november 2012 – salma hayek - icecap asset...

Our view on global investment markets: November 2012 – Salma Hayek Keith Dicker, CFA Chief Investment Officer [email protected] www.IceCapAssetManagement.com

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Some people are just not glamorous

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Salma Hayek is beautiful, rich and famous. Besides lighting up the silver screens in multi-million dollar movies, this glamorous beauty also graces the covers of People, Vogue and of course, Glamour. Friedrich Hayek is a deceased Austrian economist. He wasn’t very good looking, certainly not wealthy but he did become famous – but only 20 years after his death and then only within the make believe world of nerdy economists. Fortunately for the World today, the times certainly are a changin’ – and perhaps, if we are lucky, Friedrich Hayek may become the most famous Hayek of them all. Until then, the World remains firmly trapped in an economic hell created by Friedrich’s (and therefore Salma’s) arch enemy – John Maynard Keynes. The war that no one heard about Few people in the World are even vaguely familiar with perhaps the most important war over ideology ever waged. Some may say the American-Soviet cold war was the tops – yet this riff over 4 legs good, 2 legs bad had nothing on what we are about to share with you. On one side, you had Friedrich Hayek and the Austrian School of Economics, while the other side was anchored by John Maynard Keynes and the later to be named Keynesian Economics.

November 2012 Salma Hayek

It’s no coincidence Since WWII, the Americans, Japanese, British and Europeans have spent way more money than they owned. But that was ok because the money they borrowed wouldn’t have to be repaid until some far away day in the future. Unfortunately the future has now arrived and today, the next generations of Americans, Japanese, British and Europeans have all plunged into a deathly debt spiral. Today it is no coincidence that the Americans, Japanese, British and Europeans have all set interest rates as close to 0% as possible. Also today, it is no coincidence that the Americans, Japanese, British and Europeans are all printing money. And finally, today it is also no coincidence that the Americans, Japanese, British and Europeans ignored Friedrich Hayek and instead followed the economic principles of John Maynard Keynes. Today the entire global economic and financial system is rooted in unwavering support for John Maynard Keynes and his beliefs in deficit spending and debt-fueled growth.

2

Just enough


Money makes the World go ‘round Arts, science, and politics certainly makes the World go ‘round. Yet, nothing can move without money and capital. Thank goodness we have an army of academic and real-world economists tackling the dynamics of money. Of course, when it comes down to it we should be grateful that Mr. Hayek and Mr. Keynes, both grappled with perhaps the most fascinating economics question of all time – what causes the economy to move and what should be done when it stops moving? Mr. Hayek’s business cycle theory was groundbreaking to independent thinkers, yet terrifying to anyone with ambitions to become central bankers or masters of the universe. The groundbreaking component was actually very easy to understand. In essence, the best way to influence the economy was to not influence the economy. Rather, instead of tinkering with interest rates, taxes and deficit spending, masters of the universe should instead focus on ensuring the amount of new money released into the economy was just enough to equal the natural growth rate of the economy. Sadly, our great leaders dismissed this concept. Instead of giving us “not too much” and “not too little,” we received “way too much” and never “too little.”


Of course, the mere idea that one could not use their financial and economic acumen to control the World was clearly not acceptable to central bankers. It was even more preposterous to politicians who promised multiple chickens in multiple pots. Of course, exactly who paid for these extra chickens and extra pots was highly irrelevant. Mr. Keynes’ view was very different in that he believed the business cycle could be influenced by a government’s use of fiscal policy which included taxes, spending and deficits. So, instead of embracing Mr. Hayek’s theory, the masters of the universe obviously opted for Mr. Keynes’ economic theory. Unfortunately, and through no fault of Mr. Keynes, over the years governments and their advisors have only seen a one-way street in that changes could only occur in one direction. - Taxes were always reduced, never increased. - Spending always increased, never reduced. - Deficits always grew, never eliminated. If Mr. Keynes was alive today, we are confident he would be embarrassed that his lifelong work had been so severely distorted. Yet, presented with today’s economic dilemma - he would also be highly excited to begin his new and improved economic thesis.

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Many things can accumulate over 60 years


As most politicians and central bankers view the World in very short time frames, to truly understand the devastation wreaked by Keynesian economics, one has to take a step back and see how the financial destruction accumulated over time. December 21, 2012 – the end of the World Over 2000 years ago the Mayans were leaders in mathematics, art, architecture, and astronomy. Yet, today this has been long forgotten, and instead these guys are known as those kooks who’s Great Mayan Cycle predicts the end of the World in just weeks from today. The fact that they predicted this specific date over 5, 125 years ago is reason enough to attract attention. While the books, movies and Hyde Park gatherers believe they have all the answers – none of them realize the role played by Keynesian economics. If you only read commentary from, and speak with the big box banks and mutual fund sales people, you are forgiven for not understanding the true state of the World’s financial system. Now, those financial pundits and commission based sales people proclaim that we are in a bit of a rough patch, and the wall of worry is in fact nothing to be worried about. After all, it is always a good time to buy mutual funds. Sadly, the magnitude of this misinformation can be attributed to not understanding how we arrived at this precarious position to start with.


