Archives for December 2013

Gary Shilling: Review and Forecast

Gary Shilling: Review and Forecast

Courtesy of John Mauldin, Thoughts from the Frontline

Should auld acquaintance be forgot
And never brought to mind?
Should auld acquaintance be forgot,
And auld lang syne!

For auld lang syne, my dear,
For auld lang syne,
We'll take a cup o' kindness yet
For auld lang syne

It's that time of year again, when we begin to think of what the next one will bring. I will be doing my annual forecast issue next week, but my friend Gary Shilling has already done his and has graciously allowed me to use a shortened version of his letter as this week'sThoughts from the Frontline. So without any further ado, let's jump right to Gary's look at where we are and where we're going.

Review and Forecast

By Gary Shilling

In the third quarter, real GDP grew 2.8% at annual rates from the second quarter. Without the increase in inventories, the rate would be 2.0%, in line with the 2.3% average growth since the economic recovery commenced in the second quarter of 2009.

Furthermore, the step-up in inventory-building from the second quarter may have been unintended, suggesting cutbacks in production and weaker growth in future quarters. Also, consumer spending growth, 1.5% in the third quarter, continues to slip from 1.8% in the second quarter and 2.3% in the first while business spending on equipment and software actually fell at a 3.7% annual rate for only the second time since the recovery started in mid-2009. Government spending was about flat with gains in state and local outlays offsetting further declines in federal expenditures. Non-residential outlays for structures showed strength as did residential building. The 16-day federal government shutdown didn't commence until the start of the fourth quarter, October 1, but anticipation may have affected the third quarter numbers.

Recovery Drivers

The 2.3% average real GDP growth in the recovery, for a total rise of 10%, has not only been an extraordinarily slow one but also quite unusual in structure. Consumer spending has accounted for 65% of that growth, actually below its 68% of real GDP, as shown in the second column of Chart 1. Government spending—which in the GDP accounts is direct outlays for personal and goods and services and doesn't include transfers like Social Security benefits—has actually declined. Federal outlays fell 0.4% despite massive stimuli since most of it went to welfare and other transfers to state governments. But state and local spending dropped 0.9% due to budget constraints.

Residential construction accounted for 9% of the gain in the economy. This exceeds its share of GDP, but still is small since volatile housing normally leaps in recoveries, spurred by low interest rates. But deterrents abound. The initial boost to the economy as retrenching consumers cut imports was later reversed. So net exports reduced real GDP growth by 0.4% in the 13 quarters of recovery to date.

Inventory-building accounted for a substantial 19% of the rise in real GDP, suggesting the accumulation of undesired stocks since anticipation of future demand has been consistently subdued. Nonresidential structures fell 0.1% as previous overbuilding left excess space. Equipment spending contributed 20% of the overall growth, but has failed to shoulder the normal late recovery burst.

Nevertheless, the small intellectual property products component, earlier called software, accounted for 5% of overall growth compared to its 3.9% share of GDP. This reflects the productivity-enhancing investments American business have been using to propel profit margins and the bottom line in an era when sales volume has been weak and pricing power absent.

As we predicted over three years ago in our book The Age of Deleveraging: Investment strategies for a decade of slow growth and deflation, and in many Insights since then, economic growth of about 2% annually will probably persist until deleveraging, especially in the financial sector globally and among U.S. consumers, is completed in another four or five years. Deleveraging after a major leveraging binge and the financial crisis that inevitably follows normally takes around a decade, and since the workdown of excess debt commenced in 2008, the process is now about half over. The power of this private sector deleveraging is shown by the fact that even with the immense fiscal stimuli earlier and ongoing massive monetary expansion, real growth has only averaged 2.3% compared to 3.4% in the post-World War II era before the 2007-2009 Great Recession.

Optimists, of course, continue to look for reasons why rapid growth is just around the corner, and their latest ploy is the hope that the effects of individual income tax hikes and reduced federal spending this year via sequestration have about run their course. Early this year when these negative effects on spending were supposed to take place, scare-mongers in and out of Washington predicted drastic negative effects on the economy. But federal bureaucrats apparently mitigated much of the effects of sequestration, and the income tax increases on the rich, as usual, didn't change their spending habits much. So the positive influences on the economy as sequestration fades and income tax rates stabilize are likely to be equally minimal.

Furthermore, small-business sentiment has fallen recently. The percentage of companies that look for economic improvement dropped from -2 in August to -10 in September and -17 in October to a seven-month low. Those expecting higher sales declined from +8 to +2 in October. Most of the other components of the index fell, including those related to the investment climate, hiring plans, capital spending intentions, inventories, inflation expectations and plans to raise wages and prices. Other recent measures of subdued economic activity include the New York Fed's survey of manufacturing and business conditions and industrial production nationwide, which fell 0.1% in October from September.

The New York Fed's Empire State manufacturing survey index for November fell to 2.21%, the first negative reading since May. Every component dropped—orders, shipments, inventories, backlogs, employment, the workweek, vendor performance and inflation.

Global Slow Growth

The ongoing sluggish growth in the U.S. is indeed a global problem. It's true in the eurozone, the U.K., Japan and China. Recently, the International Monetary Fund, in its sixth consecutive downward revision, cut its global growth forecast for this year by 0.3 percentage points to 2.9% and for 2014, by 0.2 percentage points to 3.6%.

It lowered its 2013 forecast for India from 5.6% to 3.8%, for Brazil from 3.2% to 2.5% and more than halved Mexico's to 1.2%. For developing countries on average, the IMF reduced its 2013 growth forecast by 0.4 percentage points to 5%, citing the drying up of years of cheap liquidity, competitive constraints, infrastructure shortfalls and slowing investment. It also worries about their balance of payment woes. For 2014, the IMF chopped its growth forecast for China from 7.8% to 7.3% and from 2.8% to 2.6% for the U.S.

Fiscal Drag

Fed Chairman Bernanke continually worries about fiscal drag. Without question, the federal budget was stimulative in earlier years when tax cuts and massive spending in reaction to the Great Recession as well as weak corporate and individual tax collections pushed the annual deficit above $1 trillion. But the unwinding of the extra spending, income tax increases and sequestration this year and economic recovery—weak as it's been—have reduced the deficit to $680 billion in fiscal 2013 that ended September 30.

From here on, the outlook is highly uncertain with persistent gridlock in Washington between Democrats and Republicans. So far, they've kicked the federal budget and debt limit cans down the road and they may do so again when temporary extensions expire early next year. It looks like many in Congress have no intention of resolving these two problems and may be jockeying for position ahead of the 2014, if not the 2016, elections.

In our many years of observing and talking to Congressmen, Senators and key Administration officials of both parties, it's clear that Washington only acts when it has no alternative and faces excruciating pressure. A collapsing stock market always gets their attention, but the ongoing market rally, in effect, tells them that all is well or at least that it doesn't require immediate action.

The Fed

With muted economic growth and risks on the downside, distrust in the abilities or willingness of Congress and the Administration to right the ship, and falling consumer and business confidence, the burden of stimulating the economy remains with the Fed. Janet Yellen, the likely next Chairman, seems even more committed than Bernanke to continuing to keep monetary policy loose. The Fed plans to reduce its buying of $85 billion per month in securities but the negative reactions by stocks (Chart 2), Treasury bonds (Chart 3) and many other securities to Bernanke's hints in May and June that purchases would be tapered and eliminated by mid-2014 made a strong impression on the Fed. Similarly, the release of the minutes of the Fed's October policy meeting— which again said officials looked forward to ending the bond-buying program "in coming months" if conditions warranted—resulted in an instant drop in stock and bond prices.

The Fed is trying to figure out how to end security purchases without spiking interest rates, to the detriment of housing, other U.S. economic sectors and developing economies. It's moving toward "forward guidance," more commitment to keep the short-term interest rate it controls low than its present pledge to keep it essentially at zero until the current 7.3% unemployment rate drops to 6.5% and its inflation rate measure climbs to 2.5% from the current 1.2% year-over-year.

The hope is that a longer-term commitment to keep short-term rates low will retard long rates as well when the Fed tapers its asset purchases. This strategy appears to be having some success. Treasury investors are switching from 10-year and longer issues to 2-year or shorter notes. This is known as the yield-steepening trade as it pushes short-term yields down and longer yields up. As a result, the spread between 2-year and 10-year Treasury obligations has widened to 2.54 percentage points, the most since July 2011. Banks benefit from a steeper yield curve since they borrow short term and lend in long-term markets. But borrowers pay more for loans linked to long-term Treasury yields. There's a close link between the yield on 10-year Treasury notes and the 30-year fixed rate on residential mortgages.

The Fed has already signaled that it may not wait to raise short rates until the unemployment rate, a very unreliable gauge of job conditions as we've explained in past Insights, drops below 6.5%. Bernanke recently said that "even after unemployment drops below 6.5%, the [Fed] can be patient in seeking assurance that the labor market is sufficiently strong before considering any increase in its target for the federal funds rate." At that point, the Fed will consider broader measures of the job market including the labor participation rate. If the participation rate hadn't fallen from its February 2000 peak due to postwar baby retirements, discouraged job-seekers and youths who stayed in school since job opportunities dried up with the recession, the unemployment rate now would be 13%.

The Fed is well aware that other than pushing up stock prices, its asset-buying program is having little impact on the economy. In a recent speech, Bernanke said that while the Fed's commitment to hold down interest rates and its asset purchases both are helping the economy, "we are somewhat less certain about the magnitude of the effects on financial conditions and the economy of changes in the pace of purchases or in the accumulated stock of assets on the Fed's balance sheet." We wholeheartedly agree with this sentiment, as discussed in detail in our October Insight. Tapering Fed monthly purchases only reduces the ongoing additions to already-massive excess member bank reserves on deposit at the Fed.


Inflation has virtually disappeared. The Fed's favorite measure of overall consumer prices, the Personal Consumption Expenditures Deflator excluding food and energy (Chart 4), is rising 1.2% year-over-year, well below the central bank's 2.0% target and dangerously close to going negative.

There are many ongoing deflationary forces in the world, including falling commodity prices, aging and declining populations globally, economic output well below potential, globalization of production, growing worldwide protectionism including competitive devaluation in Japan, declining real incomes, income polarization, declining union memberships, high unemployment and downward pressure on federal and state and local government spending.

With the running out of 2009 federal stimulus money and gas tax revenues declining as fewer miles are driven in more efficient cars, highway construction is declining and construction firms are consolidating and reducing bids on new work even if their costs are rising. Highway construction spending dropped 3.3% in the first eight months of 2013 compared to a year earlier. Also, states are shifting scarce money away from transportation and to education and health care. We've noted in past Insights that aggressive monetary and fiscal stimuli probably have delayed but not prevented chronic deflation in producer and consumer prices.

Why does the Fed clearly fear deflation? Steadily declining prices can induce buyers to wait for still-lower prices. So, excess capacity and inventories result and force prices lower. That confirms suspicions and encourages buyers to wait even further. Those deflationary expectations are partly responsible for the slow economic growth in Japan for two decades.

Low Interest Rates

With the Fed likely to continue to hold its federal funds rate close to zero, other short-term interest rates will probably remain there too. So the recent rally in Treasury bonds may well continue, with yields on the 10-year Treasury note, now 2.8%, dropping below 2% while the yield on our 32-year favorite, the 30-year Treasury "long bond," falls from 3.9% to under 3%. Even-lower yields are in store if chronic deflation sets in as well it might. Ditto for the rise in stocks, which we continue to believe is driven predominantly by investor faith in the Fed, irrespective of modest economic growth at best. "Don't fight the Fed," is the stock bulls' bellow. Supporting this enthusiasm has been the rise in corporate profits, but that strength has been almost solely due to leaping profit margins. Low economic growth has severely limited sales volume growth, and the absence of inflation has virtually eliminated pricing power. So businesses have cut labor and other costs with a vengeance as the route to bottom line growth

Wall Street analysts expect this margin leap to persist. In the third quarter, S&P 500 profit margins at 9.6% were a record high but revenues rose only 2.7% from a year earlier. In the third quarter of 2014, they see S&P 500 net income jumping 14.9% from a year earlier on sales growth of only 4.7%. But profit margins have been flat at their peak level for seven quarters. And the risks appear on the downside.

Productivity growth engendered by labor cost-cutting and other means is no longer easy to come by, as it was in 2009 and 2010. Corporate spending on plant and equipment and other productivity-enhancing investments has fallen 16% from a year ago. Also, neither capital nor labor gets the upper hand indefinitely in a democracy, and compensation's share of national income has been compressed as profit's share leaped. In addition, corporate earnings are vulnerable to the further strengthening of the dollar, which reduces the value of exports and foreign earnings by U.S. multinationals as foreign currency receipts are translated to greenbacks.

Speculation Returns

Driven by the zeal for yield due to low interest rates and the rise in stock prices that has elevated the S&P 500 more than 160% from its March 2009 low, a degree of speculation has returned to equities. The VIX index, a measure of expected volatility, remains at very low levels (Chart 5). Individual investors are again putting money into U.S. equity mutual funds after years of withdrawals. "Frontier" equity markets are in vogue. They're found in countries like Saudi Arabia, Nigeria and Romania that have much less-developed—and therefore risky—financial markets and economies than Brazil and Mexico.

The IPO market has been hot this year. The median IPO has been priced at five times sales over the last 12 months, almost back to the six times level of 2007. And many IPOs have used the newly-raised funds to repay debt to their private equity backers, not to invest in business expansion. Through early November, IPOs raised $51 billion, the most since the $62 billion in the comparable period in 2000. Some 62% of IPOs this year are for money-losing companies, the most since the 1999-2000 dot com bubble. Some hedge fund managers are introducing "long only" funds with no hedges against potential stock price declines.

