More Debt Problems in Europe

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

While stocks weakened in the U.S. on Thursday because of disappointing economic data, they were down in Europe on the resurfacing of the debt crisis issues.

The head of sovereign ratings at S&P, Moritz Kraemer, speaking at an event at the London School of Economics said that another restructuring of Greek debt is likely, with the bailout partners such as the IMF having to take a hit the next time around. Speaking at the same event, the IMF mission chief to Greece acknowledged it would take at least a decade to fix Greece's finances. His prediction may be optimistic considering the situation in Greece is volatile and its economy is in free fall. 

Greece is of course not the only problem child in the eurozone. Portugal, Ireland, Spain and Italy also need some sort of fix. The Eurozone has attempted to put together a firewall to prevent these countries from collapsing into the same debt crisis that engulfed Greece. There are now plans to extend the ceiling of the rescue aid package to 940 billion euros ($1.25 trillion). This money is used to buy up bonds from the debt-challenged countries in order to keep their interest rates down.

The funds do not solve the underlying problem however — all of these countries are living beyond their means and until they drastically cut their expenses they will require a continual stream of rescue money. German central banker, Jens Weidmann, recognized as such when he stated, “Just like the ‘Tower of Babel,’ the ‘Wall of Money’ will never reach heaven. If we continue to make it higher and higher, we will, in fact, run into more worldly constraints".

The program has been effective in the short term however. Portuguese 10-year bond yields were at 17.39% on January 30th, but were trading at 11.52% on March 29th (still too high for Portugal to remain afloat in the long term). Italian 10-year bonds had a yearly high yield of 7.46%, but traded at 5.29% today and Spanish 10-years were as high as 6.72%, but recently went for 5.47%. The eurozone's goal is to keep these rates below 6% — the level at which Greece got into trouble.

The rescue funds should run out by 2013 and more money will have to be added to the mix. Whether or not this will be the point when additional money is not forthcoming remains to be seen, but there will be such a point. The amount of assistance Ben Bernanke is willing to provide may impact the timing. As reported by Zero Hedge, the  U.S. Fed already holds some European sovereign debt. It could easily buy more. Once again, the end will be the same unless you believe that a debt crisis can be solved by taking on more debt or by printing more and more money. At least some of the more responsible authorities are beginning to admit that this isn't possible.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Markets Rally on Hopes of Huge EU Bailout

  

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

In a replay of the 2008 Credit Crisis, global stock markets are now rallying strongly after a huge selloff last week. This pattern was common in late September and all during October three years ago. It seems to be replaying itself again in 2011. Huge moves down and up are common in severe bear markets.

As has happened many times so far, stocks are rallying on "hopes" of a resolution to the Greek debt problem and liquidity issues with EU banks. The Greek prime minister has stated confidently that Greece will definitely receive the next tranche of money from the first bailout and his comments got a lot of positive press attention. The mainstream press failed to inform the public that Greek officials have consistently made "misleading" statements during the debt crisis and their credibility might be considered questionable. The next payment from the first bailout has been delayed because Greece broke the promises it made for meeting fiscal objectives. Instead of listening to Greek officials, investors should consider that Greece has a CCC credit rating — the lowest sovereign debt rating in the world. If any country is going to default anywhere, it's Greece.

The numbers describing Greece's situation also speak for themselves and clearly indicate the inevitability of default.  Greece's debt to GDP ratio was 127% in 2009 in the early stages of the crisis. By the end of 2010, it was 143%. Reuters and a number of other sources report it as now around 160%. This rapid rise is taking place as Greece is getting €110 billion bailouts (the second one is in the works). Clearly the bailouts are not solving the problem, but merely slowing down an explosion of debt. Historically, once a country's debt to GDP goes over 150%, default seems to become inevitable.

