The general disclaimer, that these are my views and should not constitute financial advice applies with special force here. Below are my thoughts on how debtor and lender countries will have to deal with growing debt levels in developed countries and inflationary pressures in developing countries.
Debtor Countries
There are two types of debtor countries, those that can print money and those that can't. US and England, for example can print money and ordinarily like to print money to get out of debt. Some EU countries, like Spain can't print money and all they can do is restructure their debt and cut spending to get out of debt. This debt restructuring process is painful, Brazil and Argentina went through it in the early 80s, Japan in the late 80s. It amounts to a decade of no real GDP growth.
Creditor Countries
Creditor countries also fall into two categories. Those that have independent monetary policies and those that don't. These creditor, developing countries are also in an inflationary cycle because of lots of different reasons, but primarily because they have a lot of cash sitting around chasing a limited number of assets. Countries that are in such inflationary cycles like to tighten monetary policy to curb inflationary pressures. For example, China is in an inflationary bubble. China has about a 5½% inflation rate—actually, if you look at it month by month, it is 13% annualized—but let's call it 5½%, year over year. They also have nearly a 10% economic growth rate. And interest rates are at about 5%. So China's gross domestic product is growing at about 15% a year. When you have an economy that is growing at a 15% nominal rate, and you have a 5% interest rate, you would be nuts not to borrow and buy things with a higher return and you would be nuts to save in bank-deposit accounts.
Problem is, developing countries like China and Brazil are running out of capacity and are overheated. They would like to tighten monetary policy to curb inflationary pressures. But they can't. China and Brazil's monetary policy is linked to the US and while they should be tightening monetary policy, US on the other hand is loosing its monetary policy to pay off its debts. As time progresses, the inflation and bubbles in these countries will become more severe.
Debtor Countries
There are two types of debtor countries, those that can print money and those that can't. US and England, for example can print money and ordinarily like to print money to get out of debt. Some EU countries, like Spain can't print money and all they can do is restructure their debt and cut spending to get out of debt. This debt restructuring process is painful, Brazil and Argentina went through it in the early 80s, Japan in the late 80s. It amounts to a decade of no real GDP growth.
Creditor Countries
Creditor countries also fall into two categories. Those that have independent monetary policies and those that don't. These creditor, developing countries are also in an inflationary cycle because of lots of different reasons, but primarily because they have a lot of cash sitting around chasing a limited number of assets. Countries that are in such inflationary cycles like to tighten monetary policy to curb inflationary pressures. For example, China is in an inflationary bubble. China has about a 5½% inflation rate—actually, if you look at it month by month, it is 13% annualized—but let's call it 5½%, year over year. They also have nearly a 10% economic growth rate. And interest rates are at about 5%. So China's gross domestic product is growing at about 15% a year. When you have an economy that is growing at a 15% nominal rate, and you have a 5% interest rate, you would be nuts not to borrow and buy things with a higher return and you would be nuts to save in bank-deposit accounts.
Problem is, developing countries like China and Brazil are running out of capacity and are overheated. They would like to tighten monetary policy to curb inflationary pressures. But they can't. China and Brazil's monetary policy is linked to the US and while they should be tightening monetary policy, US on the other hand is loosing its monetary policy to pay off its debts. As time progresses, the inflation and bubbles in these countries will become more severe.
Over time, these links are going to cause a lot of tensions. I think we'll need something like Bretton Woods breakup in 1971, in which linked monetary policies and linked exchange-rate policies came undone. The pain of holding and liking these monetary policies is just going to be too much.
The effect of such a de-linking of monetary policy would be interesting. The likely outcome is a big exchange-rate shift between those two groups. Generally, creditor countries that are running surpluses, whose growth is too strong and whose inflation pressure is too high, and that have linked exchange rates, will revalue their currencies in order to have independent monetary policies. Debtor countries that can't print money will restructure their debts, and those that can print money will devalue their currencies.
Stocks, Bonds, Currencies and Commodities
Bonds - Debtor countries' bonds will be unattractive for the creditor countries' lenders. What they want to buy are the assets they know they'll need. They want to buy commodities. Commodities are considered safe. That's why they, particularly the Chinese, are on a commodity-buying spree.
Commodities - Commodities keep going up until China and those countries become too tight. Not only are they going to buy commodities, they are going to buy the commodity manufacturers, because there is only a certain amount of inventory of actual commodities they can hold. They are also going to buy other kinds of companies, instead of being exposed to bonds denominated in our depreciating money. We are going to see China and other creditor countries buy more assets in the U.S.
Stocks, Bonds, Currencies and Commodities
Bonds - Debtor countries' bonds will be unattractive for the creditor countries' lenders. What they want to buy are the assets they know they'll need. They want to buy commodities. Commodities are considered safe. That's why they, particularly the Chinese, are on a commodity-buying spree.
Commodities - Commodities keep going up until China and those countries become too tight. Not only are they going to buy commodities, they are going to buy the commodity manufacturers, because there is only a certain amount of inventory of actual commodities they can hold. They are also going to buy other kinds of companies, instead of being exposed to bonds denominated in our depreciating money. We are going to see China and other creditor countries buy more assets in the U.S.
Gold will be interesting in all of this. Safe used to mean U.S. Treasury bills, safe meant cash in dollars, European currency and yen. Now it is an ugly contest between those three currencies. So where is safe? Where is the least risk? It isn't going to be in those countries that have too much debt, too many obligations to pay. All debtor countries are going to print more money and will depreciate their money. Creditor countries know that. Historically, in times like this, they will increase their gold reserves.
Currencies - Additionally, Interest rates will have to rise in Germany. Interest rates will have to rise in China. So bonds are not a good buy anywhere, debtor or creditor countries. But the currency will rise, too. Rising interest rates are good for currencies, but not bonds. So currencies in developing countries would be a good buy.
Currencies - Additionally, Interest rates will have to rise in Germany. Interest rates will have to rise in China. So bonds are not a good buy anywhere, debtor or creditor countries. But the currency will rise, too. Rising interest rates are good for currencies, but not bonds. So currencies in developing countries would be a good buy.
Stocks - The US stock market went through the roof in August 1971 when Pres. Nixon announced US currency devaluation. In August 1982 the Latin American debt crises occurred with countries defaulting on a ton of US bank loans. US started printing money to offset the fallout and the resultant devaluation marked a bottom for the stock market at 777 for the Dow. Currency devaluations are good for stocks, good for commodities and good for gold. They are not good for bonds
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