Fire Up the Printing Presses . . . Again

Today, the Fed announced another round of quantitative easing, which means they will buy Treasury bonds, which means the Treasury then gets that amount of money ($75 BILLION per MONTH over the next 8 months) deposited into Treasury's checking account, which Treasury can then use to write checks for Social Security, infrastructure, anything . . . even interest payments to the Fed for having bought the Treasury bonds. In other words, the right pocket buys the bonds in the left pocket. Of course, it is all "smoke & mirrors", but it can have huge economic effects.

Milton Friedman, father of Monetarism, believed that inflation is caused by "too many dollars chasing too few goods". Another way of saying this is . . . if money supply increases faster than productivity, you will get inflation.

The Fed is worried about deflation. So, today's Fed action does make sense!

Plus, the Fed handled it well. You can tell . . . because the stock market barely reacted. That means the Fed properly telegraphed with market. When it doesn't, the market over-reacts, which is what it does best!

Political Pundit George Carlin ?

I think the late comedian was the first to describe our electoral process as "political masturbation", a very intense, focused effort to accomplish nothing. The Libertarian view is that elections merely change the Masters, with the slaves remaining the same. It is just a different set of thieves. Maybe, that's a little cynical. OK, that's a lot cynical.

Wall Street traditionally likes divided government, and I expect the stock market will reflect that. That's the silver lining. But, there are turning points in history. We may "kick the can down the road forever," but forever is over. There are some deadly serious decisions to be made, and I don't see that we have the process for making those decisions.

How are we going to keep borrowing money from our grandchildren to pay for our Social Security, for our Medicare, for endless far-flung wars, and for interest on the trillions we've already borrowed?

What changed yesterday that will help us make those decisions? What happened two years ago that helped us? What will happen two years from now that will help us? Or, will it be just another Master?

WHEN will we know . . . and HOW will we know . . . that "political masturbation" is no longer working for America? The American people deserve better!

Election Day . . . Finally!

In this world of 24/7 cable news, which spin the news as well as report the news, it is easy to become both confused and depressed. Therefore, I recommend a disinterested foreign perspective to balance the right-wing Fox News and the left-wing MSNBC. Religiously, I read The Economist, a newsweekly magazine from England and recommend it.

Sometimes, it is helpful to read things like this, which appears on page 11 of the current issue: "Despite its problems, American has far more going for it than its current mood suggests. It is still the most innovative economy on earth, the place where the world's greatest universities meet the world's deepest pockets. Its demography is favourable, with a high birth rate and limitless space into which to expand. It has a flexible and hard-working labour forces. Its ultra-low bond yields are a sign that the world's investors still think it a good long-term bet. The most enterprising individuals on earth still clamour to come to America."

Too bad politicians never remind us of anything good about America . . . but, if they did, would we even listen? Have we become programmed to process only negative news? The nation that made the world safe for democracy, put a man on the moon, and still is all the things cited above . . . simply deserves better!

Rest Up This Weekend

Next week, the market could be exciting, maybe too exciting! As I've been predicting all year, the market will begin to rally when the election outcome comes into focus. I expected that in October and was pleasantly surprised when it started in September. Historically, the market likes gridlock, which appears to the outlook.

Another reason for the recent rally is the expectation that the Fed will announce another round of "Quantitative Easing" this week. While this is inflationary in the long term, it may jumpstart the economy in the short term. I expect the market will fall after the announcement. (There is an old market axiom about "buy on the rumor and sell on the news".) If the Fed announces less than $500 billion, expect the sellout to be more violent.

On Friday, the Department of Labor will issue the single most important economic report of each month, i.e., the "Jobs Report". Expectations are low, about 75-80 thousand private sector jobs. If significantly more jobs are created, expect the rally on Friday to be strong.

Only one thing is certain . . . it will be an exciting week!

Nailed it!

Economists get ridiculed frequently and richly deserve it. In fact, they usually enjoy it!

However, today was a good day, in that they accurately predicted the GDP growth rate in Q3 would be 2.0%, compared to 1.7% in Q2.

This makes it even less likely we will see a "double-dip" or experience the worst of the recession again. This makes my forecast of a "long, hard slog" even more likely, darn it! I was still hoping we would sharp a sharp rebound, which is more typical following a recession.

Sometimes, economists don't want to be correct ...

