Lemmings

In writing a letter tonight that will be distributed around our area, I was considering putting in "lemming-like behavior." After some brief research, I found the long-standing investment concept of lemmings who supposedly follow each other off a cliff is completely false. See snopes.com. The most entertaining thing about this factoid is that traditional Wall Street still uses this analogy all the time. These are the same people who followed each other off the cliff of CMO's, CDO's, CDS's, subprime mortgages, etc. Ironic...

CPI fun and the mismeasurement of all things

So for the past number of years, reporting of CPI has slowly transitioned to media reporting core CPI (not including energy and food). The rationale is that including those highly volatile commodity-based components brings unnecessary volatility to the understanding of longer trends of CPI. This is understandable when you think of gas prices going from under $2 per gallon to over $4 per gallon and back again over the past few years.



Yet those swings in gas prices we all know has had a real effect on our personal pocketbooks and the economy as a whole. So for me, give me the volatility, and let me know how much my purchasing power is changing. But that is not how concensus has seen it in the past few years.



But now we have a funny change of sorts. The Fed is introducing substantial liquidity by working the currency printing press overtime. In equilibrium (a term I learned about in econ that has never existed in the real world of greed and fear), increasing liquidity causes inflation. But the Fed has said they are not concerned about inflation because of the substantial drawback in energy prices.



So now we use total CPI because it suits our position. This is nothing new. In fact, numerous 'improvements' to the calculation of CPI have occurred in the past, and critics were dismissed as
anti-establishment zealous lunatics. Until Bill Gross spoke out, nobody considered that CPI might be understated. Yet consider the benefits to our government just from fractionally smaller increases in social security benefits.

Unemployment is another substantial funny number. Historically, anyone who was unemployed was counted. Now we only count those who receive unemployment, not those who are still unemployed after unemployement insurance benefits expire (they are counted instead as employed). Also, when created the figure considered those who had part-time employement but were desiring full-time employment as unemployed. Now they are employed. But the biggest misrepresentation is the fact that a household with both spouses working counts as two people fully employed, but the divisor for unemployment is the number of households. So are we in a recession?

One observer believes using original calculation methods, we currently have 15% unemployment, CPI of about 13%, and GDP contraction of 2%. So yes. For more information visit here. Depressing (or maybe depression).

Where there's smoke...

What is happening in the US Economy and the stock market? How bad could this get? Is the worst almost over? Don't we wish we all knew. Here is the analogy I have been giving to clients.

So far all we know is that we do not have an out of control forest fire. Could we? Who knows. But there is plenty of smoke in the air.

What would you do if you smelled something burning in a crowded theater and happened to have the seats farthest away from the exit? Maybe the person next to you has cigarette smoke on their clothes, or has been burning leaves. Maybe someone lit a cigarette. Maybe it is burnt popcorn. Would you yell, "FIRE!"?

Don't wait to figure it out to take action, because in the case of a once in a lifetime event (which this economic scenario already is) no one has a better sense of smell than anyone else. But if we are willing to inconvenience ourselves a little more than others, we can be ahead of the game with very little sacrifice.

To continue the analogy the wise thing would be to tell your loved one to get up and go to the back of the theater and wait for you. Shortly after they leave, you do as well and simply stand by the back door and continue to watch the movie. Leave your coat to avoid causing the crisis you hope to avoid for your safety. People will think you are going to the bathroom or getting a drink. Now watch the movie standing at the back by the doors. And if someone yells, simply turn and walk out. The worst that can happen to you is losing your coat and the discomfort of standing up watching some of the movie. Much better than the worst case scenario of sitting restlessly in your seat. If the smoke goes away, return to your seat.

In the case of this economic smoke, if you display a crisis mentality, you will cause one, even if unfounded--just like in the movie theater.

Bailout Update

I too have been sick over this whole financial mess, but unlike many other people (especially financial professionals) my malady started in April (see the first post).

What are we to do???-- see below

For me, the best part is that my malady is getting better, because I believe the most likely outcome is clear. And if an outcome is known, action can be taken. I am not advocating everyone run for the hills. But in 1972, with perfect foresight, nobody would have invested in long-term bonds when interest rates and inflation were set to skyrocket over the coming decade eroding purchasing power of interest payments and maturity value.

So clarity feels good... Even on a negative basis...

If the economy can pull out of this situation by mortgaging the future, it all but ensures, there is no saving the next situation that should happen within 4 years. Next situation? As any behavioral professional will tell you, when someone is being enabled in a dysfunctional system (America's financial structure is textbook) and consequences for actions are removed, the person ALWAYS attempts to get more next time.

The enabler in this situation (China) owns almost $2 trillion of our country now, and if they choose to let this one go by continuing to hold our government, corporate, and yes, subprime debt without dumping it at any cost, they won't next time.

Even if they (who are not exactly our allies) dumped all their US debt on the market at once, and only got pennies on the dollar for their holdings, they would still be a cash positive country. They don't have debt, and own debt of other countries that are not bleeding red. I read somewhere earlier this year that in 2 years China will reach economic parity with the US--meaning we are as dependent on them as they are on us. Prior to that they needed us more (as we imported more goods and bought them).

I haven't seen the numbers, but I would bet with this crisis, 2 years to parity went by pretty fast.

So if I were China (especially with the Olympics in the books), I would aggressively dump US debt at almost any cost. Maybe they are which is why our credit markets are frozen. In reality the short-term debt (commercial notes) has been the issue in the past month, and that doesn't require sale, simply no reinvesting.

Here is some sarcasm to use with friends:

Yes the moral decline of our country led to this situation (but indirectly). After all if politicians and the public still read the Bible they would know that the borrower is servant to the lender. So keep in mind that road you are driving on, and your public water supply, and now AIG and the country's largest banks are not REALLY owned by the American government, but by China.

--So maybe I feel better because my clarity is that I plan to learn Chinese.

"Neehow"

For you, avoid the financial dysfunction. Find objectivity. And ignore everything else, especially the media. CNBC is likely increasing their price for advertising, since you all are watching.