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  • seth klarman: "but not yet" - the coming crisis

    st. augustine is famous for having prayed: "lord, make me chaste... but not yet." seth klarman - a famously successful value investor - evokes the quote without referencing augustine, and says that postponing the pain of what we need to do will lead to a crisis. my comments follow klarman's [emphases added by me].



    Seth Klarman & Baupost Group's 2010 Letter Excerpt


    "Two problems are upon us at once: short-term stimulus that is unaffordable over the long run and runaway entitlements that must be reined in. But restoring fiscal sanity will be bad for the economy and financial markets. What Treasury official or politician would want the cash spigot turned off before a recovery is certain? Recipients of government handouts – a large percentage of the population – would grumble at the termination of policies that offer them outsized benefits. So prepare for a chorus of "but not yet.” One already sees this in editorials and commentaries, such as the ones saying it's time to close down bankrupt Fannie Mae and Freddie Mac, but not yet, because doing so would harm the still-weak housing market. There will never be a good time to end housing support programs, reverse quantitative easing policies, end fiscal stimulus, or reduce massive budget deficits – because doing so will restrict growth and depress share prices. Nor will there be a good time to cut entitlement programs or to solve Social Security or Medicare underfunding. All will agree the stimulus cannot go on forever, that excessive entitlements must be reined in, “but not yet."

    The financial collapse of 2008 highlighted our national predicament. The sudden decline in consumer activity that followed the plunges in the housing and stock markets represented a reasonable – indeed a desirable – response to over-indebtedness. Yet the federal government saw this well-advised retrenchment as cataclysmic, because the national economy had grown dependent on our living beyond our means. The imagination of our financial leaders remains so shallow that their response to a crisis caused by over-leverage and excess has been to recreate, as nearly as possible, the conditions that fomented it, as if the events of 2008 were a rogue wave of financial woe that can never recur. It is only in Fantasyland that the solution to vastly excessive debt is more debt and the answer to over-consumption is less saving and more spending. Worse still, we have yet to see a serious assessment by policymakers of the causes of the 2008 financial market and economic collapses so that we might take action to ward off a repeat performance. The government’s knee-jerk response to contraction was to prop up economic activity by any and every means possible; the hole in consumer activity had to be materially repaired on the government tab. While Treasury Secretary Timothy Geithner ingenuously professes a belief that the U.S. will never lose its AAA rating, Moody's recently warned that, absent a change, a downgrading could be just around the comer. Or, in the words of David Letterman, "I heard the U.S. debt may now lose its triple-A rating. And I said to myself, well who cares what the auto club thinks."

    Most of us learned about the Great Depression from our parents or grandparents who developed a "Depression mentality," by which for decades people shunned leverage, embraced thrift, and thought twice before quitting their secure jobs to join risky ventures. By bailing out the economy rather than allowing the pain of the economic and market collapses to be felt, the government has endowed our generation with a "really-bad-couple-of-weeks-mentality": no lasting lessons are learned; the government endlessly intervenes in the economy, and, ironically, the first thing to strongly rebound from the 2008 collapse isn't jobs or economic activity but speculation.

    Benjamin Graham's margin-of-safety concept – to invest at a sufficient discount so that even bad luck or the vicissitudes of the business cycle won't derail an investment – is applicable to the economy as a whole. Bridges intended for ten-ton trucks are overbuilt by engineers to hold vehicles of 30 tons. Responsible investors assume their best judgments will sometimes go awry and insist on bargain purchases that allow room for error. Likewise, an economy built with no margin of safety will eventually implode. Governments that run huge deficits, promise entitlements that will be next-to impossible to deliver, and depend on the beneficence of foreigners to stay afloat inevitably must collapse – perhaps not imminently but eventually, as Greece and Ireland have recently discovered.

