Reggie Middleton: Economic Cycle Frozen at Top of the Bubble
The primary topic of Benzinga's discussion with Mr. Middleton centered on the unfolding Eurozone sovereign debt crisis, which continues to hold financial markets hostage. According to Middleton, the term "contagion" or "virus" when describing what is taking place in Europe is misleading. It is less a matter of market distrust and rising sovereign yields in one country spreading to another, and more a problem of a faulty foundation with regard to the entire EU and euro currency.
He said, "the problems were inherent from the beginning - from the inception of the Eurozone and the euro in general." He added, "a building was built upon a faulty foundation." Middleton noted that one of the core problems that is taking place in the EU is the fact that countries such as Greece lack true sovereignty due to the structure of the monetary union. As such, they are unable to print their own money in order to try and manage their debt burden.
Given this structure, Middleton said that there is only one way out of the current crisis, "and that is debt destruction." He added, "in order for any economic progress to be made, the debt needs to be destroyed." The reason why politicians and finance leaders refuse to take this step, however, is because it will trigger the bankruptcy of institutions who hold this debt. Due to the highly leveraged nature of many of the banks and other entities who have take on this debt, even a small haircut could destroy their capital base. According to Middleton, this group includes "nearly all of the major European banks."
Essentially, the strategy right now is to continue to "kick the can down the road," but eventually extremely harsh consequences will have to be faced. Economic value will be destroyed through either the European Central Bank's printing presses (eventually) or outright debt destruction through hard defaults. The likely consequences, according to Middleton, include "significant recessionary pressures." He said that the optimistic outlook is a "hard landing," but added that such a view is so optimistic that it is basically "unrealistic." Rather, Europe will face a "deep recession which could potentially become a depression," and the entire banking system will be restructured.
As bad as this sounds, however, Middleton views such an outcome as being cathartic. He noted that banks have been going out of business for 2,000 years and that the sun still came up every morning. The fundamental economic problem facing the developed world today is that monetary and political authorities have attempted to "freeze the economic cycle at the top of a bubble," and refuse to allow market forces to liquidate bad debt and allow the system to re-set. Until this happens, according to Middleton, there will be no growth. He said, "you have to let the economic cycle run," and that the refusal to do so just exacerbates the eventual crash.
This is where much of the developed world finds itself today. When the consequences of this reality are finally realized, Middleton said that he believes there will be significant "social, economic and political turmoil." In Europe, this could manifest itself in war. He said that he is not necessarily predicting a war, but noted that "all of the ingredients are there." In examining how his outlook relates to what the market is currently predicting, Middleton said that the market is not pricing in such a dire outcome because "the market isn't pricing in anything right now, because true market pricing is non-existent." He added, "what is perceived as market pricing right now is, in my opinion, just market manipulation."
Middleton noted that interest rates no longer are an accurate reflection of risk due to Fed policy, as well as similar policies being enacted by global central banks. He said that this is causing a distortion in the fundamentals, and as such, current market prices do not necessarily reflect accurate valuations, but rather reflect an atmosphere of extreme, stimulative, manipulation. Middleton believes that the current market situation, where reality is being distorted by fiscal and monetary policy, will resolve itself in a big move in either direction once "reality sets in." He is betting that the next cycle will be another crash. He said that "we will finish the 2008 correction because it was artificially postponed by a global cartel of central bankers who tried to trick the market."