Another Prognostication

Predictions are fun to make despite the fact they are so often wrong.

Now... we've already established that the theme for 2010 is Debt... debt and the recession.

In reality a severe recession would be a good thing for us.

After having gone through a decade of borrowing to consume, Canada needs to rebalance.

This recession was caused not by too much inventory but by too much credit and leverage in the system. And the world is in the process of deleveraging. It is a process that is nowhere near complete. While the crisis stage is over (at least for now), there is still a lot of debt to be retired on the consumer side of the equation, and a lot of debt to be written off on the financial-system side.

Total consumer debt is shrinking for the first time in 60 years. And the decline shows no sign of abating.

That's why the recession is the solution, not the problem. The problem was the bubble inflating, blowing up. Not the deflation. Now it's time to allow the pain, no matter how unpleasant it is, to correct the imbalances.

And it's not just consumers who are attempting to deleverage. The corporate sector is trying to deleverage too, as Bloomberg notes in an article today. The amount of corporate debt outstanding globally shrank for the first time in at least 15 years in the first half of 2009 as U.S. banks reduced the size of their balance sheets.

Tetsuo Ishihara, a senior credit analyst for Mizuho in Tokyo, analyzed data from the Bank for International Settlements and noted that “it’s unprecedented that the global debt market shrinks. When redemption's and buybacks are greater than new issues the outstanding size can shrink, which appears to have happened here.”

Financial companies in the Americas had $1.1 trillion of losses and writedowns since the credit crunch started in 2007, about 65% of the global total, according to data compiled by Bloomberg.

But in Canada, none of that deleveraging has happened... and it's all because of the Federal Government.

As this blog has already covered, the Feds slashed interest rates to dirt and empowered CMHC to expand their assistance into risker and risker home mortgages. It used to be that the mission of CMHC was to try and make home ownership affordable. Now their mission is to keep home prices high.

And this is where the government is making a huge mistake. The reality is that the best thing that can happen to our economy is for these high prices to come down.

But the government’s solution was to keep high prices through low mortgage payments subsidized by the government.

The free market solution would have been allowing the market to correct to bring us low prices.

If real estate prices go down, you don’t need to borrow that much money to buy a house. And if they do, it doesn’t matter that interest rates go up a bit, because your payment will be lower anyway.

But that didn't happen. Carney and Flaherty intervened and their actions have kept homes unaffordable. It ensures Canadians have to mortgage themselves to the hilt to buy a house.

Rather than help Canadians, Carney and Flaherty have made it worse. In 2010 we will see that this will become the foundation of our financial crisis.

The government looked at the problem as being one of falling real estate prices. That’s wasn't the problem, that was the solution.

The problem is that they went up to begin with.

The reality is that the world is just starting to go through a massive – and necessary – recession. Some think it is just ending. It isn't, its just getting started and we have barely gotten a taste of it.

What we really need is for the government to eliminate the deficit and go to a surplus. We need the government to stop spending money and depleting our savings (by taxing us to death).

We need consumers to stop spending money and rebuild their savings.

We need to have the government say to us, “this is the price we pay for years of indulgence and reckless spending, now comes the sacrifice. And there is nothing the government can do about it.”

We also need sound money.

Unfortunately that will mean we need high interest rates.

Kenneth Rogoff, Professor of Economics at Harvard, Former Chief Economist at the International Monetary Fund recently said, “It’s a question of how do you achieve the deleveraging. Do you go through a long period of slow growth, high savings and many legal problems or do you accept higher inflation? It would ameliorate the debt bomb and help us work through the deleveraging process.”

The developed world is drowning in debt and there are only two viable options – a global economic depression or very high inflation.

It seems policymakers have chosen the latter option and over the next few years we seem destined to experience the trauma of severe inflation regardless of Ben Bernanke's assurances to the contrary.

The American government is staring at total obligations of US$115 trillion, their debt to GDP ratio is off the charts and the American public is also up to its eyeballs in debt.

Inflation seems to be the chosen solution.

And that means Canada will be forced to deal with a readjustment that hasn't been prevented at all... just delayed.

It is notable that America is not alone in pursuing inflationary policies; most nations all over the world are printing money and debasing their currencies.

