Elliott Management: "The Entire Developed World Is On A Slippery Slope"
Elliott Management's 22-page letter to investors has something for everyone as Paul Singer ascribes his uniquely independent wisdom. From the fragility of the financial system to the hubris of academic pretenders; from inflation's various devious impacts on assets and reality to the floundering of the world's bankers; from America's "cooked data" to the pending social unrest in Europe and the perils of centralized power, Singers stresses "the temptation to debase fiat currencies... means owning claims on paper money is an act of either faith or denial." Recent market movements, Singer warns "indicate a world on life-support," and "for every day, month and year that policymakers try to substitute failed, inappropriate and risky QE policies for pro-growth policies, the debt mounts, as does resentment among middle-income families that their situation is not improving." The fact of the matter is that "no government has ever reached fiscal 'nirvana,' yet our central bank (and its peers) continues to push the envelope of risk, confidence and inflation." Despite the confident and brave words in which they are wrapped, central bank actions currently seem underscored by quiet panic.
On recent market volatility:
...the markets’ dramatic response underlines the fragility of the world’s economic and financial systems, as well as its dependence on the artificial stimulants of QE, ZIRP and extreme deficit spending, all of which are still active (or even increasing) five years after the financial crisis. The stronger growth that was supposed to be ignited by all this financial and fiscal caffeine is not present or anywhere in sight.
On the Un-Taper after any Taper:
...governments in the major developed countries are determined not to be caught by a renewed deflationary credit and banking collapse... such an event would be met by another cascade of money-printing and governmental guarantees.
It is more difficult to make judgments about whether and when the torrent of freshly-minted QE money will create widespread price increases that everyone would recognize as “serious inflation” (as distinguished from the “asset-price inflation” currently underway, which policymakers argue is not the same thing)...
...bond prices have dropped (depending on their duration) by anywhere from 3 to 15 points or more. It is not yet clear whether these price movements are only short-term fluctuations, or whether they are possibly the start of the painful acceptance by markets that inflation is likely to take place in the foreseeable future.
Is The Global Economy Turning Up?
Most economists seem to feel that growth in the U.S. economy will accelerate in the second half of 2013 and gather more steam in 2014, and that Europe may be close to reaching its bottom... Our guess is that a meaningful upturn of growth in the U.S. and Europe is unlikely, given the current mix of fiscal and economic policies in these regions.
...When we contemplate what it says about financial soundness when the U.S. 10-year interest rate goes from 1.60% to 2.60% in a few weeks and the world shakes, the implications are quite sobering. The market movements in June do not bespeak a robust, solid financial system capable of withstanding the normal ebbs and flows of human events. Rather, they indicate a world on life support, with policymakers experimenting, floundering and trying to create with the appropriate jaw movements what their extreme and empirically unsound policies have failed to accomplish in actual fact.
...China has had a hard time building the consumption side of its powerful economic engine to the same degree as the investment side. We agree with those who are marking down expectations for near-term growth in China. That is obviously a negative factor for the global economy
...Our views about Europe and the U.S. have evolved toward an expectation that we are not likely to see a meaningful pickup in growth for the rest of 2013, into at least 2014. If this view is indeed correct, it is anyone’s guess whether and when this reality will raise the level of citizen frustration and anger with the leaders and established mainstream political parties of these regions. It is also difficult to predict whether this frustration and anger will result in increased political radicalism.
On the "cooking" of US data and the harsh reality:
...America is undergoing a little data lift, but not as much as people think, because much of the data is “cooked.” We do not expect an acceleration of growth in the U.S., and there very well may be a fallback.
Five years after the crash, the labor recovery is still extraordinarily weak. The absolute level of nonfarm payrolls today is basically the same as it was in 2005. Furthermore, a significant percentage of recently created jobs are low-wage and/or part-time...
...the problem of distorted and false government statistics, and in this installment we are going to connect some dots.
...At present, most people assume that the economy is expanding at roughly a 2% annual “real” growth rate. However, the underlying presumption of that arithmetic is that the government’s inflation statistics are accurate, because real growth is measured by subtracting inflation from nominal GDP growth. But it is quite clear that the government uses various means to keep the inflation number artificially low, including its focus on “core” inflation, which removes energy and food prices from the equation. The resulting overestimation of real growth has a much greater impact during times of anemic growth than when unemployment is at normal, non-recessionary levels.
...the “core” concept is bunk: Inflation is in fact higher than officially reported, which means growth is actually lower than the government says it is. And this does not even include other gimmicks (such as hedonic adjustments) that increase the understatement of inflation (and overstatement of growth) in government statistics
On America's culture of dependence:
In December 1968, roughly 65.6 million American workers held full-time jobs, according to the Bureau of Labor Statistics, while nearly 1.3 million people collected disability – a ratio of over 50:1. In May 2013, with 116.1 million full-time workers and a record 8.9 million collecting disability, that ratio has dropped to 13:1. We reject the notion that our workforce has become that much feebler, especially as our workplaces have become dramatically safer.
