Sunday, December 19, 2010

[Video] 60 Minutes - States; the Day of Reckoning

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We are generally quite early to a trend, which in actuality is a bit of a negative from an investing standpoint because trends tend to go much longer than anticipated (and whistling past a graveyard aka ostrich head in sand, are national pasttimes).... and as we've seen the past 3 years, government and central bankers willingness to kick the can is almost unending.   So while we were discussing the coming disaster that was state budgets in 2007,  [Dec 16, 2007: California in a State of Fiscal Emergency - Coming to a Theater Near You] that can has been 'kicked' the past 2 years with stimuli after stimuli to shore up state and municipal budgets. [Jun 18, 2010: States Nationwide Plead for More Backdoor Bailouts... err, "Stimulus"] I will be very interested to see if the Tea Party club that joins Congress in 2011 bows to the states now yearly desperate pleas to spend far in excess of what they bring in.  As for those underfunded state pension plans?   [Jan 5, 2010: FT.com - US Public Pensions Face $2 Trillion Deficit[Apr 5, 2009: AP: $1 Trillion Hit to Pension Funds Could cost Taxpayers, Workers]  Furgeddaboutit... that's going to be a Federal Reserve/federal government bailout one of these days (ponzi baby).... or perhaps Ben's master plan to take the S&P to 3000 will fix everything. [Dec 30, 2009: Eric Sprott Wonders if US Debt Scheme is Simply the Biggest Ponzi Scheme Ever] [Oct 27, 2010: PIMCO's Bill Gross -  Fed's QE is "If Truth be Told, Something of a Ponzi Scheme"]

60 Minutes has been touching a lot of interesting topics of late - tonight they began introducing the topic FMMF readers have had waved in their face for 3 years.  Guest appearances by Governor Christie of New Jersey (a viable 2016 presidential candidate if he 'fixes' New Jersey)  [Feb 18, 2010: [Video] NJ Governor Chris Christie Talks Tough on Out of Control Spending, with Some Shocking Statistics] , and Meredith Whitney.

14 minute video

   

By now, just about everyone in the country is aware of the federal deficit problem, but you should know that there is another financial crisis looming involving state and local governments.

It has gotten much less attention because each state has a slightly different story. But in the two years, since the "great recession" wrecked their economies and shriveled their income, the states have collectively spent nearly a half a trillion dollars more than they collected in taxes. There is also a trillion dollar hole in their public pension funds.

The states have been getting by on billions of dollars in federal stimulus funds, but the day of reckoning is at hand. The debt crisis is already making Wall Street nervous, and some believe that it could derail the recovery, cost a million public employees their jobs and require another big bailout package that no one in Washington wants to talk about.

[Oct 29, 2010: This Day in Taxpayer Abuse - Buffalo Teachers Skim $9M in 2009 Alone for Cosmetic Surgeries]
[Jan 24, 2010: For the First Time, More Union Workers Work in Government versus Private Sector
[Aug 11, 2009: LA Times - Amid Cost Cutting, Los Angeles City Pensions Continue to Soar]
[Dec 4, 2009: Public Workers Continue to Live the Good Life in New Jersey]


Saturday, December 18, 2010

[Video] Business Development Companies (BDCs) - One Way to Find Yield

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The great thing about the markets is it is a never ending learning process; there is always something new to discover whether a niche sector or new stock.  All these years in the market and I had never really investigated Business Development Companies (BDCs) until the past month.  In in a low yield environment I am looking for some asset classes to park cash in, to balance the 'high growth, relative strength' portion of my strategy and the obvious choices are REITs and Master Limited Partnerships.  [Seeking Alpha - Outrageous Opportunities in Upstream MLPs]  Like REITs, BDCs have to pay out almost all their income hence create a nice dividend stream - many cases roughly 10% (despite a huge run up in share prices from early 09).  Unlike some MLPs however there is more risk/reward here since the BDCs normally invest in smaller to mid sized companies... so during a serious market downturn they won't offer much protection.  But in an era of cheap money being pushed out the wazoo and a year ahead that should be full of consolidation and M&A opportunities, these companies could be well positioned. 

A video on the topic from CNBC from last August on the topic - definitely an area I am spending more time learning about.

6 minutes



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Via CNBC

Ever feel like venture capital is exclusive to the wealthy  Fortunately, there is a way for all investors to participate in the medium. On The Strategy Session yesterday, we detailed a trading tool for the investment of upcoming businesses.

My "Call-to-Action" is to explore and consider Business Development Companies (BDC's) for your portfolio.  BDC's are public firms that invest in small businesses the way a venture capitalist would. They can be bought on the open market, and here's the best part.

Janney Montgomery reports that the average yield on a BDC is 9.7 percent. Remember, we have been discussing ways on The Strategy Session and right here in the K-Call about how in this low-rate environment, investments that return income are extremely attractive. Falling into this category are MLP's, REITS, and high-dividend yielding stocks.  Add BDC's to this list.

On yesterday's show, Lawrence Golub of Golub Capital BDC (and husband of our Fast Money friend, Karen Finerman) made an important distinction between BDC's now and in 2008.  When I asked him about the collapse of American Capital Limited (ACAS) and Allied Capital Corporation (ALD), Golub pointed out that the loan structure is much improved since then. 

Additionally, alignment of the fees, critical to success, has sharpened. Shareholders get more for what they paid than they did two years ago.  If you ever wanted to be a venture capitalist, or simply invest like one, BDC's are high-yielding products that can capture share of that universe.

Friday, December 17, 2010

No Luck with TDAmeritrade

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Just an update on the broker-dealer side.  Without going into specifics, I tried multiple avenues (including some help from large accounts at TDA who also will be fund investors) to create some negotiation on initial pricing to launch the fund on the Ameritrade platform, but all of it is a dead end.   Since there is no leeway on their end, I would post as highly doubtful that the fund will be listing there in 2011.

If the fund has a good year of growth in assets in 2011, I'll deploy profits into getting launched on Ameritrade in 2012 but as outlined last week, there have been many items not in the original launch budget (Vanguard, Schwab-Scottrade, many more states than I originally anticipated that I need to list in) that have come up over the past few months, so getting on every broker platform (ex Fidelity) is impossible right now.  

As always direct account with the mutual fund itself is an option.

To review the list off top of head right these are the names we'll be applying for approval (again no guarantee but we *should* be on all these)

Etrade
Vanguard NTF
Scottrade
Schwab TF
USAA
Any platform that has Penson Financial as b/d  (a lot of smaller brokers use this firm for their back end)
Any platform that has Pershing as b/d

--------------------------------

On the negative side
Fidelity - cost
Wells Fargo - not taking any new funds
Ameritrade - cost

No answer (a month+ of requests)
Bank of America
Interactive Brokers

Still Asking
T Rowe Price
TIAA CREF
Merrill Lynch - might be same as Bank of America as BAC bought Merrill in 2008, not sure though

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There are multiple 'one offs' that people have asked which I've tried to address directly via email if I have an answer; if no answer - it means they have not responded to our queries.

