Alan Greenspan raised interest rates today. Did you notice?

Talk is cheap, right?

Not when the chairman of the Federal Reserve is talking.

If he's concerned then financial markets are concerned.

If markets are concerned, then you pay the price.


What did I say?

This morning, Alan Greenspan told congress:

"The federal budget is on an unsustainable path, in which large deficits result in rising interest rates."

So, "unless major deficit-reducing actions are taken" interest rates are more likely to go up than down.

Investors got nervous, thinking this might actually signal higher interest rates (since the person talking sets the target for the overnight interest rate). They sold bonds, pushing yields higher.

As I have discussed before the bond market is what essentially sets mortgage rates. If bond yields go up then your mortgage bill goes higher too.

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It's important to remember that for policymakers, words are just as important as actions. Anything they say can be taken to imply something they may do.

Markets are always thinking about the future.

If you think like the market thinks, you can avoid getting hurt by it every single day.

It's the stupid Economy!

It's very easy to criticize other people.

It's extremely easy to criticize economists.

These dismal scientists are given the thankless task by government to solve problems for which there are a number of different solutions, each with different costs associated with them.

Every solution will come with a cost.

No pain, no gain.

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Some economists including, Friedrich August von Hayek , believe that government is the problem.

This is a very convincing argument given the history of evidence stacked against government policies over the recent past.

It seems as if every time the government tries to fix a problem they create another, larger problem in the process.

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Of course, different views on any subject represent different parts of the political spectrum, so none will provide the kind of balanced judgement that might convince everyone.

In the current political system, it is only the majority of the voting public that needs to be convinced (every 4 years) in order to choose between (usually 2) competing (and often extreme) alternatives.

The dollar's drop cometh

Every day we move a step closer to a dramatic fall in the value of the U.S. dollar.

The pull of gravity is getting stronger by the day.

Until now this pull has been mitigated by a number of forces working in the opposite direction. Unfortunately they cannot hold out for much longer.

There are three major forces waiting to take hold (in increasing order of likelihood):

1. The effects of U.S. statements in favor of a weaker dollar.
2. Reduced dollar holdings by U.S. and international investors.
3. A continually growing U.S. trade deficit.

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A record trade deficit is a symptom of a problem that has no solution.

You won't hear the U.S. government say:

"To cut the trade deficit, we are going to..."

A weaker dollar is supposed to help reduce the U.S. trade deficit by making exports cheaper.

Unfortunately, this doesn't get to the cause of the problem: the U.S. imports more than it exports.

It's understandable why the U.S. imports so much.

I often think to myself, as I wonder through a one-dollar-shop, how this is what it felt like 50 years ago. I can buy clothes and groceries using dollar bills and still have change left for the bus ride home (which now costs 3 dollars...).

Of course every country in the world is under the spell of cheap Chinese imports.

However, only the U.S. represents 250 million consumers that use greenbacks to purchase all these goodies.

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One thing you do hear the U.S. government say is:

"China needs to revalue it's currency."

A stronger Chinese currency would of course make Chinese imports more expensive. However, the U.S won't say that this will help reduce the trade deficit.

A deficit is not caused or solved by the value of a currency.

If anything it's the other way around: a weaker currency is the result of a weaker economy that imports less.

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So, what can you do?

Well, the first thing is insure against a further (and no doubt faster) drop in the dollar.

If you hold dollars, move into something else. You have two realistic options: the Swiss Franc (commonly considered a safe haven) or the British Pound.

Of course, if you live in the U.S., you could stop buying Chinese imports or imports in general. If this doesn't appeal or seems downright impossible then you will understand why the dollar can only go in one direction and you should act accordingly.

Behind the Times

People who sit behind a Times on their way to work are stuck in the past and stuck in their ways.

This is not good for them. But they do it anyway. Why?

Human nature is consistent with people choosing not just an inferior product but one that also costs more than the better alternative.

Perhaps people are paying for the convenience. After all, time is more precious than money. This would explain why fast food has always remained popular despite being so unhealthy. (No coinicidence then that in England, fish and chips are traditionally wrapped in a newspaper, since both are bad for you in different ways!)

So consumers, while driven by their own self interest, do not always act in their best interest.

