Archive for the ‘Markets’ Category

China Trade War

July 5, 2013

From a favorite blog: Humble Student of the Markets

A series of comments regarding China’s economic policy.

“Michael Pettis has a different take. He wrote a Foreign Policy article about the credit crunch related convulsions within the context of the transformation from an investment-led to a consumer-led economy and also urged caution by the West in their approach to China:”

“Last week is a reminder that Beijing is playing a difficult game. The rest of the world should try to understand the stakes, and accommodate China’s transition to a more sustainable growth model. As policymakers in China continue to try to restructure the economy away from reliance on massive, debt-fueling investment projects that create little value for the economy, the United States, Europe, and Japan must implement policies that reduce trade pressures. Any additional adverse trade conditions will further jeopardize the stability of China’s economy, especially as lower trade surpluses and decreased foreign investment slow money creation by China’s central bank. A trade war would clearly be devastating for Beijing’s attempt to rebalance its economy and have potentially critical implications for global markets.”

The comment above is stunning in its implications. I translate the comment into several variants. The first and most straightforward reads, “if the West doesn’t continue to buy China’s exports there will be a global recession.”

And, if that isn’t enough of a threat, “it is the responsibility of the West to raise the living standards of China’s peasants [by sacrificing its own workers standard of living].”

Last, and most fearsome, “the West must continue to build up a China that uses its economic might to intimidate its neighbors today and will use it to build a military force to intimidate the world tomorrow.”

China is a nation that has long tantalized the Western economies and political leaders by the sheer size of its population. The West drools over the prospect of being able to sell goods and services to the Chinese population. That drool blinds the West to the self-interest of the Chinese leadership. That is, China will only buy from the West until it either steals or copies technology that enables the Chinese to sell to their own people. The Chinese market is the proverbial carrot on a stick held in front of a Western donkey to entice the donkey to pull the Chinese cart. But the donkey never gets the carrot.

The Chinese leaders know full well that their own self interest is best served by providing for its own people. It must continue to control its population. Economic freedom begets political freedom. China will only buy from the West as long as it suits them. When it no longer does various rules, regulations, laws, partnership requirements, outright theft of trade secrets and technology, and any other useful methodology will be employed to deter and defer Western benefits. The West will forever remain outside the fence looking longingly at a market they will never conquer. For a preview examine the experience of Western companies in Russia under Putin. This too was a large market the West drooled over. It has proven to be a chimera.

Given the current Chinese weaponization of its economic might the West might well respond by ceasing to be a compliant sucker market for Chinese exports. A trade war is far preferable to a military war. A trade war with China is a weapon the West can use to bend China to the interests of the West and the global welfare. A trade war could be used to pressure China to crush the North Korean (and Iranian) nuclear threat once and for all. A trade war could be used to induce China to back off from its territorial ambitions in the China Sea. A trade war could be used to align China’s global interests with those of the West in regards to the Middle East (Syria, Iran); South America (Venezuela, Cuba) and even Africa. A self-sufficient, economically powerful China is a bull [tiger?] in a global China shop.



When Experts Disagree –

March 21, 2011

For some time now I have been pondering the conumdrum of what to do When Experts Disagree. Naturally the next line would have to be, ” And, When Don’t They?”

My interests (as with many people) lie in the political, economic, financial and investment worlds but like most folks I dip into other worlds such as medicine, environment, education and social policy as I meander down life’s paths. And as I peek into those side worlds and stare at my intrinsic worlds I am confident that this issue of When Experts Disagree flows into nearly (if not every) facet of our modern life. The great question is what, exactly, do we – the decided non-experts do when those experts upon whom we supposedly depend disagree?

As an example,Professor Don Boudreaux wrote a letter to the Wall Street Journal, noting one such disagreement among economics experts:

Justin Lahart accurately reports that, as recently as last year, the late Paul Samuelson dismissed F.A. Hayek’s book The Road to Serfdom as alarmist and wrong: “Sweden and its Scandinavian neighbors are among the most socialistic countries in the world, as Mr. Hayek defined them, Mr. Samuelson pointed out.  ‘Where are their horror camps?’ he [Samuelson] wrote” (“The Glenn Beck Effect: Hayek Has a Hit,” June 17).

Indeed, do physicists even agree on the speed of light? The short answer is, at best, maybe, maybe not. From another area, Curious About Astronomy, comes another type of disagreement among experts.

However, other astronomers disagree that the experiment is able to measure the speed of gravity, arguing that the effect is much smaller than the scientists claim and that (in effect) they got their arithmatic wrong when they decided that the speed of gravity did come into the equations. They are not claiming that the speed of gravity is different to that of light, just that it could not be measured in the experiment.

Clearly this disagreement is at an intellectual level far beyond my capability. But, then, I’m not an expert in anything so almost every disagreement by experts is beyond my intellectual capability. The question though remains: what do I (we), as  non-experts do when experts disagree – as they almost always do?

Take another set of disagreements at the stratospheric intellectual level. This is the abstract for a translation of a disagreement between Albert Einstein and Walter Ritz.

During 1908 and 1909 Ritz and Einstein battled over what we now call the time arrows of electrodynamics and entropy. Ritz argued that electrodynamic irreversibility was one of the roots of the second law of thermodynamics, while Einstein defended Maxwell-Lorentz electromagnetic time symmetry. Microscopic reversibility remains a cornerstone of our current paradigm, yet we are finding more and more evidence that experimentally discerned time arrows are asymmetrical and that they all point from past to future. This paper furnishes some comments about events leading up to the Ritz-Einstein confrontation, some subsequent developments, and an English translation of their agreement to disagree. A side by side comparison of two recent summaries of their battle communiques is included to provide an overview of what they had to say about this current issue.

In matters of scientific fact we may – and most assuredly I emphasize MAY – allow scientists to conduct their experiments to discover the facts of a situation. But what happens when the science community cannot experiment but can only create models they think mirror reality? This is precisely the circumstance in the arguments regarding global warming. Or, more specifically, anthropogenic global warming (AGW), warming caused exclusively by the acts of man. The facts cannot be determined by experiment. The various scientific camps create computer models and argue about the models and the input data and it all has taken on the slimy sheen of a political argument, not a scientific one.

