German Presidential Election

Christian Wulff failed to win an outright majority in the first vote, despite the Merkel governing coalition having the votes. Wulff had 600 votes to the SPD candidate Gauck's 499 votes, the Left party's Jochimsen had 126 votes, and NPD candidate Rennicke had 3 votes.

Now there will be a second vote, and possible a third.
German Presidency Vote Goes to Second Round in Berlin Today
Wulff verpasst absolute Mehrheit im ersten Durchgang

Update: Wulff has failed to win in the second round. This will be only the third time an election has gone to the third ballot, 1969 and 1994 the previous two instances.

Wulff's vote total increased to 615, 8 votes shy of an absolute majority. The SPD candidate Gauck fell 9 votes to 490. A combination of SPD with Left Party results in a total of 613.

Note that these votes are secret ballot, we don't know who is defecting from the governing coalition, which has 644 votes total, enough for an absolute majority if they vote together. Now, in this third and final ballot, an absolute majority is not necessary to win.

Update: The Left party candidate Jochimsen has dropped out before the third round of voting.

Update: Wulff wins with 625 votes, enough for an absolute majority had he received the votes in the first or second round.

Merkel has been sent a message, loud and clear.


You call this inflation?

I enjoy reading and watching Marc Faber, but is Ben Bernanke really a money printer? Tha above chart is from the Federal Reserve's budget report for money printing. The face value and number of notes is up, but the government is also introducing new notes, which explains some of the uptick. Still, even if all $100 billion in new face value currency was added to the money supply, how does that stack against trillions in credit losses yet to be taken?
As part of the annual print order process, we forecast five years of currency demand and allocate, as evenly as possible, the number and denomination of notes that we expect to order over that period. As a result, the print order for fiscal year 2010 includes predominantly $1, $20, and $100 notes and relatively small amounts of $5 and $10 notes. We currently anticipate that the fiscal year 2011 print order will include all denominations except $2 notes. We estimate that in calendar years 2010 and 2011 orders of approximately 4.0 billion Series 2004 $100 notes will be required to meet demand after the note is issued. Although the final release date for the Series 2004 $100 note remains uncertain, for budget-planning purposes, we assumed that the Federal Reserve will begin to issue the notes in late 2010. The BEP continues to conduct production tests on the Series 2004 $100 note. When this testing is complete, we will have a more-precise timeline for production and issuance.
Below is the currency component of M1 , which shows some growth, but it's not as large as the growth M1 itself. Plus, even if there's more cash, it's not circulating, as the velocity of M1 shows below.

Let A Thousand Nations Bloom

Separatism and secession are popular during declining social mood. I remember finding humor in reading "Manitoba, USA?" in the New York Post one morning long ago (unfortunately not online, but from what I found it was an April 14, 1990 article), but the Quebecois have not stirred for independence of late and the attraction of lower taxes in the U.S. is probably fading for the oil rich western provinces.

There's still ideas of political devolution afoot in North America though. Arnold Kling often writes of the need for competitive government, and here's his post at his blog in light of "Secession Week"at Let A Thousand Nations Bloom:
Unbundling Government
I can appreciate that technocratic management of the water system in my area is a good thing. Overall, though, the government implementation of this technocratic solution comes bundled with teachers' union featherbedding and pensions, land use regulations that impose heavy costs and foster a lucrative market in political favor-trading, and exorbitantly expensive construction projects for buildings and roads.

What I would like to see is unbundling of government services. Those that could easily be provided privately would be separated from those that are most difficult to provide privately. If private water provision would be difficult to implement, fine. Private provision of schooling would not be so difficult to implement. By unbundling, we could move incrementally toward more competitive government.

Many people resent the way that cable TV companies bundle their packages of services. I have that same resentment over government bundling.
I generally favor this approach because it is pragmatic and can be done step-by-step, but the U.S. does not have an autocratic one-party system such as China or Singapore. Therefore, someplace will try a lot of reforms and the rest of the country will pick and choose based on the outcome.

What I'm amazed of is how many regular people are talking about the need to cut school budgets, cut government pensions, etc., people who would never have even considered it 5 years ago, people who hardly ever discuss politics. Everything will be up for grabs in the coming years. There's going to be some place that has a critical mass of voter discontent and reform minded politicians who will implement a radical change.

Finally, while secession and the more "radical" plans for scaling back government are on the drawing board or in the minds of prospective reformers, there are some other mentions of it in the news.

Sudan discusses secession of South
A 2005 peace deal between southern-based SPLM rebels and Khartoum ended a 21-year conflict in which as many as 2 million people were killed. The agreement granted Southern Sudan semi- autonomy leading up to a 2011 referendum on full independence.

Under the peace accord, the two sides split the revenue from oil produced in the south, which produces most of Sudan’s oil. The export route available for southern oil is a pipeline running north and ending in Port Sudan on the Red Sea.

The revenue sharing will be one of the issues negotiated, Amum said.

“Is this going to continue? Is it going to change? It may likely change,” he said. “Is Southern Sudan going to pay fees for the use of the pipeline that is going through the north? These are issues that we will be discussing.”

According to the June 23 agreement seen by Bloomberg, the two sides will also discuss issues of currency, national debt, water, international treaties, security, and citizenship.
Secession need not be violent, although it remains to be seen what happens in Sudan.

Here's some power devolution talk from the U.S.:
GOP's Emmer: 'The State Certainly Does Have The Right' To Overturn Federal Laws (No, They Don't)
Minnesota state Rep. Tom Emmer, the presumptive Republican nominee for governor, has further expounded on his theories of nullification, declaring that states have the power under the Constitution to undo federal legislation.

There's one problem that Emmer and other nullifiers -- or to use a modern term from the blogosphere, "Tenthers," after the Tenth Amendment -- would face: State nullification of federal laws has consistently been found to be unconstitutional throughout this country's history.
I'm not sure if "Tenthers" is a self-appellation by right-wingers or a derogatory term by left-wingers, but "localism" is popular with the left. Localism has typically been more of a cultural phenomenon during the 2000s (farmers markets, buy local, etc.), but it becomes political when a big box retailer such as Wal-Mart wants to open a store.

In general, there's a trend towards local control. The right wants political control, the left is talking about economic control.

And finally, here's one that is socionomic without even knowing it:
Leach: As American citizens, civility is our responsibility
Citizens have lost confidence in many institutions of society, particularly government, and are becoming more disrespectful of their leaders, other faith systems, and each other.

Public figures have been spat upon and subjected to homophobic slurs. Others have been labeled "fascist" or "communist," sometimes at the same time. And more bizarrely, hints of history-blind radicalism - notions of "secession" and "nullification" - are creeping into the public dialogue.

One might ask what problem is there with a bit of hyperbole. Plenty.
Unfortunately for former Congressman Leach, civility is still a few years off and the incivility will ratchet up a few notches before all is said and done.

Back to Kling, he has a lot of interesting articles and books for those interested. His book "Crisis of Abundance: Rethinking How We Pay for Health Care" is a great overview of the problems in healthcare, along with possible solutions. I haven't read his other books, but I plan to.

If you're interested in the financial crisis and the GSEs, Kling worked at Freddie Mac in the late 1980s and has a great description of the firm in Freddie Mac: My Chapter
Multifamily loans were high risk. However, Freddie Mac, as a government-sponsored enterprise (at that time, it was an agency under the Federal Home Loan Bank Board), was expected to provide funds to support low-income housing. The multifamily division guaranteed mortgages on apartment buildings, which were occupied by many low-income renters.

The capital charges that we came up with for multifamily drove the division crazy, because they were so high. The capital charges made it very difficult for the division to compete for business, and their management howled about it. In an important meeting between Chief Financial Officer David Glenn and the entire Financial Research department, Glenn challenged us to justify whether we had the authority to dictate the pricing of multifamily loans, given the adverse impact it was having on our purchases.

In theory, the battle between Financial Research and Multifamily could have gone either way. In practice, Multifamily blew itself up. It turned out that their risk controls were terrible. They were lending money to slumlords who were quite happy to take the cash, let the properties rot, and hand the keys to Freddie Mac to clean up the mess. The default rates on the loans were much worse than our models predicted, and the losses nearly cost Brendsel and Glenn their jobs.

