Sovereign debt was back on top of the agenda this week. Deutsche Bank said what no other mainstream bank will…
The worst may be yet to come in the global financial crisis… Credit-default swap prices imply that four or more European nations may suffer so-called credit events such as having to restructure their debt…
“If these implied defaults come vaguely close to being realised then the next five years of corporate and financial defaults could easily be worse than the last five relatively calm years,” the analysts in London said. “Much may eventually depend on how much money-printing can be tolerated as we are very close to being maxed out fiscally.”
Translation: The insurance market expects government defaults, which will trigger private defaults, which will make things look worse than 2008, which will mean more money printing.
So it turns out sub-prime doesn’t just apply to houses. It applies to governments too. And stock markets are just as glued to the news as they were in 2008. But in a different sense. In fact, in the opposite sense.
Yes, a sovereign-debt crisis is good news if you ask stock market indices – they’ve been going up amid all this pessimism. But wait, what is ‘good news’? Is it…
- Unexpected positive information
- Nothing disastrous happened
- An expected disaster was averted
In a healthy economy, good news consists of a) – positive information. But there aren’t many healthy economies making the news these days. So we have to settle for a mixture of b) and c), which can be summarised as the absence of bad news, expected or unexpected.
Why does the difference matter? Well, good news is something for stock markets to rally about. But is the absence of bad news really worth buying shares for? Apparently it was on Tuesday in Europe and America with markets up big time. Australia followed suit on Wednesday. The fact that a successful Spanish bond auction can trigger a rally of stock markets around the world tells you a lot about the state of those stock markets. They’re expecting something really bad, probably starting with a Spanish bond debacle. And each time it doesn’t happen, everyone rejoices and buys shares.
Maybe you’ve even felt tempted to join them.
But the bad thing everyone is waiting for will happen eventually. In fact, the Spanish stock market seems to expect a real mess and soon. It has recently diverged dramatically from its fellow markets around the world, down 10% while others have been treading water or stumbling upwards.
What’s odd is that, if the Spanish stock market is signalling debacle, why aren’t other stock markets sharing in the doom and gloom? It seems like non-Spanish share investors are having their cake and eating it. Each day the Spanish government doesn’t implode is a good day. The market rallies. The fact that it will implode eventually is only a concern for the Spanish stock market. For now.
Just like with sub-prime, this problem will go viral when it does take its turn for the worse. And then the money printers will be back on the front page of Time magazine again.
So what do you do in an investment world where sovereign debt on the other side of the world dominates the news?
Well, first of all, don’t believe your so-called superiors for a minute. You might think it’s a big deal to lie about a carbon tax, but your friends outside Australia have worse to deal with. Here’s a short compilation of what politicians and public servants around the world have come up with to fool voters about their sovereign debt mess…
- In April last year, US Treasury Secretary Tim Geithner was asked ‘Is there a risk that the United States could lose its AAA credit rating? Yes or no?’ He replied that there is ‘no risk of that.’ A few months later, the US lost its AAA credit rating.
- Cometh April this year and Geithner is asked ‘If we don’t deal with these debt problems are we going to be Greece in two years?’ Now, if you were Geithner, what would you definitely not say? Well, he said that there is ‘no risk of that.’
- Over in Portugal, they’ve played the bailout denial game twice. And are about to lose for the second time. First time around, Prime Minister Sócrates said this: ‘Portugal won’t request any financial help for the simple reason that it doesn’t need it.’ Three months later, bailout talks began. Enter a new PM and repeat the process.
- In the spotlight this week was Spain’s effort to outdo Portugal with its bailout denials. (It’s kind of like the European version of State of Origin.) Bloomberg reported that Spanish Prime Minister Rajoy said: ‘Spain is not going to be rescued. It’s not possible to rescue Spain, there’s no intention to, it’s not necessary and therefore it’s not going to be rescued.’ That certainly sounds more certain than the Portuguese did. But while he spoke those very words, Spain was being rescued. Newsletter editor John Mauldin explained: ‘Spanish-bank borrowing from the European Central Bank doubled last month.’ In other words, the European Central Bank is busy funding the purchases of Spanish government debt indirectly.
The question you might ask at this point is ‘are these people lying or stupid?’ That’s the wrong question to ask of your leaders. We’ll explain why it’s wrong – and what the right question is – in a moment. But first, our answer to the wrong question is ‘they’re too stupid to be honest.’
Tim Staermose (from the excellent website Sovereign Man) explains that the officials involved know what’s needed, they just can’t stomach the truth when it applies to them:
There is a delicious irony in the world of economic policy at the moment. Back in 1997 and 1998 I had a ringside seat to the Asian financial crisis from my trading desk in Seoul. When everything collapsed, the policy prescriptions from the World Bank and IMF for Asia’s sick economies was to:
- HIKE interest rates,
- CUT government spending,
- Further deregulate, liberalize, and open their economies to foreign investment to attract capital;
- And let their zombie banks FAIL.
