Author: Scott Buchanan

Bulls and Bears Spar Over Pace of Inflation Decline and Rate Cuts

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The stock market drools and rips higher at the slightest sign that inflation is abating, since that portends rate cuts instead of rate hikes by the Fed, and a return to the golden days of easy money. But what do the latest data show? Here I’ll show several charts to show what we know so far.

First, regarding U.S. inflation, here are a pair of charts from a raging bull article by Dan Victor titled The Fed Pivot Debate And Why Bulls Are Winning.

The last couple months’ data points in the lower chart show that inflation (as estimated by CPI) has essentially leveled out and may be starting to decline a little.  That is fine but it still leaves inflation far above the Fed’s 2% target. Victor defines a Fed “pivot” not as actually cutting rates, but simply a halt to raising them. By that somewhat anemic definition, sure, a Fed pivot could well come in the next few months. But that leaves rates still very high by recent standards.  The real question is when will inflation come down low enough to justify significant rate cuts. The Fed screwed up so abysmally last year with its ridiculous “this inflation is only transitory supply chain issues” that they really cannot afford to relent too soon, and let inflationary psychology take hold.

Side comment: the big “blowout” jobs number for January (last bar on the right, on the top chart above) caused a huge buzz. But there are strong reasons to discount it as an artifact of  “  revisions, adjustments, control factors, and recoding  “, per Jeffrey Snider.

On the other side of the bull/bear divide, Wolf Richter published a glass-half-empty article noting how the Bureau of Labor Statistics recently revised its CPI numbers, and the changes shifted the numbers so as to undermine the argument that inflation has started to drop rapidly:

The chart above with revisions (red line) shows core CPI barely declining over the past 9 months or so, and no trend for an acceleration in that decline. The chart below shows CPI for Services (where we consumers spend most of our money, and which is closely correlated to wages) is holding nearly steady around a red-hot 0.55%/month or about 6.6% annualized. It could be longer than the market thinks before there are substantial rate cuts.

And from the Eurozone, there is this chart, courtesy of Bloomberg via Yahoo, depicting the results of polling economists as to the future course of inflation there:

The consensus view is that inflation in Europe will not approach the 2% target until well into 2024. The European Central Bank is expected to hike by 0.5% in March, followed by another 0.25% to reach 3.25%. (This is much lower than the Fed’s interest rates, but that is probably because the U.S. is still working off the orgy of COVID-related payments that dumped trillions in peoples’ pockets here in 2020-2021). Cuts by the ECB are not expected until the second quarter of 2024.

THIS JUST IN: The January CPI data just came out today (2/14), and pretty much matches up with the picture presented above. Inflation is falling, but ever so slowly, and so it becomes more likely that the Fed will keep its rates higher for longer:

“The Consumer Price Index (CPI) for January showed a 0.5% increase in prices over the past month, an acceleration from the prior reading, government data showed Tuesday. On an annual basis, CPI rose 6.4%, continuing a steady march down from a 9.1% peak last June. Economists had expected prices to climb 6.2% over the year and jump 0.5% month-over-month, per consensus estimates from Bloomberg. …

Core CPI, which strips out the volatile food and energy components of the report, climbed 5.6% year-over-year, more than expected, and 0.4% over the prior month. Forecasts called for a 5.5% annual increase and 0.4% monthly rise in the core CPI reading.”

(For another recent take on the inflation picture, see James Bailey’s The Murky Macro Picture, on this blog).

A Cornucopia of Financial Data from J. P. Morgan, Relevant to Investors

Scott Buchanan6 Comments

I just ran across the 1Q2023 “Guide to Markets” issued by J. P. Morgan Asset Management. This compendium of financial data is issued by a large team of their Global Market Insights Strategy Team. It consists of some seventy pages of data-packed charts, covering through December 2022. This information is selected to be of use to investors, both individual and institutional.

I was like a kid in a candy store, scrolling from one page of eye candy to the next. Without further ado, I will paste in some charts with minimal commentary.

One thing that caught my attention here was the persistence overestimation of earnings by Wall Street analysts. “Why do they keep doing that?” I wondered. A brief search led me to a 2017 article on Seeking Alpha by Lance Roberts titled “The Truth About Wall Street Analysis”.  

Continue reading →

“Five Talents” Microfinance NGO Helps the Poorest of the Poor to Start Their Own Businesses

Scott Buchanan1 Comment

It is a pleasure to be able to report on a successful microfinance outfit that helps the poorest of the poor. I heard a talk recently from Dale Stanton-Hoyle, CEO of the Five Talents organization. (He is as nice in person as he looks in this photo).

