Posts Tagged ‘Interest Rates’

Why 2010 May Be Quite Similar to 2009


If you did well this past year, I guess that’s a good thing!

Friday is my market day and it seems that with the new year some realignment of the big picture is in order. Note of optimism: When you know what’s going on you can properly position yourself to benefit from its leverage. No condition is ever entirely good or entirely bad. So here’s what’s going on…

“Sentiment Oscillation” or “Paradigm Shift”.
That’s the reason for all this mayhem. As general conditions continue to change (as they have since 2007), so will the general mindset. From growing to sustaining. From net profit to net loss. From Investment to saving. From short-term gains to long-term advantage.

Let’s focus solely on economic facts:

The How:

  1. Internationally Governments have already allocated rescue money that will be spent over the next few years
  2. They have also lowered Interest Rates which spurs a higher inflation of credit
  3. When Rates rise savings gains precedence and production falls decreasing the supply of goods and labor
  4. Less supply causes over-demand and higher prices for real goods and commodities
  5. When commodities prices rise, they tend to cut into expenses thus lowering profits
  6. Lower profits and demand for cash decrease momentum of corporate investment and the stock markets decline
  7. Lower Markets lower the sentiment of the consumer and spending decreases
  8. Less sales means less revenue and retail venues under pressure go under causing a Commercial Real Estate bust
  9. With Investing and Equity down and out people turn to Savings and Cash
  10. With Bond markets already pressured by higher Interest Rates and a debt laden currency people begin to turn to Precious Metals and Tangible Goods


  1. Someone say Bailout? Trillions have been spent and Trillions more will
  2. With the lowest Interest Rates in decades credit is merely being deferred
  3. Businesses decide to save rather than reinvest profits
  4. This one’s tricky but the former ALWAYS leads to latter
  5. Even if businesses raise prices, profits will fall
  6. Bond yields begin to resemble stock dividends only with less apparent risk
  7. Higher stock prices are always met with consumer exuberance
  8. This has already begun but has been prevented by soon ending rescue funds
  9. With higher Interest rates CD’s and Money Market funds begin to make sense again
  10. This is what happened during the 70’s as Real Interest Rates remained negative

Investing Advice: If you are going to “invest”, you must understand that the next 10 years will be similar to the last. Much higher prices for real goods, much lower valuations for equity and paper. This is because we’re doing the same things over (lower rates, more issuance of credit, more debt to pay off). These are times to seek under-valued out-of-favor securities.

Business Advice: If you are going to do business, I believe you will be better off than many people trying to make ends meet on unemployment checks and the reason for that is the ability to be proactive. Your success is what you make of it, and if you’re determination is deep then no recession or even depression could abstain it. Focus on providing customers with durable and consistent value.

Fundraising Advice: If you are in the legions of the eager financiers trying to keep the lights on in your non-profit, raising for a local charity or even seeking capital for your small business, remember that people are always searching for the best place to put their money. Your job is to provide them with the sense of value that its going to the right place for the right reasons.

Have an awesome weekend!

The Credit Crisis Visualized


An entertaining and creative explanation of what led us into this debacle.

The Crisis of Credit Visualized – Part I (about 7:30)

The Crisis of Credit Visualized – Part II
(about 3:45)

Glad you enjoyed!


Fair Value of Gold

And Why Investors Buy

We have commented on what the future has in store for stocks, whether you are buying for dividends sake, or for earnings valuations. Now we care to top it all off with an explanation as to why any conservative investor would and should buy gold.

Why So Unconventional?
In the early chapters of The Intelligent Investor, after explaining the balance between bonds and common stocks, Ben Graham goes into a lengthy analysis regarding earnings-price ratio relative to dividend yields. It does not pay, he explains, for the investor to remain invested in bonds during times when inflation of general goods are rising, and is better off holding stocks, albeit the lesser of two evils.

Mind you, the above is written by a man who experienced markets between the 1920s and early 1970s. Unfortunately, when Graham wrote the above in 1971, gold was still unavailable to the average investor and was still linked to the U.S. Dollar. This means that inflation, although an issue had no weight whatsoever with gold, as nominal loss and Dollar devaluation were synonymous.

If his book were written just a few years later I believe he’d be all the more wiser (and wealthier!) and would have urged investors to buy gold as an adequate hedge against inflation relative to interest rates. Real Interest Rates (IRs minus CPI).

Real Interest Rates and Gold
When real rates turn negative due to rising inflation greater than the return on cash, it makes little or no sense to hold anything currency denominated. This is where gold plays a crucial role that it has not played in over 120 years – the ultimate sound currency.

