Good morning!
I spend a lot of time discussing the US markets, but today I wanted to put the focus on Europe and its potential for a meltdown. I almost did a post on the Euro currency crisis the other day but something in the news over here trumped it.
Every US investor needs to be aware of the bind that some countries in Europe are in. The ECB has as tough a task as the Fed right now trying to tip toe through this economic downturn. As our multinational companies have flourished over here through exports and our cheap currency, the big European multinationals are struggling as the strong Euro is killing profits.
This has put the Euro and its possible future on center stage. Now I for one think the Euro will survive but not before potentially melting in value.
The big problem across the Atlantic is you have basically a line being drawn in the sand between Southern and Northern Europe. Southern European countries like Spain, Italy, and Greece all have struggling economies and are in desperate need for a rate cut. Spain for example has a bigger housing bubble than we do along with 4.7% inflation.
The UK also has a housing bubble, but they seem to be weathering it for now and are not in as bad a shape as Spain or Greece.
However, countries like Germany and Austria are faring much better than their southern counterparts. They prefer the ECB keeps rates high in order to control inflation. Their economies are in much better shape, and more capable of handling a slowdown in order to control prices. The ECB's Trichet(BBernanke of Europe) so far has been siding with the north.
Germany still remembers the horrors of hyperinflation in the '30's and has zero desire to see that nightmare again.
Trichet basically seems hell bent on showing the US that holding rates and controlling inflation is what needs to be done. The Fed has recently become much more hawkish on inflation and warning of higher rates.
However, if the Fed decises to back away due to weakness in the economy, Europe could end up getting screwed.
Signs of a European Crash?
The ECB is walking a fine line similar to the Fed. The risk they run is if they overplay their hand, they could destroy some of the economies in Europe which would put major stresses on the Euro as a currency. The way I see it, Trichet seems hell bent on risking Spain, Italy and Greece in order to control inflation.
Keeping rates high for too long can be dangerous.. Anyone remember the Great Depression? Lack of liquidity was the culprit.
As you can see here below, Morgan Stanley is starting to get nervous.
The UK's Telegraph reported today that Morgan Stanley is now warning of a potential for a 'catastrophic event' in Europe as the ECB fights with the Federal Reserve on policy.
Here is the story from the Telegraph:
Some highlights:
"The clash between the European Central Bank and the US Federal Reserve over monetary strategy is causing serious strains in the global financial system and could lead to a replay of Europe's exchange rate crisis in the 1990s, a team of bankers has warned.
"We see striking similarities between the transatlantic tensions that built up in the early 1990s and those that are accumulating again today. The outcome of the 1992 deadlock was a major currency crisis and a recession in Europe," said a report by Morgan Stanley's European experts.
Jean-Claude Trichet is taking a hard line on rates
Just as then, Washington has slashed rates to bail out the banks and prevent an economic hard-landing, while Frankfurt has stuck to its hawkish line - ignoring angry protests from politicians and squeals of pain from Europe's export industry.
Indeed, the ECB has let the de facto interest rate - Euribor - rise by over 100 basis points since the credit crisis began.
The point of maximum stress could occur in coming months if the ECB carries out the threat this month by Jean-Claude Trichet to raise rates. It will be worse yet - for Europe - if the Fed backs away from expected tightening. "This could trigger another 'catastrophic' event," warned Morgan Stanley.
The markets have priced in two US rates rises later this year following a series of "hawkish" comments by Fed chief Ben Bernanke and other US officials, but this may have been a misjudgment.
An article in the Washington Post by veteran columnist Robert Novak suggested that Mr Bernanke is concerned that runaway oil costs will cause a slump in growth, viewing inflation as the lesser threat. He is irked by the ECB's talk of further monetary tightening at such a dangerous juncture.
Ben Bernanke is reported to be irked by the ECB's approach
The contrasting approaches in Washington and Frankfurt make some sense. America's flexible structure allows it to adjust quickly to shocks. Europe's more rigid system leaves it with "sticky" prices that take longer to fall back as growth slows.
Morgan Stanley says the current account deficits of Spain (10.5pc of GDP), Portugal (10.5pc), and Greece (14pc) would never have been able to reach such extreme levels before the launch of the euro."
Quick Take:
Its an interesting game of chess between the Fed and the ECB isn't it? If parts of Europe like Spain start to blow up due to interest rates being too high than I could see the dollar strengthening significantly.
The dollar could suddenly become an even safer currency than it already is perceive as even though the Fed has done everything to destroy its credibility.
Keep an eye on this situation. The Fed could be all bark and no bite when it comes to raising rates. Consider this to be a game of "chicken" between the Fed and the ECB, whoever blinks first loses.
Bottom Line:
A global slowdown seems likely. If Europe blows up, how are our multinationals going to sell anything? We sure as hell can't afford to buy anything here. Our consumer is on its last leg. If the dollar strengthens, these companies will also face the headwinds of a stronger currency which will hurt exports.
Its beginning to look like the whole world has consumed about as much as it possibly could. If Europe and the US both slow down, its going to kill Chindia's exports and badly damage the emerging markets.
Trying to find a bullish scenario among this disaster is becoming increasingly more difficult. We saw a "Hindenburg" yesterday in the stock market. Could Europe's crisis be the trigger for a correction over here?
Time will tell.
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