The deception of 'decoupling'
When the Great Recession hit the United States in 2007-08, stockbrokers and their captive media maintained that growth in the emerging markets was decoupled from the U.S. and would not be affected adversely.
They were wrong.
Today, as deep recession and financial chaos threaten Europe, the same perma-bulls repeat that decoupling will ensure only minor damage to the United States. Will these same pundits be proved wrong again as deleveraging begins to hit not just banks and consumers in Europe but also in the United States?
In the 1990s and early 2000s, the Fed enabled the largest asset boom in history. The profligacy was achieved through the irresponsible creation of unprecedented quantities of U.S. dollars, under Federal Reserve Chairman Alan Greenspan, ably assisted by his successor, Ben Bernanke. In turn, it created an orgy of leverage. Governments of developed countries borrowed excessively to fund burgeoning social programs and the illusion of continued growth. Stock markets roared.
Banks involved in the enormous financial transactions were tempted to gamble with customers' money. Their huge profits reflected massive overleverage. Bonuses exploded. Most leverage was based on the security of real estate and the historically ignorant belief that prices never would fall dramatically. Inspired by these irresponsible actions, consumers, whose wages were falling in real terms, began their own borrowing spree based on climbing house values.
The total leverage -- enabled by central banks, wayward regulators and politicians -- was gigantean and unprecedented. It resulted in today's depressing deleveraging cycle. Unfortunately, despite the recent agony, the pain is nowhere near over.
Deleveraging took a strong hold of people's psyche. Corporations and consumers began prudently to accumulate cash. Even governments began to economize. Recession resulted, only to be reduced temporarily by the massive creation of more cheap money.
However, the forces of recession likely will remain for years. Despite negative interest rates, companies and consumers continue wisely to accumulate cash. Recession means lower tax revenues. Certain eurozone members who have overborrowed vastly now face default.
Meanwhile, politicians and central bankers demand austerity as part security for bailouts, driving recession even deeper and tax revenues down further.
Most economists accept that Europe is in recession. Even Germany is experiencing negative growth. With the EU accounting for about 24 percent of world trade, it is difficult to rationalize economic decoupling. Furthermore, China now is experiencing reduced growth. Indeed, world trade is shrinking.
Europe's problems stem from a currency crisis that could trigger the demise of the entire system of paper money. Meanwhile, as investors flood out of the euro, the U.S. dollar experiences a temporary renaissance.
Relationships between the world's major financial institutions are highly complex, uncertain and of staggering proportions, particularly through the unregulated derivatives markets. Through exposure to loans and credit insurance derivatives, it is estimated that U.S. banks have exposure to EU banks of about $10 trillion, equivalent to 70 percent of the U.S.'s precarious gross domestic product.
And yet, assurances are given that U.S. and other nations' banks and currencies are decoupled from Europe. Stock markets climb.
If central banks remain intent on defying the reality of a recession, long-dated U.S. Treasuries continue to offer fleeting potential gains. As deleveraging becomes increasingly manifest, precious metals might fall. However, as the deception of decoupling becomes increasingly obvious, precious metals might offer holders a rare peace of mind.