Financial topics

[Higgenbotham]

SP500 PE Ratio is Now at 723!

http://www.safehaven.com/article-14045.htm

Bill

By my methods, the giddiness in New York has even slightly overshot the extremes of the Tulip Mania. This now appears to me to be the most extreme bubble of all time.

I'm still short.

[John]

Dear Higgie,

> By my methods, the giddiness in New York has even slightly
> overshot the extremes of the Tulip Mania. This now appears to me
> to be the most extreme bubble of all time.

I'm inclined to agree. I can barely believe what I'm hearing.

The same people who, two months ago, were saying that the recession
would not end until well into 2010 are now saying that the recession
is already over. Were they right then, or are they right now?
There's nothing even remotely resembling common sense going on. It's
mind-boggling.

I noticed one interesting angle listening to the pundits on CNBC this
morning. Back in March, people were saying emphatically that the
stimulus has to continue for a long time, and that the biggest
mistake that Roosevelt made and Japan made was to end the stimulus
spending too early.

However, this morning I was hearing, at least by implication, that
the stimulus was no longer necessary, because the recession was over.

This is interesting because it shows how the craziness spewing out of
pundits mouths works against what others believe is correct stimulus
policy.

All of this makes me sick to my stomach, but I know I have nothing
to worry about, since the new health care package means that if I'm
sick to my stomach, the government will take good care of me.

Sincerely,

John

[StilesBC]

See the Nasdaq Composite below. It is running into its descending trendline from the '07 highs as well as the low of the '06 summer lows. Just happens to also be "round number resistance" which, admittedly, is less important that many make it sound.

Could be something, could be nothing. But I also see that the US Dollar has not made a new low as stocks make new highs and the two have been highly correlated throughout this rally. Oil and the precious metals are also lagging. There are, however, a number of technical levels on the S&P 500 that remain unfulfilled (between 1007-1025).

Back in April, I outlined 3 clusters of technical resistance: 930-940, 1000-1025, and 1075-1100.

As unthinkable a 130 point rally was two weeks ago, it needs to be respected that it happens again.

Elliott wave suggests the same. It suggests this current rally is A of (Z). After a B wave pullback (perhaps to test prior resistance around 950), it will embark on a C wave rally past the A wave highs. That will complete primary wave 2 up prior to beginning wave 3 down, which is typically the longest and most severe of all waves.

I'm still short via the Dec '10 puts, but have yet to add to the position. I'm willing to miss the top and make do with the exposure I have.

[zabrisk1]

"Audience question: Where would the stimulus money best be spent? Answer: Historically, the best way is military spending, because it creates demand, without creating supply. That's why economies recover quickly. But if you increase both demand and supply, then they start chasing each other. If you want the smallest budget deficit, and largest bang for money, that's the best way."

I have tried to get my head round this extraordinary idea, but to no avail. Maybe you can enlighten me. Whilst I can understand that military expenditure causes economic activity, people building tanks, guns etc, I cannot see how this differs from say, building a bridge to nowhere in the middle of a desert. Yes the state pays the manufacturers for the hardware they supply, and the manufacturers in turn pay their employees for the work they have done. So effectively the state has injected funds into the economy. So far, no different from giving everybody a tax credit.

Those employees now have funds to spend on cars, televisions whatever. But the productive capacity that might well have been used to make those items is now diverted to armaments. So presumably in a closed economy, the price of the cars and televisions would rise - less supply more demand. How does this solve anything?

I, obviously mistakenly, thought that excessive military expenditure had been the downfall of most empires, the Romans, Phillp II of Spain, Great Britain, the Soviet Union to name but a few.

I should be grateful if you could explain Mr Koo's hypothesis in a little more detail.

[StilesBC]

Dear Higgie,

> By my methods, the giddiness in New York has even slightly
> overshot the extremes of the Tulip Mania. This now appears to me
> to be the most extreme bubble of all time.

I'm inclined to agree. I can barely believe what I'm hearing.

The same people who, two months ago, were saying that the recession
would not end until well into 2010 are now saying that the recession
is already over. Were they right then, or are they right now?
There's nothing even remotely resembling common sense going on. It's
mind-boggling.

I noticed one interesting angle listening to the pundits on CNBC this
morning. Back in March, people were saying emphatically that the
stimulus has to continue for a long time, and that the biggest
mistake that Roosevelt made and Japan made was to end the stimulus
spending too early.

However, this morning I was hearing, at least by implication, that
the stimulus was no longer necessary, because the recession was over.

This is interesting because it shows how the craziness spewing out of
pundits mouths works against what others believe is correct stimulus
policy.

All of this makes me sick to my stomach, but I know I have nothing
to worry about, since the new health care package means that if I'm
sick to my stomach, the government will take good care of me.

Sincerely,

John

The best one I heard this week was along these lines: "Because most economists are expecting the recovery to be weak, and because most of the time economists turn out to be wrong, we believe that the recovery will be even stronger and are forecasting 6% GDP growth for 2010"

It is now being considered a "given" that the economy has recovered. The only thing being debated in the mainstream is how quick the recovery will be or how large it will be. Magazine cover indicator and google trends confirm the boost in confidence:

[StilesBC]

"Audience question: Where would the stimulus money best be spent? Answer: Historically, the best way is military spending, because it creates demand, without creating supply. That's why economies recover quickly. But if you increase both demand and supply, then they start chasing each other. If you want the smallest budget deficit, and largest bang for money, that's the best way."

I have tried to get my head round this extraordinary idea, but to no avail. Maybe you can enlighten me. Whilst I can understand that military expenditure causes economic activity, people building tanks, guns etc, I cannot see how this differs from say, building a bridge to nowhere in the middle of a desert. Yes the state pays the manufacturers for the hardware they supply, and the manufacturers in turn pay their employees for the work they have done. So effectively the state has injected funds into the economy. So far, no different from giving everybody a tax credit.

Those employees now have funds to spend on cars, televisions whatever. But the productive capacity that might well have been used to make those items is now diverted to armaments. So presumably in a closed economy, the price of the cars and televisions would rise - less supply more demand. How does this solve anything?

I, obviously mistakenly, thought that excessive military expenditure had been the downfall of most empires, the Romans, Phillp II of Spain, Great Britain, the Soviet Union to name but a few.

I should be grateful if you could explain Mr Koo's hypothesis in a little more detail.

His hypothesis is flawed.

It can probably be explained by a simple causation/correlation misinterpretation. Economic growth comes from savings being invested in a lengthening of the structure of production. Oftentimes, when there is a sharp increase in the rate of savings, consumption falls and the economy deleverages the previous malinvestments. This part of the process is politically unpopular, so alternatives are often looked for to "stimulate" the economy. War is often the last resort after everything has been tried and the savings rate is still stubbornly high. Because a recovery often ensues, it is taken for granted that it was the war that caused the recovery, rather than a delayed reaction in the savings being employed. Politicians, always the opportunists, make sure that it was their deft management that takes the credit, not something totally out of their control like a rise in the rate of savings.

His flawed hypothesis can also be explained by simple logic. A country's wealth is determined by the amount of accumulated capital goods it has. Those capital goods can be used to provide consumption goods. The fewer of them there are, the fewer consumption goods available, and thus the higher their price. The loss of capital goods has an "impoverishing" effect on the population. And since the primary objective of a war is to destroy as many capital goods of the enemy as possible, war is hardly an economic stimulant. Even the rebuilding of capital goods cannot be seen as stimulating. Merely replacing something that one once had does not make one wealthier. It returns one to their previous state. In the meantime, capital goods have been used to provide things that could have otherwise been used for further technological advancement. The economy is actually retarded in comparison with its state of being had no war taken place.

This is also known as Bastiat's "Broken Window Fallacy." http://en.wikipedia.org/wiki/Parable_of ... ken_window

[zabrisk1]

Thank you for that. I believe that you might find this article by Ellen Brown extremely relevant.

http://www.globalresearch.ca/index.php? ... &aid=13673

[John]

> I have tried to get my head round this extraordinary idea, but to
> no avail. Maybe you can enlighten me. Whilst I can understand that
> military expenditure causes economic activity, people building
> tanks, guns etc, I cannot see how this differs from say, building
> a bridge to nowhere in the middle of a desert. Yes the state pays
> the manufacturers for the hardware they supply, and the
> manufacturers in turn pay their employees for the work they have
> done. So effectively the state has injected funds into the
> economy. So far, no different from giving everybody a tax credit.

> Those employees now have funds to spend on cars, televisions
> whatever. But the productive capacity that might well have been
> used to make those items is now diverted to armaments. So
> presumably in a closed economy, the price of the cars and
> televisions would rise - less supply more demand. How does this
> solve anything?

