January 2010 - Posts
Please, click here to read this article in pdf format: february-1-2010
We enter February and nothing is what used to be. Keep this in mind
because you will hear, read and watch hundreds of market gurus tell you
that this “correction” represents a buying (of stocks, risk)
opportunity. We are deductive at “A View from the Trenches” and
deduction demands that we rationalize our view. Here we go:
When at the end of 2009 I expressed some optimism for 2010 (refer: http://sibileau.com/martin/2009/12/16/, “Thinking about 2010) I did so with caveats (…”I
(…) ask myself what assumptions are behind this logical thread. The
first one is the assumption of “stability” in benchmark, sovereign
rates, with independent central banks”…). As well, even though I was optimistic, I disagreed with the mainstream view that volatility would be muted in 2010 (“…with
the Euro zone falling into pieces, and with creditor countries in Asia
exacerbating the USD peg. This is barely a picture of muted volatility
and higher valuations…I am confident we will see effective policy
action on all of these fronts. But, muted volatility? I don’t think so”…).
The chart at the bottom (source: Bloomberg) shows the VIX index. It is
cruelly clear that volatility in 2010 is still relevant.
As 2010 commenced with a rally, I thought over and over how I could
rationalize the market action. I structured my view in two letters, on
Jan 20th and 21st (refer: “Two dimensions”, Part I:
http://sibileau.com/martin/2010/01/20/two-dimensions-part-i and Part
II: http://sibileau.com/martin/2010/01/21/two-dimensions-part-ii/ ).
Briefly, I think that in 2010 we see two juxtaposed forces: the
non-neutrality of money and time or lack thereof, for the structural
changes that different currency areas require.
But when on January 22nd I said : “…the market proved me wrong.
If by the close of today we see the S&P500 not at 1,120pts, then I
hope that you are as liquid as possible entering the next week…”,
I wrote purely on a technical basis (I appreciate the wisdom of one of
Gartman’s trading rules: “Think like a fundamentalist; trade like a
technician”). I turned 100% liquid that same day and also made it clear
that I was still not bearish, but neutral. I had to understand the new
fundamentals…
To understand the new fundamentals, we can still use the two
dimensional framework proposed earlier. Time has won over the
non-neutrality of money, not based on its own merit, but because the
non-neutrality of money was killed as China, the US and now India
attacked the distribution chain (banks) of the credit expansion
process, in the last two weeks. Time will also continue to win because
the main assumption of stability mentioned above, relying on steady
sovereign risk and independent central banks, is also dead. Europe is
leading the destruction of stability in sovereign risk, while Argentina
has already killed its central bank. Mexico follows, having announced
its intention to repay a $47BN credit line to the IMF, with central
bank’s reserves. And although the European Central Bank still remains
fairly independent, such independence will prove illusory. Greece,
Portugal, Spain and Italy will deceive the North and make the
posthumous case for Max Weber (http://en.wikipedia.org/wiki/Max_Weber ). Our thoughts on Greece have been fairly laid out, and I stick to my initial script (refer: http://sibileau.com/martin/2009/12/17/ ).
With this backdrop, without monetary policy coordination, our Thesis No. 2 on gold (refer: www.sibileau.com/martin/2009/04/21),
resurfaces. Gold has a chance. Tomorrow, I will write more on this
chance, which requires further elaboration on how the macro picture has
changed. But the bottom line is that now I am bearish. In the next
letters, I will seek to provide structure to the bearish (and “beta”)
trade.
Martin Sibileau
Please, click here to read this article in pdf format: january-28-2010
The bearish trend in all markets remains in place. “A View from the Trenches” has a neutral view since Friday, January 22nd, but we are increasingly nervous on “headline” risk, given the inconsistencies we hear and read on a daily basis from the world’s most influential policy makers. If this situation continues, and we fail to see why not, we will have no choice but to turn bearish sooner than later (For those interested in these inconsistencies, please, refer to: “The trade cycle and money expansion: The economic consequences of cheap money” L. Von Mises, 1946, http://mises.org/books/causes.pdf , pages 197-8 of pdf doc.)
Since our last letter on Tuesday, perhaps the main policy update we’ve had is the confirmation (as it had been widely expected) of the Fed’s intention to pay interest on reserves. These reserves surpass the $1 trillion mark and this interest payment will be charged to US taxpayers. Such is the social efficiency of central banking…This measure will increase the cost of credit, by establishing a floor on the price of “savings”. This is certainly not bullish. It will be effective, no doubt, and it will have an impact on Libor (increase) and the overnight rate. Essentially, the Fed will gain control of the cost of liquidity, as it embarks on its experiment to unwind the quantitative easing undertaken last year. We wish them well, but we cannot help expressing our distaste for price distortions created by governments, and manipulating interest rates is one of such distortions. We always prefer central banks that manage their balance sheets (leaving markets to determine prices) over those that manage prices (leaving markets to determine volumes).
On another note, Greece has received an abysmal amount of attention in the last days. The market is not pricing a near term default so far and numerous analysts have rehearsed a multitude of scenarios. At “A View from the Trenches”, we were ahead of the curve, when more than a month ago we went on record saying that we don’t believe Greece will default in the near term (12 months) and that instead, the country’s government will seek to get the indirect and hidden subsidy of the European Central Bank, by placing its debt in the private markets (Greek banks):
“…in our letter from yesterday, I incorrectly compared the situation in Greece with that of Argentina. Although it is true that in both countries the governments “stuffed” local banks with their own debt, the comparison is not correct. In Argentina, the financial system was totally compromised, because the peso was under a convertible (with the USD) system, where the Banco Central had given up the ability to act as a lender of last resort. In Greece, the situation is radically different. The EUR2BN private placement that was announced yesterday is nothing else but an undisclosed tax on Euro zone taxpayers, to subsidize Greece’s fiscal deficit. Greece cannot get a direct subsidy, but the banks that took on the government debt have access to liquidity facilities from the European Central Bank. Thus, the 250bps spread on Euribor charged for the issuance was an arbitrage on taxing jurisdictions, earned by the shareholders of the respective lenders and in a more diluted way, by Greece citizens too…” (refer: www.sibileau.com/martin/2009/12/17 ).
