Three Urban Legends on Wall Street Today

I am sure you have heard of the term “urban legends”, or at least seen the movie based upon superstition and coincidence. Urban legends go something like this, “If you put alka-seltzer in your bird seed and a bird eats it, his stomach will explode” or “If you go past the graveyard on the night that so and so died, the light will flicker 3 times”. Fear and the “unexplainable” factor make for a juicy urban legend. Since our investment decisions are driven by either fear (running for safety) or greed (joining the bull run), let's take a look at some of the urban legends on the Street today.

1. China and other foreign buyers will stop buying U.S. dominated government bonds, hence sending us into The next Great Depression. (Play spooky music here). The funny part here is that China increased its purchases of U.S. Treasuries last year by 46 percent to $696.2 billion. Guess what? We are stuck with each other now. The biggest net exporter in the history of the world is married to the biggest consumer nation in the history of the world. China would be cutting off its nose despite its face if they stopped supporting U.S. government debt. That is why Fang Shangpu, deputy director at the State Administration for Foreign Exchange, told a press conference in Beijing Wednesday, “We hope countries whose currencies are the main holdings in our international reserves will take effective measures to cope with the financial crisis. They should work to maintain economic and financial stability, and protect the interests and confidence of investors.” This is basically screaming “Holy Smokes, we are in deep here, you scratch my back and I will scratch your back. You cover us for what we already own and we won’t pull the rug out on you.” This is a classic win-win situation or lose-lose situation, and neither party wants the lose-lose outcome.

The other part is the fear monger factor. If the end of the world is just around the corner, and you had to bet on one country surviving and someday prospering, what country would it be? When push comes to shove, and you need to make sure you at least get your money back so that you can live to fight another day, U.S. government debt is what the world will buy with the thinking being “If the U.S. government goes under, I think we have bigger problems than our investments”. If the end of the world happens, do you want to be long the Euro? How about government bonds from Vietnam or Brazil? If safety is of the utmost importance, as it will be if the Dow hits 5000, the world will still turn to the US government as the safest play since they will be the last man standing if we turn into Planet of the Apes, enormous debt and all. You will see Charlton Heston gazing at a buried Statue of Liberty, kneeling in wet sand screaming, “Damn you apes, what have you done!! And by the way, what is the 30 year trading at!!???”

2. The U.S. financial systems, and the financial systems of the world, are insolvent. The interesting part of this one is the sentence that is never said after that sentence. “What does that mean, I mean, in real life?” Do we wake up one day and all the banks are closed or bankrupt? All our money on deposit is gone or only insured up to $100,000? Do people go from millionaires to hundred-thousandaires?

Even if we get clobbered on real estate and deleveraging for years, there will always be banks. Just like there will always be a police force. Banks and police are part of keeping law and order, just in different terms. Governments will take on massive debt and deal with inflation before they allow the world wide banking system to go belly up. Is it fair to the taxpayer? No. Will some rich bankers make a killing? Yes. Are the consequences of not bailing out banks far greater than the alternative? Yes! Call it the IOU bank, the World Bad Bank, the Badass Bank of the Word, we will create it, we will fund it, and life will go on.

How do we know this is a headline urban legend? Google (GOOG) is trading at $351 and Apple (AAPL), without Steve Jobs, is trading at $95. Really? So we are about to experience the world-wide financial meltdown to end all meltdowns, and two tech companies that are completely non-essential to human survival are finding buyers to drive them up. One company makes high-end, non-essential, although very nice, gadgets, and they are up almost 20% since their November lows? The other, the advertiser of last resort, caught in the biggest consumer and retail pullback of 5 generations, is up 40% since its November lows? How can we be in the biggest consumer driven recession and the biggest advertising network in the world is up 40% in 90 odd days? Which begs the question, are people using their iPhones to search Google for the best deals on rifles, bread, and clean water, as they prepare for the end of the world?