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Newspapers are moving to publish in electronic form only. Once that process is complete, it will be tomorrow's news, not yesterday's, that we are going to have to pay for, whether we want to or not.

Once people become more informed about the world around them the better that world will be.

I guess this was one cheer for the free market...!

How's the service? Terrible?

Service is bad at the best of times. Bad news: it's about to get much much worse. Why?

The internet.

The internet is migrating all of the services we once had to travel somewhere to use. You want to buy clothes? No need to ask you helpful sales assistant about their latest special offers. Just point and click.

But what becomes of the helpful sales assistant? Well, the first thing is, they become a whole lot less helpful. They get trained less and, worse, less motivated to compete with their dot.com colleague.

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While human sales assistants are a dying breed, it's the services industry that has been the main driver of economic growth for a large number of the major advanced economies in recent decades.

If a significant (and in recent years, growing) part of the workforce that lies behind a growing economy deteriorates on a mass scale then it signals a major deterioration in a large proportion of the labor force.

Ultimately, it will be the frustration of shoppers in department stores and people on line in Starbucks that will accelerate the complete migration of shoppers from the high street to the internet.

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As with all social change, a lot of the change can only be brought about by social forces moving in the direction of that change. The ever-more sloppy sales assistant may well be the last straw.

Or they could just stand up straight, look fast and pretend to be professional!

**Afterthought**

All of this clearly begs the question, what becomes of all these sales people? This also raises the issue of what to do with all space currently taken by retail outlets.

One possible scenario would be for these buildings to become residential. This would help provide homes where they are most needed: in the inner cities. This might help initiate a new industrial architectural revolution. Such a revolution would resuscitate the manufacturing industry, bringing full circle the changes seen in the 20th century.

Perhaps the hands that serve us in the stores will be those helping to build the homes of the future in the not-too-distant future.

Goodbye Greenspan, hello inflation target?

In June last year, I explained why the bond market was important.

I'm back to explain why again and also predict what will happen to U.S. interest rates after Alan Greenspan retires from the best job on earth.

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In case you hadn't already noticed it's daily movements in the bond market that actually determine the mortgage rates your bank offers you on a daily basis.

If you don't believe me, look at the chart below that shows the 10-year government bond yield (set by the bond market every day) against the 30-year mortgage rate (set by the banks every day).


(Red: 30-year mortgage rate. White: 10-year bond yield)

Most people might think it's the central bank who directly (or even indirectly) set mortgage rates, with retail banks following suit. This isn't how it works.

Firstly, central banks only change interest rates on a monthly basis, if at all. However, banks change the rates they offer to lenders all the time. You might wonder how they can do this if the central bank hasn't changed the "interest rate".

The reason is simple: banks settle their books at the end of every working day by borrowing money at a rate of interest that is being set by the bond market. The bond market sets the interest rate according to expectations of future inflation.

If inflation is expected to increase then interest rates will have to rise in order to compensate bondholders who will see the value of their investment fall in real terms.

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As I also mentioned before, the past 2 decades has seen a major crackdown on inflation. This has meant lower interest rates across many countries.

The U.S. is one of the few countries that does not directly target the inflation rate, simply because the person in charge of monetary policy does not want to use a target.

Since Alan Greenspan is expected to leave his post in the near future this raises the possibility that the Federal Reserve will adopt an inflation target as well. This will be very good news for the bond market and more importantly, great news for mortgage holders.

An inflation target means the bond market expects low inflation. Low inflation expectations means low bond market yields. Low bond market yields means low overnight interest rates and this means low mortgage rates.

3 cheers for Alan Greenspan. More cheers for the inflation target!

Tax rant cont.

Three things are certain: death, taxes and more taxes.

The closer you get to death the more in taxes you are going to pay.

As I outlined before, if your income doubles you are going to pay about double the amount of tax.

This is the society's definition of fair since taxes act to redistribute money from one group of society to another; i.e. from the rich to the poor.

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As I also outlined before, America has a major problem with saving. The government and the citizens it represents don't like doing it.

If an individual is short of savings they go to a bank to borrow money.

The government goes to the public, by way of taxation. The more money the government needs, the higher taxes go.

The problem facing the U.S. government is an increasing need to fund expenditure by way of taxation. This means taxes will need to rise further.

