know what you need to know
Investors, do you know what you need to know?
There are only two fundamental values that produce investing behaviors. By the way, investing behaviors (such as buying, selling, and borrowing) produce prices. In other words, prices are just measurable indicators of patterns of behavior, which are just indications of one of two values.
So, when prices change, that indicates a change in the behaviors of buying, selling, and borrowing, which indicate a shift in values. That is, when values shift, then resulting behaviors shift, and then resulting measurements of price shift.
Therefore, it is important to know what these two fundamental values are which influence prices and changes in pricing. It is also important to know how to tell which one of the two fundamental values is prominent, and to know how to adapt to a fluctuation between the two values.
First, the two fundamental values are:
Note that security is listed first because it is primary. In the event of a sudden decrease in perceived security, opportunity will be abandoned in favor of security. However, investors may be very interested in which opportunity offers them what they perceive to be the very best opportunity (among however many opportunities available), but comparing opportunities is only interesting (valued) when a sense of security is already perceived to be present.
So, how can we tell whether security or opportunity is the dominant value? We can simply look at behavior!
Of all investing behaviors, (buying, selling, and borrowing), the one behavior that most clearly evidences a focus on opportunity is borrowing. While “desperation borrowing” might indicate a focus on security on the part of the borrower, all borrowing requires lending, right?
Lending only happens when lenders are secure. So, all lending indicates an underlying sense of security on the part of the lender. When lenders are secure enough that they offer to lend, only then may borrowers agree to borrow. So, even when borrowers are borrowing out of desperation, that still indicates an underlying security on the part of the lenders.
In particular, lenders only lend when they are secure about two particular things. First, lenders must be secure that the local mercenary operations (called civil courts) are going to be reliable to collect their legal debts using organized violence. Second, lenders must be secure that not only will they be able to hire mercenaries of the court for third-party collections who will be willing and able to collect on their behalf, but also that borrowers will have some accessible assets to cover the debts owed. (Even if we presumed that some or all lenders were willing and able to directly collect debts without resorting to the use of the hired mercenaries of civil courts, the lenders still would only be secure to lend to a particular borrower when they expected to be able to securely collect their debts from that borrower.)
So, all borrowing indicates a willingness to lend. All lending indicates an underlying sense of security on the part of the lender as well as a matching sense of opportunity on the part of the borrower.
In fact, we could simplify further and suggest that there is only one primary value, which is security. When perceived security is increasing, people evidence that by talking about opportunity. The focus on opportunity itself indicates an underlying security. However, when perceptions of security are diminishing, any prior focus on opportunity can be quickly interrupted, abandoned, and even altogether forgotten.
So, lending is a behavior that indicates security on the part of the lenders. We can occasionally count the total amount of borrowing and then use that number counted as an indicator of changes in perceived security, at least on the part of lenders.
If the amount of total borrowing rises, that could indicate an increase in perceived security. If the amount of total borrowing drops, that could indicate a decrease in perceived security. If the amount of total borrowing is steady, that could indicate stability in the perception of security.
You may or may not already know what has happened to total borrowing in recent decades (at least in the US). Many people are aware that borrowing by certain governments has ballooned dramatically in recent decades. Many people are also aware that borrowing for the purchase of real estate has ballooned dramatically as well.
Before we review any particular trends of a certain subcategory of borrowing behavior, like borrowing for real estate speculation or for government spending, we could consider the rate of the ballooning. Has the ballooning of borrowing been increasing year after year, or just growing steadily, or growing less and less each year?
For instance, you may already know that borrowing for real estate speculation in the US had been growing faster and faster for quite a while, but then slowed down and recently decreased dramatically. What does all of that indicate about the changing behaviors of lenders and borrowers? Could it indicate a change in expectations and even a change in values (as in a change in priorities)?
So, you may not know which indicator of lending activity is the most easily available to you. Would you like to know? Again, this measurement clearly indicates the perceived security of lenders, and any changes in perceived security (their sense of current security) and the emphasis or value or priority of investing specifically in financial security (as distinct from investing in opportunity).
When investors lend money to the US government, that contract is called a bond (or a treasury note). A certain rate of interest is established in the contract, and that percentage is called the “yield.”
It is relatively easy to get current information on the current open market rate for yields on lending money to the US Treasury. While a great deal of attention may be placed on stock markets and other prices which can change quickly (like gold or oil), most financial news publications and websites report the going yields on various US treasury contracts.
