The coming global debt-driven depression

Reality begins to set in, which inspires panic. Frantic selling across various speculative assets brings prices drastically lower. Retirements and pensions wiped out. Paper investments made effectively worthless. Sound like a repeat of 2008-2009?

The American Nightmare

This horrifying scenario is coming to fruition not because the economy is dipping back in to recession — the fact is without the bailouts, deficit spending and stick saves by the Fed, we’ve been in a depression since late 2008. All of the papering over fraud was about kicking the can down the road rather than fixing the underlying economic, fiscal and monetary imbalances.

Zero interest rate policy combined with reckless fiscal measures have sealed the fate of the US markets and the greater global economy. By implementing such a robust framework without fixing any of the underlying problems on bank balance sheets, in various governments forward debt loads or in household debt we are now looking at repeating the kind of volatility we saw in late 2008 to early 2009, but worse yet there are far greater consequences to a significant economic dislocation. Consequences that were entirely avoidable had the authorities, corporate leaders, banking executives and individual households of the world looked at deleveraging more aggressively and taking the bitter pill that is a brief, but sharp depression so that the excess could be cleared out in favor of rebuilding a more stable and sustainable economy.

Past the Point of No Returns

Now we’re nearing the cliff. The drop-off that is a near mathematical certainty given that many countries governments are reaching their upward debt limit (that is to say no party but their respective central banks are willing to buy their debt). This includes the US, Japan and much of Europe — countries that were once economic superpowers are being reduced to beggar thy neighbor debtors, hat in hand, begging for handouts.

The demographic issues in these areas may differ, but the fundamental economic, monetary and fiscal problems are all too similar. Persistent high unemployment, a highly leveraged financial sector, households that are swimming in debt (with the exception of perhaps Japan) and stock markets that are losing a decade+ in any form of gains.

Worse yet, the forecasts being foisted upon the public are overly optimistic, full of fluffy economic growth predictions that are impossible to achieve. That means that the growth which was necessary to service debt burdens and keep the overly extended economies of the world lurching forward will not occur and thus leaves a much more dire scenario. One of sovereign debt defaults, crashing stock markets, currency crises and an atmosphere of higher unemployment and more civil unrest.

Caution: Debt-Driven Depression Ahead

Let’s look towards the possible future by examining one country that’s already where many will be in the coming months and years ahead. Greece’s stock market is down 85% from its peak, their 1 year government bonds are trading at an absurd yield of about 97% and there is talk of a full scale default as early as this weekend. The Greek people have been protesting, rioting and the unemployment rate by modest measures is 16%. This is a depression, not a recession. While the media is largely ignoring the severity of the crisis, those within Greece are all too familiar with the situation. One that has the potential to become significantly worse before any improvements may happen.

All of the bailouts for Greece have only managed to make the situation worse, because they piled on debt Greece could not pay off while forcing Greece to sell off the few productive assets it has to foreign parties. The combination of these factors ensure a severe economic contraction.

Much of the rest of Europe, with perhaps the exception of Germany, Norway, Finland, Switzerland and Sweden, face the same dilemma: too much debt, too little economic growth. In the United States we face the same crisis, which has only been temporarily offset by the dollar’s reserve currency status — a privilege we may not enjoy for much longer here given the incompetent and dangerous monetary policies of the Federal Reserve. By Bill Gross’ measurement the United States has $75 trillion in unfunded liabilities. That is approximately a 500% debt-to-GDP ratio (over twice that of Japan). Some even say Gross’ measurement is too conservative and the number could be closer to $100 trillion in unfunded liabilities. The fact remains that there is no mathematical or economic scenario where this debt becomes serviceable or sustainable.

The problem is simple, though the solution has been muddled by short-sighted piecemeal bailout attempts. A debt crisis cannot be solved by piling on more debt. It is impossible to achieve economic equilibrium by bailing out corporations that do not know how to manage risk properly. Consumers, who account for 70% of US GDP, are being largely ignored and yet are experiencing significant harm from this crisis. Instead these insolvent banks need to be unwound, brought through bankruptcy and their speculative subsidiaries and divisions need to be completely separated and spun off from their depository and lending functions. We learned this lesson from the Great Depression, but somehow forgot it in the last decade as banks were once again allowed to recklessly speculate with money they did not have.

Modern Banking Is Anything But

Let us remember that banks should really only function as a basic utility for depositing funds and matching those that wish to lend money with those that are seeking interest on savings. That is the vary essential function of a bank. The speculative gambling that occurs on Wall Street has no place in conventional banking and it should never have been allowed to re-join the conventional banking industry.

Those who intentionally defrauded their clients, the government and employed criminal tactics to profit should be indicted, prosecuted and hopefully incarcerated for their crimes against society. Those reckless, greedy and immoral enough to bring down the entire world economy so that they can profit from its artificial rise and subsequent demise are the true threats to a prosperous future. So long as they remain in power we will not see any trust return to the markets nor shall we see any glimpse of true economic recovery. After all, if the rule of law breaks down, there is not much left to keep people from essentially avoiding the entire gulag casino that Wall Street has become.

We must unite around the world and demand that the crooks are prosecuted, the insolvent banks are unwound and that we, the people are not robbed blind to continue to fund these morally and financially bankrupt institutions. It is the only way that we can begin to move forward and start to rebuild our respective countries.

