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Things That Make You Go Hmmm...

Anne Elk’s Theory On Brontosauruses

July 28, 2014

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Anne Elk’s Theory On Brontosauruses

“... we haven’t had any accidents for months now...Everything on that island is perfectly fine.”

 

 

 

“Did not learned men, too, hold, till within the last twenty-five years, that a flying dragon was an impossible monster? And do we not now know that there are hundreds of them found fossil up and down the world? People call them Pterodactyles: but that is only because they are ashamed to call them flying dragons, after denying so long that flying dragons could exist.”

 

 

 

 

“They don’t have intelligence. They have what I like to call ‘thintelligence.’ They see the immediate situation. They think narrowly and they call it ‘being focused.’ They don’t see the surround. They don’t see the consequences. That’s how you get an island like this. From thintelligent thinking.”

Contents

THINGS THAT MAKE YOU GO HMMM... ....................................................3

How Russian Hackers Stole the Nasdaq ............................................................21

Bubblenomics and the Future of Real Estate ......................................................23

Have Central Banks Been Breaking the Law? ......................................................24

A Tour of France: Examining the New Sick Man of Europe ......................................26

Deutsche Bank, HSBC Accused of Silver Fix Manipulation .......................................28

Billion-Dollar Billy Beane .............................................................................29

Rebels With a Cause ...................................................................................31

How the Hammer Falls As China Nails Corruption ................................................32

“All the Conditions Are There for an Explosion” .................................................34

CHARTS THAT MAKE YOU GO HMMM... ..................................................37

WORDS THAT MAKE YOU GO HMMM... ...................................................40

AND FINALLY... .............................................................................41

Things That Make You Go Hmmm...

Though they reunited this past month for a series of concerts at London’s O2 Arena, the cast of Monty Python last assembled onstage together at London’s Drury Lane Theatre a staggering 40 years ago.

Pythons.psd

As they took to the stage at the O2 in early July, the surviving members of perhaps the most famous comedy troupe in history (sadly, Graham Chapman died in 1989) boasted a combined age of 357.

As expected, neither of these facts deterred people from flocking to see the Pythons; nor, it has to be said, did the occasional “senior moment” on stage prevent rapturous critics from garlanding them with rave reviews.

The centrepiece of the show was, of course, the famous “Parrot Sketch” in which John Cleese returns a dead Norwegian Blue parrot to “the very boutique” from whence it came “not ’alf an hour ago.”

The sketch, written by Cleese and Chapman in 1969, took aim at the British fondness for euphemism (particularly as pertains to death) and (somewhat ironically, given the subject) became one of the most mimicked pieces of comedy ever conceived.

The YouTube video I linked to above (just in case there is still anybody out there who HASN’T seen the “Parrot Sketch”) has 4.5 million views alone.

However, buried in the Python’s canon of work lies another sketch which proved far less popular amongst the viewing public but which found favour amongst (of all groups) the scientific community.

Anne%20Elk.psd

The sketch, “Anne Elk’s Theory on Brontosauruses,” appeared in the 31st episode of Monty Python’s Flying Circus, which was entitled “The All-England Summarize Proust Competition”; and it featured Chapman as a television interviewer and Cleese (in drag) as Miss Anne Elk, a paleontologist, who was in the studio to discuss her new, ground-breaking theory on the afore-mentioned dinosaurs.

What followed when Elk was questioned about her theory is classic Python:

Presenter: You have a new theory about the brontosaurus.

Anne Elk: Can I just say here, Chris, for one moment, that I have a new theory about the brontosaurus?

Presenter: Uh... Exactly...

Very long pause

(prompting) What is it?

Anne Elk: Where?

Presenter: Your new theory

Anne Elk: Oh! What is my theory?

Presenter: Yes!

Anne Elk: What is my theory that it is? Well, Chris, you may well ask me what is my theory.

Presenter: I am asking.

Anne Elk: Good for you. My word yes. Well Chris, what is it, that it is, this theory of mine. Well, this is what it is. My theory, that I have, that is to say, which is mine... is mine.

Presenter: Yes, I know it’s yours! What is it?

Anne Elk: ... Where? ... Oh! This is it.

Starts prolonged throat clearing

Anne Elk: (clears throat) This theory, which belongs to me, is as follows... (more throat clearing) This is how it goes... (clears throat) The next thing that I am going to say is my theory. (clears throat) Ready?

Inevitably, after such a prolonged build-up, the payoff is predictable in that Elk is clearly stalling in order to avoid explaining her theory for as long as possible; but, eventually, she is forced into laying it out for the whole world to see:

Anne Elk: My Theory, by A. Elk (Miss). This theory goes as follows and begins now:

All brontosauruses are thin at one end; much, much thicker in the middle; and then thin again at the far end. That is my theory that is mine and belongs to me and I own it and what it is, too.

... and in that instant, she is exposed for what she is: a fraud.

The scientific community adopted Anne Elk’s theory on brontosauruses to describe any scientific observation which is not actually a theory but rather a minimal account; and that sobriquet — it seems to me — merits far broader application and acceptance.

Lately I seem to be constantly reminded of Anne Elk everywhere I turn, as the world descends into chaos and those charged with running it (at least officially) stumble from pillar to post, relying on the public’s buying into whatever they spin in order to press their agenda.

We see it in the rush to demonize Vladimir Putin for the MH17 tragedy, along with everything else that remotely touches Russia; we see it in the one-sided reporting of events in the Middle East; and we see it in the broad-brush strokes painted across the China canvas when assumptions are made about what is happening inside the political hierarchy that runs the Middle Kingdom.

However, the one place it is glaringly obvious (and has been for a number of years) is in the talk emitting from the mouths of the world’s central bank governors.

Now, I am no great fan of Putin; nor do I feel able to confidently choose sides between various factions in the Middle East — mainly because I find it impossible to take what I read in the mainstream media at face value and therefore come to what I would consider a well-informed opinion — but the beauty of central bankers is that they hold press conferences and release detailed minutes of their meetings which, if anything, throw perhaps too much light onto their deliberations, operations, and machinations for anybody’s good — least of all their own.

July 26th, 2012: Anne Elk’s Mario Draghi’s Theory on Preserving the Euro:

Draghi%201.psd

This theory, which belongs to me, is as follows... (more throat clearing) This is how it goes... (clears throat) The next thing that I am going to say is my theory. (clears throat) Ready?

We think the euro is irreversible. And it’s not an empty word now, because I preceded saying exactly what actions have been made, are being made, to make it irreversible.

But there is another message I want to tell you.

Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.

Now, unlike Anne Elk’s (brackets, “Miss,” close brackets), Draghi’s theory — though in effect every bit as toothless should his bluff ever have been called — was taken at face value by a gullible public; and disaster was averted (though, along with the gullibility, there was also an implicit explicit bribe put carefully in place — buy bonds of bankrupt countries, and we’ll make sure you don’t lose money).

Many of you will probably not remember what the edge of the abyss looked like, so here are a couple of reminders — just for old times’ sake:

2414.png 

The chart above shows the yields on 10-year government bonds for Greece’s $242 billion economy; Spain’s $1.35 trillion economy; and the behemoth, Italy’s $2.17 trillion economy through 2011, going into the unveiling of Draghi’s Elk Theory plan and beyond.

Due to scaling issues, the plot for Greece is on a separate scale on the right-hand side of the chart; but, if you look carefully, you’ll see that yields on its 10-year bonds peaked at 37% in early 2012 and, despite some serious jawboning on the part of EU politicians, were still at 28% in July when Draghi cleared his throat.

Remember those days? Europe was teetering on the edge of oblivion, and each day saw the chances of a disorderly unwind of the euro increase to the point where even some of the more staunch pro-Europe voices began to waver in their certainty about its future.

Writing somewhat presciently a few short weeks before Draghi unveiled his Elk Theory, plan, The Economist laid out the bind perfectly:

(Economist): Even the single currency’s die-hard backers now acknowledge that it was put together badly and run worse.

