Mauldin Makes the Supply-Side Pitch

John Mauldin's latest newsletter, entitled "Debt Be Not Proud", examines a couple of recent studies linking larger government ot lower economic growth. The first study is by Bergh and Henrekson; Mauldin observes,

The first study we'll look at shows a clear inverse correlation between the size of government and growth. This really confirms common sense, as government only takes from private production to fund its spending. And while one can make a case that some government spending is productive, much of government spending, including transfer payments, does not contribute to that case. That is not the same as arguing that those transfer payments should not be made. It simply points out that there is a cost to society to increase the size of government. And that cost is in jobs, hence the ugly employment numbers.
Bergh and Henrekson find a 'significant negative correlation.' Specifically, 'an increase in government size by 10 percentage points is associated with a 0.5% to 1% lower annual growth rate.'" (bold emphasis is Mauldin's)

Mauldin also quotes a paper by Reinhart and Rogoff:

"Consistent with other more recent research, the authors confirm that public debt overhang episodes are associated with growth over one percent lower than during other periods. ... duration of the average debt overhang episode across all 26 episodes lasted an average of 23 years.... Growth effects are significant even in the many episodes where debtor countries were able to secure continual access to capital markets at relatively low real interst rates. That is, growth-reducing effects of high public debt are apparently not transmitted exclusively through high real interest rates.

We see where this is going. John is in favor of government austerity based on the correlation between higher government debt and lower economic growth. He has confused cause and effect, in my opinion. Low growth (or negative growth) causes high unemployment, which in turn causes lower tax revenues and higher spending on unemployment insurance, government-provided medical care, and even disability insurance.

This is exactly opposite from John's claim that bigger government causes lower growth. This makes no sense to me, but it's the classic supply-side Republican argument. In this view, government spending "crowds out" private investment, channeling resources into non-productive government pursuits. Unfortunately, the current economic malaise represents a demand problem, not a supply problem. Government is not crowding out private spending; there is literally trillions of dollars sitting in corporate coffers and private accounts looking for a productive place to invest money. Unfortunately, at the end of the pipe, the consumer is tapped out worldwide, and has no money to spend!

They call economics the "dismal science" because it's not really science at all. The world is not a laboratory, and we seldom have the luxury of testing two possible solutions to the same problem, to see which works better. In this sense, we have been extraordinarily lucky; lower government spending ("austerity programs") have been tried in a number of countries (such as the U.K. and Greece). The short-term results have been unanimously bad: lower government spending leads to lower GDP (duh!). Long-term, it may lead to higher GDP, but there's no evidence of that.

On the other hand, spending programs (like the 2009 U.S. stimulus) have shown good short-term results, though there's no evidence of long-term benefits (unless the money is spent on long-term projects, like roads and bridges).

John Mauldin is generally a balanced, thoughtful commentator whom I generally agree with. But he really blew it on this one!

Tweet

What Really Matters This Fall

In my last post, I suggested that Medicare was a phony issue in the 2012 Presidential Election.  What, then, does matter?

Let's start with the premise that neither party will achieve a filibuster-proof 60 votes in the Senate. Nate Silver's last prediction had the Senate at 50R/49D/1I. The Democrats currently hold an effective 53 seats (including two Independents who caucus with them); they will be really lucky to hold this majority as 21 of 33 seats up for grabs this fall are theirs. Unless Mitt Romney is revealed to like live boys or dead girls, the Senate will not return to the 2009 60-vote Democratic majority.  On the other hand, Republicans would need to win every closely-contested race to get to 57 votes. It's hard to imagine where they'll find three more; the GOP would have to win all the lean-Democrat seats (FL, OH, NM), the likely-Democrat seats (WA, NJ, WV, MI, CT, HI), then somehow find one more from the safe-Democrat seats (CA, PA, NY, MN, MD, DE, VT, RI).  Very unlikely, barring death, retirement, or scandal; and even then, not likely.

It's therefore safe to stipulate that the Senate will be gridlocked once again.  Nothing important from either party will get to the President's desk.  We'll see another session like the last one: brave lawmakers reached across the aisle to name post offices and reaffirm pizza's status as a vegetable.  And that's about it.

What difference does it make, then: Obama or Romney? Here are the things that the President can do, with or without Congress:

1. Foreign policy.  Before Harry Truman, Congress and the President took the War Powers Clause of the Constitution seriously.  The country would not go to war without a Declaration of War by Congress. Faced with a recalcitrant Congress, Truman set a regrettable precedent by involving us in a "Police Action" in Korea. Since then, the U.S. hasn't declared war, but has been involved in multiple foreign adventures: Vietnam, Kuwait, Kosovo, Grenada, Iraq, Afghanistan.  And maybe some that I'm forgetting. Each of these has been initiated and driven by the White House, with cover from a timid Congress in the form of non-binding resolutions. Here's a nice piece by Michael O'Hanlon detailing how a Romney foreign policy might differ from Obama's. And here's an analysis by George Friedman (via John Mauldin) on the intellectual differences between the two.
2. Regulation. The President has considerable discretion to set government regulations. For example, Obama has expanded fuel economy standards to cover trucks, and set lofty new goals for passenger cars going forward. Aggressive environmental and financial regulations are liable to be casualties of a Romney administration.
3. Law Enforcement. President Obama has set a dangerous precedent by choosing which laws to enforce, and which to ignore. Congress was unable to reach agreement on the Dream Act, so the president acted unilaterally and decided to stop deporting young illegal immigrants. The Democrats will live to regret this precedent, in a Romney administration and down the road.
4. Supreme Court nominations.  This is the big one. There's a really good chance that the next president will appoint at least one justice.  Ruth Bader Ginsburg is the oldest, unhealthiest, and most liberal of The Nine. Were she to die or resign in the next four years, her replacement would be absolutely critical.  Obama would appoint a replacement who would hold the liberal line and preserve the center-right orientation of the court. Romney, on the other hand, would appoint a conservative who would swing the court even further to the right, conservative to overturn Roe vs. Wade if they chose to fight that battle. For this reason, Ginsburg's replacement is likely to elicit a filibuster, no matter who our next president is.

Don't be fooled by the millions of words wasted on taxes, social security, Medicare, Medicaid, welfare, the economy, education, defense spending, gay marriage, trade, and health care reform. The Executive Branch can do little to directly affect these issues. When voting for President, this short list is the only thing you need to worry about.