The crash of 2008 wasn’t simply due to an overheated American housing market – this was just the one of many final straws. In fact, those dark days of just a few short years ago were the culmination of years of too much spending and too much borrowing, and then trying to sweep these stresses under a money printing rug to be forgotten. Considering this, It shouldn’t be a surprise that we are in a precarious position. Yet, before the World can heal and move along we need to understand how we arrived at this unfortunate position in the first place. The excesses of today were not accumulated over a standard 3-5 year business cycle, but rather the excesses accumulated over 60 years of fortuitous, kicking-the-can-down-the-road policies by governments and central bankers. It is true that these policies initially provided sugar highs for the economy – but the 3 step cycle of cutting interest rates, cutting taxes and borrowing money to create growth has finally reached its end point. First out of the medicine cabinet are interest rates. The Keynesian prescription follows that whenever the economy slows or falls into a recession, central banks should cut interest rates. Chart 1 on the next page, shows the history of rate cutting for the big 4 economies. Since 1980, every time the stock market collapsed, Mexico collapsed, US thrift banks collapsed, Russia collapsed, the

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Chart 1: Keynesian Mistake # 1 – cut interest rates to 0%



0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

USA Britain Japan Germany

0% interest rates

everywhere

Source: Federal Reserve St. Louis, IceCap Asset Management Limited

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IOUs



biggest hedge fund collapsed, the Tech Bubble collapsed and the

housing market collapsed – central banks all cut interest rates to save the day. Rabid fans of Keynesian economics are steadfast that each time interest rates were cut – the day was saved. What these rabid animals do not tell you is that each time the day was saved, this very action set the ball in motion for an even bigger day that would need to be saved down the road. In fact, it is easy to see that each successive crisis was actually bigger and more threatening than the previous. Now, the “save the day” strategy of cutting interest rates can work for a really long time – well, at least until there are no more interest rates left to cut. Unfortunately – with close to 0% rates everywhere, the World has reached that day. In addition to cutting interest rates, Keynesian economics also believes that to really save the day, governments should combine cutting interest rates with deficit spending. The belief is that when the economy slumps, lower interest rates will encourage private investors to borrow, hire and spend again, but in the meantime governments should fill this spending lull by building new bridges, roads and sidewalks.

Chart 2 on the next page, shows the cumulative effect of governments filling this lull with deficit spending. To spend that much money and actually get away with it, is impressive indeed. The fact that it is still occurring shows that the voting population must really like their elected officials – how else would you explain it? Since the global economy is extremely complex in nature, one would expect that the action of continually cutting interest rates and continually spending more money than you own, would show up somewhere at some point. That point is chart 3 on page 7. Yes, we’ve shown this chart many times and will continue to post it in future global outlooks. Yet, the reason for its prominence is that it perfectly captures the reckless growth of debt over the years. And, as you’ve probably guessed by now this mountainous pile of IOUs is a result of Keynesian economics. Upon seeing the history and trend of hopeless devotion to John Maynard Keynes, it is quite reasonable to expect that the government pork road has reached its end. Maybe the Mayans will be correct after all. Don’t fret however. The end of the Keynesian road of cutting interest rates, running huge spending deficits and borrowing beyond belief has certainly arrived, but the masters of the universe have one, last Keynesian trick up their sleeves – money printing (chart 4 page 8).

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Chart 2: Keynesian Mistake # 2 – governments spend money they do not have



$(10,000,000) $(9,000,000) $(8,000,000) $(7,000,000) $(6,000,000) $(5,000,000) $(4,000,000) $(3,000,000) $(2,000,000) $(1,000,000)

$- 19

43-0

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USA Government Accumulated Deficits

-£1,000,000

-£900,000

-£800,000

-£700,000

-£600,000

-£500,000

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-£300,000

-£200,000

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£0

1979

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British Government Accumulated Deficits

billions millions

Source: British Office for National Statistics

Source: US Federal Reserve St Louis

-¥800

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¥0

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Japanese Government Accumulated Deficits trillions

Source: Naoyuki Yoshino, Keio University

$10 trillion

Yen 700 trillion

GBP 1 trillion

-€150

-€130

-€110

-€90

-€70

-€50

-€30

-€10

€10

1959

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2010

French Government Accumulated Deficits

Source: (Institut National de la Statistique et des Études Économiques

EUR 1.4 trillion

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Chart 3: Keynesian mistake # 3 - massive debts do not matter



Over the last 60 years, Americans have enjoyed the greatest borrowing binge known to mankind

