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Elliott Management: "The Entire Developed World Is On A Slippery Slope" - Printable Version

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Elliott Management: "The Entire Developed World Is On A Slippery Slope" - daily business report - 08-15-2013

Elliott Management: "The Entire Developed World Is On A Slippery Slope"

Elliott Management's 22-page letter to investors has something for
everyone as Paul Singer ascribes his uniquely independent wisdom. From
the fragility of the financial system to the hubris of academic pretenders; from
inflation's various devious impacts on assets and reality to the floundering of
the world's bankers; from America's "cooked data" to the pending social unrest
in Europe and the perils of centralized power, Singers stresses "the temptation
to debase fiat currencies... means owning claims on paper money is an act of
either faith or denial." Recent market movements, Singer warns "indicate
a world on life-support," and "for every day, month and year that policymakers
try to substitute failed, inappropriate and risky QE policies for pro-growth
policies, the debt mounts, as does resentment among middle-income families that
their situation is not improving." The fact of the matter is that
"no government has ever reached fiscal 'nirvana,' yet our central bank (and
its peers) continues to push the envelope of risk, confidence and
inflation." Despite the confident and brave words in which they are
wrapped, central bank actions currently seem underscored by quiet
panic.


On recent market volatility:

...the markets’ dramatic response underlines the fragility of the
world’s economic and financial systems, as well as its dependence on the
artificial stimulants of QE, ZIRP and extreme deficit spending, all of
which are still active (or even increasing) five years after the financial
crisis. The stronger growth that was supposed to be ignited by all this
financial and fiscal caffeine is not present or anywhere in
sight.
On the Un-Taper after any Taper:

...governments in the major developed countries are determined not to be
caught by a renewed deflationary credit and banking collapse... such an
event would be met by another cascade of money-printing and
governmental guarantees.
On inflation:

It is more difficult to make judgments about whether and when the torrent of
freshly-minted QE money will create widespread price increases that everyone
would recognize as “serious inflation” (as distinguished from the
“asset-price inflation” currently underway, which policymakers argue is not the
same thing)...



...bond prices have dropped (depending on their duration) by anywhere from 3
to 15 points or more. It is not yet clear whether these price movements are only
short-term fluctuations, or whether they are possibly the start of the
painful acceptance by markets that inflation is likely to take place in the
foreseeable future.
Is The Global Economy Turning Up?

Most economists seem to feel that growth in the U.S. economy will accelerate
in the second half of 2013 and gather more steam in 2014, and that Europe may be
close to reaching its bottom... Our guess is that a meaningful upturn of
growth in the U.S. and Europe is unlikely, given the current mix of
fiscal and economic policies in these regions.



...When we contemplate what it says about financial soundness when the U.S.
10-year interest rate goes from 1.60% to 2.60% in a few weeks and the world
shakes, the implications are quite sobering. The market movements in
June do not bespeak a robust, solid financial system capable of withstanding the
normal ebbs and flows of human events. Rather, they indicate a world on life
support, with policymakers experimenting, floundering and trying to
create with the appropriate jaw movements what their extreme and empirically
unsound policies have failed to accomplish in actual fact.



...China has had a hard time building the consumption side of its powerful
economic engine to the same degree as the investment side. We agree with
those who are marking down expectations for near-term growth in China.
That is obviously a negative factor for the global economy



...Our views about Europe and the U.S. have evolved toward an expectation
that we are not likely to see a meaningful pickup in growth for the rest
of 2013, into at least 2014. If this view is indeed correct, it is
anyone’s guess whether and when this reality will raise the level of citizen
frustration and anger with the leaders and established mainstream political
parties of these regions. It is also difficult to predict whether this
frustration and anger will result in increased political
radicalism.
On the "cooking" of US data and the harsh reality:

...America is undergoing a little data lift, but not as much as
people think, because much of the data is “cooked.” We do not expect an
acceleration of growth in the U.S., and there very well may be a fallback.



