Lessons from the prior week's market movers.
While concerns about Greece, Italy, and China loomed in the background, the two primary market movers last week were:
- Lack of Confidence In The Spain Bank Bailout Plan Sends Markets Plunging Monday
- Hope For Coordinated International Action To Prevent Contagion
We'll focus on the Spain bailout and its lessons. While Greece may be the catalyst for the EU's crisis, Spain is the decisive battleground. If they fail to rescue Spain, then it's difficult to see the EU surviving in its current form, if at all.
Reaction To Spain Bank Bailout Deal
As of the end of last week and open in Asia, markets welcomed the Spain deal.
As we moved into mid-Monday and beyond, sentiment faded as markets realized that the deal suffered from the same fundamental flaws as the earlier bailouts.
Ironically, most risk asset markets rose through the rest of the week to end higher because they believed it would fail, and that failure would bring more money printing to stave off near term disaster.
Summary of Why Spain Deal Doomed To Fail
Aside from the fact that we're still missing key details about funding and conditions for the deal, here's why the Spain bank rescue, like every EU rescue before, solves nothing.
- First, it's just adding more debt to nation with too much debt already.
- Second, and more important, it's just another piecemeal approach at time when markets will accept nothing less than a comprehensive solution. Bailouts of any one nation don't matter because speculative attacks simply then start on another weak nation. As long as just one sovereign or even large bank default can bring another "Lehman moment" in which the entire global banking system is at risk, then the only way to stop the crisis is to guarantee all depositors and third parties.
Any solution that doesn't guarantee all EU banks ultimately means that any sovereign default, or even any major bank failure, anywhere, risks bringing down the entire system. That fear alone is continues to fuel the EU crisis as a self-fulfilling prophecy.
These boil down to the following 3 reasons:
1. Only A Comprehensive Solution Stops The Crisis
As long as there are questions about parts of EU banking, all EU banks are suspected of unknown counterparty risk. Therefore to survive the EU needs some scheme to guarantee its banks at minimum, if not all sovereign debt.
The only way that even has a chance of happening is if those called on to take the risks of providing that financial backing, Germany and other funding nations, have sufficient assurances of being repaid.
The only way that can happen is if the EU quickly implements some sort of centralized budgeting and banking that can enforce agreements, insure that creditors are repaid, and make sure that nations don't spend beyond their means ever again.
2. EU Nations Unwilling to Cede Needed Degree of Sovereignty
Few believe that either debtor or creditor nations are prepared to cede that fairly extensive level of sovereignty. It took the US, with a common language and far fewer cultural and bureaucratic barriers, decades to achieve such integration.
3. EU Is Out Of Time
Even if the EU nations agreed to this immediately (they don't), the EU as we know is considered to now have a matter of months left at best before it gets hit with a wave of sovereign and banking insolvencies force an end to the EU as we know it.
Implementing such a complex level of integration across so many different languages and cultures will take far longer. Even if an agreement to do so was signed tomorrow, who would provide funding guarantees over the coming years while details are worked out? Who even believes they would be resolved?
At this point, the only thing that is likely to save the EU, is an unlimited amount of cash guaranteed to be available if needed, similar to what the US did back in 2008, that insured most depositors and other bank counter parties against the unknown risk of a given bank failure.
There are currently no foreign volunteers, and the major EU economies can't afford to do this. See here for details on that.
So what's left?
In theory, if he ECB suddenly had unrestricted ability to print money, and the countries with the cash to make that Euro still credible stayed with the Euro, then the EU might have a chance.
Would German, Dutch, and other funding nations' taxpayers accept this risk and certain loss of purchasing power and value of their savings.
Given their behavior thus far, we don't think so, nor can we blame them for refusing to gamble their futures on what appears to be a losing bet.
Conclusions: What Do You Do?
Most risk asset markets closed higher last week, implying that they believe that the EU, either alone or more likely as part of a globally coordinated effort of the G20, will step in to prevent another Lehman moment. That's their bet.
If correct, it provides a short term boost to markets. Longer term it's just more of the same money printing that risks longer term debasement of whatever currencies get printed.
In the nearer term, as long as global economies are struggling, deflation remains at least as big a risk, and cash could retain its value, with the safe haven currencies appreciating - the CHF, USD, and JPY.
As for the one universal currency hedge, as we've stated before, in times of panic it will sell off as the need for liquidity overrides the need for wealth preservation. However as long as the printers of the most widely held currencies maintain inflationary policies, then the path to wealth preservation is clear:
- Currencies (and assets bound to them) of fiscally responsible nations, like the CAD, SEK, and NOK.
- Gold and selected other hard assets.
Once we have some signs of stabilization, then we may consider equities. For those needing steady income, and are investing cash they don't need to tap, we continue to recommend a basket of solid dividend stocks that provide steady income diversified the above mentioned currencies.
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Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.