COMMENTARY & PORTFOLIO STRATEGY

Q1 2010 Managing Partner & Chief Investment Officer cullen.thompson@bienvillecapital.com

M. Cullen Thompson, CFA

New Deal Redux If I have seen further, Isaac Newton once said, it is only by standing on the shoulders of giants. In science, progress is cumulative. In managing the fiscal affairs of government, it is nonexistent. Each successive generation, it seems, must relearn the mistakes made in the past. For evidence, one needs to look no further than the recently released budget of the US government. Totaling $2.3 trillion in spending, the mismatch between revenues and expenses results in a degree of red ink no government has ever attempted ($1.6 trillion being the anticipated deficit). Following their inspection of the numbers, the Congressional Budget Office issued their independent, non-partisan assessment. Based on projections for the near-term, as well as the forthcoming entitlement spending, the worlds most successful republic apparently has no intention of ever again balancing its budget. 1 The pretense for such a gross mismanagement of government finance is, of course, the economic stagnation the nation has found itself in. Unemployment is high, while wages, home sales and bank lending are low. In an attempt to right the situation, the Obama administration has taken the fiscal baton from their nearly-equally spendthrift predecessor, and engaged in the most audacious fiscal campaign modern man has witnessed. We wonder what will be the outcome. Is prosperity, we ask ourselves, only in temporary hibernation? And if so, can it be easily resurrected by government spending, renewed conspicuous consumption and further credit expansion? In preview, we do not. Our belief, based principally on historical precedent and
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hard-nosed fundamental macro analysis, suggests that todays troubles are structural in nature while the response has assumed they are cyclical. The uncoordinated fiscal gimmicky and artificial support for asset prices is more likely to be in vain, prolonging the inevitable reckoning and delaying the eventual and necessary adjustment process. When it comes to the overall economy, rebalancing, rather than releveraging, is in order. Despite near universal acceptance of it, the history of recession-fighting in the United States is more or less a 20th century phenomenon. Common perception holds it was first introduced by Franklin D. Roosevelt, whose depression-era New Deal saved the American people from secular stagnation and unemployment. Yet it was Roosevelts predecessor, Herbert C. Hoover, an enlightened politician, who believed it was time to pioneer a new field. 2 In doing so, he boasted that no President before ever believed that there was a governmental responsibility in applying an anti-depression pill. But to Hoover, when it came to economic downturns, the era of passivity had run its course. The inherent beauty of a market economy is that debauchery in borrowing and lending has always had a way of resolving itself, and doing so with great efficiency and equality. As assetsfree from artificial supportmoved from weak to strong hands, banks comfortably expanded their balance sheets. With that, growth soon followed. Yet by attempting to defy this natural process, opting instead for populist quick fixes, the Hoover administration was the first to underestimate the powerful, regenerative forces of the market, and in turn, set an irreversible precedent for the governments role in the private market.
2

Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2010 to 2020, January 2010

Murray N. Rothbard, Americas Great Depression (BN Publishing, 2008)

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Hoovers theory of providing the economy a beneficent hand, as he described it, was in direct contrast to the philosophy of his own Treasury Secretary, Andrew Mellon, who believed ardently that in order for prosperity to return, it was first necessary to purge the rottenness from a credit-binged economy. Mellon had relied heavily on the efficient workings of this process during the depression of the 1870s, and he no doubt garnered comfort from its success in launching nearly a decade of prosperity following the cyclical hiccup of 1920-21. Leveraged speculators were liquidated and businesses re-oriented production to the new level of true demand. Following the uncomfortable episode, recoveries were often vicious and virtuous. Employment expanded robustly, as did the nations gross domestic product.
Adjusted Monetary Base
NSA, Mil.$ 2400000 2000000 1600000 1200000 800000 400000 0 2400000 2000000 1600000 1200000 800000 400000 0

now exceeds $2 trillion (when factoring in his predecessor, Alan Greenspan, the duo have collectively created out of thin air 90 percent of the 233-year old nations monetary base). In an attempt to keep mortgage rates down and home prices up, the Fed has added nearly $1.25 trillion of mortgage-backed securities to its balance sheet (a program scheduled to end in March). That Nevada Senator Harry Reid suggested to merit confirmation, Chairman Bernanke must redouble his efforts boggles the mind. 4 Neither Reid nor his boss at 1600 Pennsylvania Avenue holds a degree in economics. But advanced studies are not a prerequisite to sufficiently comprehend the powerful, liquefying nature bank credit creation has on economic growth. Provide a marginal loan to a marginal borrower, and in theory, consumption receives an immediate boost. With that, the top line of the country expands. Intoxicated by this notion, President Obama has urged bankers to do more in every responsible way to increase lending to consumers and small businesses. 5 But as we can discern from the January 2010 release of the Federal Reserves own Senior Loan Officer Opinion Survey on Bank Lending Practices, its not just the supply of credit thats clogging the wheelin fact, with the obvious exception of commercial real estate, banks generally ceased tightening standards on many loan types in the fourth quarter of last year, and the percentage of banks reporting tighter standards continued to trend lower. 6 More ominously, the report unveiled, it was demand from both businesses and households [that] weakened further, a deflationary setback that must keep central bankers the world over up at night. All of which highlights two fundamental truths that have been seemingly misunderstood in the current malaise; first, no government, family or society can spend its way to prosperity, and second, you cannot cram a loan down the throat of a consumer hell-bent
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Source: Bienville Capital Management, LLC, Haver Analytics

In the 21st century, recession-fighting ranks at the top of job responsibilities for those seeking employment in high office. To do his part on the monetary side of the equation, Ben Bernanke, Chairman of the Federal Reserve Board of Governors, as well as reigning TIME Magazines Person of the Year, has delivered on his 2002 promise of taking whatever means necessary to prevent significant deflation in the United States. 3 With little more effort than the click of his federally-issued mouse, Bernanke, in a relatively short four-year stretch, has created over 60 percent of the countrys monetary base, which, as illustrated above,
3

Deflation: Making Sure It Doesnt Happen Here, Remarks by Governor Ben S. Bernanke Before the National Economics Club, Washington, D.C., November 21, 2002

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http://reid.senate.gov/newsroom/pr_012210_bernankestatement.cfm ABC News, Obama Urges Fat Cat Bankers to Start Lending, December 14, 2009 The January 2010 Senior Loan Officer Opinion Survey on Bank Lending Practices, http://www.federalreserve.gov/boarddocs/surveys
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on deleveraging or a small business owner frightened by the fragile foundation a debt-dependent economy rests on. Todays fiscal and monetary experimentations are of a global scale. The International Monetary Fund, in preparing their Global Financial Stability Report, highlighted 153 identifiable acts by advanced economies since June 2007, most of which resulted in effectively socializing what were previously private sector liabilities. The transfer of financial risks to sovereign balance sheets, the reports states, has resulted in higher public debt levels that add to financial stability risks and complicate the exit process. 7 The exit process, of course, refers to the delicate task of extricating the massive government and central bank accommodation now in place. Do so too soon and risk a double-dip recession. Wait too late and risk a currency or debt crisis. Considering the complexity of the calculus, while also factoring in the considerable role market confidence and psychology plays, and the probability of government officials getting the timing precisely right looks quite small. Yet the potential contagion affects remain rather large. To date, policymakers have preferred to err on the side of over-accommodationtesting the boundaries, so to speak. Just how far they can safely go, no one knows. Yet if the history of sovereign defaults is any guide, we are likely to find out. What were seeing on the sovereign side, Bank of Canada Governor Mark Carney, referring to the escalating problems in Greece, is the first signs of the limits to stimulus. Market signals are helpful in this regard because, Carney continues, they will help ensure sustainable fiscal balance over time. 8 In southern Europe, financial markets are serving their important role as a sort of supra-prudential regulator, punishing profligacy and forcing austerity where austerity is most needed. As printer of the worlds reserve (paper) currency, we

