Blog Archives

Now That Everyone’s Been Pushed into Risky Assets…

If we had to summarize what’s happened in eight years of “recovery,” we could start with this: everyone’s been pushed into risky assets while being told risk has been transformed from something to avoid (by buying risk-off assets) to something you chase to score essentially guaranteed gains (by buying risk-on assets).

The successful strategy for eight years has been buy the dips because risk-on assets always recover and hit new highs: housing, stocks, bonds, bat guano futures–you name it.

Those who bought the dip in hot housing markets have seen spectacular gains since 2011. Those who bought every dip in the stock market have been richly rewarded, and those buying bonds expecting declining yields have until recently logged reliable gains.

The only asset class that’s lower than it was in 2011 is the classic risk-off asset: precious metals.

Investors who avoided risk-on assets–stocks, bonds, REITs (real estate investment trusts) and housing in hot markets–have been clubbed, while those who piled on the leverage to buy every dip have been richly rewarded.

Those who bet volatility–once a fairly reliable reflection of risk–would finally rise have been wiped out. By historical measures, risk has fallen to levels not seen since… well, just before the last Global Financial Meltdown.

Globally, financially assets have soared from a 2008 low around $222 trillion to over $300 trillion. Even in today’s financially jaded world, $80 trillion is an impressive number: over 4 times America’s GDP of $18 trillion annually, and roughly equal to global GDP.

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Sorry, Central Banks: Risk and Volatility Cannot be Extinguished

The unspoken claim of central bank policy is that risk can be extinguished by intervention/manipulation: once the Fed has your back, i.e. is supporting the market, risk disappears, and the easy profits flow to those who buy the dips with supreme confidence in the Fed’s ability to magically turn risk-assets into risk-free assets.

Unfortunately for the credulous investors who believe this, risk cannot be extinguished, it can only be transferred to others or to the system itself.

This confidence in central banks raises a pernicious systemic risk:

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Why Real Reform Is Impossible: We Can’t Believe the Mighty Titanic Could Actually Sink

Why did passengers remain on the Titanic even as its bow sank deeper into the ice-cold Atlantic? They believed the experts and authorities because they wanted to believe the ship was “unsinkable.” And why did they want to believe the ship was “unsinkable”?

Two visceral realities fueled their misplaced faith in the ship’s supposed safety:

1) The warm ship seemed so mighty, and the alternative–open lifeboats drifting in the dark cold night–seemed so vulnerable, uncomfortable and risky.

2) It was much easier to believe the experts’ assurances that the ship was safe than it was to clamber into a small lifeboat and bob around the open Atlantic.

We all know which alternative turned out to be safe and which one was fatally unsafe. The apparently risky open lifeboats were the sole source of survival and the enormous, complex “unsinkable” ship sank, ending the lives of everyone who clung to the appealing fantasy that the mighty ship was too technologically advanced to sink.

We are all on a Titanic, a complex system that experts and authorities declare safe and unsinkable for all time. Our money, our government, our Social Security, our Medicare and our entire debt-based way of life is mighty and invulnerable. Those few who see the eventual need to prepare “risky” lifeboats are mocked and ridiculed.

But the status quo’s bow is already sinking into the ice-cold waters of reality.The only way the status quo can support the debt-based financial system and government that funds all these vast systems is if the economy creates 10 million more “breadwinner” jobs (in David Stockman’s definition, a job that earns enough to support a family of four) a decade.

These new jobs are needed to raise the additional $1 trillion per year in payroll and income taxes needed to keep the fiscal ship afloat, and to provide the household income needed to support trillions more in private-sector debt–new home mortgages, auto loans, student loans, credit card debt, etc.–that’s needed to support consumption.

If the status quo can’t create at least 10 million new breadwinner jobs a decade, it sinks just as surely as the Titanic, which was doomed the moment the fifth watertight compartment was ripped open by the iceberg.

And please don’t tell me we can raise $1 trillion in new annual taxes by “taxing the owners of the robots,” another “unsinkable” fantasy I dismantle in my books Why Our Status Quo Failed and Is Beyond Reform and A Radically Beneficial World.

Now that software and robotics are commoditized, the scarcity value of these tools and the goods they produce is plummeting. Take a look at profits in commoditized goods: they’re razor-thin, and getting thinner by the day. As the cost of software/automation tools drops, they become affordable to an ever-larger pool of owners/producers, which means the competition from new owners will increase until there is no profit at all.

