A lot of people ask me what I think about the debt situation in Europe and the moves lawmakers are making to resolve it. I answer that I honestly don’t understand the details enough to comment but I do know that if they don’t come to a real resolution and Greece defaults or leaves the Eurozone in an unorganized way, the consequences for the rest of the world could be disastrous (think post-Lehman default in 2008!).
While Greece is a small country (<0.5% of world GDP), we live in a highly interconnected world. It would be one thing if all banks holding Greek debt had to write off those holdings entirely, that would be very bad. Even more so, if Greece defaults or leaves the Eurozone, that only sets precedent for other weak countries in the Eurozone to consider similar actions. While Portugal isn’t large, Spain, Italy, and dare I say France, are! The domino effect of such large countries undergoing even the stress Greece is going through now could make 2008 seem like a walk in the park.
How is all this connected to China? Well, China is the world’s exporter. Anything that affects high consumption markets like Europe and the US, indirectly affects China. If Americans and Europeans consume less, China exports less and therefore can’t pay it’s workers as much which could send China into a recession.
While China is best known right now for their exceptional economic growth and resilience, what makes them special in my opinion is what appears to be the existence of a credit bubble. In fact, their situation right now reminds me of Go-Go 1920′s in the US almost a century ago. Credit standards have been weak leading to lots of low quality lending. This lending, as it always does, has found it’s way into property markets leading to highly speculative behavior and valuations in major centers like Shanghai. People talk about apartment prices rising forever and using ever increasing valuations to borrow and purchase more property. The story around their stock market appeared similar about a year ago with everyone from stay-at-home mom’s and taxi drivers talking about stocks. The stock market has already fallen a little (the iShaers China 25 Index is down ~20% from peak) and the rest of the picture has many of the ingredients for a full on deleveraging. What is different about China is that many (all?) banks are controlled by the government. And if these banks got into trouble, I bet their government and central bank would recapitalize them quickly.
A slowing in China could then have ramifications for the rest of the world. China is amongst the largest consumers of many commodities. Any slow down in consumption would lead to falling commodity prices and to downturns in such countries as Canada and Australia and many commodity producing emerging market nations.
I don’t mean to be a Dr Doom but these feel like realistic risks to worry about. If they don’t materialize then we’re all better off but maybe the Elliot wave theorists are right (half joking), the next leg down in 2013 will have the S&P 500 revisiting the 400 level (1)!! The only way to be prepared for such uncertainty is a diversified portfolio. Only the safest government bonds will protect you if anything close to the above scenario materializes.
(1) Harry S. Dent, “The Great Depression Ahead: How to Prosper in the Crash Following the Greatest Boom in History”
