that global gross domestic product will shrink this year by some $2.3 trillion, which is a result of the dollar’s rise. To put that into perspective, they write, that’s equivalent to an economy somewhere between the size of Brazil’s and the United Kingdom’s having disappeared.

Real growth will actually increase to 3.5% in 2015 from 3.3% in 2014, the BofA ML economists project; but the nominal total will decline in terms of higher-valued dollars. The rub is that we live in a nominal world, with debts and expenses fixed in nominal terms. So, the world needs nominal dollars to meet these nominal obligations.

A drop in global nominal GDP is quite unusual by historical standards, they continue. Only the U.S. and emerging Asia are forecast to see growth in nominal-dollar terms.

The BofA ML economists also don’t expect China to devalue meaningfully, although that poses a major “tail” risk (that is, at the thin ends of the normal, bell-shaped distribution of possible outcomes). But, with China importing deflation, as the Morgan Stanley team notes, the chance remains that the country could join in the currency wars that it has thus far avoided.

WHILE ALL OF THE central bank efforts at lowering currencies and exchange rates won’t likely increase the world economy in dollar terms this year, they have been successful in boosting asset prices. The Standard & Poor’s 500 headed into the three-day Presidents’ Day holiday weekend at a record 2096.99, finally topping the high set just before the turn of the year.

The Wilshire 5000, the broadest measure of the U.S. stock market, surpassed its previous mark on Thursday and also ended at a record on Friday. By Wilshire Associates’ reckoning, the Wilshire 5000 has added some $8 trillion in value since the Fed announced plans for QE3 on Sept. 12, 2012. And since Aug. 26, 2010, when plans for QE2 were revealed, the index has doubled, an increase of $12.8 trillion in the value of U.S. stocks.

The Sinister Evolution Of Our Modern Banking System

Fed

Repost from Peak Prosperity blog. (Link to podcast and blog here.)

Because we’re all about those banks, ’bout those banks…
Saturday, January 31, 2015

I quit Wall Street and decided that it was time to talk more about what was going on inside it, as it had changed. It had become far more sinister and far more dangerous. ~ Nomi Prins

Today, the ‘revolving door’ connecting our political and financial systems is evident to anyone with eyes. But this entwined relationship between Washington DC and Wall Street is nothing new, predating even the formation of the Federal Reserve.

To chronicle the evolution to where we find ourselves today, we welcome Nomi Prins, Wall Street veteran turned financial industry reformist, and author of the excellent expose All The Presidents Bankers.

In this well-detailed interview, Nomi goes into depth of the rationale and process behind the creation of the Federal Reserve, and more important, how its mandate — and the behavior of the banking system overall — metastasized into the every-banker-for-himself regime of sanctioned theft we now live with.

Chris Martenson:   To me, it couldn’t have been more obviously obscene then in 2010, and I believe maybe 2009, right after the big banks had been handed just vast, huge, very favorable handouts and bailouts during the Great Recession — and then they handed themselves record bonuses. I thought optically that was just horrible. As somebody who was inside the banking system: Are they that tone deaf? What’s behind that sort of behavior?

Nomi Prins:   Indeed, they have become very isolated.

It began with the period before the 1970s when different people were rising to leadership in banks, and worsened in the 80s when we started seeing people who had more sociopathic tendencies or less ability to appreciate the idea of the public’s economic stability being beneficial to growing their institutions. They no longer viewed it as necessary.

And with the advent of the larger futures market, the options market, the derivatives market, and all the off-shore elements of banking that were able to be developed, so much capital was now available and off of the books that the idea of maintaining some sort of a connection to stability policy — or even to whatever the Presidency might want — dissolved. At the same time, all the Presidents that were involved in running the country around that time didn’t ask or require accountability towards financial stability from them.

So there was a bunch of things that were happening at the same time, and that’s why the media does a poor job of critiquing this because they’re not looking at all the strands. None of this is simple. A lot of things happened at the same time to create these kinds of shifts. On the one hand, you have no restraint: you don’t have the Gold Standard anymore, so you have less of a strain on having something physical be reserved against your leverage. You now have this ability of petrodollars being recycled. You have the ability to leverage more debt. You have less humility. You have a more technologically-advanced, less transparent global financial system, so you can make and hide money easier. And then you have ascendancies of leadership in banks and in the government that are OK with all this, and allow it to fester.

It’s all defended as some sort of example of a free market and competition — “the best gets the best”, and so forth — when the reality is it just destabilizes the entire system and creates an artificiality. We see central banks supporting all of this mess, as opposed to figuring out what the exit policy is — which none of them have a clue about. That’s really where we’ve evolved to.

Listen to the entire podcast.

The Understatement of the Year

Money4Nothing

Growth Management Isn’t the Fed’s Forte

The stock-market turmoil is fresh evidence that the central bank must return to market-based monetary policy. …The Fed has fostered the illusion that it can create growth. The zero-rate problem is obvious to almost everyone outside the Beltway. Credit markets don’t function with prices set at zero, and the economic results have been disastrous, with median incomes severely depressed five years into the expansion.

