Greek Deal is Another "Fiscal Solvency in Our Time"

 

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.

Once again Greece has avoided a messy default and once again its creditors have had to take a greater loss on their loans and once again standards had to be abandoned to make the deal go through. And once again, we're not done yet.

Realistically, Greece is actually undergoing a messy default; it's just doing it in slow motion. When creditors are not fully paid, there is a default. The original default terms for creditors last summer were for a 21% loss for private bondholders (read banks). This percent has been raised more than once and with the latest round of negotiations, it will be above 70% according to Jean Lemierre, who co-headed the talks for the IIF (Institute of International Finance). The ECB and national central banks in the eurozone have agreed to "forgo profits on their holdings" (presumably this means the interest payments on Greek government bonds -- something which also indicates default).The eurozone countries will reduce the interest on Greece's first package of bailout loans to 1.5% over market rates from the previous 2% to 3%. This is the first time the ECB and other eurozone central banks have agreed to take a hit on their own holdings.

What prompted the further concessions to Greece was an attempt to get its 2020 projected debt to GDP ratio down to 120%. Without them, the ratio would have been 129% even under the bailout troika's (EU, ECB and IMF) most optimistic scenario (for the non-political reader, this means the complete fantasy scenario). Projections during the first bailout deal proved too good to be true and it should be presumed that these are as well.

There are still a lot of approvals needed to ensure that the current deal goes forward. If it does, every Greek man , woman and child will have received the equivalent of $29,000 from bailout payments. Greece holds elections in April and support for the anti-bailout parties is increasing. Whether or not it will be enough to derail the bailout deal remains to be seen.

Greek one-year government bond yields reached a high of 682% today according to Bloomberg.  To say that the market is not giving the bailout deal a vote of confidence would be an understatement. Last summer, they were around 40% and have been rising continually since then. While euro-politicians are once again claiming the problem is solved, the market indicates that Greece is imploding.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

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

How Today's "Deflation" Can Turn Into Tomorrow's Hyperinflation

 

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.

Since the 2008 Credit Crisis, deflation has been the primary worry of mainstream economists and monetary and fiscal policies that utilize various forms of “money printing” have been implemented throughout the world to try to stop it. Unfortunately, money printing combined with deflation can potentially lead to hyperinflation.

Hyperinflation is a little understood and little studied phenomenon. Even inflation itself is only partially understood and traditional university economic programs devote minimal attention to it (just ask someone with an economics degree what courses they took in inflation). Almost no one seems to have made the connection between deflation and hyperinflation, which are intimately related. Hyperinflation in fact could actually be defined as a self-feeding cycle of severe deflation combined with escalating money printing.

Historical analysis shows that hyperinflation is a creature of damaged and dysfunctional economies. It does not come from overheated economies that continue to grow out of control resulting in ever higher inflation rates.  This mythical view may have been created because government stimulus measures the employ money printing in its various guises to deal with   deflation can briefly make the economy fervent because of a declining currency. This creates high export demand since foreigners can buy the country’s goods cheaply and high internal demand because the population becomes desperate to get rid of any currency it holds. This phase does not last however and it takes place just prior to the final hyperinflationary spike. It was seen in Weimar Germany in 1922 because Germany had a developed manufacturing economy and most of the rest of the world wasn’t experiencing currency devaluation.

In many cases in the past, war preceded hyperinflation. This happened in Germany and Eastern Europe after World War I and in Eastern Europe and Japan and East Asia after World War II.  It also occurred in the United States after the Revolutionary War (arguably the first case of hyperinflation in history) and in the South at the end of the Civil War. Demand can collapse after a war and this will cause prices to drop (the U.S. had sharp deflation after World War I for instance). Governments, who were already printing money to support the war effort, then frequently print more to stimulate the economy.  If the economy isn’t brought back to real functionality however, a country’s currency loses its value and an ever-increasing amount of money has to be printed to create the same amount of stimulus.  

Even if there is no war, hyperinflation can exist just because an economy is dysfunctional. This would describe the cases of hyperinflation in South America, post-colonial Africa, and in Eastern Europe during the collapse of communism.  When an economy just can’t create enough demand on its own, the authorities stimulate demand by printing money. This leads to the same cycle of currency devaluation and ever-increasing money printing in an attempt to keep up with the loss of value taking place. In reality, the economy is continually shrinking, even though prices start heading toward the heavens.

While this has happened in a number of countries over time, mainstream economists continually make the claim that inflation can’t exist if there is slack in the economy. Hyperinflationary economies actually have maximum slack, with Zimbabwe in the 2000s being the extreme example. Unemployment reached 94% there, while the inflation rate was climbing to the sextillion percent level (a number so huge it might as well be infinity). Despite this real world example that took place right before their eyes, a number of economists had no trouble looking right into the TV camera and telling the public that inflation can’t exist if there is excess capacity in the economy. If they had been testifying in court, they would have been arrested for perjury.

Since hyperinflation has only occurred in certain countries at certain times, it is important to ask what it the key factor or factors that lead to it. The short answer would be: deflation created by demand destruction, followed by money printing that is taking place because the ability to borrow doesn’t exist or has been exhausted. Since developed countries have better credit and can borrow more, hyperinflation is less likely to occur in them than in more marginal economies – at least until their lending sources dry up.   

Deflation in and of itself does not lead to hyperinflation. It depends on what the root cause of the deflation is. There were deflations in the late 1800s and in the 1920s in the U.S. due to technological innovations and not demand destruction as commonly takes place after wars. Lack of demand was not the cause of falling prices, rising supply was. The exact opposite situation takes place after a destructive war or in an economy in a post-bubble era (as is the case currently in the U.S., the UK, Europe and Japan).  In the latter case, demand needs to be stimulated, in the former it doesn’t.