And exactly how do you extract $1 trillion in phantom profits from “owners of robots” who happen to be overseas? The belief in “taxing the owners of robots” is identical to the doomed souls on board the Titanic believing the ship was unsinkable.

The belief in the status quo’s permanence is exactly like the belief in the Titanic’s invulnerability. The systems we depend on are so vast and seem so mighty, it doesn’t seem possible that they could unravel and fail. But their eventual unraveling and failure are already baked in and cannot be undone by the modest tweaks of what passes for “reform” in the status quo.

The financial realities of systemically stagnant jobs, incomes and tax revenues have already ripped a fatal gash below the waterline of the status quo. The bow is sinking but the parties on the First Class deck continue. The passengers in steerage are getting anxious because they see the cold water sloshing around the lower decks, but few on the upper decks care what mere steerage passengers are experiencing.

Unfortunately for those partying on the upper First Class decks, they are as doomed as the steerage passengers when the ship goes down.

As the supposedly risk-free status quo decays, the supposedly “risky” lifeboats– decentralized private-sector arrangements of multiple income streams derived from ownership of productive assets that are debt-free and not dependent on debt-based government funding or global corporate cartels–will be cooperating and collaborating with each other.

Those seeking lifeboats will benefit from the Mobile Creative credo: trust your network, not the corporation or the state.

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Here’s Why All Pension Funds Are Doomed, Doomed, Doomed

It’s no secret that virtually every pension fund is dead man walking, doomed by central banks’ imposition of low yields on safe investments, i.e. Zero Interest Rate Policy (ZIRP).

Given that both The Economist and The Wall Street Journal have covered the impossibility of pension funds achieving their expected returns, this reality cannot be a surprise to anyone in a leadership role.

Many unhappy returns: Pension funds and endowments are too optimistic

Public Pension Funds Roll Back Return Targets: Few managers count on returns of 8%-plus a year anymore; governments scramble to make up funding

Here’s problem #1 in a nutshell: the average public pension fund still expects to earn an average annual return of 7.69%, year after year, decade after decade.

This is roughly triple the nominal (not adjusted for inflation) yield on a 30-year Treasury bond (about 2.65%). The only way any fund manager can earn 7.7% or more in a low-yield environment is to make extremely high risk bets that consistently pay off.

This is like playing one hand after another in a casino and never losing. Sorry, but high risk gambling doesn’t work that way: the higher the risk, the bigger the gains; but equally important, the bigger the losses when the hot hand turns cold.

Here’s problem #2 in a nutshell: in the good old days before the economy (and pension funds) became dependent on debt-fueled asset bubbles for their survival, pension fund managers expected an average annual return of 3.8%–less than half the current expected returns.

In the good old days, the needed returns could be generated by investing in safe income-producing assets–high-quality corporate bonds, Treasury bonds, etc. The risk of losing any of the fund’s capital was extremely low.

Now that the expected returns have more than doubled while the yield on safe investments has plummeted, fund managers must take risks (i.e. chase yield) that can easily wipe out major chunks of the fund’s capital if the bubble du jour bursts.

Here’s problem #3 in a nutshell: everyone who rode the great bubble of 1994 – 2000 (including pension funds) soon reckoned 10%+ annual returns on equities wasThe New Normal, so expecting 7.5% – 8% annual returns seemed downright prudent.

When that bubble burst, decimating everyone still holding equities, the Federal Reserve promptly inflated two new bubbles: one in stocks and another in housing. Once again, everyone who rode these two bubbles up (including pension funds) minted hefty profits year after year.

This seemed to confirm that The New Normal included the occasional spot of bother (a.k.a. a severe market crash), but the Federal Reserve would quickly ride to the rescue and inflate a new bubble.

When the dual bubbles of stocks and housing both burst in 2008, once again the Fed rushed to inflate another set of bubbles, this time in stocks, bonds and rental housing. Lowering interest rates could no longer generate a new bubble. This time around, the Fed had to lower interest rates to zero indefinitely, and embark on the most massive monetary stimulus in history–quantitative easing (QE) 1, 2 and 3–to inflate a third bubble in stocks.

This unprecedented expansion of free money for financiers and dropping interest rates to zero generated a bubble in bonds and an echo-bubble in real estate–specifically, commercial real estate and rental housing.

