Tuesday, March 31, 2009

Socialism feeds on crisis

While walking around Neuquén this morning, I noticed an entire wall that had been plastered with copies of this poster. The picture shows a broken Statue of Liberty, and the main caption reads "The capitalist economy is bankrupt." Underneath the main caption, the slogan says "Only the working class can provide the solution: socialism." Leave off the last word of the slogan, and you have a summary of Obama's prescription for rescuing the U.S. economy from its current crisis.

The pendulum of economic policy has moved decidedly to the left all over North and South America in recent years and months. Back in the 1980s and 90s the pendulum was swinging to the right, as governments adopted policies that relied on the power of increased after-tax incentives and free markets to create jobs and boost living standards. Now the emphasis is on higher taxes for the rich and redistributing the money to the poor, relying on the power of consumer demand to boost output. What we have is a new pan-American experiment with demand stimulation, the antithesis of the supply-side emphasis of the Reagan and Thatcher revolutions.

The politics of the right requires, however, that government's role in the economy be minimized, and therein lies the rub. What led to the current crisis was not unfettered capitalism but too much government interference in markets. The Bush administration failed to check the growth and influence of government. Similarly, Argentina's grand experiment in free markets and a fixed exchange rate in the 90s failed because the government couldn't resist the temptation to borrow and spend, and the central bank mismanaged the currency peg.

Argentina has suffered a series of crises since the peso lost two-thirds of its value in early 2002. Each crisis has fueled demands for and/or acceptance of greater government intervention in the economy, in the belief that free market policies failed and only government can fix things. Argentina is now beginning to realize that the Kirchner administration has gone too far to the left. The export sector, faced with huge export tax hikes, is refusing to export. Everyone is getting worried about the increasing power of the unions and their ability to disrupt daily life.

We have seen several "protests" in recent days, where workers go on strike, close off streets and highways and otherwise disrupt the life of the country in order to publicize their demands for higher wages, etc. We happened on one such demonstration this morning, just before I snapped this picture. Four cars had pulled into the intersection of two major downtown streets, and each one turned sideways to block off the traffic approaching the intersection from each direction. Someone dumped some old tires into the middle of the intersection and set them on fire, a process which produces tons of awful smoke. Then people gathered with signs and began chanting and hanging out in the intersection. Instead of breaking it up, the police stationed officers a block away in each direction from the intersection to divert traffic. The government is plainly quite willing to tolerate such actions, and indeed much of the power that President Kirchner enjoys comes from the support of unions and workers.

I'm hopeful that the U.S. won't fall victim to the same problems that now afflict Argentina. Obama has used the economic crisis to advance his agenda, just as the Kirchners have done in Argentina. I worry about Obama's belief in the power of consumer demand and income redistribution, and I'm convinced that the market shares my concerns in spades. I can only hope that the average American voter is not so easily misled as is the average Argentine voter. Argentine living standards have fallen so far behind ours as a result of repeated experiments with income redistribution and government takeovers of industry (and today I read that Obama has decided that the CEO of GM must be fired!) that the people have lost their perspective. "Been down so long it looks like up to me" is a good description of how most people feel here.

Monday, March 30, 2009

Neuquén, on the southern frontier

We came to Neuquén in 1976 to live for a variety of reasons. We thought it would exciting to live in Argentina; we thought Neuquén, being a frontier town of only 60,000 or so at the time (now 300,000), had a decent shot at a future; and we had a very good friend who was the Dean of the Graduate School at the Universidad del Comahue, and he was able to get the Veterans Administration to approve the school so that I could get my G.I. Bill benefits there, at a time when the dollar was so strong in Argentina that we were able to pay a year's rent on a small apartment in Neuquén with just one month's worth of G.I. Bill benefits.

Neuquén is not a picture-postcard city by any stretch. It's located in what is basically a wind-swept desert that is fortunate to have two significant rivers running nearby. With plenty of water, the locals have been able to plant lots of apple trees, and more recently grapes—right now I'm drinking some great Sauvignon Semillon from a local winery. It is also blessed with what is probably one of Argentina's biggest oil fields. Some time after we left the city in 1979 there were some major paleontology discoveries in the nearby area, among which was the biggest dinosaur skeleton ever uncovered (if memory serves me correctly). In other words, a long time ago this was not a desert.

Neuquén is also the the gateway to Bariloche, which is to Argentina as the Alps are to Switzerland. We'll be driving there in a few days (from the flatlands of Neuquén to the Andes around Bariloche), and hope to post some pictures of the beautiful scenery and one of the world's most beautiful hotels, the Llao Llao Hotel.

The first two pictures here are of the Rio Limay, which comes from the lake that Bariloche is located on, about 450 kilometers from Neuquén, and flows right alongside the southern edge of the city. I'm only an amateur fisherman, but I'm told that the Limay (upstream) has some of the best trout fishing in the world. We used to drive down to the Limay, just outside of town, and go swimming in the summertime.

The next two pictures are of the house that we used to live in. I mentioned in an earlier post the mechanics of selling the house. It has since been purchased by the government and is now home to some department of the local judiciary. The front of the house you see above was added on to the very small (800 square feet) house that we built in 1978 for about $10,000. Inside we found our original dwelling, and the "office" you see was our bedroom. The guy who bought the house from us simply added on to the front, back, and side. I know this is not very exciting, but we're talking about a little tiny house built over 30 years ago that still lives on. Unfortunately, government bureacrats are now the residents. We toured the city a few hours ago with an old friend, and it struck me that there has been an awful lot of major construction here, with the government grabbing a significant portion of the business. The Provincial Legislature (in a province that can't have even a half-million people) is by far the largest and most opulent building in town.

Climate change is not settled science

My favorite foe of big government, the Cato Institute, today ran this ad in the New York Times, Washington Post, Washington Times, Chicago Tribune and Los Angeles Times. They ran a similar ad criticizing the stimulus plan not too long ago. The idea behind the “With all due respect Mr. President, that is not true” headline is to point out that on major issues – economic “stimulus” and climate change -- President Obama seems to try to avoid debate by pretending there is no debate. The 120 or so top experts on climate change who joined the ad, including MIT’s Richard Lindzen, make it clear there is plenty of debate going on over global warming. Coincidentally, the New York Times Magazine ran a cover story yesterday on Freeman Dyson, one of the most brilliant scientists of our time, focusing on his skepticism about the threat of global warming.

Dyson has said he believes that the truths of science are so profoundly concealed that the only thing we can really be sure of is that much of what we expect to happen won’t come to pass.

... climate change has become an “obsession” — the primary article of faith for “a worldwide secular religion” known as environmentalism.

This is an extremely important issue, because Obama and the Democrats seem enamoured of the idea of imposing a significant tax on our use of carbon-based fuels via a cap and trade scheme. As the Wall St. Journal points out today, cap and trade would very likely result in a significant loss of U.S. jobs to countries not willing to join us in imposing a tax on carbon. This in turn would probably lead to a very destructive tariff war. The end result would be a lose-lose for just about everyone, and any reductions in carbon emissions could be either insignificant or nonexistent. This is one of the gravest threats to our economy today: the urge to increase the cost of our cheapest source of energy in the name of global change religion. Because if there is no science behind it, that's just what it is.

HT: Russell Redenbaugh

Home builders' stocks bouncing

This is another of what Larry Kudlow calls "mustard seeds" of recovery. This index of the stocks of 18 leading home builders is up over 40% from its late November '08 low. That was over three months ago. The housing news continues to be bad, but on the margin, the news is less bad with each passing day. We've most likely passed the inflection point, where the rate of decline starts becoming less and less. Soon or later we could see the news actually become positive. The market is already beginning to figure this out.