    It is clear, both in the financial markets and in government policy, that no long-term lessons have been drawn from the events of 2008. A friend recently posited that adversity is valuable not for what it teaches but for what it reveals. The current episode of financial adversity reveals some unpleasant truths about the character and will of our country and its leaders, and offers an unpleasant picture of the future that awaits, unless we quickly find a way to change course.


    http://www.marketfolly.com/2011/03/s...#ixzz1HhzVcEb8



    jk: it is clear that "the right time" to take the pain of correcting our accumulated fiscal problems will never arrive. there will always be a reason to say "but not yet" to meaningful action. instead there will be a lot of lip service paid, and symbolic gestures made, without significant effect on the underlying issues. only a crisis beyond the capacities of gov't intervention will cause true change. the questions then are: 1. what will be the nature of the coming crisis? can we predict even its vague outlines? 2: when will it come? will there be clear warnings? and 3. what can we do to prepare? i want to address explicitly the first of these questions, mention some glimmerings about the second, and leave implicit thoughts about the third.

    bill fleckenstein has for some time been saying that what is coming is "a funding crisis," which may or may not also take the form of "a currency crisis." the compounding nature of the federal debt, combined with the unprecedentedly high deficits, surely makes these good candidates for a real crisis. [to quote herb stein's law: "if something cannot go on forever, it will stop."] what the u.s. gov't did with the bank bailouts was identical to what happened with a bit more clarity in ireland - the banks were overleveraged and effectively bankrupt, and they were rescued by having their obligations taken on by the central government. ireland, to its misfortune at least in the short term, cannot print money to "fix" this problem. the u.s. can. so ireland went into crisis immediately and obviously once it took on the bank obligations. the u.s. has postponed its crisis with the aid of the fed's printing press.

    but the fed has announced it will cease its q.e. treasury-bond-buying in july. and it is under political pressure to live up this intention. so what would happen if the u.s. treasury gave a bond auction and nobody came?

    not long ago, "bond king" bill gross announced he had sold all his u.s. gov't debt. this week, warren buffett said to avoid long term u.s. dollar debt, because the dollar would depreciate. ray dalio, in a pair of interviews a few weeks ago, said that commodities, and - especially - gold, were underrepresented in conventional portfolios. the chinese ceased adding to their u.s. treasury holdings some time ago - they'd rather buy commodities and commodity producers. the japanese are suddenly unable to generate the dollar revenues they've habitually recycled into treasuries, and perhaps will even need to repatriate capital. u.s. "friendly" oil exporters, such as the saudis, have discovered a need to spend more of their revenues on benefits for their restless populations, including subsidies to counteract the spiraling costs of food. so they will not be buying so many treasuries, either. again, what if they gave a bond auction and nobody came?

    one potential bond buyer i haven't mentioned is the domestic saver. savings rates have crept up a bit from the negative rates that existed during the housing-as-atm bubble. could the savings rate rise enough for the deficit to be funded domestically? and, even if this unlikely eventuality came to pass, wouldn't that imply a collapse in domestic demand?

    so one funding crisis scenario involves a sudden skyrocketing of long rates as the fed steps back from qe. this would be accompanied by collapsing equity and commodity prices, products of a rapid and forced deleveraging, and another "deflation scare." remember the deflation scare of 2002? that was the justification for greenspan lowering rates to the floor and blowing up the housing bubble. this time collapsing asset prices will be the justification for, and provide political cover for, qe3.

    then we get flight out of the dollar. i.e. the funding crisis precipitates the currency crisis.

    ray dalio, in the interviews i referenced above, said he expected a currency realignment, perhaps as early as 2012. dollar flight would create a dilemma for countries with currencies pegged to the dollar, most notably china. china has been experiencing its own housing bubble, as well as generalized wage and price inflation which it has been unable or unwilling to really control. a sharp drop in the dollar [measured against commodities] would provide the push for china to allow its currency to appreciate. this would mean giving up some of its export market potential in the u.s., i.e. chinese goods would cost more priced in dollars. but the u.s. is already becoming a diminished market for mass consumption goods. the so-called "hourglass economy" in the u.s. continues to squeeze mass consumption, while leaving the high end consumption market in better shape. look at the latest charts at the consumer metrics institute website- discretionary consumption has been shrinking for the past year and a quarter.