The S&P 500 index recently reached an all-time high but corrected for inflation, it remains in a secular bear market that started in 2000. This reflects the slow economic growth since then and the falling price-earnings ratio, and fits in with the long-term pattern of secular bull and bear markets, as discussed in detail in our May 2013 Insight.

High P/E

Furthermore, from a long-term perspective, the P/E on the S&P 500 at 24.5 is 48% above its long run average of 16.5 (Chart 6), and we're strong believers in reversions to well-established trends, this one going back to 1881. The P/E developed by our friend and Nobel Prize winner, Robert Shiller of Yale, averages earnings over the last 10 years to iron out cyclical fluctuations. Also, since the P/E in the last two decades has been consistently above trend, it probably will be below 16.5 for a number of years to come.

This index is trading at 19 times its companies' earnings over the past 12 months, well above the 16 historic average. This year, about three-fourths of the rise in stock prices is due to the jump in P/Es, not corporate earnings growth. Even always-optimistic Wall Street analysts don't expect this P/E expansion to persist in light of possible Fed tightening. Those folks, of course, are paid to be bullish and their track record proves it. Since 2000, stocks have returned 3.3% annually on average, but strategists forecast 10%. They predicted stock rises in every year and missed all four down years.


Residential construction is near and dear to the Fed's heart. It's a small sector but so volatile that it has huge cyclical impact on the economy. At its height in the third quarter of 2005, it accounted for 6.2% of GDP but fell to 2.5% in the third quarter of 2010 (Chart 7). That in itself constitutes a recession, even without the related decline in appliances, home furnishings and autos.

Furthermore, the Fed can have a direct influence on housing. Monetary policy is a very blunt instrument. The central bank only can lower interest rates and buy securities and then hope the economy in general will be helped. In contrast, fiscal policy can aid the unemployed directly by raising unemployment benefits. But by buying securities, especially mortgage-related issues, the Fed can influence interest rates and help interest-sensitive housing. The rise in 30-year fixed mortgage rates of over one percentage point last spring probably has brought the housing recovery to at least a temporary halt. Each percentage point rate rise pushes up monthly principal and interest payments by about 10%.

Of course, many other factors besides mortgage rates affect housing and have been restraining influences. They include high downpayment requirements, stringent credit score levels, employment status and job security and the reality that for the first time since the 1930s, house prices have fallen—by a third at their low.

Capital Spending

Many hope that record levels of corporate cash and low borrowing costs will propel capital spending. And spending aimed at productivity enhancement, much of it on high-tech gear, has been robust as business concentrates on cost-cutting, as noted earlier. But the bulk of plant and equipment spending is driven by capacity utilization, and while it remains low, there's little zeal for new outlays.

That's why capital spending lags the economic cycle. Only after the economy strengthens in recoveries do utilization rates rise enough to spur surges in capital spending. And as our earlier research revealed, it's the level of utilization, not the speed with which it's rising, that drives plant and equipment outlays. So this is a Catch-22 situation. Until the economy accelerates and pushes up utilization rates, capital spending will remain subdued. But what will cause that economic growth spurt?

Government Spending

It's unlikely to be government spending. State and local outlays used to be a steady 12% or so of GDP and a source of stable, well-paying jobs. But no more. State tax revenues are recovering (Chart 8), but the federal stimulus money enacted in 2009 has dried up, leaving many states with strained budgets.

Pressure also comes from private sector workers who are increasingly aware that while their pay has been compressed by globalization and business cost-cutting, state and local employees have gotten their usual 3% to 4% annual increases and lush benefits. As a result, those government people have 45% higher pay than in the private sector, 33% more in wages and 73% in additional benefits. Oversized retiree obligations have sunk cities in California and Rhode Island and pushed Illinois to the brink of bankruptcy. Hopelessly-underfunded defined benefit pensions are a major threat to state and local government finances.

Municipal government employment is down 3.3% from its earlier peak compared to -0.2% for total payroll employment (Chart 9). And since these people are paid 1.45 times those in the private sector, two job losses is the equivalent of three private sector job cuts in terms of income. Real state and local outlays have fallen 9.5% since the third quarter of 2009.

Federal direct spending on goods and services, excluding Social Security, Medicare and other transfers, has also been dropping, by 7.2% since the third quarter of 2010. Both defense and nondefense real outlays are dropping, and this has occurred largely before the 2013 sequestration. At the same time, federal government civilian employment, civilian and military, has dropped 6% from its top (Chart 10).

U.S. Labor Markets

The U.S. labor market remains weak and of considerable concern to the Fed. Recent employment statistics have been muddled by the government's 16-day shutdown in October and the impasse over the debt ceiling. Initially, 850,000 employees were furloughed although the Pentagon recalled most of its 350,000 civilian workers a week into the shutdown.

The unemployment rate has been falling, but because of the declining labor participation rate. We explored this phenomenon in detail in "How Tight Are Labor Markets?" (June 2013 Insight). As people age, their labor force participation rates tend to drop as they retire or otherwise leave the workforce. With the aging postwar babies, those born between 1946 and 1964, this has resulted in a downward trend in the overall participation rate—but it doesn't account for all of the decline.

The irony is that participation rates of younger people tend to be higher than for seniors, but are declining. For 16-24-year-olds, the rate has declined sharply since 2000 as slow economic growth, limited jobs and rising unemployment rates have encouraged these youths to stay in school or otherwise avoid the labor force.

Meanwhile, the participation rates for those over 65 have climbed since the late 1990s as they are forced to work longer than they planned. Many have been notoriously poor savers and were devastated by the collapse in stocks in 2007-2009 after the 2000-2002 nosedive, two of only five drops of more than 40% in the S&P 500 since 1900.


An additional sign of job weakness is the large number of people who want to work full-time but are only offered part-time positions—"working part-time for economic reasons" is the Bureau of Labor Statistics term (Chart 11)—and these people total 8 million and constitute 5.6% of the employed. This obviously reflects employer caution and the zeal to contain costs since part-timers often don't have the pension and other benefits enjoyed by full-time employees.

This group will no doubt leap when Obamacare is fully implemented in 2015, according to its current schedule. Employers with 50 or more workers have to offer healthcare insurance, but not to those working less than 30 hours per week. When these people and those who have given up looking for jobs are added to the headline unemployment rate, the result, the BLS's U-6 unemployment rate, leaped in the Great Recession and is still very high at 13.8% in October.

The weakness in the job market is amplified by the fact that most new jobs are in leisure and hospitality, retailing, fast food and other low-paying industries, which accounted for a third of the 204,000 new jobs in October. Manufacturing, which pays much more, has added some employees as activity rebounds but growth has been modest.

Real Pay Falling

With all the downward pressure on labor markets, real weekly wages are falling on balance. The folks on top of the income pile have recovered all their Great Recession setbacks and then some, on average. The rest, perhaps three-fourths of the population, believe they are—and probably still are—mired in recession due to declining real wages, still-depressed house prices, etc. Consequently, the share of total income by the top one-fifth, which has been rising since the data started in 1967, has jumped in recent years. The remaining four quintile shares continue to fall, although falling shares do not necessarily mean falling incomes.

The average household in the top 20% by income has seen that income rise 6% since 2008 in real terms and the top 5% of earners had an 8% jump. The middle quintile gained just 2% while the bottom 29% are still below their pre-recession peak. A study of household incomes over the 2002-2012 decade shows that the top 0.01% gained 76.2% in real terms but the bottom 90% lost 10.7%. In 2012, the top 1% by income got 19.3% of the total. The only year when their share was bigger was 1928 at 19.6%.

Real median household income, that of the household in the middle of the spectrum, continues to drop on balance, only leveling last year from 2011 (Chart 12). In 2012, it was down 8.3% from the prerecession 2007 level and off 9.1% from the 1999 all-time top. Americans may accept a declining share of income as long as their spending power is increasing, but that's no longer true, a reality that President Obama plays to with his "fat cat bankers" and other remarks.

Households earning $50,000 or more have become increasingly more confident, according to a monthly survey by RBC Capital Markets, but confidence among lower-income households stagnated, created a near-record gap between the two. Of the 2.3 million jobs added in the past year, 35% were in jobs paying, on average, below $20 per hour in industries such as retailing and leisure and hospitality. Since the recession ended, hourly wages for non-managers in the lowest-paying quarter of industries are up 6% but more than 12% in the top-paying quarter. These income disparities are reflected in consumer spending. In the first nine months of this year, sales of luxury cars were up 12% from a year earlier but small-car sales rose just 6.1%.

Consumer Spending

With housing, capital spending, government outlays and net exports unlikely to promote rapid economic growth in coming quarters, the only possible sparkplug is the consumer. Consumer outlays account for 69% of GDP, and with falling real wages and incomes, the only way for real consumer spending to rise is for their already-low saving rate to fall further.

Even the real wealth effect, the spur to spending due to rises in net worth, is now muted. In the past, it's estimated that each $1 rise in equity value boosted consumer spending by three cents over the following 18 months while a dollar more in house value led to eight cents more in outlays. But now the numbers are two cents and five cents, respectively.

True, the ratio of monthly financing payments to their after-tax income has been falling for homeowners, freeing money for spending. Those obligations include monthly mortgage, credit card and auto loan and lease payments as well as property taxes and homeowner insurance. Nevertheless, for the third of households that rent, their average financial obligations ratio has been rising in the last two years as rents rise while vacancies drop.

Declining gasoline prices have given consumers extra money for other purchases, and are probably behind the recent rise in gas-guzzling pickup truck and SUV sales. Furthermore, the automatic Social Security benefit cost-of-living escalator will increase benefits by 1.5% in 2014 for 63 million recipients of retirement and disability payments. Still, with low inflation in 2013, the basing year, that increase is smaller than the 1.7% rise last year and the lowest since 2003, excluding 2010 and 2011 when there were no increases due to a lack of inflation. Social Security retirement checks will rise $19 per month to $1,294, on average, starting in January.

In any event, retail sales growth is running about 4% at annual rates recently, about half the earlier recovery strength (Chart 13). And a lot of this growth has been spurred by robust auto sales, allegedly driven by the need to replace aged vehicles.


Insight readers know we've been waiting for a shock to remind equity investors of the fundamental weakness of the economy, and perhaps push the sluggish economy into a recession. With underlying real growth of only 2%, it won't take much of a setback to do the job.

Will the negative effects of the government shutdown and debt ceiling standoff, coupled with the confusion caused by the rollout of Obamacare, be a sufficient shock? The initial Christmas retail selling season may tell the tale, and the risks are on the down side. Besides the consumer, we're focused on corporate profits, which may not hold up in the face of persistently slow sales growth, no pricing power and increasing difficulty in raising profit margins.

Nevertheless, we are not forecasting a recession for now, but rather more of the same, dull, slack 2% real GDP growth as in the four-plus years of recovery to date.

If you like what you read and would like to keep up with Gary for the next year, you can subscribe to Gary Shilling's Insight for one year for $335 via email. Along with 12 months of Insight you'll also receive a free copy of his full report detailing why he believes it will be "advantage America" in the coming years and a free copy of Gary's latest book, Letting Off More Steam. To subscribe, call 1-888-346-7444 or 973-467-0070 between 10 am and 4 pm Eastern time or Be sure to mention Thoughts from the Frontline to get the special report and free book in addition to your 12 months of Insight(available only to new subscribers).

Dubai, Saudi Arabia, Canada, and Auld Lang Syne

(For a little mood music, you can listen to James Taylor croon "Auld Lang Syne." Or here'sthe Beach Boys’ version.)

I am home for the holidays until January 8, when I leave for Dubai and then Riyadh for a week. There is the potential for a day trip to Abu Dhabi to meet with Maine fishing buddy Paul O'Brien. Then I am back home for a week before I fly to Vancouver, Edmonton, and Regina for a three-day speaking tour at those cities' respective annual CFA forecast dinners. A note from a reader in Edmonton pointed out that it is already -30 there. I am actively hunting for my thermal underwear.

Oddly enough, my calendar then shows me home for four weeks before I head to Laguna Beach, CA, for a speech and then hop a plane to Miami. You would think that someone who flies as much as I do would have done a cross-country flight more than a few times, but this will be my first time ever to fly coast to coast in the US.

As noted last week, all my kids will be in town tonight, and we will celebrate our "official" family Christmas tomorrow. The poor grandchildren have had to wait three extra days to open their presents, but I keep telling them that waiting builds character. I get looks back from them that say they're not sure what character is but they want nothing to do with it.

I have always enjoyed this time of year as an interlude for contemplating the future. For whatever reason, since I was in college I have paused as the new year approached to think about where I wanted to be in five years. Given that I'm 64, that means I've gone through this process some 42 times and seen the completion of 37 five-year planning cycles.

My batting average to date is 0 for 37. I never end up where I thought I was going to be, although there are times when I at least get the direction right, and fortunately there even a few times when the new midcourse correction means things turn out even better than planned.

Next week I write my 2014 forecast, for which the theme will be "Uncertainty." Yet even in the face of overwhelming uncertainty, I will still come up with a personal five-year plan. Given the rather unique set of opportunities that have been presented to me in the past year, the plan is rather ambitious. And I expect it to change a lot. Among other projects, I expect to be announcing several new letters in the coming months that will be specifically directed to strategic portfolio planning. Right now our plan is to make these letters more or less freely available.

But the one thing that will hopefully not change is that I will be writing this letter to you, as together we try to make sense of the world. As the year draws to a close, I want to thank you for being part of my family of readers. And may the coming year surpass all your most wildly optimistic plans.

