Massive Currency and Debt Devaluations Lie Ahead
By: Bryan Rich
May 22, 2010
The run-up in the stock market from March 2009 until last month was sharp and rewarding … for some. But there was one problem, it came with disproportional risk. You see, the stock market rose to an extent that it was pricing in perfection … a V-shaped recovery … a return to normal.
That overly optimistic view on the world can make for an ugly ending …
Because if there’s one thing we can assume after enduring a global meltdown of historical proportions, it’s this: A sharp return to normal is highly unlikely.
That common sense approach to risk aversion should be clear. And it’s why I find it troubling that stock market professionals have been scrambling to explain the recent decline in global stocks and other high risk investments.
They tell themselves, “This is just a healthy correction … earnings momentum is strong … the fear weighing on stocks is unwarranted.”
Then they quietly ask, “Is there something bigger going on?”
The answer: Of course there’s something big going on! And it’s sitting right under their nose, plain as day.
It’s a sovereign debt crisis, which is putting the world’s largest collective economy, the euro zone, in jeopardy.
And It’s Not Just Europe …
People around the globe should have gotten the wake-up call from the crisis in Europe. But denial is a strong emotion to overcome, especially for the stock market bulls that make a living from rising stocks.
As I’ve warned in several Money and Markets columns, the problems in Greece aren’t just a European problem. Greece’s troubles have not only exposed the structural flaws of the European Monetary Union, but have also exposed the structural problems in the global economy.
Government officials around the world have attempted to put problems on hold for the time being, with the hope that they can deal with them later under better circumstances, when economies are stronger. They’ve responded to the debt problem by adding more debt. And that “crisis response” has only exacerbated a dynamic that created the crisis to begin with: Easy credit … i.e. debt.
We have benchmarks on how this likely turns out …
Historically, financial crises typically lead to sovereign debt crises. And sovereign debt crises typically lead to currency crises. All this is a recipe for tough economic times ahead.
Sovereign Debt Crisis Paving the Road for the Currency Crisis
The sovereign debt crisis is still unfolding. And a currency crisis is now upon us. When Europe chose to go all-in by pledging backstops for the downward spiraling weak countries within the euro zone, they made a conscious decision to devalue the euro and to inflate away the debt.
For those like the euro zone, which are backed into a corner, a currency and debt devaluation become the only option.
And with economies around the globe burdened with debt, addressing problems through currency devaluation becomes highly competitive.
You see, currencies are only valued on a relative basis, that means someone’s currency has to win the least ugly contest, and as a result appreciate against world currencies … in this case, it’s the U.S. dollar.
Meanwhile, three out of four of the most liquid currencies in the world — the euro, the pound and the yen — will likely be dramatically devalued before it’s all said and done.
As for the euro, many have been throwing around the possibility of the euro going to parity against the dollar.
Let’s take a look at my chart below to see just how low it can go …