Draghi's Sterilization Makes ECB Monetary Policy Impotent

 

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 response to concerns about the inflationary risk of more money printing, European Central Bank President Mario Draghi is going to propose "sterilizing" unlimited purchases of government debt for struggling Eurozone countries. A failed government bond auction in Germany this morning indicates why the plan won't work.

Draghi's newest strategy will focus only on government bonds of three year duration or less. These bonds from the peripheral countries have been snapped up by hedge funds in recent trading days driving their yields down considerably. Draghi will apparently also stress conditionality for the ECB's purchases. Governments must agree to ECB control to get aid and must meet the conditions they agree to in order to continue to have their bond markets supported (Greece has been notorious for violating its promises in this regard).

When central banks sterilize transactions, they pump money into one area of the financial system and remove it from another at the same time. Bloomberg reports that there is an estimated €800 billion of excess liquidity in the eurozone banking system. So, policy makers figure there will be no problem draining an unlimited amount out of the liquidity rich north and transferring it to the cash-strapped south. While this sounds good in theory, reality might be a major stumbling block for this idea to go forward.

While Draghi's plan will only be officially announced tomorrow morning, there was already a failed 10-year bond auction in Germany this morning (only the second time this has happened in recent several years). Germany attempted to sell €5 billion in bunds, but only managed to find buyers for €3.61 billion of its debt. The other more solvent credits of the Eurozone such as Finland, the Netherlands and Denmark are also likely to face this problem in the future. It is simply common sense that this will happen. If the size of the money pie isn't being made larger and some people are getting bigger pieces, someone else has to be getting smaller pieces. Lower interest rates in Spain and Italy are going to mean higher rates in the north.

The voters of the northern Eurozone countries may not be amused when they find out how they are paying for the escalating debt problems in Spain and Italy. Retail sales figure released this morning were lower month over month for the whole Eurozone and manufacturing is continuing its contraction. While Spain is in a full-blown recession, the economies of the northern countries are weakening. Higher interest rates there will not help the situation. It should be an interesting meeting of ECB officials tomorrow. 


Disclosure: Not a Central Banker

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.

If an EU Leader Says It, Don't Believe It

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.

German leader Angela Merkel revved up the markets on Thursday by saying once again that she and the other EU leaders would do everything possible to save the euro. If traders realized how reliable previous official statements concerning the Eurozone debt crisis have been, markets would have experienced a major selloff.

When the debt crisis first appeared in Greece, Merkel said there would be no bailout and the Greeks would have to solve their own financial problems. ECB President Trichet made it clear that Greece wouldn't receive any special treatment. It wasn't long before they both backtracked on their public statements. On April 11, 2010, a €30 billion bailout was agreed to and this was raised to €45 billion on April 16th. By May 2nd, a total package of  €110 billion had been arranged. This amount was meant to fix Greece's debt problems once and for all. The Washington Post reported that IMF director, Dominique Strauss Kahn, and EU Commissioner Olli Rehn stated, "the plan would lead to a more dynamic  economy that will deliver the growth, jobs, and prosperity that Greece needs in the future". If there were a worst-forecasting-prediction-of-all-time award, both Strauss-Kahn and Rehn could be potential winners.

Not only did the Greek economy not prosper, but it went into a tailspin. Other claims made by the EU proved to be equally absurd as well.  As reported by BBC News, the Greek debt to GDP ratio was supposed to rise from 115% at the time of the bailout to 149% in 2013, when it would then fall. Instead it rose to 165% in 2011. Greece's budget deficit was expected to be down to 3% of GDP (the EU target rate that all members states are obligated to meet). If Greece is lucky, it's deficit will only be 7.3% of GDP this year. It is expected to rise again in 2013 however to 8.4%. So much for that.

Even though Greece missed the EU and IMF's projected targets by a mile, this was only possible because a much bigger bailout took place in 2012. Greece received an additional €130 billion  and got to effectively write off almost 75% of its government debt held by private bondholders (the ECB and IMF were exempt from the write down). Certainly Greece must be better off after €240 billion in bailouts and writing off a big part of its debt, isn't it? Well, no it isn't. Before the first bailout in 2010, Greece had around €300 billion in government debt. Just released figures indicate in now has €303 billion in debt. While debt is no lower, GDP has collapsed, falling over 9% in 2011 alone and currently on target for an over 6% drop this year. Unemployment has skyrocketed with the someone under 25 being more likely not to have a job than to be working. By almost any criteria you wish to chose, the EU, IMF and ECB program has been a complete failure.

Now the EU and its partners are preparing to bailout Spain. Already a €100 billion loan has been committed for Spanish banks. This doesn't include any funds to bailout the government. How bad is the situation in Spain?  Well, Reuters has reported that one of Spain's regional mayor robbed a number of supermarkets last week and distributed the stolen food to the poor. As a member of  a regional parliament, he is immune from prosecution. Government stealing from those that have is of course nothing new, but apparently in Spain there's no attempt to hide it.

It looks like Spain will be asking for a full-fledged bailout soon. The EU will then directly take over its finances.  The total bailout could easily involve a trillion euros or more, unless some EU country stops it after realizing the damage this is going to cause the EU itself, let alone Spain. The long-term implications are likely to be quite ugly for both.

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.

More Debt Problems in Europe

 

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.

