Monday, March 29, 2010

Predictions 2009: more Good, Bad, and Ugly

Today is the second anniversary of the Ca$h Bull. Having made good headway this year with demonstrating the plausibility of the cash-inventory equivalency, I think this blog will be able to enjoy a tighter focus going into the future. I plan to have fewer, but longer posts, that will go into more depth onto the state of the economy once theory posts wrap up.

Out of curiosity—and not that I'm expecting a dime from this, but just to see what it is like—for this year I plan to start hosting ads. I'll report on my experiences with it next year.

I've been more leery about making predictions lately since we currently operate in a bailout economy. Bailouts drive the economy today. Wherever you find optimism and success nowadays that is usually because of government intervention. The rest of the economy is struggling if not crashing. Take away all bailout efforts including a zero-interest rate policy and I anticipate a major crash. So predictions now are nothing more than second-guessing what policy decisions will be made by Washington, rather than successfully understanding a complex system.

So, this time, I'll review predictions made over calendar year 2009 (instead of the last 12 months), repeating some before March of last year, and skipping some from the beginning of this year. This is because it is hard to comment on predictions made two months ago. Even forecasting the demise of the health bill (which I took back in a comment a week later) which would be a disastrous prediction since it recently passed—not all is said and done yet and the perspective of a year will offer a clearer view.

I'd like to revisit one prediction, from 2008:

9/11/08: "The federal government will buy troubled mortgages from banks, I imagine at near face value, floating Treasury Bonds as needed to pay for them—such that the Treasury Department holds the mortgage stinkers, bought for with bonds that will be paid off by the taxpayer over time. Banks now have the opportunity to become re-capitalized from recent losses and dump toxic mortgage securities all at once." This was on my list of predictions from last year (3/29/09) that I filed under "ugly," since last year they were doing everything BUT that. The more time passes, the more accurately it describes the situation.

Okay, without any further adieu, here on the predictions from 2009—the good, the bad, and the ugly:

The Good:

1/26/09: “future indicators show no end to budget cuts and profit downgrades.” Comment: budget cuts big time. Profit downgrades—well since banks factor bailout money and mark-to-model accounting into profits, what can you do?

1/28/09: “Expect quantitative easing soon.” And we got it.

2/10/09: About Geithner and acquiring toxic assets from banks: “The fact he is calling for the use of private capital in all of this, for this ‘bad bank,’ which obviously isn't going to happen unless it is fully guaranteed, strikes me as almost a delay tactic.” Comment: That seems like ages ago. Anyway, the whole public-private investment program has fallen by the wayside. This "bad bank" now is just the Fed and the GSEs. I can't see any private capital of significance involved in the toxic asset bailouts.

3/21/09: Regarding the establishment of some new global currency at the G20 meeting: "Anyways, from what I've been reading it does not sound like these talks have progressed very far, and unlikely will by meetings end." Cha-ching!

6/15/09: Regarding coercive tactics to get banks to modify mortgages: "Where the mortgage markets are already starting to freeze, despite the Fed's efforts at quantitative easing to keep money flowing, a move like this can't make banks more likely to originate loans." Comment: I don't have any precise data, but news and hearsay suggests they haven't been. I'll add that any benefits of quantitative easing on the general economy seem unimpressive.

6/26/09: "It's been a tepid rebound we've had since March. If it were in line with past dead cat bounces, eyeballing the DJIA over the decades, such a faux-recovery spike could have easily reached 10,000 and maybe even 12,000 before the true decline to fundamentals began." Comment: of the various general mis-statements made by me this year on the stock rebound, it is this statement I prefer to remember.

8/12/09: "In the current environment of tightening credit, we have 90% of the money supply that could potentially contract quite a bit, and if credit falls more than 15%, such would wash out any total monetary expansion from quantitative easing." Again, no exact numbers, but this seems about right. The $1.8T quantitative easing plan may have been successful at holding off economic disaster, but I would not describe our present economy as "stimulated."

12/11/09: While my post "Even Steven" does not give any predictions what direction the dollar would take, it falls almost perfectly on the date the USDX turned around and started heading north again. Even though the USDX wasn't quite at the all time lows of March '08, I wrote the post "Even Steven" on that day figuring I might not have much more chance to comment on the lows of the dollar. I guess you'll just have to take my word on that.

The Bad:

3/21/09: "With talk of a new world order, gold has been doing okay. The dollar I anticipate will recover after the meeting closes." I'm tempted to leave this one out because it offers no time frame. The USDX did take a significant hit in early March, then recovered some in April before beginning a prolonged decline that lasted until November.

4/12/09: "But I'm guessing we are closer to economic stabilization by a return to fundamentals than we are to the speculative peak of the bubble." This was about a month into a Bear Run that lasted until November. While neither correct nor incorrect, I'll use this line to represent a handful of statements that failed to sufficiently incorporate the impact of bailout efforts.

