Ad Hoc Commentary – Yellen keeps the faith

Those who stampeded out of US stocks on a panic will probably regret it by the end of the year. Yours truly have much more confidence in Fed Chairwoman Janet Yellen than most people on the street, and trust Yellen meant it when she said the Fed still planned to raise rates gradually:
“…She [Yellen] said the Fed still planned to raise rates gradually, but she didn’t try to convince investors that the Fed still might increase rates at its next meeting, in March. The Fed will publish a new round of economic forecasts then, as it does four times a year, “that will update markets on our thinking on the outlook and the risks,” she assured senators…”

“…for now, she [Yellen] still expects it to gradually raise interest rates this year, given the strong U.S. labor market and other bright spots in the economy…”

The reason why so many people are confused is simply because they fail to understand that Fed overpaying on repo to enforce the rate hikes is stimulatory in nature. Thus counter-intuitively, hiking rates is consistent with what legendary investor Ray Dalio is asking for: “…We are seven years into the expansion phase of the business/short-term debt cycle—which typically lasts about eight to 10 years—and near the end of the expansion phase of a long-term debt cycle, which typically lasts about 50 to 75 years. It is because of the long-term debt cycle dynamics that we are seeing global weakness and deflationary pressures that warrant global easing rather than tightening…”

The main problem today is the meltdown of Europe, and the concomitant economic hardship that millions of individuals will increasingly find themselves in the coming years. Recession in the traditional sense, i.e. a fall of GDP in two successive quarters, might not materialize in an environment of competitive devaluation. We need to be cognizant that many great economic theories were NOT built on the assumption of a floating exchange rate system. President Nixon brought about the paradigm shift of a floating exchange rate system in 1971, and unfortunately for us, the economics profession had not updated their theories to reflect the paradigm shift of a floating exchange rate. Perhaps that is why economics is called the dismal science – unlike the physical sciences, basic assumptions can change quite drastically and quite frequently in economics.

Legend has it that Thomas Carlyle called economics ‘the dismal science’ in reference to Thomas Malthus who basically claimed that the earth cannot support the population growth of the 19th century:

Today, the word Malthusian has a pejorative meaning. However, yours truly actually bothered to look at the graph of population growth in the years preceding Malthus. It is without a doubt that yours truly would had concurred with Malthus’s erroneous prediction. The crux of the matter is  Malthus failed to predict that that the somewhat linear curve of population growth since the dawn of mankind went exponential.

Just as capital gained dominion over most of the natural world through the Industrial Revolutions, the human race are now unleashing a new revolution centered around robotics. This will allow capital to gain dominion over much of the work that was once the exclusive domain of labor. This revolution is likely to proceed unabated by the current economic malaise and will upend many old theories. For example, the problem of Social Security and Medicare is less of a problem if robots can take care of us in our old age. Another example is the use of unemployment rate to measure usage of capacity. When robots are true substitutes to wide swathes of human labor, then unemployment, a measure based on human labor, is a meaningless measure of capacity utilization. The list goes on. The main point is old theories will need to be updated to reflect the paradigm shift.

At this moment, Europe is on the brink of destruction and it is worth re-reading Soros:

‘The EU Is on the Verge of Collapse’—An Interview

All European banks, most famously Deutsche Bank , is under stress. Since it is officially denied, yours truly now believes that the crisis in European banks was catalyzed by the bail-in regime that came into effect on Jan 1, 2016:
“…Feb 11 The sell-off in European bank stocks is exaggerated and not a cause for worry now, euro zone finance ministers said on Thursday, dismissing a link between bearish investors and a new EU law on who has to share the costs of EU bank failures…”

“…First rule in politics: never believe anything until it’s officially denied…”,_Minister

On the political front, the elections in the France and Germany in 2017 will be critical because indirect Russian meddling is probable given the power vacuum left by the receding Americans. In particular, the US pivot away from Europe and the Middle East into Asia allowed the war-weary Americans to turn a blind-eye towards the growing influence of Russia. The pivot to Asia was in all likelihood a face-saving measure to reduce military expenditure. This is corroborated by the fact that net increase, if any, of American military assets in the vicinity of the Far East had been limited. The Chinese should stop worrying about the American pivot to Asia. On the contrary, China should be proud because Obama’s pivot indirectly implies that East Asia is probably the most peaceful place on earth in the coming years. Unfortunately for Europe, the power vacuum is leading to Putin’s reassertion and partial reclamation of lost dignity. The symptoms of this new geopolitical reality manifested itself as a refugee crisis, and growing support for anti-establishment within Europe. Syria will continue to be the focal point for peace in our time. Yours truly think restrain is warranted. However, Russia is not admitting openly to its ambition, which is likely much larger than regional. It is interesting that when there seems to be no hope for the economy, countries tend to ignore the cost of war, and prepare for battle thinking that they will all be victorious and enjoy the spoils of war. In reality, it is even worse than a zero sum game.

Good luck in the markets.