The multifamily fiasco had several long-term consequences. It raised the prestige of the Foster-Van Order model within the company. Over the next decade, many other economists were hired, and the Foster-Van Order approach to default and capital costs became deeply embedded in the corporate culture, with Brendsel, Glenn, Cassidy and others in senior management well attuned to it.

The multifamily fiasco also affected how senior management handled the trade-off between making loans to support low-income housing vs. doing what was best for the financial health of Freddie Mac. After the multifamily debacle, Freddie Mac's policy was to focus on financial health and minimize the support for low-income housing.

This was the risk management culture that Richard Syron inherited when he became Freddie Mac's CEO in 2003. Syron wanted to do more for low-income housing, and he did not trust the people that he found at Freddie Mac. As we now know, there was a blow-up between Syron and Freddie Mac's Chief Risk Officer over loans with low down payments. The Chief Risk Officer argued that such loans were bad for borrowers, bad for Freddie Mac, and bad for the country. Syron fired him.
More of his blog posts can be found here.

Depew on the stealth depression

Kevin Depew covers the unfolding social mood in The Modern Stealth Depression Revisited

Social mood explains the decline

FT Alphaville does a good job of showing the futility of headlines by tossing up a few in Random Reasons to be Bearish.

The technicians are all looking at 1040 on the S&P 500 Index as a major support level; it closed at 1041.24 today.

Head and Shoulders on S&P 500?

If that's a head and shoulders pattern and if the neckline is broken (it's sitting on the neckline right now), the downside target would be around $90 on the SPY or about 900 on the S&P 500 index, a drop of 14%.


Net speculative shorts and FXE

Blue line is the net speculative short position (right axis), red line is Currency Shares Euro (FXE) (left axis). Rising blue line indicates fewer shorts, a falling blue line indicates increasing short positions.

Possible scenarios for Greece

Michael Pettis gives a great overview of what could happen with Greece in:
What might history tell us about the Greek crisis?
Here are his five predictions:
1. The euro will not survive in its current form.

2. This is the big one

3. The European crisis will be accompanied by a trade shock.

4. The economic recovery in the countries hit by crisis will not begin until they are recognized as insolvent and receive debt forgiveness from their creditors.

5. Greece’s insolvency will not be recognized for many years.
The article goes into detail on each, plus compares the current situation to the LDC crisis of the 1980s.

Hugh Hendry mentioned the trade shock in his interview with Bloomberg yesterday, comparing today with the spike in the U.S. dollar in the early 1990s, which led to cheaper European exports that then knocked out the Asian Tigers with the Asian Crisis.


Who's making the trading decisions in the market?

I had read this Macro Man post earlier—Follow your leader—but it didn't click until I read this post from EWI: EUR/USD: "Initial Reaction Will Be To Sell Dollars"
The U.S. dollar weakened on June 23, pushing the euro-dollar exchange rate as high as $1.2340.

Analysts attributed dollar weakness to the Federal Reserve's decision to leave U.S. interest rates unchanged and cautious talk about the economy.

But here's what's interesting.

Look closely at the day's action in the EUR/USD and you'll notice that the pair began to rally (i.e., dollar began to weaken) around 10 AM Eastern. By the time the Fed's announcement rolled around at 2:15 PM, the EUR/USD was already at $1.2285, some 70 pips higher. It only added another 60 or so pips after the announcement.

So it's clear that the market was way ahead of the Fed. But how can that be -- aren't prices supposed to move only when something is "moving" them?

The Elliott Wave Principle explains that markets are not driven by cold, hard reason. The real driver is market players' shared mood. It doesn't change with the news; it moves in Elliott wave patterns. That's what makes forex markets predictable.
Now, here's what the Macro Man had to say about trading desks:
Let's start with a situation once witnessed while working in the Far East markets.

When a junior trader was asked what he had in EUR/USD he said he was small long. Why? Because the trader next to him was longer and he knew something. When asked what he knew, he replied that his Head of Desk was long even more. So the Head of Desk was approached and interrogated. It turned out that he was long because the Head of the Room was longer still. Not easily put off the trail, he too was approached and asked if he knew anything about EUR/USD? "Not really, but the Treasurer has put a position on so something must be up". On we go. As it turned out the Treasurer was long because "A friend at another bank had told him that China were on the bid". When told what the whole room's exposure was on the back of this chain of rumour he was horrified. And this was only in one bank. If this was being repeated in banks across the region then the positions amassed on this whisper were huge and at some point were going to have to be unwound, which duly happened in a massive dump at about 9.30 London as Asia went home.

So why does this happen? Well behaviourally it's simple really. If you mirror your boss's position in a smaller amount you have 2 possible outcomes:

1. You make money.
2. You lose money, but not as much as your boss so he can't chastise you.

Since then watching the Asian close has always been an interesting time of the day to gauge the spread between rumour and fact. Which brings us to today. The Chinese-inflicted kicking of the FX market yesterday appears to have elevated their general FX status back to old Voldermort levels. And it appears that the whole world is so terrified that they may be buying EUR/USD around the 1.2240/50 level that is enough for everyone else to be long ahead of that level. But how much?
At least in this example, the market players were not even behaving rationally (from an investment perspective, not an employment perspective) to being with. The dynamic within the trading firm is not that different from the dynamic in the market, both exhibit herding behavior.

The noose is getting tighter and tighter in Asia

Hugh Hendry has a short interview on Bloomberg.
Longer clip below:

"Great Germans want to get rid of all of the political class that represent them. Today in Europe, we have a new Axis of Financial Evil, it is Germany and it is French bureaucrats and politicians who are determined to destroy the wealth and hard working entrepreneurs that we find in this continent."

Scott Sumner on farmers' apartments in China

Interesting post from Scott Sumner.
Farmer’s apartments in China
Yes, I understand that Huaxi is the richest village in China, and is hardly typical. But I also think that there is far more wealth being accumulated in the rural parts of eastern China than many people realize.

When I used to hear about 800 million “rural Chinese” I pictured dusty little villages in western China. I may need to re-adjust my mental images.

What does this all mean? I have no idea. I’m sure you guys will inform me in the comment section. The only thing I am willing to predict is that if Tyler Cowen ever does a post on this, the term ‘Austrian’ will appear at least once.
In the post, he first shows the cramped living quarters of some migrant workers in Chongqing, a major city in China. These guys are poor and cannot afford much space.

Then there are the rural Chinese homes on the route between Shanghai and Hangzhou. These are supposedly poor farmers. And then there's the big tower being built in the village of Huaxi.

Huaxi is a special case, read about it here: In China's richest village, peasants are all shareholders now - by order of the party

Check out Sumner's post for links to more of these photos and further discussion of these areas.

As Sumner says, there's obviously wealth accumulation taking place in the rural areas. My quick take is that perhaps its from people who left for jobs in the cities. Many Chinese still have a strong connection to their hometown and land is cheaper in rural areas. Building a nice home in the rural area is probably done for the same price as a mid-level apartment in a big city.

Falling governments

Voters around the world are implementing a Wal-Mart Rollback strategy. Instead of falling prices, however, there are falling leaders and governments.

U.K. voter turned to the Tories and LibDems in May.

Merkel's ruling CDU suffered their biggest loss post-WWII in North Rhine-Westphalia back in May, which resulted in losing control of the upper house of parliament. A presidential election will be held on June 30, it is not a general election, rather elected politicians vote. It is a secret ballot, however, and there's some speculation that even though Merkel has the votes based on the makeup of this electorate, she may face opposition from her own ranks. Merkel's government was elected eight months ago.

Japan's prime minister resigned over a flip-flop on U.S. bases in Okinawa. He was elected nine-months earlier when the DPJ swept out the LDP, which had ruled for most of the post-WWII period.

Japan has an upper house election coming on July 11. Here's the WSJ:
The LDP, which lost power last year after more than 50 years of almost unbroken rule, has 71 seats in the Upper House chamber of which 38 will be on the July ballot. Mr. Tanigaki has vowed to resign as LDP head if the DPJ secures the combined majority after the election.

Yoshimi Watanabe, leader of Your Party, a popular start-up party with "small- government" policies, is also aiming to block the DPJ from taking a majority in the Upper House.

