Gyroscopic Investing

http://www.zerohedge.com/news/dow-passe ... al-picture

As Dow Passes 13,000 In Nominal Terms, Here Is The "Real" Picture
Submitted by Tyler Durden on 02/21/2012 11:28 -0500

Three charts that perhaps will calm the nominal euphoria as Dow 13000 screams across the screens. Since May 2008, the Dow is unchanged in price and down 50% in 'real' gold terms. The picture is just as disheartening from the start of 2011 and 2012. Next stop Dow 20,000 and Gold 20,000?

From May 2008, The Dow priced in Gold is down 50% while we have nominally recovered unchanged.

From the start of 2011. The Dow is up 11.35% while in real terms it is down 12.4%...

and from the beginning of this year, the Dow is up 4.8% while in gold 'real' terms, it is down 4.25%...

Charts: Bloomberg

Please move this to the pazooza section!

No doubt Mickey (The Brave Little Tailor) would agree with you!...

I don't think gold is a fair metric for quoting "real returns", gold is too volatile with wild up & downs over the 1973-now era.

with gold, "real returns" would've been huge in the 1980s-1990s as gold fell hard, & horrible in ~2002-now as gold rose hard.

the CPI, despite the bipartisan bogus accounting that underestimates it, imho is still a better metric for measuring real returns, than gold is.

What's a pazooza? And are we talking about passing 13,000 on the way up or down?

I've been sooo tempted to get one of those Dow 10,000 caps. I'm sure I'll get a chance to wear it again.

alvinroast wrote: What's a pazooza?

An Assyrian demon.

You've got to watch Disney's Brave Little Tailor to find out...

PP67 wrote: Three charts that perhaps will calm the nominal euphoria as Dow 13000 screams across the screens. Since May 2008, the Dow is unchanged in price and down 50% in 'real' gold terms.

This just shows that markets can be irrational and can stay that way for a very long time. Since the start of the Lehman crisis we have seen big and I mean BIG problems with the credit crunch and later the European debt crisis. As far as I can tell, none of these problems are anywhere near a structural solution. We have merely bought time to solve this mess.

And the stock markets? They are at the same level or even higher than when this all started @13K pazooza's. As a Dutch blogger said: "only in America folks, only in America".

I am just happy that the money I cannot afford to loose is safely tucked away in a balanced portfolio that has been protecting and will be protecting my money during these uncertain times.

Sandoor wrote: This just shows that markets can be irrational and can stay that way for a very long time. Since the start of the Lehman crisis we have seen big and I mean BIG problems with the credit crunch and later the European debt crisis. As far as I can tell, none of these problems are anywhere near a structural solution. We have merely bought time to solve this mess.

This kind of apparent "irrationality" is also greatly exacerbated by artificially low interest rates.  With interest rates at 0% (and inflation decidedly not at 0%), investors are being herded into ever-riskier assets in the hopes of protecting their purchasing power.

Heck, I hear that some investors even buy chunks of shiny yellow metal!  Can you imagine such a thing? 

LW,

Are rates really all that "artificially low?"

During the gold standard, one had to accept (theoretical) 0% real return if they wanted what I'll call "Maximum Safety," aka, gold in their home that they protect.

At some point, it was actually riskier to hold that much wealth in your home and it paid to take it to a bank, and either pay them to store it or lend it at interest... but even if they lent it to the government they ran the risk of losing it, as the gov't was a USER of the gold as currency, and could, theoretically, default.

Now, the wealthy can hold vast sums of monetary wealth that, theoretically, if put back in the 1800's, they'd have to probably pay a bank to store (not lend, as that carries more risk) for a fee.  That means the wealthy would have to accept a negative real return on their "maximum safety" wealth... and since you're lending to a gov't with zero credit risk, you are at probably even HIGHER "Maximum Safety" than you'd be before the gov't rid itself of default risk by abandoning the gold standard.

So I guess what I'm trying to say is that if you want to take as little risk as humanly possible holding larger sums of wealth, it's fully natural to have a "natural decay" of real value... now maybe that shouldn't be over 1% or 2%, but it's worth thinking about how much people are willing to pay for "risk-free wealth storage" as a mental exercize in trying to decide how "artificially low" our interest rates actually are.

