Take your pick: A tale of two economic trends

The developed world is de-leveraging and Europe is moving toward deflation and depression. Meanwhile, the Chinese, Southeast Asian, and Indian-led developing world is growing and experiencing inflation. We will discuss both regions in this memo.

Restructuring the massive debts of European countries will begin within a few months. Greece and, in the longer term, some other European countries will default on debt and begin to de-lever their economies on the backs of those who were kind or foolish enough to lend them money. Portugal, Spain, Ireland, and possibly Italy will have to restructure all or a part of their debt over the next few years.

How will this play out is open to question. It may be:

1. Lengthening of maturities. “Your bond was to mature this year, we have decided to extend the maturity by 10 years at the same interest rate”.
2. Repudiation, or sorry…‘we cannot pay you back’…Will you take 40 cents on the dollar?
3. The insolvent country quits the Euro and says “We will pay you back all we owe you we are converting all debt to our new currency”. They then proceed to do quantitative easing so that they effectively print money to repay the debts with devalued currency.
4. The countries show that they are able to cut costs and that they can grow their economies, thus attracting new lenders.

Europe’s de-levering of sovereign debt will likely be a bigger version of the Latin American sovereign debt restructuring/repudiation crisis of a couple of decades ago.

Right now, investors are assuming that the crisis will be deflationary, causing commodity prices to fall, world trade to diminish, and create a cascade of defaults. The past eighty years of history tells us that politicians, except for those

in Germany, have chosen to handle these types of situations in an inflation-inducing manner. In our opinion, policy makers will engage in the type of Keynesian expansionary policies which will amount to money printing, creating a period of rising inflation in the long run. This money printing or quantitative easing is what the U.S. and U.K. did in 2008 and 2009. It is what they have done in Japan and Europe (excluding Germany) for years. To fight the deflationary forces, we expect Europe (outside of perhaps Switzerland and Germany) to opt to continue the same program.

Politicians everywhere want to give things to voters, and pay lip service to balancing the budget. This will lead to higher gold prices short medium and long term and higher commodity prices long term.

Guild Investment Management, Inc., a registered investment advisor. All material presented herein are solely the opinions of Monty Guild and Tony Danaher. Investment recommendations and opinions expressed in these reports may change without prior notice. Read Monty and Tony’s past periodic market and economic commentary articles by going to the Commentary Archive on www.guildinvestment.com.