Ask Rande

Top 1759. Aug 12, 1999 12:26 PM

» Roger_Babson - Kirk, Rande...

..., the construction boom (overinvestment) occurring all around the U.S. is "precisely" what one would expect at this point in the K-Wave late-Plateau stage.

This is similar to the 1820s-30s "Era of Good Feelings" (canals/river transport infrastructure), 1860s-70s early "Gilded Age" (railroads and telegraph), and 1920s "Roaring Twenties" (autos, highways, electricity, telephone, etc.), which followed a previous inflationary growth period and stagflation peak (1814, 1864, and 1920, compared to 1980-81) and were characterized by disinflation/deflation, emergence of a dominant technology paradigm, globalization of economic activity, and a period of poltical conservatism (pro-business) versus activism, economic booms and unbridled stock market speculation (Panic of 1837, Panic of 1873, and 1929 Crash), each succeeded by severe economic depressions (1840s, 1870s, and 1930s).

Interestingly, one reads how interest rates are the lowest in 30 years. Nominally, this is true. However, it is "real" rates that determine the point at which the ecomony is in the long-wave. That is, today real rates for 30-year mortgages are approaching or surpassing 6%, whereas the average rate since the beginning of the Plateau in 1981 has held around 5%, the highest since the 1920s.

So? Higher real rates of interest during a Plateau reflect the relative reduction in creditworthiness of the society, not coincidentally at the same time the concentration of wealth and income becomes acute (as ocurred in the 1820s-30s, 1860s-70s, and 1910s-20s). In other words, as wealth concentrates to the few, the bulk of borrowers in society (governments, individuals, and businesses), become less creditworthy and must borrow more over time to finance levels of investment and consumption sufficient to maintain growth. Those with capital, then, demand an increasingly higher premium against risk of default. Over the course of the Plateau, as the effects on peak spending from a peak in the Baby Boom birth rate 35-40 years earlier are felt, debt at higher average real interest rates grow and reach a peak toward the end of the economic boom phase (today).

The accumulated debt at higher real rates reach a point of diminishing returns, with respect to its effect of increasing the rate of growth of real GDP, as demographic forces peak and begin to decelerate. It is not until this point that real rates begin to accelerate above trend, reflecting an increasing degree of risk. Ironically, and what will be confusing to policymakers and observers is that real rates rise as the rate of change of demand for credit begins to decelerate (again, demographics).

This is the point at which we find ourselves today. As demographically-induced

BTW, to the 1970s inflation causes, again, demographics play a critical role. By the early 1960s, the birth rate had peaked. Not long thereafter, the rate of growth of the real per capita GDP from the lows in the 1930s and 1940s had hit stride and had begun to plateau. In effect, the U.S. economy had been satruated with goods in the 20 years following the end of WW II, prompting U.S. companies to aggresively seek markets abroad.

By 1963, the oldest of the Baby Boom had begun forming households en masse, and, by the late 1960s, the bulk of (fastest rate of change of growth) the Baby Boom cohort (born 1950 and before) had entered the labor market and begun to place demands on existing resources. The inflation of the 1970s is a result of an unprecedented increase in demand for resources, as a result of the fasting growing segment of the Boom cohort reaching age of household formation. Yet, there is another factor occurring coincident with this situation.

By the early 1960s and through the decade, transnational investment had exploded, resulting in dollars and dollar-denominated accounts to dramatically increase. Moreover, the dollar had become the reserve currency from Bretton Woods, and oil was transacted in dollars.

The increase in demand for dollars, especially throughout Europe placed severe pressure on European currencies and the ability to maintain gold reserves, especially in France and Italy. By the mid 1960s, France had begun to move against the dollar, threatening to redeem dollars for gold (as France did to sterling in the 1930-31).

With tens of billions of dollars at risk of gold redemptions, which the U.S. could not hope to satisfy, the Johnson administration made the difficult decision to begin the process to leave gold and abandon Bretton Woods in 1966-68. The borrowing and spending for the Vietnamese conflict and the Great Society only exacerbated the demographic and geopolitical dollar situation.

