Monday, February 27, 2017

Trumponomic and Great Recession Nuggets from Market Monetarists

This article was first published by me at Talkmarkets: http://www.talkmarkets.com/content/bonds/trumponomic-and-great-recession-nuggets-from-market-monetarists?post=112788&uid=4798


With the advent of Trumponomics, I try to glean information from market monetarists. I will point out important nuggets that have come across recently.

I embrace some monetarism, like the concept of real helicopter money. I like the way market monetarists track the real growth in the economy. I don't know how NGDP targeting would work out but a futures market could help.  But clearly the Fed has done and could do more to help stabilize the economy, and it has done some things to destabilize it, like mispricing risk in the MBSs last decade.

But there are a few nuggets from the MM boys to share. For example, Lars Christensen pointed this out in a tweet:
Republicans are Austrians when they are in opposition and Keynesian when they are in power. They are never monetarists.
Scott Sumner has a few very important nuggets:

1. Bond yields depend more on NGDP than on inflation according to Professor Sumner. They usually move together, but don't always move together, and in the Great Recession, bond yields tracked the decline of NGDP while inflation stayed steady for awhile.  I have FRED charts showing this relationship of NGDP decline to inflation during the Great Recession. NGDP declined while inflation was stubborn:

Graph 1

Graph 2

Chart 2 shows that bond traders were likely fooled. The rates for the 10 year declined starting in mid 2007. Then they picked back up as traders noticed that inflation held steady through much of 2008. That did not have a happy ending for those who sold early as 2009 approached. Had the bond people been watching NGDP instead of inflation they would have understood what was happening. This is just my take from looking at the graph.

Sumner says supply side will increase yields over time. Of course we didn't have trillions of dollars working as collateral in the derivatives markets back then. We do now. This part of the new normal may cause this relationship to fail as rates rise. There is likely a cap on rates or the system will disintegrate. Since this has not happened yet, I certainly don't know what that disintegration would look like. So this is just another puzzle that could seriously confuse bond traders down the road.

2. Sumner says that supply side Trumponomics will likely be modest due to two factors:

A.  Supply-side policies are simply not that effective; they don’t boost growth as much as the advocates claim.
B.  The market sees only a very modest probability that Trump will enact major supply-side reforms, either because he doesn’t want to, or because Congress will water it all down.
Sumner does not believe in massive and reckless supply side economics. He says he supports modest supply side economics. Since I think everything in moderation is good, his call for restraint makes sense.

I am guessing that Scott Sumner would be uncomfortable with anything over 3 percent RGDP growth and 2 percent inflation totaling 5 percent NGDP.

3. The United States, for once, does not lead the world in globalization. He refers to the ending of the TPP and the Asian-Pacific players' advancement of a trade deal lead by China. The discussions are called Regional Comprehensive Economic Partnership (RCEP) trade talks. It turns out that this is not a big free trade deal, so China will push for the Free Trade Area of the Asia Pacific (FTAAP).

It appears that China leads the world in globalization. How that will work out for the USA remains to be seen. Perhaps we could be invited later.

I don't like abuses of globalization. However, raising barriers to trade when we are likely headed into a recession does not seem wise, unless Trump wants to turn Austrian on us and liquidate everything like the Nowhere Man we hope he isn't.

As for the charts above, keeping track of NGDP is a useful tool for bond traders. The idea of a futures market that would track NGDP is a fascinating idea that would give traders some heads up on what really matters, because inflation tracking can let them down.









Tuesday, February 21, 2017

My Gedmatch Jewish Roots Force AntiIsrael Stance: Palestinian DNA

My Gedmatch Jewish roots are verified. It wasn't like I didn't already know. But when you are adopted, you want something concrete to back you up. I will list some charts below, but first, I want to tell you two things about Israel.

First, the African 9 test towards the end of this article shows that I am Yemeni Jewish and Ethiopian Jewish. Both of these groups made their way in recent times to Israel. Turns out they were mistreated. The Ethiopian Jews were mistreated by the racism they faced and still face in Israel. The Yemeni Jews had their babies stolen by a cruel nation.

Second, Israel, a colonial power, took away Palestinian land. But as you get into DNA, you realize that the Zionists stole the land from their biological brothers. Many Palestinians have ancient Hebrew DNA. It is true that they are not practicing Judaism, but neither do I. I am a New Covenant Christian.

And did you know that the Zionists who founded Israel were self avowed atheists? They didn't practice Judaism either! Israel Shahak verified this truth about the founders of Israel.

I reject Israeli racism and bigotry. All people with half a conscience must do so. Israel must give these people, the Ethiopian Jews, the Yemeni Jews, and the Palestinians due justice that has been denied them for decades.

Look, the nation of Spain is welcoming back Jewish Spaniards banished in the Inquisition. Spain is wanting to grant dual citizenship to Sephardic Jews. The list includes 5000 names!

So, back to my DNA. I am adopted, so it isn't easy finding birth parents, but it is easy to find your ancestry. The descendants of Jacob are physical descendants. There is a blood tie even if no religious tie. I believe in tolerance of all religions and races, so all of this DNA stuff fascinates me and should make all this info about who is inferior or superior to whom, totally irrelevant.

So, I took a few Gedmatch tests. How it works is that you test at 23 and Me, or Ancestry, or FamilyTreeDNA and you upload your results to Gedmatch. It is easy. I did both autosomal Family Finder and Y tests at Family Tree. I recommend Family Finder or Ancestry basic test if you only want to do one to see how things go. As far as I know, Y testing won't upload to Gedmatch. But Y tests are good for projects you can join on FamilyTreeDNA.

BTW, if you are Hispanic, and your people came to America from Cuba or Mexico or Spain or Azores or Canary Islands or Portugal, you may be Jewish too. Just FYI!

The fulfillment of prophesy made by the Apostle Paul regarding physical descendants of Jacob is discussed at my other blog.

