November 2009 - Posts
Please, click here to read this article in pdf format: www.sibileau.com
I think we started the week with a lot of unnecessary noise, which somehow prevents us from noticing what may be underlying trends in the making.
As we had foreseen back on September 2nd (http://www.sibileau.com/martin/2009/09/02 ) situations like the one played out of Dubai could be expected and could spiral to become a real problem, given that the world had seen coordination among developed nations’ monetary authorities, while in emerging markets that was still a speculation. Yesterday, the United Arab Emirates Central Bank announced that it “stands behind” the country’s local and foreign banks. Of course, as we also commented in the past two letters, this is becoming by the hour a political rather than a financial crisis. In addition, as rumors abound in politics, during yesterday’s session we read and heard a lot of them. The result was more discrimination within the Gulf region in corporate credit, with Dubai at the top and Qatar at the bottom of the spectrum. As well, it appears that the initially announced $59BNin liabilities affected by the announced restructuring is in fact significantly inferior, with some analysts now hinting at approximately $18BN.
Having said this, I have included this morning the already classic chart that shows the spread between 3-month Libor and the Overnight Index Swap (OIS) rate. Let’s take the opportunity to review what this spread means. The OIS is an interest rate swap between financial institutions, where the (volatile) overnight interest rate is exchanged for a fixed rate. The OIS rate is based on the average overnight interest rates transacted during a day. The overnight rate is the rate of the overnight market, where banks transact to ensure they have enough reserves at their respective central banks. The 3-month Libor rate is the USD rate banks pay when they borrow to fund the loans they extend to their customers. Therefore, the difference between the 3-month Libor and the Overnight Index Swap rate represents the cost of “renting” the balance sheet of a bank. When liquidity becomes scarce, as one would have intuitively guessed would be the case after the news out of Dubai, this cost of renting balance sheets should increase. During the worst months of 2008, it did in fact increase, and it increased exponentially. The chart below shows that during the last week the spread has remained almost flat and at record lows (10.96bps), instead of increasing….
Generally, one hears many opinions about the markets, but money always speaks too, and when it does, it leaves an echo in the 3-mo Libor – OIS spread. I heard it yesterday and it was very clear. We are awash in liquidity and yesterday wise money covered shorts in fashion. Perhaps this noise however did not let us see something more fundamental unfolding. For the first time in a while, intraday, I saw weakness in US stocks and the USD as if a weak USD no longer meant higher stocks, but rather true fundamental capital flowing out of the US. Maybe I am wrong, because at close, the equity markets were slightly higher. But I sure felt a tectonic shift yesterday…Was it not the expectation of an upcoming intervention of the Yen?
The comments expressed in this website and daily letters are my own personal opinions only and do not necessarily reflect the positions or opinions of my employer or its affiliates. All comments are based upon my current knowledge and my own personal experiences. You should conduct independent research to verify the validity of any statements made in this website before basing any decisions upon those statements. In addition, any views or opinions expressed by visitors to this website are theirs and do not necessarily reflect mine. My comments provide general information only. Neither the information nor any opinion expressed constitutes a solicitation, an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). My comments are not intended to provide personal investment advice and they do not take into account the specific investment objectives, financial situation and the particular needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
Today’s letter is very brief and is the continuation of Friday’s,
which at the same time, constitutes another good test of our Thesis No.
2 on gold, postulated on April 21st, 2009. Why is today’s letter so
short? Because it has an attached chart that I think is worth more than
a thousand words.
As we wrote on Friday, Dubai’s crisis is starting to
look contained, delimited and unique by its political background. Of
course, given the impact on financial institutions locally and in
Europe mostly, one cannot ignore it. But, as we wrote too, according to
our thesis, if central banks step in to coordinate action against
potential contagion in the foreign exchange markets, gold loses its
chances to become a reserve asset.
Thus, on Thursday night, the news that the Bank of Japan was
considering intervention (according to some analysts it did not carry
it fully out, to avoid adding confusion to the situation in Dubai), as
the chart below shows, brought gold to its knees overnight, after it
had held admirably well on Thursday. Also shown (at the bottom of
chart), is the 3-month Libor – Overnight Index Swap spread, which a
benchmark of the liquidity conditions in the USD market. On Friday,
this spread opened almost unchanged. Thus, in Europe equity markets
ended up correcting Thursday’s sell off and even as the S&P500
Index was down to 1,083 intraday, the VIX Index managed to contract
intraday, closing at 24.74 or 5+% higher than Monday’s open. What is
the conclusion? Well, I hope it will be obvious by now how much control
central banks retain yet…
Martin Sibileau
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
With US markets closed yesterday, the level of liquidity was not
normal in the face of the events/news out of Dubai. Equity markets
elsewhere got the message (finally!) and the sell-off, which to my
surprise had been absent yesterday, took place.
As I write these comments there is speculation on the motive Dubai
may have had to request the standstill (until at least May 2010) in
financing payments by property developer Nakheel and other member
companies of Dubai World, which is the company’s state-owned parent.
The markets’ deception is due to Dubai’s recent announcement of $5BN
raised in a fully subscribed transaction with two Abu Dhabi-owned
banks. I prefer not to comment on rumors. Apparently, this situation
unfolded because of some tension between Abu Dhabi and Dubai. Later in
the day, the market began to discriminate between Dubai’s systemic risk
and that of other Gulf nations.
At the big picture level, I think there are two interesting
observations to make, related to two theses I have written about
earlier. Back on September 2nd, I wrote that:
“…emerging markets are the Achilles’ tendon… We can perfectly
see a G-8 central bank coordinate assistance with another G-8 member,
but investors are wondering who is going to pay the bill, if a fiscal
problem unfolds in an emerging market. The IMF? Maybe, but given that
history suggests otherwise, the onus is on policy makers…” (www.sibileau.com/2009/09/02 ).
