I’m with Hendry

Taleb thinks hyperinflation is a strong enough possibility to justify way OTM bets on gold (long) and bonds (short). The one bit I agree with is the long gold / short stocks play (though I think gold is likely to fall with stocks, just not as much), and I suspect that deflationist Hendry would concur.

Hendry thinks that deflation is here to stay, that nations will start to default, and that the market will at least start to worry about sovereign defaults by nations like Germany and the US (even if they don’t actually default, he’ll make money in that situation as the price of insurance goes up).

(The video cuts off when Hendry passes the mic, and I don’t have a link to the rest. If anybody else does, please post it.)  (EDIT: http://2010.therussiaforum.com/news/session-video3/ Minute 24:00 and after. Thanks Charles!)

Hendry makes a point I’ve made myself: the euro is like gold for countries like Greece (they can’t print it) so it will have to default.

Hendry says his porfolio is inspired by Nassim, but basically the opposite. He’s fed up with other people’s opinions. The hedge fund guys are “so uncool.” He doesn’t talk to brokers, and he reads nobody else’s research.

Debt loads are bound to squeeze all of the vitality out of the risk takers in the market.

UK interest rates are at the lowest since the Bank of England was established in 1692. He is betting that the central banks won’t raise rates in the next 4 months and he will make 4x his dough if right.

He thinks the sovereign default scenario today is like the mortage bond situation three years ago.

Now, who is the true contrarian? Is hyperinflation really a black swan right now? Every chat board on the net has been buzzing about it for years. When Taleb said every human being should short treasuries, every human being agreed with him!

Some thoughts on government debt during deflation

A question of Keynes vs. Kondratieff

Until recently, the sovereign debt of nearly all governments would rally during panic episodes as stocks and commodities fell. This makes sense, as strong sovereign debt is cash for big boys, and investors are forced to reach further and further out for yield as short-rates are driven to zero or negative. However, starting with Greece, this pattern may change, as bonds are likely putting in a secular top in the 2008-2016 window. Their last bottom of course was the early 1980s, and their last top was 1946-47. The indebtedness and unabashed Keynesianism of all of the world’s governments seem to virtually guarantee higher interest rates in the coming years, even though US, German and Japanese bonds are still finding a bid during panics.

We have already seen the beginnings of this development in municipal bonds and the crappiest sovereign debt, but the market may slowly realize that it is all crap, beyond the short-term credit of the strongest governments.

Prechter makes the point in Conquer the Crash that higher rates on risky long-dated sovereign debt are part and parcel of deflation, an increased preference for the safest cash and cash alternatives. Steepening yield curves fit right into that trend. If the long bond sells off hard, this does not mean the end of the dollar, but the opposite. All else being equal, if T-bonds fell with stocks this year, it would just mean that the US government would finally feel the same pinch as everyone else.

Now for the tricky part. We have to keep in mind that interest rates are more than just a mechanical product of fiscal deficits, savings rates and politics. They are a kind of natural social phenomenon, a reflection of forces I can’t fully understand. They are not rational: why were short-term rates in the low single digits during the second world war when the US had just abandoned the gold standard, had a debt:GDP ratio of over 100% and inflation was running at 8-12%? Why were they still double-digit in the mid-1980s when the economy was good and inflation was 3-4%? (For some charts and discussion of the long-term rate cycle, see this post). The only answers that make any sense are that it was time for rates to bottom and then it was time for them to top.

We are certainly entering what *Kondratieff described as winter, when debts are called in and defaulted upon and cash is at a premium. This is associated with low interest rates, reflecting a low demand for credit, provided that the monetary unit retains value, which it tends to do since this unit is how debts are denominated and settled. And with deflation very much a reality, low rates can provide a high real yield so long as the credit is sound. With housing and wages falling by large percentages and every consumer good on sale, what is the real yield on a 10-year note priced at 3.6%?

There is no telling how long rates will stay low or how low they will go. See Japan, 1990-

Those are the market rates on the credit of a horribly indebted nation with terrible demographics that has been trying to spend its way out of recession for 20 years. Is there a better way to explain this than Kondratieff winter?

