We had a lively and extraordinary meeting at On The Border. We had 3 attendees: (from left to right) VJ
Arjan, Jeff Harrington, and Tommy Schultze.
The Global
Economy and the Future Thereof
"The Invisible Hand of the economy is not guiding everyone
like most economists think, it's slapping everyone around." - Jeff
Harrington
U.S.
During
the last month, bonds sold off heavily with Bernanke's implicit remarks on
ending the monthly $85 billion worth of mortgage backed securities by the end
of this year. The yield on the 10-year jumped
25% in less than 3 weeks, whic is breathtaking, and thus causing a selloff to
the tune of 700 points ensued in the market as well. Mr. Bernanke has since restated his position
on QE and has soothed investors somewhat.
 |
| (10-Year Bond) |
However,
it seems that the great rotation from bonds to stocks is beginning. VJ Arjan put together some stats about the
sheer volume of bonds that have been sold in the month of June:
-
A total of $24 billion withdrawn from bond funds, $10 billion of which was
withdrawn from PIMCO alone
-
An additional $32 billion withdrawn by foreign central banks
These
numbers are staggering given the span of time in which they occurred.
Interest
rates are bound to rise, and the confirmation may have been this last Friday
when JP Morgan Chase declared earnings and discussed laying off 17,000 workers
over the next 2 years in the mortgage and retail divisions, betting that with
the rise in rates the home refinance boom will be over.
Jeff
Harrington believes, however, that quantitative easing may continue for
significantly longer as it has been incredibly profitable for the U.S.
government in general and the tax payers specifically. He explained that the
reason for this thinking is that, by law, The Federal Reserve is required to
turn over its annual profits, less an amount allocated to cover the cost of its
operating expenses, to the U.S. Treasury, which is then funneled into The
General Fund (this is the government’s checking/spending account).
In
2012 alone, The Fed ran a profit of $90.1 billion, of which it delivered $88.9
billion to The Treasury, which was a record amount; this amount also offsets
the federal deficit. In other words, without The Fed’s profits in 2012, there
would have been a gap in funding for the overall spending and the federal
government would have been forced to borrow an additional $88.9 billion to plug
said gap in spending. See the graph below for the past 10 years of profits
(referred to as distributions) that The Fed has turned over to The Treasury.
As
one can see, Jeff continued, while the pundits lambast The Federal Reserve for
expanding its Balance Sheet from ~$700 billion to ~$2-3 trillion during the
course of the financial crisis (i.e., since 2008), The Fed has simultaneously
become an enormous revenue source for the federal government; nearly tripling
the amount of money that it sends to Uncle Sam on an annual basis. In the five
years prior to 2008, The Fed’s average annual distribution to The Treasury was
$25.06 billion [(22 + 18.1 + 21.5 + 29.1 + 34.6) / 5].
If
we assume that The Fed had not stepped in to expand its balance sheet through
the purchase of financial assets and maintained the same rate of distributions to
The Treasury from 2008 through 2012, then there would be a short fall in the
federal budget of $197.4 billion [$322.7 – (25.06*5)]!
This
would neglect the fact that without those purchases, the economy would probably
have fallen into a depression because the financial markets were all but frozen
by the end of 2008. Not to mention that
very simply it is not politically palatable to raise interest rates in an
economic environment like the current one.
Jeff
also believes that the market over-reacted to Mr. Bernanke's comments and he
wouldn't be surprised if the 10-year Treasury yield proceeds downwards over the
next few months, which he referred to as 'amateur hour' in the markets. He continues to believe that housing is
making a strong comeback and that the overall economy still looks on track to
perform well, in his estimation, through the end of this year.
Emerging Markets
We
also discussed the emerging markets which has been taken out to the
slaughterhouse, falling roughly 10% overall.
Some of the newly emerging economies like Turkey and Chile have falled between
15-20%.
Of
course, the big elephant in the room is China's economic slowdown, which the
People's Republic of China Bank has tried to play down. There seems to be an inevitable slowdown in
China, however, given the bubble that is apparent in their property prices as
well as its vast and largely unregulated shadow-banking industry. Barron's ran an extensive article on this topic
in their June 24, 2013 magazine (Vol. XCIII, No. 25) entitled, ‘China’s Looming Credit Crisis’, which discussed China’s massive
industrial over-capacity, a worrying shadow banking industry, along with empty
cities and unused train stations and roads.
Jeff
believes that the emerging markets will continue to remain weak through the end
of the year.
Europe
In
regards to Europe, we discussed what may occur in the Eurozone and whether or
not France may be the new Greece. The
statistics at least seem to indicate this.
With the government spending as a percentage of GDP climbing to 50-60%,
and steadily increasing sovereign debt, and a declining birthrate it has all
the hallmarks of a crisis coming to a head.
