Friday, August 31, 2012

The future of central banks

A WSJ Op-Ed. Here is a pdf for non subscribers:

Momentous changes are under way in what central banks are and what they do. We are used to thinking that central banks' main task is to guide the economy by setting interest rates. Central banks' main tools used to be "open-market" operations, i.e. purchasing short-term Treasury debt, and short-term lending to banks.

Since the 2008 financial crisis, however, the Federal Reserve has intervened in a wide variety of markets, including commercial paper, mortgages and long-term Treasury debt. At the height of the crisis, the Fed lent directly to teetering nonbank institutions, such as insurance giant AIG, and participated in several shotgun marriages, most notably between Bank of America and Merrill Lynch.

These "nontraditional" interventions are not going away anytime soon.

Many Fed officials, including Fed Chairman Ben Bernanke, see "credit constraints" and "segmented markets" throughout the economy, which the Fed's standard tools don't address. Moreover, interest rates near zero have rendered those tools nearly powerless, so the Fed will naturally search for bigger guns. In his speech Friday in Jackson Hole, Wyo., Mr. Bernanke made it clear that "we should not rule out the further use of such [nontraditional] policies if economic conditions warrant."

But the Fed has crossed a bright line. Open-market operations do not have direct fiscal consequences, or directly allocate credit. That was the price of the Fed's independence, allowing it to do one thing—conduct monetary policy—without short-term political pressure. But an agency that allocates credit to specific markets and institutions, or buys assets that expose taxpayers to risks, cannot stay independent of elected, and accountable, officials.

In addition, the Fed is now a gargantuan financial regulator. Its inspectors examine too-big-to-fail banks, come up with creative "stress tests" for them to pass, and haggle over thousands of pages of regulation. When we think of the Fed 10 years from now, on current trends, we're likely to think of it as financial czar first, with monetary policy the boring backwater.

A revealing example of where we are going emerged last spring, admirably documented on the Fed's website. Using its bank-regulation authority, the Fed declared that the banks that had robo-signed foreclosure documents were guilty of "unsafe and unsound processes and practices"—though robo-signing has nothing to do with the banks taking too much risk.

The Fed then commanded that the banks provide $25 billion in "mortgage relief," a simple transfer from bank shareholders to mortgage borrowers—though none of these borrowers was a victim of robo-signing.

The Fed even commanded that the banks give money to "nonprofit housing counseling organizations, approved by the U.S. Department of Housing and Urban Development." Why? Many at the Fed see mortgage write-downs as an effective tool to stimulate the economy. The Fed simply used its regulatory power to help meet that policy goal.

Even if you think it's a good idea (I don't), a forced transfer from shareholders to borrowers in pursuit of economic policy is the province of the executive branch and Congress, subject to reproof from angry voters if it's a bad idea.

The Fed said candidly that it was acting "in conjunction" with the state attorneys general and the Justice Department. So much for an apolitical, independent Fed.

True, $25 billion is couch change in today's Washington. But you can see where we are going: Hey, nice bank you've got there. It would be a shame if the Consumer Financial Protection Bureau decided your credit cards were "abusive," or if tomorrow's "stress test" didn't look so good for you. You know, we've really hoped you would lend more to support construction in the depressed parts of your home state.

Conversely, when the time comes to raise interest rates, how can the Fed not consider that doing so will hurt the profits of the too-big-to-fail banks now under its protection?

This is not a criticism of personalities. It is the inevitable result of investing vast discretionary power in a single institution, expecting it to guide the economy, determine the price level, regulate banks and direct the financial system. Of course it will use its regulatory power to advance policy goals. Of course, propping up the financial system will affect monetary policy. If we don't like this sort of outcome, we have to break up the Fed into smaller agencies with narrowly defined mandates.

The European Central Bank's political power is, paradoxically, even greater. The ECB was set up to do less—price stability is its only mandate, and it is not a financial regulator. But the ECB holds the key to the euro-zone's central fiscal-policy question. It has bought the debts of Greece, Italy, Spain and Portugal, and it is lending hundreds of billions of euros to banks, which in turn buy more of those sovereign debts.

Eventually, the ECB will have to suck up this volcano of euros, by selling back the bonds it has accumulated. If it can't—if the bonds have defaulted, or if selling them will drive up interest rates more than the ECB wishes to accept—then the ECB will need massive funds from German taxpayers to prevent a large euro inflation. It might ask for a gift of German bonds it can sell, as "recapitalization," or it might ask for a bond swap of salable German bonds for unsalable southern bonds. Either way, German taxes end up soaking up excess euros.

Our views of central banks have changed every generation or so for centuries. The idea that central banks are centrally responsible for inflation and macroeconomic stability only dates from Milton Friedman's work in the 1960s. It's happening again, and it would be better to think clearly about what we want central banks to do ahead of time.

Mr. Cochrane is a professor of finance at the University of Chicago Booth School of Business, a senior fellow at the Hoover Institution, and an adjunct scholar at the Cato Institute.

Wednesday, August 29, 2012

Gordon on Growth

Bob Gordon is making a big splash with a new paper, Is US Growth Over?

Gordon's paper is about the biggest and most important economic question of all: Long-run growth. It's easy to forget that per-capita income, the overall standard of living, only started to increase steadily in about 1750. The Roman empire lasted centuries, but the average person at the end of it did not live better than at the beginning.

Gordon's Figure 1, reproduced here shows how growth picked up in the mid 1700s, reached 2.5% per year -- which made us dramatically better off than our great-grandparents -- and now seems to be tailing off.

As Bob reminds us with colorful vignettes of 18th and 19th century living, nothing, but nothing, is more important to economic well being than long-run growth.

And modern growth economics is pretty clear on where the goose is that lays this golden egg: Innovation. New ideas, embodied in new products, processes and businesses. For example, see Bob Lucas' "Ideas and Growth" which starts

What is it about modern capitalist economies that allows them, in contrast to all earlier societies, to generate sustained growth in productivity and living standards? It is widely agreed that the productivity growth of the industrialized economies is mainly an ongoing intellectual achievement, a sustained flow of new ideas

Growth theory neatly divides economics into "growth effects," which is really how fast new ideas are born and implemented, versus "level effects." Many economic distortions screw up the level, making an area or a country less well off than its neighbors. But so long as the frontier keeps growing, even level effects only retard a country a few decades.

Here's a picture. The red line represents 2% growth (real, per capita), starting at $100,000 income. By 2100 your great grandchildren are earning $738,000. The blue line shows a "level effect." Suppose some set of harebraned policies is so awful that it reduces the level of GDP by 20% -- but does not interfere with the growth mechanism. It's pretty bad. But the blue line is really just shifted to the right, lagging a decade or so behind but still participating in the eventual miracle.

By contrast, the black line says, what if there is a policy or change in the environment that has no effect on the level of GDP, but lowers the long-run growth rate to 1%. 2%, 1%, what's the difference? Cumulate that over a century, and your great grandchildren make $300,000, not $738,000.

OK, so, to Bob's first thesis: Long-run growth is slowing down. The big ideas of the first two industrial revolutions, roughly the harnessing of energy, urbanization, clean water, have been used as far as they can. The computer revolution, to Bob, seems to running out of its ability to raise productivity. 20-somethings updating their facebook profiles instead of paying attention class are not the jet-packs and rocket ships we thought we were going to have by 2001.

I think Bob has the right question here. And his warning is well-taken. Just because growth has been steady does not mean it's assured. The "trend" does not come for free. Each improvement in productivity takes hard work, and disruptive new companies putting established incumbents out to pasture.

But I think  -- or at least I hope -- he has the wrong answer (and he freely admits this is speculative).

My pet theory is that the real defining innovation of growth was Gutenberg. Science gives us real knowledge, at last, by controlled experimentation. But controlled experimentation is extraordinarily expensive.  A farmer can't afford to test which crops grow best, a country doctor can't do clinical trials. For society to gain knowledge by scientific method, we need communication. One doctor's clinical trials inform another doctor's practice a thousand miles away. Gutenberg made that possible.

More generally, the process of growth, of incorporating new ideas into the economy, almost always represents standing on the shoulders of giants, appropriating, slightly improving, and implementing someone else's ideas. That, for example, is why we see clusters of innovation such as Silicon Valley.

