Saturday, June 27, 2009

Waxman-Markey Cynical or Gullible?

In 10 years the Waxman-Markey bill intends to dictate that energy consumption will be reduced by about 16% for the USA. This is an incredible statement and it is hoped this is not the administration's true objective.

We will hope that Waxman-Markey will not be achieved as it is an anarchistic luddite dream, a scholl boys romantic social engineered idea as to what the good society is all about. If reduction of 16% in energey is achieved, then this will have adverse consequences similar to the great Stalinist social engineering experiments - such as Aral Sea irrigation schemes or collectivization of the Ukraine agricultural regions. Only by going to Stalin's record can one find what are the results of such statist edicts which would reflect similar size of impact on a nation's GDP. (I am not even going near Pol Pot's "green" policy of deciding everyone deserved the farm life versus the terrible urban life)

The Waxman-Markey 16% reduction of carbon in ten years, if achieved, will result in an almost .5 reduction in GDP % from projected 2020 levels for every 1% drop in carbon emissions; which would mean the size of the 2012 GDP would be close to current recession 2009 levels.

A 16% reduction in carbon would therefore, if achieved, force a Japanese lost decade on the USA. But that is not taking into account that the base starting GDP, 2009, is in the midst of a serious economic crisis. In normal times the above would result but considerign where we are now, in addition to the above, Waxman-Markey would hit head on the Fed Reserve attempts to "never again" let the 1930s monetary tightness occur (Bernanke's apology to Freidman and Schwartz 2003), the Fed's 2 trillion growing to 3 trillion balance sheet, and would likely end with ruin of the nation likely making a Wiemar Republic like stagflation a sure thing.

So one is hoping Waxman-Markey is being cynically imposed with no desire to reach the intended reduction of carbon, but the real objective is to raise de facto tax revenue. The CBO has already calculated and the Obama administration has stated, cap and trade will generate approximately 1.2 trillion, reaching $300 billion per annum, of funds for the public sector by 2020.

It is hoped Obama has no intention of achieving the reduction in carbon as outlined and that cap and trade is a tax directed at the most ineffective area of the economy to tax - the corporations. Taxes imposed on corporates are immediately down streamed to the household in the forms of after tax cost of borrowings, return on dividends, corporate bonds, and the pricing of goods and services.

If this is the Obama administration intent with Waxman-Markey - then this is a most "European" cynical attempt to enlarge the public sector share of GDP and shift power and revenue from the private sector to the public sector, using "global warming" as a Trojan Horse. This is breath taking in the application of cynicism.

The reduction of carbon by 1.2 billion metric tons objective of Waxman-Markey from the levels assumed to be in place in 2020 can not be achieved but by a reduction in GDP. USA is already has the most efficient use of energy per lifestyle of any OECD countries. The increased demand on margin for crude per increase in GDP use to be a 1:1 relationship in the 70s and 80s, but since the mid 80s that has dropped to roughly .5 increase of crude to 1 increase in GDP. No other country is showing such efficiency in use of crude.

Barring a radical discovery or re-application of energy - the only ones on the horizon being nuclear fission or fusion - there are no more efficiencies to be wring out of the system.

Obama's Chicago guys know this, I think.

As Rahm says : "never let a crisis go to waste" - well he also would say "never let a mass emotional religious hysterical movement go to waste"

Notice I have not even approached the veracity of "global warming". Guess I just did. What I strongly suspect is the likes of Rahm have done what I did and spent several hours researching "global warming". Something about the man tells me he would not just blindly accept the likes of Gore's prattle just as I do not. Something tells me his research has come to the same conclusion of anyone who has spent more than 10 hours looking for primary sources and trying to achieve a direct comprehension of the math and methods of the scientific "evidence" applicable to global warming. I am certain Rahm is as bright and as industrious as I am - likely much more so in both categories - so I can only conclude that Rahm came to the same conclusion that I did after doing that. Rahm likely thinks "global warming" is religious emotional humbug. But this is where Rahm and I part path's - Rahm would never let anything like this go to waste and has proceeded to champion cap and trade as the answer to a global crisis which in his heart of hearts he doesnt think even exists.

These are bad fellows, I suspect.

The increased savings rate and reduction in consumption from this crisis is coincidently about 1 trillion dollars over the next few years. This is similar to the revenues raised for the public sector by Waxman-Markey. Therefore the de facto increase of tax via this Waxman-Markey will double the adverse impact of the core cause of the current economic recession. Then, as there is pretty well no offset in public sector investment a la Keynes to offset the current drop in consumption, and now with the addition of the planned increase in corporate tax from Waxman-Markey, we can likely be assured of a 15% unemployment rate and savings now motivated to go to about the same level. Waxman-Markey is answering a crisis with a catastrophe.


Unless Obama shows up with not windmills in the sea and other nifty romantic and totally silly green blather in terms of public investment, butObama starts to outline a public investment program in terms of about 2 trillion in public sector investment in either war or permanent services or infrastructure [but infrastructure cannot be done as this would by definition "cost" about 1 bil in carbon emissions], a depression is pretty well baked in the cake.

The major effort for what I think Rahm et al are truly after - a 50 year Democratic power control similar to the years of FDR and Rayburn and LBJ, will be dashed in terms of acheiving this power status as enraged folks from both sides of the spectrum and especially the middle will never trust a national level Democrat for a century to come.

The left-green side will see what cynics the Dems are and how they were used to impose large structural taxes (Greenpeace is already sniffing this out) and the right wing will carry on fighting the Dems for obvious reasons; but more importantly the middle ground, after going through 10 years of quasi-depression and recession, will return to Reagan like nationalistic centric leadership - shedding once and for all any European sensibilities.

And of course just about then, around 2020, the nature of sunspots influence and real science emerge (there are some Galileo's out there not saying a word as they keep away from the "Church of Global Warming" inquisition) and "global warming" goes the way of that last great social science - Marxist-Leninism.

Waxman-Markey is either the just about the most cynical and wicked legislation ever offered or is the most innocent, foolish, and gullible. I can not determine which.

Byron's Don Juan on today's economic crisis

A good "devotion" , a meditation that I am almost finished with is reading Don Juan by Lord Byron entire. I am now on Canto XIV.

Most of the poem cloaks Byron's deeper concern, almost as if he were worried that folks would see through his public personae and see his true contemplative soul. So one has to patiently read stanza after stanza of tongue in cheep and near flippant wit. But it turns out these pages upon pages of light wit frames the value of the core seminal observations all the more, and thereby serve the purpose of outlining and supporting the important thoughts. I now have the view one cannot read excerpts of Don Juan as this framing is then missing.

Here was the start of Canto XIV which though Byron was addressing t0 societal philosophy of his day and age seems of interest today:

If from great Nature's or our own abyss
Of thought we could but snatch certainty,
Perhaps mankind might find the path they miss,
But then 'twould spoil much good philosophy.
One system eats another up, and this
Much as old Saturn ate his progeny,
For when his pious consort gave him stones
In lieu of sons, of these he made no bones.

But System doth reverse the Titan's breakfast
And eats her parents, albeit the digestion
Is difficult. Pray tell me, can you make fast
After due search your faith to any question?
Look back o'er ages ere unto the stake fast
You bind yourself and call some mode the best one.
Nothing more true than not to trust your senses,
And yet what are your other evidences?

For me. I know nought. Nothing I deny,
Admit, reject, contemn; and what know you,
Except perhaps that you were born to die?
And both may after all turn out untrue.......

Canto XIV, 1-3, Don Juan, Byron.

All fine advice to current pundits and economists.

Blog - what it is worth, is reopened

Closed this down to make certain no work related conflict of interest occured.

Back to bathos.

Wednesday, February 25, 2009

Obama Timeline: Risk and SPX

Really cannot be much of a debate that the market is trading to a one factor model - the unveliling of the Obama fiscal policy in response to the crisis.

From the trial balloon float of the "Obama-Biden Plan" which allowed Obey to use as a base to write H.R. 1, the stimulus plan. The plan is not Keynesian in nature and will, through simple accounting identities, not offset the rise in savings and the drop in consumption (at one point 70% of the USA NGDP). Simple analysis along the lines of Kelecki-Levy (see previous posts) suggest that SPX earnings - if this is what we have - will be around $30 for 2009. The risk premia per annum in the long intermediates is moving back to pricing deflation as the main risk, close to negative. This means the $30 for SPX 2009 earnings is not a technical one time event but endemic and likely to go lower.