So, here are a few of my Gedmatch findings:

MDLP Test1:

Using 3 populations approximation:
1 50% Norwegian_West +25% Spanish_Canarias_IBS +25% Turk_Jew @ 3.673624


Using 4 populations approximation:
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
1 Finn + Romanian_Jew + Spanish_Aragon_IBS + Spanish_Canarias_IBS @ 3.111652
2 Finn_West + French + Maltese + Spanish_Canarias_IBS @ 3.114812
3 Finn + Romanian_Jew + Spanish_Canarias_IBS + Spanish_Cantabria_IBS @ 3.118867
4 Ashkenazi + Finn_East + Spanish_Canarias_IBS + Spanish_Cantabria_IBS @ 3.168548
5 Finnish_FIN + Romanian_Jew + Spanish_Canarias_IBS + Spanish_Cantabria_IBS @ 3.175266
6 Ashkenazi + Finn_East + Spanish_Canarias_IBS + Spanish_Valencia_IBS @ 3.179708
7 Finn + Romanian_Jew + Spanish_Canarias_IBS + Spanish_Valencia_IBS @ 3.182451
8 Finnish_FIN + Romanian_Jew + Spanish_Aragon_IBS + Spanish_Canarias_IBS @ 3.185632
9 Ashkenazi + Finn + Spanish_Canarias_IBS + Spanish_Valencia_IBS @ 3.190630
10 Ashkenazi + Finn + Spanish_Aragon_IBS + Spanish_Canarias_IBS @ 3.191257
11 Ashkenazi + Finn_East + Spanish_Canarias_IBS + Spanish_Galicia_IBS @ 3.202255
12 Ashkenazi + Finnish-East + Spanish_Canarias_IBS + Spanish_Galicia_IBS @ 3.208241
13 Ashkenazi + Finn_East + Spanish_Aragon_IBS + Spanish_Canarias_IBS @ 3.213579
14 Ashkenazi + Finnish-East + Spanish_Canarias_IBS + Spanish_Valencia_IBS @ 3.218565
15 Finn_East + Romanian_Jew + Spanish_Canarias_IBS + Spanish_Cantabria_IBS @ 3.220945
16 Ashkenazi + Finnish_FIN + Spanish_Aragon_IBS + Spanish_Canarias_IBS @ 3.222368
17 Ashkenazi + Finn_East + Spanish_Canarias_IBS + Spanish_Cataluna_IBS @ 3.224052
18 Ashkenazi + Finn + Spanish_Canarias_IBS + Spanish_Cantabria_IBS @ 3.224282
19 Finn_East + Italian_Tuscan + Portugese + Spanish_Canarias_IBS @ 3.228782
20 Italian_Piedmont + Portugese + Russian-Ural + Spanish_Canarias_IBS @ 3.230893

And the second MDLP Test:

Using 3 populations approximation:
1 50% n-european +25% sephardic-jew +25% spain-basc @ 3.416632


Using 4 populations approximation:
+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
1 morocco-jew + n-european + n-european + spain-basc @ 2.904685
2 morocco-jew + n-european + spain-basc + utahn-white @ 3.046352
3 basque + morocco-jew + n-european + n-european @ 3.112451
4 morocco-jew + n-european + spain-basc + utahn-white @ 3.252414
5 morocco-jew + spain-basc + utahn-white + utahn-white @ 3.270380
6 basque + morocco-jew + n-european + utahn-white @ 3.289033
7 morocco-jew + n-european + orcadian + spain-basc @ 3.367745
8 british + morocco-jew + n-european + spain-basc @ 3.381293
9 morocco-jew + orcadian + slovenian + spain-basc @ 3.406312
10 n-european + n-european + sephardic-jew + spain-basc @ 3.416632
11 basque + morocco-jew + orcadian + slovenian @ 3.425118
12 n-european + sephardic-jew + spain-basc + utahn-white @ 3.450739
13 n-european + orcadian + sephardic-jew + spain-basc @ 3.473914
14 lebanese + lithuanian + spain-basc + spain-basc @ 3.478182
15 lithuanian + morocco-jew + spain-basc + spaniard @ 3.480666
16 morocco-jew + spain-basc + utahn-white + utahn-white @ 3.491871
17 lithuanian + morocco-jew + spain-basc + spaniard @ 3.504484
18 basque + lebanese + lithuanian + spain-basc @ 3.534094
19 basque + n-european + n-european + sephardic-jew @ 3.535562
20 basque + morocco-jew + utahn-white + utahn-white @ 3.538383

And the Africa 9 Test:

Using 3 populations approximation:
1 50% French_Basque +25% Morocco_N +25% Yemen_Jews @ 2.005640


Using 4 populations approximation:
++++++++++++++++
1 French_Basque + Morocco_Jews + North_African + Tuscan @ 1.283478
2 French_Basque + North_African + North_African_Jews + North_Italian @ 1.295459
3 Algeria + North_Italian + North_Italian + North_Italian @ 1.773581
4 North_African + North_Italian + North_Italian + North_Italian @ 1.865874
5 French_Basque + French_Basque + Morocco_N + Yemen_Jews @ 2.005640
6 French_Basque + North_African + North_African_Jews + Tuscan @ 2.092220
7 Algeria + French_Basque + French_Basque + Yemen_Jews @ 2.196563
8 French_Basque + French_Basque + Morocco_N + Saudis @ 2.307416
9 French_Basque + Morocco_Jews + North_African + North_Italian @ 2.344756
10 Bedouin + French_Basque + French_Basque + North_African @ 2.349786
11 Druze + French_Basque + Morocco_N + North_Italian @ 2.540855
12 French_Basque + French_Basque + North_African + Yemen_Jews @ 2.653674
13 Algeria + French_Basque + North_African_Jews + North_Italian @ 2.671610
14 Algeria + French_Basque + Morocco_Jews + Tuscan @ 2.674284
15 Morocco_N + North_Italian + North_Italian + Tuscan @ 2.679471
16 Morocco_N + North_Italian + North_Italian + North_Italian @ 2.799208
17 Algeria + North_Italian + North_Italian + Tuscan @ 2.911060
18 North_African + North_Italian + North_Italian + Tuscan @ 2.929565
19 Algeria + Bedouin + French_Basque + French_Basque @ 2.941865
20 Algeria + French_Basque + North_African_Jews + Tuscan @ 3.163008