Countries also don’t print money if they can borrow it. Less developed countries have limited and sometimes no borrowing ability and this means they turn to money printing early on and this makes them more prone to hyperinflation.  Since developed countries can borrow money, they do so for as long they possibly can. This has allowed Japan to get its debt to GDP ratio to an astounding 229%. The U.S. is already over 100% (based on official numbers, the ratio using more realistic numbers is much worse) and rising rapidly.  Despite its twenty years of economic malaise, Japan has managed to support demand by running huge and continuing budget deficits funded by the massive savings of its people (money printing has been relatively minor).  It is not likely any other developed country will be able to accomplish what Japan has done.  Japan also seems to have reached the end of the borrowing road and will have to start revving up the printing presses in the near future.

In contrast to the Japanese, Americans save little and haven’t been able to fund their budget deficits internally for decades —the U.S. relies on foreign sources for this money. When the Credit Crisis arose, foreign lending became inadequate and money printing began in earnest. The Federal Reserve increasing its balance sheet by over $2 trillion is only one example of this. While foreign lending might have continued to fund $400 billion dollar annual budget deficits, it was not adequate to support the $1.42 trillion, $1.29 trillion and$1.30 trillion deficits that occurred in 2009, 2010, and 2011. Trillion dollar deficits are going to with the U.S. for many years into the future and the only way they can be completely funded is by printing more and more money.  The EU isn’t in much better shape either and has been unable to fund its peripheral country debt by borrowing. Its current solution is to print money through massive credit expansion.

Claims that money printing won’t be harmful in the 2010s because inflationary policies were utilized during the 1930s Great Depression and they worked well back then are moreover completely misleading. The debt level of the U.S. government, businesses and consumers were minimal at that time compared to what exists today. Huge amounts of untapped borrowing capacity existed then, but this is no longer true. Consumer credit expanded so much in the intervening years that during one month of the Credit Crisis it dropped more than the entire amount outstanding at the end of World War II. An apt analogy might be one drink of alcohol won’t be harmful. If you haven’t had anything to drink yet it isn’t likely it will be. If you have already had twenty glasses, it might cause fatal alcohol poisoning. The global financial system now risks being poisoned by money printing.

The monetary authorities worry about deflation and attempts to handle it with money printing are nothing new. The current actions are disturbingly similar to what took place in Weimar Germany in the early 1920s. They handled their deflation problem with money printing as well. As prices rose, instead of facing reality, the economics establishment acted in concert to deny the obvious. Deflation was cited as the biggest danger to the economy until it became laughable. When inflation exploded, the usual scapegoats — foreigners, speculators and minorities — were blamed by the government. Unless human behavior has changed in the last 100 years, the same scenario is likely to play itself out again in the 2010s.


Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

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

The Risks to the Global Financial System in 2012

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.   
As 2012 begins, markets are rallying as they did at the beginning of 2011 -- a year when the S&P 500 closed flat after many huge moves up and down. The problems in Europe that rattled markets in 2011 have not been resolved and new problems are or will be emerging in China and Japan. At the very least, investors should expect another rocky ride in the upcoming year.

The debt crisis in the EU is far from over. It is simply being momentarily contained by another short-term solution that will hold things together for a while until the crisis erupts again. The mid-December LTRO (long term purchase operations) announced by the ECB excited the markets as any money-printing scheme would. This new "solution" to the debt crisis is essentially an attempt to handle a problem of too much debt with more debt. Already close-to-insolvent EU banks are able to hold fewer assets for collateral in exchange for cheap funding from the ECB, which can in turn be used to buy questionable sovereign debt from the PIIGS. While this will keep Italy, Spain, Portugal and Ireland financially afloat for a longer period of time, it may collapse troubled EU banks sooner (the real epicenter of the debt crisis). 

Half way across the globe, problems are emerging in China. It is estimated that there are between 10 and 65 million empty housing units in the country that investors have purchased with the hope of selling at higher prices. There are in fact entire "ghost districts" there that are filled with new buildings and no residents. Prices have become so high that by last spring the typical Beijing resident would have to have worked 36 years to pay for an average-priced home. The pressure appears to be coming off though with new home prices dropping 35% in November. Beijing builders still have 22 months of unsold inventory and Shanghai builders 21 months. In the peripheral areas, existing home sales have plummeted -- down 50% year on year in Shenzhen, 57% in Tianjin, and 79% in Changsha. Investors should take note that the Chinese real estate bubble is far worse than the U.S. one that brought the global financial system to its knees at the end of 2008.

Twenty years ago, Japan had a massive real estate bubble and it is possible that prices have finally bottomed there, but that doesn't mean that they are ready to go up. Japan has had two decades of economic stagnation (and is heading toward a third, if it is lucky) because of the collapse of its real estate and stock market bubbles. Massive borrowing by the government has prevented the situation from getting worse. The debt to GDP ratio in Japan is now estimated to be 229% (well above the just over 100% in the U.S.).  More people are leaving the workforce there than entering it and this bodes ill for tax receipts. The aging population is using up its savings instead of adding to them. This is a potentially serious problem because the massive debt the Japanese government has incurred has been funded mostly internally by the savings of the Japanese people. A lot of old debt has to be rolled over in 2012 and additional debt is still being incurred. Where the money will come from is not clear.

None of the problems that could strain the global financial system originated in 2011. They have been building up for years and even decades. The first major blow up was the Credit Crisis in 2008. In every case, that problem was "solved" by more debt and money printing. This approach has of course only postponed the inevitable since taking on more debt only creates a bigger debt problem down the road and you can't create something of value out of thin air by printing money (although you will ultimately create a lot of inflation). The markets have already spent most of 2011 in an unstable state. It looks like continuing and even bigger crises await investors in 2012.
Disclosure: None
Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

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

New EU Plan is Much Ado About Nothing

 

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.

Once again the EU has come up with a too-little, too-late solution to deal with its very serious debt crises. Proposals for a tighter fiscal union and the small amount of funds committed will only delay the inevitable default.

Treaties only have meaning if their terms are actually followed. The eurozone already has a treaty that created it. That treaty has very clear fiscal benchmarks that all members must follow. The key benchmark concerning a maximum 3% debt to GDP ratio for an annual budget was almost universally ignored by all member states. Greece was only the most extreme example. It finally admitted to lying about its numbers (it was not "caught in the act" by the central EU head office even though the numbers it submitted were too good to be true). Greece originally reported a projected debt to GDP ratio of 2.0% for 2009. After many revisions, it turned out to be 15.4%. It was not punished for its duplicity or major violation of EU accords; instead it has been offered three bailout packages so far.

