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Anne Elk’s Theory On Brontosauruses
“... we haven’t had any accidents for months now...
Everything on that island is perfectly fne.”
– Michael Crichton, Jurassic Park
“Did not learned men, too, hold, till within the last
twenty-fve years, that a fying dragon was an impossible
monster? And do we not now know that there are
hundreds of them found fossil up and down the world?
People call them Pterodactyles: but that is only because
they are ashamed to call them fying dragons, after
denying so long that fying dragons could exist.”
– Charles Kingsley, The Water Babies
“They don’t have intelligence. They have what I like to call
‘thintelligence.’ They see the immediate situation. They think
narrowly and they call it ‘being focused.’ They don’t see the
surround. They don’t see the consequences. That’s how you get an
island like this. From thintelligent thinking.”
– Michael Crichton, Jurassic Park
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A walk around the fringes of fnance
By Grant Williams
28 July 2014
28 july 2014
THINGS THAT MAKE YOU GO HMMM... ....................................................3
How Russian Hackers Stole the Nasdaq ............................................................21
Bubblenomics and the Future of Real Estate ......................................................23
Have Central Banks Been Breaking the Law? ......................................................24
A Tour of France: Examining the New Sick Man of Europe ......................................26
Deutsche Bank, HSBC Accused of Silver Fix Manipulation .......................................28
Billion-Dollar Billy Beane .............................................................................29
Rebels With a Cause ...................................................................................31
How the Hammer Falls As China Nails Corruption ................................................32
“All the Conditions Are There for an Explosion” .................................................34
CHARTS THAT MAKE YOU GO HMMM... ..................................................37
WORDS THAT MAKE YOU GO HMMM... ...................................................40
AND FINALLY... .............................................................................41
28 july 2014
Things That Make You Go Hmmm...
Though they reunited this past month for a series of concerts at London’s O2 Arena, the cast of
Monty Python last assembled onstage together at London’s Drury Lane Theatre a staggering 40
years ago.
As they took to the stage at the O2 in early July,
the surviving members of perhaps the most famous
comedy troupe in history (sadly, Graham Chapman
died in 1989) boasted a combined age of 357.
As expected, neither of these facts deterred people
from focking to see the Pythons; nor, it has to be said,
did the occasional “senior moment” on stage prevent
rapturous critics from garlanding them with rave
The centrepiece of the show was, of course, the famous “Parrot Sketch” in which John Cleese
returns a dead Norwegian Blue parrot to “the very boutique” from whence it came “not ’alf an
hour ago.”
The sketch, written by Cleese and Chapman in 1969, took aim at the British fondness for
euphemism (particularly as pertains to death) and (somewhat ironically, given the subject)
became one of the most mimicked pieces of comedy ever conceived.
The YouTube video I linked to above (just in case there is still anybody out there who HASN’T
seen the “Parrot Sketch”) has 4.5 million views alone.
However, buried in the Python’s canon of work lies another sketch which proved far less popular
amongst the viewing public but which found favour amongst (of all groups) the scientifc
The sketch, “Anne Elk’s Theory on Brontosauruses,”
appeared in the 31st episode of Monty Python’s Flying
Circus, which was entitled “The All-England Summarize
Proust Competition”; and it featured Chapman as a
television interviewer and Cleese (in drag) as Miss
Anne Elk, a paleontologist, who was in the studio to
discuss her new, ground-breaking theory on the afore-
mentioned dinosaurs.
What followed when Elk was questioned about her
theory is classic Python:
Presenter: You have a new theory about the brontosaurus.

28 july 2014
Anne Elk: Can I just say here, Chris, for one moment, that I have a new theory about
the brontosaurus?
Presenter: Uh... Exactly...
Very long pause
(prompting) What is it?
Anne Elk: Where?
Presenter: Your new theory
Anne Elk: Oh! What is my theory?
Presenter: Yes!
Anne Elk: What is my theory that it is? Well, Chris, you may well ask me what is my
Presenter: I am asking.
Anne Elk: Good for you. My word yes. Well Chris, what is it, that it is, this theory of
mine. Well, this is what it is. My theory, that I have, that is to say, which is mine... is
Presenter: Yes, I know it’s yours! What is it?
Anne Elk: ... Where? ... Oh! This is it.
Starts prolonged throat clearing
Anne Elk: (clears throat) This theory, which belongs to me, is as follows... (more throat
clearing) This is how it goes... (clears throat) The next thing that I am going to say is my
theory. (clears throat) Ready?
Inevitably, after such a prolonged build-up, the payoff is predictable in that Elk is clearly
stalling in order to avoid explaining her theory for as long as possible; but, eventually, she is
forced into laying it out for the whole world to see:
Anne Elk: My Theory, by A. Elk (Miss). This theory goes as follows and begins now:
All brontosauruses are thin at one end; much, much thicker in the middle; and then thin
again at the far end. That is my theory that is mine and belongs to me and I own it and
what it is, too.
... and in that instant, she is exposed for what she is: a fraud.
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Things That Make You Go Hmmm...
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28 july 2014
The scientifc community adopted Anne Elk’s theory on brontosauruses to describe any scientifc
observation which is not actually a theory but rather a minimal account; and that sobriquet — it
seems to me — merits far broader application and acceptance.
Lately I seem to be constantly reminded of Anne Elk everywhere I turn, as the world descends
into chaos and those charged with running it (at least offcially) stumble from pillar to post,
relying on the public’s buying into whatever they spin in order to press their agenda.
We see it in the rush to demonize Vladimir Putin for the MH17 tragedy, along with everything
else that remotely touches Russia; we see it in the one-sided reporting of events in the
Middle East; and we see it in the broad-brush strokes painted across the China canvas when
assumptions are made about what is happening inside the political hierarchy that runs the
Middle Kingdom.
However, the one place it is glaringly obvious (and has been for a number of years) is in the talk
emitting from the mouths of the world’s central bank governors.
Now, I am no great fan of Putin; nor do I feel able to confdently choose sides between various
factions in the Middle East — mainly because I fnd it impossible to take what I read in the
mainstream media at face value and therefore come to what I would consider a well-informed
opinion — but the beauty of central bankers is that they hold press conferences and release
detailed minutes of their meetings which, if anything, throw perhaps too much light onto their
deliberations, operations, and machinations for anybody’s good — least of all their own.
July 26th, 2012: Anne Elk’s Mario Draghi’s Theory on Preserving the Euro:
This theory, which belongs to me, is as
follows... (more throat clearing) This is how it
goes... (clears throat) The next thing that I am
going to say is my theory. (clears throat) Ready?
We think the euro is irreversible. And it’s not
an empty word now, because I preceded saying
exactly what actions have been made, are being
made, to make it irreversible.
But there is another message I want to tell you.
Within our mandate, the ECB is ready to do
whatever it takes to preserve the euro. And
believe me, it will be enough.
Now, unlike Anne Elk’s (brackets, “Miss,” close brackets), Draghi’s theory — though in effect
every bit as toothless should his bluff ever have been called — was taken at face value by a
gullible public; and disaster was averted (though, along with the gullibility, there was also an
implicit explicit bribe put carefully in place — buy bonds of bankrupt countries, and we’ll make
sure you don’t lose money).
28 july 2014
Many of you will probably not remember what the edge of the abyss looked like, so here are a
couple of reminders — just for old times’ sake:
2011 2012 2013 2014
% %
Greece, Spain & Italy 10-Year Government Bond Yields
July 2011 - July 2014
Draghi Elk Theory Speech
Source: Bloomberg
The chart above shows the yields on 10-year government bonds for Greece’s $242 billion
economy; Spain’s $1.35 trillion economy; and the behemoth, Italy’s $2.17 trillion economy
through 2011, going into the unveiling of Draghi’s Elk Theory plan and beyond.
Due to scaling issues, the plot for Greece is on a separate scale on the right-hand side of the
chart; but, if you look carefully, you’ll see that yields on its 10-year bonds peaked at 37% in
early 2012 and, despite some serious jawboning on the part of EU politicians, were still at 28%
in July when Draghi cleared his throat.
Remember those days? Europe was teetering on the edge of oblivion, and each day saw the
chances of a disorderly unwind of the euro increase to the point where even some of the more
staunch pro-Europe voices began to waver in their certainty about its future.
Writing somewhat presciently a few short weeks before Draghi unveiled his Elk Theory, plan,
The Economist laid out the bind perfectly:
(Economist): Even the single currency’s die-hard backers now acknowledge that it was
put together badly and run worse.
