The draft proposal on the table to bail out Cyprus consists primarily of closing one bank--Popular Bank of Cyprus, also called Laiki Bank--transferring deposits of 100,000 Euros or less to another large bank called Bank of Cyprus, and freezing deposits exceeding 100,000 Euros. The frozen assets, which evidently amount to somewhat over 30 billion Euros, will be used to fund Cyprus' share of the cost of the bailout (5.8 billion Euros). How much frozen account holders will ultimately receive is unclear, since the funds for paying them out would have to come from bad assets of Laiki Bank--defaulted loans and the like. The hit they will sustain apparently could be large.
At first glance, this revised bailout appears not unlike bank liquidations as seen in the U.S. Account holders with insured deposits (i.e., at or below the $250,000 threshhold) are fully protected, and those holding excess balances are at risk, taking losses if the assets of the bank don't fully cover the nominal value of their accounts. But the Cyprus bailout is different.
The process by which Cyprus and the EU got to where they are today was one of political fits, false starts, near collapses and last minute expediency. The first proposed bailout included a levy on all deposits, a proposal which the Cypriot legislature roundly rejected. After scrambling futilely for assistance from Russia, the Cypriot government bowed to the stern diktat of the European Union that depositors be tapped. But both the EU and the Cypriot government wanted to protect insured deposits (those of 100,000 Euros or less), so the burden had to fall on deposits in excess of the insured amount. And because Laiki Bank is suspected to be the bank of choice for a supposed den of money launderers, tax evaders and other scoundrels, the blade fell on its large depositors. Large depositors at other banks were spared the guillotine.
What's missing is the due process of law. There isn't even a flimsy facade of legal due process. This isn't an ordinary liquidation of a troubled bank. Cyprus got into financial trouble, asked for a bailout, was told by the EU that a Cypriot contribution would be a prerequisite, and only then did Cyprus figure out who would pay the piper. The ultimate resolution is politically driven, not the result of the application of established legal procedures.
If the large depositors of Laiki Bank are iniquitous Russian oligarchs as some EU officials have hinted, one can't feel terribly sympathetic about their plight. Legality doesn't seem to have played much of a role in the way many wealthy Russians acquired their riches. But, ordinarily, modern nations seize property only in accordance with the rule of law. If a bank depositor isn't proven to be liable, for one lawful reason or another, then he or she shouldn't be deprived of property.
It wasn't Robin Hood, or even Jesse James, who absconded with the assets of large depositors of Laiki Bank. It was the sovereign governments of the European Union. When governments depart from the rule of law, capital will start exiting stage right. Large depositors in any EU nation that's financially shaky will likely behoove themselves to move their capital to safer places. The shaky countries may get shakier. The EU tries to present the Cyprus situation as a unique, one-time problem. But how many well-to-do depositors want to leave their money at risk, in case that's not true?
The EU will enjoy a near-term rebound from the Cyprus bailout. But longer term, it encounter trouble attracting the capital it badly needs to rebound from recession and fuel future growth. And it may well find that dealings with one of its major energy suppliers--Russia-- will take sharper tone. When the due process of law isn't applied, some people start thinking that might makes right. And that would be unfortunate for Europe, given the history of the last century.
Monday, March 25, 2013
Tuesday, March 19, 2013
Why Republicans Are Trapped by Gerrymandering
Much of the Republican Party's power today is the result of legislative gerrymandering, the drawing of electoral districts in Rorschach test-like patterns to include majorities of reliably Republican voters. (See http://www.bloomberg.com/news/2013-03-19/republicans-win-congress-as-democrats-get-most-votes.html.) Thus, the Republicans now control the House of Representatives. But their gerrymandering has also trapped them in a time warp, and they are paying the price.
After last fall's loss of the Presidential election, Republicans are trying to figure out what went wrong in a contest they could have won. One of the key conclusions seems to be that a party of, by and for old white guys doesn't have much curb appeal for America's demographically changing populace. Many leading Republican voices now call for diversification. But that won't be easy, with their feet caught in the bear trap of their own gerrymandering.
Many Republicans politicians, particularly those inclined toward tea parties, are sworn to uphold and defend, even with their cold, dead hands if necessary, values that resonate primarily with old, white guys. If they start humming Kumbaya with anyone who doesn't party with tea, they'll be run out of office by people wielding old, white pitchforks. Let's be clear: if you represent a gerrymandered Republican district, you had damn well better look, sound and act like a Republican gerrymanderer. If you start to go wobbly, expect your constituents' footprints all over your caboose the next time you run for re-election.
