Of course, the sovereign debt issues have leaked into the European banking sector. Almost everyone on Wall Street knows that these European banks need to mark their assets down, raise capital and dilute shareholders. After some European governments (France, Italy, Spain, Belgium) imposed short selling bans on financial stocks the market sniffed out the acts of desperation and the bank stocks have continued to sag.
Over the last month, the market was yet again bailed out by central bank actions. Firstly, the Fed hinted at more QE (perhaps as early as September 21) and the European Central Bank (ECB) intervened in the Spanish and Italian government bond markets. It should be noted that despite the ECB intervention, rates in Spain and Italy are now over 6%.
There is little confidence that the promised austerity measures will actually be implemented. Yesterday, Italian and Spanish government bonds sank after a poor Spanish debt auction. There were also reports that Italian Prime Minister Silvio Berlusconi was reneging on his promised austerity actions as he bows to pressure from union and business groups.
The situation in Greece appears to have reached a boiling point as a senior IMF economist now expects a default in the near term.
"I expect a hard default definitely before March, maybe this year, and it could come with this program review," said a senior IMF economist who is keeping close tabs on the situation. "The chances for a second program are slim."
In the last week of August, the new head of the International Monetary Fund (NYSE:IMF) and former French finance minister, Christine Lagarde warned attendees at the U.S. Fed’s Jackson Hole meetings that European banks needed to be recapitalized and that “Developments this summer have indicated we are in a dangerous new phase” of the financial crisis. Lagarde said that without these capital injections, “we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis.”
Lagarde's sentiments were echoed by World Bank president Robert Zoellick who warned: “We are entering a new danger zone.” At the Jackson Hole meetings Zoellick observed: “It strikes me that this is one of those moments where we have a very serious issue.” “If there is a problem in the eurozone, and the Fed extends the normal swap lines, we could find the U.S. in an election year being the major holder of European liabilities based on a crisis and I’m not sure how that would work out.”
It is becoming obvious that Europe is quickly reaching the endgame where the currency will be called into question. Subsequently, investors have responded by pushing up gold and gold stocks to new heights. Gold has benefitted, not from inflationary concerns but rather the fragility of the global banking system.