The new treaty provisions once again state that the eurozone countries need to have a balanced budget and should not violate the 3% debt to GDP limit. This wasn't enforced the first time and there is no reason to believe that it will be enforced the second time either. This time however the new treaty states that there will be automatic consequences, including possible sanctions. I'm sure they all had a good laugh about those possible sanctions. This is a complete and total joke and should be treated as such.

As for the current amount of money proposed to rescue the over indebted EU countries, it is much too inadequate to be more than a temporary stopgap measure (the only thing the Europeans seem capable of doing). The debt problem for the troubled EU countries -- Greece, Ireland, Italy, Portugal, and Spain -- runs into the trillions. How much is on the table now --  €200billion. The EU will loan this amount to the IMF, which will in turn use it to provide the same amount of aid back to the EU.  Not only is this is a paltry sum, it is disturbing they need to engage in a financial shell game as part of their bailout attempts. Even more absurd is that the ESM (European Stability Mechanism), set up to handle the debt crisis, will be capped at €500 billion. What will happen when they run out of this money and there is still a large amount of debt in danger of defaulting?

The problem with debt crises is that the amount needed to handle them is a moving target. It keeps rising and rising with time because interest rates keep rising and this makes borrowing costs continuously more expensive. Greek one-year bond yields are at 353% today. Even with three rescue packages, they continue to climb toward the stars. Immediately after the announcement of each rescue plan, yields dropped significantly for a short period of time, then they went much higher than they had been before. Expect to see this pattern with the other EU debt crisis countries. The EU is very good at getting its problems under control for a few weeks with its band aid measures.  Expect its current efforts to be another short-term success that turns into a long-term failure.


Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

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

It's a 50% Default for Greece

 

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.

EU leaders have agreed to seek a 50% reduction in Greek debt from bondholders. This supersedes the 21% reduction decided on in July that was supposed to resolve Greece's financial problems. Apparently $30 billion will be given to the banks as an inducement for them going along with the plan. The EU and IMF will also give Greece an additional 100 billion euros in bailout aid.

While the announcement was delivered with a sense of finality, the first bailout of Greece in May 2010 was supposed to solve Greece's debt problems and so was the second bailout this July. It has only taken three months since the  "everything is really fixed now" July announcement before a much bigger bailout and debt writedown proved to be needed. Until fairly recently, EU officials have constantly denied that this would be necessary or that Greece would default. Not paying 50% of your bond debt is not only a default, but it's a major default.

EU officials still seemed mathematically confused about the situation in Greece. EU President Van Rompuy claimed that the current deal will reduce Greece's debt to GDP ratio to 120% by 2020. If so, Greece is still likely headed for more trouble. Since it is estimated that Greece's debt to GDP ratio is around 160%, it should fall to 80% if all bondholders took a 50% hit. Perhaps all bondholders will not be taking a reduction after all. Both the IMF and ECB hold large amounts of Greek government debt and have in the past been reluctant to accept any writedown of their investments.

The pre-dawn news for the EFSF (European Financial Stability Fund), which is supposed to receive 440 billion euros, is that it will be leveraged up to a trillion euros. The U.S. has been pressing for two trillion. This money can be spent to bail out all the EU banks hurt by the Greek default, but only if they can't raise additional capital in the open markets. So the debt problem will be solved by incurring additional debt and borrowing against it. If this isn't a financial system ticking time bomb, nothing is.

The unanswered question is what is going with happen to Portugal (the next most likely crisis), Ireland, Spain and Italy. EU officials tried to minimize the situation by saying Greece is a special case. It would have been more accurate to say that its problems were more extreme and urgent. They are not unique.  The other countries are already somewhere on the path to insolvency and this will have to be dealt with in the future. The only question is how soon that future will arrive. 

 Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

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

2011 Budget Deficit Third One Over a Trillion Dollars

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.

U.S. budget deficit figures released on Friday afternoon indicate that the deficit for fiscal year 2011 (ending on September 30th) came in at $1.3 trillion. This is slightly higher than the 2010 deficit and the third trillion dollar deficit in a row.

Total federal spending (on-budget items) came in at $3.6 trillion. Revenues were $1.3 trillion, over 4% higher than in fiscal year 2010. Revenue rose slightly to $2.3 trillion. As bad as the budget deficit appears (and a trillion dollar deficit is really extreme), the Congressional Budget Office estimated in January that the 2011 budget deficit would reach $1.5 trillion. The fight over raising the budget deficit ceiling postponed federal spending for a few months until a deal was reached in August however. It is likely that this spending will show up in the 2012 fiscal year.

While there is a special congressional committee looking for $1.5 trillion in savings, its actions are not going to reduce the total federal spending by enough to reduce the budget deficit to something manageable. The amount being cut is for a 10-year period and averages only $0.15 trillion per year. If this had been done last year, the 2011 budget deficit would have been $1.15 trillion — still an astronomical amount.

It is also safe to assume that the budget deficit in the next five years can easily grow much faster than the intended cuts. When they did their projections for future fiscal years, the Obama administration assumed that U.S. GDP would be growing by over 5% a year until 2016. While this figure was never plausible because it is much higher than the potential growth rate of the U.S. economy, now that the U.S. is facing a possible recession and negative GDP growth, it is even more absurd.

Investors should assume that a continual stream of major budget deficits awaits the U.S. in the future. At this point, the massive cutting that is necessary to get the budget under control will cause a hit to the economy resulting in lower tax revenues, which in turn will make the budget deficit worse, not better.  This is the downward spiral that Greece currently finds itself in. More cutting actually is leading to a higher debt to GDP ratio. The U.S. debt to GDP ratio is approaching 100%. Once this number is over 90%, a country's economy becomes permanently weakened. When it reaches 150%, and it will  for the U.S. if its budget deficits remain as large as they currently are, the probability of default becomes almost 100% certain.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup http://investing.meetup.com/21

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

Markets Rally on Hopes of Huge EU Bailout

  

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.

