Euro Crisis

The European sovereign debt issues have become a contagion. Foreign politicians will have to make difficult decisions when it comes to saving sovereign bond markets as well as large private European banks. 

This past weekend, the Eurozone had an economic summit to discuss how to handle the sovereign debt issues with the PIIGS Nations [PIIGS = Portugal, Ireland, Italy, Greece, and Spain].  These countries have been net importers since the euro was created in 2000.  As members of the European Union (EU) they inherited credit ratings that should have been exclusive to Germany, France, and the Netherlands.  The PIIGS nations were able to exploit the EU with unchecked borrowing and spending.  All of these countries were able to live high off the hog while Germany, Netherlands, and France continued to produce and save. 

The PIIGS nations can be viewed as the misfit children in the European system.  Their mother and father, France and Germany, have been forced to continually bail them out in recent months.  However, after throwing more cash in the trash, the parents are starting to realize that they need to cut their children off from the unlimited credit. 

Portugal, Ireland, and Greece are the worst of the PIIGS nations.  All three countries have received IMF bailouts and remain on life-support.  Their debt to GDP ratio is through the roof because they have large burdensome governments.  Since these countries aren’t big exporters, their expenditures vastly exceed their revenue. There is no question that these three countries would have defaulted by now if it wasn’t for Germany and France providing a cheap credit line to them in exchange for austerity measures.  Austerity generally means getting back to the basics and stripping a lot of the government fat.  Unfortunately, this means government workers losing their jobs and benefits—hence the Molotov cocktail parties.   The good news is that this deleveraging** is needed to get their fiscal house in order. These economies are in trouble because they have become reliant on cheap credit, low-interest rates, and enormous government spending (cough USA cough).  However there is a catch!

France and Germany cannot afford to allow any of these PIIGS nations to default. This is where it gets trickier than my previous analogy suggests.  The hidden problem is that French and German banks have huge exposure to the PIIGS bond markets.   Not only are they heavily invested in the bond market but also bond derivative markets.  Many of these banks have leveraged insurance on the PIIGS nations’ bonds.  To keep the analogy going: the parents have already started to pay for college ahead of time even though it appears none of the kids will be able to graduate high school. 

There are several goals behind this weekend’s Euro-summit:

1-Find ways to restructure Greece’s debt

2-Recapitalizing private banks

3-Create a EU rescue fund to keep the Greece, Ireland, and Portugal problems from spreading to Italy and Spain (Europe’s third and fourth largest economies).

First, with respect to Greece, experts agreed that bond holders of Greek’s debt would need to take a 50-60 percent haircut (devaluation)  in order to make Greece’s debt sustainable.  Secondly, the leaders have already agreed that 100 billion euros would be needed to keep the French and Germany banks solvent in the face of PIIGS defaults.  Lastly, the rescue fund has become the most controversial topic. German leaders are facing resistance from the general public on the issue of using Germany’s funds to save the Eurozone.  For the rescue fund to work, many European economists are recommending between 1 trillion and 2 trillion euros.  Germany only seems comfortable contributing around 400 billion euros.  This would leave the fund inadequate and would involve kicking the can a few more months. It appears the solution that is gaining the greatest traction involves leveraging the 400 billion euros. If this doesn’t make sense then you are a logical person. Again we have the problems of financial innovation to solve an already over-leveraged system. The take-away message is that the system will live to see another day, either by increasing financial innovation or money printing.  With these leverage-increasing measures, we are only increasing the likelihood of a larger calamity. 

National Bank Transfer Day

One promising thing that has come out of Occupy Wall Street has been the formation of National Bank Transfer Day.  On November 5th thousands of Americans will close their accounts in Too-Big-To-Fail (TBTF) banks and open accounts in credit unions or community banks.  

These TBTF banks have not learned their lesson since 2008’s near systemic collapse.  They may have become flush with cash from central banks, but they still have not deleveraged** their balance sheets.  To the contrary, they have continued to invest trillions of dollars in risky derivatives and stinky packaged debt obligations—this time with exposure to sovereign debt.  Bank of America and JPMorgan recently moved 74 trillion and 79 trillion dollars in off-sheet derivatives to their banks, respectively.  These clandestine moves provide collateral for the derivatives, in the form of depositor bank accounts.  Shockingly, if these banks fail then the derivative holders will have their losses settled first.  That leaves the FDIC holding the bag for over a trillion in depositor bank accounts.  The FDIC only holds a small percentage of what it insures, so it too would face insolvency.  FDIC has been publicly outspoken on this issue, but to no avail.  The Fed has approved and encouraged these moves, putting them at odds with the FDIC.  My guess is the Fed realizes that it would have to backstop the FDIC and reimburse the depositors before there is a system-wide bank run.  They better start their printing press!