While stocks weakened in the U.S. on Thursday because of disappointing economic data, they were down in Europe on the resurfacing of the debt crisis issues.

The head of sovereign ratings at S&P, Moritz Kraemer, speaking at an event at the London School of Economics said that another restructuring of Greek debt is likely, with the bailout partners such as the IMF having to take a hit the next time around. Speaking at the same event, the IMF mission chief to Greece acknowledged it would take at least a decade to fix Greece's finances. His prediction may be optimistic considering the situation in Greece is volatile and its economy is in free fall. 

Greece is of course not the only problem child in the eurozone. Portugal, Ireland, Spain and Italy also need some sort of fix. The Eurozone has attempted to put together a firewall to prevent these countries from collapsing into the same debt crisis that engulfed Greece. There are now plans to extend the ceiling of the rescue aid package to 940 billion euros ($1.25 trillion). This money is used to buy up bonds from the debt-challenged countries in order to keep their interest rates down.

The funds do not solve the underlying problem however — all of these countries are living beyond their means and until they drastically cut their expenses they will require a continual stream of rescue money. German central banker, Jens Weidmann, recognized as such when he stated, “Just like the ‘Tower of Babel,’ the ‘Wall of Money’ will never reach heaven. If we continue to make it higher and higher, we will, in fact, run into more worldly constraints".

The program has been effective in the short term however. Portuguese 10-year bond yields were at 17.39% on January 30th, but were trading at 11.52% on March 29th (still too high for Portugal to remain afloat in the long term). Italian 10-year bonds had a yearly high yield of 7.46%, but traded at 5.29% today and Spanish 10-years were as high as 6.72%, but recently went for 5.47%. The eurozone's goal is to keep these rates below 6% — the level at which Greece got into trouble.

The rescue funds should run out by 2013 and more money will have to be added to the mix. Whether or not this will be the point when additional money is not forthcoming remains to be seen, but there will be such a point. The amount of assistance Ben Bernanke is willing to provide may impact the timing. As reported by Zero Hedge, the  U.S. Fed already holds some European sovereign debt. It could easily buy more. Once again, the end will be the same unless you believe that a debt crisis can be solved by taking on more debt or by printing more and more money. At least some of the more responsible authorities are beginning to admit that this isn't possible.

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.

Greece Interrupted — Bond Swap is Not the End

 

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.

Greece is set to swap its privately-held government bonds today for new ones that will represent a three-quarters loss of the original investment. The deal will allow the country to receive 130 billion euros in funds from its second bailout. Like the money from the first bailout, those funds will eventually run out however.   

The Greek bond swap is the biggest debt writedown in history. Over 85% of  private investors (essentially banks, the deal does not include bonds held by the IMF or ECB) holding 117 billion euros ($234 billion) agreed to the "voluntary" exchange. The CEO of one major European bank described the transaction as about as voluntary as a confession during the Spanish Inquisition. The loss to bondholders is twofold consisting of a reduction in face value of 53.5% and then lower interest payments stretched over a longer period of time. All in all, private bondholders are taking an approximately 74% hit (assuming of course there isn't another writedown or Greece doesn't renounce its debt completely in the future).

Credit rating agency Moody's decided to call a spade a spade and declared Greece to be in default. Moody's line of reasoning in stating the obvious is that it considers a loss greater than 70% to be a "distressed exchange" (that's putting it mildly) and is therefore indicative of a default.  The matter is not merely academic, since there is a significant amount of credit default swaps (bond insurance) outstanding on Greek debt. On Friday, a committee of the International Swaps and Derivatives Association —  the regulatory authority on credit default swaps — ruled that the Greek debt restructuring was a credit event, and this will trigger payouts. How much CDS holders will receive remains to be seen.

Commentary from the EU political leadership on the swap deal was more mixed than after the first Greek bailout (statements back then were upbeat and generally confident that the problem had been solved and Greece was on its way to recovery). French president Sarkozy stated, "Today the problem is solved. A page in the financial crisis is turning." Christine Lagarde, head of the IMF said, "The real risk of a crisis, of an acute crisis, has been, for the moment, removed." German officials were far more cautious however. The French may be correct as long as their words are taken literally. The problem is indeed solved for today. That doesn't mean it is solved for tomorrow.

It is actually highly unlikely that the situation in Greece will be turning around any time soon because of the massive reduction in its debt load from the bond swap. If Greece had a functioning economy, there would be hope. However Greece's economy is heavily dependent on government spending and in exchange for bailout money the IMF and ECB have demanded severe cuts in Greece's budget deficits. Greece is now entering its fifth year of recession, after GDP contracted by 7.5% in 2011. Investment fell by 21% last year after sliding 15% in 2010.  For Greece to continue to operate at all, continued bailout money will be needed. Greece has effectively gone from a welfare state to a state on welfare.

Not surprisingly, some analysts are sounding a note of caution. Predictions are that the financial bleeding in Greece will show up once again later this year. Problems may arise even sooner depending on when the next election takes place (now supposedly in May) and how much power the fringe parties gain. The bond market doesn't seem hopeful either. One year Greek government bond yields were last at 1143%.  Such yields represent collapse, not solvency.

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 EU Has Fallen Into a Liquidity Trap and It Can't Get Up

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.

While the EU is still reeling from S&P's downgrade of the sovereign debt of nine of its members on January 13th and the latest talks to keep Greece afloat have hit a wall, there is an even bigger problem with the effectiveness of its stimulus programs -- the money is just not finding its way into the economy.

Global markets were jubilant in December when the ECB (European Central Bank) pumped 490 billion euros of three-year loans into the EU banking system. These funds were used by eurozone banks to buy high-risk government debt from the struggling peripheral countries. This indeed caused a temporary decline in interest rates, especially for Spain and Italy. Money from this program and other EU stimulus measures is stuck in the banking system however and it is doing little to keep the EU from sinking into a deep recession. As of Monday January 16th, the ECB had 493 billion euros on overnight deposit -- more than the entire December stimulus package.

Large amounts of funds on deposit at any central bank are an indication of a crisis in the banking system. Before the current EU debt crisis, eurozone banks usually kept only around 100 million euros on deposit at the ECB. Even during the height of the 2008 Credit Crisis, EU banks kept only around 33% of money lent out by the ECB on deposit. The percent now is over 70% (the ECB has lent out 664 billion euros in total) meaning things are in much worse shape in the EU than they were after Lehman Brothers collapsed. When money is trapped in the banking system, the economy suffers and extra stimulus measures don't help to revive it. EU money-printing measures meant to rescue its profligate debt-ridden members aren't likely to help its economy, which in turn will result in a self-feeding cycle of more and more debt (as happened in Japan during the last two decades) or more and more money printing (as has been taking place in the U.S. since the 2008 Credit Crisis). Like the U.S., the EU has run out of borrowing power, so debt without money printing is no longer an option.

Weaker economies mean more downgrades from the ratings agencies can be expected. On Friday, both France and Austria lost their coveted triple A ratings from S&P. They were downgraded a notch as was Malta, Slovakia and Slovenia. Italy, Spain, Portugal and Cyprus were downgraded two notches. Italy is now rated BBB+. The only countries in the eurozone that still have triple A ratings are Germany, the Netherlands, Luxembourg, and Finland. S&P put the later three on negative outlook for a possible future downgrade however. The EFSF bailout fund itself may also be downgraded.

The current debt crisis that is now impacting the entire eurozone started in Greece in late 2009. The problems there have yet to be fixed despite numerous mainstream media reports to the contrary in the last two years. Greece is now on financial life support. Any missed bailout payment from the EU will send it immediately into default. Talks have broken down once again, but as before will once again be resuming shortly. The market has never been convinced that any of the proposed Greek bailouts will work.  On Monday, Greek one-year government bond yields hit a high of 416% and 10-year yields a high of 35%. These rates have continued to rise after each bailout proposal. Greece has to make substantial bond payments this March.

The EU's debt crisis is not getting resolved because it is no more possible to solve a debt crisis with more debt than it is to sober up a drunk by giving him more alcohol. Yet, every mainstream news article has comments from well-placed sources that are hopeful that some resolution will be coming to the EU's problems soon. Rarely is it mentioned they have been hopeful -- and wrong -- for the last two years as the situation has increasingly deteriorated. Nor is it mentioned that the Japanese with similar problems in their financial system have now been hopeful for twenty years that their economy will fix itself. Wishful thinking doesn't fix markets, nor do plans involving spining straw into gold -- no matter what central bankers and their toadies claim.

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.

Can the EU Solve Its Debt Crisis with More 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.

European and U.S. stocks were rallying on Friday in what appears to be a liquidity frenzy supplied by the central banks. The market is once again hopeful now that EU leaders are beginning six days of meetings on how to save Greece and the euro. Based on their previous track record, which has led to the current crisis, there is little reason for long-term optimism.

Stock prices have not been the only thing rising lately.  Interest rates have been too in the credit- challenged Eurozone countries. While yields of Greek one-year governments have fallen back to only 180%, they were as high as 189% on October 19th. Greek two-years are at a more manageable 77%. Rates keep increasing in Greece despite the bailouts and this indicates the bailouts aren't nearly large enough and will have to continue and get bigger to keep the country out of default.  The political will for ongoing and ever-larger amounts of bailout money doesn't exist in the EU or does it?

While the EU voting public doesn't approve of spending more rescue money, the EU has created the EFSF (European Financial Stability Facility) — a 440 billion euro fund to help bail out its member countries that have debt problems and to bail out the banks that lent them the money that allowed them to have those debt problems. Much remains to be decided on how the EFSF will actually function. There is disagreement of how to use it to bail out failing banks for instance (this is currently being referred to as recapitalization since bank bailouts are also unpopular with voters). There is also a proposal to leverage EFSF funds up to five times, so there will be more than two trillion euros available. This idea is apparently a "helpful" suggestion made by the U.S. monetary authorities.

While the stock market is showing almost as much enthusiasm for the leveraged bailout proposal as it did for the great innovation of triple A rated subprime mortgages in the mid-2000s, such financial trickery ended badly the first time and is likely to fall apart even faster this time. Mainstream media coverage, at least in the U.S.,  rarely looks at where the money is coming from for the EFSF. Technically, the money is being borrowed. So in order to deal with a debt crisis that is wreaking havoc on the financial system because of too much risk, more money will be borrowed and then that money will be leveraged (a form of borrowing in and of itself) to magnify the risk of the new borrowing. If this appears not to make any sense at all, that's because it doesn't. When the default comes — and there is 100% chance that it will —  the end will be much, much worse.

