Economics for the Muppet Generation

Mark McHugh of Across the Street provides a succinct summation of the problem America faces:

McHugh continues:

  • From 1947 to 1974 US income per capita grew more than National debt per capita 25 times.
  • In the last 30 years, National debt per capita has grown more than income per capita 24 times.
  • The last time income per capita grew more than national debt per capita was 2001.
  • Ben Bernanke arrived at the Federal Reserve in 2002.

So simple, even a muppet can understand what the problem is, right?

Not exactly. We know what the problem is: national incomes aren’t rising, even while we get deeper and deeper into hock trying to maintain our standard of living. We know that this pattern is totally unsustainable; unless incomes rise, that debt will become increasingly impossible to service. What is less clear is the cause of this stagnation.

So what changed between 1990 and 2005 that led the nation debt per capita to so quickly overtake national incomes per capita?

While I am mindful that correlation does not necessarily imply causation, that data fits pretty beautifully. The explanation for this trend would be that as America has become more and more consumptive, and less and less productive that more and more capital went offshore to pay for consumption, and thus less and less contributed to the national income, even as Bernanke ponied up trillions in new reserves, and even as the shadow banking system created trillions in pseudo-money.

So where’s America’s money?

Here:


So is this a criticism of free trade? Should America have been more protectionist of her industries and her domestic manufacturing? Not necessarily; what the Washingtonian elites refer to as “free trade” is heavily subsidised. The status quo that Washington has made seems to heavily favour China and disfavour America. Imports from China are subsidised by American military largesse; every dollar America pushes into its military-industrial complex pushes shipping costs like insurance a little lower. So while labour costs in the Orient are naturally cheaper (due to population density, and development level), that doesn’t necessarily mean that Chinese goods are naturally cheaper in the American market. Under a genuinely free system — where America was not subsidising shipping costs — would made-in-America be more competitive compared to Chinese goods? Would China have built up a less  mountainous supply of American cash? I think so.

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Why Goldman Sachs Cannot Be Wrong

When it comes to equities, they play both sides of the argument.

From Business Insider:

You’ve got to be kidding us, Goldman Sachs.

In recent weeks, at least four different strategists from Goldman Sachs (honestly we’ve lost count) have offered different opinions on the direction of the stock markets.  They range from extremely bullish to uber bearish:

David Kostin, Chief Equity US Strategist: BEARISH

Back in December, Kostin said he thought the S&P 500 would end 2012 at 1,250.  This officially made him one of the most bearish strategists on all of Wall Street.  And despite the monster rally in stocks since then, Kostin hasn’t budged.

Jim O’Neill, Chairman of Goldman Sachs Asset Management: BULLISH

When O’Neill published his 11 predictions for 2012, his position was that the S&P 500 was more likely to head to 1,400 than 1,000.  His call came two weeks after Kostin’s 1,250 call.

Abby Joseph Cohen, President of the Goldman Sachs Global Markets Institute and Senior Investment Strategist: BULLISH

It’s hard to think of a time when Cohen wasn’t bullish.  She made a name for herself in the late 1990’s by being bullish as the stock markets soared during the dotcom bubble.

Peter Oppenheimer, Co-Head of Economics, Commodities and Strategy Research in Europe: BULLISH

Everyone’s still buzzing about Oppenheimer’s note titled The Long Good Buy; the Case for Equities where he argued that the equity risk premium made stocks look incredibly cheap.

“The prospects for future returns in equities relative to bonds are as good as they have been in a generation,” he concluded.

The embarrassing thing for Goldman is that their uncertainty and disagreement over where markets are going reflects that the masters of the universe — no matter how well connected — are just as clueless as the rest of us.

The problem for muppets (i.e. Goldman clients) is that it is impossible to be both short and long. Muppets will have to decide whose arguments to listen to for themselves, and will have be responsible for gains or losses. The difference between the masters and the muppets is that Goldman don’t have to take responsibility for their actions. If Goldman screws up — say, by purchasing CDS from a counter-party that goes bust, like they did in 2008 — they can easily get a bailout, and  a boatload of loose QE money to turn their balance sheet around.

Underwater equities? Balance sheet full of junk? No problem for Goldman — merely “hunt elephants” (as Greg Smith put it): encourage your clients to put their money into whatever Goldman wants to sell.

Problem with regulation? No problem: just call up any of their friends in government. The friendship starts at the top.

From Firedoglake:

Certainly, Obama sucked at the teats of Goldman Sachs more than any other politician in recent times. It began for him as little-known Senator from Illinois with a razor- thin resume whose ambitions outshone his accomplishments. Obama’s eloquent, heavily prepped address to the Democratic National Convention caught not only the eyes of the Democratic top brass, but that of the big bankers. As early as the Spring of 2006, Senator Barack Obama was intimately involved with Bob Rubin and Goldman Sachs through his involvement with the Hamilton Project.

