Waiting for the other shoe to drop

August 25, 2010


-Laurence Copeland is professor of finance at Cardiff University Business School. The opinions expressed are his own and do not constitute investment advice. –

The unemployed and the terminal insomniacs who have nothing better to do than read my blogs will know that I have long been gloomy about most of the Western economies. How can you fail to be pessimistic when the world economy is still dominated by the U.S. – a basket case, becoming weaker every day, with a political class too blind or too scared to admit in public the obvious fact that the country cannot carry on living beyond its means?

Now house prices are plunging again and, with the dollar still strong, the prospects for an export-led recovery look bleak. In fact, a return to recession is far more likely, and the markets are starting to show signs of that sickening here-we-go-again feeling.

How will it all end?

Anyone who claims to know how this will all play out is on no account to be trusted, but there’s nothing wrong with trying to guess – in fact, that’s exactly what we have to do before we can decide what assets to invest in, or whether to invest at all rather than simply blowing it all on a long bankruptcy binge.

So here goes. I start from the observation that the bond and currency markets, in their infinite lack of wisdom, seem to have divided the whole membership of the United Nations into two classes, high-risk countries and low- (or no-) risk countries.

The former include ClubMed Eurozone members (the PIGS) plus Ireland, most East European and Latin American countries, and a ragbag of the weaker Asian sovereign borrowers.

The amazing thing (at least to me) is that the latter group includes not only such rock-solid risks as Germany and Switzerland, the Nordic countries and Netherlands, but also France (OK, maybe), Japan (debts more than twice as high as GDP, but with even greater accumulated savings balances), and . . . the UK and U.S. as if the mere fact of speaking English were a guarantee of creditworthiness.

(Note that there are solid reasons related to raw materials prices and sound fiscal policy for rating Canada, Australia and New Zealand as low risk).

Now as far as the UK is concerned, prospects have improved a lot since the general election on May 6, thanks to the fact that the coalition government has shown a readiness to deal with our problems that has surprised everyone (well, me at least).

Having talked tough (25 percent and cuts in spending in almost every department except health), the government now has to deliver – carry through the cuts, stick with them and keep its nerve, while all hell breaks loose in parliament, the media and, probably, in the streets too.

Meanwhile, across the Atlantic, the Americans remain in denial, with monetary and fiscal authorities primed to pick up any slack created by U.S. consumers unable to make their mortgage repayments and maxed out on their credit cards.

The policy is patently not working, because the U.S. economy is caught between a rock and a hard currency. On the one hand, America needs the world to keep believing in Uncle Sam, because the moment it stops trusting the greenback, it will dump U.S. Treasuries, pushing up interest rates dramatically and driving tens or hundreds of thousands more Americans out of their unaffordable homes.

On the other hand, as long as the markets continue to see the dollar as a safe haven, it remains strong and U.S. competitiveness suffers accordingly, making it impossible to generate the export-led recovery the U.S. so desperately needs.

How will it play out?

Japanese-style deflation and stagnation is certainly a possibility. But my guess is that it will be preceded by another major crisis  – maybe next week, next month or next year, but the longer the reckoning is delayed, the more drastic and painful it is likely to be.

It will be triggered by a drastic rerating of U.S. (and possibly British) debt, as it suddenly dawns on those who speak the language of Confucius and the Koran that those who speak the language of Shakespeare cannot necessarily be trusted to repay their debts – at least, not in hard currency.

If, by that time, Britain has taken credible steps towards solvency, it may conceivably be exempt. But more likely it will be swept up in the panic which will engulf the U.S. as investors rush to sell dollar assets.

As I have explained before, I think it highly unlikely that either country will explicitly default. But as the dollar falls, it will generate rising prices in America, and the Fed will go with the flow, since inflation will be seen as the soft option/short term solution/easy-way-out, offering the opportunity to repay the debt with devalued currency while simultaneously restoring the competitiveness of U.S. output on world markets.

So what should the ordinary investor do about it? First, remember that, with the exception of the Canadian and Australian dollars, and Swiss franc, all the world’s major convertible currencies are priced on the Manure Standard: the dollar is viewed as slightly higher grade organic fertilizer than the euro, the yen is somewhat less disgusting than the dollar . . .

All are malodorous to a degree which would have made them near-worthless only a few years ago. No wonder gold – useless, but odourless – is riding high. If I am right, it has far further to go.

As long as China keeps booming, commodity-based economies like Australia and Canada seem likely to benefit, and both have relatively responsible monetary and fiscal policy regimes too. As far as I am concerned, 10-year Australian government debt yielding nearly five percent shines like a good deed in a wicked world.