wonder when our many foreign creditors will demand the same degree of discipline. Invoking FDR and unwittingly Hoover, the current administration has laid out a new course in spending. In selling its plan to the public (now estimated to be $862 billion), its advisors are promising a hefty bang in return for borrowing our next generations many bucks. A little too hefty however for Robert Barro, professor of economics at Harvard University and Senior Fellow at the Hoover Institution, who admits to finding no scientific justification for the lofty spending multipliers underpinning the proponents assumptions. Unequivocally, the administered stimulus, along with a massive, yet fleeting inventory adjustment, has contributed positively to recent GDP calculations. But rather than obsessing over the moment in exchange for a slightly longer view, perhaps over five years, Barro suggests, the fiscal stimulus package is a way to get an extra $600 billion of public spending at the cost of $900 billion in private expenditure. This is a bad deal, he concludes. 9 Grandiose spending and statist interventions do not ensure grand results. In fact, overzealous tinkering can not only delay the necessary adjustment process, it may also intensify it, as was the case in the 1930s. In his re-nomination speech in 1932, Hoover proudly acknowledged that his administration had unveiled the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic. Additionally, then as now, banks were encouraged not to foreclose homes and short selling was condemned as unpatriotic. As for castigating lenders, The New York Times revealed that Hoover was also disturbed at the lack of cooperation from commercial banks. From his view, they had not passed on [the] relief measures to their customers, although, in a twist of foreshadowing, the banks maintain that there is no demand for commercial loans. 10 Despite all of Hoovers efforts
Robert J. Barro, The Stimulus Evidence One Year On, The Wall Street Journal, February 23, 2010 President Has Been Much Disturbed by Slack Credit Action, The New York Times, May 20, 1932
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Monetary Fund, Global Financial Stability Report , October 2009 8 Carney Says Investor Deficit Concern Not Helpful to Economy, Bloomberg, February 16, 2010
7International

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and Roosevelts New Deal, unemployment stubbornly lingered above 15 percent for another 8 years, finally falling upon the advent of World War II. And with businesses paralyzed by anti-capitalist rhetoric, overall output recovered only gingerly. Those who cannot learn from history, the philosopher and author George Santayana once remarked, are doomed to repeat it. Confronted with a crisis of its own making, policymakers have resorted to the playbook of our countrys darkest days, supplemented by stimulus programs intended to perpetuate the failed policies of conspicuous consumption in lieu of saving and investment. As the stimulus inevitably fades, we will be left with a more-heavily indebted economy still in critical need of rebalancing. And while the long-term benefit of stimulus is likely to be negligible, the damage to sovereign balances sheets is certain to be considerable. If the excessive accumulation of debt was the antecedent of the current crisis, it remains a truism that more of it will not lead us out.

US Core CPI registered a decline of 0.1% in Januarythe first monthly decline since 1982 Capacity utilization remains at 30-year lows The ECRI Weekly Leading Index, which successfully identified the economic downturn beginning in 2007, as well as the recovery in March of 2009, has begun to roll over, as has the nations monetary aggregates (i.e. money supply) If this is indeed a recovery, it is certainly of the jobless variety. More than two years after the onset of the decline and fully six months after Wall Streets strategists called for the end of the recession, the US economy is still shedding jobs, 8.4 million of which have now been lost. As a result, all of the previous decades job growth has now been eliminated, a scenario no analyst will find while digging through the Labor Departments data dating back to 1939. Even if the economy soon begins to produce 150,000 jobs per month, as expected, the level of unemployment will remain high for a prolonged period of time. Therefore, we struggle to identify where the organic, private demand will come from that is necessary to sustain the robust economic growth equity markets are currently discounting.
Loans & Leases in Bank Credit: All Commercial Banks
12-month Change 1200 800 SA, Bil.$ 1200 800

Portfolio Strategy
The epic struggle between the intensifying deflationary pressures unleashed by the collapse of the credit bubble and the inflationary policies designed to combat them continues. The following are some of the many reasons why we remain skeptical of the durability and sustainability of the current recovery: Bank loans are now contracting at an annual rate of 8.4% Consumer confidence, a necessary precondition for consumption, fell back to 46 in February (below the 61.4 level in September 2008, the month Lehman collapsed) Wages as a percent of GDP are now at an all-time low while consumption-to-GDP remains near its all time highclearly, an unsustainable trend

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Source: Bienville Capital Management, LLC, Haver Analytics

As for portfolio positioning, it now seems clear that we have surpassed the liquidity-driven aspect of the equity rally as world indices have now traded range bound for six months.

