Alaric Investments

Questions on Inflation and Debt Answered

2020-05-21T18:18:00.002-04:00

Why is inflation “low”?

1. Velocity of money has not increased.

Why? Because the Central Bank is filling the bath tub with money but Commercial Banks are pulling the plug on the bath by not increasing lending nearly as much.

This has been the case not only in the U.S. but in Japan since the 1990s.

Japanese debt/GDP is > 250%. U.S. debt/GDP > 100%.

How can inflation be created? Why?

1. If the government controls both the Central Bank and the Banking System, it can create as much inflation as society will accept. Governments may want inflation to reduce debt/GDP rather than default on debt.

Examples: France and the UK after WWII – France through the banks/central bank had high inflation from 1944 to the 1950s, the UK did it slowly, from 1945 to the early 1980s.

Each country’s debt to GDP went well below 100%, France quickly, the UK slowly.

The U.S. different. Why does the U.S. not have as much inflation as other countries?

1. The U.S. dollar is the world’s reserve currency– other countries want to hold U.S. dollars, so the dollar has not gone down, but up. If the dollar goes down, U.S. inflation will increase.

2. Most U.S. trade is with itself, in very key areas– energy (oil, nat gas), so price moves up for these do not impact the U.S. as much as other countries.

Look at Turkey for contrast: (1) weak currency others do not want to hold, (2) large energy importer. Turkey has historically had high inflation rates and high debt levels. The UK in the 1970s also had these issues.

What is the downside of money printing?

1. Without controlling where money goes, the easiest place for it to go is into financial assets.

This pushes financial assets higher, so those with financial assets benefit.

So, ultimately, unequal distribution of wealth results. (see charts below)

2. Politization of credit:

Who is worthy of getting govt money/loans – carmakers or speculators?

Who controls money/credit flows? Who decides?

Do citizens want this level government control?

3. The public may not realize their purchasing power is being eroded or know why (food costs, services (college, healthcare) have rates of inflation much higher than goods)

Why are no ‘credible’ economists talking about this?

1. Some are, though the govt and banks have incentives not to (see below)

2. Credible economists are saying there will be inflation, just not immediately.

It takes time for money to flow / demand & supply to balance (years)

3. David Rosenberg: independent economist, does not manage money, provides research.

https://www.rosenbergresearch.com

https://twitter.com/EconguyRosie

https://ttmygh.com/hmmminars/ Interview – inflation mentioned at 29.38 and 50.13

“At some point we will get ‘cost-push inflation…demand will at some point stabilize, people do not realize if you have a 3-5 year view…inflation will come back…inflation hit 5% in the late 1930s”

“Most of the world is services, initial impact is a decline in demand, deflationary outcome for now, maybe for a year, but at some point it stabilizes”

“Supply curve will become inelastic – weaker productivity, more regulation, higher costs (inventory, local supply chains)…stagflation”

“Companies will have higher cost structure (airlines, restaurants, movie theaters – less capacity)”

4. Russell Napier:

Publisher of a global macro report, founded a course and finance at the Edinburgh Business school, called a Practical History of Financial Markets, founder of "The Library of Mistakes"

https://www.financialsense.com/contributors/russell-napier

https://podcasts.apple.com/gb/podcast/98-russell-napier-gold-the-euro-and-capital-controls/id1301360737?i=1000474983530

Govts & Banks have incentives for inflation in financial assets yet still have other inflation “appear” to be low:

1. Government has incentives to:

Sell more debt / keep interest rates low –- govt pays less interest (>20% of budget)

Increase financial market values –- more tax revenue from inflationary gains

Keep inflation stats low –- lower social security payments

2. Banks have incentives:

For financial markets to increase

Make money on government debt sales

It is a career-limiting move to speak against the consensus at the Federal Reserve, academia & private industry!!

Wealth inequality by generation is surprising:

"We never quite achieved the catharsis necessary to stoke a deep re-evaluation of our wants, needs and fears"

2011-04-16T10:40:00.000-04:00

While it is preferable to read rather than see Mr. Burry's presentations, he makes some very compelling points at the end....

From 19:00 onwards the speech is most coherent and at times compelling. I definitely have not agreed with many things Dr. Burry has said in the past. Also, what he says here I also do not want to believe, however, his observations have credence, and he makes the case that individuals and families should seek to take action for another fat tail event.

Watch from 19:00 onwards:

Dr. Burry's Vanderbilt Speech

What do investing teams think about possible outcomes here? Are they sensitive to this tail risk, or do they write it off as many did before 2008 (what to they think about junk bonds at all time highs)?

Some interesting quotes:

"We never quite achieved the catharsis necessary to stoke a deep re-evaluation of our wants, needs and fears; importantly the toxic twins: fiat currency and activist Fed, remain firmly entrenched, even more-so with the financial reforms last year. In fact, the Federal Reserve, having acquired new powers of regulation, has insisted specifically that nothing in the field of economics or finance was of any help in predicting the crisis...it guarantees that we will make the same mistake again and again"

"Arguments on blooming economic recovery must be considered alongside the fact that all this debt and all the money being printed is very much a real bill, a real tax on our future: it is debtors' prison for our children, it has not yet come true today except for savers and those on a fixed income."

