I just wrote this to a contact I have developed with my congressional representative office. The congressperson is a senior member of the appropriations committee.
I advise reading this - because it likely means you have interest or are practitioners in finance and have some pragmatic experience - to write your representative and stay at it.
This is becoming an incredibly dire national and global emergency.
My letter (and there have already been a few):
Chris
Once again I am not sleeping at night.
The current environment is as sweet as it could be to someone with my trade - ostensibly an expert in long term fixed income investments which is the key area as pension funds and investors set out to survive this crisis. So I should be happy. But a combination of both the pragmatic need to have a platform (which is at risk) to practice my trade along with a civic minded concern of the misery and extreme political pressures that may be forthcoming have returned me to despair.
The "American Recovery and Reinvestment Bill" looks like it will fail - not in passage but in meeting the intent.
Just, in robust fashion, consider that the amount that went to Appropriations for the $825 billion bill, as per Appropriations rules, was for $358 billion of spending, which is a good indication of the actual "meat" or true stimulus in the bill.
The rise in savings and drop in consumption that has either already arrived or is coming shortly is about $750 billion and if it is matched with only $358 billion then it will continue to rise to in excess of $1 trillion. That is standard econ 101 which all economists, right and left, agree upon.
If the increase in savings and drop in consumption goes to $1 trillion, then we are approaching a 10% excess in labor and capital investment and as the capital investment cannot be sold given the fact that little in liquidity or interest in buying, the adjustments will be made in labor. This implies a unemployment number in mid teens. A very persistent feed back loop develops at that point which is why unemployment went to mid 20% in the 1930s.
Current market prices are reflecting this as a new wave in bank failures seem to be upon us, international trading partners GDP is being reduced on a leveraged basis to decrease in USA demand, and the negative earnings resulting from excess capacity is forcing re-adjustment of prices in the stock market. The SP 500 stock market index has continued down from highs around Christmas,as the Obama-Biden Plan and now the "American Recovery and Reinvestment Bill" is causing dismay.
We are back to the edge where we are at high risk for an explosion in unemployment, corporate default, nationalization of the larger banks, bank holidays, and a stock market crash. Already massive damage has been done to retirement plans and pensions to the extent of never being able to repair, and another adjustment down will produce a chronic crisis in that area of our populace least able to protect themselves - the elderly. Migrations to more comfortable climes for retirement will cease and massive numbers of elderly in poverty will remain in XXXXXXXX.
As I have pointed out in the Fall, I am still seeing little if any signs of literacy of key economic concepts and the realization of the potential outcome in Congress - otherwise how did the "American Recovery and Reinvestment Bill" leave Appropriations? Why is there no terrified and shrill and even hysterical debate? I could be wrong but the potential outcomes I outline are in the realm of reasonable discussion and therefore responsible people should be extremely careful and diligent now. I do not see this occurring. I do not read about this occurring. I do not perceive the necessary responsible and civic change has occurred.
I think my insights are topical and correct, please put me to work. We are now all Keynesian and right left, Republican or Democrat, as in war time, these labels are not of issue. After the rescue and some normalcy returns we can all divide back to our various disciplines but for now the country requires steady civics.
I can also gather a very learned and credentialed small group for Congresswoman XXXX and for your education. Please relay this to the Congressperson and also please accept the market outcomes as they are developing and accept the information they are providing - the "American Recovery and Reinvestment Bill" is stillborn.
I see an obvious chain from the first week of January as the first draft of the "Obama-Biden Plan" was released to Romer's disastrous defense of the tax effect in the "O-B Plan" to the President's inaugural address and the development of the "American Recovery and Reinvestment Bill" - all have obvious economic flaws that will result in disaster. That is what the market is relaying to your office.
Yours,
Friday, January 23, 2009
Oil Contango - Fed Funds Again
Another view on comparing the oil contango with Fed Funds path - how the market is pricing the Fed Funds change which will have equivalency to the market expectations for nominal GDP growth change. Think that all would agree oil shares much the same expectations - or it should.
The oil contango shows that the market feels strongly that growth will clearly be re-instated and that a completely successful reflation will occur as shown how future prices defy the cost of carry and trade steadily upwards. Given the obvious inventory of oil in both transport and also documented such as IEA PADD II etc etc, the contango can be read as only the most adamant and enthusiastic bullish future expectations of USA nominal GDP growth.
The CL contract in 12 months netted against the front CL contract:
But there is a diametrically opposed expectations in the Fed Funds market expectations. Fed Funds will over time have equivalency to nominal GDP. While there is a lot of noise in the first year at the market some robust insight can be had by looking at the future for Fed Funds one year forward versus the front Fed Funds contract. That difference will reflect the market expectations on change of nominal GDP. Looking at that chart, we can see how the crisis gobsmacked the market and expectations were for no growth for a year. Though noisy, some expectations of future growth expansion improved to the end of Oct , but then "something happened" and we have steadily deteriorated market expectations for the chance of reflation to this day.
The two schedules above both share that the most important factor is nominal growth in USA GDP. One is completely out of synch with the other. So one must ask which market is more efficient - most liquid and effective in relaying expectations. Obviously that is Fed Funds. Therefore the difference between the two markets expectations has to be inefficiencies in the less liquid oil markets - or put another way, oil is a manipulated inefficient market. The extreme moves in the contango around key settlements indicates that likely efficiency is about to return to the oil market and to force it inline with the macro USA key factors.
Thursday, January 22, 2009
What I Know and Believe
What I Know
A set of maxims.
1. There are two crisis occurring right now, one is a bank crisis and the other is a crash in future expectations.
2. The budgets/costs of the two crisis have to be differentiated and considered separately
3. The bank crisis is a classic Bagehot-Kindelberger bank crash where the inherent instability in open market financial money markets given excess growth and too rapid expansion of leverage results in sharp cusp like failure and a rush to hoard cash by banks as they cannot differentiate who might fail.
