How far does the stock market have to go down before we officially call it a crash? The Dow is now down more than 2,000 points in just the last 14 trading days. So can we now call this “The Stock Market Crash of 2011”? Today the Dow was down 519 points. Yesterday, an announcement by the Federal Reserve indicating that the Fed would keep interest rates near zero until mid-2013 helped the Dow surge more than 400 points, but all of those gains were wiped out today. It turns out that the Federal Reserve was only able to stabilize the financial markets for a single day. Fears about the European sovereign debt crisis and the crumbling U.S. economy continue to dominate the marketplace. With each passing day, things are looking more and more like 2008 all over again. So what is going to happen if “The Stock Market Crash of 2011” pushes the U.S. economy into “The Recession of 2012”?
Just like in 2008, bank stocks are being hit the hardest. That was true once again today. Bank of America was down more than 10 percent, Citigroup was down more than 10 percent, Morgan Stanley was down more than 9 percent and JPMorgan Chase was down more than 5 percent.
Bank of America stock is down almost 50 percent so far this year. Overall, the S&P financial sector is down more than 23 percent in 2011 so far.
How soon will it be before we start hearing of the need for more bailouts? After all, the “too big to fail” banks are even bigger now than they were in 2008.
All of this panic is causing the price of gold to reach unprecedented heights. Today, gold was over $1800 at one point. If the current panic continues for an extended period of time, there is no telling how high the price of gold may go.
In the United States, much of the focus has been on the fact that the U.S. government has lost its AAA credit rating, but the truth is that the European sovereign debt crisis is probably the biggest cause of the instability in world financial markets right now.
The European Central Bank has decided to start purchasing Italian and Spanish debt, and there have been rumors that French debt could be hit with a downgrade. Europe is a total financial basket case right now and unless dramatic action is taken things are going to get progressively worse.
Of course the U.S. is also certainly contributing greatly to this crisis. The federal government is on track to have a budget deficit that is over a trillion dollars for the third year in a row. The U.S national debt is a horrific nightmare, but our politicians keep putting off budget cuts.
The debt ceiling deal that was just reached basically does next to nothing to cut the budget before the next election. Unless the “Super Congress” does something dramatic, the only “budget cuts” we will see before the 2012 election will be 25 billion dollars in “savings” from spending increases that will be cancelled.
The modest spending cuts scheduled to go into effect beginning in 2013 will probably never materialize. Whenever the time comes to actually significantly cut the budget, our politicians always want to put it off for another time.
But in the end, debt is always going to have its day. Our politicians can try to kick the can down the road all they want, but eventually a day of reckoning is going to come.
In fact, if the U.S. and Europe had not piled up so much debt, we would not be facing all of the problems we are dealing with now.
Things could have been so much different.
But here we are.
The truth is that this debt crisis is just beginning. There is no magic potion that is going to make all of this debt suddenly disappear.
Most Americans have no idea how much financial pain is coming. We have been living way beyond our means for decades, and now we are going to start paying for it.
Now that long-term U.S. government debt has been downgraded, huge numbers of other securities are also going to be affected. In fact, according to a recent Bloomberg article, S&P has already been very busy slashing the ratings on hordes of municipal bonds….
Standard & Poor’s lowered the AAA ratings of thousands of municipal bonds tied to the federal government, including housing securities and debt backed by leases, following its Aug. 5 downgrade of the U.S.
That is the thing about financial markets – once the dominoes start to fall, the ripple effects can be felt for a long, long time.
So if this stock market crash gets even worse, will the Federal Reserve respond with even stronger measures?
They have already basically promised to keep interest rates near zero for the next two years. So what else can the Fed do?
Well, many now believe that there is a very good chance that we could see another round of quantitative easing.
Not that more quantitative easing is going to help much of anything. Rather than helping the economy, the last round of quantitative easing just pushed commodity prices through the roof. But the Fed is unlikely to just sit there and do nothing while financial markets struggle.
But it is not just the financial markets that are having a difficult time right now. Bad news is coming in from all over the economy. The possibility that we could soon slip into another major recession is growing by the day.
Unfortunately, our economy is so weak already that a new recession would probably hurt even more than the last recession did.
Mark Zandi, the chief economist at Moody’s Analytics, says that if we have another recession it “won’t feel like a new recession. It would likely feel like a depression.”
But the American people are in no mood for more economic pain. Every recent poll shows that Americans are already fed up.
For example, a brand new Reuters/Ipsos poll found that 73 percent of the American people believe that the country is “on the wrong track”.
So let’s certainly hope that the current stock market crash does not set off another major global recession. We certainly do not need things to get significantly worse than they are right now.
But whether it hits now or later, the truth is that a whole lot of economic pain is on the way. The U.S. and Europe have been making really, really bad decisions for decades, and we are not going to be able to escape the consequences of those decisions.
The global financial system is one huge mountain of leverage, risk and debt. A collapse is inevitable.
When you build a house of cards on a foundation of sand, you should not be surprised when it comes crashing down.
The next wave of the economic collapse is coming, and those that are wise will get prepared.
Did anyone really think that Italy would be able to get through this thing without needing a bailout? Just when you thought that things in Europe could get back to normal for a little while, here comes Italy. On Friday, there was a bit of a “mini-panic” as investors started dumping Italian financial assets. European officials are concerned that the sovereign debt crisis that has ravaged Greece, Ireland and Portugal will now put the Italian economy through the wringer. European Council President Herman Van Rompuy has called an emergency meeting for Monday morning. He is denying that the meeting is about Italy, but everyone knows that Italy is going to be discussed. European Central Bank President Jean-Claude Trichet and European Commission President Jose Manuel Barroso along with a host of other top officials will also be at this meeting. If it does turn out that Italy needs a bailout, it is going to change the entire game in Europe.
What is going on in Italy right now is potentially far more serious than what has been going on in Greece. Italy is the fourth largest economy in the European Union. If Italy requires a bailout, the rest of Europe might not be able to handle it.
An anonymous European Central Bank source told one German newspaper the following on Sunday….
“The existing rescue fund in Europe is not sufficient to provide a credible defensive wall for Italy”
The source also added that the current bailout fund “was never designed for that“.
Italy has already implemented austerity measures.
This was not supposed to happen.
But it is happening.
This latest crisis was precipitated by a substantial sell-off of Italian financial assets on Friday. An article posted by Bloomberg described the pounding that the two largest Italian banks took….
UniCredit SpA (UCG) and Intesa Sanpaolo SpA (ISP), Italy’s biggest banks, fell to the lowest in more than two years in Milan yesterday as contagion from Europe’s debt crisis threatened to spread to the region’s third-largest economy.
UniCredit plunged 7.9 percent, the biggest decline since March 30, 2009, while Intesa dropped 4.6 percent. Both hit lows not seen since the period when markets were emerging from the crisis spawned by the collapse of Lehman Brothers Holdings Inc.
Unfortunately, this is just the continuation of a trend that has been going on for a while.
When you look at them as a group, the stocks of the five largest Italian banks have lost 27% since the beginning of 2011.
That is not a good sign.
Also, investors are starting to dump Italian government debt. Reuters says that the yield on 10 year Italian bonds is approaching the danger zone….
The spread of the Italian 10-year government bond yield over benchmark German Bunds hit euro lifetime highs around 2.45 percentage points on Friday, raising the Italian yield to 5.28 percent, close to the 5.5-5.7 percent area which some bankers think could start putting heavy pressure on Italy’s finances.