U.S. Treasuries are, on this view, grossly overpriced – the biggest bubble in the world. But if you accept the judgment that neither the UK nor the U.S. is going to default, then index-linked are attractive.

Otherwise, safe and stodgy equities . . . utilities, supermarkets, healthcare and energy. Boring is beautiful.

Picture Credit: Four thousand U.S. dollars are counted out by a banker counting currency at a bank in Westminster, Colorado, in this file  picture.  REUTERS/Rick Wilking


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Professor Copeland,

I agree with most of the sentiments in your blog, however, I would like to take the argument one phase further forward.

I believe the UK (England)is in a fantastic position to push for greater financial alignment in the commonwealth.

I agree the US bond yields are unrealistic at this stage and one day the penny or cent will drop that the US with 13 trillions of debt is indeed unable to retain the position of number one world reserve currency.

My strategy would be for the commonwealth to establish a free trade zone between member states and the UK to resurrect the ‘Sterling Area’ with all commonwealth countries looking to partnership being seen as equal players, unlike when Great Britain was Kingpin.

Most already have deposits with the Bank of England so we are not talking about anything unnatural here.

The sterling area would be backed by English Law, London as the financial hub of the world,the commodities of Australia, Canada, NZ and the population of rising India.

Japan I believe would be keen to associate itself to avoid the Chinese tsunami of wealth creation and commerce. There has already been leaked stories that they would join the commonwealth.Denmark would join as well as Norway.

This would take the heat out of America and the dollar and allow them to take a rest and get their act together again.

I can see the Germans pegging their own ccy (DM)to the Sterling, this would allow them to leave the EURO and for Club Med to devalue by 40% which is required.

I firmly believe the only way out of the mess we have and will pass on is to be robust in trade as we have always been. Moving away from the EUSSR constrictions
it is political now not trade. As I suspect the next move will be to give Russia some access to joining to counter the UK’s move to bring Turkey into the EU. By creating the financial commonwealth free trade zone we could include Turkey thus avoiding upsetting Germany and France.

Your comments n this would be highly valued & appreciated.

Posted by PURPLELINE | Report as abusive

This is an inevitable eventuality

Posted by Dahc | Report as abusive

Actually, no foreigners trust the U.S. Dollar. But they know that if it goes into uncontrolled devaluation, the world economy will collapse. So they buy more of our treasuries to keep us going for a while longer.

In the meantime, the federal government is in cahoots with the U.S. markets to spend gigabucks of funny money to keep the markets up. They also keep gas and precious metals prices down with the same gigabucks of funny money.

Red China has enough treasuries to collapse our system by dumping them, has control of the Panama Canal to sabotage it, has weapons to destroy our carriers and has a big enough grudge to use them all in one surprise attack.

The American economy is only alive because bankruptcies and foreclosures are not carried out.

Posted by Timuchin | Report as abusive

Borrowing is based ONLY on our countries ability to pay the interest. Paying the interest is based ONLY on the ability of our country to tax. With the current unemployment rate, our countries ability to tax has ground to a halt, and is actually decreasing. Like a person maxed out on credit cards we are in deep trouble and the worst is yet to come. The tipping point will be the financial collapse of California, the 8th largest economy in the world, which will will have a domino effect on the already weakened rest of the USA.

To give you an idea of how out-of-touch the bureaucrats and politicians are — the most expensive High School EVER in the country opened two days ago in debt ridden L.A. in bankrupt California. Cost: 1/2 BILLION dollars. Why wasn’t this reported in the media??

Posted by cynicalme | Report as abusive

One gentle puff of wind will knock down this house of cards called the U.S. economy. Citizens better get loud quickly about getting our financial house in order or the party will end for everyone. Washingtion must be shaken out of it’s slumber by citizens willing to pick up a phone or write an e-mail…fretting is not enough.

Posted by actnow | Report as abusive

just a thought

I’m no financial wizard just a average person.
With all the storms and earthquake activity occuring
around the world. Isn’t it possible for japan or west coast US to be hit with a giant quake and since japan
owns a significant amount of our US Treasury, Isn’t it also possible they will have to cash this in to promote there rebuilding which can crash US dollar. I don’t think
IMF or World bank or the UN will give significant money
Everything they give is always pledged just like pakistan but you can only say money is give when you actually have it in your hand. The only way japan can get significant $$$$ is buy selling US Treasuries on a massive scale.

Posted by vk2000 | Report as abusive

One gentle puff of wind will knock down this house of cards called the U.S. economy. Citizens better get loud quickly about getting our financial house in order or the party will end for everyone. Washingtion must be shaken out of it’s slumber by citizens willing to pick up a phone or write an e-mail…fretting is not enough.