A case can be made however that the EFSF money isn't really borrowed, but a form of money printing instead. If governments borrow without the ability to actually pay back the money without inflating their currency, they are printing money. EU countries are already highly indebted just like the United States (Japan is in even worse shape). The fact that there is a debt crisis in a number of Eurozone countries is confirmation that the level of debt is beyond the point of no return. So a more accurate portrayal of what is going on with the EFSF is that money will be printed, this counterfeit money will be leveraged by borrowing against it and this will solve the problem of too much debt. 

The world has already lived through a debt binge in the early 2000s. The current crisis centered in Europe is simply a continuation of the unraveling of that debt. Governments handled the first implosion with trillions of dollars of bailouts, by running trillions of dollars in budget deficits, and by printing trillions of dollars of money. Debt problems keep resurfacing however. Could it be that engaging in additional reckless and irresponsible financial behavior isn't a solution for reckless and irresponsible financial behavior? EU leaders may wish to ponder this before going forward. 

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.

Debt Crisis -- Greece 2011 Compared to Argentina in 2001

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.

Headlines such as "Hopes for Greek debt progress lift world stocks" and "Wall St opens higher on European hopes" are in the financial news today. Before investors buy into the hype, they should realize that the powers-that-be always deny an obvious and inevitable default before it takes place. Greece in 2011 is on a very similar trajectory to Argentina in 2001 and is well past the point of no return for a default just as Argentina was back then.
There are many similarities between the current Greek debt crisis and the Argentina debt crisis in 2001. Greece is not using its own currency, but a transnational one, while Argentina pegged its currency to the U.S. dollar.  A connnection to a greater currency allows only limited policy responses and prevents the usual money printing that would have take place when debt becomes too high. This in turn causes a gradual rise in inflation up to the point of hyperinflation (Greece and Argentina have both experienced hyperinflation in the past). While skyrocketing interest rates in Greece are implying there is massive inflation, the official inflation rate is under 3%. Yields on one-year Greek governments reached approximately 100% on Tuesday, telling a very different story.  

While the Greeks are certainly underestimating their inflation rate (they have been caught lying and continually underreporting their debt figures and no numbers from the Greek Statistical Office can be trusted), it is relatively minor no matter what the actual number. Inflation is caused by a falling currency and hyperinflation by a collapsing currency. Since the euro is not dropping that much and Greece uses the euro, inflation is not showing up there. Argentina tying its currency to the dollar also created a very low inflation rate as long as the peg lasted.  There is no free lunch however (even though you may have repeatedly heard that there is from politicians). Profligate government spending eventually leads to major inflation. The inflation only showed up in Argentina after it decoupled its currency from the U.S. dollar and it will show up in Greece after it decouples from the euro. Instead of gradually building inflation, sudden major inflation will take place.
The Argentina crisis began when a new government was elected in December 1999 and had to deal with years of mismanagement from the previous administration. Greece elected a new government in October 2009 and shortly thereafter it revealed that it had a lot more debt and higher budget deficits than it had claimed. In both cases, sharp spending cuts were implemented and serious riots followed. By December  2000, Argentina had acquired bailout funding from the IMF. Markets rallied and press reports indicated everything was going be OK. Greece received its first bailout from the EU and the IMF in the spring of 2010 and markets rallied and press reports indicated that everything was going to be OK.  In both cases everything that followed wasn't going OK.
By the spring of 2001, events started spiraling downward in Argentina. In the spring of 2011, events started spiraling downward in Greece. In August 2001, Argentina received an increase in its standby loan agreement from the IMF. Greece received promises of a second bailout from the EU, but with some mandatory debt swaps as part of the deal. Argentina engaged in debt swaps in June of 2001. Interest payments on Argentina's debt eventually overwhelmed rescue attempts and on December 5, 2001, the IMF announced it would not disburse promised aid to Argentina. A collapse followed shortly thereafter. The EU is now questioning whether or not to continue to make disbursements to Greece. If the disbursements stop at any point, Greece will default shortly thereafter just as Argentina did.

No government is of course going to admit that it is going to default. If it did, no one would purchase its bonds and this would cause an immediate default.  It is not surprising that the Greek government is denying the obvious, EU leaders are grasping at straws to explain how a Greek default will be avoided, or that the mainstream media is trying to spin those straws into a golden fantasy of solvency. Argentina denied that it would default right up to the end as well, just like every other country (and major company) facing the same predicament has in the past. Despite the claims that, "this time is different", it never is.

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.

Interest Rate Spread Widens as Greece Heads Toward 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.

Global interest rates continue to diverge, with rates rising in the troubled eurozone countries and falling to new lows in Germany and the United States.  The same sort of divergence took place during the 2008 Credit Crisis with yields on safe-haven governments falling markedly, while yields on low-grade corporates soared.

Nowhere in the world is the current interest-rate spread more extreme than in the Eurozone (the epicenter of the current credit crisis). Greece is leading the pack with ever-rising yields on its government paper, while German rates keep falling. In Tuesday morning trade, two-year Greek government yields reached a high of 74.88% and ten-year yields a high of 25.01%. Yields on German 10-year bunds were moving in the opposite direction falling as low as 1.679%, even lower than Monday's record-low rate of 1.877% on 10-year U.S. treasuries.

