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  • the sovereign debt end game

    this is a long and somewhat rambling meditation on some of the issues raised recently. if you bother to read it and have any reactions, thoughts or criticisms, i would be grateful to hear them.

    we're certainly in the early stages of another deflation scare [as ej hates to call it]. we're also entering another wave of foreclosures, which should trigger another downleg in housing.

    the congress won't extend unemployment benefits but it looks like the bush tax cuts will be extended for all, including the wealthy however defined. [the republicans are willing to play chicken, saying it's all or nothing on extensions, and the democrats are scared of being responsible for an across-the-board tax increase right now, so the whole bush package will be extended. and when there are even more republicans, many tea colored, in the next congress, there will be no tax increases.]

    thus we continue to bifurcate the economy, hiving off another wave of losers as u.s. income distribution looks more and more south american. and the trillion dollar deficits extend as far as the eye can see.

    i don't think we'll have another financial sector/bank crisis- been there, done that, and everyone now knows where the lines are drawn. the tbtf banks will be propped up no matter what else happens. [anyone recall the movie, "weekend at bernies"?]

    where's the bubble? in the '90s it was clear that the tech sector in general, and the internet sector and the "dot bombs" in particular were crazily priced. tech ipo's doubled and tripled on their opening day of trading. people got rich day trading. by the mid '00s it was crystal clear that there was a housing bubble, as real estate appraisers started a petition to ask for federal investigations of the overblown appraisals they were being pressured to produce, and more and more stories circulated about $25k/year gardeners getting 105% ltv mortgage packages on $700k homes. people got rich flipping condos.

    so where's the new or the next bubble? i'm not running across news stories about ordinary people getting rich playing some financial game. day trading and condo flippng are equally out of date, and there is no obvious replacement for the speculator in the street. but banksters are getting rich on big bonuses based on trading profits, federal subsidies and extend-and-pretend accounting tricks. one could argue that banksters have been getting rich all along, through all the prior bubbles, so what's new? but i don't see evidence of anyone else getting rich lately.

    i think the latest and current distortion is in the sovereign bond market. no surprise there. in place of the gardener who "bought" the big house, we have greece now "stabilizing" with the balm of the ecb's shock and awe trillion dollar rescue package, which is, unfortunately, merely an illusion. the market has calmed, and turned its limited attention span elsewhere for the moment. financially, iceland died, [its last request was that its ashes be spread over europe]. the baltics along with the rest of eastern europe are in deep trouble. i am sure that greece and the other piigs will return to the headlines; the sequel is being written. but the big star of the sovereign debt follies has yet to take the stage. it's uncle sam.

    what is the basis of low rates at the long end? i am assuming, for now, that the fed is not already controlling those rates by buying long bonds. it's partly the "flight to safety," or what bill fleckenstein likes to call the flight to quantity. and it's partly a belief that we have very low inflation or even deflationary times as a result of persistent and severe economic weakness. thus the high deficits don't worry bond buyers, since inflation is not nigh. so bond holders, as opposed to traders, are betting on another 10 to 30 years of economic weakness.

    but how can the u.s. carry a debt that is growing by about 10% per year? you can say that the interest payments aren't large because rates are so low, but rates are so low because of economic weakness, and that implies anemic tax receipts and even more deficits. so this line of reasoning depends on any inflationary process being far enough away that it doesn't affect this year's investment earnings, or this year's bonus for investment managers. as long as there are no signs of growth in the immediate future, the reasoning goes, bonds will do ok, and the deficit will compound at a 10% rate while tax receipts grow at no more than 2-3%. how long can that go on? longer than someone who is short bonds can remain solvent, i know, but not indefinitely.

    why did greece suddenly rocket into the headlines? a new government came in and admitted that the old official figures had been fudged. that forced the financial world to take notice of what had been true, obvious in plain sight to anyone who cared to look, but ignored for many years.

