Replies to post #326763 on Zeev's Turnips Patch-No Politics (ZEEV)

[Justa Werkenstiff]

Z: Marcia is a "guy <g>?" As to what she wrote, let her speak for herself...seems clear enough to me.

Will the MSFT dividend's "impact" be offset by the jump last week in natural gas prices or the bullish move in oil? Hmmmmm...boy this is sure hard to figure!

[hightecheast]

Mass Insanity

November 26, 2004 ... C Kenneth Wilson

Everything I read about investing is with the purpose of understanding what has occurred in history and why. I can then at least try to make the best possible informed investing decisions.

Sometimes what I have read in the past means much more to me if I read it again later. When I read “A Short History of Financial Euphoria” – an 81 page essay by John Kenneth Galbraith – the first time three years ago, I knew it was important, but nothing jumped out at me as being extraordinary.

I recently read a reference to Galbraith that caused me to pick it up and read it again. My reaction? ….. you have probably heard people say that “lightening-struck-me” when I saw this or read that. But it was different than that. What slowly developed as I read was a realization that, for the first time, I might actually understand the psychology of previous financial euphoric events. And it made me smile in a satisfying way that I had learned something important.

What stands out now to me is that we are again involved in financial euphoria, (a) only few people understand it, and (b) the occurrence is presenting itself in a manner that we have never seen before … and it makes the situation more dangerous and troubling.

From early 2000 through late 2002, US equities spiraled downward and interest rates moved quickly lower as the Federal Reserve moved short term rates progressively lower. By late 2002, stocks bottomed and started to recover as corporate profits improved. And stocks continue to rally higher to this day.

Unfortunately, the increase in consumer spending, and spike in auto/truck sales and the residential housing market were accomplished through huge increases in US consumer debt and massive borrowing from Asian central banks and individuals. Our federal government also reversed course, and started running huge deficits to finance massive tax cuts, the war in Iraq and the war on terror.

This can easily be seen in the small improvement in the quantity of skilled jobs in the US, and the reluctance of American corporations to spend their increasing large supply of cash to expand their businesses. If we are going to soon enter a lengthy period of retrenchment and recession (both in the US and around the world), and I am certain that we are, there is no good reason for corporations to squander cash that they will need to survive the tough times ahead.

To counteract the massive over investment of capital during the internet bubble in 2000, the Fed created artificially low interest rates to support US consumption, large cash outs on home refinances, larger and larger credit card debt, a continued housing expansion, 0% interest rates on vehicle purchases, and massive importation of low-priced consumer goods from Asia.

What is there about these circumstances that comes remotely close to sounding healthy long-term for our economy? Absolutely nothing is the correct answer.

While there is not much of anything we can do at this point that will counteract a strong and difficult economic retrenchment, we will have to do some things soon. Primarily, we must balance the federal deficit – the sooner the better. That will improve US savings and encourage foreigners to have enough confidence in America that they might not sell some of their huge reserves of US treasuries and US Dollars. Otherwise long-term interest rates will rise quickly and strangle consumption and the US housing and auto/truck industries.

Even foreigners just holding onto US dollars from trade imbalances (instead of buying US debt) could quickly lead to a crisis. In fact, this is exactly what Andy Xie, Morgan Stanley’s Managing Director of their Asian/Pacific economics team proposed on November 23. “If Asian central banks sell these treasuries now and keep the dollars in cash form … the higher bond yield would stop the merry-go-round among the Fed, the hedge funds, the Asian central banks and the US consumer. With higher bond yields bringing down US consumption, the global imbalances would heal.”

Currency manipulation and slow and continuous US dollar devaluation will not solve the problems. Not while Japan and China continue to prevent their currencies from making the required gains against the dollar.

The longer the solutions go unimplemented, the greater the negative consequences to the American and world economies.

And with all of this as background, Wall Street and American investors continue to believe in a continued bull market for stocks …. I tell you – it is mass insanity.

Following are sections that I selected from “A Short History of Financial Euphoria” and will quote directly. Hopefully, you will recognize the symptoms and characterizations that apply to all the financial disasters of the past as well as those we have yet to experience.

