Roubini is a hoot: Stag-Deflation

You gotta love this guy.

Roubini, says out loud what is on a lot of minds, here it is, I give you... the STAG-DEFLATION. Where the economy stagnates and the assets deflate, as monetary volumes shrink.

Thus spoke Roubini:

The financial wildfire has turned around the stagflationary trends seen earlier this year into a vicious cycle of global deflation in debt, assets, wages, and goods. Headline consumer inflation has peaked in most of the developed and emerging world, except in places where food/fuel subsidies were recently rolled back or post-Q3 data are still unavailable. According to the IMF’s October World Economic Outlook, the world’s average consumer prices have increased 6.2% y/y Q2 2008. JPMorgan expects world CPI inflation to slow to 2.6% y/y Q2 2009. Lower commodity prices subdued headline inflation and are expected to continue doing so on slackening global demand. Core inflation has yet to show a significant decline but a feedback loop of debt deflation, asset deflation, commodity deflation, wage deflation, and slower global growth will likely lead to flat or lower headline and core consumer and producer prices in Q4 2008 through 2009. But in the short- to medium-term, stag-deflation seems the most likely scenario for the world economy.



The continued fall of U.S. house prices has morphed into global de-leveraging, which threatens to spark global deflation. Debt deflation at first sent investors seeking safety in commodities as inflation accelerated worldwide due to the weakening dollar. The dollar weakened as the world seemed resilient to the U.S. slowdown. But the lag between U.S. growth and growth in the rest of the world soon ended and so did the lag between growth and inflation.

But fear not, gentle people. The government is on the case and helicopter Ben has $3T bags to drop. At that level the needs at home would be so great they would dwarf the war economy. Make finance not war.

The question is, what does the monetary mass want to do? does it want to deleverage? the micro picture says yes, quite violently, see the hedge funds for example. Can the US government maintain its monetary supply constant? Many argue that it is already outside the purview of the FED and the Treasury, the private markets set money levels.

Then the question becomes "how much shock absorption can the government provide?" and the answer to that is "quite a bunch". US: 14T/yr, even at a DEPRESSED 10T/yr a bill of 5T is manageable over a long period of time. Say 10 years. That would be 5% of GDP for 10 years. That's a big number but a whole lot of dough that is going to flood the US.

Now remember that a reduction in money levels will set prices almost linearly. So a reduction of 25% in money levels will give us a 10T economy. GDP -25%??? In money levels, yes.

The Tesla saga: delay S, sell drivetrain, deliver Roadster

For those of you that ask about the Tesla, on the blog and privately, here is the low-down. The following is a letter sent by Elon Musk to all customers. I am customer #264, and I am semi-glad to know he cares.

These are extraordinary times. The global financial system has gone through the worst crisis since the Great Depression, and the effects are only beginning to wind their way through every facet of the economy. It’s not an understatement to say that nearly every business will be impacted by what has unfolded in the past weeks, and this is true for Silicon Valley as well.

At Tesla, we have decided that the wise course of action is to focus on our two revenue producing business lines - the Roadster and powertrain sales to other car companies. In the Roadster, Tesla has a unique product with a large order book that continues to grow, despite softness in the automobile sector. Our powertrain business is profitable today and is also growing rapidly.

Our goal as a company is to be cash-flow positive within six to nine months. To do so, we must continue to ramp up our production rate, improve Roadster contribution margin and reduce operating expenses. At the same time, we must maintain high production quality and excellent customer service.

For this critical phase of the company, the scope of my role at Tesla will expand from executive chairman and product architect to CEO. With SpaceX now having reached orbit and about to enter its third year of profitability, I can afford to increase time allocated to Tesla. Ze’ev Drori, who has made extraordinary progress with the company over the last year as CEO, will stay on the board of directors as vice-chairman and continue to help Tesla make the right decisions. It has been and will continue to be a pleasure and an honor working with Ze’ev.

Special Forces Philosophy and Consolidation of Operations

One of the steps I will be taking is raising the performance bar at Tesla to a very high level, which will result in a modest reduction in near term headcount. To be clear, this doesn’t mean that the people that depart Tesla for this reason wouldn’t be considered good performers at most companies – almost all would. However, I believe Tesla must adhere more closely to a special forces philosophy at this stage of its life if we aspire to become one of the great car companies of the 21st century.

There will also be some headcount reduction due to consolidation of operations. In anticipation of moving vehicle engineering to our new HQ in San Jose, we are ramping down and will close our Rochester Hills office near Detroit. Good communication, tightly knit engineering and a common company culture are of paramount importance as Tesla grows.

What Does This Mean for the Model S?

Tesla is absolutely committed to development of our next generation vehicle, to be unveiled early next year. However, we are going to reduce activity on detailed production engineering, tooling and commitments to suppliers until our Department of Energy loan guarantee becomes effective.

The DOE loan guarantee will cover most of the Model S program at a very low cost of capital compared with raising equity financing in what could quaintly be described as a “bear market.” The loan funding can only be drawn down after we receive environmental approval for our new 89-acre consolidated headquarters in the city of San Jose. If all goes reasonably well, we will receive that approval in Q2 next year.

The net result will be a delay in start of production of the Model S of roughly six months to mid-2011. On the plus side, we will spend the extra time refining the vehicle design and powertrain technology, so the car will end up being slightly better.

Financing

The Tesla investors and I are unequivocally dedicated to ensuring the success of Tesla. Please know that I personally stand behind delivering a product that you will love and continuing to develop new models in the future. We are not far from being cash flow positive, but, even if that threshold ends up being further than expected, I will do whatever is needed to ensure that Tesla has more than sufficient capital to get there.

I’d like to thank you, as a loyal customer of Tesla that has stood by us through thick and thin. Beyond delivering a great Roadster, Tesla will find other ways to reward that loyalty, including among other things an exclusive preview of our upcoming Model S sedan.

Should you have any questions about the actions Tesla is taking in these extraordinary times please contact me directly at xxx.

Elon Musk

The bottom line is
0- cash flow negative but getting closer to CF0.
1- I didn't know that selling the drivetrain was a line of business. Good news.
2- waiting for DoE financing. DoE loans are cheaper than private debt (is he talking about equity?), I also believe private equity has evaporated.
3- Focusing on the Roadster, delaying Model S until loan is here, S always felt like a stretch for such a small company.
4- Elon makes promises that capital needed will be there (?), capital needed for what? my roadster, the S?

