5 Reasons George Soros is WRONG about Gold
http://www.wealthwire.com/news/metals/1294
Posted by Brittany Stepniak - Wednesday, June 15th, 2011
Published 06/14/2011 -01:00PM Originally published on StreetAuthority.com and re-published with permission.
By Steven P. Orlowski
George Soros is a world-renowned former billionaire hedge-fund manager and philanthropist. He co-founded the Quantum Fund in the 1970s with Jim Rogers, another world-famous investor. Soros' fame grew in 1992 when he made $1 billion by short-selling the pound sterling, speculating that the British government would be forced to devalue the currency. He became known as "The Man Who Broke the Bank of England."
Unlike his former partner Jim Rogers, who is credited with anticipating the commodity boom that started in the late 1990s and who is keeping his gold, Soros has been selling a lot of gold. The moves speak volumes. He believes gold is in a bubble and he'd rather sell before everybody else catches on.
In September of 2010 Soros said "Gold is the ultimate bubble, it is certainly not safe." In the first quarter of 2011, he sold nearly $800 million worth of gold exchange-traded funds (ETFs) and stocks. After that sale, his company, Soros Fund Management, owned less than 50,000 shares of the SPDR Gold Trust (NYSE: GLD), down from a reported 4.7 million shares. He also reportedly sold 5 million shares of iShares Gold Trust (NYSE: IAU).
Soros was reported to have had just under $1 billion in gold ETFs and related stocks at the end of December, 2010. After these sales, the value of his gold holdings was reduced to a little more than $200 million.
Unfortunately for Soros, I think he's wrong. Gold is not in a bubble. And there are several factors pointing to even higher prices.
Gold did pull back a bit after Mr. Soros announced his sale. The GLD ETF fell from an intraday high on April 29 of $153.03 to an intraday low of $142.55 on May 5, a 6.8% fall. A temporary correction from current levels is always a possibility, but the price is flying high once again, recently trading above $150. And it seems poised to move higher.
Here are five reasons why...
1. QE2 ending is not the end
Recently released economic data point to a slowing U.S. economy. The housing market is double-dipping as prices in some areas of the country are as low as they were in the early 2000s. Unemployment is up to 9.1%. Consumer sentiment is down. And China, our critically-important trading partner, has also seen its economy slow. On June 7, Federal Reserve Chairman Ben Bernanke publicly admitted the U.S. economy is slowing.
Recently released economic data point to a slowing U.S. economy. The housing market is double-dipping as prices in some areas of the country are as low as they were in the early 2000s. Unemployment is up to 9.1%. Consumer sentiment is down. And China, our critically-important trading partner, has also seen its economy slow. On June 7, Federal Reserve Chairman Ben Bernanke publicly admitted the U.S. economy is slowing.
Given these factors, the end of QE2 (Quantitative Easing II) -- the Fed's practice of buying U.S. treasuries to add liquidity to the credit markets -- may not really be at hand. With no other viable options to stimulate the economy, it will likely keep the liquidity flowing, whether it's called QE3 or not. Maintaining current liquidity levels or adding more will likely weigh on the dollar and support gold.
2. Inflation is low (but higher than you think)
While the government wants some inflation, it also needs to prevent it from getting out of control. Governments typically increase the money supply when the economy has stalled or is in recession, making it less expensive to borrow, hoping to stimulate growth (and therefore creating inflation). The targeted inflation rate of 2% represents an idealized level of growth for the economy.
While the government wants some inflation, it also needs to prevent it from getting out of control. Governments typically increase the money supply when the economy has stalled or is in recession, making it less expensive to borrow, hoping to stimulate growth (and therefore creating inflation). The targeted inflation rate of 2% represents an idealized level of growth for the economy.
The consumer price index (CPI) is a statistic that measures the price of consumer goods and services and is the measure upon which monetary policy is based. A popular complaint is that the government focuses on "Core" CPI, the version that ignores food and energy, two critical components to a consumer's economic well-being.
Core CPI is low, up 1.3% year-over-year. "Headline" inflation, the CPI with food and energy included, is actually much higher, currently near 6%. Under normal circumstances, higher inflation would motivate the Fed to raise interest rates from the historically low 0% that has been held since December 2008. But with core CPI at an acceptable level and with the economy slowing, investors should not expect that to happen anytime soon. Continued low interest rates will likely be maintained despite the risk of higher inflation in the hope of further stimulating the economy. Low rates should translate into more economic activity and demand, driving commodity prices, including gold, higher.
3. Gold ownership by individual investors is not higher than normal
Asset bubbles are characterized not just by rapidly-escalating prices but also by abnormal participation of individual investors. During the tech bubble of the late 1990s, one would frequently hear about mailmen, landscapers, barbers and others one would not normally expect to be talking about the stock market making tech stock recommendations. That was an indication of a larger-than-normal level of participation and a bubble brewing.
