Conventional Ignorance

It looks like China is getting ready for a bidding war against BHP Billiton (the world's largest mining company) over Canadian based PotashCorp. This story is getting some play but the reporting misses the significance.

PotashCorp is the world's largest fertilizer maker. While they are in the top five producers of both agricultural nitrogen and phosphorous, it's all about the potash - potassium compounds used in agriculture. PotashCorp controls the largest reserves of potash in Canada, which has the largest potash reserves in the world. The company is responsible for almost a quarter of worldwide production.

Potash is of particular importance for agriculture. Nitrogen, phosphorous and potassium are the three primary macro-nutrients in plant biology, they lend their elemental symbols to the NPK numbers on fertilizer bags. But thanks to Fritz Haber, anyone with the motivation can convert atmospheric nitrogen into a form available to plants. And phosphorus compounds tend to be water insoluble and therefore not particularly mobile in the soil. Potash on the other hand is a mineral resource that needs to be mined where the deposits are. And it is very water soluble so the combination of tilling and irrigation so popular in agriculture these days make frequent application a necessity.

In 2008, the price of everything food skyrocketed and agricultural inputs were not excepted. Since then things have come down for the most part, but not potash.

So in a world where recent events have left many countries feeling insecure and scrambling to ensure future food supplies, China is in a battle with a massive Australian mining company to control the largest reserves of what may prove to be the most sought after agricultural input after water. Whether this resource goes to China or the world market will be a significant factor in food production over the next decade.

I, for one, am on the edge of my seat.

This is the type of article I love. Everybody is sounding off about how much cash corporations have on hand, completely ignoring the comparable amount of debt they've taken on. I'm glad that somebody had the brains to actually ask where the cash is coming from and where it's gone.

For me, the article added an interesting layer to understanding how the economy is spiraling down the toilet. I need to work out some of the details but as far as I can tell, the story goes something like this.

For the last 20 years, we've been busily shoveling cash from one sector to the next pretending things were peachy keen and growing to the stars. In the 90s, it was the stock market when an IPO was like printing gold. And then there was the housing bubble which was really a lot less about housing and a lot more about consumer debt.

I've been a little mystified about where the money is moving next. Treasury bonds have been getting some play, as have other government bonds (which is dumb, seeing as we are in the middle of a sovereign debt crisis) but it hasn't been enough. But this makes perfect sense. As consumers prove themselves unfit to borrow money, move up the food chain and lend to corporations. (Never mind that corporate accounting makes "liar's loans" look honest.)

I'm not completely convinced that corporate debt will be the next bubble but it's looking like a good candidate. And I'm not sure how to make money off of it but if it is the next hot new thing, expect some "innovative" investment vehicles to spring up.

One thing that does seem fairly certain is that whatever the next bubble is, it won't last very long. As we spiral, the boom/bust cycle is accelerating.

I've been harping on gold a little bit lately but I saw this infographic and knew I needed to do one more post. It's all about having the best available information.

The infographic dives into the convoluted relationship between Glenn Beck and Goldline. Even if you don't give a rat's ass about either one, it is still worth looking at because it highlights some of the land mines surrounding buying gold.

I've talked about why I hate gold even though I think the longterm price is headed for the stars. A lot of it comes from the Beck/Goldline type relationships and how it is so tough to actually get good information. But if you are smart about it and manage to wade through all the BS, I see no reason why you shouldn't put some money in gold.

More generally, this is what I want you to be aware of.

First, there are a lot of people out there who are going to scare the shit out of you to make a buck. This is a given and some times we're well aware of it (who doesn't love a good zombie flick?) but it happens far more often than we realize. It is much easier to get people to make decisions based in fear than logic. It is much easier to scare than inform.

Second, there are a lot of things that should scare the shit out of you. But what do you do with that info? The response to scary information is typically either to run around like a chicken with its head cut off ("Oh my god! Financial collapse! I better buy coins from Goldline!") or to pretend like the threat isn't real ("Financial collapse? Yeah right."). The challenge is to split the difference because you don't want to live in denial or panic.

You can't make good decisions (whether you are a professional commodities trader or trying to move out of your mom's basement) unless you see the world how it truly is and respond to it rationally. So when you hear scary news, be afraid and then figure out what it means.

Easy, right? No pressure.

Things are about to get a lot worse on the employment front and, by extension, the whole economy.

American consumptive spending has done okay in the face of our economy hitting a serious speed bump. EconomPic has an interesting graphic explaining why. The government has been propping the economy up through a number of routes, but unemployment benefits have played a big role in consumer spending.