The model S always worried because it felt like a lack of focus but I didn't mind as long as I got my car. Elon seems to be a controversial figure as a CEO, but I hope he can pull this through. Plus hey, I like controversial founders ;)

Can't wait for the Tesla

I am supposed to get it in early 2009. I am 200 something in line and something like 35 have been delivered? I believe I will actually get the car.

Kicker is I can't drive the car in Madrid. It is not street legal yet. It is such a perfect car for this city too. Silent, green, fast. I can see the whole fleet of taxis in Madrid redeployed replaced by these. Consider that current range is 500km on a charge, a typical taxi in MAD does below 200km.

So the car will stay in the US and will be enjoyed by family and friends :) and me on occasions.

Oil: FT says scarcity is here

Emphasis for the next president would be Energy policy. Make Research Not War.

Thug vs Thug: Porsche 1, Hedge Funds: 0

The latest drama is fun.

VW became the largest company in the world, in terms of market cap, ahead of EXXON on a little financial market coup d'etat orchestrated by Porsche.

Apparently VW stocks was on the way down, I don't know the details but many Hedge Funds (HF) were short the position. Fine. The price goes down.

Porsche starts buying the anonymous float (and probably some private too?), but the point is they build a 73% market share without many people noticing. In the US you would need disclosure after 10% or so.

Point is, that many HF wake up and realize that their short position is about to lose a lot of money. So what do they do? those idiots? they short cover all together, which means they buy the stock to cover the short.

The stock zooms up, by a full multiplier and overtakes EXXON. Porsche makes A KILLING in the process and has robbed the city robbers to the tune of "potentially $30B". Not bad for a days worth of work.

PS: hey, psst Porsche! With those new-found riches, I would go buy "Tesla" and give us all the electric Porsche. I would go for it in many colors. A new generation of super-cars awaits.

DOW up 888 points

actually 889, up to 9000. Second best day ever in absolute numbers. Expect more volatility in the band 7-9. The gyrations are enough to snap your neck.

I am following 3 threads: 1/ continuing housing slump, this is the one variable that drives much of it. Negative equity in real estate is a big source of the bad debt 2/ interbank lending? bank lending? saw reports that the White House is telling banks to lend, lend, lend, too bad no one listens to what monkey boy has to say anymore. 3/ the damage in the real economy. The theory that the crisis would be contained has been blown to pieces last spring, but what is the real tally. By all accounts the beast we are fighting weighs in the multi-trillion dollar damage range. Pretty big, but manageable.

Dow movements are just noise on top of a baseline. The baseline is depressed earnings (#3 taking hold) and the noise is violent money flows from the shadow system (hedge funds deleveraging) which will amplify any movement on thinly traded securities.

The 8000 floor seems to be holding well, so far.

Good cartoon: 7 sins

It doesn't really need commentary, but... it shows that this crisis is indeed a proof that human character doesn't really change much. The sins where there 1000 of years ago, it took 3 generations for us to forget the lessons of the Great Depression in finance (too much debt).

To me it means that mankind is incapable of learning certain things. Certain knowledge just disappears. The 'sins' are really character traits that will always re-emerge . These traits have been with us all along and are not changing.

Yet they are hardly 'deadly'. Even in the presence of those sins we have not yet eliminated our kind. In fact I would argue that some of those traits, say like pride or greed push us to action. Perhaps some of our boom and bust dynamics of doing things is a result of those psychological traits of our characters. Who knows.

Here is to financial regulation, a real-life realization that the originate to securitize model of the investment banks could not, would not auto-regulate. Sometimes market forces push for blow-ups like the spectacular one we have seen in subprime. I would argue that some of what happened there was criminal.

Too much debt kills debt. Setting debt levels must not be left to the private sector. Monetary levels must be better controlled by public sector.

One money, one world.

Macro think: Demography

The thing I keep trying to interpret is the fact that growth in the equity markets seems to have behaved linearly. A linear growth is normal for large bodies. Exponential growth is expected for small bodies, linear is recommended for mature economies.

In the very long run, growth that is infinite doesn't mean anything. Growth has to stop somewhere, at the optimal exploitation of produced and existing/renewable resources. In the meantime it seems to be a factor of demography.

If a human being can produce X then the GDP is X times N the number of people in the economy and the GDP, at X constant grows with demography.

Lately we have been seeing fake growth coming from monetary levels. Growth in this case was nothing more than INFLATION. We have been living in a era of hyper-inflation (95-now) via asset bubbles. We have been conditioned to think about inflation in terms of CPI, which is misleading. Inflation of assets, increases the gap between haves and have nots. That's it. Nothing more. Do you remember the day you realized you could not afford a house as a first time buyer? I do. That is what I am talking about.

Growth has to be growth of production, growth of monetary mass, is NOT growth. Demography is the real mass that grows and it's growth could very well be slightly under linear with efficiency helping out a bit.

Growth for the sake of growth is an ideology.

Macro think: debt

I am noodling about this delevering thing. Consumer spending is 14T a year in the US. Basically the US consumes what it produces (by definition of money) and then some. The "some" part is of course debt on the future which means that our children will have to spend what they produce minus the some payments. Please note that in this case I am talking about debt that fuels consumption, debt that fuels production is a different beast as it increases GDP and creates positive net present value.

If we were at 106 of GDP, then (bar inflation) we will need to be at 99 of GDP (100-6/6 assuming we repay over 6 years on average). With a little bit of saving juice on the way down (suckers like me) we may see spending on the order of 97%.

In a economy that produces 100, that will leave a shortfall of 3% for a few years. That is a contraction to be sure, a recession to be sure. Remember these are back of the mouse numbers, see real economist for something else than "order of magnitude" talk.

Keynes all of the sudden is back in style. Keynes is dubbed the "savior of capitalism". Let the government spend freely in things that matter because if we let the average joe the plumber spend the money, he will do a pretty crappy job at it. Yes a new SUV for mom! a hummer! yes!

Let's shun out of control consumption and invest in roads, infrastructure, energy research and above all, above all, education. Those are immediate investments that will pay off handsomely in the future. We will reap the rewards of education and energy in particular in spades. Luckily Obama seems bent on boosting education. Go Obama! I hate the fact he is going to raise my taxes (yes I make more than joe the plumber) but it is time for a new realism when dealing with public and private debt.

