Dear Reader,
Vedran Vuk here, filling in for David Galland. Today, I want to break down the boom-and-bust cycle from the perspective of someone starting their own business. Then, I'll explain the significance of Mario Draghi's statements yesterday, which shot the market upward. Finally, I'll briefly touch on why journalism tends to perpetuate economically illiterate ideas.
By Vedran Vuk, Senior Analyst
When anyone talks about macroeconomics and the boom/bust cycle, they more often than not focus on the big picture: GDP growth rates, inflation expectations, and central bank policies. In most of my articles, I am as guilty as anyone else of this. So today, I want to switch it up and discuss the boom–and-bust cycle from the perspective of a small business. How is that a period of low interest rates and excess credit can cause such widespread destruction among enormous banks as well as small businesses? After all, it's not like Mom and Pop were playing with risky derivatives.
Suppose I was starting a new business during a credit bubble. Let's say that it's something somewhat bubble-related, perhaps a high-end kitchen accessories store. Since I'm a very prudent person, I'm not just starting my business on a whim. In fact, I've done some serious calculations to discover that my monthly profit margin would be about 20%. It's not huge, but enough to start my small, high-end kitchen accessories store.
How do the Fed's policies affect my decision to open? First of all, consider that interest rates factor into my overall monthly profit margin. With rates extremely low thanks to the central bank, my business can finance its startup expenses at a much lower cost. If interest rates were much higher, my margin would be necessarily lower. As a result, the interest rate could determine whether my business is worth starting or not. If my margin after debt was only 15% rather than 20%, the business might look too risky, with only a small cushion should something go wrong.
Another way of putting it is that I'm starting a business which, under other interest-rate circumstances, might not make sense. See the problem here? Rather than the strength of my business determining its viability, rates have become a primary issue.
Now you might be thinking to yourself, how many businesses does this really affect? How many people are starting such marginal business where the outcome depends on interest rates? That's a great question. The majority of new businesses wouldn't cut it so close. However, it does happen. Think about investors flipping houses on adjustable-rate mortgages. When rates started to rise, many almost instantly went bankrupt. This is one of the clearest examples of low interest rates leading people to malinvest in projects which don't make sense. If interest rates were higher, they likely would never get themselves into the same business.
Beyond the interest payments on your debt, a second part of the profit margin is affected by low rates and plentiful credit. My margin calculation assumes that the current demand for kitchen accessories is realistic and stable. However, in a credit bubble, the demand in the economy may not be a reflection of long-term demand. Since credit is cheap, I'm starting my own business. But there's a few stores next door opening up too. And other people in the economy are taking advantage of the cheap credit as well. Whether it's through spending more through credit cards or getting a second mortgage on the house, everyone is flush with money.
And with so much money flowing around, demand is being fueled by the cheap credit. Without the cheap money, my kitchen accessories might not be huge sellers. I might not be able to charge as much for my products, and my business idea might not break even at all.
However, at some point in any credit-induced bubble, the money stops flowing into the system and the problems begin to arise. In one case, the central bank may contract the money supply and raise rates to battle inflation. In another, the credit expansion could just reach its limit. When almost everyone has maxed out their credit cards and taken second mortgages on their homes, where else is there left to go but down? Necessarily, spending will take a dip to match the realities of their debts.
When the inevitable contraction of credit happens, the demand for my products will plummet. For example, my monthly margin might fall as low 5%. At that point, my business no longer makes much sense. Things often get even worse from here. Other marginal businesses begin closing down and laying off workers. And guess what this does to my margins? I'm getting battered even more. At that point, I'm likely operating at a loss.
My kitchen accessories store was built with the assumptions of a high-demand bubble environment. In the credit-contracting economy, it no longer makes economic sense as a going concern. The business essentially just loses money. It is a malinvestment and a waste of capital.
In a recession, these wastes of capital are cleansed from the system. The economy slowly repairs itself through new businesses. The new businesses are built assuming the margins of hard times and credit constraints, i.e., assumptions of real demand versus the illusion of prosperity created by cheap credit. Businesses built with these assumptions become the bedrocks of the economy. They make sense as an investment of capital regardless of the Federal Reserve's actions.