4. The academic literature on how to manage this crisis is deep and well studied, from Bagehot’s “Lombard Street” to the ex head of the Swedish Central Bank’s essays to Kindelberger to Minsky.
5. The methods to manage a bank crisis are of a very limited set but no one can find an example of a failure in policy once these remedies are applied.
6. The “cost” to repair and fix a banking crisis is really not a cost, but a certain amount the lender of last resort has to expand their balance sheet. The concentration of problematic assets of the system, apply punitive management changes of the problem banks, make creditors whole, and ruin equity holders or substantially reduce value so precedent is set.
7. Never can the lender of a last resort work on with the bank that is being rescued's executive post-rescue. They mist be removed in punitive fashion.
8. Total balance sheet expansion for our banking crisis was once about $750 billion but as contagion spread given the lack of a lender of last resort operation other assets failed such as derivatives based upon bank counterparty risk (AIG).
9. Now the required and inevitable lender of last resort operation is equivalent to the Federal Reserve balance sheet which basically has to be returned to the private sector banking system at some point – about 1 ¾ trillion.
10. This balance sheet expansion is not a net amount but by definition a gross number – net end csts will be about ¼ of whatever the required balance sheet expansion. (Based upon historical consideration of bank crisis last 50 years on global basis – literature is deep and the above isn’t debated.)
11. The NY Fed has effected the end results of a post lender of last resort operation as shown how solid and pre-crisis levels key money market relationships are – but unless we wish a command economy this has to be returned to balance sheets of private banks.
12. The other crisis, resulting from the banking crisis, is a classic Keynesian/Minsky implosion of demand which shocks capital to a large excess capacity or excess capital. The offset to this is a drop in consumption and a comparable rise in savings and drop in gross investment.
13. Profits are near impossible to maintain given the cost of the fixed capital investment and capacity cannot be liquidated – so most industry is thrown to a deficit
14. No investments are made as the expectation develop that this state will last long enough to assure negative return on investment.
15. A spiral develops in investment and drop in consumption and attempt to remove excess capacity and is characterized by deflation; no future expected return produces an excess return to the cost of capital.
16. The public sector must fill the void of the drop in consumption and investment to initially an amount equal to this drop and with utility such that a positive expected return to investment schedule – Keynes called in “rent” returns.
17. This is a real spend, a real cost, but the public sector will have the assets or investments resulting from this spend on the balance sheet and is an offset.
18. This amount is roughly equal to the increase in savings – which is going from 0% towards 7%, or at 7% about $1 trillion. However the unresolved bank crisis along with further cycles of the Fisher Debt Deflation Spiral means a meter is running and shortly will be well in excess of $1 trillion and likely is expanding at some power law and not linearly.
19. The amount of fiscal stimulus is at or over $1 trillion now but that is not to be a spot actual dollar spend, rather it has to be firmly in expectations and certitude that it will be spent has to develop. That means spend on non-abstract clear large projects assists in the speedy development of those expectations.
20. There is much truth to “only thing to fear is fear itself” as that captures the spiral of expectations in the future problem. The ability for the USA to easily produce such a fiscal stimulus is obvious and easily proven through history and experiences of other countries - mostly recent experiences
21. The bank crisis is fixed now as far as liquidity, but until a removal of toxic assets and freeing bank balance sheets so lending and then resulting multiplier effect occurs, it can only be stop-gap and maintain with by definition no growth.
22. The Federal Reserve has to conclude the Bagehot lender of last resort operation by removing problem assets and also, just as important, removing all executives of failed bank(s). Carping about executive pay is meaningless.
23. The fiscal stimulus is getting larger and larger and the political process must be able to manage the vast sum without either ending in total gridlock and stalemate or a kleptocracy (why World Bank fiscal stimulus and projects rarely produce growth in LDCs as corruption results) Also shows why FDR was so clever to realize an SEC was required. But we likely have passed the legislatures ability to implement and manage the large stimulus now required – it will be solely a executive task. Even there political capability is being swamped by the task.
24. But, fiscal stimulus will occur sooner or later – think on that why that is logical – standard Pacioli identity. Dual sided accounting. Otherwise means a organized democratic community which is well connected now will allow deflation and depression ongoing. I think not. Either enlightened political movement starts, or a demagogue/fascist captures imagination (Huey Long, LaGuardia, Hitler, Mussolini), or classic socialism seizes n behalf of the state the methods of production, or an external motive for the fiscal stimulus is found which is inevitable war which is only variable that can generate unity and the size of stimulus to “balance” the books. The right way to read WW II was it was caused by the inability f the USA to get past political hurtles and reflate in the 30s.
25. The world will discover that there is still only one power and it is the USA and since this discovery will be from their specific countries demise, extreme frustration and anger will develop. Leaders will try to divert that anger and frustration against the USA. Keep in mind this will be desperate times with unemployment leveraged to the hegemon’s experience.
26. The pressures which force the public to insist on the fiscal flow required will be urban revolution, anarchy, riots, crime waves, and intense immoral behaviour.
27. The misery in LDCs will be unfathomable
28. The concepts of green and global warming will be exposed for what they are – an attempt to make a supra-national revenue/tax flow to empower non-nation state organizations, to the demise of the hegemon. There will be an attempt to use green policies by foreign elements/leaders to divert internal pressure to the USA.
29. So so much misery and trauma and death and destruction could be averted by firm large and classic Keynesian stimulus by Obama’s administration in very short order.
30. In the age of Google so much literature and information can be acquired. There is no excuse for any civilized American adult, especially leaders, to not understand the above.
