All government debt is a racket, and should be repudiated.

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Investment advisor John Mauldin had this to say today in his email publication:

…if Greece defaults it does not necessarily mean they have to leave the EU, any more than if Illinois defaulted they would have to leave the United States. Greece could still use the euro and life could go on. EXCEPT. The markets would no longer lend the Greek government money at anything close to a livable rate. Greece would be forced to balance its budget. Since they are part of the euro, devaluing the currency is not an option. The results of controlling their fiscal deficit would not initially be pretty and would almost insure a serious prolonged recession or depression in the Greek area, with fall out in the region. It would be a sad decade for Greece. But in the long run, it is a better option than default.

Further, and more important to the rest of Europe and the world, the results of a Greek default would be financial turmoil. 250 billion euros (and maybe 300!) of Greek debt is in international bond funds, pension and insurance companies, and above all at banks. Think German banks. Already undercapitalized banks. Also, think of all the investment banks who have been selling relatively cheap (given the apparent risk) credit default swaps on Greece, in an unregulated market, exposing their balance sheets. What should be a simple, if sad, matter for the Greeks, becomes a problem for the world, just as subprime debt in the US caused a world credit crisis. And the risk of contagion from Portugal, Spain, et al is serious. 2 trillion euros of debt could get downgraded by the bond market in very short order. It could be a replay of the last credit crisis, just with new actors as the prime problem.

Bailing out Greece without serious and credible deficit reductions by their government over the next few years would simply delay the problem, and it is not altogether clear the bond markets would go along for very long. At the end of the day, it may be the bond market which forces the Greek government and its people to take some very bitter medicine. Stay tuned. This is just the beginning of what will be a series of sovereign debt crises over the coming decade. It is important for the world that we get this one solved right, or the consequences will be quite severe.

I respectfully disagree with Mr. Mauldin. I believe that default would be the best outcome for the Greek people and the rest of Europe, as well as the financial system. It is ironic that Mauldin does not support this outcome himself, since he claims to be a fan of von Mises, Hayek and Rothbard, all of whom would be appalled at the prospect of perpetuating the racket in Athens. Rothbard specifically advocated the repudiation of government debt, since it serves only the interest of politicians and special interests at the great expense of the society at large:

In the famous words of the left-Keynesian apostle of “functional finance,” Professor Abba Lernr, there is nothing wrong with the public debt because “we owe it to ourselves.” In those days, at least, conservatives were astute enough to realize that it made an enormous amount of difference whether—slicing through the obfuscatory collective nouns—one is a member of the “we” (the burdened taxpayer) or of the “ourselves” (those living off the proceeds of taxation)…

If sanctity of contracts should rule in the world of private debt, shouldn’t they be equally as sacrosanct in public debt? Shouldn’t public debt be governed by the same principles as private? The answer is no, even though such an answer may shock the sensibilities of most people. The reason is that the two forms of debt-transaction are totally different. If I borrow money from a mortgage bank, I have made a contract to transfer my money to a creditor at a future date; in a deep sense, he is the true owner of the money at that point, and if I don’t pay I am robbing him of his just property. But when government borrows money, it does not pledge its own money; its own resources are not liable. Government commits not its own life, fortune, and sacred honor to repay the debt, but ours. This is a horse, and a transaction, of a very different color.

For unlike the rest of us, government sells no productive good or service and therefore earns nothing. It can only get money by looting our resources through taxes, or through the hidden tax of legalized counterfeiting known as “inflation.” …

The public debt transaction, then, is very different from private debt. Instead of a low-time preference creditor exchanging money for an IOU from a high-time preference debtor, the government now receives money from creditors, both parties realizing that the money will be paid back not out of the pockets or the hides of the politicians and bureaucrats, but out of the looted wallets and purses of the hapless taxpayers, the subjects of the state. The government gets the money by tax-coercion; and the public creditors, far from being innocents, know full well that their proceeds will come out of that selfsame coercion. In short, public creditors are willing to hand over money to the government now in order to receive a share of tax loot in the future. This is the opposite of a free market, or a genuinely voluntary transaction. Both parties are immorally contracting to participate in the violation of the property rights of citizens in the future. Both parties, therefore, are making agreements about other people’s property, and both deserve the back of our hand. The public credit transaction is not a genuine contract that need be considered sacrosanct, any more than robbers parceling out their shares of loot in advance should be treated as some sort of sanctified contract.

I highly recommend reading the whole Rothbard essay on Mises.org, since the ideas therein have never been more timely for the US, among a great number of other countries.