Tweet

Why Medicare Plans Don't Matter

The candidates and pundits are spending a lot of time and energy talking about Medicare Reform.  Polls suggest that 4/5 voters want to leave Medicare and Social Security alone. Even among the Tea Party, 70% of respondents want to leave this popular program untouched. (The Tea Party, of course, wants to cut the size and reach of government; but they don't want to touch Medicare or Social Security, which makes the whole thing a head-scratcher to me.)

So, regardless of how much Obama, Romney, and Ryan talk about it, Medicare won't shrink; indeed, it's likely to get much bigger (a huge majority of ex-hippies didn't heed Pete Townshend's advice and are still coming down for breakfast). If Romney wins, and proposes some version of Ryan's Medicare plan, it has no chance of getting past Congress. Indeed, if the GOP sweeps this fall's election (we're now ten weeks out, and it looks extremely unlikely), they won't even propose Medicare cuts.  If they do, the cuts will get just a trickle of votes in the House, from safe Republican seats.

Rest your grey heads easily, Medicare isn't going anywhere.


Tweet

Are the World's Great Newspapers Finally Getting it Right?

Just finished this excellent expose on the Financial Times' strange and inconsistent pricing. Apparently, the offered price differs greatly, depending on when you hit the site, which browser you use, and even where your IP address is located (a commenter notes that you can reduce the price to $50 per year by VPN-ing to India, and buying it from there).

The article got me thinking about other members of the "World's Great Newspapers" club, and how they are trying to monetize their reputation, world-class reporting, and editorial prowess in today's fast moving web-based world.  They New York Times (ticker NYT) stumbled on a pretty damned good model: 10 free articles per month (recently tightened to 5, I think), and between $15 and $20 per month for all-you-can-eat, depending on which platform you'd like to use (e-reader, web browser, mobile phone).  I like to browse articles occasionally, so I'm signed up for the $15 web-based version.  The price is a bit high, but the quality of their news, and especially the terrific insights on their editorial page, are worth the money to me.  Apparently, the rest of the world agrees, as their model has been a big success.

(I do quibble a bit with one aspect of NYT's paywall. They have erected an artificial barrier between nytimes.com and the Kindle version; I like to read the latter in bed sometimes before dozing off. But, this is not a freebie under their plan, or even a low-cost add-on; it's an additional $20 per month! So rather than paying for the same news twice at $35 per month, I use Calibre to "scrape" nytimes.com and transfer it to my Kindle. One extra step that I'd love to avoid, and would be happy to pay two or three bucks a month to avoid.)

The New York Times has learned the wrong lesson from their successful paywall, however. They think that it means that average readers will pay for news. So they recently erected a paywall on boston.com, the web site for the wholly-owned Boston Globe. We live near Boston, and got the Globe (Dead Tree Version) delivered 7 days a week for over 20 years. We were part of a declining demographic, however; to stay in business, the Globe fired most of their veteran (read: expensive) sportswriters. At one time, in fact, they had the (what some considered) the best sports page in America. From http://forums.celticsblog.com:

From the 70s-early 00s, the Boston Globe had 'the best sports section' in the nation.  Some of the Globe's writers over those years were Ray Fitzgerald, Bud Collins, Will McDonough, Ron Borges (pre-2001), Dan Shaughnessy (pre-98), Peter Gammons, Bob Ryan, Jackie MacMullan, Leigh Montville, Charlie Pierce, Kevin Paul DuPont, and I'm sure I'm missing some.  A lot of those are in the Hall of Fame of their respective sport.  With Ryan's retirement, it is the official nail in the coffin of the 'best-in-the-nation' sports section of the Globe (although, I'd say it pretty much lost that title in earlier part of this decade, as its probably not even as good of a sports section as the Herald now.)

One Sunday a few years ago, I woke up ready to spend a couple of hours reading the Globe and enjoying a bagel and coffee, and  instead found myself finishing in about half an hour. To paraphrase Gertrude Stein, there was no longer any there there. There was no content left that was worth paying more than $30 per month for. (That was another survival move on the Globe's part, they continually raised the price.) So, we canceled the subscription.

Late last year, the Times started charging $4 per week to read boston.com.  Since then, I've occasionally followed a link there, but have no intention of paying to read boston.com regularly. They have almost no original content, and certainly none that's worth paying for.

The inevitable conclusion: people will pay for quality content, but you can't charge for crappy content. Out of habit and brand recognition, boston.com was a top destination for millions of readers, but those habits can change overnight if there is no value added. There are plenty of place to find Celtics scores, game analysis, local concert news, and the like.  So, aided by it's Manhattan masters, the Boston Globe is slowly circling the drain. Tweet

Why I Love Trading the Retailers

This morning, in a generally strong market, and especially strong market for retailers, Zumiez (ZUMZ) has been dropping like a stone.  Here's a two-week chart (30 min. bars) of XRT, the SPDR S&P Retail ETF:

Here's Zumiez (ZUMZ), same scale:

There's no hard news on the tape for ZUMZ, but Piper Jaffray (PJC) has a research note out, and has downgraded ZUMZ to neutral from outperform.  I haven't seen the note, but for the stock to be down big in a good market, the opinion must be pretty bad, and the data must be pretty solid.

Ever since August 2000, when the SEC instituted Regulation FD, it has been exceedingly difficult to be a consistent winner as a purely technical trader. Prior to that, it was possible to figure out what the "smart guys" were doing by reading the charts, and looking for clues in price and volume action. The charts gave us a graphical picture of big money psychology and information flow. A savvy trader could piggyback on the big money by trading the charts (moving ahead of the public), and make nice profits by "selling the news" when important announcements (earnings, patents, FDA approvals, etc) were made.

This selective information flow has been completely cut off by Regulation FD. Corporate insiders are a weaselly bunch, but they're not going to risk a big fine or jail time by "spilling the beans" on earnings to a buddy over a 3-martini lunch. So, analysts, street touts, mutual funds, and other "wise guys" are in the same boat that the public is; they're left to read the tea leaves by pawing through publicly available information such as SEC filings, newspaper and magazine articles, online news sources, message boards, and rumors. It's still possible for smart guys (big and small money) to beat the market, but you can no longer do it with non-public information. (Except for crooks like Raj Rajaratnam, Roger Blackwell, Joe Nacchio, Martha Stewart, and U.S. Congressmen.)

