Wednesday, February 29, 2012

Or Shall We Call It Bernanke's Revenge?

Wondering about the sell-off in gold?
May be it was a revenge of Bernanke over Ron Paul?
Paul was showing him some precious metal and telling Ben how he screwed US Dollar. Then the sh*t hit the fan.

Gold Loses Glitter.

The big news for the day is sell-off in gold. GLD dropped from $172 to 168 in less than five minutes.
And there was no counter trend rally after that either. And the sell-off happened with very high volume.
By that standard, silver was relatively OK.  But almost everything in the commodity sector sold-off including copper and oil.

Such a waterfall decline in one class of risk assets do not bode well for the others.  I am not saying that the crash will start from tomorrow. Rather, I want to stress the fact that the up-trend is still intact despite all the divergences and warning signals. But Russell was down over 1.5 % while SPX was down merely 0.47%. We know that “Wall St” likes to make-up the stocks at the end of the month and high flying / well known stocks have to be guarded. May be that is why they can let Russet go but protect SPX and DOW somewhat.

I was not expecting any selling before next week so when SPX showed red I was rather surprised. With today’s price action we have a bearish reversal candle and may be a bearish engulfing candle as well. I am not sure of the bearish engulfing pattern because as per Bulkowski  : The body of the black candle should engulf or overlap the white candle’s body,…… Shadow overlap is not important.”  But in today’s case, I do not think the black candle body overlap the white candle body.
In any case, tomorrow being the 1st of the month as well as Thursday, we can expect the market to be up. May be it will re-test the high before turning down. We will have to wait and see.

The ECB handed out more than $700 Billion and that may have been the last act of kindness for a long time to come. When Mr. Ben indicated that there would be no QE for a while, the junkies in the market went for a withdrawal symptom.  Did the traders and speculators decided that since there will not be any QE anytime soon, there would be no more liquidity and so sell the gold? NY Fed even did a reverse REPO today.  Even before Bernanke opened his mouth, EURO was not showing much life after the news of LTRO. So what gives?

While the 4QR GDP was reported to be at 3% ECRI is not backing away from its call for recession.

Let us see how the next jobless numbers come out.

In the mean time the Trend Table continues in green except gold. But I am happy to wait on the side line to see if all other risk assets move in the same direction. We may see a whipsaw in gold.
Thank you for reading . Please forward / retweet the post to your friends and join me in Twitter. (@BBFinanceblog). As always, I welcome your comments and suggestions.

Pour some sugar on me

Sugar has been creeping higher lately, as seen on the daily futures chart. 

Here's the weekly view which shows the longer swings going back to 2006. 

Note the larger uptrends and ensuing deep retracements that have happened from the 2007 base, near 10 cents, on. 

Of course, the latest move is more of a slow edge higher off the recent price shelf of 23-24 cents. Sugar will have to clear the 30 cent level and the recent highs near 32 cents before any major move is evident on the weekly charts.

Here's the daily chart of SGG, the sugar ETN. I'll be watching for a pullback on lighter volume in the days ahead. Since I'm not active in the futures market, I'll consider a long position in SGG. 

Cautionary note: volume is very light in many of these single commodity ETNs. That may lead me to consider other, more liquid, trade opportunities instead.  

For those who'd like to read more about sugar from a futures trader's point of view, please see Peter Brandt's recent blog posts. He is an experienced trader and knows far more about the long-term price action, as well as building a trade via back month futures contracts.

Disclosure: no position in SB_F or SGG at the time of writing, may initiate long or short positions any time after. Educational post, not a recommendation for readers to buy/sell any security.

Selective Enforcement Once More

Prosecutors are now quietly leaking that they don't see any criminal activity in the demise of MFGlobal. Recall that MFGlobal fraudently looted $ 1.6 billion from customer accounts that were, by law, supposed to be segregated from the firm's own assets. Now, it turns out, prosecutors are leaking that this all seems to be an innocent mistake.

Interesting, after Goldman Sachs has been blistered over and over again by the SEC and by state prosecutors for activities that no one had ever considered anything other than ordinary market-making. In the brave new Obama world, Attorney General Holder and his cronies in state law enforcement invented new criminal activities where there were none, in order to make political headlines at the expense of Goldman Sachs.

But now, when former Democratic Senator and Governor John Corzine is the one whose hands appear to have dipped into the cookie jar, this all is being washed up as simply an innocent mistake. Never mind that innocent customers, whose accounts have been looted, were not protected by the Obama-led CFTC, too busy on political witch-hunts to provide for the simplest of their regulatory responsibilities.

If customer accounts at broker-dealers that are, by law, supposed to be segregated from the broker-dealers' own funds, can be looted any time the firm is run by folks friendly to the President, then no one's funds are safe -- in broker-dealers or in mutual funds either. The blank check that is being issued to Obama's cronies to steal from the public is just one more example of the collapse of the rule of law.

But, this time, the real economy will suffer. Gradually investors will begin to sense that their assets, held in broker-dealers or in mutual funds, are not safe from looting by the people running those firms. So long as the leadership of these firms, like Corzine, worship at the Obama shrine, the investors will be unable to pursue criminal wrongdoing and their losses will be simply chalked up to "innocent mistakes."

Tuesday, February 28, 2012

Apple A Day Keeps Bears Away.

Or whatever.  The stock market keeps grinding higher and everyone hates this market. The bears hate it because it is grinding them to dust. Bulls hate it because they are under invested and would like to go back and invest more. Brokers hate it because there is no action. We are all calling a top for months now and yet nobody has seen a top.

Now that DOW has closed over 13000 and SPX over 1370, do we throw away all the rules of TA, cycle analysis and just believe in the powers of Central Bankers? Buy the F**king dip?  I am no bear and I have no problem joining the buy program only if I could convince myself that this time is different. That all the divergences do not matter!  That this time is truly different!  The path of least resistance is up-ward. So the next we hear is DOW 13500 and SPX 1400.

Look at the 5 min. chart of SPX.
In the normal course I would have said it is a double top. But now I don’t know what to say.

The summation index (NYSI) is turning down and in the past it has been followed by market corrections.
(Source: Ciovacco Capital)
Will it be different this time?

J Wagner of FXCM has the following chart;
Mr. Wagner thinks AUD has some juice left. 
Look at the weekly chart of AUD.
I am thinking that AUD is at the top of the range and not much room to run.

If we have to guess the Top based on TA, then there is no better person to guess than our good friend Cobra.

As per his measured move target, SPX can go up-to 1376.

In the mean time, the trend table continues to be long.
Do not front run unless you know what you are doing. Market is smarter than all of us. Too many of us are calling for the top and reversal and it will come when we least expect it. While we wait for the market to show us the next bend, here are some interesting reads:

Thank you for reading . Please forward / retweet the post to your friends and join me in Twitter. (@BBFinanceblog). As always, I welcome your comments and suggestions.

Weird stuff in high frequency markets

On the left is a graph from a really neat paper, "Low-Latency Trading" by Joel Hasbrouck and Gideon Saar (2011). You're looking at the flow of "messages"--limit orders placed or canceled--on the NASDAQ.  The x axis is time, modulo 10 seconds. So, you're looking at the typical flow of messages over any 10 second time interval.

As you can see, there is a big crush of messages on the top of the second, which rapidly tails off in the milliseconds following the even second. There is a second surge between 500 and 600 milliseconds.

Evidently, lots of computer programs reach out and look at the markets once per second, or once per half second. The programs clocks are tightly synchronized to the exchange's clock, so if you program a computer "go look once per second," it's likely to go look exactly on the second (or half second). The result is a flurry of activity on the even second.

 It's likely the even-second traders are what Joel and Gideon call "Agency traders." They're trying to buy or sell a given quantity, but spread it out to avoid price impact. Their on-the-second activity spawns a flurry of responses from the high frequency traders, whose computers monitor markets constantly.

There's a natural question: Is this an accident, or is there intentional "on the second" bunching? You can see that a programmer who didn't think about it would check once per second, not realizing that means exactly on the top of the second. But sometimes there is more liquidity when we all agree to meet at the same time. Volume has always been higher at the open and close.  Joel and Gideon show the pattern lasted from 2007 to 2008, so was not an obvious short-term programming bug.  (Do notice the vertical scale however. The range is from 9 to 13, not 0 to 13.) I'd be curious to know if it's still going on.

Here's another one, found by one of my students on here. (Teaching has many benefits when the students know more about markets than you do!).

You're looking at bids, asks, and (white dot) trades in the natural gas futures markets. From nanex:

On June 8, 2011, starting at 19:39 Eastern Time, trade prices began oscillating almost harmonically along with the depth of book. However, prices rose as bid were executed, and prices declined when offers were executed .....price oscillates from low to high when trades are executing against the highest bid price level. After reaching a peak, prices then move down as trades execute against the highest ask price level. This is completely opposite of normal market behavior....It's almost as if someone is executing a new algorithm that has it's buying/selling signals crossed. Most disturbing to us is the high volume violent sell off that affects not only the natural gas market, but all the other trading instruments related to it.
I'm generally give efficient markets the benefit of doutbt, but it's hard not to suspect that some programming bugs are working against each other here. It's hard enough to debug a program to work alone, but when 17 programs work against each other all sorts of interesting weirdness can spill out. I am reminded of work in game theory in which computer programs fight out the prisoner's dilemma and all sorts of weird stuff erupts. If so, this will settle down, but it may take a while.

The Economist reports an interesting related story.
ON FEBRUARY 3RD 2010, at 1.26.28 pm, an automated trading system operated by a high-frequency trader (HFT) called Infinium Capital Management malfunctioned. Over the next three seconds it entered 6,767 individual orders to buy light sweet crude oil futures... Enough of those orders were filled to send the market jolting upwards.
A NYMEX business-conduct panel investigated what happened that day.... Infinium had finished writing the algorithm only the day before it introduced it to the market, and had tested it for only a couple of hours in a simulated trading environment to see how it would perform. .... When the algorithm started its frenetic buying spree, the measures designed to shut it down automatically did not work. One was supposed to turn the system off if a maximum order size was breached, but because the machine was placing lots of small orders rather than a single big one the shut-down was not triggered. The other measure was meant to prevent Infinium from selling or buying more than a certain number of contracts, but because of an error in the way the rogue algorithm had been written, this, too, failed to spot a problem. ..
High frequency trading presents a lot of interesting puzzles. The Booth faculty lunchroom has hosted some interesting discussions: "what possible social use is it to have price discovery in a microsecond instead of a millisecond?" "I don't know, but there's a theorem that says if it's profitable it's socially beneficial." "Not if there are externalities" "Ok, where's the externality?" At which point we all agree we don't know what the heck is going on.

There is also the more prosaic question whether high frequency traders "provide liquidity" and thus are in some sense beneficial to markets, or if they are somehow making markets worse. A question for another day (there is some interesting new research).

There are lots of reports of how profitable it is. But high frequency trading is a zero sum game. Anything you do in milliseconds can only talk to another computer. By definition, they can't all be making money off each other. 

Monday, February 27, 2012

The Price of Energy

As gas prices careen toward $ 5 per gallon, we are reminded that fossil fuels are the only game in town. For all of the waste and corruption of the Obama energy policy, it is good old drill, drill, drill that provides any hope of slowing the increase in gas prices at the pump.

Obama seems perplexed. He notes that energy consumption is down. So, why are prices up? Is he aware of China and India? They use energy too. Guess what? They are going to keep pushing the demand for energy higher and higher. Even with oil at $ 300 per barrel, one wonders if Solyndra would have made it. This is the most naive administration regarding fundamental economics in the past hundred years. Somehow, they think a few windmills will get it done. It won't.

Sooner or later, even the Obama crowd will realize that the US must tap its fossil fuel reservoir, potentially the largest such reservoir in the world.

Higher prices at the pump has a partial offset in profits and jobs in the US energy sector. No doubt, the bad guys in the Middle East will get their share as well. But, all in all, the only thing Americans have to fear regarding energy supply is more bad policies from the Obama Administration.

Anyone Seen A Top?

 - Otter Party!

Another BTFD day. Another world has been saved day.  And we have not seen helicopter Ben throwing money in USA yet, I mean directly. He is doing so indirectly by SWAP lines and ECB LTRO. Can you imagine where the indexes will be when Hel-Ben shows up here in USA, giving away free money? You better shed your bear skin and try to think like a bull. Because he will definitely show up.

I have whole host of technical indicators screaming murder but the bottom line is that the up- trend has not been broken. Time to buy?  I would say that unless SPX breaks 1370 convincingly (stays above the level for at least two days in a row), I am not ready to become a bull. VIX may be signaling something:

Also there is a divergence between SPX and VIX. SPX making higher high but VIX is not making lower low. Rather it is also making higher high. It is now up two days in a row.

Per ZH Dow crossed 13000 22 times today.
(Source: ZH)
Now we know that ZH is given to hysteria, but still they have a valid point here.

SPX closed 1.85 points up while Dow closed 1.44 points down. Gold sold off and so did oil. I have an interesting chart from Uempel :

He does not give conclusion but being a smart person that he is, poses a question. Anyone seen a top yet? So while wait for the trend change, here is the trend table for today. The Indexes are mostly unchanged.

Hope it will help you to stay on the right side of the market.

Thank you for reading . Please forward / retweet the post to your friends and join me in Twitter. (@BBFinanceblog). As always, I welcome your comments and suggestions.

P.S. Interesting read from Stock Trader's Almanac;

Buffett as Buffoon

Becky Quick and Joe Kiernan took Warren Buffett to task this morning on CNBC for his hypocritical stance on income taxation. Joe suggested, as has Governor Christie recently, that if Warren is so intent on paying more in income taxes why doesn't he write a check. Buffett's response: his writing a check would not solve our deficit problem.

Interesting answer. Neither would putting a surcharge on "millionaires and billionaires." Raising taxes on the rich would not put a dent in the deficit problem that the US faces. It doesn't matter whether just Buffett pays up or whether he is joined by his rich buddies. It won't move the needle.

So, why won't he write a check and show the way if he believes that is the "right thing to do."

Why? Because, Buffett is a hypocrite. He wants to appear to be the good guy, knowing full well that all he has to do to avoid income tax is shift his assets around and have no taxable income at all and pay no taxes whatever.

If Buffett wanted to pay more taxes, the route is obvious. As Governor Christie put it so eloquently: "shut up and write a check."

Buffett likes to hear the sound of his own voice, but he isn't about to share any of his wealth with the US taxpayer. Let others do that, says Warren!

Kiernan went on to query Buffett about his love for big government and having the government deciding winners and losers in the private economy and invest taxpayer dollars in the Solyndras of the world. What was Buffett's answer? "The US has the greatest industrial machine on the earth," said Buffett.

Buffett, like a lot of the far left, gives the free market zero credit for the US economic engine. To Buffett, the government is the be-all and end-all of American greatness. No wonder he supports Obama.

He should write a check!

Sunday, February 26, 2012

John Burbank talks oil, macro with Bloomberg

Noted hedge fund manager, John Burbank of Passport Capital talks oil, investing in Saudi Arabia, stockpicking in 2012, and global macro in this recent Bloomberg TV interview. 

A few key points from Burbank's interview: 

1. Oil prices are up 16% YTD, which hurts the average oil-dependent consumer (chart). Burbank feels global QE operations and "liquidity" boosts are pushing up oil prices. If gold goes up 10-20%, it doesn't cause problems for consumers the way rising oil prices do.

2. Rising oil prices are benefiting Saudi Arabia. Passport now has 15% of its capital in the Saudi stock market, a country which is slowly opening up to foreign investors. 

Passport started investing in Saudi Arabia in 2008 (through notes & swaps) and Burbank feels the potential there is similar to India in the 2003-2004 period. Here's a chart of India's SENSEX over the 1998-2012 period.

3. Liquidity is coming into the market because "things are really bad", not because things are good. Burbank feels that confidence in central banks is misplaced. The average Westerner's standard of living is not improving; rising prices and stagnant incomes are squeezing them.

4. 2012 is a stockpicker's market, a good year to be long or short certain sectors and individual names. 

Burbank is not banking on a sustained global rally. Instead, he's looking to invest in stocks that can outperform regardless of growth rates in the overall economy. Biotech is one area that he finds promising at this time. 

Enjoy the interview, and if you'd like to hear more from Burbank and other macro stars, check out the interviews in the related posts section below.

Related articles and posts

1. Must hear interview with John Burbank of Passport Capital.

2. Michael Burry talks "Big Short", America's future at Vanderbilt.

Saturday, February 25, 2012

Weekend Reading.

Some interesting reading from various places on a lazy Saturday afternoon;

First from Eric Sprott and David Baker  of Sprott Asset Management.

2012 is proving to be the 'Year of the Central Bank'. It is an exciting celebration of all the wonderful maneuvers central banks can employ to keep the system from falling apart. Western central banks have gone into complete overdrive since last November, convening, colluding and printing their way out of the mess that is the Eurozone. The scale and frequency of their maneuvering seems to increase with every passing week, and speaks to the desperate fragility that continues to define much of the financial system today.

The first major maneuver took place on November 30, 2011, when the world's G6 central banks (the Federal Reserve, the Bank of England, the Bank of Japan, the European Central Bank [ECB], the Swiss National Bank, and the Bank of Canada) announced "coordinated actions to enhance their capacity to provide liquidity support to the global financial system".1 Long story short, in an effort to avert a total collapse in the European banking system, the US Fed agreed to offer unlimitedUS dollar swap agreements with the other central banks. These US dollar swaps allow the other central banks, most notably the ECB, to borrow US dollars from the Federal Reserve and lend them to their respective national banks to meet withdrawals and make debt payments. The best part about these swaps is that they are limitless in scope - meaning that until February 1, 2013, the Federal Reserve is, and will be, prepared to lend as many US dollars as it takes to keep the financial system from imploding. It sounds absolutely great, and the Europeans should be nothing but thankful, except for the tiny little fact that to supply these unlimited US dollars, the Federal Reserve will have to print them out of thin air.

Eurozone banks may now be hooked on what is clearly a back-door quantitative easing (QE) program, and as the warning goes for addictive drugs - once you start, it can be very hard to stop.
Britain is definitely hooked. On February 9, 2012, the Bank of England announced another QE extension for 50 billion pounds, raising their total QE print to £325 billion since March 2009.3 Japan's hooked as well. On February 14, 2012, the Bank of Japan announced a ¥10 trillion ($129 billion) expansion to its own QE program, raising its total QE program to ¥65 trillion ($825 billion).
Who needs traditional QE when the Fed already buys 91 percent of all 20-30 year maturity US Treasury bonds?  Perhaps they're saving traditional QE for the upcoming election.

All of this pervasive intervention most likely explains more than 90 percent of the market's positive performance this past January. Had the G6 NOT convened on swaps, had the ECB NOT launched the LTRO programs, and had Bernanke NOT expressed a continuation of zero interest rates, one wonders where the equity indices would trade today. One also wonders if the European banking system would have made it through December. Thank goodness for "coordinated action". It does work in the short-term.

The problem with central bank intervention is that it never works out as planned. The unintended consequences end up cancelling out the short-term benefits. Back in 2008, when the Fed introduced zero percent interest rates, everyone thought it was a great policy. Four years later, however, and we're finally beginning to appreciate the complete destruction it has wreaked on savers. Just look at the horror show that is the pension industry today: According to Credit Suisse, of the 341 companies in the S&P 500 index with defined benefit pension plans, 97 percent are underfunded today.12 According to a recent pension study by Seattle-based Milliman Inc., the combined deficit of the 100 largest defined-benefit plans in the US increased by $236.4 billion in 2011 alone. The main culprit for the increase? Depressed interest rates on government bonds.

Let's also not forget the public sector pension shortfalls, which are outright frightening. In Europe, unfunded state pension obligations are estimated to total

$39 trillion dollars, which is approximately five times higher than Europe's combined gross debt.15 In the United States, unfunded pension obligations increased by $2.9 trillion in 2011. If the US actually acknowledged these costs in their deficit calculations, their official 2011 fiscal deficit would have risen from the reported $1.3 trillion to $4.2 trillion. Written the long way, that's a deficit of $4,200,000,000,000,... in one year.

I know Eric Sprott wants us to buy gold from him but I could not agree more on the points he has made here or write any better. So I quote from a very long essay and applaud.

