December 14, 2010
The Fed has just announced it's continuation of zero interest rates and the QE2 program. As I glance at the ticker, the ten year yield has risen to 3.44 and gold has moved up to 1406. What a surprise! I say that the Empire of Debt, the good old USA, is showing early signs of decay. It took quite a while for Rome to falter and implode, only because they didn't have access to a bond market. Our bond market is showing signs of stress.
Now clearly, bonds are oversold and one can expect a countertrend move in the near future but I think that a secular low in bond yields has been put in place over the past few years and yields will inexorably move up in the future. There is a wide disparity of opinions regarding how high and over what time frame this trend will occur. Bill Gross, Mr Bond, feels that yields will level out at approximately 3.5% feeling that growth will be about 2% and Inflation about 1.5%. On the other hand, there are those, those who loaded up on CDS investments prior to the implosion of 2008-9 like Paulsen, Julian Robertson and the one-eyed neurologist whose name I cann't recall, who feel that the ten year will rise to 20% within 5 years. Certainly, one's investment decisions will be predicated on which outlook one subscribes to.
I think that the Emporer has no clothes; the US is insolvent. Will we raise taxes and curtail entitlements for everyone in the near future to achieve a modicum of fiscal credibility? I doubt it. It is far more likely that the US defaults on it's debt. We did it before. In 1933, FDR changed the exchange rate for the $ from 17/ounce of gold to 35. I think Bernanke knows full well that the long term solution to the problem is to borrow in $ and repay later in wampum. Currently, there is a debate about the reasons for the bond market selloff. The consensus is that yields are rising in response to an improving economic outlook. Maybe, but in all due respect, Shelley, I am skeptical. Will most people spend more because their tax rates will not go up? Will businesses invest for the long term when everyone knows that the tax structure will be radically changed in two years?
Your President has told you that he will whack wealth and Capital in two years. The real estate market is our Achille's heel and one has to speculate that rising mortgage rates cannot be good for this area. Rising commodities, particularly food and gas cannot be good for discretionary spending. The other plausible explanation for the rise in interest rates would be increasing inflationary expectations. As proof, I offer the correlation between the TIPs market and rising yields. If the US economy is strengthening, why is the $ currently weak despite the euro's well documented problems? Gold continues in it's bull market.
To plagiarize, shamelessly, from James Grant, the price of gold = 1/n where n represents the credibility of noncollateralized paper currencies and central bankers. I suspect that the denominator of the equation will shrink with time. Therefore, I am bullish on gold. I am less so on the US Treasury market.
-Guga
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Showing posts with label interest rate. Show all posts
Showing posts with label interest rate. Show all posts
Thursday, April 28, 2011
Del Boca Vista
October 17, 2010
Regrettably, I'm leaving Bend soon to return to the land of the dying and infirm and experienced some insominia. Rather than count sheep, I pondered the complex issue of what's next for interest rates.
Certainly, conventional wisdom dictates that interest rates will surely rise. Our Federal Reserve, in contrast to the actions of Paul Volker, has a mission to defeat deflation, the inverse of which is to create inflation. Printing noncollateralized $ and flooding our monetary base is the mechanism of QE2. How can this not be inflationary?
Historically, it doesn't pay to bet against the Fed. Markets are taking note: the price of gold is through the roof, commodities climb higher, the TIPS are climbing and the 30/10 spreads are rising. Since the prices of food and energy are rising, the average American is experiencing a measure of inflation. Seems like a slamdunk but hold on. Remember that the Fed controls M1 but not M2 or M3. To say that it cannot affect the velocity of money in essance means that it cannot force banks to loan or people to borrow.