Your hearing "Auld Lang Syne" analyst,

John Mauldin

© 2013 Mauldin Economics. All Rights Reserved.

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France Seeks Another Tax on Facebook, Google And YouTube, to Finance “French Culture” Cinema

Courtesy of Mish.

The economic stupidity in France is astounding. It’s hard keeping up with all the inane ideas of President Francois Hollande’s socialist administration. Here’s another one of Hollande’s ideas for your amusement.

RT reports French broadcasting watchdog CSA eager to tax YouTube, Facebook, Dailymotion

France’s Superior Council of Audiovisual, an independent broadcasting authority, wants to impose taxes on media giants like YouTube, Facebook and Dailymotion to force them to contribute to financing French culture.

The sites fall into the same category as video-on-demand services, the organization said; so they would be subject to French cultural protection laws that require distributors to hand over some of their revenues to help subsidize productions.

“These platforms have been developing partnerships with audiovisual publishers and content providers for years, with which they share revenues from advertising,” the report [in French] said.

The watchdog has urged the French government to conduct research into the websites’ profit from professional productions and to determine how much they may be required to pay.

The obstacle which remains, though, is the fact that the legislation is only applicable to websites that are based in France. In the future, the organization is planning to demand all video-on-demand services to declare their existence to the CSA.

Culture Tax

Bloomberg reports France’s ‘Culture Tax’ Could Hit YouTube and Facebook

Should YouTube subsidize le cinéma français? France’s audiovisual regulator thinks so. In a report this week, the Superior Audiovisual Council (CSA) says that video-sharing websites should be subject to a tax that helps finance the production of French films and TV shows.

The so-called culture tax, totaling more than €1.3 billion ($1.8 billion) annually, is paid by movie theaters, broadcasters, and Internet service providers in France. The CSA contends that YouTube (GOOG), French video-sharing site DailyMotion, and their ilk are effectively providing video-on-demand services, which are already subject to the tax.

Separately, France is considering a tax on smartphones, tablets, and other devices as another source of revenue for cultural subsidies. A government-commissioned report, released in May, said that a sales tax of 1 percent should be imposed on electronic devices capable of accessing movies, music, and other content. The proposed tax would raise an estimated €86 million annually that would be used to finance the “cultural industries’ digital transition,” France’s Culture Ministry said at the time.

Trade associations for French Internet and technology companies spoke out against the proposal, which the government has not yet acted on. Rejecting the government’s assertion that a 1 percent tax would be “painless,” the groups warned in a statement in July that the government should be encouraging growth of the digital economy, rather than taxing it.

Subsidies For Films No One Watches

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Monetary policy under financial repression

Monetary policy under financial repression

Courtesy of Michael Pettis 

Following Paul Krugman’s lead I guess I can refer to this post as being “wonkish”. Much of it is based on my recent book Avoiding the Fall (Carnegie Endowment, September 2013).

In order to understand much of what is happening in China I believe it is crucially important to understand how financial systems operate under conditions of financial repression. Because most of what we know about economics is derived from economists whose operating environment is the classical “anglo-saxon” economies (I stress “classical” because for much of the 19th Century, operating under the so-called “American System”, the US itself was not, in my opinion, a classic anglo-saxon economy), there is a tendency to assume that what happens in those economies is somehow the default position in economics, and this not only causes us to underrate important economists that don’t follow this tradition, like the German Freidrich List or the American Albert O. Hirschman, but it also leads us into mistaken assumptions, like the belief that higher interest rates lead automatically to higher savings rates.

We do know some things about financial repression. Two of the first important texts to discuss financial repression comprehensively are Edward S. Shaw, Financial Deepening in Economic Development and Ronald I. McKinnon, Money and Capital in Economic Development. There is, however, a lot more to it than what is generally known, and even this is largely ignored by most economists. It seems to me that many of the mistakes we make when we think about the relationship between cause and effect, for example the impact of monetary policy on China’s economy, arise because we assume that relationships that hold in the US economy are universal and must hold in the Chinese economy too. So to return to the assumption that higher interest rates must lead to higher savings rates, I would argue that this is true mainly under two unstated assumptions, neither of which holds for China.

First, higher interest rates must must have a negative wealth effect, which they mostly do in the US. In China however the wealth effect is positive. Second, changes in interest rates should have a minimal impact on the household share of GDP. In the US, where there is a wide variety of alternative investments and where interest rates move broadly in line with changes in inflation, this may be true, but in China where most households have few alternatives to bank deposits, and where interest rates are set independently of changes in inflation, this isn’t true.

In fact distortions in domestic interest rates may be the single most important explanation of why the household share of GDP has plummeted in China, especially over the decade ending around 2010-11. So while higher interest rates in the US are typically (although certainly not always) associated with increases in the savings rate, in China they are typically associated with reductions in the national savings rate. There should be nothing mysterious about these opposite reactions to higher interest rates – both are fully explainable with our current economic tools as long as we are clear about the assumptions, often hidden, that we  make. And notice that I refer to “national” savings rates, not “household” savings rates, which are commonly confused because in the anglo-saxon economies changes in the national savings rates closely follow changes in the household savings rate, whereas in China they do not.

To understand the Chinese economy we must understand how financial repression changes the relationships between variables, many of which we implicitly and incorrectly assume are fixed and permanent. Financial repression, in other words, is not only at the heart of both China’s rapid growth and China’s economic imbalances, but it also explains a number of otherwise puzzling aspects of the Chinese development model. A repressed financial system will seem to operate in a fundamentally different way than a market-based (“anglo-saxon”) financial system, but in fact the principles under which it operates can be explained using what we already know about the operations of monetary policy in a market-based financial system.

One of the apparent puzzles about China’s growth trajectory, especially in the past decade, is the seeming disconnect between rapid monetary growth and relatively stable domestic inflation. It is well known in economic theory that countries that have open capital accounts are forced to choose between managing domestic monetary policy and managing the currency regime.  When a central bank chooses to intervene in the currency to maintain a desired exchange level, the amount of money it creates domestically is largely a function of the need to monetize net inflows or outflows. On the other hand if it chooses to manage the domestic money supply, the supply and demand for that currency in the international markets will determine the value of the currency.

In China’s case the capital account is technically closed, so in principle Beijing should be able to manage both the value of the currency and the amount of domestic liquidity. In reality, however, there are two significant limits to the country’s ability to maintain closed capital accounts. First, and most obviously, the capital account is the obverse of the current account, and any country with the volume of exports and imports that China runs necessarily will see significant activity in the capital account, especially if, as widely believed, Chinese nationals evade capital controls by over- and under-invoicing exports and imports. What is more, although much of the trade-related capital inflow and outflow is controlled by the central bank, an increasing share of capital flows occurs outside the central bank.

Second, China has extensive trading borders, a great deal of local corruption, and a long history both of capital control and capital control evasion.  Throughout history countries with large trading borders, a long history of capital controls, and wide-scale corruption have rarely been able to control capital flows as these factors undermine the ability of financial authorities to manage them, and China is not an exception. In fact during the past decade by most accounts China has experienced significant amounts of both speculative inflows and capital flight, measuring probably in the hundreds of billions of dollars, neither of which is compatible with strict enforcement of capital controls.

For all practical purposes, in other words, and in spite of formal capital flow restrictions, China is also forced to a greater or lesser extent to choose between managing its currency regime and managing domestic money creation. Clearly it has chosen to manage the currency regime, and the enormous changes in central bank reserves, which at over $3 trillion are the largest hoard of central bank reserves ever amassed by a single country, are a testament to that.

Monetary expansion and inflation

Monetary policy from the point of view of the balance of payments is pretty clearly a consequence of the central bank’s need to monetize an enormous amount of net inflows. China’s current account surplus began surging around 2003-04 to levels that are almost unprecedented in history, with the country at its peak running a current account surplus of up to 10 per cent of China’s GDP, giving it, with the surplus equal to just over 1 percent of global GDP, one of the highest current account surpluses as a share of global GDP ever recorded.

The impact of the current account surplus on capital flows tended to reinforce monetary creation in at least two ways. As money poured into the country as a consequence both of its current account surplus and its net surplus on the capital account (among other things China is been the largest recipient of foreign direct investment in the world), it helped ignite a credit-fueled asset boom, especially in the real estate sector, that encouraged additional speculative inflows looking to take advantage of soaring prices.

In addition the massive current account surplus fueled speculation about the trajectory of the renminbi.  As investors expected the value of the renminbi to rise as it adjusted to current account inflows, even more speculative inflows poured into the country seeking to benefit from any appreciation. The result was that until late 2011 substantial net capital inflows, added to the already very high current account surplus, drove up central bank purchases to extraordinary levels. 

As a share of global GDP the only comparable hoard of foreign currency reserves occurred in the United Sates in the late 1920s, a period distorted by the destruction of much of Europe’s manufacturing capacity in World War 1 and by the impact political uncertainty in Europe had in driving capital to the relative safety of the United States. During this time, when the US experienced both massive current account surpluses as well as massive private capital account surpluses that generated its huge central-bank reserve hoard, the US share of global GDP was roughly three to four times the current Chinese share, which gives a sense of just how extraordinary the Chinese accumulation of reserves has been.

With so much money pouring into the country, the People’s Bank of China was forced regularly to monetize an amount equal to a substantial share of its existing money base. Normally central banks would try to sterilize this money creation, and the People’s Bank of China did try to mop it up, but most measures of money nonetheless continued to increase rapidly, and there is anyway a real question about the effectiveness of sterilization with highly liquid and credible instruments that are already a close substitute for money. The tools used to sterilize inflows, mainly short term bills issued by the central bank, are themselves forms of money, and the more extensively they are employed, the more liquid they become and hence the more “money-like.”

The alternative to a real and effective sterilization is for the Chinese economy to adjust in the form of a surge in inflation. As the money supply grows in response to China’s current account surplus and net capital inflows, it should cause prices and wages to surge, forcing a real appreciation in the currency, until both China’s current account surplus and net capital account inflows wither away. 

This is of course the classic currency adjustment mechanism under the gold standard. As reserves soared in China, money creation soared along with it. Rapid money creation should have resulted in a rapid rise in domestic wages and prices as demand for goods and services outstripped supply. Rising domestic prices should have in turn undermined Chinese exports, encouraged imports, and reversed capital inflows.

But this didn’t happen. In fact during the past decade, price inflation in goods and services in China has been fairly moderate, and usually driven exogenously (crop failures, high commodity prices, etc.) and wages actually grew more slowly than productivity. China’s export competitiveness not only was not eroded by domestic money creation, as it would have been under the classical adjustment mechanism, but it also had, by some measures, even increased during this period. There have been periods during which inflation seemed about to take off, but these periods tended to be short-lived and were always followed by sharp declines in inflation. 

At first this might seem to imply that sterilization was indeed effective in preventing money creation in China from getting out of hand. By selling central bank bills, transacting in the repo market, and raising minimum reserve requirements aggressively (to around 20 percent, compared to the 5-10 percent that is more common in developing countries), the central bank seems to have been successful in mopping up the money created by the monetization of current and capital account in flows and so protecting the Chinese economy from the normal consequence of maintaining an undervalued currency.

What happened, however, in fact was very different.  Generally speaking, there have been a number of countries besides China that have managed for long periods to combine tremendous capital and current account inflows, rapid growth in foreign currency reserves, and low inflation – for example Japan in the 1980s.  In nearly every case these countries also had severely repressed financial systems.

What’s more, although it was hard to find in China and other similar countries the normal evidence of rapid money creation in changes in consumer prices, other parts of the economy acted in ways that seemed consistent with rapid money creation. Credit, both inside and outside the formal banking system, grew astonishingly quickly and, as usually occurs under conditions of too-rapid credit growth, credit standards deteriorated. The stock and real estate markets experienced bubble-like behavior. Producer prices rose rapidly. Global commodity prices, spurred largely by soaring Chinese demand, also soared.

Bifurcated Monetary Expansion

So was Chinese monetary expansion excessive or not, or to put it differently, why is it that what seemed by most measures to be an extraordinary surge in money creation did not also result in significant wage and consumer price inflation? The answer, I will argue, has to do with the nature of money growth in financially repressed economies. Because the Chinese financial system is so severely repressed, money growth in China cannot be compared to money growth in a market-based financial system. Monetary growth is effectively bifurcated and affects producers and consumers in very different ways.

What does it mean to say that monetary growth was bifurcated? By this all I mean is that nominal money growth showed up as different rates of money growth for different parts of the economy. More specifically the rate of monetary growth for producers exceeded the rate of monetary growth for consumers, and this becomes clear by measuring the monetary impact on different sectors within the economy of monetary expansion under financial repression.

Countries with significant financial repression can experience periods of rapid monetary expansion with results that do not conform to normal expectations precisely because of this bifurcation in the monetary impact of credit creation.  On the production side of the economy it is easy to see in China over the past decade what looked like the consequence of rapid monetary expansion – rapid growth in credit, rising productive capacity, surging production of manufacturing goods, asset bubbles, etc.

On the demand side of the economy, however, and especially considering household consumption, one gets a very different view – monetary expansion seemed to have been very subdued. Household consumption typically grew much more slowly than GDP and its share of GDP declined steadily.  Consumer price inflation also tended to be low or moderate even in the face of what seemed like rapid monetary expansion.

