In a visit to The War Rooms and a reading of every one of the 1000 pages in Manchester's The Last Lion, I was not impressed by the heroism of the French, and with deference to Jovanovich, the chances of the French not turning their navy over to the Reich after the armistice would seem to have been close to the proverbial parts in a salvage dump spontaneously assembling themselves into a jet. It led me to think of all the times all my opponents in squash defeated in earlier rounds would stay around to the finals hoping I would lose. This led me to think of whether when one market has a terrible fall, whether it predicts with inordinate frequency that a related market will suffer a similar fate. The latter must be tested.

Stefan Jovanovich writes: 

About Dunkirk there is no question that the French stood and fought–bravely and well.

The Vichy French did not turn their Navy over to the Germans; they refused to turn it over to the British. Not quite the same thing. The result was Operation Catapult.

Churchill is not to be trusted about almost everything he wrote and said regarding the strategies of the war; in almost all cases he was a blowhard and a buffoon. But, he had luck. He had one subordinate commander brilliant enough to ignore his orders and preserve the RAF (in spite of Churchill's sending two months' of fighter production to Singapore so they could be captured by the Japanese weeks after being off-loaded in their crates on the docks). Hugh Dowding and the pilots won the Battle of Britain; and then the Germans lost the war by choosing to invade Russia instead of completing their conquest of North Africa and the Middle East and Iraq and Persia's oil reserves.

Andrew Goodwin writes: 

Greenspan cares about the bond bubble. If his commentary has influence perhaps he will move to remarks about other markets that don't share the same ecosystem. That 1000 page Manchester book was excellent and the brain makes the link finally in the naming.

anonymous writes: 

Sad but true: before WW I both Churchill and Roosevelt thought that the greatest threat to Anglo-American Empire would come from the Russians in Europe and the Japanese Navy in the northern Pacific. The Germans were not going to be any problem at all, no matter what the stupid French kept saying.

Jay Thompson writes: 

Accepting the above as true then major kudos to Churchill and Teddy as they possessed more foresight than the vast majority of foreign policy experts–to say nothing of US Presidents–in the past 100 years. Russia was/is a threat to the civilized west if for no other reason than it has been such a tempest - incredibly unstable and nearly ungovernable The near totality of Russian leadership was Germanic (like most of Europe that mattered) yet the people are Slavs. This exacerbated the already tense relationship between the peasants and the aristocracy or, if you wane Marxist, the bourgeois and the proletariat. The Japanese had a long lead time in their accumulation of navy power and the associated increase in their sphere of influence.

Patton, and Churchill, were right. We should have continued on and/or let the Third Reich destroy the Soviets. If for no other reason it would have taken away the "Cold War" as an excuse to waste trillions of dollars and the lives lost in the hot wars of Korea and Vietnam. 

Victor Niederhoffer writes: 

Anyone who believes that the Vichy prezs, petain and lebrun would not have turned over their entire navy to the Germans as smoothly and easily as they killed all the jews in Southern France, and who also believes that without Churchills courage and refusal to surrender that England would not have signed an armistice with Germany in 1939 or 1940 is very biased against the man who saved the world from German rule. With French armaments their would have been no hope left for the British and Churchill would have been booted out of office by the many collaborationists he brought into his cabinet.



 In Outliers, Malcolm Gladwell seems to be making an argument for nurture in the nature v. nurture debate. In particular, he is interested in how culture, parenting, special opportunities, and timing factor into the stories of the wildly successful. The book is largely a compilation of results from various studies as well as the stories of some well-known individuals. For instance, he opens with the peculiar fact that a disproportionate amount of Canadian hockey players are born in January. The explanation being that they are the oldest players who can join the youth league. This, he argues, gives them a relative advantage, which over time, as they are selected for special opportunities, translates into real superiority.

He later goes on to analyze key breaks that allowed for the success of individuals like Bill Gates, e.g., more hours of access to a computer than virtually anyone else in the world at the time. He examines the importance of IQ, parenting, and the economic background of one's parents. He points to the strong correlation between the economic class of one's parents and one's ultimate success, and he argues that we are probably failing to cultivate a lot of human capital by not properly distributing opportunity.

This is an argument that I tend to agree with, as I have seen first-hand the difference that class makes in the distribution of opportunity. I came to grad school from Ohio State, and my roommate came from Princeton. I had better grades and a paper under my belt, but I was given a full-time teaching load whereas he had no teaching (presumably because I didn't have Andrew Wiles write my letter of recommendation). In theory, this gives him more time to work, which puts him further ahead in his research, and all things being equal, he gets the better job. (In fact, he didn't properly use his time and he was a third-round hire, and I was a first-round hire.) His parents both had graduate degrees and lived in a wealthy suburb of Boston, whereas neither of my parents went to college and lived in Appalachia. He went to Princeton, and as far as my family was concerned, that wasn't an option. I think most of us can relate to this sort of thing.