Now Congress has let extended benefits expire and it doesn't look like they will be able to restart the payments. The latest extension would have cost $33 billion, how many times could they shell out that kind of cash? Especially when all they would be doing is treading water. The past year has been great but it is pretty clear that this counter-cyclic spending has not restarted the economy. Once the government spigot gets shut off, things will go straight back to bad (with that much more public debt).

So what does an unsubsidized economy look like? As it stands an unemployed worker loses benefits every 80 seconds - and that's just in New York City! Now census workers are getting the boot and unless they can magically summon up jobs, the unemployment rate will jump from 9.5% up to 9.8%. What happens to consumer spending then?

All of this makes the future very interesting. Across the board, things should tighten in the long term. But in the medium term, governments are running the show. So predictions come down to picking out the important decisions before they happen and being on the right side of them. Just when it looked like quants doing high frequency trading were holding the permanent advantage.

This should be fun. (What? You don't like stress?!)

I started this post a little while back and got distracted. Then I talked to my boss today and he said "saw your post on gold and it made me think I should buy some". So I wanted to clarify my position. It started with an interesting article I saw about why the recent rise in gold is likely real and not a bubble. While the author made some good points, I thought I would add my two cents.

One of the things that people really like about gold is that it can't be inflated. (Not strictly true historically, the Arab world saw massive wealth destruction when Columbus started stealing gold from Native Americans by the boatload. But inflation on that scale isn't likely to repeat itself.) If we are going to be honest with ourselves, the majority of the gold that will be dug up, has been dug up. So you could think about the continued extraction of gold keeping the price down, but the rate of extraction is going to decline (and the cost of extraction will go up). That means this downward pressure on prices is going to diminish over time.

So if the global economy continues to grow, gold will experience deflation. The amount of gold per unit of productivity will go down. But even if you don't see the global economy resuming its happy little growth pattern (and I don't), the price of gold will very likely still go up.

This is because the dollar is crap and it's only a matter of time before everyone realizes that. Thanks to Bretton Woods, the dollar is the de facto world reserve currency which has been great for the US. It has allowed the Treasury to issue lots of bonds without paying much interest and the Federal Reserve to print lots of dollars without creating too much inflation. This is because the rest of the world has sopped up all of this invented wealth. Problem is, dollars and treasuries are only wealth as long as everybody agrees that they are. Once governments start deciding they don't like dollars as a reserve any more and dump them, the dollar will tank. It will look like instant inflation as dollars printed over the last 70 years suddenly pop up on the market.

To a degree, this has begun. There have been rumbling from the BRICs about moving away from the dollar for a while now and it looks like governments have begun stocking up on gold gold. Which is a trend that is likely to continue because dollars need to be replaced with something and gold is a pretty safe bet. So expect the price of gold to skyrocket. (So far, this has been muted by people pumping money into bonds but I doubt that will last.)

So does this mean investors should throw lots of money at gold? It's not that simple. There are two problems investors need to pay attention to when investing in gold. First, you probably aren't investing in gold but paper that says "gold" on it. Second, even if you are buying physical gold, you might not be actually getting gold. (And even if you are getting real gold, it has problems.)

The first problem is that people own more gold on paper than actually exists in the world. The number I keep seeing is about five times as much. This is a real problem. That means that if you have gold on deposit with a financial institution, chances are four other people also "own" that gold. Same holds true for any gold backed financial instrument. Sound good? Yeah, I don't like that either.

But what if you actually take delivery of your gold and stuff it in your sock drawer? Then you still have to worry about counterfeit gold. The problem is that tungsten is really close to the density of gold and so somebody realized that you could make a lot of money by buying a tungsten bar, coating it with a little bit of gold and selling it like it's the real deal. Tough to say how many fake "gold" bars are floating around out there because nobody tests the bars as a matter of practice (and the only easy way to test one is to drill into it). But fakes have turned up at bonded warehouses, banks and national reserves. So it's safe to say that the problem is fairly pervasive.

So let's say you buy physical gold and manage to get the real thing, is it a good investment then? Maybe. The reason why people trade paper gold (really electronic gold) is because it is convenient. Physical gold is a fairly illiquid asset, especially at small volumes. This means that you will probably be paying a hefty premium to buy it and taking a sizable haircut when you sell it. This problem isn't talked about that much, mainly because a lot of the info on physical gold is coming from people who want to sell it to you. Still, physical gold does have some merits to be considered for those investing for the apocalypse (and you should probably be investing for the apocalypse).

And what about paper gold? I expect that there will be some significant swings in price over the next few years that could translate into nice profits for the lucky and the brilliant. If you plan on going that route, all I can say is don't lose your head and good luck. I doubt it's a good play unless you're a trader with ice water in your veins.

Calculated Risk has been crunching unemployment numbers and has two interesting posts - one on the duration of unemployment and the other on the impact of age and education on employment. The numbers are pretty striking.