Well, if Gutenberg (and subsequent innovations that used his ideas, the newspaper, the scientific journal, and the public library) lowered the costs of communicating ideas and widened the community of people that a given idea could reach, the internet just did that tenfold. As I look at the cool stuff -- nanotechnology, genetic engineering etc. -- underway and the instant worldwide communication of ideas, I have hope we'll see that 2.5 percent again. If we let the process run.

For example, think how Bob's idea got to your desk. When I was a young economist, before the internet, he would have mailed a paper to the NBER, a month or two later the working paper would have been distributed. The internet buzz I saw that got me to go look at it would have taken a few more months to percolate to me by older information networks, then I'd have to go read it in the library. Finally, who knows how I would have gotten to you. That all happened in a week. The diffusion of ideas is on steroids.

Well, maybe my pet theory is wrong. Still, long-run growth is the issue,  it is not guaranteed but hard-won,  we didn't always have it and we could lose it, and that would be a catastrophe.  

Bob prognosticates not only that we seem to have run out of productivity-increasing ideas, but that "six headwinds" stand in the way. His headwinds are 1) Demographics: aging and reduced labor-force participation 2) Plateau in US educational attainment 3) "The most important quantitatively in holding down the growth of our future income is rising inequality." 4) Globalization and outsourcing 5) Energy and enviroment 6)  Household and government debt.

Here I think Bob is mostly confusing "level" effects with "growth" effects.  He is also mixing constraints -- run out of ideas -- with self-inflicted wounds -- dysfunctional public education, refusing to let in immigrants, refusing to use nuclear power or GM foods.  And, I don't see how he can focus on the US. Suppose we cede the frontier to, say, China, as the UK ceded the frontier to us in Bob's graph. But as long as we still use China's ideas and technology, and they grow at 2.5 percent, so do we.

The optimistic lesson of growth theory is that, no matter how badly you screw up level effects, growth will bail you out eventually. So, any "headwinds" need to be clearly linked to the possibility that economic distortions lower the rate of finding new ideas and incorporating them. The whole point of growth theory is that, in the long run, that's all that matters.

Do they? My impression of modern growth theory is that the economics of innovation production and adoption are not well understood. Do the distortions of a high-tax,  regulated, crony-capitalist, welfare state,  just screw up levels? Or do they  reduce the spread of ideas behind long-run growth? My fear is "yes."

In any case, just posing the question this way argues that the dangerous "headwinds" are entirely different from the ones that Bob highlights. The returns from innovation, starting new companies, introducing new products and processes -- and in that process making established incumbents very unhappy -- are the most likely targets.

But it's also clear that ideas are public goods, or high fixed cost zero marginal cost goods. Their production and diffusion depends a lot on non-market structures, like, say, universities. (Don't jump from that observation to "they need to be subsidized," as it it's all to easy to subsidize bad ideas too.) That's another lesson of Bob Lucas' paper, which is remarkably free of economic incentives.

Finally, a warning about statistics. Here is my last picture, blown up.

As you can see, if you're just looking at GDP trends, it's hard to tell a "level" effect from a "growth" effect for several decades.

Much discussion of our current slump presumes it's a temporary "level" shock; the blue line will go back up quickly to the red line. The "stagnation" hypothesis is that we're on the blue line -- we lost about 5% of GDP in the recession, and now we're on the growth path with a lower level. That's disastrous enough. Bob warns us that we might be on the worst of the blue and black lines. That would be a huge disaster.

All said before.  The graph reminds us is that it takes a long time to figure out which it is based on just eyeballing the GDP or productivity data. We have to think. Which Bob is prodding us to do.

Wednesday, August 22, 2012

CBO and the fiscal cliff

The CBO has released a report warning that a new recession could follow the  "fiscal cliff"

Background: Here's the CBO report and a Washington Post story  A few snippets from the CBO:

What Policy Changes Are Scheduled to Take Effect in January 2013?...

  • A host of significant provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312) are set to expire, including provisions that extended reductions in tax rates and expansions of tax credits and deductions originally enacted in 2001, 2003, or 2009. ...["Bush tax cuts expire"]
  • Sharp reductions in Medicare’s payment rates for physicians’ services are scheduled to take effect.
  • Automatic enforcement procedures established by the Budget Control Act of 2011 (P.L. 112-25) to restrain discretionary and mandatory spending are set to go into effect.
  • Extensions of emergency unemployment benefits and a reduction of 2 percentage points in the payroll tax for Social Security are scheduled to expire.

What Is the Budget and Economic Outlook for 2013?

CBO’s Baseline: Taking into account the policy changes listed above and others contained in current law, under CBO’s baseline projections:
  • The deficit will shrink to an estimated $641 billion in fiscal year 2013 (or 4.0 percent of GDP), almost $500 billion less than the shortfall in 2012.
  • Such fiscal tightening will lead to economic conditions in 2013 that will probably be considered a recession, with real GDP declining by 0.5 percent between the fourth quarter of 2012 and the fourth quarter of 2013 and the unemployment rate rising to about 9 percent in the second half of calendar year 2013...
And from the Post:
The nation would be plunged into a significant recession during the first half of next year if Congress fails to avert nearly $500 billion in tax hikes and spending cuts set to hit in January, congressional budget analysts said Wednesday.

The agency foresees a stronger contraction of 2.9 percent in gross domestic product, "similar in magnitude to the recession of the early 1990s." [I couldn't find thi].
“The magnitude of the slowdown we’re discussing next year is significant,” CBO director Douglas Elmendorf said at a morning briefing. He noted that going over the cliff could cost the nation about 2 million jobs.
Elmendorf said the shock of the cliff would be felt for years to come, with the unemployment rate stuck above 8 percent through 2014. And the effects are likely to be felt well before the fiscal cliff hits, according to the budget outlook released Wednesday, as “businesses’ and consumers’ concern about the scheduled fiscal tightening will lead them to spend more cautiously than they otherwise would have” during the remainder of 2012.
What do I make of this? I think the fiscal cliff is a big problem -- but that the CBO's analysis is way off.

The CBO’s projections are deeply and explicitly Keyneisan, relying on “multipliers.” If the government borrows a billion dollars and blows it on some useless porkbarrel project, the CBO will project that this raises GDP  to the tune of one and a half billion dollars. In analyzing the “fiscal cliff,” reducing such projects is bad for the economy.  That’s the key source of their estimate that the fiscal cliff leads to recession. If you, like me, think that the government spending less money on useless projects (say, ethanol subsidies) has a positive effect on output, or that taking less money from A and giving it to B has little effect, then you will not be so worried.

It used to be that the first thing you had to understand to call yourself an "economist" is that prices and taxes are first and foremost about incentives, and only secondarily about income transfers. That is especially true when thinking about national output, growth, etc. Income transfers matter a lot to people, but the overall economy really doesn't care who has the wealth. It cares about incentives.

A really good example: What will the effect on output and employment be of ending 99 weeks of unemploment insurance? That's part of the fiscal cliff, and the CBO's analysis (see above) says that reducing unemployment insurance will lower GDP. Really? A standard economic analysis comes to exactly the opposite conclusion. Generous unemployment and disability means that some people choose to stay unemployed rather than take lower-paying jobs, or jobs that require them to move.  So long as you stay unemployed, you get a check from the government. Subsidizing anything produces more of it. So, a standard analysis says that cutting back unemployment insurance lowers unemployment, and raises output and this part of the fiscal cliff analysis should go the other way.

Before you go all nuts on how heartless I am, keep the question in mind. I didn't say what's good or bad, I said what raises or lowers GDP and unemployment. The standard analysis of unemployment insurance says, yes, it raises unemployment and lowers GDP, but it provides important insurance for the truly needy and unfortunate. It's something we do out of compassion even though it hurts us.

But the CBO didn't score national welfare, or a compassion index. They scored GDP and unemployment, and their model comes to the opposite conclusion, subsidizing unemployment causes more GDP and less unemployment. As well as being compassionate. How do we have our cake and eat it too? Well, that's the magic of Keynesian economics, on which I will not digress here.  

