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Anaysis of Latest memo from Howard Marks: Economic Reality

This is going viral: Latest memo from Howard Marks: Economic Reality, presented by Oak Tree Capital.

Central bank actions can encourage or accelerate economic activity, but they can’t create economic activity that otherwise wouldn’t occur. Much of what central banks do consists of making things happen today that otherwise would happen sometime in the future. It’s not clear that the effects are long-lasting or anything more than an acceleration of events within the confines of a zero-sum game. What is beneficial, however, as Professor Randall Kroszner of the Chicago Booth School of Business wrote me, is the fact that:

Some objectivists oppose current fed policy, arguing against all forms of intervention, although I don’t, arguing that FOMC policy, as well as TARP, helped capitalism and America’s best and brightest by stemming the bleeding from the weakest parts of the economy (housing, banking) so the healthier parts (web 2.0, retail, tech) could thrive. The S&P 500 is up 200% since March 2009 and the PE ratio is still only around 17, indicating that earnings have risen in lockstep with prices (not a bubble), and that the bailout was a success at restoring confidence even if no one liked it. From professor Randall Kroszner of the Chicago Booth School of Business:

[Central banks] can help to prevent a complete financial meltdown and the negative economy-wide externalities associated with a financial collapse. In these circumstances, and if done appropriately, their actions can do more than just move up future production to the present by helping to avoid economic activity losses due to a panic.

Central banking by itself cannot create growth, but it can create economic conditions that are conducive to growth, by preventing bank runs and keeping crisis brief.

Related: The System Worked: How the World Stopped Another Great Depression •

“Populism” has been a strongly rising element in politics over the last decade. It primarily means drawing class distinctions and claiming to be on the side of the common man. This often comes down to playing on the resentment of the lower-earning majority toward the wealthy minority. Populism is a particularly strong force in the U.S. presidential election now underway, fed by economic dissatisfaction among the working class due to the effects of globalization, job outsourcing, and technological progress with which some haven’t kept up. “Outsider” or non-establishment candidates in both parties – Donald Trump and Bernie Sanders – are having a lot of success telling voters the economy isn’t working for them and appealing to resentment toward those who are doing better. Now even Hillary Clinton is saying of the wealthy and powerful, “The deck is stacked in their favor . . . my job is to reshuffle the cards.”

From Brexit, to Trump, to Sanders, we’e seeing a revolt against the ‘status quo’, which is perceived as unfair and indifferent to the needs and the wants of the people, whether it’s immigration concerns for the ‘right’, or student loan debt and jobs for the ‘left’. Although the US economy is in pretty good shape – or at least relative to the rest of the world – average Americans are not fully participating in the wealth creation, or at least not as much as they were in the 90′s, when everyone seemed to be participating, not just the top 10% or so. The metaphor of cards being reshuffled is alluded to in the post In Search of Reset.

As the decline and death of entrepreneurship shows, the ‘pioneer spirit’ of America is gone. With the exception of maybe web 2.0 and some other niches, there just isn’t much opportunity in America, or anywhere, anymore. We’re kinda moving to pre-planned economy and society. Although biological determinism is one reason, another factor is saturation: the production rate of the amount of ‘stuff’ (mostly produced by large firms and entities with market dominance) to consume vastly exceeding the rate it can be consumed. A post-scarcity economy where everything is abundant and there are endless choices, may result in deflation. Also, in accordance to micro economic theory, firms in a perfectly competitive market may generate a profit in the short-run, but in the long-run profits will converge to zero. These deflationary forces help consumers, but it may hurt small entrepreneurs.

While not everyone would change their residence to reduce their taxes, some will. Remember that seven of the 50 states do not tax their residents’ incomes. Thus the bottom line on this – I think the good news in terms of fiscal responsibility – is that states have no choice but to think of taxpayers as mobile. If you raise the top tax rate by 10%, you won’t collect 10% more taxes from them. A surprisingly large number of the people Nancy and I meet in New York have their residences in Florida. That’s a reflection of economic reality – and should restrain the tendency to excessively tax the rich.

