Wednesday, May 19, 2010

Euro Crisis: Starting to Look Like Lehman All Over Again

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The euro fell as low as 121.27 in U.S. trading on Monday. It almost touched that level again before the New York open today. Germany has banned certain types of short selling in order to contain the damage, just as the U.S. did in the fall of 2008 after Lehman's default. Investors should take note that the U.S. ban didn't prevent a market meltdown.

Germany's recently announced ban on short selling is not as extensive as the one that occurred in the U.S. less than two years ago. Germany so far has only banned 'naked' short selling. This type of short selling takes place when the party shorting has not borrowed the security to sell. It is illegal in the United States (and should be everywhere). Nevertheless during the Credit Crisis, U.S. authorities banned naked short selling as well. This was a clear admission on their part that they had not been enforcing the law against hedge funds and the big trading houses, the only market participants who had the ability to engage in this type of trading. Apparently the small trader and investor had to follow the rules, but the big players didn't.

The German ban covers government debt, CDSs (credit default swaps) and shares of a number of financial companies. After Lehman's default, the U.S banned shorting itself for financial companies. This didn't prevent their prices from collapsing somewhat later on. Both Germany and the U.S. justified their actions as an attempt to stabilize markets. There is no reason to believe that Germany's efforts now will be anymore successful than were those in the U.S. during 2008.

The market reaction to the German ban was initially negative, but then the euro started rallying strongly. How long this last remains to be seen. The euro is already extremely oversold, but the technical indicators on the very short-term charts are highly negative. A strong reflex rally could start at any point in time. This happened numerous times for U.S. stocks during the Credit Crisis, but it took months before a bottom could be reached and a sustainable rally could begin. The euro broke key support in the 1.25 area last week and this is an indication the market has lost a certain amount of confidence in the currency. A loss of trust is not something that can be restored overnight.

Disclosure: No positions at all.

Daryl Montgomery Organizer,
New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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