Just as the US government began to react when the equity markets around the world swooned after the US Treasury led by Hank Paulson allowed the “too big to fail” Lehman Brothers to fail, so too has the European Central governments reacted when an offhand remark byJean-Claude Trichet that the Central Bank had no contingency plan to rescue any countries other than Greece sent most equity markets into a tailspin this past Thursday. You probably read last week (including from us) that the Greek debt crisis had something to do with the sudden loss of confidence investors were feeling last week – although they’re apparently still investigating whatever caused theCOMPUTERS to lose confidence and decide to sell anything they could get their electronic hands on.
The Economist has been giving nonstop coverage to what it has called the sovereign debt crisis in the PIIGSarea of Euroland: Portugal, Ireland, Italy, Greece and Spain, all of which have taken on too much debt and are in the process of painful restructuring. Iceland is doing the same thing, but the acronym probably would have looked funny with an extra “I” in the middle. The magazine notes that two-year Greek government bonds were selling at prices that would have yielded 20% returns – or about 100 times what Japanese bonds of comparable maturity are paying their investors. At the same time, Portugal’s borrowing costs jumped, Spain’s government debt was downgraded by the ratings agencies and Italy came close to a failed debt auction – meaning no buyers anywhere.
Just like the banking crisis in the U.S., any bailout of Greece is deeply unpopular to the citizens of the rest of Europe, particularly Germany, where the Greek politicians are about as popular as Goldman Sachs andAIG are to American voters. The problem, of course, is that most of the Greek debt is held by regional European banks, which means that without some kind of a bailout, there will be real economic pain everywhere across the Atlantic.
The whole Greek economic tragedy has made for lurid headlines, one of those rare global business stories that gets the attention of average investors. You know that a country is bordering on dysfunction when its AIR FORCE goes on strike.
What does all this have to do with U.S. stocks? An article in the Huffington Post suggests that a weaker European economy could reduce demand for U.S. exports, and as the Euro declines against the dollar, U.S. goods become more expensive in the 16 countries that use the European currency. Under some economic scenarios, Europe could experience the second dip of a double-dip recession, where consumers stop spending and companies cut back on production and lay off millions of workers.
This past week, while the markets were on their wild ride, Europe and the International Monetary Fund finally crafted a $140 billion rescue package of Greek financing. Thirty percent of that will come from the International Monetary Fund; the largest single contributing members of that organization are the U.S. taxpayers. Over the weekend, the European Central Bank and its member countries got serious (read spooked by the worldwide equity swoon) and created the much desired PIIGS rescue package so that there is a plan in place in case Portugal, Spain, Italy or Ireland go the way of Greece to a full $1 trillion. Please note that this rescue plan also includes the International Monetary Fund, so there are loans from the U.S. Federal Reserve Board, the Bank of Canada, the People’s Bank of China, Several European Central Banks, the central Banks of Brazil, Russia, and India, as well as the Bank of Japan. Tony Boeckh, of the Boeckh Investment Letter (see below), wonders why American citizens should have to share Greek’s pain – sounding exactly like the angry taxpayers of Germany and France. The answer, in terms even the rogue computers can understand, is that in an interconnected global economy, everybody seems to have a vested business interest in avoiding the worst-case scenario.
From Wall Street (the DOW was up over 400 points) to investors around the world, almost all equity markets rose on the news – the fact that Europe has a plan is a good thing! Even more, we did not have to have the world’s economy fall to its knees for governments to act intelligently. Maybe there is hope for our World after all. As investors, we have entered a period where the economy is growing, interest rates are low and there is enough worry out there that equities should perform well. With the volatile market and current events in the background, we continue to emphasize the foreground – your strategies that are uniquely aligned with your personal vision and direction.
The Great Reflation
By Tony Boeckh
Let me start this week’s Outside the Box by venting a little anger. It now looks like almost 30% of the Greek financing will come from the IMF, rather than just a small portion. And since 40% of the IMF is funded by US taxpayers, and that debt will be JUNIOR to current bond holders (if the rumors are true) I can’t tell you how outraged that makes me.
What that means is that US (and Canadian and British, etc.) tax payers will be giving money to Greece who will use a lot of it to roll over old bonds, letting European banks and funds reduce their exposure to Greece while tax-payers all over the world who fund theIMF assume that risk. And does anyone really think that Greece will pay that debt back? IMF debt should be senior and no bank should be allowed to roll over debt and reduce their exposure to Greek debt on the back of foreign tax-payers.
I don’t think I signed on for that duty. Why should my tax money go to help European banks? This is just wrong on so many levels and there is nothing seemingly we can do. Oh, well. Thanks for listening.
