The Daily Reckoning December 5th


A Relic of a Misguided Age

The economy is not the stock market.

“Repeat this over and over,” suggests Chris Mayer by way of helping you get through this episode of The 5: “The economy is not the stock market. The economy is not the stock market. The economy is not the stock market.”


OK, feeling calm and centered?

Here we go…

 “Jeremy Grantham is a highly regarded investor,” Mayer begins. “His accurate forecast of returns for various asset classes in the first decade of the 21st century cemented his fame, and today his firm manages billions of dollars of investor money.

“Maybe that’s why so many people turn off their brains when they read what he writes…”


Barron’s, BusinessWeek and Forbes all stand in awe of Grantham’s quarterly letter this month, titled “On the Road to Zero Growth.”

“The bottom line for U.S. real growth, according to our forecast,” Grantham writes, “is 0.9% a year through 2030, decreasing to 0.4% from 2030-2050.”

At the root of Grantham’s forecast is the inscrutable notion of “gross domestic product” (GDP), one we take great latitude in abusing in The Demise of the Dollar. At best, GDP is a mathematical formula:

At worst, it fosters the illusion that economists practice a science.

“The concept of GDP is so deeply flawed,” Mr. Mayer helps us get to today’s point, “that it should be discarded entirely as a relic from a misguided age.

“Consider this example from Bill Bonner: If you mow your own lawn and your neighbor mows his own lawn, there is no addition to GDP. But if you hire your neighbor to mow his lawn and he hires you to mow his lawn, GDP rises!

“Gross domestic product also includes government spending as a positive. So if the government spends lots of money, GDP goes up. The government could hire lots of people to dig holes and refill them again. Well, GDP would go up and economists would cheer.

“The fundamental problem with GDP is that it is an abstraction. It doesn’t mean anything. You can’t eat GDP. You can’t wear it. You can’t spend it. It doesn’t change your life or your job. A rising GDP doesn’t mean you get any wealthier. It’s just a number that economists can play with.”


Fact is, “Grantham doesn’t know what’s going to happen next year,” Mayer shirks. “Forget about 2030. He’s guessing, like the rest of us. I love the false precision of 0.9% and 0.4%.”


“Even if GDP were an accurate measure of something meaningful,” says Mayer getting to today’s pedantic assertion, “should we use it to decide how and when to invest?

“Buffett once pointed out that during the years 1964-1982, the stock market went nowhere, even though GDP quintupled. But from 1982-1998, the stock market went up twentyfold, while GDP barely tripled. There are lots of reasons to explain market moves. GDP isn’t one of them.

[Say it again: "The economy is not the stock market."]

“For me, growth is what it is,” Chris concludes. “Some parts of the economy will grow. Some parts will shrink. I ignore GDP forecasts — and all such forecasts. Instead, I focus on learning more about the details of the opportunities at hand.”

Chris is fond of citing John Train, the octogenarian investment adviser and author: “You should not worry about the economy or the direction of the market. Instead, buy a share of a company the way you would buy a house, because you know all about it…”

A Relic of a Misguided Age appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

The Everyday Absurdities of the TSA

‘Tis the season to be jolly. But then there’s the TSA. No government agency inspires “Bah Humbug” like the Transportation Safety Administration. For those who travel, the agency is 65,000 employees dressed in blue to make airline travel as annoying as possible.

Last week the House Aviation Subcommittee held a hearing to discuss common sense improvements for the agency in charge of transportation security but TSA boss John Pistole thinks he has it all figured out and refused to testify. The committee has no jurisdiction over his kingdom, so why show up? Pistole didn’t even send one of his minions to be grilled. This is the third time he’s snubbed the committee.
Christopher Elliott reported on the hearing for The Huntington Post,

One by one, panelists took turns excoriating the agency charged with protecting America’s transportation systems. It was plainly clear why Pistole was a no-show, and it had nothing to do with jurisdiction; it would have been an openly hostile crowd.

Charles Edwards, the Department of Homeland Security’s acting inspector general, described the TSA as bureaucratic and dysfunctional. Stephen Lord of the Government Accountability Office, suggested the agency was ignoring the thousands of complaints from air travelers. And Kenneth Dunlap, who represented the International Air Transport Association, criticized the current TSA as expensive, inconsistent and reactive.

The TSA screening area is a logic-free zone as my wife and I were reminded over the Thanksgiving holiday. Grandmothers never like to arrive empty-handed when they visit grandbabies. A wooden flintlock toy cap pistol for a little boy in New Jersey was tucked away in our carry-on luggage. The gun was not detected by the x-ray, but two bottles of hair product spurred the TSA agent to action.

His pawing through the luggage quickly uncovered the wooden flintlock and he gingerly pulled the toy out of from under some clothes. He nervously said he didn’t know what to do and needed a supervisor’s opinion.

