Will the Fed tightening cycle produce a long period of negative returns?

An interesting article in the WSJ this morning ("Pension Funds Pile on Risk" http://www.wsj.com/articles/pension-funds-pile-on-the-risk-just-to-get-a-reasonable-return-1464713013 ) pointed out the extent to which ZIRP has forced pension funds, which typlically have a 7.5% actuarial assumption, to adopt abnormal investment policies. The question one should ask oneself is whether "normalization" will force declines in all types of long duration securities.

Given the allocations in the chart in the article, I would assume that cash, both directly and in the form of deleveraging, could suddenly become the preferred asset class. That would constitute a rude surprise for many people.

Food writer offends 1.2 billion people, for starters

The back page of the TLS of May 13th has an amusing comment on political correction. Calvin Trillin wrote a poem about Chinese food, which he loves, in the New Yorker; it has produced some outrage. Here is the offending passage: "Have they run out of provinces yet?/ If they haven't, we've reason to fret./ Long ago, there was just Cantonese./ (Long ago we were easy to please.}/ But then food from Szechuan came our way,/ Making Cantonese strictly passé./ Sometimes we do miss, I confess,/ Simple days of chow mein but no stress."

It seems that it was the word "stress" that provoked the outrage. A letter of protest from Diana Keren Lee stated that this created an us-them conflict by employing "language that is reminiscent of the Yellow Peril of the nineteenth century, in which people of Asian descent were viewed as dangerous." The TLS's commentary ends with the following: "Have they run out of ways to be offended yet? Will the well of microaggression ever run dry? Even to ask is to offend."

The TLS commentary begins by noting that the writers of an earlier generation, such as Norman Mailer, Jean Genet,John Osborne, Erica Jong etc. considered it their duty to épater la bourgeoisie by defying conventions. Then they were lauded for it; today they would be run out of town. (You may click on the image to read the article.)

Ferguson Effect: Murders up 60% in 2015 in heavily black US cities

An article in this morning's Wall Street Journal ( http://on.wsj.com/1sNu9Ws ) discusses the effect of the end of "proactive policing" produced by federal policies and various pressure groups, such as "Black Lives Matter," on security in urban areas. Last year murders were up 17% in the 56 largest urban areas in the US, 60% in heavily black cities. In Chicago, in the first 4 1/2 months of 2016 murders are up 95% compared to the same period in 2014.

I am somewhat relieved that we let our family membership in the Museum of Fine Arts (Boston) lapse. There is no point in taking unnecessary risks.

Of course, this is consistent with everything else that is happening.

You may click on the image below to read the article:

The US military is starting to look more like America. (budget-wise)

An article on page A11 of this morning’s WSJ mentioned that the Marine Corps reports that 70% of its F/a-18 jets are not flight worthy due to inadequate maintenance.

This reminded me of Robert Gates testimony in Congress just before he retired as Secretary of Defense in 2011; he said that the Pentagon was being “destroyed” (he may have used another similar but different dramatic adjective) by the cost of veterans benefits and asked that they be removed from the defense budget.

The US federal budget overall has evolved into a support system for individuals (social security, Medicare/Medicaid, food stamps, etc.)  In fact, direct payments to individuals, including salaries, are now 70% of the budget.

:

Veterans’ benefits are $160.6 billion/year, or 4% of the total spending, while other military spending is 16%, meaning the VA is now 20% of total military spending.  Disability benefits for veterans were about $20 billion per year in 2000 AD and now are about $60 billion per year.  These rising costs are squeezing the other portions of the defense budget. 

PS: Another worrisome category is “interest on debt,” which is now 6%.  Were the average cost of federal debt to rise to 4%, this would be 20%.

Feldstein warns Fed's delay in raising rates is "dangerous."

In his essay in today's WSJ, Feldstein says, among other things, the following:

• "For price stability, the Fed since 2012 has interpreted its mandate as a long-term inflation rate of 2%. Although it has achieved full employment, the Fed continues to maintain excessively low interest rates in order to move toward its inflation target. This has created substantial risks that could lead to another financial crisis and economic downturn.
• "The S&P 500 price-earnings ratio is more than 50% above its historic average. Commercial real estate is priced as if low bond yields will last forever. Banks and other lenders are lending to lower quality borrowers and making loans with fewer conditions.
• "When interest rates return to normal there will be substantial losses to investors, lenders and borrowers. The adverse impact on the overall economy could be very serious.
• "With a margin of error that large, it makes no sense to focus monetary policy on trying to hit a precise inflation target. The problem that consumers care about and that should be the subject of Fed policy is avoiding a return to the rapidly rising inflation that took measured inflation from less than 2% in 1965 to 5% in 1970 and to more than 12% in 1980."

So Feldstein says the Fed should be worrying about speculation and inflation. The markets, and probably most Fed governors, are worrying about a lack of speculation and deflation.

Who is right? The monetarist Feldman or the Keynesian consensus? What I worry about is the possibility the central banks have created an unstable situation that they will at some point be unable to control.


Lincoln

Upsurge in China's housing market boosts its economy

There is a remarkable article in this morning's WSJ on A10, "China Housing Warms as Debt Clock Ticks," In the January to through April period, housing sales increase 61.4% yoy, property investment rose 7.2%, construction starts rose 21.4%.

This is after a multi-year contraction in housing/GDP. In 2013 housing contributed 22% to China GDP, which is about the same as in Spain and Ireland in 2007. This dropped to 19.8% in 2014 and to 15.1% in 2015. (Maybe 6% is something to aim at as a longer-term healthier number?)

This recent surge reminds me of what happened in Singapore, where we happened to be living during the Great Recession. The stock market went down and housing prices went up. The Chinese, who think multi-generationally, regard property as an investment and stocks markets as speculation. When they become leery of stocks, they buy property. In normal times Singaporeans speculate on stocks during the week and gamble on mahjong during the weekend. (In the local convenience stores the thick weekly books of stock charts are hot sellers.)

Here is a quote from the article: "'Leaving my money in the bank is meaningless and it will only devalue,' said Wang Hong, a 35-year-old office administrator who is looking to buy a second home in Nanjing." Holding fiat currencies is not considered a safe investment in Asia, where they do not benefit from the US dollar's strict stewardship.

Freudian slip? In decrying high debt levels in China, the Economist points out US and Europe are in worse shape

In a bit of possibly unconscious revelation, the Economist in its "Special Report" on finance in China, provided the graphic image below:

On the right you will note that debt levels have been rising rapidly in China and are now about the same as in the US and the euro area.  Everyone's debt level is too high, but the fact is that high debt levels are manageable in fast-growing economies like China's and a real problem in low growth areas like the US and Europe.  We all have a problem, then, but ours is worse.

I am reminded of this pretty smart passage from the Bible:

Matthew 7:3-5New International Version (NIV)

3 “Why do you look at the speck of sawdust in your brother’s eye and pay no attention to the plank in your own eye? 4 How can you say to your brother, ‘Let me take the speck out of your eye,’ when all the time there is a plank in your own eye? 5 You hypocrite, first take the plank out of your own eye, and then you will see clearly to remove the speck from your brother’s eye."