There is one exception: the retailers. If you are a low-paid manager of a Zumiez store in Smallville Mall, you have some pretty valuable information at your fingertips: sales, margins, comparisons to last year for your store. And if you are a hard-working analyst at Piper Jaffray who has a network of fifty of these managers in his Rolodex (does anybody really use Rolodexes anymore?), you have a pretty damn good picture of how the company is doing, with no need for information from the CEO. In fact, you may have better information than the CEO! Look for ZUMZ to close down a few percent today on higher than average volume, and for the company to be down even harder on the next same-store sales or earnings announcement.

Consequently, if you read your charts closely, you will notice that the average stock tends to show big moves on heavy volume, and lots of sitting around on light volume in between...no follow-through. Retail stocks, on the other hand, tend to be better behaved, moving in gentle arcs and holding their trend lines for longer periods. These stocks do follow through on breakouts and breakdowns. This is why I love trading the retailers, it's still possible to beat the market using pure technical analysis. Tweet

Queen Elizabeth I Formed World's First Franchise 350 Years Before Ray Kroc

Fascinating history lesson in last week's Economist on The East India Company. Queen Elizabeth I chartered the company in 1600 as a way to facilitate British trade around the Cape of Good Hope to Asia. The Economist says this event marked the beginning of the modern world:

The East India Company foreshadowed the modern world in all sorts of striking ways. It was one of the first companies to offer limited liability to its shareholders. It laid the foundations of the British empire. It spawned Company Man. And—particularly relevant at the moment—it was the first state-backed company to make its mark on the world.

I found this passage particularly interesting. It sounds like QE1 invented the modern franchise.

The Company improvised a version of what Tom Peters, a management guru, has dubbed “tight-loose management”. It forced its employees to post a large bond in case they went off the rails, and bombarded them with detailed instructions about things like the precise stiffness of packaging. But it also leavened control with freedom. Employees were allowed not only to choose how to fulfil their orders, but also to trade on their own account. This ensured that the Company was not one but two organisations: a hierarchy with its centre of gravity in London and a franchise of independent entrepreneurs with innumerable centres of gravity scattered across the east. Many Company men did extremely well out of this “tight-loose” arrangement, turning themselves into nabobs, as the new rich of the era were called, and scattering McMansions across rural England.

How is this arrangement different than owning a McDonalds restaurant? You own the property, but  the french fries and Big Macs must be made precisely as the company says. And, if you work hard and keep the place clean, you're almost guaranteed to get rich. 
Tweet

Why the Republicans are Right on Payroll Taxes

News flash: the rich are getting richer, the rest of us are sucking wind. What should Washington D.C. do about it?

The Democrats want to raise taxes on the wealthiest 1%, the Republicans cry "class warfare" and decry any tax on "job creators". Meanwhile, our deficit is enormous and growing nearly $4b per day. How can we square these differing views?

How about a surtax on the rich, as the Dems have proposed. But, these lucky folks could recoup their tax dollars if they really do create jobs...anybody who employs Americans should be able to claim a tax credit of 1% of U.S. payroll against their personal income tax. This credit should be distributed to shareholders for publicly traded companies.

The net effect would be similar to a Republican proposal to reduce employers' share of payroll taxes, but doing it my way would make it more palatable for Democratic constituencies. It would also provide more of a boost to the economy than the Democrats current proposal to extend the payroll tax cut for employees into next year. That tax cut doesn't help the unemployed one whit, while giving the cut to employers encourages them to hire jobless Americans. While folks with jobs would certainly appreciate a tax cut, our biggest problem is folks without jobs! If we could fix that, the rest would take care of itself. Tweet

Our Schools Should Teach Less Math

When did schools remove weaving from the curriculum? How about abacus training? Does anybody still teach basic slide rule skills?

All of these used to be incredibly useful, until they were made obsolete by machines. We (as a society) eventually decided that these skills were no longer needed, and our schools stopped teaching them. Instead, we started teaching more relevant skills like computer programming and auto repair.

Yet, in the year 2011, we still spend countless hours teaching poor frazzled seventh graders how to do long division! Granted, being able to quickly do basic addition and subtraction without the aid of a calculator is a useful skill. But when was the last time you used a paper and pencil to divide a 4 digit number into a 5 digit number? I'll bet it was seventh grade!

Schools are slowly getting with the program, and have started teaching useful twenty-first century skills like spreadsheets, power-point presentations, Spanish, and Chinese. But there are only so many hours in the school day, and so many days in the year, and only a short 12 years to pack all this info into our children's pliable little minds. And we can't afford to waste time teaching obsolete skills like long division. In another generation, all mechanical math skills (fractions, even multi-digit multiplication, addition and subtraction) will be obsolete.

What should we teach instead? Here's an interesting article from Wired Magazine. It turns out that kids are great at using computers, but are lousy searchers:

High school and college students may be “digital natives,” but they’re wretched at searching. In a recent experiment at Northwestern, when 102 undergraduates were asked to do some research online, none went to the trouble of checking the authors’ credentials. In 1955, we wondered why Johnny can’t read. Today the question is, why can’t Johnny search?

Who’s to blame? Not the students. If they’re naive at Googling, it’s because the ability to judge information is almost never taught in school. Under 2001’s No Child Left Behind Act, elementary and high schools focus on prepping their pupils for reading and math exams. And by the time kids get to college, professors assume they already have this skill. The buck stops nowhere. This situation is surpassingly ironic, because not only is intelligent search a key to everyday problem-solving, it also offers a golden opportunity to train kids in critical thinking.

New skills are needed to navigate today's information-rich world. Critical thinking is at a premium. How can one tell if an email is presenting a legitimate opportunity, or worthless spam? How do we know if the Obama's dog really flew in a private jet to join the family on vacation? Believe it or not, a person with a professional degree actually sent me an outraged email with that urban legend. So maybe a high-school class on "Critical Thinking and the Internet" would be useful. Tweet

Rebuttal to Krugman/s "Things to Tax"

In a recent op-ed entitled "Things to Tax", Paul Krugman suggests a financial transaction tax.

And then there’s the idea of taxing financial transactions, which have exploded in recent decades. The economic value of all this trading is dubious at best. In fact, there’s considerable evidence suggesting that too much trading is going on. Still, nobody is proposing a punitive tax. On the table, instead, are proposals like the one recently made by Senator Tom Harkin and Representative Peter DeFazio for a tiny fee on financial transactions.

And here’s the thing: Because there are so many transactions, such a fee could yield several hundred billion dollars in revenue over the next decade. Again, this compares favorably with the savings from many of the harsh spending cuts being proposed in the name of fiscal responsibility.

This is so wrong-headed on so many levels.

