Wednesday, May 27, 2009

Fed Open Market Operations Update II

I first posted about the Fed's open market operations on May 9th in my post titled Fed Open Market Operations Update. Here are updated versions of those charts.

The Fed has purchased an additional $38.3 billion of treasury bonds since May 9th for a total to date of $130.5 billion:


Here is a cumulative version of this chart so that you can see the rate of growth:


The Fed has purchased $6.8 billion in agency debt since May 9th and a total of $93.3 billion since the program started:


The Fed has also purchased an additional $51.8 billion of agency mortgage backed securities (MBS) since May 9th for a total of $481.5 billion since the program's inception:


Here are the up to date totals for each open market operation type:


Treasury bonds have continued to get beat up over the past few weeks. Ten year treasury bond yields are currently at 3.72% and 30 year bonds are at 4.63%, both up substantially in the past few weeks. The Federal Reserve Open Market Committee (FOMC) last met on April 28-29 and is due to meet again on June 23-24. I was surprised that they did not announce plans for additional treasury bond purchases at the last meeting. Since that time, we have learned from the meeting minutes that the Fed was considering additional purchases. Since treasuries have sold off substantially in the interim, additional purchases are all but guaranteed to be announced following the June meeting, if not sooner. Agency MBS purchases have made up the bulk of the Fed purchases thus far but look for Treasury purchases to substantially increase over the course of the summer.

Wednesday, May 20, 2009

Check Your Credit Card Agreements!

This week I received a notice in the mail from Chase. My credit card APR has been increased from 13.24% to 20.24%. This is effective July 1st and covers future and existing balances. Why would my APR be raised so drastically when I have a credit score of 734 and I have paid off my balance in full each month? Now obviously I never pay interest (I like to say that I earn interest, not pay it) so it is not a major concern.

Still, I was curious, so I called Chase to inquire. The service representative told me it was a "business decision" and would not further elaborate. I asked her if it made sense to charge a customer with a perfect payment history and a 734 credit score over 20%, especially considering interest rates are near all time lows? She did not have an answer.

Why would Chase raise my rates? This could be why:

The House today gave final approval to a bill that would prohibit credit card companies from arbitrarily raising interest rates on existing balances and charging certain fees.

Also see Record Credit Card Defaults In April:


AprilMarch
Citigroup10.21%9.66%
Wells Fargo10.03%9.68%
JP Morgan Chase8.07%7.13%
Discover Financial Services8.26%7.39%

So there you have it. These two events will have major repercussions for the credit card industry. It will now be much more difficult to obtain a credit card. The days of one year 0% APR teaser rates are likely over. Now that credit card companies will have a harder time making money off of irresponsible customers, they plan to go after the responsible ones. See Credit Card Industry to Profit From Sterling Payers:

Credit cards have long been a very good deal for people who pay their bills on time and in full. Even as card companies imposed punitive fees and penalties on those late with their payments, the best customers racked up cash-back rewards, frequent-flier miles and other perks in recent years.

Hi there - that's me.

Banks are expected to look at reviving annual fees, curtailing cash-back and other rewards programs and charging interest immediately on a purchase instead of allowing a grace period of weeks, according to bank officials and trade groups.

Bring it on bankers. If my credit card company decides to enact an annual fee, eliminate the rewards program or charge me interest immediately on purchases, I will simply cancel the card. If no other credit card company will make me an offer without these options, I have no problem going back to using cash for everything.

If you have a credit card I would advise you to check your credit card agreement and even call your credit card company to check if the terms have changed. If you have an existing balance and your rates were jacked up through no fault of your own, demand that your bank lower the rate back down. If the representative refuses, ask for a manager and demand the same from them.

