Eurozone on the brink of a Lehman-style meltdown
Posted on 07 December 2010 with 7 comments from readers
The crisis now enveloping the eurozone is reminiscent of 2008 and the storm that gathered before the collapse of Lehman and the major financial crisis in the autumn. One lesson from 2008 is that once confidence begins to fall in financial markets it quickly develops a momentum of its own.
The bailout of Greece has been followed by Ireland. That leaves bond vigilantes focusing on Portugal and Spain as their next targets. If the line cannot be drawn at the Iberian peninsula then it will move on to Belgium and France say the bond traders.
Political will absent
It ought to be possible to solve this crisis with a combination of austerity dependent on a tighter control of fiscal policy from the centre that will underpin cross guarantees. But the political will to make this happen is missing in Germany.
Without it defaults by Greece and Ireland are still being priced into bond yields that make the cost of servicing national debt prohibitive, and ultimately self-defeating. The default and bust will come, and markets are pricing it in and by doing so making it certain.
But as the Lehman experience showed no financial entity is an island unto itself these days. Cross border lending in the eurozone is the same. Defaults by Greece and Ireland would set off a catastrophic chain reaction across the global banking system.
For those who so recently lived through the collapse of Lehman this would all have a sense of deja vu. The credit markets would freeze up as banks fretted about the solvency of counter parties. An absence of credit would put the breaks on global trade and any market without a considerable margin of safety would be in severe trouble.
Day of Reckoning
Why is the eurozone sleep walking into this crisis? Well to be fair the US did not handle the subprime crisis much better. It thought Lehman was not too big to fail but it was, and the same mistake may now be made over the eurozone periphery countries that are only five per cent of euro zone GDP.
In these circumstances the flight to gold and silver by European investors is very understandable as is the strength of the dollar, and both can only grow stronger as this crisis unfolds unless something very unexpected now occurs.
There is also another problem in that the Chinese economic miracle will unravel at the same time. For the bubble created by the massive bailout after the 2008 crisis is now at a critical stage, and a credit squeeze from the eurozone that pulled the rug from under global trade would be enough to burst it.
Second crash?
This would result in a massive sell-off in commodities and global stock markets. Interest rates would soar, crashing bond markets and only cash and gold would be winners. Are we seeing the next and final phase of the global financial crisis? Sometimes it is hardest to see what is staring you in the face.
The historical parallel is surely the 1931 crisis that crossed the Atlantic from Europe after the collapse of the Austrian bank Credit Anstaldt. It was the second phase of the financial crisis that started with the Wall Street Crash of 1929 – we are now coincidentally two years post the Lehman crash.
7 Comments posted by readers:
Hardly surprising, when the few decent economists left in the world have been predicting the total collapse of paper money and the world’s banking system for some time now. It’s quite a simple concept really. This ongoing great correction is all about debt… It’s not good for business to tell the truth in the mainstream about what’s more than likely to unravel over the next 12-24 months. But sit tight, because this is going to be the ride of most people’s lives!
Ed Note: That also explains why people read websites like this and not Bloomberg who play the party line.
Don’t forget Italy.
If you think Greece lied about its finances, wait until the stink emerges about The Italian Job.
http://hat4uk.wordpress.com/2010/12/07/is-there-anything-as-good-as-gold/
Get ready for another weekend, last second before the market opens, bailout by the IMF, ECB ,and maybe the US Federal Reserve. They might even have to get China to cough up a few billion for this one. Their Western export markets go down, and so does China.
There is no way the European governments ,or the US government, can let the TBTF banks go belly up from a European melt down. The economy of Europe is larger than the economy of the United States. A collapse of Europe will take down the entire world economy. It would be like Lehman squared.
The powers that be will do a last minute rescue. They had better, or they will find themselves living in a very unpleasant world within about a month.
Oil is near $90, and gold is up $9 on the news of another $900,000,000,000 to be added to the US National debt from extending the tax cuts for everyone in the USA for two years. The projected total US debt for 2020 in now AT LEAST $22,000,000,000,000. I doubt this will end well, but I could be wrong.
Jim Rogers just said on CNBC that the WikiLeaks fellow should be given a medal. He said that after WW I the world governments promised open diplomacy, but never delivered. When you are that rich, you can say what you like. Check out http://213.251.145.96/ and click on the ‘mirrors’ box at the top of the page, if you want to see something amazing. They say he is a genius. I was trying to figure out the number of combinations you can make with a 256 character secret code word that he is using. It might be more than the number of atoms in the Universe. Supercomputers will have to work for a while to get that password. I think the formula is 256 X 255 X 254 X 253…X 1 = a BIG number of combinations to try. But it has been a long time since I took statistics. Let’s hope inflation never gets THAT bad.
Lehman was allowed to fail not because it was not deemed w “too big to fail” but because it was a competitor of Goldman Sachs (it also was one of the few I-banks on Wall St. that was chuck full of GOPers in its management).
Beyond that, you might consider the idea that ‘08 was in some respects actually provoked as an “October Surprise” to get Obama in. They may not have understood the ultimate ramifications of it, but they most likely provoked this crisis.
Let us also not forget just how much taxpayer money went to the EU banks through the bail out of Lehman.
In the end you got it just backward. The mismanagement was not in allowing Lehman to fail, it was in not allowing the others to fail. If they had we would be through this by now–poorer but wiser and on the mend.
But let us optimisticly assume that the Eurozone will go through this and save the world a financial apocolypse, some questions must be asked like: now that the crisis is over, should the currency union be dissolved? or the periphery states be sacked? Since now is the oppurtunity to make it in an orderly manner instead of a distructive one Another question more related to the present is whether the UK proved that its decision out of the currency union was the sane one? Correctly me if I am wrong but I guess it was ex-prime minister Brown who instead against the union, I bet he is laughing so hard now at the situation.
And relating to GCC, after the Eurzone experience what are the precations to be taken so that they don’t have a similar experience, if they are still aiming to achieve this union? But we have to keep in mind that the GCC countries all have relatively similar economies, compared to the stark difference in the Eurozone.
If interest rates go up doesn’t that hurt cash holdings and benefit real, physical assets? You list gold but other precious metals would do well, right? That is some thing that I am trying to sort out.
Ed Note: No if you hold cash higher interest rates benefit you, and they will depress share and real estate prices. Actually this does not benefit gold as it pays no interest, and gold will only carry on up with higher interest rates if inflation is still higher.
Unfortunately this is the exact reverse of most portfolio position now – but that makes it well worth trying to sort out. You should subscribe to my newsletter to get 5,000 words not a few lines.
Good analysis
I did not enjoy it when gold corrected to below 700, I came out in a rash.
I read the other day some persuasive opinion gold would not necessarily correct with the rest because we may, instead of a flight to liquidity have a flight to safety.
Dangerous to believe what you want to hear I know, but this time around the panic might be even worse and doubts about financial institutions also worse and with good reason I suspect. Also fears about currencies I mean there would be a lot of QE again.