Since last week, every analyst places this scenario (Greece’s government using the private placement/syndication market) as a likely option. We proposed it more than a month ago, and believe that the current inversion in Greece’s sovereign credit curve presents an interesting trading opportunity. It also makes me think that Latin America’s sovereign space is very rich in light of the new tightening environment in China.
Finally, I cannot help noticing that the Canadian dollar is under real stress lately, with the bullish trend seriously challenged, as shown in the chart below (source: Bloomberg). In the next letters I will write more on this as well as thoughts on gold.
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: january-26-2010
Yesterday was the third consecutive day with the S&P500 below
its previous support of 1,020pts, validating my view on risk. We may
need to see more water running under the bridge until we can confirm a
trend here. However, reviewing market commentaries, I found that all
those who still stay on the bullish side have one thing in common: They
see the higher regulation on the world’s banking system as a positive
factor for economic growth. In particular, they believe that stronger
capitalization and focus on lending, as sought by President Obama’s
administration, will be meaningful in withstanding future volatility,
and will also drive spreads tighter in the long term. This is a strong
assumption I disagree with.
Below are the reasons of my disagreement, which were EXTENSIVELY ELABORATED in the LAST TWO CENTURIES by others wiser than I:
“…Confidence in the capacity of circulation of fiduciary media
is not an individual phenomenon; either it is shared by everybody, or
it does not exist at all. Fiduciary media can fulfill their function
only on the condition that they are fully
equivalent to the sums of money to which they refer. They cease to be
equivalent to these sums of money as soon as confidence in the issuer
is shaken even if only among a part of the community. The yokel who
presents his note for redemption in order to convince himself of the
bank’s capacity to pay, which nobody else doubts, is only a comic
figure that the bank has no need to fear. It need not make any special
arrangements or take any special precautions on his account. But any
bank that issues fiduciary media is forced to suspend payments if
everybody begins to present notes for redemption or to withdraw
deposits. Any such bank is powerless against a panic; no system and no
policy can help it then. This follows necessarily from the very nature
of fiduciary media, which imposes upon those who issue them the
obligation to pay a sum of money which they cannot command…” Cp. David Ricardo (http://en.wikipedia.org/wiki/David_Ricardo ), “Proposals”, op. cit., p. 406; Walras (http://en.wikipedia.org/wiki/Leon_Walras ), Etudes d’economie politique appliquee, Lausanne 1898, pp. 365 f.
“…The history of the last two centuries contains more than one
example of such catastrophes. Those banks that have succumbed to the
onslaughts of note-holders and depositors have been reproached with
bringing about the collapse by granting credit imprudently, by tying up
their capital, or by advancing loans to the State; extremely
serious charges have been brought against their directors. Where the
State itself has been the issuer of the fiduciary media, the
impossibility of maintaining their redeemability has usually been
ascribed to their having been issued in defiance of precepts based on
banking experience. It is obvious that this attitude is due to a misunderstanding.
Even if the banks had put all their assets in short-term investments,
i.e. in investments that could have been realized in a relatively short
time, they would not have been able to meet the demands of their
creditors. This follows merely from the fact that the banks’ claims
fall due only after notice has been given, whilst those of their
creditors are payable on demand. Thus there lies an irresolvable
contradiction in the nature of fiduciary media. Their equivalence to
money depends on the promise that they will at any time be converted
into money at the demand of the person entitled to them and on the fact
that proper precautions are taken to make this promise effective. But -
and this is likewise involved in the nature of fiduciary media - what
is promised is an impossibility in so far as the bank is never able to
keep its loans perfectly liquid. Whether the fiduciary media are issued
in the course of banking operations or not, immediate redemption is
always impracticable if the confidence of the holders has been lost…” L. Von Mises (http://en.wikipedia.org/wiki/Ludwig_von_Mises ), “The Theory of Money and Credit”, Chapter IV, p. 321-2, Yale, 1953.
As you can see, blaming banks has been fashionable since immemorial
times and financial systems will never be stronger by making their
operations more expensive. Therefore, the idea that credit spreads will
eventually tighten because of better capitalized banks is absurd. And
if credit spreads do not continue to tighten, the rally cannot
continue. Moreover, why would banks seek to be better capitalized and
pay for all the embedded costs? This is why their stock prices are off
their highs.
Please, note that I am not bearish here, but neutral. As I write
above, we need to see more water running under the bridge until we can
confirm a trend.
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: january-25-2010
You will not find a short-term view in today’s letter. I can speak
for the long term, in a negative way, but not short term. And I dare to
say that those who venture to give you a short term forecast are naïve
at best and irresponsible at worst.
Over the weekend I’ve gone through diverse readings on last week’s
action and I feel that a lot of folks are in denial mode. After China’s
and President Obama’s decision to go after their respective banking
systems, I fail to see why things should go back to normal. On this
point precisely, I may confirm at least one thing, and one thing only,
that will be of value going forward. Let me explain…
When last year I went against mainstream economists with my forecast
on higher stock and commodities prices, regardless of fundamentals, I
based my view on developments in the funding markets. Specifically, I
was monitoring the 3-mo Libor – OIS spread. This spread, as you know,
measures the cost of liquidity in the system. This cost dropped
violently during 2009, and as it dropped, the new liquidity was
allocated to the equities, credit, fixed income and commodities
markets. Liquidity “healed” in 2009. Last week, many analysts noted
that because liquidity is still intact, the witnessed sell off is a
mere correction. I think that observation is misleading. We do not face
a liquidity problem, it is true. But we face other problems.
In the chart above, I seek to make more visual, why going forward I
will not make conclusions based on the liquidity of financial systems.
It is more evident to me that policy rates in 2010 will remain
basically unchanged where it matters (USA, Europe, China), with the
only caveat that if the situation in Greece or others deteriorates
faster than expected (i.e. it will deteriorate anyway, but here speed
is key), we may see additional measures by the European Central Bank,
to sustain liquidity in the Euro zone. Therefore, we may expect Euro
weakness to continue.
But as you can also see above, the latest policies are impacting the
distribution stage of the credit market. While central banks are not
draining liquidity, they and their governments are making distribution
more expensive. They want distributors to be better capitalized, to
hold higher reserves (in China) and to be less concentrated (no
economies of scale). This will impact distribution economics and
distributors will try to pass on to the borrowers (consumers) the
higher costs. And they will succeed. Like in any other consumers’
group, in the borrowers group there are those who can afford and will
pay for the higher costs, and those who cannot and will see their
credit availability restricted.
Such a segmentation does not help economic growth. As well, observe
that in the meantime, if liquidity continues to be injected by central
banks, we will get closer and closer to inflation in consumer prices.
So, it looks like in going forward, we may get this combo: Higher
consumer prices, less growth, higher than expected defaults, stagnant
to lower stock prices, higher credit spreads, stable unemployment and
higher volatility driven by the possibility of sovereign defaults.
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: january-22-2010
What was President Obama thinking? I know I told you yesterday that
of the two forces I saw, I expected the non-neutrality of money to
prevail. Well, I think the market proved me wrong. If by the close of
today we see the S&P500 not at 1,120pts, then I hope that you are as liquid as possible entering the next week. I trust I am clear.
Please, do not lose perspective here. Earnings do not matter.
Fundamentals do not matter. This was and continues to be a liquidity
crisis. When leverage increases, prices increase. When leverage
decreases, prices decrease. The latest political action in the USA and
the decision to prohibit banks from running proprietary trading
operations, from sponsoring hedge and private equity funds, and to cap
at 10 percent the market-share on deposits is first nothing else than
idiocy of the first order and secondly, a hit to the relevering game
that was taking place since last March.
It is true, the concerns on the sustainability of Greece’s fiscal
path added to the fire yesterday morning. There was a rumor circulating
early yesterday that the European Central Bank would consider a loan
for Greece. It was immediately dismissed. But folks, let me say this:
Whatever assistance Greece may get from Europe will not be explicit.
Nobody will face the scrutiny of public opinion or the moral hazard of
such a move. As I wrote earlier, I believe Greece still has a lot of
tricks at hand that can use to its benefit, to keep financing its
current deficit. One of them is with the private placement market. If
Greece continues to use it, selling its debt to local banks (which take
deposits in Euros), then Greece will have infected the Euro zone with
its disease, forcing the European Central Bank to provide liquidity
lines to its financial system. This would be a hidden way to support
the deficit and I would be surprised if it is not explored. Therefore,
to me, Greece is only noise in the market. Loud noise, but still noise…
The situation in China is different. A lot, really a lot of different
outcomes can play out when we think of how the People’s Bank will
manage to rein in inflation and its currency appreciation. On top of
this, we must also not forget India’s latest developments, but these
are the subject of another letter.
Thus so far, only by the idiocy of politicians that don’t get Keynes’
right, we witnessed a huge technical damage to all the key macro prices
yesterday. And I find it very hard to repair this damage. What did
Keynes write? We quoted him endless times and we quote him again: “…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…” (General Theory,
Chapter 13) That’s right! Folks in Washington, London, Frankfurt,
Beijing and Tokyo: Please, be consistent. If you are going to print our
way out of this one, the world will need an increased quantity of
money, to maintain the rate of interest (or marginal efficiency of
capital). There is no other way!
Finally, a few comments on the Canadian dollar. As you can see in
the charts below (source: Bloomberg), which show the CAD vs. the USD
and EUR, it seems that the appreciating trend of the Canadian dollar
remains in place. It is being seriously challenged as we write, but it
looks like it is still in place.
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: january-21-2009
Yesterday’s action was actually very “timely”. Yesterday, I had
written that the non-neutrality of money was one of the forces shaping
the market scene. But also, I wrote that the other force or dimension
was “time”.
In 2008/09, practically every country witnessed a transfer of
losses/risk from the private to the public sector. Each country, at the
same time, was embarked on different fiscal deficit paths (sustainable
or unsustainable), if it was a debtor country, or monetary imbalances
paths (sustainable like Canada’s or unsustainable, like China’s), if it
was a creditor country.
Embedded in Keynesianism, is the belief that when output increases
after a slump and prices rise, we need to increase the quantity of
money to maintain a given rate of interest. Therefore, once liquidity
has been injected, all we have to do is wait until activity picks up,
driven by a positive marginal return on capital. And waited we have and
continue to . However, when Keynes explained this view, the world was
not as global as it is today. There is only one interest rate. If we
oversimplify the current situation (with a bit of a physiocratic
taste), we can think of today’s global exchanges in terms of three
factor-competitive monetary zones:
These zones are characterized for being competitive in supplying the global economy with production factors: There are
competitive raw materials exporters, labor exporters and knowledge
exporters. In the chart above, the arrows indicate flows, affected by
the respective foreign exchange crosses. Some of these zones are
encountering different problems.
Relevant to the knowledge exporters, within Europe, we find
institutional problems, between its Central bank and members’ fiscal
deficits. Because this zone should be competitive in terms of its
“institutional infrastructure (i.e. rule of law, developed capital
markets), when the institutional infrastructure is affected as in
Greece, there is room for an intra-zone arbitrage. Hence, the Euro is
sold and the USD is bought. Why not? Interestingly, if such
infrastructure weakness took place in Latin America, nobody would care,
because Latin America is not competitive at exporting it.
In the case of China, I think that what happened yesterday after
reading the statements of Mr. Mingkang (Chairman of China’s Banking
Regulatory Commission), was the product of cultural misconceptions. We,
in the West, are used to democracy. But China is not a democracy. When
China ordered to stop increasing new loans, we were taken by surprise.
The surprise was twofold. Firstly, it is hard for us to grasp the
degree of authority this measure carries. A suggestion like this
somewhere else would immediately bring smiles. (We would quickly see
that there would be a segmentation in the credit market, where
exporters borrow offshore and internal consumption is financed
onshore). Secondly, this measure is surprising because of its
absurdity. No central bank can simultaneously sustain a fixed exchange
rate regime and control the local rate of interest. For a creditor
country like China, a central bank that prohibits new loans sounds like
a manufacturing company that asks its distributors to keep buying its
output, while at the same time does not allow them to further sell it
to their respective customers.
I don’t think China ignores this, which is proof that all China
seeks is to delay the appreciation of its currency, very much in line
with what the Bank of Canada is doing with its open market operations
and its interest rate policy. Hence, the timing dimension referred to
above…Back to my first point, every policy maker today believes in
leaving monetary conditions as steady as possible, until activity
matches outstanding liquidity. In some zones, activity has grown faster
than expected. In others, it is growing more slowly. In the meantime,
foreign exchange crosses correct and generate volatility, as “A View from the Trenches” had anticipated and as is reflected in the break of correlation between USD weakness and US stocks markets.
But in the end, I remain optimistic that the non-neutrality of money
that I discussed yesterday will prevail as the dominant force. The
credit markets seemed to agree with this view yesterday. In the
investment grade space, for instance, the widening was smooth, with the
IG13 index up only 2 ½ bps intraday. That to me was very telling…
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: january-20-2009
In my view, we have two forces today, shaping the market scene.
These are “dimensional” forces. The first force or dimension is
associated with capital flows. I will call this force the non
neutrality of money. The non neutrality of money, as we wrote many
times already, is evidenced by the fact that, when central banks inject
liquidity, relative prices are distorted. This distortion depends on
the markets that receive the liquidity first.
During 2009, the first market to receive this liquidity was the
Agencies debt market (Fannie Mae, Freddie Mac). Consequently, the
spread between Agency debt and Treasuries tightened violently,
appreciating this debt vs. other assets. Another way of looking at this
is by comparing it with the mainstream view, that money is neutral
(implicit in Krugman’s and David Rosenberg’s works). The neutrality of
money is expressed in the famous equation, called the exchange equation:
Money in circulation * Velocity of circulation = Price level * Output level
This is why economists like David Rosenberg or Krugman tell you that
you should not worry about inflation (Price level), because even if
Money in circulation grows, the velocity of circulation is low. They
told you precisely that while markets rally, spreads compress or gold
goes from $854/oz to $1,138/oz in the past twelve months. These same
economists will now increasingly ask you to worry, because the rally is
not justified by the output level vs. its potential level (whatever
that is). And of course, they have been wrong since the whole
inflationary process began, on an afternoon of Dec 5th, 2008, with the
first purchase of Agency debt by the Fed.
Having said this, and back to my main theme, I see the non-neutrality of money shaping 2010, as follows:
Assumptions: a) The Fed will maintain a steady supply of liquidity
(not touching policy rates) and b) the US fiscal deficit will not fall
With these assumptions and given the unwinding of quantitative
easing by the Fed (i.e. will stop buy Agency debt by this spring), I
expect Treasury yields to rise with a steeper curve. The steepness in
the curve will be driven both by a compression in the front end, as
well as a sell off in the long end (For those interested in the
reasons, pls. write back. I’ll be happy to further elaborate and have
your feedback). The rise in Treasury yields should compress corporate
credit spreads. The impact of this compression can bring three
consequences: a) Further debt refinancings; b) share buybacks with
leverage, and c) capital expenditures. These three channels should
provide further fuel to the equity rally, commodity prices, and
finally, activity.
If you believe in this story, a beta strategy, where you invest in
liquid instruments as indices, should do well. I began the year firmly
believing in this story, but as with any good story, there’s always a
risk, a “bad guy”. In this case, the bad guys are sovereign risk and
political risk in every relevant currency zone. I thought these would
become relevant later in 2010, but here we are, facing them in January.
These sovereign/political risks constitute the second force shaping
the market scene that I referred to above. Tomorrow, I will elaborate
on this second dimension: Time. Why time? Because these risks affect
every monetary zone today, but with different degrees of “imminence” or
urgency. The degrees of imminence affect the foreign exchange crosses,
which define the second dimension.
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.
Given last week’s events, it may be important to step back and look at the current environment with a bit of perspective.
Historians date Polibius’ life between 201-118 B.C. Polibius, who
made insightful observations on the transition that took place from
Greek to Roman culture, also wrote “The Histories”. In its Book VI, he
suggested that there is a cycle in the forms of government. Based on
his own experience, civilizations started under a monarchy, which
provided the necessary cohesive force. But as power corrupts, the
monarchy morphed into tyranny. Under tyranny, people suffered and
reacted by choosing the best among them (i.e. the “aristos”) to bring
down the tyrant. Tyranny therefore gave way to an aristocracy. Polibius
then noted that the aristocracy would later rule only for their own
benefit, becoming an oligarchy. The people had to revolt once more and
forced the oligarchy into a democracy. But democracy would later lead
to demagogy. The only way to get rid of the demagogue was to find a
leader to bring it down. This leader would be the monarch, and the
cycle would start all over again.
We can also find a cycle in economic thought. In particular and
relevant to our situation (the Keynesian paradigm we live in since the
1930s) , we could suggest the following: Central banks issue money
that, through the credit expansion process, generate asset bubbles.
Banks lend to the participants in the inflated markets at higher
leverage ratios to remain profitable until these markets go bust. When
they go bust, the financial system goes bankrupt and governments bail
them out. The bailouts are financed with public debt which will have to
be repaid. Consistent with Keynesianism, these governments refuse to
restructure their budgets and to address their growing fiscal deficits,
they increase taxes and promote social hate against “proprietors of
stock” (i.e. bankers, investors, etc.), who are to blame for their
greed and the generation of asset bubbles. The situation becomes
increasingly untenable and soon governments find themselves debasing
their currencies, generating inflation. As the asset bubbles
(inevitably in raw materials) end up also lifting consumer prices, the
lower income (with fixed wages) strata of economies begin now
questioning the wisdom of their politicians. If these economies are
educated, as is expected in the developed world, they replace their
leftist politicians with radical conservatives. The conservatives begin
by privatizing government-owned assets, reducing taxes and reopening
their economies to free trade. But they don’t reduce government
expenses, because they also believe in Keynesianism and because they
need the vote of the public. Therefore, deficits may still linger at
the beginning, but the tax rate reductions, privatizations and free
trade lift productivity. As governments tax activity, when activity
picks up, revenue increases and deficits wane. But the higher activity
at higher prices requires a new and higher level of money supply, to
support the rate of interest. For that, there are central banks issuing
money, which takes us back to the start of the cycle…
If we understand the cycle, we can always make money in each stage.
Banks in particular will also always make money: Financing the asset
bubbles, with the refinancing of public and private debt, with advisory
and capital markets fees during the privatization of government assets
(you will see this soon in Greece), with FX fees when free trade
reopens and with derivatives as activity picks up. Such is the cynical
nature of Keynesianism…In my view, we are currently at the beginning of
the cycle, with governments increasing taxes (i.e. reserve requirements
in China, bank taxes in the US, higher regulation worldwide) and
promoting social hate against proprietors of stock. However, in this
global world, there is some heterogeneity. As I wrote on January 7th (www.sibileau.com/martin/2010/01/07 ), we will see a dichotomy in capital flows:
“…Since my last letter of 2009, the US Treasury announced it would
lift the cap on the Preferred Stock Purchase Program (…) This explicit
show of support for agency debt (which I assumed it was going to
smoothly disappear in 2010) tells me that the USD strength will be only a relative notion in 2010.
I say relative because the strength should show vs. those countries
that explicitly decide to import USD inflation (i.e. Brazil) or face
serious fiscal problems (i.e. Euro zone), while the weakness should
show vs. those countries that will profit from the credit-inflated
recovery (Emerging markets or commodity currencies, like the CAD)…”
If we give serious consideration to this dichotomy and play a beta
strategy in any space (credit, stocks, fixed income), we’ll be ahead of
the curve in 2010.
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: january-15-2009
The waters are getting murkier. The problems associated with the
2009 transfer of private sector losses to the public sector are
becoming more and more visible at faster speeds. Personally, I had
hoped that the debate on the solvency of some Euro zone members like
Greece, as well as China’s role in global capital flows would only
arise at the end of 2010. However, it looks like history has other
plans for us.
Yesterday, Greece announced a program aiming to drive its fiscal
deficit to approx. 3% of GDP over 3 years (from current 13%). Like any
other politicians, Greek politicians chose what they think is the path
of least resistance: Higher taxes. The plan of course considers a
restructuring of the public sector, with consolidation as well as
privatization. But at the end of the day, all hopes are on the ability
of the government to increase revenues. Very sad…Perhaps today more
than ever, it is relevant to remember what Adam Smith had to say on
similar circumstances (in his greatest work, “The Wealth of Nations”,
Book V, Chapter II), more than 200 years ago, in a world where
globalization was negligible in today’s terms:
“The proprietor of stock is necessarily a citizen of the world,
and is not necessarily attached to any particular country. He would be
apt to abandon the country in which he was exposed to a vexatious
inquisition, in order to be assessed to a burdensome tax, and would
remove his stock to some other country where he could either carry on
his business, or enjoy his fortune more at his ease (…) A tax which
tended to drive away stock from any particular country, would so far
tend to dry up every source of revenue, both to the sovereign and to
the society. Not only the profits of stock, but the rent of land and
the wages of labour, would necessarily be more or less diminished by
its removal (…) High taxes, sometimes by diminishing the
consumption of the taxed commodities, and sometimes by encouraging
smuggling, frequently afford a smaller revenue to government than what
might be drawn from more moderate taxes…”
If Mr. Smith could clearly “get it” in the eighteenth century, how can
the European political class of today fail to see it even more clear,
for a country that is under a monetary union?
