Expectant of greater things,
We try climbing -
Higher
And Higher;
An effort that costs us much,
Leaving us short of breath
To find only
The ground below is much prettier.

~Phillip Pulfrey

For the last couple of years I’ve been writing that I thought we might experience a biflation for a sustained period of time. Just to define the term again, biflation is an economic environment in which inflation of commodity-based assets occurs simultaneously with deflation in debt-based assets. Some of the recent economic data and market activity seem to support this.

Central Bankers Cooking Up Biflation …

Since the end of last year, coincidentally with the announcement of the ECB’s LTRO program, risk markets have gone more or less straight up. You can see on the chart below that the S&P 500 didn’t react much when the initial announcement came out on December 8, 2011, but took off just before Christmas when the actual allotment announcement came out and again at the end of February 2012 when the second allotment announcement occurred.

Click on the chart for a closer look

The charts for gold and the CRB commodities index look quite similar. It seems the idea that global central banks would do whatever it takes to rescue insolvent European countries and their banks (and their global counterparties) really took hold and gave traders the confidence to bid up risk assets. You can also see the recent dip as doubts emerged about whether bondholders would actually sign onto the Greek debt restructuring agreement and about the potential for slowing economic growth.

… But Growth Is Slowing

One of the problems with rising risk asset prices is that at a certain point they begin to harm economic growth. If you’re like us, you’ve noticed quite a jump in prices at the grocery store and the gas station. While there have been many positive economic data points lately, including signs that the U.S. economy (and even its unemployment rate) are improving a little, there are other indicators (like U.S. housing) that simply refuse to improve.

Last week the U.S. ISM manufacturing report came out, echoing some of these biflationary tendencies. The PMI came in at 52.4%, down from 54.1% in January, but still registered a 31st consecutive month of manufacturing growth. (Anything above 50% indicates expansion.) These numbers reflect continued, but slowing economic growth.

The employment index dropped from 54.3 in January to 53.2 in February – another possible sign of growth slowing. On the other hand, there was some evidence of pricing pressure (inflation) in the Prices Paid Index. It jumped 6% from 55.5 to 61.5, registering the highest level since June of 2011.

Obviously, we can’t draw sweeping conclusions from one report. But when you couple this with indications that gas prices are starting to affect retail sales, that European economies are contracting, and that even China is lowering its growth expectations, this whiff of biflation warrants some attention. (In terms of the China issue, I would still rather use the Shanghai Composite  Index as a key indicator rather than rumours or government stats/targets.)

Biflation or Stagflation?

Some have used the term stagflation of 70s fame (or infamy) to describe this combination of rising asset prices and slowing economic growth. I’m no economist, but it seems like this particular edition of that dynamic is a little different. The main distinctions would seem to be in the areas of debt and volatility.

While a backdrop of stagflation implies a kind of one-way trend where asset prices rise and GDP stalls or dips, the biflation scenario seems to result more from the bursting of a debt bubble wherein debt-based assets exert deflationary pressure while central bank efforts to avert a financial crisis create asset inflation. These two forces then have a kind of teeter totter effect on economies and investors. How often have we seen bipolar market activity over the past decade where markets zoom ahead when it looks like debtors will be bailed out, only to see them come back to earth when debt jitters and inflation worries resurface?

Joe Weisenthal of Business Insider posted some interesting charts suggesting that stagflation tendencies are on the rise, but we’re not there yet. In the end, I suppose it really doesn’t matter what you call it. It seems this type of bipolar investment backdrop is bound to persist until a) we work off the debt overhang and recover or b) we have a crash that resolves it rather unceremoniously, and we recover. If you’re looking for recovery sign posts, Barry Ritholtz suggests 3 Charts Worth Watching.

Do you see any evidence of biflation in your area? How would you describe the difference (if any) between biflation and stagflation?

Related posts:

1. Are You Ready for Biflation?
2. Investment Strategies for Biflation
3. 5 Economic Trends Affecting Your Money

The following is a guest post by Rob Bennett, who writes at many venues. We’re grateful that Balance Junkie is one of them. This instalment of Rob’s monthly column is sure to stir some debate, so I’d love to hear everyone’s thoughts on his thesis here. Enjoy!

My boys (Timothy, age 12, and Robert, age 9) and I were watching a DVD of the old television series I’ll Fly Away a few days ago. The series tells the story of the civil rights struggle of the early 1960s and how it affected the people of a small town in South Carolina. There’s one scene that we watched that I believe tells a good bit of the story of what is going on in our minds re the economic crisis of today.

A black minister and several members of his congregation make a decision to sit down at the lunch counter and order sodas. The white people in the town are horrified and take action. A milkshake is poured on the head of the minister. A cup of coffee is poured on the head of one of the members of the congregation and he runs screaming from the premises to the sound of the taunts and laughs and threats of the white people of the town.

It’s tough stuff. Obscene stuff. It’s stuff that I am confident left an impression on my boys.

The wonderful thing about the series is that its message is not “Weren’t those people awful?” That is one message, but it is balanced with others. One of the other messages is “Weren’t those people afraid?” Even the father of the black maid who is the protagonist of the show warns her against registering to vote because he fears the social unrest that will follow once people like her start making choices like that.

We have goodness in us. And we have e cowardice in us. That’s the full truth.

The people who turned to hate during the civil rights battles made bad choices. It doesn’t follow that they were 100 percent bad people. They were frightened people. Change is scary. They used their minds to rationalize justifications for behavior that could not be properly justified on grounds that “that’s the way it is” and that racism can never be ended and so it only causes trouble and pain to take steps in that direction.