What would we do if our lives were dependent on deciding which of these experts, these intellectual giants was correct? Or even which was more correct? How would we decide? What would be the basis of our decision? Ultimately, might one even be so arrogant as to ask why even consult the experts? For if they ultimately disagree and we are not expert yet we must make a decision then why consult them at all? How would we, on what basis would we, differentiate between the various expert camps?

What do we do when our experts disagree?

Bond Portfolio Frustrations

March 21, 2011

Below is an excerpt from a Morningstar article by Christine Benz published on 2/28/2011

 The Error-Proof Portfolio: Nervous Bond Investors–Don’t Make These Mistakes

“The second potential risk for individual-bond investors right now is one of lost opportunity more than anything else: If available bond yields pop up from today’s ultralow rates, buy-and-hold individual-bond investors won’t be able to take advantage of them until their securities mature. And when they do, they’ll be forced to reinvest their bonds at whatever interest rates may be on offer, even though interest rates could go even higher in the future.”

This attitude is so frustrating. I’ve seen it from Morningstar and individual investment advisors alike. In a discussion of bond allocation in a portfolio to infer that individuals should remain in cash or only buy a capital losing bond mutual fund because otherwise we’ll miss other investment opportunities is downright insulting. What the heck are the alternatives? Bond funds? The implication is that individuals should only invest in bond mutual funds so that we don’t miss investment opportunities! Phooey.

If I invest in a bond mutual fund I will lose a lot more than opportunity compared to buying individual bonds. I will lose capital and with it the opportunity to invest in anything. So what if I have to re-invest my matured bonds at “… whatever interest rates may be on offer, …”. Doesn’t that give me the chance to re-invest at much higher yields? And this is as compared to a bond mutual fund throwing my capital away in order to maintain a fixed duration in their fund. And rarely does the resulting yield rise recoup my capital loss. This comment poisons the rest of the article.

Insider Trading Hooey

October 25, 2009

The Saturday, October 24, 2009 issue of the Wall Street Journal’s “Weekend Journal” had a front page article, “Learning to Love Insider Trading” by one of my favorite bloggers. The author is Professor Donald J. Boudreaux, Professor of Economics at George Mason University. His blog, “Café Hayek” is on my daily reading list. More often than not I find agreement with his points of view. Not so with this article. In fact, were I the professor and this a student paper it would get no more than a “D” and even that only for penmanship.

 In support of insider trading Prof. Don provides two examples. The first is the governmentally imposed gasoline price fixing and limitations on purchases. How this relates to insider trading is a mystery. Prof. Don writes that it shows the failure of price discovery as it relates to supply and demand. Of course it does. That was the explicit purpose. Governmentally imposed price and supply controls are political in nature not economic. They are imposed for political reasons; they are designed for political benefit and they are wholly divorced from economic purpose. This example fails the test of relevance.

 The second example Prof. Don provides involves “unscrupulous management” that drives a company to the brink of bankruptcy but hides the financial facts from both the public and creditors alike. In this example Prof. Don uses actual, literal, criminal fraud to justify insider trading. This is even more mystifying than the price controls example. Knowingly using false information to obtain credit is criminal fraud. Hiding the actual financial condition of a publicly traded company from the shareholder owners also constitutes criminal fraud – at least in my mind it does. There simply is no link between these two non sequiturs and insider trading.

 The only other justification the professor provides are quotes from two other economists, Henry Manne and Jeffrey Miron.  The quote from Henry Manne is instructive in that Prof. Don explains it as saying, “… when insiders trade on their nonpublic, nonproprietary information …” which is interesting in itself on several counts. First, “insiders trade on their …” except that it isn’t “their” information it is the owners information. The insiders have no right to sell what isn’t theirs in the first place. Second, “nonpublic” is quite absurd since the whole issue is about nonpublic information. If the public knew the information there would be no insider trading taking place. Third “nonproprietary” information is the key to the whole issue. What possible information could be of value that isn’t proprietary? Near the end of the article the professor addresses, or feigns an attempt to address this issue but his examination is, to be polite, weak. By definition, if it is of value it must be proprietary.

Prof. Don’s quote from Jeffrey Miron, “In a world with no ban, small investors might fear to trade individual stocks and would face a greater incentive to diversify; that is also a good thing.” Right, illegally trading on stolen information that effectively robs small investors of prospective gains thereby forcing them to diversify is a good thing. Sigh. Apparently only insiders and large, presumably professional, traders have the right to profit from stolen information. Small traders should buy their mutual funds and shut up.

Trying to exculpate insider trading for its supposed beneficial economic effects is so wrong it’s bordering on the absurd. Seriously this is a “broken window” type of economic theory. It’s analogous to saying that having your car stolen is economically beneficial since you have to replace your car and that creates economic activity.

Trying to exculpate insider trading because of insider non-trading is equally absurd. Professor, insider buying and selling or not buying and not selling is public (or should be) information. You can read about it all the time. There are a number of web sites that provide such information such as, . MSN’s site gives small and large traders access to insider buy/sell information at . An investor can just type the ticker symbol for the data. When corporate insiders don’t sell shares – for whatever reason – this information is publicly available simply because they don’t sell! Claiming such non-activity as a prosecutorial bias and thereby justifying the insider trading is more non sequitur masquerading as reasoned thought.

In the end there is one issue that Prof. Don ignores that I find most troubling. I am a small business owner, the majority partner actually. Everything my partner and I provide in our business belongs to us. If an employee uses my computer for their personal email they do so at my convenience. As a courtesy I would periodically ask them to remove any personal items so that business functions can proceed uninhibited but it is my computer and I can do with it as I wish. We do not allow them to use our company vehicles for any personal reasons. They can’t use our tools or offices for private functions. Nor can they use our financial data or business plans for their own personal gain. In short what Professor Boudreaux ignores are the ownership rights of the shareholders. None of the insiders has unequivocal ownership rights to the information they are selling. At best they share ownership unless it is a private company and they are the sole owners. But in that case there is no public trading taking place. At bottom all insider trading robs information from the rightful owners for the personal gain of the employee insider.

Professor Boudreaux’s failure to protect the ownership rights of shareholders is a significant and substantive failure on the part of one who otherwise champions individual rights and freedoms.

