Posts filed under ‘economy’
Margin Surplus Retake
Like a B-rated horror movie using the same old cliques (i.e., girl home alone with serial killer on the loose or a concealed intruder hidden in the back seat of a car), one of the financial cliques that persists today is the belief that the United States trade deficit will result in financial ruin for our economy. The recent widening of the trade deficit to $40.3 billion makes this economic issue a topical discussion. Enter Andy Kessler, former hedge fund manager and author of Running Money. He believes the stale, exploding trade deficit arguments are hogwash, primarily due to his “margin surplus” theory articulated in his book and Wall Street Journal article entitled, We Think, They Sweat.
Profiting from Trade Deficits
The absolute numbers used by Kessler in his Toshiba laptop example might have changed since his book was first published in 2004, but this margin surplus theory example is just as relevant today as it was back then. Here is an excerpt from his book:
“Let’s open up that Toshiba laptop. With a $300 Intel chip (which has at least $250 in profit for Intel) and a $50 Windows license ($49.95 margin to Microsoft), the laptop is then sold by Toshiba back into the U.S. for $1,000. Toshiba and every other supplier are lucky if they make $50 profit, combined, on the deal.”
In this illustration, government statistics would recognize a $1,000 contribution to our bloating trade deficit figures, even though nearly 90% of the laptop profits would be flowing (“surplus-ing”) back to the U.S. Hmmm, maybe this trade deficit thing isn’t as evil as it is portrayed in the popular media, or perhaps we are measuring it incorrectly? Kessler makes the case that Gross Domestic Product (GDP) is not the most important economic gauge, but rather the real crucial GDP metric is actually Gross Domestic PROFIT. He adds the best indicator for economic profits is the stock market, and as foreigners seek more productive returns on their cash beyond the 3% Treasury yields, they will eventually filter back their dollar currency reserves into stocks and other more productive asset classes.
Brain Driven Economy
You don’t have to be a brain surgeon to realize our roots as an industrial economy have shifted to an intellectual property economy. So while we may be exporting low-skilled labor jobs to China and other low-cost regions, our country is also creating higher-skilled, higher-paying jobs at innovative growing companies such as Google Inc. (GOOG) and Apple Inc. (AAPL). Case in point, flip an Apple iPod over and read the fine print on the back – it reads, “Assembled in China…Designed by Apple in California.” Once again, the commoditized aspects of slapping together a widget have been outsourced to workers in far-off lands for a small fraction of what American workers earn. If improving the standard of living is our goal, then transferring low paying jobs to foreigners should not be a concern. According to Kessler, $70 in iPod profits (versus $4 for the Chinese assemblers) from this unique, differentiated device has generated millions in profits, which in turn can be used for the creation of desirable, high-paying jobs here in the U.S.
Selling the Farm
Warren Buffets has a different view about our trade deficits and the directional value of the U.S. dollar. He perceives our economy as a fixed size farm that is selling $2 billion pieces of the farm to foreigners on a daily basis. Buffet adds:
“We’re like a very rich family; we own a farm the size of Texas but want to consume more. If you force-feed $2 billion a day to the rest of the world, they get somewhat less enthusiastic over time – and the dollar is worth less.”
Over time, Buffett believes future generations will resent paying for the gluttony of consumption by prior generations and foreigners will demand a higher interest rate for their loans. What I believe Buffet fails to consider is that the farm is not static. As we sell off $2 billion chunks of the farm, portions of those proceeds are being used to adjoin additions, buy new farms, build adjacent wind turbines, and/or incorporate other productive uses. Now if the proceeds were used to solely purchase bon-bons and doughnuts, then indeed we would be in trouble. Ultimately, the financial markets will be the true arbiter of how efficiently the foreign capital is being invested and will dictate the level of rates paid on the loans. From a pure cash management standpoint, stretching out payables (net imports) is a sound practice (i.e., it’s desirable to collect early and pay late).
The flip side of the argument explains how the farm sale proceeds from our asset sales to foreigners (such as our real estate, our Treasuries, and our stocks) can be employed in a productive manner. The Buffett argument states that our farm will eventually be completely sold to foreigners or they will hold a gun to our head asking for higher interest rates to fund our deficits. The problem with that argument is that the money received from the farm sales (Treasuries, stocks, real estate, etc.) can be (and is) used to build new farms. And that is the key question…are all these deficit building dollars being used to create new, innovative, job creating companies like Google and Apple, or are these dollars being redeployed into unproductive uses (e.g., worthless t-shirts and lead-filled toys from China, or funding of bailouts and cash-for-clunkers waste) ?