The next one is from David Rosenberg of Gluskinn-Sheff:

There is perception and then there is reality. In a replay of events this time last year, investor optimism is near an extreme according to many measures and views over the economic outlook have become much more constructive. This is the perception and it is well ingrained. But there is also the reality that some critical hurdles for the economy loom on the horizon and should not be dismissed out of hand:

The European recession is just getting started and the impact on Asian trade flows is already evident in the data — with Chinese export growth completely vanishing in January and manufacturing diffusion indices flashing modest contraction in February. We are potentially one to two quarters away from seeing a significant shock to the U.S. GDP data from an eroding net foreign trade performance.

What upset the apple cart this time last year was the run-up in oil prices, followed by a lag with a surge in gas prices at the pump. Once again, oil prices have ratcheted up and with a lag, we can probably expect a return to $4 per gallon for regular gas at the pumps by the time spring rolls around. The front page of the USA Today makes the case for why $5 per gallon is likely coming. The transport stocks see what's coming, having peaked on February 3rd, and since then this group has suffered 9 losses out of the past 13 sessions, representing a 4% decline from the nearby peak. This is a bit of a problem for the bulls because the transports never did confirm the new highs that the Dow and S&P 500 made — and the index is now at a critical juncture as it kisses the 50-day moving average on the downslope.

This hurdle will likely only become apparent in the second half of the year and it relates to tax uncertainties and the implications for rising personal and corporate savings rates.
First, the top marginal personal tax rate rises to 39.6% from 35% as the Bush tax cuts expire at the end of 2012. A limit on itemized deductions will add a further 1.2 percentage points to the top rate. Second, a new 0.9% Medicare tax on incomes over $200,000 gets imposed ($250,000 for joint filers). Moreover, the top 15% rate on long-term capital gains rises to 20%. And dividends will once again be taxed at ordinary rates — 39.6% for the top income earners. A new 3.8% tax on investment income also gets introduced for incomes over $200,000 ($250,000 for joint filers). The top estate tax rate goes from 35% to 55% (60% in some cases). The estate tax exemption falls to $1 million from $5 million (the gift-tax exemption also drops to $1 million and the rate adjusts hither to 55%). In all, 41 separate tax provisions expire this year.

Of course we know Rosenberg as the perma bear and as such his views are to be read with the dark glasses but there is no denying the points he is making. Understanding the risks will save us from snake oil salesmen who are painting the sky in rainbow colours now.

And then there is some interesting reading from Greece:

Greece MP sends one million euro abroad. (s/he should know why)

A third bailout of Greece is not ruled out (and we are not finished with 2nd one yet)

China asking for its pound of flesh from EU in exchange of promise to help.

John Stewart makes fun with the Republican contenders and Republican Party in general

Bill Maher gets nasty with Republicans as well

Some beautiful time lapse video photography of Yosemite
Thank you for reading . Please forward / retweet the post to your friends and join me in Twitter. (@BBFinanceblog). As always, I welcome your comments and suggestions. Have a wonderful weekend folks.

Friday, February 24, 2012

Waiting For Godot.

First I would like to express my apologies for not being able to respond to some of the questions or comments from the readers. For some silly reason, Blogger is not allowing me to post response to the comments. I hope they sort it out soon.

Like the famous absurdist play by Samuel Beckett, we are all waiting for Godot, the market correction.  It just doesn’t want to listen to anyone. It simply refuses to show up and hiding behind the coat tails of the Fed.  In a liquidity induced rally, what will happen when all of a sudden a whole chunk of liquidity is removed from the market? As per Lee Adler of “The Wall St. Examiner” a total of $87 billion (yes, billion with a B) will be settling next Wednesday and Thursday. Won’t that be interesting! And cycles are calling for an end of this rally as well. We will see what next week brings.

Did SPX break its previous high? Yes and No.
It did a kind of peek-a-boo but there was no conviction. I suppose we will have to wait for another day to get a confirmation in either way.

While the trend is still not broken and SPX made a new high, not everything is well in the market place. Both Dow and DJ-Tran were in red. So was Russell 2000, gold, silver and copper. There are some funny disconnect in the market place and it is acting in the most irrational and suicidal manner. Euro is at a new high while Germany is saying that Greece bailout is not guaranteed. The Telegraph, UK has an interesting article on this:

While Greece has opened the bond swap under PSI, the threshold level is 75%. I am not sure if the Greek FinMin is ignorant or just bluffing but he says that nobody cares about a CDS event.  What happens if 25.1% of the bond holders do not agree and the PSI does not go through? I am sure lots of European Countries will say “Halleluiah”. The following is a chart of Greek PSI from BNP Paribus. Just replace 67% with 76%. 

Germany and other Northern European countries are waiting for such an opportunity when they can blame the greedy hedge funds for kicking out Greece.

So the risks are high in the market place and never for a moment believe in the US growth story or fall in unemployment numbers. The following chart is from which is self explanatory.

As the Trend following table is saying, the trend is up but barely so. It is advisable not to front run unless you are sure of what you are doing. I lost on the gamble which I should not have taken in the 1st place. Trading should not be a gamble and I am guilty of breaching my own discipline.
We know that a trend change is about to take place but it has not happened yet. So trade safe.

Thank you for reading . Please forward / retweet the post to your friends and join me in Twitter. (@BBFinanceblog). As always, I welcome your comments and suggestions. Have a wonderful weekend folks.

Thursday, February 23, 2012

Trend Following.

With so many pundits calling for a top, I am afraid that the top will be delayed. Market knows how to screw the maximum number of long and short.

From the hourly chart of SPX of today, it looks like back testing / revisit of the previous high. And if tomorrow it fails to take out the previous high of 1367, we can be surer that a top is in.
At least for today, the trend was not broken. The Advance Decline line bounced off the 13 DMA.
Best of technical analysis have given numerous top signals and sell signals so far. Some of the signals have been rare and with over 90% success rate in the past. But external liquidity has trumped over everything and in this Presidential election year, this is going to be the story for the rest of the year. In order not to lose money, I think it is better to follow the trend and not front run. With that in mind, from now onward I will be incorporating a trend table based on the various TA and mathematical formula. As the table starts from today, some of the columns have no data. I have selected the three indices, gold and silver and two favourite companies each from tech. sector and finance sector. It takes into account the closing price for the day.
As with everything, trend following is not perfect. There are whipsaws and quick reversals. But the losses are expected to be less and you can let the profits run. Also, it is to be used in conjunction with the overall market. Therefore, while the indices show long, it is a decision call whether to go long at this point of time when we know that the markets are over bought and can reverse any time. If you are already long, you may want to hang on. But if you are thinking of adding fresh long position, you may want to have a very tight stop loss. I will try to update it every day. Let us see how this works out.

Thank you for reading . Please forward / retweet the post to your friends and join me in Twitter. (@BBFinanceblog). As always, I welcome your comments and suggestions.

Wednesday, February 22, 2012

Hope for Europe

A provocative Wall Street Journal OpEd by Donald Luskin and Lorcan Kelly gives me hope for Europe.

No, I'm not talking about Greece, and the latest bailout deal. That's more of the usual charade. But in the end Greece is small. Europe can bail Greece out if they feel like it; or let it default.Or let it rot, which seems where they are headed. 

