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The Coming World Economic
Crisis - and How to Survive It
  Dr Sikandar Siddiqui, Heidelberg, Germany
              November 2012
Contents

1. Background and Diagnosis
2. Can‘t we be more Optimistic?
3. Historical Experience and Current Developments
4. A Likely Outcome
5. Conclusions and Recommendations
Background


• In the years 2008 to 2009, the sub-
  prime segment of the U.S.
  residential mortgage market virtually
  collapsed, leading to the deepest
  global recession since the Great
  Depression of the 1930s.
                                          Source: worldculturepictorial.com
Background

• Governments of the
  globally leading economies
  responded with rescue
  packages for troubled
  financial institutions, and
  with macro-economic
  stabilisation programmes
  which, in turn, prompted
  sharp increases in public
  sector deficits…
Diagnosis
• …so that by now, a
  disturbing fact has
  become increasingly
  obvious:
• Most of the govern-
  ments in North
  America, Japan, and
  Western Europe are
  about to overstrain their
  debt servicing capacity.
                              Source: http://www.economist.com/content/global_debt_clock
Diagnosis




            Source: Ingram Pinn
Diagnosis

• The clearest evidence supporting
  this perception is not provided
  by the level of debt-to-GDP
  ratios in the countries involved,
  but by the fact that in all these
  three regions, central banks have
  had to step in and mop up
  government bonds other
  investors were not willing to buy
  at current yield and/or risk levels.
A Giant Ponzi Scheme
• While the recent banking crisis
  served as a catalyst for the
  development of this problem,
  its roots lie further in the past:
• Since the onset of the current
  debt binge in the late 1970s,
  governments in the U.S. and
  much of Western Europe have          In 1920, businessman Charles Ponzi set up an
                                       arbitrage trading strategy in postal reply
  been essentially operating a         coupons which, later on, turned into a fraudu-
  large-scale Ponzi scheme in          lent „snowball system“ using cash inflows from
                                       new participants to pay off withdrawals from
  which expiring debt was almost       existing ones until it finally collapsed due to the
                                       inevitable, eventual cessation of follow-on
  never paid off but, instead, only    investments.
  passed on to new generations of
  creditors.
A Giant Ponzi Scheme
• What doesn’t exactly make things easier is that, in some countries,
  some of the government’s implicit payment obligations are not
  officially counted as government debt.




                                                      Source: drpinna.com
A Giant Ponzi Scheme
• Germany, while often setting
  itself up as a stern disciplinarian
  of the Eurozone governments
  when it comes to fiscal issues,
  constitutes no exception:
• The country’s implied future
  payment obligations resulting
  from future public service
  pension liabilities and its
  notoriously underfunded public        Subsidies to Germany’s ailing public pension
                                        system have been projected to exceed € 81bn,
  pension system have never             or 26.2% of total federal expenses in 2012.

  shown up in the official public
  debt statistics.
Implications

• Now, with populations ageing
  and the limits to growth set by
  the scarcity of natural resources
  becoming increasingly obvious,
  the fragility of this giant,
  government-operated snowball
  system is all too evident.


                                      Source: cartoonstock.com
Contents

1. Background and Diagnosis
2. Can‘t we be more Optimistic?
3. Historical Experience and Current Developments
4. A Likely Outcome
5. Conclusions and Recommendations
Can‘t we be more optimistic?
                                             U.S. public debt, 1940 to 2011
• Some observers might dismiss the          Source: whitehouse.gov/omb/budget/Historicals

  assessment made here as overly
  pessimistic.
• To justify their verdict, they would
  probably point to the experience
  gathered in the 30 years following
  WW2.
• At that time the capitalist
  economies managed to grow out of
  their wartime debt without
  governments imposing overly
  painful austerity measures on their    Red lines indicate the debt held by the public and black
                                         lines indicate the total public debt outstan-
  populations for too long.              ding (gross public debt), the difference
                                         being that the gross debt includes that
                                         held by the federal government itself.
Can‘t we be more optimistic?
• However, virtually none of
  the factors that fostered this
  development historically
  continues to be present today:
 A growing civilian labour
 force (resulting from workers
 switching from military
 service to civilian
 employment) and increasing
                                                          Source: hdg.de
 labour force participation        Production line in West Germany, 1960
 rates,…
Can‘t we be more optimistic?