Expectations are being destroyed.

This is a classic preamble of a debt-deflation spiral (Fisher) - though most of us thought we would never encouter this for real and it would never leave the text book pages and be kept as a strange economic history of our grandparents.

The graph shows the SPX noting key releases of Obama's fiscal plan and the market pricing per annum of the risk in holding long intermediate risk free bonds. Basically positive numbers show the market is concerned that the Fed will restrain inflation and maintain their "full employment" mandate. With negative values the market is pricing risk of the opposite that the Fed will have to manage deflation and reflate the market (depression).

Friday, February 13, 2009

Wall St Executive Pay: "Burn the Witch!"

I have to confess something - and this might explain alot to anyone still reading these things. All the success I have had in "trading" markets or at least responding in an adequate defensive way, has come from 3 key sources. 1) Inside the Yield Book; 2) Fear and Loathing in Las Vegas; 3) Monty Python. Since all three sources are considered too shallow or bizarre to be so fundamental for anyone in responsibility, I get my key idea from these three sources and then dutifully dig and prod within a whole massive array of ponderous technical and literative and current market info sources. I mean I do do my hours of study. But, and again this might not reflect well on me, I usually find that the brief insight I received from those three core sources are 95% of the core explanation for my actions. So far these three sources have served me well.

In the current debate and criticism of executive pay, the following from Monty Python immediately leaped into my mind:

Thats about all you need to know to understand how important, how critical, and how effective the Wall St executive pay issue is in the context of our current crisis.

The executive pay issue is solely to appease the mob by the leadership and buy some time and carry on in their own rule. Entertainment to try and ease some fear and developing pressures with the peasants.

But this issue could end up being one of several reasons why we get distracted and completely blow it as we feel we have accomplished something with "burn the witch".

(Oh, in the film snippet above, beautiful gem of a "knight" leader pondering and wrestling with a bird and a coconut - our House and Senate wrestling with key economic variables in regards to the H.R. 1?)

Thursday, February 12, 2009

SPX to go to at least sub 400 if nothing done

The savings rate is rising - no doubt and most would agree we aer past 3% and headed towards 7%. Likely we will go through 10% and considering the environment such a savings rate will give us - not peak until past 15%. I mapped out savings rate and the obvious effect that will have on consumption (65% plus of GDP) in this graph:

The green line which was only a few billion for many recent years and actually negative recently as folks liquidated savings to maintain lifestyle as home equity and revolving credit became unavailable, and is now on a sharp upward trajectory. The orange line is obviously effected and assuming a small drop in consumption in terms of share of GDP and the drop in consumption being matched to some degree from the rise in savings, I come up with a $1.2 trillion hit to the economy. The blue line tracks the history of the saving rate showing a return to 10% being the norm before we had "securitized nation", and then likely going on to 15% as fear and loathing develops.

Trade imbalances have suddenly "improved" - but really they reflect to rise in savings and the drop in consumption. The rapid improvement of the trade imbalances from about $70 billion deficit towards $38 billion deficit per annum shows a large drop in consumer goods and finished product imports - along with oil.

I move the annual trade deficit from $700 billion per annum deficit to $300 billion deficit per annum.

It is highly unlikely that China has positive GDP this year which from their stated views would result in an incredible - 7% output gap.

The grid of the major variables to derive the Kalecki-Levy identity for corporate profits from a macro perspective is:

The 740 bil per annum is the amount of derived corporate profit for the USA suing this identity, about 40% of earnings close 2007.

I then try to figure out the share of SPX earnings over time of the corporate earnings for the whole country - should be similar to earnings ratio of Wilshire versus SPX.

I then calibrate the above and find that SPX earnings graph out to $30 for 2009.

Hard to not to see SPX at a single digit multiple in that environment and the index sub 300.

This is a real market way to examine how important it is to provide a stimulus offset to that rise in savings and drop in consumption. By definition has to be at least $1 trillion assuming a money multiple of 1. Most I have read is a tax cut multiple if it is "demand side" will have a multiple of .2 and spending around 1. So H.R. 1 might possibly provide about $400 bil of offset to this drop in consumption which would be about $45 SPX 2009 earnings.

Lastly the texture of the equity market is dangerously stressed. While VIX has waxed and waned and seems well off the 70% plus levels of the worst of November, the long dated vol, 1 year plus is over 40% and has stayed over 40% since November. This implies a 2 1/2 % move on average for the next several years in the daily SPX. Untenable. Something will break to move volatility for the long run to sub 1%. Usually some cataclysmic natured event occurs which just eliminates all reasons to speculate, to defend or to prosper is what will move long dated vol back down.

Saturday, February 7, 2009

My National Stimulus Plan - 970 bil, problem solved (Oh - make that 970.1 bil)

The Robertson Suite of Acts

Everything I have read or know suggests that not only is the following the recommended plan, but it is what will occur. There is a tremendous force based on basic principles of double sided national accounting always present. Every asset has a liability and vice versa. Books will balance just as waters will find their level. This is why in past work I constantly evoke Pacioli - the monk in the Renaissance who invented double sided accounting - as the obvious logic of national accounts settling is perhaps a more important driver now than Keynes. Perhaps.

What one should always remember is what we take for granted - national accounting system of GDP and various sectors is a recent invention coming post-Great Depression. That Keynes's failure to capture FDR's attention (where the one time FDR met Keynes he was very unimpressed and baffled with all his "numbers") was there was little if no data set to work off - Keynes was all conceptual and abstract. It wasn’t until Simon Kuznets "invented" the national accounting system (based on his 1941 academic work) that we had a temporal and quantitative base to discuss the qualitative Keynesian theories.

So with the data record of national accounts available and understanding the inevitable power of national dual sided accounting - here is not only my suggested plan but, given the unassailable power and position of the USA in reality, what will occur as water seeks its natural level.

We will do the following either through thoughtful deliberate pre-emptive and anticipative policy or we will have to respond to foreign and domestic pressures in ad hoc approaches that produce the same. The later will be painful and likely have to go though the crucible of war and internal revolt to achieve what can be implemented now.

There are two major areas to address - the international accounts and the domestic accounts.


The international accounts clearly produced massive imbalances which are the root to the entire current crisis - Wen to the contrary regardless. The USA has to return to exemplary exceptionalism and both realize and accept the extraordinary power differential between the USA and everyone else as well as the fact that the USA has to be the beginning and the end of any solution. With the admirable goal of world peace and stability, the USA has allowed key regions to produce capacity that the only use of is exporting, or the USA has allowed commodity producers to form cartels and have extraordinary pricing over and above any reasonable cost of production or utility of the commodity. These trade imbalances were allowed to occur at first to offset the importance of the USSR and also to relieve domestic pressure of the exporters so that dangerous instability did not occur. It should always be remembered that Pearl Harbor was the direct results of not allowing these imbalances to occur.

But now those imbalances have to be administered and managed, recognized for what they are, identified and quantified, and accounted as a good the USA allows and applies. The true nature of USA strength and scope has to be acknowledged by the exporters and peace and stability guaranteed. The imbalances can exist but they must be controlled by the central monetary policy of the USA and just as weekly "float" in various money supply is "sterilized" by monetary policy devices offset, so must these imbalances be "sterilized". Imbalances must not be allowed to be invested in any USA assets but for a foreign account ledger on the balance sheet of the NY Fed. If other, private sector US dollar assets are sought by the exporter by money raised through imbalances - then currency adjustment must be insisted upon so the exporter hasa choice - either that the imbalances are allowed to be controlled by the USA Fed are a equitable terms of trade imposed such the imbalances cease to exist.

This is similar to the rules Rome imposed on much of the areas where they held suasion but were not provinces - it was pax Romana. A pax Americana must be developed.

The UN based on equal votes for any nation state unit must be either revamped or eliminated so that it is inline with the realities of pax Americana. The problem of course is few will believe that the USA is of such a status and likely will require a war to prove it out.

