Agora Financial’s Rude Awakening

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Laguna Beach, California

To liquidate or not to liquidate? That is today’s question,

Cash and kings - their slow, painful abdication of power,

Talking “Melancholy in Melbourne” down from the financial ledge and more…

Eric Fry, reporting from Laguna Beach, California…

Cash is king…or at least it used to be.

In the modern world, cash is merely President…or Prime Minister…or sometimes just Mayor. The present-day versions of cash derive their value from popular opinion…and not much else. Woe, therefore, to the currency that displeases the masses.

Cash, like kings, used to possess a kind of absolute power. That’s because cash, like kings, used to reinforce their authority with significant piles of gold. He who had the gold, made the rules. The phrase was as true for currencies as for monarchs.

But in today’s world, absolute monarchs are as rare as currencies that convert into anything other than paper and ink. Kings and queens no longer call the shots in the largest economies of the West or the East. Instead, democracies and other forms of collective authority hold sway. The monetary world has evolved along similar lines. Absolutes are out; mark-to-market public opinion is in.

Whether the modern world is an improvement upon the ancient one, we have no idea. The Spanish Flu and polio no longer plague the world. That’s a plus. But hip-hop music and reality TV do. That’s a minus. So we are inclined to accept the good with the bad and to call it a draw. But the money in our pockets is a more serious concern.

To be honest, we’re not sure if our cash is as safe as it used to be…or if it is even safe at all. We’re not even sure what cash is.

At the most basic level, almost all cash is an IOU from an indebted government. Whether that cash be dollars or euros or yen, the issuing entities owe lots and lots of money to lots and lots of people. Furthermore, these IOUs possess no intrinsic value whatsoever. They are not backed by gold or silver or oil. They are not even backed by bananas or vintage baseball cards. They are backed by absolutely nothing.

Even more troublesome is the fact that the cash that we call “cash” is not really cash at all. It is a Petri dish of short-term corporate debt obligations, mingled with a hodgepodge of obligations from debtors all over the world.

In other words, most of what we ordinary folks call “cash” is the stuff that sits in money-market accounts. And most of the stuff that sits in money markets accounts sits in commercial paper or in quirky financial instruments of one kind or another.

Take a peek inside any major money market fund and you will find massive holdings of mortgage-backed securities (MBS), as well as commercial paper from dubious issuers like Countrywide Financial and Bear Stearns. This is a very strange kind of cash indeed.

But even if cash is no longer the king it used to be, it is at least President. And the U.S. dollar, as the Supreme President of the global monetary system, is “the Decider.” The dollar still decides the value of every asset in America and every major commodity in the entire world.

So that’s why our colleague, Dan Denning, wants more of them. As flawed as America’s brand of cash might be, our greenbacks are still very handy things to have around. It’s much better to own dollars, for example, than a stock that is falling or a home that is depreciating. Dan, who produces the Australian version of the Daily Reckoning, is very uneasy about stock markets around the globe - so uneasy that he is sounding the alarm to “go to cash!” But before advising that his readers to heed this alarm, Dan dispatched an email to his colleagues, soliciting their responses to the idea of going to cash.

“I’m considering going to cash,” Dan admitted, “what do you think?”

Dan’s colleagues responded immediately with empathy, advice and counter-arguments. Over the course of several days, Dan and his colleagues examined the merits and drawbacks of “going to cash.”

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Agora Financial…”Unplugged”
Edited by Eric J. Fry

Dan Denning: I know it’s crazy. But I’ve written a draft for my next newsletter advising readers to liquidate all their positions and get into cash. If you think that’s crazy or just stupid, you needn’t bother reading on. Otherwise…read on.

I wanted to see if a letter telling people to sell everything now sounded panicky…or reasonable…or not really sensible/defensible once you go through all the risks, costs, and objections to doing so. It could also be epic stupidity.

But I’m still not sure. So I went to my white board and made a list of reasons for and against advising readers to liquidate their stock holdings and get into cash. Can you see something I missed? What do you think? Are there exceptions?

Reasons Against Liquidation:

1) Precedent. Though stocks can move sideways for years, they’ve generally gone up over time.
2) Emotion. It’s decision influenced by a rising sense of fear, not a calm assessment of probabilities and risks.
3) Transaction costs. Between taxes, transaction costs, and opportunity costs, it has the potential to be painfully bad advice.
4) Insufficient evidence. We have no evidence that even a major disruption in the credit markets will wipe out stocks, leading to forced selling and lower stock prices.
5) The government response (fiscal AND monetary) hasn’t really been cranked up yet. It may or may not work. But governments will try and do more when they think they have to.

Reasons For Liquidation:

1) Evidence of illiquid markets. The August tumult caught out the most poorly prepared leveraged borrowers. But it precipitated something larger. It would be stupid to ignore the sign.
2) Commercial paper market is dry. If companies can’t borrow using securitized assets as collateral, they too will be forced to liquidate assets to raise cash or drastically cut costs (fire people).
3) De-leveraging. This is taking place with quiet desperation in attempt to do it in an orderly fashion. To sell withouth causing a sell-off.
4) Hedge fund redemptions. Funds have to raise cash by selling assets. More sellers, fewer buyers.
5) Hedge fund redemptions refused: funds refusing consumer’s their money citing inability to value assets…for which there is no market…and thus no price (effectively zero).
6) Central bank interventions: the CB’s are already knee-deep in the problem, showing that it’s further along than just a theory. Bad moves, wrong moves, any moves that lessen market confidence in the bankers or the Banks can trigger more selling.
7) Nothing is worth buying or even owning, given the level of risk and volatility. Stocks aren’t going to rally 30% from here. So you could buy back in in December at around the same price.

Have I worried myself into a frenzy? Are our readers as scared into indecision as I am? Well, truthfully, I’m TOTALLY in cash anyway, with no debts. So I’m not much worried about at night. But it is the first time in my ten-year career I’ve been this worried.

During every other mini-crisis I felt like there was something worth buying, some other asset class negatively correlated to the “bad thing” I thought was coming. But if the credit bubble well and truly deflates (in the kind of way the Hindenburg deflated), the best place to be is with your feet firmly planted on the ground and cash in your pocket (not in the bank, or in a money market fund, or Treasuries, which should get shellacked now that Bush has proposed the nationalization of the sub-prime market.)

Here’s the essential question I am asking: “If there is one thing you could do with your money right now to make it safer, what is it?” My best answer is to take $1,000 cash out of the ATM and stash it in my cigar box.

Anyway, I’m going to have a think on it this weekend. If you’re thinking the same thing, or have any thoughts that might talk me down from the financial ledge, please share them.

Signed,
Melancholy in Melbourne

Chris Mayer, Editor of Capital & Crisis: Dan, I don’t know, I’m a long-term investor…so I have a hard time relating to this kind of all-cash option. Besides, you gotta have some favorites that you think - say in a few years time - will be worth a lot more than today.

The other thing is, say you do it and by December nothing happens…maybe the market even rises a bit…then what do you?

Liquidiating is like betting everything on the turn of a roulette wheel…Why do that?

Addison Wiggin, Co-editor of the Daily Reckoning:

I think it was BIll who pointed out at the Agora Wealth Symposium in Vancouver, that being in cash is a position. And not necessarily a good one if you’re holding dollars.

John Forde, Macro Thinker Without Portfolio:

Dan, I think the boldness of the move is interesting, as is the scope of it.

But in the end, I agree with Chris…Is there nothing to own out there?

Even the most bearish members of our group are generally talking about a long, slow decline…So, yeah, maybe getting out of all U.S. stocks is a good idea. But there’s lots out there, once you look elsewhere.

A lot of it is probably in your backyard, Dan. Right there in Australia.

Byron King, Editor of Outstanding Investments:

Dan, you said… “Nothing is worth buying or even owning, given the level of risk and volatility.”

OK, yes there are huge risks out there in this world….

But the world has already burned up its $40 oil, its $50 oil and maybe its $60 oil. Would you buy a tanker load of crude, bill-of-lading to Shanghai, at $70? Will it only be worth $65 when the ship ties up at the pier? Or will it be worth $75 by December, or $85 after a hurricane or two?

Or…If the US stock market just flushes into the overburdened sewers of New York, and the economy craters, and companies are laying off people left & right…will people still drive cars? Smoke cigarettes? Drink booze? Will the US government still pay Medicare payments for sick people, and keep the hospitals in business? You know what I mean.

Liquidating to cash is a way of saying that your ideas that you thought were great just a few months ago, are now not so great.

There have been moments when I wondered about just selling out, and buying gold.

Then…I would think of Core Labs…up 325%.

Dan Amoss, Editor of Strategic Investment:

I agree that the odds favor another leg down in this slow-motion stock market panic.

Bernanke is clearly trying to maintain his public image as an “inflation fighter,” so the chorus of money managers whining and pleading for drastic rate cuts — the Keynesian-trained institutional types who move the really big pools of money — are likely to be disappointed.

My advice:

Rather than go to 100% cash, tell your readers to sell however much is necessary to help them sleep at night. Perhaps sell 25%-50% of their stock positions, put 25% in cash, and put 25% into inverse [i.e. bearish] sector ETFs like SKF (banks), SMN (basic materials), SSG (semiconductors), or SCC (retailers). And always hold a position in gold.

The forward earnings estimates for banks in particular are way too optimistic, so they are definitely not “cheap.” Loan-loss allowances are near generational lows and must be rebuilt in the coming years to reflect the worsening default environment. So that’s why I like SKF. It is a bet that bank stocks will fall, but not necessarily that the overall market will fall.

I’ve been telling my Strategic Investment readers to expect continued volatility in the coming months, but to not lose focus on long-term opportunities in energy, mining and gold.

Joel’s Note: You don’t have to be a guru of gold, a mayor of money or a president of paper to have your say around here. If you’ve been reading today’s discussion and thinking, “Dan, don’t do it! I know what’s better than cash!” then perhaps you would like to share your thoughts with the Rude populace.

Send all “better than cash” emails to your almost-out-of-cash editor here at:
aussiejoel@the-rude-awakening.com .

We’ll publish your best thoughts and theories in upcoming editions of your Rude Awakening.

Cheers,
Joel Bowman
Rude Awakening