    this means the u.s. mass consumption market is a diminishing target in any event: giving it up implies less and less of a sacrifice. further, an upward revaluation of the yuan would directly relieve some of china's inflationary pressures by lowering the chinese price of commodities. i think this is the dynamic that underlies dalio's prediction.

    would the fed really step in? could they refrain? and could they refrain with 2012 an election year, with the fed traditionally wanting to be seen as outside the political process? which would constitute more "meddling" in the political process: stepping in to "save" the economy from an asset-value collapse and debt-deflation? or standing aside and letting high rates and collapsing asset prices decimate the economy? i think the judgement will be that the economy is "not yet" ready for such strong medicine. like a junky addicted to heroin but cut off from the drug, the economy will be in debt-withdrawal, and fed's qe3 will play the role of the methadone substitute.

    so the funding crisis leads to a currency crisis. the dollar depreciates sharply against commodities AND em currencies which are finally allowed to rise against the dollar. imports to the u.s. become much more expensive: toaster ovens and such, gadgets fabricated in china, rise in price but more importantly internationally traded commodities, most prominantly food and oil, spike in u.s. dollar terms. it will look like really bad stagflation if we're lucky, like an inflationary depression if we're not so lucky.

  • #2
    Re: seth klarman: "but not yet" - the coming crisis

    Wow... nice post JK.

    Is your US inflation commodity and import driven only? At what point would dollars 'come home' too, KaPoom style? And where they end up if they did?

    QE3 in 2012 would also serve to keep Obama, who is at least theoretically more friendly to Bernanke's policies, in office. If the Fed makes an election-year political decision it's hard to see how it wouldn't make the one that served its interests.

    Comment


    • #3
      Re: seth klarman: "but not yet" - the coming crisis

      Originally posted by WDCRob View Post
      Wow... nice post JK.

      Is your US inflation commodity and import driven only? At what point would dollars 'come home' too, KaPoom style? And where they end up if they did?

      QE3 in 2012 would also serve to keep Obama, who is at least theoretically more friendly to Bernanke's policies, in office. If the Fed makes an election-year political decision it's hard to see how it wouldn't make the one that served its interests.
      i feel like i'm groping in the dark on these issues, but "flight from the dollar" would seem to me to include ka-poom. the dollars become the "old maids" or "hot potatoes," as dollar holders look for things to buy to turn their depreciating paper into something of real value. foreigners would be increasingly reluctant to accept dollars, but they'd continue to be legal tender in the u.s., so foreign dollar holders would be buying u.s. assets to the extent they're allowed to. these dollars would be "coming home," as ej posited long ago, and by virtue of their repatriation would sharply expand money in circulation. that's got to be inflationary for u.s. asset prices, and i'd expect some feedthrough into other domestic prices.

      thinking about it, it can be conceptualized as a sudden jump in monetary velocity.

      Comment


      • #4
        Re: seth klarman: "but not yet" - the coming crisis

        What assets could foreign dollar holders even buy that would make sense and soak up all those dollars? I can't imagine the US would sell off its infrastructure, defense industries, national treasures/federal land or commodities to foreign bidders. In a severe downturn with the usual xenophobia and etc I just can't see that flying politically.

        So what's left? Productive businesses (with caveats). Real estate. Undeveloped/farm land? How do those dollars actually get back? Especially if it happens quickly. Wish I could sort that one out.

        Comment


        • #5
          Re: seth klarman: "but not yet" - the coming crisis

          Originally posted by WDCRob View Post
          What assets could foreign dollar holders even buy that would make sense and soak up all those dollars? I can't imagine the US would sell off its infrastructure, defense industries, national treasures/federal land or commodities to foreign bidders. In a severe downturn with the usual xenophobia and etc I just can't see that flying politically.

