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Wednesday, September 28, 2011

The China Premise

In analyzing financial markets and the economy, almost everyone holds a premise that's the proverbial elephant in the room: what will happen with China.


For those who believe global growth will have severe problems, their premise is that China is most likely an accident waiting to happen.  Those who believe the opposite, that global growth will take off again, almost certainly hold the view that China is a growth machine that will pull the whole world forward.


If someone holds a view on commodities, currencies, stocks, bonds or gold, I can almost guarantee that behind their view is a premise about what will happen in China.


That premise may be explicit.  Jim Rogers, a noted commodity investor who once worked for George Soros, is a China bull and makes no bones about it.  He moved his family to Singapore and is having his daughter learn Mandarin Chinese because he thinks she won't be able to succeed without it.


Jim Chanos, the famous and successful short seller, is on record saying China is a bubble that will soon pop.  He's putting his money where is mouth is, too.


Some hold their premise implicitly.  I've heard many agriculture and base metal investors insist that prices can only go up.  They may not lay out the case explicitly, but if you ask them you'll find they see endless growth and demand from China.


Others are certain that debt deflation (the unwinding of bad loans) will keep the global economy in the tank for a decade or more.  Once again, they may not come right out and say it, but if you ask them, you'll almost certainly find that they assume China can't keep growing fast enough to overcome bad debt.


The most intellectually honest will admit they don't know what will happen.  After all, it's up to the Chinese.  I agree with the bears that China's command and control economy will end badly (the history on this subject doesn't leave much room for doubt)--IF it stays on its current path.  But, that's a big IF.  


I also agree with the bulls that China has a lot of runway simply playing catch-up with developed markets, and IF they foster free market reforms (rule of law, representative government, property rights, flexible labor markets, private allocation of capital, etc.), then they can be a huge growth story for a VERY long time.  Once again: big IF.


Perhaps the best path is not to guess.  


If you could invest and do well regardless of whether China tanks or soars, wouldn't that seem the best path?  Granted, if you knew how the story would end, you would make more money betting boldly in that direction.  But, is anyone really certain they know what will happen and--more importantly for investors--when?


What happens in China will impact world markets.  In the short run, this spells opportunity whether boom or bust.  I think making a guess on this over the next few years is a fool's errand.  It's better, instead, to prepare for either outcome because getting the timing right is impossible (or lucky).


Making explicit one's China premise is important to understanding one's view of world markets and the economy.  More important than one's premise, however, is whether its based on sound reasoning or gut feel and conjecture.


Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Wednesday, September 21, 2011

QE3, Operation Twist and Balderdash

"What's in a name?  That which we call a rose
By any other name would smell as sweet."
--Juliet, from Romeo and Juliet, William Shakespeare
Balderdash - A senseless jumble of words; nonsense, trash (spoken or written)
-- Oxford English Dictionary 
The Federal Reserve is likely to take action today to "boost the economy."  This is yet another attempt in a long line of failed efforts that not only won't work, but will almost certainly make problems worse.

Whether they call it QE3 (quantitative easing, part III) or Operation Twist (named for the 1960's dance and first tried during the Kennedy administration) or Glimdragbig (a word I just made up), it will feature the Fed toying with interest rates (most likely by creating money) in an attempt to get the economy "moving."

The Fed may call it something other than what it is, but it will still smell.  They may use elaborate jargon (nonsense) to mask its true nature, but that won't change the facts.

The Fed's underlying premise is that free markets work...until they don't.  Has the Fed ever correctly forecast when markets will stop working?  Of course not.  In fact, they are almost always too ebullient when they should be cautious, and overly worried when they should be upbeat. 

But, despite these consistent failures, they still pass judgment on markets and they supposedly know when markets have stopped working, and therefore when they should intervene to "get things going." 

As Dr. Phil likes to say, "how's that working for you?"

In case you haven't noticed, economic growth is anemic at below 2%, and unemployment is high at over 9%.  And, this is after countless fiscal and monetary (and regulatory) interventions over the last 3 years.

Why aren't interventions working?  Because the first part of the Fed's premise is right: markets do work.  If you let people freely choose and act, and prevent them from initiating force against each other, they will--over time--rationally allocate capital and other resources to productive ends, thus resulting in real growth and higher employment. 

What the Fed has been doing is preventing this mechanism from working.  Interest rates are at the heart of any modern economy.  It's the time value of money, and therefore drives economic choices at the most fundamental level.  If you screw with those rates, people will mis-allocate capital and the economy will stagnate or shrink.

Sound familiar?  If you need more empirical support, please see Japan over the last 20 years and America during the 1930's as examples of interventions galore resulting in anemic growth, stagnation, or shrinkage (or the Soviet Union, or China under Mao, or North Korea, or Cuba, East Germany, Venezuela, you get the picture!).