The
question may be, whether Germany will bail out France given the sprightly
history between the two nations.
NSA Leaks
 |
| (Edward Snowden) |
"You have zero privacy; get over it." - Scott McNealy,
former CEO of Sun Microsystems
We
discussed the recent case of Edward Snowden leaking information that the NSA
has been secretly recording all information from U.S. citizens, tremendously
extending the scope defined in the Patriot Act, which specifically allows the
government to target "persons of interest".
Well,
it appears that about 100 million of us are now "persons of
interest", which is a blatant violation of the 1st Amendment which gives
citizens' rights to privacy or "privacy of beliefs".
Tommy
Schultze weighed in on this, mentioning that with the arrival of big data, the
fact that most personal and financial transactions occur online, and are
registered on "the cloud"; this large scale monitoring is inevitable.
He
also explained that through the concept of ‘Six Degrees of Separation’, which is
the theory that everyone and everything is six or fewer steps away, by way of
introduction, from any other person in the world, so that a chain of "a
friend of a friend" statements can be made to connect any two people on
Earth in a maximum of six steps. With the NSA using so-called meta-data to
track and measure people’s connections to terrorists, it is quite possible,
literally, to connect everyone in the USA to a terrorist through only six
people, and maybe fewer!
This
calls into question the methodology that is used to determine terrorist
connections. Unfortunately, since the NSA’s program is shrouded in secrecy and
not available to the public then it is nearly impossible to analyze it let
alone to challenge it in court. Though, if the NSA determined you to be a
terrorist, you will probably get shipped to Guantanamo Bay, which is outside
the jurisdiction of the Federal court system and so you probably will not be
heard from for a very long time, if ever.
There
may even be a small percent of the population that tries to escape the cloud by
going back to very primitive methods of communication like using birds much
like certain underground organizations have done for centuries. This certainly can remain off the grid unless
the method of communication is intercepted.
Tommy
believes that the next great arms race will not be over land or nuclear weapons
but over who has the access to the hidden data - a profound thought
indeed. There is a clear correlation, in
his view, between population growth and technological growth. The larger a system becomes the larger the
technological capabilities become to accommodate it.
A
perfect example is the STUXNET virus which was deployed allegedly by the U.S.
and Israel governments into Iran to dismantle the Iranian government's attempts
to create a nuclear weapon. Like a
drone, it was specifically designed to destroy data on the computers of the
scientists working on such a project.
VJ
mentioned that such power in the hands of the government seems frightening to
him. As the historian Lord Acton
explained, "Power tends to corrupt, and absolute power corrupts
absolutely."
Could
the people in the world become like the animals on George Orwell's Animal Farm
or the dystopian society in his 1984? Or
will wisdom prevail and will man be capable and wise enough to handle this kind
of technological power?
Political Meltdown and Civil Unrest
"The problem with Obama is that he can't make a
decision. He's got balls made out of
marshmellows." (Speaker John Boehner to economist John Mauldin)
VJ
discussed an online conference he saw of economist John Mauldin who explained
the economic ramifications of the political gridlock in Washington.
He
believes that the only way out of the economic collapse coming in the United
States is
for Congress to get its act together and to solve the deficit and
eventually the debt crisis. The future
strength of the U.S. rides on this.
Should the government fail to create this result, the confidence in the
country and in the U.S. dollar will be tremendously weakened.
Should
the American citizen John Q. Taxpayer find out that his Social Security and
Medicare/Medicaid debits from his paycheck is going to the roughly $220
trillion in unfunded liabilities for current recipients of these programs and
that the money he is putting into this program will not be paid back to him
when his time arrives, the foundation of the government's ability to be
fiscally responsible will be shaken to the core.
Multiply
John Q. Taxpayer across roughly 120 million people in the workforce and we are
talking American Revolution: Part II, if the purpose in the populace is
willing. We are talking political
upheaval, a complete failure of the current system and a redesigning of a
future one.
Jeff
mentioned that it is likely that the current strategy of "kicking the can
into the future" will work up to the point when a severe crisis ensues and
then he believes that this will be sufficient to get the job done.
People
wait for a crisis to get things done, unfortunate as that sounds. He went on to mention that the game of
politics can only be played in opposition - hence we have Democrats against
Republicans, etc. The recent sequester
issue was a perfect example of this political mechanism in action whereby both
parties agreed that spending needed to be cut but could not come to an
agreement on where the cuts should be made and so they settled on planning cuts
that were so deep and unpopular (i.e., Sequestration) on all side as a way to
force both parties to agree on what cuts to take.
Subsequently,
neither party was able to agree on what cuts to take and so the sequester went
into effect. Going forward, we suggested there may be similar instances where
the parties agree to disagree, ironically, as a way of fixing thing.
