Thursday, March 4, 2010

Black Swan

Notwithstanding recommendations from the likes of the CD Howe Institute, the reality is that the Bank of Canada is going to have to dramatically increase the bank rate here very shortly.

StatsCan reports that growth was a blistering 5% in the last few months of 2009, way above expectations. Virtually every mainstream economist is now saying that the Bank of Canada has every justification it needs to start in on a string of interest rate increases, starting in about 3 months.

The surging economy "increases the odds the Bank of Canada will begin to hike interest rates in July and stay on that path in the following decisions,” says the Bank of Montreal.

Rates are going up.

The only question is: 'how fast' and 'by how much'.

Which brings us back to the issue of sovereign debt and Greece.

The image posted above are the Debt vs. GDP ratios of the world's larger economies according to the Wall Street Journal (click on image to enlarge).

Note that Greece's debt versus GDP sits at a shade over 125% versus the USA's near 100% ratio. Japan comes in as the debt champion at a 200% debt load versus GDP.

So... ummm... exactly how is the western world all that different from the Greeks?

The answer is that the Greeks don't have a currency that they can devalue in order to help inflate themselves out of their debt.

Japan would be toast right now if they were in the same situation with a currency like the Euro that they couldn't manipulate.

Because the Greeks don't have this ability, it has increased the perception of the risk that Greece could possibly default. That's what's making it very costly for Greece to sell bonds in order to fund itself.

What's amusing is watching the central banks in the UK and Japan scramble to avoid becoming the next Greece. The British Pound has taken a brutal beating as some speculators believe England may be the next country to suffocate in their own debt.

But as we noted two days ago, there is no smugness in watching what is playing out overseas because even Ben Bernanke and Alan Greenspan are concerned.

And with good reason. USA government debt is 90% vs. GDP as opposed to the 130% debt vs. GDP ratio in Greece. Anyone who thinks the US is at a lower risk than Greece is only deluding themselves. It's much like telling yourself that you are at a lower risk of having a heart attack when you are 290lbs versus being 330lbs!

The biggest worry is that investors begin to panic over the sovereign debt worries of several countries all around the world.

This could potentially trigger a wild fire as the world realizes that all of the modern economies minus China have the same problem.

The subprime crisis is a good example of watching how one tiny domino can make them all come tumbling down. If the debt spreads begin to blow out on the sovereign debt of several countries like the spreads blew out in the United States with mortgage backed securities back in 2008, then we are going to see one hell of a fiscal tidal wave.

As we have already noted... Bernanke and Greenspan both see the threat and have been moved to comment publicly on it.

Greenspan keeps daily watch on the interest rate on 10-year Treasury notes and 30-year Treasury bonds and calls them the "critical Achilles' heel" of the economy.

And that's because those spreads could spin wildly out of the control of his buddy, Ben Bernanke, at a moment's notice.

It represents the quintessential 'black swan' occurrence; those high-impact, hard-to-predict events that are beyond the realm of normal expectations.

But I ask you... would such a scenario really be all that unexpected right now? And just how stupid is it if you don't make moves to protect yourself?


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  1. In the interest of "protecting yourself" what do you suggest?

    I understand the need to lower debt levels across the board, but what of home mortgage rates?

    Will we see interest levels such as in the 80's?

  2. I'm not an Financial adviser so I would never recommend any financial instruments to anyone.

    The main thing you should think about doing is locking in a fixed rate and also calculate mortgage payments with a higher "normal" rates to prepare when the fixed period ends. One way to do this is a cash flow analysis to make sure you're in positive territory. Make conservative assumptions and include EVERY cost you can possibly think of.

    If you're looking for a way to preserve wealth and purchasing power. A lot of experts have been recommending physical gold or gold stocks.

    Also if you believe that real estate is in for a correction, you should try to reduce your exposure to it as much as possible.

    However as all important decisions in life including personal finances you have to do your own due diligence.

    "Be fearful when others are greedy. Be greedy when others are fearful."

  3. Three articles at Seeking Alpha were posted yesterday --