Industrial metals prices bouncing

I keep coming back to this theme: the global economy is not going down a black hole, and there is no generalized price deflation. This chart of industrial metals prices shows that prices hit a low in late November last year, right around the time that equity markets hit their first panicked lows. Prices have since stabilized and in many cases are rising. This record of market-driven, real-time prices does not fit the current popular narrative which holds that the global economy is in the grips of a ferocious, deflation/depression. Many commodity prices today are around the same levels as we saw when the global economy first began to pick up in 2004, and they are way above the lows of 2001, when deflationary monetary policy was a real problem.

This chart is consistent with my suspicion that the worst of the economic news is clearly behind us, and I think it is consistent with my late December forecast that the U.S. economy would hit bottom before mid-year. Inflationary monetary policy created a lot of bubbles in the prices of tangible assets (e.g., real estate, oil, commodities), but those bubbles had largely popped by the end of last year. Sure, there are still ongoing adjustments in many housing markets, but the bulk of the price adjustments in the most over-inflated markets has already occurred. The physical economy is therefore in the advanced stages of correcting the excesses of the past several years. It's my belief that we would have had a nice recovery in equity markets by now if it hadn't been for the shocking fiscal profligacy of the Obama administration. Markets around the world were deeply shaken by the prospect of massive increases in the size of government and its attendant rise in tax burdens, both of which represent a significant drag on economic productivity and a significant reduction in the after-tax return on capital.

I am heartened therefore to see that many European politicians are rejecting calls for increased spending. I am very encouraged by the Tea Parties taking place around the U.S. I think the increasing push-back that Obama is feeling is good news for markets. Valuations are still terribly depressed, since at these levels they are consistent with deflation/depression. Market-driven prices, meantime, are telling us that deflation and depression are not in the cards. Fiscal overreach can and most likely will slow the pace of recovery, but it can't kill the chronically dynamic U.S. economy.

Traveling by bus

We finally figured out which was the best of the bus companies in Argentina: Andesmar. All their buses are "first class" and the service impeccable. We just arrived in Neuquén, which is almost the geographic center of the country, but most people call it the south. It's actually located at the northern edge of the Patagonia region, and this is where modern civilization peters out. We took an Andesmar non-stop bus from Mendoza, leaving at 8:30pm Sunday evening and arriving here at 7am Monday. The seats turned into flat beds that were as comfortable as any I've had on the best international first-class flights I've taken.

The one-way ticket was about $55 each (195 pesos)—bear in mind that this is the most expensive bus ticket you can buy. The bus had a pilot and a co-pilot, plus a steward that served us a nice dinner (choice of meat, chicken or vegetarian) with wine and champagne, and then a breakfast in the morning. The bus holds only 25 passengers. I don't know how in the world they can make any money doing this, but bus travel is thriving in Argentina. That such a low fare can support a first class bus manned by a crew of three for almost 12 hours tells you a lot about how low wages are in Argentina and how far your dollar can take you here. Flying would have cost us at least $300 each.

Lovely Mendoza (2)

The first picture here is of a typical street in the center of town. Notice the "acequia" (irrigation ditch or canal) on the right side of the picture that runs between the sidewalk and the street. The entire city of about 1.3 million has acequias on both sides of every single street; a fascinating public works project that keeps the city full of trees. The climate in Mendoza is very dry, and like So. California it would be almost a desert if it weren't for irrigation systems. I shot this photo Sunday morning around 10am, so most people were still in bed after staying out late on Saturday night—we got to sleep a little before 3am.

The second picture is the wide, pedestrian-only street (Peatonal Sarmiento) where we had coffee before going to dinner on Friday night. This was also shot at 10am Sunday morning, so it is only just beginning to fill up with people going out for breakfast.

The third shot was taken Saturday night while sitting at the dinner table in a very charming restaurant located in the former home of the Catena family (Catena to Argentina is almost like Mondavi to Napa-Sonoma) in the very chic neighborhood of Chacras de Corria, about 15 minutes from downtown Mendoza. We were sitting on an outdoor deck underneath some huge trees (the restaurant was called "The Decks"), and there was a rather large irrigation canal that runs right alongside the Catena's house and under the deck. The house now is home to a collection of restaurants. Naturally, we got to the restaurant a little after 11pm, and left around 1pm, then drove around and had some ice cream at 2am. The city was still buzzing with life.

Saturday, March 28, 2009

Stately Córdoba

I had never really seen Córdoba before, and ended up very impressed by its size and the wide range of things it has to offer. Córdoba is famous for its "Sierras," which are rolling foothills that seem to go on forever and are dotted with vacation homes, hostels, and retreats. We stopped at a few, one of which (La Cumbrecita) is out in the middle of nowhere and looks like a miniature German village (lots of Germans settled in the area). The first picture is the inside of a small hostel not too far from La Cumbrecita. For 160 pesos ($43) a day, you get a room plus breakfast and dinner (they call this "media pensión). We had afternoon tea there, and the homemade cakes they served us were exquisite. Wine is extra, but like most places we've been you can find very good wine for 25-50 pesos a bottle ($7-14). On the way back to the city (I was driving) we were hit by the most incredible rainstorm I have even seen.

Downtown is full of pedestrian-only streets, such as the one in the third picture here. The second picture is of an inner courtyard in the 300-year old Colegio Montserrat, a rather exclusive high school in the center of town. Most kids in Argentina wear uniforms to school.

Lovely Mendoza

Last night our Mendoza friends picked us up at the hotel around 8:30 pm. We walked around the downtown area a bit, and it was really charming. The wide, uncrowded streets are relatively clean and the people all look relaxed and happy. We wandered up the Peatonal Sarmiento, which is a very wide pedestrian-only street right in the heart of town that is lined with one outdoor cafe after another. I was thinking we were headed to dinner, but I was puzzled because 8:30 is very early for dinner. As it turned out, we were just going to stop to have some coffee, and to chat an enjoy the perfect outdoor temperature and the do some people-watching.

Our friends had made dinner reservations at 10 pm at an upscale restaurant in a brand-new shopping center just outside of town. The place didn't fill up until 11 or so.

Today they took us to a place called Termas de Cachueta (hotsprings and spa), which is a half-hour drive from the city and very near the road which goes from Mendoza to Santiago, Chile. Santiago is about a 6 hour drive from Mendoza, but you have to cross the Andes. Nearby peaks include Tupungato and Aconcagua, both over 20,000 ft. high. This picture shows one of the dozen or so pools you can relax in while enjoying the scenery in Cachueta. The price of admission (about $45) lets you use the facilities all day (including a sauna inside a cave that is heated by its own hotspring) and includes lunch: a huge salad bar, all-you-can-eat barbecue with a dozen cuts of meat, sausage and chicken, and desserts. Wine extra.

What happens when things are free

The other day as we were walking around Córdoba, we popped into the Universidad de Córdoba. It's right in the center of town. It's free to all who want to study, but it's not doing too well. Students would rather attend the nearby Universidad Católica de Córdoba, even though they have to pay. Why? Well, it seems that you can't learn very much at UC because of perpetual strikes by workers and professors who want either more pay or fewer hours. It reminded me of the problems I faced while trying to get a degree in Argentina in the late 1970s, at the Universidad Nacional del Comahue. It was also free, but sometimes there were just no classes. I met with the Dean one time to complain that because a prerequisite subject that I needed was not being offered that year, that my graduation date would be set back by an entire year. "Well, the problem is that you're just too advanced," he replied. It's not unusual for students to take 5-10 years to get a university degree. Many of those who do graduate in a timely fashion end up leaving the country for better opportunities, which is Argentina's loss and our gain.

The picture here is of a banner posted by disgruntled UC students, and my translation goes like this: "8:00 o'clock means at 8:00 o'clock. The students were there, but the law professors arrived late, and the administration was nowhere to be seen. -Union of Upset Students." There were lots of protest signs all over. Down the street at the UCC, everything looked great.

