You want to place a bet on future inflation? Well, an opportunity for you to bet on inflation is now in the works. The hedge fund Universa Investments L. P. is planning to open a fund in the near future that will allow you to back up your concern with the possibility that inflation is coming around the corner.
The fund will invest in options tied to commodities and Treasury bonds, among other things. The strategy is a “Black Swan” strategy aimed at taking advantage of wide swings in the prices of these assets.
Of course, the fund is connected with Nassim Nicholas Taleb, the infamous author of the best sellers “The Black Swan” and “Fooled by Randomness.” To Taleb, the probability that high rates of inflation might result from the stimulus efforts of governments around the world has substantially increased. This means that the possibility of a “fat tail” event happening, the chance that hyperinflation might occur, is a reasonable wager.
Mr. Taleb, in an interview, argued that “We think these things are going to see massive volatility.” These things being the price of corn, crude oil, copper, the stocks of oil drillers and gold miners, and the price of Treasury bonds and the value of the United States dollar. (For a more information see, “Black Swan Fund Makes a Big Bet on Inflation,” http://online.wsj.com/article/SB124380234786770027.html#mod=todays_us_money_and_investing.)
This effort is nothing new. It is just a high profile attempt to do what international investors have done for the last fifty years. (I know, it has been done for longer than that but I am just focusing on the modern era of imprudent government budget management.) And, there has been nothing more successful than betting against large fiscal deficits that put pressure on central banks to monetize the debt. The examples are numerous; see George Soros, the British Pound, and 1992 and Fancios Mitterand, the French Franc, and 1983 and more! The currencies of countries following Keynesian policies in which government budget deficits were used to stimulate economic growth and low levels of unemployment were easy targets for the international investment community.
Of course, inflation is not a problem now. And, many would argue that deflation is the real near term threat. Yet, the United States government, among others, is following a very “Keynesian” stimulus program with deficits that dwarf anything that has been seen in the past. The Federal Reserve System has forced an enormous amount of reserves into the banking and financial systems. For example, the year-over-year rate of increase of total reserves in the banking system was over 1,900% in April. The Fed’s purchase of mortgage-backed securities stood at $428 billion at the close of business on Wednesday May 28.
Chairman Bernanke has stated that the Fed will “reverse out” of these positions once the economy begins to pick up some speed. He may believe this and be very serious about achieving this end. BUT, there still are the large government deficits. How is the Fed going to handle them?
Not very easily, as is evident from the behavior in the bond market over the past couple of weeks. In fact, history is on the side of those that believe that the Fed cannot control long term interest rates over the longer run. Central banks all over the world have tried before, but success has only come in the short run and at the expense of monetizing too much of the government debt. This is the worldwide experience of the past 50 years! Governments all over the world have not been able to successfully combat the will of international financial markets if the participants in these markets believe that the fiscal policy of a government is not being conducted in a prudent manner.
The Federal Reserve got the first real taste of this in the last two weeks. There is more to come. The cycle is that the central bank tries to keep down long term rates by buying government securities. This is successful for a while, but the market observes that the central bank is monetizing the debt and so more pressure is put on bond prices forcing long term interest rates higher. Continued central bank efforts to hold down rates only result in the purchase of more government securities which then leads to more market concern about this monetization of the debt. Another round of central bank activity can follow. This picture of the dog chasing its tail only ends in frustration for the central bank and finally resignation that its goal cannot be achieved.
And, all during this time, the value of the currency of the country falls. Sound familiar?
When does the inflation occur?
That is uncertain. It will occur some time in the future. We know, however, that with large amounts of uncertainty, volatility increases.
In the meantime, you have a good argument for buying options which is what the Universa effort is going to do.
The question then becomes one about whether or not another Black Swan will occur. How are you betting?
Showing posts with label Nicholas Taleb. Show all posts
Showing posts with label Nicholas Taleb. Show all posts
Monday, June 1, 2009
Thursday, May 7, 2009
A Tipping Point?
Almost everyone is looking for a tipping point. At this time we are looking for signs that the decline in the economy and in the financial markets is lessening and that we might be somewhere near the bottom. If this is the case then can the turn to recovery be far behind?
It seems that every piece of information currently being released carries with it the claim that “this decline was less than expected” or ‘the decline was smaller than the last information released.” These are taken as signs of hope.
Even the results of the Treasury’s “stress tests” on the banks are accompanied by the assessment that the major banks that have just been examined are better off than was thought. Therefore, the banking system is not in as bad a condition as feared, and, stock prices can now continue moving upwards.
Fed Chairman Bernanke is still the leading spokesperson and “cheer-leader” in the administration and he stated this week that the economy will begin to expand later this year. So we must be at or near the bottom if the administration thinks so. Right?