Asset bubbles are characterized not just by rapidly-escalating prices but also by abnormal participation of individual investors. During the tech bubble of the late 1990s, one would frequently hear about mailmen, landscapers, barbers and others one would not normally expect to be talking about the stock market making tech stock recommendations. That was an indication of a larger-than-normal level of participation and a bubble brewing.
Today, despite the media coverage, the actual rate of gold ownership by individual investors is at or below historical norms (see table below). If gold were in a bubble, people wouldn't just be talking about it, they'd be buying it en masse. Until gold ownership increases dramatically, I'd take lightly claims of a bubble that's about to burst.
4. The U.S. dollar will continue to decline
Unfortunately for Americans and anyone who owns U.S. dollars, the decline in the dollar is likely to continue. The enormous debt and entitlement obligations of the United States coupled with the slowing economy suggest the government will maintain its weak dollar strategy. Until the economy stabilizes and the government seriously addresses its financial obligations, expect the dollar to continue to decline. A weaker dollar means higher gold prices. [See David Sterman's "Why Politicians in Washington Could Cause a Global Financial Crisis"]
Unfortunately for Americans and anyone who owns U.S. dollars, the decline in the dollar is likely to continue. The enormous debt and entitlement obligations of the United States coupled with the slowing economy suggest the government will maintain its weak dollar strategy. Until the economy stabilizes and the government seriously addresses its financial obligations, expect the dollar to continue to decline. A weaker dollar means higher gold prices. [See David Sterman's "Why Politicians in Washington Could Cause a Global Financial Crisis"]
5. The fear factor
The mention of replacing the U.S. dollar as the world's reserve currency was met with laughter only a couple of years ago. American dominance was considered absolute and eternal. No longer.
The mention of replacing the U.S. dollar as the world's reserve currency was met with laughter only a couple of years ago. American dominance was considered absolute and eternal. No longer.
The United States is dependant on foreign investment to fund its debt. China, the biggest buyer of U.S. treasuries, has become more and more vocal about how the United States is handling its financial travails. China can frequently be heard criticizing the U.S.'s decisions and talking overtly about replacing the dollar. And China is not alone. One idea gaining traction is to replace the dollar with a basket of currencies. Even a partial replacement of the dollar would significantly reduce demand, sending its value plummeting and gold prices higher.
Action to Take --> Don't sell your gold. If you're worried that the bubble-talk might be true, then sell some -- but not all. Gold has performed very well in the last decade, but its price ascension has not been at an unreasonable pace. And while George Soros has made some good market calls in the past, I think he's wrong on this one. Sometimes asset prices rise for very good reasons. This is likely to prove to be one of those times.
George Soros Just Spent $455 Million on These Two Stocks
Friday, June 3, 2011
9:00 AM http://www.streetauthority.com/a/george-soros-just-spent-455-million-these-two-stocks-458326
9:00 AM http://www.streetauthority.com/a/george-soros-just-spent-455-million-these-two-stocks-458326
Billionaire investor George Soros and his team of advisors take a "top-down" approach. This means they seek out big, "macro" investing themes, and then work their way down to the best ways to play that theme. Every quarter, they adjust their stakes in a range of companies, either by loading up or pulling back, while also looking to enter a few new positions.
In the most recent quarter, Soros, through his financial services company Soros Fund Management, added two brand new positions to his portfolio. Each could be viewed as a proxy for major themes playing out in the global economy.
Here's why they're worth looking into…
Adecoagro (Nasdaq: AGRO)
This ticker symbol says it all. Adecoagro owns and operates nearly 40 massive farms in Brazil, Argentina and Uruguay, a region known for fertile and productive land. Indeed, agriculture has always been the leading export in Argentina, but it also now holds the top spot in Brazil's export economy. This isn't just a play on soybeans or wheat either. It's also a play on cotton, rice, sugar cane-based ethanol, dairy cows, coffee, sugar and other commodities. This all means Adecoagro's annual results aren't subject to the vagaries of volatile prices for any particular commodity, though it surely helps that just about all the items noted above have seen a surge in price in recent quarters. For George Soros, his $330 million investment (of roughly 27 million shares) in Adecoagro is the perfect play for the ongoing global demographic changes that are taking place. As the global population continues to rise, the amount of unused arable land continues to shrink. In addition the growing middle classe in many emerging markets are consuming ever more calories on a per-capita basis.