So, in my view, most of the analysis is simply wrong. 

That doesn't mean I think the fiscal cliff is has no effect.

As a "standard" economist, I look first and foremost at incentives. Raising marginal tax rates lowers incentives to work, save, invest, start businesses.  That's not good. So I agree that the tax part of the fiscal cliff will drag down the economy. But not because it reduces Keynesian stimulus, but because it worsens incentives.

The bigger problem with the fiscal cliff is the utter chaos of it all. What serious country decides its tax laws year by year, in one big chaotic crisis during the first few weeks of the year? Will estate taxes be 55% or 0% next year? Who knows?

Moreover, this last-minute crisis atmosphere is ripe for salting the tax code with little goodies which nobody will notice until it's too late. It's a fiesta for lobbyists, tax lawyers and crony-capitalists of all stripes.

This is not how any serious country operates, let alone the supposed leader of the free world. And annual tax chaos is certainly not good for GDP.

What will the effects of the fiscal cliff be? I can't tell.  The incentive and expectations effects that I think matter aren't in any of the Washington models.

Moving from "scoring the law" to "forecast," we also have to think if the cuts will actually happen.  The CBO also has to make forecasts based on Congress’ promises. But do you really believe congress’ promises? Not even the CBO does, really, which is why they make “alternative” forecasts.
Congress hasn't passed a budget in years. Will the supposedly mandatory cuts really happen? Congress can spend money on anything it wants to. It's not like someone will sue them for violating the sequester, any more than someone can sue them for blatantly violating the budget act.

A great example is the  "reductions in Medicare’s payment rates for physicians’ services" mentioned in the CBO report. I presume their model scores this as having a reduced stimulus effect since doctors will buy fewer BMWs.  I doubt its actual effect of doctors simply refusing to work are in the CBO model.

But in any case, it won't happen. Congress promises every year that next year it will cut health costs by simply paying doctors less. They then change their minds at the last minute, because, duh, doctors won’t work without getting paid. It seems a sure bet to me that will happen again, with "emergency" reauthorization. Ditto for important priorities like farm subsidies, the export import bank, ethanol subsidies, electric car subsidies and so on. 

So, my guesstimate of the fiscal cliff? Mild drag on GDP from chaos and higher marginal tax rates. Very little effect on spending, which will be restored in a sequence of last minute bills. Therefore, very little reduction in deficit. Continuation of our slide into low-growth sclerosis.
Update: As a commenter noticed, I'm being too kind. Jacking the estate tax back to 55% alone should be a great stimulus measure to get old folks to spend money on round the world cruises, private jets and tax lawyers.

I was working on this some more and ran in to the CBO's supporting documentation here  of which tax provisions are going to expire. To the CBO each of these is a little foregone Keynesian stimulus. To me the list is reminder A of what an obscenity our tax code has become. Yes, let's drop them all, yesterday!
Cellulosic Biofuel Credit,Credit for Past Minimum Tax Liability,Depreciation of Certain Ethanol Plant Property,Election to Accelerate AMT and R&E Credits in Lieu of Electricity Production Credit for Wind Facilities, Exclusion of Mortgage Debt Forgiveness ,Indian Coal Production Credit,Partial Expensing of Investment Property,Recently Discharged Veterans Eligible for WOTC,Section 179 Expensing, Andean Trade Preference Initiative,Generalized System of Preferences,Deduction for Energy-Efficient Commercial Buildings,Depreciation Classification for Certain Race Horses,Determination of Low-Income Housing Credit Rate,Energy Credit for Nonwind Facilities,Electricity Production Credit for Nonwind Facilities,Partial Expensing of Certain Refinery Property,Liquefied Hydrogen Fuel Incentives,Credit for Motor Vehicles with Fuel Cell,Hydrogen Refueling Property,African Growth and Opportunity Act,Noncommercial Aviation Fuel Rates for Certain Aircraft,AGI Floor for Individuals 65 or Older Remains at 7.5 Percent,Credit for Business Solar Energy Property,Credit for Residential Energy-Efficient Property,Earned Import Allowance Program for Dominican Republic,Haitian Value-Added Rule for Apparel,Increase Excise Tax on Coal,Caribbean Basin Trade Partnership Act,Haiti Trade Preferences,Fuel Surtax on Certain Aircraft,Transfer of Excess Assets in Defined-Benefit Plans..............

Should the Fed risk inflation to spur growth?

The New York Times asked me and two others this question for its "Room for Debate" blog. My answer follows. Not news for readers of this blog, but maybe a fun concise summary

Should the Fed risk inflation to spur growth? The Fed is already trying as hard as it can to spur growth, and to create some inflation. The Fed has created about two trillion dollars of money, set interest rates to zero, and promised to keep them there for years. It has bought hundreds of billions of long-term government bonds and mortgages in order to drive those rates down to levels not seen in a half a century.

The fact is, the Fed is basically powerless to create more inflation right now -- or to do anything about growth. Interest rates can't go below zero, and buying one kind of bond while selling another has minuscule effects. Which is just as well. While preventing deflation in the recession was vital -- and the Fed did it -- the idea that a deliberate inflation is the key out of our policy-induced doldrums makes no sense.

 Tight monetary policy is not the source of our problems. Monetary policy is loose by any measure. Anti-growth policies are our problem. Our economy is being stifled by over-regulation, chaotic taxes and policy uncertainty. You make money now by lobbying regulators for special treatment, not by starting companies. We fix that with growth-oriented policies that remove the source of the problem.

Inflation remains a danger, but not so much because of what the Fed is doing. U.S. debt is skyrocketing, with no visible plan to pay it back. For the moment, foreigners are still buying prodigious amounts of that debt. But they are mostly buying out of fear that their governments are worse. They are short-term investors, waiting out the storm, not long-term investors confident that the US will pay back its debts. If their fear passes, or they decide some other haven is safer, watch out. The inflation some are hoping for will then come with a vengeance. It's not happening yet: Interest rates are low now. But so were mortgage-backed security rates and Greek government debt rates just a few years ago. And inflation need not happen, if we put our fiscal house in order first. But if it happens, it will happen with little warning, the Fed will be powerless to stop it, and it will bring stagnation rather than prosperity.

Followup thought (more on the last paragraph):

Yes, interest rates are low, and there is little sign of inflation. I hate to use the word "bubble," but US government debt strikes me as a "bubble," meaning "whatever it is you thought was going on with houses, mortgage backed securities and Greek government debt in 2006, or internet stocks in 1998,  and used the word "bubble" to describe, is going on with US government debt now."

More precisely, an asset can have a high value (government bond prices are high, interest rates are low) because people think its "fundamental" cashflows are high, or because people are willing to hold the asset for a year or two, and they think they can get out and sell it before its value falls.

It's hard to make a story that US long term debt has a high price (low interest rate) because investors are really impressed with the huge budget surpluses in a credible long-term US fiscal commitment. (!) If you don't buy that story, then the admittedly huge demand for US debt is must be a short-term demand, a low required return, a "flight to quality" that can easily evaporate. It can also easily increase for a few years before it evaporates. Europe does seem to be going down the tubes.

It has to be one or the other though. People (you know who) who say "interest rates are low, inflation is low, the government can borrow huge amounts and blow it on preparations for an alien invasion, don't worry, it's not a bubble, it can't burst" have to assume that markets really trust the government to pay back those debts.

Monday, August 20, 2012

Need Leave Of Absence.

Hello Friends,
For some time now, I have been unable to devote time to this blog. For that matter, I am unable to devote time to the market as well. The reason being I am in the middle of the career switch and possible relocation. I tried to do a post on the week-end but could not do anything worthwhile.
I have gained so many friends over the years and I feel bad letting down everyone. But I am helpless for now and I do not think I will be able to do justice to the blog till September 15th, 2012.
Therefore, I request leave of absence till mid-Sept.
I hope you will understand and allow me to take the time off from here to set things in order.
It is time to say " au revoir" at least for now.