Friday, March 27, 2009

Enjoying Mendoza

We made it to Mendoza fine, but this time the bus wasn't quite as nice. Mendoza is like a breath of fresh air. Of course it's the wine capital of Argentina, but it's also the most charming of all its cities. Wide, uncrowded streets lined with trees, and the residents make a point of cleaning and polishing their sidewalks every day. Between the sidewalk and the pavement, most streets have a little irrigation ditch, called an acequia, which is usually lined with river rock and looks quite charming. This keeps all the trees in good shape. There is a huge park just a few blocks from the city. The whole city lies right up against the foothills of the Andes, which can be seen soaring 14,000 feet above the flatlands as you approach from the east.

Our friends tell us that a year ago the city was doing very well, thanks to hugely expanding exports of wine. Our local Costco store (in Dana Point, CA) now has a whole section devoted just to Argentine Malbec, which is a close cousin to Cabernet Sauvignon. Most of the Malbec in Argentina is grown around Mendoza. Lately exports have fallen off sharply, and the locals, one of whom we talked to today over lunch, blame it on the Kirschner administration for sharply increasing tariffs on just about all exports. Governments never learn, it seems, especially not here in Argentina. I've followed the economic history of the country since 1980, and I've seen them make the same mistakes countless times: devaluations to boost exports, taxes on exports to boost government revenues, capital controls to keep money from fleeing overseas, wage controls to keep inflation under control, etc. These things never work, they just exacerbate the underlying problems.

Thursday, March 26, 2009

End of the recession

I'm in Cordoba with limited computer access. Can't post pictures, but I have had a look at the markets using a friend's computer. I see lots of signs showing up that could well mark the end of the recession. Weekly unemployment claims have been flat for the past 5 weeks. Banks are still lending increasing amounts of money. Commodity prices, particularly energy and copper, are moving higher. Equities have been up for over two weeks from incredibly distressed levels. Leading indicators of financial stress such as swap spreads and the VIX index, improved months ago. The news of course has been horrible for months, but the numbers aren't showing further deterioration; that means the economy has absorbed the bad news and has largely adjusted. Furthermore, tax increases are not imminent; cap and trade is going to have a big struggle getting through Congress; Obama has lost a lot of credibility and momemtum; Blue Dog Democrats are marshalling their forces to bring reason and moderation to the budget process.

Things could be an awful lot worse. I'm going to go out and do some sightseeing here in Cordoba. I think the markets will survive without me watching them!

Tuesday, March 24, 2009

Leaving Tucumán for Córdoba

Here are a few shots of downtown Tucumán. The first is the provincial government house (Tucumán is a city and the smallest province of Argentina), and the second is Congreso street, which is home to Argentina's famous "Casa Historica," the place where delegates met to sign Argentina's declaration of independence. In a way, Tucumán is like Philadelphia for the U.S., but the cities otherwise bear no resemblance to each other.

Tucumán is a relatively poor city, since it has very little in the way of industry and a lot of people. Its main livelihood is citrus and sugar cane. It used to be all sugar cane, but a lot of those fields have been converted to orange and lemon groves in the past few decades. We know some people who not too long ago began growing and exporting blueberries, of all things, a fruit that is largely unknown to Argentines. Tucumán is actually one of the world's largest exporters of citrus fruit and citrus products (e.g. lemon oil for Coca Cola). I own some shares in one of the larger lemon packing and processing firms, San Miguel S.A. (SAMI AR, traded in Buenos Aires). I wouldn't recommend it to anyone other than a dreamy fan of Argentina, but I know some of the people who work there and they tell me that business is looking up. It's extremely thinly traded, and sometimes not at all.

Tonight we leave by bus for the much larger, industrial city of Córdoba, about 8 hours by car to the south of Tucumán. We haven't been there for decades, but we want to visit some good friends of ours from California who retired a few years ago and realized that their social security checks would allow them to live in grand style in Argentina. We're taking the bus because in order to fly there we would have to return to Buenos Aires and then fly from Buenos Aires to Córdoba. Plus, the bus costs only about one-fourth what a plane ticket costs, and we can travel at night and sleep in a comfortable bed (a "cama suite" as it's called, and everyone swears it's a great way to travel). So we end up saving money and saving a lot of time.

Last night was the big party that some friends of ours threw to celebrate their 50th birthdays and their 25th wedding anniversary (third picture). There were about 200 people, and it was held in a beautiful place specially designed for big parties in the Yerba Buena neighborhood. We got there about 10:30 pm, and dinner started a little after midnight. We left about 5:30 am, not having the stamina to make it to breakfast. Lots of people were still dancing when we left. The people here are so nice and friendly and generous that it is just amazing.

Monday, March 23, 2009

Plaza Independencia, S. M. de Tucumán

This is a shot of the plaza in downtown Tucuman a little after noon today. The downtown-to-home rush hour is underway. The main government building is visible just on the left.

Fantastic food, very cheap

We finally got a chance to go have lunch by ourselves today. We went to one of our favorite places (perhaps our favorite) just down the street from the hotel: La Leñita. My wife had been there a week ago, and as soon as we walked in the waiter she had then came up and gave her a kiss. While we were looking over the menu they brought us each a delicious empanada. We ordered a bottle of Perdriel Malbec, one of the more expensive wines on the list (35 pesos, about $10).

The waiter recommended the Lomo al Verdeo, which is one of their specialties. I had been thinking of that, but my wife wanted something simpler—just the meat, the most tender cut they had. The waiter said we could split the order: a mini Lomo (filet mignon cut a special way) and a mini Lomo al Verdeo. The first two pictures you see show the two plates. I figure each piece of meat was way over 1/2 pound, and it was perhaps the best filet mignon we had ever had. Mine came with a very light white sauce, topped by pieces of melted cheese and slices of oven-roasted tomatoes. It was simply magnificent.

As you can see from the fourth picture, the bill for all this, including tax, was 141 pesos, or $40, plus we gave the waiter a very generous tip of 15 pesos (most people here would probably have left either nothing for the waiter or 5 pesos). We each had over a half pound of the very best filet mignon with a side of french fries, two salad bars, two bottles of water, 1 and a half bottles of wine (it was so good we had to order a split to have with the dessert), and a delicious regional dessert (copa Don Juan) which had carmelized squash, vanilla ice cream, walnuts, and rum. Wow.

After we finished we asked the waiter if the chef would explain to us how he did the filet. You can see the process in pictures #2 and #3 (my wife had already cut off a piece of her steak by the time I took the picture). He starts by cutting a whole filet mignon in half or maybe thirds (depending on its starting size). He then cuts it starting on the long side, so that it unrolls into a long, thin piece, which is what he is holding up. After sprinkling some salt on it, he cooks it for about 10 minutes or so on the bbq. It's the most incredible steak I've ever had.

Oil update

This is very similar to what is happening to copper prices. Animal spirits are stirring. Stocks are up about 20% in the past two weeks. The global economy is not going down a black hole. Obama has suffered materially from a series of gaffes. He's making it up as he goes. He is being exposed as an amateur. I read the transcript of his 60 Minutes interview and was amazed. He's laughing and making jokes about how the world economy is teetering on the brink, and his interviewer asks, "are you punch-drunk?"

Whatever is bad for Obama at this point is good for the markets, since it means his chances of successfully pushing his mega-spending, big-government, higher-tax agenda are diminishing. It's even better to see that economic activity is not continuing to decline, and may even be picking up, as this chart suggests. I've been saying that the worst of the economic news hit around the end of last year, and that still looks like a good call.

