Sovereign

Opening line to Alan Kohler's latest article in Business Spectator. Spot on!

At its heart, the global financial crisis is morphing from a credit crunch/real economy feedback loop into a problem of sovereign risk, and unfortunately there are few signs that politicians actually understand how much trouble we’re all in yet.

What Mr. Kohler is saying is that each government is trying to bailout its own economy simultaneously. The real danger is all this borrowing can't be repaid and that some major global economy is going to end up like Iceland.

I have always assumed the economy and currency to break first will be the US. It is borrowing more than it can repay. It was already running astounding deficits in the "good times" a legacy of the worst adminsitration in the Western World. The deficits under the Obama administration beggar belief! Those lending to the US now will not be repaid and although the default is unlikely to be de jure, it will be de facto. Firstly, default will occur via the rapid decline in the relative value of the currency and secondly through concomitant inflation that will accompany a substantial decline in the US exchange rate.

China, as the US's chief creditor is going to end up booking an unimaginable loss on its US treasury and currency holdings. It's playing a game of chicken and riding in both cars.

What the US really needs is to liquidate the excesses from its financial system, book the losses in its banking sector and commence the process of rebuilding its savings and capital base.

The Art of Being Wrong

The link to the above article is a a reprint ,of a reprint, from The Age.

Forecasters are now telling us we are in for an extended period of low inflation, and low interest rates. Just like their counterparts in late 19c. Bayer Pharmaceutical, they have it wrong.

Read this well informed article to understand why the upcoming cycle is likely to be stagflationary (like the 70's) rather than deflationary (like the 30's). Just as severe and unpleasant, but slightly more Weimar flavoured.

Schiff was Right

I recently read a post on www.europac.net where Peter Schiff felt the need to defend himself from a critic. This doesn’t surprise me. I call it the “Day Trader Mentality” which is the real reason we are in our current mess. It is the Generation-X get rich quick mentality that drove excessive risk taking, rather that considered, medium- to long-term value investing. Understanding economic cycles is not about picking the peak or troughs in markets but in developing a comprehension of what part of the cycle we are currently experiencing. The warning signals of the bubble economy had been growing since the 1990’s, with the first bubble emerging in the internet economy from 1996-2001; its collapse lead to a mini-recession. It should have been a full correction but Alan Greenspan attempted to monetise the recession away, possibly for political reasons. To achieve this, Greenspan floored US interest rates and delayed and greatly amplified the effect. Massive monetary expansion occurred with huge bubbles emerging in asset prices in both equity and property (especially the US). These asset prices were fuelled by cheap credit, leveraging and inappropriate pricing of risk. Securitisation and derivative products were key culprits in this process – as was cited in the very first post of this blog in 2004. As a result the recession of 2001-02 was smothered and has emerged as the Depression of 2008-2015, or as we like to say here the Great Recession. Where we are at now is really the beginning of the downward slope probably akin to 1931. The next two to three years will likely see the worst of it.

Mr. Schiff has my sympathies, he has been, and continues to be the most insightful and prescient economic commentator over the last decade. Unfortunately people who allow there own self interest to govern their thinking, those who operate without self examination or intellectual rigour, will always be jealous of those that do, especially when their follies are magnified by reality.

Do a search for “Peter was Right” videos on YouTube – that’s Peter Schiff not this one!