Beyond the demographic appeal of South American agriculture, Soros has likely spotted three other reasons to own this stock. First, operating income appears set to rise nicely in the near-term, from $74 million in 2010 to more than $150 million this year, and to $200 million by 2013, according to one of Brazil's largest banks, Banco Itau. Second, high-quality agricultural land is becoming a scarce commodity as new cities pop up in formerly rural areas of South America and Asia. Soros likely anticipates solid appreciation potential in the land Adecoagro holds. Third, Adecoagro plans to aggressively ramp up its ethanol business. Unlike the U.S. production of corn-based ethanol, which needs the help of government subsidies, Brazil's sugar cane-based approach is considered to be more cost-effective and more environmentally sound. In a world of high oil prices, sugar cane-based ethanol is likely to see rising demand.
Adecoagro pulled off a $11 initial public offering (IPO) in late January, rose higher, but now trades right at the offering price. The main reason for the underwhelming post-IPO action is in the complex nature of the company's business. In effect, investors need to figure out a value for each distinct business group. For example, the ethanol business alone is likely worth about $1 billion, according to Banco Itau. The bank's analysts think shares deserve to trade up to $16 (implying a 30% gain) over the course of this year, and perhaps well higher down the road as the company's growth plans come into focus and its real estate holdings appreciate in value.
Look for Soros to hold this stock as a key long-term position for his eponymous investment fund. For the rest of us, Adecoagro provides a way to get into farming without getting down in the dirt, as I discussed in this article earlier this year. The bottom line is that farmland has been a solid investment for a long time and will likely remain so for many years to come.
Visteon (NYSE: VC)
One of the most stunning consequences of the recent global recession was the absolute implosion of demand for new cars and trucks. Many key auto makers and their key suppliers had been used to operating with lots of debt, so when the downturn hit and sales began to slide, they either had to cut costs drastically, seek government bailouts or file for bankruptcy, as was the case with General Motors (NYSE: GM) and Chrysler in 2009. Visteon, which is an auto-part maker and a Ford Motor (NYSE: F) spin-off, couldn't avoid the maelstrom and sought bankruptcy protection as well.
But that's beginning to look like ancient history now: Visteon went public once again last October (with a much cleaner balance sheet) and saw its shares rise from about $50 to $75 before a recent pullback down to $61. George Soros' firm established a new 2.1-million share position (worth about $125 million), presumably after the stock suffered a 20% drop in just two days in early March, after announcing a year-over-year decline in first-quarter sales and profits.
So why would Soros buy a stock that is in the midst of a slump? It's because the slump likely won't last. A series of headwinds recently emerged in the auto sector, most notably a spike in raw material prices, which I noted in a recent analysis of Ford's stock.
Yet the longer-term outlook remains quite bright. Industry sales are expected to continue to rebound in the next few years. Visteon is now much leaner and could generate peak profits in coming years. The company has closed roughly 50 plants, seen its operating margins expand 500 basis points to 4% and looks positioned to get that figure up to 6% or 7% in a few years as revenue rises.
Investors need not worry that the company's prospects are simply tied to those of Ford -- the auto maker accounted for 88% of sales a decade ago, but today accounts for just 25%. (Hyundai is actually the biggest customer now, accounting for 28% of sales -- a real blessing when you note Hyundai's robust market share gains taking place right now.)
Weak first-quarter results surely hurt the company's near-term momentum, but analysts at UBS still think shares hold real value. They recently lowered their target price from $85 to $78. This is still nearly 30% above the current price. But Soros may need some patience: "While we still like the long-term story, (2011) guidance will likely raise investor concern about the company and may keep the valuation depressed until investors can gauge how much the weak guidance reflects management conservatism vs. fundamental issues with the business," note the UBS analysts.
Action to Take --> Soros is clearly bullish on agriculture and the auto industry, as his recent purchases highlight. Piggybacking on his moves has proven quite fruitful for investors in the past and could be the case with Visteon and Adecoagro as well.
-- David Sterman
P.S. -- If you're an income investor, why would you buy a stock yielding 2% when you can find one paying 26% right here? Watch this presentation for more.
In the most recent quarter, Soros, through his financial services company Soros Fund Management, added two brand new positions to his portfolio. Each could be viewed as a proxy for major themes playing out in the global economy.
Here's why they're worth looking into…
Adecoagro (Nasdaq: AGRO)
This ticker symbol says it all. Adecoagro owns and operates nearly 40 massive farms in Brazil, Argentina and Uruguay, a region known for fertile and productive land. Indeed, agriculture has always been the leading export in Argentina, but it also now holds the top spot in Brazil's export economy. This isn't just a play on soybeans or wheat either. It's also a play on cotton, rice, sugar cane-based ethanol, dairy cows, coffee, sugar and other commodities. This all means Adecoagro's annual results aren't subject to the vagaries of volatile prices for any particular commodity, though it surely helps that just about all the items noted above have seen a surge in price in recent quarters. For George Soros, his $330 million investment (of roughly 27 million shares) in Adecoagro is the perfect play for the ongoing global demographic changes that are taking place. As the global population continues to rise, the amount of unused arable land continues to shrink. In addition the growing middle classe in many emerging markets are consuming ever more calories on a per-capita basis.
