Connect to share and comment
We're heading for a downturn on global stock markets. Here's why the math is ugly.
The European Union, the world’s largest economic block at $16 trillion, is in the midst of trying to avert a crisis with frightful destructive potential. The collapse of 2008 laid bare the fragility of Europe’s single currency and monetary structure.
In a Feb. 21 article in the Financial Times, George Soros did not mince words: “The construction [of the euro] is patently flawed. A fully fledged currency requires both a central bank and a Treasury. The Treasury need not be used to tax citizens on an everyday basis but it needs to be available in times of crisis.”
How and when the Maastricht guidelines are modified or tossed out altogether in favor of a new and smaller currency union are anybody’s guess. The appetite among politicians to muddle through for as long as possible seems high.
Nonetheless, the longer-term investment implications seem straightforward. Fiscal austerity throughout southern Europe will restrain growth. Portugal and Ireland are particularly vulnerable, with budget deficits projected to be around 10 percent this year and 7-8 percent nex year.
Spain and Italy are in deep deficit positions as well. The debacle in Greece cannot be comforting for the finance ministers in these countries and is sure to harden the resolve to cut government spending as aggressively as is politically tolerable.
China represents perhaps the biggest wild card of all.
Two key observations stand out. First, the current leadership is clearly concerned about an overheated real estate market. The government has enacted various forms of tightening measures aimed at curbing the flow of credit to areas of the market it deems to be extended. Whether a series of incremental tightening steps will lead to an orderly decline in the rate of house price appreciation is unclear. The important point is that this lack of clarity is in itself terrible for investment psychology.
The second observation is that no major economy has grown its money supply at rates of over 30 percent with impunity. Torrid rates of money growth, if history is any guide, always seem to end up leading to a mountain of bad loans.
The central aftershock of the twin credit and property market collapses of 2008 is the sharp rise in sovereign debt risk throughout most of the developed world. Should the global economic recovery falter, many nations will face risk of default. Sovereign defaults tend to come in great waves often separated by several decades.
Some of the most thought-provoking work on financial crises has been done by Carmen Reinhart and Kenneth Rogoff. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," was published in April 2008, five months before the fall of Lehman and the ensuing recession. It is a sobering reminder that throughout civilization, profligate government spending has been the norm, not the exception. Iceland, Dubai and Greece look increasingly like the tip of a very large iceberg. The debt of much of Europe will need to be aggressively restructured in what is apt to be tantamount to “soft defaults," where creditors are not completely wiped out, but neither are they made whole. Japan, with a 2 to 1 ratio of debt to GDP, is perhaps the least talked-about ticking time bomb.
A full blown sovereign debt crisis throughout the developed economies is a distinct possibility. Is it any wonder, then, that gold continues its steady and relentless ascent? No currency is safe. Equity investors should take note.
These are, of course, dark notions to entertain.
It could be that we are in the early stages of a multi-year expansion. This would generate the tax receipts needed for municipalities around the world to fund their pensions and for governments to pay down public debt.
But should the global recovery falter, a domino effect would be set in motion that would bankrupt many a nation. Share prices are no longer pricing in enough risk. Just the opposite. In response to extremely low interest rates, investors have been chasing risk in financial assets of every flavor. It’s been quite a party.
I say it’s now time to get out and run the other way.
Andrew Parlin is a founding principal of Parlin Investments LLC in Boston.