There is rarely any kind of consensus that emerges from these sorts of things. However, it did seem that virtually everyone saw the folly and risks in the debt-laden U.S. economy. 

We all agree: Debt is the story of today’s economy. There is still too much of it. Yet the mainstream view seems to be that more of same is the elixir to see us out of this bust. In fact, debt issuances by governments are hitting new records.

Letís look at the U.S. government. It is spending money hand over fist. Thatís not new. What is new is that the bloated government will try to sell over $200 billion in Treasuries this week — a record amount of new debt. The U.S. is hoping more foolish foreign central banks will line up and absorb the deluge for pitiful interest rates. The 2-year note sells for a yield of 1.01% as of last Friday. 

Maybe Washington will pull it off. But one day, people are going to demand a better rate to take the government’s paper. At some point, the marketís appetite for puny yields will go away. When that happens, interest rates will rise significantly and debt prices will crash. Itís not a matter of if, only when. To continue at this pace is clearly unsustainable.

The crazy thing is that the U.S. government is not alone. Emerging markets are also issuing record levels of bonds. The Financial Times reports this morning that ìthe surge in issuance this year [hit] its highest point since records began in 1962. The biggest issuers include China, Brazil, Russia, South Korea and some of the Gulf states.

Incredibly, most seem to look at these debt issuances as positives for the global economy. The FT, for instance, opined (in the middle of its news story) that the debt sales were ìan encouraging sign for the world economy.î 

Itís a weird paradigm that thinks growing debt levels are a good thing for the global economy, but it is a mainstream view. Economists, lost in their models and abstract curves, preach the benefits of stimulus — printing money and spending and borrowing.

And people seem to eat this up.

From The Wall Street Journal, I give you another exhibit of this kind of thinking. Reporting on the growth of Asian welfare systems, the WSJ reports: 

Asian countries are beginning to build extensive social-welfare programs like those that long have existed in the West, a move they hope will encourage their people to save less, spend more and help put the region — and the world — on a stronger economic footing in the years ahead.

Remarkable, isn’t it? Save less and spend more to create a stronger economy. Only an economist could sell that idea. I think the average person on the street would not believe that if they saved less and spent more their household would be on ìstronger economic footing. 

All this debt also crowds out needed investment in the private sector. It all competes for the same pool of capital. It means the capital-starved mining and energy companies are finding it very costly to raise money. It means investment in real assets slows, so governments can prop up ailing banks and do other dumb things.

The fall in energy investing is already here. If you look at the oil picture, you find something interesting about where future supplies will come from. The IEA estimated as recently as November 2008 that the Canadian oil sands would account for nearly 70% of the increase in nonconventional oil production between 2009-2030. However, with the price of oil where it is, investment has been cut way back. Already, the Canadian Association of Petroleum Producers has revised its forecast for investment three times. Itís cut it from $20 billion to $10 billion currently.

It begs the question, of course, where the oil will come from. These swing producers, like the Canadian oil sands, canít stop and start very easily. They take time. And these swing producers need a higher oil price to entice them to invest in new projects.

All of this sets up another leg-up for oil prices. The same thing is happening really across the commodity spectrum as projects are cut or delayed. From an investorís point of view, you get a chance to buy stuff on the cheap.

China is certainly hungry for resources, and it is doing a lot of buying! 

In the 10 months since Lehman Brothers imploded, Chinese bidders have been busy, the Financial Times reports today. So far, they’ve announced bids totaling $50 billion. Of these, more than two-thirds have been in energy and mining.

Among those commodities China needs most is iron ore, used in making steel. In fact, cash prices for iron ore delivered to China topped $90 per ton for the first time this year. China is the worldís largest buyer of iron ore, and imports are up 28% this year.

Chinaís voracious appetite has at least one competitor worried: India. As with China, India too is a large growing market. It too needs iron ore to build its budding cities — power plants, pipelines, bridges and more.

India’s steel ministry believes that India should restrict exports to China to ensure Indian steelmakers have what they need at reasonable prices. Such a move would only make it more difficult for China to find iron ore. India makes 200 million tonnes of iron ore a year, about half of which winds up in China.  

So the takeaway from all this debt issuance is to invest in real assets. One day, the Treasury debt bubble will pop, and when capital starts to look around for where to go to preserve itself and grow, it will turn to those hard assets such as crude oil, gold, iron ore and more.

Consensus on the Treasury Debt Bubble was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Ah yes, the future. What does it hold? Well, apparently more lay-offs and CEO pay raises. Judging by Sol Trujillo’s $20 million goodbye handshake and the actions of the board at Pacific Brands (giving themselves raises while sacking workers) it looks like there are some people out there doing their level best to run the good name of their corporation into the ground.

Don’t they know that’s bad for business?

Kevin Rudd is headed over to America this month to speak with Barrack Obama about climate change, the global financial system, and other ways to save the world and improve on human nature. Perhaps he might ask him if America’s US$1.75 trillion annual deficit for next year should cause global investors to worry about America’s credit quality.

Again from Eric, “The cost of buying a five-year credit default swap (CDS) to insure against the possible default of U.S. Treasury bonds reached 100 basis points for the first time yesterday. In English, the price of insuring $10,000,000 worth of Treasury bonds for five years now costs $100,000 – up from just $5,000 one year ago.”

We’ve said before it’s nearly impossible to default on your debt when you can print the money to pay it back. But what this normally does is send interest rates up on new short-term borrowing, of which there is a lot lately in America.

Keep in mind, the Obama budget includes about US$3.5 trillion in Federal spending, much of it to be financed with short-term borrowing. In fact, this week the U.S. Treasury is selling $94 billion in debt. The Treasury is even bringing an old-friend back from the dead. The seven-year Treasury note (which had been discontinued in 1993) will be reissued beginning with an auction of $22 billion worth today.

Can you see how government borrowing needs begin to crowd out lending to the private sector? Can you see also how we are speeding into an era where more of national cash flows are redirected to central governments for redistribution and/or the service of interest payments to foreign lenders? Can you see how directing national cash flow toward wealth re-distribution does not lead to more capital formation and wealth generation?

Ron Paul is still the only man in Washington who can see all this. He made a great point the other day that no one wanted to listen to. “Credit is not capital,” he told Ben Bernanke. You can’t recapitalise the banking system by printing new money or extending credit.

Credit comes from available savings. That’s why a high savings rate is essential the formation of future capital. We’re not making it up. It’s even the first sentence of the Treasury White Paper on the Capital Assistance Program.

“The financial system plays the critical role of channeling funds from savers in the economy to the investors with the ideas and ability to turn those funds into productive economic resources,” the paper begins. This is exactly how recessions prepare the way for the future boom. As households reduce consumption they increase savings.

Banks can become solvent again by retaining earnings (cutting dividends like ANZ did earlier this week) and increasing their depository base (and, of course, writing down bad investments and making more prudent loans). Or, the bad banks go belly up and the good banks are able to come in and scoop up the remaining assets.

Losers fail. Winners win. Or, as Rothbard puts it, an increase in savings reflects an increased desire for cash from consumers. This is actually good for banks in the long run. But we won’t run on and on about it below, although we’ve provided a fuller quotation for you below.

Incidentally, as we expected a couple of weeks ago, the gold price (in U.S. and Aussie dollars) has given up some of its ground after streaking ahead. But we wouldn’t be too worried.

One last quote for the day from Eric Fry on the matter, “The credit crisis does not study technical charts or read investor sentiment indicators. It does what it does. And what the credit crisis does best is destroy credit-based enterprises…and reward the buyers of non- credit-based assets like gold.”

Huzzah.

Still with us? Good! How about a quick revisit of the “baseline” and “more adverse” assumptions that are embedded in the CAP plan (son of TARP) released yesterday by the U.S. Treasury. The table listing the assumptions is below. But let’s give you the analysis first: crrraaaaaazzzzy!

After reading it, you’ll be more convinced than ever that falling stock and house prices this year are going to be followed by a blizzard of paper money that will send inflation soaring.

Government Assumptions That Guarantee Inflationary Disaster Ahead

How about some analysis? First, the GDP assumptions are for-at worst-a 3.3% contraction this year and a recovery in 2010. It’s probably more realistic to expect a GDP contraction of between 5 and 10% this year (based on the cliff diving GDPs of Asia and Europe) and a smaller contraction of 2-5% in 2010. Although either could be much worse, as the fourth quarter GDP figure in the U.S. was already a little fishy to begin with.

Second, the unemployment projections appear to have been generated on Planet Fantastic, where the laws of gravity and reality do not apply. Has anyone generating these U.S. statistics taken a look at the economy lately?

Or are these statistics pure propaganda and fabrication, designed to obscure from ordinary Americans (and Westerners) everywhere that real wages have been falling for thirty years and will continue to do so as global production shifts to low-wage labour markets?

