"Invincibility lies in the defense; the possibility of victory in attack." - Sun Tzu
Today is a short day for the markets due to the extended holiday that is Thanksgiving and as I am taking the day off this will also be a very short blog. But while it may be a short day for the markets and volumes are typically light it is very interesting to see the commodities markets under complete attack. Oil is down almost $8 a barrel or more than 10%, Natural Gas is down more than 6%, Copper is down more than 3%, Gold is down $29 or 2.50% and Silver is down $1.20 or more than 7%; and this is all today!
This is an all out route and while Gold and Silver have not broken down completely yet, Copper has now confirmed a downside bias and Crude oil has now fallen more than 40% in less than 6 months. The raw materials of Copper and Crude will feed into inflation numbers and start to exacerbate the issue of deflation. Furthermore their continued weakness points to a global economy that may be completely out of gas regardless of what the central bankers of the world do, but their response will no doubt be to throw more money at the issue. Interest rates will remain benign for a lot longer than anyone can imagine so finding places to invest your cash will be difficult. Make sure that you do not chase yield as the risks inherent in a low interest rate environment are still the same (if not higher) but the yield is reduced.
Looking ahead it seems clear that the near term concern of deflation is very real and this environment is treacherous for stocks particularly for companies saddled with debt (IBM springs to the top of the list). Be very cautious and try to bring your debt levels down to a minimum, build up cash and wait for the inevitable.
Happy Thanksgiving to all.
Friday, November 28, 2014
Friday, November 21, 2014
Mismanagement
"It's not the lack of money that kills our economy, it's the mismanagement of it." - TJ Anderson
In a follow on to the previous two blogs I had a very interesting infusion of thought from some of my readers and one in particular caught my attention. The discussion was in terms of the size of companies and governments and how this impacts not only returns and ultimately causes the failure of the institution. The question was is it really the size or is it mismanagement of the assets and in all honesty I believe that one is a factor of the other. The larger the business or government becomes the larger the influence of political posturing and by default the larger the mismanagement of the assets. There is less concern over shareholders or tax payers and more and more concern over personal payments and power, which ultimately leads to the company's or government's demise.
As an example investment and large banking institutions are so big that they are perceived as too big to fail. This brings into account morale hazard - the hazard associated with the management's lack of accountability. Should the bank fail then there is no impact to the management team other than a loss of their reputation and potentially their jobs (although in modern times it seems that losing the job is the best financial decision as there is usually a multi-million dollar payout to fire the person), but until then taking inordinate risks in order to maximize profits and their pay checks is the norm. This bubble is protected by the central bankers of the world as they step in to sort out the problem should they cause an economic shock wave. They are essentially playing with tax payer money so their personal risk is limited to the job loss while their upside is almost unlimited. In this kind of environment the main focus is on developing new products that will maximize returns without a concern for the risks imposed.
The authorities are expected to monitor these risks and impose laws to regulate these enterprises but they are always behind the market for the simple reason that they cannot keep up with the new financial developments and derivatives that are dreamed up daily by the wizards of the financial markets. While in the Bible the 12 apostles may have been enough to spread the word, there is no way that the 12 Federal Reserve Districts can keep ahead of the army of international bankers that test the limits and find holes in the system daily. Furthermore, regulations take time to be implemented and by the time these are in place the market normally has moved on having anticipated the crack down.
The side effect is small business. These companies have to operate under intense scrutiny, they do not have the resources to comply with all the new regulations that are supposed to keep large institutions under control but cripple their ability to operate, have limited access to investment dollars and are required to repay every dollar borrowed (unlike governments and large banks who just print more). For this reason they are masters at working on a shoe string budget and remain lean and efficient. Money lent to these companies is relatively risk free for the simple reason that the loan requirement is so small that if one business is lost the impact on the bank is small. As Donald Trump explained once that if you borrow $1 million then the bank owns you, but if you borrow $1 billion then you own the bank. Much the same with small business, while it is perceived that the risk to investing in them is high (and it is as many do not make it to year two, largely due to a lack of funding) the overall risk to the economy is low due to their small size.