By David Malpass

The Federal Reserve has been a crucial bulwark of America’s market economy. Yet with interest rates near zero since the 2008 financial crisis and the Fed now controlling huge swaths of the financial industry, a central-banking approach I call “post-monetarism” has settled in. It’s built on the absurd view that zero rates promote growth and that regulators can replace markets—an immodest dogma that has hammered growth.

In the past, the Fed set boundaries on the banking system mainly by adding and subtracting bank reserves. Banks made new loans if they had enough reserves on deposit at the Fed and thought the loan would be profitable. In the 1960s the eventual Nobel laureate and father of monetarism, Milton Friedman, linked steady growth in money and market-based pricing to faster economic growth.

Under post-monetarism, the Fed has created a massive excess of bank reserves, nearly $3 trillion, to fund its bondholdings. It counteracts the transmission into the economy using huge interest payments to banks and sweeping regulatory controls that have turned the Fed into a superpowerful fourth branch of government. That’s diametrically opposed to Friedman’s deeply American insight that a central bank, if it has to exist, should be modest, and that monetary policy should be predictable and simple enough that businesses concentrate on profits and employees rather than central bankers’ economic forecasts and speeches.

Financial markets have become giddy—but not the old-fashioned way, by sharing in the nation’s rising prosperity. This time, median incomes fell as financial markets rose. The Fed has imposed near-zero interest rates on small savers, channeling trillions of dollars in low-cost credit to Fed-selected beneficiaries, especially governments and large-scale corporate borrowers. The result is helpful for the rich but has been toxic to small businesses and median incomes because underpriced credit goes to well-established bond issuers—not known for job creation—at the expense of savers and small business loans.

The Fed has in effect become the king of banks, able to violate the liquidity, leverage, capitalization and regulatory standards imposed on private banks. America’s financial industry faces a morass of litigation, huge fees and arbitrary capital requirements when they step out of line, while the Fed has piled up a record maturity mismatch—risky short-term debt to fund long-term assets. The Fed’s debt has reached 78 times its equity capital.

The Fed is the kingmaker for the mortgage industry, where it has become one of the world’s biggest mortgage holders, building up the government-sponsored enterprises Fannie Mae and Freddie Mac at the expense of the private mortgage industry.

The Fed expanded into asset management with this summer’s announcement that, rather than downsizing its assets, it will roll over its expensive bank debt. This will channel as much as $1 trillion in maturing bonds into chosen government investments over the next five years. The Fed has said it doesn’t intend to sell any of its $1.7 trillion in mortgage securities, many of which don’t mature for nearly 30 years, which would make the Fed’s failed experiment in post-monetarism almost irreversible.

The Fed is also getting into insurance-industry regulation through rules created by the Financial Stability Oversight Council. That’s the new, immodestly named club of chief regulators, all Democratic appointees, which meets behind closed doors and outranks the old system of independent two-party regulatory commissions like the Securities and Exchange Commission and the Federal Deposit Insurance Corp.

The FSOC has tagged insurance giants Prudential , AIG and MetLife as systemically important financial institutions, or SIFIs, giving the Fed regulatory oversight over them. “Oversight” often means semipermanent on-site offices paid for by the regulated company with the government practicing unprecedented involvement in the business. An industry bulletin explains that government regulators may “attend board meetings including closed sessions” and may also attend the company’s internal risk committee meetings.

MetLife plans vigorous resistance in court to its SIFI designation and submission to the Federal Reserve. But companies are running into a Catch-22 as they appeal harmful regulatory actions: Many of the regulations from the incomprehensible 2010 Dodd-Frank financial law have yet to be written and therefore can’t be challenged.

The three branches of government are bound by the appropriations process and the articles of the Constitution that created them. Not so for the Fed, which has unfettered access to nearly $100 billion a year from its bond-market arbitrage. There are no limits on the size of the Fed’s balance sheet or the justifications for it.

A critical step in ending the U.S. savings-and-loan crisis in the early 1990s was the sale of the government’s portfolio so that the economy could move on. The 2008 financial crisis is long over, yet the emergency measures remain, leaving markets heavily distorted and economic growth historically weak for a post-recession “recovery.”

The Fed should stop, but it has instead become huge, intrusive and inbred, organizing monetary policy to avoid disrupting Wall Street and the well connected. Now, with global growth slowing again and the Dow Jones Industrial Average down more than 5% in the past month, the Fed is thinking the dosage—six years of near-zero rates and $4.5 trillion in Fed liabilities—may be too low. Fed Vice Chairman Stanley Fischer raised the prospect Saturday of treating slow growth by keeping interests rates near zero even longer.

The Fed has fostered the illusion that it can create growth. The zero-rate problem is obvious to almost everyone outside the Beltway. Credit markets don’t function with prices set at zero, and the economic results have been disastrous, with median incomes severely depressed five years into the expansion. Each month the Fed delays a return to market-based monetary policy compounds the financial distortions, sacrificing the investment and hiring needed to create faster growth.