If social forces demand that governments start to shift towards frugality and default like the rest of society (and government is a reflection of social mood), this would be very supportive of the current fiat regimes. Think about it: what would happen to the Euro if Greece defaulted (which is what they should do)? Billions in euro-denominated balances would go “poof” and the remaining euros would be worth more.

What if younger generations of Americans, the ones who most enthusiastically support Ron Paul and even phonies like the new senator from Massachusetts, start to exert pressure for the rolling back of that $70+ trillion in retirement and health-care promises? Those are contracts that the government can’t honor, so by definition, it won’t. It will try to pretend otherwise, but it won’t. In effect, much of the debt will be repudiated.

There are huge caveats to the above, such as radical socialism or expanded warfare, but there are going to be real deflationary undertones to social mood that may effect policy and prolong the current paper regimes for longer than almost anyone suspects. Kondratieff winters are not short episodes, but generational, and if the last two turning points in the interest rate cycle are a guide, there could even be another ten years to the bottom.

That is hard to believe right now, but it is possible if social forces demand default. I can’t gauge the odds very well, but I have to consider this longer-term bull case for treasury bonds and a few strong currencies. Bottom line — history has not been kind to paper money and government bonds in times of crisis, but the nature of deflation may give them a longer life than we have assumed.

If you just can’t wait to short some sovereign debt, try Japan before America. They may be a generation ahead of the west in the rate cycle, and really, how much lower could they go?

*Kondratieff waves in the US (click image to expand):

[email protected], 1.23.09

One thing that strikes me in the above chart is how huge the latest wave is compared to the others. At 60 years and running, it is the longest, and prices, rates and stocks have gone up so much more than during any of the previous three. Just out of proportionality, it would be perfectly fitting if rates and prices fell for another 5-10 years.

Here’s a clearer view of the Aaa corporate bond rate from 1919 to 2010:


Also see Rothbard and then Mish on Kondratieff theory. As Rothbard makes clear, winter is not necessarily an awful time to be alive, judging from the strong economic growth of the 1830s-40s and 1880s-90s. This means that prolonged unemployment and war can’t be blamed merely on the credit cycle, but that fingers must be pointed at the socialists, Keynesians and fascists who’s actions directly brought about the nightmare of 1929-1945.

The 2000′s in one chart

The Global Dow since 2001:

Source: wsj.com


This chart makes it clear that the bubble still has a lot of air left.  The 2009 lows were well above those of 2002/3, and now stocks are back into boom-time 2006 valuations, as if the credit collapse and associated declines in earnings and dividends had never happened. This year demonstrates better than any other in modern times that stock market action has very little to do with economic reality.

Doug Casey and Tom Woods on government

Video link from Lewrockwell.com

Here’s an excerpt from The Law, by Frederic Bastiat, a French classical liberal (today we would say libertarian) economist:

A Fatal Tendency of Mankind

Self-preservation and self-development are common aspirations among all people. And if everyone enjoyed the unrestricted use of his faculties and the free disposition of the fruits of his labor, social progress would be ceaseless, uninterrupted, and unfailing.

But there is also another tendency that is common among people. When they can, they wish to live and prosper at the expense of others. This is no rash accusation. Nor does it come from a gloomy and uncharitable spirit. The annals of history bear witness to the truth of it: the incessant wars, mass migrations, religious persecutions, universal slavery, dishonesty in commerce, and monopolies. This fatal desire has its origin in the very nature of man — in that primitive, universal, and insuppressible instinct that impels him to satisfy his desires with the least possible pain.

Rosenberg: Latest employment and credit figures show deflationary depression unabated

This morning’s Breakfast With Dave is good one.

There are so many headwinds confronting the U.S. consumer it’s not even funny. For a look at the new harsh reality of soaring usage of grocery vouchers, as well as other supplements to the household budget, have a look at the grim article on page 2 of the weekend FT (Families Take Up Food Stamps as Wages Shrink). On the very same page, there is an article on the latest trend in terms of 21st-century breadlines — Middle Classes Turn to Car Park Handouts. To think we still get asked why we aren’t more bullish over the outlook for spending. Truly amazing.


