September 2009


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Mish adds Bill Gross and PIMCO to his deflationist argument.

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said he’s been buying longer maturity Treasuries in recent weeks as protection against deflation.

“There has been significant flattening on the long end of the curve,” Gross said in an interview from Newport Beach, California, with Bloomberg Radio. “This reflects the re- emergence of deflationary fears. The U.S. is at the center of de-levering as opposed to accelerating growth.”

So we have;

*Significant flattening on the long end of the curve
*Reflects re-emergence of deflationary fears
*US delevering
*Stagnant growth in US

Lets look at the narrowing of spreads first. A large portion of this year’s outflows from money market funds has moved into the bond market, increasing demand for both investment grade (IG) and high yield (HY) corporate bonds.

Chart1USCredit1

Chart2USCredit1

So essentially what we are seeing is a movement from Money Market Funds which are essentially demand deposits, that should in theory carry little to no risk, to financial assets that carry higher risk.

Corporate Bonds at their nadir, offered very high yield that was almost equity like in potential return. With these gains having been realised, could we also be seeing a rotation into Treasury paper?

fullmonth

full cycle

Why does Mish believe that a tightening of Treasury spreads signal deflation? One main reason.

The highest inflation-adjusted yields in 15 years are helping provide the Treasury with record demand at auctions as the U.S. prepares to sell $115 billion of notes this week.

Treasuries are the cheapest relative to inflation since 1994 after consumer prices fell 1.4 percent in June from a year earlier. The real yield, or the difference between rates on government securities and inflation, for 10-year notes was 5.10 percent today, compared with an average of 2.74 percent over the past 20 years.

The evidence for the high real yields is evidenced from the CPI data.

Properly adjusted for housing, I have the real CPI as of July at -6.2%. That number is arrived at by substituting the Case-Shiller CPI for Owners Equivalent Rent (OER) in the CPI. Please see What’s the Real CPI? for details

There are numerous problems with his argument. Inflation/deflation are not narrow measures. Thus falling house prices on their own do not signal anything in relation to inflation/deflation except that house prices are falling.

Second the CPI itself as a statistical construct is flawed. To actually make a statistical inference to inflation/deflation the sample should be random, and constructed anew with each reading. This obviously doesn’t fit well with an econometric model, thus we have what we have. Here are some of the varients.

CPIAUCNS_Max_630_378

CPIHOSNS_Max_630_378

CPILEGNS_Max_630_378

What Mish seemingly ignores constantly, is the relentless increase, or replacement by the government of currency + credit. Inflation or deflation are not prices per se, they [prices] are simply the symptoms of an underlying malady. The malady is the relentless debasement of the money supply by the government.

Should we have another credit crisis and contraction, this time testing the solvency of the US government, or any other government, and there are many currently following Keynesian inflationary policies, then we will potentially see a true deflation. It will be very, very ugly.

Until that apocalypse takes place, what we see, and will continue to see is an inflationary expansion of currency + credit from government offsetting any deflationary liquidations from the private sector, of which there have been, and will be many more.

These liquidations of capital are those that will condem the US to a stagnant growth picture. Higher stages of production have been and will continue to be liquidated as funding from the banking system is not forthcoming.

Credit creation from central government is being focussed at the consumer end of the economy as per Keynesian theory – which asserts that consumer demand exerts a multiplier effect. The common belief that the consumer constitutes 70% of the economy is so deep rooted that it appears even in people who should know better.

In the U.S., nominal economic growth will likely be weak over the next several years as the consumer remains constrained by a high debt burden, low savings, poor income growth and weak employment prospects. With the weakened consumer comprising 70% of the U.S. economy, nominal economic growth should be subpar over the next several years.

Mark Kiesel
Managing Director PIMCO

The effect of government policy on supporting the consumer segment has the effect of maintaining consumer demand. This demand, in the face of falling supply engendered from liquidated capital in higher stage production leads slowly at first to rising general prices, later accelerating as inflationary expectations take hold.

Bond investors may believe that prior to interest rates [short end] being raised to combat inflation, that they can and will exit their positions. This will remain to be seen.

