A disturbing fact becomes more and more obvious: The governments of the both the U.S. and most of the Eurozone member countries are about to overstrain their debt servicing capacity.
For individuals, organizations, and countries that have so far regarded the currencies of these countries as reliable storages of value, news could hardly be more alarming: Evidence is rapidly piling up that the debtor governments involved intend to rid themselves of their unsustainable debt largely at the expense of their creditors. This could be effectuated either through a sudden expropriation of lenders (nowadays euphemistically referred to as a “haircut”), or by means of a gradual dispossession through a deliberately induced devaluation.
However, investors currently holding large amounts of Dollar-, or Euro-denominated reserves, do not yet have to resign to the fate of seeing their wealth evaporate through arbitrary acts of governments they had trusted for long. In the document to this message, I have sought to specify some of the basic principles prudent investors should heed in order to protect their wealth from the impending world economic crisis. You may copy and circulate it freely, but would do me a huge favour if you could do so with a reference to my authorship. And, of course, any opportunity you could grant to me to carry its message further afield in person would be most welcome.
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
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
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