So what is WarrenB saying anyway?

He said that cash being a debt is trash in the long run. In a capitalist system, capital that isn't working is just delaying claims on the future while not helping in future production. Savings is a ponzi scheme?

In a cosmic view of the long-run we are all dead anyway, but paper not put to work doesn't produce anything. Try planting a bill, will you see a tree?

If there are more claims than there is production in the future then your paper is worth less. Monetary inflation makes cash trash, is a valid way to read what he is saying.

But investing the money is what Mr B wants you to do. Whether you do that in equities, like he did, or in fixed income, say municipal bonds or CDs is really up to you. Cash under your mattress is trash. Paper doesn't make paper.

Oh and btw I am of the dogmatic conviction that banks should not be paid for deposits with the central banks, because this is paper making itself and growing its mass without productive use. These payments should stop immediately. Cash hoarding is killing them everyone, the banks included.

In a capitalist society, capital that is not working is dead weight. Capital that is not working IS trash.

Don't keep cash under the mattress, put it to work somewhere.

DOW 5000, Fibonacci analysis

On the way down, Fibonacci reads 13 to 8 to 5. Sounds familiar?

Our innate sense of numbers and proportion would put the next floor of resistance at 5000. Let's hope 8000 holds. Don't bet on it at this point unless you are Warren.

Remember technical analysis may be just a view of the mind.

This was counterparty surveillance

The best image I can come up with to explain "the failure of counterparty surveillance" is the picture of group skydiving. I got you, you got me... what can go wrong.

When everyone was falling to ground, everyone else saw everyone stable relative to themselves. Unaware of the bigger risk, banks just kept on holding to each other.

FED to cut rates? Irrelevant

with FED fund rates at 1.5% what the FED does at this point is completely irrelevant.

I hope they don't cut, it won't change anything and there will be many many days like this one. But the FED is out of half points.

It is irrelevant if they do it, irrelevant if they don't. Bottom line it is completely irrelevant what they do.

Shame too.

Round 2 equities.

Equities are taking another big hit. Pointing at DOW7000's as a stable floor. Futures down 500 freezing markets for today. The US hasn't opened yet.

Roubini makes the prediction that market trading will be suspended overnight or for weeks at a time on a regular basis going forward just to make sure panic loops are stretched out. Welcome to the martial law in the markets?

And when you think about it, this is yet another wave of delevering. The press openly calls Hedge Funds de-levering this time around. Yeah more vomit.

If you believe in a fundamental band of 7000-9000 DOW stability. Stocks will probably swing to 7000 which would only take 3 days like this one. There must be stability at 5000. Calling the game on the way down, seems to work by steps. My brother was saying something about fibonacci levels of support during psychological markets. In the case of the eurodol for example next level of support was parity (1.0). If anyone has insights as to why levels of support show up spaced as a fibonnacci series, they must be psychological, anyone?

Extreme volatility is the norm. In a narrow band, every news, every big money movement, has serious impact. Bad weather is the norm. Brace yourselves, the deck gets washed and washed. This is going to go on for a long time and days like this one will be plenty.

Greenspan's mistake

Greenspan says he made a mistake by believing that public regulation was not necessary and only private entities rules need apply. In particular he says that "counter-party risk management" clearly was not existent. He points to sub-prime mortgage as an industry that showed serious systemic issues.

Self-regulation had become self-dealing. Greenspan then admits that his long held view in the power of deregulation had just been proven invalid. In other words, Greenspan has jumped ship. In his book he laments future crisis for they will bring back knee-jerk reactions of regulation.

Even if this late game endorsement is kind of irrelevant, it is courageous for Mr Greenspan to publicly admit to non-obvious mistakes.

FT seriously bullish on economy

In a series of editorials and comments, the FT is trying to appease is readership. The message seems to be "stop panicking".

Lately a commentary about the real cost of the bailouts to tax-payers, and another one on the wishful and non-existent world decoupling, both underline the scenario whereby our high-income economies are too big to be taken down. Slowdown and recessions yes, Depression no.

They point out that a 30% drop in money supply (liquidity) is what really dragged the world into the Great Depression, whereas the authorities are making sure that there is plenty of that nowadays. Money quote

But as far as the citizen is concerned the “cost” is what he or she might have to suffer in terms of future increases in the tax burden or lower public expenditure on tangibles such as schools and hospitals, to pay for rescue measures. The answer is; very little if anything over the next couple of years and perhaps not very much looking even further ahead. The limit to any stimulus is given not by accountancy, but the point at which rising inflation is again a danger.

Got that? The discussions on taxes is irrelevant. Truth is the US could do with no taxes at all, zero and just print the money. The limit of that mechanism is that flows must not trigger inflation. The net result will NOT be a drop in money supply but a shifting from opaque debt in the shadow banking system to transparent debt in the public sector. Transparency is good.

Long term, given that 3T is peanuts, the downside is real lost output due to non-maximized demand. But that is it according to these editorials. Friedman and Keynes are mentioned a lot these days. Public deficit is inevitable and desirable, in a deflationary debt destruction, the govts can play debt reallocation by printing new money and enforcing liquidity levels.

Does this means better schools and roads for everyone? Maybe, right now a lot of it is going to financial institutions, money markets, and maybe stricken mortgages. It also means that there is so much to be done AT HOME in terms of public investment, the war economy is a burden.

Liquidity hoarding, the USD bull case

The USD is staging a dramatic rally against the EUR.

Analysis says there is liquidity hoarding in the markets. So there is plenty of dollars but people stay in cash. Offer of dollars goes down. Demand for dollars is a fairly constant thing, for example with all oil being $ denominated. I don't buy that demand for dollar assets is going up, but rather that investment is retracting to local plays.

So offer is going down and demand is staying up so dollar is rallying short term. Long term, I am of the opinion that monetary levels are still the fundamental and it may be that the supply put in place by the US finally flood the markets.

The bottleneck still rests with the banks, from the FT this morning, one of the reasons is that the Govt pay an interest on cash held by the bank treasuries with the central banks and therefore the banks have little incentive to lend the money out.

The point is that if a particular bank’s treasury executives know that interest can be earned on a balance at the central bank they are under less pressure to lend out that cash to other banks.

The USD rally may be a result of this structural constipation.

