Wednesday, August 26, 2015

The Market Dropped 3%, So What's For Dinner?

On Monday, Oct. 19, 1987, the U.S. stock market nose-dived, with the Dow Jones Industrial Average falling 22.61% in a single day.  That was volatility.

Recently, the market has been bouncing around, losing as much as a few percent a day, and edging into correction territory (a loss of over 10% from the latest high).  This turbulence isn't surprising, given the six year age of the longstanding bull market.  Indeed, in the summer of 2011, the market dropped around 17% on account of various investor jitters.  Then, it recovered.  Markets regularly have downturns, even bull markets.

So what does the future hold?  Nothing that anyone can reliably foretell.  The direction of the financial markets today is determined first and foremost by central bank policies.  The key players are the U.S. Federal Reserve, the European Central Bank and the Bank of China.  Predicting central bank policies is difficult in the best of times.  These days, with the data unusually uncertain, central bank policy is harder to predict than one's luck at the  roulette wheel.  This is especially so since politics appears to infiltrate central bank policy, making prediction even harder.  But one thing you can expect is they'll be cautious about doing anything that isn't accommodative.  If the Fed raises rates in 2015, it will probably do so once, and be done with rate raising for quite a long while.

The Chinese stock markets have a bubbly aura, making further volatility in Shanghai and Shenzen likely.  But China's economy is not heavily dependent on rising Chinese stock prices--and neither are Europe's economy or North America's.  Many individual savers in China are getting hosed, but the Chinese economy doesn't rely on domestic consumption. If Chinese investors lose their savings, Chinese manufacturers will still keep exporting to the rest of the world.  So the acid reflux in the Chinese stock markets may, ultimately, have only so much impact and not more.

Keep an eye on the market, but don't miss any meals over it.  If you're nervous, stay the course and don't invest more right now.  On the other hand, if you're feeling lucky, think about adding a bit to your stock holdings as the averages move down.  You know what they say about not letting a good crisis go to waste.

Is there a black swan lurking?  Maybe.  Since China has been the major source of world economic growth in recent years, any major upheaval in China could be the black swan.  What could happen there?  Well, President Xi Jinping has been aggressively consolidating power.  He may be the most powerful leader China has had since Mao Zedong.  But the market turmoil in China, and the recent slowdown in its economic growth, may be causing some to question his leadership.  The secretive nature of China's Communist Party makes it impossible to know for sure how strong Xi's grip on power may be.  While there are no overt signs of change, if Xi is forced out of power and there is a struggle for control in China, then all bets are off and you might want to do some hard thinking about how much risk you care to hold in your portfolio.

Tuesday, August 11, 2015

How The Donald Could Beat Hillary

The stolid burgermeisters who run the Republican Party shrink with horror at the thought of nominating Donald Trump as their presidential candidate.  His verbal atrocities are reaching the level where they might offend Attila the Hun, and the conventional Republican wisdom is that there is no way Trump could beat Hillary Clinton, the likely Democratic nominee.

However, the latest polls that follow Trump's bloody comments directed at Fox News moderator Megyn Kelly show that Trump's support among the electorate remains essentially unchanged.  If this persists, The Donald will be a force to be reckoned with in the Republican primaries.  Democratic strategists are probably delighted, because they, too, are likely to believe that Clinton can easily beat Trump.

However, Clinton's 2008 campaign also thought she could beat Obama, and there was a problem with that line of thinking.  How could Trump beat Clinton in 2016?  By doing pretty much what he is doing now.

Within living memory, Trump has been a political centrist, and has even expressed support for liberal positions on some issues.  He's made donations to Democratic candidates.  He even made donations to the Clinton Foundation and invited the Clintons to his 2005 wedding.  As a candidate for the Republican nomination, Trump has slid dramatically to the right, proposing a wall at the U.S.-Mexico border that Mexico would have to pay for and the defunding Planned Parenthood, and generally foaming out of the right side of his mouth.  Plain talk pays off in this election cycle (see and Trump is presumably saying what he thinks will help him win the primaries.  Plain talk is certainly paying off for Bernie Sanders.