Greece should never have been let in. France and Germany rode a coach and horses through the rules designed to prevent government borrowing getting out of hand. The high priests of euro-orthodoxy failed to grasp that, though Ireland and Spain kept to the euro’s fiscal rules, they were vulnerable to a property bust or that Portugal and Italy were trapped by slow growth and declining competitiveness.

A break-up, many argue, would allow individual countries to restore control over monetary policy. A cheaper currency would help match wages with workers’ productivity, for a while at least. Advocates of a break-up imagine an amicable split. Each government would decree that all domestic contracts—deposits and loans, prices and pay—should switch into a new currency. To prevent runs, banks, especially in weak economies, would shut over a weekend or limit withdrawals. To stop capital flight, governments would impose controls.

All good, except that the people who believe that countries would be better off without the euro gloss over the huge cost of getting there. Even if this break-up were somehow executed flawlessly, banks and firms across the continent would topple because their domestic and foreign assets and liabilities would no longer match. A cascade of defaults and lawsuits would follow. Governments that run deficits would be forced to cut spending brutally or print cash.

Has anything changed in Greece since July 26th, 2012? Well, let’s see:

Unemployment?

2430.png 

Nope.

GDP?

2441.png 

Well, technically, I guess you could say it rose, since it only fell 4% last year instead of 7% — it depends on how you define improvement, I guess. Either way, though the rate has slowed, the Greek economy spent its sixth straight year in contraction in 2013.

So no real improvement in Greece then.

What about Spain?

2454.png 

It’s a different chart from the Greek one, I promise you. It just LOOKS the same. In fact, the Spanish headline unemployment rate has actually plummeted to 25.4%, so... hooray for Europe!

GDP?

2467.png 

Well, let’s be charitable here, shall we? Ermmmm... (prolonged pause)... (clears throat)... Hey, Spain ain’t Greece!

Of course, the official GDP growth forecast for Greece for 2014 is... drumroll... +0.6%. And Spain? Well that would be growth, too — to the tune of +1.1% — but this is the work of the European Commission, a body whose website makes available the following upbeat reports for your downloading pleasure:

Spring 2014 European economic forecast: Growth becoming broader-based

Winter 2014 forecast European economic forcast: EU economy: recovery gaining ground

Autumn 2013 European economic forecast: EU economy: Gradual recovery, external risks

Spring 2013 European economic forecast: The EU economy: adjustment continues

Winter 2013, European economic forecast: The EU economy: gradually overcoming headwinds

What does the more-broadly-growing/gradually-recovering/ground-gaining/headwind-overcoming EU economy look like in graphical form?

Funny you should ask. I just happen to have the chart right here, courtesy of Eurostat:

2482.png 

{cough}.

Look... as we’re doing this, we can’t leave out Italy — and, what with Renzi’s resounding victory for the pro-EU lobby and the demise of Silvio, things there must be on the up, right?

2498.png 

Wrong.

And when we move to unemployment, well, things just go from bad to worse. As you can see in the chart below, youth unemployment in Italy is still rising relentlessly (it currently stands at 43%), and headline unemployment is also steadily climbing, suggesting that Italy has yet to reach its “bang moment”:

2509.png 

A further reminder of just how perilous things were back in 2012 can be seen in the chart below, which shows the Eurostoxx European Banks Index through that crucial 2011/2012 period.

2530.png 

In the 12 months prior to Draghi’s soothing words, the index had halved in value. From the day Draghi spoke, the rot miraculously stopped and the banks began a climb that would see them appreciate in value by over 100%.

Did European banks become more sound institutions on July 27th, 2012? (That was a rhetorical question, people; put your hands down.)

The only really important happenings in Europe’s banking sector during the post Elk Theory speech period were the following:

Cyprus bail-in

Erste Bank made a tiny miscalculation in its bad loan provisions (which led to a small 25% fall in its share price).

Corporate Commercial Bank (the 4th largest bank in Bulgaria) was taken into protective custody by the Bulgarian Central Bank.

Banco Espirito Santo sort of kind of went a bit pear-shaped.

European banks loaded themselves to the gills with peripheral European debt as part of the quid pro quo with Draghi, but making free carry off the Elk Theory promise of a desperate central bank head is hardly what used to pass for banking.

Remember when banking used to be about things like making loans?

EU%20Loan%20Creation.psd 

(Zerohedge): [The] ECB update on Monetary Developments in the Euro Area was as grim as always, with the all important series of loans to the private sector sliding once again by 2.0% Y/Y, worse even than April’s -1.8% contraction, driven by a €43 billion collapse in loans to households. This happened even as the now largely meaningless M3 rose by 1.0%, an increase to April’s 0.7% Y/Y change.

In other words, Europe is in bad a shape as pretty much ever, and loan creation is just fractions above its all-time low print of -2.3% from late 2013.

Never mind.

As long as Draghi’s Elk Theory promise is held up as good, there’s nothing to worry about.

When recently (finally) confronting the spectre of deflation, Draghi once again cleared his throat. Lo and behold, yet another Elk Theory tumbled forth. Grandstanding over a frankly ludicrous 10bp cut to an already ridiculous 25bp benchmark rate (as if it will make any difference), Draghi realised, no doubt, that it was time for yet more vague threats promises rhetoric. After imposing negative rates on European banks’ deposits, Mario Draghi (brackets “Mister,” close brackets) was put on the spot once more in the press conference:

This theory, which belongs to me, is as follows... (more throat clearing) This is how it goes... (clears throat) The next thing that I am going to say is my theory. (clears throat) Ready?

Are we finished? The answer is no. If required, we will act swiftly with further monetary policy easing. The Governing Council is unanimous in its commitment to using unconventional instruments within its mandate should it become necessary to further address risks of prolonged low inflation.

2565.png 

Now, let’s be serious for a moment, shall we?

Not only have the GIS (Greece, Italy & Spain) failed to recover, but the engine room of what’s left of Europe is also sputtering:

(Ambrose Evans-Pritchard): Europe’s economic recovery has stalled. The EMU policy elites took a fateful gamble that global growth alone would lift the eurozone off the reefs, without the need for serious monetary stimulus or a reflation package to ensure take-off velocity.

Their strategy has failed. The Bundesbank says German growth may have slumped to zero in the second quarter. French industrial output has fallen for three months in a row. French business surveys point to an outright contraction of GDP, with a high risk of a triple-dip recession.

Stagnation is automatically causing debt ratios to spiral upwards yet again across a large part of the currency bloc. The situation is doubly delicate since the European Central Bank is no longer able to serve as a lender of last resort for Italy, Portugal and Spain.

Germany’s top court has ruled that the ECB’s back-stop plan (OMT) “manifestly violates” the EU treaties, and is probably Ultra Vires. The political reality is that the OMT cannot be deployed, whatever the European Court says when it issues its own judgment long hence.

Any external economic shock at this stage risks exposing the fundamental incoherence of the EMU system, and therefore shattering the fragile truce in the markets.

Ambrose talks about the gamble taken by what he calls “EMU policy elites” but fails to mention the gamble taken by Draghi — that his Elk Theory would never be challenged.

So far, it hasn’t; but at some point Draghi’s going to have to stop clearing his throat and lay out some concrete steps — and THEN we’ll see just how effective he can be. My guess is that one of two things happen: the economies of Europe prove so weak that its politicians find a way around the “technicalities” of the Maastricht Treaty, which currently prevent them from printing money, and allow Draghi to unleash an inflationary blitz; or the market realizes that his words are hollow, and confidence in the ECB head (the only thing holding European markets together) is shattered.

That... would be ugly.

Already the pernicious effects of compounding are making their mark on the debt-to-GDP ratios of European governments, a point Ambrose makes quite clearly, using Italy as an example:

(Ambrose Evans-Pritchard ): Eurostat revealed this week that Italy’s debt rose to 135.6pc of GDP in the first quarter. This is near the point of no return for a country that borrows in what amounts to a foreign currency.

What is remarkable is that the ratio has jumped 5.4 percentage points over the past year despite austerity and even though Italy is running a primary budget surplus.

This is the toxic effect of near deflationary conditions on debt dynamics. Unless action is taken to boost nominal GDP, Italy must mathematically sink deeper into a compound interest trap.