But in the end the following policy will have occurred:

1. Eliminate the UN, mandate all global US dollar imbalances resulting from trade or commodity sales to the US must be kept on the balance sheet of the Federal Reserve as a "customer account".

2. Chinese membership in GATT to be rationalized and re-examined. GATT with voting based on GDP replaces the UN.

3. All countries accept the above in terms of trade with the USA or they have USA tariffs applied or embargos such that un-economical terms of trade are eliminated.

4. All excess capacity in exporters to the USA that is basically human capital is examined and all people that meet certain qualitative standards and wish to seek it, be allowed a visa for immigration to the USA and the process form visa to Green Card to USA citizenship be expedited to a few years. A massive immigration wave to the USA is to be encouraged and developed. Qualification is based upon fluency in English, oath of allegiance, bonded to not be wards of the state for one year, health, and base education of trade, high school, or net worth. The standards to be applied to only the individual or nuclear family not extended family. The goal is to double the USA population and rejuvenate the cities and to move excess capacity abroad to some degree onshore. (National Act of Relocation and Processing 20 bil - administered through Homeland Security)

5. The standards of a two front war and nuclear deterrence are increased to Petraeus 4 locale at one time surge capability. Necessary expenditure applied. ROTC and educational programs expanded. (National Defense and International Peace Act 200 bil)

6. A permanent rapid deployment international welfare capability is developed distinct from the military developed. Force to have world wide "strike" capability. Intent is to supplant and replace most welfare NGOs eliminating their power and improving their effectiveness. Size of this "Peace Force" to be comparable to the military in reach and scope. (National International Support and Stabilization Act "The Peace Force" State Dept 100 bil)


Domestically, phase two of the "city on the hill" has to occur. In a nutshell this is to return the national government as adjunct to the state and local as the constitution outlines: "powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people." This is very important in this current crisis not in terms of what prompted the Civil War, but in terms that the state and local are the only efficient channel to provide the stimulus spend required.

The best work I have read on this is Jane Jacobs "Cities and the Wealth of Nations" which seems a bit over strident in promoting a return to nothing but "city-states" does make key discoveries as to the reality of economic flow and the process of growth. She also successfully shows how cities are also the "kernels" for trade and commence. The stimulus flow must be directed through large metropolises and administered through them as much as possible, then the states, and then the national levels only in terms of how this augments or assists the cities - such as transportation and communication. The national level is also where oversight and policing of financial markets occur.

But if the stimulus does not follow the state and local channels it will be at best ineffective and only serve to provide a "power grab" by national entities or will simply be lost in corruption.

It is critical to understand where we are in energy. All green policies must be in terms of not carbon or global warming, but in terms of zero emissions standards or close to it and not for global warming but just for smell, taste, and health reasons. If the immigration wave is to occur we require a clean healthy place to live. Therefore, as before, it will be commerce which will drive environmental improvements. Bio fuel policies must be eliminated - they are solely an attempt to avoid the harsh facts of national security and to be a windfall for the likes of Archer Daniels - it is similar to why we gave such a disgusting gift to rich Cuban immigrants in the form of sugar plantations in the Florida Everglades - this was solely for national security sugar availability. I put bio-fuel in the same relam as the Florida Everglades sugar policy.

So the programs domestically:

7. The National Metropolis Development Administration. Chaired by a rotating mayor of a qualified USA metropolis. 300 bil

8. The National Bridge Tunnel and Port Authority (modeled after the one Moses created for NYC metropolis) Oversight by board of Senators, Congresspeople, Sec HEW, and State Governors and chaired by a rotating state governor. 200 bil

9. The National Transportation Administration Dept of Commerce Charged with developing a national high speed passenger and freight capability, national internet broadband, and commodity transportation (pipelines) 150 bil

10. The Appease the Gullible Mass Hysteria and Wishful Thinking Authority Dept of HEW and Dept of Commerce Explore new energy sources and go where no man has gone before. 10 million.

It is critical that the stimulus measures be understood not only to solve the immediate problems but to set a livable template for the next century for the USA ad given our massive footprint also for the world. It is also critical to understand that we are designing this bill currently in the wrong branch of government.

Obama has to declare a national emergency - similar to war measures act - and take the responsibility for the design of these programs and their implementations to the executive. Congress is to only use their veto capability and only in terms of "appropriations" powers. We will never have success with congress designing and implementing these needs. So, given that the stimulus as written is assured to fail and given the extreme emergency such failure will produce, the executive will be in charge of this area in any case. It would be best not to go through that stage.

A summary:

Immigration.............................20 bil
Defense....................................200 bil
Peace Force.............................100 bil
City Bank.................................300 bil
Bridge Tun Port Auth............200 bil
Nat Transp..............................150 bil
Green..........................................10 mil
Total.........................................970.1 bil

Phase in: over 3 years - all placed in near "escrow" type facilities so financing arranged and certainty provided so expectations can price accordingly.

Back to Keynes - this will be an offset to the critical drop in consumption and rise in savings we are observing. This will forestall a depression. Size can be increased but it should be noted that almost all of this expense will result in a public investment of high utility which can be privatized down the road or maintained in the public sector to make available these channels in the future.

It should be noted as well that it is impossible to end with a solution, especially if we approach this solution the hard way via evoking a crisis from failed policy, that the military elements are crucial. Without a doubt we will either have a war before this is over or come close to one. Massive increase in military capacity might very well prevent a war. There is a dangerous idea of equivalency in most geo-political considerations as thats what gets certain academics jobs and writing assignments with extra-national entities like the UN or NGOs or even teaching posts with most universities. It is a very dangerous myth as the USA has never been stronger and other key international states comprably weaker. This myth along with extreme political pressures at home, as the world discovers how high the correlation their economy is to the USA, will lead to neo-fascist international adventures to alleviate pressure directed at national leadership. We must show quickly that any hard power is not an option.

Friday, February 6, 2009

Baltic Dry Index On Fire! (Not)

So I graphed it out and well, er - it isnt flatline anymore! There is some world trade!!

Baltic Dry Goods Index

Thursday, February 5, 2009

Oil Contango in % Terms: Major Move in Crude Inevitable

The oil contango is obvious and well commented on.

In past I have pointed out that the contango is unsustainable with current trend economic growth - either the oil contango is correct and we briskly move to trend growth GDP, or the contango moves to normal backwardation and then some.

In 1990 to 1992 we had a period of contango as crude speculation centered around Desert Storm. At the same time the economy was entering a shallow recession.

The contango for one year expressed in % of the front contract was this in 1990 to 92:

The weekly unemployment claims for the same period peaked at 509,000 in 3/91:

One can see that the oil contango, expressing speculative forces, had to come back into line with the economic growth reality and whats more so was depressed as speculative positions were liquidated and a large backwardation occurred.

An interesting plot is a regression of the contango for 1 year in % of front contract versus weekly unemployment claims. While the boundary is fuzzy to say the least - it is clear that from 7/86 to 1/98 no contango was sustainable past 450,000 weekly claims:

A recent plot of the same relationship from 2/07 to 1/09 shows the bizarre speculative forces still keeping the oil contango in % terms high:

The current oil one year contango in terms of % of front contract:

Current weekly unemployment claims:

It is pretty hard to not perceive a major move in the oil contango occurring shortly - or we suddenly spring upwards with growth in 2nd Q 09 GDP. Take your pick. The oil move to come is about $15. My bet is it occurs in the forward dropping which will also require spot oil to drop as well, though not as much.

Tuesday, February 3, 2009

Another Letter to my Congressional Representative (We Should All Be Doing This)


Congresswoman XXXXXXX (NY-XX)

Is there anything I can do for your office in terms of data or input? The below outlines the cash flows of HR 1:

and - which is the motivation of HR 1 - the following is in the process of playing out:

The above grids are 2% increments, showing output gap will be a negative 8% in 2009. That is, the GDP for 2009 will be 8% less than "full employment" economy. That 8% is roughly 1.1 trillion dollars of GDP which will not occur.

That will result from a combination of a drop in investments both public and private and more importantly a drop in consumption because Americans either lose their employment or they raise their savings instead of consumption, Jam tomorrow versus jam today.

Most economists and market forecasters, right and left, are in accord with the above numbers.

The auto sales numbers for the month of January proves this out as all autos from all manufacturers or types is down 30% to 40% .

If the above $1 trillion is not replaced by public sector investments - popularly called fiscal stimulus - the resulting tragedy above will confirm the conditions which prompted the fear that resulted in savings. Folks will consume then even less and save more. This is the "Fisher Deflation Debt Spiral" That would induce an even deeper depression.

Much could be done to offset the above if we could turn the tide and replace a significant part of the drop in private investment and consumption with public investment. Since public investment is just that - the acquiring of an asset for future return - it is not a spend but rather the expansion of the public sector balance sheet. The fact the Federal Reserve has grown their balance sheet from 700 billion to 2.25 trillion shows that the "money" is available. This would not be a burden on future generations as the offsetting asset would have social utility and value.

The above cash flow of HR 1 shows that the actual spend for 2009 in terms of any economic consideration is about $29 billion - perhaps a bit more for those monies for direct transfer payments like food stamps and medicaid.

This incredible small size will assure the above output gap occurring.

The next year's $120 billion will not really do much as by that time the environment will motivate people to save even more and the private sector to invest even more.

Simple logic will allow you to conclude that all transfer payments and tax fixes, unless for goods certain to be spent like food stamps or health care support, will just be used to facilitate savings. Therefore only a fraction of the amount over $29 billion will do anything, and certainly nothing is to be found to offset the $1 trillion drop in consumption.
As written HR 1 is almost certain to be the legislative product which will go down in history as the single most disastrous piece of legislation ever written by Congress. Given the above, and unless you can find some mistake in what I say above, your own logic will lead you to agree.

The 8% output gap is a depression.

It will result in well over 10% unemployment and with momentum in unemployment such that it will be very difficult for it not to go to 15% or higher.

This would invariably lead to massive tension in our urban areas.
It would most certainly lead to rage with the political leadership in allowing this to occur.

While we suffer, almost all our offshore friends and associates will be suffering even more so. The whole "multi-polar" world with countries economies going at different paces and cycles has shown to be a chimera. Every OECD and all large developing countries are now moving in lockstep with the developments in the USA. If our output gap and depression of 8% occurs, it will be double or triple that in every other country in the world.

Extreme international tensions will develop resulting in protectionism and then likely conflict.

I started writing my Congressional Representative's office, my Congresswoman XXXXX, in September of 2008. Unfortunately everything I have portrayed and warned your office about has resulted pretty well as I outlined. My credibility with your office and with Congresswoman XXXXX should be large.

I am begging Congress to reverse this approach shown in HR 1 and write in a significant public investment to at least partially offset the already occurring drop of private sector investment and consumption.

If this does not occur it is very unlikely either of us will have a job as my employer will be likely crushed and Congresswoman XXXXX returned to the private sector.
I remain to do all I can for Congresswoman XXXXX.

I hope she is reading these emails or briefed - again I point out (again I wish it were not so) - my almost perfect track record as we have gone through this crisis.

There is yet to be a sign that Congress has secured dedicated and knowledgeable advice during this most serious national crisis. When we were at the low points in Iraq, did not Congress seek out and listen carefully to those who have made a career in war craft, the Petraeus types of the Army? Did Congress ever feel, no matter how fierce the appropriate criticism, that they could devise national war policy themselves?

Why is Congress drafting and then passing HR 1 as a normal political budgetary process? It is not. HR 1 is supposedly the answer to a severe national emergency. It's drafting should require careful deliberation of our most highly trained experts which Congress should review and offer critique, but should not author. It is clear by the HR 1  no experts were really consulted. CBO staffers are not experts. Congress who have written many budgets are not experts in this particular emergency.

I am afraid that if we carry on as we are the public rage that Congress is deflecting to my industry, along with the press, will exhaust itself with Wall St after it realizes what small fry toll keepers we are, and then swing appropriately to the true cause of their misfortune.

Please avail yourself of my help. You have no reason to not consider my input most carefully, given the complete success I have had in predicting our current status, starting from my first email to Congresswoman XXXXX in September 2008. If called upon I will do all I can to help. I consider this country under the same degree of risk as in a world war.

Fiscal Stimulus a Disaster - Kalecki Levy Suggests SPX Annual Earnings of $27

The following rough grid outlines a breakdown of HR 1 ("The America Recovery and.....2009).
The actual cash flows:

Income transfer/support payments will be saved in this environment - so too with tax cuts assuming the businesses are still alive and turning a profit and the individuals have income to pay taxes upon.

That leads $29 billion in actual spend in 2009 and $120 billion in 2010.

In a typical Keynesian type of logic I use a Kalecki-Levy identity to figure out what the percentage of GDP will be corporate profits. (Go here if you wish to read on Kalecki-Levy )

For 2009 (which I provide a graph for below) the % of GDP corporate profits assuming an increase of savings to 7% and a fiscal spend of 29 billion is 4.75% for the usual 10% to 12%.

Calibrating that to SPX annual earnings, that moves the $70 to $90 corporate earnings to $27, down from the usual $70 to $90. At that point multiple will be no more than 10X, so the SPX will be less than 300, a drop of another 70% for 2009.

When the additional $117 billion kicks in during 2010, the psychology will be so dire such that savings will undoubtedly go well past 10% and the multiple contract further so any earnings increase will be offset by savings increase and then the decreasing multiple will likely make for negative returns for SPX in 2010.

The identities and formulation for Kalecki Levy is rather straight forward and we have more than enough real savings number, industrial production numbers, inventory , and other data that if we use the $29 billion as the independent variable - this is not a very strident or contorted conclusion.

Monday, February 2, 2009

Monetary Policy Success - Transfered to Fiscal? Hegemon

The worm may have turned, with the Federal Reserve successfully maintaining an orderly market in the money markets and restoring bank liquidity and credit to the "norm". The Federal Reserve almost tripled the balance sheet to accommodate various failed segments of the money markets and financial structure. The first were the Maiden Lanes " facilities established post Bear St earns force sale to JP Morgan, taking on the "toxic assets" into a LLC on the NY Federal Reserve's balance sheet. Then AIG moved considerable assets onto the Fed balance sheet, and money market funds received support, and in the final quarter a CPFF program to fund various types of commercial paper.

The total expansion of Federal Reserve footing is substantial:

But the size of the footing is being reduced. The commercial paper facility CPFF reduced by almost 90 billion last week and foreign central bank funding lines via large currency swaps also reduced. The is an obvious improvement. If this carried on, and it seems it will, it seems the Federal Reserve has been completely successful in restoring liquidity.

The majority of the Federal Reserve expansion to the crisis has not been in the AIG and dealer fundings, contrary to the press and public perception. Rather it has been in two areas, commercial paper purchases and also foreign swap likes to central bank where the Fed for an agreed unwind level at an agreed time , is credited by a foreign central bank and amount of foreign currency and in return the Fed credits that foreign central bank and amount of dollars. These dollars are then deployed by the foreign central bank in various US dollar denominated support operations in their respective countries.

The size of these swap lines is striking, peeking at 600 billion last quarter and currently at 465 billion. That combined with the CPFF facility totals to over 800 billion of additional Federal Reserve "factors" or bank credit provided.

One can see the improvement in the relationship of Fed Funds versus one month LIBOR in 2 year swaps, correcting to below 20 basis points (.20%) at levels indicating fully functioning and liquid bank credit money markets.
Also one can see that the Maiden Lane LLCs and the AIG funding really are almost a detail item - not really mattering in the larger scheme of things.
The foreign swaps is very interesting as allows illumination of various ideas as to USA hegemon and also importance in the markets. It shows that in a a few weeks the Fed Reserve can produce liquidity almost equal to the total US Treasuries held by China. It also shows that the USA has no need or use for non-dollar items yet other foreign central banks are now completely dependent on the USA maintaining their respective money markets. To the contrary of many popular views the USA is clearly the indisputable hegemon. This capability of the USA Federal Reserve shows the demise of New York is highly overrated and one should perceive this balance sheet as the financial equivalent to the 12 USN carrier task forces. Monstrous off the scale financial and monetary strength which has shown that a total Federal Reserve balance sheet at 2.25 trillion is not peak load.
The scope and raw strength of the USA has been demonstrated and successfully implemented. The Fed though has likely reached the limits of their mandate and while able to maintain money market liquidity, the comparable clout that exists in the USA fiscal balance sheets has to be first realized that it exists, and then implemented transferring much of this monetary presence to the fiscal realm.
Considering the Federal Reserve's balance sheet indicates that there are 2 crisis occurring - one a Bagehot bank crash and the second , via contagion of the bank crash, a classic crash in consumption and rise in savings producing the beginnings of a Fisher Debt Deflation spiral (i.e. a depression).
It seems the fact the popular press and many market and political players confuse these two crisis leads to obfuscation and an incorrect idea as to the USA strength and capacity.

