Monday, April 9, 2012

The Fed's Confidence Game

The "sure thing" TBT ultrashort treasury fund is down 10% over the last week and 74% since inception. Perhaps it is time for a thought experiment.

1. Conventional wisdom believes that the Fed has artificially lowered interest rates.

2. Conventional wisdom believes that this lowering of interest rates averted a deflationary Great Depression.

Correct me if I'm wrong but I think that's pretty much what conventional wisdom thinks. Right?

Let's continue with this logic to see what interest rates would be right now if the Fed had done nothing.

1. We'd be in a deflationary Great Depression.

2. In general, we would expect to see amazingly low interest rates during a deflationary Great Depression. Even buried cash investors would be pleased with their real returns.

Since interest rates are currently higher than the interest rates we would expect to see in a deflationary Great Depression, can it really be argued that the Fed has artificially *lowered* interest rates?

So what could this mean?

Perhaps the Fed has artificially *raised* interest rates and investors simply don't realize it yet? How can this be explained?

Perhaps the Fed convinced too many investors that riskier assets weren't all that risky. As low as interest rates seem right now, they could be even lower if more investors saw the true risks in riskier assets.

It's just a symptom of the following crackpot theory proposed by a safety-seeking retired anonymous blogger on the Internet (me, lol).

It will be harder and harder to make easy money off of money. That era is over.

Take it for what it's worth. This is not investment advice.


April 10, 2012
Stock Market Struggles With Worst Losing Streak Since August

This is starting to get out of hand a little bit.

Disclosure: Long cash, long-term TIPS, and long-term I-Bonds.

40 comments:

Stagflationary Mark said...

You may be wondering why this post is dated yesterday.

That's when I wrote most of it. I was busy yesterday and didn't get a chance to finish it.

If nothing else, you can see that I didn't write this in response to today's stock market selloff. That's just a bonus, lol. Sigh.

Mr Slippery said...

Your logic that the Fed has unintentionally raised interest rates seems reasonable.

The number, size, and coordinated efforts of central banks since 2008 has not been seen in history. At least I don't think so. Given that, I don't put too much credence in any "market". Not FX, stocks, bonds, or commodities.

Especially not FX. What kind of market is there in the EURCHF when the Swiss central bank has promised to print unlimited francs to buy euros?

Commodities at least have a real demand component, so they may be the closest to providing some kind of economic signal through the noise. But unlimited money printing can distort that signal up to the point of shortages.

AllanF said...

My wisdom, doubtful it's conventional, is that interest rates are the hand the Fed wants everyone to watch while they use the other to push toxic debt from Wall Street onto tax-payers.

Stagflationary Mark said...

Mr Slippery,

"Your logic that the Fed has unintentionally raised interest rates seems reasonable."

If that's true (and I'm not claiming it is since this is just a thought experiment), then it would explain why TBT investors were horribly burned.

1. Believe interest rates are manipulated lower.
2. Believe that nothing can be permanently manipulated.
3. Believe in return to the mean.
4. Therefore buy TBT.

If wrong at step #1 (interest rates were actually manipulated higher), then brace for a world of pain.

Once again, just at theory.

If the stock market continues to tank then the theory could have some serious anecdotal evidence to back it up though. D'oh! ;)

Stagflationary Mark said...

AllanF,

We just need to summarize our two theories.

On the one hand, there's the Federal Fund rates set by a bunch of guys sitting in a room.

On the other hand, there's all this toxic debt from Wall Street being pushed onto taxpayers.

And on the third hand, there is some sort of confidence game going on. ;)

Troy said...

My general take is that Greenspan expanded the money supply colossally 1995-2006 to facilitate offshoring.

Just like too many dollars chasing goods pushes the price of goods up, too many dollars chasing returns chases yields down.

And I think it's obvious that this economy has too much money at the top -- the "savers" -- and not enough at the bottom, the "schmucks".

I think when the 99% is broke like they are now, we're not going to get inflation.

Few people on the internet share this thesis, LOL.

Stagflationary Mark said...

Troy,

Just like too many dollars chasing goods pushes the price of goods up, too many dollars chasing returns chases yields down.

Yes! I believe that!

October 21, 2007
The Death of Real Yields

I referred to this article to back my "Death of Real Yields" theory.