    some event will eventually focus the financial world on the contradictions in the u.s. gov't's financial situation. extend and pretend can work for banks if they have enough time and profits enough to accumulate over time, to earn their way out of their hole. but extend and pretend won't work for the federal debt because, although it's in a hole, the federal gov't won't stop digging. at some point the compounding and the ratios becomes manifestly ridiculous. unless we have some significant inflation to discount the nominal debt to something more manageable in real terms.

    so what does a bond or funding crisis, or a currency crisis look like for the issuer of the global reserve currency? anyone? bueller? anyone?

    a failed bond auction? the cover ratio might go down, but before a failed auction occurs i think the fed would lean on the primary dealers to step up to the plate, the fed promising to quietly take any unwanted paper off their books in the secondary market. the fed might let long rates rise a bit, embarrassed to just nail them where they are now. after all, they want to maintain at least the appearance of propriety if at all possible. they will only nail down the long end at very low levels in the face of notably worse weakness or deflation than we are seeing currently.

    a drop in the currency? compared to what? it was strange to see the euro tank because greece could NOT print. surely it is greece et al's INability to print that makes the euro worth holding. i guess the market assumed that the ecb would cave, and cave it has, quietly, subtly. but for all the noisemaking and austerity-swearing in europe, is there any doubt that the ecb is monetizing sovereign bonds? and if germany pushes greece to default, who will rescue the german commercial banks and the landesbanks?

    so if the dollar has a "crisis", where will people run? i think that, given the dollar's reserve status, people won't run. they'll walk; they'll quietly edge away; they'll ease out and diversify; but they won't run because there is no market big enough to run away to. the biggest markets are currencies. but there's no currency really worth holding, and the best of the bad lot are all small. the bond market is very big, but bonds are just long duration currency holdings; worse yet. the commodity markets beckon, but they are also relatively small compared to the size of the funds that might want to get away from fiat currencies and bonds. there will be a crazy spike in gold sometime, of course, and maybe in oil as well, but there's too much money sloshing around to fit into the gold market. so there's our source of future inflation: the gradual movement away from paper.

    there is a more acute scenario, if- as i suggested at the beginning of this- housing leads the economy on another downleg, and unemployment rises further as layoffs once again start coming faster than people give up looking for new employment, leave the labor force and cease to be counted. [this disappearance of the unemployed is the only thing which is keeping a lid on unemployment now.] so tax receipts drop even more- income taxes, sales taxes, property taxes all drop. the even-more-republican congress won't pony up for the states and municipalities, and the states are still under mandates to balance their budgets, so more state and local employees lose their jobs,and state deficits nonetheless increase in spite of the cutbacks.

    a new fiscal stimulus bill is proposed by the obama administration, but it dies on the hill. the annual federal deficit rises anyway, $1.5trillion, $1.7trillion, as tax receipts dwindle and entitlement spending rises, while all the other machinery of government clanks on, lubricated by ongoing appropriations. in a dimly lit office, late at night, in the federal reserve building sits ben bernanke.... determined to avoid a deflationary collapse, the fed launches q.e. ii, doubling the size of its balance sheet from $2.4trillion [which is itself triple where it started 2 years ago], to a neat $5trillion, buying treasuries and munis to support all the domestic government bond markets.

    picture yourself at this juncture: where do you want your money? what would you sell? what would you buy? once the fed is buying bonds in size who in his right mind wants to buy them privately? rates will be low, bond prices will be high, but no one but the fed will be buying. stocks? corporate profits are in the tank as the economy plunges. commodities? maybe. economically sensitive goods will go down as consumption drops. dr copper will need emergency care himself. people will want cash. gold will do well. maybe oil.

    this scenario is essentially a replay of the last 2 years, but without the stimulus, and with the bailout money going to governments instead of banks. when bailout money went to banks, the banks put the money "to work" not by making loans, but by playing the markets. this rush of liquidity levitated the markets from their lows of march '09. but when the bailout money goes to the federal and state and local governments, it won't move on like a river into the financial markets. it will instead by sprayed around in the myriad ways all these entities spend their money. at the state and local level, bonded projects will get funding in preference to operational costs- schools and bridges will be built, and roads paved, while police forces are cut back and teachers laid off. public goods - toll roads, sanitation plants, water works - will be privatized or placed in public-private-partnerships to try to monetize them for immediate cash availability for operating expenditures of the relevant governmental entity. fees will rise.

