Toby Birch

Articles:

Consequences & Cures

By Adrian Ash March 2008 Gold Vault

After the greatest credit bubble in history, hope for the best – but plan for the worst...

OSCAR WILDE's phrase "the triumph of hope over experience" could be applied to any investor assuming that equities will always prove sound in the long-term.

Anyone with an eye for financial history knows that stock markets can stagnate and drift for decades at a time, especially when inflation is in the ascendant. Such episodes can also be tough for hedge funds; massive outflows were witnessed under similar conditions in the late 1960s.

One should plan for bad times and black swans, in other words – and the great investors of the past have prepared themselves by wallowing in the worst-case scenario as a dress-rehearsal of what could go wrong. Those who make no plans will be buffeted by unexpected events and will inevitably join the ranks of the consensus hoard.

Until recently we assumed that quant risk modeling would cover the bases, but Value at Risk may be a suspect measure of our vulnerability. When planning for possible economic problems one should contemplate their cause, effect and potential consequences. Right now that means:
Cause: Post-9/11 stimulation & tax cuts, too much money created from too much debt;
Effect: Inflation and debasement followed by deflation;
Consequence: Property and equity slump, power shift from West to East.
Causal Credit

The author John Gardner once wrote that "History never looks like history when you are living through it." The TMT crash of 2000 should have been the pre-cursor to a major recession, which over time would have brought the economy back into balance. Sadly, the terrorist attacks of 2001 made a recession politically unacceptable, and America was goaded into a state of artificial economic stimulation.

We are now paying the price for what may prove to be the biggest bet in financial history in the form of a credit crisis. This term is really a misnomer, as what we face is a debt crisis, the kind of problem which undisciplined, developing countries have to endure. This sort of thing is not meant to happen to smart westerners like us.

But we should take a hard look at the numbers. The US current account deficit could be confused with that of a banana republic, and it can be funded only as long as developing countries' currencies remain Dollar-pegged and commodities – such as crude oil and Gold Bullion – are Dollar-denominated, too.