"How Paulson Gave Hedge Funds Advance Word"

Paulson tips hedgies over lunch in '08.

Jim Lackey writes:

Looks like it just happened again. Last week an EU bank was in trouble… Monday they gap it to the moon on the relief nothing went under…and today the news.

All of this mumbo reminds me of Rocky's experiment on unemployment Fridays. Even if you know the number or have the inside scoop, do you have the whole story and or can you predict the markets move, since who else already knows?

My day trader's guess is too few knew about today's news… or we wouldn't have gone 10 over open prices. I used to let these things bother me. Now I just say, now you know…. Now you know why I gravitated to the counters. Win, lose, or draw, do your best.



Economist David D. Friedman will be speaking on the use of free markets to solve difficult problems not usually thought of as market problems, on Thursday December 1, 2011 at General Society Library, 20 West 44 St., NYC, between 5th and 6th Aves, approx 7:30pm.



 The last straight-up default was Argentina, and investors still got .35 cents back. There are still some vulture funds out there going for full recovery,

While of course there have been defaults that have gone to zero, the historical recovery is actually much higher than .35 cents.

Anyway, it's important to understand why Argentina paid the .35 cents rather than nothing:

In this modern world, there are all sorts of things that spurned investors can do to harm a country that defaults. So, if you want to maximize the present value of your default, you are not going to pay zero. Rather, you are going to pay enough to that investors choose to take your payout rather than to pursue decades of litigation and other methods of recovery.

So, given the possibility of European bailouts or even sponsored restructurings, Investors at least ought to get the .25 cents back, and most likely much more.

Stefan Jovanovich comments: 

Europe needs Henry Pelham, but there is no chance that she will get him. Pelham is the U.S. Grant among British Prime Ministers. No one among the official keepers of history has a good word for him; yet his Consolidation Act of 1749 was the fulcrum point for the explosion of production and finance that is now laughably described as The Industrial Revolution. Like Grant's Resumption bill the Consolidation Act - which replaced all outstanding government debt - established a permanent benchmark against which all markets could trade - the Consol - i.e. Consolidated Annuity– that had no maturity date.

As part of the Consolidation Act, the Royal Navy was reorganized so that the system of purchasing commissions and supply contracts was opened to examination and audit. Pelham - like Grant - was criticized for allowing a far lesser corruption to continue rather than praised for eliminating a "spoils" system so rotten that it left British merchantmen at the hands of Spanish privateers (perhaps the only time in the history of the Royal Navy when the score was Spain 1, Britain 0).

"A man can accomplish anything he sets his mind to once he decides that he does not care who gets the credit for its accomplishment."



 1. You often get the other side so angry that he walks away from the deal.

2. The counterparty sees that you are only interested in the short term money and you are not interested beyond the dollar and clock and won't hire you.

3. You can only get the edge on someone once and the next time he will save the good stuff for someone else or get even with you.

4. You get known as an ephemeral person.

5. The other side when he thinks about how you got the edge on him all the time ultimately bears many hard feelings and there is a backlash of unpleasantness much greater than the amount at issue.

6. You become a short term person only possibly getting short term edges and miss out on the big deals.

7. You lose the big for the little.

8. Loyalty is lost.

9. You look cheap to your other half and she hates all the unpleasant situations you get involved in as you haggle.

The above comes about because a lecturer at the Junta tried to get an extra edge on me. It reminds me of the time I had a chemical company for sale. The owner had a 30 million deal signed and sealed. Then in the car, he asked a wasp public company owner for 1 million more. The public company got so mad he thought he couldn't trust the guy and canceled the deal. The owner eventually sold for 1/10 the price and his life was ruined.



 Hi everyone, this is my first post. Very honored to be here. Sorry I haven't really introduced myself yet. I will do so shortly afterwards.

Regarding Goldman's recommendation, I think that it could be a very late call.

In this year, the HengSeng index started at about 24,000 and moved downward to the current level of about 18,000, a drop of 25%. That is also a drop of 45% from the 2007 high of 32,000 and a rise of 68% from the 2008 low of 10,700. Comparatively, the S&P started the year at 1270 and is now at 1200 (a 5% drop). The drop from the 2007 high of 1580 is about 24%, and the rise from the 2009 low of 670 is 79%.

I know that it is not very useful simply comparing the points in history, but what I am trying to say is that for about 4 years the market has been reflecting the bearish situations of China's economy. I am not sure whether there is anything really new at this point.

While I agree that the market could see some further leg of the fall, I am more looking at a somewhat more upside move starting in the next few months. As to what could be the trigger to the upside move, I am not sure now but feel it will manifest in the near future.


Leo Jia

P.S. I currently have no position (long or short) in either Hong Kong or mainland Chinese stock markets.



This is an interesting piece by Mike O'Hara that underscores the danger of grouping all algorithmic trading with HFT. One of the largest concerns regarding HFT is that it competes with legitimate market makers during normal trading, thus reducing incentives, and then leaves the market during abnormal trading, or worse taking liquidity to close positions when a market makers job is most important. This legislation, in an effort to make it impossible to side-step the responsibility of providing liquidity, would actually require a broker executing VWAPs all day to provide liquidity. Based on the below quote, one simple sidestep would be to start your algo a minute after the open and stop it a minute before the close, but doesn't this defeat the point?

Steve Ellison writes: 

I have thought for some time that high frequency traders play a similar role in the market ecosystem to stock specialists. Stock specialists can profitably trade based on their knowledge of order flow, but in return are obligated to use their capital to preserve an orderly market. This proposal seems conceptually to be trying to impose similar obligations on high frequency traders. 



 A film that cannot be any hue other than noir attaches our attention because it is iconic, laconic and mesmeric. In initial outline, it resembles very closely the 1978 suspenser starring a sexy, silent, bruised-looking Ryan O'Neal before the cheeseburgers set in, THE DRIVER. DRIVE is a Hollywood stunt guy who freelances as a moonlighting wheelman. It need not be added that a contract is out on him after money goes missing and a heist goes very awry.

In both, a nameless driver is the getaway designee for petty criminals escaping their penny-ante gigs. In both, the escape chases and wild rides are breath-taking, split-second exercises in adroit car-handling. The criminals hardly count in the backseats, because the stars of each of these scenes are the driver and the automobile, both close to anonymous and incognito for being so average-looking. In each film, the protagonist barely says a word throughout, instantly picks the locks of strange cars for his getaways, then abandons them, and has a difficult time (much as one expects) with letting down his guard.

While the film gripped the SRO audience from start to weary, brutalized finish, not everyone agrees the film ought to be among the finalists for the 10 best films of 2011.

My escort for the evening, a powerful male, was turned off to the excessive blood and gore, as were a number of MoMA viewers, all NYC sophisticates, and even I, more aware (I knew what was coming, as I had spoken to people who had seen it, and had read 5 reviews, including the definitive assessment in The New Yorker), was also of the opinion that the film could have evoked a better response had the camera discreetly turned away from all that spurtive blood and mashed cerebellar material.

But there seems to be more than just a brief-candle film entertainment here. The film is sort of a Clint Eastwood homage, an opera buffa of silent strong male vs. the forces of entropy arrayed against l'homme humaine et juste. The color palette is that of Kubrick's "Eyes Wide Shut." Inky blues, flashing white glints, umbers, yellow, red, washed out macadam grey. It offered very active silent spaces, a throbbing, building suspense missing in most films, and the tabula rasa of Ryan Gosling's interior turbulent though smoldering lava, unruffled exterior. Carey Mulligan is enchanting, more through expressive facial expressions than through her few words. The lush Christina Hendricks, so vavavavoom in TV's Mad Men, is here a moll seen for not long enough. Brilliant as a superficially gemutliche but merciless villain, Albert Brooks turned his comic-guy persona totally on its curly-haired ear. He is a nuanced portrait of a guy in a financial punch, plus a deftly handled shiv when necessary. Heavy-browed Ron Perlman is a furrowed presence as a questionable pizza store proprietor, and you are glad to not see too much of him.

DRIVE evoked, for me, the balletic rigor of Coppola's first "Godfather," as the 'family' extinctions and wastings swelled with the strains of operatic arias Don Corleone/Al Pacino was conveniently viewing as his assigns carried out his orders: Punish those who run afoul of his unquestioned godfather mandates.

As for the grue content, perhaps those who question its ubiquity in this engrossing film have it right: Spilling blood is also a spiritual tragedy. In the biblical literature:

Key hadam hoo hanefesh: Because in the blood is the soul.



The chair may have covered this as ballyhoo in his book as part of pattern recognition Edwards and McGeeism, but the energized SPY of late now sports a gap that is getting filled now at 116ish and has a gap below 117and change to just under 119.

Gaps as signposts and voids to be filled eventually never really aided my trading, though I noted their existence. Has anyone plyed these differently or in any useful way?



 Here's a shocker:

Take the Confidence Board Consumer Confidence raw number from May, 2010, through November 2011, and calculate monthly % changes; then regress against that series the previous month's % change (close-close) in the S&P…and you get the previous month's change in S&P being an excellent predictor of the CC change!

multiple R: +0.69

R squared: +0.48

…and just to be humorously over-precise:

CC%chng(month[1]) = -0.00498 + 1.8*S&P%chng(month[0])

Jeff Rollert writes: 

I cannot recall when that strong a relationship didn't hold, so much so I stopped doing the calculations.

One of my current stat problems is finding data sets that do not have some strong feedback dynamics, where a strong data point is reflected in market prices and becomes non-predictive. The expansion of SAP, ORCL and other large data set manipulation/analytic engines seems to be one of the culprits.



 While lounging on the beach this beautiful Thanksgiving weekend with friends we did the following questionnaire from the back of Vanity Fair Magazine. It proved very thought provoking not only for friends' answers but thinking of one's one ideas in a new way. The following is quoted in its entirety from the vanityfair website. It reminded me of the list's and the junta's questions from Ben Franklin

The Proust Questionnaire The Proust Questionnaire has its origins in a parlor game popularized (though not devised) by Marcel Proust, the French essayist and novelist, who believed that, in answering these questions, an individual reveals his or her true nature. Here is the basic Proust Questionnaire.

1. What is your idea of perfect happiness?
2. What is your greatest fear?
3. What is the trait you most deplore in yourself?
4. What is the trait you most deplore in others?
5. Which living person do you most admire?
6. What is your greatest extravagance?
7. What is your current state of mind?
8. What do you consider the most overrated virtue?
9. On what occasion do you lie?
10. What do you most dislike about your appearance?
11. Which living person do you most despise?
12. What is the quality you most like in a man?
13. What is the quality you most like in a woman?
14. Which words or phrases do you most overuse?
15. What or who is the greatest love of your life?
16. When and where were you happiest?
17. Which talent would you most like to have?
18. If you could change one thing about yourself, what would it be?
19. What do you consider your greatest achievement?
20. If you were to die and come back as a person or a thing, what would it be?
21. Where would you most like to live?
22. What is your most treasured possession?
23. What do you regard as the lowest depth of misery?
24. What is your favorite occupation?
25. What is your most marked characteristic?
26. What do you most value in your friends?
27. Who are your favorite writers?
28. Who is your hero of fiction?
29. Which historical figure do you most identify with?
30. Who are your heroes in real life?
31. What are your favorite names?
32. What is it that you most dislike?
33. What is your greatest regret?
34. How would you like to die?
35. What is your motto?