At the end of the day, money goes where it is treated best – meaning global capital seeks the royal treatment in markets where profits reign supreme. So rather than relying on rusty, obsolete statistics measuring the balance of trade (i.e., trade deficits and GDP), investors would be better served by taking a page from Andy Kessler’s book. Following the principles of “margin surplus” will increase the probabilities of profiting from global capital flows.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, Treasury securities, GOOG, and AAPL, but at the time of publishing SCM had no direct positions in Toshiba, INTC, BRKA/B or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Cockroach Consumer Cannot be Exterminated
We’re told that cockroaches would inherit the earth if a nuclear war were to occur, due to the pests’ impressive resiliency. Like a cockroach, the American consumer has managed to survive its own version of a financial nuclear war, as a result of the global debt binge and bursting of the real estate bubble. Although associating a consumer to a disease-carrying cockroach is not the most flattering comparison, I suppose it is okay since I too am a consumer (cockroach).
Confidence Cuisine
Cockroaches enjoy feasting on food, but they have been known to live close to a month without food, two weeks without water, and a half hour without air while submerged in water. On the other hand, consumers can’t live that long without food, water, and oxygen, but what really feeds buyer purchasing patterns is confidence. The April Consumer Confidence number from the Confidence Board showed the April reading reaching the highest level since September 2008. On a shorter term basis, the April figure measured in at 57.9, up from 52.3 in the previous month.
Where is all this buying appetite coming from? What we’re witnessing is merely a reversal of what we experienced in the previous years. In 2008 and 2009 more than 8 million jobs were shed and the fear-induced spiraling of confidence pushed consumers’ buying habits into a cave. With +290,000 new jobs added in April, the fourth consecutive month of additions, the tide has turned and consumers are coming out to see the sun and smell the roses. Recently the Bureau of Economic Analysis (BEA) revealed real personal consumption expenditures grew +3.6% in the first quarter – the largest quarterly increase in consumer spending since the first quarter of 2007.
Sure, there still are the “double-dippers” predicting an impending recession once the sugar-high stimulus wears off and tax increases kick-in. From my perch, it’s difficult for me to gauge the timing of any future slowing, other than to say I have not been surprised by the timing or magnitude of the rebound (I was writing about the steepening yield curve and the end of the recession last June and July, respectively). Sometimes, the farther you fall, the higher you will bounce. Rather than try to time or predict the direction of the market (see market timing article), I look, rather, to exploit the opportunities that present themselves in volatile times (e.g., your garden variety Dow Jones -1,000 point hourly plunge).
Will the Trend End?
Can this generational rise in consumer spending continue unabated? Probably not. To some extent we are victims of our own success. As about 25% of global GDP and only 5% of the world’s population, changing directions of the U.S.A. supertanker is becoming increasingly more difficult.
Source: The New York Times (Economix)
However, more nimble, resource-rich developing countries have fewer demographic and entitlement-driven debt issues like many developed countries. In order to build on an envious standard of living, our country needs to build on our foundation of entrepreneurial capitalism by driving innovation to create higher paying jobs. With those higher paying jobs will come higher spending. Of course, if uncompetitive industries cannot compete in the global marketplace, and a mirage of spending is re-created through drug-like credit cards and excess leveraged corporate lending, then heaven help us. Even the impressively resilient cockroach will not be able to survive that scenario.
Read full New York Times article here
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct positions in any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Earnings Showing Speedy Growth
With approximately 2/3 of the S&P 500 companies reporting, Thomson Reuters is reporting not only are 78% of those companies beating analyst expectations, but they are also beating them by a large margin (~16%). The financial sector is still rather volatile and is distorting comparisons, but if you look at the non-financial sector, profit growth is on pace to grow +35% this quarter as compared to +18% last quarter. Earnings are not the only thing growing…so are revenues. After four quarters of revenue declines, sales are on track to rise +11% this quarter (versus +8% last quarter) thanks to almost 80% of the S&P 500 companies reporting revenue growth (rather than declines) in the first quarter of 2010.
Source: The Wall Street Journal
Signs of Employment Improvement
Unemployment at 9.7% remains stubbornly high, but with corporation’s newfound revenue growth, there are signs companies are becoming more confident in the hiring department as well. Typically the sequence of a business cycle follows the pattern of cutting expenses and increasing layoffs into a recession; building cash at the cycle trough while running leaner expenses and staff; improving productivity with capital expenditures and technology purchases before hiring; and then as the recovery firms up, companies enjoy widening margins with sales growth, resulting in the confidence to hire. Take for example JP Morgan (JPM) mentioned they plan to hire 9,000 workers in the U.S. this year and Intel (INTC) another 1,000 new positions.