If you have an account at a Bank of America, JPMorgan, Wells Fargo, and an other TBTF bank then you may want to consider moving it  to a credit union or community bank.  The 2008 crisis came without much warning, but this time you can protect yourself.  It’s up to you to make the prudent choice. 

Understanding the Occupation

It has been two years since the formation of the Tea Party, a radical right group.  Finally, the left have responded with their own radical group; Occupy Wall Street (OWS).   Thus far, OWS has been an unorganized assembly of students, unemployed workers, and unions.   The topics of attention have ranged from beheading corporate leaders to legalizing drugs.  However, one underlying theme has been the onslaught of the rich.  Some of ‘The 99%’ have clearly placed their cross-hairs on ’The 1%’. 

However, I would argue that class warfare is not the answer.  I have heard far too many politicians crying that the rich need to contribute “their fair share.”  How much is their fair share?   Somebody making 10 million dollars pays 35% income tax which enables the government to collect $3.5 million in revenue.  Another person may make $100,000, which puts them in the 20% tax bracket.  Their tax responsibility is $20,000 a year.  So the millionaire contributed $3.5 million and the $100,000 worker contributed $20,000.   Is the wealthier individual getting more benefits from the government?  No way Jose.  However, someone making 10 million is probably a business owner.  Not only is he contributing more in taxes but he is also supplying people with jobs!  People don’t get rich at the expensive of other people.  They get rich because they provide goods or services that people want or need.

Let’s take a look at some of these one-percenters; Steve Jobs, Bill Gates, Sam Walton.   Steve Jobs was the fifth wealthiest individual in the United States when he passed away last month.   He has been an idol to American businessmen and a charitable individual.  As CEO of Apple he received $1 a year as his salary.  Jobs achieved his high net-worth via Apple’s stock, which is arguably the best stock in the last ten years.   His stock-option salary is only vulnerable to the capital gains tax of 15%.  According to Warren Buffett and Barack Obama he would not be contributing his “fair share.”    Should we demonize Steve Jobs?  Hell no, we all know that Apple has employed millions of Americans and provided many of us with high-tech gadgets ahead of their time.  Same respect and thankfulness should apply to Bill Gates, Microsoft, and the Gates Foundation.  And what about Sam Walton and Wal-Mart?  Americans would riot if they couldn’t get their cheap Wal-Mart goodies.  

So we need to redefine who we are angry at.  We can’t get angry at entrepreneurs and producers who are already hurting from the recession.  We need to focus our disproval on the companies that engage in ‘crony capitalism’ with the government (see figure above).   I’m personally peeved at the TBTF (too-big-to-fail) banks, the Federal Reserve, and the US Government for all their hand holding.  What do they really contribute to society besides phony derivatives and triple packaged “shit” (as some Goldman Sacs employees called their Credit Default Swaps)? The banks and hedge funds are the only ‘corporations’ that engage in predatory trading, where deception is a tactical skill.  These organizations also have the nerve to give their management bonuses with tax-payer money that was used to save them from failure.  Wall Street lobbyists have infiltrated and corrupted our government.  Our economic system can no longer be called Capitalism.  Capitalism has not failed us.  Crony-Capitalism is what we have and it is still failing us.   These financial organizations remain overleveraged and on the brink of failure because they continue to engage in risky trading.  These TBTF financial companies know their losses are backstopped by the government that turns to the tax-payer.   The Federal Reserve has encouraged this whole racket by keeping interest rates low—encouraging people not to save, but to invest in the stock market or buy a house/car.  Nothing will change and our economy will not recover until we cut the giant debt caboose loose.  How do we do this?  END THE BANKING CARTEL.  

Quote of the Month: Steve Jobs

“Being the richest man in the cemetery doesn't matter to me. Going to bed at night saying we've done something wonderful... that's what matters to me.” -Steve Jobs

Steve Jobs has been a captain of innovation his whole life.  Curiosity and perseverance enabled him to become a successful pioneer in the computing industry.  As his quote suggests, he was not driven by riches.  That’s not to say that he cursed the profits that followed his success.  My argument is that the most successful entrepreneurs make it because they want to make a difference in people’s lives.  Arguably, there is a lot of luck involved too as Malcolm Gladwell repetitively points out in Outliers.   With that said, people make it big when they want to change the world and the world is ready for the change.

Too many of us are chasing the job that pays the best salary.  In the process we have put family and happiness on the back burner. I believe we need more people who want to make a difference in a community.  When you look back on your life– do you want to be proud of what you accomplished or be proud of how much money you made?  Or even better, how many lives did you affect?

There are two ways to excel in life.  You can work hard, follow the rules, and do as your told.  The other option is to veer from the beaten path and think for yourself.  The best sign that I have seen from the Occupy Wall Street protest was one which said “Think for yourself or be thought for.” 

My generation knows something about everything but not everything about something. We have been falling deeper into a hedonistic, sound-bite society.  Facebook status updates have supplanted conversations while reality television has replaced true relationships.  I hope the meaning of life is a little more than being entertained and having a job.  We should question everything around us and ask why that is the way it is.  This world still needs a lot of work.  Where are our Ghandis, Mother Teresas, Bob Marleys, or Thomas Jeffersons?   It’s time to leave your mark. 

Investing in Precious Metals

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The Great Gold Bubble

Almost every day that I tune into CNBC I have to listen to someone warn Americans about the potential bubble in the Gold Market.  They have been calling it a bubble since gold was $850 an ounce.  With gold now closing in on $2,000 dollars an ounce, it is making headlines daily.   So what do you think?  Is gold in a secular bull market or is it in a bubble? 

I would like you to try to name five people who invest in physical gold or silver.   Notice I said physical and NOT precious metals stocks or exchange traded funds (ETFs).    A majority of stocks and ETFs mirror the metals’ spot prices but do not keep any physical metal in inventory.   I bet you were unable to think of three or more people investing in precious metals.   That is because almost nobody is buying physical precious metals.  I have noticed dozens of gold shops spawning up all around me but this does not suggest that gold is in a bubble.  This verifies my position, that the masses are still net sellers of gold and silver because they would rather have quick cash. You may be asking then who is buying precious metals that are causing the sky rocketing prices in the precious metals markets?  Answer:  Central Banks.  China, Russia, India, Mexico, and most recently South Korea have been buying tons (or tonnes) of gold at a staggering rate. 

Why do central banks hold gold?  Ben Bernanke said “because of tradition”, but I would say because gold and silver have been money since 7^th century B.C. when Greek city states first started bartering in coins.   Throughout history, gold and silver have remained valuable – serving as both jewelry and money.  Paper currency was first issued as way to exchange precious metals without having to carry the metals around.   Eventually, people became accustomed to exchanging the gold notes instead of physical gold and silver.   The price of gold provided an exchange rate between international currencies prior to 1945.  In 1945, the Bretton Woods System was set up and 29 nations agreed to accept the US dollar as the currency by which international business was to be conducted.  For example, if Britain was to purchase goods from Norway, they would settle in Federal Reserve Notes instead of Pounds.  At the time, the US dollar was a stable currency because it was still on a gold standard.  Thirty-five dollars equaled one ounce of gold.   However, in the early 1970’s the US economy was suffering from stagflation as we found ourselves in a never-ending conflict with Vietnam.  Low interest rates, rising military costs, and increased domestic spending (sound familiar?) paved the way for inflation and a loss in US Dollar confidence.  In early 1971 countries started to cash in some of their paper money for physical gold.  Switzerland traded in $50 million in paper for physical gold and France followed suit by redeeming $191 million for gold.    On August 15^th, 1971 President Nixon took the most drastic response and closed the gold window to prevent foreign countries from emptying Fort Knox.  Since that day, which became known as Nixon Shock, gold has been sky rocketing and the dollar has been weakening as a result of our growing trade deficit and the FED’s inflationary monetary policy.   So gold may be in a bubble, but we are only in the beginning stages!