That said, despite my sympathy for Gladwell's argument, he fails to examine these studies for flaws. He's a little too quick to make sweeping generalizations, and he spends a little too much time explaining the obvious. He should have anticipated and responded to some potential criticisms. I'm glad I read the book, because I learned of the existence of KIPP("Knowledge Is Power Program") schools, which are spreading across the country. Their goal is to provide the kind of college-prep to low income students that is available to the affluent. If you go to their website, you can find information about teaching, starting new schools, and donating. I suspect I'm preaching to the wrong audience, but I think it is a really exciting idea.

Jason Thompson writes:

It would seem your experience highlights how class is not the main variable in success, rather it is your hard work and your intellect. Instead of focusing on the details of your roommate's experience vs. yours, examine the big picture. You have accomplished a greater goal than your roommate without all of his inherent advantages as proscribed by material advantage, in-other words meritocracy works! AFA Gladwell/Side-show Bob's assertion that class matters most, significant empirical work by James Heckman or Charles Murray have thrown water on that flame. Rather its clear that IQ leads to greater wealth, that such wealth persists highlights the important of nature (aka genetics). Overtime one should expect the smart folks and their progeny to obtain greater proportions of the spoils of the economy…unless of course the state intervenes.



 The current Administration is very concerned about the poor and the middle class. But little concern is expressed for the upper middle class or as the Administration likes to call them 'the rich'. One wonders if there is a downside to this asymmetric outlook.

About a month ago the National Association of Realtors again called for an easing of terms on the large jumbo mortgages. Their argument is that the upper end of the market has seized up. In fact the data bear this out. In the upper end very few homes are being sold because of the difficulty in getting financing. Only cash buyers are nibbling and there are very few of them.

For example in the Seattle market in some areas there are 30 homes for sale but only one will sell in a given month at the high end. At the high end prices are not necessarily coming down at the rate the Case Schiller index claims. The sellers are not making concessions on a comparable same house basis. Rather, what is happening is that they are financially able to hold on hoping for some light at the end of the tunnel.

So why is there a disconnect between what the Case-Schiller and other median type indices say and the ground truth? Let's take a simple example of a neighborhood with 5 homes sold at the following prices (in thousands of dollars) :

Median = 700

Let's say that was a year ago. Now pretend that the exact same houses are sold for the exact same prices with one exception. There are no transactions above 750 because of mortgage financing issues. So now we have only homes below 750 that are sold at the same prices at which they were purchased:

Median = 600

So comparing medians one might superficially conclude that in the last year that home values have dropped from 700 to 600. But we know that the prices in fact are unchanged from the year before. The point here is that the drying up of mortgage financing at the high end has created an appearance of a greater decline in real estate prices than has actually occurred. The fix is simple and obvious. We must relax rules on high end mortgages and allow that market to function again. The interesting thing is that it will reverse the statistical anomaly and create the perception of a real estate price increase. Most importantly it will not cost the government a single dime in bailout money.

Jason Thompson writes:

J TAs a prospective home buyer that has thus far legged the trade the right way, I've been doing a lot of counting in the arena of luxury homes — following the higher end of the market in my current locales, Chicago and Reno/Lake Tahoe, and a future destination, southwest Ohio. Though I'm leaving Chicago as I've tired of the nanny state and sky-high taxes (10.75% sales tax anyone, or how about a $125 dollar parking meter fine?) I admit I'm going to a place not much better, Ohio, though at least there I will be next door to my kin. While what Dr. McDonnell says about the state of the jumbo mortgage market and the lack of compromise on pricing back to reality is largely true, his observation that easing credit will fix this is not.

Rather, there has been a collapse in the pool of buyers, combined with a glut of custom built homes by small builders that have populated the exclusive suburbs of this country for many a moon. Further delinquency checks call in to serious question the belief that these "homeowners" (they don't own anything, rather are renting from creditors) have the staying power to remain in their homes.

One market I am now knowledgeable about is Indian Hill, the most exclusive suburb of Cincinnati. Median income is $188K per household (its $47K per for Ohio overall) and median home value was $1.1 million in 2007. There are around 6K residents, enough of whom wish to sell their house such that there are 338 listed homes or prepared lots (80% are completed houses). Based on 2008 sales levels, Indian Hill has 11 years of home inventory, yet based on transacted prices, "values" are only down 18% from 2007 levels which were in-turn flat to 2006. To me this is beyond nonsense, especially when some smart sleuthing can determine 90+ day delinquency rates for loans in the 45243 zip code is rising faster than the DJIA is falling. Market clearing prices are likely 30-40% lower, just to adjust to the wealth effect, not to speak of executive level job losses and the imminent sale/forced merger of FITB.