Growth is Global
With all the headlines about Greece’s financial woes, one might underestimate the recovery abroad as well. The average earnings growth rate estimates for the G6 stock markets is +41.6% and +21.9% for 2010 and 2011 according to Ed Yardeni, but a majority of the growth is not coming from the Euro zone.
There is still no shortage of issues to worry about, assuming we understand a Utopia does not exist. Besides elevated unemployment, other issues to remain concerned about include: a lack of credit accessibility for small and medium businesses; massive government debt and deficits; and diminishing impacts in the coming quarters from government stimulus and Federal Reserve monetary stimulus.
Regardless of the nervousness, evidence continues to build for a continuation of better than expected earnings. The music will not last forever and eventual stop, but until then, our economy will enjoy the speedier than anticipated earnings growth recovery.
Read Whole Wall Street Journal Article on Earnings (Subscription)
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct positions in JPM, INTC, or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Gekko & Greed – Friedman & Freedom
Gordon Gekko and Milton Friedman
As the old saying goes, the more things change, the more things stay the same. The topic of greed, fat cat bankers, and political self-preservation is just as prevalent and relevant today as it was three decades ago, as evidenced by Milton Friedman’s past television interview (see video below). Milton Friedman and Gordon Gekko, the conniving financier from Oliver Stone’s movie Wall Street played by Michael Douglas, both may not philosophically agree on all aspects of life and politics but Friedman would likely buy into much of Gekko’s view on greed:
“Greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA.”
Although Friedman held some extreme views on certain issues, fundamentally underlying all his principles was his convicted belief in freedom – political, individual, and economic freedom.
Some things never change – Milton Friedman talks about greed and capitalism with Phil Donahue.
Background
Milton Friedman (1912-2006), one of the greatest economists of the 20th Century was a Nobel Prize winner in economics, Professor at the University of Chicago (1946-1977), and an economic advisor to President Ronald Reagan. Friedman’s laissez-faire economic views coupled with his belief that government should be severely restricted, not only had a significant influence on the field of economics in the United States, but also globally. His body of work was expansive, but some major areas of contribution include his impact on Federal Reserve monetary policy; his written work on consumption and the natural rate of unemployment; and his rejection of the Phillips curve (the inverse relation of inflation relative to unemployment), to name a few.
Political & Economic Firestorm on the Horizon
Although Friedman is tightly associated with his Republican advisor work (including Ronald Reagan), he strictly considered himself a Libertarian at the core. As much as politically left leaning Americans are blaming the 2008-2009 financial crisis on Friedman-backed deregulation and a lack of government oversight, Conservatives and Libertarians are screaming bloody murder at the Democratic controlled Congress when it comes to all the bailouts, stimulus, and entitlement legislation. If Milton Friedman is looking down upon us now, my guess is that his vote is to flush all the proposed government spending down the toilet, let the failing financial institutions drown, and for Gordon Gekko’s sake, let the greedy, fat cat bankers thrive.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at time of publishing had no direct position on any security referenced. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Money Goes Where Treated Best
“The world is going to hell in a handbasket” seems to be a prevailing sentiment among many investors. Looking back, a lack of fiscal leadership in Washington, coupled with historically high unemployment, has only fanned the flames of restlessness. A day can hardly go by without hearing about some fiscal problem occurring somewhere around the globe. Geographies have ranged from Iceland to Dubai, and California to Greece. Regardless, eventually voters force politicians to take notice, as we recently experienced in the Massachusetts vote for Senator.
Time to Panic?
So is now the time to panic? Entitlement obligations such as Social Security and Medicare, when matched with a rising interest payment burden from our ballooning debt, stands to consume the vast majority of our country’s revenues in the coming decades (if changes are not made). It’s clear to most that the current debt trajectory is not sustainable – see also Debt: The New Four-Letter Word. With that said, historical debt levels have actually been at higher levels before. For example, during World War II, debt levels reached 122% of GDP (Gross Domestic Product). Since promises generally garner votes, politicians have traditionally found it easier to legislate new spending into law rather than cutting back existing spending and benefits.