 An article I read recently would seem to have significance for producers of branded products like the bottlers, and P and G, and the bond market. What's happening on the internet seems to be spilling over into all areas with price competition increasing.

Kurt Specht comments: 

Very true, but another big issue right now for all consumer goods producers is staying ahead of commodity inflation and figuring out how much to pass along to consumers in the form of price increases and package size reductions.

Steve Ellison adds: 

In his book Trends 2000, Gerald Celente said that consumers turn away from brand names periodically, but they always come back. He noted a tendency for brand names to be out of favor in the years ending in 0 to 2 each decade, which have often coincided with recessions (the Senator has noted that those years have often not been kind to the stock market). Mr. Celente attributed this regularity to a "10-year corporate spending cycle."

Pitt T. Maner II adds: 

Chlorox would seem to be one of those companies that has had to work for decades to keep market share against generics (bleach). They appear to maintain their higher price per gallon through strong branding/advertising. Perhaps the need for the services and the money spent on strong marketing and advertising companies increases when generics and cheaper alternatives threaten. Or when one is running for election.



 I believe we've had enough of the grist for the chair and that we return from commodities. We have learned from the exchange. The market is down 7 days in a row. Where's it going? I note only 3 other occasions in the last 15 years. There is not necessarily light at the end of the tunnel 10 days later based on the past.

Ken Drees writes: 

With the euro news winds moving US equities and the "bad" German bund auction capper for the moment, the inner core begins to feel the fallout and therefore the closer we are to a plan B coming up out of the blue. Every euro bond auction is now going to be bad until something is done. I would say we are close to the rumor stage of rescue and that equities are tilted for a rally. I think the 7% retail spending increase may be enough to get things started if some positive rumors surface for rescue in euroland.

Paolo Pezzutti writes: 

Who should be the rescuer? Unless in Europe somebody questions the excessive welfare state built over the years, nothing can change. People still give for granted "rights" and privileges that cannot be afforded any more. Somebody has to question the size of governments and the perimeter of their interests and actions. Nobody is doing it so far. They are still looking for lenders and trying to find money rising taxes. How can we be optimistic? 



How have long-term US treasury bonds been used as a refuge from stock volatility over recent years? Bonds tend to rise when stocks are more volatile (and go down), and vice versa.

For every non-overlapping 10-day period (7/02-present), I calculated mean level of US 20+ year Treasury bond ETF "TLT". The data used was NOT adjusted for dividends, in order to reference then-current bond price level without dividend-updrift. For the corresponding 10-day periods, also calculated the volatility of daily SPY returns (SP500 index). From these two series formed the ratio: mean 20+ year treasury level per unit SP500 volatility, the chart of which follows.

From 2002-04, the ratio rose as stock volatility declined while treasury prices remained relatively flat. From 04-late 2006, the ratio was generally high due to many-year lows in stock volatility. From 2007-late 2008 the ratio declined; due to a combination of rising treasury prices and stock volatility which rose more - "flight to safety". The ratio formed a multi-decade bottom in late 2008, then rose due to a combination of falling treasury prices and stock volatility which declined faster. Recently there were two smaller flights to safety when the ratio collapsed in May 2010 and August 2011; both corresponding to treasury prices spiking more than stock volatility marking worry over European sovereign debt.

To the extent that the US FED has attempted to influence longer-term treasury yields over the past year or so, recent treasury price per unit stock volatility appears consistent with the longer term.



 We've had 6 down days in a row taking us down 100 points with every variety of way to do it. 2 up opens, 2 big down opens, small declines, big declines. The kids book Caps For Sale comes to mind. Every kind.

Paolo Pezzutti adds: 

Maybe this down streak of 6 anticipated lower sales is for Black Friday. Or simply, the market is schizophrenic, printing huge up and down swings driven by algos. My view is that with Europe already in a recession and the US with very few weapons left (practical and political), hoping to provide additional stimulus to the economy, even Apple will sell far fewer iPads and iPhones.

Of course, as far as weapons are concerned, we need to closely follow the Iran and Syria crisis. It could provide new elements of instability and deception from other issues. In this environment during sell-offs I am always tempted to buy lower opens… 



 Vic recently stated that we were not in a range bound market. I have held that we are in a long term secular bear market since at least 2000, and one could make an argument that we've been in a bear market since 1998.

When I look at the S&P monthly closing values starting in Dec. 1998, I see a figure of: 1229

When I look at the S&P monthly closing values through October 2001, I see a figure of 1253

Eyeballing the chart, I see a high of around 1549 and a low of around 735 during that time frame. I see the high approached several times and the low approached several times.

How can we trade in the above range for the last decade+ and it not considered to be a range bound market?

I've always contended on this list that secular bear markets and secular bull markets each have certain characteristics that you see to help you recognize them.

Bulls have lower volatility and have a general upward trend. They do have pullbacks and crashes (i.e. the bull of 1982 - 2000 had the 1987 crash). But as a general rule of thumb, you can set your sails and just ride the bull winds to profits.

Examples of secular bulls include, the roaring 20s, the 1950s/60s, the 1980s/90s.

Bears have higher volatility (often much, much higher). They shot up and down but basically end up where they started and often end up where the started several times. You need to pull your sails down, turn on your engine and use a lot of energy to navigate the rough waters of the bear.

Examples of secular bear markets include, the Dust Bowl Years, the Great Depression, the 1970s, 2000 - ?

Not being a counter or someone with great math or statistical skills, I'm sure that there is a way to refute my point. I'd be interested in better understanding where I'm wrong and where I might be right.

Steve Ellison writes: 

Mr. Brooks has suggested that it is better to invest when stocks are in an upward trend with low volatility and to stay away when stocks are in a downward trend with high volatility.

Since Mr. Brooks is talking about very long periods, I used S&P 500 index data back to 1950 and Dow Jones Industrial Average data from 1928 to 1949. For each day I calculated a sort of normalized 1-year VIC: the average of the daily absolute percentage changes over the past year. Beginning on the day after Pearl Harbor, I determined the median 1-year volatility of all the previous dates. Thus, using data that could theoretically have been known at the time, I classified the 1-year volatility each day as high or low.

If the index was higher than a year previously, I categorized the trend as up; otherwise the trend was down.

I considered a bull market to be in effect if the previous day's close was higher than the close a year earlier and the previous day's 1-year volatility was below the historical median. I considered a bear market to be in effect if the previous day's close was lower than the close a year earlier, and the previous day's 1-year volatility was above the historical median. I considered all other days to be neutral.

By this method, a bull market was in effect continuously from March 12, 1992 to March 30, 1994. The market then flipped several times between bullish and neutral as volatility was low, but prices in 1994 sometimes dropped below year-earlier levels. The market was then continually bullish from February 7, 1995 to March 31, 1997. The market then moved to neutral status as volatility rose. Except for two days in October 1998 when a bear market was in effect, the market was neutral until November 10, 2000, when it moved to bearish. It stayed bearish for all but 6 days until June 2003. There was a continuous bull market from July 12, 2004 to October 26, 2007.

There was a continuous bear market from January 14, 2008 to October 7, 2009. Then the market was neutral (up trend but high volatility) until August 9, 2011. It was bearish for one day and then flipped back to neutral. There have been a few more flips between neutral and bearish, and after Wednesday's close, this indicator has again flipped from neutral to bearish.

Using this method to contemporaneously identify bull and bear markets, I got the following results since 1941.

                                 Number    Average      Value of $1000
Type of market        of days    daily return  invested on these days only

Bull                             8118       0.034%       $16335

Bear                            2872       0.018%         $1695

Neutral (downtrend    2163       0.004%         $1094

but low volatility)

Neutral (uptrend         4463        0.031%         $3933

but high volatility)

It does appear that investing in contemporaneously recognizable bull markets is better than investing in bear markets. But wait–is that just by random chance? For example, see the following graph of the cumulative results of 300 coin flips. The underlying process is completely random, but there appeared to be a long heads trend, followed by a Fibonacci retracement.

To answer this question, I ran 500 simulations in which I randomly chose 8118 of the daily returns since 1941. I then compared the total returns of these random selections to the total return of the 8118 bull market days. The actual return of the bull market days was in the 82nd percentile of the randomly generated 8118-day returns. Thus, I estimate the outperformance of bull market days has p=0.18 and falls short of statistical significance.

Charles Pennington writes: 

I think Scott is saying that the market has been bounded ON THE UPSIDE, never going much above 1500 at any time over the past >10 years, although bumping up against that level a few times.

"Range bound" should mean that the market is tightly bound both on the upside and the downside–it has a tight RANGE. I think that when Vitaliy wrote his book, he was expecting that the market would have a true tight range going forward, and his readers might fairly have concluded it would be a good idea to sell some puts and calls to capitalize on the forthcoming tight range. Instead, of course, the market fell 50%. So Vitaliy re-interpreted his prediction to mean "bounded on the upside".

Victor Niederhoffer comments:

Yes. The professor has captured the gist of the promotion and huckstering and conversion of property and putting on the pretty face to hook the rich so typical of those raised in that environ that caused one to boot him off the site.

Anatoly Veltman writes: 

May I twist the subject slightly…

We all remember Greenspan's only explanation of unusually long subdued inflationary pressures over the 90s decade and into the 00 decade: super-efficiency, labor achievements. And then came the real-estate bubble.

Bernanke's issue appears more deflation than inflation. However, the redistribution of means achieved politically creates somewhat of an asset bubble relative to real economy.So remembering that market is never favorite to go down, I'm still struggling with these fears: what if market's only nominal robustness is purely a devaluation phenomenon? Is equity investment then justified, or is some sort of hard-money is just as well (not gold necessarily– maybe oil, gas, agri commodities)?

Paolo Pezzutti writes:

Hmm…. Maybe gold or oil? It does not seem that for the moment gas is appealing to investors. That is why I decided to buy it, contrarian as usual, and UNG went down from12$ to 8$. And when I bought it I was thinking that it could not possibly go lower given the steep fall already printed. After all gas is something tangible and oil was relatively much more expensive. Who knows, may be things will change when someone will demonstrate that shale fracturing techniques damage the environment. If this downtrend continues soon they will gas for free at the corner of the Streets…

Bruno Ombreux comments: 

I don't understand this concept of "investing" in a commodity.

A commodity is meant to be produced then consumed. How can anyone invest in that? It does not pay an interest or a dividend. You eat it, burnt it… Just taking one extreme: power. It is not storable. Supply must equal demand all the time.

I cannot think of anybody idiot enough to invest in commodities except hedge funds, who are really idiots.


p.s. Gold is the only exception. Some people say it is a commodity. I do not agree but let us accept this to avid a semantic debate. You cannot invest in it but it is money. So you can buy it and keep it. But you don't really "invest" in gold.

Just to be clear, one can "speculate" in a commodity, as long as it is storable. As Keynes brilliantly showed, the economic role of the speculator is storage. So not only can you "speculate" but also you make the world a little bit better. But "invest"? Come on… 

Gibbons Burke replies:

 Gary North, in an ebook he provides for free on his website, has an interesting description of times when commodities become money:

Joseph in Egypt

Now let’s take a real historical example, the famine era in Egypt. Joseph had warned the Pharaoh of the famine to come, and for seven years, the Pharaoh’s agents had collected one-fifth of the harvest and had stored it in granaries. Then the famine hit. The crops failed. The people of nearby Canaan also suffered. No one had enough food.