That’s where we stand today re the Get Rich Quick investing advice that Wall Street has been shoving down our throats for decades now and re the unimaginable amounts of human misery that we have caused by our failure to speak up.

Moving on to better models for understanding how stock investing works is going to mean pain. Thousands of books will need to be rewritten. Thousands of big shots who made their reputations promoting failed ideas will either need to leave the field or remake their reputations promoting very different strategies. Thousands of lawsuits will be brought by those who trusted in economic and political systems that have failed us all.

The question that prudent people need to ask in situations like this is — Is there another way? Is it possible to avoid the pain that we see coming if we do the right thing?

The people who pushed for civil rights laws were right to do so because there was no other way. The way of life that had come to be in that South Carolina town could not continue. It was degrading for blacks. And it was degrading for whites. It was unacceptable times ten.

So it is with Buy-and-Hold. Those who follow the academic research have known for 30 years that there is precisely zero chance that this “strategy” could ever work for any long-term investor. But those who can imagine the pain we will all feel as we make the transition to something better are able to rationalize not speaking up. It’s always been this way. Wall Street has always been in the business of exploiting human weaknesses and getting rich off of tall tales. That can never change.

If it were true that it could never change, the foot-draggers would be right. No good is served by fighting battles that cannot be won.

But this battle can be won and cannot be avoided. Once we did away with defined-benefit pensions and put the responsibility on workers to finance their own retirements, we made it impossible for the Get RIch Quick garbage for which Wall Street has long been famous to continue too much farther into the future. The human suffering that follows from the continued promotion of Get RIch Quick has grown too great. What cannot be will someday no longer be.

I believe that we will win this battle. I know from my conversations with tens of thousands of middle-class investors that most today want to kick the can down the road, to avoid talking openly about what caused the economic crisis and about what we need to do to bring it to an end. I also know that many also possess a secret longing for learning the realties, a longing that will achieve greater influence after the crisis worsens enough to leave us all feeling that we simply have no choice but to stop kicking the can and to start talking real.

We’re not bad people. We’re flawed people We’ve done a terrible, terrible, terrible thing in letting this situation go on so long. But my hunch is that we are going to surprise a lot of people with the good we do once we put our minds to it. Once we accept that we have no choice but to fight this fight, we will fight it hard and we will fight it to win and we will achieve a great deal of good in a short amount of time.

Those of us who oppose can kicking need to keep all this in mind. Those who aid the can kicking project will be our friends when we get to the other side of the Big Black Mountain together. I have a catch phrase that I use to remind myself of where to draw the line: We need to be as loving as we can possibly be short of becoming dishonest and we need to be as honest as we can possibly can be short of becoming unloving.

Rob Bennett is a big believer in paying off the mortgage early. His bio is here.

Related posts:

1. Liberals Came Closer to the Mark Than Conservatives With Their Explanation of the Economic Crisis
2. How the Leadership Void Feeds the Financial Crisis
3. 5 Economic Trends Affecting Your Money

Editor’s Note: The following is a guest post by John C.K. Daly.

The good news is that on 8 November the International Energy Agency released its 2011 “World Energy Outlook.” While it will cheer nuclear advocates, overall the report makes for grim reading. Pulling no punches, the report states at the outset, “There are few signs that the urgently needed change in direction in global energy trends is underway.”

Stripped of its cautious language, the IEA report essentially noted that should present trends continue, the world’s governments through a lack of progressive initiative embracing alternative energy sources would continue to rely on ‘tried and true” fossil fuels, resulting in increased pollution, more fossil-fuel dependency and increasingly upward energy prices. For environmentalists, this is all good news, but the report contained a caveat virtually anathema to all green movements, that accordingly, governments should reconsider their reluctance to embrace nuclear power, as it does not generate greenhouse gases.

Dollars, Cents and Reliable Energy Production

Like many discussions in Western economies since 2008, when the global recession first began to draw blood, the issue of reliable energy production ultimately comes down to dollars and cents issues. The grim reality for environmentalists is that no single renewable energy resource, from wind power to solar energy through biofuels, has remotely become competitive with kilowatt hours of electrical energy generated by coal or oil-fired power plants. The debate pits those opposed to a transition to greener technologies to those considering the bottom line, despite greenhouse gas emissions.

Even worse for the environmentalists, the IEA report advocates that as a short-term solution, governments ought to reconsider nuclear power, as it produces zero CO2 emissions. Projecting into the future the report notes, “A low-nuclear future would also boost demand for fossil fuels: the increase in global coal demand is equal to twice the level of Australia’s current steam coal exports and the rise in gas demand is equivalent to two-thirds of Russia’s current natural gas exports. The net result would be to put additional upward pressure on energy prices, raise additional concerns about energy security and make it harder and more expensive to combat climate change. The consequences would be particularly severe for those countries with limited indigenous energy resources which have been planning to rely relatively heavily on nuclear power”

But while sketching out a bleak scenario should governments remain largely disengaged to the larger issues involved in energy production, the IEA report nevertheless ends on a cautiously optimistic note, with its authors concluding:

“International concern about the issue of energy access is growing. The United Nations has declared 2012 to be the ‘International Year of Sustainable Energy for All’ and the Rio+20 Summit represents an important opportunity for action. More finance, from many sources and in many forms, is needed to provide modern energy for all, with solutions matched to the particular challenges, risks and returns of each category of project. Private sector investment needs to grow the most, but this will not happen unless national governments adopt strong governance and regulatory frameworks and invest in capacity building. The public sector, including donors, needs to use its tools to leverage greater private sector investment where the commercial case would otherwise be marginal. Universal access by 2030 would increase global demand for fossil fuels and related CO2 emissions by less than 1%, a trivial amount in relation to the contribution made to human development and welfare.”

