COUNTERCOLUMN: All Your Bias Are Belong to Us

I sold out of my Emerging Market holdings last May or so (I dodged a correction, but it's more than recovered now, so I might have been slightly premature. But after a 57% 2003 I don't feel too bad) and brought them over to a total international index approach.

The Vanguard Total International Stock Index fund is up over 14 points in the last three months! (Emerging Markets are up 18 points over the same period). A chunk of that gain is simply the exchange rates of a falling dollar, since the fund's stock holdings are denominated in the foreign currencies, whatever they happen to be.

The declining dollar doesn't hurt me in the short run...nor should it hurt anyone with a well-diversified portfolio too much.

The question: Will the Federal Reserve allow the inflation of the dollar to continue? We almost have to, in order to allow consumers to pay off the huge debts they've run up. The average family has over $9,205 in credit card debt alone, according to Cardweb.com (2003). If interest rates should rise, so will their debt service payments, as most of these families have very little by way of a cushion, and can't just pay off their cards on a whim.

The debt service money will have to come from somewhere. And it's going to come in a combination of decreased consumer spending, inflation, and bankruptcy.

Financiers are already becoming more and more desperate to bring in customers offering zero-interest mortgage payments (AFTER a long run-up in real-estate prices? Helllooooooooo!!!!!!!) and now 40-year mortgages.

But don't take it from me. Look at what Bill Gross is doing:

The U.S. spends too much; eats too much; drinks too much; TOO MUCH, (thank you Dave Matthews). And we pay for it with our debt and 80% of the world’s excess savings. In so doing our creepy crawly balance of payments deficit has inched its way up to 6% of GDP – a level never seen in the U.S. and reflective of third world nations in financial crisis. The imbalance has been tolerated by those nations on the surplus side of the ledger – read “Asia” – in a strange sort of mercantilistic Faustian bargain that promises China and Japan the benefits of a strengthening economy now for the perfidy of falling dollar denominated Treasuries bonds later, an arrangement that once again will prove that there is no free lunch, or that hell often follows heaven on Earth.

Read the whole thing. Bill Gross is a demigod to the credit markets, and a bigger dog than George Soros was. Bill Gross bullies entire nations.

Bill Gross rocks.

Bill Gross has been sounding the alarms for some time now, and has considerably shortened his average maturity, slipped into TIPs, and looked abroad to get out of US debt altogether ahead of the crisis.

So read the whole thing.

What's he doing?

1.) Looking at German debt, which offers a better yield, denominated in a less shaky currency.

2.) Buying TIPS at shorter maturities...mostly under 5 years, but a few in the 5-10 year range. My sense is he'd like to get out of treasuries altogether but his fund is so big he can't.

This passage is a little thick, but it's huge:

To sum up this CATCH 22, a deteriorating balance of payments deficit may actually have a positive effect leading to lower interest rates until a large creditor turns tail. It’s another way of saying that U.S. yields depend upon the kindness of strangers and that the time to not own them is when the strangers become less kind. I suspect that is just around the corner but Beijing and Tokyo have the ball in their courts.

If he's right, the rug could get pulled out from under us at any time. Tokyo will be ok. But the precarious debt situation we find ourselves in potentially has national security implications. It's not hard to imagine China calling up the Secretary of the Treasury, Secretary of State, or George Dubya himself on the phone, and saying "play ball or else," essentially blackmailing the President with the threat of a massive and sudden sell off of treasuries, which could push interest rates through the roof, choking off the housing industry, putting the screws to the automotive industry, reaming anyone holding an adjustible rate mortgage, hanging anyone on an interest-only mortgage by their ankles come refinance time, and pushing the US economy back into a sharp recession.

The president clearly can't afford for that to happen. And so a back room deal is quietly cut. Maybe one already has been. We may never know about it.

This was the best argument for a Kerry presidency. By the end of Dubya's first term, he was simply no longer credible as someone who would be able to keep a lid on U.S. spending. Kerry, for all his faults, was more credible to the debt and currency markets. And while he had a chance at winning, the world held off on the selloff. But no sooner does George Dubya win the election does the selloff begin.

Who knows where it will end?

But you don't see me buying long treasuries. But maybe I can invest in an American hotel chain catering to foreign tourists?

Splash, out

Jason