The fact that many Republican politicians are beholden to a very narrow constituency now limits their options. It's a major reason why compromise in Washington is so difficult. Republican leaders in Congress have very little negotiating latitude, and can't engage in the swaps and accommodations that comprise political compromises. The upcoming deadlines--expiration of the federal government's funding on March 27 and the expiration of the debt ceiling on May 19--will probably be "resolved" with short term kicks of the can down the road. The Republicans appear to be taking more of the blame for federal dysfunction than the Democrats, and they may have limited their own ability to do anything about it.
Although Democrats have some problems with gerrymandered limits, they are much more tolerant of a diversity of views within their party. As the American populace diversifies, the flexibility of the Democratic Party could become perhaps its greatest asset, even while Republicans trash talk from their gerrymandered districts.
After last fall's loss of the Presidential election, Republicans are trying to figure out what went wrong in a contest they could have won. One of the key conclusions seems to be that a party of, by and for old white guys doesn't have much curb appeal for America's demographically changing populace. Many leading Republican voices now call for diversification. But that won't be easy, with their feet caught in the bear trap of their own gerrymandering.
Many Republicans politicians, particularly those inclined toward tea parties, are sworn to uphold and defend, even with their cold, dead hands if necessary, values that resonate primarily with old, white guys. If they start humming Kumbaya with anyone who doesn't party with tea, they'll be run out of office by people wielding old, white pitchforks. Let's be clear: if you represent a gerrymandered Republican district, you had damn well better look, sound and act like a Republican gerrymanderer. If you start to go wobbly, expect your constituents' footprints all over your caboose the next time you run for re-election.
The fact that many Republican politicians are beholden to a very narrow constituency now limits their options. It's a major reason why compromise in Washington is so difficult. Republican leaders in Congress have very little negotiating latitude, and can't engage in the swaps and accommodations that comprise political compromises. The upcoming deadlines--expiration of the federal government's funding on March 27 and the expiration of the debt ceiling on May 19--will probably be "resolved" with short term kicks of the can down the road. The Republicans appear to be taking more of the blame for federal dysfunction than the Democrats, and they may have limited their own ability to do anything about it.
Although Democrats have some problems with gerrymandered limits, they are much more tolerant of a diversity of views within their party. As the American populace diversifies, the flexibility of the Democratic Party could become perhaps its greatest asset, even while Republicans trash talk from their gerrymandered districts.
Monday, March 18, 2013
The Central Banks' Failure to Eliminate Risk
Now, it's Cyprus--tiny Cyprus, with 0.2% of the EU's GDP--that's shaking up the financial world. The Asian stock markets are falling on Monday, March 18, 2013, and stock futures indicate that the European and U.S. stock markets are also headed downward. Runs have already started at Cyprus' banks, and a bank holiday was declared for Monday, in order to stop the outflow of rats from the ship.
The proximate cause of the panic is a proposed EU bailout for Cyprus that includes taking from depositors at its banks 6.7% of deposits under 100,000 Euros, and 9.9% of deposits exceeding 100,000 Euros. Surprisingly, this tax (which is to help pay for the bailout) would hit small depositors that were supposed to be fully insured up to 100,000 Euros. The bailout violates a sacrosanct principle of bank regulation--that deposit insurance cannot be impaired. Deposit insurance is the key to depositor confidence, and the foundation of commercial banking. America's banking system recovered from the Great Depression (which saw thousands--yes, thousands--of bank failures) only when deposit insurance was instituted. If you scare depositors, an entire banking system can go belly up in less time than it takes to scramble a couple of eggs.
The powers that be which fashioned the Cyprus bailout--the EU, the European Central Bank and the IMF--imposed the depositor tax because of the somewhat shady doings of Cypriot banks. They extended the scope of their businesses way beyond their home island, accumulating assets amounting to twice the size of Cyprus' GDP. Reportedly, around half of their deposits are from Russians, and suspicions of money laundering, tax evasion, and other alleged shenanigans lurk. The stolid burghers of northern Europe have been wrinkling their noses over the unsavory aromas rising from Cyprus' banks, and they evidently view a tax on depositors as fair compensation for the trouble the EU is now being put to.
Whether or not the deposit tax is fair is, from a commercial standpoint, pretty much irrelevant. The financial markets thrive on confidence. The EU's financial crisis eased last summer when the head of the European Central Bank said, in substance if not words, that he would authorize the printing of money to prop up failing EU member nations. The bond vigilantes backed down. But the Cyprus bailout's tax on deposits is the opposite of money printing, and implies that losses are possible for holders of deposits in banks at other weak EU nations. There's nothing that shakes confidence like the prospect of losses, especially if one was supposed to be insured against them.