Precisely, and it’s not just Italy that’s falling into this dreadful trap, as you can see from the chart below, which shows the YoY % change in debt-to-GDP ratios in Italy, Greece, France, and Spain:

2580.png 

There’s your austerity. Right there.

Greece didn’t waste any time getting back on the horse after their default restructuring wiped about 13% off their debt-to-GDP ratio in 2012, did they?

Make no mistake, folks, Europe is back — and not in the good way.

But it’s not just Draghi laying out Elk Theories.

Oh no.

Across the Atlantic, the continued narrative being spun by the Yellen Fed is one of “nothing to see here,” with a dab of “there’s no inflation,” a soupçon of “we will keep rates low for a very long time,” a dash of “everything bad that has happened can be put down to the weather,” and the merest suggestion of “these aren’t the droids you’re looking for.”

The Fed’s nemesis is inflation; and, over time, they (along with the BLS) have done everything in their power to paint a picture of benign inflation in order to further their agenda.

Take hedonics, for example.

For those of you unsure as to what hedonics (or “hedonic regression” to give it its full title) is, here’s the quick and boring dirty:

Hedonics.psd

(Wikipedia): In economics, hedonic regression or hedonic demand theory is a revealed preference method of estimating demand or value. It decomposes the item being researched into its constituent characteristics, and obtains estimates of the contributory value of each characteristic. This requires that the composite good being valued can be reduced to its constituent parts and that the market values those constituent parts.

Bottom line?

If your new iPad has more features than your old one did, then even though the price went UP, the newer model is “technically” cheaper because of the extra memory/pixels/whatever. Look, it just is, OK?

In a NY Times article published in May, the miracle of hedonics was laid bare for the world to see, and the chart accompanying it (right) showed that the cost of a television set (thanks to hedonics) has somehow fallen 110% since 2005.

Remarkable.

But back to inflation and the most recent CPI number:

2609.png 

(WSJ): “Recent readings on, for example, the CPI index have been a bit on the high side,” but the data are “noisy,” Ms. Yellen said at a press conference following a meeting of the Fed’s policymaking committee. “I think it’s important to remember that, broadly speaking, inflation is evolving in line with the committee’s expectations. The committee has expected a gradual return in inflation toward its 2% objective, and I think the recent evidence that we’ve seen, abstracting from the noise, suggests that we are moving back gradually, over time, toward our 2% objective.”

Fortunately for the world, Yellen’s own personal Elk Theory (inherited from her predecessors) is that the Federal Reserve is omniscient with regards to inflation and they can control it precisely should it get out of line:

... Ms. Yellen said the Fed “would not willingly see a prolonged period in which inflation persistently runs below our objective or above our objective.”

So basically, they are absolutely in complete control (unless they aren’t)...

She did, however, indicate the Fed might tolerate inflation overshooting the 2% goal if the U.S. economy were still far from the Fed’s goal of maximum employment. Right now, sluggish inflation and elevated unemployment both call for accommodative policy, but “there could conceivably arise policy conflicts or trade-offs somewhere down the road,” Ms. Yellen said.

... so they are OK with higher inflation for a while. Just not lower inflation.

We’ve seen this confidence amongst the academics at the Federal Reserve before. They are the group which brought you “Derivatives have permitted the unbundling of financial risks,“...many of the larger risks are dramatically — I should say, fully — hedged,” and of course the classic “Subprime is contained.”

However, in recent weeks, a hint of hesitancy has been creeping in around the edges, and without saying the dreaded B-word, Yellen took a sideways swipe at the valuations of certain social media and biotech stocks:

(Business Insider): “Equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched, with ratios of prices to forward earnings remaining high relative to historical norms.”

Wow! Janet, that’s a mere hop, skip, and a jump away from “irrational exuberance.”

Not to worry, though, the Fed Chair quickly added a postscript designed to address any possible contagion from her remarks about those “stretched” valuations in a tiny corner of the market:

(Business Insider): Some broad equity price indexes have increased to all-time highs in nominal terms since the end of 2013. However, valuation measures for the overall market in early July were generally at levels not far above their historical averages, suggesting that, in aggregate, investors are not excessively optimistic regarding equities.

Then she went for broke:

(Janet Yellen): [W]e understand that maintaining interest rates at low levels for a long time can incent reach-for-yield or asset bubbles. So we are monitoring this very closely.... My general assessment at this point is that threats to financial stability are at a moderate level and not a very high level. Some of the things that I would look at in assessing threats to financial stability to see if they’re broad-based — broad measures of asset prices, of equities, real estate, of debt — do they seem to be out of line with historical norms? And I think the answer is no. Some things may be on the high side, and there may be some pockets where we see valuations becoming very stretched, but not generally.

OK, Janet... keep going...

The use of leverage is not broad-based. It hasn’t increased in credit growth. It’s not — you know, at alarming levels by any means.... The Federal Reserve doesn’t take a view as to what the right level of equity or asset prices should be, but we do try to monitor to see if they are rising outside of levels consistent with historic norms. And as I indicated, in spite of the fact that equity prices, broad indices have risen substantially, price-equity ratios and other measures are not outside of historical norms.

Zerohedge helpfully published this table to help put Janet’s “not outside of historical norms” call into perspective:

Valuation
Measure

Description

Latest

1 Year
Ago

5- Year
Average

10-Year
Average

25-Year
Average

P/E

Price to Earnings

15.6x

13.8x

13.4x

13.8x

15.5x

CAPE

Shiller P/E

25.6

24.4

21.7

22.9

25.1

Div. Yield

Dividend Yield

1.9%

2.0%

2.0%

2.0%

2.1%

PEG

Price/Earnings to Growth

1.5

0.8

1.1

1.7

1.4

P/B

Price to Book

2.8

2.6

2.2

2.4

2.9

P/CF

Price to Cashflow

11.0

10.3

8.9

9.5

10.6

EY Spread

EY minus Baa Yield

1.7%

1.5%

2.0%

1.2%

-0.7%

Fed Chairs publishing research notes? Whatever next, I wonder?

I’ll tell you what’s next: the voice of sanity in the form of Stanley Druckenmiller, that’s what:

(CNBC): “Fed policy seems not only unnecessary, but fraught with unappreciated risk,” said Druckenmiller, speaking at the CNBC Institutional Investor Delivering Alpha Conference in New York. He said the actions are as “baffling” as they were in late 2003, when the Fed said its target rate would stay at 1 percent for a “considerable period” even when there were indications of vigorous growth.

The following year, the Fed started a cycle of tightening that pushed the rate to 5.25 percent by 2006.... “Five years into an economic and balance sheet recovery, extraordinary monetary measures are likely running into sharply diminishing returns,” he said. “The odds are high that the Fed’s monetary experiment will be more disruptive down the road than the Fed anticipates.”

Druckenmiller also questioned the Fed’s certainty over its forecasts, given mistakes in the past, including declaring in 2007 that the subprime mortgage crisis was contained.

“Where does their confidence come from?” he asked.

That’s a great question, Stan — but then we expect that from you. What we don’t expect are the likes of Janet Yellen (or, as Zerohedge have deliciously labeled her, “Yellen Capital LLC”) valuing equity markets for us.

But at the risk of being presumptuous, allow me to answer Stan’s (no doubt rhetorical) question.

Their “confidence” comes from a series of academic models and a lifetime spent studying theoretical finance and then applying it to real-world situations, often with disastrous effect.

The day these people admit to themselves (let alone to the public) that what they have believed to be foolproof doesn’t actually work, is the day they render pointless their entire lives’ work.

The alternative to grappling with hard realities — in this case to continue waltzing down the path of Keynesian folly — is, sadly, far more palatable. Eventually, though, the markets have a habit of demonstrating, beyond any reasonable doubt, that natural forces are far more powerful than the whims of a few academics. And that is, I fear, what we are setting ourselves up for.

Elk Theories — observations which are not, actually, theories but rather simply minimal accounts — are commonplace amongst today’s breed of central bankers, and for the time being there are no obvious signs of their legitimacy being challenged.

