ERICOPOLY

"The bottom line, however, is that it is totally incorrect to assume that the massive expansion in reserves created by the Fed is inflationary. Economic activity cannot move forward unless credit expansion follows reserves expansion. That is not happening." I pulled that quote from Hoisington (from page 2): http://www.hoisingtonmgt.com/pdf/HIM2009Q1NP.pdf Record Expansion of the Fed©s Balance Sheet and M2 In the past year, the Fed’s balance sheet, as measured by the monetary base, has nearly doubled from $826 billion last March to $1.64 trillion, and potentially larger increases are indicated for the future. The increases already posted are far above the range of historical experience. Many observers believe that this is the equivalent to printing money, and that it is only a matter of time until significant inflation erupts. They recall Milton Friedman’s famous quote that “inflation is always and everywhere a monetary phenomenon.” These gigantic increases in the monetary base (or the Fed’s balance sheet) and M2, however, have not led to the creation of fresh credit or economic growth. The reason is that M2 is not determined by the monetary base alone, and GDP is not solely determined by M2. M2 is also determined by factors the Fed does not control. These include the public’s preference for checking accounts versus their preference for holding currency or time and saving deposits and the bank’s needs for excess reserves. These factors, beyond the Fed’s control, determine what is known as the money multiplier. M2 is equal to the base times the money multiplier. Over the past year total reserves, now 50% of the monetary base, increased by about $736 billion, but excess reserves went up by nearly as much, or about $722 billion, causing the money multiplier to fall (Chart 3). Thus, only $14 billion, or a paltry 1.9% of the massive increase of total reserves, was available to make loans and investments. Not surprisingly, from December to March, bank loans fell 5.4% annualized. Moreover, in the three months ended March, bank credit plus commercial paper posted a record decline. If this all sounds complicated you are right, it is. The bottom line, however, is that it is totally incorrect to assume that the massive expansion in reserves created by the Fed is inflationary. Economic activity cannot move forward unless credit expansion follows reserves expansion. That is not happening. This quote from page 3 is also a good one: The highly ingenious monetary policy devices developed by the Bernanke Fed may prevent the calamitous events associated with the debt deflation of the Great Depression, but they do not restore the economy to health quickly or easily. The problem for the Fed is that it does not control velocity or the money created outside the banking system.

The key phrase you use is "if you really believe". And none of what you then go on to say I "really believe" -- as you know, I don't "really believe" that bad debt has been monetized... I think the Fed has in effect granted a loan. You go on to call it a printing press, which it is not. Hoisington has pointed out that the quantitative easing is not inflationary -- do you think he is wrong? I presume you do, but I'm not quite so quick to dismiss him. Here is what I believe QE2 is about -- an attempt to stop the increased government borrowing from starving the private sector of dollars. That starvation of dollars would counteract the money that the government is trying to spend as stimulus -- but that stimulus isn't creating much inflation because the current macro environment is heavily deflationary. It's like two very powerful winds blowing head to head but getting nowhere. I believe they intend to lend this money from the Fed (and buying a bond is in fact lending) until the de-leveraging (the massive deflationary headwind) has substantially progressed. They have said they intend to unwind it, and if you think about it all they really need to do is sit on their hands -- let the bonds mature, thus the dollars are brought back to the Fed. This does not come wholly for free (if you support the current price level it's inflationary relative to an alternate path of letting prices fall), but it's far less than 1:1 money printing as many of these dollar bears suggest. That doesn't mean that I believe QE2 will necessarily fix anything -- there is no guarantee that the private sector would invest their dollars in the US economy any differently whether or not they are starved of those particular dollars. The problem is not with QE2 -- the problem is with the government borrowing. QE2 can be reversed far easier than the government borrowing. Do I worry about QE2? No, I worry about the deficits. Do I think QE2 will bring prosperity? No, I think it will merely keep some dollars from being siphoned by the government out of the private sector... for a period of time until they mature (or perhaps sold a year or two before maturity). I've stated before that if you really want a printing press analogy, then this QE2 printing press has disappearing ink.