In this era of globalisation, no country wants a strong currency and everyone is engaged in competitive currency devaluations.

Given this reality, its hard not to agree with those who believe that this money and debt creation will cause an inflationary holocaust over the coming years.

Which brings us to our next prediction for 2010: Gold.

As we have noted before, Gold is not money... nor is it a hedge against inflation (it performs that role very poorly). What gold is, however, is a hedge against the mismanagement of the state - which at this time and place is the United States with it's world's reserve currency status.

It is almost a certainty that the United States will be forced to continue Quantitative Easing next year when they cannot find enough buyers for their $2.1 trillion Treasury sales.

As a result, gold's decoupling from the ups and downs of the US dollar may come as soon as next year as nation states and investors panic.

Because of that, I predict a gold price of over $2,000 an ounce by the end of next year.

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Whole lotta pain

Yesterday I talked about US debt and today the theme continues.

Specifically... US Treasuries and how few people acutally bought them in 2009.

Eric Sprott, the Toronto-based money manager whose Sprott Hedge Fund returned about 496% in the past nine years, has been trying to figure out that very question.

In a report entitled 'Is it all just a Ponzi scheme?', Sprott and David Franklin suggest that it's impossible to find who was the second largest buyer of Treasuries in 2009.

Of the $1.885 trillion dollars in public debt the US added in 2009, $704 billion (annualized) was bought by "Other Investors", a collection of buyers defined in the Federal Reserve Flow of Funds Report as the "Household Sector".

Interestingly, the $704 billion is 35 times more than this sector bought in the prior year, 2008.

Sprott and Franklin did some digging and here is what they found:

• Amazingly, we discovered that the Household Sector is actually just a catch-all category. It represents the buyers left over who can't be slotted into the other group headings. For most categories of financial assets and liabilities, the values for the Household Sector are calculated as residuals. That is, amounts held or owed by the other sectors are subtracted from known totals, and the remainders are assumed to be the amounts held or owed by the Household Sector. To quote directly from the Flow of Funds Guide,
  
  "For example, the amounts of Treasury securities held by all other sectors, obtained from asset data reported by the companies or institutions themselves, are subtracted from total Treasury securities outstanding, obtained from the Monthly Treasury Statement of Receipts and Outlays of the United States Government and the balance is assigned to the household sector."
  
  So to answer the question - who is the Household Sector? They are a PHANTOM. They don't exist. They merely serve to balance the ledger in the Federal Reserve's Flow of Funds report.
  
  Our concern now is that this is all starting to resemble one giant Ponzi scheme. We all know that the Fed has been active in the market for T-bills... they bought almost 50% of the new Treasury issues in Q2 and almost 30% in Q3.
  
  It serves to remember that the whole point of selling new US Treasury bonds is to attract outside capital to finance deficits or to pay off existing debts that are maturing. We are now in a situation, however, where the Fed is printing dollars to buy Treasuries as a means of faking the Treasury's ability to attract outside capital. If our research proves anything, it's that the regular buyers of US debt are no longer buying, and it amazes us that the US can successfully issue a record number Treasuries in this environment without the slightest hiccup in the market.

As we discussed yesterday, the actual number of US Treasuries sold to foreigners was next to nothing. As the Sprott report points out, the US Treasury and/or the Fed has been buying US treasuries themselves, in much larger numbers than they acknowledge.

The coming year of 2010 will be known as the year of the Debt.

It will bury entire nations. Nations like Greece and Ukraine, and states like California, and it will threaten to topple scores more.

As was posted yesterday, the looming question is who is going to buy the $2.06 trillion worth of US Treasuries next year?

China, Japan and the UK have increasing doubts about amassing USD denominated paper including Treasuries, Japan also plans to be as aggressive a seller as the US when it comes to debt. And of course there are many other countries who desperately need to sell sovereign bonds in order to pay for their already accepted and implemented budgets - not the least of which is Canada.

And that's just the nation states.

Corporations and lower levels of governments, in every nook and cranny of the planet, want to sell you their debt. Badly.

So the story of 2010 is going to be all about debt and the rapid rise in interest rates to cover it.

It's impossible to foresee at this point how high the rates may rise, but it looks patently obvious that it is going to be a lot more than a few percentage points... and there will be a lot of pain involved when they do.

