Re: Letter to Trichet

Uh... so I guess he got the memo. I was thinking something more on the order of 2 trillion dollars, but $962 billion sounds reasonable. Glad I could be of service.

Letter to Trichet

At the risk of sounding brash, I believe that Jean-Claude Trichet made a major tactical error Thursday morning by muting calls for the ECB to initiate quantitative easing.

The argument against QE in Europe is that the ECB's actions would necessarily be political, possibly opening up the ECB to scrutiny and jeopardizing the central bank's independence. However, the exigencies of the crisis necessitate bold action and I am surprised that Trichet would allow himself to be caught flat footed on this issue. He was unique amongst central bank governors in the summer of 2007 when he (by fax from the beach) provided unlimited liquidity to the European banking system. This bold action ameliorated the onset of the panic of '07.

Trichet is attempting to restore normality to the markets by withdrawing this liquidity support. This is a mistake. Trichet should have said that the ECB was prepared to come into the market with overwhelming force to drive down the unproductive interest rates on European government debt. With the TED spread and the LIBOR-OIS spread approaching panic levels (in plain English, European banks are no longer lending to each other overnight) he should have reiterated his commitment to provide unlimited liquidity.

If he feels that the "traditional" QE is unpalatable or unworkable, he should initiate a political process by which German bunds (the yields on which are currently plunging do to "safe-haven" searching) are issued and the proceeds used to purchase the debt of weaker European countries (which are in danger of being priced out of the lending markets due to their surging yields.) If this were implemented on a significant scale, it could go a long way towards driving a convergence between bond yields on the debt of European countries.

This may be a good opportunity to raise a domestic issue I've been kicking about in the back of my mind. The political separation between the two control levers of the economy, Fiscal Policy (the Spending and Taxation decisions made by Congress) and Monetary Policy (the control of overnight interest rates by the central banks) is necessary but unworkable. If I were in charge, I would make a commitment to restrain overnight interest rates around 0% for three years. Any adjustment necessary to restrain inflation by choking economic activity should be made on a quarterly basis by manipulating the tax rate on corporations and individuals. This is of course politically impossible, however, it cuts to the heart of the biggest danger facing the economy today, the surging national deficit and the possibility, however remote of a U.S. sovereign default. By increasing taxes temporarily if necessary to restrain economic growth, the government would bide its time by funding the exploding national deficit. This would increase its ability to maneuver by stocking some dry powder in the case that additional Keynesian stimulus is required. Which it will be.

Dance Casa

Also, what the fuck happened at the art sales this week?!? Excuse me for swearing three times in three posts within this hour, (I'm sorry, I got bored and stopped paying attention for three weeks worth of trading days) but $25,842,500 for a 28 inch forearm/hand by Giacometti???

Felix Salmon had an excellent post a few weeks ago. He suggested that works of art produced in limited multiples had a higher value than a unique work of art. That the cache derived from the narrative surrounding the provenance of the sister pieces would speak to the sophistication of the new buyer... to brutally paraphrase his excellent article.

But the fact of the article was that a huge Giacometti had just sold for something like $50 million dollars.

So here we have: the beginnings of bond vigilantism in the European Debt markets, the beginnings of a"1930s U.S. depression style" overproduction thing happening in China, massive surpluses of oil and basic industrial commodities, shortages of rare earth metals and soft commodities (such as coffee, cocoa, orange juice), a severe long term shortage of oil, a short term shortage of coal, Japan done and borrowed twice its GDP, excellent harvests several-years-running depressing the prices of agricultural products, and a tiny fucking Giacometti selling for half the price a monumental sized Giacometti sculpture.

Again. What is going on???

Here's the deal. We are, luckily, not going to have a post-banking system collapse how the fuck do we pay the police if the ATMs don't work kind of situation. But things are very bad. Terrible in Europe. Terrible in New York. Terrible in China.

