Tuesday, February 17, 2009

Some notable quotes

I was just heard some good experts make some important comments to Yahoo's Tech Ticker. Below I include their key points:


"There's a permanent change (in the U.S. consumer), and the worst is yet to come.... People are going to be in survival mode.... Everything you see in the mall, they're buying less of.
Our supermarket clients are telling us that the most popular items are not brands, they're private label, because that sells for less....

Prices are going to continue to come down dramatically...
When you take something like apparel, 70% off is the new 50% off...
At the end of the day in apparel you're going to have prices way down, 30-40% down from where they were, or the consumer simply won't buy them. The consumer will wait out the retailer. They won't buy.
What will happen is you'll have more private label goods, which will sell at lower prices, and that will attract the consumer."
--Howard Davidowitz, speaking in two interviews on Yahoo Finance's Tech Ticker 2/17/09

I liked these quotes from Davidowitz because they support things I have been arguing for a while on this blog. I have also asserted that the drop in home prices will become a prolonged drag on the U.S. economy, although I tend to take it a step further than Davidowitz.
I also like his argument about falling prices, because I have been warning about deflation for a while now. Finally, he mentions the rise of private-label consumer goods two separate times. I gave a historical and somewhat philosphical explanation of this phenomenon in an earlier blog posting.


"They're trying to preserve and restore the old market. They're trying to restore the securitization market ...
What they're trying to still do at the Treasury is go back to the future. And, I think the more basic question we have to ask is, what are we going to have to say to investors that's going to be credible? -- That's going to stabilize expectations for the future? Because his proposal right now is not dealing with that." (Emphasis added.)

I like Whalen's comments because they support this an argument I made in this blog entry. This is why I have argued in recent weeks about the need to restore the profit motive and normal financial behavior to the market, so that reforms are sustainable. Even if it means making significant superficial changes -- like letting Citi and Bank of America fail -- this would be better than trying to find ways to make it look like the old system is still working. (Such as by insuring their bond issuances and making capital injections.)

To properly frame this argument, I'd like to return to my roots as a social anthropologist and draw some inspiration from German thinker Max Weber, who spent a lot of time examining how people look at the world. In his most famous book, The Protestant Ethic and the Spirit of Capitalism, Weber argued religious convictions like predestination and a disdain for idleness helped drive modern industrialism. A key subtext about Weber's argument is the accidental nature of this religious influence. People didn't say, "I want to be rich, so I will embrace Calvinism." They embraced it as a religious faith, which then had unintended consequences. This is essential for anyone who wants to truly understand history. (Most people who examine their own lives will find the most important things are unplanned or unintended.)

For instance, some people say the U.S. fought the Civil War to "end slavery," which is simply untrue. Washington waged war to maintain the Union. In 1862, Abraham Lincoln issued the Emancipation Proclamation to strengthen his position in that conflict. The move solidified his standing with increasingly important Anti-Slave forces and gave the North a moral upper hand in the eyes of the world, preventing the UK and France from supporting the Confederacy.
In other words, the North didn't fight the Civil War to free the slaves. The North freed the slaves to win the Civil War! It might seem like an inconsequential point now, but it shows the importance of understanding why and how people do things because history is often the result of unintended consequences. A good leader will always focus on winning, even if it means changing the goal to exploit the opportunities that present themselves. The great man doesn't ask "what do I want?", but "what is possible?"

You know that neither Tim Geithner nor Ben Bernanke are great men because they are trying to do the impossible. Instead of focusing on halting home price declines and restoring some semblance of reality to the credit market, they have implemented countless band-aid measures that will leave the patient dysfunctional for years to come.

Many crises in history result from people trying to do what's established and traditional when reality has changed and different actions are needed. This was true in WWI, when European military commanders ignored the lessons of the American Civil War lost millions of men on hopeless frontal assaults. Our economic generals at the Fed and Treasury also misunderstand reality with amazing regularity.

I highlighted the points from Whalen above because it reminded me of a passage from the Georgetown University's Carroll Quigley which I quoted in the blog posting referenced above. Quigley, a brilliant historian and economic expert, placed heavy emphasis on the intellectual paralysis before the Great Depression as politicians and central bankers refused to appreciate how much the Great War had changed the global financial system.