One topic the article neglected to mention was the spiraling wage inflation of the 1970s. This I believe is what led to consumer price inflation -- the consumers had more nominal income and thus nominal consumer prices rose. Is the author expecting wages to take off soon? Or is he expecting consumer prices to rise even though nobody can afford price increases without increased wages? I can see the argument for gold rising over time vs the dollar. You have more goods and services in the world today than back in 1980 at the last real gold peak. Were you to exchange the increased goods and services for gold, it would put upward pressure on the real price of gold given that supply of gold is static. When mass psychology gets involved, you can have a sudden move in gold if this becomes a popular way of thinking. The same would happen for the dollar if it's quantity remained static, except that the supply of dollars has increased. This suggests that it is entirely possible to have static consumer prices (in dollars) despite both a higher supply of dollars as well as a higher gold price (expressed either in dollars or in a currency "basket" of goods and services). Consumer inflation (in dollar terms) I think would have been much higher over the past 30 years if there weren't so many advances in productive output. I think partially this is by design -- I suspect they used the advances in productivity to justify much of the dollar supply increases. Regardless, the same amount of gold should logically buy more goods and services if there have been real advances in productivity -- that ought to be a no brainer, if it costs less to produce because of some new gizmo scientific advance, shouldn't you be able to afford more of it? How can you call it a rise in the standard of living if you aren't able to afford more goods and services? I guess what I'm saying is you can have a devalued dollar even if you have stable prices. Technological advancements like machines should in theory make manufactured and farmed goods cheaper -- if you get no downward consumer price movement then you effectively have devaluation because you entirely lost the would-be cost of production savings. Your dollar made no advance in buying power despite improved technology -- therefore devaluation. Gold can therefore advance versus the dollar... but this doesn't necessarily indicate that prices will go up at the grocery store. If gold (at it's current exchange rate with the dollar) doesn't buy you an appropriately larger amount of goods and services (as suggested by increases in productivity) then it could be reasoned to be logically undervalued as a currency. Why should we believe that it should only buy you a finely tailored suit if somebody invents a machine that can duplicate the quality of that suit at 1/4 of the cost? Shouldn't it then buy you four suits? And if the dollar (due to increased supply) can still only buy you one of those suits, then shouldn't gold be a four bagger vs the dollar? In a roundabout way I suppose I'm reasoning that the dollar is already devalued more than people think, and gold could possibly be rising due to undervaluation. It can take a crisis and fear mongering to get people to look at gold again, and that becomes the catalyst to get the needed price correction -- however this may happen independently of any dollar crisis... because the purchasing power of dollar may already have been stealthily devalued during a period of historically high productivity gains that have masked the loss in would-be consumer purchasing power. Based on the supply demand argument based on the rising productivity, I would expect gold over time to buy you more and more... until we hit some productivity limit (if there is one). The question for me though is can I do better investing in other things? Prem said recently "we don't invest in gold" -- I think he feels he can just do better. He also stated that he is worried about a commodity bubble forming right now -- although he didn't say which commodities.

Quantitative easing thus far looks like lending, not printing. Look at QE2... the Fed got Treasury bonds which will repay them for their "loan" when matured. It will be printing when they "forgive" the loan.

Perhaps as a model it's more lucrative for a person of such talents to be a hedge fund manager? It looks like Sardar couldn't hack it... managing other shareholders' investments for free that is. It sure didn't take him long to get his hands into their collective cookie jar.

I suppose they need to lock you in because they won't make any money from the initial batteries. Their plan is to start making money when battery prices get cheaper. No lock in... you'd be taking a free ride for a time while it is cost effective, then when prices get cheaper you'd just buy your own battery.

He said something different (I think) -- I believe he said that the average American drives an 8 year old car. He did not comment on the average life of cars.

I know, but just remember they bought those investments despite doing original research. Original research can avoid a certain class of mistakes (greatly improving your chances), but it's the thinking outside of the numbers that avoids the problems with the stocks mentioned above. I remember Watsa staying clear of oil back when Buffett was buying COP -- it was the kind of mistake that could only be avoided from up at 10,000 feet looking down, not from being down on the ground counting the oil in the balance sheet. The problem with COP was a macro thing ultimately -- could a coat-tailer have avoided the problem by reading and analyzing all of COP's financials?

