Selling Concepts

Sometimes I feel I've got to run away
I've got to get away
From the pain you drive into the heart of me
--Soft Cell

Nice piece by John Mauldin on the sketchy nature of last week's EU summit plan w.r.t. Greece. Long on hope, short on substance.

Two particularly salient points:

Guaranteeing 20% of a government bond is pointless. When sovereign debt goes south, it is usually for a whole lot more than 20%. Greece is starting at 50%.

Changing the CDS rules. Part of last week's accord was that Greek bondholders would agree to a 50% writedown. Because this was agreed to by the creditors, the contention is that this was not a formal default, thus it would not flip the 'credit event' switch on credit default swaps.

Those big banks who were short gobs of Greek sovereign CDS's thus got a big bailout.

Those long Greek sovereign CDSs basically learned that the rules governing CDS's could be changed midstream. If these folks were seeking to hedge Greek debt exposure or bet on a Greek default they have to a) find another vehicle, or b) no participate in this market.

As such, should it be at all surprising that we saw sovereign debt of other EU countries weaken over the past few days?

position in SPX

Bagging Some Ags

"The Almanac says it's time to start plantin.'"
--Myra Fleener (Hoosiers)

Have been adding to my agricultural commodity position (RJA) over the past few days. From a technical standpoint, looks like a multi-month reverse head-and-shoulders to me w/ a gap directly above (gaps tend to be magnets for price).

From a fundamental/macro standpoint, we've waxed about the bullish set-up in commodities before (dollar heading to dust, capacity not keeping up w/ demand, gov't policies that favor famine).

As such, I'm digging this for the long side of my hedge book.

position in RJA

Heil Lincoln

"This is your last chance. After this there is no turning back. You take the blue pill; the story ends. You wake up in your bed and believe whatever you want to believe. You take the red pill; you stay in Wonderland and I show you how deep the rabbit hole goes."
--Morpheus (The Matrix)

dictator - a person exercising absolute power, especially a ruler who has absolute, unrestricted control in a government without hereditary succession

I doubt that there is a history book in the school system that labels Abraham Lincoln as a dictator. Yet, it is difficult to look at the evidence and not conclude that Lincoln's actions place him among the world's most infamous dictators.

Historians, law professors, and other intellectuals have sometimes concluded that Lincoln's actions were indeed consistent with dictatorship but, astonishingly, applaud Lincoln's dictatorial behavior as justified (e.g., Fletcher, 2001; Rhodes, 1900; Rossiter, 1948).

A government that operates within the confines of the Constitution cannot foster dictatorship. Lincoln, of course, strayed far from Consitutional boundaries. Courtesty of DiLorenzo (2002), let's list a few of Lincoln's Constitutional excursions:

• launching an invasion of the South without consulting Congress
• declaring martial law
• blockading Southern ports
• suspending the writ of habeas corpus for the duration of his administration
• imprisoning without trial thousands of Northern citizens
• arresting and imprisoning newspaper publishers who were critical of Lincoln's actions
• censoring telegraph communication
• nationalizing the railroads
• ordering Federal troops to interfere with elections in Northern states by intimidating Democratic voters
• deporting a member of Congress who critized Lincoln's income tax proposal as unconstitutional
• confiscating private property without due process
• confiscating firearms

Central to most of these actions was Lincoln's refusal to permit people to throw off a government that those people believed was despotic. By not recognizing that right of secession, Lincoln presided over the death of at least half a million citizens of the United States. He altered the balance of power between the federal government and the states, with the central government assuming an authoritarian role.

Yet, there are those that praise Lincoln as a 'benevolent dictator' (e.g., Randall, 1926).

The mainstream treatment of Lincoln's character over the years certainly has a Matrix-like feel. Seems more people need to take the red pill...

References

DiLorenzo, T.J. 2002. The real Lincoln. New York: Three Rivers Press.

Fletcher, G.P. 2001. Our secret constitution: How Lincoln remade America. New York: Oxford University Press.

Randall, J.G. 1926. Constitutional problems under Lincoln. Urbana, IL: University of Illinois Press.