31. None of the above can be seen to be out of line with either liberal, socialistic, or conservative principles as the above are that aspects of economics that is fact and are the only remedies available and are applied by all forms of government in the end - be it Hitler, FDR, Stalin, Reagan, LBJ, or now Obama. How the government proceeds post-crisis is dependent on political philosophy. But for now, considering the risk and possible dire results, all parties and people should be united to implement the above. Later folks can have a nice long debate on the unwind.
A set of maxims.
1. There are two crisis occurring right now, one is a bank crisis and the other is a crash in future expectations.
2. The budgets/costs of the two crisis have to be differentiated and considered separately
3. The bank crisis is a classic Bagehot-Kindelberger bank crash where the inherent instability in open market financial money markets given excess growth and too rapid expansion of leverage results in sharp cusp like failure and a rush to hoard cash by banks as they cannot differentiate who might fail.
4. The academic literature on how to manage this crisis is deep and well studied, from Bagehot’s “Lombard Street” to the ex head of the Swedish Central Bank’s essays to Kindelberger to Minsky.
5. The methods to manage a bank crisis are of a very limited set but no one can find an example of a failure in policy once these remedies are applied.
6. The “cost” to repair and fix a banking crisis is really not a cost, but a certain amount the lender of last resort has to expand their balance sheet. The concentration of problematic assets of the system, apply punitive management changes of the problem banks, make creditors whole, and ruin equity holders or substantially reduce value so precedent is set.
7. Never can the lender of a last resort work on with the bank that is being rescued's executive post-rescue. They mist be removed in punitive fashion.
8. Total balance sheet expansion for our banking crisis was once about $750 billion but as contagion spread given the lack of a lender of last resort operation other assets failed such as derivatives based upon bank counterparty risk (AIG).
9. Now the required and inevitable lender of last resort operation is equivalent to the Federal Reserve balance sheet which basically has to be returned to the private sector banking system at some point – about 1 ¾ trillion.
10. This balance sheet expansion is not a net amount but by definition a gross number – net end csts will be about ¼ of whatever the required balance sheet expansion. (Based upon historical consideration of bank crisis last 50 years on global basis – literature is deep and the above isn’t debated.)
11. The NY Fed has effected the end results of a post lender of last resort operation as shown how solid and pre-crisis levels key money market relationships are – but unless we wish a command economy this has to be returned to balance sheets of private banks.
12. The other crisis, resulting from the banking crisis, is a classic Keynesian/Minsky implosion of demand which shocks capital to a large excess capacity or excess capital. The offset to this is a drop in consumption and a comparable rise in savings and drop in gross investment.
13. Profits are near impossible to maintain given the cost of the fixed capital investment and capacity cannot be liquidated – so most industry is thrown to a deficit
14. No investments are made as the expectation develop that this state will last long enough to assure negative return on investment.
15. A spiral develops in investment and drop in consumption and attempt to remove excess capacity and is characterized by deflation; no future expected return produces an excess return to the cost of capital.
16. The public sector must fill the void of the drop in consumption and investment to initially an amount equal to this drop and with utility such that a positive expected return to investment schedule – Keynes called in “rent” returns.
17. This is a real spend, a real cost, but the public sector will have the assets or investments resulting from this spend on the balance sheet and is an offset.
18. This amount is roughly equal to the increase in savings – which is going from 0% towards 7%, or at 7% about $1 trillion. However the unresolved bank crisis along with further cycles of the Fisher Debt Deflation Spiral means a meter is running and shortly will be well in excess of $1 trillion and likely is expanding at some power law and not linearly.
19. The amount of fiscal stimulus is at or over $1 trillion now but that is not to be a spot actual dollar spend, rather it has to be firmly in expectations and certitude that it will be spent has to develop. That means spend on non-abstract clear large projects assists in the speedy development of those expectations.
20. There is much truth to “only thing to fear is fear itself” as that captures the spiral of expectations in the future problem. The ability for the USA to easily produce such a fiscal stimulus is obvious and easily proven through history and experiences of other countries - mostly recent experiences
21. The bank crisis is fixed now as far as liquidity, but until a removal of toxic assets and freeing bank balance sheets so lending and then resulting multiplier effect occurs, it can only be stop-gap and maintain with by definition no growth.
22. The Federal Reserve has to conclude the Bagehot lender of last resort operation by removing problem assets and also, just as important, removing all executives of failed bank(s). Carping about executive pay is meaningless.
23. The fiscal stimulus is getting larger and larger and the political process must be able to manage the vast sum without either ending in total gridlock and stalemate or a kleptocracy (why World Bank fiscal stimulus and projects rarely produce growth in LDCs as corruption results) Also shows why FDR was so clever to realize an SEC was required. But we likely have passed the legislatures ability to implement and manage the large stimulus now required – it will be solely a executive task. Even there political capability is being swamped by the task.
24. But, fiscal stimulus will occur sooner or later – think on that why that is logical – standard Pacioli identity. Dual sided accounting. Otherwise means a organized democratic community which is well connected now will allow deflation and depression ongoing. I think not. Either enlightened political movement starts, or a demagogue/fascist captures imagination (Huey Long, LaGuardia, Hitler, Mussolini), or classic socialism seizes n behalf of the state the methods of production, or an external motive for the fiscal stimulus is found which is inevitable war which is only variable that can generate unity and the size of stimulus to “balance” the books. The right way to read WW II was it was caused by the inability f the USA to get past political hurtles and reflate in the 30s.
25. The world will discover that there is still only one power and it is the USA and since this discovery will be from their specific countries demise, extreme frustration and anger will develop. Leaders will try to divert that anger and frustration against the USA. Keep in mind this will be desperate times with unemployment leveraged to the hegemon’s experience.
26. The pressures which force the public to insist on the fiscal flow required will be urban revolution, anarchy, riots, crime waves, and intense immoral behaviour.
