Using three iPods like magical props, Marco Tempest spins a clever, surprisingly heartfelt meditation on truth and lies, art and emotion.
Marco Tempest via TED
These are what caught my eye for reading this chilly Fall weekend:
• Jim Grant interview: Gold Still Looks Good; Japan Still Doesn’t (Barron’s) see also On the Asymmetry of the Impotent Bond Vigilantes (Rortybomb)
• Coppock Curve Killer Wave: Maybe Not So Killer (WSJ) see also Albert Edwards and the killer wave (Alphaville)
• Managers: Has John Paulson Lost His Touch? (Businessweek) see also Gundlach Found Liable in Trade Secret Case, but He Wins Back Pay (Deal Book)
• Setting a Price Target for Your Stocks (Barron’s) see also Peeling Back the Market’s P/E (WSJ)
• More Technicals: Debunking the ‘Death Cross’ (WSJ) see also Volatility stymies even smart money (Reuters)
• Potential Buyers Renew Their Interest in Yahoo (Deal Book) see also What’s Yahoo To Do? (Slate)
• Bartlett: Obama’s Lack of Focus Could Be Politically Fatal (The Fiscal Times) see also Why China would love ‘President Rick Perry’ (Market Watch)
• All The Dumb Things RIM’s CEOs Said While Apple And Android Ate Their Lunch (Business Insider) see also Apple IPad Data Was Given to Fleishman, Samsung Witness Says (Businessweek)
What are you reading?
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Twist and Shout?
By John Mauldin
September 17, 2011
Bailing Out Europe’s Banks
WWGD?
What Is the Fed Really Risking?
What Will the Fed Do Next Week?
Twist and Shout?
Europe, Houston, NYC, and South Africa
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What in the wide, wild world of monetary policy is the Fed doing, giving essentially unlimited funds to European banks? What are they seeing that we do not? And is this a precursor to even more monetary easing at this next week’s extraordinary FOMC meeting, expanded to a two-day session by Bernanke? Can we say “Operation Twist?” Or maybe “Twist and Shout?” Not many charts this week, but some things to think about.
But first, I have had readers ask me about my endorsement of Lifeline Skin Care and whether I was still pleased. Quickly, let me say that I am more than pleased. I have not mentioned it recently, as the company had to deal with supply issues (partially, from too many orders, which is a good thing) but those have been handled. I read a lot of positive letters from people who use the cream with excellent results. I can clearly see a difference in my own skin. If you use it correctly you will get results
But a very interesting endorsement came by way of my cynical daughter Tiffani, who was in Europe recently for 6 weeks. She did not take her Lifeline with her but used another (very) high-end product. She came back and was complaining about how her skin looked. After switching back to Lifeline for two weeks, she notes that she can already see a difference, and the “feel” is improving. Many of the re-orders are coming from men (which is not surprising, as the bulk of initial orders came from my readers), almost the reverse of industry standards.
Basically, Lifeline uses patented stem-cell technology in its cream, and it promotes a visible rejuvenation of the skin in about 3-6 weeks (depending on the individual’s skin, how often you use it, etc.) I encourage readers who are (ahem) of a certain age, or simply want to keep their skin looking younger, to click on the link to see a new, very short video; and if you like, you can order at the website. I and a number of friends are enthusiastic users. If you are interested in your appearance, you might want to consider becoming a Lifeline user. And you can use the code WAVE1 to get a $40 discount! www.lifelineskincare.com/page/46/Video.html. Now to the letter!
Yesterday the Fed announced that along with the central banks of Great Britain, Japan, and Switzerland it would provide dollars to European banks that have lost their ability to access dollar capital markets (basically each other and US-based money market funds that are slowly letting their holdings of European bank commercial paper decrease as it comes due. And if they are “rolling it over,” they are buying very short-term paper, according to officials at the major French bank BNP Paribas.
Are US taxpayers on the hook? We will deal with that in a minute. The more interesting question is, why do it at all and why now? Was there a crisis that we missed? Why the sudden urgency?
One of the little ironies of this whole Great Recession is that the central banks of the world rolled out this policy on the 3rd anniversary of the Lehman collapse. The Fed acted AFTER that crisis to provide liquidity. And we know the recession and bear market that followed.
The only reason for this move must certainly be that they are acting to prevent what they fear will be another Lehman-type crisis. Otherwise it makes no sense. They can give us any pretty words they want, but this was not something calculated to make the US voter happy. To do this, you have to be convinced that “something evil this way comes.” And to recognize the costs of not doing anything, and try to head them off.
My guess (and it is that, on a Friday night) is that the European Central Bank made a presentation to the other central bankers of the realities on the ground in Europe, and the picture was plug ugly. It should be no surprise to readers of this letter that European banks have bought many times their capital base in sovereign debt. The Endgame is getting closer (more on that in a minute).
