April 1, 2015 7:27 pm

Emerging markets: The great unravelling

James Kynge and Jonathan Wheatley

Developing economies are suffering their biggest capital outflows since the financial crisis

Faced with recession, decade- high inflation, a fiscal crisis and water rationing, more than 1m Brazilians took to the streets last month to protest against corruption and mismanagement in their government. In China, growth is slowing as property prices fall, propelling more than 1,000 iron ore mines toward financial collapse. The patriotic citizens of Russia, meanwhile, are deserting their nation’s banks, switching savings into US dollars.
Such snapshots of growing distress in the world’s largest emerging markets are echoed among many of their smaller counterparts. Several countries in Sub-Saharan Africa are beset by dwindling revenues and rising debts. Even the turbo-powered petroeconomies of the Gulf, hit by a halving in the price of oil over the past six months to $55 a barrel, are moving into a slower lane.

Though these expressions of distress derive from disparate sources, one big and insidious trend is working to forge a common destiny for almost all emerging markets .
The gush of global capital that flowed into their economies in the six years since the 2008-09 financial crisis is in most countries now either slowing to a trickle or reversing course to find a safer home back in developed economies.

Highest outflows since 2009

On an aggregate basis, the 15 largest emerging economies experienced their biggest absolute capital outflow since the crisis in the second half of last year, as a strong US dollar drove emerging market currencies into a swoon and investors grew nervous over the prospect of a tightening in US monetary policy, according to data compiled by ING. At the same time, low commodity prices slammed GDP growth rates across the developing world.
These trends, analysts say, signal a “great unravelling” of an emerging markets debt binge that has swollen to unprecedented dimensions. Importantly, the pain inflicted by this capital flight is being felt beyond financial markets in the real economies of vulnerable countries and in a surging number of emerging market corporations that are forecast to default on their debts.

“Certain parts of the world are looking really vulnerable,” says Maarten-Jan Bakkum, senior emerging market strategist at ING Investment Management. “Places like Brazil, Russia, Colombia and Malaysia, that rely heavily on commodity exports, are going to get hit even harder, while those countries that have borrowed most excessively like Thailand, China and Turkey also look risky.”

Emerging markets chart

Analysts say that while emerging markets have been the setting for several recent financial squalls, the current exodus of capital could herald more fundamental changes. Indeed, although the “taper tantrum” of mid-2013 — triggered by the US Federal Reserve signalling its intention to unwind its monetary stimulus — caused turmoil in financial markets, its impact on real emerging market economies was transitory.

This time around, though, things look more serious. The International Monetary Fund said this week that total foreign currency reserves held by emerging markets in 2014 — a key indicator of capital flows — suffered their first annual decline since records began in 1995.

Without steady capital inflows, emerging market countries have less money to pay their debts, finance their deficits and spend on infrastructure and corporate expansion.

Real economic growth is set to suffer this year, analysts say. Capital Economics expects GDP growth in emerging markets to fall to 4 per cent from 4.5 per cent in 2014, as Russia slips deeper into recession, Brazil continues to struggle and China is hampered by its ailing property market.

Underlying such sober projections is a sense that an inflection point has been reached with the end of the commodity “supercycle” and the advent of low oil prices. “What is going on is a great unravelling of the market conditions of the past 15 years,” says Paul Hodges of International eChem, a chemicals and commodities consultancy.

Mr Bakkum also sees a significant reversal in the animating forces of global capitalism. “The EM capital outflows represent the gradual unwinding of the excessive inflows into the emerging world during the years of zero interest rates in the US,” he says.

However, the outlook is not universally bad. Investors have flocked to India, which has a reform-minded government and has gained from falling energy prices that have helped it slash its current account deficit. Indonesia and Mexico are also attracting investment for similar reasons.

Foreign exchange slump

Nevertheless, according to data collated by ING for the leading 15 emerging market economies, net capital outflows in the second half of last year totalled $392.4bn. This compared to a total of $545.9bn in capital outflows over three quarters during the 2008-09 crisis. If the first quarter of this year also shows a capital outflow, the total loss from emerging markets over three quarters could get close to that seen during the crisis. It is possible, analysts say, that outflows will not only continue in the first quarter of this year but may actually accelerate to eclipse the $250.2bn seen in the final three months of 2014.

Emerging markets chart

While in 2008-09 the US was a key catalyst of emerging market distress, this time China is seen as the chief bugbear. Slowing Chinese GDP growth, coupled with a slowdown in construction, is triggering a large bout of capital flight as investors think they will earn more by parking their money elsewhere.

The main expression of this reversal is the implosion of the “China carry trade”, in which Chinese investors borrowed at low rates of interest abroad to pump back into Chinese property and a range of shadowy financial products . But such investments now seem more risky, and a record $91bn fled the country in the final quarter of last year.

“It’s all China, directly and indirectly,” says Frederic Neumann, economist at HSBC. “Despite a solid current account surplus, capital outflows over the past six months have drained reserves from China’s vast forex chest . . . and with the renminbi more fairly valued today it is difficult to see China running big balance of payment surpluses again.”

In Brazil, fragility stems from a combination of falling commodity prices and the rising US dollar.

Although the country managed to attract net capital inflows in the second half of last year, the cost of doing so was a punitive interest rate environment in which the policy lending rate is 12.75 per cent.

Paying debts

Like many emerging markets, critics say, Brazil failed to use its boom years to make the tough decisions needed to drive productivity growth. “To reform while you are facing headwinds is very difficult,” says Sergio Trigo Paz, head of EM debt at BlackRock. “Some emerging markets will struggle to keep their investment grade ratings.”

According to a study by McKinsey, total emerging market debt rose to $49tn at the end of 2013, accounting for 47 per cent of the growth in global debt since 2007. That is more than twice its share of debt growth between 2000 and 2007.

Some of the most significant capital outflows are originating from countries that piled debts up the quickest. South Korea, for instance, saw its debt to GDP ratio rise by 45 percentage points between 2007 and 2013, while China, Malaysia, Thailand and Taiwan experienced debt surges of 83, 49, 43, and 16 percentage points respectively.

But it is not only countries that are vulnerable. Another area of concern is the rise of the emerging market corporate hard currency bond market. Ten years ago, it hardly existed. Today, it is estimated at more than $2tn, making it bigger than the $1.6tn US high yield bond market, an asset class familiar to investors for decades. Its growth was fuelled by expansionary monetary policies in the US and elsewhere and by the hunt for yield among investors and fund managers with targets that could no longer be met in developed markets.

But US policy is changing course. David Spegel, head of emerging market bond strategy at BNP Paribas, is among those expecting conditions for emerging market borrowers to deteriorate. In a recent report, “Harbingers of Default”, he underlined the dangers posed by capital outflows: “The persistent higher cost of funding will continue to erode credit quality for related higher-risk issuers, if sustained . . . Since most defaults typically coincide with significant investor outflows, we continue to believe that further bouts of EM distress may yet come to bear on the market, as forced selling is exacerbated by already low liquidity conditions.”

Indeed, Mr Spegel notes, current bond prices suggest investors expect the rate of default for non-investment grade EM bonds — about a third of the total — to rise from 2.8 per cent on Wednesday to 12 per cent in January 2017.

If the upshot of all this is merely that countries and companies that have engorged themselves irresponsibly on debt are set to receive a dose of market discipline, then all well and good. The danger for emerging markets, and the wider world, is that the capital outflows will snowball to an extent that robs EM countries of the lifeblood they require to create jobs and engender their people with hope for the future.