Stock, bond, and commodity markets are likely to respond favorably to any Fed intervention--just like they always do (after all, everyone loves a party when someone else is paying).  The dollar is likely to sink (except perhaps relative to Europe, which is even more of a basket case than America) and gold is likely to rally.

That doesn't mean the economy will grow, nor does it mean unemployment will shrink.  Once again, interventions are leading to greater and greater mis-allocations of capital and thus will cause slower growth than would otherwise occur. 

There is good news in all this, and that's that much of the American economy is relatively free.  In such places, people are innovating, adapting, employing and growing.  As long as the bone-heads bureaucrats don't intervene too much, such productive people will eventually create enough growth to overcome the negative effects of repeated intervention.

It may take time, though, so patience will be necessary.  In the meantime, lets all hope the interventionists will stop distorting markets so they can do their thing.  At that point, we'll have an upward spiral to be truly optimistic about.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Friday, September 16, 2011

"Going to the sidelines"

Most investors have a recurring fantasy they can dodge market volatility. 

When markets start to tank or look scary, such folks want to "go to the sidelines," which means parking their money in cash or safe bonds, "until the skies clear."

When you ask them how they know when to go to the sidelines and when to come back, they frequently tell you they just FEEL it.

To that, I have one thing to say--BALONEY!

Feelings tell you nothing about markets, all they tell you is your emotional state.  Those who use their feelings to guide their investment decisions get nowhere.

Many of these people went to cash in the fall of 2008 or the spring of 2009.  In cash, they have earned maybe 2% returns if they were lucky.  If they had invested whole-heatedly at those times, they'd be sitting on 50% gains or more.  Those feelings don't look too smart in hindsight.

Market prices tank when people get scared.  That's when the bargains appear--when people aren't selling for economic reasons but because of their emotional state. 

The same thing can be said on the upside.  If people feel euphoric--like in early 2000 or late 2007--then it might be time to get more conservative.

Your emotions tell you just the opposite of what to do, so don't listen to them.

My best investments were made when I was scared.  I normally feel sick to my stomach when I purchase investments with the best upside.  My emotions are terrible guides, and so are yours.

When markets get scary or euphoric, it's time to look at the data.  What kind of returns will I get given current prices and normalized earnings.  When I get nervous, I look at the data.  When I'm feeling optimistic, I look at the data.  I always look at the data, not my emotions.

For those who think they can go to the sidelines until the skies clear, I wish you the best of luck--you'll need it! 

If you want to make a bundle on your investments, invest aggressively when you feel scared and get conservative when you're euphoric.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Wednesday, September 07, 2011

Kindling the jobs fire

One of the most interesting skills I learned going through Air Force survival training was how to build a fire.  It comes in handy on camping trips, with fireplaces, and in post-apocalyptic scenarios that only a worrier like me could dream up.

You need three things to build a fire: fuel, heat and oxygen.  In the right proportions, you generate warmth and light; but, in the wrong proportions, you'll get neither.  Too much fuel and you'll smother the fire.  Too little and it will die out.  Too much heat and you'll burn right through your fuel.  Too little and you'll have no fire at all.  Too much oxygen and you'll blow the fire out.  Too little and the fire can't grow.

Building a fire is more art than science.  Having built quite a few over the last 22 years, I've learned how delicate the process can be.  It seems simple in the best conditions--just throw some paper and wood together and light it.  In the worst conditions, however--when the fuel is wet, the wind is blowing hard and it's bitterly cold--a fire can be very difficult to build and keep going.

I couldn't help but think of building a fire when reading recent articles about how to get the U.S. jobs machine pumping.  Jobs growth, which is really just a derivative of economic growth, is like fire: it requires the right ingredients in the right proportions.  The wrong ingredients in the wrong proportions will snuff it out before it can even get going. 

In the best conditions--with a well-skilled workforce, property rights, labor flexibility, and readily available capital--jobs growth will seem to occur magically.  In the worst conditions, however--a workforce trained for jobs the market doesn't need, lots of rules and regulations preventing property protection and labor flexibility, and a dearth of capital--and job growth can be difficult to impossible to build and keep going.

It seems like the real job creators of the world--financiers, businesses, entrepreneurs--have been joined by policy makers trying to "help" get the fire going.  The policy makers may mean well, but they're simply preventing the right ingredients from coming together in the right proportions.  Their incessant meddling is snuffing the fire out time and again.

Job growth requires economic growth.  Economic growth will not occur by taking money from Bobby and giving it to Billy.  Nor will it occur by printing money.  Real growth occurs when capital is available, property rights are protected, labor can seek its own terms, and job skills match market demand.  No magic is necessary, and jobs will grow and flourish in such conditions.

But, any attempt to meddle with ingredients or proportions, especially in bad economic conditions like we're in, and you'll see unemployment continue to stagnate or climb.  If you want real--instead of illusory--job growth, its time to get policy makers out of the way.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.