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European Crisis Worse than 2008

-- Posted Thursday, 8 September 2011 | | Disqus

By: Dr. Jeffrey Lewis


While the US markets were closed on Monday in observance of Labor Day, it became grossly apparent that the European debt crisis would be far worse than the American financial crisis of 2008.


Astute investors will notice something vastly different from the European implosion.  Whereas fixed-income securities, primarily US Treasuries, became more attractive to investors as the equity markets tanked in 2008 and 2009, the same isn’t happening in Europe.  As European shares were pummeled in holiday trading in the United States, yields on fixed-income securities rose. 


Typically, the relationship between fixed-income and equity is one of inversion.  When stocks tank, fixed-income rises in value and yields fall.  When fixed-income products fall, stocks rise.  Stocks are considered part of the “risk-trade,” whereas debt is considered a safe-haven investment.


Crisis in Confidence


To see yields rise in Europe while equities fall should indicate to investors that this most recent crisis is fundamentally related to surging debt loads.  The previous go-to safe haven of corporate and government debt simply isn’t safe; there is no way to know which policy decisions may leave some European governments broke and others with a bailout.


Additionally, friendly relationships between EU-represented governments are strained.  Furthermore, corporate giants, which were at worst competitive allies (the largest banks in Europe), now have little confidence in one another. 


Rumors swirl about which European banks are on the brink.  On August 19th, the European Central Bank became a proverbial holding tank for scared investors.  In one day, the ECB accepted $152 billion in overnight deposits, three times the average for the rest of the year, indicating that banks favored zero returns over risking a loan to competing banks, if only for a single day.


PIGS Terrorize Banking Industry


The PIGS group of nations—Portugal, Italy, Greece, and Spain—are the most damaging to bank balance sheets.  In a note to clients, US financial services companies have sought to identify the total possible loss to the European banking sector.  The European Banking Authority reveals that European banks hold roughly 500 million Euros of Greek, Italian and Spanish debt.  Greek debt totals to just under 100 million Euros, while Italy and Spain are on the hook for 317 billion Euros and 280 billion Euros respectively.


Willingness to make banks whole on their sovereign debt holdings isn’t yet clear.  ECB officials have repeated that investors should not expect perpetual involvement by the ECB.  Interestingly, the statement came as the ECB doubled its purchases of Italian debt.


The Fed remains interested in European banking woes.  In a series of statements from early 2011 to today, the Federal Reserve noted that European and American banks would be treated as equals.  The banking business is interconnected, as European and American investors hold countless money market funds and cash instruments, which are invested in debt securities all around the world.


Even though the solution to the European debt crisis has yet to be established, investors should infer from previous bailouts that the next step is inflation.  There is simply no other solution, if one can even call it that.


Dr. Jeffrey Lewis

-- Posted Thursday, 8 September 2011 | Digg This Article | Source:

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