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An economics of magical thinking
September 23, 2009 7:00pmby FT
By Roman Frydman and Michael D. Goldberg

Confidence seems to be returning to markets almost everywhere, but the debates about what caused the worst crisis since the Great Depression show no sign of letting up. Instead, the spotlight has shifted from bankers, financial engineers and regulators to economists and their theories. This is not a moment too soon. These theories continue to shape the debate about fiscal stimulus, financial reform, and, more broadly, the future of capitalism, which means that they remain a danger to all concerned.

Unfortunately, the assumptions that underpin these theories are largely inscrutable to those without a Ph.D. in economics. Indeed, the debate is full of terms that mean one thing to the uninitiated and quite another to economists.

Consider “rationality.” Webster’s Dictionary defines it as “reasonableness.” By contrast, for economists, a “rational individual” is not merely reasonable; he or she is someone who behaves in accordance with a mathematical model of individual decision-making that economists have agreed to call “rational.”

The centrepiece of this standard of rationality, the so-called “Rational Expectations Hypothesis”, presumes that economists can model exactly how rational individuals comprehend the future. In a bit of magical thinking, it supposes that each of the many models devised by economists provides the “true” account of how market outcomes, such as asset prices, will unfold over time.

The economics literature is full of different models, each one assuming that it adequately captures how all rational market participants make decisions. Although the free-market Chicago school, neo-Keynesianism, and behavioural finance are quite different in other respects, each assumes the same REH-based standard of rationality.

In other words, REH-based models ignore markets’ very raison d’etre: no one, as Friedrich Hayek pointed out, can have access to the “totality” of knowledge and information dispersed throughout the economy. Similarly, as John Maynard Keynes and Karl Popper showed, we cannot rationally predict the future course of our knowledge. Today’s models of rational decision-making ignore these well-known arguments.

The unreasonableness of this standard of rationality helps to explain why macroeconomists of all camps and finance theorists find it hard to account for swings in market outcomes. Even more pernicious, despite these difficulties, their models supposedly provide a “scientific” basis for judging the proper roles of the market and the state in a modern economy.

But incoherent premises lead to absurd conclusions – for example, that unfettered financial markets set asset prices nearly perfectly at their “true” fundamental value. If so, the state should drastically curtail its supervision of the financial system. Unfortunately, many officials came to believe this claim, known as the “efficient markets hypothesis,” resulting in the widespread deregulation of the late 1990s and early 2000s. That made the crisis more likely, if not inevitable.

Public opinion has swung to the other extreme, as complacency about the need for financial regulation has been replaced by calls for greater oversight by the state to control the unstable behaviour of financial markets.

Behavioural economists have uncovered much evidence that market participants do not act like conventional economists would predict “rational individuals” to act. But, instead of jettisoning the bogus standard of rationality underlying those predictions, behavioral economists have clung to it. They interpret their empirical findings to mean that many market participants are irrational, prone to emotion, or ignore economic fundamentals for other reasons. Once these individuals dominate the “rational” participants, they push asset prices away from their “true” fundamental values.

The behavioural view suggests that swings in asset prices serve no useful social function. If the state could somehow eliminate them through a large intervention, or ban irrational players by imposing strong regulatory measures, the “rational” players could reassert their control and markets would return to their normal state of setting prices at their “true” values.

This is implausible, because an exact model of rational decision-making is beyond the capacity of economists – or anyone else – to formulate. Once economists recognise that they cannot explain exactly how reasonable individuals make decisions and how market outcomes unfold over time, we will no longer be stuck with two polar extremes concerning the relative roles of the market and the state.

For the most part, asset prices undergo swings because participants must cope with ever-imperfect knowledge about the fundamentals that drive prices in the first place. So long as these swings remain within reasonable bounds, the state should limit its involvement to ensuring transparency and eliminating market failures.

But sometimes price swings become excessive, as recent experience painfully shows. Even accepting that officials must cope with ever-imperfect knowledge, they can implement measures – such as guidance ranges for asset prices and changes in capital and margin requirements that depend on whether these prices are too high or too low – to dampen excessive swings.

Such measures require policymakers to exercise discretion, rather than simply rely on fixed rules. That might not please most economists, but it would leave the market to allocate capital while holding out the possibility of reducing the social costs that arise when asset swings continue for too long and then end, as they inevitably do, in sharp reversals.

Roman Frydman, professor of economics at New York University, and Michael D. Goldberg, professor of economics at the University of New Hampshire, are the authors of Imperfect Knowledge Economics: Exchange Rates and Risk.

