by Jon Markman | July 25, 2012 12:15 pm
The week is off to a negative start, not because of earnings — which are bad — but because of Europe, which is really bad. I’m afraid the crisis in Europe is now deepening and broadening, and it’s moving into a stage in which it does not just threaten countries like Greece, Portugal and Ireland, but is actually sweeping into Spain, Italy, France, Belgium, Austria and even the Netherlands.
Germany, the largest and most important county in Europe in terms of the economy, cannot stand alone as an independent pillar of strength in this environment, as all these countries are its customers as well as its dependents. There’s little doubt that Germany’s economy will be driven into recession, even if it decides not to help out its eurozone partners like Greece and Spain.
The problem is that monetary policy, as executed by both the Federal Reserve in the United States and the ECB in Europe, has loosened to a far greater extent already than anyone expected, and there haven’t been any appreciable improvements in the economies of Europe or in the United States. And now that countries in Europe (as well as the United States, but particularly in Europe) are tightening their budgets on a fiscal point of view in order to stop spending, they’re exacerbating the problems by pushing state workers as well as private sector workers out of work and then cutting off their unemployment benefits.
You wonder looking down the road, what could snap Europe as well as the United States, but particularly Europe and Asia, out of this deflationary spiral? I thought of a couple things.
One of them would be a eurozone-wide bank holiday. You may remember the term bank holiday from your text books about the Great Depression. President Roosevelt decreed an eight-day bank holiday in the middle of the depression, and it actually worked quite well. It’s very harmful to certain people, but helpful to many others.
In a bank holiday, policymakers would essentially hand over banks’ equity to senior bond holders and leave the current equity holders with nothing. So that would extinguish all the many debts that are held by the banks and let the banks start over. Naturally, this saves the bond holders and the depositors — and is a good result for taxpayers as well. But debt holders do take a big haircut on what they’re on, and the equity holders end up with nothing.
The only other option that I can see is a massive money print by the European central bank as a last resort, which would allow banks and sovereign governments to pay back their debt holders with a diluted form of money.
All three scenarios that are on the table right now that could be discussed are to do nothing (which is the current plan), bank holiday or money print. They all should make you very nervous.
The U.S. government as well as the U.S. central bank as well as the Federal Reserve as well as the U.S. major banks such as JPMorgan (NYSE:JPM) and Citigroup (NYSE:C), hold a lot of European debt. As much as they will say that Europe is not important to their balance sheets, they are wrong. It’s very important. And there’s a contagion effect. People will think that if large banks in France and Italy and Spain can go down, why not U.S. banks? People will try to pull their money out of U.S. banks, and it could be a pretty big mess.
I don’t think the worst-case scenario is going to happen. Usually these crises muddle along until policymakers figure that they need to take dramatic action. But I think that it’s going to create a pretty difficult summer for U.S. equities, particularly since U.S. companies are having so much trouble earning money anyway.
In my publications, particularly Trader’s Advantage, I have been recommending short sells on the financials as well as selected technology companies. I’ll be looking forward to an opportunity when stocks bottom out and we can start buying into this panic, rather than stepping aside and just letting it transpire.
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