Most notable about the IEA report are two things:

1. Energy options beyond dependence on traditional fossil fuels such as coal and oil not only exist, but are available in significant amounts to make a serious contribution.
2. As Germany’s experience in weaning itself off nuclear energy is showing, the alternatives are more expensive than current power production modes.

According to the IEA’s scenarios then, the issue of global power production over the next two-three decades depends upon two major issues:

1. Cost: undoubtedly an uphill struggle for many governments seeking to meet the population’s rising energy demands, who will be loathe to endure increasing energy bills.
2. Global Warming: the impact of traditional fossil fuel-fired power plants belching vast amounts of CO2 into the atmosphere.

While even the most diehard proponents of traditional power plant electrical generation do not deny that their facilities emit significant amounts of carbon dioxide, they denigrate the concerns of environmentalists as ‘fuzzy science.” So, at the end of the day, the two fundamental issues facing the world’s nations seeking to satiate their population’s demand for reliable and inexpensive power come down to cost and scientific projections.

We’ll leave the final word to the IEA, which laid out three scenarios, ranging from best- to worst-case – “The wide difference in outcomes between these three scenarios underlines the critical role of governments to define the objectives and implement the policies necessary to shape our energy future.” Accordingly, the major question is whether global governments will have both the cash and political will “to shape our energy future” to the best possible ends.

Source: IEA-Report Calls-for Governments to Embrace Nuclear Power

By: John C.K. Daly of oilprice.com

Do you think governments will be able to adopt the policies necessary to ensure that sustainable and cost-effective sources of energy are available for future generations?

Related posts:

1. Was the U.S. Employment Report Really Catastrophic?
2. Goal Setting: My Report Card
3. When the Levee Breaks

Even nectar is poison if taken to excess.

~Hindu Proverb

If low interest rates are good for the economy, it should be booming by now. After all, rates have basically been falling for 30 years. Over the last 10 years or so, short term rates have been held low by central banks. Just a few weeks ago, the U.S. Federal Reserve announced Operation Twist, which will keep rates at the longer end of the curve low as well.

Yay. Soon we’ll all be basking in the glow of a red hot global economy. So why does it sound like so many governments and pundits are preparing for perdition rather than prosperity? Why isn’t the low interest rate elixir working its magic?

10 Reasons Low Interest Rates Aren’t Helping – And May Be Hurting

Lower rates are supposed to stimulate the economy by encouraging business investment, home buying and consumer spending. Operation Twist is supposed to accomplish more of the same. As John Mauldin points out “in a normal business-cycle recession such a policy might work. But in a normal business cycle, it has never been necessary.” Here are 10 ways low interest rates are inhibiting a healthy economy:

1. Savers Are Suffering

Low interest rates mean meagre returns for retirees and risk averse investors who can’t or won’t or shouldn’t have very much of their money at risk in the markets. This means they need to spend less, find a way to earn more income, or move farther out the risk spectrum. Mauldin aptly asks “Do we really want retirees increasing their risk by seeking more yield?”

2. Artificial Boost to Other Asset Classes

I’ve lost count of the number of times I’ve heard low interest rates given as a good reason to jump headlong into stocks and commodities. A lot of investors did just that in 2009 and 2010 when it looked like the Fed would be able to engineer an economic recovery. That’s great for people invested in those vehicles, but the average consumer, many of whom do not own stocks or commodities, is now stuck with a rising cost of living, a slowing economy and a deteriorating employment picture.

3. Lower Real Returns

Real returns are what you earn after factoring in inflation. With CPI in Canada and the U.S. running over 3% and many fixed income investments yielding under 2%, it’s not hard to see that real returns are negative. While many advocate buying stocks as a remedy for this, it’s important to remember that stocks can offer negative returns on their own via capital losses and that capital gains should be converted to real returns as well. If your stock portfolio is up 3% on the year and inflation is running at 3%, your real return is zero. (Dividends can help cushion the blow with regular distributions. )

4. Increasing Debt Loads

Many young people have become accustomed to very low interest rates. Folks in their 20s and 30s find it hard to imagine that mortgage rates could go as high as 7%, never mind 12% as they were as recently as the early 90s. This tendency to presume low rates will persist as far as the eye can see has prompted many consumers, businesses and sovereign countries to take on astounding amounts of debt. Keeping rates artificially low does little to ameliorate our debt problem.

5. Decreasing Net Interest Margins for Banks

While central banks held short term rates down, global financial institutions made a lot of money borrowing short and lending long. So while they’re paying you less than 1% on your cash deposits, they’re charging you multiples of that amount for your mortgage. Heaven knows they needed a capital boost after the subprime debacle of 2008. But now the Fed is sitting on the long end of the yield curve as well, so that spread and its attending profit margins are quickly disappearing.

6. No Help for U.S. Housing

Interest rates have been low for over a decade now. Some would argue that this a major precipitating factor in the 2008 U.S. housing crash. Since then, rates have gone even lower but we have yet to see any measurable improvement in the housing market south of the border. The problem is not that rates are too low, but rather that inventories are too high and prices are still falling.

7. No Help for Businesses

John Mauldin points out that the latest NFIB (National Federation of Independent Business) survey shows that most small businesses are not suffering from a lack of lending, but from a dearth of sales. So lower rates are fine for carrying an existing line of credit, but there’s no need to take out a large business loan if the sales aren’t there to support expansion.

