Tuesday, August 28, 2012

GOP - G Old Parity.

TMM don't think we are going to get any major new direction in markets until next week, which really isn't that surprising a view as Jackson Hole and the European "6th of September" event are so well flagged. However we still smile at how easily the market can switch from panic to subservient minion

"Please take a seat Mr Panic, Mr Crisis is busy at the moment but will see you in September. Could I get you a coffee while you wait"?  
"Err. ok yes please. Oh is that a magazine on China on the coffee table?"
"Yes, and please feel free to leaf through the "Fiscal Cliff Weekly" or perhaps "The Australian Mining Review", you may find them an interesting distraction"
"Oooh yes ..   err sorry .. Why am I here?

Indeed Dr. Aghi sure is busy - ECB'S DRAGHI WON'T BE ATTENDING JACKSON HOLE FORUM, *DRAGHI NOT ATTENDING DUE TO WORK LOAD IN THE COMING DAYS - TMM are hoping that the work load involves fixing the decals to his model of a European rescue package rather just not being arsed to go to a forum where everyone will just tell him how to do his job. 

Meanwhile the US is getting even more embroiled in a debate as to by how far the Republicans are going to win without noticing the absurdity of some of their  "And I'll tell ya something else" policies being drawn up on a napkin at 2am. The latest being for a return to the Gold Standard.  We've all heard the rants from semi-literate candidates complaining that "the government is manipulating prices" and that "we should privatise money". But TMM thought they were the preserve of the loony right, because we cannot for the life of us understand why anyone would want to return to the days of pro-cyclical monetary and fiscal policy. You know - the sort that tends to blow up emerging market  countries and Peripheral Europe, amongst other things.

It's not like the development of economic policymaking over the last 80yrs was dreamed up purely to depreciate the dollar. In fact, despite all the FX volatility of the past 30yrs, the real trade weighted dollar exchange rate  sits only 15% below its pre-1971 delinkage from Gold, a level it fell to by 1973 in the post-Bretton Woods adjustment.

The presence of the US's elastic money supply has greatly dampened economic volatility, something that would be greatly amplified by the necessity of pro-cyclical fiscal and monetary policy within the rigidities of a Gold Standard. It is thus far from obvious that the current ability of countries like the US and UK have suffered from having such an economic policy framework.

Those making the calls for a return to the Gold Standard clearly haven't read their history well enough to recall that *all* economic entities suffered from the frequent and severe depressions and financial panics resulting from the lack of a lender of last resort and elastic currency. For all its failings, the study of economics has shown that counter-cyclical economic policies are the most successful way of a) maintaining stable but low inflation [there is a good deal of evidence that low but positive inflation is optimal] and (b) reducing economic and financial volatility. Such a framework is clearly not sufficient, as the excesses of the financial sector over the past decade or so demonstrate, but it is a good place to start, rather than throwing out the hard-won policy lessons of the past 80 years. 

Indeed, where countries have gone wrong in the past decade it is because they have run pro-cyclical policies of the sort a gold standard would imply. In the case of the UK, running too loose fiscal policy. In the US, running too-loose monetary policy in the 2003-2005 period, and too-tight monetary policy since 2006 and in Peripheral Europe where (a bit of an over-generalisation) both fiscal *and* monetary policy were too loose in the run up to the crisis, and now both are too tight.

And this is where TMM strongly agree with John Taylor. Where policy has departed from rule-based prescriptions, problems have developed. But then what can you expect from the bass player of Duran Duran.


Anonymous said...

"*all* economic entities suffered". It's easy - they believe that they wouldn't, because they are smarter then the average punter (and more moral too!). Since there wasn't anything to prove them differently, it's easy to maintain this belief.

yoga bali said...

nice written

abee crombie said...

gold standard talk is mainly about pandering to ron paul supporters.

perhaps it appeals to semi wealthy investors, who didnt make out like bandits in the housing boom and have missed most of the recent 3 year equity rally. Blame the fed for low rates and talk about how markets are manipulated.

