With the World War D investing conference done and dusted, we pause to reflect on it all. What was our key takeaway from the two-day event?
In short, ‘bear fatigue’. That is, the keynote speakers (Marc Faber, Jim Rickards and Richard Duncan) all made the case that we are heading towards a financial collapse…we just don’t know when. More to the point, multiple forms of can-kicking can potentially delay the inevitable day of reckoning for years to come. Therefore, to use the words of Citigroup boss Chuck Prince in 2007, while the music is playing, you gotta keep dancing.
Having suffered a bit of bear fatigue our self, we sympathise with this viewpoint. And sure, there’s room for a small amount of speculation in any portfolio. But succumbing to this fatigue is akin to throwing discipline out the window and investing just because…well, everyone else seems to be doing it.
While no one knows how long the financial system can continue its debt based expansion, Marc Faber suggested that with the bull market now entering its sixth year, it’s getting old and due for a correction. Jim Rickards thinks we’re in a bubble, while Richard Duncan reckons the US government could in theory keep the music playing by running up debt levels from the current 100% of GDP to a Japanese-like 250% of GDP.
In practice he doesn’t think this will happen and he nominates collapse as the likely outcome. Nevertheless we subsequently asked him how this was possible given that Japan is a net creditor nation (and therefore has accumulated savings to fund its deficits) while the US is a net debtor nation and relies on the savings of foreigners to finance its debts.
In other words we wondered whether the rest of the world would finance a more than doubling in the US’ already gargantuan total debt levels.
He said that because the US dollar is the world’s reserve currency, and the US issues its debts denominated in the reserve currency; as long as people go on accepting the dollar’s reserve role they will keep buying dollar based debt.
That’s true in theory, but somewhere between the current 100% debt to GDP ratio and 250%, we’re tipping that you’ll see a change of attitude about the US dollar as the world’s reserve currency.
In fact, you’re already seeing it. According to Treasury data, in the year to January 2014, official holdings (i.e. foreign central banks) of Treasury bonds and notes actually fell by US$78.3 billion. On a net basis, foreigners dumped US$336 billion in long term US securities in the 12 months to January 2014.
The only thing holding up the dollar is the fact that they didn’t repatriate the proceeds. According to the Treasury’s data, a US$540.7 billion increase in ‘dollar-denominated liabilities’ (US dollar cash holdings) more than offset the selling in other assets.
As far as we can tell, foreigners are already losing their appetite for US assets, but instead of fleeing completely they are parking the money in cash…an area they can exit at the shortest notice. When they do, the US dollar will fall heavily.
This steep reduction in foreign appetite for US assets could just be an anomaly for 2013, we’ll have to wait and see. But it doesn’t give us confidence that the US government can keep borrowing money to prop the system up when the next slowdown hits.
It CAN keep issuing debt, but the Fed will have to buy the majority of it again, which won’t exactly be bullish for the US dollar’s role as the world’s reserve currency.
The can-kicking can’t go on indefinitely. Cracks will begin to appear in the system as the QE taper continues throughout 2014. Then the Fed will panic, and re-start QE or some other form of stimulus. But by this stage confidence will have taken a hit. It won’t be pretty.
We’re guessing (and it is just a guess) that all this will play out sometime in 2015. Whether we get a sell-off and then a speculative surge to new highs before then we haven’t a clue. Markets have no monetary anchors anymore, so volatility is to be expected.
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