KOO: THE GLOBAL SLOWDOWN IS BECOMING MORE PRONOUNCED

The Pragmatic Capitalist:

Few people have a better grasp on the current economic predicament than Richard Koo. Koo is growing increasingly concerned about the state of the global economy and now believes the slowdown is becoming more pronounced:

“Signs of a slowdown in the global economy have become more prominent over the last two weeks. The deceleration in economic activity was reflected in the US jobs report and new unemployment claims, European industrial output, and Japanese consumer confidence. It was also reported on Monday that Japan’s inflation-adjusted GDP grew only 0.4% y-y in the Apr–Jun quarter, confirming that the recent slowdown actually began this spring.

This string of weak data led to a further correction in equities and pushed bond prices higher (and yields lower). Strong demand for government debt was underlined by yields ofsubstantially less than 3% for the 10-year Treasury note and less than 1% for the 10-year Japanese government bond.

In Ireland and some other countries in the eurozone, meanwhile, marked economic weakness fanned concerns about the future, leading investors to sell bonds and send interest rates higher.

In the currency markets, the narrowing yield differential between Japan and other nations prompted further buying of the yen, which set a new post-Lehman high of 84.72 against the US dollar.”

Koo is quick to note that the recovery we’ve seen since the Lehman collapse was primarily a mean reverting recovery that took us back to where we should have been in the first place had there been no Lehman related panic:

“That means that the rally that started about six months after the Lehman-inspired financial crisis was actually just a recovery from the Lehman crisis and not from the global housing bubble collapse in 2007.

The recovery from the financial crisis of 2008–09 was destined to run out of gas once economic activity rebounded to the (depressed) level where it would have been as a result of the balance sheet problems. I think that is what we are now observing in the US and Europe (Exhibit 1).”

“In other words, the level of economic activity has returned to where it would have been if Lehman Brothers had not been allowed to fail.”

Koo is increasingly concerned that governments have already begun down the wrong path of austerity:

“But governments in the UK, Ireland and Spain have already changed course and are pursuing austerity policies. Even in the US, it remains to be seen whether the Bush tax cuts and the Obama economic stimulus can be extended.

The recovery from the 2008–09 financial crisis has now run its course, clearing the fog surrounding the balance sheet recession. But I suspect that more time and even weaker economic data will be necessary before people understand this and accept the need for further fiscal stimulus.”

In particular he is very worried about Europe and the actions taken by Trichet:

“Against this backdrop, I am particularly concerned by an opinion piece contributed to the 23 July Financial Times by ECB President Jean-Claude Trichet and titled, “Stimulate no more—it is now time for all to tighten.” In the article, Mr. Trichet argues that the economic recovery is already under way and that the fiscal stimulus administered by national governments over the past two years should be quickly withdrawn.

Mr. Trichet also argues that the series of fiscal stimulus packages unveiled by the G20 two years ago was actually a mistake and says it was unfortunate that some countries had administered stimulus without any need for it. Now, he says, it is time for all countries to pursue medium-term fiscal consolidation strategies.”

Koo believes Trichet is wrong because, like Bernanke, he has misunderstood the balance sheet recession. He believes Trichet is becoming “more German than the Germans” and is directly contributing to the recovery in that single nation while the periphery burns. Ultimately, he says Trichet is making the same mistakes as Bernanke – believing that austerity and monetary policy should rule the day. Richard Koo, who has been right thus far, says they still fail to understand the balance sheet recession. It looks to me like he’ll continue to be right.

The Trader’s Mindset

Charts Gone Wild:

I wrote this article on March 15, 2009. It’s been well over a year and I know that many new folks have never seen it before. During this month, I’ll do re-postings of my best educational content because new folks who barely know me never got the chance to read my past posts from 2008/2009. It’s also nice for me to edit the articles to make them slightly better, otherwise known as ’2nd edition posts’. If you read my archives, then it’s simply nice to have a refresher once in a while. I do hope the re-print articles help in some way.

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Plutchik’s Wheel of Emotions

As you know by now, psychology is a secondary interest of mine, after reading charts and tarot cards, of course. For this week, I decided to cover the “trader’s mindset” and the most common psychological issues that all traders deal with.

