Last Friday the markets cheered news of leadership change in the center of Europe’s debt crisis.  However, there is reason to believe this won’t be the end of a thorny problem that will likely add volatility to the markets for decades.  There is one reason for this:

Voters.

The debt crisis won’t end until voters accept sacrifice in the way of budget cuts and revenue enhancements – or the markets force action.  In fact, if the debt crisis ends quickly, it will mean the markets have forced action.  The more likely event is a long, political debate over how sacrifice is carved out.  If you think this is easy or a European problem, look no further than how the U.S. Debt Super Committee is dancing around anything that would jeopardize their re-election efforts.  Word is that traders have baked debt committee failure into their fundamental analysis of the situation, but never say never.  Markets frequently surprise even the most astute and seasoned observers.

With government spending is far in excess of revenue in both Europe and the U.S., the changes required to solve the debt problem involve societal change.  This won’t be easy.  Political constituencies might be required to give things up.  Economists note the hard truth that a culture of government spending, bloated pensions and politically popular tax breaks may be required to give way to budget requirements and a different social atmosphere.

When voters meet difficult austerity measures, get ready for a volatile political environment.  To assume that the debt crisis is over because a change in leadership occurs is to assume that the budget problems and fiscal austerity required will be able to tucked away without facing voters.  There will be a point at which voters will be required to face the debt crisis.  It is when this moment occurs that the rubber meets the road in the government debt crisis.

Government debt crisis discussions have historically been conducted behind closed doors, as if the problems created by politicians can be solved through the same fashion.  That is unlikely, as the shear numbers behind the debt problem are just too big to achieve a political solution that doesn’t include revenue enhancements and spending cuts.  Speaking on CNN Money yesterday, Robert Bixby of the Concord Collation said it is better that government shine light on the problem rather than keep it behind a political cloak.  Efforts from Bixby and various ratings agencies to warn regarding debt should be lauded.  In fact, S&P’s “fat finger” episode where an e-mail warning a potential French bond downgrade is interesting.  Was it a mistake or a method of the ratings agency warning about the debt truth?  The fact that S&P might have felt it couldn’t come right out and publically downgrade Eurozone debt, much as it was criticized for downgrading U.S. debt over the summer, shows just how clandestine honest talk about the debt situation has been. However, this secrecy is viewed by many as a major tactical error.  Voters need to understand the U.S. can easily become the next Italy if solutions and sacrifice are accepted now.  That is the message voters must understand if anyone is to accept the difficult sacrifices required to keep a great nation great.

As example of the failure of the policy of keeping debt discussions under wraps, one needs to look no Look at the November 8, 2011 vote on collective bargaining in Ohio.  This is a vote when government, fighting the difficult fight to reduce spending, lost a battle when voters re-affirmed the right of unions to continue to battle politically sensitive government in pension and wage negotiations.  Voters educated in the budget crisis might have made the logical connection between bloated government pensions and the need for tax increases or spending cuts.  But when such issues are taken on their own, out of this financial context, voters tend to be soft on human suffering and less sympathetic to very real budget matters.  This is something political marketers understand and exploit, which is too bad.  The real issue Ohio voters should have faced: Are you willing to pay higher taxes or cut critical social spending to support government worker’s right to bloated pensions and socialistic work rules? Had the vote been phrased in this fashion the outcome might have been very different, indeed.

It is time the debt crisis is moved from the backroom and into the limelight.  Only with such transparency into the real issues and problems will solutions be found.  Qualified investors should recognize the very real nature of the debt crisis and the potential for volatility to the upside and downside and look for new methods of diversification.  All investors should have a risk management plan that is designed with the goal to hold up under a number of circumstances, particularly at this moment in history.

All contents Copyright © 2011 Mark H. Melin

Mark Melin is currently writing his fourth book on uncorrelated investing.  He is previous author / editor of three books, including High Performance Managed Futures (Wiley, 2010) and an adjunct instructor in managed futures at Northwestern University.  He can be reached at markhmelin@gmail.com or visit the book’s web site at www.Go2ManagedFutures.com

Risk Disclosure: Managed futures can be a volatile investment and is not appropriate for all investors.  Past performance is not indicative of future results.

The opinions expressed in this article are those of the author, may not have considered all risk factors and may not be appropriate for all investors.

This entry was posted on Monday, November 14th, 2011 at 7:37 am and is filed under Credit, Daily News, Economics, Managed Futures, Monetary Policy, Politics, Risk Management. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.