Sales Gains at HD and LOW

May 19, 2009

Lowes (LOW) came out with good  less bad earnings recently and their stock rallied sharply. Home Depot (HD) came out with less bad good earnings and their stock didn’t rally. Given the cliff dive of home builders, housing starts, remodeling/renovation and the like how is it that HD and LOW have done as well (or not as bad) as they have?

As a street level economist I have long followed national economic statistics. Over the past 40 years or so I have noted with some amusement that the self-described independent economic decisions my wife and I have made seem to show up in the national economic stats a few months later. Hmmm. Maybe we’re not so independent after all? Maybe we just make our economic decisions using information similar to that of a slew of other baby boomers.

This year, owing to a change in our personal circumstance as well as the economic situation, we decided to stop using a lawn service. Instead, since I was home more (the last 4 years I’d been working away from home, returning only on weekends) I could take care of the lawn myself. Of course, I’d have to buy a lawn mower, edger, trimmer and blower to do the work. By now some of you have already figured out where I’m going.

The act of buying all that lawn care equipment certainly boosted Toro and Echo (the equipment makers). It also boosted the sales at Coastline Lawn (the retail store where I bought the equipment) and Home Depot/Lowes where I bought some miscellaneous items (gas cans, fuel stabilizer, hand tools, etc.) I expect my purchases to show up as sales in these and other companies quarterly reports. But it’s not all gain.

 No, the pain is felt by Hardy’s Grassworks, the lawn service company. A small business, they will lose the revenue I used to provide. Hardy’s grassworks is a well run business by the way – I recommend them to the Wilmington, NC area. But the bottom line is that the $1500 annual cost for Hardy’s (worth every nickel) is greater than the $1000 or so I paid for all my equipment. Since my time no longer has the same value I chose to buy the euipment, cancel the service and do the work myself. The net result to the national economy is a gain of +$1000 for the equipment purchases (an immediate gain) but an annualized loss of -$1500 to be felt over the next 6-9 months.

Multiple my choice out by 5 or 10 million like minded 60+ boomers and the national result is an annualized drop in GDP of perhaps $5 Billion or more. Not much in a $14 Trillion economy but a billion here, a billion there and pretty soon we’re talking real money (to misquote an old congressman). And keep in mind that my particular series of choices shows up real quick in the sales figures but real slow in the small business revenues (and ultimately the taxes they pay).

Maybe, just maybe those HD and LOW sales and earnings gains improvements not so bads are temporary?

Fertility Based Ponzi Scheme

May 11, 2009

A recent article on the Political Calculations blog entitled “Demographically Driven Inflation and Deflation” described a relationship between demographics and the “…’flation” twins, IN-flation and DE-flation. By coincidence the night before the article was published I had asked myself a question: “where will the demand come from?” That is, how might my baby boom generation (e.g., “demographics”) impact the economy?

 The paragraph below and accompanying chart are from the article. Note: the Political Calculations article described a relationship between inflation, deflation and demographics. The authors found that changes in the labor work force predicted the resulting ‘flation after a two year time lag. I recommend the blog and the article.

 This consumption pattern is sustained throughout an individual’s working life, until they retire. Shortly after retirement, personal consumption expenses tend to drop sharply, as work done by Mark Aguiar and Erik Hurst demonstrate in their 2008 paper Deconstructing Lifecycle Expenditure. We’ve [“Political Calculations”] excerpted a chart from this paper (left) to show how attaining retirement age would appear to affect personal consumption. 

Personal Consumption Expenditures By Age

Personal Consumption Expenditures By Age

 As I read this post I was struck by the implications for the economy. In the current economic environment much of the Obama (and Bush) administration is striving mightily to increase the demand side of personal consumption expenditures (PCE). Massive stimulus, by some accounts almost $13 trillion (trillion with a “T”), is supposedly aimed at increasing demand, to utilize excess capacity as Paul Krugman might say. Within the framework of this life cycle expenditure chart, my question remains, “where will the demand come from?”

 Again, from the Political Calculations article:  This chart runs for individuals from Age 25 through Age 75, showing the log deviation in personal consumption expenditures from the level recorded for 25 year olds. We see personal consumption rising from Age 25 through Age 45, peaking in the range between Age 45 and 55. After Age 55, as retirement takes place, total personal consumption expenditures (the top pink line) fall steadily before leveling out over Age 65, the generally accepted age of retirement in the U.S. (emphasis added)

The gist of the Political Calculations article (assuming that I understood it properly) is that demographics can be used to predict and may be the dominant factor in, the resulting ‘flation after factoring in a two year time lag. The Aguiar/Hurst chart suggests (again, assuming my understanding) that non-durable expenditures may drop by 15% to 20% from a peak around age 55 to typical retirement at 65 and declines steadily thereafter. If you include housing services in the data the chart suggests a 10% decline (from .37 down to about .27) in total expenditures from age 55 to 65 and relatively stable spending after that. As we age we spend less and less on “nondurables” but somewhat more on housing services (cleaning, maintenance and so forth). 

Now, since

(a) the baby boomer population is fixing to retire en masse and;

(b) personal consumption declines after individual’s reach age 55 then;

(c) how will the worldwide production capacity be utilized without the demand created by the excess baby boomers as they reduce their expenditures?

Allow me to step back and personalize this a bit. At 62 I am in the second year of the baby boom generation. We are the pig-in-the-python generation that has disrupted the nation (the world?) and distorted economic data for some 60 years now. My earliest economic recollections are of a massive demand for school construction alleviated somewhat by dual session classes (K-12). My wife recalls triple session classes. Then we (some of us) filled colleges to overflowing and again there was the demand for new construction. Many of us (me included) went off to war, an unpopular war to be sure but bullets are bullets. From college/military/tech school/high school we all set off to find jobs, spouses, houses, cars and at various times we produced babies who needed all kinds of baby things.

 As we grew older our basic needs were more or less fulfilled and our wants took dominance in the economy. From starter homes we went to “McMansions”. From weekly vacation rentals we went to second homes on the beach or in the mountains. From one car we went to two, then three, four or more depending on the kids and the deals. From one TV we went to multiple, color TV’s and now to multiple plasma/LCD TV’s. From slide rules we went to calculators then personal computers followed by laptops, and now netbooks. And we didn’t have just one per person but often two or more. From landline dial up phones and pay phones on the corner we went to cell phones, smart phones and all kinds of fruit phones. But it wasn’t a growing population doing all this. It was the same demographic bulge (plus a mini-bulge from our children) basically driving the demand. But at every point in this demographic cycle business and government ignored the down slope of the backside of the bulge. That’s the point where aggregate demand trails off. That’s what the Aguiar/Hurst chart depicts.