Less than perfect in L.A., Austin, Brazil... but go to any of these places if you need to. There is oddly enough work.

Thirty-Nine Percent

39% of investors in the iShares/FTSE Xinhau A50 China Index ETF have lent their shares to short sellers. In the words of the immortal Drake, "Who the fuck are y'all?"

Holy shit.

(Update 5/6/10) Yep...

Strong demand for U.S. Debt Auction

The liquidity trap has a floor. It also apparently has a ceiling.

Bids for the $21 billion auction of 10-year U.S. government debt attracted the highest demand on record today, as investors, scared, bet on deflation or couldn't think up any better use for their money.

Homage to Clyfford Still

The depreciation of the Euro (blue) and the Dollar (orange) against Gold.
[The purple has no significance in itself. It's simply caused by the overlap of the two colors. Sometimes it's the Euro and sometimes it's the Dollar. It depends on which currency is stronger and thus in the background.]

From Gregor.us

The most disturbing thing here is the breakdown of the price mechanism- the contraction in non-OPEC oil supply despite the 2008 price surge.

It is clear that oil supply is plateauing. The price surged for coal in 2008 as well, but its discount relative to oil encouraged adoption. Gregor Macdonald predicts recapitulation into a predominately coal-biased global economy within five years.

Luxury Goods

"Luxury is a necessity that starts where necessity stops."

- Coco Chanel (attrib.)

The story of civilization, if told with economy yet in all its comprehensive beauty, can most cogently be explained through the evolution of the unnecessary goods of society. These are the most interesting aspects of civilization and in many ways the quintessence of peaceful society. Civilization is the story of the specialization of labour, the rise of trade, and the creation of a leisure class of scholars and artists and dissipated wealthy. All of these narratives revolve around the unnecessary good.

The unnecessary good exists outside of the dynamic equilibrium that governs supply and demand because its logic befuddles the balancing power of price. Sadie and I have a toast to the unnecessary. It's simply, "Fearless luxury."

If you wanted to ask my 17 year-old self his opinion, he'd tell you, "The moment a good's fundamental utility disappears, it becomes art."

These days I'm more of a Pierre Bonnard man.

Risk on.

Prices are starting to look somewhat reasonable for the first time in over a year:
Coal Company stocks and physical Lead are both down 20%.



























Brazil and India down about 15%






























I hadn't been aware of the recent performance of the Estonian economy until today, but for the very compelling reasons outlined in John Dizard's article in the FM section of the FT the other day, I believe this fund would provide good diversification to a not-Dollar portfolio. Estonia is on track to join the EU next year, so investing in its stock market provides Euro exposure without the structural weaknesses of the European economy.

SEB Eastern Europe Small Cap Fund

The Dollar is close to median value against the Euro ($1.35) and strong against the basket of currencies which make up the dollar index.















I think we are entering the moment where the paths diverge between the V-shaped recovery of low debt, youth oriented, growing economies, and the W-shaped recovery of the over-leveraged, sluggish, aging countries.

Remember the international investing formula detailed before on these pages. An successful economy and candidate for investment must contain Attractive Women + Quality Music + Decent Educational Opportunities + Young Population + Low Debt/GDP ratios + Accelerating Credit Expansion (installment plans, mortgages, etc.)

With Quality of Music and rate of Credit Expansion counting the most in projections.

Non-Specific Observations of the Energy Markets

This is a picture of the incredibly tight correlation between the price of wholesale gasoline and the yields on 10-year U.S. Treasury Bonds. I've suggested before that this may be due to the fact that unleaded gasoline is a perishable commodity and thus its supply is most tightly coupled to the short-term economic outlook, but I don't know. It's interesting though, no?












This is a picture of KOL, an ETF comprised of coal related companies. Though most markets are exhibiting classic technical analysis resistance patterns, this chart wins the award for pristine textbook example. (If your new to T.A. here's a hint... ignore the bullshit. All you need to know are 'Resistance can become Support', the Head and Shoulders formation (on long-term charts only) and 50 & 200 day moving averages. Everything else is worthless.)

