Happy Holidays

May I offer my sincerest wishes for Christmas and the Holiday Season. I will take a break from posting for a week or so - unless there are serious developments, of course.

All The Best.

A Christmas Tree For Troubled Times

The Euro's Trojan Horse

'Tis the season of giving, so it should come as no surprise that at this time Sudden Debt invokes Troy's Laocoon in Virgil's Aeneid: "Timeo Danaos et dona ferentes" (beware of Greeks bearing gifts).

Why? Because as crafty inventors of the Trojan Horse Greeks may once again become infamous for yet another inside job: the euro's downfall - or, at least, its fall from grace.

Beware of Greeks Bearing Euros

If you have been following European financial matters at all, you know by now that Greece is in dire straits. It is beset by that trio of trouble that gives finance ministers white hairs by the hundreds: huge public debt (~120% of GDP), huge budget deficit (~13% of GDP for 2009), huge current account deficit (~10% of GDP for 2009). Oh, and its private sector debt went from 38% of GDP to 100% in less than a decade, mostly because households jumped on the debt wagon: their debt went from 15% to 50% of GDP in the same period, mostly on mortgage borrowing and higher housing prices.

Does the pattern sound familiar? Of course it does... this model of "economic growth", which substituted increased borrowing for earned income, was repeated all over the western world.

The immediate result is that rating agencies have now cut their marks for Greek government debt to BBB+, the lowest in the eurozone (S&P and Fitch. Moody's is still A1 but will soon downgrade) and borrowing costs have soared. Greek government 10-year bonds are currently yielding 5.74%, 271 basis points (2.71%) over the equivalent German bunds. In the years of the credit boom, of easy money and bubbly assets, this spread was a mere 20-30 b.p.

Likewise, credit default swaps (CDS) for Greek sovereign debt have now soared to 275-285 points (late Fri. updt.), up from 10-15 (see chart below, click to enlarge). This means that the mathematically calculated Cumulative Probability of Default (CPD) comes in at 21.5%, the 8th highest amongst sovereign risks (for comparison, Dubai is 6th on the list with 26.2%). To give you an idea of other eurozone members' CPDs, France is at 2.6% and Spain at 9.1%.

Greek CDS: Nosebleed on Mt. Olympus

All this trouble brewing in eurozone's weakest link is causing reasonable questions for the euro's viability as a global reserve currency. After all, claim the euro-naysayers, what is the EU if not a mere free trade zone with a common currency attached? In other words, Greece may be the euro's Trojan Horse... or at least, a damn good excuse for selling euros (see chart below, click to enlarge).

US Dollars Per Euro

Just one month ago I sounded the bell of euro's overvaluation vs. the dollar, having just seen the movie 2012. To use another Trojan allusion, there were simply too many Dollar Cassandras around, and they had even made guest appearances in popular movies. A sure omen of reversal, if ever there was one...

Throwing Good Oil After Bad Debts

Abu Dhabi decided to bail out Dubai (once again) by providing $10 billion in order to prevent a bond coming due today from defaulting. As the post's title says, that's precisely like throwing (more of) Abu Dhabi's perfectly good oil after Dubai's stinking bad debt. At today's prices, $10 billion is equivalent to nearly two months of Abu Dhabi's full-out oil production. And there's more bad debt where that came from, of course.

Ahhh, you will quickly say: it's only fiat money - book entries upon book entries. And Abu Dhabi still gets to physically keep its oil and can always hike the price it charges and get its money back from all the rest of us - including Dubai's lenders who are currently being bailed out (again).

Oh yeah? Not so fast..

In today's push-button interconnected global economy a bailed-out lender can immediately convert Abu Dhabi's pennies from heaven into a tangible commodity (say, crude oil), hire a VLCC and anchor the whole thing off the coast of Singapore. By bailing out Dubai and its lenders, Abu Dhabians are making a fool's bargain. They would have been much better off had they told everyone to take a hike, including those who kept building castles in the sand.

Ahhh, but what about the oil producers' ability to raise prices almost at will? Hah! And why do you think the US is sitting on Iraq, to mention just one geo-political petroleum pressure-point? Please note that Iraq has just announced plans to raise production to 12 mbpd in the future (it currently produces about 2.5 mbpd). If it succeeds (admittedly a huge if), it will surpass Russia and become the world's second largest producer of crude after Saudi Arabia. Kiss pricing power good-bye..

