(Originally posted on April 23, 2012, at www.sibileau.com)
Because simplicity is a virtue, we decided to skip a week and write our comments today. Why? There had really not been any developments during the past two weeks that would have made us change our views. To be certain, even today we think nothing really fundamental has changed.
What has been keeping us awake at night however is the late and blatant manipulation of markets and key prices. The most obscene example is that of gold, where one can almost time the automatic sell-offs that are repeated continuously after 3am or between 10-11am Eastern time. Looking at the charts, the manipulation is so obvious that were it in a particular stock, the SEC would have already acted. But of course, it is gold we’re dealing with here…In general, we think the world is witnessing a phenomenon that Friedrich Von Hayek had already anticipated it could occur in a context like the one we’re living in. Here is an interesting interview on the subject:
In Von Hayek’s view, Economics is the study of social cooperation, where markets are an institution and a process for such cooperation. To be more productive and improve their standard of living, individuals specialize and allocate resources farther from the final act of consumption. But if that is the case, and the production process becomes so complex that it is carried out in different geographies by different people…how do all these people know what and how much to produce? Do men count with a signaling system to cooperate and achieve this economic calculation? The answer is fortunately positive: That signal is given by prices. The market signals that a production process is desirable by making the producer profitable and tells the same producer his resources would have been better used somewhere else, by making him unprofitable. Profit and loss therefore are nothing else but key signals needed for social cooperation.
But when men live in a levered world, with fiat currencies, these signals, particularly prices, are completely distorted. This would not be a problem if ultimately, the distortions were corrected. However, they cannot when governments start to repress markets by imposing capital ratios, bands on currencies, caps on commodity prices or manipulate interest rates (i.e. the intertemporal rate of exchange).
Taking this thought to the current context, it is clear to us, that thanks to these interventions, the European Union, to maintain its common currency has destroyed its capital markets, which consist mainly of its banks. There is a lesson to be learned: If you want to keep an overvalued currency with its banking system, you will lose both! But the authorities of the Euro zone are not alone. Back in September 2011, we had warned that the Fed currency swaps would put a floor to the Euro (just like the Swiss National Bank did), enhancing this distortion. We were not wrong here, we think, as the Euro has been able to stay above $1,30. One more thing needs to be said: The Fed swap is not targeting an exchange rate between currencies, but a maximum sovereign yield above which counterparty risk would explode generating a run against the USD financial system. The resulting implicit exchange rate is only a symptom and not the cause. If this is true, as Spain’s sovereign yield approaches key, dangerous levels, it would not be surprising to see a bailout of the Spanish system via swaps. Of course, just like they did in 2011, this time, authorities would also deny any specific bailout.
We are aware that today’s discussion may have sound too theoretical. But we are confident that very practical conclusions may be taken from it. First, this constant intervention and manipulation is going to make any economic/jobs growth unsustainable. As we mentioned in January, companies have been using this window of cheap US dollars, since December 2011, to increase dividends and leverage their operations. Default risk has consequently increased. In this regard, we maintain our bearish view of stocks, regardless of the fact that they have been making higher lows since April 10th. We think that the situation out ofSpain is going to imminently turn things for the worse. Second, and although gold may further be sold by the manipulators to the $1,500s, it will recover its value.
We should finally make some comments on the confiscation of YPF by the Argentine government, from Repsol. But we lack the space and time. Briefly, we are impressed to see how the world has been taken by surprise on this action and fear that it may become a symbol of what is to be expected in the coming years from trade and currency wars.
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