Hussman Weekly Market Comment: Passed Pawns

Meanwhile, my view continues to be that a recession in the U.S. is already an overlooked passed-pawn, as is the sharper-than-expected economic weakness in China, as is the overleveraged, undercapitalized state of the European banking system – particularly in Spain – where policy makers are misguided enough to believe that Draghi’s words alone are sufficient to substitute for bank capital and fiscal stability. The growing U.S. debt/GDP ratio is another passed-pawn, because while I expect the “fiscal cliff” will be resolved by a half-hearted combination of tax cuts and modest spending reductions, the final result is likely to leave a large structural deficit which we are only capable of financing due to the good fortune of unrealistically depressed interest costs and a combination of monetization and Chinese capital inflows (all which make endless deficits seem misleadingly sustainable).

Hugh Hendry of Eclectica recently got the tone right in his concerns about the endgame we are facing:

"Today, the world is grotesquely distorted by the presence of fixed exchange rate regimes. There are two. There is the Euro, and there is the dollar-remnimbi. All of Europe has defaulted. There are many stakeholders in the European project. There are financial creditors and then there are the citizens of Europe. Remarkably, the political economy of Europe is that the politicians chose to default on their spending obligations to their citizens in order to honor the pact with their financial creditors. And so of course what we're seeing is that as time moves on, the politicians are being rejected. So when I look at Europe, the greatest source of inspiration I have is fiction... We have the longest-serving Prime Minister, the Prime Minister of Luxembourg Mr. Juncker, who is on record as having said that 'when times get tough, you have to lie.' … the truth is unpalatable to the political class, and that truth is that the scale and the magnitude of the problem is larger than their ability to respond, and it terrifies them. The reality is that you just can't make up how bad it is. But it has precedent, and precedent perhaps offers us some navigation tools.

"The number one rule in terms of looking after wealth is preserving that wealth... I think we are single digit years away from the most profound market clearing moment - a 1932 or a 1982, where you don't need smart guys or girls, you just need to be bold. The crisis started here, it went to Europe… we could see a hard landing in Asia, coinciding and indeed being encouraged by the problems in Europe, and if you get those two events colliding, and given the lack of protection on such a scenario in Asia, then you would have another profound dislocation. And that's the point where you reach the bottom, and you don't need wise guys, you just need courage."