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No Country for Old Bears (or Young Ones)

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The S&P 500 continues to do no wrong.  After a huge run to start the month of December off, this entire week has been spent consolidating that gain.  There is not even a pullback to the 10 day moving average at this point.  Despite some loss of leadership from 'the generals' of 2010, and some degradation in underlying breadth measurements the idea of "we can't lose" is alive and well.  The information stream of the past few weeks has been almost uniformly positive (excluding that monthly labor report), and the U.S. just 'bought' itself an extra 0.5 to 1.0% of GDP for 2011 with the tax + spend stimulus package.  There are no worries about the inflation situation arising in emerging markets, and Europe continues to commit to ever bigger bailouts as the global moral hazard explodes.  But it's all good for the speculator class.  

I expect the performance chasing community to not allow much of a drop off going into year end (although we are due) and then we know the first day of the month is almost always a winner so Jan 1 should be spectacular... it will be interesting to see what happens in weeks 2 and 3 of January.  At some point good news is supposed to be discounted and at this moment we have discounted Goldilocks.... no (government reported) inflation, and bought and paid for GDP growth.



A few straggling bears must still exist but only below Ben's show on their neck.

Bespoke: 2011 Strategist Targets

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Almost uniform agreement by the strategist community that 2011 is a "must win" year (assuming the S&P does not tack on an additional 50 points before Dec 31st).   Only Morgan Stanley is calling for flattish year over year gains in the S&P 500.  The easy route each year is just to throw on another 8-11% of earnings growth, and commensurate stock price appreciation - and this appears to be most are going.   Many also are targeting S&P 500 profits at peak levels (or higher) of low to mid $90s - and expect some PE multiple expansion.

For example, S&P earnings end 2011 of $92 x 14 PE ratio = 1288.  This falls in the range the bottom half of the analysts are figuring for 2011, whereas the aggressive players are talking 1400 to 1550.  Either earnings would need to explode towards $100+ or multiple expansion would be required.  For a relatively slow growth country, heavily based on financial earnings, it is hard to make that argument ....but in a low interest rate environment some will claim 15-16x PE ratios are fair.

As always take these with a grain of salt, coming off record profits in 2007 what this sort of chart predicted for 2008 would be laughable in retrospect.


hat tip Bespoke.

Thursday, December 16, 2010

Federal Reserve Proposes 12 cent cap on Debit Card Transactions - Visa (V) and Mastercard (MA) Deep Dive

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The stocks of both Visa (V) and Mastercard (MA) took a deep dive just after 2 PM when it was released that the Fed is considering a 12 cent cap on debit card transactions.  Visa has a broader exposure to debit cards, so it seems to be taking the news a bit worse.  While the media will say this is a victory for the consumer, we can be sure retailers will not pass along any of the savings to said 'victorious' consumers - but it's a plus for the retail sector.  Per Marketwatch:

  • If the Fed approves rules, merchants may pay smaller fees on customers’ debit-card transactions. However, a 2009 Government Accountability Office report that looked at credit cards said it’s difficult to prove whether reducing fees would benefit consumers.  “Merchants may pass on their interchange fee savings through lower prices to consumers; however, the extent to which they would do so is unclear,” according to the GAO report. “The degree of savings depends on whether or not merchants are increasing their prices because of higher interchange fee costs.”

It appears the average debit transaction fee was 44 cents last year or 1.14%.  For nothing more than being a transaction mechanism for electrons of fiat money moving from 1 location to another.
  • According to the Fed, last year the average interchange fee for all debit transactions was 44 cents per transaction, or 1.14% of the transaction amount.
44 cents down to 12 cents is quite a blow; about a 70% haircut.

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Visa is approaching lows of the year (I believe the first swoon was when this news was first being debated in Frank Dodd, but the thought process was the final decision would not be punititve and the stock rebounded) while Mastercard has fallen to the 200 day moving average.  Could be an overreaction - we'll see.  Still 2 of the most bullet proof long term businesses on the planet, but these stocks are heavily owned by the hedge fund community - many of which appear to have turned into the momentum trading community.




Via Reuters:
  • U.S. banks and other debit card issuers could not charge retailers more than 12 cents per transaction under a Federal Reserve staff proposal released on Thursday.  News of the proposal sent shares of Visa Inc and MasterCard Inc down more than 10 percent.
  • Banks and transaction processors like Visa and MasterCard collect fees from retailers every time a customer buys something with a debit card. The fees total more than $20 billion annually.
  • The Fed staff proposal on so-called debit "interchange" fees seeks comment on two alternative fee structures, but both limit the maximum fee to 12 cents per transaction.
  • It also seeks comment on how to adjust fees based on fraud-prevention costs. Banks and transaction processors want regulators to broadly define those costs, and allow them to recover such costs through the interchange fees.
  • The proposal tries to prevent issuers from evading the new regulations by prohibiting them from receiving "net compensation from a network for debit card transactions."
  • The Fed board is expected to vote shortly on the staff proposals, with a comment period that would end Feb. 22.
  • The crackdown is part of the sweeping Dodd-Frank financial reform bill signed into law in July, and comes amid a broader government tightening of credit and debit card practices.
No positions

BorgWarner (BWA) is a Stud

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Looks like the crowd is catching up on our love affair with auto suppliers - specifically BorgWarner (BWA).  This looks like Salesforce.com (CRM) or Netflix (NFLX) at its best.  Massively overbought right now but chugging along without pause in the 'can't lose' market.  As much as I like this group even I am amazed at the 'action' in once boring stocks like this. Every bounce off the 20 day since Jackson Hole Wyoming QE2 has been a bottom....


[Oct 28, 2010: BorgWarner Raises Guidance]
 
No position

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Boston.com's Big Picture Year in Photos

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The Big Picture portion of Boston.com always has some compelling content.  They have a 3 part special on the Year in Pictures - it is sort of like a BBC/NPR special in about 100 high resolution photos, a handful quite graphic and unsettling but a picture of the global reality.

If interested
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Speaking of unsettling and graphic, remind me never to go to a school board meeting.... 4 minutes of frightening.  A very small portrait of (apparently) economic stress.