Italy had an auction of 5-year bonds this morning and had to pay a 5.6% yield to get them out the door
compared to 4.9% in July.  Interest rates on the Italian 10-year were at 5.75%. They were over 6% before the ECB started buying Irish, Portuguese, Spanish and Italian bonds on August 8th to force down surging rates as contagion from Greece spread to other parts of the Eurozone. Before that, yields in Ireland had reached approximately 14%, they were over 13% in Portugal, and in Spain they were at similar levels to Italy. Intervention can only maintain below free market rates for so long however. Eventually, the ECB will run out of funds.

The trajectory of Greece's decline toward insolvency is instructive for the future of Ireland, Portugal, Spain and Italy in the near future and for other highly indebted countries such as Japan, the United States and the UK later in the decade. In early 2010, Greek 10-year rates spiked above 12%, but were then driven below 8% with the first bailout. Greece had a debt to GDP ratio around 120%. Severe budget cutting was implemented to hold the debt down. This caused the economy to contract sharply, which lowered tax revenues. Despite the first and now a second bailout a self-feeding spiral of ever-increasing interest rates began. Higher interest rates and a weakened economy have caused the debt to GDP ratio to reach the 140% level (according to official numbers, estimates are as high as 160%). Rates on credit default swaps now indicate a 98% chance of default.

What the immediate effects of a Greek default will be remain to be seen. There will certainly be damage to the Eurozone banking system, which is still in a weakened state from bad loans accumulated before the 2008 Credit Crisis. At some point, the euro will have to be restructured or
it will be weakened considerably. Economic damage will not be limited to Europe, but will affect other regions of the globe just as was the case in 2008.

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.

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.

EU and UK: Raise Taxes and Cut Stimulus

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.


Europeans seem bent on acting like lemmings to the sea and jumping off an economic cliff. Not only are the eurozone and UK raising taxes and cutting spending, they want the rest of the world to follow their lead and will try to get this to happen at the next G-20 meeting in late June.

Why anyone would want to follow European countries on economic matters is a real puzzle. The EU's recent handling of the Greek debt crisis will be recorded by history as one of the major episodes of government ineptness of our time (and there is really stiff competition in that category).  Instead of dealing with the problem immediately and decisively by instituting dollarization and removing Greece from the currency union, EU leadership let the matter fester until it blew up. They then tackled the problem with an approximately one trillion-dollar bailout. The EU approach to economic problems seems to be: Why institute a simple cheap solution when an expensive difficult one is available? It's enough to make one ponder if EU policy meetings resemble a multi-lingual idiot's convention.

Over the weekend German Chancellor Angela Merkel stated that she was going to push for a swift exit from fiscal stimulus programs and a focus on debt reduction at the next G-20 meeting. It was German foot dragging on the Greek debt crisis that caused the euro to lose 20% of its value in six months. With a record of success like that, of course the rest of the world should be eager to copy Germany's economic policy ideas. Earlier in June, Merkel's cabinet unveiled substantial budget cuts and tax hikes. France did the same thing recently as have other eurozone countries. Merkel is also spearheading the drive for an international financial transaction tax with the money being used for future bailouts. The possibility that there shouldn't be government bailouts of financial institutions or that the financial institutions that might be bailed out should pay the tax themselves and not their customers seems to have eluded Merkel. Of course, financial centers like London and New York would shoulder a disproportionate amount of the burden, so it is the ultimate socialist solution - get the other guy to pay. Perhaps Merkel isn't as economically challenged as seems to be the case.

Conditions don't appear to be much better in the UK, although we won't find out until Tuesday, June 21st when an emergency budget will be announced by the Conservative-Liberal coalition government. The UK is part of the EU, but not part of the eurozone so it is not obliged to follow the 3% budget deficit to GDP limit imposed there (not that the eurozone countries themselves follow this rule). Like their fellow EU members, suddenly the Brits woke up and realized they had massive deficits (they should have been reading the papers, it's been reported there on a regular basis). Large spending cuts and tax increases are on the table. Even then, the UK's budget deficit could reach 10.5% of GDP in the 2010-11 fiscal year (still less the U.S. number for 2010). It is thought the VAT (value added tax) will be raised from 17.5% to 20.0%. There have been rumors that the capital gains tax rate will be raised from 18% to 40%. If this occurs, money will flow out of British markets at a prodigious rate.

If what's going on in Europe sounds familiar to Americans, it should. These were essentially the economic policies of the failed Carter administration in the late 1970s. During that era, the U.S. economy was chronically weak and the stock market went nowhere. This economic program instituted today could have far worse consequences. The global economy was severely damaged by the Credit Crisis and is still in a very fragile state. It is likely to go into a tailspin.  The predictable follow up will be a return to spending. This scenario happened during the Great Depression after Franklin Roosevelt tried to balance the budget after the 1936 election and the U.S. economy and stock market tanked. If elected officials today are determined to repeat the mistakes of the past, investors should take note and act accordingly.  
 
Disclosure: None

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.