Beyond the demographic appeal of South American agriculture, Soros has likely spotted three other reasons to own this stock. First, operating income appears set to rise nicely in the near-term, from $74 million in 2010 to more than $150 million this year, and to $200 million by 2013, according to one of Brazil's largest banks, Banco Itau. Second, high-quality agricultural land is becoming a scarce commodity as new cities pop up in formerly rural areas of South America and Asia. Soros likely anticipates solid appreciation potential in the land Adecoagro holds. Third, Adecoagro plans to aggressively ramp up its ethanol business. Unlike the U.S. production of corn-based ethanol, which needs the help of government subsidies, Brazil's sugar cane-based approach is considered to be more cost-effective and more environmentally sound. In a world of high oil prices, sugar cane-based ethanol is likely to see rising demand.
Adecoagro pulled off a $11 initial public offering (IPO) in late January, rose higher, but now trades right at the offering price. The main reason for the underwhelming post-IPO action is in the complex nature of the company's business. In effect, investors need to figure out a value for each distinct business group. For example, the ethanol business alone is likely worth about $1 billion, according to Banco Itau. The bank's analysts think shares deserve to trade up to $16 (implying a 30% gain) over the course of this year, and perhaps well higher down the road as the company's growth plans come into focus and its real estate holdings appreciate in value.
Look for Soros to hold this stock as a key long-term position for his eponymous investment fund. For the rest of us, Adecoagro provides a way to get into farming without getting down in the dirt, as I discussed in this article earlier this year. The bottom line is that farmland has been a solid investment for a long time and will likely remain so for many years to come.
Visteon (NYSE: VC)
One of the most stunning consequences of the recent global recession was the absolute implosion of demand for new cars and trucks. Many key auto makers and their key suppliers had been used to operating with lots of debt, so when the downturn hit and sales began to slide, they either had to cut costs drastically, seek government bailouts or file for bankruptcy, as was the case with General Motors (NYSE: GM) and Chrysler in 2009. Visteon, which is an auto-part maker and a Ford Motor (NYSE: F) spin-off, couldn't avoid the maelstrom and sought bankruptcy protection as well.
But that's beginning to look like ancient history now: Visteon went public once again last October (with a much cleaner balance sheet) and saw its shares rise from about $50 to $75 before a recent pullback down to $61. George Soros' firm established a new 2.1-million share position (worth about $125 million), presumably after the stock suffered a 20% drop in just two days in early March, after announcing a year-over-year decline in first-quarter sales and profits.
So why would Soros buy a stock that is in the midst of a slump? It's because the slump likely won't last. A series of headwinds recently emerged in the auto sector, most notably a spike in raw material prices, which I noted in a recent analysis of Ford's stock.
Yet the longer-term outlook remains quite bright. Industry sales are expected to continue to rebound in the next few years. Visteon is now much leaner and could generate peak profits in coming years. The company has closed roughly 50 plants, seen its operating margins expand 500 basis points to 4% and looks positioned to get that figure up to 6% or 7% in a few years as revenue rises.
Investors need not worry that the company's prospects are simply tied to those of Ford -- the auto maker accounted for 88% of sales a decade ago, but today accounts for just 25%. (Hyundai is actually the biggest customer now, accounting for 28% of sales -- a real blessing when you note Hyundai's robust market share gains taking place right now.)
Weak first-quarter results surely hurt the company's near-term momentum, but analysts at UBS still think shares hold real value. They recently lowered their target price from $85 to $78. This is still nearly 30% above the current price. But Soros may need some patience: "While we still like the long-term story, (2011) guidance will likely raise investor concern about the company and may keep the valuation depressed until investors can gauge how much the weak guidance reflects management conservatism vs. fundamental issues with the business," note the UBS analysts.
Action to Take --> Soros is clearly bullish on agriculture and the auto industry, as his recent purchases highlight. Piggybacking on his moves has proven quite fruitful for investors in the past and could be the case with Visteon and Adecoagro as well.
-- David Sterman
P.S. -- If you're an income investor, why would you buy a stock yielding 2% when you can find one paying 26% right here? Watch this presentation for more.
Why Politicians in Washington Could Cause a Global Financial Crisis
Monday, May 23, 2011
1:00 PM. http://www.streetauthority.com/news/why-politicians-washington-could-cause-global-financial-crisis-458301
"You can always trust the Americans to do the right thing, but only after exhausting all other possibilities."
