Turn Out the Lights, the Party’s Over

Invitation: Unchartered Waters Ahead:  I will be giving a McCombs Alumni Lecture/Discussion (open to the public) Wednesday, Sept. 14, starting at 7:30 p.m. at the AT&T Conference Center just off campus. The content will be the likelihood and effects of the three options the U.S. faces as a result of its sovereign debt: balance the budget (which implies default on entitlements), default on its debt, or monetize its debt. All are costly, but with different outcomes for financial markets, income and wealth.  Invitation link and RSVP

Press:

The Financial Times (FT.com/Alphaville) did a summary of a video I posted on TheSpellmanReport.com regarding how QE2 elevated financial markets here and abroad and generated inflation but reduced real income in the U.S. It is food for thought on why QE3 is unlikely. FT Summary

In a recent video on TheSpellmanReport, Lacy Hunt indicated why he hung in there in the long term government bond market in spite of the inflation generating QE2: The WSJ recognizes Hoisington’s admirable investment performance.

Blog: Turn Out the Lights, the Party’s Over

“Turn out the light, the party’s over” was the hymn sung by former SMU and Dallas Cowboys quarterback “Dandy” Don Meredith in his role as color commentator over the first dozen years of Monday Night Football at the point of the game (often well before time had run out) when, in his opinion, the winner and loser had been decided.

Well, I’m humming it and can’t get it out of my mind as I witness the disintegration of the Euro sovereign rescue and the attempt to launch a fourth-quarter comeback. Despite the best efforts of Europe’s politicians and central bankers to preserve the Euro zone, the euro, and European sovereign financial integrity, their heroic efforts are being overwhelmed. Consider the following:

- International lenders suspended discussions with Greece on its next €8 billion tranche of bailout loans as Greece is unable to balance its budget, a precondition of the bailout loan.  The Greek austerity program is also producing negative GDP growth.

- This week Germany’s Federal Constitutional Court will deliver its ruling — awaited for over a year — on suits claiming Berlin is breaking German law and European treaties by contributing to multi-billion-euro bailouts of Greece, Ireland and Portugal.

- Chancellor Angela Merkel has denied that a popular German backlash against euro bailouts is the cause of her party’s sixth successive defeat in regional elections.

- The market has rendered its opinion on not just Greece’s inability perform on its sovereign debt but also whether the third-party guarantee from the rest of Europe, the ECB and IMF will be forthcoming. Greece sovereign market yields speak volumes on the market’s opinion.

- Italy’s bonds now need rescuing, and the ECB is pulling back its market support and is “studying” it

- European (and U.S.) bank stock is plummeting into “option value,” reflecting investors’ beliefs that the party is over for them as well.

- The Euro zone is likely back into a recession, and with the fiscal strains of government, how can there be bank rescues on top of country rescues on top of stimulus programs?

When the bond market, the stock market, the electorate, the economy and possibly the Supreme Court are against you, those collective powers add up to more than government’s collective will.

The implications are now being priced in markets. The flight to quality asset seems to be the Swiss franc and the Japanese Yen. Oh yes, the Yuan is also doing well as deposits accumulate in Hong Kong Banks, as seen in the graph.

There is trouble with the Yen and the Swiss Franc currency appreciation in that it is not welcomed by the respective countries and they actively seek to depress their currency’s value to preserve export market share. The only flight currency that can’t be flooded by a central bank is gold, and its climb continues.

The U.S. has likely caught a break in that the Euro distress might scare us straight while we still have time to do a mid-course correction. Thus, it is too early to “turn out the lights” on the U.S. We are in the third quarter and recovery is far from guaranteed, but it is more likely with the vivid lessons of Europe fresh in our minds.

Read more at The Spellman Report