How the Federal Government will Lose in 2009 27 comments
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Through a combination of incompetence and greed, the federal government has placed itself in a position of checkmate. There is no way to finance its budget deficits without devaluing the dollar or causing interest rates to rise. With $10.6 trillion in debt, $8.5 trillion in new money created or given away in 2008, and multiple years of trillion dollar deficits planned by Obama, government has no way to fund its extravagances without either printing a lot more money or borrowing unprecedented sums.
This means that either Treasury bonds will crash, or the dollar will suffer significant devaluation relative to foreign exchange or precious metals, especially gold.
Market forces are telling the world to shed unproductive assets and shrink capacity, yet central banks and governments around the world, in particular the U.S., are refusing to listen. Rather than allow markets to snap back to sustainable equilibrium from previously artificial highs, the federal government clings to the notion that forcibly shuffling resources, propping up asset prices, and diluting the money supply will magically save the day.
There are consequences to everything. The consequences of shuffling resources (taxing productive ventures and doling out those resources to failing ones, i.e. bailouts) are stunted growth for good businesses and propagation of bad ones. Artificially propping up asset prices means that those who are generally less competent remain the custodians of society’s capital, and diluting the money supply inflates aways everyone's wealth over time, particularly harming the poor and middle class.
For decades the federal government has gotten away with this reshuffle and inflate game, but the pawns are drowning, the rooks helpless, and the knights ready to turn on the King. Perhaps this is overly dramatic. Clearly, I doubt the capability of the Federal Reserve, Congress, and Obama to “fix” the economy; rather, I strongly believe they are destroying it by forcing us all to drink this Keynesian Kool-Aid. However, whether or not the economy recovers amidst this historic central government action, there are two phenomena we can exploit to our advantage:
- Short the US dollar
- Short US Treasuries
In “When will the great Treasury unwinding begin?” I show how government debt has been bid to unsustainable levels and will likely fall. The one concern I see stated all too often is that the Federal Reserve will keep buying Treasuries to artificially depress interest rates. This will, it is claimed, keep bond prices inflated. The one undeniable counter to this is that government must somehow fund its $1.2 trillion estimated 2009 deficit. It cannot do this by issuing and then buying the same bonds. It can only raise revenue by selling bonds to other parties, or by diluting the money supply by cranking up the printing presses. There are no other options. There you have it - we have the government in checkmate!
The likely outcome is that they will try to do both. That is why I am heavily shorting both 30-Year Treasury bonds and the dollar. Both assets will likely lose as the government becomes increasingly desperate and the world’s biggest buyers realize there are better alternatives available. Make your bets now before it becomes treasonous to bet against Big Brother!
Disclosure: Long UDN, short TLT, long GLD.
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This article has 27 comments:
"There are consequences to everything. The consequences of shuffling resources (taxing productive ventures and doling out those resources to failing ones, i.e. bailouts) are stunted growth for good businesses and propagation of bad ones. Artificially propping up asset prices means that those who are generally less competent remain the custodians of society’s capital, and diluting the money supply inflates away everyone's wealth over time, particularly harming the poor and middle class."
It seems so clear, so how come our policymakers don't get it?
On Jan 09 09:14 AM prudentinvestor wrote:
> You eloquently state:
>
> "There are consequences to everything. The consequences of shuffling
> resources (taxing productive ventures and doling out those resources
> to failing ones, i.e. bailouts) are stunted growth for good businesses
> and propagation of bad ones. Artificially propping up asset prices
> means that those who are generally less competent remain the custodians
> of society’s capital, and diluting the money supply inflates away
> everyone's wealth over time, particularly harming the poor and middle
> class."
>
> It seems so clear, so how come our policymakers don't get it?
It isn't so much 'treasonous to bet against Big Brother' as it is a variation on 'The market can stay illogical longer than you can stay solvent'! With smoke, mirrors, 'staging distractions' (look over here while we do something over there), the government can keep 'tinkering' with their toolbox for quite some time. The banks KNOW a wave of defaults is headed their way which is why they cower under some flimsy TARP (It's kind of like the calm before the tsunami when the tide comes in, goes WAY out and there is a calm, THEN the big wave comes ashore! "That's odd how the tide went out so far honey, oh well, put some sunblock on me will ya?!")
