Thursday, September 2, 2010

The embarrassment of cash


I last touched on this topic in a post last October, and it's worth reading again. One excerpt:

To willingly hold cash that yields zero, you must be convinced that there is death and destruction awaiting at every turn. The market is climbing terrifying walls of worry, yet on the margin people are slowly being forced to reduce their money balances and increase their exposure to risk, and consumers are spending some of the cash they have hoarded, and it all adds up to a virtuous cycle that is giving us a V-shaped recovery. As long as the economy fails to deliver death and destruction, the market finds itself compelled to keep this virtuous cycle going.

After the market rallied strongly into April of this year, a panic attack set in, triggered by the potential for a Greek default that could bring Europe to its knees, and then fueled by intense speculation that the U.S. economy was on the verge of a double-dip recession due to continued weakness in the housing market and consumer deleveraging. This justified the fears of those holding cash, but since the low point in equity prices in early June, we've seen mounting evidence that a recession is far from imminent, and indeed it seems likely that the economy is still growing—at the very least it is clear that there are no signs of "death and destruction." The manufacturing sector is quite healthy; commodity prices are rising, and close to all-time highs; global trade is booming; China and India are not collapsing; unemployment claims are not rising; credit spreads are not soaring, and swap spreads are very low; corporate profits are very strong; the Fed is not about to take any actions that would endanger the markets; Washington is getting closer and closer to extending some or all of the Bush tax cuts.

So we are now in another cycle in which cash proves to be an embarrassment because the economy is not collapsing. The market is now climbing another wall of worry, but on the margin some of those holding cash are trying to reduce their cash balances and increase their exposure to risky assets. Consumers are likely still willing on the margin to spend some portion of the cash balances they began accumulating in late 2008. Confidence is slowly returning. All of this adds up to a virtuous cycle that points to more growth, albeit growth (3-4% being my guesstimate) that will not result in any remarkable decline in the unemployment rate.

The main point is this: when cash yields almost zero, you really need bad things to happen. If they don't, then you are passing up on huge opportunities to profit from, for example, the 8-9% yields on high-yield bonds, and the 7% earnings yield on the S&P 500. The absence of bad news is like a leak in a dike, behind which sits a massive lake of cash and cash-like instruments earning zero. The force of the water (many trillions of dollars) seeping out through the hole in search of higher returns is going to be very difficult to stop and the hole will almost certainly get bigger with time.

There are plenty of reasons to stay bullish on risky assets.

17 comments:

brodero said...

Dang...the last chart looks like the early 60'S...Hello Mad Men....

brodero said...

Get this last quarter's personal savings rate was 6.1%...the last time we were at that rate was the 1st qtr 1995.

12 month bill now .25

1st qtr 1995 6.03%

Benjamin said...

Excellent post.

No doubt investors are worried, and no doubt Obama has not made things better.

Still, we are less taxed and regged compared to previous prosperous eras, such as the 1960s.

Also seemingly forgotten now is that a real and well-armed enemy, the Soviet Union, collapsed it military in the 1990s, and the world has been much safer ever since. We face a few punks with homemade bombs today--loathsome creeps, but not a threat to our national security (despite the hysteria you hear).

In short, it is not a bad environment today. Jeez, the top tax rate used to 90 percent, then 70 percent. (thru the 1970s).

I think an excellent sign was the Burger King buyout. This says to me there is a floor on prices going forward. If the public has no faith, private investors will takeover.

The right-wing is selling doom-and-gloom, and maybe that is depressing the market.

I think we see a sustained bull market in equities and property, just don't know when.

Get used to low interest rates. The globe generates too much savings. Nowhere to put it all.

Benjamin said...

Oh, and we the Japan Wing of the Fed to realize that 20 years of zero infaltion is not a good idea.

Public Library said...

I'm not sure how you can credibly call holding cash an embarrassment. If you would have kept your money in a standard savings account since 2001 or so you would have earned far superior inflation adjusted returns over the stock market.