The U.S. is one of only a tiny number of countries whose citizens are taxed on all their worldwide income, regardless of where they live or where their income is earned. Thus, Americans don’t have a good way to escape federal income taxation by moving abroad. (Technically, they can leave the U.S. tax system by paying the taxes that would be due if they were to sell all their assets and realize all the appreciation to date. But they also have to surrender their citizenship and sacrifice frequent visits to the U.S., and the number of people willing to do all this is limited.)

This alludes to the Laffer Curve, the cornerstone of supply side economics, that the way to maximize government revenues is to not maximize taxes.

There are some parts of his analysis that are possibly wrong.

Faster economic growth? Both may be desirable, but efforts to clean up the environment may conflict with faster economic growth.

The good news is, it’s possible to have rising economic growth and less pollution:

Importantly, CO2 emissions relative to GDP growth is falling:

Total CO2 emissions from fossil fuels and industry around the world grew just 0.6% in 2014. That was down from an average of 2.4% in the prior decade. Delegates to the current UN climate negotiations in Paris may tout this as evidence that economic growth can be uncoupled from increasing emissions, for gross world product last year increased by 2.5%.

Howard Marks continues:

Quantitative easing, for example, consists of the Fed using newly printed dollars to buy outstanding debt; this should increase the amount of money in circulation and thus raise the dollar price of goods. Voilà: inflation.

Not quite. QE is not printing money, so an increase in the money supply is not expected. Indeed, the M2 rate of money has not deviated from it’s long-term exponential trend, despite multiple QE programs:

As I explain, QE is an asset swap (the fed buying long-term bonds from banks and replacing them with ‘reserves’, which are NOT lent out), not money printing. The goal of the asset swap is to discourage saving by decreasing the yield on long-term government debt, after conventional fed policy on the short-term of the curve have already been tried. The fed can only directly influence the very short-term (federal funds rate) of the curve. With long-term rates low, the fed hopes this will discourage savings and encourage investment in riskier, higher-yielding assets. But due to the post-2014 ‘flight to safety’ attributable to weakness in Europe, China, and emerging markets, there is still insatiable demand for low-yielding US debt.

The U.S. government couldn’t figure out how to stop it in the 1970s, and the nations of the world can’t find a way to start it today.

Classically, inflation has resulted from (a) “demand pull” – too many buyers for a fixed supply of goods, or (b) “cost push” – rapid increases in the costs of production. Neither of these causes is in evidence today.

Neither of these causes is in evidence today. Thus inflation is quite feeble, and that’s disappointing to countries that would like to pay their debts with cheaper currency.

Countries like Turkey and Brazil that have high inflation are unable to easily inflate their debt away, so this is hardly a panacea. Japan, American and much of Europe have low inflation, due to the flight to safety.

There was a limit on the ability of U.S. automakers to sell cars burdened with substantial benefit costs while foreign car costs included much less for benefits. The bottom line is that, in a globalized world, if people in country A will work for less than those in country B, there are only four possibilities for manufacturers in country B:

charge a higher price for the same product and lose market share,
charge the same price for the higher-cost product and enjoy smaller profit margins (or even suffer losses),
charge the same price for an inferior product (this probably can’t be done for long), or
get the government to erect trade barriers on imported goods, such as a tariff that equalizes selling prices or a quota that restrains competition.

Or ‘B” can branch out into new industries, such as information technology, healthcare, and intellectual property, which have boomed since the 80′s as US auto manufacturing declined. This does not answer the concern about the loss of manufacturing, but people need to accept that some jobs will go away and, for better or worse nothing can be done about it.

The rest of his essay is about trade-offs and how ‘good intentions’ can backfire: higher wages vs. fewer jobs; domestic manufacturing vs. higher prices; etc. The frustrating part about macro economics is that there is no consensus on these issues. Those on the ‘right’ cite studies of how raising the minimum wage will hurt job creation; those on the ‘left’ can cite opposing studies of how it can boot job creation.

Collapse Can Wait, Part 2

Aaron is right about America’s reserve currency status, and also there is the petrodollar in addition to the ‘flight to safety’ and other factors that are keeping interest rates low and the dollar high, all thanks to American exceptionalism. As bad as the US economy may seem, other countries are worse, although I am more optimistic about America’s economic prospects than many on the ‘alt right’.

