THE BUY SIDE: FINANCIAL CRISIS: MARKETS
Perhaps this rout, too, will stop at the gates of Rome
AVNER MANDELMAN
Avner Mandelman is president and chief investment officer of Giraffe Capital Corp. and the author of The Sleuth Investor. amandelman@giraffecapital.com
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September 27, 2008
After Hannibal had crossed the Alps and beaten the Roman army twice, the alarmed Roman Senate spent the nation's treasure and sent eight legions against the invader. Up to then, Rome had rarely thrown more than two legions into battle. But when the state was in danger, there was no limit to what the authorities would do.
And so it is today. The financial system has just buckled before a financial marauder - Freddie and Fannie's huge debt - and to save the system, the U.S. government took over their $5-trillion (U.S.) of debt, annihilating its own balance sheet. It is just as the eight Roman legions that gave battle to Hannibal in Cannae in 216 BC also were annihilated. And, just as after Cannae the moneyless Roman state lay defenceless before Hannibal, so does the broke U.S. government now lie defenceless before the remaining debt - which is a hundred times bigger than F&F's.
Yes, you read it correctly: A hundred times bigger. F&F cost $5-trillion, or 8 per cent of the $60-trillion global GDP; but there are $600-trillion of derivatives out there, or about 10 times the world's GDP. What would happen if some of these crumbled, as did F&F?
AIG had a "mere" $1-trillion of derivatives, which was enough for the U.S. Federal Reserve to pale and renege on its vow not to bail out anyone after F&F. And AIG is small compared with, say, JPMorgan, which has perhaps $20-trillion of derivatives; or other insurance companies and banks each of which has half-a-trillion of derivatives here, half-a-trillion there.
Almost every exchange-traded fund has derivatives (called swaps), every insurance company and every bank. It's a huge daisy chain of obligations. What would happen if a few trillion cracked? How would the now-broke U.S. authorities fight the problem? Back to Rome then, for clues.
When, after Cannae, the Roman state had no more money or soldiers, the Senate sent collectors to confiscate private citizen's horses, food and money for the coming battles; then sent out impressers to draft any able-bodied man into the army. Because when the state is at risk, no private wealth, nor private body, is safe.
And so it is today. The market just had its Cannae; the U.S. Treasury is broke. Foreign governments won't hand over their cash. Yet an even larger debt problem - derivatives - is looming. And so the authorities must gather money from wherever they can, any way they can - and they are already doing it.
First were resource stocks. The U.S. Treasury, in concert with the Fed, bumped the U.S. dollar up, drove resource prices down, and so sucked money out of anyone who was long commodities and short financials, thus giving broke banks breathing room to refinance. (BMO's Don Coxe has written a terrific piece about it.)
The authorities then forbade shorting most financial stocks - and bang! The shorts had to rush to cover - contributing a piece of their hide to the debt battle's costs. What's next?
Probably no shorts allowed at all - the California Public Employees Retirement System already announced it won't lend its stocks any more (after the Feds allegedly leaned on it), and so more shorts should rush to cover (helping the market rise - perhaps a lot).
And after this rascality, just about anything is possible, because the authorities are desperate. Thus one by one, sectors of the market, parts of the economy, whole asset classes, are likely to be raided for fresh money - just like the Roman Senate did, post Cannae.
Will this be enough? Not very likely - there's just too much debt. So the coming war against it must eventually resort to a Fabian strategy: The Roman general Fabius knew he could not stand up to Hannibal in direct battle, so he let the invader destroy the Italian countryside with impunity until the invading army dissipated its strength. (Foolhardy Roman generals who tried to fight Hannibal directly, lost.)
Similarly, today's debt tsunami may have to be allowed to exhaust itself by eating up the only store of value left: Everyone's savings (including foreigners'), following massive money printing. And so inflation must come back, the U.S. dollar must decline, gold must rise, and bonds must tank - eventually. And if bonds fall, they would take the market down with them - and the economy.
Unless. Unless.
Unless this financial debacle ends the same way the previous one did in the late Thirties - in a large-scale war. Because with so much capital destroyed, democracies look mostly inward, their will to respond firmly and early to mad rulers and evil dictators is diminished, and so evil can run unchecked for a while - until it becomes intolerable and war becomes inevitable. And a large-scale modern war, unfortunately, boosts the economy - at least for a while.
Will the late Thirties' history repeat? I hope not. But time will tell. Meanwhile, see gold as an inflation substitute for cash, and get ready to enjoy the market rise after this lengthy, scary bottom. Hannibal, remember, stopped at the gates of Rome, and so will this market slide stop - very soon.
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