It is always interesting to watch the media try to influence traders who think they are investors (they butter traders up by calling them "investors"). No doubt, this is an integral part of the grand rip off known as the stock market. Who are they targeting, and why?
If you "invest" for cap gains instead of cash flow, in other words, if you intend to buy low and sell high (or vice versa) you are a trader. You are not an investor. Most traders lose because they don't even know enough about trading to know they are doing it. Most investors win, because investors generally understand the big picture, they look for cash flow from an asset class such as business ownership (not to be confused with the stock market), which is a value play not a price play.
Who am I? I am an investor turned trader for the price decline. Why? Because by selling high and buying low you can reap the paper gains those of who've entrusted unmonitored piles of money, namely IRAs and 401Ks, to reckless trading.
Another way to look at market cycles is to note the Trader:Investor ratio. At the peak, the ratio is very high, and in the troughs the ratio is very low. One way to objectively quantify the ratio is to look at the average dividend payout, right now we have the lowest dividends ever registered--the market is still peaking.
That shouldn't be too surprising since the Dow is more expensive today than ever before in terms of total index earnings. Several times higher. The advertised P/E is extraordinarily high at 31, but that is only achieved by disregarding any index components running horrendous losses. The true index P/E with earnings reduced by losses is near triple digits.
The advertised Dow P/E ratio has only breached 30 twice before: October 1929 and 1999.
It seems the T:I ratio is actually increasing, not declining. Trader bullishness is reaching a frenzied pitch, the precise opposite of the requisite market-wide, global trader macro capitulation that needs to occur to shift the ratio to vast-majority investor dominance, 1932-style.
Also interesting is a shift in mindset of gold traders. Gold used to be traded as an inflation play, the strategy was simple: stocks up, real estate up, prices up, gold must go up. And it did, about 50x over. That has mindset has recently shifted to a deflation play: stocks down, real estate down, prices down, gold must go up. The MSM has played some role in shaping the shift by funneling inexperienced gold traders toward gold, but many prominent gold traders have also changed their tune.
Traders' markets can get very volatile and/or collapse at any moment, so keep your eye on the big picture or do the smart thing and stay in 100% cash. Ironically, at the price bottom the media may morph into something worth a listen, as traders will have been eaten, dividends will rule the day for stock buyers, and identifying solid cash flow investments will be all the rage.
Thursday, April 23, 2009
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Ha...love the gold comment. Very true.
ReplyDeleteFDR, any thoughts on the stress test results?
ReplyDeletePlanned Turning Point? Non-event?
Russ
Hi Russ,
ReplyDeleteI don't think it's an event other than in the context of the event we already understand:
Government asleep = Bull market
Government active = Bear market
Of course government-bank collusion will continue their charade that they can willfully inflate by pulling out that next "last stop" after already pulling out "all the stops." They've been saying that since the first dip from Dow 14,000.
I remember when "all-powerful Federal Reserve" rate gibberish was all that mattered. The MSM used to write entire articles analyzing the Fed chairman's eyebrow movements, "one up, one down, what will it mean for our future?!"
Nothing. Nothing then, nothing now.
The government-banks CAN do one thing without a free market engine powering their narcissism, send prices lower.
Great points FDR. Thank you.
ReplyDeleteI remember something you said a while back that stuck with me.
ReplyDeleteYou said the time to possibly begin investing in the market will be when it is the general perception that it is the worst thing to do with your money.
I think that is what people who lived through the Great Depression came to believe as they saw one bear leg after another destroy their wealth.
On that theory, which I also believe, we have a long ways to go, probably years, before there is capitulation among the general public. People are still banking their 401K, 529 education funds, and the like. My wife was just telling me to be sure and fully fund our IRA for the year (I think NOT!) - tax deferred, she says.
We are at war with the big money center banks that rule us and our government. A leader needs to emerge and do something about it.
ReplyDeleteFDR
ReplyDeleteAll good points. However the Fed is the market now. They can keep it pumped for a long time probably. Really , we are in no mans land.
They've always been in the market, and they can't print without commercial banks. All that matters is economic activity.
ReplyDeleteCentral banks and the governments they own are impotent and incompetent, they can only make things much worse and both are hellbent on ruining people to save themselves.
FDR wrote: "They've always been in the market, and they can't print without commercial banks. All that matters is economic activity."
