If you read the daily newspapers, you likely think the Fed and the U.S. government are behind the curve on this recovery. That is, they’re making critical mistakes that will leave the U.S. economy behind.
Moreover, you likely believe they’re destroying the dollar in the process through their ignorance.
Here’s how I see it …
On one hand, policymakers have gotten what they’ve wished for: They’ve restored confidence.
On the other hand, they’ve done such a good job at restoring confidence that people actually think there’s a real recovery underway. As such, global pressures on governments and central banks keep rising for them to move away from the unprecedented emergency policies that were put in place to prevent an all out global economic disaster.
But there’s a disconnect between facts and perception when it comes to the state of the world economy. And that’s put policymakers in a place where they could make mistakes that could exacerbate the depth and duration of this ongoing crisis.
The structural underpinnings of economic activity are a disaster. The global financial system is still mired in bad debt … the systemic disease that triggered a global economic collapse. And without an unprecedented scale of coordinated, official intervention to stabilize global confidence, the world would be deep in technical depression right now.
Instead, it’s in a manufactured recovery — represented only by numbers on government spreadsheets. Meanwhile, most major economies in the real world feel and look like depression.
But because the depression is masked over by intervention, the global fallout is playing out in slow motion.
No Place Is That More
Evident Than in Europe …
While most of the world’s attention is constantly focused on Fed monetary policy, the U.S. debt situation and the dollar, Europe is where the next leg of the global economic crisis is playing out.
Looking back at historical financial crises, it’s clear we should expect sovereign debt defaults to follow — and for those defaults to be contagious.
Which is preciously what is happening in Europe!
But in desperation, European officials continue to adhere to the playbook of 2008: Delay, delay, delay.
In this case, it means delaying sovereign defaults and an unknown future for the euro and the European Monetary Union.
They keep the patient breathing in hopes of bridging the gap between economic downturn and sharp sustainable global recovery. For this strategy to have a chance of working, they would need a recovery so sharp that even bankrupt countries could quickly grow out of the problems that took decades, if not centuries, to develop.
But neither sharp nor sustainable recovery is coming. Even the optimistic official outlooks now agree.
Moreover, the patient count in Europe continues to grow. And the resources to keep them breathing are dwindling.
First it was Greece. Both European and Greek officials swore off all speculation that Greece was a problem. Finally, they admitted they were bankrupt.
Then it was Ireland. Again, Irish and European officials said “nothing to see here.” And then, they asked for aid.
Last week it was Portugal. As late as Wednesday afternoon, Portugal’s finance ministry spokesperson said it could meet ALL its financing needs. Later that evening, they made a formal request for aid.
Now, Spain is on the clock. And again, the adamant message from Europe and Spain is that the buck stops with Spain. There is no risk. The sovereign debt crisis is over, they say. Spain can handle its problems itself.
I think we’ve seen this movie before.
Dominoes Still Falling!
What about the Euro?
What hasn’t played out yet is a total collapse of the euro. After all, the euro is at the core of the sovereign debt problems in Europe. It’s the monetary union of the euro-zone countries that keeps these bankrupt countries from righting their own ships.
They can’t cure their insolvency by currency devaluation. And they aren’t free to restructure their debt.
Consequently a no-win situation continues to play out in Europe, but the can continues to roll down the road!
Because the euro is the reason these bailout schemes are being undertaken in Europe. It’s the second most widely held currency in the world. And global partners, like China, have more than enough interest in helping Europe buy time by persistently keeping the euro stable and reasonably strong. But when does that time run out?
When do China and a consortium of other global central banks (through the Bank for International Settlements) back away from buying the euro, and let nature take its course?
Based on recent history, there are two good reasons to think that time could be now.
Take a look at this chart below of the euro.
Before last week, the last time the ECB hiked rates was in 2008, in the face of an unraveling financial crisis. That triggered a sharp 22 percent decline in the euro as you can see in the far left of the chart.
So it wasn’t a surprise when the ECB hiked rates last week, even in the face of a confluence of global economic threats, not the least of which resides in Europe.
Could that move get the euro ball rolling down hill again?
When Greece formally asked for aid, it triggered a 13 percent decline in the euro — until China came in to turn the tide of the euro and stabilize sentiment in Europe. After Ireland’s formal request for aid, the euro quickly dropped by more than 6 percent. Again the bottom was marked by China buying euros.
Then last week, Portugal made a formal request for aid AND the ECB raised rates. Could these two events mark another sharp downturn for the euro? And this time, will the global community be there to support it?
Either way, the situation in Europe and with the euro looks very much like a game of musical chairs …
When the music stops, and the fallout in Europe confirms the next major wave of global economic crisis, expect the world’s focus to turn back to concerns about growth and away from concerns about inflation.
So the time to look for a chair is now — before the music stops.
Money and Markets
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