Best of the Week
Most Popular
1.Crude Oil Price Trend Forecast 2016 Update - Nadeem_Walayat
2.Will Deutsche Bank Crash The Global Stock Market? - Clif_Droke
3.Gold Price In Excess Of $8000 While US Dollar Collapses - Hubert_Moolman
4.BrExit UK Economic Collapse Evaporates, GDP Forecasts for 2016 and 2017 - Nadeem_Walayat
5.Gold Stocks Massive Price Correction - Zeal_LLC
6.Stock Market Predicts Donald Trump Victory - Austin_Galt
7.Next Financial Crisis Will be Far Worse than 2008/09 - Chris_Vermeulen
8.The Gold To Housing Ratio As A Valuation Indicator - Dan_Amerman
9.GDXJ Gold Stocks - A Diamond in the Rough - Rambus_Chartology
10.Gold Boom! End Game Nears As Central Banks Buying Up Gold Mining Companies! - Jeff_Berwick
Last 7 days
Gold’s Moving Averages and Long-Term Outlook - 26th Sept 16
September Stock Market - The Not So Silent Demise of Deutsche Bank - 26th Sept 16
SPX sell signal confirmed - 26th Sept 16
SPX is testing the next level of support - 26th Sept 16
Outrageously Entertaining US Presidential Campaign Final Stages - What Happens Next? - 26th Sept 16
BoJ, FOMC and Where To Now? - 26th Sept 16
Stock Market New All Time Highs Next - 26th Sept 16
Why Trump Will Win US General Election 2016 Prediction Forecast - 26th Sept 16
Martial Law Rolls Out Across the US As Jubilee Nears - 26th Sept 16
Stock Market More Correction Likely - 25th Sept 16
US Presidential Election Forecast 2016 - Trump Riding BrExit Wave into the White House - 25th Sept 16
US Economy GDP Growth Estimates in Free-Fall: FRBNY Nowcast 2.26% Q3, 1.22% Q4 - 24th Sept 16
Gold and Gold Stocks Corrective Action Continues Despite Dovish Federal Reserve - 24th Sept 16
Global Bonds: Why Our Analyst Says Things Just Got "Monumental" - 24th Sept 16
Where Did All the Money Go? - 23rd Sept 16
Pension Shortfalls Could Be 4X To 7X Greater Than Reported - 23rd Sept 16
Gold Unleashed by the Fed - 23rd Sept 16
Gold around U.S Presidential Elections - 23rd Sept 16
Here’s Why Eastern Europe Is Doomed - 23rd Sept 16
Nasdaq NDX 100 Big Cap Tech Breakout ? - 23rd Sept 16
The Implications of the Italian Banking Crisis Could Be Disastrous - 22nd Sept 16
TwinLakes Theme Park Summer Super 6 FREE Return Entry for Real? - 21st Sept 16
Has the Silver Bullet Run Out of Fire Power? - 21st Sept 16
Frack Sand: The Unsung Hero Of The OPEC Oil War - 21st Sept 16
What’s Happening With Gold? - 21st Sept 16
Gold vs. Stocks and Commodities, Pre-FOMC - 20th Sept 16
BrExit UK Inflation CPI, RPI Forecast 2016, 2017 - 20th Sept 16
European banks may be more important than the Fed this week - 20th Sept 16
Gold, Silver, Stocks and Bonds Grand Ascension or Great Collapse? - 20th Sept 16
Mass Psychology in Action; Instead of Selling Gilead it is Time to Take a Closer Look - 20th Sept 16
Hillary - Finally Well Deserved Recognition for Deplorables - 20th Sept 16
Fascist Business Model: Reich Economics - 19th Sept 16
Multiweek Correction in Gold and Silver Markets Continues - 19th Sept 16
Stock Market May Turn Ugly This Week - 19th Sept 16
China Is Digging Itself into a Deeper Hole - 19th Sept 16
Yellen’s Footnote 8 Would Put Interest Rates on Autopilot - 19th Sept 16
Central Bank Digital Currencies: A Revolution in Banking? - 19th Sept 16
UK Government Surrenders to China / France to Build Nuclear Fukushima Plant At Hinkley Point C - 19th Sept 16

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

The Power of the Wave Principle

Sovereign Crisis from Economic Stimulus to Debt Austerity Snowball Effect

Economics / Economic Austerity Jun 18, 2010 - 11:26 AM GMT

By: Mike_Larson

Economics

Best Financial Markets Analysis ArticleA blockbuster draft report from the European Commission saw the light of day recently, thanks to some reporting from Bloomberg. It highlights an incredibly dangerous Catch-22 facing many sovereign nations — the “Snowball Scenario.”