Advice for the Vanderbilt students:

"There is nothing wrong with breaking with the social norm to ensure good outcomes....It is not a time for a responsible individual to tolerate any level of blind faith toward any man or woman. It is absolutely not a time to follow."

IMF Draft Rules Endorse Capital Controls as Last Resort

2011-03-31T10:42:00.000-04:00

For now, capital controls are being contemplated by those countries with strong currencies and large capital inflows to keep money from flowing into these countries/currencies (Brazil, etc...).

Should the U.S. fiscal position not be dealt with, when will capital controls be considered for the U.S., KEEP MONEY FROM LEAVING?

Watch this closely, this is not a positive development at all.

From Bloomberg News:

IMF Draft Rules Endorse Capital Controls as Last Resort

Nations should be able to use capital controls as a last resort to manage inflows of money that threaten their financial stability, according to draft guidelines discussed last week by the board of the International Monetary Fund.

Such controls should be applied only after countries strengthen their banking systems and adopt economic measures such as building up reserves, tightening fiscal policies and lowering central bank interest rates, according to the draft guidelines, obtained by Bloomberg News.

“In the past, capital controls were not in our toolkit,” IMF Managing Director Dominique Strauss-Kahn said separately in a statement posted on the fund’s website. “Today, we see them more as part of the toolkit, although only in specific circumstances and not, of course, as a substitute for good macroeconomic policies.”

More here...

IMF Draft Rules Endorse Capital Controls as Last Resort

Berkshire Wrote Down U.S. Bancorp, Swiss Re After SEC Query

2011-03-28T12:05:00.000-04:00

I am still not sure how Berkshire can only partially mark its equity portfolio to market....

While it is certainly encouraging that they are marking some positions to market, it seems that they are resisting markdowns on Wells Fargo and Kraft (surprising that they would not mark down Kraft in particular because high food prices will ultimately reduce margins or lead to increased product prices and resultant switching away from their name brands....as for Wells Fargo, if anyone can really analyze any of the major banks, please let me know!)

From the Bloomberg article: “As a result of our discussions, we recognize that the staff” of the SEC believes that impairments on the investments may be required according to generally accepted accounting principles, Berkshire Chief Financial Officer Marc Hamburg wrote.

Not a particularly strong endorsement of the GAAP which companies other than Berkshire are required to follow....

From Bloomberg news...
Berkshire Wrote Down U.S. Bankcorp, Swiss Re After SEC Query

(Updates with Berkshire refusing to write down Wells Fargo, Kraft in the fourth paragraph.)

By Andrew Frye
March 28 (Bloomberg) -- Warren Buffett’s Berkshire Hathaway Inc. wrote down the value of holdings in U.S. ancorp, Sanofi- Aventis SA and Swiss Reinsurance Co. after a query from the Securities and Exchange Commission over valuations.
The adjustments to the equity stakes were made to Berkshire’s fourth-quarter results in its annual Form 10-K
report, according to a Feb. 4 letter from Omaha, Nebraska-based Berkshire to the regulator. The letter was filed today on the SEC’s website.
“As a result of our discussions, we recognize that the staff” of the SEC believes that impairments on the investments may be required according to generally accepted accounting principles, Berkshire Chief Financial Officer Marc Hamburg wrote.
Berkshire, which held $61.5 billion of equities as of Dec. 31, was asked by the SEC in January for more information about stockholdings that traded below the prices paid by the company. The firm recorded equity impairments of $938 million in the fourth quarter. Berkshire told the SEC that it wasn’t writing down its holdings of Kraft Foods Inc. and Wells Fargo & Co. because it expects the stocks recover.

continued here...
Berkshire Wrote Down U.S. Bankcorp, Swiss Re After SEC Query

The SPX and the SPX vs Gold

2011-03-23T13:55:00.000-04:00

The SPX vs USD does not look like it has had a bad run, particularly over the past year....in fact, it may perhaps have a bounce (though I believe that it will retest 1265 at some point this year).

However, when you look at the SPX vs Gold, a very different picture, and far less bullish picture, emerges....will SPX vs Gold push above the 200 day moving average?

I am much less sure of this but also would expect some pullback in gold as well this year, particularly if the Fed were to indicate any normalization of interest rates, making gold, at least at the margin, a little bit more expensive to hold...however, as long as real rates are less than zero I would not bet on a large pullback, just enough to squeeze out some who have been late to the party...

Some confirmation of what you may be hearing on the elevator or train...

2011-03-23T12:41:00.000-04:00

Every so often you hear something strange on the elevator or train which, although completely anecdotal, may subtly or not so subtly influence your investment decisions, at least until you can gather facts and examine the situation somewhat objectively....

Examples for me have included:

1. The 'Pets.com' sock puppet coming back years later as the mascot for the '1-800-bar-none' sub-prime lender.
(this may have been a once in a lifetime event - recall that Pets.com paid millions for a superbowl add with this mascot and then went bust; only to have the same mascot resurrected years later for a sub-prime lender at the top of the subprime wave}

2. Very large multi-strategy hedge fund controller prior to 2008 bragging to a friend about how all their fund had to do is stay in business several years and they would all be rich....

3. Recently, a junior employee of an investment firm's long-only high yield bond investment team, speaking with a more seasoned manager at a different firm: "nothing is cheap anymore, covenants are light, but we don't care because we are supposed to buy and we will continue to buy because interest rates are zero, investors are begging for yield and if we don't buy these things, somebody else will."