House of Cards Falling Down

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. housing data for May was out today and no matter how you look at it the report was bleak. The number of houses under construction fell to a record low of 475,000. The 17% drop in single-family homes was the biggest since the 1990-91 recession. Applications for permits were the lowest in a year.

There were hints that the housing market was already in trouble last month when construction permits fell 10%. They dropped an additional 5.9% in May. The federal government housing tax credit expired at the end of April and builders clearly understood that without government subsidies consumers were going to take a hike. And take a hike they did - mortgage purchase applications peaked on April 30th, the last day of the tax credit, and are now at a 13-year low even though mortgage rates have come down.

Housing starts are now down 70% from their peak even though the federal government has made Herculean efforts to support the market. U.S. housing was in a bubble and there is no case in history of a bubble being reinflated immediately after a collapse. Trying to do so is equivalent to pouring money down a drain. There is no better example of this than ongoing federal government subsidies of Fannie Mae and Freddie Mac. Bloomberg has just estimated that these will reach $1 trillion (more than the entire TARP program). U.S. taxpayers are footing the bill. Fannie and Freddie are going to be delisted from the New York Stock Exchange, probably on July 8th. So much for unlimited financial support from the federal government leading to success.

Housing was the epicenter of the Credit Crisis collapse. The market has not returned to health and it is not likely that it will for many more years. The overall U.S. economy itself is now on the verge of turning down again as well. ECRI leading indicators turned negative last week. The last time they did so was in September 2007. A recession began two months later. So far, the ECRI is downplaying its own data and claiming that its numbers indicate that the U.S. economy will be experiencing 'slow' growth in the next six to nine months.

The 'fast' growth that has been occurring in U.S. GDP has been based on changes in inventory levels and not an actual recovery in the private sector. In Q4 2009, a slower decline (yes decline) in inventories was responsible for approximately two-thirds of the increase in GDP. In Q1 2010, inventory replenishment accounted for more than half of the growth.

While the Credit Crisis had its origins in the U.S., the new unfolding global financial crisis is centered in Europe. There are reports that the IMF and the U.S. Treasury are in talks about a 250 billion euro bailout for Spain. While Spain and the IMF have denied the report, the market indicates some serious problem exists. The risk premium on Spanish bonds over equivalent German bonds has risen to the highest level since the creation of the euro.

Government spending can certainly make the economy or any given sector of it better for a while. Based on the evidence so far, the government has to continually spend or the economy falls right back down to where it was before the spending took place. Even reduced, but still substantial spending is not likely to be enough to keep the economy in the black under such circumstances. Governments have faced similar problems many times in history and have seen that major inflation is the outcome of utilizing this approach. Apparently the world's current regimes are now determined to make the same mistakes again.

Disclosure: None

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 There Be a Summer Rally This Year?

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.


Summer officially begins next week and many investors expect this to be a bullish period for stocks. Markets are trying to rise from a very oversold condition, so early summer shouldn't disappoint. The underlying problems that created the recent sell off are still with us however and they are likely to weigh on the markets once again.

The debt crisis in Europe and the drop of the euro have been the major force controlling market action for the last couple of months.  The euro (FXE) has traded down from an intraday high of 151.27 on November 25th to a low of 118.79 on June 8th. It has been rallying the last few days, but despite mainstream media reports about improving economic conditions in Europe, the reasons are technical. The bad news has not ended either, but perhaps it is now expected and already priced in the market. Yesterday, Moody's downgraded Greece's credit rating four notches to Ba1. S&P had already downgraded Greek debt to junk status on April 27th, so Moody's move shouldn't have been surprising. France also announced a three-year budget plan to cut its deficit to GDP ratio to 3% by 2013. It will be around 8% this year (still less than the estimated 8.8% in the UK). Budget cutting is pervading EU countries in an effort to maintain the maximum 3% deficit limit, which was established during rosy economic times and became impossible to meet because of the Credit Crisis. Eurozone leadership apparently made no contingency plans in case anything went wrong, nor do they seem capable of handling a crisis when one occurs.

The other issue weighing on the market this spring has been BP's deep-sea oil spill in the Gulf of Mexico. This is already the biggest oil related environmental disaster of all time and the oil leak is not likely to be stopped anytime soon. Fitch downgraded BP six notches today to BBB (still above junk). President Obama will be addressing the nation tonight and will demand BP provide $20 billion in funds that will be used to pay off damages. This should be considered only a token sum of the actual final costs. Many of the biggest potential lawsuits against BP haven't even been filed yet. It took 20 years to resolve all the litigation from the Exxon Valdez spill, so BP could be in court until 2030. BP leadership apparently made no contingency plans in case anything went wrong, nor do they seem capable of handling a crisis when one occurs.

Budget cutting in Europe is only going to hurt the still fragile and highly socialized economies of the Eurozone. A return to recession is quite likely there if the cuts are actually implemented. In the U.S., reports indicate that the Federal Reserve is now putting together plans on what to do in case of a double dip recession.  So far, the good GDP numbers have been based on inventory restocking (or even inventories dropping at a lower rate) and not an actual growth of the U.S. private sector. The American economy has been expanding with the expansion in federal government deficits. The economic numbers could easily turn south again in the fall, as the deficit is supposed to decrease for fiscal year 2011 (beginning this October 1st). At least the Fed is making contingency plans in case something goes wrong, but it is not clear that they will be capable of handling a crisis when one occurs.