Friday, August 17, 2012

GM and Fannie & Freddie and Spain

The taxpayer stepped up to the plate in the fall of 2008 to underwrite General Motors and FNMA and FMAC requiring a commitment of $ 250 billion plus.  We are now approaching round two.  Government Motors, as most people now call GM, is rapidly on a glide path to another bankruptcy, which will cost taxpayers approximately $ 50 billion and require, at a minimum, another $ 25 billion to protect the unions' juicy benefits.  Fannie Mae and Freddie Mac have an unlimited lifeline and their losses, now over $ 200 billion, are essentially unlimited.  But both GM and FNMA and FMAC have created many more millionaires as government-appointed bureaucrats, lawyers and accountants feast at the taxpayer's expense.  This is what happens when the government gets involved.

Europe has its own version of this.  Propping up banks in Spain, France and Germany has simply made matters worse in the Eurozone and has weakened, not strengthened, the banks.

GM and Fannie and Freddie and the European banks should have been permitted to fail.  By now, a new automobile company financed and organized by the private sector would have emerged and would be competing globally in a way that GM will never be able to.  Propping up Fannie and Freddie has prevented a housing recovery and cost the taxpayers hundreds of billions of dollars.  Had there been no bailout (and no Dodd-Frank), housing would now be in its second year of a strong recovery.  Pretending that Spain's banks are saveable has cost the Spanish government and European taxpayers several hundred billion euro -- so far.  Meanwhile unemployment in Spain surges past 25 percent.

Simply letting companies fail when they make bad decisions or when they are the victim of bad luck is the proper response.  Getting government into the act has never worked and it never will.  It only makes matters worse.

Thursday, August 16, 2012

Apologies For My Absence

I am really sorry for not being able to update regularly and in time. Even now I am working but I do keep a check on the pulse of the market.
I think we have an exhaustion bar today and 30 Year is now going to turn.
So lets wait and see. This being an OpEx week, I am not going to attach much importance to whatsoever happening.
In the mean time, be safe out there.
Once again, sorry, and I hope to be there on weekend with you guys.

Inevitable slow recoveries?

The economy is stuck in slow growth, not the fast growth we should see after a steep recession. (See previous post here, as well as John Taylor on the subject)

But we've heard the defense over and over again: "recoveries are always slower after financial crises."  Most recently (this is what set me off today) in the Washington Times,
Many economists say the agonizing recovery from the Great the predictable consequence of a housing market collapse and a grave financial crisis. ... any recovery was destined to be a slog.

“A housing collapse is very different from a stock market bubble and crash,” said Nobel Prize-winning economist Peter Diamond of the Massachusetts Institute of Technology. “It affects so many people. It only corrects very slowly.”
This argument has been batted back and forth, but a new angle occurred to me: If it was so obvious that this recovery would be slow, then the Administration's forecasts should have reflected it.  Were they saying at the time, "normally, the economy bounces back quickly after deep recessions, but it's destined to be slow this time, because recoveries from housing "bubbles" and financial crises are always slow?"

No, as it turns out. I went back to the historical Administration Budget proposals and found the "Economic Assumptions" in each year's "Analytical Perspectives." This gives the Administration's forecast at the time.

Here is actual real GDP (black line) together with the Administration's forceasts (blue lines). The red line is the current blue chip consensus (also as reported in the budget), which I'll get to in a minute.

As you can see, there is nothing like an inevitable, forecastable, natural, slow recovery from a financial crisis or "housing bubble" in the administration's forecasts.
Their forecasts at the time look just like my quick bounce-back-to-the trend line that you see in my previous posts, and John Taylor's, and lots of others'. And they are surprised each year that the fast recovery doesn't happen.

Here is the same information in growth rates:

Here you see that each year the Administration was forecasting  that within a year the economy would experience a sustained period of strong, 4% or more, "catchup growth" until it gets back to trend.  And each year they have been disappointed.

So, if a slow recovery is the inevitable result of a financial crisis, why was the Administration forecasting the "normal" fast recovery all along?

The natural conclusion is that the administration thought, as I thought, that the economy should have grown quickly, as it typically has in the past. The "slow growth after financial crises" isn't a fact in the first place. And to the extent that it is a fact (it's a "fact" over a sample of countries not very representative of the US now), slow growth is not the inevitable result of a financial crisis itself, but a result of the mismanaged policy that typically follows a financial crisis, such as bailouts, close-the-barn-door-after-the-horse leaves banking regulation, trampling of property rights that scare creditors away, high taxes and so forth. After all, there isn't any economic theory of this "natural" slowness.

Browsing around the budgets, I found they had made the case even more convincingly than I have. Here are two graphs from the 2010 budget (p. 176, p. 181)

The Administration expected strong growth, financial crisis or no financial crisis. In fact they're a bit defensive that they expect stronger growth than the blue chips.

And the 2012 budget contains this beauty

Along with a lovely explanation
Some international economic organizations have argued that a financial recession permanently scars an economy, and this view is also shared by some American forecasters. On that view, there is no reason to expect a full recovery to the previous trend of real GDP. The statistical evidence for permanent scarring comes mostly from the experiences of developing countries and its relevance to the current situation in the United States is debatable. Historically, economic growth in the United States economy has shown considerable stability over time as displayed in Chart 2-7. Since the late 19th century, following every recession, the economy has returned to the long-term trend in per capita real GDP. This was true even following the only previous recession in which the United States experienced a disastrous financial crisis – 1929-1933 – although the recovery from the Great Depression was not complete until World War II restored demand. The U.S. economy has enormous room for growth, although there are factors that could continue to limit that growth in the years ahead.
Ok, except for that silly bit about how great WWII was, (almost echoing Paul Krugman's idea that the key to prosperity is for the government to fake an alien invasion) we seem agreed.

So, the natural conclusion is, what are these "factors" that "continue to limit growth?" If the patient should naturally recover quickly on his own, as every time in the past, perhaps, just perhaps, too much doctoring is to blame?

Now, the red line, the blue chip consensus forecast. The administration's forecast is quite a bit above the blue chips. As it was throughout. A natural interpretation is that this is the usual "rosy scenario" used to make budgets look better. Possible, but I prefer the interpretation that these are honest forecasts, reflecting the natural and correct idea that the economy should spring back quickly from deep recessions, no matter whether associated with more or less financial turmoil.  Really, it make no sense that they knew they were in for 3 years of horrible growth and joblessnes, but just kept putting out ridiculously optimistic forecasts, which they knew would be wrong.

The blue chips could simply be reflecting a more cynical (or in my view, realistic) effect of how bad the Administration's policies would be for growth and recovery. They are supposed to be forecasts of how the economy will behave given policy, not it's "natural tendencies."

Bloomberg TV Interview

An interview on the Tom Keene's show this morning on Bloomberg TV

I always feel bad after these things, that I could have answered much better or clearer. Or found a better tie. Well, we do what we can. A direct link

Free Markets or Bureaucratic Dictatorship

Much of the political debate today is simply a question of whether one thinks capitalism is a good idea or not.  Many westerners seem to believe that the profit motive is fundamentally evil. Defenders of free enterprise are often thought to be morally suspect.  This is where the real struggle is being waged in today's politics.

The discussion about Bain Capital brings into sharp focus the debate on the merits of capitalism.  Should people risk their own capital to make money or should, instead, the government take people's wealth and 'make investments' with it.  That is what this debate is really all about.

A similar debate about free markets rages about health care.  Should a panel of educated and enlightened people appointed by polticians decide on your health care or should you purchase the health care and the insurance that you need and make such decisions yourself with consultation with health care professionals?  That some people are poor seems to weigh heavy in this debate.  But, this argument applies to everything, not just health care.

At the end of the day, this is an argument about whether free markets are going to survive.  Obamacare tosses out what is left of free market health care for a mandated system that forces every American to do what Obama wants or else.  Making your own health decisions is not an option under Obamacare.

The idea is that there is an enlightened elite that knows what all of us should be doing, what we should buying, what should be our energy sources, our health care providers, our bankers, and on and on.  That enlightened elite can do this better than the free market is the argument.

Has this been tried before?  Yes.  The Soviet Union, the China of the twentieth century, modern Cuba, modern Venezuela, modern Argentina are excellent examples of how an enlightened elite can perform.  Except for the governing elite, these societies were free of inequality (and greed, one supposes).  The governing elite, of course, lived (and lives) in palaces.  After all, the enlightened who guide us, should live well and they do.  As for the rest of us, we should be comforted that everyone else is as miserable as we are.  That seemed to be the ethos of the old Soviet Union.