          So what's left? Productive businesses (with caveats). Real estate. Undeveloped/farm land? How do those dollars actually get back? Especially if it happens quickly. Wish I could sort that one out.
          Good article by Taibbi addresses this troubling concept:

          America for Sale


          A toll highway in Indiana. The Chicago Skyway. A stretch of highway in Florida. Parking meters in Nashville, Pittsburgh, Los Angeles, and other cities. A port in Virginia. And a whole bevy of Californian public infrastructure projects, all either already leased or set to be leased for fifty or seventy-five years or more in exchange for one-off lump sum payments of a few billion bucks at best, usually just to help patch a hole or two in a single budget year.
          .
          .
          .
          America is quite literally for sale, at rock-bottom prices, and the buyers increasingly are the very people who scored big in the oil bubble. Thanks to Goldman Sachs and Morgan Stanley and the other investment banks that artificially jacked up the price of gasoline over the course of the last decade, Americans delivered a lot of their excess cash into the coffers of sovereign wealth funds like the Qatar Investment Authority, the Libyan Investment Authority, Saudi Arabia's SAMA Foreign Holdings, and the UAE's Abu Dhabi Investment Authority.

          Comment


          • #6
            Re: seth klarman: "but not yet" - the coming crisis

            Originally posted by swgprop View Post
            Good article by Taibbi addresses this troubling concept:

            America for Sale
            Apparently Taibbi hasn't heard that the FIRE economy is dead. As atrocious as America For Sale might be, it's subordinate at present to the country-by-country wringing out of value in the First World. Ireland, Greece, Iceland, Portugal, Spain, etc. Who's not to say this won't last a decade or more. We'll see.

            Comment


            • #7
              Re: seth klarman: "but not yet" - the coming crisis

              We know what the foreigners are not going buy:

              Trophy real estate like the Sears Tower, Rockefeller center

              Golf courses

              Real estate - outside of 1 house/mansion for visiting purposes - highly debatable

              Bank stocks

              We know they won't be allowed to buy oil companies. Or gas companies. Or coal companies. Or other minerals companies.

              I'm guessing this applies to the big food companies as well - though I have zero information underlying this assumption.

              The concessions noted above - the big question is how much is available to soak up the necessary $2 trillion to $6 trillion? And how valuable would that be if the US dollar is rapidly eroding in relative value?

              Comment


              • #8
                Re: seth klarman: "but not yet" - the coming crisis

                Originally posted by c1ue View Post

                The concessions noted above - the big question is how much is available to soak up the necessary $2 trillion to $6 trillion? And how valuable would that be if the US dollar is rapidly eroding in relative value?
                GOLD


                Somebody had to say it. I prefer all money to go into gold. Gold will sky-rocket in price, U.S. government becomes rich, and Aaron can finally retire.

                Comment


                • #9
                  Re: seth klarman: "but not yet" - the coming crisis

                  Originally posted by aaron View Post
                  GOLD
                  But this is only relevant if US holders of gold are selling to foreign holders of dollars. Otherwise the currency is still circulating outside the U.S.

                  c1ue is addressing my question: are there enough assets in the US that would actually be available for sale to soak up a few $$ trillion?

                  If not, the few assets that could be purchased would skyrocket in price as the in-bound flood of dollars bid them up. So figuring out WHERE the dollars that 'come home' would be spent seems like a worthwhile thought experiment if you buy JK's post and EJ's Ka-poom version X.0.

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                  • #10
                    Re: seth klarman: "but not yet" - the coming crisis

                    minority stakes in public firms; majority or takeover stakes when possible; infrastructure- toll roads, parking, tunnels; cre; there must be other categories as well.

                    Comment


                    • #11
                      Re: seth klarman: "but not yet" - the coming crisis

                      Originally posted by WDCRob View Post
                      But this is only relevant if US holders of gold are selling to foreign holders of dollars. Otherwise the currency is still circulating outside the U.S.

                      c1ue is addressing my question: are there enough assets in the US that would actually be available for sale to soak up a few $$ trillion?