Saturday, March 21, 2009

Tucumán: A Day in the Life (2)

Last night the party (about 25 people, most of them descendants of the same family, the rest related to them by marriage or other connections) got started about 11 pm. Everyone had contributed about 10 pesos each ($8.30), and with that we had plenty of wine, sandwiches (the very thin kind like the English finger sandwiches) empanadas (chicken and meat pies that are hand-sized), and cake. We all sat outside, in the backyard of the house, and the weather was perfect. The music started at 1 am, with a guitarist accompanied by a cousin playing the drum on a stereo speaker that was lying around idle. As is typical in the northern part of Argentina, a few of the men pulled out their green plastic bags of coca leaves sometime after midnight and started to chew away. One person remarked to me that this was "a gift from Evo Morales," meaning the coca leaves come from Bolivia, which borders Argentina on the north, not too far away. Coca leaves, for the uninitiated, do not induce hallucinations, high blood pressure or addiction, but something more akin to the rush you get from drinking a few cups of tea or coffee.

The music was mostly traditional folklore and sambas. It's passionate and dramatic, with most of the songs about loves lost, feelings hurt, and poetic commentaries on life. My favorite is "Sapo Cancionero," which translates as the Singing Frog. The refrain goes something like this: "Singing frog, you sing your song because the moon has given up its life for the stars. Life is cold if we don't live it without an illusion." Guests almost always joined in the singing, and many songs were accompanied by dancing from the guests. Some people left around 3 am, but the hard core stayed until a little after 5 am. We got to bed just before 6 am.

Then the phone rang at 10:45 am. The front desk wanted to let us know that some friends were waiting for us in the cafe downstairs for breakfast. That was when we remembered, to my great regret, that the day before I had agreed to meet with them at 10 am to discuss their financial situation. 30 minutes later, after a quick shower, we were having coffee and fresh-squeezed orange and grapefruit juice with them and explaining why their portfolio had lost money in the past year.

A little after noon, I remembered that we had to go to the travel agency to get a refund for the ticket from Buenos Aires to Tucumán that I hadn't used because the flight listed on the itinerary they gave me didn't exist, and I had to buy a ticket on another airline at the last minute. We made our excuses, and hustled off to the agency which was about six blocks away. Unfortunately, we fell victim to siesta hours, as we arrived at the agency just after they had closed at 12:30 pm. But I'm leaving out the first half of this mini-story, since we had been at the same agency the day before, getting some bus tickets to go to Cordoba, and had asked about getting a refund for the ticket only to be told that we had to go to the airline's office in order to do that. In the surreal reality of South America, we were of course told by the airline agent 30 minutes later that in order to get a refund we had to go to the agency that issued the ticket. And by then it was too late to do that since the city had closed for siesta.

Somewhat frustrated, since we only had Monday to clear this up (Tuesday is a K-holiday, which means it was created by President Kirschner to endear himself to those who benefit from holidays and those who are anti-establishment like him and his wife, who is the current president), we went back to the hotel and shortly thereafter (about 1 pm) departed for the home of a long-lost cousin of my wife's who had invited us to their traditional Saturday afternoon lunch. In order to get there, we were supposed to take a taxi and meet another friend in the northern part of town (the very upscale and beautiful Yerba Buena neighborhood), and she would then take us to the cousin's house, since she was a good friend of one of their friends and was also invited (and—importantly—she knew where they lived, which was an area devoid of street signs). The taxi ride to Yerba Buena took about 30 minutes to go 6 miles (rush hour), but only cost $5 (18 pesos), which led me to tip the driver $1.50, which flummoxed him because he couldn't understand why I didn't want change for the 20 peso note I gave him. Our friend then retraced about half the route we had just covered, since she wanted to pick up her daughter at her home, but when we got there we discovered—after a cell-phone call—that her daughter had made other plans for getting to the lunch.

By 3 pm we had finished a delicious lunch, and in the course of post-prandial conversation we discovered that we knew several friends of theirs and they knew some relatives of ours. I was then picked up by 3 friends at 4 pm, while my wife, her sister, and her good friend stayed behind to round out the afternoon with conversation. Us guys drove up to the hotel at San Javier, which sits atop the first wave of the Andes mountains that rise above Tucumán. In the grand tradition of Argentine males, we sat on the patio of the hotel which overlooks the city and spent two hours over beer, coffee, coca leaves and cigarettes "fixing the world." Which means trying to figure out what the heck was going on and where one should put his money.

Quite a few hours passed between our discussion on the mountain and getting back to the hotel, and most of that was due to my very good friend getting a panicked call from his wife, who reported that a few of their kids, plus a few of their friends' kids, plus their respective boy- and girl-friends—14 all together—had been robbed while having a picnic 30 minutes outside of town. After much anxiety, calls to the local police, and a frantic dash to the picnic site, we learned that the only casualty was some pocket change and a lot of nerves on the part of the parents.

By the time I got back to the hotel about 9:30 pm, my wife was just leaving to see her best friend sing at a nearby restaurant. In fact, she was planning to first walk around a bit with her sister, then have dinner at the restaurant at 11 pm, then listen to her friend who was scheduled to sing at midnight. So instead of her walking around, we decided to go the hotel bar and have a drink. A few minutes later, we were joined by one of my wife's many cousins, who just happened to be walking by.

I was not going to hear the singing, since I can't appreciate music and the restaurant was said to be very loud, so they took off and I went to the hotel restaurant around 11 pm for some dinner, which consisted of a very nice salad, some delicious Sorrentinos (round raviolis stuffed with cheese and ham), and a nice bottle of wine from Mendoza (half of which is now in the mini-bar for tomorrow). Including tip, it cost all of $20. I should add that the hotel, the Tucumán Center Hotel, is in the center of town and is considered to be one of the two best places to stay. We have a very nicely-appointed suite which, including taxes, will cost us less than $150 a night.

Following my dinner, I came back to the room and enjoyed recording a summary of this day's events for all the world to see.

Friday, March 20, 2009

No shortage of money (10)

This chart shows the total of consumer loans at all commercial banks in the U.S. as of the end of February. As the chart shows, credit is being extended to consumers at an above-average rate, and keeps posting all-time highs. This recession has nothing to do with a shortage of money. Instead, there is a shortage of confidence: in the banking system, in counterparty risk, and in government policies which threaten capital with punitive tax rates.

In Argentina it is almost 10 pm, and we are just about to leave the hotel for a party. Dinner won't be served until almost midnight, and the festivities will undoubtedly stretch into the wee hours of the night. This is a country that I have never been able to fully understand, even after we lived here for four years. Tucumán is probably the city with the most active night life I have seen anywhere, with the possible exception of Madrid. There is a great shortage of money here (middle class salaries are maybe as high as $1000 per month) but no shortage of enthusiasm for life.

Argentine politics and capital flight

I was just in the hotel lobby and noticed the front page headlines of a local newspaper. One article noted that President Kirchner had proposed a compromise in the ongoing battle between the agro exporters and the government. She ignited the furor last year when she raised export taxes on agricultural exports, claiming that high commodity prices were a windfall for the sector and it was only fair for the government to redistribute that windfall to the more needy sectors of the economy by raising taxes. The controversy has been festering, and she keeps looking for ways to make the exporters back down; first by saying that all the money raised by the tax would be handed out in various forms to the poor, and now by saying she will "share" 30% of the tax revenues with the provincial governments provided that the money be spent on infrastructure designed to help the poor. This is sounding too familiar....

The other article noted that the start of the revenue war against exporters just happened to coincide with a new wave of capital flight. Some $9 billion dollars left the country last year. Seems that here in Argentina, just as anywhere, capital doesn't like to be taxed or threatened. It can always find more hospitable places. And the chronic lack of capital here—the inevitable result of decades of abusive, anti-capital measures—shows up in the faces of the poor, the rundown buildings, and unpaved streets. It's a real shame.

Despite all that, the people here are the nicest in the world and their generosity knows no bounds. And of course the food (lots of meat!) and the wine are great and abundant.

San Miguel de Tucumán: A Day in the Life

This small and densely populated city of about one million is in the northwest part of Argentina, so it can get pretty hot and humid at times. So much so that it long ago adopted a "siesta" routine throughout the year. That means that shops and schools open in the morning and shut down around noon, then reopen from about 4 to 8 pm, because the midday heat can be intolerable. That in turn means that most people end up commuting four times a day. It's terribly inefficient.