The market keeps predicting default in Greece by setting astronomical interest rates. The one-year government bond had a yield of 138% on September 26th, down from its high of 142% on September 14th. Two-year debt was yielding 71% yesterday and the ten-year bond 24%. How can any entity pay these interest rates and avoid default?

All sorts of schemes are being discussed by EU leaders to handle the current crisis. There are rumors of a default plan that involves Greece paying back only half of its debt. EU officials described these rumors as just speculation, although in some cases the denials were less than firm. They also denied any enlargement of the EFSF (European Financial Stability Facility) — the EU's 440 billion euro bailout slush fund — was underway. The current global stock market rally got started when CNBC News reported that the EFSF would be leveraged up to eight-times and the European Investment Bank would issue bonds to buy up sovereign debt. The specific reaction to this report from one EU official was that it was "just bizarre". The big-money investing operations can make quite a bit of profits by planting "just bizarre" stories though because they can juice the markets up for a day or two. Then some bad news story appears and markets drop right back down. We've seen this pattern over and over again in the last two months.

At some point, the Greek debt crisis will be resolved. Until then, the EU will kick the can down the road as long as it can. At this point though, the can looks like it was run over by a freight train and then tossed around by a tornado. Greek debt holders will have to take a significant haircut on their debt and this means that banks in Germany and France will have to be recapitalized. Then something will have to be done to prevent the emerging defaults in Portugal and Ireland (both have already been bailed out once) and prevent the situation in Spain and Italy from getting bad enough to need a bail out. This will take a lot of money,  much more than the €440 billion in the EFSF.  Where will this money come from? It's quite simple — it will be printed.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

10 Reasons We Are in a Credit Crisis

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Yesterday's news was about a potential Greek default and it caused a global market selloff. Today,  hopes of preventing a Greek default are causing markets to rally. This alternating news flow is repeating over and over again. Investors should pay attention to the big picture however and not the noise of the day. The important thing to realize is that we are in a second global credit crisis.

Credit crises follow certain patterns, which include: recognition of overpriced financial assets, money flowing into safe havens, increased market volatility, rising costs for financial insurance, and various forms of government action to stop the problem. The specifics of the current credit crisis are below.

1. Government debt is being downgraded. This happened in Italy yesterday, the U.S. in early August and many times in Greece. This is the upfront recognition of the problem, which is almost always widespread public knowledge by the time it happens. In 2008, securitized debt containing subprime real estate loans was downgraded in mass, frequently from the triple A ratings that had previously been given.

2. Global money is flowing into safe haven U.S. treasuries. When yields hit lower levels than a previous credit crisis or all-time lows, this indicates this is happening on a mass scale. U.S. government two-year notes had a yield below 0.15% at one point this September 19th. During 2008, the two-year held above 0.60%. The ten-year yield has fallen below the 2.04% low in 2008 and below the all-time low of 1.95% in 1941.

3. Global money is flowing into safe haven currencies. In 2008, this was the U.S. dollar and the Japanese yen. In 2010, this is the Japanese yen, the Swiss franc, and gold (which needs to be thought of as a currency if it is to be analyzed correctly). The Swiss franc rallied so much that the Swiss stopped it from trading freely. The Japanese have also taken action to try to lower the value of the yen.

4. Stock market volatility has increased enormously. In 2008, there were a significant number of mini-crashes (a drop of 5% or more in one day). These were more common in the U.S. back then. Now they are more common in Germany, but they have been happening here as well. The flip side of mini-crashes is sudden sharp moves up in the market. These are also occurring.

5. Bank stocks are the focus of the big moves up and down in the stock market. U.S. banks and other financial stocks really got hit in 2008 -- a number of the companies themselves went under. This time it's European banks falling the hardest. One-day drops for some major EU and UK banks have been as high as 10%. Bank stocks aren't dropping that much in the U.S., but they are underperforming other sectors like technology.

