Paul Brodsky

An Adult Approach – I (Investing in a Vulgar Age)

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If profanity is the weapon of the witless then how does one best describe something profane? Global policy makers are meddling in markets so that the economies they feel responsible for can achieve what seems to be a consensus objective of muddling through. A policy of meddling to muddle, if you will. Today’s meddling policy, broadly defined as manufacturing and distributing new base money, is a necessary follow-up to yesterday’s meddling policy, broadly defined as aggressively promoting when-issued base money (i.e. credit). In other words, policy makers must now rob Peter and Paul to pay Jamie, which is only slightly more acceptable than the previous policy of robbing Peter’s and Paul’s children to pay Lloyd. We have children, including young girls (sugar and spice and all that), but quite honestly the only apt response for this vulgar state of affairs is: “WTF?”

The entire display of hubris among global economic policy makers is almost too repulsive to bear – even more so than the leap year sporting event commonly known as “letting Americans believe their plutocracy is a democracy” “The Great American Media Buy” the “U.S. Presidential Election”. To quote a headliner in this year’s quadrennial circus, it “is as close to despicable as anything (we) can imagine”.

We are humble investors and it is not our occupation to sling judgmental Shinola. But it is undeniable that we exist, as do you, and therefore have a stake in the actions of fired-up world improvers oddly wired to believe unequivocally that motion is progress while demonstrating great finesse in assuring a minimum gets done. As you opened this piece not for a cynical (and increasingly trite) rant about the absurdities of contemporary authority but, we imagine, for a somewhat reasoned assessment of macroeconomic circumstances and how they may relate to makin’ money, we will try to calm our Tourette’s for a couple of thousand words. No guarantees, of course.

It is the Currency, Stupid.

Whether or not Greece will meet its debt obligations in March and beyond has little to do with Greek wherewithal and output. Everyone knows Greece is insolvent and cannot meet its March 20 payment. Nevertheless, bets are being made quite aggressively in the capital markets handicapping sovereign bailouts. As it stands today the debate surrounds how much to haircut Greek debt and through which entities the bailout would pass.

Were Greece the only insolvent sovereign then most would think it would have already been bailed out. But the dubious balance sheets of other sovereigns like Portugal and Ireland (and Italy and Spain) demand that both sides, creditors holding Greek debt and solvent sovereigns like Germany ostensibly on the hook to pay them, try to find acceptable terms. The parties involved are not only negotiating about Greek debt. They are no doubt posturing for future negotiations as well. Many if not most Greek creditors, (and certainly the most active investors in negotiations), bought their bonds and CDS in the secondary market in anticipation of this workout. Both sides are concerned with establishing precedent. Whatever discount-to-par creditors take on the March 20 sovereign Greek debt payment would establish benchmark terms for other struggling Euro sovereigns as well.

Thus, it is possible that the valuation of sovereign debt across all Euro nations will be established in relatively short order. This would conceivably indicate how much new currency the ECB would have to manufacture, which in turn would allow a more knowable valuation of the Euro vis-à-vis other major currencies. Perhaps this is why all those EURUSD shorts we keep hearing about have not succeeded in taking the Euro down? (And it still amazes us that media still do not understand that for every seller there is a buyer. Maybe they should learn to report which side, buyers or sellers, is most vociferous or has the shortest time horizon?) Nevertheless, we think ongoing currency exchange rates have been more or less accurately discounting the outcome and timing of the Greek debt workout, which in turn would establish a benchmark for sovereign debt haircuts across the Eurozone.

Strange too that public attention seems focused on the players rather than the process, as though it is a multi-front knife fight, a scatological war between politicians, taxpayers, hedge fund speculators, the ECB, IMF, and acronym-laden conduit vehicles. It is much simpler than that, in our view. The whole affair reduces to bond holders on one side and central banks on the other. After all, central banks are the only entities that can ultimately print the necessary money to service the debt and repay the creditors.

The ECB, Fed, PBoC, BOJ, BOE, SNB, Bundesbank & Banque de France have the biggest stakes in exerting austerity on profligate societies because they manufacture the world’s benchmark currencies through which all wealth and power is commonly judged. As central banks enjoy unilateral monopoly power over manufacturing the world’s money with which to repay sovereign (and corporate and household) debt, they have omnipotent control over establishing terms over indebted societies. (For those arguing Plutocracy! here is the basis of your claim.)

To be sure, central banks with insolvent sovereigns are the ones with the highest balance sheet growth rates. We thank James Bianco for the graph below showing the ECB’s balance sheet grew 44% over the last six months:

Chart: ECB Balance Sheet

Source: James Bianco; “Living in a QE World”; January 27, 2012; posted at The Big Picture

As everyone knows, the EU lacks fiscal unity which means the ECB is the focal point of intense public scrutiny when it comes to money printing for member nations. (As our friend Marshal Auerback informs, actual money printing is still done at the national central bank level, but the “orders” are placed by the ECB.) The problem for The Bank of Greece is that it must appeal to the ECB for help and the ECB is controlled by Germany, an economy in surplus. According to the BOG’s website, it “is responsible for implementing the Eurosystem’s monetary policy in Greece and safeguarding the stability of the Greek financial system”. We note the BOG has no mandate to reverse an already destabilized EU or Greek financial system.

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