It is almost always in citizens’ best interest for their government to repudiate the debt it has accumulated in their names. Politicians take out debt to spend more than is prudent or ethical, in order to buy votes, very often union votes. This is the case in Greece, where repeated strikes by teachers, dockworkers, farmers and others have been met with greater and greater pay and benefits. This system is a racket that rips off the silent majority of taxpayers.

Why should generations have their earnings stolen (make no mistake, taxation is theft, the involuntary taking of property under threat of force) to continue to support politicians, bankers and union thugs?

A default would indeed cripple the government’s ability to borrow, and would thereby end the racket. Politicians would no longer be able to offer something for what seemed like nothing: if they wanted to raise union pay, they would have to raise taxes at the same time, not at some future date beyond the next election.

Yes, a default would hurt bondholders. Duh. That’s perfectly just, since Greek (and Italian, Portugese, Spanish and Irish — GIPSI) bonds pay higher yields than those of Germany or Switzerland. These investors took a gamble, as did those who wrote default swaps on such debt. They deserve to lose money, and frankly, the astute buyers of default swaps deserve it more than they. Besides, as Rothbard makes clear, the creditors are a party to theft, guilty of receiving stolen goods.

I am tired of this nonsense that somehow banks and investors losing money means the end of the world. That is a fiction fed to a credible and ignorant public in order to justify the transfer of their assets to the most powerful banks. What is the end of the world?  War: the uniquely governmental institution of cities and industry bombed to rubble, crops burned, and whole generations enslaved, blown up, starved and displaced. A banking crisis? My god, that’s nothing, unless the government turns it into prolonged stagnation through theivery (and even worse if they take advantage of the resulting conditions to agitate for war). Factories, roads, bridges, and offices still stand; and human beings still have their lives, talents and freedom to use them. Assets change hands, that’s all. Nobody needs to starve, and unemployment only needs to be brief, unless of course the government prevents the defaults necessary to transfer assets to productive ownership by shifting the losses to the public. In that case, capital is wasted, assets stay idle and jobs disappear.

The Greek public should send a message to their politicians: “We won’t pay. Default away.” If unions can stike, why can’t taxpayers? The fact is, the debt is unpayable anyway, because the taxes necessary to service it would cripple what’s left of enterprise in that socialist economy. Just get it over with and don’t sign up for the lost decade(s) club.

This classic risk ratio is in its own bull market. Look at the spike last week, which may kick off another monster rally in 2010. Interesting also how it turned up all the way back in September.

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Checking the archives, I see that I charted this bottom as it happened.

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Silver did make a peak just then as I’d anticipated, but then it charged ahead with gold to briefly trade over $19. The deflation trade should not be kind to it in 2010.

In keeping with my idea of shorting the levered bull ETFs instead of buying the short ETFs, I’m going to be selling UGE, which has barely begun to fulfill its downside potential:

Source: Yahoo! Finance

I am wary of a bounce here, so new shorts at these levels are in small sizes. I’d like to add at higher prices.

The winners are those groups that have fallen the least since mid-January, somewhat adjusted for their potential to decline. I view these as the least prone to violent snap-back rally right now, so this is where I am adding, conservatively, to my short portfolio:

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Losers

Materials are among the big losers so far. Commodities have a tendency to fall hard right from the peak and keep crashing for months. I’d like to short here, but will wait for a better entry (which may never come).

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It is also worth noting that among the world’s stock markets, the US has held up pretty well so far, along with Japan, and believe it or not, Russia. The worst markets, besides Greece (which has already given up the majority of its 2009 gains) are the “emerging markets.”

Key to chart below:

Green: Japan; Purple: Russia; Dark blue: S&P500; Orange: India; Light Green: various emerging markets; Light blue: Europe; Brown: Brazil; Red: China (Shanghai-listed stocks)

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I suspect I’m going to be shorting Russia soon. It was among the very worst in 2008.

Someone asked for clarification on where I think we are in the wave structure, so naturally I broke out my kiddie drawing program:

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Seriously, it’s hard to get precise about labeling waves at anything but larger orders of magnitude. It’s more about the feel of the market (whether it is the probing ones and twos or a rushing three or a struggling four or an exhaustive five).

Anyway, the above drawing starts at the 2007 highs (B wave top) and ends where I think we are going in 2010. Primary 1 ended in March, primary 2 may have just ended in January, and we are now in a smaller degree first wave in primary 3. Since we’re barely 3 weeks in and are only down 6-7%, it’s likely that we are still working on minor wave 1, and within that wave probably in the 1-2 area. Minor 1 of primary 1 bottomed in March 2008 with the markets down 20% and Bear Stearns going under. This doesn’t feel anything like that yet. This is more like the early probes of February-March, July-August or October-November 2007. We’re so early in, the news guys don’t even feel the need to come up with explanatory narrative yet.