                                                           Source: Forbes.com


…stable or - in real terms - even declining crude oil prices…
Can‘t we be more optimistic?

…and a largely fragmented,
 strictly regulated capital market
 leaving safety-oriented investors
 with virtually no alternative to
 holding government bonds
 denominated in domestic
 currency, …


                                     Source: cliffcule.com
Can‘t we be more optimistic?


…greatly facilitated the
 reduction in government
 debt-to-GDP ratios in
 the U.S. and Britain after
 WW2.

                              Attribution: RJ Matson, Roll Call
                                                                  Source: patriotupdate.com
Can‘t we be more optimistic?
The U.S., in particular, used to
draw enormous profit from the
Greenback’s status as the lead
currency of the Bretton Woods
system, which, for a long time,
created a huge demand for USD-
denominated government debt to
be used as a reserve asset by
central banks.
But confidence in the suitability of
the USD as a storage of value has
since been eroding (for quite
understandable reasons), effectively
blocking this exit route today
Contents

1. Background and Diagnosis
2. Can‘t we be more Optimistic?
3. Historical Experience and Current Developments
4. A Likely Outcome
5. Conclusions and Recommendations
Historical experience

• In the past, governments with
  unsustainable debt loads have
  regularly taken up two possible
  “solutions” to this problem (or
  a combination of both):
                                    Source: DebtDecreaser.com
Historical experience



• They either forcefully
  expropriated some of their
  lenders, …


                               Forced expropriation of lenders as an
                               alternative to austerity: Execution of
                               Jews by crusaders in the 13th century
                                                     Source: de.wikipedia.org
Historical experience



• …or intentionally devalued
  the currency in which their
  debt was denominated.

                                During the German hyperinflation of 1923, some citizens
                                began to consider bank notes a convenient alternative to
                                conventional wallpapers.
                                                        Source: Hulton Archive | Getty Images
Current developments
• For the time being, some influential
  decision makers appear to prefer the
  first “solution”, i.e. the forceful
  expropriation of lenders.
• At least, this is what happened when
  Greece forced its creditors into a
  “voluntary” debt rescheduling in
  early 2012, only to expropriate
  unwilling investors, too, a few
  weeks later – and with the obvious       Source: guardian.co.uk


  consent of its political allies abroad
Current developments


• The arbitrary nature of the
  Greek “debt rescheduling” is
  all the more evident as the
  value of state-owned assets
  available for privatisation was
  estimated to exceed € 100bn
  by mid-2011.



                                    Source: FT.com
Current developments

                                   Military spending as a percentage of
                                        GDP (Source: World Bank)
• Greece’s continuously
  excessive military spending is
  another piece of evidence
  indicating that the country’s
  “payment crisis” is due to
  deliberate overspending rather
  than mere inability to pay.

                                                    Source: americablog.com
Current developments
• So what had started with a mis-
  representation of fiscal statistics
                                           Greek Public Sector Deficits,
  ended up as what otherwise might                 1997-1999
  have been called a fraudulent
  bankruptcy.
• The fact that this behaviour by the
  Greek governments has not been
  offered any noticeable resistance by
  fellow Eurozone member govern-
  ments raises perfectly understand-
                                         1) Figures from the Convergence Programme on
  able fears among investors that, at       which the inclusion of Greece into
                                            the Eurozone in 2001 was based.

  some time in future, it may repeat
  itself in the cases of Portugal,
  Ireland, Italy, or Spain.
Current developments


• On the other hand, some
  influential economists, for the
  time being, appear to favour
  the second alternative – a
  deliberately induced rise in
  inflation.