July 12, 2005
Greenspan's Mysterious Conundrum

In conclusion, the explanation of the low yield on U.S. government securities is neither expectations of low inflation or falling global time preferences ("global savings glut"), but money-pumping by the Fed and other central banks and speculation in continued high levels of money-pumping.

So back to what you have stated.

Few people on the internet share this thesis, LOL.

I believe! I'm a true believer!

Sorry, got a bit carried away there. ;)

Stagflationary Mark said...

By owning TIPS and I-Bonds, I have actually been somewhat of an inflation agnostic. We could have high inflation. We could have low inflation. I wasn't sure.

Contrary to popular opinion, TIPS and I-Bonds are not so much an inflation play as they are a real yields play.

They are both directly tied to real yields. If you think real yields will fall then you should buy them. If you think real yields will rise then you should sell them.

That's pretty much true regardless of what inflation does, which seemed pretty good to me as an inflation agnostic.

I do have stagflationary in my name of course, but that mostly just indicates my low real yield mood (real yields were also low in the 1970s). I've leaned deflationary since 2004 and I've also leaned inflationary. My mood changes.

Put another way, if I was 100% certain that severe inflation was in our future then I would have thought up something better than inflation protected treasuries and I-Bonds. Surely there would be something better than paper to protect me. I'm not positive though. There are many ways this can play out (within my lifetime anyway).

Stagflationary Mark said...

20-Year TIPS Chart

Note that the fall in real yields actually happened during the supposed recovery. That's not how it is supposed to work. It is not what mainstream economists would predict.

Take Jeremy Siegel's prediction of higher real yields on February 2, 2011 and then look at the chart.

If he's that wrong on interest rates, then what else is he wrong about? His 1994 theory on Stocks for the Long Run?

Time will tell!

Mr Slippery said...

Check out this ZH article on Treasury floaters.

I'm not sure if floating rate notes mean the Treasury is afraid of not being able to sell fixed rate notes. I think the article implies that.

I would have to see the details of the Floaters to have an opinion on whether they are good or bad, and what the rate is tied to. I-bonds and TIPS are essentially floaters tied to the CPI.

Opinions?

Scott said...

I had a small position in TBT a couple of years ago. Fortunately, after about six months I had the courage to take my losses and get out. I shudder to think about where it'd be now.

My fallacies were:

2. Believe that nothing can be permanently manipulated.
3. Believe in return to the mean.

Scott said...

RE death of real yields:

I agree. No physical investment can generate a rate of return that can match that of exponentially growing financial "assets". So given exponential credit growth, all crowd into financial "assets". At some unpredictable point the trend breaks and the assets are revealed to be castles in the air.

Scott said...

Mr. Slippery, the key from that paper is IMO this:

"This discussion was conditioned by the similar situation faced by the U.S. Treasury in 1919 after it promised to stabilize bond prices during and after WWI. This policy caused conflict with certain Fed policymakers and the eventual losses on Liberty bonds were still remembered by Congress and the Treasury in 1951, 30 years
later. "

Per Wikipedia the Treasury defaulted on these bonds and:
"The Act of Congress which authorized the Liberty Bonds is still used today as the authority under which all U.S. Treasury bonds are issued."

So the floater FRN's wold designed to make good on losses to T-holders when the Fed exits ZIRP.

Stagflationary Mark said...

Mr Slippery,

I can offer this.

It was believed that the government would ultimately save money by issuing TIPS (a form of floating rate notes). The thinking was that investors/savers would accept less real yield in exchange for the insurance.

In hindsight, no such luck. For the most part, investors have paid nothing for the insurance. It's not all bad news for the government though. I own more treasuries than I would otherwise, simply because TIPS are offered. That's a fact. There are more than likely others like me. Therefore, I would theorize that treasury rates overall are lower.

The idea of floating rate notes simply strikes me as the government attempting to repeat the process. It is a smart thing for the government to do (in any environment, good or bad). I don't see it as any indication that the bottom is about to fall out.

It's almost as smart as massively lowering the amount of I-Bonds we could buy as of a few years ago.

1. Can't have us all defer taxes for 30 years!
2. The 0.0% fixed real rate is economic paradise compared to the rate of the 5-year TIPS, lol. Sigh.

