The Financial System's Death Knell? Or an Over-Reaction?
An Over-Reaction to Current Debt Issues
Those that are sophisticated enough and experienced enough, know that after every exuberance in an economic cycle, financials matters become so difficult that many come to the conclusion that "This Time It Is Different". Analysts come to the conclusion that there is no escape from the inevitable and doom and gloom is here to stay. In the economic cycle that recently collapsed, matters were a bit different. In the US, there was a Fed Chairman named Greenspan, who came to the conclusion that economic cycles could be smoothed out by printing money every time a bump appeared on the economic horizon. The result was that in the mess that followed, the downturn was far more exaggerated that it would otherwise be.
An Example of The Extremes of Doom and Gloom
On July 18th, 2012, the German government sold US$5.13 billion worth of 2-year bonds at an average yield of -0.06%, that is MINUS 0.06%. In other words, you invest your money in order to get less money that you started with, when the investment matures. The German government borrowed money for less than nothing. When those specific bonds expire in two years' time, the German government will pay back the original $5.13 billion minus 0.06%.
This year the Netherlands, Switzerland and France have also issued short-term government debt at negative yields. Like Germany, they've been able to do this because European bond investors would rather park money in a bond that's guaranteed to only lose a small amount rather than risk losing more in a PIIGS bond in which they would actually earn some interest.
To be fair in describing this phenomena, the investors had another rationale. These investors view German, French and Dutch bonds to be cheap options on the possible break-up of the Eurozone. If the EU currency union collapses, euro-denominated bonds issued by those specific countries will likely be paid back in re-issued deutschmarks, francs or guilders, which will be more valuable than the euros that were spent to buy the bonds in the first place. Viewed this way, it is an inexpensive way to bet on the disintegration of the ECU. As a result of this thinking, the bond market auctions for these select countries have seen overwhelming demand, making NIRP (Negative Interest Rate Policy) the new ZIRP (Zero Interest Rate Policy)
Buy When There is Blood in the Streets
Baron Rothschild once said "Buy When There is Blood in the Streets. Many successful investors, including Warren Buffet, and so many others, have recognized that the world continues after every economic cycle. Exuberance rises to the extreme, and then collapses, and when it does it brings misery, losses, and fear. Despondency produces a loss of hope, and when the market in houses, or investments, or stocks, or currencies, bottoms, those that realize what has happened start investing and buying. Those that do so, profit enormously.
Investing in Gold
Those of great doom and gloom, seize upon the historical value of gold, and repeat the beliefs that one must invest in bullion (gold) to survive the coming financial apocalypse. It is true that gold has had almost a continuous rise in value since it was worth $250 to the time it reached a value of $1,900 in 2011. Still, in spite of a number of attempts to break out above that high, gold has stagnated in the same $1,600 to $1,750 range for over a year now. Today, it was trading at $1,704. It has not reached $2,500 or $5,000. It, like all other asset classes has reacted to the economic downturn in a measured and reasonable way. In previous posts, I tracked gold and the reasons and technical analysis of gold and shall not repeat this herein.
What to Do
As in every cycle, this too shall pass. The US fiscal cliff will be resolved. Politicians will posture and pontificate, but in the end, reason will win out, the debt ceiling will be raised, expenditures will be cut and taxes will be raised. As the US economy gradually improves, as it always has and always will, natural growth and minor inflation will slowly over the next decade or two, make the deficit seem a bit smaller every year, until it is no longer so significant in relation to the GNP. The actual amount of US debt, although far too high, is only slightly above historical highs. The tragedy is that those previous debts were incurred for national defense and matters of extreme urgency. This debt is indirectly the fault of Alan Greenspan and the US government.
At any rate, the USA will not disappear and USA assets will recover in value. The European Economic Union is probably fatally flawed, but the countries comprising the EU remain individually as they were. Whatever economic strength lost in the EU, has been more than replaced by the rise of China. The world is not ending, and the next cycle is already commencing.