Monday, June 27, 2016

The Real Crisis Brexit is Uncovering

BREXIT is sexy and fun, well parameterized so folks can chew it over and make sage proclamations.  And no doubt the market was rocked, with a SP500  1999 print at the lows last night from a night session high SP500 2025  as "Remain" high confidence made some hedge funds feel there was an easy harvest to be had by jamming the market upwards.  But as results came in no doubt the senior guy who ran the desk or even the hedge fund owner ordered all their folks to sell the SP500 and take their hit, perhaps even being told to not bother showing up for work this morning.  
But BREXIT is in reality a rather small event in terms of flows and company valuations.  Contracts will be honored and crates of olives from Greece will be paid for once they reach London and the boat load of Bentleys off to Poland will still be delivered on a timely basis.  No labor unions will have an incentive to strike, no tires will be burned and unless you are a migrant Uber driver in Paris - no harm no foul but for your usual risks being beat up by 3rd generation Pied Noir cab drivers who have completely forgotten that their dad or granddad was in your situation not that long ago.The Byzantine European Council will still go on and folks still nap in the European Parliament.  Tusk still is the President and Merkel wont gain or lose any votes.  

So why the excitement?  

It became a game where everyone agreed to bring their betting slips and play hard upon the vote.  But it is really a non event.   

Now I could dig deeper and discuss the Habermas Adorno form of democracy, the "deliberative democracy" is under the gun, but it is long spiel, and while I find it critical few do so I wont go over it now.  So I will let Nigel Farage do the explaining - he is more fun to listen to anyway and I am happy for him now as he chortles away.  
Markets will sort out and as it quiets down I wont be surprised to find Cameron states he thought he was clear that he meant October 2017 as his end date and the Article 50 wont be required to be filed until that time.  Lots of exclusive dinners in Brussels and lots of perks yet to enjoy.

But what is being uncovered is an extremely dangerous situation. First the lack of surprise, not the outcome but that the event was going to happen, has allowed the world's  central banks to make important phone calls and meetings to act in unity and in coordination.  All to the good one would think, but it is not the role of the world's central bankers, no matter how comfortable with each other, to put into place foreign policy for their governments.  In fact that this is not a surprise which make this all the more worrisome.   

As the world's central bankers use this event as another affirmative "club" ceremony, they become more entrenched and assured that the identical policy they are all applying is the correct and only way to go about things.All the world's central bank, with many able to now go into negative rates, have become convinced that the Wicksellian idea of a "natural rate" exists such that to place the central bank rate (in the US it is Fed Funds) below the "natural rate" one is stimulating the economy and if you place the rate over the "natural rate" then you are tightening the economy.  That if one is below the "natural rate" for long enough you will raise inflation and by the way improve the lot of your citizens.  That if inflation is not rising then you are simply not low enough and the "natural rate" is lower than you think.
And they trust in the inherent efficiency of the markets (and though they  prefer to never discuss it, the equity market especially) so that if markets trade south it must also mean that rates are not below the "natural rate", so they lower rates.  Therefore all that is given heed is the rate of inflation and the stock market - nothing else counts like retail sales or employment or home sales.  They are all furiously set to drop rates to any levels, especially now that the way is shown to go negative rates. So BREXIT is welcomed by Yellen as the drop in the SP500 and the turmoil allows her to "reluctantly" shed normalization and get back to figuring out when and how much to ease if not go to negative rates. 
This is a disaster for in truth there is no "natural rate", that Wicksell works fine when rates are well over 3% or 4%, but are a myth if not a fallacy as rates are in proximity with 0%.  In fact at some point - most see it at around 2% or lower - the so called natural rate and the Fed Funds rate become one and the same and that the reduction of Fed Funds will reduce inflation and will in fact be a depressant on the economy - Allie through the Looking Glass stuff.  Things are not what they are when played on the Blue Guitar.  This is in fact a cheeky explanation for the NeoFisherism school of monetary policy which says that once certain equilibrium points are breached, the central bank must raise rates to raise inflation and to be stimulative.  

Obviously if NeoFisherism is right this could end as a disaster and while in the end the reality of the search for corporate profits will prevail, in the meantime Yellen's Fed could produce a "lost decade" just as Japan experienced.  NeoFisherism is based upon the "Fisher Rate" (why the name) which acts like a portal from the central bank's rate setting policy to the growth (or decline) of the nation’s GDP.  That there is no "natural rate" just that the Fed Funds rate is equivalent to the Fisher Rate which is equivalent to real GDP plus inflation.  So raising Fed Funds raises real GDP and NGDP in units of NGDP, and a drop in NGDP will drop the Fed Funds rate.  That everything is malleable and coordinated.  

i = GDP + inf.  