5/7/09: Regarding the "Stress Test" of banks back in May: "I'm going to hazard a guess now that the economic contraction will exceed their worst case scenario, and another stress test will be needed before all is said and done." The Stress Test was nothing but accounting silliness that has already fallen into obscurity. My only regret is reporting on it at all. The Stress Test will not be performed again. The banks will simply be bailed out. The Stress Test is irrelevant anyway because even in this bailed out economy the numbers have exceeded the Feds worst case scenario, and no one wants to draw attention to that.

6/21/09: "My money remains in dollars, but at this point diversifying into gold and some competitively priced stocks would be a more sensible strategy than when this blog first began. Were I a more savy investor I would have jumped from dollars into stocks in March, but had I done that now I would be going back to cash." The DJIA was around 8500 at this point. It would still be months before the DJIA would plateau. It just goes to show: pay no heed to me when it comes to investment advice.

8/17/09: To summarize my post "Squeezing the Shorts": as long as there remains a strong market for short sales, there remains a strong market for stocks, and prices can stay high. I now believe the current stock market is driven by fundamentals, not by aggressively shorting the market—since competing investments are so poor nowadays, stock dividends don't have to be particularly high to sell well.

12/16/09: "Personally, I see no economic fundamental driving the recovery other than an easy money policy directed at Wall Street and Corporate America." I guess age has made me less cynical, even though that statement was made a scant 3 months ago. As stated above, I now feel stock P/E ratios of stocks are in line with other investments. Absolute numbers might have risen, but stock yields have been deflationary.

12/28/09: "Today, the Fed announced hopes of crafting a policy which would drain banks of their reserves." Now, this isn't a prediction, not mine anyway, but reserves sharply increased right after this statement was made. I don't know why I blog on anything the Fed says, other than as a contrarian indicator.

The Ugly:

3/10/09: “Get dollars now and sell your stock while you still can.” Definitely the wrong sentiment at the beginning of a long bear run. I called it as ugly last year in the same month the prediction was made, so you have only three weeks worth of malinvestments you can blame on me. Still, since the inception of this blog, if you accepted one and only one investment strategy, you would be better off holding onto cash than stocks, and I think gold is the only major investment category that would have beaten cash.

Friday, March 26, 2010

Health Bill Ramifications

Although it is still way too early to forecast how the Health Care Bill will play out, Mish recently posted some interesting comments.

Basically, it is much cheaper for businesses to pay the fine for not insuring employees. The fine is $2000 per year, whereas insurance runs closer to $6000. Similarly, it is cheaper as well for individuals to pay the fine, which runs from $700 to $2300 per year, than to buy their own policy, which for me would run around $6000. If worse comes to worse and one is diagnosed with an expensive medical condition, one can buy a policy at that point because they cannot be excluded for pre-existing conditions. Just paying the fine ends up being a very cost-effective strategy. The only place where one could still get hit is emergency treatment.

So who knows, this bill might actually move us toward the free-market solutions I desire, where one just has to pay $2000 for the government to stay out of our business; a bargain indeed. One can game the system by buying insurance only when they develop a costly medical condition.

Monday, March 22, 2010

Preliminary Health Bill Passes

Late yesterday the Senate version of ObamaCare was brought to the House where, under extreme pressure from Obama and ranking Democrats it eeked a marginal victory. As best I can tell, it enacts universal health coverage by making it unlawful not to buy it, and gives nearly $1T over the next 10 years to someone--time will tell exactly who will be the beneficiaires. To my mind, it spends $1T perpetuating all of the current problems, in exchange for one minor benefit: that one cannot be denied insurance based on pre-existing conditions. Presumably one can still be denied for other reasons. Time will tell what will be done to limit costs.

There is still plenty of maneuvering in to be expected, by both parties. The Democrats might still focus on a Public Option agenda. The package may cost them votes in November, but if it hadn't passed, I would guess it would have been worse. If there is one thing worse than bad legislation, it is failing to pass it.

Wednesday, March 17, 2010

Why 0% is Bad

In what is less and less of a news item, the Fed kept interest rates at 0% today. No change since December '08. No sign of tightening on the horizon.

So long as the economy remains deflationary in most sectors, particularly jobs and housing, in keeping with the Fed's mandate for price stability (yeah it is hard to keep a straight face while writing that), there is little alternative other than to keep rates at 0%.

So what is wrong then, in a deflationary environment, with just handing out money with the sole condition that the borrower has to pay it back, absent any interest? The problem is, it hurts all investments in the long run.