Generally speaking, it is common knowledge that interest rates for loans in the US (or for most loans at least) have been dropping for the last 30 years. Yields on all loans to the US government have also dropped in a downward wave or “trend channel” for that same 30 year period. What does this well-known 30-year trend mean?
It means that lenders have been more and more secure in lending out money. When lenders perceive a high degree of risk in the possibility that they make not get back the money they are lending to the borrower, they demand higher interest rates. However, when lenders are so secure that they are trying to aggressively attract borrowers, they offer lower interest rates. All of the above applies regardless of the lender and the borrower, even when the borrower is the US government.
The behavior of lenders is a primary indicator of perceived security. Again, among the most easily available measurements are the current open market rate of interest for lending money to the US government.
Those numbers indicate variations in the confidence of actual lenders that lending their own money to the US government is the among the very most valuable possible uses of their money. When lenders are offering to lend money to the US government at lower and lower interest rates (as has been the case generally across the last 30 years) they are voting with their money, implicitly saying “we think the US government is a secure borrower. We think they will actually pay us back (or why would we lend to them) and we also think that the money they pay us back, including interest, is a better investment than ALL OTHER AVAILABLE investments, like such that we would be able to buy more things with that amount of money at the end of this loan period than we can buy now with the amount of money we are risking by loaning it to them.”
Of course, when banks wish to attract borrowing from investors, such as “deposits” for savings accounts or CDs, they also have been offering less and less interest over the last 30 years. So, when investors lend money to the US Treasury or to banks for little or no interest, they are indicating their preference over using that money for any other purpose, such as for speculation in real estate or stocks or commodities or simply starting a business, etc….
So, here is a chart of the last few years of the yield or going interest rate on lending money to the US Treasury for a period of 1-month:
Note that starting in 2004 the interest rate rose in a steady trend channel until flattening in 2006 (multiplying by several times), and then actually fell by more than 95% by early 2008. By late 2008, the yield for open market lending to the US government for a 1 month contract had fallen all the way to 0% interest, and has stayed near or at 0% since then.
While lending money for 0% interest, even for only a single month, may seem a bit odd, it is not an entirely new phenomenon. For instance, investors lent money to Japan in the 1990s for 0% as well. When currencies are rising in purchasing power, the same amount of money can buy more things a month later.
Also, many forecasters (including me) specifically forecast that interest rates for lending money to the US government would drop all the way to zero (just like in Japan in the 1990s, for instance). This behavior evidences what some economist call “deflation.” Technically, deflation means a relative decrease in the supply of the total of cash and credit available. When investors lend money to the governments of Japan or the US at 0% interest, that indicates that the investors are expecting a decrease in the total amount of liquidity for that currency.
While many people may presume that liquidity can always be injected by central banks “printing more cash,” it is also possible for liquidity to decrease. In fact, it has happened repeatedly in the history of financial markets, most famously in the 1930s in the US and Europe.
Sometimes lenders and borrowers decrease their appetite for entering new contracts regarding promises for some uncertain future performance (which we might loosely call “futures contracts”). They may value the security of an immediate completion of the exchange of valuables, with “no loose ends.”
The promise can be to deliver a certain amount of a currency or a completed roof project or a certain number of livestock or slaves or tanks or soldiers. Note that contracts involving money are only one type of “future contract.” A contract could be that by a certain future date, a certain party will deliver a certain amount of oil in exchange for a certain amount of gold from another party. The specific things exchanged in the contract often include currency (money), but that may be somewhat incidental.
So, back to the recent history of the last 30 years and the last few years in particular, investors have been increasingly valuing lending their money to the US government. In contrast, the prior eagerness of lenders to lend money in the US for real estate speculation (both residential and commercial) has decreased each of the last few years, generally decreasing more each year, though it had been rising dramatically for a few decades before that. Overall household debt in the US (including credit cards and auto loans and so forth) has also decreased, following decades of ballooning acceleration.
Consider that lending data clearly show that the prior value of the opportunity in real estate speculation of prior decades has started, accelerated, decelerated, plateaued, peaked, and reversed. Overall borrowing by households has done the same, even though borrowing continued to grow even after overall household net worth plateaued and reversed. Further, overall borrowing by businesses in the US (as well as the net worth of businesses) has shifted as well.
