Monday, March 14, 2011

Indian Poker

In college, probably our crowd’s favorite two indoor games were Risk (the game of world domination, in retrospect a funny fave for a group of aggressively anti-war counter-cultural types) and Indian Poker. We all know about risk on and risk off in the financial markets, but Indian Poker has its place.

For those unfamiliar with the term, Indian Poker is played by placing a single playing card on one’s forehead facing outward, visible to the other player or players.

Betting then ensues, with high card winning. The suit is irrelevant.

The game is also known in polite company as blind man’s bluff. In college, among the more printable names by which we knew it were Bullsh-t and One-Card Schm-ck. Gambling is done with faux or real money.

Here’s how one game might evolve, with follow-up reference to financial markets.

Let’s say for simplicity that you are in a two-person game, which was our favorite way to play. Mano a mano or, more properly, forehead a forehead.

Let’s say you pick a 2. With aces high, you’re in trouble. Your opponent knows he can’t lose. 48 times out of 51, he’s got you beat;

3/51 times he will also have a 2 and the round will be a draw. It’s in his interest to make you think you have an ace rather than a pitiful deuce. He thus may play possum to get you to bid him up to a high level. Then he closes the trap.

When you see your card, you realize he’s been slinging the sh-t and that you were the schm-ck. Thus our terms for the game.

As in Indian Poker, so in financial markets. The insiders don’t necessarily hold all the cards, but they see them more comprehensively and earlier than you.

One of the examples of this came in the second half of the 1990s. The insiders knew that most of the tech stocks were overpriced, and the fact that the media and financial community induced a mania by pushing prices illogically higher was just like your opponent letting you push the stakes higher and higher when in fact your deuce had no chance of winning. The housing scam of the aughties was similar. In each case, large amounts of money were made by the connected class on the way up and also on the way down.

Nowadays, I think that there is also a scam going on. The scam is called fighting deflation. The authorities are playing the game of Bullsh-t with the public. They are trying to convince them of the opposite of what is really happening, on plan and on schedule, which is worsening inflation.

MIT’s Billion Prices Project is showing a 3% year-on-year rate of price increases from its survey of online retailers. Since this survey covers neither houses (stable to downward pricing) nor oil products nor food (soaring pricing), let’s say that the true CPI is in fact 3%. Thus pricing short-term interest rates near zero is wildly inappropriate.

Eddy Elfenbein of CrossingWallStreet.com has calculated that a short-term interest rate Fed strategy that produces stable gold prices is one in which the 3-month T-bill rate is 2 points above CPI. For every point above or below that metric, the price of gold moves down or up 8% over the next year. Thus if CPI and interest rates were both 3%, the correlation he has discovered would project that gold prices would rise at a 16% annual rate. Right now the Fed is behind the Elfenbein curve by about 5 points. This would project a 40% price increase for gold this year should conditions stay as is. That would translate to about a $2000 gold price within a year. (There is of course no guarantee that this a posteriori relationship will continue to hold.)

We are seeing a form of a rerun of the inflationary booms or boomlets of the late 1960s and 1970s. The authorities are blasé. I am not.

What happens in the Mideast is of little importance to the general price level. If oil is more plentiful, then pricing power will move to other sectors, but Austrian economic theory states that the net effect is the same. The central bank is creating a great deal of base money at vastly inflated price (overly low yield, in other words). The Federal government is using its command and control structure to force-feed the economy to grow. Of course, much of this Federally-induced spending is malinvestment and is wasted from the standpoint of providing the capital needed for legitimate future growth. Thus a true, durable boom appears unlikely.

One way to be the winner in the game of One-Card Schm-ck that Dr. Bernanke and the Feds are playing with the public is to watch what they do, not what they say. The Treasury is selling overpriced securities to its captive central bank, with the Primary Dealers acting as middlemen to keep the form of the circular debt monetization proper.

It is true that as in 2008, the system can crash and there can be a brief period of true deflation. I see that as a low probability event for the months ahead. To base one’s investing on the possibility or even probability of another 2008 is indeed a rational strategy, but one that requires the patience to lose ground steadily to the money-printing in the hope of jumping in during a panic.

In this particular case, you can avoid being the schm-ck by seeing that the Feds are holding deuces. You probably don’t want to buy their patter or their inventory. Eventually, there will come a time when they will be forced to truly “fight inflation” and when the gold bugs will be pushing overpriced merchandise. I can’t wait for that future game of Indian Poker, but I’m not holding my breath for it to begin any time soon.

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