What Will Tomorrow Bring: Inflation

The US Fed cut rates last week, citing the recessionary risks of credit losses stemming from mortgage/ARM losses. They seem to have fallen off the wagon. Nearly three decades of global economic stability have depended on US economic stability. And that has depended on the principle of low inflation. Below I'll look at positive AND negative pressures on the price level. The net qualitative assessment of my (admittedly quasi-scientific) analysis is that inflation will increase in the next 12 months. The message is that it's a good time to hedge against inflation.

The price inflation data is just getting less and less deniable. I put forth the following observations:

• The housing price increase is a bubble .... and that bubble will break. However, the bubble masks some degree of real (and permanent) price inflation. Thus, even as the bubble is "deflated" prices are very unlikely to drop back below historic lows for any significant period of time. In fact, they are likely not to return even to historic averages. This is a global effect.
• Recent articles have begun to raise evidence that, from mortgage costs to rental costs to maintenance and taxes there is a significant and lasting increase. BLS puts this above 4% for the 12 months to 7/2007
• Energy prices are, of course, at the forefront over many peoples' minds, and with good reason. BLS puts energy-inflation at 21% for this year (seasonally adjusted). Petro-inflation has approached 40%. Again, the impact is global on the consumption side. An interesting add-on effect further exacerbating the inflation problem is this: oil exporting countries are awash with so-called petro-dollars and are buying up everything in sight ... at any price, since that is way down their list of priorities.
• Medical costs (to the consumer) are running at 6%. Managed healthcare has placed downward pressure on medical costs, both via pressure on providers to reduce rates, as well as by ourtright refusal to pay for certain treatments, but the net effect is in favor of increased prices.
• Our current weak-dollar policy will increasingly encourage foreign purchases of (greater quantities of) US goods as they become relatively cheap in comparison to other global alternatives. This increased foreign demand will push up the price of these goods ... and also the price (exchange rate) of the Dollar. The global impact of this is less clear. The US's price increase may have offsetting effects in countries which compete with us to export goods.
• The growing wealth and mobility of billions in the third world is largely stashed into savings. However, the long term influence on global price levels cannot be denied. It may well balloon into the biggest factor in price calculations someday soon.
• Smaller anecdotal observations include:
  • Increase in private jet travel over scheduled service
  • Luxury goods inflation is running at 6%

The devil's defense counsel might retort with the following DEflationary pressures:

• House price decline leads to lower consumer confidence and fewer home-equity loans
• Increased mortgage interest rates lead fewer people to borrow, thus de-leveraging the economy and
• Innovation-driven decreases in prices, especially for electronics. While this initially requires big spending (thus an influence for +inflation in the short to medium term) it eventually leading to better, cheaper, more mass-produced, and eventually commoditized products (thus pushing for -inflation in the medium to long term). This is vividly on display in the BLS CPI reports, which have consistently reported declines in computer prices of late. Their current number for 2007 is -12%.
  • BUT ... the increase in the speed of obsolescence of most goods forces consumers to replace their goods (especially electronics) more frequently, increasing spending (as well as monetary velocity). On the corporate level, the focus is on the increased depreciation rates. This causes the PV of purchases to decrease and the net tax liability (ceterus paribus) to decrease, leaving additional funds for futher investment.
• Similar effects are attributed to increased productivity

Outside the pure "price" picture, of course the second major component of the overall inflation equation is the interest rate. This factor, at different time horizons, has different (even contradicting) effects on economic growth, as well as price inflation. For example:

• CD, money market, and other deposit interest rates are being bid up as various lenders look for additional funds to back-fill their balance sheets as their loan write-offs bloom. Please, someone, remind these guys of the S&L debacle of the early nineties.
• The Fed's rate cut has a multitude of effects. I'm currently reading Greenspan's book in which he professes not to fully understand all the ramifications. Among the clear ones, however:
  • Short-term, credit card interest rates go down, encouraging consumers to increase spending
  • Short-term, banks can grant loans at lower rates as they pass the lower interbank borrowing rates along to their customers.
  • To the extent banks get away with NOT passing these along, assuming their transaction volumes do not decrease, their earnings increase.
  • Longer-term, as both banks and companies post higher earnings:
    • They are able to invest more, a growth (and inflation) increaser
      • however, there is a a law of diminishing returns when it comes to the marginal dollar invested
    • Their stock prices increase, thus increasing the wealth of investors, who in turn may increase spending based on their self-assessment of long term net worth

Further Reading:
THE source: http://www.bls.gov/cpi/cpid0707.pdf
http://www.reuters.com/article/domesticNews/idUSL2424052620070924?feedType=RSS&feedName=domesticNews&rpc=22&sp=true

Follow-up: Power

Skip the blog and head straight for the interesting comments on nuke power ... and especially how to deal with the waste and security concerns:
http://freakonomics.blogs.nytimes.com/2007/09/26/a-good-newsbad-news-day-for-the-nuclear-energy-industry/

And then check out Wikipedia for some interesting energy production estimates from IEA:
http://en.wikipedia.org/wiki/Kardashev_scale

Don't You DARE ...

