The Ostrich Head

Quantitative easing: Great Britain’s doing it, Japan’s doing it, birds are doing it, bees are doing it… US?

	Quantitative  easing was developed by the Weimer Republic in the 1920s, further developed in Hungary , where the largest banknote ever printed — 100 trillion pengo — originated, and then perfected in modern day Zim­babwe which achieved an annual inflation rate of 89.7 sextrillion percent (152% per week). But faced with the specter of deflation, central banks are taking their cues from the Weimer Republic and Zimbabwean experts.  Why? Simply put, deflation is neutral (or even good) for the economy, but really, really bad for banks.  We saw what happened with housing price deflation: it crippled the whole system (which was totally screwed anyway).  Further deflation will mean companies make fewer profits because their products are priced lower, even though their fixed costs remain fixed.  Commercial real estate is suffering twice as badly now because not only are retail sales down, but the sale prices have fallen as well.  A 40% margin of $4 is considerably lower than a 40% margin of $5.  This lowers the re tailer’s profit and lowers the value of the premises.  Inflation works the op posite way of course.  It’s been widely reported that the Bank of England has been buying up long maturity gilts — and issuing crisp new currency in return — and that the Bank of Japan has upped its purchases of debt by $18.3 billion of govern­ment debt each week, which amounts to printing 11% of Japan’s GDP in new money.  These are hugely inflationary, but with the economy tanking, it isn’t being reflected in reported CPI, although according to shadow statistics, CPI is already on the rise.  Breaking news: CPI just hit 1.8% compared to a year ago… despite the price of oil falling by 50%.  Maybe, after all, the Federal reserve HAS been printing money. Now, on a 60 Minutes interview, Ben Bernanke admitted to doing exactly that  for several months.  The amount of money in the system — M3 — is expanding at an unprecedented rate (the Fed no longer publishes M3 num­bers). The thing is, as long as all major countries print money at the same time, there’s no immediate impact on the currency, and therefore from imported inflation.  And with oil and natural gas prices having fallen off a cliff, year over year inflation is looking really good (1.8% being just about ideal ac­cording to just about everyone).  It will probably continue to look good be­cause of lower interest rates (leading to lower mortgage costs) and lower rents.  The big problems will come when enough money has been dumped from helicopters that people get sick of stuffing it in bank accounts earning less than 1% and start spending it at the same rate it’s being printed.  I don’t know when it’s going to happen, but one thing’s for sure: we’re all getting screwed: buy condoms.
	Now that everyone’s out of work and hubby’s coming home from work early, we’re all doing it
	Couples are having fewer romantic $150 candle-lit dinners in expensive restaurants, and spending more time at home doing what couples around the world do nearly every night: watch TV.    However, even TV can get boring, and condom sales are rising, up 1.5% in the first two months of the year in the US (compared to population growth of 0.8%).   That’s just the US.  How about Asia, where the population is growing at break-neck speed and awareness of VD continues to rise.  Yeah, I know, STDs.  Whatever.  The point is, Asia is wealthier now, so condoms are more affordable and sales are growing.  If you are looking for a stock to buy right now, Ansell is probably the stock to own.  I’ve done extensive research on it’s products and have been pretty impressed.  The Research Project is still ongoing, however, so don’t ask me for any advice.    Nevertheless, if you are looking for somewhere to park your money that won’t be affected by government policy screwing with your products, this is a good bet.
	Cheers,            Peter.

US government to guarantee $15 bn in small business loans

	According to Treasury Secretary Tim Geithner, the problem is that banks are pulling back “out of a sense of prudence and caution.”  Seriously, these  banks have got to get their acts together.  They’ll never be a Citigroup or AIG if they keep this up.  The last thing the economy needs now is prudence and caution, where the market directs capital into only healthy, well-run conservative companies.  To make the process more efficient, Secretary Geithner will request that every last bank files quarterly reports on small-business lending rather than the annual filings.  By quadrupling the number of reports, banks will clearly be able to quadruple the number of small business loans.  To clarify his philosophy for those of us still too stupid to understand this move, Geithner explained that, “Many banks in this country took too much risk, but the risk now to the economy as a whole is that you take too little risk.” Translation: taking risks when the economy is strong is bad, but taking risks when the economy is collapsing is good. So how will this work exactly? The US Small Business Administration guarantees a proportion of loans through two programs to small businesses.  Last year it guaranteed $13 bil­lion worth and defaults shot up by 154%.  Banks suddenly got gun shy. But this next $15 billion raises the guarantee level to 90%.  Banks are going to love this.  Having spent some time interviewing risk management and loan officers in my old bank, this is how they would go about it: Make a $1,000,000 ten year loan at 15%.  Require that the company keeps $300,000 in a bank account in your bank to cover the first two years’ interest.  So, if the company goes bankrupt after just two years, the bank ends up with a guaranteed $900,000 in principal and $300,000 in inter est.  That’s a guaranteed 10% return.  Call me a cynic, but this is EXACTLY what my old bank did as a regular practice.  But hey, maybe US bankers won’t take a free lunch at the taxpay­ers’ expense.  Yeah, right.