 Early on when confronted with the up slope of the front side of the baby boom bulge, businesses and factories worldwide were built and expanded, workers were hired to run the factories and economies grew. Of course, expectations for growth were likewise expanded. The Wall Street Journal just recently had an article about the drop in sales for Toyota that demonstrates this very fact. Toyota over expanded automobile manufacturing factories and now has too much capacity for the demand. See the article, “Toyota Posts Big Loss, Signals More to Come“.

Toyota is not alone. Chinese factories, Australian and South American mines, United States houses, all were built and expanded to meet that expected growth. That up slope would go on forever, wouldn’t it? And it all seemed to go well for the most part. Yeah, we had a few hiccups with the oil embargoes and stagflation of the 1970’s. The inflation/recession of the 1980’s and the recession and financial meltdowns of the 1990’s (LTCM anyone?) were a bit troublesome. Then of course we had the 9-11 terrorist attacks, the tech stock bubble bursting and recession, the follow on housing bubble and subsequent bust, recession/depression of the aughts (the 2000’s).

 And now along with my cohorts I’m getting kinda old. My needs were long since fulfilled, my wants I can’t afford so well anymore and some of them I’ve just flat outgrown. Not buying any big boy toys anytime soon. Have to watch my retirement finances of course. And, like many of my compatriots, those resources are a bit tarnished of late. So I’m no longer in the market for a second home or a third car. My wife and I already have two cars, two computers, two cell phones and four TV’s.

I’m basically in replacement mode for anything I might want – need. I know too that my personal spending has been declining for the past few years. And, I know that if I’m reducing my spending then so are others of my generation. See, that’s been a pattern I’ve observed over the past 40 years or so. In a general manner, as a self-taught (and therefore untrained) street level economist, I’ve observed that as my wife and I make our seemingly independent economic choices very often those choices show up in the national economic statistics several months later. Again the Aguiar/Hurst chart depicts my families’ personal, independent, economic activity.

 So, if we’re cutting our spending where will the demand come from to utilize the now idle worldwide factory capacity? Recall that I had referenced “… excess baby boomers …” in my earlier question. Note also that the article mentioned at the start of this post considers the birth rate. By contrast, being an untrained, street level economist I choose to focus on total population not birth rate. And of the total population most especially that portion of the baby boomer population that exceeded long term expectations. They are the marginal group that has blown up economic statistics for over 60 years.

Total and 1% Trend Population

Total and 1% Trend Population

 From 1929 through 2008, excluding the years 1947-1966, population growth averaged 1% annually. However, during the baby boomer period (1947-1966 *) population growth averaged 1.7% annually.

(* Yes, I know the baby boom years are typically set at 1946 to 1964. My range is based on the percent change in total population, not the birth rate. So I started when that change was evident, in 1947 and stopped when the percent change returned to the long term trend around 1966.)

 That excess 0.7% growth above the long term trend amounts to an excess of over 24 million individuals as of 1966. That is, actual population as of 1966 was about 196.6 million. If, starting in 1947 actual population had only grown at the long term average rate of 1% then the 1966 population would have only been about 172.5 million. The difference, over 24 million is what I term the excess baby boomer population. This excess population resulted from a period of population growth well above the long term average. This excess, now approaching retirement will not be quickly replaced, if ever. The minor population boomlet from 1989 through 1992 has quickly dissipated. In fact, population growth rates have been trending downward since 1992 as seen in the chart below.

Annual Percentage Change in Total Population

Annual Percentage Change in Total Population

In 2002 those of us born in 1946/1947 hit that magic age of 55 at which time the Aguiar/Hurst chart notes our personal consumption expenditures begin to decline. Unlike other years though, what began in 2002 is a gradual reduction in aggregate demand that will be greater than would otherwise be expected had demographics been more consistent. For example, in 1947 total population was 144.1 million. Had the growth rate only been 1% (instead of the 1.9% actual) the total population would have been 142.8 million. The difference, in this one year, was 1.3 million people more than the long term average would have predicted. Starting in 2002, when these people reached 55 there will be 1.3 million more people than the expected average that will decrease their spending. And, ultimately around 2022 these additional people will begin to die thus ending their spending completely. Worse, there isn’t enough new population, percentage wise, to make up for their passing.

Since the long term rate of growth in population has returned to the 1% trend (except for a minor spurt in the 1990’s) and since the actual population that is reaching retirement is greater than expected (compared to long term trends) it follows that aggregate demand may fall greater than expected. Simply put, there are insufficient numbers of new population to both replace the natural decline in demand and also provide the desired aggregate growth in demand. Simply put, our economic system is predicated on a rising population but it is not enough to simply grow population in absolute terms. The percentage rate of growth must be high enough to provide the GDP growth rate desired to improve the overall standard of living. In that sense our economic system is essentially a “Fertility Based Ponzi Scheme”.

A recent post on The Daily Reckoning Australia , “They Say the Stock Market ‘Looks Ahead’” included a brief overview of the current state of the U.S. economy.

 The basic formula that drove the U.S. economy for the last 60 years has been the expansion of consumer spending. At first, that spending was healthy spending. People had built up savings during the war. In the Eisenhower years, they were ready to get back to work in the consumer economy, get married, have children, and spend money. America was the world’s leading lender…leading exporter…leading manufacturer…and leading everything. Gradually though, having so many advantages caught up to the United States of America. By the ’70s, the Nixon administration thought it could do away with the gold backing for the currency. By the ’80s, the United States slipped from being a net creditor to being a net debtor to the rest of the world. By the ’90s, American consumers were spending more than they made…and by the ’00s they had given up saving all together- …

What intrigued me is that all of these elements, generalized though they may be, are descriptive of the baby boomer generation. In the 80’s baby boomers were hitting their big spending strides which continued into the 90’s. But by 2002 those of us at the leading edge slowed down as we hit age 55. We stopped spending so much. Stared at the retirement abyss and freaked. The Aguiar/Hurst chart became our reality. The table below shows the excess baby boomer population for each year. The cumulative total of excess baby boomers is some 24 million. Add to that count the trend level boomer population of another 50 million or so and there is a massive demographic bomb slowly exploding.