6. Credit default swaps have hit record levels. Credit default swaps (CDSs) are bond insurance and they became a big news item in 2008 when they rose to unprecedented levels. While CDS rates for Greek sovereign debt have hit records and are rising for the other highly indebted EU countries, they have also hit records for some UK and EU banks in 2011 indicating a worse crisis than in 2008.

7. Major and ongoing bailouts are taking place. The EU had to bail out Greece in the spring of 2010 and then Ireland and Portugal. A second bailout for Greece had to be arranged this July, even though the first bailout was supposed to have taken care of Greece's debt problem. In 2008, the U.S. had TARP and arranged for failing banks to be taken over by stronger banks  (Bank America is now in trouble again because of the legacy loans from the banks it absorbed during this period). Fannie Mae and Freddie Mac had to be nationalized. 

8. Central banks are buying bonds in the open market. The EU has been buying up Italian, Spanish, Irish and Portuguese bonds in order to hold down interest rates in those countries. As long as it has an infinite access to funds, this strategy will work. The Fed began buying U.S. debt instruments in the fall of 2008 during the Credit Crisis. 

9. Global coordinated central bank intervention took place last week. The need for global action is a consequence of the interconnectedness of the world financial system. A major problem in one region (in 2011 this is Europe, in 2008 it was the U.S.) will invariably spread everywhere. Central banks coordinate their activity to try to control the contagion. 

10. The global economy is turning down.  Problems in the financial system impact the real economy and they can turn a shallow downturn into a major one as has happened in 2008. Economic figures throughout the world have flattened and there are some warnings of a bigger drop to come (extremely low consumer confidence numbers for instance). GDP contraction in a number of regions will be the final confirmation that another global credit crisis has occurred. 

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Credit Crisis Déjà Vu

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

In September 2008, the markets were in sharp decline because of a bank-centered financial crisis. The authorities took action with bailouts and by buying bonds to prop up the market. Short selling of financial stocks was banned in order to stabilize the markets. Things are certainly different in 2011.  It's not that all of these events aren't happening again, they certainly are. This big difference is that now they are happening in August instead of September.

The geographic epicenter of the crisis has shifted as well. Europe is now dragging down the global financial system, whereas it was the United States that was doing the heavy lifting in 2008. Yet stocks have been down by similar amounts in continental Europe and in the U.S. this month. Whereas the U.S. was dealing with the failure of Lehman Brothers in September 2008, the EU is dealing with a selective default of Greek debt and trying to prevent new crises from arising in Spain and Italy (problems in Ireland and Portugal are on the back burner for now). Greece received its first bailout in May 2010 and then another bailout this July. The original terms of the new bailout require bondholders to take a 21% loss on their holdings. If the bondholders were just in Greece, this would not have major implications. However, French and German banks were major lenders to Greece. The Greek bailout is really a bailout for them.

Rumors have been rife that a number of French banks are in trouble and that S&P was going to downgrade them and France's AAA credit rating. Rumors also dogged Bear Stearns before its failure in March 2008. The company vehemently denied them, especially in the week before it collapsed. The SEC threatened to investigate and find the culprits spreading false rumors about Bear Stearns being in trouble. The SEC's case fell apart though after the company closed its doors. 

Any company, especially any bank, in trouble is going to publically deny it. So French banks denying that they are financially troubled, which they have done, is in and of itself meaningless. In this case, more credence can be given to S&P's statements on the matter. S&P denies it is about to downgrade the credit ratings for France or of the French banks rumored to be in trouble. It would look pretty foolish if it turned around and lowered them in the near future. S&P of course is still smarting from the reaction from its downgrade of U.S. debt from AAA to AA+. Even though the U.S. can't pay its everyday bills without borrowing money and this is as good a definition of insolvency as any, there was incredible outrage that S&P lowered its credit rating. After all, they had given the top rating to securitized mortgage bonds containing subprime loans and some of those borrowers had no income, no assets and no prospect for paying off their debts.