Economically, America is like the smartest kid in special ed.

I’ve discussed the debt situation earlier here and here. It’s not as bad as it may seem.

However, the treasury prints money, not the fed. QE is not the same as debt monetization. This is distinction explains why the money supply has not increased in spite of QE.

The story here couldn’t be more self explanatory. The US M2 money supply is simply not expanding anywhere close to its historical rate.

As you can see, the growth of the M2 money supply is still inline with historical trends:

This explains why inflation as measured by CPI is still very low. Another reason for low inflation is that the money velocity is still very low:

Loan activity is stagnant. Monetary policy can be likened to taking a bunch of money, sticking it in a safe, and melting the key. Monetary policy seems to be more psychological (as a way to boost confidence) than to alter the structure of the economy itself.

The reasoning is simple – the money multiplier is a myth. So, it doesn’t matter how many apples (reserves) the Fed puts on the shelves. It doesn’t result in more apple sales (loans). Banks are never reserve constrained. The explosion in reserves and continuing decline in loans makes this crystal clear. The Fed can continue to stuff banks with reserves and unless we see a substantive increase in lending the expansion of the monetary base will continue to be insignificant.

QE is just another tool in the fed’s toolbox to lower interest rates on the longer-duration of the yield curve after conventional monetary policy has been tried.

Pensions funds are playing a larger role, which is why it’s not such a big deal that China is dumping US debt:

For all the dire warnings over China’s retreat from U.S. government debt, there’s one simple fact that is being overlooked: American demand is as robust as ever.

Not only are domestic mutual funds buying record amounts of Treasuries at auctions this year, U.S. investors are also increasing their share of the $12.9 trillion market for the first time since 2012, data compiled by Bloomberg show.

American funds have purchased 42 percent of the $1.6 trillion of notes and bonds sold at auctions this year, the highest since the Treasury department began breaking out the data five years ago. As recently as 2011, they bought as little as 18 percent.

There is so much demand for low yielding, safe US debt that the bigger concern is deflation, not inflation.

Aaron mentions the stock market going up a lot since 2009, and this is true, but this has more to do with strong economic fundamentals (profits & earnings, globalization, consumer spending, technology, rich people consuming, etc) than QE or money printing.

Just look at multinational companies like Google, Amazon, Apple, Disney, Microsoft, and Nike, all of which keep posting strong earnings quarter after quarter. The new Star Wars movie set a box office record and is expected to gross over $2 billion globally. People are buying stuff, and businesses are transacting with other businesses. The S&P 500 is up 25%, and the QQQ tech index up 40%, since 2013 when the fed announced they were going to end QE. That is evidence economic fundamentals, not the fed, are driving this economic and stock marker expansion.

Although valuations have risen since 2009, they are still well-below the 2000 highs in spite of the market tripling since 2009, and are still within the historical average, again evidence that fundamentals seem to be at work here:

Also, too add, foreign countries don’t want to dump their US dollar holdings, because they are devaluing their currencies to boost growth, as part of the global ‘race to the bottom’, which America is the beneficiary in the form of a strong dollar and low inflation.

However, as I have argued numerous times before, America’ reserve currency status is not an invitation for reckless spending.

As I’ve written about in the past, with the exception of certain bright spots in the US tech sector and retail, the entire global economy is lethargic, creating a flight to safety and thus low rates, especially for American, Germany, and Japan. Also, deflationary forces from falling commodity prices. Deflation is a bigger concern than hyperinflation.

To end with, Aaron is right about the limitations of the CPI, and I discuss this further in Bifurcated Inflation. While there is very low inflation as measured by the bond market and certain items like apparel and electronics, prices for services such as healthcare, tuition, daycare, cable & internet, insurance, rent, and textbooks have outpaced inflation. The idea behind ‘bifurcated inflation’ is that services will become more expensive on an inflation-adjusted basis to compensate for real price declines in hardware and other tangibles. A television set is very cheap, but the cable required to make it functional is becoming more expensive. Netflix, on the other hand is cheap, but streaming internet (required to make Netflix functional) is not, and has outpaced inflation:

Collapse can wait

From David Stockman: Why This Sucker Is Going Down…….Again!