Special economic zones

Political priority, economic gamble

Free-trade zones are more popular than ever—with politicians, if not economists

Apr 4th 2015

RWANDA has developed a strategic plan for them. Myanmar is embracing them as it opens up.

Countries that have long been fans, from China to the United Arab Emirates, are doubling down.

India’s plans in the area are “revolutionary” and could add 2% to its GDP, says a minister.

Special economic zones (SEZs) are all the rage among governments hoping to pep up their trade and investment numbers. Such havens are appearing even within havens: the Cayman Islands has a new one. “Any country that didn’t have [an SEZ] ten years ago either does now or seems to be planning one,” says Thomas Farole of the World Bank.

Studying history may give eager trade ministers pause. SEZs—enclaves in which exporters and other investors receive tax, tariff and regulatory incentives—create distortions within economies. Other costs include required infrastructure investment and forgone tax revenues.

The hope is that these are outweighed by the boost to jobs and trade. In reality, many SEZs fail.

Performance data are elusive because the effects of zones are hard to disentangle from other economic forces. But anecdotal evidence suggests they fall into three broad categories: a few runaway successes, a larger number that come out marginally positive in cost-benefit assessments, and a long tail of failed zones that either never got going, were poorly run, or where investors gladly took tax breaks without producing substantial employment or export earnings.

SEZs have a long pedigree: the first free-trade zones were in ancient Phoenicia. The first modern one was set up at Shannon airport in Ireland in 1959, but the idea took off in the 1980s after China embraced them. There are now more than 4,000 SEZs (see chart). A study conducted in 2008 estimated that 68m people worked in them. They come in many forms, from basic “export processing zones” to “charter cities”, urban zones that set their own regulations in all sorts of areas that affect business.  

The biggest success story is China, whose decision in 1980 to create a zone in Shenzhen transformed the city (pictured) into an export powerhouse. Dozens of SEZs have since popped up across the country. In March, Xi Jinping, the president, urged a faster pace of roll-outs.

Other successes include the United Arab Emirates, South Korea and Malaysia. The Philippines has won praise for its “PEZA” zones, which offer a streamlined permit process for foreign investors, says Shang-Jin Wei of the Asian Development Bank.

Most economists agree that SEZs catalysed liberalisation in China, which used them to test reforms that were seen as too hard to unveil nationwide. In the Dominican Republic they helped create a sizeable manufacturing sector in an economy previously reliant on agriculture.

The overall impact of SEZs on trade is poorly understood. A paper published in 2014 by economists at Paris-Dauphine University found that, for a given level of tariff protection, SEZs increase exports for the countries they are in and for other countries that provide intermediate goods or components.

This helps explain why the World Trade Organisation generally tolerates SEZs, even though many breach its subsidy rules. However, the paper also concluded that zones sometimes give countries an excuse to retain protectionist barriers around the rest of the economy.

More prosaic problems pop up, too. Bureaucracy can be excessive, and the bureaucrats underfunded—sometimes at the same time. Too little is often spent on railways, roads and ports to link the zone to the rest of the world. Many African SEZs have struggled for such reasons. One in Senegal flopped because of a combination of excessive bureaucracy, high electricity costs and its distance from a good port.

Developers have withdrawn from 61 of the 139 approved SEZs in the Indian state of Maharashtra because of capricious policymaking, a murky screening process and concern over economic prospects. One survey found that firms sometimes had to deal with 15 different agencies to do business in an Indian zone. Violent protests by locals over land acquisition for zones have also deterred investors.

Moreover, governments sometimes embrace SEZs for the wrong reason: to win praise for reform (and votes) without having to risk full liberalisation. Partial liberalisation can also be a way to preserve some of the rents earned elsewhere by shielding businesses from competition.

Some officials see zones as vehicles for graft. In 2005 some 60% of firms in Indian SEZs reported having to make “irregular” payments to zone authorities. Last month Ukraine’s prime minister said he opposed SEZs because of corruption. SEZs in Nigeria were firmly resisted by the customs agency, which did not want to lose its clout. Another concern is the use of zones to launder money, by inflating export values.

The SEZ concept appears to have natural limits, too. What works in manufacturing may not work in other sectors. The Shanghai Free Trade Zone, launched in 2013 and focused on finance, has been disappointing. Economists fret that it is impossible to tinker within the zone with China’s capital controls, for instance, without the effects spilling over to the rest of the economy. Perhaps as a result, the authorities have been cautious: in a recent survey, three-quarters of American firms in Shanghai said the zone offered them no benefits.

That hasn’t stopped China approving plans for more financial SEZs. The government is also promoting zones abroad: it is helping six African countries to set some up. Although its are state-run, ever more SEZs are likely to be privately owned and operated. The Philippines already has more than ten times as many private zones as public ones. This shift may go further, if privately run charter cities and other so-called “special governance zones” gain traction. The idea is to create enclaves that write their own rules in all business matters, from labour regulation to anti-corruption codes—“to look at laws as services that companies demand”, says Lotta Moberg of George Mason University.

Such ventures will provide competition more effectively than zones focused on fiscal incentives, says Shanker Singham, founder of Enterprise Cities.

Mr Singham is in talks to develop sites in the Dominican Republic, Colombia, Morocco, Bosnia, India and Oman. But these are mostly at an early stage. The most advanced charter-city project, backed by a group of American libertarians, is in Honduras. But it has yet to start and is already controversial: many Hondurans worry that it will operate as a state within a state, milked by business interests. In most countries, such parastatal ventures are likely to encounter political difficulties.

Whether or not such freewheeling zones catch on, expect more experiments. South Korea and Thailand are developing eco-industrial parks. Others are considering SEZs for refugee populations.

For better or worse, the number of zones could top 5,000 before long.

Did The Fed Just Admit to Deep Uncertainty About Our Financial Security In Retirement?

By: Daniel Amerman

Wednesday, April 1, 2015

Generally speaking, the chairperson of the Federal Reserve is treated by the mainstream financial media as being the very paragon of respectability. If the Fed says it - then the voice of economic authority has spoken, and we need to listen carefully.

Yet, recent comments by Janet Yellen have instead made her a source of "controversial" economic ideas, with some financial reporters and their editors apparently feeling a duty to protect their reading audience - and let them know this is not acceptable economic thinking, but rather is "far outside the mainstream."

Now what could the head of the world's most powerful central bank possibly say that would get the mainstream media to try to flip the narrative upside down, and turn her from the heart of authority to being a holder of unreliable and perhaps even fringe ideas?

Chairwoman Yellen's offense was to openly speak the truth about an issue that has been widely discussed by some of the leading economists around the world over the last couple of years, which is the concern about "secular stagnation".

As described in the CNBC article linked here, secular stagnation is an academic concept that has been around since the 1930s, and the article frames it as an "obscure" topic that correct-thinking economists don't worry about today.

What is not discussed in the various media articles is what matters, which is the wide ranging and potentially life-changing implications for all of us. For if it does turn out to be secular stagnation, then bond returns remain very low, stock returns fall, the chances for a new financial crisis increase, the risk of pension insolvencies increases, retirement standards of living fall, and the financial viability of Social Security and Medicare is undermined as well.

Why Secular Stagnation Matters To All Of Us

As explained in my tutorial on the subject linked here, secular stagnation refers to a long term (generally interpreted as 10 years or more) period of very little to no economic growth.

The tutorial is intended to serve as a quick introduction for the general public, but for those who are comfortable with macroeconomic theory, this linked e-book titled, "Secular Stagnation: Facts, Causes and Cures", edited by Coen Teulings and Richard Baldwin, is well worth reading. Published by the Centre for Economic Policy Research (CEPR), the Contributors to the book include Lawrence Summers and Paul Krugman, as well as numerous economists from such institutions as Harvard, MIT, Oxford, Cambridge, the International Monetary Fund and also the Principal Economist for the Executive Board of the European Central Bank.