The Italian national debt is now up to about 120 percent of GDP. The Italian government would be able to manage it if interest rates were very, very low. But unfortunately they are rising fast and if they get too much higher they are going to become suffocating.
As I have written about previously, government debt becomes very painful once you take low interest rates out of the equation. For example, if Greece could borrow all of the money that it wanted to borrow at zero percent interest, it would not have a debt problem. But now the yield on 2 year Greek bonds is over 30 percent, and there is not a government on the face of the earth that can afford to pay interest that high for long.
Unfortunately for Italy, this could just be the beginning of rising interest rates. Just recently, Moody’s warned that it may be forced to downgrade Italy’s Aa2 debt rating at some point within the next couple of months.
If things continue to unravel in Italy, all of the credit agencies may downgrade Italy sooner rather than later.
The frightening thing about Italy is that a financial crisis has a way of exposing corruption, and there are very few countries that can match the kind of corruption that goes on in Italy.
As a child, I had the chance to live in Italy. I love Italy. The people are friendly, the weather is great, the architecture is amazing and the food is spectacular. I will always have great affection for Italy and I will always cheer for the Italian national team when the World Cup rolls around.
However, I also know that corruption is deeply ingrained into Italian culture. It is simply a way of life.
Just check out the prime minister of Italy. Silvio Berlusconi is the consummate Italian politician. He is greatly loved by many, but it would take days to detail all of the scandals that he has been linked to.
At this point, Berlusconi has become a parody of himself. Each new sex scandal or financial scandal just adds to his legend. Italy is one of the only nations in Europe where such a corrupt politician could have stayed in office for so long.
Not that the U.S. government is much better. Our government becomes more corrupt with each passing year.
But the point is that if a financial collapse happens in Italy and people start “turning over rocks” it could turn up all sorts of icky stuff.
So what is Europe going to do if Italy needs a bailout?
Well, they are probably going to have to fire up the printing presses because it would probably take a whole lot more euros than they have right now.
The truth is that the EU has now entered a permanent financial crisis. You have a whole bunch of nations that have accumulated unsustainable debts and that cannot print their own currencies. The financial system of the EU as it is currently constructed simply does not work.
Some believe that the sovereign debt crisis will eventually cause the breakup of the EU. Others believe that this crisis will cause it to be reformed and become much more integrated.
In any event, what just about everyone can agree on is that the financial problems of Europe are not going away any time soon. For now, EU officials are keeping all of the balls in the air, but if at some point the juggling act falters, the rest of the world better look out.
A financial crash in Europe would be felt in every nation on earth and it would be absolutely devastating. Let’s hope that we still have some more time before it happens.
In the past, there certainly have been governments that have gotten into trouble with debt, but what we are experiencing now is the first truly global sovereign debt crisis. There has never been a time in recorded history when virtually all of the governments of the world were drowning in debt all at the same time. This sovereign debt crisis is never going to end until there is a major global financial collapse. There simply is no way to unwind the colossal web of debt that we have constructed in an orderly fashion. Right now the EU and the IMF have been making “emergency loans” to nations such as Greece, Ireland and Portugal, but that is only going to buy those countries a few additional months. Giving more loans to nations that are already drowning in red ink may “kick the can down the road” for a little while but it isn’t going to solve anything. Meanwhile, dozens more nations all over the globe are rapidly approaching a day of reckoning.
All of the bailouts that you are hearing about right now are simply delaying the pain. The reality is that when the “emergency loans” for Greece stop, Greece is going to default. Greece is toast. The game is over for them. You can stick a fork in Greece because it is done.
One of the big problems for Greece is that since it is part of the euro it can’t independently print more money. If Greece cannot raise enough euros internally Greece must turn to outside assistance.
Unfortunately, at this point Greece has accumulated such a mammoth debt that it cannot possibly sustain it. By the end of the year, it is projected that the national debt of Greece will soar to approximately 166% of GDP.
The financial collapse of Greece is inevitable. If they keep using the euro they will collapse. If they quit using the euro they will collapse. When the rest of Europe decides that it is tired of propping Greece up the game will be over.
At this point very few people are interested in lending Greece more money.
As I wrote about yesterday, many of the nations around the world are only able to keep going because they are able to borrow huge amounts of money at low interest rates.
Well, nobody wants to lend money to Greece at a low rate of interest anymore.
Today, the yield on 2 year Greek bonds is back over 28 percent.
Fortunately for the rest of the world, Greece is just a very, very small part of the global economy, but when interest rates start spiking like that on U.S. debt or Japanese debt the entire world financial system will be thrown into chaos.
So why is there so much of a focus on Greece right now?
Well, there is a real danger that the panic will start to spread.
The other day, Moody’s Investors Service slashed the credit rating on Portuguese government debt by four notches.
Portuguese debt is now considered to be “junk”.
But even more alarming is that Moody’s stated that what is going on in Greece played a role in reducing the credit rating of Portugal.
The following is a portion of what Moody’s had to say when they cut the credit rating of Portugal by four notches….
Although Portugal’s Ba2 rating indicates a much lower risk of
restructuring than Greece’s Caa1 rating, the EU’s evolving approach to providing official support is an important factor for Portugal because it implies a rising risk that private sector participation could become a precondition for additional rounds of official lending to Portugal in the future as well. This development is significant not only because it increases the economic risks facing current investors, but also because it may discourage new private sector lending going forward and reduce the likelihood that Portugal will soon be able to regain market access on sustainable terms.
Do you understand what is being said there?
Basically, Moody’s is saying that the terms of the Greek bailout make Portuguese debt less attractive because Portugal will likely be forced into a similar bailout at some point.
If the EU is not going to fully guarantee the debt of the member nations, then that debt becomes less attractive to investors.
The downgrade of Portugal is having all kinds of consequences. The cost of insuring Portuguese government debt set a new record high on Wednesday, and yields on Portuguese bonds have gone haywire.
If you want to get an idea of just how badly Portuguese bonds have been crashing, just check out this chart.
But it is not just Portugal that is having problems.
Just recently, Moody’s warned that it may downgrade Italy’s Aa2 debt rating at some point within the next few months.
Spain is also on the verge of major problems and Ireland may need another bailout soon.
Things don’t look good.
Unfortunately, if the dominoes start to fall the entire EU is going to go down.
Big banks all over Europe are highly exposed to sovereign debt and they are leveraged to the hilt.
It is almost as if we are looking at a replay of 2008 in many ways.
When Lehman Brothers finally collapsed, it was leveraged 31 to 1.
Today, major German banks are leveraged 32 to 1, and major German banks are currently holding a tremendous amount of Greek debt.
Anyone with half a brain can see that this is going to end badly.
So how is the European Central Bank responding to this crisis?
They are raising interest rates once again.
That certainly is not going to help the PIIGS much.
But Europe is not the only one facing a horrific debt crunch.
In Japan, the national debt is now up to about 226 percent of GDP. So far the Japanese government has been able to handle a debt load this massive because the citizens of Japan have been willing to lend the government gigantic mountains of money at interest rates so low that they are hard to believe.
When that paradigm changes, and it will, Japan is going to be in a massive amount of trouble. In fact, an article in Forbes has warned that even a very modest increase in interest rates would cause interest payments on Japanese government debt to exceed total government revenue by the year 2019.
Of course the biggest pile of debt sitting out there is the national debt of the United States. The U.S. is so enslaved to debt that there is literally no way out under the current system. To say that America is in big trouble would be a massive understatement.