Your Party has only one seat in the chamber, but Mr. Watanabe said if his party can make a big leap in the July election, "the DPJ would go into a collapse process, which could accelerate a realignment of political alliances."
So Japan has splinter parties that may play a role in the governing coalition in the upper house. And what does this Your Party sound like? Here's a WSJ blog discussing the Your Party.
The party was formed last year after former LDP cabinet minister Yoshimi Watanabe left the party, advocating smaller government and scaling back the political influence of Japan’s large but unelected bureaucracy. As Japan’s state coffers creak under the burden of huge debt, YP promises cutting special privileges that public employees and policymakers have enjoyed, as well as digging into government spending, rather than raising taxes. YP also says it wants to bring fundamental changes to social security and drastically increase the administrative power of local governments versus Tokyo.
Sounds like a Japanese Tea Party to me. And while they're polling well, they're not the only splinter party, something predicted by a falling social mood.

Poland's President died in a plane crash, along with much of the country's leadership, and voters favor the out of power party in the election to replace him.

Australia gets first woman PM Elections are coming up in Australia and Kevin Rudd's unpopular mining tax has cost him the leadership of his own party. He resigned before being voted out. The Labor party is headed on the wrong track with voters and they hope the new PM will help turn the polls around.

And then there's the U.S., where primary voters have already fired a considerable number of incumbents from both parties.
“Both parties are having civil wars with their Washington establishments,” said Joe Trippi, a Democratic strategist. “You are seeing it on the Republican side; you’re seeing it on the Democratic side. The reality is, regardless of what party you are in, if you’re an incumbent and it looks like the Washington establishment is backing you, you’re in trouble. It’s the wrong place to be this year.”

Mrs. Lincoln looked as if she could become the third Senate incumbent to be defeated this year, following Senator Robert Bennett, Republican of Utah, and Senator Arlen Specter, Democrat of Pennsylvania.
Some of these primary elections run all the way into mid-September. The general election is November 2.

Anti-China Senators unimpressed by yuan move

Only a few days ago, I wrote in Yuan may begin moving again
China has been increasing cross border settlements, using the yuan with more trading partners, foreign companies can now issue yuan bonds, etc. There is steady progress towards making the yuan a fully convertible currency, but it is proceeding slowly and prudently. The direction is unmistakably clear, but it's simply not fast enough for some people.
Those people would be U.S. Senators. And three days after China eased the yuan exchange rate, the Senators are back to complaining:
US lawmakers renew focus on China after yuan stalls
"They take a step forward, and then a step back. It's the same pattern we have seen for years," Democratic Senator Charles Schumer told the hearing.

He noted that the yuan rose only 0.02 percent on Wednesday, the third trading day after China's central bank said it would allow greater flexibility for the currency. That move brought the overall gain since the announcement to just 0.2 percent.

"The Chinese will keep treating us like they have us on a yo-yo unless we make a serious push for our legislation," Schumer said.

"On the currency issue, not enough is being done. So we are going to move our bill," he said in comments echoed by other Senators who are co-authors of currency legislation.


Germany and Russia getting friendly?

Germany and Russia Move Closer
German Foreign Minister Guido Westerwelle will brief French and Polish officials on a joint proposal for Russian-European “cooperation on security,” according to a statement from Westerwelle’s spokesman on Monday. The proposal emerged out of talks between German Chancellor Angela Merkel and Russian President Dmitri Medvedev earlier in June and is based on a draft Russia drew up in 2008. Russian Foreign Minister Sergei Lavrov will be present at the meeting. Andreas Peschke said, “We want to further elaborate and discuss it within the triangle [i.e., France, Germany and Poland] in the presence of the Russian foreign minister.”
Interesting because Jim Rickards recently wrote the following:
What G20 will not discuss this weekend (but probably should)
As the system breaks down anyway (because of private demand for gold due to lack of faith in official solutions) one political response will be protectionism (to appease local populations) and efforts at confiscation (to put the gold genie back in the bottle). At that point, and amid the chaos, one or more countries will "go for gold" on their own to preserve wealth and the purchasing power of export income; the most likely axis here is Germany-Russia with Austria, the Netherlands, France and possibly Italy joining in. The German-Russian axis is the most natural in the world because each has what the other needs; technology and manufacturing in the case of Germany and energy and other natural resources in the case of Russia. At that point, the U.S. may have to give up its alternative paper plans and join the gold rush leaving China heavily exposed to collapse because of its shortage of gold relative to GDP. It seems likely that China sees the same scenario which explains its own rush to gold, albeit mostly from captive domestic production in the short run.

Maintain perspective on new home sales

Today's shock headline:New home sales plunge 33 pct with tax credits gone

New home sales fell to an annualized pace of 300,000, the lowest ever since records began in 1963. Obviously, tax credits bring demand forward and people thinking of buying a new home in the March-April-May-June period would have an extremely great incentive to get a deal before the expiration of the tax credit on April 30.

A similar situation occurred in September 2009 as the "Cash-4-Clunkers" plan expired at the end of August:
U.S. September auto sales plunge; GM, Chrysler hit hard

The automakers then went on to enjoy robust sales growth in the ensuing months. Therefore, while I do believe the economy appears to be weakening, this data point is extremely low due to the incentive effects from the tax cut. If it follows the pattern of auto sales, the pickup will be slow in the first couple of months, since the buyers in these next few months had the greatest incentive to jump the gun with a purchase.


German press on Merkel-Obama dispute

Merkel lässt Obama abblitzen

Here's Google's translation:
Merkel makes Obama slapped down
The federal government engages in confrontation with America. "If we do not come to a sustainable growth, but again generate bloated growth, we will pay by the next crisis," Chancellor Angela Merkel said after the meeting with the Expert Group on New Financial Architecture "in Berlin on Monday. "It's not about a radical austerity program, but it is a question that one can not help with sustained economic growth, the same stimulus packages go on and on, one has been enforced."

So that they openly opposed President Barack Obama. This is repeated in a letter to the leaders of the twenty most important economies (G20) warned of the mistakes of the past, when the economic stimulus has been withdrawn too soon. He also called on the major exporting nations to increase their domestic demand. The countered Merkel, Germany is part of the internal market and the trade of the European Union was balanced. This is "the decisive factor."
Merkel used the term "monetary emissions" to describe the quantitative easing and bailouts last year, her position has not shifted.
Here's a Bloomberg report on the spat:
Merkel Tells Obama Germany Won’t Heed Calls to Focus on Growth
Obama’s letter urged the G-20 to reaffirm its “unity of purpose to provide the policy support necessary to keep economic growth strong,” saying order to public finances should be restored in the “medium term.”

Obama’s appeal “isn’t anything that goes against what we are doing,” Merkel told reporters yesterday. “If we don’t get onto a path of sustainable economic growth but have rather a growth bubble, then if the next crisis comes we won’t be able to pay for it.”
This conflict is going to become much fiercer if the economy contracts.

A heretic on the gold to silver ratio

Gold/Silver Ratio Rethink
A second factor, that only entered the equation in the 20th century, could be contributing further to silver’s demonetisation. This is its growing electronic, medical and general industrial role. Make no mistake, silver is now a consumed metal.

This places further strain upon its monetary value. If its industrial value is increasing, its monetary value must necessarily be diminishing.

Silver is being consumed in large quantities in ways that make it difficult to retrieve. That must mean that its stock to flow ratio is falling. It is the stock to flow ratio that ensures the stability of value so necessary for a money.

If, as is generally predicted, silver’s industrial usage continues to expand, then this can only create further volatility in its value causing further downward pressure on its monetary value.

Stock to flow ratio, and volatility of value are inversely, but not necessarily proportionally, correlated. If the above ground stock of silver fell below a certain level (whether actual or perceived), then this could lead to a huge decrease in the component value of silver which is attributed to its monetary function. Is this the cause of the 20th century acceleration of a process that started 400 years ago?

Sam Mathid's has two points, the first is that gold is divisible in the digital age. However, freegold advocates such as FOFOA see gold becoming a wealth reserve, not a transactional currency. In any event, I believe his second point is stronger. Silver is an increasingly industrial commodity and this may cause the stocks to flow ratio to decline over time. As an investment, this may be a reason to own silver, or platinum or palladium, but if there's a monetary event that causes gold to be revalued, silver may not go along for the ride. Overall, a good "outside-the-box" article.

What's the point of macro?

A good article, especially for those of us expecting some tail end events.

What's the point of macro?