The current system is therefore flawed in that not only is size the problem but there is no accountability for the actions of the large institutions. One way to solve this problem would be to adjust the method of pay. Instead of receiving a massive payment at the end of a good year it could be withheld for 5 or 10 years. If during this time period the bank ran into financial problems caused by the risk taking at the time of the bonus award the deferred payment would be used to offset the losses. In this way management might think twice about a risky bet to make a quick buck and may rather look out for the longstanding of the bank and its shareholders, not to mention the lowly tax payer!
In a follow on to the previous two blogs I had a very interesting infusion of thought from some of my readers and one in particular caught my attention. The discussion was in terms of the size of companies and governments and how this impacts not only returns and ultimately causes the failure of the institution. The question was is it really the size or is it mismanagement of the assets and in all honesty I believe that one is a factor of the other. The larger the business or government becomes the larger the influence of political posturing and by default the larger the mismanagement of the assets. There is less concern over shareholders or tax payers and more and more concern over personal payments and power, which ultimately leads to the company's or government's demise.
As an example investment and large banking institutions are so big that they are perceived as too big to fail. This brings into account morale hazard - the hazard associated with the management's lack of accountability. Should the bank fail then there is no impact to the management team other than a loss of their reputation and potentially their jobs (although in modern times it seems that losing the job is the best financial decision as there is usually a multi-million dollar payout to fire the person), but until then taking inordinate risks in order to maximize profits and their pay checks is the norm. This bubble is protected by the central bankers of the world as they step in to sort out the problem should they cause an economic shock wave. They are essentially playing with tax payer money so their personal risk is limited to the job loss while their upside is almost unlimited. In this kind of environment the main focus is on developing new products that will maximize returns without a concern for the risks imposed.
The authorities are expected to monitor these risks and impose laws to regulate these enterprises but they are always behind the market for the simple reason that they cannot keep up with the new financial developments and derivatives that are dreamed up daily by the wizards of the financial markets. While in the Bible the 12 apostles may have been enough to spread the word, there is no way that the 12 Federal Reserve Districts can keep ahead of the army of international bankers that test the limits and find holes in the system daily. Furthermore, regulations take time to be implemented and by the time these are in place the market normally has moved on having anticipated the crack down.
The side effect is small business. These companies have to operate under intense scrutiny, they do not have the resources to comply with all the new regulations that are supposed to keep large institutions under control but cripple their ability to operate, have limited access to investment dollars and are required to repay every dollar borrowed (unlike governments and large banks who just print more). For this reason they are masters at working on a shoe string budget and remain lean and efficient. Money lent to these companies is relatively risk free for the simple reason that the loan requirement is so small that if one business is lost the impact on the bank is small. As Donald Trump explained once that if you borrow $1 million then the bank owns you, but if you borrow $1 billion then you own the bank. Much the same with small business, while it is perceived that the risk to investing in them is high (and it is as many do not make it to year two, largely due to a lack of funding) the overall risk to the economy is low due to their small size.
The current system is therefore flawed in that not only is size the problem but there is no accountability for the actions of the large institutions. One way to solve this problem would be to adjust the method of pay. Instead of receiving a massive payment at the end of a good year it could be withheld for 5 or 10 years. If during this time period the bank ran into financial problems caused by the risk taking at the time of the bonus award the deferred payment would be used to offset the losses. In this way management might think twice about a risky bet to make a quick buck and may rather look out for the longstanding of the bank and its shareholders, not to mention the lowly tax payer!
