A View from the Trenches, February 25th, 2010: "The trend remains bearish"
Please, click here to read this article in pdf format: february-25-2010
We are back from a relaxing vacation and strangely glad to see that
not much has happened since we last wrote. Indeed, the markets bounced
from the lows we went through earlier this month, and we were stopped
out on our short positions, as we invest on fundamentals, but trade
like technicians.
Why do we insist that nothing really changed?
We have not witnessed a single catalyst on the Greek/Euro-zone
situation. In the US, Bernanke only continued to confirm the Fed’s view
of a weak recovery but recovery at last, while at the same time, he
asked Congress to think about a fiscal exit strategy. China continues
to expand output on its pegged currency and commodities, in our view,
are starting to price unavoidable currency collapses.
We believe that by now, it is self-evident that the world has lost
one of the most important functions money provides: Its use as a unit
of account. Please, take a moment to think about this, but not in the
standard way you have been taught to. Do not think of the USD as a unit
of account. Do not think of the EUR for the same reason, or any other
currency. Why? Because production, distribution, sales, collections,
etc. today are global processes. If you don’t believe this, just look
around you. Look at where your watch was manufactured and think of all
the different components that had to be assembled, the raw materials
that had to be used, where they came from, how they were purchased,
paid for and, as important, think about what each of the entrepreneurs
responsible for these operations did with their respective profits.
What currency did they invest them in? What was the volatility of those
profits, after adjusting them for their currency crosses (inputs vs.
output)?
If the world wants to continue growing, it will need a strong reserve
currency. There is no such a thing today. Yes, the USD continues to be
the world’s reserve currency, but by default. And this does not and
will not foster economic growth. Hence, our bearish outlook.
We recommend the reader to watch a recent interview (Feb. 21st) with
Greece’s Prime Minister George Papandreou, by Andre Marr, at: http://www.youtube.com/watch?v=EJP1Z85Hs9g
. This interview painfully reminded us of Argentina’s Plan Blindaje, in
2000-01, when it was announced by the then President De La Rua. We
wrote before that Greece’ situation is not comparable with Argentina
(refer: www.sibileau.com/martin/2009/12/17 ), but the similarities are striking.
This brings us to our final point. We read today’s Morgan Stanley’s Global Monetary Analyst research note titled “Default or Inflate or…”.
In this note, Morgan Stanley’s Global Economics Team suggests that
neither defaults nor inflation are likely or even optimal for
sovereigns. There are many reasons for this conclusion, which we will
not deal with here. However, because of this conclusion, the authors of
the note propose that governments in developed countries will push
banks to purchase and hold their upcoming debt issuances, “as a
prudential measure”. This did actually occur in Argentina and it was
precisely what led to the financial collapse of 2001. We admit we had
thought about this many times before in 2008. We even thought that the
US ownership of banks after their respective bailouts had no other
final purpose but to later have the power to steer their portfolio
allocation decisions. In particular, we thought that by owning Citi,
the US government could raise deposits outside the US to buy
Treasuries. Call us crazy, but stranger things have happened…
However, we believe there is merit to this suggestion, although it
is a bit early to worry. Under this scenario, there are two issues that
concern us. First, this would have an immediate and meaningful
crowding-out effect on the private sector. If this was the case, we
would even consider another jump in default rates, particularly in the
high yield space, which according to Bank Of America (“HY Maturity Wall – How big a Worry”,
in “Situation Room” Report, Feb. 23rd , 2010) will see over 85% of all
loans outstanding mature between 2012 and 2014. Second, we are
concerned about the sovereign credit default swap market, which we
think is the real weapon of mass destruction. Strangely enough, no
regulator has set its eyes upon it yet and honestly, we don’t think
they ever will. It is in the sovereigns best interest, as issuers, to
ensure that investors buy their issuances comfortably, under the
misleading belief that the systemic risk entailed in such purchases is
hedged away with these swaps. But we ask who in his/her right mind
would feel safe buying sovereign risk protection from banks that a few
months ago could only obtain liquidity under the guarantee of the same
sovereigns they now sell protection on, banks which would be forced to
invest up to a considerable percentage of their portfolios in sovereign
debt? Is this not as crazy as having children sell insurance on their
parents’ financial risk?
Martin Sibileau
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