"What an economy really wants, after all, is not more investment per se but better investment. It wants capital to flow to companies that will create value - not in the form of a rising stock price but in the form of more goods for less cost, more jobs and rising wages - by enhancing productivity." - James Surowiecki
Productivity is another interesting economic input. To create a product you need materials, a plant and labor. The number of products produced for a unit of labor is referred to as productivity. Throughout history there have been major leaps in productivity from the railroad to the Ford manufacturing methodology to the Internet. Each of these has fueled growth and created huge wealth for the innovators. Furthermore there is a body of consensus that points to increases in productivity providing job growth and wage increases, both of which are desperately needed today. So is there another productivity miracle in the works and will it be the golden spoon that pulls the global economy out of its quagmire?
Looking at the last 50 years there have been major leaps in productivity each decade other than the most recent one. This is leading economists to predict that another one is just around the corner however the problem with leaps in productivity is that you never know when it will arrive or where it will come from. Certainly there is more and more money being spent on research and development globally but it is hard to imagine that we will ever see something as impactful as what was witnessed with the creation of the Internet. That said we have witnessed the birth of three dimensional printing that is allowing companies to develop products far more quickly than ever before. On top of that as the price of the printers has dropped significantly more and more people have access to these machines and they are able to tinker away at product development in the comfort of their homes. While this is a great new technology it is hard to imagine it having the productivity impact of the Internet but it may result in the next productivity miracle being designed.
Another recent development has been Fracking. This new technique for extracting oil and gas out of rocks has drawn a lot of skepticism from the environmentalists but it is changing the economic landscape as America is suddenly becoming an energy super power. Once again though this innovation will not provide much in the way of a productivity benefit although it is having a marked impact to the employment numbers in the northern part of the United States.
So we do not know where the innovation will come from but it appears that we have not witnessed the next productivity wave we are only basing the expectation on historical data. Now while I have no doubt that productivity will continue to improve I do have a question as to whether this will have any meaningful impact on unemployment. In the past innovation that resulted in productivity gains resulted in increased employment opportunities and higher wages. As factories became more efficient market share was taken from others and the home country benefited at the expense of others. As I have mentioned before with the advent of the Internet the globe shrank metaphorically speaking as things could now easily be produced in countries with a comparative advantage (see previous blog on this topic). The result of this was an export of jobs to places like China and India. Those that managed to keep their skill set aligned with the changes benefited with higher wages but there was a large portion of the population that has since been made obsolete.
It is this portion of the population that is creating a drag on growth for the simple reason that the balance of the workforce has to make up for the lost wages and purchasing power of these individuals. My contention is that when the next wave of productivity gains appears (and it will) we could see another spike in unemployment. In fact we could be at a point in time where full employment in the United States is no longer 4% but has shifted to 6% or even 7%. Printing more and more money to try to foster employment by businesses in this scenario is pointless as no matter how much money is thrown at the problem the result is still high unemployment numbers. The only result is an ever burgeoning level of government debt and the problems that come with that.
Not that I believe that the way to get people to work is reducing productivity. What will happen over time as productivity continues to improve is that the employment market will shift and workers will adapt to the changes. This takes time and could take decades but the way to lower unemployment under this scenario is for the government to spend their money assisting people on retooling their skills to match the changes in the market place. Instead, the Federal Reserve continues to believe that throwing money at banks will result in a trickle down effect that will eventually reach the out of work sector. This is clearly not happening as improvements in productivity are giving businesses the ability to reduce their workforce while continuing to increase volume.
If the government and the Federal Reserve would take a long hard look at all the entitlements that reduce the desire to work and the stimulus and how it is being spent maybe they would see that a far better way to reduce unemployment is to spend money on innovation and retooling rather than blindly throwing money out the window.
Friday, September 27, 2013
Friday, September 20, 2013
Econometrics: The Big Disappointment
A mathematician, an accountant and an economist apply for
the same job. The interviewer calls in
the mathematician and asks "What do two plus two equal?" The
mathematician replies "Four." The interviewer asks "Four,
exactly?" The mathematician looks at the interviewer incredulously and
says "Yes, four, exactly." Then
the interviewer calls in the accountant and asks the same question "What
do two plus two equal?" The accountant says "On average, four - give
or take ten percent, but on average, four." Then the interviewer calls in the economist
and poses the same question "What do two plus two equal?" The
economist gets up, locks the door, closes the shade, sits down next to the
interviewer and says "What do you want it to equal?"
Three econometricians went out hunting, and came across a
large deer. The first econometrician fired, but missed, by a meter to the left.
The second econometrician fired, but also missed, by a meter to the right. The
third econometrician didn't fire, but shouted in triumph, "We got it! We
got it!"