So had there been too-rapid monetary expansion in China during the past decade or not?  Why do some sectors seem to indicate that there has been, and other sectors that there hasn’t?  The answer depends, it turns out, on which economic sector we examine, and whether that sector was a net borrower or a net lender.  We will see that financial repression can create a bifurcation in monetary expansion when

a)    net savers and net borrowers are two very distinct groups, in this case the former being households and the latter being producers of goods and infrastructure, including manufacturers, governments, real estate developers and infrastructure investors;

b)    the bulk of savings consists of deposits in the banking system and the bulk of corporate financing consists of bank lending or other forms of bank financing.

The experience of China (and other financially repressed economies) suggests out that when interest rates are set artificially low in such a financial system, any given nominal expansion in money supply creates a lower real expansion in money on the consumption side and a higher real expansion in money on the production side. The consequence may be rapid GDP growth, a surge in investment and low inflation for many years, but it also leads to sharply unbalanced growth in which the role of domestic demand as a driver of growth shrinks.

To see why, assume a country in which the “natural” nominal interest rate is 5% for all maturities.  For the sake of simplicity we will assume that deposit and lending rates are the same, and that the marginal reserve requirement is constant, although these assumptions do not affect our final conclusions in any significant way.

Now let us assume that there are immediately two transactions.  First, a saver deposits $100 dollars in the bank for one year at 5 percent and the $100 dollars are immediately lent out to a borrower for one year at 5 percent.  One year from now the borrower will repay $105 and the saver will receive $105.

Second, we assume that another saver deposits $97 for one year at 5% and the money is immediately lent out to a borrower for one year at 5%.  For the sake of simplicity we will round off the pennies and assume that in the second case the borrower repays one year later and the depositor receives one year later $102.

It is clear that the because of the first transaction the money supply has increased by $100, and the depositor will receive and the borrower will repay $105 in one year.  It is also clear that because of the second transaction the money supply has increased by $97, and the depositor will receive and the borrower will repay $102 in one year.

But now let us posit that the central bank decides suddenly and arbitrarily to reduce both the lending and deposit rate to 2%.  This has nothing to do with a change in inflationary expectations or the real demand for money – it is simply driven by other domestic considerations.

Following the decision a third, less fortunate saver decides to deposit $100 for one year at 2% and this $100 is immediately lent to a lucky borrower for one year at 2%.  Which of the first two transactions is closer in its monetary impact to the third transaction?

From the depositor’s point of view the present value of $102 one year from now is only $97 (for simplicity I am rounding off adjustments to the nearest dollar).  Although the nominal amount of his deposit is $100, just like that of the first depositor, the real value of his deposit is really only $97, just like that of the second depositor. If we define money so as to include deposits, did the money supply rise by $97 or $100? 

On a comparable basis it is pretty clear that the third depositor’s position, after interest rates were artificially lowered, is no different than that of the second depositor who deposited $97. Nominally the value of his deposit is the same as that of the first depositor, or $100, but his wealth is the same as that of the second depositor, or $97. Since it is real wealth, and not nominal deposits, that ultimately matters to the depositor, and which will affect his consumption and savings decisions, the third depositor is likely to behave over the long run as if he were in the position of the second depositor.  

Because in this case a $100 deposit results in a $97 increase in the real value of deposits, in other words, it turns out that the nominal growth in money as measured by deposits overstates the real growth. Under financial repression a $100 transfer from the household to the bank in the form of a $100 bank deposit results in a smaller real deposit than under conditions of no financial repression.

Transfers change the monetary impact

If financial repression distorts the balance sheet of the depositor, what does it do to the balance sheet of the borrower?  For the third borrower, who in our example borrowed under conditions of repressed interest rates, the transaction is the mirror opposite of the depositor’s transaction.  The third depositor effectively had $3 “confiscated” from his assets in the form of an arbitrary reduction in the deposit rate. This $3 is transferred automatically to the borrower, so that the third borrower’s liability more closely resembles that of the second bower, even though he receives upfront the same $100 that the first borrower receives. 

The nominal increase in money as measured by loans, in other words, understates the real increase. The third borrower receives both the $100 loan as well as a $3 “gift’ in the form of partial forgiveness of his debt.  His purchasing power has gone up not by $100 but rather by $103, even as the purchasing power of the third depositor has only gone up by $97.

Depositors in a financially repressed system may make the same initial deposits as depositors in a non-financially repressed system, and borrowers in a financially repressed system may receive the same initial disbursements as borrowers in a non-financially repressed system, but their resulting balance sheets are very different.  Wealth is effectively transferred from the depositor to the borrower under financial repression and so the purchasing power of the former is reduced relative to the nominal size of the deposit while the purchasing power of the latter is increased relative to the nominal size of the loan.

This transfer modifies the monetary impact on each of them and the effect is cumulative. Assume in the above example that the money supply consists entirely of $100 nominal of one-year deposits matched with $100 nominal of one-year loans.  If in any given year the money supply (loans and deposits) is increased by $20, or 20%, the impact on deposits and loans is very different. In effect the real value of deposits will have risen that year by only $2 (with $18 effectively transferred to borrowers), whereas the value of loans will have increased by $38. An increase in nominal money of 20% in other words, is associated with a 2% real increase in deposits and a 38% real increase in loans.

This is what it means to say that financial repression creates a bifurcation of monetary growth.  For households, and net depositors more generally, real monetary expansion is in effect much lower than nominal monetary expansion because of the implicit financial repression “tax”, and so consumption growth and consumer-price inflation will seem abnormally low.  For manufacturers, real estate developers, infrastructure investors and other net borrowers, real monetary expansion is in effect much greater than nominal monetary expansion because of an implicit financial repression “subsidy”, and so asset inflation and capacity growth seem abnormally high.

Perhaps one way of thinking about it is to consider how to make a comparable impact in a market system.  Imagine if somehow the US were to enact a law whose result was that every time the Fed expanded the money supply, a one-off tax was imposed on households, the proceeds of which were transferred to corporate borrowers. In that case monetary expansion would be much less likely to cause an increase in demand for consumer products, and so would create much less consumer price inflation, and much more likely to cause a surge in production.

This effective “tax” suggests that in a financially repressed system, it is normal that the impact of nominal monetary expansion will seem much greater in one sector of the economy than in another, with the differencing reflecting the net lending or net borrowing position of that sector. The impact of monetary expansion on the behavior of the saver is much lower than it is in a market-based financial system, all other things being the same. The impact of monetary expansion on the behavior of the borrower is much higher than it is in a market-based financial system, all other things being the same.

Under these conditions it is consequently not surprising that the economy can seem to be operating under conflicting monetary systems.  Consumption behaves as it would in an economy with much lower monetary growth, and production and asset prices behave as they would in an economy with much higher monetary growth.

I will leave it to an ambitious doctoral student to work out the full monetary implications of financial repression and to formalize a model of monetary growth under financial repression, but it is worth noting that there are several other real implications of this bifurcation in monetary policy, all of which seem to apply to the Chinese economy:

a)    Financial repression creates in effect a two-speed economy. There will normally be a growing imbalance between the net saving and net borrowing sides of the economy, and the latter should grow much more quickly than the former. 

b)    By subsidizing the production side of the economy and penalizing the consumption side of the economy, financial repression must always force up the domestic savings rate. This may seem at first counterintuitive because, as I discussed at the beginning of this entry, we normally associated lower interest rates with lower savings, but it is an automatic consequence of the very different wealth effect that changes in interest rates have on market-based financial systems and financially repressed financial systems. Savings, after all, are simply the difference between consumption and production, and any process that forces production to grow more quickly than consumption automatically forces up the savings rate.

Financially repressed systems with artificially low interest rates tend historically to have much higher national savings rates than market systems, and also much higher savings rates than financial systems in which interest rates are abnormally high, but oddly enough the higher savings rates are almost always ascribed to cultural preferences. Rather than explain differential savings rates by cultural factors, it seems far more promising to explain them as consequences of financial repression.

c)    To rebalance the two sides of the economy either policymakers must eliminate, or even reverse, the transfer created by financial repression (i.e. either nominal interest rates must rise or GDP growth must drop) or they must implement another mechanism that directly transfers wealth from net borrowers to net lenders.

d)    The more interest rates are repressed, the harder it is for consumption growth to keep up with production growth because monetary policy driving consumption is effectively much “tighter” than monetary policy driving production.

e)    Consumer price inflation is not the appropriate measure by which to gauge domestic monetary conditions.

f)      Hikes and reductions in interest rates are not expansionary or contractionary in the way we might expect in an open financial system.  A hike in interest rates may act to contract investment, but contrary to conventional wisdom it actually expands consumption because it reduces the wealth transfer from the saver to the borrower.  This allows the saver to increase consumption.

g)    For the same reason consumer price inflation in a financially repressed system can be self-correcting.  If inflation rises, but interest rates do not, the bifurcation of monetary growth will increase because the difference between the “correct” interest rate and the nominal rate increases.  In that case any given nominal monetary expansion is accompanied by an even lower (or negative) real expansion from the point of view of consumers as net savers. By lowering the real cost of credit for borrowers, it can expand production.  Increasing production while reducing consumption, of course, puts downward pressure on prices.

h)    Monetary expansion accelerates investment and asset price inflation.  If inflation rises, but interest rates do not, any given nominal monetary expansion is accompanied by an even greater real expansion for net borrowers.

i)      This may be why in financially repressed economies regulators often resort to formal or informal loan quotas.  Without loan quotas, monetary expansion for borrowers may far exceed the needs of the economy, even as monetary expansion for depositors is too tight.

j)      As long as the rest of the world can accommodate the consequent excess of production over consumption, the bifurcation in monetary policy will not seem to be a problem, but once the world cannot accommodate it, the bifurcation of monetary expansion will create deflationary pressures.

k)    As long as the rapid increase in monetary expansion for borrowers does not result in a misallocation of capital, the bifurcation in monetary policy will not seem to be a problem, but once rapid money expansion leads to increasingly wasted investment, as it eventually always must, the bifurcation of monetary expansion will create asset inflation and an unsustainable increase in debt (as debt rises faster than debt servicing capacity).

l)      Deflation or disinflation partially or wholly resolves the bifurcation by forcing real interest rates towards their “correct” level (because real deposit and lending rates rise in a deflationary environment in there is no change in the nominal interest rate).   Under deflation we would expect to see the gap between consumption growth and GDP growth narrow, or even reverse.

m)  Slower GDP growth partially or wholly resolves the bifurcation by forcing real interest rates towards their “correct” level (in a market system nominal interest rates move naturally in line with nominal GDP growth). Under conditions of much slower GDP growth we would expect to see the gap between consumption growth and GDP growth narrow, or even reverse. This, for example, is what happened in Japan after 1990.

n)    Disintermediation of the banking system, to the extent that it reduces the impact of financial repression, may create an unexpected burst in consumer price inflation. This is less true to the extent that, like in China, disintermediation is limited to the rich, since the consumption impact of higher income on the rich is limited.

Asset price inflation

To summarize, in a financially repressed system in which consumers tend to be net savers and producers net borrowers, consumers and producers experience very different monetary impacts of the same underlying monetary conditions. The latter exist in an environment in which the impact of monetary growth is much faster than do the former.

There are two problems, then, which must arise when a financial repressed system experiences long periods of rapid money growth. First, as growth in production systematically exceeds growth in consumption, absent exponential growth in investment a growing trade surplus is necessary to resolve the growing imbalance.  Once there are constraints on the ability of the trade surplus to continue growing – for example the global financial crisis has caused a collapse in the ability of the rest of the world to absorb China’s rising trade surplus – the only way to prevent a collapse in growth is to increase investment even more.

But if investment is being misallocated this simply exacerbates the second problem.  Rapid monetary expansion, exacerbated by the bifurcation created by financial repression, has a tendency to result in capital misallocation and asset price inflation because it accelerates monetary growth.  If the response by policymakers to a contraction in the world’s ability to absorb rising trade surpluses is to engineer a further increase in investment, we would expect debt to surge, more investment to be wasted, and for the debt consequently to become unsustainable much more quickly.

This seems to be exactly what happened in China during the 2008-09 global crisis.  Before the crisis, debt was already rising at an unsustainable pace thanks to many years of the combination of rapid monetary growth and monetary policy bifurcation.  China’s trade surplus also soared as production was forced to rise much more quickly than consumption.

The crisis caused a collapse in China’s trade surplus.  In order to limit the impact on Chinese growth, Beijing engineered an extraordinary increase in domestic investment.  What is more, Beijing increased both the total amount of loans and deposits outstanding while lowering even further the real interest rate.  The net impact was to increase the financial repression tax on households – a tax which when directly to subsidizing borrowers. 

This certainly resolved the problem of a sharp decline in growth caused by a collapse in the trade surplus, but it did so by exacerbating the investment bubble and accelerating the rate at which the growth in debt exceeded the growth in debt servicing capacity.  It also worsened the consumption imbalance. It is probably not a coincidence that it was only in 2010 that most analysts belatedly recognized the problem of soaring debt in China – probably at the instigation of a report by Victor Shih, then a professor of political economy at Northwestern University and until then one of only a handful of China skeptics, on the surge in local and municipal debt.

As Chinese growth rates stayed high even in the midst of the worst global economy in 70 years – a fact that was a necessary consequence of the combination of increasing financial repression and a surge in monetary growth – there were always likely to be two factors that would undermine growth.  First, if the pace of monetary expansion slowed, and second, if the financial repression tax declined. 

What does it mean to say that the financial repression tax declines?  This doesn’t simply mean that interest rates rise, but rather that interest rates rise relative to GDP growth.  In a market-based system, over long periods of time nominal interest rates are broadly in line with nominal GDP growth rates. This means that savers and borrowers fairly distribute the returns on growth in proportion to the amount of risk they take. Of course if interest rates are artificially low, savers receive a disproportionately lower share and investors a disproportionately higher share of the benefits of growth.