But that could change in a heartbeat. Should all the Elk Theories currently being espoused (yes, Messrs. Carney & Kuroda, I left you out of this week’s edition, but I haven’t forgotten you) be simultaneously recognized for what they are, then we will see some fireworks.

Yellen.psd

If Yellen would stop clearing HER throat long enough, her own Elk theory would, I strongly suspect, sound like this:

This theory, which belongs to me, is as follows... (more throat clearing) This is how it goes... (clears throat) The next thing that I am going to say is my theory. (clears throat) Ready?

We are absolutely convinced beyond any doubt whatsoever that we can, through the manipulation of interest rates and the theft of savings, extricate the world from its growth-free, post-2008 malaise and at the same time extricate ourselves from our $3.5 trillion dollar balance-sheet expansion.

We are quite certain that we can manipulate headline inflation to exactly where we need it to be and that any aberration can be blamed on the weather without so much as a whimper from the investing public.

We believe that bubbles are impossible to see until they burst, and we believe that we have played no part in generating the bubbles which have periodically plagued the world over the last several decades.

We know beyond question that holding interest rates at artificially and ridiculously low levels for several years will have no ill effects on the economy whatsoever; and we can assure you, with the utmost conviction, that we will be able to complete the taper without any damage being done to the equity markets.

That is my theory and what it is too.

Like those of Draghi, Yellen’s theories are nothing more than minimal observations which hardly stand up to scrutiny but for the fact that she has stated something which IS true currently.

While Anne Elk — brackets, “Miss”, close brackets — focused her keen scientific eye on the Brontosaurus, anybody with even the remnant of a childhood love of dinosaurs will remind you that the Brontosaurus — or “Thunder Lizard” — turned out to be a figment of somebody’s overactive imagination.

The creature, which in actual fact turned out to be thin at one end; much, much thicker in the middle; and then thin again at the far end, was actually the Apatosaurus, or “deceptive lizard.”

Fortunately, the world is now completely free of deceptive lizards.

Wait… what?

*******

With Spain still as my backdrop, it’s time once again to get to the meat of another Things That Make You Go Hmmm... and this week I have plenty for you to get your teeth into.

We begin with a story straight out of a Bruce Willis movie: the tale of how a group of Russian hackers tried to steal the NASDAQ. Things slow down just a little after that electric start, as my friend Ramsey Su looks at “Bubblenomics” and explains why economics and Monet have a lot in common, before Benjamin Morris attempts to put a value on Billy Beane.

Jeremy Warner ponders whether central banks have been breaking the law; we take a fascinating in-depth look at the new “sick man of Europe” — France — courtesy of Germany’s Der Spiegel; Deutsche Bank and HSBC are once again in the crosshairs — this time for allegedly rigging — there’s the word again, folks) — the silver fix (surely not???); and my great friend David Hay lays out the perils of indexation in a fabulous piece which he will be more than happy to send you in full should you ask him for it, a task I’ve made nice and easy for you with a clickable link.

China’s corruption probe deepens; former Israeli defence chief Yuval Diskin explains just how incendiary the situation in Gaza is; and we take a look at disconnects in housing and unemployment as well as Russia’s seemingly insatiable demand for gold.

Art Cashin weighs in on everything from Janet Yellen to another famous theory - that of the Efficient Market; and Canadian TV exposes L’exodus as French citizens flee François Hollande’s France in their droves.

And THAT, dear reader, wraps things up for this week, so...

Until Next Time...

*******

How Russian Hackers Stole the Nasdaq

In October 2010, a Federal Bureau of Investigation system monitoring U.S. Internet traffic picked up an alert. The signal was coming from Nasdaq (NDAQ). It looked like malware had snuck into the company’s central servers. There were indications that the intruder was not a kid somewhere, but the intelligence agency of another country. More troubling still: When the U.S. experts got a better look at the malware, they realized it was attack code, designed to cause damage.

As much as hacking has become a daily irritant, much more of it crosses watch-center monitors out of sight from the public. The Chinese, the French, the Israelis—and many less well known or understood players—all hack in one way or another. They steal missile plans, chemical formulas, power-plant pipeline schematics, and economic data. That’s espionage; attack code is a military strike. There are only a few recorded deployments, the most famous being the Stuxnet worm. Widely believed to be a joint project of the U.S. and Israel, Stuxnet temporarily disabled Iran’s uranium-processing facility at Natanz in 2010. It switched off safety mechanisms, causing the centrifuges at the heart of a refinery to spin out of control. Two years later, Iran destroyed two-thirds of Saudi Aramco’s computer network with a relatively unsophisticated but fast-spreading “wiper” virus. One veteran U.S. official says that when it came to a digital weapon planted in a critical system inside the U.S., he’s seen it only once—in Nasdaq.

The October alert prompted the involvement of the National Security Agency, and just into 2011, the NSA concluded there was a significant danger. A crisis action team convened via secure videoconference in a briefing room in an 11-story office building in the Washington suburbs. Besides a fondue restaurant and a CrossFit gym, the building is home to the National Cybersecurity and Communications Integration Center (NCCIC), whose mission is to spot and coordinate the government’s response to digital attacks on the U.S. They reviewed the FBI data and additional information from the NSA, and quickly concluded they needed to escalate.

Thus began a frenzied five-month investigation that would test the cyber-response capabilities of the U.S. and directly involve the president. Intelligence and law enforcement agencies, under pressure to decipher a complex hack, struggled to provide an even moderately clear picture to policymakers.

After months of work, there were still basic disagreements in different parts of government over who was behind the incident and why. “We’ve seen a nation-state gain access to at least one of our stock exchanges, I’ll put it that way, and it’s not crystal clear what their final objective is,” says House Intelligence Committee Chairman Mike Rogers, a Republican from Michigan, who agreed to talk about the incident only in general terms because the details remain classified. “The bad news of that equation is, I’m not sure you will really know until that final trigger is pulled. And you never want to get to that.”

Bloomberg Businessweek spent several months interviewing more than two dozen people about the Nasdaq attack and its aftermath, which has never been fully reported. Nine of those people were directly involved in the investigation and national security deliberations; none were authorized to speak on the record. “The investigation into the Nasdaq intrusion is an ongoing matter,” says FBI New York Assistant Director in Charge George Venizelos. “Like all cyber cases, it’s complex and involves evidence and facts that evolve over time.”

While the hack was successfully disrupted, it revealed how vulnerable financial exchanges—as well as banks, chemical refineries, water plants, and electric utilities—are to digital assault. One official who experienced the event firsthand says he thought the attack would change everything, that it would force the U.S. to get serious about preparing for a new era of conflict by computer. He was wrong.

On the call at the NCCIC were experts from the Defense, Treasury, and Homeland Security departments and from the NSA and FBI. The initial assessment provided the incident team with a few sketchy details about the hackers’ identity, yet it only took them minutes to agree that the incursion was so serious that the White House should be informed.

The conference call participants reconvened at the White House the next day, joined by officials from the Justice and State departments and the Central Intelligence Agency. The group drew up a set of options to be presented to senior national security officials from the White House, the Justice Department, the Pentagon, and others. Those officials determined the questions that investigators would have to answer: Were the hackers able to access and manipulate or destabilize the trading platform? Was the incursion part of a broader attack on the U.S. financial infrastructure?...

*** businessweek / link

Bubblenomics and the Future of Real Estate

Economics is like a Monet painting. Stand too close and all you see is a bunch of seemingly random paint strokes. Back up a few steps and an image emerges.

The painting of bubblenomics started with the Plaza Accord, September 1985, where five nations agreed to manipulate the dominant currencies at the time. Japan enjoyed a 50% devaluation of the US$ vs the yen, artificially enriching its citizens so they can travel the world in busloads with the eighty pounds of cameras around their necks.

The consequences of that bubble has yet to be corrected. Twenty years of fiscal and monetary accommodations led Japan to the world’s leading debt to GDP ratio.