ReplyDeleteOn this I believe you're incorrect. The Fed can print through the government, by loaning money to the government, which the government would then use to pay the people on its payroll and the other expenses it has (including non-Fed debt, such as treasuries that are coming due, FDIC expenses, bailouts, ad nauseum).
Now, if you meant that commercial banks must exist as a place for the recipients of that currency to deposit it, then you're probably correct (since the currency is generally distributed in the form of checks or direct transfers, neither of which individuals are equipped to directly handle). But I read what you said as meaning that the Fed requires commercial banks to be the indirect issuers of Fed loans, which clearly isn't the case.
As for central banks and governments being incompetent, I'd say that's true only if you assume that the outcome we're seeing isn't the outcome they want. I think they're getting exactly what they want, and that makes them far from incompetent.
There will always be economic activity, because few people (a lot fewer than during the Great Depression, certainly) are entirely self-sufficient, and therefore trade is a necessity. The real question is whether or not that economic activity is being influenced by the Fed and the government. It would be nice if it weren't, but I don't ever see that happening.
"On this I believe you're incorrect. The Fed can print through the government, by loaning money to the government, which the government would then use to pay the people on its payroll and the other expenses it has (including non-Fed debt, such as treasuries that are coming due, FDIC expenses, bailouts, ad nauseum)."
ReplyDeleteThat is true as long as you ignore the repayment which is more than double the loan amount over the life of the loan after interest. Kind of like saying VISA gives you money. Even the initial influx is minimal since everyone pays right away but very few actually benefit even in the short term.
It is the commercial banks printing $40:$1 on top of reserves that once multiplied the currency supply. We have to out-print that burning fire in order to increase the currency supply, non-leveraged borrowing cannot out-pace a highly leveraged burn rate.
It's like hoping Chicago home construction will outpace the Great Chicago Fire.
On top of that double-drain, commercial banks now cannot lend that double-amount, because the people already owe the money to the Fed. The Fed's lien on future earnings reduces the available commercial credit pool in precise balance.
FDR wrote: "That is true as long as you ignore the repayment which is more than double the loan amount over the life of the loan after interest. Kind of like saying VISA gives you money. Even the initial influx is minimal since everyone pays right away but very few actually benefit even in the short term."
ReplyDeleteI certainly didn't mean to imply that there wouldn't be any consequences of the Fed printing money, merely that, contrary to my interpretation of your assertion, it is possible for them to do so without using commercial banks as an intermediary.
"It is the commercial banks printing $40:$1 on top of reserves that once multiplied the currency supply. We have to out-print that burning fire in order to increase the currency supply, non-leveraged borrowing cannot out-pace a highly leveraged burn rate."
But we don't *have* currency deflation right now, because the deposits are staying put. Once the FDIC goes under and/or stops backstopping bank deposits, then we'll see currency deflation, and in a big way. But until then, we'll at most see currency stagnation, to the degree new currency which is printed is directly used to "pay off" defaulted loans (any excess which is not used for that purpose will be inflationary in nature because it will be added to the currency supply).
A simple example should illustrate what I'm talking about, and perhaps give you something to poke holes in. Suppose we start with $1 in reserves at the local bank, and $2 in reserves at the Fed. The bank then makes a $40 loan...
Before loan: $3
After loan: $43
Now suppose the lendee defaults. Has the total amount of currency in circulation changed? Nope. Why? Because the lendee (or someone he paid) still has it!
Before default: $43
After default: $43
Now suppose the Fed loans the government $40 so that the government can restore the bank back to health by repaying the loan it made:
Before Fed loan: $43
After Fed loan: $83
Now the government gives the money to the bank and the bank pays off the loan:
Before government payoff: $83
After government payoff: $43
So: has there been net currency deflation when comparing the currency immediately after the original loan was made and after the government bailed out the bank? Obviously not: the total currency in the first case was $43, and the total currency in the second case was also $43. This is because the only time money is destroyed in a fractional reserve system is when a loan is paid back.
Of course, after the government bails out the bank, the government owes the fed $40 plus interest, so the government has to collect that amount in taxes. But at that point, the original bank is in *exactly* the position it was in prior to the loan it made: it is fully capitalized and can make another $40 in loans. Except that now there's $43 in circulation instead of $3.
The reason all this isn't sustainable with a fixed reserve ratio is because of the interest rate itself. That either forces someone who is productive to lose money by having it forcibly reallocated (which is usually bad for the economy) or it forces the currency supply to grow (which is inflationary). And that is true no matter what the reserve ratio is, EVEN IF IT IS 1.