This gets into the whole concept behind a deflationary spiral, or
what Koo calls a "balance sheet recession."

You says that the "employees now have funds to spend on cars,
televisions whatever," and that would be true in normal times. But
this assumption completely falls apart in these times, because
employees who have funds DO NOT spend the funds on cars, televisions,
or whatever. Instead, they put the money in the bank or they pay
down debt. That's the whole point why spending stimulus money on
consumer goods fails.

We can see that from my description of what's happening in China.
Beijing used stimulus money to stockpile copper, but the copper is
just sitting there, because no one is spending money to make
investments. In "normal" times, the copper would be swallowed up in
manufacturing and construction products, but in the current
deflationary spiral that activity is not occurring.

Koo identified spending on stimulus money on infrastructure projects
to be almost as good as spending on the military. I was wondering
why it isn't just as good, and I think the reason is that
infrastructure do have some level of competing with the private
sector that the military doesn't have.

I understand that Japan spent massively on infrastructure projects,
and I understand that every stream in Japan now has several bridges
crossing it.

But the problem with unbridled spending on infrastructure projects
leads to the problems that I described in the analysis that I posted
last night. When you give the private sector infinite money for
infrastructure and construction projects, much of it is just wasted,
as people rush to spend as much money as possible as long as it's
available. In the military, presumably, such spending is much better
managed, and more attuned to the needs of preparing for war, so
there's much less waste.

> His hypothesis is flawed. It can probably be explained by a simple
> causation/correlation misinterpretation. Economic growth comes
> from savings being invested in a lengthening of the structure of
> production. Oftentimes, when there is a sharp increase in the rate
> of savings, consumption falls and the economy deleverages the
> previous malinvestments. This part of the process is politically
> unpopular, so alternatives are often looked for to "stimulate" the
> economy. War is often the last resort after everything has been
> tried and the savings rate is still stubbornly high. Because a
> recovery often ensues, it is taken for granted that it was the war
> that caused the recovery, rather than a delayed reaction in the
> savings being employed. Politicians, always the opportunists, make
> sure that it was their deft management that takes the credit, not
> something totally out of their control like a rise in the rate of
> savings.

Once again, you're describing concepts that are true in "normal"
times, but which fall apart in deflationary spirals. As you point
out, the high rate of savings means that money will not be invested
in production. Military spending may be a last resort for political
reasons, but for theoretical reasons it's the most effective way to
spend stimulus money during a deflationary spiral. But, as Koo
points out, in a dictatorship like China or Nazi Germany, there are
no political problems, and government officials can freely spend on
the military and prepare for war, without having to deal with a
recalcitrant Congress.

Sincerely,

John

[wvbill]

More from Karl Denninger on Computer Trading -- What cause today's spike up...

http://market-ticker.denninger.net/arch ... arket.html

Bill

[StilesBC]

Once again, you're describing concepts that are true in "normal"
times, but which fall apart in deflationary spirals. As you point
out, the high rate of savings means that money will not be invested
in production. Military spending may be a last resort for political
reasons, but for theoretical reasons it's the most effective way to
spend stimulus money during a deflationary spiral. But, as Koo
points out, in a dictatorship like China or Nazi Germany, there are
no political problems, and government officials can freely spend on
the military and prepare for war, without having to deal with a
recalcitrant Congress.

John,

There are no "normal" times and "abnormal" times. There are only people acting based upon the available information they have. As GD points out, people tend to weight various information according to factors involving their peer group (ie. they act based on their own archetypal characteristics). This causes inflations, deflations, manias, panics and all sorts of other things. No one combination can be seen as normal and another abnormal.

Breaking a window is breaking a window, regardless of whether it is during inflation or deflation. Destroying capital to rebuild it does not "stimulate" anything in an economy. It just shifts money from one group of people to another.

Lastly, saving money is investing. With the exception of the tiny amounts "hoarded" and stuffed under mattresses, buried, etc, all money saved is used to make loans that couldn't otherwise be made. The pace of lending right now may be slow, but it would be slower if banks did not have the extra deposits available from the increasing savings rate. They would otherwise be forced to contract credit even more. With a high enough savings rate, loans can be extended to entrepreneurs who will lengthen the structure of production, employ workers, etc. Going to war before this happens only

Only by looking at inflation/deflation as a rise/fall in prices, can this become confusing. By looking at it as increases/decreases in the supply of money and credit, one sees the cause and effect forces far more clearly.