At this time of year tradition dictates that we peer into the future and pretend that we have the foggiest idea about what is coming down the track. Those with the courage to look in the rear view mirror find they may have got a few of last year’s guesses right and those that don’t…well they just keep on guessing. Here is an interesting observation from Macro Man – http://macro-man.blogspot.com – I had to laugh when Yellen said that she “wasn’t aware of a better model” for forecasting inflation….because I wasn’t aware of a worse one! The Fed’s inflation forecasting track record is, to put it bluntly, appalling. If you track the rolling 1 year forward projection for the core PCE deflator with the actual result, you find that they have a correlation of -0.68. Quite literally, they’d have a tough time being more wrong if they tried!
Far better use of our time might be spent on reflecting on the human follies perpetrated during the year and how to recognise them through the morass of misinformation. David Collum of Cornell University has done just that. He is a Professor of Chemistry and Chemical Biology, but don’t let that fool you! Here is his opening gambit.
I wade through the year’s most extreme lunacies as well as a few special topics while trying to find the overarching themes. I love conspiracy theories and detest detractors who belittle those trying to sort out fact from fiction in a propaganda-rich world. My sources are eclectic and if half of what they say is right, the world is a very weird place.
For those of you who recall Harry Truman’s observation that “A lie will get round the world before the Truth has its pants on” will enjoy what David has to say. The sub title of his review is “Scenic views from Mount Stupid” and he has this to say in the introduction.
“Presenting such a review poses a multitude of challenges. There are important topics from past years that remain important but will not be repeated. How many times can one rail on underfunded pension plans, unfunded liabilities, or a quadrillion-dollar derivatives market? These matters are important, but the plot line doesn’t change much year to year. I’m skipping right over Japan; it’s a basket case, but not enough has changed to spill some ink. Despite reams of accrued notes and links, I am light on the Middle East because nobody understands it (or eats parsley.) It’s that Mount Stupid descent again. I leave topics like global warming, mass shootings, and Israel versus Palestine to those who like to shout a lot. Other ideas manage to stay at center stage year after year. Compartmentalizing the topics can seem artificial. How does one separate broken markets from the Federal Reserve? Sovereign debt levels from bond markets? Government from civil liberties?”
A link to the full piece, which is a long read, but extremely readable, is at the end. Here are a few more observations along with some memorable quotes that he has gathered. This first is about “broken markets”.
“These markets are all rigged, and I don’t say that critically. I just say that factually.” Ed Yardeni, president of Yardeni Research, Inc.
“Whether it’s QE in the West or China’s recent regulatory intervention in the aftermath of the bursting of its equity bubble, market manipulation has become global in scope.” Stephen Roach, Yale University and former executive director of Morgan Stanley
The markets began breaking way back when Alan Greenspan went narcissistic and accepted the dual mandate to (1) preclude equity price discovery, and (2) subvert the business cycle. Let’s look at the bomb we’ve strapped on by first considering valuation. Goldman put price–earnings (P/E) ratios in the 98th percentile. Not a problem. The Fed model asserts that equity prices should correlate inversely with interest rates, which are at ridiculous multi-century lows. As the Fed jams rates to zero in the limit, the composite P/E ratios should go to infinity, right? (Hey: I didn’t invent the model.) Now let’s drop some acid and ponder Fed chair Janet Yellen’s recent warning:
“Potentially anything—including negative interest rates—would be on the table. But we would have to study carefully how they would work here in the U.S.”
What does the Fed model predict now? Cliff Asness nicely explains why we should fight the Fed model. Common sense says fight the Fed model. David Einhorn says negative interest rates are like taking the square root of minus one. (For those of you not mathematically inclined or professors at Cornell the square root of minus one is an imaginary term as there is no real number having a negative square…apparently!)
On gold – “Buying gold is just buying a put against the idiocy of the political cycle. It’s that simple.” Kyle Bass, Hayman Capital Management.
On energy – “We keep thinking that lower energy prices are somehow good for the economy. That can’t be, because energy prices or commodity prices in general don’t drive economic growth. Economic growth drives commodity prices.” Stephen Schork
“If oil prices stay below $90 per barrel for any length of time, we will witness massive fiscal squeezes and regime changes in one or more of the following countries: Iran, Bahrain, Ecuador, Venezuela, Algeria, Nigeria, Iraq, or Libya. It will be a movie we have seen before.” Steve Hanke, Johns Hopkins University and the Cato Institute, 2014
On bonds – “Bonds have never been more expensive in human history, and yet their supply has never been higher.” Tim Price, PFP Group
“If you have the option to hold [bonds] to maturity, your risks are bounded and very small.” Brad DeLong, economist at University of California, Berkeley, ignoring inflation risks.
“We have a bond market bubble and when that decides to work its way off we are in trouble.” Alan Greenspan, Chair of the STFU Committee
I previously called the bond market the “bond caldera”—a bubble so large that you can see it only from space (or from Greenspan’s front porch). I believe that someday, we will all be hosed when the liquidity leaves the system. This is not a unique view, but many bond speculators believe that (1) central banks would never let rates rise uncontrollably; (2) they are smart enough to get out first; and (3) their counterparties will actually pay them when the time comes. Apparently, there’s a lot of omnipotence to spread around. Until the burst, I simply marvel at the metastability with awe.
On inflation – I was asked recently about why I hold gold while facing deflationary risk. That’s easy: people of prominence and authority are still saying incredibly stupid things and making asinine decisions. Let’s look at a few:
“I do not hesitate to say that although the prices of many products of the farm have gone up . . . I am not satisfied. It is definitely a part of our policy to increase the rise and to extend it to those products that have as yet felt no benefit. If we cannot do this one way, we will do it another. But do it we will.” Mario Draghi, European Minister of Inflation and Debasement
“Inflation is hopefully giving little signs of moving up in the right direction.” Christine Lagarde, director, IMF
“When older cohorts have more influence on the redistributive policy, the economy has a relatively low steady-state level of capital and a relatively low steady-state rate of inflation.” Que? James Bullard, president of the St. Louis Fed
And last but not least …”Even if we had some kind of shock that sent prices up for some reason, the Fed has the tools to stop inflation. That’s not very hard. . . . There is a whole generation of people who don’t remember inflation. They don’t know what it is, and so I think inflation is a non-existent threat.” Alice Rivlin, former Fed governor, making my brain hurt
The award for the most moronic statement goes to . . . envelope please . . . Alice Rivlin! If we don’t know what inflation is, it can’t hurt us. Fabulous!
There is more, much, much more and if your appetite has been whetted here’s the link http://www.peakprosperity.com/blog/95808/2015-year-review It has been posted on Chris Martenson’s Peak Prosperity website where you may find many other items of interest. For those of you not so whetted here’s one final quote.
“The ‘risk’ case is only being made circumspectly by people who are being ridiculed as clueless Cassandras. . . . Our belief is that the global economy and financial system are in a kind of artificial stupor in which nobody (including ourselves) has a good picture of what the next environment will look like. The difference between ‘them’ and ‘us’ is that they mostly think that policymakers will muddle through, but we assume that a very surprising and scary environment lies in wait.” Paul Singer, Elliott Management Corporation