European Debt Crisis Revisited - Implications For the US
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. European Debt Crisis Update
2. ECB Buys Bonds of Italy and Spain
3. Key German Vote on Rescue Package Just Ahead
4. Americans Ready to Clean House in Congress!
5. President Obama’s “Jobs” Speech on Thursday
Editor’s Note: Record Wildfires in Central Texas
You probably noticed that the Central Texas area where I live was ravaged by out-of-control wildfires over the Labor Day weekend, and several large fires continue to burn as this is written. Most of Texas has been in a record drought all year. We also set a new all-time record for days above 100 degrees this summer (over 80 days), and temps have been brutal at 105-112 in recent weeks. It felt like Phoenix in the summer!
Making matters worse, the hurricane that hit New Orleans last week created above normal winds in Central Texas. So conditions were perfect for wildfires, and fires broke out in several locations within an hour of Austin over the weekend. Because of the 30-40 mile per hour sustained winds, these fires were next to impossible to get under control.
My family and I live outside of Austin on beautiful Lake Travis. On Sunday afternoon, a large wildfire broke out just a few miles (five minutes) west of my home. The fire continued to burn all night Sunday and all day on Monday. At one point the fire had consumed over 12 square miles of land, and it’s still not fully under control today.
Needless to say it was a stressful time for us. Fortunately, the weather forecast is calling for light winds and cooler weather for the week ahead, but still no rain on the horizon. Fires are still breaking out in Central Texas as this is written.
As a result, I had little time to focus on writing this E-Letter over the weekend as I usually do. Thus, I have reprinted a couple of interesting articles for you below to finish out this week’s E-letter. Hopefully the wildfire threat will dissipate this week, and I can get back to my normal schedule.
European Debt Crisis Revisited
I have maintained ever since my July 19 E-Letter that the European debt crisis is the single most negative influence on the US equity markets, even more so than the continued disappointing economic reports here at home. As such, it is time to revisit the European debt crisis today. You may recall that in late July the European Union and the IMF announced a second rescue package for Greece, which was to receive the funds later this month.
As a reminder, these rescue packages must be approved and funded by all the EU members, which is quite difficult. Due to some onerous demands by some of the EU member countries, the second rescue package largely unraveled last week, and Greece may yet be faced with a default. This news weighed heavily on stock markets in Europe and the US late last week. The following analysis by Michael Schuman of TIME summarizes what has happened:
QUOTE: Only a bit more than a month ago, the leaders of the euro zone were happily congratulating themselves on overcoming their differences and cobbling together a second bailout of troubled Greece. The package, which includes 109 billion euros ($157 billion) in fresh loans from an EU/IMF bailout fund, was supposed to rebuild investor confidence in the monetary union and alleviate mounting pressure on debt-heavy Greece. But it has done neither. The euro zone debt crisis intensified after the deal, turning up the heat on giants Spain and Italy. And now, bitter infighting within the zone threatens to derail the entire Greek bailout package. If the deal can't be rescued, the failure would deliver a blow that would sink Europe deeper into financial turmoil.
What's the problem? The continued disputes over the second bailout of Greece highlight just how difficult it will be for the euro zone to resolve the debt crisis and solidify its monetary union. The very structure of the union allows too many parties with too many conflicting interests to have too great an impact on policies that impact the future and stability of the entire euro zone. Until the leaders of Europe find some more efficient method of making and implementing decisions, it is hard to envision the euro zone ever escaping from its life-threatening trials.
The case of Finland best shows us how flawed governance in the zone really is. The government in Helsinki, which leans against continued European bailouts, agreed to the second Greek rescue on the condition that it receive collateral for renewed financial support. Subsequently, the Finns and the Greeks worked out a special side deal in which Athens would deposit a chunk of cash in an escrow account for Finland to ensure Helsinki's support for the bailout. (If that arrangement – Greece putting up cash to get more cash – doesn't make any sense to you, that's because it doesn't.) But that bilateral deal quickly fell apart. Germany opposed it, while other euro zone nations, including Austria and the Netherlands, understandably demanded the same privilege as Finland. The Finns won't back down on their demand, and euro zone finance ministries are still haggling over what to do.
The Finland debacle exposes the fundamental flaws in the management of the monetary union. What it reveals is how the domestic politics of any one euro member, no matter how small, can have ripple effects through all of Europe and, in fact, threaten the survival of the euro itself. The Finns insistence on collateral could tank the entire rescue package. Under euro zone rules, the governments of all 17 members have to approve the details of the bailout before funds can be released. That means tiny Finland, which would be contributing a mere 2% of the guarantees for the rescue, could block the entire arrangement. How this gets resolved is a complete unknown. Can Finland be allowed to opt out of the bailout? Will other euro zone countries also insist on receiving collateral, defeating the purpose of the entire bailout?
What we do know, however, is that the consequences of a collapse of the Greek bailout deal would be severe. If the euro zone states can't agree on a rescue for Greece, how would they ever come to terms on a deal to bail out a bigger economy like Spain? A failure of the second Greek bailout would completely undercut what little investor confidence remains that the euro zone leadership can support other indebted members in a time of crisis, implement much-needed reform to the entire monetary union, or stand behind its pledge to protect the euro.
