Wednesday, April 28, 2010

Outrunning the Bear

When confronted by a hungry bear you don’t need to be faster than the bear, just faster than kid that ate all the Twinkies. Increasingly the global economy is looking similar with Europe being the bloated glutton. For all the problems in the United States the friends across the pond are looking more and more like bear food.

The problems in Greece, which in the recent past I wrote were not going to go gently into the night, rose up this week with a massive downgrade of their sovereign debt by S&P to junk status. There was political posturing to try to hold down the panic as a large piece of Greek debt was due to be rolled forward in May. It looks like that posture is unlikely to be upright as two-year interest rates on Greek bonds moved to 15% this week. The PIGS (Portugal, Ireland, Greece and Spain) are looking like crispy bacon.

In Club Med, Barclay’s analysts believe Greece needs 90 Billion Euros to get through the current crisis, Portugal, 40 Billion and Spain 350 Billion. The IMF runs dry at 200 Billion which would mean heating up the printing presses. If the other rating agencies follow S&P’s lead, the European Central Bank will not be able to hold Greek debt on its balance sheet. Or they will destroy the sanctity of the ECB, much as the Fed has done.

The crisis in Greece puts a stake in the heart of discussions of the Euro supplanting the dollar as the world’s reserve currency. The lack of a cohesive national government in time of crisis has been shown to be the weak underbelly of the European monetary union. The inability to enact independent monetary policy because of treaty obligations and mandates may well be the emperor has no clothes moment for the Euro.

If this lit fuse reaches Spain where there is serious German and British investment fireworks could ensue. The expectation of an imminent Fed rate hike is deflating by the day. If one looks back to 1997 a crisis in Thailand started the Asian crisis and quickly derailed plans for interest rate hikes.