How do people get to this bizarre idea?  Poor people are almost never in the vanguard of the movement to eradicate capitalism.  Friedrich Engels and Karl Marx lived luxurious life styles, certainly compared to the mass of their contemporaries.  Only from the rarified environment of the London Museum could Marx have concocted the absurd idea that a 'dictatorship of the proletariat' could bring anything worth having to anyone.  Real folks in the real world know that this is ridiculous.

Rich folks, movie stars and academics can engage in the luxury of dreaming that by imposing their views on everyone and substituting their views for individual freedom and free markets, the world will be a better place.  Everyone else is too busy trying to find a job and support their families to indulge in such nonsense.

Wednesday, August 15, 2012

The mismeasure of inequality

Kip Hagopian and Lee Ohanian have a wonderful new policy review titled "the mismeasurement of inequality."  Calmly, and with careful grounding in facts and review of research, it destroys most of the current liberal myths about the amount of inequality and its importance. The promise:
We will show that much of what has been reported about income inequality is misleading, factually incorrect, or of little or no consequence to our economic well-being. We will also show that middle-class incomes are not stagnating; in fact, middle-class incomes have risen significantly over the 29 years covered by the cbo study. Lastly, we will address assertions that the rich are not paying their “fair share” of taxes
"Address" should be "destroy", but they're being careful. Some nuggets:

Standard measures of inequality are based on pretax cash income, ignoring transfer payments from the government, goods provided directly (housing), benefits (health insurance, retirement contributions), all home-produced goods, and focus on income rather than consumption, which is often suspiciously higher than reported income.  Kip and Lee do their best. When done, the increase in inequality disappears.

Looking at consumption (though still imperfect, as it leaves out home production) yields surprising results:
In 1960–61 consumption expenditures in the lowest quartile were 112 percent of reported income, rising to 140 percent (in the lowest quintile) in 1972–73, and 198 percent (in the lowest quintile) in 2005. Thus, a family claiming $22,300 in income in 2005 would have reported about $44,000 in expenditures in that year. ... the gap between reported income and consumption is filled by various categories of government transfer payments (including Medicaid, food stamps, subsidized housing, the Earned Income Tax Credit, Temporary Assistance for Needy Families, etc.), family savings, imputed income from owner-occupied housing, barter, support from family and friends, and income from the underground economy.
The poor did not get poorer, or stagnate.
..on average America’s poor live in housing that totals 515 square feet per person, about 40 percent more per person than the living quarters of the average European household. (The average American household lives in about 845 square feet per person, or 2.3 times the average European household.)
In addition to food, clothing, and shelter, some of the most meaningful indicators of well-being are the properties and amenities that make life more comfortable or enjoyable. Based on data from the 2009 “American Housing Survey,” Rector and Sheffield report that 42 percent of poor households own a home (median price: $100,000); 80 percent have air conditioning; 98 percent have a color tv (65 percent have two or more); 99.6 percent have a refrigerator; 98 percent have a stove and oven; 75 percent have a car or truck (31 percent have two or more); 81 percent have a microwave oven; 78 percent have a dvd or vcr; 64 percent have a satellite connection; and 25 percent have a dishwasher. 
Our purpose is not to make light of the deprivations the poor suffer every day. [My emphasis. Liberals always try to say "you don't care" because you don't want to swallow the latest scheme.]  There is no doubt that the poorest Americans struggle mightily, and that too many Americans are poor. But these data are useful in understanding the difficulties in defining poverty, and for constructing effective policies aimed at helping those in need
Since "are we becoming Europe?" and "how bad is that really?" are often in the news, a fact based comparison is interesting
...the U.S. has a significantly higher standard of living than almost all of the most advanced economies. According to “The Luxembourg Wealth Study,” the data source used by the oecd for international comparisons, in 2002 (the latest year for which results were available), median disposable personal income in the U.S., adjusted to reflect purchasing power parity, was 19.3 percent higher than in Canada; 68 percent higher than in Finland; 45 percent higher than in Germany; 59 percent higher than in Italy; 31 percent higher than in Norway; 73 percent higher than in Sweden; and 31 percent higher than in the United Kingdom.
 Europe doesn't look so bad when you go visit? Answer: averages matter. Not every body lives on the Via Veneto, dear tourist.
The figures for gdp per capita and median income understate America’s economic performance advantage because the median age of the U.S. population (36.8 years) is about four years lower than the average median age in the European Union and almost eight years lower than in Japan. Age, as a proxy for experience, is a significant contributor to income until individual earnings peak sometime between age 50 and 55. 
A good point I hadn't thought of.

Taxes, and "fair share"?
The U.S. income tax system is, by any measure, quite progressive. In fact, according to a study released in 2008 by the oecd, the U.S. federal income tax system is the most progressive of any of the 24 countries in the “oecd-24,” which includes Canada, Japan, Australia, and all of the richest European nations: Germany, France, the United Kingdom, Italy, the Netherlands, Norway, Switzerland, Luxembourg, and Sweden. In fact, the U.S. progressivity index is 22 percent higher than the average for the 24 countries...
In addition to economic efficiency considerations, we believe that taxing any income from savings and investment is inequitable. Here’s why: Assume two people, Angelina and Brad, have exactly the same lifetime earned income, but Angelina saves ten percent of her after-tax income and Brad saves nothing. In this hypothetical, if income from savings is taxed, Angelina will pay more lifetime tax than Brad, simply because Angelina saved. We believe this is clearly inequitable.
Angelina will also get a lot fewer government benefits. She'll pay more college tuition, get less out of social security, have all her subsequent income taxed at higher marginal rates, and so on. (Investment income may not be taxed that highly iteslf, but it pushes you into a high adjusted gross income bracket and then makes your other income subject to more taxation.)
So what is a “fair share”? The U.S. tax system is more progressive than that of any other advanced economy. Higher-income workers already pay a substantially disproportionate amount of the income tax relative to their share of income. The top five percent pay 44 percent more in taxes than the bottom 95 percent, while 47 percent of tax filers pay no tax at all. The bottom 50 percent of filers pay only 2.3 percent of taxes, and the bottom quintile gets money back. Based on these facts, how does one make a case that the rich are not paying their fair share?
OK, as they admit, nobody has defined "fair," still well written.

I prefer cause and effect, positive analysis. Will redistribution through taxation make us better off, or consign us to egaliatrian misery? I want to raise the living standards of less well off Americans every bit as much as my lefty colleagues. Will redistribution help them or leave them worse off?
We are unaware of persuasive evidence that reducing income inequality will increase economic well-being for the majority of citizens; in fact, America’s superior standard of living and economic growth relative to other advanced economies is evidence to the contrary. 
For arguably the most commonly used measure of inequality and for the Census Bureau’s most comprehensive definition of income, inequality has not risen since 1993. Moreover, the rise in income inequality that occurred before that year appears to have been, at least in part, a byproduct of the remarkable success of a group of entrepreneurs who in the past few decades created countless jobs and contributed substantially to the higher living standards we all currently enjoy. ..
A final cheer:
Rather than focusing on income inequality, policymakers should address the very real impediments to achieving equality of opportunity, particularly for the youngest and least-skilled workers among us. We believe such efforts should begin with fixing our k-12 education system, which is failing to train many young Americans to be competitive in today’s global labor market. If we can solve this problem, we will enable future generations of young people to climb the economic ladder and achieve the economic success that has long made the United States the world’s leading economy
Yes. What the public education system in this country has done to the poor and less well off is a scandal (I don't like the term "middle class," as I reject the idea that we are a class-based society).

I'm not doing justice to the careful argument in the report. Go read the original

Tuesday, August 14, 2012

The Grind Continues.

So it does. BTFD crowd are unable to push it convincingly to the orbit beyond the gravity and the sellers have gone on strike. Possibly everyone is on vacation and the juniors do not want to rock the boat too much.   In many ways this current rally does seem like the one of March when it just kept grinding higher. But that was then. Conditions are different. Then it was LTRO driven rally. Now it is hope driven. That things are so bad, some one or other, either in China or in Europe, will intervene with money. If none else, then the dragon slayer Ben! Jackson Hole is round the corner and who can forget the QE2, which came out of JH.

