Month: May 2016

Submitted by Gail Tverberg via Our Finite World blog,

There are many who believe that the use of energy is critical to the growth of the economy. In fact, I am among these people. The thing that is not as apparent is that growth in energy consumption is dependent on the growth of debt. Both energy and debt have characteristics that are close to “magic,” with respect to the growth of the economy. Economic growth can only take place when growing debt (or a very close substitute, such as company stock) is available to enable the use of energy products.

The reason why debt is important is because energy products enable the creation of many kinds of capital goods, and these goods are often bought with debt. Commercial examples would include metal tools, factories, refineries, pipelines, electricity generation plants, electricity transmission lines, schools, hospitals, roads, gold coins, and commercial vehicles. Consumers also benefit because energy products allow the production of houses and apartments, automobiles, busses, and passenger trains. In a sense, the creation of these capital goods is one form of “energy profit” that is obtained from the consumption of energy.

The reason debt is needed is because while energy products can indeed produce a large “energy profit,” this energy profit is spread over many years in the future. In order to actually be able to obtain the benefit of this energy profit in a timeframe where the economy can use it, the financial system needs to bring forward  some or all of the energy profit to an earlier timeframe. It is only when businesses can do this, that they have money to pay workers. This time shifting also allows businesses to earn a financial profit themselves. Governments indirectly benefit as well, because they can then tax the higher wages of workers and businesses, so that  governmental services can be provided, including paved roads and good schools.

Debt and Other Promises

Clearly, if the economy were producing only items for current consumption–for example, if hunters and gatherers were only finding food to eat and sticks to burn, so that they could cook this food, then there would be no need for the time shifting function of debt. But there would likely still be a need for promises, such as, “If you will hunt for food, I will gather plant food and care for the children.” With the use of promises, it is possible to have division of labor and economies of scale. Promises allow a business to pay workers at the end of the month, instead of every day.

As an economy becomes more complex, its needs change. At first, central markets can be used to facilitate the exchange of goods. If one person brings more to the market than he takes home, a record of his credit balance can be kept on a clay tablet for use another day. This approach works as long as the credit can only be used at that particular market. If the credit balance is to be used elsewhere, or if the balance is to hold its value for a period of years, a different, more flexible approach is needed.

Over the years, economies have developed a wide range of debt and debt-like products. For the purpose of this discussion, I am including all of them as debt, broadly defined. One type is what we think of as “money.” Money is really a portable promise for a share of the future output of the economy. It can provide time shifting, if this money is held for a time before it is spent.

Another type of debt is a loan with a fixed term, such as a mortgage or car loan. Such a loan provides time shifting, allowing something to be paid for over a significant share of its life. Equity funding for a company is not really a loan, but it, too, allows time shifting. Those purchasing shares of stock do so with the expectation that they will be repaid in the future through price appreciation and dividends. It thus acts much like a loan, for the purpose of this discussion. There are many other types of promises regarding future funding that are closely related–for example, government loan guarantees, derivatives, ETFs, and government pension promises. All indirectly add to the willingness of people and businesses to spend money now–someone else has somehow made promises that remove uncertainty regarding future income flows or future payment obligations.

The Magic Things Debt Does

It is not immediately obvious how important debt is. In fact, neoclassical economists have tended to ignore the role of debt. I see several, almost magic, ways that debt helps the economy.

1. Debt brings forward the date when an individual or company can afford to purchase capital goods. Without debt, the only way to afford such a purchase would be to save up the full price in advance. Using debt, a business can add a new machine to allow it to produce more goods before the business saves up money from its prior operations. A young person can afford to buy a house or car, long before he could save up funds for such a purchase. With the help of debt, the price of capital goods can be financed over much of their working life.
2. Adding debt raises the prices of commodities. Commodities, such as lumber, iron, copper, and oil are what we use to make cars, houses, and factories. “Demand” for these commodities rises because more people and businesses can afford to buy capital goods that use these energy products. Often these capital goods also use energy products over their lifetime (for example, gasoline to operate a car), so there is a long-term impact on the demand for energy products, in addition to the demand associated with making the capital goods. Of course, with higher prices, it becomes profitable to extract oil and other energy resources from more marginal areas of production. More companies enter the field. As long as prices remain high, they are able to earn a profit.
3. Adding debt stimulates the economy, almost like turning the heat up on a stove. When debt is added for any purpose–even starting a war–it starts a whole chain of purchases, each of which acts to stimulate the economy. If a young person takes out a loan to buy a car, the purchase of the car leads to the salesman having more money to buy goods for his family. The company selling the cars is able to make a bigger profit, which the business can reinvest or pay to shareholders as dividends. The purchase of the car leads to more demand for metals used to make the car, and thus tends to increase the number of mining jobs. Each new worker in turn is able to buy more goods and services, starting a beneficial cycle that gradually radiates out through the economy.
4. Adding debt tends to lead to higher asset prices. Clearly, (from Item 2), adding debt can raise the price of commodities. Adding debt can also make it possible for more people to afford real estate and investments in the stock market. For example, Japan greatly ramped up its debt level between 1965 and 1989.
   

   Figure 1. Annual growth in non-financial debt (in Yen), separated into private and government debt, based on Bank of International Settlements data.

   During this time, a major price bubble occurred in land prices (Figure 2).

