Growing Concerned Once Again

Growing Concerned Once Again

I've often made fun of the so-called smart money. Among other things, many of those who hold themselves out to be experts on financial matters failed to see the financial crisis coming and totally missed the boat when it came to predicting the severity of the subsequent downturn.

Nonetheless, it might be time for a reassessment.

For one thing, there are plenty of charlatans, lucky-breakers, and analytically depraved "strategists" running around Wall Street and other financial enclaves who give the appearance of being tuned in to what is going on but who are actually quite clueless.

Clearly, these individuals shouldn't be characterized as "smart" in any sense of the word except with respect to their ability to fool a great many people some of the time.

However, those who have a serious wad of cash and who like to sling it around in markets were apparently more prescient than your average Wall-Streeter when it came to anticipating the ugliness that fell upon us during 2008, according to a firm that keeps tabs on what the wealthy are up to.

More importantly, as Pragmatic Capitalism notes in "The Super Rich Are Super Pessimistic," they are reportedly growing concerned once again about where things are headed:

One of the most glaring trends in the 2008 bear market was the increasing bearishness of the super rich. Generally thought of as more savvy investors and less susceptible to economic downturn, this group of investors proved more vulnerable than many previously thought. As the super rich pulled out of the markets in 2008 and pulled in their purse strings the economy ground to a halt.

Data released from Spectrem Group shows that the super rich are again becoming very bearish. Their Millionaire Investor Confidence Index plummeted to a new 2010 low and fell the most since summer of 2009. George H. Walper, Jr., President of Spectrem Group says the decline is worrisome:

“Millionaires posted their biggest decline in investment confidence in more than a year in August, while affluent investors saw their confidence decline for a third-straight month. The millionaires’ decline is particularly troubling since it suggests millionaires, typically more sophisticated than the broader affluent population, are reverting to a bearish frame of mind.”

Source: Spectrem Group

Posted by Michael Panzner on August 26, 2010 at 08:03 PM in Economics, Stock Market | Permalink | Comments (0) | TrackBack (0)

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August 25, 2010

A Matter of When

In a new paper, "Guessing the Trigger Point for a U.S. Debt Crisis," George Mason University professor and economics blogger Arnold Kling speculates on when the U.S. might have to pay the piper for its many (fiscal) sins.

Here is the abstract:

Leading authorities in the United States, including the Congressional Budget Office, use the term unsustainable to describe the long-term fiscal outlook. By the year 2080, spending on entitlements alone could exceed total federal tax revenues. In the very long run (meaning from the year 2035 through 2080), the problem is primarily one of excess costs in health care, meaning the tendency for health spending to grow faster than the rest of GDP. However, in the medium run, meaning from 2010 through 2035, the aging of the U.S. population is the dominant factor.

This paper explores the possibility of the U.S. experiencing a debt crisis in the medium run, meaning somewhere between 2015 and 2035. It is impossible to state precisely the trigger point for a crisis. At best, we can make guesses about some of the key parameters.

As I noted in "A Bad Assumption," one factor that many mainstream analysts did not eally take account of before the financial crisis erupted -- and still seem to be downplaying -- is the importance of confidence in a system built on a dense latticework of promises. If at some point faith begins to waver on a large-enough scale, then things can fall to pieces, as Professor Cling suggests, rather quickly:

A debt crisis can be thought of as a sudden transition from the high-confidence regime to the low-confidence regime. In the former, investors have high confidence in the sovereign’s willingness and ability to repay its debt. In the latter, investors lack such confidence. The loss of confidence leads to higher interest rates, which in turn exacerbates the sovereign’s difficulties with repaying debt, and that in turn reduces confidence still further. Hence, the shift is discontinuous, not a gradual smooth shift. There is no "in-between" regime in which investors have medium confidence in the sovereign’s debt, because the strong self-reinforcing feedback loop that characterizes investor confidence, interest rates, and fiscal viability drives those variables in either one direction or the other.

Posted by Michael Panzner on August 25, 2010 at 07:52 PM in General | Permalink | Comments (5) | TrackBack (0)

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August 24, 2010

A Bad Assumption

Although many factors helped bring about the worst financial crisis this century, perhaps the most underappreciated was the widespread reliance on bad assumptions.

Many people took it for granted that what had happened many years ago was, well, ancient history; they figured that with all of the regulatory and other backstops in place, any problems that might crop up would be dealt with by authorities in one way or another; they bet the ranch on the view that low-probability events were not worth worrying about.

Even now, mainstream commentators appear to be ruling out developments that don't quite fit with mainstream economic thinking. But as Jordan Roy-Byrne notes in a post at Minyanville, "Hyperinflation Is Fiscal, Not Monetary Phenomenon," "too many analysts believe there has to be some economic demand or some consumption to stimulate inflation or hyperinflation."

I disagree with the views put forth by John Mauldin, Mike Shedlock, and now Jim Rickards, who all focus on velocity and/or bank lending as important causes of hyperinflation.

The reality is that hyperinflation is first and foremost set in motion and driven by a deteriorating fiscal situation. In fact, significant economic weakness and deflation is a precursor to hyperinflation. Too many analysts believe that there has to be some economic demand or some consumption to stimulate inflation or hyperinflation. Printing money to try to stimulate your economy or excessive credit growth is what leads to inflation. Printing money because you're broke and can’t service your debts is what leads to hyperinflation.

Recently Rickards wrote about how a change in velocity can trigger hyperinflation or severe inflation.

At Mises.org, Henry Hazlitt educates us on velocity:

For example, it is frequently said that the value of the dollar depends not merely on the quantity of dollars but on their “velocity of circulation.” Increased “velocity of circulation,” however, is not a cause of a further fall in the value of the dollar; it is itself one of the consequences of the fear that the value of the dollar is going to fall (or, to put it the other way round, of the belief that the price of goods is going to rise). It is this belief that makes people more eager to exchange dollars for goods. The emphasis by some writers on “velocity of circulation” is just another example of the error of substituting dubious mechanical for real psychological reasons.

Indeed! The focus on velocity may have led you astray over the past 10 or 15 years. Take a look at this chart of velocity from Lacy Hunt of Hoisington Investment Management.

As you can see, velocity actually increased during a time of disinflation and has been muted throughout most of the bull market in commodities. Moreover, despite the sharp drop in credit growth and bank lending in the West during recent years, gold and commodities have powered higher. We know gold has made all-time highs against every currency. Yet, take a look at this chart.

Priced in euros and pounds, commodities have rallied back to their 2008 high! Priced against a basket of currencies (example: US$), commodities are 9% below their 2008 peak. Not bad considering the crash in 2008 and ensuing deflationary environment.

Why are gold and commodities performing so well if we're in a deflationary environment? The greater the deflation and the worse the economy gets, the greater the worry about sovereign bankruptcy, which will come via default or hyperinflation.

Certain government bonds are rallying because they're safe havens relative to other government bonds.

The point is, precious metals are outperforming commodities to a lesser extent even without a rise in bank lending, a rise in credit growth, and a rise in velocity. As I already explained, deflationary forces and a weak economy ultimately exacerbate the ability of various governments to service their ongoing and growing debt burdens.

Hyperinflation is a fiscal phenomenon borne out of a bankrupt state that can’t service its debts. Monetization is a trigger while a rise in consumption and velocity is a psychological effect, as Hazlitt notes. After all, if massive inflation is coming, what's the first thing you want to do? You’ll position yourself in hard assets well ahead of thinking “I need to spend now because this money will be worthless later.”