3. Times are horrific, this is the next Great Depression. Do you know how this is an urban legend? Check out every story about unemployment, contracting GDP, or any other bad news out there and you will see a common theme. They all either go back to 1981 or 1970. “This is the worst report since 1981” or “This is the lowest level for this since the 1970s!” Really? The country was founded in 1776, and we have to go back a whooping 20 or 30 years to find when times were this bad? I am not saying things are good, or aren’t going to get worse, but does a generational changing recession only go back to 1970? I checked and every Super Bowl and World Series was played in the 1970s. I even found out Disney World was open every day it was supposed to be open in the 1970s. I don’t remember the world ending then. I remember gas lines, license plates, stagflation, and tough times, but no shot guns and food riots. The only thing I can find that tells me we are pricing in for the next Great Depression is the corporate bond default rate. I guess that is why everyone is piling into corporate bonds now, getting ready for some deflation and stagflation.

In conclusion, don’t get carried away by headlines and urban legends. They are made to sell newspapers, get you to click your mouse, or open an email. Check out Bob Doll, vice president of Blackrock, and his cautiously optimistic views. Check out Warren Buffett loading up on fixed income type convertibles of U.S. companies. No gold or U.S. treasuries in his latest Berkshire (BRK.A) snapshot, no end of the world prognostication from the Oracle of Omaha. As Jamie Dimon said recently, “This country has had big problems before. This is not the first. If we face them head-on and look at the full set of problems that were made and created, we have real solutions and policies for them, we will reform like we have in the past and we will move on like we have in the past. Hopefully that will be this year, later this year, as opposed to sometime in 2010, but we don't know."

Comments

[Ferdinand E...:]

I'm an optimist, but this article is almost too optimistic. However, let's face it. If there is a way out of this mess, Obama will employ the people who can find it. Better him than somebody who wanted to distract the voters with another hundred years of war in order to win a war in Iraq that was won five years ago. And speaking of wars, why not just shut the Afghanistan gig down.

Feb 19 08:04 AM

[patio:]

4. "It's different this time." The great paradox is, it is always different, and yet the same. Cycles, although different in amplitude and wavelength, are still just cycles.
5. " The US is kaput, the Chinese century is about to begin, if it isn't there already". Yes, we have some issues to work through. But consider:
- US GDP is $14T, vs. world GDP of $54T
- #2 is Japan, at $4T; I'd say we're still pretty much the big dog for a spell, since we're bigger than Japan, China, Germany, and UK combied
- our industrial production, thats over, right? Nope, $3T, over twice the size of #2 Japan.
- Oil? USA produces 8.3 mb/d, lower than 9.7 Russia and 10.7, but still...
We import a lot of oil, but because our industrial production is huge. Oh, we're second only to Russia in natural gas
- our population density is very low; we have lots of room left
- our military does cost us a lot, but we control the world's oceans, never been done in history prior to us.
- The US will dominate this century, no one else compares to us, flaws and all- and they all know it
( Thanks, George Friedman )

Feb 19 08:09 AM

[bored2tears:]

"Cutting off its nose despite its face."

Really? Really???

Feb 19 08:30 AM

[Drobezisi:]

Hallelujah, brother! Can I get an 'Amen!' Thank you for putting some perspective on the travesty that is going on in the markets right now. Yes, things are bad, and as you said, they may even get worse, but it is not the end of the Free World as we know it. In fact, I suspect that some good may even come out of it when the historians look back (after checking their iPhones and taking a sip from a Starbuck's double-caramel-mocha no-foam latte) on it a few years from now. Yes, there will be winners and losers, but right now the market's biggest enemy is the market itself. Kind of like the guy that rips a plank out of the lifeboat to make sure he can float if the boat sinks. Well, duh.

Funny thing is, a lot of the people that are running for the fallout shelters right now probably aren't old enough to remember the 1970s - which is one of the reason panic is running rampant and urban legends abound.

Feb 19 08:36 AM

[Fabien Hug:]

Good perspective and we'll wait for the end of the world after we are all gone. I am reasonably certain that the measures taken by the governments will work. Will they stop soon enough is another problem but not the problem now.

Feb 19 09:13 AM

[kelm:]

There were multiple communications from China last week through multiple avenues all pointing out their concern about the fiscal direction the US is going in. Taken together I think they point to China communicating to us that, though they may still buy bonds, we should not count on them to increase purchases or even maintain the level of purchases we have seen in the past. Looking at recent news China is clearly executing a strategy to buy hard commodity related assets worldwide with their foreign exchange holdings and are waving off from purchases of foreign financial assets.

I'd also point out that last week the ECB raised concerns about states risking loss of confidence because of their prolific bond issuance's and the Financial Times ran an article Monday indicating that Gulf Sovereign Wealth funds were growing increasingly concerned about holding US paper.