In a word, with a printing press. But what happened today is that Draghi showed he is out of tricks and Yellen confessed she is out of excuses.

Yes, this sucker is going down. And this time all the misguided economics professors turned central bankers in the world will be powerless to reverse the plunge.

Yawn… haven’t they been predicting collapse since 2009? It gets old after awhile. There have only been two financial crisis in America in the past 100 years: 1929 and 2008…the odds are we won’t live to see another one.

M2 velocity is sill very low and the currency in circulation hasn’t grown beyond it’s historical growth rate.

All this monetary policy can be likened to taking a bunch of money, putting in a safe, and melting the key. It hasn’t gone into the economy.

The stock market and economy is doing well because of fundamentals such as record high profits & earnings and consumer spending. Central bank policy may have helped a little, but it’s hardly the major contributing factor. If the US economy were dependent on QE, why have stocks surged 25% since May 2013 when the fed announced they were going to end QE? Discuss this further here.

Indeed, for a short period of time the brunt of the industrial production adjustment occurred in China and the EM. In effect, China and its supply chain had become the exporter/creditors of the present era.

.., but China only owns 8% of the national debt, although the media hype may make it seem like they own all of it.

Likewise, labor productivity has stalled dramatically. Since the pre-crisis peak nonfarm business productivity has grown by only 1.1% annually or at just half its historic 2.3% rate. Moreover, during the last five years productivity has grown at just 0.4% per annum.

Not sure what he’s taking about. Productivity seems in-line with historical trends:

Furthermore, it seems banks and policy makers have learned their lessons from 2008: lending standards are much more stringent. For example, the quantity of subprime mortgages have fallen considerably since 2008:

After a spike between 2003-2006, mortgage debt is back to it’s historical trend:

And, Fed stress tests: Banks come out stronger than ever

Federal Reserve says 29 of the nation’s 30 largest banks could survive a severe economic meltdown. Of course, some people will never be convinced, no matter what anyone says.

Also, leverage ratios for major banks are well off the 2008 highs, which could explain the good stress test results:

Entitlement spending could be problematic. Immigration control won’t stop the millions who are already citizens and producing negative economic value. That leads to the e-word, eugenics, which few have the bravery to endorse, but I see it as possibly the only long-term viable solution to the entitlement spending problem, in addition to restricting low-IQ immigration. Boosting the national IQ by just a handful of points can help remedy a multitude of problems.

We now have life, liberty, free emergency room treatment, ebt, education, section 8 housing, and the purist of happiness…for all. The government won’t allow sick people die in the streets, nor will it deny certain services. Or maybe there will be enough abundance created by technology and the productive class to take care of everyone…hard to know.

I had an exchange with Nick Land about this, and he disagrees, arguing that the Cathedral wins if there isn’t collapse.

I’m partial to not having things fall apart…it would hurt a lot of productive people to have collapse. Hurt wage earners, businesses, retirees who have savings, home owners with equity, etc. We don’t have to throw the baby out with the bathwater.

There are better ways of dealing with the Cathedral than resetting everything. As I posit in the Kaczynski post, is it worth replacing one problem with a worse one? As for solsutions, I don’t know. Collapse doesn’t guarantee the Cathedral won’t be rebuilt. I predict, possibly within the next generation, a mass realization by politicians due public pressure to address problems such as enticement spending and immigration, averting a possible crisis.

The want or desire to see crisis when the evidence doesn’t support it strikes me as wishful thinking, which is antithetical to the rationalist in me. I care about empirical evidence and data. If there have only been two major financial crisis in the past 100 years of US history, I’m going to err on the side of there not being a crisis soon. This unwavering belief in the face of empirical evidence in crisis just strikes me as another religion or superstition, but instead of selling indulgences they are selling newsletter subscriptions, bad investments, and overpriced gold.

I’m also kinda confused by Nick Land and Michael Anissimov, both who were (or still are?) involved with futurism – Accelerationism (to serve Gnon) and Singularitarianism, respectively – but now seem to be renouncing these views by seeking collapse and the end of modernity? Eschatology seems contradictory to futurism. I think in 2011-2013 or so, the idea of a ‘sci-fi NRx’ seemed cool, but since 2014 has fallen out of favor to more of a medieval style of reaction.