It's the timing we're all interested in since currency moves and treasury prices are 'long waves' (once in motion in a certain direction, it keeps going in said direction for a bit) I'd love to know have a better sense of when the unwind will take hold since it will be a long one...
To mix metaphors, the Coyote has long since walked off the cliff but to him, he is still on firm ground. Eventually he'll look down and/or try to run for the other side of the canyon. Positioning before the downdraft gets one the most bang of course. The currency strengthening and devaluing come in long waves but I'm not so sure how fast Treasuries will re-price along the way here?
Why are you disbelieving the fact that your own eyes can see? Market forces strengthing the dollar and pushing iinterest rates down?
What about comparable economics, eg, Japan. Japan's debt dwarfs ours. It is something like 200% of GNP while ours is a measley 60% and after the Obama trillion will only rise to 66%. But here's a fact - the yen is a powerhouse, and its interest rate is a mere 1%.
Where are your facts? Not just more speculation, facts!
Your insight is valuable for that alone.
So I echo RJMoran's question, when do you start shorting?
My question is "what vehicles" are you shorting? Futures, ETFs, ETNs, If futures, what contract months?
Not having your expertise, what would be our safest way to short the USD and the 30 yr. T Bond.
Or maybe we should just buy TIPS?
...as in....
.... the US$ and Treasuries will be in the TLT.
The question becomes, when does the flushing sound begin? I do not want to be farther into the toilet than I am already.
You forget that when deflation hit Japan they were rich, had a great trade surplus and home savings ratio was very high.
US situation right now is very different: no savings, no trade surplus and it owe's money to everybody.
I agree that inlation is the only way out, that or pay debts with assets.
I Hope your'e right but if you're not, your long GLD and UDN offer no yield really and your short TLT will force you to pay the dividend each month to the owner of your short shares. But you, and many on this board, are thoroughly convinced that there can be no other outcome. I, for one, am more interested in garnering yield in these tough times while keeping a portfolio hedged just in case.
Oh, and using the Shepard Fairey graphic for your headshot while dissing the Govt. and Obama seems a little hypocritical since I don't think you are offering much in how to make things better...only in how you can profit.
One can only recreate wealth from production. Just madly printing money to re-inflate would lead to one of the following scenarios with my assessment of its likelihood:
SCENARIO #1: US$ Devaluation. This scenario is unlikely because if indeed it is officially declared, countries around the world would simply follow suit. As for the US$ being replaced as the world's reserve currency, the question then becomes replace it with what? The British Pound? The British Empire is in its twilight and its influence around the world is not once it was. The German Mark? Germany may be a European stalwart but not a world power. The Japanese Yen? Same reason as Germany but an Asian stalwart. I could go on and on, but surely not the Chinese Yuan. That currency is not even widely traded in world markets.
SCENARIO #2: Interest rate to rise. The Fed will do its utmost to keep rates down as otherwise the housing market will further tank - a suicidal mode.
SCENARIO #3: Hyper inflation and hyper unemployment. The reader could figure it out for himself/herself that this would be the only logical outcome given that #1 and #2 are not viable. Simply put, real money had been diluted, meaning that there less money around. The only way it would work out is that there will be less money to pay people for work and money will be dearer.
1) Tax the population
2) Borrow by issuing debt
3) Print more money
There are no other ways to finance government expenditure. I excluded taxation since it is outside the realm of political possibility during economic contraction. Sure, some demographic elements within our population will experience tax increases, but by and large, the net pool of tax revenue will decline, meaning the budget deficit can only be financed by borrowing and printing. There are no other alternatives.
On Jan 09 12:41 PM puttster wrote:
> You don't give a shred of evidence to support your claim that "There
> is no way to finance its budget deficits without devaluing the dollar
> or causing interest rates to rise."
>
> Why are you disbelieving the fact that your own eyes can see? Market
> forces strengthing the dollar and pushing iinterest rates down?
