Let's start with a core economic premise and build a scenario of supporting premises as we ponder the new reality of our global economic future without rhetorical, crash and doomsday scenarios which almost never play out.
Here is the premise:
Nothing will crash or collapse. Not the Euro, not the USD, not the stock market of this or that country. Not anybody’s entire financial system. Assets will swing wildly up and down, systems will change, sometimes dramatically but doomsday collapse is off the table. Now let us build the supporting premises to see why, keeping in mind the intelligence of an elementary school sixth grader, to paint a picture of the new reality in the present and for the next 10 years.
The global new reality world is a world with unfathomable trillions of sovereign deficit over everyone's heads. It is an ongoing reality, a big part of our new reality. This has been rightfully called a crisis of Biblical proportions. However, based on our premise for this essay, it is not. We just accept it as the new normal reality. We accept it and we adjust to it. Assets will adjust to it. The system will accept it and adjust to it. Individual assets in the system will respond to it by swinging up or down 30-50%, creating significant shifts in society and culture. We can't make it go away, anymore than we can change the color of the sky or the rising and setting of the sun.
So then, applying a little commonsense, how will the assets of the world economic system respond to the fact of massive sovereign debt hanging over everyone's heads in the coming years?
This is easy. Yields will go up. Higher and higher debt loads scares lenders, so they will demand higher and higher yields in return. Even sixth graders get it. This phase of the cycle has begun with Australia, India, China and the United States during the month of February 2010.
Interest rate moving up means stock prices and bond prices moving down. That’s why last month Nicholas Taleb, author of Fooled by Randomness and The Black Swan said everyone should short U.S. Treasury bonds. However, this doesn't mean stocks will "collapse." That's mostly rhetorical nonsense. We can state there is a very high probability that stocks do not enjoy the bullish joyride bubbles which are possible when interest rates are low because people don't want to leave their money in the bank earning next to nothing. When interest rates are rising, people shift their priorities to avoiding risk if possible. Why try to earn 15% with some stock where I could also lose my money if I can leave my money in the bank at 5% with no risk? Even sixth graders get it.
Please don’t make the mistake of improperly relating this point to the “failing banks” issue. Yes, we all know there is too much debt and that both sovereign and corporate default on debts is a danger to the financial system. That’s the given over the entire system which must be adjusted to.
The stock market will not doomsday "collapse" in the simple sense the word collapse tries to convey. Why? ; Because the future is inflationary per the rising interest rate scenario which has arrived. The cost and price of everything will go up including the price of stock shares. Most agricultural commodities are going up in price for the simple reason of increased global demand of a larger and larger world population. More kid stuff.
Stocks may be worth relatively less when measured against some other asset such as gold or dollars or Euros or coffee. Just look at a 30 year chart of the U.S. stock market and you'll understand the point. When the market declines sharply 30% in a much shorter period of time than it required to go up 50% in the previous year, lots of folks want to freak out. But in fact, the market will once again adjust, respond and start climbing again. It is important to have a sense of the long term reality of global economics and stock markets. Ignore most of the shorter term mainstream media spin which has little to do with helping you be wiser and smarter.
The World’s Currencies
Currencies will continue to devalue. They are in a competitive devaluation game because a lower currency value means cheaper exports to the rest of the world. Right now, the Chinese are in the lead with their refusal to revalue the RMB peg against the dollar. Again, this is kid stuff. The purchasing power of any currency will continue to decline as it has historically. It is a natural consequence of the global economic order. Sixth graders get it. Due to economic forces on the three major continents, individual currencies will keep dancing up and down 30% against each other. Last year US dollar down, Euro up; this year Euro down, US dollar back up Even a sixth grader can look at a chart and see which way the wind is blowing. The point is that in the end, the total sum balance of all the currencies added together equals basket we'll call basket A, which has the purchasing power to buy a basket of goods and services we'll call basket B.
