Europe's dilemma: Print money or cut debt?
The euro wasn't built for this continuing battle to establish financial rules, pitting more-prudent countries against those requiring bailouts.
Given all the recent chaos in financial markets around the globe, I thought I would step back and try to shed light on the commotion, taking a view from 10,000 feet in an attempt to get to the heart of the issues.
What the world is witnessing is the continuing epic battle between the printing press and excessive debt held by governments at the federal, state and local levels, as well as too much leverage on the part of the world's financial institutions.
That was also the situation the U.S. faced in early 2008 as the real-estate bubble burst. (It was worse then, at the financial-institution and consumer levels, though not at the sovereign level.) The response to fears of an ensuing financial-system collapse brought the massive rescue (bailout) programs and global quantitative easing -- governments pushing money into the economy -- which arrested that decline and levitated the world's stock and bond markets.
That process recently hit a snag, temporarily tipping the battle in favour of the debt problems, largely because Greece didn't have its own printing press with which to continue the game. (Other troubled euro nations -- Portugal, Ireland, Italy and Spain -- don't either.)
Thus we have been dealing with the consequences of over-indebted countries seeing their bond markets tank and overleveraged financial institutions tanking because they own too much of the wrong kind of paper.
The European Central Bank has essentially decided to stand down from its talk about austerity (with the German populace being dragged along kicking and screaming), and it has decided to monetize euro government debt -- in essence, to print money.
However, for the ECB to really unleash its guns, countries in Europe need to vote to agree to it. So, the big challenge in the battle between the printing press and too much debt is basically a function of the way the euro was constructed.
So much for the euro
As I've said many times, it's a shame that the ECB's attempt to create rules for financial stability has been the undoing of the euro. On the other hand, this was always to be the outcome, because the disparate member countries were never going to agree in tough times. And, oh, by the way, the ECB and European Union didn't insist on countries following Germany's somewhat orthodox and austere economic path when they allowed countries like Greece to join.
So, the euro is in turmoil. Most likely, it's damaged for good as a potential currency with any real value, if that statement isn't an oxymoron on its face.
In the beginning of this "Greek" crisis, I said that either the euro would be watered down or that the Germans or Greeks would leave. Now the euro has been watered down, and I believe that ultimately the Germans will probably leave.
Germany is one of the few countries on the planet willing to pursue austerity and prudence in some form because it believes that, in the end, a solid currency is an important asset to have (which it is). However, the rest of the world is not going to pursue the kinds of policies Germany does.
Another reason for the pressure in markets has been the Chinese trying to put on the credit-growth brakes. I believe that if that situation becomes even dicier, they will back off from their tightening moves, especially because the yuan has screamed higher versus the euro.
Yes, that was a crash
Recently there has been a lot of talk about a potential crash. However, I believe that an as-yet-unrecognized crash has occurred (and it still may be continuing). What we experienced on May 6 was not a "fat finger" event but rather a good, old-fashioned crash that just didn't last all that long.
The conditions were ripe for that collapse to happen because the market has been boosted by money printing and quantitative trading. Thus it was a market underpinned by balsawood as opposed to girders of steel.
What's different about this wipeout versus all the others I've seen in the past 30 years is that this was initially led by the indexes, not individual stocks, though I'm not sure exactly what that portends. Does it mean a generalized wipeout for all stocks is directly in front of us or that this was just an especially brutal correction?
I don't know, but I doubt we will see new highs in the stock market anytime soon. We would be lucky to see a giant trading range evolve, but we could also see a bear market evolve.
What I do know is that any sort of serious equity weakness will be met with enormous quantities of money and, potentially, new bailouts. The treacherousness of the environment is why I have had no involvement with stocks generically (excluding Microsoft (MSFT.O), the publisher of MSN Money) and prefer investment ideas that benefit from money printing -- like gold, gold mining and related businesses.
At the time of publication, Bill Fleckenstein was long Microsoft and owned gold.
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