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Prometheus, With The Cuffs On |
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Gulf market
jitters ahead of General Bernanke's take-off,
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Ivy League
economics 101: Fine-tuned science or fortune-telling quackery?
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Backhanding
risk at the dinner table, grab your "Mobs" and more...
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Joel Bowman,
reporting from Dubai, UAE...
Markets in the Gulf lagged
Sunday on fears the US will again force-feed its slash and burn monetary
policy on central banks here. Along with booming GDPs, economies in the
region are also witnessing ballooning CPIs. But don't pity them too
much; governments in the of the Gulf Cooperation Council (GCC), rich in
oil and with the largest retail gold market in the world, have chosen to
peg their currencies to, of all things, the US dollar. Woe to them...
When you lie down with
dogs, goes the old maxim, you get fleas. And when you jump into bed with
the greenback, you are liable to wake up with an unsightly rash of
similar color.
Markets around the Gulf are
panicking because their dinars, riyals and dirhams are pegged to the
flailing dollar. When the Fed meets to decide how much value to extract
from the dollar, central banks in this region will administer a similar
inflationary poison to their own currencies.
So, what does this mean?
Real term rates will surely dip further into the negative, inflation
will continue to soar, nationals and expats will carry on complaining
their bread has become more expensive, governments will dig further into
their pockets to doll out extravagant welfare initiatives. In short, it
will be business as usual.
And how do markets react to
business as usual? Depending on the business, they ease off, take off or
taper off. Testy dollar-pegged markets in the Gulf chose to drop off
instead.
Predictably, the Gulf State
with the highest inflation proved most unnerved over General Bernanke's
impending rate judgment. Banks led Qatar's slide, with Commercial Bank
of Qatar (CBQ) and Qatar Islamic Bank (QIB) both plummeting more than 5%
to drag Doha's benchmark index down into the red.
Saudi's markets too, wary
of another inflation-stoking jab by the Fed, followed Qatar into the
dumps...as did Oman, Bahrain and the UAE.
In fact, the only GCC
market to buck the trend was Kuwait. As it happens, Kuwait broke ranks
with its Cooperation Council cohorts last May, severing ties to the
dollar in favor of a basket of currencies.
On the same day that
markets of the remaining five GCC states hit the skids, Kuwait announced
that it was again letting the value of its dinar rise. Since a few other
currencies crawled into bed and Kuwait stopped paying so much attention
to the US dollar, the value of its dinar has risen around 8%. No doubt
the tiny oil-rich state is glad for its move given that it pays around
one-third of its import bills in euros.
We're not too sure what Mr.
Bernanke has in store for us when he and his helicopter co-pilots meet
to decide which flight path to take on Tuesday.
Most analysts forecast a
50-75 basis-point cut. Will a move of this size be enough to turn bad
debt into good credit? Are Wall Street gurus likely to exercise any more
prudence with their shareholders' money? Will our politicians promise to
spend less of our money if the liquidity elixir does work? If the market
does miraculously recover, are we any less likely to be caught in a
sandstorm driving to work next Wednesday?
We are certain that we have
no idea...which is more than we can say for the pinstriped artisans on
The Street and in The City.
In the column below, Bill
Bonner visits a private bank in London for a quick lesson in Ivy League
economics, but quickly realizes that fortune-telling 101 is not all it's
cracked up to be. Enjoy...
---- The Strategic
Short Report ----
How "Losers"
Get Rich During a Market Crash...
The Waiter Who Got Filthy
Rich... on Crashing Shares
Jim F. spent years waiting
tables and selling circus tickets... then he did this -- during one of
America's worst bear markets -- and got so rich, a famous Hollywood
actor played him in a movie.
Read On Here .
--------------------------------------------
Prometheus, With
The Cuffs On
By Bill Bonner
Money carries no passport,
but it slides through almost any border. It flies no flag, but it is
welcome in almost every nation. It speaks no language, but when it
talks, everyone listens. But for all its passe-partout appeal, money has
more enemies than friends. And the biggest threat is probably the
financial industry itself.
"Don't worry," the bright
young man at a London private bank told us, "we maintain the highest
levels of professionalism and use the most sophisticated tools of modern
portfolio management."
That was just what we were
worried about. What follows is a lament...and a complaint...about the
current state of people in the financial métier: they have been disabled
by their own theories...handicapped by their own greasy trade.