8. No Help for Consumers

Most consumers are trying to deleverage, so lower rates can help keep interest costs down. Still, there’s still a segment of consumers who will take the Fed’s promise to keep rates low for an extended period of time as an invitation to take on even more debt. With debt levels at or near record highs in many countries that doesn’t seem like a prudent course of action. And with sovereign sources of bailout funds struggling to keep up, it could be a recipe for disaster.

9. It Didn’t Work for Japan

Japan has maintained interest rates near zero for decades now and the result has been an ongoing deflationary depression. The Nikkei peaked around 37,000 in 1990 and hasn’t even come close to regaining that level over the past 20 years. Today it trades below 10,000. That doesn’t necessarily mean North American equity markets will follow the same path, but it’s got to at least be on the radar screen for investors.

10. Pension Funds and Insurance Companies Hurting

As recently as Monday, Sun Life Financial, generally considered to be a Canadian blue chip company, warned profits would fall well below estimates. Much of the miss can be blamed on sagging equity markets and pitiful returns on interest-bearing investments. That in turn led Moody’s to consider downgrading the insurer’s U.S. subsidiary. Sun Life is not alone. Analysts expect most insurers and pension plans to struggle to meet their benchmark returns, especially in light of Operation Twist.

Insurers and large pension funds depend on “safer” investments like bonds and term deposits to cushion their portfolios against market risk. Most of them have not modeled interest rates this low into their projections. With equity markets flat to lower over the past decade, insurance companies aren’t getting the returns they planned on and many pension plans are underfunded by a wide margin. If market conditions don’t improve, pension contributors and employers may be required to fill the gap.

Do you think record low interest rates are positive or negative for the economy and financial system?

Related posts:

1. Where Are Interest Rates Going?
2. Interest Rates: 2010 Mid-Year Review
3. Why Are Mortgage Rates Rising?

If you are neutral in situations of injustice, you have chosen the side of the oppressor. If an elephant has its foot on the tail of a mouse and you say that you are neutral, the mouse will not appreciate your neutrality.

~ Bishop Desmond Tutu

“In the wake of the global financial crisis, politicians and regulators assuaged public outrage by promising reforms that would prevent such a crisis from occurring again. But not much has improved. We haven’t even managed much of a regime change. Many of the bankers, regulators and politicians who drove the policies that led to the crisis are still in their chairs. Many of the big banks are even bigger. Too big to fail is still a major systemic threat.” I made this comment over 8 months ago as the civil unrest in Egypt was boiling over.

At the time, I wondered how long it would take before citizens in other parts of the world would grow tired of the income disparity that seems to have become a global epidemic: “How much longer will the American public tolerate government-subsidized success for large corporations while many are running out of unemployment benefits and over 40 million Americans are on food stamps? There has to be a tipping point somewhere.”

From Arab Spring to Autumn in America

The protests this spring in the Middle East seem to have given way to widespread – albeit mostly peaceful – demonstrations in more than 1500 cities across the globe this fall. Most are taking place under the auspices of the Occupy Wall Street movement. I read all the time that the movement lacks a coherent message. That may be true, but many people can identify with the pervasive sense that there’s something rotten in the halls of power worldwide, that capitalism isn’t functioning as it should and that the middle class has somehow been handed the bill for mistakes made by both ends of the political spectrum while CEOs of failed banks walked away with millions.

One OWS spokesman summed it up this way: “Does anyone really not know what the basic message is of this protest: that Wall Street is oozing corruption and criminality and its unrestrained political power—in the form of crony capitalism and ownership of political institutions—is destroying financial security for everyone else?” The chart at the top of this article illustrates just one of the reasons Wall Street protesters are angry: The top 1% of American wage earners are taking bigger percentage of the country’s total pre-tax income than at any time since the late 1920s. Their share of the national income, in fact, is almost twice the long-term average!

Josh Brown, otherwise known as the Reformed Broker, added a lot more detail in his open letter to the banks that don’t seem to get why people are mad. Incidentally, Josh is part of the 1%. He works in finance and I’m guessing he’s doing alright. That’s the thing about Occupy Wall Street. Some of its most ardent supporters actually work there, or used to. Check out the story of Josh’s encounter with Suzanne, a former Wall Streeter and current member of the 1%.  She’s down in Zuccotti Park personifying the fact that not all Occupy Wall Street sympathizers are “stoners, losers and fringe elements.”

MSM Missing in Action

It’s worth pointing out that the mainstream media (especially financial networks like CNBC) have been slow to cover the Occupy Wall Street protests. When they do, they usually throw in a few winks, nods, and sarcastic jabs about the legitimacy of those involved. It’s so far been left to blogs, social media and online publications to bring the real issues to light. (Today’s chart is from online news aggregator Business Insider.)

Documentaries like the Oscar winning Inside Job offer a lot of details on how and why crony capitalism helped spawn the 2008 financial crisis. Why have none of the MSM outlets with the budgets to support it not sent armies of investigative reporters out there to find out what really happened? Maybe it’s because they didn’t know any better. Or maybe it’s because they would never again get an interview with the business and political heavyweights that draw the big ratings. Or maybe it’s because they are owned by the crony capitalists in question.

Either way, it seems like a good idea to get your information from a variety of sources. If you’re relying on the mainstream media alone, you may only be getting one side of the story. It still amazes me how some of the folks who looked so guilty in Inside Job are regularly invited to express their views in the financial media.

