The chumps’ revenge

Those who bought US debt will be laughing, says Bill Bonner - at least for a while.

Another month gone by. Still no sign of recovery. Where are the fools when you need their money?

Yesterday, we were singing the praises of the chumps and patsies. Thank God for the dumb money, was the chorus.

People willing to spend what they don't have on what they don't need that's what made the old economy of '71 '07 spin around so fast. And now where are these chumps? They seem to have run for cover where they didn't want to go. They don't seem to want to buy stocks. Now, they're buying US Treasury bonds!

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But what's this?

"Gold Rises $40 As Markets Fall Sharply Safe Haven "Tipping Point"?

Bloomberg (on Wednesday):

Gold fell and tested support at $1,530/oz but then bounced very sharply and rose by nearly $40 from $1,532/oz to $1,570/oz. US stocks and commodities remained under heavy pressure and the benchmark S&P 500 ended down 1.43%.

Gold consolidated on yesterday's gain in Asia and during European trading it is challenging resistance at $1,570/oz.

Gold is set to incur its 4th month of losses which has not been seen in nearly 13 years. Interestingly while gold in dollar terms is off 6% in May, the sharp fall in the euro means that gold has again risen in euro terms and is up 0.3% in euro terms in the month.

Gold may have turned a corner. It was going down with stocks and other commodities. But on Wednesday, stocks fell hard while gold bounced. Then, yesterday, gold held steady while stocks fell again.

What's going on? Ultimately, gold is money. It is the only money you can trust. And when you begin to have doubt about the other currencies those made from wood and controlled by wooden heads, your enthusiasm for real money increases.

Which makes us wonder who is holding so many dollar-based US Treasury bonds? It must be the chumps. Yields fell to their lowest point ever on Wednesday. That means that a lot of people are buying them. Which is remarkable for a couple of reasons.

First, US credit quality has declined substantially over the lastfive years. Deficits have pushed up the national debt from 60% of GDP to over 100%. Both S&P and Egon Jones downgraded US debt as a result. Unlike Europe, which tries to squeeze the reckless spending out of the system, the feds are still at it and unrepentant. They now fritter and consume about $1.30 per dollar received in tax revenues.

Second, in times of stress, the custodians of the dollar at the Fed have shown themselves ready, willing and able to throw the greenback out of the lifeboat. If it's a choice between saving the dollar... or saving their jobs, or their campaign contributors, or their power, we know what they will do.

Third, unlike Japan the US still runs a substantial trade deficit. The last month tallied was March, in which imports beat exports by more than $50 billion, or about $600 billion, annualised. The Japanese and others used to use a lot of that money to buy US debt and support US deficit spending. Now, they need it for their own purposes or to buy gold. This leaves the US with neither a net flow of funds coming in from overseas nor high domestic savings. It has no means of sustaining a long spell of deficit spending.

Fourth, last year, nearly two out of every three dollars in deficits were funded by printing press money or a near equivalent from the Fed.

All of those reasons should give bond buyers pause. But they can't seem to find the pause button. They buy US bonds without hesitating. And who knows? Maybe they're right. It has been five years since the crack up in subprime. There is still no relief in sight. No recovery. Instead, bond yields themselves signal a deep economic sleep setting in. Like a Japanese Rip Van Winkle, the US economy could slumber for five, ten, 20 years. And the yield on the ten-year note could fall some more. Maybe to as low as 1%. Then the bond buyers will look like geniuses, not chumps.

People who mortgaged their homes to lock-in a 4% rate will regret not having waited for 3%.

People who bought stocks because they didn't want to miss the big recovery boom, will regret ever leaving cash as their stocks fall 20% to 50%.

And people who bought houses at a 30% discount from 2007 will cringe every time they look at the real estate section of the local paper. Those same houses will be down 40% and 50%.

Yes, it will be the revenge of the chumps, the poor schmucks who bought US Treasury debt in the spring and summer of '12. They'll be right. We'll be wrong...

... for a while.

And more thoughts

We had lunch with hedge fund manager, John Prout and others last Sunday. We were invited to join a small group of largely paleo-conservatives in the foothills of the Blue Ridge mountains. They were an interesting bunch. Whether they were suffering from a kind of nostalgic Weltanschauung, or just kvetching about the lost Republic, we weren't sure. But they were gracious, entertaining and charming; what more can you ask for?

Besides, Rappahannock County, Virginia, must be one of the prettiest places in the nation. Small country roads snake around big farms with picturesque barns, lazy cattle, and stately mansions. The tallgrass was ready to mow as the humid air of early summer sank into the copses and green hollows.

It was a delightful place for a meeting or 'gencon' (general conversation), as our host called it. And a comfortable place to talk about the broken continent.

John had analysed the euro crisis and come to a startling conclusion.

If Greece tried to leave the euro, he believed, it would cause a god-awful mess. There is just no way for a country to hobble out of the euro without getting its cane knocked out from under it and then being trampled by currency speculators, bank depositors and angry mobs. It will die before it reaches the exit.

Unlike Argentina, which could seal its financial borders, and rob its own people blind, the whole point of the European project is that the borders are open. And the more the Greeks try to keep money in their country, the more people with money are eager to leave. As soon as they let it be known that they are leaving the euro, the retreat will be like the French heading south after Dunkirk. Money and people would leak out of every mountain gap and river crossing...

...and the rest would start smashing windows and setting German cars on fire.

And then, what about Spain? Portugal? Italy? And even France? Who would want to hold euros in Europe?

The solution to this problem will have to be a radical one... one none at all.

John's big wonder as reported on CNN yesterday:

Could Germany save eurozone by leaving it?

With Greece probably heading for an exit from the euro, the European and global economies may be facing disaster. However, there is still time for European leaders to reverse this destructive dynamic with one simple, outside-the-box solution: Instead of pushing Greece out of the eurozone, Germany should voluntarily withdraw and reissue its beloved deutschmark.

The analysis of the problems of the euro and the European Union has long been upside down, focused on the debt and competitive weaknesses of the so-called peripheral countries (Greece, Italy, Spain, Portugal and Ireland) and especially of Greece. But issues of debt and competitiveness existed and were dealt with rather easily long before the euro arrived, through periodic devaluation of the currencies of the less-competitive countries against those of the more competitive countries, and especially against the deutschmark.

If Greece or Spain leave, it will be a disaster for everyone, says John. If Germany leaves, it will merely be a surprise. No riots. No revolutions. No currency debacles. The deutschmark will go up. The euro will go down. Problem solved.

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