Thinking about it from the opposite direction, I'm inclined to argue that any time the gov't offers positive real interest rates on its credit-risk-free accounts, it's offering "artificially high" interest, because it's giving people something that they could simply not achieve in a fully free-market monetary system... risk free real return.

moda0306 wrote: Are rates really all that "artificially low?"

When the Federal Reserve Chairman announces that he will move Heaven and Earth in order to hold interest rates at 0% through 2014 (during a period of low but persistent price inflation), I'm not sure how much more "artificial" you can get.

moda0306 wrote: During the gold standard, one had to accept (theoretical) 0% real return if they wanted what I'll call "Maximum Safety," aka, gold in their home that they protect.

Even if you threw that gold in a safe deposit box and insured it you'd not see anything like today's -3% real.  People simply don't have confidence that they can defend their purchasing power at today's interest rates.  They couldn't be more right.

moda0306 wrote:Thinking about it from the opposite direction, I'm inclined to argue that any time the gov't offers positive real interest rates on its credit-risk-free accounts, it's offering "artificially high" interest, because it's giving people something that they could simply not achieve in a fully free-market monetary system... risk free real return.

Although Treasury securities nearly eliminate credit risk, they do not eliminate the phenomenon of "time preference".  In other words, people generally prefer to enjoy something now rather than enjoy it tomorrow.  Tomorrow might never come and once it does, that's one fewer tomorrow you have to enjoy whatever you wish to purchase.

LW,

Holding interest rates at zero on the short end does short-change people a bit to the degree that they're losing to inflation... I agree. 3% was 2011 inflation, but with 2009 and 2010 at -.4% and 1.6%, respectively, and lower than 3% inflation expected going forward, I wouldn't use that as the measuring stick.  It IS artificially low, but I'm arguing that it's probably not to the degree that some people would claim.

I guess I would say that the "fair rate" on a US treasury bond is to keep up with CPI (after taxes on the interest!) minus a small fee for "wealth storage."  Maybe that fee should be about .5% or so (wild ass guess).  That said, during times of commodity inflation, it's difficult for ALL forms of investment to keep the risk-adjusted return they used to have. 

"Time preference" exists, of course, but not only in the presence of a negative real return on risk-free assets.  People only have so much savings to get them through the rest of their lives, and slightly positive or negative real interest rates don't change the need/will to save in financial assets denominated in the common currency.  In fact, negative interest rates might motivate some to save MORE simply because that is what is needed to live the lifestyle they want.  I don't see time preference playing any more of a role than it would in a gold standard world.

So I guess I'm not sure where you're going with that... what would you insist is a generally "fair rate" to pay people on treasuries would be?  I wouldn't disagree that they are currenty "artificially low,"but not nearly to the degree those claiming that 5% or 6% is appropriate would have us believe. 

moda0306 wrote:"Time preference" exists, of course, but not only in the presence of a negative real return on risk-free assets.

I brought up "time preference" to show why a positive real rate on "risk-free" assets might make perfect sense.  It's not just about how afraid I am that I might lose all my money.  I as the lender will also calculate the opportunity cost of lending these funds out.

Any entity that wishes to borrow must offer a rate of return that will entice me away from using the funds for other purposes.  Depending on circumstances, this rate might be 1% real or -1% real.  You just don't know.  Markets are much better at figuring this sort of thing out.

moda0306 wrote:So I guess I'm not sure where you're going with that... what would you insist is a generally "fair rate" to pay people on treasuries would be?

I disagree with the idea of centrally planning interest rates (or centrally planning \ price fixing anything.)  The interest rate is just the price at which money can be borrowed.  The market would do a much better job than I at determining what's "fair".

Lone Wolf

Although Treasury securities nearly eliminate credit risk, they do not eliminate the phenomenon of "time preference".  In other words, people generally prefer to enjoy something now rather than enjoy it tomorrow.  Tomorrow might never come and once it does, that's one fewer tomorrow you have to enjoy whatever you wish to purchase.

I think most money (rather than most people) is held by people for whom storage of value is a service that they are seeking and willing to pay for. It is the opposit of oppertunity cost. This comes about because we now have such a glut of money in relation to the size of the real economy and that money is in so few hands.

Under our current system the Fed does not have to make an effort to borrow. The only effort is creating an above zero interest rate. I'm no fan of our system but that is our system.

