Wednesday, January 12, 2011

Auburn “Pushes” Oregon, Portuguese in Denial of Debt Flash Floods, and real Floods in Australia

1/12/2011 Portland, Oregon – Pop in your mints…
We are back in Oregon mourning, along with the rest of the State, the Duck's loss to Auburn last night in the College Football championship, otherwise known as the BCS (Bowl Championship Series).  The game was not a total loss, however, as the University of Oregon will line its pockets with a portion of the PAC 10 conference's share of the $180 Million worth of revenue.  Yes, fellow taxpayer, if you were not aware of the fact already, College Football is big business.  The fact that the final spread of 3 points was covered by Auburn made any bets on either Auburn or Oregon that took the 3 points a "push", meaning that nobody wins, nobody loses, and everyone keeps their money.
Down? Ducks Uniforms the envy of the Nation.  What can Betting on Football Teach us about Price Formation? (Photo Courtesy of AP)
Gambling spreads are simply another form of price formation.  When a great number of people bet on Auburn, for example, the spread offered by the bookie has to rise in order to entice enough people to take the Oregon side of the bet.  In this sense, the price (the final point spread) is set by the betting public's collective belief about the outcome of the sporting event.  The betting public is wrong as often as they are right, just as they are in the real world about the price of stocks, bonds, goods, and services.  This is a fascinating subject, price formation as expressed through betting on sporting events, that we will likely return to in the future.  Suffice it to say that the exact same forces that set prices in the market place, right or wrong, also set the final line for a sporting event at a sports book.  What does this tell us about the level of speculation occurring in everyday life?  It boggles the mind.
With our most recent South American adventure behind us and the threat of freezing rain or snow on the horizon here in the Willamette Valley, we will attempt to make sense of all that is going on in early 2011.  There is, of course, no making sense of it, but try we must.
A quick scan of the news shows us the Portuguese singing the same tune that the Greeks and Irish have now made famous.  It is called "We don't need a bailout" and it is generally sung as yields on a country's sovereign bonds are about to blast off.  It is a sad tune and the Portuguese version includes the refrain "Our austerity is enough!  You'll See!  You'll See!"  This is of course complete nonsense.  What the Portuguese call austerity, to date, amounts to an underwater homeowner trying to refinance his debt telling the banker "Look, I've canceled my land telephone line and dropped down to basic cable!  Now loan me the money!"  The measures are too little, too late and the repo men, in the form of the Chinese and the European Central Bank, are on their way.  When they are done, Portugal will be yet another puppet government controlled by Brussels.
Looking towards the Southern hemisphere, we see that the Australians are facing floods of Biblical proportions.  The latest is a flash flood near Brisbane that the press is calling a Tsunami.  Flash floods are scary.  We grew up at the bottom of a canyon in Colorado and were not old enough to recall the flash flood in 1976 that took 144 lives as flood waters raged down through the canyon towards our town.  As I understand, the area above the canyon received as much rain as it normally received in one year over the course of a few hours.  The result was that, even though it was not raining farther down the canyon, the flood waters caused even more devastation downstream.
Rising Risk of Flash Flood in Bond Markets (Photo Courtesy of Reuters)

Allow us, fellow taxpayer, to make a leaping analogy between a flash flood and the impending problems in the sovereign debt markets.  Rumors of default and the associated market response of demanding higher yields (represented by heavily falling rain) in one area can cause unforeseen and largely catastrophic consequences further downstream.  These consequences come rapidly and often with little or no warning.  Worse, these consequences are often compounded by the destruction of dams which are meant to retain water.  These dams, which in our metaphor represent any number of government and central bank bailouts, appear to function well for a time but when they burst under such overwhelming conditions, the result is that more collateral damage occurs than would have been suffered had the original torrent been allowed to flow freely.  By the time people realize what is going on, a lot has been destroyed. 
The rain that began to fall in Greece is quickly working its way downstream.  How long until it leaps the Atlantic and reaches American shores?  Only time will tell.  But with the unemployment rate moving downwards giving the FED academic ammunition to raise rates in a not so distant future, we would start moving to higher ground!
Stay Fresh!
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Key Indicators for Wednesday, January 12th, 2011

*See FED Perceived Economic Effect Rate Chart at bottom of blog.  This rate is the FED Target rate with a 39 month lag, representing the time it takes for the FED Target rate changes to affect the real economy.  This is a 39 months head start that the FED member banks have on the rest of us on using the new money that is created.