A mathematician, a theoretical economist and an econometrician
are asked to find a black cat (who doesn't really exist) in a closed room with
the lights off: The mathematician gets
crazy trying to find a black cat that doesn't exist inside the darkened room
and ends up in a psychiatric hospital. The
theoretical economist is unable to catch the black cat that doesn't exist
inside the darkened room, but exits the room proudly proclaiming that he can
construct a model to describe all his movements with extreme accuracy. The econometrician walks securely into the
darkened room, spend one hour looking for the black cat that doesn't exist and
shouts from inside the room that he has it caught by the neck."
It is easy to pick on Economists as the jokes above show. Economics, in my mind, has always been an art even though it falls under the sciences at universities. In an effort to try to make it more precise Econometrics was devised whereby economists use mathematical modeling to determine the probability of certain outcomes. I remember when I was studying economics back in the early 80's this was thought to be the future of the industry that would unlock the secrets of the investment universe so that investors would be able to determine with clarity the risk of an investment and the likelihood of an unwanted economic event.
Fast forward 30 years and while the models have become more and more sophisticated so has the investment marketplace. As more and more intricate investment derivatives are created the ability of the econometric model to predict the risk of an event and more specifically the chance of a fat tail event are becoming more and more feeble. A fat tail event is an event that is not captured under the normal bell curve and therefore has fantastic or disastrous consequences on your portfolio. The fatter the tail the more likely an unknown event is to occur. Finding these fat tails is the job of econometrics but the models have for all intents and purposes failed.
So let's take a look at the two sides of a fat tail. On the one side you have the unknown event that helps you tremendously. For example a cousin's, aunt's mother tells you to dump $100K into Facebook while Zuckerberg is still in college. Little do you know it at the time but it is about to turn you into a billionaire. On the other side of the tail is the catastrophe that was 9/11. On that morning no one was to know what was about to happen and this played havoc with your investment returns, not to mention the poor people and families that were directly involved in the tragedy. This is a fat tail event that was unpredictable and has disastrous consequences.
So although mathematical models are used by economists to take a shot at predicting the future they are not able to capture the one event that haunts ever money manager. In order to protect your portfolio from these fat tail events it has to be broadly diversified. By this I do not mean just into a basket of stocks and bonds but into assets beyond those. In my recently published book How To Thrive In The Obama Economy" (available now on Amazon see link below) I explain the reasons why it is more critical than ever today to look beyond a "normal" portfolio. I encourage you to read the book as I am certain it will help your investment philosophy and your returns.
Looking further at fat tail events there is no need to look further than the returns on the stock market. Since its inception there have been on average 12,000 listed companies. Of these companies roughly 300 represent half of the total stock market capitalization. Furthermore a lot of companies go bust year after year and are replaced by new companies. What this means is that over time only a small fraction of companies have made investors any real money. Miss these companies and your portfolio will really be hurt. This is why investors buy the market using ETFs and is a reason why they are so popular however this strategy opens up the portfolio to the fat tail event. The need to protect your portfolio outside of this one allocation is more important today than ever so take heed, open your eyes and prosper.
http://www.amazon.com/Thrive-Obama-Economy-Stephen-Bick/dp/1490975128/ref=sr_1_1?s=books&ie=UTF8&qid=1379694723&sr=1-1&keywords=stephen+bick
Fast forward 30 years and while the models have become more and more sophisticated so has the investment marketplace. As more and more intricate investment derivatives are created the ability of the econometric model to predict the risk of an event and more specifically the chance of a fat tail event are becoming more and more feeble. A fat tail event is an event that is not captured under the normal bell curve and therefore has fantastic or disastrous consequences on your portfolio. The fatter the tail the more likely an unknown event is to occur. Finding these fat tails is the job of econometrics but the models have for all intents and purposes failed.
So let's take a look at the two sides of a fat tail. On the one side you have the unknown event that helps you tremendously. For example a cousin's, aunt's mother tells you to dump $100K into Facebook while Zuckerberg is still in college. Little do you know it at the time but it is about to turn you into a billionaire. On the other side of the tail is the catastrophe that was 9/11. On that morning no one was to know what was about to happen and this played havoc with your investment returns, not to mention the poor people and families that were directly involved in the tragedy. This is a fat tail event that was unpredictable and has disastrous consequences.
So although mathematical models are used by economists to take a shot at predicting the future they are not able to capture the one event that haunts ever money manager. In order to protect your portfolio from these fat tail events it has to be broadly diversified. By this I do not mean just into a basket of stocks and bonds but into assets beyond those. In my recently published book How To Thrive In The Obama Economy" (available now on Amazon see link below) I explain the reasons why it is more critical than ever today to look beyond a "normal" portfolio. I encourage you to read the book as I am certain it will help your investment philosophy and your returns.