In a replay of the 2008 Credit Crisis, global stock markets are now rallying strongly after a huge selloff last week. This pattern was common in late September and all during October three years ago. It seems to be replaying itself again in 2011. Huge moves down and up are common in severe bear markets.

As has happened many times so far, stocks are rallying on "hopes" of a resolution to the Greek debt problem and liquidity issues with EU banks. The Greek prime minister has stated confidently that Greece will definitely receive the next tranche of money from the first bailout and his comments got a lot of positive press attention. The mainstream press failed to inform the public that Greek officials have consistently made "misleading" statements during the debt crisis and their credibility might be considered questionable. The next payment from the first bailout has been delayed because Greece broke the promises it made for meeting fiscal objectives. Instead of listening to Greek officials, investors should consider that Greece has a CCC credit rating — the lowest sovereign debt rating in the world. If any country is going to default anywhere, it's Greece.

The numbers describing Greece's situation also speak for themselves and clearly indicate the inevitability of default.  Greece's debt to GDP ratio was 127% in 2009 in the early stages of the crisis. By the end of 2010, it was 143%. Reuters and a number of other sources report it as now around 160%. This rapid rise is taking place as Greece is getting €110 billion bailouts (the second one is in the works). Clearly the bailouts are not solving the problem, but merely slowing down an explosion of debt. Historically, once a country's debt to GDP goes over 150%, default seems to become inevitable.

The market keeps predicting default in Greece by setting astronomical interest rates. The one-year government bond had a yield of 138% on September 26th, down from its high of 142% on September 14th. Two-year debt was yielding 71% yesterday and the ten-year bond 24%. How can any entity pay these interest rates and avoid default?

All sorts of schemes are being discussed by EU leaders to handle the current crisis. There are rumors of a default plan that involves Greece paying back only half of its debt. EU officials described these rumors as just speculation, although in some cases the denials were less than firm. They also denied any enlargement of the EFSF (European Financial Stability Facility) — the EU's 440 billion euro bailout slush fund — was underway. The current global stock market rally got started when CNBC News reported that the EFSF would be leveraged up to eight-times and the European Investment Bank would issue bonds to buy up sovereign debt. The specific reaction to this report from one EU official was that it was "just bizarre". The big-money investing operations can make quite a bit of profits by planting "just bizarre" stories though because they can juice the markets up for a day or two. Then some bad news story appears and markets drop right back down. We've seen this pattern over and over again in the last two months.

At some point, the Greek debt crisis will be resolved. Until then, the EU will kick the can down the road as long as it can. At this point though, the can looks like it was run over by a freight train and then tossed around by a tornado. Greek debt holders will have to take a significant haircut on their debt and this means that banks in Germany and France will have to be recapitalized. Then something will have to be done to prevent the emerging defaults in Portugal and Ireland (both have already been bailed out once) and prevent the situation in Spain and Italy from getting bad enough to need a bail out. This will take a lot of money,  much more than the €440 billion in the EFSF.  Where will this money come from? It's quite simple — it will be printed.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

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

Is Greece About to Default?

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.

Yields on two-year Greek governments reach 46.84% last Friday. This is roughly comparable to yields on Argentine bonds in early December 2001 -- only a month before the country defaulted on its debt.

Similar interest rates occurred this spring in Greece before the second bailout package was put together. The bailout saved Greece from defaulting back then, but the bailout is now falling apart while the fiscal situation in Greece continues to deteriorate. The risk of default in the near future has returned, but the will to stop it this time around is much weaker than in the past.

Finland and a number of other countries have already demanded collateral from the Greek government for their contribution to the bailout and this reduces the money available that can be used by the Greek government to pay off its debts.  Then talks between the Greek government and the ECB, EU, and IMF broke down last Friday (September 2nd) because Greece admitted it will not meet its deficit reduction and privatization targets for the year. This potentially puts the next $8 billion tranche in bailout payments in jeopardy. The talks are supposed to resume in 10 days. Even more challenges will have to be faced this coming week.

Citizens of the fiscally solvent EU countries are getting tired of paying to support what they see as the profligate spending habits of the EU's weaker economies.  The bailout efforts have been lead by German Chancellor Angela Merkel, but support within her country has never been strong for them. Her ruling party has lost six regional elections this year, including one in her own home state this weekend. Any more pro-bailout efforts will only further weaken her politically.

At the same time that efforts are taking place to undermine the second bailout, more and more money is needed by Greece. Like many other heavily-indebted countries in the past, Greece is dealing with a destructive feedback loop of inexorably escalating interest costs that cause its debt to continue to rise regardless of what efforts it makes to control it. The Greek government claimed a debt to GDP ratio of 120% in 2010 during the first bailout talks. It is now estimated to be as high as 160%. Interest payments on that debt could be as high as 24% of GDP at current rates (the 10-year bond is yielding over 18%). Despite the first bailout and now the second bailout, interest rates keep going higher, the national debt keeps getting bigger and the problem keeps getting worse.  

Since someone elsewhere had to lend all the money that is in danger of not being paid back, Greek debt problems are not isolated to Greece, but are having a major impact on the big banks in France and Germany (the real reason Germany and France are so anxious to bail out Greece). The debt problem moreover is being spread through contagion to Spain and Italy, both of which are much larger economies and which are ultimately "too big to bail". This is casting a wider net of impacted banks. By the last week of August, credit default swaps (insurance on bonds) were rising to crisis levels for the Royal Bank of Scotland, BNP Paribas, Deutsche Bank and Intesa Sanpaolo. The problem seems to be a shortage of liquidity, just as was the case in the fall of 2008.

It has also been reported that many European financial institutions have losses on bond holdings, despite the ECB actively supporting Spanish and Italian bond prices . The global banking system has approximately $2 trillion in exposure to Greek, Irish, Portuguese, Spanish and Italian debt. On Monday, the yield premiums on Italian and Spanish 10-year government bonds over the equivalent German Bund hit their highest in a month. Italian bonds traded at 5.5%, well above the 5% rate at which the ECB has been buying recently. Italy has to roll over 62 billion euros in bonds by the end of the month.