Another government reaction that took place in 2008 that is repeating itself in 2011 is a short selling ban. France, Spain, Italy and Belgium have just banned short selling of select financial stocks. On September 19, 2008, the U.S. banned short-selling on 799 financial stocks. Britain banned short selling on similar stocks the day before. Did it work back then?  No, it didn't. A large number of banks failed and many that didn't remained functioning only because of massive bailouts or because they were nationalized. 

Direct government takeovers were more common in the UK than the U.S. in 2008 and 2009, but just as the land of the free banned short selling, the supposedly capitalistic U.S. took over Fannie Mae, Freddie Mac and eventually GM (it had been lumped in with financial stocks as part of the short selling ban). It's not clear that the bailouts have yet to end either. In August 2011, Fannie Mae paid $500 million to buy servicing rights for 400,000 of Bank of America's worst-performing loans, loans with an unpaid balance of $73 billion. or these instead of Bank of America. Who exactly benefitted from this arrangement? Fannie Mae and Freddie Mac back $5 trillion in loans and many of them are not likely to be paid off. This debt is not counted as part of the $14 trillion plus U.S. national debt, but at least some of it should be.   

In 2011, the ECB (European Central Bank) has established a Securities Market Program to buy government bonds of its troubled members in order to keep interest rates lower than the free market rate. Its first buys were Spanish and Italian bonds on August 8th. The U.S. Fed was a heavy buyer of bonds in September 2008, although it didn't announce its first quantitative easing program until late November of that year. It also denied at the time that it was engaging in quantitative easing. Most of QE 1 had already taken place by the time the Fed announced it. This highly relevant fact remained unmentioned.

So here we are in 2011 and we find events are very similar to what was taking place in 2008. Some of the players are different, the locations are different and the order things are happening may be a little different. But all in all, it looks like the more things change; the more they remain the same.  

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21
Author: "Inflation Investing - A Guide for the 2010s"


This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale 

Buy When There's Blood on the Street - Just Make Sure It's Not Your Own

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Monday August 8th, the first trading day after S&P downgraded U.S. debt, was a crash day in the American stock market.  Asia held up much better and so did much of Europe, except for Germany.

The Dow Industrials were down 635 points (5.55%), the S&P 500 was down 80 points (6.66%), Nasdaq was down 175 points (6.90%) and the Russell 2000 64 points (8.89%). The DAX in Germany was down slightly more than 5%, whereas the Nikkei in Japan and the Hang Seng in Hong Kong were down a little more than 2%.  A crash is traditionally defined as a drop of 5% or more in a day. The Nasdaq and Russell 2000 already had a crash day last week. U.S. stocks had numerous crashes during the Credit Crisis in 2008.

Stocks looked like they were about to enter freefall - a severe uninterrupted drop - around 3:00PM.  President Obama delivered a statement on the S&P downgrade and caused a temporary short-term move up instead. The market would have washed out otherwise and been ready for its first rally.

As is, the market is at the end of its first stage of selling, we may just have to wait a little longer.  The technical indicators on the daily charts have either hit their lowest points or are very close to them. Some short covering and opportunistic buying should lead to a quick sharp rally for a few days. This rally is for traders only. The weekly technicals have yet to bottom out and nothing longer term should be expected.  

Technical bottoms and price bottoms are not the same. The technicals will have to gather some strength before stocks can enter a new rally phase. The ultimate price bottom is probably as much as two months out, which would put it somewhere in October. Until then, choppy action that brings the indices intermittently lower should be expected. While the indices may not go a lot lower, individual stocks, especially small cap, high-beta stocks (those known for their volatility) can indeed go much lower. This also includes high flyers that have yet to have had a big drop. In major selloffs, almost everything goes down.