During the current recession, plenty of businesses have been very successful. They make their business plans based on the new normal around them. For example, Apple isn't a successful company because of the Fed's interest rates or artificial demand. It has a product and cost structure which appeals to consumers despite the economic turmoil. The company's growth is based on real, long-term demand for its products. If the economy started booming tomorrow, surely Apple would sell even more iPads and iPhones, but its business plan does not require boom-time demand to make economic sense.
So is my kitchen accessories store doomed? Not necessarily. When things hit the fan, central banks try to keep the party going as long as possible – hence, the Federal Reserve's near-zero interest-rate policy. Not only does plenty of cheap credit allow businesses to refinance, but it also fuels more artificial demand.
This helps business across the board, but the biggest beneficiaries are the most marginal ones. In a way, it's a backdoor bailout for the worst investments of the bubble period. Think again about the guy flipping houses with adjustable-rate mortgages. He gets the biggest benefit from lower rates. The average homeowner might have a slightly higher home value as a result of additional demand, but his gain is not huge. Sure, housing prices are bad now, but trust me, if 30-year rates jumped to 8% or 9%, the already low demand for the homes would fall through the floor.
Because of loose monetary policy, people make bad long-term business decisions. It's not necessarily their fault. All too often, we try to attach some sort of moral connotation to their decisions, i.e., they were greedy. However, what happened across the country is that everyone from small business to house flippers to bankers saw a lot of money floating around them. They saw an opportunity and jumped on it. In some ways, they were smarter than many of us who did nothing. That said, their mistake was confusing decades of monetary stimulus for real growth in the wealth of society.
The main takeaway as an investor or even as a business owner is to assess the economic environment around you prior to making a long-term investment decision. Is the economic growth in your community real, or temporary and fake? Has your community really gotten wealthier as a result of growing capital, or is it stimulus fooling us again? It's not an easy question to answer. So many people were sucked into bad investments during the boom for the very reason that it can be hard to tell the difference. Those investments typically don't come with a warning sign, and there are few barometers to help make one's decision.
However, there is one barometer which is a sure sign – interest rates. And unfortunately for us, they've been extremely low for quite some time. Does that mean the demand in the economy is all illusionary? No, but some part of it is. The million-dollar question – if not the billion-dollar question – is how much of the demand is real and how much is fake.
By Vedran Vuk
With Mario Draghi's statements sending the S&P 500 upward over 2% yesterday, Bernanke must be a little jealous. The long-anticipated Jackson Hole meeting did little more than nudge the market. However, this makes complete sense. It's no secret that the gorilla in the room is Europe. Even if Bernanke promised the world to the market, there's only so much that he could deliver to stem the problems arising from the said gorilla. This is a European problem, and ultimately only Europe can solve it.
So what did Mario say to send the market upward? He's going to print more money, right? Well, sort of. First of all, interest rates have been kept the same, so he's not stimulating the euro-wide economy, as the majority of financial economists predicted leading up to the meeting. Instead, he's offering an unlimited bailout for Eurozone countries in the worst-case scenarios.
Now, understand that this doesn't mean the European Central Bank (ECB) will start purchasing every Italian and Spanish bond in sight. It will only do so to stem "irrational" speculation of a member country leaving the euro. For a country to qualify for this bond-purchase program, called the "Outright Monetary Transactions" (OMT), it will have to meet conditions which will be partially overseen by the IMF. Furthermore, only short-term bonds between one to three years in maturity will be considered. However, the bond purchases will be limitless; the ECB is willing do anything to keep the euro intact.
Let me translate that into the most basic one-sentence message for traders across the world to understand: If you are betting that a particular country will get kicked out of the euro, the European Central Bank will beat you to a pulp.
This isn't a stimulus program sending the markets higher – it's a promise of an unlimited safety net. Draghi has promised to throw in the kitchen sink to stop anyone from leaving the euro. No, the Eurozone is not in good shape, but the market seems to think that the worst-case scenario of a euro split up might be off the table.
So what would trigger bond purchases from the ECB? According to Draghi, there is no set rule, and action will depend especially on volatility and liquidity, among other things. This approach makes sense, as it specifically targets the issue of irrationality. If bond yields are rising violently one day and crashing the next, then panic and irrationality might be driving the bond yields. However, slowly rising yields might not necessarily force the central bank to act.
