Greece’s financial problems took a dramatic turn for the worse yesterday, causing stocks and bonds around the world to plummet on news that Greek bonds had been downgraded to junk by Standard & Poor’s. The rating agency’s decision was particularly unsettling for investors because just last week a $60 billion emergency credit line was extended to Greece by the IMF, Germany and other European nations. But what may have spooked the markets even more was S&P’s downgrade of Portuguese debt to A- from A+. This suggests not only that euro-contagion is spreading, but also that any large sums of money pledged to ameliorate Greece’s crisis are no longer capable of calming the markets.
Unfortunately, perceptions are everything at the moment, and it seems most doubtful that more talk, more promises and yet more loan guarantees will arrest the spread of fear. Will the uneasiness eventually come to engulf several other nations thought to be on the financial ropes, notably Spain, Italy and Ireland? This seems a foregone conclusion, since there is no remedy possible that would address, let alone fix, their respective financial problems at a fundamental level. Indeed, for the central banks, the fatal paradox is that if any nation were to get truly serious about tackling its debt problems, the result would be an economically fatal debt deflation. Under the circumstances, it’s no wonder that our political leaders have bought into the lie that untold new sums of fiscal borrowing can reverse a debt deflation. In point of fact, untold sums of new borrowing have yet to cause even a blip in the home prices that were the explicit target of Fed stimulus.
Weimar Memories
No such remedies are likely to be attempted in Europe, since they would be subject to a German veto. To say that the Weimar hyperinflation of the early 1920s made Germany fiscally conservative is to understate the extent to which the Germans have internalized their grave misgivings about printing-press money. While America and Britain have been free to experiment with the pernicious theories of Keynes every time the economy downticked for more than a quarter or two, the Germans stop short of the kind of full-bore Keynesianism that would have a government gin up trillions of new dollars to spend on who-cares-what. If Europe does not attempt a monetary blowout equal to the one that has “saved” the U.S., it seems inevitable that the fear now gripping the markets will at some point mutate into panic. And just as Bear Stearns’ troubles begat Lehman Brothers’ even bigger troubles, so must Greece’s troubles precipitate out ruinously for the whole of Europe.
Under the circumstances, we’ll put a “hold” on yesterday’s very bullish forecast for the stock market. We had projected a rally of as much as 11 percent for the Dow Industrials, and the technical factors behind that forecast remain undisturbed by yesterday’s selloff. However, the short-term picture has turned undeniably bearish, and we now see the Dow falling to at least 10914 — 78 points below yesterday’s closing price. We’ll be watching our proprietary price levels very closely in the days ahead, since the potentially decisive turn of events in Europe could be what finally kills the 14-month-old bear rally in stocks. More to the point, it could be the death knell for a supposed economic recovery that in the U.S. and elsewhere has been sustained by little more than hot air.
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Its not really a tempest in a teapot if you happen to have seen a policeman on fire from a molotov cocktail tossed during riots in Greece.
The EU is still sitting on its hands with a 1% short term rate, they’re going to absolutely abandon ‘wise’ policy and follow the bond markets. Yields at the short end of the curve are far below the policy rate.
My guess is that they will eventually go to negative policy rates for short term money.
http://www.ecb.int/stats/money/yc/html/index.en.html