Managing Structural Economic Change and the Financial Markets

The second quarter of 2013 was particularly challenging for investors. The last two months, in particular, were impacted by the market turbulence which emerged from concerns that the Federal Reserve Bank would change its current low interest rate policy. The current policy of maintaining low interest rates was intended to support economic growth in the United States by making credit more affordable. They have done this through what is known as their quantitative easing program, which is essentially buying bonds with money that does not exist until they create it. While the historical data does not necessarily support the belief, many investors, nonetheless, associate increasing interest rates with poorer stock market performance. The prospect of a change in interest rate policy created additional uncertainty and a shift in investor sentiment from the irrational exuberance equity investors had during the first two months of the year to more anxious concerns as to the sustainability the equity markets.

What may well be a more fundamental issue, however, is that bond investors also seized upon the prospective change in the Federal Reserve Banks policy and started exiting from bonds. Trim Tabs, an investment research firm, says that investors liquidated over $60 billion from bond mutual funds and exchange traded funds in June. If this is true, that would be the single-largest monthly redemption in history. Some commentators are calling this the end of a 30 year bull market in bonds.

This drove interest rates higher causing losses for traditionally bond investments. Bonds have traditionally, and historically, been considered conservative investments. With bonds as well as stock losing value, this left very few “safe harbors” for refuge from this storm. Cash is one option that some investors will flee to, and an allocation to some percentage allocation to cash is certainly warranted as a prudent allocation strategy. However, with dollars being created without backing by anything other than the “full faith and credit” of a government that does not appear to be capable of operating in a solvent manner, it is doubtful that this is the safe refuge it might appear to be. Moreover, cash offers very little in investment return. While cash is a valuable component of an investment strategy, just as with any other asset, having too much of it has its own hazards.

In my view, while there are many economically sound justifications for higher interest rates to exist, the markets have severely over-reacted to the prospect of a policy change in the Federal Reserve Bank. Having listened to Ben Bernanke’s entire speech, I heard him say that depending upon economic conditions the Federal Reserve Bank would adjust its policy. If the economy was doing well the Federal Reserve would gradually reduce the $85 billion per month of bonds it is buying to keep interest rates low. If the economy is not doing so well, it would continue its policy, and if conditions warranted, it would even increase the amount. From what I can see, given economic conditions, the Federal Reserve Bank seems more likely than not to continue its policy longer than expected. While there can be other factors than the Federal Reserve Bank affecting interest rates, it appears to me that investors have over-reacted toward the downside during the last few months, just as they over-reacted to the upside in equity markets during the first two months of the year. These last few months of stock and bond market behavior appear to be more panicked emotional reactions of market traders rather than the economically sound reasoning of longer-term investors.

In my analysis, I would be surprised to see the Federal Reserve Bank make any significant change in the near future. The consequences for doing so would be too severe in its impact on our anemically growing economy. Were they to change their policy and allow interest rates to rise, the most recent market response to these prospects suggests that at least the initial market response would be decline in both the stock and bond markets. The result would be a further damper on economic growth because of what economist call the “wealth effect” When account values go up, people are more willing to spend and consume. When account values go down the reverse is true which results in slower economic growth. Additionally, the housing market plays a very big role in the strength of our economy. With the housing market appearing to be in the recovery stage, higher mortgage rates, resulting from a change in Federal Reserve Bank policy, could quickly kill the housing recovery, again stalling economic growth. The other important factor is that when interest rates rise, the debt servicing liabilities of the U.S. government and municipalities also start to increase. At present, the servicing of the existing debt is not financially sustainable, even given historically low interest rates. Consequently, taken together, it does not seem likely that we will see a change in Federal Reserve Bank policy anytime soon. An unknown, however, is how much control the Federal Reserve Bank really has left in capping interest rates. There have been reports of Central Banks throughout the world selling their holding of U.S. Treasury bonds. This would put additional pressure on interest rates to rise.

Overall the global economic system is drowning in debt. Were it not for the heavy debt loads that are being carried, the underlying latent economic vigor would look promising. The real challenge to policy makers is how to manage an unwinding and restructuring of that debt. This must be done in the context of continuing demands for financial resources. The real danger is having the management of this process get out of control and become a collapse rather that a slower burn process. If there is a systemic economic collapse the trajectory of where events will lead is unknown. At this point, while I do see economic turbulence ahead, I do not place a high probability on a general overall economic meltdown, at least in the near future.