From the article below, at least somebody at the Fed seems to agree, which is a good thing. To the extent that the monetary spigots are turned down a bit, however, it would seem that investors in monetary assets will have to deal with whatever hangover as this latest binge of credit easing is pulled back....

Is it time to take a vacation and simply allocate to short term instruments in various currencies until the latest binge is over?

From Bloomberg news...
Fed's Fisher Sees 'Extraordinary Speculative Activity' in U.S.l
By Caroline Salas and Rainer Buergin
Federal Reserve Bank of Dallas President Richard W. Fisher said he sees “extraordinary speculative activity” in the U.S. after the central bank pumped record amounts of stimulus into the economy.

“There is an enormous amount of liquidity sloshing around,” the regional bank chief, who votes on monetary policy this year, said in a speech today in Berlin. “There is abundant liquidity in the machine we know as the United States economy.”

The Fed will likely complete its planned $600 billion of Treasury purchases in June, Fisher said, reiterating his view that no further monetary stimulus will be needed after that. The 62-year-old bank president has criticized the plan, which policy makers voted to keep in place after their March 15 meeting in Washington.

“The word that we gave was that the program would end in June,” Fisher said in a Bloomberg Television interview. “That’s what I expect to happen. And the markets have in my opinion adequately discounted that.”

Fisher repeated remarks he made yesterday in Frankfurt that he’s seeing signs of excess evidenced in the surge of so-called covenant-lite loans and the return of payouts by private equity firms.

“We have done our job,” Fisher said at a forum hosted by the American Academy in Berlin. “We are certainly at risk of doing too much now.”

‘Self-Sustaining’

The U.S. economic recovery is “self-sustaining” and will withstand turmoil overseas, Fisher said in the Bloomberg Television interview. The earthquake in Japan may impact the U.S. economythrough some “price and supply chain effects short term,” and the “wars in North Africa” won’t have a “long- term impact on the nature of monetary policy,” Fisher said.

“These can of course pinch a nerve or they can give you a bit of a shiver,” Fisher said. “I don’t think they’re going to derail what’s happening in terms of the economic growth occurring in the U.S. or here in Europe.”

"Breaking up is hard to do Commentary: Fed’s love affair with easy money must end"

2011-03-22T08:43:00.000-04:00

Another argument against QE2....

Fed's Love Affair With Easy Money Must End

By Irwin Kellner, MarketWatch

PORT WASHINGTON, N.Y. (MarketWatch) — The Federal Reserve’s love affair with easy money must end — the sooner the better.

In the face of overwhelming evidence that inflation has become a clear and present danger, the central bank continues to insist that easy money and low interest rates are de rigueur for today’s economy.

Its rationale is simple: The economy is still struggling, unemployment remains high, and the markets are reeling from a series of global shocks — the latest being Japan’s earthquake, tsunami and nuclear crisis.

If prices were stable, there would be no question that the Fed is on the right course. But prices are not stable: From basic commodities to wholesale right up to retail, prices are jumping.

As a former governor of New York used to say, let’s look at the record.

The Economist magazine’s weekly tabulation shows raw-materials prices are 35% higher than last year at this time, with non-food agricultural products soaring a whopping 76%.

Wholesale prices have risen at a 13% annual rate since November alone. Not surprisingly, the Institute for Supply Management’s measure of prices that companies pay for goods used in the manufacturing process stood at 82 last month — a sign that price pressures are common and severe.

At the retail level, consumer prices have jumped at a 5-1/4% clip over the past three months, after inching up at a more moderate 2% pace in the previous three. This has led many people to conclude that higher inflation is here to stay. Consumers polled by the University of Michigan expect prices to rise 4.6% over the next year.

The markets sniff inflation. The Treasury-TIPS spread is at a multi-year high. ( See last week’s column.) The yield curve is steep, gold is close to a record high, while the dollar has fallen in world financial markets.

Besides today’s inflation numbers, the markets are also looking at the effects of monetary ease.

The Federal Reserve Bank of St. Louis reports that the central bank’s monetary base has soared by a 54% annual rate since early November, an 83% clip since mid-December — and a thumping 152% pace over the last two months!

Adjusted reserves have climbed at an astounding 342% annual rate since mid-January, while both the money supply M2, and the St. Louis Fed’s measure of liquid money, MZM, are both up by a rate of more than 5% over the past 10 months.

Yet the Fed’s mantra seems to be “don’t worry, be happy.” Said Fed chief Ben Bernanke recently, “the most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation.”

But any increase in prices is bad news for those whose incomes are not rising commensurately — meaning most of us. Once they are up, prices rarely come down. As I pointed out in my column of Jan. 18, during the past decade the dollar has lost 20% of its buying power; since 1990 the overall loss is nearly 30%!

Central bankers would be aware of this if they shopped regularly like the rest of us, instead of sitting in their ivory towers looking at their iPads.

Confusion Reigns

2011-03-15T08:10:00.000-04:00

Confusion Reigns.....

With everything going on in Japan, Libya has been pushed off the headlines. Benghazi looks like it will fall, as long as Gadaffi has enough fuel for his troops to drive there....France has recognized the rebels (one wonders what role Total had in this or if it was a move to outflank LePen supporters), but Italy is silent and the U.S. would be put in an awkward position should Gadaffi reestablish control and then have his revenge...