By the way, maps show you where to go. Charts show you where not to go. This is important.

Anyway... the consumption of coal has sky-rocketed this year relative to oil because it is a much cheaper alternative. There are some posts on my favorite economics blog, gregor.com, related to this subject which are excellent for both the quality and inventiveness of Mr. Macdonalds' writing and the accompanying charts. In addition to his theories on our current inflationary depression ("compartflation,") today he made the bold and sensible prediction that, "It was only 55 years ago that the world crossed over to use more oil than coal. In another five years, we will be going back to coal." Here is a link to a post of his with jaw dropping charts of recent trends in world coal consumption.

[btw/fyi... Gregor Macdonald, George Cooper, Satyajit Das, Bill Gross, and Mr. Soros (back in his prime)... the smartest guys in the proverbial room]

Missed Connections

A few thoughts on the State of the Union address. Not on what Obama said, but on what he didn't say and perhaps should have mentioned:

1) "The dollar is much stronger now then it was before I became recognized as a viable candidate for president... in fact, almost to the day of my speech at the Brandenburg Gate."

(Not that this is necessarily a good thing, or necessarily indicative of a casual relationship... though I personally believe that in the midst of the Freddie and Fannie nationalization of July 2008, Obama's appearance on the world stage marshaled confidence in the Dollar, which immediately began to pull forward against all other currencies. This was in no small part a consequence of the stamp of imprimatur bestowed by Paul Volcker's early presence on Obama's economics team... Conveyed correctly, the above statement could have been the most positive populist thing he could have said to the "American people" as they, a bit bullheadedly, really favor a strong dollar. It's simply patriotic chauvinism.)

[Incidentally, the so called "Palin effect" in the first three weeks of her candidacy on John McCain's rising poll numbers was I believe due instead to Obama's initial effect on the dollar. Dollar strength knocked the wind out of commodity prices and gasoline prices came rapidly down. This caused the widespread elation for a moment, as it seemed (to the uninitiated) that the "economy" was getting better. Of course, in short order the tail began to wag the dog as falling demand began a collapse in commodity prices which amplified the dollars surge. And then Lehman... and McCain/Palin was history. Flight to safety, indeed.]

2) "This trillion dollars I have spent since taking office is largely in line (proportionally) with the total amount spent by Europe to combat the panic and as such we are no worse off fiscally on a relative basis."

(Also a brief explanation of what an overnight shift in household savings from -2% of GDP to +6% of GDP does to an economy, along with an explanation of why only government spending can make up for the shock of such a sudden chasm in consumption... Yeah, that would have been helpful.)

Here we go!

So as the forecast on December 8th, 2009 predicted ("Short-Term Dollar Strength on Worldwide Crappiness") the Euro is now within spitting distance of $1.40 to the dollar. So far so good. But the ferociousness with which it smashed though its 200 day moving average makes me inclined to wait for further weakness rather then booking profits now. I believe that the Dollar will certainly hit $1.35. Depending on the management of the Grecian crisis, the Euro easily could fall further but $1.35 is a recurring motif I feel comfortable with.
(It was the exchange rate when I first started paying attention to the markets in 2005, it was the rate just before the panic began in late July 2007, and there has been a lot of congestion around $1.35 over the past year.)












In other news, readers of this blog will note that I have been pretty bearish throughout the past year. Not to the point of outright shorting the S&P 500, but certainly not holding any long U.S. equity positions either. The theme since December 6th, 2008 has been to pursue a simple "reflationary" strategy, with a diversified portfolio split between base metals (LD, +141%), rare metals (1211.HK, +524%), junk-bonds (PHDAX , 46%), Brazilian and Indian Equities (EWZ, +156%, INP, +129%), and Inflation-Protected Government Bonds (TIP, +11%). This strategy was intended to be long only, with a "buy on dips" mentality.