Selected quotes from
“A Short History of Financial Euphoria”
by John Kenneth Galbraith, 1990

Regulation and more orthodox economic knowledge are not what protect the individual and the financial institution when euphoria returns, leading on as it does to wonder at the increase in values and wealth, to the rush to participate that drives up prices, and to the eventual crash and its sullen and painful aftermath. There is protection only in a clear perception of the characteristics common to these flights into what must be conservatively be described as mass insanity. Only then is the investor warned and saved.

There are, however, few matters on which such a warning is less welcomed. In the short run, it will be said to be an attack, motivated by either deficient understanding or uncontrolled envy on the wonderful process of enrichment. More durably, it will be thought to demonstrate a lack of faith in the inherent wisdom of the market itself.

Less understood is the mass psychology of the speculative mood. When it is fully comprehended, it allows those so favored to save themselves from disaster. Given the pressure of crowd psychology, however, the saved will be the exception to a very broad and binding rule. They will be required to resist two compelling forces: one, the powerful personal interest that develops in the euphoric belief, and the other, the pressure of public and seemingly superior financial opinion that is brought to bear on behalf of such belief.

Those involved with the speculation are experiencing an increase in wealth – getting rich or being further enriched. No one wishes to believe that this is fortuitous or undeserved; all wish to think that it is the result of their own superior insight or intuition.

Speculation buys up, in a very practical way, the intelligence of those involved.

To summarize: The euphoric episode is protected and sustained by the will of those who are involved in order to justify the circumstances that are making them rich. And it is equally protected by the will to ignore, exorcise, or condemn those who express doubts.

A major factor contributing to speculative euphoria and programmed collapse is the specious association of money and intelligence.

In all free-enterprise (once called capitalist) attitudes, there is a strong tendency to believe that the more money, either as income or assets, of which an individual is possessed or with which he is associated, the deeper and more compelling his economic and social perception, the more astute and penetrating his mental process. Money is the measure of capitalist achievement. The more money, the greater the achievement and the intelligence that supports it.

This view is then reinforced by the air of self-confidence and self-approval that is commonly assumed by the affluent. On no matter is the mental inferiority of the ordinary layman so crudely and abruptly stated: “I’m afraid that you simply don’t understand financial matters.”

Having money may mean, as often in the past and frequently in the present, that the person is foolishly indifferent to legal constraints and may be a potential resident of a minimum-security prison. Or the money may have been inherited, and notoriously, mental acuity does not pass in reliable fashion from parent to offspring. On all these matters, a more careful examination of the presumed financial genius, a sternly detailed interrogation to test his or her intelligence, would frequently and perhaps normally produce a different conclusion. Unfortunately the subject is rarely available for such scrutiny; that, too, wealth or seeming financial competence often excludes.


Born on October 15, 1908, John Kenneth Galbraith is 96 years of age. He lives in Cambridge, Massachusetts. He is Professor of Economics Emeritus at Harvard University. He is internationally known for his development of Keynesian and post-Keynesian economics, the economics of the modern large firm, as well as for his writing and his active involvement in American politics. Among Professor Galbraith’s published books are the following. The Affluent Society (1958), The New Industrial State (1967), Economics and the Public Purpose (1973), American Capitalism (1952), The Great Crash (1955), Economics and the Art of Controversy (1955), Money: Whence It Came, Where It Went (1975), The Age of Uncertainty (1977), Almost Everyone's Guide to Economics (1979), A Life in Our Times (1981), The Anatomy of Power (1983), A View from the Stands (1986), Economics in Perspective (1987), and A Journey Through Economic Time (1994)

[hightecheast]

... Bill Gross, PIMCO, without charts ...

Bill Gross, Managing Director of PIMCO, known as the “bond king” as the highest paid money manager in the world, has been sending storm-warnings on US bonds to clients for several months now.

PIMCO manages $415 billion dollars in assets, largely invested in bonds.

In his December comments, Gross continues with very strong comments and warnings.

My question: who is listening?

Ken Wilson
___________________________


Investment Outlook

Bill Gross / December 2004

Too Much!