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Bloomberg: Silicon Valley Increasingly has Little to do with Silicon

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Silicon Valley has very much become a reflection for greater America.  While it (Silicon Valley and America) still has a role in manufacturing, increasingly our knowledge / service based economy focuses new ventures on things like social media.  So Walmart, World of Warcraft, and Facebook nation it is.  Bloomberg has a nice piece on how Silicon Valley nowadays has little to do with the actual silicon its name was based on just some 3-4 decades ago.   This is part of my broader concern - I have no doubt the U.S. will continue to innovate and create the high level knowledge jobs here - but 40 years ago the entire ecosystem was built in the U.S., allowing people from every rung of the ladder to participate in the genius of the innovators.  Now increasingly while the head of the company is in the U.S., the heart, lungs, legs, and hands are going overseas.   Hence job creation will be very top heavy and in a very narrow sliver of society.  Which is fine if you are in that sliver, but in theory we need to worry about the whole society if you believe in social balance.   If you missed former Intel CEO Andy Grove's cover story in BusinessWeek last summer on the challenges of this dynamic I'd consider it a must read - essentially he admits he would not (or could not) create Intel in the United States in the modern era.  That should scare people.  (BW July 2010 - Andy Grove: How America Can Create Jobs)  But many of his solutions would be considered 'socialistic' in a country where people do not realize every country we are competing against has government and private industry working together.

I cannot stress enough that where the manufacturing is, is where much of the research and development eventually goes - it is already happening.  China/Taiwan effectively built a Trojan horse (with the mfg) and now is slowly but surely receiving the higher end jobs as R&D centers are now being built left and right.   At current pace we're going to be a country of administrators and CEOs... and Walmart greeters (but you'll never take away our Facebook).

Anyhow... via Bloomberg:
  • Silicon Valley has lost its appetite for silicon.  While venture capitalists are pouring money into social networking, e-commerce and online-game companies, investments in chipmakers are close to a 12-year low. And yet semiconductors -- made from silicon wafers -- provide the brains for everything from computers and mobile phones to nuclear missiles. 
  • At issue is the expense to get a startup off the ground.  Chipmakers spend millions developing and testing their designs before they even know if an idea is viable. Those costs have pushed the industry abroad to countries that offer tax incentives and subsidies unmatched in the U.S. Meanwhile, the expense of starting software and Internet companies has actually gone down, thanks to cheap Web-based programs and services. 
  • “There are no lack of ideas, but it’s becoming harder and harder to find investors,” said Ken Lawler, a general partner at Battery Ventures in Menlo Park, California. “It takes too much money and too much time.” 
  • That contrasts with China, whose role as a manufacturing hub for semiconductors is helping it play a bigger role in design and innovation. The country’s worldwide share of chip- related patents is expected to rise to 33 percent this year from 22 percent last year. 
  • The U.S. has got a lot to be concerned about from a global competitiveness perspective,” said Matt Cown, co-founder of venture capital firm Bridgescale in Menlo Park, who formerly worked in corporate development at Intel Corp.  
  • Venture financing of U.S. semiconductor companies dropped 36 percent through the first three quarters of this year to $894.9 million, down from $1.39 billion in the same period in 2008. Last year, venture capitalists invested a total of $863.8 million in chip companies, the lowest level since 1998. First-time venture investments in chip companies accounted for 1.1 percent of total initial funding this year, the smallest category among 16 industry groups tracked by the NVCA. 
  • Software companies received the highest amount, with 17 percent. In the past two years, venture capitalists and other investors have piled hundreds of millions of dollars into social-networking companies such as Facebook Inc. and Twitter Inc., online-game maker Zynga Game Network Inc. and Web-coupon provider Groupon Inc. Each is valued in the billions.
  • “Semiconductors aren’t as sexy, you don’t get the valuations, and you don’t get the multiples,” said Manuel Hernandez, chief executive officer of Hercules Technology Growth Capital Inc., a Palo Alto, California-based firm that provides debt financing to startups. (very true - do you think Americans would be stepping on each other to bid up the "Applied Materials of China!" IPO to the moon as they did Youku and Dangdang? Nah!)
  • The term Silicon Valley was coined in the 1970s and refers to the 50-mile stretch between San Francisco and San Jose, where companies such as National Semiconductor Corp., Intel and Advanced Micro Devices Inc. were using silicon to create computer components.  Nowadays, a state-of-the-art chip plant costs more than $4 billion and has a useful life of about five years. 
  • Most companies don’t even consider manufacturing their own products, choosing to outsource to Taiwanese businesses instead. Taiwan surpassed the U.S. in terms of production in 2005 and has been adding to its lead ever since.
  • It used to be that we started companies here and we didn’t think about going offshore until we were substantially big,” Banatao, 64, said in an interview at his office in Palo Alto. “At the outset now, as we fund the company, we think about going outside right away."
Just another reason we need to create paper asset wealth and hope for Fed induced bubbles to be created every 5-7 years ... as 'making stuff' and now 'researching stuff' is increasingly beneath us. [Nov 29, 2010: America has Less Manufacturing Jobs Today than Before the War]

E-Commerce China Dangdang (DANG) Makes the Round Trip to IPO Spike Price

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Interested in "China's Amazon.com"?  Well lo and behold, you are now able to buy it for just about the same price it spiked post IPO 7 days ago.  Granted it is not the same price the "smart money" was able to get it for (and flip it to you for mad money for nothing more than being a good - read high volume - institutional client), but then again YOU dear sir/madam are not 'smart' money (neither am I).



With all the hype around Youku.com (YOKU), E-Commerce China Dangdang (DANG) has sort of been lost in the conversation as they IPO'd together, but it probably has more interesting potential.  That said, the chance of there being any 1 Chinese Amazon is miniscule as competition is already intense, and the model now has a blueprint to copcat, unlike what Jeff Bezos was building 12-13 years ago.  Indeed there is a company called Taobao, which probably has a lot better chance of being the Chinese Amazon.com, but since DANG is starting with books (like Amazon did) it's the easier comparison.  (Amazon also has a company it bought in China called Joyo but somehow I see the Chinese government making sure a "pure Chinese" company wins this race).  Over 80% of DANG's business is still books. Frankly no one knows - extrapolating out a decade in any market is foolish (but makes for great hype during IPOs)
  • Online bookseller now branching out into other consumer categories. DANG is the largest bookseller in China. 590,000 titles with more than 570,000 Chinese language titles. DANG believes they have more Chinese language titles available than any other seller in the world.
  • New products being offered include beauty and personal care products, home and lifestyle products, and baby, children and maternity products. Much like Amazon.com, DANG now offers third party products on their website.

DANG's IPO price was $16 so even here at $25 it is a 56% premium to what 'smart money' was rewarded the stock at, and I'd argue it was pricey at $16 but compared to YOKU it's a relative bargain.

