For the longest time, I have attempted to warn about the dangerous level of debt in the system. What is often overlooked is not what is posted and obvious to the naked eye, but rather, what lies beneath the surface of it all, derivatives. Derivatives are simply bets about the success or failure of a particular investment. When you are in the middle of a debt crisis, you want to avoid debt, plain and simple. Derivatives are like turbo charged debt instruments on steroids. Well, if you need a picture to see what that looks like, here ya go…
What we just witnessed happen in Greece and the DOW dropping over 1,000 points on May 6th is to about a lack of confidence because of the debt monster. The reason most people don’t understand the nature of this is because most of the financial media is confused as well. We’re told that “fat fingers” from one trader is the reason for the 1,000 point drop in the DOW. Do you REALLY believe this? People are trying like mad to find a scape goat to blame for what is happening. Take a look at the picture below to get an idea of what we’re facing. Just replace Greece with almost all governments and you begin to get an idea of what is to come.
Debt Crisis, What This Is – What This Isn’t
What is happening in terms of Greece, the 1000 point drop in the Dow Jones, etc. is global in nature. Those looking to remedy the situation by placing Goldman Sachs on probation, as if that is the answer, are the same people who thought paddling mischiefs in grade school would actually make a difference in their behavior.
What we are facing is not something that can be fixed by looking in the rear view. Look at the picture above. The monster is out of the bottle and running rampant. This is a Debt Crisis that’s been going on since 2007. You need to stop listening to the nonsense spouted on the mainstream financial media, for they are utterly confused and just making the problem worse. By making up ridiculous excuses for what is actually occurring, it only makes the problem that much worse as it adds to the confusion. This is not “to doom and gloom.”
Capital markets are simply confused and money is rattling around the globe, seeking safety, like a pinball bouncing off bumpers. This confusion is what causes the massive sell offs in the market place, not some trader pressing b instead of m. That’s utter nonsense. Capital concentrates, sort of like a glob or mass if you will. When it gets scared, it moves. like the flip of a light switch. This movement can cause market declines that look like a waterfall. This is what we witnessed in the 2000 tech bubble, 2007 real estate bubble and in 2008 market meltdown. Do you see a pattern?
Here is what you have to understand: When inside a debt crisis, all “crap debt” that is not payable, unravels. It defaults, never to be paid back. Now, think debt in terms of quality on a continuous line. On one side you have the worst quality and the other the highest quality. First, you saw the sub prime lenders default; this was expressed in record foreclosures. Moving up the food chain, you saw the investment banks fail (Bear Stearns, Lehman, etc) Then it was the big banks like Wachovia and WAMU. Well, keeping in line with our continuous line, what do you think is next? Yes countries. First it’s the smaller ones (Iceland and Greece) Do you really think, it stops with Greece? Remember, all bad debt gets wiped out.
The reason gold and the dollar are both making new highs, post the Greece saga is that capital is seeking safety and fleeing risk. But you can’t look at this through the eyes of the U.S. only. Greece goes bad – so capital flees the Euro and heads into the US Dollar, Canada, Australia and Gold. So, automatically we’re told that Greece is the “bad boy” and should be dropped from the Euro because they have to borrow to pay their debts. If you believe this, you have to wake up because this is an international debt crisis.
The fact that we had a 1000 point drop in a day in the DOW is only a preview as to what kind of volatility we should expect going forward. What you have to realize is that everything is linked on a global scale. Yes, Greece has to borrow to pay its budget. So, does the US. What you are seeing happening in Greece is a sneak preview of what is coming to the U.S. How can I say this? Easy. As I referred to above, what do you think happens to the U.S. when Japan and China no longer fund our budget because they run out of “spare change?” Just look at Greece.
As more and more debt defaults capital will only become more confused and seek out quality. First, that will be liquidity; again the reason the dollar and gold are rising in tandem for now. Then, it will seek quality stocks (with no debt) and other forms of “quality” investments. Quality is the opposite of debt. The most tricky thing to grasp now is sifting through the constant propaganda and realizing that the most dangerous investments are actually residing in the public domain on the state, federal and international level as they are the most debt laden entities. The real confusion will begin when the stock markets rise with gold. Remember capital will move away from debt ultimately.
Expect volatility and be careful!
Related posts:
Hey Mike,
The question is, in the face of all of this recent turmoil and the GFC, how do we keep using our resources most efficiently? How do we employ the many people unemployed currently? How do we get underutilized production capacity rolling again?
I’ve recently been having a bit of a shift in my thinking; to me, money and debt are just abstractions; it seems silly to me that so many people cannot find work because companies are selling less than they used to, because people aren’t buying, which then turns into a cycle… when there is so much work to be done in this world. There is always something more productive to do than being unemployed and sitting at home, collecting a check.
On one hand you can say that it encourages moral hazard to bailout those foolish guys who went into too much debt, and I agree with that. The market should punish the profligate and reward the responsible. However, this assumes that resources can be used by the responsible. When you have a monetary mess that leaves resources unused and sitting idle, putting people out of work and thus starting a spiral of foreclosures, defaults, and austerity, that seems kind of wasteful.
On one hand, I agree with the austrian way of thinking that says that continuing to reflate will just set up the stage for an even bigger bust later; we are not letting the system clean itself out. Capital hasn’t been properly allocated, and we need to let it sort itself out based on the proper incentives of punishment for profligacy and rewards for responsible behavior.
On the other hand, this sort of deflationary spiral seems like it could be a self-fulfilling prophecy. As people stop buying things, companies lay off workers, who subsequently can no longer afford to buy goods thus putting more pressure on companies to lay off workers. Eventually you end up with millions out of works, far less goods being produced, and many homes in foreclosure. Prices would fall through the floor, which is good for those who saved but bad for those who have a mortgage to pay off.
The austrians imply that this would clean out the system, setting the stage for a true recovery, but it seems like a pretty harsh and wasteful way to go about it, since you end up with tens of millions of people just sitting around, not doing anything except maybe collecting UI cheques. In terms of real wealth, you end up with underutilization of resources and thus less real wealth to go around, whereas if you keep the deflation from happening you at least keep things humming along which means more use of resources and more real wealth to go around.
This is all theory, of course, and I am by means no expert, but perhaps what it all means is that a bust is not necessarily such a great thing because of the waste of resources. Bailouts are bad, too, since they perpetuate poor use of resources. Perhaps there is a middle ground of some sorts here, and perhaps sovereign debt needs to be looked at in another way. I am still working through these new ideas; perhaps something else to blog about at some point
What do you think?
Well thought out Kevin. IMO we’re beyond Keynesian vs. Austrian comparisons. That was for 2000-02. I wish I saw it different but I series of defaults coming. When this occurs there will not be anymore Bailouts but simply capital lost in the form of debt. There is no sense in expecting rational outcomes when governments have used debt as the solution to our problems. The Feds original job was to provide liquidity “on the margin” of business cycles.
The paradox of the situation is that when you remove the drug, debt, the system collapses. Anyone who doubts this only need to look and how desperate Greece became. To think this stops with Greece is to believe the lie from 2007 that this was contained to sub prime.
This isn’t about going back to the gold standard. It’s simply a debt crisis and a flight to quality. This is evident in the fact that gold is rising against all other currencies.