And the J Test from Eurogenes. Click to enlarge:

Friday, February 17, 2017

Trumponomics: Increase Exports, Slow Imports, Bludgeon the New Normal

This was first published by me on Talkmarkets: http://www.talkmarkets.com/content/bonds/trumponomics-increase-exports-slow-imports-bludgeon-the-new-normal?post=112404&uid=4798

Trumponomics is further explained by a paper issued by the Donald's economic advisers. While I leave it to others to hammer out the nuts and bolts of the VAT tax debate, a simple analysis of the trade deficit based on common sense is in order. Targeted nations in this Trumpean effort to reduce the trade include Canada, China, Germany, Japan, Mexico and South Korea, accounting for 1/2 the trade deficit.

In a nutshell, these advisers appear to have no real understanding of the New Normal at all. They want well over 3 percent growth per year (with the inflation that accompanies that), when the Fed is seemingly powerless to raise interest rates 1/4 point! In spite of the new normal and the structured finance that drives it, Trump wants to increase exports and limit imports from the targeted nations. Those two partners do not dance that well together! This is probably the least realistic madness of this whole Trumponomics plan. And it is the central point of the plan!

And the Trump advisers say they want lower energy cost, but seek to balance the trade deficit by exporting energy.

These authors, Peter Navarro and billionaire Wilbur Ross, believe that the New Normal is just a political device, created by liberals. They believe it is not permanent:

Most recently, the 2012 South Korea trade deal was negotiated by Secretary of State Hillary Clinton – she called it “cutting edge.” It was sold to the American public by President Obama with the promise it would create 70,000 jobs. Instead, it has led to the loss of 95,000 jobs and roughly doubled America’s trade deficit with South Korea. Corporate America does not oppose these deals. They both allow and encourage corporations to put their factories anywhere. However, Mr. and Ms. America are left back home without high-paying jobs. There is nothing inevitable about poorly negotiated trade deals, over-regulation, and an excessive tax burden – this is a politician-made malaise. Therefore, nothing about the “new normal” is permanent. [Emphasis mine]

This is the only mention of the new normal in the entire article. The authors make no attempt to describe the pitfalls of trying to bludgeon the new normal.  Donald Trump wants an inflation/reflation component to his policy through both the trade war and also through infrastructure spending not covered by this report. While we all want to pick ourselves up off the zero lower bound, doing so too quickly will bust open a Pandora's box of dislocations, in my view. Even Jamie Dimon agrees with this assessment.

There is a permanent aspect to the new normal. If you break the conundrum, the nation will pay a heavy price in a credit crisis of monumental proportions.  Is Trumponomics prepared to allow all the collateral in the derivatives markets and systemically essential clearing houses to go bad, in order to get past the new normal? Trumponomics has nothing to say about that. That is totally irresponsible to just say the new normal is not permanent and then not comment on the conundrum, the foundation of structured finance.

It is true that hitting main street America hard with economic malaise, when main street carried the world on its shoulders with its purchasing power, was not such a smart policy on the part of big business. Most everyone acknowledges this is a big problem. So the authors of Trumponomics believe in the necessity of structural reforms. But those reforms are certain to start a trade war. The isolation of America could occur if these so called reforms are implemented. These reforms are wanted even as companies are starting to return to America to find workers. And the Donald seeks to apply these reforms as the business cycle is coming to a close. Bad idea. Helicopter money done right is a much more fiscally responsible idea.

And Trumponomics wants us to compete in industries where our wages are generally higher than other nations' wages, specifically in China and Mexico. We have not earned the right to complete in those industries. Unless we are prepared to cut wages and cut housing costs and the cost of living to the bone, it makes no sense for us to try to make things that others can make more cheaply. Trump wants to introduce lack of competitiveness into the world economy and also he wants to raise wages at home in industries where we do compete at a technological advantage. We could price ourselves out of the world markets in multiple ways. We would have to subsidize industries that couldn't make it on their own.

And the environment will suffer in doing so. Dirty coal is polluting southern Indiana, home to Mike Pence, at alarming rates. So the Trump energy plan is devised:

To attack those regulations that “inhibit hiring,” the Trump plan will target, among others: (1) The Environmental Protection Agency’s Clean Power Plan, which forces investment in renewable energy at the expense of coal and natural gas, thereby raising electricity rates; and (2) The Department of Interior’s moratorium on coal mining permits, which put tens of thousands of coal miners out of work. Trump would also accelerate the approval process for the exportation of oil and natural gas, thereby helping to also reduce the trade deficit. Numerous other low-level rules that are individually insignificant but important in the aggregate will also be reviewed. 
Trump's report does show that one important base of growth, the manufacturing sector, would benefit from deregulation:

More than any other sector, manufacturers bear the highest share of the cost of regulatory compliance. … Manufacturers spend an estimated $192 billion annually to abide by economic, environmental and workplace safety regulations and ensure tax compliance—equivalent to an 11 percent “regulatory compliance tax.”
Unfortunately, manufacturing regulations do happen to protect people. Manufacturing is important in creating 4 jobs for every 1 job created in production, but at what cost? And Trump's desire to lift all restrictions on energy production could result in efforts to drill along the pristine Northern California Coast, endangering tourism and jobs and the exceptional beauty of this area.

Exporting energy, especially oil, will keep us weak and bound by the hip to the Middle East, attendant with all the pipeline wars and turmoil that that policy brought us, unless we diminish our known reserves which are not unlimited, with the gimmick of overproduction.

Trumponomics doesn't look at it that way. Increasing the supply of oil could make prices decline according to the report. But if Trump wants to please Vlad Putin, prices would have to go up, not down.

Trumponomics seeks American production of low cost products, and expects the world, which will no longer be able to dent American markets, to have the prosperity to buy an even more exports from America than they do now. I think it is madness.

