A million-and-one things are distracting our politicians  - naturally-occurring disasters  such as the  Chile tsunami, the  Haiti earthquake, Global Warming-induced freezing weather. Then there are exceptional occurrences such as the Vancouver Games, the death of Michael Foot, the war in Afghanistan, a non-domiciled Lord  and the impending United Kingdom General Election. All are events which have provided many opportunities to ignore the one great constant, the real “elephant in the room”.  The economy.

If history teaches us anything, it’s that when even ONE major government defaults on its debts, economic chaos can follow. Unfortunately, it’s a lesson that few appear to have learned.  A crisis can unfold in just  in FIVE quick steps:

1. A  single country’s debt default will   cause ALL gilts and bonds to crash, as  investors  stampede for the gilt/bond market exits, dumping as much as they can, as fast as they can.

2.  As the gilt and bond market collapses, interest rates climb and credit tightens. The rates on mortgages, car loans and other long-term debts go through the roof. They are followed by rates tied to short-term money markets such as credit cards and other unsecured loans. 

3. Consumers stop consuming, that is to say, spending goes down. 

4. Corporate earnings and stock prices fall.

5. Unemployment rises.

Our “faux-recovery” would  stop dead in its tracks and we would all be forced  to take a hard reality check because Page 2 of the so-called “double-dip” recession will have arrived. Remember that the current recovery is only here as a result of Western Governments throwing non-existent money at the banks, purely as a stop-gap but in the vain hope that some new and hitherto unknown economic alchemy would miraculously manifest itself and those elusive green shoots of economic recovery would appear out of nowhere.  A triumph of “fingers crossed” political hope over harsh economic reality.

A disturbing tapestry is already beginning to unfold – not just in ONE major Western country but in TEN of them!

We’ve known for some time that Greece, Italy and Ireland are at risk of default — and this week, we saw how investors’ fears and uncertainties caused them to begin dumping British pounds and gilts. The soaring costs of Credit Default Swaps — “insurance policies” that protect investors against default — on the debts of Portugal, Romania, Lithuania, Latvia, Iceland and the Ukraine are a clear sign that investors believe that all of these countries are at an elevated risk of default.

Put simply, it would only take  only ONE sovereign debt default to crush this fictitiously anaemic recovery … but no fewer than TEN major Western countries are now at risk!

THREE powerful forecasting tools are confirming that a  bond/gilt conflagration, stock market decline and double-dip recession are now ”peeking ” over the horizon and are about to sneak up on us.

CYCLICAL ANALYSIS:  The cycles identified by the USA-based Foundation for the Study of Cycles have accurately anticipated nearly every major shift in market direction  since the  early 1970s. Its current prediction is that Stocks will begin to fall this year and will continue to do so for the following two years. They also anticipate that by the end of 2011, gold will have crossed the $2000 per ounce barrier. 

POLITICIANS and WORLD BANKERS:  Right now, they’re all fed up with bailouts of failed bankers with their continued  intransigence and hand-wringing.  Politicians can only watch  the skyrocketing  deficits and debts  which they created through initiating out-of-control borrowing by their Treasuries. The  mindless money-printing by the the Bank of England, the Fed and other central banks has only amplified the problem. As a result of their collective actions, there is now far more than just the mere spectre  of higher taxes and savage public spending cuts. There is no other way out because all governments need more revenue as well as lower expenditure.  Unfortunately, politicians appear to be frozen in fear and have adopted the  “Let’s wait -and-see and watch these oncoming headlights”  approach.

In the United Kingdom, we have a General Election within two months and within seven months, the Americans have their mid-term Congressional elections.  The net result is that we are languishing in a sort of economic limbo where  indecision and uncertainty are pushing investors’ nerves to breaking point – which usually means that they develop the urge to sell .

The United Kingdom has another potentially destructive issue which is causing yet more nervousness among investors. The latest polls suggest that after the General Election,  there may be a “hung parliament” with neither of the two major parties achieving an overall majority. That means that there is no clear message or even anticipation as to how the country’s massive budget deficit will be dealt with. There are not-only ideological reasons for the uncertainty but even economists cannot agree as to which will be the best way forward. That makes investors very nervous and is a very good reason for the politicians to say as little as possible – and that is exactly what they are doing.

Massive government debts have forced them  to accept that the days  of Central Bank bailouts and other “stimuli” are numbered.  That, in turn, means that the momentary economic stability  that  the recent government-induced  bursts of consumer spending will soon come to an end.

VOLATILITY ANALYSIS:  Currently, the volatility indicators that  professional traders rely on — in the gilt/bond as well as currency markets etc. are signaling that the economic stability and investment trends that most investors have depended on for the last year or so are coming  to an end. The smart money is now beginning to bet on major directional shifts in all major asset classes — plus, the generally accepted “word on the streets” is that the current ersatz recovery is beginning to unravel.

Meanwhile, politicians are grateful for all the little distractions that appear to be keeping their collective eye off the ball. While the economy burns, if Obama, Brown et al were each handed a fiddle, there is little doubt that they would play it.