Posted by actnow | Report as abusive

Tell us it ain’t so! No problem, really. We’ll just get S&P and Moody’s to issue their stellar, accurate, and credible AAAA ratings on US debt in perpetuity.

Posted by Thucydides | Report as abusive

Similar in nature to almost every other dimension, the relative strength of the US has been supported by the axiom that “we are the absolute worst, except for everybody else.”

Posted by Thucydides | Report as abusive

@ The author: Thanks for being honest. Your article confirms what I have been thinking for many months.

Posted by murfster | Report as abusive

Professor, will it help if we use the ‘power of our vote’ and kick them all out of Congress next term? Americans (who did not cause this by the way) are holding their breath not knowing which way to turn; going to work every day; spending less and less; saving what they can. Your doom and gloom is coming WHEN? 2012-2013? Not knowing what we can do to, is it time to start praying?

Posted by sjbstl | Report as abusive

The “Talking Heads of Politics” Like Paul Bagala & Rick Sanchez (CNN) and Bill Hannity & Bill O’Reily (FOX) are individuals who make their own LIVINGS by playing both sides of the political aisle AGAINST EACH OTHER (we Americans!) Both “Talking-head groups” are knowingly tearing this once great country APART! When are we going to get wise and let it be known to our so-called LEADERS in D.C and our various state capitals that what they’re doing fiscally to us is absolutely “UN-SUSTAINABLE!” and worse yet “IRRESPONSIBLE!”

Posted by Middleclassman | Report as abusive

I like the idea of other countries just floating the US just to keep the world economy from crashing. We kinda have them then don’t we? I think we should demand that they all fund our lives too – like we can just stop working and demand that they pay us all 100K each. Then travel and tourism will boom because we will be experts at it! Why are we not taking advantage of this? I want African nations to pay my way!

Posted by misdelivery | Report as abusive

Concerning the USA, it is worth noting that estimates for combined (funded & unfunded / on & off balance sheet) debt is considerably more than the $13.7 Trillion presented by the US government. Recent estimates (for that is all anyone can do as the truth is certainly not going to be published by the government) range from $100 Trillion to $202 Trillion…. These numbers are so impossibly vast I do not think anything more has to be said, just think about how much money that is and it will not take long to figure out that the USA is in a spot of bother….

Posted by JMS1 | Report as abusive

Not sure that rising interest rates will drive Americans out of their homes. Unlike the UK most Americans have fixed rate mortgages, many are refinancing now with rates so low. So when rates go up, their houses remain at the same affordability.

Posted by nicfulton | Report as abusive

“To give you an idea of how out-of-touch the bureaucrats and politicians are — the most expensive High School EVER in the country opened two days ago in debt ridden L.A. in bankrupt California. Cost: 1/2 BILLION dollars. Why wasn’t this reported in the media??”

But it was in the national TV news yesterday. What I found missing was any analysis or explanation. With our complicated system of funding most things, including public projects, it may not have been practical to try to redirect the funds elsewhere. That’s another systemic problem for the USA.

I agree with your analysis, cynicalme, I don’t see it as “cynical” :-) It’s a bit of the realism us Americans are so good at ignoring.

Posted by Rondec | Report as abusive

Dear Professor Copeland,

During historical hyperinflations the key factor to fueling the hyperinflationary inferno was wages rising buoyantly with the tide of rising prices.

I don’t see how that wage buoyancy factor is going to work in a democracy/corporatocracy? Without a mechanism for corporations to index wages to hyperinflation, any runaway inflation would rapidly burn out. In order for those who are up to their ears in debt to pay it off with hyperinflated currency, their wages have to rise (not sit on the ocean floor like ship anchors).

How do you see this mechanism of rising wages occurring? The way corporations are set up, I’m afraid they’ll simply layoff everyone, except skeleton staffs, and let facilities filled with cubicles and offices go empty (like occurred in parts of the U.S. in the latter 1980’s).

What say you? Can you perhaps speculate on the source of fuel to power the dynamo of hyperinflation in America?


A Reader

Posted by DisgustedReader | Report as abusive

Germany and China will come to everybody’s rescue

Posted by STORYBURNthere | Report as abusive

You could put all of our money in Russia, or the UK, or Greece, or any other Euro country, but you don’t. Why is that?

Posted by noway | Report as abusive

Don’t worry, China and Germany will save everybody

Posted by STORYBURNthere | Report as abusive

In my book the The Humanist Obama devalues the USD through printed money, in a race with Sterling, the Yen and Euro, to a third of today’s value. he pays off debt, makes factories that went to Asia consider a return. Rents the Navy to the UN, now in Singapore.

But the main, undiscussed issue remains: western workers have traditionally made ten times the wages of Asian workers. This truth that dare not speak its name must be addressed, and the Euro/US crowd must learn to live on a LOT less.