The majority of trades are executed for tiny profits. And I'm not just talking about the machines, I'm talking about real human beings. Even a .1% transaction tax would kill this entire business in the U.S. It simply would no longer be a profitable business. Most likely it would move offshore, to non-taxed markets. If there's one thing we've learned from globalization, it's that capital will quickly move to the most profitable location.

Secondly, by removing the high-frequency traders (and believe me, I'm no fan of HFT; the deck has always been stacked against the little guy, now it's practically impossible to beat the computers) liquidity would dry up. Formerly liquid issues would start trading with wide spreads. Costs would go up for the remaining market participants, who don't have the know-how or resources to trade overseas: retail investors. AKA, the suckers who always end up holding the bag.

Professor Krugman has made the classic error when assessing potential revenue from a new tax: he assumes that the new tax would not change peoples' behavior. If this logic worked, why not impose a $1 tax on each U.S. text message? Golly, my daughter sends hundreds of text messages every month, this tax could retire our national debt in a matter of months!

So, a financial transactions tax, which Krugman expects to raise billiions and hurt "the bad guys", would actually raise very little revenue and hurt only "the little guys." Tweet

Is the US becoming Japan? And what's in it for me?

In 1989, Japan was flying high. Prime Tokyo real estate reached $1m per square meter. The Nikkei stock index peaked at nearly 39,000 on December 29. The Japanese snapped up American real estate, including Pebble Beach and Rockefeller Center. "Japan Inc" graced magazine covers, newspaper headlines, and books. It seemed that nothing could stop the Japanese steamroller, and that they were destined to dominate the global economy.

Then, the bottom fell out. The Nikkei plunged, and has never again approached its 1989 high. Real estate plunged as well. GDP growth has been nearly nonexistent; the "Lost Decade" has endured for more than 20 years, with no end in sight. 

In response to this unfortunate turn of events, the Bank of Japan has cut interest rates over and over, but the economy hasn't responded to traditional monetary policy. Japan is stuck in a deflationary cycle, with no end in sight. Paul Krugman and others have suggested that Japan  has experienced a liquidity trap, characterized by a lack of aggregate demand, and ultra-low interest rates that have failed to stimulate the economy.

Today, in late 2011, the United States is experiencing a similar post-bubble hangover. The Nasdaq peaked 11-1/2 years ago, the Dow 4 years ago; both are down significantly since then. US stock portfolios have (at best) stood still for more than a decade in nominal terms; in real terms, equities are underwater--even as a majority of Americans have grown to count on the stock market for their retirement savings. Real estate peaked 5 years ago, and is down 30% nationwide; parts of the "sand states" (Nevada, California, Arizona, and Florida) are down more than 50%. Unemployment has remained stubbornly high, even as Ben Bernanke and the Fed have reduced short rates nearly to the so-called "Zero Lower Bound". The Fed is giving money away, and still, there is no demand for it.  Krugman (and many others) have called an American liquidity trap. 

Naturally, students of history are wondering whether America is leading the West into a long-term low-growth era, similar to Japan's "Lost Decade". Recent US short rates have traced an eerily similar path to Japan's rates in the early '90s. David Rosenberg did a nice write-up on how the U.S. is "Turning Japanese", here's his  chart showing the two countries' post-bubble interest rates.

If you're American, you may be saying "Crap! That's terrible! I'm not looking forward to that!" And I'm not, either. But there may be ways to take advantage of the situation...if life gives you lemons, you might as well make lemonade! So, let's talk about adjustable-rate mortgages.

Adjustable-rate mortgages (ARMs) are loans designed for low initial payments, with the borrower paying the loan off relatively quickly (by selling the property or refinancing to a fixed-rate mortgage). If you're thinking of buying a home, or an investment property, or if you're thinking of refinancing your existing mortgage, it's a great time to think about taking out an ARM.

While the vast majority of residential loans are fixed-rate (usually 30 year), the rest are adjustable-rate. Interest rates on fixed-rate mortgages are determined by capital markets; they usually follow Treasuries Bonds. ARMs, on the other hand, follow short rates, which are dominated by the Fed's actions.

On August 9, the Fed announced that it would keep interest rates “exceptionally low" through mid-2013. So Ben Bernanke just told you that (if you take out an ARM before mid-2012) you will enjoy at least two years of "exceptionally low" interest payments. (ARM payments typically adjust annually, so you will have till early 2014 before your rate adjusts up.) Furthermore, if the US follows Japan into long-term economic stagnation, you will enjoy low payments far beyond 2014. Both long and short rates are likely to remain low for several years (we'll look at contrary views a little later).

Let's take a look at some numbers. My credit union offers 1-year ARMs at 2.875%, 3/1 ARMs (fixed for 3 years, then annual adjustments indexed to LIBOR), and 5/1 ARMs at 3.125%. They also offer an interesting option, the 5/5 ARM, at 3.375%. This loan would start at 3.375%, stay there for 5 years, then reset every 5 years. By contrast, a 30-year fixed is quoted at 4.375%. (All loans are 0 points, on a 30-year amortization schedule.)

If you borrowed $200,000, the 1-year ARM payment (principal and interest) would be $830. You would pay  $844 on the 3/1 ARM, $856 on the 5/1 ARM, and $884 on the 5/5 ARM. The conventional 30-year fixed mortgage would cost $998 monthly. So, if you took out a 1-yr ARM today, Ben Bernanke has guaranteed you that your payment won't go up until late 2013, and you will save $168 per month for 24 months, or $4032. This is slightly more than 2% of the original principal. Not bad! In two years you can continue to take your chances with short rates, or refinance to a fixed if the economic picture has changed significantly. If you have a lower risk tolerance, you could select one of the other options. The 5/1 ARM would save you $142 per month for 5 years, or $8520 (more than 4% of principal).  The 5/5 ARM is my favorite, it would save you $114 per month for 5 years ($6840, or 3.4% of principal). And, after 5 years (when I believe rates will still be low, a la Japan), you can lock in for another 5 years of low rates.

What are the risks in this strategy? Let's think about the future level of interest rates, and what that would imply about the economy. Until 2013, we're certain of interest rates, they will be "exceptionally low". After that, rates are less certain. We could follow the "Japan Scenario": the economy continues to stumble, Fed Funds rates are virtually zero, and long rates stay low (perhaps they'll be even lower than today, if deflation kicks in). In this case, our ARM strategy will look wise, we will have saved quite a bit of money and are perfectly poised to save more.

