another site
This should be good… just don’t mention the bridge (and with any luck this won’t last as long as the press conference)
click image for NBC live stream
via Zero Hedge http://ift.tt/1m1puYX Tyler Durden
Submitted by David Howden via the Ludwig von Mises Institute of Canada,
Tax burdens are so high that it might not be possible to pay off the high levels of indebtedness in most of the Western world. At least, that is the conclusion of a new IMF paper from Carmen Reinhart and Kenneth Rogoff.
Reinhart and Rogoff gained recent fame for their book “This Time It’s Different”, in which they argued that high levels of public debt have historically been associated with reduced growth opportunities.
As they now note, “The size of the problem suggests that restructurings will be needed, for example, in the periphery of Europe, far beyond anything discussed in public to this point.” Up to this point in the Eurocrisis the primary tools used to rescue profligate countries have included increased taxes, EU and IMF bailouts, and haircuts on government debt.
These bailouts have largely exacerbated the debt problems that existed five short years ago. Indeed, as Reinhart and Rogoff well note, the once fiscally sound North of Europe is now increasingly unable to continue shouldering the debts of its Southern neighbours.
General government debt (% GDP)
Source: Eurostat (2012)
Six European countries currently have a government debt to GDP ratio – a metric popularlised by Reinhart and Rogoff to signal reduced growth prospects – of over 90%. Countries that were relatively debt-free just five short years ago are now encumbered by the debt repayments necessitated by bailouts. Ireland is a case in point – as recently as 2007 its government debt to GDP ratio was below 25%. Six years later that figure stands north of 120%! “Fiscally secure” Scandinavia should keep in mind that fortunes can change quickly, as happened to the luck of the Irish.
The debt crisis to date has been mitigated in large part by tax increases and transfers from the wealthy “core” of Europe to the periphery. The problem with tax increases is that they cannot continue unabated.
Total government tax revenue (% GDP)
Source: Eurostat (2012)
Already in Europe there are seven countries where tax revenues are greater than 48% of GDP. There once was a time when only Scandinavia was chided for its high tax regimes and large public sectors. Today both Austria and France have more than half of their economies involved in the public sector and financed through taxes. (Note also that as they both run government budget deficits the actual size of their governments is greater yet.)
With high unemployment in Europe (and especially in its periphery), governments cannot raise much revenue by raising taxes – who would pay it? With already high levels of debt it is questionable how much revenue can be raised by further debt issuances, at least without increasing interest rates and imperiling already fragile government finances with higher interest charges.
Instead, Reinhart and Rogoff see two facts of life for Europe’s future: financial repression through higher inflation rates and taxes levied on savings and wealth. This time is no different than other cases of highly indebted countries in Europe’s history – just look to the post-War examples as similar cases in point. Don’t say you haven’t been warned.
via Zero Hedge http://ift.tt/1alWHJv Tyler Durden
Just when you thought US foreign policy under John Kerry couldn’t plumb new lows, here comes Israel, mocking… John Kerry.
Yaalon quoted by “Yediot Aharonot” saying: only thing that could “save” #Israel is for Kerry to win Nobel Peace Prize and “leave us alone.”
— Richard Engel (@RichardEngel) January 14, 2014
But it wasn’t Israel’s mocking of Kerry that was embarrassing: after Syria, Israel is hardly a big fan of Hillary’s replacement who brought the Middle East to the verge of a YouTube clip fabricated war, and then promptly slank back to his yacht. It was the spirited White House defense. To wit from Reuters:
The White House on Tuesday denounced reported comments by Israel’s defense minister that were sharply critical of U.S. Secretary of State John Kerry.
White House spokesman Jay Carney responded to reports that Israeli military Moshe Yaalon said Kerry’s pursuit of Middle East peace is out of an “incomprehensible obsession and a messianic feeling.”
“To question Secretary Kerry’s motives and distort his proposals is not something we would expect from the defense minister of a close ally,” Carney said.
Well, dear “Jay”, while the US is stuck manipulating the stock market in its 5th year of attempting to trickle down the wealth effect, and defending Obama’s disastrous insurance ponzi scheme legacy, China (and increasingly Russia) are dividing up the world among them: from Africa, to Syria, to everywhere else, all the while soaking up all the gold that is not nailed down. So by all means – be prepared for more surprises.
As for Kerry’s “messianic feeling” – was anyone actually surprised?
via Zero Hedge http://ift.tt/1alOJQE Tyler Durden
Poor Uber: the limo company has had its share of tribulations in the US over the past month, being accused periodically of price gouging when it implemented surge pricing during times of peak demand and lack of alternatives (and a very confused consumer, who naturally has the option of not paying the surge price if they feel insulted by it). However, this is nothing compared to the treatment the company that is a manifestation of pure capitalism at its rawest received in socialist France yesterday.
As Rudebaguette reported previously, a French taxi drivers strike turned ugly for none other than an Uber driver who was carrying Eventbrite CTO Renaud Visage & Kat Borlongan from the airport to Paris, when “he was attacked by multiple assailants, who allegedly, after smashing one window and slashing two tires (as seen in the photo), as well as defacing one side of the car with glue, attempted to enter the vehicle. Borlongan says their Uber driver manoeuvered the two out of the situation before anything could happen, leaving the three stranded on the shoulder of the freeway.”
This is what Kat Borlongan tweeted shortly after the incident:
Got attacked in an @uber by cab drivers on strike near Paris airport: smashed windows, flat tires, vandalized vehicle and bleeding hands.
— Kat Borlongan (@KatBorlongan) January 13, 2014
And while strikes in socialist France are a daily thing, this one was different:
Taxi drivers today are protesting against the likes of Uber, and against what they consider to be a government that refuses to see things their way, according to an official press release. The only problem is that this protest comes less than a month after the French government caved in to the Taxi union demands to enforce the 15-minute law, not just for new users, as was originally intended, but for all users of Chauffeur apps.
It’s a question of credibility, according to Le Figaro’s Yann La Galès, who thinks the Taxis are looking to have their cake and protest the lack of the aforementioned cake, too.
Meanwhile, one Chauffeur App startup, Allocab, says it won’t take the protest, or the 15-minute law, lying down. According to Frenchweb, the startup is already pushing legal action through against the 15-minute law – we spoke last week about how the “law,” which actually is a Presidential decree, not voted on by the legistlative body, may be ruled invalid, due to the fact that decrees cannot take affect if they change the balance of competition – I think that’s an easy argument to make.
Shortly thereafter, Uber’s GM of France Pieter-Dimitry Gore-Coty had this comment:
“Uber strongly condemns this morning’s incident where two of our users and our driver were confronted with severe violence.
First, we are very glad all involved are safe and ok. Also, we would like to praise our partner who has shown great courage and professionalism, who focused on getting his customers out of a very challenging situation.
That the taxis chose to use violence is unacceptable, that they chose to strike is their business. However, Parisians also have a choice when it comes to moving around in their cities, and today’s incident will certainly not tempt Parisians into choosing a taxi for their next ride. Safety, reliability and choice, not violence, are what continues to draw customers towards VTCs.”