Stagflationary Mark said...

Scott,

You are indeed a brave man to share your TBT story.

I'll share one of mine.

I bought Conseco stock once and it was a large position. The stock was about $30. At around $26 the Yahoo message board shorts talked me down with rational well-reasoned arguments (no "SHORT THIS PIG!!!" advice, which was a rare treat). I sold.

I'll be darned if that stock didn't keep right on falling after I exited, much to the dismay of the message board's "table pounding screaming bargain" bull. And fall it did, to virtually nothing.

I stuck around for the duration. I felt obligated to warn others of the value trap and also felt a sense of loyalty to those who warned me. At one point I was even quoted by a mainstream article about the demise of the stock. I said, paraphrased from memory, "Conseco is a procrastinator's dream. The longer you wait to buy it, the cheaper it gets."

Stagflationary Mark said...

Conseco

In 1998, Conseco purchased the former Greentree Financial, one of the largest financiers of mobile homes, in an attempt to diversify into consumer financial services. They also bought life insurance company Colonial Penn later that year, changing their name to Conseco Direct Life, though changing the name back to Colonial Penn in 2001 (known as Banker's Conseco Life Insurance Company in New York state). Conseco (though not its subsidiary insurance companies) entered Chapter 11 reorganization in 2002 and emerged nine months later in 2003. The third-largest U.S. Chapter 11 filing, after WorldCom Inc. and Enron Corp. In the process of reorganization, GreenTree was divested and Conseco is now solely focused on the insurance industry.

Stagflationary Mark said...

There is a *must read* conversation at Credit Bubble Stocks, assuming one would find a debate between a scientist and an economist over the limits to growth as amusing as I did.

nanute said...

Mark,
Here's an interesting conversation from Dec 2010 on QE2 and yields: http://macromarketmusings.blogspot.com/2010/12/qe2-and-rising-yields.html

Troy said...

I'm with the economist and not the physicist in that debate.

The key thing is population. Population takes raw resources that are indeed bounded by our means to recover and productize them.

But this is still a big rock and we have barely scratched the surface wrt natural resources. We don't have an energy problem we have a technology problem, the heat not 100' under our feet is enough to provide our current energy needs.

The physicist doesn't yet understand the meaning of wealth and he's looking at the economy as the end and not the means.

Wealth is simply that which satisfies human needs and wants. Our economy has grown so massive thanks to the increasing virtualization and provision of soft-services that do not actually consume much in the way of natural resources.

To understand the economy one must think a bit about what wealth is, how this relates to what an economic good is, and what a service is.

When it hit me that a good is simply a tangible form of wealth that provides services I had left the Matrix as it were and found a clearer model of how the world is working at the economic level.

Troy said...

I also got into a debate on Reddit with some pro-nuke guy who threw out the statement that if we'd been building nukes we wouldn't have our high energy costs today.

I had to do an 'excuse me?' thing and point out that electricity is really not the long pole in anyone's budgetary tent, unless they live in Houston or something.

Troy said...

From the comments section:

"This statement, I think, is certainly wrong. Once you and those you love are fed, clothed and sheltered from harm and disease (something that seems doable even on our current energy budget) what else is there to life or economic activity other than endless variations on fancy desserts (arts, pursuit of learning or status, social activities)?"

bingo -- this person gets it.

And what people don't really understand is how much of our wealth production is being siphoned off by the rentier class. The top 20% of the country owns over 90% of the financial assets.

Heh, I see this comment also says what I was saying above.

dearieme said...

It's the new tax year in Britain. (It begins on April 6th because that's what became of the Quarter Day on the old calendar when the new one was introduced. Or something like that.)

So I am waiting for the government to launch a new issue of its absurdly good value Index-Linked Savings Certificates. Alas, some curmudgeons are predicting that there will be none put on sale this year because they are too much of a good thing. Woe, woe, and thrice woe!

dearieme said...

Perhaps everyone should worry more about inflation.
http://blog.redington.co.uk/Articles/Anatole-Kaletsky/April-2012/INFLATION-IS-BACK-FOR-GOOD.aspx

Troy said...

My comment in moderation:

The great comment above about ‘utility’ is circling towards what ‘wealth’ really is — sufficient utility, the absence of human wants and needs.