In the end, almost all bank fees are negotiable so do not pay any fees that you deem inappropriate. Credit card service representatives are trained to drain the most money possible out of you so if you threaten to pay nothing, they will be willing to negotiate. Here is an interesting article that sheds some light on how credit card companies operate:

Luckily for the industry, small groups of executives at most of the large firms have spent the last decade studying cardholders from almost every angle, and collection agencies have developed more sophisticated dunning techniques. They have sought to draw psychological and behavioral lessons from the enormous amounts of data the credit-card companies collect every day. They’ve run thousands of tests and crunched the numbers on millions of accounts. One result of all that labor is the conversation between Santana — a former bouncer whose higher education consists solely of corporate-sponsored classes like “the Psychology of Collections” — and the man from Massachusetts. When Santana contacted the man last month, he was armed with detailed information about his life and trained in which psychological approaches were most likely to succeed.

“Boom, baby!” Santana [a credit card representative] shouted as he put down the phone. “It’s all about getting inside their heads and understanding what they need to hear,” he told me later. “It really feels great to know I’m helping people in pain.”

Before [the writer] left the Bank of America training session in Delaware, the instructor gave the class a little pep talk. “You’re going to have some days when you help customers, and you’re going to walk out and feel really, really good,” she told them. “It’s O.K. to help people know that we are all working to make the world a better place. It’s O.K. to help them believe.”

I will leave you with that heartwarming thought.

Monday, May 18, 2009

On Treasury Bonds and Trade Wars II


I first discussed the onset of impending trade wars in my previous post On Treasury Bonds and Trade Wars. In the three weeks hence, there have been some interesting new developments.


"A policy mistake made by some major central bank may bring inflation risks to the whole world," said the People's Central Bank in its quarterly report.

"As more and more economies are adopting unconventional monetary policies, such as quantitative easing (QE), major currencies' devaluation risks may rise," it said. The bank fears a "big consolidation" in the bond markets, clearly anxious that interest yields will surge as western states try to exit their QE experiment.

Simon Derrick, currency chief at the Bank of New York Mellon, said the report is the latest sign that China is losing patience with the US and aims to diversify part its $1.95 trillion (£1.3 trillion) foreign reserves away from US Treasuries and other dollar securities.
Brazil and China will work towards using their own currencies in trade transactions rather than the US dollar, according to Brazil’s central bank and aides to Luiz InĂ¡cio Lula da Silva, Brazil’s president.

The move follows recent Chinese challenges to the status of the dollar as the world’s leading international currency.

Mr Lula da Silva, who is visiting Beijing this week, and Hu Jintao, China’s president, first discussed the idea of replacing the dollar with the renminbi and the real as trade currencies when they met at the G20 summit in London last month.


China has been pretty blunt with their intentions. They have said repeatedly over the past few months that they are worried about the dollar and they favor an alternative to the dollar as the world's reserve currency. This is just another step towards China's goal of distancing itself from the dollar. The first step is to stop using the dollar as a medium of exchange. The second step is to stop buying (or even sell) US dollar based treasury bonds. The countermeasure by the US Government is likely to be protests of currency manipulation and the imposition of tariffs on Chinese goods. In other words, a trade war.

Why would China want to distance itself from the dollar? If you visit this site regularly you should already know the answer to that question but here is one picture that summarizes the situation pretty nicely (from briefing.com):

The US Government is massively increasing spending at the same time that tax revenues are cratering. Foreign heads of state are simply trying to protect themselves against the inevitable fall in the value of the dollar.

Going back to trade wars, China is one thing but what do we have here? Strained trade relations with Canada? Trade Wars Brewing in Economic Malaise:

Is this what the first trade war of the global economic crisis looks like?

Ordered by Congress to "buy American" when spending money from the $787 billion stimulus package, the town of Peru, Ind., stunned its Canadian supplier by rejecting sewage pumps made outside of Toronto. After a Navy official spotted Canadian pipe fittings in a construction project at Camp Pendleton, Calif., they were hauled out of the ground and replaced with American versions. In recent weeks, other Canadian manufacturers doing business with U.S. state and local governments say they have been besieged with requests to sign affidavits pledging that they will only supply materials made in the USA.

The article covers some interesting anecdotes of discrimination against companies which are technically not headquartered in the US but have large operations in the US with many jobs for US workers. Trying to categorize companies as American or not-American is a process that died in the 19th century and was definitely buried in the last ten years. Political pressure by the Canadian business community could lead to a response by the Canadian government.