                      If not, the few assets that could be purchased would skyrocket in price as the in-bound flood of dollars bid them up. So figuring out WHERE the dollars that 'come home' would be spent seems like a worthwhile thought experiment if you buy JK's post and EJ's Ka-poom version X.0.
                      amazingly, i would expect select equities to also participate, especially those in critical areas such as energy, mining, and similar. owning parts of companies that thrive no matter what the environment may not be a great inflation hedge compared to gold (perhaps), but nonetheless, i would rather own Peabody Coal than condos in Florida...

                      furthermore, there are some countries than MUST trade with us (think Canada) where assets are flying off the shelves to foreign (primarily energy) buyers. And there are a few select countries where the dollar IS their currency (think Panama) or is traded in conjunction WITH their currency (think Argentina, Uruguay, ???) where dollars could be dumped to buy assets of value like.. farmland.

                      One has to think a bit out of the box as to what to do with dollars. the dollar will not blow up all at once, and the "smart money" will unload well before the big run would ever happen.

                      PS. jk, mind if I send your analysis on to an unrelated (non-finaicial) forum?
                      Last edited by doom&gloom; 03-31-11, 08:17 PM.

                      Comment


                      • #12
                        Re: seth klarman: "but not yet" - the coming crisis

                        Originally posted by doom&gloom View Post


                        PS. jk, mind if I send your analysis on to an unrelated (non-finaicial) forum?
                        no problem.

                        Comment


                        • #13
                          Re: seth klarman: "but not yet" - the coming crisis

                          I bet most of those $$ trillions will be used to buy Chinese Rs, Russian Rs, and Indian Rs. Between the 3 of them, their currencies can easily soak up a few trillion in excess dollars. These insanely high, unreal, amounts of money will sit in central bank accounts. The alternative is a currency collapse (hyperinflation), and that is a whole other story.

                          So, if the [itulip] inflation to come ends up the doubling of the cost of living, anything that lowers that cost of living should be a good bet. For example, since oil will be twice as much (in real terms) in the best of times, bus related companies may do well. Buffet seems to think rail will do well. I would personally avoid automakers - IMHO the industry will eventually end up like airlines... they will always lose money. Ford and GM will be allowed to continue via government support, but the auto industry will need to shrink by another 75%.

                          During this period of high inflation, what will people be scared into buying to "protect themselves" against inflation?

                          Gold? Silver? TIPS?

                          The ultra-rich will buy the 5th currency. It is measured in oil tankers floating at sea. The wealthy will buy companies that make the stuff we need. The regular rich will buy gold bars.

                          I think the above crowds are all ready. We are just waitin' for the 10% sheeple to panic. (the bottom 90% do not count).

                          Comment


                          • #14
                            Re: seth klarman: "but not yet" - the coming crisis

                            either the treasury is ready for the end of qe2, as ej has suggested, with a full order book for the bonds it will be issuing in q3; or the fed had better get ready for qe3. but the fed, i'm beginning to think, believes its own bs, and thus will not be ready for qe3.

                            i remember saying that the problem with the bush administration's planning [or lack thereof] in the iraq war, was that they believed their own bullshit. they really thought we'd be greeted as liberators, and the image they had in mind was our troops liberating paris in wwii. rumsfeld actually forbade planning for after the liberation, so sure was he that it would all be over quickly, a native government would spring up, and we would leave.

                            i'm beginning to think that the same is true of the fed. many people point to hawkish fed speeches as if they are part of a shadow-play, in which the fed is trying to INFLUENCE the markets. i think, instead, that these speeches constitute an effort by the fed to INFORM the market of what [THEY THINK] is really going on. i.e. they really believe the economy is on the mend, and that organic growth is sufficient for them to withdraw support. [see, e.g., phila fed pres. plosser's recent speech http://www.philadelphiafed.org/publi...-committee.cfm ]

                            they really believe that food and energy inflation won't feed through into the rest of the economy. they believe their own bs.

