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Generational Dynamics Web Log for 15-May-2010
15-May-10 News -- European financial instability returns

Web Log - May, 2010

15-May-10 News -- European financial instability returns

Bangkok, Thailand, has turned into a battlefield.

European financial instability threatens global panic

Let's put this into context. Starting several weeks ago, I said we were in the midst of a panic that was growing and spreading. This observation was based on price changes, similar to the ones shown on the following graph provided on Friday by FT Alphaville:

CDS prices for European debt, September 2009 to present <font face=Arial size=-2>(Source: ftalphaville.ft.com)</font>

CDS prices for European debt, September 2009 to present (Source: ftalphaville.ft.com)

Recall that a credit default swap (CDS) is a kind of insurance policy on debt that pays off when the underlying debt defaults. When CDS prices rise, it means that investors are increasingly afraid that the underlying debts will default.

Prior to last weekend, CDS prices were skyrocketing, as you can see from the above graph. It appeared that the entire European financial system was close to collapse. Furthermore, this was not a sudden thing; CDS prices for Greek and Spanish debt had been rising for a while, and it seemed clear that the rise would result in a full-scale bond panic.

Then came last weekend's super-nuclear $1 trillion bailout of European financials. The European Central Bank (ECB), with help from the American Federal Reserve (Fed), and other central banks, would pour liquidity into the European financial system and prevent bond debt from defaulting.

Since then, Greek and Spanish bond CDS prices have moderated, as would be expected, given the guarantees provided by the ECB.

The above graph shows the CDS prices for European bonds, issued in Brussels. This represents debt of the eurozone, rather than debt of an individual country, and it shows that the problems of the individual countries have now been transferred to the eurozone as a whole.

The graph shows that CDS prices fell sharply after last weekend's announcement. The bailout appears to have stopped the global panic that we discussed in its tracks.

But on Friday, CDS prices have begun to rise again. This is what we have to watch. If this graph levels off, then it may be investors are not afraid of a euro default; but if this graph rises again on Monday, then it may mean that the euphoria (or "euro-phoria") of last weekend's bailout has worn off, and the global panic is continuing from where it left off last week.

This comes after a full week of very gloomy news following the bailout. I've read and heard many commentaries, but I do not believe that I've seen or heard a single financial pundit or expert who claims that the bailout solved any problems in the long run. Every commentary used phrases like "postponed the problem," or "kicked the can down the road," or "simply moved money from one pocket to another," or "did not solve Europe's underlying debt problems." Every commentary said that the bailout only postponed the problem, some claiming it was for six months, some for 12 months, and some for 18 months.

So the issue that has to be assessed is whether the bailout bought only a couple of weeks, rather than a few months.

In fact, there are a number of reasons to believe that the panic resumed in full force on Friday, according to The Telegraph:

European stock markets fell 3% or more, with the Spanish index leading the way with an almost 7% drop.
The euro currency fell to a 19 month low against the dollar, reaching $1.2358 on Friday. It was at $1.42 on January 1, and it was at $1.28 only last week.
Greece, Portugal and Spain have been forced to agree to Draconian austerity programs that are likely to cause social unrest, and have already done so in Greece.
Wall Street stocks followed suit, falling 1.5-2%.

A lot of commentary has been very harsh. Most notable was Obama economics advisor and former Fed Chairman Paul Volcker, who was quoted by Bloomberg as saying, "You have the great problem of a potential disintegration of the euro. The essential element of discipline in economic policy and in fiscal policy that was hoped for [has] so far not been rewarded in some countries."

The talk about euro "disintegration" has been widely quoted. The WSJ adds that "Growing doubts about the viability of the euro-zone rescue package, and worries that it will stymie economic growth in the region, will likely continue to weigh on the euro next week."

Generational Dynamics predicts that a panic and stock market crash must come at some point, by the Law of Mean Reversion, because the stock market has been historically overpriced since 1995. (See "How to compute the 'real value' of the stock market.") Readers should watch very carefully to see if the apparent panic fizzles next week or takes off.

Some comments on the stock market selloff

The following is the response of of Michael Aronstein, Oscar Gruss & Son, being interviewed on Friday on Bloomberg TV, in answer to a question about whether investors made a mistake selling off on Thursday and Friday (my transcription):

"[I think] they got it right. [The situation in Europe] imperils the whole inflation case, where a lot of money has been invested over the past year or so [because of] the notion that with all the debt in the world, it's going to prompt a runaway inflation, because you'll have the central bank monetization, and the whole world is going to look like a big version of Zimbabwe.

That's been a pretty popular view, and there's been a lot of money invested according to that. You can see lines in front of the gold bullion banks in Austria, and they just put a gold ATM in Dubai - which, in my limited experience of 32 years, if there ever was a sell signal, that's a good one."

The last sentence refers to a vending machine in Dubai that dispenses gold bars. According to Bloomberg, the machine was developed in Germany, and dispenses 1 gram, 5 gram and 10 gram bars of gold, as well as gold coins.

Downtown Bangkok, Thailand, turns into a battlefield

Thai army troops on Friday fired tear gas and bullets and protestors, who responded with stones, slingshots and homemade rockets. According to the NY Times, sixteen people were killed and 141 wounded.

As we've discussed several times, from the point of view of Generational Dynamics, Thailand is in a generational Awakening era, and this spurt of violence will fizzle out, without spiraling into full scale civil war.

Additional links

A sign in South Africa's Greater St. Lucia Wetland Park apparently cautions visitors, when going down a hill in a wheelchair, not to roll into a crocodile's mouth. NY Times (#4)

At last weekend's negotiations over the European bailout, French president Nicolas Sarkozy threatened to leave the negotiations and to pull France out of the eurozone completely, unless the other leaders agreed to the bailout plan, causing German chancellor Angela Merkel to cave in. Guardian. The story has since been denied by all parties.

New violence has burst out in Kyrgyzstan, in the city of Jalalabad, near the volatile Fergana Valley. BBC. The country is now effectively split in two, with different groups controlling the north and south. EurasiaNet

According to a leaked foreign policy document from the Kremlin office of Russia's President Dmitry Medvedev, Russia should develop closer relations with the West, especially the United States. (This is consistent with the Generational Dynamics view that Russia will be aligned with the West in the coming Clash of Civilizations world war.) CS Monitor

"Look, I'm an economist, and economists are useless at prophesying anything." -- An Athens economist, responding to a question on Friday on the BBC World Service.

Because of increasing concerns about personal privacy, and Facebook's increasingly loose rules about preserving privacy, some long-time users are deleting their accounts -- which Facebook makes as difficult as possible to do. CNN

(Comments: For reader comments, questions and discussion, see the 15-May-10 News -- European financial instability returns thread of the Generational Dynamics forum. Comments may be posted anonymously.) (15-May-2010) Permanent Link
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