Late last week, a man who’s very likely going to become a U.S. presidential candidate suggested that the U.S. government might consider negotiating a partial repayment with creditors. That is, a U.S. government led by Donald Trump might see U.S. government debt as repayment-optional.
According to the New York Times, likely Republican presidential candidate Trump told CNBC, “I would borrow, knowing that if the economy crashed, you could make a deal.” He added, “And if the economy was good, it was good. So, therefore, you can’t lose.”
What we’ve called the “fantasy” that debt issued by the U.S. government is “risk-free” just took a small – and dangerous – step to being proven true.
A foundation of finance is that since the U.S. government can print more money or raise taxes when it needs more cash, the chances of the American government defaulting on its loans is almost nil.
As Bloomberg explained, Trump was suggesting that “he might use his business skills to reduce America’s debt burden by pushing creditors to accept write-downs on their government holdings.”
When he was a businessman, Donald Trump declared bankruptcy four times. In American business, declaring bankruptcy – which often leads to paying creditors only part of what you owe them – is widely viewed as just another tool in the toolbox of capitalism.
In that sense, Trump the businessman viewed debt repayment as optional. He could “make a deal” when his company “crashed”… but if the company grew, “it was good” and debtors could be paid. In any case, the company “couldn’t lose.” But creditors could, as they would wind up getting back a lot less on their loans than they thought they would.
(The title of a 1987 book by Donald Trump was called “Trump: The Art of the Deal.”)
As the New York Times explained, “Such remarks by a major presidential candidate have no modern precedent. The United States government is able to borrow money at very low interest rates because Treasury securities are regarded as a safe investment, and any cracks in investor confidence have a long history of costing American taxpayers a lot of money.”
The price of U.S. Treasuries barely moved on Trump’s comments. This suggests that traders and markets see little chance of Trump breaking the sanctity of the risk-free promise of U.S. Treasuries. “This is stupid and ridiculous and never going to happen,” said one banker quoted by Bloomberg.
But… not long ago, the chances of Donald Trump becoming an actual U.S. presidential candidate were viewed in similarly dim terms. Dozens of political analysts were, just months and weeks ago, absolutely convinced that Donald Trump was not going to become the Republican presidential candidate (a list of some of these confident assertions is here.) So writing off Trump’s unique vision of the U.S. Treasuries market is a bad idea.
Although the U.S. making good on its debt is viewed as sacrosanct, there have been some close calls. In August 2011, partisan infighting in the U.S. Congress nearly resulted in a default on U.S. government debt. During the episode, one-month Treasury bill yields climbed to a 29-month high. That means that, as U.S. government debt was viewed as riskier, investors demanded a higher yield to hold it – and prices of bonds fell. (For bonds, the yield increases when the price falls, and vice-versa.)
Historically, in times of uncertainty investors and traders sell their higher-risk assets, and “flee to safety”. Usually this means U.S. Treasuries, as the only “risk-free” asset. But when U.S. Treasuries themselves are the subject of uncertainty, there’s another asset that has traditionally been a safe haven: Gold. In the summer of 2011, as the political dispute that led to the standoff over U.S. government debt simmered, the price of gold soared 25 percent from early July through mid-August. The next month the price of gold hit its highest levels since 1980.
It wasn’t a coincidence that the price of gold spiked as uncertainty over the notion of “risk-free” became a topic of debate. As we’ve written before, there are lots of good reasons to own gold… and Donald Trump just gave investors another one. If Trump’s candidacy advances, and there is a greater-than-zero chance that the president of the United States views U.S. debt as subject to a deal, the price of gold will soar.
The SPDR Gold Shares ETF, (ticker: GLD on the New York Stock Exchange; code: O87 on the Singapore stock exchange; and 2840 on the Hong Kong Stock Exchange), is one of the easiest ways to get exposure to gold.
What motivated the world’s most “successful” rogue trader
On Friday, we wrote about Jerome Kerviel, the most “successful” rogue trader in history. By placing huge, unauthorised bets on the direction of European markets, he ended up losing US$7.2 billion for Societe Generale (SocGen), one of Europe’s largest banks.
Even if he got away with everything, Kerviel was not going to make much money from all his trading. So, why did he start in the first place?
Part of it may have to do with his background. He came from a working class background. He hadn’t gone to the elite business schools that many of his colleagues had. So he may have felt driven to prove that he fit in with fellow traders.
But there was something else: Failed by supervisors more concerned with profits than traders’ mental health, Kerviel had become a trading addict. As we discussed in a previous article, the brain activity of successful traders is similar to that of someone high on alcohol, cocaine or heroin. A chemical called dopamine floods the brains of winning traders making them euphoric, just like drug users. But when profits turn to losses, the trader is like a junkie in need of a fix – he needs another successful trade to get a dopamine “high.”
Years later, Kerviel admitted to becoming obsessed with winning, as if he was “playing a computer game.” He was quoted as saying that he had experienced pleasure in making “astronomic” bets. Addicted to the markets, he would stay at his desk in front of a quote screen for 16 hours at a time, only answering workmates with a robotic “yes” or “no”.
As we’ve noted in the past, Warren Buffet – considered by many to be the greatest investor in history – has no stock price monitors in his office. He knows that minute-by-minute watching of stock prices doesn’t help with long-term investment decisions. Kerviel, on the other hand, became obsessed with them and this helped cause him to make catastrophic investment decisions.
Kerviel was eventually convicted for breach of trust, forgery and unauthorized use of SocGen’s computers. He was given a three-year jail term in 2010, and ordered to pay back SocGen US$6.3 billion, a sum the bank acknowledges that it will never collect.
After spending less than five months behind bars, Kerviel was given a conditional release in 2014. He continues to appeal his sentence.
In addition to defrauding his employer, Kerviel made all the worst mistakes an investor can make: he was overconfident, used too much leverage, did not have a stop-loss strategy, and he became emotional and obsessive.
The person who lost more money than any other trader ever made the same mistakes we’re all prone to make. We all need to be alert to avoid repeating them, whether we’re trading hundreds, thousands or billions of dollars.