                                    Soruce: harvardmagazine.com
Current developments

• Given that the single most
  important lender to the U.S.
  government is the People’s
  Republic of China, which
  has obviously already begun
  to sense the danger, it seems
  unlikely that a forceful
  expropriation of creditors      In a 2011 issue of the state-controlled paper Global
                                  News, journalist Mo Luo urged a more active role of the
  will be the preferred option    Chinese military in supporting the country’s economic
                                  interests, arguing that “an invariably humble foreign
  of the U.S. government.         policy that strictly prioritizes harmonious relationship and
                                  the value of compromise will reduce us to a country that
                                  serves as an ATM machine for the West and a charity for
                                  the developing world”.
                                                                           Source: globaltimes.cn
Current developments
• Of course, theoretically, fiscal
  austerity remains another option.
• But given that, so far, even
  measures only directed at limiting
  further increases in government
  debt – rather that reversing that
  trend – have provoked very angry
  (and, in some cases, violent)          Protesters take to the streets of Athens and rise
  reactions in parts of the public, it   up against proposed austerity measures being
                                         debated in the Greek Parliament on February
  seems unlikely that this route will    12, 2012.
                                                           Source: UPI/Giorgos Moutafis
  be seriously considered by
  governments.
Another policy alternative

• It would nevertheless be too
  hasty to conclude that even if
  the last-mentioned viewpoint
  prevails, the U.S. and the
  Eurozone economies are
  bound to experience
  excessively high rates of
  inflation during the next        Although fears of inflation keep rising, it remains
  decades.                         a possible yet not inevitable consequence of the
                                   current economic dilemma
Another policy alternative
• The rationale for this argument is
  somewhat technical:
  - If the central bank of a currency area
    decides to offer member states cheap
    funding by continuously buying
    government bonds in exchange for
    central bank money,
  - …it can nevertheless curb the growth
    in the money supply – and the resulting
    inflationary pressures – by increasing
    minimum reserve ratios or regulatory
    capital requirements, or by otherwise     Source: en.wikipedia.org

    limiting private sector credit growth.
Another policy alternative
• The Japanese experience from
  the last two decades suggests that
  large-scale central bank
  purchases of government bonds
  do not have to produce
  inflationary effects, provided that
  credit growth is limited
  - either through institutional
    regulations (e.g. regulatory
    capital standards or minimum
    reserve requirements),
  - or, quite simply, because of
    the risk aversion of lenders
    and/or borrowers.
Another policy alternative

 • Yet in the long run, the cost
   of this “solution” attempt will
   (most probably) be a long-
   lasting phase of macro-
   economic stagnation or even
   contraction, due to a severe
   shortage of credit available to
   private sector entities.
                                     Source: inn-service.co.uk
Contents

1. Background and Diagnosis
2. Can‘t we be more Optimistic?
3. Historical Experience and Current Developments
4. A Likely Outcome
5. Conclusions and Recommendations
Likely Outcome

• If chosen in isolation, each of
  the three aforementioned
  “solutions” (forced expro-
  priation, inflation, and
  protracted private sector de-
  leveraging) is likely to be met
  with fierce resistance by those
                                                                 Source: Reuters.com
  worst affected                    Pensioners rallying against price rises in St.
                                    Petersburg, Russia, on November 3, 2007.
Likely Outcome


• Governments might thus be
  tempted to choose a
  combination of these three
  “medications”, allowing the
  dose of each of them to be
  less noticeable.


                                Source: drugchannels.net
Likely Outcome
• In this case,
  - inflation will be restricted to rather low
     (i.e. single-digit) levels due to con-
     straints on private sector credit growth,
   - limits imposed on private sector credit
     supply will cause economic growth to
     be low or even negative in per capita
     terms because private sector entities
     will be forced to use considerable
     fractions of their current income to pay
     down existing debt (if they can), and
   - the possibility of further selective expro-   Source: politicalbetting.com

     priations (or “voluntary debt reschedul-
     ings”) will remain on the agenda.
Contents

1. Background and Diagnosis
2. Can‘t we be more Optimistic?
3. Historical Experience and Current Developments
4. A Likely Outcome
5. Conclusions and Recommendations
Recommendations for Investors

