It's tough to make predictions, especially about the future.
Yogi Berra
The real trouble with this world of ours is not that it is an unreasonable world, nor even that it is a reasonable one. The commonest kind of trouble is that it is nearly reasonable, but not quite. Life is not an illogicality; yet it is a trap for logicians. It looks just a little more mathematical and regular than it is. Its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait.
G.K. Chesterton
The Chesterton quote caught my eye a few weeks ago when I read it as part of the opening chapter of a biography of Blaise Pascal, the father of probability theory. For those of us with an Austrian perspective of economics and even a modest understanding of probability theory, it would have seemed nearly impossible from an observation post in 1998 that the world could undergo three successive financial bubbles without ever seeing a serious and lasting period of undervaluation of financial assets, but here we are.
Read more at http://www.calculatedriskblog.com/2014/03/feds-q4-flow-of-funds-household-net.html#sB1vQ35IMmSec1X2.99
While it is impossible to be able to predict which snowflake will create the avalanche, you can apply a little probability theory to shift the odds in your favor. The first snowflake of winter never causes an avalanche, but the odds increase that a particular snowflake may cause an avalanche after a long period of cold and heavy snow. In my opinion, the financial mountain has been ready for an avalanche for quite some time, yet it hasn't happened. Chesterton's observation regarding the not quite reasonable nature of the world has kept the Austrian investor largely on the defensive of late.
Now, to take Mr. Berra up on the danger of making predictions about the future, I think that the odds are fairly high that the situation in the Ukraine may be the trigger to our expected avalanche. Valuations are ridiculous, the US is creating ten trillion dollars and near dollars per year, almost all of which is unbacked by savings or incremental output and investor complacency is, shall we say, just a bit extreme.
Most importantly, Russia and China seem to be willing to pull the pin on the US dollar hand grenade.
As I have previously pointed out, crisis in the world no longer sees a race to buy dollars on the part of the world's investors, but is now a reason to sell them. After all, everyone seems to have access to trillions of dollars. The Fed and the banking system create them as if shooting candy from a Pez dispenser. Despite what may be the most serious geopolitical crisis of my life (I was still in diapers at the time of the Cuban Missile Crisis), the dollar remains weak and weekly tallies of Fed holdings for foreign central banks of Treasury and GSE debt show foreigners to be sellers.
This week saw a particularly large decline in Fed holdings for foreigners, with most thinking that Russia transferred its holding to another party. From Bloomberg:
The record drop in U.S. government securities held in custody at the Federal Reserve is fueling speculation that Russia may have shifted its holdings out of the U.S. as Western nations threaten sanctions.
Treasuries held by foreign central banks dropped by $104 billion to $2.86 trillion in the week ending March 12, according to Fed data released yesterday, as the turmoil in Ukraine intensified. As of December, Russia held $138.6 billion of Treasuries, making it the ninth largest country holder. Russia’s holdings are about 1 percent of the $12.3 trillion in marketable Treasuries outstanding, according to data compiled by Bloomberg.
Russia has threatened to sell their dollar based assets if sanctions are imposed on them by the west over the situation in the Crimea. They appear to be ready to follow through. Investors yesterday seemed relieved to realize that the bonds were probably just moved to another custodian and not sold. Their complacency is not justified.
Ominously, we also saw the following yesterday at Zerohedge:
Vedomosti reports that Viktor Zubkov, the Chairman of Russia's massive energy monopoly Gazprom, dumped his entire stake in the company just a few weeks before Vladimir Putin crossed the red line. Gazprom shares have dropped 25% in the last 3 weeks so his timing was impeccible.
Just as a point of reference, Gazprom's chairman from 2000-2008 was none other than Dmitry Medvedev, Russia's current prime minister and previous president. The senior Gazprom post is almost certainly privy to the seriousness of Russia's intentions should the west act in a hostile manner towards Russia over the matter of the Ukraine. Someone there is ready.
Additionally, China seems willing to stand with Russia here. Furthermore, China has been willing to use its significant dollar holdings in the past to influence U.S. policy by threatening coordination with Russia. From Bloomberg, January 2010:
Jan. 29 (Bloomberg) -- Russia urged China to dump its Fannie Mae and Freddie Mac bonds in 2008 in a bid to force a bailout of the largest U.S. mortgage-finance companies, former Treasury Secretary Henry Paulson said.
Paulson learned of the “disruptive scheme” while attending the Beijing Summer Olympics, according to his memoir, “On The Brink.”
The Russians made a “top-level approach” to the Chinese “that together they might sell big chunks of their GSE holdings to force the U.S. to use its emergency authorities to prop up these companies,” Paulson said, referring to the acronym for government sponsored entities. The Chinese declined, he said.
Sure, they declined, but letting Paulson know of the approach made their point.
Also, I can't help but think of the curious timing of the recent comments from Bundesbank president Jens Weidmann as he stated that the bank would pick up the pace regarding the repatriation of Germany's gold. He finished his gold commentary with a nice line from Faust, "The lure of gold has power over all." This must be a shot from Germany across the bow the of the USS Overseas Intrusion.
Finally, given that this is the 100th anniversary of the start of WW I, I thought I might offer an observation or two on the start of that particular debacle. I just finished reading Margaret Macmillan's "The War That Ended Peace," though I don't intend for this to be a review of the book. What struck about that period was the seeming willingness of all of the parties to go to war "now" lest their enemies become stronger in the future. Germany felt encircled by France the UK and Russia and worried about Russia's growth in the future. France was worried about Germany's growing economic and demographic clout and their inability in the future to counter these points. The UK feared growing German naval clout and what that might mean to their ability to defend their empire. Everyone worried about the decline and fall of the Ottoman Empire and that the pieces there would fall into an enemy's hands.
One of the overarching themes of the period, at least for those with their hands on the machinery of war, was, "If war must come, let it be now before we are incapable of vanquishing our foes." It strikes me that similar conditions exist today. Russia certainly is tired of American encirclement with military bases and missiles going in on their doorstep. Are they thinking that they must draw the line here before these things become permanent and destroy Russia's ability to defend itself against an aggressive and hostile west? Is China tired of the U.S. as the supreme military actor in the western Pacific? Is it best to have it out now before Japan rebuilds their military with US assistance. Is the US so fearful of an allied Russia-China, an entity with a large and growing military capacity, abundant natural resources and manufacturing capacity that they would want to challenge it now before it can become any stronger?
I hope that cooler heads can prevail with regard to any military exchange, but the situation in the Ukraine should permanently unsettle dollar bulls IMO.
Disclaimer: Nothing on this site should be construed as investment advice. It is all merely the opinion of the author.