This group was birthed at Truro Anglican Church, in Fairfax, Virginia. An Anglican bishop from Tanzania noted that he had many thousands of people under his care who were suffering so much from hunger and other concomitants of poverty that they had little inclination or energy to listen to elevating spiritual messages.  As he put it, “An empty stomach has no ears.”

Inspired by Jesus’ parable of the talents, where servants were each entrusted with some large sum of money (expressed in “talents”) and were expected to multiply that money productively, a group was formed in 1998 to help people living in the most extreme poverty to build productive enterprises.

Their approach would be classified as micro-credit, which nowadays is well-known and well-regarded approach. The modern stream of micro-credit, which is a subset of microfinance, has its roots In the Grameen Bank of Bangladesh, founded by micro-finance pioneer Mohammed Yunus in the 1970s.

Five talents describes itself more specifically as:

A micro-enterprise development organization that helps the world’s most vulnerable families escape poverty. Partnering with local churches around the world, we train men and women, mostly women living in extreme poverty, to form savings groups, take out loans, and build their own businesses.    It may seem surprising, but even those living in extreme poverty can save a little each week, start a tiny business, and fulfill their God-given potential.

In general, Five Talents does not give handouts. They support a limited number of full-time trainers, who in turn train local volunteer trainers, who do most of the actual organizing and leading. They found that when Western sources provided the initial seed capital, the money was not valued as much, and the loan payback rates were unsustainably low, around 60% or so.

So their model is to form a group of 20 or more people, and have them save their own money for at least six months. This develops tremendous accountability for borrowed funds. You are borrowing precious money from your group of friends and associates, and they all have a stake in helping your business succeed so you can repay it.

During those initial 6 to 12 months, the organization provides training: first, basic literacy (many are illiterate) and math skills which are essential for running a small business. Then, they provide training for more specific business planning and operation. This graphic depicts the process:

A typical loan might be $30-$150. This might be used to buy a goat to raise, or some beans to sell in the market. The local people can be creative in coming up with enterprises. The speaker told of a woman who was stuck in a refugee camp, who had been beaten up by life and was bitter and hopeless. All she could see were wretched poor people, and not much else. But the trainer persisted in asking her, “But what has God blessed you with?”  The subsequent conversation went something like this: “Well there is this large river nearby. And…there are unemployed men in the camp who used to have skilled jobs. I could probably pay some of them to make me a dugout canoe, then I could ferry people across the river for a fee. And…there are all these ragged children running around underfoot… I could probably buy them some fishing gear and pay them to catch me fish in the river, that I could sell in the market.” So this insightful local person was able to identify two completely new business ideas that the trainer had not thought of.

Five principles for “How to Build a Successful Business Anywhere” are:

  1. Start Small and Dream Big
  2. Know Your Neighbors
  3. Plan for Success
  4. Manage Growth Wisely
  5. Let Your Business be a Blessing


Some 80% of their participants are women. These women get a huge boost in self-confidence and community status, as well as income and food for their families.

Five Talents typically operates in concert with the local Anglican church in a country, which gives them some credibility and support and structure to start with. They are currently active in nine countries, mainly in central and eastern Africa along with Bolivia and Myanmar. They aim for countries with largest numbers of people living in extreme poverty. There is a wide range of development among so-called Third World countries. Many African countries already have a nascent middle class economy, so Five Talents directs its effort elsewhere.

According to their tracking, they have developed some 95,000 businesses so far, with a total of 1.4 million family members supported. They currently train about 10,000 people a year, and hope to increase that to 20,000 people. As with most development NGOs, the ultimate holy grail is to have your development project become independent and self-sustaining. Happily, Five Talents reports a great deal of success in getting groups to become self-funding after about one and a half years.

Decline in Consumer Use of Cash Is Offset by Criminal Usage of Benjamins

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We have all seen the decline in consumer usage of physical currency. The trend has been going on for some years, with folks finding it more convenient to whip out a credit card or just wave their phone in order to make a purchase. The drop in cash use was dramatically accelerated during COVID when we avoided physical contact with anyone and anything outside our homes, preferring contactless payments or just ordering stuff on line.

The Federal Reserve has since 2016 run an annual survey of households to track trends in payments. This data set shows the big drop in cash use in 2020, with a corresponding increase in payments by credit cards and mobile apps:

Share of payments use for all payments, from Federal Reserve’s “Diary of Consumer Choice” , 2022 edition.

Similar trends hold for the U.K.; the main alternative to cash there seems to be debit cards:

Source: BBC

Cash use continues to decline but the rate of decline seems to be slowing. Among other things, some twenty-somethings have been inspired by social media discussions to practice budgeting by using physical envelopes of physical cash for specified categories of spending.

