If you haven’t read the Economic History paper by Kenneth Rogoff and Carmen Reinhart, but are interested in protecting your wealth over the coming years- now would be the time. For the reading, or economics impaired, the coming crisis which is already in progress is a Sovereign Debt Crisis.  I’ve mentioned in earlier posts that this isn’t 2008 all over again- in fact, the last time we had a crisis last this it was masked by the events of the Second World War.  Very few people are alive to remember these events today; it’s probably fair to say that those who are were either too young, or are not lucid enough to report on the economic events following the Great Depression.

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As you can see from the above chart (taken directly from Rogoff & Reinhart) significant capital mobility preceded events of the 1929 Great Depression. These capital flows (invested funds across borders- from factories to financial investment) peaked prior to 1929, collapsed, rebounded and then bottomed in 1950.  The exact same clearing of the global economy is happening today- we are likely to be in the 1930-1935 region of this chart- perched upon the precipice (the dead cat bounce region of the chart) awaiting the final dip.  Once again I will defer to the Baltic Dry Index as evidence for this- international trade is in retreat and investment won’t be too far behind.

Next take a look at Sovereign Debt burdens around the world…

Websites like the national debt clock illustrate this problem quite well.  Furthermore, it is worth noting that there have been times in history where over 50% of the world governments were in a state of default, with the last peak in defaults coinciding with the Second World War period.

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See the percentage of countries in default, as well as the inflationary pressures faced in the aftermath of default.

Probably most notable of all is Japan, with a sovereign debt:GDP burden of over 200%. In terms of historical default rates, the probability of a Japanese default is over 95% at this Sovereign Debt rate (ie: P(Default) > 0.95).  The question, of course, remains precisely when, and how- the answer is likely “soon” and “by currency debasement”, but it could also be by forcing a haircut on its creditors. The majority of  Japan’s sovereign debt is internally held.

Europe also has an inordinate amount of Sovereign Debt.  Unlike Japan, this debt is held externally- in places like the US, but moreover between its own members.  This adds an additional layer of complexity to the situation.  Whereas Japan can, to an extent, bully or coax their creditors into accepting poor terms of repayment (even if they cannot escape the unavoidable), Europe has no such option.

Up until recently (probably as last as Q4 2013) the developing nations and emerging markets were considered to have high growth prospects and thus low default risk. This market expectation has been undone by the global commodities route, which has put pressure on emerging market public finances.

And of course, we have the US itself which is sat on trillions of dollars in debt.

So what’s coming?

If history is a guide, we are in the midst of a Sovereign Debt Crisis, with the defaults starting on the periphery (see: Greece, Costa Rica and Ukraine).  We are soon to be heading into a much larger crisis which has already started in the Emerging Markets and will soon spread to Europe, then Japan, and finally move to the core in the US.

An observation of this type of cycle is the political unrest which rises out of it, with extreme ideologies arising across the spectrum.  As well as the rise of warfare and civil unrest.

There will be cries of “This time it’s different”, and “We need exceptional powers to deal with this unprecedented crisis”, from governments, as well as asset confiscation and  wealth loss via a combination of increased taxes, loss of income, destruction of savings (the decline of the sovereign debt portion of the money supply), or increased inflation.

Volatility in markets will be high as savings look for a safe haven, as will risk and anyone who makes it out of the other side should see more opportunity a decade from now, provided that governments do not do something insane.

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