In the short-term though, the stock market seems to want to trade on the technicals, with possibly a little money pumping from the major central banks helping it along. The euro is overbought and needs to rally to resolve this condition and the U.S. trade-weighted dollar (DXY) is oversold and has hit major resistance in the 88 area so it needs to sell down. The period around the July 4th holiday is usually a positive one for U.S. stocks. Late July can be quite negative however. It is best to look at the markets with a short-term perspective at the moment.

Disclosure: None

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.

Markets Trading Like They Did During Credit Crisis

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.


Stocks are selling off globally. Commodities are down, but gold is holding up the best. Money is pouring into the perceived safe havens, the U.S. dollar and treasuries. Is it the late fall of 2008 or late spring of 2010?

Without further information, you can't answer that question. There is a global financial crisis occurring now because of the problems with the euro. There was a global financial crisis in 2008 because of the collapse of the prices of derivatives related to subprime mortgages. The problems with subprime debt had begun the year before and started impacting stocks in July 2007. Stocks were already in an advanced bear market sell off by the fall of 2008. The current euro crisis is only a few months old and U.S. stocks are only in a correction so far (loss of over 10% versus loss of over 20% for a bear market).

The current stock market sell off is worldwide as it was in 2008. It goes without saying the stocks in the eurozone are suffering, but technical damage can be found in major markets everywhere. The Dow Jones has broken key support at 10,000 twice already. The Nikkei gave up its significant 10,000 level a while ago, closing at 9521 last night. The Hang Seng has fallen below important support at 20,000, dropping to 19,378. In the UK, the FTSE is barely holding above 5,000 today.

The trade-weighted dollar (DXY) was as high as 88.71 in New York this morning (June 7th). This is higher than its peak in November 2008, but not as high as the top in March 2009. There was a major sell off in the middle, with the euro (FXE) having a sharp rally. Something similar is likely to happen early this summer. The dollar is very overbought and the euro is very oversold. The euro has traded as low as 1.1878 today. It may pop back up to the 120 support level and if not, there is stronger support around 115. The dollar is already hitting major resistance, so the set up for a short-term reversal looks like it is taking place.

As would be expected, U.S. treasuries have rallied strongly during the euro crisis. It is highly unlikely that they will get to the extremely low levels they did in 2008. As treasuries rally, interest rates go down of course. Interest rates on the 10-year fell to around 2.00% in December 2008. They were at 3.18% this morning. There is strong chart support at and just above the 3.00% level. So not much more of a treasury rally, interest rate sell off should be expected for now.

Currently gold has recaptured its safe haven status. It was selling off with the euro between last December and this February. Then it started rallying with the U.S. dollar, although it usually trades opposite to the dollar. Gold sold down in the fall of 2008. Central bank leasing was responsible for this. The big banks and large hedge funds leased gold at a small price and then sold it on the market to raise desperately needed cash. This is not happening at the moment to a significant enough degree that it can offset buying elsewhere. Ironically, a sharp relief rally in the euro could be short-term bearish for gold. Despite the selling in the fall of 2008, gold still closed the year up along with the U.S. dollar and U.S. treasuries. Almost every other asset closed down. It's still too early to tell if 2010 will end the same way.   

Disclosure: None

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.

Monday Update on the 2nd Global Financial Crisis

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.


It's Monday May 17th and the Euro is heading lower, having broken its low from Friday. The trade-weighted dollar has hit new highs for this move. European stocks are having a mild rally, while U.S. stocks are mostly flat. Asian stocks sold off on Sunday night. The ECB is withdrawing liquidity from the market and this should be a negative for stocks going forward.

If there is to be a near-term recovery in world stock markets, it is important that the euro rallies back to and above the 125 level - its low during the Credit Crisis.  The euro (FXE) traded as low as 123.24 on Friday and today has been as low as 122.71 in New York morning trade. A significant break in support has taken place and this is a major development. In all likelihood it indicates a much lower low in the future. What that low will be and when it will take place are of course the key questions that need to be answered. The euro's next support is at 1.20, and it is now heading to that level. That support is relatively minor however. A number of technicians claim better support around 1.07. The equivalent strong support that existed at 1.25 would be at 1.00 however. What unfolds in the future depend on how the EU continues to handle matters affecting the currency. Up to this point, we have only seen world-class ineptness coming out of Brussels.

For its part the ECB (European Central Bank) announced that it would launch a program on Tuesday to re-absorb the liquidity that it pumped into the market early last week. They intend to withdraw $21 billion (16.5 billion euros) through this operation. If the liquidity injection was good for stocks (the market did indeed have a huge rally coincident with the ECB's move), investors should consider the withdrawal of liquidity should be bad for stocks.

In Asia the Nikkei in Japan was down 2.17% last night and the Hang Seng in Hong Kong fell 2.14%.  European markets had a modest rally today, with the FTSE in England and the DAX in Germany rallying about half a percent. U.S. markets were basically flat in morning trade (they turned down dramatically just around noon). The trade-weighted dollar (DXY) was as high as 87.06.  The U.S. markets had a massive gap up on Monday May 10th. This can be seen most clearly by looking at Nasdaq, where no specialists delay the open to balance buying and selling. Prices fell into the gap on Friday and the very short-term technicals in the day's trading were ugly. The rule of thumb it that once a gap is partially filled, it will be completely filled (prices will go down to the bottom of the gap in this case).