Our discussion so far has mainly dealt with retail purchases by consumers. However, there is another dimension of cash use. As pointed out by Andy Serwer, there has been a steady surge in international demand for the largest denomination of U.S. currency, which is the $100 bill. This chart from the Fed shows that the dollar value of U.S. dollars in circulation has roughly doubled in the past decade:

Nearly all this rise is due to the insatiable demand for $100 bills, and the vast majority of that new demand is from overseas. Some of those Benjamins may be innocently sitting in foreign central bank vaults, but it is understood that many (perhaps most) of them are used by arms and drug dealers and other criminals.  Cash is used way more than cryptocurrencies for criminal activity. According to Serwer:

A million dollars in $100 bills, in case you’re wondering, weighs about 22 pounds, they say. A double stack would be about 21.5 inches high by 12.28 inches by 2.61 inches. You could carry it in a big briefcase, or as I suggested, a satchel.

Drivers of Financial Bubbles: Addicts and Enablers

Scott Buchanan1 Comment

I recently ran across an interesting article by stock analyst Gary J. Gordon, The Bubble Addicts Are Here To Stay: A Bubble Investment Strategy. This article may be behind a paywall.  I will summarize it here. Direct citations are in italics.

SOME RECENT FINANCIAL BUBBLES

Gordon starts by recapping four recent financial bubbles:

The commercial real estate bubble of the mid-1980s

The internet stock craze of the late 1990s (with the highest price/earnings valuations ever – – e.g., a startup called Netbank possessed nothing but a website, yet was valued at ten times book value; and went bankrupt a few years later)

The mid-00s housing bubble.

The 2020/2021 COVID bubble:  “The trifecta of a ‘disruptive business model’ stock bubble, SPACs and crypto. You know how this story is ending.”

Gordon then presents an explanation of why humans keep doing financial bubbles, despite the experiences of the past. He suggests that there are both bubble addicts, who have a need to chase bubbles and therefore create them, and bubble enablers who are only too happy to make money off the addicts.

THE BUBBLE ADDICTS

The greedy. Some of us just think we deserve more. I think of an acquaintance who said he was approached to invest with Bernie Madoff, who famously promised steady 10% returns. My friend turned down the offer because he required 15% returns.

Pension funds. This $30 trillion pool of investment dollars targets about a 7% return in order to meet future pension obligations. If pension fund managers can’t consistently earn at least 7%, they have to go to their sponsor – a state government, a corporate CEO, etc. – and ask for more money, or for pension benefits to be cut. And probably lose their job in the process.

Back in the day, bonds were the mainstay pension fund investment. But over the past 20 years, bond yields haven’t gotten the pensions anywhere close to 7%. So increasingly they have invested in stocks and alternative investments like private equity, as this chart shows:

Source: Pew Institute

And venture capital fundraising, in large part from pension funds, has soared since the pandemic…

How many great new ideas are out there for venture capitalists to invest in? [Obviously, not an unlimited number]. So their investments are by necessity getting riskier. But if the pension funds back away from the growing risk, they have to admit they can’t earn that 7%. Then bad things happen, to retirees and to pension plan sponsors and then to pension fund managers. So pension fund managers are pretty much addicted to chasing bubbles.

The relatively poor. The “absolutely poor” have income below defined poverty levels. The “relatively poor” feel that they should be doing better, because their friends are, or their parents did, or because the Kardashians are, or whatever. Their current income and prospects just aren’t getting them to the lifestyle they aspire to. [Gordon provides example of folks chasing meme stocks and crypto, and getting burned]. …But can the relatively poor just walk away from chasing bubbles? Not without giving up dreams of better lifestyles.

THE BUBBLE FEEDERS

Bubbles don’t just spontaneously occur; they require skilled hands to shape them. And those skilled hands profit handsomely from their creations. Who are these feeders?

Private equity and venture fund managers. They typically earn a 2% management fee plus 20% of profits earned. That adds up fast. A $10 billion venture fund could easily generate $400 million a year in income, spread among a pretty small group of people. VC News lists 14 venture capitalists who are billionaires.

SPAC sponsors. [ A SPAC (Special Purpose Acquisition Company) is a shell corporations which raises money through stock offerings, for the purpose of going out and buying some existing company. SPAC sponsors make a bundle, and so are motivated to promote them. SPACs proliferated in 2020-2021, and for a while pumped money into acquiring various small-medium “growth” companies. But now it is clear that there are not a lot of great underpriced companies out there for SPACs to buy, so SPACs are fizzling]

Wall Street earns fees from (A) raising funds for private equity, venture capital and SPACs, (B) buying and selling companies, (C) trading bubble stocks, crypto, etc., and (D) other stuff I’m not thinking of right now.