• It seems that in any case, the
  most unwise investment
  decision will be to continue
  considering U.S. and
  Eurozone government bonds
  low-risk investments (at least
  in inflation-adjusted terms).
                                   Source: interest.co.nz
Recommendations for Investors

• Yet another piece of
  uncomfortable information
  is that in phases of
  economic stagnation (or
  recession) and moderate but
  perceptible inflation, the
  equity market as a whole,
                                Even in nominal terms, the late 1960 s and the
  too, is unlikely to perform   1970s, marked by mounting inflationary pressures
  outstandingly in inflation-   and considerable geopolitical tensions were no
                                easy times for the average equity investor.
  adjusted terms
Recommendations for Investors
• This does not, however, imply that
  risk-conscious investors ought to
  shun the equity market altogether
• The imminent decline in the value
  of Dollar, Euro- and Yen-denomi-
  nated debt will, most probably,
  induce investors to exchange their
  current holdings of credit assets
  denominated in these currencies for
  - equity stakes in attractively valued   Source: stockmarket-investing.com

    companies, and
  - commodities essential for the
    fulfilment of basic human needs.
Recommendations for Investors
• Producers of goods that fulfil basic
  human needs (e.g. food and
  drinking water, energy, medical
  supplies and pharmaceuticals) are
  more likely than others to succeed
  in a macro-economic environment
  characterised by stagnation and/or
  inflation, because in this market                                     Source: ehow.com

  segment, the sensitivity of private    In most of North America, Western Europe, and
                                         Japan, the trend towards population ageing is
  sector demand to price rises and       likely to increase the share of healthcare
                                         products and services in total aggregate
  income losses tends to be lowest.      demand during the next decades
Recommendations for Investors
• Moreover, reasonable targets for
  future equity investments will be
  companies with
- strong balance sheets (i.e. low debt
  to total assets ratios), enhancing their
  ability to withstand a protracted de-
  cline in private sector credit supply,
- stable operating cash flows, and
- attractive valuations in terms of
  price/equity ratios, signalling that       Source: takcreditmanagement.wordpress.com

  their current market prices are not
  based on over-optimistic growth
  expectations.
Recommendations for Investors


• Companies making strong
  R&D efforts in technologies
  related to food and beverages,
  renewable energies, and
  medical care also deserve a
  high degree of attention by
  equity investors.
                                   Source: immobilienblasen.blogspot.com
Recommendations for Investors

• Among the companies
  that deserve particular
  attention in this context
  are those with strong
  innovative potential in
  the fields of “clean”
  energy production…          A technological revolution in the making? The
                              Gemasolar power plant, located near Seville
                              (Spain), uses molten salt as a heat storage
                              technology to prolongation plant's operating
                              time in the absence of solar radiation

                                               Source: torresolenergy.com
Recommendations for Investors


• …resource saving
  technologies…
Recommendations for Investors


• …crop protection/yield
  improvement, and
  irrigation efficiency…

                           The flooding of rice fields requires around 2,500
                           liters of water to produce 1 kg of rough rice. As
                           water scarcity increases, so does the need for
                           water saving technologies.
                                                 Source: Sygenta International AG
Recommendations for Investors


• …as well as life sciences,
  and health care.




                               Elements of life: Close-up picture of a nerve cell
                                                      Source: University of Magdeburg
Conclusions
• Investors can protect (and
  possibly even grow) their
  wealth in the long run if they
  anticipate the coming flight
  from Euro-, USD- and Yen-
  denominated debt and “get
  ahead of the crowd” by
  starting to accumulate a well-
  diversified portfolio of
  commodities, arable land, and
  attractively valued, “defen-
  sive” equity investments.
Conclusions

• Sophisticated investors familiar
  with option strategies and short
  selling may even be able to
  enhance the risk/return profile
  of their portfolios by including
  actual or “synthetic” short
  positions in apparently
  overvalued stocks to their
  portfolio.
                                     Source: cartoonstock.com
Conclusions