Revenge Of The Bond Nerds

Well, what do you know? The participants of the Roman orgies that took place during the Debt Dump and Bail Saturnalia (feel free to add punctuation marks as you see fit) are finally being presented with the bill. It's still in the process of being added up in toto, but it looks to be a doozy.

The irony is that - for the moment - the bill is being thrown at the face of those far less responsible for the mess than the big-time orgiastes. And to add insult to injury, the bill is summarily and contemptuously presented by that troupe of orgy-organizers who arguably made the mess much worse.

But, let's explain things in plain Latin.

Recent days have seen a raft of sovereign-credit downgrades and warnings by Moody's, S&P and Fitch, causing sharp rises in government bond yields and credit default swaps (CDS) for those affected. No doubt goosed by the (near-sovereign) collapse of Dubai, rating agencies are belatedly falling all over themselves to kick weakest-link borrowers in the groin, i.e. countries like Greece and Spain. Other countries like Italy, Portugal and Ireland are seeing their bonds come under pressure, too.

For example, look at the chart below tracking 5-year CDS for Greek government bonds.

Greek Government Debt CDS

After settling down from the late 2008 - early 2009 global panic, credit concerns rose again following some domestic issues (elections, dodgy statistics); but the catalyst that really spooked the market was unquestionably Dubai's loud insolvency, which made everyone stand up and face facts.

The rating agencies are also dropping hints about the UK and US, but they are still far from daring (or foolish) enough to really step on such big toes, preferring instead the time-tested method of beating on black sheep (or scapegoats, if you are more classically educated in things Greek and Roman) in order to send veiled messages to the King.

So, what of the "bond nerds" in today's title? (Apologies to my erstwhile colleagues - I use the term affectionately, of course). They are those ladies and gentlemen on trading desks and investment committees who have the decidedly unglamorous job of making markets and selecting straight, boring government paper to invest in: Treasurys, gilts, etc. They are very, very far removed from the hustle, bustle and juicy bonus pools common to more "meaty" structured debt securities. That is, they were - until the spectre of sovereign default raised its ugly head; suddenly, the nerds are running the show.

A 50 basis point swing in, say, the spread between Greek and German bond yields is enough to send global bond, stock and FX markets gyrating, causing massive stress to mandarins from prime ministers and central bankers, to Brussels-based bureaucrats.

What are the bond nerds saying, every time they hit a bid on the 10-year GGB or buy a Spanish CDS?

Simply this: Enough already with being so free with the taxpayers' and our investors' money... You guys can't run massive budget deficits as far as the eye can see and raise debt levels to the sky, without paying the price. You can't bail out the global financial system and keep unemployment down and consumption up, without us questioning your 1+1=3 arithmetic. You can't have your cake and eat it, there's no such thing as a free lunch - and funny money is no money at all.

Yeah, we may be nerds, alright, but you better take good care of us because you need us big time. Unless you want to walk the Minsky Way, that is...

Have a pleasant weekend (pondering government finances, perhaps?).

Dollar Survey

Today, a Sudden Debt "special" survey.

Where do you think the dollar foreign exchange rate will go over the next 6-12 months? Please heed the obvious proviso: this is NOT a scientific survey, its results are NOT predictive and thus NOT to be considered investment/speculation advice.


I have re-done the poll, using a different provider that does not limit the size of the answers.

Insolvency Vs. Illiquidity

Is Dubai going through a temporary liquidity crisis, or is it facing a serious insolvency problem? Does it need a couple of billion to tide it over a rough spot, or is the income produced by the assets it built by the dozen insufficient to cover their debt load?

The answer is, obviously, the latter: Dubai has a serious solvency problem, as can be seen from the see-through buildings dotting its shore and spiking its skies.

Does it matter? Of course it does; the ONLY remedy for insolvency is debt liquidation and a commensurate drop in the price of the associated assets. That's how asset prices may once again come into line with the income said assets can produce. Corollary to this basic truth is that monetary bailouts of the type envisaged by the central bank in Abu Dhabi do nothing in such cases - except possibly avert panicky bank runs. That's a laudable and necessary step, of course, but what must come next is, perforce, the painful liquidation phase.

And why does it matter to the rest of the world what is going on in Dubai? Because it is the world's most glaring, most spectacularly obvious case of what is wrong in the real economy, all over the world. The quantities and prices of all kinds of assets rode high on a sea of easy credit with no regard to their end use. Assets were built and financed with an eye only to their immediate sale, to flipping them for an instant capital gain instead of operating them for real economic gain, like rents or dividends. That's the economic principle known as "the greater fool" or "the trading sardine". It works for a while and then always fails, quite often most spectacularly.