--Winston Churchill
When it comes to our political leaders in Washington, let's hope Churchill was right. If he's wrong, then the U.S. economy -- and the stock market -- may be headed for a sharp shock. It's bad enough that Congress and the White House can't seem to come any closer to an agreement to close the budget deficit. Now, Washington is simultaneously looking at the federal debt ceiling, aiming to tie the two issues together. [See: "The Most Important Thing You Need to Know About Our Nation's Out of Control Debt"]
That means if one problem doesn't get resolved, then the other won't either. It's unclear whether politicians understand just how dangerous that is. This means a doomsday scenario may kick in by early August. A closer look at the issues -- and some common-sense solutions -- should be the focus of all investors right now. The closer we get to that date without a resolution, the less inclined you should be to add any new stocks to your portfolio. There's no need to re-hash the issues around the budget deficit. Cuts will be need to be made, taxes will need to be raised and loopholes will need to be closed.
Yet it's the debt ceiling issue that should be in focus. Congress realized nearly two decades ago that a refusal to allow any more debt to be added to our existing obligations was the only way to stop the addiction to deficit spending. The "Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Control Act of 1985" called for automatic spending cuts if limits were breached. There was a clear wisdom behind the move: politicians like to choose where actual cuts are made and not have it forced on them. To avoid being subject to random spending cuts that ate into cherished programs, Congress and the White House suddenly became much more willing to find tangible ways to getting the budget back into balance. Credit goes to Ronald Reagan, George H.W. Bush and Bill Clinton for showing the ability to lead, each making concessions that actually put our budget into surplus 10 years later. That was an era when "bi-partisanship" didn't carry such negative connotations. The system worked well until the end of the 1990s. Then, starting in 2001, we've been on a debt binge that can be blamed on both parties.
Vigilantes nobody wants to see
The prospect of unresolved deficits in the mid-1980s created a real impediment to stocks and the economy. Interest rates began to rise as "bond vigilantes" demanded a hefty premium to keep propping up the U.S.' spending deficit addiction.
The situation was kind of a like a drug dealer asking for more and more money to provide each fix. At some point, the user simply sobers up and realizes the drug will lead him to financial ruin. That's what Senators Graham (R-TX), Rudman (R-NH) and Hollings (D-SC) sought to do with their tough-love legislation. In truth, the only consequence of higher debt at the time was higher interest rates.
This time is different.
Back then, nobody spoke of an outright government default. But this time, any push to block our debt ceiling from rising will actually trigger a potentially-catastrophic scenario, thanks to the current size and global nature of lending relationships. In relation to the size of the economy, our debt levels are nearly twice as high is they were in the 1980s, and inaction would take that ratio higher still.
The government has technically already breached agreed-upon debt limits. A step to borrow money from government pension plans that has been undertaken will only tide Uncle Sam over to early August. If no budget agreement is reached by then and Congress chooses to keep the debt ceiling in place, then the government will start defaulting on its bills.
What happens when the government stops paying bills? Bond markets seize up, as the perceived solidity of existing bonds quickly evaporates. Very quickly, global lenders would demand sharply higher interest rates, perhaps secured by hard assets, to be willing to provide any more credit. Remember the scary days of 2008 when Lehman Brothers collapsed and the government had to scramble to keep the whole system from collapsing? Well, we're talking about the same dynamic -- frozen banking systems, plunging stock markets and a freeze on new business orders. That's a kind of paralysis we hope to never see again.
Action to Take --> Word has spread that a bipartisan group of legislators aiming to fix the budget deficit, known as the "Gang of Six," has hit an impasse. Hopes had been rising that the group was on the cusp of announcing a major bipartisan plan. Frankly, if solutions don't emerge to the budget gap very soon, then it's hard to see how Congress will be willing to extend the debt ceiling. It's such an implausible scenario, yet we're inching closer to it every day.
All of this comes at a time when the U.S. economy posted a fairly tepid 1.8% GDP growth rate in the first quarter, with the possibility of more subdued economic activity to come. This game of chicken that Washington is playing comes at a very bad time. Add it up, and the desire to take a risk with stocks starts to diminish. Your game plan for the next two months should be to watch events very closely and be prepared to reduce your exposure to stocks and hold cash.
-- David Sterman
Sponsored Link: I don’t want to scare you… But right now, the U.S. government is doing something incredibly stupid, which could potentially cause a huge crisis in America, in the next few months. Watch the full investigative video here...
--Winston Churchill
When it comes to our political leaders in Washington, let's hope Churchill was right. If he's wrong, then the U.S. economy -- and the stock market -- may be headed for a sharp shock. It's bad enough that Congress and the White House can't seem to come any closer to an agreement to close the budget deficit. Now, Washington is simultaneously looking at the federal debt ceiling, aiming to tie the two issues together. [See: "The Most Important Thing You Need to Know About Our Nation's Out of Control Debt"]
That means if one problem doesn't get resolved, then the other won't either. It's unclear whether politicians understand just how dangerous that is. This means a doomsday scenario may kick in by early August. A closer look at the issues -- and some common-sense solutions -- should be the focus of all investors right now. The closer we get to that date without a resolution, the less inclined you should be to add any new stocks to your portfolio. There's no need to re-hash the issues around the budget deficit. Cuts will be need to be made, taxes will need to be raised and loopholes will need to be closed.