An entity that issues money controls the speed of issuance of that money, and therefore has huge control over the cost of money in that economy.  Throw in regulating fractional reserve banking (even if it's simply setting reserve requirements), and you have sealed that role pretty solidly.  I think expecting the issuer of money to "not set interest rates" is like asking a department of transportation to "not set speed limits."  It's implicitly woven into the government's role of issuer of currency and even the most basic bank regulations imagineable.

However, having influence over interest rates and deciding what the direction of credit should be (whether home-building, manufacturing, Company A vs Company B) are two different things, and the latter is still in the hands of the private sector (mostly), and this is what really counts.  Where most of the "setting" of interest rates comes in is treasury bonds, which are basically glorified reserve regulatory tools.

Before modern fiat currency, if you wanted to save risk-free you had to accept zero real return.  The will to save was still there, of course, because you wanted to be able to consume something in the future... People didn't save because they could earn real return... that was just icing on the cake if you took risk.

I don't see why our government should be held to a higher standard of actually providing real return on risk free assets (ST bonds).  Especially when the whole point of currency is not the value of the currency itself, but the efficiency it offers to a modern economy.  If the gov't NEEDED to issue bonds and service them with existing dollars, they wouldn't be risk-free instruments... since the gov't doesn't operate under those constraints, to insist the treasury bond market is a market that should be "left alone" is, like I said above, like saying we should leave our government's hands off of our freeways.

moda0306 wrote: An entity that issues money controls the speed of issuance of that money, and therefore has huge control over the cost of money in that economy.  Throw in regulating fractional reserve banking (even if it's simply setting reserve requirements), and you have sealed that role pretty solidly.  I think expecting the issuer of money to "not set interest rates" is like asking a department of transportation to "not set speed limits."  It's implicitly woven into the government's role of issuer of currency and even the most basic bank regulations imagineable.

That's not really true.  It's easy to imagine a Friedmanesque system where the Fed is just a computer that automatically increases the money supply by 2% per year.  Even if you buy into government as the "monopoly issuer of currency", this business of targeting interest rates in order to meet both inflation targets and unemployment targets sounds like an accident waiting to happen.

Practical experience seems to have shown that centrally planning interest rates is harder than you might think.

moda0306 wrote: Before modern fiat currency, if you wanted to save risk-free you had to accept zero real return.  The will to save was still there, of course, because you wanted to be able to consume something in the future... People didn't save because they could earn real return... that was just icing on the cake if you took risk.

No, T-bill rates were very rarely negative apart from occasional periods during the Great Depression (which had negative inflation, and thus still offered positive real yields.)

Long term, even if you chose to eschew lending and save "risk-free" in terms of dollars or gold bars, you still could get a positive real yield due to the gradual price deflation the United States experienced for the first 150 years of its existence.  That's one of capitalism's natural gifts (and one which we, unfortunately, squander by keeping the inflationary fires burning.)

LW,

MMR has been hashing out this term "monopoly issuer" recently, and it's probably more appropriate to say that the gov't is the monopoly issuer of base currency, treasury bonds, reserves, etc.  A steady 2% increase doesn't take into consideration the current account element... if we were to adjust that 2% to be indexed to the current account deficit (mostly made up of the trade deficit) you might be onto something... keep in mind our fiscal deficits were significantly behind our trade deficits for over a decade from 1997 through 2008.

Also, T-Bill's were NOT risk-free instruments until Bretton Woods was dropped.  Until then, we were constrained by our gold stock, and therefore were actually risking loss by lending the gov't money... they weren't the issuer of currency, but the user of it.

Fortunately, for the first 150 years of our existence, we were able to mine our way into a more stable monetary situation.  Eventually we effectively ran out of enough gold to mine to maintain a growing economy.  

moda0306 wrote: Also, T-Bill's were NOT risk-free instruments until Bretton Woods was dropped.  Until then, we were constrained by our gold stock, and therefore were actually risking loss by lending the gov't money... they weren't the issuer of currency, but the user of it.

True, a holder of T-bills ran the risk of devaluation during the gold standard (look no further than FDR in 1932 and Nixon in 1971.)  However, a holder of T-bills today can be pretty much assured of virtually nonstop devaluation!

In other words, the great risk you run under a gold standard is that you will be sucked into a system like ours.    (To be fair, another downside of a gold standard is that it gives government an excuse to interfere with the personal ownership of gold.)

moda0306 wrote: Fortunately, for the first 150 years of our existence, we were able to mine our way into a more stable monetary situation.  Eventually we effectively ran out of enough gold to mine to maintain a growing economy. 

How could this explanation possibly be true?  The rate at which gold was mined increased all the way through at least the 2000's.

And this is not to say that I agree with the notion that one day we could wake up to find that there's "not enough gold" around to employ as money.

LW,

It would appear that on the subject of gold production you're much more correct than my impression was indicating to me...

http://www.westernmininghistory.com/articles/4/page1

I'm going to re-group on the subject of gold cuz I haven't gone through the facts in some time around the gold standard... in short it seems to solve few of the problems the Austrians fear (bad government actors, by their very nature, don't care if we eventually default as a result of their spending) while giving false hope to the public (making a promise to the public that the public doesn't need to protect themselves against devaluation).... not to mention bringing a Euro-esque systemic risk to a national currency that hardly makes sense in a modern economy.

But on the subject of T-Bills, I'm not talking about devaluation, but default (which, I guess, could be the same relative thing during a gold standard).  The implicit promise behind both the dollar and treasury bonds was a delivery of a certain amount gold.  This means holding any treasury/fed instrument, even if super short-term in nature, carried a risk.  Positive real interest was the reward the market worked into those willing to give their gold to the government for a given period of time.

Once we broke off completely from the gold standard, the currency had to maintain its own footing through taxation and the public support of the government.  At this point, not only do bond investors going forward have to change their expectations of what they're getting by holding dollars and T-Bills (now there IS no promise upon which they should base their claims of theft), but now we have to switch our thinking about devaluation/default.  Now, there truly is no default risk behind the dollar (almost virtually), so offering positive real rates is offering wealthy investors a bottomless pit of RISK-FREE real return.... this is something that never existed during the gold standard.  You always had to take risks to get real return.  This is basically a subsidy to savers.  And it's not wholly uncommon... as it existed for a large part of the 80's and 90's.

I think it works better for everyone for the gov't to be completely free of any kind of commodity/currency peg, and savers simply do so in such a way that they are protected from devaluation.

LW,

I'll add that while I like your 2% idea to a degree (though I see deficit spending, not QE, as "monetary expansion" in fundamental terms), and I'd adjust it to our current account deficit, both price stability and full employment are signs of a healthy economy.  Unemployment is an indicator of unused productive capacity, and money on peoples' balance sheets can change the utilization of that capacity.

Both, in my mind, have a "who cares" affect as they approach zero, but with unemployment at 8.5%, and inflation averaging 1%-1.5% or so over the last few years, it's obvious where the true strain on the health of our economy truly is.

I guess this is just gibberish, and the following probably sums it up best:  The whole purpose for gov't run fiat money is optimization of the private sector of the economy to be as productive and prosperous as possible.  Much like a freeway, if you give the public a relatively stable medium of exchange that grows with the needs of the economy, prosperity will result... well, moreso than otherwise, anyway.  High unemployment is a huge sign that this is not occuring... that people are strained in some way.... and if this for the most part a problem of financial balance sheets (as it is now), it's quite obvious monetary/fiscal policy should pay attention to this, as it's indicator #1 that they're not doing their jobs right.

Right now, as we were in the 1930's, we're basically in one huge Mexican standoff that is a side-effect of a monetized economy.  We're all staring at each other with bad balance sheets, productive capacity, and diverse skillsets, but not pulling the trigger (or at least not enough).  We haven't been bombed.  We're not diseased and sick.  We aren't idiots.  We've simply had too much of our base money sucked out of our economy to properly grease the wheels of productive activity, and only recently have our deficits grown to large enough levels to make up for our trade edeficit (aka, foreign demand for our currency).

Lone Wolf, you don't have any examples do you of a country with a free floating fiat money system struggling to keep short term treasury rates low do you? Isn't the default always a zero nominal interest rate and effort is made to constrain liquidity to conjure up a positive interest rate so as to entice capital flows that support the exchange rate and so make imports more affordable?

Under a gold standard system or a currency peg system an actual default on government bonds is always a very real possibility. As an asset they then behave much more like corporate bonds than like US/UK/Japanese/Canadian/Swedish etc etc treasury bonds.