Sovereign Debt Cycles- History Spells Out Crisis.

Sovereign Debt Cycles- History Spells Out Crisis.

If you haven’t read the Economic History paper by Kenneth Rogoff and Carmen Reinhart, but are interested in protecting your wealth over the coming years- now would be the time. For the reading, or economics impaired, the coming crisis which is already in progress is a Sovereign Debt Crisis.  I’ve mentioned in earlier posts that this isn’t 2008 all over again- in fact, the last time we had a crisis last this it was masked by the events of the Second World War.  Very few people are alive to remember these events today; it’s probably fair to say that those who are were either too young, or are not lucid enough to report on the economic events following the Great Depression.


As you can see from the above chart (taken directly from Rogoff & Reinhart) significant capital mobility preceded events of the 1929 Great Depression. These capital flows (invested funds across borders- from factories to financial investment) peaked prior to 1929, collapsed, rebounded and then bottomed in 1950.  The exact same clearing of the global economy is happening today- we are likely to be in the 1930-1935 region of this chart- perched upon the precipice (the dead cat bounce region of the chart) awaiting the final dip.  Once again I will defer to the Baltic Dry Index as evidence for this- international trade is in retreat and investment won’t be too far behind.

Next take a look at Sovereign Debt burdens around the world…

Websites like the national debt clock illustrate this problem quite well.  Furthermore, it is worth noting that there have been times in history where over 50% of the world governments were in a state of default, with the last peak in defaults coinciding with the Second World War period.

See the percentage of countries in default, as well as the inflationary pressures faced in the aftermath of default.

Probably most notable of all is Japan, with a sovereign debt:GDP burden of over 200%. In terms of historical default rates, the probability of a Japanese default is over 95% at this Sovereign Debt rate (ie: P(Default) > 0.95).  The question, of course, remains precisely when, and how- the answer is likely “soon” and “by currency debasement”, but it could also be by forcing a haircut on its creditors. The majority of  Japan’s sovereign debt is internally held.

Europe also has an inordinate amount of Sovereign Debt.  Unlike Japan, this debt is held externally- in places like the US, but moreover between its own members.  This adds an additional layer of complexity to the situation.  Whereas Japan can, to an extent, bully or coax their creditors into accepting poor terms of repayment (even if they cannot escape the unavoidable), Europe has no such option.

Up until recently (probably as last as Q4 2013) the developing nations and emerging markets were considered to have high growth prospects and thus low default risk. This market expectation has been undone by the global commodities route, which has put pressure on emerging market public finances.

And of course, we have the US itself which is sat on trillions of dollars in debt.

So what’s coming?

If history is a guide, we are in the midst of a Sovereign Debt Crisis, with the defaults starting on the periphery (see: Greece, Costa Rica and Ukraine).  We are soon to be heading into a much larger crisis which has already started in the Emerging Markets and will soon spread to Europe, then Japan, and finally move to the core in the US.

An observation of this type of cycle is the political unrest which rises out of it, with extreme ideologies arising across the spectrum.  As well as the rise of warfare and civil unrest.

There will be cries of “This time it’s different”, and “We need exceptional powers to deal with this unprecedented crisis”, from governments, as well as asset confiscation and  wealth loss via a combination of increased taxes, loss of income, destruction of savings (the decline of the sovereign debt portion of the money supply), or increased inflation.

Volatility in markets will be high as savings look for a safe haven, as will risk and anyone who makes it out of the other side should see more opportunity a decade from now, provided that governments do not do something insane.

The Media’s Role in Shifting Public Perceptions.

The Media’s Role in Shifting Public Perceptions.

An important principle for any burgeoning investor to remember is that the behavioural elements of the markets trade on expectations- expectations of company profitability (or lack thereof), a mantra which embodied by sayings like, “buy the rumor and sell the news”, and “markets trade on greed and fear”.  Fundamentals are important, of course, but generally markets can remain oblivious to the underlying fundamentals for some time.

Politicians and some economists (especially central bankers), tend to take advantage of this when they plan ahead, often talking markets up and down with press releases, and trying to influence broad market expectations (see: forward guidance).

Bankers, creditors, and politicians would like eliminate cash at present, in order to make tax revenue easier to capture but unfortunately many people, especially the elderly, are currently still using cash.  This week we saw the US media float the idea that they were planning to eliminate the 100 US Dollar bill.  This comes after the Eurozone floats the idea of scrapping the 500 Euro note.  This acts like forward guidance, shifting market expectations and driving people out of cash and into bank balances, or other investments.

It’s quite likely that the frequency  and scope of articles on the television and in the media will increase in coming months. Governments will do this to shift public perception and mitigate the problems associated with shifting from paper to electronic.