Trade wars are just starting to heat up. We will keep you posted on new developments as they happen.

Sunday, May 17, 2009

It is Not 1936 Again

Alan Blinder is an American economist, a chair professor in the Economics Department of Princeton University and co-director of Princeton’s Center for Economic Policy Studies. On Saturday, he published an op-ed piece in the New York Times titled It's No Time to Stop This Train. Let's review some of the points that he makes in this essay. His words are in bold.

CONTRARY to what you may have heard from some doomsayers, 2009 is not 1930 redux. What we must guard against, instead, is 2010 or 2011 becoming another 1936.

OK I am listening.

Realistically, there is little danger that the economy is heading toward a repeat performance of the Great Depression — when real gross domestic product in the United States declined 27 percent and unemployment soared to 25 percent. What we have is bad enough: our worst recession since the 1930s. But unless our leaders behave unbelievably foolishly, we will not repeat the tragic slide into the abyss of 1930 to 1933 — for two main reasons.

I am still listening.

First, our economy has many built-in safeguards that did not exist back then — like unemployment insurance, Social Security and federal deposit insurance, to name just three. These programs serve as safety nets that cushion the fall. And while they are certainly not strong enough to prevent recessions, they should be enough to prevent another depression.

The economy is structurally different than it was in 1930 - no argument there. This means that the economy will not act precisely as it did in 1930. This, however, is no guarantee that there will not be economic collapse - this just guarantees that if there is an economic collapse, it is likely to be somewhat different. We could spend more time arguing this point but Blinder says that his next point is more important so let's move on...

The more important reason is that Barack Obama, Timothy F. Geithner and Ben S. Bernanke are not Herbert Hoover, Andrew Mellon and Eugene Meyer. (Who’s that? Mr. Meyer was the Federal Reserve chairman from September 1930 to May 1933.) In stark contrast to the laissez-faire crowd that ruled the roost in 1930 and 1931, our current economic leaders are not waiting for the sagging economy to right itself. Rather, they have taken numerous extraordinary steps already — and stand ready to do more if necessary.

Again, like reason number one above, there is no argument here. The political actions taken during this economic crisis have not and will not be the same as those actions taken during the great depression. This means that the outcome will probably be materially different. This does not mean that this outcome will be better or that it will be worse - it just means that it will be different.


That’s the good news. But even if another depression is next to impossible, there is still the danger that next year, or the year after, might turn into 1936. Let me explain.

From its bottom in 1933 to 1936, the G.D.P. climbed spectacularly (albeit from a very low base), averaging gains of almost 11 percent a year. But then, both the Fed and the administration of Franklin D. Roosevelt reversed course.

In the summer of 1936, the Fed looked at the large volume of excess reserves piled up in the banking system, concluded that this mountain of liquidity could be fodder for future inflation, and began to withdraw it. This tightening of monetary policy continued into 1937, in a weak economy that was ill-prepared for it.

There are a couple of assumptions made here. First, Dr. Binder assumes that the strong economic growth from 1933 to 1936 was sustainable. Has he considered the possibility that the economy was goosed during this time period in an unsustainable fashion? If not, why not? We know that the FDR's New Deal was initiated from 1933 to 1935. Is it wild to speculate that these programs may have caused unsustainable distortions in the economy? Second, he assumes that tightening monetary policy in 1936 was the wrong choice and that not tightening would have been been the right choice. Has he considered the possibility that there was no right choice under the circumstances. If not, why not?

About the same time, President Roosevelt looked at what seemed to be enormous federal budget deficits, concluded that it was time to put the nation’s fiscal house in order and started raising taxes and reducing spending. This tightening of fiscal policy transformed the federal budget from a deficit of 3.8 percent of G.D.P. in 1936 to a surplus of 0.2 percent of G.D.P. in 1937 — a swing of four percentage points in a single year. (Today, a swing that large would be almost $600 billion.)