The financial markets have been coasting on a mellow buzz from toking up on central bank monetary accommodation. Ultra low interest rates and quantitative easing have taken the edge off volatility, and the markets seem to know no fear. But there is no way to eliminate financial risk. You can only transfer it somewhere. The Cypriots apparently wanted to transfer the risks and costs of their bankruptcy as far north as they could. But the folks up north didn't seem to cotton to that notion. So the risks and costs blew back, and as we now see, blowback can be nasty.
Who knows how this will all end. No doubt high ranking officials on both sides of the Atlantic are engaged, even as we write, in frantic discussions to figure out how to prevent the spread of financial contagion. The baseline problem is that the EU as a whole hasn't decided how to allocate the costs of resolving its financial crisis. This is probably a harder problem than the resolution of the U.S. government's current dysfunction, since, in Europe, people from disparate countries and cultures must somehow find common ground. Since these are the same people who fought two horrendous World Wars against each other in the 20th Century, it remains unclear if they will succeed.
In the meantime, remember that central bank monetary policy can provide a methadone high, at best. It won't last forever, and the aftermath may be a real downer. It's fine to feel good about the financial markets right now. But keep in mind that the central banks cannot eliminate financial risk, and if you relax your vigilance, risk could bite your left ankle in a flash.
The proximate cause of the panic is a proposed EU bailout for Cyprus that includes taking from depositors at its banks 6.7% of deposits under 100,000 Euros, and 9.9% of deposits exceeding 100,000 Euros. Surprisingly, this tax (which is to help pay for the bailout) would hit small depositors that were supposed to be fully insured up to 100,000 Euros. The bailout violates a sacrosanct principle of bank regulation--that deposit insurance cannot be impaired. Deposit insurance is the key to depositor confidence, and the foundation of commercial banking. America's banking system recovered from the Great Depression (which saw thousands--yes, thousands--of bank failures) only when deposit insurance was instituted. If you scare depositors, an entire banking system can go belly up in less time than it takes to scramble a couple of eggs.
The powers that be which fashioned the Cyprus bailout--the EU, the European Central Bank and the IMF--imposed the depositor tax because of the somewhat shady doings of Cypriot banks. They extended the scope of their businesses way beyond their home island, accumulating assets amounting to twice the size of Cyprus' GDP. Reportedly, around half of their deposits are from Russians, and suspicions of money laundering, tax evasion, and other alleged shenanigans lurk. The stolid burghers of northern Europe have been wrinkling their noses over the unsavory aromas rising from Cyprus' banks, and they evidently view a tax on depositors as fair compensation for the trouble the EU is now being put to.
Whether or not the deposit tax is fair is, from a commercial standpoint, pretty much irrelevant. The financial markets thrive on confidence. The EU's financial crisis eased last summer when the head of the European Central Bank said, in substance if not words, that he would authorize the printing of money to prop up failing EU member nations. The bond vigilantes backed down. But the Cyprus bailout's tax on deposits is the opposite of money printing, and implies that losses are possible for holders of deposits in banks at other weak EU nations. There's nothing that shakes confidence like the prospect of losses, especially if one was supposed to be insured against them.
The financial markets have been coasting on a mellow buzz from toking up on central bank monetary accommodation. Ultra low interest rates and quantitative easing have taken the edge off volatility, and the markets seem to know no fear. But there is no way to eliminate financial risk. You can only transfer it somewhere. The Cypriots apparently wanted to transfer the risks and costs of their bankruptcy as far north as they could. But the folks up north didn't seem to cotton to that notion. So the risks and costs blew back, and as we now see, blowback can be nasty.
Who knows how this will all end. No doubt high ranking officials on both sides of the Atlantic are engaged, even as we write, in frantic discussions to figure out how to prevent the spread of financial contagion. The baseline problem is that the EU as a whole hasn't decided how to allocate the costs of resolving its financial crisis. This is probably a harder problem than the resolution of the U.S. government's current dysfunction, since, in Europe, people from disparate countries and cultures must somehow find common ground. Since these are the same people who fought two horrendous World Wars against each other in the 20th Century, it remains unclear if they will succeed.
In the meantime, remember that central bank monetary policy can provide a methadone high, at best. It won't last forever, and the aftermath may be a real downer. It's fine to feel good about the financial markets right now. But keep in mind that the central banks cannot eliminate financial risk, and if you relax your vigilance, risk could bite your left ankle in a flash.
Tuesday, March 12, 2013
The Federal Reserve's Obligation to Support Stock Prices
The Dow Jones Industrial Average is setting a new record almost every day. Stocks are up 10% in 2013, and the year isn't even three months old. Since the recent closing low on Nov. 15, 2012 of 12,542.38, the Dow has risen over 15%. Stocks are on a tear and fresh money is coming into a market that's going up at an annualized rate of 50% or more.