Yes the key word was selective. At (my prior employer) we interviewed software engineering candidates serially in a loop of about 5 people -- each interviewer had about 45 minutes alone with the candidate, then a brief summary was typed up for the next interviewer in the loop. If the candidate progressed as far as the fifth person, then you could be certain that all the low level competency questions has been asked already. So the fifth person didn't have to ask questions about whether or not the person could implement a searching algorithm -- he could instead focus on probing the candidate for personality, ambition, passion, fit, whatever. I'm saying that I can do the same thing for investments. I can treat potential investments as interview candidates and I can be that fifth person. I won't have to ask the truly low level nuts and bolts questions if I have a great team pre-screening the candidates. So instead of whipping through the financials exhaustively, I can instead think about the macro or whether I like the business, how it makes money (high level explanation) -- often this means pulling the power point presentations off of the company websites rather than wading through their financial reports. That fifth interviewer may not have ever been a competent engineer himself -- more like a career manager in many cases. So he simply would not benefit from doing the entire loop himself -- in fact it would most likely lead to poor results. In my case, I'm not a competent enough screener of the financials to consider another approach (entirely on my own for example). Less mistakes ultimately get made if I stick to that fifth man position. But I only buy if I convince myself that I really understand why the investment kicks ass -- or at least if I'm really convinced. Ultimately, I buy a lot of stuff that I sell soon afterward because once I own a big position I ultimately get nervous and lots of questions hit my mind -- if I can't answer them I sell out until I feel more comfortable (happened a few times this year actually). We still made some bad hires of course (at my previous employer).

Eric, who else beside Berkowitz are you following? Starting my master in January, won't have much time for research anymore so I will have to co-tail the greats. BeerBaron Really just the Fairfax guys, Berkshire, and Berkowitz. As an extreme example (Buffett&Munger), I feel completely free to trade in and out of Wells Fargo without doing any research whatsoever because it has the Buffett&Munger seal of approval. I hope I never convince myself for a moment that I will think clearer than them -- so do I really need to sit down and read every detail in Wells Fargo's annual report looking to uncover the hidden fraud? Mentally I sort of pretend that they are the analysts that work for me -- only they are the best in the world and I conveniently don't have to pay them. They don't even mind that I cheat over their shoulder -- heck, Buffett gets on CNBC and hands out stock tips on WFC and AXP. Put differently, would I not take their advice if I was just a director and they were on my payroll? Perhaps some directors cannot delegate -- to these guys, I don't hesitate to delegate. If Buffett were managing my personal portfolio and allocating my money to stocks that I hadn't researched personally, should I be worried? Every shareholder of Berkshire I suppose has to put up with this "uncertainty" :) I do actually have enough time to do original research, and that sounds exciting in a rugged individualist sort of way, but I instead try to limit it to reading about (to my level of satisfaction) investments that have already been pre-selected by selective investors. I think that they will still make mistakes from time to time, but they'll make less mistakes than I would. This year I violated this winning formula when I bought KSP -- although I will give myself some credit for identifying it from day one as a fairly speculative gamble. I think a lot of people on this board can do much better through independent research -- because you have small funds and can find the larger mispricings in the smaller stocks. My results would likely go down though, due to competency limits. And with that, a couple of words from wiser men : "A man's got to know his limitations" (Harry Callahan). "Only three things to gamblin'," Puggy once said, "knowing the 60/40 end of a proposition, money management and knowing yourself."

It's interesting how much respect Ackman attracts for his rigorous research, while at the same time his largest holding is Citigroup -- a pick that gets little respect from others that do independent research because "it's too much of a black box and can't be understood". A Martian would not be unreasonable to say that Ackman thinks Citigroup is the best financials investment out there (in his weight class) -- why else would he make it his only financial holding? (not that it matters but Citigroup is my #2 holding -- and what I do isn't exactly research... more like selective coat-tailing).

In late 2009 he claimed to have 5 gigs of data from a BofA executive -- said he has the hard drive.

That's pretty much what Jeremy Grantham said -- he just feels like Graham's ideas are a "Duh" (his word). You could summarize The Intelligent Investor as -- "Buy low and sell high". Obviously, that's a "Duh". Graham emphasizes that you must appraise the value of the business in order to have an informed opinion of "high" and "low" -- once gain, "Duh". I know an interesting story from a value investor who once had a ten bagger buying a stock that Ben Graham himself trashed, in his own nice way, in the 1973 edition of The Intelligent Investor. If anyone can guess the name of the stock, I'll tell the story. :) That was the year I was born. Around that time, Graham was telling Davis to buy GEICO -- Graham giving a stock tip! That was a terrible time to recommend GEICO!!!! Right before it collapsed.