Yet it's the debt ceiling issue that should be in focus. Congress realized nearly two decades ago that a refusal to allow any more debt to be added to our existing obligations was the only way to stop the addiction to deficit spending. The "Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Control Act of 1985" called for automatic spending cuts if limits were breached. There was a clear wisdom behind the move: politicians like to choose where actual cuts are made and not have it forced on them. To avoid being subject to random spending cuts that ate into cherished programs, Congress and the White House suddenly became much more willing to find tangible ways to getting the budget back into balance. Credit goes to Ronald Reagan, George H.W. Bush and Bill Clinton for showing the ability to lead, each making concessions that actually put our budget into surplus 10 years later. That was an era when "bi-partisanship" didn't carry such negative connotations. The system worked well until the end of the 1990s. Then, starting in 2001, we've been on a debt binge that can be blamed on both parties.
Vigilantes nobody wants to see
The prospect of unresolved deficits in the mid-1980s created a real impediment to stocks and the economy. Interest rates began to rise as "bond vigilantes" demanded a hefty premium to keep propping up the U.S.' spending deficit addiction.
The situation was kind of a like a drug dealer asking for more and more money to provide each fix. At some point, the user simply sobers up and realizes the drug will lead him to financial ruin. That's what Senators Graham (R-TX), Rudman (R-NH) and Hollings (D-SC) sought to do with their tough-love legislation. In truth, the only consequence of higher debt at the time was higher interest rates.
This time is different.
Back then, nobody spoke of an outright government default. But this time, any push to block our debt ceiling from rising will actually trigger a potentially-catastrophic scenario, thanks to the current size and global nature of lending relationships. In relation to the size of the economy, our debt levels are nearly twice as high is they were in the 1980s, and inaction would take that ratio higher still.
The government has technically already breached agreed-upon debt limits. A step to borrow money from government pension plans that has been undertaken will only tide Uncle Sam over to early August. If no budget agreement is reached by then and Congress chooses to keep the debt ceiling in place, then the government will start defaulting on its bills.
What happens when the government stops paying bills? Bond markets seize up, as the perceived solidity of existing bonds quickly evaporates. Very quickly, global lenders would demand sharply higher interest rates, perhaps secured by hard assets, to be willing to provide any more credit. Remember the scary days of 2008 when Lehman Brothers collapsed and the government had to scramble to keep the whole system from collapsing? Well, we're talking about the same dynamic -- frozen banking systems, plunging stock markets and a freeze on new business orders. That's a kind of paralysis we hope to never see again.
Action to Take --> Word has spread that a bipartisan group of legislators aiming to fix the budget deficit, known as the "Gang of Six," has hit an impasse. Hopes had been rising that the group was on the cusp of announcing a major bipartisan plan. Frankly, if solutions don't emerge to the budget gap very soon, then it's hard to see how Congress will be willing to extend the debt ceiling. It's such an implausible scenario, yet we're inching closer to it every day.
All of this comes at a time when the U.S. economy posted a fairly tepid 1.8% GDP growth rate in the first quarter, with the possibility of more subdued economic activity to come. This game of chicken that Washington is playing comes at a very bad time. Add it up, and the desire to take a risk with stocks starts to diminish. Your game plan for the next two months should be to watch events very closely and be prepared to reduce your exposure to stocks and hold cash.
-- David Sterman
Sponsored Link: I don’t want to scare you… But right now, the U.S. government is doing something incredibly stupid, which could potentially cause a huge crisis in America, in the next few months. Watch the full investigative video here...
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.
5 Things You Need to Know about the European Debt Crisis
Wednesday, May 25, 2011
9:00 AM. http://www.streetauthority.com/news/5-things-you-need-know-about-european-debt-crisis-458306
Here in the United States, the scary days of 2008 when Bear Stearns and Lehman Bros. collapsed, major auto firms needed to be bailed out and Uncle Sam injected $85 billion into a teetering AIG (NYSE: AIG) are starting to seem a like a distant memory. The bailed-out auto makers are looking stronger, the rest of Wall Street failed to buckle under as Lehman and Bear did, and much-reviled AIG is valued at more than $50 billion once again.
But from Berlin to Paris to Rome to Athens, the painful economic crises have never left the stage. Three years on, policy makers are struggling to come up with yet another plan to save the weakest economies in Europe without saddling the larger, healthier economies with open-ended liabilities. It's been a Sisyphean task, trying to get that boulder up the hill -- and Sisyphus is getting tired. If Europe can't reverse course and develop a better game plan, then a whole series of events will play out, with mixed implications for equity investors.