The Gulf nations have intervened in Bahrain and Iran is protesting, as expected. In this unstable environment, and with Japan most likely moving to import more non-nuclear fuels, it would seem reasonable to expect oil to be higher rather than lower.....

However - confusion reigns at least for now as the margin clerks go to work...

Today's rather modest positioning....

Longs:

CHF

Oil

Cheap Telecom, Tech stock

Shorts:

GBP

EUR

Expensive Cloud stock

There's Only One Sure Thing in This Life and That's Doubt, I think. (Mulvaney, Goodbye Pork Pie)

2011-03-02T08:56:00.001-05:00

Recent events in North Africa led me to think about a quote from a movie called "Goodbye Pork Pie", New Zealand's version of Easy Rider with a yellow mini instead of a motorcycle...(if you ever find yourself on an 18 hour flight, it helps kill the time).

"There's only one sure thing in this life and that's doubt, I think."

That sums up quite a bit. Now is the time for caution - and for some selective buying.

Will U.S. equity markets test interim lows? Will U.S. bond rates come in with some safe haven buying? Will U.S. high yield rates back up to more reasonable levels? Will QE3 be just over the horizon or will QE2 be left to pass?

I would add the following corollaries:

1. It is impossible to predict virtually anything with any sort of precision.

(Five year forecasts? How are they possible?)

2. Be very wary of anyone who is 100% sure of anything.

(Most high profile example: The Bernank. First thing you learn on Wall St. is to never guarantee anything, but then again The Bernank is an "academic".)

3. Revolutions do not end in days or weeks.

(It is clear that nobody remembers the Spanish Civil War, WWII. It takes time to move people and materials around the world, you cannot move ships, people and material via email, yet. The revolutions may end well but we will not know for quite a while)

4. Recent past experience guides most people's thoughts and opinions.

(Market up, sentiment up, high yield rates down, covenants being loosened again)

5. Just because a problem persists for some time, or longer than expected, does not mean that it is not a problem and does not mean that the problem will mushroom into a crisis.

(U.S. looming debt crisis)

Yes, there is quite a bit of negativity out there. On the plus side, the economy is improving, real interest rates are negative, and the prevailing trend for equity prices is usually up so it is better not to be completely neutral or bearish unless the world is falling apart.....

Goodbye Pork Pie (from the beginning)

(It is a product of its time, the late 1970s; not appropriate for children)

Grinding Higher

2011-02-17T12:32:00.001-05:00

The economy continues to expand, and as winter gives way to spring, it seems that unless there is some shock, employment and growth will continue, albeit at a modest pace and with some headwinds in the form of high prices...

Until there is some confirmation of that the expansion has stalled - or some external shock, it appears that the equities markets seem destined to move higher, although from a valuation perspective they are quite high already and with the run from Q3 2010 would seem to be prime for a correction.

With high food prices, the probabilities for external shocks in the form of unrest in significant exporting countries, appears to be higher than it was in the recent past - indeed Libyan protests, Bahrain, etc. and now even Madison Wisconson!

So, now is the time to be modestly long, with a sharp eye on the door....

At some point the Fed will have to stop the money printing and at some point the general public will realize that purchasing power has declined and that perhaps this modest growth was not enough to offset rising real costs (have to wait for the data to see if this is the case)...

Longs:
Gold
CAD
CHF
SEK
Cheap Tech Stocks

Shorts:
JPY
GBP
AUD
Expensive Tech Stock

Some further comments:

Two points worth mentioning in the AG Capita monthly letter, posted on the Business Insider (you rarely see the effects of inflation being related to taxes):
AG Capita Monthly Letter at the Business Insider

"For politicians, printing money is desirable for two reasons. Firstly, it acts as an unseen tax. One which few voters understand and for which even fewer are likely to blame the political class, at least in the beginning. Secondly, by reducing the value of the currency, the measuring stick I mentioned above, politicians are able to fool many of the voters that their wealth has increased, but of course no such thing has happened."

Funny but true commentary from Caroline Baum:

Referring to the Fed:
"It’s this kind of stuff that makes former first lady Nancy Reagan’s reliance on astrology look sound."
Fat Lady Wanted as Guide to Fed Rate Setters (Caroline Baum - Bloomberg)

Has the Yen Finally Cracked?

2011-02-15T11:15:00.000-05:00

At some point, the perception of the Japanese yen as a safe haven will be tested - and perhaps this test is starting now. A move lower in the yen is implied in the chart below; it has been a long time coming.

With commodity prices at all time highs, interest rates worldwide on a higher path, and a seemingly paralyzed sitting government, Japan faces the unpleasant prospect of lower growth combined with higher debt financing costs should interest rates increase....

As long as China booms, Japan will do well, however, a strong currency and high commodity import prices definitely hurts profits and growth. Better to allocate to countries less reliant on imports....

Ideas for 2011

2011-01-26T12:08:00.000-05:00

I am not spending much time in the markets these days (very busy with other business issues), but am ruminating over two or three big ideas for 2011.....

1. Sell AUD - yes, the AUD has recently topped out and turned down; with the floods there will be no interest rate rises and a squeeze on consumption (other than construction of course) -- the big issue at hand though is that the currency is simply fundamentally overvalued (just look at housing costs, costs of consumables) and long speculation in the currency has been quite high. The question is "When do you sell?"....because the catalyst for a major drop will be Chinese production flattening, or declining.....