When investors squabble over gold being a hedge against inflation (flight to assets) or deflation (flight to currencies), what they really refer to are real rates of interest. Gold now has the ability to act as both a currency that retains its value amidst a flight from fiscal assets and debt, and a commodity that rises with the tide of the rush to hard goods.

Dow/Gold Ratio
This trend can be seen on a wide scale from the Dow-Gold ratio. Seemingly, the business cycle runs through years of investment and expansion, with money flowing out of cash into businesses, to times of savings and contraction, with liquidity flowing out of enterprise and into the highest yielding accounts.

Not much explanation should be necessary to understand what this ratio represents. Why would I buy shares trading at 20-40 gold ounces when I can just hold my gold and expect to buy a business at a later date at practically parity?

Hold and Buy!
The ratio reminds us that just as the “buy-and-hold” strategy worked so well for so many throughout the 40s, 50s, 80, and 90s… a “hold-and-buy” strategy would have done just as well during the 30s, 70s and 10s.

What would Buffett Say?
Quite frankly, I believe that the wealthiest investor of our time may have missed out on one of the greatest profit opportunity of the decade (excluding Uranium). Buffett himself expressed his thoughts when he said regarding his silver investment “We bought too early and sold too early”. He knows better than to buy into a rally. He missed out and that’s something he’s gotten used to over the years. If you asked me, I think that the $40 billion pile of cash in his portfolio is filling gold’s role as his savings. And don’t be surprised to see him splurge it all at once in the coming months!

Real Valuations
Many investors look for opportunities that stand square in their favor. With the Dow crossing over the 15 ounce line stocks will soon be trading in the lower buying range. The last chance to buy gold is now!

Unless you know of a stock that has fundamentals set to rally over 300% in the coming years, you may want to look into gold!

Disconnecting the Dots

Risk is selling for too cheap and the Carry Trade is the culprit. These are thoughts that the world most succesful investor seems to agree with but somehow it always gets left off the major highlights of his remarks.

In the market there is a price for everything. For every public company, for every commodity, for every currency. There are even prices for insurance on your portfolio and on the price of risk. The price is usually right. After all they’re scrutinized and evaluated by thousands of analysts and millions of speculators daily.

There are many different types of buyers. Many are there every day, not looking for good value but just something they can sell 10 minutes later at a higher price. Some only show up only once in a while, usually when they hear there’s some sale or issues selling at bargain prices.

Risk Undervalued
But every once in a while, the market as a whole gets it wrong. The 10-minute buyers offer unbelievable bargains for the value-savvy costumers.

In this light, Risk too has a price. You wouldn’t buy hurricane insurance in Kansas, would you? Of course not! But if a hurricane were to show up for all unpractical reasons many home owners would face a major loss of capital. You can afford the risk since your premiums wouldn’t pay off such a far margin of error.

But how about not buying insurance in South Miami because its out of season? That sounds ridiculous. But this seems to be the mistake many investors are making. They are selling risk out of season.

This is demonstrated by the low interest rates seen worldwide. True, they have been rising, but has this essentially performed its duty?

The Carry Trade
Japan has had it tough they had a wonderful economy doing wonderful things, the share market flourished and housing prices boomed. But, then came the inevitable bust that the frenzied public always seem to count as discounted. Japan and everything associated with it tanked.

Just a few years later we have the U.S. and the western world amid such a similar predicament. With the Dow soaring to new highs and a strong economy there wasn’t a dark cloud in the sky.

But then came the moment of transition. But we American’s are so much smarter than the Japanese. After all its been over 70 years since the last depression. So how do we prevent it from happening again? Offer the people what those in the depression lacked most – Cash. The Fed slashed interest rates to a mere 1% and threw cash piles out to the masses.

But it wasn’t just the Federal Reserve who was helping along. Japan at the time was offering a ZIRP or a zero-interest-rate policy. This meant that the government was practically begging for people to take its money, usury aside.

This being the case, even after the Fed began hiking rates investors and companies still found a way to cash in on yesterday’s price of interest. Borrow in Yen. This following later became widely known as the Yen Carry Trade. Yen were purchased on zero interest charges and swapped for higher yielding treasuries such as the U.S., Australian and New Zealand.

Here is what the market is discounting. Eventually, this moat is going to narrow. As a matter of fact this has already begun. Once it begins and the spread becomes less profitable the whole house of cards will collapse no different than the stocks that were selling for 50 times earnings in the past. You can only bet on a phenomenon while its still in motion. Once it stops, and every moving thing that is propelled by nothing more than limited resources does, the game is up.