What if a more normal economy prevails, housing and other asset prices rebound, and both long and short rates rise? This scenario is bad for our interest-rate bet, but is positive for your home value, your career, your savings, and your other investments. So in this case, we can look at our interest rate bet as a hedge--mortgage payments will go up, but we'll better be able to afford them than we are today. And we will have enjoyed many months of savings.

The third case, which I view as quite unlikely at this point, is one of inflation. In this case, both long and short rates will be higher than they are today. The Fed may raise short rates above long rates to slow inflation. In this case, your house will have appreciated and your bank savings will be doing well. It's not as favorable as the second case, but your ARM will have acted as an effective hedge.

Of course, the further out in time we go, the less visibility we have. We can say with a high degree of certainty that we will still be in a low interest-rate environment in two years, but we're less certain in 5 years, and even less sure in 10.  The 5/5 ARM seems the best balance of interest rate risk with a guaranteed long run of low rates (5 years) and another 5 years of very probably low rates.

Disclaimer: This strategy is quite risky, and may not be for you. It's appropriateness depends on many factors: your age, income, marital status, tax status, local real estate market, credit rating, and some I'm not thinking of. DO NOT use an ARM's low initial rate to buy a property that you can't otherwise afford!!! That approach is responsible for many of the recent tsunami of foreclosures. Only take out an ARM if you can afford the worst-case payments.

Tweet

Investor Sentiment and other Dumb Statistics

 I just read an interesting post on this weekend's Saints-Texans game (National Football League). The writer (Kerry J. Byrne) says

The 2010 Texans, for example, were dead last in Defensive Passer Rating (100.5), the best way to measure pass defenses because it consistently has a high correlation to wins and losses. Champions throughout history are almost always among the very best in the league at Defensive Passer Rating.

But, do teams win because they have good passing defenses? Or, do teams get ahead, then sit back in a "prevent defense" (5 or 6 defensive backs), against which it is more difficult to throw the ball? Also: the defensive linemen can "pin their ears back" and go after the passer, knowing that their hapless opponents are trailing late in the game and don't have time for a long, time-consuming drive.

To test Mr. Byrne's theory, we need to look at the data in a slightly different way. Does Defensive Passer Rating in the First Quarter also have a high correlation with wins and losses? Presumably, the game is more likely to be competitive in the first quarter than in the fourth. Does DPR show a better correlation to success than other statistics? Obviously, a team with a good pass defense will win more than a team with a lousy pass defense, but is this stat really a superior predictor? I'd be really interested to see the data broken down this way.

My favorite dumb football statistic is the  relationship between having a 100-yard rusher and winning the game (not so common these days, as the NFL has become a passing-dominated league). It used to be that, when a back reached 100 yards rushing, a graphic would flash on the screen, like "Bears are 53-24 (.688) when Walter Payton rushed for at least 100 yards and 58-58 (.500) when he doesn't." Maybe the Bears won because Payton went for 100. Or, maybe they got ahead, then ran out the clock by giving "the rock" to one of the NFL's all-time greats.

Investor Sentiment numbers are a dumb stock market statistic. If you pay attention to these numbers, you will see that sentiment follows the market. Investors become fearful after the market goes down, and greedy after it goes up...sentiment is worthless as a predictor! This chart from wallstreetcourier.com illustrates this point perfectly.

So, when you find a correlation that seems too good to be true, ask yourself if A really causes B, or does B cause A, or maybe an external factor C causes both A and B.

The lesson, of course: Correlation does not mean causation. Tweet

Trading Home Depot around Hurricane Irene: Post-Mortem

On Friday, I outlined a few HD options strategies to profit from the weekend super-storm Hurricane Irene (The Perfect Storm: Trading Home Depot around Hurricane Irene).  Today (Monday 8/29 11:30AM EST), the storm has passed. As expected, implied volatility in HD has collapsed back to it's historical average (32.5%). Let's take a look at how the various recommended strategies fared.

"For long-term HD shareholders: Sell out-of-the-money calls, like the Sept 35 Calls for .70.  By selling out-of-the-moneys, you won't run afoul of the IRS and won't owe any taxes on the underlying shares unless they're exercised. If they're called away, you'll have benefited from this week's 7% gain,  plus .85 appreciation (2.5%), plus .70 options premium (2%). Total profit since last Friday: 11.5%. Profit from today: 4.5%. Not bad in a low-return world. You can also buy back the calls on Monday, after volatility collapses, if you're married to the stock."

Sept 35 Calls are now at .46 (IV is now 31%). Close the position for .24 profit (34% on the options or .7% on the underlying).

"For short-term HD shareholders: Sell slightly in-the-money calls, like the Sept 33 Calls for 1.85.  This gives you a .70 (2%) premium in a pretty sleepy stock, and it can drop nearly 4% before your protection runs out.  Of course, you're giving up any upside if Irene is even worse than expected, and HD adds to it's already impressive run.  Still, you will benefit from collapsing IV."

Sept 33 Calls are now at 1.45 (IV is 34.7%,  time premium is .45).  Close the position for a .40 profit (24% on the options, or 1.2% on the underlying).

"For non-directional options traders: Sell high-IV options, and protect yourself with lower IV options. For example, sell the Sept 30 Puts for .27 (IV=50%) and buy the Nov 30 Puts for .97 (IV=40%) for a net debit of .70. Cover early next week for a small profit as IV collapses. Even bigger bump if HD fades."

Sept 30 Puts now .21 (IV=47.44%), Nov 30 Puts now .90 (IV=38.72%). Spread is now .69, basically break-even with Friday's spread of .70. Not worth the trouble.

"For bullish options traders: Sell high-IV puts. For example, sell the Sept 32 Puts for .54 (IV=41%). If HD rallies next week, pocket the .54. If it drops, you can buy it 9.4% cheaper if it falls through 32 (your breakeven is 31.46, 10% below today's price). Don't be afraid of selling naked puts! It's a very conservative strategy; Warren Buffet uses it to buy companies he likes at a discount, and generate income to boot."

Sept 32 Puts now at .47 (IV=38.5%). Close the trade for .07 profit (13%). Probably not worth it, on a risk-adjusted basis.

"For bearish options traders: Sell high-IV calls, like the Sept 33 Calls for 1.80 (IV=38%). If HD drops next week, pocket the .65 risk premium, plus whatever the drop is, to a max profit of 1.80 at 33 or below. If it rallies into expiration, your effective short price is 2% higher than today's price."

Sept 33 Calls are now at 1.45 (IV is 34.7%,  time premium is .45).  Close the position for a .40 profit (24%).