In fact, the whole world is headed for trouble.
Right now government debt around the globe continues to soar at an exponential pace. At some point a wall is going to be hit.
The Wall Street Journal recently quoted Professor Carmen Reinhart as saying the following about what we are facing….
“These processes are not linear,” warns Prof. Reinhart. “You can increase debt for a while and nothing happens. Then you hit the wall, and—bang!—what seem to be minor shocks that the markets would shrug off in other circumstances suddenly become big.”
That is the nature of debt bubbles – they keep expanding and expanding until the day that they inevitably burst.
Governments around the world will issue somewhere in the neighborhood of 5 trillion dollars more debt this year alone. Debt to GDP ratios all over the globe continue to rise at a frightening pace.
Because the world is so interconnected today, the collapse of even one nation will devastate banks all over the planet. If even one domino is toppled there is no telling where things may end.
The combination of huge amounts of debt and huge amounts of leverage is incredibly toxic, and that is what we have all over the globe today. Almost every major nation is drowning in a sea of red ink and almost all of our major financial institutions are leveraged to the hilt.
There is only one way that the sovereign debt crisis can end.
Very, very badly.
I hope you are ready for what is coming.
2011 has already been the most memorable year in ages and we haven’t even reached April yet. Revolutions have swept the Middle East, an unprecedented earthquake and tsunami have hit Japan, civil war has erupted in Libya, the price of oil has been soaring and the entire globe is teetering on the brink of economic collapse. It seems like almost everything that can be shaken is being shaken. Unfortunately, it does not appear that things are going to settle down any time soon. The Japanese economy has been dealt a critical blow, the European sovereign debt crisis could flare up again at any moment and the U.S. economy could potentially plunge into another recession by the end of the year. The global economy and world financial markets were really struggling to recover even when things were relatively stable. If all of this global instability gets even worse it could literally rip world financial markets apart.
Yes, things really are that bad. The mainstream media has been really busy downplaying the economic impact of the disaster in Japan and the chaos in the Middle East, but the truth is that these events have huge implications for the global economy. Today our world is more interconnected than ever, so economic pain in one area of the planet is going to have a significant effect on other areas of the globe.
The following are 10 economic disasters which could potentially rip world financial markets to shreds….
#1 War In Libya
Do you think that the “international community” would be intervening in Libya if they did not have a lot of oil? If you actually believe that, you might want to review the last few decades of African history. Millions upon millions of Africans have been slaughtered by incredibly repressive regimes and the “international community” did next to nothing about it.
But Libya is different.
Libya is the largest producer of oil in Africa.
Apparently the revolution in Libya was not going the way it was supposed to, so the U.S. and Europe are stepping in.
Moammar Gadhafi is vowing that this will be a “long war”, but the truth is that his forces don’t stand a chance against NATO.
Initially we were told that NATO would just be setting up a “no fly zone”, but there have already been reports of Libyan tank columns being assaulted and there has even been an air strike on Moammar Gadhafi’s personal compound in Tripoli.
So since when did a “no fly zone” include an attempt to kill a foreign head of state?
Let there be no mistake – the moment that the first Tomahawk cruise missiles were launched the United States declared war on Libya.
Already the Arab League, India, China and Russia have all objected to how this operation is being carried out and they are alarmed about the reports of civilian casualties.
Tensions around the globe are rising once again, and that is not a good thing for the world economy.
On a side note, does anyone recall anyone in the Obama administration even stopping for a moment to consider whether or not they should consult the U.S. Congress before starting another war?
The U.S. Constitution specifically requires the approval of the Congress before we go to war.
But very few people seem to care too much about what the U.S. Constitution says these days.
In any event, the flow of oil out of Libya is likely to be reduced for an extended period of time now, and that is not going to be good for a deeply struggling global economy.
#2 Revolutions In The Middle East
Protests just seem to keep spreading to more countries in the Middle East. On Friday, five Syrian protesters were killed by government forces in the city of Daraa. Subsequently, over the weekend thousands of protesters reportedly stormed government buildings in that city and set them on fire.
Things in the region just seem to get wilder and wilder.
Even in countries where the revolutions are supposed to be “over” there is still a lot of chaos.
Have you seen what has been going on in Egypt lately?
The truth is that all of North Africa and nearly the entire Middle East is aflame with revolutionary fervor.
About the only place where revolution has not broken out is in Saudi Arabia. Of course it probably helps that the United States and Europe don’t really want a revolution in Saudi Arabia and the Saudis have a brutally effective secret police force.
In any event, as long as the chaos in the Middle East continues the price of oil is likely to remain very high, and that is not good news for the world economy.
#3 The Japanese Earthquake And Tsunami
Japan is the third largest economy in the world. When a major disaster happens in that nation it has global implications.
The tsunami that just hit Japan was absolutely unprecedented. Vast stretches of Japan have been more thoroughly destroyed than if they had been bombed by a foreign military power. It really was a nation changing event.
The Japanese economy is going to be crippled for an extended period of time. But it is not just Japan’s economy that has been deeply affected by this tragedy.
According to the Wall Street Journal, the recent disaster in Japan has caused supply chain disruptions all over the globe….
A shortage of Japanese-built electronic parts will force GM to close a plant in Zaragoza, Spain, on Monday and cancel shifts at a factory in Eisenach, Germany, on Monday and Tuesday, the company said Friday.
Not only that, GM has also suspended all “nonessential” spending globally as it evaluates the impact of this crisis.
The truth is that there are a whole host of industries that rely on parts from Japan. Supply chains all over the world are going to have to be changed as a result of this crisis. There are going to be some shortages of certain classes of products.
Japan is a nation that imports and exports tremendous quantities of goods. At least for a while both imports and exports will be significantly down, and that is not good news for a world economy that was already having a really hard time recovering from the recent economic downturn.
#4 The Japan Nuclear Crisis
Even if the worst case scenario does not play out, the reality is that the crisis at the Fukushima Dai-ichi nuclear plant is going to have a long lasting impact on the global economy.
Already, nuclear power projects all over the world are being rethought. The nuclear power industry was really starting to gain some momentum in many areas of the globe, but now that has totally changed.
But of much greater concern is the potential effect that all of this radiation will have on the Japanese people. Radiation from the disaster at the Fukushima Dai-ichi nuclear plant is now showing up in food and tap water in Japan as an article on the website of USA Today recently described….
The government halted shipments of spinach from one area and raw milk from another near the nuclear plant after tests found iodine exceeded safety limits. But the contamination spread to spinach in three other prefectures and to more vegetables — canola and chrysanthemum greens. Tokyo’s tap water, where iodine turned up Friday, now has cesium.
Hopefully the authorities in Japan will be able to get this situation under control before Tokyo is affected too much. The truth is that Tokyo is one of the most economically important cities on the planet.
But right now there is a lot of uncertainty surrounding Tokyo. For example, one very large German real estate fund says that their holdings in Tokyo are now “impossible to value” and they have suspended all customer withdrawals from the fund.
Once again, let us hope that a worst case scenario does not happen. But if we do get to the point where most of the population had to be evacuated from Tokyo for an extended period of time it would be absolutely devastating for the global economy.
#5 The Price Of Oil
Most people believe that the U.S. dollar is the currency of the world, but really it is oil. Without oil, the global economy that we have constructed simply could not function.
That is why it was so alarming when the price of oil went above $100 a barrel earlier this year for the first time since 2008. Virtually everyone agrees that if the price of oil stays high for an extended period of time it will have a highly negative impact on the world economy.