   

   Figure 2. Land Prices in Japan. Figure from Of Two Minds by Charles Hugh Smith.

   There is a reason why this bubble could occur. Because of the stimulating effect that debt had on the economy, more people had the wealth to buy real estate, especially if this too was sold on credit. Once private debt levels stopped rising rapidly, price levels crashed both for land and stock prices. TheBubbleBubble.com explains what happened: “By 1989, Japanese officials became increasingly concerned with the country’s growing asset bubbles and the Bank of Japan decided to tighten its monetary policy.” Doing so popped both the home and stock price bubbles.

5. Adding debt adds to GDP. GDP is a measure of the goods and services produced during a period. Many of these goods and services are bought using debt, so it is not surprising that adding more debt tends to add more GDP. The amount of GDP added is less than the amount of debt added, even when inflation growth is considered as part of GDP.
   

   Figure 3. United States increase in debt over five-year period, divided by increase in GDP (including inflation) in that five-year period. GDP from Bureau of Economic Analysis; debt is non-financial debt, from BIS compilation for all countries.

   The general tendency is toward the need for an increasing amount of debt per dollar of GDP added. This is especially the case when oil prices are high. In the US, the ratio of non-financial debt to GDP added was almost down to 1:1 for a time, back when oil prices were less than $20 per dollar (in today’s dollars).

6. Adding debt tends to increase wealth disparity.  Adding debt tends to increasingly divide an economy into “haves” and “have-nots.” Many of the “haves” own the means of production, including an ever-increasing amount of capital goods, and thus can earn profits and dividends from these capital goods. Others are high-level officials in businesses and the government who earn high salaries. Interest payments also tend to transfer payments from the poor to the more wealthy. We might say that the common laborers are increasingly “frozen out” of the economy that otherwise is heating up. This shift started to take place in the United States about 1981.
   

   Figure 4. Chart comparing income gains by the top 10% to income gains by the bottom 90% by economist Emmanuel Saez. Based on an analysis IRS data, published in Forbes.

7. Adding debt is something that governments can influence, either by lowering interest rates or by borrowing the money themselves.  Actions by governments to reduce interest rates can be effective, because they lower monthly payments that borrowers need to make to take out a loan of a given amount. Thus, they tend to encourage more borrowing. In Figure 5, below, note that the decrease in interest rates in 1981 corresponds precisely with the rise in debt to GDP ratios is Figure 3 and the shift in income patterns in Figure 4.
   

   Figure 5. Ten year treasury interest rates, based on St. Louis Fed data.

   Figure 6 later in this post shows that changes in Quantitative Easting (which affects interest rates and the level of the US dollar relative to other currencies) also correspond to sharp changes in oil prices. Changes in the level of the dollar also affect demand for oil. See a recent post related to this issue.

What Goes Wrong as More Debt Is Added?

It is clear from the discussion so far that quite a few things go wrong. These are a few additional items.

1.There are limits to government manipulation of debt levels.  First, interest rates eventually drop so low that they become negative in some countries. Negative interest rates tend to cause bank profitability to drop and lead to hoarding by those who planned to use savings for retirement.

Second, government borrowing doesn’t work as well at stimulating the economy as investments made by the private sector. A likely reason is that private sector investments are made when the borrower believes that the return on the investment will be high enough to pay back the debt with interest, and still make a profit. Government investments often do not meet this standard. Some reports indicate that  Japan’s government has used borrowed money to fund bridges to nowhere and houses with no one home. China’s centrally directed economy seems to lead to similar over-borrowing problems. Chinese businesses also borrow to cover interest on prior loans.

2. Ratios of debt to GDP tend to rise, worrying government leaders. Debt is a way of accessing the benefits of Btus of energy, in advance of the time they are really available. As the amount of easy-to-extract oil depletes, the cost of oil extraction gradually rises. Unfortunately, the amount of “work” a barrel of oil can perform–for example, how far it can make a truck travel–doesn’t rise correspondingly. As a result, the higher price simply reflects increasing inefficiency of extraction, and thus the need to use a larger share of the economy’s output to extract oil. The amount of debt needed to keep GDP rising keeps growing, in part because oil is becoming higher priced to extract, and in part because goods that use oil in their production also tend to rise in cost. As a result, the ratio of debt to GDP tends to spiral upward.

3. Rising debt allows for a temporary false valuation of the benefit of energy products. The true value of oil and other energy products comes primarily from the Btus of energy they provide, such as how far a truck can be made to travel. Thus we would expect that the true value of energy products would remain relatively constant over time. If anything, the value of energy products will tend to rise by a small amount (say, 1% per year) as technology improvements lead to growing efficiency in their use.

What we think of as the magic hand of the economy determines a price for commodities at all times, based on “supply” and “demand.” This price clearly is not very close to the future energy profit that the energy products will actually provide, because it tends to vary widely over time. We don’t know what the true value of a barrel of oil to society is. If the true value is $100 per barrel (in today’s money), then back when oil prices were $10 or $20 per barrel (in today’s money), there would have been $80 to $90 (equal to $100 minus the actual price) of “energy profit” that could be pumped back into the economy as productivity gains for workers, interest on debt, and dividends on stock, tax revenue, and money for new investment. The economy could (and did) grow quickly. There was less need for added debt, because goods made with oil were cheap. Wages for workers could rise rapidly, as they did in the 1950 to 1968 period (Figure 4).