• Moreover, an emergency
  reserve physically held in the
  form of precious metals may
  prove vital in situations of
  existential peril.
• Priority should probably be
                                   Palladium, for example, is a rare metal
  given to substances which also   frequently used in catalytic converters,
                                   in jewellery, dentistry, in watch
  have a range of important        making, in blood sugar test strips, in
                                   aircraft spark plugs and in the
  industrial applications.         production of surgical instruments and
                                   electrical contacts.
                                                      Source: en.wikipedia.org
Conclusions

• No-one can tell with certainty
  when the current debt overhang
  is going to develop into the
  next, full-blown economic
  crisis.
• But one thing increasingly
  obvious: For investors seeking
  to protect their wealth, the
  time for action has come, and
  the early movers are most        Source: 3.bp.blogspot.com


  likely to succeed.
Comments? Objections? Requests?

Feel free to contact the author:


           Dr Sikandar Siddiqui, CFA, FRM
                 Managing Director
         SRS Ecofina UG (haftungsbeschränkt)
           Ringstr. 21, D-69115 Heidelberg
                       Germany
               Email: siddiqui@web.de

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The coming world economic crisis and how to survive it

  • 1. The Coming World Economic Crisis - and How to Survive It Dr Sikandar Siddiqui, Heidelberg, Germany November 2012
  • 2. Contents 1. Background and Diagnosis 2. Can‘t we be more Optimistic? 3. Historical Experience and Current Developments 4. A Likely Outcome 5. Conclusions and Recommendations
  • 3. Background • In the years 2008 to 2009, the sub- prime segment of the U.S. residential mortgage market virtually collapsed, leading to the deepest global recession since the Great Depression of the 1930s. Source: worldculturepictorial.com
  • 4. Background • Governments of the globally leading economies responded with rescue packages for troubled financial institutions, and with macro-economic stabilisation programmes which, in turn, prompted sharp increases in public sector deficits…
  • 5. Diagnosis • …so that by now, a disturbing fact has become increasingly obvious: • Most of the govern- ments in North America, Japan, and Western Europe are about to overstrain their debt servicing capacity. Source: http://www.economist.com/content/global_debt_clock
  • 6. Diagnosis Source: Ingram Pinn
  • 7. Diagnosis • The clearest evidence supporting this perception is not provided by the level of debt-to-GDP ratios in the countries involved, but by the fact that in all these three regions, central banks have had to step in and mop up government bonds other investors were not willing to buy at current yield and/or risk levels.
  • 8. A Giant Ponzi Scheme • While the recent banking crisis served as a catalyst for the development of this problem, its roots lie further in the past: • Since the onset of the current debt binge in the late 1970s, governments in the U.S. and much of Western Europe have In 1920, businessman Charles Ponzi set up an arbitrage trading strategy in postal reply been essentially operating a coupons which, later on, turned into a fraudu- large-scale Ponzi scheme in lent „snowball system“ using cash inflows from new participants to pay off withdrawals from which expiring debt was almost existing ones until it finally collapsed due to the inevitable, eventual cessation of follow-on never paid off but, instead, only investments. passed on to new generations of creditors.
  • 9. A Giant Ponzi Scheme • What doesn’t exactly make things easier is that, in some countries, some of the government’s implicit payment obligations are not officially counted as government debt. Source: drpinna.com
  • 10. A Giant Ponzi Scheme • Germany, while often setting itself up as a stern disciplinarian of the Eurozone governments when it comes to fiscal issues, constitutes no exception: • The country’s implied future payment obligations resulting from future public service pension liabilities and its notoriously underfunded public Subsidies to Germany’s ailing public pension system have been projected to exceed € 81bn, pension system have never or 26.2% of total federal expenses in 2012. shown up in the official public debt statistics.
  • 11. Implications • Now, with populations ageing and the limits to growth set by the scarcity of natural resources becoming increasingly obvious, the fragility of this giant, government-operated snowball system is all too evident. Source: cartoonstock.com
  • 12. Contents 1. Background and Diagnosis 2. Can‘t we be more Optimistic? 3. Historical Experience and Current Developments 4. A Likely Outcome 5. Conclusions and Recommendations