For the time being, all Greece did was to buy time, and I believe
that the European Central Bank shares this view. As we anticipated on
January 7th (“Don’t forget Greece” www.sibileau.com/martin/2010/01/07
): “…If the European Central Bank validates this situation, both
spreads should converge to a lower level. If it doesn’t, they should
converge to a higher level. The contagion is undoubtedly a fact, and
under any scenario, this situation will continue to weight heavily on
the Euro…”
As you can see from the chart below (source: Bloomberg), where we show
the spread between the 5-yr credit default swaps of Greece (sovereign,
in orange) and that of the National Bank of Greece (in white), it seems
that the convergence is actually going to take place a higher level.
This is not good, but at least, it is not surprising either…
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: january-14-2009
Yesterday, the People Bank’s of China went further with its
tightening move, raising reserve requirements. Raising reserve
requirements is “wrong”, in my view. If a central bank wants to
really stop asset inflation, all it has to do is withdraw liquidity.
Raising reserve requirements does not withdraw liquidity. It only makes
it more expensive, and only in nominal terms!!! What if banks
in China manage to transfer their higher costs to borrowers? As
borrowers see the monetary expansion clearly unfold in front of their
eyes, what will happen if they accept higher borrowing rates, with the
expectation of also higher NOMINAL profits? (In Economics, we say that
agents “validate the rate of money supply”. It happened in Argentina in
the 1980s and it led to hyperinflation!)
With the news out of China, the European Central Bank’s negative
comments on Greece’s loan-relief program, Moody’s statement on Greece’s
“slow death” and the resulting 49bp widening of the country’s 5-yr
credit default swap, when at last the 10:30am oil inventory data was
released, I thought a major correction in stocks would follow…And I was
wrong, oh so wrong….However, I did not take profits in my equity
positions because there was something that had caught my attention from
the start: The strength of the Canadian dollar.
As you can see in the first chart below (source: Bloomberg), after
10:30am stocks actually started to recover, while Treasuries began
selling. The inventories of crude oil, gasoline and distillate had
risen beyond expectations and yet, stocks started to recover. With
these negative news, on the other hand, the Canadian dollar was
steadily firm. Oil is lower so far this week, having dropped from
83.50/bbl on Monday to $79.77/bbl yesterday in the afternoon. The
Canadian dollar, managed to reach 97+ USD cents intraday (second chart
below, source: Bloombreg). What is behind all these intuitive
contradictions?
First, the market may be realizing the liquidity drain may not come
in 2010, regardless of what central banks tell you. Hence, the drop in
Treasuries and steepening yield curve (=inflation on the way) and
recovery in stocks. Second, something must be cookin’ in the Canada.
The action seen yesterday clearly speaks of a large “long Canada”
position. Perhaps to profit from upcoming commodity rallies? Perhaps
escaping Euro weakness? A mix of the two?
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: january-13-2009
As we woke up early on Tuesday, we learned that the People’s Bank of China had raised its auction rate on 1-yr bill by 8bps, or 100% higher than the expected 4bps. Together with lower than expected earnings coming from Alcoa, this set the stage for the profit taking that took place yesterday. Does it make any sense to raise rates for China? I think the answer is negative and because this may likely be the beginning of a tightening cycle, we now have to expect more volatility, which is EXACTLY as I anticipated in previous letters. On December 11th, a month ago, I wrote:
“…Next year will give us an environment with a US Treasury issuing more debt (and with longer average duration), with a still unsolved demand for Agency debt (once the Fed stops its bid in Apr/10), with the Euro zone falling into pieces, and with creditor countries in Asia exacerbating the USD peg. This is barely a picture of muted volatility and higher valuations…I am confident we will see effective policy action on all of these fronts. But, muted volatility? I don’t think so…” (www.sibileau.com/martin/2009/12/11 “Thinking about 2010”)
Briefly, with a bird’s eye view of the current situation, during last year in the debtor countries, we witnessed a transfer of risk (and losses) from the private sector to the public sector, and the public sector took the losses with leverage. Now, the public sector has to cover those losses. The leverage, partly came from monetization of public debt and from straightforward debt issuance. Let’s call creditor countries those whose governments and/or central banks are net buyers of such issuance. One of these creditor countries is of course China. As everyone knows, China has a fixed exchange rate regime. Under this system, with the trade surpluses they have, the USD accumulation forces the People’s Bank to issue Yuans, to maintain the exchange rate, which currently stands at 6.82+ Yuans/USD. It is difficult to sterilize the effect (i.e. the monetary expansion) of this accumulation process, because it requires to change the composition of the asset side of the balance sheet, and this side gets increasingly crowded with USDs.
The other simultaneous problem arising from this situation is that the continuous expansion of the local currency (in China’s case the Yuan) increases asset prices. Unlike a central bank with flexible exchange rate regime, if the People’s Bank of China wants to keep the currency peg, it cannot be a lender of last resort, if the asset bubbles caused by the monetary expansion go bust. Therefore, the path of least resistance is to directly intervene the credit (not monetary) expansion process, by raising policy rates. However, when rates (i.e. prices) are distorted, liquidity must adjust. But the demand for liquidity has a tangible counterparty in the real economy. If the People’s Bank surprises the market, it surprises the real economy as well, generating volatility.
I know that most of you understand this process very well. I bring it up however to point out two issues that I think are underestimated: a) the underlying source of volatility that this unstable situation represents for the whole world, and b) the shock that a delayed correction will bring either through a financial crisis in China or an appreciation of the Yuan (USD devaluation). As I mentioned above, the public sector in the developed (and also not so developed) world took the pain in 2009, but at some point, everybody needs to pay its dues.
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:january-11-2009
As anticipated on earlier letters (December 2009), in 2010 I expect the continuation of the ongoing asset appreciation trend. I had also disagreed with the mainstream view that volatility was going to average down in 2010. A week is gone and I am losing on that one. However, the view of high volatility in 2010 is based on my concern that, regardless of the strength of the monetary stimulus, sooner or later, governments will have to show investors that a fiscal restructuring is undertaken.
Since Friday, I am starting to believe that this restructuring will be required sooner rather than later. This of course implies that markets are getting ahead of themselves…and I hate myself whenever I arrive to this sort of conclusions.
The speed at which credit spreads are compressing, the resilience in sovereign credit spreads vis-à-vis red flags coming from China, Greece, Ireland, Mexico, Venezuela, the US housing sector to name a few, tell me that something will have to correct sooner, rather than later.
As we have the privilege of having about six decades of Keynesian economics behind us, we may understand how the system works. Governments will refuse to restructure and will follow the path of least resistance. Governments will issue and issue and issue and issue until investors tell them to stop voting with their feet. Whoever bets on 2010 as the year of the liquidity drain, I think will be disappointed. I include myself in the group of those who thought a few weeks ago, that a slow but steady decrease in liquidity was going to occur. Yes, we will see liquidity programs unwind but we will see other more subtle and indirect ways of credit expansion.
The case of Greece, with private placements sustained under the silent and hidden support of the European Central Bank is only one of the forms liquidity will remain offered. In Venezuela, we just learned that Mr. Chavez likes a more direct and explicit approach, with the announced 50% devaluation of the Bolivar. In Argentina, the federal government had absolutely no shame in requesting reserves from the Central Bank to pay upcoming debt maturities. In the US, the Treasury is getting ready to capitalize its GSEs (government sponsored entities) when these start to suffer from increasing mortgage delinquencies. In Canada, we keep telling ourselves we have the best financial system in the world, when we failed our asset-backed commercial paper investors and still require approx. C$1BN /week in repurchase agreements from the Bank of Canada to subsidize inefficiencies. Furthermore, we are in total denial with respect to the clearly skyrocketing fiscal deficits.
In this global world, it is a mistake to think that problems in the periphery do not affect us in the developed world. Episodes in Dubai, Venezuela or Argentina are only symptoms of a truly global problem. In the meantime, the path of least resistance will be supportive of equity and credit here in North America, of commodities and commodity related currencies and the capital structure trade we mentioned in our January 4th letter will continue to unfold relentlessly. Not necessarily of gold.
I want to stay alert and as liquid as possible. Most analysts tell you that 2010 is no longer a “beta” year and that alpha will be achieved by….well, by chasing alpha strategies. For you and me, this means that to be able to get stellar results, we will have to be picky with our investment choices, looking for solid fundamentals to outperform the market. If my diatribe above is correct, these analysts are delusional and actually never quite understood why things rallied in 2009, in the first place. If I am correct, the risks you will avoid by being long liquid beta assets in 2010 will more than offset whatever alpha you think you may get by abandoning liquidity.
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: january-7-2009
Yesterday, I attended the Economic Club of Canada’s 2010 Economic Outlook event, presented by the chief economists of Canada’s largest banks (W. Jestin, Bank of Nova Scotia; Craig Wright, Royal Bank of Canada; Don Drummond, TD Bank Financial Group; Sherry Cooper, BMO Capital Markets and Avery Shenfeld, CIBC World Markets). In one sentence, the collective outlook was of cautious optimism, favoring emerging markets, the Canadian dollar, equities (not bonds), subject to no escalation in sovereign risk. I was comforted to hear that some of the speakers shared my view that relevant volatility was still to be expected in 2010 (refer: www.sibileau.com/martin/2009/12/15 “Confusion wanes”)
However, I see the picture for sovereign risk looking uglier by the day. Below, I have attached a chart (source: Bloomberg) with the credit default swap spreads (5-yr tenor) for the National Bank of Greece SA (NBG) and Greece (sovereign). As you can see, the spread of NBG has closely followed that of Greece. NBG is one of the banks (together with Alpha, Piraeus, EFG and Imi) that participated in Greece’s EUR2BN private placement, on Dec 15th. Since then and given Greece’s fiscal outlook, it has become more evident that the government can only access the private debt market. Furthermore, on January 5th, Mr. Spyros Papanicolaou, managing director of Greece’s Public Debt Management Agency confirmed the intention of the government to find financial support in that market.
What does this mean? It means that the deposits of Greece’s citizens are used to finance Greece’s fiscal deficit. Greek depositors may believe their guaranteed investment certificates are liquid instruments, but in fact, they are being directed to buy sovereign debt nobody else wants to buy…
Should this be of concern? When this same situation unfolded in Argentina, in 1999-2000, it ended with the collapse of the financial system in December 2001. However, Argentina’s banks could not be bailed out, because the Peso was convertible in US dollars. Argentina’s Central Bank could not do “quantitative easing”. Can Greece carry out quantitative easing? No, because the funds lent to the government are in Euros. Therefore, the final solvency of Greece’s banks rests on the willingness of the European Central Bank to act as lender of last resort, if needed. This is exactly what is weakening the Euro lately.
The chart below also shows that since the statements made by Mr. Papanicolaou, the correlation between NBG and Greece’s spreads has broken, with a wider NBG risk and tighter sovereign risk. This clearly shows the transfer of sovereign risk to Greece’s financial system. Perhaps, rather that “transfer”, “infection” is the better word here. In my view, if the European Central Bank validates this situation, both spreads should converge to a lower level. If it doesn’t, they should converge to a higher level. The contagion is undoubtedly a fact, and under any scenario, this situation will continue to weight heavily on the Euro. There is a lot of moral hazard at stake here as well, as other countries potentially embarked on the same path attentively watch things unfold. Nothing good can or will come of this. Trade accordingly.