Friday, January 30, 2009

Addendum To SPX Long Volatility and SPX Levels: Realized Long Dated Vol vs SPX

The above is long dated realized volatility for SPX - 220 days of realized volatility which is about 1 year.

Clearly shows the tracking of long dated volatility, or risk, and the price level of SPX.

The realized volatility explosion is "persistent" or even prescient where in the end the SPX trading level over the long run will be in accord with the SPX volatility. Notice how the drop in long dated realized SPX preceded the bull move in SPX from 2003 to 2007. Given the effect of correlation in the index, the rise in SPX volatility is more often coincidental - yet the obvious improvement in realized long dated SPX vol has to occur before a rally starts in a lag.

SPX Volatility: Long Dated Vol Not Correcting

SPX Vol surface not correcting - still building large "mid range" formation which means either new vol regime is low 40s and extremely large peak still to come, or that the rules of vol have changed. Vol regime in 40s is unsustainable and indicative of an economy in extreme stress for the the long run.

SPX volatility should be watched in the long dated implied, one year or longer, to consider the "risk" in the equity market and also to calibrate to ideas on credit spreads. SPX (comparable to AA plus credit) in the long dated implied space has not corrected form November crash. The short dated implied which the VIX picks up is incorrectly providing a sense of improvement. This explains why high grade credit spreads are sticky and haven't followed the SPX market when it moves upwards.

GDP Deconstructed: Financial World Trade Center Occuring

Written in a bit of a rush, GDP a catastrophe.

While the broad index is down "only" 3.8% versus expectations of down 5.5%, the parts tat matter were every bit as bad as expectations and in the case of prices far worse than imagined.

Personal Consumption (PCE) part of GDP was down 3.5% as expected.

Core prices (so no energy which would make this far far worse) for PCE was .6% versus expectations of 1%. Inflation is nonexistent and has obviously gone deflationary.

The broad deflator was down .1% versus the expected .4%

The pics below do not have detail (haven't figured out how to cut and paste to a blog higher resolution) but they are form 1956 so in a way they are better as force you to see the pattern.

Keep in mind all the following depicted recessions prior to this one were monetary recessions, with almost all econs agreeing that the slowdown in consumption, deflator, and personal consumption deflator were all directly related to a period where the Fed was tightening in response to either currency and inflation in the 50s and 60s or inflation in 80s and 90s and 00.

Though post 9/11 had some bit of a fiscal shock, this time around the drop in GDP is substantial and, more importantly, is occurring with the Fed starting in a neutral or, if you follow John Taylor (Taylor Rule), in an overly easy status. This crisis is all consumption and fiscal - not monetary and is preceding the Fed - a runaway train.

The Personal Consumption Price Index (core) since 56 - 4th Q 08 +.6%:

The Personal Consumption component (again all prior dips were result of Federal reserve monetary policy, this isn't) -3.5% 4th Q 08:

And the broad deflator - tracking and confirming the PCE deflator above:

Note how this time the personal consumption engine is leading GDP, not following.

The data as per the nations capacity and ability to employ people and a precursor of what the savings rate may do (rise substantially) are a catastrophe.

One should be seeing this data in same gut visceral feel you had when the World Trade Center went down. In crass economic terms it is far worse, and in terms of the safety, security, and well being of the American people - this data set is far worse htan World Trade.

Sunday, January 25, 2009

Where We Are Now; How We Got There - Morality and Geopolitics

I was stunned reading the NY Times this Sunday, article after article goes on to confirm my worst foreboding; or rather what were issues of foreboding are now here larger than life.

I. Where We Are Now; “All The Family to Dinner”

A great writer or trickster (often one and the same thing) is William Gaddis and in a few of his books he uses a fulcrum point of epiphany, of either finding what one fears or acquiring self knowledge of something one always was or knew but had hidden or was obscured. His key citation is of Emerson quoting Thoreau:

“What you seek in vain for, half your life, one day you come full upon, all the family at dinner. You seek it like a dream, and as soon as you find it you become its prey.”

That’s the feeling, the sense of dread but also one of “no way out” as you stumble upon the whole clan and find it all as you expected or imagined and the clan looking up, all of them, as they take you in and ready to respond to your intrusion.

I suspect this is the core feeling now for many depression economists of good character who like military commanders who learn their warcraft well but war finally occurs they are sickened and repulsed in the practice their craft and even at first falter. Depression Economists must feel that way now as they do know depressions and the mechanisms and the connections of them; but they also know the terrible wake the depression will lead. The economists and leaders they consul seem now like the person who just opened the door and there they are “all the family at dinner”. It seems most economists are silent and somewhat stunned and have yet to declare what their craft provides in prediction.

This is hopefully that stunned shock in finding what they seeked and explains the lack of vigor and action and intense commitment to forestall a tragedy now being shown by most economists, that it is just that, initial shock, as they stand looking the family over.

But the family, in the midst of dinner interrupted, will be, or is in midst of, taking action.

Back to the Sunday NY Times, once again a “movable feast” of gloom where only the tempo is picking up and more and more the results seem inevitable.

What is going on?

First, I know what is wrong in the majority of economic stances and views, and thereby what is wrong in resulting prognosis and prescriptions - a seriously misplaced moralism.

As we approach “our” depression, I am starting to realize that Keynes' most important attribute likely was that he was gay.

Why? I think it allowed him to consider economics and social construct with an absence of judgment, as I am sure as he was always on the anvil, in someway or somehow, of having to accommodate or explain or hide his homosexuality in Edwardian England; he knew firsthand the effect of the judgment on his homosexuality as a case of morality and likely realized that this was an avenue that provided little truth or improvement in the person judging him. This had to have developed a studied absence of values in Keynes economic thought, or applying the lenses of morality to viewing how an economy could take a crapper and how to get it out of that status. Yet this amoral stance was augmented with a very deep and fierce sense of civics. Keynes was a patriot.

Concentrating on civics and the status of civics, and freed from having to judge society, Keynes was able to see with a glance what almost all missed. That the core functionality and ability of the society was unchanged and the current times were actually more promising than prior times. The problem was the mechanism and structure of the economic structure of society and even there Keynes was a humanist and suggested that if Western societies wished to enjoy many of their finest attributes, then Western capitalistic democracies were required and always would have an inherent instability which would make for periodic crisis. That the central governments main purpose is to offset or make these periodic economic storms the least damage as possible. Minsky is of course the key “reader” of Keynes (how Minsky described his life’s work) who developed this aspect of Keynes which is most relevant to financial markets.

But Keynes not only felt that morality and qualifying merit in society was a totally useless avenue to pursue, but that it would even impede the solution.

All through this morning NY Times I see this terrible flaw of applying "judgment" in both the most usual analysis of how we got here and also in what the solution should be. All I read is economics as written in Leviticus. Blinder’s “Six Blunders” are all the blunders experienced formulated by base greed or selfish cunning gone astray. “..[P]eople in authority owe millions of Americans an apology.” September 11 was our fault as the NSA of the time Clarke told the 9/11 commission. Apologize! says Blinder.

Ben Stein this day and age’s Will Rogers or Mark Twain, our fabulist, recites tales of woe about a friend living in terrible denial who is likely gonna get it and get it good even though she is a “sweet lady”. But her shallow materialism and lack of reality is such a sin that this will be inevitable. Then he moves on to his own son’s lack of awareness of his plight. The core of the problem is American’s inability to be prudent and save. We must once again become a nation of savers and Stein suggests we should work harder and with greater acceptance to the reality of life.

