Monday, April 28, 2008

Pay Attention

The "speculators have taken over the commodities markets and someone (i.e., Congress) must do something about it" meme is spreading...this from Bloomberg today and apropos considering my previous post.

Wall Street Grain Hoarding Brings Farmers, Consumers Near Ruin

By Jeff Wilson
April 28 (Bloomberg) -- As farmers confront mounting costs and riots erupt from Haiti to Egypt over food, Garry Niemeyer is paying the price for Wall Street's speculation in grain markets.
Commodity-index funds control a record 4.51 billion bushels of corn, wheat and soybeans through Chicago Board of Trade futures, equal to half the amount held in U.S. silos on March 1. The holdings jumped 29 percent in the past year as investors bought grain contracts seeking better returns than stocks or bonds. The buying sent crop prices and volatility to records and boosted the cost for growers and processors to manage risk.
Niemeyer, who farms 2,200 acres in Auburn, Illinois, won't use futures to protect the value of the crop he will harvest in October. With corn at $5.9075 a bushel, up from $3.88 last year, he says the contracts are too costly and risky. Investors want corn so much that last month they paid 55 cents a bushel more than grain handlers, the biggest premium since 1999.
``It's the best of times for somebody speculating on grain prices, but it's not the best of times for farmers,'' said Niemeyer, 59. ``The demand for futures exceeds the demand for cash grains.''
Commodity investors control more U.S. crops than ever before, competing with governments and consumers for dwindling food supplies. Demand is rising with population and income gains in Asia, while record energy costs boost biofuels consumption, sending grain inventories to the lowest levels in two decades.

Commodity bubble, toil and trouble (part II)

A colleague recently made his case for commodities to me. I understand the arguments, usually amounting to "China has a gazillion mouths to feed". However, these discussions of "aggregate demand" fail to consider an important initial source of the bubble's inertia. In essence, I disagree with their assessment of risk, but agree with some of their initial premises (i.e. increased global demand)

So, let's talk about governmental intervention.

Whenever the political mechanism is responsible for price movements, it can be equally responsible for violent volatility.

Consider the following:

What if Congress decreased the amount of subsidies for biofuel production? What if they increased the subsidies for non-biofuel use crops?

What if Congress even made a whiff of a mention that U.S. pension funds, endowments, and retirement funds can no longer invest in long only (passive) commodity funds?

What if a Federal Highway transportation (non-commercial) tax was enacted?

These are only examples off the top of my head, but they serve to illustrate that this commodity bubble has an extremely high sensitivity to putative U.S. Legislative action. This is especially the case considering commodities are priced in U.S. dollars. (comparing the U.S. dollar trade weighted index to the GSCI or DJC is an exercise I leave to the reader)

So I understand the underlying demand/supply dynamics, but those can change with the stroke of a pen...and there is far more risk embedded in such a strategy than a discussion of supply and demand dynamics.

Sunday, April 27, 2008

Euro Meme spreading

We are quickly moving towards a capitulation point for the Euro area, especially in light of Berlusconi's victory, which raises non-trivial questions regarding the future viability of the Euro experiment.

And lending standards are presaging the coming difficulty.

Relevant section:

Meanwhile, banks are clamping down on buyers amid fears that the credit crunch is spreading to Europe. For example, Banco Halifax, the Spanish division of Britain’s biggest lender, has increased the minimum deposit required from 30% to 40%, adding about £16,000 to the typical euro mortgage of €200,000. It has also cut the maximum it will lend to borrowers from €2.5m to €1m.


More evidence of narrowing interest rate spreads in developing countries. Look for the BOJ to raise, the Euro and UK area to lower, and for the U.S. to pause.

Price actions (again, news follows price and this is no exception) have already presaged these movements, with the U.S. dollar leading the way.

Two-Year Treasury Notes Fall on Bets Fed Cuts Almost at an End
2008-04-26 08:00 (New York)

By Daniel Kruger and Sandra Hernandez

April 26 (Bloomberg) -- Treasuries fell this week,
pushing two-year note yields to the highest since January,
on mounting speculation the Federal Reserve will halt its
cycle of interest-rate reductions as soon as this month's
policy meeting.

Ten-year note yields climbed a fifth straight week as
crude oil set a record high, fanning concern that rising
prices for food and energy will cause inflation to
accelerate. Traders in interest-rate futures see about a 25
percent chance the Fed will keep its main rate unchanged at
2.25 percent on April 30 after six rate cuts since

``What we're seeing now is a big shift in market
sentiment regarding the Fed,'' said Gary Pollack, who helps
oversee $12 billion as head of fixed-income trading at
Deutsche Bank AG's Private Wealth Management unit in New
York. ``The feeling is the Fed may pause after it meets
next week.''

