Euro Crisis Totally Out of Control? Implications

By: Christopher_Laird

The evolving Euro crisis is expanding and deteriorating rapidly. In only one week since the $1 trillion EU proposed bailout, the following happened:

• Merkel’s party got creamed in the regional German elections last week. This is paralyzing Germany politically.
• UK’s Brown resigned and Cameron took over.
• France’s Sarkozy threatened to pull out of the Euro and banged his fist on the table, making Merkel blink and leading to their disastrous German elections.
• Now Germany bans short sales on Banks and CDS and sovereign bonds – revealing the panic out there in the EU.
• EU is in total chaos politically, they cannot solve this crisis with their many nations who must approve each major fiscal measure like bailouts. The ECB and EU are not capable of the quick unilateral action like the Fed is capable of – meaning they are always behind the curve on this rapidly EU escalating sovereign bond crisis, which is spreading now to EU banks and CDS, not only sovereign bonds, and spreading to the Euro.
• They say the Euro has never been tested severely like this since its inception in 1999/2000. The test is a huge FAIL. The Euro is falling in an out of control way.
• ECB’s Trichet had to relent and do the nuclear option to buy bad paper (bonds etc) off the Greeks for starters. ECB loses huge credibility.
• Net effect of the political and financial failures is huge uncertainty for the Euro and the EU.
• This all leads to a Lehman like contagion, which is now in process. It’s all out of control.
• EU and ECB are only reacting to this mess and are they not in control at all.
• Contagion is spreading to all financial markets, and appears unstoppable.
• Electronic trading and ETFs cause liquidity to dry up in minutes to zero (means crashes are not controllable whatsoever).
• EU countermeasures are too late and are panicky – (they have lost control of the Euro and debt situation). Derivatives (like ETFs) have made markets highly susceptible to huge flash crashes. Attempts to counteract this only makes things worse. Markets are now totally out of control as circuit breaker measures in one market are merely circumvented by others moving to alternative markets/exchanges where they can still trade.

This list goes on but you get the idea.

Overall, you can say that the US housing crisis spread to the US financial system first, The US blew up first, but now the others with the same problems (EU) are breaking down, and as the world tried to reflate financial markets and succeeded with public money, that is now over and the new outcome is the EU region is the next ‘Lehman’ style crisis, but it’s a crisis of the biggest economic aggregate in the world the EU (Yes it’s bigger than the US).

Since Germany just acted unilaterally to ban short sales in the Sovereign bond market and CDS, it indicates a lack of EU financial coordination. Germany never wanted to do this bailout, and is dragging its heels, making any attempts at countermeasures too late to increase confidence.  (CDS by the way have been the ONLY real market with real pricing for the last several years, and the CDS markets always led to the final deterioration and final ‘verdict’ before the crises of the day spiraled out of control. CDS are bets on debt defaults, their prices reflect the reality. Hitting the CDS market takes away any remaining market transparency. Now all markets are being hidden inside huge public purses).

What this means for markets

Overall, this means that the EU is in serious trouble. It means the EU has shown they cannot contain this situation. It probably means the Euro is going down to parity with the USD at least. If the situation is not brought under control, the EU itself is threatened, and imagine what would happen to the Euro if Germany or anyone bolts the EMU (Euro monetary union). The Euro would collapse.

The USD benefits, the carry trades are unwinding (USD, Yen and others). Gold benefits because it’s a major haven, even with the USD rallying hard and commodities tanking. Gold can still get dragged in if there is a huge world stock sell off, so be cautioned.

US markets benefit as money flees into the US, but still US markets are continuing to drop – this is hugely bearish.

Three weeks ago, we told subscribers that the Dow peaked at 11,000. The Dow peaked at about 11200. It looks like that call is going to hold up.

With Asian and EU markets down, commodities tanking due to expected economic slowing, and US markets down and looking to continue falling, and China already in the early stages of popping their construction bubble (60% of China GDP is construction related) there are no bright spots out there. The US recovery will stall and is stalling now.

None of the above trends are a surprise because the world tried to remove public stimulus and QE (where the public treasuries buy all falling assets) at end of March 2010. We predicted back then that taking out QE would crash markets in two months… well, here we are. Going back to QE with the ECB now is not working either. QE may be a dead resource at this stage. (IE we are not going to see another big world stock rebound with new QE).

The only remaining question here is when will markets really start a long grinding decline, with the EU and Euro right in the middle of the storm. This has probably already started.

By Christopher Laird
PrudentSquirrel.com

Copyright © 2010 Christopher Laird

Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

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