Somebody Needs to Do the Math

 | May 31, 2017 | 1:00 PM EDT
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I've written about numerous market oddities over the years. Situations that appear to exist over long periods of time, or perpetually, that contradict mathematical logic and that market participants collectively choose to ignore. I refer to that as "conscious obtuseness" and it's always presented a huge obstacle for me in trying to assess markets and assign logic-based valuations. 

I've not been able to figure out why these "beliefs" persist, but it does cause risk and security mispricing that allows for the determination of whether an issue is being sold at a discount or premium to "reality." 

The problem with that, of course, is that the mispricing can be sustained as long as the belief and obtuseness are. 

This is an extraordinarily important, complicated and nuanced point that deserves far more attention than I can discuss in this venue. 

I've written about this concerning the mathematical limits to sovereign debt, the mismatch between the Bureau of Labor Statistics employment report and payroll tax receipts, the relative mispricing of U.S. versus sovereign debt of Western European countries and many more. 

I won't supply URLs, here but if you are interested, just search the site for "Arnold insolvency," "Arnold tax receipts" and similar, and you'll find numerous columns addressing these subjects and more. 

Yesterday, ZeroHedge discussed the concept of European "sovereign bond-backed securities" in response to an article concerning such by the Financial Times

This is not a new subject, but since I received queries concerning it, I'll address it here. 

The idea of selling securities backed by sovereign debt issued by a basket of EU countries is one possible pragmatic response to the looming insolvency of some of the members. As the terminal insolvency threshold approaches for some EU member countries, the government and financial sector leaders are confronted with a decision. They can either admit that insolvencies can occur, are going to occur and create a response for such, or they can create another "beLIEf." 

Since the entire world shares the belief in the impossibility of sovereign insolvencies by currency-issuing countries, though, the path of least resistance is to create the next step in the evolution of the European collective toward full fiscal integration. The "beLIEf" being that once that is achieved, default and insolvency at the individual sovereign level are no longer possible, and thus the current situation disappears. 

The empirical support for believing such is the situation Japan is in. It's well beyond the mathematical limits of debt-carrying capacity and terminally insolvent as a result. 

Everyone in a position of authority globally chooses to participate in the "beLIEf" that currency-issuing countries cannot become insolvent and are therefore immune to mathematical constraints, so the illusion that such is the case can be sustained for an undetermined period of time. 

It's a suspension of reality, a hot-potato game of sorts. 

The reality is, of course, that no thinking person believes such a ludicrous idea. 

Having said that, I will add that in the 20 years or so that I've discussed mathematical limits to sovereign debt issues, the vast majority of "eCONomists" I've interacted with have insisted I am wrong. They have insisted such while refusing to address the math. I've always found this to be deeply disturbing. 

On a smaller scale, it's akin to the detachment from mathematical constraints evidenced in the U.S. residential mortgage markets that reached its zenith about a decade ago. 

What the smart folks believe, and gamble on, just like in a Ponzi scheme, and just as they did during the U.S. mortgage insanity, is that the illusion can and will be maintained during the time they are participating in the economy, business and their own personal wealth accumulation. 

The next generation will have to figure out how to deal with the situation for themselves.

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