We were impressed by the
man in front of us. Handsome, well-dressed, well spoken in three
different languages, he had spent years learning the principles of
economics, finance and business management. His palaver to prospective
clients was flawless. Yes, he said, the research department is keenly
searching for alpha...but it knows that 80% of performance comes from
careful asset allocation, which the bank's strategists have calculated
based on risk/return analyses going back a hundred years. The expected
return from Japanese equities over the next five years, for example,
will be precisely 7.56%...but with an anticipated volatility of 20.43%.
But then we learned that we
didn't have to live with volatility. The firm's analysts have done
extensive research, he explained; they've been able to find many
different asset classes that had equal and opposite volatilities.
When Japanese stocks bob in
one direction, for example, the firm's Ultra-leveraged Macro Opportunity
Hedge fund weaves in another.
Just throw the
mathematicians a bone; they'll figure out how to put these things
together so that you can optimize your return while minimizing your
risk. Then, according to the math whizzes' calculations, you could find
yourself with a 90% probability that your $100 investment will grow to
somewhere between $292 and $132 in year 10. This, it should be
mentioned, is a "nominal" value. Even if the target is hit, the $132 may
not even buy you a cup of coffee in London. It barely buys you one now.
So many numbers... 6s and
7s...5s and 4s...every number the Arabs ever invented is brought into
service. But what do they really mean?
"Can you tell us what the
price of oil will be next week," we began to torment our interlocutor.
"Or, how about the dollar?"
"Of course not."
"Then, how can you make
projections ten years out...on investments, all of which will be greatly
influenced by the price of oil, the strength of the dollar, inflation
rates and completely unforeseeable events?"
"Well, these are not
predictions. They are projections, based on many years of experience.
Our researchers are the best in the business, with degrees from Harvard,
MIT and Oxbridge. Of course, no one knows what the future will
bring...but these projections are the best output of modern portfolio
management."
Pointing to a helpful chart
supplied by the investment firm, we continued our interrogation:
"In the last 6 months,
Merrill Lynch has had to write down an amount equal to almost half its
book value? UBS has written off 40%. If these financial engineers were
really able to project earnings and risk out to 2 decimal places, how
come they couldn't protect themselves from this blow up?"
They ought to give special
parking places to anyone who studied business, economics or finance in
the last 30 years. Higher education has lowered their I.Qs. Years of
toil in academia have weakened their vision and taken the common sense
right out of them.
A blind man could have seen
the blow-up in sub-prime coming. But somehow, the geniuses missed it.
What went wrong? The disabling infection may be understood by looking at
how the hot shots handle risk. Of course, they don't really have any way
of knowing what real risk is; no one can know the future. For all we
know, a plague will wipe us all out in the next three weeks. None of us
knows what the price of oil will be next week...or next year...or 10
years from now. Nor do any of us know what real risks the oil market
faces. War...weather...technological advance...who can say?
But rather than admit that
it just didn't know...the financial industry embarked on a staggering
series of myths and conceits that must have taken the gods' breath away.
Since they couldn't know
real risk, they substituted volatility as a proxy, which is a little
like getting an inflatable doll to take your wife's place at a dinner
party; the conversation may be dull, but at least she won't contradict
you.
Once they had shut up risk,
they could say whatever they wanted. They could pretend that price
movements, for example, were like natural phenomena. It was absurd and
everyone knew it. Prices depended on what people thought; volcanic
eruptions did not. But Richard Fama put forward the Efficient Market
Hypothesis in the 1960s as if he had stolen the gods' fire. He claimed
market data could be treated as if they were random fluctuations. If an
earthquake had stuck Rome only twice in the last 100 years, the 'risk'
of an earthquake was only 2%. For all they know, the streets of the
Eternal City will rock and roll every day for the next 200 years...but
this little subterfuge gave their mathematicians something to work with.
Then, looking at price patterns as if they were seismic records, they
could make all sorts of fantastic simulations...and come up with fancy
new products, such as a Highly Leveraged, Sub-prime Debt Portfolio.
Using historical norms, they pressed the junk credits together like
potted meat and - in a miracle that would have floored Jesus –
transformed it into Prime A.
But it was all nonsense.
