On a day when stocks are declining I have a lot of thoughts that I would like to share about the current financial volatility and upheaval that has taken place in recent days and weeks.
Over the past few weeks the value of the Euro has rocketed from 1.19 up to 1.29 against the U.S. dollar. The primary reason for this sudden surge in the value of the Euro against the dollar is that investors no longer view the U.S. as a place that will withstand the problems in Europe. When the Euro was at 1.19 investors foolishly thought that the U.S. would be immune to the problems of Europe. Investors are now beginning to realize that the U.S. is also at risk of a major economic downturn.
- The latest ECRI which is a weekly leading indicator of U.S. economic activity fell from a -8.3 to a -9.8. This is very significant because a value of -10.0 virtually guarantees a recession that will be reflected in the U.S. government’s highly dubious data.
Yesterday I read a quote from David Bloom, the currency chief at HSBC, which I feel does a good job summarizing the situation and explains why there has been so much volatility in the financial markets recently. Bloom said:
"We're in a world of rotating sovereign crises. The market seems to become obsessed with one idea at a time, then violently swings towards another. People thought the euro would break-up. Now we're moving into a new phase because we're hearing alarm bells of a US double dip."
I get the sense from everything I read and from indicators like the ECRI that the global economic and financial system is weakening. As the global economic and financial system weakens investors are moving their money to where they perceive to be a place of relative safety. However, there are few safe places to put one’s money in the long-run as the global economic and financial system is in major trouble.
Perhaps the next trouble will come in the U.S. municipal bond market (the market for bonds issued by state and local governments in the U.S.). Right now state and local governments are experiencing major fiscal problems as the tax revenue they are taking in is not nearly enough to cover their spending plans and are facing a looming problem with underfunded pensions. The credit ratings of many municipal bonds are ridiculously high as the same credit rating agencies who told us that toxic real estate investments were risk-free bets back in 2007 now claim that there is not going to be a major problem in the municipal bond market.
The state of Illinois, who has not been paying its bills and is in complete disarray, has a credit rating several notches above “junk” status (A1 by Moody’s). With an A1 credit rating, the cost to buy insurance to protect oneself against the possibility of default by the state of Illinois should theoretically be low. However, the cost to buy insurance to protect oneself from the possibility of default by Illinois is currently higher than the cost to buy insurance to protect oneself from the possibility of default by Iceland, whose credit rating is virtually “junk” status, whose economy has collapsed, whose currency has collapsed, and is experiencing a depression!
There is a major disconnect between what the credit rating agencies say and what is actually going on in the municipal bond market. Given the poor track record of the credit rating agencies, I suspect we will begin to hear a lot more about the problems in the municipal bond market soon. When the majority of investors realize the problems of the municipal bond market I wonder where investors will turn for safety…
