The Wall Street Journal reported that Greece has ordered that its banks remain closed for the next week to the stem panicked cash withdrawals by depositors. This drastic move indicates that the five year long Greek debt crisis is coming to an end game.
After the financial meltdown occurred in 2008, the economic folly of Europe’s single currency, the Euro, became apparent. The European Union was created in an effort by Europeans to create a political climate that would lessen the likelihood of future wars on their continent. This desire was a reaction to the carnage that inflicted on Europe during two world wars in the 20th century. While the political idea was noble, little thought was given to the economic consequences that a central currency would lead to. Those consequences are now playing out.
The Euro was destined to create an economic calamity because the political union was not accompanied by a truly economic union. European countries maintain their own banking systems and Euro central bank was weak.
After the European Union and the Euro were created, the more efficient and stronger economies of North Europe, specifically Germany, obtained the lion share of benefit created by the Union. With nearly all European countries having a single currency, less efficient countries had their cost of labor increased in relation to more efficient ones. As a result, the poorer countries had a artificially strong currency that enabled them to consume increased amounts of the more efficient countries’, i.e. Germany. Through the Euro, Greece had to access to relatively cheap borrowing via an overall European credit rating that did not reflect the realities of individual countries. As a result, Greece and other Southern European countries borrowed more funds than they could afford to pay back and use these funds to purchase imports from Germany and other exporting countries.
When the recession hit, Greece and other countries were unable to make payment on their debt. This led to a battle between the creditor countries such as Germany and debtors like Greece.
For five years the Greece debt crisis has been a can kicked down the road. Creditors including, Germany, have been unwilling to forgive Greece’s debt, even though Greece is not a position to repay it. Had Greece continued to have its own currency, it would have devalued versus the German currency making its exports cheaper and more likely that it would have been able pay back its debt obligations. The single currency has curtailed this natural rebalancing mechanism of sovereign debt. Continue reading
Stock Markets Slump Worldwide
The Wall Street Journal reported Friday on the worldwide slumping stock indices. In the United States the Dow Jones Industrial Average fell nearly 280 points or 1.5%. In Germany the DAX fell over 2.6% with France’s CAC dropping 1.6%. The decreases were not confined to the West with Japan’s Nikkei losing 1.2% and the Chinese stock market down over 5%. This worldwide slump indicates investors are running scared.
In addition, European bond markets are in turmoil. The yield on Greece’s 10 year bonds on Friday was 12.49%, while yields on its two-year bonds were over 26%. This perverse and inverse yield curve demonstrates substantial fear in the short-term relating to Greek finances.
According to the Journal, investor concerns center around three issues: 1) Greece’s financial situation, 2) China’s recent crackdown on stock market borrowing, and 3) weak in US corporate earnings.
As for the Greek financial crisis, this is an unresolvable problem without significant pain. Greece owes more debt than it can afford to pay back period. In addition, its economy has been rendered uncompetitive by the unnatural imposition of the euro on European economies. The European Union’s answer is to kick the can down the road by extending Greece’s loan repayment schedule. Each time and extension is given, equity markets sigh relief and bounce back only to be rattled when the extension runs out. Sooner or later the central bankers will have to admit the obvious, Greece’s debt will have to be written off with negative consequences to lenders worldwide.
The Chinese economic miracle has been built on the backs of cheap labor and significant debt used to inefficiently over build factories and cities. Chinese labor prices have been increasing. It is only a matter of time until a significant correction will be required to correct the imbalances created by imprudent use of debt.
Finally, the policies of the Federal Reserve and other central banks have resulted in an unnatural appreciation of the US dollar. While this has some positive implications, such as dropping oil prices, it also offers negative consequences. One such consequence is that US manufactured goods sold in dollars become uncompetitive in the world market. This leads to the third problem raised by the Journal, dropping US corporate earnings.
The problems that currently concern equity markets are the result of unnatural interventions by central banks and governments in their attempt to alleviate economic pain resulting from the 2008 meltdown. This meltdown was intern caused by the same central banks making credit available at artificially low rates and creating excess liquidity vis-à-vis poor lending practices. Had the central banks allowed the markets to take corrective action in 2008, while the initial recession/depression might have been deeper, the rebalancing of supply and demand would allowed for a stronger recovery. Instead, the economies worldwide jump from one problem to another and with investors then waiting for still further central bank corrective actions. Sooner or later this central bank alchemy will cease resolving problems even in the short run.