The per-worker GDP in the US is over $100,000 currently. We have an amazingly productive economy, even if its output is distributed too unevenly.

One other dynamic that people are missing is economic rents in the current system.

Housing is most people’s dominant life expense and most of this housing expense is not paying for the physical wealth of the housing good, it is actually paying the economic value of the abstract perpetual tenancy rights to exclusively use (and in the case of ownership, profit) from the property.

Same thing with our #2 life expense, medical care. Per-capita medical costs in the US are 2-3x the OECD average, there are immense economic rents also to be found here.

Low energy costs have allowed these rents to grow and grow over the past decades, and should energy costs go up thanks to supply failure, my thesis says housing and other rents will go down in response.

Our human experience is not as mechanistic as the physicist believes. The economy is a means, not an end, and economics — how the wealth pie is divided — is really ‘political economy’, not the abstract science of scarcity some practitioners prefer to the limit discussion to, either.

Stagflationary Mark said...

nanute,

Your link from 2010 is a real gem!!

Though it too soon to know for sure, the data seem to support the recovery interpretation of the rising nominal yields. Below is a figure showing the 10-year expected inflation rate and the 10-year real interest rate from the TIPs market. This figure shows that inflation expectations pick up first and eventually the real interest rate does too: (Click on figure to enlarge.)

It was certainly too soon to know for sure. The 10-year real interest rate is now below 0%, lol.

Stagflationary Mark said...

Troy,

I am definitely with the physicist in that debate.

He was not arguing that there wouldn't be enough energy. He argued that it would create too much heat.

"This statement, I think, is certainly wrong. Once you and those you love are fed, clothed and sheltered from harm and disease (something that seems doable even on our current energy budget) what else is there to life or economic activity other than endless variations on fancy desserts (arts, pursuit of learning or status, social activities)?"

I agree. That's not real growth though, and that is all the physicist was trying to argue.

Stagflationary Mark said...

dearieme,

So I am waiting for the government to launch a new issue of its absurdly good value Index-Linked Savings Certificates. Alas, some curmudgeons are predicting that there will be none put on sale this year because they are too much of a good thing. Woe, woe, and thrice woe!

That's how I felt when the government lowered the amount of I-Bonds we could buy. Thrice woe!

Stagflationary Mark said...

Troy,

Our human experience is not as mechanistic as the physicist believes.

Are you sure we read the same article?

The physicist's main point was that real economic growth cannot extend to infinity in a finite world. Do you believe otherwise?

Stagflationary Mark said...

In my opinion, the physicist didn't concern himself with the particulars of which economic system we had or could have. I think if you were to debate him on that he would probably agree with much of what you have to say.

All he wanted to show was that the physics of the real world would eventually limit real growth.

Stagflationary Mark said...

In other words, even if we were to miraculously come up with the perfect economic system that promoted real growth optimally, physics would still limit real growth within the next few hundred years.

Physicist: Before we tackle that, we’re too close to an astounding point for me to leave it unspoken. At that 2.3% growth rate, we would be using energy at a rate corresponding to the total solar input striking Earth in a little over 400 years. We would consume something comparable to the entire sun in 1400 years from now. By 2500 years, we would use energy at the rate of the entire Milky Way galaxy—100 billion stars! I think you can see the absurdity of continued energy growth. 2500 years is not that long, from a historical perspective. We know what we were doing 2500 years ago. I think I know what we’re not going to be doing 2500 years hence.

Troy said...

The physicist's main point was that real economic growth cannot extend to infinity in a finite world. Do you believe otherwise?

Once we're put into the VR pods all bets are off.

It's kinda a dumb argument that is missing the reality of the present situation.

We are already living in the Jetsons future now:

http://research.stlouisfed.org/fred2/graph/?g=6oy

but since our economy is as corrupt as the Soviets ca 1985 we need to talk about "growth" to hide the corruption and keep the ponzi going.

I was slightly flabbergasted by this photo:

http://mit.zenfs.com/102/2011/04/Paul-Ryan.jpg

The discussion today is just 99.9% BS, if not 100%.

We don't need growth, we need redistribution.

Now, it's easy to say this as an American and ignore the 4B+ people living in poverty, but I would say that every society that can limit itself to ZPG can also have an American standard of living eventually.