Money Goes Where it’s Treated Best
If our government leaders choose to ignore the growing upswell in fiscal discontent, then the global financial markets will pay more attention and disapprove less diplomatically. As the globe’s reserve currency, the U.S. Dollar stands to collapse if a different direction is not forged, and interest costs could skyrocket to unpalatable levels. Fortunately, the flat world we live on has created some of these naturally occurring governors to forcibly direct sovereign entities to make better decisions…or suffer the consequences. Right now Greece is paying for the financial sins of its past, which includes widening deficits and untenable debt levels.
As new, growing powers such as China, Brazil, India, and other emerging countries fight for precious capital to feed the aspirational goals of their rising middle classes, money will migrate to where it is treated best. Speculative money will flow in and out of various capital markets in the short-run, but ultimately capital flows where it is treated best. Meaning, those countries with policies fostering fiscal conservatism, financial transparency, prudent regulations, pro-growth initiatives, tax incentives, order of law, and other capital-friendly guidelines will enjoy their fair share of the spoils. The New York Times editorial journalist Tom Friedman coined the term “golden straitjacket” in describing this naturally occurring restraint system as a result of globalization.
Push Comes to Shove
Push will eventually come to shove, but the real question is whether we will self-impose fiscal restraint on ourselves, or will the global capital markets shove us in that direction, like the markets are doing to Greece (and other financially strapped nations) today? I am hopeful it will be the former. Why am I optimistic? Although more government spending has typically lead to more votes for politicians, cracks in the support wall have surfaced through the Massachusetts Senatorial vote, and rising populist sentiment, as manifested through the “Tea Party” movement (previously considered a fringe group).
Political gridlock has traditionally been par for the course, but crisis usually leads to action, so I eventually expect change. I am banking on the poisonous and sour mood permeating through the country’s voter base, in conjunction with the collapse of foreign currencies, to act as a catalyst for financial reform. If not, resident capital and domestic jobs will exodus to other countries, where they will be treated best.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including emerging market-based ETFs), but at time of publishing had no direct positions in securities mentioned in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Banking Crisis Broken Record (1907 vs. 2007)
Like a spinning and skipping broken record, our history has been filled with an endless number of banking crises. And unfortunately, the financial crisis of 2008-2009 will not be our last (read more about rhyming history). Robert F. Bruner, professor and Dean at the Darden Graduate School of Business Administration, has studied the repetitive nature of banking crises and identified core foundational aspects present in these vicious financial events.
In a period spanning 105 years (1900 – 2005) Bruner references 31 separate crises occurring across the world in various countries. Just in the last handful of decades, Americans have experienced the seizure of the Continental Illinois National Bank and Trust Company (1984), the S&L crisis (Savings & Loan – late 1980s), the disintegration of Long-Term Capital Management (1998), followed by the recent falling of dominoes in the first decade of the 21st Century (Bear Stearns, Lehman Brothers, Wamu, AIG, etc.). What do many of these crises have in common?
In comparing the recent global financial crisis, Bruner compares the recent events to the “Panic of 1907” – the last financial crisis before the creation of the Federal Reserve System in 1913. The last few years have been rough, but a century ago San Franciscans endured the mother of all crises. This is how Bruner described the time period:
“The San Francisco earthquake of 18 April 1906 triggered a massive call on global gold reserves and a liquidity crunch in the United States. A recession commenced in June 1907. Security prices declined. In September, New York City narrowly averted a failure to refinance outstanding bonds. Then, on 16 October, a “bear squeeze” speculation failed and rendered two brokerage firms insolvent. The next day, depositors began a run on Knickerbocker Trust Company…Runs spread to other trust companies and banks in New York City. And the panic rippled across the United States.”
Bruner highlights four key factors inherent in these, and other, financial crises. Here is a summary of the four elements:
Existence of Systemic Structure: In order for a crisis to occur, an economy needs a collection of linked financial intermediaries to form a system. Throughout history, transactions and deposits have connected to multiple systems around the globe.
Systemic Instability: Hyman Minsk, a renowned 20th Century economist, was known for his thoughts on his “Financial Instability Hypothesis.” At the core of Minsky’s crisis beliefs was the idea that economic slumps were caused by the credit cycle. At the late stages of an economic cycle there is a larger appetite to assume additional risk and debt. A spiraling vortex can occur as “Easy credit amplifies the boom, and tight credit amplifies the contraction,” Minsky states.
