David Einhorn, head of Greenlight Capital, the value-investing firm, and a pretty legendary short seller at this point in his young life, takes the podium.
Basically, he’s shorting US creditworthiness with today’s presentation.
Einhorn’s talk was “Good News for the Grandchildren,” by which he meant that your grandchildren won’t have to pay off today’s debt in years to come, as the Cassandras are always warning.
In reality, the government response to the recession has created sufficient stress to prompt a crisis much sooner, Einhorn wryly observed.
The amount of the US federal deficit has increased from a little over 3% of GDP in the 70s to over 9%, not to mention the socialization of risk through promises of social security benefits down road. The vast majority of government stimulus has increased the baseline of government spending in a long-term fashion. Government workers are high-cost and hard to fire, notes Einhorn.
How far can we travel down this path without a crisis? Einhorn wondered. What is the level of government debt that makes future default go from unthinkable to possible?
Einhorn says it’s imperative to work out a plan now to avoid falling into a debt crisis down the road. One obvious lesson of the credit crisis is to eliminate official credit ratings. The current proposals in Congress just preserve the status quo in bond ratings, which leads to bond pros exploiting “less active investors,” said Einhorn.
He cites an anecdote regarding Standard & Poor’s, one of whose representatives recently told NPR during a radio segment that S&P had “two pairs of eyes” in every country examining sovereign ratings.
“Just two?” Einhorn quotes the stunned radio jockey as saying.
He goes on to lampoon, to much laughter from the crowd, the ridiculous quotes from the S&P rep about how they huddle in a meeting to decide on sovereign ratings.
“Government leaders are learning it isn’t a good thing to have ratings agencies say things are fine even as problems are mounting, only to cut their ratings down the road,” Einhorn observed.
US Treasury Secretary Tim Geithner has effectively put all his eggs in the basket of S&P’s ratings team, says Einhorn. The danger is that banks could do what they did with Greece: load up on sovereign debt with no capital requirement, then turn around and sell credit default swaps, wrecking the credit status of the country.
Geithner has insisted the ratings agencies will never cut the US’s credit rating, but, “Mr Geithner may learn that never is a long time,” says Einhorn.
“I don’t believe a US debt default is inevitable,” says Einhorn, but unless serious steps are taken, “we might find ourselves negotiating austerity measures with foreign creditors” some day.
The recent round of money printing has not led to headline inflation, which has given central banks confidence. But don’t look to government stats for real information on inflation, Einhorn contended.
When the price of chocolate bars goes up, government simply assumes everyone switches to peanut bars. In other words, government numbers reflect don’t reflect real-world costs.
For example, medicare and higher employer health-care costs are not carried in government’s inflation statistics. “if your goal is to never see inflation, you will never see it until it is rampant.”
The Fed wants to have an accommodative�policy to encourage employment. That’s driving equity prices higher, leading to some goods purchases, and driving employment.
His conclusion: higher rates would lead to more lending to the private sector, rather than the current easy money policy, which is allowing banks go simply lend to the government and play the yield curve.
Why is the Fed proceeding with an “emergency” zero-rate money policy when the emergency is over?
A zero-rate policy can create bubbles that collapse, with terrible consequences.
And here, Einhorn does a brilliant turn recounting all manner of various post-bubble credit easings that in turn prompted other bubbles, with the Fed Reserve in each instance insisting that it didn’t see any bubbles — until it was too late.
Einhorn ends with an actual long recommendation, African Barrick Gold PLC, a gold miner that owns operations in Tanzania, among other places, traded in London under the ticker “ABG.” ABG could be added to indices going forward, including the FTSE 100, which would boost institutional ownership.
So, in conclusion, “We own some gold and some gold stocks for our investors and for ourselves. We will worry about our grandchildren later.”
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