Five years after the crash, the labor recovery is still
extraordinarily weak. The absolute level of nonfarm payrolls today is
basically the same as it was in 2005. Furthermore, a significant percentage of
recently created jobs are low-wage and/or part-time...



...the problem of distorted and false government statistics,
and in this installment we are going to connect some dots.



...At present, most people assume that the economy is expanding at roughly a
2% annual “real” growth rate. However, the underlying presumption of
that arithmetic is that the government’s inflation statistics are
accurate, because real growth is measured by subtracting inflation from
nominal GDP growth. But it is quite clear that the government uses various means
to keep the inflation number artificially low, including its focus on “core”
inflation, which removes energy and food prices from the equation. The
resulting overestimation of real growth has a much greater impact during times
of anemic growth than when unemployment is at normal, non-recessionary
levels.



...the “core” concept is bunk: Inflation is in fact higher than
officially reported, which means growth is actually lower than the
government says it is. And this does not even include other gimmicks (such
as hedonic adjustments) that increase the understatement of inflation (and
overstatement of growth) in government statistics
On America's culture of dependence:

In December 1968, roughly 65.6 million American workers held full-time jobs,
according to the Bureau of Labor Statistics, while nearly 1.3 million people
collected disability – a ratio of over 50:1. In May 2013, with 116.1
million full-time workers and a record 8.9 million collecting disability, that
ratio has dropped to 13:1. We reject the notion that our workforce has
become that much feebler, especially as our workplaces have become dramatically
safer.



Rather, we think this alarming and significant increase in the number of
people receiving disability payments, in many cases transitioning directly from
unemployment benefits to disability benefits, denotes an increased
culture of dependence, which bodes poorly for the prospects of a strong economic
rebound.
On why policy matters:

The dividing lines between success and failure in achieving the goals of
strong growth and high-quality job creation are easy to see. A stable,
predictable and relatively low-tax regime is an attractive feature for potential
job-providers, whereas high and rising taxes combined with class-warfare
messages are detriments. Policies that reduce the power of
special-interest groups to set wages at uncompetitive levels and/or dictate
corporate or governmental staffing are additive to growth, compared with rigid
employment rules and structures.



...what has caused America to spend the last five years mired in recession?
Bad policies are to blame. The Administration’s rationale is
that things would be much worse in the absence of such policies.



...Bad choices were made, and they are still in effect today. The
ultimate consequences may prove to be disastrous.



...Perhaps the best approach would be for the government to just get
out of the way.
On the 'obvious' failure of central planning:

Over a long period of time, a mechanistic and technocratic mentality
has taken hold, spread by people who believe in all-encompassing
central control over people’s lives, and embraced by elites who have
come to believe that policies have precise and definable effects. In
“normal” times, perhaps the lack of a precise connection between cause and
effect gets lost in the sauce, largely ignored by the public and policymakers
alike. But in a low-growth environment like the present, deficiencies in the
causal relationship are more discernable.



First of all, life is less predictable than the relationship
presumes. Furthermore, there are second-order, delayed, interactivity
and reflexivity effects, any or all of which can be every bit as important, or
even more important, than the immediate and “obvious” firstorder effects.
Monetary policy is a great example. Print trillions of dollars, markets go up,
financing conditions become easier and banks can make money with carry trades.
But what about the potential attendant effects of this monetary
experimentation, such as: distortions, resentments, the
inability of the middle class to participate, the risk of future inflation and
so on? And when those things occur, at some “unpredictable” time in the future,
will policymakers raise their hands and admit
responsibility?
On political promises:

In most realms of endeavor, the more centralized the power, the
greater the chances of inefficiency, corruption, inflexibility and
waste. As businesspeople, we all know that.