The Halloween Indicator

Of all the many market indicators, this is the most useless but must be fun, as it rolls out year after year. Here it is:

Since 1950, the stock market performs best from the last trading day of October to the end of April. (Of course, there are always obvious exceptions, like the oil embargo of 1973-74, the dot com bust of 2001-2, and the Great Global Financial Crisis of 2007-9.)

It is not news that the market does better during the winter and spring than it does during the summer and fall. In fact, it does a lot better!

The only thing scary about this is that we call it The Halloween Indicator. Let's just hope it works this year, and the market does as well as it usually does after goblins go away!

Baking a Cake . . . or Baking a Market

When you look at a cake, you are seeing the end result of whatever ingredients went into it. The same is true when you look at the market. Instead of flour, butter, mix or whatever goes into a cake, information and expectations go into the market.

Most people understand why information moves a market, but expectations about information are just as important. Yesterday's roller-coaster market is a good example.

Yesterday's Wall Street Journal reported the quantitative easing by the Fed to be announced next week would be much less that expected and over a longer period of time. The market promptly dropped almost 160 points. That afternoon, legendary Abby Joseph Cohen of Goldman Sachs predicted the Fed would do more than the Journal reported, about $500 billion as earlier expected. As a result, the market rallied over a hundred points, finally closing down only 43 points.

Expectations are important. Just imagine how you would feel if you expected a German chocolate cake from Neiman Marcus and only got a Twinkie from 7-11. You might lose your appetite for sugar . . . and for stocks.

Paddling Hard . . .

Arthur Conan Doyle once described how Sherlock Holmes unraveled a mystery because of the "dog that didn't bark". That's reminds me of the G-20 meeting in Korea. China is clearly manipulating its currency, but so is the U.S. But, there was little furor about this.

While the finance ministries are warning of a currency war, there was no furor that we were already in it.

U.S. Treasury Secretary Geithner proposed measurable goals for the emerging markets to reduce their trade surpluses, which is as ridiculous as the U.S. promising to reduce our trade deficit. Again, no indignation, no furor?

There must be an unusual amount of behind-the-scenes negotiation going on, but we won't know anything until the dog barks.

If logic prevails, China will revalue their currency. Since that has nothing to do with the only thing China does care about, i.e., internal tranquility, don't expect to hear the dog bark anytime soon.

Please Take My Money?

Yesterday, the Treasury Department issued $10 billion in five-year bonds. In other words, they borrowed another $10 billion. But, something was different . . . very different. Instead of repaying $10 billion at the end of five years PLUS interest earned by the bond-holder, the government will repay $10 billion LESS interest paid to the government for holding the money. This has never happened before! The lender or bondholder doesn't get paid regular interest.

What made this possible was that the bonds were TIPS or Treasury Inflation Protected Securities, which means the principal amount ($10 billion in this case) will be increased to offset inflation. It is a good way to protect investors with minimal income needs from inflation. Yesterday's investors were willing to take a negative interest rate in order to get protection from inflation.

What makes this significant is that it clearly shows the market is expecting inflation. The Fed is widely expected to begin another round of quantitative easing on November 3rd, which the market expects will create inflation. Actually, this is a good thing, as deflation is much worse than inflation. Now that an inflationary psychology has developed, the fear of deflation is reduced . . . hallelujah! That's a good thing!!

A Benefit of Aging

One of the benefits of aging is that a person has had time to benefit from all the good advice they have received over the years. One of the disadvantages is that you cannot remember who gave you the advice . . .

Some of the best advice I received as a young investment advisor was to be an "economics agnostic and a political atheist".

Long time readers know I have written often that there are lessons to learn from Supply-side economics, Keynesian economics, Monetarism, Classical economics, etc. No one school of economics has a monopoly on forecasting, truth, realism, or logic. I'm agnostic on economics.

Whomever it was that gave me this advice also said "The Repubican Pary and the Democratic Pary both make whorehouses look respectable." A person may hold conservative or liberal philosophies, but neither political party reflects well on either political philosophy. I'm an atheist about politics.

What does all this mean? Don't expect predictability in economics and don't expect truth in politics. Trust only in unpredictability.

And, if you are the long forgotten person who gave me this advice . . . Thank You!

Keyboarding Burnout?

With regret, I have noticed my blog gets neglected whenever I finish doing my quarterly column for Inside Business. (You can receive copies by email at no cost by signing up at www.baycapitaladvice.com.)

To be even more confessional, I have also been working on a book, which is still another excuse for my keyboard burnout. No more excuses, just apologies!

With the highly important G-20 meetings in Korea this weekend, amidst a bull run in the market, there will be much to blog about. So, stay tuned . . .