... Claim to be Canadian when backpacking abroad! Ever!

What a chickenshit move to deny one's own citizenship. Move up there if you like it so much. They're quite good at dealing with "take care of me" liberals like you. The US economy can just replace you with three Mexicans and a Pakistani and STILL have money left over.

OK, maybe thats a little harsh.

My main objection to the practice is this: when Americans travel abroad, we become the face of the nation to hundred of people wherever we go. The US has an image problem right now and you, the broke college kid travelling Europe on 5 (ok 100) Euros a day, are one of our best remedies. Go out there and do what you do best: be yourself. Go laugh and have fun. Walk with self-confidence. Try the language ... and the food ... and then make a point to reach out and talk to locals about both things wherever you go. Swap email addresses with someone on the train ... and someone else in a bar. Show pictures of your girlfriend and roommates. Talk about basketball. You (and, more importantly, THEY) will be amazed at how much common ground there is in the foundations of the human experience.

Ahem, well one change: be more humble. Give thanks and compliments liberally. Give opinions conservatively. Reserve judgement. Agree that the US has issues and follow up that we're constantly working on them.

It seems that most people abroad have three simultaneous yet conflicting images in their head when they think of Americans:

• Gee-Dubya: The warmongering cowboy cariacature propigated in the irri-tainment media
• Brangelina: The idealistic image of the young and attractive, carefree, optimistic, and friendly, wealthy (and yes, perhaps materialistic and naive) "normal Americans" as propigated by Hollywood.
• Rosie O'Donnell: Fat, self-centered, and obnoxious

So when they see an actual living American in their midst, they test these stereotypes against your actions. By being yourself - adventurous, interesting, fun, educated - you open the door to a fourth option ... one locals can't help but like.

What Will Tomorrow Bring: Wireless Power

Very cool.
http://www.autobloggreen.com/2007/09/26/wireless-power-from-wipower-ready-for-commercialization/

What Will Tomorrow Bring: UN Relocation?

I'm working a block from the Waldorf Astoria in NYC this week, which has given me the opportunity to see the unbridled circus which surrounds the annual meeting of the United Nations General Assembly. The UN was generously donated a prime plot of land on the east side of Manhattan for their headquarters in the 50's. Since then, they've graced the US with petulance. First let me say that I agree with the concept of the UN, but not with its practice.

Of late, they've grown increasingly irritating to the whole country over their insistence on purview in international affairs, promptly followed up by their reluctance or inability to get ANYthing done in that sphere. The Reagan (and Clinton) effect on world opinion of the US has, I fear, completely worn off, leaving the UN an anti-US mouthpiece for gripes from all corners of the globe. Leaders such as AchMADeenJIHAD are so visibly gauled to even have to set foot in this capitalist hellhole that I'm surprised they make the trip.

For New Yorkers, the UN has been an unequivocal pain in the butt for New York since arriving. Motorcades messing up traffic; Dignitaries from all over ("that's a country??") requiring NYPD overtime to escort;. lawless consolidates with unpaid parking tickets. And General Assembly week. Ugh, the traffic nightmares.

So, since they irritate us and we irritate them, and they irritate us, I'm quite sure we will start to see a movement within the Secretariat to move the HQ elsewhere. With the $4 billion they might make from the sale of prime Manhattan real estate, they could buy quite the retreat in Geneva.

Power

The future of energy is resolving itself to a new level of clarity. We certainly need to work on the "zoom" to see exactly the mechanisms that will get us to the future, but the horizon is now visible.

To state the obvious, the energy of the future is electricity. Other mechanisms will also coexist (see below), but not predominantly. Everything from power plants to factories to cars to home heat will become electric. Because of this demand will skyrocket from the current 500 exajoules of primary energy per year to perhaps 2000 EJ by this time next century. So-called "energy intensity" (energy production/economic output) will continue to decline in industrialized countries, but overall demand will continue to increase. In the 3rd world, unfortunately, both will rocket skyward for a half century. Conservation will slow the growth perhaps but even the most asceticly stringent views could not suggest that we will reduce overall demand as billion after billion people move from subsistence to industry.

For the next 20 to 40 years, new energy generation will be nuclear. It's there, it's safe, it's cheap. This will give breathing room for R&D to successfully develop methods of harvesting energy from a very broad range of geological sources (see below). Somewhere around 2050, we'll wake up to find that geo sources account for more than 50% of total generation. At that point, the only talk about carbon- or nuclear-sourced generation will be how fast these dinosaurs can be killed with economic efficiency.

