Sanjay Bakshi: Seven Patterns of Inefficiency in Pricing of Quality Businesses (LINK)
Letter reveals fragility of Greek finance (LINK)
Greece came so close to defaulting on last week’s €750m International Monetary Fund repayment that the prime minister warned IMF chief Christine Lagarde he could not pay it without EU aid.
Athens ultimately made the payment without financial assistance from the bloc but only by tapping a rarely used emergency account Greece holds at the fund — an unorthodox transaction that amounted to borrowing IMF funds to pay the IMF.
Alexis Tsipras wrote to Ms Lagarde, warning that the IMF repayment would be missed unless the European Central Bank immediately raised its curbs on Greece’s ability to issue short-term debt.
The letter, first reported by the Greek daily Kathimerini but independently confirmed by the Financial Times, raises questions about how close Athens is to bankruptcy. In addition to payments due to the IMF next month totalling €1.5bn, the Greek government has struggled to meet its wage and pension bills, which must be paid at the end of the month.
The next €300m IMF payment is due on June 5.
Finance chiefs urge action on bubble fear (LINK)
A group of leading financial executives have urged authorities around the world to beef up their crisis-busting tool kits amid fears that ultra-low interest rates have increased the risks of financial instability.
The heads of companies including HSBC, UBS and BlackRock will on Monday release a joint statement backing the use of macroprudential tools, but warn that rules, if too narrowly applied, could push risks into the more thinly regulated realm of shadow banks.
Macroprudential tools are used to guard against emerging dangers such as overvalued property assets, in theory reducing the need for authorities to raise interest rates to rein in investor exuberance. Among the most developed are counter-cyclical capital requirements on banks and caps on the amount of debt customers can borrow relative to their incomes.
Macau Bets $27 Billion on Reversing the Law of Supply and Demand [H/T Matt] (LINK)
Dan Ariely: Why The Next Market Downturn May Quickly Become A Full-Blown Panic (audio) (LINK)
Maria Popova discusses Oliver Sacks' memoir, On the Move: A Life (LINK)
Brad Feld: Build Your Life Where You Want To Live (LINK)
Related book: Startup CommunitiesI was an undercover Uber driver [H/T The Browser] (LINK)
John Mauldin - Secular Versus Cyclical: Notes from SIC 2015 (LINK)
It is hard to say what my “favorite” presentation was, as there were so many excellent ones, but Bill White’s would certainly be on a very short list. He was the former chief economist at the Bank for International Settlements and is now the chairman of the Economic Development and Review Committee at the OECD in Paris.
Bill may not be as familiar to some of my readers as he is to me, but he is one of my economic heroes. A little history: Bill predicted the financial crisis of 2007–2010 before 2007's subprime mortgage meltdown. As early as 1996 he was one of the critics of Alan Greenspan's theory of the role of monetary policy. He challenged the former Federal Reserve chairman's view that central bankers can't effectively relieve the causes of asset bubbles. On Aug. 28, 2003, White made his argument directly to Greenspan at the Kansas City Fed's annual meeting in Jackson Hole, Wyoming. White recommended to “raise interest rates when credit expands too fast and force banks to build up cash cushions in fat times to use in lean years.” Greenspan was unconvinced that this would work and said, “There has never been an instance, of which I'm aware, that leaning against the wind was successfully done.” If you’re not willing to take a little political heat, which clearly Greenspan wasn’t, then we may never know whether that would work. However, I disagree with Greenspan: I think that Volcker leaned quite successfully. Yes, there were recessions, so you might not see that as successful, but I think the long-term positive results of Volcker’s moves are evident.
That is the problem with having a monetary policy that is influenced by the political temperament and decisions of a small group of people. What happens is that people look around for scapegoats when a recession comes along, and they will point to a central bank that wasn’t as accommodative as they would have liked and blame the bank, rather than simply understanding that the business cycle is what it is. Bill White is my favorite central banker.
Central bank models, he told us, are artificial machines. His best quote was, “The basic problem with central banks: they think they know how the economy works.” Their models are built to be gamed and always assume a return to equilibrium. But there is no equilibrium – you are where you are. The problem with equilibrium models is that they don’t reflect reality.