And Joseph gathered up all the money that was found in the land of Egypt and in the land of Canaan, for the grain which they bought; and Joseph brought the money into Pharaoh’s house. So when the money failed in the land of Egypt and in the land of Canaan, all the Egyptians came to Joseph and said, “Give us bread, for why should we die in your presence? For the money has failed” (Genesis 47:14-15).

What did they mean, “the money has failed”? They meant simply that compared to the value of life-giving grain, the money was worth nothing. Why would a man facing starvation want to give up his remaining supply of grain in order to get some money? What good would the money do him? He wanted life, not money, and grain offered life.

Because the money “failed,” it had fallen to almost zero value. Thus, in order to buy food, the people had been forced to spend all of their money. Now they were without food or money.

And Joseph said, Give your livestock, and I will give you bread for your cattle, if the money is gone. So they brought their livestock to Joseph: and Joseph gave them bread in exchange for the horses, the flocks, the cattle of the herds, and for the donkeys. Thus he fed them with bread in exchange for all their livestock that year (Genesis 47:16-17).

Were the Egyptians foolish? After all, all those cattle and horses were useful. But animals eat grain. The grain was too valuable during a famine to feed to animals. All that the animals were worth was whatever they would bring as food, and in Egypt, the meat wouldn’t last long. Dead animals in a desert country don’t remain valuable very long. Why not trade animals for grain, which survives the heat? The only reason the Pharaoh had any use for the animals and money is that he knew he had enough food to survive the famine. He knew that it would eventually end. Thus, he would be the owner of all the wealth of Egypt at the end of the famine. For him, the exchange was a good deal, but only because he had the food, and the army to defend it, and he also possessed what he believed to be accurate knowledge concerning when the famine would end. Joseph had told him it would last seven years.

Because he had a surplus of grain beyond mere survival, and because he had “inside information” about the duration of the famine, money and animals were valuable to the Pharaoh, even though they were not valuable to the people. Thus, a voluntary exchange became profitable for both sides. The Pharaoh gave up grain for goods that would again become very valuable in the future. The Egyptians gave up goods worth very little to them in the present in order to get absolutely vital present goods. Each side gave up something less valuable in exchange for something more valuable. Each side improved its economic position. Each side therefore gained in the transaction.

Notice here that we are not dealing with any so-called “equality of exchange.” This theory says that people exchange goods only when the goods are of equal value. It is true that in the marketplace, they may be of equal price, but they are not of equal value in the minds of the traders. What we are always dealing with in the case of voluntary exchange is inequality of exchange. One person wants to possess what the other person has more than he wants to keep what he already has. Because each person evaluates what the other has as more valuable, a voluntary exchange takes place.

Egypt’s money failed. In fact, grain became the new form of money, although the Bible doesn’t say this explicitly. What it says is that everyone was willing to trade whatever he had of former value in order to buy food. But if some item is what everyone wants, then we can say that it’s the true money.

The Properties of Money

Why would grain have served as money? Because it had the five essential characteristics that all forms of money must have:

1. Divisibility
2. Portability
3. Durability
4. Recognizability
5. Scarcity (high value in relation to volume and weight)

Normally, grain doesn’t function as money. Why not? Because of characteristic number five. A particular cup of grain doesn’t possess high value, at least not in comparison to a cup of diamonds or a cup of gold coins. The buyer thinks to himself, “There’s lots more where that came from.” Normally, he’s correct; there is a lot more grain where that came from. But not during a famine.

Why divisibility? Because you need to count things. Five ounces of this for a brand-new that. Only three ounces for a used that. Both the buyer and the seller need to be able to make a transaction. The seller of the used “that” may want to go out and buy three other used “thats” in order to stay in the “that” business, so he needs some way to divide up the income from the initial sale. This means divisibility: ounces, number of zeroes on a piece of paper, or whatever.

Portability is obvious. It isn’t an absolute requirement. I have read that the South Pacific island culture of Yap uses giant stone doughnuts as money. They are too large to move. But they are a sign of wealth, and people are willing to give goods and services to buy them. Actually what are exchanged are ownership certificates of some kind. Normally, however, we prefer something a bit smaller than giant stone doughnuts. When we go to the market, we want to carry money with us. If it can’t be carried easily, it probably won’t function as money.

Durability is important, too. If your preferred money unit wears out fast or rots, you have to keep replacing it. That means trouble. A barrel of fresh fish in a world without refrigeration won’t serve as money. But there are exceptions to the durability rule. Cigarettes aren’t durable the way that metal is, but cigarettes have functioned as money in every known modern wartime prison camp. Their high value per unit of weight and volume overcomes the low durability factor. Also, they stay scarce: people keep smoking their capital.

Recognizability is crucial if you’re going to persuade anyone to trade with you. If he doesn’t see that it’s good, old, familiar money, he won’t risk giving up ownership of whatever it is that you’re trying to buy. If it takes a long time for him to investigate whether or not it’s really money, it eats into everyone’s valuable time. Investigations aren’t free of charge, either. So the costs of exchange go up. People would rather deal with a more familiar money. It’s cheaper, faster, and safer.

So what we say is that any object that possesses these five characteristics to one degree or another has the potential of serving a society as money. Some very odd items have served as money historically: sea shells, bear claws, salt, cattle, pieces of paper with politicians’ faces on them, and even women. (The problem with women is the divisibility factor: half a woman is worse than no woman at all.)

Rocky Humbert disagrees:

I'm not going to waste everyone's time articulating why Mr. Bruno is wrong. (You can find that in any reasonable textbook.) I will simply note that ALL investments (including commodities) have many complex and related attributes, including replacement cost, store-of-wealth, scarcity value, Graham & Dodd "margin of safety," and of course, cash flow and future expected value. (If Bruno doesn't understand how to derive cash flow and future expected value from a commodity and/or commodity futures investment, I'll be more than happy to tutor him at an hourly fee that appropriately compensates me for my annoyance in having to deal with a pompous windbag.) Whether one is "investing" (or "speculating") in a start-up company in someone's garage, in a T-bill (with a negative real return), in natural gas (which is trading below its fully-loaded marginal cost of production), in aluminum (which may have a worldwide supply deficit), in Groupon (because eventually they will make a profit), in BAC (because it's trading below Book value)….etc, etc, etc., the discipline, analysis and approach are consistent.

I have to hand it to Mr. Bruno — he now has two things in common with my brilliant wife. They both enjoy fine French wine, and they both think I am an "idiot." (The similarities end there — since my wife knows that California produces some wines that embarrass the French Premier Cru's — and she also knows that those with an IQ between 51 and 70 are "morons;" whereas "imbeciles" possess an IQ between 26 and 50. She sadly knows that as a hedge fund manager, I live in the "tail" of the distribution — as "idiots" have an IQ between 0 and 25.

Bruno Ombreux replies:

I am not going to retract. I think the hedge funds who say they invest in commodities are idiots. If they are not idiots they are crooks which is even worse.

You cannot invest in a commodity. If you present it as an investment, there are two possibilities:

1) You do not know it is not an investment, and then you are an idiot.
2) You know it is not an investment, and then you are a crook.

And I am sorry, I met many people from hedge funds. It is true they are nice people and sometime extremely clever, if often a bit naive. But the are not competent in trading commodities. They are clever marketers. That is they are clever at raising money. But most of them suck as traders or investors.

I wouldn't blame them if they took exception to your comment and demanded that you be keelhauled then ordered to buy a round of drinks for all. I know a couple hedge fund managers on the list and they seem to be the smartest people I've ever had the occasion to know. 



 I'm noticing that gasoline is below $3.00 here in OKC but oil is up.

According to Yahoo, the oil ETF has gone up +9.7% since start of Sept. While the USA gasoline (UGA etf) has gone down -9.5%.

With oil as the x and intercept set to zero, the daily slope is 83.5% with an R2 of 78% (UGA only goes to Feb. of 2008) Running a scatter diagram, with oil on the X axis, the recent moves seem to be on bottom right hand edge. It does appear the oil will drop with gasoline rising with greater differences. But this the reverse moves are not usually this large.

Is this due to fear in oil regions, but too much current supply?

This is good new for those driving this Holiday. But is there a Thanksgiving leftover meal here? Ideas?



Investment bank predicts 1100 S&P (news item ).

 1. It used to be with the dignified female fundamentalist who issued her forecasts invariably upon very bullish technical occasions like 100 day minimums, that she would come up with some folderol after a huge decline, and pretend that the fundamentals were bullish as she issued her bullish forecast.

But now the bank apparently wishes to panic its customers and have them sell into panics. They predict a 10% decline if no further service revenues are preferred. The reason for their reason to reason that further reasoning at the hill to accept a compromise with reasonable service increases seems unreasonable to this non flexion.

2. Could the "bank" predicting a 10% decline be doing this to curry favor with the flexions and cronies, or do they dare to blind side the base so that they can take the position, or do they already have that position and wish to hype it like the upside down man, or do they really believe a 10% decline is in order?

Russell Sears responds:

Could it be the bankers signal to their masters in central planning what the bankers predict will happen if the central planners most recent proposals are adopted or in this case no new compromise proposal comes to be? Or could this be a second order deception, where they imply to the markets they are against such ill conceived planning, but secretively have already front run the public and hope, as they have been lead to believe by the central planners, that no deficit reduction compromise will be reached.



 I see a water boil type market where slowly the heating ramps up until it bursts into boil. Multiple country bond market auctions failing or stumbling, euro equities struggling, S&P hanging like a turkey from a hunter's hand, mf global is a needle in the confidence arena, the heating up of a bad kettle keeps going.

So I'm not seeing things from a contrary view, but I'm seeing things as slowly unraveling…or maybe there is a grand rescue that will be hatched on turkey day?

Somehow I feel that table talk will be interesting on Thursday.

Victor Niederhoffer comments:

The idea of buying the announcement and selling the rumor for profit has been exemplified recently. 



 Mistake: I was up at 130CST after a nap, and I look at quotes, and say to myself, okay, cool. But I must have shut off the alarm in a sleep walk as it's set to continue to go off every 30 minutes to 5am…ya know, to be sure you're on the job. I wake up in a panic at 3:30 am. I am still in the markets and knew I haven't moved any. I look at the quote now 2 points difference against me. I look at hi low which is 5 points worse. I worked it out and of course, but you're so mad after such a mistake you can't sleep.

I just told my buddy about that and he said, you ever wake up on a Saturday and think you're long and had a nightmare about a crash? Then you realize not only is it Sat am and you're flat? That is funny.

"Good luck": Luck in a casino is for… or let's say cards. Either you're good or not. In general as traders we do not wish each other luck often. I will in this market! In racing we wish each other luck, but its for all to not have a bad crash and get hurt. It is never good luck for your cohorts to win. Team mates, its understood, finish 1-2 and we usually say go get em. Yet in these markets I now consider luck as a very nice gesture and appreciated.



 We are creating a world very different from our grandparents. What will your last tweet/post be like?

Stefan Jovanovich replies:

Indeed, it is certainly a world without any training in grammar or usage. First sentence from this professional journalist: "people that". His presumption is fittingly modern. The literal explosion in writing and newspaper publishing that produced and required mail deliveries 5 times a day and fast mail trains that delivered Special Delivery letters and major city newspapers in 3 days to anyplace in America with a railroad depot is ignored completely in favor of a portrait of our grandparents with their snapshot albums and "diaries". Even as Google and others make the archives of what people wrote in the past available for free, the ignorance of what the past grows exponentially among the technocrati.



