The World's "Cleanest Dirty Shirt in the Laundry Basket"

Written by Gerardo Del Real
Posted June 5, 2017 at 3:14PM

Long-Term Capital Management (LTCM) was a hedge fund with nearly $130 billion in assets. In 1998 it nearly collapsed and would have, had it not been bailed out by the Federal Reserve.

The founder of LTCM was a Salomon Brothers trader, John Meriwether. The principal shareholders were Nobel Prize-winning economists Myron Scholes and Robert Merton.

LTCM’s strategy was relatively straightforward. It hedged against “predictable” volatility in foreign currencies and bonds. 

It didn’t predict that Russia would devalue its currency and that it would default on its bonds as a result. The U.S. stock market dropped 20%, while European markets fell 35%.

Federal Reserve Bank of New York President William McDonough convinced 15 banks to bail out LTCM. They spent $3.5 billion in return for a 90% ownership of the fund.

The rationale? That LTCM was too big to fail and that not intervening would set off a global contagion.

Fast forward to 2017 and we appear to be in a similar predicament as emerging markets are taking on more dollar-denominated debt at an unsustainable pace.

At the start of 2016 debt in U.S. dollars in emerging markets stood at approximately 50% of the U.S. national debt.

One year later offerings of new dollar debt are close to $160 billion, which is twice the U.S. dollar value of last May.

Dollar bears and the Harry Dents of the world who believe the next crash is right around the corner are rushing into corporate bonds from places like Brazil, Argentina — that bastion of financial security — and Indonesia.

The high returns compared to returns in the U.S. or Japan and short maturities make the speculation attractive to fund managers. After all, this time is different and they’re confident that this time they will be able to predict the volatility. 

Martin Armstrong, who does an incredible job of tracking global capital inflows and outflows, puts it this way: 

"The bond debt from developing countries is growing exponentially with total commitments reaching around $425 billion+. This crop of bonds have an average maturity of 6.3 years as compared to 10 year maturities for investment grade rated as risk-free.

"This is adding to the crisis we see on the horizon and a dollar rally will set off a debt crisis like nobody has ever seen in more than 100 years. Private debt among emerging markets is almost about $1.6 trillion with maturity due to foreign creditors over the next five years. It looks like about 90% of this debt is in US dollars."

Why should you care what Martin Armstrong thinks? Because — among other notable predictions — he’s the person who predicted the collapse in Russia which led to the bailout of LTCM.

I’ve used the phrase that the U.S. is the cleanest dirty shirt in the laundry basket, meaning that although our economy is far from a real recovery our currency will be where big money parks itself when Europe and Japan blow up. 

Central Banks have distorted the risk by manipulating yields to the point where the risk of default is not reflected in the yield, which is why capital is taking on the risk of emerging market debt. 

Higher rates will lead to sovereign defaults, which will lead to a dollar rally and a continued rally in the major U.S. stock indices. Real assets such as art and collectables will continue to benefit, and the rally in the precious metals will be one for the history books. 

We’re in the set-up stage but the way forward is clear.

To your wealth,

gerardo-sig

Gerardo Del Real
Editor, Junior Mining Monthly and Junior Mining Trader.

For the past decade, Gerardo Del Real has worked behind-the-scenes providing research, due diligence and advice to large institutional players, fund managers, newsletter writers and some of the most active high net worth investors in the resource space. Now, he is bringing his extensive experience to the public through Outsider Club, Junior Mining Monthly, and Junior Mining Trader. For more about Gerardo, check out his editor page.

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