Investors need to realize that the world's central banks are well aware of this crisis. How much comfort this should be to them is open to debate. The central banks all saw the global financial disaster that resulted from Lehman's failure in the fall of 2008. They all know that a small currency crisis in Thailand in 1997 spread throughout Asia and then damaged world stock markets for more than a year thereafter. This knowledge though didn't prevent the ECB from sitting on its hands for more than six months while the situation in Greece escalated into an international problem. The central banks then finally acted with a trillion dollar bailout (likely to be just the beginning). So, we can conclude the central banks haven't learned to react in time to prevent a future crisis, but they do know how to print money - a talent that has some serious downside risks if you don't like inflation.

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.

Euro Problems Threaten World Markets

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.


These days a trillion-dollar bailout just doesn't seem to go that far. Spending that amount to rescue the euro made the markets euphoric for only a couple of days. While stocks rose sharply immediately after the announcement, they are now selling off again. The euro itself is testing its low made in the fall of 2008.

The euro is being rattled today because of reports that French president Sarkozy threatened to pull France out of the currency union. This allegedly happened (the French deny that it did) at a May 7th meeting of ministers before the bailout plan had been worked out. If it did happen, it's old news. If you only read the press headlines though, you would think it had just occurred and is a new development. It didn't and it isn't. The source for this news item came from Socialist leaders in Spain. They may wish to see the euro system fall apart to further their own anti-capitalist agenda and to increase their personal power. So can you believe what they are saying?

So far in New York trade this morning, the euro (FXE) has traded as low as 123.24. This takes out the Credit Crisis low of 124.04 on October 27, 2008.  The euro has major technical support around the 125 area. A break of that level is a serious problem. The next step down is to around 120. A nose-diving euro is not just a problem for Europe however. In our globally interconnected economy, it will spread around the world like a financial tsunami. Not only is there a danger of dropping stock markets, but economies will be damaged as well. While the euro was falling this morning so were U.S. stocks. The Dow was down almost 200 points and the Nasdaq 60 points. The trade-weighted dollar (DXY) traded up as high as 86.24.

The euro has gotten to its current troubled state because of a complete lack of planning, an inability to face reality, failure to consider intelligent alternatives and a delay in taking action on the part of the eurozone leadership. Instead of making the hard decisions to handle the problems that began with the Greek debt crisis, they have engaged in stonewalling and dealing with the PR aspects of the problem, instead of solving the problem itself.  Unfortunately, this type of economic leadership is not unique to Europe, but is typical in most of the world today. If the euro blows up, Americans will be very much aware of it because of the big hole it leaves in the U.S. economy.

Disclosure: No euro or dollar postions.

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.

Liquidity from Euro Rescue Pumps Up Stock Market

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 I have said many times, liquidity is ultimately the driver of stock prices. A perfect illustration of that took place on Monday when a trillion dollar rescue package was announced for the euro before the market opened. After finding out about the latest big liquidity injection into the global financial system, traders went wild and the Nasdaq gapped up 100 points. Huge volatility though is rarely a good sign for the stock prices going forward.

The extreme move up could be seen as a positive event, if the problems in the eurozone will actually be solved by the recently announced euro rescue package. This is unlikely. First the need for a large-scale regional bailout indicates that we are still suffering from conditions that arose during the Credit Crisis. These have been papered over by previous massive bailouts that have paused the problems the world faces, but have not created long-term solutions for them.  Spending more money on bailouts means printing more money and this will ultimately have unpleasant consequences down the road.

Investors need to realize that the euro rescue effort is a bailout for the big banks, the ultimate beneficiaries of the many trillions spent previously by government  and central bank Credit Crisis programs. The debt crisis in Greece could have been solved instantly and without spending one penny on a bailout, if dollarization had been used to deal with the problem. Under this approach, Greece would have been allowed to continue to use the euro, but been kicked out of the currency union. This would have prevented contagion to the entire eurozone and markets worldwide. It would have cost nothing. Instead, we now have another trillion-dollar bailout to rescue the global financial system.

The euro rescue package consists of three parts. The biggest part is $560 billion in new loans from the 16 countries that are part of the eurozone. Of those 16 however, five - Greece, Portugal, Ireland, Spain and Italy (the so called PIIGS) are troubled. So it might be more accurate to say that these loans are really from the 11 more solvent countries in the currency union. The second part of the package is $318 billion from the IMF. The IMF is controlled by the United States from which it gets around 40% of its funding (if not more). So American taxpayers are participating in bailing out Europe for its misdeeds and incompetence. The third and smallest part of the rescue program is a $76 billion lending facility from the European Commission.

The huge gaps up in stock prices on Monday morning came after a short-lived market meltdown in U.S. stocks the previous Thursday. In a span of 16 minutes, the Dow Jones Industrial Average dropped 700 points and then rose 700 points. The Dow essentially opened up 400 points higher on Monday morning. Healthy markets don't have multiple big moves up and down, especially within a short period of time. Sudden big drops in the spring can frequently lead to much bigger drops in the fall. Recovery in the middle, usually lulls investors into a false sense of security. You may want to think about that while you're relaxing at the beach this summer.

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.

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.