Monday, April 27, 2009

On Treasury Bonds and Trade Wars

Well, a lot has happened since my quick treasury bond market update, treasury bond market update and my prediction that the fed will buy all treasury bonds in existence if necessary. Quite frankly, I don't know where to begin but let's get started.

Let's start with a chart. Here is a six month chart of TLT, the 20 year treasury bond ETF:

Notice the large rise late last year, the sharp drop in the beginning of 2009 and then the long sideways chop since then. That sideways chop may be ending as TLT has just broken its 200 day moving average (the yellow line). In a (somewhat) free market, one may even be inclined to short such a technical setup. The amount of manipulation taking place forces us to take a different approach, however. So?'s opinion on treasury bonds is that you would be crazy to take either side of this trade.

The US Federal Government is now running a yearly deficit of $2+ trillion. This quarter alone, the Treasury expects to borrow $361 billion of debt. Because real market demand could not dream of soaking up this level of supply, the Fed has stepped in and agreed to buy the treasury debt with newly minted dollars - in effect monetizing the debt. This is in addition to the money the Fed has allocated to buying up agency debt sold by Fannie Mae and Freddie Mac as well as its financial commitments to a plethora of alphabet soup programs.

It might sound complicated but it is really quite simple. Any government can effectively spend more than it makes by simply paying for its costs with newly created money. What prevents most governments from attempting this on anything near a large scale is the risk of a currency crisis which leads to a devaluation of their currency and debt followed by massive inflation. The US Government has been allowed to get this far already chiefly because (1) the US economy is crucially important for world trade and (2) the US dollar is the world's reserve currency.

The other world powers have already begun to reject the current US financial doctrine. Witness China, which is now at the forefront on pushing for an alternative to the US dollar by looking to utilize IMF Special Drawing Rights. China has also announced that it has been heavily buying gold over the last few years. This has all the signs of the beginning of a trade war between the US and China.

I believe that the trends outlined above will be the storyline for 2009 and the next few years. We will revisit these topics in greater depth as events unfold. For now, I will leave you with this. There is precisely zero chance that this game ends well. I challenge my readers to outline one possible scenario where this leads to economic prosperity. I have not even heard a single Treasury or Fed official make a plausible argument for what they are doing. China, on the other hand, is taking long term, rational steps towards cementing its fate as the world's number one economy of the future.

Sunday, April 19, 2009

Janeane Garofalo on the Tea Parties

Every once in a while someone says something so irresponsible, unjustified, ignorant and mean spirited that you just have to sit back in amazement. I present to you Janeane Garofalo on the Keith Olbermann show:

Garofalo refers to anyone who attended one of Tea Party rallies on April 15th as the following:

Neurologically Disordered
Anti Intellectual

It is amazing how thousands of people meeting up in hundreds of locations across the country are all exactly alike. Did it ever occur to Olbermann and Garofalo that these rallies consisted of all sorts of people with all sorts of differing viewpoints? It is unfortunate that because radical Republicans and the Fox News channel decided to latch onto this movement at the last minute, all those who attended were immediately painted with the same brush.

Olbermann and Garofalo jump to the conclusion that one speaker at a tea party rally making pro-Democratic remarks and getting some boos shows that these right-wing Republicans were duped at their own rally. The proper conclusion to draw is that if an Obama supporter spoke at a rally, maybe these rallies were not entirely made up of ultra right wing Republicans.

Here is a video of REPUBLICAN Congressman Gresham Barrett getting booed at the Greenville, South Carolina tea party rally. Mr. Barrett was apparently booed because he voted for the TARP bill:

The worst part of Ms. Garofalo's comments is the accusation of racism. If you are a media outlet you have a certain level of responsiblity to uphold. When you allow a person to fling around an accusation of racism with no thought whatsoever and you do nothing to stop it, you are completely irresponsible. Calling an individual or a group of people racist is a very serious thing to do these days. Ms. Garofalo's comments come backed up with absolutely no evidence making her cowardly and a bully. Mr. Olbermann should be ashamed of himself for not only letting her off the hook but actively encouraging her.

This is not a political blog and I have no interest in starting political bicker fests with readers. I posted this because it is the perfect example as to why I do not get my news from MSNBC, CNN or FOX News and neither should you. This level of discourse is childlike and revolting.

Tuesday, April 14, 2009

Elizabeth Warren: The Coming Collapse of the Middle Class

Elizabeth Warren is the Leo Gottlieb Professor of Law at Harvard Law School, where she teaches contract law, bankruptcy, and commercial law. In the wake of the 2008-9 financial crisis, she has also become the chair of the Congressional Oversight Panel created to oversee the U.S. banking bailout, formally known as the Troubled Assets Relief Program.

Embedded above is the video of an excellent speech given by Elizabeth Warren titled The Coming Collapse of the Middle Class: Higher Risks, Lower Rewards, and a Shrinking Safety Net. It is a bit long, with a run time of just under an hour, but it is well worth your time.