The next big one was the US dotcom bubble, generating great wealth during the 1990s. More importantly, it started the era that income and savings became old school. Everyone can live off and retire on never ending asset appreciation. When that bubble burst, in came Greenspan with the mother of all bubbles — the subprime bubble. Amazingly enough, that mother of a bubble would soon be exceeded by the Bernanke/Yellen yield bubble.

In Europe, unbeknownst to the world, the Euro/EC bubble was brewing. Subprime countries like the PIIGS were allowed to borrow in the same manner that dishwashers in the US were given loans to buy McMansions. Marginal economies such Greece were able to buy Mercedes and import Armenians to do their work while the citizens collect pensions and crowd all the coffee bars. The ability to repay was never a consideration.

This massive global bubble financing has unintended benefactors. China, India and other emerging markets could never have double digit growth rates without the flood of capital from the West and the importing of jobs that were deemed unneeded by the asset rich Westerners. Countries like Australia and Brazil benefited from supplying raw materials to fuel the bubbles.

In summary, this Monet painting is becoming quite clear. In the modern world, there are no economies, only bubbles. There is not a country in the world that is not struggling to survive on yesterday’s stimulus plan , other countries’ stimulus plans, or waiting for tomorrow’s bailout to live another day. To anyone who is not in denial, it is obvious that no central banker has a viable solution and no one is willing to take the pain. In reality, there is no stimulus, just a continuous game of borrowing by governments and printing by central banks to keep the peasants from revolting.

Forget Samuelson or Friedman, this is the way I define the economic jargon. A stimulus is an investment into something that has future production value, at a cost today. A bubble is the creation of pseudo demand for something that we do not need, made possible by debt and leverage that we cannot afford. A bailout is a perpetuation of the bubble, using newly created fiat money and/or more debt to pay off the old. It sounds awful like a Ponzi Scheme.

How does real estate fit into this picture? For at least the last two decades, the real estate market is nothing but a by product of economic bubbles. Going forward, the future of real estate is dependent upon on what the all-mighty policy makers want to do. Yellen, unwilling to hide in the shadow of the QEs of her predecessor, is coming up with her own strategies, or terminologies. She has been promoting this thing called Macroprudential Policies. If I had studied that term in college, it has been long forgotten. I have to look up the definition and found a good explanation by the IMF. It is a very interesting paper with no practical use. Who is Yellen kidding besides herself?

She really thinks she understands the subject matter, have all the necessary tools and knows how to deploy all these complex unproven theories in the real world, as if she is adjusting the volume of her radio? Regardless of whether it is micro quantitative easing vs macro prudential, the bottom line is the Feds will accommodate whenever it is needed....

*** Ramsey su / link

Have central banks been breaking the law?

The best way to destroy the capitalist system, the Russian revolutionary leader Vladimir Lenin is reputed to have said, is to debauch the currency. The world’s major central banks have certainly been having a fair old go at it. In the six years since the financial crisis first broke, they’ve been printing money like there is no tomorrow.

Fortunately, they have not yet managed to bring down the free market system. On the other hand, they have succeeded in putting a rocket under asset prices and, in so doing, they have greatly exaggerated the wealth divide.

In a number of cases, including the US and the UK, they have also significantly assisted governments in financing burgeoning fiscal deficits. To the extent that quantitative easing (QE) has had any effect at all, it is asset prices and governments that have been the prime beneficiaries.

This might seem something of an old issue now; the Bank of England stopped buying assets more than two years ago, while the US Federal Reserve is “tapering” fast. For the US and Britain, the age of “unconventional monetary policy” seems to be largely over.

Elsewhere, however, QE remains very much a work in progress. In Japan it’s continuing at heroic pace, while on the Continent the European Central Bank is being urged by the International Monetary Fund to stop dilly-dallying in the face of deflationary pressures and get on with it.

Full marks, then, to Prof Andrew Johnstone and Trevor Pugh, of Sheffield Institute of Corporate and Commercial Law, for a new analysis, The Law and Economics of QE, which concludes that not only has QE been largely ineffectual but that it was also illegal.

Like common brigands, central banks have been acting outside the law — their only real excuse being the supposedly higher purpose of economic necessity, a sort of Robin Hood-type operation where the ends justify the means, only with a slight flaw; by driving up the value of financial assets and real estate, QE further skews the distribution of wealth towards those with already large holdings of it. It robs from the poor and gives to the rich.

Not that there is any possibility of the courts judging QE in all its various forms to be against the law, the writers concede. In Europe, the European Court of Justice has admittedly been asked to rule on ECB bond buying, but will almost certainly deem it to be a necessary price for holding the eurozone together. Never mind the law, the single currency comes first.

The director and deputy director of the IMF’s Europe division said in a recent blog: “So long as the ECB buys sovereign bonds in pursuit of its mandate and in a way that has nothing to do with fiscal outcomes it can rebut the oft-heard charge that QE violates the prohibition against ‘monetary financing of fiscal deficits’.” Thus does looking for ways around the law take precedence over its observation.

Lots of claims have been made for QE but no central bank has yet been able convincingly to demonstrate that it helps stimulate economic recovery. About the best that might be said for it is that it raised confidence at a critical moment in the crisis when financial and economic armageddon were threatened. But the persistence of asset purchases thereafter is much more questionable. There is not a whole lot of evidence to suggest it has played much of a role in restoring growth.

QE is supposed to work in a number of ways; it is, for instance, hard to argue that it hasn’t depressed long-term interest rates. Some have benefited from this phenomenon undoubtedly, in particular mortgage holders and large companies, but it doesn’t seem significantly to have reduced the cost or availability of finance to the real economy, which for many smaller companies remains high and scarce.

It was also meant to have led to “portfolio rebalancing”, with investors replacing the bonds bought by the central bank with other assets such as equities. This in turn might have marginally reduced the cost of capital but, again, for the vast majority of privately-owned businesses it has made no difference at all.

Another declared purpose was to raise inflationary expectations, which in turn was meant to boost spending and wages. Again, nil effect, unless you count the scare stories in the early stages of QE of Weimar-style hyper-inflation. In any case, real wages, the chief driver of domestically-generated inflation, have gone nowhere for nearly a decade now....

*** jeremy warner / link

A Tour of France: Examining the New Sick Man of Europe

There is a new word in the French language: La mannschaft. It’s the term used to define everything that is enviable on the opposite bank of the Rhine River — in other words, Germany’s success. It’s a success that is the product of the collective and is free of any of the egocentrics, self-deluded, bling-bling divas and “general director presidents,” as the heads of French companies are called, that can make France so stuffy.

A week ago Monday, on Bastille Day, newspapers across France sighed that it wouldn’t hurt if the country were a bit more like la mannschaft. Instead, unemployment is twice as high as it is in Germany, growth and investments have fallen far and former President Nicolas Sarkozy was recently detained for questioning by police at dawn. La mannschaft is the polar opposite of the other word currently in fashion in France: le malaise. A deep gloom appears to have taken hold in France. A recent survey showed that two-thirds of the French are “pessimistic” about their country’s future.

“Viewed from the outside, France under François Hollande is like Cuba, only without the sun but with the extreme right,” the newsweekly Le Point recently wrote. The country is “impoverished, over-indebted, divided, humbled and humiliated and finds itself in a pre-revolutionary situation in which anything seems possible.”

The only thing missing, it seems is the travel warning, because right at this moment, large numbers of vacationers from the rest of Europe are traveling in the country. Are these vacationers all francophone lemmings on their way to the cliff, blind to anything that doesn’t involve a game of boule or finding a camping spot?

Something is adrift in France. Rarely has the public mood been this miserable and the sullenness as omnipresent as it has been this summer. A president currently resides in Elysée Palace who was mercilessly booed during the July 14th military parade. It doesn’t seem possible for Hollande to get any less popular, and yet his popularity continues to fall from one low to the next.

But at least the country still has the Tour de France, the grand race that circles the country and serves as a prelude to the summer holiday season. Each year, it provides a long beloved view of a different, rural and idealized France — one where local firehouses still host annual dances, where there’s a memorial to those lost in the wars in front of every city hall and where the people know where they belong. But do they really?

