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.

Risks of Market Contagion from a Greek Default

 

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 U.S. markets closed slightly up on Monday September 12th, panic reigned in Europe. The risks of a hard default by Greece reached 98% according to one model. Interest rates in Greece were spiraling out of control (the two-year government yield hit almost 70%) and credit default swaps on European sovereign and bank debt reached record levels again.

While Greece is a small economy and there are only two major countries --- France and Germany -- that hold substantial amounts of Greek government and corporate debt, this is only the very tip of the financial iceberg that threatens a titanic like sinking of world markets similar to what occurred during the 2008 Credit Crisis when Lehman Brothers collapsed. Problems in Greece are shared by two other small national economies, Ireland and Portugal, and by two much large economies, Spain and Italy. The Italian economy is roughly the size of the UK economy. It is too big to bail out. Can you imagine the UK defaulting and there being enough money available for an international rescue? If not, don't assume that problems with Italy can be fixed either. Spain is also too large to rescue.

Country defaults have implications well beyond their borders because large international banks have exposure to loans in them. In the global financial system, all large international banks are interconnected. Big banks such as Deutsche Bank, Société Générale, and Bank Paribas have substantial relationships with U.S. banks. The large banks are still in a weakened state from the 2008 crisis. This is showing up in British banks, which like the U.S. banks have limited exposure to Greek debt, and in Bank of America. Credit default swaps have reached record levels for some British banks and Bank of America's stock price keeps dropping.

The Greek default, and this will happen one way or the other at this point, will be similar to the demise of Lehman  in 2008. Contagion spread throughout the world financial system. In the U.S. the close to trillion dollar TARP program had to be instituted to hold up the banking system. In total, as much as $11 trillion in programs (the Federal Reserve alone had half a dozen major ones) had to be implemented to patch things up. The will for such an effort no longer exists, which will mute whatever response the authorities come up with will be delayed and muted. After Greece, something will have to be done with Ireland, Portugal, Spain and Italy. Those who think that the U.S. markets will be isolated from these events are at best engaging in wishful thinking and at worst are purposely misinforming the public.

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.

Quantitative Easing Means Foreigners Will Dump Treasuries

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.


Stocks and gold rallied strongly yesterday on the news that Japan is doing more quantitative easing and remarks from Fed Chair Ben Bernanke that more quantitative easing (also known as money printing) would be good for the U.S. economy. The major, and possibly disastrous, downside risks were not mentioned in mainstream media reports.

Quantitative easing has been tried many times before in Japan. It has failed to produce any lasting results, which is why it needs to be done again. The Fed has already engaged in quantitative easing during the Credit Crisis (frequently referred to as QE1) and is also doing it again because it didn't have any lasting results. Moreover, it isn't clear that any positive results took place at all because of QE1. The Fed claims it was a great success, but hasn't offered any proof to support its contention. There is certainly proof that it didn't work. Exhibit one is the much higher unemployment rate that we currently have. Just the need to do quantitative easing again is in and of itself proof that this was a failed policy.

While the advantages of quantitative easing are dubious, the risks can be horrendous. The biggest danger is for a country with a massive debt held outside that country (this describes the United States, but not Japan) Printing money is inflationary. It devalues the currency of the country doing it. The trade-weighted dollar did indeed have a big sell off on the news. Inflation-sensitive gold hit another all-time high. Quantitative easing will encourage large foreign holders to sell U.S. debt and to not make purchases in the future, except for TIPS (treasury inflation protected securities). Even TIPS will ultimately be shunned because they reflect the understated official U.S. government inflation rate. Without this source of foreign capital, the U.S. cannot fund its budget deficit or its trade deficit. This would send the economy into a severe contraction. The only way to avoid that would be to print even more money...and then more money ....and then more money. Without the money printing, the U.S. economy would enter a severe depression. With money printing, the risk is hyperinflation.

The biggest foreign holders of U.S. treasuries are China, Japan, the UK, the Oil Exporters, Brazil, the Caribbean Banking Centers (off-shore money havens used to hide the parties involved in financial transactions), Hong Kong, Russia, Taiwan, Switzerland and Canada. Why would these countries continue holding U.S. government bonds if they know they are going to be paid back in devalued currency? Why will these countries want to buy more bonds in the future? According to TIC (Treasury International Capital) data, China held $939.9 billion in U.S. treasuries in July 2009. In July 2010, it held only $846.7 billion. It is also known that China has been selling long-dated paper and moving into the short end of the yield curve. Other countries would want to do the same in response to quantitative easing. This may be why yields on the two-year note keep hitting all-time lows.

The impact of the first round of U.S. quantitative easing shows up even more clearly in the amount of treasuries held by the Fed. At the end of the first quarter, the Fed held $5.259 trillion in U.S. government bonds - more than five times the amount of China, the largest foreign holder. The nightmare scenario of the U.S. having to print money to buy its own government bonds because it can no longer borrow enough money from foreign sources to fund its government operations has clearly already taken place. That the Fed is now doing more quantitative easing indicates a self reinforcing inflationary cycle is underway. Investors should act accordingly.

