What can actually lead to another Financial Meltdown?
The economic and financial landscape looks worse with each coming week. Unemployment, inflation and uncertainty are on the rise. Investment returns, corporate budgets and the strength of the “full faith and credit of the United States” are declining. With so many problems being covered incessantly in the news, it’s easy for everything to morph into one giant “eco-financial mess” from which we want to look away. Not all problems have the same degree of severity. It’s important to identify those problems that could truly lead to a crisis of catastrophic economic proportions.
These problems could serve as catalysts to a financial meltdown within the near term. Unlike the collapse of Long Term Capital Management in the late 1990s or the collapse of Lehman Brothers in 2008, these problems can’t be resolved by a few VIPs in a room. If they come to fruition, they will be too massive to “fix.” The world economy will simply have to live through the consequences for decades.
Catalyst 1: The Euro ceases to exist
From an historical perspective, the Euro as a currency is a baby. It launched on January 1, 1999, and currently 17 countries use it as their official currency. There are over €800 billion in circulation across the world, more than the value of U.S. dollar currency in circulation. Every day over 332 million Europeans use Euros, and an additional 175 million people live in countries that peg the value of their currency directly to the Euro.
The Euro as a currency is in crisis. Since late 2009, certain European countries that adopted the Euro as their official currency have experienced severe financial and economic problems. Just like a company that isn’t performing well, these countries—Greece, Ireland, Portugal and others—are having difficulty paying the interest and principal on their sovereign debt. When a country can’t pay its debt, a common action is to devalue its currency. This makes debt repayments in local currency less expensive, and makes exports more competitive which gives the country access to hard currency. It acts like a released pressure valve.
Euro countries don’t have that option.
Instead, the weaker members must rely on the stronger members, like Germany, to make up the difference by providing money and their “guarantee” to investors. Pools of money, like the European Financial Stability Facility, rely mainly on the support of the stronger members. The problem is that countries like Germany and France have their own problems and it’s become highly unpopular to continue pumping German tax dollars into Greece.
If the situation doesn’t improve for the weaker members and anti-Euro politicians are elected in the stronger member countries, it could very well lead to the collapse of the Euro.
Catalyst 2: The dollar loses its “reserve” status and declines rapidly in value
Since the conclusion of World War II, the U.S. dollar has been the safest currency in the world. The majority of countries that hold foreign currency reserves have most of these reserves in U.S. dollars. The current financial condition of the federal government have led many to questions the wisdom of concentrating reserves in a currency that may not hold its value.