Friday, November 14, 2014
The Problem with Size
"Likewise, government deficits are particularly concave to changes in economic conditions. Every additional deviation in, say, the unemployment rate - particularly when the government has debt - makes deficits incrementally worse. And financial leverage for a company has the same effect; you need to borrow more and more to get the same effect. Just as a Ponzi scheme." - Nassim Taleb "Antifragile"
As a follow on to last week's blog on Keynes, this blog will look at the other side to the argument which is normally based on the theories of the Austrian economist Ludwig von Mises. Mises concluded that printing money would never work for the simple reason that not only does more debt not solve the problem but unless you have the ability to clean the balance sheet up at a later date that every incremental increase in the level of debt from printing money out of thin air has a smaller and smaller impact on outcome. At some point in the future the amount of money required to have any impact is so large that the system collapses.
The issue is that the initial benefits are perceived to be linear rather than concave. On the surface if some money issued into the economy produces a decent effect then more must produce a larger effect in a linear fashion or a straight line - the more you add the more you receive in economic growth. This is a common fallacy and one that is truly debunked in the book Antifragile by Nassim Taleb. (Once again if you have not read this book then you really need to - or keep reading this blog as I will continue to beat the drum for him).
Size is the issue. As an example if everything was linear in the risk world then taking 50 jumps off stairs each one foot high would be the same as jumping off a 50 foot building. Obviously the impact on landing from the 50 foot jump would be far more severe (if not fatal) to the jumper than jumping one foot 50 times. The same can be seen in a mound of sand. You can keep adding bucket after bucket of sand but at some point the whole pile will collapse. That last grain of sand is all that is needed to dismantle the entire work of all the previous buckets that were piled on top of each other.
This philosophy can be used to show how size can destroy governments and businesses alike. Looking at the market the large banks are a big issue as if one goes they all go and the economy is gone. Lose a small regional bank and no-one is the worse off other than the few people that worked there. The FDIC can easily handle paying out depositors their funds and all goes back to normal quickly. If Bank of America goes under the problems are huge and the impact on the economy enormous. The theory goes that the government can and will step in to repair the damage but they are already leveraged to the maximum and are possibly the most inefficient group available to manage the problem.
Think about small business. Things get resolved quickly, there are no political debates or posturing (not always but mostly and if it is rife the business will fail) and new products and services are added quickly to take advantage of an opportunity. On the other side of the scale is large business which while able to take on global issues always sees the profit margin fall and the efficiency drop until there is a tipping point where the company size is ultimately its undoing.
The same for governments. The bigger they become the harder it is for them to shrink to a more manageable and efficient size. Feuds are rife and bureaucracy fosters inefficiency as the more inefficient you are the larger your budget and the more power you control. Become efficient and your budget and your power is cut. So the thought of a smaller efficient government that balances a budget is akin to asking a child if they would like another candy. Of course they would and of course the government size will continue to grow. The only time governments are reigned in is during times of crisis when they are forced to do their job and many lose theirs in a change of the political system.
Now last week I said that Keynes' theories of printing money and providing fiscal stimulus would work and it appears that I am now saying that they will not so let me clear that up. I believe that Keynes' theories would work if they were all done at once (money printing, shovel ready projects and tax reductions) and that once they were seen to stimulate the economy that the government would efficiently clean up their balance sheet and trim its size. In business language, push the product with marketing and then cut back to make sure that the profits flow and the debt level is paid down or off. The problem is, as I have detailed above, that the government will not balance its budget, nor will it cut its size and it is not using all three of the legs of the stool but only one or maybe two. Under this scenario the results are concave (see image below) in that the benefits are felt early but ultimately they are doomed to failure, it is just a matter of time.
As a follow on to last week's blog on Keynes, this blog will look at the other side to the argument which is normally based on the theories of the Austrian economist Ludwig von Mises. Mises concluded that printing money would never work for the simple reason that not only does more debt not solve the problem but unless you have the ability to clean the balance sheet up at a later date that every incremental increase in the level of debt from printing money out of thin air has a smaller and smaller impact on outcome. At some point in the future the amount of money required to have any impact is so large that the system collapses.