The Federal Reserve. Part of the Federal Reserve’s mandate is to reduce unemployment. Lowering interest rates increases stock values, which creates wealth, which drives the “wealth effect”. The wealth effect is the estimate that households increase their spending by about 3% as their wealth increases. More spending increases GDP, which reduces unemployment, which makes the Fed happy, and politicians happy with the Fed.

In my view, the wealth effect is why the supposed economic geniuses at the Fed never figure out that bubbles are occurring, so they never take steps to minimize them.

Social media and CNBC certainly benefit from more viewers while bubbles are blowing up [i.e., inflating].

INVESTING IN CURRENT MARKET ENVIRONMENT

Gordon sees us still in recovery from the recent bubble of “disruptor companies” and crypto, and so the market may have more than the usual choppiness in the next year. So he advises being nimble to trade in and out, and not mindlessly commit to being either long or short. “Value stocks are probably the best near-term bet, even if they can’t offer the adrenaline jolt offered by bubble stocks.”

Bank for International Settlements: $70 Trillion Dollars Is Missing from Official Global Financial Accounting

Scott Buchanan2 Comments

Seventy trillion dollars is a lot of money. It is nearly three times the size of the U.S. GDP, and approaches total global GDP (around $100 trillion). That is the amount of funds that are missing from normally reported financial statistics, according to a December, 2022 report from the Bank for International Settlements. That report caused a bit of a flurry in financial circles.

It’s not that this money has been stolen, it’s just that it is not publicly known exactly where it is, i.e., how much money that which parties owe to whom. Here is the Abstract of this paper:

FX swaps, forwards and currency swaps create forward dollar payment obligations that do not appear on balance sheets and are missing in standard debt statistics. Non-banks outside the United States owe as much as $25 trillion in such missing debt, up from $17 trillion in 2016. NonUS banks owe upwards of $35 trillion. Much of this debt is very short-term and the resulting rollover needs make for dollar funding squeezes. Policy responses to such squeezes include central bank swap lines that are set in a fog, with little information about the geographic distribution of the missing debt.

Much of this money is in the form of currency swaps, especially foreign exchange (FX) swaps. Even though the U.S. economy no longer dominates the whole world, the U.S. dollar remains the premier basis for international trade and even more for foreign exchange:

As a vehicle currency, the US dollar is on one side of 88% of outstanding positions – or $85 trillion. An investor or bank wanting to do an FX swap from, say, Swiss francs into Polish zloty would swap francs for dollars and then dollars for zloty.

Who cares? Well, the incessant demand for dollars periodically leads to a dollar funding squeeze in international trade, which in turn reverberates into world GDP.

Currency Swaps as Lending Events

In many cases these currency swaps effectively amount to short-term lending /borrowing (of dollars). Much of the financial world is utterly dependent on smoothly flowing short-term funding to cover longer term debt or investments. Borrowing short-term (at usually lower interest rates) and investing or lending out longer-term (at higher rates) is how many institutions and funds exist. For instance, depositors at banks effectively lend their deposits to the bank (short-term), in return for some pitiful little interest on their checking or savings accounts, while the banks turn around and make say 5 year or 30-year loans to businesses or home-buyers. Banks earn profits on the spread between the interest rates they receive on the funds they loan out, and the typically lower rates on the short term funds they “borrow” from their depositors.

This “mismatch” between the maturities of borrowed funds (especially dollars) and invested funds can cause a complete melt-down of the financial system if holders of dollars stop being willing to lend them out, or to lend them out at less than ruinous interest rates:

The very short maturity of the typical FX swap/forward creates potential for liquidity squeezes. Almost four fifths of outstanding amounts at end-June 2022 in Graph 1.B matured in less than one year. Data from the April 2022 Triennial Survey show not only that instruments maturing within a week accounted for some 70% of FX swaps turnover, but also that those maturing overnight accounted for more than 30%. When dollar lenders step back from the FX swap market, the squeeze follows immediately.

Financial customers dominate non-financial firms in the use of FX swaps/forwards. Non-bank financial institutions (NBFIs), proxied by “other financial institutions” in Graph 1.C, are the biggest users of FX swaps, deploying them to fund and hedge portfolios as well as take positions. Despite their long-term foreign currency assets, the likes of Dutch pension funds or Japanese life insurers roll over swaps every month or quarter, running a maturity mismatch.  For their part, dealers’ non-financial customers such as exporters and importers use FX forwards to hedge trade-related payments and receipts, half of which are dollar-invoiced. And corporations of all types use longer-term currency swaps to hedge their own foreign currency bond liabilities .

It is really bad if pension funds or insurance companies get starved of needed ongoing funding. Central banks, especially the dollar-rich Fed, have had to repeatedly jump in and spray dollar liquidity in all directions to mitigate these “dollar squeezes”.  The BIS authors’ main concern is that these big public policy decisions are currently made in absence of data on what the actual needs and issues are.  Hence, “Policy responses to such squeezes include central bank swap lines that are set in a fog.”