But many politicians think they always have to do something.
And many citizens let them, especially when the politicians promise to
take money from someone else and give it to them if they vote
“correctly.”
On overconfidence:

It is remarkable that global central bankers are so confident in their
simultaneous QE policies. The prevailing wisdom seems to be that the
developed world simply needs to place its faith in the central banks to hold the
world together with just enough growth and job creation to ward off
revolutions.



Apparently the combination of a
rising stock market, falling gold prices and low reported CPI has lulled
policymakers into ignoring the dangers of their
policies.
And the consequences of their hubris:

Today, there is a serious structural growth problem, not to mention a deep
long-term insolvency, in the “legacy” countries, so called because they are
steeped in the legacy of unrepayable debt and long-term entitlement obligations.
Can anyone pretend that governmental policies in the U.S., Japan, the U.K and
continental Europe are effectively addressing such problems? Of course not.



So how does this global money-printing, bondbuying, ZIRP, QE, whatever you
want to call it, actually end? The overwhelming majority of professional money
managers (including us) will admit to having no clue, yet the central
bankers think they have all the answers. The consequences for
the world if they are wrong are very serious.
On 'Fiat currencies':

It is very hard for policymakers to avoid the temptation to debase
fiat currencies. To maintain confidence in paper money, policymakers
need to adopt strict discipline and a tone of sobriety and respect for their
moral commitment to maintain the real value of this infinitely creatable and
ethereal “standard” and “store of value.” Since the globe’s major central banks,
starting with our own, have long since abandoned such discipline and sobriety,
there is actually no solid justification for investors and citizens to have
confidence that paper money or claims on paper money (bonds) will actually
maintain their value.



Thus, owning claims on paper money is an act of either faith or
denial.
On Inflation and QE:

QE has not solved the world’s economic problems, and it has had
massive second-order effects, but QE has neither been abandoned nor
replaced by smart policies designed to stimulate real growth. Central banks seem
to be fanatically determined to generate inflation, since somehow inflation is
thought to be a proxy for growth.



In fact, inflation is an arbitrary wealth redistribution and
confiscation mechanism that sometimes (but not always) accompanies
growth and boosts asset prices. But inflation, in a nutshell, is the developed
world’s pro-growth policy at present.
On 'fiscal nirvana':

No government has ever achieved those goals and reached fiscal
“nirvana,” yet our central bank (and its peers) continues to push the envelope
of risk, confidence and inflation.
On 'faith':

The monetary policies of the legacy countries may or may not be a house of
cards, but they certainly seem dangerous. So much belief and reliance is
being placed on a small group of policymakers who personally had very little
understanding of the financial system in advance of the last
crisis.



Their lack of humility has created a distorted and inequitable
“recovery.” Some social theorists rail against “trickle-down
economics,” but is there any clearer and more patently unfair example of this
concept than QE?



The rich get richer, and the government takes credit for doling out
handouts to those who have not benefited from asset-price
inflation.
On unintended consequences:

Policymakers who engage in QE other than at times of dire emergency are
assuming they understand the precise linkages between output gaps, asset-price
movements and consumer demand. In our opinion, that assumption is presumptuous
in the extreme, whether for the most seasoned financial industry veteran or a
government bureaucrat. It is foolish of the Fed and its peers to think
they can figure out and finely-tune the expectations of markets.



In a large monetary debasement, there usually comes a time when
central bankers start to realize that they have set society on the road to ruin,
but they are reluctant to stop printing money because it would cause immediate
pain. Few have the courage to swallow this medicine, so they persist or
double down. Maybe at some point they understand that there is no way out and
that they are just digging a deeper hole, or perhaps they think that printing
another slug will buy them enough time for some deus ex machina to enter the
equation and fix things.