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A commonly heard argument is that people with higher incomes (let's call them 'companies') should be taxed more than those with lower incomes.

This is considered a fairer way to raise the extra money the government needs.

However, since it's companies that hire people on lower incomes, then taxing the rich indirectly taxes the poor.

A company that loses a higher share of it's income to the government will have less left over to hire more people.

You can only go to the well so many times before it eventually runs dry.

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The economy runs in a circle: companies make things, people work for companies, people spend money on things companies make.

If one part of this cycle is taxed more than another then it takes away from all other parts as well.

If the government needs to raise more money by increasing taxes it does not benefit any part of society by focusing those increases on certain groups.

**Afterthought**

In light of the comments to this blog, perhpas this is the best 3D representation of how wealth is distributed amongst various groupings of the economy..

The trouble with jdate

These days one Jew isn't expected to marry another.

This is a freedom of choice past generations never had.

However, like most freedoms it isn't one most people today have had to earn. It's the result of years of struggle between parents and children at a time of social change.

Consequently, when one Jew enters into a relationship with another it carries with it a sense of being something special.

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JDate gives Jews the 'freedom' to choose from thousands of available people who share the same religion.

It makes it easier for Jewish people to enter into a relationship with one other.

The fact that both people are Jewish can even help sustain the relationship; it can start to feel like eating chocolate without gaining the pounds.

However, this heightened sense attraction to each another can turn out to be illusory:

"What did I ever see in him?"
"He was Jewish?"
"Oh, yeah."

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Meeting the right person doesn't always have to be an impossible task. But by making it easier to start a relationship with someone on the basis that they share the same religion is a very sandy beach on which to build the family home.

Too often the relationship will escalate too quickly and then everything comes tumbling down.

Dollar may keep falling, reality says

Two facts explain why the dollar will keep falling for another generation at least.

Americans don't like saving. Japanese like saving.

This is cultural. This won't change.

If anything, this cultural gap will widen over the next 50 years as the Japanese population ages terribly and becomes even more thrifty.

But what does American indulgence have to do with the dollar?

A currency is like a reality check. It's one of the few things the government can't influence directly (unless they do something to influnce it directly).

Every time Americans swipe their credit cards at the cashier they're chipping away at their nation's credibility with overseas investors.

The only way to make up the monthly payments is to attract foreign money and this attraction rises when the dollar becomes cheaper.

And so the market bids down the dollar, every day.

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The dollar should only weaken as a last resort. After all, it's the currency most people use around the world to facilitate transactions and a weaker dollar is reducing the incomes of people around the world.

This is bad for the world, by the way.

There is no feasible solution to the problem other than to impose upon Americans the idea that by spending more than they earn will hurt them, their friends, family and future generations.

The odd frown shown upon those who spend too much would be a cracking start...

You've seen one bubble...

Two months ago I predicted that oil prices would eventually drop. It turns out I was right... for the wrong reason.

I thought that a recession in the U.S. economy would be the cause of slowing demand and falling oil prices.

It turns out that a speculative rise in prices was cut short by speculation that prices wouldn't rise any more.

Another bubble bites the dust.

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Everyone touts the benefits of a free market without truly understanding the consequences of what they endorse.

They emphasise the positives without weighing them with all the possible negatives.

Quite often negatives are not actually seen as negatives.

Bubbles in stock prices, home prices or any prices are seen as a way of letting the market breathe.

Until greed is permanently eliminated from the English language, too much freedom will always be a very dangerous thing.

Why Kerry won't win

Polls are quite useless, but they're not completely useless.

The most useful message they provide is one of voter apathy.

In large, this isn't apathy towards George W. Bush, but towards John Kerry.

After all, Kerry is the one who has the mountain to climb. He's the one trying to dislodge the incumbent.

If there were even the slightest indication that Kerry were about to become the next U.S. president, you would expect the polls to have caught some whiff of it. They haven't.

What the polls are telling us is that a lot of people do not see John Kerry as someone for whom it's worth taking an hour out of their working day to go and vote. (Note: why does this election have to fall on a Tuesday? When an election is this close it makes sense for the largest number of potential voters to have the chance to go and cast their vote.)

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Politicians thrive on momentum.

John Kerry needs more time to build enough momentum to win.

