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Five Things You Need to Know: Hair of the Dog; Follow the Money; Illusion Meets Reality; Emerging Hyperreality; Socionomics of Downsizing


What you need to know (and what it means)!


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Hair of the Dog

"The time has come for the Federal Reserve to cut the federal funds interest rate substantially, starting on a path from the current 5.25% to 4.25% and possibly even less," reads an Op-Ed piece in the Wall Street Journal.

  • Hey, look everybody!
  • A Wall Street Journal opinion piece is urging the Fed to cut rates!
  • OK, that's not exactly what we would call a "ground-breaking development."
  • It is only slightly more noteworthy that the person who wrote the Op-Ed piece is Martin Feldstein, National Bureau of Economic Research President.
  • Be that as it may, Feldstein's commentary is a cogent, if horribly misguided, outline of the Case for a Federal Reserve Rate Cut.
  • "The current credit market crisis was started by widespread defaults on subprime mortgages," he writes.
  • That is true, if by "started" he really means "culminated in," for to be sure the "current credit crisis" was most certainly not "started by" subprime mortgage defaults, those are merely symptoms of reckless credit expansion meeting the upper limits of credit appetites.
  • Later in the piece Feldstein writes, "Fed action to lower interest rates cannot solve the credit market problems," - true - "but it would help the economy," he adds.
  • How so? "[B]y stimulating the demand for housing, autos and other consumer durables; by encouraging a more competitive dollar to stimulate increased net exports; by raising share prices to increase both business investment and consumer spending; and by freeing up spendable cash for homeowners with adjustable-rate mortgages."
  • That's all well and good except for the reality that this credit crisis was itself started by stimulating [artificial] demand for housing, autos and other consumer durables; encouraging a more competitive [read:devaluation] of the dollar to [artificially] stimulate increased net exports; raising share prices [artificially] to increase both business and consumer [credit] spending and [mal]investment; and expanding credit creation [the only thing Feldstein can possibly mean when he writes "freeing up spendable cash for homeowners with adjustable-rate mortgages"].
  • Ordinarily we encourage Minyans to read source material, but in this case save yourself the time.
  • Feldstein's bottom line is this: The Fed should cut rates by 100 or more basis points to "help" the economy by... feeding it more of the same virus that caused the sickness in the first place.
  • And the worst part? That's not the worst part. Number Two is...

2. Follow the Money

Whenever money and information cross paths it becomes difficult to sort through the propaganda, for when money is at stake there are no disinterested parties.

  • The person in charge of delivering an interest rate cut, Federal Reserve Chairman Ben Bernanke, certainly has an interest.
  • As we discussed yesterday, Bernanke's Global Saving Glut speech is nothing short of an initial parry of blame.
  • It's not the Fed's fault, it's the Global Saving Glut's fault.
  • And as one would expect, nearly all of the people calling for a Federal Reserve rate cut are people who would personally benefit from one.
  • In other words, those calling for credit expansion are those who benefit the most from it.
  • But what about you? Will you benefit?
  • Credit expansion makes vast sums available overnight, out of thin air.
  • But there is a hidden cost.
  • For the majority of us, credit expansion, the exact credit expansion those who are demanding a Fed rate cut are clamoring for, offers the illusion of wealth and prosperity.
  • It's a powerful illusion, to be sure.
  • It promises that everyone can be wealthy. Everyone can be rich. Everyone can be prosperous.
  • To see through this illusion, it is necessary to understand the difference between various credit transactions.
  • Borrowing is not evil. For example, if one borrows money from someone who has saved that money, that is what is called a "transfer-of-savings."
  • In a transfer-of-savings transaction the bank is merely a broker that helps match up borrowers and savers.
  • The illusion and fantasy of limitless prosperity is created by something different.
  • In our version of credit expansion, there are no savers - hence Bernanke's twisted logic in tirelessly defending the absence of public and private savings in his "Global Saving Glut" speech.
  • As Mr. Practical wrote on Minyanville yesterday, "In today's world if a bank takes in $1,000 in deposits they will lend out $10,000!"
  • That extra $9,000 is nothing. It is an illusion. This illusion leads us to the harsh reality found in today's Number Three...

3. Illusion Meets Reality

More than 100,000 jobs may well be lost from the US mortgage industry in the next few months, according to the Financial Times.