About this inflation/reflation push by the Trumpeans, Edward Lambert told me by email:

Truly I see strong headwinds to inflation. But if the new government insists upon pushing for strong fiscal stimulus, then the model in my post describes what will happen. High inflation potential and high interest rate potential.  It is wiser to go slowly with the fiscal stimulus when this close to the end of the business cycle. I assume Alan Greenspan sees something similar.
Dr Lambert was referring to Alan Greenspan's worry about stagflation. Here is the post he made for reference. It is worth reading and the Fed should be ready for what may happen with Donald Trump as president, as Professor Lambert projects a Fed rate path.

Business Cycle Ending Based on Effective Demand (Green Line)













Sunday, February 12, 2017

Bizarre Collateral in Securities Lending Exposed by Bank of Mellon

This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/bonds/bizarre-collateral-in-securities-lending-exposed-by-bank-of-mellon?post=112318&uid=4798

There is a bizarre use of collateral these days, and it is exposed by Bank of Mellon. First of, the banks are being advised by certain bankers to hoard bonds.  And counterparties are encouraged to bolster their stock and securities positions by using stocks as collateral! The securities lending market often is used for short positions in the stock market.

Here is a definition of securities lending from Investopedia:


Securities lending is the act of loaning a stock, derivative or other security to an investor or firm. Securities lending requires the borrower to put up collateral, whether cash, security or a letter of credit. When a security is loaned, the title and the ownership are also transferred to the borrower.


Peter Venkman once said in Ghostbusters something to the effect that we have dogs and cats, and mass hysteria. I think that in securities lending, defined below, we  are finding out we have exactly that.

Based on data from the four main tri-party service providers in Europe (BNY Mellon, Clearstream, Euroclear and JP Morgan) – which collectively hold the vast majority of non-cash collateral received by lenders – 57% of securities held in tri-party were equities at the end of June 2015, up from 53% six months earlier. Clearly, post-crisis regulatory and macro-economic trends have turned conventional wisdom in the securities lending market (i.e., where asset owners historically lent out equities in return for government bonds as collateral) on its head! [emphasis mine]
Tri-party acts as a clearing house, a third party that holds the collateral for the securities lending market. Mutual funds, ETF's, insurance companies, and pension funds are often the main lenders and hedge funds are the primary borrowers.

Hedge funds appear to be taking advantage of this arrangement, as the collateral in a downturn would be worth far less than the original loan amounts which would seem to breach fiduciary requirements of pension funds and insurance companies. Other dangers and disadvantages are shown at this second Investopedia article.  However, the tri-party market may increase the safety of this market.

Offsetting that safety is the use of non cash collateral. Even the author of the above quote, Steve Kiely, EMEA Head of Securities Finance New Business Development BNY Mellon Markets Group, appears to be astonished at the amount of non cash collateral, ie stocks being used as collateral. Because of this change, banks are being encouraged to hoard treasury bonds (as if there was not already enough demand for bonds):

Although low interest rates and the very real possibility of downgrades for OECD government bonds have played their part, Basel III’s Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) are the key reasons for this switch. These ratios encourage banks to hoard high-quality liquid assets (HQLAs) – largely government  bonds, while other aspects of the Basel capital and liquidity framework (which is being rolled out by national regulators up to 2019) punish balance sheet holdings of equity securities. Moreover, lenders that are naturally long on equities can experience operational and cost efficiencies in accepting equities as collateral, even when lending out equities.
Needless to say, this is risky business as Mr Keily goes on to say. And hoarding of bonds in this theater is sort of Japan-like, and hoarding in general is, well, a reason why yields are low, not only in this area, but also throughout structured finance.

The new ISLA report has stocks used as collateral standing at 48 percent of all collateral in tri-party as of June, 2016. That is a pretty large drop from 57 percent the year before. Does this mean that banks are getting nervous about equities as collateral? They certainly have deleveraged and have used more bonds as collateral in 2016. That will further increase demand for bonds.

Perhaps equity collateral makes less sense if a potential crash is considered, forcing margin calls and putting institutions who loaned out the money at great risk of violating their fiduciary responsibilities. If the Bank of Mellon is concerned about the risk in this market, perhaps individual investors, pensioners, and those insured by insurance companies should be as well. 

Friday, February 10, 2017

Reflation Cannot Save Tantrum Trump from a Painful Recession

This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/bonds/reflation-cannot-save-trump-from-a-painful-recession?post=112162&uid=4798

Donald Trump is a real estate guy. He knows American real estate skates on thin ice. His contract with Wall Street is to try to supply more bonds through deficit spending to Wall Street. But the senate will likely not be behind this deficit spending as it relates to infrastructure. Trump has indicated that he wants to cut corporate taxes from 35 to 15 percent, and spend more on military and infrastructure.

The reflation trade that we are seeing is a tantrum against the bond market. Long bond yields are up to over 2 percent. But what is the reflation trade and what can it accomplish? Investopedia has a precise definition of reflation as government sponsored business expansion:
Although almost every government tries in some form or another to avoid the collapse of an economy after a recent boom, none have ever succeeded in being able to avoid the contraction phase of the business cycle
The question then is, are we in the middle of a boom or at the end of it? If we are at the end of this boom, reflation will only make things worse, and the recession deeper. Who will take it the hardest?

Likely those who will incur the most pain will be the working class supporters of Trump, along with the rest of main street. Who will benefit most from the reflation before the crash? Well, try investors in real estate of course. Here is a chart from Dr. Edward Lambert that proves we are at the end of the business cycle:


Here is my explanation of this chart in a recent article:

So basically, the chart shows two things. The red is the traditional CBO measure of the output gap, which is real GDP minus potential GDP. The green is Edward Lambert's measurement of the effective demand limit caused by labor's share of income being low. He is saying the growth cycle has already passed and the green line indicates the road to recession. He says the Fed missed the interest rate cycle already!