I believe it is time to close out this portfolio and move to cash. Investor bullishness is the highest its been since 2006. China is removing liquidity. The VIX is near its 3-year lows and Junk-Bonds have returned to yields not seen since the moments before the panic in July 2007.

We may be moving into a new phase of the crisis. The big story of the Panic of 2008 was the run on the "cyber" banks, the money-market accounts where investors park their cash. The sudden withdrawal of cash from these accounts after the Primary Reserve fund "broke the buck" ushered in a wave of forced selling as money-market accounts sold their investment holdings to meet redemptions. We are unlikely to see a liquidity panic of this sort again. It is likely that the troubles in Europe will spread in unexpected ways. The specter of a Greek sovereign default will seriously undermine faith in the European Monetary Union, and until there is a clear protocol for dealing with the Greek crisis, we may very well see a solvency panic of the sort which accompanied the failure of Lehman Brothers.

I am not suggesting that this crisis is imminent, simply that the December 6th, 2008 portfolio reallocation has made stunning, one-in-a-lifetime returns, and there is enough uncertainty to the outlook to take a breather and reflect.

I am a firm believer that equity investors must be burned three times before a true bull market can begin. I've never read this anywhere, it simply seems like a prerequisite to the necessary capitulation which allows assets values to reach appropriate valuations for the onset of a bull market. I mark the bursting of the tech bubble as burn #1 and the panic of '08 as burn #2.

As a corollary to this thought however, I would reiterate my comments of last spring. The questions regarding L, W, or V shaped recoveries are misplaced. With the increasing globalization of the world financial markets and the shifting demographic patterns between developing and developed markets, I believe we will see a W-shaped recovery in the 1st world and a V-shaped recovery in Brazil and India.

We may very well be approaching half-time in this (so far) three year long bear market. Don't let anyone try to fool you into thinking otherwise.

Sovereign Default Swaps and Corporate Risk Premiums

The price of insuring the European Union against a member's default rose above the price to insure Europe's companies against default today for the first time since the height of the financial crisis in March 2009.

Meanwhile, the risk premium to own the riskiest safe corporate bonds instead of 30 year government bonds (and their "risk free" rate of return), has narrowed to the smallest spread since July 2007... the moment just before the panic began.

Debt Deflation : The Echo of Inflation

When one spends using credit and the interest rate on that debt is hiked, (arbitrarily to 29.99% in my case) it is the same as a sudden burst of price inflation on every good that one has ever bought with that credit.

It is almost like a strong echo.

This has been happening nationwide ever since the passage of the new consumer finance laws last fall. While the rules are excellent in many ways, they also severely restrict a bank's ability to price risk appropriately. They also have the effect of modifying, in a sense, the contracts that govern credit card master trusts- one of the securitization vehicles that made credit so cheap over the past decade. This dramatic change in their financial architecture has happened without the underlying contracts being strictly violated. The foundations of their profitability, however, been shaken, and since these trusts a revolving this may have caused a profound shift in their desirability as investments. This marks a permanent shift in the credit landscape, partially ameliorated by this recent skulduggery, but likely to have continuing consequences as new credit issuance is restricted to consumers and small businesses.

The jacking up of interest rates on everyone's credit card balances will prove to be highly deflationary. We will see the effects of this disgraceful practice by May.

Art Market Rules

(A beautiful Van Dyck self-portrait from his late period. $13.5 million as of December 9, 2009... shocking, given that the previous day a throwaway sketch by Raphael went for $47.5 million and a perfectly ordinary Rembrandt self-portrait went for $32.7 . Though I wonder if my infatuation with this painting is partly due to its astonishing and perfect frame. It is scandalous that museums' information labels universally fail to account for the origin of a painting's frame. Nothing else in cultural history is so elementary and evocative of its moment.

