Archive for June, 2011

Debtors vs. Bankers: The Only Winning Move Is Not To Play?

Wednesday, June 15th, 2011

De-financialization:  To beat the squid, we may have to quit the game!

It is hard to fathom that during today’s episode of Bankrupt Greeks vs. Bankrupt Bankers, the herd fled into Treasuries, gold and silver, dumping the Euro, stocks and oil.  Given the unsustainable debt levels here, the long-term U.S. economic picture has to include either severe deflation or severe inflation (or both in alternating sequences).  But apparently Greece is on fire now and our own conflagration remains in the future, so the herd has moved here for temporary safe haven.

But isn’t this a bit like hiking to the stern of the Titanic, to avoid going down first with the bow, only to be sunk later?

In an over-financialized world, it’s unlikely that either the debtors or the lenders will win. Deleveraging means de-financialization, and that means less net interest going to the lenders. Some lenders have to lose.

Meanwhile, the lack of new credit means that not only do the ponzi borrowers go broke (those who require fresh loans even to pay interest), but even the speculative ones (who can cover interest but not principal) start to have real trouble rolling over their debts.  And in the maelstrom of inflation, deflation and unemployment, nearly everyone loses something.

It reminds me of the classic line from the movie War Games, when the insane computer finally learns the truth about the nuclear war “game”:  “The only winning move is not to play.

So how does one “invest for sustainable gains” in this environment?  Shakespeare’s line comes to mind next:  “Neither borrower nor lender be.”

In practical terms, that’s not completely possible, but it does provide a sense of direction when considering options and choosing the next path.  The first move is to minimize fees to the financial sector, and to bring loans (bonds) into balance with debts (mortgage and other leverage). Second is to identify low-debt, high-tangible-value stocks and funds, that should hold their real value regardless of inflation or deflation.

Here we now have a portfolio with an overall 0.25% annual average expense ratio, and we’re closing on on zero net debt holdings (while allowing some room to make contrary rate-spread plays as the herd runs back and forth on the Titanic). The challenge of which tangible-value investments to hold is more challenging…

And, as this grows long, more about that later…

Break the Debt Cycle before it breaks us.

Tuesday, June 7th, 2011

The debt ceiling battle qualifies as a “Squid Sighting”.

It’s absolutely time to break the endless-increase-in-debt cycle.  It was time 7 years ago when the economy recovered from the dot-com crash. Several trillion dollars later, more waiting won’t improve the situation. It’s time to stop spending “more” and start spending “smarter”.The rate of debt increase since 2004, compared with the lack of corresponding sustainable GDP increase, strongly indicates that we’ve passed the point where additional debt yields worthwhile benefits to the nation (or world) as a whole. Whatever we’re borrowing for, it’s not worth it!

From a certain point on, more debt primarily helps the lenders (who get secured streams of long-term income), not the borrowers.  I think we passed that point a long time ago.  Now we’re at the point where even the lenders are starting to realize that more debt may not help them, because a loan to someone who can’t repay is money gone. Widespread default and insolvency is bad for everyone, and the banksters can’t shift the bad debts onto Uncle Sam anymore without risking losses.

I think the markets know this, particularly after watching Iceland, Ireland, Greece and Portugal.  The U.S. has the advantage of the reserve currency, but we also have a lot of national obligations not consolidated into the national budget.

What I see is that Wall Street isn’t nearly as worried about the debt ceiling per se, as they are about the total unwillingness of Washington to face reality in terms of eliminating the structural deficits and bringing Uncle Sam’s spending back in line with tax income.

Some examples:
(1) Gold and silver have risen a lot in the past year.  It’s not because those investors are worried that there will be a deflationary government shutdown! It’s because investors are worried that there will be an inflationary spiral, unless we break out of our current print-and-spend and/or borrow-and-spend paradigm.

(2) TIPS yields range from -0.5 to +1.8%, whereas historically TIPS have had yields in the 2-3% range.  The historical TIPS yields reflect the fact that historically bonds yield 3% above long-term inflation.  The current low yields say that the market sees bonds as unlikely to yield as much as inflation (-0.5% TIPS for 5 years) or at most 1.8% above inflation.

(3) In stark contrast to the above, the overall low Treasury yields and hoarding of cash by household and corporations both suggest a strong fear of deflation as well.

Some commentators view the fear of deflation and the fear of inflation as mutually exclusive opposites, but they aren’t. It’s possible to be afraid of both, because our economic circumstances suggest that one or the other are becoming increasingly inevitable. For a nation with its own currency, excess debt must inevitably be defaulted upon, or repaid only in devalued money. The one is deflationary and the other inflationary. At this point, for us to avoid one or the other may no longer be possible.

Some people claim that Uncle Sam can borrow a lot more, since “interest rates are still low now”.  But Greek, Irish and Portuguese rates were low, too — even as they borrowed too much. But the lending markets aren’t omniscient, and can have a change of heart in a heartbeat. For those nations, once the market woke up, the credit markets shut down and the sovereign borrowers were doomed. We have to avoid having that outcome here!
Here in the U.S., we’ve got to take the foot off the gas pedal of manic deficit spending. Ideally we want to coast the budget into balance, rather than having a hard stop (or a crash over the cliff). But the most important thing is to quit accelerating our indebtedness.

To “spend smarter”, we will need a lot of thoughtful reprioritization and structural reform in how the government taxes and spends.  But we absolutely have to stop borrowing money for no good reason.  If we borrow money, squander it, and never repay the principal, all we’re doing is feeding the financial sector a perpetual interest income stream, stripped every year out of our nation’s productive output!  Right now I don’t think there’s much, if anything, on the margins of the federal budget for which we really want to further enslave ourselves to the bondholders!

Stop Feeding The Squid!

Must-Read Article: Breaking the banksters’ framing

Monday, June 6th, 2011

From Michael Hudson by way of Naked Capitalism (also circulating via Mauldin’s newsletter):

Michael Hudson: Will Greece Let EU Central Bankers Destroy Democracy?

The majority of today’s financial discussions use bank-centric framing and terminology to discuss the situations facing the debtor nations (and debtor citizens and corporations).  However, there are two sides to every contract, and it’s clear that the borrowers are not exclusively to blame for their over-indebtedness, as a result of fraudulent inducements, bribes, and all manner of self-serving spin from the financiers.  Moreover, when the bankers’ “solutions” consist of (a) more debt for the over-indebted, and (b) taxpayer bailouts for the bankers when the over-indebted finally stop paying, it’s clear that the bankers are part of the problem, not part of the solution — literally!

So I like the article above because it re-frames the issues (with emphasis on Greece and Iceland) in terms of the more fundamental, classical economic issue:  how do we reorganize to optimize national output?  It most likely does not entail continuing to enable the lenders to live off the labors of others, at least not as much as they do now.

Quick implications for debtor nations and investors therein:  (1) Stop feeding the squid!  Get out of debt if you can, and don’t fund the banksters’ shenanigans with your “investments”.  (2) Prepare for higher interest rates due to defaults and devaluation-driven inflation. Obviously more thought will be needed here, but as in the 1970s, a simple stock-and-bond portfolio may result in serious losses after inflation.  Watch and learn from the other nations, before it comes to our own doorstep…

The Economy Needs an Overhaul, Not Just Tinkering

Monday, June 6th, 2011

Following last week’s abysmal economic reports, particularly the May Employment Situation Report, there’s a lot of hand-wringing among policymakers and economists.  Why isn’t the economy responding to the Fed’s low rates and QE2?  How can Washington do more about jobs without further worsening the already-too-high national deficit?

As in my prior post pointing out that the Fed could do a lot more than just setting rates and running QE2, I think Uncle Sam could also do a lot more than just throw money around.  But most of the people commenting seem to be locked into the two prevailing political dogmas, and don’t seem to be thinking creatively about the options.  It might take some leadership to break through the political logjam, but isn’t that what elected leaders are for???

Typical framing of the issue is highlighted in a recent post by DeLong – both parties appear to have “prioritized deficit cutting over job creation and full employment”.  However, like the Greek and Japanese economies, the problems with the U.S. economy are much deeper than “lack of jobs” vs. “excessive deficits”.  The problems are structural and we need an overhaul, not just numerical tinkering with budgets, tax rates and Fed policy parameters.

We need to step back a bit and ask what, as a nation, the United States is all about?

Viewed holistically, we are a nation of 300,000,000 people, of which some are working, some are too young or too old to work productively, and some could be working, but aren’t.  Right now, too few are working, more are becoming too old to work (though some are retiring before they should), and too many aren’t working who should be.

Of those who are working, too many are engaged in activities which don’t actually improve the nation as a whole.  We could probably create a national situation in which there was gainful employment for all who wanted it, but we need massive institutional reforms across much of the scope of government.

Among many examples, we might consider actions to (a) cut back on military and “homeland security” spending via institutional reforms, (b) reinvent the health-care delivery apparatus to streamline costs relative to outcomes, and (c) make it easier for the poor to get richer through hard work, while making it harder for the rich to get richer without working.

For (a), we ought to figure out why it costs $1,000,000/year to deploy a single combat soldier overseas, and cut the number in half — possibly without cutting back on the soldiers themselves.  That number speaks volumes about Pentagon waste.  For (b), we ought to figure out why the U.S. spends twice as much of it’s GDP on health care as its peer nations, yet gets no better results.  That number speaks volumes about medical waste, and examples are legion of pointless paperwork, frauds against the bureaucracy, and “treatments” whose cost-benefit equation is negative.  No doubt the health care costs could also be cut in half.  And for (c), we probably don’t need to raise marginal tax rates, we just need to streamline the tax and legal codes (to simplify financial decision-making, another huge source of wasteful economic friction) and make sure everyone pays fairly again.

None of this is easy, particularly because those profiting from the current culture of Federal waste will fight it tooth and nail, but together these actions could turn the U.S. current 10%-of-GDP deficit into a healthy surplus.  And they would free up a large fraction of the workforce to perform work that actually adds value to the country… not just adding statistics to “GDP”.