The greater the difference between nominal lending rates and the nominal GDP growth rate the greater the financial repression tax. In China during the first decade of this century nominal GDP growth rates have been 16-20%, depending on which period you measure and what assumptions you make about GDP growth, while nominal interest rates have been roughly 6-7%.  This gives some idea of the extent of the financial repression tax, although even this understates its extent because the spread between the lending rate and the deposit rate is set artificially high, thus lowering even more the returns to depositors (an additional tax is effectively levied on depositors to recapitalize the banks).

The important point is that beginning sometime in late 2011, both conditions were in place.  As debt continued to rise in China and as slowing growth eroded China’s trade surplus, there is evidence that beginning in 2010 capital flight from China began to surge, while beginning some time in the fourth quarter of 2011 speculative inflows into the renminbi began drying up. The combination turned China’s position from running net capital inflows to running net capital outflows (excluding changes in central bank reserves, which by definition balance out total flows to zero).

As a result, in late 2011 and 2012 we witnessed for the first time China’s reserves rise by less than the already-much-lower current account surplus. By the middle of the year, net capital outflows actually exceeded the current account surplus (reserves, in other words, declined in spite of a current account surplus).

As Chinese money creation slowed, exacerbated by monetary bifurcation, Chinese growth slowed along with it.  This had the impact of reducing the financial repression tax (the difference between nominal GDP growth and nominal interest rates narrowed).  The consequence was predictable.  GDP growth slowed far more quickly in 2012 than even the pessimists had expected.

This is part of the self-reinforcing tendencies that financial repression creates for an economy. Rapid growth increases the financial repression tax, which tends to create even more rapid growth by reducing the real cost of capital. Slowing growth reduces the financial repression tax, which slows growth even further. These self-reinforcing tendencies imbedded in the national capital structure are typical of developing countries and one of their great sources of economic volatility – one that tends to undermine long-term growth.

This is an abbreviated version of a chapter of my recent book (Avoiding the Fall) which itself came out of one of my newsletter several years ago.  Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at, stating your affiliation, please.  Investors who want to buy a subscription should write to me, also at that address.


Obamacare Showdown: Missouri Bill to Gut Obamacare, Ban Penalties, Ban Healthcare Exchange; How Would Obama Respond?

Courtesy of Mish.

If enough states act, we are on the way to a constitutional showdown over Obamacare. The Washington Times reports Missouri bill would gut Obamacare

Next month, the Missouri Senate will consider a bill which would effectively cripple the implementation of the Affordable Care Act within the state.

Following the lead of South Carolina, where lawmakers are fast-tracking House Bill 3101 in 2014, and Georgia, where HB707 was recently introduced by Rep. Jason Spencer, Missouri State Senator John T. Lamping (R-24) pre-filed Senate Bill 546 (SB546) to update the Health Care Freedom Act passed by Missouri voters in 2010. It passed that year with more than 70% support.

SB546 would ban Missouri from taking any action that would “compel, directly or indirectly, any person, employer, or health care provider to participate in any health care system.” That means the state would be banned by law from operating a health care exchange for the federal government.

The bill also proposes suspending the licenses of insurers who accept federal subsidies which result in the “imposition of penalties contrary to the public policy” set forth in the legislation. Since it is unlikely that any insurer would then accept a subsidy, not a single employer in the state could be hit with the employer-mandate penalties those subsidies trigger.

Following significant portions of the Tenth Amendment Center’s four-step plan to nullify Obamacare on a state-level, Fox News Senior Judicial Analyst Judge Andrew Napolitano noted that such actions were not just legal, but effective.

“If enough states do this, it will gut Obamacare because the federal government doesn’t have the resources … to go into each of the states if they start refusing,” he said.

Tenth Amendment Center national communications director Mike Maharrey suggested that a large-scale effort against the Act would be coming. “Our sources tell us to expect at least ten states moving in this direction in the coming months. But that will only come true if people start calling their state representatives and senators right now. State lawmakers need to know they should introduce bills to ban the state from participating in any Obamacare programs.”

Nullify Obamacare

Inquiring minds are investigating the Nullify Obamacare website for further information.


States have always held the prerogative of whether or not they will enforce or participate in federal acts or regulatory programs.  This legislative package seeks to ban the state from enforcing or assisting in the enforcement of the federal Patient Protection and Affordable Care Act of 2010.  It also seeks to ban the State, along with all its political subdivisions, from operating or participating in the operation of a health care exchange under the federal act.  It also provides for penalties for violations of the act.


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Fear the Octopus: Judge Says NSA Phone Surveillance Is Legal; Case Likely Headed to Supreme Court

Courtesy of Mish.

December 16 Ruling vs. Ruling Today

On December 16, in a rare victory for constitutional freedoms, U.S. District Court Judge Richard Leon, ruled NSA phone program likely unconstitutional. (See District Court Judge Rules NSA Phone Taps Likely Unconstitutional; 68 Page Ruling Cites “Orwellian Technology” and Unreasonable Searches).

In contrast, a Manhattan District judge ruled today NSA Phone Surveillance Is Legal

U.S. District Judge WIlliam H. Pauley III in Manhattan sided with the government in his decision Friday, calling the collection program a “vital tool” to combat terrorism and deeming it “the Government’s counter-punch.”

The ruling stands in conflict with a decision issued earlier this month in a separate case by a federal judge in the District of Columbia who said the program “almost certainly” violated the Constitution.

The New York case was brought in June by the American Civil Liberties Union, which claimed that the NSA was violating the group’s constitutional rights by collecting metadata from the ACLU’s phone calls. It was among the first big legal challenges against the NSA program after it was disclosed in June.

The group sought a court order declaring that the mass call logging violated federal law governing foreign intelligence surveillance as well as constitutional free speech and search-and-seizure protections.

Judge Pauley disagreed. “The right to be free from searches and seizures is fundamental, but not absolute,” he wrote.

Case Likely Headed for Supreme Court

The Guardian comments on today’s NSA Phone Ruling.

A legal battle over the scope of US government surveillance took a turn in favour of the National Security Agency on Friday with a court opinion declaring that bulk collection of telephone data does not violate the constitution.

Friday’s ruling makes it more likely that the issue will be settled by the US supreme court, although it may be overtaken by the decision of Barack Obama on whether to accept the recommendations of a White House review panel to ban the NSA from directly collecting such data.

But the ruling from Judge William Pauley, a Clinton appointee to the Southern District of New York, will provide important ammunition for those within the intelligence community urging Obama to maintain the programme.

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Madrid Bans Vacation Home Rentals to “Protect Tourists” and “End Unfair Competition”

Courtesy of Mish.

In the name of “Protecting Tourists” Madrid Prohibits Vacation Rental Homes. Via Mish-modified translation from El Economista

Proposed rules would effectively prohibit homeowners from renting their homes. Rental licenses will be only given to properties for primary uses (hotels, offices, etc.), not to individuals for temporary use.

The Community of Madrid seeks “to establish minimum requirements designed to “protect the rights of tourists” and to “end unfair competition.”

News follows rent laws published in June in which prime minister Mariano Rajoy allowed each of the 17 regions to legislate rentals on their own.

If approved, individuals will find it almost impossible to temporarily rent their home through internet sales as it will be very difficult to obtain a license to conduct such activity. According to the Hoteliers Association of Madrid (AEHM), there are currently about 8,000 community accommodations.

Clearly, the proposal seeks to eliminate competition to the unfair advantage of hotels. If hotels cannot compete against homeowners, they are charging too much for what they offer.

Mike “Mish” Shedlock

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European Monetary Union Misnamed; I Propose GEU (German Economic Union) or USG (United States of Germany)

Courtesy of Mish.

The irony and hypocrisy in chancellor Angela Merkel’s first parliamentary speech of her third term would be astounding were it not par for the “Everything for Germany” course of action.

Please consider Chancellor Urges Reforms to Preserve Euro

In her first parliamentary speech since her re-election for a third term on Tuesday, she warned that Europe needed to take further action to make the euro zone crisis-proof.

More European Control

“I know that pushing through treaty changes in the member states can be difficult, but if you want more Europe, you have to be prepared to develop it further,” Merkel said. “In a world that is constantly changing, we can’t stand there and say that at some point we agreed the Lisbon Treaty and there’s no need to change it again. This won’t work.”

Germany wants closer economic policy coordination and will push at a summit of European Union leaders on Thursday and Friday for members to agree binding contracts with the European Commission to implement further reforms.

It is also pushing for changes to the Lisbon Treaty to give greater European control over policy. Germany’s closest ally in Europe, France, opposes such a move, as do other member states.

“European unity remains one of the most important tasks of the grand coalition,” said Merkel. “Germany is only strong if Europe is strong.”

Criticism of EU Green Energy Probe

She said she would fight an EU probe announced on Wednesday into exemptions from a green energy surcharge for some 2,000 German companies. The European Commission is examining whether the exemptions, totalling some €5 billion and granted to heavy energy users like the steel industry, were unfair and should be repaid.

The German government would not tolerate a weakening of German industry or job losses, she said. “Germany wants to remain a strong industrial location, we need competitive companies,” she said. “This is about companies and when it’s about companies, it’s about jobs.”

She said Germany’s new Economy and Energy Minister, Social Democrat Sigmar Gabriel, would make this very clear to the European Commission.

Merkel the Hypocrite

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Some Themes To Watch In 2014

Courtesy of Charles Hugh-Smith of OfTwoMinds blog,

Propaganda, phony fixes and more debt can only cover the widening gap between fiscal reality and official fantasy for so long.

So what else besides the potential for another global financial meltdown bears watching in 2014? Here are a few worthy prospects. Continuing our end-of-the-year tradition of exploring themes that have disruptive potential in the coming year, Gordon Long and I discuss a half-dozen such topics in 2014 Themes: CHS with Gordon T. Long (28 minutes).

My short list is centered not on one-time crises or potential black swans but on long-festering systemic problems that cannot be fixed within the current status quo, and thus they are destined to continue eroding systemic resilience. Kicking the can down the road and phony accounting "solutions" fix nothing, and so these systemic problems will eventually explode into crises that cannot be tamped down with the usual fiscal and monetary tricks.

Student loans and the impossible-to-solve conflict between skyrocketing local government pension and healthcare costs and delivering services to taxpayers/residents are both prime examples. Something's got to give in both of these bubbling pressure cookers, and propaganda, phony fixes and more debt can only cover the widening gap between fiscal reality and official fantasy for so long.

Five years of phony fixes have gotten us to 2013; I doubt the same illusions and tricks will get the global economy through 2014-2015 unscathed.

Twitter Now Has A Larger Market Capitalization Than 80% Of All S&P 500 Companies

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

As everyone is well aware by now, Twitter investors and speculators have been on a sharp, sudden and very relentless buying spree, sending the company nearly 50% higher since the first week of December, and nearly doubling it since late November.

Why the stock has exploded the way it has, nobody knows, and frankly nobody cares: it has entered that mythical zone of raging momentum where things work, until they don't for whatever reason. But in order to present readers with a sense of where TWTR's $40 billion market cap, which is greater than 403, or 80%, of all S&P 500 companies, puts in in the context of several companies all of which have a market cap that is lower than Twitter's, we have shown on the chart below Twitter's 2014 projected Revenue compared to this same universe of immediately smaller S&P500 companies. Again, just for the sake of perspective.

Certainly, we have no doubt that Twitter's growth curve, based on the realistic assumption of infinite and growing advertising budgets, will promptly eclipse not only the revenues but certainly the earnings and cash flows of all the below-listed companies, and why not all other companies, both in the US and the world, too. Surely, more idiotic things have happened under Bernanke's centrally planned regime.

China Cash Crunch Eases, For How Long? Three Things China Needs to Avoid; When can Beijing Truly move to Market-Determined Interest Rates?

Courtesy of Mish.

As noted on December 23, China Interest Rate Crisis Continues: China Bans Words “Cash Crunch”, the 7-Day Interest Rate Doubled to 10%. The doubling of rates took about a week.

Then, on December 24, China injected 29 billion RMB (Yuan), about $4.8 billion.

For the size of China’s RMB 130 trillion economy (about $2.14 trillion), that $4.8 billion is a trivial amount. Nonetheless, the 7-day repo rate crashed back down to about 5.33%.

Mission accomplished?

It’s a lot more complicated than “mission accomplished” as the following discussion shows.

China’s Move to Market-Set Rates

Let’s step back to December 8 and look at China Relaxes Grip on Interest Rates

China is relaxing its grip on interest rates with the launch of a financial instrument that allows banks to trade deposits with each other at market-determined prices.

The certificates of deposits will push banks closer to an operating environment in which rates are deregulated and are also aimed at improving the circulation of cash in the country’s interbank market.

Beijing used to fix deposit and lending rates, limiting competition between banks and in effect transferring cash from savers to borrowers because of the artificially low rates. But over the past two years, the government has rolled back its controls, lifting all restrictions on lending rates and giving banks more freedom to determine deposit rates.

Under the changes – which come into effect on Monday – individual CDs will have to be at least Rmb50m ($8.2m) in size and issuers will have to inform the central bank in advance how much they plan to issue in a year. Banks, fund managers and other institutions in the interbank market will be able to trade the CDs, but non-financial companies and retail investors will be barred.

The liberalisation is seen as a necessary part of China’s efforts to reduce its reliance on investment and boost consumption as well as to integrate itself more fully in the global financial system with lighter capital controls.

