The Keynesian Solvency Standoff and the Case for Shorting Treasuries

Includes: GLD, IAU, IEF, TBF, TBT, TLT
by: Paco Ahlgren

“Markets can remain irrational longer than you can remain solvent.”

– John Maynard Keynes

I wish I had ten dollars for every market novitiate who had the temerity to enlighten me with the above quote in response to my proclamation that U.S. Treasuries are doomed to fail. Of course, then I’d be holding stacks of paper bearing the face of evil incarnate — Alexander Hamilton. By the way, yes, I did adjust my cliche for inflation.

What, exactly, constitutes “solvency?” Look, everybody knows I hate Keynes. And why shouldn’t I? My God, he even loathed himself by the time he stood before his maker. His theories are preposterous, and he knew it! And with every day that passes, we get ever closer to the inevitable collapse of the American empire, caused by decades of reckless abuse of the financial system by the federal government — all justified by Keynesian theory. I know many of you disagree, so I’m going to point out some of the reasons why you’re wrong.

1. In real (yes, I said real) terms, the U.S. has more outstanding debt than any empire in history. This includes such famous examples as (in no particular order): Rome, Britain, Spain, Portugal, and the USSR — among so many others. And what happens when empires mismanage their currencies? They fail.

2. The American consumer has fueled the U.S. economy for decades. Where did he get his wealth? Primarily by borrowing against his home. Do you think that’s sustainable? See 2007. The American consumer is facing massive unemployment, salary reductions, and bonus evaporations. He isn’t spending now, and he won’t be anytime soon. Thus the primary driver for the U.S. economy is no longer a substantial factor in that economy.

3. On one hand, the government blames Wall Street. I’m not sure how that works, since the government controls the money supply and dictates to Wall Street what it can and cannot do. Was it Wall Street’s fault the government created artificial entities and interest rates to ensure so many unqualified housing loans? The U.S. government was clearly pandering to an ignorant democracy; Wall Street was merely the vehicle. So, fine. The government has at least admitted that the housing bubble existed, and that it was caused by the fact that unqualified borrowers were buying real estate — at absurdly low rates. For decades. So what’s the government’s response to this crisis? Of course! Take interest rates to the lowest levels in history, and leave them there! Encourage stupid lending! Encourage stupid investment! That’s what we’ve always done!

So which is it? Was the housing crisis a mistake or not? Do we stop the abuse of unified, monopolistic currency manipulation, or do we try something new? We can’t have it both ways.

4. The United States is issuing debt in record amounts to support quantitative easing (point number three, above). This means the government is using borrowed money to buy its own debt, in order to keep interest rates artificially low. Confused? Of course you are! Let me help clear the fog… Imagine you borrowed money against your house, then borrowed money from your credit cards to pay the mortgage on your house. Your salary isn’t enough to cover all this debt, so you keep borrowing more money from more credit card companies, in order to pay your previous credit card debt. And your house payment. And so on. And so forth… This is what your government is doing. You can disagree with me until pigs start driving trucks, but you can’t change the math. Period.

5. Today, the DJIA hovers between 10,000 and 11,000. When it goes down, everyone freaks. When it goes up, everyone freaks. But what about gold? In 1999, gold hovered between $200 an ounce, and $300 an ounce. Where was the DJIA? Between 10,000 and 11,000! Please read the first sentence of this point again. Gold is currently at about $1300 an ounce. That’s a record high. You’re asking yourself why this is important. Gold is the ultimate harbinger of coming inflation. Markets are smart. When rates are about to skyrocket, gold is the place investors go. Normally, during strong economic periods, gold prices collapse as investors anticipate low inflation, and strong asset-growth over the long-term. Stock prices soar, as investors anticipate expansionary boons. But that’s not happening. Today, gold moves higher with stocks. Why? Because stocks aren’t really moving higher at all, in real terms — they’re simply increasing in value to account for inflationary price increases.

6. Hoards of people laugh at me, telling me we’re in a deflationary period. Just look at housing, right? As if that were the only metric of rising prices… Have you been to the grocery store lately? The gas pump? Yes, the government wants you to believe that falling housing prices are the ultimate indication of our inflationary (or lack thereof) condition. Really? Didn’t we just establish that the American consumer has been the ultimate driver of the U.S. economy — for decades? If that’s true, then why are we looking at housing as the metric for price acceleration (or deceleration)? Shouldn’t we be looking at the goods and services affecting the consumer most? Energy? Commodities? You think we’re in a deflationary period? You’re deluding yourself. Of course, the American consumer is dead (point number two, above), so these price increases are only further damaging our already fragile economy.

Let’s return to the main point of this article. Yes, I suppose if your only source of income is the rate of return on your investments, then you (and Keynes) are correct: markets can remain irrational longer than you can remain solvent. And in the context of shorting Treasuries (which I’ve been doing since late 2008), that would certainly be a frightening prospect. But I have to ask this question: didn’t Keynes have an alternative source of income? Don’t most of us? In light of that probability, I’m going to modify his famous quote to suit a more realistic context:

Markets can remain irrational (and they certainly have for the last two years). But I have a job, and I have disposable income. The more Treasuries rise, the more I’m going to short them. If I lose my primary source of income, I’ll re-evaluate. But for now, I intend to remain solvent until market irrationality ends, and I intend to profit handsomely from the ignorance and folly that have brought us to this point in history.

You can point to empirical evidence all you like. I encourage you to stand up straight, place your hand over your heart, and sing the National Anthem with boisterous pride. But this is not the constitutional republic founded over two centuries ago with the principles of great minds like John Stuart Mill and Thomas Hobbes. No, your government has been systematically stealing from you, your parents, and your grandparents for over a hundred years. The past is no indication of future performance. Take a deep breath. Do the math. React appropriately.

Disclosures: Paco is long gold and oil, and short Treasuries — all through leveraged ETFs.