The U.S. economy is actually 9.4 million jobs short of being anywhere remotely close to being fully employed, which is why any inflation that can somehow be created by the Fed is simply going to be unsustainable noise along a fundamental downtrend in pricing power. After last Friday’s report, we have now lost 6.9 million positions that have been cut during this recession and we have to count in the additional 2.5 million jobs that need to be created — but never were — just to absorb the new entrants into the labour market. The ‘real’ unemployment rate is now 16.8%, so to suggest that this down-cycle was anything but a depression is basically a misrepresentation of the facts.


It is interesting that the equity market has begun to wobble (fade last Friday’s rally on such low volume) because we have noticed that some key liquidity indicators are not behaving very well, all of a sudden. M1 fell 1.0% in the August 24th week and over the past four weeks is down at a 6.5% annual rate. M2 has contracted in each of the past four weeks too and over that time has slipped at a 12.2% annualized pace, which is a near-record decline. We see the same trend in the broad MZM money measure — off at a 15.8% annual rate over the past month. Bank credit also remains in a fundamental downtrend — contracting at an epic 9% annualized pace over the past four weeks.

So for the first time in the post-WWII era, we have deflation in credit, wages and rents, and from our lens this is a toxic brew that in the end will ensure that the focus on capital preservation and income orientation will be the winning strategy over a strict reliance on capital appreciation.

Do P/E’s matter?

Source: Irrational Exuberance, Robert Shiller, 2000

The average 12 month earnings for the S&P 500 from June 2000 to June 2009 (10 years) is $49.84.  The index earned $14.88 in 2008 and $7.62 in the 12 months through June 30, 2009. The respective PE’s at a value of 1000 are roughly 20, 65 and 130.

Assuming earnings soon rise to $50 and are sustained, a tall order in my opinion, the expected 20-year annualized return on the S&P would still only be about 1%. Is that enough to justify the risk that earnings do not recover? Shiller’s method of smoothing earnings over 10 years makes good sense, but what if that 10 years encompassed the greatest credit bubble in history, and it has now been popped? What is the expected return then? To look at it another way, I would say that your expected return on T-bills is very, very high in terms of stock.

Hugh Hendry walks around China

Hendry is the founder of Eclectica Asset Management.

“Who is going to pay the debt that that building is resting on? …A building with no tennants. Half a billion dollars of someone else’s liabilities.”

“…very expensive, empty building where the developer went bust.”

“I haven’t seen any sign of a manufacturing base anywhere close to here.”

Tour des charts

All the world’s a short…


Charts below are 5-year views.

NASDAQ biotech index:


[email protected] WK Internet Index:


Value Line Arithmetic (where’s the value?):


Philadelphia Gold and SIlver Index (XAU), back at ’06-’08 commodities bubble levels:


Mexico Bolsa:




Argentina’s Merval Index:


Pakistan’s Karachi 100 (look at the flat line where the govt suspended trading last fall — worked wonders, didn’t it? This market is up a lot less than most others — maybe people don’t trust it as much anymore, since they can’t be sure they’ll be able to sell when they want):


Bet you didn’t know Mongolia had a stock market. Looks like a one hit wonder:


Singapore Straits Times:


Indonesia’s Jakarta Composite:


Taiwan Taiex:


All images above from Bloomberg’s stock index pages

Scaredy bears


Well, we’ve hit the first common Fibonacci retracement level (38.1%). We’ve now rallied 350 S&P points after a 904 point fall (1570 to 666). This is the best shorting opportunity since 12 months ago, IMO.

Source: Interactive Brokers

Nasdaq is nicely lagging, and the dollar is looking good. China could have topped already. The chatter on the boards is of scared bears and confident momentum chasers.

Next week could be nasty, maybe a drop to 950 before a rally to test 1000 again soon thereafter. Or maybe we slowly roll over and don’t break 950 til almost Labor Day (first week of Sept — when summer vacation ends in the US).

If this really is wave 3 down, it should be another 5 wave move, like wave 1. During the first wave, and even the second, most won’t believe the top is really in. Wave 1 could start from right here, since the momentum guys would be buying in on the decline and there would be few shorts to drive a squeeze to new highs. It would be seen as a “healthy correction.”