A principal reason for the hyperventilation in the markets is the Federal Reserve's ultra lax monetary policy. Even though unemployment has fallen from over 10% in 2009 to 7.7% now, and the economy has resumed moderate growth, the Fed has spent the last four years swinging its scythe far and wide to cut down any positive interest rates that might sprout up. At the same time, it has printed shiploads of money through its quantitative easing policies. An abundance of cash, having few other alternatives, has flowed into stocks. At this point, the market depends on the Fed to maintain and increase its accommodation. Moral hazard abounds. Investors have put their precious savings in stocks relying on the Fed's promise to practically give away money for a really long time. If the market falters now, the Fed will have to step up and accommodate some more, enough to prop up stocks. It can't allow investors to suffer a third evisceration of their portfolios in less than 15 years. If the market stages another major downturn, investor and consumer confidence will surely collapse, sending the U.S. into another recession and putting the U.S. financial system under enormous stress. The stock market has become Too Biggest To Fail.
Of course, the Fed would deny that it has any obligation to support stock prices. Legally speaking, that's true. But the U.S. Treasury had no legal obligation to support Fannie Mae and Freddie Mac, yet it nationalized them in order to prevent a collapse of the financial system. The Treasury Department had no choice, given that the market had implicitly assumed that Fannie and Freddie were federally guaranteed. By relentlessly inflating stock prices, the Fed has put itself in a comparable position. It has implicitly guaranteed that stocks will not suffer a major collapse.
The Fed is already honoring its implicit guarantee. It's stated that the most recent round of QE (call it "QE Unlimited") will go on until unemployment falls to 6.5%. The market has risen about 10% since the Fed announced this target. A gnawing risk of the Fed's current policy mix is inflation, and the Fed has said it will step back if inflation flares. But the question is whether it actually will. Having drawn investors back into stocks after the market crash of 2007-08, the Fed may hesitate to take away the punch bowl if doing so will precipitate another bear market and recession.
Of course, it can't leave the punch bowl at the party forever. But, given the pickle it's currently in, it may let the party go on too long. We are at a crossroads in the history of central banking. If the Fed pulls off its current maneuvers and nurses the economy back to health while keeping inflation in the 2% range, it will have established the paradigm for monetary management of the economy for decades and perhaps centuries to come. If it fails, however, central banking as we now know it will likely become a thing of the past.
A principal reason for the hyperventilation in the markets is the Federal Reserve's ultra lax monetary policy. Even though unemployment has fallen from over 10% in 2009 to 7.7% now, and the economy has resumed moderate growth, the Fed has spent the last four years swinging its scythe far and wide to cut down any positive interest rates that might sprout up. At the same time, it has printed shiploads of money through its quantitative easing policies. An abundance of cash, having few other alternatives, has flowed into stocks. At this point, the market depends on the Fed to maintain and increase its accommodation. Moral hazard abounds. Investors have put their precious savings in stocks relying on the Fed's promise to practically give away money for a really long time. If the market falters now, the Fed will have to step up and accommodate some more, enough to prop up stocks. It can't allow investors to suffer a third evisceration of their portfolios in less than 15 years. If the market stages another major downturn, investor and consumer confidence will surely collapse, sending the U.S. into another recession and putting the U.S. financial system under enormous stress. The stock market has become Too Biggest To Fail.
Of course, the Fed would deny that it has any obligation to support stock prices. Legally speaking, that's true. But the U.S. Treasury had no legal obligation to support Fannie Mae and Freddie Mac, yet it nationalized them in order to prevent a collapse of the financial system. The Treasury Department had no choice, given that the market had implicitly assumed that Fannie and Freddie were federally guaranteed. By relentlessly inflating stock prices, the Fed has put itself in a comparable position. It has implicitly guaranteed that stocks will not suffer a major collapse.
The Fed is already honoring its implicit guarantee. It's stated that the most recent round of QE (call it "QE Unlimited") will go on until unemployment falls to 6.5%. The market has risen about 10% since the Fed announced this target. A gnawing risk of the Fed's current policy mix is inflation, and the Fed has said it will step back if inflation flares. But the question is whether it actually will. Having drawn investors back into stocks after the market crash of 2007-08, the Fed may hesitate to take away the punch bowl if doing so will precipitate another bear market and recession.
