25 August 2009 – The Aleph Blog

Questions and Answers

Posted on 25 August 200925 August 2009 by David Merkel

This may become a series, but I’m going to post some questions I have been asked, and the answers that I gave.? Anyway, here goes:

Has anyone prepared a summary of US Treasury bonds, say five years ago and now and looked at average maturity, etc.

GE was taken to task by the investment community in 2002-03 for using very short term money to fund long term lending/capital needs.? Was the investment community right?

Where is the US government right now ? Are they playing the short end of the maturity ladder, if so what could be the reasons why and what are the implications for the investment community?

Thanks for all of your insight.

This is a graph of the average maturity in months of the marketable portion of US Government debt.? Reagan really lengthened the debt, and Bush, Jr. shortened it.? (Just another bad legacy for that economic liberal, Bush, Jr.)? The most notable aspect of that was the elimination of the 30-year bond in 2001, and its subsequent reappearance in 2006.? The Obama Administration is not a known quantity in these matters yet.

The sharp drop from June 2008 to September 2008 I believe is due to the creation of a lot of short-dated debt that was given to the Fed to allow it to grow its balance sheet.

With respect to GE, yes, the lending community was right.? Prudent borrowers match assets and liabilities.? I recently criticized GE for borrowing with too much short-term debt for their finance arm.? As it is, GE has had a wild ride in its stock price, dipping below six this year.? Without the TLGP, who knows?? GE might have had to send GE Capital into insolvency.

In general, I have been an advocate of lengthening the maturity structure of the US government’s debts.? Governments are supposed to try to be permanent; thus they should finance long.? Governments like the generally lower cost of short debt, and so they sometimes finance shorter than they ought to in an effort to save money.? Governments that don’t finance long enough can be subject to runs, such as Mexico in 1994.

I hope the US government takes the opportunity to finance long while it is still cheap to do so.? My guess is that the opportunity gets wasted; not that the average maturity shrinks a lot, but that it doesn’t grow much.

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What does your husband say about this? Small investors don’t bother?

> http://money.cnn.com/2009/07/29/pf/steve_lehman_federated_investors.fortune/index.htm

This one came to my wife for me.? Quoting from the article, my response was:

>>So what’s a retail investor to do? Lehman’s answer: Leave it to the pros. “It’s never been more difficult [to invest],” he says, “and it will remain more challenging than ever. Unless someone really has a flare for investing and enjoys doing it, I would say don’t waste your time.”<<

Small investors should probably use low cost index funds and vanilla Exchange Traded Funds.? That will lower their costs, which will raise their returns.? It is rare for outperformance to persist in funds management, particularly as the funds under management for any manager grows.? There are some value managers that are worthy of being invested in over the long haul for equities, and if you want a list, I will provide one.

David

PS — to the editors at Money — “flare” s/b “flair”

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We have a certificate of deposit that we are cashing out and are wondering if buying some gold would be a better way to protect our savings? Considering the way the government is spending money, it seems the only way to be safe from the inflation that is coming.

This is a tough one. A lot depends on whether the government inflates their way out of this or not. I almost think they have to, but they could have done it in the Great Depression/WWII, and did not. They raised taxes, and the best investment was government bonds for a long while.

This situation is probably different. Gold will preserve purchasing power over the long haul, but it rarely does more than that. Sometimes, that’s the best you can do.

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I don’t have a good place to post this last bit, so here it goes: here is a recent audio interview of me. I only wish we had focused more on investing topics. For those interested, I had my notes in front of me, which cited a number of my articles.

Full disclosure: I don’t own any gold, aside from my wedding band.

Three Notes on the Federal Reserve and Financial Services Reform

Posted on 25 August 2009 by David Merkel

As I have said before, it doesn’t matter who the next Fed Chairman is, because all of the candidates are basically the same when it comes to monetary policy.? There are no hard money candidates.? So, with the announcement that the reappointment of Ben Bernanke is likely, we can all breathe a sigh of relief because Larry Summers won’t be there (ego kills), and, Ben Bernanke is a known quantity.

