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The Coming World EconomicCrisis - and How to Survive It  Dr Sikandar Siddiqui, Heidelberg, Germany              November 2...
Contents1. Background and Diagnosis2. Can‘t we be more Optimistic?3. Historical Experience and Current Developments4. A Li...
Background• In the years 2008 to 2009, the sub-  prime segment of the U.S.  residential mortgage market virtually  collaps...
Background• Governments of the  globally leading economies  responded with rescue  packages for troubled  financial instit...
Diagnosis• …so that by now, a  disturbing fact has  become increasingly  obvious:• Most of the govern-  ments in North  Am...
Diagnosis            Source: Ingram Pinn
Diagnosis• The clearest evidence supporting  this perception is not provided  by the level of debt-to-GDP  ratios in the c...
A Giant Ponzi Scheme• While the recent banking crisis  served as a catalyst for the  development of this problem,  its roo...
A Giant Ponzi Scheme• What doesn’t exactly make things easier is that, in some countries,  some of the government’s implic...
A Giant Ponzi Scheme• Germany, while often setting  itself up as a stern disciplinarian  of the Eurozone governments  when...
Implications• Now, with populations ageing  and the limits to growth set by  the scarcity of natural resources  becoming i...
Contents1. Background and Diagnosis2. Can‘t we be more Optimistic?3. Historical Experience and Current Developments4. A Li...
Can‘t we be more optimistic?                                             U.S. public debt, 1940 to 2011• Some observers mi...
Can‘t we be more optimistic?• However, virtually none of  the factors that fostered this  development historically  contin...
Can‘t we be more optimistic?                                                           Source: Forbes.com…stable or - in r...
Can‘t we be more optimistic?…and a largely fragmented, strictly regulated capital market leaving safety-oriented investors...
Can‘t we be more optimistic?…greatly facilitated the reduction in government debt-to-GDP ratios in the U.S. and Britain af...
Can‘t we be more optimistic?The U.S., in particular, used todraw enormous profit from theGreenback’s status as the leadcur...
Contents1. Background and Diagnosis2. Can‘t we be more Optimistic?3. Historical Experience and Current Developments4. A Li...
Historical experience• In the past, governments with  unsustainable debt loads have  regularly taken up two possible  “sol...
Historical experience• They either forcefully  expropriated some of their  lenders, …                               Forced...
Historical experience• …or intentionally devalued  the currency in which their  debt was denominated.                     ...
Current developments• For the time being, some influential  decision makers appear to prefer the  first “solution”, i.e. t...
Current developments• The arbitrary nature of the  Greek “debt rescheduling” is  all the more evident as the  value of sta...
Current developments                                   Military spending as a percentage of                               ...
Current developments• So what had started with a mis-  representation of fiscal statistics                                ...
Current developments• On the other hand, some  influential economists, for the  time being, appear to favour  the second a...
Current developments• Given that the single most  important lender to the U.S.  government is the People’s  Republic of Ch...
Current developments• Of course, theoretically, fiscal  austerity remains another option.• But given that, so far, even  m...
Another policy alternative• It would nevertheless be too  hasty to conclude that even if  the last-mentioned viewpoint  pr...
Another policy alternative• The rationale for this argument is  somewhat technical:  - If the central bank of a currency a...
Another policy alternative• The Japanese experience from  the last two decades suggests that  large-scale central bank  pu...
Another policy alternative • Yet in the long run, the cost   of this “solution” attempt will   (most probably) be a long- ...
Contents1. Background and Diagnosis2. Can‘t we be more Optimistic?3. Historical Experience and Current Developments4. A Li...
Likely Outcome• If chosen in isolation, each of  the three aforementioned  “solutions” (forced expro-  priation, inflation...
Likely Outcome• Governments might thus be  tempted to choose a  combination of these three  “medications”, allowing the  d...
Likely Outcome• In this case,  - inflation will be restricted to rather low     (i.e. single-digit) levels due to con-    ...
Contents1. Background and Diagnosis2. Can‘t we be more Optimistic?3. Historical Experience and Current Developments4. A Li...
Recommendations for Investors• It seems that in any case, the  most unwise investment  decision will be to continue  consi...
Recommendations for Investors• Yet another piece of  uncomfortable information  is that in phases of  economic stagnation ...
Recommendations for Investors• This does not, however, imply that  risk-conscious investors ought to  shun the equity mark...