Because this is primary 3 already, don’t expect the market to be as generous with shorting opportunities as in the drawn-out, rounded top of 2007. I expect minor 1 alone to do some serious damage, certainly get down under 9000 on the Dow.

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I snapped these photos of gold coins for sale at a Western Union in a German train station. Pretty cool, but a sign of a top?

When the short-term gets hazy, remember the big picture.

The drop so far (about 6% in 12 days on a closing basis, 9% in 13 days intraday):

Source: Prophet.net

Here are the conditions I am watching: RSI on the daily scale is now oversold. However, DSI bullishness has dropped from near 90% to the 30s, which still leaves a little room on the downside for a first wave down from a big bull move (these sell-offs often end with about 20% bulls). Put:call is still very low for the bottom of a sell-off of this intensity. The VIX also has room to run, since it has still not cracked 30.

The deeply oversold hourly RSI, the swiftness Friday afternoon’s 2% snap, and the daily reversal bar (new low, then a close above the previous close) suggest that a countertrend rally has just kicked off, but if that is the case, it is from somewhat more subdued conditions than often mark the end of sell-offs of this type (a sudden drop after a long, smooth trend upward on great complacency). If this were 2009, the market would respect the current oversold condition, hold and then rally, but the Great Bounce is over, and the character of the market has changed. Although it feels like we’ve already filled our panic quota, the put:call ratio, VIX and DSI leave open the possibility of a very sharp (3-6%) intraday drop early this week from which the market would recover quickly and rally for several days or weeks.

Another possibility, and I somewhat favor this one, is that the rally from Friday’s lows is meaningful, but will not retrace as much of the decline as rallies from bottoms with more signs of panic. In this case, I’d be looking for a top no higher than 1100 on the S&P.

This is a tricky juncture to trade, since there is no near-term expectation of anything but volatility. I would not want to be levered short nor long here. A trader could go long against Friday’s lows for a quick trade, or stay short while ready to absorb a 5% or even 10% rally. Traders with modest, unlevered short positions (not inverse ETFs) can relax and just check the market each evening and not worry about the chop or even a big retracement. The real money is made in the sitting, as Livermore said. 50 points is not worth getting shaken out of 500.

Deflation has been here all along; the markets just pretended otherwise.

I sure wish I’d sat tight on all of my (levered) shorts from January: stocks, sugar, cocoa, oil, copper, platinum, palladium, silver, euro, Swiss franc, New Zealand dollar, South African Rand. ALL of these have fallen heavily. I captured 1/4 - 3/4 of their respective drops, so it has been a great three weeks, but I would have been served so much better by just letting everything run than attempting to finesse positions. This across the board selling, with strength in the dollar, yen and Treasury bonds is the same old deflation trade that pummelled everyone but shorts in 2008.

I view 2008 as a warm-up, a down payment on what is coming in 2010 and beyond. The recovery of 2009 is a fraud, and it will be seen clearly as such a year from now. Obama, Bernanke and Geithner will be thrown to the wolves, and politics will start to get more interesting, with all kinds of radical ideas gaining traction with the public, few of them sensible.

To help prop up the government another war could be started, since the neocons (who never left power but just use a “D” puppet now) would like to destroy more of the middle east. Ugly, ugly stuff, but all too familiar… how does that song go, “all my life, panic in America”?

Ok, let’s look at some charts:

Here is the 5-day average equity put:call ratio. I’m still looking at the summer 2007 period for clues. Remember the flickers of early panic that August, like Cramer’s tantrum? (By the way, my money says that was staged to get public support for inflationary Fed actions at a time when everyone was worried about inflation.)

Indexindicators.com

You can see that we’ve still only reached the mean on this powerful fear gauge. It sure feels like panic out there, but only becuase of how serene things have been lately, just like in spring 2007, the Goldilocks era.