It directly hurts cash and treasury bonds, in terms of reducing interest payments there. But it indirectly hurts stocks as well. With interest rates on cash and bonds generally low in the 0-2% range, stock dividends no longer have to be as much to still be attractive investments. Price-earnings ratios for stocks can go way down and still be competitive in the 2-3% range, which drives the prices of stocks higher. Say a stock pays 50 cents in dividends per share per year. If you are looking for a return of 6%, each share would have to be priced at around $9 to be of interest. But in a climate where 3% is considered a competitive return, then the stock should sell okay at $17.50. The DJIA going up absent higher dividends simply means investors are willing to accept lower P/E ratios.

Now, if an investment bank can borrow money from the Fed at close to 0%, and invest it with a 3% return, well that is a good deal for doing no work and producing nothing of value. The Fed maintaining interest rates at 0% thus insures low yields for all investements.

Sunday, March 7, 2010

Icelanders Reject Bailouts

In early January, Iceland's president vetoed legislation that would cost everybody in Iceland $16,000 on average—probably twice that if you just count taxpayers—to make British and Dutch governments whole (after they bailed out depositors in collapsed Icelandic banks). It would force the people of Iceland to pay for banking collapses. Yesterday the same resolution was put to public vote where it lost by a near unanimous 98% margin[1].

If $16,000 seems like a shocking number, Americans owe more than $90,000 per taxpayer on our national debt. In America, such legislation never would have gotten to the voters because Congress would have gladly passed it and the president would have gladly signed it. Imagine if the TARP were put to public vote, or the Obama Stimulus? Each of these would have easily been defeated, as would the current bill for health care "reform." Personally, I think any legislation big enough to cost taxpayers that kind of money should be put to public vote.

This probably is not totally over but I don't know how much recourse Britain and the Netherlands have. The Iceland government will have serious credit rating problems over the coming years, and probably Great Britain has enough influence that there will be any number of diplomatic consequences for Iceland. But Icelanders will reap the benefit of a government now forced to live within its means, which creates a healthier society for all[2].

1. Iceland's Message: Don't Bail Them Out.
2. Iceland's GDP rises 3.3% ahead of referendum.

Saturday, March 6, 2010

Savers Go Away

Our economy was once driven by reckless credit. Now it is driven by government bailouts. Through all this, savers have been social pariahs for the better part of a decade.

Banking is simple: borrow money at low interest rates and lend it out at higher rates. The difference is your profit. Now, back when the Fed was offering 5% interest rates, if banks could get the money from a saver instead at 3%, that was a good deal for everybody, or at least for the banks. Now today, where federal programs freely make money available at close to 0%, there isn't much point in drawing capital from savers. Aside from interest to the customer, which at this point is 0% wherever you go, banks have to pay 0.25% in FDIC (or NCUA) guarantees, soon to be raised to 0.4%. It appears there aren't enough loans to be made these days to make that 0.4% cost worthwhile.

At least that is what one bank in Nevada is reporting, who is now paying savers to withdraw their deposits. The figures it supplies are interesting. We will see if this becomes a broader trend.

Source: Credit Union: Puh-lease take your money.

Loses to Depositors

Depositors in failed banks are guaranteed protections of their deposit from the FDIC of up to $250,000. In failed banks where people had deposits higher than that, they have generally been made whole as well, usually when the purchaser of the failed bank assumes the deposit. However, if there is nobody who buys the bank then the money one has over the guarantee limit can be lost.

So, this article from the The Street [1] is saying such a thing did happen in the latest round of bank seizures on Friday. For two of the four seized banks, the FDIC couldn't find a buyer. This is a little surprising because the FDIC practically gives the assets of a seized bank away to healthy banks. Even at the rock bottom prices charged by the FDIC for the sale, this week, for two banks, there were no takers.

The day is still young and buyers could still be found. I'm just saying, for you quarter-of-a-millionaire's out there, just be mindful.

Source: Four Banks Fail, Depositors Suffer.

Friday, March 5, 2010

Fannie, Freddie Guarantees

For Fannie Mae and Freddie Mac, there has always been the belief that the federal government would bail out bond holders if they went south, even though it was explicit there were no guarantees that would happen. In 2008, they went south, and indeed all bond holders were made whole as the GSEs went into federal receivership. Now that they are run by the federal government, I imagine a lot of people figure they are about as safe as a higher-interest treasury bond, and I wouldn't be surprised if these people are right. But today, Rep. Barney Frank (D-Mass.) is saying otherwise.[1]

I recall politicians warning us there were no guarantees right before they went into receivership, yet the bond-holders remained as safe as can be. So if it were any other person saying that, other than Obama, it would hardly be post-worthy, but Frank has always been a cheerleader of the GSEs and has about as much oversight over their operation as any congressman.

So today's news may be a small thing, but at least it is a step in the right direction—at least from Obama's pledge of unlimited bailouts. Time will tell if Frank's statements are a red herring to distract and assuage public resentment over a never-ending stream of bailout efforts that protect nothing but greed and fraud. An interesting figure from the article is the amount of debt the GSEs hold, on the order of half the federal debt.