Finally, how is it no one in the media picked up on the fact that the Treasury’s “baseline” forecast is for an 18% decline in house prices over the next two years (under rosy assumptions about GDP growth and unemployment)? Or that the “more adverse” forecast has house prices falling 29% in the next twenty-four months?

And here’s a question…how could house prices fall and unemployment continue to rise without having a further massively negative effect on bank loan books?

If TARP and CAP are designed to shore up bank capital by taking some a snapshot of how banks will perform under certain scenarios, then the plans are almost certain to fail if those scenarios fail to account for increased default and foreclosure rates in residential and commercial real estate that would come in the next two years (not to mention poor performance in securitised credit cards, student loans, and auto loans…all of which would deteriorate as unemployment rises.)

And how is simply raising taxes and transferring money to the newly unemployed going to solve this again?

All we can think of now is a supernova. In the rush to repair the broken financial system (which was broken by the explosion in credit and the enormous misallocations and distortions it caused) liberals and conservatives and professional politicians of every stripe (without brains or spines) are launching every conceivable spending plan they can think of. Their goal is to tag the culpable private sector for all the blame, shift the burden for losses on to the public balance sheet and future generations, and replace the private sector with the government as the prime mover of economic life in the modern world.

Or have we missed something?

A supernova, of course, is the death of a star. It unleashes a giant amount of light, heat, energy, and radiation in one brilliantly beautiful moment of destruction. But let’s not forget it’s a moment of death, as pretty as it might be.

Perhaps that’s where we’re headed. Instead of seeing a recession as the method of re-establishing the efficient allocation of an economy’s resources and capital, the banksters and pollies are going to give us an even bigger global system of paper, as Ron Paul suggests.

With the dollar-standard in tatters, the only place left to go in the artificial evolution of paper money is a global fiat standard on top of the dollar standard. We have no idea what it would look like. But you can bet there are some other folks who’ve been thinking long and hard about it and are more than willing to use the current crisis as an excuse to inflict it upon you.

Finally, the last (and longish) word from Rothbard on why booms require busts.

“The ‘boom,’ then, is actually a period of wasteful mal-investment. It is the time when errors are made, due to bank credit’s tampering with the free market. The ‘crisis’ arrives then the consumers come to re-establish their desired proportions.

“The ‘depression’ [ed. note, Rothbard uses the word 'depression' in place of 'recession'] is actually the process by which the economy adjusts to the wastes and errors of the boom, and re-establishes the efficient service of consumer desires.

“The adjustment process consists in rapid liquidation of the wasteful investments. Some of this will be abandoned altogether (like the Western ghost towns constructed in the boom of 1816-1818 and deserted during the panic of 1819); others will be shifted to other uses. Always the principle will be not to mourn past errors, but to make the most efficient use of the existing stock of capital.

“In sum, the free market tends to satisfy voluntarily-expressed consumer desires with maximum efficiency, and this includes the public’s relative desires for present and future consumption. The inflationary boom hobbles this efficiency, and distorts the structure of production, which no longer serves consumers properly.

“The crisis signals the end of this inflationary distortion, and the depression is the process by which the economy returns to the efficient service of consumers. In short, and this is a highly important point to grasp, the depression is the ‘recovery’ process, and the end of the depression heralds the return to normal and optimum efficiency.

“The depression, then, far from being an evil scourge, is the necessary and beneficial return of the economy to normal after the distortions imposed by the boom. The boom then requires a bust.”

Some people don’t want a return to normal. Bankers don’t want it because it means a lot of them would be out of business for good. Investors in credit-backed bonds don’t want it because it means taking losses. And politicians certainly don’t want it because the sense of continual crisis is the perfect mechanism for the relentless expansion of government power in private life.

The only who want things to be normal are normal people. And they are stuck right now living on Planet Death Star; a spaceship captained and crewed by a bunch of morons who will be the financial death of us all. Or are we just whistling a bizarre Dixie?

Regards,
Dan Denning
Australian Daily Reckoning

March 2, 2009

The Fed Prints, The Government Borrows: Welcome to Planet Death Star was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Dozens of stocks come to mind that were sold down to insanely cheap levels as hedge funds scrambled for cash. That scramble is probably not over, so we may be in for more turbulence. Plenty of stocks come to mind that are still trading too high relative to their earnings potential. We’ll be looking to bet against those in 2009. Plus, many companies will not make it out of 2009 without going through bankruptcy. I expect to find a few more “short to zero” stocks — like Fleetwood Enterprises (NYSE: FLTW) — in 2009. We sold Fleetwood short in March at $4.43 and covered in October at 27 cents, for a 94% gain.

When asked by family and friends over the holidays what I think about the 2008 stock market and economy, my response has been, “I expected a nasty bear market in 2008, but the carnage since September took me by surprise. The economy will remain weak, but I think the worst of the widespread market carnage is behind us. Future damage should be concentrated in sectors with horrible fundamentals. Thankfully, 2009 should be a year when fundamental analysis should start to matter once more.”

This will be a welcome development, because 2008 was a year when the following strategy worked best:

1) Sell short any stock or ETF, without bothering to do any fundamental research
2) Invest the proceeds in Treasury bonds, preferably with as much margin as possible
3) Repeat Steps 1 and 2, over and over.

Clearly, this “deflation trade” strategy is not sustainable over longer time frames — not in an era of worldwide paper money standards. In fact, I’d expect that such a shotgun-based investment strategy of short S&P 500/long Treasuries could lead to big losses in 2009.

I think the key to approaching 2009 markets will be to view everything form the perspective of the Treasury and the Fed. Everyone knows that the real economy stinks and that America is overly indebted. But I doubt everyone realizes just how extreme Treasury/Fed will be in using the deficit and the paper money system to stop the Great Depression II scenario. Theses tactics will be inflationary at some point.

The U.S. banking system became destabilized because its core collateral – houses and mortgage-backed securities – collapsed in 2008. While the authorities may not be able to re-inflate old bubbles in these assets, I’m betting they can employ cheap Treasury financing to cushion the decline. This involves refinancing homeowners out of toxic mortgages into conventional mortgages. They’ll also find some way to deal with the problem of negative home equity, even if it involves highly inflationary tactics like Treasury assuming losses from principal reductions via Fannie and Freddie. And even if foreigners balk at absorbing new Treasuries, the Fed will monetize them – i.e., buy them itself. Again, these tactics would be highly inflationary.

So let me enumerate a few predictions for the New Year:

1) It’s far too easy and popular to be bearish on everything but Treasury bonds, so odds favor a sharp rally in early 2009 — a rally in the S&P 500, led by stocks with the most sustainable fundamentals, including energy, commodities, and infrastructure. Stocks with weak fundamentals may participate, but quickly roll over as economic reality sets in. Many will go to $0 in bankruptcy.

2) The SEC will suspend mark-to-market accounting, or at least modify it to allow more management discretion in marking values of securities. The era of wholesale shorting of financial stocks is likely over. A massive wave of refinancing is also a backdoor way to recapitalize the banking system; perhaps the most efficient way to increase the value of exotic mortgage-backed securities, (and bank capital) is for many of the mortgages backing these securities to “prepay” upon refinancing. Bankers will re-emerge from their bunkers and look to make new loans to creditworthy borrowers, since a sub-1% cost of funds courtesy of the Fed is too low to ignore.

3) Oil will rebound to $80 per barrel on lower than expected production, despite weak demand. If demand rebounds, oil could go to $120.

4) Gold will rally beyond $1,200 on weakness in the U.S. dollar, unprecedented Treasury bond issuance, and tepid foreign demand for U.S. dollar assets. Weaker foreign demand for Treasury bonds will prompt the Fed to step in as buyer of last resort and monetize debt. In its December policy statement, the Fed signaled that if foreign lenders look to sell Treasuries, it would step in as a buyer to keep rates low. If this happens, more savers and bond fund managers will look to invest in inflation hedges like gold and energy.

5) Many more hedge funds will fold in 2009, but this is good for the long-term health of the market. Most of the new funds should not have been started because they just went “long” everything on margin. Their closure will result in a more efficient – and less volatile – market.

6) 2009 will be a “stock picker’s” market. Nothing worked consistently in 2008 other than indiscriminate shorting of stocks and buying of Treasuries. The worst of the wholesale liquidation of stocks is likely over, so 2009 will offer lots of opportunities to buy and sell short individual stocks using fundamental analysis.

That’s the good news…So let’s end on that note.

Regards,
Dan Amoss

January 12, 2009

Stock Strategies: Random Predictions for 2009 was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Life in the Leafy Suburbs

There is a problem with living in a leafy suburb. When autumn rolls around, the leaves turn brown and fall off the trees. So you have to deal with cleaning up the yard. And after being away in South Africa for two weeks, I sure had a lot of dead leaves in my yard. Thus did I spend time the other day, working like a man on a chain gang — totin’, liftin’ and haulin’.

