01 April 2015

Of Some Interest

For a long while now, I've been needling the micro- and quant crowd with respect to understanding and predicting interest rates. The real rate is set by the productivity of physical capital used by business. When business can't figure out what to do with their moolah (demand), as has been the case since at least 2000 (all that moolah went into housing, rather than productive physical capital, for a reason), good old supply and demand drives down price (interest). When business considers yet another web advert platform the wisest placement of capital, well... The reactionaries always claim, now that the rate is low, that the Fed (and ECB and Japan and ...) are killing investment by their actions. Never mind that when rates are high they bitch that Damn Gummint debt (i.e., interest payments) drives out private investment. Cake and eat it too, and all that. In sum, the moolah hoarders want the American taxpayer to ship them 10%/annum no matter what's going on in the real economy. In fact, a sort of bailout: no use for moolah in the real economy, then the Damn Gummint should pay them their God given 10%! Nice work if you can get it.

Well, Gentle Ben has spoken up:
But what matters most for the economy is the real, or inflation-adjusted, interest rate (the market, or nominal, interest rate minus the inflation rate). The real interest rate is most relevant for capital investment decisions, for example. The Fed's ability to affect real rates of return, especially longer-term real rates, is transitory and limited.

The bottom line is that the state of the economy, not the Fed, ultimately determines the real rate of return attainable by savers and investors.

He closes with
The state of the economy, not the Fed, is the ultimate determinant of the sustainable level of real returns. This helps explain why real interest rates are low throughout the industrialized world, not just in the United States. What features of the economic landscape are the ultimate sources of today's low real rates? I'll tackle that in later posts.

It may be time to send him a bill for my consulting services.

29 March 2015

Who Will Give a Fig?

The general view of Apple is that it is a Midas money maker. Yet, before the iPhone, it wasn't. With the iPod, Apple began the successful morphing from computer company to toy company. And, it wasn't the first attempt. Remember the Newton? Its short life is explained by bulls and bears in two ways:
Bull: Newton was just too far ahead of its time
Bear: Newton just didn't do anything anyone really needed

The Bear is mostly right. One might argue that iPhone 6 is Newton Reborn. Don't say that too loud near a Fanboi, however.

The trick Apple pulled off with the iPhone was to morph telephone communication into infotainment device. Before the iPhone, cellphones were really portable telephones. Yes, with a flip-phone one can have some measure of innterTubing, but iPhone shifted the emphasis to selling apps. Despite Jobs' objection to phones larger than about 4", without them iPhone wouldn't generate the profit it does.

Which brings us to Watch. Will anyone give a fig about it?
Bull: of course, it's just the latest in Apple bling (or is it, shine?) that the X% can't do without
Bear: what sort of app can one turn into infotainment heroin on a postage stamp sized screen

Logically, Bear is right. Watch can do little but tell you the time without the tether to iPhone. Even as a watch (saw the TeeVee advert last night), it's not very interesting. What makes a watch interesting is the 3D depth of the face. All those tasty nooks and crannies. Watch's display, while colorful, is just flat and boring.

Time will tell, but I sense more Newton, this time.

24 March 2015

Verrry EEEnteresting!

Do you remember who made that phrase famous? Ain't gonna tell ya.

What I am gonna ask is a simple question. The "I'm entitled to my 10% risk-free payment on my moolah" crowd are starting to make noise again. Fisher, ex-Dallas is in the news.
With all this liquidity in the system once it gets activated into real investment and the velocity of money picks up, then what might happen? The real challenge to my successors and the FOMC (Federal Open Market Committee) is to manage that carefully, and to make sure it doesn't become inflationary fuel. It has that potential.
[Aside: my emphasis, and his admission that neither the Stimulus nor QE worked.]

The question: where does the moolah to pay the interest come from?

Since Fisher is of the 10% crowd, the sooner his cabal can get their money for nuthin' and their chicks for free, the better. What he pleasantly ignores is the simple fact that The Great Recession was caused by the over-supply of idle moolah chasing 10% risk-free income. The Giant Pool of Money is still out there, fattened up with all that added moolah sitting, idle of course, on corporate balance sheets. Trillions of dollars that the CxOs, aka Masters of the World, have no bloody idea how to invest into physical capital. To put it plainly: there's been a stark lack of demand for real investment for more than a decade, nearly two. If QE had worked, it really didn't, the moolah wouldn't be sitting on those balance sheets, but converted to physical capital. The Fed (and the ECB and Japan and ...) is pushing a string. Treasuries still get bought at cratered rates just because there's so much moolah chasing risk-free bonds; the CxOs can only counter with a 0 opportunity cost. And the US Treasury isn't the only bond going at auction for next to no interest. All that moolah chasing risk-free return. Remember your Econ 101 class, and virtually anything written by Friedman, about government debt crowding out private investment and how terribly horrible such a situation is??? Well, those Masters of the World want the Damn Gummint to pay them more than they can generate in their businesses. Just because they've accumulated all that moolah. And you and I and the rest of the 99% have provided them with that moolah. Crowding out? Not so you'd notice from them.