Stocks have of course been negatively impacted by the problems in Greece and this will continue until there is some resolution. The German DAX had another mini-crash on Monday, falling 5.28% or 292 points. The drop in Paris was just under the 5% mark that defines a crash day. London held up somewhat better as it has during the entire crisis so far. U.S. markets were closed.

At this point, the only thing that can prevent a default by Greece is if its entire debt is bailed out by the EU and IMF (this would require a third and even fourth bailout package). This is not going to happen. The second bailout itself is highly unlikely to go through as planned. Without it, Greece will default this fall.  With it, a little more time will be bought before a third bailout is needed - and support for that measure doesn't currently exist and isn't likely to exist. The important question concerning Greek default seems not to be if, but when.

Disclosure: None
Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2000s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

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

Eurozone Fiscal Problems Turn Violent

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.


Mass protests against austerity erupted througout the eurozone this week and in some cases turned violent.  Spain had its credit rating downgraded. Some yield spreads on peripheral countries bonds are reaching crisis levels again. Somehow though, the euro managed to rise on all of this negative news.

The left-wing union sponsored protests took place in Spain, Ireland, Greece, Portugal, Slovenia, and Brussels, where an estimated 100,000 people marched on EU headquarters. Spain had its first nationwide strike in eight years and rioters clashed with police who fired rubber bullets into the crowd. Most flights into and out of the country were canceled. Greece already had slowdowns during the past two weeks, but this time the Athens metro was shut down and doctors went on strike. Supermarkets are seeing food shortages there. The Irish parliament was blocked by protesters as a symbolic gesture of closing down the government.

Spain had its credit rating downgraded by Moody's from triple A to Aa1. All the other major rating agencies had already previously downgraded Spanish debt. In Ireland, the government announced that the bailout of the Anglo Irish bank could push the Irish debt to GDP ratio to 32%. EU guidelines call for this number to be 3% or below. Ireland says it will go to the bond market to raise the money. The yield spread between Irish and German government bonds rose sharply on Monday, hitting a record high. Irish and Portuguese yield spreads had already hit record highs on September 7th, when Greek yield spreads were the largest in four months.

Currency markets reacted to the financial chaos and political instability of the eurozone by bidding up the euro and selling down the safe haven U.S. dollar. This sounds totally and completely absurd because it is. No trader in their right mind would buy a currency with the problems of the eurozone. It is more than reasonable to assume the currency purchases came from the government run Euro-TARP bailout fund. While the eurozone member states are telling their respective populations that they are taking away the free lunch they have been serving all these years, they are making it clear that they are still willing to provide a free lunch to the currency markets. Of course, one day the bill for that 'free lunch' will arrive too and when it does the currency markets will turn violent and ugly as well.

Disclosure: No positions.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

There is no intention to endorse the purchase or sale of any security.

Nasdaq Gives Bear Market Signal

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.


As the mix of good earnings and weak economic reports continue, Nasdaq gave a bear market trading signal on Wednesday. It joined the Dow and S&P 500, which gave their own sell signals earlier this month.

While the technical picture for the market has improved somewhat after seven days of rally, the rally didn't prevent Nasdaq's simple 50-day moving average from falling below its 200-day. The Nasdaq closed at 2249.84, its 50-day fell to 2251.39, and its 200-day was at 2254.88. This means Nasdaq is also at a strong resistance point that it needs to break and stay above. Trading in the next ten days will determine if the Nasdaq continues to fall apart (and the rest of the market with it) or manages to turn around with a rising 50-day average. The recent rally has taken place with below average volume on Nasdaq every single day. The volume on the Dow Industrials was even weaker. From a technical perspective, this is another negative for the market.

Mixed news for the economy and earnings continues. JP Morgan reported a 77% Q2 rise in profits. Mainstream media accounts explained that "a slowdown in losses from failed loans helped offset a difficult spring in trading and investment banking". Huh?  Makes you wonder who does their numbers. Anyone who happens to believe that the big banks earnings reports have anything to do with reality should recall that Bear Stearns in March 2008 was rushing to get its positive first quarter earnings numbers out early, but the company went under before it could release the good news.

Meanwhile, the weekly unemployment claims rose last week, but the Labor Department reported they fell by 29,000. Huh? Makes you wonder who does their numbers. Apparently the magic of seasonal adjustments led to this 'sows ear as silk purse' news. Automakers aren't closing down for their usual summer retooling this year. Based on recent reports, there is no evidence that business in the sector is so good, or even good at all, that they can't afford the down time.

Industrial production figures in the U.S. were up by 0.1% in June. The number was only positive because of a big increase in utility output caused by increased use of air conditioning during the unusually hot month. Consumer goods seem to have been down across the board. As a reminder, consuming spending was 72% of the U.S. economy before the Credit Crisis hit. Business and industrial equipment were up, but it is likely we have exports to China to thank for that. The Chinese economy expanded by 10.3% in the second quarter, but this was below expectations. Even at the bottom of the Credit Crisis Chinese GDP was up over 6%. It was down by almost that amount in the U.S. The economy in China seems to be slowing and if this continues, watch out below.

Disclosure: No positions.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.

G-20 Meeting's Deficit Goals Are Meaningless

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 G-20 met this weekend and set a goal that member countries should cut their deficits in half by 2013. The agreement also calls for G-20 countries to start reducing their deficit to GDP ratio by 2016. Even with such easy to reach targets, success is by no means guaranteed.

For some reason the G-20 recently woke up and realized countries can't continue to forever spend a lot more than their income from tax receipts. Some of them have been doing just this for many decades at this point. The statement released from the meeting said, "Sound fiscal finances are essential to sustain recovery, provide flexibility to respond to new shocks, ensure the capacity to meet the challenges of aging populations, and avoid leaving future generations with a legacy of deficits and debt."  So at least ten years after the horse has left the corral, the G-20 now wants to close the gait.... but not all the way.