Obviously, like you mention, no one cares to look at what actually happens on the gold standard. Namely more panics, less money supply and likely lower growth

but hey, its got gold out of the trading range its been stuck in..silver too!

WellRed said...

I am confused where the "no lender of last resort" bit came from. There was still a lender of last resort under the gold standard..

Then again, a glance at my half-full coffee mug reminds me that I have confused myself in the morning before.

Matthew said...

Good stuff. The one thing I'm not sure about is using the real trade weighted dollar, the 'real' bit almost by definition makes the depreciation go away. Perhaps the point is relative to other currencies, in which case I think it's a fair one.

Gnome of Zurich said...

I am a bit disappointed that Macro Man is just mindlessly rehearsing mainstream economic views without actually checking the facts. As far as I know, overall GDP growth was much higher under the gold standard and there was much less inflation. Busts were more frequent, but less severe or drawn out.

If money supply growth was a condition for more growth, countries like Argentina or Zimbabwe would be the richest on earth.

But of course the governments will never give away the control over the printing presses. So inflation will stay, which may be good for performance fee driven asset jugglers like us but bad for Joe Average with his savings account and life insurance.

Leftback said...

Can we have some BS here about what the J Hole speech might contain and what the Fed may or may not do?

LB looks at this through the prism of struggling indebted middle income Americans in blue collar towns rather than the designer eyeglasses of J. Carlton Noseworthy 3rd and his wife Muffy, with whom he rides the commuter train to New York.

LB suspects that BB will use J-Hole to basically jawbone about the Fed monitoring US economic data and standing ready with more accommodative policy. The only thing more specific than that might be a possible statement to the extent that Operation Twist will be extended.

BB is in a comfortable place here, b/c Draghi has already driven a run up in energy prices that has countered the ever-present deflationary forces in the US, to the point where US CPI is close to BB's sweet spot. Markets might sell off b/c "QE3" is priced in, but they will soon rally "on future QE3 expectations".

BB definitely does not want to be seen to be spiking US inflation between now and the election, especially as Joe Sixpack is already feeling the pinch at the pump with gasoline over $4/gallon. I know our European friends think this is ridiculously cheap, but this is a comfort threshold for the American middle class, and demand destruction kicks in every time we hit this level. The electorate does NOT CARE about the stock market, in fact most of them aren't in it, think it is rigged, and would cheer if it went down, along with gasoline prices.

So to sum up, LB thinks the "reflation trades" have priced in a lot of QE ($300-450B), and even if it is announced here there could be a Sell The News event. So we want to be out of all that lot, energy, metals, and hence emerging markets etc...

We remain optimistic about Europe, and perhaps eventually China, where reflation efforts seem more likely to be urgently required. It's been a bloody good year for us already but central bank utterance day isn't our favorite time to take risk.

Leftback said...

Speaking of the dollar, we should be more than aware of the potential for a snap rally in Uncle Buck. EURUSD retrace may be over and many of the high yielders might be over extended in the short term:

High Beta FX

Anonymous said...

LB, would you by CIM? I know the dividend is not guarnteed, but it should do ok if no QE3?

Anonymous said...

"there is a good deal of evidence that low but positive inflation is optimal"

Got any references for this? It seems to me that the "asset prices always go up" mentality (why is one percent inflation good and one percent deflation bad?) is a primary cause of excessive leverage, unsustainable debt buildup and malinvestment that is endemic to the current situation.

Polemic said...


The US and the UK had central banks under the Gold Standard, but they were far from being *true* lenders of last resort because they could only lend what Federal Reserve Dollars or Sterling beyond what gold reserves they had. Clearly this approach failed (most spectacularly in the UK, which was forced off Gold when the BoE ran out of Gold). That's quite different to being able to infintiely increase the liability side of your balance sheet.

Underpants Gnome,

We're more inclined to suggest that in fact it is your good garden-ornamenty self who has not checked their facts.