There's a rush hour in the morning as cars, buses, bicycles and motor scooters flood into the city in the morning, then another rush hour from noon to 1 pm as they all head back home for lunch. Families get together for lunch from 1 pm to 2:30 pm, which is very nice for family unity, and then the parents take a nap before those who have to work head back to the office around 4 pm. Then everyone migrates back to their homes around 8-9 pm. Dinner is usually light, and often doesn't get started until 10 pm.

Since we have a lot of friends and family here, we have invitations for lunch and dinner every day. Lunch from 1:30 to 3:30 pm, then back to the hotel for a nap, then meet friends for coffee and do some errands in the city. We were invited to dinner last night at 10 pm, but got there a bit late since it's always hard to disentangle oneself from a gaggle of friends at the coffee shop, and the rush hour traffic was worse than we thought. Dinner and conversation lingered until after 2 am, at which time our host drove us back to the hotel. We got to bed around 3 am, and he probably had to get up at 7 am to go to his office.

We got up at 10 am this morning, and today for the first time we'll have a chance to have some breakfast downstairs before running some more errands before shops close and then going to a friend's house for lunch. Since Tuesday is a holiday (to honor the victims of the military takeover in 1976—which seems strange to me because we were living here at the time and everyone rejoiced when the military took over and then began to rid the country of the leftist guerrillas that were planting bombs everwhere and sowing anarchy), some friends are having a huge party Monday night to celebrate their wedding anniversary and milestone birthdays. The party starts officially at 10 pm, but most people probably won't arrive until 11 pm. Then dinner might get underway at midnight, followed by dancing and conversation that could last until breakfast. Finishing off a big party with breakfast is a sign of a successful party. I should know, because we threw a similar party for ourselves some years ago, and breakfast was part of the planning process.

Thursday, March 19, 2009

Copper update

Copper prices are up over 40% from their December lows. You see this pattern in a lot of commodities (crude oil is up about 50%), even though broad commodity indices are relatively flat. The main message I see is that the big commodity price deflation of late last year is history. Demand is coming back, monetary policy is reflationary, and forced liquidation of carry trades appears to be a thing of the past. The global economy is not going down a black hole. Optimism is warranted.

Why I like Apple (2)

AAPL is up about 30% from Nov. 20th, the day the market hit its first panic low, and up almost as much from the time I recommended it in mid-January. And that's despite the disappointing news that Steve Jobs would take a medical leave of absence. Apple's strength lies not in the virtues of one person, but in its passion for excellence, industrial design, and ability to innovate in the area of consumer electronics. Apple has been gaining market share from Microsoft in the personal computer market for years, and is very likely to continue to do so for many years to come, in my view, mainly because its software is superior, and its computers will run Apple software as well as Microsoft software. That all adds up to a reason to own this stock for the long run.

Full disclosure: I am long AAPL at the time of this writing.

TIPS update

The big story in the bond market so far this year has been the gradual disappearance of deflation expectations. Nominal Treasury yields haven't changed much on balance (despite yesterday's huge decline), but real yields on TIPS have fallen significantly. The difference between the two yields represents the market's expectation of future inflation (aka the breakeven inflation rate). Over the next 10 years, the market expects the CPI to average about 1.3% a year; over the next 5 years about 0.7% per year. Over the next few years, though, the market still expects the level of the CPI to fall a bit. The market may be correct in its implicit view that Fed stimulus may take awhile to impact reported inflation. But sensitive indicators such as gold and the dollar are signaling that monetary policy is likely to push inflation higher, and it wouldn't surprise me if inflation went well above the 1.5-2% inflation that is expected five years from now (that's the measure the Fed likes to use: the five year inflation expectation, five years from now).

TIPS aren't nearly the screaming buy they were a few months ago (see my "TIPS are a steal" posts), because real yields have declined so much. But relative to Treasuries they still make sense. If you need something that is as safe as a U.S. government bond, TIPS are the best choice. It wouldn't take much of an increase in inflation expectations to make them pay off.

I would also note that the on-the-run 5- and 10-year issues are still much more highly valued than their nearby issues, because the market is willing to pay a higher price for new issues since they have more deflation protection built in. So if you are buying TIPS because you mainly want inflation protection, then steer clear of the OTRs. Better to buy seasoned issues, and if you're not an institutional investor, better to buy TIPS via a fund such as Vanguard's TIPS fund or Barclay's iShares TIPS fund; you'll get a better real yield and you'll save on transactions costs, because the TIPS market is still relatively illiquid, meaning bid/ask spreads are still relatively high.

Full disclosure: I am long TIPS and long TIP as of the time of this writing.

Wednesday, March 18, 2009

The global warming debate is heating up, and clearly not settled

More than 700 international scientists have now joined the ranks of those dissenting from the supposedly unanimous consensus that man-made global warming is going to destroy the world's climate unless we take drastic measures to reduce carbon emissions.

The skeptical scientists are responding not only to an increase in dire “predictions” of climate change, but also a steady stream of peer-reviewed studies, analyses, real world data, and inconvenient developments that have further cast doubts on the claims of man-made global warming fear activists.

“I am appalled at the state of discord in the field of climate science…There is no observational evidence that the addition of anthropogenic greenhouse gas emissions have caused any temperature perturbations in the atmosphere.” - Award-winning atmospheric scientist Dr. George T. Wolff, former member of the EPA’s Science Advisory Board, served on a committee of the National Oceanic and Atmospheric Administration (NOAA) and authored more than 90 peer-reviewed studies.

To paraphrase P.J. O'Rourke, Obama's cap and trade proposal should be taken out behind the barn and killed with an axe. The sooner the better.

HT: Russell Redenbaugh

Quick thoughts on the Fed's mega-stimulus plan

Markets were up today because the Fed announced it was prepared to launch a major initiative to buy up to $2 trillion or so of Treasury bonds, mortgage-backed securities, agency securities, and other asset-backed securities. Wow. Those who still believe in deflation should be heading for the exits pretty soon.

I note that yields on Treasury bonds literally collapsed in the wake of the announcement. I think this is one of those times when the bond market's initial reaction to a big change in monetary policy is wrong. Bond yields fell big-time today, but they won't stay down for long. Ok, so the Fed will buy $300 billion of Treasury bonds, but that's only a small fraction of the amount outstanding, and a lot less than half of what the Treasury will be selling this year to finance the deficit.

Putting things in proper perspective, we're talking big-time stimulus now, and it comes very close to anyone's definition of "helicopter money" which is printed up and shoved out of helicopters flying all over the country. This is ultimately inflationary, and the bond market vigilantes will eventually realize that and push yields higher. (As a corollary to this, we should see gold and commodity prices rise and the dollar fall.) Meanwhile, stocks and corporate bonds should move higher, since this virtually eliminates deflation risk, and that has been a major factor weighing down stocks and corporate bonds for the past several months.

The impact on mortgage rates is tough to predict, because MBS spreads can tighten as Treasury yields move higher. But the Fed's move shouldn't be a big negative for housing in any event, because inflationary monetary policy means the bottom in housing prices will come sooner than otherwise. The prospect of rising home prices should significantly increase demand for mortgage financing. A housing market recovery doesn't need lower mortgage rates; what we need is for buyers to realize that prices have stopped falling. As I've said before, one of the sure signs of an economic recovery would be rising yields on Treasury bonds. That hasn't exactly happened so far, but I suspect it won't take long for animal spirits to revive and prove me right.

I'm not saying that today's Fed announcement is a big positive for stocks and the economy, since I've always believed that inflation was bad for equities and bad for growth. But to the extent that expansive monetary policy eliminates deflation risk at a time that the market is priced to a significant risk of deflation, then I do think it is a positive, but a positive which only helps to reverse an awful lot of negative news. Even if equity prices rise another 20%, they will still be miserably low relative to where they were a year ago.