  • 13. Can‘t we be more optimistic? U.S. public debt, 1940 to 2011 • Some observers might dismiss the Source: whitehouse.gov/omb/budget/Historicals assessment made here as overly pessimistic. • To justify their verdict, they would probably point to the experience gathered in the 30 years following WW2. • At that time the capitalist economies managed to grow out of their wartime debt without governments imposing overly painful austerity measures on their Red lines indicate the debt held by the public and black lines indicate the total public debt outstan- populations for too long. ding (gross public debt), the difference being that the gross debt includes that held by the federal government itself.
  • 14. Can‘t we be more optimistic? • However, virtually none of the factors that fostered this development historically continues to be present today: A growing civilian labour force (resulting from workers switching from military service to civilian employment) and increasing Source: hdg.de labour force participation Production line in West Germany, 1960 rates,…
  • 15. Can‘t we be more optimistic? Source: Forbes.com …stable or - in real terms - even declining crude oil prices…
  • 16. Can‘t we be more optimistic? …and a largely fragmented, strictly regulated capital market leaving safety-oriented investors with virtually no alternative to holding government bonds denominated in domestic currency, … Source: cliffcule.com
  • 17. Can‘t we be more optimistic? …greatly facilitated the reduction in government debt-to-GDP ratios in the U.S. and Britain after WW2. Attribution: RJ Matson, Roll Call Source: patriotupdate.com
  • 18. Can‘t we be more optimistic? The U.S., in particular, used to draw enormous profit from the Greenback’s status as the lead currency of the Bretton Woods system, which, for a long time, created a huge demand for USD- denominated government debt to be used as a reserve asset by central banks. But confidence in the suitability of the USD as a storage of value has since been eroding (for quite understandable reasons), effectively blocking this exit route today
  • 19. Contents 1. Background and Diagnosis 2. Can‘t we be more Optimistic? 3. Historical Experience and Current Developments 4. A Likely Outcome 5. Conclusions and Recommendations
  • 20. Historical experience • In the past, governments with unsustainable debt loads have regularly taken up two possible “solutions” to this problem (or a combination of both): Source: DebtDecreaser.com
  • 21. Historical experience • They either forcefully expropriated some of their lenders, … Forced expropriation of lenders as an alternative to austerity: Execution of Jews by crusaders in the 13th century Source: de.wikipedia.org
  • 22. Historical experience • …or intentionally devalued the currency in which their debt was denominated. During the German hyperinflation of 1923, some citizens began to consider bank notes a convenient alternative to conventional wallpapers. Source: Hulton Archive | Getty Images
  • 23. Current developments • For the time being, some influential decision makers appear to prefer the first “solution”, i.e. the forceful expropriation of lenders. • At least, this is what happened when Greece forced its creditors into a “voluntary” debt rescheduling in early 2012, only to expropriate unwilling investors, too, a few weeks later – and with the obvious Source: guardian.co.uk consent of its political allies abroad
  • 24. Current developments • The arbitrary nature of the Greek “debt rescheduling” is all the more evident as the value of state-owned assets available for privatisation was estimated to exceed € 100bn by mid-2011. Source: FT.com
  • 25. Current developments Military spending as a percentage of GDP (Source: World Bank) • Greece’s continuously excessive military spending is another piece of evidence indicating that the country’s “payment crisis” is due to deliberate overspending rather than mere inability to pay. Source: americablog.com
  • 26. Current developments • So what had started with a mis- representation of fiscal statistics Greek Public Sector Deficits, ended up as what otherwise might 1997-1999 have been called a fraudulent bankruptcy. • The fact that this behaviour by the Greek governments has not been offered any noticeable resistance by fellow Eurozone member govern- ments raises perfectly understand- 1) Figures from the Convergence Programme on able fears among investors that, at which the inclusion of Greece into the Eurozone in 2001 was based. some time in future, it may repeat itself in the cases of Portugal, Ireland, Italy, or Spain.
  • 27. Current developments • On the other hand, some influential economists, for the time being, appear to favour the second alternative – a deliberately induced rise in inflation. Soruce: harvardmagazine.com