With approximately 78M ADRs the $16 IPO price gave a value of $1.25B to DANG; the current price of $25 still equates to $1.95B.  Revenues look like they will hit roughly $330Mish for the full year 2010 so we are talking 6x sales - which is generally a premium paid to technology buyout candidates but at least is within the realm of something tangible, unlike YOKU.   DANG has profits but much like AMZN in its early days has razor thing margins (AMZN still has razor thin margins but a huge revenue base).  Frankly you can forgive profitability in the 'hyper growth' stage - the company just needs to continue to push out 70-90-110% year over year growth for a while to justify its case.  I'd be interested in taking some shots here or there in building a position with the caveat that if the market ever corrects again this type of stock can lose 10-15% in a day very easily.  If DANG is treated in the investing community like say a Baidu.com (BIDU) it will never be 'cheap' in traditional terms - it will simply waver from very expensive to quite expensive.  (BIDU has a far more profitable business model)

p.s. Twitter received a round of private financing yesterday valuing it at $3.7B... for $50M in revenue.  That is 74x sales.  Internet bubble 2.0 has arrived.  Any coincidence both are happening when our central banker went wild? (Alan with Y2K and Ben to paper over all of America's problems with the 'wealth effect')

No position

Shadowstats.com: Consumer Inflation as Measured in 1980 Would be 8%+; as Measured in 1990, 4%

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I used to speak of the "inflation adjustments" by our government often in 2007 and 2008 but chose to stop beating a dead horse.   However in the past few years FMMF has added a lot of new readers, so for 'educational' purposes it probably makes sense to review this topic since it has been a year and a half since I've devoted any air space to the topic and it is becoming increasingly relevant again, as many people feel like there is inflation, when the government insists there is none.  To repeat, inflation is not the only government statistic that the politicos have pressured our governmental statisticians to 'adjust' over the years, to make them more sunny side up  [Apr 23, 2008: Barry Ritholtz on Disappearing Economic Indicators].  [May 10, 2008: Finally Some Mainstream Reports are Figuring Out the Spin from Government] - but let's focus on that one as the Fed believes as long as there is no inflation it can QE and 0% Fed Funds rate to the moon, with no impact.

Shadowstats.com is a website I found long before I started FMMF, as a lot of things the government reported just did not pass the smell test.  It's actually a small treasure trove for anyone of an analytic mindset and when you really dig into all the changes in government reporting (under the guise of 'improvement' of course) over the past few decades in multiple reports it is quite awe inspiring.   Specific to inflation this entry from 2004 is a compelling read for any interested in the topic.

Before we continue, if you think this commentary is from sort of sensationalist random blogger type, let me point you to the fact that the biggest bond investor in the U.S. and one of the most powerful men in the investing world - PIMCO's Bill Gross - puts forward all the same arguments I do.  [May 13, 2008: News of the Day - Inflation]

Americans are feeling a lot more economic pain than the government's official statistics would lead you to believe, according to a growing number of experts. They argue that figures on unemployment and inflation are being understated by the government.

Bill Gross, the manager of Pimco Total Return, the nation's largest bond fund, refers to the CPI as a "con job" that deliberately understates the price pressures faced by Americans in order to keep Social Security payments and other government costs pegged to the index unduly low.

And.... [May 22, 2008: Bill Gross - Inflation Underplayed]

Americans are fooling themselves if they think U.S. inflation is under control, the manager of the world's largest bond fund said.  Bill Gross, chief investment officer of Pacific Investment Management Co (PIMCO) said in his June investment outlook that he has been arguing for some time that inflation statistics "were not reflecting reality at the checkout counter."

He said statistical practices in calculating price growth had favored lower U.S. inflation over the last 25 years and called for change. "Being fooled some of the time is no sin, but being fooled all of the time is intolerable," Gross said.

"Join me in lobbying for change in U.S. leadership, the attitude of its citizenry, and (to the point of this Outlook) the market's assumption of low relative U.S. inflation in comparison to our global competitors."

Bill still does not understand that as long as you give the people their circus and bread (even at inflated prices) they are content to fulfill themselves with Dancing with the Stars, American Idol, and NFL. Lobbying for change? hahaha.  All this economic stuff is "too hard to understand"...got to get to the mall.... need to keep up with Joneses.... who no longer pay their mortgage so live rent free and can really power shop now!

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There are 2 main ways that our measurement of inflation has changed over the years - (a) substitution and (b) hedonic adjustments.  I explained the substitution effect in one of the 2008 pieces

put simply when the cost of steaks gets too high they assume you move down to hamburger - so they substitute steaks for hamburger in their measure (seriously) and hence inflation disappears. So in the government's eyes we are going to be a world of bicycle riding, barefoot, and beltless (or using string to keep pants us) people. Because otherwise, inflation would go up.

Now to be fair, when prices go up people in the middle and lower economic classes DO substitute to some degree - they have little choice.  But that does NOT mean inflation has gone down - a constant basket of goods would compare apples to apples - steak in 1956 vs steak in 1978 v steak in 2007.  Instead we measure steak in 1956 v hamburger in 1978 v SPAM in 2007. i.e. as prices go up the average American is moving downward in living standard.... but it keeps "government inflation" in check.  I'm using meats as the example since it is easy to see the move down the (excuse the pun) food chain, [Meat Inflation Picking Up] but it applies to many other subsectors.  I think anyone with a shred of common sense (thankfully, this excludes much of the federal government) would say you need to measure a movie ticket from 50 years ago with a movie ticket from 25 years ago to a movie ticket from 5 years ago to measure inflation.  Granted, we can replace a movie ticket with a walk in the part (free!) and say there is no inflation at all, but most would laugh at that sort of 'analysis'... but that's the substitution effect!