Rhodes, J.F. 1900. History of the United States from the compromise of 1850 to the final restoration of home rule at the South in 1877. New York: Macmillan.

Rossiter, C. 1948. Constitutional dictatorship. New York: Harcourt Brace.

Did Germany Capitulate?

It ain't no use, we're headed for disaster
Our minds say 'no!' but our hearts are talking faster
--Donnie Iris

Many view yesterday's EU agreement as a capitulation by Germany. Essentially, risk was re-syndicated from the balance sheets of banks lugging euro sovereign debt onto the backs of German taxpayers.

Germany has essentially signalled the loss of its individual sovereignty in for of the EU collective.

Peter Atwater cautions against this conclusion. Yesterday's events bring into ever greater focus Germany's continued willingness and capacity to support the rest of Europe.

Many view yesterday's events as Germany's willingness to write giant blank checks to the rest of the EU. Atwater disagrees, and suggests instead that Germany will likely make future funds contingent on specific and prehaps tortuous preconditions.

If Peter is correct, then markets are nowhere close to figuring this out.

position in SPX

Fail and Bail

So forget all that you see
It's not reality
It's just a fantasy
--Aldo Nova

Equity markets screamed higher worldwide on news that EU nations and banks struck an agreement on a Greek debt writedown and containment fund bolstering. Still largely concept only but that's obviously not today's business for the markets.

Banks were really on fire, with many putting on 10% or more today. One reason: the language of the accord makes the 50% haircuts to be taken by some bondholder 'voluntary.' As such, this is not viewed as an outright 'credit event' (a.k.a. default), so banks who are short Greek credit default swaps cannot be tapped.

Nothing like a little wordsmithing to line banker pockets...

The current agreement solves nothing and is consistent w/ the approach that bureaucrats continue to elect. Paper over a problem with more money printing, debt, and leverage. Tears is where this will end, but again that's not today's issue.

On the domestic front, President Obama announced a bailout of his own. Those burdened w/ college loans will be able to limit their debt payments to 10% of income, with the balance of loans to be forgiven after 20 yrs.

This, of course, is nothing more than pure vote buying on the president's part. He is also once again sidestepping Congress and the inconvenience of the Constitution to issue an 'executive order' to enact this policy.

Does a bailout a day keep reality away?

position in SPX

Fire Sale

Don't you know we're playing with fire?
But we can't stop this burning desire
--Donnie Iris

Sold most of my Cisco (CSCO) position. Did some yesterday and then lion's share this am into the EU bailout euphoria. Will keep a small 'core' position bought at much lower levels. I do think that the stock reflects decent value here but I also think chances of buying it much cheaper in the next few months are good given the macro set-up.

After the sale, my overall risk position is pretty much hedged. My remaining position in CSCO coupled with some commodity exposure (GLD, SLV, RJA) is offset nearly one for one by an index equity short (SH).

If prices continue to rip higher from here, then I might sell of bit of commodity exposure or add a bit to my index short. If prices reverse lower from here, then I might add some more precious metal exposure or shed some of my short position.

Meanwhile I wanna sit back and observe for a while.

position in CSCO, GLD, SLV, RJA, SH

Tax Fraud

Don't ask me what I want it for (ah-ah, Mr Wilson)
If you don't won't to pay some more (ah-ah, Mr Heath)
--The Beatles

Doubt he took a cue from yesterday's missive, but Judge N lends additional historical context on the Sixteenth amendment during his monologue last night.

Prior to the Sixteenth Amendment, the federal government did not directly confiscate individual property (with the exception of Lincoln, who enacted an income tax to help pay for his war). As the judge notes, confiscationo of property without a jury trial was not permitted by the Constitution, specifically by the Fifth Amendment.

The judge provides some historical color around the Sixteenth Amendment ratification, which confirms some of the tidbits we extracted from the newspaper article sample. According to the judge, the Wilson administration was promising that the income tax would apply only to those earning $10,000/yr (the article said $5K) and that the rate of taxation would never exceed 3% (the article said 1%).