This suggests that to perpetuate any system in which interest against loans is charged, one must work around or eliminate anything which would prevent the currency supply from growing. In the case of our current fractional reserve system, if the fractional reserve limit itself is the limiting factor then it will have to be increased or eliminated entirely.
Whether or not that actually happens depends on just how much the people in power wish to perpetuate the system.
"But we don't *have* currency deflation right now"
ReplyDeleteStocks down 50%, RE down 50%, silver down 50%, gold down 10%, clothing down 40%-70%, food down 20%, oil down 70%.
Pricing is the only direct measure of the currency supply, and prices are plunging.
The Fed uses a model to show how much cash they've "printed," but printing cash is completely irrelevant to the currency supply, just like your water bill is completely irrelevant when you have a structural leak that has resulted in an empty pool.
I have bought 100,000 gallons of water, therefore, I must be able to go swimming. Not true.
Only asset pricing indicates the number of dollars left in circulation. We must look at the water level, not the water bill, before diving in.
This example of the water bill is what I just needed to fully understand this topic.
ReplyDeleteKudos, FDR
FDR wrote: "Pricing is the only direct measure of the currency supply, and prices are plunging."
ReplyDeleteBut prices aren't a direct measure of the currency supply. They are a measure of the combination of the currency supply, the supply of the object being priced, and the current demand for the object.
When people en masse elect (or are forced to, as is the case with those who can borrow no more) to spend less, either directly as a result of their own financial condition or as a result of their perception that they will need the money in the future, guess what? DEMAND DROPS. And when demand drops, prices drop.
It doesn't require a drop in the currency supply for that.
If the currency supply is *really* dropping, then there has to be a mechanism behind it, but I haven't seen one mentioned yet. Loan defaults don't cause it (see the previous example for why), and a reduction of borrowing simply reduces the rate of growth, which is *not* the same thing as a reduction!
I was actually hoping you'd poke holes in my example, since most of my understanding of how the whole game works is embodied in it...
kcb said, "If the currency supply is *really* dropping, then there has to be a mechanism behind it, but I haven't seen one mentioned yet. Loan defaults don't cause it..."
ReplyDeleteLoan defaults DO cause it. Take the Bernie Madoff example. Bernie ran off with the money. He owed it back to his clients, who remained in the dark for quite a while. When they discovered their money was gone, the PERCEIVED money supply contracted.....Bernie had it and they thought they had it available. Now, apply that example to the whole economy. There were lots of PERCEIVED money that disappeared.
Also, in order for your logic to hold, that means that expanding credit does not increase the money supply. I.e. If, in your mind, tightening credit does not decrease the money supply, then loose credit cannot expand it. That pretty much counter to basic economics, so you are not going to convince many intelligent people otherwise. You might as well move on to some other topic you might understand.
Anonymous wrote: "When they discovered their money was gone, the PERCEIVED money supply contracted.....Bernie had it and they thought they had it available. Now, apply that example to the whole economy. There were lots of PERCEIVED money that disappeared."
ReplyDeleteWell, if it's perceived currency supply that matters, then it immediately follows that an uneven distribution of the real currency supply is the same thing, and therefore as the disparity in money held between the top and the bottom grows, the appearance will be that of a money supply contraction. Because, after all, people in the middle class and below tend to spend the majority of the money they acquire, while people with more money than that tend not to spend it. Instead, they tend to invest it, but investment activity tends not to increase real economic activity (which is the exchange of goods or services) as quickly as direct spending. I'll be happy to explain why that's the case if you'd like.
"Also, in order for your logic to hold, that means that expanding credit does not increase the money supply. I.e. If, in your mind, tightening credit does not decrease the money supply, then loose credit cannot expand it."
If currency is being issued through loans faster than currency is being used to pay off loans, then you have expansion of the currency supply. If more currency is being used to pay back loans than is being issued through new loans, then you have currency supply contraction.
Now, we may have *some* contraction as a result of loans being paid back, but as I understand it, loans are being destroyed through default far more aggressively than they're being paid back.
As it happens, a default can result in at least some of the loan being paid back. When a loan is defaulted upon, the collateral for the loan is sold off and is used to pay back whatever amount of the loan it can. So there are two general cases to consider: the one where the asset price is greater than the remaining loan balance, and the one where the asset price is less. In the first case, the loan gets paid off in its entirety and the remainder of the money from the sale counts as profit. In the second case, the loan has a balance remainder which ends up being written off. BOTH CASES RESULT IN NET CURRENCY INFLATION (relative to no loan having been issued at all).