                            geab apparently has published something along the lines of my commentary above:


                            GEAB N53 is available! Global systemic crisis: Second half of 2011 – Get ready for the meltdown of the US Treasury Bond market

                            - Public announcement GEAB N53 (March 17, 2011) -



                            Beyond its tragic human consequences (1), the terrible disaster that has just hit Japan weakens the shaky US Treasury Bond market a little more. In the GEAB No. 52, our team had already explained how the sequence of Arab revolutions, this fall of the “petro-dollar” wall (2), would translate during 2011 into the cessation of the massive purchases of US Treasury Bonds by the Gulf States. In this issue, we anticipate that the sudden shock experienced by the Japanese economy will lead not only to the halt in US T-Bond purchases by Japan, but it will force the authorities in Tokyo to make substantial sales of a significant portion of their US Treasury Bond reserves to finance the enormous cost of stabilization, reconstruction and revival of the Japanese economy (3).

                            With Japan and the Gulf States alone accounting for 25% of the total 4.4 trillion USD of US federal debt (December 2010), LEAP/E2020 believes that this new situation which is asserting itself during the first quarter of 2011, against a background of China’s increasing reluctance (holding 20% of US Treasury Bonds) to continue to invest in US government debt (4), carries the seeds for the collapse of the US Treasury Bond market in the second half of 2011, a market that now has only a single buyer: the US Federal Reserve (5).

                            It is certain that the context of the crisis of US local authority securities (Munis) and European government debt (the entire periphery of the EU, including the United Kingdom) that our team anticipated for this timeframe (see GEAB N50 ), will only exacerbate the event. Moreover, it is highly significant that PIMCO the world’s largest bond fund manager decided, at the end of February 2011, to liquidate its US Treasury Bond holdings. And that was before the disaster in Japan (6)!




                            But beyond the Japanese and Arab shocks (see GEAB N52 ), the process of US Federal debt market implosion in the second half of 2011 is accelerating under the effect of four other events:

                            . the introduction of budget austerity in the US (as anticipated in GEAB No. 47) which condemns US local authorities to a major crisis in the market for their debt ("Munis")
                            . impossible for the Fed to introduce QE3
                            . the inevitable rise in interest rates against a backdrop of global inflation
                            . the end of safe-haven status for the US currency.

                            Of course, these events are related and, characteristic of a major crisis, we are entering a period that will see a mutual strengthening of their effects, leading to this sudden shock in the second quarter of 2011. Incidentally, we could add a fifth event: the complete decisional paralysis of the US powers. The daily confrontation on virtually all subjects, between Republicans (hardened by the "Tea Parties") and Democrats (demoralized by an Obama administration that has betrayed the substance of its campaign promises (7)), tends to show, a little more each day, that Washington has become a sort of "Ship of Fools ", tossed about by events, without any strategy, without willpower, incapable of action(8); in other words, according to LEAP/E2020, when the US Treasury Bond collapse begins, one cannot expect anything from Washington other than a colossal squawking that will only worsen the crisis.

                            etc

                            http://www.leap2020.eu/Global-system...ket_a6091.html

                            Comment


                            • #15
                              Re: seth klarman: "but not yet" - the coming crisis

                              p.s. re the fed's belief's- was just re-reading an email i wrote a few days ago and came on a passage i thought i'd post:

                              i just read a speech given by philly fed pres plosser about the fed's "exit strategy," when and how they should shrink their balance sheet, raise rates, and so on. i think they really believe that the economy is on the mend. of course, they also really believed that the housing problems were only in the subprime sector, and that the subprime problems were "contained," so i don't necessarily think they have an accurate picture of the world.

                              i think they mostly talk to bankers, and the bankers - flush with free money and a steep yield curve, and flush with new bonuses and now renewed dividends in spite of all the make-believe they're hiding on their books with extend and pretend - anyway, sorry for going off on a rant. as i was saying, i think the fed people mostly talk to bankers. and the bankers thought subprime was contained. and the bankers are feeling pretty good about life now, again, and so the fed thinks all is well. that's my latest theory, which i just created as i typed this paragraph, and i'm sticking to it til i think of something better. ;-)

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