This reporter recently traveled across France to take the country’s pulse with the people on the ground. The route followed stayed true to the course of the 2014 Tour de France, taking in cities, towns and villages, and sought to observe signs of the crisis, decline, collective depression and other specters that are haunting Germany’s most important neighbor.

The first stage of the tour to take place in France (the first three are in Britain this year) ends at the periphery of Lille in Pierre Mauroy Stadium, a sparkling arena of glass, steel and concrete. The only person in sight is a guard. Lille is one of the few success stories in a French Socialism that is otherwise in a state of crisis. Local Mayor Martine Aubry even managed to get re-elected recently. The politician is the anchor of the Socialist Party’s left wing. In contrast to the president, she is cherished by the party base. Aubry also happens to be the daughter of former European Commission President Jacques Delors, the father of currency union.

Although Lille has profited from Europe, Joël Leclerc has not. “Lille is for the rich,” he says, noting that he doesn’t even buy his coffee here. Leclerc is the sole security guard standing in front of Pierre Mauroy Stadium.

He’s the son of a miner and has a crew cut, as is common among members of the French Foreign Legion. He says he raised his children with a “good kick in the ass.” Unlike Lille, he says the village of Avion where he lives isn’t home to any “vermin,” the highly disparaging term used by Sarkozy to describe the children of immigrants who rampaged through the streets of Paris’ suburbs in 2005.

“We still have values here in the village,” Leclerc says. He’s the archetypical supporter of Marine Le Pen, leader of the far-right Front National party. Leclerc says he once had aspirations to become a member of the police force, but that he wasn’t able to. “My father threw lumps of coal during the 1968 strikes at the CRS, the special police,” he explains. “That’s what people here in the village do. Avion has been communist for 200 years. People call it Little Russia. Me? Of course I’m a communist. A simple worker.”

Leclerc remains loyal to the communists for the same reason that most of his colleagues have since begun voting for Front National — out of tradition, patriotism and the desire for order. He says his father once lived in Poland, somewhere near Katowice, but, no, he didn’t work in the mines there. The place had a different name. He had to stay there for three years. Then, without any special emphasis, he says the name: “Auschwitz.”...

*** der spiegel / link

Deutsche Bank, HSBC Accused of Silver Fix Manipulation

Deutsche Bank AG, HSBC Holdings Plc and Bank of Nova Scotia were accused in a lawsuit of rigging the price of billions of dollars in silver, an allegation similar to earlier suits involving the London gold fix.

The banks unlawfully manipulated the price of the metal and its derivatives, an investor claims in a complaint filed yesterday in federal court in Manhattan. The banks abused their position of controlling the daily silver fix to reap illegitimate profit from trading, hurting other investors in the silver market who use the benchmark in billions of dollars of transactions, according to the suit.

“The extreme level of secrecy creates an environment that is ripe for manipulation,” according to the complaint. “Defendants have a strong financial incentive to establish positions in both physical silver and silver derivatives prior to the public release of silver fixing results, allowing them to reap large illegitimate profits.”

The lawsuit is the latest to be brought against banks alleging manipulation of a benchmark. Suits have been filed against Deutsche Bank and Bank of Nova Scotia, HSBC and other banks in federal court in New York over allegations involving the London gold fix.

“We intend to vigorously defend ourselves against this suit,” Diane Flanagan, a spokeswoman for the Bank of Nova Scotia, said in an e-mail. Juanita Gutierrez, a spokeswoman for HSBC, and Amanda Williams, a representative for Deutsche Bank, declined to comment.

J. Scott Nicholson, a Washington state resident who filed the case, is seeking to represent a class of investors who have bought silver future contracts since Jan. 1, 2007.

The suit includes claims of aiding and abetting manipulation, as well as violation of antitrust laws and the Commodity Exchange Act. Nicholson seeks unspecified damages.

The 117-year-old system of fixing prices for the $5 trillion silver market is set to change next month.

London Silver Market Fixing Ltd. said in May it would stop administering the benchmark, used by everyone from mining companies to central banks to trade or value metal, once Deutsche Bank ends its participation on Aug. 14.

The German lender, HSBC and Bank of Nova Scotia (BNS) conduct the silver fixing, which first took place in 1897 at the office of Sharps & Wilkins with former dealers including Mocatta & Goldsmid, Pixley & Abell, and Samuel Montagu & Co.

Deutsche Bank, Germany’s biggest lender, said in January that it would withdraw from participating in setting gold and silver benchmarks in London, a month after announcing that it would cut about 200 jobs in commodities and exit dedicated energy, agriculture, dry-bulk and base-metals trading. JPMorgan Chase & Co., Morgan Stanley and Bank of America Corp. also are retreating from raw materials.

Precious metals are getting more attention from regulators after price rigging in everything from interbank lending rates to currencies led to fines and overhauled financial benchmarks.

The U.K.’s Financial Conduct Authority in May fined Barclays Plc after a trader sought to influence the gold fix in 2012. An LBMA survey showed the market wants a new silver system to be an electronic, auction-based process with more direct participants and prices that can be used in trades.

*** bloomberg / LINK

Billion-Dollar Billy Beane

The film version of “Moneyball” depicts many establishment baseball types as ignorant of where wins in baseball come from and clueless about how to properly value talent.

Take, for example, the scene when John Henry — the billionaire owner of the Boston Red Sox — tries to recruit the Oakland Athletics’ general manager Billy Beane. Henry tells Beane that any managers not rebuilding their teams with Beane’s system in mind are “dinosaurs,” and then hands him a slip of paper. On it, there’s an offer for Beane to become the new Red Sox general manager for the insane amount of $12.5 million dollars over five years. His fictional colleague tells us that the offer would make Beane “the highest-paid GM in the history of sports.” Despite appearing tempted, Beane ultimately declines the deal, claiming, “I made one decision in my life based on money and I swore I’d never do it again.”

Beane may not be the highest-paid GM in the history of sports, but he may be the most famous. An outfielder originally drafted 23rd overall by the New York Mets in 1980, Beane made his MLB debut in 1984, but was never successful against top competition. After getting washed out of the league, he became a scout for the A’s and eventually worked his way up to GM in 1997.

As GM, he has used Bill James-style advanced statistics to inform his decisions, and taken a strictly economic approach to valuing and acquiring players. Under his leadership, the A’s have been a very successful franchise despite routinely carrying one of baseball’s smallest payrolls. Beane’s story caught the attention of author Michael Lewis, who made him the central character in his 2003 bestseller “Moneyball” and something of a cultural icon for sports analytics.

Beane’s methods continue to be analyzed and celebrated by sabermetricians, and the A’s continue to massively exceed expectations given the amount they spend. They own the best record in baseball so far this season, and have the fifth-lowest payroll. It’s the best 100-game start of Beane’s career, and the best for the organization since its 1990 pennant-winning squad. Over the last 15 seasons, the A’s under Beane have had the fifth-best winning percentage in baseball, with the fourth-lowest total payroll. (The data used here is current through Monday, July 21.)

Beane has been a godsend to the frugal A’s, enabling them to achieve top-tier performance at bottom-tier prices. For this, the A’s have paid him fairly modestly — but since we don’t know how much winning is worth to the A’s organization, it’s hard to say exactly how much Beane has been worth to them.

For a team like the Red Sox, however, the picture is much more clear. Over the last 15 years, they’ve happily spent over $2 billion dollars in the pursuit of wins — and because they’re one of baseball’s most successful franchises, no one in Beantown is complaining.

From a strictly economic perspective, not offering Beane however much money it took to get him may have been one of the Red Sox’s poorest decisions since letting Babe Ruth go to the Yankees for next to nothing. And I mean that literally: Over the past 15 years, Billy Beane has been nothing less than the Babe Ruth of baseball GMs. The Red Sox offered Beane $2.5 million per year, but even $25 million would have been a bargain.

Billy%20Beane.psd

Finding Beane’s potential dollar value to the Red Sox is relatively simple: It’s the amount the team spent under general managers Theo Epstein and Ben Cherington, minus the amount it would have had to spend for the same performance with Beane as GM.