Unfortunately, what was left out of the mainstream financial media's treatment of Yellen's comments was not only the extraordinary implications of secular stagnation, but also the tools being used to fight long-term stagnation. Instead, all that was discussed in the CNBC article for example was the concept of very low interest rates over a long term period of time.

While technically accurate, it misses the most important part, as you can easily see if you review the tutorial or go directly to the CEPR e-book.

That is, what matters most is the way that the nations of the world fight secular stagnation, which is not so much low interest rates - but rather creating negative interest rates in inflation-adjusted terms.

What so many leading economists agree upon is that if we're truly facing a long-term environment of stagnation, then investor behavior has to be changed. And the recommended tool of choice for changing investor behavior is effectively to punish those who follow traditional investment strategies.

Interest rates are thus forced below the rate of inflation, creating a negative return in inflation-adjusted terms as a matter of policy.

In other words, the "cure" is what we've been seeing in practice for about the last five years or so with short-term interest rates.

So if you've wondered why you've been getting almost no interest in your checking, savings or money market account even while food and utilities and medical care continue to increase in price - this is the reason.

If you're a traditional investor, the pain you're feeling is a direct result of deliberate government policy. You're supposed to feel the pain. Pain is what makes people change their behavior. In this case the desired change in behavior is to pull your money out of the bank, and go take some risks. So you can at least stay ahead of inflation, and alleviate the pain.

These risks are ones you would not ordinarily take, but the theory is that the more people who are driven to seek out risk, then the greater the supply of low cost money to corporations and innovators, and the greater the resulting business development, and the more jobs that become created, until the stagnation is eventually broken.

This is happening right now on a major scale in Europe, and again - it's entirely intentional. A new massive program of quantitative easing by the European Central Bank is driving yields into negative territory, which has investors scrambling for alternatives, and is intended to drive them into taking risks that will help create economic development and jobs.

What needs to be understood is that for conventional investors, the implications are completely upside down compared to what is generally assumed in financial planning and retirement planning strategies. The entire basis of those plans, as we're taught, is that we will receive market-based positive returns, and that this interest will compound over time and thereby create wealth for us and fund our retirements.

If we accept the chairperson of the Federal Reserve as a knowledgeable authority, and thereby accept the possibility of secular stagnation, then we have to accept the possibility that for years to come as a matter of governmental policy we will lose money if we follow the usual investment advice, as the process of what is supposed to be wealth creation is reversed into a process of wealth destruction.

Now from the perspective of a financial firm whose livelihood depends upon one's clients following the usual investment advice, perhaps one could see how this is extremely dangerous information that is being circulated. If the general public ever genuinely understood the potential implications - there could be changes in investor behavior on a massive basis.

Of Stocks & Bubbles

The implications go well beyond just interest rates, for secular stagnation also means very little economic growth in real terms.

Again, as with interest rates, this is something we've been seeing in practice with the US economy for some years now. The economy is continuously presented as being on the edge of a breakthrough, and then another round of disappointing economic news comes out that things aren't quite working as planned.

Now when it comes to stock returns, they are of course usually driven by economic growth on a fundamental basis. So if the economic growth is low or nonexistent, then we should expect much lower stock market returns in the future than what we've seen in the past.

Also, as covered in this analysis linked here, when you study the research - there is another danger with secular stagnation.

The basic idea is that when enough people are forced to take higher risks with their money and investments than they would otherwise like to - which is the whole essence of the measures for fighting secular stagnation - then all of this cheap and easy money leads to a very strong possibility that a series of financial bubbles will be created.

And as history has taught us well, the popping of those financial bubbles can lead to severe financial crisis.

So we face the potential 1-2 combination of much lower interest income, indeed negative returns, and much lower stock market returns - unless investors around the world take the actions that these theoretical economists want to force, which is to take on more risk.

Which then creates the possibility of financial bubbles, which leaves us with very low returns - until the floor drops out.

Financial Security In Retirement

There is a potentially even bigger issue, which is that the projected funding for Social Security and Medicare is based upon the assumption of historic rates of economic growth continuing into the long term future.

The following two graphs may be helpful in understanding this essential point. When people talk about future shortfalls, usually they are talking about projections which are themselves based upon the assumption that we know the future, and that it is one of steady economic growth at historical rates.

The Future Hole in the Economy

As shown in the first graph, and as developed in more depth in this analysis, the economy is expected to double in size in a little more than 20 years - assuming historical growth rates. There are a number of reasons why this growth might not happen, including the slower growth rates of heavily indebted nations, or the slower growth rates of nations with rapidly aging populations, or future potential economic and/or financial crises, or a shift in economic growth from the West to Asia... or it could be "all of the above" coming together into one package labeled "Secular Stagnation."

What does secular stagnation look like? That would be the hollow part of the right-hand bar. What a long-term lack of economic growth means is a necessary void in the future, an emptiness where the phantom wealth which was assumed and counted upon - fails to materialize in practice.

People don't usually think about it that way, but when we talk about the solvency of Social Security, or Medicare, or the value of long-term stock returns - those are generally all based on wealth that doesn't actually exist yet. Rather it is wealth that is merely assumed into existence, by taking historical growth for the United States during a time of economic prosperity and even world domination, and projecting them forward indefinitely into the future.

To be clear, then, to have the rug pulled out from underneath what we are told the financial future will be doesn't actually take any great crisis, or catastrophe, or collapse, or any other sort of world-changing "high drama" scenario. Oh, those could indeed happen, but they aren't actually needed for the future to unfold in an entirely different way than what the voice of financial authority tells us will be the case.

All it takes is for the assumed growth to not occur.

That's what secular stagnation truly is - not a doomsday event, but a big, gaping hole in the future. It's hypothetical wealth that simply fails to materialize. With any financial security or investment returns based on assumptions about that future wealth - also failing to materialize.

Part II

The 2nd part of this article discusses the grave threat that secular stagnation poses for Social Security, Medicare and other retirement promises, as well as how even allowing for the possibility can require changes in how we plan for retirement.

To understand the next level of risk posed by secular stagnation, we need to consider the difference between officially recognized national debts and what accountants call "unfunded liabilities".  That is, when a corporation or even a state or local government takes on a financial obligation for the future, and they have not set aside the money to pay for it, then they have to recognize the cost of that promise as a debt, in current dollars.

The federal government on the other hand makes its own rules for its own accounting, and for the obvious political reasons – it chooses to ignore that requirement.  Unfortunately, however, ignoring it doesn't make it go away. The three right-hand columns in the following graph are various estimates of what the real debt of the US government is after taking those unfunded liabilities into account, over and above future expected tax receipts. 

As explored here, the cost per above poverty-line household is over $900,000, and that means that the rules governing retirement investment accounts are likely to be changed, and in ways that most of us are not currently expecting.

But here's what almost no one is taking into account:  those towering red and yellow bars with their tens of trillions of dollars of shortfalls are all based on "normal" economic growth. They assume that most of the future cost of retirement promises will be funded by taxes on wealth that does not yet exist, but which will materialize from ongoing economic growth over the coming decades.

Now obviously if that growth doesn't occur – then those taxes aren't collected.  And the shortfalls grow much, much larger.  Even as they move much closer in time.  And that means that the day that the rules change on Social Security, Medicare, pension payments and potentially retirement accounts – also moves forward in time.