Here’s a daily chart of the last 8 months (I’m also eyeing last summer’s dip for hints, since it was a deflation scare and major sell-off that may offer clues as to some of the dynamics at play):

Prophet.net

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Here are some more snapshots of tops, starting with the 2007-2008 b-wave top (the a-wave was 2000-2003, and c is underway — this is Prechter’s labeling, which considers 2000 the start of the bear):

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If this move is like the initial drops at the b-wave top, it is mostly over and will be followed by a rally that retraces most if not all of the way back up. There is a difference, though — that was a cycle wave top, and while market complacency has been extreme lately, social mood is nothing like 2007, and the economy is in the toilet. This is the most overvalued market in history (including ‘99-’00), and more importantly, it has already taken a wrecking ball to the 2002-2005 technical support. As we saw in the spring of 1930, third waves can move very swiftly through the territory of second waves. Actually, this whole cycle wave c is a third wave on a larger scale, and it only took 12 months to retrace the entire 4.5 year rally from spring 2003. The start of a smaller scale 3rd wave can been seen above in the decline from the May 2008 peak: unrelenting. (Much of this labeling of higher degree waves has emerged as a kind of consensus among wavers, including Prechter’s EWI, Mish, Daneric and Mole.)

Here is the top of the bear market rally that lasted from Nov 1929 -  April 1930:

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That drop started off with more intensity than this one, as the Dow has fallen just 8.3% intraday in 13 trading days, compared to 16% in 12 days. It is of course possible that we catch up very quickly with a minor crash, akin to the gap down and 6.4% intraday drop on May 5th 1930. Prior to that the market was down 11% intraday. Note how the market crashed from allready oversold conditions, as it usually does. Such a washout also happened on August 16, 2007. A 5% intraday loss this Monday or Tuesday would be one way to resolve the still mild VIX, put:call and DSI readings. If such a crash does occur, it would be a good time to buy in anticipation of a very sharp snap-back. It is probably too early for a sustained crash (Oct ‘29, Oct ‘87, Oct ‘08), but of course in ‘87 the market went from oversold to very oversold to the greatest intraday drop of all time. It did not, however, do that right from the top without putting in a first and second wave:

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Now that’s why you need stop-losses (and another reason why futures are best since you get stopped out overnight and not at the open by which time the market could be down 8%).

One more big top for your consideration, 1937: the first wave down was composed of a series of ones and twos — 5% declines, 3% gains, rinsed and repeated:

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(That’s right, the market crashed again after FDR’s policies hamstrung the economy and pushed the US deeper into the depresssion. The market fell lower still in 1942 as the war and inflation crushed private enterprise.)

I’m also keeping an eye on the finacials and REITs, which would both look better if they dropped a bit more before a bounce. There just isn’t that much so far to react against. The financials (XLF):

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The REITs (IYR):

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I don’t see much panic at all in these groups, though they are clearly rolling over. They could stall for a while, but It is hard to see a big bounce here, and without the financial sector the rest of the market isn’t going to get far.

In sum, my best guess is that this will play out like either (1) July-August 2007: chop for the next week or two — big swings, maybe a new low — then some kind of rally for 2-6 weeks (though I don’t think we’ll get a new high — my target would be 1075-1115); or (2) May-June 2008, with a steady drift down. But for 2010, it’s just down, down, down.

This is the last 5 days of the S&P 500:

Source: Prophet.net

From Elliottwave.com:

Ending Diagonal

An ending diagonal is a special type of wave that occurs primarily in the fifth wave position at times when the preceding move has gone “too far too fast,” as Elliott put it. A very small percentage of ending diagonals appear in the C wave position of A-B- C formations. In double or triple threes (see next section), they appear only as the final “C” wave. In all cases, they are found at the termination points of larger patterns, indicating exhaustion of the larger movement.

Ending diagonals take a wedge shape within two converging lines, with each subwave, including waves 1, 3 and 5, subdividing into a “three,” which is otherwise a corrective wave phenomenon. The ending diagonal is illustrated in Figures 8 and 9 and shown in its typical position in larger impulse waves.

New lows for stocks overnight, and new highs for bonds (man, do I wish I hadn’t gone flat yesterday afternoon). By the way, that fractal played out, since the small decline into the close yesterday foretold a greater decline overnight.

S&P futures in white, 30-year treasury futures in blue here. You can see that they have each formed a megaphone pattern. We’ll see if they respect them today or slice right through in a panic.

Source: Interactive Brokers

And for those who are waiting with baited breath for the long bond to collapse, consider this 3-month chart of futures for 30, 10, 5 and 2 year treasuries. They all still move together, and they all go up as stocks go down.

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But of course risky debt moves opposite to treasuries — just when you most need bonds for safety, it trades like the stock market. Here’s a 3-month shot of TLT (blue, 20-30 year T-bonds), JNK (red, junk bonds) and HYD (green, high-yield munis):

Source: Yahoo! Finance

Source: Prophet.net

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Does that mean if we fall 5 pts right now we’ll fall 50 next week?