First off, nearly 4.5% of the labor force has been unemployed for more than 6 months. Now this is troubling on its face but when you consider that long-term unemployment tends to lead to a drop off in employability, these workers are more likely to stay unemployed.

The second piece is, perhaps, even more significant but in a less obvious way. Long term unemployment rates increase with both age and education. This means a good chunk of the long-term unemployed are middle-aged and middle class. Studies have been done which help to explain this and it basically boils down to not wanting a job involving handing burgers through a window.

As their time out of work stretches on and cash reserves dwindle, the older and better educated can fall back on sales of their assets - stocks, bonds and real estate. The bond market can likely handle the unloading (do treasuries seem incredibly overbought to anyone else?) but with stock and real estate markets already being really soft, even a handful of motivated sellers can drive prices down even further. And what of those who are out of work and losing hope of that changing soon with a mortgage that is underwater? Nothing like a couple high end distressed homes on the market to trash the real estate value of a neighborhood.

It's difficult to predict the overall impact that this demographic group will have over the next few months. But I think it is something very much worth keeping an eye on because it should offer some clues of what's to come, since the situation will likely be similar as the boomers start retiring en mass and trying to liquidate their retirement savings to finance their golden years. Similar but much more so.

The press seems to be loving this story about foreigners in the US passing information to Russian intelligence officers. But they all seem to be missing the point.

First off, those arrested are almost certainly not "spies" or "agents". It does seem a little odd that they appear to have been here for an extended stay with faked identities (as opposed to traveling here on business with their real papers) but they pretty clearly don't have the sort of training you would expect of a professional intelligence officer. One of them even cozied up to the undercover FBI agent posing as a Russian operative without bothering to check him out with her higher-ups. Pretty amateurish, James Bond wannabe bullshit if you ask me.

These people most likely were assets. They would have had handlers who were Russian intelligence officers and their purpose would have been to casually collect general information of interest and pass it up the chain. No breaking into top secret government labs to photograph specific experimental data. But it seems their handlers did a bad job of managing expectations and keeping tabs on the wannabe spies and they started trying to escalate things on their own.

The real story isn't that Russia has people here covertly collecting information. I'd bet every country on earth with both an airplane and a vaguely legitimate basis for doing business in the US have people doing the same. What is of note is the information these 0.07s were charged with collecting. Not a lot is getting reported on this except it seems to be economic in nature and gold seems to be of particular interest.

It seems fairly intuitive that people reporting back to Russian intelligence on gold deals and the fact that Russia has been buying up gold like they're snorting the stuff (in spite of record prices) is somehow linked. My suspicion is that the covert action of real interest isn't a handful of Boris and Natasha types running around drinking martinis with guns under their pillows but Russia making a play to get off the dollar.

An article on the decline of domestic energy production in the UK caught my eye. It touches on several incredibly important issues but really doesn't scratch the surface of what they mean.

The declines that the UK is experiencing are an inevitable consequence of using fossil fuels. Because fossil fuels exist as non-replenishing reserves, there is necessarily a point in the future where the production rate will be zero and remain zero for all time after that. This also means that there will be a peak where maximal production occurs. These are mathematical imperatives which are absolutely guaranteed to be true provided that the non-replenishing assumption is valid. (This also holds true for self-replenishing reserves which are exploited faster than the rate of replenishment except that instead of falling to zero, the production rate falls to the rate of replenishment. Imagine pumping water out of a lake, you can pump more water out of the lake than is replenished up until the point that the lake is dry. Then you can only remove water at the rate that water flows in.)

The significance of this seems to be completely lost on the field of economics. While a country is exploiting energy reserves, it is adding to its GDP for free. Sure consumers need to pay to use the energy but the nation's economy doesn't have to pay to create it. So as long as its energy reserves are large enough and can be produced at a fast enough rate, a nation's economy can grow with very little resistance. All that needs to happen is to implement ways of utilizing the energy.

But once the rate of production begins to falter and imports are needed in order to meet growing demand, the energy actually needs to be paid for. If you imagine a nation's economy as if it were a factory, it's like all of the factory's electricity is provided for free. So the factory adds more and more machines and constructs new buildings, producing more and more until one day it starts getting charged for a small portion of the electricity. And over time, the factory has to pay for more and more of its electricity until it has to pay full price for all of it. You would imagine that while it could post great profits and have significant growth while electricity is free, that would become more and more difficult to do as has to actually pay for its electricity.

This is what UK is looking at currently. The article suggests that the decreasing production rate of domestic energy has played a small part of the current recession, if any. They are currently paying nearly $15 billion to import energy which is a little more than half a percent of their GDP. Contrast that with a decade ago when they were a significant exporter of oil and it becomes difficult to imagine that the decline in energy production isn't having a notable role in the decline of the UK economy. If energy production hadn't started to decline, the GDP growth rate could easily be a point higher.

Another thing to note is that rising energy prices helps exporters and hurts importers. And as more countries transition from production growth to decline, it's difficult to image the prices going anywhere but up which does not bode well for the British economy.

I was perusing my news when I came across an article which started off by arguing that deficit doves are well intentioned but misguided and deficit hawks are disingenuous morons. Great, right there with you. But then the author took the "if only people paid attention to the smart doves" position. And that's about when I started getting cranky and shouting profanities.

The deficit hawk position (as popularly presented) is really easy to counter, so I'll start there. These people have overwhelmingly proven themselves to be a bunch of self serving hypocrites and as such don't deserve the slightest recognition on the subject. Deficit hawks all but disappeared in 2001 when Bush got sworn in (former hawks suddenly argued that they needed to give tax cuts to the wealthy because it's "your money" and that "deficits don't matter"). Then magically, they reappeared in 2009 when Obama got sworn in. This tells a big chunk of the story. Also, deficit hawks tend to be defense hawks who are completely opposed to any military budget which doesn't include substantial growth (including incredibly expensive weapons the military doesn't actually want). Enough to give you pause.

The deficit hawk position boils down to deficits are fine when they are getting their way and really bad when they are not.

There are some deficit hawks out there who are sincere and at the end of the day I probably want to go further than most of them. But I have very little tolerance for partisan hacks using good ideas as a cudgel to beat back their opposition and maintain power rather than actually applying them and doing some good.

Well what about the deficit doves? The doves arguing for countercyclical deficit spending are absolutely right - if you live in the fantasy world where the majority of economic theory exists.

So what's the reality?

A lot of definitions of insolvency get thrown around but the one that I like is: a financial state where revenues are unable to cover obligations (operating expenses and servicing existing debt) without taking on new debt. Now there are some situations where taking on debt in response to an insolvency might be okay. If it is purely a temporary cash flow problem which will certainly be resolved in the short term then taking on additional debt is probably the preferred option over default or bankruptcy. But in the vast majority of situations, borrowing in response to insolvency only makes matters worse.

What the doves are arguing is that the government should take on massive amounts of debt in the hope that it will stimulate the economy enough to offset that debt in the medium term. This is a very tricky sell and would amount to making the US government insolvent in the short term - if it wasn't insolvent already!

A quick review of the US national debt data shows that the last time it decreased from one fiscal year to the next was 1957. (Yeah, Clinton spent a couple weeks paying down the debt at the end of his term but it still went up by $17 billion in 2000.) Think about that for a minute. For better than 50 years the national debt has gone up. The US government has had to take on more debt to pay off existing loans.

The United States government has existed in a state of insolvency for more than 50 years!

So to the deficit doves, I ask - what is this short term deficit spending going to accomplish? What is the path to financial responsibility? And I'm not interest in a response grounded in some vague unproven theory which completely ignores that "getting back" to fiscal responsibility requires going back more than a half century.

The history of national debt increases combined with trade deficits indicates that the American lifestyle is paid for with borrowed money and has been for quite some time. Sooner or later we need to take responsibility for those debts and figure out how to repay them. Up until this is acknowledged, any discussion of reigning in spending or countercyclical stimulus is a waste of time.

A strange story coming out of Hyderabad, India, Business Insider reports that many shop keepers have quit accepting five rupee notes. This seems to be due to an untrue rumor that the Reserve Bank of India has taken them out of circulation.

While largely an oddity, this story highlights a very interesting point - no money is real. Money is used to simplify transactions exchanging goods or labor, allowing the exchange to be indirect (I'm a chicken farmer, you're a doctor and money means the amount of medical care I can receive isn't limited to your desire for chickens - unless you live in Nevada). When it works, currency is great but we forget that it only works as long as everyone has faith in the system.

The value that money has is only relative to what you can buy with it. (In contrast, if I'm a pig farmer and I don't want to sell my pigs at market prices, I can always eat bacon.) This becomes clear when you invert prices - how many candy bars or bushels of corn is a dollar worth? But as soon as people lose faith in a given currency, it can rapidly cease to function.

Which brings us to Hyderabad, where a five rupee note seems to have ceased to be money. It doesn't matter if the government says it is valid currency, if you can walk into a shop and buy something with a ten rupee note but not two fives then how much is a five rupee note worth? The only way a monetary system works is if everyone believes that the currency has some value, otherwise accepting it is giving something for nothing. Once this belief is challenged, the effect is self-reinforcing and the whole system can grind to a halt.