The Inadvertent Spread Of "Dangerous Knowledge"

There is a fascinating contrast between Janet Yellen and her predecessor, Ben Bernanke. 

I've written about Mr. Bernanke many times, and while often in vigorous disagreement – one of the things I came to understand was just how disciplined he was. That is, he was keenly aware that one poorly chosen sentence could send a tremor through the markets, and that one of his primary roles as Fed Chairperson was one of Perception Management.  I don't know that he ever spoke his actual mind in a public speech, but rather everything passed through a mental filter of sorts, screening out any thoughts or opinions that might invite negative consequences.

Ms. Yellen, in contrast, seems to every now and then – just say what she is thinking.  She is a top-level economist, she is immersed in the professional puzzle of a lifetime as the nation's chief economist during difficult times, and there are so many complicated factors involved that she spends her time thinking about. And with her personality, it seems that occasionally a thought does slip through the screen, and she shares what she is actually concerned about, with an inconvenient truth thus being spoken.

One could call this habit a bit klutzy, or characterize it as a welcome breath of fresh air. 
So, just as Bernanke surely was, Yellen is very well aware of the danger of secular stagnation. 

Of course she is!  This is cutting edge stuff, with a global conversation among economists in process.

Yes, there is controversy about whether secular stagnation does exist right now, or if it doesn't – whether an aging population and heavily indebted nations will bring it about in the future. 

And yes, there is controversy about the macroeconomic tools to fight it, and whether they will be effective in overcoming the stagnation.
But there is absolutely nothing "obscure" about it – unless one defines "obscure" as being something the media almost never chooses to cover.

When Janet Yellen spoke of secular stagnation, she was only making a clarification about what could affect future interest rates, and she didn't pursue any further implications.  Nonetheless, she publicly and inconveniently used the term – and in the process helped to disseminate knowledge into the world.  She let people in on the "controversial theory" that even the highest levels of government, economics or finance don't actually know for sure what future economic growth will be, or even whether it will be positive.

Now after cutting through all the economics jargon, some might call this common sense. 

Hey, guess what maybe the "experts" don't actually know the future after all. 

So maybe we should reconsider betting everything we have for retirement on wealth that doesn't actually exist yet, and which in fact may not ever materialize?

Yet, that same common sense, aka highly "controversial theory" – poses a very dangerous threat indeed to those people and institutions whose wealth and political power are aided by the current dominant belief system that assumes we know what the size of the economy will be in 2025 or 2035.

When we don't.

Let me suggest that there is an enormous difference between planning for genuine uncertainty, versus planning based on false certainties.  Both can be done – but the specifics are quite different.

And what America's chief economist just let slip is that as far as she knows – there is genuine and profound uncertainty.

What you have just read is an "eye-opener" about one aspect of the often hidden redistributions of wealth that go on all around us, every day.

A personal retirement "eye-opener" linked here shows how the government's actions to reduce interest payments on the national debt can reduce retirement investment wealth accumulation by 95% over thirty years, and how the government is reducing standards of living for those already retired by almost 50%.

An "eye-opener" tutorial of a quite different kind is linked here, and it shows how governments use inflation and the tax code to take wealth from unknowing precious metals investors, so that the higher inflation goes, and the higher precious metals prices climb - the more of the investor's net worth ends up with the government.

When we look at all government retirement promises over the coming decades – the total is simply unpayable.  As explored in the "eye opener" linked here, this means that there is a high probability of an eventual tax code "revolution" that could rewrite all the rules when it comes to the future treatment of our current retirement accounts.


Hung, drawn and first-quartered

The trend in corporate profits in America is worrying

Apr 4th 2015

IF ONLY America could abolish the first quarter, its economy would look so much better. In 2014 a cold snap triggered by the “polar vortex” caused GDP to fall by 2.1% at an annualised rate. This time round, more cold weather, a decline in oil drilling and a labour dispute at west-coast ports is causing growth estimates to be revised down once more.

Figures for manufacturing output, durable-goods orders, housing starts and retail sales have all been weaker than expected. The consensus forecast for growth in the first quarter is 1.4% at an annualised rate. But a nimbler model created by the Atlanta Federal Reserve points to just 0.2%—barely any growth at all.

A weak first-quarter number will make life even harder for the Federal Reserve, which has hinted that it might push up interest rates later this year. Inflation is running at zero, so the justification for higher rates would look very flimsy if the growth outlook was faltering too.

However, as in 2014, most economists expect the first-quarter figures to be a blip, with activity rebounding in the rest of the year. Low oil prices should be a boost to spending; consumer-confidence figures released on March 31st showed an upturn. The employment figures for March, which are due to be published on April 4th, will be the next big test of the economy’s strength. The Fed has indicated that the labour market may trigger a decision to raise rates; if unemployment falls much below the current rate of 5.5%, wage pressures might start to appear. Strong figures on job creation have generally belied the weak tone of numbers on durable-goods orders and retail sales.

Some investors may be inclined to take a relaxed view of the Fed’s dilemma. After all, if the economy is strong enough to allow the central bank to raise interest rates, that would be good news; and if the economy isn’t strong enough, then investors will continue to enjoy the benefit of low rates.

However, that rosy view is being somewhat undermined by the recent weakness in corporate profits.

After plunging in 2008, profits rebounded strongly, hitting their highest levels as a proportion of GDP since the second world war. That trend may be coming to an end. Corporate profits in America fell by 1.6% in the fourth quarter of 2014, according to the Bureau of Economic Analysis, and were 6.4% lower than in the same quarter of 2013. Those figures do not translate directly into the profits of S&P 500 companies, many of which are multinationals: their earnings per share rose at an annual rate of 7.8% in the fourth quarter, with the help of buy-backs, which spread profits among a smaller number of shares (see chart).

However, the dollar’s surge in 2015 is dragging down earnings forecasts for the current year: earnings per share for S&P 500 firms are now expected to rise by only 2.6%. Three factors are at work. First, the strong dollar is reducing the value of profits earned in other currencies.

Second, those foreign profits are being squeezed by a slowdown in developing economies. And third, the fall in the oil price is battering the profits of the energy sector.

Wall Street analysts tend to be optimistic when it comes to medium-term profit projections.

After a sluggish 2015, they think 2016 will be a bumper year, with earnings per share rising by 12.9%. That allows them to claim that the market looks cheap when future earnings growth is taken into account: using their 2016 forecasts, the market is on a prospective price-earnings ratio of 15.3.

But if the market is compared with past earnings numbers, the picture looks rather different.

The cyclically-adjusted price-earnings ratio (which averages profits over ten years) is currently 27.9, according to Robert Shiller of Yale University. The long-term average is 16.6. The sluggish performance of profits may explain why the American stockmarket has struggled to make progress so far this year.

Investors in the rest of the world should also be concerned about weak economic data. There have been 29 instances of monetary easing by central banks around the world in the past five months, an indication that monetary authorities are worried about growth. Low government-bond yields and falling commodity prices are further signals of poor economic momentum.

Although there have been tentative signs that the euro-zone economy is recovering, the world has been very reliant on China and America in recent years. China’s growth rate has slowed to 7% or so from the double-digit rates regularly seen in the past decade. If America’s growth slows as well, the global economy may find itself becalmed.

04/03/2015 06:28 PM

The Persian Paradox

Iran Is Much More Modern Than You Think

An Essay by Erich Follath

People in the West tend to have a monolithic view of Iran. But there's a lot more to the country than the mullah-led theocracy, and it often gets ignored. And national pride is alive and well.

Which government cabinet is home to more ministers with doctorates from American universities than Barack Obama's administration? The correct answer is that of of the Islamic Republic of Iran. And, no, that list does not include President Hassan Rouhani. He got his doctorate at the University of Glasgow law school.