27. The misery in LDCs will be unfathomable
28. The concepts of green and global warming will be exposed for what they are – an attempt to make a supra-national revenue/tax flow to empower non-nation state organizations, to the demise of the hegemon. There will be an attempt to use green policies by foreign elements/leaders to divert internal pressure to the USA.
29. So so much misery and trauma and death and destruction could be averted by firm large and classic Keynesian stimulus by Obama’s administration in very short order.
30. In the age of Google so much literature and information can be acquired. There is no excuse for any civilized American adult, especially leaders, to not understand the above.
31. None of the above can be seen to be out of line with either liberal, socialistic, or conservative principles as the above are that aspects of economics that is fact and are the only remedies available and are applied by all forms of government in the end - be it Hitler, FDR, Stalin, Reagan, LBJ, or now Obama. How the government proceeds post-crisis is dependent on political philosophy. But for now, considering the risk and possible dire results, all parties and people should be united to implement the above. Later folks can have a nice long debate on the unwind.
My Response to DeLong's Yglesias-Barro Postings on Keynesian Fiscal Multiplier - Bigger Issues Involved
DeLong posted the following blog material http://delong.typepad.com/sdj/2009/01/matthew-yglesias-vs-robert-barro.html on the fiscal "multiplier" from stimulus - an issue gaining notoriety since Romer's half-backed defense on the Obama-Biden Plan.
Delong posted (and I actually think he is complimenting Yglesias):
Matthew Yglesias vs. Robert Barro
One of these people is a tenured university professor. The other is a juicebox-drinking basement-dwelling bathrobe-clad weblogger.
Robert Barro writes:
Multipliers and Diminishing Returns: What do the data show about multipliers?... [T]he best evidence comes from large changes in military purchases.... The usual Keynesian view is that the World War II fiscal expansion provided the stimulus that finally got us out of the Great Depression. Thus, I think that most macroeconomists would regard this case as a fair one for seeing whether a large multiplier ever exists. World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports — personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses — there was a dampener, rather than a multiplier...
Matthew Yglesias responds:
I think this is running together two separate issues. One is “whether a large multiplier ever exists” and one is whether such multipliers suffer from diminishing returns. World War II spending was enormous relative to GDP. Wartime spending on that kind of scale goes way beyond the conversations we’re having right now about fiscal stimulus—the equivalent today would be something like a $5.2 trillion package rather than the $800 billion or so we’re talking about. And to get spending up to that level the government had to resort to quasi-forced savings (”war bonds”), rationing, etc.--deliberate efforts to direct production away from where demand was highest and toward the national objective of military production. The 0.8 multiplier is probably the result of diminishing returns. The question is whether you got a decent multiplier out of the first 5-10 percent of GDP you spend on stimulus. It shouldn’t surprise us if it turns out that defense spending eventually got somewhat higher than would be economically optimal in the middle of the largest war in history.
My comment on the above I left on DeLong's blog:
I think the multiplier issue is almost a red herring in regards to Keynesian measures required when savings rate soar (out of classic expectations or "forced" via war measures with lack of things to buy)and consumption dives. Obviously WW II spend "worked" - end of argument, and the size of fiscal stimulus FDR applied in peacetime did not do the trick, though important constitutional mandates were determined, rule of law via organizations like the SEC, and agencies to apply investments were initiated.
A far better example of Keynesian fiscal stimulus applied and the utility and "multiplier" it generated is the 1956 "Federal-Aid Highway Act of 1956" which created from scratch the Interstate Highway system. Avoiding for now chatting about cars and global warming - this was a massive undertaking which ended with a total $425 billion (2005 $) fiscal stimulus, unquestionable multiplier (most studies have it producing $1.5 and higher GDP per $1 spent)and had massive secondary and tertiary effects one cant account for such as auto industry growth to Howard Johnsons to...and so on. The project was solely conceptual in the start and certainly not "shovel ready".
Rather than worry about multiplier and whether or not it is "shovel ready", worry about making sure the project has utility and a long duration. Market pricing and the "rent" schedule will make for an almost immediate impact on GDP via first adjusting various market prices and then later with actual cash spend. The "shovel ready" is not required, only the certitude that the project will occur.
That's the trouble with abstracts or conceptual fiscal stimulus such as education or "green" technologies - the abstract nature will make for the GDP impact to not occur until actual cash flows are experienced .
So hard boundaried non-abstract projects which only a nation-state can budget for should be sought and declared. My call is the $600 billion high speed rail system nation wide. Or re do of the St Lawrence Seaway. Or rebuild every bridge over 20 years old (I am nervous driving over the Tappan Zee now). Or.. It has to be non-abstract and certain in public utility and it has to be not additive to existing programs and processes but be projects which the scope and size defy any budget unit but the federal.
The interesting question to ask is that if such projects are required, if we do not supply this fiscal spend in an obvious developing Fisher debt deflation spiral and if the USA as a power unit has any power or capability, that size of fiscal stimulus will occur. Sort of a weird supply side type thinking, voo doo I guess, but I think one can muse or even state that because FDR could not provide the fiscal stimulus outlined above, the fiscal stimulus did occur in a form that was politically applicable: war.
We will get our fiscal stimulus equal to the drop in consumption and investment and the rise in savings - one form or the other. I would prefer peace and the ability to drive over the Tappan Zee Bridge without thinking of the impact of water at such a height and the winter temperature of the Hudson.
Delong posted (and I actually think he is complimenting Yglesias):
Matthew Yglesias vs. Robert Barro
One of these people is a tenured university professor. The other is a juicebox-drinking basement-dwelling bathrobe-clad weblogger.