Of course, it can't leave the punch bowl at the party forever. But, given the pickle it's currently in, it may let the party go on too long. We are at a crossroads in the history of central banking. If the Fed pulls off its current maneuvers and nurses the economy back to health while keeping inflation in the 2% range, it will have established the paradigm for monetary management of the economy for decades and perhaps centuries to come. If it fails, however, central banking as we now know it will likely become a thing of the past.
Friday, March 8, 2013
Political Risks of Social Insecurity
The financial press has reported that the United States ranks 19th worldwide in the retirement security, lagging behind Slovenia, the Czech Republic and Slovakia, among other nations. http://www.cnbc.com/id/100534205. We're one step ahead of Britain, but well behind France and Germany. The Scandinavian countries rank at the top, along with Switzerland, Austria, the Netherlands and tiny Luxembourg. Even Japan, after more than two decades of economic malaise, ranks 15th, four steps higher than America.
This probably doesn't surprise many Americans, particularly those who are approaching or in retirement. They have probably already viscerally sensed their comparative insecurity. Herein lies great risk for politicians who would reduce America's social safety net. Our net is modest compared to the protections offered by most of the industrialized world. If it's cut, the pain--particularly for moderate and lower income Americans--could be pronounced. It's one thing if your retirement benefits may not cover as many restaurant meals as you would like. It's another if your cost of living increase is so paltry that you can't afford needed prescription medications.
That we have a fiscal imbalance is because our taxes are even lower on a comparative basis. (See http://usatoday30.usatoday.com/money/perfi/taxes/2009-11-25-oecd25_ST_N.htm.) America could without enormous pain pay for its current social safety net without having to borrow. We just don't want the taxes it would take to get there.
Many politicians in Washington sound off about cutting Social Security and Medicare benefits. This isn't just Republicans. President Obama has been quick to offer reductions in Social Security. One is to change the Social Security inflation adjustment from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to the Personal Consumption Price Expenditures Index (PCE). The effect of this change would to gradually erode the relative value of Social Security benefits, with the most elderly being the hardest hit over time. Is is really a good thing to whack the most vulnerable, who may have exhausted their savings and be unable to work?
Consciously or subconsciously, Americans know that their retirement benefits aren't great. And many of them won't be happy with politicians who make their retirements bleaker. If the President and the Republicans somehow reach a Grand Bargain to stabilize or even balance the budget, the political impact may surprise them. As Republicans clumsily attempt to embrace diversity, their core of older, white Americans may abandon them if they lead the charge to cut retirement benefits. President Obama, instead of being viewed as a latter day FDR, may end up appearing to fall into the mold of Herbert Hoover. And the liberal left, annoyingly shrill as they can sometimes be, may end up inheriting the White House in 2016.
This probably doesn't surprise many Americans, particularly those who are approaching or in retirement. They have probably already viscerally sensed their comparative insecurity. Herein lies great risk for politicians who would reduce America's social safety net. Our net is modest compared to the protections offered by most of the industrialized world. If it's cut, the pain--particularly for moderate and lower income Americans--could be pronounced. It's one thing if your retirement benefits may not cover as many restaurant meals as you would like. It's another if your cost of living increase is so paltry that you can't afford needed prescription medications.
That we have a fiscal imbalance is because our taxes are even lower on a comparative basis. (See http://usatoday30.usatoday.com/money/perfi/taxes/2009-11-25-oecd25_ST_N.htm.) America could without enormous pain pay for its current social safety net without having to borrow. We just don't want the taxes it would take to get there.
Many politicians in Washington sound off about cutting Social Security and Medicare benefits. This isn't just Republicans. President Obama has been quick to offer reductions in Social Security. One is to change the Social Security inflation adjustment from the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) to the Personal Consumption Price Expenditures Index (PCE). The effect of this change would to gradually erode the relative value of Social Security benefits, with the most elderly being the hardest hit over time. Is is really a good thing to whack the most vulnerable, who may have exhausted their savings and be unable to work?
Consciously or subconsciously, Americans know that their retirement benefits aren't great. And many of them won't be happy with politicians who make their retirements bleaker. If the President and the Republicans somehow reach a Grand Bargain to stabilize or even balance the budget, the political impact may surprise them. As Republicans clumsily attempt to embrace diversity, their core of older, white Americans may abandon them if they lead the charge to cut retirement benefits. President Obama, instead of being viewed as a latter day FDR, may end up appearing to fall into the mold of Herbert Hoover. And the liberal left, annoyingly shrill as they can sometimes be, may end up inheriting the White House in 2016.
Wednesday, March 6, 2013
Idolatry in the Financial Markets
A lot of investors, it would appear, are throwing money at increasingly esoteric investments in order to prevent inflation from eroding their capital. Junk bonds, asset-backed securities and real estate investment trusts have become fashionable. With the Fed waging a 24/7 scorched earth campaign against positive interest rates, risk is being embraced. One can only hope that the end result isn't like embracing a cobra--"risk on" investing strategies aren't risk-free.
A false premise widely circulated by financial sales people and cable TV pundits is that you have to preserve your savings from the ravages of inflation. And, certainly, over long periods of time, inflation can significantly diminish your capital. But you can't overlook the costs and risks of trying to protect yourself from inflation. If those risks smack down your net worth, you haven't accomplished anything except lose money and then suffer inflation's death of a thousand cuts. There's nothing wrong with losing a little ground now and then to inflation, while saving and investing with a view to long term financial equanimity. If you lose ground to inflation for one, two or even a few years, don't panic. Try to position your portfolio so that you can make up the "losses" later on. Also spend less and save more. This will increase your net worth without requiring you to dial up the risk.
The same is true of keeping pace with market averages. The Dow Jones Industrial Average, the S&P 500, or whatever benchmark you might follow may be convenient ways to assess the performance of money managers who want to take your savings. But market indices don't need to be your financial goals. If your portfolio is conservatively deployed and doesn't keep pace with the S&P 500, you haven't "lost" unless you decide you're a loser. As long as you are saving enough for retirement, your kids' college costs, and whatever other goals you might have, it doesn't matter a rat's left ear whether or not your investment returns match one market index or another. If your portfolio is more cautiously invested than the stocks found in an index, you won't suffer the volatility of the index. Maybe the Dow just reached a record level (although this really isn't a record once you factor in inflation). But looking back at what happened in 2000 and 2007 after the Dow previously reached record levels will tell you that keeping up with market indices can be a losing proposition.
Keeping pace with inflation and with market averages are, for individual investors, false idols that they need not worship. Building your net worth isn't a contest. It's a process. There are lots of ways to make your retirement years golden. Do whatever helps you sleep at night.
A false premise widely circulated by financial sales people and cable TV pundits is that you have to preserve your savings from the ravages of inflation. And, certainly, over long periods of time, inflation can significantly diminish your capital. But you can't overlook the costs and risks of trying to protect yourself from inflation. If those risks smack down your net worth, you haven't accomplished anything except lose money and then suffer inflation's death of a thousand cuts. There's nothing wrong with losing a little ground now and then to inflation, while saving and investing with a view to long term financial equanimity. If you lose ground to inflation for one, two or even a few years, don't panic. Try to position your portfolio so that you can make up the "losses" later on. Also spend less and save more. This will increase your net worth without requiring you to dial up the risk.
The same is true of keeping pace with market averages. The Dow Jones Industrial Average, the S&P 500, or whatever benchmark you might follow may be convenient ways to assess the performance of money managers who want to take your savings. But market indices don't need to be your financial goals. If your portfolio is conservatively deployed and doesn't keep pace with the S&P 500, you haven't "lost" unless you decide you're a loser. As long as you are saving enough for retirement, your kids' college costs, and whatever other goals you might have, it doesn't matter a rat's left ear whether or not your investment returns match one market index or another. If your portfolio is more cautiously invested than the stocks found in an index, you won't suffer the volatility of the index. Maybe the Dow just reached a record level (although this really isn't a record once you factor in inflation). But looking back at what happened in 2000 and 2007 after the Dow previously reached record levels will tell you that keeping up with market indices can be a losing proposition.
Keeping pace with inflation and with market averages are, for individual investors, false idols that they need not worship. Building your net worth isn't a contest. It's a process. There are lots of ways to make your retirement years golden. Do whatever helps you sleep at night.
Thursday, February 28, 2013
No Fiscal Discipline in the Stock Market
As the federal government belly flops into sequestration, the stock market merrily rolls along. Europe is sinking into recession, an inevitable result of its austerity and deleveraging policies. Japan is in recession, and has pledged to worship at the altar of monetary accommodation in an effort to revive its economy. American consumers are creeped out by continued government dysfunction, continued economic dysfunction and an increase in Social Security taxes. Retailers are reaching for the little paper bag in the seatback on front of them. But stocks are delirious.
Of course, it's all because Federal Reserve Chairman Ben Bernanke yesterday swore up and down that central bank accommodation is next to godliness, or something to that effect. If the most powerful agency in the United States government promised to subsidize you indefinitely, you'd be delirious, too.