There are few countries in the world that are subjected to as much Western prejudice and misunderstanding as Iran. I have known the country since the era of the shahs and I have visited it more than a dozen times in the past four decades, including a recent visit.

I can remember sitting in a tea house in Shiraz at the grave of the great poet Hafez, who was greatly admired by Goethe, between comfortable pillows and smoking a water pipe, and jotting notes on how disastrously the shah had misjudged the people's mood and how brutal his secret service, the Savak, was. And I recall how the masses greeted Ayatollah Khomenei as their savior when he returned from exile in 1979 and how they celebrated the Islamic Revolution.

But I also observed how quickly those illusions were destroyed with the rise of a new and even bloodier dictatorship in the name of a theocracy waging battle against the "great Satan" (the United States) and the "little Satan" (Israel). I observed just how mercilessly the insurgency brought on in 2009 by the children of the revolution was stamped out. I recall how reckless former President Ahmadinejad was in his denial of the Holocaust. Then, in 2013, I watched as moderate President Rouhani got elected, increasing the possibility of rapprochement with the West.

Pro-West Sentiment

The Iran of today has changed dramatically. In more liberal cities like Shiraz and Isfahan, young entrepreneurs have opened small cafés and Bob Dylan's "The Times They Are a-Changin," has become the favorite song. Young students hold hands in public and women pull their obligatory headscarves back to the point where their hair is visible (a forbidden act).

Tourists are welcomed all over the place and are treated with overt hospitality.

With the exception of Israel, there is unlikely any other country in the Middle East where pro-Western sentiment is as pronounced as it is in Iran. Millions of young people attend university.

And even though women are still discriminated against -- laws limit their right to divorce and custody of their children and also stipulate that they can be subject to prosecution starting at the age of nine as opposed to 15 for boys -- they live more freely here than in many other countries in the region. With the help of quick-to-install illegal satellite dishes that can be found everywhere, they also have access to Western news programs.

Only a few hundred kilometers west of here, fanatical Islamists have erected a caliphate in Iraq and Syria. In Iran, however, the role of religion is in decline. People here consider the mullahs to be corrupt and they are the objects of contempt. Friends tell me to avoid standing next to a cleric wearing a turban and robe when hailing a taxi. The drivers, they say, won't stop. And while the many mosques may be empty, the country's consumer cathedrals, its new shopping centers, are packed. Group-think today is scorned and individualism is in vogue.

The disillusionment, of course, isn't new. Already back in 2003, Grand Ayatollah Hossein Ali Montazeri, a former comrade-in-arms of Khomenei's who would later be placed under house arrest as a member of the opposition, openly admitted this failure during a meeting we had in Qom. "We have lost the world's respect through our excesses -- and my dreams are dead," he said. "The religious leader should limit his role to representative duties -- and that is what will happen."

But Montazeri was mistaken. There is no recognizable trend in Iran suggesting a move toward a constitutional monarchy let alone a Westminster democracy. Even today, Iran's system of government, with Ali Khamenei in the highest position as a higher authority than the president and parliament, doesn't appear to be seriously threatened. Following the crushing of the protests almost six years ago, few people continue to believe that politics can be changed through demonstrations.

Instead, they take advantage of the small amount of freedom they are given in public parks and galleries. Inside their own homes, though, they party exuberantly in a parallel private life.

More Madrid than Havana

The cities suffer under constant traffic jams and, at least at first glance, it doesn't look like people are living in want. Despite the sanctions, the standard of living and shopping opportunities are more comparable to Madrid than Havana. A remarkable number of new shopping centers are currently under construction, with names like Palladium or Mega Mall, and you can see Porsches parked out in front. The upper class doesn't appear to be suffering much under the economic bottlenecks.

Many in the West have a monolithic image of Iran, but that is not the reality. Iran is a country with diverse centers of power that view each other suspiciously. The elected government often doesn't even know what the Pasdaran, the powerful paramilitary organization, is actually doing. And the Revolutionary Guard, which theocracy founder Khomenei once built up for his own protection, is today better armed than the army itself and has become something of a state within a state.

The Revolutionary Guard also finances many of the new shopping centers, and its economic power has become just as big a problem for the moderate president as its military prowess. The Revolutionary Guard symbolizes the other, more threatening Iran. It controls exports as well as the country's nuclear program. Using the Basij militia, which the Revolutionary Guard deploys as its unofficial police force, it goes after demonstrators. And it doesn't shy away from terrorist acts abroad with its Quds Force. It is often hostile towards Rouhani, who sometimes retaliates.

Recently, for example, he threatened to give the people their own voice in the form of a referendum -- a provocation against the Revolutionary Guard, but also an affront to the religious leader.

In contrast to the highly networked Pasdaran, "normal" Iranians have been hit by the country's economic decline. During 2012 and 2013, gross domestic product shrank considerably, the national currency, the rial, fell significantly in value against the dollar and inflation is high. In the longer term, the country, which is reliant on oil exports, is threatened with deep cuts to its social system. In order to cover the government's budgetary needs, the price per barrel of oil would have to be $130, but in recent months it hasn't even been half that.

Growing Disatisfaction

Furthermore, Iranians are also outraged by the numerous death sentences meted out and they suffer from the restrictions placed on press freedom and culture. It's especially painful to them when a movie like "Taxi," by Tehran director Jafar Panahi, can take the top prize at the Berlin International Film Festival but cannot be shown in their own cinemas. People are dissatisfied with their political leaders, which has made many grow cynical. So far they have excluded the president they elected from the worst criticism, but he will need to deliver soon and improve their standard of living.

More than anything, Rohani needs a final nuclear deal. Iranian industry is eager for sanctions to end so it can once again begin moving forward and Western partners are also eager to enter the Iranian market. In many cases, preliminary contracts for joint ventures in automobile manufacturing and even in the exploration of new oil and gas fields are already sitting in drawers, just waiting for signatures.

But there is one thing that connects all Iranians, regardless of their political leanings: pride in their own culture and fear the country will be humiliated. Iranian school children are taught that Persian history is at the very least on par with that of Rome or Athens -- and that its civilization was far ahead of that of Iran's Arab neighbors. Alexander the Great, viewed as a legendary conqueror in the West, is scorned as a criminal here because he destroyed cultural assets. At the same time, people like to point out that it was obvious that the world conqueror would settle down in Persia and marry one of its beautiful women as he did. It's a perfect example of what author Hooman Majd calls "our superiority complex."

It's an element of the Persian paradox that this feeling goes hand in hand with a sense of deep uncertainty. I have been repeatedly confronted during my visits to Iran with the complaint that the West doesn't care anything about Iranian history and culture. With this ignorance, they complain, people are treating Iran like a third-class state and aren't even granting the country its rights under international law. The political class in Tehran has successfully tied this general conviction to a very specific problem -- the issue of Iran as a nuclear power. Throughout, politicians have acted as though much of the world were conspiring against Iran -- as though the conflict were about Iran's "dignity" rather than about a justified suspicion that the country is building a nuclear bomb.

Almost every Iranian politician, including former presidential candidates Mir Hossein Mousavi and Mahdi Karroubi, who are still being held under house arrest, stress the country's entitlement to conduct scientific research into nuclear energy. In their opinion, that also includes the right to enrich uranium. It's a view also shared by the majority of the population.

In contrast to Israel, they argue, Iran has signed the Nuclear Non-Proliferation Treaty. And Iranian interview partners often point out that the Jewish state has over a hundred deployable nuclear weapons at its disposal. Western experts place that figure at 80.

