Byron Wien and the Firedancer on the Financial Crisis

What the article lacks in good cheer it makes up in edifying.

Two days ago famed market strategist Byron Wien reported a conversation with someone he called “the smartest man in Europe.”

The man is so smart that he offers his opinions about the world financial crisis anonymously.

For reasons that escape me Wien calls him Firedancer. In truth, the man is saying that the financial world’s policymakers are playing with fire. He believes that they and we will inevitably get burned.

Wien does not see it that way, but does not argue his side of the case in this advisory report.

He presents the Firedancer’s admonition:

He started out by saying he had done some preparation for our visit.  “I think the title of your essay should be ‘Dancing around the Fire of Hell.’  For years I’ve been telling you that the accumulation of debt was going to be the ending of the developed world and for years you have been telling me my views are too extreme.  The problem is you are an optimist and I am a realist.  You go around with a smile on your face thinking that there are serious problems facing us, but that everything will turn out favorably because the policy makers will do what they have to do to avoid disaster, and so far you have been right.  The developed economies and their stock markets have plodded along and investors haven’t made or lost much money in spite of the challenges.  At a certain point, however, the temporary measures that the policy makers put in place to avoid financial catastrophe prove insufficient and that’s where we are now.  I’m not saying that it will happen tomorrow but events are falling into place that will take the smile off your face.

Gazing into his crystal ball, Firedancer predicts:

Spain and Greece will default.  There won’t be outright financial disaster because by the time the defaults take place the banks will have sold most of the troubled sovereign debt on their balance sheets to the European Central Bank.  France’s deficit will get worse as Hollande implements some of the programs he talked about in his campaign.  Human beings and governments have an unlimited imagination and they will use it to delay the day of reckoning.  In the longer term the crisis may turn out to be a good thing because the pain of what we are about to go through will prevent it from ever happening again.

At this point you will be asking where he is investing. He replies:

So what am I doing with my money?  It is hard to hide in stocks.  Even Danone is reporting disappointing earnings; people are so worried they aren’t even buying yogurt.  The French auto companies are in trouble.  I think gold is going much higher.  I am buying energy stocks because I want to own something real.  Preserving capital is my focus now, not making money, but I like IBM and Apple.  Also some Swiss multi-nationals.  If Obama wins in November the market will go down.  A Romney victory will create a rally, but once he gets into office he will find there is not much he can do to make things better.

After the conversation Wien was chastened but retained his optimism:

My optimism was clearly diminished by what he had to say, but I still believe that somehow disaster has a way of usually not happening.  It seems clear that world leaders are going to do everything possible to avert a financial catastrophe and I think they have the resources to accomplish that goal.  It does seem, however, that the developed world has to resign itself to a prolonged period of slow growth.

So, we have two alternative scenarios: financial catastrophe and sluggish economic growth. But aren't the two closely connected? What will “a prolonged period of slow growth” do to the struggling debt markets?