Albeit it is a sample of one market, but it is in the Heartland of America and as Ohio goes so goes the nation, no? What rose-colored glasses should I be using if above not correct?

Kim Zussman comments:

It's relatively easy to look up foreclosures/REO in your area of interest. Realty-Trac sells lists of these (notice they don't call it "Reality"), and the ghost of Countrywide has about 20,000 nationally:

Prices won't bottom until there is no one left with money or interest to buy, and judging by the size of the recent bubble that could take some time. The wealth effect should work both stocks –> housing and vice versa.

Upscale homesellers of coming years have the same problem as stock-invested boomers: sell to whom?

One can quibble with Shiller's methodology or his optimism, but he is certainly on the short list of market timers of the millennium.



JasonI've been re-reading parts of two terrifically enlightening books on the Federal Reserve this week, "The Creature from Jekyll Island" and "Secrets of the Temple".

In the course of my review, I was reminded of a gentleman who once was the head of the Federal Reserve System who believed in sound money and hard banking, William McChesney Martin. Appointed by Truman in 1951, Martin would last through 5 Presidents, finally retiring in 1970 during the Nixon administration. A Yalie that had concentrated in English and Latin, McChesney Martin had deep family ties to the Federal Reserve. His father, William McChesney Martin Sr., had been both the Governor then President of the St. Louis branch of the Fed as well as helping to craft the original Federal Reserve Act of 1913. Junior himself was instrumental in the 1951 Accord, the agreement that is seen as re-establishing the Fed's independence.

Harry S. Truman thought that by appointing Martin Jr. to head the Fed, he could over-ride the agreement. Despite being a Democrat and growing up in the bosom of the private-public power duopoly of NYC and Washington D.C. elites, William Jr. did not play ball. Instead he ran monetary policy in a strong, counter-cyclical manner and was very mindful of inflation - refusing to return to the practice of debt monetizing as Fed Chairman Eccles had been apt to do.

He was a hard-nosed real money man who lectured Congress sternly on what he saw as excesses in spending and a growing lack of appreciation of the two-sided nature of capitalism. In August of 1957 he told the Senate "We are dealing with waste and extravagance, incompetence and inefficiency; the only way we have in a free society is to take losses from time to time. This is the loss economy as well as the profit economy."

50 years hence the man that occupies the seat at the head of the Fed's table is completely devoid of such character. Instead of warning Congress that inflation causes mal-invest, encourages excess speculation (NASDAQ, real estate), and particularly afflicts "hardworking and thrifty… little man on the fixed income who could protect neither his income nor the value of his savings. Often, he was also the unemployed victim of the collapse", B.S. Bernanke recommends easy money and opening the spigots of government largess.

The history of the Fed is intriguing and insightful, giving generous lessons to those that would heed such knowledge. The obvious message today is that the current Fed is much like that of Arthur Burns or George Miller, men who would quickly acquiesce to the whims of politicians. In stark contrast to William McChesney Martin, Benjamin Bernanke wants to be loved and accepted and is willing to commit grave errors in monetary policy to achieve that aim. Speculators and pensioners beware!

Edward Talisse adds:

The most recent offering of Grant's Interest Rate Observer includes a witty cartoon. A local motorist pulls up to his nearest filling station and exclaims to the station attendant that "the recent price increase in gasoline is outrageous." The Greenspan-Bernanke schooled attendant coyly replies "yeah, but is not a core increase!" Correctly assessing the medium to longer term inflation outlook has always been a key to investment success and preservation of wealth in real terms. The problem is that inflation forecasting is a tall order and even the pros cannot agree on an appropriate methodology. Today's CPI readings are met with much cynicism and skepticism. The bond trader's lament "that of course when you take out everything that went up, it goes down! Anyway, here is a PDF that explains the difference between the CPI and the PCE. CPI typically runs higher than PCE. Chose your poison carefully.





Adi Schnytzer concurs:

It's time the world learnt how data collection functions. These numbers are produced by turkeys who never ask whether their numbers make sense. And to think that markets respond to them!

Bill Rafter adds:

Lots of the data put out are also seasonally adjusted. One of my big peeves is that the data monkeys who work for the gummint do not know how to properly do the seasonally adjustment. As a result there are a lot of bad data out there. The real problem comes when the bad data are released, and everyone follows them. In other words, perception becomes reality. You (having the good data) have to follow the bad data also, at least until some time elapses and the whole thing gets corrected. So you have to watch against being too clever for your own good.