MMIFF was her name

The Federal Reserve Board on Tuesday announced the creation of the Money Market Investor Funding Facility (MMIFF), which will support a private-sector initiative designed to provide liquidity to U.S. money market investors.

And MMIFF has big fat dollar bags that will milk the markets with liquidity for years to come. She carries double T. More importantly, she is fast, agile, she knows kung-fu.

In a very Japanese anime way, the MMIFF is facing the shadow banking beast. At least we have seen it, we have measured it, or so we think with an ease in credit spreads, to be a multi-T based beast, it is still moving fast, but I for one, find the current administration to have proven somewhat capable and nimble. Good for everyone.

They may have bungled Katrina, but for Shadow banking beast (yet to be named) they were almost ready!

Credit markets are easing

In signs that the dramatic government intervention is finally taking hold, there is an increasing number of reports that say that conditions in the credit markets are improving.

They see a narrowing of spreads and hence a rebirth of the market.

Not so long ago the spread between bid and ask was so large (200bips for large banking institutions) there was no market.

Bottom line, this is good. We can narrow the spread. The beast has been slowed down if temporarily, to the tune of 3T.

In it is that order of magnitude, and that is the good news. Remember the US economy alone packs a healthy 14T run-rate. A 5% tax increase would take 4 years to reimburse such a debt.

In that optic I am long US of A. Bring it on, you fat 5T big baby, bring it on!

Banks are wards of state

I realize my previous statement was not entirely clear about the banks. The banks are transmission mechanisms of debt into the system. They have proved riddled with self-regulation issues. When it came to setting optimal monetary levels in the market, the unregulated banks exploded like mosquitos too full of blood.

Unregulated finance, my ass.

Touching the debt supply, and thereby setting monetary levels, proves to be something that should be violently regulated from the core and the public institutions. Banks cannot have equity structures that reward their executives or you read non-sense from white dough boy below on the screen.

It follows that leverage is something that must be TIGHTLY regulated in the shadow banking system. Investment banks should see the amount of risk they can individually dump into the system regulated. They were polluters. With securitization markets shut down, they are not going anywhere either. They cannot dump their waste assets on investors any longer. Thank God for that.

Someone quickly legislate this guy into oblivion

This is the kind of thing that makes me mad. The head of JPM goes on and says "we will not lend the money the govt has given us".

THEN WHY THE FUCK DO WE GIVE IT TO YOU IN THE FIRST PLACE YOU STUPID M@THERFXCKER?

In his defense he is protecting the interests of his shareholders and this is another reason I am slowly gravitating towards the opinion that

BANKS CANNOT BE PUBLICLY OWNED ENTITIES.

And in my own paranoid opinion, one of the big reasons we are in this mess in the first place.

Oil at $69

That's the way, huh huh, huh huh, I like it huh huh huh huh

LIBOR is a transmission mechanism

The shadow banking world is finding a way to the real economy. Not only is it wracking havoc on money markets and thus hurting the investment capability of our economy, by way of the LIBOR it is levying a large tax on the economy.

A back of the spreadsheet calculation is that the increase in LIBOR, which controls an estimate 300T of contracts, will result in higher payment on the order of $1T damage on the economy.

If the US economy is in dire straights this is cost that will go to banks but will heavily tax the economy. Remember that the cause for the Great Depression wasn't so much the crash of 29 as it was the mis-steps in the 30's that put too many demands on banks and the economy.

LIBOR is also set in opaque ways by banks who announce what they would like to be paid for their loans. Of late, that number has been reset higher, way higher, and EVERYONE will feel the pinch.

KILL LIBOR NOW!!! LIBOR IS ARBITRARY SINCE THE BANKS DON"T DO LENDING ANYMORE ANYWAY THIS MUST BE LEGISLATED IN SHORT ORDER.

FT this morning: Hedge FUN

It is in the FT this morning. They blame the HF industry for the wild price swings and the VIX action lately. This is the death spiral in earnest. Remember as they delever 10% to lower their debt/assets ratio, the ratio actually goes UP because by selling and delevering the prices go down 15%. Got it?

If it is in the front page of the FT, its got to be over right?

Maybe. Citadel is rumored to be barfing in the markets, which explains yesterday volatility (intraday 10% swing!) and shows a strong resistance of bulls. There is NO capitulation here, this is still an optimistic market. Also in related news, Funds of Funds faced dramatic redemption lately adding to this pressure.

We will see. I am thinking this is not over and I don't need to be exposed while we figure out if it is over. Buy and hold is dead.

Technical investment themes

I am 80% cash have been for 6 mo or so. I am now 85% cash, not because I moved out of equities (EQ) but because they lost a ton of value in the past few days.

Which leaves me thinking. Is it time to get back in EQ or out for good and just go fixed income? CD's in EU are yielding 600 bips. They can be unsecured (in my case they are) which adds a bit to the stress.

One approach is to create synthetic EQ exposure is based on current volatility levels (VIX). With VIX flirting with 80. You may want to SELL regular option (puts to get in, calls to get out) and leg into the market that way. You may want to BUY knock-out options and create synthetic exposure this way. The difference with regular and KO is reverse correlation with volatility.

Trade at your own risk, last time I did this, with VIX at 35, my personal portfolio of options, went to ZERO a couple of weeks ago when the VIX hit 60 (I was KO options only, my mistake). Not lost 5 or 10 or 30% but lost 100%. Think cash flow off the principal in safe muni or CD and invest that proceed to lever up, that is what a structured note is by the way, minus the fees all the piggies in the middle take. Do it on liquid securities like SPOOS and other indexes. Narrow down to boost risk profile.

Nothing is full-proof.

Monetary levels since depression

The timescale is 1910-now and includes the Great Depression.
Obviously we are all hoping that the fall is nothing like the old one. We are crying for our MOTHERS on the way up, imagine what it will be on the way down. Scary part is you can see the 2 credit bubbles, mid-90 and now. They are recent and blew us up in a jiffy.

History: DOW mean 2010 is 7000?

I am recycling old material as (via Eve) it is now a story in Bloomberg. The picture above shows clear signal on a linear scale. It shows garbage on a log scale.

Here is the log view of 80-now.



It is as if the log scale doesn't convey the information as clearly.

When you see it in linear you see all growth, corrections included, sums up to linear growth. Why is this news?

