If Germany Caves

There is always the possibility that Germany will agree to underwrite the sovereign debt problems of the PIIGS countries (Portugal, Italy, Ireland, Greece, Spain). How would that look? Imagine the concept of creating Eurobonds that all of the Eurozone countries stand behind (which would basically put Germany on a hook that they are not currently on) or have the ECB buy $ 2 Trillion of Sovereign debt (which would be pretty much the same thing). What happens then?

If this happens, you have the situation that will, in time, present itself to the US. There will be a massive debt that really cannot ever be paid off other than by simply printing currency and using the currency to continue to fund the debt. That means massive worldwide inflation with the purpose of destroying the "value" of the outstanding sovereign debt. If the inflation does not spiral out of control, this could work. It would be simply another way of defaulting.

Imagine a 10 percent inflation rate worldwide. In a reasonably short time, the value of outstanding sovereign debt would fall dramatically (along with all currency-denominated assets). In effect, you simply destroy the value of the sovereign bonds as you use the printing press to keep them current. If you can keep the inflation rate high but under control, this will do the trick. The danger is, of course, that inflation can have a mind of its own and might not remain under control. This could mean hyperinflation which could destroy the major economies of the world. But, it is possible that inflation could be kept under control at a high level. Who knows?

One side effect is the destruction of all of the entitlement programs. Social security and pension funds which are denominated in dollars will lose much of their value (politicians will find a way to eliminate cost of living indices that are in place to preserve the value of these funds). Health care programs are budgeted in dollars. They will become worthless as well. Public employees will find their salaries fixed and they will find themselves impoverished.

What will prosper in this environment is anything whose value is not stated and fixed in currency terms -- commodities, free market businesses, anything where prices adjust upward with inflation.

In other words, world wide inflation triggered by selling Eurobonds or some other equivalent scheme, is just a default by another name (see Rogoff and Rinehart's recent book, "This Time is Different").

Just plain defaulting would be much simpler, but may not suit the politicians as well as massive inflation.

The Blame Game

If you buy a residence in the US and live in it, you are in a remarkable situation, especially if you finance the home with a large mortgage. If the value of your home rises, you can sell it tax free (in more than 98 percent of actual home sale situations) and if the value of your home falls, you can, in most states, simply move away and owe nothing. Even better, the government subsidizes the interest expense that you pay on the mortgage by permitting tax deductions for mortgage interest paid.

If you decide to pay off your mortgage early (to take advantage of lower mortgage rates), the government insists that all "conformable" mortgage loans (comformable to GNMA standards, which accounts for more than 90 percent of all US mortgages) provide for no penalty whatsoever to homeowners choosing to refinance their homes (a luxury unheard of in the mortgage market for commercial real estate).

As if that isn't enough, Congress has created two "quasi" government agencies, Federal National Mortgage Association (Fannie Mae) and Federal Mortgage Corporation (Freddie Mac) who currently own or guarantee more than half of the mortgages in the US. The effect of this taxpayer largess to home buyers is to lower the interest rates paid on home mortgages by providing massive amounts of taxpayer dollars for the mortgage market.

Is there a wonder that there was a housing bubble? Does it really require predatory lenders to get this rocket-fueled housing bubble going?

If virtually all capital gains on common stock were tax free, we would see a massive bubble in US stocks, especially if the interest on stock loans were tax deductible and if the government provided taxpayer money to loan money to potential stock holders.

So, why the deal with housing?

The government (both political parties) made the decision to favor home ownership over renting for the average American.

Note that none of the legislation introduced by either President Obama or Republicans does anything to change the current government favoritism of residential housing. So, guess what? We are absolutely assured to repeat the housing bubble and bust in the future. Nothing in Dodd-Frank or the other sledgehammer attacks on capitalism initiated by President Obama and his Democratic Congress do anything to change government's policies that guarantee another housing disaster at some future date.

What about Canada? Canada does not have tax-free sales of residential homes. Canada does not permit tax deductions for interest expense. Canada does not have a Fannie Mae or Freddie Mac? Guess what? Canada had no housing bubble either. Are Canadians that different from Americans? Nope. They just have different government policies regarding housing.

So, why are Wall Streeters blamed for the housing bubble, but government policies get a free ride? Because politicans have no clue as to what happened from 2006 to the present. Today's Obama tirades are simply a knee-jerk, anti-capitalism reflex to a downturn that their very own political allies put in motion generations earlier.

Wall Streeters did not cause the housing bubble or its subsequent collapse. Wall Streeters did not put in place the Obama policies that have stifled any hopes of a vigorous economic recovery.

The real blame for the housing bubble and collapse belongs to current government policies regarding residential housing. Until those policies end, we are doomed to repeat the housing bubbles and busts.

Background Noise

Occupy Wall Street (OWS) and the President's "jobs plan" have become background noise to the faltering US economy. Far more interesting are the political shenanigans in Europe attempting mission impossible -- trying to keep most of Europe from defaulting. This steady drumbeat of irrelevance beats on as the Western economies slide into the mud.

Capitalism is now so hamstrung in the Western economies that we will soon be trumpeting 8 % unemployment as full employment. Europe is pretty much used to that already. European countries haven't seen four percent unemployment since Queen Victoria's days and they are not likely to see it again in the future. The US is a tag along.

All of our troubles in the Western world stem from one simple consideration: many people have an insatiable desire to be appear to be "good" people. Appearance is the key here. Really helping people is not the plan.

Look at Buffett. He is complaining that people like him don't pay enough taxes. That problem is easily solved. He can send in more money with his tax return. Then he can pay what he deems his fair share. You think he would do that? Are you kidding? Buffett is just trying to prove that he is a "good" guy. This is all about appearances. Buffett has no intention of paying more in taxes. If he did, he would do it. Nothing prevents Buffett from paying more in taxes right now, except that he doesn't want to pay them. But, he sure wants to BS about how he wants to pay more. Interesting!

Most good ideas that people want to foist on others, such as minimum wage laws, don't affect anyone but poor people. Minimum wage laws simply outlaw certain contractual arrangements because one is poor. That's it....nothing more. Heaven help you if your skill set doesn't merit some liberal's idea of a living wage. You are just flat out of lack. Let them eat cake, one supposes.

And so it goes. Laws passed to help workers invariably end up creating reasons for employers to not have workers. Anytime government favors a group, it makes them toxic to other people and especially toxic to people who make hiring decisions.

Good ideas designed to help people become anchors that prevent people from the having the opportunity to improve their lot. That's why inequality has grown so dramatically in the past several decades. Liberal help has created a situation where the poorest among us have no real upside anymore.

The rich are comfortable which is why virtually every wealthy suburb in America is now represented by some arrogant white liberal. Nancy Pelosi's district isn't full of poor people and Nancy Pelosi is herself among the 1/100 of 1 percent of the richest people in America. Let them eat cake. Thanks Nancy!

These folks bask in self adulation thinking that they are doing good, but what they are really doing is preserving their dominance over folks less fortunate. The welfare state is like a boot on the neck of poor people. They just don't have a chance in this kind of environment.

What the less fortunate among us need is for the government to get out of the way and give them a chance. Asia is giving their citizens a shot. That's why Asia will supplant the West as the dominant economic power within another two generations.

Not Out Of The Woods Yet.

The Futures are up. European markets are up and yet it does not feel like we have reached the bottom.

let us consider the following news items;

By www.thetrader.se
Ft.com
Aluminium company Alcoa opened the US corporate earnings season with disappointing results for the third quarter, reporting profits below consensus expectations, the FT reports. Earnings per share were 15 cents for the third quarter, http://ftalphaville.ft.com/thecut/2011/10/12/699756/alcoas-3q-earnings-d...

European authorities plan to set a higher than expected capital threshold for the region’s banks and give them six to nine months to achieve that level or face government recapitalisations under the auspices of the eurozone’s €440bn rescue fund, http://ftalphaville.ft.com/thecut/2011/10/12/699716/eu-banks-face-higher...

A bill that aims to punish Beijing for holding down its currency passed the Senate on Tuesday despite a warning from China that the legislation could plunge the global economy into a 1930s-like depression,http://ftalphaville.ft.com/thecut/2011/10/12/699626/currency-bill-passes...

Slovakia’s government became the first in the eurozone to fall over opposition to expanding the European financial stability fund when just 55 of the parliament’s 150 MPs voted in favour of the measure,http://ftalphaville.ft.com/thecut/2011/10/12/699636/slovakia-votes-again...

