Reading the World

The near bankrupt state of California is the front line for the liberal takeover of banks, car companies and all other things in the federal scope. Here is the real test. If the government can “nationalize” California then Washington’s agenda is greatly advanced. If the government is rebuffed it may turn the tide away from the assumption that Washington is the proper owner and controller for all activities that turn out worse than we wished for them.

California has created its own problems. The state’s money is more than gone, and the unemployment system is massively under funded. The normal solution is to renegotiate the retirement plan - the world’s most “generous.” However, political types have rigged it so these changes can only be made if the state is in bankruptcy or if the state constitution is changed. What great protection.

As our good friend John Hearne said, “Socialism ends when the government runs out of the other fellow’s money.” Well, California is there. They say tax the rich, but the California border states are already receiving a migration flood of wealthy people fleeing an oppressive CA tax code. Watch California closely. The result there will tell us how the nation will fare.

My friend, Jack Kemp, died last night. In the 30 years I knew Jack, he never spoke ill of anyone. He was an inspiration to me. He never saw my blindness as a limitation, and he always brought out the very best in me. I worked with him on the Kemp Commission, a task force to design pro prosperity tax policy. He was a national treasure, as he often said about others. I will miss him. - Russell Redenbaugh

Changes in monetary policy from easy money to tight money cause banking panics. This often takes both lenders and borrowers by surprise and causes windfall gains/losses between them. It also causes changes in the general price level, switching from inflation to deflation.

A stable value of money eliminates these panics and sudden losses. However, with our money backed only by the promises of politicians we often fall into mistrust about the future value. This is what Art Laffer calls a loss of “moneyness.” We can fix this loss of trust or “moneyness” by tying the money to gold. This worked for thousands of years and was in a loose form until Nixon broke the standard in 1973, creating misery for the next decade. Let’s go back to a dollar we trust.

Forget Inflation Targets, Go for Dollar-Price Stability by John Tamny

Watching Obama’s press conference last week, I must agree with the CNBC host who said it was a “tentative news conference,” though I’ll add given by a tentative President. As the leader of the free world, we expect President Obama to command, order and declare the changes necessary to grow our economy and protect our country. Unfortunately, President Obama’s language reflected the weak role of a community organizer and not the powerful position of a President. When asked about his proposed budget which includes cap and trade, he responded that “in his opinion it is best,” and that he understood Congress would be reviewing it carefully. In short, he deferred to Congress. When asked about Mexico and the threat of drug cartels at our border, he informed us that expensive surveillance equipment and additional personnel were dispatched to “monitor” the situation which he assured us he “was taking seriously.” Of course, he needs to take this seriously. But we expect him to commit to action, assure us that he will stop the inflow of drugs and crime, not that he will be watching it. Another reporter commenting on the AIG bonuses opened with the claim “Cuomo is taking more action while you are merely expressing anger.” When speaking about the budget, Obama assured us that he is doing everything he can to reduce the budget but then reminded us it was difficult. This is like saying I’m trying but it’s hard. Another reporter said that he was alienating the Europeans by asking them to increase their stimulus. Obama was quick to say, “I haven¹t asked the Europeans to do anything! I’ve suggested.” Why isn’t he asking the Europeans to do anything? I would hope our President uses the authority we gave him to do more than suggest. Regarding the Middle East, a reporter reminded Obama that he pledged peace between Israel and the Palestinians. Ducking his commitment, Obama said that a two state solution is necessary and that we’ve “signaled this reality.” Signaled? This is not the vocabulary of a leader but rather a dreamer hoping things will go his way. Our President has the audacity to hope instead of lead!

by Natalia Redenbaugh

Per today’s Fed release, the monetary base increased 10% over the last two weeks and is up 104% yoy. M1 fell 1% on the week and is up 14% yoy. Excess base (monetary base – M1) is up 90% yoy. Looking further at the Fed’s balance sheet we see that reserve bank credit is over $2 trillion and is up over $1 trillion from a year ago. The increase in the monetary base over the last two weeks is due mainly to increases in Mortgage Backed Securities (up $168 billion) and Federal Agency Debt Securities (up $6 billion). These increases were part of the initial plan to purchase $500B in ABS. Notably, these purchases happened before the Fed announced new plans to purchase an additional $750B of ABS and $300B of Treasuries. The Fed’s combined plan will put roughly $1.55 trillion of ABS and Treasuries onto their balance sheet ($30 billion per week.) Expect Fed purchases to ramp and the monetary base to keep expanding. Deflation is over. It is time to continue adding to inflationary bets.