 A debt-reduction committee with special powers that was supposed to dissolve congressional gridlock in Washington is instead on the brink of failure, setting the stage for $1.2 trillion in automatic spending cuts.

Finally. Hopefully the US will show the Europeans that solving the economy problems by just issuing new debt is not an option. Markets have just reacted printing higher prices for EURUSD. It seems that the Euro continues to be relatively strong despite the situation in Europe.

How long can the markets be blind and not see the obvious?


a frustrated short on the Euro.



 All The Devil's Are Here by Bethany McLean and Joe Nocera describes the speed with which a sickness in one part of the financial industry spills over to others. The failure of the Bear funds led to the failure of Bear which led to the failure of Lehman which led to the fire sale of Merril, and the failure of AIG. All was set in motion by the aggressive selling without checks at Countrywide and Ameriquest. The loss of confidence in one week which could crater all the banks of those days leading to 80% losses in a month was astonishing if you hadn't seen movies like Contagion or read about the Black Plague. Many of the characters talked about in the book have great tragic flaws, striving to emulate Goldman, for example, or not wishing to hear bad news, or firing their risk officers when the sales volume gets too low. It's a sobering tale of the fault lines among people and Wall Street that gives me the same willies that I feel when I read about all the writers who went under during the depression. Well worth reading.



The worst [Australian investment] funds are revealed: ''Regardless of the overall return metrics, not-for-profit funds have consistently outperformed for-profit funds by around 2 percentage points a year".

Maybe this is a lesson, as Nick Bhuta from Goldman's pointed out: "Macro correlations across major asset classes have been at decade highs (99th percentile) over the past couple of months while trend strength has been at near decade lows."

Not a good time to be paying up for bro and underperformance in for-profit funds, that is if you want to pay up at all.

But the cost of doing business in mean reversion is no doubt greater than set and forget.

Read more here. (Sidney Morning Herald).



 Some questions about the Fitch announcement:

1. When a ratings service says there is a potential for contagion if the situation worsens, is this bullish or bearish.

2. If it were true, is it bullish or bearish.

3. What are the chances it is true?

4. Why does it happen at 310 so as to liquidate longs.

5. Is it subsumed by the next highly important piece of data like the state of manufacturing in the phil area?

6. Does is serve any purpose except to create friction so the strong can take chips from weak.

7. When the market drops 2 % in a half hour like it did, is it bullish or bearish?

8. Is the sentiments of a rating service related to the threat by the French to vet all their methodologies and to switch in the future? How does this relate to the profit margins and survivability of the services

9. Do the sentiments of one rating service tend to be unduly reversed by an announcement from the next rating service?

10. What other queries would seem relevant?

Rocky Humbert adds: 

About the Fitch announcement:

1. Why do people tend to attribute market price moves to announcements by credit rating agencies? Has there been a single news story that notes that the US Treasury is higher versus when the USA lost its AAA; whereas the French 10 year is roughly 8 points lower since it held its AAA at the same moment in time.

2. Why do people think that falling gasoline prices are bullish but spiking WTI prices are not bearish? Why do people choose to pick particular headlines as "explanations" but ignore the other hundreds of headlines that appear coincidentally? (i.e. MF Global's bankruptcy judge yesterday withheld his ruling on the release of billions in frozen collateral (which isy leveraged into massive liquidity)…and this non-decision arguably has a much bigger impact on the day-to-day price moves)…etc.

3. The ratings agencies receive no compensation for their ratings of the G7 sovereign debt. They do this as a "public service" and a legacy. Why do they do this? If they ceased to issue sovereign ratings, would anything change? Would that be bullish or bearish?

4. After a multi-week/multi-month period of downward prices, a 2% spike in the last 30 minutes brings out the naysayers "the market cannot be trusted," "it's a bear trap," etc. But I've found with absolutely no statistical significance (due to insufficient data points) that it's often a very tradeable bottom. In contrast, a 2% decline in those conditions rarely makes the news.

5. What does bullish or bearish mean?

John Floyd makes three points: 

1. Today's action in Europe provides and interesting contrast. Amongst other negative factors the Spanish bond auction was by almost accounts a failure and yet spreads are tighter between Spain-Germany, Germany yields are up, the Euro higher, etc. So perhaps there are many factors at play that determines what drives prices and it is instructive to observe how the market moves relative to a given piece of news in comparison as to how one would expect it to react. For example if Spanish bond spreads had been tightening the past few days prior to the auction would they react the same?

2. I am not sure given the daily volatility in SPX and the track record or operations of rating agencies that they are able to time and focus on the minutia of the market in such a way. I would need to look but I imagine there are instances like the Spain one above where the market acts in opposite fashion as to what one might expect.

3. I would liken the rating agencies to a biker in the back of a peloton, or a swimmer behind a pack of others, they are getting dragged along by other forces en masse, not breaking new ground. There is the consideration however that a ratings change may cause sales (or buys) buy making an asset class unavailable or available to a subset of market participants. 



Here is a nice paper on "New Evidence on the First Financial Bubble".


The first global financial bubbles occurred in 1720 in France, Great-Britain and the Netherlands. Explanations for these linked bubbles primarily focus on the irrationality of investor speculation and the corresponding stock price behavior of two large firms: the South Sea Company in Great Britain and the Mississippi Company in France. In this paper we collect and examine a broad cross-section of security price data to evaluate the causes of the bubbles. Using newly available stock prices for British and Dutch firms in 1720, we find evidence against indiscriminate irrational exuberance and evidence in favor of speculation about fundamental financial and economic innovations in the European economy. These factors include the emergent Atlantic trade, new institutional forms of risk sharing and the innovative potential of the joint-stock company form itself. These factors ultimately had long-lasting transformative economic effects which may have been anticipated by the markets at the time. We use the cross-sectional data to test the hypothesis that the bubble in 1720 was driven by innovation by dividing the London share market into "old" and "new" economy stocks. We find that firms associated with the Atlantic trade and with the new joint-stock insurance form had the highest price increases and had return dynamics consistent with current models of "New Economy" stocks. New, high frequency data allow us to pinpoint the date of the 1720 crash and track its international propagation.



 Sears started as a catalog/mail order company and will eventually turn back to its old roots–shed the real estate, close all the stores and sell from the internet only.

Just a thought.

Rocky Humbert comments: 

Interesting timing for Ken's post!

Exact 7 years ago today, (11/17/04), Eddie Lampert announced the acquisition of Sears by Kmart. Lampert took control of Kmart during its bankruptcy.

Eddie (a fellow Yalie and GS risk-arbitrage alum) is a very smart guy. His resume includes the improbable feat of having talked his way out of a kidnapping, and some fabulous investments, including Autozone.

Alas, Sears was Eddie's biggest transaction.

And how have Sears shareholders fared? Not so good. The Sears story morphed from a real-estate play (which quadrupled the stock) to cost-cutting to "we're not going to sacrifice profits for revenues"  to who cares about sames-stores-sales to the present morass.

Since the merger, the S&P 500 has returned +23.1%. Walmart has returned 24.1%. Sears has returned negative 24%.

Which raises the tasteless counterfactual question: How would have Sears performed if the kidnappers had not been persuaded?

The lesson: always have an exit strategy other than the graveyard.

Stefan Jovanovich comments:

This is Sears' own potted history of its going into store building:

The first Sears retail store opened in Chicago on February 2, 1925 in the Merchandise building. This store included an optical shop and a soda fountain. During the summer of 1928 three more Chicago department stores opened, one on the north side at Lawrence and Winchester, a second on the south side at 79th and Kenwood, and the third at 62nd and Western. In 1929 Sears took over the department store business of Becker-Ryan Company. In 1933 Sears tore down the old Becker-Ryan Company store in Englewood, and built the first windowless department store, inspired by the 1932 Chicago worlds fair. In March of 1932, Sears opened its first downtown department store in Chicago on State Street. Sears located the store in an eight-story building, built in 1893 by Levi Z. Leiter, which for years housed the Stegel-Cooper department store. The original Chicago occupant on this piece of land was William Bross who in 1871 mounted his house on wheels and rolled it down State Street to the corner of Van Buren Street. He kept his house on wheels for several years because of the marshy conditions of the land. The Leiter Building, designed by famous skyscraper architect William LeBaron Jenny, included walls of New England granite.

The store sat on the corner of Van Buren, State and Congress streets and cost over a million dollars to refurbish. A 72-foot long electric Sears sign greeted shoppers at the front entrance. A stunning black and white terrazzo covered the main floor. The State street store was the first Sears store in a downtown shopping district, the sixth store in Chicago, and the 381st store the company built. Opening day for the State Street store took place deep in the Great Depression. Local newspapers reported that 15,000 shoppers visited the new store and several thousand people flooded the store's employment office. Sears did everything it could to help put people to work, employing 750 Chicago workers for four months during the renovation and staffing the new store with over 1,000 people.

Illinois Governor Louis Emmerson in a message to Sears Chairman Lessing Rosenwald stated, "I cannot help but feel that this opening will mean a great deal for your organization as well as for your city." Rosenwald proudly proclaimed that, "We regard the opening of our new store on the world's greatest thoroughfare as one of the high spots of our company's history." Within the store the sale of tombstones, farm tractors, and ready-made milking stalls caught customer's attention. The sporting goods department featured a model-hunting lodge. Other attractions included a candy shop, soda fountain, lunch counters, a shoe repair shop, a pet shop, dentists, chiropodists, a first aid station with a trained nurse, a children's playground, and a department for demonstrating kitchen utensils.

The company's chronology of its adventures in retailing in North Carolina is revealing. It did not build stores outside of the major cities– Charlotte, Durham, Goldsboro, Raleigh, etc, — until the 1980s! Meanwhile, some bright people in the truly small town of Wilkesboro had started their own enterprise, now known as Lowes.

Market Caps today (according to Google Finance):

SHLD - 6.83B LOW - 29.98B



"But the surprise is that almost all sports follow exactly the same law–the Pareto Principle. In other words, regardless of the sport, 20 percent of the players enjoy 80 per cent of the success and prize money.

Exactly how this rule emerges in sports with different rules, governing bodies and tournament structures is something of a puzzle.

However, it means there is certain predictability in the outcome of events in which two players are pitted against each other. To test the nature of this predictability, Deng and co have found a model that exactly reproduces the statistics of the real sport.

They make a few assumptions about the players involved, the most interesting being that the probability of one player beating another depends only on their difference in ranking. So the number 1 ranked player is just as likely to beat the number 10 player as the number 75 is of beating the number 85. In fact, the same probability applies to any two players separated by ten places in the rankings. "

"Universal Law Discovered for Player Rankings"



Is the EU end game near or will they be next year's business as often happens. moving August biz into the Fall? I'm trying to discern the real crisis intensifying vs. institutions, I'm just not willing to hold any new paper for YE marks making things look worse than they seem. I noticed Belgian 3M paper moved from ~1.4% to ~3% after only 1 year without an elected govt in place.



 It is my understanding that my friend Prof. Kevin Kelly, of Rice University, was the developer of the first ‘nano-car’ about 4 years ago.