Of course, it was not until the Nixon administration in 1971-73 (formally under Ford in 1974) that the dollar left gold and was in effect devalued. This allowed the dollar to freely float and eventually lose 40% of its value in a short period of time.

The resulting collapse in the value of the dollar resulted in an immediate decline in real profits to oil producers and nations, prompting them to form OPEC and raise prices to adjust to the new floating value of the dollar. This is the REAL reason for the dramatic increase in oil prices, instead of the "oil shortage".

By 1979-80, the youngest of the Boom cohort (born 1961) had entered the labor market. It was at this point, irrespective of Fed policy or otherwise, that prices would have peaked, as the rate of change of the growth of the labor market (and thus the rate of change of aggregate demand associated with household formation and child rearing) peaked. This is characteristic of the end of a K-Wave Stagflation Peak and the onset of a Plateau, which, upon reaching the peak in the youngest boom cohort segment's peak spending phase (1995-99), turns down into a K-Wave Secondary Depression, precipitated by an endogenous shock and dramtically rising real rates, even as short rates fall.

Thus, the relative inflation in assets, real estate, commodity prices are the function of the demographic peak (folks born 1957-61) and temporary. The Fed (banks) is (are) not misguided in their concern over inflation. It is not general price inflation but asset price inflation that is the real danger at this point. Having allowed excessive credit and the speculation it encourages to get so far out of hand (as in 1929, Japan in the late 1980s, and Hong Kong in the 1990s), the banks have been reducing lending and distributing risk to the markets since the summer of 1998.

Unfortunately, there is no precedent for the Fed/banks succeeding in slowly deflating the asset bubble, as I fear they believe that they can do. Thus, the rate hike, IMO, are not justified and are merely a formality. They will have to be cut again as soon as the stock market declines and affects the economy, as it surely will, IMO.

I apologize for the length of the post. I suspect that by this point, most readers will have become bored, disinterested, or confused, so I will end here. Needless to say, there is more to relate and more context to apply, but this will suffice for the present.

Regards,

-- posted by Roger_Babson

Top 1760. Aug 12, 1999 1:10 PM

» Phish - Thanks Rande, you are correct

My bad, I should have verified before posting:

> Actually, a little less than 5%. Check out the POP clocks:

> http://www.census.gov/main/www/popclock....

On second thought, I was recalling a recent article that discussed the percentage of the world population that speaks English.

If you add L1 (first language - mother tongue), L2 (second language) and EFL (English Foreign Language - occasional usage) speakers of English, then the estimated number is around 12% of World population.

That means approximately 88% of the world does NOT speak English.

Interesting thought, no?

-Randy

-- posted by Phish

Top 1761. Aug 12, 1999 1:14 PM

» KirkL - Thanks Roger.

Thanks Roger. I followed that, believe it or not!
There is much to digest there, but much makes sense. Interesting about the OPEC crisis. I wasn't aware it was tied to the dollar losing value relative to other currencies due to going off the gold standard. It makes sense they wanted to protect their profits.

Your explaination for why real rates are so high makes far more sense than some I've heard. IF inflation is so low, I wondered why rates were not lower as they were in the 1950's and 1960's?

IT still all comes down to how do you assign worth or value to something and it is nothing more that "what someone is willing to pay". I suppose figuring out when people are willing to start paying less is key to predicting the next bear.

I remain unconvinced of demographics as I have explained many times, but the argument that assets ARE expensive and won't be willing to pay as much for them SOMETIME is true.... Just when is the issue.

-- posted by KirkL

Top 1762. Aug 12, 1999 3:16 PM

» Roger_Babson - Kirk...

..., you wrote:

'IT still all comes down to how do you assign worth or value to something and it is nothing more that "what someone is willing to pay". I suppose
figuring out when people are willing to start paying less is key to predicting the next bear."

This is true, but I would add, however, that what one "can pay" for something (stocks, in this case) is determined largely by (1) the amount of credit available and (2) the cost of the credit.