Many cities, states, and private companies have had financial challenges recently such that analysts and lenders agree that many businesses (large and small) are less and less credit-worthy then they have been for decades. Some, such as General Motors, continue to operate only through the involvement of US government funding.
Of course, some industries, such as the military, weapons manufacturing, and education, have been essentially government-run sectors for perhaps over a century. The growth of influence of governments in general and the federal government in particular have been enormous in recent decades, mainfesting through direct government operation (such as courts, mass transit and primary schools), direct government subsidy (like through medicare benefits or purchasing weapons ), or preferential government-backed loans (like to college students even at private institutions or for real estate speculators who do not have enough financial stability to qualify for a private loan, based on private lenders’ estimations that those borrowers would be relatively unlikely to repay).
Now, it is fair to admit that the actual information indicated in the two charts of this presentation, the next one to follow shortly, are themselves very simple and relevant. However, would you be able to recognize the clear message in these charts without some commentary? I offer the extensive commentary and interpretation to give added urgency to the clear message of these charts. By the way, what is the message we see in the following chart?
Well, let’s start with the red line. It is the same red line as in the above chart: the dropping of yields that lenders are willing to offer when loaning money to the US Treasury for 1 month. Again, it fell over 95% from early 2007 to early 2008, soon falling the rest of the way, to 0.
The blue line shows the change in the yields for 1 year borrowing by the US Treasury, which peaked in 2006. Then, yields collapsed from mid-2007 to early 2008, with new lows in late 2008, late 2009, and now falling again toward a new all-time low.
Again, both the red line and the blue line clearly indicate that multitudes of investors think that the best thing to do with their money for the next month (red) or year (blue) is to lend it to the US Treasury for little or no interest. In other words, they value the security represented by the people doing business as the US Treasury, including the courts and militaries which operate in association with that Treasury. The investors may even think that in a month or in a year, their money would buy more then than it would now. In other words, they may be expecting the purchasing power of dollars to rise or even soar, such as if there was continuing weakness in lending markets, real estate prices, stock prices, and commodity prices.
The green line is the open market yield for 10 year US Treasury notes. It double-peaked in 2006 and 2007. Then it bottomed in late 2008 at an all-time low. Next, it pushed up to a few similar peaks, finally resuming a downward pattern in recent months.
Again, bond market investors (lenders) clearly are valuing the security of 10-year debts owed to them by the US Treasury. Considering that prices of the US stock market are down from 10 years ago, as well as a lot of US real estate, why would bond market investors reverse their 30-year pattern of increasingly valuing the alternative of lending money to the US Treasury?
The pink line tracks the stock market value of the 500 biggest companies in the US. It peaked in late 2007, which was after bond market yields reversed. Then, in 2008, a few months after bond market yields started falling from their multi-month rebound, US stock market prices plummeted. In early 2010, shortly after 10-year bond yields fell, US stock prices followed.
While the media focuses the attention of the public on the possibility that US stocks will exit their decade-long waivering and return to the historically unprecedented upswing of the 1980s and 1990s, how much media attention is given to the historic lows in the open market lending rates that lenders have been volunteerily demanding from the US government? Why such aggressive lending to the US Treasury, even while lending is shrinking to real estate speculators and corporations and smaller units of government?
For instance, investors could have been lending money to the government of Greece or Portugal for 8% or 12%. Why instead lend to the US (or Japan) for 3% or even 0%?
Perhaps investors overwhelmingly value the security they associate with the US (and Japan). Perhaps investors are foregoing the opportunity to make 12% returns because of concerns that Greece (or Illinois) will default rather than repay (as well as any concerns that the currency repaid by the Greek government may decrease in purchasing power).
Further, perhaps investors presume that the US government will continue to pour funds in to the US stock market, further bailing out auto-makers, banks, and of course people who have invested in those industries. Maybe soon the government will be the primary funder or direct provider in the US of education and roads as well as cars, banking services, health care, housing, and, if controlling all of those industries, why not also of jobs?
There are many labels for a government that operates in such a way. I will simply note that some people may value living in places in which open market competition is at least legal if not actually encouraged.
As I have long said in relation to the US government pouring money in to the auto industry, of course that would produce a surge in stock prices as “the taxpayers” assume the risk of owning those nearly bankrupt companies. I consider that an excellent opportunity to exit for people who currently own shares of those companies.
Some ask: “is it fair to subsidize investors who invested in the auto industry?” Of course it is not fair, but I ask this: how wise is it to reward the businesses that have been least successful (as in least responsive to the values of the marketplace)? If the US auto industry did not earn the support of the buying public, who apparently instead favored such things as lending money to the US Treasury, does changing who owns an auto-maker automatically change in any way the fundamental long-term value or viability of the struggling business?
When the USSR or China began nationalizing private companies, did that shift of ownership result in efficiency and innovation? Or wasn’t it the US that became famous worldwide for competitiveness, productive efficiency and innovation, followed by places like West Germany, Japan and Korea? Well, maybe now it is time for places like India and Taiwan and even Mexico to emerge as centers of growth and opportunity.
In review, borrowing in the US (and elsewhere) has dropped drmatically and apparently has evidenced a long-term reversal of behavoiral trends, in accord with the forecasts of many analysts including myself. Perhaps lenders just do not value accumulating more debts owed to them by real estate speculators, corporations, or struggling states like California, Illinios, and New Jersey. Lenders value the security they associate with the US Treasury, and after 30 years, the only close competition to the US Treasury for conservative lenders are banks and credit unions, who also are offering no more than a few percent interest in exchange for lending them money.
The future of prices is clear for US real estate, US stocks, and global commodities… unless some new source of buying power is redirected to those investments. But from where? The lending “well” may have already dried up. When the mainstream recognizes this reality, prices will probably have already collapsed.
By collapse, I do not just mean the 1 day double-digit decline of stock prices as in October 1987 or of silver in April 2006. Whatever the speed of the drop, and it may be record-setting, I continue to forecast a long decline, such as that of Japan for the last 21 years or even that of the Soviet Union or the Ottoman Empire.
For now, the most prominent market in the world that is registering all time highs in investing behavior is the open market for US Treasury debt, evidenced by new record low yields. However, that 30-year trend could eventually change, perhaps within a decade from now. (Note that gold’s recent all-time highs are actually far below the 1980 peak if adjusting for inflation. Similarly, silver is currently down more than 80% from 1980 if adjusting for inflation- a dismal 30 years, notable for people who are repeating the 1979 arguments for long-term precious metal investing.)
On that note, you may remember a time when the phrase “adjusted for inflation” was much more common. Get ready for “adjusted for deflation” or even a neutral term like “adjusted for currency fluctuation.” The 1980s and 1990s are over, similar to the 1970s and 1860s and 1700s.
Are there places in the world where lending and borrowing are growing overall? Yes. The US, UK, and EU are just not among those places. Even in Japan, an emerging leader in high technology and productive efficiency throughout the 1970s and 1980s, the social mood is much more reserved. After 21 years of deflation in Japan, security may still be valued over opportunity.
In other places, recent decades have meant tremendous increases in security, stability, infrastructure, and competitiveness. Where momentum is building, opportunity is ripe. Once upon a time, the US was such a place- as was Japan, Rome, Persia, Sumeria, and so on.
- The Steady Rise of the Auto Loan Industry (loans.org)
- Peer-to-peer lending: How to borrow from and lend to ordinary people (confused.com)
- Peer-to-peer lending challenges tigh-fists banks (blogs.confused.com)
- P2P Lending of Personal Loans (loans.org)
- Reid Hoffman Wants You to Invest His Money (inc.com)
- Families’ home-buying dreams shattered as banks get tough with new parents (dailymail.co.uk)
- Looking to Borrow? An Audited Financial Statement Can Help (bjconquest.com)
- Nationwide is latest lender to crack down on interest-only mortgages (telegraph.co.uk)
- No, Uncle Sam Should Not Live ‘High on the Hog’ (theatlantic.com)
- How a Bank Determines How Much You Can Borrow for a Mortgage (rentersinsurance.com)
- Savills says there are more lenders (realestatepublishing.wordpress.com)
- American Greed. (isellerfinance.wordpress.com)
- SGmoney | Money Lender | Payday Loan | Personal Loan | Loan in Singapore (sgmoneysg.wordpress.com)
- Bringing Wenzhou’s Black Lenders Out Of The Shadows (chinabystander.wordpress.com)
- Beware taking on ‘bargain debt’ (business.financialpost.com)
- The U.K. is Battling Payday Loans Just Like Us (loans.org)
- OFT slams lenders for risking borrowers homes (confused.com)
- New loan shark laws unveiled (nzherald.co.nz)