The real interest rate is never determined by monetary policy or gold bugs, just by increases in real productivity in real production. There has been a significant slacking off of such. Consider the "innovations" in consumer goods over the last couple of decades. How many of them had the impact on household life as did the automobile, telephone, washing machine, stove, dishwasher, vacuum cleaner, etc. The last such is likely the microwave oven. When was it invented? Depending on definition, as early as 1933, or as late as 1945. In any case, a long time ago. Over the last two decades? Mostly toys and miniaturization of existing devices. Well, and Watson and the self-parking car. But both of those are engineering exercises, not scientific discovery.

The point being: we're not in 1850 with most of physics and chemistry and biology yet to be discovered. Real return is paid for out of increased productivity. One might argue that playing games on mobile phones (i.e., not using the phone as a phone, in the first place) diminishes human productivity. Without such an increase in output, the vig has to come from delayed/foregone consumption; otherwise known as a Zero Sum Game. In other words, paying the Fat Cats their 10% comes out of the lives of the rest of society. Not a prescription for a long lived, stable society.

17 March 2015

New Gold, Part The Second

Well, that didn't take long. Time for the Second Installment. And I still Hate Neil Irwin; perhaps I should sue ESPN and Laettner for trademark infringement? It was just a few days ago that New Gold got its own serialization. Today Neil Irwin offers up some quotes that I couldn't get.

Let's start with:
In India, it is a leading electric utility, Jaiprakash Power Ventures, selling off facilities and negotiating with lenders to avoid a default, having increasing its debts thirtyfold in six years.

Before getting into the New Gold aspect of that, a quick tangent. Gentle reader may recall the observation that even the 1% will require Obamacare if they get their way in excluding a significant fraction of the 99% from healthcare. The issue, of course, is amortizing the fixed cost of healthcare. It was reported yesterday (I forget which newscast I heard it from), that electric utilities here in the USofA are banding together to penalize home solar. The argument is simple: for every house that goes off grid with solar panels, the fixed costs thus lost to price must be born by those that remain on the grid. The utility lobby is shrewd in framing the issue as, "the rich can avoid the grid, leaving higher costs to the poor on the grid". Or, as the old saying used to condemn stupid businessmen: "we lose money on each widget, but make it up on volume". In fact, that's exactly how large corporations do make money; they spread large fixed cost over large output. (This is also why obliterating the middle class is bad for capitalists, but they haven't figured that out yet.) If Rolex sold watches by the tens of millions, they'd cost not much more than a Timex. You can do the thought experiment as an exercise.

OK, back to New Gold. What Irwin, and other high priced pundits, doesn't tell you is what QE was all about. The right wingnuts in particular framed QE as "printing money" into the general economy; dropping dollars from an airplane over every Anytown, USA. "Inflation is coming. Inflation is coming." Of course, that hasn't happened, because QE was structured so it couldn't happen. QE raised the demand for bonds, thus driving up their price and driving down return (interest rate). The Fed (and ECB and Japan and ...) was pushing a string, assuming that by lowering the opportunity cost of physical investment, corporations would turn all that moolah into plant and equipment rather than yet more convoluted fiduciary instruments.

But, none of these "banks" bothered to look at the history of The Great Recession. To wit: it was caused by The Giant Pool of Money ending up in housing (by definition, a non-producing asset class) rather than physical productive investment in the first place; the lack of willingness to turn fiduciary capital into physical capital was the real cause of The Great Recession, so QE by itself didn't matter. Changing the rules to remove the obvious egregious uses helped. So, most of QE went into various fiduciary products. Stock buybacks. Sub-prime used car loans (d'oh!). And, it turns out, all those explosive emerging markets.
In effect, as Fed policy makers sit around a mahogany table in Washington to try to guide the United States economy toward prosperity, their actions are having outsize, often unpredictable impacts across the globe, owing to the dollar's central role in the global financial system. [my emphasis]

The point, of course, is that the impacts are purely predictable. The US buck is New Gold and if there isn't enough to go around, markets get screwed.
By September 2014 there were $9.2 trillion of such dollar loans outside the United States, up 50 percent since 2009, according to the Bank for International Settlements.

The cries of anguish from the likes of Apple and IBM and ... over the devaluation of their winnings in other currencies just break my heart.
Since the Federal Reserve signaled in summer 2013 that it would wind down its "quantitative easing" policy of buying billions of dollars in bonds using newly created money -- that the gusher of dollars flowing into the global financial system would come to an end, in other words -- the dollar is up 25 percent against a basket of commonly used international currencies.