Initially the printing presses will cease to produce these paper notes.  Finally, as the money gets spent into the economy, they will be gathered and destroyed by the issuing bodies (regional treasuries).

Electronic currency: coming soon to a developed country near you.

Taxes, Travel and Asset Confiscation.

Taxes, Travel and Asset Confiscation.

“I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.” – Winston Churchill.

Recently, traveling through a major airport in Europe I noticed that new security measures have been put in place.  This isn’t really about terrorism, as many have been led to believe, but rather about stopping capital outflows- restricting the flow of wealth across borders.

Precious metals are one such example of a monetary asset which will be confiscated if evidence cannot be given as to how they were purchased.  There is a 10,000 Euro limit on non-declarable cash and cash equivalents when traveling around Europe.  No doubt the same thing will be true in many other parts of the world too.  Be aware that this limit will not increase in the near-term, so a devaluation of the currency will mean that asset classes that hold their values against devaluation will become increasingly less mobile.

Asset seizure is also evident in Denmark, where immigrants will face asset seizure on the border.


The great hunt for taxes has begun in earnest and the hunt for taxes does not stop with precious metals- physical holdings of bonds, stocks, or cash must also be declared.  It will not only be necessary to show custom border agents that purchases of assets have been carried out in a manner which complies with the local laws and regulations, but to also prove the value of the assets are not over the limits specified.

“Innocent until proven guilty” does not apply to customs agents, no court trial will be given, guilt is assumed in the initial exchange.  In this instance the burden of proof lies with the individual holding the assets.  Therefore it is recommended that travelers carrying unusual assets which might raise suspicion provide a paper trail in advance to show that this is not an example of money laundering, or criminal activity.  Of course, laws are only as good as those enforcing them- if custom agents themselves become sick of carrying out what they perceive to be unjust laws, which they may, this entire legal structure may fall apart.

This raises an interesting opportunity- if you are young and cannot find a job, why not apply to the immigration agency?  Their budget will swell over the coming years. People need to eat, afterall, but do not expect to be looked on kindly by travelers if you are seizing their wealth.

Meanwhile, the drive for 100% electronic cash continues, with both the Eurozone and the US considering removing their higher denomination notes from the printing press.  As public budgets come under increasing pressure moving into 2017, people will come to realize what these controls are truly about.

Gold Queues in London.

Gold Queues in London.

The Telegraph has reported record purchases of gold in London with queues at bullion dealers.  This is on account of the stock markets unraveling.  Everyone believes that we are witnessing 2008/2009 all over again.

While we are liable to see a recession very soon, if not already, is probably fair to say that this will not progress like the 2007-2009 Financial Crisis for several reasons:

  • Central Banks now have experience with dealing with financial shocks; the (electronic) markets have been safeguarded from crashes to an extent.
  • Big market moves are rarely obvious until after they happen.  The fact that this crash seems obvious is going to catch a lot of people out.
  • Regions are becoming increasingly protectionist post crisis (both in terms of trade and finance), this will mitigate some of the impact of a crash and inter-regional exposure.  We are still in a highly integrated financial system, but there are better barriers in place.

This move in gold and silver prices highlights the real distinction between financial and real assets; this is likely to be a tremendous short-squeeze in the financial markets and despite gold and silver being purchased as a safe-haven asset, it is unlikely that the bear trend is over yet.  When all commodities move down together, we’ll see the bottom- probably coinciding with a US Dollar top.

Gold is a safe-haven against counterparty risk and taxation.  It is a very misunderstood asset class.  We’ll need to shake the poorly informed loose before it rises again- there is a lot of nonsense floating around in this market space.

Suffice to say that this recession will neither be a “this time it’s different” moment as many bankers and politicians are touting (we’ve seen this type of market correction before, but not for a long time), nor will it be a carbon copy repeat of the Global Financial Crisis.

Trade Update. 11th Feb. 2016.

Trade Update. 11th Feb. 2016.

Following my own advice in this previous update, I went net short in the market this week.  My returns have been minimal, with small gains and losses over the previous trading week, therefore I will simply post the previous week’s total returns.  I was using this period to focus on other projects, which has ate into my free time.


Portfolio return value at start of the week of Feb. 8th was 2.836% across the whole portfolio from the starting position a few weeks ago.  As of writing this my total returns on my portfolio will be around 6.860%.  I have one small position waiting to be closed.

Overall a good week other than one misguided attempt to swing trade LinkedIn after its 43% stock price collapse on Monday- admittedly this would have been better placed via an option trade in retrospect, but I simply do not like holding derivatives. This minor trade was more than offset by positions which shorted the S&P500 and traded on dovish ECB rhetoric with respect to the financial sector (and I expect more to come.)