Middle Class Uprising?

Occupy Wall Street is often viewed as a left wing movement. Given that many powerful labour unions joined the protests this past weekend, I suppose it makes sense to think so. Many would like to write off the nascent organization as just another extremist group of wing nuts and rabble rousers. If the Tea Party is the crazy uncle of the political right, maybe Occupy Wall Street is just the crazy aunt of the political left.

I’m not sure what the right answer is, but it strikes me that this movement is trying to represent the masses in the middle. These are the folks whose taxes helped bail out the banks as well as the auto companies. These are the folks who work in the private sector, where cushy pension and benefit plans are nonexistent. They earn less than their unionized counterparts and just a fraction of the income many in the financial industry take home.

Like the classic psychological portrait of a middle child, the middle class feels overlooked, underappreciated and a little exploited. They are, by nature, more diplomatic and therefore more prone to defuse rather than invite conflict. Perhaps this is why it’s taken so long for the middle class to pipe up and have its say. Perhaps it’s also why the demonstrations have thus far been mostly peaceful.

It seems the middle class is less interested in tipping the scales to the left or the right than in simply restoring some sense of balance to our society. They’re hoping that they can avoid the violence that so often accompanies social change. Who knows? Maybe they can do it. After all, these imbalances have grown slowly and almost silently for decades. Let’s hope we can correct them without too much upheaval as well.

What do you think of Occupy Wall Street? Have we hit a tipping point?

Related posts:

1. Nightmare on Wall Street II
2. Book Review: The Weekend That Changed Wall Street
3. Egypt: Financial Lessons and Tipping Points

Growth for the sake of growth is the ideology of the cancer cell.

~Edward Abbey

Although I visit the grocery store at least once a week, lately I’ve had the feeling that I’m in a different place – and that’s not just because we recently moved. I sometimes can’t believe the prices I’m seeing on staples like milk, cheese, or sugar and I can’t help but notice that my cart doesn’t have to be very full in order to rack up a pretty big bill.

My shopping trips highlight several economic trends I’ve been noticing over the past few years. These trends are having a direct effect on our finances, and I’m curious to know whether others are finding the same thing. Here are 5 of the most salient trends that seem to be affecting our personal finances:

1. Less for More

Not only do the large cheese bars we buy regularly cost almost ten bucks at regular price, they are only a fraction of the size they were a few years ago. I’m sure most folks can come up with many other such examples. More recently, I noticed that Minute Maid reduced the size of their cans of orange juice – not that we’ve been buying the brand names for a while now. The price just keeps going up and we only buy it if it’s on sale.

This trend is not limited to the grocery aisles. Energy prices have risen and that feeds into pricing for all kinds of goods and services. Have you noticed that services that used to be free or included with your purchase have gone the way of the dinosaurs? It seems that so many transactions nowadays come with a service charge, administration fee, or surcharge. When we moved, just about every utility or agency that sent us a bill included some kind of exorbitant “service change” fee even if we remained with the same company. Either way, I can’t escape the feeling that my pocket is being picked repeatedly.

2. Biflation

Less for more seems to be a natural by-product of the biflation trend I highlighted early this year as one of the major factors affecting your money in 2011. In spite of a lacklustre economy and pervasive unemployment, commodity prices have risen, mostly as a result of the monetary machinations of central bankers. It will be interesting to see whether the recent slide in commodities brings any relief in the inflation half of the biflation equation.

What about the deflationary component of biflation? That usually means falling interest rates and housing prices. It can also mean lower prices for gadgets. The U.S. housing market has yet to recover. Interest rates have remained low and have fallen even further during the latest round of economic malaise emanating from the Eurozone. It looks like the trend will continue until we can find some kind of resolution to the global debt problem.  And that brings us to trend #3.

3. Debt Boom

I won’t spend too much time on this one since I’ve written so much about it already. The global debt problem has been building for decades. The 2008 financial crisis brought it to the forefront and the solutions provided by governments and central banks have made it worse. Consumers and sovereign entities alike have taken on huge amounts of debt and we are now struggling to understand whether it will ever be repaid. We covered some of this in Monday’s article on principal vs. principle.

4. Growth at Any Price

We live in an economic system that values growth above all else. Growth isn’t necessarily a bad thing – unless we take it too far. Many would agree that we’ve done just that. Pushing growth at any price has led to the debt boom and many of the misguided solutions to our problems. Barry Ritholtz had an excellent commentary on the idea that we’ve repeatedly ignored a key trading axiom: Take the Loss. Late last year I wondered What Happens When the Glass Is Too Big? Almost a year later, we’re seeing some of the results.

Monetary and political authorities have been reluctant to allow institutions to fail for fear that falling stock prices and derivatives implosions would bring down the financial system. Perhaps those fears are well-founded – all the more reason to fix the system so that failure is once again a key component. Regular recessions are part of the business cycle. Bankruptcy is part of capitalism. Both allow for rebirth and real growth based on sound economic fundamentals rather than bogus backstops.

5. Wealth Disparity

It’s hard for the average middle class family to be successful when unemployment is stubbornly high, the cost of living is rising, and interest rates are so low that saving for the future seems fruitless. Jeremy Grantham recently pointed out some of the stats:

“The top 10% of U.S. workers currently receive about half of the nation’s total income, with half of that going to the top 1%. The last time this country saw a wage gap so extreme was just before the 1929 stock-market crash and the Great Depression. By comparison, in the late 1970s the top 1% garnered about 9% of all earnings.”

