FYI | Nov 19 2009
By Greg Peel
French bank Societe Generale has made the headlines many times in the past two years, but two particular occasions stand out. The first was in January 2008 when, under cover of a US holiday, the bank dumped billions of dollars worth of shares onto the market which had been surreptitiously accumulated by a “rogue” in SocGen’s midst. While the end result made little difference, that trade set the tone for 2008.
By May of 2008, SocGen was stealing the limelight once more, announcing it had moved its balanced investment portfolio to its statutory minimum weighting of 30% equity, predicting a stock market collapse of 50-75%. In January world markets had been trying to recover out of Christmas. In May, markets had managed a 50% retracement of the fall from the highs, figuring the collapse of Bear Stearns was the end of the crisis.
In both cases, SocGen helped turn sentiment around.
And the analysts weren’t too far off the mark. The complacent bulls laughed off such a dire prediction in May, but we ended up down about 55%. We have now, once again, retraced 50% of the drop from the high in 2007, this time post-Lehman rather than just post-Bear Stearns. Things are clearly looking brighter than they did, and thoughts of SocGen’s 75% have been put to bed. Or have they?
SocGen is not making a specific prediction this time, rather the analysts have issued a warning against a possible worst-case scenario. And it’s all to do with global debt. Start shorting cyclical equities, they say, including those in emerging markets. Sell the US dollar and buy government bonds. Buy agricultural commodities and gold. Buy lots of gold.
SocGen is readying its clients for a possible “global economic collapse” over the next two years, with its warning contained in a report entitled “Worst-Case Debt Scenario”. What the analysts base their fears on is simple and patently obvious, to wit, the public “rescue” of the private sector has not solved any pre-GFC problems in regards to excessive debt levels in the developed world. It has simply transferred the debt from the private to the public balance sheet.
Total public and private debt in the US has now reached a level of 350% of GDP. That’s like saying an individual would need to use all of three and a half year’s worth of income just to pay off his credit card. Public debt alone will reach dangerous levels within two years, says SocGen, at 105% of GDP in the UK, 125% in the US, 125% in the EU and 270% in Japan. Total world state debt will reach US$45 trillion, representing a two and a half times what it was only ten years ago.
This is an underlying debt burden greater than what it was after the Second World War. One might thus suggest “well we survived that okay”, but remember that following the war was the baby-boom, the explosion of mass production and the advent of the consumer society. It was a golden age of growth.
This time around, the baby-boomers are ageing and threatening to place a huge burden on the public purse. And growth is in the labour-unintensive information and technology industry. In short, there seems no golden age ahead.
SocGen believes we have all but reached a “point of no return” for government debt. Put simply, developed economies will never to be able to produce enough income to net reduce debt levels. A deflationary spiral will prevail, making the whole of the world look like Japan in its “lost decade”. Emerging markets will be dragged down as well given they are more leveraged to the US economy than even Wall Street is.
Governments may only have one choice, and that is to hyperinflate their way out of debt by simply printing money. When money is printed, everything loses value, including debt. Welcome to Weimar.
Government bonds would be purchased by central banks just as has been the case in quantitative easing measures to date. Yields would fall to near zero on longer dates. Gold would absolutely soar. Food would become very expensive.
I repeat: this is not a prediction, this is a warning.