Once a bottom is established, the volatile stocks you wanted to avoid in the selloff are the ones you want to own. This is where you will make the most money. Small, emerging, and leveraged are the keys. Smaller cap stocks will go down the most and then back up the most (just make sure the drop was market related and not because the business of the company is threatened). Emerging markets, both the BRICs (Brazil, Russia, India, and China) as well as smaller ones will have the same up and down behavior. Russia was down 12% on August 8th for instance. You will do better still if you use leverage on your buys. There are ETFs that provide 200% and 300% exposure. For the emerging markets, these include LBJ (300% Latin America), YINN (300% China), RUSL (300% Russia), EDC (300% Emerging Markets), INDL (200% India) and UBR (200% Brazil). For small cap stocks, TNA (300% long the Russell 2000 index) is the most leveraged play.

Traders should be able to make good use of these ETFs to move in and out of the market. Investors with a longer-term perspective will want to wait until a market bottom has had time to fully develop.  

Disclosure: Waiting to buy.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

U.S Credit Rating Downgrade - A Humpty Dumpty Moment

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

As everyone knows by now, S&P downgraded the U.S. sovereign debt rating from AAA to AA+ on Friday. While the extent of the downgrade is minor, the implications are major. As the recent debt ceiling negotiations revealed, the U.S. cannot run its day-to-day operations without borrowing money. It lives on credit (as do most countries in the world today) and anything that impacts its ability to borrow money has serious consequences.

It takes a lot for a credit rating agency to lower the credit rating of a top corporation or country. This is usually only done long after the actual credit worthiness has experienced a significant decline.  The last major Friday afternoon credit downgrade from the credit rating agencies was when they lowered Bear Stearns rating on March 14, 2008. The company didn't open its doors again the following Monday.  The rating agencies were also tardy with lowering the credit ratings of accounting fraud poster child Enron, although they all did finally lower its rating to junk status four days before it declared bankruptcy. Perhaps the best analogy to the current U.S. situation though is the AAA ratings given to a number of securitized bonds that held subprime mortgages. These turned out not to be worthy of a top credit rating after all.

The farcical nature of how the credit agencies determine the rating of U.S. government debt was made clear during the debt ceiling negotiations. Numerous articles in the press reported that failure to come to an agreement, which would allow the U.S. to continue to spend money it didn't have because it could borrow more, would be viewed as fiscally irresponsible! A more rational response would have been, it's quite obvious that the U.S. can't function without borrowing an increasing amount of money and it is therefore insolvent. Under such circumstances its credit rating should be at the junk level - a BB or less - not an AA+. Eventually, this might happen, but as was the case with Enron, this would mean the U.S. would likely be going under a few days later.

The difference between the AA+ credit rating and the BB or lower one is caused by the fantasy factor. The AA+ rating is based on the glorious financial past of the U.S. and ignores the current downward trajectory it is on. Before the debt ceiling problems temporarily curtailed spending for a while, the U.S. was on course for as much as a $1.65 trillion budget deficit. This represents 11% of the current GDP number of $15 trillion (there are many reasons to think GDP is substantially overstated). It is true, that the U.S. is not borrowing money to pay for most of this deficit however - it's printing it. Quantitative Easing 2, a form of money printing, conducted by the Fed covered 70% of the deficit in the first half of the year. A country doing this certainly does not deserve an AAA credit rating, nor does it deserve an AA+ credit rating unless you can make a case that a company engaged in the business of counterfeiting money also deserves a close to top credit rating.

The Obama administration complained that S&P overestimated future U.S. deficits by $2 trillion. What this means is that S&P refused to accept the pie-in-the sky budgets numbers that the government generates. If you look at these, you will see that they assume GDP growth of over 5% a year, each and every year, until 2016. One year of GDP growth over 5% would be good and continual annual GDP growth of over 5% for the U.S. economy just isn't possible. The budget scenario also assumes very low inflation, which would certainly not be the case if the high growth it assumes takes place.  A combined deficit of $20 trillion in the next decade instead of the administration's $7.7 trillion would be more plausible. S&P assuming $2 more is still ridiculously low.

