US Debt Crisis and the Threat of Economic Warfare

Greece is the word…or at least it was during yesterday’s trading sessions in Europe and New York. Everywhere you looked, there was that word again…

“Euro Surges Against Dollar as EU Signals Support for Greece.”

“Canada’s Dollar Rises Most in Month on Prospect of Greece Aid.”

“US Stocks Rally on Growing Prospects for Bailout of Greece.”

“Corporate Credit Risk Falls Amid Prospects of Greece Support.”

“Treasuries Tumble on Prospect European Union Will Assist Greece.”

“German Bunds Decline Amid Speculation Greece May Get EU Support.”

Greece, it seems, was responsible for almost everything everywhere yesterday…

No news headlines drew any connection between the bailout of Greece and the massive winter storm in the East. But maybe that story will land on the front page of tomorrow’s papers.

The proposed bailout of Greece by Germany – and a cast of EU members to be named later – might be as significant a macroeconomic event as yesterday’s financial market reactions would suggest. On the other hand, the Greece headlines may merely have provided a convenient excuse for what would have happened anyway – short-term, counter-trend moves, signifying nothing in particular. After all, markets don’t always zig; sometimes they zag.

The euro, for example, had tumbled nearly 10% during the last two months. Didn’t it deserve a little bounce? And US stocks had slumped nearly 8% during the last two weeks. Didn’t they deserve a bounce as well?

Maybe yesterday’s stock market bounce will keep on bouncing for a while. But your editor would not want to take that bet. The price charts still depict a stock market that is “rolling over.” More importantly, even if we were to feed our price charts into a shredder, the global economy is still looking shaky.

Here at home, a close examination of the stats on GDP and unemployment reveal an economy that is far from healed. Over in Europe, the “bullish news” that Germany will bail out Greece is actually quite bearish. (Will Germany also bail out Spain, Portugal, Italy and Ireland?) Over in Asia, meanwhile, the Chinese central bank is withdrawing credit from the local economy, while the Chinese military is urging the central bank to withdraw credit from the American economy as well.

That’s right, according to Reuters News, “Senior Chinese military officers have proposed that their country boost defense spending…and possibly sell some US bonds to punish Washington for its latest round of arms sales to Taiwan.”

“Our retaliation should not be restricted to merely military matters,” Luo Yuan, a researcher at the Academy of Military Sciences, tells Reuters, “and we should adopt a strategic package of counter-punches covering politics, military affairs, diplomacy and economics to treat both the symptoms and root cause of this disease… For example, we could sanction [the US] using economic means, such as dumping some US government bonds.”

Probably, Luo Yuan’s suggestion will gain no traction in Beijing. Probably. But his suggestion nevertheless underscores the precarious economic arrangements that support the modern world of finance. Prudent investors cannot afford complacency.

Even if we assume that Germany will ship its savings to Athens to plug Greece’s funding gap; and that China will ship its savings to Washington to plug America’s funding gap, the global economy is not the revitalized organism that Wall Street analysts imagine.

Greece is spared…for the moment…but what happens to the euro in the process? What happens to the fiscal discipline that supports the euro and keeps European interest rates low?

America, too, breathes easily for the moment. But what happens if Luo Yuan gets his way? What happens if US interest rates jump higher than our leveraged economy could easily withstand?

No one knows for sure. But a bull market in stock and bonds would probably not be the first result.

Therefore, as we gaze across the global investment landscape, we see many, many reasons to own hard assets like gold and commodities. We see a few reasons to own selected value stocks and/or special situations. But we see absolutely no reason to own long-dated government bonds.