Thu, Feb 5, 2015|Sean Goldsmith

Another central bank cuts interest rates...

Another central bank cuts interest rates... A billionaire who's more bearish than we are... The ECB cuts Greece off... Greece can't afford its debts... People are still drinking beer...

What would a Digest be this week without another central bank cutting rates?

Danmarks Nationalbank – Denmark's central bank – cut interest rates for the fourth time in three weeks... The deposit rate has fallen from -0.50% to -0.75%. It now costs you three-quarters of a percent to deposit money in Denmark.

The central bank pegs its currency – the krone – to the euro. After the Swiss National Bank abandoned the cap on the franc-euro rate last month, Denmark is the last remaining currency pegged to the euro.

Denmark is cutting rates to discourage people from buying the krone and putting pressure on the peg. The market believes the krone peg will break, just as the franc did.

Denmark's efforts are futile. Eventually, economics always win. And no cartel – whether it's OPEC or a country's central bank – can manipulate prices forever.

Yesterday, we said that nobody knows how this situation will end... You can't know how individuals will choose to allocate this excess capital... You can't know when the market finally loses faith in central banks and paper money... But you have to prepare for the worst.

One of the greatest hedge-fund managers in history – Elliott Management founder Paul Singer – shares our views. His fund manages around $25 billion. And he's one of the most vocal, mainstream financial figures when it comes to speaking out against the Federal Reserve and the current monetary policy. Many of his predictions make us seem outright sunny. From his latest letter to investors...

We are a little bit more simpleminded than the consensus-buyers who are looking just ahead. They think there is slack in the global economy, workers do not have pricing power and inflation is something that governments always will need to boost and push just to reach their (arbitrary) targets.

We, on the other hand, are most focused on the combination of the trustworthiness of governments to protect the value of paper money (which has never been lower than at present), plus the structural impediments and barriers to smoothly functioning growth, innovation, entrepreneurship and private-sector job creation.

Singer noted that there is still some misplaced confidence in central banks and policymakers. He went as far as to say that leadership in developed nations is largely weak and confused...

We are not complacent, because we can easily imagine a transition from the current post-2008 context to a different and scarier environment. Recent abrupt and intense trading shakeouts give some hint of the potential power and violence that resides in modern, over-leveraged, technologically wired markets, and confidence in paper money and central bankers can be lost at any moment.

When it is, and what that development will look like, are mysteries. The difference between "us" and "them" is that we are trying hard to figure out what is essentially unknowable and impossible to ascertain, while most people are just shrugging and accepting the current calm as a given.

Singer went on to explain the concerns his fund is assessing in regards to the market...

Trying to make sure that a sudden loss of confidence in paper money, or in any of the major markets in which we trade, does not unacceptably jostle our portfolio; keeping dry powder for the inevitable moment when the next flood of distressed securities becomes available at reasonable prices; and being cautious and visionary about the regulatory landscape in order to be cognizant of regulatory directions as well as where regulators are focusing today.

The lesson here, again, is that nobody knows how this situation will play out. We're in unprecedented territory. But you have to take measures to protect yourself against any possible scenario: Own gold, hold cash (which is king in a deflationary environment), own some real estate, and concentrate your investments in only the highest-quality businesses (ones that can withstand an economic shock).

And while we can't know how this situation will play out, we can be certain we'll see plenty of surprises along the way. One of those could be Greece leaving the European currency union.

After Germany's latest announcement, that possibility seems even more likely.

The European Central Bank (ECB) said it would no longer accept Greek bonds as collateral for funding unless Greece honors the terms of its bailouts. This shifts Greece's immediate funding needs – including runs on the banking system and an estimated 9 billion euro budget deficit this year – to Greece's central bank (the Bank of Greece). Deutsche Bank estimates that shifts 50 billion euros of liabilities to the Bank of Greece.

The current ECB bailout package ends this month... The ECB wants to extend the loan and impose austerity on Greece. But the newly elected Syriza party is asking for the ECB to write down the value of the debt.

The ECB is trying to force Greece to accept the terms of the bailout by strangling it from capital. It's trying to force Greece to accept the terms of a bailout it can never expect to repay.