What does Draghi's plan mean for our readers, who might be more skeptical of central-bank programs than the rest of the market? We can't ignore that the ECB has made a major announcement here regarding the solvency of the euro. Though the euro might fall apart one day, it's not going to be tomorrow. Before a country leaves the euro, the ECB's program will first have to fail. And considering that the program hasn't even started, don't expect Greece to leave the euro Monday morning.
By Vedran Vuk
Over the years, I've heard many people gripe about the media. It's always so anti-free market and economically illiterate. When there is some favorable mention of markets, it's usually a trained economist or financial person. Insightful commentary from a journalist on economic matters is, sadly, a rare commodity. In my opinion, the root of the problem comes from the sort of person who wants to become a writer.
As an analyst and a financial writer, I meet a lot of people who want to be writers. It's quite a strange aspiration. Personally, I enjoyed studying economics and finance and kept having ideas which I wanted to share with others. Hence, I started writing about them. A few twists and turns later, and here I am.
The problem with journalism is that most journalists come from the exact opposite approach. They decided to write long before having any background knowledge to write about. The vast majority of college freshman enter their first journalism or English class without anything important to say on the matters of economics and politics. Despite their ignorance in the ways of the world, they still want to write about it anyway. Reflect for a second on what an odd concept that is.
It's kind of like wanting to open an art gallery just so that you can sip wine with artsy people. Shouldn't the point be to use your art as medium to express an idea or emotion or something else significant?
Call me biased, but I'm of the persuasion that one should know something about a topic before writing on it. Otherwise, writing is just screaming at a mountain to hear one's own voice. There's no point to it.
Unfortunately, after four years of reading poetry and the classics, the young aspiring writer is no better prepared for his or her future role of commenting on economics, politics, and science. After college, you've got a very dangerous weapon on your hands – a person who can write persuasively but doesn't really know much about anything. It's quite irresponsible of colleges to let such people loose on society.
These journalists aren't spending their waking hours studying economics to compose the best-informed articles. Instead, they'll just formulate some half-baked idea from the top of their heads with little background knowledge to defend their assertions. Their goal is not to become the most knowledgeable economist, physicist, or historian. It is not the search for truth or important ideas which motivates most. Their goal is simply to write – and the bigger publication, the better. With this as the inspiration for many writers, why are we surprised to see so many economically illiterate articles in the media?
While the lack of intelligent economic news articles is bad, far worse is the dearth of clear political thinking on economic matters. As a result of this ignorance, the government has centralized the economy to an extreme degree, rendering the maps we've used to guide our portfolios essentially useless.
That's why we teamed up with Sprott, Inc. to host the Navigating the Politicized Economy Summit, which is going on right now in Carlsbad, California. It features 28 economic experts who will help you devise strategies to profit from our overly politicized economy, including Doug Casey; Dr. Lacy Hunt, who was voted "most popular speaker" at our last summit; Karl Denninger, author of The Market Ticker, a daily market commentary; and Bob Hoye, chief financial strategist of Institutional Advisors and widely recognized for his unique approach to forecasting based on previous eras of financial booms.
The Summit will also feature insights from true "insiders" into how the government waylaid the economy, including former US Comptroller General David Walker, and Dr. Thomas P.M. Barnett, who has worked in US national security circles since the end of the Cold War. And of course, there will be plenty of actionable investment advice from the Casey editorial team and other financial luminaries.
You can hear every stock pick... every expert investment strategy... every recorded presentation with the Summit Audio Collection, which will be produced as soon as the conference ends on September 9.
If you order before the Summit ends, you'll save $100. Don't miss out on this deal – it could prove to be the best investment decision you've made all year.
I'm not sure if the first Friday funny necessarily qualifies... I'll let you decide. It will either make you laugh or cry. In this video, Peter Schiff goes to the Democratic National Convention and tries to get as many people as possible to support banning corporate profits. It's amazing how many people agree with him.
A Response the San Diego Padres Won't Forget for Some Time
Here's an article from Deadspin going viral about a job applicant's hilarious response to getting rejected by the San Diego Padres baseball team one too many times. Please excuse the foul language:
Taylor Grey Meyer estimates that she applied for a job with the San Diego Padres at least 30 times since moving to Coronado, Calif. initially in the sales office; but as she was alternately rejected and ignored, she lowered her sights. This past March, she applied for a minimum-wage job selling tickets at Petco Park. This is what she heard back:
We want to thank you for your interest in the above mentioned position. We had many fine applicants for the position, including you. However, we have filled the position with someone whose background and credentials we feel best meet our needs at this time. We welcome you to apply for any future positions we have available that match your skills and experience.