Looking further at fat tail events there is no need to look further than the returns on the stock market. Since its inception there have been on average 12,000 listed companies. Of these companies roughly 300 represent half of the total stock market capitalization. Furthermore a lot of companies go bust year after year and are replaced by new companies. What this means is that over time only a small fraction of companies have made investors any real money. Miss these companies and your portfolio will really be hurt. This is why investors buy the market using ETFs and is a reason why they are so popular however this strategy opens up the portfolio to the fat tail event. The need to protect your portfolio outside of this one allocation is more important today than ever so take heed, open your eyes and prosper.
http://www.amazon.com/Thrive-Obama-Economy-Stephen-Bick/dp/1490975128/ref=sr_1_1?s=books&ie=UTF8&qid=1379694723&sr=1-1&keywords=stephen+bick
Friday, September 13, 2013
The World Is Shrinking
"Globalism began as a vision of a world with free trade, shared prosperity and open borders. These are good, even noble things to aim for." - Deepak Chopra
While the global economy is still trying to recover from the Great Recession global trade is surging. In 2012 world goods exports surged to just over $16 trillion from $12.5 trillion in 2009. It is interesting that this surge in trade is coming on the back of weak global economic expansion but when you look at some of the reasons behind the growth it appears that this trend will continue unabated for the foreseeable future making the world seem to be shrinking.
Basic economic theory states that goods and services will migrate to a country that has a comparative advantage over other countries. Comparative advantage refers to a country's ability to produce goods or services at a lower opportunity cost than another country. This means that even if one country can produce all goods and services at a lower cost than every other country, there is still an opportunity to increase profits by focusing on the goods and services that reduce the overall opportunity cost. So let's assume country A can produce every good and service cheaper than everyone else. Country B however is able to produce certain goods that have a low opportunity cost in country A cheaper (in opportunity cost measures) than country A. Therefore country A stops producing that good and imports this from country B. There is a benefit to both countries in doing this as their overall profit increases.
So let's explore opportunity cost. This is the cost of doing something at the expense of not doing something else. Take for example work versus play. At any given time in the day you could walk out of your office and go for a surf. Now while you are surfing you are not making any money so the opportunity cost is relatively high. That said if you value your free time more than the amount of money you would make during that hour surf session then it would be wise to go surfing. Now to take this one step further it may be that there are no waves that day in which case you would stay at work as suddenly the opportunity cost is higher at work than surfing. So you can see that opportunity costs can vary over time depending on circumstances. This is why countries can have an opportunity cost in one product for a while and then lose it a few years later for the simple reason that international trade shifts all the time.
Looking at how this landscape has changed over the years it is easy to see not only technology at work by also economies of scale. Technology is making it easier and easier to transact globally. It is relatively simple to wire money across borders, find a manufacturer in a foreign country and fly there and back for a small fee. Furthermore shipping costs are falling and with things like three dimensional printing a product can be designed on the fly, the specifications emailed across the globe in seconds and a week later the product is being shipped back to your home port.
Economies of scale are also helping drive the costs down and this too sets the stage for growth in international trade. Architects in London are used to design buildings in Australia and the main infrastructure of the building is made in Indonesia with parts shipped from China. These parts are then shipped from Indonesia to Australia where they are assembled much like Lego blocks with the finishing touches done by Australian artisans. The only way that this can be done in a cost effective manner is if each part of the equation is cheaper than doing it in the home country. Looking more carefully at this example the cost of the building is mainly made up of parts and labor. Parts are far cheaper in China and labor costs only $7 a day in Indonesia. So all that is left is to make sure that the shipping costs do not blow the budget.
To this end Maersk is building 20 Triple-E container ships. These behemoths are as long as the Empire State building and can house 18,000 containers, enough to ship 182 million i-Pads in one go. The ship itself weighs 55,000 tons. One link in the anchor chain weighs 500 pounds. If you stacked the containers end to end they would stretch over 68 miles. Fuel one way from Rotterdam to Shanghai costs around $2.5 million. The bet of course is on the continued growth of global trade but as amazing at is first appears it also is driving down the cost shipping. The reason of course is the economies of scale. Back in 1956 to ship one ton of freight across the Atlantic was $5.83. Using container ships drove this down to 15.8 cents per ton. Using the Triple - E will drive these costs even lower and that is the benefit of economies of scale.
Interestingly the boat is being built in South Korea with parts shipped in from around the globe and assembled on the docks. It is clear that with the continued advances in technology combined with economies of scale and comparative advantage, global trade will continue to flourish. This should be seen as a positive as it will draw the global closer together and should foster better relations between countries. The one fly in the ointment would be war and while one can never count this out unless Syria sparks an international divide, for the foreseeable future global trade should continue to flourish.