Friday, April 25, 2008

The Dollar is coming home to roost.

All the negative news in the world cannot stop the international flow of dollars back to the United States. This is not a question of earnings for 1st quarter, but for 3q GDP figures and projected earnings RELATIVE to other international financial asset returns going forward.

Again, earnings, news, pundit opinion, and any economic projection based on the former are lagging reality. Reality is a forward looking concept as economic decision makers are deploying capital for FUTURE appreciation and return.

As I have stated multiple times on this blog, once G7 interest rates compressed, the push back into the dollar would be swift. Aggressive governmental intervention in the form of interest rate reductions and fiscal stimulus packages is exacerbating this effect.

Japan and China lead the way last night with the actions in their respective bond markets, and with inflation the major economic danger, bond yields will increase and continue to compress in a bid to stave off the arbitrage creating govenmental funding "imbalances".

Thursday, April 24, 2008


Once the rule of law returns (or at least the perception of the rule of law) to Zimbabwe a flood of international capital will flow in, not to mention more open policies for former nationals (i.e., mostly ethnic whites who were forcibly removed from their farms)to return and help grow the country.

Also, FIFA will be pressured to host a game in the new Zimbabwe in order to showcase a new Africa.

With African Central Command up and running and talks of a "presence" in Liberia or somewhere else on the equatorial west coast, Africa just might make it past the commodity bubble. Booms increase margins and create temptation and opportunity for misappropriation of assets, especially where legal structures are not firmly in place - which is precisely the scenario Sub-Saharan Africa is in.

By CELEAN JACOBSON, Associated Press Writer 45 minutes ago

PRETORIA, South Africa - Zimbabwe's opposition leader won his nation's disputed presidential election, the top U.S. envoy to Africa said Thursday.

Assistant U.S. Secretary of State for African Affairs Jendayi Frazer said that Morgan Tsvangirai won the March 29 vote, and that therefore no power-sharing arrangement with longtime President Robert Mugabe was needed.

"We think in this situation we have a clear victor," she told reporters. "Morgan Tsvangirai won and perhaps outright, at which point you don't need a government of national unity. You have to accept the result."

But she added: "There may need to be a political solution, a negotiated solution."

Frazer was speaking in South Africa at the start of a visit to bolster international pressure on Zimbabwe's government. The U.S. has long been among Mugabe's sharpest critics.

News follows price.

Fed Fund Futures have already signaled the conclusion for the following article. As I have stated, one should look to the Euro area and the compression of interest rate spreads in the developed world, with deleterious effects for commodity countries and Emerging markets. It's high time for a crisis in one of those countries, and massive profligacy will be revealed when the bubble pops.

Fed Weighs Pause
After Next Rate Cut
Inflation Worries
Loom as Economy
Continues to Stall
April 24, 2008; Page A1

WASHINGTON -- The Federal Reserve is likely to cut its short-term interest rate by a quarter of a percentage point next week -- but then may be ready for a breather.

The Fed, meeting Tuesday and Wednesday, is likely to make what would be its seventh cut in eight months. The reason: Some officials see a case for more insurance against a deeper recession.

But others are concerned a cut could contribute to inflationary pressure with little benefit for growth. That means the option of standing pat will likely also be on the table. If it does cut rates, the Fed could signal in the statement accompanying the decision an inclination to pause and assess the impact of its cuts, which have lowered the federal-funds rate to 2.25% from 5.25% since last year.

Officials say the case for lowering rates further rests primarily on the value of additional insurance against a worse-than-anticipated economic scenario.

The shifting sentiment doesn't mean the Fed thinks the worst is past for the economy. It is almost certain to signal continued concern about economic growth and a willingness to cut rates further if the outlook worsens.

Still, officials would like to see whether their rate cuts, the Fed's other steps to lubricate credit markets and imminent tax rebates help produce a second-half recovery.

Moreover, while they think inflation is headed lower over the next year, they are sensitive to the risk that additional rate cuts could stoke inflationary psychology. Once embedded, such psychology can make a temporary rise in inflation permanent. A willingness to pause in rate cuts could help reassure investors the Fed takes the inflation risk seriously.

Wednesday, April 23, 2008

Russia: "We have no more oil"

Just in time for the "peak oil" theory which has everyone in the world conveiniently forgetting the demand side of the equation when it comes to market prices, Russia is floating trial balloons such as the below. Best to remain skeptical of any claims regarding supply, demand, and prices of oil in a speculative bubble.