28 july 2014
Greece should never have been let in. France and Germany rode a coach and horses
through the rules designed to prevent government borrowing getting out of hand. The
high priests of euro-orthodoxy failed to grasp that, though Ireland and Spain kept to the
euro’s fscal rules, they were vulnerable to a property bust or that Portugal and Italy
were trapped by slow growth and declining competitiveness.
A break-up, many argue, would allow individual countries to restore control
over monetary policy. A cheaper currency would help match wages with workers’
productivity, for a while at least. Advocates of a break-up imagine an amicable split.
Each government would decree that all domestic contracts—deposits and loans, prices
and pay—should switch into a new currency. To prevent runs, banks, especially in weak
economies, would shut over a weekend or limit withdrawals. To stop capital fight,
governments would impose controls.
All good, except that the people who believe that countries would be better off without
the euro gloss over the huge cost of getting there. Even if this break-up were somehow
executed fawlessly, banks and frms across the continent would topple because their
domestic and foreign assets and liabilities would no longer match. A cascade of defaults
and lawsuits would follow. Governments that run defcits would be forced to cut
spending brutally or print cash.
Has anything changed in Greece since July 26th, 2012? Well, let’s see:
2004 2005 2006 2007 2008 2010 2012 2013 2014 2009 2011
Greece Under-25 Unemployment (%)
Greece Unemployment (%)
Greece Headline & Under-25 Unemployment Rate
2004 - 2014
Source: Bloomberg
28 july 2014
2013 2012 2011 2010 2009 2008 2007 2006
Eurostat Greece Real GDP % Change YoY
2006 - 2013
Source: Eurostat
Well, technically, I guess you could say it rose, since it only fell 4% last year instead of 7% — it
depends on how you defne improvement, I guess. Either way, though the rate has slowed, the
Greek economy spent its sixth straight year in contraction in 2013.
So no real improvement in Greece then.
What about Spain?
Spain Under-25 Unemployment (%)
Spain Unemployment (%)
Spain Headline & Under-25 Unemployment Rate
2004 - 2014
Source: Bloomberg
1999 2001 2003 2005 2007 2010 2012 2013 2014 2009 2011 2000 2002 2004 2006 2008
It’s a different chart from the Greek one, I promise you. It just LOOKS the same. In fact, the
Spanish headline unemployment rate has actually plummeted to 25.4%, so... hooray for Europe!
28 july 2014
Eurostat Spain Real GDP % Change YoY
2006 - 2013
Source: Eurostat
2013 2012 2011 2010 2009 2008 2007 2006
Well, let’s be charitable here, shall we? Ermmmm... (prolonged pause)... (clears throat)... Hey,
Spain ain’t Greece!
Of course, the offcial GDP growth forecast for Greece for 2014 is... drumroll... +0.6%. And
Spain? Well that would be growth, too — to the tune of +1.1% — but this is the work of the
European Commission, a body whose website makes available the following upbeat reports for
your downloading pleasure:
Spring 2014 European economic forecast: Growth becoming broader-based
Winter 2014 forecast European economic forcast: EU economy: recovery gaining ground
Autumn 2013 European economic forecast: EU economy: Gradual recovery, external risks
Spring 2013 European economic forecast: The EU economy: adjustment continues
Winter 2013, European economic forecast: The EU economy: gradually overcoming
What does the more-broadly-growing/gradually-recovering/ground-gaining/headwind-
overcoming EU economy look like in graphical form?
Funny you should ask. I just happen to have the chart right here, courtesy of Eurostat:
28 july 2014
EU (15 countries)
EU (27 countries)
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Eurostat EU GDP % Change YoY
2002 - 2013
Source: Eurostat
Look... as we’re doing this, we can’t leave out Italy — and, what with Renzi’s resounding
victory for the pro-EU lobby and the demise of Silvio, things there must be on the up, right?
Eurostat Italy Real GDP % Change YoY
2006 - 2013
2013 2012 2011 2010 2009 2008 2007 2006
Source: Eurostat
28 july 2014
And when we move to unemployment, well, things just go from bad to worse. As you can see
in the chart below, youth unemployment in Italy is still rising relentlessly (it currently stands
at 43%), and headline unemployment is also steadily climbing, suggesting that Italy has yet to
reach its “bang moment”:
Source: Bloomberg
1999 2001 2003 2005 2007 2010 2012 2013 2014 2009 2011 2000 2002 2004 2006 2008
Italy Headline & Under-25 Unemployment Rate
2004 - 2014
Italy Under-25 Unemployment (%)
Italy Unemployment (%)
A further reminder of just how perilous things were back in 2012 can be seen in the chart
below, which shows the Eurostoxx European Banks Index through that crucial 2011/2012 period.
Draghi Elk Theory Speech
2011 2012 2013 2014
Eurostoxx Banking Index (SX7E)
July 2011 - July 2014
Source: Bloomberg
28 july 2014
In the 12 months prior to Draghi’s soothing words, the index had halved in value. From the day
Draghi spoke, the rot miraculously stopped and the banks began a climb that would see them
appreciate in value by over 100%.
Did European banks become more sound institutions on July 27th, 2012? (That was a rhetorical
question, people; put your hands down.)
The only really important happenings in Europe’s banking sector during the post Elk Theory
speech period were the following:
Cyprus bail-in
Erste Bank made a tiny miscalculation in its bad loan provisions (which led to a small
25% fall in its share price).
Corporate Commercial Bank (the 4th largest bank in Bulgaria) was taken into protective
custody by the Bulgarian Central Bank.
Banco Espirito Santo sort of kind of went a bit pear-shaped.
European banks loaded themselves to the gills with peripheral European debt as part of the
quid pro quo with Draghi, but making free carry off the Elk Theory promise of a desperate
central bank head is hardly what used to pass for banking.
Remember when banking used to be about things like making loans?
28 july 2014
(Zerohedge): [The] ECB update on Monetary Developments in the Euro Area was as grim
as always, with the all important series of loans to the private sector sliding once again
by 2.0% Y/Y, worse even than April’s -1.8% contraction, driven by a €43 billion collapse
in loans to households. This happened even as the now largely meaningless M3 rose by
1.0%, an increase to April’s 0.7% Y/Y change.
In other words, Europe is in bad a shape as pretty much ever, and loan creation is just
fractions above its all-time low print of -2.3% from late 2013.
Never mind.
As long as Draghi’s Elk Theory promise is held up as good, there’s nothing to worry about.
When recently (fnally) confronting the spectre of defation, Draghi once again cleared his
throat. Lo and behold, yet another Elk Theory tumbled forth. Grandstanding over a frankly
ludicrous 10bp cut to an already ridiculous 25bp benchmark rate (as if it will make any
difference), Draghi realised, no doubt, that it was time for yet more vague threats promises
rhetoric. After imposing negative rates on European banks’ deposits, Mario Draghi (brackets
“Mister,” close brackets) was put on the spot once more in the press conference:
This theory, which belongs to me, is as follows... (more throat clearing) This is how it
goes... (clears throat) The next thing that I am going to say is my theory. (clears throat)
Are we fnished? The answer is no. If required, we will act swiftly with further
monetary policy easing. The Governing Council is unanimous in its commitment to using
unconventional instruments within its mandate should it become necessary to further
address risks of prolonged low infation.
Main Refnancing Rate
Deposit Rate
2008 2009 2010 2011 2012 2013 2014
European Central Bank Interest Rates
2008 - 2014
Source: JK Financial
Now, let’s be serious for a moment, shall we?
28 july 2014
Not only have the GIS (Greece, Italy & Spain) failed to recover, but the engine room of what’s
left of Europe is also sputtering:
(Ambrose Evans-Pritchard): Europe’s economic recovery has stalled. The EMU policy
elites took a fateful gamble that global growth alone would lift the eurozone off the
reefs, without the need for serious monetary stimulus or a refation package to ensure
take-off velocity.
Their strategy has failed. The Bundesbank says German growth may have slumped to
zero in the second quarter. French industrial output has fallen for three months in a
row. French business surveys point to an outright contraction of GDP, with a high risk of
a triple-dip recession.
Stagnation is automatically causing debt ratios to spiral upwards yet again across a large
part of the currency bloc. The situation is doubly delicate since the European Central
Bank is no longer able to serve as a lender of last resort for Italy, Portugal and Spain.
