We Asked David Kotok What His Biggest Economic Fear Was, And What Told Us Was Absolutely Terrifying

TBI ^ | 9-17-2012 | Joe Weisenthal

[blam]

We Asked David Kotok What His Biggest Economic Fear Was, And What Told Us Was Absolutely Terrifying

Joe Weisenthal
Sep. 17, 2012, 10:14 AM

The market is characterized by bulls who are in deep anguish: On the one hand, they think the market is super-stretched. On the other hand, they see the Fed and the ECB going to new heights of accommodation, and don't want to fight that trend.

So we're trying to discern something: What's the #1 threat to this market right now?

We asked David Kotok of Cumberland Advisors what worries him most.

In a phone call, he painted a very worrying scenario that combines geopolitical unrest, surging oil prices, overly-loose monetary policy, and a tax disaster.

Here's what he said:

"The scenario that worries me is a geopolitical shock that spikes oil, and does so now, such as to remind people of what happened in 1973/1974, with the Yom Kipur war, when oil went from $3 to $12. I admit to being old enough to remember it. It did so at the same time [former Fed Chair] Arthur Burns was in a very expansive Fed policy mode. In 1973-1974, what the Fed did through monetary policy was to fuel the inflation that occurred in the late 70s and became virulent."

"On the monetary policy side [today], the policy is geared to blunt the force of deflation. The position of the Fed is: We'll deal with inflation later. And that's fine... when there is no shock."

"AIn a shock, when policy is very stretched, it means the system has no resilience."

"It's like jumping on a trampoline of cement."

"My worry is, the Northern piece of Nigeria is embroiled in civil war with Islamic extremists."

"Nigeria is the most important oil producer in the world."

(snip)

[Red Badger]

... remind people of what happened in 1973/1974, with the Yom Kipur war, when oil went from $3 to $12. I admit to being old enough to remember it.

I do, too. Gas lines as far as you could see down the road, and people fighting over places in line. Today, it would be like a zombie apocalypse..............

[Kartographer]

"Fill her up Obama's paying for it from his stash."

[Ruy Dias de Bivar]

***oil went from $3 to $12***

I remember those days! Gs went from 30 cents a gallon to 45 cents and America went berserk!

***In 1973-1974, what the Fed did through monetary policy was to fuel the inflation that occurred in the late 70s and became virulent.” ****

I remember those days! WIN! (WHIP INFLATION NOW) buttons were being made, and the price of them went up, wage and price controls in place.

Then under Carter the interest rate hit 21%! The Unions a few years later blamed Reagan.

The only advantage of high interest rates is I got lots of high pay raises, even though I could not buy more with the inflated money, but I had bought a house a few years before at 7.9% interest. The high inflation rate helped me pay it back with inflated (worth less) dollars.

Then the crash when the Savings and Loans and banks went broke.

A few years back as I watched the price of homes skyrocket I told my wife that we were heading for a fall just like the 1980s. It happened the year I retired and I kissed my 401k good by.

[9YearLurker]

So have we got Ben Arthur Burnsnanke running things now?

[kabar]

We do have the strategic reserve and most of our oil comes from this hemisphere. Since oil is a global commodity, we would see a huge spike in gas prices and that could scuttle the economy. It just depends on the length of the crisis. If Israel hit Iran, it could last weeks or months depending on what the Iranian response was.

One of the costs that would drive the price of oil up would be the insurance costs for the maritime industry that transports the oil.

[blam]

We have agreements with some allies to supply them with ‘X’ amount of oil/gas during certain circumstances regardless of our prices.

[KingLudd]

I’d love to have that Mercedes SL convertable you can see in the picture behind the red beetle.

[Georgia Girl 2]

Oh God!! Of all the carpola I have lived through those gas lines were the absolute worst. I was living in Miami at the time and my only saving grace was that I drove an MG and it went forever on a tank of gas. We used to cruise around at really odd hours looking for a gas station with a semi short line.

[Red Badger]

It would also ruin the economies of the EU and South Asia and Japan. The whole world would go into an economic disaster that would dwarf the Great Depression. Perhaps THAT is the target...............

[Ruy Dias de Bivar]

***Oh God!! Of all the carpola I have lived through those gas lines were the absolute worst.****

It is interesting that in the middle of the US from New Mexico to Arkansas gas was plentiful at that time. Just higher in price. Then there was that d***ed 55 mile speed limit on all highways.
We used to think it was funny to watch the Californians get into fist fights over who was next in line at a gas station while we had plenty.

The only time gas got tight here was on 9-11. It went up almost 200 % on that day. It later dropped.

[Sequoyah101]

I posted this elsewhere but thought this might be a place for one of the many brilliant FReepers to weigh in.

So what I’ve been trying to figure out in my pea brain is this:

What good does it do the Federal Reserve, a private corporation, to print money and thus make the money they have and trade in worth less?

What good does it do them to have 5 Trillion dollars worth of debt that is becoming worth less and more prone to default every day?

I could print money, you could print money but it isn’t worth anything. You can print more stock but eventually it becomes worthless and your share holders lose confidence. In the long run making your stock worth less makes it worthless.

So what is in this for the Fed? What am I missing?

[Auntie Mame]

Inflated money makes debt disappear. There’s a LOT of debt.

[TexasRepublic]

I remember the oil crisis all too well. We could only buy gas on odd or even days, depending on the license plate. We had to drive from Houston to Dallas one weekend and had to carry 10 extra gallons of gas in the truck to assure we wouldn’t get stranded in between. That was a dangerous practice, but we had no alternative choice.

[Sequoyah101]

But they hold at least 5 Trillion in U.S. debt. It does not make sense for them to sell debt at one higher rate for dollars and take a return in dollars that are worth less.

Inflation is your friend when you are paying debt back not when you are loaning money.

[TChris]

Inflated money makes debt disappear.

...and wealth, and investments.

Those who have behaved responsibly get screwed.

[ctdonath2]

A few years ago gas jumped to an astounding $4/gal around Atlanta. The lines were very long, and many stations ran out - expecting a one-week refill delay. I didn’t go to work one day for fear I couldn’t make the 40 mile drive back for want of gas.

$4 gas? can you believe it? that’s nuts...oh, wait...

[commish]

That picture looks like the lineup outside a Mecum or barrett jackson auction today. :-)

[commish]

I’d love to have that Mercedes SL convertable you can see in the picture behind the red beetle.

I would go for the Mustang at the end of that line. :-)

[ctdonath2]

So what is in this for the Fed? What am I missing?

Interest.

My (flawed) understanding:

The Fed is the only business allowed to write a random number in their balance sheet. The guy in charge writes "$1,000,000,000,000" in the Assets column, and "-$1,000,000,000,000" in the Liabilities column. It all adds up to $0, you see. They then loan out that vast new asset, and charge interest on that loan. Oh, sure, the interest rate is something absolutely pathetic like 1% ... but one percent of one trillion dollars is a cool ten billion dollars. The trillion-dollar loan eventually gets repaid*, the trillion-dollar liability gets erased, the "$1,000,000,000,000" in the Assets column and "-$1,000,000,000,000" in the Liabilities column vanish into $0 sum, and the business enjoys its nifty new $10,000,000,000 profit. Not bad a few seconds of writing and a little interim bookkeeping.
(* - meh, at that kind of interest income for that size a loan, nobody cares if it's never paid back so long as the interest payments keep rolling in.)