Russian Oil Has `Peaked,' Billionaire Vekselberg Says (Update1)
By Greg Walters and Maria Kolesnikova
April 23 (Bloomberg) -- Oil output in Russia, the world's biggest supplier after Saudi Arabia, has ``peaked'' and may decline in the coming years,
said billionaire Viktor Vekselberg,an owner of BP Plc's venture TNK-BP.
Russian companies need tax breaks to spur exploration and
development of new fields to revive growth, Vekselberg told an
American Chamber of Commerce conference in Moscow today.
Oil output is falling for the first time in a decade as
Soviet-era wells dry up and the costs of developing harder-to-
reach deposits surge. Russia pumped 9.76 million barrels a day in
March, down from 9.83 million in December, according to CDU TEK,
the Energy Ministry's central dispatch unit.
The output level we have today is a plateau, stagnation,''Energy Minister Viktor Khristenko said in an interview April 10.

Anchors Away

The Fed has a myriad of ways to gauge inflation. One of the things I pay close attention to is when it switches from measure A to measure B, where the only benefit in doing so is to say that inflation is lower.

It is well known that Bernanke is a big proponent of "inflation expectations". This can be quantified by looking at futures prices and the year over year change in consumer expectation surveys.

The REcapitulator thinks surveys are biased and silly when attempting to gather data for the analysis of macro trends, but futures prices are useful, and far more informative than governmental forecasts. Bernanke and the Fed has cited oil futures prices as a useful guide for inflation expectations - oil is becoming a store of value as its price moves inversely with the U.S. dollar.

So, when looking at oil futures prices (Feb 09 Price: 112.60), I wonder what will the Fed switch to when trying to say inflation expectations are anything but "anchored"?

Consistency in measurement would help the Fed's credibility at this point.

Tuesday, April 22, 2008

Against the FRACTAL!!

It always amuses me when traders and investment professionals start talking about "Chaos Theory" and "FRACTALS". (I always capitalize the word FRACTAL to enhance its aura of mystery and magic...very complicated and wondrous things, these FRACTALS)

FRACTALS are self-similar groupings of scale invariant objects. Got that? what? Going from power laws to deriving a probability distribution that accurately reflects asset returns or risks is impossible. It's intellectual window dressing.

BUT, even if it were possible, had I found the keys of the kingdom, I would never, ever give them away. I assume anyone motivated by economic gain would do the same. So, when I read the following excerpt from an article (read: press release from a publicist) about a "new FRACTAL system", I silently nod and say "the spectrum of human behavior is a narrow one" and file it to the recycle bin in my head.

"In addition to managing money for others, Mr. XXXXX also is willing to teach others how to use the XXXXX Fractal forecasting and trading models. So far he’s trained two proprietary traders and he’s open to sharing it with institutions, but it doesn’t come cheap—1 Fractal charges individuals $500,000 plus expenses, and the price is $2.5 million plus expenses for institutions. The training takes about a week, Mr. XXXXX said, and his teachings are subject to a non-disclosure and confidentiality agreement."

So,I pay this person $500,000 for a week of training...and off I go with my newfound FRACTAL knowledge, confident that I have mastered this technique as applied to trading. Sign me up!

I'll end this post with a quote from Von Mises:

"In the third quarter of the 19th century, the biological analogy was very popular with positivistic economists and sociologists. Serious men then wrote treatises like “what is the intercellular substance of the “social body”. Nobody any longer denies that these studies…were a meaningless toying with words. Today men prefer the mechanical analogy. But this fashion too will pass without leaving a trace.”

...and so it is the same with "FRACTALS"

Commodity Bubble, Toil and Trouble

In light of my article yesterday briefly discussing "crowded trades", today will feature the most crowded trade of all. I wonder how many pundits are recommending passive commodity funds...

Anyway, Anatole Kaletsky gets it right:

"What, then, has suddenly boosted demand for agricultural commodities
and how might this be related to the credit crunch? A possible
explanation is that the rise in prices itself has triggered a
self-sustaining upward spiral of demand, in which investors,
wholesalers and final consumers want to buy more of a commodity each
time its price rises and this leads to more hoarding and still higher
prices. Such self-sustaining price trends are normally rapidly
reversed because value-oriented investors and commodity producers
start to trade against the trend, selling more each time the price
rises. In present conditions, however, it is harder than usual for
speculators to trade against the rising price trend, because bank
lending has dried up. Several American grain wholesalers, for example,
have been pushed towards bankruptcy because they have sold futures
against grain supplies they bought in advance from US farmers and have
then been unable to finance these temporary "short positions" until
the next harvest comes along."

Monday, April 21, 2008


First off, hindsight is 20/20, but one expects better from formerly world class institution.