In the general election, however, if Trump is the Republican nominee, he could easily slide leftward, shifting his views to draw enough support from the political middle to win.  It wouldn't be hard for him to adopt centrist positions, since he's been a centrist for much of his life.  There is plenty of precedent for candidates from both parties to shift toward the middle in the general election.  The advantage that Trump has over Clinton is that he appears sincere, unscripted and bold.  Clinton seems unable to emerge from her cautious, calculated, too well-burnished image.  We can't see the real Hillary; and her destruction of e-mails only compounds the sense that we'll never get to truly know her. 

Both Trump and Clinton have tarnished images.  But Trump appears to have a way to overcome the tarnishes in his image.  Clinton seems bedeviled by the tarnishes in her image, and apparently can't prevent them from dominating the news coverage of her candidacy.  If this state of play continues, The Donald just might beat Hillary if they were to meet in the general election.

Tuesday, July 28, 2015

China's Financial Isolation

China's manufacturing sector is deeply embedded in the world economy, and has made China an economic superpower.  But China's government has isolated the Chinese financial system, and that turns out to be a good thing for the rest of the world.

China's stock market has fallen about 30% from its recent high in June 2015.  The impact on investors of this dizzying drop has been acutely painful, especially for recent entrants.  Many of those purchased on margin, and have taken crushing losses.  The Chinese government has announced various measures to pump more money into the stock market and stabilize prices.  The verdict on this blatant governmental effort to manipulate prices has yet to come in. 

However, the rest of the world hasn't felt much impact from the gyration's of China's stock market.  While foreign investors in Chinese stocks have taken losses, it's not that easy for foreigners to invest in Chinese securities.  Similarly, it's difficult for foreign banks to do business in China.  They wouldn't have that much at stake, since the Chinese government limits the scope of their activities.  Although foreign losses in China aren't trivial, they also aren't enough to destabilize the international financial system.

The Chinese government deliberately limited foreign access to the Chinese financial system, fearing the volatility seen in the 1997 Asian financial crisis, when Western capital exited, stage right, as things got stinky.  This rapid outflow of capital only made things worse for the developing Asian nations.  The last thing the Chinese government wanted to do was indenture itself to Western capital.

Of course, what the Chinese government did on its own was pretty silly.  It tried to use monetary and regulatory policy to stimulate the economy by pumping up stock prices.  This is unpleasantly reminiscent of U.S. government policy in the early 2000's to stimulate the economy by pumping up real estate prices.  The Chinese have greatly modernized their nation in the last 40 years by adopting ideas from the West, but imitation can be taken too far. 

Financial websites are filled with speculation about the supposedly dire consequences to everything in the entire world from the drop in Chinese stocks.  Not to be a cynic, but bad news is news and good news is trash left at the copy desk.  The most likely impact from the turbulence in the Chinese financial markets is an economic slowdown within China, and a possible economic slowdown in the rest of the world.  But the Chinese financial system won't collapse.  That's because the Chinese government, which owns and/or controls China's banks, can simply print money to recapitalize them.  Since the Chinese government controls trillions of dollars of foreign exchange, it can make sure that foreign banks having exposure to Chinese financial institutions aren't left in the lurch.  The Chinese can't let their stock market gyrations take down the rest of the world's financial system, or they won't have any export markets.  And if the Chinese economy slows, they'll seek to export their way back to prosperity.

Of course, stay vigilant.  The economic slowdown in China is one of the major factors pushing down commodities prices.  It's possible that secondary and tertiary effects of the drop in commodities (and the currencies of commodities producing nations) could have unanticipated impact on Western financial institutions.  (Don't underestimate the potential for major banks to have unexpected exposures from derivatives positions and overly optimistic lending policies.)  But, thus far, China's financial isolation has largely protected the rest of the world from China's financial mistakes.

Monday, July 13, 2015

Is Greece No Longer a Risk?

In the last few days, the upstart government of Greece formed by Syriza Party leader Alexis Tsipras has completely reversed itself and signed up for a bailout from the EU that requires far more austerity than Greek voters rejected in a referendum just a week ago.  By all appearances, the EU rammed the ultra austere package down the throat of the Greek left-wing party, flattening Syriza's contentions like a tractor trailer rolling over a marshmallow.  We've had months of hand-wringing and teeth-gnashing over the dangers of a Grexit, and financial markets have shuddered every time Greece appeared to be heading out of the EU.  The EU's peremptory demands at the last minute might seem to have been a high-risk roll of the dice that somehow went in the EU's favor.  Or the EU knew that Greece had no leverage and made the Greeks take everything the EU wanted.

