Markets braced for more turbulence on US budget block and new Spanish government

The US Congress looks deadlocked over $1.2 trillion in long-range budget cuts this week and the election of a new Spanish government yesterday is going to do little to calm market nerves with central control over the eurozone sovereign debt crisis degenerating into a farce.

There is a dangerous vacuum of leadership and where a vaccum exists rumor and speculation will fill the gap. Just as the congressional committee cannot agree on where to make really very modest cuts in US spending, the eurozone seems paralysed and unable to come up with a big solution to its debt crisis.

US deficits

Then again the failure of the US congressional committee is symptomatic of a wider realization among analysts that actually the current US policy of rampant spending cannot continue indefinitely, and if that is all that is holding up the US economy then a further bout of recession or worse is inevitable.

For the US cannot actually spend more than it earns indefinitely, even the richest nation in history will eventually reach its borrowing limits. Spain is a reminder of what that means: once national debts go beyond a certain point then interest rates start to surge in local bond markets.

In Spain bond yields came within a whisker of the seven per cent limit at the end of last week. They will surely go higher this week. This is the limit beyond which it becomes technically impossible to ever repay the principal of a bond, supposedly the safest instruments in any financial system though actually a key area of default in any banking crisis in history.

So let us not mince words. The US has bought itself time in financial markets with its ballooning Fed balance sheet. More time indeed that some investors thought possible. But the day of reckoning, or the proverbial can kicked down the road still has to come.

When will that be? Will US bonds continue to strengthen as the eurozone sinks? Perhaps. But then what? The sinking eurozone will drag the US economy down with it. Investors will then pull their money out of US treasuries and dollars.

Money flow

Where will the money go? Into Asia to overvalue local currencies? That at least is a rebalancing of the global economy. ArabianMoney has long held that precious metals would also be a primary winner as an alternative currency of fixed supply in this doomsday scenario.

We are not there yet but nothing is happening to prevent this scenario which is only an extension of the market forces now operating in the global economy. Unless you think yourself Atlas and able to roll the world back up a hill we would argue that going with the flow makes a lot more sense for investors than going against it.

The next ArabianMoney newsletter will take up this theme with a guest column about Thailand’s answer to Warren Buffett (subscribe here). If we are right then the time to start reallocating cash outside of the US dollar zone is coming right behind an exodus from the euro.