The issue is that the initial benefits are perceived to be linear rather than concave. On the surface if some money issued into the economy produces a decent effect then more must produce a larger effect in a linear fashion or a straight line - the more you add the more you receive in economic growth. This is a common fallacy and one that is truly debunked in the book Antifragile by Nassim Taleb. (Once again if you have not read this book then you really need to - or keep reading this blog as I will continue to beat the drum for him).
Size is the issue. As an example if everything was linear in the risk world then taking 50 jumps off stairs each one foot high would be the same as jumping off a 50 foot building. Obviously the impact on landing from the 50 foot jump would be far more severe (if not fatal) to the jumper than jumping one foot 50 times. The same can be seen in a mound of sand. You can keep adding bucket after bucket of sand but at some point the whole pile will collapse. That last grain of sand is all that is needed to dismantle the entire work of all the previous buckets that were piled on top of each other.
This philosophy can be used to show how size can destroy governments and businesses alike. Looking at the market the large banks are a big issue as if one goes they all go and the economy is gone. Lose a small regional bank and no-one is the worse off other than the few people that worked there. The FDIC can easily handle paying out depositors their funds and all goes back to normal quickly. If Bank of America goes under the problems are huge and the impact on the economy enormous. The theory goes that the government can and will step in to repair the damage but they are already leveraged to the maximum and are possibly the most inefficient group available to manage the problem.
Think about small business. Things get resolved quickly, there are no political debates or posturing (not always but mostly and if it is rife the business will fail) and new products and services are added quickly to take advantage of an opportunity. On the other side of the scale is large business which while able to take on global issues always sees the profit margin fall and the efficiency drop until there is a tipping point where the company size is ultimately its undoing.
The same for governments. The bigger they become the harder it is for them to shrink to a more manageable and efficient size. Feuds are rife and bureaucracy fosters inefficiency as the more inefficient you are the larger your budget and the more power you control. Become efficient and your budget and your power is cut. So the thought of a smaller efficient government that balances a budget is akin to asking a child if they would like another candy. Of course they would and of course the government size will continue to grow. The only time governments are reigned in is during times of crisis when they are forced to do their job and many lose theirs in a change of the political system.
Now last week I said that Keynes' theories of printing money and providing fiscal stimulus would work and it appears that I am now saying that they will not so let me clear that up. I believe that Keynes' theories would work if they were all done at once (money printing, shovel ready projects and tax reductions) and that once they were seen to stimulate the economy that the government would efficiently clean up their balance sheet and trim its size. In business language, push the product with marketing and then cut back to make sure that the profits flow and the debt level is paid down or off. The problem is, as I have detailed above, that the government will not balance its budget, nor will it cut its size and it is not using all three of the legs of the stool but only one or maybe two. Under this scenario the results are concave (see image below) in that the benefits are felt early but ultimately they are doomed to failure, it is just a matter of time.
Monday, November 10, 2014
Keynes Rules!
"The importance of money flows from it being a link between the present and the future>" - John Maynard Keynes
In an article in Business Week Keynes was listed as "The Man of the Moment". Keynes died in 1946 but his economic theories live on. He was the first to promote the idea of fiscal and monetary policy as a solution to economic turmoil. To summarize his ideas he said that during good economic times governments run surpluses and these surpluses should be spent during times of economic weakness to take up the slack from a weakened business environment. Using both fiscal (tax cuts and spending on shovel ready projects) and monetary (printing money and lowering interest rates) an economy can be stimulated. Once business picks back up the government can exit the market and recoup their investment through increased tax revenues.
It appears that the world's central bankers (German's aside) are bent on giving Keynes's theories one massive try. The interesting thing to me is that his theories encompass ALL of the aspects of stimulus not "some" of the inputs. Looking around the world then it is clear that while on the surface his principles are being used to "stimulate" the global economy when you dig deeper there are a number of things amiss and these missing pieces are undermining the efforts.