Here is how shadowstats explains substitution (the writer explains the political history behind the changes as well, which I am skipping here)
  • Up until the Boskin/Greenspan agendum surfaced, the CPI was measured using the costs of a fixed basket of goods, a fairly simple and straightforward concept. The identical basket of goods would be priced at prevailing market costs for each period, and the period-to-period change in the cost of that market basket represented the rate of inflation in terms of maintaining a constant standard of living.  
  • The Boskin. Of course, replacing hamburger for steak in the calculations would reduce the inflation rate, but it represented the rate of inflation in terms of maintaining a declining standard of living. Cost of living was being replaced by the cost of survival. The old system told you how much you had to increase your income in order to keep buying steak. The new system promised you hamburger, and then dog food, perhaps, after that. 
  • The Boskin/Greenspan concept violated the intent and common usage of the inflation index. The CPI was considered sacrosanct within the Department of Labor, given the number of contractual relationships that were anchored to it. The CPI was one number that never was to be revised, given its widespread usage. 
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Hedonic adjustments are a bit tougher to explain - and if you laugh at how substitution works you will really get a chuckle out of hedonics.  Per shadowstats:
  • Aside from the changed weighting, the average person also tends to sense higher inflation than is reported by the BLS, because of hedonics, as in hedonism. Hedonics adjusts the prices of goods for the increased pleasure the consumer derives from them. 
  • That new washing machine you bought did not cost you 20% more than it would have cost you last year, because you got an offsetting 20% increase in the pleasure you derive from pushing its new electronic control buttons instead of turning that old noisy dial, according to the BLS
  • When gasoline rises 10 cents per gallon because of a federally mandated gasoline additive, the increased gasoline cost does not contribute to inflation. Instead, the 10 cents is eliminated from the CPI because of the offsetting hedonic thrills the consumer gets from breathing cleaner air. The same principle applies to federally mandated safety features in automobiles.  

So let's review.  You go to Sears to buy a washing machine.  Whirlpool put some super cool features on said machine so the new model costs 13% more than the model from last year.  You walk up to the counter and pay 13% more.  You leave the store with 13% less than you would have paid the previous year.  Inflation of 13%?  NOT SO FAST!  If you get 13% more pleasure from the new model versus what you would have received from the old model, prices are flat: 0% inflation!  (forget what your wallet says)  (also forget asking how the government can measure pleasure - they are all knowing)

Indeed if you get 20% more pleasure from the new washing machine, prices apparently went down 7% year over year with the new model - per government inflation reporting.  Can you imagine how 'cheap' washing machines are for people who derive 50% more pleasure from the new machine?

I am being a bit sensationalist here in my example, but really it is so absurd one cannot resist.

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Ok time to pick yourself up off the floor - your co-workers are wondering what is so funny.  See economics is NOT that boring when the government is involved!  This is why I say, while the Chinese prefer to use straight out obfuscation to lie about adjust their government statistics, the U.S. is far more sly about it.  Our nonsense is out in the open, but except for a few of the 'conspiracy theorists', most don't care.  (I do wonder if we passed this data around to all the seniors who received 0% COLA adjustments in their social security checks the past 2 years - if they'd be interested.  Somehow I think yes.)  But the end result is the same - a fairy tale that is disconnected from what people feel on the ground.

So what's the takeaway?  We live in a world of "no inflation" per the government - see yesterday's 0.1% CPI figure!  It's a miracle.   More QE please Ben!

But what happens when we detach one arm from the matrix and look at how inflation was measured in 1990?  Uh oh - not so rosy - inflation seems to be a bit over 4%.  (it was as high as 6% earlier in 2010)

[click to enlarge any chart]



And if we remove our whole body and go back to 1980 measurements, Neo style?  Rut roh raggy!  8%ish



I only bring you this message of course for education and entertainment;  for stock market purposes, there is no inflation - we live in a Goldilocks environment of government steroid induced growth and no inflation. (sort of like China, but with a mad central banker running the show)  To make sure we get inflation QE2 and 0% Fed fund rates are a must.  And after QE2, we have QE3 thru QE9 ready because we *REALLY* need to get some inflation going.  By the time the government shows 3% inflation in their reports, you can only imagine what it really will be.  Thankfully, reality is just a state of mind in our new paradigm.

Back to your regularly scheduled market melt up....

Bloomberg: No Emerging Market Bears Unsettles Investors Shunning Conformity

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Two points on this article from Bloomberg.  First, a theory can be correct conceptually but that does not mean asset prices must go up to reflect said theory.  Second, when everyone (and their mother) believes something - rarely does that thesis continue to make the crowd money.  For example "the internet will change the world" turned out to be very accurate when proposed in the late 1990s.   Second "invest in anything China as they are becoming a dominant force" is turning out to be very accurate, but didn't stop commodities and Chinese equities from going bust in 2008.  Wall Street is excellent at taking a viable thesis, and overdoing it to a point of massive excess.  And then things tend to go bust; even if the underlying thesis is 100% correct.

To that end, the Brazilian & Chinese markets have returned almost nothing in 2010.  But speaking more broadly - are there any emerging market bears in the world?  Not that there *should be* but again, when one side of the boat gets extremely heavy, bad things tend to (eventually) happen.  Timing 'eventually' is of course the trick.



Via Bloomberg:
  • Individual investors are pouring money into emerging-market stocks at the fastest pace since 2007 as the biggest rally in 16 years spurs three of the world’s largest banks to predict shares will hit record highs next year.  
  • The last time investors were this bullish, the MSCI Emerging Markets Index sank 11 percent in three months, data compiled by EPFR Global and Bloomberg show. The gauge trades for 2 times net assets, within 4 percent of the most expensive level on record versus the MSCI World Index of developed-nation shares, according to MSCI Inc. 
  • After all this money has flooded in, with everyone in love with them and all the euphoria surrounding them, it’s hard to find fundamental value,” said Harris Associates LP’s David Herro, who was named international stock fund manager of the decade this year by Morningstar Inc. “Growth in emerging markets is greatly helping the world, but you can overpay for it and that’s what’s happening.”  Moving away from the fastest- expanding economies puts Herro at odds with strategists from UBS AG to Citigroup Inc. 
  • Jack Ablin, the chief investment officer at Harris Private Bank who said emerging-market stocks were too expensive a month before they peaked in 2007, favors shares of U.S. companies that sell to developing nations.  “Yes, I believe that the emerging economies will outpace the developed world,” said Ablin, who helps oversee about $55 billion at the unit of Canada’s BMO Financial Group. “But I still don’t want to chase these valuations because a lot of optimism is priced in.”
  • Ablin of Harris Private Bank said a losing investment in Chinese stocks for his personal account in 1993 showed him that economic expansion doesn’t always translate into stock-market gains. While the Chinese economy posted average annual growth of 12 percent in the four years through 1996, trouncing the global rate of 3.1 percent, Ablin’s bet on the China Fund Inc lost 50 percent of its value.
    “I had pretty much bought into the consensus and I was late to the party,” he said. “That lesson told me there’s a big difference between the fundamental economic backdrop and the valuation of stocks.”

After a huge 2 year run for many of these markets, the investment banking performance chasers say 30% more to go next year!