S.O.S. = Same Old Song . . . Whew!

The famous fat lady sang this morning, and, thankfully, didn't sing anything surprising. The rate of unemployment remained constant at 9.6%, instead of increasing to 9.7% as expected.

Total non-farm jobs decreased by 95 thousand, far better than the 600-700 thousand monthly decreases we saw last year but way below the 250 thousand a month increases that we need. Tragically, 6.1 MILLION people have been out of work for six months or more. If job growth were 250 thousand monthly, it would still take over two years to get them back to work, and that doesn't count the millions unemployed less than six months or those millions who have quit looking. This is one of two major reasons I've forecast a long, slow recovery.

Private sector jobs were up 64 thousand and is probably the most important number released today. This is slightly better than the expected 55-58 thousand.

Government jobs decreased 159 thousand, which were mostly census jobs. Except for this, there would have been actual job growth last month.

Because the numbers were close to expectations, the market didn't react nor over-react. Whew . . . ! Of course, Friday afternoons are notariously unpredictable.

. . . Waiting for the fat lady . . .

She will sing this Friday morning, when the monthly Civilian Unemployement Report or "Jobs Report" will be released. To the market, this is the single most important economic report each month, probably too important.

But, it is even more important this month. Yesterday, the Non-Manufacturing ISM Report indicated there was more job growth in the services sector than expected. As a result, the Dow roared upwards, almost 200 points. This morning, the ADP National Employment report was released, showing job growth in the private sector at only 20 thousand, compared to 60 thousand the market was expecting. Getting two contradictory reports in two days makes the report on Friday even more important to the market.

In addition, Friday's report will be the last one before the all-important mid-term election. Politicians of one side or the other will make a bigger deal of this report than normal, which is already too big a deal. Since Friday afternoons are normally the most volatile part of the week, expect anything this week!

Sometimes . . . The Truth Hurts!

For years, economists and financial analysts have talked about the BRIC countries, i.e., Brazil, Russia, India, and China. As a group, they were rapidly growing economies dependent upon export growth. As a group, they need to curb their internal savings by individuals and increase consumption spending by those individuals. This is a happy problem.

Now, economists and financial analysts are talking about the HIIC countries, i.e., heavily indebted industrial countries, like the U.S., England, Europe and Japan. As a group, they are well-established democracies with a high level of social benefits, such as Social Security and Medicare, which creates a high level of debt. As a group, they are growing slowly and are dependent upon consumption spending to power their GDP. As a group, they need to increase internal savings at the expense of consumption spending and to increase exports. This is not a happy problem.

So, which set of countries will have the best performing stock markets? Here are the BRICs for the third quarter: Brazil (+22.1%), Russia (+12.3%), India (+16.1%) and China (+12.1%). The U.S. stock market gained a relatively puny +11%. Of course, one of the reasons foreign markets beat us so badly is because the dollar has resumed its expected depreciation. But, since it is easier to increase consumption spending than to increase exports, I continue to believe the emerging markets are very attractive for investors. The depreciating dollar will only magnify the difference.

Talk about an inconvenient truth . . . we need to save more, export more, and consume less!

Final Thoughts on China

All of my life, the U.S. has been the engine of growth for the world. That is no longer the case, as China has clearly taken our place. While that may be sad, I don't think it is anything to be feared.

During my travels over the last two weeks or so, I've focused on China, but it is time to move on. For now, here are some concluding thoughts on "The Chinese Century".

In the near term, China's importance is clearly growing. Investing there is a smart thing for growth investors. However, the Shanghai stock exchange is not transparent and very volatile. If you have a weak stomach, stay out.

In the mid-term (5-8 years), I especially like consumer oriented stocks in China. However, don't do this on your own. Find a good, specialized mutual fund for this targeted exposure.

In the long-term, China faces enormous problems, with the fastest aging population on the planet. Their centralized government has done an excellent job of guiding the economy so far but are only human. No centralized government can consistently allocate resources more efficiently than the market. They will screw this up! "Buy and Hold" is not the right strategy for China.

Now, back to the U.S.-- my beloved America!

Save Your Breath, America!

The Bush Administration started applying pressure on China years ago, to allow their currency to increase in value. This makes their exports more expensive to foreigners who buy them, like the U.S. As a result, foreigners buy less, which means China produces less, and fewer Chinese workers are needed. Layoffs increase and so does social unrest.