Say what you like about class warfare or picking on bankers, this is not a good scenario for future economic prosperity – for anyone. As Grantham observes “You can’t run the economy on BMWs alone.” While the statistics he uses focus on the U.S., we are seeing a similar dynamic play out in many other parts of the globe as well.

What Does It Mean?

All of this will affect each of us a little differently depending on our age, income level and job security. For us, it means waiting for sales on items like cheese, cereal and orange juice before we buy. It means holding off putting any more money into GICs until rates rise. (Right now, a savings account at Ally pays 2% while many 5-year GICs are only yielding about a half a percentage point more.) It means we’ll use the ultra-low mortgage rate we just received to pay down the principal as quickly as possible. It means limited participation in the stock market until that mortgage principal is a lot lower.

Have you noticed similar trends? What do they mean to you?

(Photo Credit: Shutterstock/Shkurd)

Related posts:

1. Why We Are Afraid to Acknowledge the True Cause of the Economic Crisis
2. Liberals Came Closer to the Mark Than Conservatives With Their Explanation of the Economic Crisis
3. Revenge of the Dumb Money

Wisdom is knowing what to do next; virtue is doing it.

~David Star Jordan

It’s funny how rather complex issues can sometimes become a little more clear by accident. One of the spelling riddles I sometimes come across when I’m writing is the difference between principal and principle. Unlike other words like favourite and favorite, this is not simply a matter of unique international spelling conventions. Principal and principle actually have completely different meanings.

Principal vs. Principle: What’s the Difference?

According to my trusty dictionary, principal can refer to:

1. a school administrator
2. something or someone of first rank or importance
3. capital bearing interest

Principle, on the other hand, is:

1. a fundamental truth, or doctrine on which others are based
2. rules of conduct or ethical behaviour

Who Cares?

I’m sure some of you can already see where I’m going with this. It’s not about spelling trivia. It’s about the global economic pickle we seem to have landed in. The markets have reflected the uncertainties we face by alternately surging and plunging. The last few trading sessions have obviously leaned pretty heavily toward the plunging side. Even the precious metals complex, considered by some to be a safe haven, has been hammered. At one point on Friday gold was down over $100.

These manic-depressive tendencies reflect the uncertainties surrounding the mountains of debt that have been piling up in the Eurozone, the United States, and even China. While China’s massive stimulus programs helped us out of the 2008 economic ditch, there’s growing concern that they may have inadvertently thrown themselves into it along with us. So it seems China may not be able to come to our rescue again.

The recent market gyrations are simply a continuation of the financial crisis that began in 2008. I’ve written quite often about the idea that the root causes of the crisis were never addressed. I am by no means the originator of that assessment. The measures taken in 2008 and 2009 only served to rescue the financial sector with taxpayer money. Now taxpayers are tapped out, governments are tapped out, and we have even more debt on global balance sheets than we did in 2008.

While the problems facing us seem quite complex at times, we can probably boil it all down to 6 simple words: too much principal; not enough principle.

Too Much Principal

Obviously, we are dealing with an unmanageable quantity of “capital bearing interest” worldwide. We are very close to the terminal stages where the interest owing alone is causing many debtors to incur more debt just to pay the interest charges. Forget about the principal. No one seems to be able to comprehend making a ding in that at all. We have put ourselves into survival mode where we are just trying to tread water, buying time (on credit of course) and hoping for a miracle solution.

Creditors do not want to acknowledge that the debt will probably not be repaid, but they don’t want to take the haircuts that go with that reality. It’s time to face the music. It’s unfortunate that we didn’t do it sooner.

One of the major reasons governments and creditors have been reluctant to allow debtors to default is the exponential effects of credit default swaps. If a large financial institution or sovereign nation were to default on its debt, bondholders would suffer, but so would anyone who wrote CDS on those bonds. It’s widely acknowledged that the amount of CDS out there vastly outnumbers the capital in the financial system. In other words, the folks who insured the debt can’t pay up.

We’ve had a few years to figure out a solution to the CDS conundrum. How can we allow failed institutions to default without bringing down the global financial system? Instead of taking a serious stab at curtailing the size and influence of the financial sector, we gave them more money. Exposure to derivatives has reached new highs.  Now the rescuers need rescuing.

Not Enough Principle

It’s not hard to look at the global leadership vacuum and see that one of the major problems confronting us is a lack of principle. I don’t know a single soul who isn’t completely exhausted and/or disgusted by watching the political brinkmanship play out across the globe with progressively poorer results. We seem to be getting better at calling each other names, but worse at addressing the mounting problems that confront all of us.

A second major problem might be a pervasive failure to recognize the fact that some of the principles we’ve embraced over the past few decades may not have been of the highest calibre. Consumerism, growth at any price and short-termism have undermined our economy. We’ve listened to Alan Greenspan, Henry Paulson, and a host of others who are either revered or reviled depending on whom you ask. They have been the alleged champions of free market capitalism.

Now I’m a big fan of capitalism. But the last time I checked, capitalism is supposed to allow for failure. That’s one of the things that makes it great.

We can have a great idea about how to solve a problem or provide a service. We can develop and bring that idea to market. If our idea takes off, we will likely reap financial rewards commensurate with that success. If it doesn’t, we close up shop and go back to the drawing board, hopefully richer in experience, if poorer in cash.

Failure is an essential component of capitalism. It can’t work without it. Unfortunately, the version of capitalism under which we are currently operating is more like Gore Vidal’s idea of “socialism for the rich and capitalism for the poor.”

