The Great Money Shift

It will be a thoughtful reckoning today. Put on your thinking cap. There is a lot to think about. What exactly is going on in the world and what, if anything, can you do about it?

Let’s start with China, where Shanghai stocks fell 5.1% yesterday and are 26% off the index’s 52-week high. If Chinese stocks are leading the economy, one crash is in and another could be just beginning.

About the only bright side of any crash in Chinese equities – and any slump in the Chinese economy – is that we’re talking about a run-of-the-mill kind of crash and not a systemic failure. That might not sound positive. But it is. It means that while the pain of a China crash would be sharp and probably not short, it wouldn’t be the end of the world. Just the end of the world as we know it.

And that would be fine too. Because over the next few decades, you get the sense that the balance of economic power in the world will have decisively shifted. It’s shifting away from the over-indebted industrialized Western Welfare States and toward the higher-saving nations of the developed world. A few years ago, we called this “The Money Migration.” And our view then was that this shift favored Australia, despite Australia’s own massive private debt levels. But who knew that so much paper money would be destroyed in the transit between points A and B?

Markets in Europe and the Americas were again indifferent yesterday. It’s like investors can’t quite believe that they’re actually watching a junior reserve currency (the euro) slowly take off its shoes and socks and lower its disheveled self into its deathbed.

Can this really be it for the euro? Well, there is always the possibility that reports of the euro’s demise are simply premature. That’s how the 24/7 news media cycle works these days. Everything is a crisis all the time, especially right now. A lot of what passes for urgency is just manufactured panic.

Despite the theatrics, though, there’s something rotten at the heart of the currency. The real problem for the euro is that it is the unbacked liability of a political union that is slowly unraveling. The central planners and bureaucrats of Europe probably cannot imagine an economic landscape without their common currency. But they better start imagining it…and printing D-marks.

This must be what it’s like to live on the slopes of a dormant volcano. You plant a colorful green garden in the fertile soil and live on the gentle slopes and pass your days comfortably. And then one fine day, in the twinkling of an eye, you are erased from existence by a searing hot pyroclastic flow. Game over.

Except, switching metaphorical gears, we have always feared that the volcano underlying a global financial system built on debt could erupt at any time. It was never truly dormant. Throwing virgins into the crater to appease the gods – like throwing Fed money onto bank balance sheets – could not ever be a realistic survival strategy. Virgins don’t prevent volcanic eruptions any more than easy money prevents insolvency.

So what IS a realistic survival strategy?

Well, the conventional wisdom – and we say this not really knowing what conventional people think – is probably to not try and time the market, to have a diversified portfolio with an asset allocation strategy designed to suit your risk and your financial goals, and to let time do your work for you, with annual rebalancing to make sure you are not over-exposed or under exposed to any particular asset class. That’s how they write it up in the textbooks.

For most of the last twenty years, that strategy has worked. But will it keep working in a world where you may see de facto default by sovereign governments or, if they manage to avoid that, massive inflation? What do you reckon?

Dan Denning
for The Daily Reckoning

The Daily Reckoning