FAQ - Frequently Asked Questions
... and some just plain interesting Q&A
How did you put together all those predictions?
As you can imagine, we're not going to give away all the formulas and relationships that go into them, but will say in general how it was done. We started out with the basic definition of inflation. We then applied it by locating all sorts of different goods and money data from many sources, including but not limited to all the ones mentioned in our definition of money measures. As a rough guess, about 80% of the data comes from the FRED database at the Federal Reserve site here. Then we plugged all that data into a set of huge Excel© computer spreadsheets.
Next, by a very long process of trial and error, plus adding different time lags and weights to the various numbers, we came up with the basic predictions. By weights, we mean that items like Bank Credit get a much higher weight than for example Currency since the amount of credit available is much more important to money growth than printed currency in circulation. By time lags, we mean that different types of money take differing amounts of time to get into the economy. For example again, tax refunds or Fed Open Market Operations get into the economy faster than changes in a money measure called M3 (M3 is defined in money measures).
Lastly, in order to modify the basic prediction model to match a particular market like the stock market, we did more research and located factors that specifically affect it and then added them into the prediction matrix. One example that's part of the set of stock market adjustments is program trading percentages and dollars (data available here).
The whole process started from being curious to see if the basic definition of inflation and deflation could be directly translated into predictions, and we were quite surprised at the results too. Do note that like almost anything, not only are they not 100% accurate but also eventually the formulas will cease to work well at which time we'll go back to the drawing board. Also note that there are at least two significant missing elements in all the predictions - any objective measure of human fear and any allowance for unexpected events like terrorism or calamities, etc.
(Note for folk with a large economic background: there are many adjustments and factors for more exotic methods of money creation represented by GSEs, ABSs and MBSs, hedge fund activity, fractional reserve banking, etc. There are also adjustments for GDP hedonic factors on the goods side.)
How is the CPI calculated and what's wrong with it?
- The offical government CPI FAQ on how its calculated, etc.
- Some of the issues we have with it under stating what is actually happening and the way its incorrectly calculated are:
- It is frequently incorrectly called or promoted or understood as a cost-of-living index, and was not designed for that purpose.
- Most taxes are not included.
- Substitutions are done when something goes up. If beef goes up and chicken doesn't for example, chicken prices are used instead of beef prices.
- On housing prices, something called "homeowners equivalent rent" is used even though over 2/3 of the people in the US live in a non-rented home, so any large increases in housing prices are not included.
- On cars, used car prices are used instead of new car prices.
- It does not attempt to measure a standard of living.
- It does not address many changes in health care, quality changes in products included, water and air quality, crime levels, consumer safety, or educational quality to name a few.
- Political bias exists to keep it lower than actual since many government payments are based on it.
- Various other statistical errors and biases.
- See hedonics, which also applies.
- Comparison of CPI rates before & after Boskin Commission changes were implemented, courtesy of Financial Sense.
- For a much more detailed discussion of this issue, see The Core Rate.
- One specific from June 2005 statistics; the CPI component for gasoline showed a 6.9% increase since June 2004, while the actual retail price was up well over 20%.
How does one know when to sell during a mania?
- Study past manias to help identify them. See the false data page for examples.
- Notice that prices usually go almost vertical in the last stage.
- Notice that at the peak "everybody" thinks its a sure thing.
- Notice that they can go far beyond what any rational interpretation would allow.
- Use technical analysis and especially trend lines on a price chart that represents the item.
For U.S. housing for example, the Philadelphia Housing Index and the Dow Jones REIT Index work for us.
How are markets manipulated?
From a Technical Analysis view, the following 50 year old quote from R.W. Schabacker, the father of modern technical analysis, applies in showing how the public can be manipulated. This is also known as chart painting.
"Insiders and professionals are by no means unaware of the growing public interest and education in chart theories and patterns. In normal trading there are certainly not enough chart traders to make it worthwhile for the professionals to play against them instead of against the general public, but we have learned that the professionals must play against someone in order to make money. It is quite conceivable, therefore, that the insiders might take a ‘crack’ at chart traders now and then by manipulating false patterns in their campaign stocks, with the knowledge that, by arranging certain chart pictures, they could draw in a certain amount of buying or selling, as they chose, with a view to strengthening their own position."