Recommendations for Investors• Producers of goods that fulfil basic  human needs (e.g. food and  drinking water, energy, m...
Recommendations for Investors• Moreover, reasonable targets for  future equity investments will be  companies with- strong...
Recommendations for Investors• Companies making strong  R&D efforts in technologies  related to food and beverages,  renew...
Recommendations for Investors• Among the companies  that deserve particular  attention in this context  are those with str...
Recommendations for Investors• …resource saving  technologies…
Recommendations for Investors• …crop protection/yield  improvement, and  irrigation efficiency…                           ...
Recommendations for Investors• …as well as life sciences,  and health care.                               Elements of life...
Conclusions• Investors can protect (and  possibly even grow) their  wealth in the long run if they  anticipate the coming ...
Conclusions• Sophisticated investors familiar  with option strategies and short  selling may even be able to  enhance the ...
Conclusions• Moreover, an emergency  reserve physically held in the  form of precious metals may  prove vital in situation...
Conclusions• No-one can tell with certainty  when the current debt overhang  is going to develop into the  next, full-blow...
Comments? Objections? Requests?Feel free to contact the author:           Dr Sikandar Siddiqui, CFA, FRM                 M...
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The coming world economic crisis and how to survive it

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A disturbing fact becomes more and more obvious: The governments of the both the U.S. and most of the Eurozone member countries are about to overstrain their debt servicing capacity.

For individuals, organizations, and countries that have so far regarded the currencies of these countries as reliable storages of value, news could hardly be more alarming: Evidence is rapidly piling up that the debtor governments involved intend to rid themselves of their unsustainable debt largely at the expense of their creditors. This could be effectuated either through a sudden expropriation of lenders (nowadays euphemistically referred to as a “haircut”), or by means of a gradual dispossession through a deliberately induced devaluation.

However, investors currently holding large amounts of Dollar-, or Euro-denominated reserves, do not yet have to resign to the fate of seeing their wealth evaporate through arbitrary acts of governments they had trusted for long. In the document to this message, I have sought to specify some of the basic principles prudent investors should heed in order to protect their wealth from the impending world economic crisis. You may copy and circulate it freely, but would do me a huge favour if you could do so with a reference to my authorship. And, of course, any opportunity you could grant to me to carry its message further afield in person would be most welcome.

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Transcript of "The coming world economic crisis and how to survive it"

  1. 1. The Coming World EconomicCrisis - and How to Survive It Dr Sikandar Siddiqui, Heidelberg, Germany November 2012
  2. 2. Contents1. Background and Diagnosis2. Can‘t we be more Optimistic?3. Historical Experience and Current Developments4. A Likely Outcome5. Conclusions and Recommendations
  3. 3. Background• In the years 2008 to 2009, the sub- prime segment of the U.S. residential mortgage market virtually collapsed, leading to the deepest global recession since the Great Depression of the 1930s. Source: worldculturepictorial.com
  4. 4. Background• Governments of the globally leading economies responded with rescue packages for troubled financial institutions, and with macro-economic stabilisation programmes which, in turn, prompted sharp increases in public sector deficits…
  5. 5. Diagnosis• …so that by now, a disturbing fact has become increasingly obvious:• Most of the govern- ments in North America, Japan, and Western Europe are about to overstrain their debt servicing capacity. Source: http://www.economist.com/content/global_debt_clock
  6. 6. Diagnosis Source: Ingram Pinn
  7. 7. Diagnosis• The clearest evidence supporting this perception is not provided by the level of debt-to-GDP ratios in the countries involved, but by the fact that in all these three regions, central banks have had to step in and mop up government bonds other investors were not willing to buy at current yield and/or risk levels.
  8. 8. A Giant Ponzi Scheme• While the recent banking crisis served as a catalyst for the development of this problem, its roots lie further in the past:• Since the onset of the current debt binge in the late 1970s, governments in the U.S. and much of Western Europe have In 1920, businessman Charles Ponzi set up an arbitrage trading strategy in postal reply been essentially operating a coupons which, later on, turned into a fraudu- large-scale Ponzi scheme in lent „snowball system“ using cash inflows from new participants to pay off withdrawals from which expiring debt was almost existing ones until it finally collapsed due to the inevitable, eventual cessation of follow-on never paid off but, instead, only investments. passed on to new generations of creditors.
