More on n-Drunks Fighting

This Bloomberg article is worth a read and relates to a previous post on how constant competition between the fiat currencies to be the most relatively worthless.  This competition is so fierce, apparently a worthlessness arms race has taken place.  Over a long time period, it’s nearly a tie (the US Dollar is slightly less weak than it’s competitors).

This chart shows that since September 2003 (the earliest that Google finance had FX data), the USD has been the biggest loser–except for a close tie with the GBP.

Illusory Keynesian Fiscal Policy to Forestall Recovery

The United States, following in the footsteps of Keynes, itself in previous generations, and Japan is attempting to spend its way out of the Great Recession.  This policy of incurring debt and spending will prove illusory and any interim gains will quickly replaced by sudden downturns.

The United States needs to destroy the malinvestments created by cheap money policies of the past two decades. 

On the one hand, consumers and businesses destroy their malinvestments (as indicated by shrinking consumer and business credit, and large banking reserves).  On the other hand, the US Government/Federal Reserve appear to a) buying the bad investments from troubled banks and industry and, b) borrowing money to create new malinvestments. 

These US Government/Federal Reserve malinvestment efforts are a bad strategy.  Bizarre and meaningless market volatility will be created by the combined consumer/business malinvestment destruction and US Government/Federal Reserve malinvestment creation policy.  The result will make us all worse off.  Alas.

Hayek vs Keynes

You guys have probably seen this rap posted elsewhere, but I post it here as it relates to many of our discussions.

This rap is particularly thoughtful and well done.

It’s interesting to note that Keynes and Hayek were good friends, with Keynes using his extensive resources to help Hayek escape Nazism before WWII.

The Road to Serfdom is a classic/must read by Hayek.

Shadow Open Market Committee

This is an interesting paper from the St. Louis Federal Reserve Bank discussing the Shadow Open Market Committee.  In 1973, a disaffected group of Fed economists tried to affect Federal Reserve policies on inflation.  Their views were not aired, so they formed their owned Shadow Open Market Committee. 

I wonder if current dissatisfaction with Fed policy will produce a similar alter ego institution.  Perhaps in the age of the blogosphere, such an institution is less important.

Backtest of High Beta Trading Strategy Since October 2009

As we discussed, I sold my long uber-Beta stocks in October 2009.  At the time I detected about 30 days of data where my uber-Beta stocks were underperforming the S&P500.  This reverse the trend apparent since late March 2009 when long uber-Beta shares massively outperformed the S&P500.

Despite the S&P500 trending higher into the year-end, uber-Beta underperformance continues.  This chart shows the UYG losing relative to the S&P500 since October 2009.

As long as this trend continues, I have a bearish outlook on the market.  This chart shows one important reason–the US Dollar.  Dollar weakness leads to bank (and S&P500) strength, and Dollar strength leads to bank (and S&P 500) weakness.  

The banks, especially UYG which is a 2x bank ETF, have a Beta >1.  The USD has strengthened vs other major currencies since October 2009 by almost 4%.  The consequence is a lower S&P500 and an even worse performing uber-Beta UYG.

As such, I remain happy in my cash position.  I continue to watch these relationships hoping for a bullish change, but am not optimistic in the near term.  The uber-Beta vs S&P500 relationship illustrates the relative desire for risky assets, and so I watch closely…biding my time…until the world loves risk again.  For now, risk is despised.

Japan, the United Kingdom, the PIIGS, and numerous former Eastern Bloc nations are all near default.  Until this major source of uncertainty resolves itself, the US Dollar will find a bid.  If a default actually occurs, the US Dollar will bid through offers and find massive strength.  At best the near future will bring us a congested 2010 trading environment.  At worse, a massive selloff of risky assets worldwide.

I think I’ll add UUP (the USD bullish ETF) to my watch list.

Results of Banking Subsidization

The wealth transfer we discussed previously is apparently working, according to this Pragmatic Capitalist post.

Masking Government Borrowing

This is an excellent article on the Federal Reserve’s quantitative easing program and it’s role in masking new government borrowing.

Eventually, this will lead to inflation.  There is not enough velocity in the money supply to produce inflation in the near term.

Should Rating Agencies Downgrade US Treasury Debt?

When will rating agencies downgrade US Treasury debt?  The Financial Times comments on the only tepid comments from Moody’s suggesting that maybe, someday, if things get bad, might US Treasury debt get a rating downgrade.

A cynic might think that the rating agencies purposefully won’t downgrade US Treasury debt for fearing a reprisal from their largest paying customer.  On the other hand, does it even make sense to downgrade the US Treasury?  Maybe not.  I mean that $70-100 trillion of unfunded liabilities isn’t like a real debt. 

The US Government did not actually contract with each American to provide Medicare, Medicaid, and Social Security benefits.  As such, the US Government can eliminate or reduce program obligations, their fiscal liabilities, and the need to borrow to fund those liabilities at the government’s whim.  Further, the US Treasury and Federal Reserve can print money at their own whim, to pay debt obligations.

It seems like a US Treasury will eventually default…if it (and the Federal Reserve) behave like responsible citizens.  If they act like I expect them to act, then there is no reason to expect rating agencies to downgrade US Treasury debt. 

I expect the US Government to renege on Medicare/Medicaid/Social Security obligations and/or US Treasury and Federal Reserve inflationary activities designed to greatly mitigate the fear for a US Treasury default.

So maybe the rating agencies are right in maintaining their AAA rating of US Treasury debt.

A worse fate shall befall US Treasury debt if the market perceives that the US Treasury or Federal Reserve will inflate away the value of the debt it issues.  This fear will put downward pressure on Treasury debt prices, increasing the cost of borrowing to potentially unsustainable levels.

In this lies the real stick.  There is no carrot.

Trading Strategy Update

I remain on the sidelines…100% cash.  My target to buy back into the equity market is when the DJIA reaches the 7-8,000 range.  I keep re-assessing this and there is no way to know from today’s perspective, what will prompt me to buy.  In all likelihood, I will look to buy when I sense politicians will embark on a new and ill-fated attempt to stimulate the economy.

In a deflationary environment, a 100% cash position is the second best trading position.  I’m not brave enough to be short today, because of the non-fundamental and erratic price movements I see.  On the other hand, being long of anything seems foolhardy at these levels.

Just be patient, you can buy in the future for lower prices.

Social Security Cash Flow Negative in 2010?

This is a great article about Social Security going [operating] cash flow negative during 2010.  The only reason the program is technically not cash flow negative is that the Social Security “trust fund” produces interest income [note: "Social Security Trust Fund" is a joke name applied by politicians to a Ponzi scheme of non-marketable IOU's from the US Treasury to one of a couple Social Security administered funds].

When these Social Security funds run cash flow negative in a particular year, one of a few actions must be taken:

1. Reduce benefits or default on Social Security “obligations”
2. Raise taxes
3. US Treasury borrows more money [from the Federal Reserve?  Compounding the Ponzi scheme?].

This adds non-helpfully to US Treasury borrowing requirements.

We discussed these possibilities in a previous post.

The burden for fixing this program will fall on the young.  The older generation–as all early adpoters of a Ponzi scheme will always vote for recruiting or forcing new recruits into the system.  This will be apparent in voting patterns.  Mises.org has a great post today on the war on the young.