Italy and Spain are where the real issue lies. Italy and Spain are too big to bail.

Growth is the only hope for paying back large government debts. "Growth" to an economist means long-run growth, growth that lasts decades. Even the most hard-bitten Keynesian, if honest,  has to admit that "stimulus" does not produce long-run "growth."   Growth comes from more people or more productivity. Period. Italy and Spain can only grow if they free up their markets, clean up their tax systems, put themselves quite a few notches higher on the list of good places to do business.

Growth  is also essential for solving the more immediate debt problems. Italy and Spain need to roll over debts. Markets can be quick to do that, and even lend more, if they see countries have good long-run growth prospects. Markets will stay away as long as they do not see a coherent plan for long-term growth. ("Growth" is distinct from "austerity." "Austerity" means high and distorting taxes, spending cuts but no liberalization of the economy. This quickly runs the economy into a death spiral as people and money leave.)

I had long thought that like the Greeks -- or, increasingly, like the Americans -- Italy, Spain and the rest of Europe (Belgium? France?) simply did not have the will to free their economies. If so, Europe seemed to me destined for a huge bout of inflation. The ECB is basically buying up the debt (via the banks); if the debt can't be bailed out, defaulted on, or repaid, it must end up with inflation.

But, as Luskin and Kelly point out, I may have for once been too Grumpy. Mario Monti, Italy's prime minister, is on a rampage of liberalization. They quote him, growth "will have to come from structural reforms or supply-side measures." Spain's prime minister Mariano Rajoy is headed in the same direction. Monti and Rajoy recognize that companies will only hire people if they can later fire them; that barriers to entry for all the professions ("from pharmacy and baking to taxi-driving") just drag down the economy, that state industries don't provide "jobs," but instead suck the lifeblood out of growth.

Will they get there? Will they reestablish growth soon enough to get the bond markets to roll over debt, or pay back the ECB before it needs to unwind its purchases to avoid inflation? It will be dicey. There is a lot of entrenched opposition to liberalization -- which is why obviously good ideas have such a hard time being implemented for decades. But, as my mayor once said, a crisis is a terrible thing to waste. Maybe Monti and Rajoy can achieve the needed "grand bargains."

What is remarkable -- what gives me hope --  is that they are even talking about "supply side" growth measures and liberalization at all!

The Conventional Wisdom makes no connection between stifling labor market regulations and a debt crisis. The debt crisis is about "confidence" and "contagion," to be met with bailout funds, "firewalls,"  financial engineering,  and ECB debt schemes.

For example, in her most recent speech, IMF Director Christiane Lagarde recommends that "stronger growth"  come first of all from "additional and timely monetary easing." Then, "raising [bank] capital levels" (Note the usual passive policy voice -- who does this raising and how? Translation: taxpayers give money to banks.) Then, "maintaining orderly funding conditions" whatever that means. (Watch your wallet.)

She warns that " On fiscal policy, resorting to.. budgetary cuts will only add to recessionary pressures...those with fiscal space should support the common effort by reconsidering the pace of adjustment planned for this year." Translation: Economies with stratospheric debt/GDP ratios need just a little more fiscal stimulus. As St. Augustine lamented,  Lord give me frugality, but not quite yet.

The bond market?  She wants a  "larger firewall.... Adding substantial real resources..folding the EFSF into the ESM, increasing the size of the ESM,.." Then, "Action by the ECB to provide the necessary liquidity support to stabilize bank funding and sovereign debt markets would also be essential." Translation: ECB to buy debt with printed Euros. 

Eventually, yes, "some countries still have much to do to boost their competitiveness and growth potential." Some? What, most of Europe is right on its "growth potential? And finally, at the very end, "..structural reforms are critical, however medium or long-term their impact might be. ... fiscal sustainability depends, ultimately, on generating long-term growth." Four or five years down the line, maybe, meekly approach Italy's unions and government-run industries with a request for "structural reforms." Sure, that's going to work. 

I don't mean to pick on Lagarde. Her speech is just a good example of global bien-pensant policy Conventional Wisdom. I'm sure everyone murmurs this sort of thing at Davos.  Grumpy's favorite columnist, Paul Krugman is, believe it or not, arguing for more spending and stimulus across Europe. I'm not exactly clear how he wants Italy, Spain, Portugal or Greece to borrow more money to spend it. Budget constraints are never the forte of Keynesian economics. He seems to saying that  multipliers are so large that spending is self-financing:  "Because spending cuts have deeply depressed their economies, undermining their tax bases to such an extent that the ratio of debt to G.D.P." It's either that or the Easter bunny: I don't see bond markets ponying up more stimulus. But "growth," tackling absurd regulations, unions, labor market rigidity denying employment to a generation of Italians and Spaniards... that' s not even on his agenda.

In this noxious intellectual environment, it is remarkable and praiseworthy that Monti and Rajoy are putting "supply side growth" on the front burner at all; that they make a connection between a debt crisis and sclerotic microeconomics. This is a Reagan / Thatcher moment, when courageous politicians may seize the moment of crisis to jump to the long run; let their economies grow and pay off a mountain of debt, ignoring the Conventional Wisdom. It could happen. Or not, but at least there finally is hope.  

In bocca al lupo ("good luck" in Italian -- and, literally, "into the mouth of the wolf," an unusually apt expression) Signor Monti!

Are We There Yet ? Part 2

The ever so slow trend change is yet to be confirmed. The Advance Decline line is sitting just above the 13 DMA.
After a long time today all the three indexes were in various shades of red, none severe. 
DeMark set-up gave a Trap Sell confirmation on SPX today. It is not one of the strongest of signals but taken with everything else, it does increase the chances of a correction. In the absence of any other trigger let us look at the FX today.

After the Greek drama, there is nothing much left for EURO to move higher. From a low of 1.2975, it spiked to 1.3291 on the news that Europe has been fixed.

After that it seems to have lost its MOJO and like the cardiogram of a dying patient, it is losing momentum. Sooner rather than later, gravity will pull it down. Its counterpart, USD has surprisingly come back to life.
From FXCM: "The dollar breached key resistance at the confluence of the 100-day moving average, former channel resistance dating back to January 13th, and the 50% Fibonacci extension taken from the August 1st and October 27th troughs at 9850. The index encountered resistance at the 50-day moving average at 9884 before closing just lower at 9880. Note that the daily relative strength index broke above former RSI support dating back to the October 27th low suggesting further dollar advances may be in the cards in the days to come."

AUD is on a sell signal and a comparison of SPX vs AUD shows that SPX has some catching up to do:

But if AUD cannot break down 1.06 level, then we may see it run above 1.0840 and SPX runs higher along with it.

While all these points to further downside in the short term, LTRO-2 will commence by end of the month and more liquidity will be pumped in. So unless we see some big drop in the next four trading days, we can kiss the correction goodbye for another two weeks. 

Thank you for visiting and following me in Twitter.(@BBFinanceblog).

