Global Financial Crisis Worst Since 1930's Depression

By: William_R_Thomson

Q: Are we looking at a financial system "avalanche" rather than a technical bear market, in equities and bonds?

A: In no way can this be seen as a normal bear market. This is undoubtedly the worst financial crisis in the developed world since the 1930s. The only period remotely similar was the bear market of 1973-75, which was itself a part of the extended 1966-82 bear market in US shares. That bear market was driven in part by a 13 fold increase in oil prices from 1972 to 1980. This time we have had a 14 fold increase in oil prices from the $10 low of 1999. Last time we had massive inflation of 20 percent per annum. That has not yet arrived but may well be in the pipeline.

However, in my view, the situation is far worse this time since the US financial system is extraordinarily stretched and stressed. Last time we only had the minor bankruptcies of Franklin National Bank and Continental Bank to contend with. Then there were no derivatives. This time they amount to more than 10 times world GDP and a greater multiple of bank capital. Within that total the most toxic ones are those unlisted, opaque, over the counter variety amounting to over $50 trillion, again multiples of US bank capital.

The revolution in market finance that began with the deregulation of the 1980s may be about to eat its young, as we have seen with the putative bailouts of Fannie Mae and Freddie Mac; if nationalization goes ahead the US visible national debt increases by $5 billion and is effectively double. The US would no longer qualify to join the Euro!

The US budget deficit could be on the verge of exploding upwards. Including war costs it is already over 4 percent of GDP. The economic slowdown and President Obama's plans for healthcare, whist noble and justifiable, even after tax increases, could send the deficit north of $1 trillion or 7 percent of GDP by 2010.

Q: What do you think the total "wealth loss" might be as a result of recent crises (in terms of falls in market cap, sub-prime losses and other losses by banks and investment banks, derivatives market losses in general)? Does anyone really know - or is the whole thing too opaque to estimate?

When Chou En-Lai was asked by Kissinger if he thought the French Revolution had been a success he responded ‘it's too soon to tell'. That applies to the current situation. But we could be looking at $6 trillion in mark downs of housing wealth, $3-4 trillion in stock market losses if we get a 25-35 percent mark down in the market – and it could be worse – and then we have the losses of the banking system. So we are talking about possibly $10 trillion as compared with a GDP of $13 trillion. Proportionally, I would look for the UK to suffer similarly. It's not chicken feed!

Q: Do you think that inflation or deflation is the greatest threat facing the global e conomy - i.e. commodity price inflation versus the collapse in asset values (real estate and stocks etc).

This is the great debate. The losses are deflationary but the monetary and fiscal policies are hugely inflationary. So far the secondary effects of wage inflation are the dogs that have not barked yet, but the unions are clearly getting restive in Europe and the pressures are so intense on US wage earners that it surely must just be a matter of time before they try and restore some of their lost incomes.

Ultimately, governments never repay their debts in real terms. I look for the US to try and inflate its way out of its mess whilst, all the time, denying it is happening and quoting the manipulated inflation data. But one only needs to look at the private estimates of M3 growth to see that it has been growing at 18 percent per annum, double what it was when they stopped publishing the information and double the worst time in the stagflationary 1970s.

Q: How safe is US government debt as an investment now, given the stress of financing financial system bail-outs?

You will be repaid in US dollars with less purchasing power than when you subscribed. Whilst this crisis continues and the management of the White House and the Fed remain unchanged, the US dollar is a poor bet and a worse investment.

Q: What is the safest thing to "hold onto" in this avalanche - gold, other commodities, cash etc?

Gold, in my opinion, is the asset of last resort. It is no one else's liability and has shown its value in crises over the millennia. That situation remains unchanged. It is still cheap relative to oil on a historical basis and is only 40 percent of its all time high on an inflation adjusted basis. New supplies coming onto the markets are constrained by high costs and a lack of mining skills after a generation when no new graduates entered the sector.

Given the global geopolitical tensions added to the banking crisis, gold remains a superb insurance policy. Before the present cycle exhausts itself I would not be surprised to see gold reach all time highs on an inflation adjusted basis i.e., $2500.

Silver is also interesting here since it is a minor precious metal with expanding industrial applications. On an inflation adjusted basis it is even cheaper than gold.

There are an ever expanding range of instruments to tap the commodity space with ETFs and ETNs - long and short. There are also natural resource funds of hedge funds.

Q: Amongst equities and bonds, what (if anything) is there to go for now? Emerging markets versus advanced markets?

I believe we are entering a new phase in the global economy, one with increased government regulation, controls and spending. The old Thatcher-Reagan supply side revolution is likely to take a breather and a return to a modified Keynesian is a possibility. This is driven by the increased scepticism in developed economies about globalization, largely because the rewards have not been adequately distributed. This accords with the likelihood that the 36 year cycle in US Presidential elections will probably make the Democrats the leading party of government in the coming years with all that means for interference in the economy – and inflation.

The extent to which the growing scepticism of globalization in developed economies affects the future growth of emerging markets cannot be determined at this time. At the margins growth may be reduced slightly but the fundamental factors changing the shape of the global economy are too strong to be derailed. Emerging markets remain a field of great opportunity, especially after recent declines in countries like China, India and Vietnam. Others with essential commodities are exciting. Powered by Chinese and Indian investment, Africa could have a renaissance. Those with financial imbalances like those in Eastern Europe should be avoided.

By William R. Thomson
Chairman
Private Capital Ltd.
Hong Kong 
wrthomson@btconnect.com

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