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Should Australian investors worry about the European debt crisis?
Apparently not, if you read the local financial news. While the problems with Greece continue to dominate the headlines on international news portals, our headlines are focused on Australian company earnings. Yesterday the stock market celebrated our low unemployment rate and Rio Tinto’s great earnings report. After the Australian market had a 9% correction which started in January 2010, our advisers said the correction was a “gross overreaction” to the Greek crisis and assured everyone that “this crisis is self contained and unlikely to spread through the global financial system as the US subprime problem did a few years ago”. Funnily enough, those were the exact same words uttered by Henry Paulson and Ben Bernanke about the subprime crisis when it first showed up in early 2007. The markets believed the then US Treasury Secretary and Federal Reserve Chairman and continued to rise until October 2007. We all know what happened after that.
Respected UK economist and financial historian Niall Ferguson tell us it would be a grave mistake to assume that the sovereign debt crisis that is unfolding will remain confined to the weaker eurozone economies. He says “It is a fiscal crisis of the western world. Its ramifications are far more profound than most investors currently appreciate“. Most investors are assuming that the European Union will bail Greece out like Abu Dhabi did for Dubai and the problem will just go away but doing a bailout for Greece will be a lot more complicated. Due to the way the European Monetary Union was designed, there is in fact no mechanism for a bail-out of the Greek government by the European Union or other member states or the European Central Bank (articles 123 and 125 of the Lisbon treaty). Nor is there a way for Greece to devalue its currency, as it would have done in the pre-EMU days of the drachma. There is not even a mechanism for Greece to leave the eurozone. Ferguson sees only three possibilities: one of the most excruciating fiscal squeezes in modern European history – reducing the deficit from 13 per cent to 3 per cent of gross domestic product within just three years; outright default on all or part of the Greek government’s debt; or (most likely, as signalled by German officials on Wednesday) some kind of bail-out led by Berlin. As none of these options are very appealing, and because any decision about Greece will have implications for Portugal, Spain and possibly others, it may take much horse-trading before one can be reached. Wealthy Greek investors are also not as confident of a bailout and have been pulling billions of Euros out of Greek banks. According to Erik Nielsen, chief European economist at Goldman Sachs, many long-term investors have sold Greek bonds.
If you think Niall Ferguson is pessimistic, wait till you read what former Chief Economist of the International Monetary Fund (IMF) Simon Johnson has to say. In a recent blog post entitled “Europe risks another global depression” (yes you read it right – Depression, not Recession). He is not so confident that the European countries with deep pockets are willing do anything except insist that all countries under pressure cut their budgets quickly and in ways that are probably politically infeasible. This kind of precipitate fiscal austerity contributed directly to the onset of the Great Depression in the 1930s. Another option for Greece may be to go to the IMF but doing this brings with it a great deal of stigma and strings attached. He says “Another Lehman Brothers/AIG-type situation lurks somewhere on the European continent, and again our purported G7 (or even G20) leaders are slow to see the risk. And this time, given that they already used almost all their fiscal bullets, it will be considerably more difficult for governments to respond effectively when they do wake up.”
I don’t profess to be an expert on financial crises and I don’t know exactly how the Greek crisis will affect the Australia. Even today, I would still struggle to explain why the US subprime crisis and the collapse of one US investment bank managed to cause all the global equity markets (including Australia’s) to nose dive in October 2008, but I know it did. I am going to heed the advice given by economists like Niall Ferguson and Simon Johnson that the European sovereign debt crisis may not end well and this will have serious implications globally, and we could be in for another wild ride (credit crunch, exploding credit default swaps, and stock market crashes) like what happened when Lehman Brothers collapsed. I prefer to stay in safe investments and will think twice about buying or holding the types of stocks that were badly affected in the last market crash (e.g. banking and resource stocks), no matter how good their earnings were last year . For those who hold a lot of resource stocks, consider also the chart of the Reuters/Jefferies Commodities Index courtesy of Marketclub. Prices have broken below a 12 month uptrend line and Marketclub has flashed a red monthly trade triangle (click on the chart to zoom in if needed) which indicates the start of a long-term downtrend. Marketclub traders use this signal to get out of long positions.Trade triangles are signals created using Marketclub’s proprietary technical analysis algorithms. As you can see on the chart below, the last monthly trade triangle was a green one in May 2009 which correctly indicated the start of a strong uptrend.
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[...] of the markets I follow, which have helped to confirm my views on these markets. The first was a bearish triangle on the Reuters/Jefferies Commodities Index, which is a good index to watch if you have mining stocks. The second was a bullish triangle on the [...]
[...] you may want to subscribe to my RSS feed. Thanks for visiting!Back in February 2010 when I wrote my first blog post about the Greek debt crisis, Australian financial advisers were assuring everyone that this crisis is self-contained and [...]
[...] my own research, I disagreed with point 2 so I wrote “Should Australians be concerned about the European debt crisis” where I highlighted views of other economists like Niall Ferguson and Simon Johnson who [...]
[...] I used in the serious of blog posts I wrote about the crisis starting with this post in Feb 2010 Should Australians worry about the European debt crisis? As an MIT economics professor and a former chief economist of the IMF, Simon had a very good [...]