Though they experienced brutal recessions after swallowing this tough medicine, the two countries which carried out these policies to the fullest extent: South Korea, and Indonesia, are today among the most successful and dynamic economies in Asia, and the WORLD.
The Asian crisis, back then was brought on by the same things that led to the current crisis in Europe and the US (and the one I believe is coming to China): Too much cheap money. Too much borrowing by people who couldn’t afford it, to buy non-productive assets. And an insanely leveraged banking system run amuck.
Today, the same Western policymakers whose advice got Indonesia and South Korea quickly back on the rails are giving the EXACT OPPOSITE prescriptions for their own economies. They’ve CUT interest rates to near ZERO. Governments have SPENT trillions of borrowed money that they have no hope of ever repaying on ill-advised “stimulus.” They’ve BAILED OUT nearly all the brain-dead banks, keeping them on life support in a coma. Protectionist rhetoric is building up, and more onerous regulations are being ushered in.
This is what Japan did after its 1980s bubble. And look at them now. They’re stuck in a time warp, and the Japanese economy remains in a funk.
You might have noticed that the Germans are sticking to the script the West advocated during the Asian crisis. But without much luck and plenty of opposition from neighbours. Unfortunately, they’re bound to those neighbours by currency. This has created an incredible investment opportunity we’ve only just figured out, by way of our German grandmother. But it’s not one we can reveal here in the Daily Reckoning.
(Stay tuned and we’ll let you know where you can find out all about it in another issue of the weekend DR.)
So, if it doesn’t matter whether world leaders are liars or nincompoops, what is the right question to ask? Well, it’s ‘how do I make money off the fact that they’re consistently wrong?’ That’s a question that one editor here in our office specialises in answering. Murray’s whole methodology is based around the idea of profiting from other’s mistakes. But in a very specific way. To learn more about this technique – and the gut-wrenching stuff-up that led to its discovery in 2008 – click here.
Oh, by the way, there is one stock market keeping Spain company in its gloomy outlook – China. And since the Aussie market is largely a China proxy, guess where we are? Right in between optimists and the realists. Our market isn’t up as much as the Americans, but it’s not down as much as the Spanish.
Click here to enlarge
One last thing: Can anyone verify that Iceland just ‘forgave’ a rather large portion of its citizen’s mortgage debt? The story sounds a little dodgy and no major news agency has picked up on it yet. Let us know at email@example.com
Until next week,
The Daily Reckoning Weekend Edition
ALSO THIS WEEK in The Daily Reckoning Australia…
A Bad Idea Coming to an Australian Bank Near You
By Dan Denning
Today, we need to talk about how the never-ending European debt crisis is making Australian banks more deposit dependent and prone to taking risks that don’t look like risks but are. The end result of this change in Australian bank behaviour will be lower loan growth (and lower house prices) and more bad investment decisions. This is how a debt crisis on the other side of the world has an everyday impact here.
Given the lax lending standards in the run up to the credit crisis in 2008, a 20 per cent deposit seems quaint. The banks may have tightened their lending requirements after the GFC scare. But we would guess a large proportion of first time homeowners in the past five years or so would not have scraped together a deposit of more than 20 per cent. So that means a lot of mortgage insurance. And now, with the China slowdown in the early stages, Australia’s subprime borrowers are getting into trouble.
How Empires Really Work
By Paul Craig Roberts
The US Constitution has been extracted in the interests of the Security State, and Americans’ incomes have been redirected to the pockets of the 1 percent. That is how the American Empire functions. The New Empire is different. It happens without achieving conquest. The American military did not conquer Iraq and has been forced out politically by the puppet government that Washington established. There is no victory in Afghanistan, and after a decade the American military does not control the country. In the New Empire success at war no longer matters.
Despair and the State
By Jeffrey Tucker
The state acts as a dream killer. It becomes all the more maddening when there is nothing that the citizen can do about it. There is no real choice. Oh they tell us that in a democratic system, we can vote and that this is our choice. We have nothing to complain about. If we don’t like the system, we can change it. But this is wholly illusory. The government completely owns the democratic system and administers it to generate the types of results that government wants. More and more people are catching on to this.
In the derivatives markets, the term, “net exposure,” conveys a sense of certainty and reliability – a sense of finely calibrated balance. In fact, “net exposure” more closely resembles the image of two drunks leaning against one another. The net balance between the two drunks is the only pertinent risk factor, the apologists argue. As long as the two drunks are leaning towards one another, the two of them can toss back as many tequila shots as they wish. On a “net basis,” they behave as if they are completely sober. But what if one of the drunks should keel over backwards, instead of merely leaning toward his fellow drunk?