FedUpUSA

Archive for the ‘default’ Category

The big banks’ loans to Greece were predatory by design.

There is only one ethically defensible choice for Greece: default now. Before you flame me with emails about the “responsibilities of debtors,” please read the entire entry.

Let’s look at credit (offered by lenders) and debt (sold to borrowers) from the point of view of predation.

Would you borrow $1 billion if it was offered to you at zero interest, with no collateral required? I would, without hesitation, and I would buy various assets which offered a reasonable return above zero with the “free money,” because the lender has no recourse if my investments fail to return the capital.

Who would be dumb enough to make such a loan? The Federal Reserve, of course, and they do so only to their special buddies, the “too big to fail” banks as a way of diverting the national income to recapitalize the banks without directly transferring taxpayer funds.

What does it take for a transaction to become predatory?

1. The lender (if they had sufficient leverage) could change the terms after the fact, for example, demanding more collateral. This would be predatory because the terms of the loan were “too good to be true” and were designed to fail–i.e. a lead-in to a carefully planned predation.

2. The borrower misrepresented his financial circumstance, i.e. committed fraud, which is a type of predation on unwary lenders.

But there is a quantitative difference between the borrower seeking to defraud an unwary lender and a lender planning a predatory loan:

1. The lender is in effect marketing the debt. If a potential borrower declines a loan, life goes on. If a lender doesn’t sell loans, it dies. Therefore the incentives to push “too good to be true” or otherwise misrepresented loans are asymmetrically on the lender side.

2. The lender is an institution that is built upon risk management and risk appraisal. The borrower is not, and thus the skills of assessing (and thus of pawning off) risk are asymmetrically on the lender side.

There is an unsavory analogy to lenders offering under-collateralized, low-interest loans with “gotchas” built into the terms: Pushing these types of loans at interest rates which do not reflect prudent risk management is akin to offering an inexperienced young maiden a large sugary drink that is heavily spiked with a tasteless alcohol, with predatory designs.

So when the maiden wakes up groggily the next morning sans clothing in a strange bed, is it really fair to say, tsk, tsk, she should have known better? Doesn’t this ethical symmetry miss the reality that the risks of predation were masked and asymmetrical by design?

The banks that lent vast sums to Greece were in essence offering “too good to be true” loans at rates of interest that did not reflect prudent risk management. Anyone who glanced at Greece’s history of defaults might have wondered if Greek rates should have been almost as low as those in Germany.

Was the “collateral” any sounder than that offered in the many previous instances of default?

We’re left with only two possible conclusions:

1. The big banks which lent stupendous sums of money to Greece at low rates of interest were hapless incompetents when it came to risk assessment and management, or

2. The loans were predatory from the start.

#1 is patently absurd, and so we are left with #2: the banks designed and offered these loans with predatory intent. Now the banks are offering their political lackeys a menu of predation to choose from:

1. Deliver the wealth of the Greek nation directly to the banks via transfer of national assets

2. Deliver the wealth of the nation over time via “austerity” programs that in essence divert the surplus national income to the predatory banks

3. Increase taxes on the “core” Euroland nations’ taxpayers to fund a “bailout” of Greece that is in essence a direct transfer of those taxpayers’ wealth to the big predatory banks; the “bailout” is just a pass-through to the banks.

If you think this through, there is only one ethical thing for the maiden to do: toss the spiked sugary drink in the face of the predator and deliver a swift, hard kick between his legs “where it counts.”

Greece should respond to this planned predation with complete and total default: not a “haircut” or “extended terms,” a complete and total refusal to pay any of the debt.

We are constantly warned that the resulting collapse of the “too big to fail” banks would trigger a global implosion. That is false; life would go on after the predators declared bankruptcy and were liquidated. What the predators fear most is an awareness that any disruption in normal life would be brief and relatively painless compared to the vast suffering imposed to render them their pound of flesh.