By ignoring real world problems, and flying high on the Fed's fiat paper meth lab, the market is letting Congress off the hook. Without someone or something twisting their arms behind their backs, the members of Congress have little or no incentive to get real and work out the nation's fiscal problems. The stock market has the leverage to make Congress devote its full attention to a problem. In the fall of 2008, when the financial system teetered on the brink, Congress voted down a rescue package. The market promptly nosedived, and squashed 401(k) accounts from sea to shining sea. Constituents deluged Congressional offices with negative commentary (that's putting it mildly). Congress immediately reversed course and enacted the TARP rescue legislation.
Today, however, fed by the Fed with printed money, the market romps. Congress fiddles. And the rest of us get nervous about the smell of smoke that waffles through the air. By not holding Congress accountable, the market enables government dysfunction. The market can be quite effective when it imposes discipline. But an undisciplined market is scary.
Of course, it's all because Federal Reserve Chairman Ben Bernanke yesterday swore up and down that central bank accommodation is next to godliness, or something to that effect. If the most powerful agency in the United States government promised to subsidize you indefinitely, you'd be delirious, too.
By ignoring real world problems, and flying high on the Fed's fiat paper meth lab, the market is letting Congress off the hook. Without someone or something twisting their arms behind their backs, the members of Congress have little or no incentive to get real and work out the nation's fiscal problems. The stock market has the leverage to make Congress devote its full attention to a problem. In the fall of 2008, when the financial system teetered on the brink, Congress voted down a rescue package. The market promptly nosedived, and squashed 401(k) accounts from sea to shining sea. Constituents deluged Congressional offices with negative commentary (that's putting it mildly). Congress immediately reversed course and enacted the TARP rescue legislation.
Today, however, fed by the Fed with printed money, the market romps. Congress fiddles. And the rest of us get nervous about the smell of smoke that waffles through the air. By not holding Congress accountable, the market enables government dysfunction. The market can be quite effective when it imposes discipline. But an undisciplined market is scary.
Tuesday, February 26, 2013
Politics Keep the Economic Crises Going
We are vividly reminded today that the economic crises bedeviling the world are political in nature. The election deadlock in Italy, with leftists likely to control one house of the Italian Parliament, and rightists and leftists apparently in a draw in the other house, is a vote against austerity and centralization of the EU's governance. Although the political nuances differ from Greece's initial anti-austerity vote last year, the Italian election, like Greece's, signals that numerous voters have yet to learn the words of the pan-European version Kumbaya. Another election in Italy may well be needed, or the country will be unable to stay on track to meet the EU's expectations.
In America, sequestration now seems almost a certainty. The arbitrary cuts imposed by sequestration were supposed to be unpalatable to either party, and would therefore incentivize both parties to cut a real deal. Fat chance of that in these days of political dysfunction. Truth is there won't be a real deal. That's why the Dems and Republicans kicked the can down the road when the fiscal cliff loomed and the debt ceiling threatened to descend like the Sword of Damocles. The government right now can do little more than bring its foot back for another kick. The one silver lining in the clouds is that the economy seems to be recovering to some degree. The better the economy does, the lower the deficit will be. We should hope and work for economic growth, because that is the only politically feasible solution to the budget deficit. The federal government needs to repair and upgrade infrastructure, adopt a pro-growth immigration policy, work hard to cut the growth of health care costs (perhaps the biggest expense in future federal budgets), and work toward supporting and expanding educational opportunities while reducing the cost of education. (Internet-based instruction may be a great way to educate at much lower expense, and should be encouraged and supported.) The current squabbling in Washington over budget cuts and tax increases is a game of musical chairs that no one can win. We have to take a different approach.
In America, sequestration now seems almost a certainty. The arbitrary cuts imposed by sequestration were supposed to be unpalatable to either party, and would therefore incentivize both parties to cut a real deal. Fat chance of that in these days of political dysfunction. Truth is there won't be a real deal. That's why the Dems and Republicans kicked the can down the road when the fiscal cliff loomed and the debt ceiling threatened to descend like the Sword of Damocles. The government right now can do little more than bring its foot back for another kick. The one silver lining in the clouds is that the economy seems to be recovering to some degree. The better the economy does, the lower the deficit will be. We should hope and work for economic growth, because that is the only politically feasible solution to the budget deficit. The federal government needs to repair and upgrade infrastructure, adopt a pro-growth immigration policy, work hard to cut the growth of health care costs (perhaps the biggest expense in future federal budgets), and work toward supporting and expanding educational opportunities while reducing the cost of education. (Internet-based instruction may be a great way to educate at much lower expense, and should be encouraged and supported.) The current squabbling in Washington over budget cuts and tax increases is a game of musical chairs that no one can win. We have to take a different approach.