Our problems are political problems not economic or physics-related.

As I said elsewhere recently, once someone somewhere pointed to some land and said "this is mine", politics got involved in economics. John Locke observed as much.

Troy said...

That's not real growth though

Then growth is the wrong metric.

We need to examine utility and its distribution.

I said this in relation to Japan -- if a society can feed, clothe, house and hospital itself, it is a wealthy society.

Japan can do that. We, in our current economic reality, cannot, as evidenced by our $700B/yr+ hard trade deficit.

More people require "growth" to sustain. Same or fewer people really do not. The economic footprint -- in terms of actual hard-wealth consumption -- of a happy person need not be that much in the modern world, so much of the present ratrace is just making sure the parasitical rent-skimmers in the system get their due.

Stagflationary Mark said...

Troy,

Once we're put into the VR pods all bets are off.

He covered that in the article. It may require too much energy to put everyone in a VR pod.

We don't need growth, we need redistribution.

Once again, he's not necessarily disagreeing with you. He shared no opinion on that. He's a scientist trying to explain that the math behind the growth models is doomed to fail.

Then growth is the wrong metric.

I agree. I have stated so many times. Our economy should not need to grow exponentially for *all* of us to prosper.

Instead, we use growth as a crutch, constantly stealing prosperity from those who come after us (our children, our grandchildren).

Stagflationary Mark said...

You would clearly say that we steal from ourselves too, as a parasite would, and I would not disagree.

Stagflationary Mark said...

Put another way, we've put ourselves in a horrible situation where the ponzi scheme we've been running requires *real growth* in order to just stay where we are on the tread mill.

Troy said...

the ponzi scheme we've been running requires *real growth* in order to just stay where we are on the tread mill.

Dunno, really. We're just locked into BS thought patterns and meek acceptance that the status quo is the way things have to be.

What does it mean to steal from our future? Is that even possible?

I think it's safe to say the $5T sovereign debt held by foreigners is a check our future citizenry will have to cash, but that's only 1/3 our national debt and 1/10th of the total debt picture (though much of that is no doubt also owed to foreign interests).

I suspect our current system could lock in zero monetary inflation, zero wage growth and things would eventually work themselves out.

The problem with that is existing power centers -- The Establishment -- would take it in the pants with defaults and other messy retrenchments from the existing status quo.

I consider the trade deficit our #1 economic problem. I didn't check all the Republican debates, but the couple I did check didn't mention it at all.

The BS floating around this country is really something. I don't know which is worse, if it is intentional disinformation or just our collective inability to see root causes.

Stagflationary Mark said...

Troy,

What does it mean to steal from our future? Is that even possible?

Perhaps steal isn't quite the right word. Let me replace it with borrow. That's assuming we pay it back of course.

I consider the trade deficit our #1 economic problem.

If I had to make a list of my concerns, that would be the top of my list as well.

Troy said...

I think we'll agree that our foundation of debt is predicated on "growth" such that the masses will be able to pay at least the interest on this burden.

I was watching Chris Hedges on BookTV yesterday and he had an interesting point, that Wilson got us into WWI in response to the bankers' panic about their loans to the Allies in danger of defaulting (due to the Germans being able to redeploy 100 divisions from the Eastern Front).

While I think this thesis has timing challenges, it's one of those things that certainly sounds believable.

I don't think the System is that nefarious though.

increasing consumer debt leverage and declining wages are symptoms of an untenable status quo that is unwilling to face expensive truths.

The Nordic states do not particularly enjoy their 50%-to-GDP tax burdens, but that is apparently what it takes to fund government in the 21st century.

Economies are path-dependent things though, and us moving towards that state of sustainability is a path of pain that the powers in the current system aren't willing to allow.

That would be the 'high road'. The 'low road' is just moving back to the 19th century norms of wealth differentials and privilege for the few vs. poverty for the masses.

In the Latin, Privilege means 'private law'.

Stagflationary Mark said...

Troy,

I think we'll agree that our foundation of debt is predicated on "growth" such that the masses will be able to pay at least the interest on this burden.

As a holder of long-term treasury bonds, I was planning to die broke (as I burn through the principal).

If I only get the interest then my plan should pay off sooner than expected, lol. Sigh.

Gallows humor.

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