2. Sell GBP - GBP has bounced down from 1.60 after the GDP figures were released....so interest rate increases will be deferred at the least...the real question is --- shouldn't the looming fiscal cutbacks and tax increases flatten growth, and if the prospects for growth diminish, shouldn't this be reflected in the currency?

3. Sell US equities - all time highs again, not many bargains - do you short this or just stay out for a while?

This is a trading market....the Fed is printing money so paper assets should appreciate, but there has been a good run and it would appear that there should be some pause.....(?)

More color on AUD below:

"The Aussie has lost 3.4 percent for the past month, the worst performer among 10 developed-country currencies, according to Bloomberg Correlation-Weighted Currency Indexes. The currency weakened on concerns floods in the state of Queensland will dent the nation’s economic growth."

Australian Dollar Falls After Consumer Prices Increase Less Than Forecast (from Bloomberg news)

Australia’s dollar is “down a little bit as a consequence of the lower-than-expected CPI because you had a drop in the OIS market,” said Richard Grace, chief currency strategist in Sydney atCommonwealth Bank of Australia.

The Australian dollar fell 0.8 percent to NZ$1.2962 as of 11:30 a.m. in New York. The Aussie dropped to 98.98 U.S. cents from 99.74 cents yesterday.

New Zealand’s dollar, known as the kiwi, gained 0.1 percent to 76.36 U.S. cents.

Australian consumer prices rose 0.4 percent in the fourth quarter from the previous three months, the Bureau of Statistics said in Sydney today. The median estimate of 25 economists surveyed by Bloomberg News was for a 0.7 percent increase.

Swaps Show

Australia’s 12-month overnight index swap rates, a security based on what investors expect the central bank’s rate will average during that period, declined to 4.9790 percent from 5.0180 percent yesterday. The Reserve Bank of Australia left the overnight cash rate target unchanged at 4.75 percent last month.

The Aussie has lost 3.4 percent for the past month, the worst performer among 10 developed-country currencies, according to Bloomberg Correlation-Weighted Currency Indexes. The currency weakened on concerns floods in the state of Queensland will dent the nation’s economic growth.

Demand for the New Zealand dollar increased as the MSCI Asia Pacific Index of stocks rose 0.7 percent.

“Higher stock prices boost appetite for risk and tend to spur buying of commodity-linked currencies,” said Toshiya Yamauchi, a senior currency analyst in Tokyo at Ueda Harlow Ltd.

Fed "Simulation": 3 Million Jobs Created From Bond Buying

2011-01-09T11:46:00.002-05:00

It is more than a bit surprising that you now see Fed officials touting "simulations" to make unsupported assertions that their bond purchasing policy will create 3 million jobs!

And media reaction to this - simply to repeat the assertion and quote some of the usual suspects who disagree, rather than dig a bit deeper into the "simulation", its underlying assumptions and details, is a remarkable dereliction of responsibility...

This is living proof that Dr. Goebbels theory of the Große Lüge is alive and well. It also shows how obviously political the Fed has become, and how it is being used as a tool of U.S. fiscal policy!

Conclusion: this is clearly a signal that the Fed will continue its QE policy, and that it will support this policy by really any means necessary....so -- the task for U.S. asset holders should be to continue to diversify asset holdings, concentrating on those assets which will retain value against a depreciating dollar, over the longer term...

Could be time to put on some positions in CAD, other strong currencies, Gold, Grains, oil stocks...

From the Wall Street Journal

By LUCA DI LEO

DENVER -- Federal Reserve Vice Chairwoman Janet Yellen issued one of the strongest and most detailed defenses to date of the Fed's controversial decision to buy more government debt to promote the U.S. economy's recovery.

Illustrating the results of Fed research to an audience of top economists from around the world, Yellen argued the central bank's purchase of U.S. Treasuries is helping boost jobs and prevented a dangerous slide in consumer prices.

"It will not be a panacea, but I believe it will be effective in fostering maximum employment and price stability," Yellen said in prepared remarks Saturday to the annual conference of the American Economic Association.

The Fed's $600 billion bond-buying program, which began in mid-November and is set to run through June, has met strong criticism both in the U.S. and abroad. Even a minority of Fed officials have spoken against. Many economists here have expressed skepticism it will do much to help the U.S. economy, with some warning it may do more harm than good by eventually leading to runaway inflation across the globe.

Yellen responded to each and every criticism, pointing to a recent Fed paper suggesting the bond purchases may help create 700,000 jobs. Together with a previous Fed program, in which the Fed bought mortgage and government bonds in 2009 and early 2010, around three million private-sector jobs may have been added thanks to the central bank's efforts.

The U.S. economy's 18-month-old recovery from the worst recession since the 1930s should speed up this year, Fed Chairman Ben Bernanke Friday told Congress, where some Republicans have attacked the Fed's move for fears it will spark inflation. But it will take many years to make up for all the jobs, Bernanke added, and that's why the Fed's continued support is needed.

The bond purchases, Yellen explained, help the economy by keeping borrowing rates low, driving investors into riskier assets like stocks, and lifting exports by keeping the value of the U.S. dollar low.

