Bits and Pieces

On the rise of the James Tobin gang and the fall of the house of Milton Friedman, read here.
For more on James Tobin, I strongly recommend this by this other famous economist.

Many gems as always in Warren Buffet's highly entertaining and informative letter to shareholders:

"Though Berkshire’s credit is pristine – we are one of only seven AAA corporations in the country – our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one."

"Local governments are going to face far tougher fiscal problems in the future than they have to date. The pension liabilities I talked about in last year’s report will be a huge contributor to these woes. Many cities and states were surely horrified when they inspected the status of their funding at yearend 2008. The gap between assets and a realistic actuarial valuation of present liabilities is simply staggering."

"If merely looking up past financial data would tell you what the future holds, the Forbes 400 would consist of librarians. [...] Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas."

"Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier. Beware the investment activity that produces applause; the great moves are usually greeted by yawns."

"Derivatives contracts, in contrast, often go unsettled for years, or even decades, with counterparties building up huge claims against each other. “Paper” assets and liabilities – often hard to quantify – become important parts of financial statements though these items will not be validated for many years. Additionally, a frightening web of mutual dependence develops among huge financial institutions. Receivables and payables by the billions become concentrated in the hands of a few large dealers who are apt to be highly-leveraged in other ways as well. Participants seeking to dodge troubles face the same problem as someone seeking to avoid venereal disease: It’s not just whom you sleep with, but also whom they are sleeping with.
Sleeping around, to continue our metaphor, can actually be useful for large derivatives dealers because it assures them government aid if trouble hits. In other words, only companies having problems that can infect the entire neighborhood – I won’t mention names – are certain to become a concern of the state (an outcome, I’m sad to say, that is proper). From this irritating reality comes The First Law of Corporate Survival for ambitious CEOs who pile on leverage and run large and unfathomable derivatives books: Modest incompetence simply won’t do; it’s mindboggling screw-ups that are required."

And finally, a little bit of old-fashioned Barron's bashing!
The quotes above are indicative of not just folksy intelligence, as I hear people say about Warren Buffet, but of true genius. If you want to read something that is definitely not indicative of genius but rather of inflexible, ideological and misguided thinking, then try any article on the economy by Barron's in-house economist, Gene Epstein. In a letter I recently sent Barron's editor, I couldn't help being brutally honest:

"To the Editor. As a longtime faithful Barron's reader, I'm wondering how much longer I will be subjected to your in-house economist's never-failing wrong assessments of the state of the economy. Mr. Epstein has wildly, consistently and unapologetically underestimated this economic crisis since the beginning and, having been so wrong for so long, can hardly be expected to ever be right in the foreseeable future. He might be trying to emulate Mr. Abelson, who was bearish and wrong for the longest time until he became oh so right. However, Mr. Abelson never pretended to be an economist nor did he ever make, month in month out, numbered predictions that inevitably turned out to be far off the mark. Moreover, Mr. Abelson is a joy to read and does not respond shrilly to legitimate protest mail. Could you at least bring in some sort of assistant or associate economist who would give us a more realistic view of the economy, someone less ideological and more pragmatic. Best regards."

Gold Haters vs. Gold Bugs

Gold bugs everywhere, this week's contrarian chronicle by Bill Fleckenstein will be music to your ears.

I agree with BF that there are a lot of rabid, irrational gold haters out there. I guess it's only fair in the sense that their existence is probably a reaction to that of the equally rabid and irrational end-of-the-world, back-to-the-stone-age variety of gold bugs. However, what the bears seem to overlook is the simple fact that, considering the current global economic and monetary situation, gold is widely perceived, by default, as the only stable currency. Given that perception, it's only normal that it should rise (and it has been all in all a gentle rise so far: gold doubled in the last 5 years) against all fiat currencies.

As Warren Buffet so eloquently says in his latest letter to the Berkshire Hathaway shareholders:
"Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation".

That's why I truly believe gold should be a fixture in every investor's portfolio. Should the rise go parabolic, which very well might happen in the next few years, I'll have to reconsider. It hasn't happened yet as shown in this weekly chart of GLD, the gold ETF (click to enlarge). It has been a little overbought lately as evidenced by the Slow Stochastic indicator, though not by the 14-week RSI. I think what really attracted the gold bears to this chart is the apparent double-top near the nice round $1,000/ounce number (equivalent to a little below 100 for GLD). Therefore, I wouldn't be surprised to see continuing selling pressure, possibly bringing GLD down to last January's low at 78.87. As long as GLD does not decisively break below 70, the 2006 high that proved formidable support during the "Great Liquidation" of Fall 2008, I will hold on to my theory.

Since the Madoff scandal broke, it has become very fashionable to label everything a Ponzi scheme. Housing was nothing but a Ponzi scheme. The stock market between 2003 and 2008 was a Ponzi scheme. So was the oil market. The government bailouts and the stimulus package are giant Ponzi schemes, etc... The Ponzi scheme meme (no rime intended) is now being used by the gold bears. The problem with such an argument is that it's not really saying anything...unless you consider that every situation where somebody buys something with the hope of selling it later to somebody else for more money is a Ponzi scheme. Personally, I prefer calling it capitalism.

Triangle, Projection, Disclaimer

(Click to enlarge SPY chart)

Head and Shoulder bottom? Not exactly. Symmetrical triangle resolved to the downside is more like it. Waited till the end of the week to be able to say that it had "decisively" broken to the downside. As far as measurements, my calculations tell me that the height of the triangle is 100.86 (11/04 high) minus 74.34 (11/21 low) equals 26.52. Let's subtract that from the break point of 82.74 (2/13 low) and we obtain a projected value for SPY of.....56.22.

Yes it is a stunningly low number (equivalent to around 560 on the S&P 500). But remember, technical analysis is not a science (and here I will spare you the usual platitude about it being an art). It's a series of more or less complex and high tech calculations (the triangle falls into the low complexity, low tech category) based on empirical observations that should be used as a helpful tool to guide your trading decisions.
There, I got my disclaimer in.

Nationalization as Option

Great post on the Bronte Capital blog about bank nationalization (and lack thereof).

Basically, having nationalization as one of many options on the table for dealing with problem banks is the secret ingredient that made the Swedish model, well, such a good model. It's also the lacking ingredient in the US model such as it stands right now. We might still be headed that way though considering the groundswell of political support the nationalization concept is gathering these days.

Adding nationalization as a possible outcome (if, say, a bank fails the much-talked about stress test) should clarify the whole process a great deal and allow for a few banks (the ones that do not get nationalized) to become 20 or even 50-baggers as were a few Swedish banks in the mid-90s.

Self-Defeating Prophecies

Cool article in yesterday's French newspaper Le Monde by Pierre-Antoine Delhommais. It sort of deals with one of my favorite subjects, contrarian thinking and more generally market psychology.

After noticing that most leaders (Nicolas Sarkozy, Gordon Brown and Barack Obama) have been brutally honest lately about how bad the economy was and wondering if they might be exaggerating just a little bit (each one for different political reasons), he moves on to the fascinating subject of self-fulfilling and self-defeating prophecies. As an aside, I wasn't aware until I read the article that it was sociologist Robert K. Merton (Nobel Prize winner Robert C. Merton's father) who coined the expression "self-fulfilling prophecy".

As an example of self-defeating prophecies, he gives us the positive example of the Y2K bug (remember that?). Everybody was so scared, the media made such a big deal about the potential dangers that, through widespread mobilization of private and public resources, the problem was prevented. The main thing about Y2K is that nothing happened, which made it seem so anticlimactic.

Along those lines, the journalist is wondering if this current wave of official pessimism isn't an attempt at mobilizing all the ideas and all the resources so that 2009 is not a repeat of 1929. He muses: It could be " a self-defeating prophecy to avoid the defeat and the destruction of the global economy".

Spend Now, Save Later...Please

An interesting Reuters article titled To save or to spend? Americans ponder their duty highlights the current dilemma facing the nation. On the one hand, most people are financially overextended and will tend to save. On the other hand, what the economy needs right now to slow down its current collapse is for people to spend (the Stimulus by itself will be far from sufficient to do that).

What's interesting is that here's a situation where the individual self-interest and the collective interest are misaligned. Free-market capitalism is based, among other things, on the notion that the pursuit of individual self-interest leads to collective prosperity. That notion, as during the Great Depression, will surely be under attack for years to come.

Another dilemma is short-term versus long-term. Ideally, people should collectively be spending now until the economy stabilizes and only then start saving. As you can judge from the article, it will be quite a tall order to convince people to do just that, and in that order please.

For animal (and to a lesser degree people) lovers out there. Great article.
(Hat tip the Naked Capitalism blog)

Not The Same Universe

This disastrous-looking chart has been making the rounds (hat tip The Big Picture Blog).

It was apparently released by the Office of Speaker Nancy Pelosi to bolster support for the stimulus bill. Even taken with the required grain of salt, this chart (click to enlarge) should put to rest once and for all any notion that this recession is of the same species (nay, the same universe) as the two most recent ones (1990 and 2001).

On Mental and Economic Depressions

Very illuminating Op-Ed piece by Frank Rich in today's New York Times about the current angry, revenge-seeking mood sweeping the country. Mr. Rich advises President Obama to get ahead of that "tsunami of populist rage" lest he be swept by it too.

I've been wondering lately about that much-maligned remark Phil Gramm made last summer about how the country is suffering from a "mental recession". What outraged many people (on top of his other remark that we were "a nation of whiners") was the fact that the infamous deregulator seemed to imply we weren't really in a recession, that it was all in our minds, that we were imagining things. That implication was proven dead wrong last December when the NBER officially declared the US had been in a recession since December 2007.

But what if Phil Gramm were partly right? What if we are ALSO in a mental recession? A recession in the economy, especially if it's ferocious like the current one, is bound to provoke a psychological depression. And if that collective depressed mood is strong and durable enough it, in turn, in a vicious cycle, can make the recession worse, maybe turn it into a depression in the economy. It is no coincidence that the feared d-word (depression) is used in both the economic and the psychological sense.

Maybe this collective anger directed towards bankers and politicians is just one symptom, one manifestation of the current collective depressed mood. As long as it doesn't subside, it will be hard for any kind of stimulus and/or bank rescue plan to get traction. Depressed people and, one can musingly generalize, depressed nations or economies are very hard to cure because, among other things, they don't really want to be cured. Their very depression makes them wallow in their misery, oblivious to what's good for them, indifferent to what's going on around them except maybe when the world around them is crumbling. That situation can, perversely but fleetingly, alleviate their somber mood.