Archive for the ‘Foreign Investment’ Category

Beyond Sovereign Debt

Friday, November 11th, 2011

Put together a union of strong countries like Germany and weak countries like Greece and what will happen?  Will the weak countries learn from the strong ones and become fiscally responsible?  Or will they expect the strong countries to support them and drag them down in the process?

The later appears to be the case in Europe, where sovereign debt contagion has spread from Greece, Italy, Spain, Portugal and Ireland to threaten the European banking system.

Many European governments have spent recklessly and even attempts to keep the crisis from spreading are being met with wide resistance.  Once a government entitlement is given, it is difficult to take it away.

The crisis goes well beyond government spending.  As Stratfor Global Intelligence recently noted, while attempts are being made to control sovereign debt, “all of the broader problems of overcrediting, housing markets, pensions problems” are not even being addressed.

But the sovereign debt crisis and the European banking crisis are joined at the hip.  The severity of the problem was made evident by the October collapse of Franco-Belgian bank Dexia, which agreed to nationalize its Belgian banking business in exchange for a 90 billion euro ($121 billion) bailout.  Austria has also seen a couple of bank failures, and banks in France have also been reported as being in trouble.

Stratfor believes that “Europe’s banks are as damaged as the governments that regulate them.”  The firm’s analysis notes that, “As a rule the largest purchaser of the debt of any particular European government will be banks located in the particular country. If a government goes bankrupt or is forced to partially default on its debt, its failure will trigger the failure of most of its banks.”

In Europe, banks are more highly regulated and are more dependent on the government than in the U.S.

“You have got the states, who have the banks beholden to them, they are able to twist the arms of the bank executives and force them to do things they would not otherwise do,” according to Stratfor Vice President of Analysis Peter Zeihan.  “Banks just are not willing to challenge the regulators, and so you probably will be able to get a significant buy-in that is voluntary, although not very voluntary.”

And just as European banks are dependent on their government, the European economy is deeply dependent on European banks.

“Americans only use bank loans to fund 31 percent of total private credit,” Stratfor notes, “with bond issuances (18 percent) and stock markets (51 percent) making up the balance.  In the eurozone roughly 80 percent of private credit is bank-sourced.”

This interdependence hints at the complexity of the sovereign debt problem, while underscoring just what’s at stake and why all of Europe is so dependent on a solution to the sovereign debt crisis.

Europanic Spreading

Thursday, November 10th, 2011

Stocks surged recently when a new plan for dealing with Europe’s sovereign debt was announced.  Then they came crashing back down when it became clear that the plan was more style than substance.

The continental crisis is much deeper than initially advertised, and the future of the euro, the European Union and Europe’s banking system is being threatened.  Likewise, though, when someone sneezes in Greece, America catches a cold.  American banks have more than $1.2 trillion in loan exposure through German and French banks, which is one reason why the sovereign-debt crisis has affected U.S. markets.

So how deep is the crisis and what impact can we expect in the U.S.?

Stratfor Global Intelligence recently noted that the plan agreed upon to date is “not even more than a baby step on the road to saving Europe.”

Stratfor Vice President of Analysis Peter Zeihan further noted that even after writing down a percentage of the debt, Europe is going to need to attract investments from countries like the U.S., China and Japan.  Unfortunately, such investments will likely carry more potential risk than reward.

“And so the Chinese, the Japanese and anyone else who thinks they have a vested interest in the success of Europe,” Zeihan said, “they have to be asking why would I put my money into a system that the Europeans are not willing to back?”

One problem is that profligate spenders aren’t changing their behavior.

“The primary reason Greece has not defaulted on its nearly 400-billion euro sovereign debt is that the rest of the Eurozone is not forcing Greece to fully implement its agreed-upon austerity measures,” according to Stratfor.  “Withholding bailout funds as punishment would trigger an immediate default and a cascade of disastrous effects across Europe.  Loudly condemning Greek inaction while still slipping Athens bailout checks keeps that aspect of Europe’s crisis in a holding pattern.”

Europe is trying to “rescue its rescue,” as The Wall Street Journal put it, but with little success so far.  The Europanic crisis of the day is that Italy is in danger of having financing cut off.  Italy is nearly 2 trillion euros in debt ($2.77 trillion).

The European Financial Stability Facility (EFSF) can’t raise enough to get European debt under control, but it hopes leverage will help.  Leverage … there’s a term we haven’t heard much since 2008.

Coming Soon to the U.S.A.

Europe’s woos should provide a cautionary lesson to the United States, with its $15 trillion in debt.  While a “super committee” is seeking solutions, one party wants to raise taxes without making significant spending cuts, while the other party wants to make cuts without raising taxes.

If the super committee fails and U.S. debt continues to grow, who will bail us out?

No Recovery For Most Investors

Tuesday, January 19th, 2010

Two factors make reaching the 10,000 milestone for the Dow what Dorsey Wright calls “the quintessential Pyrrhic victory” for many investors around the world.

First, bond funds attracted net deposits of $209.1 billion in the first eight months of 2009, while stock funds drew just $15.2 billion.  For every new dollar moving into equities, $14 was moving into bonds.

This shows that investors who lost money in the collapse of 2008 were moving what was left to the perceived safety of bonds, just as the market bottom materialized.  This is not unusual.

Second, according to Dorsey Wright, the continued decline of the U.S. dollar has meant that foreign investors in U.S. markets have not been made whole.  Far from it.  They gained more dollars as the market recovered, but each dollar is worth significantly less.

In terms of the Euro, the Dow would need to rally an additional 45% to return to its October 1999 levels … and that’s assuming no further decline in the U.S. dollar.  The Dow would have to recover 46% for Australian and Canadian investors to recover.  At least when priced in the yen, the Dow is within less than 20% of its 1999 levels.

Some believe the current rally is a “fool’s rally,” which is not grounded in solid market fundamentals.  If that’s true, it may be a long time yet before most investors’ portfolios return to the level they were at in 1999.