Very simply because if it were real growth, real growth usually manifests itself with a straight line on log. It is the very definition of log actually since the mathematical definition is that the growth equals a fraction of the whole and that resolves in a exponential.

The point is that it isn't there.

It shows up linear however, and that's news. SOMETHING has been growing linearly lately for the past 30 years and it isn't all growth. Could it be the money supply? WIth a narrow focus on CPI, have we missed the obvious that asset prices were going up in a inflationary signal of monetary levels?

That is what the anemic linear scale tells us. And if you want to look really closely at the log you will start seeing, not a straight line, but in fact, an arc.

Is the beast stuned? Nightmare is back

Just when I was looking for signs of the shadow beast being stunned by the latest kung-fu moves from the govt it rips the markets a new one. Not good.

Saving the Banks: 3 actions

1- Buy stricken commodities (TARP original) and set a price in the markets. This price will trigger systemic trust in valuations. This will help restart the credit markets.

2- Equity Injection (TARP extended). Take preferred participation alongside private interest to ensure arm's length dealing and recapitalize the banking system with up to $250B. This will translate, if properly enforced at banks, into 2.5T liquidity available for lending. This will help restart the credit markets.

3- Guarantee debts in the credit markets. To make sure step one and step two restart the credit markets, guarantee the debt taken on by the banks and reduce counter-party risk.

These are all coordinated move. The US and EU are following suit to the brave if puny Bank of England. Smart boys leading the way. Hopefully this is enough to stun the shadow banking beast and stop it in its track if only temporarily. Already the markets have stabilized. At least we bought time. Time is expensive. Time is money.

A word in for MGS4

MetalGearSolid 4 is a great game. I too vote for it. For those of you who want to take some time off, this is a good game.

I wasn't a big fan of the series but this one, 4, is very good.

The story is really a movie, with a thick SF book plot. Essentially warfare is an economic proposition, the war economy is essentially a short on a existing economy. The troops are all linked in a classic japanese net based operations. It is well done, even though I am seriously warming up to the format of watching a movie with some killer fight scenes in it. The evasion is good and it works, you get into character. It reminded me of a well done Assassin's Creed for the fluidity of movement. Favorite weapon, stun gun. Deadly effective and silent.

Treat yourselves. Those of you that still don't have the latest generation hardware be it Sony or MSFT, go get it. I will even put in a word for the Wii, Mario is fun, I am liking it! It is a good time to be gaming what with the recession and all. I go long Gaming!

Money. M3 Style.

Money is but debt. Debt in the government that issued the money. The government represents the mass through taxation. The money is a bond you can redeem against the state and good for "all debt, public and private".

Therefore the definition of money is debt and measuring the aggregate debt levels, and therefore the amount of liquidity in the system, is what economists do when they talk about M3 levels. I think of it as a big volume of air.

All debt is equivalent to money. Debt level are therefore money levels and money levels control the face value of things. Monetary inflation or deflation are levers at the disposal of the FED for example. Controlling the amount of money supply is what the FED wants to do. However that control has partially been taken by the private sector and that lever has been activated by it of lately like the proverbial rabbit pushing the cocaine paddle until it dies.

Securitization has been a key innovation in moving those liabilities off balance, replacing them with cash and rinsing all over again, in a semi perpetual movement machine where the shadow banking system can almost set monetary levels by itself.

Money levels were left to be set by private interest. Believing an "invisible hand" emergent property would apply to this lot may have been our failure. Invisible hand is an emergent property that may appear in idealized systems, usually with many participants, as opposed to the highly conflicted few investment banks that devised the products in the first place and flooded the market with them.

With an incentive indexed on the volumes of business and money flowing through the system (hedge 2/20 incentive anyone?) , it was the interest of the investment banks to flood the shadow banking system with liquidity. And for the shadow entities to be little piggies at the trough. Self regulation of individuals was non existent and resulted in immediate death of the investment banks. Everyone had failed, why let Lehman fail???

Money is debt and money is going down. Money in the shape of debt. If that debt is invested in liquid instruments then good, if not you redeem said debt and unwind investments. The whole borrow short lend long service is so investments do not get bothered by this kind of movement. Yet there it is. As Krugman pointed out once, the problem with this dynamic is that if the context is nasty enough, unwinding debt to lower cash to asset ratios adds so much pressure on selling that assets go down faster than cash is raised. At that point, even trying to lower the ratios has the nasty effect of raising it. We were there last thing I think. The markets lost $8T... 8T is enough to snap the hedge industry (2 I read recently) in half. Mark to paulson will reset a lot of balance sheets, a good mark to market temporary suspension until pricing is applied.

Debt has been lost. Here is debt that materialized into real money that will never be recaptured. Money supply will not go down to zero as all bad debt has been transformed into free floating hard cash. Cash is but the residual form of bad debt written off, they are orphaned bonds. Yet they carry cash value.

By buying stricken assets, the governments provides transparency on the worth of assets that were up until then not priced or thinly priced. Hope here is to restart the credit markets. Second move is to buy preferred equity. So that Neel Kashkari, the 35 year old robot from Goldman, is walking around with a few trillion of goodies, courtesy of Hank.

Paul Krugman gets Nobel

One of my favorite reads, Paul Krugman over at the NYTimes just got the Nobel in economics. I always thought his writings were the best, very clear, very concise. A more powerful way of explaining.

From comments: Nuke some petrodollars?

From the comments a paranoid scenario submitted by PCLeddy. The name of the game is: selectively reimburse US debt.

Imagine: The FED creates a "new dollar". It pays its debt only on new dollars not the old dollars one. The new dollar is bought with old dollars. The price you will see depends on who you are. The government will not honor its debt with selective targets, I don't know, say Chavez could be left out for example. Something tells me this is how we all make good with Russia, which itself defaulted on its bonds in 1907. Here the us honors its debts selectively.

It is an interesting scenario. A few things come to mind.

This will be done only if China is aligned. There is a symbiotic relationship as China produces and US shops.
Only if the US energy needs on the inside are met. US economy is gas guzzling. We consume the most by a lot. The international community can turn off the spigot.
Oil below $90 nukes Chavez anyway.
Let's say the payments with Russia are kept in old dollars and redeemed for new dollars with variable pay as you go basis. This is a way to make sure the bear doesn't misbehave too much. He also has nuclear weapons, remember MAD.
This would trigger FFWW (First Financial World War).
It is very very paranoid

WHAT A WEEK

In what is described as the WORST WEEK EVER, we finish an epic 5 days.