The banks are in effect imposing Droit du seigneur–”lords rights”– on Europe. Someone needs to take the predators down, and it might as well be Greece.

I have covered this before in regards to Ireland: Ireland, Please Do the World a Favor and Default (November 29, 2010).

Of Two Minds

This guy doesn’t know when to quit:

NEW YORK (AP) — Treasury Secretary Timothy Geithner said Tuesday that if Republicans insist on passage of their budget plan as a condition for approving an increase in the nation’s borrowing limit, they will be responsible for the consequences.

Speaking to a New York audience, Geithner said that Republicans would bear responsibility for the first debt default in the nation’s history if they insist they will not vote for an increase in the $14.3 billion borrowing limit unless they win approval of a House Republican budget plan.

Your administration has known full-well what the debt limit has been for a very long time.  So has CONgress.  Both bodies were well aware that raising the limit is discretionary.

You seem to believe that playing the “Armageddon” card is something that can be done with impunity, mostly because your predecessor Hanky-Panky Paulson did so and Bernanke was a party to that.

The fact of the matter is that you seem to think that there’s no limit to the nation’s credit card.  You’re wrong.

Yes, I know, the bond market hasn’t cared (yet) about all this idiocy.  Then again it didn’t care over in Greece either, right up until it did.  Same with Iceland, Ireland and Portugal.

In fact, it seems to work the same way with most personal bankruptcies too.  People think they can push things a bit further, a bit more, they get another credit card, they play the balance-transfer rollover game, they feel the pressure and make some sort of maneuver and then breathe easier.

All this works for a little while, right up until it doesn’t in dramatic fashion.  And then, once again, we hear “nobody could have seen it coming.”

Well Timmy, lots of people saw this coming.  I did.  Hundreds of others who write on economics did.  The only people who “couldn’t see it coming” are those who are so arrogant as to think they can play Global Thermonuclear Financial Armageddon whenever their social spending and military adventure bonanza is threatened and who have their heads firmly buried up the bankster’s asses.

Let’s cut the crap: That’s exactly what this has been.

The jackbooted games are completely out of control.  The Federal Government has doubled in size since 2000.  Have we gotten twice as much service from the government?  No, we’ve gotten serviced instead.  And 2000 was a bad time in that regard as the government was dramatically overblown and overbloated at that point in time.

That was the last time I ran a mid-sized business and had to deal with that crap.  I will never do it again, so long as that “mass” is amassed against me.  And it will forever be, until the government shrinks.

The Feral Government is like a vampire that has gotten to weigh 500lbs.  It loves to suck the blood out of the nation and consume it.  Government employees like the TSA folks think that virtually rape-searching people with X-rays is “cool” and “for our safety” – including sticking their hands down a baby’s diaper.  What sort of sick bastard engages in that sort of act?  The fact is that it was never about safety – it’s entirely about shielding airlines from the risk of failing to secure their own aircraft and terminal facilities. We can’t have certain “favored” businesses risk failure when they blow it; rather, we have to make sure the boot of the government presses ever further on the people’s necks.

The vampire needs to be put on a severe diet.  Yeah, it will scream and holler, like every fat man does when told that he can’t gorge at McDonalds’ any more.  But just like the 400lb man that needs two seatbelt extensions if the government doesn’t cut this crap out the nation is going to have a heart attack and die.

I say chain the 500lb vapire to its chair and cut its rations by 50%.  When it screams, and it will, wear earmuffs and slam the door shut.  In short, Geithner, here’s my response to your threats: Pound sand.

We’re well-beyond the time where we should be neutering the government, not enabling it.  Emasculating the Federal Government with a nice, sharp knife, feeding its former pair of testes to the closest shark would do more to help this nation’s economy than anything else that could be undertaken.