It does not matter that things are about to go kaput. O & B team will provide free money to every one in America. O to the voters and B to the Banksters. Then everyone is happy.
We just can't stop salivating.

But we will leave the Economorons with the task of lifting the heavy duty discussion about economics. And just keep the common sense functioning in this mine field. We all have some quantifiable edge in dealing with stock market. Some use TA, some use Elliot wave, I depend mainly on cycle analysis and understanding of the criminal psychology of the TBTF bankers and Oligarchy. In fact if you read history, you will find that the criminal behaviour pattern of this group has not really changed over centuries. Thus a study of the financiers of middle age Venice will give you some behavioural clue of the financiers of modern age. They are more dangerous than a Mexican gang.

Coming back to market, my cycle top was around August 13 -14. So we will see what tomorrow brings. If SPX closes below 1385, I will add to my short positions. The existing short positions are in red but not by much. It was like buying a lottery ticket with higher odds not an investment decision. I still recommend everyone not to front run and manage the risks. The market is not going to move aimlessly like this and a definite trend will soon develop. So lets wait patiently for the definite trend. The movement of AUD is hinting that the storm is brewing and we just have wait a bot longer. My COT indicators are definitely bearish.

I am still tied up with other work and now a days I hardly get time to monitor the market. But that's not a big deal because I am not a day trader anyway. The posts are getting later than usual and not much discussion in depth. So please bear with me for a month or so.

Thanks for sharing my thoughts. Please invite others to join the gang and follow me twitter.( @ BBFinanceblog).

Monday, August 13, 2012

Some Quick Scribblings.

Hi Friends. I am still working and did not have much time for the market. But I guess nothing much happened anyway. It seems no body wants to sell and VIX is down below 14. My short positions are bleeding red but my position is small and the pain is bearable. Some of you asked about VIX and whether it has bottomed yet. I have the right post for you. Bill Luby is a very smart guy who writes only on VIX. He is a consultant for CBOE and he is long VIX at this time.
I see many smart guys are bullish and buying in equities. May be I am dumb to doubt the rally but I still think time is not right yet for going long. I think this is a hope rally where everyone is waiting for Central bank liquidity injection. I think the markets will reach the highs of 2007 by the end of the year but it is still little early for that and we need one correction before the final upswing. And that time is awfully close as per my calculation. So I am not really worried that VIX is down along with SPX. It does not really matter if the SPX goes up a bit tomorrow or day after because the bigger trend is that of a trap. At least that is what I think.
The market action is grinding folks and forcing them to take positions which are risky.
My advice, just don't do anything silly and wait. It is not going to hurt to wait for a definite break out or breakdown.
If you are long, keep your stop loss limits tight. If you are short, keep a close watch and decide when you should cut your losses. Because, despite all indicators, market can remain irrational longer than we can anticipate.
That's it for today. I will have to get back to work. I will try to update with interesting stuff but for now I see just a grind.
Thanks for sharing my thoughts. GLTA.

Saturday, August 11, 2012

Illusion In The Wonderland.

1st , let me apologies for my absence for the last few days. I was hoping that I will get some respite after 8thAugust but now it seems my pressure situation will continue till mid-Sept. But that’s life, so no point cribbing.

Coming back to market, I would like to start with some interesting COT data. We would do well to remember that COT report does not result in immediate action. It just shows what smart money is doing well in advance behind the scene while the retail is distracted. The 1st  chart is the S&P Emini contracts. 

The smart money has gone short from last week while retail is long.

The 2nd chart is more dramatic and it is a chart of Nasdaq.

The short interest in Nasdaq by the smart money is huge and is a real concern. It seems that at any point of time, retail will be left holding the bag full of crap.

The whole of last week the markets have struggled to move higher and have made multiple tops. It may still make one more break out on Monday or Tuesday, which is also the top as per my cycle analysis. Again, this is not an exact science, but it has proven to be fairly accurate in the past with few days variation. Looking for top is of course a fool’s errand and front running is a bad idea. The reason is not to time the market exactly, but to reduce risk by reducing any long exposure. I am short but in a very limited way and would not increase the short position unless I get the confirmation of the breakdown.

I do not buy the bull logic because I think fundamentally, the world is in a recession and Europe is just taking a rest with everyone in vacation. Nothing has been solved for the stock market to go up. I think the only way it can go up any further is through central bank liquidity, be it Mario or Bernanke. One chart from Mr. Dominic Cimino of PPC tells an interesting story.

The green line is the ratio of XRT to XLP. XRT is the retail sector ETF where as XLP is the consumer staples ETF. When the ratio is rising, it means retail sector is doing well. Retail sector does well when consumers are spending money. And we all know that 70% of American economy runs on consumer spending. When the ratio is going down, it means consumer staples are doing better and retail is going south. Which also means the economy is not really doing well. So when the green line is moving up, SPX should move up and when the green line is moving down, SPX should move down. Simple but powerful concept and it had indicated both the downmove of 2008 and upmove of 2009. Now we see a divergence with green line moving down while SPX moving up. This definitely calls for caution and I do not think there is much to be bullish about unless of course, and again, Ben shows us the colour of the money.

There are many technical divergences which is calling for a top but all these divergences take time to work out. In a way, that’s how the smart money plays with the muppets. While they are busy selling at the top, they create an illusion of new prosperity. And with the markets being manipulated like never before, volume at extreme low level, their job is not that difficult. I think higher the market goes from here, harder it will fall.
Also let us not forget that if the markets continue at this level, there will be no free money coming from Ben. That is not exactly helpful to the Banksters. So be prepared for some action in the coming weeks. In all possibilities, volatility will spike from next week and a crescendo will be reached by end of the Month. It has taken longer than I anticipated but by not front running we have avoided all the whipsaw and mental agony. As I always say, in this present environment, return of capital is more important than return on capital. So be safe out there.

Hope you are having fun in this beautiful weekend. Stay sharp and filter the noise. Thanks for reading . Please forward / re-tweet / post it on your wall and join me in twitter. (Twitter @ BBFinanceblog) 

Romney Shows His Serious Side

By picking Paul Ryan, Mitt Romney has elevated the national debate.  Whether one agrees or disagrees with the Ryan budget plan, it is the only serious plan put forth by any elected official in the US.  Ryan is courageous and smart.  This has to change Romney's image with his conservative base.

One wonders if the Democrats will continue to look for irrelevant issues -- Bain, for example, or Romney tax returns for another -- or will the Democrats finally engage on the real issues of our times.

This election will become a true test for the American electorate.  I suspect Americans will rise to the occasion.

Friday, August 10, 2012

Debt Isn't The Only Problem

Even if there was zero sovereign debt in Europe, Europe's economic troubles would not be over.  Unemployment would still be high and the Euro-economy would still be mired in stagnation.  It is very hard to start a business in Europe and hiring workers is just plain stupid.  Since you cannot legally fire employees in most countries in Europe (as a practical matter), there will always be very, very high unemployment across the European plain.  Unemployment is a way of life in Europe and is becoming a way of life in the United States for pretty much the same reason.

It is very expensive in Europe and in the US to hire an employee even if the employee were willing to return every dime of their take home pay back to the employer.  The mandated costs and potential litigation make an employee, especially those of relatively low income, uneconomic.  This fact will be a persistent and continual drain on the economy of the US and Europe.  The antidote for this, according to most politicians, is bigger government which further sucks the life out of free markets and makes the body politic more and more beholden to government and less interested in promoting free enterprise.  What you end up with is modern day Greece. 

Few Greeks today believe in free enterprise.  Instead most Greeks believe that somehow magically by taxing the rich they can live a life of leisure with high per capita income and little or no work effort.  Why not? It has worked that way for the last two generations.   If only the rich would pay higher taxes!  So, the Greeks vote for increasingly polarized political parties of the far left and far right.  Either a neo-nazi or neo-communist regime is likely the political future of Greece.  Democracy hasn't much of a shot because it cannot deliver an economy that works.  So voters look for someone else who can deliver the good life and there are plenty out there who claim that they can do just that.