By: Dylan Grice

Most people would see the macro strategist's role as timing macro events ... switching between defensives and cyclicals, adjusting duration, risk-on/risk-off trades, and so on ... the only problem is that most of us are rubbish at seeing macro events coming, let alone timing them, as our evolutionary programming blinds us to events which are forecastable (and many are not even that). Perhaps we should embrace our limitations by accepting that 'outlier events' are actually quite regular, and use macro research to aid in the search for appropriate insurance strategies.

* A few weeks ago I mapped out a strategy that was based on the idea that since global banks' solvency was so dependent on government bond holdings, central banks would have no option but to quantitatively ease in the face of future government funding crises. I argued that such funding crises could provide opportunities to buy cheap risk assets before liquidity/QE-induced rallies and that some value was beginning to emerge, but also that that value still wasn't extreme enough to go all in.1

* As usual, I received some interesting feedback - some favourable, some not (one pm said my 'deflation-begets-inflation' view was a "dog's leg" forecast). But one client asked why I bothered looking at valuation at all. Surely my extreme macro views trumped such considerations? "I just don't understand how you can separate your ... economic research from your stand-alone valuation tools." I thought this was a brilliant question because it gets to the heart of a permanent tension between macro and micro: what should the relationship between top-down macro and bottom-up valuation be?

* At the risk of oversimplifying what our more macro-focused clients do every day I'd characterize pure macro-focused managers as being less concerned with valuation. For a start, the traditional macro instruments such as commodities and currencies are difficult to value. But by far the biggest macro market - the bond market - is largely priced off central bank perceptions of what the economy is doing, and risk assets tend to be priced off those bond markets. Since mispriced assets can become even more mispriced depending on the macro climate and central banks' reading of it, timing is everything and for such managers an understanding of the 'big picture' is far more important than valuation.

* But at the opposite end, where the pure value hunters reside, Warren Buffett has said that even if he knew the Fed's exact interest rate moves two years in advance it still wouldn't make any difference to how he would invest today. Indeed, most value investors shun macro completely and focus entirely on bottom-up valuations. They view recessions as good times to buy and have little confidence in anyone's ability to predict them. But they don't really care because they know recessions occur frequently enough and they are patient enough to wait. So why bother with macro?

At last year's Value Investing Congress, David Einhorn neatly reconciled the top-down versus bottom-up investment philosophies. He was describing his Damascene conversion following a foray into a high quality US homebuilder just before the housing bubble burst:

"At the May 2005 Ira Sohn Investment Research Conference in New York, I recommended MDC Holdings, a homebuilder, at $67 per share. Two months later MDC reached $89 a share, a nice quick return if you timed your sale perfectly. Then the stock collapsed with the rest of the sector. Some of my MDC analysis was correct: it was less risky than its peers and would hold up better in a down cycle because it had less leverage and held less land. But this just meant that almost half a decade later, anyone who listened to me would have lost about 40% of his investment, instead of the 70% that the homebuilding sector lost.

"I want to revisit this because the loss was not bad luck; it was bad analysis. I downplayed the importance of what was then an ongoing housing bubble. On the very same day, at the very same conference, a more experienced and wiser investor, Stanley Druckenmiller, explained in gory detail the big picture problem the country faced from a growing housing bubble fueled by a growing debt bubble. At the time, I wondered whether even if he were correct it would be possible to convert such big picture macro-thinking into successful portfolio management. I thought this was particularly tricky since getting both the timing of big macro changes as well as the market's recognition of them correct has proven at best a difficult proposition. Smart investors have been complaining about the housing bubble since at least 2001. I ignored Stan, rationalizing that even if he were right there was no way to know when he would be right. This was an expensive error.

"The lesson that I have learned is that it isn't reasonable to be agnostic about the big picture. For years I had believed that I didn't need to take a view on the market or the economy because I considered myself to be a "bottom-up" investor. Having my eyes open to the big picture doesn't mean abandoning stock picking, but it does mean managing the long-short exposure ratio more actively, worrying about what may be brewing in certain industries, and when appropriate, buying some just-in-case insurance for foreseeable macro risks even if they are hard to time."

I think most people would agree with this very reasonable hybrid approach: use macro analysis to avoid economic turbulence by managing your portfolio's "long-short exposure ratio" more, and bottom-up analysis to maintain a value bias to the holdings within your portfolio.

But there is still a problem with the applicability of this philosophy: your ability to 'actively manage' your portfolio's beta is a function of your ability to accurately call the market's shortterm direction correctly on average over time. But just because most of us think we are reasonably competent at calling such short-term moves doesn't mean we are. In fact, the reality is that we're appalling at it.

The future is wild, but our forecasts are mild
One problem is that many of the big moves we're supposed to "trade around" are fundamentally unpredictable (Taleb's Black Swans) and no amount of research will predict such events. Perhaps a more important thought is that we're simply not hardwired to see and act upon the big moves that are predictable (Taleb's Grey Swans).

To see why, it's important first to understand the nature of those big "outlier" moves. Benoit Mandlebrot, the inventor of fractal geometry, distinguished between uncertainty that is "mild" and that which is "wild."2 For in a sample from a population that is only mildly random, extreme occurrences won't change the estimated characteristics of the population. To use Taleb and Mandlebrot's example3, imagine taking 1000 men at random and calculating the sample's average weight. Now suppose we add the heaviest man we can find to the sample. Even if he weighed 600kg - which would make him the heaviest man in the world - he'd hardly change the estimated average. If the sample average weight was similar to the American average of 86kg, the addition of the heaviest man in the world (probably the heaviest ever) would only increase the average to 86.5kg.

With mild distributions, extreme outliers are insignificant to our understanding of the likely weight of someone randomly chosen from the population. The insignificance of such outliers makes the uncertainty around people's height, blood pressure or IQ so mild that fairly accurate probabilities can be judged using the well-known Gaussian "bell curve" distribution. The bell curve is usually referred to as the normal distribution because it has known and convenient properties, yielding safe and predictable probabilities, and we like to think that safe and predictable is normal.

But it's not actually that normal. There are plenty of very important variables which are more "wildly" random and in which outliers make a transformative difference. For example, suppose instead of taking the weight of our 1000 American men, we took their wealth. And now, instead of adding to the sample the heaviest man in the world we took one of the wealthiest, Bill Gates. Since he'd represent around 99.9% of all the wealth in the room he'd be massively distorting the measured average so profoundly that our estimates of the population's mean and standard deviation would be meaningless. If wealth distribution was mild this would never happen. But it's not. So it does. If weight was wildly distributed, a person would have to weigh 30,000,000kg to have a similar effect!

The simplest way to see if something is mildly random - if it follows a Gaussian distribution - is through a QQ plot. You plot the variables of the series you're interested in on one axis with manipulations of the same variable (which ensures it is Gaussian by construction) along the other, and if the scatter plots a neat diagonal line, your distributions roughly match and your variable is likely normally distributed. If it doesn't you may have a "wildly" random variable on your hands.

The following chart shows a QQ plot of three-month changes in various dollar exchange rates from mid-2006 to the present. Simply eyeballing the data shows that we can't draw a neat straight line through the scatter plot, suggesting the data is non-Gaussian (more rigorous statistical tests show this to be true) and the "fat tails" are clearly visible. It has been known for some time that financial market variables were not mildly random, but LTCM demonstrated just how dangerous assuming away wild randomness could be.

Now take a look at a similar plot below, only this time of forecast 3m changes (I calculated these using Bloomberg's history of quarterly forecasts relative to the 3m forward rates prevailing at the forecast date). Contrast the near perfect diagonal straight line below to the poorly fitting one above. Forecasts are mildly distributed along Gaussian lines (more formal statistical tests show this to be true). Thus, even though we know changes in financial market variables are non-Gaussian, our expectations of those changes remain Gaussian. We see the world in which we live as mild even though we know it's wild.

Why we all think we're great traders
I was dumbstruck in a recent meeting I did with Albert when one of the attendees, who was a well known tech bull in the late 1990s, dismissively claimed (with a completely straight face) that Albert's call to overweight bonds relative to equities in 1999 was "pretty consensus at the time really." This was a time when the tech mania was in full swing, when adding "dot com" to the end of a company name was enough to double its share price that day, when the Nasdaq was trading at a PE in excess of 50x, and when Jim Cramer was telling investors in his hedge fund that PE ratios were redundant because none of his favourite stocks even had earnings "so we won't have to be constrained by that methodology for quarters to come."4 Yet Albert's call to sell stocks and buy government bonds at this time was "pretty consensus"!