A 'Great Civilization'

US President Barack Obama has sought to accommodate Tehran and its sensitivities. He admitted that CIA participation in the 1953 putsch against liberal Prime Minister Mohammed Mossadegh had been a historical mistake. He also congratulated Iran on its new year holiday, Nowrus, calling the country a "great civilization," and he has written several personal letters to Supreme Leader Khamenei.

Despite all their differences, it appears that Secretary of State John Kerry is more comfortable negotiating with his smooth Iranian counterpart Mohammad Javad Zarif, who studied international law in Denver, than with his coarser Israeli counterpart Avigdor Lieberman. And US Energy Secretary Ernest Moniz, the former head of the physics faculty at the Massachusetts Institute of Technology, seems to get along very well with Ali Akbar Salehi, the No. 2 man in the Iran delegation. It's no wonder, either, given that Salehi himself graduated from MIT.

If the nuclear negotiations do ultimately fail, Tehran will decry it as a humiliation. It will follow up by eliminating any restrictions and placing all of its energy into its effort to build a nuclear bomb. It will use national pride as the argument to oblige its people to persevere through difficult times.

In an interview with SPIEGEL in 2012, Salehi -- the former foreign minister, who is now the head of Iran's nuclear program -- had the following to say. "For over 30 years now, we have been living with boycott measures that ultimately make us independent and strong," he said. "Iranian society is used to living with hardships -- perhaps more so than people in Spain and Greece. We can count on the patience of our people. What about you in Europe?"

Heard on the Street

Italy, Not Greece, at Heart of Euro Question

Lifting Italy’s growth path is more important to the eurozone’s future than Greece’s troubles

By Richard Barley

April 2, 2015 10:59 a.m. ET

Italian Prime Minister Matteo Renzi arrives for a European summit in Brussels on March 20, 2015. Photo: Agence France-Presse/Getty Images

Greece may be the canary in the eurozone coal mine. But Italy is the elephant in the room.

For the eurozone to prosper, its members must be better off inside it than outside, as European Central Bank President Mario Draghi has highlighted.

The most obvious example of this is Greece. The new Greek government has submitted a fresh set of policy proposals to the eurozone in an effort to unlock €7.2 billion ($7.7 billion) in financing as deadlines for International Monetary Fund repayments and debt rollovers approach. The latest ideas rely heavily on generating new tax revenues and appear optimistic.

Many investors still expect Europe to reach some agreement that keeps Greece in the euro, although nerves are being tested by the lack of progress so far.

But a longer-term and arguably more important question surrounds Italy, the eurozone’s third-biggest economy. If Greece’s crisis is acute, then Italy has the chronic variety: it has barely grown since joining the euro.

In fact, Italy’s economy has been slowing down for decades: in the 1980s, average annual real gross domestic product growth was 2.1%, IMF data show. It slipped to 1.4% in the 1990s, 0.6% in the first decade of this century and has averaged -0.5% since 2010. Output remains some 9% below its 2008 peak.
Hope springs eternal for Italy, however, aided by ECB quantitative easing, lower oil prices and a weaker euro. The latest round of survey indicators look good: Markit’s March manufacturing purchasing managers index for Italy came in at 53.3, an 11-month high.

Consumer and business sentiment has surged higher. The first quarter might mark the first since 2011 in which Italy records positive growth. UniCredit expects expansion of 0.2% on the quarter.

But hard data has been underwhelming. Industrial output fell 0.7% on the month in January, against expectations of an increase. Unemployment rose in February to 12.7%; youth unemployment climbed to 42.6%. Economists are inclined to view this as disappointing, but temporary: with conditions for the eurozone as a whole set fair, Italy should benefit. Indeed, if Italy cannot grow now, then when?

Yet Italy’s growth potential remains worryingly low. J.P. Morgan’s economists have pegged it as running near zero for several years. Prime Minister Matteo Renzi’s efforts to reform the country are vital. His efforts to improve the labor market deserve credit; one of the major barriers to growth has been a culture that stops small firms expanding and that over-protects existing employees to the detriment of young job seekers. But meanwhile Italy urgently needs to show it can at least generate cyclical growth.

Many important dates loom in the eurozone’s future. Greece’s April 9 repayment of €450 million to the IMF is a key hurdle for the eurozone to surmount. May 13 should bring news of Italy’s exit from a three-year recession; if it doesn’t, expect more questions to be asked about what the single currency does for its members.

Oil Spikes On U.S. Production Dip, Gasoline Supplies Sink

By Sumit Roy
Crude oil prices get a boost from the latest supply and demand data from the EIA.

The Department of Energy reported Wednesday that in the week ending March 27, U.S. crude oil inventories increased by 4.8 million barrels, gasoline inventories decreased by 4.3 million barrels, distillate inventories increased by 1.3 million barrels and total petroleum inventories increased by 3.2 million barrels.

Crude oil was trading higher after the release of the latest inventory figures. While crude inventories rose significantly once again, the big decline in gasoline stockpiles offset that, leading to a neutral inventory report overall.

For oil, "neutral" is a big step up from the relentlessly bearish inventory figures that have come out in past weeks. Thus, it's not surprising to see prices rally on this report.

WTI may be poised to test the $50 mark, while Brent makes its way into the upper $50s.



Whether this rally is sustainable or not depends on whether supply has truly tightened. In addition to the smaller build seen in inventories, the EIA reported that U.S. crude oil production declined to 9.39 mmbbl/d last week, down 36,0000 mmbbl/d from the multi-decade high set the previous week.

Declining U.S. output is something that many have been anticipating for some time now and is a key factor in any bullish oil prices thesis. That said, one week does not make a trend, and we've seen similar declines in the past. If output continues decreasing in the coming weeks, the market will take notice and send prices decisively above $50 for WTI and $60 for Brent.

Meanwhile, as U.S. production faltered last week, output in OPEC countries went the other way. According to the latest survey from Bloomberg, OPEC production topped 31 million barrels per day in March, 1 million barrels per day above the group's quota and the highest level since 2013.

OPEC Crude Oil Production

Within OPEC, Iraq led the charge as output hit a record high near 3.75 million barrels per day.

Iraq Oil Production

OPEC's output would get a further boost if world powers and Iran are able to come to a successful resolution to the ongoing nuclear talks. Thus far, a deal has alluded negotiators, but if one comes to fruition and sanctions are lifted, Iranian crude oil exports could increase by upward of 1 million barrels per day down the line.

Turning to this week's EIA inventory figures, total petroleum inventories in the U.S. increased by 3.2 mmbbl, against the five-year average of a 3.7 mmbbl increase. In turn, the inventory surplus decreased to 149.3 mmbbl, or 14.1 percent, against the five-year average.

Crude oil inventories rose by 4.8 mmbbl, against the five-year average of a 2.7 mmbbl increase. In turn, the surplus in the crude category widened to 102.5 mmbbl, or 27.8 percent.

Regionally, inventories inside and outside the Midwest rose.

Gasoline inventories fell by 4.3 mmbbl against the five-year average of a 1.3 mmbbl decrease.

Gasoline inventories now have a surplus of 9.7 mmbbl, or 4.4 percent. Distillate rose by 1.3 mmbbl against the five-year average of a 0.1 mmbbl decrease. In turn, the distillate deficit narrowed to 5 mmbbl, or 3.8 percent.


Total petroleum demand in the U.S. jumped to 19.5 mmbbl/d, while gasoline demand climbed to 9.5 mmbbl/d and distillate demand fell to 3.8 mmbbl/d. On a four-week rolling basis, total demand was up by 2.7 percent from last year. On that same basis, gasoline demand was up 1.9 percent and distillate demand was up by 1.3 percent.

