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How To Profit As Global Debt Soars (EWJ, FXE, FXA, VGK, FXI, EWU, EEM)

February 20th, 2012

JR Crooks:  It’s no secret that the world’s central bankers and governments are cranking out money at lightning speed to stave off a global depression.

Let’s assume for a moment, that they’re right.

I of course would say much of the stimulus was simply to save the old order, i.e. the welfare state in Europe (NYSEArca:VGK), which Mr. Obama seems desperate to emulate on this side of the pond. After all, this isn’t the first time we’ve seen massive buildups of debt to save Europe.


Here is an excerpt from the magazine Sphere of July, 1935, summarizing public statements by Adolph Miller, a member of the Reserve Board at that time:

“Mr. Miller, of the Federal Reserve Board, states that the easy credit policy of 1927, which was father and mother to the subsequent 1929 collapse, was originated by Governor Strong, of the New York Federal Reserve Bank, and that it did not represent a policy either developed or imposed by the Board on the Reserve Banks against their will.

“The policy was the result of a visit to this country of the Governors of foreign central banks, who unequivocally stated in New York that unless the United States did adopt it there would be an economic collapse in Europe. It was a European policy, adopted by the United States.”

And even someone who supports this stimulus must be worried when they look at the numbers. If they aren’t afraid, they should be.

I’m not predicting a depression. I do believe, though, that all the elements are in place for one to develop if policy makers don’t act to reduce global debt and institute growth policies.

Since 2008, global GDP has grown 4.7 percent or $2.9 trillion. Yet global debt has grown 14 percent or $25.7 trillion!

And look what David Rosenberg, of Gluskin Sheff, said recently in a research note:

“Maybe the economy seems to be doing better because we have all adjusted our expectations so radically after being disappointed for so long — I mean — take 2011 as an example. A year that would normally see 5 percent real GDP growth for this stage of the cycle came in at a woeful 1.7 percent.

“This, despite a $3 trillion Fed balance sheet (triple its normal size), zero percent policy rates now for three years and now going on year number four of $1 trillion-plus fiscal deficits. Based on all this stimulus, if this were a normal post-recession recovery, GDP growth would be 8 percent right now, not sub-2!!”

Based on the chart below, on a global basis, $0.89 cents for every $1 of “stimulus” is disappearing down the rabbit hole instead of going into the economy.

A few more numbers to view in sheer horror showing Industrialized Countries Debt/GDP adding private indebtedness to the equation:

  • United States — 350 percent
  • Japan (NYSEArca:EWJ) — 490 percent
  • Euro-currency countries — 443 percent
  • United Kingdom (NYSEArca:EWU) — 459 percent

And in case you missed Monday’s front page of the Financial Times, it said China (NYSEArca:FXI) is being forced to extend out the time for repayment on debts to local governments, in the $1.7 trillion range, because they can’t be repaid now.

Many mistakenly believe, I think, that China’s Debt/GDP is perfectly manageable, and believe the official numbers suggesting it is in the 30 percent range. But more savvy estimates peg the debt closer to 90 percent.

No problem you say when compared with the industrialized countries. Maybe you should rethink that.

Why? Because emerging economies (NYSEArca:EEM) have a much lower threshold for debt. According to Rogoff and Reinheart, economists extraordinaire and authors of This Time is Different: Eight Centuries of Financial Folly:

“[For emerging economies] When total external debt reaches 60 percent of GDP, annual growth declines about 2 percent; for higher levels, growth rates are roughly cut in half. [IMF recently warned a euro crisis would likely cut China's growth rate in half.]“

Not many investors seem worried now, though. The chart below shows how faith in central banks and governments springs eternal despite the lessons of history.

Dow Jones Industrial Average versus the Fear Index (VIX)

To sum it up:

Debt above the 90 percent threshold for the industrialized world means slow growth …

Debt above the 60 percent threshold for the emerging market world means slow growth …

Thus those currencies geared to growth, such as the Australian dollar (NYSEArca:FXA), could get hit the hardest. And of course, the debt crisis is bound to sink the euro (NYSEArca:FXE).

There are several ways you can play this, including ETFs and options. Sorry, I can’t give you the specifics. That wouldn’t be fair to my World Currency Trader members.

But I can tell you this … the simple truth is that right now things seem to be shaping up for a break in risk appetite. The public’s perception of this global debt crisis will spark sustained risk aversion once it makes it into the spotlight. And the approaching Greek default could be the catalyst as it would offer a much-needed dose of reality.

Best wishes,

Written By JR Crooks From Money And Markets

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss  along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson and  Bryan Rich. To avoid conflicts of interest, Weiss Research and its staff  do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance  returns cited are derived from our best estimates but must be considered  hypothetical in as much as we do not track the actual prices investors  pay or receive. Regular contributors and staff include Andrea Baumwald,  John Burke, Marci Campbell, Selene Ceballo, Amber Dakar, Maryellen  Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker,  Leslie Underwood and Michelle Zausnig.

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