While the global economy is still trying to recover from the Great Recession global trade is surging. In 2012 world goods exports surged to just over $16 trillion from $12.5 trillion in 2009. It is interesting that this surge in trade is coming on the back of weak global economic expansion but when you look at some of the reasons behind the growth it appears that this trend will continue unabated for the foreseeable future making the world seem to be shrinking.
Basic economic theory states that goods and services will migrate to a country that has a comparative advantage over other countries. Comparative advantage refers to a country's ability to produce goods or services at a lower opportunity cost than another country. This means that even if one country can produce all goods and services at a lower cost than every other country, there is still an opportunity to increase profits by focusing on the goods and services that reduce the overall opportunity cost. So let's assume country A can produce every good and service cheaper than everyone else. Country B however is able to produce certain goods that have a low opportunity cost in country A cheaper (in opportunity cost measures) than country A. Therefore country A stops producing that good and imports this from country B. There is a benefit to both countries in doing this as their overall profit increases.
So let's explore opportunity cost. This is the cost of doing something at the expense of not doing something else. Take for example work versus play. At any given time in the day you could walk out of your office and go for a surf. Now while you are surfing you are not making any money so the opportunity cost is relatively high. That said if you value your free time more than the amount of money you would make during that hour surf session then it would be wise to go surfing. Now to take this one step further it may be that there are no waves that day in which case you would stay at work as suddenly the opportunity cost is higher at work than surfing. So you can see that opportunity costs can vary over time depending on circumstances. This is why countries can have an opportunity cost in one product for a while and then lose it a few years later for the simple reason that international trade shifts all the time.
Looking at how this landscape has changed over the years it is easy to see not only technology at work by also economies of scale. Technology is making it easier and easier to transact globally. It is relatively simple to wire money across borders, find a manufacturer in a foreign country and fly there and back for a small fee. Furthermore shipping costs are falling and with things like three dimensional printing a product can be designed on the fly, the specifications emailed across the globe in seconds and a week later the product is being shipped back to your home port.
Economies of scale are also helping drive the costs down and this too sets the stage for growth in international trade. Architects in London are used to design buildings in Australia and the main infrastructure of the building is made in Indonesia with parts shipped from China. These parts are then shipped from Indonesia to Australia where they are assembled much like Lego blocks with the finishing touches done by Australian artisans. The only way that this can be done in a cost effective manner is if each part of the equation is cheaper than doing it in the home country. Looking more carefully at this example the cost of the building is mainly made up of parts and labor. Parts are far cheaper in China and labor costs only $7 a day in Indonesia. So all that is left is to make sure that the shipping costs do not blow the budget.
To this end Maersk is building 20 Triple-E container ships. These behemoths are as long as the Empire State building and can house 18,000 containers, enough to ship 182 million i-Pads in one go. The ship itself weighs 55,000 tons. One link in the anchor chain weighs 500 pounds. If you stacked the containers end to end they would stretch over 68 miles. Fuel one way from Rotterdam to Shanghai costs around $2.5 million. The bet of course is on the continued growth of global trade but as amazing at is first appears it also is driving down the cost shipping. The reason of course is the economies of scale. Back in 1956 to ship one ton of freight across the Atlantic was $5.83. Using container ships drove this down to 15.8 cents per ton. Using the Triple - E will drive these costs even lower and that is the benefit of economies of scale.
Interestingly the boat is being built in South Korea with parts shipped in from around the globe and assembled on the docks. It is clear that with the continued advances in technology combined with economies of scale and comparative advantage, global trade will continue to flourish. This should be seen as a positive as it will draw the global closer together and should foster better relations between countries. The one fly in the ointment would be war and while one can never count this out unless Syria sparks an international divide, for the foreseeable future global trade should continue to flourish.
Friday, September 6, 2013
An Economic Recovery?
"People are realizing that they cannot make it in the current Wall Street dominated corporate capitalist economy. It is not designed for most people to make it. Rather it is designed for a small percentage to profit while everyone else is exploited and economically insecure." - Kevin Zeeze and Margaret Flowers
This week there were some signs of an economic recovery. There were some impressive numbers from the service sector with the US ISM non-manufacturing index jumping in August to a seven-year high of 58.6. This points potentially to an improvement in GDP growth in the third quarter. Looking deeper into the number it appears that most of the demand came from internal orders and not exports so there is hope that the local economy may be on more solid ground than previously thought. The payroll report today was not great as it appears that the level of growth in payrolls is slowing however there is still growth which is mildly encouraging.