A whole lotta pain.

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Email: village_whisperer@live.ca
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The Hangover

The week after Christmas is a time for 'the hangover'; general recuperation from post-feasting over-indulgence.

And it could well be that 2010 is viewed as a giant 'hangover' year. With that in mind I'd like to toss out a few thoughts for your consideration.

A few faithful readers wanted my advice about investing in this tumultuous time.

The first, and best, advice I can ever give is that you should never take serious investing advice from an anonymous Internet blogger.

As a portion the disclaimer at the bottom of this blog so eloquently states, "the author(s) of the posts on this site are not investment advisors and they do not offer investment advice. They try to provide some hopefully useful data with sources - especially concerning real estate - and then add their own analysis."

With that in mind, a few things for you to consider...

The number one issue that faces our country in the coming year, in my humble opinion, has already be pinpointed by our Finance Minister.

"Canada could face 'serious' economic consequences should the United States fail to address its bulging budget deficit", warns Finance Minister Jim Flaherty.

2009 will be remembered for two things: there was a huge credit and liquidity crunch, and then there was Quantitative Easing.

And Quantitative Easing was the way government played a shell game with the economy.

Right now the vast majority of us are oblivious to the debt monster hiding in the closet.

Consider this from Zero Hedge:

• In 2009, total supply of all USD denominated fixed income, net of maturities, declined by $300 billion from $2.05 trillion to $1.75 trillion. Accounting for securities purchased by the Fed, the stunning result is that net issuance in 2009 was only $200 billion.
  
  Take a second to digest that.
  
  And while you are lamenting the death of private debt markets, here is precisely what the Fed, the Treasury, and all bank CEOs are doing all their best to keep hidden until they are safely on their private jets heading toward warmer climes: in 2010, the total estimated net issuance across all US$ denominated fixed income classes is expected to increase by 27%, from $1.75 trillion to $2.22 trillion. The culprit: Treasury issuance to keep funding an impossible budget.
  
  As everyone who has taken First Grade math knows, there is no way that the ludicrous deficit spending the US has embarked on makes any sense at all. Out of the $2.22 trillion in expected 2010 issuance, $200 billion will be absorbed by the Fed while QE continues through March. Then the US is on its own: $2.06 trillion will have to find non-Fed originating demand.
  
  To sum up: $200 billion in 2009; $2.1 trillion in 2010.

Where is the money going to come from?

2010 is going to be a hangover year for the US economy. There is an upcoming explosion in US Treasury issuance. Fiscal 2010 gross coupon issuance is expected to hit $2.55 trillion, a $700 billion increase from 2009, which in turn was $1.1 trillion increase from 2008.

Unless the US consumer decides to dramatically ramp up purchase of some US Treasuries (and not just any: 30 Year Bonds or bust), the Bond printer will be forced to find vast foreign appetite for its debt.

We already know that China is a major question mark, and will aggressively be looking at pumping capital into its own economy instead of that of America. Japan will have its hands full monetizing its own sovereign issuance, let alone America's. And lastly, the UK - traditionally the third largest purchaser of US debt - is beset with problems worse than the United States and will not be doing much purchasing any time soon.

So the tipping point could be as close as 2010.

Which brings us to the first of the predictions for 2010. Look for:

1. the United States to announce a new iteration of Quantitative Easing, a move that will be met with massive disapproval.
2. Prepare for a major increase in interest rates. Carney and Flaherty can see it coming and have started pounding the warning drums in Canada. Many observers in the US are confounded by Ben Bernanke's complete lack of preparation from a monetary standpoint to a forced interest rate increase. This is what is fueling the fears of runaway inflation almost overnight.
3. Watch for an engineered stock market collapse. Stock Market investors have realized there is no more risk in equities because taxpayers have involuntarily become safekeepers for the entire stock market, due to Bernanke's forced intervention in bond and equity markets. When the time comes to hit the reverse button, the resultant rush into safe assets from the stock market will be dramatic. Will it be enough to generate the needed endogenous demand for US Treasuries? Doubtful. But you can rest assured that there will be an engineered sucking of money from equities into Treasuries on a giant scale nothwithstanding... and it will drive the market down by 30% or more.

Baby New Year will have a spinning head right from day one.

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