However, the fact remains that policymakers, devoid of vision or
humility, have far less insight into the medium- and long-term consequences of
their policies than they publically purport to
possess.
On the opacity of financial institutions:

To our knowledge, no policymaking individual or body is actually working on
addressing the opacity of financial institutions, so goodness knows how
modern, large financial institutions with tens of trillions of dollars (notional
amount) of derivatives on their books can ever be understood or trusted by
traders and governments in the absence of explicit or implicit government
guarantees. At the risk of sounding like a broken record, this problem
needs to be studied and fixed.
On the ignorance of the Fed:

It is extraordinary to us that the world’s most powerful central
banker, in the midst of a gigantic and powerful monetary policy
experiment consisting of zero percent interest rates and trillions of dollars of
money-printing, expresses puzzlement that markets act how they want to
act rather than pursue the script set out for them by the Ph.D-approved
models of the exquisitely educated and experienced Fed.



Sadly, 2008 demonstrated conclusively that the major central banks,
most energetically the Fed, possess only the most rudimentary understanding of
the modern financial system.
On how it came to this?

The truth, of course, is that stock prices are at these levels only
because the government printed trillions of dollars to bid them up. The
economy is not performing well, and when inflation kicks in, everyone will
realize that they have been hoodwinked by the oldest trick in the book: debase
the currency and fool the people into thinking that they have more than they
actually do, that they owe less than they promised to pay, and that everything
from savings to work is based on shifting ground, rather than any stable or
enduring standards of value.



How did it come to this? The answer is simple: arrogance,
hubris and academics masquerading as leaders and
experts.
On Ponzi-merica:

Today, suffice it to say that credit is deeply embedded as a
substitute for income, in many instances completely replacing equity in
purchases of homes and other large consumer goods. Tens of millions of
Americans (the “thought leaders” on this road to perdition) are now completely
in the grip of their own personal “Ponzi finance.” The same can be said
about the U.S. government...
On getting off the slippery slope:

The entire developed world, not just the U.S., has been on a slippery
slope, with policy actions that gave the impression of adding to growth
without increasing risk.



...The most effective way to escape a slippery slope is to dig in and
step off, deliberately and thoughtfully, as quickly as possible, accepting some
current pain for the greater long-term good. In the context of
repairing the U.S. economy and improving the outlook for future prosperity, this
process includes reforming unpayable entitlements, deleveraging financial
institutions, requiring homebuyers to make substantial down payments, ending the
interest-expense tax deduction and, most of all, growing the economy faster
using sustainable methods of generating growth, not just by giving people credit
for which they do not qualify.



All of this progress can be made, but it takes leadership and
determination.
Where are we now?

Typically, periods prior to crashes and financial crises are times of
complacency, characterized by extreme pricing of financial assets that removes
future reward and increases future risk. Another common feature of such
periods, some of which can be quite lengthy, is a mentality of denial and
inadequate focus on risk among investors and policymakers, increasingly leading
to the building of very large positions that are untenable if the environment
changes. It is always the case that traders with large leveraged books are
vulnerable to sudden shifts in the trading landscape, and that when such traders
are forced to unwind, markets are roiled. But the advent of derivatives in
modern markets has allowed the creation (with relative ease and limited capital
requirements) of unimaginably massive, highly-leveraged positions, in turn
increasing the number of vulnerable traders.



Moreover, in a modern twist with roots in the financial crisis,
central banks have leaped to the top of the heap, becoming some of the
largest leveraged and exposed traders in the world.
Multi-trillion-dollar positions in bonds and even some stocks have left these
institutions with “nowhere to go.” They have driven up the prices of most asset
classes, and markets hang on their every word, discussing the third derivatives
of their intentions. (“We may start to think about deciding when to reduce
the pace of our buying as a prelude to actually selling the paper we own or
letting it mature, but don’t be scared! Everything’s gonna be okay! We know what
we are doing!”) Central bankers must arise every morning and pray
that the world’s major economies surge into growth and full employment so that
the $14 trillion (and counting) of assets already on their balance sheets can
somehow quietly disappear into the large flows of global
markets.
It would appear that being 'smart money' is really just a matter of telling
it like it is - as opposed to herding sheep-like in behind the rest of your
apparent peers - a topic we are well aware of.

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