What’s the colour of money ?

“The easiest way for your children to learn about money is for you not to have any.”

-       Katharine Whitehorn.

 

 

Stop the bail-outs, I want to get off. The trouble with flood-gates is that, once opened, they have a tendency to let the floods through. So along with the flotsam and jetsam of the banking industry, Detroit has now joined the queue for “emergency” assistance. The FT’s Lex column recently pointed to the rich irony of this, given that

 

“..less than two months ago, six of eight representatives in the Detroit area voted against the first iteration of Tarp [the Bush administration’s Troubled Assets Relief Programme]. Only too happy to play a game of chicken with the global financial system by scoffing at the concept of “too big to fail”, that is precisely the justification they make for rescuing car manufacturers and the dozens of suppliers and millions of jobs linked to the Big Three, whose “collapse” would be unacceptable.”

 

Economist John Tamny is similarly sceptical, recalling the words of Ludwig Von Mises that the entrepreneur who fails to use his capital to the best possible satisfaction of consumers is “relegated to a place in which his ineptitude no longer hurts people’s well-being”. Detroit’s so-called Big Three are curiously vestigial entities – embarrassing, mismanaged throwbacks to the dawn of car-making. And there can be little doubt that any business (such as General Motors) that has posted $70 billion in losses over the past four years – versus a current market capitalisation of just $1.8 billion – is hardly a success story. President-elect Barack Obama has described US carmakers as “the backbone of American manufacturing”. This particular backbone has advanced osteoporosis.

 

Citigroup’s Hans Kullberg (“Reconstructing America: Why the US Government should turn a blind eye to US automakers.. and invest in the future”) has written an interesting piece in which he details the extent of the problems facing the US auto sector, but also puts forward a strategic alternative simply to shovelling money at them (in the form of investing into energy and alternative energy infrastructure):

 

“Every time I see a commercial on television advertising a “0% APR No-Fees, No-Money Down” loan for a car, I cringe. The average American household currently owns 2.28 cars – how many of these are idle ? The days of “buy now and pay later” are over, meaning there’s no money left to buy cars, meaning there’s no money left to support the auto industry, meaning there’s no sales revenues to pay absurd pension plans, meaning there’s no reason for the US Government to extend a lifeline simply to postpone the inevitable future of a futile auto industry. Although politically appeasing, to do so would be a disservice to the American taxpayer, which is a much larger contingent than the 2 million or so odd jobs that would be saved. It’s readily apparent the “modest” loan would be used simply to renegotiate debt terms which are now trading at 25 cents on the dollar and yielding over 30% a year. To put off the day of reckoning will make the downfall worse when it finally comes.”

 

But then, let he who doesn’t need government money cast the first stone. And the problem with government money is that in most jurisdictions the very term is a misnomer, because governments too are already heavily indebted, so it’s taxpayers’ money we’re really talking about. And this gets us to the heart of the debate: at what tipping point do effectively unlimited guarantees and capital support by governments start to become self-defeating, inasmuch as they start to erode belief in the very instruments (specifically, government bonds, and in due course fiat currency) from which they are constructed ? Or to put it another way, when does money start to eat itself ?

 

It seems to be doing so already. As economist Willem Buiter points out, credit default swap spreads (the price of insuring against a default) have risen for the most seemingly credit-worthy sovereign entities, including the UK (5 year sovereign CDS at 0.46%), the US (0.33%) and Germany (0.27%), well above their post-war historical averages. Bloomberg reported that credit-default swaps on US Treasuries have risen by nearly 40% since TARP was signed into law in early October, “and are now about the same as Mexican and Thai government debt before the credit markets began to seize up in June 2007.”

 

Walter Wriston, former head of Citibank, famously observed that “countries don’t go out of business” – i.e., that countries don’t go bankrupt. That was before all of Latin America effectively did. And as Nassim Taleb pointed out in ‘The Black Swan’, after sovereign defaults in Latin America,

 

“In the summer of 1982, large American banks lost close to all their past earnings (cumulatively), about everything they ever made in the history of American banking – everything.”

 

So systemic banking crises caused by doltish banking management are more frequent than commonly believed. What is more common is for banking crises to metastasise into currency crises – and (in UK Pound Sterling terms alone) we are arguably already there.

 

It seems perverse to be buying the US Dollar as a ‘safe haven’ currency given that the US was the epicentre of the current financial shock. Such is the by-product of being the world’s reserve currency. But can this really last ? If one concludes that it can’t, gold is the natural next hedge.

 

And if the global currency markets end up becoming as dysfunctional and competitively devalued as, say, global equity markets are currently, then another perverse outcome of comparably counter-intuitive inflationary pressure further down the line would be that rational investors would stockpile equities as a natural inflation hedge. But we are getting ahead of ourselves. We are only just entering synchronised global recession. For the immediate future, bracing for further asset deflation and concentrating on capital preservation are the core priorities. But with every announcement of a further government bail-out to be paid for by future tax-payers, sceptics might rightly wonder whether a crisis brought about by easy credit is going to be resolved by more of the same. Never was true portfolio insurance more passionately and urgently sought, nor more difficult to come by.

Comments

[Gregor]

And yet, things are moving quickly. Much of the world is already positioned for further asset deflation, as much of the world's global capital has rushed into cash and sovereign bonds. Sentiment wise, everyone has embraced deflation. This suggests to me that we are surprisingly much closer in time to a trigger. The parabolic growth in treasury supply looked to me like it got some feedback on Thursday, at a very bad auction of 30 Year Treasuries.

I think Treasury supply is now the lever by which reflation will come, because it will repel capital into other assets. We have reached the point globally where the genesis of inflation and deflation comes at least as much from the movement of capital, as it comes from the real economy.

[ARI]

The US$ isd the worlds reserve currency until those countries with historic large current account surpluses either fail to generate them, or choose to invest them in the bricks and mortar of infrastructure.

When the US starts to struggle to finance their deficit by a reduction in demand from the above countries, all those seeking safe haven will flee.

Not sure when to start shorting the US$ and Treasuries but the current rally will end when it does, and not a moment before!

[Andrew Knight]

Hi Tim,

I'm emailing you in regards to a followup email I sent you a month ago in response to a partnership, have you had a chance to think about it?

If you have any questions or would more information, please advise me and we can go from there.

Kind Regards,
Andrew Knight

[ziekenfonds verzekering]

I think it is a great blog.I am not here to accept the facts that bailout option has lots of risks however i believe that this is only appropriate solution to the challenge we have.