Notes From Underground: Old Friends

Time it was

and what a time it was, it was

a time of innocence

a time of confidences

long ago it must be

i have a photograph

preserve your memories

they’re all that’s left you [Simon & Garfunkel]

Looking at things past do not necessarily accurately predict going forward. The airwaves are filled with sell-side sales people comparing the Trump electoral victory to the Reagan election of 1980. Please immediately dispose of such trash. The time of innocence and confidences are long past. The world is a far different place than 1980. From a stock market perspective it is vastly different. We are now at ALL-TIME HIGHS ON THE SPOOS, BOND YIELDS ARE STILL WITHIN VIEW OF ALL-TIME LOWS, AND REAGAN WAS TO BE AN AGITATOR FOR UNFETTERED GLOBALIZATION AS THE BERLIN WALL CRUMBLED AND THE SOVIET UNION WAS LAID UPON THE HEAP OF FAILED EMPIRES.

The European Union was still in an embryonic state, inflation was the bane of all central banks and the U.S. was the undisputed leader of the democratic capitalist world with NATO and the Asian-Pacific treaties maintaining a stable Asia and though China was a nuclear power, it wasn’t even considered in the panoply of global economic players. Trump would wish for such a backdrop. The only constant is that a DEBT OVERHANG plagued the emerging markets as DEBT continues to hinder global economic growth. Otherwise, Trump faces a totally different economic and financial landscape in which the outcomes are dependent on the outcomes of capricious actions of economic and political actors.

In tomorrow’s Financial Times, there’s an article by Wolfgang Munchau, whose work I have cited throughout the years (sometimes positively but most recently in a more negative way). Munchau has gone from being a Pollyanna on the EU, especially after Draghi’s “whatever it takes” policy to save the euro, to being a Cassandra, warning of the doom confronting the European Union. Brexit, the AfD and now Trump are heralding a rise in nationalism in Germany, France, Greece and others that provides a challenge to the current structure of the EU. In the FT op-ed, “Italy’s Referendum Holds the Key to the Future of the Euro,” Munchau raises some very important points for people involved in the financial system.

First, “A French or Italian exit from the Euro would bring about the biggest default in history.” Second, “Foreign holders of Italian or French euro-denominated debt would be paid in the equivalents of lira or French francs. Both would devalue”; and third, “There is a lot of German wealth waiting to be defaulted on.” These are issues I have discussed in Notes From Underground ad nauseam, but when a member of the European elite raises the issue, it’s time to pay close attention.

There is a growing fear that the rise of Trump is unleashing a strain of nationalism in which alienated middle classes are pushing back against the negative effects of global capitalism. Under globalization, the educated elite have reaped the major benefits of world trade, while the entrance of two billion workers from new capitalist-producing countries like China and India have caused wages to stagnate in advanced market economies.

Nationalist parties are decrying the one-size-fits-all response to the resolution of domestic problems. While Germany believes the economic malaise can only be solved by structural reforms and austerity budgets, the French and Italians are looking to increase deficit spending and create infrastructure spending programs to put people to work. The EU is in the throes of a deep political crisis with gigantic financial repercussions because of the massive amount of  sovereign debt on the balance sheets of the ECB and the various national central banks and domestic lending institutions. If the French were to leave the EU the financial hit to domestic lenders around the globe would be catastrophic, especially to German commercial banks who have loaded their balance sheets with zero risk-weighted sovereign assets.

As Munchau noted: Chancellor Merkel has spent the last four years denouncing a eurozone bond backed by a harmonized tax system but if an Italian exit beckoned, “Merkel would accept a eurobond rather than an Italian exit.” One of the brightest financial minds I know sent me an e-mail today asking me what I thought 10-year German bunds would do during the next year. I told him I will ponder this as there is no short answer. If Renzi loses and Marine Le Pen were to miraculously become the French President, the bund would become the ultimate haven within Europe.

But if Munchau were to be proved right and the  Germany is forced to accept a eurozone bond, the outcome would be vastly different. The German credit guarantee is the backbone of the EU and global financial system. It is this fear that makes me reticent to be short GOLD even as long-term yields rise and the odds of a December Fed rate hike is 98%. If the Europeans move toward the use of bail-ins to resolve the issue of undercapitalized banks, then GOLD will become a major default position as cash hoarders will seek a different haven. We are approaching year-end but like OLD Friends on a park bench there is much to ponder.



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3 Responses to “Notes From Underground: Old Friends”

  1. Rob Syp Says:

    Happy Thanksgiving everyone!

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