Thursday, February 14, 2013
Keep Your Investments Simple, Because the Alternatives Could Be Worse
As reported by the New York Times (and linked through CNBC.com: http://www.cnbc.com/id/100449551), retail investors are once again being burned by complex alternative investments. This is an old story in the annals of investment busts. The more complex an investment, the less likely a retail investor will understand it, and the greater the advantage an unscrupulous broker will have in foisting it on the unsuspecting. What's troubling is that many of the victims weren't seeking a fast, speculative buck. They were often conservative investors who were pushed by the Federal Reserve's scorched earth policy against interest rates to hunt in dark, dank thickets for elusive, ethereal positive yields. Desperate for investment income, they fell victim to sales people saying what they wanted to hear, but maybe not what they needed to understand.
An underappreciated element of saving and investing is the need to manage risk. Manage doesn't mean avoiding all risk, and it certainly doesn't mean seeing greater risk as the path to greater rewards. It means understanding that risk and reward are linked, and that not getting too greedy about rewards is the way to long term success. Some risk is reasonable, as long as you don't expose yourself to so much volatility that you grab the little paper bag in the seatback in front of you and put all your money in a mattress. The tortoise beats the hare when it comes to investing. Searching for quick returns is like donning wings of paraffin and flying toward the Sun. Don't invest in anything that you don't understand--and that means having a full appreciation for every way your hmmmm can be deep fried. Simple, steady and average are a decidedly better bet for making you comfortable in retirement than the latest in glam financial fashions. For more, see http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.
An underappreciated element of saving and investing is the need to manage risk. Manage doesn't mean avoiding all risk, and it certainly doesn't mean seeing greater risk as the path to greater rewards. It means understanding that risk and reward are linked, and that not getting too greedy about rewards is the way to long term success. Some risk is reasonable, as long as you don't expose yourself to so much volatility that you grab the little paper bag in the seatback in front of you and put all your money in a mattress. The tortoise beats the hare when it comes to investing. Searching for quick returns is like donning wings of paraffin and flying toward the Sun. Don't invest in anything that you don't understand--and that means having a full appreciation for every way your hmmmm can be deep fried. Simple, steady and average are a decidedly better bet for making you comfortable in retirement than the latest in glam financial fashions. For more, see http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.
Wednesday, February 6, 2013
Dow 14,000: So What?
What does Dow Jones Industrial Average at 14,000 mean? Not much, when you consider that it's to a large degree the product of the Fed's unremitting money printing policy. A "value" achieved through government policies, rather than market forces, has little intrinsic value. Witness the real estate markets of 2007-08: decades of government subsidies through the mortgage markets, tax laws and Federal Reserve monetary laxity puffed up home values until they exploded in our faces. Comparable subsidies (like quantitative easing) and more easy Fed money can do the same to financial assets.
Right now, retail money has started flowing into stocks again. That's deemed by many market pros to be a sign of an impending market peak. If you want to get in and out of the market--i.e., trade it as if it were an asset bubble--there may be some greater fools who would buy from you. That is, if you act quickly enough. But investor, beware. The Fed is making an enormous bet right now: that enough monetary stimulus will somehow revive the economy to the point that it will independently resume sustained growth and return to full employment. That such will occur is unusually uncertain. Aside from the fact that economic revival has been painfully slow even with all the printed money, one has the sneaking suspicion that the Fed has quietly placed a side bet that its easy money policy would push down the value of the dollar enough that America might export its way to prosperity. But other export-centric nations are fighting back. Japan has effectively undermined the independence of its central bank in order to push the yen down. China has stopped levitating the renminbi. And the Germans are starting to grouse audibly about the revival of the Euro. Currency wars tend to take on the look and feel of a circular firing squad, and the major economies of the world are charging their muskets.
Right now, retail money has started flowing into stocks again. That's deemed by many market pros to be a sign of an impending market peak. If you want to get in and out of the market--i.e., trade it as if it were an asset bubble--there may be some greater fools who would buy from you. That is, if you act quickly enough. But investor, beware. The Fed is making an enormous bet right now: that enough monetary stimulus will somehow revive the economy to the point that it will independently resume sustained growth and return to full employment. That such will occur is unusually uncertain. Aside from the fact that economic revival has been painfully slow even with all the printed money, one has the sneaking suspicion that the Fed has quietly placed a side bet that its easy money policy would push down the value of the dollar enough that America might export its way to prosperity. But other export-centric nations are fighting back. Japan has effectively undermined the independence of its central bank in order to push the yen down. China has stopped levitating the renminbi. And the Germans are starting to grouse audibly about the revival of the Euro. Currency wars tend to take on the look and feel of a circular firing squad, and the major economies of the world are charging their muskets.
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