The prices thought to be random weren't random at all, but the
consequence of practices, ideas, and institutions built up over
centuries. Change the circumstances...and the numbers changed too. As
Soros puts it, markets are 'reflexive.' In our words, prices are neither
fixed nor random...but subject to influence. For example, it was
observed that stocks outperformed bonds over the longterm. Stocks for
the Long Run was the title of a best-selling investment book in 1994,
which argued that stocks would make you rich if you held them long
enough. This long-term reward was in return for investors' willingness
to take short-term risks; they called it the risk premium...which they
defined, again, as volatility. Stocks were down in some periods, but
always up over the long term. Thus, for a person who could wait, there
was no risk at all.
By 1999, no truth was more
obvious: stocks would make you rich. By then, the whole financial world
was alight...stocks had risen three times since 1994 – to over 11,000 on
the Dow by the end of the year. Now, it was time to pour on the
gasoline. Another best-seller appeared that year: Dow 36,000 .
No one seemed to notice
that those data points that convinced investors that stocks were such a
great investment were registered when people thought stocks weren't so
great. For much of the stock market's history, investors had demanded
higher dividend yields from stocks than they got from bonds – to make up
for the risk. And they had rarely paid more than 20 times earnings. Yet,
in 1999, the p/e ratio of the S&P rose over 32 – about twice the long
term average. Circumstances had changed; the insight was no longer
valid. And the fire went out.
The Dow may still go to
36,000, probably when a cup of coffee goes to $132. Last we looked, it
was almost 10 years later and the Dow was back to where it ended 1999.
During this time, too, the dollar has lost about 30% of its purchasing
power...so the investor who believed in stocks for the long run is down
about a third.
To be continued next
week...
[Joel's Note:
Bill's latest book, Mobs, Messiahs and Markets: Surviving the Public
Spectacle in Finance and Politics, written with co-author Lila Rajiva,
is available right now.
Don't forget to grab your mobs right here .
-------------------------------------------------
[Rude Endnote:
In the Rude mailbag this week we find a symbolic visualization from a
retired military officer who is an old acquaintance of our Peak Oil
correspondent and Outstanding Investments editor Byron King.
"I always wanted to know
how large an oil tank it would take to hold all the conventional crude
we've ever had on the planet," writes our contributing officer, "so I
sat down to do the math one day.
"To keep it simple, let's
assume 2 trillion barrels total proven reserves, of which we've consumed
approximately half to date. I invite people to please check my math
(nothing worse than being off by an order of magnitude or two), but
using volume conversion factors readily available on the Internet, one
42-gallon barrel of oil equals 5.615 cubic feet. You do all the math and
you come up with 76 cubic miles (5,280 ft on a side) of crude oil. Apply
some basic geometry (V = H * pi * R^2), and we quickly discover that our
2 trillion barrels of oil would fit nicely into a single tank only 5
miles wide and a mere 4 miles high.
"To put that into
perspective, the boundaries of Washington, D.C. are 10 miles on a side,
and modern jet liners cruise at 40,000-plus feet, approximately twice
the top of our tank. To make matters worse, that tank is now about half
empty, or filled to a depth of roughly 10,500 ft - only 19 Washington
Monuments at 555 ft tall each. If the world is using 85M bbls per day,
the tank is draining at approx. 10 inches per day or about 300+ ft/yr.
Again, please check my math, but if accurate, this is hardly the "Great
Lakes-size" worth of oil that many people might be visualizing in their
minds. In fact, when I ask people to give me their personal analogy of
how much oil they think there is in the world I get nothing close to the
5-mile tank. 'Great Lakes', 'Caspian Sea', etc. are common answers.
"I see the Washington
Monument every morning as we crest the I-395 hill riding the bus to
work. And every morning I can't help but think about how our global oil
tank now has about a foot less oil in it than when I saw it during the
previous day's sunrise. I would hope that all policy makers have this
same mental picture when they see this iconic monument to our great
Founding Father.
"What would George
Washington do if he were faced with our situation today? I've been to
Mount Vernon many times to see his great farm and ingenuity. I think
he'd tell us to become sustainable, and to do it quickly, otherwise
we're ultimately back to the living standards of his day. That era is
nice to see as a tourist attraction, but I very much prefer to preserve
the personal freedoms and opportunities that an energy-blessed modern
society offers if I can help it."
Send comments and equally
arresting visualizations along to the address below.
Until tomorrow...
Cheers,
Joel Bowman
Rude Awakening
aussiejoel@the-rude-awakening.com |