How does someone know that they reached the trader’s mindset? Here are a few characteristics:

1. No anger whatsoever.

2. Confidence and being in control of the self

3. A sense of not forcing the markets

4. An absence of feeling victimized by the markets

5. Trading with money you can afford to risk

6. Trading using a chosen approach or system

7. Not influenced by others

8. Trading is enjoyable

9. Accepting both winning and losing trades equally

10. An open mind approach at all times

11. Equity curve grows as skills improve

12. Constantly learning on a daily basis

13. Consistently aligning trades with the market’s direction

14. Ability to focus on the present reality

15. Taking full responsibility for your actions

Developing the trader’s mindset takes time.

Let’s take 100 traders using the same trading system or approach. It is highly likely that two of them will not trade a system exactly the same way in all aspects. Why is this? Because our mindsets, beliefs, and understandings are unique. It is no surprise that most traders fail and the reason why is because they lack the trader’s mindset.

There are two parts to fixing any psychological problems:

1. Recognizing that it exists

2. Accepting it so you can move on

In trading, this is where it’s so crucial to take responsibility for your own actions because it induces change and you can start making improvements. If you don’t recognize and accept a problem, then you won’t get anywhere!

What are some of these issues that I speak of? Here are a few along with their causes and/or effects (these 15 issues are not meant to perfectly coincide with the above 15 mindset characteristics):

1. Anger over a losing trade – Traders usually feel as if they are victims of the market. This is usually because they either 1) care too much about the trade and/or 2) have unrealistic expectations. They seek approval from the markets, something the markets cannot provide.

2. Trading too much - Traders that do this have some personal need to “conquer” the market. The sole motivation here is greed and about “getting even” with the market. It is impossible to get “even” with the market. Trading too much is also indicative of a lack of discipline and ignoring set rules. This is emotionally-driven.

3. Trading the wrong size – Traders ignore or don’t recognize the risk of each trade or do not understand money management. There is no personal responsibility here. Typically, aggressive position sizes are used, however if risk is not contained, then it could spiral out of control. Usually, this issue comes from traders wanting to make a huge killing. Maybe they do win, but the point is that a bad habit emerges if a trader repeats this behavior.

4. PMSing after the day is over – Traders are on a wild emotional roller coaster that is fueled by a plethora of emotions ranging throughout the spectrum. Focus is taken off of the process and is placed too heavily on the money. These people are very irritable akin to the symptoms of premenstrual syndrome (something I wouldn’t know about personally).

5. Using money you can’t afford to lose – Usually, a trader is pinning his/her last hopes to make money. Traders fear “losing” the “last best opportunity”. Self-discipline is quickly forgotten but the power of greed drives them, usually over a cliff. Here, the rewards are given more attention and overall personal financial risk is ignored.

6. Wishing, hoping, or praying – Do this in church, but leave this out of the market. Traders do not take control of their trades and cannot accept the present reality of what’s happening in the market.

7. Getting high after a huge win – These traders tie their self-worth to their success in the markets or by the value of their account. Usually, these folks have an unrealistic feeling of being “in control” of the markets. A huge loss usually sobers them up pretty quickly. It’s important to maintain emotional restraint after wins, just as you would for losses.

8. Adding to a losing position – Also known as doubling, tripling, quadrupling down, typically, this means that the trader does not want to admit the trade is wrong. The trader’s ego is at stake and #6 comes into effect as the trader is hoping the markets will “work in their favor”. If you are wrong, you have a near 0% chance of making a full recovery.

9. Compulsive trading – Similar to #2, except these traders have an addiction to trading and quite possibly gambling issues. They need to constantly trade, even if there is no rational reason to do so. They are always excited whether they win or lose. These traders will trade in all environments and usually trade when it’s advisable to sit out.

10. Afraid of “pulling the trigger” – This usually means that the trader does not have a system or approach already in place. They have not calculated risk/reward and many times, these trades are unplanned. This also comes after a string of losses. They don’t want to be “wrong again”. There is no trust from within and an obviously lack of confidence.

