Ted Auch

The Dow Jones Industrial Average (DJIA) a group of 30 companies that are supposedly an adequate proxy of Capitalism’s Temperature is under a great deal of flux. Recently we saw the removal of Citi and GM replaced by Travelers Corp. and Cisco Systems. GM had been on the Big Board for 83yrs, with only General Electric (November 1907) having a longer tenure. General Motors was one of “…the original 12-company Dow index created by Charles H. Dow in 1896. (GE has been in and out of the index three times.)” All the more reason to be disturbed given that Citi only joined the club in 1997 only to merge with Travelers, which was later spun off in 2002 (http://blogs.wsj.com/marketbeat/2009/06/08/gm-citi-officially-get-boot-from-dow-industrials-at-bell/). This comes on the heals of AIG’s removal from the DJIA in September (http://www.nytimes.com/2009/06/02/business/02dow.html?ref=business). Oh yeah and the other shoe has yet to drop given that Bank of America, which only joined the DJIA in February of 2008.

It used to be that the S & P 500 a more holistic index was well correlated with the DJIA and was approximately 12% of the DJIA.

As both have expanded in volume we see the ability of the DJIA to account for the S & P’s variability remains at 99% when plotting the annual relationship from 1950 to 2009.

However, if we hone in on 1997 to the present, the point at which futures – universally acknowledged as precursors to the toxic instruments we all now know and love (ie CDOs and CDSs) – began to be publicly traded (See “The day the signal died!”, May 18,2009) we see that while the S & P remains 12% of the DJIA the latter now only accounts for 82% of the former, which means the signal:noise ratio has essentially declined by 17% in 12 years. This roughly translates to an increase of 1.38% year over year.

While on the surface this value appears trivial it gains import when compared to annual Global GDP in the last ten years, which has hovered around 3.04-3.97% per year or more locally here in the US 5.02% per year between 1999-2008. In other words US and Global macro- and micro-economic markets are embedded with variance factors equal to 27.5 and  39.3% of US and Global GDP, respectively.

So, if the developed world continues to grow at a rate of 2.46% per year and the Dow Jones/S & P 500 decoupling continues to propagate we will see noise accounting for 52-56% of actual statistics, which even for the non-statistician has to be unsettling. What we are seeing is a decoupling of High & Low Finance, To Big To Fail & To Small To Matter, and a shift from an onus on Goods to Services here in America and the developed world. We are also seeing that once robust predictors of corporate growth are being usurped by associated noise. As we see goods being replaced with services and bank assets climbing as a % of GDP, which presumably will result in higher fractions of the DJIA being allocated to financial services, it can safely be assumed the days of a 99% DJIA Vs S & P relationship are safely in the rear view mirror. Consider for a minute the fact that US commerical bank assets stand at 70% of GDP a whopping $9.69 trillion, which doesn’t speak at all to the proliferation of hedge funds ($1.6 trillion, 12% of GDP),  investment banks OR for that matter the graying of the line(s) between commerical and investment entities following Senator Phil Gramm (R-TX) and Representatives Jim Leach (R-IA) and Thomas J. Bliley’s (R-VA) gift to the folks on Wall Street in 1999 (http://www.nytimes.com/1999/11/05/business/congress-passes-wide-ranging-bill-easing-bank-laws.html?scp=4&sq=Gramm-Leach-Bliley%20Act%20November%201999&st=cse; http://topics.nytimes.com/top/news/business/series/the_reckoning/index.html).

This basically means that in the past if investment banks sneezed commercial banks would be there with chicken soup and offer to drive them to the emergency room. Now however if those same investment bankers sneeze commercial banks (i.e. US) will most assuredly catch a cold. Not sure if 1500mg of Vitamin C will help though! Some might say we should look towards or European brothers and sisters. Well think again! Swiss bank assets equal 6.8 times GDP and the banks of the once robust Celtic Tiger were as of late 2008 approximately 9.5 times Ireland’s GDP (http://www.nytimes.com/2009/03/05/business/worldbusiness/05swiss.html?scp=1&sq=Ireland%20Switzerland%20GDP&st=cse). Scary thought I know and a long way out most certainly, but inconceivable I doubt it!

Are there ways to reverse this inertia? Of course there are but it will require engineers of capitalism and society as a whole to embrace the “Scorched Earth” principal. We need look no further than the field of ecology for examples of how this principal has done wonders for certain ecosystems, most notably the native grasslands the US and Russia, the savannahs of South America and Africa, and the pinelands of the Southeastern US. It has been shown quite conclusively at this point that these systems require periodic fire and subsequently reset to a vigorous stages of early succession. However, fire can be grouped into 2 broad categories: i) infrequent, intense, and spatially expansive or ii) frequent, mild, and spatially discrete or patchy. The former tend to not only reset biological clocks but also hinder initial succession, while the latter simply tidy up the joint a little.

The economic analog would the S & P requiring category 2 and the DJIA category 1. Many will be hurt under either scenario, but the long-term health of our economy and more importantly (to some!) capitalism hinges on successful implementation of a Scorched Earth paradigm along with political discipline in the face of irrational rhetoric reflecting the irrational exuberance we all languished in during the good times. It seems at least qualitatively that macro-economic forces de facto subject the S & P to mild and infrequent resets, however, it also seems these same forces are determined to protect those in the DJIA from a category 1 type of disturbance. The results will be a complete divergence of the two indices and the apparent creation of 2 sets of rules. This type of contrived and against-the-grain muscling will blow up in the faces of all it’s proponents, including the politicians that champion(ed) it.

The globalisation of our economy is resulting in more nuanced and noisy data. Simply bailing out the To Big at the expense of the To Small will only exacerbate the problem. As it stands we are choosing cosmetic over structural/functional surgery. I for one would much rather look under the hood than take the word of the salesman wouldn’t you?

It appears that the Obama administration is going to hand over the reigns of their Public Private Investment Program (PPIP) to the money manager BlackRock, which is on the surface awfully similar to handing over the security responsibilities in Iraq and Afghanistan to a private contractor. Wait that did happen and boy has it turned out swimmingly (http://www.thenation.com/doc/20060828/scahill; http://www.thenation.com/doc/20070528/scahill) with the outsourcing approved by the Bush administration and lucrative contracts given to companies like Blackwater, Triple Canopy, and KBR (ie Kellogg Brown and Root a subsidiary of Halliburton). If the actions of Blackwater in Baghdad’s Nisour Square in September of 2007 are any indication of what happens when the government privatizes crucial responsibilities we had better get ready to duck! (http://www.nytimes.com/2007/09/21/world/middleeast/21blackwater.html?scp=2&sq=Blackwater%20Nisour&st=cse).

Privatization is increasingly the trend with the federal government and it is exactly the remedy for what ales Grover Nordquist & Co. vis á vis describe in their “Starve the Beast” complex (becker_2001_starve-the-beast-article1; bartlett-2007_starve-the-beast1; http://www.nytimes.com/2003/09/14/magazine/the-tax-cut-con.html?scp=1&sq=Tax%20cut%20con&st=cse), which simply states we should gradually or suddenly reduce all taxes, which would force the Federal Government to shrink. This will be the case if the the debt to GDP ratio in the U.S. continues it’s dramatic upward trajectory from 58% at the start of the Bush administration to a historical high of 70% last year. Yeah I know fiscal conservatives will argue that big government = big deficits and that is the downfall of democracies. Well not according to none other than Dicky Cheney who in meeting with the administration’s economic team in 2002 stated “Reagan proved deficits don’t matter,” WAIT Cheney said that? The Dick Cheney? The same Dick Cheney who Mr. Nordquist presumably idolizes? Yep. Yep. And Yep! Turns out he was talking about short-term impact according to William A. Niskanen then of Reagan’s Council of Economic Advisers and now at the Cato Institute (http://www.washingtonpost.com/ac2/wp-dyn/A26402-2004Jun8). Of course we should have know that it was short-term, why would any neocon think about the long-term health of anything let alone the federal government? If we privatize our tax dollars via Blackrock-like partnerships as Mr. Geithner’s PPIP is suggesting than we de-insentivize the private companies responsibility. Our indebtedness to China will go up while the folks at Blackrock and PIMCO will get off scot free. Classic heads I win Tails You Lose scenario!

The reason why this % increases is not so much a function of government spending as many Adam Smith and Milton Friedman economists would have us believe but rather a result of increasingly smaller tax revenues. Again we are not talking about the regressive idea of increasing payroll taxes (ie poor folks suffering disproportionately) but rather the drastic cuts we have seen in income, inheritance, and capital gains taxes all of which lead Warren Buffett to conclude that his secretary hands over a greater % of her income than he does.

Now what does this all have to do with Blackrock? Well Blackrock just happens to be 47% owned by Bank of America and it seems that The Great Timmy Geithner has figured out a way to give Ken Lewis & Co. the $33.9 billion his bank will need to proceed according to Mr. Geithner oh so stressful “Stress Tests” (http://www.nytimes.com/interactive/2009/05/07/business/0507-bank-stress-test.html). He will do this not by directly handing over the capital to BofA but rather letting Blackrock’s oracle Laurence Fink invest it for him seeing as how Geithner and Mr. Fink are quit chummy back to the former’s days as the head of the NY Federal Reserve Bank (http://online.wsj.com/article/SB124269131342732625.html).

It is amazing how many people Timmo is friends with or has done favors for I feel like he is to the financial services industry what George Bush was to the Military Industrial Complex and Religious Right. Anyway you might ask well why doesn’t Geithner just give the money to BofA? Well besides the fact that they have already been given $45 billion and are 6% owned by Joe The Taxpayer (http://www.nytimes.com/2009/01/17/business/17bofa.html?scp=1&sq=Bank%20of%20America%20government%20aid%20total&st=cse) there is a little something called AIG, which really didn’t go well for the Feds.

In bailing out the giant insurer we found out in March that much of the money went towards foreign banks like Société Générale and Deutsche Bank ($12 billion each), Goldman Sachs ($12.9 billion), Merrill Lynch ($6.8 billion), and the aforementioned BofA ($5.2 billion). This incident demonstrated the incestuous nature of the financial services industry, the power of Goldman Sachs, and that these companies operate with incredible degrees of hubris and impunity two characteristics not so coincidentally used to describe Blackwater (http://www.nytimes.com/2009/03/16/business/16rescue.html?dbk). We’ll see if the general public catches on to the hypocrisy of going in on an investment in toxic assets with a company almost half owned by BofA.

This type of blurring of the lines that should clearly separate the public and private sectors can be traced back to the repeal of the Glass-Steagall (1933) Act via Phil Gramm and Jim Leach’s Gramm-Leach Bliley Act of 1999. More importantly and much earlier the taxpayer was made the prime guarantor of all Savings & Loan (S&L) deposits, while allowing S&Ls to lend more aggresively (ie predatory lending) via the Garn-St. Germain Depository Institutions Act of 1982. These crucial laws had broad bi-partisan support. However, I would imagine if they were given to the public to vote on without the DC double-think and -speak we would have laughed them away outright.

As for Blackwater they were a result of a President and VP who were in bed with the Military Industrial Complex (On Steroids!) and the Oil Companies and why shouldn’t they be they stood to profit greatly upon returning to the private sector where much of their blind-holdings are undoubtedly in the $1.16 trillion industry.

Blackrock will likewise benefit greatly from only putting up 7cents for every dollar of investment, while we will invest 7cents and the FDIC will loan the remaining 85 as non-recourse loans to the banks, meaning if they aren’t happy with the way things are going they can just walk away. Wouldn’t it be nice if we could do that with student loans? This company has $1.3 trillion in assets or 9% of US GDP in 2008. You would think with all these assets and a 47% stake BofA could fund their own damn bailout? Unfortunately if you had such a crazy notion you would be dead wrong.

SO as I think we now know what Rahm Emanuel meant when he said “Never let a serious crisis go to waste!”. It essentially means, in DC parlance, that when a crisis comes down the shoot it is time to convince folks that preemptive war is good, torture is necessary, action without thought is patriotic, and…….. giving money to those that least deserve it is necessary to avoid Armageddon. Oh yeah what about privatization of our military and our tax dollars? Well you’ll thank us later! I think not and I think we have an administration now that is dangerously close to being changed rather than being the agent of change! Bush had his Blackwater scandal and I think if Obama ain’t careful he’ll have an equally if not greater hubbaloo with Blackrock.

Let me get this straight if an energy source is finite and came into being over a geologic scale it is fair to pay less as we deplete it but if it is ubiquitous and markedly easier to access we should pay more? That doesn’t make sense to me I mean don’t we have to pay an order of magnitude more for a Ferrari then we do a Tato Nano? Furthermore don’t we pay equally disparate fees for handcrafted furniture, jewelry, or pastries then we do stuff at Ikea or a Hostess Cupcake? Now that makes sense but the initial example makes absolutely none and needs to be dealt with here in the US ASAP. What makes us so special that we were at the height of the oil bubble paying $3.37 and folks in Britain, Italy, and France between $8.06 and $8.33 a gallon?

Are we owed this discount and if so why? Everyone knows by now that we consume ~ 25% of the world’s energy. Additionally, each of us is responsible for 15.1-23.6 tons of CO2 per year ranging from a low of 7.2 in the nation’s capital to 123 Tons of CO2 per year in Wyoming, with nearly 20% of this coming from transportation related needs.

It is true that China and India are emitting a lot with rough respective totals of 7,150 and 1,210 Tons of CO2 annually.

However the latter on a per capita basis pale in comparison with 5.5 and 1.1 tons per capita CO2 annually.

All these trends roughly, although not as well as you might think, with prosperity as is evidence in the graph to the right.

You may say you’re just a self-hating American and I would respond only when I/we deserve it and only when we arrogantly disavow logic and certain norms accepted the world over, because for some systemic and at this point cancerous reason we feel entitled.

Did you know that those statistics I mentioned earlier include a 12% gas tax for us and >55% for the Euros?

They get it and the reason they get it is that they have been forced to work with their neighbors, both locally and within the union to offset their many years of insensitive and short-sighted practices. Again some will retort that the US will do the same in good time and I would note that Churchill’s notion that Americans always do the right thing once we tried everything else is not an option at this point.
Any politician worth his or her backbone would have left the price of fuel where it was last summer or maybe even kept raising it! Yeah I know political suicide and boy would I feel really bad for any politician who really told the American people what they really needed to hear. Wait one such politician did his name was Jimmy Carter and the moment was his now famous and probably in his mind infamous “Malaise Speech”. The former president sounded much like a parent would when trying to curb the mindset of a spoiled child. Only in Mr. Carter’s case the dog was too old, had no interest in new tricks, and would bite the hand of anyone who said otherwise. This is an example of a prescient politician who paid the ultimate price for his honesty. Aren’t we always looking for honest politicians? The answer is no we just portend that is what we want when really we desire someone who looks just as good on his ranch as he does on an aircraft carrier, at a barbecue, or on a basketball court. We want a Big Brother who will demand that our needs as a nation are met, whether that comes at the expense of other nations, plants, animals, or fish so long as the price of gas plummets the masses will be pacified. The challenge of reversing this inertia has been gleefully passed from our erstwhile “leader” to Barack Obama, who in my opinion is the smartest man ever to hold this office and truly understands the concerns of this country irrespective of tax bracket. However, the jury is still out as to whether he will have the conviction and long-term vision to shower us with the tough love we as a nation so rightfully deserve. My confidence in this occurring is in the words of Gen. David Patreus “fragile and reversible”. This cynicism could easily be transformed into elation if President Obama conveyed to the American people that the only tool they have to stabilize oil prices is driving less and that they need to come to the realization that the laws of supply and demand and matter conservation dictate that anytime demand exceeds supply the consumer pays the ultimate price, whether we like it or not. This is not so much a matter of national security as it is a question of what if anything we want to leave for future generations. Rome is burning folks and all we’re worried about is how much the arsonist is paying to commit the crime.

There is a bipartisan notion perpetuated by industry and many politicians – specifically those so utterly disconnected from their home states/districts true needs – that natural resource exploitation and large agricultural infrastructure is the key to job creation. Just a little hint before moving further if you hear this rhetoric spewing from a politician’s mouth inquire as to their primary donors. Anyway this is one of the biggest if not the biggest lies being sold the American public today and the data buttresses my argument quite robustly. Here it is in black and white when production increases whether it be in the coalmines of West Virginia or cornfields of Iowa what happens is a massive shift towards mechanization, with larger and larger combines or draglines, or Komatsu front-loaders.

The latter able to move tons of earth or overburden allowing relatively uninhibited access to the coal seam, which by the way are increasingly smaller and smaller requiring less laborious methods or more dangerous exploration of deeper seams. This is evidenced in the exponential growth in surface mining throughout the US a method that requires markedly less labor then its underground alternative. Thus, if you look at the debate in simple output:input ratio terms, with # employed as the input, you will see an inverse relationship developing quite rapidly in recent times, which is to say that large multi-nationals like Massey Energy were extracting 5,087,150.3 short tons per thousand works in 1985 and managed to nearly triple this ratio (~290.2%) to 14,762,463.5 short tons per thousand works. Keep in mind the fact that total coal extraction in the US has only increased by 129.6% since 1985.

How you ask would one go about counteracting this 160% profit disparity? Well you can start by purchasing larger and large equipment, vast swaths of land, breaking the systemic will of the UMW of America, and insuring that crimes against labor like the recent tragedies in Utah and West Virginia go virtually unpunished. If you own the hearts and minds of people like the governor of West Virginia, Senators Byrd and Rockefeller and McConnell, and the supreme courts of many coal producing states you don’t need carrots and frankly you don’t really have much need for sticks either.
If you buy that the above ratio is a valid measure of workplace efficiency and by association a primary driver behind the decline in jobs related to natural resource exploitation and agricultural production then let’s apply it to the farm sector specifically corn to see if it still holds up. The answer is as you could probably guess by my tone is that it does indeed and is slightly more robust in this instance. It turns out that if you look at data associated with corn production in the US at five year intervals since 1910 you will see that that the total number of farms and workers are currently 66.1 and 78.2% of what they were at the turn of the century, while production and output:input have increased by 347.6 and 1,595.4%, respectively.

This suggests that one of two things is occurring, either we are getting better at how we manage our agricultural lands vis à vis chemical fertilizers, pesticides, etc and crop-rotation or our current farmers are on steroids, which I am not ruling out but would hope is not the case.
This is a marked increase in “efficiency” by any standard begging the question: Why not get more from less? The answer is of course that there is no surficially viable reason, but more to the point portending that more coal mining brings more jobs when you know the exact opposite to be true is quite the bait and switch wouldn’t you say?
It is true that neither underground nor surface mining is great but it is underground mining, while extremely dangerous and liable to create vast stability problems down the road, that has traditionally been the engine employing much of Appalachia. This method imbued a greater sense of community and unification that was/is anathema to the coal companies and their strike breakers so vividly depicted in “Harlan County KY”. Much of the debate around “clean coal”, which if you ask anyone from Appalachia is a complete whitewashing, centers around jobs as does the research and production of biofuels and it is true that if done right these industries do create jobs. The fact is that since 1949 when much of the high grade anthracite-type coal was still available surface-mining accounted for 25.3% of all mined coal in the US whereas today it accounts for nearly 70% or 794,263,579 short tons. Furthermore, anthracite coal extraction has declined from 8.9 to 0.14% of all coal extracted in the US during the same period, with a parallel decline in jobs from a high 1,737,000 miners in 1985 to 776,000 in 2007.
So, what we have are two lies being pushed down the throats of Appalachia and America writ large: 1) exploitation of our mountains and arable lands is a perpetual large-scale benefit to the job market and 2) that clean coal and biofuels will benefit the environment, Appalachia, and industry. According to Judy Bond of Coal River Mountain Watch “Even if you could get rose petals to come out of the smokestacks, coal is filthy and will never be clean as long as mountains and communities are blasted and streams and communities are poisoned…The entire cycle of coal must be examined. We in Appalachia are blasted by over 3 1/2 million pounds of explosives daily and are similar to a “banana republic”. The coal industry is allowed to simply kill us slowly with toxic waste.” So, in plain English folks the only ones benefitting are John D. Rockefeller, WV Supreme Court Justice Brent D. Benjamin, and the pious head of Massey Energy Corporation Don L. Blankenship.

It was June 5th, 1997 a day that at first glance seemed quite innocuous. However, there was nothing insignificant about this day from a financial services perspective as it was the day that the Dow Jones & Company signed license agreements for three exchanges to begin trading in the nascent futures market (http://www.nytimes.com/1997/06/06/business/after-15-years-dow-jones-lets-futures-trade-on-its-average.html?scp=2&sq=Norris%201997%20futures&st=cse). Initially Dow Jones was hesitant for fear of excessive market manipulation, but later determined regulations were sufficient to allay such fears. According to an article at the time by Floyd Norris in The Times an editor at the Wall Street Journal John Prestbo felt “…that trading in the Dow derivatives would have little if any effect on market volatility.” Well this appears not to be the case at all. In looking at the historical record for the Dow Jones and NASDAQ I came across a very curious divergence that was initiated on or around June of 1997. It turns out that prior to that month and year what the Dow opened at was a fairly (R2 = 76%) robust linear predictor of their volatility throughout the day, previous day, and next day.

However, post-June 1997 this relationship was non-existent. The same is evident for the NASDAQ, however, the change in predictability declines by 26% vs the 76% for the Dow.
This is fascinating to me and I think it speaks to what we in the biological community refer to as “Buffer Capacity” or “Poise”. That is to say how well a system in this case the Dow & NASDAQ are equipped to handle a perturbations or in the ecological world invasive species. Regardless the point is that all those who were sure that futures were good for business writ large appear to be wrong and furthermore their contentions as to the level of volatility associated with futures are greatly underestimated, given that the data presented here demonstrate even short-term/daily swings in the market have become increasingly difficult to forecast post-futures. This happened to coincide with a considerable uptick in the ratio of Gross Domestic Purchases (BDPu) to Gross National Product (GNP), more than double the increase from 1980-1987.

It is becoming clear from this data that two things are happening at an accelerated rate in the markets: 1) volatility and risk are increasing at an unsustainable exponential rate and 2) the corporate world and financial “institutions” are working very hard to constrain the popular rhetoric so as to promote consumer spending at an equally unsustainable level. Why? Because the multi-nationals, banks, and insurers are assuming – and rightfully so to this point – that the former orgasmic spending will counterbalance the latter’s total disregard for future generations or their fiduciary responsibilities down the road.
This is the message our in-the-pocket of the banking industry Treasury Secretary and National Economic Adviser Timothy Geithner and Lawrence Summers will not tell us. The more this volatility increases the more the American citizen will pay for it, whether it be lessening mark to market accounting regulations, non-recourse loans for the folks engaging in the PPIP, or outright fraud in the case of AIG and the cozy relationship Geithner’s predecessor Henry Paulson had with virtually everyone on Wall Street. Consider that Bush told us to go out and spend after 9-11 and now this administration and congress are telling us that we should spend. Is spending the solution to everything? The solution is understanding that capitalism has tons of problems and one is the boom-bust nature of it all. Well in nature there are those systems that require fire to regenerate and if they don’t get it at timely intervals productivity stagnates. Furthermore, in these systems there are 2 types of fire regimes with one being frequent, mild, and spatially confined to small areas, while the other is an infrequent, spatially broad, and intense scouring of the land. We need the latter desperately, but what we don’t need is a bunch of tricky financial instruments and an over reliance on consumer spending to get us out of this. These amounts to using the frequent mild fire to resuscitate an ecosystem in desperate need of a complete overhaul. The fat cats on Wall Street might need this for their substantial egos and bank accounts, but it is time we decouple from this Oligarchic way of running things as Simon Johnson stated recently in The Atlantic. They can afford & indeed thrive on the amazing daily volatility of the markets, because they always get their share of the pie, but we can’t because we didn’t, don’t, and won’t if this aggregation of wealth continues based entirely on our insatiable appetite for stuff!
Norris F (1997) After 15 years, Dow Jones lets futures trade on its average. The New York Times (p 1). New York, NY