Back from trip to Greece, visiting with our friends who gave us a wonderful tour of the Ionian. Perfect weather, great scenery, hospitable people and great company. Many beautiful little harbors whose main business is the summer yachting trade, mostly chartered sailboats from bases in the areas. Few powerboats, diesel at €1.35/liter might have something to do with that. Each harbor has its collection of tavernas on the waterfront, serving excellent Greek dinners from gleaming, spotless kitchens. Somehow, the bill always came out to €70 for the four of us, including wine and gratuity. Water temperature was 20C, discouraging swimming, but crystal clear - one could easily see the bottom in 30 feet of water. Exploring meant hill-climbing, but was rewarded with gorgeous views and Greek towns that look just like the tourist brochure.

Athens, well, another story. Dirty and crowded, but still a must see for the connection with the past. Not just the Acropolis and the Agora, the National Archeological Museum is amazing with artifacts from the region that are up to seven thousand years old. The Metro is a cheap and easy way to get around, the airport trip costs only €10 each way for two people, and trips in the city center are only 80¢. But still, the most personal connection was in the museum at the Agora, from the beautiful little oil lamps from the classical era, still smudged with soot where they had been used 2,500 years ago. Just brought up images of someone blowing out the lamp and going to sleep, so long ago.

Didn’t miss a thing  in the markets, it appears. OK, I’m back, let’s get the bear thing on again.

In combat, ambiguity and confusion about the enemy’s intentions, dispositions, capabilities and so forth is common. Every military force seeks to confuse the opposition as much as possible so that it obtain strategic and tactical advantage.

It is the same in investing and speculating. Participants seek to confuse others about prices, values, intentions, positions and so forth so that they can obtain profit from the unwary or less well informed.

One of the best-known myths in financial history is the story that Nathan Rothschild received early notice of Napoleon’s defeat at Waterloo, but then sold consols (British Government bonds), causing a panic in the market. Traders believed that he indeed had early warning, and that his selling indicated a British defeat. At which point he is supposed to have turned around and bought back his position, to make huge profits when Wellington’s dispatches arrived the following day. The story isn’t true, ironically. In fact, he did have early warning, but he passed the information to the British government and it was also published in a daily gazette. He wasn’t believed. There was a market panic as rumors of defeat went around, but Rothschild was a consistent buyer in the panic. He did make huge profits. The irony is that nobody believed that a trader like Nathan would tell the truth!

As the protagonist of my favorite television program, “House”, says - everyone lies. Some lie deliberately, but more commonly others are ignorant, misinformed or careless or simply cling to ideas and beliefs that aren’t true, despite overwhelming evidence to the contrary.

This has seldom been clearer than the present time. I see four distinct camps of belief or opinion.

1. The recession that hasn’t begun yet is over. The bottom is in after a brief and mild correction in the stock market. Swift and deft action by the Fed has stopped a credit problem from affecting the broad economy, and the fiscal stimulus programs soon to come into effect will put consumption and property prices back on a growth track. Supply will respond to demand, and the commodity inflation that has recently plagued the US will gradually disappear. The dollar’s decline will soon reverse itself, if it has not done so already, as growth accelerates once more. The recent pullback in the market has created a wealth of buying opportunities in “beaten-down” shares, notably in housing, financials and technology.
2. A recession has begun, which may be prolonged, due to falling consumer demand in the US. It may be just a growth recession, as although recovery will be slow, the recession will not be very deep. Unemployment may reach 6 or 7%, but the powerhouse Asian and European economies will keep global growth strong, and the US will be able to turn to exports for the resumption of growth, fortified by a falling dollar. Precious metals, commodities and overseas investments will be useful to protect wealth. The stock market probably has further to fall, likely to around 1100 on the S&P 500 to complete a cyclical bear market.
3. A recession has begun, which will be long and deep. Deep enough to be considered a depression, with US GDP falling 10-15% or possibly more and unemployment rates in the teens. Asian and European economies will not “decouple”, and will be pulled down along with the US. Deflationary pressures will be strong, and the major currencies will come back towards PPP. Demand for commodities and precious metals will fall as the world economy slows, and so will prices. Company earnings will fall, and shares fall even further, as years of bubble overvaluation come to an end, probably as low as the 400s on the S&P 500. Growth will only resume after the US has cleared the debt bubble and households have resumed saving.
4. A recession has begun, which will become a major depression, similar to, if not worse than, the 1930s. The financial system will crumble, and persistent attempts by the US Federal government to reflate the economy will cause hyperinflation, devaluing the US dollar to the point of worthlessness, along the lines of Weimar or Zimbabwe. Massive unemployment and shortages of food and energy will lead to civil unrest and wars. Commodities and the stock market will soar in nominal terms, but owners will not keep up with inflation. A gold-based currency will be seen as the only reasonable basis for renewed growth, and only holders of gold will be able to preserve their wealth as the price of gold soars to accommodate the need for hard currency.