He says that after WWI ended, policymakers tried to force a return to the pre-war financial system: "Since the essential element in that system was believed to be the gold standard with its stable exchanges, this movement was called 'stabilization.' Because of their eagerness to restore the prewar financial situation, the 'experts' closed their eyes to the tremendous changes which had resulted from the war...
Instead of seeking a financial system adapted to the new economic and commercial world which had emerged from the war, the experts tried to ignore this world, and established a financial system which looked, superficially, as much like the prewar system as possible."

He also mentions that, even as policymakers tried to restore the gold standard, they also tried to hoard bullion -- undermining the free flow of gold the gold standard required. This reminds me of our current credit market, where the Fed and Treasury have extended a confusing mishmash of guarrantees and supports while pushing rates to insultingly low levels. (I have opposed Fed rate cuts from the moment they began in the summer of 2007.)
Just as the sterilization of gold and big war debts prevented the old money system from working in the 1920s, today's mountain of ad hoc measures rules undermine the transparency and individual profit motive necessary for the credit market to function. Instead of saving the system, they are slowly killing it. The patient is has a gangrenous leg. A sensible doctor would cut it off to save the life. Ben Bernanke is ignoring the severity of the infection because he doesn't want to be the guy who cuts off someone's leg. His squeamishness will cost the patient his life.

In the case of the Civil War, the intention was the save the Union. The end of slavery was an unintended consequence (and obviously a good one.) An even more interesting way to look at the situation is to ask why the South even tried to secede? It wasn't to keep their slaves, because only the most radical and marginalized absolutionists spoke in favor of ending slavery before the war began. I believe Southerners fought out of a commitment to states' rights, a sense of inferiority towards the North, a sense of self-doubt because of slavery (after all, if you "fight for freedom" it helps you delude yourself into thinking you stand for liberty) and their own desire to re-enact the American Revolution. The South also had a proud citizen-soldier tradition and many men grew up hearing stories of the victory over Mexico. (For more, see Why Confederates Fought by Aaron Charles Sheehan-Dean. Link) These factors all combined to make them want to fight, but have been lost to history. All we know now is they fought to defend slavery and lost. (Another, even more interesting point is that, if they hadn't fought, who knows when slavery would have ended? Their stupidity and eagerness to fight did more to end slavery than did Northern heroism.)

My point is that history doesn't care what you mean to do. It only looks at what happens and that will become your legacy. Say I am a news reporter going to a press conference on credit ratings, and instead learn of a hugely important merger. I can chose to stick to my original story, or I can adapt to the new reality and break the takeover story. In the end, no one will care that my intention was to cover a boring credit-rating seminar. I would be judged by the merger story.

Likewise today, history won't care that Bernanke/Geithner are trying to restore the old financial system. It will only judge them by the consequences of actions. (That's why we snicker at the Fed's decision to raise interest rates at the start of the Great Depression, not realizing that it made a lot of sense when they did it. Today, we just call them stupid for removing credit at the start of a Depression.)

Just like 78 years ago, the authorities are ignoring the new realities at hand: unending declines in home prices, the unprecedented role of securitization and speculation in this crisis, or the failure of interest-rate cuts to fix the problems. (See this blog posting and this one for more.) This is why Whalen's quote was so salient to me.

Finally, I want to comment briefly on today's trading, which was shockingly bad. The S&P 500 made a huge gap lower. I am not sure whether it will try to rally back to fill this gap at least partially in coming days, but the momentum is clearly to the downside. The S&P500 took out the key support level at 800. Furthermore, the oscillators are looking bad. My slow stochastics has shown a cross below the 20% line. That has happened five times since November 2007, and each instance was followed by significant downside.

The night of Feb 9, I correctly called a top for the market, arguing that money would flow back to Treasuries and away from stocks. This is now happening. Despite all the talk about deficits, etc, Treasuries offer major value at these levels -- especially at the longer end of the yield curve. I expect to see money flowing out of stocks and back into the 10-30 year space. As I have been thinking all along, the "reflation trade" was a perverse thought by equity managers with too much cash on their hands. (Idleness might be the devil's workshop, but "dry powder" runs a close second...)

I have been predicting a 480 level on the S&P500 since November. I am sticking by that call.

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