The original proposal for cutting deficits in half was changed from would to should because Japan, the U.S. and India objected. No one actually seems to think that Japan will be able to accomplish this goal. Japan is the most indebted major country on earth with its debt to GDP ratio reaching over 200% this year. Interestingly, the long-term budget projections of the Obama administration are for a deficit of $778 billion for 2013, which would be less than half of the $1.6 trillion projected budget deficit for 2010. The 2013 figure is still almost double the biggest deficit prior to the Credit Crisis however. It also assumes robust GDP growth and minimal inflation during the next few years. Another recession or rising inflation could easily move the U.S. deficit numbers back to well above a trillion dollars. 

European markets were up on the news today and the U.S. market is rallying slightly as well in morning trade. It should be clear to the markets that world leaders are not really serious about reducing government spending. Although, the markets might be worried that even small spending reductions could turn the global economy back down and risk another recession - assuming the first recession actually ended that is.

Disclosure: None

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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

Why Decisive Action is Needed to Save the Euro

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.


This morning, the euro has traded as low as 126.55 to the dollar. The currency has extremely strong support around the 125 level, so some bounce up from there should be expected. While some short-term relief is likely, in the longer term the survival of the euro is threatened until some significant changes are made in how the currency union is managed.

The current problems in Greece have exposed the flaws behind the euro. The currency was created with a set of rules that were meant to insure stability, but the eurozone seems incapable of enforcing its own standards. Because of this, the euro is losing credibility in the world markets. At this point, the EU has only two choices if it wants to regain an image of responsibility for its currency. It can either enforce its maximum 3% budget deficit to GDP limit or change the limit to something that can be accomplished and make sure all member countries stick to it. The Credit Crisis has made the first choice impossible, but the EU has yet to try to deal with this realistically. The second choice, while it would tend to lower the value of the euro, would allow it to keep functioning as a viable currency.

So far, the EU has chosen neither of these alternatives. Instead it has decided to take the bailout route. This is only a stopgap measure to deal with the problem and is not a workable solution in the long-term. It can be done for Greece, although it will be expensive, because Greece represents only 2% of the EU economy. It also could be implemented for Portugal and maybe even Ireland. At that point though the amount of bailout money being spent would be tremendous and would certainly create an inflationary strain on the entire eurozone. As the situation in Greece has shown, the cost of an actual bailout will be much larger than initial estimates. The funds for a proposed Greek bailout have already almost tripled from the first proposal and they will ultimately be much higher. The bailout solution has its limits though. Spain will be the breaking point. Italy is not even possible.

A good question is: Why are bailouts even being considered? Dollarization could easily have solved the problem - let Greece continue to use the euro, but remove it from the currency union (Greece would almost certainly have defaulted on its debt already if this had been done early on). The answer of course lies in who is really being bailed out. French and German banks together have funded the majority of external Greek government debt. They also have a decent chunk of Portuguese government debt. Just as was the case with the subprime crisis in the United States, the big banks are the ones being bailed out. Most large European banks were already bailed out is some way, shape, or form then as well. This would represent a second series of bailouts for them.

At some point, the EU has to make some tough decisions. This is something that governments throughout the world seem incapable of doing these days. Up to now, the governing body in Brussels has reacted like a deer caught in the headlights - frozen and incapable of action. Greece not only violated the EU's debt to GDP limits by a factor of four, but also lied to the EU about its numbers for many years. Instead of being punished for these serious infractions and being thrown out of the currency union, the EU and IMF have decided the best course is to reward Greece for its bad behavior with a bailout. The EU is sending the markets a clear message that their supposed standards behind the euro are meaningless. The market, not surprisingly, has sold down the euro in response.

As I said repeatedly during the Credit Crisis, there is no such thing as a single bailout. This will certainly be the case in the eurozone. If the EU wants to save its currency, it will have to take decisive action at some point. If it won't do so now, it will have to do so once it becomes obvious to them that the bailout approach is just too costly. Unfortunately for the rest of us, this can have a serious negative impact on world markets at any point in time. The Nikkei in Japan was down 3.3% last night and China's Shanghai composite was down 4.1% and they are not anywhere near Europe.

Disclosure: No position in euros.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.

First Quarter GDP: A Look Inside the Numbers

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 advance report for first quarter GDP was out today and it indicated that the U.S. economy expanded by 3.2%. Approximately half of that was due to increases in business inventories. Business equipment and software investment supposedly went up over 13% and was the biggest sub-category gainer. Consumer expenditures somehow went up 3.6% even though real disposable income was flat. Increases in federal government spending helped raise the numbers.

While the biggest contribution to the report was in the inventory category, this represented a lower percent than in the fourth quarter of 2009. Inventories added 3.8% of the 5.6% increase in GDP last quarter, or two-thirds of the total. Inventories didn't actually increase in the fourth quarter either; they dropped by $19.7 billion. Thanks to the peculiarities of GDP math, the slower rate of decline led to a big increase in GDP.  Mainstream media then reported this turn of events as the U.S. economy being on fire (if they meant it was burning down, they may have been correct). In Q1, inventories actually increased though by $31.1 billion. This is certainly more positive, but inventory restocking by itself doesn't indicate a recovering economy. It does however lead to a recovery in the GDP number.

The increase in business equipment and software of 13.4% in Q1 was less than the also very high 19.0% last quarter. Overall this led to nonresidential fixed investment increasing 4.1% in the current quarter even though investments in nonresidential structures (commercial buildings) declined 14.0%. Still, that was better than the 18.0% drop in Q4 of last year. Real residential fixed investment  (housing) decreased 10.9% this quarter, in contrast to a supposed increase of 3.8% in the fourth quarter of 2009. Real estate, which was the epicenter of the Credit Crisis and the damage to the economy, is obviously still troubled. How can there be recovery under such circumstances?