Defending the program from criticism it received by foreign officials ranging from Germany to Brazil, Yellen noted the bond purchases have not let to a sharp depreciation of the U.S. dollar as some feared. She said growth in foreign export-led economies should not be hurt if countries take the right measures; on the contrary, the global economy will benefit by an acceleration in the U.S. recovery.

In the program's first phase, when short-term interest rates were close to zero, the Fed purchased $1.25 trillion in mortgage bonds, along with hundreds of millions in agency and Treasury debt. It followed that with a decision to reinvest the proceeds of maturing mortgages into Treasurys. Then, late last year the Fed said it would buy an additional $600 billion in government bonds.

These actions have driven the Fed's balance sheet from around $800 billion at the start of the financial crisis in late 2007, to what the Fed research paper states will be $2.6 trillion by the middle of this year.

The paper came from the San Francisco Fed, where Yellen was president before joining the Fed Board in Washington DC in October 2010. It was authored by the San Francisco Fed's research chief John Williams, along with Federal Reserve Board economists Hess Chung, Jean-Philippe Laforte and David Reifschneider.

By injecting more money with the bond buys, the Fed warded off a dangerous slide into a deflationary environment that would have been caused by the economy's weakness, Yellen said. She expressed confidence that the Fed has the tools to unwind the program and lift interest rates when needed to prevent an accelerating economy from stoking inflation.

Some economists disagree. The Fed's easy money policy is a "serious mistake," according to Ronald McKinnon, a professor at Stanford University, who presented a paper at the AEA-ASSA meetings Friday.

By driving rates so low the Fed has made the global economy less stable, the paper argues, leading to beggar-thy-neighbor policies reminiscent of the international currency chaos that worsened the 1930s Great Depression.

McKinnon draws a parallel with the policies the U.S. followed under President Richard Nixon in the early 1970s, when an easy U.S. monetary policy forced other industrial countries to appreciate their currencies against the dollar, eventually leading to high inflation around the world.

However, other economists at the Denver conference appeared to side with the Fed. Speaking in the same panel as Yellen, Martin Feldstein, a Harvard University professor, said more government support is needed to help an economy that remains too weak to cut unemployment significantly.

Feldstein, a former economic aide of President Ronald Reagan, said the weak housing sector still poses a threat to the recovery because it can seriously hamper consumer spending, banks and the construction sector.

Pared Down Some Positions

2011-01-04T15:38:00.000-05:00

With the great December rally in most asset classes, yesterday is was time to take some chips off the table and reassess....

Also relevant is the recent Queensland, Australia flooding of an area the size of Texas -- this will have a great effect on economic output, particularly wheat & coal production and as such will negatively impact the AUD. Also, with the AUD at highs, things are particularly expensive there and the property market is due for a pullback - when, I do not know, but it looks like the U.S. did to me in 2005...if there is any one bet I would like to make this year it is now to short AUD, however, I will wait for now...

The AUD, CAD, Gold & Corn positions were all very profitable; all came off and a 1% positions in Soybeans was put on. I will look to add a small position in Wheat if all commodities do not sell off in the near term.

I am also looking at putting Gold back on and shorting Yen, but again, not yet...

Now flat equities approx. net 0%, gross 25%; equities mostly in defensive sectors for now (Oil stocks & Asian ETFs had a nice run, so lightened up). The prevailing move in equities is up, so I want to be long, but want to buy cheaper if possible....

Longs in:

Asian ETFs - 2.5%

Pharma - 5%

Telecom - 2.5%

Agriculture - 2.5%

Oil, Gas, Industrials - 2.5%

Tech - 5%

Forward PE's on the individual longs are still approximately 11x.

Pending Trades:

Long Gold

Short Yen

Long Wheat

Long Equities (Asian ETFs / Oil Stocks)

Short AUD

The Economics of Inflation

2010-12-26T23:15:00.001-05:00

If anyone is interested in learning the details of the great post World War I German hyperinflaiton, they should read at this book. It is the seminal text on the matter and covers the details of events leading up to the hyperinflation, its causes and of particular interest to me, the social effects - ie, who lost most from the inflaiton and who benefitted.....

It was written in the decade following the events described, and is incredibly detailed, including a wide array of detailed economic and monetary statistics - inedeed it is more of a text book than a narrative that you would find these days - you must have a strong desire to understand the subject matter, but it is well worth it.

It is hard to believe that hyperinflation could occur in any advanced economy today, particularly with well-documented events of hyperinflation and its horrible results, such as those describedin this book --- however, it seems that the lessons of the German hyperinflaiton (and the high inflations in 1980s Latin America) are not widely understood at all (perhaps QE I & II may end up being examples of this lack of understanding, it remains to be seen).

So, who were the losers? The "rentiers' or those small business owners, property owners, retirees who had monetary assets....and workers whose wages were not linked to inflaiton...

Who were the winners? Some large industrialists who owned or had access to foreign assets, currencies, raw material production or importation, speculators (opportunists who had the foresight and flexibility to move monetary assets out of paper currency), farmers (who had mortgage debt which became worthless and who had the flexibility to use earnings from production for machinery, labor and other input purchases).

Take note -- equities did not maintain their value vs the inflation. Of course, bond investors and those in cash lost it all......

Enjoy !

