Last week, I published an article at Seeking Alpha titled "What Euro Crisis?" Based on the comments on that article, most did not agree. The market has since stabilized. The bailout plan for Spain came on Saturday. To me, that wasn't a surprise. Again, what euro crisis?
Modern economic theory has advanced so much from the great depression that if something is expected, it can hardly ever become a severe crisis. Wherever there is a known problem, there is a way. It is a real problem only if we do not realize its existence or its scale.
One of the greatest inventions in modern economy is fiat money. Policy makers can control currency supply in the economy, thus avoiding all kinds of trouble under the old gold (GLD) standard. Under a gold standard, a typical monetary supply caused recession goes like this:
- Step 1: The economy booms because of productivity improvements.
- Step 2: Because of excessive production, products become abundant. cheaper. In the meantime, mining technology doesn't necessarily improve in sync, therefore gold becomes more valuable.
- Step 3: There isn't enough supply of currency (GOLD) in the economy. Individuals and businesses start to hoard gold with deflationary expectations. This further deteriorate the shortage of currency and dampens investment.
- Step 4: Things become so cheap that production capacity is cut.
- Step 5: Wage is cut and demand decreases.
- Step 6: Further decrease in price.
This is a malicious deflationary spiral, similar to what we have seen in the great depression. By removing the freedom of printing fiat money from individual eurozone countries, euro has created a system with the similar flaws as the gold standard: the government does not have any control of monetary supply and it becomes virtually useless in a financial crisis (in a way even worse than useless as the government tightens spending further). Although it may seem that over spending caused the problem, the quick solution to the problem is almost certainly not austerity.
The problem we face in the eurozone is man-made. The currency system is built on separate governing of different countries. While the eurozone does not have a central power for fiscal policy, the power that decides its monetary policy is also very fragmented. Fortunately, Angela Merkel and the ECB both seem to understand reality, and they take actions whenever necessary. Yet unfortunately, neither wants to act preemptively to prevent the next crisis, likely due to political pressure from member countries or their voters.
So the problem we are having is a patient, with lingering chronic disease, lying on bed. Next to the bed, there stands a life supporting system and an army of doctors and nurses on the side. Yet no surgery is scheduled. The problem is not going away easily without a surgery. But the patient doesn't die easily when the caretakers are well prepared.
The U.S. stock market, in particular the S&P 500 index (SPY) will likely take small dives here and there as we have recently observed, but it's unlikely to experience a large-scale crisis that sinks big financial institutions such as JP Morgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC), and Citibank (C). For investors, any dip is a good buying opportunity. The next four years can be great if the newly elected U.S. president can push Europe to take bolder steps more quickly.