From Mark Grant, author of Out Of The Box
The Other Side of the Coin
Coins have two sides. That much we know and can agree upon. Trader, portfolio manager or senior executive; I think we can all agree on this premise. Since the financial debacle of 2008/2009 we have seen one side of the coin and what it has accomplished. We have also learned something in the process I hope. The Central Banks of the world have spewed out money like a whale does water when it hits the surface. Giant amounts of cash have been deployed into the marketplaces. We are given numbers that only reflect the surface because what can be hidden from our eyes and ears is done so with regularity given the penchants of the various Central Banks and their stated and not-stated purposes.
Equities have rallied to all-time highs, sovereign debt is still just off their all-time lows and risk assets have compressed to their benchmarks in ways not dreamed about five years ago. The absence of hyper-inflation, once thought to be the consequence of this type of behavior, is nowhere to be seen and this has befuddled many economist and money manager alike. In other words, what most people thought would happen has not happened and there is a lesson here which rests upon all of the Central Banks acting in concert. Money is always put to use, it is never idle because it then earns nothing, but since it cannot be invested off-world it must go into the spaces that are provided and so it has. One can honestly say that the game has been rigged and this is an accurate statement but it makes no difference; this is the game that we have been given to play. Investors get to make all kinds of choices but we do not make the rules and arguing with reality may be an interesting academic exercise but it changes nothing in the end.
The sovereign debt of the United States is now around $16.5 trillion, non-financial debt just hit a record high of $13.9 trillion; then throw in municipal debt and financial debt and you end up with about $57 trillion. Then if you add in the balance sheet at the Fed you are up to about $60 trillion and with an American economy of $14.3 trillion the problem begins to emerge. The debts of the country are 4.2 times the size of our economy. The problem with debt, of course, is that interest must be paid on the principal and then the principal must be re-paid at maturity. The issue is where does this money come from as the debt balloon increases and the answer has been to print money. You see it is not just that Quantitative Easing has funded our sovereign debt it has also allowed for increased borrowing from every other sector as an off-shoot to helping to finance the government. The current psychology of the markets is that this will go on forever and without end and that the coin on the table is without a flip side but I am here to tell you; that is not the case.
While there are three types of Valuation (Absolute, Intrinsic and Relative), the marketplaces operate on Relative Valuation for the most part. There was the thought, for a time, that Gold as the alternative to currencies would sky rocket and this was part of either a hyper-inflation thesis or an Armageddon thesis. Gold did go up but not to the levels many predicted and so there has been a pause in this play. Gold rises when one of two conditions are in place and the first is inflation and the second is calamity. Neither, to date, has taken place and so the speculation, while profitable for some, has not been the panacea as thought. Yet the Relative part of the equation continues to operate and some sort of currency battles are in progress no matter what you are told. The reason for this is twofold; the recession/depression in Japan and the worsening recession in Europe as brought on by mis-management and by austerity measures in a time when there is no growth to cure the ills of fiscal decline. This will then lead to both Japan and Europe doing what they can to devalue their currencies against the Dollar as China adjusts the Yuan to keep up with the ministrations of the rest of the world. The German economy at $3.5 trillion cannot support all of Europe and as things worsen not just in Greece, Cyprus and Portugal, all manageable because of the size of their economies, but worsen in Spain, Italy and France; the real trouble will begin. Everyone has been cute and managed to play hide-and-seek up until now but the coin is ratcheting about and may soon flip. The Euro was kept high against the Dollar in an attempt to compete for the world’s reserve currency but this can no longer be afforded by Europe and soon, in my opinion, great efforts will be made by the ECB and the other central banks in Europe to devalue their currency against the American one in an attempt to upright their economies. Austerity and high taxes reduce spending and raise income in the short-run but in the longer term they both decrease gross revenues as a result of their implementation. In my view the short-run has ended its course and now the longer term effects are coming into play and this will make the recession worse than thought by almost everyone and the financial projections for the upcoming several years a prayer that was never answered.
Now in Europe a strange method of arithmetic is used. The do not count liabilities, eighty percent of the liabilities on the banks’ balance sheets are declared “risk free” and revenues are double counted by being put in various baskets and trotted out as official numbers. Long before the end though this kind of arithmetic becomes troublesome. The money is not there to pay the bills, the interest and principal must be paid by someone and contingent liabilities become current liabilities with the passage of time. Then assets that have been declared “risk free” are all of the sudden at risk and Pandora shows up with her Box. Here is another cause of the coin’s palpitations and why I think the flipside may be showing its face soon.
Jumping to conclusions, running up bills, stretching the truth, bending over backward, lying down on the job, sidestepping responsibility and pushing your luck.
Just as everything rose in tandem as all of the water came in with the tide; the reverse will take place as the tide goes out. It will be higher yields, wider spreads and an equity market that will stutter and then plunge as the reality of the numbers overtakes the official counting of the numbers. As we all await the outcome of the Italian elections I am reminded of one truth in a democratic country; the people get to vote and their collective decision cannot be ignored. This is also the way of it in the financial marketplaces. All of us get to vote and the ballot box is the placement of our money and as confidence evaporates as the result of greatly disappointing numbers the coin will shudder and flip.
Beware the Ides of March!