The bigger story is energy sourced from the earth and the sky. In a sense, this is the next evolution in conservation, since currently the universe wastes (well, expends anyway) inconceivable amounts of energy. Our long-term focus will be on harnessing these joules. Or would that be jewels? To quote Wikipedia (whence all good info eventually alights) the amount of solar energy intercepted by Earth every minute is greater than the energy produced by fossil fuels each year. The earth's core alone generates an incredible 140,000,000 EJ a year. It is estimated that this could easily translate into potential of 5,000 harnessed EJ of geothermal energy per year using currently-existing technologies.

Let me put this overall theory into pictures. As these are simply theories, the numbers are indicative.

Power Sources (first tab) ... and estimates (second tab):

Further reading:
http://www.fao.org/DOCREP/006/AD550E/ad550e00.pdf
http://secondlawoflife.wordpress.com/category/power-generation/
http://ies.lbl.gov/iespubs/42949.pdf
http://web.mit.edu/space_solar_power/

and, as always: http://en.wikipedia.org/wiki/Renewable_energy

What Will Tomorrow Bring: Riding Light

Yes, folks - photon-jet propulsion will allow us to take our grandkids on vacations to "a galaxy far, far away"

ARMs of mass destruction

I've been saying it for years, but realized I haven't officially recorded here my opinion on adjustable rate mortgages.

So here it is: ARMs were, are, and always will be evil. As in IED evil. Ticking timebombs.

I don't blame FIs for offering them - I blame borrowers for accepting them. Most families are on a fixed (or predictably steadily increasing) income. They put together a family budget which matches income to expenses. Why, then, enter into an extremely long-term contract (30 years) committing yourself to an unpredictable stream of housing payments? There is the very real risk that your family's biggest expense will increase without a corresponding increase in income. Therefore, the only available adjustment is to your other expenses (ie: your consumption level), which has a very direct impact on your overall standard of living, present and future. The fact that real estate is so illiquid makes the bind that much tighter; there's no short-term exit strategy should your non-housing expenses go up (or income go down) unexpectedly. You would, at that point, be faced with the choice of default (and loss of assets, including the house) or refinance at a higher rate, which again directly impacts your future standard of living.

Maybe it's just me, but the more I can lock down (stabilize) my expenses, the better I sleep at night.

Euro / Dollar Rates

News every day this week was that the Euro is at an all-time high against the dollar. Primarily, I chalk this short-term move up to the simple and obvious interest rate differential, since the Fed cut Fed Funds and Discount rates on Tuesday. Asia followed suit Wednesday. London has announced increased liquidity availability Thursday. That leaves the ECB as the sucker-bank willing to pay the highest rates.

But the Euro's been bumping its head on records for months now. Part of the blame, of course, falls to the US. Instability, volitility, inflation fears (more on that later), recession fears, budget fears, and the overall US move away from Rubin's "strong Dollar" policy has put them on their heels, but I would think that they could have softened by now if they desired to do so. Question, then, is why they're pursuing the strong Euro.

• Is the ECB trying to avoid inflation in the high-growth zones in Scandinavia and Ireland?
• On a related note, does it have to do more with the steep yield curve and implication of higher future inflation?
• Are they so focused on becoming a reserve currency that they prefer interest rate stability to economic competitiveness and consequent GDP growth?
• Are they simply proving again that they are slow and inept? Just now buying into the "strong currency" concept which appears to have benefitted the US through the 90's?

Unfortunately for Europe (and Canada and others BTW) there is a heavy cost to the "strong" theory.

The full answer .... I leave to you!

Good ole Jolly ole Scientific Method

Decision-making in business needs a ton of help. This field, fertile for improvement, may very well give us a decade of productivity gains ... if we can get it right.



The tools are 99% there to have data-based, risk-based, results-based, analysis-based decisions instead of the current brainstorm and committee approach employed today. They're new, so I forgive execs for not using them ... but the grace period will be up shortly. Once the first domino falls, we're likely to see a tidal wave of change in corporate decision-making models. We see hints of juvenile attempts at this in the hedge fund industry. These hints are actually just an outgrowth of the whole risk-math fad that blazed through banking in the nineties.



Here's a novel thought for you: The Scientific Method. Yes, the one from 8th grade. Need a refresher? Okay, just this once:


1/State the problem

2/Record Background Research

3/Construct a Hypothesis

4/Do the Experiment to test the Hypothesis

5/Draw a conclusion





In a corporate environment, this could be soft-sold using concepts already familiar: "Hypothessis" can be re-named "top-down analysis." The difference is recognizing that this is only one step in a longer process. Conclusions cannot be drawn from top-down analysis ... no, not even in whatever case you've just imagined.

"Do the Experiment" can be re-named "bottom-up analysis." The hypothesis must be tested against actual data, using actual logic and generating actual statistical results.

Communication

Here are two communication tips I constantly give myself:

1/ The first response to "what should we do?" should usually be "What's YOUR opinion?"
2/ To improve communication, use your listener's exact terminology and phraseology in your response.