Niall Ferguson has given a brilliant example of how such "selective memory" can permeate the collective psyche. In his book "War of the World", his fascinating interpretation of the 20th century's rolling conflicts, he shows that pretty much any narrative of WW1 will painstakingly show how all the warning signs of an impending conflict were there and how inevitable the war must have seemed at the time. Germany and France almost came to blows in 1911 over Morocco in the Agadir crisis, a European arms race was in full swing as Russia committed in 1912 to rebuilding its military, and the Kaiser's determination to surpass Britain's naval supremacy was intensifying the armaments build-up in Germany and the UK. Indeed, at Germany's Imperial War council meeting of 1912, von Molkte even argued (now famously) for an immediate attack on Russia since war with her was "unavoidable, and the sooner the better." The march to war was clearly on, wasn't it ....

Well yes, with hindsight perhaps, but no-one realised it at the time. The now familiar historical notion is that a tension was slowly building up between the European powers and that this reached such a fever-pitch that by 1914, when Archduke Franz Ferdinand was assassinated in the Balkans, Europe was a like a barrel of gunpowder just waiting for a spark. But as Ferguson shows in his book, this notion is in fact highly dubious. It implies that everyone knew how significant the above events were at the time, which they did not.

Or at least, the bond market didn't. The chart below shows German bond prices (which were considerably higher than they had been a year earlier) had barely budged following the assassination of the Archduke, which ultimately triggered the "war to end all wars"!

The classic study on hindsight bias was done by Fischhoff and Beyth5 who asked their students to estimate probabilities for possible outcomes during Nixon's visit to China in 1972 before it occurred (for example, "what is the probability that the USA will establish a permanent diplomatic mission in Peking, but not grant diplomatic recognition"). What the subjects didn't know was that they would be later asked to recall those probabilities. But when they did, between two weeks and six months after the visit, they recalled that their estimate of events that did happen was much higher than their actual estimate had been, and likewise that their estimate of events that had not transpired had been much lower.

This hindsight bias helps explain our inability to see outliers. If you were perfectly rational in forecasting returns, an unexpectedly positive or negative number would widen your volatility estimate. But if you "knew it all along" you wouldn't accept that the return was unexpected. Your estimate of potential price volatility would be unchanged and you'd continue to disregard the possible outlier events as too unlikely because your forecast range would remain too narrow. This was actually evident when I put the data together for the QQ charts above. The standard deviation of the actual exchange rate changes was 5.7%; that for the forecasts was only 1.8%.

This over-confidence bias is well documented. In spelling tests, subjects who mark answers they're "100% certain" of are only correct 80% of the time. Where an error of 0% is expected, one of 20% occurs. But hindsight bias contributes to this natural pre-disposition towards overconfidence because if you think you predicted past events accurately, you'll think you can predict future events too.

If you ask a class of students how many expect to finish in the top 50%, come the end of the year around 80% will put their hand up. Similarly, I've been amazed at the number of clients who've told me they think "buy and hold is dead" and that "these markets have to be traded." For traders in the market, the odds are considerably worse than students in exams. Performance data typically show that around 70-80% of active managers underperform the indices6 while studies of brokerage accounts show similar odds for individual traders.

There is absolutely nothing wrong with "trading these markets" if that's what you love doing and it's what you're good at. But the evidence clearly shows that the vast majority of us aren't. Worse, the vast majority of those who think they are good at it aren't either, and they will be competing against traders who are. So my advice to anyone about to embark upon Einhorn's path of using macro to "actively manage your long-short exposure." is to think long, hard and honestly about what your sphere of competence actually is. Otherwise, the chances are that you'll be making your broker far happier than your investors.

So what is the point of macro research?
So if our confidence in our forecasting ability is for most of us more likely to be reflecting a cruel trick of our evolutionary development than any real ability, is macro research completely redundant? I don't think so. In fact, I agree with the second part of David Einhorn's conclusion in the excerpt above, of "when appropriate, buying some just-in-case insurance for foreseeable macro risk".

At this year's Berkshire Hathaway conference, Charlie Munger said that while most people and firms do whatever they can to avoid large losses, Berkshire Hathaway is designed to take them. "That's our edge", he said. When asked about his successor at the helm of Berkshire, Buffett said that the most important thing his successor at Berkshire must be able to do is "to think about things which haven't happened before." Most insurance companies lose money on their underwriting operations but make money on the float. Berkshire Hathaway makes profits on both. They haven't been able to do this because they've been better at predicting the future than the competition - they openly admit to not even trying - but because their whole approach is grounded in a) the understanding that "outlier" events happen every few years, and b) being patient enough to hold capital in preparation for deployment when such "outliers" inevitably arise.

There are two broad approaches to a more insurance-based approach. The first and most simple is the avoidance of the purchase of overvalued assets. Ensuring an adequate margin of safety against the unknown and unknowable future - rather than trying to predict it - is the central philosophy behind Ben Graham's concept of value investing and one of the simplest differences between investment and speculation. It's as important today as it has always been and is why a careful and prudent analysis of valuation is so important. This is why I spend what some might think is an unusual amount of time on equity valuation for a macro strategist.

The second approach is to focus on the "grey swans" - the tail risks which are predictable - by devoting time to thinking about them and to finding effective and efficient protective insurance should they happen. Most of the research Albert and I write aims in this direction. It is for most of us, I believe, a more fruitful use of macro research than trying to predict various markets' short-term moves. There is a very big difference. Some have interpreted my work on government solvency as a reason to short government bonds, and JGBs in particular. I've actually never suggested doing this. To get it right you have to get your timing right, and ? well ? see the above on how confident most of us (myself included) should be about that.

But just because you can't predict when something will happen doesn't mean you should act as though it won't happen. If, for example, you are as worried about the implications of what appears to be widespread public sector insolvency in developed markets as I am, there are numerous insurance products worth considering. Popular Delusions is of course a strategy product, and regulatory boundaries preclude me from making too specific recommendations, so I'm going to end by doing something I very rarely do: shamelessly plug my colleagues (look away now if you don't want to be soiled by such unbridled commercialism!).

I think it's fair to say that derivatives is one of SocGen's genuine competitive strengths. We have a world class and award-winning derivatives operation and, as far as I know, compete favourably with any other house on the street. So if you're like most of the clients I talk to and are interested in insuring against any of the scenarios Albert and I have explored in our research (whether an inflation crisis in Japan, the break-up of the euro, a funding crisis in the US, a Chinese hard landing) or indeed any that we haven't, but don't know the best way to do so, let me know and I will put you in contact with the appropriate members of the derivatives team here. Having sat down with them in recent months, seen them work and seen the tailevent hedges that can be squeezed out of the options market I'd be surprised if you weren't impressed at what can be done. I certainly have been.


Gold & Gold Miners Hammered

Nevsun (NSU) is down nearly 10%, knocking out a big chunk of the gains I have in it. A lot of gold and silver miners are down 3 to 5%, with spot gold down almost $30 from its intraday record high.

A correction in gold and gold miners was overdue and once again GDX fails to reach a new record high above March 2008 levels. If this is part of the broader deflationary trend, today's move in gold makes sense. However, if this is a reaction to the yuan exchange rate, it's the opposite of what I'd expect. Just as the broader stock market reversed itself this afternoon, I'd expect gold to also reverse itself overnight or tomorrow.

A path to euro breakup: the two-tier euro

If there is an existing plan of action, it increases the range of possible action. Thus, an outright euro breakup is quite extreme and would be resisted strongly. However, the euro-skeptic Telegraph has an article claiming there's another path. This is the oft-mentioned, but not officially sanctioned two-tier euro.
Germany and France examine 'two-tier' euro
"It's an act of desperation. They are not talking about ideal solutions but the lesser of evils. Helping Greece could be done relatively cheaply but Spain they can't afford to let fail or bail-out.

"And putting more pressure on the people of France and Germany to save other countries is politically unfeasible."

One option, to protect the wealthier northern European countries and to help indebted southern Europeans, would be for Germany to lead a group of countries out of the existing euro into a new single currency alongside the old.

The old euro would decline sharply against the new German and French dominated currency but both north and southern Europeans would be protected.

Northern economies would be protected from debt contagion and southern countries would be spared the horrors of being thrown out and forced to go it alone.