Nowhere to Run to…

QE ForeverJust something we’ve been talking about at this blog for the past five years…can’t borrow and spend our way to prosperity.

From the WSJ:

A Year of Living on the Brink

Ebola, ISIS, Ukraine, a stock-market wipeout—there’s nowhere to hide.

By Daniel Henninger

Oct. 15, 2014

History will mark down 2014 as the year predicted 49 years ago by Martha and the Vandellas. In 1965 the group recorded a Motown classic, “Nowhere to Run, Nowhere to Hide.” We’re there, at the brink.

Liberia, ISIS, Ukraine, Hong Kong, a hospital fighting Ebola infections in Dallas, the year’s stock-market gains obliterated, and I almost forgot—just last week Secretary of State John Kerry warned that climate change could end life as we know it.

Then this week the clouds parted and the year’s best news arrived: Led by Europe’s sinking economies, global economic growth is falling, taking stocks and bonds with it, and the world’s central bankers say they have run out of ideas on doing anything about it. [That took long enough.]

How this is good news requires explanation.

The annual meetings of the International Monetary Fund concluded in Washington last weekend. This gathering of the world’s finance ministers, central bankers and international financial organizations sets the tone for the direction of the world’s economic prospects.

As the meetings ended Sunday, a WSJ.com headline summarized the consensus: “Governments, central bankers have fewer tools left to revive economies after years of sluggish growth.” European officials are now talking about a “lost decade.” The IMF calls the economic policies in the years after the 2008 financial crisis a succession of “serial disappointments.”

Let’s begin with the first and most significant policy disappointment. The central economic event of the past six years, both as policy and symbol, was the Obama administration’s $834 billion stimulus bill in 2009, the American Recovery and Reinvestment Act. Its explicit purpose was to revive the U.S. economy. How was nearly $1 trillion of additional federal spending supposed to do that? [Here we call that a Crapshoot with OPM (other peoples’ money).]

Proponents of the stimulus bill’s theoretical underpinnings, which date to the 1930s and a famous economist with three names, have argued for 80 years that by injecting large quantities of money into a weak economy (public spending), the population will use the unexpected money to make purchases, and this stimulated consumption in turn will cause private companies to hire more workers to produce goods to meet—the key idea—demand.

Beyond this textbook, Depression-based effort at economic stimulus, the only other significant initiative taken by the Obama presidency (not counting the indirect effects of Dodd-Frank, ObamaCare, shutting down power plants, putting bankers under house arrest and whatnot) has been to transfer responsibility for economic growth to the Federal Reserve Bank. The Fed produced three rounds of quantitative easing, a monetary policy that created so-called zero-bound interest rates in the U.S. from late 2008 until now. The Bank of England followed. Early last month, the European Central Bank adopted its own version of quantitative easing. It’s been the greatest monetary experiment since the creation of coins around 700 B.C.

It is essentially the prescriptive promise of this 2009 to 2014 policy mix that was repudiated by officials at the IMF meetings in Washington the past week. Recognizing the real need, IMF Managing Director Christine Lagarde said, “There is too little economic risk-taking, and too much financial risk-taking.” [Here we call that Casino Capitalism.]

The U.S. and Europe have paid a high price for six years of stimulus that didn’t stimulate, programmed consumption that fell short, regulatory expansion that froze private producers, and high tax-rate regimes that benefited the public-spending class and beggared everyone else, especially young people and the working poor scrambling for jobs.

No one should underestimate the political dangers of persisting with a Keynesian economic model that looks depleted.

Several months ago this newspaper described how younger Europeans who are unemployed or underemployed have become bitter at their parents’ generation for wallowing in a system whose labor protections suppress the creation of new jobs. Economic anxiety in turn has fueled the rise of extremist political movements in France, Germany, England, Hungary and elsewhere.

Sustained, seemingly irreversible, weak economic growth in Europe or the U.S. is a political risk to national stability.

There is an alternative economic policy set to this failure. It would be based on the best policies that produced strong growth and jobs in major, formerly moribund Western economics.

Those successes include the German labor-market reforms initiated by Chancellor Gerhard Schröder in 2003; the structural public-spending reductions begun in Canada in 1995 by Liberal Finance Minister Paul Martin and sustained by current Conservative Prime Minister Stephen Harper (Harvard economist Alberto Alesina has documented the pro-growth payoff from permanent spending reductions); Poland’s remarkable post-Soviet revival from the 1989-91 pro-market reforms of Leszek Balcerowicz ; and of course the primary model—the U.S.’s tax-rate reductions and regulatory reforms in Ronald Reagan ’s presidency.

The key element in reviving the West isn’t economics, though that matters. It is political courage. Each example of high-growth success required a political leader willing to stand against finance ministries and a financial media that will ride demonstrably failed models off another cliff.

Given the admission of generalized policy collapse at the IMF meetings, what we are talking about is the courage of one leader: the next American president.