The AIG bonuses — Does this administration have a clue?

	This and the previous administration have spent about $173 billion bucks bailing out AIG — about $120 billion of which has since been doled out to governments, domestic banks, and European banks.  Most of the top man­agement was sacked and those that remain — apart from the top tier — are getting paid as usual.    The government had its choice: let AIG go, break it up, take it over, or bail out the shareholders with tax-payer money.  Having decided to socialize the losses but none of the upside, what’s the government complaining about?    Apart from the few at the top who have foregone bonuses, the next 43 in line are only getting an average of $22,000 each.    Sure, the derivatives guys are getting more, but the government will at least get a third of it back in taxes — unlike the billions that went to foreign banks and shareholders of the Federal Reserve!
	Cheers,            Peter.

Mortgage lending: The criminally insane leading the incompetent

 

Freddie Mac, the world’s second most bankrupt listed entity (after Fannie Mae), last week eliminated many fees to lenders that compensate for risks of low credit scores or small equity stakes -- and urged other lenders to follow suit.

 

This is the largely the same management team that steered Freddie to a $25 billion loss in the third quarter last year. 

 

The reason for the losses was a failure to use information on credit scores and equity stakes to manage the risk -- most commonly done through charging fees to offset the risk.

 

Now, having partially fixed the system that didn’t manage risk and encouraged moral hazard, Freddie is trying as fast as possible to unfix the system.

 

The reason is pretty simple: there aren’t enough buyers out there at current prices so to move to equilibrium, they have to either let prices fall or expand the number of willing buyers. 

 

“No deposit?  No problem.  We’ll call your first payment the deposit.”

 

“Only temporary part time work?  Don’t worry about a thing: we’re willing to waive the mandatory first year payment insurance fee.”

 

There are three major problems with embarking on this course of action:

 

1. It will reduce profits for Freddie and therefore reduce payments to its owner, the US tax payer

 

2. It may not work and housing prices will fall anyway.

 

3. It may work and keep the bubble partially inflated… only to deflate further down the road.

 

At least Fannie hasn’t followed her brother’s lead.  Hopefully other banks will try to maximize profit rather than let themselves get blown around by political brain-farts.

Geithner: Global stimulus plans may need extension

That’s right folks.  Not only have the US stimulus plans been too small and the record $3.6 trillion budget been way too tiny, but the rest of the world’s governments are failing in their duties to spend tax payers’ money in unprecedented levels as well.

The big problem is that US tax payers are saving their money.  This is great for the long term US economy, but really bad in the short term (i.e. the coming election cycle).  The government can’t tax savings, but by god can it spend them!

The even bigger problem for the US government is that other countries’ stimulus packages are smaller than America’s.  If these prove to be more effective, Geithner will look like a complete idiot.

Whereas the US $800 billion wastes 4.7% of US GDP, Germany, France and the UK are only willing to waste 1% of their GDP -- and probably on stuff like infrastructure rather than sod and government department headquarters.

The other problem is that the Europeans seem willing to let companies go bankrupt.  This of course is the main reason for having recessions: lose the deadwood and new shoots will appear.

The trouble is, markets never get things quite right: often the companies that are important to the national well-being (GM, Citigroup, AIG) are the ones that go bankrupt by mistake, while others fluke it through good management. 

What you really need here is government intervention and good judgment.

Leave it to the bureaucrats.  They KNOW how to distribute wealth better then the market.  And don’t let conservative politicians and tax payers interfere with the spending by asking where it’s going. 

My favorite quote on the subject comes from Canada’s Prime Minister Stephen Harper on his $30 billion stimulus bill:

“We cannot have the opposition in parliament replacing bureaucratic red tape with political red tape.”

Exactly.  We need both.

 

Cheers,

Peter.

An investment opportunity: this huge company has a whopping 36% return on equity; is trading at less than $2, and is an American icon.

    That’s right, it’s GM.  Warren Buffet loves companies with 36% ROE because they keep making more and more money.  The same applies to GM of course, except with negative equity and negative profits, the losses compound rather than the profits.

    News Item: GM Auditors cast doubt on GM’s viability to survive without another government bailout.

    How on earth could this have affected the market?  What did these forensic accountants find hidden deep in the basement of GM’s headquarters that tipped them off?