Wow, every day -7. It has been a fascinating thing.

In the usual blogs I read you can feel the weariness, the confusion. Commentary is starting to make some sense at last.

This was it, this was the big one we had been waiting for.

There it is: US buys bank stakes

in what is described as a first since the great depression. The TARP is being put to good use. Remember $1 from TARP translates into $10 liquidity if invested as capital in banks. Hopefully this will prompt the banks to start lending again, by force if needed, instead of just putting it back in US Treasuries :)

Nationalize Banks: the holder of last resort

From the FT, a conclusion: states must nationalize their big banks now.

Banks borrow short and lend long. The short part is tough and so they don't hold to illiquid assets that are long or even mid-term. There is simply no credit markets right now.

The Level 3 assets (L3) are supposed to be long term assets that one invests in and can sit on to ride out volatility and reap the rewards of economic value creation. The debt that enables these investments is a good thing.

Without debt and L3 holding there can be, very simply, no growth in a economy. Capital preservation by liquidity hording is not a long term strategy, not even mid-term. It is a short term feral preservation mechanism. But from a galactic perspective, you are just holding on to bits in a computer, thinking they are worth something beyond the disk electrons that represent them.

When all else fails, the governments are L3 holders of last resort. They should be paid handsomely for that service (see TARP ongoing discussions for an example).

Let's nationalize the banking system and go home, yeah?

Software industry, up or down?

As I visit some old friends from my JBoss days a lot of them ask me what the whole crash means for them.

Here are some back of the envelope factors.

Negative. IT is a servant of the financial industry. Conventional wisdom says that there is no way but down. Consider SUN valued at a paltry 3.8B with 3B of cash. It is a poster child. Private equity and management should take out this company. Who's got $800M? anyone? I should leverage right now with a few private equity friends and go buy it out...

Very Negative. Widely known dirty secret of the software industry is that earnings were 30% investment revenues. These are now strongly negative but probably wont be realized. Nevertheless that is a drop in 30% in earnings, possibly more as the markets tank. If you realize a -20 when you were clocking +10 then the hit on earnings is -60%. Ouch... RHT was trading at 24 this summer it is now at 13... yep, numbers work out.

Very positive. With all the banking consolidation going on, plus the amount of regulation that will surely rain on this activity, my software integrator friends will be busy for many, many, many years to come.

When the first financial world war (FFWW) is over and the bombers have stopped levering the field we will need to rebuild. The software skills, the integration skills will come in handy. There is a bright future for my friends. And I feel good about that.

From an investor standpoint. Adjust Cash flows on the way down. Look for maintenance revenue. In a crash like this people will not pay new licenses but will certainly continue paying maintenance. Buy Oracle, Short MSFT. IBM should fare well in the long run (services).

Erasing the bubbles: DOW 6000-8000

Grasping at straws for meaning here.

I am going "technical analysis" an exercise normally left to witches and market exorcists.

Went and plotted the 1929 dow signature. Click on it for larger picture. The important thing is that the scale is 1928-1955



DOW went from 400 to 50 that is a 7/8th reduction which in our case would mean DOW 1750. I just don't buy it. While the reason for our problems are the same, namely over lever, the remedies are much better today.

A recession can be entrenched however. It could go on for a LONG time. See how the DOW regained previous peak 25 years later. Today, it may mean 10 years? DOW 15000 in 2020?

The following time line is 95-08


Next you can clearly see the two bubbles in these shapes. Notice how the curve is very smooth up to 95 and then volatility kicks in at the dotcom boom: too much liquidity, too much money moving too fast, a sign of speculation? too much liquidity? computers? jittery coked-up investors?

95-00 the dot com bubble. 01-08 the housing bubble. If you mentally erase the bubbles, and project the line from 90-95 which was very STABLE, you get DOW 8000. If you assume overshooting on the way down, which is very likely, we may be staring at DOW 6000.

WERE WE JUST LOOKING AT MONETARY INFLATION OF ASSET PRICES THE WHOLE TIME, and nothing more? what a depressing thought. Coming from the IT industry, I believe that productivity gains were real since the mid 90's, so let's give them a round of applause and extra 10%, which gives us a stable position at 9000. Overshoot 6, stable 9. 8.5 is just the beginning then?

Ouch. Wait for it, wait for it.

TARP to buy bank preferred

Coverage in the FT this morning. If 700B of assets is peanuts compared to the 5T that are being vomited in the markets by various shadow funds, 300B in bank capital will translate into 3T liquidity.

Now we are talking.

Hank and Ben are starting to make a whole lot of sense. I hope the govt gets a killer deal as it saves our miserable peed on collective pants. Think Buffet or better. Make the trade of the century.

Dow 8500

Well, I called it yesterday "by the end of 2008" and it is here today.

I got to admit, for the first time since this whole debacle started, I am scared.

I do not believe this is the end of delevering either, the shadow banking beast is continuing its epic run. The Hedge Funds, the regular funds are all facing massive redemptions and are barfing in the markets. You know when you are really drunk and you just barf and barf and barf sitting miserably by the toilet? wishing you were dead?

It cannot go on for ever. I am sort of ready, I was joking at dinner with friends that if it gets to 8500 i would go back in... then it hit 8500. I am going to leg back in and see what happens to my leg.

OpenRemote reaches 200 members

it may be nothing to many of you out there but for us it is a giant leap :)

OR has just reached 200 registered members. The quality of subscriptions is very high. Reminds me of the original 300 over at JBoss.

What I really wanted to validate is that OSS is indeed a useful approach. It is not a given. For example OSS may not be very relevant to crude oil production or the woes of the hedge fund industry.

For HA it is however very relevant. All participants passionately believe that OSS can help. With releases like Beehive, we are trying to prove the point that open collaboration can easily bring about positive changes to a historically fragmented industry. There is a lot of passion and knowledge be it with hobbyist and professionals. I had one pro tell me privately that he would monitor the group just for "competitive threat intelligence". I like to think we will actually help him, but that is for us to prove, isn't it!