Thus, both monetary and fiscal policies did an abrupt about-face in 1936 and 1937, and the consequences were as predictable as they were tragic. The United States economy, which had been rapidly climbing out of the cellar from 1933 to 1936, was kicked rudely down the stairs again, and America experienced the so-called recession within the depression. Real G.D.P. contracted 3.4 percent from 1937 to 1938; the total G.D.P. decline during the recession, which lasted from mid-1937 to mid-1938, was even larger.

The moral of the story should be clear: Prematurely changing fiscal and monetary policies — from stepping hard on the accelerator to slamming on the brake — can be hazardous to the economy’s health.

Agreed. Rapidly goosing the economy and then abruptly stopping causes economic problems. Maybe we just should not goose it in the first place. Is that option on the table?

Wow, we’ve learned a lot since the ’30s, right? Well, maybe not. For the echoes of 1936 are being heard right now, even before the current recession hits bottom. If you’ve been paying attention, you know that a number of critics of the Fed are sounding alarms over the huge stockpile of excess reserves it has created — more than $775 billion at last count. What these critics are fretting about now is exactly what goaded the Fed into action in 1936: that the vast pool of loose money will ultimately be inflationary. The clear inference is that some of it should be withdrawn before it’s too late.

Will loose money not ultimately lead to inflation? Yes or no? Dr. Blinder never attempts to answer the question. I would argue that the loose economic policies should not have been implemented in the first place.


On the fiscal side, many of President Obama’s critics are complaining vociferously about the huge federal budget deficits. Try to ignore, if you can, the sheer hypocrisy of many Congressional Republicans who, having never uttered a peep about the huge deficits under George W. Bush, are suddenly models of budget probity. But whatever the motives, the worries of today’s deficit hawks sound eerily reminiscent of Roosevelt in 1936 and 1937.

In general I try to ignore politicians - period. Why does Dr. Blinder choose only these hypocritical individuals as the basis for dissent? Why not point towards those that are sounding the alarm that are not politically affiliated? Why not point towards Ron Paul, a Republican Congressman who has always been for fiscal and monetary conservatism from the 1970s into the latest Bush presidency and up to today? Probably because it is easier to whitewash all those who disagree with you as hypocrites instead of arguing the case itself. It is the oldest crutch in debate.

FORTUNATELY, Mr. Bernanke is a keen student of the Great Depression who will not allow the Fed to repeat the errors of 1936-37. But his critics, both inside and outside the Fed, are already branding his policies as dangerously inflationary, and no Fed chairman wants to be called an inflationist.


Again, I agree that Dr. Bernanke is aware of the policies enacted in 1936 and will not repeat those policies. Different policies will likely lead to different results. Why does one assume that these results will necessarily be better or worse than those results?

Similarly, I hope and believe that President Obama will not transform himself from the spendthrift Roosevelt of 1933 to the deficit-hawk Roosevelt of 1936 — at least not until the economy is back on solid ground.

How do we know when we are back on solid ground? If the economy grew on average 11% annually from 1933 to 1936, and that was not solid ground, then when will we know it is time to change course? Are you telling me that if the economy grows by the same amount through 2012 that we should continue with current record deficits and quantitative easing? Does that sound insane to anyone else besides me?

That said, a growing flock of budget hawks are already showing their talons. They will have their day — but please, not yet.


The budget hawks that Blinder is referring to are most likely Republican Congressmen. Through eight years of Bush spending excesses they did nothing (besides Ron Paul). They have more in common with vultures than hawks. Let's get that insult into the lexicon - hypocritical Republican budget hawks shall now be referred to as vultures.

To avoid a replay of the policy disasters of 1936-37, both the Fed and our elected officials must stay the course. Mark Twain once explained that, while history does not repeat itself, it often rhymes. We don’t want any rhymes just now.

At this point you most likely realize that I completely disagree with Dr. Blinder's view. What he is arguing is thus:

In situation A, we enacted policy B which lead to outcome C. Because outcome C was bad, we want to avoid policy B. Therefore, in situation A2 (somewhat similar to A), we will enact policy Y which will lead to outcome Z. Because Y is different from B (different policy), Z must be better than C (better outcome).

In reality, all Dr. Blinder is guaranteeing is that Z must be different from C (different outcome). Different does not mean better! He has refuted none of the inflationary warnings being fired by dissenters.