    we needn't worry what the chinese will do with their currency: they will be earning few dollars as their u.s. export market shrivels. their pace of commodity buying around the world will pick up, if it can. perhaps dr copper will be moved from the icu to less urgent care. the old maid dollars circulating around the world will rise in velocity even as dollars at home slow. foreign dollar holders will buy dollar denominated assets, and as foreigners become less and less eager to accept dollars, those dollars will have to be spent where they are legal tender.

  • #2
    Re: the sovereign debt end game

    Originally posted by jk
    where's the bubble?

    ...

    so where's the new or the next bubble?
    We're in it. The US sovereign debt bubble.

    Originally posted by jk
    what is the basis of low rates at the long end?
    Try as I might to see a basis for the 10- and 30-year Treasury rates going down, the only rationale I can see is the deflationary dip before the Argentinian inflationary jump.

    Poom at last! Poom at last! Praise EJ Almighty, Poom at last!

    Originally posted by jk
    but how can the u.s. carry a debt that is growing by about 10% per year?
    Sure the US can. By increasing the debt 20% next year, then 40% the year after that, then doing an internal default via entitlement spending cuts.

    Originally posted by jk
    so what does a bond or funding crisis, or a currency crisis look like for the issuer of the global reserve currency? anyone? bueller? anyone?
    It is already happening methinks. Even as the US continues to deficit spend like mad, the foreigners have ceased buying Treasuries even with the "UK intervention". The 6 month trend, especially if May's behavior is continued, will be a clear signal IMO.

    Of course this doesn't mean a literal cessation or even outright sale. What will happen in all likelihood is a straight conversion of export proceeds into Treasuries, minus asset purchases. But that's bad since trade is falling and record deficit funding needs are ongoing.

    Originally posted by jk
    a failed bond auction?
    So long as there is a Fed and its TBTF hangers-on, there will never be a 'failed' bond auction.

    Originally posted by jk
    a drop in the currency?
    The currency will drop, but exchange rates will be less indicative.

    What will happen is that much trade will either disappear or attempt to shift elsewhere.

    Originally posted by jk
    so if the dollar has a "crisis", where will people run?
    From what I am seeing, it does seem like the gold bugs' long awaited PM breakaway is coming soon.

    Originally posted by jk
    picture yourself at this juncture: where do you want your money? what would you sell? what would you buy? once the fed is buying bonds in size who in his right mind wants to buy them privately? rates will be low, bond prices will be high, but no one but the fed will be buying. stocks? corporate profits are in the tank as the economy plunges. commodities?
    If Argentina and Weimar are any indication - the initial stages will see a massive consumption binge as people run, not walk, to spend their money on ANYTHING tangible. Then Sudden Stop.

    What will America look like politically, economically, and societally with a fall in standard of living by a minimum of 20% - for the 85% and below percentile income - simultaneous with an increase in standard of living for the top 1%?

    Adolf Palin?

    For me, this is the opportunity to build a new business. If you've got the plan, the cash, the ability to survive w/o income for 2 or 3 years, this is a great time to do it: labor is cheap, competition in new fields same as always, opportunity with new customers as the comfortable old routines are destroyed, etc etc.

    But I've got the bolthole(s) ready as well.
    Last edited by c1ue; 07-18-10, 02:23 PM.

    Comment


    • #3
      Re: the sovereign debt end game

      Excellent piece, jk. Always eager to read your stuff, and EJ's of course.

