Let the Failures Fail

Baltimore, Maryland

Trichet to Greece: Drop dead!

Obama to California: Uh...

Yesterday, stocks lost 103 points on the Dow. This looked like a confirmation to us. The stock market appears to have begun its final phase...

AP seemed to think so too:

“Stock investors see threats from all directions,” said the headline.

We didn’t bother to read the article. We already know the directions.

From the north investors worry about falling consumer demand. Consumers are in a funk – they have more debt, less income, fewer jobs and less access to credit. The only news on that front we have today is that even jumbo housing loans are going bad... delinquencies are up to 9.6%.

From the east, investors worry about the continued invasion of cheap consumer goods and cheap services. China’s economy is said to be growing at double digit rates. How can US firms compete? And what if China is a bubble, as Jim Chanos believes? When it blows up, US stocks will come down too.

From the south comes the threat of higher interest rates. The poor dopes think the recovery might be for real. If so, inflation will rise and the feds will increase interest rates… possibly cutting off the new boom.

And from the west what do they have to fear? Well, there’s that business in Europe. You know, Greece and all. The PIIGS – Portugal, Italy, Ireland, Greece and Spain…

Europe’s peripheral countries are in trouble. Lenders fret that they may be forced to default on their debt. So, they want higher interest rates. This, of course, just makes state finances worse... pushing the PIIGS closer to default.

The PIIGS owe $2 trillion, which may need to be restructured. Yes, dear reader, the sovereign debt problem is a big one – much bigger than Bear Stearns, Lehman Bros and AIG. But the biggest porker of all – the USA – has fives times as much sovereign debt as all the PIIGS put together.

It won’t take investors long to figure out that there isn’t a whole lot of difference between Greece’s finances and those of the US. Each has about the same amount of debt and the same size deficit relative to GDP. The big difference is that the US ultimately controls the currency in which its debt is calibrated. Greece does not. Neither does California.

Both California and Greece borrow long-term at about the same rate... around 6%. Lenders know that when their backs are to the wall, both governments will have only two choices, not three. They can cut spending. Or, they can default. What they can’t do is wiggle out of their obligations by inflating their currencies.

Jean-Claude Trichet has already made that clear:

“...belonging to the euro area, you... have an easy means of financing your current account deficit. You share a currency that is credible, so that you have a quality of financing that corresponds to that of a credible currency”.

He went on to say that Greece contributes only about 3% to the total output of the eurozone. If push comes to shove, Greece will be pushed out rather than allowed to weaken the euro...

Then, Mr Trichet made an odious comparison. California is a much bigger part of the US economy than Greece is of the euro economy. In fact, it is more than four times as large. Will the US come to California’s aid? Mr Trichet didn’t say.

It is possible, of course, that Mr Obama will say to the Golden State what Gerald Ford said to the Big Apple. In 1975, New York City’s back was to the wall. It appealed to Washington for help. “Ford to City: Drop Dead,” was the famous headline in the New York Daily News, reporting the president’s response.

New Yorkers were incensed. Later, they realised that by vowing to veto a bailout, President Ford had done them a great favour; he forced New York to clean up its act. The city went on to its greatest years.

Likewise, the feds would be doing all of us a favour by letting failure fail with dignity.

Will Obama help California mend its ways? Or will he turn it into a zombie state?

More news – and an interesting development in London...

Are we witnessing the slow death of the euro?

“With several European governments having reached a state where you could say that they are fighting for financial survival, it’ll soon be that it’s every man for himself. This in turn is preparing the centre-stage for talks about a return to national currencies.”

The quote was from our London team’s e-letter back in August 2004. Back then, they’d pinpointed the downgrading of Italy’s sovereign debt on 7 July that year as being “the day the eurozone started to fall apart”.

The team picked up the story in last Friday’s issue of The Right Side:

“Our point was that most Europeans were still unwilling to support tough economic reforms,” writes Frank Hemsley. “Which meant the only way to prop up their economies would lie in devaluing the currency.

“Of course, individual Eurozone countries are not able to devalue the Euro. “That means you have to consider the possible re-introduction of national currencies.”

Of course, as Frank pointed out, that seems unthinkable. It wouldn’t make any economic sense for some of the smaller nations to leave the currency union. In fact, it would be suicidal.

But is it too far-fetched to think that Germany might not like being tarred with the brush that’s affecting the PIIGS?

Certainly, things are going from bad to worse in the euro zone.

The Right Side continues: “…since we last wrote, Italy’s sovereign debt has been downgraded again. Ireland has also been downgraded. And the latest shock was in Greece. There could well be more to come.

“In the meantime, the [euro] is getting battered in the markets. Our macroeconomic trading friend, John Lewis, gave us a tip last week. It was part of a test for a new trading system we’re working on.”