If we haven’t acknowledged that de facto slavery relationship of old, we’re a long way from adjusting to its dissolution.

Posted by Dwight_Jones | Report as abusive

I still like my idea about holding the world hostage. We need to be capitalizing on that. Pay me to be your peace police!

Posted by misdelivery | Report as abusive

Please, some other country, or more likely, group of stable countries, take over as a currency standard and provide some mature, measured economic policy to promote growth and stability. The US is incapable of doing so. If it is any consolation, the country is large and unified enough to somehow eventually weather through this self created catastrophe, in spite of having inflicted irreparable suffering upon its own people and societies all over the world, but America needs to be less influential.

Posted by Greenspan2 | Report as abusive

For all concerned citizens. Whilst we are all very sadly innocent victims of this global ponzi scheme WIth ourselves, our governments, future generations born into debt slavery, it does not have to be this way, there are solutions out there – http://www.bankofenglandact.co.uk/

Posted by JMS1 | Report as abusive

Stronger Gold weaker the Dollar! If at all the other shoe is dropped some one will wear it WHO?

Posted by satsangi | Report as abusive

You all wondering what the world will be like once the U.S. is no longer #1, just look back to the end of WW2, the world lead by the US just defeated one army (Axis) which was trying to take over the world, and once that was done it immediately faced off against world-takeover-threat #2, the USSR. The USSR supposedly “fell” (shed some of it’s less profitable countries) in 1988 and things have been dandy ever since, but not really. The threat does and will always exist.

So just imagine if the US wasn’t there to save the day toward the end of WW2, where would we be today, what sort of compromises we’d have made with the war machines?

Pay no attention to anybody trying to compare the “average wage” of one country with another (like Dwight_Jones has done above). It’s trick that leads to robbery.

Posted by zardthebard | Report as abusive

[…] Waiting for the Other Shoe to Drop […]

Posted by » Financial News Update – 08/29/10 NoisyRoom.net: The Progressive Hunter | Report as abusive

Astonishing to hear a Cardiff man espousing such pablum as “dumping treasuries,” and a myriad of other doom-and-gloom contained herein. But, then, insight into the United States at any level from outside sources is typically quite woefully bad.

Over the next 30 years the United States economy will generate a minimum of 600 trillion dollars in GDP. That’s assuming creaking average growth. Even if the U.S. economy did not grow a dollar in the next 30 years, it would still generate $435 trillion in income.

China cannot “dump treasuries,” there is no mechanism which truly allows this.

China owns roughly 6.5% of U.S. debt Japan owns a bit less. Not a quarter of U.S. debt, not 40+% of U.S. debt.

China cannot dump treasuries without destroying its own economy, its own fiscal fortunes, and its own shallow markets.

China (to a commenter) does not have “a missile that can sink our carriers.” I’m, again, astonished at the level of ignorance on display. Trying listening to the majority of defense analysts from around the world, not a single AP writer seeking headlines. Try researching the systems the United States has been developing for theatre ballistic missile defense.

The massively costly school that just opened in California WAS reported “in the media,” Mr. Copeland, widely so.

America’s GDP is roughly $14.5 trillion annually. I am, again, astonished at how rarely this figure is published. Debts and deficits are published. The size of China’s economy is published. But this figure is virtually never so. Why might that be? Claiming $13 trillion in federal debt is unpayable because $13 trillion is such a huge number relative to every other country perhaps makes a bigger buzz when you don’t also point out that relative to the size of the ANNUAL income of the United States it looks far less daunting. This is roughly akin to someone making $100,000 annually seeing a one million dollar mortgage and having a heart attack, despite the fact that the holder of that mortgage makes over a million dollars annually.

Posted by RathaPM | Report as abusive

What I would love to see from Mr. Copeland is an acknowledgement and discussion of the dire scenarios facing the Asian economies of which he is so enamoured. I do not suspect that this level of objectivity and intellectual honesty will ever be forthcoming, however, as I have found that those seriously discussing “treasury dumping” and the other memes he propagates here are simply too laden with baggage to do so. These are men and women are well-enough educated to know better, but who engage in these arguments anyway. Sometimes they are simply defeatist and declinist. Sometimes they want to make their name on the bandwagon. Sometimes they just want to stake a claim to be able to cover their bases so that in any negative scenario they can say they “called it” (hence being a long-term hyper-bear on western economies). Sometimes they simply romanticize the other, which seems to be something the British are particularly prone to.

Sometimes it’s all of the above.

Always, though, these people peddle what is essentially thinly disguised gossip and rumour into fearmongering, all the better that people will read what they produce.

Posted by RathaPM | Report as abusive