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: january-6-20091
In my view, the main factor driving markets yesterday continued to be the concern on the housing sector. The release of the month-over-month Pending Home sales data at -16% vs. a -2% expected, confirmed investors’ fear that the housing sector is lagging vs. other recovery stories. This is directly connected to my earlier comments this week on the Treasury’s decision to support GSE debt indirectly, through the Preferred Stock Purchase Program (see www.sibileau.com/martin/2010/01/04 and www.sibileau.com/martin/2010/01/05 ).
Having said this, you can see why range-bound trading in almost every major market took place yesterday. At the same time and consistent with the amount of speeches given by US monetary authorities this week, there is a lot of media attention on the timing and form of exit strategies. On the latter, I notice increased interest in the alternative of bond sales by the Fed. If you have been following these letters, you may remember that I went on record on November 24th and 26th with a new thesis precisely on this point (refer: “Introducing Thesis No. 3”, www.sibileau.com/martin/2009/11/24; and www.sibileau.com/martin/2009/11/26). At the time, I wrote it didn’t make sense to target a level of reserves consistent with what we had pre-crisis, in disagreement with the mainstream opinion. It seems this view may be getting more support.
Thus, there appears to be an increasing crowd favoring asset sales by the Fed. In an online forum, I made two points yesterday on the rationale for this, which I reproduce below:
- Historical:
Bond sales are consistent with what Keynes had in mind, on how to get out of a mess like the one we’re in. He discussed this in Chapter 13, of his “General Theory …”. In 1936, Keynes wrote: “…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…”. I am convinced that Bernanke has been following Keynes since this whole thing began. If I am right, Bernanke then should be seeking to manage the quantity of money, necessary to maintain the status quo… Keynes believed in managing a level of liquidity to determine rates, and not the opposite. How do you manage money, which is the liabilities of central banks? By managing the other side of the balance sheet: Its assets. Bond sales are therefore the way to go.
- Analytical
Quantitative easing policies are very disruptive to an economic system, because they distort relative prices. Therefore, if central banks want to reverse the distortions they produced in the markets (for instance the Agencies’ debt basis), the simplest way is to unwind the initial trades that originally created these distortions. Bond sales, again, are the way to go. When the variable is “quantities”, the model adjusts via prices. I always, always, always, prefer markets rather than governments to figure out prices (i.e. market clearing rate of interest).
Finally, there is also another big debate on how to prevent financial crisis going forward. This is a topic for another day. In the meantime, let me say that financial crisis will not be prevented as long as we have central banks. It’s that simple.
Financial crisis can only be prevented under four necessary conditions: a) A free banking system (= no central banks and no legal tender); b) A central clearinghouse for the issuance of money (notes). A free banking system without a clearinghouse, where banks compete for the seignioriage (proposed by many authors within the Austrian school) is also a flawed system; c) a commodity-based unit of account (i.e. gold oz.); and d) free and flexible exchange rate system. Gold convertibility under a Conversion Agency (as proposed by Ludwig Von Mises on Part IV, Ch. III, p. 449 of his “The Theory of Money and Credit”, Yale, 1953) is a quick and sure way to utter failure, in my view.
Like Fermat, I also have discovered a “truly marvelous” proof of this proposition, which this letter is too narrow to contain…
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: january-5-2009
The year started with a very straightforward session of USD weakness. To me, the trade was very simple. At 10am yesterday, with the release of the macro data of the day (ISM Manufacturing Index at 55.9 vs. 54.3 expected and 53.6 prior; ISM Prices Paid at 61.5 vs. 57.2 expected and 55.0 prior), the market received confirmation that credit expansionary policies are elbowing their way through the markets.
When you overflow a bucket with water, if it spills over to a next one underneath, Archimedes’ principle says that a body immersed in the bucket underneath will be buoyed up by a force equal to the weight of the displaced fluid. Think of the buckets as markets and the fluids as liquidity… However, what happens if the overflow is not a one-time event but a constant stream of liquidity? This is what the markets thought yesterday. If the macro data would have been the confirmation of only a one-time event, I don’t think we would be seeing the steepening of the US yield curve shown in the chart below (Source: Bloomberg), since the beginning of last December.
Indeed, investors seem to disagree with the notion that the credit expansion was a 2009 event only. Until proven wrong, the credit expansion should continue in 2010. To this point, on yesterday’s letter, I briefly mentioned my concern over the US Treasury’s announcement on GSE (Government-sponsored enterprises) debt. Briefly, the Treasury made it clear that it will stay behind (i.e. inject capital in the form of preferred stock) the GSEs (i.e. Fannie Mae, Freddie Mac) should their net worth deteriorate in 2010, as delinquent loans (mortgages) increase and these Agencies buy these out. (Why? Precisely, because delinquent loans are expected to increase!)
In order to carry out these buyouts, Agencies need not only to be capitalized, but also to borrow to fund the purchases. This is why investors may be right, if they think the current overflow will not be a one-time event. While market participants expect the US Treasury to keep issuing more debt with longer average duration, it is now more evident that Agency paper will also be in supply. Thus, the USD weakened and oil, gold, equities and credit rallied. Sometimes, it is best to leave things as simple as that. (Feedback here is welcome = If you don’t think that was the catalyst for USD weakness yesterday, please, share your views on what other factors might be behind this. Also, please, note that my view disagrees with the mainstream one that attributes the rally in equities to the release of bullish economic data out of China. If this was the case, higher rates should have been expected, lifting rather than weakening the USD, and keeping equities in check, but not rallying).
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.
More Posts
Next page »