      I'm voting for your acute scenario. The thing that's surprised me the most, recently, is all the anger in the U.S. at government spending. I can see why the rich would be angry, but somehow they've got many Joe6packs on their side, too. It's as if they took the raw anger over bank bailouts, and expanded it to include all spending -- even though that's probably contrary to J6P's interest. I don't know how much if any of this is manipulation by TPTB, but regardless, the signs are pointing to a relapse into recession. I think it will be a sharp movement down, as the recovery hopes clash with reality, and the feds are late with stimulus due to unwillingness to admit there's a big problem (again). No one wants to sit through another 2008 with a shortage of cash again, so I wouldn't be surprised to see the current decline feed on itself. I've been buying some stock index puts recently (already have plenty of PMs), as a hedge.

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      • #4
        Re: the sovereign debt end game

        but it looks like the bush tax cuts will be extended for all, including the wealthy however defined.
        I'll disagree here. The bailout for the rich won't get extended. It'll be portrayed (rightfully) as increasing the deficit, so the Republicans backed themselves into a corner on this one.

        After November, it will be complete gridlock for legislation. If the Republicans take the house, there will be hearings on scandals, corruption... and meanwhile the economy will be sinking. I believe they will also bring us to the brink, and probably over the brink on several budgetary issues. Maybe preventing an extension of the National debt limit, preventing the passing of a budget... Lots and lots of crises after Nov.

        a new fiscal stimulus bill is proposed by the obama administration, but it dies on the hill. the annual federal deficit rises anyway, $1.5trillion, $1.7trillion, as tax receipts dwindle and entitlement spending rises, while all the other machinery of government clanks on, lubricated by ongoing appropriations. in a dimly lit office, late at night, in the federal reserve building sits ben bernanke.... determined to avoid a deflationary collapse, the fed launches q.e. ii, doubling the size of its balance sheet from $2.4trillion [which is itself triple where it started 2 years ago], to a neat $5trillion, buying treasuries and munis to support all the domestic government bond markets.
        No more stimulus, but I'm not sure there will be a rise in deficits. The Republicans shattered all records for use of the filibuster, and the new congress will not hesitate to filibuster any budget that increases the deficit. They probably will force a decrease in the deficit. If the Democrats hold on to the Senate, what happens in the economy could be greatly influenced by a Democratic attempt to change the rules of the filibuster.

        Now that brings up the FED's ability to implement QEII. The states and municipalities won't be able to supply (won't have the will), enough bonds to allow the FED to create much new money. And we know the deficits the Federal Gov is currently running isn't enough to stimulate the economy, and if the congress won't allow the Federal Gov to run bigger deficits, how can the FED do much QE? Bernanke is going to have to get VERY creative if he wants to pump more dollars into the economy.

        I think we're 6 months to 1 year from becoming an official 3rd world country. I agree with C1ue that a big drop in the standard of living has already come to many Americans, and many more about to share the experience.

        As far as protecting myself from becoming one of the unfortunate many, Oil and PM's until I see something that changes the above scenario. But I also believe that things are going to get so chaotic, that I don't think you can make an investment plan for years into the future. We'll have to be constantly watching for changing conditions (mostly political) and be prepared to shift if necessary.

        Comment


        • #5
          Re: the sovereign debt end game

          Originally posted by we_are_toast View Post
          Now that brings up the FED's ability to implement QEII. The states and municipalities won't be able to supply (won't have the will), enough bonds to allow the FED to create much new money. And we know the deficits the Federal Gov is currently running isn't enough to stimulate the economy, and if the congress won't allow the Federal Gov to run bigger deficits, how can the FED do much QE? Bernanke is going to have to get VERY creative if he wants to pump more dollars into the economy.

          The FED will buy stocks. They'll buy Fannie/Freddie MBS. Corporate bonds. Whatever. Right?

          Comment


          • #6
            Re: the sovereign debt end game

            Originally posted by we_are_toast View Post
            ...No more stimulus, but I'm not sure there will be a rise in deficits. The Republicans shattered all records for use of the filibuster, and the new congress will not hesitate to filibuster any budget that increases the deficit. They probably will force a decrease in the deficit. If the Democrats hold on to the Senate, what happens in the economy could be greatly influenced by a Democratic attempt to change the rules of the filibuster...
            Interesting. I have always held the view that one should never, ever underestimate the desire of politicians to sprinkle money on their constituents...and all the current fuss about deficits ["I have to cut back, so the government should cut back too..."] evaporates once the stimulus package has been expanded to include everyone's pet project in their constituency...

