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.

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.