And some more recent updates from the French socialist vs capitalist taxi battleground:
So there you have it dear Uber: no matter how bad you think you may have it in the US, there is always France. Because sometimes socialism and capitalism just don’t mix…
via Zero Hedge http://ift.tt/1hnC5CN Tyler Durden
Poor Uber: the limo company has had its share of tribulations in the US over the past month, being accused periodically of price gouging when it implemented surge pricing during times of peak demand and lack of alternatives (and a very confused consumer, who naturally has the option of not paying the surge price if they feel insulted by it). However, this is nothing compared to the treatment the company that is a manifestation of pure capitalism at its rawest received in socialist France yesterday.
As Rudebaguette reported previously, a French taxi drivers strike turned ugly for none other than an Uber driver who was carrying Eventbrite CTO Renaud Visage & Kat Borlongan from the airport to Paris, when “he was attacked by multiple assailants, who allegedly, after smashing one window and slashing two tires (as seen in the photo), as well as defacing one side of the car with glue, attempted to enter the vehicle. Borlongan says their Uber driver manoeuvered the two out of the situation before anything could happen, leaving the three stranded on the shoulder of the freeway.”
This is what Kat Borlongan tweeted shortly after the incident:
Got attacked in an @uber by cab drivers on strike near Paris airport: smashed windows, flat tires, vandalized vehicle and bleeding hands.
— Kat Borlongan (@KatBorlongan) January 13, 2014
And while strikes in socialist France are a daily thing, this one was different:
Taxi drivers today are protesting against the likes of Uber, and against what they consider to be a government that refuses to see things their way, according to an official press release. The only problem is that this protest comes less than a month after the French government caved in to the Taxi union demands to enforce the 15-minute law, not just for new users, as was originally intended, but for all users of Chauffeur apps.
It’s a question of credibility, according to Le Figaro’s Yann La Galès, who thinks the Taxis are looking to have their cake and protest the lack of the aforementioned cake, too.
Meanwhile, one Chauffeur App startup, Allocab, says it won’t take the protest, or the 15-minute law, lying down. According to Frenchweb, the startup is already pushing legal action through against the 15-minute law – we spoke last week about how the “law,” which actually is a Presidential decree, not voted on by the legistlative body, may be ruled invalid, due to the fact that decrees cannot take affect if they change the balance of competition – I think that’s an easy argument to make.
Shortly thereafter, Uber’s GM of France Pieter-Dimitry Gore-Coty had this comment:
“Uber strongly condemns this morning’s incident where two of our users and our driver were confronted with severe violence.
First, we are very glad all involved are safe and ok. Also, we would like to praise our partner who has shown great courage and professionalism, who focused on getting his customers out of a very challenging situation.
That the taxis chose to use violence is unacceptable, that they chose to strike is their business. However, Parisians also have a choice when it comes to moving around in their cities, and today’s incident will certainly not tempt Parisians into choosing a taxi for their next ride. Safety, reliability and choice, not violence, are what continues to draw customers towards VTCs.”
And some more recent updates from the French socialist vs capitalist taxi battleground:
So there you have it dear Uber: no matter how bad you think you may have it in the US, there is always France. Because sometimes socialism and capitalism just don’t mix…
via Zero Hedge http://ift.tt/1hnC5CN Tyler Durden
"Continuing large-scale asset purchases risks placing us in an untenable position, both from the standpoint of unreasonably inflating the stock, bond and other tradable asset markets and from the perspective of complicating the future conduct of monetary policy," warns the admittedly-hawkish Dallas Fed head. Fisher goes on to confirm Peter Boockvar's "QE puts beer goggles on investors," analogy adding that while he is "not among those who think we are presently in a 'bubble' mode for stocks or bonds; he is reminded of William McChesney Martin comments – the longest-serving Fed chair – "markets for anything tradable overshoot and one must be prepared for adjustments that bring markets back to normal valuations."
Via Dallas Fed President Richard Fisher
Beer Goggles, Monetary Camels, the Eye of the Needle and the First Law of Holes
During the holiday break, I spent a good deal of time trying to organize my thoughts on how I will approach monetary policy going forward. Today, I am going to share some of those thoughts that might be of interest to you as corporate directors.
At the last meeting of the Federal Open Market Committee (FOMC), it was decided that the amount of Treasuries and mortgage-backed securities (MBS) we have been purchasing should each be pared back by $5 billion, so that we would be purchasing a total of $75 billion a month (in addition to reinvesting the proceeds of maturing issues we hold) rather than $85 billion per month. In addition, it was noted that “if incoming information broadly supports the Committee’s expectation(s) … the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.” And it was made clear that the FOMC expects it will hold the base rate that anchors the yield curve—the federal funds rate, or the rate on overnight money—to its present near-zero rate well past the time when unemployment is reduced to 6½ percent.
I was pleased with the decision to finally begin tapering our bond purchases, though I would have preferred to pull back our purchases by double the announced amount. But the important thing for me is that the committee began the process of slowing down the ballooning of our balance sheet, which at year-end exceeded $4 trillion. And we began—and I use that word deliberately, for we have more to do on this front—to clarify our intentions for managing the overnight money rate.
As an economist would say, “on net” I was rather pleased with the decision taken at the December FOMC meeting.
Under the chairmanship of Ben Bernanke, all 12 Federal Reserve Bank presidents, together with the sitting governors of the Federal Reserve Board, have input into the decision-making process. There is a formal vote—regardless of who is the Fed chair—that includes only five of the 12 regional Bank presidents plus the governors, but all of the principals seated at the table participate fully in the discussion of what to do. And yet, either because we will effect a change in the chairmanship starting in February or because at the last meeting we took the step of tapering back by a small amount our massive purchase of Treasuries and MBS, great attention is being placed on the voters for 2014, of which I am one.
Two comments I recently read have been buzzing around my mind as I think about the many issues that will condition my actions as a voter.
The first was by Peter Boockvar, who is among the plethora of analysts offering different viewpoints that I regularly read to get a sense of how we are being viewed in the marketplace. Here is a rather pungent quote from a note he sent out on Jan. 2:
“…QE [quantitative easing] puts beer goggles on investors by creating a line of sight where everything looks good…”
For those of you unfamiliar with the term “beer goggles,” the Urban Dictionary defines it as “the effect that alcohol … has in rendering a person who one would ordinarily regard as unattractive as … alluring.” This audience might substitute “wine” or “martini” or “margarita” for “beer” to make it more age-appropriate, but the effect is the same: Things often look better when one is under the influence of free-flowing liquidity. This is one reason why William McChesney Martin, the longest-serving Fed chairman in our institution’s 100-year history, famously said that the Fed’s job is to take away the punchbowl just as the party gets going.[2]
The other eye catcher for me was a cartoon in the Jan. 6 issue of The New Yorker. Sitting in a room are two businessmen who are apparently conversant with the New Testament’s book of Matthew. One says to the other, “We need either bigger needles or smaller camels.”
Today, I want to muse aloud about whether QE has indeed put beer goggles on investors and whether we, the Fed, can pass the camel of massive quantitative easing through the eye of the needle of normalizing monetary policy without creating havoc.
Boockvar is right. When money available to investors is close to free and is widely available, and there is a presumption that the central bank will keep it that way indefinitely, discount rates applied to assessing the value of future cash flows shift downward, making for lower hurdle rates for valuations. A bull market for stocks and other claims on tradable companies ensues; the financial world looks rather comely.
Market operators donning beer goggles and even some sober economists consider analysts like Boockvar party poopers. But I have found myself making arguments similar to his and to those of other skeptics at recent FOMC meetings, pointing to some developments that signal we have made for an intoxicating brew as we have continued pouring liquidity down the economy’s throat.
Among them:
And then there are the knock-on effects of all of the above. Market operators are once again spending money freely outside of their day jobs. An example: For almost 40 years, I have spent a not insignificant portion of my savings collecting rare, first-edition books. Like any patient investor in any market, I have learned through several market cycles that you buy when nobody wants something and sell when everyone clamors for more. During the financial debacle of 2007–09, I was able to buy for a song volumes I have long coveted (including a mint-condition first printing from 1841 of Mackay’s Memoirs of Extraordinary Popular Delusions, which every one of you should read and re-read, certainly if you are contemplating seeing the movie The Wolf of Wall Street). Today, I could not afford them. First editions, like paintings, sculptures, fine wines, Bugattis and homes in Highland Park or River Oaks, have become the by-product of what I am sure Bill Martin would consider a party well underway.
I want to make clear that I am not among those who think we are presently in a “bubble” mode for stocks or bonds or most other assets. But this much I know: Just as Martin knew by virtue of his background as a noneconomist who had hands-on Wall Street experience, markets for anything tradable overshoot and one must be prepared for adjustments that bring markets back to normal valuations.
This need not threaten the real economy. The “slow correction” of 1962 comes to mind as an example: A stock market correction took place, and yet the economy continued to fare well.
Here is the point as to the market’s beer goggles. Were a stock market correction to ensue while I have the vote, I would not flinch from supporting continued reductions in the size of our asset purchases as long as the real economy is growing, cyclical unemployment is declining and demand-driven deflation remains a small tail risk; I would vote for continued reductions in our asset purchases, with an eye toward eliminating them entirely at the earliest practicable date.
Let’s turn to the camel, by which I mean the size of the Fed’s balance sheet.
A little history provides some perspective. We began to grow our balance sheet as we approached year-end 2008. On Sept. 10, 2008, the amount of Reserve Bank credit outstanding was $867 billion. On Nov. 25, 2008, we announced a program to purchase $100 billion of securities issued by the housing-related government-sponsored enterprises, together with our intent to purchase up to $500 billion in MBS in order to goose the housing market. I supported these initiatives, recognizing that the economy was in the throes of a financial panic.
Following our December 2008 meeting, the FOMC announced that it had cut the target range for the fed funds rate to 0-to-1/4 of 1 percent, and being thus “zero bound,” we floated the idea of purchasing longer-term Treasuries in order to provide further monetary accommodation (when we buy Treasuries or MBS and agency debt, we put money into the financial system, substituting for further interest rate cuts). On March 18, 2009, we announced additional purchases of up to $750 billion of agency MBS and up to $100 billion of agency debt, plus purchases of up to $300 billion of longer-term Treasury securities over six months. That day, our balance sheet was marked at $2 trillion.
There are some details that impacted our balance sheet, which I have omitted so as not to bore you or entangle you in the entrails of central bank operations: For example, liquidity swaps with other central banks declined from a peak occasioned by the financial crisis of $583 billion the week ended Dec. 10, 2008, to $330 billion the following March, thus somewhat mitigating the growth of our balance sheet over that period.[3]
From my perch, I considered a balance sheet of $2-plus trillion and a base lending rate of 0-to-1/4 of 1 percent more than sufficient to stimulate not just the housing market but the stock market, too, thus placing us on the path of what economists refer to as “the wealth effect”—the working assumption that rising prices for homes, stocks and bonds floats the income boat of all Americans.
I basically said so publicly on March 26, 2009, in a speech to the RISE Forum, an annual student investment conference. At the time, the S&P 500 was priced at 814, the Nasdaq at 1,529 and the Dow at 7,750. The mindset of investors at that moment was summarized at an earlier FOMC meeting by one of my most esteemed colleagues at the Fed, who quipped that in looking at the balance sheets of most financial institutions, “nothing on the right is right and nothing on the left is left.” As I looked at the faces of the students gathered in that vast auditorium, I could see in their eyes a reflection of the gloom and doom of the time.
Here is what I told these young investors that dark morning: “… the current economic and financial predicament represents a potential gold mine rather than a minefield. Historically, great investors have made their money by climbing a wall of worry rather than letting a woeful consensus cow them. … Your job as investors is … to ferret out from the general-market malaise good financial and business operators whose franchises and prospects are overdiscounted at current prices. Were I you … I would be licking my chops at the opportunities that always abound in times of adversity. … There are a lot of dollar bills that can be found in the debris of the current markets that can be picked up for nickels and dimes.”
Of course, I would not mention this today had I been wrong! Currently, the right hand side of the balance sheet of most any well-managed market-traded business is chock-full of restructured, cheap debt and leaner common stock, while the left side is bulging with surplus cash. The S&P closed yesterday at 1,819, the Nasdaq at 4,113 and the Dow at 16,258—a plateau over two times above the valley into which they had descended in 2009.
And, again, there are the signs of conspicuous consumption I mentioned earlier that reflect a fully robust stock market. If there is indeed a wealth effect that spreads from clever market operators to the working people of America, a $2 trillion balance sheet might well have been sufficient to have performed the trick.
The FOMC is a committee, however, and the majority of my colleagues have disagreed with me on this point. We have since doubled our balance sheet to $4 trillion. This has resulted not only in saltatory[4] housing, bond and stock markets, but a real economy that is on the mend, with cyclical unemployment declining and inflation thus far held at bay.
Here is the rub. We have accomplished the last $2 trillion of balance-sheet expansion by purchasing unprecedented amounts of longer-maturity assets: As of Jan. 8, 2014, 75 percent of Federal Reserve-held loans and securities had remaining maturities in excess of five years.
The brow begins to furrow. To be sure, Treasury and MBS markets are liquid markets. But the old market operator in me is conscious that we hold nearly 40 percent of outstanding eligible MBS and of Treasuries with more than five years to maturity. Selling that concentrated an amount of even the most presumably liquid assets would be a heck of lot more complicated than accumulating it.
Currently, this is not an issue. But as the economy grows, the massive amount of money sitting on the sidelines will be activated; the “velocity” of money will accelerate. If it does so too quickly, we might create inflation or financial market instability or both.
The 12 Federal Reserve Banks house the excess reserves of the depository institutions of America: If loan demand fails to grow at the same rate as banks accumulate reserves due to our hyperaccommodative monetary policy, the resultant excess reserves are deposited with us at a rate of return of 25 basis points (1/4 of 1 percent per annum).
Here is some math confronting policymakers: Excess reserves are currently 65 percent of the monetary base and rising. The only other time excess reserves as a percentage of the base have come anywhere close to this level was at the close of the 1930s, when the ratio hit 41 percent. We are in uncharted territory.