  9. 9. A Giant Ponzi Scheme• What doesn’t exactly make things easier is that, in some countries, some of the government’s implicit payment obligations are not officially counted as government debt. Source: drpinna.com
  10. 10. A Giant Ponzi Scheme• Germany, while often setting itself up as a stern disciplinarian of the Eurozone governments when it comes to fiscal issues, constitutes no exception:• The country’s implied future payment obligations resulting from future public service pension liabilities and its notoriously underfunded public Subsidies to Germany’s ailing public pension system have been projected to exceed € 81bn, pension system have never or 26.2% of total federal expenses in 2012. shown up in the official public debt statistics.
  11. 11. Implications• Now, with populations ageing and the limits to growth set by the scarcity of natural resources becoming increasingly obvious, the fragility of this giant, government-operated snowball system is all too evident. Source: cartoonstock.com
  12. 12. Contents1. Background and Diagnosis2. Can‘t we be more Optimistic?3. Historical Experience and Current Developments4. A Likely Outcome5. Conclusions and Recommendations
  13. 13. Can‘t we be more optimistic? U.S. public debt, 1940 to 2011• Some observers might dismiss the Source: whitehouse.gov/omb/budget/Historicals assessment made here as overly pessimistic.• To justify their verdict, they would probably point to the experience gathered in the 30 years following WW2.• At that time the capitalist economies managed to grow out of their wartime debt without governments imposing overly painful austerity measures on their Red lines indicate the debt held by the public and black lines indicate the total public debt outstan- populations for too long. ding (gross public debt), the difference being that the gross debt includes that held by the federal government itself.
  14. 14. Can‘t we be more optimistic?• However, virtually none of the factors that fostered this development historically continues to be present today: A growing civilian labour force (resulting from workers switching from military service to civilian employment) and increasing Source: hdg.de labour force participation Production line in West Germany, 1960 rates,…
  15. 15. Can‘t we be more optimistic? Source: Forbes.com…stable or - in real terms - even declining crude oil prices…
  16. 16. Can‘t we be more optimistic?…and a largely fragmented, strictly regulated capital market leaving safety-oriented investors with virtually no alternative to holding government bonds denominated in domestic currency, … Source: cliffcule.com
  17. 17. Can‘t we be more optimistic?…greatly facilitated the reduction in government debt-to-GDP ratios in the U.S. and Britain after WW2. Attribution: RJ Matson, Roll Call Source: patriotupdate.com
  18. 18. Can‘t we be more optimistic?The U.S., in particular, used todraw enormous profit from theGreenback’s status as the leadcurrency of the Bretton Woodssystem, which, for a long time,created a huge demand for USD-denominated government debt tobe used as a reserve asset bycentral banks.But confidence in the suitability ofthe USD as a storage of value hassince been eroding (for quiteunderstandable reasons), effectivelyblocking this exit route today
  19. 19. Contents1. Background and Diagnosis2. Can‘t we be more Optimistic?3. Historical Experience and Current Developments4. A Likely Outcome5. Conclusions and Recommendations
  20. 20. Historical experience• In the past, governments with unsustainable debt loads have regularly taken up two possible “solutions” to this problem (or a combination of both): Source: DebtDecreaser.com
  21. 21. Historical experience• They either forcefully expropriated some of their lenders, … Forced expropriation of lenders as an alternative to austerity: Execution of Jews by crusaders in the 13th century Source: de.wikipedia.org
  22. 22. Historical experience• …or intentionally devalued the currency in which their debt was denominated. During the German hyperinflation of 1923, some citizens began to consider bank notes a convenient alternative to conventional wallpapers. Source: Hulton Archive | Getty Images
  23. 23. Current developments• For the time being, some influential decision makers appear to prefer the first “solution”, i.e. the forceful expropriation of lenders.• At least, this is what happened when Greece forced its creditors into a “voluntary” debt rescheduling in early 2012, only to expropriate unwilling investors, too, a few weeks later – and with the obvious Source: guardian.co.uk consent of its political allies abroad
  24. 24. Current developments• The arbitrary nature of the Greek “debt rescheduling” is all the more evident as the value of state-owned assets available for privatisation was estimated to exceed € 100bn by mid-2011. Source: FT.com
  25. 25. Current developments Military spending as a percentage of GDP (Source: World Bank)• Greece’s continuously excessive military spending is another piece of evidence indicating that the country’s “payment crisis” is due to deliberate overspending rather than mere inability to pay. Source: americablog.com
  26. 26. Current developments• So what had started with a mis- representation of fiscal statistics Greek Public Sector Deficits, ended up as what otherwise might 1997-1999 have been called a fraudulent bankruptcy.• The fact that this behaviour by the Greek governments has not been offered any noticeable resistance by fellow Eurozone member govern- ments raises perfectly understand- 1) Figures from the Convergence Programme on able fears among investors that, at which the inclusion of Greece into the Eurozone in 2001 was based. some time in future, it may repeat itself in the cases of Portugal, Ireland, Italy, or Spain.