In an age of knowledge every man and woman, regardless of whether or not they ever stepped into a course on economics has become yen-carry-trading, Chinese-stock-betting maniacs.

A Life Savor for a Dollar
This is what is holding up the U.S. economy. J
apan is supplying it with credit, allowing it to borrow and spend as much as it needs to survive. We then spend this money is low-cost-producing nations such as China and Japan. They in turn reinvest those funds back into U.S. Treasuries benefiting from the interest we will borrow from them to pay them with.

Sounds ridiculous, doesn’t it? But here’s why they continue to do it. If they lose the U.S. they lose their best costumer. As long as he comes in every day and buys half the store, there is no reason to deny him credit.

But Japan is paying out more to keep its best costumer than would be worth to forgo the debt. Real rates in Japan are negative. This means that it far more sensible for people to hold consumer goods which are increasing at the rate of inflation than to hoard cash that compounds at a mere 1/2 percent.

A higher yen as a result of rising inflation fears and higher wages will mean more inflow to economy, raising U.S. rates and consumer prices in the process. This translates as destruction – Hiroshima-style – for the Dollar and the American economy. We will once again face the deflation side of the equation that the Japanese know all too well. The spread between physical goods and its immaterial derivatives will narrow.

You can speculate on a rising Yen, a weaker dollar, a narrower spread for rates on interest and credit, do not however discount what you may not know.

Rethinking Words

In our January article “Let’s Talk Interest Rates” we said

Most of the larger players in the game including commercial institutions and hedge funds understand this game well. They know the risks of the system and in the bets made therein. Many therefore are ready on a minutes notice to liquidate just about everything. This was one of the dynamics experienced during the late 1920s. The speculators, masters and novices alike, new damn well that their money was at risk. But who wouldn’t take on that risk for gains of 20-30% a year? Furthermore, each reasoned with himself that on the first sign of imbalance money would be taken off the table, bets closed and a dashing for the door would be in order.

Of course the financial markets don’t have a very good track record of maintaining peace-of-mind for the investors that push it to sky’s limits… If the wise and intelligent investor were a caveman he’d warn “Catch the beast when its weak and tired not when it’s mad and hungry”.

When the floor drops, as it always does, many will be quite disappointed. Meanwhile with the dam of equities along with the credit of both housing mortgages and the Federal Reserve crashing in, the Fed will face its true debacle. Plummeting house prices, sub-prime loans defaulting all over and stocks being sold fervently, all the while flooding the marketplace with billions if not trillions of dollars of liquidity. Hence, contrary to popular belief inflation will occur regardless of whether or not the Fed and the government attempt to flood accounts with easy credit and loan Repos. Post facto this liquidity would have inevitably been filtered in through financial assets.

We have found this to be half true with its premise intact. We will understand based on our assumed knowledge of inflation. Inflation, once again, is categorized as the increasing of credit and expansion of monetary restriction. When this occurs, we perceive an overall trust in the nations money and in the nature of business expansion as a whole.

Conversely, in regard to deflation we have the opposite. A flee from fiat trusts is formed, as all issues of promise and of future marketed worth, as oppose to physical intrinsic value, are abandoned.

Where we currently stand the latter is inevitable. Financial assets currently sell for far more than they are inherently worth, stocks sell for historically high multiples to earnings, derivatives have infused the system with a breadth that bodes well only for high-net-worth risk-savvy speculators. Many investors are sitting out, while hedge funds scour their way from private equity to the latest IPOs.

When this begins to collapse, and many already believe it has, the Federal Reserve will have its final chance to hold on raising rates and dump as much of their magically created money and credit as they can before the system realizes what has happened. But what will stop it then? Nothing. It will only stall what has been a process in the making since late 1999. More investors are coming to light of the truth, as oppose to those being sucked in as they were at the height of the last century.

So there are two courses the Fed can take. Allow free-markets to unravel themselves, resulting in a deflationary scenario where money is saved and hoarded rather than invested and spent bringing a halt to the momentum that the speculators currently thrive on. Or they can disallow markets to take their course. This would result in hyperinflation – any nation’s worst nightmare – where money becomes absolutely worthless, the dollar goes to zero and the U.S. falls into an economic debacle of cataclysmic proportions.

In regard to interest rates there really isn’t much the Fed can do to help the situation if it isn’t willing to face the facts openly. It can save the dollar from its ultimate value or the economy from recession, but not both. Their policy in the future will dictate their intentions. For now they are watching like so many other investors wondering.

Wondering which, the fiscal assets or the physical, will give way, as it’s assured that one no doubt will.


A Mistake in Action or in Reason?

