Euro Crisis Is Worse Than 2008

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Includes: GLD, SPY, TLT
by: Sammy Pollack

Many pundits have compared the current crisis in Europe with the 2008 financial crisis in America. They tend to say things like "this is going to be like 2008" or "this may be as bad as 2008." What these pundits fail to see is that this crisis will actually be much worse than 2008. The reason is simple, we are in worse shape in every aspect of the crisis than where we were in 2008.

Starting point

Entering the 2008 financial crisis, the economies of the world were in a relatively healthy state. Unemployment rates around the world were at the lower end of their long-term averages. Currently, as we enter the euro crisis, unemployment rates around the world are elevated. Elevated unemployment is especially high in the nations that are about to enter the toughest times, the PIIGS. This means that things will get worse from an already bad place vs 2008 where things got worse from a good place.

Monetary Bullets

At the start of the last crisis, interest rates in the U.S. where over 5%. This allowed the Fed to reduce rates to combat the weak economy. Currently, interest rates in the U.S. are at 0%. This means that the Fed cannot lower rates further to induce growth if the economy slides into recession. The Fed is also limited in what it can do as far as QE3 goes. Political pressure is mounting on the Fed, and it appears as though there is little more the Fed can do. Other central banks throughout the world face a similar situation. Rates are near record lows at the ECB, BOJ, and BOE. The ECB cannot do "QE" because Germany will not allow it. The BOE has already started a significant QE program that appears to be having little impact. The central bankers have simply used up most of their bullets.

China

In 2008, China was able to help lead the world out of recession and back to growth. China cut interest rates, and initiated a major stimulus program that worked. Today, China cannot cut rates aggressively because inflation is a major worry. China is also facing a collapse in parts of the real estate market, this is leading to a China story that does not bode well for the rest of the world as it did in 2008.

Fiscal Policy

Just as central bankers have used up most of their bullets, so too have politicians. Major governments simply cannot increase the deficits much further right now. In 2008, governments across the globe were able to initiate large stimulus and bailout programs to help the economy. Now, governments simply are unable to spend money to help heal the economy. This is most obvious is troubled EU nations Italy and Spain. The economies in these nations are entering terrible recessions, but the governments cannot spend money to stimulate the economy. Rather, both Italy and Spain are being forced into massive austerity that will only further hurt growth. The coming economic depressions in Italy, Spain, Portugal, Ireland, and Greece, will bode very badly for healthy EU nations such as Germany, France, and Britain. Unfortunately, these nations won't be able to stimulate their economies either because they simply cannot afford to do it. The problems with austerity are discussed in more detail here.

Bank Guarantees

In 2008, the U.S. Government was able to put a halt to the banking crisis by guaranteeing the deposits in the U.S. banking system. In Europe, no central authority exists to guarantee the banking system. Right now, the responsibility falls upon each nation to guarantee its own banking system. This presents a major problem: many large banks in PIIGS nations cannot be saved because the governments do not have the money. Perhaps the depositors will be saved, but stock and bond holders will almost certainly be wiped out. Even healthy nations such as Germany and France will have difficulties saving their banks because the banks are very large and the governments have limited funds. The only hope to save the banking system may be the Soros solution discussed here.

Political Chaos

In 2008, there was something of a political unification that helped to stand behind the economy. While not everyone supported government actions, these actions were still able to be implemented. Examples include TARP, Fannie (OTCQB:FNMA) and Freddie (OTCQB:FMCC) bailouts, GM and Chrysler bailouts, the massive stimulus, etc... In Europe, for anything to happen 17 nations must agree to it. Each nation has different interest that it is trying to protect. The agreements must also be reasonable enough that each nation can pass the legislation through its own government. The EU political process is making is so that policy makers are unable to act with the speed and force needed to bring the crisis under control.

Conclusion

Things are much worse than 2008. The prudent thing to do is reduce risk and move into safe heaven assets such as Treasurys (NYSEARCA:TLT) and the U.S dollar (NYSEARCA:UUP). Importantly, gold (NYSEARCA:GLD) is not (discussed here) one of these safe heaven assets to move into.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.