Risk off panic selling, Euro collapse and more

The world markets were roiled today by panic selling. The sell off was catalyzed by negative news on Italy’s solvency, accelerated further by margin calls on major institutions, forcing a major deleveraging across the board. Many are fearing a reemergence of recessionary declines across the globe.

Europe’s outlook has significantly weakened as of late after its been revealed that the fiscal problems of the sagging debtor states are growing more severe at a rapid rate. Headlines today included major exchanges shuttering temporarily, bond issuances being suspended and civil unrest growing. The Euro lost about 1.35% of its value in a single day, a significant sell-off — and one that is likely to continue.

The downside risks for speculative paper assets are intensifying. Growth stocks lost 5-8% or more of their value in a matter of minutes. Some posted double digit losses. The selling in the US continued in to the close without much sign of short covering, indicating that many are still bracing for a negative jobs report tomorrow.

Gold, silver and other precious metals were no exception, as margin calls forced traders and investors who were employing margin to deleverage their portfolio, selling their profitable positions to cover losses, presumably in equities.

The only green on the board was primarily in the US dollar and bonds, once again finding themselves as a safe haven asset during times of panic. One has to wonder, given the underlying uncertainty regarding the US debt, and the condition of global and local financial markets, how long such a phenomenon can last — especially given the tendency for investors to migrate in to hard assets when there’s a whisper of inflation.

The most likely scenario from this point forward is more quantitative easing, probably coordinated by the G7 countries, instead of a unilateral US effort, to prop up sagging markets. Such a liquidity infusion would likely spark a significant rally in commodities and equities, at the cost of the purchasing power of various fiat currencies. Such a powerful inflationary force could cause precious metals to stage vicious upward price discovery as more paper currency is created out of thin air.

In the short term and intermediate term we are looking at a very oversold market. By just about every measure possible we are in a very dangerous zone to be selling stocks. A violent bounce is highly likely, but how sustainable that bounce is depends entirely on what the ECB and Fed say in the coming weeks.

Technically on the S&P 500 there’s a good chance that we’ll see a retest of November, 2010’s lows around 1171 if economic data and news continue to build on the negative sentiment. The 1225 area has now become resistance. This could be the formation of a new trading range or the beginning of a significant downtrend.

Gold made new highs today, but margin calls forced liquidation and brought the price down over $40 from its highs. Silver tested the $42 level, but the same liquidation brought silver down by over 7% at the lows. There’s a good chance that the correction in precious metals could continue if the liquidity vacuum effect of souring debt markets in Europe continues. If instead central banks announce additional easing and credit expansion then we may see a significant rally.

Unfortunately today’s markets are no longer primarily powered by economic growth, but instead moreso from central bank money printing and artificially low interest rates. This is the main reason that more and more investors are turning to hard assets to hedge against, if not profit from, future inflation. If the sell-off continues, with gold, silver and other hard assets seeing discounts, I would consider it an opportunity to buy such assets as the longer term outlook is higher inflation and a resulting attraction towards precious metals.

Long term outlook for 2009

Just when a collective sigh of relief was breathed about 2008 ending and a fresh year beginning, 2009 was ushered in by the worst ever index performance in the S&P 500 and Dow Jones 30 for a January.  This was certainly not encouraging for those that believe in the adage, “So goes January, so goes the year”.

Outlook not so good

2009 promises investors and traders one thing.  Uncertainty.  While the market has declined nearly 50% peak to trough, the deleveraging process has not been completed.  Banks still have far too much common stock equity vs. assets on book.   Usually recoveries in any stock market are led by financials, so this turn around prospect seems bleak until the equity to assets ratio improves.

Inflation prospects seem to be rearing their ugly head again, as precious metals are catching a strong bid.  Oil seems to have bottomed.  Gas prices are on the rise again for consumers.  Treasury bonds are selling off.  The baltic dryships index has been recovering based on Asian demand for raw materials.  Certainly ZIRP (zero interest rate policy) has created the possibility of a new carry trade.

Recovery, what recovery?

Most predict that the US markets will tread through a slow, “L-shaped” recovery because of the serious damage to credit and stock markets, and most importantly, confidence.  Nearly $9 trillion is sitting on the sidelines in virtually zero yield short term treasuries and money markets.  That cash has yet to be deployed, and was originally retracted from equities, because of a flight to safety from confidence being lost.

The smart money is watching China and Taiwan, as the markets there have enjoyed a significant recovery from their lows and forming a bottoming pattern.  With the US dollar nearly free to borrow for currency traders, the possibility of the dollar becoming a carry trade currency is quite real.  Long term prospects for the dollar are weak so traders would not feel as though their principle loan is going to increase from dollar strength.

History in the making or repeating itself?

The possibility is striking because when Japan suffered a similar crisis in the early 90s, their currency suffered this very fate.  The carry trade in Japan caused most financial institutions to move money outside of Japan rather than invest in the country and assist its recovery.  Infact, Japanese equity markets have never recovered and still thrash around making significant lower highs and lower lows in recent months.

In my opinion, this is indicative of a significant risk to recovery in the US markets.  Already gold is more valuable per ounce than the S&P index.  Other stock markets are outperforming the US market on their recoveries.  Will the trend continue?