Contrast the enormous fall in mortgage rates engineered by the buying of 1.25 trillion $ of these securities with the current state of our housing market. Deflation is a real threat. The folks at the Federal Reserve are justifiably worried about this issue. Look at a chart of the core CPI over the past few years; much more descent leaves us around zero. Simplistically, inflation is too much $ chasing too few goods and deflation is too much debt chasing too little cash flow. Following a two decade debt binge, I think the latter scenario most accurately describes our current plight. So the question becomes, will more $ printing reverse this trend. I doubt it. To date, money has recirculated back to the Fed in the form of bank reserves and abroad where growth opportunities exist. Large corporations are flush with cash but they're not spending. This experiment has been tried before in Japan and the inflation rate has become mired at a negative 1% and the ten year JGB yields about 1%.
I know that we're not Japan, but people have been alleging that for the past 5 years despite the progression of the similarities. The critical difference between Japan and the US is that they have savings and a capital surplus that allows them to fund their burgeoning debt. We're dependant on the kindness of strangers. What to make of these opposing forces? I think that the key, independant variable is the $. The last default of US sovereign debt was created by FDR in 1933 when he halved the value of the $ relative to gold. Our government is determined to undermine the value of our currency. The obvious salubrious effects will be an edge to our exports, raising nominal wealth in the financial markets, a perception of inflation. This policy could have untoward effects, however in igniting an allout currency war and an abrupt rather than gradual fall in the value of the $. Once again, the US defaults on its debt via a significant devaluation of the value of its debts.
At some point, the strangers who fund our debt will no longer be friendly. I have maintained for some time that the US Treasury market is the greatest bubble in human history and the issue is not if but when it deflates. Therefore, I am awaiting the appearance of the 2013 options of TBT. In the interim, I am investing in issues which should hold up in a rising interest rate environment: floaters, junk, converts Canadian oil trusts and pipelines.
-Guga
Regrettably, I'm leaving Bend soon to return to the land of the dying and infirm and experienced some insominia. Rather than count sheep, I pondered the complex issue of what's next for interest rates.
Certainly, conventional wisdom dictates that interest rates will surely rise. Our Federal Reserve, in contrast to the actions of Paul Volker, has a mission to defeat deflation, the inverse of which is to create inflation. Printing noncollateralized $ and flooding our monetary base is the mechanism of QE2. How can this not be inflationary?
Historically, it doesn't pay to bet against the Fed. Markets are taking note: the price of gold is through the roof, commodities climb higher, the TIPS are climbing and the 30/10 spreads are rising. Since the prices of food and energy are rising, the average American is experiencing a measure of inflation. Seems like a slamdunk but hold on. Remember that the Fed controls M1 but not M2 or M3. To say that it cannot affect the velocity of money in essance means that it cannot force banks to loan or people to borrow.
Contrast the enormous fall in mortgage rates engineered by the buying of 1.25 trillion $ of these securities with the current state of our housing market. Deflation is a real threat. The folks at the Federal Reserve are justifiably worried about this issue. Look at a chart of the core CPI over the past few years; much more descent leaves us around zero. Simplistically, inflation is too much $ chasing too few goods and deflation is too much debt chasing too little cash flow. Following a two decade debt binge, I think the latter scenario most accurately describes our current plight. So the question becomes, will more $ printing reverse this trend. I doubt it. To date, money has recirculated back to the Fed in the form of bank reserves and abroad where growth opportunities exist. Large corporations are flush with cash but they're not spending. This experiment has been tried before in Japan and the inflation rate has become mired at a negative 1% and the ten year JGB yields about 1%.
I know that we're not Japan, but people have been alleging that for the past 5 years despite the progression of the similarities. The critical difference between Japan and the US is that they have savings and a capital surplus that allows them to fund their burgeoning debt. We're dependant on the kindness of strangers. What to make of these opposing forces? I think that the key, independant variable is the $. The last default of US sovereign debt was created by FDR in 1933 when he halved the value of the $ relative to gold. Our government is determined to undermine the value of our currency. The obvious salubrious effects will be an edge to our exports, raising nominal wealth in the financial markets, a perception of inflation. This policy could have untoward effects, however in igniting an allout currency war and an abrupt rather than gradual fall in the value of the $. Once again, the US defaults on its debt via a significant devaluation of the value of its debts.