This debt crisis seems to have certain unique characteristics, given
the Emirates’ political dynamic. However, given that local banks were
involved in the financing of the real estate delusions with people’s
deposits, this is also another typical emerging market debt crisis.
Therefore, policy makers in the developed world will be forced again to
consider assistance mechanisms.
The second observation relates to our old thesis on gold. On September 3rd, I suggested that:
“…A run against an emerging market’s currency would not necessarily
be supportive of the USD, if the same is triggered by a wave of
defaults affecting the country’s financial system. It could potentially
be supportive of gold, if the big guys (G-8 countries) don’t lend a
timely hand...” (www.sibileau.com/martin/2009/09/03 )
Gold did not rally yesterday, but the USD did. Does this therefore
mean that there will be a “timely hand”? (Our gold thesis reads as
follows: “…when there is global coordination of inflationary
monetary policies, gold cannot be a safe and lucrative asset. When
inflationary monetary policies are not globally coordinated, gold is a
safe and lucrative asset…”)
One is tempted to induce an answer. However, we are not inductive at
“A View from the Trenches”. We follow the Austrian method, which is
purely deductive. It is a fallacy to think that if A is true –>B is
true, therefore, when B is true –>A is true.
Applied to this situation, it is wrong to conclude that: “If
when there is global coordination (of central banks) gold doesn’t rally
(=is not lucrative), therefore, when we see like yesterday that gold
did not rally (= was not lucrative), global coordination is on the way”.
It is nevertheless a bit early to draw conclusions here because:
1. - Yesterday the US markets were closed (maybe this was precisely the reason behind the sudden announcement by Dubai),
2. - It is not yet clear what Dubai really intends to do.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Happy Thanksgiving to all the readers in the United States that follow “A View from the Trenches”. Even though this is a short week, what we witnessed yesterday makes it impressive, indeed.
Yesterday was full of macroeconomic data (overall positive, with new jobless claims in the US dropping below 500k), but two events really stole my interest.
Early in the morning, the news out of that Dubai announcing the restructuring of Dubai World, which is state-controlled, seemed that it would add more stress to the sovereign credit default swap market, after last week’s concern over the health of Greek banks. Dubai World was going to ask all providers of financing to Dubai World and Nakheel PJSC to standstill and extend maturities until May/10. With this press release, Dubai’s credit default swap widened 116bps to 434bps, but without impacting the sovereign market. Truly unbelievable, if you compare this to other past debt crisis in emerging markets.
The other (by now not so unbelievable) event is related to my last comment, on Tuesday, about my view on how the exit strategy by the Fed will play. The main point I made was that contrary to what many analysts predict, I believe the Fed will not target a level of excess reserves. In my view, it is more consistent with the policy developed so far to target a level of “excess supply of liquidity”. The problem here is how to define “excess supply”. Liquidity measurements have always been a concern, and perhaps deserve a special chapter in the theory of statistics rather than monetary theory. This problem is faced by every central bank. Therefore, we may not be able to measure the excess supply, but we can see its impact. This is similar to Heisenberg’s principle in Physics. For instance, yesterday we had the 7-yr Treasury notes auction, which took the total issuance during this short week to $118BN!!! It was a complete success, with the yield closing down -4bps and a flatter curve.
What does this have to do with excess supply of liquidity? The solid demand for this issuance did not affect at all the equity market. At all! Let me repeat this: Yesterday, we had the explicit insinuation of an upcoming sovereign default coming out of an emerging market, a successful auction of a US Treasury 7-yr issuance, an increase in equity prices and an increase in gold! Amazing! Who was the big loser? The US dollar!
This is an example of the impact of excess liquidity (as I write, Gold is trading at $1,194/oz.). Below is a chart, showing the 30-yr Treasury (in white) and S&P500 Index(in orange)prices during the session yesterday (Source: Bloomberg). The change in dynamics after 1pm, when the auction results were announced is very, very clear. And both the 30-yr note and S&P500 Index rose in conjunction. Under “normal” conditions, a increase in bond prices (higher interest) rates, should have the opposite effect on equities. These are certainly not normal times…
Yesterday too, an interesting note on Quantitative Easing by Prof. Charles Goodhart, from the London School of Economics (Mr. Goodhart was also member of the Bank of England Policy Committee from 1997 to 2000), was published by Morgan Stanley (”The Global Monetary Analyst”, Nov. 25th). In it, Prof. Goodhart indirectly sides with the notion of excess supply, suggesting that “asset markets (…) determine the end of QE”. I fully agree.
Now, the important issue here is that if you want to be consistent all the way on this subject, excess supply is eliminated with asset sales, not necessarily with interest rate increases. Please, take a good note of this. If you target excess reserves, you can play with interest rates. If you target excess supply, you must sell assets in the balance sheet of central banks. It makes sense. When central banks buy assets, they inject liquidity that creates asset bubbles. To keep them muted, central banks must sell assets.
Will central banks sell assets? Not initially, but eventually. Why should we care about this? Because it should provide us with a good tool to assess when the bubbles will go bust. You can trade gold accordingly!
The comments expressed in this website and daily letters are my own personal opinions only and do not necessarily reflect the positions or opinions of my employer or its affiliates. All comments are based upon my current knowledge and my own personal experiences. You should conduct independent research to verify the validity of any statements made in this website before basing any decisions upon those statements. In addition, any views or opinions expressed by visitors to this website are theirs and do not necessarily reflect mine. My comments provide general information only. Neither the information nor any opinion expressed constitutes a solicitation, an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). My comments are not intended to provide personal investment advice and they do not take into account the specific investment objectives, financial situation and the particular needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
The widespread impression that the US deficit will continue set all
non-money assets on a rally yesterday. Gold reached $1,174/oz. As we
said many, many times over, it is as simple as that. Interestingly
enough, with the 10am announcement on the 10.1% increase in the
existing home sales (month-over-month), the market took profits in
equity and gold.
Yesterday, I quoted comments from our April 28th letter (www.sibileau.com/martin/2009/04/28
“A Keynesian Perspective”) on Keynes approach to monetizing financial
crisis like the one we are in. I thought it was interesting to see
Keynes’ point here, because in my opinion, Keynes is Bernanke’s
intellectual father.
Keynes thought that a readjustment of prices to a new level in the
quantity of money was possible, without further unintended consequences
(from Chapter 13, “General Theory of Employment, Interest and Money”,
1936). In his words:
“…Circumstances can develop in which even a large increase in
the quantity of money may exert a comparatively small influence on the
rate of interest…” (Have we not seen this happen in front of us over all of 2009?)
“…Whilst an increase in the volume of investment may be expected
… to increase employment, this may not happen if the propensity to
consume is falling off…” (Is this not what all economists keep telling us on the weakness of this recovery?)
“…If employment increases, prices will rise in a degree
partly governed by the shapes of the physical supply functions, and
partly by the liability of the wage-unit to rise in terms of
money..(…)…when output has increased and prices have risen, the effect
of this on liquidity-preference will be to increase the quantity of
money necessary to maintain a given rate of interest…”
From this last paragraph, we learn that the exact price level at
which prices would adjust would depend on productivity and unemployment
rates. Please, remember that rates are a metric, which depend on time.
Thus, timing was indirectly also accounted for. Of course, Keynes
neglected the non-neutrality of money (i.e. fluctuations in the
quantity of money do not affect all prices at the same time). Note that
ignoring the non-neutrality of money is expensive, because if you do
so, you miss on the rally we’ve been enjoying since March. But in the
long term, it is true, there is an adjustment of prices to a new
quantity of money, as long as your currency is not debased enough to
push investors to massively dump it. In the case of a global crisis,
Keynes correctly appreciated the value of monetary policy coordination
to avoid a run against fiat money and proposed the creation of what
later came to be the International Monetary Fund.
Where do I go with all this? Do I believe that there will not be an exit strategy after all? Not at all.
My view is that if Bernanke follows Keynes, the Fed will withdraw liquidity in the quantities that it sees in excess of demand
(=excess supply). As long as it sees demand for a certain quantity of
liquidity, that quantity will not be reduced and of course, further
liquidity will not be provided. Let’s call this Thesis No. 3,
which I will test going forward and will elaborate more on (i.e. how do
we measure “excess supply”?)
This view significantly differs from the mainstream opinion, which
holds that the Fed, once it starts unfolding its exit strategy, will
seek to return the level of bank reserves, which are expected to rise
to $1.35 trillion to the historical average of $10 billion (i.e. normal
levels prior to the crisis; this strategy consists therefore in
eliminating excess reserves). This would represent a significant reduction in liquidity.
The difference here between the Fed and a typical inflationist
third-world country would be in that third-world countries not only do
not withdraw liquidity but also keep providing it indefinitely.
What do we make of it? In the foreign exchange market, such scenario
should continue the depreciation of the USD against gold and those
currencies that do not import USD inflation. Which are the countries
that do not import USD inflation? Those countries where their central
banks do not accumulate either USD or securities from their financial
institutions in the asset side of their balance sheets.
MASSIVE DISCLAIMER
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Although the past week did not seem to show a fair amount of important trading or direction, I think that it was a relevant week nevertheless. Monetary authorities and government have made it very clear, if there ever were any hesitations, that at least in the US the accommodating policies will stay in place for as long as needed. In addition to this, over the weekend, a major hurdle to the collectivization of the US health care infrastructure was removed.
The natural winning choice here seems to be gold. However, over the long term, it doesn't seem right to me. Call it a hunch. Indeed, the world is struggling to come up with a reserve asset, on the prospect that the USD may fail to work as one. But, does anyone doubt for a moment that liquidity will eventually be drained out of the market? To be honest, I do. The issue is that what we call liquidity today, may only be so at a diminished value tomorrow. Let's see...
Everything may seem a challenge these days, but Keynes foresaw decades ago the dilemma we currently have in front of us. We, at "A View from the Trenches", also suggested this approach, in our letter of April 28th (www.sibileau.com/martin/2009/04/28 "A Keynesian Perspective"). In April, I quoted Chapter 13 of the General Theory, writing that:
"...Keynes says something rather ominous: "…if employment increases, prices will rise in a degree partly governed by the shapes of the physical supply functions, and partly by the liability of the wage-unit to rise in terms of money…". Essentially, the final rise in prices that we may expect will depend on how we address productivity issues today (i.e. physical supply functions...) and how our current politicians reshape the labour market today (i.e. contract negotiations with unions, etc. that determine the liability of the wage-unit to rise in terms of money).
The final sentence is perhaps the most relevant. Keynes wrote that "…when output has increased and prices have risen, the effect of this on liquidity-preference will be to increase the quantity of money necessary to maintain a given rate of interest…". This strongly suggests that an exit strategy by the Fed may be counterproductive. Inflation may be high enough for us to need today's increase in the quantity of money, to maintain the rate of interest at the end of this experiment"
The discussion above is more relevant after the events of last week. Strategists worldwide are writing research on how to hedge against upcoming inflation, the initial consequences in the credit markets (spread tightening in 2010 will continue) and the evolution of the global monetary system as the US may be too focused in trying to orchestrate a joint exit program with China only. Thus the degree of productivity increases (= strength of the recovery), which we check every quarter, as earnings are released, becomes critical. Unemployment, which so many an analyst sees as a burden for growth in consumption is, in my view and following Keynes' comments, a plus. With a 10%+ unemployment rate (i.e. the liability of the wage-unit to rise in terms of money), prices will rise slower than otherwise. Thus, is there a role for gold? Unfortunately, even as this commodity will certainly continue to rise, unless something more fundamental takes place, gold has limited chances of becoming a true reserve asset. But this does not mean, at all, that gold's chances to outperform in the near term are compromised.
Lastly, as I read the news last week, it seemed to me that we were closing on many questions that we had had since the beginning of the year. Will the Treasury be able to place its debt? Will the Fed indicate a path on rates? Will the US have a collective social health care system? Will there be enough demand for corporate credit? Will we see a clear inflationary reading in the Consumer Price Index? Will we see a clear trend in the reduction of unemployment claims?"
Thus, on this note, I think a comment about Method can be suggested. Thomas Bayes (London, 1701-1761) became posthumously famous thanks to his paper titled "An essay toward solving a problem in the Doctrine of Chances", published in the Royal Society's Philosophical Transactions, in 1764. Bayes had elaborated conditional probability, to be able to answer this question: "How can we infer underlying probability from observation"? (refer L. Mlodinow's "The Drunkard's Walk", Ch. 6").
It is very tempting, as questions become certainty, to infer what will happen in 2010. In the past weeks, I have read a lot of economic and financial research that is nothing else than inferences made on conditional probability (i.e. if the Fed leaves rates unchanged in 2010, what are the chances that investing in corporate credit outperforms investing in equity or gold?) But here's the trick: In conditional probability, once you identify and quantify your sample space, you have to prune it, to adjust it for the conditions you already know. Can we do this in a global multi-currency world, where the unemployment rate that is assumed to delay consumption growth is not in the country that produces most of the goods sold worlwide? I think the answer is negative. But it is also negative because money is non-neutral, which means that it affects assets prices at different stages in an inflationary process and in different degrees. Therefore, I believe that we are not even able to work with a specific sample space, let alone prune it.
The comments expressed in this website and daily letters are my own personal opinions only and do not necessarily reflect the positions or opinions of my employer or its affiliates. All comments are based upon my current knowledge and my own personal experiences. You should conduct independent research to verify the validity of any statements made in this website before basing any decisions upon those statements. In addition, any views or opinions expressed by visitors to this website are theirs and do not necessarily reflect mine. My comments provide general information only. Neither the information nor any opinion expressed constitutes a solicitation, an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). My comments are not intended to provide personal investment advice and they do not take into account the specific investment objectives, financial situation and the particular needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
In the chart below (source: Bloomberg), I show the intraday spread between the 30-yr US Treasury and the S&P500 Index. As you can see, this spread widened significantly until 11am yesterday.
Macroeconomic data released yesterday morning by 10am were mixed. On one hand, the initial jobless claims and Philadelphia Fed Manufacturing Index were positive. Jobless claims are approaching the 500k level and should they break through to the downside, an important milestone will have been achieved. On the other hand, the Leading Indicators index and Mortgage delinquencies data disappointed (0.3% vs. 1% expected and 9.64% vs. 9.24% expected, respectively). However, as the chart above shows, before the releases (i.e. overnight) the fixed income market was already selling off overseas (white line shows price of 30-yr Treasuries going up until 11am). Afterwards, the market did not react either, until 11am.
What made markets react at 11am? The only news I found at 11am was the US Treasury bills and coupon auctions announcements. But there was nothing to be surprised. Analysts were fully expecting $118BN of coupon issuance in total, composed of different maturities. Not only were the full $118BN announced, but their composition was also announced in the exact maturity buckets the market had been expecting. Why did markets react?
I think investors are starting to acknowledge that the burden of the fiscal deficits worldwide will be significant. The sell off was triggered in Europe, where Greece’s central bank expressed concern over the usage of Euro liquidity facilities by Greek banks. Greek bank stocks sold off on the news and the contagion effect spread further sovereign credit default swaps. Sovereign credit default swaps saw a steady and solid bid yesterday. Yes, the problems are macroeconomic and those who have been suggesting otherwise may be proven wrong. The proof is, in my view, in the price of gold, which tracked the movements in US Treasuries simultaneously. It was exactly after 11am that the price of the ounce began to regain what had lost, to finish almost flat. This meant, I think, that once there were no surprises on the auction announcements (=the party can continue) the bid for risky assets could keep going on.
Was someone out there expecting a different auctions announcement? At the end of the session, almost most key variables remained flat; the sovereign credit default swap market was left with wounds. Maybe they heal, maybe they don’t.
I thought I would throw these thoughts to the Mises.org crowd:
Canada, where I work, has only 5 big banks. These banks play a sort of "money distribution" role in the system. Money flows from the Bank of Canada to these banks, which later allocate it as they see fit. At my work, I think I 've had the privilege to see how the whole credit crisis unfolded and will continue.
Having always been on the side of free banking, I've noticed that whenever I suggested the advantages of such system to folks working in the capital markets, their rejection was based essentially on a few points. These points are, as far as I know, not addressed by the Austrian literature. Perhaps I am wrong, perhaps I 've not read enough to base my thesis and if such is the case, please, let me know by responding to this blog.
Below, I elaborate on the issues I think the Austrian school has not done enough to make their case on Free Banking:
1.-Going back to a gold standard is not feasible operationally:
Most people believe that a free banking system would be difficult to establish. From what I read from Rothbard, he calls for the gold convertibility of the USD. This, in my view, does a poor job to the cause, because Rothbard only goes as far as to address the closure of the Fed. There is way more than that. Other authors explain the problem in terms of different banks issuing their own notes, and address the relative value between them. That is certainly not feasible in a dynamic world as the one we live in.
In my view, we need someone to write about how a CLEARINGHOUSE for issuing banks would work, with one single currency being issued. Has anyone at Mises.org ever took the challenge of elaborating on this? (Feedback welcome). I think this is a very timely subject, as banks nowadays get so much stupid scrutiny on their counterparty risks, future regulatory schemes etc. Has Ron Paul come up with something like this? Somebody has to come with a feasible, easy to visualize framework. Otherwise, we Austrians are destined to keep talking to the walls, or maybe to be sent to a nuthouse.
The role of the clearinhouse would be to MARK TO MARKET every loan that is posted as collateral to back the outstanding liquidity.
2.- The transition to free banking
As far as I know, Austrian authors have not addressed how the transition from central banking to free banking should work. Did they really think that the financial community was going to accept having their investments carried on an accrual basis discounted to market? Never! This is a real killer and financial leaders would take 100 times the humiliation of having to speak to a Senate panel asking for forgiveness than seeing their investments discounted.
One alternative here is to suggest a phasing of this transition. Has anyone ever written about this at Mises.org? For instance, a way to do this is to lead banks to keep a 100% reserve on investments as they mature. If the funds are reinvested, they can only be reinvested with a 100% capital allocation. This would create a significant change in the money markets, shape of credit curves etc., but it would be very gradual.
3.-The myth of free banking as a killer of leverage
Every person I have discussed free banking with answers that with free banking there is no leverage. It is a misconception that Austrian authors should specifically address. In my view, leverage is eliminated at the aggregate level. The whole economy cannot leverage itself. But businesses can definitely get as much leverage as the market permits them. The other side of the coin is that someone else will have to save to provide that leverage. But we all know that the interest rate market will fix that problem.
Perhaps an interesting detail here is that the aggregate yield curve of the "economic system" (not that of government debt, because government debt would probably cease to be the benchmark) would ALWAYS be steep or flat, but never inverted. (Think about this proposition and please, provide feedback). This would be consistent with Wicksell's notion of a natural rate of interest. This would be a good selling point to counterattack the idiots that keep telling us that we need regulation or some central bank to fix inverted curves. Inverted curves can only exist under fiat currency/central banking systems.
4. - Issuing banks would also make money!
Both politicians and bankers are united to preserve the status quo. Austrians should seek to break this front by showing bankers that the seignorage that is enjoyed today by central banks would be a new revenue stream for them, if they adhere to free banking. Yes, seignorage would not end, it would simply shift from governments to issuing banks, and it can be very considerable. Has any Austrian author addressed this issue? We need to get bankers against politicians. If Austrians don't get the support from bankers, the cause is dead. And bankers will do no charity. Show them the money, and they will listen!
5. Free banking in a global economy
This may be the least explored issue in Austrian literature, if I am correct. How would flows adjust under a free banking system and free, flexible exchange system? For instance, what would happen if the US adopted free banking? How would China react? How can/would creditors countries react? What about debtor countries? Do we need coordination in monetary policies? What about the gold market?
I think these points are very relevant and if we Austrians ever want to succeed pitching free banking, we must have a clear answer to them. As I said, maybe I have not read enough and this blog exposes my ignorance on the subject. But I am only giving feedback on what one hears about free banking from the guys in the trenches.
The comments expressed in this website and daily letters are my own personal opinions only and do not necessarily reflect the positions or opinions of my employer or its affiliates. All comments are based upon my current knowledge and my own personal experiences. You should conduct independent research to verify the validity of any statements made in this website before basing any decisions upon those statements. In addition, any views or opinions expressed by visitors to this website are theirs and do not necessarily reflect mine. My comments provide general information only. Neither the information nor any opinion expressed constitutes a solicitation, an offer or an invitation to make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g., options, futures, warrants, and contracts for differences). My comments are not intended to provide personal investment advice and they do not take into account the specific investment objectives, financial situation and the particular needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
Perhaps yesterday was an opportunity to take a break and think
matters over more carefully. Although equities closed almost flat in
the US, there was some intraday volatility. The underperformance in
mortgage-backed securities (some overseas trading at 7am ET exactly)
caught my attention, as it would not be the first time that such
overseas/overnight trading sets the stage for the day or week…
There are a few themes (not thesis) being discussed lately, that I think may anticipate a tough 2010:
-Global Imbalances, the USD and rates:
This issue has been on the table for decades already. It has gained
more airtime with Obama’s recent visit to China and Bernanke’s comments
at the Economic Club of New York. The short summary of its 2009/10
version is something like this: China’s monetary policy of fixed
exchange rates has forced the Bank of China to buy the dollars the Fed
has been issuing. Some analysts (see Bank of America’s “Situation
Report” of November 16th) call this”China’s vendor financing”. I think
the term is spot on. When the Bank of China buys dollars, it issues
Renmimbis, which have been used to buy local assets, among which real
estate has a prominent place.
While China worries about the USD devaluation, the other side of the
coin is that if the US was to stop what I am now convinced is an
intentional devaluation, it would only need to raise rates. That would
kill many bubbles, would it not? This is worrying investors, who see
the asset bubbles in China as a potential time bomb, when rates start
rising in the US. I am a bit less pessimistic on this issue. First,
this is nothing new. It has been going on for a long time and with
different countries, as it was denounced back in the ’30s by Jacques
Rueff. Secondly, the Bank of China, like any other central bank, always
has unlimited means to debase its currency, if they deem it necessary.
Please, note that if this scenario played out, the biggest loser here
would be gold…
-Emerging Markets:
There is increasing concern on the public finances of Mexico and
Brazil. The potential future problems, like the global imbalances that
grow by the hour, are still far ahead on the horizon. But the issue
with these economies, in my view, is not potential shocks, but their
leaders’ sudden and unpredictable reactions to them. In any case, if
there were a financial panic, the contagion effect across the globe
would be very painful.
-Rates, credit and stocks:
By now, I guess the market has come to understand that stocks have been
driven by rates, via the credit markets (Rates decrease as central
banks buy securities, the liquidity so injected goes to refinance short
term debt, firms delever and together with cost-cutting measures, the
value of the call option on the firms’ assets (=value of their equity)
rises). The market now seems to accept the futility of seeking
fundamentals to justify valuations; the irrelevance of calling an asset
class over or undervalued. Liquidity injections distorted all relative
prices and relative value comparisons work at best, in my view, within
the same asset class. Having said this, what if rates rose? I don’t
want to answer this question, because I am convinced rates will not
rise until activity picks up meaningfully. The other side of this is
the high risk of inflation that would come out of such scenario. Would
bonds not sell off? I need to think more about this, but for now, I am
not convinced to take either side…
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
The week started on a highly “accommodative”, inflationary tone.
