Gimme a head with hair
Long beautiful hair
Shining, gleaming,
Streaming, flaxen, waxen
Give me down to there hair
Shoulder length or longer
Long beautiful hair
Shining, gleaming,
Streaming, flaxen, waxen
Give me down to there hair
Shoulder length or longer
There's been plenty of talk this week about hair; long beautiful hair, shining, gleaming, streaming, flaxen, waxen... well you get the picture. But as a bald guy, I want to talk about haircuts. No, not Troy's, I'm sure Head & Shoulders wouldn't be too happy about that. Keisel's maybe, he says he is shaving for charity after the game, "I know I was handsome, but I don't really remember what it was like." No, the haircut I'm talking about is a debt haircut.
A debt haircut is a euphemism for a bond default. If you are a bondholder, and the issuer of your bond gets into trouble, you may experience what is known as a haircut. A nice way of saying, you won't be getting back what you went in with. As with real haircuts there are many styles of debt haircuts. For the sake of this note we'll focus namely on government defaults.
First is the "buzz cut," an old fashioned, outright default on the principal. This can be rather embarrassing, and it also makes it rather tough to borrow much in the near future (though investors memories can be short). This haircut is usually reserved for second tier countries like Greece, Iceland, or Argentina.
Second is the "just a little off the top" haircut. This haircut is more discreet. The government strives to devalue their currency, thereby decreasing the real value of their debt (paying bond holders with devalued dollars). This type of haircut has a nasty side-effect though, it increases import prices and lowers the country's standard of living. Unfortunately we've become too accustomed to this type of haircut.
Third is the "I thought I was just getting a trim" haircut. This is probably the most nefarious of debt haircuts. With this haircut the government tells its bondholders and citizens that there is no such thing as inflation, therefore we can keep interest rates exceedingly low, let's say zero. By doing this (keeping interest rates below the true level of inflation) the government is able to issue debt at negative interest rates. This negative real interest rate policy has the effect of transferring assets directly from savers to the central bankers. If you doubt this is happening the just listen to Mervyn King, head of The Bank of England, "I sympathize completely with savers, and those who behaved prudently, who now find themselves among the biggest losers from this crisis."
As you watch all that wonderful hair flying about this weekend, remember that the haircuts are coming, and some are much harder to see than others. As investors we will have to be doubly vigilant that we don't get sheared. This requires diversification and nimbleness, you don't want to fall asleep in the barbers chair when that barber is the federal government.
The Age of Deleveraging:
This is a pretty good piece that explains our financial crisis and the coming deleveraging "on the back of a napkin."
GO STEELERS!
Be careful out there, and keep the light's on,
Chris Wiles, CFA
412-260-7917
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This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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