Let’s look at just one country. French banks are leveraged 4 times total French GDP. Not their private capital, mind you, but the entire county’s economic output! French banks have a total of almost $70 billion in exposure to Greek public and private debt, on which they will have to take at least a 50% haircut, and bond rating group Sean Egan thinks it will ultimately be closer to 90%. That is just Greek debt, mind you. Essentially, French banks are perilously close to being too big for France to save with only modest haircuts on their sovereign debt. If they were forced to take what will soon be mark-to-market numbers, they would be insolvent.
Forget it being simply French or Greek or Spanish banks. Think German banks are much different? Pick a country in continental Europe. They (almost) all drank the Kool-Aid of Basel III, which said there was no risk to sovereign debt, so you could lever up to increase profits. And they did, up to 30-40 times. (Greedy bankers know no borders – it comes with the breed.) For all our bank regulatory problems in the US (and they are legion), I smile when I hear European calls for US banks to submit to Basel III. Bring that up again in about two years, when many of your European banks have been nationalized under Basel III, at huge cost to the local taxpayers.
Next, let’s look at the position of the ECB. They are clearly seeing a credit disaster at nearly every major European bank. As I keep writing, this could and probably will be much worse for Europe than 2008. So you stem the tide now. But for how long and how much does it cost? A few hundred billion for Greek debt? Then Portugal and Ireland come to mind. If bond markets are free, Italy and Spain are clearly next, given the recent action in Italian and Spanish bonds before the ECB stepped in.
Could it cost a half a trillion euros? Probably, if they have to go “all in.” And that is before the ECB starts to buy Italian and Spanish debt (Belgium, anyone?), which no one in Europe is even thinking that the various bailout mechanisms (EFSF, etc.) could handle, which leaves only the ECB to step up to the plate. The ultimate number is quite large.
What Will Germany Do? That has to be the question on the mind of the new ECB president, Mario Draghi, who takes over in November, just in time for the next crisis. I believe German Chancellor Angela Merkel at her core is a Europhile and wants to do whatever she can to hold the euro experiment together. But for all that, she is a politician, who knows that losing elections is not a good thing. And the drum beat of the German Bundesbank and German voters grows ever louder in opposition to the ECB printing euros. Can she explain the need for this to her public?
As my friend George Friedman wrote today, Europe is complex. Speaking about Geithner going to the Eurozone finance meeting this weekend in Poland, he says:
“Geithner’s presence is particularly useful for two reasons. First, despite the vitriol that is a hallmark of American domestic politics, American monetary policy is remarkably collegial. The transitions between Treasury secretaries are strikingly smooth. Geithner himself worked for the Federal Reserve before coming into his current job, and Geithner’s partners in managing the U.S. system – the chairmen of the Federal Reserve and the Federal Deposit Insurance Corporation – are typically apolitical. Geithner holds the United States’ institutional knowledge on economic crisis management.
“Second, what Geithner doesn’t know, he can easily and quickly ascertain by calling one of the chairmen mentioned above. This is a somewhat alien concept in Europe, which counts 27 separate banking authorities, 11 different monetary authorities, and at last reckoning some 30 entities with the power to carry out bailout procedures.
“Getting everyone on the same page requires weeks of planning, a conference room of not insignificant size and a small army of assistants and translators, followed by weeks of follow-on negotiations in which parliaments and perhaps even the general populace participate in ratification procedures. The last update to the European Union’s bailout program was agreed to July 22, but might not be ready for use before December. In contrast, the key policymakers in the American system can in essence gather at a two-top table for an emergency meeting and have a new policy in place in an hour.
Frederick Sheehan is the co-author of Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve.
His new book, Panderer for Power: The True Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession, was published by McGraw-Hill in November 2009. He was Director of Asset Allocation Services at John Hancock Financial Services in Boston. In this capacity, he set investment policy and asset allocation for institutional pension plans.
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The prices of gold and silver shares are derived from the price of their reference metals. The referral method has gone astray, akin to a renegade ETF.
Osiris Investment Partners L.P. in Boston, under the authorship of Principal and Managing Member Paul Stuka, wrote to clients on August 18, 2011. The XAU Gold Index was down 6% for the year-to-date, and the GDXJ Gold Stocks Index of smaller gold miners had fallen 10%. On that same mid-August date, gold – the real stuff that hardly anyone owns but of which everyone within the media’s range is expected to express an opinion – had risen 26% in 2011.
The gap between gold and the diggers will close – when is hard to say. In which direction we will discover. The view here is that the stewardship of paper currencies, the medium in which gold, silver, and oil (crude, canola, and palm) are priced, has never been in worse hands. This is saying less than might be thought since it was not until 1971 that official money went untethered from impartial restraint (usually, gold). Alas, the world is slow to grasp central banks are peopled by political hacks (as Senator Harry Reid called then-Federal Reserve Chairman Alan Greenspan in 2005, but equally true of today’s empty suit) so now is the time to make money.
Money is to be made by holding anti-dollars. Federal Reserve Chairman Ben S. Bernanke continues to decompose before our eyes, stating on September 8, 2011, that the United States is blessed with lower inflation than other countries and “Low inflation means that the buying power of the dollar, in terms of domestic goods and services, remains stable over time.” It does not take a trial lawyer to see the inconsequentiality, inconsistency, or mendacity in that labored claim. Ben may be fishing turtles from the local creek, painting his barbarous equations on their backs, and selling them at the local five-and-dime (which would still be overvaluing his scholarship by at least a nickel), but shoppers at local farmer’s markets are paying the price for purchasing with dollars.
Osiris Investment Partners went on to write: “[S]ince the early 1980s, when the XAU Index was first constructed, until the fall of 2008, this ratio remained in a range of .16 to .38, even during the depths of the gold bear market. [That is the ratio of the XAU Gold Stock Index divided by the price of an ounce of gold in U.S. dollars. - FJS] During the financial crisis of 2008, this ratio dropped briefly to .09. Since that time, it has traded up to .16, but it has never exceeded the former floor. As I write today the ratio is .114. In other words, the gold shares are currently the cheapest that they have ever been, excluding a one-month period in the fall of 2008. On a fundamental basis, gold stocks have historically traded at 10 times or more annual cash flow. We are presently seeing many companies priced at one to three times potential forward cash flow, if they can execute their plan. Clearly, not all of them will realize the potential. However, many will.”
Of the cash flow, Erste Group, (Erste Bank, Vienna: “In Gold We Trust;” July, 2011; Ronald-Peter Stoferle), estimates the “aggregate free cash flow of the 16 companies in the Gold Bugs Index will amount to [$8.5 billion] this year and will increase to [$14 billion] by 2013.” Erste Group continues: “The companies in the Gold Bugs Index currently command an estimated 2011 [price-to-earnings ratio of] 14x, which is expected to fall to 12x in 2012. This is extremely low in terms of its own history (average PE 2000-2010: 33x) and in relation to many other sectors.” (The Gold Bugs Index consists of 16 mining companies that do not hedge their gold production. This is not necessarily true of the miners in the XAU Index.)
Potential investor seek the potential catalyst. What might that be?
First, the correlation among sectors in the S&P 500 has never been greater. ETFs and high-frequency trading rule the waves. Machines trade stocks in bulk, with little distinction among industries and companies. Such periods of over-zealous gimmickry and of intimidated investors are often good times to buy stocks that will later assert their superior characteristics.
Second, gold- and silver-mining shares are underowned in relation to one-stop-shopping ETFs. The miners know this. Shareholders have enlightened management: they need to pay out dividends to distinguish themselves as real companies. Recently, Newmont Mining stated it will increase its dividend by twenty cents per share for every $100 rise in the price of gold. Gold Resource Corporation has set a target of paying out one-third of its cash flow in dividends to shareholders.
Third, the argument of whether the world is inflating or deflating is tangential to the price of gold. Better expressing the “price of gold”: how many units of paper currency (such as the dollar) does it cost to buy an ounce of gold? (We are returning, now, to the reference metal). Gold has performed better in deflations than inflations, but the cause and effect that this relationship addresses (“gold is an inflation hedge”) may be misleading. Monetary, military, and political chaos have more often corresponded with deflationary than inflationary times. The real story is that gold is money but only speaks up when the credibility of states and their currencies deteriorate.
Fourth, the proportion of people who own gold and silver is small. (Particularly so in the United States, but that is not the point, here.) This is the greatest flaw of the “gold in a bubble” chorus. There has been no panic into gold, or, more likely for the Average Joe, into gold shares. At some point, the sight of Bernanke may be worth a quick $500-an-ounce trading profit. It should be, already.
I am not a fan of the mortgage mods and abatements or principle write-downs, but this is an interesting viewpoint:
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Sept. 14 (Bloomberg) — Philip Angelides, chairman of the Financial Crisis Inquiry Commission, talks about the outlook for solving the housing crisis in the U.S. He also discusses mortgage modifications for underwater homeowners and credit availability for home buyers. Angelides speaks with Lisa Murphy on Bloomberg Television’s “Fast Forward.”
Source: Bloomberg
Herewith a potpourri of unrelated items I’ve found on my never-ending voyage through the internet. Grab a cup of coffee and pull up a chair.
First up, an excerpt from a speech given by Teddy Roosevelt in December 1906. I was taken by the opening line and the third paragraph. Indeed, his opening line could probably have been used countless times since he spoke it, most recently six or seven years ago:
As a nation we still continue to enjoy a literally unprecedented prosperity; and it is probable that only reckless speculation and disregard of legitimate business methods on the part of the business world can materially mar this prosperity.
But the third paragraph was really the jaw-dropper for me:
I again recommend a law prohibiting all corporations from contributing to the campaign expenses of any party. Such a bill has already past one House of Congress. Let individuals contribute as they desire; but let us prohibit in effective fashion all corporations from making contributions for any political purpose, directly or indirectly.
I’m always fascinated by how little we seem to learn and how likely we are to simply ignore history’s lessons. I wish I had more time to study our country’s history via the infinite documents and archives that have made their way on to the internet. So much to learn, so little time.
I took Senator Jon Kyl to task here (March 2010) for an offensive comments about lazy Americans who would prefer to remain on unemployment benefits than be gainfully employed (“In fact, if anything, continuing to pay people unemployment compensation is a disincentive for them to seek new work.”). It’s worth re-running the chart I used at the time:
We now see, in a newly issued report, via the Wall St. Journal that:
“Any negative effects of the recent unemployment insurance extensions on job search are clearly quite small, too small to outweigh the benefits of transfers to people who have been out of work for over a year in conditions where job-finding prospects are bleak,” according to the report. [...]
There’s a chance extended benefits actually increase the number of Americans who find new jobs, according to the study. By one calculation, unemployment insurance extensions increased the share of workers who became reemployed by about 1.3 percentage points in January 2011 by reducing the fraction who excited [sic] the labor force.
The change in year-over-year Industrial Production (INDPRO) and Private Sector Jobs (USPRIV) have a correlation of 0.83 over the past 50 years. Industrial Production seems to have put in a peak and, if my eyes don’t deceive me, I see payrolls just starting to rollover:
I posted here back in early August about Street-wide year-end S&P500 forecasts. I will say that I’ve breathed a sigh of relief as it’s become clear over the last six weeks that those forecasts were too optimistic and have been chopped across the board. I then posted here about one month ago when the first batch of 2012 S&P earnings estimates were published (Median: $104). I suspect it’s only a matter of time before those start getting pared, if they haven’t already.
I decided to take a look through the Barron’s archives to see what the seers were saying year-end 2010, and found the following graphic. What really jumped out at was the extent to which the consensus was looking for the 10-year in the range (generally) of 3.50 – 4.00% at YE 2011. Of course, it is only September, but I’d say that call’s as shaky as S&P1400. I also noted that the buy-side doesn’t look much better than the oft-maligned sell-side.
The Fed released its Z.1 Flow of Funds report which, although always a bit stale, is a treasure trove of data. I never tire of finding ways to look at the data presented in the report.
Here, from Table B.100, are Household Real Estate (Line 4) and Corporate Equities (Line 24) as a percent of Total Household Assets (Line 1)
Here are Treasury Securities as a still-insignificant part of the American household’s financial assets (not total assets, just financial assets):
In terms of dollar holdings, Treasuries are now $835 billion on the household balance sheet versus financial assets of $49 trillion and total assets of $72.3 trillion. Liabilities stand at $13.9 trillion. Household real estate stands at $16.2 trillion, down some $6.6 trillion from the 2006Q4 high of $22.8 trillion.
Here’s Owners’ Equity as a Percentage of Household Real Estate:
On the chart above, we have made no progress since since the fourth quarter of 2008, when we sat at 40.1 (we’re now at 38.6 for two quarters running). This decline in homeowners’ equity speaks to the credit expansions that allowed Americans to live beyond their means while incomes — as we saw when the Census released its report last week — have been stagnating.
Last but not least, here’s Liabilities as a Pct of Disposable Income:
Though we’re below the upward sloping trendline on this file, the average over the period shown is 102%, which is a further shedding of about $2.25 trillion in liabilities (or similar gain in income, which we plainly know is simply not happening).
As has been noted in several places, it appears we have moved as a country toward something that I find unrecognizable:
Via Mediaite:
Jon Seidl at The Blaze tries to get the Tea Party audience some room to wiggle out of this ghoulish display, theorizing, alternately, that it was a delayed reaction to something Paul said earlier (not unless those folks were watching on their portable DVRs), or that the hoots were from liberals, cheering on Blitzer’s “Gotcha!” (which would make them the quietest bunch of liberals in the world for the rest of the debate)
The reactions of three or four audience members at a debate isn’t all that meaningful on its own, but this outburst follows last week’s Death Penalty Ovation at the Reagan Library debate, and another ugly moment at the Tea Party debate in which the crowd cheered for fed chairman Ben Bernanke to be tried for treason, a capital crime.