Someone explain this one to me. We all know that bond prices and yields are inverted. That means that investors buy bonds, usually on economic weakness, yields lower. Similarly when the economy is doing well, investors sell bonds, thus raising rates.

Bloomberg reports “Treasuries fell, pushing yields on benchmark 10-year notes to the highest level since January, on a sign of housing strength… after a government report showed the biggest rise in new-home sales in 14 years.”

But this news is bad! After stagnant home-sales over the past few months its about time we get some action. But this means that some buyers, impatient and reluctant to wait for lower prices, have thrown in the towel and decided to buy anyway. Now although they may not be categorized as investors, they are nonetheless not that stupid. Look at the numbers: Marketwatch reports Median sales price off 10.9% in past year, Biggest drop since 1970! (emphasis our but should be theirs). Existing Homes sold for a 2% discount. Now wonder there are suddenly so many buyers.

[As to why the Existing Homes are lagging New Homes, Adrian Ash from Bullion vault explains that Builders are smarter than Buyers. “The only way U.S. Builders can shift unsold homes is to discount. Existing homes, in contrast, won’t sell – because the discounting has yet to begin…”]

So now tell me. This economic report is supposed to be good news? A reason to sell bonds and buy what? Houses? Maybe Bloomberg has it wrong. It could be these bond investors are off to cash in on something altogether different (and I sure as hell hope it doesn’t require a mortgage to buy or contains the words “Private” and “Equity” in the same sentence).

Oh, and I just got word that the reality show “Flip This House” was a setup.

I repeat over the words of Bill Hampel, chief economist for the Credit Union National Association. “The bottom of the housing sector is not upon us.”

The Case For Housing and the U.S. Economy
By Yours Truly

I was just reading an article, a quite bearish one actually, from written back in 2004. A few interesting things stood out.

It shows a very bearish outlook. Something that was mainstream at the time. Sentimentally this may have been the reason why the markets couldn’t give yet and why we may be ready just for that now as the mainstream media is currently in denial as to a recession, much more an all out credit bust.

The fundamental reasons driving speculation of a housing recession are just as prudent if not greater than they were at the time.

  • Rising prices well above the historical averages
  • Historically low interest and mortgage rates
  • Home prices as a percentage of disposable income
  • Increased debt creation
It also mentions how the real slow down would begin with the lenders. This we saw clearly with the implosion of the sub-prime sector. Interestingly enough he also points to an apparent recession in the auto industry, something we know all too well.

Interest Rates, Inflation and Oil
We all know that from 2004 interest rates have surged from 1% to the current 5.25%. Although the economy has not yet collapsed we also have not yet seen the substantial decline in housing that we most definitely will in the future.

At the time real interest rates (Fed Funds rates minus Inflation) was in the negative. The 20 year average for Real Interest Rates was Positive 2.4%. He mentions that rates would thus have to rise to 4.75% to break even.

It would then seem quite proper for the Federal Reserve to pause from tightening while inflation had begun to slow (and Real Rates stayed within margin). However, with Inflation now coming in at 2.75% YoY and the Federal Funds Rate at 5.75%, giving us a Real Interest Rate of 3%, well above the average, we are most probably due for some more raises.

We see an obvious correlation between inflation (primarily costs of producers passed down to consumers) and oil prices. Interestingly enough, rates paused just about the time when oil prices began falling, from their high of $78 down to 52. (Currently trading around the 58-60 area).

There is now a good chance that inflation (due to rising commodity prices), and thus interest rates (higher real rates), will continue their multi-year uptrend.

What this means for investors – Stagflation.
This means that while the economy makes little ground forward, inflation will nevertheless continue to rise. When housing tanks, it will drag along with it higher unemployment (all those no-longer-needed Realtors and investors), rising defaults and a storm in the bond markets, followed by lower earnings, which would inevitably lead to higher price ratios resulting in a sharp sell-off, along with the confidence of the American people and the long awaited for recession.

What you should be buying… Precious Metals, Short-term Cash, Hard Assets and Commodities.

What you should be selling… Stocks, Bonds, Leveraged issues and Financial Assets (and of course any second homes).

Remember… It’s times like these when the key advice is simply not to lose. Forget about beating the market for now. If you stay safe and out of debt that shouldn’t be much of a problem.


Amidst Feud Between Politics and Economics BOJ Raises Interest Rates from 0.25% to 0.5%

HONG KONG (MarketWatch) — The Bank of Japan’s policy board voted by an 8-to-1 majority to lift its overnight call rate by a quarter percentage point, bringing the benchmark lending rate to 0.5% Wednesday. The BOJ said the Japanese economy is likely to continue expanding moderately, noting that positive trends in production, spending and income continue.