In an "open letter" to German citizens, published on January 13 in German newspaper Handelsblatt, Syriza leader (and Greek Prime Minister) Alexis Tsipras explained why the ECB's demands are ludicrous.

While we don't agree with the political views of Syriza, its economic arguments are dead on. We've excerpted from his letter below...

In 2010, the Greek state ceased to be able to service its debt. Unfortunately, European officials decided to pretend that this problem could be overcome by means of the largest loan in history on condition of fiscal austerity that would, with mathematical precision, shrink the national income from which both new and old loans must be paid. An insolvency problem was thus dealt with as if it were a case of illiquidity.

In other words, Europe adopted the tactics of the least reputable bankers who refuse to acknowledge bad loans, preferring to grant new ones to the insolvent entity so as to pretend that the original loan is performing while extending the bankruptcy into the future.

Nothing more than common sense was required to see that the application of the 'extend and pretend' tactic would lead my country to a tragic state. That instead of Greece's stabilization, Europe was creating the circumstances for a self-reinforcing crisis that undermines the foundations of Europe itself...

So, let me be frank: Greece's debt is currently unsustainable and will never be serviced, especially while Greece is being subjected to continuous fiscal waterboarding.

The answer to too much debt has never been more debt. And eventually, the ECB will be forced to take a haircut on Greece's debt. It will either strike an agreement or Greece will default... because Greece cannot afford to repay its debts, much less any additional debts...

Still, the ECB wants to "extend and pretend."

On a bright (and possibly related) note, people are still drinking booze...

Extreme Value recommendation Constellation Brands (STZ) – the third-largest beer company in the U.S. – is trading at an all-time high. We wrote more about the company in the January 8 Digest.

Extreme Value subscribers are up nearly 430% on the recommendation since 2011. It's the top-performing open position across all Stansberry Research portfolios. Kudos to editor Dan Ferris and research analyst Mike Barrett on the excellent recommendation.

New 52-week highs (as of 2/4/15): Apple (AAPL), Esperion Therapeutics (ESPR), and Constellation Brands (STZ).

Would you buy governments bonds at negative yields? Maybe not... but institutional money doesn't have that luxury today. Send your e-mails to feedback@stansberryresearch.com.

"Given this era of negative interest on bonds, which is something that I've never experienced and have no knowledge about, perhaps you could explain why someone would invest in a bond at negative interest rather than holding the equivalent in cash?

"In the history of mankind, has there ever been a period of negative interest on bonds, and if so, what happened? Do I understand the following investment suppositions correctly?

Cash neither returns interest nor accrues value and would not be considered an investment.
Bonds accrue interest only, then you get only the money invested back after a period of time (does not appreciate like a stock).

"Why would a person with 10,000 Swiss Francs PAY to put that money in a bond when they just could put it in a safe deposit box for less cost? It would seem that the value would fluctuate equally as either a cash or bond but the cash would offer more flexibility and perhaps an element of safety." – Paid-up subscriber Guy Bull

Goldsmith comment: It's much easier for someone with 10,000 francs to simply stuff it under the mattress or place it in a safety deposit box, as you say.

But the game changes when you're dealing with governments, banks, and giant institutional investors. They need a safe place to store trillions of dollars. There aren't enough mattresses or safe deposit boxes in the world to store that much paper. To these entities, "cash" is the most secure and most liquid asset available... and that's government bonds.

The goal of zero interest rate policy (ZIRP) – or what we could now call "negative interest rate policy" – is to force capital into riskier assets by making "cash" less attractive. And that has worked... That's why stocks have tripled since the financial crisis and real estate prices have soared. But for now, investors are willing to lose a small percentage every year to park capital.

Regarding your two investment suppositions, No. 1 is correct (although there is a great value to having cash). But bonds do appreciate... For the yield on a bond to go down, the price goes up... Remember, the coupon is always fixed. You always see bonds trading at discounts/premiums to "par," or 100 cents on the dollar. If you hold a bond until maturity, you will receive the money you invested and the interest payments.

Regards,

Sean Goldsmith
February 5, 2015