To the former, it is said that in a credit-based monetary system (as opposed to a gold-based one), there is theoretically "no limit" on the amount of credit that can be created and thus, by extention, therefore, there is no risk of deflation as long as the central bank does not do something foolish and "cause a panic" (as is the cause attributed by most revisionists with respect to the 1929 Crash and depression).

This neglects the fact that at some point, demographic factors result in a situation where the relative rate of growth of high-multiplier spending peaks and begins to decelerate (1999-2000). This reduces the rate of growth of credit expansion (money supply growth), which is required to keep asset prices and demand rising. No amount of increase in reserves and decrease in nominal short rates to simulate borrowing can make already debt-burdened borrowers more creditworthy, nor can it make up for the loss of demand-induced credit expansion that contributed directly to the previous rate of growth ("pushing on a string" argument).

To the latter point, the real rate of interest rises as the expansion wears on, as risk rises, eventually reaching a point at which compounding effects begin to outpace the rate of growth of income (and cororate earnings). No amount of new, nominally cheaper credit to service increasingly expensive existing debt can overcome this immutable law of compounding and diminishing returns of credit.

We are there now, as it is now requiring the maintaince of $3 of debt to produce $1 of real GDP. This is without question unsustainable and far worse than the situation that existed in 1929 and Japan in the late 1980s.

The perception of households that the rising values of their mutual funds and homes are making them wealthier belies the fact that the debt that they are accumulating as a result (home-equity, signature loans, borrowing against or from 401Ks, etc.) of the perceived increase in wealth is resulting in their "net wealth" becoming "negative". The perceived wealth is a direct result of demographic forces, which, in turn, cause an increase in demand for credit. At some point, the rate of change peak is reached and deceleration occurs, causing asset prices to fall and economic contraction to ensue.

In my assessment, we reach this point this summer and begin to decelerate after the first of next year.

Regards,

-- posted by Roger_Babson

Top 1763. Aug 12, 1999 3:37 PM

» RandeS - Anyone who harbors the slightest "good feeling" is a fool.

Anyone who harbors the slightest "good feeling" is a fool. Optimism over the future, whether with regard to the potential continued prosperity of American and global businesses or advancements in technology having a positive impact on anything whatsoever is the hallmark of an ignorant, woefully uneducated member of the easily-duped masses (this includes the Chairman of the Federal Reserve and the so-called "brightest" minds of corporate America). Only the truly enlightened ones who recognize that there are immutable cyclical forces at work, beyond anyone's control, which will destroy all that is presently good and any future good that might be hoped for, are prepared for the disasters soon to come. Those who stupidly believe there is even the slightest possibility for anything positive during their lifetimes, no matter how "reasonable" they think their exptations might be, deserve to be decimated by the tidal wave of doom soon to befall them. Pigs.

-- posted by RandeS

Top 1764. Aug 12, 1999 3:39 PM

» RandeS - Just in case.

Just in case....only kidding. ;)

-- posted by RandeS

Top 1765. Aug 12, 1999 3:59 PM

» BPyles - Thought the stress had cracked you up. You should sign

posts like that as "Orsen Wells."

-- posted by BPyles

Top 1766. Aug 12, 1999 4:03 PM

» TONYBRIG - Practicing being a Bear?

Practicing being a Bear?
Rande you been rubbing elbows with the wrong
people.
Talk to a confused person/group too much and
one feels sorta confused.
Need to step back and detach oneself from the
World to really see what is happening.
Now if I had a Crystal Ball like the Wizard.
Ha one guy e mailed me and said Hi Wizard today.

vbolhh

-- posted by TONYBRIG

Top 1767. Aug 13, 1999 5:43 AM

» RandeS - PPI came in better than expected at .

PPI came in better than expected at .2% overall and unchanged at the core (vs. expectations of .3% overall .1% at the core). Next Tuesday's core CPI is more important, and the good PPI number doesn't change the FOMC picture much, but it's encouraging neveretheless. Although intermediate goods rose .6% after a .4% rise last month, the overall and core numbers look exceptionally good when you consider the recent sharp increases in energy prices. The overall economy appears to remain in a non-inflationary trend.

-- posted by RandeS