What Is The Real Price of Anything?

The intersection of where supply meets demand is the point where prices get set.

demand supply curve

This lesson is the basis of all classes on economics. It was drilled into me at college and graduate school by my professors.  The principal is the basis of all economic theory implemented by Wall Street as well as government officials.  Without it there would be no way to measure and track prices.

However, given the economic stagnation that has permeated the U.S over the last eight years, the U.S. has gone on a money printing scheme the likes of which the world has never seen. The Federal Reserve, the United States central bank, has “printed” more than $2 trillion since the global economic crisis began in 2008. This has more than tripled the size of its balance sheet.  Prior to beginning this paper money creation spree, the Fed held $950 billion in assets; now it holds nearly $3 trillion.” (This number is dated and actually much higher today). Since we had no demand, the U.S decided to print more money (supply) so that people would actually go out and purchase things as well as invest in order to increase demand.

The basis of sound investing is the principle that you earn a good rate of return given sound fundamentals. However when so much money is printed and flooded into the economy, the price of things naturally goes up; and, its at this point that investing becomes quite difficult. At that juncture, you have to decide if the investment looks good on its merits, or looks so because the amount of money that is in circulation is causing the price to go up.

Investors throughout the world grabbed the billions being created by the government and made bets on certain sectors where they thought they could make money. A rising tide lifts all boats; but, as business magnate, investor and philanthropist Warren Buffett said, “when the tide goes out you get to see who’s been swimming naked.”

To understand the consequences of this, take a look at oil.

Spending on global oil production has increased by around 350% since the early 2000s. Back then, the global oil exploration and production industry was spending around $150 billion a year on capital investments. By 2013, that figure had grown to more than $500 billion a year. In the U.S. alone, the 50 largest oil and gas production companies in 2013 invested nearly $200 billion into new production.”

The U.S discovered so much oil that its now the second largest producer of oil in the world. Drivers in the U.S are ecstatic that they are now paying less at the pump. But these lower prices are a result of the billions of dollars that went into that industry. What about the investors who poured that money into oil?

The industry is in trouble  because a lot of the capital used was raised via debt.  Since 2007, total debt in the U.S. exploration and production sector has gone from $125 billion to almost $300 billion.  Much of this debt is destined to default. These defaults are going to wipe out many companies and many investors.

These defaults are a direct result of too much money chasing too few goods. The investors thought they were making good decisions; but, the influx of all this money tricked them. The investments in oil were made because the price of oil was high and investors could borrow money easily. Most investors in this space had no idea that the price of oil would drop dramatically. But, when you have smart people and $300 billion dollars flooding into the oil sector, the inevitable happened: they found more ways to extract oil from the earth.

The oil sector is not alone in this phenomena. In the end, the flawed decision by policy wonks to create more cash to get the economy going will cause much more capital destruction.  Last year along renewable energy attracted $329 billion. I believe much of this money will be destroyed as well.  Even as money pours into that sector, defaults are already surfacing.  Sun Edison, a solar company valued at $10 billion  a year ago is facing a $1.4 billion default.

This money creation has also effected many real estate markets here in the U.S.  Major cities, such as Manhattan and San Fransisco, have seen prices skyrocket as the wealthiest people in the world have bought homes in order to make money from the certain price appreciation. The rich know that when the government turns on the printing presses it is time to trade dollars for assets. The poor and middle class do not have this opportunity available to them as they do not have the disposable dollars to invest. Once again those sectors of the population will feel the brunt of this as they get priced out of these markets.

The decision to print money to bolster the economy will not end well. History is replete with examples showing that no country has ever spent its way to prosperity. The same way households have to contract spending and make priority decisions on necessary spending when attempting to wipe out debt, so too nations. After 2008, the U.S had a chance to clear the decks and eliminate many companies that had made bad fiscal decisions and were on the verge of collapse.  Instead, the financial sector as well as the auto industry were “rescued (read: “bailed-out”) instead of allowing them to go under. Those bad debts did not disappear. The government just restructured them and printed a boat load of money hoping the problems would go away. They did not. They remain…bigger and worse than before.

We now have a second default wave coming from the oil and renewable energy sectors that, once again, will put us in the same or worse peril than did the housing crisis.

Don’t kill the messenger.




Death and Work

I use to work at a bond shop where seventy percent of the people that worked there are now dead.

When I moved to NY in 1994, I worked at at bond brokerage shop. For those unfamiliar with the business of brokering bonds, here is a brief primer. The major banks trade bonds all over the world with their clients, and if they can’t find a counterpart for their trades they will use bond brokers to sell or buy bonds for them. The business is very lucrative, but it is very demanding and stressful. A mistake at work can cost you your job and it can cost you lots of money.

trading pitI worked with a collection of characters that made each day an adventure. Frank M., my boss, was brilliant. He had been taught by some of the most brilliant minds in finance. Aside from that, he talked to himself all day long and would think nothing of suddenly breaking into an array of Broadway tunes. Rich C., a recovering alcoholic, was Frank’s partner. He was  so paranoid and manipulative that the two of them would literally have fist fights every few weeks.  In his previous career, Rich had worked on a cruise ship and as he put it, he was “the male companion for all of the older lady’s on the cruise.” Joe K., a repo broker  who used to print money all day long, could talk non-stop for hours. He had 5 kids and loved his family dearly. Antonio R., from Italy, spoke as if he had marbles in his mouth. Nobody could ever understand a word he said and he used to jet set every weekend to someplace new. He was rumored to have been super wealthy with a ton of money stashed away in the Caribbean. Rob W., so fat he would break a chair every week because the chairs couldn’t withstand his weight, would eat all day long nibbling on donuts and coffee that inevitably left stains all over his shirt. John S., a non nonsense tough guy from the Bronx, used to have such great relationships with his clients they would bend over backwards to give him business. Finally there was “Jimmy the Fish.” Jimmy was the youngest guy on the desk. He gambled all day long and was always  hung over and had a  disheveled look about him.

They each died young. And tragically. I have always maintained that desk was cursed and by the grace of God the curse passed me by. Most of them died as a result of the attacks of 9/11 as the majority of them worked at brokerage shops in the World Trade Center. After the attacks happened I knew that could have been my fate had I stayed in that business.

In 1996, I left the bond brokerage business of my own accord, even as I left a lot of money on the table as I knew the business would have killed me. In order to be good in the bond brokerage business, I had to go out five times a week. Many times I would have to play golf on the weekends with my clients (even though I don’t like the game and I am not very good at it). After 2 years I became so run down physically and spiritually I knew I had to get out. The tipping point came when I ran into a colleague of mine who worked at a different company. He proceeded to tell me that he had not spent a single night at home in three years as a result of all the entertaining he was doing to secure business. The guy looked like the walking dead and he knew it; but he was so hooked on the money he could not give it up. Tragically, he committed suicide about 10 years later. He walked into the woods in winter, took some sleeping pills and froze to death.

The other reason I left that business was that I knew the bond brokerage business would eventually have the margins squeezed out of them and the business would become primarily electronic. I don’t know how I knew but I did and for that I am grateful.

The lives of those with whom I formerly worked who still survived have been a mixed bag. Sean M., a fast talking Floridian who went bankrupt and got divorced, had to start over. Fred A. and Lisa A. have not worked in years. Wanda L., became a Jehovah’s witness. The rest of we lucky few moved on and have been able to find our own definition of happiness in life.

When I mentioned to my colleague Gil , who worked with me on that desk, about the “cursed” he looked at me with awe and terror. It seems he had never really looked at the brokerage desk in quite that way. When I mentioned that besides the tragedy of 9/11,  two of  our colleagues died after 9/11 (Jimmy the Fish died in his sleep at 34 while Bobby W. died in a hospital from obesity) Gil said he had never analyzed all the tragedy that had befallen our co-workers and was genuinely shook by my analysis. I  do believe I was blessed with a certain intuition that I followed. Perhaps my surviving colleagues would feel the same if asked.

As for now, I am in a new phase in my life. I’ve learned the importance of listening to and following the promptings of my gut. I am walking proof those messages are given for our protection and well being. All we need do is open to the possibility and trust in the guidance.

Steve Clark