Not all lessons of JBoss are portable to OR. Many things to do not translate. Most notably the distribution network. Today's distribution network in HA is installer centric. Crestron for example, leaves 60% of its price on the table for installers to make a living. The promise of cheap hardware and software is viewed with justified worry by many professionals. I am sure the key in getting everyone to agree is in increased productivity for the installers, so they don't need that big a margin and can migrate profitably to mid-market. As this happens, via tools and frameworks and hardware, you will see the emergence of the mega-integrator. Like the PC went from cottage industry to mass.

It is a hot field. The passion is there, the business is interesting. OSS presents its own set of challenges, mostly free software related, duh!

Hedge Fun in the markets?

I analyze the sharp drops in the markets in spite of the TARP announcements as the result of monetary delevering in the shadow banking system, specifically the highly levered hedge fund industry. At best, the hedge fund industry is an optimizer of financial allocation by taking many possible bets in the posible world, at worst is just another over-levered pork that will suffer a quick cutting back down to size amid the most violent credit contraction we have known in years. Heck according to some blog rumors, even money markets are feeling the pinch of panic.

Hedge funds are facing massive losses and radip redemptions. They try to freeze their customers assets! In any case, the Hedge Funds are facing a full blown run on their assets. They will be the first agent of massive and rapid delevering in the markets. So they have to sell their positions further depressing the markets. The TARP will help stabilize this as they now have authorization to buy all kinds of commercial paper out there. But in a industry that is probably $10T, the delevering will mean a new HF industry at $5T? $2T? a further dumping of $5T assets is quickly going to overflow the TARP paltry $700B. Marc Faber call for $5T maybe right on the money.

I think we need to delever. $5T is a big number. Price stability is going to be tough to keep in that environment.

This is a brutal destructive spiral on the valuations in markets. It will take out the liquidity so fast that many individual hedge funds will be caught dead in motion like the proverbial dinosaur caught in ice, the fly caught in amber, or the copulating couple taken in by the Vesuvio volcanic eruption. There is a certain "nature caught dead" or nature morte quality to it all, but the net result is unprecedented dumping on the markets and the resulting nose-dive.

And I don't think it is all over either it is just starting. The run on the shadow banking system is barely 6 weeks old? 5 weeks? ah geeze I am loosing track of time, it feels like an eternity.

I will call DOW 8500 again at 60% during 2008. DOW 7000 at 20. The rest could be volatility upside in the short term and the Buffet effect.

This kind of brutal monetary delevering will greatly depress assets and prices. Deflation?

Y tu porque no te callas

Via Eve Smith, Chavez proposes a bank to make sure the price of oil doesn't go below $90. It is there and it wants to go down, some say all the way to $50. In other words, our friendly dictator over there on that pile of shit is soon worthless to us, economically speaking.

See the problem with the fucking clown over there is that his shit economy will not work under 90 because his crude is worth shit and he needs those prices in order to cover the cost of purifying the stuff. In other words, he is fucked.

I for one, jump for joy here. That a dirt bag, arrogant, nasty piece of shit like this gentleman will quickly be drowned in his own vomit bag rejoices the heart and makes you hope for more cosmic justice. Little things like this one rejoice.

Oye Chavez! porque no te vas a tomar por el culo ya de una puta vez? Good riddance too,

Kashkari the new member of the TARP

Paulson is selecting his team to implement and manage the TARP. Latest recruit is a guy from Goldman called "Neel KashKari". What a name!!! What irony. At first I thought it was a joke. That kashkari was an imaginary robot, I mean look at the face!. You can't make stuff up like that. This is starting to read like a super-hero comic.

Of course political chorus cries GS bias as well as lack of experience in the relevant products being dealt with at the moment. From my 10,000 ft I give the Paulson/Bernanke team the benefit of the doubt. Teams are important, if you know and you trust some people, in times of crisis it is normal to fall back to known devils.

Paulson was the CEO of GS for a long time (2001-2006), it would be normal for him to handpick young talent to implement TARP. Who really wants that job? Obviously these guys should be scrutinized publicly like Britney Spears. I don't know cash and carry is kind of scary.

Europeans lack of central response, maybe irrelevant.

It is every nation for itself according to both Merkel and Sarkozy. The Germans has essentially bailed out Hypo for $65B. In times of crisis, local governments try to take precedence and those that can pay for their own rescues do so, very verbally proclaiming that they do not want their moneys to go an bail someone else out. Me first.

Sarkozy acknowledges that it is going to be every nation for itself on rescue packages for the moment and most people do not believe that the EU is capable of official action, although in the field, response seems to be quick and decisive.

Monetary levels are the link

News flow is thick and full of furry meaning nothing right now. Nature publishes research warning us that the brain is trained to kick pattern detection when under stress, usually resulting in astrology taking over analysis in the absence of rational meaning. I understand it as evolution, since a new threat pushes you to start learning again.

So I stick to basics, money levels. That basic, my brother Carlos explained it to me about a year ago, it was the notion of "money" as in M3 and that all debt was money. I had never actually thought about money, but now I did, all paper (fiat) money was ultimately debt, private or public. Quelle surprise! In retrospect I feel very silly.

For those looking for an in-depth explaining of the debt mechanism, if somewhat cynical and off the wall, I recommend this. Careful with it. Look at the Mandrake mechanism, whereby $1 deposit is turned into $10 in circulation. (Spoiler: you lend 9/10 of capital so 1 dol is lent 90c, which comes back as a deposit to the bank, which it lends 81 and so on until the sum of it all asymptotically reaches 10).

This is how the system regulates fractional lending by setting regulatory levels of debt to capital ratios. This number of 10 is then fixed by law, was established during the Great Depression as a safety and applies to regular banks, but importantly not the old iBanks and adjacent shadow banking systems who levered up to the thirties, fifties.

They were creating their own money essentially outside the control of the authorities and essentially where creating their own money levels. This has proved dangerous if left unregulated. It has come back to bite them, actually just plain destroy them in one big blow. The TARP is aimed right at the heart of that problem.

Debt is a creative force. By investing today you help create a positive economic value by summing the discounted future cash flows. The FED can and does heavily use monetary tools as it controls the source of such debt, the US Treasury debt paper.

So when it became clear that some of the promised cash flows were never actually there, what with the real estate bubble exploding, the system started choking on its own bad debt with the dramatic consequences of the last weeks. And since the bad debt has been securitized with rubber-stamped "made in wall street" AAA ratings, the rest of the world is kind of watching the spectacle of this in horror in shock.