Considering how cautious the EU has been in the past, giving Greece two earlier bailouts totaling some $250 billion, it isn't probable the EU was bluffing in this round of talks.  That would likely mean it believes it has built a shield wall around its banking system that could withstand the consequences of a Grexit.  Stated otherwise, Grexit may no longer be thought to be a major risk to the European financial system. 

Even though the EU and Greece announced a "deal" today for a bailout, it's not at all a firm agreement, but rather a process for pursuing the possibility of more European assistance to Greece.  First, Greece has to adopt a number of austerity measures dictated by the EU.  Next, the parliaments of individual EU member nations have to approve further bailout talks.  Then, Greece will get interim financing that will keep it barely afloat while it and the EU yak for more months, maybe many more, to try to reach the final terms of a third bailout. 

There are many contingencies in this process, and it's quite possible the process won't lead to another bailout.  In that case, Grexit will follow.  But will it matter?  The EU seems to believe that Grexit wouldn't be a disaster, or it wouldn't have taken such a seemingly high risk negotiating position.  If it's right, then Greece will be mired for a long time in austerity and hard times one way or another.  And if the EU is wrong, then watch out, because a European financial crisis could lead to many, many bad consequences for a lot of people.

Monday, July 6, 2015

Ode To Greece's No Vote

Greek voters said "no" to the EU's latest bailout proposal, defiantly rebuffing another round of austerity. Democracy spoke, but the fat lady has yet to sing.  With a nod to Gilbert and Sullivan, this is how the song might go:

Here's a how-de-do.
If I vote for you,
When the time comes to make payments,
You will tell them we have ailments,
Default will ensue.
Here's a how-de-do,
Here's a how-de-do.

Here's a pretty mess.
In a month or less,
Greece will add some extra drama
By reviving the old drachma.
Banks will be distressted.
Here's a pretty mess,
Here's a pretty mess.

Greece's state of things
Is to life it barely clings.
Paying its debts with devotion
Doesn't seem to suit its notion.
More depression it brings.
Here's a state of things,
Here's a state of things.

No one knows what will be the result of this crisis.  Just remember that, no matter what, a good gyros makes for a fine meal.

Saturday, June 27, 2015

Greece, the EU and the Power of Fiat Currency

Greece is evidently going to hit the financial skids next week.  The EU appears to have stopped bargaining (as have the Greeks, who now want to put the issue of austerity in exchange for another EU bailout to their voters).  Without bargaining, there won't be a deal.

How did things end up this way?  One perspective is that, by entering the Euro Zone, Greece gave up a lot of power and put itself under the control of the EU.  When a country issues its own currency (i.e., fiat currency), it has considerable control over its currency's value in relation to other currencies.  If the country slides downhill economically speaking, it can devalue its currency and export its way out of trouble.  The Japanese have done this for decades, and the Chinese and other developing nations are endeavoring to emulate the Japanese. 

But what if the country, instead of issuing its own currency, uses another medium of exchange?  Historically, gold and silver, and sometimes copper, served such a role.  But a country that uses an independent medium of exchange can't devalue its way out of a recession.  It has to find another way; and sometimes it can't.  That's why the industrialized West moved off the gold standard in the 20th Century.  It prevented them from using central bank policies to recover from economic downturns.

Fiat currencies have a very bad image among many in the political right.  Gold standard conservatives fear that governments will inflate the wealth of citizens away for reasons of political expediency.  They rightly point to the morass of post-World War I Germany, when the Weimar Republic did that, resulting in widespread malaise and paving the way for fascism. 

But gold standard adherents forget a basic principle of economics:  goods become widespread in the market because people demand them.  Fiat currency is simply another good, and people demand a lot of it.  It serves as a medium of exchange, and no major economy can exist without a copious supply of the medium of exchange.  Gold was extremely scarce in Colonial America, and deer skins (i.e., buck skins, from whence came the term "buck"), tobacco and other goods served as an alternative to gold.  Various commercial promises to pay, such as drafts, promissory notes, banker's notes, and the like, also came to be used in lieu of gold.  Fiat currency was government's way of simplifying the problem of lack of gold and silver that could be used as media of exchange.