The Obama Administration has substantially increased that pressure on the Chinese currency. Yesterday, Chinese Premier Wen said a 20% appreciation of the Yuan would cause widespread bankruptcies in China. As their bankuptcy system is rudimentary, the impact would be far greater than we would expect.

The single more important takeaway from this series on China is how critical it is to understand the driving force behind all their decisions, i.e., stay in power by avoiding social instability. Any discussion of China without that clear understanding is wasteful.

So, Wen has made it clear that a 20% appreciation is not going to happen. Most currency analysts believe it needs to appreciate 20-45%. If Obama pushes for a fairly priced Yuan, he is far more likely to get a trade war, which would be far worse for the U.S. Like a rat, Wen is backed into a corner and likely to bite!

What Chinese and Americans Have In Common . . . Taxes

The Chinese have a progressive tax on income, which means your tax rate increases as your income increases, similar to ours. However, they have no estate tax, at least not yet.

As income inequality increases, so does social instability, which is the greatest fear of the Chinese government and can hardly be emphasized enough. To take more from the rich, there is now growing pressure to tax the estates of the rich.

What amuses me is the argument by the Chinese Academy of Social Sciences that says "Before imposing inheritance tax on the rich, the government must study international taxation laws and practices thoroughly. What happens if some countries do not impose inheritance tax at all or have much lower rates and China decides to implement it hastily? It could cause many rich Chinese to migrate abroad and lead to unnecessary outflow of domestic capital, harming the national tax revenue and even the national economy."

This is pure classical economics, which says capital flees taxation and goes where it is appreciated. Funny, I haven't noticed too many Americans leaving our great country just to avoid taxes . . . that aren't even paid until after they're already dead anyway. Let me know if you do!

Peeling the Onion....

Last week, I marveled that China was making the same mistake as the U.S. by letting its Social Security system get as out of control as ours. Digging into this has not been easy, but I have learned that:

1. It started in 1978, when China was still a "socialist-paradise".

2. By 2030, it is expected to be the oldest, on average, population on the planet.

3. By 2040, over 28% of the population will be 60 years old or older.

4. Today, each recipient is supported by 3.5 workers, which drops to 2.0 workers in 2035.

5. Men working in "arduous conditions" can retire at 55 and women at 45.

6. They do have to pay into the system 15 years, compared to 10 years in the U.S.

7. But, the people don't see the problem coming, i.e., 90% are opposed to raising the eligibility age.

Remembering the single most important objective of the government is to maintain social stability, in order to maintain control, it is unlikely China will make the necessary changes, maybe more unlikely than the U.S. to make those same needed changes. I just wish both our governments would peel back the onion on this problem and actually address it...silly me...

Deja Vu.....Not This Time

Back in 1986, I was a Vice President with Citibank out of New York, and based in Dallas. With no data to go on, except a general sense of unease about the possibility of serious over-building, I rented a large van for a full day and invited all the best bankers I could to spend a day . . . sightseeing in our hometown. Collectively, we came to the judgment that the office building market in the North Dallas market and the condo market in far east Dallas were headed for big trouble. Fortunately, we immediately stopped lending to those markets. Because we knew there had to be “spillover” damage, we reduced overall lending all over north Texas.

For the last few days, I’ve remembered that experience, as I’ve driven around east China with businesspeople from the Chamber of Commerce. We are seeing an awful lot of construction, epic levels of construction in fact. There are countless “see-thru” buildings. I’m told that one of every three construction cranes in the world are working in China and have been for many years. Based on our experiences back home, most Chamber leaders think China is headed for big real estate problems.

I’m not so sure. Remember: The PRIMARY function of the Chinese government is to prevent social instability and thereby to remain in power.

One of the principle complaints of young professionals is the high cost of housing. Finally, after a long climb, residential sale prices in Shanghai have fallen about 2% since last year, to $2,971 per square meter or about $330 per square foot. Not surprisingly, sales are up 9%. Their unstated policy, I suspect, has been to increase the supply of housing enough to stop the inflation in housing prices. Even if they cause some deflation in home prices, it is unlikely to create a credit problem, since most mortgages require a 40% down payment, unlike the U.S.

Driving around north Texas in a van and east China in a bus . . . are very different!

Strutting With the Best of Them.......

I was born immediately after World War II. It was a time when America became the most powerful nation on the planet. We had triumphed over evil during the War and “deserved” to be #1 among nations. We were truly “exceptional”. As a young man (and especially when I wore my Army uniform), I walked with a swagger . . . because I was an American and damn proud of it!