If one is on the lookout for the Fisher Rate one can derive the rate form various maturities and then start to compare to various other assets that in the end are dependent on their setting of the nation's GDP.  This is the Origin of all return and why we call our process the 'Origin" - the "Origin Process".

So if the central bank is in error using ancient Wicksell ideas of a natural rate, a rate that doesn't exist, then the central bank - especially if the central bank is powerful, and in the end not have the Origin of the economy, its NGDP, but actually have the Federal Funds rate price the NGDP. And if an event like BREXIT comes about and gets the central bank all fired up, then as they are now - from their perspective - completely justified in taking extraordinary measures and drop rates, now into negative levels, to whatever works until inflation rises and economy is revived.  If NeoFisher rates are the right way to look at life this never happens and if powerful enough the central bank will at best cause a "lost decade" or perhaps even a depression. At the head of this note is SP500 (the SPYDR) in a scatter plot versus the implied NGDP expected in 7 years (which is tricky to mine in the markets and worth your price of admission to take me on as your money manager just for that alone) which shows that as Yellen goes slow or now even avoid normalization those Bloomberg odds of a rate rise by December, say, is also pricing out the odds of a depression.  
If the SP500 were to take implied NGDP to heart, and see a high likelihood of a lost decade ahead, were to occur then SP500 would price toward 1200 to 1400 level.  And of course this is what happened to Japan after then first up trade in the N225 during the early part of the 1990s. So BREXIT might be the rather minor event which triggers the resolution of the real problem, the massive error in policy that the Federal Reserve is now committing.  The right way to read this is via the Fisher Rate lenses where the forward Fisher Rate is the forward NGDP forecast.  The US simply cannot survive politically if the Yellen Fed are to carry on insisting that the potential NGDP in the USA is, around or less than 1%.  Certainly the SP500 will not be trading where it is now if that is so.  

Since I do not think this is what the US will do, then I am also saying Yellen must go, US Treasury 5 years must go to around 5% and Fed Funds normalize.  Or Yellen figures out how to duck the righteous Bullard attack and adopts with honor NeoFisherism ideas.  This likely means she has to replace the Board of Governors economic staffers and dash her relationship with Princeton and Woodford crew.   I do not  think she can.

The immediate tactical problem is that given the above the US Treasury market is "blown" as the usual and correct offset in providing the offset to risky assets selling off.  While this may seem trite, it is not when the portfolio management problem is the Met Life balance sheet, or the Texas Teachers retirement portfolio, or Norway sovereign fund.

Monday, June 6, 2016

The "Five Points" or Party Planks Required by the GOP to Gain Power (or How to Destroy the Democrats)

". . .those who are disabled from work by age and invalidity have a well-grounded claim to care from the state." 
                                                                        Otto von Bismarck   1881

I would assume that Bismarck’s conservative credentials are well intact, and one would hardly accuse him of being a running mate of Hillary Clinton let alone Bernie Sanders.  Yet Bismarck’s ideas of the obligation of the state to support the people, or “Volk”, is undeniably left of both Hillary and Bernie.  Unlike Hillary, Bismarck not only saw social security as a pragmatic political expediency, but he thought that social security and the state’s safety net for the “Volk” was critical for the state legitimacy.  Bismarck was also wily and knew that social security and other social services would take the legs out from under the socialist by once eliminating concerns for baseline survival, the innate patriotism of the conservative platform would resonate with the people.  It did and allowed the monarchy to stay in power until the tragedy of WW I – which Bismarck also warned against.

Taking Bismarck as the “gold standard” for a thoughtful conservative policy platform, perhaps some insights can be gained by the Republicans in this election year.  What is more, until the Republicans honor the rights of every American to health, education, basic welfare and retirement – to honor the ability of the American people to honor the “pursuit of happiness – they are not conservative in any thoughtful sense but merely the henchmen to rentiers to maintain current value purchasing power and forestall inflation for the rentier wealth. 

The GOP must return to true conservative ideals.

The key one is: “pursuit of happiness”.

Madison on 1786 wrote the following:

 “There is no maxim in my opinion which is more liable to be misapplied, and which therefore needs elucidation, than the current one that the interest of the majority is the political standard of right and wrong. Taking the word “interest” as synonymous with “ultimate happiness,” in which sense it is qualified with every necessary moral ingredient, the proposition is no doubt true. But taking it in its popular sense, as referring to the immediate augmentation of property and wealth, nothing can be more false.”