Again, the mistake of assuming that US bucks are all the same. They are, of course, but not really if they remain sequestered in the banking industry. Again, the Fed didn't send out 747s dropping Franklins over the countryside; if they had we'd be closer to real full employment than we are. Businesses only expand to satisfy unmet demand; the notion that they create output just because they can is silly. The US banking system had all those trillions of bucks sitting on the balance sheet. American corporations had no use for them; they also had/have outlandish cash positions, even with the foreign devaluations. Real returns, direct real returns, come from new productive plant and equipment put to good use. Returns from fiduciary instruments aren't inherent, but depend on increased income from the holder. Which is why The Great Recession happened; houses don't produce saleable output and household incomes certainly weren't/aren't rising.

Hyun Song Shin, who heads research at the Bank for International Settlements, argues that a rising dollar has an effect of tightening the supply of money across the global economy.

As they say in Texas, "Boy, howdy!!"

15 March 2015

Mutually Assured Destruction

There is no whining in baseball. Well, that's a paraphrase. Situationally, there is not much that financial quants can tell you worth knowing.

Yet, another story.
Look more closely at those gaudy returns, however, and you may see something startling. The truth is that very few professional investors have actually managed to outperform the rising market consistently over those years.

It's not a complete condemnation, though,
The data in the study didn't prove that the mutual fund managers lacked talent or that you couldn't beat the market. But, as Keith Loggie, the senior director of global research and design at S.&P. Dow Jones Indices, said in an interview last week, the evidence certainly didn't bolster the case for investing with active fund managers.

All those thick books on financial engineering and academic papers? There are better ways to exercise your quant muscles.

13 March 2015

New Gold, Part The First

As has been discussed in these various endeavors over the last couple of years, the US Buck is the globe's New Gold. There just isn't enough of the yellow stuff to go around. And what with Apple figuring out how to make 18k with less than 75% Au, one wonders how the gold bugs are sleeping at night? As always with Apple, and its cabal of knuckleheads with more money than brains, "cheap goods sold dear". Apple is a marketing machine, pure and simple.

Once again, we see an object lesson in the conflict twixt the macro-quant and the micro-quant. What's good for Apple isn't necessarily good for the USofA. Or anyone else, for that matter.

Which brings us to today's Krugman installment. He isn't as forthright as I've been on the subject of New vs. Old Gold, but today's musing gets closer to the bone. The bone being: in order for the globe's commerce to move forward, and avoid that deflationary trap, the value of US Bucks has to keep expanding out in Those Other Countries.
We've been warned over and over that the Federal Reserve, in its effort to improve the economy, is "debasing" the dollar. The archaic word itself tells you a lot about where the people issuing such warnings are coming from. It's an allusion to the ancient practice of replacing pure gold or silver coins with "debased" coins in which the precious-metal content was adulterated with cheaper stuff. Message to the gold bugs and Ayn Rand disciples who dominate the Republican Party: That's not how modern money works. Still, the Fed's critics keep insisting that easy-money policies will lead to a plunging dollar.

Well, as already pointed out, Timmy has no problem debasing Old Gold if it makes him a couple of extra bucks.

And, in order to keep good order in international commerce, this means the US has to run trade deficits each and every year.
Who wins from this market move? Europe: a weaker euro makes European industry more competitive against rivals, boosting both exports and firms that compete with imports, and the effect is to mitigate the euroslump.

Well, German luxury goods exporters, in particular. The 1% get a break on the next Mercedes or Audi. How thoughtful.

Readers may have noticed that the financial services industry, insurance and brokerage in particular, have gone on an advert blitz in the last couple of years. Scaring the non-wealthy into thinking like the truly wealthy; toss more moolah to the financial services mega-corps and quit buying stuff. Two problems with that are immediate:
1) the tsunami of moolah that moved into US (and Spain and ...) real estate due to no demand from industry is still out there looking for above average returns with below average risk; add in Ma and Pa Kettle's nest egg, and one gets yet lower interest return -- that ol' supply and demand canard.
2) the current US and global malaise is directly the result of over supply of (or, slack demand for) consumer goods due to slack growth, if at all, in median income

In the end, real return is a measure of real improvement in production. We know, right wingnuts excepted, that production gains over the last few decades have flowed to the 1%, rather than the rest of us. When you've got more moolah than you can spend, getting more won't appear in real demand. Surprise: it hasn't. D'oh!

As described before, paying interest for the use of moolah without better productivity from the "investment" is just forgone consumption. There won't be any real return generated. This is the primary reason for the Great Recession: paying the vig on house mortgages comes out of the incomes of the "owners" of said houses. And, increasing incomes of those holders aren't generated by the houses, of course. And those incomes weren't, and aren't, increasing. Eventually, 2 + 2 = 4 couldn't be denied.

The new "Housing Bubble"? Sub-prime used car loans.

09 March 2015

Another Quandry

Hot off the presses:
Germany's trade surplus narrowed to EUR19.70 billion from EUR21.60 billion (expected surplus of EUR21.00 billion) as exports fell 2.1% month-over-month (consensus -1.5%; prior 2.8%) and imports declined 0.3% (expected 0.5%; last -0.7%)

The problem with killing your customers is that you end up killing yourself. The Great Quandry twixt the macro-quant and the micro-quant.