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What Happens in Warsaw…


…Stays in Warsaw? That is a key question for your retirement savings that needs to be answered.

London’s Financial Times reported this week that Poland, facing a debt limit that it can’t surpass, opted to confiscate and cancel the Polish Treasury Bonds owned by private pension funds so that they would have room under their debt caps to borrow additional money to spend.

Here is an excerpt from the FT:

“Premier Donald Tusk said that part of the country’s obligatory pension system run by private funds would be dramatically revamped, with 120bn zlotys ($37billion) in government bonds held by the 14 (private pension) funds being transferred to the government pension scheme and cancelled, which will reduce public debt by about 8 percentage points from its current 55 per cent of gross domestic product.

“Market reaction to the long anticipated move was negative. The Warsaw Stock Exchange, where the private funds, known as OFEs, have a big presence, was down by more than 2 per cent. Yields on 10-year Polish government bonds jumped to 4.75 per cent, the highest in a year.

[The graph above shows the performance of the Polish stock market over the past month as this news was being leaked out. It started tumbling then accelerated with a near 5% drop on the specifics of this news.]

“Poland, which has one of the EU’s lowest birth rates, reformed its pension scheme in 1997, shifting from a classic pay-as-you-go system, where today’s workers pay for the pensions of today’s retirees, to a mixed system with some obligatory social security contributions funnelled into privately run funds.

“However, the new system has a built-in shortfall that the government covered by issuing debt, worsening the country’s public debt ratio, something that has become increasingly controversial because of the economic crisis. Other countries with similar systems have frozen payments to private funds, while Hungary scrapped its scheme.

“The OFE system is a system built in part on increasing public debt and it turned out to be an expensive system,” Tusk told reporters.”

There have long been stories that the economic advisers to many politicians in Washington DC have recommended this specific action for our own country. Those stories, like this one from PBS’s Frontline (Click on the link to go to PBS’s site to read it) contend that the government can handle your retirement savings better than you can – and the side benefit is that it gives them more spending/debt issuing capability. You can argue that point pro-and-con from many perspectives but that is not the point of this blog post.

The point of this blog post is to let you know that we are beyond the point of speculating that government debt has grown too large and is a systemic threat to our economy.

Our own country now has debt to GDP ratio of roughly 107% – that is more than $52,876.12 per person in our country, or $16,740,521,939,998.45 (nearly $17 trillion).
I honestly have no idea how we can, as a nation, ever pay that back. But, as big as that is, it pales in comparison to Japan’s national debt to GDP ratio which is double ours (although the total dollars are much less).

How will we get out of it? Can the Federal Reserve continue to buy > 80% of all treasury debt that is issued just by printing money? (please note that the Fed cannot actually print money – it instead credits the fed accounts of the sellers of the treasury debt with purchase amount and thus increases the size of its balance sheet – the effect, however, is to increase the money supply without printing paper notes)

The answer is obviously “No” simply because you now have the Federal Reserve Governors all in a dither about when to start “tapering” or in other words, when to slow down their treasury purchases. The latest news in these discussions is that the Fed will cut back on Treasury Bond purchases but continue to buy mortgage securities in an effort to keep home mortgage rates as low as possible for consumers.

So, let’s play the game of “If, Dog, Rabbit” and ask rhetorically, who will buy our debt to fund our deficits if the Federal Reserve cuts back?” Historically, China, Japan, the Middle East and Europe have been the big buyers of our debt – China and Japan because they were recycling our dollars our from purchases of their manufactured goods into treasury bonds, the Middle East because they were recycling oil purchase dollars into treasury bonds, and Europe because of standard bilateral trade activity between the governments.

But where are we now? China and Japan have been liquidating their treasury portfolios, we are now nearly energy independent so fewer dollars are flowing to the Middle East making less available for treasury purchases, and Europe is concentrating on buying its own debt (much like the Fed) to keep its own economy afloat.

You can see how radical economists can propose (and conspiracy theorists believe) that the vast dollars available in IRA’s, 401k’s, and private pension funds could be used as the next logical buyer of treasuries – if it were just legislated into being.

Will this happen? Obviously it happened in Poland, so anything can happen here. But I can’t see something like this ever being approved by the House of Representatives. Can you imagine these Congressmen meeting with their constituents and having to explain to them that their 401k was confiscated (or “Overhauled” as the Poles are calling it) so that the government didn’t have to face making tough decisions on fixing our fiscal mess? Not likely to happen by Congressmen from either party in my estimation.

This does, however, add an extra dynamic to the upcoming debt ceiling discussion that we will hear much more about in coming weeks.

What happens in Warsaw stays in Warsaw? My best guess is yes, this won’t happen here, but just in case I thought you should hear about it since it is not being covered by our news in the US but is clearly on the minds of our friends in Europe with similar fiscal issues to our own (and on the minds of radical economists and conspiracy theorists – but you can’t take either seriously).

This brings me to Gold – I get a lot of emails from readers of the blog asking me to talk about Gold. On July 3rd, after the big sell-off in Gold, I added a position to client portfolios in the exchange traded fund GDX which is the gold miners index fund. Since that time, it has performed really well compared to the market itself:


The chart above shows that the miners index is up over 20% since that time. Gold itself is also up, but not as much as the miners. So, why did I choose the miners? Great question – the miners are a higher beta play on gold so since I was expecting gold to bounce higher after the sell-off I wanted as much bang for the buck as possible, so I chose the miners index instead of GLD which is the ETF that holds (the promise of) physical gold. GLD has been up 11% during this same time period – not bad at all compared to other investments the past two months.

Gold is considered a safe have or insurance policy for tough times – so I assume that a few readers of the blog will want to know what will happen to gold if this Poland story starts to get some legs here in the US. Gold might go up – or it might go down. Sorry, gold is a “fear” trade – either the fear of the future or probably more importantly the fear of inflation. Right now, there is no evidence that inflation is brewing so any Poland induced fear trade will likely be short-lived. However, at some point, with all of the money that is being created, inflation is a very possible scenario.

What is inflation? Too many dollars chasing too few goods. We are on the path to too many dollars, but that line for too few goods keeps being pushed further into the future. So, owning gold at this point is (1) a tactical trade – sort of like my purchase of the miners, they were undervalued and we will likely sell that off when I see either they are more fully valued or gold reverts to a downward price trend again; or (2) it is an insurance policy against an uncertain future – and given all of the issues in our world there is certainly some uncertainty.

I get kidded by a friend of mine because I buy – as part of my person investment plan – gold coins each month and put them in my safe deposit box – I call it the Krugerrand of the Month Club, but it really just a systematic purchase that I make monthly through a coin dealer. My friend doesn’t understand why anyone would invest in physical gold – it pays no dividend like a blue chip stock and there is no way to independently determine its intrinsic value since there are no cash flows which you can discount nor real estate that can be built upon or farmed to generate those cash flows.

My answer is simple – diversification. If the stock and bond markets goes down in a big way like we saw in 2008 due to some systemic crisis, those coins in my safe deposit box are still going to be there. They will never amount to a huge dollar investment on my part – that wouldn’t make sense because of the cash flow reasons stated above – but they are just an alternate asset that isn’t specifically tied to the stock nor bond market.

As friends will do, he always ends the discussion by telling me that I don’t need to plan for a zombie apocalypse – he chides me that the TV show The Walking Dead isn’t real, but dividends are. I end it by reminding him that when the zombie apocalypse happens, I’ll still be able to buy guns and clean water whereas those cash flows from his stock and bond investments that cease to exist will be worth nothing. Then we have a scotch.

Friends – what can you do…

[Full Disclosure – I don’t believe in the zombie apocalypse, just in case some of you were worried. I do however, enjoy The Walking Dead]

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If you aren’t a fan of the Walking Dead, the new season starts soon. You can visit AMC\'s Official Site by clicking on the link and catching up on past seasons.

Have a great weekend!