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            • #7
              Re: the sovereign debt end game

              i am assuming, for now, that the fed is not already controlling those rates by buying long bonds
              I am assuming otherwise, that by various indirect or non-public means, shell games are being played with the U.S. national debt.
              Most folks are good; a few aren't.

              Comment


              • #8
                Re: the sovereign debt end game

                Originally posted by jk
                this is a long and somewhat rambling meditation on some of the issues raised recently. if you bother to read it and have any reactions, thoughts or criticisms, i would be grateful to hear them.
                I recommend to your consideration the writings of Charles Hugh Smith, such as his recent The Con of the Decade Part I and The Con of the Decade Part II. He considers many of the same topics you do here, from a particularly clear and coherent perspective. His views are more deflationary than iTulip's position, so some will choose to discount him for that reason. Not I.
                Most folks are good; a few aren't.

                Comment


                • #9
                  Re: the sovereign debt end game

                  Originally posted by ThePythonicCow View Post
                  I am assuming otherwise, that by various indirect or non-public means, shell games are being played with the U.S. national debt.
                  I fully agree, and have said the same to friends as well. Who is buying all those Treasuries when everyone in the wolrd is broke (government-wise)? Has to be US Banks on "free" money from the Fed.

                  Originally posted by ThePythonicCow View Post
                  I recommend to your consideration the writings of Charles Hugh Smith, such as his recent The Con of the Decade Part I and The Con of the Decade Part II. He considers many of the same topics you do here, from a particularly clear and coherent perspective. His views are more deflationary than iTulip's position, so some will choose to discount him for that reason. Not I.
                  I personally love Charles writing so much, I sponsored his forum. It amazes me how, out of the blue, you can find someone so sensible and logical who has nary a background in finance, banking, economics, or anything close.

                  Comment


                  • #10
                    Re: the sovereign debt end game

                    Originally posted by doom&gloom View Post
                    ... nary a background in finance, banking, economics, or anything close.
                    The lack of such background might be more of help than a hindrance to understanding.
                    Most folks are good; a few aren't.

                    Comment


                    • #11
                      Re: the sovereign debt end game

                      comments in-text below...

                      Originally posted by we_are_toast View Post
                      I'll disagree here. The bailout for the rich won't get extended. It'll be portrayed (rightfully) as increasing the deficit, so the Republicans backed themselves into a corner on this one.

                      I agree, no exytension of the tax cuts as Obama loses his base completely on this one. maybe they throw a few targeted credits back into the mix, or manage to vote to keep a few small measures, but the cuts expire. However I do not see this as the Republicans backing themselves into a corner, as study after study show tax cuts lead to increased spending, and tax increases lead to decreased spending. Maybe the cuts were "targeted towards the rich", but the rich have a funny way of stabilizing their income where possible, and "the poor" end up on the unstable end.

                      After November, it will be complete gridlock for legislation. If the Republicans take the house, there will be hearings on scandals, corruption... and meanwhile the economy will be sinking. I believe they will also bring us to the brink, and probably over the brink on several budgetary issues. Maybe preventing an extension of the National debt limit, preventing the passing of a budget... Lots and lots of crises after Nov.

                      Gridlock, yes. Brink, maybe... The Republicans got as drunk on spending as the Democrats used to get. Then they got their come-uppance. If they have tossed away the "deficits don't matter" kool-aid, I would expect them to hold the line on the budgets. But wat is the alternative, to keep "deeming passed" more and larger budgetary holes? Why do we have no budget now? Probably because if the real numbers came out, the Democrats would lose everything wholesale in November. Why else is the Budget Director saying adious? Who wants their name sullied like that? After Pelosi/Obama/Reid played the whole budgetary games on Republican spending excess, they went even further. If the Republicans do NOT get some fiscal discipline should they win, they will lose their fiscal base as wwell, and we could see the rise of a true third party. That could be better or worse, who knows.