At some point, the strangers who fund our debt will no longer be friendly. I have maintained for some time that the US Treasury market is the greatest bubble in human history and the issue is not if but when it deflates. Therefore, I am awaiting the appearance of the 2013 options of TBT. In the interim, I am investing in issues which should hold up in a rising interest rate environment: floaters, junk, converts Canadian oil trusts and pipelines.
-Guga
The Great Disconnect
September 24, 2010
I have been asked recently about my failure to blurt out my observations of life, the economy and the financial markets recently, but frankly, I have been puzzled. No more; often wrong but never in doubt! I will title this issue, The Great Disconnect.
The economy and the fate of most Americans is about to diverge from financial markets. Let's start by examining the economic realities, (as I see them). To plagerize shamelessly from PIMCO, we are entering the new normal, at best: low growth, deflation, deleveraging, high unemployment, falling home prices and mindaltering levels of debt. Many thought that I was insane, several years ago when I said that we were heading the way of Japan. We should be so lucky. Remember that when the shit hit the fan in 1990, Japan had a huge current account surplus,(we have an enormous deficit), personal savings,(the American public is pathetically insolvent), and a strong global economy to support it's export driven economy, (Americans consume and do not produce). The majority of Americans naively assume that the federal government holds the keys to reverse this process, if only we could elect the right guys to implement the correct policies.
As I have stated previously, revisionist history leads to widely accepted misconceptions which leads to failed policies. Americans hold FDR, the New Deal, John Maynard Keynes in high regard for ending the Great Depression. For the most part, these policies were abject failures and we owe our recovery to the policies of Adolph Hitler. Nonethless, the Keynsians reign in DC,(as opposed to Europe where they have run out of money), and we await with baited breath, our next stimulus and more quantitative easing. Heaven forbid that markets be allowed to function, to clear the debris of bad debt and overvalued assets.
Americans, a profoundly illiterate group, know nothing of the Great Depression, let alone the economic history of the nineteenth century. We had economic calamities in the 1820's, 1830's 1870's 1890's and early 1900's. Why don't most people know of these events? Because they were relatively short. Why were they short? Because the government did not interfere in the economy. An interesting historical tidbit: Martin VanBuren lost the 1840 election because he refused to intevene in the downturn of the 1830's. Shortly after his loss, the economy returned to vigor. We operated under the principles of Australian economics in the nineteenth century, experienced several viscious short term economic downturns, but were able to create in aggregate, enormous economic growth, employment and a general increase the standard of living for the citizens of the country.
Many of our ancestors, including my grandfather immigrated to the US because it was a global source of jobs. These ramblings are irrelevant; our politicians,(don't doubt that Bernanke is a politician) don't subscribe to free markets and will intervene. Additional stimulus is uncertain given the Nov. elections rendering the Fed more central to the government's push to reinvigorate our economy. The consensus is that they will purchase another trillion bucks worth of Treasuries come November. What effect will this risky strategy accomplish? Sure didn't work in Japan. Conceptually, forcing interest rates down another 25 basis points will allow those who qualify to refinance, improving their monthly cash flow. Theorectically, the cost of capital will decrease for business. The reality is that printing $ will decrease the purchasing power of the $. Will that alleviate our deflationary concerns? Probably not. There will be no wage increases in the face of a glut of labor. The prices of consumer goods will continue to decline given the oversupply of productive capacity. Housing will continue to decline in value,(rental rates, under pressure, make up 1/3 of core CPI.)
What will go up in price as the $ falls? Stuff. Gold, silver, but more importantly, oil, gasoline,copper, iron ore, wheat, soybeans, etc. In short, with high unemployment, stagnant wage growth, the cost of survival, ie. the cost of food and energy, will rise. Conveniently the Fed doesn't include food and oil in their calculations of core CPI. Americans are going to get poorer. Interestingly, the financial markets will do well. If I am completely wrong, the economy takes off, the Fed doesn't intervene, the equity markets will do well.