Robert Barro writes:
Multipliers and Diminishing Returns: What do the data show about multipliers?... [T]he best evidence comes from large changes in military purchases.... The usual Keynesian view is that the World War II fiscal expansion provided the stimulus that finally got us out of the Great Depression. Thus, I think that most macroeconomists would regard this case as a fair one for seeing whether a large multiplier ever exists. World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540). The other way to put this is that the war lowered components of GDP aside from military purchases. The main declines were in private investment, nonmilitary parts of government purchases, and net exports — personal consumer expenditure changed little. Wartime production siphoned off resources from other economic uses — there was a dampener, rather than a multiplier...
Matthew Yglesias responds:
I think this is running together two separate issues. One is “whether a large multiplier ever exists” and one is whether such multipliers suffer from diminishing returns. World War II spending was enormous relative to GDP. Wartime spending on that kind of scale goes way beyond the conversations we’re having right now about fiscal stimulus—the equivalent today would be something like a $5.2 trillion package rather than the $800 billion or so we’re talking about. And to get spending up to that level the government had to resort to quasi-forced savings (”war bonds”), rationing, etc.--deliberate efforts to direct production away from where demand was highest and toward the national objective of military production. The 0.8 multiplier is probably the result of diminishing returns. The question is whether you got a decent multiplier out of the first 5-10 percent of GDP you spend on stimulus. It shouldn’t surprise us if it turns out that defense spending eventually got somewhat higher than would be economically optimal in the middle of the largest war in history.
My comment on the above I left on DeLong's blog:
I think the multiplier issue is almost a red herring in regards to Keynesian measures required when savings rate soar (out of classic expectations or "forced" via war measures with lack of things to buy)and consumption dives. Obviously WW II spend "worked" - end of argument, and the size of fiscal stimulus FDR applied in peacetime did not do the trick, though important constitutional mandates were determined, rule of law via organizations like the SEC, and agencies to apply investments were initiated.
A far better example of Keynesian fiscal stimulus applied and the utility and "multiplier" it generated is the 1956 "Federal-Aid Highway Act of 1956" which created from scratch the Interstate Highway system. Avoiding for now chatting about cars and global warming - this was a massive undertaking which ended with a total $425 billion (2005 $) fiscal stimulus, unquestionable multiplier (most studies have it producing $1.5 and higher GDP per $1 spent)and had massive secondary and tertiary effects one cant account for such as auto industry growth to Howard Johnsons to...and so on. The project was solely conceptual in the start and certainly not "shovel ready".
Rather than worry about multiplier and whether or not it is "shovel ready", worry about making sure the project has utility and a long duration. Market pricing and the "rent" schedule will make for an almost immediate impact on GDP via first adjusting various market prices and then later with actual cash spend. The "shovel ready" is not required, only the certitude that the project will occur.
That's the trouble with abstracts or conceptual fiscal stimulus such as education or "green" technologies - the abstract nature will make for the GDP impact to not occur until actual cash flows are experienced .
So hard boundaried non-abstract projects which only a nation-state can budget for should be sought and declared. My call is the $600 billion high speed rail system nation wide. Or re do of the St Lawrence Seaway. Or rebuild every bridge over 20 years old (I am nervous driving over the Tappan Zee now). Or.. It has to be non-abstract and certain in public utility and it has to be not additive to existing programs and processes but be projects which the scope and size defy any budget unit but the federal.
The interesting question to ask is that if such projects are required, if we do not supply this fiscal spend in an obvious developing Fisher debt deflation spiral and if the USA as a power unit has any power or capability, that size of fiscal stimulus will occur. Sort of a weird supply side type thinking, voo doo I guess, but I think one can muse or even state that because FDR could not provide the fiscal stimulus outlined above, the fiscal stimulus did occur in a form that was politically applicable: war.
We will get our fiscal stimulus equal to the drop in consumption and investment and the rise in savings - one form or the other. I would prefer peace and the ability to drive over the Tappan Zee Bridge without thinking of the impact of water at such a height and the winter temperature of the Hudson.
Wednesday, January 21, 2009
SPX realized Vol (10 day) and VIX
Be careful wedding VIX with a directional bias in SPX.
By definition volatility can be bi-directional with those trading the gamma being long SPX options able to make money if the market moves up or down as they reset their deltas.
In fact, vol regimes are raised with a long term bull market, not bull, while short dated vol spikes up it seems only with a bear move given the impact of the correlation of the sum of the vol of all the underlying stocks in the index. This is how most think VIX will always behave.
But, while the VIX is trading down given the strong up move today, the vega of the underlying names along with the likely correlation staying unchanged or rising in the large bull move, and also given the reality of a large move in regards to delta hedging - all this makes for large loses in option trading today.
Also, while a bull market in the long run results in volatility rising in general, that has limits of being true from, say, low teens to high 20s but anything above 30 vol indicates stress, period. Stress from either hedgers not making money as the actual or realized volatility results in ill timed resetting of the delta exposure. Losses all around. Therefore while a bull market raises vol in general, once a certain level on vol is passed, increased vol reverts back to being a bearish indicator.
So, the VIX trades as most expect the VIX to move given the 30+ up move in SPX. But note how during this crisis how realized volatility - in this case the volatility the SPX showed in rolling 10 day periods - realized volatility was very prescient or at least concurrent with how the VIX ended trading.
I think for the up trade today and the drop in the VIX to give me comfort, I want to see it developing in a more steady fashion and showing a steady drop in realized volatility as well.
Do not think we are out of the woods yet by any means.