How is money created in the U.S.?
First, don't expect an easy answer. Also, don't expect that it is a fully sane or believable process either. Some of the answers below are deceptively simple, don't necessarily expect to understand them quickly.
- The system of fractional reserve banking.
- The Federal Reserve, by virtue of its ability to set certain interest rates, can encourage or discourage borrowing and therefore affect item #1.
- The Federal Reserve doing open market operations.
- Banks borrowing from the Federal Reserve via the Discount Rate or the Fed Funds Rate, and the Federal Reserve creates the money via a book keeping entry. Then #1 above applies.
- The Federal Reserve can also affect banks needs for funds via changes in reserve requirements, directly causing an effect on the fractional reserve system.
- Via tools such as the buying and selling of repos they can affect short term supply of and demand for money, and therebt affect #1.
- Loopholes in banking laws and regulations allow certain types of lending and borrowing actions that are not subject to reserve requirements or reporting or oversight, so money can be created easily and in large quantities by simply moving it around in the financial system.
- Government sponsored entities such as Fannie Mae borrow money very cheaply and then lend it out. They act similarly to a bank and item #1 applies again.
(If you're really a economics masochist and have to know details of how this is done, see Doug Noland's work here. It's called Money Market Fund Intermediation.)
- There are many other financial companies and entities and even financial instruments that act similarly to Fannie Mae.
(If you just have to know... and I really don't recommend mentally abusing yourself and also leave it up to you to find definitions and understanding but... some of them are captive finance companies such as GE Capital, Wall Street brokerage houses, credit swaps, hedge fund activities, and other quite sophisticated and complex instruments like CDOs, asset or mortgage backed securities, and SPEs.)
- An "outside" and indirect source, is central banks of other countries like Japan. They print their own money, and then use it to directly buy dollar denominated items from the Federal Reserve, or directly buy assets from other U.S. financial institutions.
- Note that the actual currency is printed by the US Treasury, and only distributed by the Federal Reserve System. Total currency is less than 5% of the grand total of all dollars everywhere.
There may be other ways, but that's all we're currently aware of.
One last point and it's mildly political. The U.S. Constitution states "The Congress shall have Power To ... coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures", so that's the source. The Federal Reserve System was created by Congress by the Federal Reserve Act of 1913, but the Federal Reserve Banks are is not part of the government in spite of their name. It's a private corporation, but does at least report to Congress frequently.
How is money destroyed?
One simple way is via investment losses. The US stock market lost about $7 trillion in total value between 2000 and late 2002, and that $7 trillion was actually destroyed as of late 2002.
Another would be if the Fed, during an open market operation, sold bonds in the Federal Reserve accounts back to the US Treasury without buying at least as many as they sold. Remember that when the Fed buys bonds from the Treasury during an open market operation, that creates money out of virtually thin air.
Another is losses in the banking system itself. An example is the Saving & Loan crises in the early 1990s when there were huge losses recognized by a number of Savings & Loan associations who had hugely overextended themselves - much of that money just disappeared.
If the Federal Reserve had not stepped in and provided support, the LTCM crisis in 1998 would also have destroyed a lot. Another is likely going on in early 2005 in Fannie Mae, due to some "special moments" in their accounting and financial actions since the late 1990s.
Warren Buffet, the second richest man in the world after Bill Gates, has warned repeatedly over the last few years about the dangers of derivatives, and a problem there could easily destroy many many billions.
This is not a complete list. It is just intended as examples.
What are the top five currencies in the world, ranked by amount in circulation?
- Euro
- U.S. dollar
- Japanese Yen
- China
- United Kingdom
How about the population top ten?
- China - 1,306.3
- India - 1,080.3
- European Union - 457.0
- United States - 295.7
- Indonesia - 241.9
- Brazil - 186.1
- Pakistan - 162.4
- Bangladesh - 144.3
- Russia - 143.4
- Nigeria - 128.7
Numbers in millions - July 2005 estimates, CIA factbook
Can we please have some perspective on deaths from various causes?
- World War II, 55 million (U.S. share, about 400,000)
- China - Mao Zedong (1949-1975), 40 million
- Flu epidemic, 1918 - World wide, 30+ million (estimates range from 20-100 million)(U.S. estimate is 600,000+)
- Russia - Stalin (1924-1953), 20 million
- World War I, 15 million
- AIDS - 1981-1998, 11.7 million
- Holocaust - about 6 million Jews (and up to 6 million Christians too)
- Congo War, ended in 2002 - 3.8 million
- Natural disasters - 1900-1999, 3.5 million (floods, earthquakes, volcanos, etc. but not drought or famine)
- Malaria - world yearly, 1+ million
- U.S. Civil War - about 600,000
- Flu, World - yearly 500,000+
- Vietnam war - U.S. only, 58 thousand
- Auto accidents - U.S. 2004 total 42,636 (alcohol related - 16,694)
- Flu, U.S. - yearly average 36,000
- Suicide - U.S. yearly, 30 thousand (2000)
- U.S. Revolutionary War - about 25,000
- Guns - U.S. yearly, 15 thousand (32 thousand if suicides included) (1997)
- 9/11/2001 - approx. 3000
- 12/7/1941 Pearl Harbor - approx. 2400
- Russian Civil War (1919-1920) - about 500
How about a list of countries that have had hyperinflations since 1985?
- 1985, Bolivia - 12,000%
- 1989, Argentina - 3,000%
- 1990, Peru - 7,500%
- 1991-97, Russia - 700%
- 1993, Brazil - 2,100%
- 1993, Ukraine - 5,000%
- 1993-4, Yugoslavia - 1,000,000+%
- 1999, Ecuador - 70%
- 2002, Argentina - 400%
- 2004, Zimbabwe - 133% (14 countries in 2004 had inflation rates over 15%)
What are some of the next probable financial issues or crises?
Under funded pension plans.
June 7, 2005 – Washington Post (Albert B. Crenshaw): “Although the financial markets have been on the upswing recently from their post-boom low, many of the nation's private pension plans have been sinking deeper into the hole, according to new figures from the government's pension insurance agency. The 1,108 weakest pension plans -- those whose assets are at least $50 million below the value of the benefits they promise -- were short by an aggregate $353.7 billion at the end of last year, figures from the government’s Pension Benefit Guaranty Corp. show. That was 27 percent more than the shortfall a year earlier, contrary to the hopes of many that funding would improve as the economy strengthens.”
Medicaid drug bill
The Medicaid drug bill due to go into effect in January 2006 is part of the the overall massive problem with US budget deficits and government spending. It is estimated to cost about $150-200 billion per year. Add in $150+ billion of off budget spending for Iraq, another probable $150+ billion for Katrina and other hurricanes, the existing $350+ billion official deficit and the longer term outlook for inflation and the strength of the US dollar becomes less than optimistic.
Derivatives
Warren Buffet, the second wealthiest man in the U.S., has stated that derivatives are the WMD of financial markets. Also see "The Derivative Conundrum" by Jim Sinclair, his letter to the Chairman of the Federal Reserve warning about the area.
Alternative Minimum Tax
Another that has received little coverage in any of the media is changes in how the alternative minimum tax (AMT) will be implemented starting in 2006. The Congressional Budget Office has estimated that it will affect an additional 20-25 million tax returns between 2006-2010, and is expected to raise about $80 billion in revenues. It will more than offset any of the tax breaks enacted in the years since 9/11.
What nations have the most popular brands?
- Australia
- Canada
- Switzerland
- UK
- Sweden
- Italy
- Germany
- Netherlands
- France
- New Zealand
- United States
- Spain
- Ireland
- Japan
- Brazil
- Mexico
- Egypt
- India
- Poland
- South Korea
- China
- South Africa
- Czech Republic
- Russia
- Turkey
Source: GMI Poll, August 2005
What was it like right before the Great Depression?
Here is a short two page article from the August 1929 issue of "Ladies Home Journal", a publication not exactly known for investment advice, entitled "Everybody ought to be rich".
(requires Adobe Acrobat to display)
Is Earth safe?
Two answers - No, and it varies over time regarding safety.
More than 2.5 billion people were affected by floods, earthquakes, hurricanes and other natural disasters between 1994 and 2003, a 60 percent increase over the previous two 10-year periods, U.N. officials reported at a conference on disaster prevention in January. Those numbers don't include millions displaced by last December 2004's tsunami, which killed an estimated 180,000 people as its monstrous waves swept over coastlines from Indonesia's Aceh province to Trincomalee, Sri Lanka, and beyond. By another measure -- property damage -- 2004 was the costliest year on record for global insurers, who paid out more than $40 billion on natural disasters, reports German insurance giant Munich Re. Florida's quartet of 2004 hurricanes was the big factor. But generally it's not that more "events" are happening, rather that more people are in the way, said Thomas Loster, a Munich Re expert. "More and more people are being hit," he said. One third of the world’s population lives within 100 km (about 62 miles) of the ocean – thirteen of the eighteen ‘mega cities’ in the world are by the sea.
Does history repeat itself?
Two of our favorite quotes are:
- "History doesn't repeat itself, but it does rhyme." -- Mark Twain
- "Those who do not learn from history are doomed to repeat it." -- George Santayana.
- "You have enemies? Good. That means you've stood up for something, sometime in your life." -- Winston Churchill
Warren Buffett is one of the world's greatest living investors, how about some quotes from him?
- Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway.
- Managers should never forget one of Abraham Lincoln's favorite riddles: “How many legs does a dog have if you call his tail a leg?” The Answer: Four, because calling a tail a leg does not make it a leg.
- The future is never clear, and you pay a very high price in the stock market for a cheery consensus. Uncertainty is the friend of the buyer of long-term values.
- Value investing is so simple that it makes people reluctant to teach it. If you've gone and gotten a PhD and spent several years learning tough mathematics, to have to come back to this is like studying for the priesthood and then finding out that the Ten Commandments were all you needed.
- The stock market is there only as a reference point to see if anybody is offering to do anything foolish. When we invest in stocks, we invest in businesses. You simply have to behave according to what is rational rather than according to what is fashionable.
- If you're in a card game and you can't figure out who the patsy is, you're it.
- You don’t know who’s swimming naked until the tide goes out.
In the probably better known than left mysterious department, what would happen if a nuclear bomb hit your city?
This link only shows a limited number of specific U.S. cities, but if you know your longitude & latitude it will show your location.
Find your longitude and latitude.
To the best of our knowledge, "suitcase" nuclear devices are around 10 kiloton and the "average tactical nuclear bomb" is 100 kiloton. A kiloton is equivalent to 1000 tons of dynamite.
How about a quote from Hitler, early in his career?
"My feelings as a Christian points me to my Lord and Savior as a fighter. It points me to the man who once in loneliness, surrounded by a few followers, recognized these Jews for what they were and summoned men to fight against them and who, God's truth! was greatest not as a sufferer but as a fighter. In boundless love as a Christian and as a man I read through the passage which tells us how the Lord at last rose in His might and seized the scourge to drive out of the Temple the brood of vipers and adders. How terrific was His fight for the world against the Jewish poison. To-day, after two thousand years, with deepest emotion I recognize more profoundly than ever before the fact that it was for this that He had to shed His blood upon the Cross. As a Christian I have no duty to allow myself to be cheated, but I have the duty to be a fighter for truth and justice... And if there is anything which could demonstrate that we are acting rightly it is the distress that daily grows. For as a Christian I have also a duty to my own people."
--Adolf Hitler, in a speech on 12 April 1922 (Norman H. Baynes, ed. The Speeches of Adolf Hitler, April 1922-August 1939, Vol. 1 of 2, pp. 19-20, Oxford University Press, 1942)
Feel free to substitute any other group for the word "Jews" above. We think that doing that can add perspective, and frequently more truth, to any age or time.