First let's take a look at Japan. While the world applauded their most recent money stimulus and government spending packages they failed to mention that Japan has already raised the consumption tax and is planning to raise it again. According to Keynes tax reductions are needed in addition to these other stimulus's and so while Japan is using two of the inputs the third is offsetting any perceived benefit.
Europe, the laggard of the group is barely using any stimulus other than monetary. The Germans are even against that but the problem is that fiscal policies remain under the tight constraint of the Eurozone parameters. This makes it near impossible for any of the countries that fall under the EU umbrella to stimulate beyond some monetary stimulus that they receive from the central bank and even this stimulus is becoming increasingly difficult to achieve.
The United States has definitely been the shinning star in terms of monetary policy having printed more than $4 trillion. However on the fiscal side there has been little in the way of shovel ready projects and the tax burden being felt by individuals and businesses is massive. Not only are the tax rates higher but with Obamacare in full force the cost of keeping full time employees is growing and is akin to an additional tax.
The final problem is that virtually none of the countries have had a budget surplus in decades (other than Germany). They were all in a hole before they began printing money and are now in an even bigger one. Furthermore the thought of them ever being able to balance their budgets seems impossible. The United States as an example has not only a huge deficit to fill but with Social Security and Medicare kicking in the chances of a balanced budget are slim to none.
So while it appears that Keynes rules the day, unfortunately his ideas are really nor being followed as if they were I have to believe we would be out of this mess instead of digging a deeper hole each and every day.
In an article in Business Week Keynes was listed as "The Man of the Moment". Keynes died in 1946 but his economic theories live on. He was the first to promote the idea of fiscal and monetary policy as a solution to economic turmoil. To summarize his ideas he said that during good economic times governments run surpluses and these surpluses should be spent during times of economic weakness to take up the slack from a weakened business environment. Using both fiscal (tax cuts and spending on shovel ready projects) and monetary (printing money and lowering interest rates) an economy can be stimulated. Once business picks back up the government can exit the market and recoup their investment through increased tax revenues.
It appears that the world's central bankers (German's aside) are bent on giving Keynes's theories one massive try. The interesting thing to me is that his theories encompass ALL of the aspects of stimulus not "some" of the inputs. Looking around the world then it is clear that while on the surface his principles are being used to "stimulate" the global economy when you dig deeper there are a number of things amiss and these missing pieces are undermining the efforts.
First let's take a look at Japan. While the world applauded their most recent money stimulus and government spending packages they failed to mention that Japan has already raised the consumption tax and is planning to raise it again. According to Keynes tax reductions are needed in addition to these other stimulus's and so while Japan is using two of the inputs the third is offsetting any perceived benefit.
Europe, the laggard of the group is barely using any stimulus other than monetary. The Germans are even against that but the problem is that fiscal policies remain under the tight constraint of the Eurozone parameters. This makes it near impossible for any of the countries that fall under the EU umbrella to stimulate beyond some monetary stimulus that they receive from the central bank and even this stimulus is becoming increasingly difficult to achieve.
The United States has definitely been the shinning star in terms of monetary policy having printed more than $4 trillion. However on the fiscal side there has been little in the way of shovel ready projects and the tax burden being felt by individuals and businesses is massive. Not only are the tax rates higher but with Obamacare in full force the cost of keeping full time employees is growing and is akin to an additional tax.
The final problem is that virtually none of the countries have had a budget surplus in decades (other than Germany). They were all in a hole before they began printing money and are now in an even bigger one. Furthermore the thought of them ever being able to balance their budgets seems impossible. The United States as an example has not only a huge deficit to fill but with Social Security and Medicare kicking in the chances of a balanced budget are slim to none.
So while it appears that Keynes rules the day, unfortunately his ideas are really nor being followed as if they were I have to believe we would be out of this mess instead of digging a deeper hole each and every day.
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