Angela Merkel, the German Chancellor, has already paid a political price for forcing the rescue plan on a reluctant public, losing her majority in the upper house of parliament in a recent election.
This is better for the euro in the long-run and increases its survivability, but it also puts the breakup on the table and increases volatility and weakness in the currency. What foreigner wants to be stuck holding the Club Med euros? On the flip side, German bonds become more attractive.

Anti-China Rhetoric in Congress

In US anti-China rhetoric at danger level, Benjamin A Shobert discusses the current debate. With socionomics as the frame, the why of the issue becomes clearer than Shobert sees it, but there's lots of specifics in the article too.
During last week's USCC testimony, Senator Charles Schumer (Democrat, New York) provided in written testimony a very specific insight into the grievances of many Americans and, as a consequence, the powerful politicians who represent them: "China's policy of large-scale intervention in the exchange markets and the significant undervaluation of its currency also subsidize Chinese exports to the United States and, at the same time, make US exports to China more expensive. Thousands of US factories have been shuttered and millions of jobs have been lost or displaced over the past decade as a result."

He went on to share that, "There is no question that this is what one might call a 'put-up or shut-up' moment for US lawmakers. American jobs and wealth are flowing out of the US, across the globe to China and other countries with cheap labor, lax environmental standards, and no compunction about flouting WTO rules to gain an unfair competitive trade advantage. This has got to stop."
Americans are angry at Congress and an election is coming up. Schumer has been anti-China for much longer, but he was unable to forge a majority when the economy was growing. He has a much better shot today and that's why we saw China adjust its currency policy over the weekend.
This week, during a separate congressional hearing of the House Ways and Means Committee, Republican Congressman Dave Camp (Michigan), asked whether "enough was doing to push China ... on its egregious economic barriers" specific to its currency manipulation, the country's "Indigenous Innovation" policies, and ongoing intellectual property compliance with WTO rules.

...During this week's House Ways and Means Committee hearing on "China's Trade and Industrial Policies", chairman Sandy Levin (Democrat, Michigan) said simply but forcefully " ... China must change its ways". Straight-forward words certainly, but important coming from an influential congressman long known for his reputation of urging caution and balance in America's relationship with China.
Lots of Michigan in there, as well as Ohio. Manufacturing regions that have lost many jobs. Anti-incumbent sentiment will cross party lines in November and even Republicans in these hard hit states will need someone to point a finger at.
Senator Debbie Stabenow (Democrat, Michigan), provided in testimony to the USCC panel her plan to introduce the "China Fair Trade Act, legislation that will prevent Federal taxpayer dollars from being used to purchase Chinese products and services until they sign on to and abide by the WTO Agreement on Government Procurement, which will allow American companies to export into their government markets." This sort of move, while it remains uncertain as to whether it will be advanced in the House, does represent the sort of escalation between two countries that tends to indicate a looming conflict over trade that could, given the present economy, too easily get out of hand.

During last week's USCC hearing, Congressman Tim Ryan (Democrat, Ohio), a long-time critic of China's currency policy and one of the first to propose legislation attempting to address the matter, echoed the concerns of his colleagues but perhaps most importantly hinted at deeper concerns which are too often glossed over by those who suppose such critics want to simply hit rewind on the global economy: "Several years ago, progress toward further market liberalization began to slow and it became clear that some parts of the Chinese government did not yet fully embrace key WTO principals."
Emphasis mine. Socionomics says bullseye to that comment.
It has been quite literally several decades since the interests of the working class and the ownership class have been so front and center in Washington as they are now. The still-powerful pro-business lobby will push back against bills like those mentioned earlier, but unless the American economy begins to show additional life, even organizations like the critical Business Roundtable may be ineffective at limiting a political retaliation against China.

During last week's testimony, this was communicated most eloquently by James Bacchus, formerly a two-term chairman of the Appellate Body of the WTO and a former Special Assistant to the United States Trade Representative in the Executive Office of the President. "I worry when I hear other Americans describe China as a 'threat' to the United States," he said. "I am reminded at such times of the warning of Thucydides in his history of the Peloponnesian War - that a belief in the inevitability of conflict can become one of the main causes of conflict. Trade disputes between the United States and China are inevitable. Conflict is not."
Here's where the rubber hits the road. It is likely the case that American workers have lost their jobs due to globalization. China is just one piece of the puzzle. Consider this article China lassoes its neighbors
But is the Chinese locomotive really pulling the rest of East Asia along with it, on the fast track to economic nirvana? In fact, China's growth has in part taken place at Southeast Asia's expense. Low wages have encouraged local and foreign manufacturers to phase out their operations in relatively high-wage Southeast Asia and move them to China.

China's devaluation of the yuan in 1994 had the effect of diverting some foreign direct investment away from Southeast Asia. The trend of ASEAN losing ground to China accelerated after the financial crisis of 1997. In 2000, foreign direct investment in ASEAN shrank to 10% of all foreign direct investment in developing Asia, down from 30% in the mid-nineties.

The decline continued in the rest of the decade, with the UN World Investment Report attributing the trend partly to "increased competition from China". Since the Japanese have been the most dynamic foreign investors in the region, much apprehension in the ASEAN capitals greeted a Japanese government survey that revealed that 57% of Japanese manufacturing transnational corporations found China to be more attractive than the ASEAN-4 (Thailand, Malaysia, Indonesia, and the Philippines).
Prechter's call for a sub-1000 Dow hit the media rounds last week. I'm not convinced that it will be as bad as he predicts, but if he's right, then it's obvious where protectionism will lead. Eventually, WTO membership and globalization will be on the table, as it will become clear that China is not the whole problem. Or, if China remains the focus, bilateral relations will deteriorate to their worst in 40 plus years.

For more on Prechter's thinking, last week he did an interview with Jim Puplava on the Financial Sense Newshour.

Yuan advances 0.37%

What will be the impact of renminbi appreciation versus the U.S. dollar? Last time it occured against the backdrop of a weakening U.S. dollar and the result was inflation
Hugh Hendry made the connection between yuan appreciation and oil appreciation.
Yuan and Oil—The Bubble Connection?

Here's a link to all the posts about renminbi. I have both count and counterpoint, some blogs discuss RMB appreciation and others depreciation.

If there is appreciation going forward, I anticipate gold, gold miners (plus other hard assets and hard asset producers) and SE Asian markets to perform well.

Renminbi depreciation would be a symptom of global deflation.


How does a dollar rally appear to the world?

One reason I believe the U.S. dollar rally could be epic is due to the international impact of a massive deflation. Changes in currency value drive investment because, ceteris paribus, it increases the value of everything in the country. During a currency appreciation, a hefty slice of the return for a foreign investor can be due to a change in currency valuation. This creates a feedback loop that leads to rising asset prices and rising currency as more money flows into a country, and it reverses very rapidly on the way out. Think Asian Crisis in 1997.

Speaking of the Asian Crisis, at that time there was a big U.S. dollar rally and that helped fuel the technology bubble. Here's Alan Greenspan on January 3, 1998:
Nonetheless, a drop in the prices of existing assets can feed back onto real economic activity, not only by changing incentives to consume and invest, but also by impairing the health of financial intermediaries--as we experienced in the early 1990s and many Asian countries are learning now. But historically, it has been very rapid asset price declines--in equity and real estate, especially--that have held the potential to be a virulently negative force in the economy. I emphasize rapid declines because, in most circumstances, slowly deflating asset prices probably can be absorbed without the marked economic disruptions that frequently accompany sharp corrections. The severe economic contraction of the early 1930s, and the associated persistent declines in product prices, could probably not have occurred apart from the steep asset price deflation that started in 1929.
In 1998 and into 2003, Greenspan was worried about deflation because he just witnessed it in Asia and saw an ever increasing U.S. dollar. While the deflation argument one hears from the bears is based in macro and microeconomics, in the late 1990s it was capital flows that were driving the discussion.

Bringing it back to today, look at the 6-month chart of the SPDR S&P 500 (SPY). It's basically flat for 2010.

Now look at how the SPY appears to a European investor whose home currency is the euro (using CurrencyShares Euro (FXE) for comparison:
The chart uses a price ratio and the price of SPY is currently 90% of FXE (as of June 18, FXE was $123.36 and SPY was $111.73). This is also the euro value of SPY, if one converts $111.73 into euros, it would be $90.19 at the current rate of 1.2388. Assuming the euro went to parity, SPY could still be worth $90.19 to a European if it fell to $90.19, a drop of 19% from these levels. Any smaller decline would appear as a gain to a European and may lead to increased purchasing of U.S. assets, thus leading to further U.S. asset relative outperformance. Also, consider U.S. Treasuries, which will go up in nominal U.S. dollar terms during a deflation. From about April 24 until iShares Barclays 20+ Year Treasury (TLT) peaked on June 7, an investor keeping score in euros would have seen this ETF rise 24%.