Let me give you an example how this works …


Suppose country A’s economy goes into the tank. The government responds by borrowing boatloads of money and spending like mad on stimulus packages.

The markets allow it to go on for a while. But then investors start to get antsy about all the debt being added to the government’s balance sheet. So they start dumping its bonds, driving prices lower and rates higher. That, in turn, forces the country to implement austerity measures to get its debt and deficit under control.

The problem?

Those moves send the economy BACK into the crapper! Government spending has to rise yet again to pay for things like unemployment insurance, new stimulus packages, and so on … at the same time tax revenues fall. That drives debts and deficits even higher.

The end game in this snowball scenario? A sovereign default!

And that’s not just a theory. In fact …

Snowballs Are Already Rolling Downhill in Spain, Greece, and Portugal

Spain is trying to slash its budget deficit from 11.2 percent to 9.3 percent in 2010 and 6 percent in 2011. Portugal wants to cut its deficit from 9.4 percent to 7.3 percent this year and 4.6 percent next year. They plan to do so by some combination of pension freezes, wage cuts, new taxes, and other measures.

But the European Commission, which is the executive arm of the European Union, says that probably won’t be enough. Its conclusion?

“While the newly announced measures are significant and the targets imply impressive budgetary consolidation, more measures are needed to meet those targets.”

The EU has told Spain and Portugal to get their budgets back in shape.
The EU has told Spain and Portugal to get their budgets back in shape.

In plain English, the message is “Get even tougher! Crack down more! Slash spending! Raise taxes!”

But as the Commission admits, the governments it is counseling face “low GDP growth, poor competitiveness, stable or declining prices and wages and high real interest rates.” So it’s virtually impossible to avoid a “snowball effect on the government debt.”

Stay Cautious! Stay Safe!

Bond traders aren’t dumb. They can see this coming from a mile away. Yields on Spanish 2-year notes shot up recently, then eased a bit. But now they’re rallying yet again — hitting a new cycle high just this week.

Spanish borrowing costs have skyrocketed from 1.51 percent in March to 3.29 percent, the highest in 17 months! It now costs more on a relative basis for Spain to borrow than it does the euro-area’s main economy, Germany. And it’s the highest that the 10-year Spanish/German yield spread has been since 1999 — when the euro currency debuted.

Portugal is seeing costs rise, too. It’s paying 5.58 percent to borrow money for 10 years, up from 4.15 percent back in April.

Reports are surfacing that Spain may need a 250 billion euro ($307 billion) credit line from the International Monetary Fund, the European Union, and possibly the U.S. Treasury.

Naturally, policymakers are denying that anything is in the works. But what do you expect them to do? These guys said the same thing about Greece, claiming it wasn’t at risk of defaulting. Then they pushed through a $135 billion bailout!

Use market rallies as selling opportunities.
Use market rallies as selling opportunities.

In short, this sovereign debt crisis is playing out just like the private credit market crisis did before. It comes in waves — with periodic sharp drops triggered by some event, then some kind of bailout that makes everybody breathe a temporary sigh of relief, and finally yet another plunge as another hole appears in the dike.

My advice?

Don’t get suckered in by the short-term rallies. This sovereign debt crisis is nowhere near over, and that means you have to stay cautious and safe in your investments.

Consider using inverse ETFs to hedge risk, keeping positions small, and dumping stocks into sharp rallies if you’re lucky enough to get them.

Until next time,

Mike

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.


© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Jim Green
18 Jul 10, 16:23
Response to article

I think your article is right on. It seems we are chasing a moving target. We pin that target down for a moment's notice and somehow it seems to escape and cause chaos in financial markets. It also seems there is not a right or wrong answer to ours, or the EU's financial woes and taking a more risk averse stance might prove to be the winner in all of this.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife