Here’s our current take on the state of markets and political economy – plenty of fodder for anyone seeking reading material for Memorial Day weekend!
REFLECTIONS ON MEMORIAL DAY
It’s easy to forget that this three day weekend is more than just a respite from a busy and uncertain world, but also an opportunity to reflect on the public sacrifices of so many, and what they mean to us. Part of that is obvious, part of it less so. As Oliver Wendell Holmes observed of Memorial Day in 1884 (emphasis added):
…to the indifferent inquirer who asks why Memorial Day is still kept up we may answer, it celebrates and solemnly reaffirms from year to year a national act of enthusiasm and faith. It embodies in the most impressive form our belief that to act with enthusiam and faith is the condition of acting greatly. To fight out a war, you must believe something and want something with all your might. So must you do to carry anything else to an end worth reaching. More than that, you must be willing to commit yourself to a course, perhaps a long and hard one, without being able to foresee exactly where you will come out. All that is required of you is that you should go somewhither as hard as ever you can. The rest belongs to fate. One may fall-at the beginning of the charge or at the top of the earthworks; but in no other way can he reach the rewards of victory.
We’ll be thinking of all servicemen and women, past and present, and hope you will too. We’ll also be thinking of ’the Captain’ — we miss having him on the bridge with us.
GEITHNER RALLIES EUROPE
Markets have had a nice little relief bounce this week, thanks in part to Treasury Secretary Geithner’s solidarity promoting visit to Europe. Interbank funding markets, though somewhat improved, continue to show signs of stress. This shouldn’t be surprising, as Geithner’s message is that the current EMU-IMF rescue plan is a good one, and just needs coordinated implementation:
“The European leaders have put together a very strong programme of reforms on the fiscal side and a very strong commitment on the financial side,” he said at a news conference alongside new British finance minister George Osborne.
“I think it’s got the right elements and again I see a very strong political commitment — you see that not just in Germany but across Europe — to make it work. I think what Europe should do is implement the program they’ve laid out.”
As we’ve pointed out, we think that assessment is just dead wrong. Unless the ECB is somehow surreptitiously monetizing Greek debt, then the current plan virtually assures its eventual default. And as with the once supposedly “contained” subprime crisis, it’s extremely unlikely that Greek debt can be ring fenced in a way that will prevent global financial contagion and damage to the real global economy. The euro’s continued descent (like the flight to the USD and U.S. Treasuries) implies as much. As long as “fiscal austerity” is given primacy the world over, then the bullish USD and UST trade should continue, and gold should look increasingly precarious.
THE AUSTERITY BAND PLAYS ON
We commented yesterday on the OECD’s double barreled assault on recovery. Larry Elliott of The Guardian also penned a good counter point:
…the risks of tightening too quickly are probably greater than tightening too slowly. Why? Because in the US and in the European Union (although not in the UK) deflation is now a threat. Should the global economy tip back into recession, policymakers would have no ammunition left to fire. Interest rates are at rock-bottom levels already, budget deficits have exploded, new money has been created electronically, central banks are awash with the bad debts they have scooped up from financial institutions.The best (or least bad) outcome would be for policymakers to hold their nerve, keeping pro-growth policies in place until there is evidence both of recovery becoming embedded and of the reforms necessary to prevent a second financial crisis. Unfortunately, the European sovereign debt crisis has muddied the waters, making governments – and institutions like the OECD – nervous. The voices urging austerity are currently more powerful than those urging the need for job creation. After a brief flirtation with unconventional economic policies, the old orthodoxy is making a comeback.
There’s also a good video piece on the Peter G. Peterson Foundation’s most recent fiscal scarefest, er, summit, with some pointed jabs at the man himself. The scariest part of the video, to us, is when deficit reduction commission co-chairs Erskine Bowles and Alan Simpson offer their intensely hawkish views, as we expect them to have the President’s ear when it comes time to enact fiscal consolidation.
In a NYT op-ed, David Einhorn, a hedge fund manager who’s one of the best balance sheet analysts alive, tried his hand at macroeconomic analysis, with mixed results. One particular aspect is especially curious — Einhorn derides credit rating agencies (and “modern Keynesianism”, whatever he means by that):
Modern Keynesianism works great until it doesn’t. No one really knows where the line is. One obvious lesson from the economic crisis is that we should get rid of the official credit ratings that inspire false confidence and, worse, are pro-cyclical, aggravating slowdowns and inflating booms. Congress has a rare opportunity in the current regulatory reform effort to eliminate the rating system. For now, it does not appear interested in taking sufficiently aggressive action.
Yet only a few paragraphs later, Einhorn sounds just like those same rating agencies – the ones that have gotten Japan so remarkably and consistently wrong over twenty years — when discussing the risk of sovereign debt default:
I don’t believe a United States debt default is inevitable. On the other hand, I don’t see the political will to steer the country away from crisis. If we wait until the markets force action, as they have in Greece, we might find ourselves negotiating austerity programs with foreign creditors.
Some believe this could be avoided by printing money. Despite the promises by the Federal Reserve chairman, Ben Bernanke, not to print money or “monetize” the debt, when push comes to shove, there is a good chance the Fed will do so, at least to the point where significant inflation shows up even in government statistics.