Then the ill understood and thereby fearful credit default swap bogey man is trotted out by Gretchen Morgenson, who has the be the world’s master in diving into and intelligently writing upon areas and topics of great import which she has not even a clue as to their inherent reality. It makes her columns rich fields to help put together your own thoughts together, and her columns are fertile pre-finished intellectual ideas, much as a sour mash is required to make in the end good bourbon. But she shows again the central error, the great danger as out pundits and observers wade in – CDS market was where folks “raking in” premiums like river boat gamblers while regulators let this immoral casino carry on with no supervision as if the gamblers were slipping them C-notes at the end of every session. Then she goes on to mangle a very sensible “rule of law” idea which is an open outcry market for CDS – but quickly removes herself form being accused of anything sensible and wades into bizarre margin requirements completely out of accord to the nature of risk. Again, morality, or lack thereof, seeps throughout her thinking.

And of course evoking the great film “The Talented Mr. Ripley” in Creswell and Thomas “The Talented Mr. Madoff” article puts this cheek to jowl to all the other articles.

It seems the USA has never lost its Winthrop and Puritanism, always lurking to remind us that all is God’s and all form His grace and if we do not understand whether or not we are “saved” and lead a moral life to assist us in this revelation – well we are to be flung into hell. This is really still the main economic theory ruling the land. We are a sinful and willful people who must be brought back to Yah-Weh, to Jehovah, to the correct way of life.

I think a Mayfair Crowd meticulously educated Cambridge gay man of impeccable refinement would have either totally missed this message and if he did note it he would have realized the huge road black that attitude presented to the solution. First in most considering the solution as just more of the immoral behaviors that brought us to the crisis in moving the spend thrift ways of the populace to the national balance sheet, and second with most considering punishment be meted out to those who brought this on us be a critical part of the solution (Apologize! Repent!) and some measures of the pain and suffering they caused are self realized.

Both of those approaches are a catastrophe on their own right. Or existing rules and regulations are more than enough to find and eliminate the Mr. Madoffs of this crisis and this is solved through empowering the Feds and adding a few beds to a federal penitentiary. Mr. Madoff in house arrest is not our finest moment. But to go on from there and start witch hunts and financial pogroms and to not accept the basic sound and good character of our business leaders and politicians is a route of self flagellation and an attempt to appease Jehovah and will eliminate the necessary business leaders and financial risk takers we will desperately need.

The path to being prudent savers and sober cautious livers of American life is also an avenue of catastrophe. The core driver of all pain and suffering we may receive shortly is the savings rate of Americans going from 0% to in excess of 5% in short order. The shock in the complimentary drop in consumption (“jam today or jam tomorrow”) will force a massive over capacity in American industry and service. In short a depression.

As Keynes said:

“The resources of nature and men’s devices are just as fertile and productive as they were. The rate of our progress towards solving the material problems of life is not less rapid. We are as capable as before of affording for everyone a high standard of life.”

And more importantly:

“"...most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits--of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities...if the animal spirits are dimmed and the spontaneous optimism falters... enterprise will fade and die,"

The last quote taken from the all important “Chapter 12” of the “General Theory”

This exuberance, near irrational hope in a future better than today, a “rent” schedule of improvement of your lot in the future is the fundamental driver for all Western democratic capitalistic society. This central and indispensable notion of hope and spirit defies quantitative metrics and analysis and is not often embraced and more often than not shunned from debate and analysis and policy.

And this is the main attribute of the current crisis, despite our “audacity of hope” man in the White House, is actually the reverse – not only a crash in hope and spirits but even an embarrassment with our past enthusiasm. And a desire to stamp out the animal spirit and hope in some misguided and terribly cowardly and loathing of our present makeup in hopes a salvation results in the afterlife to save our sorry souls. This is what I think is really meant when we talk about the terrible burden a fiscal stimulus would impose on our future generations – it is really that to mollify or save ourselves from current pain and suffering prevents our salvation and throws into doubt our chances of the after-life.

II How We Arrived Here

The above American values of sin and redemption; crime and retribution – of seeing social values through a prism of morality and whether one is living a righteous life in the ways of the “elected” or “saints”, does allow society to bear down and produce great achievement under duress as our history shows. But it also has delivered great pain and suffering upon others who did not subscribe to our formula as to what the moral life is. It also is the greatest danger to reclaiming the “animal spirits”, the enthusiasm and belief in a manifest destiny, American exceptionalism which has also provided wonderful status of life from the third fourth generations of immigrants, towns in Mexico, and even African descendants who can become President.

We are not a lazy nation but one of the hardest working on earth. Anyone who has wondered at traffic jams as the midnight shifts end in Manhattan or that one has to get on NY City parkways prior to 6:00 AM can easily observe that.

Families are careful and prudent, work hard and save, and plan carefully for their children’s future and lay the base for generational success. Our loathing to retire, to stop work, is obvious, and no developed nation on earth has fewer holidays taken.

Lazy and spendthrift we are not.

Large dreamers, the masters of the animal spirit (at least so far) we are.

So how did we get to this point if it was not a sudden and bizarre dedication to immoral or at best amoral behavior and an orgy of enjoyment of the present?

That comes to the second series of NY Times articles that caused me much stress this morning.

The first article was discussing the unemployment situation in China. Now it should be clear that this is not really representative of China, but the employable part of China – the 250 MM educated and technically adept workforce. The other 750 MM is still mired in a peasant and vassal like existence. But 250 MM is about equal to the entire populace of the USA and dwarfs the educated and productive part of the USA population. So it certainly has great impact. What’s more that amount of world caliber productive employable people was about 25 MM only 20 years ago, so this growth is truly an incredible achievement and something the whole world has great interest in maintaining and promoting. What’s more the growth in those becoming educated and trained and making the transition from peasant and urban poverty to this world caliber workforce requires China to maintain a 7% growth in GDP just to absorb, to break even. This part of the populace is the traditional source of revolution and social change in China. It is the core of the makeup of the Maoist revolution and the subsequent social organization post Imperial and kleptocratic China. China is also a plutocracy which unlike democratic regimes the people have a very narrow and small list of specific folks to target and blame if things go astray. So China must produce, in the long run, growth of at least 7% or massive social unrest will result. Tienanmen Square was the last showing of this beast and the fact China completely embraced this proto-capitalism model shows both the need and the great fear underlying Chinese structure.

In the 1990s, China had to design a system that would gainfully incorporate well over 200 MM people in short order or it would slide into anarchy and terror and absolutism. They have succeeded.

But, the major problem, and also a major attribute for China, was the emergence of a hegemon power which allowed globalism to exist, not seen since either the Edwardian England or “The Twelve Caesars” in Rome. That power, the USA, allowed globalism by becoming the “buyer of last resort” and by evoking “soft power” via mercantilism versus hard power of the “boots on the ground” like Rome or England. Though certain key outposts were maintained with “boots on the ground” like Okinawa or Korea, these forces were more often than not welcomed or even insisted upon by the host countries. Global trade flourished where to gain entry of the system a country would ascribe to pax Americana and in return could be the mercantilist rather than in the time of Britain, the major power was the mercantilist. Currencies and command economies could be managed and applied which deliberately set terms of trade such that the USA was eager to move production to these foreign locales. The USA itself was moving to another phase of economic production of service and technology and also finance which was the hub administrating this globalism network of trade. In short, the USA to prosper deliberately allowed itself to be “used” in being the recipient of uneconomic terms of trade of mercantilist systems.

Japan prospered under this pax Americana system, so too did the “Tigers”, and then so did China, the largest client of the USA system.

China was certainly aware of this “deal” and must have felt that they could take advantage of the USA as long as required until China could produce internal terms of trade such that the exporting part of the economy would become complimentary and supportive to a vibrant near self sustaining domestic economy. But that has yet to occur and as long as tiered elitist system carries on (albeit one based on national merit testing) large swaths of China are basically welfare states which exchange and support has to be forthcoming from the export sector. The fact that there are over 250 MM productive workforce now in China was supposedly self evident that this shift from export trade to domestic economy was a given. And any suspicious fellow had to only go to Shang Hai or make the tour of the “100 Cities” to have all suspicions cast aside and an eager fan of China would emerge – often with the added insight as to newly discovered errors in the central hegemon, the USA. It has even gotten to the point where the obvious shift from the hegemon to just one sorry member in a multi-polar world had befallen the USA. But again, the story in the NY Times shows China is still riding the dragon as all mercantilists do and that their power and prestige and ability to function as a society is a function of the USA status. Ergo the shock in Chinese students finding they cannot get jobs and the correlation of near one with Chinese economy with developments in the USA.