Paulson & Co, the giant US hedge fund run by billionaire investor John Paulson, has warned that in a “worst case” scenario, it could suffer redemptions equivalent to between a fifth and a quarter of its assets by the end of the year, http://ftalphaville.ft.com/thecut/2011/10/12/699776/paulson-co-warns-of-...



I think till uncle Ben comes up with QE 3 or whatever number, we shall see renewed weakness. Time is not right to invest. I think the rally is just a bounce and the bears are not done yet.

5 predictions from 'Trader Vic' Sperandeo

Victor Sperandeo makes 5 "Frightening Market Predictions", as well as a few policy prescriptions for the USA in this Real Clear Markets piece. Here's a taste: 

"...1. The U.S. is going into recession.

This is being entirely caused by the woefully misguided fiscal policies of the Obama administration.

Their anti-business, socialist agenda is killing the "Golden Goose" (i.e. Capitalism). Raising the costs for small and big business via tax hikes, Obamacare, and massive regulation is in effect causing a capital "strike" by entrepreneurs. As a result, GDP is going to decline..." 

Recession is not the only thing on Trader Vic's mind. Head on over for a few thoughts on gold, the future of the EU, hyperinflation, and the global bubble in debt. 

Plus, a few key changes that may help the US fix its problems and change our course for the future (only wish Victor had some more time and space to really flesh these out). Check it out. 

Columbus Day Short Squeeze

That was a jolly good show. But what the pundits are forgetting to mention is that economic fundamentals did not change from last week. Team Markozy or Sarkel (your take) just agreed to agree without a detail plan yet and the entire song and dance is being played by HFTs without a shade of retail participation. The TBTF banks and the likes of GS or  MS really need to generate profit to cover their zero value assets. By the way the biggest gain was made in stocks which had the highest short interest.

 The bond markets are not impressed yet with Greek one year yield around 150% ! I have never seen anything like this before. That market is more than convinced about a Greek default and yet everything seems to rosy. What am I missing?
The only silver lining I can think of is the coming earning season. A good earning season will justify a short year end rally but most likely it will be the last of the bull rally when it comes.
For now I am happy to sit outside till I am convinced that we have a bottom. This week was the week of killing the bears, next will week will be the season of hunting the bulls. 

Is it time to go long?

Is it time to go long equities again? While it is possible that some kind of low was in, I am not ready to dip the toe in the water yet, let alone jump in it. There are chances that while dipping the toe to test the water, we might lose the foot altogether. The European drama is far from over and unless a definitive course of action is implemented, we might see more violent market actions. Moreover, the Fed has not yet come out with more free money for the TBTF banks.  So no sustainable rally can be expected yet.

So far as the Greek drama is concerned, Greece has been in default for 140 years out of last 200 years. So what makes you think that they will not default again? The following are from John Mauldin;

“Greece used its access to low rates that came along with the euro to borrow and increase the wages of government workers, until the Greek train system, for instance, had €100 million in revenue and €400 million in salaries, with another €300 million in expenses. A government-sponsored retirement plan for some 600 different "hazardous" jobs (like hairdressing and radio work) was available at 50 years of age”

And now the Greeks are rioting on the street because their privileged lifestyle is being threatened? How long before Germany either throws Greece out of Euro or quits itself? I think till they figure out how much they need to recapitalize their banks. That may well be within the next six to eight months. And if and when Greece gets a haircut or restructuring of its lazy bum loans, Ireland will ask for its fair share and so will Spain, Portugal and yes, Italy. Euro zone will need between two trillion to six trillion euro to re capitalize its banks and tide over the bad loans. Do they have that kind of money? I doubt it very much. So my views of the long term prospect of the Euro zone and the world economy is pretty much certain.

But that does not mean we will roll over tomorrow. The central bankers and governments of the western world, including the US government, will do their best to prevent a Lehman type situation by pumping more and more liquidity. That is the only solution they know and that effort is already underway. We can see that happening with ECB agreeing to buy bonds of Spain and Italy, BOE injecting more money in the system and BOJ also joining the liquidity pumping operation. We are just waiting for the FED to join the party and we may not have to wait for long. With so much liquidity being thrown in the system, we might see short term ISM turning up and economy showing some life again. The net result, we should be seeing a yearend rally starting possibly by late October.

 I am monitoring various indicators to decide if that rally is going to have any traction at all and if it is worth going long equities by end of October. For now though, it is better to wait outside and not join the game even on the short side.