The weak dollar – causes and consequences

John Snow and Allen Greenspan have finally bowed to the inevitable. Instead of blocking the lane in defense of a Shaq Attack slam dunk, they have politely if somewhat obfuscatingly stepped aside. “Put it down brother” they seem to be saying but it’s the dollar and not a round ball that they’re referring to. The dollar has gone down. The dollar is going down. The dollar will continue to go down because it’s the easiest way out (for the U.S.) to begin to rectify its imbalanced finance-based economy. Balance the budget? Fugitaboutit. Raise interest rates to historic norms? Fugitaboutthattoo. “Let the market decide,” Snow says. “Likewise,” chimes Greenspan, warning that sooner or later foreign lenders will not be so exuberant in their purchase of U.S. Treasury bonds. Perhaps they’ll be a little less irrational with their money he might have thought but that’s a word he doesn’t use anymore. And so the market’s most crowded trade-short the dollar – will inevitably become a little more crowded, perhaps irrational itself at some point. There is a whiff of crisis in the air.

How the world came to this point is well documented in some journals, including this one, but it bears repeating if only to reacquaint pre-Alzheimer candidates and those with “senior moments” such as myself with the facts. The U.S. spends too much; eats too much; drinks too much; TOO MUCH, (thank you Dave Matthews). And we pay for it with our debt and 80% of the world’s excess savings. In so doing our creepy crawly balance of payments deficit has inched its way up to 6% of GDP – a level never seen in the U.S. and reflective of third world nations in financial crisis. The imbalance has been tolerated by those nations on the surplus side of the ledger – read “Asia” – in a strange sort of mercantilistic Faustian bargain that promises China and Japan the benefits of a strengthening economy now for the perfidy of falling dollar denominated Treasuries bonds later, an arrangement that once again will prove that there is no free lunch, or that hell often follows heaven on Earth.

There are those that argue that this tidy little bargain between debtor and creditor nations can go on for a long long time. Since each party gets what they want – The U.S. to consume, and Asia to produce – who’s to say when the first player will opt out? For now, China’s rather introverted geopolitik allows them the flexibility to revalue their Yuan whenever they damn well please as long as their inflation rate behaves. Japan is beholden to the U.S. militarily and continues to struggle with deflationary pressures. That argues for at least jawboning its Yen lower. “Dirty float” is and likely will remain synonymous with Japanese forex policy. So there seems no immediate incentive for either China or Japan to opt out of their Faustian bargain. On the debtor side, the U.S. will shop ‘til it drops – pure and simple but that phrase up until now has always accentuated the “shop” and conveniently forgotten about the “drop.” The drop comes when this comfy cozy current relationship between giver/taker, consumer/maker for some reason ends in divorce. The only question is one of timing. At some point, as Greenspan so astutely pointed out, “foreign lenders will eventually resist lending more money to the United States, causing the dollar to drop further.” What he didn’t say is that that will be the point when the shopping stops and the fun goes out of a trip to the mall. That’s the point when U.S. inflation heads gradually but inevitably higher, and that’s the point, of course when interest rates move into harm’s way.

If it seems strange that Treasury Secretary Snow and Fed Chairman Greenspan are actually encouraging this weak dollar policy one can rationalize that they’ve seen the end game and they want to ease their way around the pileup. Better to talk the dollar down now before the balance of payments gets so bad that a true crisis is inevitable. I cannot disagree. And as mentioned in my opening paragraph, alternative solutions to the problem are “pie in the sky” unimaginable. For Americans voluntarily to begin to get the old time religion of saving more money is beyond dreaming, especially with employment so weak and the source of historic capital gains – stocks and houses – still above cost. Likewise a Bush Administration seems unlikely to move towards a more balanced budget with its aggressive legislative agenda which includes social security reform. Optimists tout the escape route of faster foreign growth to suck up American exports but Europe has caught a congenital case of influenza, Japan is back to the zero growth line and China is maneuvering for a soft landing.