"For neutral options traders: Sell at-the-money puts and calls.  Sell Sept 34 puts for 1.10, Sell Sept 34 calls for 1.13. (HD now at 34.30). Trade is a winner if HD closes between 31.77 and 36.23 on 9/16. Or, exit the trade early next week. Seems like a nice risk/reward here as premium covers +/-6.5% move in 3 weeks."

Sept 34 Calls at .86 (IV=32.67%), Sept 34 Puts at 1.15 (IV=33.2%). Close the combination for a .22 profit (10%).

Of course, you can also let the trade run, either for a few more days as damage estimates are fine-tuned, or even all the way to expiration. The advantage to the last approach is you save money on commissions and "slippage", and the result may fit your overall portfolio strategy.

Conclusion: 4 wins, 0 losses, 2 ties. Not too bad! To re-emphasize the most important point from the original post, never go long options into an approaching natural disaster! Everybody knows it's coming, but nobody knows how bad the damage will be. You will be paying a high price to gamble on Mother Nature, as premiums will be inflated. Those premiums are sure to return to their baseline when the event has passed.
Tweet

How is Greece like your brother-in-law?

You've worked hard your whole life. You've scrimped and saved and, by the grace of God, you've managed to buy a nice home, provide a comfortable life for your family, and put a little away for a rainy day. Things have worked out for you.

Your wife has a big family, and you love them dearly. Her brother Billy has 7 kids, and they're beautiful and engaging. Everybody loves them. Unfortunately, your wife's brother is a deadbeat. He likes to gamble, smoke pot, get drunk, and can't keep a job. You've tried to talk to him about these problems, but he gets very defensive, says things are about to turn around. But they never do.

Your deadbeat brother-in-law has really done it this time. He bet $5,000 on the Steelers to win the Super Bowl. Thought they were a sure thing. Turns out they weren't. Of course, Billy has no money to pay the bookie, who's very large and not very empathetic. So of course, Billy wants to borrow money from you.

You'd love to tell your brother-in-law to f**k off, let him get roughed up (or worse). He deserves it. Maybe he'd even learn a lesson. But your wife, and her whole family, are very protective of him. If you don't save him, you're the jerk. If anything were to happen to Billy, your wife and her whole family would hate you forever. But, if you bail him out, he'll never change. Even now, he's unapologetic. It's the bookie's fault for being so tough on him, his ex-boss's fault for firing him, even Ben Roethlisberger's fault for not playing better in the Super Bowl. You now hate his friggin guts.

As you've guessed by now, your wife and her family are the Eurozone, your brother-in-law is Greece, and the bookie is the Greek bondholders. And you're the German government.  To make it even worse, if you bail out the deadbeat, the rest of the family will stop paying their bills, and will expect you to bail them out too. And one more thing--even if you decide to bail out your brother-in-law...I mean, Greece...you still have to convince the hardworking, thrifty German people to go along with the plan. And you'll probably be tossed from office for your trouble.


What do you do?

Tweet

The Perfect Storm: Trading Home Depot around Hurricane Irene

Today, we have a very nice setup for trading Home Depot (HD).  Hurricane Irene is currently bearing down on the Outer Banks of North Carolina,  a lovely stretch of beach in the midst of vacation season.

A brief history/geography lesson on the Outer Banks.  A famous vacation spot, The Outer Banks is a thin (usually less than 1/2 mile wide) barrier island separating the Atlantic Ocean from Pamlico Sound and mainland North Carolina.  It has been the scene of many vicious storms in the past; an 1846 hurricane opened , which is now the site of a 2-1/2 mile long bridge:

"Whoa!" you may say.  A storm did that! Unbelievable! I would never build a nice house there.  And for many years, people didn't.  Here's a typical 1960's-era cottage:

Nice! Small but comfortable, close to nature, and no big deal if it gets washed away. But, as usual, people forgot how powerful Mother Nature can be, and she fortuitously chose to ignore the Outer Banks. By the 2000's, people were building homes like this:

Ridiculous! Talk about hubris! Or maybe stupidity. Needless to say, if Hurricane Irene is anything like the 1846 storm, this million-dollar home will be reduced to splinters.

Anyway, Irene is currently headed directly for the Outer Banks. After that, it's projected to roll through the heavily-populated Northeast USA, from Washington to Boston. Damage is projected to reach the billions. And when residents wake up Monday morning, and start repairing windows, doors, shingles, and possibly rebuilding homes, where will they start?  Yup, Home Depot.

Of course, if I know this so does every wit and half-wit with a brokerage account. Consequently, as the storm track has crystallized, HD stock has been ramping up. It is currently trading at 34.15, up 7% from last Friday's close at 31.88. Here's the kicker: since Irene's full thrust will be felt mostly tonight and this weekend, the ultimate damage will be done while the market is closed. This means that a nimble options trader can profit a bit more from a post-storm "sell the news" move in HD.

HD's historical volatility is about 32%. September around-the-money options are trading at implied volatilities from the high-30s to nearly 50 (Sept 30 Puts). The smart(?) guys are betting on the weather! I expect implied volatility to collapse back to it's long term average on Monday. So the play today is to sell volatility. Here are a few possible strategies.

For long-term HD shareholders: Sell out-of-the-money calls, like the Sept 35 Calls for .70.  By selling out-of-the-moneys, you won't run afoul of the IRS and won't owe any taxes on the underlying shares unless they're exercised. If they're called away, you'll have benefited from this week's 7% gain,  plus .85 appreciation (2.5%), plus .70 options premium (2%). Total profit since last Friday: 11.5%. Profit from today: 4.5%. Not bad in a low-return world. You can also buy back the calls on Monday, after volatility collapses, if you're married to the stock.

For short-term HD shareholders: Sell slightly in-the-money calls, like the Sept 33 Calls for 1.85.  This gives you a .70 (2%) premium in a pretty sleepy stock, and it can drop nearly 4% before your protection runs out.  Of course, you're giving up any upside if Irene is even worse than expected, and HD adds to it's already impressive run.  Still, you will benefit from collapsing IV.

For non-directional options traders: Sell high-IV options, and protect yourself with lower IV options. For example, sell the Sept 30 Puts for .27 (IV=50%) and buy the Nov 30 Puts for .97 (IV=40%) for a net debit of .70. Cover early next week for a small profit as IV collapses. Even bigger bump if HD fades.