11. Over-thinking or second guessing – Similar to #10, but these people are usually looking for a “sure thing”, when they clearly don’t exist. Losing is not recognized as a normal part of trading and the risks and unknowns of trading are not fully accepted. These traders cannot make decisions in the face of the unknown.

12. Limiting profits or getting out too early - These traders do not have a plan. There is a direct effect from believing that profits were undeserved…a typical reason for giving them up. Usually a trader is stressed over a trade for some reason and closing the position quickly eliminates the anxiety. Usually, there is a fear of “giving back” those gains.

13. Fear of being stopped out – Traders fear failure and the pain from taking losses is great. Here is another instance where the ego is at risk. They must always be correct or suffer a feeling of “let down”. Don’t forget that your stop loss is your last line of defense.

14. Not following your system – This is a trust and follow-through issue. Perhaps the trader didn’t test it enough, or it recently produced a string of losses, casing some doubt. Your faith in the system is broken. Not only do you not trust the system, you can’t even trust yourself with picking one that works for you. Find and stick with one that is consistent and ‘fits’ with your personality and style.

15. Following other traders (indiscriminately) – These traders do not have a system. They are also limited in trading knowledge. They feel that they will become winners if they simply “follow” someone. These trades are usually impulsive. It’s too dangerous to follow without cause.

The key to all things is creating balance. Remember, it takes time and discipline. The important thing here is to recognize the issues and learn to seriously accept them and take responsibility for your actions. When you finally recognize and accept each of these common pitfalls, you’ll be well on your way to acquiring the trader’s mindset.

Keynesian End Game – Fooled By Stimulus.

TraderSutra:

Nassim Nicholas Taleb wrote a fabulous book called Fooled By Randomness. It’s a treasured part of my library and will stay so to the day I die. Everyone should read it and then read it again. I won’t go into too much specifics, but it’s all about how investors as well as humans in general often are unaware of the existence of randomness. We tend to explain random events as non-random. Often from this we over analyze and over estimate causality. We tend to make the simple complicated and the complicated simple. When in fact the random happens all of the time and that most are unprepared for it because our belief systems are so out of whack. We have years of ingrown cognitive biases that distort our view of the world and its surroundings.

My point here is not to talk about randomness per say but to talk about being fooled. World markets are currently being fooled into thinking that Keynesianism is going to save us all. In fact, it’s the opposite. Keynesianism will be the hammer to the nail to the coffin to what Neo Classical Economics started. Policy makers and central bankers around the world have been indeed “Fooled By Stimulus.” The idea that exponential increases in debt and leverage will eliminate debt and leverage is at the foremost zeitgeist of Central Bank circles. This one single toxic theme has permeated almost all policy circles. Cheap debt begets more cheap debt. Bankers get drunk off of cheap debt because they can always invest somewhere to gain the spread.

Most central bankers call the Keynesian Theory of Economics the “Beautiful Theory.” This was the most influential economic theory of the early 20th Century. It saved us from the depths of the Great Depression. It is also currently the preeminent theory that is housed today. Keynes was an exceptional thinker who alerted all that financial markets are inherently unstable, Hyman Minsky said similar things in greater detail decades later but it was Keynes who mentioned it first. Keynes also had this Gem, “In the long run we are all dead.” Western democracies needed an approach to balance free market capitalism with government initiatives. Keynesianism was the approach. But all “beautiful” things inherently hide some ugly truths. Like the super model who has an eating disorder, and the gorgeous porn star who comes from a broken home. At the end of the day it all comes out on the wash.

I believe that the Keynesian miracle is dead. The game is over. The stimulus programs have not reduced unemployment and not spurred the real economy. America is currently running two economies and it’s the financial economy that Keynesianism has greatly helped at the expense of the real economy. This is the great divide in our country. It’s not Democrats V. Republicans. That’s too easy. It’s the Have V. Have Not’s. The debt costs used to prop up the financial economy has a direct consequence to the real economy for generations to come.

http://tradersutra.blogspot.com/2010/08/dual-economies-busted-financial-system.html
Keynesian economics was born with the publishing of John Maynard Keynes’ 'The General Theory of Employment, Interest and Money.” This theory states or advocates a mixed economy, predominantly driven by the private sector, but with significant intervention by government and the public sector. Keynes argued that private sector decisions often lead to inefficient macroeconomic outcomes, and advocated active public sector policy responses to stabilize output according to the business cycle. Keynesian economics served as the primary economic model from its birth to 1973. It lost some of its luster during the high inflation and subsequent stagflation in the 70’s, but made a comeback during the credit crisis of 2007-2008.