For John Kerry time is running out.

Only a miracle can save him now...

Oil & the bigger picture

In case you were wondering, oil prices will stop rising... eventually.

Now more than ever it's looking like only one thing can stop this uncontrollable rally.

A recession in the U.S. economy.

While this is not likely to happen soon, it will become an ever-growing reality by early 2005.

A global economic slowdown has been in the works since the start of 2004.

Rising oil prices will likely be the last straw.

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The idea of a confluence of factors giving rise to the recent surge in oil prices is a very worryng predicament.

You would think the world has managed to figure out how to prevent oil prices from rising too rapidly.

It hasn't.

It seems we're just as vulnerable now as we were 10 or even 30 years ago.

Good intentions

When religious leaders speak passionately about something their very show of emotion is sometimes enough to prompt a reaction by those listening.

The Rabbi's Yom Kippur sermon got me thinking.

He got me considering doing things I hadn't thought of doing before; such as attending a protest march in the street.

What I realized is that he got me thinking of doing things I neither wanted to do nor had ever thought of doing before.

This concerned me.

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While someone living a comfortable life has no strong incentive to correct the inequalites of the world, someone who is far less well off is very easy to convince of the need to take some form of 'action'.

What shape and form this action might take is left up to listeners.

Sitting in a New York church, I wasn't amongst a crowd of people likely to engage in any form of violence protest.

However, if transplanted into the Middle East or any other place where violence and poverty are far more widespread, I might expect a different response.

In a region where religion and religious beliefs are enbedded in everyday life, religious leaders have far more reponsibility.

This means they need a game-plan. If they don't then their good intentions could result in an even more violent world.

Addicted to debt

Everybody has something they are prone to liking too much for their own good.

For the government, debt falls very neatly into this category. Given the opportunity they just can't get enough of it.

For people in power only a short period of time, going deeper into debt is a win-win situation. The more they spend, the more popular they get, at the expense of people they aren't accountable to.

But all is not lost, right? The U.S. economy will grow faster, making the government finances healthier?

Wrong. For two big reasons: the war on terror and baby boombers.

These are two problems that can't be fixed and have huge costs associated with them.

Add to that modest economic growth not capable of generating the types of tax revenues enjoyed in past upturns and you get a very nasty surprise ahead.

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At the moment we are enjoying low interest rates, mainly because of low inflation. However, this has only made it easier for the government to get it's fix of debt without anyone noticing.

Until now.

Record government deficits have made headline news but they're still not that interesting to most people. That's mainly because it doesn't affect the majority of us.

This is going to change, fast.

The first thing we are going to notice is that the government's huge borrowing requirment isn't going to go away as quickly as it did in the past.

Then we are going to notice higher taxes and this is going to make things a lot worse.

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You know things have gotten really bad when the government starts raising taxes. It's something they are loath to do and usually end up regretting (i.e. they get the boot, first chance people get).

This is going to happen in the very near future. When it does people are going to blame the government and they should. Only thing is, it's not the present leaders they should pin the blame on but those from the past.

** Afterthought **

An absurd moment at today's testimony by Fed Chairman Alan Greenspan to the U.S. Senate had certain politicians lauding "His Excellency" for bringing with him the solutions to all the future debt problems: Pay as You Go.

This scheme, whereby the working population funds the retirement costs for the present elderly, is a very leaky boat.

The debate is a debate and not a problem with a unique solution. There are a number of solutions to the problem.

The first unambiguously positive step is to get people more active and eduacated about investing. Once people understand that they are responsible for their future wealth they can go ahead and ensure they have enough of it.

Rising oil prices give central bankers a lift

While many of us look on in despair at the rising price of oil, Alan Greenspan and his friends are enjoying every minute.

Why?

Because rising oil prices are doing the job most central banks need to do but resent doing: raise interest rates and damp rising demand.

The dilemma for most central banks is how to achieve price stability while not jeopardizing economic growth. This is not an easy task and more often than not entails sacrificing one for the other, making central banks very unpopular when the situation gets nasty.

In the past year central banks around the world have been on tightening mode. Global economic growth was getting to the point where it might generate more inflation than necessary. Things needed to be kept under control. So central banks, armed with their interest rates, starting raising.