There have been 54 distinct warming and cooling cycles since the Earth first cooled. 53 of these happened before human beings existed. So even if there currently is warming, about which the data are very unclear, then how do human CO2 emissions explain it? Think about this. Without the man made global warming story the government will lose all of that needed money, now estimated at $1.4 trillion. The government will also lose a chance to regulate the economy and trade. They lose a chance to make solar and wind power commercial as gas prices soar to $12/gallon. They lose a chance to favor certain group and industries by handing out carbon credits to favorites. Why would the government want to give up this enormous opportunity to grab power and expand itself? It is time to just say NO! No to bank bail outs and no to the bailouts of green energy businesses.

Today’s CPI release confirms yesterday’s PPI release - No Deflation. This is welcome news. Deflation is the big killer of asset prices. Just look at what happened when house prices deflated a little. The Fed was far too tight in 2007, increasing liquidity too little and too late. In fact, the monetary base didn’t start growing until more than a year after the Fed’s first rate cuts in 2007. Thus the downward spiral began. Throw in changes to mark to market accounting and the uptick rule and you suddenly have a toxic asset stew in a banking system collapsing from paper losses. Then when credit freezes in a “black out,” the real economy falls to its knees. The subsequent bail outs and stimulus only make things worse. Now after two painful years of deflation, it is coming to an end.

Our banking system can deal with price level inflation. It can not deal with deflation and the crushing increase in debt burdens that result. Fed policies over the past year caused price level instability that was most disruptive to the banking system and the real economy.

The price of gold has been the best way to measure changes in price level over the past decade or so. It first fell in half, from $500 to $250, then rocketed up four fold to $1000. This “gold signal” directed buyers to move capital into housing as an inflation hedge. Housing’s appeal as a store of capital was of course augmented by the Clinton administration’s favorable changes in the housing tax code and their push to cause Fannie and Freddie to easily make mortgage loans to unworthy borrowers. When the Fed ultimately tightened, the bottom dropped out of the housing market.

Now the gold price is signaling firmer prices ahead for houses and other things. This is good news, as we can deal with inflation far better than deflation. Of course the best outcome would be a stable price level. This would create trust in the value of the U.S. dollar and zero inflation. However, our monetary masters want to fiddle with the money system. This tinkering gives the very savvy a chance to profit from the mistakes of the less well informed. Our only recourse has been to try to be among the best informed.

Uncertainty over tax rates and regulatory policies cause companies to defer capital investments, bankers to stop lending and investors to stop buying. No one can know the value of a home mortgage. With changes in bankruptcy law, they can not even know their rights in foreclosure. The result is far less lending in this credit intensive sector. As demand decreases, house prices fall. Banks say they are pressured to make loans to borrowers that fail to meet credit standards, but wasn’t this the original cause of the problems?

Two policy errors persist. The first is mark to market accounting. The second is the rule adopted by the Bush administration SEC that allows short sellers to sell stock they don’t own without waiting for an up tick in the stock price. These two policy errors are working together to allow “gangs of short sellers’ to drive down the stock prices of banks. Thus, raising capital through stock sales becomes impossible. At the same time the paper losses from mark to market accounting drive banks into the arms of the government. These policies are wrong and must be ended.

Here is a new article we wrote for www.realclearmarkets.com

March 05, 2009
Policy Matters, Now Profit From It
By Russell Redenbaugh & James Juliano
As a follow-up to our previous piece on absolute return, we will now show you one of the ways to make money when others are not. Investors must expand on our absolute return approach to investing and use changes in government policy to direct investment across multiple asset classes.

Understanding government policy is the best way we know to see and anticipate changes in asset values; not merely stocks, but also bonds, currencies, real estate, commodities and foreign markets. Changes in policy impact the economy by altering the supply/demand for products, labor and capital. This in turn changes the relative supply/demand for stocks and other asset classes. (more…)

We have outlined before how bad policies were becoming for taxes, trade and regulatory. And the hits just keep on coming. According to Bloomberg, “President Barack Obama’s administration will seek congressional approval for as much as $750 billion in new aid to bolster U.S. financial institutions if it is needed, ” and “AIG may get a commitment for as much as $30 billion in new government capital.”

