It’s easy to lose perspective on where the global economy stands – to be confused by the daily deluge of information – so let’s look at the big-picture of where we are today. As an investor it can mean the difference between making and losing a lot of money. So let’s take a look and see [where we are at and what events are unfolding – slowly but surely]. Words: 1186
Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com, provides below further reformatted and edited [..] excerpts from the Bryan Rich’s (http://www.moneyandmarkets.com) original articles* for the sake of clarity and brevity to ensure a fast and easy read. (Please note that this paragraph must be included in any article reposting to avoid copyright infringement.) Rich goes on to say:
We have endured the sharpest fall in global economic activity since the Great Depression and one of the most threatening financial crises ever and, according to studies by the IMF, recoveries of past recessions with these dualities tend to be longer and slower than normal recoveries — typically around five years until economies sustainably resume trend growth. That means, if you mark the start of the recent crisis as late 2007, we’re less than three years in! Therefore, we should expect more bumps in the road ahead. Furthermore, history also shows us that financial crises are generally followed by sovereign debt crises, which is where we are now.
The 4 Stages of Sovereign Debt Crises
Stage #1: Burgeoning Deficits
In a financial crisis government spending increases dramatically in attempts to stabilize the financial system and stimulate economic activity. Tax revenues fall, fiscal surpluses turn into deficits and economies with existing deficits keep piling it on – and that is just what is unfolding now.
The leading economies of the world have all seen their deficits shoot higher, some to record levels. In fact, the deficit spending that’s gone on in recent years can be summed up as follows: Over 40 percent of world GDP comes from countries that are running deficits in excess of 10 percent.
Stage #2: Ballooning Debt
When economies are contracting or even growing slowly, bringing these deficits back down to earth becomes an unenviable challenge. Governments have to make ends meet by turning to the markets. Then those burgeoned deficits turn into growing debt loads – and that is just what is unfolding now.
When debt reaches 80 percent of GDP threshold, the borrowing costs for governments starts ticking higher and so does the market scrutiny. The IMF says five of the top seven developed countries in the world will have debt levels exceeding 100 percent of GDP in the next four years.
Stage #3: Credit Downgrades
When deficits and debts rise and economic activity appears unlikely to curtail fiscal problems, the credit worthiness of the government falls under intense scrutiny. That’s when we see downgrades – and that is just what is unfolding now.
Greece’s sovereign debt rating has been downgraded to junk status. Spain has lost its AAA rating and the UK could lose its AAA status if its deficit isn’t addressed. Japan’s outlook has been cut to negative and rating agencies have even warned the U.S.
Stage #4: Sovereign Debt Defaults
This is the final and most deadly stage because downgrades only make the vicious cycle of weak economic activity and growing dependence on debt worse. When investors see more risk, they require more return [and, as such,] the borrowing costs for these troubled countries rise. Then it becomes harder to finance spending needs and harder to finance existing debt and that’s when we see defaults – and that is on the verge of unfolding.
When S&P downgraded Greece to junk status, it warned debt holders [that they] should be prepared to receive just 30 cents on the dollar… [in spite of the] $1 trillion rescue package committed by the EU and IMF. [Then there is] Spain, an economy that represents 12 percent of GDP for the euro zone, [which is] rumored to be next in line for a massive funding request.
In sum, a sovereign debt crisis has arrived – the fuel for contagion is fear – and unless governments can demonstrate they’re willing to take tough steps to reign in debt this crisis can spread quickly.
Currenncy Crises Are Likely Next
History shows us that financial crises tend to be followed by sovereign debt crises – and that sovereign debt crises tend to lead to currency crises, i.e. a loss of confidence in countries’ currencies which is something we’ve seen very clearly in recent months with the euro. A study from MIT on historical currency crises lays their progression out as follows:
The Three Stages of a Currency Crisis
Stage #1: Loss of Confidence
The number one cause of a currency crisis is when investors flee a currency because they expect it to be devalued – and when the euro zone stepped in and threatened to cough up $1 trillion dollars in an attempt to save the euro monetary union, it was a conscious decision to devalue the euro.
Stage #2: Herding Mentality
When it’s thought that investors are moving out of a currency, others follow. [A case in point is the euro which] currently is being shorted [moreso than ever before in history] and when the market is heavily positioned one way — and the fundamentals support it and an intentional devaluation appears underway — big institutions have to react. Put simply, they have too much to lose by getting caught the wrong way. As such, for example, Iran’s central bank has announced they will be diversifying euro exposure bytrading into gold and U.S. dollars while China and the UK have shown a significant increased interest in owning U.S. dollars as opposed to euros.
Stage #3: Contagion
Contagion is a phenomenon in which a currency crisis in one country triggers crisis in other countries with similar weaknesses. A crisis that started in Dubai now confronts Greece, Spain, Portugal … and will likely spread to the UK, Japan and even the U.S.
The day-to-day ebb and flow of economic data and news can be distracting. That’s why it’s important, especially with all that is going on, to keep the big picture in perspective. History shows us that a global recession when combined with a financial crisis tends to stifle economic activity longer than normal recessions. History also shows us that financial crises tend to lead to sovereign debt crises, which tend to lead to currency crises so, with that in mind, it’s fair to say that a V-shaped economic recovery has always been very unlikely.
We are going to see more shocks to the global economy, more challenges and more investors fleeing risky investments in favor of safe havens. [Got gold?]
(Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil.)
– The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
– Permission to reprint in whole or in part is gladly granted, provided full credit is given.
– Sign up to receive every article posted via Twitter, Facebook, RSS feed or our Weekly Newsletter.