It is very difficult for free markets to survive in an open society.  People see problems and they want to fix them.  The fix is always bigger government, more regulations, less freedom.  Eventually, free enterprise is simply overwhelmed and economic stagnation takes over.  That's where we are.

So, debt is one thing but by no means the biggest thing.  People go bankrupt and live to rise again and so do countries.  But snuffing out hope for the future through big government, through excessive regulation and taxation can keep a country from returning to true prosperity.  That's where we are.  If all the US and Europe suffered from was excessive debt, then the future would be bright indeed.  Unfortunately overwhelming sovereign debt is not even remotely the biggest issue that is bedeviling the economies of the western world.

Subsidies for economists?

My colleagues Gary Becker and Jim Heckman have an interesting OpEd in the Wall Street Journal, arguing for Federal funding for economists. I respectfully disagree.

Yes, economic research is a public good. And, yes, they point to some good examples of good research that was supported by the Federal Government. That does not prove the research would not have been produced without Federal support.

We would demand a much higher standard of proof from, say, the Sugar Farmers of America, asking for continuation of their tariffs, on the grounds that saving the American Family-run sugar farm is a crucial public good that will vanish without support. Or any of the other supplicants from the federal government, all of whom make public interest arguments on behalf of their subsidies and tax brakes. 

We need a grand bargain. I give up mine, you give up yours. If economists pushing for the grand bargain are the first to say, "you give up yours, but we're an important public good," we're hardly credible.  At a minimum, we need a uniform standard of proof of just who is a public good that really would not be produced without Federal support.

The largest subsidy for economic research -- other than the tax exempt status of our employers -- is the National Science Foundation. They give grants to economists. But they don't pay for the one thing that would generate more research -- they won't buy out teaching. Instead, we operate under the fiction that the university pays us for 9 months, and the NSF can then pay "summer salary." (The NIH, which supports some of the research cited by the OpEd, will buy out teaching as they do for real scientists.) One might defend this as a prize for good past research, which is how it works out in practice. Might.

Is this producing important research that would not be done otherwise?  I've received a few NSF grants in the past. I can tell you the answer. I enjoyed the money. The institutions that took 60% "overhead" enjoyed the money. But I would have written exactly the same papers exactly as fast without it. (I don't apply for NSF grants any more. Given my views on others taking federal money, even though the institutions I work for would appreciate the overhead, it seems inconsistent to do so.)

Is there really not enough economic research being done? Research is not a good of which there is simply "more" or "less," like, say domestically-produced corn-based ethanol. It's "good" and "bad." There is a tremendous amount of it. And mostly "bad."

An economist, looking at the way economic research is funded, would say this is a system designed to produce lots and lots of not very innovative papers. 

Ask a few scientists, after a few beers, about how much faster human knowledge increased in the "war on cancer," the massive funding for HIV research, or now global warming. More federally directed research, is not necessarily better.

An economist looking at this system would also predict swift capture, and that the result of Federal support of research would be that lots of research comes to conclusions supportive of the Federal Government and its agencies. How many papers supported by the Federal Reserve are critical of the Fed? How many of the huge volume of health - policy studies even consider market-based approaches that don't have a huge role for federally sponsored health policy research? Is it just a coincidence that the kind of research that ends up being most critical of the Federal government is supported by private foundations, think tanks, and universities that don't take of federal money?

There are other mechanisms. Adam Smith did not have a Federal grant. Most of us support research by teaching, an activity that produces at least some externalties towards research. Private foundations support economic research, and would do so a great deal more if the Federal government did not. Yes, many private foundations have political goals. But they recognize that research is more credible if it's a-political, and as long as there is competition, all voices can get supported.  Having to convince a wider audience of the importance of our work might produce a lot better writing.  I want to see fewer papers and more second drafts!

And what's good for the goose is good for the gander. Many economists look down disdainfully at what our social science and humanities colleagues call research. They view it as jargon-ridden, highly politicized, intellectually shoddy waste of good trees  (or, now, bits). Well, nothing in Jim and Gary's column would not apply fairly to everything done in the academy.  Their panels of experts can write reports, hand out money, and plead public goods as well as we do.

I do agree heartily on support for data. For the moment, the Federal Government does have a unique role in creating and supplying economic data. We can't study what we can't measure. This really is a public good, reasonably well created managed, and starved for resources. But most of our data sources are decades old, and have not been adequately re-thought or expanded in that time.  Especially with the internet, there is more and more private collection and supply of data, but for the moment it cannot supplant the Federal government.

Here I think there is a middle ground where we agree. Economics is not, yet, "big science" requiring massive infrastructure to produce research. Economic data collection is "big," and best directed by researchers not government officials. Data can be sold, so it's not a pure public good. But I'm willing to go with the idea that not enough good data is produced. Much of the research Jim describes as success is really massive data collection. But much of the federal research subsidy to economists does not go to creating new, publicly useful data sets. So, I think we can agree on research support for researchers to produce new data, but we don't need support to analyze that data. Fortunately, for now, that just needs an office, a computer, and some free time

Wednesday, August 8, 2012

All Quite In The Western Front.

Nothing much to say really. Today was a nothing happened kind of day. In the morning when the futures were down about 5 points, I sent out tweets that it is not the real deal. We may still have to wait for few more days to see some action.

I have initiated some short position yesterday and they are almost unmoved or in small red. So that's not all that bad. I cannot expect to hit the nail on head in every attempt but at-least it did not go up huge. There will be couple of false moves before the real one. Have to have patience.

Bulls and bears have their own story to tell and both sides have merits in their argument. But I am following cycles, which says that possible trouble ahead. All the price levels that were to be achieved, have been reached for now. And a cycle top is close by. So let us see which way the wind blows.

The market has been a meat grinder for the last few months and it has been very difficult to make money or invest. The best course of action was no action at all. Hope you guys have kept your fire power dry.  So whichever way the opportunity comes, you will be ready to move.

For now though, I think the opportunity is to the downside.

Thanks for sharing my thoughts. 

Bain, Private Equity and All That

What is the economic role of private equity?  Private equity firms buy or invest in businesses, mostly private businesses, sometimes public companies.  The usual pattern is that a private equity investment helps a fledgling company expand by providing funding and often management expertise.  For public companies, private equity is often the source of turning a poorly run company into an efficiently run business.  With rare exceptions, private equity enhances shareholder value.

Absent private equity, private and public businesses alike are less valuable.  Why?  Because private equity funds are a source of equity capital, a liquidity provider (through the sale of a company to a private equity fund), and an enhancer of value (by providing management and consulting expertise).  Because of the existence of private equity funds, business large and small are more valuable.  More valuable businesses hire people and are the engine of economic growth in a free enterprise economy.

Politicians who have nothing else to brag about have been attacking private equity as if there is something evil about the industry.  If you despise free enterprise and prefer government control of business, then you probably will not like private equity.  But, if you like free enterprise, job creation and a health economy, then you will love private equity.  President Obama has made his views clear.  He is no fan of private enterprise, job creation, or free markets.  It is hardly a surprise that Obama does not like private equity.

Tuesday, August 7, 2012

Almost There?

For a change let me share a chart with you.
This funny little chart is actually McClellan Oscillator in Kelter Channel. You will note that when the McOs crosses the upper band, it means a correction is due, when it is below the lower band, it means a bounce is coming. Not 100% right all the time, but close. Again, you have to see it in conjunction with many other things and nothing is 100% right all the time.

Given that bit of information, may be we still have little bit more to go. I am not saying it will, but be mentally prepared. Anyway, it is close to the upper channel. So anything can happen and my XLF cycle topped today.

Going past 1400 serves two purpose. Kills all the weak hands and secondly, convinces everyone else that this rally is for real. Last March, I was reading in the Blogosphere that the rally is not suspect, we who doubt it are. Rather we are crazy to doubt the rally. I am reading exactly the same thing again. Not long after that, the markets topped in April. Will history repeat soon? We will find out.

Yesterday I wrote that I am afraid that they might push it past 1400 mark. Because it is so easy and kind of watermark for many investors, who invest , trade based on TA. That if SPX crosses 1400, we will go long kind of folks. And that's how it happened today. SPX closed just above 1400.

