European Debt Crisis Escalates Before Greek Election

by: Daryl Montgomery

As Greeks go to the polls in a pivotal election, trouble is escalating all over the EU.

Spain is rapidly becoming the new trouble spot, with Italy not far behind. Ireland's debt problems have resurfaced and tiny Cyprus needs a bailout. Markets are confident though that the same people who have failed to solve the problem so far with their various money-printing schemes will now be successful solving it with new spinning straw into gold approaches.

Interest rates in Spain and Italy continue to climb and in the case of Spain remain at destabilizing levels. The 10-year bond has gone over 7% in Spain and 6% in Italy. When rates stay above 6%, it creates the danger of a downward financial spiral because of the heavy debt burden of the countries involved. Things would be no different in the United States.

Spain has suffered a number of credit downgrades recently. This week, Egan-Jones downgraded Spain's sovereign debt to CCC+, a rating lower than Uganda's. Moody's cut Spain to Baa3, one notch above junk. Fitch had previously cut its rating for Spain to two notches above investment grade. Moody's further warned that it could cut Spain's rating to junk within three months. The downgrades are a direct result of the ECB bank rescue plan. Technically, this is structured as a loan to the Spanish government, so it increased the country's indebtedness significantly. A lower credit rating of course means higher borrowing costs. So the EU's plan to rescue Spain's banking system has wound up damaging the ability of the Spanish government to fund itself. Genius, pure genius.

A recently released IMF report was fairly hopeful about Spain's prospects however. It cited Ireland as a bigger worry. The IMF is urging the EU to help Ireland refinance its bank debt and consider taking equity stakes in Irish banks. Otherwise, it thinks Ireland will need a second bailout. While the average person might consider option one to be a bailout as well, the IMF obviously has a very narrow operational view of the word bailout.

The Spanish bank bailout itself has become an issue in the Greek elections. The leader of Syriza has pointed out that it came with no harsh conditions, but Greece is suffering terribly because of the austerity imposed on it. If Syriza wins on Sunday, it should thank the EU leadership for handing it the election. What is actually going on in the voters' minds is hard to discern. Polls cannot be published in Greece within two weeks of an election. There have been independent polls leaked to the press outside the country that show either anti-bailout Syriza or pro-bailout New Democracy ahead. There seems to be a steady stream of propaganda as well indicating how much the Greek people love the euro.

The G20 meets on Monday in Mexico and one of the major items on the agenda will be how much additional money should be printed now. The markets rallied strongly much of the week on just such "hopes". Not that this has stopped the crisis from continually getting worse so far and there is no reason to believe that it will. Apparently, while money may die, fantasy never does.

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