He and another friend and a Rice colleague of Prof. Kelly, Prof. Rich Baraniuk, did some amazing work on a new camera technology employing Compressive Sensing, that has applications for High Frequency Trading, their paper, A New Compressive Imaging Camera Architecture using Optical-Domaine Compression, I don’t have the link, but I posted it a few years ago, and it was buried in these comments sections,

Anyway, check the website. It provides “innovative cameras and hyper-spectral imagers that employ advanced computational imaging to provide unmatched price and performance. InView’s innovative computational imaging technology can be employed across the electromagnetic spectrum, including the ultra-violet, visual, infrared and terahertz wavebands”.

When I mentioned that I too was incessantly playing playing Lucky Man, Osaid it was by Oasis, obviously I meant to say Richard Ashcroft’s The Verve, which I still incessantly play and has merited my Top 25 list. Other recent obsessions, include Blue Rodeo’s "5 Days in May" and "Hasn’t Hit Me Yet". Also, Ryan Adams new "Lucky Now" and The Turtles' "I Don’t Know Why", but even before this new Travelers commercial, I seem to be incessantly playing Elenore's "Happy Together".

Check out the Turtles story, one of the great persistence stories where the two progenitors lost their song rights only to repurchase them years later when the buyers filed for bankruptcy and the two Turtles bought them back at auction and ‘happily’ cashing in on this commercial resurgence digging Wilco’s new I might.

And Mick’s effort with Super heavy and his and Joss Stone’s, One Day One Night. Last discovery, all specs should instantly download ELOs 10538 Overture and pay particular attention to the amazing sound of the “cheap Chinese cello” employed here! Stunning.



 I just watched Changeling  directed by Clint Eastwood (2008) yesterday and found it's a very Randian story.

The story occurs in Los Angeles in 1928. A little handful of individuals trying to fight against the system. Alas the movie is based on a horrific and true story: "the chicken coop murders".

I found the story interesting because of the depiction of how information, gaining information and broadcasting it, can change things. And also, sadly, how so many people not only cooperate with the system, but will peacefully destroy those who don't.

Rev. Gustav Briegleb Dr. Gustav A. Briegleb (September 26, 1881 – May 20, 1943) Briegleb was a Presbyterian minister and pioneer radio evangelist. He was the pastor of St. Paul's Presbyterian Church, Jefferson Boulevard at Third Avenue, Los Angeles, California. He took up many important causes in the City of Los Angeles in the 1920s and 1930s, most notably the poor handling of the Walter Collins kidnapping case in 1928. He fought to have Christine Collins released from a mental hospital after she was committed there as retaliation for disagreeing with the LAPD's version of events.

The movie is a bit long, but worthwhile.



 I conducted my own version of Bastiat's broken window parable this weekend on a microcosm for the economy, my back yard. After the second debilitating storm of the year, there are shed and broken limbs scattered throughout the woods behind my house. I like to believe that I can keep the forest somewhat organized and English garden like, so set about making piles of woods and pulling some to the driveway for collection.

There was much activity and I did have a nice afternoon in the woods, and my daughter of 4 assisted for a while. So there was some productive activity. However on the whole the woods are still a mess, much worse than before the October storm. And the opportunity costs must be factored in, as I never got around to repainting my younger daughters room or reading all the spec post for the weekend. There is a marginal amount of firewood now available for collection, and I did hire a college kid to help for a while. But, he had to leave in the middle of the job to attend OWS. So maybe those can also be factored in the plus column.



 Dear Vic,

Thanks so much for the compliment and kind consideration.

Regarding publishing, my concern is mainly around the tight controls by the government on this side. In this country, anything can easily be fathomed as a state secret — I was shocked at times when I saw slogan banners on streets saying "keeping state secrets is every citizen's responsibility". At the moment, financial topics are especially sensitive for the reasons that on the one hand there is a crisis on the globe and at home the government has a lot of hardship, and on the other, the wave of shorting China is coming. Shorting China is being generally portrayed and perceived as hostile to China's development. Although to my belief the article has no non-public information and my concern might not be very well-grounded, I just try to be cautious.

Pardon me if this may have caused your confusion. The situation may be hard for Americans to understand, just as in quite the same ways some American situations are hardly imaginable to the Chinese. I have experienced both. Over 20 years ago, I had never known what freedom really meant until I stepped on American soil to study for my PhD at Dartmouth. Then in America, the concept of being controlled gradually faded away from my mind. Only about 10 years ago, I started to re-realize it after I came back to China to lead an American business.

Your kind efforts in circulating it will be very much appreciated. While I fully understand that in this age, nothing stays being covered for very long, a circulation at the moment within a community (let's say the financial community, large or small) rather than over to the general public makes me feel a little more comfortable. I appreciate very much your kind understanding.

Again, my great honors in communicating with you.


Leo Humbert


Mainland China's Securities and Derivatives Exchanges [15 page PDF]



 One of the greatest regularities known to seasonal players is the tendency for the market to rise on the first day of the month. It was strange, as for many years despite its wide dissemination, it continued. Indeed for the last 180 of them, the market has rises about 62% of the time, averaging up about 1/3 of a % on the day. Indeed, the entire market gain during the last 15 years in a sense came on the first day of the month, and you would have lost money by buying on all the other days.

How could something so widely anticipated and disseminated actually give someone a chance to profit? Possibly it was due to the fixed schedule of purchases and sales of investors who received pay checks and institutions that put their money to work at the end of the month. Based on the regularity, an ETF giving investors the opportunity to participate in the regularity was formed. It is interesting to consider the performance of the market on the first day of the month in 2011 in that context.

Performance first day of month 2011 S&P futures

Jan +08

Feb +17

March -21

April +8

May -11

June -32

July +20

Aug -45

Sep -49

Oct -08

Nov -25

The average is down 10, about 0.8% down so far this year with six of the last 7 being particularly ruinous.

Thus, another seasonal regularity, one of the most long standing, and one that had the most reasonable foundation for working goes to boot hill. 



Here are the specs for the world's smallest electric car, recently developed by researchers at the University of Twente in the Netherlands.

Size: 1 molecule long Range 6 billionths of a meter Operating temp: -266C Seating: 0

Frankly, you have to see this to believe it.



 In his latest blog post Bruce Krasting says "I have no life". Me, too. Krasting is reading Energy Business Review, Power Generation, Biofuels & Biomass– the trade rag for biomass. I am going through William Amassa Scott's History of the Repudiation of State Debts.

According to Krasting the biomass projects all have these common characteristics:

- They are long life projects with long-term paybacks.

- They (almost) always have a municipal involvement.

- There is (almost) no equity in these projects. They are funded 99% with debt.

- The capital structure has debt maturities out to 15+ years.

-In (almost) all cases vendor financing of major components is a requirement for an equipment sale.

- The cost of debt is THE critical component for a project. Without the availability of cheap long-term money these co-gen facilities never get off of the drawing board.

What the repudiating states had in common was that they chartered state banks whose initial deposits were not specie but bonds from the states themselves. The bonds were secured by investments in infrastructure projects - canals and railroads - and sold largely to foreign investors. (Hope & Co. in Amsterdam was the big wheel in American state bonds.)

An example is the Bank of Pensacola, chartered in 1831 and completely gone by 1841 after having issued bank notes backed by its investment in the Alabama, Florida and Georgia Railroad. The territory of Florida had backed the bank with its full faith and credit - as it had the Union Bank of Florida (chartered 1833, began operations in 1835, suspended specie payments in 1837 but continued to sell bonds in Europe as late as 1839 to cover the interest payments on its already outstanding debt).

By the time Florida became a state (1845) the claims against the failed state banks were literally clogging the Federal courts. The Florida legislature and its newly-elected governor solved the problem very neatly; they repudiated the obligations of the territory as having been unconstitutional.



 Anyone who understands the game of cricket may be quick to understand this, though it no doubt applies through other sports and, of course, business.

During the week Australia played South Africa in a test match. Each party has two innings (where 11 players bat and total score for the two innings is registered.) Australia batted first, and only one batsman, the captain, did any good, and Australia got to through on a paltry score of mid 200's. South Africa, then batted and fared badly, with no batters doing any good.

At this point it gets interesting, since now there is an "acceptance" in the player's mind that the track i.e the batting pitch is very difficult to get runs on. Australia then go into bat for their second innings and don't make a combined score of 50 runs! South Africa then comes out in the notoriously difficult last innings of the test, where the pitch notoriously has deteriorated, which should be the most difficult innings of the match, and they then smash Australia, scoring runs with ease.

What is of interest here is the role the past conditions and the perceived situation has in affecting the batters mind set. With Australia having trouble in the first innings, then seeing South Africa in the same situation, there was acceptance by them walking out for their second bat that "no one can score a run", and so they didn't!

Is there a lesson to learn here? Probably. Don't accept the norm, and the less you know about the past, in one of the great contradictions of investing, the better off you may be, and stay flexible and adapt on your feet, (if you're a one trick pony, you have to know when the crowd is after you), and don't give weight to the excuse "markets are tough at the moment.



 The term Roach Motel ("where roaches check in, but they don't check out!") was coined by Black Flag pesticides in 1976. Judging from my experience yesterday, Groupon membership is quite similar.

Groupon (GRPN) went public recently after some kerfuffles with the SEC. (The SEC demanded that their stated revenue be reduced massively.) In the IPO filing, GRPN stated that they had over 50 million subscribers as of December 2010 (page F-37 of Form 424B4), and by September 2011, that number had grown to 143 million (page 1)! Notably, in 2009, they had only 152,000 subscribers (of which 43,000 made purchases) whereas in 2011 "only" 29.5 million purchases were made on the 143 million. That means purchase activity among Grouponers declined from 28.3% to 20.6%. (If one considers the fact that 16 million customers made multiple purchases, the activity percentage is declining much faster.)

That GRPN has never been profitable is beyond the scope of this post.I don't like crowds, and I didn't like being one of the 143 million Grouponers. Also, as a bald man, I had grown especially weary of the daily 20%-off Groupons for hair removal services. (There were never any discounts for hair retrieval services.)

Hence I tried to "cancel" my Groupon membership yesterday. Alas, there is NO ability to do that on their website, and NO instructions on how to cancel membership. So I sent an email to the GRPN "customer support line," with the question: "How do I cancel (and close) my Groupon Account?

The response: "You will no longer receive any promotional emails from Groupon. Please note that in the future you may receive transactional emails regarding past or future purchases made though your account and important business announcements that could affect your rights as a customer. You may receive an email if we update our privacy statement or our terms of service."

One can interpret this to mean that they may still count me as a "subscriber" for the purposes of the 143 million, but they won't count me as a subscriber to their daily emails. Gone, but not forgotten….

Misquoting Shakespeare, "I come neither to bury Groupon, nor to praise him. But the email address that Groupon captures lives after them."

[Disclosure: I have no Groupon position. I note that Blag Flag Roach killer comes in both "fragrance free" and "fresh pine scent." Here, I smell a rat.]



 Neither professor says so explicitly but their model leaves countries with a cafeteria plan of choices regarding their political economies:

1. Maintain Fixed exchange rates - what the European economies now have with each other, what the states in the U.S. have, and what the Chinese enforce for their currency vs. the rest of the world

2. Allow Central bank/sovereign Treasury control over banking reserves and the supply of credit/money - what everyone has

3. Allow Capital market transfers between domestic and foreign currencies - what the Chinese don't have officially but are actively doing privately and what some in the U.S. Congress would like to restrict (following the Chinese model to "punish" China)

Countries can safely choose any 2 out of 3, but they cannot have all 3.