Confidence seems to be returning to markets almost everywhere, but the debates about what caused the worst crisis since the Great Depression show no sign of letting up. Instead, the spotlight has shifted from bankers, financial engineers and regulators to economists and their theories. This is not a moment too soon. These theories continue to shape the debate about fiscal stimulus, financial reform, and, more broadly, the future of capitalism, which means that they remain a danger to all concerned.

Indeed it does. In many ways the bankers exploited politicians, who know next-to-nothing and rely on economists and other experts to advise them, while trying to appease their lobbyists who pay them their campaign purses.

However it is simply another form of credit creation or inflation. The government is directly creating a credit expansion rather than indirectly creating one through the banking system. As such, those that recognise this fact are acting rationally in bidding up the PV of capital, which is the stockmarket. Should the credit expansion falter, which at some point it inevitably must, then, once again, the value of capital will fall precipitously. The trigger, as before, will be signalled within the Bond markets, the market for debt.

The centrepiece of this standard of rationality, the so-called “Rational Expectations Hypothesis”, presumes that economists can model exactly how rational individuals comprehend the future. In a bit of magical thinking, it supposes that each of the many models devised by economists provides the “true” account of how market outcomes, such as asset prices, will unfold over time.

This would be Samuelson and his ilk, who created econometrics, believing that human behaviour was mathematically precise.

But incoherent premises lead to absurd conclusions – for example, that unfettered financial markets set asset prices nearly perfectly at their “true” fundamental value. If so, the state should drastically curtail its supervision of the financial system. Unfortunately, many officials came to believe this claim, known as the “efficient markets hypothesis,” resulting in the widespread deregulation of the late 1990s and early 2000s. That made the crisis more likely, if not inevitable.

Unfortunately, before you can claim to disprove “Efficient Market Hypothesis” you would actually require “unfettered, unhampered markets.” The financial markets are very far from being unfettered with the Federal Reserve Central Bank aiding and abetting a government endorsed [promoted] inflation lasting 80+ years.

Public opinion has swung to the other extreme, as complacency about the need for financial regulation has been replaced by calls for greater oversight by the state to control the unstable behaviour of financial markets.

Is this true? I would argue that many are actually waking up to the fact that less government would be increasingly beneficial. That government is basically incompetent to direct the economy and should not attempt to do so. Of course, government will spin whatever story keeps them in power with access to the money.

Behavioural economists have uncovered much evidence that market participants do not act like conventional economists would predict “rational individuals” to act. But, instead of jettisoning the bogus standard of rationality underlying those predictions, behavioral economists have clung to it. They interpret their empirical findings to mean that many market participants are irrational, prone to emotion, or ignore economic fundamentals for other reasons. Once these individuals dominate the “rational” participants, they push asset prices away from their “true” fundamental values.

That market participants do not conform to the econometric model. These are not the “Behaviouralists” they are the Krugmans of the economic world. The “Behaviouralists” accept that prediction is fraught with problems.

The problem is not whether people are rational or irrational, the problem is that government has debased the money for so long that prices are distorted and obsfucated, making it difficult to “rationally” calculate profits and losses that are essential in driving price towards true economic values.

The behavioural view suggests that swings in asset prices serve no useful social function. If the state could somehow eliminate them through a large intervention, or ban irrational players by imposing strong regulatory measures, the “rational” players could reassert their control and markets would return to their normal state of setting prices at their “true” values.

I don’t think the “Behavioural” school advocates any such thing. Prices are critical to the efficient allocation of resources. It is, as stated, the gross mismanagement and theft by government that has seriously impaired the structure and function of price.

This is implausible, because an exact model of rational decision-making is beyond the capacity of economists – or anyone else – to formulate. Once economists recognise that they cannot explain exactly how reasonable individuals make decisions and how market outcomes unfold over time, we will no longer be stuck with two polar extremes concerning the relative roles of the market and the state.

An exact model is not required. What is required is simply an unhampered market, sound money and enforcement of property rights through a legal system that is transparent.

But sometimes price swings become excessive, as recent experience painfully shows. Even accepting that officials must cope with ever-imperfect knowledge, they can implement measures – such as guidance ranges for asset prices and changes in capital and margin requirements that depend on whether these prices are too high or too low – to dampen excessive swings.