To prevent excess reserves from fueling a too-rapid expansion of bank lending in an expanding economy, the Fed will need to either drain reserves on a large scale by selling longer-term assets at a loss or provide inducements to banks to keep reserves idle, by offering interest on excess reserves at a rate competitive with what banks might earn on loans to businesses and consumers. Or we might employ more widely new techniques we are currently testing, such as “reverse repos,” complex transactions in which we, in effect, borrow cash overnight from market operators while posting securities as collateral.
Such inducements to control the velocity of the monetary base might expose the Fed to intense scrutiny and criticism. The big banks that park the lion’s share of excess reserves with us are hardly the darlings of public sentiment. Raising interest payments to them while scaling back our remittances to the Treasury might raise a few congressional eyebrows. And as to our repo operations, we have never implemented them on anywhere near the scale envisioned.
Of greatest concern to me is that the risk of scrutiny and criticism might hinder policymakers from acting quickly enough to remove or dampen the dry inflationary tinder that is inherent in the massive, but currently fallow, monetary base.
In the parlance of central banking, the “exit” challenge we now face is somewhat daunting: How do we pass a camel fattened by trillions of dollars of longer-term, less-liquid purchases through the eye of the needle of getting back to a “normalized” balance sheet so as to keep inflation under wraps and yet provide the right amount of monetary impetus for the economy to keep growing and expanding?
I have great faith in the integrity and brainpower of my fellow policymakers. I am confident that the 19 earnest women and men that make up the FOMC will do their level best under Chairwoman Janet Yellen’s leadership to accomplish a smooth exit that keeps prices stable and the economy in a job-creating mode. But my confidence will be bolstered if my colleagues adopt the First Law of Holes espoused in the late ’70s by then-British Chancellor of the Exchequer Denis Healey: “If you find yourself in a hole, stop digging.”
The housing market is well along in repair;[5] the economy is expanding; cyclical unemployment is declining. To be sure, there will be individual data points that appear to challenge confidence, like the just-released employment report for December. But I believe the odds favor continued economic progress. And I believe that continuing large-scale asset purchases risks placing us in an untenable position, both from the standpoint of unreasonably inflating the stock, bond and other tradable asset markets and from the perspective of complicating the future conduct of monetary policy.
The eye of the needle of pulling off a clean exit is narrow; the camel is already too fat. As soon as feasible, we should change tack. We should stop digging. I plan to cast my votes at FOMC meetings accordingly.
via Zero Hedge http://ift.tt/1j5Z7AZ Tyler Durden
"Continuing large-scale asset purchases risks placing us in an untenable position, both from the standpoint of unreasonably inflating the stock, bond and other tradable asset markets and from the perspective of complicating the future conduct of monetary policy," warns the admittedly-hawkish Dallas Fed head. Fisher goes on to confirm Peter Boockvar's "QE puts beer goggles on investors," analogy adding that while he is "not among those who think we are presently in a 'bubble' mode for stocks or bonds; he is reminded of William McChesney Martin comments – the longest-serving Fed chair – "markets for anything tradable overshoot and one must be prepared for adjustments that bring markets back to normal valuations."
Via Dallas Fed President Richard Fisher
Beer Goggles, Monetary Camels, the Eye of the Needle and the First Law of Holes
During the holiday break, I spent a good deal of time trying to organize my thoughts on how I will approach monetary policy going forward. Today, I am going to share some of those thoughts that might be of interest to you as corporate directors.
At the last meeting of the Federal Open Market Committee (FOMC), it was decided that the amount of Treasuries and mortgage-backed securities (MBS) we have been purchasing should each be pared back by $5 billion, so that we would be purchasing a total of $75 billion a month (in addition to reinvesting the proceeds of maturing issues we hold) rather than $85 billion per month. In addition, it was noted that “if incoming information broadly supports the Committee’s expectation(s) … the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.” And it was made clear that the FOMC expects it will hold the base rate that anchors the yield curve—the federal funds rate, or the rate on overnight money—to its present near-zero rate well past the time when unemployment is reduced to 6½ percent.
I was pleased with the decision to finally begin tapering our bond purchases, though I would have preferred to pull back our purchases by double the announced amount. But the important thing for me is that the committee began the process of slowing down the ballooning of our balance sheet, which at year-end exceeded $4 trillion. And we began—and I use that word deliberately, for we have more to do on this front—to clarify our intentions for managing the overnight money rate.
As an economist would say, “on net” I was rather pleased with the decision taken at the December FOMC meeting.
Under the chairmanship of Ben Bernanke, all 12 Federal Reserve Bank presidents, together with the sitting governors of the Federal Reserve Board, have input into the decision-making process. There is a formal vote—regardless of who is the Fed chair—that includes only five of the 12 regional Bank presidents plus the governors, but all of the principals seated at the table participate fully in the discussion of what to do. And yet, either because we will effect a change in the chairmanship starting in February or because at the last meeting we took the step of tapering back by a small amount our massive purchase of Treasuries and MBS, great attention is being placed on the voters for 2014, of which I am one.
Two comments I recently read have been buzzing around my mind as I think about the many issues that will condition my actions as a voter.
The first was by Peter Boockvar, who is among the plethora of analysts offering different viewpoints that I regularly read to get a sense of how we are being viewed in the marketplace. Here is a rather pungent quote from a note he sent out on Jan. 2:
“…QE [quantitative easing] puts beer goggles on investors by creating a line of sight where everything looks good…”
For those of you unfamiliar with the term “beer goggles,” the Urban Dictionary defines it as “the effect that alcohol … has in rendering a person who one would ordinarily regard as unattractive as … alluring.” This audience might substitute “wine” or “martini” or “margarita” for “beer” to make it more age-appropriate, but the effect is the same: Things often look better when one is under the influence of free-flowing liquidity. This is one reason why William McChesney Martin, the longest-serving Fed chairman in our institution’s 100-year history, famously said that the Fed’s job is to take away the punchbowl just as the party gets going.[2]
The other eye catcher for me was a cartoon in the Jan. 6 issue of The New Yorker. Sitting in a room are two businessmen who are apparently conversant with the New Testament’s book of Matthew. One says to the other, “We need either bigger needles or smaller camels.”
Today, I want to muse aloud about whether QE has indeed put beer goggles on investors and whether we, the Fed, can pass the camel of massive quantitative easing through the eye of the needle of normalizing monetary policy without creating havoc.
Boockvar is right. When money available to investors is close to free and is widely available, and there is a presumption that the central bank will keep it that way indefinitely, discount rates applied to assessing the value of future cash flows shift downward, making for lower hurdle rates for valuations. A bull market for stocks and other claims on tradable companies ensues; the financial world looks rather comely.
Market operators donning beer goggles and even some sober economists consider analysts like Boockvar party poopers. But I have found myself making arguments similar to his and to those of other skeptics at recent FOMC meetings, pointing to some developments that signal we have made for an intoxicating brew as we have continued pouring liquidity down the economy’s throat.