Ronald Reagan used to talk about “rugged individualism.”  He was right in that regard, although he sure didn’t believe it when it came to certain personal choices.  He thought it was great if you wanted to drink a beer (boosts the economy) but smoking a doobie was good for 10 years in the slammer.  Like most statists he was a hypocrite when it came to that true “rugged individualism” and to add to his hypocrisy the “deal” he made on cutting taxes and slashing the size of government had no verification on the second half – which didn’t happen.  Instead he sat back, patted himself on the head and then watched the vampiric Feral Government pack on another 50lbs.

Well, Timmy, it’s time to go cold turkey.  You have enough tax revenue to avoid a default.  You can pay principal and interest, easily, with the tax money that comes in.  You then get to choose – do you send Granny her check (after you blew her contributions over the last 30 years in a puerile display of idiocy) or do you continue to fund the magical oil “reserves” that we “defend” with our $750 billion a year in defense expenditures rather than having a cogent and defensible energy policy?

Choices, choices.  They’re tough.

But default, in the legal sense, is in fact a choice, as the government’s income does exceed it’s actual lawfully mandated debt service.

Remember Timmy, Social Security and Medicare are not “obligations” – they’re entitlements.  Your very agency has argued this, successfully I might add, in court.  The Federal Reserve does not count those “obligations” as actual debts as a consequence.

In short Turbo, your “Armageddon Card” is frayed around the edges and doesn’t work any more.  Multiple attempts at a balanced Federal Budget have been circumvented and fraudulently avoided.  It is time to pull the rug out from under this game and throw the board on the floor; balancing the budget by refusing to raise the debt ceiling is the right way to do it, and now is the time.

The Market-Ticker

Unfortunately, no other country has considered the just and common-sense approach that Iceland took.    From Bloomberg:

Iceland is betting its decision two years ago to force bondholders to pay for the banking system’s collapse may help it rebound faster than Ireland.

Iceland’s taxpayers face a smaller debt burden than their Irish counterparts, where the government’s guarantee of the financial system in 2008 backfired this year when the banks came close to insolvency. Iceland’s budget deficit will be 6.3 percent of gross domestic product this year and will vanish by 2012, compared with the 32 percent shortfall in Ireland, the European Commission estimates.

While analysts expect Iceland’s recession to extend into next year, the nation’s exporters are benefiting from a 28 percent drop in the krona against the dollar since September 2008. The decline may help the nation of 320,000 people rebalance its economy faster than Ireland, whose euro membership rules out a currency devaluation. With Iceland’s OMX share index up 16 percent this year, the third-biggest gain in Europe after Denmark and Sweden, Nobel Prize-winning economist Paul Krugman says Iceland may be an example of “bankrupting yourself to recovery.”

“The difference is that in Iceland we allowed the banks to fail,” Iceland President Olafur R. Grimsson said in a Nov. 26 interview with Bloomberg Television’s Mark Barton. “These were private banks and we didn’t pump money into them in order to keep them going; the state did not shoulder the responsibility of the failed private banks.”

That last paragraph is the key.  Private institutions that make bad business decisions should FAIL.  All this nonesense the banks want everyone to believe that the ‘economy would collapse’ without them, is just that, a bunch of baloney.  Think about it.  As opposed to the wonderful, glorious economy we have now?!!  The proof that they are lying can be found in Iceland.

Instead here in the US and in other countries around the world the avenue being taken is to fleece the taxpayers to print the money to support the insolvent banks and for governments to ‘reign in’ spending by cutting any and all programs that actually support citizens (pensions, unemployment, medical care) and raising taxes.  At the same time, governments are increasing the spending on their own salaries, benefits, pet projects and of course, lining the bankers’ pockets with newly minted cash and bending laws, rules and regulations to exclude the bankers, so that the banks will continue to show their gratitude by funding the government officials’ campaigns for reelection.

I think it should be obvious to anyone who has even remotely studied history.  There’s a name for this system.  It’s called communism.

Iceland has chosen freedom and so far, the rest of the world has chosen slavery under what now amounts to communist regimes.