If prices approach the true value of oil (assumed to be $100 per barrel), the extra energy profit would pretty much disappear. The economy would increasingly become “hollowed out.”  Productivity gains that lead to wage gains would mostly disappear. Businesses would find it hard to earn adequate profits, and would cut back on dividends. Some companies might need to borrow money in order to pay dividends. World economic growth would slow.

Prices can even temporarily overshoot their true value to the economy, then drop sharply back. This happens because prices are set by demand, and demand depends on a combination of wage levels and debt levels. Oil prices can be high for a while, if borrowing is temporarily high, and then fall back as it becomes clear that profitable investments are not really available if oil is at such a high price level.

4. Wages of non-elite workers tend to drop too low. Workers play a very special role in the economy: they both (a) provide the labor for the economy and (b) act as consumers for the economy. If workers aren’t earning enough, there is a problem with many of them not being able to buy the goods and services the economy produces. This is especially the case for purchases such as homes and cars, which are often bought using debt. Indirectly, this lack of ability to afford the output of the system puts a downward pressure on the price of commodities, particularly energy commodities. Prices may fall below the cost of production, or may not rise high enough.

The reason that wages of the less educated, non-managerial workers tend to lag behind is related to the issue of diminishing returns. A workaround is a more “complex” society, with bigger businesses, bigger government, more capital goods, and more debt. In some cases, manufacturing is shifted to parts of the world with lower wages. Non-elite workers increasingly find themselves with too small a share of the output of the economy. Figure 7 shows some influences that tend to lead to too low wages for non-elite workers.

When wages for a large share of workers drop too low, there is a problem with workers not having enough money to buy goods like cars and houses. The economy tends to contract. This is a different form of too low Energy Return on Energy Invested (EROEI) than most people think of. In my view, low return on human labor is the most important type of EROEI. Falling wages of a large share of workers can lead to economic collapse, because there are not enough buyers for the output of the system.

5. Eventually, debt defaults become a problem. As the world becomes more divided into “haves” and “have-nots,” falling ability to repay a debt becomes more of a problem. To some extent, this happens at the individual level, with auto loans, student debt, and mortgages. If commodity prices fall or stay too low, it happens to commodity producers, including oil producers. It also happens to countries, especially to those who are dependent on commodity exports.

The rise in the cost of oil extraction is another factor. As the cost of extraction begins to exceed the benefit of oil to the economy (assumed above to be $100 per barrel), the energy profit from oil is no longer sufficient to allow the economy to grow as in the past. Without economic growth, it becomes much harder to repay debt with interest.

6. At some point, we reach peak debt. The economy acts like a pump. As long as the there are sufficient energy profits coming through the system (based on $100 per barrel minus the actual oil price, in our example), wages can rise and corporate profits can rise. Assets prices can rise, and energy prices can stay high. Once these energy profits start falling back, wages stagnate and business profits decline. Businesses cut back on borrowing, because they see fewer profitable opportunities for investment. Individuals cut back on borrowing, because with their lower wages, it becomes more difficult to buy a house or car. Governments try to fight declining demand for debt, but eventually reach limits of the economy’s tolerance for negative interest rates.

Once debt begins contracting, the contraction tends to bring down commodity prices. This is a huge problem for commodity producers, because they need prices that are high enough to cover their cost of production. Ultimately, falling debt, together with falling wages, and lack of energy profit have the potential to bring down the system.

Conclusion

The situation we are facing today is one in which growing debt has been holding up oil prices and other commodity prices for a long time. We are now reaching limits on this process, as evidenced by growing wealth disparity, low commodity prices, and the frantic actions of governments leaders around the world regarding slow economic growth and the need for more stimulus. These issues are becoming major ones in the upcoming US political election.

Those studying oil issues from an EROEI perspective tend to miss the connection with debt, because EROEI analysis strips out timing differences. In my view, debt is essential to oil extraction, because it brings forward an estimate of the value of the oil and other energy products, so that businesses of all kinds can make use of the “energy profit” in paying their employees and in paying their taxes. Most people don’t think of the issue this way.

In this article, I suggest a different way of thinking about the limit we are reaching–oil prices can’t rise above some price limit without adversely affecting the economy. It is the savings below this limit that aids productivity growth and government funding. Perhaps researchers should be examining this price limit approach more carefully. This is not the same approach as EROEI analysis, but has the advantage of having fewer “boundary issues.”  It also offers a check for reasonableness of EROEI indications developed through conventional analysis. If an energy product needs a government subsidy, it is doubtful that that energy product is really providing an energy profit.

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Either The BoJ steps in soon and intervenes (even by just “checking levels”) or Kuroda-san is truly terrified of The G-20. USDJPY has now crashed 7 handles since last Thursday’s shock BoJ disappointment crashing to within 5 pips of a 105 handle tonight for the first time in 18 months…

 

 

Pewrhaps Jack Lew’s “currency manipulation” report was enough to stall the Japanese currency war for now? Or is China greatly rotating its Yuan devaluation pressure against another member of its basket…?