  • 28. Current developments • Given that the single most important lender to the U.S. government is the People’s Republic of China, which has obviously already begun to sense the danger, it seems unlikely that a forceful expropriation of creditors In a 2011 issue of the state-controlled paper Global News, journalist Mo Luo urged a more active role of the will be the preferred option Chinese military in supporting the country’s economic interests, arguing that “an invariably humble foreign of the U.S. government. policy that strictly prioritizes harmonious relationship and the value of compromise will reduce us to a country that serves as an ATM machine for the West and a charity for the developing world”. Source: globaltimes.cn
  • 29. Current developments • Of course, theoretically, fiscal austerity remains another option. • But given that, so far, even measures only directed at limiting further increases in government debt – rather that reversing that trend – have provoked very angry (and, in some cases, violent) Protesters take to the streets of Athens and rise reactions in parts of the public, it up against proposed austerity measures being debated in the Greek Parliament on February seems unlikely that this route will 12, 2012. Source: UPI/Giorgos Moutafis be seriously considered by governments.
  • 30. Another policy alternative • It would nevertheless be too hasty to conclude that even if the last-mentioned viewpoint prevails, the U.S. and the Eurozone economies are bound to experience excessively high rates of inflation during the next Although fears of inflation keep rising, it remains decades. a possible yet not inevitable consequence of the current economic dilemma
  • 31. Another policy alternative • The rationale for this argument is somewhat technical: - If the central bank of a currency area decides to offer member states cheap funding by continuously buying government bonds in exchange for central bank money, - …it can nevertheless curb the growth in the money supply – and the resulting inflationary pressures – by increasing minimum reserve ratios or regulatory capital requirements, or by otherwise Source: en.wikipedia.org limiting private sector credit growth.
  • 32. Another policy alternative • The Japanese experience from the last two decades suggests that large-scale central bank purchases of government bonds do not have to produce inflationary effects, provided that credit growth is limited - either through institutional regulations (e.g. regulatory capital standards or minimum reserve requirements), - or, quite simply, because of the risk aversion of lenders and/or borrowers.
  • 33. Another policy alternative • Yet in the long run, the cost of this “solution” attempt will (most probably) be a long- lasting phase of macro- economic stagnation or even contraction, due to a severe shortage of credit available to private sector entities. Source: inn-service.co.uk
  • 34. Contents 1. Background and Diagnosis 2. Can‘t we be more Optimistic? 3. Historical Experience and Current Developments 4. A Likely Outcome 5. Conclusions and Recommendations
  • 35. Likely Outcome • If chosen in isolation, each of the three aforementioned “solutions” (forced expro- priation, inflation, and protracted private sector de- leveraging) is likely to be met with fierce resistance by those Source: Reuters.com worst affected Pensioners rallying against price rises in St. Petersburg, Russia, on November 3, 2007.
  • 36. Likely Outcome • Governments might thus be tempted to choose a combination of these three “medications”, allowing the dose of each of them to be less noticeable. Source: drugchannels.net
  • 37. Likely Outcome • In this case, - inflation will be restricted to rather low (i.e. single-digit) levels due to con- straints on private sector credit growth, - limits imposed on private sector credit supply will cause economic growth to be low or even negative in per capita terms because private sector entities will be forced to use considerable fractions of their current income to pay down existing debt (if they can), and - the possibility of further selective expro- Source: politicalbetting.com priations (or “voluntary debt reschedul- ings”) will remain on the agenda.
  • 38. Contents 1. Background and Diagnosis 2. Can‘t we be more Optimistic? 3. Historical Experience and Current Developments 4. A Likely Outcome 5. Conclusions and Recommendations
  • 39. Recommendations for Investors • It seems that in any case, the most unwise investment decision will be to continue considering U.S. and Eurozone government bonds low-risk investments (at least in inflation-adjusted terms). Source: interest.co.nz
