Thunder Road Report 18 17th December 2009

report

17th December 2009

Phase II of the crisis – waiting for the“Creditanstalt moment”

It was the failure of Austria’s Creditanstalt bank in May1931 which brought on the second phase of the Great

Depression. Capital ows led to the transmission of the

crisis in terms of cascading debt defaults from smaller,weaker economies to the rest of the world, just whenmany commentators thought the corner had been turned.Fast forward to today and the Dubai news, together withproblems in Greece, Ireland, Spain and now Austria,

conrmed that the current debt crisis is alive and well andspreading to sovereign nations. The European banking

system (especially in Austria, Germany, Italy, France)

is horribly over-exposed to nearly bankrupt nations onEurope’s periphery. Despite this, there has been no change

to the normal modus operandi for generating consensus

expectations, i.e. extrapolating current conditions, trends,

hopes, etc, in a linear way into the future.What has been missing so far is a “Creditanstalt moment”and I would put more money on this being a “when”

rather than “if” event. It almost happened at the weekend

with the failure of Austria’s (again!) Hypo Group AlpeAdria (HGAA) bank. HGAA posed systemic risk and wasnationalised just in time, but Austria is in a terrible mess.Hungary, Romania and Ukraine are on IMF life support,Contact/additions to distribution:

Paul Mylchreestpaul@thunderroadreport.com

This issue is dedicated to:

Martin ArmstrongImprisoned for being the best

nancial analyst of us all

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Greece and Ireland remain horribly vulnerable, while the UK and Spain are getting close tothe edge. How long can the obscene bailouts and decits continue without government bondmarkets raising the white ag? Yields are nally beginning to edge up.Powerful inationary and deationary forces remain locked in combat – an incredibly dangerousand volatile scenario and a result of policy makers attempting to defy economic gravity. I expectthe next phase of the crisis to be characterised by massive global capital ows as “hot money”traverses the planet in response to “shocks”, moving from currency-to-currency and assetclass-to-asset class, looking for security and/or asset price ination. The remonetisation of

gold continues to unfold and the recent acceleration in capital concentrating in the gold market

is, above all, a huge vote of no condence in the economic stewardship of the major nations.

One of the enduring aspects of the nancial markets for me is the existence of asymmetric information/understanding and the need for its continual pursuit in order to gain that all-important “edge”. With theproliferation of information these days, the search for new angles or ideas seems to take more sifting froman ever widening number of sources, while my “physical” library gets ever bigger (a “neurosis” accordingto my wife). It has also led to me to largely dispense with sources in the mainstream media, apart fromhaving “Financial Entertainment TV” (CNBC) on in the background.Looking back 3-4 years, the crucial asymmetric information in the nancial markets was an understandingof credit bubbles, debt/GDP ratios, Kondratieff waves, the dysfunctional US mortgage market and (asalways) a good knowledge of nancial history. That said, just because I saw it then doesn’t mean I’ve gota handle on the key themes right now – but I hope you’d be disappointed if I didn’t have a go. Here are afew in no particular order - the prolonged nature of debt crises, lessons from the cascading debt defaults of 1931-33, Martin Armstrong’s model, the wrecking ball of global capital ows, ination and crack-up booms,etc.Talking of asymmetric information in general, it fascinates me how few people have been aware of the hugedebate regarding the end of the Mayan calendar on 21 December 2012. The Mayans were the “keepers of time” and I’ll allude to this again later. Dan Brown referred to the end of the Mayan calendar in his latestnovel, “The Lost Symbol”, and the 2012 movie has recently premiered, so it should begin creeping into

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people’s consciousness to a greater extent. I was chatting to one of London’s smartest fund managers andhe remarked how he’d love to be able to: “Buy shares in 2012 awareness”!So would I and would also add awareness of the works of Joseph Campbell and Carl Gustav Jung. Notsurprisingly, the 2012 movie takes an “apocalyptic” approach to 2012 in line with the common usage of theword. However apocalypse can also mean an “unveiling” according to Dan Brown or, just as interestingly, a “revelation”. I expect the nancial markets will deliver a revelation, for these really are strange times when:

B

Grown men enthusiastically advocate quantitative easing and near zero interest rates on the part of insolvent governments in the hope of a quick x, little realising that they are literally just “papering” over the cracks; and

B

Experienced nancial professionals genuinely believe that we have “dodged the bullet” with regard tothe debt crisis and things will be okay going forward, even if the recovery is slower than normal, blah,blah, blah.John F. Kennedy said: “Too often we enjoy the comfort of opinion without the discomfort of thought.” While portfolio manager John Hussman nailed it in his article, “Reckless Myopia”, from two weeks ago: “I should have assumed that Wall Street’s tendency toward reckless myopia - ingrained over the pastdecade - would return at the rst sign of even temporary stability. The eagerness of investors to chaseprevailing trends, and their unwillingness to concern themselves with

predictable

longer-term risks, drovea successive series of speculative advances and crashes during the past decade - the dot-com bubble,the tech bubble, the mortgage bubble, the private-equity bubble, and the commodities bubble…In part,the market’s increasing propensity toward speculation reects the increasing lack of scal and monetarydiscipline from our leaders. Policy makers who seek quick xes and could care less about long-termconsequences undoubtedly encourage investors to embrace the same value system.” It’s truly staggering really when one of the biggest lessons of nancial history, and very recent nancialhistory no less, is that prolonged periods of cheap money lead to asset bubbles and eventual disaster.We’ve seen it time and time again, but the majority always fall into line with the reassurances of centralbankers and politicians – no matter how bad their track records.In this vein, Doug Noland in his Credit Bubble Bulletin highlighted how the majority of commentators don’tforsee the disastrous consequences of current US monetary policy: “The sources of acute systemic fragility are generally not easily or commonly recognized during periodsof excess. The risks wrought from Fed-induced market distortions and mis-pricings during the mortgagenance bubble were not apparent to most until it was much too late. The perception today is that our post-bubble systemic backdrop is not vulnerable to either excesses or inationary pressures. The bulls scoff atthe notion that there are domestic risks associated with sticking with ultra-easy monetary policy. The risksare there but not so visible.” There’s been a procession of Fed “big cheeses”, who didn’t see the debt/real estate bubble coming, reassuringus that they aren’t creating another one now. According to Ben Bernanke “It’s not obvious to me in any case that there’s any large misalignments currently in the U.S. nancialsystem.” Oh yeah? How about a bubble in your currency even though its value is declining? That really is economicsturned on its head! But my favourite comment from the Federal Reserve recently was San Francisco FedPresident, Janet Yellen’s comment about identifying asset bubbles: