Europe’s Troubles Take a Dire Turn

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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  • FranSix April 28, 2010, 7:29 pm

    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

  • C.C. April 28, 2010, 6:31 pm

    It’s kind of hilarious to watch this ‘Huge crisis’ of 4 or 5 non-producers gain so much attention and consternation. Perhaps it is the realization that trying to bring together disparate cultures – (with even more disparate philosophies on how to handle finances), may not work out in the long run…?

    What is even more hilarious than the current Euro-trash situation, is how so many (here in the U.S.) are looking at it as if it were the Crisis of crises…

    I wonder how the debt-load and upside-down fiscal nature & policy of States like California, Illinois, Florida (and a few others) stacks up in the negative $$$ column, as opposed to Grecian formula 16 and its 6 weeks-of-vacation-per-year neighbors…?

    All eyes on the Euro – we here are doin’ just fine – with our ‘reserve’ currency –

  • DG April 28, 2010, 5:36 pm

    The deflation/inflation debate is entertaining. The fact that is now observable is that Greece, due to unsustainable debt, has deflated its equity as money flees, and the 2 year Greek public note is now 20%. Meanwhile, its influence on the Euro has driven this currency down. Deflation? Inflation? It is all greek to me and likely will become greek for everyone else that cannot sustain its debt load. We may be losing the ugly contest for now (PIGS first place), but eventually, the US’ public and private debt will be speaking greek. How can we avoid it?

  • cameroni April 28, 2010, 3:50 pm

    Absolutely agree with your assessment Rick. There will be few winners in the Euro Zone now no matter what happens. They have been painted into a corner and there is no escape. I suspect Greece will be jettisoned from the group. There are few to no good choices if the Euro will survive intact.

  • Rich April 28, 2010, 3:38 pm

    Aloha All
    Checking in from Residence Inn on the road.
    [Great (free) breakfast and internet.]
    Pre-Market Dow up 50, so insiders may slam the market down today. Re Germans, only reason they signed on to Euroland was for larger freer markets for their trade surplus economy. As soon as that disappears, they are so gone. We see the impact of rolling deflationary meltdowns we have not seen since the 1930s. Thus, sovereign interest rates climbed with the imminent risk of default insolvency, and gold and silver may cascade down with more margin calls from deflating risk assets. GS Lord Voldemart sideshow Bob frosting on the upside down financial cake. The real question: when risky assets fail and Treasuries become risky, where to put precious assets?
    See Big4 with some ags and currencies.
    It is clear media underestimated financial realites, so now they may overcorrect in a a twisted form of financial reflexivity.
    Regards*Rich

  • Benjamin April 28, 2010, 9:13 am

    After a good nights sleep I’ve come to conclude that this will be a sort-of repeat of the last ‘too big to fail’ fiasco of ’08.

    Looking outside Europe, let’s not forget that team Obama has their pet legislation that, like those bailouts, is going to, um, prevent the too-bigs from ever failing again (even if that means, as GWB said in his final months, abandoning free-market principles to save the free market. Gotta wince over the abusive language here).

    But in terms of just logic, the recovery has no choice but to slow at the very least, evaporate at the worst. If Greece (and the rest) can get a loan somehow, that of course costs, and the market is not going to just behave because the powers say it should. If they can’t, the recovery fails the test, pure and simple, and the bear will be absolutely ravenous after months of forced hibernation.

    The only thing that remains to be seen is whether the following bounce-back will be as long and as extensive (percent-wise) as the first is/was… Which is why I said a “sort-of ” repeat.

  • Bradley April 28, 2010, 6:31 am

    Two things Rick should be commended for: Allowing dissenting opinions to be posted on his site, and being able to change his mind on a moments notice.

    &&&&&

    Thanks, I guess. I am instinctually deaf, dumb, blind and perhaps even slightly retarded where the stock market is concerned, Bradley, so I depend solely on technical evidence to steer me right or change my mind. The wildly bullish targets for the DJIA that I billboarded on Tuesday are in fact still technically valid, but let’s just say that Europe’s developing crisis has sensitized me to any subtle changes that might occur on the lesser charts. For starters, let’s see what happens if and when the Dow falls to the 10913.77 target flagged in today’s edition. RA

  • Chirs T. April 28, 2010, 4:13 am

    “…is to understate the extent to which the Germans have internalized their grave misgivings about printing-press money.”

    one can never underestimate to what extent the one German party (similar to our one party in DC) has devoted itself to the EUROpean dogma these last 30-40 years. They will try anything to save this construct, even if it’s deadly to them (self-scarifice for the greater good). This can even get them to ignore Weimar memories, if they were (led) to believe that cranking up the presses would save their Precious.

    After all, the mere fact that they sacrificed the DM to this holy cow shows this thinking. Kohl so much as admitted this, that the Euro was not an economic venture, but one to force an even greater pan-European integration, even at great cost.

    Asking this Euro-cabal to give up the Euro is like asking the Pope to spit on the cross.
    External circumstances will have to make it impossible for these people, before they desist in trying just about anything.

    Let’s hope I’m wrong.

  • Occdude April 28, 2010, 3:24 am

    You know S&P ratings have some power when you think about it.

    A simple downgrade and next thing you know, the financial markets are coming unstuck. Of course these are the same yahoos who gave AAA ratings to junk tranches of subprime.

    How with such a poor track history of debt quality rating ala the subprime fiasco, are they suddenly the word of the almighty? Why haven’t the ratings agencies been investigated substantially? How do they determine that on 04/27/2010 Portugal gets a downgrade and not on 04/28/2010? Is there any link between the “Lord of Darkness” senate testimony today and the ratings agencies downgrade?

    Too much concentrated power in a small cadre of people.

  • FranSix April 28, 2010, 2:48 am

    Rick, yields on ten year bonds on the Euro zone actually declined today, they’re not going anywhere.

    The only yields which increased on the day were; Greece (of course,) Italy, Spain, Columbia, Brazil and Mexico. (You can throw in Portugal, but I think you will find that Portugal is probably very conservatively run compared to Greece.)

    All other yields are down, signifying a move INTO sovereign bonds, because the financial crisis is moving into the last stage.

  • PhotoRadarScam April 28, 2010, 2:43 am

    I guess I don’t understand how the debt ratings work, they seem to be kind of a scam to me. And I don’t follow foreign economics that closely, but to me, anyone who believed that Greece wasn’t junk and Portugal was A+ last week or even last month is probably foolish.

    I guess what I’m saying is that the reaction today surprised me because I would have figured this would have all been priced in. This wasn’t anything we didn’t already know.

    I guess that’s why I take a cautious view when a market move is explained away with news or some kind of justification.