Adding More Positions

2010-11-23T09:58:00.000-05:00

Increased the long equities by 5% (mostly Asian ETFs particularly Singapore):

Still modestly long equities approx. net 10%, gross 35%

Longs in:

Asian ETFs - 10%

Pharma - 5%

Telecom - 2.5%

Agriculture - 2.5%

Oil, Gas, Industrials - 5%

Tech - 5%

Mar 11 AUD 2%

Mar 11 CAD 2%

Mar 11 Gold 2%

Dec 11 Corn 1%

Forward PE's on the individual longs are approximately 11x.

ETF PE's are a bit higher, however, this trade is more about currency devaluation rather than valuation per se.

To the extent there is a correction, will be adding to the long equity side and possibly the FX side.

Still expecting EUR to test 1.329-ish level.

Bernanke's Defense of Debt Monetization (ie, Quantitive Easing)

2010-11-19T12:18:00.000-05:00

All in all the Fed Chairman's speech is supportive of a weak dollar policy prominent among U.S. government officials, but hitherto unexpressed explicitly....bottom line - keep exposure to fx of resource rich countries and keep long Non-U.S. equities vs short U.S. equities...

Although commentators do not appear surprised by the contents of Bernanke's Frankfurt speech (full text in the link below), I was shocked to read what can only be described as a rather open attack on surplus countries seeking stable exchange rates, and an ode to a weaker dollar.

To start, he states that U.S. debt monetization is "appropriate" because it is a "stimulus" measure as though this were a fact, even though the stated aims of asset inflation are unproven and it is unpredictable as to where the excess liquidity from this exercise will end up (ie, will it end up driving commodity prices higher?).

Additionally, there is a direct reference to the monetization's effect on the U.S. dollar, I believe for the first time:

"The resulting increase in emerging market interest rates relative to those in the advanced economies would naturally lead to increased capital flows from advanced to emerging economies and, consequently, to currency appreciation in emerging market economies."

However, even though the U.S. is reducing interest rates and thereby lowering the value of its currency, the fault all lies with emerging market countries (ie, China):

"An important driver of the rapid capital inflows to some emerging markets is incomplete adjustment of exchange rates in those economies, which leads investors to anticipate additional returns arising from expected exchange rate appreciation. The exchange rate adjustment is incomplete, in part, because the authorities in some emerging market economies have intervened in foreign exchange markets to prevent or slow the appreciation of their currencies."

Ok - so basically, printing money to buy government bonds to "stimulate" the U.S. economy is ok and not currency manipulation meant to drive down the value of the dollar while emerging market fx stabalization policies are currency manipulation....

Is there any wonder that there is dismay among foreign central bankers at this policy?

Finally, David Rosenberg of Gluskin Sheff has an interesting take, and points out that Bernanke's remarks are entering the political relm.....

So much for Fed independence, the money printing policy very much puts this in the political relm...

From David Rosenberg, Gluskin Sheff:
"Ben Bernanke delivered a speech today in Frankfurt where he pointed the finger at China as a source of global imblance (never mind that the U.S. dollar has collapsed 70% against the yen since I joined the business in the mid-80s and the bilateral trade deficit with Japan hasn't come down one ioata. Maybe a good part of the imbalance is a U.S. tax code that massively promotes consumption at the expense of savings.)

As an aside, Mr. Bernanke's subtle approval of President Obama's fiscal policies in today's sermon is sure to draw the ire of the new GOP-dominated Congress."

Link to the Full Text of Bernanke's Speech in Frankfurt 19 November 2010

Russell Reynolds 2010 Asset & Wealth Management Trends Report

2010-11-18T12:27:00.000-05:00

Interesting report on the state of the wealth management industry from Russell Reynolds, particularly the hedge fund portion of the report...

Interestingly, if the statement below is true, then investors should take heart and go all-in, risk-on...! Personally, I do not buy it...

"Many investors see current market levels as temporary rather than indicative of a trend, liabilities now significantly outstrip assets and return assumptions far exceed reality. The inflation vs. deflation debate rages on. Indeed, the basis for allocating across a basket of non-correlated assets no longer is an investment cornerstone."

Russell Reynolds 2010 Asset & Wealth Management Trends Report

China vs Corn & Beans

2010-11-17T06:36:00.001-05:00

I am not at all sure how China can curb the market price of corn. Yes, they can control the price of corn that their farmers pay through price controls, however, if they need to import corn to satisfy demand, they the Chinese government would lose money subsidizing it by paying a higher price for imports and receiving a lower price from domestic consumers...

Once there is more clarity on the Ireland situation, I would say that corn, and perhaps beans should resume their upward trends - unless China stops buying, produces more, I cannot comprehend how this would not be so considering the supply situation...

From Bloomberg:

Corn and soybeans fell to five-week lows in Chicago on concern that demand may wane as China, the biggest consumer of commodities, moves to limit speculation and inflation.

China is drafting measures to curb excessive price gains, Premier Wen Jiabao said yesterday, suggesting possible interest- rate increases and price controls. The Dalian exchange last week said it will curb “abnormal” trading to prevent price manipulation. The dollar has gained in two of the past three sessions, curbing demand for U.S. crops.

“Talk of China curbing speculation and a stronger dollar is working against the ags,” said Luke Chandler, global head of agricultural-markets research for Rabobank in London. “We still remain supportive of the grain markets. There’s just some momentum to the downside.”

