policy makers are not recklessly expanding the taxpayers involvement in the largest financial calamity since the Great Depression but simply investing in distressed assets to generate positive returns in the future?
With investors watching the economy wade into deeper recessionary waters their lifejackets have been stuffed with variants of the above. Will investors really be gullible enough to buy into this belief hook, line, and sinker?
Needless to say, the correct policy response to the financial crisis and recession that picked-up speed in 2008 would have been to do nothing; to allow bad debts to be written off and to allow free market capitalism to work. Under these conditions the fallout would have indeed been swift and deep, but it would have also brought with it much needed doses of certainty and closure. As per the band aid analogy, it is better to quickly rip it right off.
Oblivious to the need for a dramatic change in the way regulators interact with the markets, the exact opposite tact has been taken, with dozens of band-aids being haphazardly applied. Moreover, with his rod and reel in hand President Obama – whose very platform centered on the word ‘CHANGE’ – has emerged from the murky waters and is angling for even more bailouts, a massive government stimulus package, and tax cuts. Apparently change can wait…
Suffice to say, straddling the already saddled U.S. taxpayer with more debt obligations threatens to exasperate the current crisis rather than cure it, because the U.S. is ill-prepared for the day when foreign appetite for U.S. debt wanes. As for Citigroup, the entire financial apparatus may well have fallen down if it had been allowed to fail, but from this rubble a new attitude might have also emerged. It is this ‘attitude’ that the U.S. has sorely lacked for a very long-time. In other words, as was the case with LTCM –
a point we highlighted years ago – Citigroup should have been allowed to fail.
Fishing For Returns In 2009
We highlighted 8 prophecies in this space last year, and with the possible exception of gold not seeing a historic bust (the verdict is still out), all 8 came true. Given that in all probability we will never replicate the uncanny accuracy of last year’s prophecies, please allow us to indulge for a moment before conjuring up the spirits of 2009:
1) As the U.S. economy enters recession the rest of the world will feel the consequences.
2) As ‘decoupling’ proves itself fiction and U.S. investors check their confidence in foreign stocks, U.S. equities will outperform many world markets in 2008.
3) The U.S. dollar will tread water for much of 2008 rather than drown…don’t be surprised by a stable greenback in 2008. Despite models and rap-stars flashing their admiration for Euros in 2007, it is still in the best interest of most of the financial world to support rather than run away from the dollar.
4) Gold is headed for a historic bust akin to that of 1980. This bust will arrive once the U.S. economic slowdown starts to deeply erode strength in emerging markets and/or once investors recognize that central banks are unable to quickly reflate the financial markets. With nearly everyone growing deeply enamored with the idea of ‘stagflation’, our gold bust theory is based upon the yet unseen threat of deflation.
5) China will burn out but will not fade away…Like the U.S. based internet mania, no one can be exactly sure when, but a great Chinese stock market bust is coming. When it starts everyone will claim it was obvious, although only a handful of analysts are bearish on Chinese stocks today.
6) Commodity prices will decline in 2008. Going against the grain with this call (not to mention the surging price of ‘grains’)…As the global economy ‘recouples’ demand for many commodities will flatten and commodity super-cyclists will spin their wheels as no new driver powers the commodities train forward. We see base metals as leading this softening commodities price trend by mid-late 2008.
7) Crystal ball grabag: The Federal Funds rate will end the year at or below 2%. Long-term U.S. interest rates will end 2008 flat or lower. U.S. equities will end 2008 lower, although they will not be down as much as many world markets. The contrarian dream of Japanese equities will remain exactly that.
8) Greenspan is already receiving his share of bad press, but by the end of 2008 his image will be fully transformed from that of miracle worker to wacko alchemist. No one will remember the ‘good times’ Greenspan supposedly helped create as times turn increasingly bad.
Based upon the above, our intentions leading in 2008 were to “lower our precious metals position as the gold price rises and slowly add to our equities position as stock prices decline”. And while we basically followed this outlook via a reduction in precious metals in early 2008 and the addition of a couple of stocks throughout the year, what we did not envision is that stocks would decline so rapidly and policy makers would attempt to reflate so desperately. In other words, there are valid reasons to believe that the record gold high seen in 2008 was not the start of a historic bust but ground zero for the next launch.
Before getting to 2009, it is worth pointing out that we are generally conservative investors and the speculations below are undertaken in an attempt to flush out some basic macro ideas. They are not, in any way, a method by which to generate profits. We believe that owning companies you understand at attractive market prices and being aware of longer-term advantages of owning gold instead of the liabilities of a government are useful. We have held firm to this stance since 1999. Without further adieu, here are the prophecies:
1) The global recession will deepen to begin 2009, unemployment will not bottom until mid/late 2009, and a sustainable recovery is years away. But this does not mean we are in another Great Depression. The key difference between the Great Depression and today is that policy makers have taken away many of the panic-pathways previously available to frightened investors. In other words, with systemically important bad debts being backed by government and Fed, with post-depression efforts insuring bank deposits, and with much of the money in ‘the markets’ either passively controlled or restricted from being removed, the risk of a complete meltdown is remote.
Caveat: If more and more investors continue to move into gold out of a fear that paper assets will continue to be destroyed all bets are off.
2) The great U.S. dollar bust will draw closer but will not come to pass in 2009. Those that believed that the financial crisis in the U.S. would spell the end of USD hegemony were patently wrong. Instead of a global panic out of dollars in the latter half of 2008 there was a global panic into dollars. We would speculate that the U.S.