These three bubbles once again generated handsome yields for pension funds.Once again fund managers’ faith in the Federal Reserve maintaining a New Normal of occasional crashes quickly followed by even bigger bubbles was rewarded.

But the game is changing beneath the surface of Fed omnipotence. The returns on zero interest rates (or even negative rates) have diminished to zero, and the Fed’s vaunted monetary stimulus programs have been recognized as enriching the rich at the expense of everyone else.

Even with the unprecedented tailwinds of one massive bubble after another, pension funds are in trouble. The high-risk returns of Fed-induced bubbles followed by the inevitable crashes cannot replace the safe, high yields of the pre-bubble-dependent economy.

If funds are in trouble with stocks in a new unprecedented bubble high, how will they do when stocks fall back to Earth, as they inevitably do in boom-bust cycles?

The usual justification for nose-bleed valuations is sky-high corporate profits.But profits have rolled over, and irreversible headwinds are increasing: a stronger U.S. dollar, an aging populace desperate to save more for retirement, an entire generation burdened with student debt and often-worthless college diplomas, a global economy on the brink of recession, diminishing returns on firing workers, diminishing returns on financialization legerdemain, etc.

Meanwhile, commercial real estate loans have soared above the previous bubble highs.

This seems to prove that no bubble bursts for long with the Federal Reserve at the helm, but there are limits on what the Fed can do when this bubble bursts, as it inevitably will, as surely as night follows day.

The Fed can’t lower interest rates below zero without signaling that the economy is well and truly broken, and it can’t force people who are wary of debt to borrow more, even if it effectively pays borrowers to take on more debt.

All the Fed can do is extend new debt to unqualified borrowers who will default at the first sneeze. This will trigger the collapse of whatever new credit-fueled bubble the Fed might generate.

The political winds are also changing. The public’s passive acceptance of central banks’ let’s make the rich richer and everyone else poorer policies may be ending, and demands to put the heads of central bankers on spikes in the town square (figuratively speaking) may increase exponentially.

It’s looking increasingly likely that third time’s the charm: this set of bubbles is the last one central banks can blow. And when markets free-fall and don’t reflate into new bubbles, pension funds will expire, as they were fated to do the day central banks chose zero interest rates forever as their cure for a broken economic model.

A Radically Beneficial World: Automation, Technology and Creating Jobs for All is now available as an Audible audio book.

My new book is #2 on Kindle short reads -> politics and social science: Why Our Status Quo Failed and Is Beyond Reform ($3.95 Kindle ebook, $8.95 print edition)For more, please visit the book’s website.

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We’re in the Eye of a Global Financial Hurricane

The Keynesian gods have failed, and as a result we’re in the eye of a global financial hurricane.

The Keynesian god of growth has failed.

The Keynesian god of borrowing from the future to fund today’s consumption has failed.

The Keynesian god of monetary stimulus / financialization has failed.

Every major central bank and state worships these Keynesian idols:

1. Growth. (Never mind the cost or what kind of growth–all growth is good, even the financial equivalent of aggressive cancer).

2. Borrowing from the future to fund today’s keg party, worthless college diploma, particle board bookcase, stock buy-back, etc. (oops, I mean “investment”)–a.k.a.deficit spending which is a polite way of saying this unsavory truth: stealing from our children and grandchildren to fund our lifestyles today.

3. Monetary stimulus / financialization. If private investment sags (because there are few attractive investments at today’s nosebleed valuations and few attractive investments in a global economy burdened with massive over-production and over-capacity), drop interest rates to zero (or below zero) to “stimulate” new borrowing… for whatever: global carry trades, bat guano derivatives, etc.

Here is my definition of Financialization:

Financialization is the mass commodification of debt and debt-based financial instruments collaterized by previously low-risk assets, a pyramiding of risk and speculative gains that is only possible in a massive expansion of low-cost credit and leverage.

That is a mouthful, so let’s break it into bite-sized chunks. (more…)

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Why Our Financial System Is Like the Titanic

The “unsinkable” global financial system is rushing headlong toward its encounter with the iceberg.


Why did the Titanic sink, despite being considered unsinkable? The conventional answer is the design of its watertight compartments was flawed: the watertight bulkheads were limited in height to a few feet above the waterline.

The ship was designed such that if the first few compartments were flooded, the flooding would be contained by the watertight bulkheads.

