This Book is Worth an Ounce of Gold…

2- The End of Discipline

(Accompanying audio contains more context 1)

Zoltan Pozsar’s new firm Ex Uno Plures publishes pieces similar to his prior work at Credit Suisse which we had broken down for GoldFix subscribers (after being introduced to his work by ZH) the past two ‘plus” years. All of his CS work since the end of 2021 can be found in our archive with accompanying analysis and translations. Original PDFs can be found at his site.

His most recent missive entitled The End of Discipline, was posted May 8, 2024. What follows is a sort of table of contents for the note that has been circulating in some quarters. We have not read the note itself, but as mentioned in the audio portion, feel very comfortable commenting in a big picture way here. His nine-point list (cryptic as it is), is kind of a “Zoltan Pozsar TL; DR” section without his conclusions. We add at least one of his conclusions as interpreted. That bottom line essentially, is that term premiums must increase. Here is that list.

“The End of Discipline

1. Seth Klarman’s book Margin of Safety on value investing sells for the price of a troy ounce of gold on Amazon.
2. David Einhorn says value investing is dead, which implies that stock investors shouldn’t buy Klarman’s book…
3. Value investing in stocks is dead because bonds offer no value.
4. Bond investors need to discover Klarman’s book and re-price term premia so there is a margin of safety in bonds…
5. …but the zeitgeist won’t let them implement Klarman’s wisdom. Have you noticed the reverse Treasury-Fed accord?
6. The endless backstopping of nominal safe assets is ultimately inflationary, which means we need new safe assets…
7. …real safe assets like gold, commodities and stocks. The FX value of the U.S. dollar is a nominal yardstick…
8. …and can fool you into notions of strength when the price of real safe assets already scream weakness.
9. Janet Yellen has a lot of bonds to sell. Bill Gross is telling you not to buy any. A bond revolt is coming…” 2

The Bottom Line

Unless things change meaningfully, the yield curve must change and steepen. Bonds must yield more or there will eventually be hell to pay. A Bear (perhaps a bull/bear combo or “fulcrum shift” as we used to call it) steepening of some sort must be in the cards given current circumstances.

3- The Problem Identified

The problem can be framed by answering this one question: How do markets reconcile the enormous amount of bond issuance coming up in a world increasingly averse to loaning the US money?

Further, given these assumptions that;

1. no reduction in Bond issuance comes via the Treasury,
2. the world does not overnight decide to buy our bonds again,
3. and the Fed remains steadfast in resisting outside (and perhaps some inside) forces opposing its inflationary fight
4. and some miracle of  high-employment productivity (e.g. cold fusion) is not born;

What must happen to restore some normative (as Pozsar and a growing number of participants must see) functionality to markets and reduce chances of truly systemic financial collapse? In short, what is the path to normalcy if it is to return? The “normal’ part refers to risk management discipline in the nominal market place.

If normal market discipline does not return, something surely will break and to the extent normalcy’s reemergence is even delayed, large segments of our financial economy can dislocate permanently. 3 By normalcy, we refer to the return of logical consequences governing undisciplined risk management. Or as Pozsar implies: what does the end of The End of Discipline look like? Given the assumptions above, that end will manifest in worsening bond prices.

The key to disciplined risk management in all notional markets including FX is the Bond market. The bond market is the king of nominal risk. All risk within a financial system with nonconvertible (paper/fiat) money is a function of present value of money versus future value of money.

The eternal question governing all financial nominal deals which do not factor in counterparty/collateral (real) risk is this: How much money do I have to give you in the future to delay giving you that money back now? All disciplined risk management funnels down to that one question: Future vs. Present Value.

And in this regard, markets are grossly mispricing risk as a result of a lack of discipline enabled by years of QE coddling which in turn trained the investing world to wait for handouts. The investor class is spoiled4.