This crisis rejuvenated Keynesian policy and we then received the following from government:
-TARP
-TALF
-American Recovery/Reinvestment Act
-QE
-ZIRP
-Cash For Clunkers
-HAMP

Most of these programs were indeed geared to bailout the financial economy. It had very little effect on stabilizing the real economy but the financial economy just reloaded on the cheap debt.

This type of policy basically makes the point that we can have debt and credit expansion if the economy also grows with it. A rising tide lifts all boats. The rising tide really is a debt tsunami that is going to drown us all. Deflation will be the prevailing theme for developed economies for the foreseeable future. This is why the Fed is obsessed with a busted QE policy. Deflation is poisonous to levered risk assets. What typically happens after we have deflation is mass monetization of bad debt which undoubtedly leads to hyper inflation or general destruction of all Fiat currencies. Hyper inflation is not prices spiraling upwardly out of control, it’s the loss of confidence in ones currency. The Keynesian End Game is total and complete debt monetization which will lead most investors to give up on fiat paper currencies. Any wonder that gold and silver are all in rally mode? What should be happening is debt restructuring and outright default. This would cleanse economies and make lending much more responsible.

The prevailing wisdom of ever expanding debt loads being offset with stronger economies have been around for a long time. It worked all through the 1960’s. The debt loads were high but world economies were just getting in line and economies were able to grow. This made the debt load manageable. Many were worried about corporate debt loads, deficits, and personal debt burdens, but world economies powered higher. The critics were all wrong and looked like idiots.

Statistics on almost all types of debt showed a high correlation between their increases and increases in measures of economic health like the GDP, average personal net worth, and the country’s standard of living. This marched on for decades, but underneath the beauty was a sleeping slug. Over the years, the dollar increase in debt necessary to generate a dollar increase in GDP kept growing. In the late 1940’s and 1950’s, it took about a one dollar increase in debt to generate a one dollar increase in growth, but in each succeeding decade the amount of debt necessary to generate a dollar increase in GDP kept growing. Through the most recent decade, it seems to have taken more than five dollars of debt to produce one dollar of growth, and over the last few years the numbers might have gone into reverse, or perhaps only toward infinity, as all the increase in debt does not seem to create any growth.

Debt used to be the answer but it is increasingly becoming the wrong answer for our current ills. What are the alternatives? Painful ones I presume, that is why that they still alternatives. The easy thing to do is print and monetize debt. The world has not seen a reduction in debt levels since the Great Depression and it is painful obvious that debt reduction is what is needed but will not be implemented until all is lost.

Going back to the correlations of debt and GDP. We see that global GDP especially US Economic growth was 100% credit generated. The 2000-2007 boom was all about residential construction and homeowners using their homes as ATM machines. When the credit boom collapsed, we saw both economic and credit contract. From this policy makers instituted a ZIRP to try and reinflate past bubbles via animal spirits. In the past this worked but presently most Americans are experiencing a balance sheet recession, and no matter where short rates are most are in secular deleveraging mode. Expansionary monetary policy is failing because the debt levels are enormous, as an expansion of credit has lost its power to stimulate growth. As such a reduction in debt levels coupled via restructuring and outright default of debt will have a devastating effect on economic output. What we are experiencing and seeing before our own eyes is the Keynesian End Game. A dead end for Risk Markets .

Just from this logic I can deduce: Forget a double dip recession. The vast amount of Americans never fully recovered from the 2007-2008 credit crisis. A new depression has begun. There will be massive amounts of new debt issued around the world by Central Bankers, this only delays the process of recovery as new debt will not stimulate growth but only keep alive zombie financial institutions. Eventually there is no other option than to restructure/default the debt load. Global debt loads need to shrink and shrink fast. Only after this catharsis where the debt is purged can we can realistically think of growth via reflation.