Inaugural Speech a Crisis
Getting a rebound day after, which may calm my concern, but I found the market verdict on Obama's inaugural very troubling. While not as severe, Obama has unusual similarity with FDR inaugural as the prime problem then as now was a bank credit crisis. Things have been learned in last 76 years and the monetary side of the fiscal-monetary measures has been implemented and has worked a shown by the return to normalcy for bank credit spreads in the money market tenor. But Bernanke, noting a near absence of coherent political and executive plan in the fiscal area has started to move down the yield curve and trying to evoke fixes in areas that in the end will only be fixed by appropriate fiscal measures. This is Bernanke's quantitative easing measures with program purchases of agency backed mortgages and now an intended program, TALF, in asset backed securities.
I could find only one solid Keynesian concept in the inaugural which addresses expectations and risk (or "rent" in Keynes words) schedules over time. When Obama said:
"We remain the most prosperous, powerful nation on Earth. Our workers are no less productive than when this crisis began. Our minds are no less inventive, our goods and services no less needed than they were last week or last month or last year. Our capacity remains undiminished. "
This is almost a direct quote from an essay Keynes wrote in the 30s found in "Essays of Persuasion" It indicated awareness that the crisis had nothing to do, in fact, with the justification or even reality of the fiscal actions to be taken, just that expectations have to be modified to a base schedule that can sustain growth. But that's all I could find. The rest of the inaugural was a hodge podge of shibboleths and wordsmith and a cynical lack of daring or courage resting solely on the historical significant event of being the first black President. In normal times that would have been sufficient to make the history books for all time - and it will. But in the midst of a once in a lifetime crisis, more courage and more daring and more dedication to showing resolve and the obvious, that a solution will occur with dispatch no matter what the cost in treasure, this was not forthcoming.
In March 1933 the SPX, after the immediate bank holiday solution after an extraordinary and immediate special session of congress called by FDR on his first day in office, showing resolve and definitive immediate action, rallied 22% in a few days - with a near immediate reversal of deflation and liquidity re-established in the banking system occuring. The stock market rallied the 22% almost immediately. These were problems that Hoover and most felt were intractable and just something that required fortitude and endurance which Americans have a history of accessing during tough times. FDR found that inhuman, unacceptable, and insisted on immediate action. Expectations which most academics thought were written in stone and would at minimum last a decade were reversed and shaped in one speech and with one day of policy choices. One day. "All we have to fear is fear itself". And FDR immediately demonstrated that was not a semantic phrase but that he enforced that philosophy immediately.
It is a serious and terrible error for Obama to take on what is basically a Hooverite train of thought, as ironic as that sounds. Paragraph after paragraph of text shows that Obama shares the standard view that we should be "afraid, be very afraid". Winter, woe, crisis, words have meaning as FDR showed and Obama's inaugural is a trail of tears. I was left with the idea that he was offering me the opportunity to show to all my good character but with near term results that I would not enjoy and basically suffer for the sake of my children. Just picture in whatever color or form your own representation of the schedule of expectation, of "rent" for the economy - I see this image as Obama spoke gremlin gleefully running down a structure indicating time slamming away at any positive outcome I could expect.
This inaugural speech, read without being aware this is the first black President and real historical significance - read with the idea that the speaker is a standard WASP very intelligent populist good looking male; read the text with that in mid as the speaker and you see not just a suave Jimmy Carter, but even at times Hoover.
Given the context this inaugural address is one of the most cynical and politically expedient and cowardly of any of the 44 addresses given.
With all the above in mind it is easy to see and understand why the Dow made the largest swoon in the history of data for when the leader of the USA provides his game plan.
Unless Obama reads stuff like this, accepts and understands the markets grading of his policy stance ( or lack there of), and makes corrections - he will have a four year term, Congress will come in Republican majority in 2010, the Senate and the Presidency Republican by 2012. The only administration to successfully apply Keynesian principles to date have been Republican - Eisenhower, Nixon, and Reagan. I thought of that as pictures of Obama were shown in the shadow of the Great Emancipator. Very ironic as perhaps Obama should have been running in the party of Lincoln, the Republicans.
SPX volatility surface certainly confirms the dim view I have of this inauguration:
I could find only one solid Keynesian concept in the inaugural which addresses expectations and risk (or "rent" in Keynes words) schedules over time. When Obama said:
"We remain the most prosperous, powerful nation on Earth. Our workers are no less productive than when this crisis began. Our minds are no less inventive, our goods and services no less needed than they were last week or last month or last year. Our capacity remains undiminished. "
This is almost a direct quote from an essay Keynes wrote in the 30s found in "Essays of Persuasion" It indicated awareness that the crisis had nothing to do, in fact, with the justification or even reality of the fiscal actions to be taken, just that expectations have to be modified to a base schedule that can sustain growth. But that's all I could find. The rest of the inaugural was a hodge podge of shibboleths and wordsmith and a cynical lack of daring or courage resting solely on the historical significant event of being the first black President. In normal times that would have been sufficient to make the history books for all time - and it will. But in the midst of a once in a lifetime crisis, more courage and more daring and more dedication to showing resolve and the obvious, that a solution will occur with dispatch no matter what the cost in treasure, this was not forthcoming.
In March 1933 the SPX, after the immediate bank holiday solution after an extraordinary and immediate special session of congress called by FDR on his first day in office, showing resolve and definitive immediate action, rallied 22% in a few days - with a near immediate reversal of deflation and liquidity re-established in the banking system occuring. The stock market rallied the 22% almost immediately. These were problems that Hoover and most felt were intractable and just something that required fortitude and endurance which Americans have a history of accessing during tough times. FDR found that inhuman, unacceptable, and insisted on immediate action. Expectations which most academics thought were written in stone and would at minimum last a decade were reversed and shaped in one speech and with one day of policy choices. One day. "All we have to fear is fear itself". And FDR immediately demonstrated that was not a semantic phrase but that he enforced that philosophy immediately.