Systemic Shock: Beyond an unstable system, a crisis needs a spark. For Bruner that spark must have four characteristics:
- Real, Not Apparent: The shock must be “real, not apparent.” The disturbance must be disruptive enough to shake the trust of the financial system and be large enough to have a real economic impact (e.g., new technologies, massive labor strike, deregulation, or even an earthquake).
- Large: The trigger of a financial crisis must be large enough to shift the outlook of investors.
- Unambiguous and Difficult to Repeat: The shock must unambiguously stand out from the standard marketplace news.
- Surprising: The event must be unanticipated and cause a shift in thinking.
Response and Intervention: Effectively, the response to a shock converts an overconfident boom into fear and pessimism. The reply can often be an overreaction to the existing fundamentals, which flies in the face of efficient markets and rational decision making.
According to Bruner, crises including the one triggered by the earthquake of 1906 carry the four previously mentioned elements.
Solution = Leadership
At the vortex of any financial crisis lies fear and panic, which require leadership to mitigate the damage. John Pierpont “J.P.” Morgan, semi-retired banking executive, orchestrated leadership in 1907 by organizing a rescue of “trust companies, banks, the New York Stock Exchange, New York City, and the brokerage firm of Moore and Schley.”
Time will tell and history will judge whether Federal Reserve Chairman Ben Bernanke and Treasury Secretaries Hank Paulson and Timothy Geithner provided the necessary leadership to sustainably lead us out of the financial crisis. Of course, decisions made by the key U.S. leadership figures are not made in a vacuum, so choices made by our international brethren can impact the success of our monetary and fiscal policies too.
There have been 18 substantial global bank crises since World War II and the recent credit-induced collapse will not be the last as long as Bruner’s four elements of a crisis exist (structure, instability, shock, and intervention). The ultimate outcome of a crisis will be dependent on the nature of leadership, coordinated government intervention, and regulation. The global economic record will continue spinning, but with Robert Bruner’s lessons learned from the Panic of 1907, hopefully the music will last for a very long time before skipping on a crisis again.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and a derivative security of an AIG insurance subsidiary, but at time of publishing had no direct positions in JPM. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Short-Termism & Extremism: The Death Knell of our Future
In recent times, American society has been built on a foundation of instant gratification and immediate attacks, whether we are talking about politics or economics. Often, important issues are simply presented as black or white in a way that distorts the truth and rarely reflects reality, which in most cases is actually a shade of grey. President Obama is discovering the challenges of governing a global superpower in the wake of high unemployment, a fragile economy, and extremist rhetoric from both sides of the political aisle. Rather than instituting a promise of change, President Obama has left the natives restless, wondering whether a “change for worse” is actually what should be expected in the future.
Massachusetts voters made a bold and brash statement when they elected Republican Senator Scott Brown to replace the vacated Massachusetts Senate seat of late, iconic Democratic Senator Edward Kennedy – a position he held as a Democrat for almost 47 years. Obama’s response to this Democratic body blow and his fledging healthcare reform was to go on a populist rampage against the banks with a tax and break-up proposal. Undoubtedly, financial reform is needed, but the timing and tone of these misguided proposals unfortunately does not attack the heart of the financial crisis causes – excessive leverage, lack of oversight, and irresponsible real estate loans (see also, Investing Caffeine article on the subject).
With that said, I would not write President Obama’s obituary quite yet. President Reagan was left for dead in 1982 before his policies gained traction and he earned a landslide reelection victory two years later. In order for President Obama to reverse his plummeting approval ratings and garner back some of his election campaign mojo, he needs to lead more from the center. Don’t take my word for it, review Pew Research’s data that shows Independents passing up both Republicans and Democrats. The overall sour mood is largely driven by the economic malaise experienced by all in some fashion, and unfortunately has contributed to short-termism and extremism.
Technology has flattened the world and accelerated the exchange of information globally at the speed of light. Any action, recommendation, or gaffe that deviates from the approved script immediately becomes a permanent fixture on someone’s lifetime resume. Our comments and decisions become instant fodder for the worldly court of opinion, thanks to 24/7 news cycles and millions of passionate opinions blasted immediately through cyberspace and around the globe.
Short-termism and extremism can be just as poisonous in the economic world as in the political world. This dynamic became evident in the global financial crisis. Short-termism is just another phrase for short-term profit focus, so when more and more leverage led to more and more profits and higher asset prices, the financial industry became blinded to the long-term consequences of their short-term decisions.