There had seemed to be an opposition from the Government regarding Interest Rates, but as all markets eventually configure themselves I guess Japan realized too that markets just work.

Carry Traders Beware!

The famous Carry Trade [a neat mechanism for instant profits by borrowing money from low interest rate economies (namely Japan who held a Zero-Interest-Rate-Policy till last year) and investing the funds in stronger economies with higher yields (England, US)] may further come under fire as the rate margin is dwindling.

The United States has held its rates steady for almost 6 months now as economies such as the Euro Zone, Japan, England and Australia have been tightening.

Interest Rates tighten and loosen the money supply by demanding more or less interest on borrowed funds from the Central Banks. We seem to be in a secular bull market for interest rates as liquidity is rampant and easy credit has been flowing for decades now.

Even in the likely event of a recession in the short-term, as far as the long term is concerned banks and lenders alike will need to start cutting down on the liquidity they have for years been dumping into the open markets.

This inevitable “inflation” is yet to be seen on a consumer product level, but as many homeowners who bought on sub-prime loans and exotic mortgages are now finding out that Money – contrary to the current popular belief – does not grow on trees.

Let’s Talk Interest Rates

Let’s talk Interest Rates… Rising or Falling in 07?

It’s the talk of the town, be it USA Today or on CNN Money. What will “Gentle Ben” and the “smooth landing” Federal Reserve do? Housing could sink the economy which would bring rates down, yet inflation still gives plenty of reason for concern. Earnings and markets are up, but what will happen when they run out of steam?

Reading through a stream of articles today, I state my humble opinions on an economy that by all practical purposes has lost touch with the standards of a true “Goldilocks” scenario. The only factors investors worry about today are market-beating returns and cheaper prices on their daily expenses. Problem is that it’s more a matter of which they’ll get first rather than when they’ll get both.

Interest Rates and Inflation

Reading through some historical charts on there seems to be weaker equity markets during extended periods of rising rates. Conversely, commodity and assets rise due to inflation and flight from dollar nominated assets. Of course the initial culprit for the raising rates begins with concern regarding inflation.

This correlation would seem quite reasonable. Money and wealth that is generated through increases in credit, liquidity lower interest rates and years of stock market prosperity lead to reinvestments of these dollars back into these mediums of significant return. We will call this “Financial Asset Inflation” a concept you’ll probably never hear spoken of by the Fed. As a matter of fact the Fed even discontinued their announcing of M3 – the total amount of money in circulation.

This “Financial Asset Inflation” is not currently visible for quite a few reasons. 1) These returns come mostly to those of the highest asset class who have a larger disposable income left to invest 2) Thus, these returns are in turn able to easily be reinvested without immediate need for these funds. 3) Most of this money doesn’t even exist in terms of actual dollar holdings but in credit assets, swaps, bond insurance and interest rate derivatives maintained primarily on margin.

When the Going Gets Tough

However, most of the larger players in the game including commercial institutions and hedge funds understand this game well. They know the risks of the system and in the bets made therein. Many therefore are ready on a minutes notice to liquidate just about everything. This was one of the dynamics experienced during the late 1920s. The speculators, masters and novices alike , new damn well that their money was at risk. But who wouldn’t take on that risk for gains of 20-30% a year? Furthermore, each reasoned with himself that on the first sign of imbalance money would be taken off the table, bets closed and a dashing for the door would be in order.

Of course the financial markets don’t have a very good track record of maintaining peace-of -mind for the investors that push it to sky’s limits. Let alone those who don’t even understand the monster they wish to milk their money out of. If the wise and intelligent investor were a caveman he’d say “Catch the beast when its weak and tired not when it’s mad and hungry”.

When the floor drops, as it always does, many will be quite disappointed. Some will shoot themselves dead while some will sing merry tunes of grace. Meanwhile with the dam of equities along with the credit of both housing mortgages and the Federal Reserve crashing in, the Fed will face its true debacle. Plummeting house prices, sub-prime loans defaulting all over and stocks being sold fervently, all the while flooding the marketplace with billions if not trillions of dollars of liquidity. Hence, contrary to popular belief inflation will occur regardless of whether or not the Fed and the government attempt to flood accounts with easy credit and loan Repos. Post facto this liquidity would have inevitably been filtered in through financial assets.

Why Raise?

This is where many economists get hazy. Will this cause the Fed to cut, hold or raise? (Yes, that does sound like the game of poker it is). I believe the Fed will need to raise. My reasoning is as follows:

1. Many investors then out of the market – exempt those few who were fortunate to get a decent short position beforehand – will need safe places to stash their spoils. This will end up in goods, hard assets such as gold and commodities in strong foreign currencies.

