ICangles Investments Post…
As 2012 comes to an end, rather than the oft mentioned fiscal cliff, I have tulips on my mind. Despite my documented concerns about government debt levels, the fiscal cliff is not a top concern. In fact as I write this a deal appears to be coming together between the Democratic and Republican parties, where they agree to the specifics of how the U.S. government will manage the borrowing of even more money. The inability of politicians to agree about going deeper into debt is not something I worry much about, even if the media is full of dire predictions of the impact on the economy if more debt is not incurred. However, I do think it is worth pausing and pondering exactly how bad things have gotten, when it is considered an economic crisis if the U.S. government is forced to not spend more money than it taxes. That the world’s largest economy has become so dependent on deficit spending that the inability of its government to spend more than it takes in would be considered a threat to the economy is the real danger.
The real worry isn’t that politicians won’t someday agree to borrow more money. Rather, the danger is that borrowing at the current rate cannot go on forever. Yes, politicians could come to their senses, and embrace sensible austerity and as much as that would be a long-term economic positive, in the short-term it would be a negative. Far more likely is that austerity will eventually be forced upon politicians. Current borrowing rates are predicated on low interest rates, and with central banks going to great lengths to pump liquidity into the global economy, inflation seems a matter of when not if. And when inflation rises, and borrowing rates go higher, the ability of governments to keep borrowing money even with the acquiescence of politicians will significantly diminish. This will have serious implications for a global monetary system predicated on debt.
Consequently, there is plenty of reason to be uneasy as we head into 2013, and I stand by my view that market risks are rising. All of which brings me back to my thinking about tulips. In the 1600’s an investment mania swept Holland, with people speculating in and driving the prices of tulip bulbs ever higher. The flowers newly introduced had become a collectable craze. Like other investment bubbles, whether recently for dotcom stocks or real estate, prices were bid to exorbitant levels on the faith that someone else would pay a still higher price in the future. But the market did eventually turn, with one cause for falling prices being a decree by the Dutch government that Tulip bulbs were not investments, but goods–therefore they could not be sold or traded in a contract many times over as if the contract itself were currency before the bulb was delivered. Anyone with common sense could have seen the unsustainable nature of the tulip bulb mania, but removing liquidity hastened its end.
So, how do I get from tulips in the 1600s to government debt in the 21st century. The answer in one word is “liquidity”–perhaps the most important concept in finance. Right now anyone who cares to seriously look can see current rates of borrowing cannot go on forever. But as long as interest rates remain low and central banks keep generating liquidity and buying government debt, it will most likely go on. And as we head into 2013, governments are not withdrawing liquidity. Rather the pumping of money by one hand of government in the central banks and the borrowing and spending of it by the other continues unabated–policies that threaten the future value of cash, while also depressing the interest rates payed by bonds. Therefore, despite trepidations, I continue to keep a significant portion of my investments in stocks, while keeping an eye on the major central banks for any signs of tightening. Yet, with China’s central bank easing monetary policy in 2012 and America’s Federal Reserve recently announcing QE4, where it plans to inject another trillion dollars of liquidity, the time has not come in my view to substantially reduce stock exposure, even if risks are rising. Of course if government easy money policies change, most likely due to inflation worries, my equity outlook could reverse quickly.