The shareholder report (produced for Swiss banking regulatory agencies) discussing UBS's write-offs makes for interesting and entertaining reading.

The following (only 10 pages into the 50 page report, no less)describes a firm that simply listened to unnamed "external consultants" who recommended plowing into an already crowded trade, and chased the high returns from ABS, CDO, and any other of the alphabet soup of names that comprise levered credit and/or "fixed income" risk.

It is astonishing that no-one at this SWISS (a brand name that supposedly makes one conjure images of hyper conservative bankers wearing designer eyeglasses) institution threw the "external consultants" out of the board-room.

Here is the snippet from the report:

"At the same time, the (Investment Bank) also undertook a specific review of the Fixed Income business in conjunction with external consultants. It was recognized in 2005 that, of all the businesses conducted by the (Investment Bank), the biggest competitive gap was in Fixed Income, and that UBS's Fixed Income positioning had declined vis-a-vis leading competitors since 2002. In particular, the IB's Fixed Income, Rates & Currencies ("FIRC") revenues decreased since 2004, and accordingly, FIRC moved down in competitor league tables by revenue. According to an external consultant, the IB Fixed Income business grew its revenue at a slower rate than its peers.

The external consultant compared the gap between UBS and the composite leader (defined as top 3 in a specific product area) in various fixed income products and concluded that the (Investment Bank) had gaps in the Credit, Securitized Products and Commodities businesses, with smaller gaps in Rates and Emerging Markets.

The consultant also noted that strategic and tactical initiatives were required to address these gaps and recommended that UBS selectively invest in developing certain areas of its business to close key product gaps, including in Credit, Rates, MBS Subprime and Adjustable Rate Mortgage products, Commodities and Emerging Markets. ABS, MBS and ARS (in each case including underlying assets of Subprime nature) were specifically identified as significant revenue growth opportunities. The consultant's review did not consider the risk capacity (e.g. stress risk and market risk) associated with the recommended product expansion"

Amazing. Restraint does not get one promoted. (or share in year-end bonuses which do not have to be returned due to poor performance)

Thursday, April 17, 2008

The Euro.

There have been many articles in recent weeks discussing the future viability of the Euro, which has promptly ignored these warnings and gone on to record levels against the dollar.

A few people asked me "how can this be?"

The occupation of government is to "pluck the most feathers with the least amount of hissing" from its populace, while keeping a monopoly on violence. Traders know this and punish governments who begin to think their monopoly powers apply to free markets as well.

Put less grandly, if the EU will not lower interest rates, and continues to be blind to their internal problems, traders will oblige them and push the dollar price of the Euro to record levels.

Markets win. Beurocrats and civil servants lose. It happens over and over and over again. Policy makers become arrogant in their belief that they can somehow "centrally plan" a "soft landing" and markets give them a dose of reality mixed with humility.

Then the beurocrats write books explaining how difficult it is to engineer an economic if we did not already know that.

Parent of Chaos theory...

...dead at 90.

Along with the other parent, Mandelbroit (who has made so many contributions to mathematics applied to markets), Edward Lorenz was the pioneer on the subject of "Sensitive dependence on initial conditions", or "chaos theory".

More of a meditation than a theory, it still holds great impact for those of us who attempt to discern movements between the "1st and the ith" variable (a cute way of saying that its really difficult to compute relationships when there are 100s of variables in a equation, and initial conditions are "fluid" at best).

I guess the final question is: Who gets custody of the kids" for these two giants of mathematics.

Full Article:

Relevant portion:

"As recounted in the book "Chaos" by James Gleick, Dr. Lorenz's
accidental discovery of chaos came in the winter of 1961. Dr. Lorenz
was running simulations of weather using a simple computer model. One
day, he wanted to repeat one of the simulations for a longer time, but
instead of repeating the whole simulation, he started the second run
in the middle, typing in numbers from the first run for the initial

The computer program was the same, so the weather patterns of the
second run should have exactly followed those of the first. Instead,
the two weather trajectories quickly diverged on completely separate

At first, he thought the computer was malfunctioning. Then he realized
that he had not entered the initial conditions exactly. The computer
stored numbers to an accuracy of six decimal places, like 0.506127,
while, to save space, the printout of results shortened the numbers to
three decimal places, 0.506. When typing in the new conditions, Dr.
Lorenz had entered the rounded-off numbers, and even this small
discrepancy, of less than 0.1 percent, completely changed the end

I can relate...

Wednesday, April 16, 2008

Anecdotes from the Fed

...also known as "The Beige Book".