Nick Land discusses how NRx is Accelerationism with a flat tire being the Cathedral.

Neoreaction is Accelerationism with a flat tire. Described less figuratively, it is the recognition that the acceleration trend is historically compensated. Beside the speed machine, or industrial capitalism, there is an ever more perfectly weighted decelerator, which gradually drains techno-economic momentum into its own expansion, as it returns dynamic process to meta-stasis. Comically, the fabrication of this braking mechanism is proclaimed as progress. It is the Great Work of the Left. Neoreaction arises through naming it (without excessive affection) as the Cathedral.

So so the solution is to somehow remove or override the decelerator (re-accelerationism) instead of destroying the system, which agrees with my approach as well. The whole thing is kinda confusing, and in the past year I haven’t seen any posts in the nrx-o-sphere about accelerationism, suggesting it may have fallen out of favor.

To conclude, collapse can wait. But who knows, I will leave the window open for < 1% probability for crisis, just in case.

Economics Myths, Part 5: QE (Quantitative Easing) Misconceptions

Few subjects cause as much confusion as QE. The confusion arises due to the politicization of the issue, as well as common misunderstandings and misconceptions about QE that reverberate throughout the blogging/media echo chambers. There are three major misconceptions about QE:

1. QE is money printing

2. Stocks are rising because of QE – and or – the economy is dependent on QE

3. QE, with 100% certainty, does or does not work


1. It’s not. QE is an asset transfer in which the federal reserve buys long-term treasury bonds and replaces them with reserves. The reserves cannot be lent out, nor can they be used to buy stocks, as sometimes believed. This is why QE has not caused rampant inflation in spite of fears that it would. The rationale behind QE is that by buying long-dated bonds, the fed can spur inflation by lowing long-dated yields after conventional monetary policy at the ‘short-end’ of the yield curve has been exhausted, since the federal funds rate cannot go below zero. Lower treasury bond yields makes riskier assets like stocks more attractive.

Right now, QE is still profitable for the fed:

The reality has been happier. The Fed’s assets have ballooned to nearly $3 trillion, mostly in Treasuries and mortgage-backed securities (MBS). It paid $89 billion in profit to the Treasury for 2012, the largest in a string of record-breaking remittances

80% of the Fed’s income goes back to the treasury.

The so-called “bail-outs”, for instance, weren’t in the form of a taxpayer loan or bond to these member banks, it was simply the act of the Federal Reserve allowing certain favored member banks the one-time privilege to actually print money without loaning it out. You don’t join the Federal Reserve system because you want to be a member, you join because you have no choice.

That’s why TARP didn’t cost the taxpayer anything, and won’t. Nothing costs really anyone anything unless someone demands payment, and thankfully the entire global economy runs off IOUs (credit). When a program costs so-and-so billion, it’s paid for by the treasury, which has the power to print money by fiat and sell bonds (the fed does not issues bonds, it only makes purchases buying or selling securities in the secondary market from or to dealers, either outright or through repurchase agreements). This is not an invitation to wasteful spending, but it’s tiring hearing the same nonsense that a government spending program must be immediately payable, like a toll at a bridge, when it isn’t. Debt is rolled over. This related is to fallacy of composition, which I discuss earlier, in people mistaking government spending as being the same as a personal transaction. In the US, taxes have only gone up due to political pressure by the left, not out of economic necessity.

From federalreserve.gov Is the Federal Reserve printing money in order to buy Treasury securities?

No. The term “printing money” often refers to a situation in which the central bank is effectively financing the deficit of the federal government on a permanent basis by issuing large amounts of currency. This situation does not exist in the United States. Global demand for Treasury securities has remained strong, and the Treasury has been able to finance large deficits without difficulty. In addition, U.S. currency has expanded at only a moderate pace in recent years, and the Federal Reserve has indicated that it will return its securities holdings to a more normal level over time, as the economy recovers and the current monetary accommodation is unwound.

Due to huge demand (foreign and domestic) for low-yielding US debt, inflation has remained low, as well as record low interest paid on debt relative to GDP. As I discuss here, contrary to popular myth of America being ‘enslaved’ to China, China only holds about 8% of the debt.

