Wednesday, September 7, 2011

EU-Centered Credit Crisis Continues

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 2011 Credit Crisis continued Tuesday with the Stoxx Europe 6000 index hitting a two-year low, the Swiss taking desperate measures to control the franc, more record high prices for credit default swaps (bond insurance) on British Banks and yields on 10-year U.S. treasuries hitting an all-time low. Despite the dramatic turn of events, stock losses were somewhat muted.

U.S. markets opened sharply lower, but the Nasdaq and S&P 500 recovered toward the close in a technical move that involved filling the gap down that took place on the open. The Dow however still had a 101 point loss at the close. In Europe, the German DAX was down 1.0% and the CAC-40 in Paris 1.13%. While these losses would have been considered significant only a few months ago, they are minor compared to what has taken place on a number of trading days since late July. The British FTSE up even up 1.06%, despite trouble in the UK banking sector.

The British banks most in trouble are the ones that were nationalized during the 2008 Credit Crisis -- Royal Bank of Scotland and Lloyd's Banking Group. Credit default swap (CDS) rates for these banks are higher than they have ever been. CDS rates for HSBC and Standard Chartered are at one-year highs. The problem with these banks seems to be toxic loans left over from earlier in the 2000s. It is not clear if they were included in a sweeping statement made Monday by Josef Ackermann, CEO of Deutsche Bank, that "numerous" European banks would collapse if they were forced to recognize all losses against their holdings of government debt.   

The most significant market event yesterday was the Swiss capping the value of the franc. The Swiss National Bank (SNB) said it would "no longer tolerate" a euro franc exchange rate below 1.20. The franc then had a significant drop against all major currencies. A similar approach was tried in 1978 and it did succeed in stabilizing the franc back then. Such currency intervention measures generally only work for a short time however. It remains to be seen how long it will take before the franc begins rising again.

The new Credit Crisis is also showing up in U.S. treasury rates just as the one in 2008 did.  The 10-year yield made another all-time low at 1.97%, taking out the 2008 low. Global money flows into U.S. government bonds during periods of financial system instability because they are still seen as safe havens. While the 10-year is only a little below its low in 2008, the two-year at 0.20% on Tuesday is well below its low point back then.

Credit Crises are not very short events. The previous one lasted six months. This one could last that long or even longer. The cause of the problem has to be gotten under control. In this case, it is the ongoing debt crisis in Greece and the emerging ones in Italy and Spain. While a default in Greece could happen this fall and create some finality there, the problems in Italy and Spain are only in their early stages. So, this could go on for some time.

Disclosure: None
Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.