If I am correct, all financial markets will prosper. The Greenspan put has been replaced by the Bernanke put. Hence the title, the Great Disconect; financial markets will do fine while the American public will suffer.
-Guga
I have been asked recently about my failure to blurt out my observations of life, the economy and the financial markets recently, but frankly, I have been puzzled. No more; often wrong but never in doubt! I will title this issue, The Great Disconnect.
The economy and the fate of most Americans is about to diverge from financial markets. Let's start by examining the economic realities, (as I see them). To plagerize shamelessly from PIMCO, we are entering the new normal, at best: low growth, deflation, deleveraging, high unemployment, falling home prices and mindaltering levels of debt. Many thought that I was insane, several years ago when I said that we were heading the way of Japan. We should be so lucky. Remember that when the shit hit the fan in 1990, Japan had a huge current account surplus,(we have an enormous deficit), personal savings,(the American public is pathetically insolvent), and a strong global economy to support it's export driven economy, (Americans consume and do not produce). The majority of Americans naively assume that the federal government holds the keys to reverse this process, if only we could elect the right guys to implement the correct policies.
As I have stated previously, revisionist history leads to widely accepted misconceptions which leads to failed policies. Americans hold FDR, the New Deal, John Maynard Keynes in high regard for ending the Great Depression. For the most part, these policies were abject failures and we owe our recovery to the policies of Adolph Hitler. Nonethless, the Keynsians reign in DC,(as opposed to Europe where they have run out of money), and we await with baited breath, our next stimulus and more quantitative easing. Heaven forbid that markets be allowed to function, to clear the debris of bad debt and overvalued assets.
Americans, a profoundly illiterate group, know nothing of the Great Depression, let alone the economic history of the nineteenth century. We had economic calamities in the 1820's, 1830's 1870's 1890's and early 1900's. Why don't most people know of these events? Because they were relatively short. Why were they short? Because the government did not interfere in the economy. An interesting historical tidbit: Martin VanBuren lost the 1840 election because he refused to intevene in the downturn of the 1830's. Shortly after his loss, the economy returned to vigor. We operated under the principles of Australian economics in the nineteenth century, experienced several viscious short term economic downturns, but were able to create in aggregate, enormous economic growth, employment and a general increase the standard of living for the citizens of the country.
Many of our ancestors, including my grandfather immigrated to the US because it was a global source of jobs. These ramblings are irrelevant; our politicians,(don't doubt that Bernanke is a politician) don't subscribe to free markets and will intervene. Additional stimulus is uncertain given the Nov. elections rendering the Fed more central to the government's push to reinvigorate our economy. The consensus is that they will purchase another trillion bucks worth of Treasuries come November. What effect will this risky strategy accomplish? Sure didn't work in Japan. Conceptually, forcing interest rates down another 25 basis points will allow those who qualify to refinance, improving their monthly cash flow. Theorectically, the cost of capital will decrease for business. The reality is that printing $ will decrease the purchasing power of the $. Will that alleviate our deflationary concerns? Probably not. There will be no wage increases in the face of a glut of labor. The prices of consumer goods will continue to decline given the oversupply of productive capacity. Housing will continue to decline in value,(rental rates, under pressure, make up 1/3 of core CPI.)
What will go up in price as the $ falls? Stuff. Gold, silver, but more importantly, oil, gasoline,copper, iron ore, wheat, soybeans, etc. In short, with high unemployment, stagnant wage growth, the cost of survival, ie. the cost of food and energy, will rise. Conveniently the Fed doesn't include food and oil in their calculations of core CPI. Americans are going to get poorer. Interestingly, the financial markets will do well. If I am completely wrong, the economy takes off, the Fed doesn't intervene, the equity markets will do well.
If I am correct, all financial markets will prosper. The Greenspan put has been replaced by the Bernanke put. Hence the title, the Great Disconect; financial markets will do fine while the American public will suffer.
-Guga
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