Among them:
And then there are the knock-on effects of all of the above. Market operators are once again spending money freely outside of their day jobs. An example: For almost 40 years, I have spent a not insignificant portion of my savings collecting rare, first-edition books. Like any patient investor in any market, I have learned through several market cycles that you buy when nobody wants something and sell when everyone clamors for more. During the financial debacle of 2007–09, I was able to buy for a song volumes I have long coveted (including a mint-condition first printing from 1841 of Mackay’s Memoirs of Extraordinary Popular Delusions, which every one of you should read and re-read, certainly if you are contemplating seeing the movie The Wolf of Wall Street). Today, I could not afford them. First editions, like paintings, sculptures, fine wines, Bugattis and homes in Highland Park or River Oaks, have become the by-product of what I am sure Bill Martin would consider a party well underway.
I want to make clear that I am not among those who think we are presently in a “bubble” mode for stocks or bonds or most other assets. But this much I know: Just as Martin knew by virtue of his background as a noneconomist who had hands-on Wall Street experience, markets for anything tradable overshoot and one must be prepared for adjustments that bring markets back to normal valuations.
This need not threaten the real economy. The “slow correction” of 1962 comes to mind as an example: A stock market correction took place, and yet the economy continued to fare well.
Here is the point as to the market’s beer goggles. Were a stock market correction to ensue while I have the vote, I would not flinch from supporting continued reductions in the size of our asset purchases as long as the real economy is growing, cyclical unemployment is declining and demand-driven deflation remains a small tail risk; I would vote for continued reductions in our asset purchases, with an eye toward eliminating them entirely at the earliest practicable date.
Let’s turn to the camel, by which I mean the size of the Fed’s balance sheet.
A little history provides some perspective. We began to grow our balance sheet as we approached year-end 2008. On Sept. 10, 2008, the amount of Reserve Bank credit outstanding was $867 billion. On Nov. 25, 2008, we announced a program to purchase $100 billion of securities issued by the housing-related government-sponsored enterprises, together with our intent to purchase up to $500 billion in MBS in order to goose the housing market. I supported these initiatives, recognizing that the economy was in the throes of a financial panic.
Following our December 2008 meeting, the FOMC announced that it had cut the target range for the fed funds rate to 0-to-1/4 of 1 percent, and being thus “zero bound,” we floated the idea of purchasing longer-term Treasuries in order to provide further monetary accommodation (when we buy Treasuries or MBS and agency debt, we put money into the financial system, substituting for further interest rate cuts). On March 18, 2009, we announced additional purchases of up to $750 billion of agency MBS and up to $100 billion of agency debt, plus purchases of up to $300 billion of longer-term Treasury securities over six months. That day, our balance sheet was marked at $2 trillion.
There are some details that impacted our balance sheet, which I have omitted so as not to bore you or entangle you in the entrails of central bank operations: For example, liquidity swaps with other central banks declined from a peak occasioned by the financial crisis of $583 billion the week ended Dec. 10, 2008, to $330 billion the following March, thus somewhat mitigating the growth of our balance sheet over that period.[3]
From my perch, I considered a balance sheet of $2-plus trillion and a base lending rate of 0-to-1/4 of 1 percent more than sufficient to stimulate not just the housing market but the stock market, too, thus placing us on the path of what economists refer to as “the wealth effect”—the working assumption that rising prices for homes, stocks and bonds floats the income boat of all Americans.
I basically said so publicly on March 26, 2009, in a speech to the RISE Forum, an annual student investment conference. At the time, the S&P 500 was priced at 814, the Nasdaq at 1,529 and the Dow at 7,750. The mindset of investors at that moment was summarized at an earlier FOMC meeting by one of my most esteemed colleagues at the Fed, who quipped that in looking at the balance sheets of most financial institutions, “nothing on the right is right and nothing on the left is left.” As I looked at the faces of the students gathered in that vast auditorium, I could see in their eyes a reflection of the gloom and doom of the time.
Here is what I told these young investors that dark morning: “… the current economic and financial predicament represents a potential gold mine rather than a minefield. Historically, great investors have made their money by climbing a wall of worry rather than letting a woeful consensus cow them. … Your job as investors is … to ferret out from the general-market malaise good financial and business operators whose franchises and prospects are overdiscounted at current prices. Were I you … I would be licking my chops at the opportunities that always abound in times of adversity. … There are a lot of dollar bills that can be found in the debris of the current markets that can be picked up for nickels and dimes.”
Of course, I would not mention this today had I been wrong! Currently, the right hand side of the balance sheet of most any well-managed market-traded business is chock-full of restructured, cheap debt and leaner common stock, while the left side is bulging with surplus cash. The S&P closed yesterday at 1,819, the Nasdaq at 4,113 and the Dow at 16,258—a plateau over two times above the valley into which they had descended in 2009.
And, again, there are the signs of conspicuous consumption I mentioned earlier that reflect a fully robust stock market. If there is indeed a wealth effect that spreads from clever market operators to the working people of America, a $2 trillion balance sheet might well have been sufficient to have performed the trick.
The FOMC is a committee, however, and the majority of my colleagues have disagreed with me on this point. We have since doubled our balance sheet to $4 trillion. This has resulted not only in saltatory[4] housing, bond and stock markets, but a real economy that is on the mend, with cyclical unemployment declining and inflation thus far held at bay.
Here is the rub. We have accomplished the last $2 trillion of balance-sheet expansion by purchasing unprecedented amounts of longer-maturity assets: As of Jan. 8, 2014, 75 percent of Federal Reserve-held loans and securities had remaining maturities in excess of five years.
The brow begins to furrow. To be sure, Treasury and MBS markets are liquid markets. But the old market operator in me is conscious that we hold nearly 40 percent of outstanding eligibl
e MBS and of Treasuries with more than five years to maturity. Selling that concentrated an amount of even the most presumably liquid assets would be a heck of lot more complicated than accumulating it.
Currently, this is not an issue. But as the economy grows, the massive amount of money sitting on the sidelines will be activated; the “velocity” of money will accelerate. If it does so too quickly, we might create inflation or financial market instability or both.
The 12 Federal Reserve Banks house the excess reserves of the depository institutions of America: If loan demand fails to grow at the same rate as banks accumulate reserves due to our hyperaccommodative monetary policy, the resultant excess reserves are deposited with us at a rate of return of 25 basis points (1/4 of 1 percent per annum).
Here is some math confronting policymakers: Excess reserves are currently 65 percent of the monetary base and rising. The only other time excess reserves as a percentage of the base have come anywhere close to this level was at the close of the 1930s, when the ratio hit 41 percent. We are in uncharted territory.
To prevent excess reserves from fueling a too-rapid expansion of bank lending in an expanding economy, the Fed will need to either drain reserves on a large scale by selling longer-term assets at a loss or provide inducements to banks to keep reserves idle, by offering interest on excess reserves at a rate competitive with what banks might earn on loans to businesses and consumers. Or we might employ more widely new techniques we are currently testing, such as “reverse repos,” complex transactions in which we, in effect, borrow cash overnight from market operators while posting securities as collateral.
Such inducements to control the velocity of the monetary base might expose the Fed to intense scrutiny and criticism. The big banks that park the lion’s share of excess reserves with us are hardly the darlings of public sentiment. Raising interest payments to them while scaling back our remittances to the Treasury might raise a few congressional eyebrows. And as to our repo operations, we have never implemented them on anywhere near the scale envisioned.