Mixed reports, but it does provide some justification for the Fed's tenacity in lowering rates. Since the price of money (a commodity) is more or less standardized by the Fed's setting of interest rates, "LENDING STANDARDS" becomes a massively influential variable in predicting where the economy will go.

So, this portion of the report held great interest for me:

"Credit quality was reported to have deteriorated, on balance,
since the last report. Increased delinquency rates were noted
by New York, Philadelphia, and Cleveland, while Kansas City
reported that loan quality remained lower than a year ago.
Widespread tightening in credit standards was reported,
especially on residential and commercial real estate loans. In
general, banks were reported to be tightening credit standards
in the New York, Cleveland, Atlanta, Chicago, Kansas City,
Dallas and San Francisco Districts. In addition, Boston noted
that standards remain tight on commercial mortgages, while
Philadelphia indicated that banks are limiting lending in this
category. Richmond indicated tighter standards on residential

Friday, April 11, 2008


Pretend you are the CEO of a very large multi-national corporation with a massive product line, horizontal and vertical integration in several class-leading categories, and have historically displayed a certain penchant for "earnings management".

If economic conditions were poor, would you like to clean some nasty things off your balance sheet and tell all the analysts: "It's the macro-environment, stupid", and that forecasts for business growth are "poor"? (all the while never mentioning how accurate your predictions of market conditions have been) Or, would you rather continue to report "bad" results when conditions were favorable?

Then, when (warning: silly market analogy alert) the brush fire allows new plants to grow and economic conditions improve, you can finally look like a rock star and cash out on all those stock options that have been 20 fathoms deep.

Given compensation structures, short term incentives, and the fact that this particular company (o.k., o.k., its GE if you have not figured it out by now) has not had a good record of soundly trouncing street estimates, the above seems like an awfully good strategy.

Wednesday, April 09, 2008

"Why" indeed...

A monthly columnist and "financial consultant" from a "respected" financial publication wrote the following:

"Volatility makes people nervous, and when they are nervous they think about recession. Here's a heretical observation: The basic economy is doing better than most reports, and pockets of the stock market are sensing that. We keep hearing that the consumer is under pressure. Meanwhile, stock in Wal-Mart, where America shops, continues to hold firm in the $50 area. If we truly are mired in a recession, then why are Caterpillar (up 5% this year) and IBM (up 10%) doing so well?"

Why indeed. Again, my position going forward should be clear enough by now, but to answer this man's question, could it be that these (and most of the S&P 500) derive a significant amount of their revenue from foreign sources (or wholly-owned foreign subsidiaries)? Could this fact be augmented by the decrease in interest rates, and therefore the discount rate (or cost of capital) used to evaluate the future cash flows from these companies?

Think about that. A company is earning more while paying less.

Once again, the dangers of stringing together disparate facts and searching for confirmation (rather than falsification) rears its ugly head.

Musical Chairs

Key takeaway from this article:

"U.K. house prices dropped the most since 1992 last month as the seizure in worldwide credit markets made mortgages harder to obtain, a report by HBOS Plc showed. While manufacturing unexpectedly rose in February to the highest since 2001, the Confederation of British Industry says the Bank of England needs to reduce the benchmark interest rate tomorrow.

``The Monetary Policy Committee is still odds-on to cut,'' said Paul Dales, an economist at Capital Economics Ltd. in London. ``The better news on the U.K.'s industrial sector does little to offset the dire news on the housing market seen in recent days.''

The pound weakened to 80 pence per euro for the first time earlier today after the consumer confidence report. It traded at 79.85 pence at 11:13 a.m. in London."

With traders, former politicians (doubtlessly using the media to float "opinion balloons" to constituents regarding interest rate cuts), and economists all pining for a BOE rate cut, the stage is set.

My position on the U.S. dollar and S&P 500 stocks should be clear. Just now the rest of the western world realizes that they are playing a different game and competitive devaluation is the only move they have.

It is only a matter of time before the EU is forced to play "catch-up" to the rest of the world's declining interest rates and depreciating currencies...or there will be no seat for them once the music stops.

Tuesday, April 08, 2008

From the Fed Minutes released today...

Fed almost out of bullets, but we are just entering the point where effects from last year's cuts will be felt.

Earnings are bad, but not destructively terrible and U.S. business (a large part of which depends on foreign trade) has the wind at its back.