STOP THE LOOTING AND START PROSECUTING

Could the next black/green/dark gray swan be so obvious that it has avoided everyone? Well, except for the deputy governor of the Bank of China, who just gave the world a startling reminder of economics 101, when he said that it is “getting harder for governments to buy United States Treasuries because
the US’s shrinking current-account gap is reducing the supply of dollars
overseas.” Oops.

The funny thing about natural (and economic) systems: they can only be pushed so far before they snap back to default state. With the entire world embarking on an unprecedented spree of domestic bubble blowing to mask the collapse in global GDP, everyone forgot to trade. Zero Hedge has long emphasized that the drop in world trade can only sustain for so long before it brings the current destabilized system back to some form of equilibrium. Because with every country intent on merely printing more of its own currency, whether it is to build bridges or to make the stock of electronic book fads trade at 100x earnings, said countries ran out of non-domestic cash. Alas, this is most critical for the United States, now that Treasury monetization is over, as the US needs to constantly find foreign buyers of its debt to fund unsustainable deficits. Foreign buyers who have US dollars. And according to Shanghai Daily, this could be a big, big problem.

Here is what the BOC’s Zhu Min said earlier:

“The United States cannot force foreign governments to increase their
holdings of Treasuries,” Zhu said, according to an audio recording of
his remarks. “Double the holdings? It is definitely impossible.”

“The
US current account deficit is falling as residents’ savings increase,
so its trade turnover is falling, which means the US is supplying fewer
dollars to the rest of the world,” he added. “The world does not have
so much money to buy more US Treasuries.”

In a nutshell, in printing trillions of assorted securities, the Treasury has soaked up the world’s dollars, which due to US banks not lending, is sitting and collecting dust in the form of bank excess reserves. These excess reserves can not be used to buy Treasuries and MBS as that would be literal monetization (as opposed to the figurative one which is what QE has been). And the world is running out of dollars with which to buy Treasuries.

Does this mean that the “world” will be forced to buy dollars, and thus spike the value of the greenback? Not necessarily:

In a discussion on the global role of the dollar, Zhu told an academic
audience that it was inevitable that the dollar would continue to fall
in value because Washington continued to issue more Treasuries to
finance its deficit spending.

Submitted by Greg Simmons and Brett Buchanan of Scope Labs

Are financial markets a direct reflection of the overall health of a nation? I wish they were not, but I fear they are.

I wonder at times if our nation has entered a state of purgatory –
all of us mulling around in the waiting room to Hell, anxiously
counting the minutes until the grim reaper saunters through the door
sickle in hand his mission to send us off to eternal damnation.
Unfortunately, there is little time to close this door so that we may
stave off this potential fate that looms so near. What we need to alter
this course is a procession of men who possess moral fortitude and
common sense, men of rationality and reason. Men of action who will set
in motion the dismantling of institutions that bleed this nation dry.

Hope is not a strategy. This present state of manufactured optimism
emanating from the White House and our news outlets is contemptible. We
are in dire need of new reformist leadership and of new voices that
will speak the truth. A national purification is long overdue. Time is
not on our side. Look at the track record this nation has racked up
over the last few decades and this economic and moral purgatory in
which we find ourselves might very well mark the beginning of our walk
of death down the long road to Hell.

I make this analogy of a national state of purgatory not in jest,
but rather in practical terms. This nation has gone the way of an
absolute meltdown of morality and ethics. We’ve reverted to a sort of
Wild West where anything goes. From the halls of congress to our
corporate boardrooms our collective morality bar has sunk so low we
cannot go any lower without disconnecting from the great past this
nation is starved to regain. We stand dangerously close to the point
where immorality begets our undoing.