Solutions:
- Small Bites First: Rather than trying to ram through half-baked, massive proposals laced with endless numbers of wasteful pork barrel projects, why not focus on targeted and surgical legislation first? If education, deficit-reduction, and job creation are areas of common interest for Republicans and Democrats, then start with small legislation in these areas first. More ambitious agendas can be sought out later.
- Embrace Globalization: Based on the “law of large numbers” and the scale of the United States economy, our slice of the global economic pie is inevitably going to shrink over time. How does the $14 trillion U.S economy manage to grow if its share is declining? Simple. By eschewing protectionist policies, and embracing globalization. Developing country populations are joining modern society on a daily basis as they integrate productivity-enhancing innovations used by developed worlds for decades. In a flat world, the narrowing of the productivity gap is only going to accelerate. The question then becomes, does the U.S. want to participate in this accelerating growth of developing markets or sit idly on the sideline watching our competitors eat our lunch?
- Hail Long-Termism and Centrism: Regulations and incentives need to be instituted in such a fashion that irresponsible behavior occurring in the name of instant short-term profits is replaced with rules that induce sustainable profits and competitive advantages over our economic neighbors. Much of the financial industry is scratching and screaming in the face of any regulatory reform suggestions. The bankers’ usual response to reform is to throw out scare tactics about the inevitable damage caused by reform to the global competitiveness of our banking industry. No doubt, the case of “anti-competiveness” is a valid argument and any reforms passed could have immediate negative impacts on short-term profits. Like the bitter taste of many medicines, I can accept regulatory remedies now, if the long-term improvements outweigh the immediate detrimental aspects.
The focus on short-termism and extremism has created an acidic culture in both Washington and on “Main Street,” making government changes virtually impossible. If President Obama wants to implement the change he campaigned on, then he needs to take a more centrist view that concentrates on enduring benefits – not immediate political gains.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Article first submitted to Alrroya.com before being published on Investing Caffeine.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds but at the time of publishing had no direct positions in securities mentioned in the article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Soros on the Super Bubble
Like a bubble formed from chewing gum, the gradual expansion of the spherical formation occurs much slower than the immediacy of the pop. A minority of investors identified the treacherous, credit-induced bubble of 2008 before it burst, however not included in that group are financial regulators. Now we’re left with the task of cleaning up the sticky mess on our faces and establishing measures to prevent future blow-ups.
George Soros, Chairman of Soros Fund Management and author of The Crash of 2008, has been around the financial market block a few times, so I think it pays to heed the regulatory reform recommendations as it relates to the “Super bubble” of 2008. As you probably know, financial bubbles are not a new concept. Beyond the oft-mentioned technology and real estate bubbles of this decade, bubbles such as the “Tulip-mania” of the 1630s serve as a gentle reminder of the everlasting existence of irrational economic behavior. If the Dutch were willing to pay $76,000 for a tulip bulb (inflation-adjusted) almost 400 years ago, then virtually any mania is possible.
Bubbles and Efficiency
Efficient markets are somewhat like UFOs. Some people believe in them, but many do not. In order to believe in the existence of bubbles, one needs to question the validity of the pure form of efficient markets (read more about market efficiency). Here’s how Soros feels about market efficiency:
“I contend that financial markets always present a distorted picture of reality.”
I believe we will be in a hyper-sensitive period of bubble witch-hunting for a while, as the fresh wounds of 2008-09 heal themselves. If you get in early enough, bubbles can be profitable. Unfortunately, like a distracted teen fixated on the sunbathers at a nude beach, the excitement can lead to a painful burn if preventative sunscreen measures are not taken. Most bubble participants are too exhilarated to carry out a thoughtful exit strategy – the news can just be too tempting to jump off the top.
In his analysis of market regulation, Soros lays some of the “Great Recession” blame on the Federal Reserve and Alan Greenspan (Chairman of Fed):
“Instead of a tendency towards equilibrium, financial markets have a tendency to develop bubbles. Bubbles are not irrational: it pays to join the crowd, at least for a while. So regulators cannot count on the market to correct its excesses…The crash of 2008 was caused by the collapse of a super-bubble that has been growing since 1980. This was composed of smaller bubbles. Each time a financial crisis occurred the authorities intervened, took care of the failing institutions, and applied monetary and fiscal stimulus, inflating the super-bubble even further.”
Soros’ Recipe for Reform
What is Soros’ solution for the “Super bubble?” Here are some recommendations from his Op-Ed in the Financial Times:
- Regulator Accountability: First of all, financial authorities need to accept responsibility for preventing excesses – excuses are not an acceptable response.