Who would have thought that a simple spelling puzzle could help define the financial crisis? I realize that defining the problem does not automatically lead to a solution, but it strikes me that reducing principal and redefining principles might be a good place to start.

What do you think?

Related posts:

1. 5 Economic Trends Affecting Your Money
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I am more afraid of an army of one hundred sheep led by a lion than an army of one hundred lions led by a sheep.

~Charles Maurice, Prince de Talleyrand-Périgord

When the financial crisis erupted in 2008, many questioned the leaders and regulators in place at the time. How could the global financial system be humming along one minute and completely bankrupt the next? Clearly, those in charge either made some very questionable decisions or failed to inform the public of the potential consequences of those decisions. Most likely it was both.

When it came to constructing solutions for the crisis, however, we continued to listen to and implement the ideas of the same people who brought us to the brink. In turn, those people followed policy prescriptions similar to the ones that got us into trouble in the first place. Were there no other options available? There were. They were simply ignored. And what role did we the public play? Were we willing sheep, helpless dupes, or both?

While I’ve been thinking and writing about this exasperating situation for some time now, the reality of it hit home once again this past weekend as Joe Nocera published an excellent exit interview with outgoing FDIC chairwoman Sheila Bair. Ms. Bair added a refreshingly candid piece in the the Washington Post. I highly recommend reading both.

Notes from the Exit Interview

Here are a few points that stood out to me from Nocera’s article:

• “Not long after she took charge in June 2006, Bair began sounding the alarm about the dangers posed by the explosive growth of subprime mortgages, which she feared would not only ravage neighborhoods when homeowners began to default — as they inevitably did — but also wreak havoc on the banking system. The F.D.I.C. was the only bank regulator in Washington to do so.”
• “Just a few months ago, she went so far as to send a letter to Standard & Poor’s, the credit-ratings agency, suggesting that its ratings of the big banks were too high because they reflected an expectation of government support. If a too-big-to-fail bank got into trouble, she wrote, the F.D.I.C. would wind it down, not bail it out.”
• “the last female financial regulator to be labeled difficult was Brooksley Born, the head of the Commodity Futures Trading Commission in the mid-1990s. Fearful that derivatives were becoming a threat to the financial system, Born wanted to regulate them but was stiff-armed by Alan Greenspan and Robert Rubin.” I had the same sense of déjà vu. (If you get a chance, watch the PBS documentary called The Warning that I wrote about in Market Integrity Should Not Be an Oxymoron.)
• “She favored “market discipline” — meaning shareholders and debt holders would take losses ahead of depositors and taxpayers — over bailouts, which she abhorred. She didn’t spend a lot of time fretting over bank profitability; if banks had to become less profitable, postcrisis, in order to reduce the threat they posed to the system, so be it. (“Our job is to protect bank customers, not banks,” she told me.)”
• Ms. Bair felt the authorities should have let Bear Stearns fail: “Banks and bank-holding companies are in the safety net. That’s why they have deposit insurance. Investment banks take higher risks, and they are supposed to be outside the safety net. If they make enough mistakes, they are supposed to fail. So, yes, I was amazed when they saved it. I couldn’t believe it.”
• The FDIC was the lone regulatory agency that foresaw and tried to stem the toxic impact of subprime mortgages. The responses of the Fed, the Office of the Comptroller of the Currency and the Office of Thrift Supervision “were at best tepid and at worst hostile.”
• As head of the FDIC, Sheila Bair also fought against U.S. adoption of the Basel II accords. Already taken up by most European countries, Basel II “would allow banks to hold capital on a “risk-weighted” basis, meaning that assets with lower risk would require less capital. (As it turned out, triple-A-rated mortgage bonds stuffed with bad subprime mortgages were considered very low risk under the Basel proposal. That is why so many banks loaded up on them in the years leading up to the crisis.) To make matters worse, the Basel II accords, as they were called, permitted banks to evaluate their assets with their own internal risk models.”

It turned out that Bair’s approach, often labeled “difficult” by bankers and fellow regulators, left U.S. banks in a slightly better position than their European counterparts when the credit crisis hit. If they had listened to her ideas with regard to tightening capital requirements and regulations in the first place, however,  perhaps the crisis could have been averted.

In Her Own Words

I can remember watching media coverage of the financial crisis as it unfolded in 2008 and 2009 and wondering what some of the key players were really thinking behind the spin and the rhetoric. Sheila Bair’s Washington Post article on Short-Termism and the Risk of Another Financial Crisis provides a glimpse into what she feels is the primary cause of our economic and financial problems. Given that many of the “solutions” employed continued the policies of short-termism that she abhors, it’s easy to see how frustrating that period of time must have been for the FDIC chairwoman.

Bair begins her op-ed with an incredulous observation that we have quickly returned to “the same untenable business practices that brought [the financial system] to its knees less than three years ago.” She notes that “too many industry leaders, as well as some government officials, compare the crisis to a 100-year flood. ‘Who, us?’ they say. ‘We didn’t do anything wrong. Nobody saw this coming.’ ”

In reality, plenty of people saw this coming. They did the best they could to try to stop it, but no one at the political or public level was listening:

“The truth is, some of us did see this coming. We tried to stop the excessive risk-taking that was fueling the housing bubble and turning our financial markets into gambling parlors. But we were impeded by the culture of short-termism that dominates our society. Our financial markets remain too focused on quick profits, and our political process is driven by a two-year election cycle and its relentless demands for fundraising.”

Just as she did back in 2006, Sheila Bair wants to “sound the alarm again.” The problems created by short-term thinking are “actually getting worse, not better.” Will we listen this time?