The Constitutional gold standard worked because the trading countries that allowed 2. and 3. accepted a fixed rate of exchange for all their currencies into gold. (This is why the authors of the Constitution made such a big deal about the regulating the value thereof of foreign coin.)

Reviving that fixed exchange rate agreement is impossible given the certainty that at least some countries will want to have their central banks/Treasuries manipulate their currencies in the mistaken notion that this will somehow increase wealth for their countries.

That leaves the U.S. with the choice of abandoning either 2. and 3.

Those of us who have now read Professor Timberlake 's book (which puts Schwartz and Friedman utterly to shame) would like to see the U.S. choose option 2. However, if history is any guide, the religion of central banking is far more likely to triumph politically than the quaint notion that people should be free to hold their wealth in the money of their choice. The odds are very poor that anyone will be able to drive a stake through the heart of vampire economics, aka IS-LM.



“We were told not to expect reward without risk, gain without the possibility of loss,” he says in disgust. “Now we have been forced to accept crony capitalism, private profits and socialized losses, and corporate welfare.”


Derman's new book is out. Here is a nice article about it.

"MODELS.BEHAVING.BADLY. Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life"

Emanuel Derman was a quantitative analyst (Quant) at Goldman Sachs, one of the financial engineers whose mathematical models became crucial for Wall Street. The reliance investors put on such quantitative analysis was catastrophic for the economy, setting off the ongoing string of financial crises that began with the mortgage market in 2007 and continues through today. Here Derman looks at why people– bankers in particular –still put so much faith in these models, and why it's a terrible mistake to do so.

Though financial models imitate the style of physics and employ the language of mathematics, ultimately they deal with human beings. There is a fundamental difference between the aims and potential achievements of physics and those of finance. In physics, theories aim for a description of reality; in finance, at best, models can shoot only for a simplistic and very limited approximation to it. When we make a model involving human beings, we are trying to force the ugly stepsister's foot into Cinderella's pretty glass slipper. It doesn't fit without cutting off some of the essential parts. Physicists and economists have been too enthusiastic to acknowledge the limits of their equations in the sphere of human behavior–which of course is what economics is all about.

Models.Behaving.Badly includes a personal account of Derman's childhood encounters with failed models–the oppressions of apartheid and the utopia of the kibbutz. He describes his experience as a physicist on Wall Street, the models quants generated, the benefits they brought and the problems, practical and ethical, they caused. Derman takes a close look at what a model is, and then highlights the differences between the successes of modeling in physics and its failures in economics. Describing the collapse of the subprime mortgage CDO market in 2007, Derman urges us to stop the naïve reliance on these models, and offers suggestions for mending them. This is a fascinating, lyrical, and very human look behind the curtain at the intersection between mathematics and human nature."



 One is always reminded in situations like today where the market is down 3% at the open, of card games I played in 50 years ago, where negotiation about the split was allowed before the call. If one was bluffing or busted, especially in hi lo, one would often smile at the other side, and say something like split 50-50 before the close, expecting a pleasant acceptance from the other side. But instead, the other side never had mercy on you when you were bluffing and would take all your chips and refuse to split with you until the final call, where invariably he'd go both ways against you or the same way as you.

The market has weak longs in its grips. Many brokers and others and hangers on with access to weak hands and liquidations, make their money by front running their weak customers or trading the other side when their customers are forced to liquidate. The idea of mercy or a split is non-existent. This is when they take everything, albeit it has to be a temporary thing here, because the news is ephemeral and tomorrow yet another rabbit will be pulled out.



1) Hawaiian hellman Garrett McNamara has cheated death to ride what is being billed as the largest wave ever surfed. The big wave rider caught the huge 30m (90 feet) monster earlier this month off the coast of Nazaré in central Portugal.

2) From an interview with McNamara:

ESM: Do you have a training regimen to prepare you for big surf?

GM: It varies based on wherever I am because I'm on the road so much. I stretch and do breath-holding exercises every day, and then I do Bikram yoga and lift weights whenever possible.

ESM: Are you focused on nutrition too?

GM: Yeah, I eat about five small meals a day, mainly greens, and I've recently eliminated animal product from my consumption. I read this book called The PH Miracle, and it changed my life.

ESM: So what's up next for you? GM: I have a jam-packed schedule touring around with Wave Jet. We will be in LA Tuesday for a Discovery Channel shoot, then I head to Hawaii for a commercial shoot with WaveJet and Thule. Then it's off to Utah for the Outdoor Retail Show, then the US Open, then the SEA Paddle NYC around Manhattan. After that comes my favorite part, a week with Surfers Healing. Then I'm off to Florida for the Surf Expo, then Battle of the Paddle, then the International Boat Show, and finally, back to Hawaii for the Eddie and Pipe Masters.

ESM: Wow, that's quite a schedule. What inspires you to keep going?

GM: Surfing is my passion. It's what I love. It's what I live for. The ocean is my church and my playground all in one.



 Here in Florida, and in many other areas of the country, McDonalds sandwich, the McRib is back on the menu for a limited engagement. I wrote earlier on Daily Speculations in 2009 about how much I enjoyed this tasty morsel of mystery pork. Since the McRib is back, I felt the need to stop by and get one or twenty.

A little back story here. On my way to McDonalds, I needed to fill up my car and went over to 7/11 where the gas is the cheapest in town. While going inside and getting a coke, I noticed that 7/11 has their own version of a BBQ sandwich in their deli section (who knew that 7/11 had a deli section). Their BBQ sandwich is wrapped in plastic, has a sell by date, and needs to be microwaved. My first thought…."This would be perfect for a McRib, 7/11 "Barbeque Rib Sandwich" showdown. They're really cheap and I paid $2.19 and walked out with a 7/11 "Barbeque Rib Sandwich." I went straight over to MickeyD's and bought a McRib and some fries.Took both sandwiches home and put the 7/11 version in the microwave as instructed. When it was warm, I took the McRib and 7/11 sandwich out of their packaging and put them side by side to compare.

The McRib was still warm and had a nice looking bun with a 1/4 inch of mystery meat poking out the side of the bun with some of the tangy sauce dripping down the side. The 7/11 version had an anemic looking bun, stale and soggy, and one could not tell what was inside. I opened the McRib and saw the mystery meat, BBQ sauce, onions, and pickles, and it looked pretty good. Opening the 7/11 version, I noticed that there was some nasty type of ketchup like sauce that was misapplied and all on one side of the meat leaving the other side completely without sauce. The 7/11 version had no onions or pickles. There was, on that side without sauce, some half congealed grease stuck to the bun which really looked yummy. The meat itself, looked kind of gray and reminded me of what cadaver meat looks like, and I thought that it would look good in a Wes Craven movie. I decided to try the 7/11 BBQ sandwich first. I took a bite of the stale 7/11 bun and was immediately repulsed by the meat which tasted kind of like ALPO(and I know what ALPO tastes like due to a prop bet I made in my youth.)

The meat/bun/sauce,congealed grease combination from 7/11 sandwich was so horrible that I could only take two bites, and was not only reminded of ALPO, but had the disturbing thought that this is what cadaver meat probably tastes like.It gave new meaning to the definition…rancid.. I washed my mouth out with a Coke and bit into the McRib. The tang of the BBQ sauce, the onion and pickle made their mystery meat very palatable. The McRib bun was fresh, and I ended up eating the whole thing. I found the McRib to be pretty good and the onion/pickle garnish topped it off. There was no comparison, the McRib beat out the 7/11 Cadaver…I mean "BBQ Rib sandwich," by a million miles. This was the most lopsided food showdown in the history of the world. Granted, one will find a better BBQ sandwich at just about every real BBQ place on the planet, but in a pinch, the McRib manages to satisfy one's BBQ Jones.



 Today was a first ever for up, up, and up, and up, reasonably defined. With this 1 or 2% magnitudes. Amazing.

Like a stone wall, the stolid Germans are ready to sacrifice for the good of the over lords + or - at the round number of 6000.

Vince Fulco adds:

Negative news couldn't make a dent for long; does that mean teflon conditions till Thanksgiving? Not likely.

Russ Sears writes:

Pardon the talk of politicians, but the count is two days in a row that prime ministers have announced their resignation and the market moved up.

At this rate one wonders how high the Dow would go if every day a member of Congress would announce their retirement.



Why would people PAY the government to take their money?

WSJ: Paying to Give U.S. Money? Some Like Idea [registration may be required]


With yields plummeting on U.S. government bonds, the Treasury Department has quietly asked some banks if they would agree to buy new short-term bills offering yields below zero.

Effectively, the Treasury is asking investors if they are willing to pay the government to take their money. And some big banks have answered, "Yes."

It may sound crazy, but yields on Treasurys of less than three-month maturity are already occasionally trading below zero in the secondary market. Under current auction rules, though, the Treasury can't sell so-called T-bills with a negative yield. In the bond market, however, higher yields mean lower prices, so the Treasury is effectively losing out every time it sells bills with higher yields than the prevailing level in the market.

The question was included in a questionnaire the Treasury delivered on Oct. 14 to the 22 primary dealer banks that are obligated to bid on primary auctions of its debt.


Gibbons Burke comments:

It is just another form of protection racket. For a small tribute, you can keep your money.

Victor Niederhoffer comments: 

The banks are so indebted to the government for their survival and bonuses and trading and purchase of distressed assets, and redeeming of sovereign debt, and capital at the funds rate, and bailouts, and investments et al , and freedom out of hotels that they are happy to accommodate their masters on the Hill with any emoluments like paying the master a fee for the privilege of holding the master's…



Professional money had sold into the liquidity ramp that preceded this break, adding to their existing short positions. Somewhat coincidentally, they then pulled liquidity before the calls accommodating the sell-off. They proceeded to cover about 25% of their shorts on the break, while weak longs puked and flipped short.

This now leaves the market in a situation where the dumb money is a small short, and the smart money is still a relatively large short, which goes a long way in explaining why there was a short covering rally, on less than spectacular volume, ahead of last weekend. This also indicates large traders are reducing their short exposure as small traders begin to get short.

Given the current market structure, seasonality, willingness of global central bankers to add liquidity, and professional short covering, it would appear that the path of least resistance would be up. However, any bullish sentiment must be tempered by the current context of the market, i.e., Eurocratic risk.

Still very short, institutional traders will pull liquidity at the first sign of indecision or negative news or have their bots step down a vulnerable market. This of course, offers a wonderful opportunity to accumulate some longs.



 Real interest rates are back near their recent record lows (5 year TIP= negative 1.2%; 10 Year TIP= negative 0.15%); and gold's recent behavior is once again consistent with these facts. Riddle me this, Batman:

If I buy a 5-year TIP at a negative 1.2% real yield, and hold it to maturity, that means I am certain to lose 1.2% of purchasing power over the next five years. BUT: Were I instead to short a 5-year TIP at a negative 1.2% yield, and hold the short to maturity, does that mean I am certain to make 1.2% of purchasing power over the next five years? And, how can BOTH of these statements be false?

Private riddle for The Chair:

What do Galton, Batman, and Robin have in common?

The Riddler's False Notion:

Robin: Holy molars! Am I ever glad I take good care of my teeth!

Batman: True. You owe your life to dental hygiene.

Sushil Kedia writes: 

Logic Riddle is a misnomer for what is truly a contradiction. The presentation has a contradiction. In life, in markets there are no contradictions. Allow me to quote Ayn Rand from the Atlas Shrugged, "If there is a contradiction, check your premise".