Higher interest rates always make central banks unpopular. After all, most people need to borrow money to buy a home, a car or whatever. Savers always look to alternative means of outperforming the saving rates a bank offers, so they aren't going to complain too much either way so long as the stock market is given a chance to provide them with a decent return.

The issue for central banks is how to keep everyone happy. How to make everyone better off.

The rising price of oil is a convenient scapegoat for everyone and this includes the central banks.

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It's important to remember that rising oil prices are not the same as rising inflation.

Accelerating inflation usually happens when the economy is growing out of control, not when oil prices rise (the 1970's was an exception to this rule).

Global inflation picked up in the past year, making central banks nervous.

Rising oil prices have come just at the right time. Why?

Higher oil prices will help cool demand and keep the economy from generating too much inflation.

It's easy to forget that a large part of the reason why oil prices have risen this far is because of increased demand from China, not to mention the summer driving season in the U.S.

Higher fuel costs will act to correct the pickup in demand, without causing central banks to break a sweat.

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We don't live in the 1970's anymore.

We are't experiencing the type of oil price shock that will tip the global economy into recession.

What we are seeing, however, is a convenient way for central banks to get out of doing their least favorite job: raising interest rates.

Investing 301

Investors are getting smarter.

They're still pretty stupid, but they're getting smarter nonetheless.

There used to be a time when investors would lose money when stock prices fell. That doesn't always happen now.

Some investors still complain about the low value of the stock market.

That's because their methods of investing haven't changed in decades. They need to catch up or forever lack the wealth they need to survive into old age.

Some people never get the chance to learn about how to invest and that's a shame. It's a shame because they will live their lives without job security and a sufficiently large pension.

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Investing isn't just about the stock market.

Investing is about stocks, bonds and currencies (in ascending order of importance). When you invest in the stock market you need to be aware of what's happening in the other two since all three interact with each other on a daily basis.

Investing is about the future and being able to correctly predict where all of these prices are going to go.

The majority of investors hope prices will move in one direction, and that's up.

Unfortuntaely for them, prices also go down.

The way around this is to trade derivatives.

The derivatives market started in the 1970's, became big in the 1980's, got even bigger in the 1990's and keeps getting bigger. So what's it all about?

Essentially, trading in derivatives allows you to benefit when prices rise or fall.

Not everyone expects prices to move in the same direction.

If you expect the price of apples to fall you would want to agree to sell apples to someone at a certain point in the future at today's price. If that person expects the price of apples to remain the same as today or to go higher then they will happily enter this agreement with you.

Of course you don't need to trade with someone else directly. You can sit at home at trade on the web.

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Investors today understand the importance of reading the financial press to understand when is the right time to buy and sell stocks.

If they broadened their knowledge of how the financial markets work they can avoid getting burned when stock prices (inevitably) fall.

One way to be wise of events on the horizon is to monitor leading indicators! But that lesson is for another day...

The writing on the wall

People write a lot of things on the walls of a public lavatory. Some consider this to be vandalism. To me it's occasionally a source of inspiration.

This morning, while in a sedentary position at our office's facilities, I came across the following message:

Think about the future

I'm not sure what the person was thinking when they wrote it, but it got me thinking about a lot of things.

Firstly, how often we think about our future really depends on our age.

If you're in your 20's you probably don't think too much about your future; you're too busy spending money to worry about not having enough of it once you get older.

If you're in your 30's you're probably thinking about nothing but your future; who you're going to be with and how much money you're going to need.

Once you're in your 40's what you do tomorrow is as important as what you're doing today.

In your 50's the future is now.

In your 60's the past has caught up with you.

Above 70 and you're enjoying the moment like you were 21 again.

You're probably going to live a very long life; at least until you're 70, hopefully longer.

You don't know exactly when you're going to die and that's a problem.

It's a problem because you don't know how much you're going to need to see you through. Given this dilemma people tend to overcompensate and put a 'little extra' away. How much extra is determined a great deal by your culture.

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After reading the message on the wall I also though about how much we should be thinking about the future.

Should we always be thinking about the future? Probably not.

Should we never think about the future? Not unless you're over 70.

What if we don't think about the future enough? What then?

I know I don't think about the future as much as I should. But how do I know that? When is it enough?