When reporting on first quarter GDP, big media highlighted the consumer spending numbers. The 3.6% current number was much higher than the 1.6% number at the end of last year. Durable goods sales supposedly increased 11.3% in Q1 compared to just 0.4% in Q4 2009. Motor vehicles created a 0.52% growth in GDP by themselves. Nondurable goods were up 3.9% compared to 4.0% last quarter, so almost all of the big change took place in durable goods. U.S. consumers managed to increase their spending on these high-ticket items even though real disposable income didn't go up. Consumer credit was also declining in the first quarter. Revolving credit (credit cards) fell at a 13% annual rate in February. So somehow consumers are now spending more money even though they don't have the funds available from their income or credit. That certainly is interesting.
 
Finally, government spending, which has been the mainstay of the economy for the last two years, increased by 1.4% in the first quarter compared to no change in the last quarter of 2009. Nondefense spending increased 1.7 percent in the beginning of 2010 and this compares to a jump of 8.3% at the end of last year. State and local spending were down in both quarters. At this point it will be hard for the federal government to increase its spending from current levels, so decreases are likely in the future and this will be a drag on GDP going forward. What part of the economy will pick up the slack? Well, I guess that depends on what numbers the statisticians find easiest to manipulate.

Disclosure: None relevant.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.

Questionable Oil Statistics More Accurate than Other Government Numbers

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.


If it's Wednesday, it oil inventory report today. At 10:30AM New York time, the EIA (Energy Information Agency) releases it weekly statistics on the amount of crude oil, gasoline and distillates in U.S. storage. The price of oil can move sharply up or down based on this information. Unfortunately, the numbers in the inventory reports are not reliable.

An article in the March 18th edition of the Wall Street Journal entitled "DOE Documents Cite Outdated Methodology, Errors in EIA's Weekly Survey" revealed why the weekly oil data could not be trusted. The Journal stated that the process utilized by the EIA to determine inventory levels hadn't kept up with important changes over the years. It went on to mention a litany of problems with data collection at the EIA including old technology and out-of-date methodology. It specifically cited an inaccurate report in September that caused an unjustified big move up in oil prices.

Knowing that there are problems with the statistics being published by the EIA, investors should immediately wonder how accurate the other numbers are that the U.S. government publishes. There are more than enough reasons to question the GDP reports, inflation statistics and employment reports. Unlike the EIA reports, which are inaccurate because of neglect, these other reports are inaccurate because of lack of neglect. Government statisticians have gone out of their way to introduce 'improvements' over the past thirty years in the how the numbers are determined in these other reports. These 'improvements' seem to have only made the numbers more and more favorable looking. When statistical adjustments only produce better numbers, they are more accurately referred to as manipulation.

The oil report today indicated that crude oil inventories went up by 2.9 million barrels last week and gasoline inventories were up 300,000 barrels. U.S. crude oil inventories and gasoline were above the upper limit of
the average range for this time of year according to the EIA.  While these numbers don't look good, who knows whether or not they are even close to the actual ones.

Problems with the EIA notwithstanding, investors should be watching oil at this point and paying attention to the stock charts. The price of oil is determined globally, not just by what happens in the U.S. Oil is entering a seasonal strong period that will last until the summer. Light sweet crude has been in a trading range from 70 to 83 for many months now.  A breakout above that range would be bullish and could happen at any time. ETFs/ETNs that investors can use to go long on oil include OIL, DBO, USO and USL.

Disclosure: None

NEXT: Agricultural Prices Weaken on Ample Supplies

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.

Euro Zone Support Package Doesn' t Solve the Problem

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.


After many press reports over the last two months about a possible bailout for Greece, euro zone leaders seem to have finally come up with a plan to handle the crisis. The plan however will only be used as a last resort, is limited to loans at market interest rates, and requires unanimous agreement from all member countries before aid can be granted. Euro zone countries would provide about two-thirds of the loan money and the IMF the remaining third. Given the restrictions, the support package is likely to have limited impact.

While no loan amount has been specified, unofficial sources indicated that 22 billion euros was the proposed amount. Greece has to borrow 20 billion euros in April and May alone. Greece has not had problems borrowing money so far, but has had to pay high interest rates to do so. The high rates are causing problems because more money has to go to debt service and this means less money for other government spending elsewhere. The country has already been plagued with riots because of its enactment of budget cuts and higher taxes. The euro zone support package though doesn't lower borrowing costs for Greece. It only assures that Greece will be able to continue to borrow in case no one else will lend to it. Essentially the euro zone, along with help from the IMF, has established a policy of acting as a lender of last resort for its sovereign entities.

Admittedly, the euro zone has to trod a very narrow path in the extent of its aid to member countries. If Greece were the only member in trouble the situation wouldn't be so delicate. The Credit Crisis has devastated Europe, just as it has the rest of the world. The more economically marginal countries have suffered the most. Greece is merely the canary in the coal mine. Ireland just released fourth quarter GDP figures indicating that its economy shrank at a 5.1% annualized rate. GDP contraction there in 2009 was the largest on record and that includes all the years of the Great Depression in the 1930s. Italy's GDP dropped 5.1% in 2009. Official figures indicate that Spain's economy was 3.6% smaller for the year. Portugal, which just had its debt rating downgraded by Fitch, claims that its GDP was down a mere 2.7% in 2009.

While all of these numbers are bad, they could actually be even worse. The media reported that Greece shocked markets and other EU nations when it admitted it falsified its statistics to make its budget deficit look much lower than it was, even though the numbers was obviously impossible. The original Greek government figures projected a budget deficit to GDP ratio of 3.75% for 2009 and below 3% (the euro zone target for members of the currency union) for 2010. Greece also claimed that its GDP would increase by 1.1% in the midst of the severe global downturn that was taking place last year (as of now it looks like GDP dropped 2.0%). While these fantasy figures were treated as reality at EU headquarters, the OECD didn't buy them. Long before the Greek government admitted to the truth, it estimated that the budget deficit to GDP ratio would be 6% in 2009. So far, it looks like it will actually be 12.7% - around 250% higher than initially claimed by the Greek government. If such outrageous fabrications could be accepted, would 50% or even 100% errors be discovered?  Greece is not the first country to lie about its economic statistics. Only the very naive would assume that there aren't many other countries doing the exact same thing. Moreover, Greece only got caught because it turned itself in.

