Two Collapse Scenarios

 

Never before has the government’s manipulation of financial markets created greater dangers — and opportunities — for investors!

How do we know? Because lesser manipulations in recent years have already proven to be disastrous.

They led to a stock market bubble and bust in 2000 … to an even larger housing bubble and bust in 2007 … and then the greatest banking crisis of our lifetime in 2008.

Nothing Learned

What’s most ironic is that, despite those obvious failures, now those very same policies — even larger in scope than ever before — have led to still another massive bubble, this time in the one asset that, until now, had been considered above the fray: U.S. government debt.

We know how disastrous the sovereign debt crisis has been in Europe. We know that the United States government’s finances are definitely not in better shape. And we also can anticipate that a bust in U.S. debt could make the housing and banking crisis of 2008 look mild by comparison.

The only remaining question is not if, but HOW a debt crisis will hit the U.S. as well. I see two possible scenarios …

Bond collapse scenario. Mass psychology in global bond and currency markets drive the action.

One night, you go to bed thinking that the majority of market participants retain confidence in government debt, more than enough to prop up bond markets forever.

Then, the next morning you wake up to discover that the global confidence in the U.S. has been shattered by a singular event, and all hell is breaking loose.

Borrowing becomes next to impossible or prohibitively expensive. Banks fail. The financial system as we know it unravels. The economy plunges into another recession.

A video replay of 2008? No. Because this time governments do not have the will or the means to fight it.

Recession scenario. We wind up essentially falling off the same cliff as in the bond collapse scenario, but we get there via a different pathway.

This scenario begins where the first scenario ends — with a double-dip recession.

The recession guts government tax revenues, bloating the federal deficit even further.

And this is what leads to a government funding crisis, much as it has for many cities and states around the U.S.

Advertisement

Which Scenario Will it Be?

Still too soon to say. But we already have some evidence that BOTH are in process.

S&P’s warning on Monday, putting the U.S. government’s debt outlook on “negative” status, was just one more reminder of the unfolding debt crisis scenario.

Meanwhile, we also see abundant new signs of the double-dip recession scenario:

• Inflation: Historically rapid rises in inflation have consistently triggered a recession, or at a minimum, severe bear markets or crashes. Since inflationary pressures are clearly on the rise, this indicator is a clear warning sign.
• Severely rising crude oil prices have also been associated with recessions in the past. Increases of more than 150% in two years rarely happen. But when they do, a recession isn’t far off. So this indicator is currently also in “recession warning” mode.
• The U.S. housing market has started to fall again. And the mortgage credit reset schedule seems to assure much more downward pressure during the next 12 to 15 months. This doesn’t bode well for the housing market itself, the banking sector, or the economy. Indeed, a sustainable economic recovery with an ongoing price slump in housing is highly improbable.
• Then we have rising interest rates. In both the U.S. and in Europe the bond market is driving longer term rates up. And in emerging markets, central banks have long started with restrictive monetary measures, hiking interest rates and reserve requirements. Needless to say, rising interest rates can trigger bear markets and recessions.

These are four strong reasons for another economic downturn in the not-too-distant future.

With governments already massively over-indebted …

With inflation expectations on the rise, and …

With central banks starting to jack up interest rates …

I doubt the governments of Europe or the U.S. can pull another rabbit out of the hat. Soon the stock market will feel the pressure, and the economy would likely follow.

My recommendation: If you’re overloaded with stocks, use inverse ETFs like the ProShares UltraShort Financials ETF (symbol: SKF). They’re easy to buy. You can never lose more than you invest. And they’re a very good hedge.

Best wishes,

Claus

http://www.moneyandmarkets.com/two-collapse-scenarios-44194