Personally, I am father to a daughter of fourteen years. Brett, my
co-author, is father to a twenty-month old daughter and an
eighteen-year old son. We desperately want to create for our children a
better world. But we are fallible men, and certainly not saints. The
paragraphs you are about to read are not written from some moral high
ground, or a Holier-than-thou pulpit, but rather from saddened hearts
when we see that by walking our own moral tightrope, if we were to
allow ourselves to slip below the bar, however slightly, we would be
just as guilty as the worst perpetrators of our nation’s moral
destruction. Also, when witness to greater moral transgressions, by our
own inaction, we become part of the problem. And we are just two men.
Amplify this by fifty million, one hundred million, or three hundred
million fold and it is no wonder immorality permeates our society.

This article is our personal effort to call people’s attention to
the truth. The brevity of our circumstance is immeasurable by past
reference. Economically, we have never been so challenged. Over the
past few decades a gullible US population cheered the halls of congress
and the Oval Office alike as the incestuous bedfellows of money and
politics ushered in a financial Coup d’état – co-opting our public
trusts with the greed and excess of Wall Street. Profits are now had at
any cost – damn the long-term consequences. Instead of being exposed as
the obvious fraud he was, Bernie Maddoff was coddled by the SEC – an
institution whose role as regulator is a complete failure. As Wall
Street and Washington raped an entire nation, employees of the SEC were
too busy surfing porn on the Internet and running private businesses
instead of doing the jobs taxpayers pay them to do. All the while,
young girls were selling their virginity to the highest bidder in
public cyber-forums where grown men (not hormonally charged teenage
boys) seek out their sexual fantasies in the netherworld of Internet
pornography. What of the wives, children, and even parents of these
men? Do they approve of such questionable actions?

Think of our children turning on the television to see people eating
bile, cow blood, and live bugs for money on game shows like Fear
Factor, or Flavor Flav and his hit reality show where he maintains a
stable of women all of whom physically fight each other to have sex
with him because he’s a celebrity – and a damn ugly one at that. And
finally, there’s always Survivor, the ultimate demonstration of all
things wrong with modern human interaction. A reality show that pits
person against person in a deceitful game of moral destruction where
lack of ethics are rewarded, instead of punished. Survivor, this is
what our nation’s leadership has become. Win at any cost. Damn the
future of anyone but myself.

Morality is in great part the measure of a nation. Have we unlearned
morality? Is this why we find ourselves staring down the abyss?

We are allowing ourselves to become more corrupt by the minute. We
stare into the face of our future being raped, but we do nothing. We
are as corrupt as the corrupters. We accept the unacceptable. We fail
to understand that absolute power, corrupts absolutely. In what will go
down as the greatest financial heist in history our leaders have chosen
to reward corrupt individuals and their hollow corporations for what
are arguably criminal levels of risk behavior by the moneyed elite of
this country. What message does that send to our children, or to anyone
for that matter? Be as corrupt as possible in the US and you will be
rewarded? Be the biggest failure jeopardizing the fate of others then
stand in the corporate welfare line with all the other wealthiest
institutions of the world, your greedy hand extended for a government
bailout check while you simultaneously foreclose on an entire nation?
Talk about the rich corralling the masses. It’s no wonder someone
coined the term “The Sheeple.”

The path we traveled to this purgatorial limbo is both easily
understood and misunderstood. The answers to understanding are
sometimes right in front of us. What are seemingly benign things or
actions, those everyday judgments or decisions we make to do one thing
or another, are not always benign. Tell a little white lie to make that
one sale that will put us into our bonus. Rig the game in our favor so
that we might enjoy a little more opulence for the few decades we have
remaining on this planet. Look the other way while the Federal Reserve
and Wall Street blow economic bubble after economic bubble and in the
process create a six-hundred trillion dollar shadow banking system that
plays by no one’s rules but its own. In the case of Goldman Sachs, and
Wall Street in general, lie, cheat, and steal their way to
profitability at the expense of three hundred million taxpayers. The
fact is that we have become an uncooperative nation willing to take
advantage of anyone for the sake of profit. The idea of building a
cooperative future where everyone wins has been sacrificed at the altar
of short-mindedness.