So then, my personal opinion is that Trump is doing what he knows and what will benefit him. If he is prospering, by the reflation of real estate, then in his mind, that nation is prospering. I remain skeptical, because this reflation could make the inevitable recession even worse for the guy on the street. The investors will leave early, having bought low. They will sell high.

But the average people may seek to tap HELOCs, or spend to improve their houses, and then when they are ready to sell, the recession could already be upon them and hurt them.

As far as interest rates are concerned in the treasury tantrum, I believe that there is massive demand for long bonds, so that I disagree with one article on partner site Seeking Alpha. The author, Harry Kourouklis, says there are multiple attacks upon long bonds, that are in the works. First is Trump's reflation. Second is China's explosive inflationary growth, which the author also notes in another article. 

It is difficult to measure the demand for long bonds, other than getting hints from people who see the demand from the inside. Rick Rieder said there is monumental demand. Monumental is a pretty strong word. Needing more bonds in a margin call at your derivatives account if collateral declines in value too quickly, is a sure sign of bond strength. It would seem that there can be agreement with Marc Faber that buying into the selloff of bonds makes sense above 2 percent yield on the 10 year.

Reflation is here, for awhile. Reality will set in if Dr. Lambert's predictions of recession hold. Math don't lie, so investors should assess his views seriously.








Wednesday, February 1, 2017

Edward Lambert on Bond Demand, the Coming Recession, and New Normal

This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/bonds/edward-lambert-on-bond-demand-the-coming-recession-and-new-normal?post=111806&uid=4798


Edward Lambert is the blogger at Effective Demand Research. He is a noted economist, having shared his work at Angry Bear Blog, where he is an active contributor, and elsewhere. He has come up with an equation to measure effective demand and predict recessions. His calculations indicate we are on the path to recession already. I will address that aspect of his work with his charts down the page, but what has excited me most about his theories is that he agrees with me about monetary theory.

He is the only economist I know of who has come right out and said that monetary theory is dead, a point which I have been trying to share with economists to no avail until I ran across his comments.  Many economists simply refuse to speak about bond demand, like many Market Monetarists I have tried to engage.  Dr. Lambert explained it to me this way in an email:

I agree with you. Money theory, as it applies to bonds, is dead. Basically
because the models of economists cannot grasp the new normal. That is where my
effective demand is making sense of so many things. 
Krugman is waiting for the whites of inflation's eyes, but with after-tax
corporate profit rates at never before seen record highs, there is no price
pressure, too many firms are still able to undercut any price rise. So the
only thing that will bring on inflation is a substantial fall in after-tax
profit rates, which brings on a recession. So when Krugman gets his inflation,
a recession will already be happening. [Emphasis Mine]
 
Dr Lambert read some of my articles on Talkmarkets regarding these subjects, and the email he sent spoke to Effective Demand and to fiscal stimulus as an economic tool:

Economic theories have not grasped how the economy has changed. For me,
getting a working model for effective demand has made the difference. My
models are describing cycles that existing models cannot do...
About fiscal stimulus, I do not think it will work. Any money injected into
the circular flow of the economy will just flow into high corporate profit
rates and low labor share. Effective demand will stay weak. And with
unemployment low, and some marginal firms unable to pay the rising wages,
there will be internal decay in the business cycle leading to a contraction.
The contraction will want to clean out marginally unproductive firms. It is
long overdue with these low interest rates that we have had for years.

The pressure will build for wage increases. So the pressure on marginal firms
will build too. That cascades into a contraction.
More economists are expecting a recession in a few years, like Larry Summers.
But a recession is closer than they think because they still have one foot in
the camp that thinks there is still lots of slack. Yet as Keynes described it,
weak effective demand will keep the economy from reaching normal full
employment. The slack we see now will not be used due to weak effective
demand. So the recession will come on earlier than they think. [Emphasis mine]

For more on the concept of Effective Demand, Dr Lambert has put together a Synopsis of Effective Demand on his blog. The effective demand limit has an equation that he created that can tell us that:

In 2015, capacity utilization fell while the utilization of labor increased (unemployment fell). The equation predicted this.

Dr Lambert's conclusion is that:
Unlike capital, labor never reaches its optimum utilization since it never reaches zero in the graph. Capital comes first in capitalism. And since the 1990's, the utilization of labor has been getting worse as seen by the plot steadily trending upward. The increasingly unmet potential of labor utilization coupled with lower labor share is a problem. The US is becoming over-capitalized in relation to the labor force. Supply-side economics can be partly blamed for this?

The chart he refers to is at the Synopsis. Dr Lambert went on to say in separate emails:

When labor share declines, so does the optimization level of capacity utilization.

In other words, profit rates increase, but the maximum utilization level of capital declines. As such potential GDP declines too.
and:
 
When the decline in production due to lowered optimization of capital is not factored in, one cannot see that potential GDP has declined. My model saw that potential GDP declined in real time as the crisis appeared. The CBO and Fed have been very slow in realizing this. They still haven't. 

In essence, they missed the biz cycle. Real GDP has already gone positive and is now falling relative to potential.
and the definition of effective demand limit, a new economic concept:

It is a limit placed on the utilization of labor and capital by the percentage of labor share of income. It has always been there in every business cycle. It determines such things as potential GDP and the profit rate cycle. [Emphasis mine]

I believe that Dr Lambert is essentially saying that labor's share of income is low, and GDP simply will not grow and that it may take a recession to fix the problems and we are headed there. Dr Lambert likes the Scott Sumner idea of NGDP Targeting but the key of any stimulus is to increase potential GDP. Also at his synopsis page he offers this FRED chart:



So basically, the chart shows two things. The red is the traditional CBO measure of the output gap, which is real GDP minus potential GDP. The green is Edward Lambert's measurement of the effective demand limit caused by labor's share of income being low. He is saying the growth cycle has already passed and the green line indicates the road to recession. He says the Fed missed the interest rate cycle already!