This all is part of the murky “Eurodollar” universe of dollar-denominated bank deposits circulating outside the U.S. (more on this some other time).  Investing adviser Jeffery Snider offers the “Eurodollar University” on podcasts and on YouTube, in which he explores the many dimensions of the Eurodollar scene. He likens the Eurodollar system to a black hole: we cannot observe it directly, but we can estimate its size by its effects.

In his YouTube talk on this BIS paper, among other things Snider notes that this short-term lending associated with currency swaps functions much like repo borrowing, except the currency swaps (unlike repo) do not appear on bank or other balance sheets as assets/liabilities. That is part of the attraction of these swaps, since they are effectively invisible to regulators and are not constrained by e.g., capital requirements.

What the Fed does in a dollar squeeze is largely lend dollars to large dealer banks. But unless those other banks then lend those dollars out into the private marketplace of manufacturers and shippers and pension funds, having trillions of dollars in central bank reserves has little effect. It is not the case that “the Fed floods the world with dollars”  — actually, mainstream banks get those dollars, and then lend out at high rates to the dollar-starved rest of financial world, where they can actually do something.

The result, according to Snider, is that the Eurodollar is the only functional reserve currency in existence. This is the real, effective banking system (not “reserves” sitting on some bank’s balance sheet), even though the current accounting system doesn’t show it.

Can Central Banks Go Bankrupt?

Scott Buchanan3 Comments

Finnish crisis researcher Tuomas Malinen has for some time been predicting the collapse of the Western financial system, starting with the melt-down of the European Central Bank. Malinen, an associate professor of economics at the University of Helsinki, offers his views on his substack and elsewhere. He correctly warned in early/mid 2021 of coming inflation, which would present central bankers with severe challenges.

Among other things, by raising interest rates (to counter inflation), the banks necessarily cause the value of bonds to drop. However, a lot of the assets of the central banks consist of medium and long term bonds, especially those issued by sovereign governments. We have come to the point where some central banks are technically insolvent: the current cash value of their liabilities exceed their assets.

Is that a problem? Most authors I found did not seem to think so. For a normal private bank, as soon as the word got out that it was insolvent, customers would rush to withdraw their funds, in a classic “run on the bank”. Customers who waited too late to panic would simply lose their money, since there would not be enough assets on the bank’s balance sheet to cover all withdrawals.

However, no one seems to be in a hurry to beat down the doors of the Fed and demand their money. Most of the liabilities of the Fed are (a) paper currency in circulation, and (b) “Reserve” accounts of major banks at the Fed.

Bandyopadhyay, et al. note that negative equity in central banks (including those of smaller countries) is not uncommon; at any given time, about one out of seven central banks worldwide in the 2014-2017 timeframe suffered operating losses, some of which were large enough to wipe out their capital. However, most central banks are owned by, or have some other synergistic  relationship to , the governments of their respective countries. For instance, there is a standard contractual relationship between the Bank of England (BOE) and the British government. Thus, when the BOE recently fell into arrears, the government provided them with additional funds. This was apparently a routine non-event. (I don’t know where the government came up with those additional funds; did they just issue more bonds, which in turn were purchased by the BOE?)

The Fed, as a privately-owned public/private hybrid, technically has a more arms-length distancing from the U.S. Treasury. For instance, the Fed is not supposed to buy government bonds directly from the government. Rather, the government sells them to large banks, who in turn sell them to the Fed (if the Fed is buying). It is possible for the U.S. Treasury to transfer funds to the Fed to recapitalize it; but for now, the Fed is just booking losses as a “deferred asset”. Voila, the magic of central bank accounting. The presumption is that sometime in the future, the Fed will receive enough net income to overcome these losses.

The biggest debate is over the fate of the European Central Bank (ECB). Its relation to sovereign governments is even more arms-length; it is difficult to see all the European countries, with their own budget issues, agreeing to cough up money to give to ECB. As Malinen sees it, this likely leads to the “deferred asset” accounting scheme to handle negative equity for the ECB. He worries, “Will the markets or the banks trust the ECB after losses starts to mount forcing the Bank to operate with (large) negative equity? We simply do not know.” This is a weighty issue. As we noted earlier, “money” is in the end a social construct, an item of trust among parties for future payments of value. Central banks are the lenders of last resort, the source of money when it has dried up elsewhere; they regularly have to step into financial liquidity crises to inject more money to keep the system going. If people stopped accepted the keystroke-created money from central banks, the whole economy could freeze up.