We still have the nay-sayers out there claiming that things remain in terribly bad shape. Nicolas Taleb, of Black Swan fame, is saying that the economic situation is worse than it was in the 1930s because world markets are much more integrated now than it was then. And, Nouriel Roubini continues to sound alarms about how bad things could get. Part of his argument rests on the fact that the worst case scenario used in the Treasury’s “stress test” is out-of-date due to the recently released estimates issued by the International Monetary Fund that financial sector losses have doubled in the last six months. Yet are their claims sounding awfully shrill these days amidst the hope others are seeing?
Where are we?
To me, the uncertainties still outweigh any real sense of which direction the economy might take. I would tend to lean on the side that we have not seen the bottom yet, but what odds would I place on this possibility? Maybe I would give odds of 2-to-1 that the economy still will decline further. Maybe they should be 3-to-1. Maybe they should be 3-to-2. Somewhere in there.
First off, I am not convinced that the banks are coming out-of-the woods yet. Even if they are able to obtain more capital, I don’t see their lending picking up in any major way. Personal and business bankruptcies are still on the rise and there are still several major “black clouds” on the horizon that threaten that the storm that has hit bank balance sheets is not over. There are still large companies that are going out-of-business on a regular basis, in retail, in commercial real estate, in some areas of manufacturing, and we are waiting for the full ramifications of the collapses in the auto industry. Car dealerships are being closed, parts supply companies are on the edge, and the spread of these closures are affecting many other organizations and geographic regions. If unemployment is going to continue to rise, since it is a lagging economic indicator, then there still are houses that are going to need to be sold if not foreclosed upon and some credit card debt and auto loans that will need repayment.
And, speaking of cars. Last time I looked the price of a barrel of oil was approaching $60. Where is the price of oil going? And, the price of other commodities? The Financial Times has had several articles recently about why the price of commodities, including oil, might be going higher if a trough or bottom has been reached. What would higher commodity prices do to any recovery?
Then there is the level of interest rates. The government held an auction today for $14 billion of 30-year Treasury securities. The result? The yield of the new issue came out at 4.288% higher than the expected 4.192%. This caused a decline in bond prices with the 10-year Treasury note trading around 3.30% up from 3.14% late last week which was above the 3.00% level, reached earlier last week a level that had not been crossed since November 24, 2008.
How high are these interest rates going to go and what impact will these higher rates have on mortgage rates and corporate rates? We are already seeing spreads between Treasuries and corporates reach levels since last October and November. And the interest rate spreads on lesser credits have also been increasing. And, there is still much more Treasury debt to come.
Furthermore, the economic structure of the United States (and the world) has changed. The manufacturing base is going to be different in upcoming years and everything is going to be more connected technologically than before. And, what if the personal savings rate in the United States reverts back to 8% or so as it was before 1992? We are not going to be able to force employment, human or otherwise, back into the same industrial and financial structure with the same employment intensity as existed before this economic collapse.
I am not intentionally trying to stay on the “dark side”. It would be great if things were bottoming out and the economy were about to start on an upward path once again. But, there still seem to be too many “unknowns” out there, unknowns that relate to serious problems, for us to get our hopes up too high at this point. Managements must still re-focus their businesses and must deleverage their balance sheets. Boards of Directors still must make sure they have the right executives in the right places, and if the Boards don’t do this then the shareholders must become more aggressive. Many executives that managed in the pre-2007 period, I believe, are not the executives to lead our companies in the post-2009 period.
Are we at a tipping point? Are we at or near the bottom of the downturn?
The most important questions are still going unanswered: even with the results of the Treasury stress tests. Will a major bank fail? How many regional banks might fail? So far there have been 32 bank failures this year, up from 25 last year and 8 the year before. How will a General Motors bankruptcy impact the economy? What other possibilities are out there?
Other company failures? Bloomberg reports today "Moody’s is forecasting the default rate among high-yield companies globally to soar to 14.8 percent by year-end from 8.3percent in April as companies that financed a record amount of high-yield, high-risk debt leading up to the credit crisis struggle to refinance."
And, I haven’t mentioned the debt overload that exists throughout the country. The list goes on.
It seems to me that what we are seeing a lot of these days is wishful thinking. I really haven’t seen anything yet that one could argue was a “hard” fact pointing to a bottom of the downturn. I really don’t think we are going to see any “hard” facts in the near future, so the stock market and other areas of the economy will just to continue to live off of wishful thinking. This is a situation made for traders. Uncertainty creates volatility and traders feast off of volatility. I guess it is good to know that at least some people profit from this environment.
It seems that every piece of information currently being released carries with it the claim that “this decline was less than expected” or ‘the decline was smaller than the last information released.” These are taken as signs of hope.
Even the results of the Treasury’s “stress tests” on the banks are accompanied by the assessment that the major banks that have just been examined are better off than was thought. Therefore, the banking system is not in as bad a condition as feared, and, stock prices can now continue moving upwards.