In other news, some banks scrambled today as Fannie Mae withdrew much of its cash holdings to cover delinquent debt.[2] No doubt, they will be needing the rest of it pretty soon.

1. Fannie, Freddie Holders shouldn't assume guarantees.
2. Banks scramble to raise cash after FNM cuts.

Thursday, March 4, 2010

$15B Jobs Bill

The house passed a $15B "jobs bill" intended to help job creation.[1] That is $109 T*Bux. I remember last month, when it was still $80B, being impressed with Washington's new restraint.

But it also announces clearly where the priorities of Washington lay. In 2008 a $700B ($5075 T*Bux) TARP, or "bank bill," was ramrodded through Congress over the course of a couple weeks. Shortly after Obama took office, a $787B ($5706 T*Bux) "public employees union bill" similarly found easy passage.

Maybe they think 10% unemployment and another 7% underemployment, and higher in places like California, is nothing to be very concerned about and $15B will solve everything. But I doubt that is why the figure is so low.

Words of trillion-dollar health care reform are still batted around as democrats strategize to get a couple republican votes needed for passage. So the easy money days of Washington are not totally over yet.

Source: House OKs $15B jobs bill.

Monday, March 1, 2010

"Purchases Cannot Exceed Earnings"

The economy may be going to hell in a hand basket as bailout efforts have soured on main street and are met with ambivalence in Washington, but I'm determined to prove the cash-inventory equivalency. This relationship allows one to value the dollar (or any fiat currency) independent of comparisons with foreign currencies, and offers a precise model to explain pricing, and how it relates to monetary policy.

I see three strategies to substantiate the relationship that the total of all prices of all things for sale will self correct to be exactly equal to the money supply: 1. a mathematical proof, 2. a logical defense of the symmetry, or 3. an empirical summation of all things for sale and comparing that with the money supply. My math skills are probably insufficient for the first approach, and besides, we are dealing with diffuse and inexact values. Now, even if I were to have all the data to calculate inventory, and even if it were the same as the money supply, that might just be coincidence—although enough similarities, over a long enough time, and in enough different circumstances, might be regarded as a de facto proof.

But today I would like to consider the second approach: the logical argument, and to do so, let's start small. Let us examine the truism that purchases, at the level of an individual, cannot exceed his income. Purchases cannot exceed earnings.

Laugh, you do? Naive I am, you say? "Living in a cave, are you?" you ask, "born yesterday, perhaps?" Yes, I understand we have solvency problems from reckless credit, which only proves my point. Credit extended now consumes earnings in the future, be it your own, or the bank's in the case of default, or the taxpayer's in the case of bailouts. Repayment has to come from somewhere, it should come from the beneficiary of a loan, but if they do not pay, it will be diffused elsewhere on society. While credit allows one to leverage income over time, in a sustainable economy, purchases cannot exceed earnings.

Now let's expand "purchases cannot exceed earnings" to all of society. At the social level, I propose earnings equate with money supply. Money supply is the exact measurement of earnings across society since, excluding barter arrangements, money is the only unit of income. All paychecks taken from the money supply will go toward purchases or to savings. Purchases reflect earnings for the sellers. Earnings will pass quickly through some but settle with others; savings are still earnings, just money that is earned previously. Savings do not rest but will be lent out by banks. This consumes future earnings from the borrower as repayment, so credit balances with earnings over time. Whether money moves or stays it has been earned at some point. All earnings have to come out of the money supply. All money that enters the money supply is earned, even if it came as a lien on future earnings, or more cynically, came by virtue of having friends with a printing press. Printing money counts as "earning" it.

In a Venn diagram, with a money supply circle and earnings circle, the only part of the earnings circle that reaches outside money supply would be barter arrangements. If earned money, spent money, saved money, borrowed money, and printed money is all earned, then I see no money that does not fall within the earnings circle, other than unpaid debt to a bank that goes bankrupt and is not bailed out. The two circles are very close to being perfectly superimposed.

Let's turn to inventory. Inventory, here, is defined as the set of all goods available for purchase. The identity of inventory and actual purchases isn't quite as close. While purchases have to come from inventory, inventory can remain unsold. But the relationship of purchases to inventory is one of considerable overlap. In a sustainable economy all inventory eventually has to be sold.

So, extending the statement: "purchases cannot exceed earnings" to all society, we can almost say "inventory cannot exceed money supply." It can—if sellers overprice their items. But then sales velocity slows, and unsold inventory accumulates. Production must be slowed or prices lowered such that the item sells, otherwise producers and sellers will not be compensated and will stop producing it.

So, the cash-inventory equivalency is defended on the grounds that purchases can never exceed earnings in a sustainable economy (where purchases equate with inventory and earnings with money supply at the social level). Purchases can equal earnings though, so to maximize profits sellers will price their wares to that effect.