A more sanguine view of central bank negative equity issues from MMT proponent Bill Mitchell. In his “Central banks can operate with negative equity forever” Mitchell heaps scorn on the very idea that central banks could run into solvency problems. He states that a “government bailout” is an inconsequential paper operation, merely transferring money from the left pocket to the right pocket of the government/central bank joint entity (as he views it). Furthermore, central banks have the capability of creating money out of thin air, so they can always meet their obligations and therefore can never be deemed insolvent:

The global press is full of stories lately about how central banks are taking big losses and risking solvency and then analysing the dire consequences of government bailouts of the said banks. All preposterous nonsense of course. It would be like daily news stories about the threat of ships falling off the edge of the earth. But then we know better than that. But in the economic commentariat there are plenty of flat earthers for sure. Some day, humanity (if it survives) will look back on this period and wonder how their predecessors could have been so ignorant of basic logic and facts. What a stupid bunch those 2022 humans really were.

“Let whoever needs to die, die”:  China’s Abrupt COVID Reopening To Achieve Rapid Herd Immunity and Resumption of Industrial Production, at the Cost of a Million Deaths

Scott Buchanan3 Comments

I noted a month ago that President Xi and the CCP have taken credit for relatively low (reported) deaths from COVID, due to strict lockdown protocols. By “strict” we mean locking down whole cities and blockading residents in their apartment buildings for months at a stretch. However, public protests rose to an unprecedented level, and so the Chinese government has done a surprising full 180 policy change, towards almost no restrictions.

According to Dr. Ezekiel Emanuel in the Wall Street Journal, the way this policy is being carried out has the makings of a mass human tragedy:

Zero Covid was always untenable and had to be ended. But it could have been done responsibly.

Among other things, that would involve buying Pfizer and Moderna bivalent vaccines and administering them to the elderly and other high-risk people, and purchasing Paxlovid and molnupiravir to treat those who test positive. Supplies of these products are ample. Authorities could continue mask mandates to reduce transmission. And China could institute a rigorous wastewater testing program to identify potential SARS-CoV-2 variants as soon as possible – and commit to sharing the data with the world.

Due to nationalistic pride, China has spurned the purchase of effective mRNA vaccines from Pfizer and Moderna, pushing instead the less-effective in-house vaccine.

Readers may recall in the early days of COVID spread in the West, masking and social distancing were promoted, not because they would prevent everyone from ultimately becoming infected, but because these measures would “flatten the curve” (i.e. reduce the peak load on hospitals at any one time, but instead spread it out over time). China is headed into a very un-flattened infection curve; some 800 million people (10% of the world’s population) may get COVID in the next 3 months, overwhelming hospitals and leading to over a million deaths. Besides the near-term human costs, this concentration of active COVID cases is likely to lead to a slew of new, even more virulent variants which will affect the rest of the world, along with China. What should help mitigate the situation is that the newer, most virulent variants of COVID may be somewhat less fatal than the original strain.

Why is the Chinese government doing it this way? Well, the sooner the country gets through mass exposure to the virus, the sooner everyone can get back to their factories and start producing stuff again. If in the process a bunch of (mainly older) people die, well, that’s just the price of progress. Let ‘er rip…

From MSN:

[U.S.] Epidemiologist and health economist Dr Eric Feigl-Ding estimate that 60 per cent of China’s population is likely to be infected over the next 90 days. “Deaths likely in the millions—plural,” he added.

According to Eric, bodies were seen piled up in hospitals in Northeast China. “Let whoever needs to be infected infected, let whoever needs to die die. Early infections, early deaths, early peak, early resumption of production,” the epidemiologist said terming it to be summary of Chinese Communist Party’s (CCP) current goal.

But don’t expect any acknowledgement of mass death from the official Chinese media. Just as the initial COVID outbreak was denied and censored by the Chinese propaganda machine, so the current surge is being minimized. From Barrons:

On Friday, a party-run newspaper cited an official estimate of half a million daily new cases in the eastern city of Qingdao. By Saturday, the story had been amended to remove the figure, an AFP review of the article showed….

Several posts on the popular Weibo platform purporting to describe Covid-related deaths appeared to have been censored by Friday afternoon, according to a review by AFP journalists.

They included several blanked-out photos ostensibly taken at crematoriums, and a post from an account claiming to belong to the mother of a two-year-old girl who died after contracting the virus.

Posts about medicine shortages and instances of price gouging were also taken down, according to censorship monitor GreatFire.org.

And social media users have posted angry or sardonic comments in response to the perceived taboo around Covid deaths.

Many rounded on a state-linked local news outlet after it reported Wu Guanying — designer of the mascots for the 2008 Beijing Olympics — had died of a “severe cold” at the age of 67.

Perhaps we should not be surprised that the Chinese Center for Disease Control and Prevention just reported zero COVID deaths for December 25 and 26.

