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“Housing is the best single indicator of whether you’re heading toward a financial crisis” ~ Ken Rogoff (2009)

Bubbles amidst the Nordic Countries garner less attention than others. I still like a long – short portfolio of REITS and Banks, with longs concentrated in Japan, US, Germany, Ireland, et al. vs shorts in China, Australia, Brazil, Canada, Denmark, et al. and . CNBC

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Rogoff and Reinhart (2008)

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‘Credit expansion and real currency appreciation have been the most significant predictors of financial crises’ ~ Gournichas & Obstfeld (2011)

Overall credit growth is quite high, highlights LATAM and Brazilian Bubble too

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Kenya is my favorite stealth bubble:

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Valuations:

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The BIS, the central bank’s central bank, published a paper entitled “Interpreting TARGET2 Imbalances” by Cecchetti, McCauley, and McGuire (2012).

BIS international banking data, by contrast, point to the importance of TARGET2 balances as a symptom of a reduction by core European banks of credit previously extended to borrowers in peripheral Europe. These same data suggest that banks headquartered outside the euro area, particularly UK banks, boosted TARGET2 balances by hedging redenomination risk. As such, TARGET2 balances reflect not only concern regarding actual credit exposures but also potential currency exposures.

Ed Yardeni published a few charts of Target 2 Imbalances. Figure 1 shows that despite the reduction in interest rates, and the ECB’s pledge for unlimited printing, Target 2 Balances remain quite high.

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Cecchetti, McCauley, and McGuire (2012) believe this suggests both foreign and European banks continue to harbor doubts about Europe’s future. 

The downtick in France’s (red) target 2 imbalances is also noteworthy. I’m very negative on French bonds.

The large exposure of German banks to the rest of Europe partly explains the willingness of Germany to back “extend and pretend loans” and ECB printing.

However, German banks are taking advantage of the programs to cut and run from Europe:

…the stock of German banks’ claims on peripheral Europe has fallen by roughly one half since their pre-Lehman peak, from just under €600 billion to €300 billion.

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Graph 9 shows British Banks want out of Europe:

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I have suggested on several occasions that Germany could be among the first to leave the Euro. One could argue this is happening; of course, this trend could reverse.

Catalysts for Germany removal: a. Europe pushes through laws for joint Euro bonds despite Germany’s resistance or b. Europe otherwise passes resolutions that threaten Germany’s sovereignty.  

The less risk German banks have to the rest of Europe, the more likely German removes itself. Regardless, Target 2 balances are worth watching.

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The literature shows that any benefit to tax revenues in the years following tax hikes are offset by reduced revenues from slower growth in future years.

Over twenty peer reviewed studies confirm the research below by Christina Romer, former Obama administration economic advisor. Romer is also from Berkeley, so not exactly a conservative supply sider.

Europe is the out of sample. The consolidation had been initially false promises for cuts and tax hikes. It failed until payrolls and benefits were reduced.

This has implications for the dollar and bonds over the long term if politically biased investors believe this will help solve the debt when it will not.

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On crisis early warning signs:

"Certainly, one of the indicators is looking at credit bubbles. There is a lot of evidence for that. I think central banks need to go back to looking a lot harder at what’s happened to credit throughout the cycle. It’s an indicator that has fallen by the wayside."

Actually, Bernanke says he can only forecast out two or three quarters. He rightfully associates credit growth with stronger GDP growth; but of course, this generally results in a crisis over the long term. 

"Housing bubbles are another indicator."

"It’s hard to know the exact timing."

On Recovery:

Typically housing takes five or six years

Unemployment can take double that.

On Countries:

Does not see another crisis around the corner, unless that comes from Europe or Japan

Europe and U.S. could be something like Japan, but talk of Greece is hyperbole

  • wish he had commented on California

Lot of signs of bubbles in China

On Policy:

"tax hikes hurt proportionally more than spending cuts”

Current fight is just a skirmish in a war.

“I see the President’s strategy – the long term strategy – let’s raise taxes on the wealthy, then let’s do it again, then let’s do it again, and finally go the people and say this isn’t enough.”

Supportive of printing, wants higher inflation, thinks there is more to come.

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Phil Tetlock has been studying professional forecasters, penning a book on the matter.   In an interview with Edge.com, he shares what he’s learned.

One of the biggest surprises:

“I was assuming that political analysts were in the business of making accurate predictions, whereas they’re really in a different line of business altogether. They’re in the business of flattering the prejudices of their base audience and they’re in the business of entertaining their base audience and accuracy is a side constraint. They don’t want to be caught in making an overt mistake so they generally are pretty skillful in avoiding being caught by using vague verbiage to disguise their predictions.”

Practically speaking:

“We found three basic things: many pundits were hard pressed to do better than chance, were overconfident, and were reluctant to change their minds in response to new evidence.”

Here are ten steps to more effective forecasting:

    1. Discount your forecast due to the “overconfidence bias”
    2. Play or appoint a devil’s advocate.
    3. Actively hunt for new information that counters your thesis.
    4. Follow people with a track record of successful calls, more to learn about techniques used than for their current calls.
    5. Think and speak in probabilities, not certainties.
    6. Never mistake a clear view for a short distance.
    7. Document your forecasts and review mistakes.
    8. View mistakes as an opportunity to learn.
    9. Avoid forecasting everything all the time.
    10. Defer to models and/or aggregated crowd views unless there is data or information that cannot be modeled, or information not widely known.

The Fox vs the Hedgehog Forecaster, by Philip Tetlock

Philip Tetlock, The Expert who Models Experts

Model Thinking Notes I from Stanford Class

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