12-27-08 - Financial Quackery

I know very little about finance. It's time to play Financial Quackery. Put on your tin foil hat.

I believe the US economy is still in far worse shape than the mainstream media or politicians are saying. The reality is that we have been sustaining a period of artificial growth by taking out massive loans against our future. We have not been spending on education or research or infrastructure, and we now have a huge population that thinks it deserves to own a house and drive a nice car with absolutely no skills or hard work. There is hardly any sector of the US economy that can be said to be a real healthy engine of profit and economic growth. The biggest parts of our economy are phantoms : 1. Finance has been propping up the S&P for the last ten years and it's all an illusion. 2. Real Estate was just a bubble funded by inflationary dollars printed by the Fed. 3. Health Care is a huge part of GDP but is really just a drain. 4. Consumer Spending is just sending borrowed dollars back to China with interest, and consumer spending can collapse. 5. Service jobs in general rely on big spending from a small part of the population and high-paid service industry is not sustainable.

To get out of a recession you need real productive industry that makes something the world wants, and we don't have it (or only < 1% of us do). As I've said before, the long-term low interests rates which the Fed has used for the past ten years has put us in a trap where Stagflation is just about the only possible outcome. Our economy is already pumped full of free cash which has nothing productive to do, we've been running on empty and borrowing to keep up standard of living, and now we have tons of worthless paper.

Basically every financial number that's reported in the mainstream media these days is cooked to make it look better than it really is. Everybody knows the unemployment number has been bogus for some time; it's not 6%, it's really more like 12%. All the investment return numbers look way better than they really are because they don't include inflation, fees, & taxes. Furthermore, the widely reported inflation number is bogus. The other big thing they do is fail to adjust for population changes; so you'll see things like the number of jobs increasing, but it actually descreased as a percentage of population.

I've written about how the standard inflation measure is bogus here before. Anybody who has been alive for the past 10 years and has a brain should know that it's nonsense. The nominal 3% inflation would be 34% over the last 10 years. I think it's more like 100% over the last 10 years if you actually compare apples to apples. The normal CPI inflation measure assumes that you gave up the nice house you had in Travis Heights 10 years ago for which you paid $500 a month and you moved to Detroit in order to keep the inflation measure low.

(BTW 100% over 10 years = 7% annual, which is pretty close to the measure under the "pre-Clinton CPI")

Some reference :
SafeHaven article on the CPI by John Mauldin - see also his other newsletters ,
ShadowStats article on the CPI by WJ Williams - also other good articles by the same guy on other misleading stats

Even the people who do show inflation adjusted numbers tend to do so against the CPI for lack of a better accepted measure. Some graphs of "real returns" (sort of - some of these don't count dividends, and they all use the CPI which is bogus, and most don't count taxes or fees) :

Simple chart of DJIA
Intelligent Bear detailed chart
More optimistic log scale chart - where he accounts for reinvestment of dividends.

There have basically been two primary sources of the false growth in the last 10 years. One is just lies. Distorted figures and misreporting make the growth look good even though it's not really there. The Fed basically prints a bunch of money, the financial industry books it as profit, and then they lie about the inflation and we all think we're getting richer. The other are risky leveraged bets.

Basically the corporate system is completely broken. I've written a bit about this before and will probably again, but if you think about it in a game theory sense from the standpoint of an executive - why in the world would I ever do what's good for the company or the country? I can get huge bonuses based on short term profit, and then I can leave the company or sell it or just let it go bankrupt, I get to keep my profit, what do I care if I wrecked the company? My only motivation is to maximize short term returns, and of course that is exactly what they do. We've always known this, and executives have screwed up many companies by not having long term vision, cutting R&D, laying off too much staff to cut costs, etc. What happened in the last 10 years is they just got much more clever about it. When your core business can't make money because the entire economy is in the shitter, what do you do? You take out loans and make massive leveraged bets in risky markets to possibly get a big profit. The actual EV of these moves is maybe zero or negative, but the thing is for the executive they get a big payout if they win the bet, and they get almost zero penalty of they lose the bet. It's gambling for free, or rather gambling where they get the profit and the shareholders and taxpayers pick up the loss. I can't blame them for taking that bet, obviously it's a winning proposition for them.

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old rants