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As the make-or-break Indiana primary looms for the GOP establishment, Ted Cruz suffered a develishly-dismal day. First, as Gallup reports, Cruz's favorability has utterly collapsed in the last few days (blame Carly?) with 45% unfavorable to 39% favorable (a negative spread for the first time in his campaign). But it got worse, as not only does trump hold a commanding 15-point lead in Indiana, but the latest Rasmussen survey shows Trump (41%) ahead of Hillary (39%) for the first time as The Donald is now doing twice as well among Democrats as Clinton does among Republicans.

 

Republicans' views of Cruz are now the worst in Gallup's history of tracking the Texas senator. As Gallup details, his image among Republicans and Republican-leaning independents is at 39% favorable and 45% unfavorable, based on April 24-30 interviewing, for a net favorable score of -6. The last few days have marked the first time we have seen Cruz's image underwater since we began daily tracking in July.

The Ted Cruz Death Cross

 

In sharp contrast to the recent trajectory of Cruz's image, we find Trump's image on an upswing in recent days.

 

The remarkable aspect of this trend line is the degree to which since mid-April Trump's net favorable rating has moved steadily upward just as Cruz's net favorable rating has moved steadily downward. Cruz's image was consistently more positive than Trump's from July through the end of February; then the two closely tracked one another before the recent divergence.

But now, as Liberty Blitzkrieg's Mike Krieger details, regular readers won’t be the least bit surprised that Donald Trump continues to gain ground against Hillary Clinton in general election polling. As he recently wrote in the piece, Could Trump Beat Clinton in New York? Yes:

I continue to see Hillary Clinton as one of the most overrated political figures in American history, and Donald Trump as one of the most underrated. This is why I think “the experts” are wrong about the outcome of a potential Clinton vs. Trump showdown in the general election.

 

Hillary’s weaknesses are obvious. I’ve highlighted new shameless transgressions or scandals on these pages virtually every day for several months now. Furthermore, the fact that the grassroots campaign juggernaut known as the Sanders movement seemingly came out of nowhere, proves there’s a huge ideological vacuum on left just asking to be filled in light of Clinton’s neoconservative candidacy.

 

As far as Trump’s concerned, I’m of the view that his real genius is marketing and his tremendous force of personality. He’s not so much a brilliant businessman, as he is virtually peerless when it comes to selling himself to whomever he targets. While I don’t condone or respect such behavior, I do think a lot of what he said during the primary was carefully crafted rhetoric designed to appeal to a certain demographic in order to win the nomination. It worked. The fact that he knew exactly what to say, while most pundits kept expecting his frequent outbursts to bury him proves that he knew what he was doing, and exposed the pundits’ cluelessness.

 

If he ends up as the Republican nominee in the general election, he’ll analyze the American public as a whole, as opposed to merely registered Republicans, and he’ll campaign accordingly. Can he pull this off? If anyone can, he can. He’s a billionaire primarily because he is a genius at knowing exactly what people want and then selling himself to them.

With that in mind, check out the results from a recent Rasmussen survey:

Last week, Rasmussen Reports gave voters the option of staying home on Election Day if Hillary Clinton and Donald Trump are the big party nominees, and six percent (6%) said that’s what they intend to do for now. Clinton and Trump were tied with 38% support each; 16% said they would vote for some other candidate, and two percent (2%) were undecided.

 

But Trump edges slightly ahead if the stay-at-home option is removed. Trump also now does twice as well among Democrats as Clinton does among Republicans.

 

A new Rasmussen Reports national telephone survey of Likely U.S. Voters finds Trump with 41% support to Clinton’s 39%. Fifteen percent (15%) prefer some other candidate, and five percent (5%) are undecided. (To see survey question wording, click here.)

 

This is the first time Trump has led the matchup since last October. Clinton held a 41% to 36% advantage in early March.

 

Trump now has the support of 73% of Republicans, while 77% of Democrats back Clinton. But Trump picks up 15% of Democrats, while just eight percent (8%) of GOP voters prefer Clinton, given this matchup. Republicans are twice as likely to prefer another candidate.

 

Among voters not affiliated with either major party, Trump leads 37% to 31%, but 23% like another candidate. Nine percent (9%) are undecided.

 

Clinton’s narrow 38% to 32% lead among those under 40, traditionally a reliable Democratic group, suggests that younger voters will be a big target in the upcoming campaigning.

As Krieger so eloquently concludes, I continue to think Donald Trump is Hillary Clinton’s worst nightmare in the general election, and that the Democratic Party made a fatal error in pushing her candidacy.

 

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The US became an unsustainable service sector based economy from the 1970s onward when service sector employment diverged from manufacturing without a corresponding boost in productivity. Even Alan Greenspan has warned that America is "in trouble basically because productivity is dead in the water…" There are numerous reasons for this plunge in worker-productivity, from perverted inventives not to work to unintended consequences of monetary policy enabling zombies, but perhaps the most critical driver is exposed in the following dismal chart…

51% of total time spent on the Internet is on mobile devices – in 2015, first time ever mobile is #1 – to make a total of 5.6 hours per day snapchatting, face-booking, and selfying…

Source: @kpcb

So, while every effort can be made by Ivory Tower academics to solve the problem of American worker productivity, perhaps it can be summed up simply as "Put The Smart-Phone Down!"

