If you want to be prescient regarding the future of the global economy you must be able to forecast the largest motivational force out there: Fear.
Step 1: Define the greatest fear.
Step 2: Let it guide your perception of risk.
Bailouts increase the interconnectedness of markets. If China bails out parts of Europe, if those parts of Europe fail to make good, China suffers and those parts of Europe suffer -- for example. This is very similar to what happened in 2008 when the United States had exported lots of soon-to-become systemically risky sub-prime mortgages. Right now, Chinese liquidity is locking up and so is liquidity in the eurozone, mostly because it's obvious to private investors that investing in the debt of these companies is buying into a liability and not buying into an asset if you discount the cash flows, whereby if you invest, you are now on the list to bail out people that spend beyond their means. Let's take a look at the big players:
- 'The Solvent' - Germany has been the net beneficiary of the eurozone's and the ECB's policies. Effectively, the currency of Germany is subsidized and this drives business to Germany at the expense of the eurozone nations that I'll call 'The Shoes.' Germany has a lot more systemic risk than they'll ever let you believe. They can't afford to let 'The Shoes' drop.
- 'The Shoes' - Greece, Ireland, Portugal, and Italy are all involved in a game of trying not to default, while at the same time consistently spending more than they make. The shoes will drop.
- Public - States, municipalities, and the government as a whole have recently started to push deficit spending to a point where politicians feel the need to clamp down on spending. MMT indicates otherwise, but a USA debt downgrade is certainly in the pipeline now, and the average american gets to enjoy the burden, while our politicians continue to effectively act like children.
- Private - Balance sheet recession. Hopefully, the public sector continues to leverage up, because if it can't, we're going to contract incredibly quickly, forcing the rest of the world into recession too as the largest global spender starts cutting back.
- Ruling Party - Lives a quality of life multiple standard deviations beyond those of everyone else. Greatest fear: Social Unrest; Greatest Enemy: Freedom of Speech.
- Everyone Else - Well, you don't hear much about these folk. They're expendible. Mao puts it best: "When there is not enough to eat, people starve to death. It is better to let half of the people die so that the other half can eat their fill."
Australia, Canada, Brazil, Russia - These are the beneficiaries of the global trend to big government that sponsors bubble economics, that drive prices beyond what markets would normally allow, and encourage speculation over prudence. These are the beneficiaries because they are net exporters of the commodities that the rest of the world is using to build pyramids of speculation.
What you can do: If this all makes sense to you, perhaps the euro and the yuan are overvalued. Perhaps the highest corporate profit margins ever are unsustainable and perhaps companies as a whole are overvalued. If the Federal Reserve insists on keeping interest rates low, the dollar will weaken as the overall costs of borrowing rise to reflect the uncreditworthiness of borrowers. Industrial metals should get cheap, and perhaps companies like Vale S.A. (NYSE:VALE) that have built entire fleets to ship commodities to China will realize that China has been running ponzi pyramids based on increasing commodity prices.
Disclosure: I am long EUO, BOM.