Of greatest concern to me is that the risk of scrutiny and criticism might hinder policymakers from acting quickly enough to remove or dampen the dry inflationary tinder that is inherent in the massive, but currently fallow, monetary base.
In the parlance of central banking, the “exit” challenge we now face is somewhat daunting: How do we pass a camel fattened by trillions of dollars of longer-term, less-liquid purchases through the eye of the needle of getting back to a “normalized” balance sheet so as to keep inflation under wraps and yet provide the right amount of monetary impetus for the economy to keep growing and expanding?
I have great faith in the integrity and brainpower of my fellow policymakers. I am confident that the 19 earnest women and men that make up the FOMC will do their level best under Chairwoman Janet Yellen’s leadership to accomplish a smooth exit that keeps prices stable and the economy in a job-creating mode. But my confidence will be bolstered if my colleagues adopt the First Law of Holes espoused in the late ’70s by then-British Chancellor of the Exchequer Denis Healey: “If you find yourself in a hole, stop digging.”
The housing market is well along in repair;[5] the economy is expanding; cyclical unemployment is declining. To be sure, there will be individual data points that appear to challenge confidence, like the just-released employment report for December. But I believe the odds favor continued economic progress. And I believe that continuing large-scale asset purchases risks placing us in an untenable position, both from the standpoint of unreasonably inflating the stock, bond and other tradable asset markets and from the perspective of complicating the future conduct of monetary policy.
The eye of the needle of pulling off a clean exit is narrow; the camel is already too fat. As soon as feasible, we should change tack. We should stop digging. I plan to cast my votes at FOMC meetings accordingly.
via Zero Hedge http://ift.tt/1j5Z7AZ Tyler Durden
As global central bankers appear set on a game of inter-continental reach-around, the Japanese – printing press handle in hand – have taken the lead. For those wondering why EURJPY is so high and why, despite an endless stream of disappointingly near-record-bad macro and micro data in Spain and Italy, yields are near record lows… wonder no more. As Reuters’ Jamie McGeever reports, the Japanese bought Spanish and Italian government debt at the fastest pace in 5 years. As Abe increases his militaristic presence in Asia, perhaps his ‘promise’ to buy any and all European peripheral debt is just the handshake he needs to pressure China (through its largest export market).
What do you do when the world is aware of the fact that domestic banks and pension funds are gorging on their own sovereign debt in a wildly systemic-risk-creating manner?
You call your friends in Asia…
We just wonder what the quid pro quo that Abe was promised for this? Remember, Draghi did says “whatever it takes!”
Source: @ReutersJamie
via Zero Hedge http://ift.tt/L0DOm3 Tyler Durden
by Keith Weiner
Last week, I wrote about a curious development in silver. The bid-ask spread widened in November and December. My article concluded:
One should regard this as another type of rot in the core of the system. The point of my dissertation is that narrowing spreads is a sign of increasing economic coordination, and widening spreads is a sign of discoordination. And now we have widening spreads in one market for one of the monetary metals.
This is not good.
I received a lot of email in response to this. Everyone wanted to know what I meant, and if this predicts a rising or a falling silver price. I think the price is likely to fall, though that prediction is not based on the widening spread. It’s based on my supply and demand analysis. My standard caveat is: never naked short a monetary metal. Look at the sharp rise in silver for no reason on Friday, when a disappointing payroll report was released. A 60-cent rise would hit naked shorts in the shorts (if I may be permitted a rude analogy).
If a widening-spread has any impact on price, it won’t be in direction but in volatility. Let’s look at the mechanics. When Joe comes to the market to buy, he pays the ask price. When Sue comes to sell, she is paid the bid price. If the bid-ask spread is a penny, then the trace on your screen moves up one cent and then down one cent, first moved by Joe and then by Sue. Supposing the spread widens to 20 cents (it has gotten nowhere near that yet, but just for example), then your screen will show a 20-cent move for one tick. That is a 1% move.
Not only does one more tick increase the move to 2%, but there are many momentum traders watching for a price breakout. With them piling on, and with a 1% move per tick, silver could easily have 10% or 15% moves in a day. How will the market makers respond to this? Most likely by widening the bid-ask spread, to give themselves a safety margin for big price swings. And how will most traders respond to this? They’ll pile onto big moves they see developing, but set tight stop-losses.
Volatility will beget volatility.
Before I explain what I meant by my last comment “this is not good,” I want to say something important. I don’t regard the rising price of gold and silver as good, though I argue that it’s inexorable. I remind everyone that it’s not gold going anywhere, but the dollar going down. The price of the dollar must be measured in gold, though by force of habit we presume to measure gold in dollars. As an analogy, think of having a rubber band in your left hand and a meter stick in your right. Which can be used to measure the length of which?
It currently costs about 25mg of gold or 1.6g of silver to buy one dollar (keep in mind a paperclip is one gram). The price has been lower in recent years, and it will go much lower than that in the not too distant future. Why? Not because of the dollar’s quantity. The problem is its falling quality. The dollar is backed by debt, and as that debt moves closer to default the dollar moves closer to its high-velocity rendezvous with zero.
In the end, it will come to a race between a rapidly rising dollar-denominated price of gold and the onset of permanent gold backwardation. There is no way to predict what the last gold price will be, before gold goes off the board, though I think it will be a highly non-linear process at the end.
It should be obvious why a collapse of the dollar is bad.
Now, on to my parting remark last week. A widening bid-ask spread is evidence of rot in the heart of the system. It’s definitely not good. Why not? I alluded to my dissertation, the theme of which is that narrowing spreads mean increasing coordination and widening spreads mean decreasing coordination.
What does coordination mean in the economy? It means cooperation, the division of labor, specialization, efficient production and distribution, economies of scale, and the extension of credit. It means that you can have confidence that prices and terms won’t change tomorrow, that things are stable, and that everyone realizes it’s better to work productively and trade with others than to become a parasite who lives by attacking others.
What could cause economic coordination to go in reverse? The government can.
The single most important thing in the economy is money. If the government distorts the meaning and value of money, then rot inevitably sets in. Activities that add value, that people demand, that produce wealth, may appear unprofitable as measured in dollars. Other activities, which destroy or consume wealth, may appear to be quite profitable as measured in dollars.
An unstable and distorted dollar, with an unstable and falling interest rate imposes massive perverse incentives. Whether this causes prices, as measured in terms of the defective dollar, to rise is a whole separate question. I answered this question “sometimes, but not necessarily” in my theory of interest and prices.
Whether prices rise, stay flat, or fall, damage is still being done. One way to look at the damage more closely is to look at spreads. This is the approach I take in my supply and demand analysis of gold and silver. I study two spreads between metal in the spot market and the futures market. By seeing whether there is an increasing or a decreasing spread to carry or warehouse metal—to buy physical metal in the spot market and sell it forward in the futures market—we can glean a lot of information about the current state of the markets. If metal is flowing into the warehouse, we know that the marginal demand for metal is to be carried. Sooner or later this will reverse, and this source of demand will disappear to become the marginal source of supply (I plan to publish more about the gold markets, arbitrage and warehousing in the near future).
