America’s Linear Thinking Is Endangered: Winter Is Coming

The United States used to be a unique and wonderful place. We take it for granted but that’s because it’s all we’ve ever known. Go back just three centuries and the average person’s life wasn’t much different from a person living four five or even six centuries ago. Each person was a prisoner of his or her fate.  If you were born poor you would die poor. If your father was a stone mason, you too would become a stone mason. These people saw the sun rise and set each day, the seasons come and go and thus they believed in cycles.

Today we have a more linear way of thinking, where progress builds on itself. If your father is a stone mason, he can work and put you through college so that you become an architect. You then could build a skyscraper, larger than any castle your father ever dreamed of. And so we thought ourselves masters of our own fate and with enough hard work we can rid ourselves of these unnecessary cycles.

But we were wrong. We live in a UNIVERSE of cycles. The sun still rises and sets. The seasons come and go. We may be able to fly to Miami for the winter but that doesn’t change the fact that it’s snowing in Buffalo. We may be able to print money when the economy turns down, but that doesn’t change the fact that there was mal-investment that led to the downturn. Although we’ve taking quantum leaps in hiding the cycles, they still never go away.

My generation, may be the first in the history of America to have a shorter lifespan than the previous generation.home ownership is declining. Work participation is declining. The good high paying jobs are leaving. The older generations are cannibalizing the younger ones in a desperate attempt to squeeze out a few more good years before Winter arrives. The funny thing about winter is that it comes whether you want it to or not. My grandfather wonders why the young people don’t carry sticks on election day and go around beating the elderly into submission and I must say I too am starting to wonder. But at least I don’t live in peripheral country in Europe where youth unemployment is above 50% and it’s practically illegal to fire someone.

 

The New Marshall Plan: EU Morghulis

Slowly but surely Europe will realize how screwed it is. Like an old man on his death bed coming to realize that all men must die. Talks of A New Marshall Program to save Europe from the deflation dragon are starting to spring up which immediately piqued my interest. There must be some irony here! And lo and behold there was!

The original Marshall Plan was the largest stimulus program of it’s time. The US spent billions upon billions of dollars rebuilding Europe after the most devastating war in human history. A war that resulted in the complete and utter destruction of entire cities, populations and ethnic groups. Farms factories, roads, towns, and millions of lives were destroyed in this most extreme example of human folly. WWII was awful. Everyone knows this, and the following stimulus program had to be of both equal and opposite in magnitude in order to bring Europe back from the dead.

So here’s where I see the absurdity. Europe needs a New Marshall Program but there’s been no major war for decades. Most of the major countries don’t even have a sizable army to waste precious resources on. There’s been no mass murders. No second holocaust. No Total War that resulted in the obliteration of humanity AND YET the politicians of these countries are calling for a New Marshall Program because there has been massive destruction. Millions of people have lost their life savings due to a banking system so corrupt and devastating that it requires a stimulus response equal to that of the post WWII era to counteract. Think about. European bankers and their counterparts in government have done economic damage equivalent to that of WWII. Or don’t, because when you do, it’s depressing … especially when you realize that Germany has once again conquered Europe.

Central Banks have been able to mask the destruction for a while now but that won’t last. The call for a new marshal program is another desperate gasp of an old man coming to grips with his mortality. It’s time to get ready for the end game. EU Morghulis.

Mission Impossible 5: Rate Hike

Put this shot on the list of things more likely to hit its target than the Fed’s inflation expectations.

Janet Yellen has a better chance playing Ethan Hunt in the next mission impossible film than she does successfully raising rates without disaster. As the days go by and central bank after central bank eases monetary policy even further the prospects of a rate hike dims. The currency wars are full on now as countries try to export deflation and import inflation and yet the Fed is going to try and buck the trend. It’s confusing to me and it’s confusing to the market which believes a rate hike is more likely to occur at the end of the year.

I’ve been trying to make sense of a decision that on the surface following the Fed’s (and I’m using this word very lightly here) “logic” they shouldn’t raise rates. I specifically remember being reassured by a Fed president that if inflation gets too high he only needs 10 minutes to beat it back down. So why raise rates? The Fed hasn’t achieved 2% inflation yet. It stopped printing money before the goal was ever achieved and now it’s tightening monetary policy even further as inflation expectations continue to fall. The Fed was close to its 2% inflation target why not wait till they hit it and then worry if there is too much. Did Jason the Argonaut toss his sword away just before he got to the Minotaur? Did Achilles throw away the Hephaestus’ shield before his duel with Hector? Did David throw away his sling before he fought the Goliath? No. Of course not. So why the Hell is the Fed tightening into a deflationary environment!? It seems almost every central banker in the world is trying to get his or her hands on the secret elixir that is inflation. But here the Fed is tossing it away like it’s a love potion from Bill Cosby.