But the iceberg ripped open a gash almost a third the ship’s length, flooding the first six compartments. As the ship’s bow sank, water poured over the bulkhead into the seventh compartment, and so on, until the ship’s bow sank deep enough to bring the ship almost vertical, at which point the hull broke roughly in half–hence the two hull sections discovered on the bottom of the Atlantic in 1985.

But further analysis has revealed this isn’t the only reason Titanic sank. It turned out the ship’s hull plates were brittle due to high sulfur content in the steel, especially at cold temperatures (the water was near freezing at the time of the wreck).

Causes and Effects of the Rapid Sinking of the Titanic

Rather than deform as the iceberg scraped against the hull, the plates and rivets fractured, opening the gash that sank the ship.

<bThe technologies of the early 1900s enabled shipbuilders to construct enormous ships almost 900 feet in length capable of steaming at 24 knots, transporting passengers across the Atlantic in comfort, but the technologies that made such ships and transits low risk were not yet developed.

The fact that large ships and powerful engines could be built created the illusion of low risk, because the risk factors were invisible until disaster struck. After the disaster, the flaws in the design of the watertight bulkheads, the inadequacy of the lifeboat requirements (there were not enough lifeboats for the crew and passengers), and the deficiencies in the wireless/radio requirements (ships were not required to have radio operators on duty 24 hours a day) were all obvious.

But the flaws in the steel plates and rivets would remain invisible until the technologies of steel production finally caught up with the other shipbuilding technologies. And better detection and tracking of icebergs would have to wait for radar and better navigational technologies.

Our financial system is like the Titanic: technologies such as high-frequency trading (HFT) and innovations such as securitization and complex derivatives have enabled major players to construct an enormous, fast-moving financial system that creates the illusion of low risk because the risks are not visible until disaster strikes.

The Global Financial Meltdown of 2008-09 was a close call, the equivalent of the Titanic veering off and barely missing the iceberg. In response, authorities imposed a variety of new regulations that are the equivalent of changing the regulations guiding lifeboats and radio operations.

But these regulations did nothing to address the risks created by the technologies of financialization that have leapfrogged safety systems and the real economy. In effect, the idea that the financial system is unsinkable remains intact, even though the flaws in its design (the equivalent of the watertight bulkheads) and its core technologies (the equivalent of the flawed steel plates) remain invisible.

The financial system’s huge size and apparent strengths have created a false confidence that it is unsinkable, and the ineffective regulations imposed after 2008-09 have only added to the illusion that the risk of a complete collapse is low.

All that has been accomplished since 2008-09 is there are a few more lifeboats and better communication when disaster strikes. But the risks of financial disaster have actually increased since 2008-09, as participants have bypassed regulations via shadow banking, dark pools,etc., and deepened their dependence on HFT skimming via superfast trades executed by superfast computers.

The “unsinkable” global financial system is rushing headlong toward its encounter with the iceberg, while the passengers and crew remain supremely confident and unaware of the risks, risks that will only become “obvious” after the global financial system has broken in half and sunk to the bottom, destroying most of those who believed it unsinkable.

 
We need a new system, one we control from the ground up:
A Radically Beneficial World: Automation, Technology and Creating Jobs for All. The Kindle edition is $8.95 and the print edition is $20.82.

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If Zero Interest Rates Fixed What’s Broken, We’d Be in Paradise

The fundamental premise of global central bank policy is simple: whatever’s broken in the economy can be fixed with zero interest rates (ZIRP). And the linear extension of this premise is equally simple: if ZIRP hasn’t fixed what’s broken, then negative interest rates (NIRP) will.

Unfortunately, this simplistic policy has run aground on the shoals of reality: if zero or negative interest rates actually fixed what’s broken in the economy, we’d all be living in Paradise after seven years of zero interest rates.

The truth that cannot be spoken is that zero interest rates (ZIRP) and negative interest rates (NIRP) cannot fix what’s broken–rather, they have added monumental quantities of risk that have dragged the global financial system down to crush depth:

Crush depth, officially called collapse depth, is the submerged depth at which a submarine’s hull will collapse due to pressure. This is normally calculated; however, it is not always accurate.