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8

Real change you can count on



Money printing, quantitative easing, outright monetary transactions,

and blowing out birthday candles all mean the same thing. Keynesians want you to believe that although cutting interest rates, running deficits and excessively borrowing didn’t exactly work out as planned – this last great hope of money printing should work. We of course have our doubts. Like Friedrich Hayek, we believe the only way for the global economy to recover is for governments to dramatically reduce their interference in private markets. As long as central banks and governments continue to influence interest rates, lending, and employment - private capital will not return. Instead of living in a World where economic success is rewarded, we now see a wave of new Western World governments who support taxing success to reward those who failed. While this initial wave of love for more left-leaning governments is sweeping the Western World, it is only a matter of time before voters discover this alternative isn’t improving life any more than the previous alternative. The result of course will see calls for real change – you know, the kind of change that changes things. Greece cannot continue as is, while separatist movements in Spain and Italy are growing as well. Some are calling for Britain to leave the European Union, and we should all prepare for perhaps a 3rd party in American politics in 2016.

$0 $1,000,000,000,000 $2,000,000,000,000 $3,000,000,000,000 $4,000,000,000,000 $5,000,000,000,000 $6,000,000,000,000 $7,000,000,000,000

Total Fake Money 1930 to 2008

Total Fake Money 2009 to 2012

Money Printing by USA, Britain, Europe and Japan

Source: IceCap Asset Management and Goldman Sachs Global Economics

Following and understanding this political shift from the right to the left and then somewhere else will become the next big show in our economic World. Get your popcorn ready. Really IMPORTANT It seems like everyone these days are experts in global monetary and fiscal policy. Suddenly, newspaper headline readers, 24-hour CNBC watchers and fiscal cliff followers are know-it-alls. Yet, the one point we hear no one pondering aloud is exactly what happens the moment the Americans decide (or are forced) to stop printing money. Some pundits fantasize that it will be an easy process – we disagree on two fronts. First of all, Ben Bernanke and the current Federal

Chart 4: Total money printing programs since 2009

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Send in the clowns


Reserve will never stop printing. Be prepared for endless and continuous rounds of money printing. For those who don’t quite understand the effects of money printing, you just have to know that during the last year the Americas had a $1 trillion deficit – meaning the government spent $1 trillion more than what they collected in taxes. In a normal World, people and countries have to borrow the $1 trillion to pay the bills, but not the Americans. Only in America does money grow on trees. And, in this case of the $1 trillion that was needed to fund the deficit, Ben Bernanke and the US Federal Reserve will print about $480 billion. For those with level heads, you’ll agree that this isn’t sustainable, nor believable. Don’t be alarmed, for an even more unbelievable experience we invite you to ask your financial planner, advisor or banker exactly what this means and what you should do about it. Moving along, the second point we make about the Federal Reserve and what happens when they stop printing money is that markets will be surprised at the reaction by private investors. Since this grand experiment has never before been contemplated, much less attempted, the central bankers of the World have convinced themselves that they can in fact pull a genie out of a bottle. In 2010, when posed with this question Ben Bernanke stated that he


could stop printing money and raise interest rates in as little as 15 minutes. At the time, you could hear a collective <whew!> as many thought it would take at least 20 minutes for the clowns to exit the car. But this isn’t so. The real concern and balancing act facing Mr. Bernanke and his Keynesian team is what happens to private capital the moment it is announced that money printing will stop, or if over night interest rates were to rise. At that moment, make believe becomes real believe as private capital once again gets to play in the real World. And in the real World, private capital will demand to be paid given the amount of real risk that is present. Two things will happen. For starters some of the private capital will simply leave to find a new home in other countries or markets. In addition, the price of money (ie. interest rates) will increase but not just for US government treasuries and bonds – but across the entire credit spectrum. This is a big deal as currently the singular hope for the great America recovery lies with ultra low interest rates. The moment rates start to increase, the hope (remember, “hope” is never a good strategy) is that the recovery is well under way.

10

Mark Carney buys tweed jacket



considering the British have followed Keynesian economics to the nth degree, we can assume money definitely changed hands. Central bank watchers everywhere should watch Mr. Carney’s move closely. Any indication of re-starting the Bank of England’s money printing ways will provide a glimpse as to how the Bank of Canada may be positioning themselves if needed. Meanwhile, at Goldman Sachs they too must be celebrating Mr. Carney’s promotion. After all, the hiring of the former Goldmanite firmly places the “Vampire Squid” in key positions across all of Europe. Go Goldman! As for Canada, the search begins for a new central banker and in our opinion there is no better place to start than at IceCap Asset Management – we await your call. The Fiscal Cliff What can we say about the American Fiscal Cliff that already hasn’t been said? A few things actually.