In the end, Dr. Blinder has nothing to worry about in regards to a repeat of 1936. I have little doubt that any such tough fiscal and monetary policies will be enacted. I mean, really, does he honestly think that Obama will try to balance the budget any time soon? No chance there.

The outcome of this economic crisis will not be 1936. It could be better and it could be worse. A lot worse. Read this description of the hyperinflation episode in Weimar Germany in the 1920s. In that context, maybe FDR made the right choice in 1936. Of course, we will never know what could have been we only know what happened. I have been on the inflationary/deflationary fence for quite some time now but I think I am ready to jump off and lump myself in with the inflationists. Any deflationists care to offer an opposing view?

Wednesday, May 13, 2009

Commodity Diversification

I have updated my commodity ETF and ETN google docs spreadsheet with the latest average daily volume information. Most of these funds have shown increases in volume in the last few months. Feel free to save yourself a copy or download the information to an excel spreadsheet.

If you want to diversify your commodity investments with ETFs and ETNs you have two choices: buy one of the diversified funds or buy multiple specialized funds. I have an issue with most of the diversified funds - they are all too heavily tilted towards energy. For example, take a look at GSG, which tracks the iShares GSCI Commodity index. This fund allocates 71% of its holdings towards energy! I believe that energy is one of the least interesting commodity sectors for investors, so this level of concentration is unacceptable. Why? Because oil had such a screaming bull run until last year that it is less likely to have as much upside as say, gold, which has yet to make a parabolic move in this secular bull market.

So the diversified funds are out. Let's build our own diversified fund based on what commodities we think are going to perform best over the next few years.

Allocation #1 Basic:
SymbolFund Name% Allocation
DBAPowershares Agriculture40%

---Agriculture Total40%
GLDSPDR Gold35%

---Precious Metals Total35%
USOUnited States Oil Fund25%

---Energy Total25%

If you want to keep it simple the basic portfolio will cover most of your bases. DBA is an agriculture ETF consisting of 25% corn, 25% soybeans, 25% sugar and 25% wheat. I believe that agriculture will be the next big commodities winner so that it why it has the highest allocation of the three funds. GLD is the most heavily traded gold ETF in the world. Gold is a must have in these times of economic turmoil. USO is the most heavily traded oil ETF in the world. I only allocate 25% to it because while I believe that oil may have hit already hit its high for this secular bull market.

Portfolio #2 Moderate:
SymbolFund Name% Allocation
DBAPowershares Agriculture40%

---Agriculture Total40%
GLDSPDR Gold25%
SLViShares Silver10%

---Precious Metals Total35%
USOUnited States Oil Fund15%
UNGUnited States Natural Gas Fund10%

---Energy Total25%

The moderate portfolio keeps the same percentage allocation among agriculture, precious metals and energy but adds two new funds. SLV is the most heavily traded silver ETF. UNG is the most heavily traded natural gas ETF. These two important commodities add some extra diversification over the basic portfolio.

Portfolio #3 Complex:
SymbolFund Name% Allocation
DBAPowershares Agriculture25%
NIBiPath Cocoa5%
JOiPath Coffee5%

---Agriculture Total35%
GLDSPDR Gold15%
SLViShares Silver10%
PTME-TRACS Platinum5%

---Precious Metals Total30%
USOUnited States Oil Fund15%
UNGUnited States Natural Gas Fund5%

---Energy Total20%
LDiPath Lead5%
JJCiPath Copper5%

---Base Metals Total10%
COWiPath Livestock5%

---Livestock Total5%

The complex portfolio adds several new funds and categories. For agriculture, we now include NIB, the cocoa ETN, and JO, the cleverly named coffee ETN. For precious metals we add PTM, the platinum ETF. In the new base metals category we include LD, the lead ETN, and JJC, the copper ETN. We also added a small allocation to livestock via COW, the wonderfully named livestock ETN.

Monday, May 11, 2009

New Comments

Check out the new comments style and let me know what you think.