We waited for a supervisor while the clocked ticked closer to our departure time. A young woman finally appeared. She asked what the toy was. “What’s it look like?” asked the exasperated grandmother. “I don’t know what it is,” the supervisor shot back, “and I won’t touch it until you tell me.”

“It’s a piece of wood carved in the shape of gun.” The young supervisor picked up the toy carefully and said she needed to consult her bosses. In the distance, I watched her hand the toy over to a group of TSA higher ups hanging around the central command post located behind the inspection lines.

Eventually the offending item was passed up to what looked to be a metro cop, who looked it over and passed it back with no conversation. The gathering of supervisors then inspected the wooden pistol again. Finally, without thought, one of them threw it (our property) in the trash.

While this pow-wow was taking place, a discussion ensued about us solving this problem by returning to the airline counter and checking the bag. The TSA screener supported that idea until the supervisor returned, with another supervisor in tow. “The gun can’t be taken on an airplane.”

We again make the mistake of believing that logic and reason are of some use with the TSA and calmly pointed out that the toy was not a gun. The supervisor countered that it was a replica of a weapon and TSA rules don’t allow replicas to be carried on planes. “OK, return our replica and we’ll go back and check our bag.”


The supervisor thought quickly, knowing they had already thrown the toy away. “You can’t store a replica of a weapon in luggage unless it’s in a hard case that’s locked.”

At this point my fellow traveler, who makes her living arguing in court, threw up her hands. “You deal with these people,” she fumed. “I can’t do it anymore.”

The supervisors then tried to convince me that they were really giving us a break. They should be writing us up for this offense and that we could be fined. I told them I didn’t want to hear their nonsense, finally sticking my forefingers in my ears and chanting “lalalalala.”

“Can I please just have my bag,” I pleaded with an eye on the ticking clock. “No, this bag hasn’t been cleared,” the screener said. Back through the x-ray it went. Again another problem, this time it was plastic curlers.

Finally, after eyeballing the curlers the screener and supervisor together determined the beauty aids passed muster.

“Thanks, I feel so much safer,” the aggravated grandmother told the supervisor as we finally left for our flight. Being trained or medicated not to react, the supervisor calmly replied, “have a nice day.”

Sadly this story isn’t unusual and pales in comparison to stories of molestation and theft by TSA employees. It was just an average day with the TSA.

“As this mushrooming agency has spun out of control,” chairman, John Mica, concluded last week, “passengers have not been well served.” He went on to say that the agency should be closed down or at least closed down as we know it.

If the political class were forced to fly commercial one wonders whether the TSA would exist at all. As it is, while every flyer complains and congress is well aware of the problem, the TSA’s head man is not accountable to anyone. All the while, on the ground, unionized TSA employees make up rules as they go along to suit their own purposes.

“TSA has become the butt of countless jokes,” Charlie Leocha, director of the Consumer Travel Alliance told the subcommittee. “TSA is set up like the Maginot Line, the poster child for generals fighting the last war.”

It’s no joke when government employees callously throw passengers’ property away. This is how all of government works. While most people don’t deal with government day-to-day, we get to enjoy the TSA up close and personal. For those who believe government has a role to play, remember the TSA is as effective, efficient and careful as any other government agency.

They are indeed fighting the last war. Safety isn’t the issue. The war is on us.

Douglas French

Original article posted on Laissez-Faire Today 

The Everyday Absurdities of the TSA appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Capitalist Dystopia

When investors are fearful, they look to hedge their portfolios by buying “insurance” that will protect them if the market falls.

Right now, fear is super high, says Christopher Cole at Artemis. This past September, he says it cost more than ever to hedge against a collapse — even more than in 2008, when everyone was scared the whole system was going to blow. “Ironically,” Cole writes, “markets are at their very best when everyone is scared out of their minds.”

He goes on:

The worst crashes usually occur when investors are not prepared or excessively leveraged. Very rarely are you ambushed when you are totally ready for it. Widespread hedging provides an unseen floor to equity prices. In a hedged market, the majority of investors 1) are not forced to sell in a decline or 2) have the ability to buy on the dip.

Which is to say, as Cole does, “Fear is a better reason than fundamentals to own stocks right now.” Stocks look expensive, he concedes. By his lights, it hardly matters.

What? Stocks are expensive but buy them anyway?

Cole trades volatility for a living, and I saw him make a presentation at Grant’s Fall Investment Conference. I also dug out his recent paper “Volatility of an Impossible Object: Risk, Fear and Safety in Games of Perception.” What follows are some thoughts on what he calls our “capitalist dystopia.”

If volatility seems rather far removed from the grubby world of flesh and blood and companies, I agree. I am too steeped in the Marty Whitman tradition to buy stocks because the market is “fearful.” (Whitman is the founder of the Third Avenue Value Fund and a longtime investment thinker par excellence. “Our interest is how the businesses in which we will invest will perform over the long term,” Whitman once wrote, “rather than what investor-speculator sentiment might be short term.”)