As I travel through the provinces around Shanghai, I am again seeing that swagger but from the Chinese, of course. I recall that airy confidence of young men who believe they are exceptional but don’t think I recall seeing that back in the U.S. in a long time. Strutting with an attitude is not the same thing as walking with a swagger.

After being occupied by the Japanese from 1933 to 1944 and suffering thru a four year revolution between the Communists from 1945 to 1949, before the Cultural Revolution when 30-40 million of their countrymen starved to death, and then created the greatest economic leap in history, the Chinese feel they have the right to walk with a swagger. I agree!

The Triumph of Madison Avenue

Certainly, one of the most apparent changes in China from my last visit in 1987 is the western style of clothing, which has been completely adopted by the Chinese. It is not unlike a typical walk thru Chinatown in San Francisco. Who said advertising doesn’t work?

Yet, this is one of those discussions where business bleeds into ethics quickly. If advertising works for clothing, why should we assume it does not work for credit card companies? Anybody is savvy enough to buy clothes, but is everybody savvy enough to manage credit, when advertisers constantly encourage us to use it?

Oh, yeah . . . it is the consumer’s choice, I forgot. But, it’s odd that I haven’t seen a single advertisement for Master Card or Visa since I got here . . .

A Day in the Life of ....China

This nation boasts the greatest number of newspapers, with over 400. It is also accused of having jailed the most jounalists, number unknown. Still, a good read of one day's edition offer insights into Chinese thinking see www.chinadaily.com.cn:

1. Pressure from the U.S. to allow the Chinese currency (Yuan) to appreciate is not motivated by any trade protection of Chinese exporters but entirely by the mid-term elections in the U.S.

2. With Beijing selling 1,500 cars every day, it is getting more dangerous to ride bicycles (duh).

3. A widely used form of contraception for young Chinese women is the "morning-after" pill, where it is available at roadside pharmacies without a prescription.

4. If you kill a person with an auto, the driver pays a one-time penalty. If you cripple that person, you may have to pay the person for the remainder of their life. In the city of Xinyi, a man driving a BMW was videotaped running over a 3 year old boy before doing it several more times, to make sure the boy was dead.

5. There is a summit underway in Brussels on how the 500 million strong European Union can cooperate more closely with the stronger 1.3 billion Chinese.

6. Eight tourists from Hong Kong were killed in the Philipines.

7. One of the fastest growing businesses in the urban areas is "online snacks", where office workers call for delivery of snacks, not just food but snacks.

8. The Shanghai Composite Index or CSI was down 1.9%.

9. Life goes on......

What Mao Meant.....?

Mao said that all great men have climbed The Great Wall. What he meant to say was “All great financial advisors have . . . “

A Rocker Got it Right

As a child of the Cold War, I just assumed I would die in a nuclear war. When I first heard the song by rocker Sting, called “Do the Russians Love Their Children Too?”, I was caught a little off-balance by the question.

Yesterday, I watched an older lady stop a young mother to admire her baby. I saw a man photographing his wife and then she photographing him before a stranger asked if he could use their camera to take a photo of them together. I missed my wife as I watched couples walk down the street holding hands.

Yes, Sting’s rhetorical question is important. The Russians do love their children, just as much as Americans or Chinese or everybody else. It is easy to forget that people are more alike than different . . . Thank God!

We’re #1, We’re #1 . . . Today!

Last month, China passed Japan to become the world’s second largest economy. At current rates, it should bypass the U.S. in 2020, which is a mere ten years away. It may do so, but it is interesting that they are not learning from our mistakes. Already, they are allowing retirement for women at age 50 and men at age 55, along with a comparable Medicare plan. Just ask Greece how that worked out for them!

There is a difference between a budget deficit and a structural deficit. A budget deficit looks at one year. A structural deficit looks at much longer time periods. For example, we all know that Medicare, Medicaid, and other health care costs are ballooning out of control, with or without Obamacare. Politicians talk about the budget deficit but simply resort to partisan name-calling on the structural deficit.

As we all know, China is running enormous annual surpluses, but I would love to see some numbers on their swelling structural deficit. To make their problem even worse, the U.S. permitted a huge social safety-net partly out of mere humanitarian interests, and because we could afford it at that. China has a far different problem. They face a much greater risk of social instability than the U.S. and politicians may be forced to pander even more to the disaffected.

At this point, I don’t see any scenario that will prevent China from over-taking us, but I am confident they won’t be #1 forever.