On the European front it appears that certain of the economies are starting to recover and unemployment while still high seems to have stabilized. So with both of these economies appearing to be in recovery mode it must now be time for the Federal Reserve to exit the market, right? The issue is that as I have mentioned repeatedly, the recovery is very tentative and any sign that the safety net that is the Federal Reserve will be removed will have dire consequences on the stock and bond markets. The question is will a spike in bond yields combined with a sudden drop in the stock market unnerve the Federal Reserve and send them back to the printing presses? My guess is that it will as it has in the past and therefore there is no reason to believe that this time will be any different.
Beneath the surface of this recovery is a very tepid technology sector, weak growth in the small business market, slow growth in employment and increased expenditure coming in the form of Obamacare. Furthermore stock prices are exceptionally elevated and have baked in a far more robust recovery. Removing the stimulus will take away the fuel and the fire will die. As an example of stocks at ridiculous levels take a look at the stock of the year Tesla. Now I have seen their cars and have been told they are fantastic to drive but the stock is trading at a market capitalization of over $21 billion on earnings of negative $112 million. Sure they did report a profit this last quarter but please, the headwinds against this company are still enormous and to command such a lofty market capitalization you need to be selling cars into the mass market and not just to the rich and famous in California. At the current vehicle sticker price that is not an option.
So it will be very interesting to see at the FOMC meeting later this month whether the Federal Reserve will consider trying to taper again and how the market reacts this time. Based on previous meetings it is clear that even the Federal Reserve knows that it needs to exit this printing game but the question is how as they have shown that they have no stomach for a stock market crash. Furthermore if yields on the 10-year bond rise much higher any form of recovery in the housing market will be put to rest right as they are deciding to exit the government owned mortgage finance companies, Fannie Mae and Freddie Mac. It seems that once again the officials have timed the exit from the housing market to perfection!
This week there were some signs of an economic recovery. There were some impressive numbers from the service sector with the US ISM non-manufacturing index jumping in August to a seven-year high of 58.6. This points potentially to an improvement in GDP growth in the third quarter. Looking deeper into the number it appears that most of the demand came from internal orders and not exports so there is hope that the local economy may be on more solid ground than previously thought. The payroll report today was not great as it appears that the level of growth in payrolls is slowing however there is still growth which is mildly encouraging.
On the European front it appears that certain of the economies are starting to recover and unemployment while still high seems to have stabilized. So with both of these economies appearing to be in recovery mode it must now be time for the Federal Reserve to exit the market, right? The issue is that as I have mentioned repeatedly, the recovery is very tentative and any sign that the safety net that is the Federal Reserve will be removed will have dire consequences on the stock and bond markets. The question is will a spike in bond yields combined with a sudden drop in the stock market unnerve the Federal Reserve and send them back to the printing presses? My guess is that it will as it has in the past and therefore there is no reason to believe that this time will be any different.
Beneath the surface of this recovery is a very tepid technology sector, weak growth in the small business market, slow growth in employment and increased expenditure coming in the form of Obamacare. Furthermore stock prices are exceptionally elevated and have baked in a far more robust recovery. Removing the stimulus will take away the fuel and the fire will die. As an example of stocks at ridiculous levels take a look at the stock of the year Tesla. Now I have seen their cars and have been told they are fantastic to drive but the stock is trading at a market capitalization of over $21 billion on earnings of negative $112 million. Sure they did report a profit this last quarter but please, the headwinds against this company are still enormous and to command such a lofty market capitalization you need to be selling cars into the mass market and not just to the rich and famous in California. At the current vehicle sticker price that is not an option.
So it will be very interesting to see at the FOMC meeting later this month whether the Federal Reserve will consider trying to taper again and how the market reacts this time. Based on previous meetings it is clear that even the Federal Reserve knows that it needs to exit this printing game but the question is how as they have shown that they have no stomach for a stock market crash. Furthermore if yields on the 10-year bond rise much higher any form of recovery in the housing market will be put to rest right as they are deciding to exit the government owned mortgage finance companies, Fannie Mae and Freddie Mac. It seems that once again the officials have timed the exit from the housing market to perfection!
Thursday, August 29, 2013
The Current Account Conundrum
"Well, the U.S. is running a current account deficit; we are creating lots of investment opportunities in the United States that exceed our own domestic savings rate, so the issue here is to encourage higher savings rates in the United States." - John Snow
As the Federal Reserve debates when to scale back on its massive quantitative easing program shudders are being felt around the world. In an article penned by Stephen Roach, one of Yale's most prodigious economists, he states that the current account deficits being run in countries such as Brazil, South Africa, Turkey and Indonesia (to mention a few) will rear their ugly heads once the Federal Reserve cuts its massive stimulus program. Mr. Roach has his finger pointed firmly at the central bankers of the world for overindulgence in printing money as the cause once again of these countries coming plight.
