The Case for a Global Depression
Conditions in the global economy appear to be deteriorating. Is this a temporary "bump in the road," as President Obama described, or are we due for something much worse?
It is perfectly possible that the economy could turn. As of yet undiscovered technological improvements, impossible to predict, could greatly increase the global rate of productivity. It is also possible that central bankers and politicians around the world are conducting a first rate job, and that the economy will grow in the second half of the year, as Federal Reserve Chairman Ben Bernanke has predicted.
Yet, ominous clouds appear to be forming over the world's economies; it seems as if the world is teetering on the brink of collapse.
Unfortunately, it appears as though we may be headed for a major global depression, far worse than the aftermath of 2008.
Following the crisis of 2008, the emerging markets of the world—particularly China—were able to continue to grow at an accelerated pace. The developed countries of the world, mainly the United States and Western Europe, prevented a complete break down of their economies through quantitative easing and fiscal stimulus.
In order to conduct these stimulative programs, developed nations had to take on massive debt loads. Although right-wing critics harshly objected, these programs had little affect on prices in the economy, and inflation remained subdued. Emerging economies, flush with reserves, were able to foot the bill for the fiscal programs, and they bought the U.S. dollar to prevent run-away inflation.
Yet, now it seems as though the emerging market is breaking down, while growth in the developed world has stagnated.
China is backed into a corner. Despite raising interest rates and reserve requirements, inflation is spiraling out of control in the economy. At this point, the Chinese may have no choice but to pull their yuan off its U.S. dollar peg. Migrant workers, struggling to afford food, have begun to riot in China. In terms of brutality, the Chinese government can hang with the best of them, but at some point it seems inevitable that the protests will spiral out of control.
Of course, if the Chinese pull their peg, their currency is likely to appreciate significantly. That might put a stop to rampant inflation, but it will effectively make all those factories in China designed to produce American goods worthless overnight. If the price of Chinese manufactured toys doubles, many Americans may be unable to afford them. The Chinese could always buy them with their appreciated yuan, but do Chinese kids really want Barbie dolls? Will the Chinese buy the plastic American flags produced in Chinese factories?
Simultaneously, nearby nations like Australia, New Zealand, South Korea and Japan have become integrally tied to the Chinese economy. If China implodes, those nations might follow suit.
On the other side of the Eastern Hemisphere, Europe is struggling. Despite rhetoric from European government officials, it appears as though Greece may default. The potential ramifications of a Greek default would be utterly massive.
Greece may have to abandon the euro. In that case, the euro may cease to exist, as other debt straddled nations like Portugal and Ireland exit in quick succession. Even if euro stays intact, the effect a Greece default would have on the European financial system is hard to quantify. Which banks are holding Greece's debt? How about credit default swaps?
If Greece takes down Europe and China takes down Asia, who will be left standing? The United States, Canada, and Latin America?
If the Japanese tsunami has demonstrated anything, it is that global supply chains are increasingly interdependent. If the economies of the Eastern Hemisphere go down, how will the economies in the Americas prosper?
The price of oil and other industrial commodities might fall in such a scenario, but where would economic demand come from?
In that case, there's the possibility of government-backed stimulus. However, with many Western nations wallowing in debt, there might simply not be the funds available with which to stimulate with.
The central banks could always print the money to finance the programs, but if China and other emerging markets are not there to mop-up the liquidity, inflation could rapidly spiral out of control. Entire fiat currencies might outright collapse. With little demand, there would be no velocity of money due to economic growth. However, if economic agents believed that the central banks would print forever, confidence in the currencies might vanish.
Hopefully, such a scenario never plays out. But it seems more possible everyday.
Bullish: Traders who believe that the global economy will emerge from the present rut largely intact might want to consider the following trades:
- Buy Pro Shares Ultra S&P 500 (NYSE: SSO) in a long play on U.S. equities. U.S. equities might do well in a global recovery, and SSO could benefit.
- Buy United States Oil Fund (NYSE: USO) in a long play on oil. USO may rally if oil increases in price, on increased global demand.
Bearish: Traders who believe that the global economy is heading down a dangerous path may consider taking positions in the following:
- SPDR Gold Trust (NYSE: GLD) is a long play on gold. Gold has traditionally done well in times of economic crisis. Traders may run to the save-haven of gold, if the global economy collapses.
- Pro Shares Ultra Short Dow 30 (NYSE: DXD) is a short play on the Dow Jones. If the U.S. market tanks, DXD may do well.
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