As we detailed previously, adjusting for the WWII anomaly (which tells us that GDP is not a good measure of a country’s prosperity) US productivity growth peaked in 1972 – incidentally the year after Nixon took the US off gold.

The productivity decline witnessed ever since is unprecedented. Despite the short lived boom of the 1990s US productivity growth only average 1.2 per cent from 1975 up to today. If we isolate the last 15 years US productivity growth is on par with what an agrarian slave economy was able to achieve 200 years ago.

In addition, the last 15 years also saw an outsized contribution to GDP from finance. If we look at the US GDP by contribution from value added by industry we clearly see how finance stands out in what would otherwise have been an impressively diversified economy.

With hindsight we know that finance did more harm than good so we can conservatively deduct finance from the GDP calculations and by doing so we essentially end up with no growth per capita at all over a timespan of more than 15 years! US real GDP per capita less contribution from finance increased by an annual average of 0.3 per cent from 2000 to 2015. From 2008 the annual average has been negative 0.5 per cent!

In other words, we have seen a progressive (pun intended) weakening of the US economy from the 1970s and the reason is simple enough when we know that monetary policy broken down to its most basic is a transaction of nothing (fiat money) for something (real production of goods and services). Modern monetary policy thereby violates the most sacred principle in a market based economy; namely that production creates its own demand. Only through previous production, either your own or borrowed, can one express true purchasing power on the market place.

The central bank does not need to worry about such trivial things. They can manufacture the medium of exchange at zero cost and express purchasing power on the same level as the producer. However, consumption of real goods and services paid for with zero cost money must by definition be pure capital consumption.

Do this on a grand scale, over a long period of time, even a capital rich economy as the US will eventually be depleted. Capital per worker falls relative to competitors abroad, cost goes up and competitiveness falls (think rust-belt). Productive structures cannot be properly funded and the economy must regress to align funding with its level of specialization.

In its final stage, investment give way for speculation, and suddenly finance is the most important industry, pulling the best and brightest away from every corner of the globe, just to find more ingenious ways to maximise capital consumption.

As the slave economy got perverted by incentives not to work, so does the speculative fiat based economy, which consequently create debt serfs on a grand scale.

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Submitted by Jeff Thomas via InternationalMan.com,

In the fifth century B.C., Greek dramatist Aeschylus said, “In war, truth is the first casualty.” Quite so. Whenever national leaders decide to go on the warpath for the sake of their own ambition or self-aggrandisement, it’s the citizenry that will pay the bloody price for their aspirations. Since war is rarely desired by the citizenry, it has to be sold to them. Some form of deception, exaggeration, or outright lies must be put forward to con the populace into getting on board with the idea.

War, after all, represents a monumental failure of national leaders to serve the rightful national objectives of a citizenry – peace and prosperity. Of course, in the case of an empire going to war, this represents a monumental failure on steroids – the outcome may well be world war in such a case.

Readers of this publication will no doubt be well-versed in the knowledge that, when an empire is nearing the end of its period of domination, war is almost always used by leaders as a last-ditch attempt to maintain order. (During wartime, a populace tends to focus more on the war than the failure of its leaders. In addition, they’re likely to tolerate the removal of freedoms by their leaders to be “patriotic”.)

This being the case, we might surmise that an empire in decline would be likely to display similar symptoms to a country at war. One of those symptoms might well be the loss of truth, not just as it relates to warfare, but as it relates to the society as a whole. A nation in decline might even welcome the disappearance of truth, as it would allow the people to continue to feel good about themselves at a time when a truthful outlook would be too unpleasant to be tolerable. Further, the closer to collapse the country may be (economically, politically, and socially), the more extreme the self-created loss of truth would likely be.

Let’s have a look at a few cultural examples and see if that premise seems viable.

Silver Versus Chocolate

As I described in January in “Running Out of Candy,” Californian Mark Dice stood on a street corner offering passers-by either a free ten-ounce bar of silver or a free bar of Hershey’s chocolate. Without fail, each one chose the chocolate. Even though Mister Dice was standing in front of a coin shop where the silver bar could be redeemed, they rejected the silver which they knew had to have greater value.

Only twenty years ago, people would have been far less likely to deny truth in favour of a falsehood that was more palatable – the instant gratification of candy. In effect, this is the abandonment of basic truth in favour of whatever perception is more pleasant.

Kim Jong-Un on "Dancing With the Stars”

Talk show host Jimmy Kimmel recently asked people on the street if they had seen Korean leader Kim Jong-Un on the popular television show “Dancing With the Stars.” Clearly they had not, as the idea was absurd, yet many answered yes, then went on to describe their appraisal of his performance as though they’d seen it. (Some went into depth, expounding on the artistry and social value of the non-existent performance.) The interviewer went on to remind the interviewees that Kim Jong-Un is in fact a dictator and asked whether they thought it was in good taste for him to have pointed a machine gun at the audience. In spite of the now-blatant absurdity, interviewees continued to pretend they had actually witnessed the performance, offering their opinions on how well he had performed. They responded in accordance with what appeared to be expected of them rather than choose the less-pleasant option of saying, “I’m sorry, but I didn’t see it.”

Now, the video was clearly offered by Jimmy Kimmel to show his audience “how dumb people can be,” but it demonstrates something more. It shows us that a significant segment of the population is quite prepared to simply abandon reality by, first, pretending to have witnessed something they have not and, second, offering firm and even complex opinions on something that did not occur.