During the weekend, we had the Asia-Pacific Economic Cooperation
meeting and yesterday, Fed’s Chairman Bernanke gave a speech in New
York. Both forums contributed to the obvious notion that monetary
policies will remain accommodative in the US and the countries that
have decided to import US inflation (i.e. Brazil, Canada, Russia,
China). With the weekend news, the positive GDP numbers from Japan and
Retail Sales figures released at 8:30am yesterday, everything took a
lift from the big tide: Oil, gold, equities, treasuries, corporate
credit…
Investors seem to have lost perspective here and, as year-end
approaches, the need to show performance by fund managers is taking us
to new highs. Is this dangerous? Not necessarily. From where I see
things, I am gradually coming across debt refinancings that no longer
target longer maturities for the sake of delaying the Day of Reckoning,
but which seek to facilitate acquisitions, mergers or simple
restructurings. That is a good thing, as long as resources diverted in
that direction are based on the right premises, one of which is their
price outlook. I sincerely hope this is the case for the energy,
transportation/logistics and mining industries.
On another note, I believe there is a piece of news that market
participants may have discounted. On November 12th, the Federal Deposit
Insurance Corp. (FDIC) approved the final rule on prepaid assessments.
In short the FDIC, “…voted to require insured institutions to prepay
slightly over three years of estimated insurance assessments…” (Refer:
http://www.fdic.gov/news/news/press/2009/pr09203.html ). According to
the FDIC, “…Payment of the prepaid assessment, along with the payment
of institutions’ regular third quarter assessment, will be due on
December 30, 2009. The FDIC estimates that it will collect
approximately $45 billion from total prepaid assessments. The payments
will come from the industry’s substantial liquid reserve balances,
which as of June 30, totaled more than $1.3 trillion, or 22 percent
more than a year ago…”
Think about this for a moment… The US government is bankrupt,
issuing debt that is placed at foreign official institutions to avoid
the scrutiny of the laws of supply and demand. On the other hand, it
issues a guarantee for deposits in its financial system, for which it
charges a premium of $45BN.
How can the also bankrupt financial system afford the premium? It
credits the FDIC with funds from its Reserves account at the Fed.
But…where did the funds that are currently allocated to Reserves come
from? The US government provided them through its stimulus programs.
How did it do so? By issuing more debt!
If this is not the Ponzi scheme of all schemes, then I do not know
what is. What is one left to conclude? When individuals engage in these
transactions, they end up in jail. When governments engage in them, are
their financial systems strengthened? As far as I know, the last
country to take this path was Argentina, under the Menem and later the
De La Rua administrations. If my memory works well, Argentina’s
financial system also had a reserve ratio in the order of 30%.
Everybody knows how the story ended in 2002.
True, the US has considerably more resources than Argentina, but at
the end of the day, we all have to buy, sell, pay and collect. Of
course, gold is now trading at $1,140+/oz. Why would it not?
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
Friday’s session was range-bound and nothing fundamentally new has so far taken place. Therefore, I would like to take the opportunity this morning to write about a topic that may be more relevant in 2010.
A reader and friend recently passed me a book titled “The Drunkard’s Walk”, by Leonard Mlodinow. Mr. Mlodinow is a Ph.D. in theoretical physics from the Univ. of California at Berkeley and he currently teaches probability, statistics, and random processes. I think the merit of the book resides in this: It does not support the view that our lives (and markets) can be modeled according to a random-based approach. Instead, Mr. Mlodinow makes the case that randomness influences our lives more than we can acknowledge and therefore, he gives us insights to distinguish when that is the case, and when it is not. On that account, I thought it would make sense to take a retrospective look at 2008 and 2009, analyze my market views and thesis and discuss, if possible, to what degree randomness would have had an influence on them. Why is this relevant? I feel that 2010 will be more “random” than 2009. Let’s see…
The approach taken at “A View from the Trenches” is that of the Austrian school of Economics. As Toby Baxendale put it: “…The (…) distinguishing mark that separates Austrians from the mainstream economists is the use of the a priori logical analytical method as opposed to the a posteriori, empirical approach (…. If you can reason from self-evident propositions and not contradict the laws of logic as you reason, anything you deduce can only be true…” (T. Baxendale, “The Method of an Austrian Hedge Fund”).
Indeed, since March (this daily letter began to be posted online in April however), I suggested a series of propositions, market theses (for instance, refer: http://sibileau.com/martin/2009/04/21/ “Two main market theses”) that have so far worked well. In short, these were:
1. When the Fed injects liquidity, asset prices rise. When the Fed does not inject liquidity, asset prices fall
2. When there is global coordination of inflationary monetary policies, gold cannot be a safe and lucrative asset. When inflationary monetary policies are not globally coordinated, gold is a safe and lucrative asset
There was no randomness here and I laid out axioms and recommended corresponding tests. One of such tests, for thesis No. 2, was that gold should be a good buy on September 29th (refer http://sibileau.com/martin/2009/09/29/a-tought-on-a-convertible-euro/). Gold had sold off on the news that Robert Mundell had proposed the convertibility of the euro, and in my view, it was self-evident that such proposal was not feasible and that monetary coordination was (and is) falling apart.
Now, when you take the view that randomness dominates economics, because you have an educated view on it or simply because you cannot understand what happens around you, you must trade with stop-losses and stop-profits. When you take the Austrian approach, it is very tempting not to trade that way. I think that is a weakness. In 2009, it was in my favor. I took a consistent long-equity and long-commodity view, never hedged it, and had a great performance. However, in 2008, this approach almost ruined me.
What was random in 2008? The political developments in the US, I think. The “surprises” presented by the financial industry could have been addressed differently. However, in the UK, resources initially went to capitalize institutions, rather than buy assets (i.e. quantitative easing). In the US, the Congress did not approve quantitative easing initially. Furthermore, in the Fall, Secretary of the Treasury Paulson destroyed whatever value was left in Citigroup, when he announced that bailout funds were not going to be used to buy assets, as the law had established, but to capitalize institutions (this changed later, but the damage, had been done).
What was “random” to me in 2009, but which I am sure someone wiser must have foreseen? To me, the random variable was the impressive virtuous cycle triggered by the April-May/09 refinancing wave in the corporate credit market. It was clear to me that liquidity was going to spill over to asset markets (see my letter from April 14th ). However, I never thought that with the maturity swap in debt, the reduction in jump-to-default risk was going to be so supportive of stocks. As well, the almost perfect global monetary coordination carried out in the first half of 2009, was also not in the radar of many.
Coming 2010, the main source of randomness will be the different paths central banks take in developed and emerging markets. Therefore, understanding monetary and political problems from Brazil to Norway and South Korea to Canada will be critical. If we cannot, we will have no alternative but to blindly trade with stop-losses/profits, which is very expensive.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
After the close of yesterday’s session, commentators attributed the
drop in equities (S&P500 closed at 1087.24 or -1.03%) to the Crude
Inventory Report. Indeed, it was after the release of the report at
10:30am, that the sell-off was triggered. However, if the move had to
come from that corner, we should have seen a better bid for the
Treasuries auction at 1pm. The Treasury auctioned $16BN in 30-yrs. The
auction was a bit soft vs. others in the past months, and awarded at
4.469% or at 2bps higher.
Thus, yesterday, even though the session started with the jobs data
release coming better than expected (Initial jobless claims at 502,000
vs. 510,000 expected and 512,000 prior week), the market had made up
its mind. Would it take profits and seek refuge in Treasury Bay? Not in
my view. The market only wanted to money. The market preferred the USD,
in my view.
My interpretation is in disagreement with the consensus view. The
consensus view is that yesterday, as the USD strengthened, commodities
had to sell off, which weakened energy stocks, dragging everything
else. To me that was the symptom. My question to you is: Why did the
USD strengthen? The answer to this question will be the real
explanation. I am including below a chart of the Dollar Index (DXY). As
you can see, the trend upwards was very solid all day long. Weakness
after the jobs data release was bought. Strength after the Crude
Inventory Report was not sold.
I will try now to explain why, in my view, the USD strengthened:
Since October, the yield curve has steepened. The Fed has finished
its $300BN Treasury Purchase Program and the market is wondering who’s
going to finance the obscene 2010 deficit + refinancings, next year.
Recent data shows that it may not be foreign institutional accounts.
Furthermore, the Treasury has announced its intention to increase the
average maturity of its debt. In summary, while the US government
insists in keeping or even increasing the current stimulus programs,
the Fed is honoring its word that although it will not raise rates, it
will not accommodate fiscal budgets either. The financial situation at
the municipal level has not improved and consumer weakness is still out
there. This is enough to understand that a steeper yield curve is very
feasible, hurting credit, stocks and Treasuries, and strengthening the
USD, ceteris paribus.
May this mean that we are set for some range-bound trading? What
will decide a future gap higher or lower in risky assets? On the fiscal
side, the situation looks very solid in favor of stable deficits.
Therefore, what is the missing piece here? I suggest it is the actions
other central banks may take.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
Today is Remembrance Day in Canada and markets are closed. Today
marks the anniversary of the armistice in 1918, and my thoughts go out
to all those who made the greatest sacrifice for the defense of our
individual liberties. A View from the Trenches will not be published
tomorrow.
Yesterday was a quiet day, so I will be brief today and take the
opportunity to discuss one of the latest trends I see in the collective
economic thinking. With the indisputable fact that the US is ready to
sacrifice the value of its currency for the illusion of full
employment, many market analysts are concerned about the long impact of
this move on investors’ expectations.
Personally, I think it is misleading to frame the analysis of markets’ developments in terms of expectations. What do I mean?
I have recently started to note that some analysts seek to explain, to
forecast, future asset prices or speculate on the evolution of the
yield curve in the US, based on their own assessment of investors’
expectations. There are models that analysts can use to address this
issue. If things have not changed since my Undergraduate days, one can
think of three types of expectations: Regressive, adaptive and
rational. I don’t intend to get into details here, but I want to say
that this is an analytical approach I would not want to take.
What we are witnessing in the markets today has nothing to do with
expectations, but with flows: Supply and demand. Get the right picture
on supply in the government debt, corporate, agency and mortgage
securities market, net it of the funds flowing to these markets, and
you will have the correct answer on where prices are going. Look what
central banks buy and they buy that with, ask yourself what happens to
the notes they give the market and you will get the right trend on
prices. Of course, I do not carry out this quantitative work myself, but the results on the same are available.
When investors use the expectations perspective, ignoring flows and
the corresponding distortions in relative prices, they may be lucky or
not. It is really of no consequence to us. But when politicians use
this perspective, it is a calamity. Politicians believe that
expectations, not their actions, are what drive prices. Therefore, when
they reach the point where they realize such expectations go against
their view on economic problems, they regulate. This is sad, but I am
convinced is the path developments will take in the not so distant
future.