Tommy
and Jeff mentioned that what may end up happening is that the entitlement
programs will crumble slowly over time, that way it is less noticeable. This could happen with the continual watering
down of the U.S. dollar, for instance.
Egypt and the French Revolution
 |
| (Morsi with his Senior General Tantawi on the right) |
As
the Arab Spring in Egypt came to a head and toppled the Mubarak government a
year ago, so has the Morsi government been toppled by a military coup after
being in power for appoximately one year.
There
were lessons to learn in how this occurred.
Morsi
probably could have held on to power had he not fired his senior general
Hussein Tantawi, within weeks of taking office or trying to place his decisions
beyond judicial review, thus creating enemies in both the military and
judiciary.
He
forgot the lesson that reverberated in history. During the French Revolution's
Reign of Terror, of which King Louis XVI and Marie Antoinette were among the
thousands guillotined, Maximilian Robespierre became the hand of the masses
who were seeking to exact their justice upon those of the privileged
classes.
 |
| (Maximilian Robespierre) |
However,
Robbespierre had become power hungry and he started executing his own
supporters, like Jean-Paul Marat, a fiery and powerful Jacobin journalist. Robbespierre was eventually guillotined
himself. The Reign of Terror lasted
approximately one year.
Going
back to Egypt, the tipping point for Morsi came when he was unable to fix the domestic
problems that had led to the fall of Hosni Mubarak; rising prices, rising
unemployment, and high population growth, which only compounded the former two
problems. The military threatened a coup
unless Morsi start working with those who rose in opposition to him over
Egypt’s domestic problems, which Morsi ignored to his own detriment.
He
was duly deposed and the coup was successful.
There is now a criminal investigation pending against Morsi. This does nothing to Egypt’s domestic issues
as they still remain, so the game of musical chairs regarding leadership
rotation in Egypt continues.
Rather
than trying to fix Egypt’s domestic issues, Morsi arrogantly thought he could
replace Egypt’s existing governing structure with one The Muslim Brotherhood
envisioned. He was wrong. He failed to recognize that The Muslim Brotherhood
simply was the last man standing after the fall of Mubarak’s regime that did
not have the stain of Egypt’s domestic problems all over them and so they were
given a seat at the table, a very high one at that, as a means to try and fix
Egypt’s problems. The expectation was that he fix Egypt’s problems, not
overturn the entire power structure.
Now
ousted President Mohamed Morsi forgot the lesson in history that he needed to
have more friends than enemies to retain his power and so he lost it.
A Lesson in Psychology
 |
| ("Count" Victor Lustig) |
Tommy
discussed the small gestures that people make that reveal their psychology,
which was fascinating.
For
instance, one can tell the relative economic background of an individual by how
he or she holds a glass. If his/her
pinky is extended then we have the impression of holding a cocktail glass. Most blue collar workers will hold a glass
with their fingers bunched together, like they are holding a bottle of beer.
VJ
mentioned the example of Victor Lustig, who was arguably the best con-men of
the ages - second perhaps to Bernie Madoff.
He played on people's psychology in order to get what he wanted. In such a way that he was able to falsely
sell the Eiffel tower in Paris - Twice - and even dupe one of the most
notorious gangsters of his time, Al Capone, into making a small fortune for
himself.
A Winner's Strategy
 |
| (Scrooge McDuck) |
In
closing out the summary for what we may see in the volatile economic and
political future ahead, Jeff mentioned that it would be wise to prepare for the
famine while at the feast.
The
vicissitudes of the economy are such that they are built into the nature of
capitalism and the market itself. There
will be good times and bad times.
In
fact, a recent Nobel laureate economist, Hyman Minsky, showed how when external
forces try to stabilize the market, the result is more instability. In other words, stability inherently breeds
instability. The government trying to
bail out banks, for example, may significantly cut down on the individual's
moral hazard and greatly increase the risks he/she takes if one knew there
would be a bail out in the end.
The
winners will build their net worth while things are good in order to prepare
for when things get ugly. The losers get
sucker-punched when things get ugly. It
is, of course, difficult to do this and so that is why most people remain poor
throughout their lives. It takes
tremendous discipline, courage, and a vision - but that's what winners do.
The
result is that those who become the winners of the system end up, as Plato
said, "recreate to work better".
They end up doing (working at) what they love to do. Most people have it backwards, they are
constantly working to recreate better - but, of course, this never ends up
happening to most people; they just end up working.
So
in these volatile times that we are living in, it may be good to take as a
comfort and remember what it takes to win over the long-run.
The
next meeting will be on Sunday, August 4th, 2013.
For
those who have not attended a meeting, but would like to attend, please email
your wish to VJ Arjan at scarletkings@gmail.com
Also it seems that there are many domestic and
international readers who are following our blog posts not only in the United
States but all over the world including Europe, Latin America, and Asia. If you
wish to be added to our email list, please email at scarletkings@gmail.com