For bullish options traders: Sell high-IV puts. For example, sell the Sept 32 Puts for .54 (IV=41%). If HD rallies next week, pocket the .54. If it drops, you can buy it 9.4% cheaper if it falls through 32 (your breakeven is 31.46, 10% below today's price). Don't be afraid of selling naked puts! It's a very conservative strategy; Warren Buffet uses it to buy companies he likes at a discount, and generate income to boot.

For bearish options traders: Sell high-IV calls, like the Sept 33 Calls for 1.80 (IV=38%). If HD drops next week, pocket the .65 risk premium, plus whatever the drop is, to a max profit of 1.80 at 33 or below. If it rallies into expiration, your effective short price is 2% higher than today's price.

(Updated 1:30pm; just thought of another one)
For neutral options traders: Sell at-the-money puts and calls.  Sell Sept 34 puts for 1.10, Sell Sept 34 calls for 1.13. (HD now at 34.30). Trade is a winner if HD closes between 31.77 and 36.23 on 9/16. Or, exit the trade early next week. Seems like a nice risk/reward here as premium covers +/-6.5% move in 3 weeks.

Note that the "wise guys" are betting on a post-Irene drop, as IVs are higher on the put side than on the call side. They're expecting a "sell the news" reaction early next week, regardless of Irene's ultimate damage. Whatever you do, don't buy options outright in this environment! You could easily be right on HD's direction, and still lose money to collapsing volatility!

Also, stick to the more liquid strikes/expirations, as volume is likely to dry up post-Irene and you may be stuck having to leg out of a multi-leg option into an illiquid market...another good way to turn a winner into a loser!

Tweet

Bernanke Knows His Keynes

"Perhaps a complex offer by the central bank to buy and sell at stated prices gilt-edged bonds of all maturities, in place of the single bank rate for short-term bills, is the most important practical improvement which can be made in the technique of monetary management."

Keynes, John Maynard (2010-12-30). The General Theory of Employment, Interest and Money Tweet

Germany Now Running the Euroshow

Fascinating read from Peter Zeihan and Marko Papic, courtesy of John Mauldin.  If you don't get John's free e-mail letters, sign up now at http://www.frontlinethoughts.com/subscribe.  He's always thought-provoking and non-partisan, with a long view. Anyway, back to Zeihan and Papic's article, "Germany's Choice: Part 2".

An introduction:

"However, with the end of the Cold War and German reunification, the Germans began to stand up for themselves once again. Europe’s contemporary financial crisis can be as complicated as one wants to make it, but strip away all the talk of bonds, defaults and credit-default swaps and the core of the matter consists of these three points:

• Europe cannot function as a unified entity unless someone is in control.
• At present, Germany is the only country with a large enough economy and population to achieve that control.
• Being in control comes with a cost: It requires deep and ongoing financial support for the European Union’s weaker members."

On Germany's policy dilemma:

"It is easy to see why the Germans did not simply immediately write a check. Doing that for the Greeks (and others) would have merely sent more money into the same system that generated the crisis in the first place. That said, the Germans couldn’t simply let the Greeks sink. Despite its flaws, the system that currently manages Europe has granted Germany economic wealth of global reach without costing a single German life. Given the horrors of World War II, this was not something to be breezily discarded. No country in Europe has benefited more from the eurozone than Germany. For the German elite, the eurozone was an easy means of making Germany matter on a global stage without the sort of military revitalization that would have spawned panic across Europe and the former Soviet Union. And it also made the Germans rich. 

But this was not obvious to the average German voter. From this voter’s point of view, Germany had already picked up the tab for Europe three times: first in paying for European institutions throughout the history of the union, second in paying for all of the costs of German reunification and third in accepting a mismatched deutschemark-euro conversion rate when the euro was launched while most other EU states hardwired in a currency advantage. To compensate for those sacrifices, the Germans have been forced to partially dismantle their much-loved welfare state while the Greeks (and others) have taken advantage of German credit to expand theirs."

On the new EFSF  (European Financial Security Facility):

"In practical terms, these changes cause two major things to happen. First, they essentially remove any potential cap on the amount of money that the EFSF can raise, eliminating concerns that the fund is insufficiently stocked. Technically, the fund is still operating with a 440 billion-euro ceiling, but now that the Germans have fully committed themselves, that number is a mere technicality (it was German reticence before that kept the EFSF’s funding limit so “low”).

Second, all of the distressed states’ outstanding bonds will be refinanced at lower rates over longer maturities, so there will no longer be very many “Greek” or “Portuguese” bonds. Under the EFSF all of this debt will in essence be a sort of “eurobond,” a new class of bond in Europe upon which the weak states utterly depend and which the Germans utterly control. For states that experience problems, almost all of their financial existence will now be wrapped up in the EFSF structure. Accepting EFSF assistance means accepting a surrender of financial autonomy to the German commanders of the EFSF. For now, that means accepting German-designed austerity programs, but there is nothing that forces the Germans to limit their conditions to the purely financial/fiscal."

Long term, this is very good news for the euro and Eurozone countries, though it may slow down Germany's growth somewhat.  There's more in the article, including an analysis of Germany's newfound heft on her neighbors. Download the whole thing here.

Tweet

Gold is the New Cash

August 3, 2011: The Day the Fiat Currency Died.  It's not as poetic as , and Don McClean won't be writing any hit songs about it, but it is a milestone in financial history.  For on 8/3,  Switzerland became the last of the strong money countries to throw in the towel, as they lowered rates “as close to zero as possible” in order to weaken the Franc and improve Switzerland's competitive position.  The prim-and-proper, all business, tight-money Swiss have given up the ghost.  There are now no safe haven currencies left.



It all started with the Asian economies, principally China and India.  China has become an export powerhouse by pegging the yuan to the dollar at an ridiculously low exchange rate.  Of course, China's gain is the rest of the world's loss, as manufacturing jobs have been lost all over the world to China and other East Asian countries that have emulated China's policies.  India has been just as effective at importing jobs by adopting the same strategy, only India's strength is in the service sector:  customer support, engineering, legal services, etc.

What is the magnitude of this currency manipulation?  Economists estimate that the yuan is about 50% undervalued compared to the dollar. The Economist magazine has just updated it's Big Mac Index, and a Big Mac costs just $2.27 in China.and $1.89 in India*!  This sandwich will set you back $4.07 in the U.S. (too damn much, IMHO) and $8.06 in Switzerland!  No wonder the Swiss decided to weaken their currency; the Swiss love them some Big Macs!  (Big Mac arbitrage, anybody?  All you need is a few hundred yuan, a big suitcase, and a one-way ticket from Beijing to Geneva.)