That the recent round of money printing has not led to headline inflation may give central bankers the confidence that they can pursue this course without inflationary consequences. However, printing money can go only so far without creating inflation.
The Pragmatic Capitalist penned a good rebuttal to Einhorn’s piece:
First, the government doesn’t actually print money (at least not in terms of money creation). They simply press a button on a computer that changes accounts up and down. It’s not like they find a gold miner and print up a note and “monetize” anything. Most importantly though, the government never actually has nor doesn’t have dollars. They simply change accounts up and down as they tax and spend. So what does the Fed do? They target the Fed Funds Rate via monetary operations with the belief that they are the grand wizard behind the whole operation. The Fed’s interest rate mandate or target of “price stability” actually means they can’t monetize the debt. In a Q&A session last year Mr. Bernanke admitted as much…
Now, this is generally the point in the conversation where the inflationistas begin talking about the “effective default” of the USA via dollar devaluation. The problem is, each time the crisis flares up the price action in markets makes it abundantly clear that there is no inflation, but rather continuing deflationary fears.
…The inflationistas have made the same error that Mr. Bernanke made when he supposedly “saved the world” in 2008. Mr. Bernanke assumed that banks were reserve constrained while Mr. Einhorn assumes that adding to reserves is inherently inflationary.
But as we see very low levels of borrowing (due to the private sector’s lack of debt demand – caused by the continuing balance sheet recession and de-leveraging) we also see zero signs of inflation.
Einhorn is not the only smart hedgie manager who’s worried about inflation — Seth Klarman is too:
The concern that the dollars he earns for his clients will lose their purchasing power is always on hedge fund manager Seth Klarman’s mind. The possibility that the government will continue to print money to solve our economic problems has left him more worried than at any time in his career.
“There are not enough dollars in the world to do that, unless we greatly debase them,” he said.
Our take is that Klarman isn’t thinking deeply enough about stocks, flows, and multipliers in making such a statement. Monetization should be sufficient to stem deflationary pressures long before it approaches 100% of outstanding debt. And as we noted recently, in a deflationary balance sheet recession, there is a period of ”disdeflation” that must unfold before we can arrive at actual inflation:
Deflation implies a shortage of money. If that shortage persists, eventually all or most prices will come down, even if relative prices (e.g., the number of eggs exchanged for a quart of milk or a certain amount of gold or silver) do not move. And because most debt contracts are priced in nominal rather than real terms, this causes carnage in credit markets, e.g., waves of default, bankruptcies, and restructuring…
Under fiat monetary systems, precious metals are nothing more than a barometer of inflation (rising) and deflation (falling), and like any other prices, they are subject at times to human error and herding. And today, with everything on the planet flashing deflation ahead, there is simply no fundamental reason for gold prices to increase.
So why has gold been rising? It’s most likely due to the fear that policymakers will use inflation to involuntarily “restructure” public sector debt…
Here’s the thing though – if there’s outright deflation, then monetizing debt, be it sovereign or private, cannot be inflationary until deflationary pressures have been completely extinguished. This idea simply mirrors the concept of ”disinflation” that has held currency with economists from the 1980s into the 2000s — similar to how today’s environment is an inverse reflection of the episodes that have people like [Einhorn and Klarman] wringing their hands about inflation, and gold bugs screaming that the sky’s the limit.
Is it disdeflation? Whatever we choose to call it, it is not a “door” or a magical threshold that is instantly crossed as soon as central banks monetize interest bearing debt, or treasuries credit accounts with new units of money. It’s more like a long passage, with plenty of room between here (deflation) and there (inflation). Most importantly, there are places along that passage that offer a sounder economic and financial footing than what we’re currently on.
Most importantly, if the world’s governments continue hurtling towards austerity as currently promised, at least part of his statement will prove true: “There [will not be] enough dollars in the world…”
THE INTERGENERATIONAL DEBATE
On the “sounder footing” point above, given how the intergenerational “mountain of debt” meme continues to run wild, we can’t over emphasize this: debt is not the only thing that one generation leaves to another!!! There are also tangible and intangible assets — not only financial wealth, but also public and private resources, knowledge, security, technology, arts and culture, peace, health, etc. Poorly timed austerity measures will mean that FEWER of those assets are available to future generations, due to Wicksell’s ‘residue of social maladjustment’; they will also require even further expansions in public sector outlays, due to poor economic performance, thus raising the dreaded debt-to-GDP levels that they’re aimed at lowering (Japan, anyone?).
Alan Simpson acknowledges as much in the Real News video, though he seemed to be deeming it necessary, perhaps laboring under the prevailing dogma that government deficits always work against private sector economic growth. For a competing take, we recommend Richard Koo’s take on Japan, the U.S., and balance sheet recessions.
IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC is a state registered investment advisor. The foregoing information is for informational, educational, or entertainment purposes only. It does not constitute an offer to buy nor a solicitation to sell any security, or to engage in any investment strategy. Some clients of the firm hold positions that are expected to move inversely to gold prices.