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The Bottom Line #3

The Bottom Line #3

“It is generally agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of Stock Exchanges.” –John Maynard Keynes

“The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies. … Increasing America’s debt weakens us domestically and internationally. Leadership means that “the buck stops here.” Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better.” – Senator Barack Obama back in 2006.

“No risk of that.” – Tim Geithner (more on this below)


AAA?  More like Peewee.

Late Friday -in case you spent your weekend under a rock, or getting married in a French Chateau, or anything else more interesting than listening to CNBC- Standard and Poors, a division of publicly-traded McGraw Hill, decided in their infinite wisdom to downgrade the credit rating of the USA to AA+ from AAA, and kept the USA on creditwatch for potential further downgrade.  On the news, Treasuries rallied, which pretty much tells you all you need to know about S&P’s credibility, they of the AAA-rated subprime mortgage tranche…. 

Really, S&P’s move was not much more than a make-work program for financial commentators, and for that, thank you, S&P!  It’s not like anyone is really concerned about the possibility that the US will stop paying its debt; really, if you could pay your credit card bills with toilet paper (although toilet paper IS a necessity, so perhaps I should choose confetti), why would you stop paying?  The real question is whether the US will continue to pay its obligations with currency that retains its value, and that’s a very real concern.  What S&P appears to be saying is not that the USA will stop paying its obligations, but that bondholders should be concerned about the value of the currency they get paid in, and on that front, you’ll hear no arguments from this quarter.  If you believe, like us, that precious metals are a good indicator of the confidence or lack thereof in central bank policy, then the fact that gold has rallied roughly $60 to a little over $1,700 for the first time on this news has got to be seen as a bigger slap in the face than S&P’s downgrade!

Besides, this downgrade wasn’t just telegraphed, it was shouted as a distinct possibility from the hilltops.  Who can really say they were surprised?  Oh, yes, Tim can.  You remember Tim?  He’s got a bunch of degrees, used to run the NY Fed, and now they call him Treasury Secretary.  On April 11th of this year, in response to a question from Fox News about the risk of the US suffering a downgrade, he had this to say: “No risk of that”.  The interviewer didn’t seem sure about the answer and followed up with: “no risk?”.  Mr. Geithner’s response, likely to be quoted almost as often as some of the best Dan Quaylisms of the 90s: “No risk.”  Well, there you have it folks.

Let’s ignore the headlines and get back to the underlying issues: too much debt and spending above your means.  It really is as simple as that.  There are a few ways that you can fix this problem: 1) you can spend less; 2) you can increase income; 3) you can do some mixture of both; 4) you can print more money, or; 5) you can “kick the can down the road”, meaning you can borrow even more money from foreign countries and your own grandchildren.  Financially, the first three make by far the most sense.  Politically, though, 4 and 5 seem to be the choice du jour.

So what does this really mean for the US?  And is this drop in the markets a buying opportunity?  Is this a bear market for US equities?  Having gone through the Mexican Peso crisis, the Russian default, the LTCM bailout, the tech bubble bursting, and the 2008-2009 crisis, we’d say that there are far too many people still calling this a great buying opportunity for this to be a real market bottom.  We’d also point out that insider selling has been running at around 10 times the pace of insider purchases.  Finally, we see danger in a vicious circle of higher borrowing costs creating still-greater weakness in an already painfully weak housing market, causing greater weakness to the US consumer, creating less demand for companies goods etc. etc.

We do think that this WILL herald a bear market in the US dollar, at least compared to our own currency, a currency that deserves to be seen in a better light than the Greenback.  As Canadians, we have no absolute requirement to own US dollars, so why own them?  We also see bull markets ahead: a bull market in precious metals; a bull market in poor central bank policy, and our favourite, a bull market in professional financial advice!

Overseas in Europe, Trichet and co. seem intent on making the same mistakes their US counterparts have already made.  Frankly, this is probably more serious news than the US credit downgrade, so deserves a bit of discussion.  Let’s start with a reminder.  The European Central Bank has, unlike its US counterpart, only one objective: containing inflation.  Yet the events of the past few days make it appear that the ECB has decided to ignore its own policy in favour of attempting to avoid “contagion”.  Specifically, the ECB has agreed to make direct market purchases of Spanish and Italian bonds, and they are making every effort to signal to the markets that they’ve got enough bullets in the gun to take on the evil speculators.  Make no mistake: until all of the AAA-rated members of the Euro-Zone officially sign off on this deal, there is no deal!  Do German and French citizens really feel comfortable expanding the credit facility from several hundred billion Euros to well over a trillion Euros?  The buyer of last resort, the US Federal Reserve, is less likely today to bail out Europe than they were last week before the downgrade, and that probably has a few people in Brussels worried….

For a glimpse ahead, just keep your eyes out for further downgrades of lower levels of government and agency debt in the US, as well as other sovereign nations, and look out for the fallout to bank balance sheets stemming from these downgrades.

Ultimately, the markets are responding less to a single downgrade than they are voting with their feet on the entire political process the world has been engaged in, turning private mistakes into sovereign debt, saving institutions while hurting pensioners.  The markets don’t like what they see.  And that’s the bottom line.

Those who know and deal with us know that we’ve been more surprised by the rallies we’ve seen in the markets over the last few months than by the recent weakness, and that we are well-prepared for the downturn we’re currently experiencing, and know how to take advantage of it.  One nice thing about writing a piece is that you can always refer back to what you said before.   We invite you to do so.  And, as always, we invite your comments.


Paul Azeff and Kory Bobrow are Investment Advisors and Senior Market Strategists in the Montreal office of Euro Pacific Canada and can be reached at 514 940-5093 or via email at or
This publication is for informational purposes only. The statements and statistics contained herein are based on material believed to be reliable, but are not guaranteed to be accurate or complete. It is not an offer or solicitation with respect to the purchase and sale of any security, investment fund, or other product and does not provide individual financial, legal, tax or investment advice. Please consult your own legal, tax and investment advisor. Euro Pacific Canada is not liable for any errors or omissions in the information or for any loss or damage suffered in connection with its use.



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