A painting's frame speaks of successive generation's conceptions of space- this tension in art between art's utility as a decorative object and art's function [forgive me here for Elijah Craig's influence...] as a metaphysical text. In no other media can you learn as much about the sophistication and empathy of the owners or curators who have lived with the art itself in its intervening years.)

* * *

My dad told me a funny anecdote he once heard. When asked about the price of Rembrandt painting he had recently purchased, Norton Simon said something to the effect of, "Well this painting probably cost about a dollar in 1650 and its worth about 5 million now, so all in all art appreciates at a fairly boring rate of return."

At the end of his book "The $12 Million Stuffed Shark," Don Thompson sets out some tongue in cheek rules for purchasing art:

"With the work of western artists, what kind of painting will appreciate most? There are general rules. A portrait of an attractive woman or a child will do better than that of an older woman or an unattractive man. An Andy Warhol Orange Marilyn brings twenty times the price of an equal-sized Richard Nixon.

"Colors matter. Brett Gorvy, co-head of contemporary art at Christie's International, claims the grading from most salable to least is red, white, blue, yellow, green, black. When it comes to Andy Warhol, green moves up. Green is the color of money.

"Bright colors do better than pale colors. Horizontal canvases do better than vertical ones. Nudity sells for more than modesty, and female nudes for much more than male. A Boucher female nude sells for ten times the price of a male nude. Figurative works do better than landscapes. A still life with flowers is worth more than one with fruit, and roses are worth more than chrysanthemums. Calm water adds value (think of Monet's Water Lilies); rough water brings lower prices (think of maritime pictures). Shipwrecks bring even less.

"Purebred dogs are worth more than mongrels, and racehorses more than cart horses. For painting that include game birds, the more expensive it is to hunt the bird, the more the bird adds to the value of the painting; a grouse is worth three times as much as a mallard. There is an even more specific rule, offered by New York private dealer David Nash: painting with cows never do well. Never.

"A final rule was contributed by Sotheby's auctioneer Tobias Meyer. Meyer was auctioning a 1972 Bruce Nauman neon work, Run from Fear/Fun from Rear, which referred to an erotic act. When the work was brought in, a voice from the back of the room complained, 'Obscenity.' Meyer, not know for his use of humor on the rostrum, responded, 'Obscenity sells.' Often it does not, but for a superstar artist like Jeff Koons or Bruce Nauman, it does. It did."

* * *

















(A very early Robert Irwin. Probably the kind of painting he would have destroyed later in his career, if given half the chance. Sold September 24th, 2009 for $16,000. Estimated in May 2009 for $80,000-$120,000. It went unsold at that time.

I'm not sure (heat of the moment and all) what it would have sold for had I been present in the room. But I assure you, if we check back on this painting in a few decades we will find this buyer got the the deal of the century.

I don't mean to insinuate that I particularly like this painting. But centuries from now, when the concept of the post-modern has long ago become but the conceit of only the most pathetic of Ph.d types trolling for a brutally sloppy and disease ridden end to a pathetic gang-bang worth of a dissertation topics- Robert Irwin will be viewed a one of the men who brought the progression of modernism from its origins in multi-plained abstractions of Cezanne and the shimmering equal-luminescences of Monet to its apotheosis in pure perceptual bliss. And this crappy early abstract work will certainly achieve a perfectly respectable rate of return.)

Short Term Dollar Strength on Recognition of Worldwide Crappiness

We've reached a short-term inflection point in our general asset reflation scheme. General worldwide crappiness and uncertainty will lead to a short-term dollar strength. Safe-haven searching, a general one sided bets against the dollar, and a slightly brightening U.S. Economic Outlook will assist this move.


An overview of volatility-driving upcoming events:
The next due date for part of Dubai World's debt is on Dec. 12th. There is an upcoming important court decision on the restructuring of the first bankrupt Islamic "Sukut" bond.