An Overview of 2013 - Setting the Scene

There were several driving forces affecting market conditions in year 2012. The year opened on a very strong start. In fact much of the overall market gain in 2012 occurred in the first six weeks of 2012. The rest of the year could best be characterized as one finger nail biting financial crisis followed by another, with a measure of election year political uncertainty thrown in for good measure.

The first crisis was the deteriorating economic conditions in Europe and the inability of governmental policy-makers to develop a constructive program to address it. While never really resolved over the course of the year, it was pushed off center stage by our own home grown financial crisis in the United States that came to be known as the fiscal cliff, and similar to their European counterparts, the inability of our own government political leaders to develop a constructive resolution. In each of these crises some sort of gerrymandering solution was developed; but the underlying problems remain not addressed with sustainable policies. The uncertainty of these circumstances created of great deal of volatility in the investment markets. In each case heightened tension increased the fear level of the markets and caused consequent drops in the markets. In each case, as well, the fears gave way to relief rallies in the markets as some policy was cobbled together to at least temporarily address the issues.

While the markets have started the year strongly, it is inevitable that will see these crises reemerge in 2013. In fact, it is highly likely that we will see a return to the same sort of volatility we experienced in 2012. The United States government has already reached the debt limit allowed by law, and while an agreement was reached with respect to taxes, the only agreement with respect to the mandatory budget cuts, known as sequestration, was to defer them for two months. This means that by March we will see the political and economic tensions again escalate, and market fears and uncertainty increase.

The issues at hand are very significant and marginalizing them into just another economic crisis would be poor judgment. The potential consequences mean there is there is not really no one safe harbor. Cash or bonds, the traditional conservative investments have to also be considered as at risk. Considering cash, in US dollar form, to be conservative would be to not recognize the link between the guarantor of the US dollar, the U.S. government, and the intractable financial problems that have brought it to the financial cliff, or are pushing it to have to continually increase its allowable debt ceiling. Bonds are also at risk as interest rates begin to rise from an unsustainable low interest rate environment, bond values, especially those long-term in nature, will decline in value. Indeed, as the markets have started 2013 strongly, many bonds have declined in value because of interest rate pressures.

One thing that seems to be fairly certain is that crises do resolve themselves, one way, or another. At this point we can only speculate on how that will occur. The worst case scenario would be a total global financial collapse and an ongoing subsequent global depression. While this cannot be dismissed as an impossible event, I see the probability of this as being extremely small. There is a great deal of potential economic vigor and potential growth. At present the main problem is the huge overhang of legacy debt. This is putting a damper on economic expansion and its consequent investment potential. Over-indebtedness is always dealt with by some sort of restructuring. That is what I would expect as a resolution in this case as well. What that restructuring will look like remains to be seen. However, as this process unfolds, we will see the economic vigor and investment potential be released. My take is that 2013 will be a pivotal year in beginning that resolution process. While I expect to see heightened volatility, I also expect to see the investment markets becoming more and more attractive as the year unfolds. As the year unfolds, I will be trying to steer a balanced course between the volatility and the potential longer term opportunities through maintaining well diversified portfolios. 

Diversified Investment Strategy

Investment markets over the last quarter have been driven primarily by uncertainties with respect to outcomes in resolving the debt crisis in Europe. As in the United States, Europe has been having its own political gridlock as to its way forward in the face the potential government insolvencies. Most recently, Greece had been the foremost concern. Having been in a severe recession for several years because of budget cuts required per terms of previous financial bailouts by the other countries of the European Union, Greece had called an election to determine whether or not it would stay in the European Union and adhere to the austere budget required by their financial bailout. The alternative was to leave the European Union and default on billions of Euro’s worth of debt. A good portion of this debt was held by major European banks, as well as some major U.S. banks. The fear was that if Greece defaulted, the fallout would be far reaching perhaps undermining the solvency of major global banks and financial institutions. Greece narrowly voted to remain in the Union, but with a significantly divided parliament. No sooner did this occur, than Spain rose to front and center as a problem area. Spain being one of the largest economies in Europe required a new approach to this entire European issue. Germany and France had been forcefully advocating an austere approach to dealing with the over-indebtedness of the countries in the middle of these financial crises. The problem was that the programs of austerity were also damping growth to make it even more difficult for countries like Greece and Spain to deal with their debt problems. Elections in France changed the leadership from Sarkozy to Hollande who was much more sympathetic to relaxing the programs of austerity and do more to stimulate growth. Only Germany’s Angela Merkel remained as the lone, but powerful voice of the austerity programs, and consequently political gridlock. Most recently, Merkel appears to be relaxing her position and the framework of a structural agreement to deal more comprehensively with the issue emerged. Whether the agreement will accomplish this remains to be seen. It did, however briefly, give hope to the investment markets which reacted very favorably to the news.