An economy is like a forest ecosystem, not a machine. We are on a very bad path – debt is unsustainable. Notice the environment since the 2008 crisis: the Eurozone crisis is a limited variant on a global crisis; fiscal and regulatory restraint is not helpful; and monetary policy is the only game in town and is not effective.
Does White expect better days ahead? The IMF and OECD expect modest expansion – but they have very poor forecasting records. Why should demand suddenly strengthen?
Is low inflation really so great?
Looking around the world, Bill thinks that Abenomics could backfire. Can China adapt to a new growth model? Can the Eurozone sustain confidence? Political problems are everywhere (which Friedman and Bremmer highlighted!). It is much easier in today’s world for a crisis to spread worldwide because we have increasingly complex systems with far more linkages and rising correlations.
Hussman Weekly Market Comment: The "New Era" is an Old Story (LINK)OECD simulations indicate global fragility. Rising rates still threaten fiscal reform.
Bill was very critical of the seemingly single-minded focus on monetary policy. Monetary policy hasn’t delivered, and more of the same won’t help. He offers three endgames:
- Endgame 1: global recession, policy and long rates stay low, debt deflation, more aggressive monetary policy and hyperinflation in some countries. Japan is very vulnerable in this scenario.
- End game 2: Rapid growth with an orderly exit from debt. Rates rise, inflation under control, debt-servicing problems diminish.
- End game 3: Rapid growth with a disorderly exit: long rates rise sharply, a rush to exit from all risk assets, capital outflows from emerging markets, inflation expectations rise sharply, debt service problems increase, inflation fears fueled by fiscal dominance.
In the Q&A session Bill and I talked about the nature of current economic thinking and why it is inadequate. Independently, we’re both beginning to look at a new way to understand markets called Complexity Economics. It has several sources, but the current center of gravity is the Santa Fe Institute in Santa Fe, NM. I may be “forced” to go spend some time in Santa Fe, burrowing into this new way to look at economics. It is significantly more complex, as you might imagine, than equilibrium models are; and it will therefore be even harder to create models that actually work, but it is certainly a place to start.
Among the recurring features of speculative episodes across history is the appearance of “new era” arguments to justify the elevated prices, coupled with arguments that historically reliable measures no longer apply. In our view, the problem is not that investors search for new, more reliable tools of market analysis – that should always be an objective. The problem is when investors adopt theories and models that embed the most optimistic assumptions possible, run contrary to historical evidence, or embed subtle peculiarities that actually drive the results (see, for example, the “novel valuation measures” section of The Diva is Already Singing). Eventually, the final refuge of speculation is to abandon historically reliable measures wholesale, resting faith instead on the advent of some new era in which the old rules simply don’t apply.
John Kenneth Galbraith noted this phenomenon decades ago in his book The Great Crash 1929: “It was still necessary to reassure those who required some tie, however tenuous, to reality. This process of reassurance eventually achieved the status of a profession. However, the time had come, as in all periods of speculation, when men sought not to be persuaded by the reality of things but to find excuses for escaping into the new world of fantasy.”
In late-1929, Business Week observed: “This is the longest period of practically uninterrupted rise in security prices in our history… The psychological illusion upon which it is based, though not essentially new, has been stronger and more widespread than has ever been the case in this country in the past. This illusion is summed up in the phrase ‘the new era.’ The phrase itself is not new. Every period of speculation rediscovers it… During every preceding period of stock speculation and subsequent collapse business conditions have been discussed in the same unrealistic fashion as in recent years. There has been the same widespread idea that in some miraculous way, endlessly elaborated but never actually defined, the fundamental conditions and requirements of progress and prosperity have changed, that old economic principles have been abrogated… that business profits are destined to grow faster and without limit, and that the expansion of credit can have no end.”
“This time” is not different. There’s no question that investors have come to believe that somehow quantitative easing has durably changed the world – that central banks have (or even can) put a floor under the markets as far as the eye can see. But if you examine the persistent and aggressive easing by the Fed during the 2000-2002 and 2007-2009 plunges, it’s clear that monetary easing has little effect once investor preferences shift toward risk aversion –which we infer from the behavior of observable market internals and credit spreads. Monetary easing only provokes yield-seeking speculation when low-interest money is viewed as an inferior asset.
It’s not monetary easing, but the attitude of investors toward risk that distinguishes an overvalued market that continues higher from an overvalued market that is vulnerable to vertical losses.