My holdings for the week were as follows (columns left to right, position open price, position close price, per unit percentage rise, percentage rise on previous total portfolio value) :

DXB* (long)  :         $18.79             $ 20.68               1.005%              0.351%

GE (long)       :         $28.01              $28.45                1.570%              0.245%

LNKD (long) :         $111.25             $108.70             -0.229%           -0.479%

TVIX** (long):           $10.95               $12.32              12.511%           3.715%

*Sold out in two lots- one larger and one smaller between Tuesday and today to mitigate downside risk.

**Bought in two increments to increase exposure.


My cryptocurrency portfolio returns are up by 6.46%.  A near-term bubble appears to forming in ETH.  More on this next week.


The currency pegs which are fixed to the US Dollar looks increasingly unsound at present.

I will be looking at ways to trade this in future, in a manner which mitigates risk.


Corporate Taxes, Pensions and Ponzi Schemes

Corporate Taxes, Pensions and Ponzi Schemes

Further to the initial article and my previous post here some further questions have been asked by a reader.  I’ll break each down and discuss it in turn.  The questions assume that the information provided within the article is correct (and I’ll assume the same.)  The questions are as follows:

  1. Given that this situation of high tech startups with stacks of investor capital is only going to continue in other sectors, what can we do to ensure that market efficiency is optimal?
  2. What do you think the role of government is in protecting against this form of dumping?
  3. You have written about the transition to a full digital currency – do you think there is a case for this, given the international structure of companies like Uber, who are difficult to audit, and could be more efficiently taxed in real time?

I’ll take each question in turn here.  As I specified previously, there is a lot to discuss within the article itself:

Given that this situation of high tech startups with stacks of investor capital is only going to continue in other sectors…
Actually, I don’t believe that this trend will continue.  I suspect that the trend is nearing the end of its run.  This has a lot to do with the global money supply and market moves. This is somewhat complex theory which delves into monetary economics.  I can, of course approach this in another article but in short governments have been complicit in creating a huge surge of money, and a lot of that money has spilled over into the equities space.
…what can we do to ensure that market efficiency is optimal?
To take the second part of the first question, I would point out that this suggests that governments want markets to be efficient.  Governments have a long history of involving themself in the market mechanism.  Often just through being well-intentioned, but sometimes also through vested interests (see here for direct evidence of governments steering markets and remember, this is quite likely a coordinated effort across geographic regions.  If you steer the monetary supply, you steer every transaction in every market; for better or for worse, this is a reality in which we live.)
A UK Government billboard ad.  Since the ad the UK has given themselves the powers to hunt income in private bank accounts.
Despite this I would say that a well-intentioned government could regulate this type of behavior through antitrust legislation.  I’ve written legal papers on antitrust legislation before, and the difficulties of applying this across borders- of course it becomes extremely difficult to apply competition laws if you have foreign allied governments furthering their international agendas and empowering corporates by leaning on their allied governments.  Google is likely to be one such case if it goes against US foreign policy wishes.
What do you think the role of government is in protecting against this form of dumping?
The government, as a supposedly elected body, has a mandate to protect its citizens from market inefficiences and abuse of market power.  Whether this is practical in reality remains the subject of debate.  I think I’ve touched on how it should be achieved.  Given that government employees have apparently been watching pornography in the office, I don’t have very high hopes for the sort of necessary market power reducing graft being done any time soon.
Perhaps it’s worth pointing out that an individual who is willing to show apathy in the face of a serious issue is as guilty as the individuals perpetrating the negative issue.  Where antitrust regulation and market power is concerned, the same general principle is true, and change must arise from propert governance. We could probably bring Voltaire into it again:
“…So long as the people do not care to exercise their freedom, those who wish to tyrannize will do so; for tyrants are active and ardent, and will devote themselves in the name of any number of gods, religious and otherwise, to put shackles upon sleeping men.”
Or Plato:

 “But the chief penalty is to be governed by someone worse if a man will not himself hold office and rule”