Don’t be surprised markets are falling. Markets will not turn until policy turns positive. What’s more, could our national security be in jeoaprdy? What if we have a threat from a foreign enemy? Where is the will and the ability to respond? This could be a great chance for an oportunitic and adventuring enemy, and that is much scarier than falling markets. Obama, get it together.

There are plenty of ideas out there for how to stabilize house prices, reignite our economy and save our banking system. The Obama administration has outlined three separate plans to do so, totaling at least $1.5 trillion (stimulus bill =$787 billion, rumored second stimulus bill = unknown, housing bill = $287 billion and TARP 2 = at least 350 billion.) We think a better and singular solution for all of these problems is a simple price fixing scheme.

It all begins with housing. According to housing affordability data, house prices should have already bottomed. The National Association of Realtors’ data shows housing affordability at an all time high of 160 (meaning a family earning the median income has 160% of the amount needed to purchase a median priced home). Despite record affordability, house prices have not bottomed as they should have. Lack of confidence, selling pressure related to “margin calls” on underwater properties and banks’ frozen balance sheet have prevented a return to normal housing supply/demand economics. Our plan to fix housing begins with a spark to ignite the market and restore the proper supply and demand forces.

To bottom house prices we must affect the economics of housing supply and demand. We must decrease supply, increase demand, or both. Market forces have already done much to decrease housing supply, so let’s assume no policy is needed to keep new home construction down. So, how can we increase house demand and at the same ignite the economy? Simple. The plan is to offer a temporary tax holiday to any purchaser of an existing (not new construction) home. The amount of income that will be tax free should be scaled to the size of the home purchase (to keep it simple assume purchasing a $500,000 existing home would qualify you for a 6 month income tax holiday on $500,000 of income.) House prices would immediately bottom. Remember, we do not need to stop foreclosures. We need to stop house price declines. This will not help those people who never could afford nor deserve to afford their house payments. But for people on the edge, a 10% increase in house values will prevent them from having to foreclose. A 10% increase in house values would also save banks from having to write down more toxic mortgage paper and raise more capital. Lastly the income tax holiday would create a tremendous surge in work activity and ignite U.S. GDP almost instantly.

What is the cost of this plan? The cost of this plan is the amount forgone from lower income tax receipts. This would no doubt be less than TARP 2 and stimulus 2.

by James Juliano and Russell Redenbaugh

The Obama administration’s attack on capital continues. There is a bill proposed for a “Trader Tax” equal to .25% on every stock, option and bond transaction. Section 1 of the bill states that it be cited as the “Let Wall Street Pay for Wall Street’s Bailout Act of 2009.” They are trying to sneak a similar proposal for a transaction tax into upcoming health legislation. Up next will be energy and healthcare proposals designed to aid the recovery. They won’t. Since this administration is anti capital, the feedback loop of a falling stock market will not be seen as proof of bad policies. Inf fact, they view sell offs as fair and just.

It has been clear for some time that the “just one thing” of the crisis is the collapse of housing prices. The banking system cannot be fixed until house prices stop falling. Now the government is lowering the price of your house by disrupting the contract between borrowers and lenders. Our good friend and great investor Chuck Kadlec explains,:

“Counter party risk in the U.S. is now being increased by the Federal government messing with contractual obligations of borrowers who pledge their house as collateral. Call it sovereign risk imposed on private markets. So, lenders and borrowers can no longer agree on what promise is being made, or assess what actions will be permissible if the promise is broken. Therefore, they cannot assess the sincerity or the capability of the promissory. The government, therefore, has created a new kind of uncertainty – adding to the barriers to commerce world wide, and decreasing the market value of the assets already on the books of the banks.” - Chuck

Here is the link to an article we wrote today. It examines the perils of a relative return investment strategy and offers a different investment apporach for not only preservingcapital, but building it long term. It serves as an outline of the investment strategy we use at Kairos Capital Advisors to manage client portfolios.

Mean Reversion - Longer Than Your Life?

Protectionism is a big worry, and the risk is increasing since the stimulus bill passed with “Buy American” provisions. Protectionism should be seen as a tax increase on all Americans.

China favors free trade, even if U.S. doesn’t
from Associated Press

U.S. labor groups that pushed hard for inclusion of the measures have argued that their main purpose is to ensure that U.S. Treasury dollars are used to the fullest extent to support domestic job creation.China has promised to avoid “Buy China” protectionist measures in its own multibillion-dollar stimulus effort, and appealed to other governments to support free trade….

President Barack Obama is expected to sign the economic stimulus package on Tuesday in Denver, Colorado

Our fears have been realized. The Senate did not block passage of the stimulus bill. Republican senators Specter, Snowe and Collins joined all the Democrat senators in voting yes. The stimulus bill will not stimlulate economic activity, and over the long term it will our economy much weaker. As a result we expect power in Congress to shift back to the right in two years and for Obama to be a one term President.

“The U.S. Senate late Friday night passed a $787 billion economic stimulus package by a vote of 60-38. The vote on the 1,071-page American Recovery and Reinvestment Act (H.R. 1) came hours after the U.S. House of Representatives approved the bill 246-183, with no Republicans supporting the bill. The bill is expected to be delivered to President Barack Obama’s desk for his signature by Monday. “

This morning we were on the Laffer Associates conference call hosted by Art Laffer. Here are the notes from it:

Capitalized economic profits valaution chart shows that stocks are extremely undevalues. This gap will close and can do so in 4 ways. 1. Profits fall. 2. Interest rates rise. 3. Tax rates rise (after tax profits fall) 4. Stock prices rise. Laffer thinks gap will close due to first 3 reasons, not because stock prices rise.

1. Profits will fall as a % of GDP. Can fall by almost 50% from now levels to lowest levels, so lots of room for declinel. Also, GDP growth will be small, maybe negative.
2. 10 year yield is lowest in any time in recent history. Expect that to rise substantially. Monetary base signaling inflationary environment. Perfect storm for high inflation and rising rates – falling GDP and rising excess base.
3. Deficit projected to be over 8% GDP, not including all the new stimulus spending. Government will start worrying about raising revenues, and will raise taxes.

Grand policy areas (and ideal policy)

1. Fiscal – (fiscal restraint and low flat taxes)

2. Monetary – (Stable money, stable currency)

3. Trade – (minimal impediment to free flow of goods, services and people across boundaries.)

4. Incomes – (minimal regulations necessary to achieve order and structure in society)

What is happening in the policy domains:

Fiscal – there is no stimulus in the stimulus package. There is no Keynesian multiplier effect. For government purchases of goods and services there is a one quarter increase, then crowding out takes effect and there is n0 multiplier effect. Transfer payments actually reduce GDP.

Monetary – no linear relationship between any of the alphabet fed programs (TAF, etc) and bank reserves. And it is bank reserves that matter – monetary base. Until September 2008 the fed was too tight. This changed dramatically in September 2008 and the base has grown rapidly since. Fed assets gone from 904 billion to 1.9 trillion (2X). Total reserves 98 billion to 916 billion (10X). Monetary base 860 billion o 1.75 trillion (more than 2X). There is no sense from the Fed of taking these reserves out of the system. Largest increase of monetary base ever in US history. No sign the fed knows what it is doing or how to control it. Expect inflation and rates rise sharply. This is much worse than it was in the 1970’s.

Trade – In Davos the administration made it clear that they are putting in “Buy American” programs. In Britain there were riots over hiring foreign workers.

Incomes – green legislation, first presidential executive order was to strength unions.

Overall, very bearish on U.S. equities. Bullish on Gold and Real Estate (Laffer is buying Kentucky farm land for his grandchildren)

To steal a phrase from Jim Cramer, “He knows nothings!” Tim Geithner did not even release a plan today, merely a set of goals. No private monet will buy when the rate of return and terms are going to changing to help the borrower. Price discovery is not the problem. The problem is not being able to even guess at the cash flows. The current bank rescue plan will fail to save the banks. The current stimulus plan will fail to ignite the economy and will cause more long term harm that good. Ultimately, it is Obama who has failed. He is trying to create an administration that knows better than the markets and everyone else. The government is trying to be the allocator of capital, decding where it is most needed and best used. History has proven this never works and, after last night’s speech, it is clear Obama is a true believer in this approach. He will be a one term candidate.

Wall Street can oftern be wrong in the short term. However, over the long term stocks are titles to capital and reflect the present value of a company’s future cash flows. The government’s plans to “help” the economy and banking sector have been associated with declines in stock prices. The government aciton is making the future capital and cash flows less valauble. Shouldn’t this be a clue that they are not the right actions?

The following notes are from Davis Malpass of Encima Global: