Financial topics

[aedens]

http://research.stlouisfed.org/fred2/se ... ?cid=32242

https://www.youtube.com/watch?v=ZPXaPhpmvtc

Hearth Tax - sound familar?

[Higgenbotham]

Based on the fidelity of the recent advance to this price structure, we estimate the “finite-time singularity” of the present log-periodic bubble to occur (or to have occurred) somewhere between December 31, 2013 and January 13, 2014. That does not mean that prices must immediately crash – only that the dynamics will then lend themselves to a great deal of potential instability, if prior log-periodic bubbles in equity and commodity markets across history are any indication. It bears repeating that our own defensiveness is driven by a broad ensemble of evidence, not simply price dynamics, not simply valuations, not simply sentiment, but the “full catastrophe” – which includes the fact that strong economic, speculative and monetary enthusiasm has historically been quite a contrary indicator for stocks.

The chart below shows the current position of the S&P 500. The light red line shows the log-periodic price trajectory that most closely approximates the present overvalued, overbought, overbullish, Fed-induced speculative run since 2010. While the initial gains from the 2009 low until about mid-2010 represented what we view as a move from reasonable valuation to full valuation (our stress-testing “miss” was not on valuation grounds), I expect little, if any of the market’s gains since 2010 to be retained by investors over the completion of this market cycle. Despite very short-run uncertainties about market direction, I should note that we now estimate negative prospective total returns for the S&P 500 on every horizon of less than 7 years.

wmc140106a.png (21.05 KiB) Viewed 2692 times

[John]

> http://research.stlouisfed.org/fred2/se ... ?cid=32242
> That is a hell of a skid mark fellas.

This is an interesting graph because it shows the generational side of
the current situation. There are two conflicting forces: (1) the Fed
has poured trillions of dollars into the banking system, which should
have caused huge inflation or hyperinflation; but the velocity of
money continues to crash, and the inflation rate = (increase of money
supply) x (velocity of money).

So far, the two conflicting forces have balanced out, since the CPI
has remained reasonably flat, with an inflation rate near zero. (In
the eurozone, the falling velocity of money has been "winning out"
during the last year.)

It's also interesting to focus on the 1970-1985 time frame:



This period is interesting because hyperinflation DID occur, during
this period, between 1977 and 1980.

Here are some questions that these two graphs raise:

• The CPI rose to 12% in the 1973-75, which is reflected in the
  graph as rising velocity. I've attributed this to Nixon's wage-price
  controls. One explanation might be the "promise" of a lower inflation
  might stimulate consumers to buy more, and might stimulate businesses
  to hire more, creating both higher price inflation and higher wage
  inflation.
• I think that's too simple. I think it's more likely that by 1973
  people began to realize that Nixon's controls were going to fail, and
  that they began purchasing and hiring more rapidly to before higher
  inflation set in, increasing the velocity of money, and creating an
  inflation spiral.
• The fall the velocity of money from 1975-77 can presumably be
  attributed to the OPEC oil price rise shock, and the rationing of
  gasoline. (A lot of this is admittedly "Post hoc ergo propter hoc"
  reasoning.)
• There was actual near-hyperinflation of 30% from 1977-1980, and
  this is reflected in the wild increase in the velocity of money. Once
  again, this can be attributed to a reaction to Nixon's wage-price
  controls, once the oil shock ended.
• I've also attributed the entire 1970s inflationary experience to
  purely generational considerations: The 1930s had completely wiped out
  most businesses, forcing the creation of new businesses across the
  country. Even businesses that survived had to completely renew
  themselves by cleaning house and starting from basics. So, by the
  time the 1970s arrived, almost all businesses were at their peak of
  vigor and productivity. A wealth of new products provoked an increase
  in the velocity of money and price inflation, and a demand for new
  workers to produce the new products, creating wage inflation.
• Beginning in the 1980s, Fed chairman Paul Volcker sharply
  increased interest rates to above 10%. This produced the desired
  decrease in the velocity of money, pushing down the inflation rate.
• In the 1990s, the velocity of money shot up, but the money supply
  fell sharply, following Volcker's pattern.
  
  
• Since the Nasdaq crash in 2000, and then more so after the
  "financial crisis" in 2008, the velocity of money has been plummeting,
  with no change in sight. This is the generational change that I
  believe happens in every "great depression." There is always a huge
  bubble from debt securitization, where pieces of paper saying "IOU"
  are traded as if they were money. (This was even true in the famous
  Tulipomania bubble, where certificates were issued for tulips to be
  grown the following year.) Once the bubble starts to burst, the
  population goes wildly into a "savings mode," and the velocity of
  money collapses, creating a deflationary spiral.