Food Price Increases Won’t Be Solved by Raising Interest Rates

Scott Buchanan1 Comment

I make a hobby of reading, and sometimes acting on, investment advice, particularly regarding high-yielding securities (many of my holdings are now yielding over 10%/year). One of the best authors on the Seeking Alpha investing site writes under the name of Colorado Wealth Management. He mainly writes on REIT (real estate investment trust) stocks, but recently opined on the wisdom of raising interest rates to combat inflation regarding some of the major components of CPI.

His article, Why High Yields Will Be Popular Again, may be behind a paywall for some readers, so I will summarize some key points. He kind of sidesteps the influence of massive federal deficit spending that injected trillions and trillions of new dollars into the economy for COVID, which I think has been the major driver for this inflation; and the reignited deficit spending which is already on the books for November and likely even huger for December of this year. However, he does make some interesting (and new to me) points regarding food prices in particular.

He sees the price 2021-2022 price increases in some major food items as being driven by supply constraints, rather then by excessive demand. Specifically eggs, coffee, and vegetable oils have been hit by exogenous factors which have constrained supply; raising interest rates will not help here, and may even hurt if higher rates make it harder for farmers to recover and re-start high production. I’ll transition to his charts and mainly his excerpted words, in italics below:

Avian Flu, Culled Hens, and the Price of Eggs

The background here is that tens of millions of chickens, including egg-laying hens, have been deliberately killed (“culled”) this year in an attempt to slow the spread of avian flu. This, of course, cuts into the egg supply and raises egg prices. We went through a similar cycle in 2015 with avian flu, where culling led to a rise in egg prices, but then prices fell naturally as a new crop of chicks grew into egg-laying hens. Similarly, the current shortage in eggs should correct itself:

Raising interest rates has never produced additional eggs. Raising interest rates and driving a recession (with larger credit spreads) only makes it more difficult for farmers to get the funding necessary to replace tens of millions of hens that were culled to slow the spread of the avian flu….If interest rates don’t work, what will? The cure for high prices is high prices. We can see how it played out with the Avian flu in 2015:

  • Is Jerome Powell going to lay even one egg? Probably not.
  • Are farmers going to focus on turning their chicks into egg-laying hens? Absolutely.

Since eggs go into several other products, it drives inflation throughout the grocery store. Even if a product doesn’t use eggs, the drop in egg production means more people eating other foods.

Drought in Brazil and the Price of Coffee

Coffee prices have been rising rapidly. Well, domestic prices have been rising rapidly. Global prices actually declined since peaking in February 2022:

So, what drove the price up? Brazil normally produces over 35% of the world’s coffee and bad weather in Brazil (not to mention the pandemic impacts) drove dramatically lower production in 2021. As the shortfall in production became evident, global prices began rising rapidly. That’s why the global [wholesale] prices were ripping higher in 2021, not 2022. However, [retail] consumers are seeing most of the impact over the last several months.

War in Ukraine and the Price of Sunflower Oil

Margarine requires vegetable oil. Soybean, palm, sunflower, and canola oil are the key ingredients. What country produces the most sunflower oil? Ukraine. This is one of several inflationary impacts of the war. You can see the impact of reduced supply in the following chart:

Government Bungling in Indonesia and the Price of Palm Oil

What happened to palm oil? How could it soar so much and then fall so hard?

The first issue is that dramatic increases in the price of fertilizer made production more expensive. … That contributed to a reduction in supply. However, Indonesia is the world’s largest exporter of palm oil. Yet exports of palm levy were subject to a huge levy. That made exporting far more expensive. Despite the levy, it was still worth producing and exporting palm oil. Then the Indonesian government decided to simply ban exports over concern about higher domestic prices. Banning exports for a country that produces 59% of the world’s total palm oil exports had a predictable impact.

If you guessed that the supply of palm oil couldn’t be sold domestically, you’d be right. The ban was lifted. However, it was only after:

“High palm oil stocks have forced mills to limit purchases of palm fruits. Farmers have complained their unsold fruits have been left to rot. There were 7.23 million tonnes of crude palm oil in storage tanks at the end of May, data from the Indonesian Palm Oil Association (GAPKI) showed on Friday.“

With palm oil prices at all time-record highs, nearly triple the level from two years prior, the supply was left to rot. Each business tried to make the best decision they could, given the ban on exports. Rather than record profits for mills and record profits for farmers, the produce was wasted. That’s supply constraints for the global market, and it destroys the local economy.

Global prices are plunging now as mills seek to unload their storage. As bad as the higher prices were for the rest of the world, no one suffered worse than the farmers whose product became worthless as a result of government failure.

Contrary to today’s popular opinion, higher interest rates won’t do anything to improve production of vegetable oil.