It might be this purgatorial limbo I speak of is simpler than it
appears. It could be that we are collectively suffering the
consequences of the “Peter Principle”, or getting to the job of
failure. This principle supposes that an individual rises in a
corporate hierarchy to their first level of incompetence. An assembly
worker gets promoted to supervisor then to assistant manager, then
manager, until he next gets promoted to an upper management job for
which he is ill equipped and subsequently gets promoted no further as
he can no longer demonstrate the competence required for the task at
hand. He rather relies on subordinates who are then stuck with an upper
manager who cannot carry out his own duties. Could this be the state of
our nation? Have we been promoted as far as our competence allows? Are
we in fact incompetent to handle our future? Have we now elected a man
just incompetent enough for the Presidency who is being manipulated by
Goldman Sachs, the Federal Reserve, and a circle of (previous) Wall
Street insiders now on the government payroll as cabinet members and
high-ranking advisors? The saddest thing is that we sit idly by whilst
our virtue is being stolen. We do nothing.

A view of the world through rose-colored glasses does no one, any
good. We are not as resilient as we think we are. Instead, we exist in
a world of synthetic productivity where multi-tasking renders us
incapable of doing anything effectively or with any level of
competence. Multi-tasking, that art of simultaneous ineffectiveness is
a counter productive weapon that to a large degree has contributed to
the potential failure of this nation. If you were to listen to Alan
Greenspan however, you would believe that multi-tasking through
technological gains by way of the “new paradigm” was the gold at the
end of the Information Superhighway and that exotic mortgages and the
burgeoning spending class paved the road to riches. We now know these
premises to be empirically wrong.

It can now be argued that what would seemingly be advancements in
productivity are proving to be setbacks. The Information Superhighway
has led us to an era of technological arrogance. In reality all we have
accomplished is to dilute our ability to carry out simple tasks as we
click from a quarterly sales report due in an hour, to Facebook, to
on-line solitaire, to writing an email explaining to our boss why the
quarterly report will be delayed this day. We are a nation of excuse
makers. We look for someone else to keep us one step ahead of our
accumulating debt that smothers the potential of what could have been
an equitable future. Ironically, it is our technological arrogance that
impedes our ability to produce and manufacture our way to prosperity.

Craftsmen who used to flock to this country to fulfill the needs of
a manufacturing base flock here no more. “Made in the USA” used to mean
something. It meant quality. It was the definition of industrial
capitalism. But now through the wonders of globalization we have
exported our craftsmanship through an outflow of jobs to China and
India as we turned everyone in the USA into real estate agents,
mortgage brokers, and web designers – a perfect playground for bankers
to ply their craft, lending money in every creative manner both
thinkable, and unthinkable. “Made in the USA” has been reduced to the
status of punch-line – synonymous only with “Mortgage Backed
Securities” and other “Toxic Derivatives.”

Is it any wonder we have evolved into the ‘entitled society’? If we
weren’t on the government payroll, or subsidized by the US taxpayer
through social welfare then we were borrowing our way to prosperity.
Enter the God-fearing middle class. Just dumb enough to buy into the
scam a couple hundred million people began signing over their
paychecks, selling their future for the enjoyment of having things now.
We were transformed into non-productive Sheeple, selling our souls for
an easier life in lieu of a better future for our children. At our
current rate of productive attrition we will soon be a nation of
declawed housecats, possessing no skill-set whatsoever to survive in a
world where the ability to produce real goods still reins supreme. Yet
we remain the ‘entitled society’, when we are entitled to nothing.