Could it have been any of the following?

*       If you add up the total equity of GM, Microsoft and Google, you still have negative equity.

*       GM has averaged a $20 billion a year loss for the past four years -- twice as huge as Exxon Mobil’s record setting $10 billion a year.

*       Even though GM makes “world class cars”, it can’t export them because other companies make better world class cars.

*       Anyone thinking of buying a Cadillac or Chevrolet right now is waiting for the post-bankruptcy sale.

*       GM’s fuel efficient hybrid Escalade is LESS fuel efficient on the highway than a V8 Cadillac STS and only just beats the gas guzzling Hummer.

 

    One thing I noticed on the news these days is that fewer people are referring to the current state of the economy as a “recession” and using “down turn”, “decline”, and “deterioration”.  Some are even using the other D word.  I doubt we’ll get that far, but it does look pretty serious.  Here’s why:

You know the recession is serious when…

*       Putting ten gallons of gasoline in your tank costs more than buying ten shares in the car company

*       It’s cheaper to buy 10% of the company building your house… than to actually build the house

*       A company’s market cap is smaller than your original investment

*       You can buy five houses in Detroit for the same price of a new car made there.

*       GM is worth less than 10% of its inventory

*       Your airline considers charging you to use the toilet

*       A $2.7 trillion dollar deficit sounds manageable

*       Your credit card company cancels the credit card because they run out of money to lend to you -- even at usury rates

*       Your option based incentive program is now worth less than what you spend each day getting to work

*       Taking a slow boat to China sounds like a realistic way to save transport costs

*       Spending a mid-sized country’s annual GDP on a stimulus plan sounds reasonable

*       You consider 0.1% US treasury bills a good investment

*       Your ATM slip costs more than a share in the bank.

 

Cheers,

Peter.

GDP -- the metric that got hijacked into stupidity and meaninglessness

Gross Domestic Product has become the one and only metric that anyone cares about these days, although it’s actual meaning has become completely FUBAR.

If you actually read the three words, you’ll notice that the word “service” isn’t included.  But as “stuff” became cheaper compared to “services”, two economists at a restaurant started arguing about whether they were buying food or paying for the service.

From that point on, GDP became “Gross Domestic Production of Goods and Services”, although how the hell service is “produced” beats me.

But the importance of including services in the GDP numbers was absolutely essential, politically, as US companies stampeded into China and the only “Production” left was McDonalds, the defense industrial complex, the minting of ever larger numbers of banknotes, and a car industry on life support.  

Importing became as American as apple pie.  Especially as most apples are now imported from China.  

But it didn’t affect GDP did it?  

Take a nylon stocking for example.  Some Chinese company manufactures a stocking and sells it for 20c to a US importer.  This has added 20c (less the cost of raw materials) to the Chinese economy. But at the US end, it is branded, warehoused, transported, advertised, marked up, and retailed for $5.  So that 20c Chinese stocking added $4.80 to the US Gross Domestic Product -- even though it wasn’t a US product to begin with.  

Each time a factory closes and moves production overseas to produce it more cheaply, prices come down, demand rises, and GDP increases.  

The whole US retail industry has become a mere service for Chinese manufactures and “contributing” up to 25 times the GDP created by the production by not actually producing anything.  

This is all thanks to credit, of course.  If the US had to actually produce something to trade with China and Japan, wages would have to drop to make actual “production” price competitive.  

The whole “service” industry, which is as bloated as a week old corpse, would have to shrink to the point where it provides the services required rather than the services that credit cards and national debts can support.  

Ironically, as real Gross Domestic Production increased, the shrinking of the bloated corpse would make reported GDP numbers actually shrink and the politicians would think we had a crisis on our hands.

As usual, they would revert to stupidity.

“Quick, spend more, import more!”  After all, the more the US imports on credit, the stronger the reported GDP numbers.  

How’s that for a meaningless metric?

 

Imagine if you measured your household this way?  If you measured your household success by your family’s “Gross Domestic Production of Goods and Services” you wouldn’t bother trying to save money.  You’d look at ways to simply “do stuff”, no matter how pointless, to increase GDP.  

“Hey Randy, my family GDP grew by 11% this week.  We dug ten holes in the back yard and filled in the nine we dug last week.”

“Well done Hank.  We’ve been even more productive.  My wife hired this Mexican guy to dig our holes now.  We spend our time naming and branding them, which doubled their value. Our GDP is now up 120%.”

Maybe not a precise metaphor, but you get the idea.

 

Incidentally, US GDP fell by 6.2%.... it would have been 7.3%, but for the positive contributions by “services” and federal government.