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Tags: US | euro | area | known

This Year Will Have a Lot of 'Known Unknowns,' Not Too Many 'Unknown Unknowns'

By    |   Tuesday, 21 January 2014 01:04 PM EST

I don't think it's an overstatement to say for the moment there are apparently no blinking "warning" signs that signal we could be at risk of a resurgence of accelerating financial stresses in different places on the globe, apart from those places where we have ongoing political unrests like in Egypt, Thailand, Turkey, etc.

We could say it this way: it looks like the new year will be another one with a lot of "known unknowns," and hopefully not too many "unknown unknowns." The "unknown unknowns" include most of today and tomorrow's geopolitical risks/rivalries as well as emerging nationalism/separatism movements in Europe, climate and nature calamities, global health threats, global debt/credit excesses (leverage), etc.

Coming back to one of the category "known unknowns," outgoing Fed Chairman Ben Bernanke speaking last Thursday at the Hutchins Center on Fiscal and Monetary Policy at The Brookings Institution said something that really caught my attention. He stated he believes the only "credible risk" quantitative easing (QE) poses is the potential for instability in the financial markets. He noted that at the Fed they have spent the most time thinking about it and trying to make sure that they can address it if it were to happen.

Interestingly, Bernanke stated he could speak for his colleagues on this specific matter and at the Fed they don't think financial stability concerns should, at this point at least, detract from the need for monetary policy accommodation.

So, in clear English, Bernanke admits QE has the potential of causing instability in financial markets. What he didn't say was what the Fed could/would do if that were to happen or what the Fed has in mind to prevent broad-based instability in the financial markets.

I'd like to qualify this, certainly for long-term investors, as an important known unknown. Again, if that were to happen, many investors could face difficult times to get out of their investments/placements when they try to cash in their gains. The day markets start sliding there could be a serious risk they instead could be obliged in a lot of places, but not in all, where their assets/placements are located to pay an imposed "contribution" for the "QE pipers," yes "piper" in plural.

Please keep in mind that "money for nothing" will have its price and the bill will have to be cancelled one way or another. Just think about all these still-ongoing QEs in the United States, Japan (we can expect another expansion in the coming days), the euro area and China, just to name a few.

I might be good to refresh our memories a little bit with the recently, but nevertheless definitively, accepted EU bank "bail-in" scheme, which, in case it would be needed, would be similar to how last year in Cyprus a one-time bank deposit levy of about 40 percent (!) was imposed on all "uninsured" deposits (uninsured means the amounts that were above 100,000 euros in deposit at the financial institution) at the Bank of Cyprus, the island's largest commercial bank at the time.

Now, please don't be surprised, but also the United States, as part of the Dodd-Frank financial reform act, has "bail-in"-like powers that were put in place and whereby the law includes a resolution scheme that gives regulators the ability to impose losses on the bondholders of a "sick" financial institution and then use that capital to ensure keeping the critical parts of that "troubled" financial institution running.

Never forget, a bail-in always takes place before a troubled financial institution goes into bankruptcy and losses are imposed on the bondholders of that institution, while other creditors of similar stature, such as derivatives counterparties, are left untouched.

Let's now take a look at our next known unknown — the future of the euro area itself.

From the perspective of a long-term investor, it could be enlightening to take a closer look at the recently released "Quarterly Report on the Euro Area" by the European Commission. This report didn't cause headline news, but it gives serious warnings for long-term investors who want to put some capital at work or for those who are financially engaged in the euro area for the longer term.

"On the assumption that the euro area and U.S. forecasts underpinning this scenario prove accurate, the euro area is forecast to end up in 2023 with living standards relative to the U.S. which would be lower than in the mid-1960s. If this was to materialize, euro area living standards (potential GDP per capita) would be at only around 60 percent of U.S. levels in 2023, with close to 2/3 of the gap in living standards due to lower labor productivity levels, and with the remaining 1/3 due to differences in the utilization of labor (i.e., differences in hours worked per worker and the employment rate)," the report states.

No, that doesn't bode well at all for the euro area!

If you ask me, that's by far one of the most negative forecasts by the European Commission on the euro area I've ever seen. Of course, nothing is written in stone.

Needless to say my preferences for investing continue remaining for a great part focused on the United States and the U.S. dollar. In contrast, the euro area continuously lacks implementation of the absolutely necessary structural reforms that haven't materialized yet and for which 2013 was again another "kick the can" year with a lot of meetings, a lot of talks and very few constructive deeds on structural reforms.

I'm not saying the euro area will never return to sounder, better growth prospects, but things will have to change quickly and profoundly in order to not run the risk of drowning in its own self-made "euro quick sands."

Realistically speaking, long-term investing can't permit taking on risks of such kinds of negative expectations and as described by serious institutions like the European Commission itself. Maybe the euro area has become a nice place for a certain class of risk takers that mainly focus on hype and not on fundamentals.

All that said, and with Fed tapering still on the agenda, I also will keep, at least for the time being, avoiding emerging economies.

As most of you who regularly read me here know I believe physical gold has its place in long-term-oriented portfolios, but I still wouldn't buy it at to day's prices and instead would prefer to wait for prices to come below $1,100 per ounce.

Here's one of the reasons why: African Barrick Gold PLC reported their preliminary fourth-quarter "cash costs" per ounce of gold sold was $774, and the "all-in sustaining cost" per ounce of gold sold was $1,171

An investor who is patient enough and starts buying gold over a longer-term time period between those two prices of gold would probably have a good long-term investment.

Of course, that's easier said than done, but generally, patience pays off well over the longer term.

Wasn't it Jean-Jacques Rousseau who said: "Patience is bitter, but its fruit is sweet"?

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I don't think it's an overstatement to say for the moment there are apparently no blinking "warning" signs that signal we could be at risk of a resurgence of accelerating financial stresses in different places on the globe.
Tuesday, 21 January 2014 01:04 PM
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