I’ll avoid the moral aspect moving forward.  There’s a lot that could be said and much has already been said by me here.  The final question is interesting.
You have written about the transition to a full digital currency – do you think there is a case for this, given the international structure of companies like Uber, who are difficult to audit, and could be more efficiently taxed in real time?
This is a complicated question.  Transition to a global electronic currency by the major economies has two dimensions.  On one hand, yes, hiding capital from government would be much more difficult.  In essence you would have a closed loop and every single transaction into the system would be recorded and reported.  So yes, it could be more efficiently taxed. I believe that bankers and government would love to transition to this sort of system. It would prevent bank runs, it would prevent tax avoidance etc.
On the other hand you must understand that much of human history has been fought between the desires of governance and the desires of the people- the two often diverge in interest.  Ceding liberty for security leaves populations in a paradoxical situation, whereby you trade the threat of external risks for internal risks.
Don’t participate in non-taxable economic activity.  It is really, really bad.  It’s so bad in fact, that we’ll add it to our GDP calculations.
Electronic currency, with the increased efficiency and taxation that it brings would signal the death knell of the market mechanism.  Governments have been systematically dismantling the free markets over the course of the last century and this would be the end of it.  It is likely that there would be a rapid rise in “criminal” activity in the black market.
True entrepreneurs would likely avoid participation in the above ground economy altogether- if the game is rigged against you, don’t play.  I expect a transition to electronic currency with the current incentives that government has would be the end of individual prosperity for quite some time.
If there is any question as to where public preferences lie, just take a look at all of the media articles which call for increased taxes as well as advertisments rife everywhere. There will always be loopholes for the wealthy and affluent- they write the rules.
Perhaps we should be worried about precisely who it is that the governments intend to tax.  Smart and wealthy people will always find ways to avoid laws- particularly in a corrupt system, and once an electronic currency system is in place, the tax hikes are just as liable to be on the average citizen.
There is no question that most wealthy people owe the societies which they have accumulated the wealth in.  You simply cannot profit from economic activity at expense of everyone around you. The question really lies in why electronic taxes are being called for. Given the cadre of bankers and politicians jumping on board at a time when our failing social systems are yet to be addressed, I remain a skeptic.
We have a least one mathematically unsound major government program running in the form of pension schemes.  This is widely accepted by Nobel Prize winning economists like Friedman, Samuelson and Krugman.  We have mathematically unstable systems like public national healthcare systems, and mandatory healthcare insurance schemes.  Both of these need to be addressed as a matter of necessity, not as a matter of desire.  We can quite literally eat every ounce of true value-adding economic activity through hiking taxes if we do not.
If you’re running a private Ponzi Scheme, you will be locked up in cuffs and ostracized like Bernie Madoff, however, if we’re operating one it is in your best interests as a taxpayer.
Furthermore, even if governments are not corrupt and are largely well-intentioned there is no single government who has ever been right about everything in human history. Often governments create multiple mistakes (unintended consequences) for every one thing they try to do.  Even Milton Friedman who reluctantly accepted the modern currency system pointed out as much.
Hopefully that helps.

Wave Goodbye to Global Property.

Wave Goodbye to Global Property.

While property is heavily tied to the traits inherent in the local (regional) market, I fully expect that the next 20 years (or so) will be an extremely bad time for global property.  Here are potential some reasons why I expect property to broadly decline in value:

  1. High propensity for access to credit to shrink.
  2. Lack of new buyers entering into the markets.
  3. High propensity for increased property taxes in some regions.
  4. Potential for civil unrest in some regions.
  5. Potential for war in some regions.
  6. Declining fertility rates globally- threat of reduced population.

Characterising the Property Market:

The property markets exhibit all of the classic traits of a pyramid scheme, but on an intergenerational basis.  Property is buoyed  in real value by increased population densities (to a point- more on this), with more populous younger generations driving demand on the lower levels of the pyramid.  Choking the supply of new houses at the top, as governments are sometimes prone to do, while increasing the bottom of the pyramid tends to drive values over time.  In some areas (like London, Hong-Kong, or Tokyo) there is a serious lack of space which naturally restricts housing supply.

In addition, property prices have been inflated through mortgage loans over the past 80 years.  Loans act as an accelerant, with more individuals eligible for property than would otherwise be the case in a loan-less market- in short they transfer income from expected future earnings into the present day, thus buoying the prices in the short term.

It is also worth noting that property is far from a liquid asset- when the markets decline it will be difficult to liquidate. People may be stuck with their properties far longer than they expect.

Now we’ll take each point in turn.

A high propensity for the access to credit to shrink and lack of new buyers.

There are two considerations to this story- the demand and the supply side.  In some regions of the world the credit bubble popped in ’07-’09 with a bang.  While the supply of loans hasn’t dried up the demand for loans has not recovered from its 2006 peak.


fredgraph (2).png
This graph courtesy of the St. Louis Fed. shows the reality of the sluggish US mortgage market.  Despite declining rates on fixed-rate mortgages (as well as ARMs) the total mortgage debt outstanding has not broken above the 2006 peak.

