Syzygeist

Another view

I am spurred to write this week on a confluence of factors, and I do not pretend to know more than the next guy about the future, only that it is ahead of us.

I do want to dispute my former Morgan Stanley colleague Barton Biggs (of Traxis Partners) who went on television two days ago with a prediction that equity markets would soon move up 15-20%, led by technology. This is in keeping with other optimists who say the US recession has ended and the US will return to powering the global economy. After all, who else can?

 

Okay Barton, maybe, but here is another view:

The debt crisis in Europe, the overheated real estate bubble in China, the $5.2 Trillion of debt the US faces in Freddie Mac and Fannie Mae, the million+ foreclosures with more to come, are all conspiring to alert the world to the obvious:

TOO MUCH DEBT (and no clear will or way to pay)!!!

This debt has risen – seemingly central governments’ only antidote to trouble – while relative earning power in Europe and the US continues to go down. Cheap labor in China/India/Asia, fueled by hundreds of millions, is not going away fast enough, soon enough. So how are these government debts to be paid off? Greece has already shown, and California (and Michigan, Illinois?) may follow in this, that people who have benefited from profligate policy will not suddenly submit to austerity. (And even if they did, the economy would not then grow enough to pay back the debt.)

I watch as the gold price continues to creep up and I am thankful that I bought it when it was still only $900 an ounce. I am further encouraged to affirm that gold is not historically as much an inflation hedge as it is valuable during deflation. To see how gold shares might act in the upcoming credit crunch, please consider a chart of Homestake Mining in the 1930's (courtesy of Gold Eagle.)

 

I like the way this chart calls into sharp relief a line of reasoning that I have been following: if governments print too much paper, eventually its value erodes and people look for something more durable. This is even truer if they want to hoard something of value as the economy stagnates. Historically, that has meant precious metals, and the Homestake chart is powerful evidence.

Barton Biggs may be right that another up-move is due in US equities because Europeans seeking a haven from their falling currency and lagging markets may choose the US. But that will not pay off our unprecedentedly high and rising debts nor counter the effects of diluted currency, a game which the European Central Bank and IMF have now fully joined with the US Treasury. US equities may seem to appeal for the moment, and the dollar may be the “least worst” of various currency options, as an analyst put it recently during a Bloomberg interview.

But it’s bad, and it’s going to get worse.

Capitalism After the Crisis

April 26th's news (see WSJ Page 1) on how Warren Buffett has intervened in the Congressional debate on derivatives is not good news. It underscores the point made eloquently and persuasively in the recent paper “Capitalism After the Crisis,” by Luigi Zingales, a professor of finance at the University of Chicago School of Business.

Zingales’ warns that the nature of American capitalism is at risk. Financial industry interests – as distinct from the interests of a fair and open-to-competition market – are becoming too powerful and risk being unduly served by government. America is becoming more like Europe or many Asian and South American markets, where it is not what you know but whom you know (or can influence to your way of thinking and in your interest).

Buffett’s latest intervention - in the interest of his holdings and the interests of non-transparent financial practice – is a powerful signal of this financial influence on the political process.

It may be that Obama can resist Buffett on this, but I would wager not. And will the resulting legislation actually serve the public interest in a fair market? Zingales is asking us to consider what is really at stake here, as a Congress heavily supported in campaign contributions by financial interests (note Goldman Sachs et al), and influenced by lobbyists (is Charles Schumer a handmaiden in disguise?), is about to decide where the power will lie. We should remember that Warren Buffett is an investor with investors to protect, and a P&L to preserve.  And P&L is not an acronym for public interest.