Euro Crisis: Starting to Look Like Lehman All Over Again

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


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

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

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

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

Disclosure: No positions at all.

Daryl Montgomery Organizer,
New York Investing meetup
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.

Greek Debt Crisis: Why Not Try Dollarization?

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.


Like a thousand page novel that never gets to the climax, the Greek debt crisis is still dragging on. Terms have yet to be worked out for the aid package from the EU and IMF and the Germans seem hesitant about providing it. The market reacted by pushing yields on two-year Greek bonds above 13% today. Even with the proposed aid, Greece's debt problem will merely be put on hold until next year and not solved.

Greece is only 2% of the EU economy, yet its debt crisis has had outsized impact on global markets. Funds have flowed out of Europe into North America and Asia because of it. This has particularly benefited the U.S. and Canadian dollars and weakened the euro. Constant talk about the potential collapse of the euro currency union has accompanied these moves. This has happened not just because of Greece, but also because of looming problems in Portugal, Ireland, Spain and Italy.

There have been suggestions that Greece leave the euro currency union, at least temporarily, and start reusing the drachma. This would be more than disruptive to say the least. I have seen no one recommend the obvious solution of dollarization. This doesn't mean Greece would use U.S. dollars; it would still use the euro, but not as a member of  the currency union. Dollarization is the generic term for when one country uses another country's currency. Panama and Ecuador for instance use American dollars as their official currency, although neither is part of a currency union with the United States. In early 2009, Zimbabwe dealt with its hyperinflation problem by allowing foreign currencies to be used in the country. One of those currencies was the euro.

The EU should consider handling the problem with Greece by temporarily suspending it from the currency union with the understanding it would still be using the euro. Greece could rejoin when its debt problems were finally resolved. This of course might not be soon. At some point a country accumulates so much debt that default becomes inevitable. That point differs for every country. Greece looks like its already gotten to that state with its debt to GDP ratio over 100%. The debt to GDP ratio for Japan is going to be over 200% though this year and it is still functioning better than Greece. Japan has its own currency though and can therefore print any amount of extra money if need be. It has funded its spending internally by borrowing the massive savings of its people. That game is over however and the situation there could eventually turn ugly almost overnight as occurred in Greece.

While Greek bond interest rates and spreads are hitting new highs, the euro itself is trying to stabilize. A look at its chart shows that it has so far made a triple bottom in late March, early April and mid-April trading. Traders are obviously getting bored with selling the euro down and the currency will be due for a rebound soon. How long that lasts depends on how the EU handles its member countries ongoing debt problems. So far, it's been only an unending number of promises with no results out of Brussels.

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.

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.