Jason Thompson reveals:

I've developed a localized index of inflation that is actually reflective of folks' consumption baskets. It includes taxes, insurance, education, and healthcare in more accurate weights. It has shown me how far off the CPI has been versus reality since at least 2002.  The spread has consistently grown! This local inflation measure focuses on prices in the Chicagoland area and so would be best compared with CPI-U. Further, the resolution is quarterly not monthly. The inflation measure for Q1 2008 will likely show an increase of 8.6% YoY.



BreadCan the global macro boys explain to me how wheat is up 60% for the year but i can get a loaf of bread or a box of Wheaties at the same price as 2006? Would seem the producers of food hedge their costs so as to control both the cost to consumer and their profits from the best recurring biz in the world — food.

But if they hedge then of course the must hedge at certain levels and if it keeps going they must keep hedging until the reflexive traders are satisfied and in the end it seems only the consumer gets the bill, so there must be inflation upon us as a result not only of the quants but also of the global macro reflexive crowd.

Jason Thompson replies:

First, I'd very much question the observation that you are paying the same price YoY. This is certainly not the case here in Chicago as Wheaties, along with Raisin Bran, Cheerios and Cornflakes are measured as part of a basket in a private inflation survey. They are up roughly 9% 3rd Quarter to 3rd Quarter and will experience price increases (already announced by manufacturers) of 10-12% to be seen within the next six months. It's very likely what you are missing is the reduction of discounts. By this I mean there are fewer promotions, coupons to the consumer, or rebates being offered to the grocery store. The price quoted on the rack may not have changed, but the average price paid by the consumer has increased.

I'm much more perplexed by your observations on bread, as that has seen the one of the largest increases in our basket of food, outside of milk and cheese, and some fruits and vegetables. Bread here in Chicago is up 18% YoY.

David Lamb extends:

WifeI've got to be luckiest husband on Daily Spec. My wife makes our bread and she orders hard wheat for $6-$7 per 25 lb. bag.  It takes 12-13 cups to produce five pounds of wheat flour, which is needed to make five loaves. We go through five loaves every week (she gives away half of it). Therefore, she spends $6-$7 per month on our breadstuffs (rolls, loaves of bread, etc).

Compared to store bought bread — well, there is no comparison, at least in taste. However, if we bought the same number of loaves at a store it would cost us, for the cheapest bread at WalMart, almost $2 a loaf. That would be $40 a month. Yes, I have seen an increase in wheat prices but the greatest wife in the world can handle it!

Riz Din replies:

The cheapest bread in the UK is less than 50p a loaf. Currently, £1 (or two UK cheap loaves) buys two dollars (or 1 US cheap loaf). Perhaps the international cheap bread arbitargeurs have helped to lower the USD/£.

Eli Zabethan explains:

Most food producers hedge out several years, but now there is little carryout as supplies are being used for alternative energy projects.

Kurt Specht replies: 

It's true that most food producers (and processors) hedge out several years, but the levels of hedging and the duration can vary widely by company and by item.  Several companies have cited various raw materials increases in their quarterly earnings reports this year as a cause of diminished earnings per share, but as the prices of commodities rise and more time passes, more and more of these companies will have to raise prices to keep up.



 With the merger of the CBOT and the CME, a physical consolidation of the two exchanges' trading floors will take place with the Merc floor being shuttered. As a result some current open outcry pits will move exclusively to the screen, a move that will likely mean the death of the product in certain cases. Oh Frozen Pork Bellies, how we knew thee.

Ryan Carlson writes:

On Monday, bellies traded only 148 contracts, all in the pit, with an open interest of 710. Not a huge loss for the floor crew.

The meats are funny at the Merc because it's such an old-school crew down there. Walking down to those pits, everyone will eyeball anyone new. Also, they've been trying to push the meats to the screen but they won't go. I've been told that no one will trade with you if you wear a headset (computer trader on other end). Also, I've been told that unless you know people down there, they won't trade with you either.

The power of the CME always flowed from the meat pits, so I've done my best to align my interests with theirs.



 My wife and I just returned from a dozen days in the UK, including a visit to Caledonia and its stately capital, Edinburgh. London prices verge on the absurd; the average Londoner must be living a far inferior life as compared to someone of a similar station here in Chicago. For instance, public transport costs 50% to 200% more than the CTA on a per ride basis, taxis are roughly 300% more per mile, a TESCO food bill 35% more. My tip of the hat to the Economist comes in my notations of the cost of a Big Mac Meal (medium size) at McDonald's whenever I travel. In London I saw 3.69 pounds as the cheapest, on High Street across from Kensington Tube station, with prices in Edinburgh and Inverness ranging from 2.99 to 3.19. This compares to a local price of $4.70, about 2.35 pounds.


Resources & Links