Political Candidacy

Certainly, political hopefuls have always had a reputation for being less than truthful and any responsible voter would be advised to look at every candidate with a jaundiced eye. But what if voters choose to lie to themselves in order to validate candidates?

Back when the US became the unquestioned empire in the world (just after World War II), Americans took a great deal of pride in truth and honour. A candidate might be suspected of personal immoral behaviour and/or corruption and still be elected, but if it were blatant, he would not.

Today, the liberal media regularly refer to the record of presidential candidate Donald Trump, highlighting the companies that have gone bust and people who have been financially ruined as a result of his dealings. They also highlight his ever-changing political viewpoints, arrogance, and disdain for virtually everyone but himself. Yet, supporters of Mister Trump virtually block out the repeated reports, focusing only on their enjoyment of his bombast toward the establishment.

And the conservative media have been equally persistent in calling attention to candidate Hillary Clinton’s long history of shady business dealings, her failure with regard to the Benghazi incident, her selling of influence whilst acting officially as secretary of state, her acceptance of large campaign donations from Wall Street and, most prominently, her (very possibly illegal) abuse of top-secret government documents.

Yet, half of all democrats at present are content to simply treat all that evidence as though it has no significance.

To put this in perspective, as recently as 1974, the American public were so outraged over their president having complied with a cover-up of an information burglary that he was forced to resign his office. Today, however, we observe not a sitting president, but candidates for president, each of whom, regardless of their glaring unsuitability, is able to attract a major portion of the public’s support and continue to campaign.

Here, we need not focus on the shortcomings of the candidates, no matter how unfit for office they may be, but on the voters, who choose to disregard the obvious truth.

Again, abandonment of basic truth in favour of whatever perception is more pleasant.

All of the above I believe are symptoms of a greater problem. As a Briton, I’m very aware that, during the decline of the British Empire, many of my fellow Brits pretended that it wasn’t happening, saying, “There will always be a Britain,” and “The sun never sets on the British Empire.” And, tellingly, they continued to behave as though Britain were still top doggie in the neighbourhood. (We still had vestiges of this, right up until the 1980s, decades after it was clearly all over.)

The US, in its own decline, is showing this same self-destructive tendency. The worse things get, the greater the inclination of the citizenry to say, “Carry on, everything’s fine.”

When a ship is going down, the very worst reaction is to pretend that everything’s fine and that it will all turn out okay. Yet, just as it occurred in Britain, we see today in the American people a desire to pretend that, although all is not well, there’s a rainbow just over the next rise, and that if the people (and their presidential candidates) will only make their hopes and promises big enough, the greatness will return along with good times for all.

I wish that that were the case, but I’m inclined to believe that self-deception does not improve the situation; it exacerbates it. Better to face reality then create a plan to address that reality.

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For anyone concerned that $800 billion in student loans over the last decade simply won't be enough debt burden for millennials to carry, worry no more, a solution has been found.

$800 billion in new student loans in the past decade but aside from that "consumers are deleveraging" http://pic.twitter.com/MwaWby89H4

— zerohedge (@zerohedge) May 2, 2016

 

Visa has come up with a plan to add infinitely more debt to millennials who are working diligently as bartenders and waiters: credit cards. Visa has even unveiled a detailed timeline by which they can accomplish the task.

The thought process is as follows:

First, Visa estimates that all of those minimum wage jobs will be adding up to $8.3 trillion in personal income for millennials by 2025.

 

Next, Visa believes that millennials use cards for 57% of their spending, making them an attractive "target" for massive amounts of additional debt credit card marketing.

 

And finally, as a percentage of total available users, millennials use revolving credit more than any other generation.

 

How long will it take to market the idea, sell the credit, and wait for the debt to pile up? Why, not soon after college of course. Visa estimates that if done properly, banks and other credit card issuers can have millennials saddled with billions in new debt by the young age of 28. The company even puts together a nice infographic to add to their excitement.

 

In summary, everyone can rest assured that while young millennials may not have their future mapped out quite yet, Visa and other institutions have that all taken care of for them – just make sure to pay that monthly interest.

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Now that there have been at least four documented close encounters between Russian fight jets and US ships and/or spy planes (including two barrel rolls) in the past two weeks, each of which has taken place in the immediate vicinity of Russia’s borders (or above Russian naval bases), there have been two recurring questions: i) why does the US continue provoking Russia with its “fly-by” attempts, well aware what the Russian response would be and ii) if one simply ignores who was the instigator, why has Obama not contacted Putin to at least express indignation at these interceptions.

Today, Donald Trump was interviewed by Indiana radio show host Charly Butcher, and addressed if not the first point then the second one. Commenting on the Friday barrell roll incident, Trump focused on Obama’s diplomatic shortcomings and said that the president should have first called Putin to object.

“Normally, Obama, let’s say a president, because you want to make at least a call or two, but normally Obama would call up Putin and say, ‘Listen, do us a favor, don’t do that, get that maniac, just stop it.’ But we don’t have that kind of a president. He’s gonna be out playing golf or something,” Trump said.

Having bashed Obama, Trump then went on to say that, if diplomacy didn’t work, the U.S. should open fire.

