I’m sure most of you have now heard about the near $1 trillion bailout package the European Union has put together to help solve the financial issues that have been plaguing Greece, Portugal, Italy, Spain and Ireland. Greece especially has been hit hard by economic woes, and the fact that people have died due to riots in the streets caused by these troubles certainly brings the struggles to the forefront. The media would have you believe that the EU’s actions over the weekend were in response to Greece, and that Greece is in fact the problem; therefore, the size of this plan is to send down a nuclear bomb which wipes out any potential flare ups in the other struggling member-nations of the Union. My good friend Jim Cramer (ha-ha) in fact has an article out this morning spinning this very story line for the masses to devour and commit to heart; however, my contention is that this situation should look and feel very familiar to all of us.
Social mood and risk appetites shape financial markets. One of the greatest misperceptions of all time was that The Crash caused The Great Depression when The Great Depression actually caused The Crash. Jim’s story isn’t necessarily all false, but it falls short of telling the “whole” truth. Greece’s struggles and riots aren’t the problem, but rather the symptom. What if Greece (and other Eastern European countries for that matter) was the very same type of sub-prime borrower that helped bring down our own financial system in 2008? What if Greece is Fannie Mae, Portugal is Freddie Mac, Spain is AIG and Ireland is Lehman Brothers? That would of course mean that this cross-border solution (or nuclear bomb as Jim Cramer labeled it) is nothing more than the masked nationalization of Fannie Mae and Freddie Mac which only pushed risk out on the time continuum.
In all reality, Europe is nothing more than a house of mirrors at this point. Last week the New York Times ran a wonderful story discussing this very fact, and I’ve copied a graphic they put together showing the volume of debt that European nations owe one another. Upon full examination of the circumstances you will see that one country’s asset is really just another’s liability, and should one member fail the rest would surely follow. Greece, therefore, is merely the first domino to fall. Without action by the European Union, all the mirrors would fall and we would be left staring at a small candle which in reality is all that is being used to illuminate what they would have us believe is the “strength” of the economies of the union. As such, the EU’s actions over the weekend are not a proactive strike against degrading economies in their member-nations, but rather a reactive measure forced upon them by lack of action previously.
To those of you who argue that Greece, Portugal or Ireland have little to no bearing on the global financial markets let me again remind you that today’s announcement is more “band-aid” solutions, and does little to actually address the real issues causing the symptoms. A contagion, as defined by Mr. Webster, is a disease or influence that spreads rapidly. Though the intent of the bailout package is to contain this poison before it spreads too far around the globe, the real truth is that it may in fact be too little too late.
While the markets in America today are rallying on the news, one real risk is flight to quality. The dollar has rallied 10% since its December lows, and a strengthening dollar isn’t necessarily good news in certain sectors. Hedge Funds have made large bets on various asset classes rising on the back of the dollar devaluing further. Should the greenback continue to strengthen, due to the flight to quality argument, the risk of those bets unwinding rises in equal fashion, and we’re all very familiar now with the consequences of large holdings being forced to be undone hastily. In addition, we have the continued risk of abatement in risk appetites around the globe, and continued increases in geopolitical risks as well.
When you live in a glass house the rule of thumb is that you can’t throw rocks; hence the reason you won’t ever hear the facts told in their entirety. We’re rather expected to believe that Europe’s “nuclear bomb” has solved the problem, and that there is nothing more to fear. America was first in line to “react” and prop up their house of mirrors, and today we see Europe having to take their turn. Don’t be fooled into thinking that this actually solves the real issues at hand any more than our own government’s actions erased our financial problems back in 2008. My vote is that we all look to get out of the house of mirrors and head home to put some plywood on the windows!