- The impact of the current downturn could be shaping up to have some interesting long-term ramifications. This is now the second market crash in less than two years and could be shaping up to be the third time small investors have been seriously burned in a decade. You have to wonder how comfortable the small investor is in this market now. The game must appear entirely rigged to an unsophisticated investor and the accusations of a system error during yesterday’s trade has to make some people wonder why they are putting their hard earned cash at risk of a massive computer glitch. Investors were just beginning to feel comfortable about the economic recovery and then whoosh! -1,000 points in one day. I don’t know exactly how this will impact prices in the long-term, but my guess is that the small investor is growing increasingly frustrated with the equity markets. This can’t be good for the long-term performance of stocks.
- Although developments in Greece are stealing all the headlines the developments in the U.K. are nearly as interesting as election night comes to an end. They have managed to entirely sidestep the mess in the EMU by maintaining their own currency, but are somehow attempting to drive their economy into a near equally disastrous situation. I cannot stress how important it is that the U.K. is the sovereign issuer of their currency. They are the currency isser in a non-convertible floating exchange rate system. What does this mean? It means that the U.K. has the same exact currency system as the United States and Japan. Why does this matter? Because the U.K. cannot technically default. This is most important because solvency is not a problem as it is in Greece or any other EMU nation. What’s interesting is that their leaders and populace continue to call on the government to cut the budget deficit in order to stave off the “next Greece”. Greece is in their current debacle because they don’t control their own monetary policy. Of course, this doesn’t mean that the U.K. can just spend and spend, but like the U.S. and Japan they can spend up to a certain level so long as they don’t cause inflation. In this continuing period of low aggregate demand, high unemployment and general deflation the government of the U.K. has a great deal of buffer room in which they can spend. The high deficit is not an immediate problem. Thus far, government spending has done much to bolster their economy. As of this writing it looks like the Conservatives will win the election and with them will come the harshest of fiscal austerity measures. They have promised harsh budget cuts in order to avoid default (which is impossible). It will be very interesting to see if Cameron’s attempt to save the nation from default actually drives the nation back into recession. My guess is that Europe is already headed for a double dip on the back of this Greece mess and that the U.K. is likely to get dragged in with them – the deficit cuts will be the icing on the cake.
- Speaking of Greece – I have been doing a bit of research on their austerity measures and am increasingly convinced that they should defect and default. I hate to keep beating on this story, but it did cause a market crash yesterday so please bear with me. We have a fairly recent precedent for Greece in Ireland. Ireland implemented harsh austerity measures in 2008 and these programs have done nothing to help matters. In fact, their deficit continues to go backwards. Since the government implemented austerity measures in 2008 their government debt as a % of GDP has actually INCREASED to 64% from 43.9%. Government deficit as a % of GDP has almost doubled. This is exactly what will occur in Greece as tax receipts will fall off a cliff and austerity measures will result in decreased aggregate demand and recession. That means a Greek bailout will likely prove fruitless unless the ECB plans to offer low rates ad infinitum. This is one of the primary reasons why the market is now looking beyond Greece at surrounding nations. A bailout is looking like a waste of money. The only true way to fix Greece is by fixing their currency. The sooner the member nations of the EMU realize this the sooner a workable solution can be formed.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.