Rather, we think this alarming and significant increase in the number of people receiving disability payments, in many cases transitioning directly from unemployment benefits to disability benefits, denotes an increased culture of dependence, which bodes poorly for the prospects of a strong economic rebound.
On why policy matters:
The dividing lines between success and failure in achieving the goals of strong growth and high-quality job creation are easy to see. A stable, predictable and relatively low-tax regime is an attractive feature for potential job-providers, whereas high and rising taxes combined with class-warfare messages are detriments. Policies that reduce the power of special-interest groups to set wages at uncompetitive levels and/or dictate corporate or governmental staffing are additive to growth, compared with rigid employment rules and structures.
...what has caused America to spend the last five years mired in recession? Bad policies are to blame. The Administration’s rationale is that things would be much worse in the absence of such policies.
...Bad choices were made, and they are still in effect today. The ultimate consequences may prove to be disastrous.
...Perhaps the best approach would be for the government to just get out of the way.
On the 'obvious' failure of central planning:
Over a long period of time, a mechanistic and technocratic mentality has taken hold, spread by people who believe in all-encompassing central control over people’s lives, and embraced by elites who have come to believe that policies have precise and definable effects. In “normal” times, perhaps the lack of a precise connection between cause and effect gets lost in the sauce, largely ignored by the public and policymakers alike. But in a low-growth environment like the present, deficiencies in the causal relationship are more discernable.
First of all, life is less predictable than the relationship presumes. Furthermore, there are second-order, delayed, interactivity and reflexivity effects, any or all of which can be every bit as important, or even more important, than the immediate and “obvious” firstorder effects. Monetary policy is a great example. Print trillions of dollars, markets go up, financing conditions become easier and banks can make money with carry trades. But what about the potential attendant effects of this monetary experimentation, such as: distortions, resentments, the inability of the middle class to participate, the risk of future inflation and so on? And when those things occur, at some “unpredictable” time in the future, will policymakers raise their hands and admit responsibility?
On political promises:
In most realms of endeavor, the more centralized the power, the greater the chances of inefficiency, corruption, inflexibility and waste. As businesspeople, we all know that.
But many politicians think they always have to do something. And many citizens let them, especially when the politicians promise to take money from someone else and give it to them if they vote “correctly.”
It is remarkable that global central bankers are so confident in their simultaneous QE policies. The prevailing wisdom seems to be that the developed world simply needs to place its faith in the central banks to hold the world together with just enough growth and job creation to ward off revolutions.
Apparently the combination of a rising stock market, falling gold prices and low reported CPI has lulled policymakers into ignoring the dangers of their policies.
And the consequences of their hubris:
Today, there is a serious structural growth problem, not to mention a deep long-term insolvency, in the “legacy” countries, so called because they are steeped in the legacy of unrepayable debt and long-term entitlement obligations. Can anyone pretend that governmental policies in the U.S., Japan, the U.K and continental Europe are effectively addressing such problems? Of course not.
So how does this global money-printing, bondbuying, ZIRP, QE, whatever you want to call it, actually end? The overwhelming majority of professional money managers (including us) will admit to having no clue, yet the central bankers think they have all the answers. The consequences for the world if they are wrong are very serious.
On 'Fiat currencies':
It is very hard for policymakers to avoid the temptation to debase fiat currencies. To maintain confidence in paper money, policymakers need to adopt strict discipline and a tone of sobriety and respect for their moral commitment to maintain the real value of this infinitely creatable and ethereal “standard” and “store of value.” Since the globe’s major central banks, starting with our own, have long since abandoned such discipline and sobriety, there is actually no solid justification for investors and citizens to have confidence that paper money or claims on paper money (bonds) will actually maintain their value.
Thus, owning claims on paper money is an act of either faith or denial.
On Inflation and QE:
QE has not solved the world’s economic problems, and it has had massive second-order effects, but QE has neither been abandoned nor replaced by smart policies designed to stimulate real growth. Central banks seem to be fanatically determined to generate inflation, since somehow inflation is thought to be a proxy for growth.
In fact, inflation is an arbitrary wealth redistribution and confiscation mechanism that sometimes (but not always) accompanies growth and boosts asset prices. But inflation, in a nutshell, is the developed world’s pro-growth policy at present.
On 'fiscal nirvana':
No government has ever achieved those goals and reached fiscal “nirvana,” yet our central bank (and its peers) continues to push the envelope of risk, confidence and inflation.
The monetary policies of the legacy countries may or may not be a house of cards, but they certainly seem dangerous. So much belief and reliance is being placed on a small group of policymakers who personally had very little understanding of the financial system in advance of the last crisis.
Their lack of humility has created a distorted and inequitable “recovery.” Some social theorists rail against “trickle-down economics,” but is there any clearer and more patently unfair example of this concept than QE?