I once wrote that strong leadership is one of the missing links in our current, distorted version of capitalism. If so, the only way to change that is to find a way to better educate the public about the long term consequences of short-termism – no small task given our “gotta have it now” society.

(There’s a lot more to both of these articles, so I would urge you to go and read both in their entirety.)

Should we have listened to Sheila Bair and others who warned of the longer term consequences of a lack of market discipline? Why are we still ignoring them?

Related posts:

1. Why We Are Afraid to Acknowledge the True Cause of the Economic Crisis
2. Liberals Came Closer to the Mark Than Conservatives With Their Explanation of the Economic Crisis
3. Financial Spilled Milk: Macbeth Meets Ponzi

Investors have very short memories.

~Roman Abramovich

Today’s U.S. Nonfarm Payroll Report was a huge disappointment by any measure. Paraphrasing some reaction to it (mostly from economists who got it wrong):

• catastrophic
• severely disappointing
• no redeeming qualities whatsoever
• Stop looking for the silver lining. There is none.

Now most of you know that I have a fairly bearish view on the economy due to the global debt burden. So I’m doing an I-told-you-so happy dance right now, right? Not so much. While I did add to my tiny HIX position today, I’ll be out of it again quickly if the market changes its mind, as it’s wont to do regularly.

Attention Deficit and Hyperbole

Why so sanguine in the face of data that is, by all accounts, unexpectedly and extremely negative? Because years of following the markets have taught me two key things:

1. Markets have a very short memory.
2. Anything can happen.

It’s not wise to cling to a single idea, data point, or theme. The markets are full of too many variables for that kind of strategy to be successful. Markets, and the traders who drive prices, tend to be prone to both hyperbole and attention deficit disorder. The news of the moment is often blown out of proportion – until the news of the next moment takes over. How many times have we seen a premarket bomb turn into an afternoon delight?

ADP vs. BLS

Markets jumped on Thursday due to a better than expected employment report out of ADP. Many economists raised their estimates for today’s BLS report as a result of that report. Obviously, the BLS report looks that much more disappointing in light of those elevated expectations.

ADP is slammed regularly for missing the BLS nonfarm payroll number, sometimes by a wide margin. To me, this misses the point. It seems like it might be more productive to ask which report is more accurate. What if the ADP report is actually presenting a more accurate view of the U.S. employment picture? I’m not sure whether that’s the case or not, but I’d love to know the answer.

Potentially Positive Catalysts

So what are some of the catalysts that could trigger my stop? Any of the following could cause an upward mood swing for traders:

• The ADP number could be catching an uptick in employment before the BLS. Future economic data may look better.
• While many other data points have been negative, there have also been some positives: rail traffic has increased in both the U.S. and Canada, corporate earnings have been rising, and retail sales recently beat expectations.
• Those who say the recent soft patch is mainly due to the supply chain disruptions caused by the Japanese disaster may turn out to be correct.
• Earnings season is upon us. We may see some upside surprises. (For a much more cynical take on earnings beats, take a look at the latest note from Albert Edwards via Zero Hedge.)
• If the data continues to be negative, we could see another Jackson Hole miracle toward the end of the summer as Bernanke dangles the QE3 carrot and causes another short squeeze/asset price liftoff.
• The U.S. government comes to an agreement on the debt ceiling. While this wouldn’t solve the long-term debt problems facing our neighbours to the south, it would likely provide some support to the markets.

If I sat here a little longer, I could probably come up with a few more ideas. And there are always those white swans to consider too. You never know when some completely unanticipated event will move markets one way or the other. In the end, none of us knows what will happen next. Even if we have some insightful hypotheses, they may not play out according to the timeline in our heads. Best to remember that anything can happen.

By the way, I could come up with an equally long list of negative catalysts, but I’ll leave that for another time. For now, I see the NFP number as concerning, but not necessarily catastrophic. I would be much more concerned if things started to unravel on the European sovereign debt front, or if more rumblings of trouble with Chinese debt began to surface.

Off Topic: Thanks

I just wanted send a note of thanks out to those who have wished my son well following the recent surgery on his leg. Your kind thoughts are much appreciated. He’s feeling much better now, although it will be months before this whole process is complete. Luckily, lots of experience on crutches has him operating pretty independently now that he is over the initial trauma of the surgery itself.

We will be out of town every couple of weeks visiting his specialist for follow-up. When you add that to all of the stuff that goes with moving to a new city, things will be pretty busy for the next couple of months. I appreciate your patience as my posting schedule will be inconsistent at best during that time period. I hope to resume more regular writing in the fall. In the meantime, thanks for reading and for sticking with Balance Junkie.

Do you think the U.S. payrolls report was a harbinger of weaker economic data, or just a temporary blip?

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Truth is after all a moving target
Hairs to split,
And pieces that don’t fit
How can anybody be enlightened?
Truth is after all so poorly lit.

~Neil Peart, Turn the Page

The following is an excerpt of an article that was originally published on Seeking Alpha as premium content. You can read the entire article there.

I read two fascinating articles this week that shed a little light on the opaque workings of our global financial system. One used recently declassified documents to show that foreign banks were the greatest beneficiaries of the Federal Reserve’s efforts to quell the financial crisis. The second elucidated a recent BIS report that revealed the relative exposure of U.S. versus European financial institutions to a PIIGS default. The former article posited that the data provides the grounds for Ben Bernanke’s impeachment. The latter offers some information on why that might not necessarily be the case – at least not for one of the reasons given.

Read the full article at Seeking Alpha . . .

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