Fed Chairman Bernanke is still the leading spokesperson and “cheer-leader” in the administration and he stated this week that the economy will begin to expand later this year. So we must be at or near the bottom if the administration thinks so. Right?
We still have the nay-sayers out there claiming that things remain in terribly bad shape. Nicolas Taleb, of Black Swan fame, is saying that the economic situation is worse than it was in the 1930s because world markets are much more integrated now than it was then. And, Nouriel Roubini continues to sound alarms about how bad things could get. Part of his argument rests on the fact that the worst case scenario used in the Treasury’s “stress test” is out-of-date due to the recently released estimates issued by the International Monetary Fund that financial sector losses have doubled in the last six months. Yet are their claims sounding awfully shrill these days amidst the hope others are seeing?
Where are we?
To me, the uncertainties still outweigh any real sense of which direction the economy might take. I would tend to lean on the side that we have not seen the bottom yet, but what odds would I place on this possibility? Maybe I would give odds of 2-to-1 that the economy still will decline further. Maybe they should be 3-to-1. Maybe they should be 3-to-2. Somewhere in there.
First off, I am not convinced that the banks are coming out-of-the woods yet. Even if they are able to obtain more capital, I don’t see their lending picking up in any major way. Personal and business bankruptcies are still on the rise and there are still several major “black clouds” on the horizon that threaten that the storm that has hit bank balance sheets is not over. There are still large companies that are going out-of-business on a regular basis, in retail, in commercial real estate, in some areas of manufacturing, and we are waiting for the full ramifications of the collapses in the auto industry. Car dealerships are being closed, parts supply companies are on the edge, and the spread of these closures are affecting many other organizations and geographic regions. If unemployment is going to continue to rise, since it is a lagging economic indicator, then there still are houses that are going to need to be sold if not foreclosed upon and some credit card debt and auto loans that will need repayment.
And, speaking of cars. Last time I looked the price of a barrel of oil was approaching $60. Where is the price of oil going? And, the price of other commodities? The Financial Times has had several articles recently about why the price of commodities, including oil, might be going higher if a trough or bottom has been reached. What would higher commodity prices do to any recovery?
Then there is the level of interest rates. The government held an auction today for $14 billion of 30-year Treasury securities. The result? The yield of the new issue came out at 4.288% higher than the expected 4.192%. This caused a decline in bond prices with the 10-year Treasury note trading around 3.30% up from 3.14% late last week which was above the 3.00% level, reached earlier last week a level that had not been crossed since November 24, 2008.
How high are these interest rates going to go and what impact will these higher rates have on mortgage rates and corporate rates? We are already seeing spreads between Treasuries and corporates reach levels since last October and November. And the interest rate spreads on lesser credits have also been increasing. And, there is still much more Treasury debt to come.
Furthermore, the economic structure of the United States (and the world) has changed. The manufacturing base is going to be different in upcoming years and everything is going to be more connected technologically than before. And, what if the personal savings rate in the United States reverts back to 8% or so as it was before 1992? We are not going to be able to force employment, human or otherwise, back into the same industrial and financial structure with the same employment intensity as existed before this economic collapse.
I am not intentionally trying to stay on the “dark side”. It would be great if things were bottoming out and the economy were about to start on an upward path once again. But, there still seem to be too many “unknowns” out there, unknowns that relate to serious problems, for us to get our hopes up too high at this point. Managements must still re-focus their businesses and must deleverage their balance sheets. Boards of Directors still must make sure they have the right executives in the right places, and if the Boards don’t do this then the shareholders must become more aggressive. Many executives that managed in the pre-2007 period, I believe, are not the executives to lead our companies in the post-2009 period.
Are we at a tipping point? Are we at or near the bottom of the downturn?
The most important questions are still going unanswered: even with the results of the Treasury stress tests. Will a major bank fail? How many regional banks might fail? So far there have been 32 bank failures this year, up from 25 last year and 8 the year before. How will a General Motors bankruptcy impact the economy? What other possibilities are out there?
Other company failures? Bloomberg reports today "Moody’s is forecasting the default rate among high-yield companies globally to soar to 14.8 percent by year-end from 8.3percent in April as companies that financed a record amount of high-yield, high-risk debt leading up to the credit crisis struggle to refinance."
And, I haven’t mentioned the debt overload that exists throughout the country. The list goes on.
It seems to me that what we are seeing a lot of these days is wishful thinking. I really haven’t seen anything yet that one could argue was a “hard” fact pointing to a bottom of the downturn. I really don’t think we are going to see any “hard” facts in the near future, so the stock market and other areas of the economy will just to continue to live off of wishful thinking. This is a situation made for traders. Uncertainty creates volatility and traders feast off of volatility. I guess it is good to know that at least some people profit from this environment.
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