Gold is just another asset to store value which in general keeps going up in value relative to currencies. The part most people miss is the relativity, i.e., recently gold went UP against the Euro, right? No no; the Euro is going down, so the price of everything including gold against the Euro is going up priced in Euro. To someone holding Euro, the price of gold and the price of a vacation in the U.S. are both going up. Yes I think even a sixth grader can get that after a five minute explanation.
Knowing that interest rates are going up long term and that currencies are devaluing long term, then gold will also continue going up long term. It will also go up as it is regarded as a safe-haven asset against government instability and volatility in the global economic scenario. We can see there's plenty of that going around. Your final clue on the floor of the price of gold is that China and India and George Soros are buying lots of it at around the current $1000-1100 price range. Our sixth grader isn’t lost yet.
Oil and Energy
The price of oil is a tricky one to get a handle on for a number of reasons. First, the price of oil is highly manipulate and controlled by traders and speculators with billions at their fingertips in the 24 hour futures markets. Few would beg to differ. Meanwhile, the oil industry has become more like a mainstream McDonald's or Nike brand. They are now running this massive orchestrated "the world needs oil" PR campaign while instead, the world is quite intent on going on an oil diet. You do know that big corporations including oil corporations retain PR and marketing firms, right?.
That's not just for crisis response on oil spills. Seems weird, doesn't it? I mean, they're just supposed to be providing a commodity, what the heck are they doing getting involved in PR and branding? Anyway, the second point about oil is that demand is not going to skyrocket. At best it is going to slowly rise. The third point is that oil production levels are dropping, but again this scenario can change significantly.
The fourth point in the oil discussion is the one we sense the oil industry's PR campaign is trying very hard to downplay to stall a decline in oil prices; that there is now a massive global commitment to the alternative energy sources. The buildup in the combination of wind, solar, natural gas and nuclear energy has the potential to put a much more significant dent in the demand for oil than makes them happy. Of these, nuclear will be most significant because it is already a well-established industry and due to advances in technology, nuclear safety today has improved multiple generations beyond what it was in the days of Three Mile Island. Over the next few years, as hundreds of new nuclear power plants come online, most located in America and China, a complimentary pro-nuclear PR campaign will insure that images of nuclear disaster will drift out of the collective psyche. (By the way, my family lived near Three Mile Island the week it’s reactor had a breach. We high-tailed it to Grandma's back in Yonkers for a few weeks!)
We can sense that big oil wants oil in the $80-$90 range while in reality; the price of belongs in the $55 to $70 range, which would also be much more supportive of the global economy. Finally, the use of alternative energy sources in practical daily life will cause the routine of our daily life to change. You will not own a big fat SUV. You will own an electric car, electric bike or even electric golf cart type vehicle which you use only for local trips at 20 mph. You will not buy gas. You will drive home and plug your electric scooter in the wall every 25 miles. You will in fact, enjoy the change and appreciate saving money. Electric bikes and scooters have been mainstream transportation in China for years along with buses and subways. Why do you think Chinese have so much cash? In America, think Sun City where the residents own golf carts to get around the neighborhood. In the future, that lifestyle won't be restricted to retirees.
It is true we are facing global economic circumstances which can be painted with a doomsday brush. We could also use a Chinese silk brush to paint the picture less harshly. If we take the time to look at the situation with long term eyes and through the eyes of a sixth grader, it enables us to understand that whatever is happening in the world of scary global economics, the parts of the system, the various assets in the global economy, adjust and respond in cycles along the way. We must become smarter so that we too, know how to adjust and respond as effectively as possible, living as we do, here in the new reality.
Biography: Mario Cavolo has been based in China for over 10 years. He is a professional speaker, writer and media event personality providing multinational and media industry clients with training, coaching, communication, market research and advisory services. Take advantage of Mario’s “on the ground” China insights by visiting www.mariocavolo.com, where you will find insightful articles and commentary on business challenges, communication, and global market advisory with a special focus on China business and culture.
© 2010 Copyright Mario Cavolo - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
Disclosure: short via czi, ery, sdow