Taylor on Lehman and TARP

John Taylor took the trouble to respond to Paul Krugman's latest outrage on the sources of the financial crisis.  Taylor's post -- along with the deeper analysis he points to -- is well worth reading.

Krugman's calumnies are so nonsensical I generally do not find it worth responding.

The idea that I now like stimulus is simply preposterous if you bother to read what I write about it. (Here, here and here.)  The idea that I or John Taylor don't think there was a run is even more preposterous.  (One of many examples here, p. 7: "Why was there such a large fall in output? For once in macroeconomics we actually have a good idea what  the shock was—there was a ‘‘run’’ in the shadow banking system.")

To top it off, Krugman writes "Anyone else have the impression that something happened in the second half of September 2008?" I mean really, accusing Taylor and myself of thinking that nothing happened in September 2008? Are Krugman's readers such simpletons that they fall for such unvarnished falsehoods?

Taylor did us a service by taking the time to straighten this one out.

Yes there was a run.

Taylor's detailed work shows what many of us sensed: That the run was not triggered by Lehman's bankruptcy. Instead a good part of the run can be laid at the feet of Treasury Secretary Paulson, who showed up on national TV asking for 700 billion dollars, with three sheets of paper in front of him, no clear explanation of what he wanted to do with the money, and with a hastily-imposed short-sale ban on bank stocks. How to Cause A Run 101.

More importantly, Taylor's work also puts to rest Krugman's idea (last sentence) that Lehman caused or threatened a chain of bankruptcies. Ed Lazear puts it nicely: it wasn't dominoes, it was popcorn.

That's what a run is. When a piece of news comes out that banks may be in trouble,  people pull their money out of all the banks at the same time.  Krugman is being simply incoherent in first calling it a run and then a threatened chain of bankruptcies only saved by further bailouts.

In fact, the run is central to my view of the crisis and its lessons. I doubt Krugman has thought through the implications carefully, along with the distinction between dominoes and popcorn, as they run directly counter to his worldview.

Runs don't have a single cause, they have a straw that broke the camel's back. Ask yourself, would simply bailing out Lehman have avoided this whole mess? Obviously not.  People saw Lehman go under -- and Paulson's speech, plus short-sale ban, plus everything else going on at the time -- and asked themselves, "gee, my bank was investing in the same things Lehman was. I wonder how they're doing? I'd better pull my money out just to be safe."   ("People" here means institutional investors in the shadow-banking system, i.e. prime-brokerage customers, repo investors, derivatives counterparties, asset-backed security investors.)

In the circumstances of Fall 2008, suppose that the government had announced a big Lehman bailout, especially along with Paulson's speech. Well, you come to just about the same worries about your own bank, as if Lehman had not been rescued, don't you? If they had to rescue Lehman, they must have been in real trouble. I wonder if my bank is in similar trouble?

Actually it would have been worse. such a bailout would have also come with a howl of protest, and it was clear that the bailouts would have to end somewhere, and the next one would be bigger.  AIG? Citigroup? Hmm, let's take our money out extra special fast as a big blowup is coming this way.

The insight that it was a run is central to my view of  how to fix things. If it was a run, echoing, as Krugman says, Friedman and Schwartz's view of the Great Depression, then some of Friedman and Schwartz's conclusions are surely warranted! No, this was not some mysterious failure of  capitalism and we need to have the Fed run everything under Dodd-Frank. No, this does not require that we save every big institution and protect them from competition and failure forever. This was one run very like the many runs and panics we've seen throughout history.

Our run was in the shadow-banking system. I recommend Darrel Duffie's "Failure mechanics of dealer banks," the article  and the book  Once you read these, you naturally see simple ways in which we can fix bankruptcy law and run-prone assets in place of Dodd-Frank. How, exactly? That's a subject for another post -- actually a long series -- coming up.

Yes it was a run. And that fact leads directly to some very un-Krugmanlike conclusions.

(If you want to read what I actually have written so far about this issue it's all here. I'm teaching a class this week on financial crisis -- we're going to spend a lot of time on Duffie and Gary Gorton's analysis of the run in repo markets.)

"The Rich are Bulletproof"

So spoke Meredith Whitney, bank analyst of some note this morning on CNBC. As Ms. Whitney described our current economic plight, she marched through one set of new regulations after another that are roadblocks set up to thwart the economic future of middle and lower income Americans, while noting that the rich are unaffected by all of the new Obama Regulatory regime.

Dodd-Frank and the Consumer Protection Agency are open assaults on the American middle class. It has now become much, much harder to get any kind of credit -- be it a mortgage, a home equity loan, a credit card, a pay day loan, whatever. The nanny state has decided that middle and low income Americans should take their business to the loan shark community. We've seen all of this before.

In the name of protecting middle and low income Americans, the Obama Administration has put middle America into an economic straight-jacket. Credit is the life blood of any economy, but by declaring war on those who issue credit to middle America, the Obama Administration is laying waste to the hopes and dreams of the average American.

It is a mistake to blame lenders when folks get in debt over their heads. Let people do whatever they want. People will learn. By declaring war on those who provide credit, American policy is making sure that people who need credit won't be able to get it when they need it.

This is one of the many terrible consequences of our new over-regulated economy.

Tuesday, February 21, 2012

Are we there yet?

We had lots of comments from the readers regarding the debt ceiling and thereafter. It seems that it will be one of those "buy the rumour, sell the news" type of things. Nobody believes that Greece has been saved and everyone is just buying time. I do not think the other EZ countries will pay even one cent. The editorial in "The Guardian," UK, says it all:

If anyone was hoping for a run-off rally after Europe had been fixed, they were surely disappointed. Question now is, are we done with this rally? Let us be very clear about the rally. This is not a fundamental driven rally. This is all about liquidity pumped by ECB and the FED in the form of LTRO. The 2nd phase of LTRO does not start till the end of February and the FED will be selling lots of bonds here in USA. This will drain out some of the excess liquidity and may cause the expected pull back in the stock markets.

In terms of market internals, breadth is becoming weak. Various summation indexes measure the market indexes and all things being equal, when the summation indexes turn down, that increases the odds of market correction. Let us look at NYSI first:
Parabolic Sar is giving a sell signal as well.

Let us look at BPSPX or SP 500 bullish percentage index, which is another breadth indicator.
As you can see on the weekly chart, it is as high as you can imagine and way over bought. Normally there is not much scope of further advance in prices from this level and more often than not, this level signify correction.

Of course there are many divergences and in the normal course of things we would have a correction long time back. But this is not a normal market.

However, we have to wait for the change of trend and my simple measure of change of trend is the AD line. Till AD line does not convincingly break through the 13 DMA, I would not consider it a valid trend change.
I would be very worried to front run even with all technical indicators screaming trend change because external forces like the FED or ECB can and do distort the market big time.

