Yesterday was an ugly day on the markets.
And little wonder. Here’s what’s bothering investors: the world is weighed down by debt. The only painless way to break free of that debt, is to grow our way out of it.
This is where we hit a snag. Global growth seems to have hit a brick wall. The payroll figures from the US on Friday (which showed that a grand total of no jobs were created in August) were just the latest in a litany of economic data pointing to a severe slowdown across the world.
If we can’t grow our way out of debt, that means we’re left with the painful options. You can default; you can embrace debt slavery by slashing spending and dedicating all of your resources to repaying debts; or you can combine the two options by inflating your way out of debt.
None of those options is pleasant. But as eurozone members are currently finding out, crossing your fingers and praying for growth is no longer an option…
The eurozone crisis is getting worse
With US markets shut yesterday, the eurozone was the main thing on investors’ minds. As World Bank President Robert Zoellick told Bloomberg, “we are moving into a dangerous period,” with Europe facing a “particularly sensitive time.”
There were rumours that a credit rating agency was preparing to downgrade Italy. The latest Greek bail-out is in confusion over demands from the Finnish for collateral to back their part of the loan. And a grim regional election result in Germany over the weekend for Angela Merkel’s party raised fears that voters may not be in the mood for more bail-outs.
Italy saw its ten-year borrowing costs rise by the most in almost two months. Spanish bond yields also jumped. What really unnerved the market is that the European Central Bank has been intervening in the market a lot more aggressively than anyone had expected. Last week it bought €13.3bn in eurozone government bonds, twice the total of the previous week.
As we’ve noted already, the bottom line is this: there is too much debt in the world. It can’t be repaid at the terms agreed when the money was lent out. So that means that somebody is going to carry the losses. The fundamental problem with the eurozone right now is that no one is sure exactly how that is going to play out.
The three ways to deal with bad debt
You can deal with debt through default. You admit the debt is bad, and just wipe the slate clean. That’s what Iceland did. It was painful, and continues to be. But the country is seeing the light at the end of the tunnel, and has been able to return to the capital markets to borrow money.
You can deal with it through severe austerity. You break your back if necessary to slash costs and carry as much of the debt burden as you can, and write the rest off. That’s what Ireland is doing. That’s been painful too, and still is. But as my colleague David Stevenson noted yesterday, bond yields. Borrowing costs for Ireland too, have fallen from their highs.
Or you try to deal with it by stealth. You repay the debt in devalued currency. So far, that’s the plan being followed by both Britain and the US. And it’s also the plan that markets would really like Europe to follow too. This, ultimately, is what a ‘Eurobond’, or an agreement by the European Central Bank to do quantitative easing, would be.
So far, that’s resulted in a drawn-out painful process where the standard of living for the vast majority is declining. Meanwhile, no one is quite sure what will happen next, and as a result, is not prepared to invest for the future. But it does mean that the banks can keep pretending to be solvent, and their chief executives can still get paid vast sums.
I favour default, I must say. That way you punish lenders who failed to do their jobs properly, and clear a space for more competent ones. You also rapidly and cleanly reduce asset prices to levels where those with capital to deploy are keen to jump in. That can include pejoratively-named ‘vulture’ funds. Or it could be the army of first-time buyers who still can’t afford to buy property in the UK, for example. It’s the fairest way to do it.
But it doesn’t matter what I think. So far inflation is the favoured option for those governments that have the choice. The worry for Europe is that there’s a chance it will be forced into the ‘default’ option before politicians can agree on a way to go for the ‘inflation’ option instead.
What should you do? Stick with safe gold. It will continue to do well as long as the Federal Reserve continues to go for the inflation option. It may well also benefit from the Swiss National Bank’s attempts to protect its currency from strengthening any further by pegging it at 1.20 francs to the euro. With one so-called ‘safe haven’ out of commission, demand for others can only grow.
Meanwhile, the euro is looking very wobbly again. If you fancy trying your hand at trading it – bearing in mind that playing currencies is pure speculation and so very risky – then spread betting is one of the easiest ways to do so for a private investor. You can find out more about how to go about it, and tactics for minimising losses and maximising profits, in our free MoneyWeek Trader email.
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