  • Industry experts predict that lenders and brokers will cut at least 20% of their headcount as volumes look set to fall more than 25% next year, the FT says.
  • Guy Cecala, of Inside Mortgage Finance, told the FT, "The boom brought tons and tons of people into the business, which has been carrying excess weight for several years."
  • Yes, "excess weight."
  • What gives birth to this excess weight?
  • The illusion of prosperity... exactly what Feldstein and others demand when begging the Fed to cut rates to "stimulat[e] the demand for housing, autos and other consumer durables" and "rais[e] share prices to increase both business investment and consumer spending."
  • But this is not an illusion:
    "There were nearly 80,000 announced job cuts in August, up 85% on July, according to Challenger, Gray & Christmas, the outplacement consultants. Financial companies announced nearly 36,000 job losses in August, the highest since 1993. Most were in mortgage lending. The financial sector has announced 103,000 cuts in 2007 and is on court to outdo the high of 117,000 in the recession 2001."

4. Emerging Hyperreality

In 1981 French philosopher Jean Baudrillard wrote a book attempting to theorize the post-modern, titled "Simulacra and Simulation." Why should you care? Because many of the themes Baudrillard discussed are related to the breakdown in "financial simulation" we are seeing in credit and currency markets.

  • First, what is "Modernity"?
  • "Modernity" is most often viewed as the child of the Renaissance and as heralding the development of social and scientific thought; the "modernization" and integration of large-scale societies that had been previously separated by technological, social and even religious boundaries.
  • In terms of finance, we can characterize "modernity" as a seemingly linear progression of the following:
    - increased modes of production
    - increased movement of goods and capital backed by some thing, a store of value
    - the development of a structural framework in which the movement of goods and capital can interrelate and "grow"
    - corresponding division of labor
  • The reason for bringing up Baudrillard's "Simulacra and Simulation" is to discuss what he called the "successive phases of the image" and the relation to our fiat-based monetary system.
  • In a fiat-based monetary regime, what is the "price" of a security but an image?
  • It is a "signifier" of some "thing."
  • But what?
  • Is it objective?
  • Is price "real"?
  • Baudrillard's successive phases of the image translate well with the progression of price discovery in markets as money transitions from reality (backed by something physical, a store of value) to image (backed by absolutely nothing).
  • Baudrillard's Successive Phases of the Image
    (with price relation in parentheses)
    1) it is the reflection of a profound reality (price "means" something profound with respect to the security)
    -2) it masks and denatures a profound reality (price disguises a profound reality - the value investor's dream)
    3) it masks the absence of a profound reality (say, 1999)
    4) it has no relation to any reality whatsoever; it is its own pure simulacrum, a copy without a model (the decoupling of fiat money and the continuous supply of liquidity and credit to market participants with no underlying attachment other than the promise of a central bank).
  • From the standpoint of Baudrillard's final phase of the image (price), we now seem to be witnessing in credit markets objects that have no relation whatsoever to anything - many credit instruments are simply not capable of being valued.
  • They are now solely existant as a pure simulacrum from which higher and lower are relations to something without meaning; in other words a hyperreal market.
  • Baudrillard argued in Symbolic Exchange and Death that our society overall has undergone these successive phases of image, from an era of The Original, to The Counterfeit, to the Mechanical Copy, something "Produced" to the "third order of simulacra, where the copy replaces the original.

5. Socionomics of Downsizing

According to the Wall Street Journal, home builders are putting up fewer supersize homes and offering smaller floor plans to lure buyers by keeping prices low.

  • The psychology of credit expansion feeds into everything.
  • Over the past three decades the average size of newly constructed single-family homes expanded by nearly 45%, according to the Journal, even as the size of the average family declined.
  • According to the Census Bureau, the median size of a newly completed single-family home reached 2,248 square feet, up from 1,560 square feet in 1974.
  • In the second quarter of this year, however, that expansion abruptly declined, from 2,302 square feet in the first quarter, to 2,241 square feet.
  • Jeffrey Mezger, chief executive of Los Angeles-based KB Home (KBH), told the Journal that the change has been "driven by data on what our home buyers want and what they can afford in a new home."
  • Toll Brothers (TOL) chief marketing officer, Kira McCarron, conceded that there "probably is more demand for 3,000- versus 6,000-square-foot," homes, the newspaper said.
  • Sarah Susanka, author of "The Not-So-Big House," said "I used to be asked all the time why would anybody want to downsize? People thought I was crazy. Now it's becoming much more mainstream."
  • As deflationary forces grow, the psychology spreads, infecting markets, consumer decisions and attitudes toward tangible goods and consumer goods.
  • We'll likely see this theme recurring again and again in the coming years.
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