But we cannot afford to get married to one side of the market. If the market decides to go up and up, we are not going to fight it. But since GS recommended to its clients to but EURO, I am hopeful that EURO will now tank soon and will take the risk assets along with it. It may take few days to work out.We have to be sceptical yet opportunistic.

I shorted with few puts and have invested less than 5% of my trading capital. My risk tolerance is 20% of the trade. 20% of 5% is 1%. In other word I am risking 1% of my capital for now and if things do not work out that way I think, I will get out. If things move in my direction, I will add more in stages. So let us see how things play out.

I am unable to devote more time to the market with my other assignments and in any case, I should not worry about every tick. It does not matter what happens in short term so long I get the big picture right. I do not think we are in for a new Bull run but who knows.

Thanks for reading my ramblings and sharing with your friends. Be safe out there whichever way you are going.

Buy Bonds -- The New Cure for Government Excess

Markets and politicians are clamoring for the Fed and the ECB to buy sovereign bonds, presumably to make it easier for absurd debt levels to get to even more absurd levels.  Great policy.  It's almost reassuring to see Tim Geithner in support, since he has a perfect record -- he's never been right once regarding economic policy.

So what is the logic behind asking the Fed and ECB to buy sovereign debt?  Basically, to make it easier to sell more of that debt by increasing the demand.  Where will the Fed and ECB get the money to buy the debt?  Ah, that is the question.  How about -- out of thin air!  What we used to call the printing press.  In modern times, the printing press has been replaced by digital creation, but is there any real difference?

So Europe and the US are reduced to hoping that running the printing press to put more money into circulation will rescue their stagnant economies.  Let regulatory overkill, oppressive taxation, and massive government bureaucracy continue unabated.  Instead, let's just print dollars and euros.  That's the new policy for the Geithner-Obama-Monti-Draghi generation.

The only thing we know for sure is that inflation -- a lot of inflation -- is in our future.  For Europe, inflation will be accompanied by economic and political chaos reminiscent of the German situation in 1923.  For the US, it could be the same.  The US has an alternative available in November.  But, if that comes and goes, the US will follow the European route.

Re-instituting free markets and reducing the reach of government are the only tickets to economic expansion.  Printing money, as a cure-all, simply exposes the desperation of the modern politician who has run out of bullets.

Christie Delivers

New Jersey Governor Chris Christie, with bi-partisan support, has delivered once more for the average citizen in New Jersey.  Yesterday Christie signed a law that finally begins to put some accountability into the public schools in New Jersey by requiring annual reviews for public school teachers and makes it easier to remove incompetent teachers.  Naturally the unions fought this reform, preferring incompetence and unaccountability to a successful future for New Jersey children.  Together with Scott Walker of Wisconsin and Bobby Jindahl of Louisiana, Christie has shown what can be done when you try -- even in states that are normally heavily Democratic.

Contrast the leadership of Christie, Walker and Jindahl with that of McDonnell and others who take no political risks to help the average citizen.  McDonnell's conservatism seems to stop at the church door.  He actively opposed having employees contribute to their own retirement during his first year in office, a position exactly opposite that of Christie in New Jersey.  McDonnell has never shown any inclination to take on the VEA, Virginia's public school teacher's lobby.  Quite the contrary.  McDonnell seems to have placated the VEA at every turn.  McDonnell's main legacy is likely to be his aborted attempt to remove the first female president of the University of Virginia in its history, while pretending to stay aloof from the process.

Republicans and Democrats alike are beginning to wake up to the fact that empty rhetoric and no action do not produce reform -- reform that almost every state in the United States desperately needs.  The fiscal problems and public employee largesse, issues that are intertwined, need to be addressed.  Courageous leaders address them.

Monday, August 6, 2012

Do We Turn Here?

Following chart is from Stock Trader's Almanac:
According to them, Dow Jones is just below the monthly pivot point and the late day sell off created a shooting start which is a sign of bearish reversal.

Now, I am no expert in candle stick pattern, but the fact that SPX came within the touching distance of 1400 and reversed is an indication of failing momentum. I think tomorrow morning it may again try to breach 1400 but most likely it will close in red. Today both the VIX and SPX closed in green and that calls for caution.
Sentiment has definitely turned bullish. Now folks are talking of the indexes running on auto pilot based on higher job number and retail sales and they do not require the Fed or ECB. I think the Indexes are running on fume and now that bears have been killed and bulls have been trapped, it is time to pull the lever.

Precious metals are not showing much enthusiasm and that worries me. Crude spiked with the rumour of Assad getting killed. But Copper was down and AUD is kind of toppy. The risk on trade may still surprise with one last hurrah and take SPX above 1410 but the odds favour the trip down.

I plan to start laying the short trades from tomorrow. But I want to caution readers that The Powers That Be around the world, from USA to China, do not want the the market to drop. In America Obama does not want the market to fall because it will impact his bragging rights. Europe cannot afford any major correction because they do not have much to save their financial markets and China wants to continue the illusion till infinity. So it will be very difficult for bears because there is always the threat of intervention by the Central Banks. If and when the correction comes, it better be fast and furious. If we do not see a correction of 100+ points in SPX in 5 days, the battle is lost. More importantly, SPX will have to break down the support at 1335 convincingly before we can get serious.

Either way, we are set for some fun time. Take your pick but always use proper risk control measures. I do not know what is your risk tolerance level so it will be wrong to suggest names. I may use leveraged ETF but I will not hold them for long. Instruments like TVIX is highly risky because if the market does not fall rapidly, these kind of instruments lose value quickly. But if we are lucky, they may return the jackpot. There is no one size fits all formula.

Thanks for sharing my thoughts on the market. Please share it with your friends. And trade safe.

Saturday, August 4, 2012

Are We There Yet?

I remember writing somewhat similar headline around the same time last year. More things change more they remain the same. So here we are again, oscillating between breaking higher on hope and promise or breaking down on Euro worries and Global slowdown. The Central Bankers have not yet showed up with the promised money to propel the market to far away galaxy. But that has not exactly stopped the the bulls. We are almost near the high of the year. Will we break it and reach new highs?

There are many reasons for the market to march higher. Almost 50% of the S&P 500 companies have exceeded the earnings forecast. But the bar was set low to start with. With growth in real earning being negative, I do not see what will propel the economy higher. Where the growth will come from if people do not have money to spend in the 1st place?

But we are not here to discuss economics. There are many intelligent folks out there who do a better job of explaining the economics. I simply to try to figure out where the market will go next. Try to read the minds of  TPTB as to what they have in store for the sheeples. It is like reading the tea leave and pray that it works out  as I see it.

So far I have been lucky and I hope that the luck runs a bit further. The formula is to reduce risk and not fall for the temptation that our masters are dangling before us. Last week I expected the action, rather the lack of action from the Fed and ECB. I also saw the immediate market reaction and what is coming next. It is like playing a game of chess and trying to read the mind of your opponent. Only here we cannot see the opponent but he is very much there, in many shape and form, waiting to rob you of your money.

In " Waiting for Mario" I said I will be more comfortable to short if we reach 1400 level. We are almost there. I think even now it is OK to start shorting with a very tight stop, but I want to wait few more days to see if they can push it past 1400. Logically they should make every last effort to cross that landmark. That will convince many that a new bull market is here and jump in. Now that they have killed the bears, their next target is to bring in more bulls to the slaughter house. So I would prefer  to wait a little while more but I think the game is up.

I was looking for the correction by 1st week of August but it got pushed down the time line by factors like FOMC and ECB. Now there is nothing much between earth and hope for at least till  Jackson Hole when Ben will bring in QE3.

So play it safe. Do not chase the bus. And above all, remember, even if we miss this opportunity, there will be many more to come. Markets always go up and come down. But once our capital is gone, it will be very difficult to get it back. I do not have much of fancy charts to show you but I can share what I have learned by mistakes and all the hard punches the market has given me over years. Even if it benefits one person, I will consider that as mission accomplished.

Thank you for sharing my thoughts. Please share it with your friends and if this blog has benefited you in any way, please invite others to join the readership. Right now, that is my only motivation. Have a wonderful weekend folks.