To compound the uncertainties and the implications surrounding the European financial crisis, lurking in the background, ready to jump forward at any instant, is the financial and economic situation in the United States. More and more frequently, reports are being aired on the mainstream media of an approaching fiscal cliff the United States will be facing at the end of the year. This refers to the prospect of increased taxes and mandatory federal budgets cuts. The outcome is a result of the political gridlock in the United States and is a default position in the event Congress is not able to reach an alternative agreement. Given the extreme ideological polarization of our Congress, the probabilities seem small that an alternative agreement will be reached. There seems to be a fairly wide economic consensus that this is likely to result in the weakening of the already weak US economy. Moreover, even if an agreement is reached, as in Europe, the fixes seem to do little more than “kick the can down the road” a little further without really developing a sustainable solution to very real structural problems. Needless to say, the situation is very complex, and we could continue for some time to discuss it. All of these uncertainties create a very unstable economic and investment environment. The outward appearance is a great deal of volatility as investors swing from the extremes of fear and hope. The relevant question for us is: what is the best investment strategy in this type of environment? There is no shortage of opinion predicting where the investment markets are headed. They range from catastrophic calamity, to the cusp of a new bull market. For over two decades, on a regular daily basis, I consider countless numbers of these viewpoints. I have come to value some commentary and analysis more than others, and I certainly form my own opinions. I have, however, learned several important lessons over the years. One is that no one has a perfect crystal ball. Another is that the reporting media seems to create its own spin. When things are going relatively well, a general impression is created that happy days will never end, creating a type of euphoria. On the other hand, when events turn toward the negative, it sometimes appears that the end of the world is approaching, creating an atmosphere of fear and panic. It is a well documented that investors over-react to news. For example, Dalbar Inc. is a company which studies investor behavior and analyzes investor market returns. The results of their research consistently show that the average investor earns below average returns. For the twenty years ending 12/31/2010 the S&P 500 Index averaged 9.14% a year. The average equity fund investor earned a market return of only 3.83%. While I cannot absolutely dismiss either of the extreme outcomes from occurring, my observation has been that the fundamental principle of risk management, diversification, should still serve as the foundation for a prudently managed investment portfolio. This does not mean that the portfolio will be resistant to all market downturns, and it does not mean that diversification adjustments should never occur. It does suggest, however, maintaining focus and investment discipline is a critical component of navigating what are sometimes, very stormy seas.

Looking forward, it would be great to say that the worst is behind us. Unfortunately, that does not appear to be the case. It is likely that the global economy and investment environment will get worse before it gets better. It will require patience and fortitude whatever the investment allocation is. The silver lining, however, is that unless you believe the world will be ending as a result of these issues, the foundation of future economic health is being established. Despite the grim shorter term picture, my opinion is that the global economic challenges and issues now being confronted will be worked through and resolved, and that the world will not end.

A Review Primer on the Components of Diversification – if needed

The four broad categories, or asset classes, of investments are cash, bonds, or equities. Included within these categories are such things as real estate, commodities such as energy, food, as well as precious metals. Each has its own particular characteristic strengths and weaknesses, and consequently a prudent risk management approach would not allocate 100% to any one of these asset classes.

If we consider cash, for example money market funds, we recognize that this can provide liquidity and stability, but very little investment gain. It is not without risk. In fact, when interest rates are as low as they are today, the risk is known as purchasing power risk. This means that if you have $100,000 in an account today, and $100,000 in the account one year from now, will the $100,000 one year from now be able to purchase what is can purchase today. If inflation is running at 2.5%, one year from now you will have a guaranteed loss of 2.5% in the purchasing power of your account. Currently, by the government’s statistics, this is around the range inflation is running, other independent analysts believe the real inflation number is higher. And some analysts believe that the future rate of inflation will be significantly higher. This suggests to me that while it makes sense to have a portion of an investment portfolio in cash, or cash-like investments such as a money market, 100% would probably be unbalanced in failing to address the unique risks of cash.