What this suggests is that politicians were telling US citizens that the income tax law would minimally impact them, if at all. Indeed, judge, Americans were sold a fraudulent bill of goods.

When the Eighteenth Amendment was enacted, few thought it possible that the constitutional amendment process could ever be reversed to repeal it. But it happened.

Hard not to imagine a repeal of the Sixteenth Amendment, and what it would take to get it done.

Headline 1913

"And so it begins."
--Charles Grimes (High Crimes)

While chewing thru the Ken Burns miniseries Prohibition, I was browsing the photo gallery on the PBS site and found an old newpaper excerpt of interest (click the Atlanta Constitution image here). It is a clipping from the 4 Feb 1913 Atlanta Constitution discussing the Sixteenth Amendment, which had recently been ratified by the requisite 3/4 of the states.

As previously noted, Ken Burns makes the case that the passage of the Sixteenth Amendment (income tax law) was necessary in order to make way for what became the Eighteenth Amendment (prohibition law) six years later.

I found several passages from the article informative/amusing. Here are a few:

"...it is believed [that the income tax law] will exempt all incomes below $4,000 or $5,000, and will provide a tax of 1 percent upon the majority of personal incomes that do not run to an excessive figure."

A dollar in 1913 is worth about 3 cents today, meaning that $5,000 earned in 1913 equals an annual income of about $170,000 today. This passage helps explain how the income tax bill was able to pass a supermajority of states. Simply, people did not believe that they would be subject to the take. Only 'the rich' would be soaked (vuja de).

"One feature, which it is believed will be included in the law, will be provision for 'collecting at the source' of income. This feature, now in operation in England, would require firms to certify the amounts they pay in salaries or fees or pay the tax direct to the government. It is believed that this would remove much complaint that might be made if the government had to investigate every citizen's income and would prevent evasion of the law."

We now know that any promotion of the Sixteenth Amendment under the banner that it would not require government intrusiveness into individual matters of income was a complete farce.

"One of the important results of the income tax," said Representative Hull [that would be Cordell Hull, Democrat TN and future FDR crony], "will be the curbing of unnecessary federal expenditures. When a great part of the government's income is derived by a direct tax upon the citizens of the nation, they will scrutinize more carefully the appropriations made by congress."

If people truly believed that rationale, then perhaps we deserved what we subsequently got.

Hull continued, "Thus the law will enable congress to equalize tax burdens, requiring every citizen to contribute to the government in proportion to his ability to pay...This is the fairest of all taxes, and the cheapest and easiest of collection. Those who shirk their taxes say it is inquisitorial, but no one can deny that a modernized income tax is less inquisitorial than any of our existing taxes, federal, state, or local. No tax is desirable, but it is always best for the people to know something as to the amount of taxes that they pay. They then keep a close eye on the expenditure of moneys."

Do you suppose that Jefferson, Madison, et al knew that their founding framework was finished then and there?

Overdrive vs Overhead

Headin' into twilight
Spreading out her wings tonight
She got you jumpin' off the deck
And shovin' into overdrive
--Kenny Loggins

Markets continue to gear higher. The SPX is now up 17% from the early Oct lows. Can it continue? Sure, markets can do anything they want, cookie.

The technicals suggest some stiff resistance dead ahead in the 1260ish area. Many of the stochastic oscillators are starting to 'pretzel' in overbought zones on a daily basis.

I for one have resumed hedging mode, adding some index shorts (SH) against my equity (CSCO) longs. I have trimmed a bit of CSCO but hope to do much more into any further strength.

Have also been adding some GLD and ultimately would like that to represent the lion's share of my long side exposure here.

Right now I'm 7-8% net long. I hope to be 'delta neutral' in the near future. Long some CSCO and GLD paired against an index short.

position in CSCO, GLD, SH

Student Loan Mountain

There's a place where the light won't find you
Holding hands while the walls come tumbling down
When they do
I'll be right behind you
--Tears for Fears

Follow on to recent post on higher ed bubble. Student loan debt amounts to just under $1 trillion, and exceeds credit card debt category. This is a deflationary set up.