The immediate impact of the U.S. credit downgrade will be to cap the credit rating of companies at AA+. The government of the country has to have the highest credit rating in that country because in theory it has no default risk. Economists say that governments can use their ability to tax to pay off their debts. Although as finances deteriorate it is much more likely governments will print money to pay off their debts. No fiscally solvent government ever engages in excess money printing however. The U.S. Fed had increased its balance sheet (a measure of money printing) by $2 trillion since 2007. It doesn't appear that the credit agencies are taking this into account.

The longer-term implications for the lowered credit rating are far more serious.  More downgrades are likely. Interest rates will go up. Money will leave the United States. The U.S. dollar will lose its reserve currency status and this will lower its value substantially. Higher interest rates and a falling currency will both be inflationary. 

The financial world operates very much on image and reputation. Once that's shattered, it can take years to repair it, if it can be done at all.  When Bear Stearns was downgraded in March 2008, the damage to its ability to operate in the financial markets was terminal. The company imploded like an overinflated balloon that had a pin stuck in it. Fortunately, this is not likely to happen to the U.S. - at least not yet.

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21
Author: Inflation Investing - A Guide for the 2010s

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Is Too Much Liquidity Creating New Investment Bubbles?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Near month silver futures closed at a 30-year high on Friday and December gold futures hit another all-time high. Traders are looking for a breakout on the S&P 500 today as stocks have continued to rally throughout September. Liquidity is the driving force behind the market's move and it is unlikely the Fed will saying anything in this week's meeting that will indicate a reduction in its current massive pumping operation.

Unfortunately, it's not just the Fed that has the money spigot open full-force; the operation is global in nature. This evidence of this is that a number of government bonds of various maturities hit all-time high prices this summer. In a free market, this would normally be interpreted as an indication of an extreme economic weakness and deflation. While there is indeed significant evidence of slowing economies in a number of countries, particularly in the United States, purchases of government bonds can be influenced by central banks and treasury departments and can even be done by them as well. This can create significant distortions in the market. What is going on is that a lot of the excess liquidity is being used to buy bonds that then pay for day to day government operations.

Inflation sensitive gold is a much better arbiter of whether or not there is inflation or deflation. The gold market is not completely free of attempts at government influence of course, although there is far less of it than in the government bond markets. Gold is not only saying there is inflation, but that inflation is escalating. The U.S. Federal Reserve says otherwise. Of course, Fed officials also said that sub-prime loans wouldn't cause any serious problems in the financial markets. Yeah, you can really trust what the Fed says.

Outside the U.S, the European Financial Stability Facility, also known as Euro-TARP, is adding significantly  to financial market liquidity. The facility is currently valued at 440 billion euros. All three major rating agencies just gave it a triple A credit rating. Yes, these are the same rating agencies that gave securitized sub-prime loans triple A credit ratings. Certainly there was no reason to think that loans to people without jobs, without income, without assets and histories of defaulting on their debts were unlikely to be paid back. The same level of intelligence and insight was probably applied to the recent Euro-TARP rating.

The cause of the global real estate bubble was too much liquidity. We all know the ugly collapse that followed. Government officials have tried to reinflate the bubble, but reinflating a just collapsed bubble is not possible. This became quite apparent this summer when housing sales in the United States fell off a cliff. Creating new bubbles in bonds, commodities and stocks is possible however. Excess liquidity could cause all three. The collapse that would follow would be much worse that the recent Credit Crisis. Why are central bankers taking this risk?  Quite frankly, it's because they are just not as smart as the people who work for the rating agencies.

Disclosure: No positions.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Moody's Sovereign Debt Assurances Should Concern Investors

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


According to ratings agency Moody's, credit ratings of the world's four largest Aaa-rated sovereign nations - the U.S., UK, Germany and France - are currently "well positioned despite their stretched finances". The agency does however admit that risks have grown. Based on Moody's past actions, this should give investors little comfort.