Therefore, it is very likely that another major bout of deflation will again result in a move into U.S. dollars, not just by euro holders, but by anyone holding currency that is rapidly depreciating versus the U.S. dollar. This isn't meant to be an argument for deflation, that will come about for other reasons. But for inflationists who cannot imagine how the U.S. dollar could rally or become a "safe haven" asset again, this shows that the reversal of capital flows alone can deliver a sustained U.S. dollar rally.

Socionomics—Hemlines drop, men's swim wear confusion

Given the greater diversity of fashion these days, it's sometimes difficult to pinpoint a trend just by looking at photos, since designers offer a mix. A more reliable indicator comes from the fashion reporters and bloggers, what they cover as new or trendy. Here's one from Styleite, Bye-Bye Bare Legs, Hello Mom Skirt
Ah bare leg! We love the feeling after a season of itchy tights and confining denim to set our skin free with the warm springtime air. But unfortunately, this coming spring, designers have other ideas in mind for us.
In flipping through show after show, one main trend keeps popping up — the uber-conservative, knee-length skirt.

Chris Benz basically offered a survey of these longer length hemlines for his entire Resort 2011 collection. Both skirts and dresses were cut crisply below the knee, if not further down, to provide a much more mature aesthetic than in previous collections. One needs to wonder if this is a move to maximize sales and target a demographic that will purchase the clothing instead of one that will just google it and then splurge for the knock-off version.

On a different note, Christopher Bailey for Burberry Prosum waved his magic wand again this season to make even a questionably matronly silhouette appear sexy. Gathers and ruching created dynamic surface detail to the skirts in a way to taunt for the viewing pleasure. The looks were increasingly feminine with light fabrics offering a romantic and nostalgic feel.
Uber-conservative, mature, matronly, nostalgic.

One contra article is looking at men's swim trunks, Short trunks lengthen economic hopes, say US fashion experts
Shorter swim shorts are, according to Eric Jennings of luxury department store Saks Fifth Avenue "definitely the look right now". He told trade-sheet Womenswear Daily that he expected the trend to continue well in to 2011 too. Although he added the caveat that anything "aggressively short" was not a trend. Similarly in the UK Selfridges are also reporting that sales of shorter swimwear are up 42%. If the theory holds, this international soar in sales of skimpy shorts augers well for a worldwide economic recovery.

But not everyone is convinced. Mithun Ramanandi, bodywear buyer at Selfridges, says: "I don't think the two are connected unless it is to do with men going on more holidays when they are more financially secure." Instead he cites footballers as the real reason why shorter trunks sales are increasing. "It started a year ago when Cristiano Ronaldo was pictured in skimpy silver shorts and this year Beckham has been pictured in shorter shorts too. Before then the average guy was buying board shorts, but footballers make trends less intimidating."

Ramanandi concedes that the last time smaller trunks were in fashion was during the 1980s boom and that board shorts became popular during the economic slump of the 1990s. He added: "Smaller shorts are often made by designer brands which have a higher price."
I'm failing to see a connection with social mood here. I found this timeline of swimwear, but its focused more on female swimwear, Glamour Surf Swimwear Timeline
Some highlights:
Lower neckline and larger armholes
Stockings were finally discarded in the mid 20's

High necklines in swimwear
Belted suits for men and women

The bikini is launched in Paris in 1946.
Bathing suits, play suits, or sun suits became more revealing and charming.

Swimwear takes on the look of of the hourglass
Pointed bust cups
Swimcaps are popular beach accessories

White lace is used quite a bit in swimwear
Bright psychedelic color palette
Midriff is the focus

The thong is introduced
String bikini's gain popularity
High cut leg openings appear

Athletic body build emphasized
Wrestling low cut bodice swimwear
One piece comes back into fashion
Shoulders and backs are the focus
There did seem to be a socionomic trend at least up until the 1970s, perhaps the impact of the sexual revolution drowned the signal. However, take a look at some of the vintage men's suits from Glamour Surf. The 1980s did have shorter shorts, but not Speedo type wear.

Finally, I came across a three-part history of men's swim wear on The Bespoken: For Gentlemen.
From Swimwear To Himwear: A History (part two of three)
Interestingly, men could still get in trouble for going topless in the 30s, but this changed in the period from 1933-1937, which coincides with the stock market rally.

I found this part most relevant to today:
While an arguable thesis, we are living in a period of greater conservatism, at least fashion wise. Fashion’s pendulum has gone in the other direction starting in the mid-1990’s. Men’s swimwear now covers up more of the leg down to, or even below the knee, not unlike the length that our Victorian ancestors wore. Surf and extreme water sports enthusiasts embraced the pant cum swimsuit as the preferred form of swimwear. Dual purposed; it could be worn off the beach. This Speedos vs. Boardies clash of styles has even been the source of political strife. In many European countries, local governments have banned board shorts , Bermudas and the like in municipal swimming pools because of hygiene concerns. In 2007, one local authority in Belgium was accused of imposing the rule in order to dissuade Muslims presumed to want to dress more conservatively from using its pool.

The other big recent innovation is the development of body-covering sun protection swimwear. Through the use of Lycra and new finishing techniques, ‘rash vests’ and one-piece body suits have appeared on the beaches providing 50+ UPF sun-blocking properties.
The fact that full body coverage and rash vests are selling along side those shorter trunks, at best there's no signal here. Also, to the extent the trend favoring those shorter trunks is politically influenced by anti-Muslim sentiment, that itself a sign of negative social mood as Europeans turn anti-immigration.

China: Boom or Bust? A Faber/Kroeber Debate

Arthur Kroeber from Dragonomics says boom, Marc Faber says bust.
See the Reuters Insider video.


China tax reform

Interesting editorial in Caing yesterday: Tax Relief Time for Strained Manufacturers
The editorial argues that China needs tax reform because corporate taxes are now as high or higher than some developed nations.
Besides taxes, all kinds of fees add burden to Chinese companies. Through the decade ending in 2008, the percentage of government income from all sources including taxes and fees rose to 32.2 percent of national income from about 20 percent. As a result, this ratio in China now exceeds what's found in many other countries including the United States, South Korea and Switzerland. And it comes close to the 36.6 percent average for all OECD countries.

A World Bank report said tax rates in low-income countries where per capita GDP is around US$ 750 should be about 20 percent. In countries with a per capita GDP of US$ 2,000, it said, tax rates should be around 23 percent. And in countries with a per capita GDP of US$ 10,000, tax rates can be 30 percent.

China's per capita GDP in 2008 was more than US$ 3,000, but government income levels exceeded those of developed countries. Clearly, the tax level is beyond China's development stage and adjustments are needed.

In order to help China maintain economic development and social stability, value-added tax, corporate income and operational taxes should be lowered first.
What piqued my interest was this paragraph:
Vice Premier Li Keqiang recently wrote an article for the Qiu Shi Journal, a publication of the Central Committee of the Communist Party, that made the case for "positive and steady strides in tax system reform" as well as "reducing (government) fees and balancing the tax burden." There are also discussions within National People's Congress Financial and Economic Affairs Committee to "lower the (tax) burden and raise wages."
Li Keqiang (李克强) is regarded as a potential successor to Premier Wen Jiabao in 2013. If he's spearheading a push for tax reform, it's likely going to come to pass. First up is a resource tax:
On June 1, China unveiled its first resource tax, to be imposed at a rate of 5 per cent on fossil fuels in Xinjiang, as a means of retaining some of the region's mineral wealth in local hands.

Since then Vice-Premier Li Keqiang has advocated a national resources tax in a speech published in Seeking Truth, the Communist Party's leading theory magazine.
And then there's the property tax:
The simmering scandal behind China's rapid development has been the treatment of the 100m-150m migrant workers. Deprived of the right to become permanent residents in the cities, they are often denied access to subsidised schools and other social benefits. Chinese reformers bemoan the fate of "second-class citizens" and talk of "apartheid". Li Keqiang, forecast to be China's next premier, said this month that reforming the system was a priority.

