It has been five long years since the U.S. housing debacle took place, which in turn exposed the fragility of the European system. And with every passing year the mantra repeats itself: The worst is over and nirvana is quickly approaching. On the opposite side, we're heading toward Armageddon, stock up on beans, guns and gold.
One thing that I was taught as a child is that extremes touch, and are always wrong. The truth lies somewhere in between, and while default is the only medicine that would allow the eurozone to start anew, hard times will lie ahead. The recent study by the IMF highlighted the need for further government intervention, as reported by Reuters, although 30 years is hardly enough to illustrate the present condition.
The IMF studied advanced economies over the past three decades and found that household spending and national output fall more steeply, unemployment rises further, household deleveraging - whether as a result of debt default or debt pay down - is more pronounced when a crash is preceded by a large run-up in consumer debt.
Furthermore, "Monetary policies can ease the pain quickly via a reduction in interest rates to reduce the cost of household debt repayment, the IMF said." Rates are already extremely low, and if governments are to provide stimulus to satisfy the austerity naysayers, the money must either be printed or borrowed. We've already gone down that road in the U.S., as demonstrated by the Federal Budget and Fed Balance Sheet charts below, without any measure of true success. If success had been attained, markets should not be hoping for QE3 as yet another life line.
The idea behind the IMF's study is to reinforce the fact that austerity reduces growth, and any fifth grader would have arrived at the same conclusion in about five minutes. What the study does not address is how we arrived here, and that the austerity being imposed is a requirement to pay the bills, as prescribed by the IMF itself. Harsh? Yes, it is. Effective? No, because we get into a vicious cycle where lower growth begets even lower growth, although this is a case of contraction leading to higher contraction.
But since government borrowing never stopped during good times, the private market is in no mood to keep financing government vices as if it was yesteryear. In addition, what the study does not mention is that the easy way out is to default, learn from the mistakes, and rebuild with a new political and socioeconomic blueprint. They want to have the cake and eat it too, and keep the status quo intact, while avoiding any loss of any kind. Not quite how the world works, never mind the free markets.
But if only we could devalue currencies, all would be well. Nouriel Roubini pointed in that direction, as reported by CNBC.
"The eurozone needs a real depreciation in the periphery to achieve the restoration of growth, external balance and competitiveness," he said at the Ambrosetti Workshop on the shores of Lake Como, Italy. "The periphery needs to have the euro closer to parity with the U.S. dollar."
It's Economics 101, and every country wants to solve its problems through exports. However, someone has to incur a deficit, and nobody is willing to take the other side of ledger. And to assume that currency depreciation will not be adopted by every country, because everyone is in dire straits, is too simplistic.
But there's yet another factor that the markets have not fully discounted: The changed American consumer. A fact remains that the American consumer goes through more goods and services than any living soul on this planet, and the end result of the housing induced crisis was that the consumer in the U.S. embraced a trait that only those that lived through the Great Depression can relate to: Frugality.
Yes, one can broadcast to the world that the BRICS will come to the rescue, but numbers don't lie, and the last time I looked, everyone was complaining. As reported by Reuters, Brazilian President Dilma Rouseff complained to President Obama about U.S. monetary policy, and I'm assuming that she didn't realize that she was talking to the wrong person, for he does not control the Fed.
Rousseff said low interest rates and other expansionist policies in wealthy nations have created a glut of global liquidity, which in turn has the unintended effect of damaging growth in poorer countries such as Brazil.
Glut of global liquidity? Can't the BRICS trade among themselves? Isn't America irrelevant, and aren't the BRICS planning alliances so they can grow without American and European markets? Believe me, there's no time like the present to push forward.
The outstanding answer as it relates to investing is "where are we headed?" Economically speaking, it's pretty clear that no resolution will be forthcoming until the "officials" accept reality, and bite the bitter bullet. From a stock market perspective, the constant confluence of monetary gimmicks, coupled with bright economic spots that are followed by disappointments, only to be followed by rumors to prop sentiment, provides periods of opportunity that at times evaporate before one can even savor the moment. Thus, the latest indication is that the ECB may be open to yet more bond buying, as reported by the Financial Times.
The suggestion by Benoît Coeuré, an ECB executive board member, of possible market intervention, helped to ease tension over Spain's debt on Wednesday and push down the country's implied cost of borrowing. However the comments could spark renewed disagreement within the central bank over one of its most controversial crisis-fighting tools.
As old and new forms of liquidity continue to hit the markets, their impact will continue to be economically temporary and only a patch job, while allowing the stock market to propel forward without regard for the underlying reality. The caveat is that one must stay alert as to when, nor if, market participants stop trusting the actions and words of central bankers, and when the bluff is eventually called as the monetary gimmicks cease to suffice. Till then, it's an unclear daily affair.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.