>
>
> What about comparable economics, eg, Japan. Japan's debt dwarfs ours.
> It is something like 200% of GNP while ours is a measley 60% and
> after the Obama trillion will only rise to 66%. But here's a fact
> - the yen is a powerhouse, and its interest rate is a mere 1%. <br/>
>
> Where are your facts? Not just more speculation, facts!
On Jan 09 09:14 AM prudentinvestor wrote:
> You eloquently state:
>
> "There are consequences to everything. The consequences of shuffling
> resources (taxing productive ventures and doling out those resources
> to failing ones, i.e. bailouts) are stunted growth for good businesses
> and propagation of bad ones. Artificially propping up asset prices
> means that those who are generally less competent remain the custodians
> of society’s capital, and diluting the money supply inflates away
> everyone's wealth over time, particularly harming the poor and middle
> class."
>
> It seems so clear, so how come our policymakers don't get it?
As suggested by my article, and many others I've written over the last year, I consider the chief culprits to be policymakers over the last several decades who've systematically distorted our economy. Sure, I blame loansharks, unethical Wall Street salesmen, and many a mortgage firm for dispensing cheap capital to anyone who'd sign on the dotted line. But ultimately, it was Fed created and Congressionally mandated cheap money that all these parties were playing with.
Timing is an issue on these trades, so I certainly recommend caution in going after the government checkmate. Managing your risk is critical, so I'm a fan of risk-bounded solutions. Here are some suggestions:
1) Short US Treasuries (recommend focusing on 30-year bonds since these are most sensitive to inflation)
-Futures options: buy long OTM put options on ZB (favorite choice)...selling calls is another alternative, but risky given market volatility
-Buy puts on TLT
-Outright short TLT and buy OTM calls to bound risk
2) Short the USD...I'm having a tough time picking a good pair trade currency, but Yen, Swiss Franc, and Renminbi come to mind as possibilities.
-Buy UDN or call options on the ETF (which I did)
-Buy FXY, FXE, CNY, or call options on the first two (also consider FXC and FXA)
-Gold (GLD), gold stocks, or other precious metals or mining stocks (I have GLD calls)
On Jan 10 06:01 AM paultaut wrote:
> I find your Article very interesting because As a Hedge Fund Manager
> and Derivatives Trader, you helped create "This Problem".
>
> Your insight is valuable for that alone.
>
> So I echo RJMoran's question, when do you start shorting?
>
> My question is "what vehicles" are you shorting? Futures, ETFs, ETNs,
> If futures, what contract months?
>
> Not having your expertise, what would be our safest way to short
> the USD and the 30 yr. T Bond.
>
> Or maybe we should just buy TIPS?
>
I have plenty of ideas for solutions, but that was not the nature of the article. Wanted to give a few investment options, not my political ideas. To name a few, however, here's what America can do to remedy our decline:
1) Deeply cut our military empire, reduce the size of the standing army and bring troops back from most overseas outposts
2) Identify and eliminate major policy areas that are distorting our economy, i.e. HUD, Federal Reserve, Social Security, Medicare, Medicaid, HMO Act of 1973, to name just a few
3) Eliminate all bailout programs; let the market work...we drastically need to shed overcapacity and reallocate capital to productive activities. This will take time and pain, but is the result of decades of bad policy.
4) Make it illegal for Congress to spend more than it takes in on an annual basis; deficit spending enables bad habits
5) Alter the tax code to free productivity and encourage savings and other good behavior; the Fair Tax is one reasonable alternative
These are just a handful of ideas off the top of my head. Perfectly willing to discuss in greater detail.
Cheers!
On Jan 10 01:52 PM mavericks wrote:
> This article only regurgitates alot of what already is widely assumed...treasuries
> and dollar to collapse, gold goes to the moon. With so many expecting
> this outcome, I'm wondering if it is a contrarian indicator.
>
> I Hope your'e right but if you're not, your long GLD and UDN offer
> no yield really and your short TLT will force you to pay the dividend
> each month to the owner of your short shares. But you, and many on
> this board, are thoroughly convinced that there can be no other outcome.
> I, for one, am more interested in garnering yield in these tough
> times while keeping a portfolio hedged just in case.