China’s Central Bank Discusses Deposit Insurance

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VA Refuses Christmas Cards from 51 School Kids Intended for Disabled Veterans

Courtesy of Mish.

A group of 51 school children in Texas spent the week before Christmas making Christmas cards for veterans. According to the VA, the kids made a mistake by saying “Merry Christmas”.

Fox News reports VA hospital refuses to accept ‘Merry Christmas’ cards.

Boys and girls at Grace Academy in Prosper, Tex., spent most of last Friday making homemade Christmas cards for bedridden veterans at the VA hospital in Dallas.

Fourth-grader Gracie Brown was especially proud of her card, hoping it would “make their day because their family might live far away, and they might not have somebody to celebrate Christmas with.”

Gracie’s card read, “Merry Christmas. Thank you for your service.” It also included an American flag.

But the bedridden veterans at the VA hospital will never get to see Gracie’s card. Nor will they see the cards made by 51 other students. That’s because the Christmas cards violated VA policy.

Hiram Sasser, director of litigation for Liberty Institute said “Targeting the benevolent work of little children for censorship is disgusting. Do the Grinches in the administration of the VA really believe our bravest warriors need protection from the heartfelt well wishes of small children saying Merry Christmas?”

The cards will not be thrown away — they are being shipped to Brook Army Medical Center in San Antonio and to a private facility for veterans in Louisiana.

Offending Cards

The VA is protecting our soldiers from receiving “offensive” such as the following.

Also consider this image fom Breitbart Veterans Affairs Bans Christmas Cards to Troops over Religious Content.

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What Could Go Wrong Here?

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

We wondered previously what happens when there are no more greater fools to sell to? But, US investors have turned the euphoria dial to 11 this week as the percent bullish is the highest since the peak in Fall 2007 and bears are at their lowest percentage since Spring 1987. Thus, the Bull-bear spread (based on AAII's survey) has never been wider (and don't forget, even Cliff Asness knows the unbridled idiocy of the 'money-on-the-sidelines'-meme).

And remember, we don't need to worry about record high margin debt as along as stocks keep going up…

As – over the long-term – the bull-bear spread has never been wider (by a long way)…

h/t @Not_Jim_Cramer

Pettis on Debt, Malinvestments, Hidden Losses, and China’s GDP

Courtesy of Mish.

Heading into 2014, Michael Pettis at China Financial Markets remains adamant that growth estimates for China are too high and that rebalancing (while necessary), implies lower growth than most expect. Via email …

It is widely acknowledged that perhaps the most important reason to change the Chinese growth model is its excessive reliance on debt to generate growth. Debt has soared in recent years, to the point where many economists simply look at credit growth in the current quarter in order to determine what GDP growth over the next few quarters are likely to be.

But as China deleverages, growth in demand must drop sharply. After all, if economic growth over the past several years has been goosed by rapid credit expansion, deleveraging must have the opposite effect. It is strange that economists who acknowledge that the current growth model is overly dependent on debt have failed to understand that its reversal will have the opposite impact. If it did not, it is hard to explain why anyone would consider debt to be a problem in the first place.

If China currently has wasted significant amounts of investment spending, it is clear that much of the accompanying bad debt has not been written down correctly. Bad loans are almost non-existent in the banking system – that is they have not been recognized in the form of reserves or write-downs.

But the failure to recognize the loss does not mean that the loss does not exist. The losses implicit in the bad loans must (and will) be written down over the future, either explicitly, in which case they will result in a direct deduction to GDP growth, or implicitly, in which case they will require implicit and hidden transfers from one part of the economy or another (usually the household sector) to cover the gap between the “real” cost of capital and the nominal (subsidized) cost of capital. This transfer must reduce future growth.

The point here is that if credit is a problem in China – something no one doubts – it must be a problem because of wasted investment that has yet to be recognized, otherwise it would have resulted in negative GDP growth today. Failure to recognize the investment losses will, of course, artificially boost GDP growth today, but it must also artificially reduce GDP growth tomorrow as the recognition of those losses is simply postponed, not eliminated. The failure of many economists to recognize that wasted investment has a cost – even as they recognize that investment has been wasted – has caused them both to misunderstand the relationship between wealth creation and GDP and to understate the future impact of this overstated GDP.

Debt matters, and the only time it can be safely ignored is when debt levels are so low, and the borrower is so credible, that it creates no financial distress costs and has a negligible impact on demand. Neither condition applies in China, and so any prediction that ignores debt is likely to be hopelessly muddled. In fact I would like to propose a simple rule. Any model that predicts China’s future GDP growth must include, if it is to be valid, a variable that reflects estimates of the amount of hidden losses buried in the banks’ balance sheets. If it does not, it cannot possibly be a valid model to describe China’s economy, and its predictions are useless.

China’s astonishing growth during the past three decades is partly the result of a system that subsidized growth with hidden transfers from the household sector. These transfers are at the root of the current imbalances, and once reversed, so that China can rebalance its economy towards healthier and more sustainable sources of demand, the very processes that turbocharged growth will no longer do so.

If growth has been healthy and sustainable, there would be no need for Beijing to change its growth model – in fact it would be foolish to do so. If growth has not been healthy and sustainable, this is almost certainly because it has been artificially propped up, and if the reforms are aimed at unwinding the mechanisms that artificially propped up growth, then subsequent growth rates must be substantially lower.

Low interest rates, low wages, an undervalued currency, nearly unlimited access to credit for state-owned enterprises, a relaxed attitude to environmental degradation, and other related conditions were both the source of China’s ferocious growth as well as of China’s unprecedented economic imbalances. Reversing these conditions will rebalance the economy, but will do so while lowering growth in the obverse way that these conditions had accelerated growth.

One of the most obvious places in which to see this is in excess capacity in a wide range of businesses. It is clear that Beijing recognizes the problem of excess capacity. Here is Xinhua on the subject: Tackling excess capacity will be one of the top tasks on China’s economic agenda in 2014, as the issue becomes a major challenge to maintaining the pace and quality of economic growth. “The Chinese economy still faces downward pressure next year,” the Central Economic Work Conference pointed out on Friday, citing the capacity issue weighing down some sectors as one of the major challenges facing the world’s second-largest economy.

It should be obvious that building excess manufacturing capacity, like building up inventory, is a way of propping up growth numbers today at the expense of tomorrow’s growth numbers. Closing down excess manufacturing capacity must be negative for growth in the same way that building it was positive….

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The unintended consequences of Abenomics

The unintended consequences of Abenomics

Courtesy of Sober Look

As discussed earlier (see post), Japan continues to struggle in its endeavor to generate demand-driven inflation. To a large extent price increases have been the result of costlier imports due to a weaker yen, particularly items related to food and energy. Outside of those sectors, prices remain soft.

The danger of Japan's current policy (Abenomics) is that the outcome could turn out to be the exact opposite of what was originally intended. With wages stagnant, these import-driven price increases are hitting the Japanese consumer quite hard. As a result, spending on domestically produced goods and services could end up falling, constraining domestic prices instead of increasing them.

Scotiabank: – Key here is that the Japanese CPI inflation figures continue to showcase evidence of a relative price shock driven by imported food and energy price spikes significantly related to yen depreciation. Most CPI components not related to food and energy either continue to fall or remain soft as shown in the accompanying chart. The big gainers are prices for fresh food, utilities due to soaring electricity prices in the wake of the T?hoku disaster coupled with rising imported energy costs, and the energy impact on rising transportation prices. CPI ex-food-and-energy remains largely flat. We maintain the year-long view that Abenomics would impose a relative price shock that would force wage- and credit-constrained consumers to spend more upon what they have to (food and energy) by restraining spending elsewhere in the economy in disinflationary fashion on the second- and third-round effects. That’s a very different inflation dynamic than would be the effects of a generalized increase in economy-wide prices in that it counsels future effects that will be bearish for the outlook for Japanese consumers. At the same time, the other main supposed benefit of Abenomics is an improvement in the trade account by stimulating export growth through yen depreciation, yet this is only evident via a price effect as export volumes remain weak [see post]. 

One sad consequence of Abenomics is the impact on Japan's elderly, whose ranks are swelling rapidly (see post). Isolation combined with rising prices on food and electricity makes survival for many older Japanese citizens a struggle. According to the National Police Agency survey, shoplifting incidents accounted for close to 10 percent of all crimes. And the number of shoplifting offenses is only growing among people 65 and older – with 68 percent of those cases representing food items. The latest 18.6 trillion yen stimulus package from the government is supposed to (among other things) provide additional help for the elderly, but it remains unclear how sustainable such efforts will ultimately be.

Darlene Love – Christmas Wish

Courtesy of Mish.

Darlene Love has been appearing on the David Letterman Show every Christmas week since 1986, always singing the same song, ‘Christmas (Baby Please Come Home)’. I watched most of them. I caught the 2013 version this year as well.

She is one of my favorite “girl group” singers from the 60’s

1986 Rendition 

The productions now are quite spectacular vs. 1986. Here is the 1986 rendition.

Broadway World has many interesting details.

The legendary Darlene Love, who’s become a Late Show with David Letterman holiday staple, returned to the hit show this week for her annual performance of “Christmas (Baby Please Come Home)” with Paul Shaffer. Love, who’s appeared in Broadway’s HAIRSPRAY and GREASE, first took to Letterman’s stage in 1986.

From her first number one recording, “He’s A Rebel,” through her string of label hits with legendary producer Phil Spector, including “Da Doo Ron Ron,” “He’s Sure The Boy I’m Gonna Marry,” and “Christmas Baby Please Come Home” to the countless songs she sang backup on for artists like Sam Cooke, Elvis Presley, Dionne Warwick, Cher,Luther Vandross and Aretha Franklin, Darlene Love is still blazing a trail of success in the music industry and has been nominated to the Rock and Roll Hall of Fame. Her albums include Age of Miracles, recorded live in New York City, her first gospel album; Unconditional Love released by Harmony records.

Over the course of her career Darlene has been hailed as one of the greatest singers in pop music by such music legends as Cher, Better Midler and the legendary Luther Vandross. She has proven herself a talented actress as well on stage and screen, starring as Danny Glover’s wife in all of the Lethal Weapon films and lighting-up Broadway in such musicals as Grease and the Tony Award-nominated Leader of the Pack. Darlene also starred for three years on Broadway as Motormouth Maybelle in the Tony Award-winning musical Hairspray.

Wikipedia notes

Darlene Love (Wright; born July 26, 1941) is an American popular music singer and actress. She gained prominence in the 1960s for the song “He’s a Rebel,” a No. 1 American single in 1962, and was one of the Phil Spector artists who produced a celebrated Christmas album in 1963.

She appears in the documentary film 20 Feet From Stardom (2013), which premiered at the Sundance Film Festival.

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Merry Christmas from Snowden

Courtesy of Dangerous Minds. Via Paul Gallagher.

Whistleblower Edward Snowden has given an “Alternative Christmas Message” on Britain’s Channel 4 television.

Snowden, who revealed the mass surveillance programs operated by US and other governments, spoke about the dangers of such operations, “A child born today will grow up with no conception of privacy at all. They’ll never know what it means to have a private moment to themselves—an unrecorded, un-analyzed thought.” 

The full transcript runs as follows:

Alternative Christmas Message 2013

Hi, and Merry Christmas. I’m honored to have the chance to speak with you and your family this year.

Recently, we learned that our governments, working in concert, have created a system of worldwide mass surveillance, watching everything we do.

Great Britain’s George Orwell warned us of the danger of this kind of information. The types of collection in the book—microphones and video cameras, TVs that watch us—are nothing compared to what we have available today. We have sensors in our pockets that track us everywhere we go.

Think about what this means for the privacy of the average person. A child born today will grow up with no conception of privacy at all. They’ll never know what it means to have a private moment to themselves—an unrecorded, unanalyzed thought. And that’s a problem, because privacy matters. Privacy is what allows us to determine who we are and who we want to be.

The conversation occurring today will determine the amount of trust we can place both in the technology that surrounds us and the government that regulates it. Together, we can find a better balance. End mass surveillance. And remind the government that if it really wants to know how we feel, asking is always cheaper than spying.

For everyone out there listening, thank you, and Merry Christmas.


H/T Channel 4 and Slash Gear

Relaxing Oil Export Ban is Bad News for US Consumers

Relaxing Oil Export Ban is Bad News for US Consumers

By EconMatters  

US Energy Boom
The US is producing much more energy domestically the last decade in all forms from natural gas to crude oil with a myriad of boutique products along the way, and so it is natural for producers to want to maximize profits by expanding their marketplace.

