Good Evening: Yesterday’s stock market rally continued today when neither the earnings reports nor the economic releases contained any bombshells. CSX, JNJ, and GS all reported positive earnings, though only Goldman really surprised to the upside. Of course, since GS had its rally yesterday after the Whitney upgrade, the company’s shares barely managed to hold on to Monday’s gains. The action in GS shares was just one more reminder that expectations and pre-positioning matter just as much as the actual news when earnings are released. All in all, it was a pretty lackluster trading session. Perhaps the best way to spice up an otherwise dull day will be to examine the latest thoughts from Nassim Taleb and others on the subject of how piling on more debt during a debt crisis will only make the problem worse over time. Let’s first get a handle on the dimmdimensionthe problem facing our Treasury by hearing from Eric Sprott before we turn to Mr. Taleb for a potential answer.
U.S. stock index futures were up a bit overnight, though not as strongly as the overseas bourses that played a bit of catch up ball after Monday’s up move in Wall Street. Retail sales and PPI were both disappointing in that each statistic had a stagflationary feel (see below). Ex the sales of both autos and gasoline, the retail sales figures were well below expectations. But with the earnings news taking center stage, these data points were mostly shrugged off. After opening a touch higher, equities paid an early visit to negative territory before recovering in the late morning.
The rest of the day was then spent moving mostly sideways on light volume. The gains in the major averages ranged from the Dow’s +0.3% to +1.3% for the Dow Transports. Treasurys were hammered after the PPI data pointed to some potential pressure building in the inflation pipeline. Whether these rising raw costs ever reach their end markets is different matter, but yields rose between 4 bps and 15 bps as the yield curve resumed its steepening trend. The dollar was mixed against its rivals, but commodity prices were firm, anyway. Copper and natural gas were the standout performers helping to lift the CRB index to a gain of 1.1%.
“Central bankers and finance ministers have achieved an uncommon meeting of the minds. The cure for what ails us is the hair of the dog that bit us, they prescribe, though not exactly in those words”. (Jim Grant, Grant’s Interest Rate Observer, July 10, 2009 — www.grantspub.com)
As is almost always the case, Jim Grant has it right when it comes to describing the open-throttled approach to monetary and fiscal policy around the world these days. To Jim’s clear voice, I add two others (see last articles below). In “The Solution…is the Problem”, authors Eric Sprott and David Franklin break down into raw numbers what we all know in our guts is a glut of governmental debt issuance. They break down the total U.S. Public Debt (as of September 2008) by the 11 broad categories of those who now hold it (a.k.a. our creditors). The authors make a compelling case that the math is hard enough to reconcile with a public debt of just more than $10 trillion. The current holders and other prospective Treasury buyers will likely demand higher interest rates as compensation for absorbing all the net new debt we’ll have to issue during the next few years. We’ve added another trillion to this total in just the past nine months, so it’s hard to see how the U.S. won’t be facing higher interest rates, a lower dollar, or perhaps even a funding crisis of sorts as we move through time.
Time is something we just don’t have, assert Nassim Nicholas Taleb and Mark Spitznagel, the authors of a piece in today’s Financial Times. Debt and way too much of it is what got us into this mess, and piling on more of it at the governmental level will only add to systemic instability, in their view. To them, debt is a pernicious and inflexible way to finance assets and enterprises. The risks are binary — and hidden — until the debtor cannot pay (at which point it’s too late to calmly address the problem). Debt makes for a fragile economic system, one that is highly vulnerable to cyclical downturns, secular shifts, and the occasional external shocks imposed by Mr. Taleb’s famous “Black Swans”. Equity, by contrast, is a hardier and more flexible form of capital, one that is by nature more volatile but also more transparent (the risks are more visible).
Eschewing the “stimulus and more debt” prescriptions from some of the same misguided economic minds that helped us into the credit crisis, Taleb and Spitznagel instead offer a very simple way out — a massive and pervasive exchange of equity for debt at all levels of the economy. Much the same way an overly indebted corporation seeks to restructure its balance sheet in a Chapter 11 proceeding by handing over ownership of the company to the creditors in exchange for a more manageable debt burden, the authors propose a similar swap needs to now take place among various individuals, corporations, financial institutions and the pools of capital that finance them.
If only it were that easy. In our contentious and litigious society, debtors, creditors, and stakeholders don’t make such equity for debt exchanges without at least a chat – accompanied, of course, by a battery of lawyers. Such swaps, even the appealing one proposed by the authors for residential mortgages, will be both difficult and time consuming. Then again, given the Obama administration’s strong arm tactics with the creditors of both Chrysler and GM, perhaps Washington will simply, in Wall Street parlance, “make it happen”. Considering the daunting Treasury issuance looming as the baby boom generation transitions from net contributors to net drainers of our social safety net programs, we should try to tackle this problem sooner rather than later. If the solutions we’re trying now are indeed part of the problem, then we need to find innovative, market-mindful ways of encouraging exchanges of old debt for new equity. It would be the type of change we could all believe in.
— Jack McHugh
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The Solution is the Problem
Time to tackle the real evil: too much debt