2. With the rates hovering above 5% – historical lows considering the rates of 17% in the 70s – there will be little if not zero use in lowering rates.

3. With the dollar is a steady fall the Government will have no choice but to raise substantially in order to bring some stability to the dollar keeping its safe-return competitive with the rates of the Euro, Yen and Pound.

With all this, gold and silver will only then begin to show their true sustainability amid a falling economy. Of course as the sentiment turns the interest in hard assets and commodities will once again emerge – as it did after the market meltdown of 2000 – beginning stage two, the strongest and longest of the commodities bull run.

Where to Invest

If I’m usually not a fan of overpriced issues or momentum speculation then at this point I would strongly warrant selling out of any position where the margin for safety isn’t in your favor. Remember, Buy Low, Sell High. Not “Buy High and hope to sell higher”.

Although it may be too early, a short position in any of the major indexes could be quite rewarding. I would wait for a blow-off in stocks to do so. Wait for everyone to be bullish, then go with the bears and you’ll be sure of a profit.

Hold onto any hard assets and precious metals. Although they may fall in the coming months, “We’re in a Bull market” they used to say. Don’t loose your positions no matter how rough the correction gets. If you insist on speculating don’t short and get ready to jump back in at a moments notice.

In addition, each investor should be sitting on a good cushion of cash. If the market does tank severely you want to have substantial cash on the sideline to snatch the bargains that many investors won’t be able to afford.

Articles to Read:

Home-loan house of cards to fall
Why Stocks Will Fall
World Assets hit Record Value of $140 Trillion
Markets Face Severe correction in 2007
25 Surprises for 2007
What if the Bulls are Wrong in 07?
There Are Signs the Conventional Wisdom Is Off
Short-covering Boosts Gold
Making the Bear case

If I may, I wish to repeat the words of one of the most famed investors, that should resonate with us in our investing mindset as well as throughout our lives

“After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting”. – Jesse Livermore

What do we know?

What if tomorrow’s headline read…
“Interest rates are still at 1% and The Dow is more leveraged than it was in 1929″

I think we must first clarify a few things.

Inflation and Interest Rates.
Banks have the right to print as much money and credit as it deems fit. This may lead to an unhealthy economy. The Federal Reserve controls this expansion of the money supply with short-term interest rates, restricting the amount that must be paid by the Federal Reserve Banks as well as the amount banks must hold on margin.

The Fed has many techniques and factors that show an inflationary monetary system all of which have recently been above their “comfort levels”. The Fed has raised interest rates 18 times over the past few years, from a rate of a meager 1% to the current 5.25%. Although this “tightening” has raised the awareness level of excess consumption, which can be detrimental in a slowing economy, rates are considered to be relatively low by historical levels when rates rose above 15%.

When industrial buyers wish to hedge or secure themselves from rising or falling prices in a competitive market they can do this by buying a contract on the particular commodity of interest. If a jeweler worries that the price of gold may rise in the future he can buy a contract on the market for the current price of gold and will pay this amount even if the general market price for gold rises. This can be done with financial instruments as well, including interest rates.

The Derivatives market has exploded over recent years with an surge of speculators, especially since the late 90s when many experienced traders, primarily Hedge Funds bought derivatives to hedge themselves against a serious decline in stocks. In addition, these contracts can be bought on extremely low margins. For instance, it is possible for a trader to buy and control over 20 times his initial down payment. Thus the amount of credit or money lent on margin far exceeds the amount of actual materials, be it stocks, interest rates or commodities. It is for this reason that the wise have considered these “Financial weapons of mass destruction”.

A Nasty Combo.
When searching for a medium of success in addition to venturing all the possibilities of the future of that success, we must also consider all the historical reasons for failure.

Looking back at all the times that wrought havoc for investors, we see the same irrational yet consistent behaviors and mindsets.

* Markets reaching new highs with more jumping on board as the trend continues.
* Excess optimism regarding future rises in prices and profits.
* A publishing frenzy of books on investing and trading.
* Smaller allocations of cash due to excess invested capital.
* An insatiable apatite for risk and gains.
* Large sums of leverage and margin.
* More speculators focusing on the technical factors as well as
* More Momentum Investors deliberately riding the trends in the market.
* A lack of following, even an opposition towards the underlying fundamentals.
* Lastly but most importantly, the lack of vision to realize the potential pitfalls and risks.