There I was, raking leaves and dragging them down to the front curb. From curb side, the local municipality has a dump truck with a big sucking machine (the “suck truck”) that scoops up the leaves and takes them to some place called “away” — wherever that is.

And then this guy drives up in a pickup truck and says, “Hey sir, are you the owner?”

I acknowledged that I was the owner, and the man said “I need work. Could I help you clean your yard for a couple hours and you could just pay me?”

The guy seemed OK, and I had a heck of a lot of yard work to accomplish. So I figured I’d hire him for a couple of hours and get the work done faster. Thus did Mike — my casual employee — and I clean up the area around my house.

As we worked, Mike and I talked. Mike is 45 years old. He’s a high school graduate. He served in the Navy (See? I knew he was OK.) After the Navy he worked at a manufacturing job, from which he was laid off in the early 1990s. Then he worked in a warehouse, which closed in the mid-1990s. Then he worked as a mechanic, until his employer went bankrupt in 2000. Then he drove a truck and hauled freight, until that fell through last year after his major customer moved operations out of the country.

“It’s the story of my life,” said Mike. “I’ll work someplace for a couple of years. Then the economy changes or there’s a business setback, and I’m out on my butt.”

Doing Jobs That Americans Won’t Do

Now Mike drives around leafy suburbs. He looks for people who might need help with cleaning up around their house. Mike’s wife is a cashier at Target, “so she’s got the real job in my house.” Mike has settled down to where he lives in the world of cash, earning a few dollars here and there.

“Y’know,” said Mike, “George Bush said that we need more immigrants here in the U.S. because ‘they do jobs that Americans won’t do.’ What the hell was he thinking when he said that? Here I am. I can strip a diesel engine down to the last nut and washer. And I’m cruising neighborhoods looking for yard-work. Heck, I was born in Pittsburgh. I served my country and I’m no immigrant. But I can’t tell you the kinds of crappy jobs I’ve done just to pull a couple of bucks out of the economy for me and my family.”

“We’re All Immigrants Now”

Mike continued. “I don’t see it getting much better for people like me. That’s for sure. And now all the big banks and big businesses are laying people off too. Everybody’s losing their retirement funds. I guess we’re all immigrants now.”

Where Do We Go from Here?

So where do we go from here? At least Mike can strip a diesel engine down to the last nut and washer. Are we all destined to become — as Mike so delicately put it — “immigrants.”

Call me quaint — even old-fashioned — but I’m proud to be an American. It’s just that I don’t like this “immigrant” sort of governance that has evolved within the U.S. We have too many family political dynasties, taking care of their old friends from way back — if you know what I mean.

Really, it seems like every political administration of recent vintage has had people from Goldman Sachs hiring other people from Goldman Sachs to bail out more people at Goldman Sachs.

Yes, it may be paranoia at work. I confess that I think along these lines quite often. But it has been especially prominent in recent days, as Treasury Secretary Hank Paulson — a former Goldman man — comes up with new and different versions of the Wall Street and banking bailout plan.

First Congress authorized $700 billion — quite a bit more than the entire Department of Defense budget — for some sort of “troubled asset relief plan (TARP).” (Nobody ever really explained it to my satisfaction. Somehow we were going to throw money at a very big problem and fix it.) Then the money flowed like rainwater to Wall Street and a bunch of banks. Then the banks and Wall Street houses continued to pay their insiders’ big salaries and bonuses. And the banks have not exactly been lending into the economy. Meanwhile nobody has been buying up any of those so-called “troubled assets.” So for $700 billion, we are not getting any results. And there’s little or no accountability.

Then Sec. Paulson comes along and says that the TARP money really doesn’t have to be used to buy “troubled assets.” He says we’ll use it for other things instead.

But wait a minute. It would be like Congress authorizing funds for the Navy to buy a new aircraft carrier (actually, 100 new aircraft carriers for $700 billion), and then the Secretary of Defense saying, “No, we won’t use the money to buy aircraft carriers. We’ll use it to pay big salaries and bonuses to defense industry executives.” How long do you think that a charade like that could go on?

Let’s go back to the beginning. Did it ever make any sense for the U.S. Treasury to buy up “troubled assets” — whatever those are and however one might value them? And does it make any sense for the Treasury to just hand out funds to banks and bankers? Like I said, call me quaint or old-fashioned, but of course not.

Until we meet again,
Byron W. King
November 18, 2008

Americans as Immigrant Workers in America was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.