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Generational Dynamics Web Log for 20-May-2010
20-May-10 News -- Angela Merkel roils markets with demands

Web Log - May, 2010

20-May-10 News -- Angela Merkel roils markets with demands

Massive anti-austerity protests in Romania

Angela Merkel gives apocalyptic speech on euro

On Wednesday, German Chancellor Angela Merkel for a radical overhaul of Europes financial system, following the rules established by Germany itself. Merkel's speech appeared to be directed at France and other countries, especially southern European countries, the vigorously fought for the $1 trillion bailout a couple of weeks ago.

In a speech to the German parliament, Merkel said the following, as quoted by AFP:

"The current crisis facing the euro is the biggest test Europe has faced in decades, even since the Treaty of Rome was signed in 1957.

This test is existential and it must be overcome ... if the euro fails, then Europe fails.

The euro is in danger. If we do not avert this danger, then the consequences are incalculable and the consequences for the whole of Europe are also incalculable.

We need a comprehensive overhaul of the Stability and Growth Pact, [the rules stating that EU countries should keep budget deficits below three percent of gross domestic product (GDP) and debt below 60 percent of GDP.]

The rules must be geared to the strongest, not to the weakest ... our (German) stability culture is tried and tested."

Merkel also confirmed that Germany is unilaterally implementing a ban on naked short selling of government bonds (see below).

The result was that the euro fell to new lows on Wednesday, and stock markets in Europe and New York continued to fall.

Merkel's speech prompted a great deal of discussion on Wednesday on the question of whether the euro was going to collapse. Some people pointed to increasing divisions between the eurozone countries as evidence of a possible collapse, while others said that any talk of collapse was crazy talk.

The context for this discussion is that Europe's financial markets appeared to be in a panic a month or so ago. The $1 trillion bailout appears to have stopped the panic in its tracks, but the situation is still extremely volatile, and a sharp market collapse is still a possibility. Web site readers should continue to watch the markets warily.

Germany bans naked short selling

If you think that the price of a stock is going to go up, then you buy the stock ("go long"). If the price of the stock goes up, then you make money.

If you think that the price of a stock is going to go down, then you can "go short" as follows: Borrow some shares of the stock, usually from your broker, for a fixed period of time; sell the stock at current market price; after the fixed period of time, purchase new shares of the stock, and return them to the person you borrowed them from in the first place. If the price of the stock has gone down, then you've made money.

Naked short selling occurs when you arrange with your broker to sell shares of stock that you don't actually have. Your broker sells the non-existent stock to a buyer who won't actually try to take possession of the shares. At the end of the fixed period of time, all accounts are settled in exactly the same way as above, except that no stock shares were actually involved.

For more information, see my 2008 article, "SEC blames stock market problems on 'false rumors' and 'naked short selling.'"

The article referenced in the last paragraph also shows that blaming naked short selling doesn't do much good.

What Germany has done is to ban naked short selling of government bonds, such as those from Greece and Portugal that appeared to be crashing two weeks ago. The theory is that the crashing behavior was caused by speculators using naked short selling, without even owning any of the bonds in question.

The German ban has increased the volatility of Europe's financial markets, according to FT Alphaville:

"After a dull week start to the week it was back to the volatility we have become familiar with. Again the sovereign world was the source, though the trigger in this case was somewhat unexpected. Bafin, the German regulator, announced a ban on naked CDS referencing eurozone countries, as well as naked short sales of eurozone sovereign debt and equities of certain German financial institutions. The unilateral action took the market by surprise this morning and saw some unusual spread movements."

Once again, I repeat the warning that readers should be very wary of the markets until they settle down again for a while.

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 takes off.

Additional links

Tens of thousands of Romanians marched in the streets of Bucharest on Wednesday, to protest austerity measures that will cut wages by 25% and pensions by 15% for public workers. Unions have called a general strike for May 31. Deutsche Welle

Bangkok Thailand is under curfew after the army assaulted the "red shirt" protestors with live ammunition, and the radical protestors retaliated by burning down shopping centers and the stock exchange. At least six people died on Wednesday. BBC

The French cabinet approved a bill banning women from wearing a full Islamic veil. French president Nicolas Sarkozy said, "We are an old country anchored in a certain idea of how to live together. A full veil which completely hides the face is an attack on those values, which for us are so fundamental. Citizenship has to be lived with an uncovered face. There can therefore be absolutely no solution other than a ban in all public places." Guardian

Ethnic violence is spreading in Jalalabad, Kyrgyzstan, and a state of emergency has been declared, as clashes grow between Uzbek and Kyrgyz people. Jalalabad is in the volatile Fergana Valley, where the countries of Kyrgyzstan and Uzbekistan meet. Reuters

(Comments: For reader comments, questions and discussion, see the 20-May-10 News -- Angela Merkel roils markets with demands thread of the Generational Dynamics forum. Comments may be posted anonymously.) (20-May-2010) Permanent Link
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Generational Dynamics Web Log for 20-May-2010 20-May-10 News -- Angela Merkel roils markets with demands

Angela Merkel gives apocalyptic speech on euro

Germany bans naked short selling

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Generational Dynamics Web Log for 20-May-2010
20-May-10 News -- Angela Merkel roils markets with demands