This Wild Market

stock-market-the-ride

This Wild Market

Perhaps we can figure out what’s going on in the markets today if we read between the lines.  Prof. Shiller explains that “…the value of the earnings depends on people’s perception of what they can sell it again for” to other investors. Which means that CAPE today is largely a reflection of the Greater Fool Theory of investment.

Then Mr. Shiller states that “[t]oday’s level “might be high relative to history, but how do we know that history hasn’t changed?”

I would guess that history has changed. Starting when the dollar and all other currencies became free floating in 1971, empowering central banks to create credit at will according to political dictates. This credit creation has occurred simultaneously with the expansion of the global labor supply in concert with new technology, both of which have depressed inflationary price signals, permitting central banks to continue their credit expansion at little apparent cost. It’s all good, as the shadow bankers might say.

But the less obvious result has been volatility of asset prices that we see reflected in the 30 year transition of financial markets toward trading away from new productive capital investment. This is how the hedge fund industry has blossomed.

The value of financial assets has departed from cash flow fundamentals and the result is markets that pop one day and deflate the next, depending on the sentiment of the moment, rather than underlying economic fundamentals. We’ve created greater price uncertainty in the economy that hampers productive long-term investment and concentrates the rewards in a shrinking cohort of lucky asset holders. This violates the most basic theory of financial management under uncertainty, which is stability through diversification.

This history was not inevitable, it was deliberately pursued under faulty intellectual models of our market society.

From the WSJ’s MoneyBeat:

Robert Shiller on What to Watch in This Wild Market

By Jason Zweig

You would have to be crazy to think the stock market isn’t crazy.

In three tumultuous days this week, the Dow Jones Industrial Average dived 273 points, then jumped up 275 points, then dropped 335 points.

But you might be even crazier if you think you know exactly when to get out of the market.

Few people understand that better than Robert Shiller, the Yale University finance professor who shared the Nobel Prize in economics last year for his research documenting that stock prices fluctuate far more than logic can justify—and who is renowned for telling people when to get out of the market.

Prof. Shiller predicted the collapse of both the technology-stock bubble in 2000 and the real-estate boom in the late 2000s. And he developed a measure of long-term stock valuation that many professional investors rely on.

Yet the central message that emerges from three conversations with Prof. Shiller over the past few weeks isn’t a cocksure forecast; it is a deep humility in the face of irreducible uncertainty.

Many analysts have warned lately that Prof. Shiller’s long-term stock-pricing indicator is dangerously high by historical standards.

Known as the “cyclically adjusted price/earnings ratio,” or CAPE, Prof. Shiller’s measure is based on the current market price of the S&P 500-stock index, divided by its average earnings over the past 10 years, both adjusted for inflation. It stands at nearly 26, well above the long-term average of about 16.

If only things were that simple, Prof. Shiller says.

“The market is supposed to estimate the value of earnings,” he explains, “but the value of the earnings depends on people’s perception of what they can sell it again for” to other investors. So the long-term average is “highly psychological,” he says. “You can’t derive what it should be.”

Even though the CAPE measure looks back to 1871, using data that predates the S&P 500, it is unstable. Over the 30 years ending in 1910, CAPE averaged 17; over the next three decades, 12.7; over the 30 years after that, 15.7. For the past three decades it has averaged 23.4.

Today’s level “might be high relative to history,” Prof. Shiller says, “but how do we know that history hasn’t changed?”

So, he says, CAPE “has more probability of predicting actual declines or dramatic increases” when the measure is at an “extreme high or extreme low.” For instance, CAPE exceeded 32 in September 1929, right before the Great Crash, and 44 in December 1999, just before the technology bubble burst. And it sank below 7 in the summer of 1982, on the eve of a 17-year bull market.

Today’s level, Prof. Shiller argues, isn’t extreme enough to justify a strong conclusion. So, he says, he and his wife still have about 50% of their portfolio in stocks.

On Thursday, as the Dow fell more than 300 points, Prof. Shiller told me, “The market has gone up for five years now and has gotten quite high, but I’m not selling yet.” He advises investors to monitor not just the level of the market, but the “stories that people tell” about the market. If a sudden consensus about economic stagnation forms, that could be a dangerous “turning point,” he says.

Based on new research he has done into industry sectors, he says, he is “slightly overweight” in health-care and industrial stocks.

The third edition of Prof. Shiller’s book “Irrational Exuberance,” coming out in February, will feature a chapter on bonds.

Is the bond market, as some investors have suggested, a bubble bound to burst?

“A bubble is a product of feedback from positive price changes that create a ‘new era’ ambience in which people think increasingly that prices will go up forever,” Prof. Shiller says.

Today’s bond market, he adds, “is just the opposite of a new-era ambience.” Instead, the demand for bonds is driven by “an underlying angst” about the slow recovery and pessimism about the future. “That’s not a bubble,” he says.

It also is worth considering where Prof. Shiller gets his knack for seeing what others overlook—the kind of gift that the renowned hedge-fund manager Michael Steinhardt has called “variant perception.”