Saturday, May 9, 2009

Fed Open Market Operations Update

Back on January 28th, we predicted that the Fed would soon begin purchasing long dated treasury bonds. You can view the article here.

Sure enough, on March 18th, the Fed announced that it would be buying $300 billion of long dated treasury bonds over the following six months. The first purchases were made on March 25th and have continued ever since. Here is a chart showing these purchases (click on images for larger views):


Since the initial euphoria of the announcement wore off, long dated treasuries have taken a thrashing. Here is a chart of TLT, the 20+ year treasury bond ETF:


The chart for IEF, the 7-10 year treasury bond ETF is not much better:


So far, the results have to be disappointing to the Fed. The Fed now has two choices. Their first choice is to stick with their $300 billion in purchases over the next six months and accept that long dated treasury bond yields are likely to continue rising. The second choice is to increase their purchases in the hope they will meet their goal of suppressing rates.

In our view, the Fed is likely to go the second route and announce an increase in treasury purchases in the coming weeks. The Fed has gone to great lengths to engineer this recovery and the risk of having interest rise in the face of a minor recovery is too great. A quick rise in rates will likely strangle the recovery before it has a real chance to take hold which would be quite an embarassment to the Fed, the Treasury and the President's entire administration.

Some have argued that Ben Bernanke is bound to realize that the treasury markets are just too big to control in any reasonable sense. For those people I would again like to point to my article written on January 28th which shows that Bernanke is certain of his ability to control the prices of long dated treasuries. Whether you agree with Mr. Bernanke's approach to the financial crisis or not, one thing everyone can agree with is that he is not gun shy about putting his theories into practice.

Moving on, the Fed first began to purchase agency debt (obligations from housing government sponsored enterprises) in September, stopped in October and November, began again in December and has continued ever since. Here is a chart showing these purchases:


The Fed has also been purchasing Agency mortgage backed securities since the beginning of the year. Here is a chart showing these purchases:


In total, the Fed has purchased $92 billion in treasury bonds, $85 billion in agency debt and $429 billion in agency MBS since last fall:


As you can see, Fed purchases of treasuries and agencies make up less than half the value of agency mortgage backed securities. In our view, this leaves a lot of room for the purchase of additional treasuries in the coming months. The Fed is playing a very dangerous game. The consequences of losing this game and having the bond market blow up in their face cannot be understated. Those expecting the Fed to sit idly by as rates rise are bound to be surprised.

Much of the data obtained for this article was found at the The Federal Reserve Bank of New York's website. You can visit the site here.

Sunday, May 3, 2009

Meet The Doomers

Gloom and doom is in. Some people see the glass as half full, some see it as half empty and yet others think that what looks like water is a mirage and the glass is actually empty. The post is about the people who fall into the last category. All joking aside, these doomers have been very right over the past few years and are worth listening to.

Gerald Celente is a trend forecaster, author and CEO of The Trends Research Institute, which he founded in 1980. He makes very consistent and reasonable arguments and has a long track record to back up his forecasting confidence. He is predicting total economic collapse. Visit his YouTube channel here.



Max Keiser is a film-maker, broadcaster and former broker and options trader. While I disagree with some of his viewpoints, mainly on minor topics such as intellectual property, I agree with a lot of his ideas regarding economics and the financial industry. He is predicting total economic collapse. Visit his YouTube channel here.



Jim Rogers is the former hedge fund manager of the Quantum Fund and author of Hot Commodities, A Bull in China, Adventure Capitalist and Investment Biker. He has been bullish on commodities and China for many years. Of late, he is most bullish on agricultural commodities. Jim had a rough 2008 but his long term track record is hard to dispute. He is predicting the long term economic decline of the West and the rise of Asia. Visit his YouTube channel here.



Peter Schiff, the President of Euro Pacific Capital and author of Crash Proof and The Little Book of Bull Moves In Bear Markets. While I have issues with this second book, as I noted here, Schiff is better digested in video form. Like Jim Rogers, Schiff had a rough 2008 but I would not bet against him going forward. He is predicting total economic collapse. Visit his YouTube channel here.


So, are the doomers right or are they just chicken littles? Only time will tell.