Excess Baby Boomer Population

Excess Baby Boomer Population

As of 2002 individuals born in 1947 have reached age 55 and have begun to slow their spending. The excess population in that year’s age group is 1.323 million. In 2003 another set would reach age 55 and the excess population in that year’s age group is 1.077 million. Cumulatively it is 2.4 million aging baby boomers in excess of long term trend population. Obviously this continues every year and now, as of 2008 there are almost 8 million boomers aged 55 or over in this excess population group. As of 2008 per capita “Personal Consumption Expenditures” (PCE) averaged $33,035. If my group of boomers (I am one of them now) reduce their PCE by 10% it will be at least $3300 per person. Probably a lot more since this age group is at both peak spending and earnings levels.

8 million aged boomers x $3300 per person = $26.4 Billion in lost PCE

Next year, 2009, will be more of course. Now I grant that in a $14 Trillion economy $26.4 Billion is a rounding error. Unless of course, it is your job, business or retirement that depended on that bit of extra spending. Then it is a calamity.  Just ask Toyota, or GM or Chrysler. By 2021 when the last of the boomers hits 55 the total lost PCE will begin to approach triple this amount – over $79 Billion at 2008 rates. Again, not a huge hit in a $14 Trillion economy but for those operating at the margins of this economy it may be a serious blow. But keep in mind that this reduction in spending is only from the excess baby boomer population. The remaining 50 million “average population” of aging boomers (about double the number of “excess” boomers) will also be reducing their spending. And it is the younger generations that must recoup that entire reduction in demand and then some if they are to achieve net economic growth. That is, the 25-45 age group will need to recoup some $240 Billion of spending (all boomers reducing spending by at least 10%) just to remain even.

But I don’t see any obvious mechanism for this loss of excess demand to be recouped. The remaining population will do well just to maintain some economic growth. There simply isn’t enough population growth to create an increasing economic growth rate and overcome the Personal Consumption Expenditure loss from the excess baby boomer population. And, even worse, since the government and business community has ignored this demographic bomb production capacity has been expanded to meet what was falsely assumed to be a rising demand curve. Now we have both falling demand and over built capacity.

Ratio of 55+ to Total Population

Ratio of 55+ to Total Population

The chart above is a dramatic illustration of the demographic tsunami that is just now hitting the US (and the world) economy. Over the next 20 years the aging of America will have a similar, albeit reversed, impact on the economy as it has for the past 60 years. But now the baby boomers will start to extract growth instead of provide growth. But few of those in a political position to comprehend this issue seem to be concerned. Today their singular concern is to force feed credit in what I believe will be a futile effort to revive a PCE demand that simply will not return. It cannot return. Our “Fertility Based Ponzi Scheme” has run out of new investors, so to speak. The US economy has pulled a “Bernie Madoff” and both are in deep trouble.

Regulatory Failure

April 22, 2009

In a post on “Economist’s View“, Mark Thoma wrote:
“Every market that was supposed to self-regulate failed?” … “So more and more I’m starting to think there may be a single explanation after all, that the regulators of these markets were captured by powerful forces that wanted the game to continue.”

Well, which is it? Did self-regulation fail or did government regulators fail to do their job? Which of the steps Mark has noted was wholly self-regulated? Mortgage brokers, realtors, appraisers, and rating agencies, are all licensed and regulated! Truly the only players not regulated by the government are homeowners and the government. Corporations being a mixed bag of limited regulatory oversight.

Everyone has some aspect of self-regulation. Don’t rob customers. Don’t cheat on taxes. And all of us have layers of regulations. If self-regulation failed then put the miscreants in jail. But if regulatory agencies failed what do we do then?

Mark and the commenter’s seem determined to paint the regulatory failure as a Republican failure – usually Reagan or Bush (43) or both. Granted this is a liberal blog with a liberal author and most commenter’s seem to also be liberals (judging from the comments). I assume therefore all are Democrat. You don’t like Republicans in general and Reagan and Bush (43) in particular. Peachy.

But for all your dislike (and I’m being kind) the regulatory failure that is at the heart of this morass has been and continues to be a massive bi-partisan affair. One clear example: the failure of Congress and regulators alike to label a Credit Default Swap (CDS) as an insurance policy. Doing so would have put every CDS under the insurance regulator. Not doing so let every bank, hedge fund, pension fund, go wild.

That simple act was/is a key factor in this economic maelstrom. That act was totally bi-partisan and totally intentional on the part of Congress and the various agencies. If it wasn’t for the CDS all the MBS and CMBS would not have had their AAA ratings and would not have been such “good” investments.

Get over your disklike of Reagan and Bush (43) if you really want to truly reform our economy. Shove your anti-Republican rants over to Wonkette. It’s a sport over there.

Gold vs CPI

March 19, 2009

Gold as a store of value  

I appreciate all the comments on my article. Even those who call me an “idiot” will not be surprised to learn that my wife agrees with them at least once a week. In an effort to diminish that view I have done a bit more research to compare gold with the CPI (consumer price index) as published by the Bureau of Labor Statistics. The CPI is available from 1913 to the present. I selected, again, the annual values to compare with the annual spot price of gold. Several comments suggested gold is an insurance policy against inflation I presume.  Others suggested gold is a “store of value” (SOV) not an investment, again I presume against the loss of value due to inflation. At least one excoriated me for ignoring the fact that ownership of gold was prohibited until 1974.


The comment about gold ownership being prohibited until 1974 ignored the main thrust of the article. Gold completely failed as an investment over the twenty year period from 1980 through 2000. Yet gold was freely traded during this time. I examined the longest possible historical record to obtain as much information as possible about the relative value of gold versus the DJIA. Yes, gold was prohibited until 1974. But ownership of stocks was relegated to a small minority of the population as well. Neither fact changes the conclusion of the article that whether gold outperforms the DJIA depends on the current economic circumstances. Neither is “best” at all times.