To show this, we first we need to figure out just how many A’s wins Beane has been responsible for, and how much those wins would cost on the open market.

Let’s start by comparing the A’s performance under Beane’s leadership to the performance we would expect from a typical GM with the same payroll. I created a logistic regression model8 that predicts a team’s win percentage by season based on the team’s relative payroll (excluding Oakland from the data), as measured by how many standard deviations it was above or below the average MLB payroll for each season. Above, I’ve plotted the non-Oakland team-seasons from 2000 to 2013 (on which the model is based) in groups of 15 by payroll (so, the dot farthest to the right represents the 15 team-seasons with the highest relative payrolls), and plotted the model’s prediction as a red line. I then plotted Oakland’s 15 seasons through 2014 as a single green point....

*** Five Thirty-eight (via Barry Ritholtz) / link

Rebels With a Cause

Now, let me take you back several years ago to a time when EVA readers numbered in the hundreds, not thousands. My wife and I were on our annual “date vacation” to Hawaii. While reading a book over in paradise, Justin Fox’s excellent The Myth of the Rational Market, I had an epiphany totally in synch with Charles’ essay from last week. As the handful of you who were EVA readers back then may dimly recall, I wrote about the dangers of what happens when a benchmark becomes an investment strategy.

One of my main points at the time was that when Vanguard’s Jack Bogle first concocted the idea of index investing in the early 1970s, it was a novel concept. It remained that way for many years. As a result, there was very little money devoted to simply replicating the S&P 500, the first iteration of indexing. And, in those days, when almost all money was actively managed, the kissing cousins of index investing, Exchange Traded Funds (ETFs), weren’t even a glimmer in the eye of their progenitor, State Street.

Yet, as the years passed, and a growing body of academic research supported the superiority of passive, or index, investing, the scales began to tip decidedly toward “no-think” money management (using that last word very loosely). Ironically, just as indexing became the accepted mantra, a new generation of academics, personified by Robert Shiller (of the eponymous and famous, Shiller P/E) and Daniel Kahneman, came to the fore. They broke ranks with the dominant orthodoxy and challenged the most basic and sacred assumptions of Efficient Market Theory (EMT), the cornerstone premise of passive investing.

In their view, the relatively mild market volatility prior to the crash of 1987—and well before the incredible bouts of extreme price fluctuations since 2000—were wholly inconsistent with an efficient market. Dr. Shiller’s seminal work on this was an early- 1980s treatise showing that stock prices even then were far more variable than the discounted-to-present-value-stream of future dividend income they were supposed to represent.

EVA%201.psd 

In very simple terms, his contention was that the price you pay for a stock in the long run should reflect the cash flow it is likely to produce. Because dividend payments have long maintained a steady upward arc (periodically, but temporarily, interrupted by recessions), stock prices should roughly track that path. Instead, as you can see in Figure 1 above, stocks prices swung up and down far more violently than the dividend trend line, again even prior to more recent extreme volatility. In other words, there was clearly a major inefficiency at work.

One could argue this was because, as indicated above, active management was overwhelmingly the leading investment approach, meaning that emotions might have played a much greater role than if money was simply managed on auto-pilot, mimicking a benchmark.

Yet, the facts of the last quarter-century, as indexing and quasi-indexing have gained so much market sway, tell a radically different story.

EVA%202.psd

Contrarians—the latest endangered species? In at least one prior EVA, I’ve observed that bubbles and their inverse—crashes— were relatively rare in the first half of my 35-year investment career. From 1979, when I started, to the late-1990s, there was the crash of 1987 and the Japanese bubble and bust. But, other than those events, there weren’t the wild and wooly swings we’ve experienced over the last 15 years. The following chart (left) reveals that since 2000, price fluctuations in the S&P 500 have returned to the extreme ranges of the Great Depression and the immediate post-war years (when another depression was widely anticipated).

Certainly, there are multiple causes for the plethora of mini- and maxi-bubbles we’ve experienced since the late 1990s. Misguided Fed policies would rank high on my list of probable causes, with long stretches of excessively cheap money encouraging multiple episodes of rank speculation, but I think the proliferation of mindless investing is another prime suspect.

*** DAVID HAY / Email for full commentary

How the Hammer Falls as China Nails Corruption

Curiosity is one reason the website of the Central Discipline Inspection Commission (CDIC) attracts up to 2 million page views every day.

Another reason is fear. Some website visitors, for example, want to know whether they or anyone they know has been targeted by a government campaign to root out corruption led by the CDIC Inspection Team.

Since the campaign began in December 2012, 33 high-level government and state company officials — all in positions at the deputy provincial level or higher — have come under investigation for violating laws or Communist Party rules. Each has been removed from office and detained. Some have been kicked out of the party.

Scores of executives, managers and bureaucrats on lower rungs of the ladder have been affected as well by CDIC, which reports directly to party brass and functions outside the realm of the nation’s judicial system.

The campaign began shortly after the 18th National People’s Congress with the December 2, 2012, detention of Li Chuncheng. Li, who was then serving as a deputy party secretary for Sichuan Province, was taken into custody by CDIC officials less than a month after being named an alternate member to the party’s 205-member Central Committee.

In recent weeks, the campaign has intensified. Losing their jobs in June were Jiangxi Province party official Zhao Zhiyong; China People’s Political Consultative Conference (CPPCC) Vice Chairman Su Rong; Shanxi Province Deputy Governor Du Shanxue; Shanxi Province CPPCC Vice Chairman Ling Zhengce; and Guangzhou’s party secretary, Wan Qingliang.

Perhaps the most powerful party official to fall in recent weeks was Xu Caihou, who served on the 25-member Politburo and as vice chairman of the Central Military Commission, the party’s highest authority on the military.

No one knows for sure who might fall next, which makes the website — http://www.ccdi.gov.cn/ — a must for anyone following the anti-corruption crackdown. These followers include members of the general public, ardent campaign supporters and a few cautious critics.

The critics include some party members who fear the CDIC may be going too far. Some of them argue that the crackdown could threaten everyday operations at targeted companies, the nation’s economy and even government stability in China.

Anxiety is running high, for example, at the state-run oil company China National Petroleum Corp. (CNPC), where chief accountant Wen Qingshan was placed under investigation in December and deputy general manager Bo Qiliang was probed in May. Previously removed were more than a dozen executives, including top brass like the company’s petroleum planning department general manager Wu Mei, Indonesia operations general manager Wei Zhigang, and Iran operations general manager Zhang Benquan. Other CNPC executives axed since 2012 included Wang Yongchun, Li Hualin, Ran Xinquan and Wang Daofu.

CNPC sources said that high-level managers are so worried about these investigations that they have drawn up a contingency plan for filling any position left vacant after a CDIC inspection. As part of the plan, all mid- to upper-level company managers must contact department heads daily. Anyone who does not report is considered gone, and replaced the next day by a pre-approved successor.

Amid the anxiety at CNPC, other state companies and government agencies in the bull’s eye of CDIC inspectors, some officials have asked whether it might be time for the campaign to slow down, easing the pressure on the nation’s party members. These go-slow voices include party supporters who worry that the campaign could tarnish the public’s view of the government and party. Others wonder whether the campaign is hurting economic growth and the productivity of officials, some of whom are laying low in hopes of avoiding the inspectors.

“The shock created by the anti-corruption campaign inside and outside the party is unprecedented,” said Professor Cai Xia of the Central Party School’s Party Construction Education and Research Department. “The shock and deterrence it has exerted on the thinking of cadres is also unprecedented.

“It’s evident that, at this point, very few cadres are risking any violations of party discipline rules.”

But supporters of the campaign point to its necessity at this stage of China’s modernization — and its long-term benefits.

One source close to the CDIC said most of the corrupt activity uncovered in government agencies was related to sales of government-owned land, mine development and transportation infrastructure projects. State-owned enterprises have been implicated in underhanded schemes involving project bidding, equipment procurement and overseas acquisitions.

“These areas just happened to be at the center of gravity during China’s high-speed urbanization and industrialization era,” the source said. “No nation has ever been able to avoid paying this kind of price during such a period. Not Britain, the United States, South Korea or Japan. This period is always rife with corruption.”...

*** caixin / link

All the Conditions Are There for an Explosion

SPIEGEL: Mr. Diskin, following 10 days of airstrikes, the Israeli army launched a ground invasion in the Gaza Strip last week. Why now? And what is the goal of the operation?

Diskin: Israel didn’t have any other choice than to increase the pressure, which explains the deployment of ground troops. All attempts at negotiation have failed thus far. The army is now trying to destroy the tunnels between Israel and the Gaza Strip with a kind of mini-invasion, also so that the government can show that it is doing something. Its voters have been increasingly vehement in demanding an invasion. The army hopes the invasion will finally force Hamas into a cease-fire. It is in equal parts action for the sake of action and aggressive posturing. They are saying: We aren’t operating in residential areas; we are just destroying the tunnel entrances. But that won’t, of course, change much in the disastrous situation. Rockets are stored in residential areas and shot from there as well.

SPIEGEL: You are saying that Prime Minister Benjamin Netanyahu has been pressured to act by the right?

Diskin: The good news for Israel is the fact that Netanyahu, Defense Minister Moshe Ya’alon and Army Chief of Staff Benny Gantz are not very adventurous. None of them really wanted to go in. None of them is really enthusiastic about reoccupying the Gaza Strip. Israel didn’t plan this operation at all. Israel was dragged into this crisis. We can only hope that it doesn’t go beyond this limited invasion and we won’t be forced to expand into the populated areas.

SPIEGEL: So what happens next?

Diskin: Israel is now an instrument in the hands of Hamas, not the opposite. Hamas doesn’t care if its population suffers under the attacks or not, because the population is suffering anyway. Hamas doesn’t really care about their own casualties either. They want to achieve something that will change the situation in Gaza. This is a really complicated situation for Israel. It would take one to two years to take over the Gaza Strip and get rid of the tunnels, the weapons depots and the ammunition stashes step-by-step. It would take time, but from the military point of view, it is possible. But then we would have 2 million people, most of them refugees, under our control and would be faced with criticism from the international community.

SPIEGEL: How strong is Hamas? How long can it continue to fire rockets?

Diskin: Unfortunately, we have failed in the past to deliver a debilitating blow against Hamas. During Operation Cast Led, in the winter of 2008-2009, we were close. In the last days of the operation, Hamas was very close to collapsing; many of them were shaving their faces. Now, the situation has changed to the benefit of the Islamists. They deepened the tunnels; they are more complex and tens of kilometers long. They succeeded in hiding the rockets and the people who launch the rockets. They can launch rockets almost any time that they want, as you can see.

SPIEGEL: Is Israel not essentially driving Palestinians into the arms of Hamas?

Diskin: It looks that way, yes. The people in the Gaza Strip have nothing to lose right now, just like Hamas. And this is the problem. As long as Mohammed Morsi of the Muslim Brotherhood was in power in Egypt, things were going great for Hamas. But then the Egyptian army took over and within just a few days, the new regime destroyed the tunnel economy between Gaza and the Sinai Peninsula, which was crucial for Hamas. Since then, Hamas has been under immense pressure; it can’t even pay the salaries of its public officials.

SPIEGEL: All mediation attempts have failed. Who can stop this war?

Diskin: We saw with the most recent attempt at a cease-fire that Egypt, which is the natural mediator in the Gaza Strip, is not the same Egypt as before. On the contrary, the Egyptians are using their importance as a negotiator to humiliate Hamas. You can’t tell Hamas right now: “Look, first you need to full-stop everything and then we will talk in another 48 hours.”

SPIEGEL: What about Israel talking directly with Hamas?

Diskin: That won’t be possible. Really, only the Egyptians can credibly mediate. But they have to put a more generous offer on the table: the opening of the border crossing from Rafah into Egypt, for example. Israel must also make concessions and allow more freedom of movement.

SPIEGEL: Are those the reasons why Hamas provoked the current escalation?

Diskin: Hamas didn’t want this war at first either. But as things often are in the Middle East, things happened differently. It began with the kidnapping of three Israeli teenagers in the West Bank. From what I read and from what I know about how Hamas operates, I think that the Hamas political bureau was taken by surprise. It seems as though it was not coordinated or directed by them....

*** der spiegel / link

Charts That Make You Go Hmmm...

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Source: WRI

The number of disconnects that are building up in various parts of the financial system is troubling, but every now and again one pops up that is just too crazy to ignore; and today, courtesy of Zerohedge, we have one such chart.

As they ask:

Does this look like a “recovering” economy five years after a central bank unleashes its extreme monetary policy?

Well I have to answer in the negative, but it’s the punchline from Zerohedge that really sparks the imagination:

Just what happens if interest rates ever rise?

What indeed...

*** zerohedge / link

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Another great chart from Tyler and the boys at Zerohedge, this time highlighting what they call “the new scariest chart in America,” courtesy of the True Economics blog of Constantin Gurdgiev.

This recession — in case you needed reminding — is not like any we’ve seen in several generations.

Nick Laird of the wonderful Sharelynx.com website keeps tabs on the change in gold holdings of the Central Bank of Russia, and depite all the sturm und drang surrounding the country at present, one thing remains constant: the bank’s appetite for gold bullion.

Another 500,000 ounces made its way into the vaults of the Central Bank of Russia in June of this year, and as you can see from Nick’s great chart below, not only has the trajectory of Russia’s accumulation changed dramatically since 2008, but since mid-2006 there have been only four months when minor sales were made.

*** sharelynx / link

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Source: Sharelynx

Words That Make You Go Hmmm...

 

Quitter%20France.psd 

Even Canadian TV is catching on to the fallout from François Hollande’s pernicious policies...

CLICK TO WATCH

Art Cashin is a true legend on the floor of the New York Stock Exchange.

In this interview with Eric King he discusses the skittish nature of the stock market as it digests geoopolitical worries and some poor earnings from Amazon and Visa, the unrest in the Middle East, problems in the currency markets and, of course, Russia.

As always, Art’s is the voice of reason in an often unreasonable world and one you should listen to.

Cashin.psd 

CLICK TO LISTEN

Rickards.jpg 

Jim Rickards discusses the June FOMC meeting, Janet Yellen’s July congressional testimony, the fact that the Fed Chair is now stock picking, and his belief that Efficient Markets Theory is junk science. Possible market crashes, asset freezes, and bail-ins — Jim goes into great detail in an excellent interview that is as broad as it is deep.

CLICK TO WATCH

and finally...

Watch in astonishment as marriage expert Mark Gungor explains the difference between men’s and women’s brains in a little over 13 minutes.

Who knew THAT could be done?!

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CLICK HERE TO WATCH VIDEO

Hmmm...

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Grant Williams

Grant Williams is the portfolio and strategy advisor to Vulpes Investment Management in Singapore — a hedge fund running over $280 million of largely partners’ capital across multiple strategies.

The high level of capital committed by the Vulpes partners ensures the strongest possible alignment between the firm and its investors.

Grant has 29 years of experience in finance on the Asian, Australian, European and US markets and has held senior positions at several international investment houses.

Grant has been writing Things That Make You Go Hmmm... since 2009.

For more information on Vulpes, please visit www.vulpesinvest.com.

*******

Follow me on Twitter: @TTMYGH

YouTube Video Channel: http://www.youtube.com/user/GWTTMYGH

PDAC 2014 Presentation: “Gold and Bad: A Tale Of Two Fingers

ASFA Annual Conference 2013: “Wizened In Oz

66th Annual CFA Conference, Singapore 2013 Presentation: “Do The Math

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As a result of my role at Vulpes Investment Management, it falls upon me to disclose that, from time to time, the views I express and/or the commentary I write in the pages of Things That Make You Go Hmmm... may reflect the positioning of one or all of the Vulpes funds—though I will not be making any specific recommendations in this publication.

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Hmmm...

A walk around the fringes of finance

THINGS THAT MAKE YOU GO

By Grant Williams

28 July 2014

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