While the world economy grew, the USA looked the other way.  Sure, we lost jobs to Asia, but the economy was growing, Wall Street was getting rich, home values were soaring, and corporate profits were surging.  And (maybe most importantly), presidents, senators, and representatives were being re-elected.

That all changed in 2008.  The world plunged into The Great Recession, featuring the worst job losses since the 1930's.  Rich-world GDP plunged, while China and India continued to grow.  Helicopter Ben Bernanke, Tim Geithner, and President Obama pulled out all the stops: they turned the Mint's printing presses up to 11, orchestrated QE and QE2 to drive both short- and long-term interest rates into the dirt, and flooded the world with dollars.  The hope was that this would prop up housing prices, get businesses to invest and hire again, and restart the economy.  (It hasn't really worked, as housing prices bounce along the bottom and much of the new investment has taken place in China.  But that's a story for another day.)

Europe was faced with many of the same challenges, but with a twist.  Creation of a common currency had encouraged reckless borrowing by the less-productive members of the Eurozone (the so-called PIIGS).  As I write this, Europe is enmeshed in a full-fledged currency crisis.  Greece is broke and has no chance to repay large loans from big European banks.  Portugal, Italy, Ireland, and Spain are vying for second place in the race to the bottom.  Consequently, the Euro is in mortal danger, and has dropped like a stone since 2008 against the Yen, Franc, and gold.  Nobody believes in the Euro anymore, and the smart money has left town.

Now that the Swiss have given up, where can cash be safely stashed?  The dollar?  Fuggetaboutit.  The Euro?  See above.  The Yen?  Only because Japan has been in the ditch for 20 years, and have gotten comfortable there. You'll get no yield there.  The Canadian and Australian Dollars, or the Brazilian Real?  Maybe, but they're totally levered to commodity prices.  The "full faith and credit" of the USA isn't what it used to be, but we haven't sunk below Brazil yet, have we?  In the early '80's, Brazil converted the Crusado to the Cruizero by stamping "000" on their paper money...I kid you not!  When the Fed stamps "000" on Dollars and starts calling them Dollaroos, I'll move my meager savings to Brazil.

So what does that leave?  Nothing!  There are no reliable currencies left, where you can relax in cash and get paid a small amount of interest to wait. 

Wait a minute, I forgot about one currency...gold!  The has represented money since before it was called money.  It's heavy, clunky, and you can't buy a Big Mac with it, but it has held it's value better than any currency the last ten years.  Of course, it yields nothing and is difficult to store.  But today, one can buy electronic versions of gold (as easy to store as cash) and the non-existent yield matches the Dollar, Swiss Franc, and Yen.


Here's a couple of interesting graphs.  First, a few commodities priced in Dollars:

Corn and copper have more than doubled since 6/2010 and oil has been flat, indicating a healthy world economy.  Not so fast...here are the same commodities priced in gold:

Corn and copper are still up, but oil is down a third since March, and both copper and oil have fallen off a cliff the last two weeks.  The market smells a recession coming!  US Treasuries have rallied strongly and the stock market is down 8 days in a row, further signs of a coming recession.

Gold is the new cash!  Keep your idle savings in gold, rather than one of the fiat currencies.  It will preserve your purchasing power without geopolitical risk, earthquake risk, tsunami risk, Obama risk, Bernanke risk, Merkel risk, or Greek risk. 


*Actually, it's called the "Maharaja Mac" in India, presumably containing no beef.  Sounds gross. Tweet

Take Some Francs off the Table

On June 14, I shorted the Euro against the Swiss Franc (EURCHF) at 1.21.  The Euro has obediently fallen to a low below 1.08, before staging a massive rally overnight when the Swiss dropped interest rates to nada%, matching the rest of the world. (Expect this headline soon: "Swiss Bankers Head to Rio, Excited to Dance in Carnival Parade")  EURCHF is currently trading just under 1.11, time to unwind the position.

The Swiss Franc is still an unrivaled safe haven, but has gotten way ahead of itself.  We recently met some American expatriates living in Switzerland, they were stocking up on Ugh boots as they could buy three pairs in the US for the price of one in Switzerland!  Another data point: a small Diet Coke costs $12 in Zurich! We'll continue to watch the Franc for a good re-entry point.

Some of the European safe haven money will look elsewhere on the Swiss Central Bank news.  Look for the other safe havens to rally today:  US Treasuries, gold, silver. Tweet

D.C. Fiddles While the Economy Burns: What the Market is Telling Us

As the endless debt ceiling nonsense continues unabated this morning, the markets are telling an interesting story.  SPY (which represents the S&P 500) is down .75%, while TLT (ETF for 20-year treasuries) is up 1.34%!  What's going on?

The message is split.  If the current "Capital Hill Circle Jerk"© proceeds through Aug. 2 (only 4 days away!), the government will be forced into a partial shutdown: workers will be furloughed, parks will be closed, medicare and medicaid reimbursements may be held back, and social security checks may be reduced or delayed.  Certain to cause an economic slowdown, or maybe a double-dip recession!

Whether or not a deal is reached before "Tim Geithner Turns Into A Pumpkin Day", it's becoming more and more clear that real spending cuts are coming down the pike, and they'll hurt.  Contrary to Tea Party rhetoric, austerity is not good for the economy (at least in the short term).  So, regardless of the timing of a debt deal, this will exacerbate an economic slowdown.

On the other hand, the sturm and drang over potential default has been overdone.  Interest payments are not due till August 15, nearly two weeks after Geithner's spending cuts kick in.  Well before that time, the entire country will be in a lather, the political pressure will be too much, and a deal will certainly be made.  Additionally, if Uncle Sam tries to stiff bondholders, expect the courts to issue an injunction preventing default, as I suggested here. Treasuries are gaining further strength because the market anticipates economic weakness, as mentioned above.

So, I was wrong a few weeks ago.  Buy treasuries here. Tweet

Dr. Doom Hits the Chinese Nail on the Head

I don't usually agree with Nouriel Roubini but he nailed this one.  A sample:

The problem, of course, is that no country can be productive enough to reinvest 50% of GDP in new capital stock without eventually facing immense overcapacity and a staggering non-performing loan problem. China is rife with overinvestment in physical capital, infrastructure, and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns, and brand-new aluminum smelters kept closed to prevent global prices from plunging.

Roubini's  post vividly illustrates some of the reasons I'm quite bearish on China.  How can the whole world be so excited about a command economy?  Has there ever been a centrally-directed economy that creates long-term prosperity?  Tweet