The likelihood of China dumping all of their Treasuries is nil. In any market though prices are set at the margin. Given $2.5 trillion in bonds to auction this year (vs. $890 billion last year) there is a lot of room for error.

And I do remember the 70's and this crisis is very different

Feb 19 09:25 AM

[User 356279:]

Sorry to say it, but this whole article is an urban legend in itself. The author does a great disservice to play Pollyanna about these issues. To call potential problems urban legends is disingenuous.

While it is true that China and the U.S. are current partners on a sinking ship, the idea that the consumerism based on debt and trade deficits will continue for infinity is ludicrous.

The U.S., as China’s consumer base, will lose it’s value as the debt creation and trade deficit spending on credit continues. The ultimate result can only be that the U.S. is drained of all it’s wealth and China will own everything. At that point there will be no partnership to protect.

As the dollar loses value, the consumers in the U.S. will not be very good customers.

Most of the defenders of the present status quo are stuck in the illogic of the system they think can still work.

By the way, Charlton Heston was not damning the apes. He was damming the humans for the destruction of civilization. I think you missed the point. And I think you missed the point on most of you observations in this article.

Feb 19 09:45 AM

[Larrysyr:]

This recession is different in being a deflationary credit contraction rather than a monetary fight against inflation. But your perspective is right on.

I remember growing up in the 70s, the gas lines, the price of common items going up every time I went to the store. While it hurts to have the value of my stocks and IRA collapse, I have not noticed gas lines, food riots, or other signs of civil unrest.

It certainly could happen, but ee have a long way to go before it REALLY gets bad.

Feb 19 09:49 AM

[Pat Shuff:]

Comparisons to previous eras is apple to oranges because of three hockey stick-style charts..debt, debt and more debt.
Every debt is eventually repaid, if not by the debtor then by the creditor.

Feb 19 10:07 AM

[User 143167:]

China will buy the US Treasuries, but the problem is how much. China ran a surplus of $30billion with all countries. and even if they put all those money into treasuries, it still won't be enough.
Also, China's surplus is from all over the world, if they put all these money back to the US, it means they drive the liquidity out of Eurozone, Japan, etc to the US and it will devascate the world's economy as well.
Furthermore, with the slumping US importation, the surplus in China will soon shrink and they can't maintain their pace of government debt purchasing, even if they want to.

Feb 19 11:10 AM

[Tony Petroski:]

Stockton Sage: Very entertaining and insightful article. Are you a pirate? "I checked every Super Bowl and World Series played in the 1970's" Very funny stuff. More articles please.

Feb 19 11:14 AM

[Stock Marke...:]

Jamie Dimon joins the list with Mogan Stanley and Goldman Sachs..

Settling Up with the Government
JPMorgan chief Jamie Dimon partners up with the government and plans to give TARP money back, reports CNBC's Charlie Gasparino; with Wilbur Ross Jr., WL Ross & Co.

Feb 19 11:32 AM

[biomedlives:]

I suspect the British might dispute the notion that no other nation has ever controlled the world's oceans. More important, how much good does our control do us? We don't exact a toll from every voyage that a cargo ship or tanker sails.

On Feb 19 08:09 AM patio wrote:

> 4. "It's different this time." The great paradox is, it is always
> different, and yet the same. Cycles, although different in amplitude
> and wavelength, are still just cycles.
> 5. " The US is kaput, the Chinese century is about to begin, if it
> isn't there already". Yes, we have some issues to work through. But
> consider:
> - US GDP is $14T, vs. world GDP of $54T
> - #2 is Japan, at $4T; I'd say we're still pretty much the big dog
> for a spell, since we're bigger than Japan, China, Germany, and UK
> combied
> - our industrial production, thats over, right? Nope, $3T, over twice
> the size of #2 Japan.
> - Oil? USA produces 8.3 mb/d, lower than 9.7 Russia and 10.7, but
> still...
> We import a lot of oil, but because our industrial production is
> huge. Oh, we're second only to Russia in natural gas
> - our population density is very low; we have lots of room left

>
> - our military does cost us a lot, but we control the world's oceans,
> never been done in history prior to us.
> - The US will dominate this century, no one else compares to us,
> flaws and all- and they all know it
> ( Thanks, George Friedman )

Feb 19 01:54 PM

[toobad41:]

I loved this article. You might say that the sun will come up tomorrow just as it did today. I lived through the 40's, 50's, 60's, 70's, 80's, 90's and hopefully through the first decade of the 21st century. Maybe into the second decade as well. The more things change the more they stay the same. Greed, fear and control are what this world is all about.