Indeed, in spite of all the doom and gloom about printing money and hyperinflation, the growth rate of currency in circulation is in-line with historic trends of about 6% per-annum or, equivalently, about 80% every 10 years:

The growth rate between 1985-1995, 1995-2005, and 2005-2015 are all roughly the same.


Furthermore, population projections predict that when the “baby boomers” start to retire, the working population in the United States, and in many other countries, will be a smaller percentage of the population than it is now, for many years to come. This will increase the burden on the country of these promised pension and other payments—larger than the 65 percent[21] of GDP that it is now. The “burden” of the government is what it spends, since it can only pay its bills through taxes, debt, and increasing the money supply (government spending = tax revenues + change in government debt held by public + change in monetary base held by the public). “Government social benefits” paid by the United States government during 2003 totaled $1.3 trillion.[22]

Which is why I advocate euthanasia to help curb healthcare spending, which I will in detail in a forthcoming post…

2. As shown here, stocks are rising mainly because of buybacks and record-high profits & earnings:

The link between QE and rising stock prices may be spurious. The fed began to taper way back in Spring 2013, but the market rallied another 20% in the two years that followed. The market continued to rise after the fed officially ended QE in October 2014. But if the market and economy were entirely dependent on QE, there would have been a bear market and recession in 2013, which obviously there wasn’t.

3. Related to number 2, the verdict is still out as to whether or not QE 2 & 3 were a success. #2 suggests the economy is is not dependent on QE, and QE may amount to little more than a ‘nudge’ for the economy than a life-saving elixir, in spite of all the media and blog attention it has gotten. The fact stocks respond favorably to QE announcements suggests the market deems it somewhat effective, but how much is hard to quantify. Importantly, inflation is still below the fed’s target, which pretty much refutes those hyperinflation fears. Even if inflation were to rise above the target, because correlation does not imply causation, one cannot necessarily blame QE. And, by the same token, an improving job market is not proof QE worked, as there are other possible reasons for the improving job market. QE, like most complicated subjects, raises more questions than it answers.

Nike Reports Blowout Earnings, Don’t Blame Bull Market on QE

Wish I had more time to read NRx & HBD blogs and related commentary, but I’ve been glued to the stock market in anticipation of the market breaking higher, in which case I am prepared.

The Grey Enlightenment is a midpoint between the ‘Dark Enlightenment’ and ‘The Enlightenment’, in rejecting egalitarianism and liberalism but supporting capitalism, technology, and the study of human biodiversity (HBD). Anther theme of the blog is debunking sensationalism, whether it’s doom and gloom, economics nonsense, liberalism in the news, or get-rich-quick schemes.

Based on my economic analysis, there is no compelling reason for much further downside in the market. Today Nike had huge earnings in agreement with my thesis that the economy fundamentally sound thanks to consumer spending, especially consumer spending from the wealthy and foreign consumer.

The left insists that QE is driving the market higher, ignoring the role of blowout earnings from companies such as Nike, Disney, Google, and Apple…ignoring the role of the consumer, technology, and globalization.

The correlation between QE and rising stock prices may merely be coincidental. For example, the fed began to taper way back in Spring 2013, but the market rallied another 20% in the two years that followed. The market continued to rise after the fed officially ended QE in October 2014. But if the market and economy were entirely dependent on QE, there would have been a bear market and recession in 2013, which obviously there wasn’t.

Nike sales +14%, orders +17%. China +30%, EMs +19%, Japan +35%, Eastern Europe +26%. But.. But.. $CAT told us world is falling apart…$NKE

— Rahul Sharma (@retail_guru) Sep. 24 at 01:57 PM

As you can see, there is huge growth of Nike sales in in China. So much for that China crisis, libs. Another doom and gloom prediction debunked by empirical evidence and data.

Nike apparel is not cheap, as everyone knows. So when the left says the consumer is dead, capitalism is dead, or the economy is weak, the left is projecting their own personal anti-capitalism biases instead of being impartial to the data. There is weakness in some areas such as wage growth, but strength in many others like consumer spending.