Domestic political issues are emerging elsewhere in Europe as well that can potentially undercut the zone's efforts to resolve the debt crisis. German Chancellor Angela Merkel, for example, is facing mounting opposition within parliament to a plan to expand the capabilities of the euro zone's $1 trillion rescue fund – a reform analysts believe is crucial to help Europe combat contagion. Fear of a political uprising at home have also squelched any hope that Merkel will support the formation of a eurobond jointly backed by the governments of the monetary union, a tool many see as an important method of stabilizing the debt crisis.
Meanwhile, the Greek bailout is being threatened in other ways. Part of the package is a bond swap, in which private holders of Greek government bonds would exchange them or roll them over for bonds with longer maturities, easing the pressure on Athens. The scheme was supposed to be “voluntary,” but policymakers were counting on it getting done anyway. Well, as you can imagine, the “volunteers” aren't exactly lining up to join the program. There are concerns that several large German banks and agencies holding billions in Greek bonds have not yet declared if they will join the swap program. The Greek government, meanwhile, has warned it would scrap the entire scheme if fewer than 90% of the private investors sign up.
So what does all this mean? The squabbling over the second Greek bailout shows just how unlikely it is that Europe can solve its greater problems. The political structure of the euro zone is just not designed for either crisis management or achieving fundamental reform. More importantly, the political will, never strong enough to begin with, seems to be faltering even further. The members of the monetary union simply are not committed enough to that union to make it work. If the euro members can't agree on the Greek bailout, can they achieve the greater integration necessary to solve the zone's problems, which would require even bigger sacrifices? As the euro debt crisis rolls on, I become ever more doubtful that it can ever be resolved.END QUOTE
Greece’s two-year Treasury notes spiked to a yield of 46.5% on Friday, a euro-era record. Clearly, Greece is headed off a cliff if the rescue package is not revived soon. Germany’s Chancellor Andrea Merkel is pushing hard to put the package back together, even though she has no formal guarantee that her own parliament will approve the bailout.
ECB Buys Bonds of Italy and Spain
On August 8, the European Central Bank announced that it would begin large scale bond purchases from Italy and Spain. Previously, the ECB had only bought bonds from the periphery nations of Greece, Portugal and Ireland. These purchases are similar to the US Fed’s quantitative easing programs.
There is a serious debate on whether or not the ECB has the legal authority to buy bonds of troubled European nations. Many believe it does not. Yet the debt crisis is so dire, the ECB has stepped in despite accusations that it has no such mandate.
One thing is sure: the ECB is buying tens of billions of bonds on a scale never seen before. Some speculate that the ECB is acting as the lender of last resort until such time as the EU increases funding for the European Financial Stability Facility (EFSF) bailout fund from €440 billion to €1-1.5 trillion.
If the EFSF is expanded to this much larger level, it would presumably take over the bond buying in place of the ECB. Here too, the expansion of the EFSF must also be ratified by all of the EU members, including Germany, so it is far from a done deal. That puts the ECB in the uncomfortable position of not knowing just how many bonds it will have to absorb in the meantime.
In any event, the ECB is demanding that Italy and Spain undertake serious austerity measures to balance their budgets as soon as possible. Italy’s parliament just approved austerity measures to balance its budget by 2013, and its Senate is expected to approve the measures later this week. All of this underscores the fact that the situation is very dire in Italy and Spain as well.
The ECB spent a record €22 billion (US$31.4 billion) in the week ended August 12 in its initial purchases of bonds issued by Italy and Spain. The ECB made additional purchases of 21 billion euros in the following two weeks, bringing its three-week total to the most since it set up the Securities Market Program in May 2010 to stabilize markets roiled by the debt crisis.
Key German Vote on Rescue Package Just Ahead
By now I assume most of my readers understand that Germany is the big, deep pocket in the Eurozone, and it holds the key to any meaningful rescue plan. The German people are by and large opposed to another bailout of the periphery nations, much less Italy and Spain. Yet as noted above, German Chancellor Angela Merkel is actively promoting such a second larger bailout, this time including Italy and Spain, despite the obvious risks to her political future.
The German parliament is scheduled to vote on the second bailout sometime in the last week of September, between September 23 and September 29. As of today, it is very unclear as to the result of that vote. Odds are about 50/50 as this is written. And this gets us to the bottom line on the European debt crisis:
If Germany votes NO on its participation in this second round of the rescue package, including Italy and Spain, expect the global equity markets to take another serious hit on the downside. This decision should come before the end of this month.
If Germany pulls out, I would expect another serious drop in US equity prices, as we will be back to fears of a further European debt crisis escalation to which there will be no good solutions.
Serious readers/investors need to keep a close eye on these developments as things are changing rapidly. I can’t keep you posted on a daily basis, but things are unfolding on a daily basis, and the next few weeks will be critical.