Nial Ferguson is wrong, it is not Chimerica but rather Rome and Egypt, Athens and the Aeolian wheat growers in the Black Sea, the UK and India, and so on. What is different is none of those vassals to the hegemon had 1 billion people of which 250 MM are literate and technically adept. Whatever the form that China pursued, the threat to USA security was always apparent. A strategy to be able to defend the USA and utilize the Chinese presence in constructive ways insisted on China being a core focus of all USA foreign policy efforts.

Before being elected in 1968, Nixon made several tours of the world ostensibly as the spokesman for Pepsi-Cola. One such tour was in Germany where the elder statesman and leader Adenauer, the father of modern Germany, pleaded with Nixon that the USA must be mindful of the USSR successes in propaganda and pressure on Europe, that Europe was being ignored by the USA with their preoccupation with Vietnam and a history of China bashing. Adenauer suggested rapprochement with China to split the China-USSR axis and open a new front against the USSR. At the same time various leaders in Eastern Europe such as Romania’s Ceausescu also hinted that China may be an important counter to USSR power. Nixon went on to SE Asia and noted that the real heavy hand were not Maoist, but rather Neo-Stalinist with roots in Europe (Sorbonne) or Russia. Nixon also visited Chaing Kai-Shek in Formosa and when Chaing told Nixon the time was ripe to invade the mainland, he realized what a shaky and delusion ally Taiwan had become.

Then Nixon went through the process of leaving Viet Nam – which was really an evacuation - and it was important to at least have China standstill. In the crux of the Cultural Revolution Mao saw sense in this and he did.

The ability to work with China was a surprise and noted by the USA and in 1972 Nixon made his historical visit to Mao and the seeds of the partnership were laid.

From that point on China left the domain of the geo-political Kennan “containment” strategy which eventually destroyed the USSR, and was offered to join the pax Americana mercantilist system that Korea, Japan, Singapore, and even to some degree Indonesia was enjoying. The ravages of the Cultural Revolution taught China that the Jefferson/Trotsky periodic and constant revolution would not work given the size and unwieldiness of China. So trade and mercantilism was the answer. Tiananmen Sq clinched this as being the paradigm.

The USA had a choice of either continuing to contain China as they had the USSR and all the treasure that would require, or allow China access on disproportionate terms in China’s favor to the USA markets. The choice was to double the soldiers in Japan or in the indefensible Korea and add three more carrier task forces; or allows that part of growth required in China to maintain stability to be based upon selling into the USA markets. Basically it was (and still is) “guns or butter”. Unequal terms of trade were to be manageable as shown by the success in accommodating Japan and Korea and to some degree Germany in the same way. In the 1960s the USA was supposedly going down the tubes as German trade and German sound DM were obviously superior, and in the 1980s the same thought was applied to Japan. Germany was able to successfully raise productivity and allow the DM to float so that part of their trade surplus was not the results of manipulated currency but soundly based on equable terms of trade. Not only that German domestic demand increased substantially so that trade with the USA was not critical. Japan found that when limits of trade were reached and the USA was adversely affected to the point it was not longer tenable; the USA simply moved the Yen to sub 100 and eliminated the excess trade that was manipulated. Peaceful and close alignment allowed a managed response to this problem form Toyota plants in Georgia to Japan’s own domestic markets stressed, but still the “lost decade” that followed the currency change the USA insisted upon still showed the USA hegemonic position and power. An important and critical part of a weaker power having unequal advantageous terms of trade with a stronger power is the assumption of debt or assets in the end market assets, otherwise the mechanism which enable the mercantilist trade flow cannot be enabled – which is basically the Yen kept at levels cheaper than any “true” purchasing parity or real value vis a vis the dollar.

Now here is the rub and the key element to all the above and the main issue regarding the current economic crisis. That asset accumulated in the importing country’s currency has to be maintained at the purchased value otherwise it becomes impossible to maintain the currency level that allows the unequal terms of trade. In fact, in many ways, this asset does not exist but is the record of whatever economic fiction the exporting country applied to prompt the trade. Further most developing countries have an internal axis of fiction as well, or “trades of decline” as Jane Jacobs calls them where the currency generating areas of the economy have to send transfer payments or repatriations to the non-producing areas. Often those areas are also parts of the country where dissension and social pressure can evolve. So Japan had both the ever accumulating fiction of supposed wealth in US Treasuries, but if it were touched the fiction of the Japanese manipulated currency becomes apparent, and also large transfer payments were being made to non-productive areas of the country and sectors to maintain certain important cultural legacies or core support for the LDP party (rise farmers and rural elderly – Hokkaido). In the end Japan accepted their position and to maintain political power those in charge zombified the banks and the country “ate” the lost decade.

China is in the same status as Japan but perhaps in even more dire position.

The trillions of US Treasury are a brittle support edifice which if touched could uncover the true competiveness and status of China. This is perhaps why such deep concern is expressed in any loss that Chinese money management produces in dollar assets. Further more this asset creation that China required to balance the “fiction” in the terms of trade was massive and also occurred when the USA was not in a strong growth phase as Japan enjoyed in the 80s, and even in support during the 90s. USA had just entered a long war in the post 9/11 world as well as suffered wrenching re-organizations in corporate governance post Enron and Tyco and WorldCom, and was emerging from a market mania in dot com economy crashing. The absorption of the Chinese capacity for good destined to the USA market, realized through fictional pegs in the currency, is growth or is one side of a Pacioli identity which has to find another side. If the major cash flow realized destined to China has to be maintained in stable and unobtrusive US Treasuries, otherwise a “true” accounting occurs, then a proxy asset liability structure has to be developed in the USA.

And there you have it. Sub prime RMBS. I cannot think of any other market that might have occurred to fill that imbalance. But noting what has happened in the past, through a chain of causality, American financial institutions insisted that this time the assets would be AAA unlike times past when the investment was in EMD or other volatile assets. Not only this but to a lesser degree the whole world affiliated with the USA was allowing China to do this – and the whole world through various financial chains led back to the USA and then to RMBS. RMBS structures then established an absolutely standard bubble in the core asset – the USA home. Risk control was applied but based on data sets of past where such international flow did not exist and the regional makeup of mortgage banking provided a risk ameliorating profile which made the ratings agency and internal data reasonable in the support of the AAA rating. People were not fools but for not seeing how a market dominated by regional USA economy had become and integrated global market. There was to be no portfolio effect.

This also allows parameters as to the size of the USA problem – it is roughly in synch with the size of the Chinese (and to a lesser degree some other Asian exporters and oil producers) story.

All of this is good news and bad news. First perceived in this way – which is the correct and valid version of how we got here I feel – takes the average American person and society off the hook. We have a sub prime crisis because we did not want to risk putting young Americans in harms way on the Asian battlefield. And that remains the problem as there is still an excellent case to be made that to provide these imbalances to continue will allow a more secure and peaceful world. To eliminate these imbalances and insist on China (and others) to exist solely on the realities of their own domestic markets would lead to war as it is very unlikely that the current leadership of China will “take the fall” and fess up and admit they blew it in face of 200 MM very well educated and angry Chinese youth. Japan did take the fall, but we also cushioned the blow and worked closely with great respect with the Japanese nation. China will likely try and buy time and diversion by moving first on Taiwan and then perhaps India and then assist North Korea to be a great problem. If USA does not realize why this occurring we may respond with protecting Taiwan and at the very least a full war footing will be adopted. But that is if China responds as normal folks will. After Tiananmen, Chinese leadership actually reversed the direction of governance, the assassinated Hu Yaobang’s policy was instituted and Zhao Ziyang deposed. That steady and enlightened ability to move in such dramatic fashion to repair error has much to do why one should be hopeful. Also, despite Geithner’s jingoism on “manipulation” and the USA leadership inability to perceive the crisis as I outline above and instead pursue their own “blame game” and moralistic based crusades, despite this dismal start the USA may check up and realize what has happened and what could occur.