  • 40. Recommendations for Investors • Yet another piece of uncomfortable information is that in phases of economic stagnation (or recession) and moderate but perceptible inflation, the equity market as a whole, Even in nominal terms, the late 1960 s and the too, is unlikely to perform 1970s, marked by mounting inflationary pressures outstandingly in inflation- and considerable geopolitical tensions were no easy times for the average equity investor. adjusted terms
  • 41. Recommendations for Investors • This does not, however, imply that risk-conscious investors ought to shun the equity market altogether • The imminent decline in the value of Dollar, Euro- and Yen-denomi- nated debt will, most probably, induce investors to exchange their current holdings of credit assets denominated in these currencies for - equity stakes in attractively valued Source: stockmarket-investing.com companies, and - commodities essential for the fulfilment of basic human needs.
  • 42. Recommendations for Investors • Producers of goods that fulfil basic human needs (e.g. food and drinking water, energy, medical supplies and pharmaceuticals) are more likely than others to succeed in a macro-economic environment characterised by stagnation and/or inflation, because in this market Source: ehow.com segment, the sensitivity of private In most of North America, Western Europe, and Japan, the trend towards population ageing is sector demand to price rises and likely to increase the share of healthcare products and services in total aggregate income losses tends to be lowest. demand during the next decades
  • 43. Recommendations for Investors • Moreover, reasonable targets for future equity investments will be companies with - strong balance sheets (i.e. low debt to total assets ratios), enhancing their ability to withstand a protracted de- cline in private sector credit supply, - stable operating cash flows, and - attractive valuations in terms of price/equity ratios, signalling that Source: takcreditmanagement.wordpress.com their current market prices are not based on over-optimistic growth expectations.
  • 44. Recommendations for Investors • Companies making strong R&D efforts in technologies related to food and beverages, renewable energies, and medical care also deserve a high degree of attention by equity investors. Source: immobilienblasen.blogspot.com
  • 45. Recommendations for Investors • Among the companies that deserve particular attention in this context are those with strong innovative potential in the fields of “clean” energy production… A technological revolution in the making? The Gemasolar power plant, located near Seville (Spain), uses molten salt as a heat storage technology to prolongation plant's operating time in the absence of solar radiation Source: torresolenergy.com
  • 46. Recommendations for Investors • …resource saving technologies…
  • 47. Recommendations for Investors • …crop protection/yield improvement, and irrigation efficiency… The flooding of rice fields requires around 2,500 liters of water to produce 1 kg of rough rice. As water scarcity increases, so does the need for water saving technologies. Source: Sygenta International AG
  • 48. Recommendations for Investors • …as well as life sciences, and health care. Elements of life: Close-up picture of a nerve cell Source: University of Magdeburg
  • 49. Conclusions • Investors can protect (and possibly even grow) their wealth in the long run if they anticipate the coming flight from Euro-, USD- and Yen- denominated debt and “get ahead of the crowd” by starting to accumulate a well- diversified portfolio of commodities, arable land, and attractively valued, “defen- sive” equity investments.
  • 50. Conclusions • Sophisticated investors familiar with option strategies and short selling may even be able to enhance the risk/return profile of their portfolios by including actual or “synthetic” short positions in apparently overvalued stocks to their portfolio. Source: cartoonstock.com
  • 51. Conclusions • Moreover, an emergency reserve physically held in the form of precious metals may prove vital in situations of existential peril. • Priority should probably be Palladium, for example, is a rare metal given to substances which also frequently used in catalytic converters, in jewellery, dentistry, in watch have a range of important making, in blood sugar test strips, in aircraft spark plugs and in the industrial applications. production of surgical instruments and electrical contacts. Source: en.wikipedia.org
  • 52. Conclusions • No-one can tell with certainty when the current debt overhang is going to develop into the next, full-blown economic crisis. • But one thing increasingly obvious: For investors seeking to protect their wealth, the time for action has come, and the early movers are most Source: 3.bp.blogspot.com likely to succeed.
  • 53. Comments? Objections? Requests? Feel free to contact the author: Dr Sikandar Siddiqui, CFA, FRM Managing Director SRS Ecofina UG (haftungsbeschränkt) Ringstr. 21, D-69115 Heidelberg Germany Email: siddiqui@web.de