John

[Higgenbotham]

Hussman's attempt to fit Sornette's equation to this bubble doesn't work. There is no decay function that has any fixed ratio where the peaks are occurring closer and closer together. That can be readily seen by the fact that peaks were seen in September 2012 and May 2013, but the one that the equation predicted in between didn't happen. The masses are responding to the semi-random moves of an economic dictator and there can't be any logical or fractal order to those movements. An economic dictator creates random and outsized moves compared to the averaging process that would normally occur in a free market.

It would be like if there is a group of pigs on display and people are asked to guess the weight of each pig. A lot of farmers or 4-Hers who have an interest in pigs congregate to this and give their best guess. In a free market those guesses are averaged and that average is the best that can possibly be done and will be very close to the true weight of each pig. In the current case, nobody is allowed to see the group of pigs. Instead, a representative from the Department of Agriculture at the state university is acting as the "pig weight expert" and before anybody else is allowed to guess the weight of each pig, he gives his guess and then discusses in vague terms what the pig looks like and how he is going to adjust the feed ration of the pig. Then those participants who are interested may guess the weight of the pig based on what the "pig weight expert" is saying without actually getting to look at the pig.

This describes the current condition of the markets with Bernanke acting as the economic dictator and "market expert". There is no possible way the market can conform to orderly behavior under such conditions because there is no way market participants can guess ahead of time as to what Bernanke's assessment might be or how accurate it might be or what the response to that will be.

Over a longer time horizon than a few months, I think it is fair to say that the outsized, semi-random and inaccurate guesses and market movements Bernanke throws into the mix will average out and the peak of the bubbble can be guessed somewhat, but the range of possible outcomes is necessarily wider.

[Higgenbotham]

Q&A from the National Association of Business Economics conference, Philadelphia, January 3, 2014:
William Nordhaus, Yale University economics professor and chairman of the Federal Reserve Bank of Boston: "I asked my students if they had a question for [Bernanke]. And there were a number of them, one which I won't ask is 'what about bitcoin?' - which I know he knows about. But I thought a really interesting one was this: 'If you knew in 2006 what you know now, what step or steps would you have taken then to prevent or ameliorate the financial crisis and subsequent severe downturn?'"

Bernanke: "Well that's a really unfair question. I mean, the reality is that everybody - every policymaker has to make - this is the nature of policy - it has to be made in very, very foggy conditions with very imperfect information - a lot of uncertainty. So, in order to do anything, I think I would not only have to know everything in advance, everyone else would have to know I knew everything in advance."

So how is it a better or more accurate process for Bernanke to dictate his "guess of the weight of each pig" than for the free market to "guess the weight of each pig" and average it? Having gone through the process, Bernanke himself admits that it is not.

[Higgenbotham]

fredgraph.png (17.52 KiB) Viewed 2677 times

It's interesting that the velocity of money increased (initially) during the 1970s recessions. Whereas during the past 2 recessions it has plummeted.

[John]

It's interesting that the velocity of money increased during the 1970s recessions.

Which is cause, and which is effect?

[Higgenbotham]

It's interesting that the velocity of money increased during the 1970s recessions.

Which is cause, and which is effect?

My understanding is that high oil prices brought about the late 1973 stock market collapse and 1974 recession. I would suppose that as oil prices were going up, the velocity of money was increasing. That doesn't really answer the question, though, because it appears that in 2008, with oil prices skyrocketing, the velocity of money was plummeting. And that was before the increase in the monetary base would have been a factor in reducing the velocity of money.

My guess is that what you said here is correct:

"I think it's more likely that by (late in) 1973 (as oil prices rose) people began to realize that Nixon's controls were going to fail, and that they began purchasing and hiring more rapidly to before higher inflation set in, increasing the velocity of money, and creating an inflation spiral."

Perhaps there was a mild recession going on initially that was offset by the increase in the oil price and hoarding. I was too young to have a clear view of what was happening. It seems like people were hoarding goods at that time (stocking up). Metals prices were strong through May of 1974.

[vincecate]

Here is a graph I made on interest rates and velocity of money:

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[vincecate]

This graph is adding 10 year bond interest rate and inflation rate and comparing that to the velocity of money:

tmp.png (22.47 KiB) Viewed 2658 times