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Best Buy, Krugman and the Carry Trade
I looked at the Best Buy (BBY) Black Friday ads and compared them to
last year's. The prices were about the same. One thing I thought was
worth noting. Look how they stretched the interest free financing
period:
The
folks at BBY know their business and they are good marketers. They
understand that American consumers who see a chance to “borrow at no
cost” just can’t resist. For BBY to double the term of interest free
financing to three years is just an effort to increase top line sales.
I am sure that it will work.
BBY has a $17 b market
cap and a good balance sheet so it can take advantage of the near zero
cost money that is around today. For them to provide their customers
with this free financing means a cost of 2% of sales. Given their gross
margins, that is an easy price to pay.
This is an
example of the “Carry Trade”. We normally think of this in purely
financial transactions. The Aussie Dollar carry trade is an example
that comes to mind. However, the BBY example is just as much of a carry
trade as anything one might do with the Australian dollar and the
derivatives market.
When the cost and availability of
debt capital are such that one can borrow money and simultaneously
invest it and be assured an economic gain, then the conditions for a
Carry Trade have been met. Of course we have not gotten to the point of
alchemy, but we are getting close.
On ABC’s "This Week" show there were some interesting thoughts from Paul Krugman. He remarked:
“The cost of the deficit is only 1.2% real rate of interest at the Federal level.”
This is economic speak. What Mr. Krugman was
saying is that the Government can borrow long term at 3.2% and
inflation is 2% so the real cost of debt is only 1.2%.
In response, George Will made the point:
"In ten years the interest cost of servicing the debt will go to $700 billion per year!"
Mr. Krugman responded:
In ten years GDP will be $20 trillion, debt service would still be 3.5%. “That doesn’t sound too bad”.
Mr.
Krugman believes in the ultimate carry trade. His view is that growth
will come from affordable (cheap) debt capital. He thinks that the US
can go to 100% Debt/GDP without upsetting the applecart. I think he is
dead wrong.
We are at the point where the laws of big
numbers start to come into play. For Mr. Krugman’ view to work out we
would have to successfully sell an additional $900 billion of debt each
year for the next decade. I think that is an impossible task. But what
is truly impossible is that that amount of debt can be sold without an
increase in the 1.2% after inflation cost of the debt that Mr. Krugman
is relying upon. You can just fool so many bondholders for so long
before they look elsewhere.
The cost of servicing
our debt will likely double. The increase will be a combination of a
general rise in interest rates and in increase in the “spread” that the
US will have to pay. If debt expense was a modest 6% it would put the
cost at $1.2 trillion. I don’t think we will get to that level. We will
blow up first.
The Carry Trade is fraught with risk.
You can lose six months of positive carry in A$ in just one day in the
FX market. Best Buy can create sales from free money, but what credit
losses will they incur in the process?
Mr. Krugman’s
comments are an endorsement of a policy that is in pencil already ‘out
there’. We are going to double the size of the Federal debt in the next
ten years.
If the A$ moves against you, you can cut
the position in a phone call. If capital cost were to rise, Best Buy
would shorten its interest free period to one year, or just eliminate
it. But the carry trade that the US is on can’t be reversed. It’s too
big.
Who on this list is going to speak for the $9 trillion of paper that is coming?
-Social Security –They will be sellers long before ten years
-China/Hong Kong/Singapore- No chance.
-EU/UK/Canada- No chance.
-Russia/Venezuela/Brazil/OPEC – Don’t count on it.
-US Public-Maybe, but not at the cost Mr. Krugman hopes for.
-The Federal Reserve-Their
1.4Trillion of Agency buys and some of the Treasury debt will mature in
the ten years. On a net supply/demand basis this is the equivalent of
them being sellers.
If Mr. Krugman is relying on the
Fed to keep debt cost low by continuing to purchase what Treasury
offers, he is wrong. The fallacy of that thinking is becoming exposed
as the price of gold rises.
»
Mandatory government "guaranteed retirement account". Filled with nothing but safe Treasuries. Sleep soundly now.
You're in good hands, with the all encompassing state.
PS-- feel free to go to Krugmans blog on NYT and tell him how you really feel. ;)
In one of his latest, Krugman suggests that if we don't do what he thinks is a good idea in this regard, then "America won't be America."
Rarely does an "economist" make me laugh.
Oh wait, I meant dilettante idealogue.
Scratch the "economist" part.
Whats funny is that even the comment page on NYT is turning against him. It used to be packed with slobering worshippers. Some are still there, but there are a lot of people deriding him these days.
I think Einstein would have inserted Krugman in his definition of insanity.
Shoppers spent less over Black Friday weekend:
http://news.yahoo.com/s/nm/20091130/bs_nm/us_holidaysales
Its unexpectedly less worse!
Sure, GDP will be $20TR in 10 years. Fuggedaboutit.
Check in with Japan on that number. What an
irresponsible egghead Krugman is.
What will you do if/when something really really bad happens somewhere in the world. Just keep printing more money?
"We are at the point where the laws of big numbers start to come into play."
"The cost of servicing our debt will likely double. The increase will be a combination of a general rise in interest rates and in increase in the “spread” that the US will have to pay. If debt expense was a modest 6% it would put the cost at $1.2 trillion. I don’t think we will get to that level. We will blow up first."
The Minsky Moment is upon us.
One big difference between now and '03 is unemployment. K-man wants the govt to spend on job creation. Icansupport that over sending $$ down a bank hole.
Also, the cost of debt hasn't doubled in japan, why would is it more likely to rise in the US than it did for the Japanese?
If there were no Federal Reserve, there would be no interest payment or the need for a bond market. As a sovereign nation, the US Treasury could simply pay down debt without incurring the interest payments that is the profit going to the owners of the Federal Reserve. The Treasury could simply payoff all real estate and consumer debt in a Jubilee year. The entire financial discussion is taking place within the confines of the current game instead of changing the game.
Great piece! Can they hold the GDP to ONLY 20 Trillion 10 years out?
The key is how many businesses can take advantage of the cheap credit . And consumers? Now if revolving credit begins to offer zero
or low interest accounts, then I will believe the green this is green shoots.
Hand in hand, China and USA jump off the cliff together!
Everyone else will flee into Hard assets. The USD will
more and more resemble a game of musical chairs with
everyone racing to not get caught holding(Velocity becomes breath taking).
The Gold
Bugs(and everyone else who has to catch their breath) all stand on the sidelines in Gold.
The 64 Trillion dollar is at what level and when will it finally unwind?
Economist of Dreams,it's obvious how many have zero clue about business in general, when you start with the assumption that there will always be BUYERS, you're pretty much already on the wrong rail.
I get your point about the BBY credit as a carry trade. Interesting insight.
The problem is that it's an unsecured loan. To people in an imploding economy. Many people could still have good credit even though they haven't paid their mortgage in a year and lost their job months ago. And a huge majority of the people who wind up having to pay the 3 years interest will default.
COST may undercut BBY, WMT crush COST, AMZN delete WMT
and EBAY outbid WMT...
There are two parts of the BBY strategy. 1) they take advantage of no cost money and 2) they assume credit risk.
1 is the carry trade. 2 is the derivative risk that results.
BBY will price #2 based on some assumptions. Then they will pray that your idea that a huge majority will default does not come true.
I think you might be right.
I don't think BBY assumes the credit risk on their 0% interest deals. If you Google "Best Buy Credit" or perhaps look in the fine print of their ads you'll find that HSBC (most recently in the news as having the largest exposure to Dubai) supplies the credit for Best Buy customers. It requires filling out an application and getting approval from HSBC. I don't know if Best Buy has any contingent liability but doubt it. If so, it should be disclosed in their quarterly or annual SEC reports.
As to how HSBC makes money on 0% financing, I would guess that Best Buy pays them some type of a rebate upfront based on a percentage of the amount financed. In addition, I believe the way most of those type of 0% financing programs work is that when you're a day late with one payment, the 0% immediately converts to 20%+. So the lender would count on some percentage of the loans going that route.
Krugman's deficit carry trade seems to hang on the principal that they can sneak unexpected inflation past the Treasury market, thus keeping real yields ultra low. I am not sure I buy it - real yields are a measure of inflation risk, credit risk, and supply demand dynamics, if any one of these breaks down, the real yields will jump sharply.
Add to that the urgent need to term out the debt maturity profile and it looks like trying to thread a needle in a thunderstorm...
Krugman has recently tried to square the 2003 deficit circle on his blog. its a FAIL though.
John Maynard Krugman
Krugman proves that the whole study of economics is a farce. A sham created by bankers to legitimize theft. Krugman is in the same boat as those global warming fools at U of East Anglia.
isn t that "the plan"?
Too bad Krugman isn't connected somehow to ClimateGate. He's a political panderer and would fit right in with Gore,Mann,Jones,Gavin, and the rest of those fraudsters.
Hey, printing money to pay the debt to France after WWI worked so well for Germany we should try it. Maybe we can start WWIII to generate the out of control spending to get of the mess just like they started WWII to get out of theirs.
Err. Or 'they' (who is they?) could put ron paul circa 1981 or peter schiff circa 1992 in a debate with krugman, and realize krugman is right. But no, gotcha, gold is right, and so is being wrong!
Err. Or 'they' (who is they?) could put ron paul circa 1981 or peter schiff circa 1992 in a debate with krugman, and realize krugman is right. But no, gotcha, gold is right, and so is being wrong!
The Fed's actions look more and more like part of those policies chosen for the world by the Bilderberg group.
Krugman is a complete buffoon.
From a very good Niall Ferguson piece in Newsweek that was linked on another thread at ZH:
http://www.newsweek.com/id/224694/page/3
Now, who said the following? "My prediction is that politicians will eventually be tempted to resolve the [fiscal] crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt. And as that temptation becomes obvious, interest rates will soar."
Seems pretty reasonable to me. The surprising thing is that this was none other than Paul Krugman, the high priest of Keynesianism, writing back in March 2003. A year and a half later he was comparing the U.S. deficit with Argentina's (at a time when it was 4.5 percent of GDP). Has the economic situation really changed so drastically that now the same Krugman believes it was "deficits that saved us," and wants to see an even larger deficit next year? Perhaps. But it might just be that the party in power has changed.
Rather than have Paul Krugman debate George Will on government deficits, they should have split the screen and had 2009 Paul Krugman debate 2003 Paul Krugman. Or at the very least put Krugman's quote from 2003 on the screen and asked him if he could explain the contradiction between what he said then and what he's saying now.
Devaluation did not work in Argentina, Japan, Mexico,
Germany, Vietnam or Zimbabwe, but it will work for the
largest capital markets in the world?
Check out real interest rates.
They are considerably higher than most realize when
the CPI is subtracted, a negative math problem ZH
captcha:
EU CPI y/y = .6%
US CPI y/y = -.3%
Japan CPI y/y = -2.2%, their 8th straight year.
The CPI this Wednesday is widely expected to confirm
the lasting return of US inflation, but so-called experts have been saying this for a long time. Instead we have
popped a series of asset bubbles in Dot.Com, RE, Banks, and Bonds and Stocks, with gold maybe next.
Not one man in a million living understands deflation
accounting or investing...
http://www.jubileeprosperity.com/
As Peter Schiff once said, "US is sitting on a big optional arm that will reset pretty soon b/c our foreign creditors are tired of the low yield bonds. W/o a raise in interest rate, they will stay away from TBonds."
Who is/was in power.
Bingo--Krugman was screaming about fiscal irresponsibility when Bush and the Republicans were deficit-spending like crazy, but now that the people in charge have (D)s after their names, he does an 180 and says it's not a big deal.
Krugman is a propogandist and a hack whose analyses are entirely dependant on who is in charge, not on the facts.