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Today looks eerily similar to what was going on in 2007 and early 2008. Then, as now, the vast majority of my macro-economic and stock market indicators issued massive warning signs. And then, as now, the stock market ignored them for a seemingly endless time.
The big difference: Then it was the beginning of the housing slump that massively disturbed me. Now it’s the beginning of the international government debt and funding crisis that makes me increasingly bearish.
If you recall, the housing and mortgage credit crisis did not befall the world out of the blue. There had been many warning signs. And some of the best market analysts clearly pointed them out. Plus it was a relatively slow development that took many months until it finally culminated during the autumn of 2008.
Then It Was the Fed’s Bernanke,
Now It’s the ECB’s Stark
Now It’s the ECB’s Stark
I remember when Ben Bernanke spoke out in 2007, at the beginning of the housing crisis. “Containment” was his buzz word. And he assured us that neither the housing market nor the economy was in danger. He even gave an estimate of “up to $100 million” in mortgage-related bad debts.
In an interview at the time I strongly rebutted Bernanke’s soothing remarks and added that he was probably off by at least one zero.
Now we have another central bank bureaucrat uttering soothing words: Jürgen Stark, Chief Economist of the European Central Bank (ECB). He said,
“The discussion about restructurings in the Eurozone is based on the totally false assumption that one or another EU member state is insolvent.”
Well, as we all know there are three EU member states — Greece, Ireland, and Portugal — that have already needed an illegal bailout by other EU members. If that’s not insolvent, what is?
These countries don’t have a liquidity problem, they have solvency problem … a severe one at that! And solvency problems don’t get cured by injecting additional credit.
According to Stark, a single euro member country default could trigger a banking crisis worse than the one that followed the September 2008 Lehman Brothers collapse. And I certainly agree with him on this point.
But he doesn’t expect any defaults! That’s where we disagree …
I think that European government defaults are just a matter of time. And the market is massively supporting this view.
In fact, yields on 2-year Greek bonds are well above 20 percent — a strong market signal that default is unavoidable.
Now, let’s take a look at the …
Six Theoretical Escape Hatches
In theory, there are six ways to resolve the global debt trap — six escape hatches:
- An economic growth miracle
- Major interest rate cuts
- Bailouts by other governments
- Money printing
- Austerity
- Outright default
In case of Greece, Portugal, Ireland and other European countries sitting in a debt trap: Options one, two, three and four aren’t available.
Growth miracles are the result of free market policies not in sight anywhere in Europe. Interest rates are already as low as they can get.
Bailouts have already been tried. Now it’s getting clearer that they weren’t enough, and the willingness of donor countries to do more is fading.
And due to the common currency, the ECB is the only one that can print money. That is as long as the troubled members want to keep their euro membership.
This leaves them with escape hatches 5 and 6: Austerity and default. They are trying the former to a minor degree. But because of the huge debt load it’s not enough to solve the problem.
What’s more, austerity is very unpopular …
Resistance among citizens is snowballing. And sooner or later populists will ride on this wave and opt for outright default — the only other way out.
The situation in the U.S. isn’t much better. The country is also trapped. But …
The U.S. Has More
Options Left
Options Left
First of all, the U.S. has a printing press as Mr. Bernanke so famously said ten years ago. Therefore inflation is feasible.
Second, the U.S. has much more fat available to cut. Hence severe austerity policies could still lead the way out of this mess.
Third, the U.S. is much more flexible, politically and as a society. A return to real market-oriented policies is still conceivable, accepting short-term hardship to foment a growth miracle later.
Mr. Stark has a point when he says that an EU government default would trigger another major banking crisis. But he is either naïve or whistling in the dark with his statement that a default would not occur.
It will, and probably soon. Therefore a bet against the banking sector might be a good idea since we’re talking about another global banking crisis due to the direct involvement of U.S. banks and the strong interconnection of the global financial system.
Interestingly, as you can see in the chart below the banking sector continues to show conspicuous relative weakness — another reminder of the 2007/08 episode.
To take advantage of that weakness, you might consider ProShares UltraShort Financials (SKF), an inverse ETF that tracks the financial sector. If you pick it up at current levels, $58-$59, set your stop loss at $54.50.
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