I think my taxable accounts are enough to carry me the next 20 years (Plan A). SEPP is my "Plan B", to be tapped as a last resort. It's a good idea if you run out of taxable funds.

That's pretty much what Jeremy Grantham said -- he just feels like Graham's ideas are a "Duh" (his word). You could summarize The Intelligent Investor as -- "Buy low and sell high". Obviously, that's a "Duh". Graham emphasizes that you must appraise the value of the business in order to have an informed opinion of "high" and "low" -- once gain, "Duh".

Isn't it a taxable event to switch from common to TR swaps?

It would wipe 3 months of Citicorp's earnings, and would slow the ongoing de-leveraging perhaps enormously as it would be more painful to move more assets to HFS. People have been focusing on QE2 in terms of how much wealth effect it generates and how much GDP it will translate to. But I don't think that's what QE2 is for -- if you look at what the banks need to sell in order to deleverage (top dollar for low quality bonds) then QE2 begins to make sense -- get the banks deleveraged as fast as possible and we've got a fighting chance (I think that's Ben's mentality). Unless of course one believes it doesn't matter when banks have their capital tied up in illiquid assets. Otherwise, I'm at a loss to understand what the real strategy is.

I was looking at the Citigroup "Special Asset Pool" -- this is where they put their junkiest non-core assets that they are selling and running off. The size of the pool is down to $94.8b in Q3 2010, vs $162.5b in Q3 2009. 38% of the pool is marked-to-market (including the "available for sale"). What's interesting is that tje available for sale assets are marked at 90% of face value, but their held-to-maturity assets are marked at 69% of face value. You are saying that available for sale is marked-to-market -- it just surprises me that market is 90% of face value I guess, whereas the hold-to-maturity is marked much lower. Sort of counterintuitive to me. page 9: http://www.citigroup.com/citi/fin/data/p101022a.pdf?ieNocache=309

We have laws that cleanse the borrower's record after seven years if they default on their loan. Perhaps an exception can be made for strategic defaulters. I would rather start with this before handing out money.

I can't understand why it would make sense for a bank to be required (as some people advocate) to mark their loans to market -- wouldn't that implicitly provide a loss reserve (embedded in the market price). So theoretically wouldn't the bank then be justified to operate without a loss reserve? Just a passing thought. Sometimes these thoughts don't amount to much -- but every now and then I see somebody advocate a mark-to-market model for banks and it makes me think of this double counting of anticipated loss in the loan portfolio.

Microsoft has already "allocated" $100b to non-technology related businesses -- it was the return of capital to shareholders. Berkshire would have decided on your behalf where those funds are best deployed -- Microsoft doesn't make that decision for you, you are on your own. But then Microsoft isn't an investment holding company so it's not their role to be your investment fund manager. Microsoft isn't Berkshire -- just like BNSF isn't Berkshire. BNSF's managers don't allocate capital outside of railroads, and Microsoft's managers don't allocate capital outside of technology. In both cases, they return the excess earnings to the owners and the owners can decide where to invest those earnings. In BNSF's case that owner is Berkshire. I think this is why Gates hasn't directed Microsoft to reinvest earnings outside of technology. Microsoft isn't a holding company, Berkshire is. The whole point of Berkshire is to have Buffett allocate the capital rather than pay it out to shareholders. If you are a Microsoft shareholder, you have your choice of managers to allocate your earnings -- you can reinvest directly in Sanjeev's fund, or in Fairholme, whatever you choose.

Buyback or dividend -- either way there is a smaller amount of net assets. That just leaves the "larger stake" part -- so sell enough of it to bring your ownership level back to where it was before the buyback. Your treasurer doesn't get it.

Bronco, a wise man would just stay out of the shower. (overvalued stock == shower) A court might suggest that you consented.

I've sold this -- I want to think more about it.

I'm sort of swinging back to the buybacks are no worse than dividends mentality. If buybacks at a high price increase your ownership by 10%, then just sell an offsetting amount of shares to manufacture a dividend for yourself -- given that dividend and capital gains taxes have been identical, you at least save on taxes through the buyback route as you don't pay tax on your cost basis. So you wind up with more money post-tax via the buyback. And who is complaining anyhow about an overvalued stock -- only people who don't own it. Owners would have sold and become non-owners if they thought the valuations were stupid -- and if they did... they were happy to have a ready buyer.