In effect he has said that central bankers around the world believe that they are able to manage their economies so well that current account deficits are nothing to worry about. The problem with these deficits is that they have to be financed by someone. Up to now that someone has been the Federal Reserve as yield seeking investors have taken over $4 trillion and plowed it into developing nations fueling the bonfire. The problem is that when the fuel runs out, it is hard to keep the economy warm. The effects of this are being felt in these nations as their currencies are taking a beating against the dollar and the economies splutter for air.
In simple terms a current account deficit comes about when a country imports more than it exports. It is widely viewed that a developing nation running a current account deficit is headed for recession. However, if the deficit is temporary then going into deficit can be a useful way to stimulate an economy. If a country can import products, run a short term current account deficit while turning these imports into products that stimulate the economy reversing this trend then there is nothing to worry about. The issue comes when these imports are not used wisely and it appears that rather than invest this stimulus it has been used to live beyond their economic means. As the Federal Reserve switches off the stimulus hose these economies will be left to repay the investment. This would not be a problem if they were running current account surpluses but as this is not the case it looks like they will have a hard time doing making these payments and this could be the beginning of another global mess.
So if current account deficits are bad, how can the United States continue year after year, to run a massive deficit? The answer is that being the largest economy in the world it pays all the other players of the globe to support this deficit. Furthermore the United States has the ability to finance this deficit and make good on their interest payments. It is considered a safe bet and until this opinion changes it can run current account deficits.
The question is how long can this current account deficit be run before the amount owed is so large that the rest of the world questions whether it has the ability to repay the debt? At present this seems a long way off for the simple reason that the rest of the world is dealing with their own problems and certainly cannot afford to have a crippled US economy. That said a spike in interest rates could unravel this happy equation and reeling in the stimulus could have this effect as there will then be no false market to keep interest rates low. On the other side of the equation continuing to print is unsustainable as the emerging economies can attest. The answer could be to encourage saving but with interest rates at all time lows it is hardly conducive to encouraging savings.
This means that there is no easy way out of the hole that they have dug but as Will Roger's said, "When you find yourself in a hole, the first thing to do is to stop digging." It is time for the Federal Reserve to own up to this fact and start to look at the problem through an eyeglass that portrays realism rather than speculation.
As the Federal Reserve debates when to scale back on its massive quantitative easing program shudders are being felt around the world. In an article penned by Stephen Roach, one of Yale's most prodigious economists, he states that the current account deficits being run in countries such as Brazil, South Africa, Turkey and Indonesia (to mention a few) will rear their ugly heads once the Federal Reserve cuts its massive stimulus program. Mr. Roach has his finger pointed firmly at the central bankers of the world for overindulgence in printing money as the cause once again of these countries coming plight.
In effect he has said that central bankers around the world believe that they are able to manage their economies so well that current account deficits are nothing to worry about. The problem with these deficits is that they have to be financed by someone. Up to now that someone has been the Federal Reserve as yield seeking investors have taken over $4 trillion and plowed it into developing nations fueling the bonfire. The problem is that when the fuel runs out, it is hard to keep the economy warm. The effects of this are being felt in these nations as their currencies are taking a beating against the dollar and the economies splutter for air.
In simple terms a current account deficit comes about when a country imports more than it exports. It is widely viewed that a developing nation running a current account deficit is headed for recession. However, if the deficit is temporary then going into deficit can be a useful way to stimulate an economy. If a country can import products, run a short term current account deficit while turning these imports into products that stimulate the economy reversing this trend then there is nothing to worry about. The issue comes when these imports are not used wisely and it appears that rather than invest this stimulus it has been used to live beyond their economic means. As the Federal Reserve switches off the stimulus hose these economies will be left to repay the investment. This would not be a problem if they were running current account surpluses but as this is not the case it looks like they will have a hard time doing making these payments and this could be the beginning of another global mess.
So if current account deficits are bad, how can the United States continue year after year, to run a massive deficit? The answer is that being the largest economy in the world it pays all the other players of the globe to support this deficit. Furthermore the United States has the ability to finance this deficit and make good on their interest payments. It is considered a safe bet and until this opinion changes it can run current account deficits.
The question is how long can this current account deficit be run before the amount owed is so large that the rest of the world questions whether it has the ability to repay the debt? At present this seems a long way off for the simple reason that the rest of the world is dealing with their own problems and certainly cannot afford to have a crippled US economy. That said a spike in interest rates could unravel this happy equation and reeling in the stimulus could have this effect as there will then be no false market to keep interest rates low. On the other side of the equation continuing to print is unsustainable as the emerging economies can attest. The answer could be to encourage saving but with interest rates at all time lows it is hardly conducive to encouraging savings.
This means that there is no easy way out of the hole that they have dug but as Will Roger's said, "When you find yourself in a hole, the first thing to do is to stop digging." It is time for the Federal Reserve to own up to this fact and start to look at the problem through an eyeglass that portrays realism rather than speculation.