Denial on the part of euro zone governing bodies is what has lead to the current crisis with Greece. In order to avoid future problems, the euro zone needs to assure the integrity of the numbers produced by its member countries, so no other major surprises will take place. There also needs to be a more formal mechanism to establish economic equilibrium among member nations as well. The potential trouble spots in the euro zone are characterized as relying excessively on consumer spending, having weak public finances, and relying on foreign capital to supplement low savings rates. Interestingly, this is also an excellent description of the United States.

Disclosure: None

NEXT: U.S. Consumer Spending: Not Inidcating Economic Recovery

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

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.

Will EU Accept Greece's Trojan Horse of Debt?

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.


International markets are looking for resolution to the debt crisis in Greece. European Union leaders have a summit meeting on February 11th and either a debt restructuring or a bailout of some type is on the wish list of traders. Whatever happens however will only be at best a temporary solution that will delay the day of reckoning for the global financial system. In the short-term, it will not undo the damage done to the euro nor to the stocks and commodities that have been impacted by the currencies current drop.

The problem in Greece is neither new nor exceptional for the EU. The conditions of the currency union in the euro zone have been violated from day one. The Maastricht Treaty set a limit for budget deficits of 3% of GDP and a 60% limit for the debt to GDP ratio of participating countries. The euro was launched in 1999 and replaced individual country currencies in 2002. Germany itself, the economic powerhouse of Europe, had a budget deficit of at least 3.7% between 2002 and 2004. France also violated the treaty conditions within the first three years, as did Portugal. The Netherlands did so in 2003. Initially Greece appeared to be in compliance, but was later accused of manipulating its statistics (a historical commonplace for fiscally irresponsible governments) and later admitted that its budget deficit averaged 4.3% between 2000 and 2004.

The euro currency union actually helped countries reduce their budget deficits by lowering their borrowing costs. When the debt to GDP ratio becomes large, reducing interest payments can reduce the budget deficit considerably. This phenomenon benefited Italy tremendously. Interest rates on Italian government bonds fell from around 12% in 1994 to 4% in 2004. It also improved the situation in Belgium. Belgium's debt to GDP ratio was 134% in 1993, but only 90% in 2008. It has never gotten anywhere close to the 60% limit. Italy's debt to GDP ratio in 2008 was 106% and is growing rapidly. It will not be long before it reaches Greece's 120% level. Yet, the market is focused more on Portugal with an 85% ratio - equivalent to the official numbers in the United States (the actual numbers are similar to Greece's) and Spain which has only a 66% debt to GDP ratio.

The EU rules don't have any provisions for bailing out one of the members of the currency union. Such legal niceties though can easily be ignored during a crisis. The EU executive committee has furthermore previously maintained that no bailout of Greece will be needed. Mid-day on February 9th however, news was released stating that the euro zone countries have decided in principle to aid the debt-stricken country. Reports indicated that the EU authorities were considering a range of possible actions, but no specifics were given. The euro of course rallied strongly on the news.

The euro has traded down from a high around 1.51 to the U.S. dollar in late November to the 1.36 level on February 5th. It is trading well below its 200-day moving average at the 143 level. The 50-day moving average, also at the 143 level, is about to cross the 200-day and trade below it, giving a classic bear trading signal.  The euro will not be able to recover from this technical damage overnight. Nevertheless, sharp counter rallies are inevitable since short positions on the euro have reached a record. This will create conditions for a nice longer-term rally in the future, but a period of volatility is more likely first. Commodities, particularly the precious metals, and U.S. stocks tend to trade with the euro, so investors should expect them to follow this pattern as well.

Disclosure: No Positions

NEXT: Economists and Governments Pave the Way for Global Inflation

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

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.

Currency Markets - California Dreaming is Greek to Me

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 trade-weighted U.S. dollar has been rallying since early December 2009. Except for a sell off after the beginning of this year, the rally continued because of trouble in the euro zone centered around Greece. The euro, representing more than 50% by weight of the basket of currencies that make up the trade-weighted dollar, hit a seven-month low and lost more than 7% of its value from its recent high. It takes a huge leap of logic to think that fiscal troubles in the euro zone are bigger those in the United States, but this is what the mainstream media has dished up as the explanation for what is going on. The invisible hand of the ECB (European Central Bank) manipulating the currency markets would offer a more rational explanation.

Greece represents 2% of the euro zone economy, compared to California which represent 13% of the U.S. economy. Both are in fiscal trouble. Neither can print their own money to get out of that trouble because they are both part of currency unions. While it is generally not recognized, U.S. states are de facto part of a currency union for the dollar, which was established in the 1800s. Their fiscal problems should be considered as analagous to european countries that are part of the euro zone. California is essentially in default and is only being kept afloat by constant cash infusions from a number of federal stimulus programs. It represents a much bigger drain on the U.S. dollar, than Greece does for the euro.

Selling the euro and buying the U.S. dollar because of the fiscal profligacy of countries like Greece is also absurd considering that the U.S federal government is just, if not more profligate, than the most fiscally irresponsible euro zone countries. It is considered outrageous that Greece had a budget deficit that represents 13% of its GDP. The 2011 U.S. federal budget submitted by president Obama on February 1st has a deficit of 11% of GDP (U.S. GDP figures are grossly overstated). For every dollar the U.S. intends to spend in 2011, 40 cents will have to be borrowed or printed.  Does that sound like a country that is protecting the value of its currency?

Greece has submitted a plan to the European Union (EU) for slashing its budget deficit to 3% by 2012 - the maximum allowed by the EU. While many people think that this is unlikely to happen, the U.S. has no intention whatsoever of slashing its budget deficit to that level in 2012 and will be fortunate if it is even lower than current levels. As for California, there seems to be no path to fixing the problem there without a massive federal government bailout - and it is only one of several U.S. states that have serious fiscal problems. Yet, the markets are selling the euro and buying the U.S. dollar because the U.S. is viewed as being in better fiscal shape that the euro zone? Perhaps I missed something when I took Logic 101.

Disclosure: None

NEXT: Withdrawal of Liquidity Threatens Second Global Meltdown

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

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.