I’m still trying to figure out exactly what’s going on here. While Perry’s presiding over 234 state-run executions during his terms as governor may speak to our adherence to the rule of law (much as I may wish we had no such law), should we really be applauding the fact that our government puts people to death? Similarly, should the uninsured — specifically those who can afford but choose not to buy insurance — be left to die should something happen to them? And how far have we drifted from our moral moorings that we have a president (Obama, not Bush) who unilaterally orders the extra-judicial execution of American citizens? These developments are all deeply troubling, and speak to a society that has lost its way. It’s almost as though we can no longer distinguish between “reality TV” and reality.
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I found myself in complete agreement with Phil Angelides in this interview with Bloomberg’s Lisa Murphy.
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Catch up with me on Twitter: @TBPInvictus
They $2 billion hit of UBS is being called the work of a “Rogue” Trader. This is a false and misleading statement. Why? Because there are no rogue traders — just as there are no predatory borrowers — there are only rogue banks.
Here’s a news flash: If you issue credit, your working assumption MUST BE that there will be people who are not qualified who will try to borrow money. Your job each day is to separate qualified borrowers with the capacity to service that debt from the unqualified borrowers who do not have that ability.
Similarly, if your are in the business of using leveraged capital to speculate, then you MUST KNOW there are some people who are not competent to do so. Some of your employees (traders) will take losses, and in some cases enormous (but manageable) losses before moving on to other professions. A small few, however, may try to hide their inabilities. YOUR JOB is to separate the qualified from the unqualified, and to watch over the full lot. Thus, you establish trading limitations, leverage constraints, risk parameters. Traders have to stay within their money lines, maximum draw downs, loss limits, etc.
Thus, Firms that highly leverage their capital in order to put it into the hands of a few 1,000s employee speculators have a crucial job: They must ensure that capital is being precisely and properly managed. They must also make sure that risk levels are tolerable, that proper controls are in place, that their IT systems and internal technology can track what is happening, in as near to real time as possible.
This is not easy. It is a complex, difficult set of processes that requires constant vigilance. It must be reflected in the corporate culture from the top down. And, it becomes more and more complex as the size of the organization grows. The assumption MUST BE that EVERY employee is a potential rogue trader. (I was a rogue trader, but that’s a story for another day).
Anyone who runs a shop that has a proprietary trading desk is obligated to do everything in their power to prevent a single employee from bringing down the company. Indeed, everyone who earns their bonus by risking firm capital is a potential disaster. A rogue trader with massive losses is a sign of complete and utter failure BY THE BANK’S MANAGEMENT. It means that the supervisory functions have failed. That the ability to track what is occurring is not happening, certainly not in real time. In the case of the UBS London trader, he hid the losing trades for 3 years (so much for real time supervisory tracking).
That represents an utter failure of management.
Hence, the arrest of a so-called rogue trader is actually a red flag that the firm is not up to the task of discharging its internal oversight obligations. It is not being run properly — indeed, the discovery of the fraud is in fact a company admission of a poorly managed, failing organization. Senior management must be held equally as responsible as the trader. They may not have committed the same legal fraud (in hiding the trades), but they certainly should be sacked for their gross dereliction of duty.
Understand what this means within the broader context of our financial sector’s not so innocent foibles: Any firm that hires Robo-signers is just as bad as a firm that has rogue traders. Both actions are an indictment, an admission of failure and of managerial incompetence. Each represents a crucial failure of risk management, of legal compliance, of the ability to do their jobs safely AND within the law.
Why is this of interest to public policy makers? UBS’s failure to identify and prevent their rogue, just as Citigroup’s and Bank of America’s foreclosure frauds, are all part of a broader gallery of errors, omissions, foibles and illegalities.
In an era of bailouts on the backs of the taxpayer, it points to a simple reality: Firms must decide whether they are going to sacrifice profits in pursuit of safety, or sacrifice safety in pursuit of profits. Whatever they decide, however, it is not the responsibility or obligation of taxpayers to backstop these choices.
Consider the choices made by management: The collapse of firms such as AIG, Bear Stearns and Lehman Brothers were caused by the same sort of poor judgement as UBS’s $2 billion in losses. Only the rogues gallery there were the senior-most managers of the firms. Ace Greenberg exhorting his staff to focus on reusing paperclips, while the Mortgage Syndication division lost $100s of billions means that Ace had gone rogue; Dick Fuld surrounding himself with Yes Men while the firm’s leverage and risk exposure went through the roof also marked him as a rogue. Tom Savage, President, AIG’s Financial Products, calling derivative underwriting “Free Money? Yet another C-level rogue in a corner office.
These are the Rogues who belong in jail — the executives, managers and boards that recklessly pursued profits REGARDLESS OF RISKS. Their failures point out who the true threats to society are.
Paul Volcker, arguably the greatest Central Banker in history, has persuasively argued that proprietary trading should not be part of the insured depository banking sector. I utterly agree with Fed Governor Thomas Hoenig, who has described the banking sector as “more akin to public utilities” than independent entities. Want to be independent to pursue proprietary trading? Let’s drop their FDIC insurance and see how far their reputations carry them.
The next crisis — the one AFTER the present one in Europe — is where I expect to see the ultimate damage wreaked by rogue bankers.
The prior bailouts have created a moral hazard, where leveraged speculators and rogue bankers know that the state will bail them out. This is unacceptable. There is no reason that taxpayers should be responsible for ANY rogues, be they traders or bankers.
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Excerpts from current press after the jump.
In our galaxy, but far, far away: A planet orbiting two stars at once.
If that sounds familiar, than you are a “Star Wars” fan: Tatooine, Luke Skywalker’s desert homeworld in the first Star Wars movie (episode IV).
Details:
“This discovery provides confirmation of a new class of planetary systems that could harbor life. Given that most stars in our galaxy are part of a binary system, this means that the opportunities for life are much broader than if planets form only around single stars This milestone discovery confirms a theory that scientists have had for decades but could not be proven until now.”
If you could stand on the planet, Kepler 16b, you would see a “dynamic range of sunsets,” according to Laurance Doyle, a participating scientist on the Kepler team and lead author at the SETI Institute. Scroll down for video of the miraculous planet.
“Sometimes the red star would set first, other times the orange star would, sometimes they’d set at the same time,” Doyle continued at a NASA briefing on Thursday at NASA’s Ames Research Center in Moffett Field, Calif. “To tell the time using a sundial you’d need calculus.”
-Kepler principal investigator William Borucki, NASA
Source:
NASA Discovers ‘Tatooine’
TPM, September 15, 2011
The Dismal Optimist started out as a simple letter sent out to clients and friends. Without any advertising, its circulation has reached the point where it has outgrown its simple Hotmail format. My daughter CC, who is a designer and art school graduate, has be complaining to me for months that it needed a more professional look. She has redesigned the format and this is the new look.
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“Some people actually believe government can create jobs by taxing and borrowing from people with jobs and then giving that money to people without jobs. They call this demand stimulus. To make matters worse, other people think these demand-stimulus ideas warrant a serious response.” -Arthur Laffer, Wall Street Journal, Sept 12, 2011
“It’s a good idea to save your money. One day it might be worth something again!” -Alfred E Newman
The Euro – Free At Last?
As I began to write this, the media was reporting that Greece was on the verge of default. I started to write “let’s do it!” Default of one sort or another may be the only way out not just for Greece but for a vast majority of borrowers in the Western world. In my opinion, a Greek default need not bring the end of the euro.
Unfortunately, it now looks like Greece will get bailed again and the country’s default will be put off. All of the top European leadership apparently believes the survival of the euro depends on Greece not defaulting. German Chancellor Angela Merkel, along with French President Nicolas Sarkozy, is doggedly trying to avoid a Greek default. I applaud Merkel’s steadfast backing of the euro concept and European unity. But deep in her East German heart, she doesn’t trust markets or her own electorate for that matter. It’s too bad.
As I look forward, what I see is the coming end of the populist/socialist welfare state. It’s not going to be pretty but depending on the medicine taken, brighter days could lie ahead. The euro crisis is about much more than the euro. Massive unpayable debts and obligations have been accrued by all Western countries and their citizens. Default is the only way out. Investors have to be sure that they are not the ones defaulted on.
The populist/socialist state will need drastic alteration. The bond markets will force this. Intellectually Europe (and to a lesser extent America) is of the left. Barring a massive fiscal conservative sweep in the US 2012 elections, alteration of the populist/socialist welfare state won’t be initiated by politicians. Witness the continued political theater on this subject in the United States. Universal suffrage- based European electorates, along with those of the US and Japan, have voted themselves a cornucopia of welfare benefits. Let the rich pay, we are entitled. The coming demographic tsunami of old people supported by fewer and fewer of their adult children makes this an untenable situation. The days of cornucopia are over.
Dismal vs. Optimist
People have complained that this essay is all “Dismal” and no “Optimist.” Let me set that straight. The long run outlook for humanity (including investors) is bright. While the debt crisis looms and markets are going haywire, globalization and technology will march on as indeed they did even in the dark days of the Depression and WWII. Asia in particular will become a locus of technological progress as millions of Asian scientists and entrepreneurs join the global economy. Smart young Americans and Europeans may migrate to Asia if the US and Asia make the wrong decisions on the debt crisis. In any case American tech firms will become more and more Asian in terms of their own employees and facilities locations.
I have long been a fan of Ray Kurzweil who has written about the law of accelerating returns. Essentially Kurzweil sees technology as accelerating and taking over human evolution. (Kurzweil sees homo sapiens as eventually being replaced by Artificial Intelligence successors. Some people are put off by this. But you don’t have to buy that to accept Kurzweil’s insights on accelerating human progress) The global internet and computer technology links the millions of new minds and entrepreneurs and accelerates progress and technology.
America is renowned for its innovation and technology. If the right decisions are taken as a response to the coming debt crisis, that will continue. Emerging Asia is a growth technology center. Longer run, these are the areas that will reward investors.
What Europe Should Do
Since the beginning of the Greek crisis I have been arguing that Greece, like the American states in the 1840s, should be allowed to default and that the euro would come out of such an event stronger. I have argued that the euro represented a tremendous value-added in both economic and political terms and that the force of history was behind it. Turning the clock back would be a catastrophe.
Unfortunately the Europeans so far have managed to do all the wrong things. Once viewed as the Bundesbank reincarnated, the European Central Bank (ECB) has shed that image and has been buying the bonds of the so-called GIIPS countries (Greece, Italy,Ireland,Portugal and Spain—slightly more polite than PIIGS). Now Europe is in the throes of putting together a second bailout for Greece. The new European bailout fund, the European Financial Stability Facility (EFSF), if it is going to bail out countries, is a giant step in wrong direction. Germany, the strong economic man of Europe, will be turned into an ATM machine. Needless to say, the German electorate is less than overjoyed at this and the German electorate is rebelling.
In the twentieth century, catastrophe was something the Europeans seemed to seek out. In 1909 Norman Angell wrote a book called The Great Illusion in which he argued that war among the European powers was outdated and unthinkable because its cost would be so high. He was dead right. Unfortunately in 1914 Europe went on to have its war anyway and then for good measure went on to have an even worse one twenty years later. It made a special effort to massacre its Jewish population, which was in the vanguard of science and finance. In 1914 Europe (including the UK) ruled the world. By mid-century Europe was a morally and financially bankrupt force. Who is to say the Europeans will not choose catastrophe again?
I know that Milton Friedman and Martin Feldstein, recognized gods in the economic profession and both heroes of mine, predicted trouble for the euro. They assumed a European currency in the absence of European political union would eventually founder. So far they are looking pretty prescient. Nevertheless, perhaps with more hubris than brains, I would argue that the euro can get by the current crisis without taking the step towards further political unification.
Here’s how Europe can do this:
1. Embrace the rule that each member state must be responsible for its own fiscal affairs. No sovereign bailouts. Bailouts are just throwing good money after bad. Let the Greeks and all the others default. Let the markets impose the discipline, not the Germans. The weaker member states will simply have to live within their means. They have been living beyond their means since the euro began. They should not be able to rely on a German ATM machine. Somehow the Europeans have lost sight of the concept of responsibility. In this case, it should be the obligation of each member state to conduct its fiscal policy responsibly. The world and Europe needs the euro. The market has finally learned there is a difference between Greek and German debt, even if they are both denominated in euros.
2. Each country should recapitalize its own banks if these banks cannot raise capital on their own. The IMF and the EFSF should step in and help the weaker countries who cannot afford to fully recapitalize their own banks. The banking system cannot be allowed to collapse. The operative word for Europe should be “T A R P”. Thanks to Basel II which treated each member country’s sovereign debt as a risk free asset, the banks of Europe are stuffed to the gills with European sovereign paper. Basel II provided a perverse set of incentives for the bankers to toss risk analysis to the wind. Along the same lines, stress tests that didn’t haircut sovereign debt are an intellectual fraud and a joke. There is a substantial likelihood that a significant number of European banks are insolvent on a genuine market to market basis. IMF chief Christine Lagarde hit the nail right on the head when she ruffled feathers and called for capital injections into the European banks.