As insurance against inflation I believe gold also fails since insurance is designed to replace value dollar for dollar. If 10% of a portfolio is in gold then a doubling of the value of gold is required to increase the portfolio by 10%. Stated differently, to protect against a 10% inflation rate requires that gold (at 10% of the portfolio) double in price. Gold certainly can double in a year (or less) but it has never done so over any extended period of time and never done so during periods of low to moderate inflation. Gold only jumps in value during periods of extreme financial stress. Of course, today we are in fact experiencing extreme financial stress so gold is doing well. For now.


As a store of value (SOV) gold, or any asset for that matter, must also perform well as an investment. I am clearly not the brightest bulb in the chandelier but I cannot understand how a poorly performing investment can succeed as a store of value. But set that argument aside. Given a historical record of the CPI how does gold stack up as a store of value? The BLS statistics set 1982-1984 as 100 and then adjust the CPI up or down accordingly. Thus if inflation at some future time is double what it was in 1982-1984 the CPI goes to 200. If it were half the CPI drops to 50.


Since the 1983 CPI is set at 99.6 I arbitrarily used that as my base level for inflation. Also, since gold had been trading freely at that time I set the yearend spot price of gold, 415.00 as my base level for the price of gold. Using the base level of gold I then adjusted the price using the annual CPI figures for each year. By coincidence the CPI adjusted price of gold in 1974 was 203.78 versus the actual spot price of 195.20 which is extremely close.


There were several interesting results from this exercise. First, the CPI adjusted price of gold was well above the government set levels from 1913 through 1973, sometimes by 2 or 3 times. This suggests the government was arbitrarily devaluing the dollar, in gold terms during this period. No big surprise there. What was a surprise is that from 1974 through 1978 spot gold was still below the CPI adjusted level. However, even more stunning is that the only times spot gold exceeded the CPI adjusted level was from 1979-1983 plus 1987 and 2008. If we only look at the period from 1974 through 2008, when gold was freely traded its SOV function was only reliable for a single 5 year period plus two additional separate years of extreme financial stress. Obviously 2009 and beyond may add to gold’s SOV utility.


My conclusion is that gold as a store of value, as a hedge against inflation and as an investment is only valuable during periods of extreme financial stress. We are in such a period at the present. Gold is doing well, at the present. Stay alert for improvements in the underlying economic circumstances and protect yourself. The gold versus CPI table is available below.

CPI Adjusted Price of Gold

March 19, 2009
Finfacts Ireland Consumer Price Index
Historical Gold Prices U.S. Department Of Labor
Source: Bureau of Labor Statistics
Global Financial Data 1982-84=100
CPI Adj.
GOLD CPI Price of
Year  Close Annual Gold
1913 20.67 9.9 40.92
1914 20.67 10.0 41.33
1915 20.67 10.1 41.75
1916 20.67 10.9 45.05
1917 20.67 12.8 52.91
1918 20.67 15.1 62.41
1919 20.67 17.3 71.51
1920 20.67 20.0 82.67
1921 20.67 17.9 73.99
1922 20.67 16.8 69.44
1923 20.67 17.1 70.68
1924 20.67 17.1 70.68
1925 20.67 17.5 72.33
1926 20.67 17.7 73.16
1927 20.67 17.4 71.92
1928 20.67 17.1 70.68
1929 20.67 17.1 70.68
1930 20.67 16.7 69.03
1931 20.67 15.2 62.83
1932 20.67 13.7 56.63
1933 32.32 13.0 53.73
1934 35.00 13.4 55.39
1935 35.00 13.7 56.63
1936 35.00 13.9 57.45
1937 35.00 14.4 59.52
1938 35.00 14.1 58.28
1939 35.00 13.9 57.45
1940 34.50 14.0 57.87
1941 35.50 14.7 60.76
1942 35.50 16.3 67.37
1943 36.50 17.3 71.51
1944 36.25 17.6 72.75
1945 37.25 18.0 74.40
1946 38.25 19.5 80.60
1947 43.00 22.3 92.17
1948 42.00 24.1 99.61
1949 40.50 23.8 98.37
1950 40.25 24.1 99.61
1951 40.00 26.0 107.47
1952 38.70 26.5 109.54
1953 35.50 26.7 110.36
1954 35.25 26.9 111.19
1955 35.15 26.8 110.78
1956 35.20 27.2 112.43
1957 35.25 28.1 116.15
1958 35.25 28.9 119.46
1959 35.25 29.1 120.28
1960 36.50 29.6 122.35
1961 35.50 29.9 123.59
1962 35.35 30.2 124.83
1963 35.25 30.6 126.48
1964 35.35 31.0 128.14
1965 35.50 31.5 130.20
1966 35.40 32.4 133.92
1967 35.50 33.4 138.06
1968 43.50 34.8 143.84
1969 35.40 36.7 151.70
1970 37.60 38.8 160.38
1971 43.80 40.5 167.40
1972 65.20 41.8 172.78
1973 114.50 44.4 183.52
1974 195.20 49.3 203.78 Gold Ownership Permitted
1975 150.80 53.8 222.38
1976 145.10 56.9 235.19
1977 179.20 60.6 250.48
1978 244.90 65.2 269.50
1979 578.70 72.6 300.08
1980 641.20 82.4 340.59
1981 430.80 90.9 375.73
1982 484.50 96.5 398.87
1983 415.00 99.6 413.34 Base Value
1984 331.30 103.9 429.46
1985 354.20 107.6 444.75
1986 435.20 109.6 453.02
1987 522.9 113.6 469.55
1988 441.00 118.3 488.98
1989 433.40 124.0 512.54
1990 423.80 130.7 540.24
1991 379.90 136.2 562.97
1992 356.30 140.3 579.92
1993 419.20 144.5 597.28
1994 409.80 148.2 612.57
1995 385.60 152.4 629.93
1996 367.80 156.9 648.53
1997 288.80 160.5 663.41
1998 288.00 163.0 673.74
1999 287.50 166.6 688.62
2000 272.15 172.2 711.77
2001 278.70 177.1 732.03
2002 346.70 179.9 743.60
2003 414.80 184.0 760.55
2004 438.10 188.9 780.80
2005 517.20 195.3 807.25
2006 636.30 201.6 833.29
2007 833.20 207.3 857.03
2008 926.72 215.303 889.93  

DJIA vs. Gold

March 15, 2009

Gold as a store of value

I’m not a gold bug. I believe gold’s use as an investment and store of value is a historical artifact not well suited to the modern era. When sailing ships ruled the seas it may have been a fine store of value but when spaceships rule the skies it feels, well, a bit leaden. But, still, in the current environment the question needs to be asked: “does gold still have investment value or has it become the fool’s emporium?”


