While the idiotic behavior in Washington marches on, the endless tongue in cheek discussions about default and what that means in terms of the full faith and credit of the United States continues. As we mentioned in our previous blog, some debtor nations have weighed in on the process but have yet to add to any real discourse on the broader context of our serious debt load. However, the Central Bank Governor of Sri Lanka has saved the day by both cutting rates ( in case of a default) and also providing some commentary on the lasting collateral damage done to our global reputation. The Governor stated ” Even if the U.S. were to get their act together and get past the debt ceiling, I think the fact that the global economy has been put under so much stress is something that many policy makers would not forget. That’s going to lead to various changes in the way central banks will perceive the safety and quality of investments”. Standard and Poors take note.
One has to wonder whether we are seeing Act One in what we have termed the “flight to tangibility”. Our original thesis involving the shift towards hard assets involved a sharp decline in the dollar brought about by a crisis of confidence involving governmental finances. While we have no doubt that this latest food fight in Washington will be resolved, the ease with which lawmakers were willing to create a crisis of their own making gives us pause as to their ability to make the truly hard choices should a real crisis occur. I am absolutely staggered by the ignorance displayed on both sides regarding the real world implications of a default( soft or not). While large scale holders such as the Chinese and Japanese sit in amazement at our inability to exhibit any kind of fiscal restraint, they should both hold their fire to some extent as they have both been willing participants (Japan especially) in this world wide game of print and spend.
Back in the ridiculous days of the late 90’s there was a product called split alert. This pager device would receive a message when a stock was splitting, which would then cause a pavlovian buy response on the part of the user. The premise was, at the time, that stocks splits were bullish because as we all know a pizza sliced into 24 slices instead of 12 is inherently worth more. We look back on all of the ridiculous behaviors and attitudes that existed during this time and we shake our head as to how this mentality was allowed to take hold. For some reason, I was thinking about split alert as I listened to Chairman Bernanke’s comments post FOMC. I wondered if we will look back years from now in amazement as to the gullibility of a market so fixated on monetary stimulus that it failed to see the flaws in thinking that a $15 Trillion Economy could be micro-managed using untested, unconventional and, to date, unsuccessful monetary policies. A question was asked during the Q&A about the recent backup in rates and Chairman Bernanke went to great lengths to explain that the market simply was misinterpreting the Fed’s intent. They did not understand that, while at some time their pace of asset purchases may slow, the stocks of assets that the Fed holds will remain unchanged. This, he stated, should be sufficient to hold down rates. We would suggest to the Chairman that bond market participants are not hard of hearing. What they are hearing quite clearly is a Central Bank intent on pursuing a policy of reflation/inflation and they are voting with their feet. Buy stuff, sell paper.
The sell off in precious metals over the past several weeks, combined with the recent hacking of an AP reporters twitter account, should lead some to question the concept of true liquidity. There is much made about the need for instant liquidity in capital markets, mostly because investors need the warm fuzzy feeling that goes along with the knowledge that one can liquidate one’s position instantaneously. However, the speed of execution, along with the structure of physically based ETF’s provide a level of instability not inherent in the actual physical markets. This is evidenced by the recent wave of ETF based selling in precious metals, which in turn caused forced selling in the physical markets as ETF managers were forced to sell their captive holdings. What has been interesting about the recent price action, is that this paper driven selling was met with a substantial amount of physical buying, both from the commercial user community as well as those interested in building or adding to their metals position. For example, this buying has pushed physical gold premiums to multi-year highs. What this price action clearly tells us, is that the knee jerk reaction of most commodity markets to what really was no new information unveils the danger in reading too much into these types of moves. Conversely, the willingness on the part of longer term players (commercial users and others) to step up in the face of such moves gives us a sense that the shift towards “stuff” continues.
A recent study by Bain& Co. forecasts a “superabundance of capital” between now and 2020. Bain projects that there might be up to ten times the level of global financial assets relative to global GDP within the next several years. This divergence, driven by surpluses in Asia and the Middle East, should exacerbate bubble like behavior over the next 6-7 years the study reports. While we would normally ignore such drivel, it does make one think about all of the existing excess liquidity that exists today, and will most likely continue to exist going forward. The study assumes however, quite naively we might add, that this liquidity will flow mainly to public capital markets/financial assets. We maintain that smart capital seeking a home does not necessarily look only to traditional conduits of investment such as stocks and bonds but rather seeks out where it will be treated the best (return and safety). We highly doubt that the conditions which would warrant a sustained divergence between the real economy and the paper economy would be sustainable over any extended period of time. Very recent history would suggest that negative real rates of interest have oftentimes caused excess liquidity to bleed over into areas of the real economy, sometimes in highly unpredictable and highly disruptive manners.