We could probably go on to check almost every one of the above mentioned. But the reason for concern doesn’t apply as much to the traditional markets as they do the derivatives market in particular. It is with these instruments that many, including large speculators, hedgers, banks and institutions have the capabilities to wager not billions but Trillions of dollars in the market. Originally these conducts were reserved for those with large amounts of capital, but as the gains increased so did the “insatiable apatite” for the small investor become whetted.

I refer not only to the stocks markets, commodities or even credit-default swaps and other exotic contracts that many don’t even have the slightest idea of who holds the opposite promise to fill or fulfill the terms involved. I’m referring primarily to a tool used by the Federal Reserve Bank of the United States that has become apparently unknowingly “manipulated” and de-regulated – Interest Rates.

With modern day derivatives an organization or bank can place contracts on short-term rates to hedge against the possibility of a rise in rates. In 2001 the Fed lowered rates to fend off the severity of a 1929-like recession during the stock market debacle in late 2000 to supply credit to the markets and to free cash flow and loosen tied on monetary availability.

But many caught on. With rates at 1% lows, it seemed like an historical opportunity to lock in rates to benefit when the Fed would inevitable raise in the future. To date these contracts now total in the hundreds of trillions of dollars.

Now with these astronomical numbers there is nothing short of something just as phenomenal that must occur. An increase of rates muscling out many from their positions? A de-regulation in parts of the hedging industry? A collapse in the derivatives market? We don’t know. But such growth is simply unsustainable and caution – one that many probably won’t even consider – is strictly warranted. Remember, we don’t know. The same way investors didn’t know what would come out of all the millions of stocks they bought on margin back in 1929.

For if they had it probably wouldn’t have turned out the way it did. Don’t you think?


What is Bernanke trying to do?

Here’s an excerpt from an article I read based on the faults of the Federal Reserve leading into the Great Depression.

“Milton Friedman and Ben Bernanke, stress the negative role of the American Federal Reserve System in turning a small depression into a large one by cutting the money supply by one-third from 1930 to 1931. With significantly less money to go around, businessmen could not get new loans and could not even get their old loans renewed, forcing many to stop investing. This interpretation blames the Federal Reserve, especially the New York branch, which was owned and controlled by Wall Street bankers. The Fed was not controlled by President Hoover or the U.S. Treasury; it was primarily controlled by member banks and businessmen and it was to these groups that the Fed listened most attentively regarding policies to follow.

“In Milton Friedman’s work, A Monetary History of the United States, he writes that the downward turn in the economy starting with the stock market crash would have been just another recession. In general, he states the problem was that some very large, very public bank failures, particularly the Bank of the United States, produced widespread runs on banks, and that the Federal Reserve sat idly by while bank after bank fell. He claims that if the Federal Reserve had acted by providing emergency lending to these key banks or simply brought government berry bonds on the open market to provide liquidity and increase the quantity of money after the key banks fell, all the rest of the banks that fell after the very large and public ones did would not have, the money supply would not have fallen to the extent it did, and would not have fallen at the speed it did.”

Based on this I now understand why Bernanke, as was his predecessors Greenspan and Volcker, is so vigilant regarding inflation. They all know and understand that the only way to keep America out of a depression, like the 30s, is by letting Markets correct themselves, the way the Stock Market did in 1929 and he hopes the Real Estate market will today. Once the recession is underway, he is ready to flush the world with liquidity in order to prevent a stagnating or, worse, a receding economy.

He isn’t fighting inflation. His getting ready to fight a depression with inflation that he must account for as well.

The economy and Fed policy seem ready for this:
* Government Spending, the Trade deficit and the national Debt all don’t seem to be a problem, since he knows the mint is ready to push a button and print as many bills as it needs.
* The Fed has halted public indication of M3 – total amount of money in the cash, savings and security market – which clearly indicates that a run of monetary liquidity is imminent.

So what will he do after inflation or even hyperinflation hits? He has three options. (if there are anymore please let me know, I’d like to hear about them).
1) Raise Taxes (risky especially if the government is devoted to lowering taxes).
2) Raise Interest Rates (the “Hidden Tax” since it “creates wealth” for people but more so it pushes incomes into higher tax brackets.
3) By the deflation of the Dollar, either through a devaluation (for instance making every $100 = $1) or by instituting a Gold Standard by which all cash is traded in for gold and used as a peg to the currency.

The Dollar deflates back to its original value (hopefully, as long as they don’t push taxes/rates too far) as does gold, and the process starts over.

Bernanke’s ready for all this. Gold bugs have spoken of it for years. Is this all a hype or as the Daily Reckoning puts it “Does the Empire have no clothes?” after over 90 years in the spotlight?

I lost the source. Sorry.

Fed Math: 1% Funds Rate – 3% Inflation = 2% Off when you Borrow?

