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Too interconnected to fail
The above is a beautiful graphic from The New York Times article Europe’s Web of Debt which demonstrates the European debt crisis very succinctly. As you can see European debt is highly interconnected. If one country defaults, many others in the European Union will be affected. The size of the circles and the width of the arrows have been drawn to scale so you can easily visualise the relative size of the debt. It is also quite clear that the European debt crisis is a much bigger problem than the US subprime crisis. When the subprime crisis happened, banks all over the world got into trouble and the respective country’s government had to bail them out as many were deemed “too big to fail”. With the Greek debt crisis, some have used the term “too interconnected to fail”. If Greece defaults on its loans, we can see that the biggest loser will be French banks who hold the bulk of Greek debt. No wonder both the head of IMF and ECB (both Frenchmen) have been pressuring Germany to approve the bailout for Greece, which really amounts to a bailout for French banks. Germany has been reluctant to approve the bailout because they only have a small slice of Greek debt. However, they have a big chunk of Spanish debt. If they don’t help Greece, the problem may spread to Spain so it is in Germany’s interest to help Greece and hopefully prevent contagion to all the countries that make up the now famous acronym PIIGS for Portugal, Italy, Ireland, Greece and Spain. Not surprisingly, Dominique Strauss-Kahn, the head of IMF (and aspiring French Presidential candidate) has been the biggest champion for a Greek bailout. Of course it is a great idea to bail out your own country’s banks using other people’s money, mainly American taxpayers’ as the US is the biggest contributor to the IMF. In case anyone still thinks this problem will be contained, the IMF has recently asked it’s members for additional contributions of USD 500 billion to boost its New Arrangements to Borrow fund. The previous size of the fund was only USD50 billion so I leave you to come to your own conclusion as to why the IMF thinks it needs to increase this fund ten fold!
Despite a bailout arrangement that was finalised last Sunday by the IMF/EU, stock markets globally have fallen dramatically this week as it slowly dawns on investors how big the sovereign debt problem is and a Greek bailout is unlikely to solve the problem. The effect of the European debt crisis on stock markets reminds me of what happened in 2007 with the subprime crisis. Stocks fell in July 2007 when the crisis first surfaced. After some intervention and reassurances by the government, stocks managed to climb to a new high in October 2007 before falling 50 percent in the next 18 months. Stocks fell heavily in Jan 2010 when this crisis first surfaced and managed to recover to a new high in April 2010 before falling again.
The ASX200 is trading at 4660 as I write this post, which is the level it was at in October 2009. Six months of gains have been wiped out in a few weeks. There is little reason for the Australian market to continue to rally. Our banking stocks are falling again due to the effects of the ongoing global debt crisis. Despite announcing record earnings, Westpac fell 3 per cent today. The strengthening US dollar is causing commodity prices to fall. China, the biggest customer for our resources continues to tighten credit and recent data shows manufacturing is slowing down again. The Chinese stock market has been on a downwards trend since August 2009 and well-known investor Marc Faber has just joined Jim Chanos in predicting a crash in China’s real estate bubble in the next 9 to 12 months. On top of problems caused by the GFC, Australian miners also have to deal with the KFC (Kevin Rudd financial crisis) which started after he announced the hefty tax on Australian miners on Sunday. The reversal of the ruling to allow foreign investors to buy Australian property on April 23, and yesterday’s interest rate hike is surely not going to help our housing rally to continue. The only thing that perhaps could turn things around for Australia would be a second stimulus package by the Chinese government. This article on Bloomberg mentioned that China plans to announce in August a new stimulus package of possibly 4 trillion yuan ($586 billion). This was reported by a China Business newspaper on its web site, citing unidentified sources. Let’s keep our fingers crossed that these sources are correct…
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