In my opinion, Dubai is the warning bell that the global economy has entered Phase B. The greater part of the liquidity crisis is over; but now starts the real pain of dealing with insolvency. Central banks and financial ministers did a creditable job of subduing illiquidity. They even fostered the view that the global Great Recession was over. That's a mistake.

Dealing with insolvency will require far greater political resolve and much different skills than merely lowering rates and opening credit facilities to all comers.

The Value Of Money (Plus Bye-Bye, Dubai)

First, this item about Dubai:

Nov. 25 (Bloomberg) Dubai World, the government-owned holding company struggling with $59 billion of liabilities, is seeking to delay repayment on all of its debt, even after Abu Dhabi banks provided $5 billion for Dubai’s support fund.

It didn't take long, did it, for the "pearl" to turn into a turkey?

---------------------------------------------------------

On with the value of money (Debra's comment on the last post made me do it, honest....).

There I was two days ago sitting in my attorney's office, when a couple of guys walked in; a father and son pair, as it later turned out. They had come to receive compensation as settlement of a securities fraud case. Apparently, they had invested in a fund that went under several years ago; after a prolonged legal battle they were finally to get forty cents on the dollar. Despite the buzz-saw cut they suffered they were very happy - grateful even - to get something back.

They didn't look all that prosperous and I felt kind of sorry for them, when I noticed that what they were about to receive implied an original investment of over $1 million. Not exactly a pair of hoi polloi. But, anyhow...

We started talking while the lawyer was drafting a receipt and our discussion inevitably turned to money. I climbed onto my usual monetary affairs soap-box and started the dime speech on what constitutes money and banking in a fiat currency regime. Back I went into monetary history, watching their faces all the time... The link between dollars and gold (yes, yes of course we know this, signalled their nods), Bretton Woods (eh?), Nixon's final revocation of the gold standard in 1971 (whaaa..?), how money is created today (the government prints it, no?), the power of banks to create money out of thin air via credit demand (no, no, that's not possible!).

In this exchange, as in many before it, I once again witnessed the widespread ignorance about money and banking that permeates our society. Father and son, like 99% of all people, still hung on to a super-outdated notion that gold and money were - somehow - still connected. That money is still attached to (and thus reflects) some tangible "value", and that its creation is strictly regulated by a higher authority permanently answerable to society.

So, I explained to them that our money is like a ship: centuries ago it was firmly anchored (gold and silver coin), but that as time passed more and more cable was let out so the ship swung wider around its anchorage (gold standard). Finally, in 1971 Nixon let go the anchor altogether by shutting down the gold "window", so the ship is now completely untethered; it floats and rides the waves freely, counting solely on its captain's seamanship to stop it from running aground.

Though father and son listened attentively and even respectfully (probably a reflection of our legal surroundings and the fact they were about to receive a bunch of money they considered forever lost), I could see that they didn't really believe me.

I was not surprised; this is almost always the case: people find it extremely difficult to come to grips with the idea that today's money embodies nothing more than pure confidence, fides, credo.. That fiat money is a belief system; an organized, state-sponsored religion complete with high priests, acolytes and genuflecting flock.

In more scientific terms, the pair's aversion to the truth is similar to believing in a Newtonian/Einsteinian unitary "reality", as quantum uncertainty and multiplicity are swirling all around us.

So, what is the Value Of Money? Just like the quantum universe(s), simply what we think it is.

Happy Thanksgiving to all.

2012: Dollar At The End Of The World

I am a devoted and frequently bemused student of aberrant market behaviour as expressed in the popular media, i.e. "lifestyle" TV programs, films, radio, magazines, etc. I'm always on the lookout for such market signals emanating from unlikely, non-professional sources because I see them as excellent signs of excess. In other words, I'm an inveterate watcher of unusual bubble clues.

A few days ago I saw 2012, the latest "end of the world" movie. Apart from the spectacular end-of-days visions (California slipping into the Pacific, mile-high tsunamis crashing on Mt. Everest), what really caught my attention was the mention of the dollar's low value against the euro; I believe it was highlighted three times. (Oh well.. my obsession with all things monetary is obviously well beyond redemption.)

An Unusual Clue For The Dollar?

The one I remember best is when an Arab sheik is asked to pay "a billion" per person to be saved; he responds that "he has a big family" and that "a billion dollars is a lot of money" - only to be told that the price is "a billion euro".

