You stand at the dead-end of a dark alley and there are footsteps coming from the shadows. As the footsteps approach, you're left quivering in fear and frantically deciding whether to run, hide or stand your ground. For you know not if the stranger is friend or foe - you only know that you are trapped.
This is the predicament all players in the global economy currently face. Unusual, scary events are unfolding and, as we desperately evaluate our options, nobody really knows what to do. All we know is that something big is about to happen.
For a while, we (in North America) felt protected. It looked like the European mess wasn't affecting U.S. markets and the U.S. economy continued to slowly improve. But now that the post-LTRO buzz is wearing off the hangover begins… again.
We're living in a world that is hooked on easy money - QE, QE2, Twist, LTRO. Now that the latest liquidity injections are wearing off, the global economy is trapped by fiscal profligacy of years past. Like the person cornered at the end of the dark alley, investors are frantically searching for an escape by overturning central bank statements for any hint of the next round of QE.
Recently however, the ECB and PBoC (People's Bank of China) stated that they have no plans to print like they did in 2008/2009. Some now believe we're on our own - I believe this is all talk.
Today, Italian Government 10yr Bond Yields are approaching 6%, Spanish Government 10yr Notes are breaking above 6.65% and the Greek Government 10yr Bond yields are back above 30%! The cost of borrowing (i.e. the cost to run the country aka the cost to avoid a rebellion) is clearly not sustainable. With yields heading higher, it will only get worse for these countries. Greece and Spain already have 50% youth unemployment - a disenfranchised, bored, scared, poor youth is never a recipe for social stability when governments are making cuts to social programs.
Unless growth returns to the European continent, the periphery countries' fiscal and social disasters will worsen, eventually leading to default (or default by proxy) and perhaps revolution. However, this is not merely an issue that concerns periphery EU countries - this is an issue that concerns the core European countries that are invested in the periphery, i.e.:
German and French banks holding bonds could be devastated by a default.
If periphery countries separate, the remaining stronger core EU will be hurt badly by a stronger euro.
I am fairly confident that the core EU countries will do their best to ultimately avoid a default or separation, assuming they can help it. So when the stuff really hits the fan, the talk about monetary restraint will turn to talk about emergency lending, looser collateral requirements, swap lines and quantitative easing. I think the ECB, Fed and PBoC will all join the party. The Fed because it has a role in minimizing a global dollar shortage and PBoC because a European catastrophe will slash China's exports at the knees (if it hasn't already).
Notwithstanding the chance that the problem is kicked down the road (probably only by a few months) with another stop-gap arrangement, we're on the verge of a European "event" that could potentially end in a monetary deluge rivaling that of 2008/2009. Maybe it happens, maybe it doesn't. I don't wear a seatbelt hoping to get in a car crash, but it doesn't hurt to be prepared.
With Treasury yields trading at record low yields (TLT), I wonder if there's much upside left. Gold (GLD), on the other hand, is about 20% off its all-time high and if 2008/2009 is any indication another round of global monetary easing could be constructive for the asset class.
Disclaimer: This is not advice. While Plan B Economics makes every effort to provide high quality information, the information is not guaranteed to be accurate and should not be relied on. Investing involves risk and you could lose all your money. Consult a professional advisor before making any investing decisions.