Tuesday, March 22, 2011

When will the Problems in the Euro Block Hit the Markets?

The markets have been remarkably resilient in the face of multiples worries.

Japan, Libya, rising commodity prices, increased Chinese censorship - nothing seems to bother the investor community. Stock markets around the world had a collective hiccup when the tsunami hit Japan, but now show every sign of recovering.

And in this morning's trading the euro is hitting a 4 month high versus the dollar. Globally, at least, investors are looking at the euro zone as "safe harbor".

But is it really?

Robert Samuelson wrote an interesting editorial in yesterday's Washington Post pointing out that the problems in Europe continue to fester, despite the fact that the world's attention is turned elsewhere:

While the world has been transfixed with Japan, Europe has been struggling to avoid another financial crisis. On any Richter scale of economic threats, this may ultimately matter more than Japan’s grim tragedy. One reason is size. Europe represents about 20 percent of the world economy; Japan’s share is about 6 percent. Another is that Japan may recover faster than is now imagined; that happened after the 1995 Kobe earthquake. It’s hard to discuss the “world economic crisis” in the past tense as long as Europe’s debt problem festers — and it does.

Europe’s finances may shake the global economy more than Japan’s tragedies - The Washington Post

The European Central Bank has been lurching from one bailout plan to the other in a desperate attempt to keep the whole euro idea afloat.

While Germany prospers, Greece; Ireland; Portugal; and even perhaps Spain are, as Mr. Samuelson puts it, "in receivership".

How long can this continue is anyone's guess. The willingness of the international community to lend money to Germany and France at rates near or below U.S. Treasury yields has been helpful, but I suspect investors will one day run out of patience.

As Mr. Samuelson notes later in his editorial:

The whole scheme {of the euro bailouts} is debtors lending to debtors. It could collapse if investors conclude it’s unworkable, dump bonds and demand higher interest rates.

...What would happen then is anyone’s guess. Would defaults occur? Would a banking crisis follow? Would some countries abandon the euro?..

.. Would the European Central Bank — the continent’s Fed — buy vast amounts of government bonds? Would the International Monetary Fund organize a bailout, financed heavily by China, to rescue Europe?