It's worth noting that these figures may be overstated due to the EIA's methodology for calculating demand.


Crude oil imports fell fractionally to 7.3 mmbbl/d. On a four-week rolling basis, imports have averaged 0.1 percent below the year-ago level.

Refinery Activity

Refinery utilization ticked up from 89 percent to 89.4 percent. Utilization is above the year-ago level and above the five-year average. Gasoline production surged to 9.7 mmbbl/d, while distillate production edged rose to 4.9 mmbbl/d.


U.S. crude oil production declined to 9.39 mmbbl/d, down 36,0000 mmbbl/d from the multi-decade high set the previous week. Output has been rising swiftly due to surging production in unconventional oil plays. Since the start of the year, output has averaged 1.2 mmbbl/d, or 14.2 percent, above the same period a year ago.

Inventories at the Nymex delivery point in Cushing, Oklahoma, rose by 2.6 million barrels to 58.9 million barrels, or 69.4 percent of the EIA's estimate of capacity. Overall, Midwest inventories rose by 4.3 million barrels to 147 million barrels, or 89 percent of estimated storage capacity.

Front-month WTI calendar spreads remained in contango at +$1.74.

Front-month Brent calendar spreads remained in contango at +$1.10.

West Texas Intermediate's discount to Brent decreased week-over-week from -$7.86 to -$7.55. WTI's discount to Louisiana Light decreased week-over-week from -$8.25 to -$6.10.

The Baker Hughes oil rig count decreased by 12 to 813 rigs last week.

Baker Hughes Oil Rig Count


The End of History, Part II

The new Advanced Placement U.S. history exam focuses on oppression, group identity and Reagan the warmonger.

By Lynne V. Cheney    

If you seek peace, if you seek prosperity for the Soviet Union and Eastern Europe, if you seek liberalization: Come here to this gate! Mr. Gorbachev, open this gate! Mr. Gorbachev, tear down this wall!

—President Ronald Reagan, speech at the Brandenburg Gate, Berlin, 1987

President Reagan’s challenge to Soviet Premier Mikhail Gorbachev remains one of the most dramatic calls for freedom in our time. Thus I was heartened to find a passage from Reagan’s speech on the sample of the new Advanced Placement U.S. history exam that students will take for the first time in May. It seemed for a moment that students would be encouraged to learn about positive aspects of our past rather than be directed to focus on the negative, as happens all too often.

But when I looked closer to see the purpose for which the quotation was used, I found that it is held up as an example of “increased assertiveness and bellicosity” on the part of the U.S. in the 1980s. That’s the answer to a multiple-choice question about what Reagan’s speech reflects.

No notice is taken of the connection the president made between freedom and human flourishing, no attention to the fact that within 2½ years of the speech, people were chipping off pieces of the Berlin Wall as souvenirs. Instead of acknowledging important ideas and historical context, test makers have reduced President Reagan’s most eloquent moment to warmongering.

The AP U.S. history exam matters. Half a million of the nation’s best and brightest high-school students will take it this year, hoping to use it to earn college credit and to polish their applications to competitive colleges. To score well on the exam, students have to learn what the College Board, a private organization that creates the exam, wants them to know.

No one worried much about the College Board having this de facto power over curriculum until that organization released a detailed framework—for courses beginning last year—on which the Advanced Placement tests on U.S. history will be based from 2015 onward. When educators, academics and other concerned citizens realized how many notable figures were missing and how negative was the view of American history presented, they spoke out forcefully. The response of the College Board was to release the sample exam that features Ronald Reagan as a warmonger.

It doesn’t stop there. On the multiple-choice part of the sample exam, there are 18 sections, and eight of them take up the oppression of women, blacks and immigrants. Knowing about the experiences of these groups is important—but truth requires that accomplishment be recognized as well as oppression, and the exam doesn’t have questions on subjects such as the transforming leadership of Martin Luther King Jr.

The framework requires that all questions take up sweeping issues, such as “group identity,” which leaves little place for transcendent individuals. Men and women who were once studied as inspirational figures have become examples of trends, and usually not uplifting ones. The immigrant story that the exam tells is of oppressed people escaping to America only to find more oppression.

That many came seeking the Promised Land—and found it here—is no longer part of the narrative.

Critics have noted that Benjamin Franklin is absent from the new AP U.S. history framework, and perhaps in response, the College Board put a quotation from Franklin atop the sample exam. Yet not one of the questions that were asked about the quotation has to do with Franklin.

They are about George Whitefield, an evangelist whom Franklin described in the quote. This odd deflection makes sense in the new test, considering that Franklin was a self-made man, whose rise from rags to riches would have been possible only in America—an example of the exceptionalism that doesn’t fit the worldview that pervades the AP framework and sample exam.

Evangelist Whitefield, an Irishman who preached in the colonies, was a key figure in the Great Awakening, an evangelical revival that began in the 1730s. Here, however, he is held up as an example of “trans-Atlantic exchanges,” which seems completely out of left field until one realizes that the underlying notion is that we need to stop thinking nationally and think globally. Our history is simply part of a larger story.

Aside from a section about mobilizing women to serve in the workforce, the sample exam has nothing to say about World War II, the conflict in which the U.S. liberated millions of people and ended one of the most evil regimes in the history of the world. The heroic acts of the men who landed on Omaha Beach and lifted the flag on Iwo Jima are ignored. The wartime experiences that the new framework prefers are those raising “questions about American values,” such as “the internment of Japanese Americans, challenges to civil liberties, debates over race and segregation, and the decision to drop the atomic bomb.”

Why would the College Board respond to criticism by putting out a sample exam that proves the critics’ point? Perhaps it is a case of those on the left being so confirmed in their biases that they no longer notice them. Or maybe the College Board doesn’t care what others think.

Some states are trying to get its attention. The Texas State Board of Education, noting that the AP U.S. history framework is incompatible with that state’s standards, has formally requested that the College Board do a rewrite. The Georgia Senate has passed a resolution to encourage competition for the College Board’s AP program. If anything brings a change, it is likely to be such pressure from the states, which provide the College Board with substantial revenue.

Some 20 years ago, as chairman of the National Endowment for the Humanities, I made a grant to a group to create voluntary standards for U.S. history. When the project was finished, I had standards on my hands that were overwhelmingly negative about the American story, so biased that I felt obliged to condemn them in an op-ed for The Wall Street Journal called “The End of History.”

I learned an important lesson, one worth repeating today. The curriculum shouldn’t be farmed out, not to the federal government and not to private groups. It should stay in the hands of the people who are constitutionally responsible for it: the citizens of each state.

Mrs. Cheney, a senior fellow at the American Enterprise Institute, writes about history. Her most recent book is “James Madison: A Life Reconsidered” (Viking, 2014).

martes, abril 07, 2015



Valuing Gold

 By: GoldMoney
Thursday, April 2, 2015

There is only one way to value gold, and that is to quantify the expansion of the fiat currency in which it is priced. That is the sole purpose of the Fiat Money Quantity (FMQ), which since I last wrote about it five months ago has increased by $375bn to $13.7 trillion. This is despite the end of quantitative easing, which had been tapered down before being abandoned altogether. The long-term chart of FMQ is shown below.

Fiat Money Quantity

FMQ is the total instant-access cash and deposits in the commercial banks plus their reserves at the Fed and the temporary means by which those reserves are changed. Its purpose is to quantify the difference between sound money and fiat currency by including the steps by which gold has been progressively absorbed into the banking system from private ownership and into government vaults via the commercial banks and the Fed. A fuller description can be found here.