The rest from Bloomberg:
Corn, Soybeans Slide to Five-Week Lows as China Moves to Limit Inflation

Adding Some Positions

2010-11-16T16:54:00.001-05:00

Added 2% positions today in the following:

AUD
CAD
Gold

Still modestly long equities approx. net 5%, gross 25%

Longs in:
Asian ETFs - 5%
Pharma - 5%
Telecom - 2.5%
Agriculture - 2.5%
Oil, Gas, Industrials - 5%
Tech - 5%

Forward PE's on the individual longs are approximately 11x.

ETF PE's are a bit higher, however, this trade is more about currency devaluation rather than valuation per se.

To the extent there is a correction, will be adding to the long equity side and possibly the FX side.

Missed the EUR correction, but would expect a rebound off the 100 day average of 1.3238....

From the Wall Street Journal Blog, an open letter to Ben Bernanke....

2010-11-15T08:52:00.002-05:00

Should there ever be a QE3, 4, etc., perhaps we may look back on this letter as the first "cry from the wilderness". Also, note the signatories...and the robotic reply from the Fed bureaucracy...

"The following is the text of an open letter to Federal Reserve Chairman Ben Bernanke signed by several economists, along with investors and political strategists, most of them close to Republicans:

We believe the Federal Reserve’s large-scale asset purchase plan (so-called “quantitative easing”) should be reconsidered and discontinued. We do not believe such a plan is necessary or advisable under current circumstances. The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.

We subscribe to your statement in the Washington Post on November 4 that “the Federal Reserve cannot solve all the economy’s problems on its own.” In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.

We disagree with the view that inflation needs to be pushed higher, and worry that another round of asset purchases, with interest rates still near zero over a year into the recovery, will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.

The Fed’s purchase program has also met broad opposition from other central banks and we share their concerns that quantitative easing by the Fed is neither warranted nor helpful in addressing either U.S. or global economic problems."

From the Wall Street Journal Blog:
Open Letter to Ben Bernanke

Nothing is as Permanent as Things Called "Temporary" (Nassim Taleb)

2010-11-12T13:56:00.000-05:00

In this video, Nassim Taleb's clear articulation of the effects of the U.S. government's policies regarding money printing and those affected by it are rather blunt and clearly welcome.

His visible agitation throughout this interview, when discussing former Fed officials, his views on the morality of U.S. fiscal and monetary policy and also recalling his experiences with inflation in Lebanon is telling...

In my conversations with Latin Americans who have moved to the U.S., I hear similar views regarding monetary policy and 'stability'...they wonder how the U.S., which when they emigrated was considered the beacon of stability, could have fiscal and monetary policies reminiscent of the countries they fled...

Fund Managers Beware: Dodd-Frank Has Provided for "Bounties" for Whistleblowers

2010-11-12T11:42:00.000-05:00

Regulations on whistleblower "bounty" provisions have been released....

The fact that there is now an institutionalized bounty system at all is surprising, indeed a bit shocking. If this works, will there be new 'bounties' in future, say for ratting out your doctor, accountant, neighbor, or wife ?

All you whistleblowers note: before you blow the whistle, it looks like you will need to spend quite a bit of time consulting with an attorney to determine the chances that you will actually be compensated by the SEC, because this regulation is definitely not straightforward...

Dodd-Frank Whistleblower Bounty Provisions

Who Wants to Jump in Front of This Train?

2010-11-12T11:14:00.001-05:00

Update: Governor Schwarzenegger calls emergency budget session...
Schwarzenegger declares California fiscal emergency (Reuters)

The ishares AMT-free municipal bond fund chart is looking a bit like a cliff.....no idea why, but it cannot be a positive omen....

Any thoughts on this are appreciated...

Are Stocks "Dangerously Overpriced?

2010-11-11T11:45:00.000-05:00

It is interesting when a long-only manager says that stocks are over-valued and may become even more over-valued...

Is he just talking his book lower so he can buy?

He is right that stocks will 'crack', however. Those old enough to recall the 1987 crash may remember that one of the possible catalysts for the crash was when James Baker, the treasury secretary, while in Germany expressed the need for a cheaper dollar...the Treasury today has been mostly silent or dismissive when discussing the dollar - if this changes, there would be good cause to look out below!

Grantham Says Fed Asset Purchases May Make Stocks 'Dangerously Overpriced'

From Bloomberg News:

Jeremy Grantham, chief investment strategist at Grantham Mayo Van Otterloo & Co., said the Federal Reserve’s attempt to boost the economy could push U.S. stocks to a level where they will be “dangerously overpriced.”

The Fed’s decision to purchase Treasuries and flood markets with cheap money will drive investors out of cash and encourage them to speculate in stocks, which are already overvalued, Grantham, 72, said today in an interview with the CNBC cable television network. He put the fair value of theStandard & Poor’s 500 at 900. The index closed yesterday at 1218.71.

“The S&P is already overpriced and if you push it up another 20 percent it becomes dangerously overpriced,” Grantham said in the interview. “In the not-too-distant future stocks will crack again.”

Grantham accurately predicted in 2000 that U.S. stocks would lose money in the coming decade. The S&P 500 lost an average of 1 percent a year in the 10 years ended Dec. 31, 2009.

Boston-based Grantham Mayo managed more than $94 billion as of June 30, according to the company’s website.