On the surface, it appears the Fed once again is overestimating the strength of the US economy. Bernanke a “student” of the depression knows very well how devastating an artificially strong currency can be during times of a currency war. And yet this is exactly what the Fed is risking with a June/July rate hike.

Already the USD has strengthened to a point where it is affecting American companies. Proctor and Gamble as well as Microsoft are some of the big name companies to suggest the strong dollar is providing a headwind for growth. Growth that the world economy is depending on to sustain itself through these lean times.  Remember the Fed hasn’t even hiked interest rates yet. Imagine what would happen if they did. And that’s the point…

Four months from now, will the Fed be armed with enough data to support a rate hike? It certainly doesn’t look likely, which is why the market believes a Fed rate hike won’t occur till late in the year, but perhaps the market falls victim to the belief that five extra months will make all the difference. The dominant force in the world isn’t inflation right now. It’s deflation. So given even more time, which is most likely to win out? Most likely, deflationary forces will force the Fed into an awkward position come June.

This brings up a potential answer to the question “why hike rates?”. Simply put, if the Fed waits too long they won’t have enough data support a rate hike. Then when the next crash comes the Fed won’t have enough ammunition. It’s important to remember these people are academics. They don’t run businesses or take risks. They take the easy way out. Which is what I think they are trying to do now. Is that a real fear? Not having ammunition? I don’t know if this is actually a real argument or not. But imagine if we do go into a recession with the fed funds rate at zero. What do they do? Do they go negative like Europe?

Perhaps there is a misunderstanding of where the world economy is at the moment compared to where it was nine years ago when they last hiked rates. Back in 2004, the demographics of the developed world were RISING towards their respective peaks. But now the demographic trends are stacking up against the developed world. As the population ages and the young remain depressed, unemployed, and underemployed we won’t see any growth to support a tightening of monetary policy.

What I think most people can agree on is that the Fed’s behavior is unusual. They didn’t have to tell the market they were going to hike rates. They didn’t have to give a specific date when they would like to do so. But they did. And that was a huge misstep on their part because it opened them up to doubt. Doubt in their omnipotence. Doubt in their omniscience. Doubt in the public’s belief in their ability to control the economy. Four months from now I still expect the Fed to hike rates but it seems silly to put their credibility at risk for a couple of basis points.

 

Greece Finally Came Out

Like Greece No One Was Surprised.

Something amazing happened last week. Something that isn’t getting enough attention. Something that for once is a change for good. I’m talking about Greece and it’s new government Tsyriza. Greece’s newly elected Prime Minister has called for a write down of the debt and he’s now gained support from France, Spain and ironically enough President Obama. I don’t think President Obama realizes the consequences a Greek write down will have for the world. But that’s OK, it’s not like his opinion matters…

Anyways for the first time in a long time, we have a government is opposed to the “extend and pretend” status quo. Extend debt out to longer term and pretend it doesn’t matter any more. This is the very Bullshit our world runs on. But now that’s coming to an end. Greece is forcing the whole world reexamine its debts. It’s obvious that Greece can’t pay off its debts which stand at 175% of gdp. It’s also obvious that a lot of other developed countries can’t pay their debts. But no one has yet admitted it… Until now. Or at least Alexis Tsipras did last week in an open letter to the citizens of Germany. This amazing moment cannot be overlooked as the tiny country of Greece whose citizens have been pushed to the breaking point finally shout out “WE’VE HAD ENOUGH!”

Welcome to the end game, where the coyotes start to tilt their heads below the horizon and the solid ground vanishes into thin air.  Greek debt won’t be the last to be written down. A favorable outcome for Greece will spur other indebted peripheral members to seek debt deals of their own. The most obvious case is Spain where the anti-austeriy party Podemos (“We Can”) Party which was only formed one year ago is now leading the polls ahead of Spain’s elections later this year. Podemos is seen as the Spanish counterpart to Greece’s Syriza. Change happens slow and then all at once. The latter will be a rude reminder to the politicians of Europe as the populist movements use each victory to rally more to their cause.

Investment Idea: The first idea that jumps out is shorting the Spanish 10 year bond. At a rate of 1.38%, Spain’s government can some how borrow at lower rate than the US government. Strange to think, especially considering Spain’s debt has jumped from 36.9% of gdp in 2007 to 95% today. A 160% increase in just 6 years! That certainly isn’t sustainable. Italy and Portugal are two other countries who will most likely be forced to write down part of their debts before this is all over. But I like Spain in the short term due to their impending elections and a popular party willing to challenge the unelected overlords in Brussels.