It is exceedingly tedious to sift through the competing and often repetitive claims of gold’s investment value or lack thereof. Attempts at discussion often devolve, and rapidly so, into emotional arguments emanating from rigid positions of gold owner versus non-owner. Such arguments are hardly a useful insight into gold’s value as an investment and thus as a store of value.


The thought occurred to me that if gold was indeed the best investment vehicle and store of value then it ought to handily outperform other investment vehicles over extended periods of time. On that premise I determined to compare the long term spot price of gold versus the long term Dow Jones Industrial Average (DJIA). Such a head to head comparison might be able to determine the relative value of either investment vehicle as a long term store of value. In this process I arbitrarily assume that the better investment vehicle is therefore, the better store of value.


Of course, if gold or the DJIA does not provide a net positive return then it fails as an investment and also as a store of value. Thus we need to first determine if either vehicle provides a long term positive return. If so, then we can compare those returns to determine which vehicle is better. So, does either provide a positive return? Which is the better investment: gold or the DJIA?


It depends

As is too often the case the answers to both questions are disappointing. Do gold and the DJIA provide a positive long term return? It depends. Which is the better investment? It depends. What do these answers depend upon? They both depend upon the time period selected. Pick one time period and neither is positive. Pick another and both are positive. Pick a third time period and gold handily outperforms the DJIA. Pick a fourth time period and the DJIA buries gold. Let’s take a closer look to better understand the importance of the time period in answering these two questions.


I confess that I am not a mathematician but a small time investor and trader. My objective is to find investments that preserve my capital and provide a net, positive, real rate of return. Given an opportunity I will of course, pick the higher, risk adjusted, rate of return over the lower. Who wouldn’t? With stocks having fallen some 50% over the past year the gold bugs are out in force.  Having been inundated with the buy gold, buy gold, buy gold mantra in the news media, blogs and commentary I have decided to examine gold more closely. Being at best agnostic about gold I wanted to find out if I am wrong and the gold bugs are right or if my negative intuitive response was more appropriate.


The data

I have obtained the annual DJIA values from 1899 through 2008. I have also obtained spot gold prices over the same time period. Since I am examining both vehicles as long term investments rather than as short term trading vehicles I contend that annual prices are sufficient for my examination. To buttress that contention I note that it is exceedingly rare for any gold bug to ever recommend selling gold. And, clearly the most profitable investor of our time, Warren Buffett is a self-described buy and hold investor. Thus I believe annual data is sufficient for a long term investor.


Within the time period available, 1899 through 2008 some anomalies exist. The biggest is that up until 1933 the price of gold was fixed at $20.67. It is not a fair comparison when one investment vehicle is fixed in price while the other enjoys a measure of volatility. Most of my comparisons then are relegated within the time frame of 1933 through 2008. Even so it is interesting to note that from the bottom of the Great Depression (1932) through 1941 (the start of WWII) the DJIA more than doubled while the price of gold languished.


The importance of time

In a previous existence during the Neanderthal period of personal computer technology I spent way too much time examining various rules based trading strategies. Looking back at those efforts it slowly became apparent that the time period of the data played a much greater role in the outcome of those strategies than was initially evident. Now, at a somewhat riper age one of my first questions regarding investment returns and data is, “over what period of time?” Even more important is the second question, “why that time period?”


As an example, the annual price of gold was in a long term downtrend from 1980 through 2000. The spot price declined by over half from a high of $641 in 1980 to a low of $272 in 2000. Over this same time period the DJIA increased by 1000% from 964 in 1980 to 10787 in 2000. Any comparison of gold versus DJIA over this twenty year period is overwhelmingly in favor of the DJIA.


Let’s take another time period. From 1965 through 1981 the DJIA languished from a high of 969 in 1965 down to 875 in 1981 before embarking on a twenty year bull market. Gold also languished from 1965 to 1971 but starting in 1971 gold rallied from 35 to over 430, a 1200% gain. This time the results are overwhelmingly in favor of gold. But does this tell us, as long term investors, which is the better investment?


It still depends

Table 1 below depicts the simple percentage change, or rate of return on a long term investment in the DJIA and gold. The returns are based upon the change in value over a selected period of time. The change in the DJIA value from 1899 through 2008 is 13252% while the change in spot gold over the same period is only 4383%. Since spot gold was fixed from 1899 through 1932 I next looked at the period 1933 through 2008. During that time the DJIA change in value was 8795% while spot gold only gained 2767%. The next data line looked at the post WWII period to the present (1946-2008). The results were similar if not so dramatic.

                                    Table 1

Dow Jones Industrial Average vs. Historical Spot Gold

Percent change in value over indicated time period











































































The remainder of Table 1 depicts the start of a series of time periods to the present, with two exceptions. Given the dramatic selloff in the DJIA and the dramatic rise in spot gold over 2008 I also took a quick look at some results as if the data ended in 2007. These are the periods from 1970 through 2007 and the current decade, 2000-2007. Excluding 2008 data does not alter the direction of the overall results just the magnitude. These are simple calculations, value at start of period (technically end of prior year) versus value at end of period expressed as a percentage of starting value.


What this table depicts is that neither the DJIA nor gold is “THE” single best investment over all time periods and economic conditions. It clearly shows that the time period, which is to say the economic circumstances of a time period, is the determining factor as to which is the better investment.


Value of $1000

I next looked at the data in a slightly different manner, value of $1000 over a selected time period. By only examining data points at the start and end of a time period the ebb and flow of an investment is masked. While the volatility of an investment is important for long term investors, my objective was to examine the value of $1000 during the selected time period in hopes that would provide additional useful information towards determining which asset is the better investment. Table 2 below shows the value of $1000 at the end of a series of selected time periods.


The results shown in Table 2 were calculated by assuming an initial $1000 investment in each asset using the prior yearend value. That is, for the time period of 1933-2008 the yearend value of 1932 is used to initiate the investment. For the period 1970-2008 the yearned value of 1969 was used as the basis. The investment value was then adjusted up or down depending on the percentage change in each of the asset values as of yearend. The percent change was simply calculated as (last value – first value)/first value expressed as a percent. Table 2 shows the end results of this ebb and flow over various time periods.