This is unlikely to be entirely due to supply.  While banks did get their fingers burned (to say the least) in 2006, governments are supercharging the debt market by lowering interest rates on excess reserves.  It is quite likely that first time “buyers” who could potentially afford a mortgage simply do not feel confident enough to enter into long-term mortgage contracts, and are opting to rent rather than take on long term debt obligations, while first-time buyers who are not creditworthy are deemed to be too high risk by banks post-crisis. Cash purchase is likely the preferred method of house buying now, but either way decades of excess leverage need to be worked out of the system.

The situation above is not just limited to the US, but also the UK and Europe.

Other regions of the world.

Where the European and US markets tumbled in 2007, some parts of the world sneezed and kept going.  This includes markets like Australia, Canada and China.  Part of this is due to a lack of a severe credit crunch during the Financial Crisis in these resource rich economies.  The second part is due to international capital flows of “hot money” coming out of China.

Let’s take a look at London, because this is an interesting case of a bull trend in an otherwise bearish market, which helps to explain the other markets quite well.

The rate at which London property has outstripped the rest of the UK has been tremendous, borne by international capital flows into the UK.  However, this trend as of the 4th Quarter of 2015 seems to be reversing, as London property fell approximately 25% in the luxury market.

Capital has been fleeing China, other emerging markets and the Middle East for some time and looking for yield in assets all over the world.  This is quite evident in the London markets where the prices of luxury property have gone stratospheric, causing asset price inflation.  Good for property sellers, not so good for buyers who are still holding property.

The story has been the same in some regions of the US, like Detroit, as well as Canada, Australia and just about anywhere with relaxed laws for international investors.  The trend is driven by fear of taxation by government.  Of course, as I mentioned before, property is a fixed asset- very hard to liquidate.  A “five lane highway going in, and a goat trail coming out“, as one hedge fund manager, Kyle Bass, has quipped.  Good luck to these investors. I wish them well, because a market which has doubled decade over decade for the last six decades is not a market I want to be trapped in.

High propensity for taxes in some regions.

London is, once again, the perfect example of how this capital cul de sac is liable to work.  Foreign capital flows in, leaving wealthy individuals stuck with fixed assets on their balance sheets which the smart hands sell out into the buoyed demand.  The government will then (partly through populist necessity and partly through the need to survive) hike taxes on property holdings to try to increase their tax revenues. This will be a common theme over the coming years internationally, and it bodes ill for property in general.

As taxes get hiked the markets fall in value, as the markets fall in value, assets become liabilities.  In the absolute worst case scenario people will simply abandon and walk away from their property.  This seems ludicrous to most, perhaps, but it has historical precedence.  I would point out this would probably be the final rally of an increasingly desperate government that is struggling for funds.  It may never come to this.

Propensity for civil unrest in some regions.

Anyone who is familiar with Marxist writings (and their mark on Russian history) must be familiar with the Bolshevik Revolution.  While I do not agree with the course of the revolution, or the solutions implemented by the Bolsheviks who hollowed out their national economy and actually allowed their future political leaders to become wealthy beyond all imagination, it should be noted that the unrest started through economic suffering of the common people.  Namely the middle class and the lower class.

This highlights the problem with a widening rich/poor wealth divide and unrest tends to start slow and then accelerate rapidly.  The Arab Spring, for instance, was building for many decade, but exploded across the Arabian Peninsula and North Africa in a matter of months.

Potential for war in some regions.

Desperate governments turn to desperate measures, including measures to distract the wider population.  Wars are a great distraction, provided they do not spill over into your own back yard.

Property in Homs, Syria.  No doubt five years ago these hollowed out high-rises had commercial value.

Declining fertility rates; threat of a reduced population.

There are many ways this can come about.  Fertility rates have already been in decline in the West for many years, propagated by the socialist system (taxes for healthcare, social security, etc.)

There is the possibility of disruptions to the global supply chain- war, famine, drought etc.  There’s possibility of a pandemic like the influenza epidemic of 1918- long overdue by the way.

If someone held a gun to my head and told me to pick a course for future human population growth, I would err to the downside.

This shouldn’t alarm readers, it is not intended to- we might have unprecedented population growth over the next five decades.  I am simply pointing to this as a risk factor for property in the future.

The goldilocks scenario for property.

Property will continue to increase in value if:

  • Global stability is maintained.
  • Population growth is maintained OR property supply is reduced at a greater rate than population declines.
  • Interest rates are taken increasingly negative AND the markets respond without a major incident.
  • Taxes do not increase.

If I had to invest in a property somewhere, I would be looking rural, not urban.  I see urban property broadly to be one of the worst asset class investments of the next half-century.