  • Emerging-market stock strategists at UBS, Citigroup, JPMorgan Chase & Co., Credit Suisse Group AG and Morgan Stanley are more optimistic than their counterparts following the U.S. and Europe. The average of five estimates for the MSCI index next year is 1,463, or 30 percent higher than yesterday’s level and 9.3 percent above the all-time closing high on Oct. 29, 2007. 
  • The MSCI emerging-market index has surged 136 percent from its March 2009 low as developing economies exited the global recession in better shape than advanced countries by almost every measure. 
  • Government debt will probably amount to 37 percent of emerging-market gross domestic product next year and budget deficits will be 2.9 percent, compared with levels of 101 percent and 6.7 percent in advanced nations, the Washington- based International Monetary Fund predicts. 
  • Emerging economies may expand 6.4 percent in 2011, almost three times the 2.2 percent rate for developed nations.

And retail investors also see no potholes.
  • Emerging-market equity mutual funds are attracting money at an accelerating pace even after gains in the MSCI emerging markets index slowed to 13 percent this year from 75 percent in 2009. Inflows from individuals into funds during the past three months topped $12 billion, the highest level since the three- month period ended December 2007.
  • “Heavy inflows of equity capital into emerging markets suggest a more cautious stance is appropriate,” Ian Scott, the London-based global equity strategist at Nomura Holdings Inc., wrote in a Dec. 5 research report. He cut developing-nation stocks to “underweight” from “overweight,” saying they’re vulnerable to rising borrowing costs and capital controls. 
  • China’s central bank raised benchmark lending and deposit rates in October for the first time since 2007 and Indian policy makers have lifted interest rates interest rates six times in 2010.
  • Brazil raised taxes on foreign investments in fixed-income securities this year. Thailand removed a 15 percent tax exemption for foreigners on income from domestic bonds. Countries from Taiwan to South Korea have intervened in foreign- exchange markets to stem currency gains, according to traders.

Wednesday, December 15, 2010

Halfway Through December, and NASDAQ & SP 500 have only Suffered 1 Negative Session Each

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The unshortable market continues.  Even losing some of the 'generals' doesn't seem to matter anymore.  We are now at the halfway point of December and despite a huge run for the month, the 2 major indexes (I don't consider Dow Jones to be useful as it's 30 stocks and price weighted) have each only suffered 1 day of drops.  A crushing 0.1% drop in the S&P 500 on Dec 6th, and a debilitating 0.5% loss in the NASDAQ on the 13th.  Other than that, every other day is a non stop win (or tie).



Just another in a series of V shaped moves (that were once rare) since QE1 began.  Truly the only time this market acted normally these past 1.75 years was in a short period late spring/early summer of 2010 when we were in between QE1 and QE1.5 (when the Fed decided it needed to begin buying Treasuries to keep its balance sheet from shrinking and before QE2 was announced)  Each time I think to myself this market is overbought and needs a rest, I have to remember - this is not a market with normal price discovery.... overbought is only a state of mind.  Dick Arms stated this morning, using his ARMS index the market is the most overbought in the nearly 50 years since he began the measure. 
  • It has been nearly 50 years since I invented the Arms Index (also known as the TRIN) and wrote about it in an article for Barron's. Since then, the Index has had many big swings, most being very good signals. Now, in terms of both the five-day and the 10-day moving averages, the Arms Index is at its most overbought levels ever

We did have a few drops during the QE 1, 1.5, 2 campaigns such as July 2009 but other than a few weeks in November '10 when Europe temporarily interfered with the "we can only go up or sideways" market, this has been a non stop party since Jackson Hole, Wyoming in late August...

Obviously at some point we are due to consolidate a now soon to be 4 month move... but a lot of fingers have been severed trying to use any historical pattern as to when this time will come.  I continue to be amazed all the 'free market capitalists' on certain TeeVee channels are applauding the Fed's intention to inflate assets... I guess intervention is super cool as long as it pushes things in the 'right direction' versus a true market value.

[Video] CNBC - Deep Thoughts with Michael Milkin

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Junk bond king Michael Milkin had some 'interesting' experiences in the 1980s - effectively he was the Gordon Gekko of his day.   After serving 2 years in prison (don't worry - he is doing ok, still in the Forbes 500) he has reinvented himself, turned his interests to more philanthropic type activities with a heavy focus on healthcare.  Whatever the background he is another person who is always an interesting interview and had some very sobering and insightful commentary in 2 CNBC interviews yesterday.  If you only have time to listen to one, the first is probably more encompassing of the long term challenges ahead for the U.S.

Video 1 (11 minutes)



Video 2 (7 minutes)


Joy Global (JOYG) - Solid Results, Good Outlook

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With Bucyrus (BUCY) off the market, Joy Global (JOYG) is the last man standing among the major mining equipment makers.

Joy Global Inc. is a worldwide leader in manufacturing, distributing and servicing equipment for surface mining, through its P&H Mining Equipment division; underground mining, through its Joy Mining Machinery division; and bulk material conveyor systems, through its Continental Crushing & Conveying division.

They also happen to do an excellent job in their quarterly earnings report commenting on the sectors / commodities they service, as opposed to just reporting figures.  Always worth the time to review.  Based on the Joy Global report this morning the bull market in all things Chinese (and Indian) consumption continues. [May 13, 2009: Commodities - It's China's World; The Rest of Us Just Live in It]  Booking surged 48%.

  • Joy Global said fourth-quarter bookings rose by 48 percent, which indicates mining customers would continue to raise capital expenditure to address a strong demand for commodities such as copper and coal.  "Mining companies have announced capital expenditures that are up 30 to 35 percent this year ... announced capital expenditures for 2011 are expected to rise another 15 to 20 percent."
  • Joy Global, known for its giant shovels and draglines, forecast fiscal 2011 earnings of $5.00-$5.30 a share, on revenue of $3.9-$4.1 billion.  Analysts on average were expecting earnings of $4.79 a share, on revenue of $3.86 billion, according to Thomson Reuters I/B/E/S.
  • For the fourth quarter, the company reported earnings of $1.39 a share, on revenue of $1.05 billion. Analysts were expecting earnings of $1.16 a share, on revenue of $922.8 million. 



Via Press Release:
  • The commodity end-markets have strong fundamentals and a positive outlook despite slow economic recovery in the industrialized countries and slower growth in the emerging markets, particularly China, which results from efforts to balance economic growth while containing inflation.
  • After recovering beginning in the second half of 2009 and continuing into 2010, copper demand hit an all-time high in June of 2010 and continues to run well above its prior five year range. This was not driven by China alone, and in fact, China demand has leveled from 2009 while demand from the rest of the world has increased significantly since the beginning of 2010. Copper prices have moved steadily up during 2010 in response to both increasing demand and limited capacity to expand mine production in the near term. The longer term outlook is further impacted by the continued trend of declining ore grades.
  • The seaborne demand for both thermal and metallurgical coal continues to be driven by China, India and the other emerging markets. China continues to import coal at an annualized rate of more than 140 million metric tons, up from imports of 104 million metric tons last year. India also continues to import more coal, with its imports expected to triple during the next five years. In addition to emerging market demand, coal burn has been increasing in Europe and stockpiles there have been drawn down. Seaborne thermal coal prices have been increasing on the projection that continued demand growth from the emerging markets will keep supply under pressure.
  • U. S. coal production year to date is flat with last year, but with an improving trend in more recent months. Based on the recent trend, coal demand is on pace to recover 60 to 80 million tons from last year. In addition, the favorable U.S. dollar exchange rate is increasing export opportunities for both thermal and metallurgical coal. U.S. coal production has been restricted by safety and permitting issues and is mostly flat while demand continues to improve. This has resulted in increasing prices across all regions since the first of this year. 
  • Similar to copper, global demand in 2010 for iron ore and metallurgical coal has come mostly from increases in steel production outside of China. Prices for both metallurgical coal and iron ore have been rising in recent months and should see continued upward pressure as demand growth resumes from the emerging markets. China has started to relax power rationing in the major steel-making province of Hebei, and this resulted in steel production increases in October. In addition, India’s imports of metallurgical and thermal coal are expected to rebound after weather related slowing. 
  • Inventories in the industrial sector of the developed countries were substantially reduced during 2009 as companies adjusted to lower demand volumes, and the replenishment of those inventories will add further upside to commodity demand as economic recovery continues. In addition, China and India have included significant infrastructure programs in their next five year plans. India plans to spend $350 billion over the next three years for infrastructure projects. A major focus will be on power generation, with capacity additions expected to double by 2012. China’s plan focuses on the development of the western provinces and on second and third tier cities. Fixed asset investment is targeted to grow at 20 percent per year and includes the build out of the electricity grid in the western provinces, which alone could add a million tons to annual copper demand. 
  • Based on this outlook, mining companies are realizing strong demand and prices, with the expectation of significant increases in demand during the next 3 to 5 years. As a result, they are making major increases in their capital expenditures for mine expansions. Mining companies have announced capital expenditures that are up 30 to 35 percent this year, and are approaching the levels of 2008. In addition, announced capital expenditures for 2011 are expected to rise another 15 to 20 percent.

[Dec 16, 2009: Joy Global Earnings Report Always Worth a Read]

No position

USA Today; American Workforce Graying as the Young Increasingly Locked Out of Workforce

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I won't make any jokes about 40-50 year old B.A.'s taking the jobs the 16-24 set once held at our Burger King and Walmart's... but this story in USAToday should come as no surprise.  We discussed it some 2+ years ago in [Sep 1, 2008: AP - Laboring Longer is Growing Trend for Americans] and it is the equivalent of a national mortgage crisis, but strung out over decades rather than 4-5 years - hence much less apparent. Back in 2008 I wrote:

....highlights what I see as a very long term 'emergency' in America.  Due to financial illiteracy, spending over our heads, inflation costs that are far higher than wages, the "I deserve this even if I cannot afford it" ethos, healthcare costs, tuition costs, energy costs, food costs, not to mention making nothing in the stock market for at least a decade (if not outright losing a lot - see NASDAQ bubble), along with many losing in the real estate bubble, along with the switch from company supported retirement benefits to "do it yourself" 401(k)s. Well you get the idea - it simply is becoming much harder for the "middle class" or "working class" types to keep up in this country as more and more jobs being created are lower paying than those shipped overseas and many benefits their parents had are going the way of the dodo bird.

....you will see over the next 15-25 years the "cost" to the vast majority who won't strike it rich. Many of these people now will have to support both their aging parents along with helping their kids.   Since this lifestyle erosion is happening over a very long period of time it won't get the headlines but this is the reality - a generation who will work until they drop - I call it the Walmart greeter generation (but you can throw Lowe's, Home Depot, Kmart, Target and a few others in there) People not in the upper 5-10% are simply being squeezed from every which angle and the long term trends are ominous. People will survive but it will be a drop in lifestyle or as I call it "The Pooring of America"

Now, a part of this is people are living longer than in the 80s but life expectancy has not increased *that* much in 3 decades... the reality is a world of 1 income, pension earner type of families is long gone except in the government sector, and left to their own devices a lot of people either live only for today (by choice rather than lack of income) or due to income simply cannot save for the long term due to cost of living in the country.  Obviously the two 'jobless recoveries' of the past decade have not helped - and frankly many of the new 'service' jobs replacing those that have been shipped overseas (or made obsolete through technology) don't pay nearly the same... indeed many men make less now (inflation adjusted) than they did in the 1970s. [Sep 2, 2010: NYT - New Jobs Mean Lower Wages for Many]  [this is an often ignored point in the media, as we only look at job creation/destruction but do not ask what the replacement jobs are - and how much they pay, versus what has been lost the past few decades - replacing millions of $48-60K jobs with $34-42K jobs causes a huge dislocation over time]

Simply put the idea of retirement is going to mean a very different thing in the real world go forward, than you see on the cozy TV commercials.  "Work til you drop" will be more common; and in the past I did not think about the effect of this on the young - many are being squeezed out of jobs by elder folk and hence will start their career further behind.  (many with college debt to boot)  Once more - the global labor pool has expanded by a few hundred million in the past 20 years (and only rising as education standards improve overseas)... there is only so much work to go around.  Basic economics 101 - much more supply of labor, a rising (but at much slower pace) amount of jobs = price of work goes down in aggregate.  It is all connected..



Via USAToday:
  • The number of people 55 and older holding jobs is on track to hit a record 28 million in 2010 while young people increasingly are squeezed out of the labor market, a USA TODAY analysis finds.
  • The portion of people ages 16-24 in the labor market is at the lowest level since the government began keeping track in 1948, falling from 66% in 2000 to 55% this year. There are 17 million in that age group who are employed, the fewest since 1971 when the population was much smaller.
  • By contrast, people in their 50s, 60s or 70s are staying employed longer than at any time on record. For example, 55% of people ages 60 to 64 were in the labor market during the first 11 months of 2010, up from 47% for the same period in 2000.
  • "What's striking about this recession is that people 62 and older — those eligible for Social Security — are increasing their participation in the labor force," says Richard Johnson, an economist at the Income and Benefits Policy Center of the non-partisan Urban Institute. All groups younger than 55 have declining shares of the population in the labor force.
  • Johnson says a change in economic incentives — such as raising the retirement age for full Social Security benefits and creating tax breaks — have made it more rewarding to work at an older age.
  • Better health, longer lives and less physically damaging jobs have prompted people to work longer. But it's not all good news.  "Most people work longer because they have to," says Carl Van Horn, director of the Heldrich Center of Workforce Development at Rutgers University. "Many can't afford to drop out of the labor market without severe financial implications."
  • That can indirectly hurt young workers, he says. "There are only so many jobs to go around," he says, and older workers have a job advantage that younger ones don't: experience.