I fear that it will never be enough. It's hard enough to manage my life right now, let alone my future as well.

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My future is becoming increasingly important as each day passes and so the less I think about the future each day the more costly it's becoming.

I should probably do something about it. Maybe tomorrow...

Tax rant

A quick back of the envelope calculation:

-- A single person earning $110,000 loses about $27,000 to taxes.
-- A single person earning $52,000 loses about $10,000 to taxes.

-- A couple earning a combined $185,000 lose about $47,000 to taxes.
-- A couple earning a combined $130,000 lose about $30,000 to taxes.

-- Anyone earning above $288,350 loses 38.6% of each dollar to taxes.

Do these numbers make sense? Do you see a problem here?

John Kerry does. Why?

The thrust of his argument goes something like this:

"The U.S. economy is being undermined by a rising budget deficit, the prospect of ballooning interest rates, unfairly high taxes on the poor and unfairly low taxes on the rich."

His solution: tax the rich more and tax the poor less. Put the proceeds into public healthcare and education. There will be plenty to go around. Share the wealth!

Firstly, why is the budget deficit rising? Didn't Clinton sign a balanced budget not long ago?

The point here is that in 2001 the economy went into a tailspin for the first time since Clinton was in power. The stock market lost a lot of ground and the 9/11 terrorist attack left investors gob-smacked. Is it any wonder why the fundamentals of the U.S. economy are so out of sync?

What is easy to forget is that when an economy is performing badly the government is the first to suffer. The less people earn, the less they spend and the less the government receives in tax revenues. The upshot is a rising budget deficit. The government is borrowing to cover it's spending commitments; commitments made when the economy was doing a lot better than it is now.

The irony of all this is that the economy is being run by people who remain in office for a short period of time. This is usually part of the problem, not the solution. What we have now is a situation where things look bad and will probably get better. They will get better irrespective of who is in power. Anyone who thinks otherwise is kidding themselves.

The only lasting difference those in power can make is in the distribution of income. Some might say this is government getting in the way. Others might say it's the government righting wrongs. The truth of the matter is, as always, somewhere in between.

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What is crucial is that government not intefere excessively.

What I see when I look at the calculations above is a situation where a moderate redistribution of wealth is taking place already.

Financial market truisms

On average, the following are true (corrolory in italics):

Stock prices move up and down for all the wrong reasons.
You can't anticipate the reason why a stock price will move next.

With currencies, all you know is what just happened.
You can't predict the direction in which a currency will move next.

Bonds and stocks are being traded by the same dumb people.
All traders are not as smart as they should be.

Tomorrow's news is today's news.
Don't trade on news you read in the printed press.

Taking risk is inevitable.
Don't expect to see your initial investment again.

Time is the hardest thing to buy.
Use all of the time you have to your advantage.

The only information that matters is private.
Don't trade on something you read about in the public domain.

Always confirm what your instincts tell you, never trust them.
Think, then act!

Read all the news, even the made-up stuff.
Be aware of what everyone else knows.

Don't do the same thing you did yesterday.
Avoid making systematic errors.

Vote for Blog!!

I'm going to try and make this point as concisely as I can. It's a point I think needs to be made and it's a point that might seem obvious once it's been made.

My point is this: we no longer need a single political leader to run our country. In fact, we no longer need politicians. We can govern ourselves. How?

We will be (self-)run by Bloggers. The collection of thoughts and writings of people around the world will help shape the society in which we live.

Blogs will be organized into specialized communities. Each community will comprise individuals who specialize in a particular field. They will decide and vote on laws. The debate and the final vote will rest on each seperate individual, not on individuals who represent the interests of others.

What I'm trying to say is this: it's become easier for us to go online and be involved in a debate that we will finally vote on than have someone do it for us. This gives us a far greater incentive to get involved in the debate than to just sit on the sidelines and let others decide for us. Apathy is not an option.

Doctors, teachers, police will all be organized by experts in their field. Changes to the way they are run can be debated and decided upon by an all-inclusive discussion and final vote.

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There needn't be a reluctant choice for President, Prime Minister or Mayor. They are someone who we don't entirely trust.

We are capable of running our own society, determining our own future. This is something that most people are willing to work towards.

Change is now really possible.