Free Markets haven`t been Free for a long time

This would be the free market response, and that would be a great principle in theory, but nothing has been ‘free market’ in this country, and the world we live in for decades; that nostalgic business ideology has been replaced with corporate cronyism, powerful lobbying, state sponsored agendas, and closed door deal-making. 
Petroleum Products versus Natural Gas
We have seen the inevitable outcome of any lifting of this ban by looking at the products markets, namely gasoline. There is an abundance of cheap domestic oil (would be a lot cheaper without excessive QE Stimulus & Artificial Demand created by refinery Exports of Products) but still domestic oil production, and oil production in North America is at multi-decade highs, and yet gasoline prices are at record highs for this time of the year, and this is after coming down considerably from earlier highs in 2013.
An Abundance of Natural Gas & Oil Subsidizing Gulf Coast Refiners
Why is this the case? It is because the highly profitable export market for end products like gasoline where refiners along the gulf coast have expanded capacity to take advantage of cheaper North American oil, and low natural gas prices that enabled lower petro manufacturing costs. 
These cheaper input costs made US fuel and other derivative petroleum products very competitive on a global price basis which had the effect of higher prices for US consumers as supply markets were much tighter than they would have otherwise been without a robust export market during the last five years of this US Energy resurgence. 
Lower Prices Good for US Economy
Natural Gas is the energy market that has helped domestic businesses and consumers with lower prices which has benefited the overall US economy, while the domestic oil market which should be helping US consumers and businesses more, is being pegged higher due to the exporting of products. This gets even worse for US Consumers and businesses if the Oil Export Ban is relaxed. 
Somebody Wins, Somebody Loses
In effect, this results in the following scenario: US Consumers & Businesses pay higher prices, US Domestic Oil becomes more expensive due to widening the marketplace for exports, and Global Oil becomes cheaper for international consumers. This process just becomes a giant wealth transfer, another tax, a business subsidy from the US Consumer & Businesses that utilize domestic energy to foreigners and companies exporting said products to these international consumers.
Let`s just be consistent: Lift all Exporting Bans
While the government is at it let us just lift any Natural Gas bans on exporting, and just raise costs all along the energy input continuum for 2014. I am sure Dow Chemical will love this outcome and open up more manufacturing capacity here in the United States. Profits will be great for those who benefit from the aforementioned changes to energy export bans. But those business interests who rely on energy input for operations will be hurt from this legislative change, and so will US Consumers. 
I am sure these same gulf coast petro-refiners will have no problem with also lifting the export bans on any natural gas products so that their manufacturing and operational costs will rise along with higher natural gas prices which will eat into their operating margins and thus transfer this wealth to the natural gas industry players.
Market Correlations & Paradigm Shifts 
One can see the positive correlations in the charts between the increased production of domestic natural gas, thus leading to much lower input prices for refiners; and the takeoff in petroleum products exports from a pretty stable baseline previously , starting to gain steam around the 2005 to 2006 timeframe.  
This export dynamic for petroleum products along with high oil prices relative to the economy due to QE Stimulus liquidity and potential Middle-East instability inflated commodities and oil specifically thus further incentivizing US Domestic Oil Production along with new and cheaper technological drilling techniques in the energy industry activating the rebound around 2010 for the increased Domestic Oil part of the equation. 
This led to the Gulf Coast refiners expanding capacity and seeking cheaper transportation methods of this increased North American and Domestic Oil via pipelines, rail, and barges. The US domestic Oil production was the definite laggard in this US energy boom renaissance.
It will be interesting to see how this all plays out from a market standpoint, i.e., will US Domestic Oil production continue to trend higher without a robust export market like Natural Gas or will the recent trend reverse itself with production shutdowns in domestic Oil production projects? 
Another interesting dynamic to watch is what price is needed for the marginal cost of production for these domestic oil producers? Some refiners close to the fields are currently paying $25 below the WTI price for Oil – this is telling in how inefficient and costly our oil transportation system currently is, and that the actual market price needed for oil projects is much lower than the rhetoric thrown around in the media.  
When you factor in alternative opportunities for capital use, the oil industry has been quite attractive for investment over the last decade at these prices; that ought to tell you something given the contraction in most other industries. 
Consequently what happens when the Oil production market gets too frothy relative to demand, and what happens if there is a major pullback in oil prices which has been built into many market intelligence scenarios at the big oil companies? 
Moreover, would cheaper oil prices be all bad as this could lead to an improved economy both domestically and globally causing demand for consumption to rise thus soaking up some of these increased production gains of the last three years. 
The energy markets will be fascinating to watch over the next ten years as the big players fight for production share and lucrative revenue streams on a global scale from Iran and Venezuela to the United States and Canada.
Self-Interests Problem & Power
If this comes down to a self-interest problem which it usually does then one would think that the vote would fall along the lines of a 2-1 constituency vote against lifting the export ban on these domestic energy resources, but US Consumers haven`t had a vote at the table for a long time.
It probably will come down to which corporate lobby is stronger, and has more sway with the politicians in the decision making process. If past history is any indication, consumers usually get taxed with higher prices in the end, so the exports ban probably has a bunch of complicated and opaque loopholes added that provide enough cover for the politicians, and increased profits for the oil exporters.
But the lobbyists better get going and influence the politicians on this issue ASAP because once the next presidential election comes around higher gas prices seem to matter a whole bunch to these same politicians – see Barack Obama during the last election cycle.

Merry Christmas, Happy Holidays

Courtesy of Mish.

Merry Christmas and Happy Holidays to you and your loved ones. Mish

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Herbalife: The Greater Fools Theory

Courtesy of EconMatters

Short Squeezes – Easier Said, Than Done

On December 5 Herbalife Ltd. (HLF) got as high as $76.43 and some investors might be thinking that they could get in on a short squeeze of Bill Ackman and Pershing Square Capital Management`s public and noteworthy short position on the company.

Well since then the stock has dropped to $68.36 in 6 trading days and longs shouldn`t look for any help in front of the all-important FOMC Meeting and Tapering decision on Wednesday of this upcoming week in the markets. The mood has been Risk-Off with investors taking considerable profits in many stocks the last 5 trading days.

Retail Investors shouldn`t Invest on Short-Squeeze Thesis

This just goes to show that even when the big players of the investing world are seemingly teaming up to cause Bill Ackman to cover his position and reap the benefits of a massive short squeeze, this should never influence an investor`s decision to invest in companies. An investor should first and foremost pick strong companies which are well run and have products in the marketplace that have a definitive strategic or competitive advantage.

Herbalife isn’t exactly GE Quality

I have done enough research on Herbalife to say definitively that this is not GE that you are investing in when it comes to a real genuine quality company. Herbalife is like the infomercial of stocks that comes on late at night to sell consumers products with all kinds of gimmicks and marketing sleight of hand.

Beware of Buying Credibility

Whenever a company spends so much money trying to make themselves seem credible it is because they aren`t in the first place. BMW doesn`t need to buy credibility, the quality of their products speak for themselves, and have for decades. GE doesn`t have to pay credible people to associate themselves with their products so as to gain credibility in the marketplace.

Just read the weekly press releases by Herbalife they are usually about trying to buy credibility. You see this with a lot of companies that are listed on the Pink Sheets, and many of these companies are borderline scam companies, or another way to put it would be un-investable.

Semantical Debate Meaningless

Whether one wants to label Herbalife a Ponzi scheme, a multilevel marketing firm, or some other derivation this is purely a semantical question an unimportant for investing purposes; the big picture is that this company doesn`t make for a good long-term investment because it doesn`t have a legitimate business model.


Herbalife`s Revenue Stream: Products versus Recruitment

I work out and like many people these days I buy fitness and health supplement products, but I and most people in the world do not buy overpriced commodity products from a multi-level marketer. 

This is the age of the internet and many wholesale suppliers offer all the branded products that the consumer could possibly want in the health and fitness supplement industry online at much cheaper prices than the retail market.

Less price savvy consumers may buy some health products at their local gym or GNC outlet. Shoot Walmart even sells nutritional supplements these days and usually at very competitive retail prices. However, it is abundantly clear to all but the uninitiated that there is not a booming market for buying overpriced nutritional supplements from a multilevel marketing organization.

Greater Fools Theory

Consequently Herbalife isn`t making a fortune off of selling their products, they are making money off of predatory recruitment of greater fools, plain and simple Herbalife is a “Recruiting Company.” It is unfortunate that there happens to be an abundance of greater fools in the world to support this type of business model.

However, this is not an unusual phenomenon in the world, and it usually ends very badly when governments have to step in to protect the citizens from themselves. Alternatively, the marketing scheme ends when the economics crash on themselves because people will only participate in a scheme if there are legitimate financial incentives for the bulk of the recruitments, and/or the market runs out of foolish people to recruit.

Pink Sheets Methodology & Business Model

The business model that exemplifies Herbalife where they need so fanatically to purchase credibility with large sums of money is one of recruiting. The greater fool theory of recruitment where a few people at the top who managed to get many levels of recruited fools to buy into the scheme below them make some decent money off the backs of all the recruited fools under them, and each level down in the scheme represents larger proportions of members who make virtually nothing at all.

Call it what you want but it is a very unsavory business model. It is highly predatory and probably should not be allowed to be listed on a major exchange. This is the type of company that investors need to be wary of on the Pink Sheets that releases all these monthly and weekly press releases trying to make them seem legitimate because they have no credibility that stands on its own, so they need to affiliate with credible and respected people to attract investors.

It is a whole different aspect as well, but shame on the credible people for selling out their integrity for a quick buck, but that`s where the size of the payments comes in, and Herbalife has spent quite a large sum of money to try and buy some marketplace credibility. Accordingly at high enough remuneration levels the temptation becomes too great for those who need the money – so they sell out the one quality that the multilevel marketing company needs to sell new recruits on this unique business opportunity – Market Credibility.

If you Don`t Know Anybody Who Buys Herbalife Products, then avoid Investing in Company

So needless to say Herbalife doesn`t offer any products that cannot be acquired through much cheaper means by consumers. They don`t offer any unique product offerings, they don`t own a whole bunch of patents, they don`t have one single revolutionary product. So you shouldn`t be investing in this company on its own merits.

Investing Options for Retail Strategy

Consequently is there any way to play this stock for the investor. The short answer is no, and here are the reasons why.  The stock could by all accounts be a worthy short candidate, but with the big players who have publicly lined up against Bill Ackman, and once this has become an ego driven trade for some of these players, this for all practical purposes eliminates an investor taking a reasonable short position. Further exacerbated by the fact that if a short squeeze ever occurred, the stock could gap up so high that no effective stop loss could protect the investor.

Options Market: Hefty Premiums

I looked up the options prices even 16 months out, and there are no bargains to be found. The market makers are willing to sell the investor an option on the stock, but with a hefty insurance premium, in a liquidity fueled bull market that can keep poor company`s stocks afloat long after these options expire.

The investor would have to buy a strike for the option way out of the money, and hope that regulators step in, but this is a strategy that relies upon a lot of outside intervention – and I try to avoid those plays.

There are safer places to put your money as an investor than needing to have government or outside intervention for your position to work as an investor. This is a sign of a poor investment calculation, and more of a pure gambling play.

Game versus Investing

What about piggy backing upon the big players and try and force Ackman to cover his positions? Leave this to the big players as many of these players can hedge risk a lot cheaper than the average investor, and for some of these players it is more of a game than an investment.

Carl Icahn has more money than he will ever need in his remaining lifetime, he wants to win, but if he loses it is no big deal to his personal wealth as one of the wealthiest investors on Wall Street. This is a personal revenge issue between the two, and Icahn has the personal wealth to spare to play this game – regardless of the outcome; the Retail Investor doesn`t fit into this category.

Stock Gaps are Account Killers

Plus these guys are big, and they talk to each other discreetly, so they know when they are getting out of the stock, you as an average investor will be the last to know when the short squeeze party is over, or has failed altogether. The only sign you will receive is if the stock gaps down below your stop level, and forcing you to cover in a potentially account devastating manner on a crashing, free-falling stock that was at all-time highs.

Final Thoughts

In summation, the retail investor cannot go long the stock on its own merits, this is not an investable company with a great long-term future in product or market differentiation – this is not BMW or General Electric Company.

The retail investor cannot adequately control risk to play the short squeeze from a long standpoint on a short-term basis. In addition, the retail investor cannot take a short position in the stock because of the potential for the stock to gap above a reasonable stop on a short squeeze.

The options market is not a viable strategy either for the retail investor because the market makers are charging too much premium for the possibility that some future volatility comes into play for this stock in either direction. So the risk reward equation makes no sense for the retail investor on this company.

There is no rational, sound investment theme for the retail investor in Herbalife. This is nothing to be sad about, this is part of investing, and there are plenty of legitimate investment opportunities in this market available that make sound investment sense for the retail investor.

Remember, it is just as important the money the investor doesn`t lose, than the money they could potentially make – always evaluate both sides of the equation when investing.

Article Update

We wrote this article before PricewaterhouseCoopers had finished re-auditing three years of Herbalife’s financial statements, and the stock soared to $81.75 on Friday December 20th. However, since then Herbalife has sold off contrary to the overall market, and now stands at $78.55 on December 24, 2013. 

Again we think the audit news spurred some shorts to cover, and propelled some traders to take advantage of the news for a nice trade to the upside, but this will be short-lived in our opinion, as it seems to have presented a nice entry price for new shorts to put on a position to the downside. But experience has taught us that shorting in any market, let alone a bull market is not for the weak of heart, and we advise retail investors to just stay clear of this stock. However, in the end this is not going to end well for investors who are long the stock, Herbalife is just not a good company with a sustainable business model for the long term, and eventually this company and their lofty stock price comes crashing back to the level representative of a sham, multi-level marketing company with a finite supply of dimwitted recruits in the world. 

Many Ponzi schemes work for a while, even create the illusion of great returns and earnings in the short-term, but as the legacy of such enterprises teaches investors, it is only a matter of time before the tide goes rolling out to Sea, and the newest investors are left shivering on the beach with no clothes on begging for justice. 

Merry Christmas From the TSA

Courtesy of Mish.

Traveling this holiday season? Whether yes or no, the TSA has 12 helpful hints about what you can and cannot carry on planes.

Link if video does not play: TSA’s 12 Banned Items of Christmas

Mike “Mish” Shedlock   

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Christmas 1919 – Christmas 2013

Courtesy of Larry Doyle.

This story has become my traditional post to embrace the true spirit of faith, hope, and love. This tale of real heroism and sacrifice ran in The Wall Street Journal in 2008. I think if you read it you will understand why I like it so much.