Madison clearly shows that “happiness” was not just ease in living or property, but the baseline ability for the state to allow everyone an equal footing to prosperity.

Madison was without a doubt a conservative, often locking horns with the  arch leftist Jefferson.  So it is worth the GOP while to think on what Madison meant by “happiness”.  It is also to be noted that “happiness” was not provided for all, but the “pursuit” of happiness.  That implies not only an ability to better oneself but also a level playing ground so as others do not take away your ability to pursue happiness.

Bismarck understood this which is why this very conservative, if not arch-conservative, created or invented “social security”.

Socialist and leftist have little interest in social security or other safety net apparatus as they realize what the conservative Monroe and Bismarck are about – they know if the state can legitimize their power via providing the ability to “pursue happiness” for all, the ability of the socialist and left to seize power is diminished if not eliminated.  A Bernie Sanders has not a leg to stand on if all of his platform, but for wealth distribution, is put forward by the conservative wide of the field.  Then a Bernie Sander has no recourse to effect wealth distribution but through revolution, which in history has been violent. 

The GOP should therefore provide the following:

1)   Universal health care;

     2) Universal education at all levels, admission decided by merit;

    3)   Guaranteed income of at least the poverty level plus, say, ten percent;

    4)Matching social security to the poverty level plus, say, ten percent and eliminating income tax past a certain age – 70 or older;
    5)‘Ellis Island” immigration policy without limitations as to numbers and based upon merit and basic moral and physical rectitude, also requiring a loyalty oath which to break is a felony.

Most GOP would claim all the above would be prohibitively expensive and pragmatically beyond the means of the US purse.  This is a recent tenet of the GOP and during the age Eisenhower, Theodore Roosevelt, Nixon, Coolidge, Hoover and even Reagan – basically all the successful GOP POTUS – did not feel the US was limited in its ability to invest in the future.  And those GOP POTUS who had success but pursued balance budget and parsimonious policy either had the brutal Keynes spend from war help them join the list or they are slated for obscurity.  George H Bush is such a man who was pulled by the nose from the Pete Peterson crew and therefore will be forgotten by history.

The USA concern with a balanced budget is a ruse applied by both Democratic and Republican alike so as to prevent inflation and protect the rentiers – who in the end want only to maintain the value of their capital they put out for rent, or rentiers, by avoiding the estate tax of inflation.

Rentiers are the true enemy of the GOP -  whether the GOP realize that or not – and to continue on with the Pete Peterson types protection of the rentier class is not only anti-democratic but it denies America to provide for “pursuit of happiness and thereby will in the end not provide legitimacy for the GOP executive.

To provide for my 5 points above – healthcare, education, guaranteed income, enhanced social security, and free merit based immigration – would be almost paid for itself within a decade from the NGDP increase from the increased immigration alone.  The education costs should be seen as not a consumption of capital but rather an investment and would undoubtedly result in a multiple greater than one with increased productivity and a larger more effective Labor Force.

The debate would come from guaranteed income, but a thoughtful person would see the immediate cost savings in health expenses and incarceration and in optimism that would motivate the work force to do better.  And universal health care would simply redirect the current waste in billions and billions of those under covered and eliminate the cost of multiple selective private sector health insurers.

The only cost would be the enhanced social security payments and the elimination of taxes for those past 70.  I think such cost would be more than covered with the pickup of the first 4 points.

The main attraction for these five points for the GOP is a political one.  Just as perhaps it was what motivated Bismarck, adopting these five points would effectively destroy the Democratic Party.  It would swing blacks and Hispanics to the GOP.  The Democratic Party would be forced to, or be flushed out to show its true stripes which is now, after the KKK foundation Democrats lost their “state rights” platform in defense of racism, income distribution of the socialist type.  That would be repugnant to the new GOP party membership and until the Democrats find “something new” they would be out of power at the federal level,  for the most part, likely for our lifetime.  The Democrats would likely assume near permanent control of the large cities as that is what they are good at – providing effective public sector nuts and bolts services, just as the communists run most of the cities in Italy now.

I will go further, until the GOP realize they have been taken over by rentiers and are no longer a conservative party but a recidivist reactionary party of the uber rich, they will not have a significant long term role going forward.

The “pursuit of happiness” is the core ideal of the GOP and is the way to power.