The swings were substantial simply because the extent of the governmental theft, executed through the banking system suddenly became very public as losses exposed the extent of the theft. The swings were not excessive, they were perfectly rational. Why would you pay $60/share for Citi Bank, when Citi Bank was totally insolvent and bankrupt?

Roman Frydman, professor of economics at New York University, and Michael D. Goldberg, professor of economics at the University of New Hampshire, are the authors of Imperfect Knowledge Economics: Exchange Rates and Risk

This is why economists are currently enjoying the reputation of used car salesmen, essentially because they are either dishonest, stupid, or a combination thereof.

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flippe-floppe-flye is back, preparing his latest blog monetization scheme for iBC now that ChartAddict seems to have lost his mo-mo due to his return to college to study psychology I believe.

Coming Soon to iBankCoin
Monday, September 28, 2009 at 9:32 pm 68
First name Henry, last name Fool. His blog, which was carved out with the shards from his bones, is set to launch on 10/1.

Additionally, Mr. Woodshedder’s system trading splendor is almost ready for public consumption. This is the type of product that can be sold to wirehouses and hedge funds for millions, yet you ingrates will get it here, for fractions of what you should be paying.

Finally, “The Fly” is looking to hire (that’s right, I fucking pay my bloggers, unlike others) a high quality blogger—a person who knows stocks and can write in english, coherently.

All developing, as always

I believe some of the dross will be let go, cretins such as Chuck. Looks like more subscription options will be on offer, Wood’s system looks set to be added to the menu. As to always paying his bloggers – how about paying your gambling debt – you still owe me $10 from your excreable call on MVIS

“The Fly” doesn’t care about your penmanship. He doesn’t care about your ability to absorb information and if you are able to make money in the market. I blog here, daily, to write. I just let it flow, from the lower left part of my brain to the internets, for all the world to see. Unlike most bloggers, I have a job, that pays me a great sum of money—to do what I was born to do: manage money. So, don’t come here asking for handouts or advising me how to teach you better. Le Fly is light years ahead of the competition—just watch and absorb

My main man.

If I was a chart-chomper, which I am most certainly not, I’d be buying this market—hand over fist. However, thanks to the good grace of the Gods, I am not (sorry for the redundancy of that statement). Nevertheless, I am a buyer of IAC/InterActiveCorp (IACI: 20.3775 -2.36%) at these levels, for it is “DILLER TIME” (no homo), with regards to the internet. Ad rates are back on the mend; Omniture, Inc. (OMTR: 21.48 +0.19%) got bought out— and for the love of black flags: “The Fly” is all about the “net.”

flippe-floppe-flye stockpicking…

monkey750X938

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Took my lumps in RIMM and closed the trade.

rimm

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A tale of jumping trades without waiting for confirmation. Needless to say RIMM is not working out well currently. I’ll continue to hold for possibly a few more days and then re-evaluate.

rimm

UNP however is looking better currently. I’m looking for circa $62+ to exit currently, and should see that price by tomorrow.

unp

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Amid the first signs of an economic rebound, Americans are ready to do what they do best: go shopping. That’s according to a new survey by credit-card company American Express.

People are starting to spend again, albeit slowly, after the savings rate rose to a 15-year high during the longest economic contraction since the 1930s. Abercrombie & Fitch, Aeropostale, The Gap, J. Crew and Nordstrom may benefit the most, as many of the 2,032 adult respondents in the survey said they plan to buy clothes. Also on their to-do list? Perform car maintenance and make an appointment at the hair salon.

American Express surveyed the general U.S. population as well as two sub-groups: the “affluent” and “young professionals.” The company’s Spending & Saving Tracker, the first in a monthly series of reports about consumers’ views about the economy and attitudes about spending and saving, was completed in late August. Consumer spending accounts for more than two-thirds of the U.S. economy, which fell into a recession at the end of 2007. Federal Reserve Chairman Ben S. Bernanke has indicated the economy has started to grow again.

Young professionals were more optimistic about the economy and more likely to increase spending during the next 30 days (24% versus 14% of the affluent pool and 10% of the general population), the American Express survey showed. Asked what they would be buying, two-thirds said clothing and more than half said dining out and travel.

Consumer goods will with reduced production via liquidation in higher stages of production drive the inflationary pressures. Reduced production will create the supply/demand imbalance, exacerbated by improving profit margins in lower stage consumer goods.

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Two potential trades for Monday.

mhs

gva

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