“I don’t know, at a certain point, you can’t take it,” the businessman continued. “I mean, at a certain point, you have to do something that, you just can’t take that. That is not right. It’s against all, you know, when you talk about Geneva convention, there’s gotta be things that are against it. You can’t do that. That’s called taunting. But it should certainly start with diplomacy and it should start quickly with a phone call to Putin, wouldn’t you think?”

“And if that doesn’t work out, I don’t know, you know, at a certain point, when that sucker comes by you, you need to shoot. I mean, you gotta shoot. And it’s a shame. It’s a shame. It’s a total lack of respect for our country and it’s a total lack of respect for Obama. Which as you know, they don’t respect.”

We are confident that if Trump had been aware that these “encounters” in which the “maniac” was in fact responding to US “taunts” took place either on top of Russian territory or in its immediate vicinity, he may have reassessed his conclusion that the Russian defensive response is a lack of respect; in fact one can make the argument that the lack of respect is shown by the provocative intruder seeking precisely the kind of outcome that Trump is suggesting.

On the other hand, we are confident that since Putin appears to have a far better dialog with Trump than Obama, and at least some trace of respect, World War III will be avoided, especially since Trump’s entire angle with this exchange was to once again disparage Obama’s foreign policy, not that it is necessary at this point.

As for Putin losing any sleep over Trump’s suggestion, we doubt it. After all the Russian defense ministry had a very simple solution how to avoid such future confrontations:  

“The US Air Force has two solutions: either not to fly near our borders or to turn the transponder on for identification.“

Assuming a rational US president who is not a raving neo-con in a liberal Nobel peace prize winner’s clothing, it stands to reason that the two suggestions will be followed.

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Submitted by Pater Tenebrarum via Acting-Man.com,

Damned If You Do…

After waking up on Thursday, we quickly glanced at the overnight market action in Asia and noticed that the Nikkei had tanked rather noticeably. Our first thought upon seeing this was “must be the yen” – and so it was:

 

June yen futures, daily – taking off again – click to enlarge.

 

Given the BoJ’s bizarre plan to push consumer price inflation to a 2% annualized rate within [enter movable goal post here] years, Mr. Kuroda cannot be overly happy about that. In fact, lately it seemingly doesn’t matter what he decides to do or not to do – the yen is going up anyway.

Last Thursday he reportedly “disappointed” markets by not expanding the BoJ’s madcap asset purchase program even further. We are not quite sure what people believe could possibly be achieved by making the parabola shown below even more parabolic.

 

Assets held by the BoJ – Mr. Kuroda’s “QQE” (“quantitative and qualitative easing”) was started in April of 2012. The program has certainly impoverished Japan’s citizens, who have seen their real incomes plummet. Lately it has however abjectly failed to achieve its stated goal, which is actually a blessing in disguise… – click to enlarge.

 

As far as the yen is concerned, we should point out that the trade-weighted real exchange rate of the yen at one point last year had declined to levels last seen in 1973. Combined with the recent strengthening of its technical condition, there is thus actually a good reason for the market to bid the yen up.

Moreover, in terms of perceptions, there are several issues in play. One is that some sort of sub-rosa agreement may have been struck at or around the G 20 meeting to allow the dollar to depreciate and the yen and euro to rally, so as to indirectly support the yuan, assorted other EM currencies as well as commodities, as the moves in these appeared to be triggering a potentially sizable stock market decline (naturally we cannot prove this, but it seems likely).

Moreover, since the US economy is clearly weaker than anyone thought possible a few months ago and Ms. Yellen is a dove by inclination anyway, the market is “pricing out” the US rate hike cycle it had previously priced in. However, we are by now certain that Japan’s money supply growth is greater than it appears from looking at official BoJ data.

Since the “M’s” published by the BoJ include only deposits of non-financial money holders, they are actually not really comparable to the money supply data of other developed countries. While bank reserves with the central bank should of course be excluded from money supply measures, the deposits of non-bank financial companies such as brokers, insurance companies, etc., should be included. If they are not money, what are they? We will come back to this topic soon.

 

Inflation Targeting Fail

We soon plan to discuss the 2% price inflation target pursued by central banks in more detail – for now we want to stay focused on Japan and the BoJ. As we have mentioned in the past, it appears particularly absurd to try to make consumer prices rise in Japan, given the country’s ever-growing army of fixed income-dependent retirees (many of Japan’s seniors are reportedly already unable to cope, which has inter alia led to an elderly citizen crime wave).

Interestingly, the BoJ’s attempts to achieve its price inflation target continue to end in failure with unwavering regularity. While the central bank’s astonishing ineptness in this respect is a blessing for Japan’s citizens (at least for the moment, their cost of living doesn’t increase further), it harbors the danger that even crazier monetary experiments will eventually be tried.

 

Between 2014 and 2015, Japanese citizens suffered a large reduction in their real incomes, as consumer price inflation flared up (mainly due to a one-off increase in sales tax) while wages remained flat, but recently core CPI has returned to where it was before QQE started. In other words, as of the current juncture, it was all for nothing from the BoJ’s perspective – click to enlarge.