>
> Oh, and using the Shepard Fairey graphic for your headshot while
> dissing the Govt. and Obama seems a little hypocritical since I don't
> think you are offering much in how to make things better...only in
> how you can profit.
On Jan 10 07:25 PM istartedi wrote:
> The only trouble is, the government can remain irrational longer
> than you can remain solvent. The duration of the deflationary cycle
> is unpredictable. Will we turn the corner and start inflating right
> after Obama takes office? At the end of 2009? After all the option
> ARMs have blown up in 2012?
>
> In the meantime, your investments in gold, foreign currency, foreign
> equities, etc. may continue to decline.
>
> I think averaging into some of these other assets might be prudent.
> I wouldn't short the dollar; but then I wouldn't short anything.
> It's way too easy to get burned in the short run.
Other than that great article. I have been telling my economics students your tax/borrow/print altenatives for decades...i hope the hordes out there have taken this advice to heart.
cyclingscholar
I totally agree with the proposals but totally disagree with both degree, time frame and selection of vehicles to use.
The proposals should be Insurance, not a 100% investment philosophy.
A % of total assets should be assigned, the time to do so would be after the USD starts to decline and the vehicles should not be High Risk in themselves.
Faber has an interesting comment(paraphrased) in Barron's this weekend: Some say the dollar will collapse this year...Against what?, The Euro?, Ruble?...In the Very Long Run...own physical platinum, gold, silver...
not derivatives.
Since he has been one of my favorite writers for 30 years. I will stick to his recommendations.
Insurance is great, no problem. It is insurance, treat it as such. An Insurance Salesman will tell you to buy every type of Insurance.
I would just prefer to insure my portfolio. I would also like to see that any insurance bought is not subject to market forces which will erase its value before it begins to bear fruit.
Marc Faber's "in the very long run" does not translate into "tommorow" for myself.
-- Kind of like a druggie trying not to come down from a high. Give me more!
Teutonic Knight: SCENARIO #1: "US$ Devaluation. This scenario is unlikely because if indeed it is officially declared, countries around the world would simply follow suit."
-- Ah, but what does this do to all our debt? Wipes it out, doesn't it? So even if every country devalued together, all that debt we have accumulated over the decades would be effectively defaulted.
Rob Viglione: "I excluded taxation since it is outside the realm of political possibility during economic contraction."
-- Wouldn't it have made sense to add a tax surcharge during the good times so we could responsibly cut taxes and increase spending now that the proverbial rainy day has arrived? Most of the last 25 years have been prosperous. It seems like we only use half of the Keynesian prescription -- stimulate when times are bad -- and skip the save more/slow the economy when it's hot part.
Politicians are like kids who want everything. The bad part is that they are arrogant enough to believe they can have it all.
On Jan 11 04:18 PM Kunst wrote:
> "Market forces are telling the world to shed unproductive assets
> and shrink capacity, yet central banks and governments around the
> world, in particular the U.S., are refusing to listen. Rather than
> allow markets to snap back to sustainable equilibrium from previously
> artificial highs, the federal government clings to the notion that
> forcibly shuffling resources, propping up asset prices, and diluting
> the money supply will magically save the day."
>
> -- Kind of like a druggie trying not to come down from a high. Give
> me more!
>
> Teutonic Knight: SCENARIO #1: "US$ Devaluation. This scenario is
> unlikely because if indeed it is officially declared, countries around
> the world would simply follow suit."
>
> -- Ah, but what does this do to all our debt? Wipes it out, doesn't
> it? So even if every country devalued together, all that debt we
> have accumulated over the decades would be effectively defaulted.
>
>
> Rob Viglione: "I excluded taxation since it is outside the realm
> of political possibility during economic contraction."
>
> -- Wouldn't it have made sense to add a tax surcharge during the
> good times so we could responsibly cut taxes and increase spending
> now that the proverbial rainy day has arrived? Most of the last
> 25 years have been prosperous. It seems like we only use half of
> the Keynesian prescription -- stimulate when times are bad -- and
> skip the save more/slow the economy when it's hot part.