And if the economy is going to do so well in your eyes, short rates should head north and eventually beat inflation so the zero threshold will not last.

Holding equities while they fell off the cliff in 2000 and 2008 was an embarrassment while the holders of cash were laughing all the way to the bank.

Sad to see you resorting to CNBC style headlines.

Scott Grannis said...

It's not hard for me to imagine a "melt-up" scenario, in which risky asset prices rise significantly, and that in turn causes the demand for cash to collapse. The two reinforce themselves. Also, the decline in the demand for money would boost velocity and nominal GDP, and this could be the source of rising inflation. The Fed might get caught with its pants down, unable to react fast enough to keep the declining demand for money (i.e., the rising demand for loans) from expanding the money supply. There are a trillion dollars of excess reserves just waiting to get turned into loans if the demand for money declines by enough.

Scott Grannis said...

Public: I never said cash over the last 10 years was an embarrassment. I have only said that holding cash that yields almost zero is a problem, since it only makes sense if you expect a lot of bad news.

Jeff said...

Benjaman...the "right-wing selling doom and gloom" is our problem? Really?

Obama has socialized (to some degree or another) student loans, healthcare, autos, AIG, banking, insurance, etc. He wants big income tax increases, a new national VAT, inheritance/gift taxes going back to 55%, not to mention a HUGE energy tax in Cap and Trade.

They ignored historic and legal capital structures in the auto deal; threw out the constitution in trying to deem and pass health care; took congressional authorized TARP money and used them not for TARP (toxic assets) but for capital "investments".

The left is DOING doom and gloom! That's what has people fearful.

Jeff said...

Benjamin...I also have to wonder about "too much savings" and "zero inflation" are both bad.

So I guess you are are with Biden...we need to "spend our way to prosperity"!

I have a stack of uncirculated $100 Trillion dollar bills from Zimbabwe--a 100 of them actually. Crisp and new. Do you know what all their spending has made that stack of $10 Quatrillion dollars worth??

Jeff said...

Price stability is never bad!



Scott, if I'm wrong, go ahead and correct me...gently.

Scott Grannis said...

Price stability and a strong dollar can never be a bad thing.

Benjamin said...

Well, if by "price stability" you mean mild inflation, then it is not a bad thing. If by a "strong dollar," you mean one that aids two-way trade, okay.

Japan has experinmented with a strong yen and zero inflation for 20 years.

It has been a failure. An abject failure.

You want to lose 75 percent of the value of your stock and property portfolios (lal Japan)?

Then sent a thank-you note to the Japan Wing of our Federal Reserve. They love zero inflation too.

No, I am no fan of Obama (though Bush was probably even worse). I hold out hope for Ryan Paul, or perhaps Chris Christy (though I confess to knwoing nothign little about the latter).

When I hear the doom-mongers on radio hustling gold, then yes I think the right-wing is selling fear.

We need optimism now, not doom-sniveling.

Hyperinflation is not a risk of any reasonably aggressive Fed policy. Deflation is a risk of the present Japan-R-Us gang.

marmico said...

Sad to see you resorting to CNBC style headlines

That's news. Don't think so.

A blast from the past. September 2, 2008. Grannis's first blog post.

1. Good reason to stay bullish on the economy and on stocks, and bearish on bonds.

The oldies but goodies are a veritable embarrassment of riches.

2. Without the negative of declining construction spending, the economy is much more likely to avoid a recession.

brodero said...

Marmico...let's see your predictions???

marmico said...
This comment has been removed by a blog administrator.
Boomer said...

"Price stability and a strong dollar can never be a bad thing."

Well CPI stability and a strong dollar in the late 90s got us the internet bubble. A rapidly rising dollar or a rapidly falling dollar are both a problem. What we need is a stable dollar. A stable dollar not only produces long term price stability but also reduces interest rate and commodity volatility which would reduce the use of derivatives.

Scott Grannis said...

Boomer: good points. A strong and stable dollar is almost nirvana.