For the sake of information, you might be interested in the latest from Tom Demark:

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A Silly Deal

The Greek bailout announced overnight is ridiculous and will not avert plunging the Greek economy into chaos. It will only be a matter of a few months until this deal will create political conditions in Greece that will shake up the Eurozone. There is simply no way the Greek citizenry will abide this deal.

Meanwhile Merkel and Sarcozy will take a victory lap for nothing. Note that on the bailing side is the IMF, of which the biggest single donor is the US taxpayer. So, Obama has stepped the US into this quicksand and dragged the US taxpayer in with him.

No one wins with this outcome. But, it will look like a win to the politicians ... for a while.

The only apparent winners are the French and German banks. But, their victory is only temporary until this deal unravels as it smacks up against reality.

Sunday, February 19, 2012

Fed Independence 2025

Headline: The Fed just  forced mortgage servicers  that got caught submitting "documents that were not properly notarized," among other sins, to cough up money towards principal reduction, for people unaffected by the notarization scandal, as well as to fund "nonprofit housing counseling organizations" and other policy objectives. 

Deeper question: What will the Fed look like in 2025? How long can it stay independent as it takes on more and more power, and uses that power for these kinds of political policy actions?

Act 1:  Three recent news items add up to a scary picture.

Item 1: Led by the White House, the state Attorneys General announced their "settlement" with banks.

Here's what happened. Suzie, Bob, and Joe each bought  $300,000 houses, that are now worth $200,000. Suzie stopped paying, and was foreclosed.  Bob borrowed $280,000, so he's "underwater," but he likes his house, doesn't want to ruin his credit, and is still paying his mortgage.  Joe only borrowed $200,000 and is also still paying.

The banks got caught robo-signing Suzie's paper work. The Administration and Attorneys General (with the laudable exception of Oklahoma) used the threat of prosecution to get the banks to lower Bob's principal by $20,000. Suzie might get a small check. Joe gets nothing.

There is a story for doing this. Bob might decide to stop paying his mortgage, forcing the bank to foreclose. The foreclosure might lower the value of his neighbor's property.

There are also costs. This money comes from somewhere -- the mortgage investors, the bank equity holders, or eventually the taxpayers. Maybe they had better things to do with $20,000. Maybe banks and investors, seeing their contracts torn up ex-post by the government, are going to be a whole lot more careful about who they lend to in the future. We live in a time of 3.5% mortgages that nobody can seem to get. To say nothing of the blatant unfairness, and moral hazard, of giving Bob this little present for taking out a huge loan, or the larger moral hazard of using the threat of prosecution for procedural errors to force anyone to cough up money towards unrelated policy goals.

As you can guess, I think it's a rotten idea. The Fed's own White Paper on Housing puts the ineffectiveness of the policy and its costs better than I can, citing the relevant research. Look at the top of p. 21.

But that's not important here. Even if you think it was a great idea, you have to admit it is a controversial policy, one on which there is likely a strong partisan divide. You also have to admit that the Administration threatened the banks with prosecutions to force them to finance a  policy goal having nothing to do with the actual legal case.

Ok, that's the kind of tough hardball that the executive branch plays. Which is why, in our society,  they have to face the voters.

Item 2: The Federal Reserve thinks foreclosures and underwater mortgages are a big problem too, and has been cheering the Administration's various mortgage-modification programs.  See Governor Elizabeth Duke's Speech on September 1, or Ben Bernanke speech on February 10, titled "Rebalancing the Housing Market" -- a new job for the Fed -- or the Fed's extensive White Paper on Housing. (Actually, reading this stuff, the Fed seems much more keen on "government-facilitated rent-to-own programs," but that's an intervention for another day.)

Item 3: In case you missed it, the Federal Reserve is taking on regulation of financial institutions at a very detailed level. I reviewed its massive plan to regulate large banks in an earlier oped and blog post The Fed just announced its plans to actually go forward and "designate" non-banks as "systemically important" and subject to its mercies as well. Together with the new "Consumer Financial Protection" bureau, located in the Fed, the Fed can and will tell large banks what to do at an amazingly detailed level.

Let's put two and two together. How long will it be until the Fed starts acting like the Administration. "Nice bank you have there. Wouldn't want anything to happen to it. Those consumer financial protection nerds can be a real pain in the butt, can't they? To say nothing of those wonks down in the systemic risk department. Say, we notice you're still sitting on a lot of reserves, and nobody's lending to support the housing market in Detroit. Sure would be nice if you pitched in and helped a bit. And why aren't you writing down mortgages instead of foreclosing on all those houses?"

I don't mean to ascribe any bad motives here. The people I know at the Fed are all well-meaning and really smart.  The problem is the power. If you really believe that "the market is not functioning as it should." (Elizabeth Duke, Sept 1), i.e. that the housing markets are impeding recovery, and that banks could do a lot about it;  if your institutional mandate includes micromanaging the state of the economy by watching individual markets, and detailed regulation of bank's activities,  the outcome is inevitable: You will soon be using your regulatory power to force the banks to accomplish policy goals.

Act 2: It's already happening

As I was writing this, I thought I was writing one of my usual doom-and-gloom worries about  the far-off future. Browsing the Fed's website, it turns out it's already happening.  For the Fed is a party to the Administration's deal, and is using its banking supervision powers to force mortgage reductions.

The Fed announced its actions in a February 9 press release 
The Federal Reserve Board ...has reached an agreement in principle with five banking organizations regarding the issuance of monetary sanctions against the organizations totaling $766.5 million. The monetary sanctions would be assessed for unsafe and unsound processes and practices in residential mortgage loans servicing and foreclosure processing.

... the Board is acting in conjunction with a comprehensive settlement agreed in principle between the five banking organizations, the state Attorneys General, and the Department of Justice on February 9, 2012 ("Settlement Agreement"). The Settlement Agreement requires these organizations to provide $25 billion in payments and other designated types of monetary assistance and remediation to residential mortgage borrowers. 
It's right there in print:

1) The Fed is using its banking supervision powers, to call the robosigning scandals "unsafe and unsound" banking practices.

2) The Fed is acting in conjunction with the Administration -- so much for independence and standing outside of politics.

3) The Fed is forcing the banks to write down mortgages and provide other "assistance," policy goals unrelated to the actual "unsound processes and practices." 

The details, in the followup Feburary 13 press release are even more astonishing. Reading from the Ally Financial settlement,
WHEREAS, the Mortgage Servicing Companies [Ally Financial Subsidiaries], ... allegedly:

(a) Filed or caused to be filed...numerous affidavits.. making various assertions, such as the ownership of the mortgage note and mortgage, the amount of principal and interest due, and the fees and expenses chargeable to the borrower, in which the affiant represented that the assertions in the affidavit were made based on personal knowledge or based on a review by the affiant of the relevant books and records, when, in many cases, they were not based on such knowledge or review;

(b) Filed or caused to be filed in courts... numerous affidavits and other mortgage-related documents that were not properly notarized,..