Dr Lambert encourages those of us who are not economists to actively attempt to understand how the economy works. Probably his work at Atlantic International University as a tutor has given him the patience to attempt to convey important economic concepts to non economists. The lack of understanding of the New Normal by economists and non economists alike is limiting the advancement of the discipline. Economists are often too remote to bother with non economists. And they are often stuck in their schools and cannot see other and more contemporary concepts. 

We can only observe the outworking of his efforts, to see if he has a better measurement of the growth cycle going forward. He sees no problem with derivatives as they exist and believes that massive bond demand will not get in the way of efforts to raise rates when needed in a modest but way. That timeliness has not been utilized. He does not think rates need to plunge into the negative, but will have be range bound due to demand for bonds.

Thursday, January 26, 2017

Blackrock, Cap on Yields Because of Monumental Bond Demand

This article was first published by me on Talkmarkets:  http://www.talkmarkets.com/content/bonds-education/blackrock-cap-on-yields-because-of-monumental-bond-demand?post=111451&uid=4798


Business Insider, primarily because of Jonathan Garber, is actively engaged in bond tantrums from time to time. This is my opinion only, but  I think there are statements in Garber's interview with Blackrock's Global Fixed Income Investment Guru, Rick Rieder, that illustrate my view.

 In the long titled article, The Bond Chief at 5 Trillion Investment Behemoth Blackrock Told Us the Most Dangerous Place to Put Your Money, Rieder essentially makes two opposite predictions in the same interview.

At the end of the article, the bond king makes a statement that runs along the traditional belief, that:

In this environment, small moves in yields result in big price adjustments in long-dated fixed income, potentially resulting in significant losses in investors’ portfolios. For this reason, we have a much higher conviction in holding short/intermediate maturity rates over the coming quarters, as the longer end of the curve is likely to back up to levels more reflective of fundamentals. [Emphasis Mine]
This is often what you hear from financial advisers. It is classic stuff. Certainly, as inflation increases, bond yields tend to rise. But, this is not an ordinary interview. It is a dual track interview. It is almost if Rieder is speaking to two different audiences, and is speaking in code. For prior to the standard prediction, he makes an astounding statement, confirming what I have believed all along. Rieder said:

Rates may have a bit more room to run higher, but there’s a ceiling to that based upon the monumental demand for yield. [Emphasis Mine]

Got that? There is a ceiling to a rise in rates because there is a monumental demand for yield. This second quote from the Business Insider article is simply the opposite prediction of the first quote. Garber did not challenge the contradiction.

I have put it otherwise in discussing this issue that so many people do not factor in to investing and into economic theories. I have said many times, from studying somewhat obscure postings that there is a monumental demand for bonds. This is even more monumental than simply a demand for yield! Demand for yield is massive, but bonds are the new gold and demand for bonds is explosive even at low yields and sometimes at negative yields. Blackrock first showed us this demand in an article I shared here at Talkmarkets.

I think the phrase, "monumental demand for yield" is a bit of code for the ideal that bonds themselves are in massive demand as collateral in derivatives markets, besides all the other uses they fulfill.

The interview revealed a few nuggets, like bond yields are slightly up all around the world. The central banks are working hard to keep us off the zero lower bound. That is not a bad thing. Second, the central banks don't like the idea of negative rates as a means of stimulus, that they are falling out of love with the concept. That is also a good thing, if it continues.

But the central banks remain bound by monumental demand, the conundrum, as another tantrum fellow, you heard of him, Alan Greenspan spoke of. Pushing long yields up is difficult because the central banks have simply done too good a job selling bonds. That is their main job, after all. Now everyone wants them.

So, the return to normal is dubious. Tantrums frighten some into selling the bonds, since monetary theory says rates will rise and you need to be in cash and not in bonds when rates are low. But I have argued that theory is dead.

All that is left is for people who know it is dead to go out and scare people into selling their bonds so they can buy them. That is tantrum. And it is kind of sickening. It is a trick.

But if you are having a hard time determining if what I say is true, consider that Janet Yellen sees the need for more bonds. She recently said as posted by Zero Hedge that:

And as Reuters notes, the Fed could get benefits from buying assets other than long-term U.S. debt if in a future downturn it could not buy any more government bonds, Fed Chair Janet Yellen said on Thursday.
She knows bonds are very scarce, almost to the point of not being able to buy them in the next recession!

The Century Foundation has advocated fiscal stimulus coupled with a tax on Wall Street transaction. While the argument is always couched in what it will do for government and main street, truth is, it would help Wall Street get more bonds to be used as gold, and the government would get a huge windfall from Wall Street in return.

I would not advocate fiscal stimulus without advocating a tax on Wall Street transactions, but Helicopter Money probably would be easier to implement. I can just see Wall Street getting the bonds from fiscal stimulus, but not coming through on the transaction tax. Silly me for being so skeptical of our government's power to exact any just policy from Wall Street.

If Wall Street does not want to help America, do their part, just let Wall Street eat cake. It will be a nice cake, but don't give them more bonds until they buckle, America! And watch out for these bond gurus and pay attention to what they really say.

Sunday, January 22, 2017

Sane and Silly Economics from Sumner, Yellen and the BIS

This article was first published by me at Talkmarkets: http://www.talkmarkets.com/content/bonds/sane-and-silly-economics-from-sumner-yellen-and-the-bis?post=109558&uid=4798

Scott Sumner, well known market monetarist, discusses Janet Yellen's procyclical bias on a recent post at The Money Illusion blog. He believes that Yellen's experimental idea to let inflation run hot in an expansion, would be a mistake. 3% inflation, Sumner says, while unemployment is low, would ultimately destabilize the economy. You could argue about how low unemployment is. But lets say Prof is right for the purposes of this article.

Before I talk about Sumner's comments that make sense, I would like to speak to a comment he makes that I disagree with, that may prove to even be as silly as some Fed and BIS talk.

