Wednesday, November 9, 2011

How Bad is it?

I do not know what will happen next in the Eurozone. But the situation is not good. Since I posted last Saturday on the the trouble in Italy, things have worsened--the ten year yield on the Italian bond today stands at 7.25--dramatically higher than the very dangerous level I spotlighted at the close of Friday.

Here is a canvas of expert opinion:

Alistair Darling, Former UK Chancellor of the Exchequer: “I despair of the way in which EU leaders are constantly behind events. I do not think enough people realise how serious this crisis is, and how hard it is going to hit us. This is far worse than the banking crisis of 2008.”

Paul Krugman, Noble Prize Winning Economist: "I believe that the ECB rate hike earlier this year will go down in history as a classic example of policy idiocy. We would probably still be in this mess even if the ECB hadn’t raised rates, but the sheer stupidity of obsessing over inflation when the euro was obviously at risk boggles the mind. I still find it hard to believe that the euro will fail; but it seems equally hard to believe that Europe will do what’s needed to avoid that failure. Irresistible force, meet immovable object — and watch the explosion."

Jim Rogers, legendary hedge fund manager: "We're certainly going to have more crises coming out of Europe and America; the world is in trouble. The world has been spending staggering amounts of money that it doesn't have for a few decades now, and it's all coming home to roost now. Last time, America quadrupled its debt. The system is much more extended now, and America cannot quadruple its debt again. Greece cannot double its debt again. The next time around is going to be much worse. In 2002 it was bad, in 2008 it was worse and 2012 or 2013 is going to be worse still – be careful."

Jeremy Warner, business columnist for the London Telegraph: "[UK] Treasury analysis points to negative consequences for the UK from a disorderly break-up of the euro, with economic contraction and financial chaos at least as bad as that which followed the Lehman Brothers collapse three years ago.With the Government’s deficit reduction strategy in ruins, interest rates would soar, condemning the UK to the sort of disastrous debt dynamics which have engulfed Italy. The whole of Europe would soon slip into prolonged depression. The UK economy may already be in some form of renewed recession and a eurozone breakdown would multiply its effects. But despite the threats posed, there is still very little sign of the eurozone adopting the policies necessary to save the single currency. As recently as last July, the ECB was still raising interest rates, greatly exacerbating a serious economic slowdown outside its doors. Even if the euro survives, the austerity imposed on the eurozone periphery will deny growth and could condemn the single currency area to years of stagnation or worse."

Simon Johnson, MIT economist and former IMF Chief Economist: "We have built a dangerous financial system in the United States and Europe. We must step back and reform the system. Like 1931, people thought the worst was behind them, but instead the crisis just broadened. The last crisis cost 50% of GDP and involved the socialization of losses but even that has failed to address the fundamental issues. We are looking straight into the face of a great depression.”

Brad Delong, UCal Economist and former Treasury Official: "Time to spread foam on the runway: The Federal Reserve needs to act Now to firewall off the Eurocrisis. I have been complaining for some time now that Reinhart and Rogoff think that the time is always 1931 and that we are always Austria--that the great fiscal crisis is about to erupt and send us lurching down toward Great Depression II. Well, right now guess what? The time is 1931, and we are Austria. The Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash before the increase in eurorisk leads American finance to tighten credit again and send us down into the double dip. The Federal Reserve needs to do so now."

Christine Lagarde, Managing Director of the IMF: "There are clearly clouds on the horizon. Clouds on the horizon particularly in the advanced economies and particularly so in the EU and the United States. Our sense is that if we do not act boldly and if we do not act together, the economy around the world runs the risk of downward spiral of uncertainty, financial instability and potential collapse of global demand. We could run the risk of what some commentators are already calling the lost decade."

From The Economist:
"I have been examining and re-examining the situation, trying to find the potential happy ending. It isn't there. The euro zone is in a death spiral. Markets are abandoning the periphery, including Italy, which is the world's eighth largest economy and third largest bond market. This is triggering margin calls and leading banks to pull credit from the European market. This, in turn, is damaging the European economy, which is already being squeezed by the austerity programmes adopted in every large euro-zone economy. A weakening economy will damage revenues, undermining efforts at fiscal consolidation, further driving away investors and potentially triggering more austerity. The cycle will continue until something breaks. Eventually, one economy or another will face a true bank run and severe capital flight and will be forced to adopt capital controls. At that point, it will effectively be out of the euro area. What happens next isn't clear, but it's unlikely to be pretty."

Ok, that is all pretty grim. But I worry things may still darken more. France is now seeing a rise in its cost of borrowing, and French financial strength is the only hope for any solution at this point. And, Spain now appears to be worsening too. Also, the margin required to hold Italian debt was increased so if investors want to continue to hold (or buy) Italian debt they need to pony up more cash. Imagine that, paying for the right to get hammered on an investment. Last, but not least, Germany and France are now openly discussing the break-up of the Eurozone, under something called "two-speed Europe." Yikes!