(c) Litigated foreclosure and bankruptcy proceedings... without always confirming that documentation of ownership was in order at the appropriate time, including confirming that the promissory note and mortgage document were properly endorsed or assigned and, if necessary, in the possession of the appropriate party...
Heavens, what a scandal...Documents not properly notarized! Notice it does not even "allege" that anyone was actually kicked out of a house who was paying their mortgage.
WHEREAS, as part of the Settlement Agreement the Ally Parties agreed to provide consumer relief, which may include mortgage principal reductions or refinancing, and other assistance to certain residential mortgage borrowers (the “Borrower Assistance”)

NOW, THEREFORE, ..and solely for the purpose of settling this matter without a formal proceeding being filed and without the necessity for protracted or extended hearings or testimony, it is hereby ORDERED by the Board of Governors,... that:

1. Ally Financial, ResCap, and the Mortgage Servicing Companies are hereby jointly and severally assessed a CMP [civil monetary penalty] in the amount of $207,000,000...

2. ...the Board of Governors shall remit up to $207,000,000 of the CMP by an amount equivalent to the aggregate dollar value of the Borrower Assistance provided....

3. .. the Board of Governors shall also remit up to $207,000,000 of the CMP... by an amount equivalent to the aggregate amount funds expended by Ally Financial, ResCap, and the Mortgage Servicing Companies on funding for nonprofit housing counseling organizations, approved by the U.S. Department of Housing and Urban Development, to provide counseling to borrowers who are at risk of or are in default or foreclosure, or to provide assistance to borrowers in connection with the independent foreclosure reviews required by the Consent Order...
Again, right there in print:

1) Ally is to provide "relief" to borrowers, not victims of the lack of notarization.

2) They're doing it to avoid the threat of huge legal bills.

3) Legally, the Fed can't tell Ally to write people checks. So, the Fed is  going to levy a $207 million penalty because Ally's lack of notarization is an "unsafe and unsound" practice. Then the Fed will "reduce the penalty" by exactly the amount that Ally spends on "borrower assistance."

4) It's not just writedowns,  but all the hilarious stuff in the last paragraph -- "funding for nonprofit housing counseling organizations!" Stuff that the Administration wouldn't dare put in a budget it sent to Congress.

It's a bit puzzling that the Fed signed on to this agreement, actually. As above, the White Paper on Housing and Fed official's speeches are pretty negative on mortgage writedowns. One sniffs a lot of pressure coming form the White House.

Which is the danger, for the Fed, of getting involved in these policies at all: Who knows what great ideas the Santorum Administration will have for the Fed to "support manufacturing," or the Romney Administration will have for its idiotic "day 1" currency war with China?  Now we know what the Fed is,  it is only a matter of the price. It would be have been far better for the Fed to say, "as the price of our independence, we're not allowed to do things like this."
Act 3: Independence

The Fed is set up to be politically independent, and central bank independence is a cherished principle of monetary economists.

Academics typically think the Fed's main job is to control short-term interest rates: too high and we get unemployment, too low and we get inflation. Fed "independence" helps it to make this decision without too much political interference. Such interference might skew the decision to temporary stimulus at the expense of long-term inflation.

Before the financial crisis, thinking around the world was moving towards the idea that the central bank's job is really just to control inflation. Efforts to micromanage the economy  were largely seen as illusory.  This view was embodied in the ECB's mandate and many "inflation-targeting" regimes. The whole banking supervision part of the Fed was a separate backwater, unrelated to the Fed's macroeconomic policy roles.

That all seems so quaint now. The Fed is now the Gargantuan Financial Regulator, as well as Controller and Stimulator of the Macroeconomy.  Its macroeconomic role is increasingly the Supporter of Particular Markets and the Allocator of Credit. It's also getting in to the business of running whole markets, i.e. the details of how mortgages are written and serviced. And it's loudly cheering for particular Administration policies such as mortgage modifications. Monetary policy is way down the list.

The price of independence is limited power. Central banks that only try to control inflation, and only using one tool, such as purchases and sales of Treasury debt, can be walled off from the political process. As a country, we can decide that the price level will not be used for political purposes and assign its maintenance to technocrats.

The Fed was assigned great power after the financial crisis. It's more competent than most of the other agencies, and as a result of its historic independence can act with great power. But this situation cannot last. The Federal Reserve cannot command that one group of voters cough up $20,000 checks to another group of voters, and not expect those voters to want a say in the matter. Locating financial regulation in the Fed may turn out to have been a terrible idea.

What to do? Good question. My preferred answer would be to save the independence, competence, and a-political nature of the Federal Reserve. That means breaking up its functions. Focus monetary policy on the price level, and stop pretending to micromanage activity. In any case, separate monetary policy from financial regulation -- break the institution up so that financial regulation tools cannot be used to promote macroeconomic policy goals, except by direct political intervention, by politically accountable officials.

The alternative is to bring the whole of the Federal Reserve's activities under much more direct control and accountability to elected officials. I have no more faith in the wisdom of elected officials than the next person, so I foresee a politicized Fed will be disastrous. But our society is not built on faith in the wisdom of an unaccountable aristocracy with huge power and no supervision. That will be even more disastrous. That's where the Fed is going, and it cannot last.

Saturday, February 18, 2012

What Do You Think?

The market knows exactly when to screw the most longs and when to kill and bury the most shorts. It will possibly do the exact opposite what most people agree on. Do you remember the debt ceiling drama of last year? I do because I was burnet. Everyone expected and knew that the Republicans and Democrats will ultimately agree at the last moment and the debt ceiling will be raised. We all expected the share market to continue the rally of the previous week. The market was up till then. And then, Boom.  The market tanked big time after the debt ceiling was raised. Looking back I now realize that the boat was loaded too much on one side and that’s why it sank.

So what it will be this coming week? Will Greek bailout sail out of the gate? What is your take? Since it is a long weekend, why not send some well thought out comments. Looking forward to it. 

Myopia Reigns

A "Greek Deal" will be cheered by stock markets as taking the Greek issue off the table. But, does it? Will Greece honor the severe austerity embodied in any Greek deal? Not likely.

Politicians love situations like this. A patchwork solution that makes the long run problems far, far worse than simply ignoring the problem and letting nature takes it's course.

Greece needs a "workout," not a debt expansion and extension and austerity.

The Eurozone needs policies that promote economic growth and economic opportunity. European politicians are supporting policies that do the opposite. Default is not a bad thing. "Extend and pretend" is not a policy. It is a cop-out.

What is needed are two things: 1) a recognition that the high levels of debt in the Eurozone are not only unsustainable, they are unpayable; 2) the absurd "protection" and "entitlement" programs that characterize the European welfare model are inconsistent with economic growth and economic opportunity.

But, in the short run, the Tim Geithner mentality will reign, no doubt. A Greek deal is reminiscent of the famous "Emporer Has No Clothes" story. For a while, it works, but it has no chance of working in the long run.

None of this will matter for long as the Greeks will not live up to the austerity programs forced upon them by their politicians. The bailout will simply buy time for the present disastrous economic policies to continue unabated until discussion begins about the next bailout that Greece will need.