Friday, August 23, 2013
A Perfect Signal
"Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell."
"If you want to have a better performance than the crowd, you must do things differently from the crowd."
"The four most dangerous words in investing are 'This time it's different'." - All three are quotes from one of the world's best traders Sir John Templeton
In trading there are a number of keys to making money, a few of which are presented in the quotes above. Traders are constantly searching for a signal that will give them an edge over their fellow traders and the market. Using this edge they can amass a small fortune by timing the market and predicting the direction of the move. In order to keep that fortune a high level of discipline is required to exit poor positions, but that topic will be left for another day.
When a trader finally finds a signal that works he or she will protect that signal fiercely as once the word gets out, more and more people will use the signal and its value will eventually vanish. Interestingly that does not mean that the signal is lost forever as once the signal losses its predictive value everyone moves on and, guess what, the signal will suddenly start to work again. So traders spend their time trying to find signals that work, move on when they don't and circle back around to check old signals to see if they are "working" again.
So what if there is a signal that has worked remarkably well for the last 150 years? I would think that you would take notice of that signal unless the signal has no economic merit. I will explain this by way of an example. The so called Super Bowl Indicator says that if the team from the AFC division wins the Super Bowl then the market will decline the following year and if the NFC team wins then the market will rally. Now while there is a relatively high level of correlation between the team that wins and the following year of market returns, no-one takes this too seriously as there is no economic link between a football team winning a game and the stock market, it is just a happenstance!
Now what if the signal does have some economic merit? Well obviously we would take serious notice of this. So does the Skyscraper Index have economic merit and what is the Skyscraper index? This index was first discovered in 1999 and has been providing a good indicator of economic recessions for over 150 years. It turns out that every time a country decides to build a building that once completed will become the tallest in the world, it signals the beginning of a severe economic slowdown in that country. The most recent signal was the building of Burj Khalifa in Dubai in 2008 right at the beginning of the worst financial crisis since the Great Depression. Prior to that the Chrysler Building was built right at the start of the Great Depression and the World Trade Center was completed right on the eve of a recession.
So with this is mind it is a little eerie to see ground being broken on the Sky City building in Changsha China. It is not hard to see that this signal may once again prove itself valid and point to an economic slow down in China. Already their economy is stuttering and it will not take much of an exogenous shock to push it right off the rails. So the question is should we take this signal with a pinch of salt or seriously, in other words does it have any economic merit?
While building a tall build in and of itself has no economic merit, the fact that it is the world's tallest does in fact have some merit for the simple reason that building a structure of this magnitude is normally a sign of economic ego. The authorities are trying to show the world that they are financially strong and it is a signal that the underlying economy is burgeoning. It is a show piece of economic strength. The problem is that it takes years of planning to finally get a shovel in the sand and by that time economic euphoria has set in or is fading; just as is the case in China (see the quotes above as a point of reference). This is the reason that the signal works. These buildings are thought of at the peak of economic euphoria which is the exact time when caution should be taken.
Looking out a year or two I would not be at all surprised to see that this signal once again marked the time when the economy (in this case it will be China's economy) took a tumble. The problem is that with China slowing down this could be a signal that marks the beginning of the next global recession. Certainly not a time to be euphoric.
"If you want to have a better performance than the crowd, you must do things differently from the crowd."
"The four most dangerous words in investing are 'This time it's different'." - All three are quotes from one of the world's best traders Sir John Templeton
In trading there are a number of keys to making money, a few of which are presented in the quotes above. Traders are constantly searching for a signal that will give them an edge over their fellow traders and the market. Using this edge they can amass a small fortune by timing the market and predicting the direction of the move. In order to keep that fortune a high level of discipline is required to exit poor positions, but that topic will be left for another day.
When a trader finally finds a signal that works he or she will protect that signal fiercely as once the word gets out, more and more people will use the signal and its value will eventually vanish. Interestingly that does not mean that the signal is lost forever as once the signal losses its predictive value everyone moves on and, guess what, the signal will suddenly start to work again. So traders spend their time trying to find signals that work, move on when they don't and circle back around to check old signals to see if they are "working" again.
So what if there is a signal that has worked remarkably well for the last 150 years? I would think that you would take notice of that signal unless the signal has no economic merit. I will explain this by way of an example. The so called Super Bowl Indicator says that if the team from the AFC division wins the Super Bowl then the market will decline the following year and if the NFC team wins then the market will rally. Now while there is a relatively high level of correlation between the team that wins and the following year of market returns, no-one takes this too seriously as there is no economic link between a football team winning a game and the stock market, it is just a happenstance!