Sincerely,
The Hiring Manager for the "Ticket Seller – San Diego Padres (San Diego, CA)"
MLB Baseball Jobs
That was that. She gave up on the Padres, and gave up on ever hearing from them again, until this past Sunday morning, when this showed up in Meyer's inbox, from a manager in the sales office:
On Sun, Aug 5, 2012 at 10:09 AM, <[Redacted]@padres.com> wrote
Hi Taylor,
I wanted to reach out to you as you had previously applied for a position here with the Padres to join our Inside Sales Program. While it may not have been a fit at the time, we appreciate your interest in the position and encourage you to pursue your dream of working in professional sports.
With that being said, I wanted to make sure you are aware of an opportunity to get your start and to pursue a career in sports. Dr. Bill Sutton, author of Sports Marketing, has asked our organization to host the Sports Sales Combine here at Petco Park on September 14-15. It will be the first ever West Coast Combine! As a Combine attendee you would have the opportunity to spend quality time with the hiring managers for multiple teams from different leagues across the country.
Job seekers like you have found this to be the most authentic training and networking experience available. The sales managers who join us claim the Combine is the best recruiting tool for them. Having been to multiple combines myself, and hired numerous people from the events, I could think of NO better way to get a start in the sport industry. This event could change your whole career. I know it changed the lives of some of my staff.
Please note that this is NOT a job fair where participants spend a few minutes speaking with prospective employers. Over the two-day event, participants receive high-quality, one-on-one training from attending sales coaches and several unique opportunities to demonstrate their skills in addition to the hours spent with attending managers. You will have a chance to showcase your sales leadership skills as well.
We anticipate attending sales managers will be looking to fill 50+ jobs at the Combine. Teams from the MLB, NBA, NHL, NFL, MLS and college athletics all use the combine as a key source to find talent for their organizations. This is your chance to make an impression on ALL of them in one weekend. Also, what better place to network and learn for a weekend than San Diego, CA?
Taylor, as we look for the best young talent from across the country we wanted to make sure you were aware of the opportunity. You can find the combine application at Teamwork Online through the link below. I've also included a link to the Sports Sales Combine website.
http://www.sportsalescombine.com/
Combine Description and Application
Please do not hesitate to reach out to me should you have any questions about this special event.
All the Best,
[Redacted]
The Sales Combine is just what it sounds like: a job fair, the chance to join thousands of other applicants for five minutes of face time with potential employers. All for the low, low price of $495. Here's what Meyer wrote back:
On Sun, Aug 5, 2012 at 11:56 AM, Taylor Grey Meyer <[Redacted]@gmail.com> wrote
Hi [Redacted],
I wanted to thank you for reaching out to me when thinking of ways to meet your quota for the Sports Sales Combine.
After careful review I must decline. I realize I may be burning a bridge here, but in the spirit of reciprocity, I would like to extend you a counter-offer to suck my %&$#. Clearly, I don't have one of these, so my offer makes about as much sense as yours. But for the price you're charging to attend the event, I'm sure I would have no problem borrowing one.
Managers like you have found this to be the most authentic training available. Real, hands-on experience getting you on your way to perfecting the techniques you will need to climb the corporate ladder. In these tough economic times, it's always good to widen your skill set.
Let's talk about why I wasn't a good fit with your organization. Was it my extensive education that made me less of a fit, that now paying $500 will allow me to overcome? My graduate work in sports commerce? Being a law student, working toward becoming an agent? Was it my past experience overseeing the execution of national and international events? Wait, I know, maybe it was my previous internship with Major League Soccer, and that I actually got my "start" in professional sports at the age of 15 when I volunteered at a minor league ballpark in my hometown. And given all that, I chose to apply with the Padres, at least 30 times since moving to San Diego. Persevering through countless anonymous email rejections, I continued to submit my resume despite never even being granted the courtesy of a face-to-face interview. All for the joy of making $30K a year. Maybe you're right. Maybe I'm not the best fit for your company. But here's a nice fit, my foot in your *#%.
All the best,
Taylor
That's it for today. Thank you for reading and subscribing to Casey Daily Dispatch.
Vedran Vuk
Casey Senior Analyst