It is a serious and terrible error for Obama to take on what is basically a Hooverite train of thought, as ironic as that sounds. Paragraph after paragraph of text shows that Obama shares the standard view that we should be "afraid, be very afraid". Winter, woe, crisis, words have meaning as FDR showed and Obama's inaugural is a trail of tears. I was left with the idea that he was offering me the opportunity to show to all my good character but with near term results that I would not enjoy and basically suffer for the sake of my children. Just picture in whatever color or form your own representation of the schedule of expectation, of "rent" for the economy - I see this image as Obama spoke gremlin gleefully running down a structure indicating time slamming away at any positive outcome I could expect.
This inaugural speech, read without being aware this is the first black President and real historical significance - read with the idea that the speaker is a standard WASP very intelligent populist good looking male; read the text with that in mid as the speaker and you see not just a suave Jimmy Carter, but even at times Hoover.
Given the context this inaugural address is one of the most cynical and politically expedient and cowardly of any of the 44 addresses given.
With all the above in mind it is easy to see and understand why the Dow made the largest swoon in the history of data for when the leader of the USA provides his game plan.
Unless Obama reads stuff like this, accepts and understands the markets grading of his policy stance ( or lack there of), and makes corrections - he will have a four year term, Congress will come in Republican majority in 2010, the Senate and the Presidency Republican by 2012. The only administration to successfully apply Keynesian principles to date have been Republican - Eisenhower, Nixon, and Reagan. I thought of that as pictures of Obama were shown in the shadow of the Great Emancipator. Very ironic as perhaps Obama should have been running in the party of Lincoln, the Republicans.
SPX volatility surface certainly confirms the dim view I have of this inauguration:
Sunday, January 18, 2009
Grim thoughts: truly frightened
I guess I shouldn't read the NY Times this seriously and especially on Sundays now. Amongst all the Saint Obama (man, I really really hope he is anointed) walking (hope not slouching) to Bethlehem stories found article after article which outline that this is not some recession we are entering but without enlightened swift policy, this is it - the big one.
Mostly in NY City, the financial segment of the economy has lost 240,000 jobs over last 18 months - all at the highest percentile in income for the nation be it clerical or head of the shop.
Trade is down world wide with the best being the likely cooked books or at least rigged currency of China down YoY 2% and the rest of the world down well over 10% in exports YoY.
Then we read banks are not lending out TARP funds but hoarding. Do you expect bank executives acting on behalf of their shareholders, as they should and have to legally, would do anything else?
And so on.
Folks, none of this pattern was seen before 81, 87, 88-91, 94, 98, 00, 02 - be it technical like Russian collapse of 98 or the stock market crash or the agency mortgage backed crash of 94 or Long Term Credit collapse, or dot-com crash of 00 - never have we even come close to such devastating macro economic metrics. I also can not find them as I extend past my experience, into the 70s, or the mania crashes of the 60s, the late 50s Eisenhower recession that gave Kennedy his entre, or the Truman Korea recession.
There are only two times these numbers start shows some precedent and it is not even 29 - 30, but 33 to 36 and the numbers that prompted the Fed creation in 07, the crash of 1903.
And while there was some correlation amongst global economies - with 03 having more global wide impact than 33 - 36, the correlation between nations has never been higher.
This is a global calamity in the making.
All those who have some wisp or even a cable of importance in the line of development of economic policy should, like Dickens Christmas Carol, take a ride in past, present, and future worlds given our current Scrooge orientation.
It is crucial we take on some common reference points and crisis management behaviour:
1. The USA is the unipolar power or factor - or call it whatever you have to be ye French or Harvard grad;
2. All rests on the USA - we save the USA we save the world, the USA crashes and carries on as it is Global misery of something we have not seen but for the worst of WW II will occur.
3. Keynes - as he seems to be the only developed lexicon that is shared and understood - is our template of solution
4. A steady read of bank crisis similar to what the USA is going through required an average of 15% of GDP absorption of problematic assets (toxic assets - call it what you will) onto the national balance sheet or national agencies, and then result to either a 4% of GDP to 18% of GDP (Japan's zombie approach) all in final cost.
5. That the balance sheet required for the bank crisis resolution is not at all the same funds required for the Keynesian fiscal stimulus spend required.
6. The Keynesian fiscal stimulus will be equivalent to the drop in consumption which results from the increases savings from folks with their wits scared out of them. Figure out the change in savings rate and one has the size of the fiscal stimulus required. The USA entered this crisis with a problematic 0% savings rate.
7. All moralistic and judgemental themes and approaches that qualifies bands of the populace going into this crisis must be scrapped. It will only impede the solution if the starting point is about the lack of character or morals of "spenders" and equally bad no status should be assigned to "savers". In fact savers now are the dangerous element.
8. There is no generational assumption or passing on of burdens in the USA. Anything we do now will either provide a vital and useful context for future generations or will provide a crucible of pain and all of that rests on civic structure and organization and has nothing to do with debt. "You shall not crucify man upon a cross of gold" has much applicability now as when Jennings used this rallying cry. The USA, as far as a valuation of going concern has only two values - infinity or zero. It is a digital with nothing in between. There is no shades of gray or incremental movement in this. In the long run the USA will prevail and maintain seinorage and the question is how much misery and suffering domestic and international does the path entail.
9. And the fact the USA will maintain seinorage, of an infinite economic value spot and forward, is perhaps the most dangerous and important variable. This is because the core power of the USA will be maintained and those in political control of the USA power will in the end insist on a reflation. The reflation will occur one way or another. Water will find its level. Given all the above the leveling involves at some point a $2 trillion bank crisis solution with at least a $1 trillion Keynesian stimulus - a total of $3 trillion or over 20% of USA GDP. This is the most alarming and critical consideration. Realize this leveling of the waters will occur, one way or another.