On the other hand, if the German government agrees to underwrite this new rescue package, it may be resurrected and we may buy some time. How long we don’t know.
Another debt crisis looms on the horizon at the same time the US economy may be falling into a double-dip recession. We gave Europe the sub-prime crisis. They may be are about to give us an even larger one. I hope I am wrong.
Americans Ready to Clean House in Congress!
Congressional approval ratings are at record lows today, even lower than President Obama’s approval rating which is also at a record low. For as long as the congressional approval rating polls have been taken, a majority of Americans always said that their personal congressmen (or women) should not be voted out of office.
In other words, everyone else’s Representatives in Congress should be voted out, but not their own. Well, guess what? A new CNN poll out last week found that for the first time ever, a majority of Americans now feel that even their own representatives should be voted out! Here’s the story from CNN:
QUOTE: Need more evidence that Americans are extremely angry at Congress? Well, here you go: According to a new national survey, for the first time ever most Americans don't believe their own member of Congress deserves re-election.
And the CNN/ORC International Poll released Tuesday also indicates that while Republicans may have had the upper hand in the recent battle over raising the debt ceiling, they appear to have lost a lot of ground with the public and the party's unfavorable rating is now at an all-time high.
Only 41 percent of people questioned say the lawmaker in their district in the U.S. House of Representatives deserves to be re-elected - the first time ever in CNN polling that that figure has dropped below 50 percent. Forty-nine percent say their representative doesn't deserve to be re-elected in 2012. And with ten percent unsure, it's the first time that a majority has indicated that they would boot their representative out of office if they had the chance today.
"That 41 percent, in the polling world, is an amazing figure. Throughout the past two decades, in good times and bad, Americans have always liked their own member of Congress despite abysmal ratings for Congress in general," says CNN Polling Director Keating Holland. "Now anti-incumbent sentiment is so strong that most Americans are no longer willing to give their own representative the benefit of the doubt. If that holds up, it could be an early warning of an electorate that is angrier than any time in living memory."
As for all members of Congress, the poll indicates only a quarter of the public says most members of Congress deserve to be re-elected.
A lot of that anger seems directed toward the GOP. According to the survey, favorable views of the Republican party dropped eight points over the past month, to 33 percent. Fifty-nine percent say they have an unfavorable view of the Republican party, an all-time high dating back to 1992 when the question was first asked.
The poll indicates that views of the Democratic party, by contrast, have remained fairly steady, with 47 percent saying they have a favorable view of the Democrats and an equal amount saying they hold an unfavorable view.
"The Democratic party, which had a favorable rating just a couple of points higher than the GOP in July, now has a 14-point advantage over the Republican party," adds Holland.
The same pattern holds for the parties' leaders in Congress. House Democratic Leader Nancy Pelosi and Senate Majority Leader Harry Reid, the top Democrat in the chamber, have never had great numbers, but the public's view of them have remained essentially unchanged in the wake of the debt ceiling debate. But House Speaker John Boehner's favorable rating has dropped 10 points, and his unfavorable rating is up to 40 percent, a new high for him. On the Senate side, Senate Republican Leader Mitch McConnell isn't faring much better - his unfavorable rating is 39 percent, a seven-point increase since July.
The poll indicates that Americans' views of the tea party movement have also turned more negative, with 51 percent saying they have a negative view of the two-year-old limited government and anti-tax grassroots movement, with favorable ratings dropping from 37 percent down to 31 percent. Freshman House Republicans elected with major support from tea party activists were instrumental in keeping any tax increases out of the agreement to raise the nation's debt ceiling.
The CNN poll was conducted by ORC International on August 5-7, with 1,008 adult Americans questioned by telephone. The survey was conducted both before and after Friday night's downgrading of the country's credit rating by Standard and Poor's. The poll's overall sampling error is plus or minus three percentage points. END QUOTE
President Obama’s “Jobs” Speech on Thursday
For much of the last month, the Obama administration has said that the president will deliver a major economic policy speech during the week after Labor Day. Last week, as I’m sure you are aware, the Obama administration announced that the president would deliver this much awaited speech on Wednesday, September 7 (tomorrow) before a joint session of Congress.
The problem is that tomorrow night is the first Republican presidential debate since Texas Governor Rick Perry entered the race. This debate (on this date) had been planned for months. The Obama administration was clearly trying to steal the Republicans’ thunder. To his credit, House Speaker Boehner stood up to the Obama administration and said tomorrow’s date just did not work.
To my surprise, President Obama backed down, to the chagrin of his liberal base, and agreed to deliver his “jobs” speech on Thursday instead (in conflict with the NFL season-opener football game that same night).
I have no idea what President Obama will have to say on Thursday. It is clearly the most important speech of his presidency with his approval ratings at record lows. Everyone is speculating about just what he might propose.
Here is a very interesting article about Obama’s economic policy options written by well-known columnist Tony Blankley. I think you should read it before the president’s speech on Thursday.
That’s all for today; time to hit the “send” button.
Praying for rain in Texas,
Gary D. Halbert
Rasmussen: Reviewing Last Week’s Polls
Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.