You may find a long history of economic data at Measuring Worth (http://www.measuringworth.com/datasets/usgdp/result.php).

Over the period 1790-1847 during which the US ran a bimetallic standard and experienced relatively rapid real growth at an average rate of 3.8% per year. The volatility of growth over that period was around 2.5%.

From 1848-1957 a period covering various attempts at Gold Standards, the US grew at around 3.4% per year on average, however, with a far larger volatility of 5.7%.

From 1958-present it has grown aroun d 3.2% per year with a volatility of just 2.1%.

The fact that it grew more rapidly in the 19th century is hardly a surprise, given the expansion and industrialisation of the country, but 3.8% vs 3.2% can hardly be termed "much higher". As for the period covering the Gold Standard, 3.4% is statistically the same as 3.2%, though not with more than double the volatility in output.

TMM know what they'd pick, but hey, never let the facts get in the way of a good conspiracy theory.

Leftback said...

Just to amplify my previous point about the weakened state of the US "middle class" (i.e. not really middle income, but what the British would call "working class"), check out this interesting graph of the consumer confidence divergence between higher and lower income groups:

US Consumer Confidence and Income Level

Watching the US wake up to good old-fashioned class warfare is quite an amusing spectator sport....

Consumer confidence in the US, as seasoned observers will know, is driven by gasoline prices, gasoline prices and gasoline prices. In 2009, with $gaso languishing at $2/gallon, BB could QEase with ease, but at these levels? Fuhgeddaboudit.

OK, I'm off....

Anonymous said...

No QE = weak Euro. Dr.Arghi printing = weaker Euro.???

Polemic said...

A non @ 4.26,

Google "optimal inflation targeting". A very rough summary would be that monetary policy loses traction at the zero bound for many reasons, including wage stickiness to name just one.

And TMM would point out that periods in which inflation averaged zero over time (for example the gold standard) all experienced significant build ups in debt and excessive leverage and associated busts. Except those busts were more acute and damaging - what Ray Dalio et al call "ugly deleveraging" as opposed to the "orderly deleveraging" that we have experienced in the US since early-2009.

Lb... thanks sir.. appreciated as always

Leftback said...

Anon @ 4:25, we used to have a lot of REITs but sold all except TWO, ARR and NLY preferred. There seems to be a slaughter of the innocents in these names every year and it's usually late summer.

If you had bought these puppies at the REIT Flash Crash last summer, then you would have had an absolutely stonking return (20% div + 20% appreciation) in the 12 months following.... :-)

Let's assume Everyone's Uncle now "knows QE3 is coming" and that the Fed will "buy MBS", then one might assume that prices of the mREITs might just be bid up on those expectations.

Perhaps BB will walk in to J-Hole and say "we are all about having all of your dodgy sub-prime MBS, so you can have a massive end of year bonus, order Dom Perignon and piss on the masses from your Ferraris, you poor sad bankers" but given the political context in the US, perhaps not this time?

So to answer your question, CIM, CYS, NLY etc. are names we always have half an eye on but, true to the Kevlar-wearing knife-catching ethos espoused by others on this blog, we like them best when they have cliff dived and the divi is back at levels (18-20%) that make the inherent risks more palatable.

Anonymous said...

@LB, thnx for the reply. Now everyone and their uncle are talking about China slow down and Aud meltdown..Time to buy FXI?me

Leftback said...

China slowdown and AUD meltdown will go on as long as the PBoC want them to. They certainly have the resources to turn it around, but do they want to?

Anonymous said...

Tasty data laden discussion of what ails The Land Down Under, where (insert insults here) and Men Chunder....

Australian Economic Chart Porn

abee crombie said...

LB, CIM is the worst. Owned it for past couple of years. Just a dog. They were 6 months late reporting. Keep cutting the divy. For what should be a great investment (subprime) thier REIT is balls.