- Control Credit: Rather than having static monetary targets such as margin requirements, capital reserve requirements, and loan-to-value ratios, Soros argues these metrics can be adjusted in accordance with the swinging moods of economic cycles. He punctuates the point by saying, “To control asset bubbles it is not enough to control the money supply; you must also control credit.”
- Limit Overheating in Specific Sectors: Had regulators limited lending during the real estate explosion or had the SEC limited technology IPOs in the late 1990s, perhaps our country would be in better financial health today.
- Manage Derivatives and Systemic Risk: Basically what Soros is saying here is that many market participants can become overwhelmed by certain exposures or exotic instruments, therefore it behooves regulators to proactively step in and regulate.
- Manage Too Big to Fail (read related Graham IC article): According to Soros a big reason we got into this trouble relates to the irresponsible proprietary trading departments at some of the larger banks. Responsibly separating these departments and limiting the amount of risk undertaken is an important element to the safety of our financial system.
- Reformulate Asset Holding Rules: Underestimating the risk profile of a certain security can lead to concentration issues, which can potentially generate systemic risk. Soros highlights the European Basel Accord rules as an area that can use some improvement.
Soros admits most, if not all, the measures he proposes will choke off the profitability of banks. For this reason, regulators must be very careful with the implementation and timing of these financial strategies. If employed too aggressively, the economy could find itself in a deflationary spiral. Move too slowly, and the loose monetary measures instituted by the Fed could fan the flames of inflation.
Bubbles will never go away. Eventually, the recent panic-induced fear will fade away and the entrepreneurial seeds of greed will germinate into new budding flowers of optimism. As investors nervously chomp away at their chewing gum, I will patiently await for the next financial bubble to form. I echo George Soros’s hope that regulators prick future “mini-bubbles” before they become “super-bubbles.”
Read Full George Soros Op-Ed on The Financial Times 10/25/09
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at time of publishing had no direct positions in an security referenced. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Rogers: Fed Following in Path of Dodo
Jimmy Rogers, the bow-tie boss of Rogers Holdings and past co-founder of the successful Quantum Fund with George Soros, is no stranger to making outrageous predictions. His latest prophetic assessment is the Federal Reserve Bank is on the path of the Dodo bird to extinction:
“Don’t worry – the Fed is going to abolish itself. Between Bernanke and Greenspan, they’ve made so many mistakes that within the next few years the Fed will disappear.”
Given the shock and awe that transpired from the Lehman Brothers collapse, I can only wonder how investors might react to this scenario….hmmm. If this doozy of an outlandish call catches you off guard, please don’t be surprised – Rogers is not shy about sharing additional ones (Read other IC article on Rogers). For example, just six months ago Rogers said the Dow Jones could collapse to 5,000 (currently around 10,472) or skyrocket to 30,000, but “of course it would be in worthless money.” Oddly, the printing presses that Rogers keeps talking about have actually produced deflation (-0.2%) in the most recently reported numbers, not the same 79,600,000,000% inflation from Zimbabwe (Cato Institute), he expects.
I suppose Rogers will either point to a data conspiracy, or use the “just you wait” rebuttal. I eagerly await, with bated breath, the ultimate outcome.
Is U.S. Fed Alone?
If the U.S. Federal Reserve system is indeed about to disappear after over nine decades of operations, does that mean Rogers advocates shutting all of the other 166 global reserve banks listed by the Bank for International Settlement? Should the 3 ½ century old Swedish Riksbank (origin in 1668) and the Bank of England (1694) central banks also be terminated? Or does the U.S. Federal Reserve Bank have a monopoly on incompetence and/or corruption?
Sidoxia’s Report Card on Fed
I must admit, I believe we would likely be in a much better situation than we are today if the Federal Reserve board let Adam Smith’s “invisible hand” self adjust short-term interest rates. Rather, we drank from the spiked punch bowls filled with low interest rates for extended periods of time. The Federal Reserve gets too much attention/credit for the impact of its decisions. There is a much larger pool of global investors that are buying/selling Treasury securities daily, across a wide range of maturities along the yield curve. I think these market participants have a much larger impact on prices paid for new capital, relative to the central bank’s decision of cutting or raising the Federal funds rate a ¼ point.
Although I believe the Fed gets too much attention for its monetary policies, I think Bernanke and the Fed get too little credit for the global Armageddon they helped avoid. I agree with Warren Buffett that Bernanke acted “very promptly, very decisively, very big” in helping us avert a second depression while we were on the “brink of going into the abyss.”