Sumner said: 
Yellen’s statement was not an indication of Fed policy, but merely the musings of one person.  It’s very unlikely to be put into action.  And yet bond prices plunged. Now imagine if all 12 members of the FOMC got on a stage and said they were raising the inflation target from 2% to 3%.  The impact on the bond market would have been at least 10 times greater than what occurred yesterday.[Emphasis mine]
I disagree with the last sentence of that quote. I am skeptical, because of the conundrum, that the Fed has the power to bust open long yields upward. I think increases would be short lived, and a massive buying opportunity for bond investors. It seems to me that Scott Sumner and most market monetarists, and most economists, do not take seriously the conundrum caused by massive bond demand as collateral. I still believe that there is a solution for this long bond problem that is shared at the end of this article. Monetary policy is simply aimed at the wrong entities.

And I am thinking that the Fed would not even up the target to 3% in a downturn. Until someone shows us otherwise, the Fed behaves as if it is in a straight jacket of derivative insanity. It is useless to talk to Professor Sumner about this issue of bond demand because he is mum. You have to wonder why. And Yellen is just talk, if, as Sumner says, the rest of the governors would never impose the 3 % target. The bond market seems to be rigged by Fed talk, and by bank manipulation, to push yields on the long bond up incrementally, but only to create buying opportunities.

As to the sane and sound thinking, Sumner shares this about procyclicality:
It would be destabilizing to let inflation go to 3% while unemployment is low.  It would bring the recovery to a premature end, triggering another recession as soon as the economy was hit by another oil shock.  Instead, the Fed should shoot for 3% inflation during the next recession—not during this expansion.  But they currently lack a policy regime capable of achieving that (countercyclical) outcome.  Yellen’s policy remains resolutely procyclical.  NGDPLT anyone?
NGDPLT would require measurements of GDP that are not easy to come by, so I like economists who try to solve the problem with helicopter money in down times, as I wrote about them in past articles.
There is proof from other economists that the Fed and central banks are procyclical, offering easy money during expansion and tight money during contraction. That just makes things worse.

Sumner says, in the comment section of his article, that easy and tight are not always the issue. He says that procyclical money is the problem. Currency that appreciates during good times is procyclical and currency that appreciates during bad times is countercyclical, according to the World Bank.

Countercyclical policy is generally better, because it smooths out booms and busts, but human nature is not inclined to go with it. The World Bank also says that appreciation in good or bad times may not  always be caused so much by easy or tight money at home, but may be caused by net foreign asset positions that have nothing to do with domestic tight or easy money. That reality could complicate issues at home, to be sure.

However, since the US economy is suffering, tight money on mainstreet remains a big problem.  Banks are holding onto money and  are paid for their massive excess reserves and fear lending to main street. That is a big problem that can give rise to populist anger. We all know what that exercise in political hostility has done to the nation, as strife and frustration seems to be increasing. People are talking about assassinating leaders, and as frightening as that talk is, they haven't yet turned their wrath towards bankers, although that day could come.

So, raising rates would be really good because some fear a downturn that would bring us into an unfortunate negative rate regime if we start from low rates in an expansion. But I understand those who say that at this point in the recovery, raising rates could temporarily cause a large setback.

So, there is a solution:

As Kyle Bass says, there is simply no other solution than helicopter money. The Fed won't have to touch interest rates. The conundrum can be left alone. Inflation could be controlled because helicopter money would not be aimed at Wall Street, which is awash in money, but rather to main street, which is depressed as to money supply.

Facing any major slowdown, the Fed needs to appreciate the positions of Kyle Bass and Eric Lonergan and Adair Turner, and not be so insulated from new ideas from the outside. After all, the Fed already possesses monetary tools to improve things at home but is frozen in its will to use them.

Just remember, when someone wants fiscal policy solutions as Fischer does, they are calling for more  spending and bond creation, and realize that the new gold collateral must be minted by deficit spending. That is highly irresponsible when monetary policy is not dead, just comatose, because of silly people like Janet Yellen and Stanley Fischer and the Bank of International Settlements.

One would think that Fischer, saying it is difficult to tamper with interest rates in these economic times, would jump for joy for real helicopter money which would not increase government debt. But people like Richard Koo no doubt scare the Fed with sky is falling pronouncements about helicopter money. But clearly helicopter money would not necessarily promote massive lending once people pay off their debt. Lending can be controlled, still, by credit score requirements, by payment of interest on excess reserves, by government advocating what millennials now do, practice frugality. Government can teach people that banks are foolishly procyclical and will pull the rug out from under you if you get into too much debt.

Koo says helicopter money is the end of monetary policy and would create too many bonds in circulation, as the Fed would have to sell bonds to get rid of excess reserves that banks could lend out. Well, there is a shortage of bonds now. Debt free (to the government) helicopter money, would at least be better than more fiscal debt!

And the BIS says this, and it can't be right:
 If the reserves are non-interest bearing - as they must be for helicopter money-the increase will inevitably also drive the short-term (overnight) rate to zero. This is because when the system as a whole has an excess of reserves, no one wants to be left holding it but someone must.
Why would this have to be? The Fed would not be lending out excess reserves as helicopter money. They would create helicopter money and bypass the banks to issue it, not increasing reserves at all! There is no rule saying continuing interest payments on reserves would be contrary to helicopter money. That is crazy, silly talk by the BIS. The BIS is saying that Milton Friedman is wrong and it is saying that all reserves must be paid down for helicopter money to work. That is ridiculous. Keep having central banks pay interest on excess reserves to the banks if that is your worry, BIS. Keep Wall Street from price gouging on rents and it would work just fine, in a controlled environment, as Lonergan seeks. If this attempt is not made the wealth divide will only increase and destabilize the economy, the very thing central bankers don't want.

For further study:

Tuesday, January 17, 2017

Economic Theory Is Dead. New Normal Means No Recovery

This article was first published by me on Talkmarkets: http://www.talkmarkets.com/content/bonds/economic-theory-is-dead-new-normal-means-no-recovery?post=108622&uid=4798


Economic theory is dead. It is like an emperor who has been stripped of his clothing. It is nothing of consequence in the New Normal. 