Fiat currency also conferred power. When the American Revolution began, the Continental Congress issued paper money in order to finance the rebellion.   This paper was subject to inflation, and considerable controversy eventually surrounded its use.  Nevertheless, the Continental Congress' ability to issue fiat currency helped to sustain the Revolution.

The U.S. government in the 19th Century outlawed the issuance of bank notes and other private currency and substituted the greenback in their stead.  Although the U.S. government clung to the gold standard, it devalued the dollar against gold once the Great Depression began, and took the dollar off the gold standard during the economic difficulties of the early 1970's.  In other words, gold wasn't really the standard.  The dollar was worth what the government said it was worth, not what the market price of gold happened to be.

The power of fiat currency became vividly clear during the Great Depression and World War II.  The U.S. government began to borrow in large amounts (i.e., engage in deficit spending) in order to alleviate the Depression.  Then, it borrowed enormous amounts to finance the war and defeat fascism.  After World War II, the U.S. government flooded the free world with dollars, so that there would be a currency to replace the British pound as the world's reserve currency.  The U.S. government derives enormous power from the fact that the dollar is the world's reserve currency.  People in other countries have to pay attention to America, because America's currency keeps the world's economy going.  Even in the Communist bloc, the dollar mattered.  As Communist economies flagged, the dollar became the underground, but de facto real, currency in many Communist nations.  Communism's legitimacy was in part undermined by the strength of America's fiat currency.

Greece is in a real fix, because its citizens don't want austerity, but they want to remain part of the EU.  Reality is that they are damned if they do and damned if they don't.  Staying in the EU will require agreement to the EU's demands for more austerity, which will probably worsen Greece's depression.  Leaving the EU will also likely mean that the Greek depression will worsen.  Who's at fault for this mess is a complicated question, but the answer, in short, is like Agatha Christy's novel, Murder on the Orient Express.  Everyone involved in and with the EU is responsible.  And there's no easy way out of the mess, for anyone.

But a larger point is that fiat currencies aren't good or evil.  They are a tool, one that can be used productively or counter-productively.  We need to watch what the Fed is doing--closely.  But let us recognize that much of America's strength comes from its fiat currency. 

Friday, June 19, 2015

An Epidemic of Price Fixing in the Financial Markets

Nothing is more antithetical to the principles of free enterprise than price fixing.  Rigged prices undermine the efficient functioning of markets and defeat their ability to maximize economic welfare.  Sadly, we've had an epidemic of price fixing in the financial markets, frequently involving the largest and most important banks.

The London Interbank Offered Rate has been the subject of governmental investigations in Europe and the U.S. for alleged years-long collusion. Billions of dollars of fines, penalties and other payments have been assessed on various big banks, and the investigation of other major banks continues.  Trillions of dollars of loans and contracts were priced based on Libor, and the potential impact of this price fixing is massive.

Foreign exchange rates have been investigated for rigged prices, and billions of dollars of fines, penalties, etc. have been paid in government and private civil lawsuits.  Again, some of the largest banks are implicated.

Now, word comes that the market for interest rate swaps has been under investigation for price fixing via the alleged collusive manipulation of the ISDAfix, a benchmark swap rate that is used in the pricing of a variety of financial products.  The interest rate swaps market, although obscure to the general public, involves hundreds of trillions of dollars of financial products (in notional value) sold to corporations and other commercial customers to offset interest rate risk.  Big banks are reportedly involved this collusion and the fines, penalties, etc. could total perhaps billions.

There are also reports of investigations of price manipulation by big banks in the metals markets.  These might involve restricting supply and other maneuvers to rig prices.  If wrongdoing is uncovered, more large fines, penalties, etc, can be expected.

Many of the banks involved in these matters are likely to be too big to fail.  In other words, while conspiring against the public in very large and important markets, these banks enjoyed the explicit and/or implicit backing of the taxpayers.  This backing helped them attain Brobdingnagian size, which in turn probably facilitated their ability to rig markets. 

