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
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
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.
Best wishes,
Claus
{ 23 comments }
Hi Claus,
Yo have been a perma bear for past 2yrs now. You said that “this is not garden variety recession” blah blah blah. See what happened? You missed the biggest Bear Market Ralley. Flexibility is the key in this market. Your Million Dollar Contraian portfolio is great either when it comes to making money.
I hope to see better articles from you instead of the same bearish sentiments all the time. It pays to be positive. After all Warren Buffet made most of his money if not all of it going long.
Thanks,
Akash
I have been an investor for 50 years. One thing I have learned is that there has never been a financial guru who is right 100% of the time. Following several proven advisers and making your own financial investment decisions has proven to be a great approach to the markets.
We have been in uncharted economic territory for some time now. I, for one, have sincerely appreciated the educated opinions of Mr. Vogt.
Claus;
You have been sooo very right for the two years I have been following your comments, I thank you for your insights. Detractors have been very short term sighted and given the longer term you have saved many of our life’s saviings. Thank you.
I read an average of eight newsletters every day and most have a self serving point of view. When I read your work it comes straight out of Austrian economics with no personal financial gain for you. Thank you again.
Your work has helped me to make sound financial decisions for myself and I appreciate that very much.
Norm
Sir,
I understand and share your concerns for an EU member state default and the resulting cascade. I am not sure I agree that the bank index chart “shows conspicuous relative weakness”. The trend line appears to have stablized on the mean representing repricing for the “new norm”. I see this as somewhat positive in a period of consolidation. The EUR appears over valued considering the PPP index. Germany is the driving economy, exports are the engine. Is it not more likely that one sign post is revaluation of the currency?
doesn’t make sense poor quality sorry mate.
Claus, I agree with you 1000%. What worries me most about this European crisis is that it is more than just a sovereign debt crisis, it is also a European banking crisis. European banks have lent hundreds of billions to European governments through all of this mess, just like they have for three centuries. What most people do not understand is that default really means restructuring of bank debt, leaving the individual investor in bonds behind. The French and the Germans have the largest exposure to this crisis and will always be bailed out by their governments. Austerity never lasts in the human spirit.
If you look at the history of the European continent since the fall of the Western Roman Empire, how many rulers and churches tried uniting all of Europe under one flag? A lot. How many succeeded? None in the long term. The EU and its Euro will fail, it is only a matter of when.
Comment to Akash,
it doesn’t matter whether you are berish or not. The main thing is to be in control. Buffet is very much in control of his companies. Therefore he could and will earn the money. Claus and Weiss are also in control whether they will earn on the Million Dollar Contrarian portfolio or not. As long as enough will buy the abonnement and the advices, their business is done. People with money invest in stock and bonds etc. not the earn money but as an atempt to secure their money earned else where. If you want to earn money the average divident the stock market can give is not enough and you have absolutly no control – too many unknown factors.
It’s amazing how long govt.’s can prolong the inevitable.Trillions of dollars put in the hands of banks/hedge funds who act as agents for the govt.will drive markets higher.We all know these are not normal markets.High unemployment,housing taking another hit,it will be years and years before the housing market gets back to normal.World currencies in trouble.Countries,states,cities in financial trouble.High inflation eating away at the few dollars people have left at the end of the week.When interest rates do rise,commodities will fall,strong currencies backed by countries with commodities/natural resources will take a hit.The govt. is definately scared to death about the stock market collapsing.It’s the only asset people have that has not collapsed.When your stock portfolio,401k,IRA,take a hit along with your worthless home,watchout.
Claus,
This may be out of the box thinking, but one option you didn’t mention was for Greece and all the troubled countries to leave the EU and print their own non-debt based currency. The European Central Banks want everyone to believe that there are no other options, but Europeans should be in outright revolt against their banking masters.
Brad O’ Neal, there is a problem with simply leaving the Euro. Greece will still owe boatloads of money for bills that are denominated in Euros. They can redenominate domestic obligations into their new currency, but that may not work with foreign obligations, especially ones (like oil purchases) that are recurring and therefore cannot be abrogated. The new Drachma will sink like Bin Laden in the ocean, so they won’t be able to print their way out of their problems.
The KBW nose dived in 2007-2008. It’s moved up a little since 2009 and has been basing for the past year. It hardly looks like it’s about to fall off a cliff. In spite of all the negatives you mention the market keeps going up because corporate earnings are strong. As long as they stay strong the market will continue to rise. The market wil probably continue to rise anyway due to inflation.