This brings us to bonds. Bonds, in general, have traditionally been considered a conservative investment. This is a broad generalization, and it is important to understand some of the unique characteristics of bonds to appreciate their role in an investment portfolio. An attractive characteristic of bonds is that they pay interest on a regular basis, which is of course if the issuer continues to have the ability to pay. The risk that the issuer may not be able to continue paying the interest, as well as the principal at maturity is known as solvency risk. Depending upon the type of bond this risk can be higher or lower. Historically, government of developed economies had been considered low risk, with the United States having the least solvency risk. Municipal bonds have also been considered safe, conservative investments. These days we hear of the developed country bonds being less safe because of over-indebtedness, as well as municipalities in the United States declaring bankruptcy. Another risk of bonds is known as interest rate risk. This is the risk that if interest rates increase, bonds already owned will decline in value. Some investors say this is not a problem because if they do not sell the bonds until they mature, they expect to receive all of their principal back, as well as the promised interest payments. What these investors neglect to consider is that if interest rates increase, it is usually for a good reason, such as higher inflation. They are stuck with lower interest paying bonds they had previously purchased. The bottom line is that bond can also decline in value, sometimes significantly. In historically low interest rate environments, as we currently have, this risk is elevated. These risk management implications imply that while bonds are an important part of an investment portfolio, they also should not represent 100%, and the portion of an investment portfolio that is in bonds should itself be diversified with respect to the types of bonds and the unique risks for each type.

This brings us to equities, or stocks. As with bonds there are a wide range of offerings, as well as a wide range of approaches to investing in them. They have their own unique set of risks, as well as presenting opportunities. Despite regular variations in value, sometime significantly so, they offer income opportunities through dividend payment, and/or growth opportunities through their increase in value. Needless to say they can also decline in value. With a diversified investment position, for example in fund of utility companies, the main risk seems to be primarily psychological. The belief that, for example, that all of the strongest and largest utility companies in a fund will simple become worthless is placing a disproportionate weight on the occurrence of something with an extremely small probability of happening. Despite periodic declines in value, sometimes having nothing to do the real merit of the investment itself, these funds can pay annual dividends of 4% per year or more. In an environment where interest rates are so low, having some component of a portfolio in equities, or stocks, is part of a well diversified portfolio. One way in which the potential volatility can be managed is by having a smaller percentage.

It is interesting to note that some of the same investors in bonds who claim that it does not matter if the bond declines in value because they intend to hold the bond until maturity, will consider it unacceptable to own a utility fund paying 4% or more because of the potential for it to decline in value.

Nonetheless, each type of investment has its own unique set of risks as well as opportunities. There is no one safe harbor. The best overall way to construct and manage a portfolio is with a diversified selection of different types of investments. In some cases, there will be significant declines in value. Some investors believe it to be possible to time when the declines and when the increases are coming, thereby avoiding declines while riding the increases up. Even if this were consistently possible, and there is reason to doubt this, from a prudent investment decision-making perspective, there needs to be some rational decision-making basis, other than an environment of fear and panic driving the markets. With the outcome of so many hugely impactful global issues pending resolution, trying to respond to these unresolved issues offers little other than randomness as a foundation. This is unacceptable, and argues all the more strongly, for holding a well structured portfolio comprised of cash, bonds and equities despite the volatility, and periodic declines.

Creditors of the World Are Not Necessarily Captive to the Debtors

In response to Martin Wolf's article in the Financial Times,  I offer the following commentary.

The conceptual framing of this argument is somewhat misleading. To begin with the phrase indicating a belief by creditors that they will inherit the earth suggests a context for concentrating wealth and power that is more benign than the underlying capitalist and human drive for dominance and control. There are enough examples in human history, and biology, be it modern or ancient, that one does not have to be much an historian to be compelled to believe that a basic survival instinct is to attempt to manage one’s environment so as to better the chances of surviving and thriving. Because of the complex web of relationships there is often some sort of mutual interdependence, sometimes beneficial, sometimes not so much.

The heart of Martin Wolf’s argument seems to suggest that the relationship between creditors and debtors is such that there is some sort of “lock” binding specific sets of creditors and debtors to one another. While perhaps the world cannot trade with Mars, specific parts of the world can rearrange their trading relationships and thier drivers of growth. For example, while no doubt the western developed world does serve an important function in sucking up the exports of China, it is also possible that through a combination of weaning itself from such heavy dependence on an export driven economy by developing its domestic aggregate demand, and shifting its trade relationships to for example Brazil, or even Russia, to meet some of its export needs it can transition from its heavy dependence its current export targets. As to being held captive because of its $3,200bn of currency reserves, it should be keep in mind that it is only held captive as long as the currency reserve exists in its current form. If these reserves begin to be exchanged for foreign equity positions representing control in strategic future resources that China needs, the current foreign reserves cease to be a control on China’s behavior, and rather serve to further concentrate power and wealth in the hands of those with capital.