We forget (through economic amnesia) that throughout history all
societies fail. Nicolaus Copernicus maintained that civilizations
failed when bad money, controlled and understood by an elite few, drove
out good money. The same can be said for morality. Bad, drives out
good. This is a reality of which we should all be acutely aware but
rather are immune to its possibility. We dangerously believe we cannot
fail. That, in fact, is the greatest gamble of all. A roll of the dice
against history, a bet against all natural laws of the universe, all
things are in a state of entropy. All things eventually wither away to
nothing. To possess longevity is to be ahead of the universe. Sadly, we
have constructed a fragile world that produces material things that do
not last. The fiat money we use as the currency of our production is by
design, destructive itself. The Federal Reserve prints greed, nothing
more. But still we covet it. We pursue it as if it had value. And in
this pursuit we destroy earth’s resources as if the laws of nature have
no relevance. We believe there is only now.

We, the entitled society, morally and fiscally bankrupt have borrowed,
spent, and bailed our way into a historical corner. Nero should be so
proud. Our public trusts are nothing more than government sanctioned
check-kiting operations shifting liabilities from one credit card to
another faster than our creditors can say “Federal Reserve.” The
Ponzi-scheme that is our fiat currency system is about to go the way of
what was for a time the symbol of American superiority, General Motors.
It used to be said that what was good for General Motors was good for
our nation. As I claimed in 2005 that GM would go bankrupt I will now
guarantee that the US government is soon to follow. How our ultimate
entropy will take form I cannot say, but form it will. We will default.
We will restructure. It will be at this point our arrogance will end.

Courtesy of David Rosenberg of Gluskin-Sheff

It’s that time of the year when ‘sell-side’ research departments publish their Year-Ahead Reports (as I once did in the not-too-distant past); as do all the financial magazines.

I realized after countless emails and phone conversations (in that order) that there is a very high expectation that I publish one too. I honestly have no intention of publishing a specific set of forecasts in my current role as the Chief Economist and Strategist for Gluskin Sheff for public consumption — the granularity of my recommendations is reserved for our Investment team and our client base. Be that as it may, I am more than happy to comment on what I see as an emerging consensus and my general view on the direction of the economy and the markets in the coming year without getting into too much detail or numerical forecasts, which are the domain of the ‘sell-side’ macro teams globally.

At the outset, let it be known that when I read everyone else’s year-ahead prognostications, all I can think of is, “where do I store this stuff for a year so I can look back and say ‘That was so wrong!’.” It’s not that the reports are always bullish every year; it is that they seem so contrived. And, as I mentioned in the December 10th edition of Breakfast with Dave, this year, probably like most years, there seems to be a remarkable level of agreement. Based on my reading, here is what I conclude the consensus views are as we head into 2010:

• Muted recovery, but positive growth, for sure! No risk of a ‘double dip’.
• Equity markets up!
• A barbell strategy of domestic multinational blue chips and emerging market equities.
  The U.S. dollar is…neutral, but we did locate more bulls than bears (so much for the ‘carry trade’ thesis).
• Positive on commodities for the most part.
• Concerned about government balance sheets, and therefore…
• …Bearish on long term government bonds because they are the ‘competition’ and, after all, who would tie their money up for 10 years at 3.5% when you can lose 22% in stocks? And, therefore…
• …Bullish on spread product (as long as it’s not long-term). And, therefore…
• …Really comfortable with high yield (just for the coupon and the view that default rates will come down).
• Certain that volatility will not be an impediment.
• The Fed will begin to raise rates in the second half of the year, but that this will have no impact since they will still be low.

So here we are with a glorious opportunity to reintroduce Bob Farrell’s Rule 8: “When all forecasts and experts agree, something else is going to happen.”

That being said, these economists and strategists, many of whom I know, are smart guys (and gals) and they are human. To ‘talk your book’ is human; to have the courage to ‘buck the consensus’ is divine. I too am human; I also like to feel that I have courage of my convictions; and I too have a “book” (of sorts — it’s called reputation). But I have decided to take the opportunity of the “Year-Ahead Moment” to transition from sell-side to buy-side and more importantly, to reflect on the past year and really try to prognosticate from the gut. You would be surprised how a blend of intuition and experience can make a difference in a cycle like the one we are in that has absolutely nothing in common with the other recessions of the post-WWII era.