Cap and Trade is a big deal

Obama's Energy Secretary Steven Chu won a Nobel Prize in physics, but that doesn't make him an expert in economics or international trade. According to this article in today's WSJ, he makes his lack of understanding painfully clear. If the U.S. raises the price of carbon-based fuels with a cap and trade scheme, it will put all the U.S. economy at a decided disadvantage relative to countries which don't impose a higher price on these same fuels. This much he realizes, since he says that "If other countries don't impose a cost on carbon, then we will be at a disadvantage." But then he goes on to say that "we would look at considering perhaps duties that would offset that cost." That is nothing but a prescription for trade wars, and those have never done anything but harm. Trade wars might result in a meaningful reduction in carbon-fuel usage globally, but only at the expense of a severe global depression. No one, not even Al Gore, can claim with enough certainty that a global depression is the price we need to pay to save the planet, especially when there are other and far cheaper alternatives such as simply adapting to a warmer climate.

The basic problem is that those who believe in man-made global warming seem ready to do just about anything, even if it makes no economic sense, in order to "save the planet." Sorry, but that just doesn't make any sense at all. If the Obama administration doesn't soon come down from its Ivory Tower to the realities of how things work, the world is going to be facing problems that are much bigger than global warming.

UPDATE: Read Pete DuPont's editorial in today's WSJ ("California or Delaware?") for a more detailed explantion of why the Obama folks are headed in the wrong direction on energy and tax policy.

And you must read Phil Kerpen's short article noting that Obama's Jason Furman now admits that the effective tax imposed on the economy by a cap and trade scheme could be in the trillions of dollars.

Obama & Co. are making so many grievous mistakes in so short a period that it is simply wonderful. Wonderful, because the mistakes are so egregious that they are increasingly likely to be reversed. And that is very good news for a market that was priced to the end of the world as we know it.

UPDATE #2: I've been reading and hearing about a lot of the crazy things that the Kirchner administration is doing in Argentina. (For example, yesterday they nationalized the former Lockheed aircraft facility in Cordoba, but it was already just a shadow of its former self. And the teacher's union is upset that the administration agreed to raise their salaries by only 15%.) But nothing going on here in Argentina is as crazy as the things coming out of Washington D.C. these days.

No deflation

As with yesterday's PPI announcement, the thing to focus on here is core inflation, which is not falling. Strip out food and energy prices, and you find that prices in general are still rising (0.2% in February) despite one of the sharpest declines in demand in decades. Fears that weak demand would lead to a generalized deflation, with falling prices further depressing demand, etc., are proving to be unfounded. Deflation happens only if the Fed is too tight, and it is pretty difficult to argue that they are too tight.

This may explain why, in the past week, equity prices have risen while the dollar has fallen. With the growing realization that deflation is not happening as so many said it would, the market begins to realize that the outlook for the economy is improving—which pushes equity prices higher—while bets that deflation will push the dollar higher are losing, and thus being unwound.

Last night we were out with some friends until almost 2am, and when we came back to the hotel (we're in Tucumán now, which is in the northwest part of Argentina) there were still plenty of people at cafes. Everyone's worried about the U.S., and they are suffering from depressed commodity prices (Tucumán is a major producer and exporter of citrus products), but life goes on as usual.

Tuesday, March 17, 2009

Crude approaching $50

Just got back from a stroll around Buenos Aires and a lunch with some friends. I couldn't resist posting this chart of oil prices, as it reinforces my belief that deflation is not a threat to the world economy. Oil prices have rebounded quite a bit from their recent lows. It also suggests that global demand is not collapsing. Don't believe the horror stories that are making the rounds. Here people are terrified with the news they get, since it greatly exaggerates the plight of the U.S. economy.

A filet mignon steak with french fries at a nice restaurant costs about $11; a salad big enough for three costs $4; a wine near the top of the price list costs $23; medium priced wines are around $10. It's a lovely day here, with perfect weather. The sidewalks are full of people. In the Plaza Libertador there is an exhibition of 140 "Buddy Bears" that have been painted by artists from all of the countries of the world. Here's a picture.


PPI update

The thing to watch these days is core (ex food and energy) prices, since headline measures of inflation are being dominated by the big drop in energy prices. At the producer level, core prices are still rising. This is extremely important because it shows that we are not in a deflationary environment. Fear of deflation and fear of a continuing economic decline is what has contributed signficantly to the market's paralysis in the past several months. The more news like this we see, the more confident we can be that we have seen the worst of the economic news and can expect a bottom in economic activity before too long. I'm sticking with my year-end prediction that the bottom will come before mid-year.

Monday, March 16, 2009

More on mark-to-market

Here's an excellent explanation of the problems with mark-to-market accounting from William Isaac, in recent testimony to a House financial services committee. Isaac knows of what he speaks, being the former chairman of the FDIC. HT: Bob McTeer's blog. Amidst all the gnashing of teeth and wringing of hands, we tend to forget that the maximum losses from subprime loans could have been easily absorbed by the global financial system. Because of MTM, the write-downs and capital losses have been orders of magnitude more than they should have been.

At the outset of the current crisis in the financial and credit markets, we had no serious economic problems. Inflation was under control, economic growth was good, unemployment was low, and there were no major credit problems in the banking system.

The dark cloud on the horizon was about $1.2 trillion of subprime mortgages (most had been securitized), about $200 billion to $300 billion of which were believed to be held by FDIC-insured banks and thrifts. The rest were spread throughout the world.

The likely losses on these assets were estimated by regulators to be roughly 20%. Losses of this magnitude would have caused pain for banks that held the assets, but would have been quite manageable, particularly for an industry that had after-tax earnings of roughly $150 billion in 2006 and had capital of $1.4 trillion.

He makes one good point I haven't seen elsewhere, which is that MTM focuses only on the asset side of the balance sheet, ignoring potential offsets on the liability side. He also includes an actual example of an anonymous bank that makes the point quite clearly:

Below is an example of the distortion that occurs when using mark to market (MTM) accounting. This example involves an actual case study from an anonymous bank that made loans and securitized them as a mortgage backed security (MBS). Expected losses and expected cash flows for the MBS differ dramatically from MTM write downs. The Bank is required to record MTM losses of $913 million as opposed to the maximum expected lifetime losses of $100 million, resulting in a significant overstatement of losses and having a negative impact on tangible common equity.

This is the core of the problem today

Most people seem to be saying that the financial crisis must be solved in order for the economy to recovery. I think the financial crisis could solve itself if the threat of damaging government policies recedes. What is lacking today is confidence in the future, but so far what has come out of the Obama White House inspires only fear.

I have no problem saying that Bush & Co. messed up big time, by allowing government spending to rise and by creating new government programs that will surely grow like topsy in the future. But Obama & Co. are doing their best to win the prize for outrageous abuse of the public purse. I think the market today is terrified of the prospect of a significant increase in the size of government and an attendant rise in tax burdens. "Cap and trade" promises to severely impact not only all energy-intensive industries, but our international competitiveness as well. Trade wars, such as the one just ignited today by Mexico's announcement of higher tariffs on 90 U.S. products in retaliation for U.S. restrictions on Mexican trucks, promise to escalate under cap and trade, since U.S. exports will suffer if carbon-based fuel costs rise here but not in other countries.

Brian Riedl of the Heritage Foundation has written an excellent summary of the details and consequences of Obama's budget proposals. Here are the main points, with a HT to Andrew Roth at the Club for Growth. Do read the whole thing.

