Bad Momentum, Bad Fundamentals and 10,000 in the Rearview Mirror

by: Michael Ashton

Yesterday, stocks attempted to add on to Friday’s rally, but the best of intentions wasn’t enough to do it in the face of bad momentum and bad fundamentals. The S&P declined 0.9%, with the Dow perhaps putting 10,000 in the rearview mirror for now by trading to 9908. Yields also rose, with 10y futures declining 12 ticks…pressured, I am sure, by the debt supply this week.

The dollar continues to strengthen, and I am not sure I fully understand that. Of course, there is a knee-jerk response to exit positions in the euro, and at the margin that makes sense to me since any bailing out of Greece would involve a lot of easy money, and any failure to bail out Greece would tend to weaken the union or raise the possibility of its dissolving altogether (this is not something I expect, in the reasonably near-term anyway). But selling the euro to buy the dollar? With our deficit, our debt, our leaders’ studied insouciance when confronting the monumental task of putting the fiscal house back in order? Maybe what Churchill once said about democracy is also true about the buck: it’s the worst (currency unit) around, except for all the others.

But if that is true, then there are clearly alternatives to currency units that preserve wealth better. I am not a fan of physical gold, since it pays no dividend but implies storage and insurance costs, and tends to be subject to much greater tides of fad and fashion than less-lustrous metals, but commodities must be a consideration if people are running to greenbacks because it “sucks less” than paper currencies. Inflation-indexed securities in your domestic currency, which do pay interest, are a superior alternative although subject to the default option if your country doesn’t control its own scrip. Although real yields are very low, we’re talking about safe havens now and surrendering 0-1% in inflation-adjusted terms over the next year or two must warrant some consideration..

Another article yesterday celebrated the “fact” that the unchanged $81bln quarterly refunding implies that the government can fund its much-larger debt this year without increasing auction sizes (and without the benefit of Fed buying, let us not forget). Let’s pretend for a second that we can somehow run the same auctions this year as last year…at least at the end of last year…with the same sizes, and yet raise more money.

A very good article by Robert Samuelson yesterday (“Big Government’s Big Shortfall“) notes that:

By the administration’s estimates, that publicly held debt (the accumulation of all annual deficits) balloons from $5.8 trillion in 2008 to $18.6 trillion in 2020.

Let’s assume too, to be generous, that the government manages to have only 30% of that debt maturing in 2020 (even though, for a very long time, the percentage of marketable debt that has been maturing every year has not fallen below 34% – see Chart below, , Source: Bloomberg).

Same Percentages But Bigger Debt Means Bigger Problems

That would imply that in 2020, the Treasury will need to fund the $1 trillion deficit they project for that year plus another $5.58 trillion of maturing debt, or about $25bln per business day. If 35% is rolling over, the numbers go to $30bln per day. Does anyone think that is sustainable, even on the generous assumption that the Administration’s numbers – which, remember, imply an uninterrupted decade-long expansion – are accurate? If we can’t do that in 2020, then sometime between now and then there will be a crisis. And the result of that crisis will very likely be that the value of those dollars changes markedly.

Because I mentioned Robert Samuelson just now, I want to also mention a book of his that I recently finished reading. The title of the book is The Great Inflation and Its Aftermath: The Past and Future of American Affluence. It is interesting partly because it was published in 2008 and at that time, the Great Inflation was considered by many “the worst domestic policy blunder of the postwar era” (as the dust jacket says). I think there is a new blunder or set of blunders that must be considered, but it is very instructive to look at the anatomy of the prior blunder and consider whether we are any more likely to avoid them this time.

I don’t agree with all of Samuelson’s explanations about what caused the inflation, nor all of his theses about the results, but it would be startling if, given a book of this depth and breadth on a topic I feel strongly about, I did. But his reasoning is very plausible and I think he lays out the hidden costs of inflation (as opposed to the direct costs that rapidly changing price levels cause) very well. Costs like the way society changed as a result of dealing with inflation. There are also, quite apart from the backstory about inflation, some very insightful nuggets that it would do us well to think about deeply right now, such as this one:

‘Capitalism’ is a term of art. There’s no precise definition, though there are some basic requirements. A capitalist system must permit private property, must tolerate relatively free markets and must endorse the social value of economic risk taking – meaning that people who take greater risks or who work harder can earn greater rewards. Up to a point, inequality is accepted as a necessary and desirable incentive for talent, effort, and innovation.

I hate to say it, but that doesn’t sound like any Western economy I know.

There is another little blurb worth thinking about, and he hits on some of the same themes in the column linked to above. In talking about certain entitlements, in particular Social Security and Medicare, Samuelson opines:

The fact that we haven’t made these and other changes says a lot about the welfare state. It is a profoundly conservative institution. It favors the past over the future. For recipients, the very act of receiving – or being promised – benefits creates a moral right to receive them, even if the original circumstances that justified them have vanished. Not by accident do we call these benefits ‘entitlements’ as opposed to the more straightforward term ‘welfare’…the self-serving vocabulary avoids the pejorative stigma of ‘welfare,’ which in America signals charity or a handout.

This is very insightful, and reminds me of some of the observation behavioral economics expert Robert Shiller has said. And it provides a brilliant place to start changing the debate about Social Security. Let’s first just pass a bill changing its name to “Oldster Welfare,” and see how long it takes for some people to decide they don’t want it, or don’t feel it ought to be handed out to people who “don’t need welfare.” I think the national dialogue would completely change, maybe overnight. Let’s do it. You first...

Today, the market will absorb ABC Consumer Confidence and not much else on the economic calendar. Some more auctions, of course (1y and 3y securities)…what else is new? And folks on the Eastern seaboard will stampede grocery stores to prepare for the next wave of snowstorms, due to arrive tonight and blow all day on Wednesday. And economic bulls will plot how that will somehow excuse any bad economic data over the next month, since after all I guess it doesn’t snow most winters. (???)

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