In this week’s episode we discuss why most commentators have it backwards in blaming the market downturn on the S&P US debt downgrade. The S&P downgrade occurred BECAUSE the general economic mood is becoming more bearish instead of the reverse. The markets would have crashed anyway even if there hadn't been a downgrade.
Stocks had already been losing ground for weeks and there is ample evidence that the global economy has been slowing down. The US debt downgrade is almost irrelevant. The established trend (i.e. long before the downgrade) has been for investors to flee for the perceived safety in bonds of the largest industrial nations (i.e. Germany, US, Japan). Nothing has really changed, the process has just sped up a bit.
In the end, the US dollar is set for massive appreciation as the global economy goes into another tail-spin. Most of the world's private (and public) debt is denominated in dollars which creates unstoppable deflationary forces in an economic contraction as debtors are forced to sell whatever assets they have in order to raise the cash to repay loans. Ironically, all the debt everyone complains about is going to be the primary force that drives up the value of the dollar (and the subsequent crash in all asset prices).
We also talk about the idea that as volatility increases we can expect the unexpected with relationships between asset classes behaving in ways that no one would have imagined. The web of relationships between assets has become so convoluted with modern financial instruments and trading strategies that things will behave in surprising ways when markets are under stress.
09 August 2011
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