"In their discussion of the economic situation and outlook, FOMC
participants noted that prospects for both economic activity and
near-term inflation had deteriorated in view of increasingly
fragile financial markets and tighter credit conditions, rising
prices for oil and other commodities, and the deepening
contraction in the housing sector. Home prices had declined more
steeply than anticipated, and the weakening housing market,
combined with a softening in labor markets, appeared to be
weighing on consumer sentiment. Businesses also were seen as
becoming more pessimistic and cautious, despite a strong foreign
demand for U.S. goods. Strains in financial markets had increased,
portending a possible further tightening in the availability of
credit to households and businesses. Against this backdrop, many
participants thought some contraction in economic activity in the
first half of 2008 now appeared likely. The economy was expected
to begin to recover in the second half of the year, supported by
recent monetary policy easing and fiscal stimulus. Accommodative
monetary policy and a recovery in financial markets along with an
abatement of the downdraft in housing activity were expected to
help foster a further pickup in economic growth in 2009. However,
considerable uncertainty surrounded this forecast, and some
participants expressed concern that falling house prices and
stresses in financial markets could lead to a more severe and
protracted downturn in activity than currently anticipated.
Participants noted that recent readings on inflation had
generally been elevated, that energy prices had risen sharply,
and that some indicators of inflation expectations had risen.
Most participants anticipated that a flattening of oil and other
commodity prices and easing pressures on resources would
contribute to some moderation in inflation pressures. Nonetheless,
uncertainties about the outlook for inflation had risen."

Greenspan: It's not my fault

"Doubtless each individual housing bubble has its own idiosyncratic
characteristics and some point to Federal Reserve monetary policy complicity
in the US bubble. But the US bubble was close to median world experience and
the evidence that monetary policy added to the bubble is statistically very
fragile. Paul De Grauwe, writing in the Financial Times' Economists' Forum,
depends on John Taylor's counterfactual model simulations to conclude that
the low funds rate was the source of the US housing bubble. Mr Taylor (with
whom I rarely disagree) and others derive their simulations from model
structures that have been consistently unable to anticipate the onset of
recessions or financial crises. Counterfactuals from such flawed structures
cannot form the basis for policy."

Of course the evidence is going to be "statistically very fragile". As any attempt to compare sets of completely different dependent variables would be.

However, Counterfactuals are something we use extensively here. Briefly, one asks something like this: "If its not raining, then it cannot be cloudy." Or in the above context "if the fed funds rate was not low, then there would not have been a U.S. Housing bubble".

Counterfactuals are a tool, like everything else. We have found that this tool is incredibly difficult to use when large numbers of independent variables are involved. Stripping out historical phenomenon in a study and concluding a future outcome is something we have not been able to do with any degree of large scale macro-studies.

All this being said, Mr. Greenspan's vigorous defense of his pump-priming monetary policy is amusing, and reminds me of the following (paraphrased)quote from a friend: "The major career choice for former central bankers is ascertaining what their former colleagues are likely to do." It did not take long for PIMCO to hire Mr. Greenspan as a "consultant".

A rule of thumb: when networking is valued over accurate forecasts, one should be very, very skeptical of the output, and Mr. Greenspan has talked for hundreds of hours and wrote thousands of words on the subject.

Strangely comforting.

Monday, April 07, 2008

China: magnanimous neighbor and good Shepard.


The below has nothing to do with Tibet, the Olympics, the U.S. Election, missile defense systems, the declining dollar or anything else. It's simply China being a magnanimous global citizen and helping out its people as a good and righteous Shepard.

/end sarcasm

China Agrees to Let Banks
Buy U.S. Stocks, Mutual Funds

HONG KONG -- Chinese banking and securities regulators signed an agreement with their U.S. counterparts Monday that will help lay the groundwork to enable mainland investors to buy and sell U.S. securities.

Under the plan, Chinese banks will be able to buy U.S.-listed stocks and mutual funds for their clients.

The agreement signed between the Securities and Exchange Commission and the China Banking Regulatory Commission marks a further expansion of QDII -- short for the qualified domestic institutional-investor program -- and brings the U.S. in line with similar agreements signed between Beijing and regulators in Singapore, Hong Kong, Japan and the U.K.

Sovereign Wealth Funds...

Hysteria regarding these investment vehicles is nearing panic levels...which is when yours truly feels ethically bound to inject some skepticism and rationality into the discussion.

No, SWFs are NOT the biological equivalent of white blood cells, waiting to engage in financial phagocytosis upon the U.S. and hasten the demise of our way of life.

The reason is as follows: The liquid wealth (in terms of cash on hand as opposed to oil in the ground...the source of many of the more aggressive SWF's wealth) of these funds is not that ominous.

This is because SWFs consider interests in national companies as "assets" on their balance sheet. This is hardly a source of liquid capital that can be used to purchase, oh, say, the United States Senate or some other equally absurd consequence.

