Submitted by Mr. Practical of Minyanville
We're All in a Race to the Bottom
The political and economic environment is unfolding much as we discussed several months ago.
Markets are being socialized and the government/central bank policies
are meeting the problem of too much debt with more debt. But investors
are beginning to see risk in a different light: The only "growth" is
from stimulus, and how long can that last?
A good example is the discussion of the 2-year-10-year treasury spread from Zero Hedge:
The 10 Year continues to burrow ever deeper inside 250 bps, last seen at 2.46% or eight bps tighter on the day, as now the Greek-Bund spread has blown up: Did the fake stress tests buy Europe all of one month of time? A country fully backed by the faith and credit of the ECB is once again imploding -- what can we say about the "faith and credit" of the ECB then? The only thing keeping the EUR from plunging at this point is the expectation that the Fed will (soon enough) print another cool $2-3 trillion. And the kicker, for Julian Robertson and whatever the macro hedge fund rumored to be liquidating (aside from the TRS, which we pointed out yesterday), the 2s10s has just crossed inside 200 bps, the tightest the spread has been since April 2009. Since at least half the market players are still stuck holding on to steepeners, and are now about 30% underwater from the top four months ago, add 10 times TRS-based leverage, and you can see why whatever fund is blowing up now won't be the last.
This illustrates the unwinding of risk, or in better terms, the
fear of inflation, which is prevalent given the Fed's implied threat of
further monetization (QE2). The government can't print enough money to
make up for the destruction of it (foreclosures, bankruptcies). Not even
close. It can talk about QE2 all it wants, but that's just buying
treasuries and keeping already non-existent treasury rates near zero.
It's essentially printing money and buying US treasury debt through
dealers, which is making them tons of money on the "carry trade" at taxpayers' expense but gets stuck on the Fed's
balance sheet as excess bank reserves and only increases the monetary
base (currency and reserves from banks at the Fed) with no multiplier effect (demand
deposits being lent out on a fractional basis). To free up bank
reserves, the Fed has to buy risky paper from the banks that's
mis-marked; only that would free up banks to lower some of their lending
standards (what a freak cure/objective). Ben Bernanke talks a good
talk, but does he really have the nerve or the stupidity to buy
trillions more in bad assets from insolvent banks?
People's conception of deflation is false, created by sophists in government. Deflation corrects all the imbalances and debt loads of the massive inflation (excess bank debt) that's occurred for 30 years (really since the inception of the Fed). Deflation lowers prices, just what the average guy would want. But sophists in media and government cry "it will create mass unemployment" to scare the general public about deflation. This isn't correct. As prices come down, including price of labor (the government gets out of the way of supporting artificial labor prices through extended benefits), labor will increase faster than anyone thinks.
Most will blame the banks. Fine. But don't forget the Fed/government/corporate complex that created and used the excess credit to create massive imbalances and great wealth for a small segment of the population. But also don't forget the US consumers who for years has lived beyond their means.
We're all racing to the bottom. There will be no winners, only
non-losers as the government "spreads the pain." The non-losers will be
those who have prepared: no or little debt and some savings for a rainy
day (or decade). This was my only real advice for years.
I'm still in the US on extended vacation. It's obvious I left Japan early as the yen strengthened even further than I expected (or was willing to risk) from increasing delfationary forces. I'll probably leave the US early as well, but not yet. The dollar will strengthen further against the euro, but I'll leave early because being late is a lot worse than being early.
Stay strong. Take care of your neighbor. Risk is high.