In the current Greek debt crisis, Moody's was behind S&P and Fitch in downgrading Greek government debt. As reported in the Wall Street Journal, it took Moody's until December 23rd to make a downgrade of just one notch from A1 to A2. After the elections on October 4th, the Greek government admitted it had lied about its budget deficit and its ratio to GDP would be 12.7%, several times higher than previously reported. Even though the original numbers from the Greek government should have seemed unbelievably rosy, this apparently didn't make the rating's agencies suspicious. Are they likely to be more suspicious of the numbers generated by the politically powerful major countries that get their top ratings?

Prior to the Greek crisis, there was Iceland. According to the Central Bank of Iceland's website, Moody's downgraded Iceland's long-term debt obligations in domestic and foreign currency to A1 (still well within the investment grade range) on October 8, 2008. This was the same day that the Iceland's krona peg to the euro collapsed. Iceland had already nationalized major banks Glitnir and Landsbanki the month before. The Iceland prime minister had stated on October 6th that there had been a real danger of national bankruptcy. That scenario would have justified a rating of C from Moody's, many notches below the October 8th rating.

Investors should also not forget the role of the rating's agencies in giving securitized sub-prime loans top triple A ratings (Aaa in the case of Moody's). Moody's had to downgrade more than 5000 mortgage securities in 2007. The ratings agencies in general blamed mortgage holders that turned out to be 'deadbeats' and not their own practices. They would like us to believe that it was unreasonable for them to have assumed that people with spotty employment, a history of not paying their bills, and who bought houses they couldn't afford would default on their mortgages. If the rating agencies can ignore those problems, investors should ask themselves what problems they are ignoring with U.S., UK, German and French government financing?

How did the rating's agencies do with problem companies? Moody's downgraded Bear Stearns to Baa1 from A2 on March 14th, 2008. The Baa1 rating is an investment grade rating for Moody's (there are five speculative rating's below that level). That downgrade took place on the last day that Bear Stearns' stock traded. Moody's was still maintaining it was an investment quality company. The rating agencies did a little better with Enron, downgrading it to below investment grade four days before it declared bankruptcy. The stock had already lost almost all of its value before the downgrades, so the move was too little too late.

In its current analysis of sovereign finances, Moody's maintains that the major countries will be able to maintain fiscal stability because interest payments are reasonable compared to government revenues. However, government debts are increasing rapidly because of weak economies. If the global economy continues to stay weak, interest payments will go higher , tax receipts lower and debt will continue to pile up. Recovery, on the other hand, will raise interest rates substantially and this could overwhelm tax receipts and create a major debt spiral. The rating agencies are unlikely to consider that the major countries are caught in a lose/lose situation though since they seem to reserve their most speculative ratings for basic logic and common sense.

Disclosure: None

NEXT: The CFTC and Manipulation of the Silver Market

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Dollar Weakens; S&P's British Outlook, TED Back From Dead

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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Minutes for the Federal Reserves April 28-29th meeting were released yesterday and they revealed that the Fed thought that more purchases of long-term debt might be necessary to spur the economy into recovery (and uncontrolled inflation... but they left that part out). More quantitative easing would require the 'printing' of additional currency and debase the dollar even further. Not surprisingly the dollar fell on the news and hit a 7-month low of 80.002 (if it breaks key support of 79, watch out below). While the condition of the U.S. government's finances are in worse shape than Britain's, S&P revised Britain's credit rating outlook to negative this morning. While the pound fell for a short time, it is way above its lows against the dollar. Even though the central banks are flooding the world with more fiat money, the TED spread, a measure of stability in the global financial system, has returned to normal levels - this is a necessary, but not sufficient condition for recovery.