Is this so different than when the Native Americans in New York sold Manhattan Island for the equivalent of $24 in baubles, or when the Soviet Union dissolved, dispersed shares of ownership of formerly state owned enterprises among the people, only to have aspiring oligarchs acquire and concentrate these assets for controlling interests in exchange for perhaps teh equivalent of a supply of vodka for a short period of time. There are innumerous other examples which can be given wherein the exchange of future earnings capacity (read indebtedness) for a more immediate gratification leads to servitude.

To suggest that because we are all on the same planet, as Martin Wolf does in his argument, the fix to the current capital imbalances are compelled by some notion of constraint by reciprocity is to have blinders hindering one’s vision as to the fuller range of feasible alternatives.

George Soros' European Crisis Solution

If one accepts George Soro’s solution to preventing a second Great Depression, the prognosis is indeed grim. His solution, while in itself conceptually problematic, appears in a pragmatic context to reside in never-never land. The bold steps he presents as necessary conditions to prevent a second Great Depression require the cooperation and coordination which would transcend the polarization and fractionalization of regional narrow self-interest at such a scale that defies observable reality. Moreover, while the conditions he proposes may or may not be necessary, he has not presented a convincing argument that they are sufficient conditions.

A nebulous foundation block of his strategy is to provide time for “Europe to develop a growth strategy, without which the debt problem cannot be solved”. The development of a growth strategy is central to every economic and business interest, as he well knows. The question which must be asked is what the potential drivers would be of any effective growth strategy, what are the competitive and comparative advantages that Europe could bring forth, and what the time frame for implementation would be? If this proposed growth strategy would be a palliative to the “debt problem”, one is assuming a sufficient rate of growth to offset the burden of debt service. Even assuming a growth strategy could be developed; getting a realistic idea of whether the growth rate would be sufficient to counter the demands of debt servicing takes us into the unquantifiable speculative realm. While George Soros is a demonstrably recognized master in the realm of speculation, a no small part has been his ability to be adaptable and flexible as changing conditions warrant. Unfortunately governmental and national policies rarely show the same nimbleness in response to changing realities.

http://blogs.ft.com/the-a-list/2011/09/29/how-to-stop-a-second-great-depression/#axzz1ZHNkRk4j

European Union Debt Crisis

The majority of the global economic discourse these days revolves around a central thesis; too much debt, and burdensome deficits. To some degree, the debt problem contributes to the deficit problem because of the requirements of servicing the debt. The actions of policy makers are decried as lacking in leadership as they stumble around seeking politically acceptable ways to resolve these issues, while at the same time being economically effective in really addressing the issues. The results have been skewed towards being politically acceptable via some form of “kicking the can down the road”. The economic realities suggest the end of the proverbial “road” may be near. The debt issue is more of a global issue than regional issue; or at least global with respect to the indebtedness of the western developed economies. Questions such as whether Greece remains part of the European Union seem a little flat when one considers that regardless of whether Greece is or is not part of the EU, the outcome of resolving this issue in any manner other than some sort of default is unlikely. Because of the integrated scale of connectedness, I doubt anyone, or any institution really fully knows what the unanticipated consequences and effects will be. Consequently, talk of “ring fencing” or containment of these issues smacks more of intellectual arrogance than a sober acceptance of the magnitude of the problem. I suspect that after all the “shucking and jiving” is done what we a headed for, and what seems inevitable, is a global restructuring of monetary regimes with some attempt at a functional global monetary unit, be it a basket of currencies, or for that matter a basket of commodities. Along the same line, it would seem that the only effectively managed way out of this global financial mess will be some sort concerted global effort to inflate away the real value of the debt burden.

No Free Lunch

The extraordinary measures being taken by central and governments in an effort to stabilize create markets, and intervene in cases of prospective institutional insolvencies, will result in a huge funding need by these governments. In the United States, the Congressional Budget Office has estimated that the Budget for the United States will exceed $750 billion next year. Other estimates are for a U.S. budget deficit in excess of $1 trillion. This is before possible and probable additional costs for an economic stimulus package, $300-$400 billion, and other funding demands arising from this financial meltdown. Questions which should be of interest are: Where will this funding come from; and what be be the implications of funding these needs?

The United States has had the benefit of foreign sources of capital to meet its need of $60-$70 billion per month. This was prior to this financial meltdown and the new capital funding requirements ensuing. Countries like China, and petro-dollar beneficiaries were accomodating enough, for whatever reason, to meet these needs. If the U.S. budget deficit doubles, while probably not a strictly linear relationship, one might estimate that the capital funding requirements of the United States from foriegn capital sources might rise to $110-$120 billion per month. What would be the willingness, ability, and desirability of foreign capital sources to meet this need?