Ms. Warren provides some excellent economic statistics that shows exactly how the middle class has been getting squeezed over the past 30 years. Here is a brief summary of some of the more important points she makes:
  1. Families today spend comparatively less money on small ticket items (clothing, food, appliances) then they did 30 years ago but spend more on big ticket items (housing, cars, health care)
  2. Household income is up slightly but that is mostly the product of most households having two incomes (most mothers now work) instead of the typical single earner family of 30 years ago. This is because men now make less than their fathers did.
  3. For most households, if either the mother or the father lose their job, they can no longer afford to pay the mortgage. This has lead to a huge jump in bankruptcy filings overall, with a particular jump for those with children and especially for single mothers.
I would argue that this speech is improperly named - if you digest the numbers presented and agree with the arguments made by Ms. Warren then the middle class has already collapsed. If the middle class falls much more from current levels then it becomes pretty much extinct which is quite scary because we are in the midst of a very deep recession.

Ms. Warren does not state this, but if you understand how badly families have been hurt by spending such a large portion of their earnings on housing (up 76% from just 30 years ago), you would realize that the best medicine is for a steep fall in housing prices so that a median income family can comfortably afford a median priced house. On cue, the market has been repricing housing to the new economic reality but certain politicians see this as far too painful for them to endure. This is not an argument you will hear being made by talking heads on TV.

Friday, April 10, 2009

Peter Schiff: The Little Book of Bull Moves in Bear Markets

Peter Schiff, the well known market pundit and "perma-bear", released his second book, The Little Book of Bull Moves in Bear Markets, in October. At first glance this seems like brilliant timing. Markets worldwide have been in free fall since the release of his book and what all investors are looking for is a way to make some positive returns in this massive bear market. As it turns out, this book contains a lot of advice that would have failed to protect investors from recent market turmoil.

Let me state this up front: I neither hate Peter Schiff nor dislike him. I am familiar with his investment theories through his writings and numerous media appearances. I happen to agree with many of his views and he has proven to be correct in many of his prognostications. With that being said, he has not been right about everything.

Now that I have that out of the way, let me state outright that The Little Book of Bull Moves in Bear Markets is a bad book. It is not necessarily that I disagree with the arguments that Schiff makes, it is that I disagree with the way Schiff makes his arguments. This book contains some dangerous investment advice and is borderline disingenuous at times. On top of that, the book is surprisingly short on details and reads more like a sales brochure than a serious investment book. Let us tackle a few of my issues with this book:


On pages 28-29, Schiff raises issues with the way the Consumer Price Index (CPI) is measured:

For Example, the inflated price of residential housing was never reflected in the CPI because instead of using home sales figures, the Department of Labor substitutes a figure they call "owner equivalent rent." With all the shenanigans used to turn renters into buyers during the recent bubble, the rental market went into a slump for lack of takers. Since owner equivalent rent was used to represent residential real estate prices in the CPI, the index significantly understated the rate at which real estate prices were actually rising.

Schiff mentions several times in the book that the real inflation rate is closer to 8-10% instead of the 2-5% typically measured by the CPI. What he is arguing is that we should measure housing prices as part of the inflation rate. Great - the only problem is that, using his own arguments, now that housing prices are crashing that also means that the "true" inflation rate has crashed as well. If we use the Case-Shiller Composite-20 housing index, which is generally considered the most accurate metric, housing prices are off 29.1% from the peak in Summer 2006. If housing prices represented 40% of the CPI, as they once did, the CPI would be deeply negative right now. Has Schiff since changed his stance and argued that deflation is occurring? Nope. Watch any of his media appearances readily available on YouTube - he hasn't budged one bit.


Decoupling is briefly defined as the idea that the US economy could fall apart but the rest of the world would manage solid economic growth - in other words the US would decouple from the rest of the world. On page 134 Schiff asserts:

Were the entire global economy to go down the tubes, there would be little point in investing anywhere. But that's not going to happen, which again brings me to the issue of decoupling.

I would argue that this is precisely what is happening right now - the entire world economy has already entered a synchronized recession that is rapidly turning into a depression. I won't rail on Schiff for incorrectly predicting this event, as most experts did as well, but at least most of those experts have the excuse that they did not see the US entering such a tough economic period. Schiff predicted that the US economy would fall apart, yet still held on to the notion that the world economy would be smooth sailing. How intelligent is that? This notion of decoupling has proven itself to be completely wrong as this crisis has unfolded. More on decoupling on page 212:

In the 1930s, the Great Depression affected not only the United States but nearly every nation on earth, so hard times here were matches by hard times elsewhere. This time it will be different. Even the most uninformed U.S. citizens will be forced to notice that other nations' living standards are on the rise, just as ours is on the decline

With the US GDP making up just over 25% of the world's GDP, what are the chances that a serious economic crisis in the United States would not drastically affect the rest of the world? As long as international markets are highly intertwined and the US makes up a large percentage of the world's economy, the decoupling thesis makes no sense in theory and current events backs up this commonsensical view.

Falling more under the category of general inconsistency but still based on his decoupling theory, on page 161, Schiff begins to go through the countries that he rates highly for investment purposes. He notes that Australia exports 60% of its products to China and thus is immune to a US slowdown. On the very next page he recommends Canada despite that fact that 80% of its exports go to the US! You can't have it both ways.

The Dollar

Schiff's entire investment thesis rests on one single premise of which he is so absolutely certain - the dollar will crash. He uses this assumption to suggest investing in everything from gold, energy and foreign currencies. On page 133:

The one risk of foreign investing that exists regardless of the merits of the investment is currency exchange risk - the risk that when we convert income or sales proceeds from a foreign currency to the dollar, we will experience a loss because the dollar has become stronger. That, of course, will be the least of our worries looking ahead.

Now, to be fair, Schiff admits that counter-trend rallies are always a threat, but for the last year Schiff has been dead wrong about the dollar. When you rest your entire investing thesis on one central tenant, you are taking big risks no matter what minor diversification among specific investments you choose.

On page 160, Schiff notes the currency gains against the dollar that he predicted in the last year:

Here is a breakdown of the basket of currencies I invest in for the bulk of my clients and how each fared against the U.S. dollar in the 52-week period ended April 30, 2008: Australian Dollar +19.41% Norwegian Krone +18.70% Euro +18.35% Swiss Franc +15.07%...

Schiff goes on to mention other currencies as well. Here is a multi-year chart pricing the dollar against a basket of currencies. Note how the dollar has performed since April 30, 2008:

Here is a media appearance of Peter Schiff on Kudlow and Company on February 18, 2009. When Schiff is confronted with the fact that the dollar has since risen against almost all currencies in the past year, he responds by saying that his predictions are long term and that he looks years and years out. At the same time, in his book here he is patting himself on the back based on a 12 month move in currency rates. As I said before - you can't have it both ways:

Dangerous Advice

Later in the book, Schiff goes way too far with some wacky investment advice. On pages 219-220 Schiff recommends, under certain conditions, borrowing against the equity of your house to invest. "Since you're paying your loan in dollars, if you invest abroad and the dollar continues to fall, that difference will grow into quite a today sum that you can collect on a monthly or quarterly basis." What absolutely terrible advice. I don't think anyone should ever gamble with their home equity under any circumstances - period! Why take a chance, even a tiny chance, and risk losing you and your family's place to live? No investment adviser should ever suggest such rubbish.

Accurate Forecasts

To be fair to Mr. Schiff he doesn't have it all wrong. He accurately called the housing crash and has been bullish on gold for many years. Let's examine a few other areas where Schiff nailed it:

Chapter ten is titled "To Infinity and Beyond - Secure Employment for the Future." In it, Schiff notes that at the time of publication (Summer 2008) the unemployment rate was 5.5% and would climb much higher. Today it stands at 8.5% and shows no sign of abatement.

On page 230, Schiff says that the government "will keep spending, printing and borrowing from abroad to try to preserve a lifestyle that our country can no longer afford. This will only ensure that the crisis will be deeper and be more painful than it needs to be, requiring 10 or even 20 years before it is resolved." This is exactly what has been happening and I completely agree that we are now looking at a 10 to 20 year period of weak economic growth because of these governmental policies.


In the end, here is Schiff's problem. He recognizes all of the risks inherit in the dollar and the US economy but ignores all the issues present in foreign economies and their currencies. In this way, he is political. It is akin to a Republican supporter who recognizes the flawed arguments of Democrats while ignoring his own parties hypocrisies. The absolute last person you want to listen to for investment advice is someone who is biased in any way. You want to invest with someone who is able to change their mind when the facts change at a moment's notice. Schiff fails this test.

If you think Schiff is mostly right about the US economy and the dollar, here is some free investment advice. Stay out of the US stock market, stay out of US dollar denominated bonds (especially long term government debt), buy some gold just in case and take some long term positions in other commodities such as agriculture and energy. Any other advice Schiff mentions tends to be speculative and may end up in investment losses even if his central thesis proves correct.

Tuesday, April 7, 2009

Argentina's Economic Collapse

Embedded below is a powerful documentary on the economic troubles that have plagued Argentina since, well, basically forever.

There is a heavy political agenda to the film but besides that I think there are two important non-political points to be made:

1. Mass corruption, be it done by politicians, judges or private businessmen, leads to disaster
2. Mass government debt leads to disaster

The documentary rails against the privitization of Argentinian owned companies but the crux of the issue is that the companies were sold for less than they were worth, the private owners broke laws by not upholding their ends of contracts and these injustices were not held accountable by the laws of the land. That is corruption.

The private banks, the world bank and the International Monetary Fund are also demonized. While I will not defend these organizations, massive accumulation of debt is terrible policy regardless of the source. The absolute last thing a struggling nation should do is strap itself with debt.