Forecasting is a humbling profession even in the best of times and I have learned a lot in the past year, especially from my partners here at Gluskin Sheff who realizes all too well that:

1. It is what is embedded in asset prices benchmarked against the forecast that is of utmost importance for investors;
2. The focus of any forecast must take into account the reality that minimizing portfolio risks is at least as critical as maximizing the returns, and;
3. Every forecast has an error term and the range around any projection in a post-bubble credit collapse can be extremely wide.

I do not view the economic events of the last two years as a classic recession/recovery phase. They only exist in the context of a secular credit expansions and contractions. We are in a post-credit bubble credit collapse that is ongoing, à la Bob Farrell’s Rule 4: “Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.”

Mainstream economists called this downturn “The Great Recession”. This is truly a gentle way of saying “Depression”. When we can have the courage to come to grips with the fact that we did in fact experience a depression of sorts, which is by definition a credit event, then and only then can we draw a conclusion that a sustainable recovery will not get underway until the ratio of household credit to personal disposable income reverts to the mean (and goes to an excess in the opposite direction). I know it sounds harsh, but we shall endure — believe it. Transition is rarely without pain.

The ratio of household debt to disposable income is up from a 30% ratio back in the 1950s to 125% today (though down from 139% at the peak in 2007). Mean reverting to a ratio closer to 60% means that the deleveraging process will be a multi-year event and by the time it is over, more than $7 trillion in additional household credit will have to be extinguished. For more on this see the unbelievably grotesque article on the front page of last Thursday’s (December 10) Wall Street Journal — The New American Dream.

Perhaps inflation is a consensus forecast but deflation is the present day reality and often lingers for years following a busted asset and credit bubble of the magnitude we have endured over the past two years. The fact that China’s voracious appetite for basic materials will continue to exert upward pressure on commodity prices does not detract from this view, especially given the widespread excess capacity in the manufacturing sector and the new frugality that has gripped, and in many cases, been embraced by the retail sector. Higher raw material prices, owing to developments in Asia as opposed to demand pressures here at home, will prove to be a sustained source of profit margin compression for many sectors and companies linked to finished consumer goods and services.

So, much of what I have read in various Year-Ahead Reports predict corporate earnings, GDP growth here and abroad, interest rates and relative values of currencies. As I mentioned earlier, the error term is bound to be very wide in this new paradigm (since WWII) of a secular credit collapse. GDP growth in 1934 was 10%, but the Depression wasn’t over until 1940.

Since 1989, the Japanese stock market has had no fewer than four 50%-plus rallies and there still has been no period of growth that can be called a sustained expansion. Today, we have our own special set of conditions and it is bound to be tricky as is typical during a post-bubble credit collapse, no matter how intense the government reaction. Prematurely committing to the ‘risk’ trade is probably going to be the most lamentable action over the next few years.

Suffice it to say, we believe that the dominant focus will be on capital preservation and income orientation, whether that be in bonds, hybrids, hedge fund strategies, and a consistent focus on reliable dividend growth and dividend yield would seem to be in order. To reiterate, I see the range of outcomes in the financial markets and the economy to be extremely wide at the current time. But one conclusion I think we can agree on is the need to maintain defensive strategies and minimize volatility and downside risks as well as to focus on where the secular fundamentals are positive such, as in fixed-income and in equity sectors that lever off the commodity sector.

This, in turn, underscores my primary focus of favouring Canadian dollar based investments over the U.S. because at no time in my professional life have the downside risks — economic, fiscal, financial and political — been so low on a relative basis and the upside potential so high as is the case today. The near-2,000 basis point gap this year between the TSX and the S&P 500 — the former leading — should be taken in the context of being just past the halfway point of a secular (ie, 16-18 year) period of outperformance. Northern exposure never felt this hot.