On another front, a Federal judge ruled that the Fed would have to turn over data requested by Bloomberg, LP, regarding the emergency lending programs that the Fed has entered into.? Good thing, as I have said before, there is no reason why banks can’t disclose their asset books as insurers do.

Finally, Paul Volcker wants to regulate money market funds like single purpose banks.? Interesting idea, but money market funds have suffered far fewer losses than regulated banks.? I would pass on this idea, and look for more substantive ways to modify the financial system — as an example, make banks as transparent and complete in their regulatory filings as insurance companies.? Now, that would be real reform.

Book Review: Making Sense of the Dollar

Posted on 25 August 200912 February 2011 by David Merkel

Many people think in non-systematic terms.? They consider the US current account deficit to be an unmitigated disaster.? They look at one side of the issue and conclude that the US has become less competitive.

Understanding accounting, the books must balance.? Not everyone can run a current account surplus.? Some countries must run deficits in order to purchase goods from those that run surpluses.? Capital account surpluses balance out current account deficits; net foreign investment fills the gap.

Marc Chandler, with whom I became acquainted while writing for RealMoney, has written a book for the average reader to explain the basics of international economics and foreign exchange.? The book deals with common myths that arise in the discussion of trade and currencies.

Why do we lose industrial jobs in the US?? It’s not foreign competition, though that may occasionally play a role when countries subsidize their industries.? We lose industrial jobs because of technological improvements that require less labor in the manufacturing processes.? As I have said, Nucor was a bigger risk to the rest of the steel industry than foreign competitors.

Chandler is a proponent of the turn-of-the-century Open Door Policy, which led the US to be more free market capitalist than the rest of the world, gaining influence through trade.? Together with military victories, this led the US to be the world’s dominant economic power post-WWII.? Given the change in currency regimes, this made the US Dollar the leading reserve currency in the world.

Aside from military superiority, and political calm,? labor market flexibility and a culture of innovation have made the US dominant in global economic affairs.? As I have sometimes said, if the world did not have America, it would have to invest one.? Where else would all of the spare labor, capital and goods go?

There are advantages to being the world’s reserve currency.? The US runs current account deficits, and other nations buy our debts.? Such a deal; every nation should want this (but, as we learn, it is likely only one nation can have this at a time).

Capital flows are much larger than trade flows; it should be no surprise that the US Dollar does not react to the current account deficit.

(An aside: when I was in Grad School, the idea that interest rates drove currencies through arbitrage was new, and gaining favor.? Since then, a blend of the interest rate markets and goods markets driving currencies is the dominant paradigm, with momentum thrown in.)

Chandler deals with these issues, and other myths that plague the discussions around international economics and the currency markets.? In general, I agree with his views, but with a few quibbles/additions:

It is not costless for countries to run current account deficits.? Countries that run current account deficits have to offer attractive opportunities for foreigners to invest in their country, or suffer declines in the value of the currency.
The country taking the non-economic action will eventually pay the price.? Whether hoarding gold in mercantilism, or neo-mercantilism, hoarding US debt assets, whether Japan in the late ’80s or China today, the nation forcing the issue gets hurt more.? China will suffer for over-promoting growth of exports.
It would be reasonable to have a gold standard once more — the trick is setting the initial price level, so that it would not be inflationary or deflationary.
It would have been nice to offer retail investors some theory to explain how currencies move, rather than just dispel myths.? That said, there probably is no such theory, and if it exists, ordinary people probably could not understand it.

Absent my quibbles, on foreign currency Marc Chandler knows far more than me.? If foreign exchange and trade is of interest to you, you will benefit from this book. One more note: this is not a technical book with lots of math, and there is no technical analysis on its pages.

If you want to buy the book, you can buy it here: Making Sense of the Dollar: Exposing Dangerous Myths about Trade and Foreign Exchange

Full disclosure 1: I actually read the books that I review.? Many reviewers don’t.? They read the stuff the PR flack sends along, and read a chapter or two, and write the review.? I throw away what the PR flack sends before I read the book.? I give you my own opinion on the matter, nothing more, nothing less.? Finally, if you enter Amazon through my site and buy anything, I get a small commission.

Full disclosure 2: long NUE