However, attempts at reform have always been stalled by the fragile finances of the local governments that would have to provide these benefits. Those finances have got weaker in the past year as cities and provinces have borrowed to fund spending on infrastructure.

Indeed, if China's post-crisis boom has an Achilles heel, it is the hidden levels of local government debt. A property tax would eventually help provide local governments with the resources to begin paying migrant workers their due.

The spill-over effects do not end there. With more stable income sources, local governments would not need to be so aggressive about selling land to developers, one of their main sources of revenue and the cause of endless social tension as residents or farmers are displaced. Such a tax would also increase the pressure on local governments to be more transparent in their spending. As Li Daokui, an adviser to the Chinese central bank, put it , local governments would have to "report back to the homeowners how they have used this money. In other words, the tax can be used as an instrument to improve local government management."
And then there's rising minimum wages:
The Chinese government is deliberating to re-divide the cake of national wealth among businesses, workers and its own revenues with a move to raise salaries and cut taxes, as a round of minimum-wage hikes kicks off this year.

The Beijing Bureau of Human Resources and Social Security announced Thursday that, from July 1, the city's minimum wage will rise by 160 yuan ($23.50), or 20 percent, from the current 800 yuan ($117.30) per month.

The capital city has set a minimum wage since 1994, and the average annual increase rate is 10.02 percent, according to the bureau, which estimates 100,000 people in the capital will benefit from the increase.

Beijing is one of about 30 provinces or municipalities that have raised or will raise their minimum wage this year, according to figures released by the Ministry of Human Resources and Social Security.

After recent raises, Shanghai currently has the highest minimum wage across the country - 1,120 yuan per month ($164.20) - and Guangdong Province claims the crown for the highest minimum wage per hour, which stands at 9.9 yuan ($1.44).

...Vice Premier Li Keqiang noted in an article published Tuesday by Qiushi magazine that the government will try to increase the proportion of the middle-income group and create an "olive type" wealth distribution system.
After looking at the original Chinese, the word for olive turns out to be the same word for an American football, which obviously has a middle bulge. In addition to tax reforms, a large middle class will grow out of rising wages in China and Andy Xie's latest article is hitting on the theme again.

今后十年大幅上涨的是工资,而不是利率 He says wages, not interest rates, will rise greatly in the next ten years. An English version may or may not become available, here's a link to the Google translated version. He also says inflation could reach double digits, the rise in wages could eventually lead to yuan depreciation, and he's sticking to his target date of 2012 for a potential real estate bubble burst and economic hard landing.

More Euro Breakups?

ZeroHedge has a flair for hyperbole:
Ferocity Of Imminent Spain-Germany Cold War Will Only Be Second To Upcoming Fox Biz-CNBC No Holds Barred

A nice juxtaposition position of a Spanish-German dispute with U.S. network battles.

But the Reuters headline on the euro news is not sanguine:
German-Spanish whispering wars hit euro zone
A whispering war between German and Spanish officials has exacerbated the euro zone's debt crisis this month, keeping financial markets on edge and exposing deep frustrations in Berlin and Madrid.
Reuters lists some of the claims and then writes:
After extensive checks, Reuters decided there were no facts to report. But the rumours were already affecting the markets.
The rumors are the facts. The content of the rumor is not fact, the fact is that Germany and Spain are waging a war of words and there is still trouble ahead for the euro.

Reuters did its job in checking the rumors out, but it raises the next question of why? The answer, I believe, is declining social mood.

Yuan may begin moving again

I say moving, not appreciating, because as I've pointed out, if the Chinese end the U.S. dollar peg and diversify away from the U.S. dollar, they're going to be moving into weaker currencies. The only thing I'm looking for right now is the longer-term rally in the U.S. dollar and Chuck Schumer's blood pressure. But don't take my word for it on the yuan, even the Chinese are thinking the same thing.China Signals End to Yuan’s 23-Month Peg Before G-20
“The central bank’s statement means China’s exit from the dollar peg,” said Zhao Qingming, an analyst at China Construction Bank in Beijing. “If the euro continues to remain weak, it could also mean that the yuan may depreciate against the dollar.”

Here's just one of many articles that come out every few months from China, this one from November 2, 2009.
China Central Bank Opens Second Monetary Policy Unit
The People's Bank of China has established a new department to oversee exchange rate policy, sources told Caijing on Friday.

The department was scheduled to start operations on Friday, the source said, although this has not been confirmed.

The establishment of such a department indicates the significance of the exchange rate reform as a major issue in China's economic reform. Analysts believe the exchange rate policy is as important as the exit strategy for the moderately loose monetary policy.

The central bank said the department will formulate and implement foreign exchange policy, help develop an international yuan market, monitor international capital flows and advise the bank how to make the yuan convertible.

It will also take over management of the yuan settlement program operating among Hong Kong, Macau and five mainland cities that was previously administered by the bank's monetary policy and international affairs departments.
China has been increasing cross border settlements, using the yuan with more trading partners, foreign companies can now issue yuan bonds, etc. There is steady progress towards making the yuan a fully convertible currency, but it is proceeding slowly and prudently. The direction is unmistakably clear, but it's simply not fast enough for some people.

China ended yuan appreciation in 2008 and it's been re-pegged to the U.S. dollar since then. During the Asian Crisis, there was a lot of concern that China would devalue, but instead they held firm and generally one finds that this policy is described favorably. The recent policy is following the same logic. We've seen fluctuations in the euro destabilize markets and a change in the yuan policy during this time would probably have led to more volatility.

As the economy recovers (or is perceived to recover), crisis policy is no longer necessary. India is raising interest rates and other nations in the region are adopting similar stimulus exit policies as they see economic recovery ahead. China is clearly trying to deflect political pressure from the U.S., but they may also be more confident and looking to continue currency reform.

Here is China's statment, released ahead of the G20 Summit:
In view of the recent economic situation and financial market developments at home and abroad, and the balance of payments (BOP) situation in China, the People´s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility.

Starting from July 21, 2005, China has moved into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. Since then, the reform of the RMB exchange rate regime has been making steady progress, producing the anticipated results and playing a positive role.

When the current round of international financial crisis was at its worst, the exchange rate of a number of sovereign currencies to the U.S. dollar depreciated by varying margins. The stability of the RMB exchange rate has played an important role in mitigating the crisis´ impact, contributing significantly to Asian and global recovery, and demonstrating China´s efforts in promoting global rebalancing.

The global economy is gradually recovering. The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability. It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility.

In further proceeding with reform of the RMB exchange rate regime, continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market.

China´s external trade is steadily becoming more balanced. The ratio of current account surplus to GDP, after a notable reduction in 2009, has been declining since the beginning of 2010. With the BOP account moving closer to equilibrium, the basis for large-scale appreciation of the RMB exchange rate does not exist. The People´s Bank of China will further enable market to play a fundamental role in resource allocation, promote a more balanced BOP account, maintain the RMB exchange rate basically stable at an adaptive and equilibrium level, and achieve the macroeconomic and financial stability in China.
The statement references the recent uptick in China's trade balance, which led to outbursts of anger from Congress. But as the statement notes, they see the trade balance heading towards equilibrium, so don't expect much in the way of yuan appreciation.

Unfortunately for Congress, even if China let the yuan rise they may not see a decline in the U.S. deficit, with nations such as Vietnam looking to attract capital and factories to its market. There's a lot of debate about how the trade balance is calculated and the impact of global supply chains on the U.S. trade deficit, of which the yuan may be a component. Which is to say, Congress' simplistic notion of exchange rate policy is more about good politics rather than good economics.

And if the renminbi should fall against the dollar...I expect the Schumers and Grahams of the world, rather than having the egg on their face be the center of attention, will instead turn up the heat on China. At that point, the odds of protectionist legislation passing Congress could be quite high, and given the lack of leadership from Obama, it's not clear to me that he would have the ability to defeat them. He may not even oppose them at that point in time, since the policy may be popular if the economy contracts again.

Update: Another story that shows currency reform is ongoing: Cross-Border Yuan Settlement to Expand
After nearly one year of a pilot program, cross-border trade settlement based on the yuan will expand to 20 provincial-level regions in China and all of China's trading partners.

Heilongjiang, Sichuan, Jiangsu, Fujian and Yunnan are among the new regions that will join the cross-border yuan settlement program.