Before we turn the page to 2012 we must take a look back at the year that just passed so we can extract context for the year to come. Looking at where the stock market began and ended in 2011, it appears nothing much happened.
As of Thursday’s close, the S&P500 was at 1,263. This notched an increase of less than one half of one percent from its year’s opening at 1,257. Obviously, these two data points, taken alone, do not offer an appropriate depiction of the year’s market. The S&P500’s 52-week range, a gaping gulch extending from 1,074 to 1,370, provides a more accurate perspective of what went on.
In short, things went haywire. Massive selloffs, like the S&P500’s 16.8 percent swan dive between July 22nd and August 8th, were followed by wild swings to the upside. Traders who capitalized on the extreme volatility may have loved it, but for those saving for retirement, via an index mutual fund, the instability was incredibly unnerving.
Geopolitically, the world’s an entirely different place than it was one year ago. After more than eight years of searching for weapons of mass destruction, the U.S. military vacated Iraq. Unexpectedly, dictators in power for a generation or more, like Muammar Gaddafi and Hosni Mubarak, were removed by popular force. Others, like Kim Jong-il, up and died before their people could unite against them.
In any case, it’s still not clear if the change in rulers will be for better or worse. Of course, we’d like to think the exodus of Gaddafi would result in an improvement in conditions for the people of Libya, but we don’t have much faith in the Muslim Brotherhood or other entities currently positioning for power. Likewise, the verdict’s still out on the “Great Successor” of North Korea, Kim Jong-un.
In addition to world politics, financial and economic systems also sputtered and convulsed throughout the year…
Slogging Along Like a Tired Mule
Ten Year Treasury Note yields dropped to historic lows – less than 2 percent – during the last four months of the year. While these ultra-low yields are emblematic of the sluggish low-growth economy and stock market volatility, we believe they also place an undeserved premium on U.S. government debt.
U.S. Treasuries have garnered the broad conviction that they’re the safest investment in the world. This status has been abused by the Treasury’s over issuance of debt, now at nearly 100 percent of gross domestic product, and the Federal Reserve’s willingness to inflate through QE2, Operation Twist, and other malfeasances.
Following S&P’s downgrade of U.S. government debt on August 5th, we expected yields to skyrocket. Instead, they did the opposite…they skidded around 2 percent. What to make of it?
First off, market’s rarely do what one expects when they expect it. But they always do what they must. We suspect that at some point the willingness of lenders to extend credit will be exceeded by the amount of debt outstanding and the ability of the U.S. government to pay outright. As 2011 comes to a close that day of reckoning appears to be imminent.
The abundance of outstanding debt is also a ball and chain weighting down the economy. Future growth, which is needed to support the mountain of debt, is encumbered by the capital needed to make debt payments. Rather than new investment being directed into the economy for productive use it is directed into paying interest on money the government borrowed and spent decades ago.
Perhaps this is why, after officially exiting recession over two and a half years ago, the economy slogs along like a tired mule. Unemployment’s persistently high, economic growth’s persistently low, and, despite their best intentions, the clowns in Washington continue to make a mess of things.
At the moment, however, and as we’ve chronicled at the Economic Prism, Europe’s financial system is splitting apart at the seams. The debt serpent in the old world, that grew larger and larger by consuming its tail, has gnawed the whole thing down to the nub. Each new plan the European leaders announce to save the financial system is followed by fears of another liquidity crisis. Unfortunately, there’s no easy way out. The world’s one default away from financial doomsday.
So now that 2011’s backdrop in place…let’s conjecture about the year ahead…
2012: Predictions, Prognostications, and Prophecies
Before we begin we must pause to clarify that what follows is merely a guess. Moreover, it’s a guess about one single episode for 2012…a prediction, prognostication, and prophecy all rolled into one.
Are you ready? Here it is…
European bank failures, due to their massive holdings of bad sovereign debt, will set off a financial crisis in early 2012 that will make the crisis of 2008 seem like a walk in the park.
European governments, who are the source of the bad debt, will be unable to bail the banks out. Additionally, it’s against the European Union’s accord for the European Central Bank to backstop the financial system. Nonetheless, a panic in European financial markets will quickly spread to U.S. financial markets; thus, the Federal Reserve will provide all the liquidity – funny money – needed to keep the whole shebang from crashing down.
The Federal Reserve’s actions following the 2008 financial crisis marked the end of the beginning for the Fed. Up until then, the American populace was largely oblivious to the Fed’s monetary antics. Since then they’ve become wholly aware of the dishonesty and deceit of central banking.
What we mean is the forthcoming Fed actions to rescue Europe’s financial system and, by extension, the U.S. financial system will mark the beginning of the end for the Federal Reserve. And if it doesn’t, it should.
The social objection, popular outrage, and eventual political opposition will be too much to overcome. At the least, a disgraced Fed Chairman Ben Bernanke will be given the boot. But the damage will have already been done. The Fed’s money creation experiment will drive one more nail into the casket of the dollar and paper based fiat currencies.
In this regard, gold will continue to be the safe haven asset of last resort. While gold’s had a rough go of it of late, the forces of massive deficits and central bank mischief that have pushed gold up over the last decade will continue to propel gold’s rise through 2012.
Hang on to your hat… We’re in for a wild ride!
for Economic Prism