John Lewis is the guy behind a new “top down” trading service the team in London has been monitoring. What does that mean? Well, John looks at “the big picture”, i.e. what’s happening in the global economy from day to day, and then finds a way to trade it… at the micro level. Typically this can be done with a simple spread bet we understand.

So he’s not restricted to stock markets. He also looks at international bond markets (“there’s big money to be made here in 2010,” he reckons); Forex (and we know how massive that is right now); interest rates (yes, he knows a way you can actually bet on what’s happening with rates); and commodities (not just gold and oil – John trades across the commodity spectrum if there’s an opportunity for short-term gain).

That sounds to us like a useful thing.

Here’s an extract from the recent trade rationale that John Lewis sent to our colleagues in London.

“The government finances in the Euro zone are fractured with no central issuing authority, unlike in the UK, US or Japan. This means the individual countries in the Euro zone decide their own public debt profile, but within guidelines set by the growth and stability pact.

“But because of the recession, those guidelines aren’t being followed. Peripheral countries like Greece and others are running unsustainably large budget deficits and debt to GDP ratios.

“The Japanese Yen on the other hand is supported by a very strong external trade position and very large foreign currency reserves. I expect the Yen to strengthen much further against the Euro over the coming weeks. Sell euros, buy yen.”

That’s a trade that makes sense to us… certainly in the short term.

The Right Side warns us not to trade this one now...: “That trade’s already playing out. It’s 400 pips in profit and too late to enter now, based on John’s risk/reward guidelines. But John’s someone you should check out in the future. We’ll let you know when his service becomes available.

“Once thing looks clear. The dollar is no longer the whipping boy of the Forex markets. And neither is the pound. For the next little while, it’s the euro that is on death row.”

We’ll keep you posted on this “big picture” trading idea. It makes sense. There are plenty of major forces at the global level… and if it’s easy to trade them for the small investor, then that’s worth knowing.

Is this the kind of thing you’d be interested in? Let us know. And if you are, stay tuned.

And more thoughts...

*** Snowmageddon has paralysed the nation’s capital. Once again, the feds announced that only ‘emergency workers’ had to report to work. And once again, we wondered about all the rest.

As near as we could tell, the pumps still worked when we went to fill up our pick-up truck. The coffee tasted the same. Plumbers still plumbed. Bakers still baked. Economists still pretended to know what they were talking about.

All the things that mattered continued... without the intrusion of federal employees.

*** And here comes more snow! No kidding. Now we have a storm warning for this afternoon. Ten to 20 inches of new snow are forecast.

The highway crews are beaten. They’ve been piling up snow since Friday. Many have worked around the clock. This new weather forecast must be depressing to them. They must feel like Custer’s troops when scouts reported that more Sioux warriors had arrived.

*** We spent the weekend digging out our driveway. We had only begun when a young man with a heavy Spanish accent came up to us.

“You want some help?”

“How much would you charge?”

“One hundred dollars.”

“Hmmm... well, thanks... but I’ll do it myself.”

Actually, we didn’t do it ourselves. Daughter Sophia and son Edward lent a hand. Between the three of us, we did the work in about three hours. It was fun. Besides, what else did we have to do? We were snowed in.

As we were working, we noticed other Latin Americans walking up and down the street with snow shovels on their shoulders. After three hours, your editor felt his muscles ache. These guys must have done it all day long... Saturday and Sunday.

In this area, the Latinos seem to do all the housework, the road work, gardening, landscaping and much of the construction. They truck, they bus, they tote and lift. They’re everywhere.

They don’t seem to mind hard work. And they are enterprising – like real Americans! This weekend, they hustled. And each one of them probably made $500 to $1,000. In cash.

*** By 6pm yesterday, Baltimore had an eerie feeling to it. The sky was clear. The park in front of our office was covered with snow. No car moved. No human being either.

What had happened? There was something unearthly about it... So quiet. So dead. Had zombies taken over?

Life imitates art. There are so many movies about zombies. Maybe, now, zombies really are taking over. They don’t foam at the mouth. They don’t eat human flesh in public. But many of our fellow Americans are exhibiting some very strange behaviour.

Mr Timothy Geithner, for example. We’re not saying he’s a zombie. We’re not accusing him. We just don’t know. All we know is that he’s saying remarkable things. For example, he told the nation that the US bond rating was safe. The Wall Street Journal went on to report that he said we would “never” lose it.

Huh? Of course, US bonds will lose their triple A rating. The only serious question is when.

Zombies will say the damndest things, won’t they?

Until tomorrow,

Bill Bonner
For The Daily Reckoning

P.S. If you enjoyed this article you can find out more about our free email, The Right Side by clicking here.

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