Another way is to look at the bid-ask spread of something. In my article last week, I noted that the bid-ask spread in silver futures had widened. I discussed why this might be occurring. It is heavy buying at the ask, and at the same time selling on the bid—in a market with fewer and fewer market makers.
Now let’s address why this is bad.
The bid-ask spread is the loss one will take to get into and out of an asset. In the case of a silver future, let’s say the bid is $20.15 and the ask is $20.16. Then you could buy and sell and lose only 1 cent per ounce. On the other hand, if the bid drops to $20.10 and the ask rises to $20.20 then your loss would be 10 cents.
Another way of looking at the bid-ask spread is liquidity. Commodities with narrower spreads are more liquid than those with wider spreads. For example, gold is more liquid than platinum and platinum is more liquid than molybdenum.
The monetary metals became money, as I argue in this article, because they had the narrowest bid-ask spreads. Now we see evidence that silver’s spread is widening. This is tantamount to saying that silver may be losing some of its moneyness. Though it should be emphasized that this is not happening in the spot market for silver, but the futures. I think it may not be silver losing its moneyness, so much as the futures markets becoming less efficient.
Along with too much focus on price, I think too many people look at the futures market in terms of how many ounces are in the warehouses vs. how many ounces are under contract. They expect the market to blow up by a failure to deliver metal when demanded at contract maturity.
A different kind of worry, which is completely off the radar at the moment, is if the futures market seizes up due to lack of liquidity. If the spread were to continue to widen significantly more (this is a big “if”), then we should expect to see falling trading volumes. At some point, the bid-ask spread could widen to the point where either silver stops trading or silver trading is forced into another venue. It’s far too early to make predictions about this.
So who is impacted by wider bid-ask spreads? Producers and consumers are hurt. Wider spreads reduce the profitability of silver miners and recyclers, and any other producers or hedger who must sell future production or inventory on the lower bid. It also reduces the profitability of jewelers, electronics manufacturers and other silver users who must buy future production at the higher ask. It will also hit those who must buy and sell futures to hedge inventory like bullion dealers. They typically sell futures short when they buy inventory, and buy those futures back as the inventory sells through to the consumer.
The only beneficiary is the surviving market maker. Unlike everyone else, who experiences the bid-ask spread as a cost, to him it’s a profit because he buys at the bid and sells at the ask.
Since I wrote A Curious Development in Silver, the silver basis for most contracts has risen about to its level of the third week of November (the March contract is beginning to spiral into the gravity well of temporary backwardation). It seems that the widening bid-ask spread cancer has gone into remission for now, though it bears watching.
Just before I hit send, comes this piece from Bloomberg. It makes an interesting postscript. “The Federal Reserve is planning to release a notice seeking information on ways to curb banks’ ownership and trading of some commodities,” it says. Here’s the money quote, “Senator Sherrod Brown, an Ohio Democrat, has raised concerns that banks may have a conflict of interest when they own and trade both physical commodities and instruments tied to them.” That would seem to target carrying metal—buying spot and selling it forward. Forcing banks out of this business will cause the basis spread to become wider and more volatile.
via Zero Hedge http://ift.tt/L856rl Monetary Metals
Submitted by Ben Hunt of Salient Partners
Well, it’s funny that people, when they say that this is evidence of the Almighty, always quote beautiful things. They always quote orchids and hummingbirds and butterflies and roses. But I always have to think, too, of a little boy sitting on the banks of a river in West Africa who has a worm boring through his eyeball, turning him blind before he’s five years old. And I reply and say, “Well, presumably the God you speak about created the worm as well,” and now, I find that baffling to credit a merciful God with that action. And therefore it seems to me safer to show things that I know to be truth, truthful and factual, and allow people to make up their own minds about the moralities of this thing, or indeed the theology of this thing.
– David Attenborough
Ash: You still don’t understand what you’re dealing with, do you? Perfect organism. Its structural perfection is matched only by its hostility.
Lambert: You admire it.
Ash: I admire its purity. A survivor… unclouded by conscience, remorse, or delusions of morality.
Parker: Look, I am… I’ve heard enough of this, and I’m asking you to pull the plug. [Ripley goes to disconnect Ash, who interrupts]
Ash: Last word.
Ripley: What?
Ash: I can’t lie to you about your chances, but… you have my sympathies.
Parasite Rex
From an evolutionary perspective, the parasite is a beautiful
creature. Instead of possessing a set of adaptations that make it
suitable for thriving within a “natural” habitat – an ocean, a forest, a
tundra, a jungle, etc. – the parasite typically finds its habitat
within an organism itself. Parasites twist the core evolutionary process
of adaptive radiation in a new direction, finding opportunities for new
niches and species differentiation within host species that emerge over
time in new geographies, not the new geographies themselves. To a
parasite, the world IS an oyster. Given the amazing diversity of life on
Earth, using life-forms as habitats presents a phenomenal opportunity
for parasitic adaptive radiation and thus, evolutionary success. Almost
every multi-cellular life-form on the planet serves as a host for one or
more parasites, and as a result parasites account for more biodiversity
and sheer numbers than non-parasitic life. In many respects, the
parasite is an evolutionary apex.
Why do parasites get such bad
press? Most of them are not what zookeepers would call “charismatic
vertebrates”, but instead tend to be viruses or squishy worms with nasty
looking (from a human perspective) and voraciously-presented mouths.
That’s a problem for any public relations campaign. More importantly,
parasites do not behave according to what game theorists call a “nice”
or cooperative strategy. These are not win-win relationships, where
there’s some sort of symbiotic benefit shared between the two organisms,
some sort of reciprocal value provided by the tapeworm to whatever
warm-blooded intestinal tract it happens to inhabit. No, the very
definition of a parasite is that it is harmful to its host, with a
one-way transfer of resources. Parasites are squatters, not tenants.
They are thieves, not buyers.
But they don’t steal a lot. Not
usually, anyway, as examples of Alien-esque life-forms that kill their
hosts in some burst of gore are few and far between. Almost all
parasites are better off keeping their hosts alive for as long as
possible, so it would seem natural for any individual parasite to take
just enough from its individual host to live well without killing off
the host. And this is, in fact, the case – few parasites kill their
hosts – but it’s the why behind this fact, the evolutionary dynamic
behind this fact, that I want to examine.
An individually successful
hookworm is not thinking “Gee, I better slow down a little bit here.
Wouldn’t want to damage my host too much.” That hookworm acts exactly as
it is programmed to act … to eat and reproduce as much as it is
hookworm-ly possible to eat and reproduce. An evolutionary perspective
requires us to look at the population of hookworms in relationship to
its habitat – the population of host animals – to figure out the
evolutionarily stable strategy (or ESS as it’s known) for hookworms. We
will never figure out the ESS by looking at an individual hookworm and
an individual host, because you can’t just extrapolate from what’s good
or bad for that individual relationship, no matter how much of a
long-term view you take for that individual hookworm and its
descendants.