Claus, I am amazed at the continued lack of understanding on this problem. Real Estate is always worth something….more so if it’s paid off……it can and does generate income, even if someone says it’s dropped massively in “value.” Why we all have and continue to be duped into holding onto fiat money….or be linked to it via “investments” that when “settled” will pay out in the fiat money, is very tough for me to understand. I am not a beneficiary in the holding onto fait money or settlement in it.
The overt risk in doing so is too obvious, or should be by now…..If you want to earn a return….fine go look best how to do it…..start with a job and the income from it…….but as for demanding that ones assets/savings produce an income/return also…….well I think that just working on the plan that allows you to NOT loose your assets/savings is the necessary path to pursue, certainly over trying to earn a return. The risks in that are just NOT absorbed/understood enough by folks today. So loose some “return” and avoid loosing all that you have amassed……would seem to be to be the prudent way to go !!!
Dear Claus:
I have been reading your missives for quite a while now. Actually, since you were introduced to the Weiss team. I find your writings logical forthright. You mentioned and economic growth miracle amongst some other not so appealing alternatives in your article. We might have one. Andrea Rossi and Sergio Focardi (University of Bologna) appear to have discovered (rediscovered) Low Energy Nuclear Reactions (LENR) otherwise known as Cold Fusion. First demonstrated in January they have gone on to demonstrate it several more times in the past few months. According to Rossi he has made a deal with a Greek company(how poetic/ironic) to manufacture these devices and also 2 American firms. No names are given for the US companies. Seems that this is going forward. Have not heard of it? Its been all but completely ignored in US main stream media. If allowed to come to fruition this will be a game changer.
A seminal technology that will knock down oil and all the commodities leaving the Fed and other central banks to print, print, print and maybe, just maybe, print us out of this depression. I am hopeful but there are possible strong head winds. Anyway, take a look at it. I also hope that it is not bunkum.
Dear Claus,
I note your ‘escape hatches’ numbered one to six. However surely there are a few more to consider in no particular order:
7) Progressive taxation so that those who have more pay more.
8) The closing of tax loopholes so that large Corporations are compelled to pay their share of the tax burden.
9) Halting and reversing the ‘out-sourcing’ of the manufacture of goods and provision of services to cheap labour economies to stimulate employment at home.
Regards
Your Robin Hood syndrome is PATHETIC. Get help! Why should people who work hard to earn more and risk investing to make more automatically be targets to steal from?
Good answer to a liberal who does not recognize economic logic! Margaret Thatcher said it best; Liberalism works well spending other people’s money until it runs out!
Very interesting article , Claus is someone worth listing to. Some points that stood out. ” The U.S. is much more flexible, politically and as a society” , this is so true and the downside is the US will correct itself brutally where as the EU will try to cushion the fall and make it worse.” Yields on 2-year Greek bonds are well above 20 percent — a strong market signal that default is unavoidable” . I heard 15 percent but this is the key , maybe default is inevitable.
If a Greek default would actually be worse than the failure of Lehman, don’t you think that the ECB will do what is necessary to prevent it? What makes you think that the ECB won’t simply print up a few trillion Euros and buy up all that bad debt, and then restructure it so that Greece pays it off over time at a very low interest rate. In fact, the ECB could probably buy the debt up for pennies on the Euro if they wait until the brink of default before making the purchase. If they got it real cheap they could restructure it more easily without a formal loss to the ECB. It really is just a question of what pounds of flesh will be extracted from the PIGS in exchange for a bailout with printed money.
It took decades of dishonest govt policies to create this mess and I don’t think citizens have the patience or knowledge necessary for the cure to happen.Likely,we just keep going down long term,with some short term up and down cycles along the way.
This is an unusual Claus dour-dire forecast ( with which I have always agreed.) The unusuality is that the market sold off sharply in accordance with the prediction. Very frequently, it has been the opposite. Unfortunately, one day does not a trend make.
Claus, I agree 100%. The facts have been building to support this thinking of a similarity with 2007/2008, only this time, we are replacing the housing sub prime debt catalyst with the sovereign debt crisis. In the end, it is all about debt and this is what happened during the Great Depression and also happened to Japan during the last 22 years since their equity and real estate markets burst. The question is, what happens from here. I would expect, the same assets to fall just like in 2008 (ie. Stocks, Commodities etc.) while cash, Treasuries, shorting the market will do the best, just like in 2nd half 2008. In short, we should have a pretty good “risk off” deflation trade coming straight ahead.
Are the derivatives used by the SKF etf make this a safe etf to invest in? Will they go “bellyup” like mortgage derivatives did?
Lawrence,
I don’t mean to be offensive but could you please leave your fairy-tale “cold-fusion” nonsense out of these discussions? I come here to learn – not waste time. Thank you.