During the third quarter of the year, global stock markets lost US$5.3 trillion in value. This is almost as much as Japan’s, or China’s, annual GDP. The Chicago Board Options Exchange volatility index (CBOE VIX), also known as the “panic index,” increased by 160 percent in a single quarter, the largest single quarterly increase since records began. Even more ominous, US and European financial stocks and the stock markets in the BRIC countries — Brazil, Russia, India and China — are a disaster area: All have lost 25 percent or more in value. The clock is about to strike midnight and the party is almost over, and Cinderella can’t find her pumpkin coach.
The US Federal Reserve’s two quantitative easing packages following the financial crisis injected a lot of liquidity into markets, but apart from providing financial speculators with cheap bullets, unemployment remains high, stock markets have been reset, housing prices remain sluggish and the “wealth effect” that US Federal Reserve Chairman Ben Bernanke was waiting for never appeared. After the US sovereign rating was cut, and with markets still full of hot money, the Fed can no longer issue large sums of cash.
The fact is that the facade of financial prosperity that EU countries and the US have propped up with their low interest rates and loans creates no substantive investment in the real economy. Expedient economic growth has reached its end. If you want to reduce your debt or if the government wants to reduce its deficit, it is still necessary to reduce expenditure.
It seems that Thanksgiving in the US and Christmas holidays this year will be cold and dreary affairs and for the BRIC countries or the Four Asian Tigers — all countries that rely on exports — this implies that orders will shrink and that the coming quarter will be anything but a pleasant experience.
In addition, there is the risk that Greece will default, a potential disaster. European leaders want to maintain the outward image of unity and harmony, but voters may well expose the emperor’s new clothes. No popularly elected leader of a hardworking nation will take voters’ hard-earned money and give it to another country to help them maintain a high welfare level.
Greeks receive 14 months of salary in a working year and someone who retires at 40 or 50 years of age continues to receive 70 percent to 80 percent of their original monthly salary in pension payments while they enjoy the sun on the beaches of the Aegean. Germans have to work for another 10 years before they can retire and they will not receive the same salary or retirement payments. Needless to say, many Germans are not very enamored of the Greek attitude toward work.
A while back, the Hualien County Government issued a policy to eliminate tuition fees for elementary schools and junior high schools. Such examples of local benevolent rule is of course the envy of people in other counties and cities, but at least the money is derived from the local government’s fiscal policies.
What would happen if everyone living in Hualien County received a three-month year-end bonus and if they could all retire 10 years earlier, with a fatter pension than other counties, and if all the extra pay and welfare benefits were financed by debt issued by the county government? Would the governments in other counties be obliged to help solve Hualien’s problems when the county government was unable to sustain interest rates shooting up to 20 percent? Would it really be possible to achieve sustainable development in a single currency area simply by lofty talk about how we all are brothers of the same nation, while ignoring fiscal discipline and a fair welfare system?
If Greece defaults, it will not be merely a problem in one small country. Prices will drop drastically for all collateral, credit default swaps and other even more complicated derivatives. European banks, which are even more leveraged than banks in the US, will find that the junk bonds they are holding will be worth precisely nothing. The chain reaction that was a result of the broken capital chain will appear to be a series of volcanic eruptions even more ominous than the financial crisis itself.
People are about to learn what Warren Buffett meant when he said that derivate instruments are “financial weapons of mass destruction.”
The two long-term bearish cycles during the 20th century lasted for about 17 years each. Maybe the bearish cycle that started in 2000 will reach its final stages when the dust settles after the euro experiment blows up.
Jason Yeh is an associate professor of finance at the Chinese University of Hong Kong and a visiting associate professor in the College of Social Sciences at National Chengchi University.
Translated by Perry Svensson
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