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Generational Dynamics Web Log for 3-Aug-2011
3-Aug-11 News -- Possible bond panic is in process, after can-kicking debt ceiling deal

Web Log - August, 2011

3-Aug-11 News -- Possible bond panic is in process, after can-kicking debt ceiling deal

Bond panic in Europe

Possible bond panic is in process, after can-kicking debt ceiling deal

Mainstream economists and analysts expected the stock market to rise on Tuesday, after the uncertainty about raising the debt ceiling was resolved by a bill passed by Congress. Instead, stocks on Wall Street fell 2%. As usual, mainstream economists were wrong.

Congress leaves for a taxpayer-paid four week vacation in the sun, as Spain's prime minister José Luis Rodríguez Zapatero has been forced to abandon holiday plans because of financial crisis. (AFP)

Congress leaves for a taxpayer-paid four week vacation in the sun, as Spain's prime minister José Luis Rodríguez Zapatero has been forced to abandon holiday plans because of financial crisis. (AFP)

When the bailout of Greece was announced a couple of weeks ago, at least the Europeans got two or three days of euphoria out of it, before it all fell apart into bitter recriminations. In Washington, the euphoria was almost nonexistent, and the bitter recriminations began instantly.

The Brussels agreement and the Washington agreement have one huge thing in common: Neither of them did anything but "kick the can down the road." In particular, the debt ceiling agreement sets up some kind of super-committee that's going to meet this fall and decide on budget cuts and tax increases. And the budget cuts won't actually cut anything -- they'll only slow the budget growth a little.

The situation in Washington is just as chaotic as it was before the agreement, except that the debt ceiling got raised, which everyone knew was going to happen anyway, one way or another.

However, investors were swayed by one piece of bad economic data after another:

Last week's GDP figures were disastrous. ( "30-Jul-11 News -- Economists in shock over GDP report")

On Monday, worldwide manufacturing figures from America, Europe and Asia were extremely disappointing, as we reported yesterday. U.S. manufacturing activity hit a two-year low in July.

The Commerce Dept. announced on Tuesday that consumer spending dropped in June for the first time in nearly two years, according to Reuters. This is considered highly significant because consumer spending accounts for something like 70% of the economy. If consumers are spending less, then it could mean a sharply slowing economy, and with unemployment at 9.2%, it's not surprising the consumers are spending less.

Italy 10 year bonds - 8/2/2011 - 6.1% yield

Italy 10 year bonds - 8/2/2011 - 6.1% yield

Bond panic in Europe

Returning now to Europe, there has been increasing concern over unstoppable increases in bond yields (interest rates) for Italy and Spain. In particular, analysts who have been commenting on these bond yields have been saying that if Italy's 10-year bond yield ever goes up above 6% and stays there, then it will cause a major crisis for Italy.

Well, Italy's 10-year bond yield ended the day at 6.1% on Tuesday. Given Europe's experience ever since Greece was bailed out last year in May, there's absolutely no reason that I know of to assume that the bond yields are going to start falling.

Cyprus is also in serious trouble, as the government budget deficit widened sharply in the first half of the year. Yields on a 10-year government bond were at 10.54% on Tuesday, up from 9.71% on Friday, and around 6.2% in mid-May, according to the Cyprus Mail.

Bond prices move in the opposite direction as bond yields. So if bond yields are rising rapidly, then it means that bond prices are falling rapidly, and there may be a major panic at hand. We should know within a few days or weeks.

And as we've pointed out before, the recent bailout of Greece requires large banks to "voluntarily" take a 21% "haircut" -- which may be closer to 90%. The "voluntary" bond swap that will accomplish this is supposed to take place at the end of August.

So, we have a European bailout that won't be implemented until the end of August, and an American debt deal that won't be implemented until a super-committee starts to meet in the fall.

As a side note, Moody's Investors Service announced on Monday that it was not planning to reduce the AAA rating of the United States, citing the decision to raise the debt limit, according to Reuters. However, Moody's assigned a negative outlook to the rating.

Some pundits are predicting that the political pressure on the major ratings agencies (Moody's, S&P, Fitch) will be so great that they'll never reduce America's AAA ratings. But this overlooks a big problem that these ratings agencies have: They've been lowering the debt ratings of various European countries once or twice a week for months. The financial community will not tolerate giving America a pass for purely political reasons.

One thing that's become clear is that the people's attitudes have been changed by this debt. I know from experience that when I tell people about my web site and how bad things are, then they assume I'm just making stuff up. What this debate has done is to educate the American people about how bad things really are.

This feeds into the risk-aversion of people now. As I've said before, from the point of view of Generational Dynamics, a major generational change in attitudes is occurring, in that people have been badly burned financially, and they've become extremely risk averse, and will remain so for the rest of their lives. The result is that, despite the Pollyannaish nonsense predictions from mainstream economists, there will not be any recovery until the 2020s, when a new generation starts spending money.

(Comments: For reader comments, questions and discussion, see the 3-Aug-11 News -- Possible bond panic is in process, after can-kicking debt ceiling deal thread of the Generational Dynamics forum. Comments may be posted anonymously.) (3-Aug-2011) Permanent Link
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Generational Dynamics Web Log for 3-Aug-2011 3-Aug-11 News -- Possible bond panic is in process, after can-kicking debt ceiling deal

Possible bond panic is in process, after can-kicking debt ceiling deal

Bond panic in Europe

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Generational Dynamics Web Log for 3-Aug-2011
3-Aug-11 News -- Possible bond panic is in process, after can-kicking debt ceiling deal