Sell ‘em All! Central Banks And The Socialist Calculation Problem

John Dizard Has the Right Idea

John Dizard is one of the few FT columnists we actually like to read (much of the paper’s editorial line consists of boring, if in our opinion dangerous, Keynesian shibboleths). Anyway, Mr. Dizard’s most recent column doesn’t disappoint. It contains what is known as “actionable advice” and is entitled “Embrace the contradictions of QE and sell all the good stuff”. It starts with a quote attributed to New York based short seller Ben Smith, reportedly uttered in the fall of 1929: “Sell ’em all! They’re not worth anything!”

Bail-out or not, one way or another it’s eventually going to become a default …

Photo via desicomments.com

Here are a few excerpts from Mr. Dizard’s article:

“There are two ways for “real money” bond investors to deal with the shortage of high quality assets caused by quantitative easing. They can spend the next few quarters buying five year Bunds with negative yields, and then go home to curl up in a foetal position every night. Or they can look on the current market environment as the cheapest, most liquid offering of hedges against financial disaster they will ever see. I say, embrace the contradictions of quantitative easing, the restrictions on banks’ buying and selling securities, and every other way that regulators and politicians are insisting that risks be taken without taking any risk. The policy regime has now made it mathematically impossible for fiduciaries to meet the beneficiaries’ future needs through the prudent buying of securities.

This is most acutely the case in Europe. Pension obligations or annuity obligations should be discounted at something close to a risk free rate. But if the risk free rate is negative, then the obligations spiral upwards even when the pension sponsor or insurance company shovels in the plan contributions.

The good news is that the usual problem with “tail risk” hedges, the bleeding of money from the “negative carry” of paying out interest or dividends on borrowed securities, is now nearly nonexistent. In the case of Bunds, Swiss governments, and their close corporate cousins, the issuers, or the secondary markets, are paying you to bet against them.

So as Ben Smith allegedly said, “Sell ’em all”. Not the bad securities, such as high cost American oil companies with looming bond maturities. Those might be bought by energy majors in search of cheap reserves, and your short sale will have blown up.

You should be selling short the good stuff, such as those Bunds and near Bunds, the high end of investment grade European corporates, or even the nearer maturities of credit default swap indexes. Get whatever legal opinion you can to support the short selling of high quality corporate or government debt. Call it a hedge, certainly not a speculation. Perhaps you can use a total return swap underwritten by one of the too-big-to-fail American banks. Or a managed account with a hedge fund or a short selling ETF. In these market circumstances, short selling by prudent fiduciaries is not about cynical greed, but an attempt to preserve the beneficiaries’ capital.

Hallelujah! Clearly this is an idea the time of which has come. How often is one offered an opportunity to short bonds while getting paid for the privilege? Normally, never. Now however, a whole smorgasbord of bonds is begging to be shorted so you can actually – ha ha! – collect the negative carry, while waiting to get paid off at par. In other words, you’re in the position many governments now find themselves in, as several of them have actually begun to refinance themselves at negative rates (it has recently happened in Switzerland and Germany).