Merry Christmas, Happy Hanukkah, Happy Kwanza, or however you celebrate, Happy Holidays!!


A Christmas Tale — 1919The Wall Street Journal, December 2008


It’s easy to complain in the midst of a stressful holiday season. But my family has a unique remedy: We remember one special Christmas in 1919 that gave us the freedom and liberty we enjoy today. This will be the 89th anniversary of the year my father celebrated Christmas Eve deep in the snow-laden woods of Russia as he fled the Communist takeover of his homeland. 

When I tell people that my father was an officer in the White Army who fought the Bolsheviks in the Russian civil war, they usually look at me with disbelief, because I am only 49. But he married and started a family later in life, after he lived through both world wars.

He had been an officer in the Russian Army in World War I; after the Bolshevik putsch he ended up fighting against them in the far north of Russia. In 1919 he was close to the Arctic Circle in the port city of Arkhangelsk, where at the beginning of the year, six feet of snow fell and the temperature was regularly 30 degrees below zero.

The Allies — the English, Americans and French — had put military forces in Russia, including in Murmansk and Arkhangelsk, in 1918. When they withdrew in September 1919, the White Army forces faced dire peril: Their source of supplies, including arms, was gone. Many regular soldiers deserted en masse to the Bolsheviks.

As the situation deteriorated, my father and his unit were surrounded. They fought until very few supplies remained. By December, their commander told them that they would soon be unable to continue to fight and that the Bolsheviks had promised that surrendering White forces would be freed and sent home.

But my father knew that the communists shot the officers they captured. The only way he could escape was through the frozen White Sea on the lone icebreaker in the port, which was not large enough to evacuate everyone. Only a small number of high-ranking White Russian officers eventually fled that way.

One woman and 16 men, including my father, decided they would try to get out another way. In the middle of a very snowy night, they skied through the Bolshevik lines toward Finland. As my father later told his five children, it was an arduous and long journey. They had so little food that at one point they were reduced to eating the beeswax candles they carried with them.

They soon ceased to count the days. Time became amorphous as they traveled through the chilling cold of an Arctic winter in the darkness of the deep woods. Their singular goal was to avoid Bolshevik patrols.

On one of those timeless, dark days, my father said, the woman in their group reminded the men of something they had all lost track of — tomorrow would be Christmas Eve.

The next day they skied ’til the beams of the sun turned the treetops golden and the shadows in the forest became longer and longer. They stopped in a small glade for the night, and my father cut down a small fir. They placed some of their remaining candles on its branches and adorned it with blue ribbons cut from a blouse the woman had carried in her knapsack.

With the dark veil of night covering them, they lit the candles and their small pine became a Christmas tree. The scene seemed almost mystical to my father — 17 human beings sitting in the glow of a makeshift Christmas tree in the thicket of a primeval forest. They forgot about the frost of the northern wintry night, their exhaustion, and their anxiety about the future.

No more hatred remained in their hearts, my father told us — only love for God and men alike, friends and enemies. They said a prayer, sang some Christmas hymns, and then sat silently, thinking about what they had lost and were leaving behind, including their families. (My father never saw his mother or his father again.) The candles burned out, and it became dark again around them.

The next day they resumed their journey. Once Christmas had passed, and they did not encounter any Bolshevik patrols, my father felt they had been saved. Two weeks later, they arrived safely in Finland. They had skied hundreds of kilometers through the wilderness in the dead of winter.

My father died in 1988, just short of his 93rd birthday. There is a lot more to his story — great drama, more danger, and adventures that he always said were better to recall as memories than to have lived through. He eventually immigrated to the United States with my mother, whom he met in 1946 in a refugee camp in occupied Germany.

So this Christmas, besides opening presents and singing carols, my family will observe one other tradition. We will drink a toast and give thanks to a man who fled a murderous, cruel dictatorship and gave us a gift more precious than anything else: the chance to grow up in freedom and to enjoy the liberty that is our birthright as Americans. Merry Christmas!

Mr. von Spakovsky is a visiting legal scholar at The Heritage Foundation and a former commissioner of the Federal Election Commission. He is a proud first-generation American.

GM: Momentum Stock Candidate 2014

Courtesy of

By EconMatters

Momentum Stocks

Every year on average there are at least 4 momentum stocks that capture Wall Street`s fancy and all the fund managers pile into these names. Hedge funds realize this investing phenomenon and try to figure out which names are going to be the chosen ones this year so they can ride along the coattails of the institutions, pension funds and money managers. These stocks are the absolute best stocks to invest in from a risk and return standpoint because you are riding along with the smart money, the crowd and every other technically based buy program as these stock charts are an investor`s paradise.
Impossible to Short Momentum Stocks in Heart of Momentum Run
The shorts come in at various times thinking these names are overdone on valuation concerns and they get their head handed to them, or shorts more specifically, causing additional fuel for the upside trek to higher monthly highs in the stocks. In essence, these stocks are 'un-shortable' and short sellers need to recognize what constitutes a Momentum Stock on Wall Street just as much as longs because failure to do so is just like committing investor suicide.
Notable Momentum Stocks
Notable Momentum Stocks in the past have been Blackberry (BBRY), Crocs, Inc. (CROX), Google Inc. (GOOG), Apple Inc. (AAPL), First Solar, Inc. (FSLR), Potash Corp. of Saskatchewan, Inc. (POT), Sears Holdings Corporation (SHLD), and Freeport-McMoRan Copper & Gold Inc. (FCX).
2013 Momentum Stocks
This past year for 2013 the momentum stocks were Netflix, Inc. (NFLX), Inc. (AMZN), Tesla Motors, Inc. (TSLA), Incorporated (PCLN), Google Inc. and The Boeing Company (BA). One look at these charts can tell the investor why identifying next year`s momentum stock candidates is so important from an investment strategy. It is very helpful to be aligned with all the players on the right side of the investment.
Drivers for GM being a Momentum Stock
Here are some of the reasons why I think General Motors Company (GM) makes for a good momentum stock candidate in 2014. First, the government has finally exited their stake in the company freeing up institutional investors to start acquiring a sizable position in the automaker now that GM is no longer influenced by the government`s jurisdiction.
The second factor is that several other notable players like Kyle Bass of Hayman Capital Management, L.P. have started talking up the name recently, and when Hedge Funds start talking the old adage where there is smoke, there is fire applies here. GM is being talked about in the investment community which includes conferences, meetings, seminars and money raising initiatives. Big players raise money around investment ideas, and I think GM is one of these names.
The third factor is the broader economy seems to be slowly getting better with the jobs environment improving each quarter; this bodes well for new vehicle sales.
The fourth factor is now that the government is no longer involved with management influence in regards to decisions, GM can be more aggressive in driving the profit factor, and they should be able to pursue more aggressive business practices which generate better quarterly results year over year on a comparison basis.
The fifth driver for the stock is the way it is trading relative to the broader market, and while the broader market has exhibited some weakness mainly on the risks associated with the FOMC meeting this week, GM has been hanging in there quite strong and fighting against this overall recent market weakness. This is a very bullish sign, and it usually means that investors think there is considerable long-term value in the stock so they aren`t selling, and other players like institutions are probably holding this stock up because they are in the acquiring mode on any weakness in the stock. Again, this is what an investor wants to see in a stock, how well it trades against the broader market.
Potential Concerns
One potential concern is that GM has sold a lot of automobiles over the last three years, and if there is one factor to watch it is how many more customers there are in the broader economy that need to upgrade to a new vehicle this year. I have seen just an amazing number of those Chevrolet Camaros on the streets, and I wonder if GM could run into some tough comps on certain product categories, and market and product saturation issues. This is something to monitor as a possible concern, and to follow in the quarterly presentations by the company.
The other possible concern is that GM is up about 18% in 6 months, and 61% in 2013. However, the stock is only up 17% over a five year time period, and the government yielded considerable influence during this period both from a management perspective and an ownership stake in the company.
My thesis is that with the government being a net seller on the market, this has limited GM`s upside, and now that longer term investors have acquired these shares, the company is set to really take off in 2014 like some of the Momentum Stocks of the past 5 years.
Price Targets
However, all that being said my initial price target for the stock is $65 a share sometime over the next six months, and maybe as soon as this April. I also have my mid-term price target at $80 a share towards the end of 2014. Some of this depends upon what the overall stock market is doing, but I am assuming in this analysis that GM holds up better, probably outperforms the overall broader market.
Acquiring GM Position & Entry Points
Thus, this is my first Momentum Stock candidate for 2014 in General Motors Company and I would recommend buying this stock if possible on a slight pullback, in the $38 a share range would be a great entry price. However, I have been watching this name, and the investor may not get the chance to get into the stock on a pullback, so beware of that possibility. Sometimes good stocks that everybody is interested in don`t offer ideal pullback entry points, regardless I would recommend acquiring a position before 2014 begins in the investing universe.

Article Update
We wrote this article prior to the Ford 2014 Profit Downgrade, which sent GM shares lower just below $40 a share before rebounding higher, but it seems investors are worried that Ford`s troubles may be hinting of broader concerns in the vehicle marketplace. The question for investors is whether these concerns are Ford specific or have broader implications for the rest of the automakers? The next quarterly earnings calls should shed some light on this subject, and give possible clues for investors.  However, GM the stock has definitely underperformed the broader market once the Ford news came out, something to watch before putting new money to work in the stock.

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Lawyer Advises Me “Don’t Go to France”; French Pub Fined €9,000 for Using “Undeclared Labor” after Customers Returned Empties to Bar

Courtesy of Mish.

A few days ago my lawyer advised me “Don’t go France” (not that I had any plans to of course). The advise, coupled with the message “First amendment rights stop at the US border“, was in reference to my November 20 article Mish Fined 8,000 Euros for Quoting French Blog.

All I did was quote a French blogger on bank leverage, and the numbers I quoted were matched by the Wall Street Journal.

Wolf Richter at the Testosterone Pit commented on Gagging Doubt: French Crackdown On French And American Bloggers Who Question Megabank Balance Sheets

The France’s Financial Markets Authority (AMF) announced on Nov. 14 that its Sanctions Commission had decided to slap fines on two bloggers, Frenchman Jean-Pierre Chevallier and American Mike “Mish” Shedlock, “for having spread inexact information about the level of indebtedness” of megabank Société Générale.

The same bank, incidentally, that entered the annals of the silly when it blamed and successfully hounded a low-level trader, the hapless Jérôme Kerviel, for its €5 billion zinger of a loss during the financial crisis, while other banks blamed their toxic assets.

Digging through financial statements and coming up with conclusions that differ from those that the almighty bank serves up is just a sign of not having yet imbibed too much of its Kool-Aid.

Freedom of speech, bien sûr, somewhat, kinda. But not when it comes to French megabanks. Nope. No one is allowed to doubt anything. Are they in that bad of a shape that they cannot withstand the doubt of a blogger?

In its decision, the Sanctions Committee stated that it had jurisdiction to rule on the dissemination of inaccurate information about a financial instrument that can be traded in a regulated French market, whether or not it was disseminated in France, and regardless of whether it was disseminated by a Frenchman or a foreigner. And for the first time, the commission applied Article 632-1 of the AMF’s General Regulations to information posted on the Internet by financial bloggers; it reads: “Everyone must refrain from disclosing or knowingly disseminating information, regardless of the medium used, that gives or may give inexact, inaccurate, or misleading indications about financial instruments, including spreading rumors or broadcasting false or misleading news, when that person knew, or should have known, that the information was false or misleading.”

A blatant attempt to gag doubting bloggers.

Shooting Yourself in the Foot

Automatic Earth had some interesting comments in How To Fine A Fine Blogger And Shoot Yourself In The Foot in reference to the quote from Testosterone Pit.

Everyone of course should include SocGen itself, because they too “may give” inexact, inaccurate, or misleading indications. And the AFM is the only institution with the legal powers to check if SocGen’s financial statements are correct. Have they? How are we to even know? By accepting SocGen’s statement, the AFM makes itself a potential accomplice if any irregularities appear in that statement, either today or in the future. But they don’t seem to care.

Instead, they turn around and fine two bloggers who write they think those numbers are not correct, and who might otherwise, had they not been “investigated”, have been more than happy to retract their words if either SocGen or the AFM had published numbers that were both correct and transparent. Where is the AFM report on its investigation into SocGen’s numbers?…

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Economic Illiterate Proposal: “Inflation Creates Jobs”; Inflation Economics 101

Courtesy of Mish.

Those looking economically illiterate proposals can have a field day reading Ezra Klein’s “Wonkblog” on the Washington Post.

In Full Employment Gives People Jobs Klein states (citing two others) “The Federal Reserve Bank’s focus on keeping inflation below 2 percent effectively sacrifices the other half of its dual mandate: full employment.

It’s difficult to know where to start debating such economic lunacy, but let’s briefly discuss the notion of a “dual mandate“.

Dual Mandate Equals Mission Impossible

Here’s the deal.

1. The Fed can control money supply but it will have no control over interest rates (or anything else).

2. The Fed can control short-term interest rates, but then it would have no control over money supply (or anything else).

That is the full and complete extent of the Fed’s “control”. Note that neither price stability nor unemployment is in either equation. The reason is the Fed controls neither.

That is a mathematical certainty, yet people have preposterous beliefs that the somehow the Fed can not only control inflation but also unemployment.

If the Fed, the Bank of Japan, the Reserve Bank of Australia, the ECB, or the Bank of England, or the central bank of China could control the unemployment rate, rest assured they would have done so long ago.

The economic illiterates will point out the unique nature of the Fed’s dual mandate, but I will counter with the mathematical stupidity of such an idea.

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