In particular, the U.S. economy is highly, highly dependent on cheap oil. This country is really spread out and we transport goods and services over vast distances. That is why the following facts are so alarming….
*The average price of a gallon of gasoline in the United States is now 75 cents higher than it was a year ago.
*In San Francisco, California, the average price of a gallon of gasoline is now $3.97.
*According to the Oil Price Information Service, U.S. drivers spent an average of $347 on gasoline during the month of February, which was 30 percent more than a year earlier.
*According to the U.S. Energy Department, the average U.S. household will spend approximately $700 more on gasoline in 2011 than it did during 2010.
#6 Food Inflation
Many people believe that the rapidly rising price of food has been a major factor in sparking the revolutions that we have seen in Africa and the Middle East. When people cannot feed themselves or their families they tend to lose it.
According to the United Nations, the global price of food hit a new all-time high earlier this year, and the UN is expecting the price of food to continue to go up throughout the rest of this year. Food supplies were already tight around the globe and this is certainly not going to help things.
The price of food has also been going up rapidly inside the United States. Last month the price of food in the United States rose at the fastest rate in 36 years.
American families are really starting to feel their budgets stretched. According to the U.S. Labor Department, the cost of living in the United States hit a brand new all-time record high in the month of February.
What this means is that U.S. families are going to have less discretionary income to spend at the stores and that is bad news for the world economy.
#7 The European Sovereign Debt Crisis
Several European governments have had their debt downgraded in the past several months. Portugal, Spain, Greece and Ireland are all in big time trouble. Several other European nations are not far behind them.
Right now Germany seems content to bail the “weak sisters” in Europe out, but if that changes at some point it is going to be an absolute nightmare for world financial markets.
#8 The Dying U.S. Dollar
Right now there is a lot of anxiety about the U.S. dollar. Prior to the tsunami, Japan was one of the primary purchasers of U.S. government debt. In fact, Japan was the second-largest foreign buyer of U.S. Treasuries last year.
But now as Japan rebuilds from this nightmare it is not going to have capital to invest overseas. Someone else is going to have to step in and buy up all of the debt that the Japanese were buying.
Not only that, but big bond funds such as PIMCO have announced that they are stepping away from U.S. Treasuries at least for now.
So if Japan is not buying U.S. Treasuries and bond funds such as PIMCO are not buying U.S. Treasuries, then who is going to be buying them?
The U.S. government needs to borrow trillions of dollars this year alone to roll over existing debt and to finance new debt. All of that borrowing has got to come from somewhere.
#9 The U.S. Housing Market
The U.S. housing market could potentially be on the verge of another major crisis. Just consider the following facts….
*In February, U.S. housing starts experienced their largest decline in 27 years.
*Deutsche Bank is projecting that 48 percent of all U.S. mortgages could have negative equity by the end of 2011.
*Two years ago, the average U.S. homeowner that was being foreclosed upon had not made a mortgage payment in 11 months. Today, the average U.S. homeowner that is being foreclosed upon has not made a mortgage payment in 17 months.
*In September 2008, 33 percent of Americans knew someone who had been foreclosed upon or who was facing the threat of foreclosure. Today that number has risen to 48 percent.
#10 The Derivatives Bubble
Most Americans do not even understand what derivatives are, but the truth is that they are one of the biggest threats to our financial system. Some experts estimate that the worldwide derivatives bubble is somewhere in the neighborhood of a quadrillion dollars. This bubble could burst at any time. Right now we are watching the greatest financial casino in the history of the globe spin around and around and around and everyone is hoping that at some point it doesn’t stop. Today, most money on Wall Street is not made by investing in good business ideas. Rather, most money on Wall Street is now made by making shrewd bets. Unfortunately, at some point the casino is going to come crashing down and the game will be over.
Most people simply do not realize how fragile the global economy is at this point.
The financial crash of 2008 was a devastating blow. The next wave of the economic crisis could be even worse.
So what will the rest of 2011 bring?
Well, nobody knows for sure, but a lot of experts are not optimistic.
David Rosenberg, the chief economist at Gluskin Sheff and Associates, is warning that the second half of the year could be very rough for the global economy….
“A sharp slowing in global GDP in the second half of the year cannot be ruled out.”
Let us hope that the world economy can hold together and that we can get through the rest of 2011 okay. The last thing we need is a repeat of 2008. The world could use some peace and some time to recover.
But unfortunately, we live in a world that is becoming increasingly unstable. With the way that the world has been lately, perhaps we should all just start to expect the unexpected.
But world financial markets do not respond well to instability and unpredictability. In fact, investors tend to start fleeing to safety at the first signs of danger these days.
Most Americans simply have no idea how vulnerable the world financial system is at this point. Nothing really got “fixed” after 2008. If anything, global financial markets are even more fragile than they were back then.
So what do all of you think about the state of the global economy? Please feel free to leave a comment with your opinion below….
The price of oil is shaping up to be the number one economic story of 2011, and right now the eyes of the investing world are closely watching the developing situation in Saudi Arabia. All of the other recent Middle East revolutions have been organized on the Internet, and now all over Facebook and Twitter there are calls for a “Day of Rage” in Saudi Arabia on March 11. The Saudi monarchy is attempting to head off any protests by promising to give $37 billion in “benefits” to the people and by publicly proclaiming that all political demonstrations are specifically banned. In addition, the Saudi government is stationing thousands of security forces at various potential “hot spots” around the country. So far similar measures have not done much to quell unrest in other nations in the Middle East, but Saudi Arabia will be a true test of the revolutionary fervor that is sweeping the region. The Saudis have a long history of brutally repressing their own people. They simply do not mess around. So a revolution in Saudi Arabia will not be nearly as “easy” as it was in Tunisia, Egypt or Libya. However, if a revolution does sweep across Saudi Arabia, it is going to send the price of oil into unprecedented territory. Saudi Arabia is the number one exporter of oil in the world, and if their oil fields get shut down even for a little while it is going to have a dramatic effect on the global economy. With the world already on the verge of a major sovereign debt crisis, the last thing it needs is for the price of oil to start soaring into the stratosphere.
Right now the investing world is not sure what to think about all of this, and financial markets do not like uncertainty. One piece of really bad news could send markets all over the globe crashing down.
Speculation in oil futures is absolutely rampant. A recent report on CNN noted the following….
The speculative fervor is so remarkable that the big trading firms now have nearly twice as many long contracts open as they did in 2008, when oil spiked to $147 in the summer, a development that either foreshadowed or caused the global economic meltdown, depending on how you look at it.
In particular, the number of investors that are betting that a revolution in Saudi Arabia is going to send the price of oil up to $200 a barrel has exploded in recent days.
$200 a barrel?
Are people actually betting that is going to happen?
The all-time record is only $147 a barrel. Just a few months ago it was absolutely unthinkable to most economists that we could potentially see $200 oil in 2011.
But it would be a mistake to assume that a full-blown revolution is guaranteed to break out in Saudi Arabia. Remember, this is a nation that has a very, very long history of denying even the most basic freedoms to the people.
For example, in Saudi Arabia the practice of any religion other than Islam is strictly forbidden. By law, citizens of Saudi Arabia are not permitted to change religion. Even foreign visitors are forbidden to openly practice any other religion. It is a whole different world. You cannot go to the store and buy a Bible in Saudi Arabia. In fact, if you try to pass out Bibles in Saudi Arabia you will be thrown into prison.
Beheadings and other brutal public executions still happen in Saudi Arabia to this day.
So if you plan of being a revolutionary in Saudi Arabia you had better put your big boy pants on, because the Saudis play hardball.
Much of the rest of the globe is desperately hoping that a revolution does not happen in Saudi Arabia because the global economic situation is precarious at best.
In Europe, if the price of oil causes a significant economic slowdown right now it could have global implications. Moody’s Investors Service just slashed Greece’s debt rating three levels all the way down to B1. But Greece is far from alone. Several European governments are finding it much more expensive to finance their debts these days. We are right on the edge of a major European sovereign debt crisis and the chaos in the Middle East could potentially be just the thing to spark a panic.
The United States could feel a rise in the price of oil even more than Europe because the U.S. economy is so spread out and it is so dependent on products from overseas.
Did you know that in 1960 only 8 percent of the things Americans bought were made overseas but that today 60 percent of the things Americans buy are made overseas?
So what would happen if the cost of transporting all of those products suddenly doubled? All of the products we buy must be transported somehow, and a rise in transportation costs will be passed on to U.S. consumers.
But the truth is that the pain is already here. Already, millions of American families are starting to feel some very real financial pain from the chaos in the Middle East.
From February 18th to March 4th, the average price of gasoline in the United States rose 33 cents. That was the biggest two week increase ever recorded.
The rise in the price of oil has some broader economic implications as well.
The more the price of oil goes up the bigger our trade deficit is going become. As the trade deficit gets bigger, that means that more money is going out of the country and less money is going to support American businesses and American workers. When American workers lose jobs, that means that they aren’t producing wealth anymore and they aren’t paying taxes anymore. Instead, they become a drain on the system as they start receiving government handouts.
When millions of Americans go from being productive, taxpaying workers to unemployed welfare cases it causes our federal budget deficit to become even larger.
Most Americans do not understand how connected our trade deficit and our federal budget deficit really are. One feeds right into the other.
Unfortunately, the Federal Reserve seems to think that the solution to any economic problem these days is to print more money.
According to Atlanta Fed President Dennis Lockhart, if the price of oil goes up high enough, it could force the Federal Reserve to do even more quantitative easing.
One of the reasons why the price of oil and other commodities has been going up over the last six months is because of all of this reckless money printing.
Now Lockhart is saying that because of the oil price increases they may have to do more money printing?
How bizarre is that?
Unfortunately, several other top Fed officials have dropped hints about a possible “QE3” lately. It just seems like the insanity never stops.
Let us hope that the Fed does not go there because the U.S. dollar is falling apart fast enough already.
In any event, the rest of 2011 is certainly going to be very interesting to watch.
Even if a revolution does not happen in Saudi Arabia, the price of oil will most likely continue to slowly move higher just as it has been doing for months.
But if a full-blown revolution does happen in Saudi Arabia, it could literally change the global economy almost overnight. The entire world financial system would be thrown into a state of chaos.
Oil is the lifeblood of the world economy. Without a continuous supply of very inexpensive oil, life as we know it would dramatically change. Most of us just assumed that we would always live in a world where we would always have an endless supply of very cheap oil.
Well, the times they are a changing.
You had better buckle up because it is going to be a bumpy ride.
It seems like almost everywhere you turn these days there is bad economic news. Foreclosures are setting records, unemployment remains depressingly high, poverty is exploding, U.S. government debt is wildly out of control and Europe is on the verge of an economic collapse that could send the entire globe into a devastating financial panic. If all that wasn’t enough, the oil spill in the Gulf of Mexico has destroyed the seafood and tourism industries along the Gulf coast and threatens to push that entire region into a depression for years to come. The truth is that the more you look at the economic statistics coming in from around the globe the more it becomes obvious that we are headed for a complete and total economic nightmare.
Just consider some of the most recent economic news….
*The number of U.S. home foreclosures set a record for the second consecutive month in May. How can the U.S. housing industry be recovering when the number of Americans being foreclosed on continues to set all-time records?
*As of March, U.S. banks had an inventory of approximately 1.1 million foreclosed homes, up 20 percent from a year ago. Instead of working their way through the huge backlog of unsold homes, U.S. banks continue to pile up a massive inventory of foreclosed homes at a staggering pace.
*According to figures from the U.S. Commerce Department, housing starts in the United States fell 10 percent in May, the biggest decline since March 2009. The data also revealed that single-family home starts suffered the biggest drop since 1991. There is already a massive glut of unsold homes on the market, so builders simply do not think it is profitable to build many new homes right now.
*Officials now tell us that the cost of “fixing” Fannie Mae and Freddie Mac, the government-backed mortgage companies that last year bought or guaranteed the vast majority of all U.S. home loans, will be at least $160 billion and could grow as high as $1 trillion. The twin pillars of the U.S. mortgage industry have become financial black holes that the U.S. government endlessly pours massive amounts of cash into. That is not a good sign.
*Fannie Mae and Freddie Mac are to be delisted from the New York Stock Exchange because their stock prices have been trading under $1 per share for more than 30 trading days. The truth is that Fannie Mae and Freddie Mac would have completely imploded by now if the U.S. government had not decided to step in and bail them out.
*The average duration of unemployment in the United States has risen to an all-time high. Not only are a ton of Americans out of work, they can’t find work for a very, very long time once they are unemployed.
*For Americans younger than 25 years of age, the unemployment rate is 18.8%. But even those young Americans that can find employment often find themselves working in very low paying service jobs.
*Federal Reserve Chairman Ben Bernanke says that the U.S. unemployment rate is likely to stay “high for a while”. Considering how badly Bernanke has been doing his job, it would be really nice if we could add just one more person to the unemployment rolls.
*According to one new study, approximately 21 percent of children in the United States are living below the poverty line in 2010 – the highest rate in 20 years. There are hundreds of thousands of American children on the streets each night, and yet we continue to insist that we are the greatest country in the world.
*For the first time in U.S. history, more than 40 million Americans are on food stamps, and the U.S. Department of Agriculture projects that number will go up to 43 million Americans in 2011. How many tens of millions of Americans have to be on food stamps before we officially say that we are in a depression?
*According to the Wall Street Journal, the debates have begun inside the Fed about what it should do in the event of a “double dip” recession. If they are already debating what to do during the next economic downturn that means it is probably a foregone conclusion.
*If you were alive when Christ was born and spent one million dollars every single day from then until now, you still would not have spent one trillion dollars by now. But somehow the U.S. government is now over 13 trillion dollars in debt. According to a U.S. Treasury Department report to Congress, the U.S. national debt will top $13.6 trillion this year and climb to an estimated $19.6 trillion by 2015.
*It is being projected that the U.S. national debt will grow to surpass our gross domestic product in 2012. Needless to say, that is a really, really bad sign.
*The total of all government, corporate and consumer debt in the United States is now equal to 360 percent of GDP. At no point during the Great Depression did we ever even come close to such a figure.
But things may be even worse in Europe right now. Unfortunately for the U.S., when Europe experiences an economic collapse it will devastate the American economy as well.
The economic news coming out of Europe lately has been extremely alarming….
*George Soros says that a European recession next year is “almost inevitable”. Considering how much access George Soros has to inside information, the fact that he is so pessimistic about Europe is a very troubling thing indeed.
*A report by the Bank for International Settlements says that the debt crisis hitting southern Europe resembles the 2007 subprime mortgage crisis. Is history about to repeat itself?