1. Why do the problems persist?
A number of European governments run persistent budget deficits, just as we do in the United States. The solution was to cut spending, raise taxes and let economic growth help maintain newfound momentum by bringing in ever-higher tax receipts as economic activity builds. It soon became apparent that budget cuts weren't deep enough, a tolerated outcome in the face of rising social unrest. Yet few officials anticipated that these countries' economies would get worse. Economic activity in Greece, for example, is weak and getting weaker, and the government is bringing in a lot less money than was hoped. So those massive capital injections from neighbors have been going down the tube. 2. What's next?
Tough choices are being looked at. Greece, with $500 billion in sovereign debt, needs even more money. Citizens in France and Germany are quickly tiring of seeing their governments send good money after bad, depleting their own national treasuries. Politicians are loath to say it, but Greece may eventually be left to fend for itself. And that's not necessarily a bad thing. Greece could follow Argentina's example and announce plans to only pay its lenders $0.30 cents on the dollar while exiting the euro and bringing back the drachma. And the value of the drachma would be much lower than the euro, quickly making Greece more competitive in terms of exports.
3. If Greece bolts...
If Greece pursues this course (which would be quite appealing to me if I were an average Greek citizen), attention will immediately turn to the other PIIGS (Portugal, Ireland, Italy and Spain). With all due to respect to Portugal, whose economy is fairly small, a defection from The European Union would not likely be devastating and could prove helpful. But those other three countries, with their larger-sized economies and deeper integration with the rest of the continent, cannot be tossed off the boat quite so easily.
4. Spain and Italy
A look at Italy and Spain highlight the landmines ahead. They have the world's eighth and 12th-largest economies and are key players in European trade. They have given and received so many gains from economic integration with partners such as France and Germany that any sort of divorce would cause a huge amount of pain. Trade flows would drop, exacerbating already-weak economic trends.
But a real test looms: banks in these countries used short-term loans to get through the crisis. Those loans are now coming due. In the next two years, for example, Spain will need to roll over about $200 billion worth of loans. Who will buy them? (And at how high an interest rate?) Northern European policy leaders have been on the fence. Even if they buy them, they are bound to place very restrictive terms on the loans, tied to even further belt-tightening. That's why some believe the worst of the social unrest we've seen in Europe has yet to come. Nobody's happy. French and German citizens don't want to shovel billions more to their weaker neighbors, and Spaniards and Italians are wearying of externally-imposed austerity measures.
5. The consequences
For U.S. investors, this can all play out in several ways. France and Germany can continue to expend their considerable financial assets shoring up their distressingly weak neighbors. This would also imply that all nations use a common currency, but it's hard to see how the weakling nations can start to rebuild their economies when they are so uncompetitive from an export perspective.
France and Germany can also waive the proverbial white flag, tacitly suggesting that the grand economic experiment has failed by tightening up the European Union to only the healthiest nations. In effect, you would have two Europes, largely along northern and southern lines, that could help each to emerge stronger. German and French banks (after a series of massive write-downs) would no longer worry about their financial strength (though those countries would have currencies as strong as the Swiss franc, which has nightmarish implications for exports -- think German cars are expensive now?) The weaker nations would likely default on their debt and devalue their currencies, which if Argentina is any guide, may not be a bad thing.
Action to Take --> The longer-term implications for U.S. investors are not yet fully clear. If Europe slips into a much deeper crisis as a solution isn't found, then it could be quite messy and the United States could be sucked down in the global vortex. The long-shot scenario is that economic conditions start to improve in places like Greece and Spain, enabling governments to bring in materially higher tax receipts, and making their existing and future borrowings look more manageable. Right now, especially as they are tied to the euro, countries like Greece, Portugal and Spain hold many economic disadvantages compared with their northern neighbors.
I hold the minority opinion that we are indeed looking at the beginning of the end of the European economic union. Secession by some of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) countries looks to be the clear path. It would be a disruptive process, but perhaps healthier for the global economy and our key European trading partners. And if France, Germany and other strong economies stay together, then their remaining currency could rise enough in value to make the dollar a relative bargain. And might that help the United States to finally re-emerge as an export powerhouse? Time will tell. But the best thing for investors right now might be to take a "wait-and-see" approach before making any major moves.
-- David Sterman
P.S. -- I don't know if you're aware of this or not, but a 20-year energy agreement between the United States and Russia is about to expire. The problem is, this deal supplies 10% of America's electricity. When the Russians refuse to renew the agreement, the U.S. will face an entirely new kind of energy crisis. This disruption could send a handful of energy stocks through the roof. Keep reading…
But from Berlin to Paris to Rome to Athens, the painful economic crises have never left the stage. Three years on, policy makers are struggling to come up with yet another plan to save the weakest economies in Europe without saddling the larger, healthier economies with open-ended liabilities. It's been a Sisyphean task, trying to get that boulder up the hill -- and Sisyphus is getting tired. If Europe can't reverse course and develop a better game plan, then a whole series of events will play out, with mixed implications for equity investors.