Prof. Shiller is an unconventional thinker who relishes investigating ideas that other people regard as eccentric or unrewarding. “I don’t fit in so well,” he says, shrugging. “I’m socialized differently somehow.”

Prof. Shiller—and his wife, Ginny, a clinical psychologist—suspect that he has “a touch” of attention deficit hyperactivity disorder. “I’m very distractible, although I can be highly focused on tasks that interest me,” he says.

It is that intensity of thinking that leads to rare big insights—and to the recognition that, as he puts it, “a lot of fundamental problems aren’t really soluble.”

One friend recalls meeting him for lunch in New Haven; afterward, Prof. Shiller offered to give him a lift to the train station. But, the friend recalls, “Bob couldn’t find his car. He couldn’t remember where he had parked it.”

“Bob came into my office one day in the early 2000s,” his colleague, Yale finance professor William Goetzmann, told me. “He said, ‘I think we are in a real-estate bubble.’ I listened to him and said, ‘Hmm, that’s interesting,’ and when he left, I went right back to whatever research I was doing.” Prof. Shiller went on to produce the first serious warnings that the housing market would collapse.

Prof. Shiller says both stories sound right to him.

I reached him by phone earlier this month after he had missed an earlier appointment to speak. “I was awaiting your call,” he said, “but somehow never heard the phone ring.” Later he clarified that he might have left his cellphone in the next room but wasn’t sure.

It isn’t hard to imagine him sitting there, oblivious to the ringing phone and every other sight and sound, lost in contemplation of big ideas.

Capitalism’s Everyman (woman!)

This is one of the most inspiring and uplifting stories I’ve ever read in the financial press (from Barrons, September 12). Stephanie Mucha has defied what all the policy experts in Washington and Wall St. claim: That one cannot participate in the success of capitalism at every income level through capital accumulation. This woman did not get rich through a salary wage, she got rich by accumulating and investing capital successfully. I can’t tell you how many policy experts I’ve heard state this is not possible. No, not everybody will be as successful, but the basic golden rule of working, saving, and investing prudently in capitalist enterprise is as sound as it ever was.

What we need to do is to stop punishing people who pursue such prudent strategies through our misguided tax code that rewards borrowing and spending money one has never earned. The biggest crime is to continue to convince people that such participation is not even worth trying. That’s what ZIRP, TBTF, and double and triple taxation of capital is doing to us all. Let’s encourage and defend the rights of the small public shareholder.

The second accolade for Mrs. Mucha is her desire to spread that capital around before she dies. She has done this through public charities, but there is no reason not to pursue good by providing angel capital to potential entrepreneurs who hope to create something of lasting value. The venture capital industry is not the only channel. The sustainability of capitalism derives from the constant recycling of capital. I’d have to say Buffett and Gates could learn a thing or two from Stephanie Mucha.

The Oracle of Buffalo

A 97-year-old former VA nurse, Stephanie Mucha lived frugally and invested wisely. Now she’s giving away over $5 million.

Our image of who is rich is often at odds with reality. Consider Stephanie T. Mucha, 97, who remembers the 1929 stock market crash. The Buffalo, N.Y., resident worked as a licensed practical nurse for more than four decades, and has parlayed her humble earnings into a Penta-size portfolio. In recent years, she has given away $3 million—and she still has $2.5 million left. Her goal: to give away a total of $6 million before she dies.Mucha was no debutante. She dropped out of high school and worked as a maid, helping her parents hold on to their house during the Great Depression. Later, she worked for 44 years at the Buffalo Veterans Affairs Medical Center, where she was one of 100 civilians to receive the Purple Heart. Mucha earned $23,000 a year when she retired in 1994.When she was 25, her father, afraid she’d be an old maid, matched her up with Joseph Mucha, a machinist 26 years her senior who emigrated from Poland at age 18. Joseph earned $6,000 a year when he retired around 1958. By the time he passed away in 1985, the couple’s portfolio was worth roughly $300,000.

The Muchas invested without the help of Wall Street. Some 30 years ago a broker advised them to sell their Intel shares (ticker INTC); after that, they ignored his advice. But gifted investors, always on the lookout for ideas, often make their own luck. Mucha was working in the VA hospital when Wilson Greatbatch, a local inventor, implanted a pacemaker in a dying dog. In about 10 minutes, the dog’s tail started to wag; a little later, it sat up and walked around.

“I came home and said to my husband, ‘I saw a dead dog come to life.’ ” What she had seen was a demonstration of the first implantable cardiac pacemaker. The device was licensed in 1961 to Medtronic (MDT). In around 1964, the Muchas spent $255.50 to purchase 50 shares at $5.11. By the time she donated a portion of the shares in 2007, the position had grown to $459,000. She still owns about 300 shares, at $66.

Hard work and frugality also contributed to the Muchas’ success. They created three apartments in their house, one to live in and two to rent out. The Muchas, who weren’t able to have children, owned only one car. After her husband’s death, Mucha sold her diamond ring and wedding band for $2,700, investing the proceeds. She also rented out a room in her apartment for $15 a night to women visiting their sick husbands at the VA hospital. She invested the estimated $25,000 she earned over 20 years from that rental in the market.