During his presidential campaign, President Barack Obama promised the American people a "net spending cut." Instead, he signed a "stimulus" bill that spends $800 billion, and he has proposed a budget that would:

• Increase spending by $1 trillion over the next decade;
• Include an additional $250 billion placeholder for another financial bailout;
• Likely lead to a 12 percent increase in discretion ary spending;
• Permanently expand the federal government by nearly 3 percent of gross domestic product (GDP) over pre-recession levels;
• Raise taxes on all Americans by $1.4 trillion over the next decade;
• Raise taxes for 3.2 million taxpayers by an average of $300,000 over the next decade;
• Call for a pay-as-you-go (PAYGO) law despite offering a budget that would violate it by $3.4 trillion;
• Assume a rosy economic scenario that few economists anticipate;
• Leave permanent deficits averaging $600 billion even after the economy recovers; and
• Double the publicly held national debt to over $15 trillion ($12.5 trillion after inflation).
• A new cap-and-trade energy tax that could devastate the manufacturing sector
These are the things that are depressing the market; this is the current source of the apparent crisis in the financial markets. If Congress can cut back on even just a few of these anti-growth, anti-free market and anti-capital measures, I think we would see a much faster resolution to our financial crisis.

For more on how, in his own words, Obama is anti-free market, see this article.

Saturday, March 14, 2009

Going to Argentina

Monday morning I leave for Argentina to visit friends and family for three weeks. My Argentine wife—who has been there for the past week while I have been skiing—and I lived there for four years in the late 1970s, and that is when I acquired a permanent interest in inflation, economics, and finance. During the time we lived there, inflation averaged about 7% per month, and was routinely in the triple digits per year. I remember one month in particular when prices rose almost 50%. I also remember when we went to Argentina in 1986 for a three week visit, and prices tripled during our brief stay. I went to the corner grocery store daily, and noted how prices were posted on chalk boards and were changed sometimes once or twice a day.

The image above is a photo of a 1 million peso note I keep as a reminder of how inflation works. When it was first introduced, sometime around 1978, it was worth the equivalent of about $2,000 dollars. When it went out of circulation about ten years later (caution--my memory may be failing me and I might be off a few years), it was worth the equivalent of about 20 cents. I asked some friends to collect a bunch of the notes for me, and I still keep them tucked away in a drawer. Who knows--they may be worth a bit more than 20 cents someday, if only as a curiosity.

When we were in Argentina in 1986, I remember my 6-year-old son was fascinated by all the banknotes that people carried around in order to conduct their daily transactions. They had denominations of 3-8 digits, and most were essentially worthless. Prices were routinely quoted in "palos" with a palo being slang for a million, much as we would say "5 bucks." A friend gave him a grocery bag full of old peso notes that he had collected, and my son went almost crazy with delight. "Wow, Dad, how much can I buy with all this money?" he asked me. "Well, Ryan, with all that money you might be able to buy a pack of chewing gum," I replied, even though the nominal value of the notes must have been in the tens of millions. I then tried to explain to him how inflation worked, but I quickly realized he just couldn't understand what had happened.

In 1979 we sold our house in Neuquén Argentina, in preparation for returning to the U.S. There was no such thing as a mortgage at that time, and hardly anyone had a checking account. If you wanted to buy a house, the best terms you could find were "0-30-90," which meant that you had to pay one-third of the purchase price at the time of signing the purchase contract, followed by the second third a month later and the third third in three months. The man who bought our house graciously agreed to pay me the full amount in cash at the signing of escrow. Before going to the escrow office to finalize the deal, we went to his office. There he took out several grocery bags full of money and started counting the bills; after counting each stack he passed it over to me, and I counted it, then he placed the stack back in one of the bags. I wish I could remember what the price of the house was in pesos, but all I remember is that the bills were of large denomination and they filled three grocery bags. It took us about 25 minutes to count it all. In dollar terms, we got about $30,000 for the house. After we had both counted the money and signed the escrow papers, he accompanied me to the bank, mainly in order to help me carry all the money and to serve as an informal body guard—can you imagine carrying cash equal to the price of a house in grocery bags while walking 6 blocks to the bank? I handed over the bags of money to the cashier and explained that I wanted to convert the pesos to dollars and wire the total amount to my account in the U.S. It took the cashier another 25 minutes to count and verify the bills. I was fortunate that at the time it was legal to convert pesos to dollars and to wire dollars to an overseas bank account—it hasn't always been like that.

Things have progressed significantly in Argentina since that time, but inflation and other bad government policies have left permanent scars on the economy. I hope to be posting interesting tidbits from Argentina during the next several weeks, commenting on how the country is faring under the leadership of the Kirschners, who are, like Venezuela's Chavez, in the process of nationalizing one industry after another. Already I know that there are too many things happening in the U.S. these days that remind me of what it was like to live under a regime that wants to control prices, regulate industries, and nationalize failing companies. Stay tuned, as thanks to the internet and Bloomberg I'll still keep posting comments on developments here in the U.S. as well.

Thursday, March 12, 2009

Update on fiscal policy

These charts reflect revenue and spending data through February 2009, with my assumption for GDP growth (-4% real growth for the quarter, plus 2% inflation). The point is that spending and deficits are "off the charts." By the time we get to the end of this year or early next year, federal spending will be close to 30% of GDP, and the deficit will probably be 13% of GDP.

To be fair, a lot of the spending this year is "emergency" spending, and is not really spending per se. It is the result of government (and Fed) purchases of securities. So it might be appropriate to call it a type of investment, since not all the money spent on security purchases will be wiped out, and some securities may even result in a profit for the government.

Looking out over the long term, however, Obama's wish list budget calls for government spending to average about 22% of GDP. That's rather fanciful in my view, since a lot of the extra spending jammed into the budget already for this year will be very hard to reverse entirely in the years to come. A conservative estimate would be for government spending to average at least 23% of GDP and possibly more, if Congress acquiesces to all that the Obama administration is asking for. We haven't seen anything like that since WW II.

If government spending is going to be at least 23% of GDP in the future, whereas for the past 40 years revenues have averaged a bit less than 18% of GDP, then we are either going to have gargantuan deficits for as far as the eye can see (5% of today's GDP is $750 billion), or we are going to have a significant increase in the economy's tax burden. I pin my hopes for "change" on the fact that, no matter how high tax rates have been in the past (recall the 70% top marginal rates in the late 1970s and early 1980s), the federal government has never been able to grab much more than 20% of the economy's income. I think this economy is going to significantly resist a massive expansion of government and its attendant tax burdens. If it does, then that would be extremely bullish news for financial markets.

Wealth destruction on a global scale

Since the peak of global prosperity in 2007 until today, the value of global equities has dropped by $34 trillion, as shown in the first chart. The second chart shows the components of U.S. households' net worth as of the end of last year. Most of the $12 trillion decline in net worth has come from the collapse in equity markets, not real estate values. As of today's prices, I estimate that U.S. households' financial assets have declined another $6 trillion since the end of last year, putting the total wealth loss to U.S. households at approximately $18 trillion, and probably more if you figure that housing prices have continued to decline this year.

So in round numbers, and adding in the losses in real estate values outside the U.S., figure that the world has lost at least $40 trillion in wealth in the past 18 months, while U.S. households have lost about $20 trillion. This is pretty remarkable when you consider that the initial catalyst for this mega-decline was $1-2 trillion of subprime mortgage debt that went sour. And even after 3 years of housing price declines, real estate values in the U.S. have only declined by about $5-6 trillion from their peak.

How can the real estate tail wag the global equity dog? Real estate losses have been only a fraction of total wealth losses. Lots of paper wealth has vaporized, to be sure, but the physical assets (roads, machinery, computers, factories, office buildings) that make the global economy function are still very much intact. The physical size of the global economic appartus has surely grown over the past 7 years, hasn't it? (The market cap of global equities today is about the same as it was 7 years ago.)

