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Crunch Time


In the ultimate game of chicken, US bets foreign creditors won't allow its economy to collapse.


For all the ugliness we saw in 2008, 2009 will be a lot more difficult to navigate. Believe it or not, much of the 2008 script had been written in 2005 and 2006.

The fate of the great unwinding of 2008 was sealed back then, with only the timing left to be determined. For traders who saw it coming, the only question was whether they had the staying power to wait out its unfolding. Now the picture is far less clear and certainly has far fewer precedents.

From 30,000 feet, everything the Treasury and the Federal Reserve have done over the last several months has been far less sophisticated than they perhaps want to be given credit for:

1. The government is absorbing as much private domestic debt as it can get its hands on.

2. To sustain its ability to absorb the debt, the government is effectively destroying large swaths of it by debasing the currency with which it will presumably repay it.

3. If points 1 and 2 were not enough for our foreign creditors to swallow, the US government has the hubris to expect that they will continue to finance our sacrosanct standard of living with fresh credit at laughably low rates.

It's the ultimate game of chicken, where we bet that foreigners won't have the courage to step back and let the US economy collapse. To complicate matters, how the parties will navigate this game will be driven not only by economics and finance, but by diplomacy and foreign affairs.

Some gut-feel 2009 calls in no particular order:

  • If the Fed continues to manipulate 10- and 30-year Treasury rates down at these levels, the US will experience a failed auction of its debt, which will effectively shift control of our long-term rates over to our creditors.

  • S&P 500 GAAP (generally accepted accounting principles) earnings will come in closer to $40 than $60.

  • Unless oil prices recover to at least $70, by the end of the year Dubai and Abu Dhabi will become household names as the next epicenters of the global financial meltdown.

  • Several major publicly traded homebuilders will file for bankruptcy and be sold or liquidated for pennies on their outstanding debt. Housing statistics will bottom and over several quarters thereafter the public will forswear real estate as an asset class. With prices in many metro areas eventually falling between 50% and 70% from their peaks, a base for the next bull market in real estate will start forming.

  • As suggested by Professor Krueger, supply shortfalls will lead to inflation making a comeback much sooner than consensus believes.

  • The price of gold will begin its march toward $2,000.

  • Corporate bonds will start attracting capital at the expense of equities - and the notion that "because corporate bonds are improving, stocks will follow" will prove a major disappointment for investors.

  • Commercial real estate will be slammed.

  • China will be written off as the next great engine of world growth. Millions of Chinese will migrate back to the countryside to reconnect with the safety nets of family and local communities.

  • The global economic crisis will set in motion the demise of the euro and governments will struggle to quench populist calls for protectionism.

  • In the midst of what will feel like economic and financial chaos, US equities will bottom at price levels that will offer a generational opportunity for investment.

And so it's said: Nothing would make me happier to be proven wrong on all counts.

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