A fan of Jeremy Siegel’s book Stocks for the Long Run, she held on to her stocks in both up and down cycles. She also realized that women tend to outlive men, so they need to know how to invest. “Women need to learn how to use their money so it outlasts them.” She waited until she was 70 to start collecting Social Security, and now collects about $40,000 a year from Social Security and her VA pension, plus $675 a month from a renter.

Mucha doesn’t have a computer. She has an Ameritrade account that gives her free trades over the phone, reinvests her dividends, and sends her five research reports a month. She reads The Wall Street Journal every day, along with Barron’s, Forbes, the Economist, and the New York Times, and watches CNBC and Bloomberg. As for picking stocks, she recalls her husband saying, “You can’t build without nuts and bolts.” With that in mind, in recent years she has bought Precision Castparts (PCP), Snap-on (SNA), and Illinois Tool Works (ITW).

Age has caught up with her a bit, but it hasn’t dimmed her wits. Mucha’s portfolio made 11% last year, but when she learned her accountant’s portfolio made 36%, she gave his financial advisor a call. “I wanted to see if I was doing the right things,” she says. Larry Stolzenburg of Sandhill Investment Management in Buffalo now manages her portfolio. “Stephanie’s portfolio was one of the best I’ve seen,” he says. “It was well balanced and thought out. I almost offered her a job.”

Mucha, who never spent a dime of her investment capital, has put $1 million in trust each for the Kosciuszko Foundation, which helped her husband when he immigrated to the U.S.; the University at Buffalo’s School of Arts and Sciences, because it has a Polish studies program; and the School of Engineering, as her husband had wanted to be an engineer. This month, she plans to make a donation to the School of Medicine and Biomedical Sciences. She has also earmarked money for the schools of nursing and dentistry.

“She’s a fantastic, smart person,” says Alex Storozynski, president emeritus and a trustee of the Kosciuszko Foundation. In addition to the $1 million donation, Storozynski says she has given him dietary tips, like eating chia seeds and almond butter. Advice to live by, no doubt.

What’s Going On?

pigs

Marvin Gaye asked this question referring to American society in the 1960s. We could ask it again in the 2010s.

This macroeconomic and monetary policy analysis by the Hussman Funds is extremely insightful. Read the full essay here. I include a few relevant excerpts below:

Several factors contribute to the broad sense that something in the economy is not right despite exuberant financial markets and a lower rate of unemployment. In our view, the primary factor is two decades of Fed-encouraged misallocation of capital to speculative uses, coupled with the crash of two bubbles (and we suspect a third on the way). This repeated misallocation of investment resources has contributed to a thinning of our capital base that would not have occurred otherwise. The Fed has repeatedly followed a policy course that sacrifices long-term growth by encouraging speculative malinvestment out of impatience for short-term gain. Sustainable repair will only emerge from undistorted, less immediate, but more efficient capital allocation.

First, we should begin by stopping the harm. Quantitative easing will not help to reverse this process. The dogmatic pursuit of Phillips Curve effects, attempting to lower unemployment with easy money, has done little to materially change employment beyond what is likely to have occurred without such extraordinary intervention, but has contributed to speculative imbalances and an increasingly uneven income distribution. Indeed, Fed policy does violence to the economy by helping to narrow it to what complex systems theorists call a “monoculture.” Nearly every minute of business television is now dominated by the idea that the Federal Reserve is the only thing that matters. Meanwhile, by pursuing a policy that distinctly benefits those enterprises whose primary cost is interest itself, the Fed’s policies have preserved and enhanced too-big-to-fail banks, financial engineering, and speculative international capital flows at the expense of local lending, small and medium-size banks and enterprises, and ultimately, economic diversity.

The always observant Charles Hugh Smith puts it this way: “Diversity and adaptability go together; each is a feature of the other. The Federal Reserve has created an unstable monoculture of an economy. What should have triggered a ‘die off’ of one predatory species – the ‘too big to fail’ mortgage/commercial banks and the Wall Street investment banks – was redistributed to all other participants. In insulating participants from risk, fact-finding, and volatility, you make price discovery and thus stability impossible.”

The Federal Reserve’s prevailing view of the world seems to be that a) QE lowers interest rates, b) lower interest rates stimulate jobs and economic activity, c) the only risk from QE will be at the point when unemployment is low enough to trigger inflation, and d) the Fed can safely encourage years of yield-seeking speculation – of the same sort that produced the worst economic collapse since the Depression – on the belief that this time is different. From the foregoing discussion, it should be clear that this chain of cause and effect is a very mixed bag of fact and fiction.

The economy is starting to take on features of a winner-take-all monoculture that encourages and subsidizes too-big-to-fail banks and large-scale financial speculation at the expense of productive real investment and small-to-medium size enterprises. These are outcomes that our policy makers at the Fed have single-handedly chosen for us in the well-meaning belief that the economy is helped by extraordinary financial distortions.