Today, because asset prices are contracting, the loans will typically have a remaining balance after the sale of the asset. That remaining balance represents the amount of currency that remains in circulation as a result of the issuance of the loan. It's less currency than existed immediately after the issuance of the loan, but it's still more currency than would have existed had the loan not been issued at all. Which means the issuance of a loan which defaults results in currency inflation.
So through a default, you can get currency destruction relative to when the loan was first issued, but if the asset prices are falling relative to what they were when the loan was issued, then you generally get *less* currency destruction that way than you do when the loan is paid off in full.
And note that the above applies only to secured loans. A default on an unsecured loan causes no currency destruction at all, because there is no collateral sold and therefore no money from that sale used to pay the loan off.
And where all this leads is simple: the currency destruction we may be seeing now is a pittance compared to the destruction that occurred during the Great Depression, because during the GD, despository accounts *disappeared* as a result of banks failing without any sort of fallback mechanism. We may yet see that happen if the FDIC stops backstopping depository accounts.
One more thing: based on the above, the faster asset prices fall, the slower the currency supply destruction will be, because assets sold to pay back loans will generate that much less currency to pay back the loans in question, and therefore the remaining balances (and therefore the amount of currency remaining in circulation) will be that much larger. But the ability for the bank in question to issue new loans will be decreased, so the result will be a reduction of future inflation unless the bank is somehow recapitalized.
Anonymous wrote: "If, in your mind, tightening credit does not decrease the money supply, then loose credit cannot expand it. That pretty much counter to basic economics, so you are not going to convince many intelligent people otherwise."
ReplyDeleteI think this deserves a little thought experiment to illustrate why I've been saying what I'm saying.
Suppose a bunch of people take out a bunch of unsecured loans. As a result, the currency supply increases. At the time the loans were issued, the credit was very loose: anyone could get a loan.
Now suppose *everyone* defaults on the loans. As mentioned previously, the result is that the currency that was issued for the loans remains in circulation. The response of the banks is to issue no more loans. Credit is now as tight as it can possibly be.
The currency in question continues to be used by the people who received it to pay each other for goods and services. No new loans are issued and no loans are being paid off.
The question then is: did the currency supply *decrease* in the above, since credit was tightened as much as possible?
Obviously not. As I said, the people are still using it to pay each other for goods and services.
I cannot stress this enough: THERE IS A DIFFERENCE BETWEEN "DEFLATION" AND "LESS INFLATION".
Tightening of credit by itself directly results in less inflation. To get deflation, you need more than just that: you have to have loans being paid off.
Exactly. The $40 loan from the bank was really only $1 in real terms. $39 was the perceived nominal price marked on the books but the leverged 'reserves' never existed in the first place. So, the $39 defaulted on in the system I assume you trust in judging by your attitude, created a supply shortage in real terms as the nominal price fell but the real asset value rose.
ReplyDelete"Tightening of credit by itself directly results in less inflation. To get deflation, you need more than just that: you have to have loans being paid off."
ReplyDeleteOr defaulted upon. Defaults are much more deflationary than payoffs, mostly because the default kills property prices and proves the bank's lending standard is too loose, but most think the bank writedown, or the bank eating the principle they never had plus the interest, is the big issue.
The above sources of deflation:
- The defaultee eats $500K in perceived net worth.
- The bank eats most or all of the principle they printed to obtain the unearned cash flow, offsetting hundreds of performing loans.
- The bank reigns in lending to the same class of customers because their lending standard was demonstrated to be wrong
- By far the biggest deflationary influence is none of the above, it is that property values in the neighborhood all fall to match the distressed sale. Whereas the above only sucks a few million out of the economy, this one might suck a few $100M or more.
kcb, please understand....the $39 never existed in your $40 loan simple example. That's why $39 is missing from the pot and it can't be magically reprinted. The price of the asset has been reduced but the value has gone up.
ReplyDeleteFDR: while I may disagree that loan defaults are deflationary in net terms of outstanding currency (relative to conditions prior to issuance of the loan), I certainly do agree they're deflationary in terms of the prices of the objects used as collateral. If the type of object in question is one that is heavily used as collateral, then the result will be much less lending overall, and that will rein in the currency inflation rate.