  27. 27. Current developments• On the other hand, some influential economists, for the time being, appear to favour the second alternative – a deliberately induced rise in inflation. Soruce: harvardmagazine.com
  28. 28. Current developments• Given that the single most important lender to the U.S. government is the People’s Republic of China, which has obviously already begun to sense the danger, it seems unlikely that a forceful expropriation of creditors In a 2011 issue of the state-controlled paper Global News, journalist Mo Luo urged a more active role of the will be the preferred option Chinese military in supporting the country’s economic interests, arguing that “an invariably humble foreign of the U.S. government. policy that strictly prioritizes harmonious relationship and the value of compromise will reduce us to a country that serves as an ATM machine for the West and a charity for the developing world”. Source: globaltimes.cn
  29. 29. Current developments• Of course, theoretically, fiscal austerity remains another option.• But given that, so far, even measures only directed at limiting further increases in government debt – rather that reversing that trend – have provoked very angry (and, in some cases, violent) Protesters take to the streets of Athens and rise reactions in parts of the public, it up against proposed austerity measures being debated in the Greek Parliament on February seems unlikely that this route will 12, 2012. Source: UPI/Giorgos Moutafis be seriously considered by governments.
  30. 30. Another policy alternative• It would nevertheless be too hasty to conclude that even if the last-mentioned viewpoint prevails, the U.S. and the Eurozone economies are bound to experience excessively high rates of inflation during the next Although fears of inflation keep rising, it remains decades. a possible yet not inevitable consequence of the current economic dilemma
  31. 31. Another policy alternative• The rationale for this argument is somewhat technical: - If the central bank of a currency area decides to offer member states cheap funding by continuously buying government bonds in exchange for central bank money, - …it can nevertheless curb the growth in the money supply – and the resulting inflationary pressures – by increasing minimum reserve ratios or regulatory capital requirements, or by otherwise Source: en.wikipedia.org limiting private sector credit growth.
  32. 32. Another policy alternative• The Japanese experience from the last two decades suggests that large-scale central bank purchases of government bonds do not have to produce inflationary effects, provided that credit growth is limited - either through institutional regulations (e.g. regulatory capital standards or minimum reserve requirements), - or, quite simply, because of the risk aversion of lenders and/or borrowers.
  33. 33. Another policy alternative • Yet in the long run, the cost of this “solution” attempt will (most probably) be a long- lasting phase of macro- economic stagnation or even contraction, due to a severe shortage of credit available to private sector entities. Source: inn-service.co.uk
  34. 34. Contents1. Background and Diagnosis2. Can‘t we be more Optimistic?3. Historical Experience and Current Developments4. A Likely Outcome5. Conclusions and Recommendations
  35. 35. Likely Outcome• If chosen in isolation, each of the three aforementioned “solutions” (forced expro- priation, inflation, and protracted private sector de- leveraging) is likely to be met with fierce resistance by those Source: Reuters.com worst affected Pensioners rallying against price rises in St. Petersburg, Russia, on November 3, 2007.
  36. 36. Likely Outcome• Governments might thus be tempted to choose a combination of these three “medications”, allowing the dose of each of them to be less noticeable. Source: drugchannels.net
  37. 37. Likely Outcome• In this case, - inflation will be restricted to rather low (i.e. single-digit) levels due to con- straints on private sector credit growth, - limits imposed on private sector credit supply will cause economic growth to be low or even negative in per capita terms because private sector entities will be forced to use considerable fractions of their current income to pay down existing debt (if they can), and - the possibility of further selective expro- Source: politicalbetting.com priations (or “voluntary debt reschedul- ings”) will remain on the agenda.
