Like Steve Wynn's quarterly conference calls, Greenlight Capital's David Einhorn's missives are not to be missed. Today, he pens a lengthy op-ed in the NY Times, well worth reading. Extended snippet:
"Government statistics are about the last place one should look to find inflation, as they are designed to not show much. Over the last 35 years the government has changed the way it calculates inflation several times. According to the Web site Shadow Government Statistics, using the pre-1980 method, the Consumer Price Index would be over 9 percent, compared with about 2 percent in the official statistics today.
While the truth probably lies somewhere in the middle, this doesn’t even take into account inflation we ignore by using a basket of goods that don’t match the real-world cost of living. (For example, health care costs are one-sixth of G.D.P. but only one-sixteenth of the price index, and rising income and payroll taxes do not count as inflation at all.)
Why does the government understate rising costs? Low official inflation benefits the government by reducing inflation-indexed payments, including Social Security. Lower official inflation means higher reported real G.D.P., higher reported real income and higher reported productivity.
Subdued reported inflation also enables the Fed to rationalize easy money. The Fed wants to have low interest rates to fight unemployment, which, in a new version of the trickle-down theory, it believes can be addressed through higher stock prices. The Fed hopes that by denying savers an adequate return in risk-free assets like savings deposits, it will force them to speculate in stocks and other “risky assets.” This speculation drives stock prices higher, which creates a “wealth effect” when the lucky speculators spend some of their gains on goods and services. The purchases increase aggregate demand and lead to job creation.
Easy money also aids the banks, helping them earn back their still unacknowledged losses. This has the perverse effect of discouraging banks from making new loans. If banks can lend to the government, with no capital charge and no perceived risk and earn an adequate spread, then they have little incentive to lend to small businesses or consumers. (For this reason, higher short-term rates could very well stimulate additional lending to the private sector.)
Easy money also helps the fiscal position of the government. Lower borrowing costs mean lower deficits. In effect, negative real interest rates are indirect debt monetization. Allowing borrowers, including the government, to get addicted to unsustainably low rates creates enormous solvency risks when rates eventually rise."
and then, this:
"EASY money has negative consequences in addition to the risk of inflation and devaluing the dollar. It can also feed asset bubbles. In recent years, we have gone from one bubble and bailout to the next. Each bailout has rewarded those who acted imprudently. This has encouraged additional risky behavior, feeding the creation of new, larger bubbles.
The Fed bailed out the equity markets after the crash of 1987, which fed a boom ending with the Mexican crisis and bailout. That Treasury-financed bailout started a bubble in emerging market debt, which ended with the Asian currency crisis and Russian default. The resulting organized rescue of Long-Term Capital Management’s counterparties spurred the Internet bubble. After that popped, the rescue led to the housing and credit bubble. The deflationary aspects of that bubble popping created a bubble in sovereign debt, despite the fiscal strains created by the bailouts. The Greek crisis may be the first sign of the sovereign debt bubble bursting."
-KD
6 comments:
This is why I won't buy TIPS--who wants to own something where the borrower gets to decide what the payment is (within certain limits)?
What Matt Phillips said (wsj.com).
..we don’t blame Einhorn for using his bully pulpit to talk his gold book. And he might be right. Others are making big bets on the shiny rock. And Gold is up about 11.4% so far this year, as the S&P and Dow have fallen more than 3%. Still, we just wanted to call the book talking what it is.
Couldn't have said it better myself, especially given where inflation data actually point (down, pace imaginary math and tinfoil-hat intimations).
Full disclosure: my portfolio has a roughly 3% levered-long-gold exposure in the form of a high-political-risk junior gold. But I know better than to pretend it is a long-term inflation play.
the great thing about Einhorn is that he's not afraid to tell people what's wrong, because he knows they won't do what they should do to fix it! In other words, he was short Lehman, and tried to explain how they could fix themselves so that he would no longer be short. I view this piece similarly
Einhorn does a terrific job of explaining WHY he is in the positions that he's in.
it's usually a good assumption to ALWAYS assume that someone is talking their book - so then you have to get past that point and figure out if the argument is a good one or not! I think Einhorn's argument is a good one.
WCW, i think the comments on that WSJ article are dead on: "Einhorn is telling us what he thinks. Naturally, he will have put his money where his mouth is. That doesn’t detract from the value of his comments."
"So EInhorn has a rational basis for his investment positions and is willing to articulate his rationale. Good for him. He also wants to alert people to problems while there is still some time to respond with something other than full-fledged panic and mayhem. Good for him."
also, WCW - if you are seeing deflation in your life, congrats to you. that's what matters. however, in my life, Concord just raised parking meter rates from 50c to 75c an hour - and the violation fine from $5 to $10! MASSIVE inflation ;-)
The best work I've seen recently on inflation is from the Cleveland Fed (always your go-to bank on inflation, I find), where they disaggregate sticky from non-sticky prices. Non-sticky prices are very responsive to economic conditions. Sticky prices, by contrast, contain a component of inflation expectations. Those are the ones uoi watch.
So, where are the sticky prices? As the Atlanta Fed notes, ..the sticky-price part of the CPI that seems to be most forward looking is only limping ahead, up 1.25 percent in April, and is less than 1 percent on a year-over-year basis.
see Dean Baker has some critiques of the thinking. Ignore the gratuitous sniping, a Baker specialty, and focus on the main points: that asset price changes are neither in- nor deflation, and price measures that include health care do not show inflation. To buy Einhorn's thinking here, you need to disagree with both, which I don't.
The signals I track are not flashing inflation warnings. Like Einhorn I am talking the bigger portion of my book, of course. It'll be interesting to see who's right.
" (For this reason, higher short-term rates could very well stimulate additional lending to the private sector.) "
- I'm so glad someone else finally wrote this. The rock bottom rates clearly aren't making it through to small businesses and consumers (and the jury's still out on whether that is a supply or demand problem).
Why not lift them a little, and reduce the possibility of another bubble down the road?
While I'm still in the deflation camp - for demographic reasons over anything else, a ZIRP seems seems to be benefiting only the banks and the government - resulting in reluctance to address serious fiscal policy deficits, and of course more moral hazard.
Disclosure - I trade/sell bonds - higher short rates would make my life easier... there I go talking my book.
Just to play devil's advocate KD, your parking might be 0.25c more, but your car is probably 10 grand cheaper than it was two years ago :), especially if you buy used like I do!
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