ReplyDeleteBut property values and currency are two very different things. Currency is immediately exchangeable for goods and services. Property generally isn't, especially when the property is deflating in value (such deflation makes it harder to sell because buyers are inclined to wait for prices to drop further).
The current situation is most definitely deflationary in terms of price, but I don't think it's become terribly deflationary in terms of currency yet, in part because the Fed has started to lend directly to the government, which will in turn inject that newly printed currency into the economy by paying individuals and corporations with those funds, and in part because the remaining balance on the loans that are defaulting is quite high (thus causing a lot of distress on the banks).
I think we'll see truly major deflation on the scale of the Great Depression when the FDIC stops paying depositors of failing banks.
So here's what I think is happening in the economy currently, and please feel free to correct me on anything I get wrong:
1. The U.S. has been operating under a trade deficit for the past 30 years. A trade deficit means more currency is being used to pay for imported goods or services than is being brought in as payments for domestically produced goods or services. As is the case for an individual, this is an unsustainable condition: initially savings are depleted and finally the currency is borrowed. This latter is where we were at the height of the housing bubble: loans against such assets were being used to pay for imported goods and services, and were thus used to maintain the trade deficit.
2. Housing prices increased past the point of affordability. As a result, demand for them dried up despite outrageously lax lending terms. This caused the prices to stop increasing, which caused much of the demand to disappear (prior to that point, some/many people were buying houses with the expectation that prices would rise relatively quickly and that they'd be able to turn a quick profit. They were forced to exit the market when that condition disappeared). When that demand disappeared, prices started to fall, and thus the deflationary spiral in the housing market began.
2. As a result of (1), the lending that U.S. consumers depended on to maintain their lifestyle started drying up, and as a result consumers curbed (or even stopped) their discretionary spending.
3. As a result of the drop in spending, demand for many things (even food) has dropped. This of course forces prices downwards.
4. Also as a result of the lack of funds, many loans are being defaulted upon. Since the prices of most items used for collateral are falling, many of these loans don't get paid off in full. Even so, there is some currency deflation relative to the state of things immediately after the loans were issued. This also pushes prices downwards, but I'm of the opinion that the primary deflationary force right now is decreased demand.
5. Remember that trade deficit? As with individuals, unless the country as a whole defaults en masse, the U.S. will have no choice but to revert to a trade surplus to pay off its obligations. That can't happen until the price of labor in the U.S. becomes competitive with the price of labor in the rest of the developing world, and that means that the standard of living in the U.S. has to fall and fall hard. An alternative would be to bootstrap the process by imposing tariffs to equalize the price of labor here versus abroad, so that manufacturing here in the U.S. becomes viable at least for servicing the domestic market. That's something that would have to be done *very* carefully: it won't do to raise tariffs to the point that foreign labor becomes uncompetitive. Frankly, I think those in government have neither the balls nor the brains to do such a thing, assuming those who control them would approve of such a thing.
Bottom line: we're in for a world of hurt, just like FDR suggests. Prices will continue to fall and the standard of living will continue to drop. Because we've gone so much higher than before, we must fall further. The only bright side to this is that the human cost of goods and services is significantly lower now than it was during the Great Depression thanks to automation, so it's entirely possible that we'll be better off in real terms than our Great Depression predecessors were. But even that may not matter.
Sorry I screwed up the numbering in the last message. As a result, there are two number (2) entries. Obviously the second (2) and all subsequent entries should be bumped by 1. After the numbering adjustment, what has become (3) should say "As a result of (2)", i.e. it should be referring to the housing price discussion.
ReplyDeleteAnd hopefully this message doesn't add any more confusion. Ugh. :-(
Anonymous wrote: "kcb, please understand....the $39 never existed in your $40 loan simple example."
ReplyDeleteWell, maybe there's some subtle meaning to what you're saying, but if I take what you say at face value then ... of course the $39 existed!
If it had never existed then the loan recipient could never have used it in exchange for goods and services. But he did, and therefore it existed. Not only that, but it still exists, because the people he handed it to in exchange for goods and services have either used it in exactly the same way or still have it available to them to use in that same way.
To illustrate what I'm talking about, suppose you take out a loan and immediately convert it to physical cash (which is something you can do because once you receive a loan you can deposit it, and then convert that into physical cash), and then default on the loan. Do you still have the physical cash? Of course you do. It didn't just up and disappear just because you defaulted on the loan.