Debt Doomers and Deficit Deniers

November 19, 2012
By

Fear not, Twinkie lovers… your beloved snack may survive… news of the twinkie’s demise (via Hostess liquidation) created such a stir of pent-up demand, it’s possible the spongy yellow snack could return as a Mexican import.

Could we see the “twinkie market” also return to life, in some newly revived version, as Bernanke passes the mantle to another ‘true believer’ just as committed to super-stimulative monetary policy as he?

In the latest issue of Grant’s Interest Rate Observer, Jim Grant makes the case that Janet Yellen — a strong choice for the next Fed head — could be even more of a “gift” to gold buyers than Ben…

As we noted on Friday (via tweet and Live Feed), the market looked ripe for a bounce, and now it’s here. Here is an excerpt from Friday’s pre-opening commentary, as time-stamped Nov 16th, 8:20 AM EST, and broadcast via the Mercenary Live Feed:

…Does Thursday’s action presage a bounce? Markets have gotten extremely ovrsold here, and while the “fiscal cliff” is a legitimate and frightening concern, there is also a prospect of last-minute resolution if Democrats and Republicans come to some sort of agreement. Middle East tensions continue to escalate, meanwhile, but Wall Street’s attitude there will continue to be “show me the money” — or rather, “show me the war.”

…Gold looks particularly interesting here. Gold (and silver too) has held up particularly well even as precious metals stocks have gotten slaughtered. This may be due to a bunker mentality prevailing in gold — armageddon insurance etc — whereas the PM miners are much more speculative-only type instruments. (Gold also has a potential edge in a true Middle East blow-up.)

Retail also looks interesting… US consumer sentiment (and consumer spending) have held up surprisingly well, for the top 30% of US consumers anyway, and many of the major retail plays look severely beaten down (and oversold) in the short-term time frame. XRT is also putting in a bullish wedge type formation, with increasingly narrow price action into 200 EMA support…

In keeping with the above, we bought a hefty slug of XRT on Friday — and went long gold and silver on Monday. For all of our trade rationales and commentary — real money and real time — check out the Live Feed (and sign up for a no-obligation free trial)…

Monday’s surging rally is pinned on upbeat housing data and optimism over the fiscal cliff.  “It is quite clear both sides want to come to a compromise and that a reasonable compromise is available,” says JP Morgan strategist David Kelly.

In some ways the fiscal cliff is like the Greece / “Grexit” situation. As we described it prior to Monday’ open, the fiscal cliff is “ a source of drama over which investors can freak out, then indulge in temporary euphoria when disaster is averted.”

In so many other ways it is NOT like Greece, however — particularly in respect to the fact that America’s fiscal situation is nowhere near as bad… a point that some would vocally contest.

In Confessions of a Deficit Denier, Anatole Kaletsky argues that the Western debt load is really no big deal:

…there is actually no fiscal crisis in the United States, Britain or most European countries — including even Italy and Spain. Greece is another matter. But the very specific Greek disaster hardly justifies a generalized global panic about all government debts.

Consider some statistical facts. Interest rates are lower today than at any time in history, meaning that governments find it easier to borrow money than ever before. This hardly suggests impending bankruptcy.

Especially since the investors falling all over themselves to lend them money are not naïve widows and orphans or government-controlled central banks. Rather, hedge funds, billionaires and the sovereign-wealth funds of financially sophisticated nations like Norway and Singapore have all poured far more money into government bonds than into shares, property or gold over the past three years.

Why are sophisticated investors unmoved by the deficit panic? Because they know that governments, at least outside the euro zone, are nowhere near bankruptcy. In fact, debt levels are not dangerously high…

Running exactly counter to that view, Kyle Bass of Hayman Capital sees Central Bankers “leading the sheep to slaughter:”

Central bankers are feverishly attempting to create their own new world: a utopia in which debts are never restructured, and there are no consequences for fiscal profligacy, i.e. no atonement for prior sins. They have created Potemkin villages on a Jurassic scale. The sum total of the volatility they are attempting to suppress will be less than the eventual volatility encountered when their schemes stop working. Most refer to comments like this as heresy against the orthodoxy of economic thought. We have a hard time understanding how the current situation ends any way other than a massive loss of wealth and purchasing power through default, inflation or both.

Call them the Deficit Denier and the Debt Doomer. So who is right? In the long run we suspect Bass (the debt doomer) is closer to the mark.

But in the long run we are all dead, as Keynes once said… and premature bets on market “eventualities” can have very painful here-and-now results (as KB’s investors know all too well). The problem with debt-related macro predictions of panic, dislocation and chaos is the timeframe it can take for such prophecies to play out. Short Japanese Government Bonds (JGBs) — aka “the widowmaker trade” — has been making widows for more than a decade now…

Part of the problem with assunptions of fiscal chaos, especially as relating to the United States, is a refusal to look at the asset side of the balance sheet.

As we have written before, a country can be thought of as a publicly traded stock that issues currency instead of shares. The price of the currency (shares) rises and falls for various reasons, most of them related to attractiveness of said country as an investment destination.

The ability of the country (company) to leverage itself with debt, meanwhile, is dependent on the quality of earnings, the potential for future growth, the presence (or absence) of comparable alternatives, and the presence (or lack thereof) of risk appetite.

A country, or company, with a much stronger foundation of revenue streams and a very attractive balance sheet can shoulder substantially more debt leverage than an entity without these advantages. Debt doomers tend not to think about these factors too much. They just point to absolute debt levels (which are relative anyway) and holler.

For a deeper look at why the US is not Greece — or anywhere close to it —  check out our piece “Hey Bill Gross, Why So Serious?”

And speaking of Greece, the privatization plan isn’t going so well, as the NYT reports…

THE government inspectors set out from Athens for what they thought was a pristine patch of coastline on the Ionian Sea. Their mission was to determine how much money that sun-kissed shore, owned by the Greek government, might sell for under a sweeping privatization program demanded by the nation’s restive creditors.

 What the inspectors found was 7,000 homes — none of which were supposed to be there. They had been thrown up without ever having been recorded in a land registry.

“If the government wanted to privatize here, they would have to bulldoze everything,” says Makis Paraskevopoulos, the local mayor. “And that’s never going to happen.”

Athens agreed. It scratched the town, Katakolo, off a list of potential properties to sell. But as Greece redoubles its efforts to raise billions to cut its debt and stoke its economy, the situation in Katakolo illustrates the daunting hurdles ahead…        

In addition to the problem of not being able to issue its own currency — no sovereign control over monetary policy — Greece is troubled by the reality of not being serious as a capitalist country. As the Peruvian free market economist Hernando de Soto has argued, property rights and rule of law are the bedrock of what allows Western economies to function.

On deeper inspection, Greece is awful at both…

JS (jack@mercenarytrader.com) 

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