Indeed, the risk that has been generated by ZIRP and NIRP cannot be calculated with any accuracy. The sources of risk arising from NIRP are well-known:

1. Zero interest rates force investors and money managers to chase yield, i.e. seek a positive return on their capital. In a world dominated by central bank ZIRP/NIRP, this requires taking on higher risk, as higher yields are a direct consequence of higher risk.

The problem is that the risk and the higher yield are asymmetric: to earn a 4% return, investors could be taking on risks an order of magnitude higher than the yield.

2. To generate fees in a ZIRP/NIRP world, lenders must loan vast sums to marginal borrowers–borrowers who would not qualify for loans in more prudent times.

This forces lenders to either forego income from lending or take on enormous risks in lending to marginal borrowers.

3. The income once earned by conventional savers has been completely destroyed by ZIRP/NIRP, depriving the economy of a key income stream.

Please consider this chart of the Fed Funds Rate and tell me precisely what’s been fixed by seven years of zero interest rates:

Bank credit soared. If our only problem was a dearth of new bank lending, we’d be in Paradise now. Alas, we’re not:

The reality is that zero interest rates have only brought debt-based consumption forward, expanded lending to marginal/high-risk borrowers and forced capital into dark caverns of risk from which there is no orderly escape.

What’s the crush depth of all this impaired debt and risky credit? Nobody knows. Rather than fix what’s broken with the real economy, ZIRP/NIRP has added problems that only collapse can solve.

If zero or negative interest rates actually fixed what’s broken in the economy, we’d all be in Paradise now. Instead, we’re in a sinking submarine awaiting the implosion of predatory excesses. In other words, a financial Hell.

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2016 Theme #5: The Systemic Failure of High Finance

A number of systemic, structural forces are intersecting in 2016. One is the failure of high finance to fix the global economy’s systemic problems.

The operative conceit of the past 7 years has been that high finance can fix whatever’s broken in the world’s economies. According to this narrative, all the world needed to boost “growth,” employment and profits was lower interest rates, more liquidity, reverse repos and some other fancy financial footwork.

Once all this high finance generated more borrowing by debt-serfs, property developers, students, corporations buying back their shares and financiers skimming billions from asset bubbles, systemic problems would be dissolved or mitigated.

Cheap credit, asset bubbles and immense profiteering by financiers would heal all wounds and make everything better for everyone, even those at the bottom layer of the economy.

Unfortunately, this isn’t true. High finance and cheap credit have intensified structural problems such as rising inequality, not resolved them.

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China’s Shenzhen Stock Exchange: The Sky’s the Limit, Baby!

In the event you haven’t heard about the stock bubble currently inflating in China, please take a quick look at these two charts of the Shenzhen Composite:

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The Central Problem with Central Banks: They Become the Greater Fools/Bag-Holders

Those who are confident the central banks can print unlimited money may find there are political and financial consequences to such extremes that cannot be foreseen.

The central problem with central banks is their mandate now includes propping up all asset markets globally. Back in the good old days before the Global Financial Meltdown of 2008-09, central bankers reckoned they could control the “animal spirits” released when the risk-on herd destabilized into a chaotic risk-off stampede.

As former Federal Reserve chairman Alan Greenspan noted in his 2014 Foreign Affairsarticle Why I Didn’t See the Crisis Coming, the models used by central banks and private economists alike presumed the demand for risk-on assets would remain robust even in a downturn:

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The Changing World of Work 3: “Full-Stack” Skills

More important than being a full-stack employee is owning a full stack of skills.

My longtime friend G.F.B. sent me an article on the emerging value of tech-savvy generalists: The full-stack employee by Chris Messina:

Nearly two years after I left Google, I’m starting to understand what’s going on in the professional sphere. The conventional seams between disciplines are fraying, and the set of skills necessary to succeed are broader and more nebulous than they’ve been before. These days, you’ve gotta be a real polymath to get ahead; you’ve got to be a full-stack employee.

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The Changing World of Work 2: Financialization = Insecurity

Promises of wealth and security are far more contingent than is being advertised.

The Millennial Generation, if we’re to believe various polls, aspires to either make boatloads of money on Wall Street, or secure a can’t-be-fired job in the government. Given the dominance of finance and an economic backdrop of rising insecurity, these are rational choices.

But all those Millennials hoping to work for Goldman Sachs does raise a question:when did playing financial games become so much more profitable than producing goods and services?

And that raises another question: is the dominance of the FIRE sectors (finance, insurance, real estate) permanent or cyclical?

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