Rocky, your logic is based on inflation remaining what it is right now the same also during the maturity and at the point of maturity of the 5 year TIPS! Market is not pricing that! Market is pricing inflation will come down! That's all. Check the premise, there are no contradictions.

Purchasing Power is a good term to help create this contradiction. Purchasing power will be Cash in your hand on day of maturity Divided by (1+inflation)^5 if I take the Annualized realized inflation readings. Realized Inflation readings five years from now will be known only then.

Rocky Humbert responds: 

Dear MisterMeanor:

1. You should check your bloomberg before you check your premise. These bonds are trading above 105 in price (even forgetting about the inflation adjustment).

2. That means it's possible to have not only a negative REAL YIELD but it's also possible to have a negative NOMINAL RETURN! (So much for the risk-less treasury market.

3. Your definition of purchasing power is unusual. Purchasing power has absolutely nothing to do with the cash in your hand. It's WHAT YOU CAN BUY with the cash in your hand. (Stefan — please elucidate this point).

4. Your statement "Market is pricing inflation will come down! That's all. Check the premise, there are no contradictions" is 100% UPSIDE DOWN. There is little justification for locking in a negative 1.2% compounded real yield UNLESS you have no alternative investment that does better. You need an inflation assumption of RISING INFLATION not falling inflation due to the way these seasoned bonds behave.

I reckon, back of the envelope, north of 3.8% compounded CPI…. is required to have these TIPS beat the bullet 5 year … and even then you still lose 1.2% of purchasing power (compounded) per year. If you want to bet on disinflation/deflation, you would short these bonds at 105 with an inflation factor of 226/220 with abandon, and buy 5 year bullet bonds to term.

Batman just ended. The Flintstones are on now.

Charles Pennington writes: 

That's a very nice riddle.

These bonds trade dearly I think because there aren't many other competing foolproof CPI inflation hedges.

Obviously if you short the bonds AND hold the short sale proceeds in cash, you are at risk of losing money. You short $1 million in bonds and hold the $1 million proceeds in cash. The bonds could go up in nominal terms by a factor of ten to $10 million. Meanwhile your short sale proceeds sit there in cash, still just $1 million, and when you cover, you lose $9 million. That's a loss in any terms.

Of course, if you could use your short sale proceeds to buy something that tracks the CPI without the built-in "negative carry" that the TIPS have, then you'd have a perfect arbitrage. But such a thing doesn't exist.

(Does it?)

Tyler Mcclellan comments:

A 1 year bond is four three month bonds.

A three month bond is a treasury bill financeable for cash as legally defined by the government at the rate set by the federal reserve.

If ex ante you knew that rate, let's say it would be zero for the next year, then if the one year note traded at 1 percent, there would be risk free arbitrage in buying the note (because the note is defined as acceptable collateral to get cash without exception at the overnight rate, it is perpetually fungible).

But all of this is true because arbitrage needs a unit that you're left with at the end, say for example cash, to make the calc.

I will not solve the last part of your riddle yet Rocky.

Let me ask, can the fair value of cash, the unit of account in arbitrage, which is merely the desire to lend known resources today for unknown future wants x years from now, change?

I don't want to lend at these rates.

I'd rather just have the money in the bank.

But if you know the money in the bank is guaranteed to earn zero shouldn't you buy the bonds and finance them at zero?

And if you know that the nominal bond is priced on the arbitrage condition above, and you believe that inflation will be three percent,t hen if you short the bond and earn the overnight rate risk free, and buy the tip and pay the over night rate risk free,and you hold these positions to maturity, since they are both fungible for cash, then you are guaranteed to earn the difference between future CPI and the ex ante break-even, which is an unknown variable free to take any value.

If you had an opinion on the future rate of inflation you could express that view only because of the other variable being priced to remove arb.And the riddle you speak of which seems to be, why would you commit ex ante to a negative real return can be answered by saying arbitrage of the other instruments demands that only the break-even and not the real rate is solved for by the buyers and sellers in the tips market.

Then What is the real rate set by? That is a very tricky question. The answer is in the above, but not obviously.

Duncan Coker writes:

I believe selling the 5 year Tip and buying the 5 year bond would do better than 1.2% (anti negative real rate) and would actually capture the inflation rate of around 2%. Empirically if you convert them to zero coupon for calculations then sell the 5 year tip around 105, buy the 5 year bond at 95, this makes for a compounded return of around 2%, 10 profit, holding to maturing. But then again there is a reason I don't trade bonds much.

Michael Cohn comments:

 I think of tips only in term of the real yield. It would take a very unusual set of circumstances to get me excited about investing in a situation where I can earn a negative real return. These bonds, if I recall all have CPI floors built into them so persistent deflation while sapping a bond of its built in inflation accretion can't turn the redemption figure below par. Each bond has a different sensitivity to the built up inflation component depending upon when issued. This is because the bond pays the same real coupon and the principal balance is adjusted by prior CPI (riding on a train so can't look up)

Certainly these bonds are one of the only high quality ways to hedge inflation. There are a number of global ways to do this but France, etc. Have bigger issues.

So what can happen when you short one of these. I wonder for those who can obtain info what the cost to borrow for the short is here. Obviously the overnight reinvestment is not a plus here.

Seems like I should expect to earn the real yield in this case which is a depreciation toward par but what is my short cost?

Tyler McClellan responds:

 I set up my example clearly.

The reason the thirty year bond cannot be arbitraged to short term rates is very simple. There is no way to credibly make the claim that short term rates will be X for thirty years. There is no institution that can impose the stick. I put very little weight on all the other things. Its the fact that short terms rates could be radically different in the future that generates the volatility not the other way around. Long bonds are very convex and thus this is a major reason they should have a lower yield, offsetting the term premium.

Your examples about LTCM and MF Global are meaningless. Their assets were never fungible at 100 percent leverage for the overnight rate. The Fed conducts monetary policy by making cash and bonds of certain maturities exchangeable for each other at certain overnight rates. To compare this to MF global where the bonds are explicitly not instantaneously fungible with cash (euros) is very odd.

Your example about RV strategies in fixed income is a good counterpoint to the limits of arbitrage. I agree that a one year rate 29 years forward is not subject to the same laws of arbitrage as other instruments. This is for a simple reason. The one year rate 29 years forward is not something that is dynamically set in the market by participants trading until equilibrium. It is an artifice of other things that are traded in this manner and thus it "falls out" of other asset prices.

In general arbitrage is the mechanism by which the sum of views in the market derive their equilibrium condition. You have to have a variable that reflects some view for arbitrage to do heavy lifting. I cannot arbitrage a one day interest rate 17.75 years forward for the simple fact that there are no views on that variable and thus it is merely an artifice that arises from the ecology of the market.

As for mingling "real and nominal". You do not understand your own analysis. The market already believes that we will have about 2% inflation and is nonetheless holding cash at 0%. So the accepting of negative real returns ex ante exists in many markets as a necessary fall out of accepting other variable. To say that this comes from the TIPS market is strange. All the tips market does is allow people to have differing views on the future rate of inflation. Everything else is determined by much more liquid (and therefore likely to be subject to arbitrage pricing) markets.

You will get negative real returns (your vaunted guaranteed decline in real wealth (a phrase that I dont understand)) ex ante in either the nominal or the TIPS market. If you reread what you wrote, you will understand this has nothing to do with TIPS.

As for your last question. You already understand the answer rocky. You get more than PAR day one for being short the TIP.

If you

1) take all those proceeds and reinvest them at the fed fund rate at the future path

2) and if inflation is equal to the breakeven-rate

3) then you will lose the real value of the capital lent to you at exactly the same rate that the market says the real value of the capital lent to you must go down ex ante.

Put another way,


1) you must earn the nominal return priced in the market,
2) experience the inflation rate priced into the market,
3) and deposit your funds at the monopoly price set by the FED,

then you are indifferent between the two outcomes and are guaranteed to earn the same negative return. Which is of course why there is a market. All of which i wrote a long time ago as a explanation for why it might make sense to be short tips but if an only if you could tell me why based on your estimate of the above three variables. Any speculation on the real rate is meaningless, it is not a variable one can have a view on outside of the above (if and this is a key assumption, cash money from the fed reserve is the unit of account you wish to sum all the steps across. Its very possible the real term structure of other commodities is different)

Rocky Humbert responds:

I will address your many points more specifically when I have some time. But I will make a very simple observation (which you ignored)….which has to do with the interactions between inflation and tax policy and the zero interest rate boundary problem.

Let's assume a simple Taylor rule and that the fed sets overnight funds at inflation+100 basis points. Let's further assume a marginal tax rate of 30%.

Case I) Let's assume that inflation is running at 5%. Then fed funds is 6%. Then my after-tax nominal return = 0.7x 6% = 4.2% and my after-tax real return is negative 0.8%.

Case II) Let's assume that inflation is 2%. Then fed funds is 3%…and my after-tax nominal return = 0.7×3%= 2.1% and my after-tax real return is positive 0.1%.

Case III) Let's assume that inflation is NEGATIVE 2%. Then fed funds is 0% … and my after-tax nominal return = 0%, but my after-tax real return is positive 2%.

This is a clear example where real after tax returns behave in counter-intuitive ways…. and so the apparent negative return on TIPS might have less to do with inflation expectations per se, and more to do with the tax effects…. (or more succinctly, an investor in Case III above would be willing to buy a tip that has a negative 2% real yield and would be indifferent to case II, where the same TIP has a +100 real yield.) Just a thought

Tyler McClellan writes:

Very true. I once worked with Paul McCulley on the tax implications of same. As you never posed that as a question I didn't address it.

I agree with your points and thing it is a modest contributor the the current equilibrium pricing.

 Philip J. McDonnell writes:

I think one point that has not really been made in this discussion is that TIPS are paid back at the greater of inflation adjusted value or par. This means that they have an implied deflation protector built in.

It is like a deflation put which has intrinsic value in and of itself. In many ways we are in a deflationary environment caused by the great credit bubble unwinding throughout the world economy.

Gary Rogan comments:

I just scanned the riddle discussion. It seems to me that the reason you can't make money shorting TIPS is like the obviously idiotic action of shorting dollars in dollars. Let's say you decide to short a million dollars, and sell it to someone for a million. That's what shorting is, and yet you are in exactly the same situation as you once were.

If TIPs are losing purchasing power against a basket of commodities, but dollars are losing it faster, if you short TIPS you get something that loses purchasing power even faster than TIPS, hence no gain. If you could find a way to get paid for your shorted TIPS with a basket of commodities, and there is high inflation, you can buy them back with fewer commodities, so you make a profit.



 Two of the common features to crashes such as the 60 point drop from Friday to Tuesday are:

1. The forced liquidation of European accounts because of margin calls, in this case because of MF where all their account were liquidated Tuesday at the German open and

2. The missing piece of the puzzle. In this case the 450 million that supposedly was missing from MF segregated customer funds that may or may not have ended up with a large bank.

It is reminiscent of the 1987 crash where the missing piece was whether the us investment banks would be forced to make good on the British Petroleum underwriting price. Of course the most comparable crash was the crash set out by Kerviel where again the inside trading of European entities knowing that there would be massive liquidation at the opening added an exponential fall to the panic. Similar liquidation followed the Lehman bankruptcy.



MF Global “was felled by over-the-top leverage and bad derivative bets on debt-weakened European countries.”.