The steep downgrade of Greece's debt today, is going to force the European Central Bank to spell out its long-term support of excessive Greek borrowing. The ECB is lending to the Greek banks, which in turn are holding large amounts of Greek Government Bonds. This is complicated by the fact the Greek banks are barely solvent. And the Greek Government is broke. This uncertainty about the European Monetary Union will negatively affect the euro until the issues concerning the weaker states are resolved.

The Japanese have been hurting due to their currency's strength against the Euro and Dollar. Intervention is possible, probably by the enlargement of the Central Banks relatively un-extended balance sheet.

The amount of correlation between general asset prices over the past year has been quite incredible. Gold, oil, and stocks around the world has fallen for the past several days. The dollar has been rising.

We are about to witness short-term correction in the dollar's long-term decline.

I believe the stimulus dollars are beginning to enter the general money supply. There's a hum in the air on main street that whispers of a significant increase in the velocity of money. Money is a momentum- a product of its quantity and the speed at which it moves. Money is coming out of the mattress and being spent. In labor news, the employed are working longer hours. People are taking home more weekly pay, despite hourly wages continuing to fall. This suggests overtime.

Finally in other news, an extremely destabilizing bill just passed the House Financial Services Committee, which if enacted into law will severely restrict credit by shutting down some portions of the interbank lending market, and introducing new destabilizing panic pathways into the overnight market. Also worth mentioning is the accounting rule change going into effect in January, bringing all of bank's off-balance sheet entities back onto the balance sheets.

In short, short-term dollar strength probably clustered around $1.40 against the Euro lasting around than three months. Higher US stocks relative to Gold but lower in general. Lower Europe Stocks. Brazil lower but not as far. Other emerging markets with deficits, harder hit.

Forecast

Real Estate. We are in the midst of an inflationary depression. On one side we have the ravages of debt. On the other, an uneasy coalition between the printing press and the psychology of a people.

The government will continue printing dollars to support the economy. Debt which pushed up asset values will now cause them to deflate as people pay down their debts instead of buying. The over-leveraged will continue to experience pain and their defaults will further damp asset values. The government prints dollars under different names but its key effort is to replace the personal spending that is now devoted to saving.

The rise of gold is unremarkable. Against copper, gold has risen about 40% since the beginning of 2007. Against oil, gold has risen 60%. Against stocks, of course gold is up 120%.

I'm not sure exactly how much gold has risen against "real estate," but with housing prices roughly down about 30% nationally, and gold up around 100%, we can all guess the relevant math.


Of course we are looking at values versus their peak, but that is exactly the point. The point in the past which we pick for measurement is arbitrary; we can only make decisions in the present. We are looking for the point at which we collectively hit our debt maxima, and we are guessing the point at which the government will target for suitable valuation.

Of course, this assumes that the government has any agency in the matter, which it does, but only indirectly.

My biggest mistake in the past 2 years has been trusting in the efficacy of printing dollar bills. It turns out this is an extremely blunt instrument. The government can no more guarantee asset values.

Our collective debt will hold down "real estate." But "real estate" values hold a reflexive power over broad swathes of the economy. The government will thus target a price level based on real estate values.

In this process, the government will anchor the values of all other goods. Tangible, fungible goods will attain a steady state value. Tangible but subjective/discernible goods, another. Subjective paper goods will suffer against common paper but against gold most of all. Gold, the most subjective of goods.

Regardless, under the best of scenarios, we will see "real estate" values depreciate by the scale of each buyer's dreams... assuming these dreams are rooted and leveraged in paper.

Real Estate- Unqualified Japanese Example

The prospects for real estate in the United States are grim. This is the mechanism by which real estate deflates.

The adjustment in the world economy is accompanied by much higher interest rates in the U.S. This dampens the price of real estate. Prices will remain at the same level as today and not inflate along with the prices of food and energy.

Japanese House Prices 1979-2005:

Ignore the Hype.

U.S. Stock Paper vs. Paper Gold since last Thanksgiving.