Americans didn’t come up with a good debt reduction plan, incurring a S&P downgrade. This in turn results in the crashing of European markets. Just to make things clear, although the crash happened before the downgrade, note that due to information asymmetry, sell signals emerge before the event. Remember when George Soros sold all his equity and quit? That was already a sell signal for the downgrade. I suppose the sell signals on July 26th also suggested that something was cooking in S&P. The downward trend from there was sort of a danger alert confirming the downgrade. To be openly on the same page, I’m going to go ahead and say insider trading is deeply rooted into America, and thus sell signals reflecting the downgrade began before the actual event took place.
The European stock markets crashing reflects this downgrade. The downgrade would bring borrowing costs to record highs for Spain and Italy, and thus drag down all Eurozone nations. This in turn resulted in investors, seeing this chain of events, rapidly pulling out of European stock markets (especially Germany).
Now, looking forward. I’ll first talk about what I think is the more likely scenario, then a bull and bear case in my opinion
Eurozone Credit Ratings Drop in Turn: Eurozone Sheds Excess
A management quote I really like is: “If you don’t want to see someone the next day, it’s a sign you should fire them.” It’s about time Germany fired Greece. We all know that. It’s also time Germany fired the PIGS. Cost-benefit analysis: you either take a hit to your continent’s economy at the price of your own growth in the future, or you watch yourself stagnate with the rest. In what I think is the more likely case, I think Germany will go ahead and shed unnecessary nations from the Eurozone because we will begin seeing more downgrades. It will be good for everyone. What I really don’t like about human nature is that they are unwilling to take large short-term losses for even larger long-term gains. This experience will finally cause Germany the remove the Eurozone PIGS.
This allows for a Euro low point. The Euro will deflate, but on the long-run, Germany can see their (debatable use of this possessive adjective) Euro become a reserve currency alongside the U.S. dollar. I would propose buying Euros after the low point caused by shedding PIGS nations. I operate on the Chinese saying “don’t eat the tail and head of the fish so you’ll less likely choke on bones” philosophy so there is no reason to hastily enter the market. Plus, major currencies are likely to be less volatile. I would buy Euros if the given scenario occurs, the world economic situation has stabilized, and the remaining Eurozone nations push forward a potential debt-reduction plan. This scenario should push the new Euro into “reserve currency” status.
Depression 2.0: Credit Around the World is Tied Up
Well, it might not end so easily. I will write more about this worst case scenario in details later including how and how much it will hurt the world. But in essence, it’s the Depression-esque credit lock-up that drags everyone down. Except this time, it’s not speculators locking up credit, but sovereign nations. For the moment, let’s assume that each country is an investor. It will be like banks dragging each other down: governments will drag each other down. China has too much American debt, Germany and France’s central banks probably hold some amount of debt from all the Eurozone countries, and many nations rely on European consumption and American consumption for growth. France doesn’t really deserve that AAA, so they get knocked down, causing people to panic over Spain and Italy, causing them to downgrade. Portugal and Greece default, and America also fails to come up with a new debt reduction plan, giving them a downgrade too. Central banks try to save the markets. There will probably be a high point as things like QE3 and European bailout packages get rolled out. It solves problems on the short term, but credit lock-up is unavoidable.
At that point, borrowing costs will be too high, and not enough credit will be available at affordable rates. Governments can no longer do anything, and markets go in free fall. Depression 2.0. If above scenarios begin to occur, get rid of everything and get out before you can’t sell your securities. Gold will become a good buy at this point. Again, I operate on a very conservative ideology. Don’t go for the “rebound” because that will just fuel the problem more. Follow David Soros’s example and say: “you know, I’m going to just give the money back to my investors and sit out for now.”
Problems are solved: World leaders gain some common sense
I’m not going to lie: this is solvable. I’m not going to go into details about how each country should be saving themselves. That would probably be a few hundred pages of analysis and I probably can’t handle writing industry reports AND distilling them down. Point being, it hasn’t happened yet. I want to just go ahead and say that people should get rid of the bad habit of being unable to take short-term losses. One nation I admire is Japan. After the nuclear crisis, they have serious energy quotas for the country. Yet, the Japanese, to keep their country afloat, only uses 70-80% of that quota.
In short, I’m going to distill it down to this: if the government is signing a series of plans that you are furious about, look to see the crisis ease on the long-run. Not that I’m a responsible person either. I planned to write this blog entry two weeks ago, but procrastination got in the way. Lesson being: people can’t be bothered to spend lots of time and pain to do things. Unfortunately, I see this proposal as not likely working, because it requires us to overcome a human characteristic that simply is impossible for the majority.