Of course there are variations on the above. But these are the major themes that I see. Pick one you like and trade that way. I’m in #3. I’d be happy to hear other scenarios.

I’ve installed Akismet, an anti-spam tool, and turned off comment moderation (except for comments with links).

Edit: Wordpress is still queuing comments for moderation. Sorry, I’ll try to get it fixed.

Over time, the Fed has lost control of the money supply. In part because it deliberately gave it up - by reducing or eliminating reserve requirements - and in part because of the development of an alternate financial system that bypasses traditional banking and creates credit without regulatory restraint and, for the most part, without being counted as money in the monetary aggregates.

Some years ago, a friend of mine who was a senior executive with one of the major Canadian banks made himself unpopular by suggesting that the bank give up its banking license. He did this because he saw that the profits would be greater in the unregulated alternate system than in the traditional, regulated banking system. Not that Canadian banks are unprofitable - they are amazing money machines. But that truly staggering amounts of money could be made with the regulatory restrictions removed. Like Goldman Sachs, for example.

Every time someone signs a promissory note - a mortgage, an auto loan, a credit card slip - whatever - money is created. That signature creates, instantaneously, a valuable asset that had not existed before - the signer’s promise to pay money in the future. That is the moment when money is created, everything else is just book-keeping.

The signer, the borrower, in effect sells that promise to the lender in return for money. Just like a bank, as soon as the lender accepts the note, he has a liability to the borrower for the agreed value of the loan. Now it may not be counted as money, because the lender’s liabilities may not be on the list of liabilities to be counted as money in the aggregate statistics. But it is as much money as any of those. Once you get past the state money, the direct liabilities of the Federal Reserve, everything else is just some private party’s promise, whether an actual security or an account statement. That’s why we get multiple money supply numbers - MZM, M1, M2, M3 and so forth - because they each include different classes of private money in addition to the real money. When Joe and Jane Doe sign the promissory note that is secured by a mortgage on their property, that note is their promise to pay money. Now the promise may not be a good one, and so it gets packaged and passed through various intermediate stages - RMBS, CDO, etc. - that attempt to segregate the risks.

We see that various different kinds money market funds are counted in most of the money supply aggregates except M1. But money market funds are simply mutual funds that invest (principally) in short-term debt.Why count money market funds and not, for example, commercial paper? Where is the line drawn? This is why the monetary aggregates have lost their predictive value - they don’t include most of the money. We’ve seen the rise in “money supply” triggered by investors substituting money market funds for asset-backed commercial paper. That’s an unnatural artifact of excluding commercial paper from the statistics.

The consequence of these measurement problems is that we do not get good information about the amount of credit and/or private money that is being created, nor its quality. The Great Depression in the 1930s was the result of banks failing to make good on their promises. Too many things went wrong all at once. The “fix” for this problem was to double reserve requirements and institute deposit insurance.The deposit insurance is still around, but the reserve requirements are gone again (Thanks, Al!). Perhaps more importantly, the new private money - money market funds, etc. - has no insurance and no reserve requirements. An immense amount of private money has been created, no-one knows how much. How good is it?