Notes From Underground: Europe has AUSTERITY and POLITICAL REPRESSION; The U.S., FINANCIAL REPRESSION

****WARNING: TRADING IN HOLIDAY THINNED MARKETS DURING TURBULENT TIMES CAN BE DANGEROUS TO YOUR WEALTH****

Today’s 2-YEAR NOTE auction in the U.S. received a 4.07 bid to cover ratio, the highest in records dating back to 1992. The rate NOTE BUYERS received was a meager 28 basis points. (Yes, thank you sir, may I have another?) There are those on the FED who are concerned that inflation is a threat and feel that the FED is too easy to meet its stable price mandate. The question becomes: Which financial geniuses are purchasing a TAXABLE INSTRUMENT AT A LOWER RETURN THAN THE INFLATION RATE?

If the CPI is 1.8% and the 2-year yields 0.28% what is the possibility of achieving any type of positive return? It is at this point that I want to invoke the theory put forward by one of Chicago’s most successful traders: Richard Dennis. In the book “Inside the House of Money,” author Steve Drobny cites the theory on page 205, although its original presentation was in NEW PERSPECTIVES QUARTERLY, Fall 1987. It is an honor to present this to the readers of NOTES.

The Slower Fool Theory (link to full text from New Perspectives Quarterly):

“We are playing a variant of the Greater Fool Theory which should be called the Slower Fool Theory. According to the Greater Fool Theory, investors buy things they know to be worth a lot less than they cost, on the hope that they can find a greater fool to sell to. It is not such a great strategy since there are not enough fools to go around.
Following the Slower Fool Theory, investors do not Intend to let their bonds mature and receive face value and possibly lose real purchasing power. What May plan to do Is to be faster than the other fools holding debt Instruments and liquidate theirs before the oncoming economic Armageddon devastates them.
… Unfortunately, the future will arrive and Inflation’s turn will come, and consequently the economy’s demise. It will be a discontinuous leap for investors specifically and the economy generally Into illiquidity, panic and chaos. I suspect many people’s investment strategies are not much different from mine Keep buying that paper even though it Is no good; if you ever see 8% inflation again, head for the safe harbor of inflation hedges.
So, the catastrophe is out there lurking, probably happening sooner than later, and probably nastier than we can understand. It is avoidable, just as 8% Inflation Is avoidable, but not very likely to be avoided in the absence of taming the debt monster Prosperity will last only as long as the Slower Fool Theory of bond Investing lasts.
Read these words and reread them as the wisdom of trading professionals used to be worth the price of admission to the PITS. As we watch the U.S. Treasury perform feats defying economic logic–although FEAR is certainly an economic fundamental–keep in mind the theory of a trader with the scars to prove it.
***Last night Japan released its TRADE DATA and it was mildly disappointing. Exports were weak as it seems that YEN APPRECIATION and EUROPEAN TURMOIL led to a 3.7% decline in shipment. Food and energy imports continued to climb as Japan recovers from the March disaster. Crude oil imports have risen as Japan’s nuclear power generation has been dramatically curtailed. One of the positive impacts of the STRONG YEN has been that OIL prices in Japan are back at 1983 levels.
In a Bloomberg article, Andy Sharp and Aki Ito reported that there is concern about the hollowing out of Japan’s industrial base due to the YEN‘s strength. South Korea reported that the Korea Development Bank has seen stepped up interest by Japanese firms for companies on the Korean Peninsula. Japan’s domestic problems mount as the strong currency is a problem in a very fragile global economy. Will the BOJ/MOF utilize the HOLIDAY MARKETS TO HAVE A GREATER IMPACT? Watch the TECHNICALS for any hint, especially on the YEN CROSSES and not just DOLLAR/YEN.
*** From one of my favorite economists: Simon Johnson warns in a Bloomberg op-ed that DEUTSCHE BANK IS HIGHLY LEVERAGED TO THE SOVEREIGN DEBT MARKETS. He warns that its “risk weighted assets” in “European context” are sovereign bonds, which were 337.6 billion EUROS as of Sept. 30, and are considered riskless under Basel guidelines. Johnson warns that the German banks risk may be greatest of all in the U.S. where it has large exposure as a securitization trustee.
Deutsche Bank operates on an equity base of 51.9 billion EUROS while having assets of 2.28 TRILLION EUROS, a leverage ratio of almost 44 to 1. Johnson argues that its U.S. exposure under the Taunus Corp. is even higher. The exposure of DEUTSCHE BANK is a serious global issue and maybe the Germans should stop the finger-pointing. Remember, when you point the finger there are three pointing back at you.

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8 Responses to “Notes From Underground: Europe has AUSTERITY and POLITICAL REPRESSION; The U.S., FINANCIAL REPRESSION”

  1. rohrintl Says:

    Finger Pointing Indeed… Which is why only the “Even Slower Fool” will be the one who keeps faith with the equities when the rest of what’s out there catches up with the US. While the relatively limited leverage and fat corporate balance sheets provide that warm glow for now, the full deleveraging cycle has only been forestalled by the excessive liquidity provision. And no amount of additonal liquidity will get the money to the folks who need it to prevent the system being stressed vigorously one more time for good measure on the way to the bottom.

    A lot of folks think Europe is going into a more than mild recession. My cynical view is that the Germans are happy to engineer a mild Depression as a clear excuse to boot out the weak sisters, because they are too xenophobic to think through the implications of a $1.80 euro… which destoys what’s left.

    So that govvies buyer may be a Fool, but he’s one who’ll get paid by the guys who own the presses, and can be rightfully less concerned about the (extremely) negative real yield for quite awhile yet…

    Whattaya think the 2-yr yield will be when the S&P hits 800 again?Want to see what a very normal guy who knows thinks it all? Catch the Charlie Rose interview of Ray Dalio.

    All of which is right in line with your Japan perspective. What a mess… Interesting that NIKKEI was leading the way down recently even as Europe hung in (prior to Monday.)

  2. arthur Says:

    Great post, what do yo think about yesterday decission on US ratings? Double “technical” moral?

  3. yra Says:

    Arthur–I try not to think about the ratings agencies and their output–they are lagging indicators

  4. Jon Says:

    Yra- my head hurts….. outside of cash could you offer up a non technical investment idea. Where do you see some value if at all.
    Thanks

  5. yra Says:

    JON–i could join the ad nauseam group and say buy high quality dividend paying stocks which i do believe in but of course timing that makes the net returns the key result.There is so little out there as the idea promoted by Carmen Reinhart on “financial repression” is very real–I will cover that piece again very soon but you should read it

  6. Greg Says:

    Yra – I’ve been using a barbell strategy with cash and gold during the current period with some success. The fundamentals behind the strategy still seem favorable to me but I was wondering your thoughts.

  7. yra Says:

    I don’t know how you are using the barbell concept–that is a broad idea depending if you are using GOLD both as a long and short but I really don’t know unless i know what you are doing –trading it or using it as an investment

  8. Notes From Underground: Looking Back Two Weeks and Two Years | Notes From Underground Says:

    […] November 21, 2011: Europe has AUSTERITY and POLITICAL REPRESSION; The U.S., FINANCIAL REPRESSION […]

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