One need only look at the U.S. Treasury data tables to determine how much liquid wealth SWFs hold (the following is from the 3 major oil exporting countries, whose SWFs seem to elicit the most angst):

Treasury Securities: (Oil Exporters) $140.9
Foreign Exchange Reserves (Oil Exporters) $110.0

This is a far cry from "the natural enemies of the U.S. have 1.5 Trillion of our money and will buy everything" meme that currently infects's no different from 1990 Japan which, if memory serves, promptly went bust shortly thereafter.

Friday, April 04, 2008

On a more philosophical note...

This statement, taken from the below Bloomberg hagiography about George Soros, is a little misleading:

In reality, Soros says, misjudgments and misconceptions influence market prices, which in turn distort the fundamentals that they are meant to reflect. He calls this two-way feedback loop ``reflexivity,'' a concept influenced by the philosophy of Karl Popper.


Yes, Karl Popper (who was enormously influential on Mr. Soros's thinking as a professor to Soros at London Business School) "influenced" the theory of reflexivity. But "reflexivity" is not a new concept...more on that later.

Karl Popper is one of my idealogical heroes, and "Open Society and its Enemies" is required reading, but he certainly did not invent reflexivity or recursive systems.

But, giving due credit, Kurt Godel was the first to enumerate the curious behavior of functions which describe themselves. One could also argue that Darwin observed this as well in The Origin of Species.

There is a well-known saying among investors that "news follows price". In other words, you see the price action and a news article quickly follows explaining the reasons for the movement...this happens for the obvious reason that information is far more valuable when a small number of people have it.

In this case, "reflexivity" followed recursive functions and the math that came with it. And, in my humble opinion, it is in Mr. Soros's best interest to increase general anxiety in order to "reflexively" influence the upcoming election. Mr. Obama has very, very close ties with Mr. Soros.

Competitive Devaluation

The following excerpt is bewildering, and I am always amused at how policy-making economists in the EU (to a man, career beurocrats) tangle up their thinking. The article is a warning about lowering interest rates for fear of an "inflationary spiral", yet presents as evidence oil and food.

Oil and food markets are priced in dollars (well, the futures markets in any case), so from the evidence presented it would seem lowering EU interest rates (depreciating the Euro) would be the proper policy measure.

Friday April 4, 9:29 am ET
By Aoife White, AP Business Writer
European Finance Ministers Urge Efforts to Cool Inflation, Warn of Price Spiral

BRDO PRI KRANJU, Slovenia (AP) -- European officials warned Friday that governments must act to curb a possible inflation spiral as record-high price increases risk hurting people on low incomes.

High prices for oil and food pushed inflation to 3.5 percent in March, far above the European Central Bank's guideline of 2 percent.

European Central Bank President Jean-Claude Trichet signaled a determination to keep interest rates on hold, saying "price stability is something which is essential for the poorest and the most vulnerable of our citizens."

"They cannot protect themselves against inflation," he said after he joined euro finance ministers for talks. "It is extremely important that we understand that moderation today is necessary if we want to deliver price stability in the medium term."

Thursday, April 03, 2008

Credit is easing (cautiously), part II

More evidence of easing credit conditions amid swirling rumors of another big 5 investment bank having severe cash problems. My retort to this line of thinking is that if "traditional" markets, such as repos, etc. have dried up, why not borrow from the Fed for a pittance?

Stone & McCarthy (Princeton) -- The Fed announced the results of the Term Securities Lending Facility (TSLF) auction. The auction opened at 200PM and closed at 230PM.

This was a "Schedule 1" auction, which includes all collateral that is eligible for tri-party repurchase agreements arranged by the NY Fed's Open Market Desk.

$46.9 bln was bid in today's $25 bln auction, for a bid/cover of 1.88. The stop-pout rate was 16 bps. These results compare to last week's "Schedule 2" auction, which generated a total bid of $86.1 bln for the $75 bln auction, for a bid/cover of 1.15, and a stop-out rate was 33 bps.

Both of these auctions tell a similar story in the sense that the dealers did not have to bid aggressively to secure collateral. Dealers paid a modest 6 bps above the stipulated minimum bid which is 10 bps for "Schedule 1" collateral auctions; last week dealers paid a modest 8 bps above the minimum bid which is 25 bps for "Schedule 2" collateral auctions. There is no sign of a distress bid. While there was a higher bid/cover ratio in today's auction, that needs to be considered in the context of the smaller auction size of $25 bln vs last week's $75 bln.

We think that both of these auctions are good news in the sense that they do not convey any sense of urgency on the part of dealers to finance positions. A lack of urgency suggests that there is also a lack of major stress. Today's auction did generate $46.9 bln bids, so there is a demand for some financing assistance just as there was a week ago. However,

This week's results again suggest that financing stresses may be less severe than feared because this first TSLF auction did not attract massive interest.