But still, the NY Times now “on any given Sunday” sickens me and frightens as to date I do not see these positive trends forthcoming.

Instead I see “all the family to dinner”

Saturday, January 24, 2009

The Hooey in Peak Oil

OK (Chart swiped from CIBC )

Here it is - someone has to explain this to me. Central part of "peak oil" is the graph above which shows the incremental cost of new oil.

Suddenly, out of the blue, incremental cost to make one more barrel of oil appear out of the ground moved, after decades, from sub $20 pre 2002 to just shy of $100? What happened in 2002, were the Saudi fields nukes? Did I miss that?

That's ridiculous. We can choose to make energy from bio-fuel or the $60 or so per barrel for Ft McMurry oil, but the least expensive incremental cost to make one more barrel of oil is still south of $20. And it will be so as as long as Russian and Middle East reserves are not depleted.

This chart above (er that part before 2002) also shows where oil is headed. Also shows the pain felt in many parts of Canada like Ft McMurry or Halifax yards servicing Hibernia....

Violence in Trade Data Shows Enormity of Crisis

Swiped the above from a terrific blog the economist Toma referenced: "Calculated Risk"
They were posted to outline the price of oil's impact on trade as well as to qualify Geirthner's China comments on trade.
What I find interesting is not in terms of trade and China - though China is about 1/2 of the above data and the interesting essay long question is what this change is doing to China, but more so that these pictures are a very clear view of what is happening to the US economy.
In the end of the Clinton era Japan hit a wall with little effect on us but for their mercantalistic trade impact. The first Iraqi war also had large impact as oil went through large gyrations. Trade moves can be explained by these exogenous factors to USA domestic economic waxing and waning.
This time around there are little in the way of exogenous factors.
Trade numbers have gone through these incredible shifts due to the developments in the USA domestic economy
This gives us an early read as to what is happening to USA consumption. Foreign imports have dropped at around a $600 billion annual rate in a shock move. The rate of droppage in US imports has dropped over 20% in a very short time span. And these are likely snapshots midstream of the total move that is occurring.
This translates to a drop in USA consumption of around 6% which implies the USA ha increased their savings rate from 0% to well over 5% in about 4 months. It also makes mincemeat of the NBER "declaration" that the recession started in 12/07 - the recession clearly started in July 08 or later. This is even more appalling considering the speed and violence of this wrenching move. The 12/07 start date helped provide some "same old, same old" calming in terms of a "normal" developing recession.
If one uses the trade data to provide a "seismic" measurement of the USA domestic economy, a picture of an incredibly violent crash in USA consumption/investment becomes apparent as well as the view that we are still midstream. Better analogy is we are in some tenuous shelf on a Thai beach on a recent Christmas and the first of three tsunami waves has just passed by.
The eventual rise in savings and drop in consumption looks like it will be well over 10% of GDP.
That will likely result in are touching or being in reach of touching 20% unemployment.
The only small but important "hope" in the above data picture is that the swiftness, size, and velocity of the move indicates that it is technical, meaning it is not form inherent problem or sea-change in the USA economic structure but - and I know it is a large "but" - for the $700 billion to $1 trillion foreign flows imbalances which insisted on the bogus AAA RMBS assets creation. This means that the start of this crisis and still likely the main problem is still a very enormous bank credit crash. Fix that with a Bagehot like action in total finality and then mend the drop in consumption and calm folks so they drop their savings rate and we can fix this with the same speed and violence with which it is occurring. But if we do not match tempo with tempo, then no fix will work and if anything a Keynesian "muddle" develops to augment the original problem.
These trade pictures above should make you pause long and hard and think.
If we do not provide the fix we are entering an economic setting which we have no experience of, even the 1930s.
These are very very calm and reasonable thoughts which make this all the more terrifying.
We have no time. We have perhaps already crossed the point of no return but I suspect we have a few more months. But the violence of this trade reversal data is amazing - like being in the lifeboat and seeing the fully lit Titanic upend and start the slide this is an amazing and singular thing to see and witness. Rather watching this given the political action and will shown to date, it is more like being on the Titanic stern and watching the slide into the water. We cannot let this get to the point where massive social unrest and societal pain on a global basis forces a solution as that is always the time of demagogic leadership and fanatical thesis.
Write a letter to your Congress, Senate, and our new President - or, go buy a gun as the poor and desperate will come calling.

Friday, January 23, 2009

A letter to a congressional staffer in charge of the economic issues

I just wrote this to a contact I have developed with my congressional representative office. The congressperson is a senior member of the appropriations committee.

I advise reading this - because it likely means you have interest or are practitioners in finance and have some pragmatic experience - to write your representative and stay at it.

This is becoming an incredibly dire national and global emergency.

My letter (and there have already been a few):


Once again I am not sleeping at night.

The current environment is as sweet as it could be to someone with my trade - ostensibly an expert in long term fixed income investments which is the key area as pension funds and investors set out to survive this crisis. So I should be happy. But a combination of both the pragmatic need to have a platform (which is at risk) to practice my trade along with a civic minded concern of the misery and extreme political pressures that may be forthcoming have returned me to despair.

The "American Recovery and Reinvestment Bill" looks like it will fail - not in passage but in meeting the intent.

Just, in robust fashion, consider that the amount that went to Appropriations for the $825 billion bill, as per Appropriations rules, was for $358 billion of spending, which is a good indication of the actual "meat" or true stimulus in the bill.

The rise in savings and drop in consumption that has either already arrived or is coming shortly is about $750 billion and if it is matched with only $358 billion then it will continue to rise to in excess of $1 trillion. That is standard econ 101 which all economists, right and left, agree upon.

If the increase in savings and drop in consumption goes to $1 trillion, then we are approaching a 10% excess in labor and capital investment and as the capital investment cannot be sold given the fact that little in liquidity or interest in buying, the adjustments will be made in labor. This implies a unemployment number in mid teens. A very persistent feed back loop develops at that point which is why unemployment went to mid 20% in the 1930s.

Current market prices are reflecting this as a new wave in bank failures seem to be upon us, international trading partners GDP is being reduced on a leveraged basis to decrease in USA demand, and the negative earnings resulting from excess capacity is forcing re-adjustment of prices in the stock market. The SP 500 stock market index has continued down from highs around Christmas,as the Obama-Biden Plan and now the "American Recovery and Reinvestment Bill" is causing dismay.

We are back to the edge where we are at high risk for an explosion in unemployment, corporate default, nationalization of the larger banks, bank holidays, and a stock market crash. Already massive damage has been done to retirement plans and pensions to the extent of never being able to repair, and another adjustment down will produce a chronic crisis in that area of our populace least able to protect themselves - the elderly. Migrations to more comfortable climes for retirement will cease and massive numbers of elderly in poverty will remain in XXXXXXXX.

As I have pointed out in the Fall, I am still seeing little if any signs of literacy of key economic concepts and the realization of the potential outcome in Congress - otherwise how did the "American Recovery and Reinvestment Bill" leave Appropriations? Why is there no terrified and shrill and even hysterical debate? I could be wrong but the potential outcomes I outline are in the realm of reasonable discussion and therefore responsible people should be extremely careful and diligent now. I do not see this occurring. I do not read about this occurring. I do not perceive the necessary responsible and civic change has occurred.

I think my insights are topical and correct, please put me to work. We are now all Keynesian and right left, Republican or Democrat, as in war time, these labels are not of issue. After the rescue and some normalcy returns we can all divide back to our various disciplines but for now the country requires steady civics.

I can also gather a very learned and credentialed small group for Congresswoman XXXX and for your education. Please relay this to the Congressperson and also please accept the market outcomes as they are developing and accept the information they are providing - the "American Recovery and Reinvestment Bill" is stillborn.

I see an obvious chain from the first week of January as the first draft of the "Obama-Biden Plan" was released to Romer's disastrous defense of the tax effect in the "O-B Plan" to the President's inaugural address and the development of the "American Recovery and Reinvestment Bill" - all have obvious economic flaws that will result in disaster. That is what the market is relaying to your office.