  38. 38. Contents1. Background and Diagnosis2. Can‘t we be more Optimistic?3. Historical Experience and Current Developments4. A Likely Outcome5. Conclusions and Recommendations
  39. 39. Recommendations for Investors• It seems that in any case, the most unwise investment decision will be to continue considering U.S. and Eurozone government bonds low-risk investments (at least in inflation-adjusted terms). Source: interest.co.nz
  40. 40. Recommendations for Investors• Yet another piece of uncomfortable information is that in phases of economic stagnation (or recession) and moderate but perceptible inflation, the equity market as a whole, Even in nominal terms, the late 1960 s and the too, is unlikely to perform 1970s, marked by mounting inflationary pressures outstandingly in inflation- and considerable geopolitical tensions were no easy times for the average equity investor. adjusted terms
  41. 41. Recommendations for Investors• This does not, however, imply that risk-conscious investors ought to shun the equity market altogether• The imminent decline in the value of Dollar, Euro- and Yen-denomi- nated debt will, most probably, induce investors to exchange their current holdings of credit assets denominated in these currencies for - equity stakes in attractively valued Source: stockmarket-investing.com companies, and - commodities essential for the fulfilment of basic human needs.
  42. 42. Recommendations for Investors• Producers of goods that fulfil basic human needs (e.g. food and drinking water, energy, medical supplies and pharmaceuticals) are more likely than others to succeed in a macro-economic environment characterised by stagnation and/or inflation, because in this market Source: ehow.com segment, the sensitivity of private In most of North America, Western Europe, and Japan, the trend towards population ageing is sector demand to price rises and likely to increase the share of healthcare products and services in total aggregate income losses tends to be lowest. demand during the next decades
  43. 43. Recommendations for Investors• Moreover, reasonable targets for future equity investments will be companies with- strong balance sheets (i.e. low debt to total assets ratios), enhancing their ability to withstand a protracted de- cline in private sector credit supply,- stable operating cash flows, and- attractive valuations in terms of price/equity ratios, signalling that Source: takcreditmanagement.wordpress.com their current market prices are not based on over-optimistic growth expectations.
  44. 44. Recommendations for Investors• Companies making strong R&D efforts in technologies related to food and beverages, renewable energies, and medical care also deserve a high degree of attention by equity investors. Source: immobilienblasen.blogspot.com
  45. 45. Recommendations for Investors• Among the companies that deserve particular attention in this context are those with strong innovative potential in the fields of “clean” energy production… A technological revolution in the making? The Gemasolar power plant, located near Seville (Spain), uses molten salt as a heat storage technology to prolongation plants operating time in the absence of solar radiation Source: torresolenergy.com
  46. 46. Recommendations for Investors• …resource saving technologies…
  47. 47. Recommendations for Investors• …crop protection/yield improvement, and irrigation efficiency… The flooding of rice fields requires around 2,500 liters of water to produce 1 kg of rough rice. As water scarcity increases, so does the need for water saving technologies. Source: Sygenta International AG
  48. 48. Recommendations for Investors• …as well as life sciences, and health care. Elements of life: Close-up picture of a nerve cell Source: University of Magdeburg
  49. 49. Conclusions• Investors can protect (and possibly even grow) their wealth in the long run if they anticipate the coming flight from Euro-, USD- and Yen- denominated debt and “get ahead of the crowd” by starting to accumulate a well- diversified portfolio of commodities, arable land, and attractively valued, “defen- sive” equity investments.
  50. 50. Conclusions• Sophisticated investors familiar with option strategies and short selling may even be able to enhance the risk/return profile of their portfolios by including actual or “synthetic” short positions in apparently overvalued stocks to their portfolio. Source: cartoonstock.com
  51. 51. Conclusions• Moreover, an emergency reserve physically held in the form of precious metals may prove vital in situations of existential peril.• Priority should probably be Palladium, for example, is a rare metal given to substances which also frequently used in catalytic converters, in jewellery, dentistry, in watch have a range of important making, in blood sugar test strips, in aircraft spark plugs and in the industrial applications. production of surgical instruments and electrical contacts. Source: en.wikipedia.org
  52. 52. Conclusions• No-one can tell with certainty when the current debt overhang is going to develop into the next, full-blown economic crisis.• But one thing increasingly obvious: For investors seeking to protect their wealth, the time for action has come, and the early movers are most Source: 3.bp.blogspot.com likely to succeed.
  53. 53. Comments? Objections? Requests?Feel free to contact the author: Dr Sikandar Siddiqui, CFA, FRM Managing Director SRS Ecofina UG (haftungsbeschränkt) Ringstr. 21, D-69115 Heidelberg Germany Email: siddiqui@web.de
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