-New York Times.

(Quoted by ISDA)

The main issue is that some segregated funds are apparently missing. Complex economies rely on trust. If actors cannot trust counterparties, intermediaries or legal constructs, the scope and pace of activity will decline, and all actors will suffer.

The Lehman debacle's aftermath concentrated the commanding heights of US finance into a menagerie of TBTF above-the-law cronies.

The control frauds at the GSEs, AIG, and others have gone conspicuously unpunished.

A broad sustainable ramp up in living standards and asset values requires capital allocators to have faith laws and regs and rules and norms will be honored. (For some recent research on this see for example, Zingales: Measuring Trust ).

So don't blame the highly leveraged players. First they came for the highly leveraged specs, and I said nothing…..

James Lackey writes: 

JPM could have said we have a couple billion here on Monday night, or on Tuesday Open; or even Tuesday at 3 would have been nice.. Wednesday goes by,  Thursday, Friday.. Oh Friday how nice.. That was no, let's wait to report we have a few billion from MF here.. Let's imply it was lost or stolen. Of course this doesn't bother hedged unleveraged fee-collectors.



 Some years ago I was a tourist in Turkey and I hired the captain of a small sailboat to take me out for the day. The captain could only speak a little English but enough for me to learn he was a retired Sergeant from the Turkish Army.

When I said to him the Turkish Army had a reputation as very fierce fighters, he explained that was necessary because Turkey was surrounded by bad countries — the Syrians, the Iraqis and, shaking his head, the worst of all, "the Greece people".

As I scan financial news reports from Europe over recent weeks, the Sergeant's words echo back to me: "The Greece people, very bad."

[No offense to SpecListers or others who may be of Greek descent. I just liked his serious and striking English phrasing: The Greece people, very bad.]

Paolo Pezzutti comments:

I think an extremely weakened Greece could destabilize the area. You heard also that "the government of Greek Prime Minister George Papandreou has sacked the top commanders of the Greek Armed Forces in one afternoon.

The move came within 24 hours of Papandreou's announcement that he intends to hold a referendum on the European Union's bailout package, which is widely seen in Greece as a ploy to forestall early elections." Very unusual move in a NATO country.



 The NYC Junto will feature Tracy Quan, a frequent contributor at The Daily Beast and author of the bestselling Nancy Chan trilogy. Her writing has appeared in Financial Times, New York Times, Marie Claire et al. Tracy Quan talks about trends and factions in romantic work.

The meeting will be held at 8:00 pm on Thursday November 3rd, 2011, at the Mechanics & Tradesmen Library, 20 West 44 Street, NYC. All are invited.



 One type of false modesty or at least related has to be the “sandbag”. It often refers to golf, meaning to falsely increase ones handicap to give an advantage during tournaments. Examples are everywhere, as before any friendly competition with a neighbor, “I’ve not played in weeks… just recovering from a hurt…” This makes ones the underdog giving a slight advantage.

Sales reps sandbag the budget for a lower number then they might actually expect thereby increasing their potential bonus, ”..competition is tough, order are down, conditions bad.” Of course on the other side are the executives who pad the budget and maybe these two forces make the market. In fishing the sandbag equivalent would be, “ this is my first time on the river.. not sure how to work this water…” in which case your friend surrenders the best fishing holes and runs.

Southerners I think have particular skill with the "sandbag" given their genteel mannerisms which can hide their true sagacity and abilities. They are in fact much more adept at most things practical and otherwise. At first I underestimated my college roommate his being from small town Florida. But he was my better at everything from music to sport to study and I learned much from him.



 Last summer I gave talks to students about money and monetary history at Foundation for Economic Education, Independent Institute, and Economic Thinking seminars. I explained how the government had dramatically reduced the value of the dollar (students rarely guessed how Motel 6 got its name, for example). I played a fun YouTube clip from an Austin Powers movie where Dr. Evil, after hibernating through the high-inflation 1970s, returns to ransom the world for "a MILLION dollars".

But after giving these presentations a number of times, explaining how the gold standard maintained the value of the dollar, and arguing the benefits of commodity-based money, I started wondering if financial innovation had addressed some of the concerns of government paper money losing value.

Have most Americans already returned to a commodity-based system? People have bank and investment accounts containing money market funds, stocks, bonds, and other liquid assets. How much money do most people keep in paper currency on any given day? On payday, they receive a check or electronic payment that converts assets from the employer's portfolio (stocks, bonds, money market funds, gold) to cash–for a few hours or days–until the cash enters the employee's bank account, and is spent on goods and services, or allocated from checking, savings or money market accounts to various commodities or investments.

So much of the physical world has been sliced up into paper (or computer bits) representing tiny slices of every imaginable asset. Most can be converted back and forth, to and from cash, quickly by tapping keys on a home laptop, and exchanged for goods on Amazon–goods that may arrive just a few hours after the transaction is processed.

The commodity exchange system is based on trust. Sellers trust buyers, and buyers trust sellers and intermediaries like Amazon, Visa, and American Express. People may not trust the government and the Federal Reserve, but as people convert their assets to money for purchases, their wealth is exposed as fiat currency for only a few days, hours, or just minutes, on its way to be exchanged for goods or services purchased.

Technologies allow most people protection from paper money uncertainties. Inflation raises the value of their assets as it raises the prices of the goods and services they purchase.



 One is working on a post about false modesty. From Uriah Heep to the sage and gross and denial of false modesty by the "bank" and would appreciate any insight you might have. To me, pretending to be low, when you wish to gain sympathy and set a low bar for doing better is very common. The athlete that pretends "all the young kids are so much fresher than I" should not be overlooked.

 Gary Rogan writes: 

False modesty is mostly useful when you are buying, and for some reason almost everyone seems to be aggressively selling something complicated, and it also seems like these days (and it's not always been the case), the way to do a big sale is to seem like the big man on campus fully confident in your product as opposed to someone who just fell of the turnip truck and has no idea how to price what they are selling. Probably because when you are selling complicated things it strains credibility to claim that you have no idea what they are or what they are worth, yet they somehow will work. On the other hand if you are selling horses or gold-mining rights it pays to appear stupid.

There are of course still many examples. One example is Soros often understating his involvement in various causes buy being way too casual in his comments, as in this OWS case.

“Actually I can understand their sentiment, frankly,” he told reporters while announcing a large donation to the United Nations. “I can sympathize with their grievances.”

While not exactly false modesty, it's a kind of diminution of his involvement in a very similar way.

And just about anyone who had anything to do with the credit crisis is very modest about their involvement. Barney Frank, Chris Dodd, Fannie Mae, all the people who encouraged the millions of loans that had no chance of being repaid have turned into gently well-meaning almost-bystanders.

Pitt T. Maner III comments:

 False modesty could be a means of minimizing the potential backlash caused by delivering false opinions to the public (while taking the opposite side on the trade). Also it may lower the mental costs of engaging in the deception and manipulation of others ("that's what I believed at the time too").

1) New book out by Robert Trivers entitled The Folly of Fools: The Logic of Deceit and Self-Deception in Human Life may be of interest.

2) From a recent review:

In “The Folly of Fools” Robert Trivers, an American evolutionary biologist, explains that the most effectively devious people are often unaware of their deceit. Self-deception makes it easier to manipulate others to get ahead. Particularly intelligent people can be especially good at deceiving themselves.

All of this deceit comes at a price. Mr Trivers suggests that the most cunning people (whether conscious fibbers or not) tend to benefit at the expense of everyone else. He highlights the way overconfident Wall Street traders may hurt investors and taxpayers at little personal risk. Then there are politicians who spin stories of national greatness to bolster support for costly wars in which they will not be fighting.'

3) Consider this paper from von Hippel and Trivers:


to conscious deception that might reveal deceptive intent. Self-deception has two additional advantages: It eliminates the costly cognitive load that is typically associated with deceiving, and it can minimize retribution if the deception is discovered. Beyond its role in specific acts of deception, self-deceptive self-enhancement also allows people to display more confidence than is warranted, which has a host of social advantages. The question then arises of how the self can be both deceiver and deceived. We propose that this is achieved through dissociations of mental processes, including conscious versus unconscious memories, conscious versus unconscious attitudes, and automatic versus controlled processes. Given the variety of methods for deceiving others, it should come as no surprise that self-deception manifests itself in a number of different psychological processes, and we discuss various types of self-deception. We then discuss the interpersonal versus intrapersonal nature of self-deception before considering the levels of consciousness at which the self can be deceived. Finally, we contrast our evolutionary approach to self-deception with current theories and debates in psychology and consider some of the costs associated with self-deception.In this article we argue that self-deception evolved to facilitate interpersonal deception by allowing people to avoid the cues

 4) Dr. Trivers is making the speaking rounds to promote his new book, about which there is probably lively debate.

About Dr. Trivers:

Robert L. Trivers (born February 19, 1943) is an American evolutionary biologist and sociobiologist and Professor of Anthropology and Biological Sciences at Rutgers University. Trivers is most noted for proposing the theories of reciprocal altruism (1971), parental investment (1972), facultative sex ratio determination (1973), and parent-offspring conflict (1974). Other areas in which he has made influential contributions include an adaptive view of self-deception (first described in 1976) and intragenomic conflict. Trivers is arguably one of the most influential evolutionary theorists alive today. Steven Pinker considers Trivers to be "one of the great thinkers in the history of Western thought". Says Pinker, Robert Trivers has:

"inspired an astonishing amount of research and commentary in psychology and biology—the fields of sociobiology, evolutionary psychology, Darwinian social science, and behavioral ecology are in large part attempt to test and flesh out Trivers' ideas. It is no coincidence that E. O. Wilson's Sociobiology and Richard Dawkins' The Selfish Gene were published in 1975 and 1976 respectively, just a few years after Trivers' seminal papers. Both bestselling authors openly acknowledged that they were popularizing Trivers' ideas and the research they spawned. Likewise for the much-talked-about books on evolutionary psychology in the 1990s— The Adapted Mind, The Red Queen, Born to Rebel, The Origin of Virtue, The Moral Animal, and my own How the Mind Works. Each of these books is based in large part on Trivers' ideas and the explosion of research they inspired (involving dozens of animal species, mathematical and computer modeling, and human social and cognitive psychology)."

By the way, he will be speaking at a meetup in LA next week.

5) True modesty is a discerning grace, and only blushes in the proper place; But counterfeit is blind, and skulks through fear, Where 'tis a shame to be asham'd t' appear: Humility the parent of the first, The last by vanity produc'd and nurs'd. - William Cowper

Pitt T. Maner III continues:

A statement from Dr. Trivers (in light of his controversial views, past associations, and strange biography) catches the eye:

Interviewer: "Are you a self-deceiver?"

Trivers: I end the book with a chapter on fighting our own self-deception. I've been remarkably unsuccessful in my own case. I just repeat the same kinds of mistakes over and over. If you ask me about my self-deception, I can give you stories, chapter and verse, in the past. But can I prevent myself doing the same damn thing again tomorrow? Usually not, though in my professional life as a scientist, I feel that I probably practice less self-deception, I'm more critical of evidence, a little bit harder nosed.

Interviewer: You could be deceiving yourself about that.

Trivers: Absolutely."



It is interesting to look at what companies have an October Fiscal Year end, and how today may impact their accounting.

Recall that balance sheets are converted as of the close today, and income statements use a different method.


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