European debt crises, Pt. 3
By WealthVest Marketing
Author's note: In part one, I outlined roughly why the crisis is occurring from an economic perspective at a broad level. In part two, I took a closer look at why credit default swap spreads are rising lately. In other words, why the market has become more scared in the last couple months.
Don’t worry about the Greek debt crisis
That was the clear stance of James Bullard, president of the Federal Reserve Bank of St. Louis, recently in London. His major message was sovereign debt crises occur frequently, but in my opinion his strongest statement is on the resilience of the U.S. economy so far:
In all, the economic situation in the U.S. and globally is not very different from median forecasts made at the depth of the recession in late 2008 and early 2009. Since that time there have been several moments when it may have appeared that the global economic recovery would be derailed, but, as it turned out, the recovery has remained on track…
Governments have made it very clear over the course of the last two years that they will not allow major financial institutions to fail outright at this juncture. Because these too-big-to-fail guarantees are in place, the contagion effects are much less likely to occur. “Too big to fail” is a controversial policy, but it does have its upside in the current situation.
The U.S. may actually be an unwitting beneficiary of the crisis in Europe, much as it was during the Asian currency crisis of the late 1990s. This is because of the flight to safety effect that pushes yields lower in the U.S.
When the Asian economies shuddered and currencies nearly collapsed in 1998, many economists predicted the tremors would take down the United States and European economies. Quite the opposite occurred. A stream of money flowed from Asian banks into United States Treasury bonds, and interest rates fell as a result. Oil prices also dropped. And the United States emerged stronger…
There is suggestive evidence that this could happen again. American interest rates have fallen in recent days, as investors apparently seek refuge in Treasury bonds. And talk of a slowdown has caused the price of oil to fall, which helps the American consumer.
It could be argued that the infusion of cash in 1998 further inflated the Internet stock bubble, which popped several years later with disastrous consequences.
Worry about the crisis
After years of vast research, Professor Kenneth Rogoff, of Harvard University, and Carmen Reinhart, of the University of Maryland, published the formative academic work on debt crises in 2008. Besides impeccable timing and a sarcastic title, "This Time is Different: Eight Centuries of Financial Folly," offers wise insight into the patterns of debt crises as we try to prophesy the global economy’s future.
The first historical phenomenon we must understand about debt crises is that they are bunched in temporal and regional clusters. These often correspond to the boom-bust cycles of international capital flows. Here is a series of default clusters and debt restructurings in Europe over the last two centuries. Notice the dates of 1915, 1932, and 1981.
- Austria 1868 1914 1932
- Bulgaria 1915 1932
- Greece 1824 1893
- Germany 1932
- Hungary 1931
- Italy 1940
- Moldova 2002
- Poland 1936 1981
- Portugal 1834 1892
- Romania 1915 1933 1981
- Russia 1917 1998
- Serbia/Yugoslavia 1895 1933 1983
- Spain 1831 1867 1882
- Turkey 1876 1915 1940 1978
- Ukraine 1998
Greece, which is expected to have a debt that is 120 percent of its gross domestic product this year, but isn’t likely to see any surge in growth that might help it cut this debt…
Debt ratios will rise throughout Europe this year and next, analysts say, as a weak recovery drains government tax revenues while spending on unemployment and other benefits remains high. Spain, for example, which entered the crisis with a debt-to-GDP ratio below 40 percent, is expected to hit 66 percent this year and 74 percent by the end of 2011. The problem extends beyond Continental Europe. The U.S., U.K. and Japan all have debt that is 90 percent of GDP, or are expected to soon reach that level…
We’re going to be raising taxes sky high. The federal tax take probably needs to go up by about 20 percent.
The history of past crises suggests that the job market probably won’t start getting better till the middle of next year, and that house prices may stay flat “for a long time, many, many years,” according to Rogoff.
So, in a nutshell, the most frequently cited outcome from the Greek debt crisis, and the public and private global debt crisis is more inflation. This environment generally, at least in the short term, forces down equity valuations, while inflation forces interest rates higher.
This was our investment consensus for our company. A secular bear market in bonds and a secular bear market in stocks. A sustained period of higher interest rates and falling equity market multiples. In short, a perfect storm for fixed index annuities, and a renewed American focus on savings and privatizing pensions.