Monetary movement is what is happening.

The Shadow Banking System (SBS) is eating its own children with a full blown run on Hedge-funds. Money markets are hit and flight to the security of Treasuries and certain bonds (EU, US Muni). The unregulated banking system was the most levered up and is disappearing quickly and dramatically.

Just like we have monetary inflation, we have monetary deflation. If we are witnessing monetary deflation by destruction of outstanding debt in the SBS. Then the good news is that governments have plenty of leeway to start running the money presses. It will take out unregulated debts in the shadowy private sector and start managing it out in the open. Replacing opaque debt by transparent one will be, in and on itself, a stabilizing factor on this crisis. The "Mark to Paulson/Bernanke" reset button on the system may very well deliver the catalysis to go through the crisis.

Price stability is the mandate of the public entities. On the way down, servicing existing debt becomes a real burden, further choking the economy. You want to use all means necessary to prevent that spiral from taking hold. Price Stability will take priority and as debt deflates in the SBS, the FED can re-inflate on the monetary in the public eye, via programs like the TARP.

Of course this scenario is threatened by the inflationary pressure of commodities which sparked a very real price increase 6 month ago. But with Oil back down to 90's, from a high of 140, are we witnessing deflationary pressures from commodities this year as well? Some are talking about a $50 barrel, further adding to the deflationary pressure.

We will see, it is very hard to make any sense of what is going on, besides the basic monetary analysis of monetary deflation.

The ME meme?

From Sacha.

1. Take a picture of yourself right now.
   
2. Don’t change your clothes, don’t fix your hair…just take a picture.
   
3. Post that picture with NO editing.
   
4. Post these instructions with your picture.
   

Quelle Surprise! Naked Capitalism is a She

Via Yves Smith, herself, a first video interview. I don't know I never thought of her as a her, it's weird...

In retrospect Yves is a french surname pronunced "Eve". Funny, clever and very fond of french apparently.

Open Remote is a KNX certified entity

I am a low-voltage programmer. Amid the madness in the markets, I got out of Madrid and flew my ass to Good Old Sussex by The Sea. At 45 min from Heathrow, it is actually a workable destination. That and it had a superb restaurant in a the form of Croucher's, so that changed my whole perception on british cooking and I had a great week.

I was going to this KNX certification by a shop called Ivory Egg. The KNX certification specifies how devices interact in distributed systems. It is a firmware layer specification that enables domotics. The devices are made of sensors, like a switch, a light sensor, an IR eye, a presence detector and of actuators, or actor that actually do things in the home (turn on lights in this configuration). They are powered by the bus (29V) and self-reliant in that they don't need a controller. OpenRemote could be middleware in this field.

You can get certification on basic features, which is a 5 day class including certification. I passed the cert with 84%, aced practice (yay!) at 47% and lost a point because I didn't write my name right in the project and 2 points because I hadn't set the timer on the blinds. Silly me. I passed the theory, with 37%, but will say that the test was tricky. Anyway, I am actually quite proud to be a certified low-voltage programmer. I can do programming magic on twisted pair :)

What started in Europe as an Industrial standardization of legacy standards is finding its way to high-end residential. Recently China became a member by way of the government implementing the Olympics on KNX. That means lights, blinds, heating, cooling, security and grouping of all of these functions if necessary.

The basic programming notion is that of groups. What is shared is some devices emit a message and others listen to that message. A Class or Type is defined by bit, 2 bit, nibble, byte, 2 bytes. And that's it. So either your devices share a critical bit together or they don't. That's is known as type-safety in the firmware world and it works well, with the ETS tool not letting you drop a device in a group that doesn't have a compatible bit signature.

The really cool part in it is that actuators listen for group signatures (of the address type, 2/3/4 for example. This way they actually publish or subscribe to a topic. It is a rather clever way to get hardware to implement publish and subscribe. The point being that you don't need a controller to have a functioning system. Your physical layout of green cables and high voltage is a working configuration. The positive way to see that is that an additional controlling layer can offer functionality without interfering with the physical setup.

For example one thing that was a bit frustrating is that in order to test any hypothesis, which is the way you normally learn, you would have to round trip through physical programming. That was a slow USB connection to the physical system. Clearly a mock object, in software that would emulate the behavior of the physical device and would let you debug your installation in a completely virtual environment would have great value in terms of productivity.

I grew a new appreciation for what KNX is and isn't. It isn't what I thought it would be, a full programming model for HA that we could implement. But what I thought it would be doesn't matter. What is important is what it is. It talks about getting devices to share bits, in a Remote Procedure Call (RPC) distributed programming model way. It is cool that it implements an RPC in firmware when you think about it. It does a good of it too. That is something.

It also would be a big market for OR to tap into. With KNX as a standard there is an ever growing community of members (I am number 29970) that implement sensors, actuators, software, services or what have you. We plan on offering something soon from OR, like an ORC manager with gateway into KNX. Program iPhones and gateway into KNX, I validated with the teacher that it would be something interesting.

I have also developed a sense that this will take a long time, like 5 years. Which is cool by me since I was actually looking for a new project anyway. I don't mean a job but something I can prioritize in my life. I like the people, I like the field, I like the tech, I like what we can do with Open Source in the field.

Good thoughts on the business and the ecosystem. The role of the installers for example. This is long running and I need some real work besides indulging a financial news nascent addiction.

So I have bought a KNX test bed, that I plan on driving from a Mac and Java. Something to turn on lights, dim them, detect presence and light. Something to have fun with my boys and girl. Look! daddy can turn on the lights! I have to express the childlike wonder at seeing your lights dim correctly. The test bed cost me (Open Remote :) $4000. It is an expensive toy. Maybe I can get into the habit of funding research through OR for me and some selected friends. But anyway I have it here on a bench. It includes cool hardware from guys in Spain (ZENNio) which is based right out of Toledo. I got to go visit sometimes.

A good friend and member has been banging out code for OR while on vacation and has put seeds out. One is Beehive, and we will be releasing PR about that one, and the other is the manager. A graphic iPhone UI assembler with drag and drop built on GWT. I almost have my work cut out for myself :) I need to plug in Calimero (a Java library to KNX IP and extend the tool to give iPhone control and visual programming of groups and voila, I know the teacher will give me an A mark ;)