3. No country should be encouraged to leave the euro. But the Greeks and others should be allowed to make that decision on their own. I think they will choose to stay in the euro. For any departing country, this would entail the forced conversion of euros into some kind of devalued new national currency. True this would be a type of default. I just argued default is necessary. But I don’t think any European government has the political will to default on its own citizens in such a manner. The Greeks would burn down Athens. And Greece would still owe its sovereign euro denominated debt, upon which it will default anyway. A Greek departure would engender a bank run of unthinkable proportions in neighboring GIIPS countries. (As it is, I don’t understand with all this talk of weaker countries exiting the euro why any Italian or Spaniard or Greek with a brain would leave his or her euro deposits in one of their national banks.) Greece exiting the euro for a bank depositor means a giant capital loss when his or her deposits are forcibly converted into the new debased currency. Staying in the euro means that Greece and the other weaker countries will have to adjust their wages and prices to more competitive levels. I think this is an easier task than a monetary scorched earth policy that leaving the euro will require. The idea of an independent Greek central bank replacing the ECB is not believable. It will turn into a money printing machine and the new drachma will be avoided by all. Greece is not Argentina. In 2002, Argentina got away with breaking its dollar link and devaluing its citizens’ bank accounts. But Argentina is located at the end of the earth. Its citizens had nowhere to go. And Argentina as a major agricultural country got lucky. China was there to buy its exports. Greece is in Europe. No agriculture. They can’t sell China the Acropolis.
4. Problems with the euro payment system have to be addressed. This problem is described in detail in a recent paper entitled “Europe on the Brink” from the Peterson Institute. According to this report, obligations of over three hundred billion have been incurred by the GIIPS central banks to the German central bank. According to the Peterson report, the ECB has effectively guaranteed these obligations. But this form of backdoor financing for the GIIPS should be ended.
5. The ECB should provide liquidity to the European banking system which will be needed during the turbulent months ahead as Greece and possibly other countries need to restructure their debts. The just announced support for the ECB by other central banks is a positive step towards maintaining a functioning banking system. The ECB will be needed until the sovereign debts are restructured and the banks are recapitalized. Bank liquidity not solvency should be the ECB’s problem.
6. Bloated governments have to be cut and growth oriented supply side policies implemented including tax simplifications and reductions, privatizations and the elimination of regulations. The austerity plan imposed on Greece with its tax increases is already killing growth. Warren Buffet excepted, no sane citizen is going to be happy to pay more taxes to finance a bloated welfare state. Regardless of whether Greece stays in the euro or not, if the Greek government doesn’t implement growth policies the best and the brightest of Greece will emigrate. Greece as a country will be finished.
Investment Survival in a World of Near Term Chaos and Long Term Technological Progress
Investing in the current environment is extremely difficult. Short rates are near zero and returns on cash inflation-adjusted are negative. Extreme volatility has become the new normal. The Fed and other central banks have recklessly thrown caution to the wind with their various quantitative easing programs. And the prospect of global defaults lies ahead. The US and Europe are verging on a new recession. Asia faces inflation and at least a slowdown. There’s no place to hide.
I continue to see recommendations that investors buy emerging market and American tech stocks. The former are located in countries without excessive levels of sovereign debt and with relatively high GDP growth rates. The latter have loads of cash, in some cases pay significant dividends, have come down price and, as I have argued, technology is accelerating. The trouble is that near term—and that means the next year or so at least—nobody can promise that a drop in stocks similar to 2008 cannot happen. Long term investors may be able to ignore a let’s say thirty percent decline in their holdings near term so long as they make some multiple on their money say five years out. But most investors don’t have that kind of staying power. The decline of the populist/socialist state will not be pretty and accompanying defaults may pull markets down all over the world.
I have written extensively on the imperfections of the current dollar based fiat money international monetary system. I view gold as one way to hedge against that system’s eventual downfall. Asian central banks and retail buyers both have discovered gold. Living part time Hong Kong as I do, I detect huge enthusiasm for buying gold among Mainland visitors who come to Hong Kong. Gold recently has run up in a rocket-like manner. No doubt it needs to consolidate near term. Various people have come up with ways of valuing gold including comparing gold with inflation or calculating how much gold would be needed if some version of the gold standard were to be reinstated. I don’t have a formula for calculating the value of gold and I don’t have some kind of target price. Clearly there isn’t enough gold at current prices to support an entire global monetary system and a revived gold standard. Looking at gold that way leads to the conclusion it is substantially undervalued. Gold in my opinion is an alternative currency. So long as the current dollar based fiat money system remains in place, gold remains an important hedge. But what the gold price will do near term is anybody’s guess.
The historian Daniel J Boorstin once said “The greatest obstacle to discovery is not ignorance – it is the illusion of knowledge.” Lots of investment advice is coming from all sides from people suffering from the illusion of knowledge. We are in a difficult period without historical precedent. The illusion of knowledge could be fatal.
-Peter T. Treadway
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Dr. Peter T Treadway is principal of Historical Analytics LLC. Historical Analytics is a consulting/investment management firm dedicated to global portfolio management. Its investment approach is based on Dr. Treadway’s combined top-down and bottom-up Wall Street experience as economist, strategist and securities analyst.
Dr. Treadway also serves as Chief Economist, CTRISKS Rating, LTD, Hong Kong.
"Markets can remain irrational longer than you can remain solvent." —John Maynard Keynes
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