Witness the consolidation of global liquidity in the coming bond-market Stalingrad...
SO GREEK POLITICIANS are at it again, writes Dan Denning in his Daily Reckoning Australia.
Last year's €197 billion Greek bailout – negotiated between the major Greek parties and the 'troika' of the International Monetary Fund, the European Union, and the European Central Bank – should be "null and void" says 37-year old Alexi Tsipras, leader of the Coalition for the Radical Left that did so well in May's parliamentary elections.
Cue yet more political uncertainty for financial markets worldwide. To be frank, it's getting harder to tell the difference between politics and finance these days. The cosy relationship between central banks and governments is responsible for this. The financial has become political. And currently, the political is a complete mess in Europe.
Central banks used to just be responsible for the stability of the currency, but now they're responsible for the entire financial system. And because the financial crisis has torpedoed government finances and the economy, the entire system of free enterprise in the Western world has finally been supplanted by central planning. All the resources of the nation get directed to the State where they are to be taxed, allocated, or otherwise redistributed by the very smart people we elect.
What a great racket this whole deal turns out to be for financial institutions. You can borrow from virtually any global central bank at near-zero rates and then buy government bonds yielding, say, 2%. It's free money!
It's also the trade you make if you're a big firm terrified of the Euro. The chart below shows what we mean. Yields on 10-year US Treasury notes are trading just above their record lows from September of last year.
In other words, investors are so nervous about what's going on in Europe that they're willing to loan money to the US government for 10 years at 1.88% interest. Even without figuring in the consolidation of global liquidity due with the coming bond-market Stalingrad, what kind of rational person or firm would do that?
Well, obviously the concentration of cash in Treasuries makes sense if you don't want to be in cash and don't want to be in Europe. But let's call it what it is: a massive concentration of assets in a dwindling number of asset classes.
To us here in Melbourne, it's akin to capital being conscripted into the US government instead of being free to go do other work, like start a business. This is a reminder of one of the biggest drawbacks to being a debtor country.
When you borrow short term (so that the maturity schedule of your debt shifts to the short end of the yield curve, forcing you to refinance with new loans very much more often) then your ability to raise money and meet current obligations becomes very interest rate sensitive. For now, this is great news for the United States government. Because it can run $1.5 trillion annual deficits...and investors can't get enough of the debt being issued by the Treasury Department to fund it!
But at higher rates, the interest on the debt becomes an albatross on the economy. And interest rates do move up, from time to time. But that is another story for another day. For today, we want to make the point that financial markets have all but decoupled from reality. The manipulation of interest rates has completely distorted prices. If prices don't communicate useful information anymore, markets aren't markets. They're just vehicles for transferring money from one party to another...from the suckers to the Madoffs.
So what of the challenge against barbaric gold made by Warren Buffett's right-hand man Charlie Munger at Berkshire Hathaway last weekend? He said that "Civilized people don't Buy Gold," urging investors to choose productive businesses instead. But how is it possible to invest in productive businesses – as he urges – when the financial system has been completely compromised and overtaken by a dynamic which doesn't allocate capital but only funds deficits and profitable trades for investment banks? This isn't just a dysfunctional market. It's a complete farce.
It all goes back to what Benjamin Graham, the godfather of value investing, wrote about buying stocks with a 'margin of safety'. Graham wrote that when a stock's price is below the intrinsic (book) value of the shares, the difference is your 'margin of safety'. You're getting the liquidation value of the business at a discount. It doesn't guarantee you won't lose money on the shares (price and value being different things being a good start).
Warren Buffet and Charlie Munger took this one step further and said you can look beyond book value to a return on equity. They looked for book value. But the real goal was a business that could sustain high returns on equity over time.
When it comes to that, some businesses are better than others. Some managers are better than others. And some investors are better at spotting good businesses run by good managers than others – at least that is the proposition behind Berkshire Hathaway, as far we understand it.
The trouble today, as we see it, is that share prices have been hijacked by this evolution in the relationship between the financial sector, central banks, and governments.
You might think you're buying a good business at a good price, but if we don't live in very enterprising times with real markets, what good is it to do the hard work of valuation?
Ready to Buy Gold today...?