1. Why do the problems persist?
A number of European governments run persistent budget deficits, just as we do in the United States. The solution was to cut spending, raise taxes and let economic growth help maintain newfound momentum by bringing in ever-higher tax receipts as economic activity builds. It soon became apparent that budget cuts weren't deep enough, a tolerated outcome in the face of rising social unrest. Yet few officials anticipated that these countries' economies would get worse. Economic activity in Greece, for example, is weak and getting weaker, and the government is bringing in a lot less money than was hoped. So those massive capital injections from neighbors have been going down the tube. 2. What's next?
Tough choices are being looked at. Greece, with $500 billion in sovereign debt, needs even more money. Citizens in France and Germany are quickly tiring of seeing their governments send good money after bad, depleting their own national treasuries. Politicians are loath to say it, but Greece may eventually be left to fend for itself. And that's not necessarily a bad thing. Greece could follow Argentina's example and announce plans to only pay its lenders $0.30 cents on the dollar while exiting the euro and bringing back the drachma. And the value of the drachma would be much lower than the euro, quickly making Greece more competitive in terms of exports.
3. If Greece bolts...
If Greece pursues this course (which would be quite appealing to me if I were an average Greek citizen), attention will immediately turn to the other PIIGS (Portugal, Ireland, Italy and Spain). With all due to respect to Portugal, whose economy is fairly small, a defection from The European Union would not likely be devastating and could prove helpful. But those other three countries, with their larger-sized economies and deeper integration with the rest of the continent, cannot be tossed off the boat quite so easily.
4. Spain and Italy
A look at Italy and Spain highlight the landmines ahead. They have the world's eighth and 12th-largest economies and are key players in European trade. They have given and received so many gains from economic integration with partners such as France and Germany that any sort of divorce would cause a huge amount of pain. Trade flows would drop, exacerbating already-weak economic trends.
But a real test looms: banks in these countries used short-term loans to get through the crisis. Those loans are now coming due. In the next two years, for example, Spain will need to roll over about $200 billion worth of loans. Who will buy them? (And at how high an interest rate?) Northern European policy leaders have been on the fence. Even if they buy them, they are bound to place very restrictive terms on the loans, tied to even further belt-tightening. That's why some believe the worst of the social unrest we've seen in Europe has yet to come. Nobody's happy. French and German citizens don't want to shovel billions more to their weaker neighbors, and Spaniards and Italians are wearying of externally-imposed austerity measures.
5. The consequences
For U.S. investors, this can all play out in several ways. France and Germany can continue to expend their considerable financial assets shoring up their distressingly weak neighbors. This would also imply that all nations use a common currency, but it's hard to see how the weakling nations can start to rebuild their economies when they are so uncompetitive from an export perspective.
France and Germany can also waive the proverbial white flag, tacitly suggesting that the grand economic experiment has failed by tightening up the European Union to only the healthiest nations. In effect, you would have two Europes, largely along northern and southern lines, that could help each to emerge stronger. German and French banks (after a series of massive write-downs) would no longer worry about their financial strength (though those countries would have currencies as strong as the Swiss franc, which has nightmarish implications for exports -- think German cars are expensive now?) The weaker nations would likely default on their debt and devalue their currencies, which if Argentina is any guide, may not be a bad thing.
Action to Take --> The longer-term implications for U.S. investors are not yet fully clear. If Europe slips into a much deeper crisis as a solution isn't found, then it could be quite messy and the United States could be sucked down in the global vortex. The long-shot scenario is that economic conditions start to improve in places like Greece and Spain, enabling governments to bring in materially higher tax receipts, and making their existing and future borrowings look more manageable. Right now, especially as they are tied to the euro, countries like Greece, Portugal and Spain hold many economic disadvantages compared with their northern neighbors.
I hold the minority opinion that we are indeed looking at the beginning of the end of the European economic union. Secession by some of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) countries looks to be the clear path. It would be a disruptive process, but perhaps healthier for the global economy and our key European trading partners. And if France, Germany and other strong economies stay together, then their remaining currency could rise enough in value to make the dollar a relative bargain. And might that help the United States to finally re-emerge as an export powerhouse? Time will tell. But the best thing for investors right now might be to take a "wait-and-see" approach before making any major moves.
-- David Sterman
P.S. -- I don't know if you're aware of this or not, but a 20-year energy agreement between the United States and Russia is about to expire. The problem is, this deal supplies 10% of America's electricity. When the Russians refuse to renew the agreement, the U.S. will face an entirely new kind of energy crisis. This disruption could send a handful of energy stocks through the roof. Keep reading…
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