“I don’t think that the boom came from a 1 per cent Fed funds rate or from the Fed’s easing. It came from the collapse of the Berlin Wall,” Mr. Greenspan told his listeners.

The Financial Times reports:

“The former Fed chairman said the collapse of Communism in Eastern Europe and the shift towards more market-based economies in China and other parts of the developing world brought ‘billions of cheap labourers onto the scene.'”

“This, brought disinflation and lowered inflation risk premiums and long-term interest rates, creating a decline in real interest rates and equity-risk premiums. The real market value of assets increased faster than GDP”.

There is undoubtedly some truth to what Greenspan says. But this is one of those occasions for which the word ‘disingenuous’ must have been invented. Yes, global integration probably has reduced inflation expectations, thus permitting lower interest rates and higher asset values. But without the active aiding and abetting of the Fed, which set the Fed Funds rate under 2% – i.e., below inflation – for 35 months, the boom in housing prices would probably never have turned into a bubble. And millions of Americans would still be solvent today. Globalization may have lowered inflation rates…permitting lower interest rates. But globalization didn’t bring with it lending rates below the rate of inflation. Those negative lending rates were not imposed by Mr. Market, but by Mr. Market Manager Greenspan.

A negative lending rate is a marvel. It allows a speculator to borrow, knowing that he can repay less than he was lent. Negative lending is to the financial world what a negative-calorie dessert would be to Sara Lee or a negative-year prison sentence would be to a bank robber. You can imagine, dear reader, what mischief they would cause.

Even at low real rates of interest, a borrower has to be careful. But what kind of care is needed when you are guaranteed to make a profit, merely by borrowing?

The actual effect of the Fed’s sub 2% rate is now history…well, a history that is still being written, one painful page at a time. That it brought about a huge bubble in housing prices is beyond question. It also helped sustain the whole U.S. economy…and, by extension, the economy of the whole world. Goldman Sachs calculates that since 2002, American homeowners have been able to “take out” enough money from their houses to add 2.5% a year to real GDP growth – which was most of it.

And now, it appears that the bubble is deflating. The Fed is no longer giving away money. And the housing market is no longer bestowing big gains on homeowners. The granite countertop business is slowing down…along with the rest of the housing-manufacturing complex.

If Mr. Greenspan were right, investors could expect high asset prices for a long time. Global trade, after all, is not likely to disappear any time soon. Why should house prices go down then? Or stock prices, for that matter?

But now, even the Maestro concedes house prices are going down. Only, he says, it is because houses have become unaffordable. And he guesses that the worst of the housing slump is already behind us.

And who knows? He could be right. But an investor has to play the odds. What are the odds of making serious gains in stocks at today’s record prices? What are the odds of making serious gains in houses? What are the odds that Mr. Greenspan knows better?

We wait to find out.


Are you a Monetarist or a Keynesian?

Recently I decided to read a bit about Inflation. I went to wikipedia and realized that the reason why we are constantly finding bubble after bubble is because we’re in one big bubble, so naturally wherever you’ll look you’ll see…Bubble. We’re in an Inflation Bubble.

Inflation is simply when there’s too much money to go around so everyone has more than they need, they throw it around and people feel “wealthier”. It’s almost like a stock split. Nothing changes other than peoples sentiment.

Inflation is a hidden tax since a) it makes people believe they have more b) it simply pushes people into higher and higher income brackets.

So we have to fight inflation right? How? Here’s what I found: Wikipedia Inflation

“Monetarists emphasize increasing interest rates (reducing the money supply, monetary policy) to fight inflation. Keynesians emphasize reducing demand in general, often through fiscal policy, using increased taxation or reduced government spending to reduce demand as well as by using monetary policy. Supply-side economists advocate fighting inflation by fixing the exchange rate between the currency and some reference currency such as gold. This would be a return to the gold standard. All of these policies are achieved in practice through a process of open market operations.”

So from what I understand, whether your a Monetarist, a Keynesian or approve of the Gold standard… we’re in trouble.

Higher Interest Rates would mean “more expensive” money, less money in circulation, less spending, less income, even less money, deflation of Dollar (people feel poorer).

Increased taxation or reduced government spending will mean more harsh living conditions due to decreased benefits.

A Gold Standard? This would either put gold at over $36,000 an oz. (gold supply/m3) or would seriously depreciate the dollar.

I think we’re in for the 70’s all over again. High interest rates (18%?) and then some drastic move in gold – Gold Standard (1934)? Gold Rush (1980)?

More on the Gold Standard in the coming articles – as well as that argentum I was telling you about.