The Age of Deflation is Intensifying:
Last week I wrote about how interest rates on some European government debt was trading at a negative yield...that is...you buy short term German or Swiss bonds and you get your money back...minus a safekeeping charge. This week the number of European countries with government securities trading at negative yields grew to include Germany, Switzerland, Holland, Finland, Denmark and Austria....while the yield on Spanish 10 year government bonds rose to 7.3%...their highest level since the introduction of the Euro.
This week the value of the Euro fell to a 2 year low against the US Dollar, a 12 year low against the Yen, a 21 year low against the CAD and a 23 year low against the AUD.
Credit Quality Spreads Widen:
The market is focused on Spain...where the debt problems only seem to be getting worse...while at the same time citizens of countries that might provide financial help, particularly Germany, seem to be increasingly unwilling to do so....this is making the "Euro debt crisis" an even tougher problem to solve...fear is driving capital from the periphery to the center in an attempt to find relative safety...the yield spreads between problem countries and perceived safe havens continues to widen.
The Crisis Could Get Much Worse - Quickly:
Despite the fact that several European financial crisis have come and gone over the past couple of years it now feels as though the crisis could suddenly take a dramatic turn for the worse...the debt problems seem to be getting much bigger and the solutions seem to be getting much harder to find. A dramatic turn for the worse would have a contagion effect on global markets...which would inspire central bankers to take dramatic action...have no doubt, when push comes to shove central bankers will fight deflation with stimulus.
A Real Crisis Could Produce a Real Solution:
Perhaps a really dramatic crisis will force the politically unpalatable action necessary for a lasting solution to the European debt crisis...such a solution would certainly include default/bankruptcy in some form...either a debt write-off or a dilution of liabilities through the adoption a new currency.
If The Stock Markets Aren't Much Worried - The Credit Markets Certainly Are:
Until Friday the major European and North American stock markets had made good gains for the week...they appeared oblivious to the European credit market stresses, and to the growing evidence of a global economic slow down. Perhaps the markets sensed more central bank stimulus was coming soon, although Fed Chairman Bernanke seemed to rule that out during his Congressional presentations...or perhaps the stock markets were benefiting from capital flows seeking safety....however they turned sharply lower Friday as the Spanish debt crisis intensified.
Despite the European stresses and the evidence of a global economic slowdown the DJI has rallied nearly 1,000 pts from its June 4 lows to this week's highs...the British, German and French stock markets have also made good gains while the AUD has rallied over 8 cents, and the CAD is up 3.5 cents. However, if the stock markets aren't worried the credit markets certainly are...witness the negative yields in perceived European safe haven countries and note that the yields on all US Government debt are at or near all time record lows...even while the US Treasury issues new debt at a record pace.
Two Big Risks Ahead For Investors As The Macro-Economic Deflation Intensifies:
1) Asset prices decline, and
2) Taxes on "rich" people will go up. This will make it harder to preserve capital...and it won't much matter which political party is in charge...the "math" of the debt problems supersedes political dogma...way more money has been borrowed than will ever be repaid...and somebody...maybe everybody...is going to get stuck with the "bill." As veteran analyst Richard Russell says of a bear market, "He who loses the least wins." My long term savings remain very conservative and liquid and I've also been very cautious lately with my short term trading accounts.