Table 2

Dow Jones Industrial Average vs. Historical Spot Gold

Growth of $1000 over indicated time period




























Table 2 vividly shows the impact of the different time periods. From 1970 to 2008 gold handily outperforms the DJIA yet starting ten years later, 1980 to 2008 reverses that outcome by a dramatic margin. What happened to change the outcome so dramatically? The obvious answer is that during the mid 1970’s through the early 1980’s the economy was in a serious slump while inflation was raging to historical levels. Stocks were in the cellar while gold was going through the roof. But by the early 1980’s that circumstance had turned. The economy recovered, inflation was abating and gold was declining.


A similar circumstance appears today. Although inflation has yet to rage the economy is in a serious slump (clearly a recession, perhaps a depression) and the price of gold has once again risen to historical levels. Gold bugs are ubiquitous and the economic panic and fear is feeding the frenzy. But does that make gold a better long term investment than equities?



Chart 1 (shown below) depicts the annual change in value of a $1000 investment in both the DJIA and spot gold from 1933 through 2008. As the chart depicts the DJIA appears to exceed gold as an investment in all periods except during extreme financial stress. This is evidenced by the value of the gold investment reaching and exceeding that of the DJIA beginning in the mid 1970’s and persisting until the early 1980’s. This period was the worst post WWII recession until the present time. A similar pattern exists during the period from 2000 through 2008 as shown in Chart 2 (shown below). The DJIA shows great volatility with the end result being a severe downturn through the present time.

 The economic circumstance that is missing however may be the proverbial 800# bear in the room. So far, inflation is not raging and there are serious people who believe deflation is the more likely event. Is it possible that the gold bugs have acted quite rationally – but too early – to defend against the government’s monetary and fiscal response to the economic turmoil?

Chart 1


DJIA vs Gold Value of $1000 1933-2008

DJIA vs Gold Value of $1000 1933-2008



Chart 2


DJIA vs Gold Value of $1000 2000-2008

DJIA vs Gold Value of $1000 2000-2008


While gold bugs may have acted early their combined response has until recently been self fulfilling. Gold has risen from its 1980’s doldrums (after having reached a nadir in 2000) to record highs as of late. What isn’t clear is whether this is a trend that will continue. Note that gold at $2000 has been bandied about much like oil at $200 a barrel was bandied about in mid 2008. Still, there is no denying that gold has seriously outperformed the DJIA over recent years and most especially this last year. But reasonable people can point to the triple economic shocks of (a) the 2000 tech stock bust; (b) the 9-11 attacks in 2001; and (c) the housing/equity bust of 2007-2008 as the reason for the sub-par DJIA. Clearly there have been rational reasons to put more trust in gold over the past eight years. But does that make it the better investment for long term investors?


Chart 3


DJIA vs Gold Percent Change in Value 1933-2008

DJIA vs Gold Percent Change in Value 1933-2008



Chart 3 above shows the percentage change in value, as of yearend, for gold and the DJIA over the period 1933-2008. These percents are simple calculations of yearend price minus prior yearend price divided by the prior yearend price expressed as a percentage. This chart avoids the starting point distortions evident in the Change in Value of $1000 charts. It also clearly shows the two periods when gold substantially outperformed the DJIA. Gold substantially outperformed the DJIA during the limited period of 1972-1974 and again during 1978-1981. There are other years when gold outperforms the DJIA but none as substantial or long lasting.


My Answer

I’m at best agnostic about gold. I wanted to find out if gold was in fact a better long term investment than equities as typified by the DJIA. I believe that the data has given me an answer: it depends. Whether gold or the DJIA is a better investment depends on the economic circumstances. More specifically gold appears to depend on having a substantial rate of inflation and expectations of future inflation in order to outperform the DJIA. If those expectations are absent then the DJIA outperforms. 


After gold hit its record high price in 1980 it slumped for some twenty years while the DJIA had a twenty year bull market. What happened is that inflation expectations were crushed as the government took steps to break the inflation cycle. The key factor in that case is the government correcting the economic issues of recession and stagflation thereby setting the stage for an economic recovery.


When the DJIA gets run over by its own malfeasance or by exogenous factors it too tends to slump for extended periods, circa 1965-1981, 2000-2002 and also 2008-2009. But again, when investors determine that corrective actions are underway that slump (hopefully) ends. Thus rational investors must make a determination as to whether the corrective actions of government are in fact starting to resolve the economic malaise. They must also make a valiant effort to forecast future economic circumstances and from there choose gold or equities.


Inflation or Deflation

Much of the talk today is of the extraordinary government monetary and fiscal response to the economic downturn as an inflationary factor. Even worse, this government response is a global phenomenon unlike mere national recessions of the past. Counter-balancing that are the severe credit restrictions coupled with a substantial downturn in global demand as a deflationary factor. How one interprets the outcome of these factors will determine whether gold or the DJIA is the chosen investment instrument.


One comment I read made a salient point. The unused factory capacity in China, India and the Far East is enormous. Indeed, domestic capacity as well is severely underutilized. Further, inflation is a monetary phenomenon that requires excess capital chasing too few goods. As well, deflation too is a monetary phenomenon but it requires excess goods chasing too little capital. But if the existing supply and potential supply of goods is substantial relative to demand (capital) then perhaps, just perhaps there will be insufficient capital to fully utilize all available supply. Hence, inflation may not be the 800# bear most of us believe it will become. Instead we may actually face a deflationary cycle for the first time in many generations.


This conundrum is explained by the velocity of money. As an aside capital in this case includes the money supply and the velocity of money or how fast a given dollar gets used. Velocity is currently restrained for a variety of reasons and those reasons may not recede quickly or ever. Baby boomers tend to sway the economy out of proportion to their numbers. If boomers (like me) have permanently changed their consumption habits then it is unlikely that monetary velocity will quickly resume at prior levels. Or, at the least it will not resume anytime soon.


Bottom Line

If your estimation is that future inflation is the most likely prospect then buy gold (IAU, GLD). If your estimation is for deflation then bonds (BND, HYG, LQD) are the better investment. If neither prospect seems most likely then you should select equities (DIA, SPY, QQQQ) to outperform both investments. Pick your poison.