Germany’s top court has ruled that the ECB’s back-stop plan (OMT) “manifestly violates”
the EU treaties, and is probably Ultra Vires. The political reality is that the OMT cannot
be deployed, whatever the European Court says when it issues its own judgment long
Any external economic shock at this stage risks exposing the fundamental incoherence
of the EMU system, and therefore shattering the fragile truce in the markets.
Ambrose talks about the gamble taken by what he calls “EMU policy elites” but fails to mention
the gamble taken by Draghi — that his Elk Theory would never be challenged.
So far, it hasn’t; but at some point Draghi’s going to have to stop clearing his throat and lay
out some concrete steps — and THEN we’ll see just how effective he can be. My guess is that
one of two things happen: the economies of Europe prove so weak that its politicians fnd a
way around the “technicalities” of the Maastricht Treaty, which currently prevent them from
printing money, and allow Draghi to unleash an infationary blitz; or the market realizes that
his words are hollow, and confdence in the ECB head (the only thing holding European markets
together) is shattered.
That... would be ugly.
Already the pernicious effects of compounding are making their mark on the debt-to-GDP ratios
of European governments, a point Ambrose makes quite clearly, using Italy as an example:
(Ambrose Evans-Pritchard ): Eurostat revealed this week that Italy’s debt rose to
135.6pc of GDP in the frst quarter. This is near the point of no return for a country that
borrows in what amounts to a foreign currency.
What is remarkable is that the ratio has jumped 5.4 percentage points over the past
year despite austerity and even though Italy is running a primary budget surplus.
28 july 2014
This is the toxic effect of near defationary conditions on debt dynamics. Unless action
is taken to boost nominal GDP, Italy must mathematically sink deeper into a compound
interest trap.
Precisely, and it’s not just Italy that’s falling into this dreadful trap, as you can see from the
chart below, which shows the YoY % change in debt-to-GDP ratios in Italy, Greece, France, and
2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001
Debt-to-GDP Ratios YoY Change (%)
2001 - 2014
Greek Sovereign
Bond Default
Source: EU
There’s your austerity. Right there.
Greece didn’t waste any time getting back on the horse after their default restructuring wiped
about 13% off their debt-to-GDP ratio in 2012, did they?
Make no mistake, folks, Europe is back — and not in the good way.
But it’s not just Draghi laying out Elk Theories.
Oh no.
Across the Atlantic, the continued narrative being spun by the Yellen Fed is one of “nothing to
see here,” with a dab of “there’s no infation,” a soupçon of “we will keep rates low for a very
long time,” a dash of “everything bad that has happened can be put down to the weather,”
and the merest suggestion of “these aren’t the droids you’re looking for.”
The Fed’s nemesis is infation; and, over time, they (along with the BLS) have done everything
in their power to paint a picture of benign infation in order to further their agenda.
Take hedonics, for example.
28 july 2014
For those of you unsure as to what hedonics (or “hedonic regression” to give it its full title) is,
here’s the quick and boring dirty:
(Wikipedia): In economics, hedonic regression or
hedonic demand theory is a revealed preference
method of estimating demand or value. It
decomposes the item being researched into
its constituent characteristics, and obtains
estimates of the contributory value of each
characteristic. This requires that the composite
good being valued can be reduced to its
constituent parts and that the market values
those constituent parts.
Bottom line?
If your new iPad has more features than your old one
did, then even though the price went UP, the newer
model is “technically” cheaper because of the extra
memory/pixels/whatever. Look, it just is, OK?
In a NY Times article published in May, the miracle of
hedonics was laid bare for the world to see, and the
chart accompanying it (right) showed that the cost of a
television set (thanks to hedonics) has somehow fallen
110% since 2005.
But back to infation and the most recent CPI number:
US CPI YoY % Change
Nov 2009 - June 2014
2009 2010 2011 2012 2013 2014
Source: Bloomberg
28 july 2014
(WSJ): “Recent readings on, for example, the CPI index have been a bit on the high
side,” but the data are “noisy,” Ms. Yellen said at a press conference following a
meeting of the Fed’s policymaking committee. “I think it’s important to remember
that, broadly speaking, infation is evolving in line with the committee’s expectations.
The committee has expected a gradual return in infation toward its 2% objective, and I
think the recent evidence that we’ve seen, abstracting from the noise, suggests that we
are moving back gradually, over time, toward our 2% objective.”
Fortunately for the world, Yellen’s own personal Elk Theory (inherited from her predecessors) is
that the Federal Reserve is omniscient with regards to infation and they can control it precisely
should it get out of line:
... Ms. Yellen said the Fed “would not willingly see a prolonged period in which infation
persistently runs below our objective or above our objective.”
So basically, they are absolutely in complete control (unless they aren’t)...
She did, however, indicate the Fed might tolerate infation overshooting the 2% goal
if the U.S. economy were still far from the Fed’s goal of maximum employment. Right
now, sluggish infation and elevated unemployment both call for accommodative policy,
but “there could conceivably arise policy conficts or trade-offs somewhere down the
road,” Ms. Yellen said.
... so they are OK with higher infation for a while. Just not lower infation.
We’ve seen this confdence amongst the academics at the Federal Reserve before. They are the
group which brought you “Derivatives have permitted the unbundling of fnancial risks,” “...
many of the larger risks are dramatically — I should say, fully — hedged,” and of course the
classic “Subprime is contained.”
However, in recent weeks, a hint of hesitancy has been creeping in around the edges, and
without saying the dreaded B-word, Yellen took a sideways swipe at the valuations of certain
social media and biotech stocks:
(Business Insider): “Equity valuations of smaller frms as well as social media and
biotechnology frms appear to be stretched, with ratios of prices to forward earnings
remaining high relative to historical norms.”
Wow! Janet, that’s a mere hop, skip, and a jump away from “irrational exuberance.”
Not to worry, though, the Fed Chair quickly added a postscript designed to address any possible
contagion from her remarks about those “stretched” valuations in a tiny corner of the market:
(Business Insider): Some broad equity price indexes have increased to all-time highs
in nominal terms since the end of 2013. However, valuation measures for the overall
market in early July were generally at levels not far above their historical averages,
suggesting that, in aggregate, investors are not excessively optimistic regarding
28 july 2014
Then she went for broke:
(Janet Yellen): [W]e understand that maintaining interest rates at low levels for a
long time can incent reach-for-yield or asset bubbles. So we are monitoring this very
closely.... My general assessment at this point is that threats to fnancial stability are
at a moderate level and not a very high level. Some of the things that I would look at in
assessing threats to fnancial stability to see if they’re broad-based — broad measures
of asset prices, of equities, real estate, of debt — do they seem to be out of line with
historical norms? And I think the answer is no. Some things may be on the high side, and
there may be some pockets where we see valuations becoming very stretched, but not
OK, Janet... keep going...
The use of leverage is not broad-based. It hasn’t increased in credit growth. It’s not
— you know, at alarming levels by any means.... The Federal Reserve doesn’t take a
view as to what the right level of equity or asset prices should be, but we do try to
monitor to see if they are rising outside of levels consistent with historic norms. And as
I indicated, in spite of the fact that equity prices, broad indices have risen substantially,
price-equity ratios and other measures are not outside of historical norms.
Zerohedge helpfully published this table to help put Janet’s “not outside of historical norms”
call into perspective:
Description Latest
1 Year
5- Year
P/E Price to Earnings 15.6x 13.8x 13.4x 13.8x 15.5x
CAPE Shiller P/E 25.6 24.4 21.7 22.9 25.1
Div. Yield Dividend Yield 1.9% 2.0% 2.0% 2.0% 2.1%
PEG Price/Earnings to Growth 1.5 0.8 1.1 1.7 1.4
P/B Price to Book 2.8 2.6 2.2 2.4 2.9
P/CF Price to Cashfow 11.0 10.3 8.9 9.5 10.6
EY Spread EY minus Baa Yield 1.7% 1.5% 2.0% 1.2% -0.7%
Fed Chairs publishing research notes? Whatever next, I wonder?
I’ll tell you what’s next: the voice of sanity in the form of Stanley Druckenmiller, that’s what:
(CNBC): “Fed policy seems not only unnecessary, but fraught with unappreciated
risk,” said Druckenmiller, speaking at the CNBC Institutional Investor Delivering Alpha
Conference in New York. He said the actions are as “baffing” as they were in late 2003,
when the Fed said its target rate would stay at 1 percent for a “considerable period”
even when there were indications of vigorous growth.
28 july 2014
The following year, the Fed started a cycle of tightening that pushed the rate to
5.25 percent by 2006.... “Five years into an economic and balance sheet recovery,
extraordinary monetary measures are likely running into sharply diminishing returns,”
he said. “The odds are high that the Fed’s monetary experiment will be more disruptive
down the road than the Fed anticipates.”
Druckenmiller also questioned the Fed’s certainty over its forecasts, given mistakes in
the past, including declaring in 2007 that the subprime mortgage crisis was contained.
“Where does their confdence come from?” he asked.
That’s a great question, Stan — but then we expect that from you. What we don’t expect are
the likes of Janet Yellen (or, as Zerohedge have deliciously labeled her, “Yellen Capital LLC”)
valuing equity markets for us.
But at the risk of being presumptuous, allow me to answer Stan’s (no doubt rhetorical)
Their “confdence” comes from a series of academic models and a lifetime spent studying
theoretical fnance and then applying it to real-world situations, often with disastrous effect.
The day these people admit to themselves (let alone to the public) that what they have
believed to be foolproof doesn’t actually work, is the day they render pointless their entire
lives’ work.
The alternative to grappling with hard realities — in this case to continue waltzing down the
path of Keynesian folly — is, sadly, far more palatable. Eventually, though, the markets have
a habit of demonstrating, beyond any reasonable doubt, that natural forces are far more
powerful than the whims of a few academics. And that is, I fear, what we are setting ourselves
up for.
Elk Theories — observations which are not, actually, theories but rather simply minimal
accounts — are commonplace amongst today’s breed of central bankers, and for the time being
there are no obvious signs of their legitimacy being challenged.
But that could change in a heartbeat. Should all the Elk Theories currently being espoused (yes,
Messrs. Carney & Kuroda, I left you out of this week’s edition, but I haven’t forgotten you) be
simultaneously recognized for what they are, then we will see some freworks.
If Yellen would stop clearing HER throat long enough, her own Elk
theory would, I strongly suspect, sound like this:
This theory, which belongs to me, is as follows... (more
throat clearing) This is how it goes... (clears throat) The
next thing that I am going to say is my theory. (clears
throat) Ready?
28 july 2014
We are absolutely convinced beyond any doubt whatsoever that we can, through the
manipulation of interest rates and the theft of savings, extricate the world from its
growth-free, post-2008 malaise and at the same time extricate ourselves from our $3.5
trillion dollar balance-sheet expansion.
We are quite certain that we can manipulate headline infation to exactly where we
need it to be and that any aberration can be blamed on the weather without so much as
a whimper from the investing public.
We believe that bubbles are impossible to see until they burst, and we believe that
we have played no part in generating the bubbles which have periodically plagued the
world over the last several decades.
We know beyond question that holding interest rates at artifcially and ridiculously low
levels for several years will have no ill effects on the economy whatsoever; and we
can assure you, with the utmost conviction, that we will be able to complete the taper
without any damage being done to the equity markets.
That is my theory and what it is too.
Like those of Draghi, Yellen’s theories are nothing more than minimal observations which hardly
stand up to scrutiny but for the fact that she has stated something which IS true currently.
While Anne Elk — brackets, “Miss”, close brackets — focused her keen scientifc eye on the
Brontosaurus, anybody with even the remnant of a childhood love of dinosaurs will remind
you that the Brontosaurus — or “Thunder Lizard” — turned out to be a fgment of somebody’s
overactive imagination.
The creature, which in actual fact turned out to be thin at one end; much, much thicker in the
middle; and then thin again at the far end, was actually the Apatosaurus, or “deceptive lizard.”
Fortunately, the world is now completely free of deceptive lizards.
Wait… what?
With Spain still as my backdrop, it’s time once again to get to the meat of another
Things That Make You Go Hmmm... and this week I have plenty for you to get your teeth into.
We begin with a story straight out of a Bruce Willis movie: the tale of how a group of Russian
hackers tried to steal the NASDAQ. Things slow down just a little after that electric start, as my
friend Ramsey Su looks at “Bubblenomics” and explains why economics and Monet have a lot in
common, before Benjamin Morris attempts to put a value on Billy Beane.
28 july 2014
Jeremy Warner ponders whether central banks have been breaking the law; we take a
fascinating in-depth look at the new “sick man of Europe” — France — courtesy of Germany’s
Der Spiegel; Deutsche Bank and HSBC are once again in the crosshairs — this time for allegedly
rigging — there’s the word again, folks) — the silver fx (surely not???); and my great friend
David Hay lays out the perils of indexation in a fabulous piece which he will be more than
happy to send you in full should you ask him for it, a task I’ve made nice and easy for you with
a clickable link.
China’s corruption probe deepens; former Israeli defence chief Yuval Diskin explains just
how incendiary the situation in Gaza is; and we take a look at disconnects in housing and
unemployment as well as Russia’s seemingly insatiable demand for gold.
Art Cashin weighs in on everything from Janet Yellen to another famous theory - that of the
Effcient Market; and Canadian TV exposes L’exodus as French citizens fee François Hollande’s
France in their droves.
And THAT, dear reader, wraps things up for this week, so...
Until Next Time...
How Russian Hackers Stole the Nasdaq
In October 2010, a Federal Bureau of Investigation system monitoring U.S. Internet traffc
picked up an alert. The signal was coming from Nasdaq (NDAQ). It looked like malware had
snuck into the company’s central servers. There were indications that the intruder was not a
kid somewhere, but the intelligence agency of another country. More troubling still: When the
U.S. experts got a better look at the malware, they realized it was attack code, designed to
cause damage.
As much as hacking has become a daily irritant, much more of it crosses watch-center monitors
out of sight from the public. The Chinese, the French, the Israelis—and many less well known or
understood players—all hack in one way or another. They steal missile plans, chemical formulas,
power-plant pipeline schematics, and economic data. That’s espionage; attack code is a
military strike. There are only a few recorded deployments, the most famous being the Stuxnet
worm. Widely believed to be a joint project of the U.S. and Israel, Stuxnet temporarily disabled
Iran’s uranium-processing facility at Natanz in 2010. It switched off safety mechanisms, causing
the centrifuges at the heart of a refnery to spin out of control. Two years later, Iran destroyed
two-thirds of Saudi Aramco’s computer network with a relatively unsophisticated but fast-
spreading “wiper” virus. One veteran U.S. offcial says that when it came to a digital weapon
planted in a critical system inside the U.S., he’s seen it only once—in Nasdaq.
28 july 2014
The October alert prompted the involvement of the National Security Agency, and just into
2011, the NSA concluded there was a signifcant danger. A crisis action team convened via
secure videoconference in a briefng room in an 11-story offce building in the Washington
suburbs. Besides a fondue restaurant and a CrossFit gym, the building is home to the National
Cybersecurity and Communications Integration Center (NCCIC), whose mission is to spot and
coordinate the government’s response to digital attacks on the U.S. They reviewed the FBI data
and additional information from the NSA, and quickly concluded they needed to escalate.
Thus began a frenzied fve-month investigation that would test the cyber-response capabilities
of the U.S. and directly involve the president. Intelligence and law enforcement agencies,
under pressure to decipher a complex hack, struggled to provide an even moderately clear
picture to policymakers.
After months of work, there were still basic disagreements in different parts of government
over who was behind the incident and why. “We’ve seen a nation-state gain access to at least
one of our stock exchanges, I’ll put it that way, and it’s not crystal clear what their fnal
objective is,” says House Intelligence Committee Chairman Mike Rogers, a Republican from
Michigan, who agreed to talk about the incident only in general terms because the details
remain classifed. “The bad news of that equation is, I’m not sure you will really know until
that fnal trigger is pulled. And you never want to get to that.”
Bloomberg Businessweek spent several months interviewing more than two dozen people about
the Nasdaq attack and its aftermath, which has never been fully reported. Nine of those people
were directly involved in the investigation and national security deliberations; none were
authorized to speak on the record. “The investigation into the Nasdaq intrusion is an ongoing
matter,” says FBI New York Assistant Director in Charge George Venizelos. “Like all cyber cases,
it’s complex and involves evidence and facts that evolve over time.”
While the hack was successfully disrupted, it revealed how vulnerable fnancial exchanges—as
well as banks, chemical refneries, water plants, and electric utilities—are to digital assault.
One offcial who experienced the event frsthand says he thought the attack would change
everything, that it would force the U.S. to get serious about preparing for a new era of confict
by computer. He was wrong.
On the call at the NCCIC were experts from the Defense, Treasury, and Homeland Security
departments and from the NSA and FBI. The initial assessment provided the incident team with
a few sketchy details about the hackers’ identity, yet it only took them minutes to agree that
the incursion was so serious that the White House should be informed.
28 july 2014
The conference call participants reconvened at the White House the next day, joined by
offcials from the Justice and State departments and the Central Intelligence Agency. The
group drew up a set of options to be presented to senior national security offcials from the
White House, the Justice Department, the Pentagon, and others. Those offcials determined
the questions that investigators would have to answer: Were the hackers able to access and
manipulate or destabilize the trading platform? Was the incursion part of a broader attack on
the U.S. fnancial infrastructure?...
Bubblenomics and the Future of Real Estate
Economics is like a Monet painting. Stand too close and all you see is a bunch of seemingly
random paint strokes. Back up a few steps and an image emerges.
The painting of bubblenomics started with the Plaza Accord, September 1985, where fve
nations agreed to manipulate the dominant currencies at the time. Japan enjoyed a 50%
devaluation of the US$ vs the yen, artifcially enriching its citizens so they can travel the world
in busloads with the eighty pounds of cameras around their necks.
The consequences of that bubble has yet to be corrected. Twenty years of fscal and monetary
accommodations led Japan to the world’s leading debt to GDP ratio.
The next big one was the US dotcom bubble , generating great wealth during the 1990s. More
importantly, it started the era that income and savings became old school. Everyone can live off
and retire on never ending asset appreciation. When that bubble burst, in came Greenspan with
the mother of all bubbles — the subprime bubble. Amazingly enough, that mother of a bubble
would soon be exceeded by the Bernanke/Yellen yield bubble.
In Europe, unbeknownst to the world, the Euro/EC bubble was brewing. Subprime countries
like the PIIGS were allowed to borrow in the same manner that dishwashers in the US were
given loans to buy McMansions. Marginal economies such Greece were able to buy Mercedes and
import Armenians to do their work while the citizens collect pensions and crowd all the coffee
bars. The ability to repay was never a consideration.
This massive global bubble fnancing has unintended benefactors. China, India and other
emerging markets could never have double digit growth rates without the food of capital from
the West and the importing of jobs that were deemed unneeded by the asset rich Westerners .
Countries like Australia and Brazil benefted from supplying raw materials to fuel the bubbles.
28 july 2014
In summary, t his Monet painting is becoming quite clear. In the modern world, there are no
economies, only bubbles. There is not a country in the world that is not struggling to survive on
yesterday’s stimulus plan , other countries’ stimulus plans , or waiting for tomorrow’s bailout
to live another day. To anyone who is not in denial, it is obvious that no central banker has
a viable solution and no one is willing to take the pain. In reality, there is no stimulus, just
a continuous game of borrowing by governments and printing by central banks to keep the
peasants from revolting.
Forget Samuelson or Friedman, this is the way I defne the economic jargon. A stimulus is an
investment into something that has future production value, at a cost today. A bubble is the
creation of pseudo demand for something that we do not need, made possible by debt and
leverage that we cannot afford. A bailout is a perpetuation of the bubble, using newly created
fat money and/or more debt to pay off the old. It sounds awful like a Ponzi Scheme.
How does real estate ft into this picture? For at least the last two decades, the real estate
market is nothing but a by product of economic bubbles. Going forward, the future of real
estate is dependent upon on what the all-mighty policy makers want to do. Yellen, unwilling
to hide in the shadow of the QEs of her predecessor, is coming up with her own strategies,
or terminologies. She has been promoting this thing called Macroprudential Policies. If I had
studied that term in college, it has been long forgotten. I have to look up the defnition and
found a good explanation by the IMF. It is a very interesting paper with no practical use. Who is
Yellen kidding besides herself?
She really thinks she understands the subject matter, have all the necessary tools and knows
how to deploy all these complex unproven theories in the real world, as if she is adjusting the
volume of her radio? Regardless of whether it is micro quantitative easing vs macro prudential,
the bottom line is the Feds will accommodate whenever it is needed....
Have central banks been breaking the law?
The best way to destroy the capitalist system, the Russian revolutionary leader Vladimir Lenin
is reputed to have said, is to debauch the currency. The world’s major central banks have
certainly been having a fair old go at it. In the six years since the fnancial crisis frst broke,
they’ve been printing money like there is no tomorrow.
Fortunately, they have not yet managed to bring down the free market system. On the other
hand, they have succeeded in putting a rocket under asset prices and, in so doing, they have
greatly exaggerated the wealth divide.
28 july 2014
In a number of cases, including the US and the UK, they have also signifcantly assisted
governments in fnancing burgeoning fscal defcits. To the extent that quantitative easing
(QE) has had any effect at all, it is asset prices and governments that have been the prime
This might seem something of an old issue now; the Bank of England stopped buying assets
more than two years ago, while the US Federal Reserve is “tapering” fast. For the US and
Britain, the age of “unconventional monetary policy” seems to be largely over.
Elsewhere, however, QE remains very much a work in progress. In Japan it’s continuing
at heroic pace, while on the Continent the European Central Bank is being urged by the
International Monetary Fund to stop dilly-dallying in the face of defationary pressures and get
on with it.
Full marks, then, to Prof Andrew Johnstone and Trevor Pugh, of Sheffeld Institute of Corporate
and Commercial Law, for a new analysis, The Law and Economics of QE, which concludes that
not only has QE been largely ineffectual but that it was also illegal.
Like common brigands, central banks have been acting outside the law — their only real excuse
being the supposedly higher purpose of economic necessity, a sort of Robin Hood-type operation
where the ends justify the means, only with a slight faw; by driving up the value of fnancial
assets and real estate, QE further skews the distribution of wealth towards those with already
large holdings of it. It robs from the poor and gives to the rich.
Not that there is any possibility of the courts judging QE in all its various forms to be against
the law, the writers concede. In Europe, the European Court of Justice has admittedly been
asked to rule on ECB bond buying, but will almost certainly deem it to be a necessary price for
holding the eurozone together. Never mind the law, the single currency comes frst.
The director and deputy director of the IMF’s Europe division said in a recent blog: “So long
as the ECB buys sovereign bonds in pursuit of its mandate and in a way that has nothing to
do with fscal outcomes it can rebut the oft-heard charge that QE violates the prohibition
against ‘monetary fnancing of fscal defcits’.” Thus does looking for ways around the law take
precedence over its observation.
Lots of claims have been made for QE but no central bank has yet been able convincingly to
demonstrate that it helps stimulate economic recovery. About the best that might be said for
it is that it raised confdence at a critical moment in the crisis when fnancial and economic
armageddon were threatened. But the persistence of asset purchases thereafter is much more
questionable. There is not a whole lot of evidence to suggest it has played much of a role in
restoring growth.
QE is supposed to work in a number of ways; it is, for instance, hard to argue that it hasn’t
depressed long-term interest rates. Some have benefted from this phenomenon undoubtedly,
in particular mortgage holders and large companies, but it doesn’t seem signifcantly to
have reduced the cost or availability of fnance to the real economy, which for many smaller
companies remains high and scarce.
28 july 2014
It was also meant to have led to “portfolio rebalancing”, with investors replacing the bonds
bought by the central bank with other assets such as equities. This in turn might have
marginally reduced the cost of capital but, again, for the vast majority of privately-owned
businesses it has made no difference at all.
Another declared purpose was to raise infationary expectations, which in turn was meant to
boost spending and wages. Again, nil effect, unless you count the scare stories in the early
stages of QE of Weimar-style hyper-infation. In any case, real wages, the chief driver of
domestically-generated infation, have gone nowhere for nearly a decade now....
A Tour of France: Examining the New Sick Man of Europe
There is a new word in the French language: La mannschaft. It’s the term used to defne
everything that is enviable on the opposite bank of the Rhine River — in other words, Germany’s
success. It’s a success that is the product of the collective and is free of any of the egocentrics,
self-deluded, bling-bling divas and “general director presidents,” as the heads of French
companies are called, that can make France so stuffy.
A week ago Monday, on Bastille Day, newspapers across France sighed that it wouldn’t hurt if
the country were a bit more like la mannschaft. Instead, unemployment is twice as high as it is
in Germany, growth and investments have fallen far and former President Nicolas Sarkozy was
recently detained for questioning by police at dawn. La mannschaft is the polar opposite of the
other word currently in fashion in France: le malaise. A deep gloom appears to have taken hold
in France. A recent survey showed that two-thirds of the French are “pessimistic” about their
country’s future.
“Viewed from the outside, France under François Hollande is like Cuba, only without the
sun but with the extreme right,” the newsweekly Le Point recently wrote. The country is
“impoverished, over-indebted, divided, humbled and humiliated and fnds itself in a pre-
revolutionary situation in which anything seems possible.”
The only thing missing, it seems is the travel warning, because right at this moment, large
numbers of vacationers from the rest of Europe are traveling in the country. Are these
vacationers all francophone lemmings on their way to the cliff, blind to anything that doesn’t
involve a game of boule or fnding a camping spot?
Something is adrift in France. Rarely has the public mood been this miserable and the
sullenness as omnipresent as it has been this summer. A president currently resides in Elysée
Palace who was mercilessly booed during the July 14th military parade. It doesn’t seem possible
for Hollande to get any less popular, and yet his popularity continues to fall from one low to the
28 july 2014
But at least the country still has the Tour de France, the grand race that circles the country and
serves as a prelude to the summer holiday season. Each year, it provides a long beloved view of
a different, rural and idealized France — one where local frehouses still host annual dances,
where there’s a memorial to those lost in the wars in front of every city hall and where the
people know where they belong. But do they really?
This reporter recently traveled across France to take the country’s pulse with the people on
the ground. The route followed stayed true to the course of the 2014 Tour de France, taking
in cities, towns and villages, and sought to observe signs of the crisis, decline, collective
depression and other specters that are haunting Germany’s most important neighbor.
The frst stage of the tour to take place in France (the frst three are in Britain this year)
ends at the periphery of Lille in Pierre Mauroy Stadium, a sparkling arena of glass, steel and
concrete. The only person in sight is a guard. Lille is one of the few success stories in a French
Socialism that is otherwise in a state of crisis. Local Mayor Martine Aubry even managed to get
re-elected recently. The politician is the anchor of the Socialist Party’s left wing. In contrast
to the president, she is cherished by the party base. Aubry also happens to be the daughter of
former European Commission President Jacques Delors, the father of currency union.
Although Lille has profted from Europe, Joël Leclerc has not. “Lille is for the rich,” he says,
noting that he doesn’t even buy his coffee here. Leclerc is the sole security guard standing in
front of Pierre Mauroy Stadium.
He’s the son of a miner and has a crew cut, as is common among members of the French
Foreign Legion. He says he raised his children with a “good kick in the ass.” Unlike Lille, he says
the village of Avion where he lives isn’t home to any “vermin,” the highly disparaging term used
by Sarkozy to describe the children of immigrants who rampaged through the streets of Paris’
suburbs in 2005.
“We still have values here in the village,” Leclerc says. He’s the archetypical supporter of
Marine Le Pen, leader of the far-right Front National party. Leclerc says he once had aspirations
to become a member of the police force, but that he wasn’t able to. “My father threw lumps
of coal during the 1968 strikes at the CRS, the special police,” he explains. “That’s what people
here in the village do. Avion has been communist for 200 years. People call it Little Russia. Me?
Of course I’m a communist. A simple worker.”
Leclerc remains loyal to the communists for the same reason that most of his colleagues have
since begun voting for Front National — out of tradition, patriotism and the desire for order.
He says his father once lived in Poland, somewhere near Katowice, but, no, he didn’t work in
the mines there. The place had a different name. He had to stay there for three years. Then,
without any special emphasis, he says the name: “Auschwitz.”...
28 july 2014
Deutsche Bank, HSBC Accused of Silver Fix Manipulation
Deutsche Bank AG, HSBC Holdings Plc and Bank of Nova Scotia were accused in a lawsuit of
rigging the price of billions of dollars in silver, an allegation similar to earlier suits involving the
London gold fx.
The banks unlawfully manipulated the price of the metal and its derivatives, an investor claims
in a complaint fled yesterday in federal court in Manhattan. The banks abused their position of
controlling the daily silver fx to reap illegitimate proft from trading, hurting other investors in
the silver market who use the benchmark in billions of dollars of transactions, according to the
“The extreme level of secrecy creates an environment that is ripe for manipulation,” according
to the complaint. “Defendants have a strong fnancial incentive to establish positions in both
physical silver and silver derivatives prior to the public release of silver fxing results, allowing
them to reap large illegitimate profts.”
The lawsuit is the latest to be brought against banks alleging manipulation of a benchmark.
Suits have been fled against Deutsche Bank and Bank of Nova Scotia, HSBC and other banks in
federal court in New York over allegations involving the London gold fx.
“We intend to vigorously defend ourselves against this suit,” Diane Flanagan, a spokeswoman
for the Bank of Nova Scotia, said in an e-mail. Juanita Gutierrez, a spokeswoman for HSBC, and
Amanda Williams, a representative for Deutsche Bank, declined to comment.
J. Scott Nicholson, a Washington state resident who fled the case, is seeking to represent a
class of investors who have bought silver future contracts since Jan. 1, 2007.
The suit includes claims of aiding and abetting manipulation, as well as violation of antitrust
laws and the Commodity Exchange Act. Nicholson seeks unspecifed damages.
The 117-year-old system of fxing prices for the $5 trillion silver market is set to change next
London Silver Market Fixing Ltd. said in May it would stop administering the benchmark, used
by everyone from mining companies to central banks to trade or value metal, once Deutsche
Bank ends its participation on Aug. 14.
The German lender, HSBC and Bank of Nova Scotia (BNS) conduct the silver fxing, which frst
took place in 1897 at the offce of Sharps & Wilkins with former dealers including Mocatta &
Goldsmid, Pixley & Abell, and Samuel Montagu & Co.
Deutsche Bank, Germany’s biggest lender, said in January that it would withdraw from
participating in setting gold and silver benchmarks in London, a month after announcing that it
would cut about 200 jobs in commodities and exit dedicated energy, agriculture, dry-bulk and
base-metals trading. JPMorgan Chase & Co., Morgan Stanley and Bank of America Corp. also are
retreating from raw materials.
28 july 2014
Precious metals are getting more attention from regulators after price rigging in everything
from interbank lending rates to currencies led to fnes and overhauled fnancial benchmarks.
The U.K.’s Financial Conduct Authority in May fned Barclays Plc after a trader sought to
infuence the gold fx in 2012. An LBMA survey showed the market wants a new silver system to
be an electronic, auction-based process with more direct participants and prices that can be
used in trades.
Billion-Dollar Billy Beane
The flm version of “Moneyball” depicts many establishment baseball types as ignorant of where
wins in baseball come from and clueless about how to properly value talent.
Take, for example, the scene when John Henry — the billionaire owner of the Boston Red Sox
— tries to recruit the Oakland Athletics’ general manager Billy Beane. Henry tells Beane that
any managers not rebuilding their teams with Beane’s system in mind are “dinosaurs,” and then
hands him a slip of paper. On it, there’s an offer for Beane to become the new Red Sox general
manager for the insane amount of $12.5 million dollars over fve years. His fctional colleague
tells us that the offer would make Beane “the highest-paid GM in the history of sports.” Despite
appearing tempted, Beane ultimately declines the deal, claiming, “I made one decision in my
life based on money and I swore I’d never do it again.”
Beane may not be the highest-paid GM in the history of sports, but he may be the most famous.
An outfelder originally drafted 23rd overall by the New York Mets in 1980, Beane made his MLB
debut in 1984, but was never successful against top competition. After getting washed out of
the league, he became a scout for the A’s and eventually worked his way up to GM in 1997.
As GM, he has used Bill James-style advanced statistics to inform his decisions, and taken
a strictly economic approach to valuing and acquiring players. Under his leadership, the A’s
have been a very successful franchise despite routinely carrying one of baseball’s smallest
payrolls. Beane’s story caught the attention of author Michael Lewis, who made him the
central character in his 2003 bestseller “Moneyball” and something of a cultural icon for sports
Beane’s methods continue to be analyzed and celebrated by sabermetricians, and the A’s
continue to massively exceed expectations given the amount they spend. They own the best
record in baseball so far this season, and have the ffth-lowest payroll. It’s the best 100-game
start of Beane’s career, and the best for the organization since its 1990 pennant-winning squad.
Over the last 15 seasons, the A’s under Beane have had the ffth-best winning percentage in
baseball, with the fourth-lowest total payroll. (The data used here is current through Monday,
July 21.)
28 july 2014
Beane has been a godsend to the frugal A’s, enabling them to achieve top-tier performance at
bottom-tier prices. For this, the A’s have paid him fairly modestly — but since we don’t know
how much winning is worth to the A’s organization, it’s hard to say exactly how much Beane has
been worth to them.
For a team like the Red Sox, however, the picture is much more clear. Over the last 15 years,
they’ve happily spent over $2 billion dollars in the pursuit of wins — and because they’re one of
baseball’s most successful franchises, no one in Beantown is complaining.
From a strictly economic perspective, not offering Beane however much money it took to get
him may have been one of the Red Sox’s poorest decisions since letting Babe Ruth go to the
Yankees for next to nothing. And I mean that literally: Over the past 15 years, Billy Beane has
been nothing less than the Babe Ruth of baseball GMs. The Red Sox offered Beane $2.5 million
per year, but even $25 million would have been a bargain.
Finding Beane’s potential dollar value to the Red
Sox is relatively simple: It’s the amount the team
spent under general managers Theo Epstein and Ben
Cherington, minus the amount it would have had to
spend for the same performance with Beane as GM.
To show this, we frst we need to fgure out just how
many A’s wins Beane has been responsible for, and how
much those wins would cost on the open market.
Let’s start by comparing the A’s performance under
Beane’s leadership to the performance we would
expect from a typical GM with the same payroll. I
created a logistic regression model8 that predicts a team’s win percentage by season based
on the team’s relative payroll (excluding Oakland from the data), as measured by how many
standard deviations it was above or below the average MLB payroll for each season. Above,
I’ve plotted the non-Oakland team-seasons from 2000 to 2013 (on which the model is based) in
groups of 15 by payroll (so, the dot farthest to the right represents the 15 team-seasons with
the highest relative payrolls), and plotted the model’s prediction as a red line. I then plotted
Oakland’s 15 seasons through 2014 as a single green point....
28 july 2014
Rebels With a Cause
Now, let me take you back several years ago to a time when EVA readers numbered in the
hundreds, not thousands. My wife and I were on our annual “date vacation” to Hawaii. While
reading a book over in paradise, Justin Fox’s excellent The Myth of the Rational Market, I had
an epiphany totally in synch with Charles’ essay from last week. As the handful of you who were
EVA readers back then may dimly recall, I wrote about the dangers of what happens when a
benchmark becomes an investment strategy.
One of my main points at the time was that when Vanguard’s Jack Bogle frst concocted the
idea of index investing in the early 1970s, it was a novel concept. It remained that way for
many years. As a result, there was very little money devoted to simply replicating the S&P
500, the frst iteration of indexing. And, in those days, when almost all money was actively
managed, the kissing cousins of index investing, Exchange Traded Funds (ETFs), weren’t even a
glimmer in the eye of their progenitor, State Street.
Yet, as the years passed, and a growing body of academic research supported the superiority
of passive, or index, investing, the scales began to tip decidedly toward “no-think” money
management (using that last word very loosely). Ironically, just as indexing became the
accepted mantra, a new generation of academics, personifed by Robert Shiller (of the
eponymous and famous, Shiller P/E) and Daniel Kahneman, came to the fore. They broke ranks
with the dominant orthodoxy and challenged the most basic and sacred assumptions of Effcient
Market Theory (EMT), the cornerstone premise of passive investing.
In their view, the relatively mild market volatility prior to the crash of 1987—and well before
the incredible bouts of extreme price fuctuations since 2000—were wholly inconsistent with
an effcient market. Dr. Shiller’s seminal work on this was an early- 1980s treatise showing that
stock prices even then were far more variable than the discounted-to-present-value-stream of
future dividend income they were supposed to represent.
28 july 2014
In very simple terms, his contention was that the price you pay for a stock in the long run
should refect the cash fow it is likely to produce. Because dividend payments have long
maintained a steady upward arc (periodically, but temporarily, interrupted by recessions), stock
prices should roughly track that path. Instead, as you can see in Figure 1 above, stocks prices
swung up and down far more violently than the dividend trend line, again even prior to more
recent extreme volatility. In other words, there was clearly a major ineffciency at work.
One could argue this was because, as indicated above, active management was overwhelmingly
the leading investment approach, meaning that emotions might have played a much greater
role than if money was simply managed on auto-pilot, mimicking a benchmark.
Yet, the facts of the last quarter-century, as indexing and quasi-indexing have gained so much
market sway, tell a radically different story.
Contrarians—the latest endangered species? In at least one prior EVA, I’ve observed that
bubbles and their inverse—crashes— were relatively rare in the frst half of my 35-year
investment career. From 1979, when I started, to the late-1990s, there was the crash of 1987
and the Japanese bubble and bust. But, other than
those events, there weren’t the wild and wooly
swings we’ve experienced over the last 15 years.
The following chart (left) reveals that since 2000,
price fuctuations in the S&P 500 have returned to
the extreme ranges of the Great Depression and the
immediate post-war years (when another depression
was widely anticipated).
Certainly, there are multiple causes for the plethora
of mini- and maxi-bubbles we’ve experienced since
the late 1990s. Misguided Fed policies would rank high on my list of probable causes, with long
stretches of excessively cheap money encouraging multiple episodes of rank speculation, but I
think the proliferation of mindless investing is another prime suspect.
How the Hammer Falls as China Nails Corruption
Curiosity is one reason the website of the Central Discipline Inspection Commission (CDIC)
attracts up to 2 million page views every day.
Another reason is fear. Some website visitors, for example, want to know whether they or
anyone they know has been targeted by a government campaign to root out corruption led by
the CDIC Inspection Team.
28 july 2014
Since the campaign began in December 2012, 33 high-level government and state company
offcials — all in positions at the deputy provincial level or higher — have come under
investigation for violating laws or Communist Party rules. Each has been removed from offce
and detained. Some have been kicked out of the party.
Scores of executives, managers and bureaucrats on lower rungs of the ladder have been
affected as well by CDIC, which reports directly to party brass and functions outside the realm
of the nation’s judicial system.
The campaign began shortly after the 18th National People’s Congress with the December 2,
2012, detention of Li Chuncheng. Li, who was then serving as a deputy party secretary for
Sichuan Province, was taken into custody by CDIC offcials less than a month after being named
an alternate member to the party’s 205-member Central Committee.
In recent weeks, the campaign has intensifed. Losing their jobs in June were Jiangxi Province
party offcial Zhao Zhiyong; China People’s Political Consultative Conference (CPPCC) Vice
Chairman Su Rong; Shanxi Province Deputy Governor Du Shanxue; Shanxi Province CPPCC Vice
Chairman Ling Zhengce; and Guangzhou’s party secretary, Wan Qingliang.
Perhaps the most powerful party offcial to fall in recent weeks was Xu Caihou, who served on
the 25-member Politburo and as vice chairman of the Central Military Commission, the party’s
highest authority on the military.
No one knows for sure who might fall next, which makes the website — http://www.ccdi.gov.
cn/ — a must for anyone following the anti-corruption crackdown. These followers include
members of the general public, ardent campaign supporters and a few cautious critics.
The critics include some party members who fear the CDIC may be going too far. Some of them
argue that the crackdown could threaten everyday operations at targeted companies, the
nation’s economy and even government stability in China.
Anxiety is running high, for example, at the state-run oil company China National Petroleum
Corp. (CNPC), where chief accountant Wen Qingshan was placed under investigation in
December and deputy general manager Bo Qiliang was probed in May. Previously removed were
more than a dozen executives, including top brass like the company’s petroleum planning
department general manager Wu Mei, Indonesia operations general manager Wei Zhigang,
and Iran operations general manager Zhang Benquan. Other CNPC executives axed since 2012
included Wang Yongchun, Li Hualin, Ran Xinquan and Wang Daofu.
CNPC sources said that high-level managers are so worried about these investigations that they
have drawn up a contingency plan for flling any position left vacant after a CDIC inspection.
As part of the plan, all mid- to upper-level company managers must contact department heads
daily. Anyone who does not report is considered gone, and replaced the next day by a pre-
approved successor.
28 july 2014
Amid the anxiety at CNPC, other state companies and government agencies in the bull’s eye of
CDIC inspectors, some offcials have asked whether it might be time for the campaign to slow
down, easing the pressure on the nation’s party members. These go-slow voices include party
supporters who worry that the campaign could tarnish the public’s view of the government and
party. Others wonder whether the campaign is hurting economic growth and the productivity of
offcials, some of whom are laying low in hopes of avoiding the inspectors.
“The shock created by the anti-corruption campaign inside and outside the party is
unprecedented,” said Professor Cai Xia of the Central Party School’s Party Construction
Education and Research Department. “The shock and deterrence it has exerted on the thinking
of cadres is also unprecedented.
“It’s evident that, at this point, very few cadres are risking any violations of party discipline
But supporters of the campaign point to its necessity at this stage of China’s modernization —
and its long-term benefts.
One source close to the CDIC said most of the corrupt activity uncovered in government
agencies was related to sales of government-owned land, mine development and transportation
infrastructure projects. State-owned enterprises have been implicated in underhanded schemes
involving project bidding, equipment procurement and overseas acquisitions.
“These areas just happened to be at the center of gravity during China’s high-speed
urbanization and industrialization era,” the source said. “No nation has ever been able to avoid
paying this kind of price during such a period. Not Britain, the United States, South Korea or
Japan. This period is always rife with corruption.”...
All the Conditions Are There for an Explosion
SPIEGEL: Mr. Diskin, following 10 days of airstrikes, the Israeli army launched a ground invasion
in the Gaza Strip last week. Why now? And what is the goal of the operation?
Diskin: Israel didn’t have any other choice than to increase the pressure, which explains
the deployment of ground troops. All attempts at negotiation have failed thus far. The army
is now trying to destroy the tunnels between Israel and the Gaza Strip with a kind of mini-
invasion, also so that the government can show that it is doing something. Its voters have
been increasingly vehement in demanding an invasion. The army hopes the invasion will fnally
force Hamas into a cease-fre. It is in equal parts action for the sake of action and aggressive
posturing. They are saying: We aren’t operating in residential areas; we are just destroying the
tunnel entrances. But that won’t, of course, change much in the disastrous situation. Rockets
are stored in residential areas and shot from there as well.
28 july 2014
SPIEGEL: You are saying that Prime Minister Benjamin Netanyahu has been pressured to act by
the right?
Diskin: The good news for Israel is the fact that Netanyahu, Defense Minister Moshe Ya’alon and
Army Chief of Staff Benny Gantz are not very adventurous. None of them really wanted to go
in. None of them is really enthusiastic about reoccupying the Gaza Strip. Israel didn’t plan this
operation at all. Israel was dragged into this crisis. We can only hope that it doesn’t go beyond
this limited invasion and we won’t be forced to expand into the populated areas.
SPIEGEL: So what happens next?
Diskin: Israel is now an instrument in the hands of Hamas, not the opposite. Hamas doesn’t
care if its population suffers under the attacks or not, because the population is suffering
anyway. Hamas doesn’t really care about their own casualties either. They want to achieve
something that will change the situation in Gaza. This is a really complicated situation for
Israel. It would take one to two years to take over the Gaza Strip and get rid of the tunnels,
the weapons depots and the ammunition stashes step-by-step. It would take time, but from
the military point of view, it is possible. But then we would have 2 million people, most of
them refugees, under our control and would be faced with criticism from the international
SPIEGEL: How strong is Hamas? How long can it continue to fre rockets?
Diskin: Unfortunately, we have failed in the past to deliver a debilitating blow against Hamas.
During Operation Cast Led, in the winter of 2008-2009, we were close. In the last days of the
operation, Hamas was very close to collapsing; many of them were shaving their faces. Now,
the situation has changed to the beneft of the Islamists. They deepened the tunnels; they are
more complex and tens of kilometers long. They succeeded in hiding the rockets and the people
who launch the rockets. They can launch rockets almost any time that they want, as you can
SPIEGEL: Is Israel not essentially driving Palestinians into the arms of Hamas?
Diskin: It looks that way, yes. The people in the Gaza Strip have nothing to lose right now, just
like Hamas. And this is the problem. As long as Mohammed Morsi of the Muslim Brotherhood was
in power in Egypt, things were going great for Hamas. But then the Egyptian army took over
and within just a few days, the new regime destroyed the tunnel economy between Gaza and
the Sinai Peninsula, which was crucial for Hamas. Since then, Hamas has been under immense
pressure; it can’t even pay the salaries of its public offcials.
SPIEGEL: All mediation attempts have failed. Who can stop this war?
Diskin: We saw with the most recent attempt at a cease-fre that Egypt, which is the natural
mediator in the Gaza Strip, is not the same Egypt as before. On the contrary, the Egyptians
are using their importance as a negotiator to humiliate Hamas. You can’t tell Hamas right now:
“Look, frst you need to full-stop everything and then we will talk in another 48 hours.”
28 july 2014
SPIEGEL: What about Israel talking directly with Hamas?
Diskin: That won’t be possible. Really, only the Egyptians can credibly mediate. But they have
to put a more generous offer on the table: the opening of the border crossing from Rafah into
Egypt, for example. Israel must also make concessions and allow more freedom of movement.
SPIEGEL: Are those the reasons why Hamas provoked the current escalation?
Diskin: Hamas didn’t want this war at frst either. But as things often are in the Middle East,
things happened differently. It began with the kidnapping of three Israeli teenagers in the
West Bank. From what I read and from what I know about how Hamas operates, I think that
the Hamas political bureau was taken by surprise. It seems as though it was not coordinated or
directed by them....
Charts That Make You Go Hmmm...
Source: WRI
28 july 2014
The number of disconnects that are building up in various parts of the fnancial
system is troubling, but every now and again one pops up that is just too crazy to ignore; and
today, courtesy of Zerohedge, we have one such chart.
As they ask:
Does this look like a “recovering” economy fve years after a central bank unleashes its
extreme monetary policy?
Well I have to answer in the negative, but it’s the punchline from Zerohedge that really sparks
the imagination:
Just what happens if interest rates ever rise?
What indeed...
Another great chart from Tyler and the boys at Zerohedge, this time highlighting
what they call “the new scariest chart in America,” courtesy of the True Economics blog of
Constantin Gurdgiev.
This recession — in case you needed reminding — is not like any we’ve seen in several
28 july 2014
Nick Laird of the wonderful Sharelynx.com website keeps tabs on the change in gold
holdings of the Central Bank of Russia, and depite all the sturm und drang surrounding the
country at present, one thing remains constant: the bank’s appetite for gold bullion.
Another 500,000 ounces made its way into the vaults of the Central Bank of Russia in June
of this year, and as you can see from Nick’s great chart below, not only has the trajectory of
Russia’s accumulation changed dramatically since 2008, but since mid-2006 there have been
only four months when minor sales were made.
Source: Sharelynx
28 july 2014
Words That Make You Go Hmmm...
Even Canadian TV is catching
on to the fallout from François Hollande’s
pernicious policies...
Art Cashin is a true legend on the foor
of the New York Stock Exchange.
In this interview with Eric King he discusses
the skittish nature of the stock market as it
digests geoopolitical worries and some poor
earnings from Amazon and Visa, the unrest
in the Middle East, problems in the currency
markets and, of course, Russia.
As always, Art’s is the voice of reason in an
often unreasonable world and one you should
listen to.
Jim Rickards discusses the
June FOMC meeting, Janet Yellen’s July
congressional testimony, the fact that the
Fed Chair is now stock picking, and his belief
that Effcient Markets Theory is junk science.
Possible market crashes, asset freezes, and
bail-ins — Jim goes into great detail in an
excellent interview that is as broad as it is
28 july 2014
and fnally...
Watch in astonishment as marriage expert Mark Gungor explains the difference
between men’s and women’s brains in a little over 13 minutes.
Who knew THAT could be done?!
28 july 2014
Grant Williams
Grant Williams is the portfolio and strategy advisor to
Vulpes Investment Management in Singapore — a hedge
fund running over $280 million of largely partners’
capital across multiple strategies.
The high level of capital committed by the Vulpes
partners ensures the strongest possible alignment
between the frm and its investors.
Grant has 29 years of experience in fnance on the
Asian, Australian, European and US markets and
has held senior positions at several international
investment houses.
Grant has been writing Things That Make You Go Hmmm... since 2009.
For more information on Vulpes, please visit www.vulpesinvest.com.
Follow me on Twitter: @TTMYGH
YouTube Video Channel: http://www.youtube.com/user/GWTTMYGH
PDAC 2014 Presentation: “Gold and Bad: A Tale Of Two Fingers”
ASFA Annual Conference 2013: “Wizened In Oz”
66th Annual CFA Conference, Singapore 2013 Presentation: “Do The Math”
Mines & Money, Hong Kong 2013 Presentation: “Risk: It’s Not Just A Board Game”
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making any specifc recommendations in this publication.
28 july 2014
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