Still, Cole makes some well-known points in a memorable way.

For example, we know the Federal Reserve’s manipulation of asset prices severely hampers our perceptions of market realities. Cole finds a neat metaphor for this. He likens the market to an impossible object — these are 2-D figures that cannot exist in three dimensions. “Famous examples include the Necker cube, the Penrose triangle, the devil’s tuning fork and the artwork of M.C. Escher,” he writes. My favorite is the Penrose staircase (see nearby illustration).

As Cole notes, the fundamental characteristic behind the impossible object is an uncertainty of perception. Can you go up the staircase or down? Cole believes the impossible object is important in understanding the distortions of markets.

We live in a world that is nominally capitalistic. There are profits and losses. There are businesses and stock markets. There are interest rates and prices for commodities like oil and gold. We have the glitter and tinsel of capitalism. But do we have the real thing?

Real market prices reflect a process of price discovery. Buyers and sellers freely do their thing, and the results of their actions are the trails of prices those transactions leave behind. The signals these prices give off are what we rely on to plan and invest.


Cole believes that in today’s modern financial system, this process is arrested to a degree that makes the whole thing a fiction or illusion. “In a world where global central banks manipulate the cost of risk,” he writes in his third-quarter letter to investors, “the mechanics of price discovery have disengaged from reality.”

Consider the Federal Reserve’s recent announcement for so-called QE3. The Fed will buy mortgages in the form of unlimited $40 billion monthly purchases. It will also continue to keep interest rates low through “at least mid-2015.”

These monetary experiments create all kinds of problems. Superlow interest rates create big funding gaps in pension plans, for example, which could lead to social unrest as those pensions can’t make good on their promises.

Superlow interest rates also lead to the creation of a lot more debt on an already leveraged financial system, with little bang for the buck. Cole points out each $1 added in debt leads to ever smaller increments of economic growth. What the Fed is doing, essentially, is piling up lots of risks in the system to pump up stock prices in the short term. As Cole writes:

It is very hard to justify the risk-to-reward payoff of this monetary experiment. The defense of quantitative easing rests largely on an assessment of what would have happened to the economy absent its support. Nonetheless, we should fear the law of unintended consequences, because it takes a very small shift in perception to result in uncontrollable socioeconomic change. We may get higher asset prices today, but at the expense of inflation, class warfare, social unrest or something even worse tomorrow.

Cole points out that if the Federal Reserve follows through on its promise to buy mortgages to the tune of $40 billion per month, it will own the entire market in a decade. The Federal Reserve is already the largest holder of U.S. Treasury debt. Keep in mind the Federal Reserve is hardly an economic agent in the sense of normal buyers and sellers. It has its own agenda and an unlimited playbook. It is, in short, the illusionist.

Cole goes pretty far with this. In fact, he says, “The market is no longer an expression of the economy… it is the economy.” In other words, central bank strategy is trying to supplant the needs and wants of the market economy with its own ugly designs. It is as if the economy were a horse that pulled a cart. But the Fed wants to use the cart to pull the horse. Cole writes:

Our fiscal well-being is now prisoner to financial and monetary engineering of our own design. Central banking strategy does not hide this fact with the goal of creating the optional illusion of economic prosperity through artificially higher asset prices to stimulate the real economy. In doing so, they are exposing us all to hyperreality or what Baudrillard called “the desert of real.” In Fed speak, this is what Bernanke calls the “wealth effect,” and during his Sept. 13 press conference he explained the concept: “If people feel that their financial situation is better because their 401(k) looks better or for whatever reason… they are more willing to go out and spend, and that’s going to provide demand that firms need in order to be willing to hire and to invest.”

Jean Baudrillard was a French philosopher who wrote Simulacra and Simulation. This was the inspiration for the movie The Matrix. In the movie, people live ignorantly in a projected image that they believe is reality. In the same way, Cole argues, there is no real economy anymore — just false images.

I don’t go as far as this. There is still a real economy. And it is more powerful, in the long run, than the Federal Reserve or any government. Ultimately, the fundamentals — profits, losses, balance sheets, competitive positions — matter. They matter more than sentiment or Fed maneuvering. When this real economy asserts itself, we have one of our periodic crises.

Bottom line: We must be careful when we weigh “market” prices. We have to think more creatively about what is real and what is smoke and mirrors.

Don’t believe the Fed’s goosing of the market is the real thing. Don’t fall for credit-induced prosperity. More so than in the past, market prices can go up and down for reasons having nothing to do with the fundamentals. Yet in the long run, the fundamentals are the only thing that’s real.

Chris Mayer

Original article posted on Daily Resource Hunter 

Capitalist Dystopia appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

avatarThe Daily Reckoning - The Daily Reckoning posted Wednesday, December 5th, 2012.

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