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.

Why Quantitative Easing Will Raise Long-Term Rates

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.


The two-year treasury yield fell to another record low on Monday, touching 0.3987%. The 10-year treasury yield was up slightly however in September, rising for the first time since March. Federal Reserve money-printing is behind both falling shorter-term rates and rising longer-term rates.

A survey by Bloomberg of more than 60 mainstream economists indicates they expect 10-year treasury yields to keep rising in 2010 and through 2011. Perhaps someone has been passing around some notes on the approximately 500 hundred year old 'quantity theory of money', which states if the amount of currency is increased without an appropriate increase in economic growth, inflation will result (and consequently interest rates will have to rise, with the biggest increase taking place on long-term bonds).  For this not to happen, the laws of simple arithmetic have to be violated. The Federal Reserve has essentially been maintaining that that is what has taken place for the last two years. Bernanke of course does not directly state that we have entered a new economic age where two plus two no longer equals four because he would be laughed out of Washington and even the never questioning U.S. mainstream media wouldn't print such garbage.

Bloomberg also reports that a survey of primary dealers (the people who buy the paper that the Treasury issues) estimates that the Fed will buy $100 billion to $1 trillion in Treasuries by the end of the year. According to Deutsche Bank however, the market has reacted as if $315 billion to $670 billion of quantitative easing has taken place recently. The Fed announced on August 10th that it would be conducting further quantitative easing this year. The stock market then had its best September in seven decades. Money printing is an easy way to juice up stock prices. And since there is an important election on November 2nd, it would make sense to think all or almost all of what is scheduled for 2010 will take place before people vote. It looks like that is exactly what is happening.

While the Fed's actions can make the stock market look good in the short-term (investors need to watch out for what follows however) and can make shorter-term rates like the two-year go down because of all of the buying that it is doing,  longer-term rates will go up if the market sees this as inflationary. The 10-year treasury is the bench mark for everything from home mortgages, to credit cards, to corporate bonds. Higher yields on the 10-year are a drag on the economy. The Fed has supposedly reinstituted quantitative easing to stimulate the economy, although there is little evidence that the Fed has managed to stimulate the economy very much in the last three years. The stimulus has instead come from massive government budget deficits. The Fed seems oblivious to the existence of a liquidity trap, a condition where increased 'money' generated from the central bank just moves around the financial system and never gets into the real economy. Under such circumstances, doing more of the same won't make things any better, but can easily make them worse.

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.

The Fed's Minimum Price Stability, Maximum Unemployment Policy

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.


The Fed says it's worried about deflation and high unemployment. So in order to tackle these two problems it's going to do more of the same things that lead to them.

In its post meeting statement yesterday, the FOMC said that inflation is 'somewhat below' levels consistent with its congressional mandate for stable prices.  Since the official inflation rate is positive, this indicates that under no circumstance should prices actually remain stable in the U.S. It also means that prices have to increase by more than the amount they are rising now. This of course leads to long-term dollar devaluation and indeed the dollar has lost 96% of its value since the Fed has been in business. They obviously can't wait to lop off the remaining 4%. Having a worthless currency is obviously a good thing as far as the Fed is concerned (you might disagree when you have to pay $5,000 for a loaf of bread). Inflation-sensitive gold hit its fifth record high in as many days on the news and was pushing $1300 an ounce this morning.

It order to tackle the non-existent deflation problem, the Fed intimated that more quantitative easing - also known as money printing - is on the way. There is no case in financial history when excess money printing hasn't eventually led to higher consumer inflation and it has frequently led to hyperinflation. The Fed has already done a lot of 'printing' and the ever increasing price of gold is showing the dollar losing value right in front of our eyes. However, the see no inflation, hear no inflation, and speak no inflation Fed ignores the gold market. Instead they are looking at ever dropping interest rates - the two-year treasury hit another record low after the meeting. Falling interest rates are being caused by all the new money they are manufacturing because bonds are being bought with some of it and this drives their price up and rates down. Using some form of inverted, twisted thinking, they view a market reaction caused by excess money printing as a sign of deflation.

The Fed first lowered its Funds rate to zero in 2008. With help from the U.S. treasury, they have engaged in an expansionary money creating policy since then as well. Unemployment is now much higher than when they started these moves and is stuck around the 10% range if you believe the official numbers (if not, it's much higher). After the worst recession since the 1930s, the economy is stuck in neutral, if you believe the official numbers (if not, we have already entered another recession). So the Fed's solution is to ratchet up the same policies that have failed over and over again and they claim somehow they will work now. It is far more likely the Fed's actions will nstead lead to minimum price stability and maximum unemployment.

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.