That said,I think it is below NAV. Personally I'd rather stick with TWO, AGNC.

As far as growth under gold standard, why would we only measure US growth. Global growth is arguably higher in the past 30 years than at any other time in history, ala BRICs. All that growth wouldnt have happened if there was a gold standard bc the US would have been broke a long time ago.

Anonymous said...


What weapons does the PBOC have exactly? Unless they order SHAFE to rotate out of dollars into iron ore or whatever, all they can do is what they are doing now. Dodge between fear of inflation and fear of collapse of big real estate developers with key links to the Party. And this is without the Big Four banks revealing that their regional divisions 'accidentally' loaded up 2-3x the NPL loans everyone expected them to have.

Leftback said...

"Dodge between fear of inflation and fear of collapse".

Exactly right, yes. But unlike Greece, they have a huge war chest of reserves to do it with and don't have to go begging! One thing China can't do to help at the moment (and this may be where you were heading) is generate aggregate demand from their largest customers, only the ECB and the Fed can attend to that problem.

Tradebot said...

REITs are bit of leveraged long agency spread play , given their portfolio composition of agency only debt and tendency to hedge the IR risk. I think the risk there is mostly on prepays, it is pretty hard to replicate the current spreads if/when QE3 buying and prepay on refi hits their portfolios.

Cap gains on housing and QE are well priced in, the days of divis in teens will be soon over but they still beat most other places to park cash given the risk/reward/volatility.

Tradebot said...

pardon the typos, most of the REITS are agency debt only. TWO has a decent chunk of non-agency in the mix which is performing well + they are testing the buy-to-let landlord biz.

Mezz/Junior ABS credits across the board are VERY decent value in this low-rates-forever-environment. You can reg arb the banks and get a decent risk/reward return with relatively little volatility. I have been bullish for 2-3 years now...no gray hairs and values are slowly grinding up.

Leftback said...

More or less agree with all of that, Tradebot, certainly on the "low rates for ever" part, but we just like to buy these at occasional Kevlar Moments where Mr Market loses his mind over a fall in Greek dolmades prices.

As of now (presumed near term market top), sitting in a preferred (NLY-A) seems to be more prudent than some of the common stock, and especially some of the dodgier ones like CIM. We think there will be better entry prices ahead for those who like Killing It Softly via double digit divis.

There are a few modest rate risks ahead of us, although none are large.

1) No Qe3, fast money that was front running the Fed exits Ts and MBS.
2) Europe fixes itself a bit, real money exits Ts.
3) US growth engine roars to life under Romney, HAHAHAHAHAHAHAHA

Tradebot said...

REIT Prefs...can't say I knew anything about those. I am still long REITs, probably going to sit on those and hedge by shorting the frothy assets (ie. indices, AUD, etc).

Oh yeah, going to put a cheeky small punt on short AAPL , ATM strikes JAN expiry. I'm a droid man so I am biased but I can't see anything with va-va-voom on horizon for AAPL. iPhone 5? Whats the game changer? No conviction on this though, certainly no research to back up my hunch , just good old place your bets on lucky nr 13 and spin the wheel gamble.

abee crombie said...

NLY also has some convertible bonds, though the new issue has changed the dividend adjustment factor

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Anonymous said...

Responsible expansion of money base over the long run in order to accommodate productivity growth, is in fact, the same thing as a gold standard. The problem is, there's no historical precedent for responsible management of the monetary base. And so, the necessity for a gold, or whatever you want to use as long as it can't be freely expanded by political influence, is necessary in order to maximize improvement of our quality of life. Booms and busts are necessary if credit is a tool we want to use. The key to managing booms and busts is to keep a close eye on private sector credit growth and credit money. The unit of monetary exchange has nothing to do with it. Personally I hope they dont actually go forward with a gold standard since I'm a long only equity manager.

Cosmo10 said...

The Gold Standard is obsolete because there is simply not enough gold on earth. Monetary policies can only at best control GDP growth and inflation.