From a population perspective, a parasite species is
trying to balance growth with robustness in the context of its life-form
habitat in exactly the same way that a non-parasite species is trying
to balance growth and robustness in the context of its geographical
habitat. Both grow by consuming resources. If growth outstrips resource
supply, that’s a problem, because the offspring population is going to
starve and die off. This is the population dynamic that is most closely
associated with the work of Thomas Malthus, who despaired of any animal
(including the human animal) escaping this deterministic pattern of
population growth outpacing resource availability, punctuated by
enormous population die-offs in order to restore the balance between
resource supply and demand. In the human context, innovation in our
tools and our mental constructs has allowed us to increase our species
population essentially unchecked by Malthusian logic since the 14th
century and the Black Death, with only a small hiccup from pandemic and
global war in the early 20th century. In the non-human context, any
respite from resource-depletion die-offs must come from the glacially
slow process of natural selection and the evolution of adaptations that
push a species into a more robust, less volatile relationship with its
environment. This is an ESS.
What’s interesting (to me, anyway) is
that a parasite species tends to have more options in the development of
its ESS than a non-parasite species. A parasite is not geographically
“grounded” like a non-parasite. Because its habitat is another
population of life-forms, the population of parasites can more easily
“choose” how to allocate its resource consumption. Maybe the parasite
species is better off if it concentrates on a few individuals within the
host population and really loads up on those unlucky targets, depleting
all of their resources and killing them in the process, but leaving a
critical mass of healthy hosts unharmed so that they can reproduce and
provide juicy targets in the future. Maybe the parasite species is
better off by getting smaller and less noticeable or impactful on the
host species. Maybe the parasite species is better off if it moves from
host species to host species within its lifecycle, so that no single
host species is damaged too severely even if the individual parasites
run rampant during their stay. These are strategic options at the
population level that are much more difficult to develop or evolve
within species that have a specific geography for a habitat. Not
impossible … maybe you can rotate from one resource-rich patch of your
geography to another and then back again (migration) … but more
difficult. A resource habitat created by life-form populations is just
more fungible than a resource habitat created by a singular geography,
and that’s a really big deal for an ESS.
This flexibility (and hence
evolutionary speed) in creating an ESS is a big reason why parasites
dominate the world. Like humans, they’re pretty good at getting around
the gloomy future that Malthus predicted. Not by inventing the printing
press, fossil fuel energy sources, and liberal ideas of social
organization, but by quickly evolving a wide range of behavioral
adaptations that are extremely effective at balancing resources and
growth. Here’s what these parasite ESS’s have in common: they make the
parasite population invisible to the host population. The relationship
between individual parasite and individual host may also be invisible,
but it also might be a violent struggle to the death or somewhere in
between … evolution doesn’t care about individuals. Evolution has to be
understood at the group level, and the evolutionary beauty of the
parasite is its amazing suitability and fitness – at the group level –
for using life itself as a habitat.
Now why do I care so much about
parasites and their evolutionarily stable strategies? Because the most
effective alpha-generating investment strategies are parasites. An
alpha-generating strategy of the type I’m describing uses the market
itself as its habitat. It’s not an investment strategy based on the
fundamentals of this company or that company – the equivalent of a
geographic habitat – but on the behaviors of market participants who are
living their investment lives in that fundamentally-derived habitat. A
parasitic strategy isn’t the only way to generate alpha – you can also
be better suited for a particular investment environment (think
warm-blooded animal versus cold-blooded animal as you go into an Ice
Age) and generate alpha that way – but I believe that the investment
strategies with the largest and most consistent “edge” are, in a very
real sense, parasites.
What do these parasitic strategies look like?
Their number is legion. They exist in every nook and cranny of every
public market in the world, and they feed off the behaviors of
non-economic or differently-economic market participants. A giant
pension fund isn’t engaged in commodity markets because it has an
opinion on the contango curve of oil futures; it’s trying to find a
diversifying asset class for a massive portfolio that needs inflation
protection. If you’re an experienced trader in that market and you see
signs of the giant pension fund lumbering through the brush … well,
you’re in the wrong business if you can’t skin a few dimes here. This is
what good traders DO, and the really good ones have devised effective
processes and strategies that comprise a strategy, so that it’s not just
a one-off trade but an expression of a consistent informational edge.
These strategies are inherently niche-oriented, and they do not scale
very well, any more than any single parasite species can scale beyond
the size of its host species. But the informational edge is real, which
means that the alpha generation is real, and that’s a beautiful thing
even if the outward form is as ugly as a hookworm.
Why does a
parasitic strategy have a bigger informational edge than a non-parasitic
strategy? Because market participant behaviors are far more consistent
over time than the economic fundamentals of companies or countries. I
can predict with 100x more confidence what a giant pension fund is
trying to achieve with its market activities than what S&P 500
earnings will actually be next year. World events and market outcomes
are utterly unpredictable, especially in a global environment of
economic deleveraging, massive monetary policy experimentation, and
political fissures the size of the Grand Canyon within and between
countries. Human nature, though, is as constant as the northern star.
How
does a parasitic strategy with an informational edge persist? Why isn’t
it arbitraged (or regulated) away? First, remember that we’re talking
about the group level, not the individual. Certainly it’s possible to
have competition between individual parasitic strategies that split the
economic resources taken from the host. But at the group level, just
like their biological cousins, effective parasitic investment strategies
are largely invisible to their hosts. As Baudelaire said way before
Kevin Spacey did in The Usual Suspects, the greatest trick the devil
ever pulled was convincing the world he didn’t exist.
What’s the
pay-off for thinking about alpha-generation investment strategies
through this evolutionary perspective? Two big pay-offs, I think.
First,
one of the trickiest puzzles of effective allocation and risk
management for anyone who invests in actively managed funds is trying to
figure out the capacity limits of those strategies. This typically
isn’t something you worry about with a strategy that is focused on
capturing broad market returns or one that uses big liquid securities
like S&P e-mini’s to express its portfolio, but it’s a significant
concern with funds that claim to have some sort of informational or
process edge (alpha generation potential) and express that edge with
single-name securities or any sort of liquidity-challenged instrument.
There are very powerful formulas in the evolutionary biology toolkit for
figuring out both the optimal population size of a parasite species
relative to its host as well as the optimal amount of resources that the
parasite population should take from the host. This is at the heart of
figuring out what behaviors, including size, are evolutionarily stable
for the parasite, and it is directly applicable to alpha-oriented
investment strategies with parasitic qualities. Instead of taking a
manager’s word on investment capacity or making some rough guess based
on the AUM of other managers (which is basically the state of the art
today), these ESS tools should allow us to project investment capacity
directly for many alpha-generation strategies.
Second, it shows how
one might create an advanced multi-strat investment platform, one that
uses the Adaptive Investing perspective to identify the alpha-generation
strategies with the most effective ESS’s, as well as the optimal
capacity and allocation characteristics for the market “habitat” in
which these strategies operate. Unlike the individual strategies, which
inherently scale poorly, a multi-strat structure scales easily, limited
only by the number of individual strategies brought under the
operational umbrella. Would this sort of investment platform have
something of an image problem, intentionally seeking out and unafraid to
characterize certain investment strategies as parasites? Maybe. But
somehow I think there are plenty of others out there who, like me, can
see the evolutionary beauty of these strategies and are not afraid to
call them by their proper name. I hope you’ll join me in this
exploration.
     |
via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/uXKHH9hvudM/story01.htm Tyler Durden