And that bodes ill for recovery. Before I get into John Mauldin's timely comments about this sorry state of affairs, we can look to see if monetary theory still applies.

John Maynard Keynes was right about monetary theory in his time. But that was then and this is now. Somebody needs to prove me wrong but I don't think they can until the powers that be change the rules.

Here is what Keynes said, paraphrased:

When interest rates are low, the opportunity cost of holding money is low, and the expectation is that rates will rise, decreasing the price of bonds. So people hold larger money balances when rates are low. Overall, then, money demand and interest rates are inversely related. [Emphasis mine]
Well, it ain't happening that way folks. Bonds are being hoarded even when interest rates are negative, in Europe. And US bonds are being hoarded. Interest rates are low, and real rates are likely negative, and Keynes rule does not work now. The rules have changed, and unless they are changed back, money demand and interest rates are no longer inversely related.  



 The New Normal has forced the rules to be changed. What is the New Normal? The New Normal at Google Search is defined this way:

 A previously unfamiliar or atypical situation that has become standard, usual, or expected.
Why are economists, and investors who listen to them, expecting interest rates to rise? Because they live in that parallel universe of old. That rule does not apply here and now. They are fossils, dinosaurs, and they are wasting everybody's time.

Interest rates and money demand are not inversely related when bonds are being hoarded for collateral. Keynes didn’t have that issue, apparently.

But Keynes got one thing right. Applying it to the New Normal is chilling. It is positively chilling. Keynes said rates rise during expansions. But since they are not rising, we can be assured that we will never have an expansion! Never, never, never, never.

I really wish somebody could prove me wrong, but talk is cheap. The talk of rising rates is endless, blah blah, blah blah blah. Show me. I am not from Missouri, but show me anyway!

So, continuing on with the article above, citing Keynes, there are some good points made:

1. If inflation erodes the purchasing power of the unit of account, economic agents will want to hold higher nominal balances to compensate, to keep their real money balances constant.
That may be true. Certainly, those hollering for NIRP don't think it is true. But if it is true, the New Normal has a big problem.

2.  When interest is high, more people want to supply money to the system because seigniorage is higher. So more people want to form banks or find other ways of issuing money, extant bankers want to issue more money (notes and/or deposits), and so forth.
We know this is true. When is the last time anybody saw new banks? It is hard to expand the money supply if there isn't much competition and aren't many new banks created. The New Normal has seen to that.

John Mauldin made a statement that everyone should take notice of. Central bankers are not alarmed, but they should be. Banks have been booted off American soil before, and they can be again. They can't be too complacent. Mauldin said this in a wonderful article:

Because the Fed is banker-driven, it thinks cost of capital is everything and therefore that a lower interest rate will stimulate activity. They’re right up to a point, but that relationship is not linear. It flattens out as you get closer to zero.
Yellen is aware of this. Her point with Footnote 8 was that interest rates aren’t always an effective stimulant. But also, she isn’t the only vote. She has to convince the other governors and regional Fed bank presidents, and they are all influenced to varying degrees by the banking industry, which loves lower rates.
Come to think of it, this might also explain Footnote 8. Negative rates are death to commercial banks. A -9% NIRP would kill many banks. So maybe that footnote was a warning, the Yellen equivalent of a brushback pitch to overly eager bankers. “Look what can happen if we don’t do it my way.”
I truly don’t think Yellen will take us down to -9% or anywhere close to it. I do think she is mentally prepared to go below zero if she sees no better alternatives according to her personal economic religious beliefs. I also feel very confident that she and her colleagues won’t take rates much higher from here. I think we will see 0% again (and below) before we see +2%.
Look, sooner or later a recession is coming. This recovery, feeble as it has been, is already long in the tooth. I think there is the real possibility we will enter at least a mild recession no later than the end of 2017, brought about by a crisis and recession in Europe. Those of us in the US really should pay close attention to what is going on at the polls in Europe just as we pay attention to the polls in Florida. How will the Fed respond when that recession hits?
The Fed is making those plans right now. If you think 2008–2009 was a wild ride, I suggest you fasten your seatbelt and prepare to take an airbag in the face. The next ride will be even wilder.
Now, it is true that the central bankers think that by keeping yields for bonds low, by setting the table for massive demand and hoarding, and by goosing the stock market, that they can stop the business cycle in its tracks. But if they can't, and Mauldin is right about the need to fasten a seatbelt, then low rates give no comfort in downturn, no margin of comfort at all.

Mauldin also blasts Stanley Fischer, Vice Chairman of the Fed in the same article:

Let’s read that sentence again: “… the idea is, the lower the interest rate the better it is for investors.” They are sacrificing mom-and-pop middle America, the hard workers who have played by the rules and retired and saved and now want to live out their lives enjoying their grand-kids and a little well-deserved relaxation, and they find they can’t do that because the Federal Reserve thinks that protecting Wall Street and wealthy investors and bankers is more important.
The true is, it is likely that Fischer and the Fed are simply satisfied with themselves. As I have said before, they are just happy the big banks are still around and the counterparties are buying bonds. That is all they care about.

But it would seem necessary for insurance companies and pension funds to invest in way more risky investments, which they are constrained not to do, to keep from raising insurance rates and pension contributions to absurd levels.

And what happens if insurance companies get the green light to invest in risky instruments? What kind of insurance is that? Is it like a rock? No, it is jellyfish insurance. Nobody will want it. Or maybe the insurance companies will keep it a secret. 


The theater of the absurd is what the Fed policy is. Fischer is trading sanity for insanity. But we know structured finance and bond hoarding is here to stay until something bad happens. Maybe nothing will happen. If anything, more and more need for collateral, as risk increases, will just drive bond yields down further.

And thus the New Normal will remain true for no telling how many light years, indicating that money demand and interest rates are no longer inversely related. I leave it to the economists to create the appropriate New Normal Equation.

The New Normal is fueled, as I recall Mohamed El-Erian saying someplace, by "ill understood financial innovations". That is an understatement of a disturbing reality, if there ever was one.