My point is this: dollar depreciation now, and Chinese Yuan revaluation as soon as possible is the easiest first step to rebalance an imbalanced U.S./global economy. This realization is and has been as close to a slam-dunk as we have seen in the world of finance; slam dunkier than calling the stock market top at NASDAQ 5000 or Soros breaking the Pound Sterling. You can count on it (the Dollar going down against Asia)– not that there won’t be frantic short squeeze reverses even as this Outlook is being written, or that against some currencies (the Euro) the U.S. dollar actually may be cheap.

But how best to profit from it? Like I’m fond of telling my fellow PIMCO portfolio managers as they pontificate about the future of the economy, “You can’t invest in GDP futures, what are the investment implications?” Granted, some of you readers can or have already joined the trash party and are short the dollar. We can as well and have done so in minor amounts. But currencies are not the game for which we were hired. They go up and down quicker than 30-year 0’s and can ruin or make your day/year/career. And aside from the obvious benefits that a declining dollar imparts to gold and commodity prices, the focus of this Outlook should be on bonds. What bonds should be bought or sold? I have several specific thoughts:

1) As long as the Euro strengthens against the dollar, there is reason to favor German Bunds instead of U.S. Treasuries. We have recently reduced some of our positions but remain confident that the inflationary impact of a weaker dollar and the disinflationary benefit of a stronger Euro favor Bund/Euroland positions. A 10% decline in the trade weighted dollar according to our calculations increases U.S. inflation by approximately ½% over the ensuing 24 months. While a strengthening Euro/dollar relationship has a positive disinflationary impact in Euroland it will unquestionably not be the inverse of the U.S. due to the smaller dollar impact on their trade weighted currency. But as Chart II shows, the inflation differential in the short run may be as high as ¾% in favor of Euroland with the Euro at its current 1.30 level. Because the Euro has appreciated inordinately as Asia has controlled their own currencies, I would be leery of Bunds when and if China revalues. That point, however may be months ahead.

2) Buy TIPS. I’ve said this before when discussing U.S. reflationary tendencies. Since a declining dollar is perhaps the most quantifiable of all reflationary weapons – ½% higher inflation per every 10% trade weighted dollar decline – the benefit should accrue to short maturity TIPS on an almost one for one basis and to 5-10 year intermediate TIPS in smaller proportions.

3) Be careful with U.S. Treasuries. I offer a word of caution here if only because of a strange rather unquantifiable twist in the balance of payments saga. While Greenspan has correctly suggested that foreign private institutions and central banks will not lend at the current pace forever because of a burdensome trade deficit, there is the probability that until the first sizeable creditor turns tail that an accelerating deficit actually lowers interest rates. Think about it: For every dollar we spend on imports, that buck comes straight back to us (for now) in the form of a Treasury buy ticket. So the more we spend on imports in the short run, the more we save. Sounds like my wife at a sale, but it makes sense as long as foreign creditors buy longer dated Treasuries. Purchases of intermediate and long maturity Treasuries reflect a confidence in the fiscal/monetary stability of the U.S. economy. When that confidence disappears, foreign purchases take the form of overnight deposits as the buck is tossed from one holder to another like a hot potato. That’s when the dollar tanks, the balance of payments deficit eases back towards 2 or 3% and perversely, intermediate and long-term interest rates are more susceptible to going up. To sum up this CATCH 22, a deteriorating balance of payments deficit may actually have a positive effect leading to lower interest rates until a large creditor turns tail. It’s another way of saying that U.S. yields depend upon the kindness of strangers and that the time to not own them is when the strangers become less kind. I suspect that is just around the corner but Beijing and Tokyo have the ball in their courts.

Wherever that should occur, there’s no doubt that the dollar is on the run and that higher U.S. interest rates are the inevitable consequence. Dollar depreciation leads to higher inflation and ultimately forces foreign creditors to question their rationale and indeed their sanity for continuing purchases of U.S. Treasuries. Investors don’t need necessarily “TOO MUCH” intelligence to do this trade. Rather, they may need lots of patience in order to turn it into a profitable, near slam dunk opportunity.

William H. Gross

Managing Director

[TREND1]

Zeev still on bearish signal