The need for the U.S. to print more money well into the future could easily be determined by anyone with knowledge of elementary arithmetic. Nevertheless, the market is constantly surprised such a thing will be necessary. Bonds and the dollar should sell off on this news, but stocks and oil are getting hit today as well. Oil, which has to be purchased in U.S. dollars, should automatically go up if the dollar falls or if there is news about increasing inflation. NYMEX crude closed at $62.04 yesterday and is still above its breakout point of 60. Gold was flat this morning and silver down slightly. They should be zooming.

Although S&P changed Britain's credit outlook to negative, this is not as bad as being on credit watch. S&P reaffirmed Britain's triple A credit (they also rated a large number of subprime mortgage bonds triple A, so take that into account when considering the accuracy of this rating). S&P is worried that Britain's government debt will rise to 100% of GDP by 2013. If the U.S. doesn't beat Britain to this milestone, we will indeed be lucky. If there was an accurate measure of both out national debt (it's understated) and our GDP (it's overstated), we might indeed already be there. Perhaps S&P will be making an announcement on this matter soon?

The TED spread was mentioned frequently in this blog last fall. When the financial system is in stress it zooms upwards. Its long term average is around 50 basis points. It went over 450 last October, substantially exceeding its peak during the 1987 market meltdown. It was 48 this morning. This indicates that the global banking system has returned to normal interbank operations. This was an important goal of central bank policy that they have been successful in accomplishing it. Now that stabilizing the banking system has been achieved, the possibility of economic recovery exists.

NEXT: A Golden Opportunity with a Silver Lining

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

IMF Notices Recession; Possible Sovereign Defaults

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

Our Video Related to this Blog:

In what could only be described as 'you heard it here last' news, the IMF (International Monetary Fund) has just released a report that predicts the deepest global recession since the Great Depression. What caused this great revelation is a mystery. Perhaps they finally started reading last years papers and realized all the economic news around the world was bad. We'll probably never know. Meanwhile, U.S. News and World Report has complied a list of countries in danger of default - and get this, Argentina is on the list. Well, that is a shocker! A country that has defaulted on its debt over and over and over again is at risk of defaulting again. Who could have predicted it?

I have often said economists are the last people to know about a recession. Apparently, international economists take this concept to an extreme. While anyone who doesn't live in a cave has realized for at least a year that there have been serious global economic problems (the New York Investing meetup itself predicted recession in December 2007), the IMF has finally come out with a prediction of global contraction in 2009. They are predicting a 1.3% drop overall and a 3.8% drop for the advanced economies. The IMF is also predicting that the major economies will have budget deficits of 10.5%. Who the money is going to be borrowed from when almost every government has a big deficit was not in the report (they should have just included a picture of a big printing press). The current IMF forecast is the fifth downgrade for global growth in a little over 6 months. Thank you IMF for that timely update.

As for the risk of sovereign defaults, this is based on information from the ratings agencies S&P and Moody's, the people who gave subprime loan securities triple A ratings (well, there's no question that they're on top of things). Pakistan, which already defaulted 6 months ago is in danger of defaulting again. The usual Eastern European suspects, the Ukraine, Belarus, and Latvia aren't in good shape either (and you could probably add three to four more countries in the region). Closer to home, Mexico is in danger of default. It is only a question of when and not if for a possible Mexican default. Mexico gets a significant percentage of its federal revenues from the rapidly declining Cantarell oil field and its budget problems are only going to get worse. The U.S. will have no choice but to bail out Mexico. The IMF will take the lead for the other countries (picture that printing press again). Countries not on the list include Greece, Portugal, Spain and Ireland. Well, maybe next year.

As an investor you should be concentrating only on what is likely to happen sixth months in the future. News that everyone already knows is irrelevant because it has already been priced into the market. That doesn't mean that the mainstream media won't announce it in blaring headlines or give it dramatic coverage. You need to ignore all of these superficialities. You also need to consider whether or not you are the last to hear the news. If a stock price has already been going up long before some good news has been officially announced, you can be pretty assured that lots of other people knew what was going on long before you did.

NEXT: The Gold is in Eastern Capitalism

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.