On a more happy note: tomorrow must be better than today. Right?


  1. After reading the above expert opinions, I too am quite depressed about the near term future. I think the expert from The Economist is spot on in describing the situation in Europe as a death spiral. It seems the solutions are becoming fewer and less effective each week with the exception of temporary blind euphoric moments due to the newest bailout. Recent developments only serve to reinforce my belief that the situation is uncontainable and that it is only a matter of time before the true extent of it all will be realized. Wasn't it just a couple of weeks ago that the long awaited resolution over Greek debt was "voluntarily" agreed to by the European banks? At the time, one would have though that all was well, but obviously this is much larger than the public is being led to believe.

    I did find the recent open discussion of a Eurozone break-up telling in that, before now, I think most analysts would have considered such an outcome highly unlikely. My prediction is that whether a meltdown occurs or not within the next 6 months to year will depend entirely on Italy. Italy can not and it appears will not be offered the same forms and degrees of support that Greece was offered. If the above expert opinions are even close to accurate then the odds emerging from this crisis unscathed seems slim at best.

  2. I completely agree with Darling's assessment of the magnitude of the crisis. Sovereign debt for too long was considered safer than other debt and many banks invested heavily in it to satisfy their capital requirements. But, like the mortgage backed securities of 2008, we find out this debt is not worthy of its credit rating either.

    To Krugman I would simply say that the ECB has a long history (if long can apply to a central bank with less than a twenty year history) of focusing on price stability and letting the member states worry about their economies. Furthermore, given the run up in commodity prices recently it is not unreasonable to argue that a monetary policy of price stability would provide a better stimulant to the ailing Euro economies than a loose monetary policy. After all Europe's only hope is to somehow grow out of their current fiscal mess. Austerity and tax increases will only compound the current problem.

    Are we looking at the sequel to 2008? While you ponder that please excuse me while I short some European bank stocks.

  3. Robert_(Memphis Law)November 20, 2011 at 3:43 AM

    Very frightening. I very much doubt the Eurozone will be able to solve this mess. The chaos in Greece and the mixed messages sent by the former Greek Prime Minister Papaandreou on getting their debt under control in the past month are not relieving any fears. Although the proposed Greek Debt Swap may cut the Greek deficit to 5.4 pct/GDP, this will only happen if Greece and its new Prime Minister Papademos gets serious about its problems and targets such problems as tax evasion and the rival parties in Greece can cooperate. (>)
    Likewise, Italy and its new Prime Minister Mario Monti need to get serious about their debt crisis and target problems like fighting the endemic tax evasion in Italy. If countries like Italy and Greece do not take serious steps, it is very unlikely that Germany will come to their aid.
    For the Eurozone to survive the further problems that are predicted to come down the pike for 2012, some analysts feel the Eurozone should take drastic steps like finally brining Turkey into the Eurozone.
    Without any drastic action on the part of Europe, I feel that Jim Rogers best sums it up, “be careful.”

  4. Natasha (Memphis Law)November 23, 2011 at 12:43 PM

    How bad is it? Very bad. According to the 11/22/11 Article, MF Global "filed the eighth-largest ever U.S. bankruptcy after a wrong-way $6.3 billion trade on its own behalf on bonds of some of Europe's most indebted nations."

    This shows that in today's global economy, economic meltdowns occurring in other countries' markets can eventually negatively impact one's own economy.

  5. Unfortunately, the only way out of this mess is for everyone to do more with less. When economies are built on credit extended on the basis of unrealistic returns, what else can one expect? America is headed right down the same road. We now have a national debt of $15 trillion which is greater than our GDP of $14 trillion. Out of the GDP, the federal government takes around $3 trillion to operate. Somehow, Congress believes that amount equates to a spending budget of $4 trillion. Somewhere, something has to give if America is to avoid a complete fiscal meltdown. This country has some of the brightest minds on the planet. We have more wealth than any other country and are still the leading producers and consumers in the world, but if we are going to maintain our strength, we have to use some common sense and forget about absolutist mantras which disallow synergistic problem solving. Meet in the middle. Some loopholes and deductions which produce taxation inequality based on percentage should be closed, which will raise revenue. Some programs which are wasteful must be cut. Everybody must sacrifice, give back some of what we took on credit that shouldn't have been extended, and do more with less.

  6. Kirkland (Memphis Law)November 28, 2011 at 2:41 PM

    I know that recently, Italy's Prime Minister has met with Angela Merkel and Nicolas Sarkozy have met. I feel at this point, we are long past the point of being comforted by a meeting like this and that there is now a desperate need for action, rather than discussion.

  7. Franklin A (Memphis Law)November 28, 2011 at 9:05 PM

    Not only must countries reign in spending but individuals as well. Individuals, like governments, must exist within their means. We are now experiencing the harsh fallout of societies based on debt.