The rich get richer, and the government takes credit for doling out handouts to those who have not benefited from asset-price inflation.
On unintended consequences:
Policymakers who engage in QE other than at times of dire emergency are assuming they understand the precise linkages between output gaps, asset-price movements and consumer demand. In our opinion, that assumption is presumptuous in the extreme, whether for the most seasoned financial industry veteran or a government bureaucrat. It is foolish of the Fed and its peers to think they can figure out and finely-tune the expectations of markets.
In a large monetary debasement, there usually comes a time when central bankers start to realize that they have set society on the road to ruin, but they are reluctant to stop printing money because it would cause immediate pain. Few have the courage to swallow this medicine, so they persist or double down. Maybe at some point they understand that there is no way out and that they are just digging a deeper hole, or perhaps they think that printing another slug will buy them enough time for some deus ex machina to enter the equation and fix things.
However, the fact remains that policymakers, devoid of vision or humility, have far less insight into the medium- and long-term consequences of their policies than they publically purport to possess.
On the opacity of financial institutions:
To our knowledge, no policymaking individual or body is actually working on addressing the opacity of financial institutions, so goodness knows how modern, large financial institutions with tens of trillions of dollars (notional amount) of derivatives on their books can ever be understood or trusted by traders and governments in the absence of explicit or implicit government guarantees. At the risk of sounding like a broken record, this problem needs to be studied and fixed.
On the ignorance of the Fed:
It is extraordinary to us that the world’s most powerful central banker, in the midst of a gigantic and powerful monetary policy experiment consisting of zero percent interest rates and trillions of dollars of money-printing, expresses puzzlement that markets act how they want to act rather than pursue the script set out for them by the Ph.D-approved models of the exquisitely educated and experienced Fed.
Sadly, 2008 demonstrated conclusively that the major central banks, most energetically the Fed, possess only the most rudimentary understanding of the modern financial system.
On how it came to this?
The truth, of course, is that stock prices are at these levels only because the government printed trillions of dollars to bid them up. The economy is not performing well, and when inflation kicks in, everyone will realize that they have been hoodwinked by the oldest trick in the book: debase the currency and fool the people into thinking that they have more than they actually do, that they owe less than they promised to pay, and that everything from savings to work is based on shifting ground, rather than any stable or enduring standards of value.
How did it come to this? The answer is simple: arrogance, hubris and academics masquerading as leaders and experts.
Today, suffice it to say that credit is deeply embedded as a substitute for income, in many instances completely replacing equity in purchases of homes and other large consumer goods. Tens of millions of Americans (the “thought leaders” on this road to perdition) are now completely in the grip of their own personal “Ponzi finance.” The same can be said about the U.S. government...
On getting off the slippery slope:
The entire developed world, not just the U.S., has been on a slippery slope, with policy actions that gave the impression of adding to growth without increasing risk.
...The most effective way to escape a slippery slope is to dig in and step off, deliberately and thoughtfully, as quickly as possible, accepting some current pain for the greater long-term good. In the context of repairing the U.S. economy and improving the outlook for future prosperity, this process includes reforming unpayable entitlements, deleveraging financial institutions, requiring homebuyers to make substantial down payments, ending the interest-expense tax deduction and, most of all, growing the economy faster using sustainable methods of generating growth, not just by giving people credit for which they do not qualify.
All of this progress can be made, but it takes leadership and determination.
Where are we now?
Typically, periods prior to crashes and financial crises are times of complacency, characterized by extreme pricing of financial assets that removes future reward and increases future risk. Another common feature of such periods, some of which can be quite lengthy, is a mentality of denial and inadequate focus on risk among investors and policymakers, increasingly leading to the building of very large positions that are untenable if the environment changes. It is always the case that traders with large leveraged books are vulnerable to sudden shifts in the trading landscape, and that when such traders are forced to unwind, markets are roiled. But the advent of derivatives in modern markets has allowed the creation (with relative ease and limited capital requirements) of unimaginably massive, highly-leveraged positions, in turn increasing the number of vulnerable traders.
Moreover, in a modern twist with roots in the financial crisis, central banks have leaped to the top of the heap, becoming some of the largest leveraged and exposed traders in the world. Multi-trillion-dollar positions in bonds and even some stocks have left these institutions with “nowhere to go.” They have driven up the prices of most asset classes, and markets hang on their every word, discussing the third derivatives of their intentions. (“We may start to think about deciding when to reduce the pace of our buying as a prelude to actually selling the paper we own or letting it mature, but don’t be scared! Everything’s gonna be okay! We know what we are doing!”) Central bankers must arise every morning and pray that the world’s major economies surge into growth and full employment so that the $14 trillion (and counting) of assets already on their balance sheets can somehow quietly disappear into the large flows of global markets.
It would appear that being 'smart money' is really just a matter of telling it like it is - as opposed to herding sheep-like in behind the rest of your apparent peers - a topic we are well aware of.
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