Wednesday, April 02, 2008

Credit is easing.

This is good news. The Fed is auctioning less (yes, I know its balance sheet is somewhat lopsided at the moment) and accepting less kinds of security as collateral. The Fed has a pretty good idea of the needs of depository institutions and investment banks at the moment, and we think that this, coupled with the action in the Term Auction Rate facility, is a good sign.

"Boston, April 2. Details of the second-ever TSLF auction are quite different from the first, most notably in the sharp drop in the offering amount. The Fed will auction just $25 bln in Schedule 1 collateral, down from $75 bln in Schedule 2 collateral at last week's auction. The minimum fee rate will be 0.1000%, compared to a minimum fee rate of 0.2500% last week. The Treasury general collateral basket includes 22 issues, including two inflation index issues. That's down from 25 issues (four TIIS) last week."

Defense Agencies

We scan the Defense agencies on a quarterly basis looking for nuggets on defense spending and changes in fiscal expenditures. Interesting to note what the "most significant" news story was for 2007. One would think that global warming is not exactly an "imminent threat" to U.S. security.

Naval Year In Review

World Naval Operational News Highlights

The ten most significant naval news stories / themes this year included:

* The US military's recognition that climate change poses a security threat to the U.S. Most interesting was their recommendation that the U.S. government work to mitigate climate change.

* The Chinese anti-satellite test which showed that China has the capability to destroy satellites in low earth orbit. Could the U.S. Navy operate today without satellites?

* The Russian cyberwar waged against Estonia, which showed how wars in cyberspace will be conducted. Could the U.S. Navy have defended itself as well as the Estonians did?

* The success of the surge / Sunni Awakening in Iraq. Remember that the Sunni Awakening began in Anbar Province and was aided by the US Marines first.

* The seizure of Royal Navy personnel in the Gulf by Iran. Iran continues to take an offensive rather than defensive attitude in the Gulf.

* The growing sovereignty claims over the Northwest Passage. This year Russia planted a flag on the seabed there, the US Coast Guard opened a base there, and the Canadian Navy funded a class of arctic patrol ships intended to work there.

* The resurgence of the Russian Navy, funded by petrodollars. Long range patrol flights coupled with the first task force deployment to the Mediterranean Sea since Soviet times means the Russian Navy is (mildly) back.

* The decreasing size of the Royal Navy. Note though its two new aircraft carriers were formally funded this year.

* The deepening disaster of the U.S. Coast Guard's Deepwater procurement program. It seems empowering contractors to oversee their own contracts was not such a great idea after all.

* The crisis in the U.S. Navy's shipbuilding program has come to a head with the canceling of follow-on Littoral Combat Ships due to massive cost overruns. Will the U.S. Navy finally take a more hands-on approach to its shipbuilding programs to keep costs down?

Tuesday, April 01, 2008

Letter from a friend II...

...who inquired about our "time for greed not fear" call on stocks:

"Vix coming down fast, but then when you take the largest negative and turn it into a positive doesn't leave much to complain about... Still worried about foreign stocks I know they r down a lot, exception brazil."

My reply:

"Yes...and the volatility of the Vix is coming down too. This is "different" than the last rallies...that's the quantitative difference.

And we have a completely different liquidity situation with aggressive policymaking...that's the qualitative difference."

I realize this is a technical answer. Foreign asset holders are now coming back to the U.S., and the rallying dollar only confirmed this today.

A general note: Any readers are invited to email me or comment. with any questions or excoriations.

Briefly Speaking (liquidity and credit)

One of the reasons my firm has taken the (prescient)view that the worst of the credit malaise is behind us is the extraordinary measures taken by the Fed, and the Term Auction Facility in particular.

A bombastic and loud member of the media regaled the Fed last August to "OPEN THE DISCOUNT WINDOW!!".

We knew this was not likely to occur, and that the credit crunch would continue.


When your counter-parties to trillions of dollars in levered assets are other multi-national investment and commercial banks, you do NOT want to SIGNAL to them that your institution has borrowed funds from the discount window. It is not a secretive process and the entire world will know what you have done, and, as we have seen, rumors can do massive damage to institutions whose main asset is confidence in their financial position.

So no-one took advantage of the Fed's commitment to open the window to all-comers (subsequently, recently, several investment banks borrowed at once to "remove the stigma").

So the Fed saw the conditions, and suprisingly enough, innovated a solution. The Term Auction Rate Facility is more anonymous and has been a tremendous success thus far.

This is one of the reasons we see the worst of the credit crisis (save more write-offs of a billion here, a billion there...) is now over.