The pace of FMQ creation from 2008 continues well above the pre-Lehman crisis trend, and it is now $8,259bn higher than at that time, an increase of 152% in 78 months. Who would have thought that a temporary provision of money and credit to stabilise the financial system in the wake of the Lehman crisis would have developed such permanency?

As a measure of monetary inflation, FMQ differs from more conventional metrics by including liquid bank assets held on the Fed's balance sheet. By including money parked out of sight in this way a truer position is obtained. Critics of this approach say it is double-counting, because bank reserves recorded at the Fed are also recorded at the commercial banks as customer deposits. This is undoubtedly true, but the whole fractional reserve system involves multiple counting of the same underlying money, so it is hardly disqualified on these grounds.

The next chart shows how FMQ has deflated the price of gold, measured in constant 1934 dollars.

This was the year that President Roosevelt devalued the dollar from $20.67 to $35 per ounce of gold.

Gold in 1934 USD

The gold price is shown in nominal US dollars and also in constant 1934 dollars adjusted for the increase in FMQ; the disparity between these two prices has widened over the years to $1,211 and $3.91 respectively. The two previous times the adjusted gold price hit these low levels were in April 1971 at $3.31, four months before President Nixon was forced to suspend the Bretton Woods Agreement, and in October 2001 at the start of the last bull market when it got down to $3.45. This time, the higher rate of increase in FMQ suggests the price today is more undervalued than the two previous times on a forward-looking basis.[1]

The last chart is of the gold price since the Lehman crisis and in July 2008 constant dollars, when FMQ accelerated above the long-term trend as shown in the first chart.

Gold Adjusted for FMQ in 2008 versus Constant US$

While the nominal price taken in February 2015 was $1211, the adjusted price was $480, representing a 45% fall from the $918 price in July 2008.

In summary, FMQ shows that gold is substantially under-priced in dollars on a long-term value basis. In the past this level of under-pricing has been followed by major price shocks to the upside on both occasions.

[1] Note: previously I deflated the gold price by the increase in above-ground stocks. I am persuaded this is not necessary because the growth in mined gold is approximately the same as global population growth.

How I Disproved Efficient Market Theory by Being a DJ

By Jared Dillian

April 2, 2015

Yes, DJing is a hobby of mine. I’ve been doing it for about seven years, picking it up late in life. Call it midlife crisis number one.


I have had a pretty fun DJ career, all things considered. I’ve played in a couple of really famous clubs, and I’ve done all kinds of private parties—parties where people have gone nuts. I post my mixes online for people to enjoy. I’ve spent way more money than I’ve earned (especially on music—I pay for all my tracks). But it’s been worth it.

Most people here are probably dimly aware of the electronic-music phenomenon that’s been happening worldwide, but they might not know or understand what DJing is all about. A DJ plays recorded music live. That’s it. He chooses the order of the songs. In the old days, this was done via vinyl records, and there was a great deal of skill involved in adjusting the speed of the records to match the beats. Nowadays, you can get a computer to do that for you if you want, though the annoying purists will hate you for it.

None of this sounds hard, right? Why do people consider it an art form? Well, first of all, the DJ is a curator of music.
This is more difficult than it sounds. It’s not like pop music, where the same ten songs play on the radio on a loop. If you’re into underground music like me, you’re digging deep to find great tracks that nobody has ever heard before. In the old days, this would entail spending hours at the record store. Now you can do it online. But it’s still a lot of work.

Is the curator an artist? Yes and no. Think of the museum curator—he decides what paintings to hang and what order to hang them in. A DJ does the same thing. It’s an art form that is not fully appreciated. Back when I lived in New York and went to clubs, there was a progressive house DJ named Zack Roth who used to warm up for all the big trance acts that came to town. I was obsessed with being a warm-up DJ.
The warm-up DJ goes on first, around 10 p.m., and plays dark, deep stuff, gradually bringing up the energy (and the tempo) until he’s whipped the crowd into a frenzy just as the main event comes on. Zack Roth was the master.

All this is done by playing songs in a particular order. Amazing!

Why does this work? Well, it works because you have memory. You may not notice the transition from one song to the next, but you will notice the increase in tempo, the rise in energy. Over the course of a few hours, you will have noticed that you started at 1 and ended up at 10.

If you had no memory—if you had the memory of a goldfish and you couldn’t even remember the last song played—DJing wouldn’t work. You could play the songs in whatever order; it wouldn’t matter. The only song that would matter would be the one you were currently playing.

Path Does Matter

There is a concept in finance known as path dependency. Like, the price of a security goes from A to B over time. Does it matter what path it took to get there?

In the derivatives markets, this question is of crucial importance. There are some exotic options, like lookback options, whose price actually depends on the path the asset takes. But with plain-vanilla puts and calls, path doesn’t matter—all that matters in the pricing of the option is where the asset is currently.

It seems obvious that path would be super important, though. Think of it this way: right now the S&P 500 is at about 2,000. You know what path it took to get there. It went down to 666 in the financial crisis and has basically gone up for six years straight, until today. People are pretty bullish, right? The market has been going up every single year, for six years.

But what if the market had gone down to 666, then up to 4,000, then crashed to 2,000?      

This is a stupid example, but not really. Would people feel the same with the SPX at 2,000 if it had taken this path, crashing 50%, rather than the previous one, where the market went straight up?

Of course not. If the market had arrived at 2,000 by going down 50%, nobody would be bullish at all.

Path really matters. Here’s another example.
The Gas Tax and Path Dependency
Gas prices were really high over the last several years. Even if you’re not a financial expert, you can probably tell me the approximate path of gasoline prices over the last 20, 30 years. Because you remember.

So gas prices were high for years, running up to $4 a gallon and more—until they suddenly crashed, dropping by over 50%.

Did you see what happened next?

Politicians started calling for an increase in gas taxes. Why? Because people were used to high gas prices and could easily absorb an extra 10 cents on the gallon.

What’s interesting is, if gasoline had been $2 all along—or, say, it had been at $1 for 10 years and then had gone up to $2—there is no way politicians would have been calling for gas tax hikes. People would be furious. So gas prices are path dependent!

Well… so is everything else.

EMH Is Dead

The Efficient Market Hypothesis is the idea that all information (including the path of previous stock prices) is reflected in current stock prices.

Even in the age of the Internet, this is not true.

There was a 60 Minutes episode on curing cancer last Sunday. The biotech guys have known about this for years.

The information is publicly available, but unsurprisingly, most people don’t make the effort to learn about that stuff. It takes time for information to travel, sometimes a long time. 

Most options are priced with similar assumptions. They’re modeled on something called geometric Brownian motion, which describes the behavior of a particle suspended in gas.
The particle has no memory. It is path independent. But unlike the particle, the market has memory. People have memory. And as we demonstrated, it is path dependent. So its behavior will not be a true random walk.

People are slowly learning what the quant guys have known for years: the market is not random, and you can profit from that. There would be no commodity trading advisors (CTAs) if the market were random. But the guys who have disproved market efficiency are making too much money to bother filling out a Nobel Prize application.

This is the problem technical analysis claims to solve. The technical guys are half right. The market is path dependent, yes, and they have constructed a set of rules to describe this behavior. Problem is, sometimes the rules work… sometimes they don’t. Technical analysis is most helpful as a guide rather than gospel.

This is a roundabout way of saying that the efficient-market people who tell you that you can’t beat the market so you shouldn’t try—well, those people suck. Don’t hang around with those people. Deep down, I have always felt that you should try. Anything worth doing is worth doing well.

Jared Dillian