Historically the USA has only been able to implement a fiscal spend and evolution of over 10% of GDP via war. No other motive has been able to overcome the political tensions and frictions. This explains why Mussolini and Hitler were able to move their countries out of the depression that for them started in the 20s - dictatorship of national socialism allowed the development of political will to allows such a stimulative spend over 10%. It explains why the common understanding that the Great Depression was not ended but for WW II.
Therefore, certainty can be applied with the thought that we either develop a new commonly shared lexicon and principles such that the democratic political debate can apply a budget with well over 10% deficit in any one year or we will have war.
The trade numbers in today's NY Times start to suggest the genesis of the tensions required to prompt either a global potential adversary attack us and allow for a righteous defense as in Pearl Harbor, or for us to cook up the shared righteous wrath to attack someone, anyone, so as to go out and spend $2 trillion dollars.
The choice is ours. I hope everyone adopts the above points as a starting point.
I also must include a disclaimer that some emotional alarmist feeling in the above that I might express is that eldest son is in the US Army and middle son wants to sign up next week.
Mostly in NY City, the financial segment of the economy has lost 240,000 jobs over last 18 months - all at the highest percentile in income for the nation be it clerical or head of the shop.
Trade is down world wide with the best being the likely cooked books or at least rigged currency of China down YoY 2% and the rest of the world down well over 10% in exports YoY.
Then we read banks are not lending out TARP funds but hoarding. Do you expect bank executives acting on behalf of their shareholders, as they should and have to legally, would do anything else?
And so on.
Folks, none of this pattern was seen before 81, 87, 88-91, 94, 98, 00, 02 - be it technical like Russian collapse of 98 or the stock market crash or the agency mortgage backed crash of 94 or Long Term Credit collapse, or dot-com crash of 00 - never have we even come close to such devastating macro economic metrics. I also can not find them as I extend past my experience, into the 70s, or the mania crashes of the 60s, the late 50s Eisenhower recession that gave Kennedy his entre, or the Truman Korea recession.
There are only two times these numbers start shows some precedent and it is not even 29 - 30, but 33 to 36 and the numbers that prompted the Fed creation in 07, the crash of 1903.
And while there was some correlation amongst global economies - with 03 having more global wide impact than 33 - 36, the correlation between nations has never been higher.
This is a global calamity in the making.
All those who have some wisp or even a cable of importance in the line of development of economic policy should, like Dickens Christmas Carol, take a ride in past, present, and future worlds given our current Scrooge orientation.
It is crucial we take on some common reference points and crisis management behaviour:
1. The USA is the unipolar power or factor - or call it whatever you have to be ye French or Harvard grad;
2. All rests on the USA - we save the USA we save the world, the USA crashes and carries on as it is Global misery of something we have not seen but for the worst of WW II will occur.
3. Keynes - as he seems to be the only developed lexicon that is shared and understood - is our template of solution
4. A steady read of bank crisis similar to what the USA is going through required an average of 15% of GDP absorption of problematic assets (toxic assets - call it what you will) onto the national balance sheet or national agencies, and then result to either a 4% of GDP to 18% of GDP (Japan's zombie approach) all in final cost.
5. That the balance sheet required for the bank crisis resolution is not at all the same funds required for the Keynesian fiscal stimulus spend required.
6. The Keynesian fiscal stimulus will be equivalent to the drop in consumption which results from the increases savings from folks with their wits scared out of them. Figure out the change in savings rate and one has the size of the fiscal stimulus required. The USA entered this crisis with a problematic 0% savings rate.
7. All moralistic and judgemental themes and approaches that qualifies bands of the populace going into this crisis must be scrapped. It will only impede the solution if the starting point is about the lack of character or morals of "spenders" and equally bad no status should be assigned to "savers". In fact savers now are the dangerous element.
8. There is no generational assumption or passing on of burdens in the USA. Anything we do now will either provide a vital and useful context for future generations or will provide a crucible of pain and all of that rests on civic structure and organization and has nothing to do with debt. "You shall not crucify man upon a cross of gold" has much applicability now as when Jennings used this rallying cry. The USA, as far as a valuation of going concern has only two values - infinity or zero. It is a digital with nothing in between. There is no shades of gray or incremental movement in this. In the long run the USA will prevail and maintain seinorage and the question is how much misery and suffering domestic and international does the path entail.
9. And the fact the USA will maintain seinorage, of an infinite economic value spot and forward, is perhaps the most dangerous and important variable. This is because the core power of the USA will be maintained and those in political control of the USA power will in the end insist on a reflation. The reflation will occur one way or another. Water will find its level. Given all the above the leveling involves at some point a $2 trillion bank crisis solution with at least a $1 trillion Keynesian stimulus - a total of $3 trillion or over 20% of USA GDP. This is the most alarming and critical consideration. Realize this leveling of the waters will occur, one way or another.
Historically the USA has only been able to implement a fiscal spend and evolution of over 10% of GDP via war. No other motive has been able to overcome the political tensions and frictions. This explains why Mussolini and Hitler were able to move their countries out of the depression that for them started in the 20s - dictatorship of national socialism allowed the development of political will to allows such a stimulative spend over 10%. It explains why the common understanding that the Great Depression was not ended but for WW II.
Therefore, certainty can be applied with the thought that we either develop a new commonly shared lexicon and principles such that the democratic political debate can apply a budget with well over 10% deficit in any one year or we will have war.
The trade numbers in today's NY Times start to suggest the genesis of the tensions required to prompt either a global potential adversary attack us and allow for a righteous defense as in Pearl Harbor, or for us to cook up the shared righteous wrath to attack someone, anyone, so as to go out and spend $2 trillion dollars.
The choice is ours. I hope everyone adopts the above points as a starting point.
I also must include a disclaimer that some emotional alarmist feeling in the above that I might express is that eldest son is in the US Army and middle son wants to sign up next week.
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