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By the first
week of October, after having dropped more than 18 percent from its highs
achieved in May 2011, U.S. stocks were desperate to latch on to any good
news. In this context, the apparent agreement between the major European
players to kick their debt can down the road was viewed as an "all
clear" for shell shocked investors.
Since October
4th the Dow has rallied almost 10 percent, one of the best 10-day stretches
in the history of the stock market. The gains have been enough to push the
Dow into positive territory for the year. However, the agreement in Europe
that sparked the good times solves absolutely nothing and virtually assures
that problems will re-emerge in the near future.
To salvage
their most indebted banks and some of their struggling periphery members,
including Portugal, Ireland, Italy, Greece and Spain, Europe has agreed to
create, and fund, the 440 billion euro ($590 billion) European Financial
Stability Facility. It remains to be seen how this extra layer of bureaucracy
will make any difference in putting the continent back on a sustainable path.
While a meeting
between two Euro leaders (Sarkozy and Merkel) may have galvanized Eurozone
politicians into more dramatic group action, the new Facility fails to
address the intractable political problem that solvent countries are tiring
of funding profligate neighbors. It also fails to reverse the fundamental
structural problems that plague the euro.
Just a few
weeks ago, when the EFSF bailout fund was announced, it was widely trumpeted
as a cure-all. However, many have already deemed the Fund to be too small,
with some calling for it to be increased five times to over $2 trillion.
However, even $2 trillion would be a paltry sum with which to confront any
debt problems erupting from larger countries such as Italy.
In his recent
attempts to block the adoption of the EFSF, Mr. Richard Sulik,
leader of Slovakia's Freedom and Solidarity Party said "I'd rather be a
pariah in Brussels than have to feel ashamed before my children who would be
deeper in debt should I raise funding for the EFSF bail-out mechanism."
I believe that the vast majority of EU's 400 million citizens would echo this
view. But with democracy crushed almost to death already within the EU, such
a view would not easily be published. Unfortunately for young Slovaks, the
plan passed.
The recent
collapse of Dexia Bank, which had been considered
to be fiscally sound earlier this year, was too big for Belgium to handle.
Help was required from France and Luxembourg. However, it is important to
understand that there are many banks in Europe that may have substantially
more "troubled" assets than Dexia, which
carried less than $600 billion of total assets on its balance sheet.
For instance,
the three largest French banks which recently passed the euro stress test (as
Dexia had in the past) have total assets of some $6.3
trillion, or about half of America's GDP! While it is unclear how much of
these assets would fall into the "troubled" or "toxic"
categories, it is reasonable to assume, given the extent to which these banks
have loaded up on sovereign debt, that the percentage is not insignificant.
Clearly then it will not take a tremendous amount of asset downgrades to
force a systemic crisis. On this basis, how much confidence can be inspired
by the new framework?
I believe
that it is just a matter of time before these possibly catastrophic debt
chasms erupt into full view. When they do, the euro itself may be pulled
apart. In today's interconnected world, a collapse of the world's second
largest currency would create such chaos that soon it would threaten the
continued viability of the fiat U.S. dollar.
Facing these
possibilities, as well as the realities of anemic U.S. economic growth, and
the risk of disappointing Q3 corporate earnings, it is hard to trust the
recent U.S. stock rally. This is particularly so as the rising stock prices
have been based on very low volume.
John
Browne
Euro Pacific Capital, Inc.
John Browne is a former member of the UK
Parliament and a current senior market strategist for Euro Pacific Capital. Click here to learn more about Euro
Pacific's gold & silver investment options. For a great primer on
economics, be sure to pick up a copy of Peter Schiff's hit economic parable, How an Economy Grows and Why It Crashes
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