 

 

 

What’s the New Normal?

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Better yet, what’s normal about this? The Fed has accumulated massive amounts of Treasury and mortgage-backed securities to prop up government spending and housing prices and kept interest rates at zero in the vain attempt to stimulate economic growth. The question is, now what?

From the WSJ:

How Would the Fed Raise Rates?

With banks chock full of excess reserves, the federal-funds rate may prove useless as a tool to drain liquidity.

By George Melloan
Central bankers at the Jackson Hole symposium on Friday heard a lot of talk from Federal Reserve Chair Janet Yellen about the labor market, over which central bankers have proved to have only limited influence. They heard very little about global asset inflation, over which they could have a lot of influence.Yet the Fed is in no mood to exercise such influence. As expected, Ms. Yellen said the time is not ripe to raise short-term interest rates, ending six years of a near-zero (“zirp”) policy and restoring something more closely resembling financial normality. Wait until next year remains the Fed’s motto.Given the risks of a resulting stock market crash or political uproar, it may not happen even next year unless some crisis, internal or external to the Fed, forces Ms. Yellen’s hand. Meanwhile, savers and investors will continue to be denied a proper return on their investments and multibillion-dollar pension funds will flirt with insolvency.

A question mostly unasked at Jackson Hole is a crucial part of today’s when-will-it-happen guessing game: Exactly how would the Fed go about draining liquidity if a burst of inflation urgently presented that necessity. The traditional mechanism used by the Fed no longer looks to be serviceable.Before the “zirp” binge began in 2008, the Fed’s primary monetary policy tool was the federal-funds market, overnight lending among banks to balance their reserves in compliance with the Fed’s required minimums. The Fed withdrew liquidity by selling Treasurys to the banks and increased it by buying Treasurys. Fed-funds rates moved accordingly, becoming the benchmark for short-term lending rates throughout the economy.

But thanks to the Fed’s massive purchases of government and mortgage-backed securities from the banks over six years of “quantitative easing,” the banks no longer need to worry about meeting the minimum reserve requirement. They’re chock full of excess reserves, to the tune of $2.9 trillion. For all practical purposes, the federal-funds market no longer exists.

Fed economists undoubtedly have given the absence of the traditional interest-rate control mechanism some thought. Stanley Fischer, the International Monetary Fund and Bank of Israel veteran who was brought into the Fed as vice chairman in June, indirectly addressed it in an Aug. 11 speech. Asking himself whether the Fed still has the tools to manage interest rates, he came up with answers that sounded, well, tentative.

Mr. Fischer said that the Fed, for instance, could regulate the money supply by paying higher interest on the excess bank reserves on deposit at the Fed, thus holding them in check. That was an eye opener. The Fed could persuade the banks to tighten credit by bribing them with higher returns on their reserves?

What would these higher interest payments on reserves do to the Fed’s earnings on its $4.5 trillion portfolio? The Fed returned only about $80 billion to the U.S. Treasury last year, not a huge amount to finance the massive largess imagined by Mr. Fischer. How would the politicians react to huge payouts to banks, including foreign-owned institutions, for the purpose of making credit more expensive?

He also mentioned another “tool,” reverse repos, basically overnight borrowing by the Fed. The Fed already is active in the repo market, offering lenders the equivalent of up to 50 basis points in interest. It does this mainly to give favored lenders like Fannie Mae and Freddie Mac a payoff similar to what the banks get on their reserves. But why would it want to destroy its own earnings by borrowing at a higher rate than it does now? The repo market is far broader than the old fed-funds game, encompassing lenders of all stripes. It might not be as easy to manipulate.

Mr. Fischer also mentioned “other tools” that he did not describe. One might take a guess. A new buzzword at the Fed, frequently employed by the academic-minded Ms. Yellen to describe policies available in her toolkit, is “macroprudential” measures. What this expansive word means is not entirely clear, but a simple translation might be “muscling the banks” to bend to Fed diktats. Mr. Fischer used the term often in his speech.

The 2010 Dodd-Frank law, which was enacted on the premise that banks should be punished for the sins committed by politicians, enlarged the muscle power of the Fed and other federal agencies that regulate the financial industry. None of them have been timid about using that power.

The Fed, well attuned to politics, was engaged in mission creep even before Dodd-Frank, having entered the new game of credit allocation in response to the 2008 crisis. It began buying great masses of toxic mortgage-backed securities as a favor to the powerful housing lobby. Paying interest on excess reserves was its gift to big banks, even as Dodd-Frank was putting them under stricter capital requirements and forcing them to write “living wills” describing how they can be “resolved” should a crisis force them into insolvency. (The response from Goldman-Sachs, in essence: “We would declare bankruptcy.” Duh.)

So presumably “macroprudential” measures are now to become a more important part of the Fed’s money management. If the Fed can’t control interest rates, the dollar supply and inflation by any other means, maybe it hopes to do it by fiat. Well, the dollar is a fiat currency so perhaps its management by fiat was inevitable.

But then the question arises: Is anyone at the Fed, even the estimable Mr. Fischer, smart enough to do that without precipitating some new financial disaster?

The 1% Conundrum

Worshiping_Greenspan_2From the WSJ:

Liberals Love the ‘One Percent’

The left has a strange affection for Federal Reserve policy that has turbocharged inequality.

Federal Reserve Chair Janet Yellen has said the central bank’s goal is “to help Main Street not Wall Street,” and many liberal commentators seem convinced that she is advancing that goal. But talk to anyone on Wall Street. If they are being frank, they’ll admit that the Fed’s loose monetary policy has been one of the biggest contributors to their returns over the past five years. Unwittingly, it seems, liberals who support the Fed are defending policies that boost the wealth of the wealthy but do nothing to reduce inequality. This perverse outcome is not the Fed’s intent. It has kept interest rates near zero in an effort to combat the great recession of 2008-09 and nurse the weak economy back to health. Many analysts will argue that the recovery might have been even worse without the Fed’s efforts. Still, the U.S. economy has staged its weakest recovery since World War II, with output up a total of just 10 percentage points over the past five years. Meanwhile, the stock market has never been so high at this point in a recovery. This is the most powerful post-recession bull market in postwar history, with the stock market up by a record 135% over the past five years.The Fed can print as much money as it wants, but it can’t control where it goes, and much of it is finding its way into financial assets. On many long-term metrics, the stock market is now at levels that fall within the top 10% of valuations recorded over the past 100 years. The rally in the fixed-income market too is reaching giddy proportions, particularly for high-yield junk bonds, which are up 150% since 2009.It’s no secret who owns most of these assets. The wealthiest 1% of households, according to a study by Edward Wolff (National Bureau of Economic Research, 2012), now owns 50% of all financial wealth in the U.S., and the top 10% owns 91% of the wealth in stocks and mutual funds.

Over the past decade, easy-money policies also have fueled the rise of an industry that transforms raw commodities—from soybeans to steel and oil—into financial products, such as exchange-traded funds, that can be traded like stocks. Hundreds of billions of dollars have poured into these products. In many cases, large investors hold the commodities in storage, driving up demand and the price.

On average, prices for commodities from oil to coffee to eggs are up 40% since 2009, double the typical commodity-price rebound in postwar recoveries. Though rising prices for staples such as these are inconsequential expenses to the rich, they are burdens for the poor, who spend about 10% of their income on energy and a third of it on food. Meanwhile, since bottoming in 2011, median house prices have risen four times faster than incomes, putting homes out of reach for many first-time buyers.

Leading Wall Street figures such as Stanley Druckenmiller and Seth Klarman are warning that the Fed is blowing dangerous asset-price bubbles. These warnings—given political suspicion of the financial community—seem only to confirm liberal faith in the Fed. Economists including Joseph Stiglitz and Brad DeLong cling to the hope that at least some of the easy money helps to create growth and jobs. Yet the abnormally low cost of capital is giving companies another incentive to invest in technologies that replace workers, rather than hiring more workers.

Some liberals are skeptical even of the basic premise that easy money is fueling higher asset prices. As Paul Krugman put it, “for the most part” the money printed by the Fed is piling up in bank reserves and cash. While banks are generally reluctant to lend, the fact is that commercial and industrial loans in particular are increasing rapidly, and much of that credit is reportedly going to financial-engineering projects, like mergers and share buybacks, which do more to increase stock prices than to create economic growth.

There is no doubt that easy money is boosting the stock market. Low interest rates are driving investors out of money-market funds and into stocks, while they also allow wealthy investors to borrow money cheaply to buy more stocks. In the U.S., margin debt has more than doubled in the past five years to a record $438 billion.

Many liberal economists note that dire warnings of how the Fed’s money printing would lead to runaway inflation have not come true. Overall consumer prices are indeed contained and the mandate of a central bank has traditionally been to control consumer prices. But that target is out of date. In a global economy, rising competition has a restraining effect on consumer prices because producers can shop around for the lowest-cost country in which to make goods like clothes or flat-screen TVs. The effect on asset prices is the opposite, as the supply of houses and stocks is relatively limited, and because demand is rising, as investors seek higher returns than the near-zero interest rates they can get at the bank. That is why investors are bidding up asset prices, even as consumer prices remain stable.

There is a fundamental shift in the challenge facing central bankers, everywhere. Top Fed officials including former Chairman Ben Bernanke have argued that rising asset prices are less a risk than a plus, because the rising value of houses, stocks and bonds makes families feel wealthier, so they spend more and boost the economy. But monetary policy should encourage investments that will strengthen the economy and create jobs in the long term—not conjure an illusory “wealth effect” that is for now lifting mainly the wealthy.

Mr. Sharma is head of emerging markets and global macro at Morgan Stanley Investment Management and the author of “Breakout Nations: In Pursuit of the Next Economic Miracles” ( Norton, 2012).

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