In recent weeks Europe took steps to stave off a funding crisis with the long term refinancing operation ("LTRO"). Economist and investors have been very skeptical of the strategy. While the LTRO might address short-term tightness in the credit markets and support bank lending, the long-term issues have not been addressed. The lack of workable solution from EU summits in late 2011 indicate solutions will have to come from central bankers. Due to the lack of real policy solutions to our rolling debt crisis, central bankers will continue to be forced to step in with additional liquidity measures.
Parsimony believes that the U.S. and the developed world is suffering from a debt crisis. Over the past 50 years, the U.S. has been experiencing diminishing returns from an additional dollar of debt.
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Source: Hinde Capital
Despite diminishing returns from additional debt policymakers and central bankers continue to leverage the existing playbook for dealing with our debt crisis. Over the last 70 years, each crisis brought greater stimulus.
Perma growth fueled by expanding debt levels is not limited to the U.S. Total global credit market debt has grown at more than an 11% CAGR from $80 trillion to approximately $200 trillion. Over the same period of time, global real GDP has grown at approximately 4% CAGR.
Central bankers are pushing against debt deleveraging with new liquidity and quantitative easing programs. The investing world remains highly uncertain as current debt levels are simply unsustainable.
We envision three potential scenarios:
- Prolonged subpar growth weighed down by too much debt
- Massive debt restructuring and write downs
- Inflation caused by expanding central bank balance sheets
Our view is that most investors are "hoping" for scenario #1 of prolonged subpar growth.
We think that investors should prepare for further strains in Europe from restructuring and the potential for high inflation.
That said, we think the euro could be headed significantly lower over the next 12 months (potentially down to parity with the dollar). As shown in the chart below, the euro is in a confirmed downtrend and we plan on staying short for the foreseeable future.
Investors that are looking to take a short position in the euro (without shorting actual spot currency) can either short the Currency Shares Euro Trust (FXE) or go long ProShares UltraShort Euro (EUO).
We also own gold and silver in physical and ETF forms (GLD and SLV). We follow a policy of not timing the market, but slowly accumulating these metals, as they are our insurance policy against inflation. Investors interested in vehicles that retain physical metal should look into Sprott Asset Management’s Sprott Physical Gold Trust (PHYS) and Sprott Physical Silver Trust (PSLV).