There are two possible interpretations :

a) The dollar's demise is now irreversible and will proceed as a natural catastrophe.

or,

b) The dollar's drop has gone so far that it permeates even the most popular global mass media. Therefore, it has nowhere else to go but up.

Being mostly a contrarian I favor choice (b), but not yet with any real conviction, i.e. I have not put my money where my bemused observations logically lead me.

However, I am also increasingly vigilant for other, more fundamental signs of trouble brewing in euroland, where several peripheral economies are in real danger of falling apart under the triple stress of a weak uncompetitive economy, huge debts and an overvalued currency.

Calling Archimedes

Within 6 hours deserts receive more energy from the sun
than humankind consumes within a year.

________________________________

Prompted from the previous post about Dubai, today's post is about a quiet revolution planned for the deserts of North Africa. It's called DESERTEC and it's a pretty simple concept: harvest the massive amounts of solar energy in that region, turn it into electricity and send it across to Europe via cable.

The basic technology is quite old and proven: Concentrated Solar Thermal Power (CSP), i.e. using mirrors to concentrate sunlight, generate steam and thus drive turbines and electrical generators. The crucial difference between this and direct conversion of sunlight into electricity via photovoltaic panels, is that heat can be stored in media exhibiting high heat capacity (e.g. salts) and used to generate electricity 24/7, even when there is no sunlight. In addition, waste heat (i.e. lower enthalpy steam) can be used to desalinate water or drive cooling systems.

If you think that this sounds a bit like "pie from the sky" (sic), think again: a few days ago twelve of the world's largest companies signed on to the project, including the likes of Siemens, ABB, RWE, E.ON, MAN, Munich Re, Deutsche Bank and ABENGOA, bringing the project one step closer to becoming reality. The thumb-prints of Germany are all over this consortium, as one would expect from the largest EU member that is also forward-looking and firmly committed to alternative energy and infrastructure transformation.

This type of massive, game-changing project rings a huge wake-up bell: the days of debt-fuelled consumer spending growth are over. The economic paradigm for the next hundred years will be based on huge infrastructure spending, to radically transform energy sourcing, generation, transmission, storage and utilization.

Please keep this simple maxim in mind:

• Energy is the biggest business of them all, by a long shot.
  

(If you have any doubts, I strongly urge you to read The Prize , Daniel Yergin's Pulitzer Prize winner about how oil companies and producers came to dominate our world.)

I am hopeful that after wasting resources* on financial bailouts (perhaps a necessary evil), our societies will see the light and now shift to productive and responsible courses of action.

* (Well.. it's only fiat money, actually, so the damage is mostly limited to the public's perception of policy priorities, i.e. propaganda. But such perception makes a big difference to the success or failure of necessary initiatives.)

What does this mean for investors with longer-term horizons?

1. Avoid the consumer non-essential sectors. By definition, societies will have to save more in order to finance these projects and will thus have less to spend on non-essentials.
2. Avoid the consumer finance sector, for the same reason.
3. Interest rates will have to rise from near zero, to induce savings.
4. Grid-related technologies will become increasingly important.
5. Let Gaddafi pitch his tent where he wants (smile).
   

Dubai's Shut Up Finance

We have heard of project finance, debt finance, LBO finance, islamic finance... we have even heard talk of Green Finance (self serving smile). But until yesterday, we never had the pleasure of Shut Up Finance.

As with indoor skiing when outside temperatures reach 120 degrees Fahrenheit (50 C), seven star hotels and artificial islands shaped like palms and world maps (see below), the dubious distinction for most uncouth bond salesmanship belongs to none other than Dubai.

Hubris As Seen From Space

The emirate's ruler just said the second half of its $20 billion bond program will be “well received,” and that those who doubt the unity of Dubai and Abu Dhabi (the United Arab Emirates' petro-wealthiest member) should “shut up”. The "unity" in question is, of course, all important since the first $10 billion was bought entirely by the U.A.E.'s central bank and has been used in part to bail out the developers of said artificial islands and other such hubristic extravaganzas.

The bailout money is sorely needed because Dubai is... well... broke. Since it has no hydrocarbons to call its own, the tiny nation first rose to prominence as the playground of other, notionally abstemious, Arabs residing next door. It then went on to blow its own bubble on a sea of easy credit, margin and rollickingly speculative share and real estate markets.

To grasp the magnitude of hubris at the Gulf bubbledom all we need do is compare "before" and "after" pictures from downtown Dubai.

Photos: Dubai Architecture

Dubai In 1990


The Same Place, Last Year

I'm going to shut up now.