I don’t have a lot of personal experience on the consequences of
this type of reactionary regulation. But individuals always win if they
channel their civil disobedience through the sale of their respective
fiat currencies. In Latin America, it is usual to see the sale of the
“pesos”, in exchange of dollars, to express civil disobedience. In the
developed world, I imagine currencies will be sold for gold. Yes, the
gold boat is overcrowded and yes, expectations may be pricing too much
into this asset. Never mind. As long as the supply of government debt
is alive and increasing to fund fiscal deficits, gold will be used to
express civil disobedience. Trade accordingly.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
I did not write too much in October (I was traveling). But as soon
as I got back, on October 21st, I went pretty much against the standard
research, saying I was bullish on the S&P500, in USD terms. Since
then, I have many times explained why, under specific circumstances, I
was bullish both on the S&P500 and on gold. I wrote:
On Oct. 21st : “…Should this be bullish on equities? I think I
would be a bit of a contrarian if I said it would. (…) should we not be
bullish again on the S&P500? In USD terms? I think I should…”
On Oct. 29th : “…In general, if this correction continues, it
may present us with an opportunity to step in. For now, the general
economic backdrop remains constructive in my view, and although the new
home sales figures or oil inventories disappointed today, I see these
issues anecdotal and it would be naive to expect a recovery process to
go unidirectional, from the lower left to the upper right…”
On Nov. 2nd : “…The week is starting on bad news (…) As long as
central banks and governments of the G-8 “play it cool”, quiet and do
not screw up with unnecessary hostile rhetoric, the market should take
profits, the late longs should get their lesson and things should get
back to normal (…) Personally, I don’t give a lot of probability to a
catastrophic scenario, because it is hard for me to believe that so
much political reputation will have been put on the line to arrive to
November and make a false move that brings down the house of cards…”
On Nov. 3rd , I framed the problem along two main lines: Historical
context and logic. My conclusion was a question to the reader: “…Therefore,
my question to you is: “What makes you think monetary authorities will
either pull the plug (=let interest rates increase) or recklessly
accelerate the monetization of fiscal deficits (=let the USD or GBP
plunge)?…”
On Nov. 4th , I anticipated the news that would come this past
weekend, from the G-20 meeting: “…In my view, yesterday’s action was
all about the fear that the Fed will have no alternative but to delay
any increase in rates. It may be as simple as that…”
On Nov 5th , I reiterated my thesis on gold and on Nov. 6th, I
further wrote: “…The trade is simply out of “money” and into
everything. Money is here described as the medium of indirect exchange.
Money is being debased and given the slack in the system, there is a
case for still being long Treasuries. This will only help exacerbate
the low interest rate period and the imbalances created by it. Are we
therefore out of the woods with the correction in stocks? Personally, I
want to see the S&P500 close above 1,066pts, for three consecutive
days. Yesterday was one of them…”
Finally, last Friday and today, we closed above 1,066 on the S&P500. But are we really out of the woods?
The answer is not simple. In the short term, I am confident we are. In
the not too long term…not so much. Money, as we know, has three
functions: It serves as a medium of indirect exchange, a store of value
and a unit of account. Since March, money has started to lose its
usefulness as a unit of account. There is no longer a way to measure
value objectively. But analysts tell us that stocks are “ahead of
themselves” or “overvalued”. There is no point in trying to measure
their value when we have no real benchmark. For instance, the USD lost
1+% intraday against gold yesterday, or 1.81% against the CAD. In one
day! How can we be sure of what value is these days? Furthermore…why
bother?
The erosion on the “unit of account” function of money has been slow
but steady. In the past days, it accelerated. When money definitely
loses the unit of account function, it can no longer store value.
Therefore, value is to be found in other things: real estate,
commodities, etc. This process is what mainstream economists call
“asset bubbles”. The problem is that with the loss of these two
functions, economies become inefficient, because relative prices are
distorted and resources are misallocated. Governments will continue to
enforce their notes as medium of indirect exchange, but capital will not be created,
unemployment will not decrease and growth will not appear. Is there a
way out of this? Yes, through sustainable fiscal budgets.
I no longer want hear central bankers talk about exit strategies. I
don’t want to hear Finance ministers talk about taxing the financial
system or expanding their respective stimulus programs. What we need to
hear is that every Parliament or every Congress engages in serious
debates to CUT COSTS and NOT INCREASE TAXES. Taking the path of higher
taxes has never led anywhere. So far, I have not heard any Member of
Parliament or Representative come publicly saying he/she proposes to
cut costs. Therefore, in the long term, we are definitely not out of
the woods.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
The trade out of the USD (money) and into risky (and not so risky)
assets continued yesterday. Again, as I have written so many times,
this is nothing to be surprised. The trade has had the help first of
Buffet’s bet on Burlington Northern Santa Fe Corp. and the reduction in
crude oil inventories (on Wednesday) and later that of the weekly
jobless claims (yesterday), which came at a level lower than expected
(512k vs. 530k). But the real trick here was the Federal Open Market
Committee’s statement yesterday, with the firm message that low
interest rates are here to stay.
In our comments yesterday, we addressed the dynamics of gold. Gold
is not a hedge against the Consumer Price Index, but against
uncoordinated monetary policies, which are reflected in volatility in
the foreign exchange crosses.
Below I show the intraday chart of the 30-yr Treasury (white line) vs.
the S&P500 (orange line), for yesterday (Nov. 5th, source:
Bloomberg). As you can see, the rally in stocks was not accompanied by
a sell off in Treasuries. Both stocks and Treasuries rallied. We’ve
seen this one before:
The trade therefore was not out of fixed income and in favor of risky
assets. The trade is simply out of “money” and into everything. Money
is here described as the medium of indirect exchange. Money is being
debased and given the slack in the system, there is a case for still
being long Treasuries. This will only help exacerbate the low interest
rate period and the imbalances created by it. Are we therefore out of
the woods with the correction in stocks? Personally, I want to see the
S&P500 close above 1,066pts, for three consecutive days. Yesterday
was one of them. Below, I show the chart for the S&P500 (source:
Bloomberg), to visualize my point.
And, of course, as we said at the beginning of the week, we must enjoy
a period of calmness, without idiotic moves or statements by
politicians. The news out of the UK and European Union these last days
have not necessarily helped us on this regard. But if everybody stays
calm and “plays cool”, we should see the 1,066 level behind us, and we
shall move beyond.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
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