                      As to investigations, well, the Democrats are always good at trotting those out and promising to do it to the Republicans, so should they expect any less? Frankly, in the last 1.5 years there has been plenty to investigate. How large spending bills like HC "reform"got put together would be nice, though all those Goldman Sux people running around the White House would look like juicy targets as well. Certainly ol' TurboTax(cheat)Tim Geither would be quite a prize, and if any Treasury official ever begged for a jail cell he does. But enough of that rant, realistically, the political gamesmanship of both parties is destroying the country.

                      No more stimulus, but I'm not sure there will be a rise in deficits. The Republicans shattered all records for use of the filibuster, and the new congress will not hesitate to filibuster any budget that increases the deficit. They probably will force a decrease in the deficit. If the Democrats hold on to the Senate, what happens in the economy could be greatly influenced by a Democratic attempt to change the rules of the filibuster.

                      I agree, more filibusters. But don't be so quick to sling mud at the Republicans when you seem to side with a party that passed massive spending bills like The Porkulus Project and HC "reform" without even bothering to read them. I don;t defend the Republicans, but you tread WAY to soft on the party in power. Their excesses in power shand on their own as well, especially the first ever budget deemed passed.

                      Now that brings up the FED's ability to implement QEII. The states and municipalities won't be able to supply (won't have the will), enough bonds to allow the FED to create much new money. And we know the deficits the Federal Gov is currently running isn't enough to stimulate the economy, and if the congress won't allow the Federal Gov to run bigger deficits, how can the FED do much QE? Bernanke is going to have to get VERY creative if he wants to pump more dollars into the economy.

                      I believe there are still ways the Fed will "pump & dump" money intot he economy, especially when we cannot get a full and honest audit of them. Currency swaps, no interest on deposits at the Fed, (even charge for money at the Fed?), more hidden QE thru free money to banks that buy Treasuries, and on and on. All that money is gonna be lookin for a home somewhere...

                      I think we're 6 months to 1 year from becoming an official 3rd world country. I agree with C1ue that a big drop in the standard of living has already come to many Americans, and many more about to share the experience.

                      Fully agree. I have a friend in Argentina. He makes a bit better than the avge Argentine. His pay -- $24k/yr. But everything that is "of value" like real estate is priced in dollars, and mostly at numbers he cannot afford. Hos wife probably makes close to the same as him. If they want an apartment (to buy), they need to pretty much save it all up, as there is little lending in the country. The banks are worthles, and no one with any sense keeps money there, they all send it to Uruguay. Which, BTW, Uruguay has a similar standard of living for most as a middle class Argentine, though I fail to see how as their export economy is all grain, cattle, lumber, rice. They don;t make much. 10% of their economy is profits from the banking sector. But I digress. The wealthy in that part of the world sink their money into real estate and farmland. In Argentina no one trusts the currency, in Uruguay no one has much money. In both cases though, land becomes the "bank" that preserves wealth that can be passed down to further generations. Makes me wonder how "productive" land like farmland will fare hefre in the US... I have already noted I have invested in some farmland in Uruguay to date.

                      As far as protecting myself from becoming one of the unfortunate many, Oil and PM's until I see something that changes the above scenario. But I also believe that things are going to get so chaotic, that I don't think you can make an investment plan for years into the future. We'll have to be constantly watching for changing conditions (mostly political) and be prepared to shift if necessary.

                      I STILL don;t know what to buy -- literally. More famrland out of the US? More metals? more cash? Foreign bonds? (asked EJ on this one but never got the answer I was looking for -- you can get short term dollar denominated bonds out of South America that pay better than treasuries here). Anyway, I keep telling my wife I never though there would be a day when hanging on to what we have would be the hardest job I have ever had.

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