In the context of a global economic slowdown it would appear that foreign reserves of US $'s would diminish from decreases in exports as well as lower oil prices. This would leave less funds available for re-investment back into U.S. Government debt instruments. One might also expect that as the U.S. financial picture becomes more impaired by its crushing debt burden, potential investors may well look more closely at alternative choices, as well as the redeployment of capital back into their own countries. In any case, this suggests that in order to secure the funding necessary for ongoing operations, the costs, ie interest rates, will be pushed up my market conditions. As the United States and other central banks have become the "bailouters of last resort", who has the ability and willingness to bailout these governments and institutions? I suspect there is no one to do this. If so, this may well make the current financial meltdown look like a picnic on a nice spring day.

If the current operational strategies offered by Central Banks and governments are any indication, we might expect that a high interest rate environment(read impaired credit availability), in a severe recessionary environment would be unacceptable. It would then seem like the strategy of the printing press for the manufacturing of money would be the only feasible choice available. One might then conclude that despite this current period of asset deflation and a strengtening of the dollar, this may well be a period that is relatively short lived.

While there is no free lunch, there may well be soup lines.

Financial Crisis Solutions

Congress has passed the Paulson Mega Bailout Plan. Much of the public dialogue around this issue appears to confuse the two major factors underlying this crisis. These two factors are liquidity and solvency.

The credit markets are the lifeblood of a healthy functioning global economy. This financial crisis has resulted in a “freezing up” of the credit markets. Despite Central Banks flooding these markets with access to funds, the credit markets had remained frozen. The ostensible reason is that there is an underlying fear of institutional insolvency arising from exposure to toxic assets on their balance sheets. Because of the complexity of the financial structure of these assets, valuation becomes, more or less, conjecture. At the very least there is an asymmetric knowledge regarding the real quality of these assets. Probably, however, this even overstates the value assessment of these assets because, apparently, even the holders of these assets have exercised poor judgment regarding their value.

A more nefarious explanation as the why the credit markets continue to remain frozen after hundreds of billions of dollars have been injected into the system, could be a “money cartel strategy”. In this case, the fear generated by this credit crisis provides great cover for the institutional withholding of credit. The resulting worsening of financial market conditions result in more institutional and corporate failures and an increased availability of distressed asset sales for those who have access to capital.

Whichever explanation may be partially, or wholly, representative, the recently passed Paulson Plan is intended, at least at face value, to address the frozen credit market conditions by alleviating the institutional solvency concerns.

Unfortunately, as the point has been made by Roubini, and others, this only partially addresses the real problem which is the crushing personal debt burden. This is an underlying weak point which has lead to the deterioration in home values, and the associated mortgage securities. The idea that making more credit available to an economic system whose members are already drowning in debt seems to leave something to be desired as to this strategy’s future efficacy and effectiveness.

Because of the immense magnitude and pervasiveness of this financial crisis, it is likely that $700 billion will not be sufficient to successfully address this problem because the dollar value is insufficient, and its focus is incomplete. The other aspect which must be addressed is how to provide relief to an overly indebted population who cannot adequately service its debt, and how to do it equitably so that those who have acted prudently do not feel penalized for their more prudent financial behavior.

From my perspective the inevitable public policy which will arise will be monetizing the debt, and creating enough inflation to diminish the real value of the existing debt. This appears the only real option if the global financial system will not collapse in a shambles. This would be the case where the number of losers is maximized, and a result would arise from either an immensely stupid public policy decision, or a monumental geopolitical miscalculation. My inclination is to believe that because the vested interests are at stake of so many who truly are mentally sharp, as well as business and worldly-wise, the inflating option will be the direction we find ourselves going in. Given the monetary and fiscal policy apparatus, mechanisms, and policy maker predispositions, this seems the most probable outcome.

The next step in this would be to more directly address the personal solvency issues. This is a bitter pill to swallow, but this would be a natural consequence of the imprudent financial behaviors on the scale we have witnessed over many years. There are many creative ways in which this could be done. I would think, however, that a policy this is bold, and demonstrably decisive would be what is really required to breathe life back into the system. The follow-up, if we were to really correct the error of our ways would be to put in place regulations as well as financial education, training, and counseling programs, and a rethinking of our values, as to not get ourselves, globally, back into these circumstances.