Feb 19 02:12 PM

[grh1212:]

I was an adult during gthe 1970s and, of course, remember the times very well. We were living in OK and there was no shortage of gasoline and when we went on vacation via auto to the backwoods of NM there was no shortage there either. I believe the shortage was carefully staged where it would do the most media "good". There were certainly no riots. We Americans are a passive lot in terms of social protest, perhaps to our detriment.


On Feb 19 09:49 AM Larrysyr wrote:

> This recession is different in being a deflationary credit contraction
> rather than a monetary fight against inflation. But your perspective
> is right on.
>
> I remember growing up in the 70s, the gas lines, the price of common
> items going up every time I went to the store. While it hurts to
> have the value of my stocks and IRA collapse, I have not noticed
> gas lines, food riots, or other signs of civil unrest.
>
> It certainly could happen, but ee have a long way to go before it
> REALLY gets bad.

Feb 19 04:15 PM

[kalasend:]

Speaking of paradox, you've just given an example:
4) "...it is always different, and yet the same"
5) "...no, it will different this time, the giant won't fall"


On Feb 19 08:09 AM patio wrote:

> 4. "It's different this time." The great paradox is, it is always
> different, and yet the same. Cycles, although different in amplitude
> and wavelength, are still just cycles.
> 5. " The US is kaput, the Chinese century is about to begin, if it
> isn't there already". Yes, we have some issues to work through. But
> consider:
> - US GDP is $14T, vs. world GDP of $54T
> - #2 is Japan, at $4T; I'd say we're still pretty much the big dog
> for a spell, since we're bigger than Japan, China, Germany, and UK
> combied
> - our industrial production, thats over, right? Nope, $3T, over twice
> the size of #2 Japan.
> - Oil? USA produces 8.3 mb/d, lower than 9.7 Russia and 10.7, but
> still...
> We import a lot of oil, but because our industrial production is
> huge. Oh, we're second only to Russia in natural gas
> - our population density is very low; we have lots of room left

>
> - our military does cost us a lot, but we control the world's oceans,
> never been done in history prior to us.
> - The US will dominate this century, no one else compares to us,
> flaws and all- and they all know it
> ( Thanks, George Friedman )

Feb 19 09:46 PM

[auto44:]

The politicians in China are way smarter than ours. They understand finance and commerce and the value of commodities. For a country that came from so far behind and a history steeped in ignorance they are coming on like gangbusters with the indians not far behind. if you think for one moment that the're not going to continue to move up on the rest of the world that mostly shuffles paper for a living you are sadly mistaken. As education and medicine advance on this continent there is a rapidly rising tide of success. There are two types of money pumps, big companies like GE used to make things here and sell them all over the world and pump money back here. Today the malls buy mostly junk from all over the world we could do without, but just gota have, until we quickly send it to the land fill, which we pay for with a 20% credit card and pump our dollars out. Tell me where you see optomisim here and tell me where I am wrong. Is the world going to end or is the standard of living we enjoy sinking slowly in to the east?

Feb 19 10:04 PM

[User 337783:]

for all consideration:

China has been around a lot longer than the US. While seemingly backward to us for centuries, thier long existence speaks for it's self.

Could it be that they, not us, are smarted? Perhaps they have learned much over the centuries? Perhaps they know something we don't? Thay sure are accumulating a lot of commodities and barter deals. You don't last this long and not learn of few things. Ya know those Chinese proverbs might mean something.

They can easily dump our debt. They are a God-less country w/no mercy toward anyone especially their own people. They are still communist w/inherent desire to take from those who have and decide who gets what's let over after the politicians get theirs.

I think the trap has been set and ready to spring shut. Kreshev thought he could take us over "w/o a shot being fired." If we aren't vigilant, Chinese food may be a whole lot more prevelant in the US. I don't like rice!

With all the forecasting of economic opinion, perhaps it's getting time to interject our God into this. He, not us, has the last Word/Will. Lord help, again, please!

Mar 01 08:23 AM