It doesn't seem unreasonable to me to say that the equity market is exceedingly bearish on the prospects for the future, and/or there is something else, such as a major shift in the direction of U.S. fiscal policy, with its attendant surge in future tax burdens, that is to blame. I've been arguing for quite some time that equity valuations have been extremely pessimistic, and I continue to believe this. We don't need much in the way of good news for things to turn up.

Used car prices bounce

Here's another quick chart before we leave for the slopes. This shows that the prices of used cars rebounded significantly in January and February. That's another sign that we've seen the worst of the economic news (see previous post for more details on what this bounce means). It also suggests that economic weakness is not leading to a general decline in the price level. There is still plenty of money out there to support prices.

Economy not in free-fall

Here's a quick chart of Retail Sales excluding autos before we leave to ski The Canyons in Park City. The main point is that the economy is not in free-fall. The worst of the contraction happened in the last few months of 2008. Activity has bounced a bit since then. This supports my current thesis that a) we have seen the worst of the economic news, b) the recession is likely to be over by mid-year, c) the recovery will be unusually slow, and d) the problem with the markets so far this year has its roots in Obama's massive lurch to the left, since it raises the burden of government and taxation significantly and is generally capital-unfriendly.

Wednesday, March 11, 2009

The Fed wasn't to blame?

Alan Greenspan today writes in the WSJ that "The Fed Didn't Cause the Housing Bubble." He asserts that "it was indeed lower interest rates that spawned the speculative euphoria. However, the interest rate that mattered was not the federal-funds rate, but the rate on long-term, fixed-rate mortgages." He blames the bond market for setting long-term interest rates too low.

Well, as George Will would say. We are thus left to conclude that the Fed can set the funds rate wherever it pleases, and things will only go awry if the bond market misjudges where long-term rates should be. Greenspan further defends his now-tarnished legacy by attacking John Taylor for promoting the mistaken notion that the Fed kept short-term interest rates too low.

I have my own explanation for what happened. I think the Fed was at least partially responsible for the housing boom, and government subsidization of borrowing costs (e.g., via Freddie and Fannie, the home mortgage deduction, the Community Reinvestment Act, and favorable capital gains tax treatment) did the rest. Monetary policy was generally inflationary following the 2001 recession, as evidenced by rising prices of almost all tangible goods: gold, energy, commodities, and real estate. Interest rates were in general not high enough to offer a compelling alternative to borrowing money and buying hard assets. The housing boom was copied in the commodity and energy markets. That is how monetary inflation works.

The Fed only sets the overnight interest rate, but the Fed can and does influence interest rates along the rest of the yield curve through its actions and its statements. When the Fed tells the world that it will keep interest rates extremely low for a long period, as it did in 2003, the bond market assumes that inflation is not a problem and sets long-term interest rates at levels that it believes are consistent with a reasonable expectation of where the funds rate is likely to be in a noninflationary future.

The corollary to this view of how Fed policy works is that the bond market is not always a good predictor of inflation, and it can and does make mistakes. But that doesn't absolve the Fed of blame. If the Fed had paid more attention to commodity prices, and in particular gold, it would have realized by late 2003 that policy was too easy, and it would have moved sooner to tighten. That might well have mitigated the subsequent housing boom, as well as the commodity and energy price roller coaster that has rocked the global economy.

UPDATE: A new book by John Taylor, "Getting Off Track" appears to do a good job of describing how this whole crisis evolved.

Tuesday, March 10, 2009

Gold still suggests inflation, not deflation

It seems like almost every day I read something from another analyst saying something to the effect that we are doomed: deflation is pervasive, our living standards will never recover, global demand is on strike, the Fed's balance sheet is shrinking, etc. I offer this chart of gold prices to make the point that even though gold has not done very well in the past year or so, it is still in what looks to me like a seven-year rising trend. If you had told me two years ago that gold today would be around $900/oz., I would have said "that would be a clear indication of inflationary monetary policy."

I don't see any deflationary signs in the commodity markets. Shipping rates are still rising. Copper is up 34% from its December lows. The JOC, JOC metals, and CRB indices are all flat to up over the past several months.

M2 growth has slowed in recent weeks, but it is still up at a 15% rate in the past 3 months, and 9.5% in the past year!

Core CPI is still rising, and energy prices have been rising for the past few months. So I don't see how CPI is going to be negative going forward. This obsession with deflation is just the Phillips Curve deja vu. Weak demand does not dictate deflation. Indeed, the weakest economies that I have ever seen were those that were afflicted with plenty of inflation. Inflation is bad for growth. Slow growth is not necessarily good for inflation.

I think the deflationary part of this current bear market reached its maximum intensity around the end of last year. Most of the deleveraging had occurred by then, and spreads and commodity prices support that view. Things were all set to get better in the new year. Since then the bear market has been driven mainly by Obama and his radical promise to increase the size of our federal government by 15% in the space of just a few years (from 20% of GDP to 23%). That is a level that we have never seen post-war, and it implies a totally unprecedented rise in tax burdens. That is what has caused capital to go on strike (Atlas Shrugged is surging in popularity for a good reason). That is enough to explain almost any bit of bad news.

The market is severely bogged down by oppressive government and the promise of more to come. And also by details such as mark to market and cap and trade. Today we saw the promise of some relief from MTM. And I recently noticed that the Senate does not have the votes to pass Obama's budget. That is extremely good news. If only something like cap and trade would be taken out, this would be very good news. Cap and trade is simply awful. It is a guaranteed recession-extender. Surely if people have a chance to think about this, it will fail to pass. If reason prevails, the economy will survive and the markets will recover. I'm still an optimist, even thought I admit to feeling awfully bad.

Meanwhile the skiing has been excellent, and although we didn't have a problem finding a table at the Skier's Buffet at Deer Valley yesterday or today, there were still plenty of people enjoying what has to be the best lunch at any ski resort I have ever been to. Deer Valley demand is not dead.

Monday, March 9, 2009

Christina Romer defends Obama's policies

Christina Romer today delivered a major address to the Brookings Institution, in which she laid out the intellectual foundation for Obama's aggressive expansion of government's role in the economy. I have only read through the text of her address once, but that was enough to know that she is using it to justify all that Obama has done to date, by asserting that it is being driven by the lessons to be learned from the Great Depression. Two things stand out: 1) she claims that fiscal stimulus in the Depression was not effective because it was too timid and did not last long enough; and 2) monetary policy was effective mainly because it caused a huge devaluation of the dollar. Needless to say, her interpretation of the lessons to be learned from the Great Depression are not universally shared. For example, Amity Shlaes wrote a book on the Great Depression, "The Forgotten Man," which draws very different conclusions, if not opposite conclusions. My own understanding of the Depression is that fiscal policies were very harmful, and I would be loathe to recommend as a solution to our current problems any policies that resulted in a signficant devaluation of the dollar.

In any event, read Romer's paper for yourself. It is amazing to me that she could come to such clear conclusions about such an historically complex event as the Great Depression, and then use those conclusions to justify the most aggressive government expansion and intervention in the economy in modern times.

Sunday, March 8, 2009

Mark to market should be scrapped

Whether or not to keep in place the rule that banks should mark their assets to market is a major issue these days. I've seen lots of arguments pro and con. I would recommend this article by Steve Forbes, who I think has proved to be a consistently excellent thinker and all-round economist over the years. Mark to market accounting is a tragic legacy from the Bush administration that Obama should dump posthaste. Doing so should go a long way to fixing our current banking crisis. Some excerpts:

Regulatory capital by its definition should take the long view when it comes to valuation; day-to-day fluctuations shouldn't matter. Assets should be kept on the books at the price they were obtained, as long as the assets haven't actually been impaired.

Mark-to-market accounting does just the opposite. When times are good, it artificially boosts banks' capital, thereby encouraging more investing and lending. In a downturn it sets off a devastating deflation.

If the president really takes Roosevelt's legacy seriously, he should suspend mark-to-market accounting rules, restore the uptick rule, and enforce the prohibition against naked short selling.