[Video] CNBC - Ron Paul v Ben Bernanke ... Prepare for Thunderdome

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One of the most eagerly awaited developments in 2011 for certain fiscal conservatives is the appointment of Ron Paul to head the House's subcommittee on monetary policy.  Paul is extremely libertarian and in many ways for a few decades represented a large part of what the Tea Party has tried to grab hold of lately.  After being a 'lone wolf' for a long time, suddenly quite a few are coming around to his way of thinking.  With most politicians being attorneys and having little to no economic training or knowledge (with sometimes embarrassingly vacant questions during these hearings), Paul's commentary during any Fed hearing is always compelling, but having the gavel should make for 'must watch' TV.  Anyone who has written a book called "End the Fed" - and who then has oversight over the organization, certainly is going to create some interesting moments - although I am still doubtful much will change; too many powerful interests demand the status quo.

Ron Paul was on CNBC yesterday and the opening line of the questioning explains in a nutshell why we're going to have some fun video in 2011.

Maria B: "So you've written a book titled 'End the Fed'.  Do you still want to eliminate the Federal Reserve?"
Paul: "Oh sure, but I think the Fed will end itself before I'm able to do it."

8 minute video






(one interesting side note - I often mention how the government has massaged statistical inputs in their economic reports, so that the outputs better fit into the story they are telling us; usually I use labor statistics but inflation statistics is another place a host of changes have been made.  Paul says if we used the 'old version' of CPI we'd be printing 4% consumer inflation rather than much more convenient 0.3-0.5% or whatnot. With the cover of 'there is no inflation' Ben can keep doing his QE and 0-0.25% fed fund rates thing, and the government can save some sheckles by not handing out cost of living adjustments to seniors.)

Tuesday, December 14, 2010

Fed Statement: No Inflation

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Fed sees little to no inflation...indeed expectations of long term inflation remain disappointing to Ben.

Next rate hike circa 2015...maybe...speculate at will. Lower and middle class please ignore what you see at gas station and grocery...it is not there. Saver class continue to enjoy your sub 1% CD rates.

Yawn.

WSJ: Offshore Trading in Yuan Takes Off

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This story in the WSJ is an interesting early step in the Chinese yuan's potential threat to the dollar as a reserve currency but we are in the 2nd out of the first inning in a very long game here.  The Chinese are very patient and have very long term goals in mind, but now they are allowing the yuan to trade (in relatively small figures) in Hong Kong, and an increasing number of bilateral trade agreements have been priced in yuan as well.  [Jul 21, 2009: China's Plans for Replacing the Dollar]  We will know the yuan has hit critical mass when the it starts showing up in rap videos circa 2020. [Nov 14, 2007: Bloomberg - American Gangster's Wad of Euros Signals US Decline]
  • In a video for the movie ``American Gangster,'' hip-hop maestro Jay-Z thumbs through a wad of 500-euro notes on a night of cruising through the concrete canyons of New York, a city where the euro isn't legal tender.



Via WSJ:

  • China's currency, pent up inside the country's borders for decades, is emerging as a hot property in global foreign-exchange markets, just months after Beijing allowed the yuan to be bought and sold outside the mainland for the first time.
  • Daily trading in the yuan has grown from zero to $400 million in the past few months, as the currency of the world's second-biggest economy begins to flow around the globe. Global trading in yuan allows businesses to buy and sell the currency to finance trade, investment and borrowing. It's an important step for the yuan to play a role in global financial markets.
  • The value of the yuan remains tightly controlled by China, so its value won't rise and fall to the same extent as the dollar or euro, in spite of the new trading. Even so, foreign-exchange traders who are embracing the currency see demand for yuan rising sharply. Bankers in New York, London and Tokyo are rushing to set up new trading systems and back offices to trade in yuan.
  • "This is the beginning of a new era," said Norman Chan, head of Hong Kong's central bank. "This is a step moving to full convertibility of the yuan, and is a major change of the international financial landscape."



  • The yuan makes up a sliver of the $4 trillion daily trading in currency markets and is dwarfed by trading in the dollar, yen and euro. But traders are surprised at how quickly it is gaining critical mass. Chinese companies are placing yuan into accounts in Hong Kong, where the offshore trading is allowed, and could have as much as 300 billion yuan ($45 billion) there by the end of the year.
  • The continued growth in yuan trading isn't a foregone conclusion. China could reverse itself and slow the growth of the market. China's leaders fear that if too much currency builds up too quickly overseas, they could lose control of inflation and interest rates, said Xiang Songzuo, deputy director of the Center for International Monetary Research at Remin University of China.
  • Nevertheless, the establishment of offshore trading in yuan is "game changing," said David Mann, head of research in the Americas for Standard Chartered Bank. "It's arrived much faster than anyone expected."
  • In July, Chinese regulators opened the door by letting banks and individuals freely trade yuan outside of mainland China for the first time. Creating that infrastructure is a necessary step in allowing the yuan to float freely, and have markets set its value. For now, China will keep its tight rein on the value of the yuan even with the parallel market in Hong Kong.
  • Some predict it will only be a few years before 20% to 30% of China's $2.3 trillion of imports could be conducted in yuan rather than U.S. dollars. Today less than 1% is done in yuan, according to Standard Chartered.  Mr. Mann says trading in yuan could match that of the Japanese yen before long as the third most-actively traded currency behind the dollar and the euro.
  • The move has opened the doors to wider issuance of yuan-denominated bonds and other investments. McDonald's Corp. and Caterpillar Inc. recently became the first U.S. non-financial corporations to sell debt priced in yuan, in what is being nicknamed the "Dim Sum" bond market.
  • A big driver of the increase in yuan holdings offshore is emerging economies, major trading destinations for China. HSBC forecasts that at least half, or nearly $2 trillion worth, of China's cross-border trade with emerging markets could be settled in yuan annually within three to five years.  For example, countries rich in natural resources that export commodities to China could get paid in yuan and then use the yuan to buy finished goods and services from China—cutting out the cost and hassle of converting to dollars.
  • The moves come against a broader background of growing Chinese concern over the country's reliance on the dollar.  Long term, the offshore yuan market could decrease demand for the dollar and lower its value. That's in part because Chinese companies doing business with counterparts in other countries wouldn't need U.S. dollars to conduct that business as they do today.
  • For the yuan to become fully convertible, China would have to allow it to be exchangeable for other currencies at any time, something that's not possible under the new regulations.




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