Now what if the signal does have some economic merit? Well obviously we would take serious notice of this. So does the Skyscraper Index have economic merit and what is the Skyscraper index? This index was first discovered in 1999 and has been providing a good indicator of economic recessions for over 150 years. It turns out that every time a country decides to build a building that once completed will become the tallest in the world, it signals the beginning of a severe economic slowdown in that country. The most recent signal was the building of Burj Khalifa in Dubai in 2008 right at the beginning of the worst financial crisis since the Great Depression. Prior to that the Chrysler Building was built right at the start of the Great Depression and the World Trade Center was completed right on the eve of a recession.
So with this is mind it is a little eerie to see ground being broken on the Sky City building in Changsha China. It is not hard to see that this signal may once again prove itself valid and point to an economic slow down in China. Already their economy is stuttering and it will not take much of an exogenous shock to push it right off the rails. So the question is should we take this signal with a pinch of salt or seriously, in other words does it have any economic merit?
While building a tall build in and of itself has no economic merit, the fact that it is the world's tallest does in fact have some merit for the simple reason that building a structure of this magnitude is normally a sign of economic ego. The authorities are trying to show the world that they are financially strong and it is a signal that the underlying economy is burgeoning. It is a show piece of economic strength. The problem is that it takes years of planning to finally get a shovel in the sand and by that time economic euphoria has set in or is fading; just as is the case in China (see the quotes above as a point of reference). This is the reason that the signal works. These buildings are thought of at the peak of economic euphoria which is the exact time when caution should be taken.
Looking out a year or two I would not be at all surprised to see that this signal once again marked the time when the economy (in this case it will be China's economy) took a tumble. The problem is that with China slowing down this could be a signal that marks the beginning of the next global recession. Certainly not a time to be euphoric.
Friday, August 16, 2013
Speculate Like Its 1999
"I was dreamin' when I wrote this, Forgive me if it goes astray
But when I woke up this mornin', Could of sworn it was judgment day
But when I woke up this mornin', Could of sworn it was judgment day
The sky was all purple, There were people runnin' everywhere
Tryin' to run from the destruction, You know I didn't even care
Tryin' to run from the destruction, You know I didn't even care
'Cause they say two thousand zero zero, Party over, oops out of time
So tonight I'm gonna party like it's 1999" - Lyrics to the Prince song 1999
So tonight I'm gonna party like it's 1999" - Lyrics to the Prince song 1999
For those of you who traded through the 90's it was a time when speculation was rife. It was extremely easy to make a killing and many people did just that. The problem was that once the party was over the market cratered. Tech stocks were the hardest hit as their earnings were non-existent. Stocks values were based on concepts and perception rather than solid fundamentals. On top of this the rally was fueled by Greenspan money printing. A lot of this money found its way into the stock market and the frenzy fed off itself until one magic day the frenzy stopped. The party was over and the hangover set in.
Today is not much different. Stock earnings ratios are nearing their highs of 2007 right before the last crash, bad news is ignored and the focus is on the 50 day moving average over fundamentals. Will this magical line hold and if so the speculators will pile in once again blindly trading off this signal. I would not be surprised if there is not another new all time high printed very shortly. The problem as I have repeatedly mentioned throughout this blog is that all of this frenzy is being created by easy money printing and is not based on proper fundamental value. As we have seen time and time again this will end poorly but this time it is different for the simple reason that never in the history of man has there been such a combined global monetary easing effort as the one currently being undertaken. Moreover for all the effort there is no success other than a high flying market and a once burgeoning housing market.
I say once burgeoning housing market as the recent data points of housing starts and resale have slowed considerably for the simple reasons that house prices have rapidly become unaffordable to the masses and interest rates at 4.6% have put a lot of potential purchasers on hold. To think that a rate rise to 4.6% can derail the housing market is a signal in and of itself as that rate is low by historical standards. The fact that the rise to this level has caused buyers to walk from purchases points to a very weak economy and not something to be proud of if you are the Federal Reserve.
Furthermore the Federal Reserve as we have seen recently with the hiccup in the market at the announcement of the tapering of their purchases has painted themselves into a corner. If they stop printing money bond yields will rise choking any growth and the stock market will dive into the abyss. As these are the only two data points that show any kind of success losing control of these markets without a feasible plan of action in place will undermine the Feds credibility and place the economy in the hands of the open markets. This is when the end will not be pretty as for the first time since the 90s the markets of the world will ignore the Federal Reserve and deal with the problem head on making the hangover of 1999 seem tame. With Bernanke set on printing to the end of his term and then scampering off back to the bubble world of learning institutions the mess will have to be sorted out by someone else. The problem is that the lineup all seem to be intent of blasting more champagne corks into the air rather than dishing out the pain relievers and hitting the gym!
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