 

While threatening additional easing measures at his press conference (such as driving negative deposit rates further into negative territory) Mr. Kuroda seems to have explicitly ruled out the adoption of “helicopter money” by the BoJ. This is quite funny, since it seems extremely unlikely that the BoJ will ever be able to extricate itself from its balance sheet expansion (which de facto amounts to an “unannounced” case of helicopter money provision):

“BOJ Governor Haruhiko Kuroda told reporters at a press conference following the decision that the central bank remained committed to achieving its 2 percent inflation target in about two years.

But he ruled out the possibility of the BOJ directly financing the government, a policy also known as “helicopter money,” Reuters reported. Such a move would be illegal under Japan’s current legal system, he said.

 

Kuroda said the BOJ’s surprise move on January 29 to start charging banks for the privilege of parking some of their excess funds wasn’t criticized at the Group of 20 meeting, and he warned market participants that it would be wrong to assume the central bank could not cut rates deeper into negative territory, Reuters reported.

We actually fear that Kuroda’s remark about the illegality of direct government financing by the central bank may be a hint to the government that it is time to change the law. After all, in the course of the BoJ’s application of various post-bubble ministrations over the past 26 years, many of the rules that previously restricted its actions have been thrown overboard.

For instance, since 1999 all rules imposing limits on government bond purchases by the BoJ have been gradually repealed. In other words, a few years ago, “QQE” would have been illegal as well. Obviously, such obstacles can be easily circumvented.

 

Mr. Kuroda shortly after seeing an intra-day chart of the yen on Thursday.

Photo credit: AFP / JIJI

 

Conclusion

The BoJ’s inaction on Thursday is probably bound to be a strictly temporary affair. This thought is actually quite worrisome considering what it is already doing (for a  detailed list of its existing programs, see the policy statement it published last week).

Until then, the yen seems likely to continue to rise, although it is beginning to look a bit overbought in the short term after last week’s big jump.

 

Addendum: Bedeviled

A friend has pointed a curiosity out to us – the Nikkei Index is the third major market to have been struck by a touch of devilry in recent years. It actually closed precisely at 16,666.05 last week (both the S&P 500 Index and the gold market have previously run into analogous numerological hicc-ups – see here for the details).

 

Nikkei Index daily – did they have to close it right there? – click to enlarge.

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We are confident that the first thing readers will be curious to look for in Greenlight’s latest just released first quarter letter is David Einhorn’s take on his investment in the now bankrupt former hedge fund hotel, SunEdison. Einhorn’s spares no self-criticism here: “SunEdison (SUNE) collapsed from $5.09 to $0.54. In January we negotiated with the company to add an independent director to the board. Unfortunately, and to our surprise, the patient was already in terminal condition. Obviously, we underestimated the fragility of the situation.” Concise, brief, and to the point.

With that out of the way, this is how Einhorn’s described the Q1 environment.

It has been a while since we’ve had a profitable quarter to report. Though we would like to make it a habit, trying to manage for quarterly  results is really not our philosophy. We think one of our advantages is the ability to be more patient than others, especially as investment horizons appear to be getting shorter.

 

It was a strange quarter. The S&P 500 spent the first half of the quarter going straight down. Then in the spirit of “never mind”, it turned on a dime, recovering all of the loss and then some. Continuing the game of lower and beat, most companies beat low-balled fourth quarter estimates and many further lowered targets for 2016. In 2015, the S&P 500 companies collectively earned $117, which was 6% less than expected at the beginning of the year.

 

Yet each quarter when companies reported, earnings were about 3% higher than expected, with roughly two-thirds of the companies exceeding estimates. Impressively, there were 32 companies in the S&P 500 that earned less last year than was expected at the beginning of the year, and reduced expectations for 2016, while somehow managing to report positive surprises every quarter in 2015.

 

2016 looks to be more of the same. Since the beginning of the year, bottom-up consensus estimates for S&P 500 earnings have fallen from $126 to $120. Companies are again poised to succeed at clearing a continually falling bar.

Hardly as “catastrophic” as Loeb’s take in his letter from last week, but not that much better either.

While we know Einhorn’s biggest loser, his winners were the following: Consol Energy, Michael Kors, the bubble basket of shorts (which declined by 13%), and of course, gold.  This is what he said about the precious metal:

Gold advanced from $1,061 to $1,233 per ounce for a number of reasons. Foreign central banks implemented even more aggressive, and in our view, counter-productive monetary policies. Also, the U.S. Federal Reserve reduced its forecast for future rate hikes in response to a variety of fears/rationalizations including foreign exchange rates, corporate credit spreads, and equity market volatility. Notably, the Fed’s “data dependency” doesn’t appear to relate to employment, which continues to improve, or core inflation, which is now running above its 2% target. We believe the increasingly adventurous monetary policy is bullish for gold.

Among the other notable highlights from the letter is that Greenlight has opened a new long in Yelp and a new position in PVH Corp, as well as reinitiating positions in American Capital Agency and Hatteras Financial.

On the topic of his shale nemesis Pioneer, he had this to say: “We recently read the Pioneer Natural Resources (PXD) annual Form 10-K. We are amazed at how little conversation it has provoked. Rarely have we seen a company where management’s investor presentations are so disconnected from the company’s SEC filings.”

There is much more in the full letter (see below) and we are confident we will hear much more on Einhorn’s investment thesis during Wednesday’s Ira Sohn conference.

Full Greenlight letter.

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