The financial markets are the central venue of the capitalist system, being the place where holders of capital and borrowers of capital meet to determine the allocation of society's financial resources.  The largest banks are at the center of the financial markets, and their conduct ripples through the financial markets and the entire free enterprise system.  That such crucially important players are so regularly conspiring against the public and the public interest presents a galling spectacle that damages the credibility of the capitalist system.  Are markets truly socially beneficial or are they simply a means by which the rich and powerful fleece others? 

The world's largest banks have the legal and social responsibility to refrain from such reprehensible conduct.  However, their sad record of massive, multi-market price fixing seems to tell us that their chances of upholding these responsibilities aren't very high.  Their collusive activities often arise in markets that have a bi-level structure:  an inner inter-dealer market where the big banks and other financial firms trade among themselves, and an outer market where the dealers trade with the public at usually marked up prices.  The inside inter-dealer market is a perfect venue for price-fixing, as the dealers have to talk and trade with each other every business day.  As Adam Smith put it in The Wealth of Nations, "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or some contrivance to raise prices."

Thus, the challenge falls on regulators and law enforcement authorities to be vigilant and firm.  The sheer magnitude of the wrongdoing, as demonstrated by the billions that have been paid out to date, is astonishing.  Those who may seem paranoid about the financial markets have it right--way too often, the markets are rigged.

Wednesday, June 3, 2015

How To Beat ISIS

It's clear that conventional warfare won't beat ISIS.  The Iraqi Army is a joke, and not a very funny one.  Whatever it does, it doesn't fight.  The Shiite militias in Iraq can't be expected to succeed in the mostly Sunni areas of Iraq now controlled by ISIS,  because they present too much risk of sectarian conflict.  The U.S. isn't going to send in ground troops to fight for the Baghdad regime (nor should it).  The Kurds, like the Shiites, can't effectively take and hold Sunni majority areas.  So how to beat ISIS?

Stop fighting World War II.  There isn't a conventional force available that can realistically be expected to beat ISIS, and probably won't be one for the foreseeable future.  Instead, hoist the Islamic insurgents on their own petard.  Sponsor insurgency against ISIS.

The problem ISIS has is that it is trying to establish a caliphate--an actual country representing the promised land of ISIS's ideology.  ISIS doesn't merely conquer.  It endeavors to establish governments, social order and a functioning economy.  If it succeeds at nation building, its legitimacy will be heightened. 

The United States, although the most powerful nation in the world, is in the uncomfortable position of being weaker in Iraq and Syria than ISIS.  Time to take a page from insurgents going back to Ho Chi Minh and Mao Tse-Tung.  When you're weak, go asymmetric.  America doesn't have armored columns to roll into ISIS-land.  The armor was surrendered by the Iraqi Army to ISIS.  Giving the Iraqis more conventional weapons may turn out to be provisioning ISIS even more.  Remember that to this day, Iran flies American F-14 and F-4 fighter-bombers. 

Instead, America should foment rebellion against ISIS.  This would be rebellion by the Sunni population in the areas where ISIS governs.  ISIS imposes a very harsh, medieval form of Islam, complete with diverse and sundry outrages such as televised beheadings, burnings, shootings, and so on.  As time passes, more and more of the population under ISIS's heel will likely harbor desires to turn their Kalashnikovs on their draconian overlords. Organized nations provide easy targets for insurgencies, since governments have to operate openly.  Their facilities, personnel and infrastructure can all be attacked.  ISIS would expend substantial resources trying to defend itself internally, leaving fewer resources for further territorial aggresion.  Predictably, ISIS would respond to insurrection harshly, and that in turn would harden hearts and minds among the oppressed.  The rebellion would continue apace.

Of course, American-supplied weapons for such an insurgency could some day be turned against America.  That was a problem in Afghanistan, when the CIA helped to arm and train Afghan rebels fighting the Soviet occupation.  But would we be better off with a Soviet/Russian controlled Afghanistan today?  What would a guy like Vlad the Invader (you know, that Putin fellow) do if he had Afghanistan as a launching pad for further territorial aggression?

We have no effective conventional options in Iraq.  Let's go unconventional.  Let's go asymmetric.

Sunday, May 24, 2015

A Winning Strategy for the 2016 Presidential Election

Be unscripted.  That's the way to win the Presidential election in 2016.  The American people are looking for an authentic, sincere, unscripted candidate they can, for the most part, agree with.  Someone who speaks from the heart, and empathizes and sympathizes with them.  Someone they can sit down and have a beer with.  Not that they need to agree with everything the candidate advocates.  You can disagree with your friends and still like them.  But you can't be friends with a phony.

Unfortunately, scripting is what modern politics is all about.  Data-driven, Internet-interfaced, bet-hedged down to the last precinct, today's politics is a game of angles, maneuver and percentages.  There is a lot of well-deserved publicity about money in politics. But the money has to be spent wisely.  As Mitt Romney demonstrated in 2012, simply having a lot of money doesn't win the election.  It's important to appear genuine.  Mitt couldn't pull that off when it came to hunting or being a right wing maniac (a prerequsite for bringing the far right to the polls).  He is basically a moderate who tried to pose as a conservative and came across as implausible.  That cost him the election.

The political cognoscenti understand the importance of appearances.  Armies of political scriptwriters are furiously working on scripts for how to appear unscripted.  Candidates are making appearances in very small towns in Iowa with real people, as in folks who might drive nine-year old cars because they can't afford anything better.  Candidates appear in shirtsleeves and eat ethnic food, preferably the kind that's not healthy so that you don't appear preachy about diet. 

But the electorate isn't fooled.  Hillary Clinton seems to have used her financial war chest to scare off serious primary challengers.  But she's so heavily scripted she's having trouble generating enthusiasm outside her longtime coterie of loyalists. Jeb Bush was against the invasion of Iraq, then he was for it, then, last we heard, he was against it.  At this rate, he won't have a chance even with the ardent support of the Republican establishment.  There are genuine, sincere wackos on the far left and far right.  But the general election won't be won by a mouth-foamer.  It will be won by a charismatic, empathetic, reasonable candidate who captures the public's imagination.  And that candidate will . . .  uh . . . perhaps . . . um . . . arrive with Godot.

Wednesday, May 20, 2015

Planning For Your Obsolescence

The ongoing debate over trade policy highlights a major career risk:  the possibility that you could become obsolescent because of cheaper labor elsewhere and/or automation.  For example, in the auto industry, many car parts and some cars are made in other countries and shipped to America because labor and other costs are cheaper elsewhere.  In America's auto assembly plants, robots have replaced large numbers of people because robots are more reliable and cheaper.  This trend will continue as many other tasks become mechanized and/or cost-effective in lower wage nations.  Computer programming, radiology, legal research and legal document review have joined data entry and call center jobs as routinized work that can be done by smart people living in many countries.  What can you do about your potential obsolescence?

Keep up your skills.  Maintain and upgrade your professional skills.  People capable of cutting edge work will often have an advantage over foreign competition and robots.

Be flexible.  Keep an open mind about working in new and different jobs.  Many people have succeeded in fields they didn't plan on entering.  But they were open minded about learning new things and taking on new challenges.  The economy will keep changing, and success can follow if you change with it.  If you're unemployed, be open to taking temporary and part-time work in order to prevent your personal finances from eroding faster than necessary.

Computers and computer science.  Much of the reason for personal obsolescence is computerization.  Computers and related technologies (most importantly, the Internet) make it possible for workers overseas and robots to compete against American workers.  Don't get angry about this because computerization will continue--and most likely at an accelerating pace.  If you can't beat them, join them.  Acquire and maintain computer skills.  Go into a computer-related field.  Become a programmer, technician, data management engineer or something else computer-related that fits your skills.  Computers won't become obsolete, and people who can work with them have a better chance of staying employable.

Build your benefits.  Work as long as possible to build Social Security credits.  If you have the potential to earn a pension, stay in that job long enough to qualify.  Having a stream of payments that doesn't depend on your employability is a major victory over obsolescence.

Save.  Here's an ugly truth:  just as the wages and salaries of the middle class have fallen due to globalization and other reasons, the returns on capital have improved.  People who hold capital are becoming comparatively better off, while people who work are on average becoming comparatively worse off.  Save. Acquire capital and improve your chances for a comfortable life.  Then save some more.  Whatever your views on social issues like the distribution of income and wealth, you are individually better off with a pool of savings to protect you from the riptides of a free enterprise economy.