*Moody’s has downgraded Greece government bond ratings into junk territory, citing the risks inherent in the rescue package that the rest of the eurozone has put together for them. Soon Spain, Portugal, Italy, Ireland, Romania and a number of other European nations could have their debt downgraded as well.
*The U.K.’s new Office for Budget Responsibility has announced that the U.K. economy was more damaged by the recent financial crisis than previously admitted, and that it may never fully recover. But the same could be said for many other nations across the world as well.
*21.5% of all working-age people in the U.K. do not have a job. It seems like almost every country has a shortage of jobs these days.
*New U.K. Prime Minister David Cameron is warning that Britain’s “whole way of life” is about to be significantly disrupted for years by the most drastic public spending cuts in a generation. In fact, severe austerity measures being implemented all across Europe could make this one of the most “interesting” European summers in ages.
*Spanish banks are borrowing record amounts of money from the European Central Bank as Spain’s financial institutions are finding it increasingly difficult to acquire funds in international capital markets. But the truth is that it isn’t just Spanish banks that are facing a liquidity squeeze – the entire world is heading for a massive credit crunch.
But the biggest piece of bad economic news of all is the nightmare that is unfolding in the Gulf of Mexico. There is no way that the southeast United States is going to be the same after this. Hordes of businesses and entire industries have been literally destroyed over the past two months. The total economic damage from this unprecedented disaster will easily run into the hundreds of billions of dollars. This is an economic blow that the teetering U.S. economy simply could not afford right now. Once the oil finally stops flowing the crisis will not be over. In fact, the aftermath from this oil spill could end up echoing for decades.
So are things bad out there? Yes, things are incredibly bad and they are about to get a whole lot worse. In fact, there are so many cancers eating away at the U.S. economy that it would take an entire book to detail them all.
What we are dealing with is not “just another recession” or “just another economic downturn”. What we are witnessing is the fundamental unraveling of the monstrous debt spiral that our economy is based upon. Any economy that is built on a foundation of debt and paper money is inevitably doomed.
So yes, the bad economic news is going to continue. Things may get better for a while here and there, but the truth is that we are caught in a long-term spiral of economic decline from which there is no escape.
So what do you think? Do you believe that there is hope for the U.S. economy? Feel free to leave a comment with your opinion….
Barring an economic bailout of mammoth proportions, the economy of Spain is completely and totally doomed. The socialist government of Spain is drowning in debt, unemployment is running rampant and everywhere you turn there are major economic problems. So will Spain be the next Greece? No. When the economy of Spain implodes it is going to be a whole lot worse for the world economy. The economy of Spain is more than four times the size of the economy of Greece. Spain accounts for 11.5 percent of eurozone GDP while Greece only accounts for approximately 2.5 percent. Spain is the 4th largest economy in the 16 nation eurozone and it is the 10th largest economy in the world. If the economy of Spain fails it will cause a shockwave that will be felt in every corner of the globe. In fact, there are quite a few analysts that believe if Spain defaults it would ultimately lead to the breakup of the eurozone.
So will the EU step up and bail out Spain? Well, there are rumors that EU officials have begun work on a bailout package for Spain which is likely to run into the hundreds of billions of dollars, but on Monday the European Commission, the Spanish government and the German government all denied that the European Union was preparing a bailout for the Spanish economy.
Of course we all know that politicians don’t always tell us the truth.
So who knows what is going on over there right now.
But the reality is that the economy of Spain is not going to make it much longer without serious help, and some EU officials are already using apocalyptic language to describe what an economic collapse in Spain would mean.
For example, EU Commission President Jose Manuel Barroso recently warned that democracy could completely collapse in Greece, Spain and Portugal unless urgent action is taken to tackle the burgeoning European debt crisis.
So could democracy actually fail in those nations?
Well, considering the fact that Greece, Spain and Portugal only became democracies in the 1970s, and that all three of those countries have a history of military coups, such a scenario is not that far-fetched.
Without a doubt there would be serious public unrest in those nations if public services collapsed because their governments ran out of money.
So are there signs that the economy of Spain is about to collapse?
Well, yes, there are quite a few of them.
The following are 9 reasons why Spain is a dead economy walking….
#1) Even before this most recent crisis, unemployment in Spain was approaching Great Depression levels. Spain now has the highest unemployment rate in the entire European Union. More than 20 percent of working age Spaniards were unemployed during the first quarter of 2010. If people aren’t working they can’t pay taxes and they can’t provide for their families.
#2) In an effort to stimulate the economy, Spain’s socialist government has been spending unprecedented amounts of money and that skyrocketed the government budget deficit to a stunning 11.4 percent of GDP in 2009. That is completely unsustainable by any definition.
#3) The total of all public and private debt in Spain has now reached 270 percent of GDP.
#4) The Spanish government has accumulated way more debt than it can possibly handle, and this has forced two international ratings agencies, Fitch and Standard & Poor’s, to lower Spain’s long-term sovereign credit rating. These downgrades are making it much more expensive for Spain to finance its debt at a time when they simply can’t afford to pay more interest on their debt.
#5) There are 1.6 million unsold properties in Spain. That is six times the level per capita in the United States. Considering how bad the U.S. real estate market is, that statistic is incredibly alarming.
#6) The new “green economy” in Spain has been a total flop. Socialist leaders promised that implementing hardcore restrictions on carbon emissions and forcing the nation over to a “green economy” would result in a flood of “green jobs”. But that simply did not happen. In fact, a leaked internal assessment produced by the government of Spain reveals that the “green economy” has been an absolute economic nightmare for that nation. Energy prices have skyrocketed in Spain and the new “green economy” in that nation has actually lost more than two jobs for every job that it has created. But Spain so far seems unwilling to undo all of the crazy regulations that they have implemented.
#7) Spain’s national debt is so onerous that they are now caught in a debt spiral where anything they do will harm the economy. If they cut government expenditures in an effort to get debt under control it will devastate economic growth and crush badly needed tax revenues. But if the Spanish government keeps borrowing money their credit rating will continue to decline and they will almost certainly default. The truth is that the Spanish government is caught in a “no win” situation.
#8) But even now the IMF is projecting that the Spanish economy is going nowhere fast. The International Monetary Fund says there will be no positive GDP growth in Spain until 2011, at which point it will still be below one percent. As bleak as that forecast is, many analysts believe that it is way too optimistic considering the fact that Spain’s economy declined by about 3.6 percent in 2009 and things are rapidly getting worse.
#9) The Spanish population has gotten used to socialist handouts and they are not going to accept public sector pay cuts, budget cuts to social programs and hefty tax increases easily. In fact, there is likely to be some very serious social unrest before all of this is said and done. On May 21st, thousands of public sector workers took to the streets of Spain to protest the government’s austerity plan. But that was only an appetizer. Spain’s two main unions are calling for a major one day general strike to protest the government’s planned reforms of the country’s labor market. The truth is that financial shock therapy does not go down very well in highly socialized nations such as Greece and Spain. In fact, the austerity measures that Spain has been pressured to implement by the IMF have proven so unpopular that many are now projecting that Spain’s socialist government will be forced to call early elections.
So what is going to happen in Spain?
The truth is that nobody can predict for sure how things are going to play out over the coming weeks and months.
But what everyone can agree on is that the stakes are incredibly high.
Speaking at the World Economic Forum in Davos, Switzerland, world famous economist Nouriel Roubini put it this way: “If Greece goes under, that’s a problem for the eurozone. If Spain goes under, it’s a disaster.”
But right now the entire population of Spain (along with much of the rest of the world) is completely distracted by the World Cup. As long as the Spanish team does well, that is likely to keep the Spanish population sedated. But if the Spanish team gets knocked out of the tournament early that will put the entire Spanish population in a really, really bad mood and that could mean a really chaotic summer for the nation of Spain.
The summer of 2010 promises to be the most tumultuous summer in the short history of the European Union. The sovereign debt crisis sweeping the continent threatens to cause economic and political instability on a scale not seen in Europe for decades. The truth is that governments across the eurozone have accumulated gigantic piles of debt that simply are not sustainable. Prior to the implementation of the euro, these European governments often “printed” their way out of messes like this, but now they can’t do that. Now they either have to dramatically cut government expenses or they have to default. But the austerity measures that the IMF and the ECB are pressuring these European governments to adopt are likely to have some very painful side effects. Not only will these austerity measures cause a significant slowdown in economic growth, they are also likely to cause the same kinds of protests, strikes and riots that we saw in Greece to erupt all over Europe.
You see, most Europeans have become very accustomed to the social welfare state. Tens of millions of Europeans aren’t about to let anyone cut their welfare payments or the wages on their cushy government jobs. In most of the European nations that are experiencing big financial problems there are very powerful unions and labor organizations that do not want anything to do with austerity measures and that are already mobilizing.
As the IMF and the ECB continue to push austerity measures all over Europe this summer, the chaos that we witnessed in Greece could end up being repeated over and over again across the continent. This could truly be Europe’s summer of discontent.
The following are just a few of the countries that we should be watching very carefully in the months ahead….
In many ways, the economic situation in Spain is now even worse than the economic situation in Greece. Spain’s unemployment was already above 20 percent even before this recent crisis. There are now 4.6 million people without jobs in Spain. There are 1.6 million unsold properties in Spain, six times the level per capita in the United States. Total public/private debt in Spain has reached 270 percent of GDP.
But this past week things really started to spin out of control in Spain. Ambrose Evans-Pritchard of The Telegraph describes the current situation in Spain this way….
For Spain it has been a horrible week. The central bank seized CajaSur and imposed draconian write-down rules on banks to restore confidence. The Spanish Socialist and Workers Party (PSOE) of Jose Luis Zapatero then rammed a 5pc cut in public wages through the Cortes by a single vote, shattering consensus. The government cannot hope to pass a budget. Its own trade union base is planning a general strike.
The austerity measures that Spain has been pressured to implement have proven so unpopular in Spain that many are now projecting that Spain’s socialist government will be forced to call early elections.
Spain finds itself in a very difficult position. They have a debt that they cannot possibly handle, the IMF and the ECB are pressuring Spain to implement austerity measures which are wildly unpopular with the public, and if Spain does implement those austerity measures it may send the Spanish economy into a downward spiral.
In addition, the fact that Fitch Ratings has stripped Spain of its AAA status has pushed Spain to the edge of financial oblivion.
A recent editorial inEl Pais spoke of the “perverse spiral” that Spain’s economy is entering….
“The Fitch note drives home the apparently unsolvable contradiction in which the Spanish economy finds itself. To maintain debt solvency Spain must squeeze public spending: yet this policy undermines the chances of recovery which itself causes further loss of confidence.”
And Spain’s very powerful labor organizations are not about to take these austerity measures sitting down. In fact, the two largest trade unions in Spain are already calling for a general strike.
So could Spain end up being the next Greece?
France admitted on Sunday that keeping its top-notch credit rating would be “a stretch” without some tough budget decisions.
But French citizens are not too keen on belt-tightening. We all remember the massive riots in France a few years ago when it was proposed the the work week should be shortened. It certainly seems unlikely that the French will accept “tough budget decisions” without making some serious noise.
The Italian government recently approved austerity measures worth 24 billion euros for the years 2011-2012. But the Italian public is less than thrilled about it.
In fact, Italy’s largest union has announced that it will propose to its members a general strike at the end of June to protest these measures.
Under pressure from the IMF and the ECB, Portugal has agreed to impose fresh austerity measures that include much higher taxes and very deep budget cuts.
And the truth is that Portugal desperately needs to do something to get their finances under control. Recent EU data shows that Portugal’s total debt is 331 percent of GDP, compared to only 224 percent for Greece.
So will the Portuguese public accept these austerity measures?
It doesn’t seem likely.
In fact, Fernando Texeira dos Santos, Portugal’s finance minister, says that he expects “violent episodes” comparable to those in Greece but insists that there is no other option.
So it promises to be a wild summer in Portugal. The CGTP trade union federation in Portugal has promised to mobilize their members….
“Either we come up with a very strong reaction or we will be reduced to bread and water.”
They have already been rioting in the streets in Romania.
Tens of thousands of workers and pensioners recently took to the streets in Romania to protest the harsh austerity measures that the Romanian government is imposing at the request of the International Monetary Fund.
The Romanian people have been through incredibly hard times before, and they aren’t about to let the IMF and the ECB impose strict austerity measures on them without a fight.
It is being reported that Germans are bracing themselves for a “bitter” round of government budget cuts. It seems that even Germany has some belt-tightening to do.
In addition, resentment is rising fast in Germany as the population there realizes that it is Germany that is going to be the one funding a large portion of the bailouts for these other European nations.
How long will the German people be able to control their tempers?
The Wall Street Journal is warning that Ireland could be Europe’s next financial basket case.
Well, the Irish have gotten into a ton of debt, and they are now finding it very expensive to finance new debt. The Irish government is now paying approximately 2.2 percentage points more than Germany is to borrow money for 10 years, while Spain (even with their economy in such a state of disaster) only has to pay 1.6 percentage points more than Germany.
But if “austerity measures” come to Ireland, how do you think the public will react?
It likely would not be pretty.
The United Kingdom
The exploding debt situation in the U.K. was a major issue in the most recent election. David Cameron promised the voters to get the U.K.’s exploding debt situation under control. But the coming budget cuts are likely to be incredibly painful. In fact, Bank of England governor Mervyn King has even gone so far as to warn that public anger over the coming austerity measures will be so painful that whichever party is seen as responsible will be out of power for a generation.
But it isn’t just national governments that are in trouble in Europe. The European Central Bank is warning that eurozone banks could face up to 195 billion euros in losses during a “second wave” of economic problems over the next 18 months.
The truth is that almost everyone is expecting the next couple of years to be very tough economically all across Europe.
But the vast majority of the European public is not going to understand the economics behind what is happening. All most of them are going to know is that the budget reductions, tax increases and pay cuts really, really hurt and that is likely to result in a whole lot of anger.
When Europeans get really angry it isn’t pretty. If what happened in Greece is any indication, this upcoming summer and fall could be a really wild one throughout Europe.
“Euroland, burned down. A continent on the way to bankruptcy”
-The front page of Der Spiegel, May 5th, 2010
Most Americans have no idea what the term “Keynesian economics” means, but the truth is that it has been deeply influencing U.S. economic policy for decades. Essentially, it is an economic theory that originated with a 20th century British economist named John Maynard Keynes, and it advocates government intervention in the economy in order to smooth out economic cycles. The general idea was that lower interest rates and increased government spending could be used to increase aggregate demand when the economy was experiencing a downturn, thus increasing economic activity and reducing unemployment.
And you know what?
To a certain degree, Keynesian economic theory actually does work.
Increased government spending DOES stimulate the economy.
But the problem is that governments all over the world decided that they would just run constant budget deficits and stimulate the economy all the time.
All of this debt has brought a temporary prosperity to many of the nations around the globe, but there is one huge problem with debt.
It has to be paid back eventually.
So what happens when nations have to start spending huge chunks of their national budgets just to service all the debt that they have piled up?
Well, that is when they taste the bitter side of Keynesian economics.
In fact, we see that starting to happen all over the world right now.
All of a sudden, governments all over the globe are talking about huge budget cuts, pay decreases, and higher taxes.
We all know about what is going on in Greece right now, but suddenly it seems like “austerity measures” are being implemented all over the place. Just consider the following examples….
*Portugal has pledged to impose fresh austerity measures that include much higher taxes and dramatic budget cuts.
*Barack Obama is personally pressuring Spain to make severe austerity cuts.
*It’s not just Southern Europe that is facing these austerity measures either. It is being reported that Germans are bracing themselves for a “bitter” round of budget cuts.
*The exploding debt situation in the U.K.was a major issue in the most recent election. Bank of England governor Mervyn King has even gone so far as to warn that public anger over the “austerity measures” that soon must be implemented in the U.K. will be so painful that whichever party is seen as responsible will be out of power for a generation.
*Federal Reserve Chairman Ben Bernanke says that United States citizens will soon have to make difficult choices between higher taxes and reduced government spending.
*California Governor Arnold Schwarzenegger is reportedly planning to seek “terrible cuts” to eliminate an $18.6 billion budget deficit facing the most-populous U.S. state through June 2011.
*In fact, many U.S. states are getting ready for their biggest budget cuts in decades.
Austerity measures for everyone?
That is the way it is shaping up.
So what happens when austerity measures are implemented?
Well, just as Keynesian economics correctly predicts that economic growth goes up when government spending increases, it also correctly tells us that economic growth goes down when government spending decreases.
So all of these austerity measures are going to mean economic pain for a whole lot of people.
Not only that, but there are now whispers that this European debt crisis could potentially cause the break up of the euro.
Whether or not that is actually the case, officials in Europe are sure seizing on this crisis to advocate for increased centralization of power in the EU.
For example, senior administrators of the European Union are proposing that they be given unprecedented power to scrutinize the spending plans of member countries before national parliaments can vote on those budgets.
Talk about a loss of sovereignty.
But not only that, the Governor of the Bank of England, Mervyn King, has come right out and said that he believes that the European Union must become a federalized fiscal union if it is to survive.
Doesn’t it seem like whenever there is a crisis the solution that is always being proposed is to give centralized institutions even more power?
There has also been talk that nations such as Greece could end up being ejected from the euro, but the reality is that such a scenario is not very likely.
For one thing, the ECB has already come out and said that under current EU law, ejection of a nation from the monetary union is “legally next to impossible”.
In addition, leaders throughout Europe realize that if the euro fails then the entire EU may fail as well. German Chancellor Angela Merkel made this very clear when she recently warned that if the euro collapses, “then Europe and the idea of European union will fail.”
For many in Europe that would seem like a disaster, but the truth is that it would be a wonderful, wonderful thing if the euro failed.
Because it would represent a major defeat for those who are seeking to drag us towards a “world currency” and a “global government”.
It would also be a huge victory for those who still believe in national sovereignty and the decentralization of economic power.
So let us hope that the euro breaks up.
But don’t count on it.
Meanwhile, the one thing that we can count on is all of the economic pain that all of these new austerity measures are going to bring.
Now that the Greek debt crisis has been “fixed” by a gigantic pile of more debt, many are wondering which European nation will be next to experience a massive debt crisis. Increasingly, all eyes are turning to the U.K. and their public debt that is spiralling out of control. The U.K. government’s deficit is projected to be approximately 13 percent of GDP in 2010, which is even worse than Greece’s 12.5 percent figure. Right now the public debt of the U.K. is “only” at 68 percent of GDP, but three years ago it was sitting at about 40 percent, so as you can see the national debt of the U.K. is absolutely exploding in size. In fact, it is now being projected that the public debt of the U.K. will exceed 100 percent of GDP within the next three years. Considering the fact that citizens of the U.K. are some of the most highly taxed people in the world already, there just is not much room for raising more revenue.
So obviously there is a problem.
A massive, unchecked, out of control problem that threatens to blow out the entire U.K. economy.
And considering the fact that it took just about everything that Europe could muster to bail out poor little Greece, how in the world is Europe going to be able to bail out the U.K. when their debt crisis violently erupts?
If Greece almost brought down the euro and the financial system of Europe, then what would a financial implosion in the U.K. do?
Considering the fact that the Greek economy is approximately 16% the size of the U.K. economy, it is very sobering to think what a “Greek style” debt crisis in the U.K. would mean for the entire world.
But if something is not done rapidly it will happen.
Just consider the following charts….
Now how in the world do you go from a deficit that is between 2 and 3 percent of GDP in 2007 to one that is above 11 percent in 2009? That takes some serious financial mismanagement. Not only that, but as we mentioned earlier, this year the deficit is projected to be approximately 13 percent of GDP. That is a level that is catastrophic.
Kornelius Purps, the fixed income director of Europe’s second largest bank is very open about the fact that he believes that the U.K. is likely the next European nation that will face a very serious debt crisis….
“Britain’s AAA-rating is highly at risk. The budget deficit is huge at 13% of GDP and investors are not happy. The outgoing government is inactive due to the election. There will have to be absolute cuts in public salaries or pay, but nobody is talking about that.”
In fact, Morgan Stanley has already warned that there is a very strong probability that some of the rating agencies may remove the U.K.’s AAA status before 2010 is over.
If that happened, it would make the crisis that we just saw in Greece look like a Sunday picnic.
So what must be done?
Well, already world financial authorities are calling for “austerity measures” and deep budget cuts to be implemented in the U.K., but the reality is that those moves will cause deep economic pain.
In fact, Bank of England governor Mervyn King recently warned that public anger over the “austerity measures” that soon must be implemented in the U.K. will be so painful that whichever party is seen as responsible will be out of power for a generation.
The cold, hard reality is that the U.K. is in for economic pain in any event. Either they cut the budget and implement severe “austerity measures” which will hit people really hard economically, or they continue on the current course and risk a much worse version of what just happened in Greece.
Not that the rest of the world should be gloating about what is going on in the U.K. either.
The financial situation in Japan is even worse than what the U.K. is dealing with, and the United States is going to have the biggest economic downfall of them all one of these days.
As we wrote about yesterday, the sad truth is that the governments of the world are rapidly running out of money and are drowning in debt. It is a gigantic mess, and the term “sovereign debt crisis” is going to pop up in the news very regularly from now on.
You see, it is not just the financial systems of the U.S. and the U.K. that are broken. The entire world financial system is fundamentally flawed and is doomed to failure.
Right now the central banks of the world can do their best to try to hold things together with a tsunami of debt and paper money, but they are not going to be able to keep up this balancing act forever.
When it does all start coming apart and the dominoes do start falling, it is going to be a complete and total nightmare. Paper currencies around the globe will lose value at breathtaking speeds as central banks flood economies with cash in an attempt to stop the madness.
But more debt and more paper never solves anything. All it does is make the long-term problems even worse.
When the tipping point comes, things are going to move fast. Let’s just hope that we all have a good bit more time to prepare before that happens.