Reckless Management Led to BlockFi Crypto Bankruptcy

Scott Buchanan2 Comments

Since my nontrivial deposits at the cryptocurrency lending firm BlockFi have been blocked (maybe forever) from withdrawal, I keep an eye on news from that front. My main source of information has been missives from BlockFi itself, in which management portrays itself as being very careful with customer funds; it was only the shocking, unforeseeable collapse of the FTX exchange that forced the otherwise sober and responsible BlockFi into its recent bankruptcy. I have believed that view of things, since that is all I knew.

However, Emily Mason at Forbes has poked around behind the scenes, including finding insiders willing to talk (off the record) about less-savory doings within BlockFi. The title of her recent article, BlockFi Employees Warned Of Credit Risks, But Say Executives Dismissed Them, pretty much says it all. The article starts out:

In its bankruptcy filing last week, New Jersey-based BlockFi attempted to paint itself as a responsible lender hit by plummeting crypto prices and the collapse of crypto brokerage FTX and its affiliated trading firm, Alameda.

That is the view I have held up till now. However, Mason then goes on to note:

 But a closer look at the company’s history reveals that its vulnerabilities likely began much earlier with missteps in risk management, including loosened lending standards, a highly concentrated pool of borrowers and unsustainable trading activity.

To keep this blog post short, I will just paste in a few excerpts where she fleshes out her case:

While the company regularly touted a sophisticated risk management team, current and former employees indicate in interviews that risk professionals were dismissed by executives preoccupied with delivering growth to investors. As early as 2020, employees were discouraged from describing risks in written internal communications to avoid liability, a former employee states.

Ouch. Not a good sign.

Until August 2021, BlockFi advertised that loans were typically over-collateralized. But large potential borrowers were often unwilling to meet those requirements, a cease and desist order brought by the Securities and Exchange Commission against BlockFi in February states. The availability of uncollateralized capital from competing companies like Voyager created stiff competition in the lending field.

Under pressure to continue growing and delivering yields, BlockFi began lending to these parties with less collateral than publicly stated without informing customers on the amount of risk involved with interest accounts, according to the SEC order which resulted in a $100 million fine for the company. As a result, BlockFi paused access to its interest accounts in the U.S.

Wait, that is MY money they were messing with. Now I am really annoyed.

In addition to lowering its collateral requirements, BlockFi’s due diligence process had flaws, former borrowers say. Available credit for borrowers was decided based on their assets, but BlockFi and other lenders failed to investigate both the size and quality of potential borrowers’ holdings. Like Voyager and other crypto lenders, BlockFi accepted unaudited balance sheets from hedge funds and proprietary trading firms former borrowers say, leaving room for manipulation on the borrower side.

In the due diligence process, lenders like BlockFi and Voyager did not examine whether borrowers’ balance sheet assets were denominated in dollars or less liquid tokens like FTX-issued FTT.

… The revelation that Alameda’s balance sheet was mostly FTT tokens was the news that set off the unraveling of both Alameda and FTX and triggered contagion effects across the industry. In early November, Alameda defaulted on $680 million in loan obligations to BlockFi, according to the bankruptcy filing.

Some BlockFi employees reportedly warned of the shakiness of the parties to whom clients’ finds were being loaned. Management dismissed these concerns because the loans were “collateralized”,  but as noted above, the extent of that collateral was *not* what we clients were told:

… An internal team at BlockFi also raised concerns that the borrower pool was too concentrated among a pool of crypto whales, including mega hedge funds Three Arrows Capital and Alameda, another former employee states. Management responded that the loans were collateralized, according to the employee.

This is a very common scenario in finance: In search of profits, management  cuts corners and takes more risks with client funds than they were telling the clients. Maybe Sam Bankman-Fried will up with cell-mates from BlockFi.

Because BlockFi survived the Luna/Terra collapse some months ago and because I believed the steady stream of reassuring pronouncements from BlockFi management, I only withdrew a third of my funds back in the summer. But as it turns out, that withdrawal was apparently bankrolled by a big loan to BlockFi from Bankman-Fried’s FTX; but FTX is now caput.  So the odds of my ever seeing the rest of my funds are slim indeed:

In BlockFi’s bankruptcy filing and in public statements made by its CEO, Zac Prince, the company points to its survival through the collapse of the Terra/Luna ecosystem and subsequent shuttering of Three Arrows Capital as evidence of strong management. But that endurance four months ago was made possible through a $400 million credit line from now-defunct FTX, which allowed the firm to meet panicked withdrawal requests from depositors. When FTX folded in early November, BlockFi lost its lending back stop and could no longer meet fresh waves of withdrawal requests.

One lesson learned: If there is a reasonable chance of a panic, it can pay to be the first to panic, not the last.