ETC

Guest Post: One Dam Metaphor For The 2012 Global Financial System

Metaphors have an uncanny ability to capture the essence of complex situations. Here is one dam metaphor that distills and explains the entire global financial system in 2012. The way to visualize the current situation is to imagine a dam holding back rising storm waters. The dam is the regulatory system, the rule of law, trust in the transparency and fairness of the system and the machinery of perception management. All of these work to keep risk, fraud and excesses of speculation and leverage from unleashing a destructive wave of financial instability on the real economy below. As legitimate regulation and transparency have been replaced with simulacra and manipulated data, the dam's internal strength has been seriously weakened.

European Elections And Tolstoy's Portugal

For better or worse, all of last year had Merkel and Sarkozy on the same page.  Saying whatever it took to calm markets.  They didn’t really spend a whole lot of time worrying about their own citizens.  With the elections coming up, expect more negative and potentially confusing headlines to come out of Europe. Does Germany really want to control the Greek budget process? Sarkozy wants to “unilaterally” impose a financial transaction tax in France by August. That is the problem, what the politicians have to say to appease the voters is not always what the financial markets want to hear. The EU continues to try and perpetrate the myth that Greece is unique and that Portugal is different. Portugal has the benefit of being smaller, but they are next in line for principal write-downs (or whatever they are calling haircuts now).

Is High Yield Credit Over-Extended?

"Reach for yield" is a phrase that never gets old, does it? Whether it's the "why hold Treasuries when a stock has a great dividend?" or "if this bond yields 3% then why not grab the 7% yield bond - it's a bond, right?" argument, we constantly struggle with the 100% focus on return (yield not capital appreciation) and almost complete lack of comprehension of risk - loss of capital (or why the yield/risk premium is high). Arguing over high-yield valuations is at once a focus on idiosyncrasies (covenants, cash-flow, etc.), and technicals (flow-based demand and supply), as well as systemic and macro cycles, which play an increasingly critical part. Up until very recently, high yield bonds (based on our framework) offered considerably more upside (if you had a bullish bias) than stocks and indeed they outperformed (with HYG - the high-yield bond ETF - apparently soaking up more and more of that demand and outperformance as its shares outstanding surged). With stocks and high-yield credit now 'close' to each other in value, we note Barclay's excellent note today on both the seasonals (December/January are always big months for high yield excess return) and the low-rate, low-yield implications (negative convexity challenges) the asset-class faces going forward. The high-beta (asymmetric) nature of high-yield credit to systemic macro shocks, combined with the seasonality-downdraft and callability-drag suggests if you need to reach for yield then there will better entry points later in the year (for the surviving credits).

Guest Post: Gold Bonds: Averting Financial Armageddon

It seems self-evident. The government can debase the currency and thereby be able to pay off its astronomical debt in cheaper dollars. But as I will explain below, things don’t work that way. In order to use the debasement of paper currencies to repay the debt more easily, governments will need to issue and use the gold bond. The paper currencies will not survive too much longer. Most governments now owe as much or more than the annual GDPs of their nations (typically far more, under GAAP accounting). But the total liabilities in the system are much larger. The US dollar game is a check-kiting scheme. The Fed issues the dollar, which is its liability. The Fed buys the US Treasury bond, which is the asset to balance the liability. The only problem is that the bonds are payable only in the central bank’s paper scrip! Meanwhile, per Bretton Woods, the rest of the world’s central banks use the dollar as if it were gold. It is their reserve asset, and they pyramid credit in their local currencies on top of it. It is not a bug, but a feature, that debt in this system must grow exponentially. There is no ultimate extinguisher of debt. In reality, stripped of the fancy nomenclature and the abstraction of a monetary system, the picture is as simple as it is bleak. Normally, people produce more than they consume. They save. A frontier farmer in the 19th century, for example, would dedicate some work to clearing a new field, or building a smokehouse, or putting a wall around a pasture so he could add to his herd. But for the past several decades, people have been tricked by distorted price signals (including bond prices, i.e. interest rates) into consuming more than they produce. In any case, it is not possible to save in an irredeemable paper currency.  Depositing money in a bank will just result in more buying of government bonds.  Capital accumulation has long since turned to capital decumulation... I propose a simple step. The government should sell gold bonds. By this, I do not mean gold “backed” paper bonds. I mean bonds denominated in ounces of gold, which pay their coupon in ounces of gold and pay the principal amount in ounces of gold. Below, I explain how this will solve the three problems I described above.

smartknowledgeu's picture

For a new investor in gold and silver, here is the most lucid piece of advice I can offer. Identifying severe undervaluation points in gold and silver, buying gold and silver assets during these times, and not worrying about interim short-term volatility, even if the immediate volatility is downward, is much more likely to impact your accumulation of wealth in a positive manner than trying to perfectly time market tops and bottoms in the highly manipulated gold and silver game.