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Recognizing the possibility of a correction (which would not be uncommon following such a substantial increase), as well as acknowledging the unfortunate reality that little value is currently offered in many risk asset classes, our positioning could be characterized, unsurprisingly, as cautious. To provide some insulation to our portfolios, as well as express some compelling opportunistic views, we have initiated a few tactical positions, all of which nicely complement our strategic, longer-term holdings: First, in order to reduce some unwanted marketdirectional risk (i.e. beta), we have hedged part of our high-quality, long-only equity exposure with a modest short position in the Russell 2000a proxy for lowerquality equities (i.e. smaller cap companies with less access to credit or the inventory rebound benefiting large, global manufacturing firms). The effect of the combined position is to concentrate our returns into the relative performance of our exceptionally-skilled managers versus the index, thereby delivering an uncorrelated stream of (hopefully positive) returns. To date this strategy has succeeded and we remain confident in the abilities of our underlying portfolio managers to execute. Second, in December, we initiated a long USD position (mostly vis--vis the euro, pound and yen) in equal size to our gold position, effectively denominating the majority of our gold holdings in those three currencies. With the material correction in both the euro and the pound over the past few months, this strategy has proven to be a nice generator of incremental returns. Additionally, it has minimized some of the volatility of our gold position. Third, anticipating periodic bouts of stress, we have used brief periods of overall market complacency to initiate tactical long positions in volatility. By being owners of volatility, we no longer have to fear it. The VIX Index, a proxy for volatility, has been trading below its 20-year norm during a period when the possibility of a macroeconomic shock is arguably well above average.

More generally, we remain conservative in terms of our overall equity exposure and have continued to orient more of the portfolio to high-quality yield in lieu of lower levels of cash, which is yielding essentially nothing. Nonetheless, our current conservative positioning should in no way be misconstrued as a universallyapplied philosophy (that is, to be precautious for precautions sake at all times), but rather a symptom of the current environment where we believe prudence is warranted. With the recent release of the Berkshire Hathaway Annual Letter, we were reminded of one of our favorite Buffet quotes: Be fearful when others are greedy, and be greedy when others are fearful. Bienville Capital Management, LLC

Bienville Capital Management, LLC

Bienville Capital Management, LLC is an SECregistered investment advisory firm offering sophisticated and customized investment solutions to high-net-worth and institutional investors. The members of the Bienville team have broad and complimentary expertise in the investment business, including over 100 years of collective experience in private wealth management, institutional investment management, trading, investment banking and private equity. Bienville has established a performance-driven culture focused on delivering exceptional advice and service. We communicate candidly and frequently with our clients in order to articulate our views. Bienville Capital Management, LLC has offices in New York, NY and Mobile, AL.

Disclaimers
Bienville Capital Management, LLC. (Bienville) is an SEC registered investment adviser with its principal place of business in the State of New York. Bienville and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisers by those states in which

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Bienville maintains clients. Bienville may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements. This document is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by Bienville with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Bienville, please contact Bienville or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). This document is confidential, intended only for the person to whom it has been provided, and under no circumstance may be shown, transmitted or otherwise provided to any person other than the authorized recipient. While all information in this document is believed to be accurate, the General Partner makes no express warranty as to its completeness or accuracy and is not responsible for errors in the document. This document contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. The views expressed here are the current opinions of the author and not necessarily those of Bienville Capital Management. The authors opinions are subject to change without notice. There is no guarantee that the views and opinions expressed in this document will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Past performance may not be indicative of future results and the performance of a specific individual client account may vary substantially from the foregoing general performance results. Therefore, no current or prospective client should assume that future performance will be profitable or equal the foregoing

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