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The Investing World In 10 Objects

What do an old German bank note, a current $100 bill, and an apple all have in common? The answer, according to ConvergEx's Nick Colas, is that these simple objects can tell us much about the current investment scene, ranging from Europe’s economic challenges to the U.S. Federal Reserve’s attempts to reduce unemployment. Colas takes an “object-ive” approach to analyzing the current investment landscape by describing 10 common items and how they shape our perceptions of reality. The other objects on our list: a hazmat suit, a house in Orlando, a barrel of oil, a Rolex watch, a butterfly, a heating radiator in Berlin, and a smartphone.

 

Via ConvergEx's Nick Colas,

Imagine a radio program about the 100 most significant pieces in the British Museum. At first blush, this would seem to be a stupendously bad idea. Art is visual, after all, and radio is about the least visual medium out there. Still, the BBC did such a series a few years ago and the overwhelming success of the program led to a book titled, predictably enough “The History of the World in 100 Objects” that went on to be a New York Times bestseller.
 
The idea works, even in radio format, because it simplifies large swaths of human history into identifiable works created by real people down through time. You might know very little about the situation in China 1000 years ago, but a statue or painting from the period allows you to relate to a community of actual human beings who lived, loved, worshipped and died there. Not just the world, but history itself, gets smaller and more approachable when viewed through this lens.
 
We can do the same with the world of investing and economic analysis, distilling many complex topics to their essential core.  For the sake of brevity, let’s take 10 – rather than the 100 from the BBC series and book – and see how far we get.  Here’s our take on a list:

1.       A Hazmat suit. Certainly the object-du-jour with worries over Ebola, Personal Protective Equipment (PPEs in the health care trade) is actually several layers of gear designed to eliminate the chance of disease transmission.  They are hot to work in and require extensive training to use properly. The suits need to be donned in a certain way and fully decontaminated afterwards. Any slip up in the process means potential exposure.

 

To investors and anyone else watching the news, the appearance of an individual in a hazmat suite symbolizes risk and fear of the unknown. The fact that healthcare workers in Dallas contracted Ebola despite their use also highlights the failings of the U.S. health care system in addressing the disease.   Reporting on Ebola in the last few days has become more reassuring about the small chances of a large scale epidemic, but the fear remains. 

 

2.      A House in Orlando. There have been boom-bust cycles in Florida residential real estate since the 1920s, but the housing bubble of the mid 2000s certainly touched the greatest number of people. In July 2006, the average house in the Florida city went for $236,000, according to Zillow. By December 2010, that number was $95,000. Anyone who had put the standard 20% down at the peak was in the hole by over $100,000 on their equity. Values have now risen to $134,000 for the typical Orlando house, but are obviously well below their peak and not even back to the $154,000 average from 2004. 

 

The U.S. housing bubble of the mid 2000s casts a number of shadows beyond consumer spending in America. First, it made investors and regulators acutely aware than such speculative excess can be obvious – and avoidable – even when it is still in full force.  Whether they learn anything from that is another matter. It also made investors keenly aware of “Bubbles” as a construct and there is an active cottage industry in calling them out wherever they may (or may not) exist.  Lastly, the U.S. housing bubble was just the latest proof that even in a technology-enabled 21st century world, human nature hasn’t changed a drop since tulip bulbs were the next “Big Thing”.

 

3.      An apple. The Fall of 1930 in America brought two things: a full dose of the Great Depression and a bumper crop of Washington State apples. Those two features of the landscape joined forces in New York City, where unemployed men sold cheap surplus apples at 5 cents apiece as a means of making ends meet.  The image is one of the most durable symbols of the hardships of the age. 

 

This period in American history has cast a long shadow on economic policy.  You can trace the Federal Reserve’s extraordinary bond buying programs directly to the humble apple through Ben Bernanke’s acknowledgement – in 2002 – that the Federal Reserve had been wrong to contract the supply of money during the Great Depression. That observation assured that when the time came, the Fed would go in the other direction with ultra-low interest rates and quantitative easing. 

 

4.      A German banknote from the early 1920s.  If the apple is a powerful symbol in America of the ravages of the Great Depression, then the German Papiermark – the nation’s currency from 1914 to 1924 – holds the same position for that country. Germany was saddled with essentially impossible reparations payments after World War I, and tried to print their way out of the problem in the early 1920s. This led to hyperinflation, economic collapse, and – at least tangentially – the rise of National Socialism. 

 

This national history with rampant inflation informs the German perspective on monetary policy to this day. In the decades before the adoption of the euro, the German Bundesbank was a famously tight-fisted operation, leading to a post-War economic revival unparalleled on the Continent.  Now, its history with hyperinflation (horrible) and cautious monetary policy (excellent) informs its approach to solving the threat of deflation in Europe. In short, it will be very hard to convince Germany that a U.S. – style large-scale bond buying program is a good idea.

 

5.      A barrel of oil. There are 42 gallons in a barrel of oil, a figure that originally dates back to 1860s America and the first wells in Pennsylvania. Producers took a standard 40 gallon whiskey barrel, a common container of the age and region, and added 2 gallons to inspire confidence in buyers that they were getting their money’s worth.  Fast forward to today, and according to the U.S. Energy Information Administration the world currently consumes 92 million barrels per day.

 

Prices for crude oil have been falling precipitously, from $104 in late May to $83 on Friday. Market watchers view that decline with alarm for two reasons.  The first is that oil demand is a good proxy for global economic growth, given the commodity’s ubiquity in both energy, chemical and plastics production.  The second is that the drop creates concerns over global deflation.  While lower energy prices may create a tailwind for consumers’ wallets going into the Holiday shopping season, their decline also stokes concerns over a recession in Europe, a cooling Chinese economy, and the durability of the recovery in America. Those old whiskey barrels mean a lot…

 

6.      A Rolex watch. A new Rolex Submariner, made famous by movie icon Steve McQueen, will set you back about $7,000. A Timex Ironman (Presidents Bush and Clinton wore them, for what its worth) will set you back about $35 on Amazon, and keep better time than the Rolex with far less maintenance.

 

Why would you spend more for a product that does less?  Because you can, and you want everyone to know that.  That makes the Rolex a convenient hook upon which to hang one of the decades most discussed topics: income inequality.  This is far from a fringe topic, as Fed Chair Janet Yellen’s Friday speech highlights.  How her perspective – sympathetic to the problem but troubled by what practical solutions exist – might inform Fed policy in coming years is hard to know, but it clearly weighs on her mind. 

 

7.       A butterfly. American mathematician and meteorologist Edward Lorenz once famous asked, “Does the flap of a butterfly’s wings in Brazil set off a tornado in Texas?”  It was an elegant example of a basic notion: in an interconnected world, small changes can have outsized – and unpredictable - effects.

 

The Financial Crisis probably started with a late mortgage payment on a house in Phoenix or Las Vegas – the butterfly flapping its wings that eventually caused the tornado on Wall Street and beyond. We now live in the aftermath of that storm, and struggle to make the global financial system more robust.  Banks must have more reserve capital now. Money market funds now have liquidity fees and redemption gates for institutional shareholders. Financial institutions need “Living wills”. Does the butterfly care?  Probably not. 

 

8.      A U.S. $100 bill. Think the world is going exclusively online when it comes to payment systems? Think again. The U.S. Bureau of Engraving and Printing, part of the Treasury Department, launched a new $100 bill last October and it has been a runaway success.  To date in Fiscal 2014, the BEP has printed over 600 million notes, worth +$60 billion.  In the two prior fiscal years, Treasury printed over 7 billion $100 bills, worth +$700 billion.  According to the Federal Reserve, most of these bills circulate overseas. 

 

The humble “Benjamin” is a good touchstone for the concept of a “Reserve currency” – a globally accepted means of exchange. Since the end of World War II, that has been the U.S. dollar. If you wanted to buy gold or oil, you generally needed dollars. This is changing now, as different countries try to reduce their dependence on the greenback. China is trading with EU countries directly, with newly established euro/yuan convertibility.  Russia sells oil and gas to China, taking yuan rather than dollars. How this will change global demand for U.S. Treasuries or the dollar itself, it is too early to tell. One point worth mentioning, however: the largest Chinese banknote is 100 yuan. Worth about $16. 

 

9.      A heating radiator in Berlin. According to a recent article in Deutsche Welle, Germany’s national media company, more than 70% of the country’s energy supply depends on imports.  Russia alone accounts for a quarter of the country’s coal, oil and gas imports.   

 

The key question is, of course, how will this shape Germany – and therefore Europe’s – response to the Ukraine crisis? While ISIS and Ebola have dominated the headlines in recent weeks, Russia’s involvement in the Ukrainian civil war is an important and unresolved issue. Winter is coming, and with the cold Russia’s political leverage increases exponentially. Germany is already teetering on recession without an energy crisis.  How this conflict shapes headlines in the coming months could do much to either roil – or calm – capital markets. 

 

10.   A smartphone. We will finish on an upbeat note – the role of technology in society.  Since the dawn of the Internet, users needed a personal computer to go online. Various efforts to bring low-cost PCs to the emerging market never really caught on, leaving most countries seriously behind the adoption curve. Now, Gartner Group expects 71% of all global phone shipments to be Internet-enabled smartphone. The affordable PC is finally here, and it makes phone calls too.

 

The implications for personal freedom, commerce and social advancement are profound. Communication is cheaper with free services like WhatsApp, the texting service recently acquired by Facebook. Online price discovery and shopping bring information and choice to billions of consumers and small businesses. Myriad chat services enable everything from social connection to political dissent. The smartphone is certainly the one object that will make the most difference over the next decade to the greatest number of the world’s population.