Awaiting the capitulation event as stimulus no longer works

You can hand a heavily indebted person a credit card and let them go off spending for another few months. You could even be kind and foolish and do this again. But you eventually reach the end of the road where their bad credit is a danger to your own financial position, and then you would have to stop.

This is an anology for what has happened to the global economy over the past three years. Debt has been piled upon debt. But right now the flat US yield curve shows that it has become unprofitable for banks to lend, and that is the beginning of the end as Pimco boss Bill Gross has so rightly pointed out (click here).

Eurozone sticking plasters

It is the same story in the eurozone. Last week the central banks of the world came to the rescue of European banks with dollar loans that they are now too afraid to lend each other. It is another sticking plaster to stem the bleeding artery, and this can only be a temporary solution. Inter-bank lending is critical to the system.

For US Treasury Secretary Tim Geithner to be in Europe late last week lecturing European finance ministers on how to deal with the eurozone crisis was a bit much: talk about the pot calling the kettle black. The US is far more deeply indebted than the whole eurozone and its credit system is also at breaking point with the yield curve flat.

Meanwhile, we hear reports back from China about the scale of indebtness there. Is that any wonder? The Chinese stimulus package three years ago was the biggest as a proportion of GDP in the world with a sum equivalent to half of annual GDP thrown mainly into emergency bad loans.

The Chinese subprime crisis is bound to come back to haunt us. That sort of bailout just has to have unintendend consequences. China has seen the inflation this year. The bust part of the boom comes next.

Capitulation event

At what point to do financial markets just roll over and capitulate? J.M. Keynes adage about markets remaining irrational longer than you can remain solvent comes to mind.

Keynes himself made and lost fortunes gambling on markets in the 30s, although he died a wealthy man in 1946 with an astonishing legacy for a British academic of $20 million. Speculators are winners in these markets, not honest investors.

But all the ingredients required for a capitulation event are in place: high volatility with equity markets unsure from one day to the next what the future holds; huge and unsustainable levels of debt in the global economy; massive exchange rate instability; and a collapse in industrial orders predicting an imminent recession. Does anybody have a way out of this?

Staying liquid, long in precious metals and short in just about everything else looks the only rational position in irrational markets that really only have one way to go. The next ArabianMoney newsletter will have some specific ideas for subscribers looking to make money out of this chaos (subscribe here).