Fittingly, Senator Obama was chosen by Rubin and the Hamilton Project to give the inaugural address of the Hamilton Project in April, 2006. An excellent, seminal discussion of the Hamilton Project by Dr. Kirk James Murphy, M.D., can be found here. A video clip of then Senator Barack Obama speaking at the inauguration of the Hamilton Project in April, 2006 can be found here and here (with an excellent discussion) and here.

Obama not helpful? Is he having one of those days where he needs to pretend to be a populist to keep his muppets (i.e. voters) on board? That’s fine — Goldman can try Geithner, Robert Rubin, Larry Summers, Hillary Clinton, Peter Orszag, William Dudley, or any of the other Goldmanites in positions of power.

Muppets may not be so well-connected. Muppets don’t get bailouts, or QE slush money.

Get Bullish, Muppets!

Sounds like Goldman has some equities (AAPL?) to dump on its muppet clients.

From Business Insider:

Goldman portfolio strategists Peter Oppenheimer and Matthieu Walterspiler are out with a doozy of report, basically presenting a big bullish case for stocks, relative to bonds.

From Goldman:

In 1956, George Ross Goobey, the general manager of the Imperial Tobacco pension fund in the UK made a controversial speech to the Association of Superannuation and Pension Funds (ASPF) arguing the merits of investing in equities to generate inflation linked growth for pension funds.  He became famous for allocating the entirety of the funds investments to equities, a move that is often associated with the start of the so-called ‘cult of the equity’.

Prior to this, equities were largely seen as volatile assets that achieved lower risk adjusted returns than government bonds and, consequently, required a higher yield. As more institutions warmed to the idea of shifting funds into equities, partly as a hedge against inflation, the yield on equities declined and the so-called ‘reverse yield gap’ was born. This refers to the fall in dividend yields to below government bond yields; a pattern that has continued, in most developed economies, until recently.

In his speech to the ASPF, Ross Goobey talked about the long-run historical evidence that the ex-post equity risk premium was positive and that investors ignored this at their own peril.

The long-run performance of equities was much greater than for bonds having adjusted for inflation. As he said: ‘I know that people will say: ‘Well, things are never going to be the same again’, but … it has happened again, and again. I say to you that my views are that it is still going to happen yet again even though it may not be the steep rises which we have had in the past.’ Over the 50 years that followed Mr. Ross Goobey’s pitch, his predictions proved very successful. The annualized real return to US equities (as a proxy)  between 1956 and 2000 were 7.4%.

But things have changed since the start of this century and the collapse of equity markets following the bursting of the technology bubble. In this post bubble world valuations fell from unrealistically high levels. But the decline of equity markets continued well after most equity markets returned to more ‘normal’ valuations. The onset of the credit crunch, and the deleveraging of balance sheets in many developed economies that followed this have punctured the confidence that once surrounded equities, and the pre-1960s skepticism about equity returns has returned. Dividend yields are once again above bond yields and both historical, and expected future returns have collapsed.

That’s right muppets, time to get bullish and hoover up all the equities we want to offload! This is a once in a generation opportunity to own equities!

Or not. Let’s just say that prices aren’t exactly being supported by a surge in manufacturing:

That’s right: manufacturing is just about where it was at the turn of the millennium, and unsurprisingly so is the S&P.

However there is a sliver of a superficial hint that the muppet masters may be right.

Here’s the S&P500 priced in gold:


Looks cheap next to where we were ten years ago. But in the long run I don’t really think where we were ten years ago tells us much about the fundamentals; it tells us more about Greenspan’s propensity to grease markets with shitloads of liquidity and watch stocks soar. The deeper I dig into the data, the more I tend to conclude that we really need to throw all recent historical trends out of the window.

Here’s a choice data set:


Does that look like a normal recovery? It looks like a complete paradigm shift to me. I’ve already covered my underlying reasons for believing that we live in unprecedented times. But this chart from Zero Hedge speaks as much as anything else:


So, if you have money to burn and a gullible nature go ahead and throw your money at the muppet masters. In the long run, equities and other productive assets have proven themselves superior to any other asset class, because they tend to produce a tangible return.

But right now? The real problem is that the global economic system is a mesh of interconnected fragility where one failed party can take the entire system down. Well run companies can be dragged down by badly-run counter-parties, and badly run companies can just be bailed out, totally obliterating the market mechanism. This is not an environment conducive to organic growth. It’s a cancerous environment, juiced up on (priced in) central bank interventions. It is the very definition of iatrogenesis: when “medicine” causes deeper and worse sickness.