To understand the importance of this concept, you just need to know that currently the average interest rate paid by the Americans on their debt is 2.56%. This equals $417 billion/year. If long-term rates were to double to 5%, the cost of funding this mess rises to $834 billion or 6% of GDP. In other words, this is a big deal. Something so big that it cannot be solved in 15 minutes. No worries though, as long as Ben Bernanke and his Keynesian worshipers control monetary policy, there will be no 15 minutes of fame. Canada vs England Hockey: Canada 42-0 England Curling: Canada 12-0 England Soccer: Canada 0-0 England Canada may trump the English in most sporting events, however when it comes to the World stage of central bankers, England just scored a major victory, or did they? On a day when everyone else was trying to figure out if Greece would be bailed out for the 27th time, or if the fiscal cliff would be kicked down the road – the Bank of England announced a stunner with the hiring of Canada’s head central banker, Mark Carney to run the 318 year old English institution. There is no word yet if it was a trade, or straight buy-out. But,

For starters, this latest and greatest catastrophic crisis is second only to the infamous Y2K scandal that had everyone worried about not being able to make toast the morning after New Years. As we recall, the greatly feared day-after did not produce any riots, AOL Dial-up service was alive and well, and day trading was still awesome. In short, the World didn’t end.

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Blame Bush


Yet, judging by the media coverage of the Fiscal Cliff, the day after 2012 has the potential to plunge the American economy straight into the abyss. Once again, if it does happen we have no one to blame but George Bush – yet we believe it will not come to that. For those smart enough not to follow the minutiae news coverage of this next great crisis, the details are as follows: - In 2001 the US economy was in recession and Keynesian economists recommended taxes everywhere be cut. Lower taxes would mean more money in people’s and business’ pockets which would lead to more spending and more jobs and more of everything.

- It didn’t work of course as the 2001 can was kicked to 2008, and we all know how that worked out.

- In 2011, the 10 year tax cuts were scheduled to expire but the economy was once again not doing well, so the US Congress and the US Senate were not prepared to raise taxes. This resulted in the can being kicked once again (just as the Mayans predicted) – to the end of 2012.

- January 1, 2013 tax rates for many items are scheduled to increase significantly. If this were to happen, it is estimated to result in individuals and business’ paying new taxes of about $607 billion.

- Many analysts believe taking $607 billion out of people’s and

business’ pockets will push the US economy over a “cliff” and into a severe recession. When we put it this way, the fiscal cliff certainly does sound like a scary adventure – no wonder there’s a big hoopla over it. Considering the US deficit is out of control (see Chart 2), something has to happen – otherwise, foreign investors might get the impression that the Americans don’t really care about their finances. To keep things real, a few observations are required. First, the US or any other country cannot fix their deficit over night. As well, one year of higher taxes and less spending also won’t do the trick. Any solution will consist of forecasts many years into the future. Next, politics is politics and despite the Democrats and Republicans being kilometers apart, they will come to a “solution” to kick the fiscal cliff can down the road a few more years making the 2016 election the next most important election ever. Yet supposing an agreement isn’t reached, the economic impact could range from a mild recession of -1% growth to a severe -4% recession. Assuming the rest of the World doesn’t fall out of bed, the likely outcome will be somewhere in between. Individuals and business’ will recover and make adjustments, life will go on. Financial markets however, will not react kindly to no solution. Over a


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What happens in the real World, stays in the real World


short time frame, expect equity markets to decline significantly and if you can believe it, the US Dollar to actually strengthen. Yes, as bad as the US will look, it will continue to look better than its Keynesian cousins in Japan and Europe. Our Strategy IceCap’s view on the economy, and policy responses by governments and central banks has been very clear. The World remains in a pickle and there is no easy way out. However, one must always understand that what happens in the real World can stay in the real World for a while before it hits the stock and bond markets. Despite our negative outlook for the economy, we do expect a year-end rally to develop. Since October, we have been waiting patiently for market sentiment and technicals to signal an entry point. This patience has been justified and as of today we continue to remain ready but patient. Of course, should a strange twist develop with Greece or the Fiscal Cliff, we will quickly change our view. Until then, we continue to believe that near-term global systemic risk has been significantly reduced due to commitments by the US Federal Reserve to print unlimited amounts of money forever.

However, the ill-fated exercise of following Keynesian economics to kick the can down the road will continue once again. The World has already seen the failure of the Keynesian approach of continuous interest rate cutting, deficit spending and tax cuts. The bad news is that the money printing option embraced today will not create a different outcome. The good news is that acknowledging and correctly understanding these financial and economic policies will help investors to profit immensely the next time the can cannot be kicked any further. As always, we’d be pleased to speak with anyone about our investment management capabilities. As well, we encourage you to share our global market outlook with those who you think may find it of interest. Please feel to contact: John Corney at [email protected] or Keith Dicker at [email protected]. Thank you for sharing your time with us.








november 2012 – salma hayek - icecap asset...

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