Beyond the monetary policy of fractional rate setting, the Fed also has essential other functions:
- Supervise and regulate banking institutions.
- Maintain stability of the financial system and control systemic risk of financial markets.
- Act as a liaison with depository institutions, the U.S. government, and foreign institutions.
- Play a major role in operating the country’s payments system.
I will go out on a limb and say these functions play an important role, and the Fed has a good chance of being around for the 2012 London Olympic Games (despite Jimmy Rogers’ prediction).
Sidoxia’s Report Card on Rogers
As I have pointed out in the past, I do not necessarily disagree (directionally) with the main points of his arguments:
- Is inflation a risk? Yes.
- Will printing excessive money lower the value of our dollar? Yes.
- Is auditing the Federal Reserve Bank a bad idea? No.
My beef with Rogers is merely in the magnitude, bravado, and overconfidence with which he makes these outrageous forecasts. Furthermore, the U.S. actions do not happen in a vacuum. Although everything is not cheery at home, many other international rivals are in worse shape than we are.
From a media ratings and entertainment standpoint, Rogers does not disappoint. His amusing and outlandish predictions will keep the public coming back for more. Since according to Rogers, Bernanke will have no job at the Fed in a few years, I look forward to their joint appearance on CNBC. Perhaps they could discuss collaboration on a new book – Extinction: Lessons Learned from the Fed and Dodo Bird.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (VFH) at the time of publishing, but had no direct ownership in BRKA/B. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Friedman Looks to Flatten Problems in Flat World
Perhaps Friedman could use Gallagher's "Sledge-O-Matic?"
Thomas Friedman, author of recent book Hot, Flat, and Crowded and New York Times columnist, combines a multi-discipline framework in analyzing some of the most complex issues facing our country, from both an economic and political perspective. Friedman’s distinctive lens he uses to assimilate the world, coupled with his exceptional ability of breaking down and articulating these thorny challenges into bite-sized stories and analogies, makes him a one-of-a-kind journalist. Whether it’s explaining the history of war through McDonald’s hamburgers, or using the Virgin Guadalupe to explain the rise of China, Friedman brings highbrow issues down to the eye-level of most Americans.
In his seminal book, The World is Flat, Friedman explains how technology has flattened the global economy to a point where U.S. workers are fighting to keep their domestic tax preparation and software engineering jobs, as new emerging middle classes from developing countries, like China and India, steal work.
The Flat World
In boiling down the recent financial crisis, Friedman used Iceland to explain the “flattening” of the globe:
“Fifteen British police departments lost all their money in Icelandic online savings accounts. Like who knew? I knew the world was flat – I didn’t know it was that flat…that Iceland would become a hedge fund with glaciers.”
The left-leaning journalist hasn’t been afraid to bounce over to the “right” when it comes to foreign affairs and certain fiscally conservative issues. For example, he initially full-heartedly supported George W. Bush’s invasion of Iraq. And on global trade, he has a stronger appreciation of the economic benefits of free trade as compared to traditionally Democratic protectionist views.
Calling All Better Citizens
In a recent Charlie Rose interview, Friedman’s patience with our country’s citizenry has worn thin – he believes government leaders cannot be relied on to solve our problems.
When it comes to the massive deficits and foreign affair issues, Friedman comes to the conclusion we need to cut expenses or raise taxes. By creating a $1 per gallon gasoline tax, Friedman sees a “win-win-win-win” solution. Not only could the country wean itself off foreign oil addiction from authoritarian governments and create scores of new jobs with E.T. (Energy Technologies), the tax could also raise money to reduce our fiscal deficit, and pay for expanded healthcare coverage.
It’s fairly clear to me that government can’t show the leadership in cutting expenses. Since cutting benefits for voters won’t get you re-elected, taxes most certainly will have to go up. Wishful thinking that a recovering economy will do the dirty, debt-cutting work is probably naïve. If forced to pick a poison, the gas tax is Friedman’s choice. I’m not so sure the energy lobby would feel the same?
Political gridlock has always been an obstacle for getting things done in Washington. Technology, scientific polling, 24/7 news cycles, and deep-pocketed lobbyists are only making it tougher for our country to deal with our difficult challenges. Regardless of whether Friedman’s gasoline tax is the silver bullet, I welcome the clear, passionate voice from somebody that understands the challenges of living in a flat world.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) owns certain exchange traded funds (BKF, FXI) and has a short position in MCD at the time this article was originally posted. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
