Stocks went on a wild ride this week, first rallying furiously on the reality that the administration’s plan to penalize the big banks was unlikely to ever make it into law and then diving to new lows on fears about sovereign debt in Europe. Friday’s market was a microcosm of the week’s action as the Dow was knocked for a loss of 167 points on a continued “flight to safety” in the dollar, but then recovered in the last hour to finish higher.
Much of the selling this week was based on fear as traders flocked to the dollar as a safe haven, which, in turn, put pressure on stocks, commodities, and the emerging markets. The fear stemmed from concerns about the potential for a credit contagion to develop should a handful of the smaller Eurozone countries, now affectionately known as the PIGI’S (Portugal, Italy, Greece, Ireland, and Spain), default on their debts or experience further rating downgrades.
What may have been curious to many investors this week was the fact that none of this is new. The markets have known about Greece’s difficulties for some time now. In fact, we actually got good news early in the week on this subject as the EU commission endorsed Greece’s plan to cut their budget deficit. This served to quell fears about the region – until Thursday, that is.
On Thursday, we learned that Portugal had a little trouble with their t-bill auction. This little PIGI went to market and came home almost empty handed, so to speak. Apparently Portugal’s treasury held an auction for 500 million Euros and could only find takers for 300 million. Think about that for a moment. A member of the EU tried to sell short-term paper backed by the good faith and credit of the country and came up short when trying to roll over debt. Wow.
It didn’t take long for traders to play the extrapolation game with this situation. If a country can’t raise money by selling bonds and they don’t have enough revenue coming in to cover all the expenses, a default on future debt payments becomes a real possibility. Next, this would lead to a downgrade (or three) in terms of the creditworthiness of the country’s debt. This, in turn, would create big problems for the banks and investors holding the debt. And if the rating on the debt were to fall far enough, it might cause certain types of institutional investors to be forced to sell the paper. But the question, of course, is: Sell to whom?
Is this taking the situation too far? In a word, yes. A key point to keep in mind is that none of these countries has defaulted on any debt payments or is close to a default. But with investors fresh off the worst bear market in a generation that also just happened to be caused by problems with credit; the sell-first-and-ask-questions-later mentality displayed in the markets was certainly understandable.
Although the heat seemed to be taken off of Greece this week, the country isn’t exactly out of the woods. Greece has a budget deficit projected to be 12.7% of GDP in 2009. While this doesn’t sound too outlandish, it is the highest of the PIGI’S as Ireland’s deficit is at 12.5%, Spain’s is 11.4%, Portugal is at 9.3%, and Italy’s budget deficit is a mere 5.3% (according to Haver Analytics).
What’s worse is that Greece has government debt equal to 113.5% of the country’s GDP, which is second only to Italy’s 116.2%. The problem here, in layman’s terms, is these two countries have effectively maxed out on their credit limits. (This is akin to a family having credit card debt equal to a year’s salary.)
The other problem Greece has is its credit rating. At BB-, the analysts at Ned Davis Research worry that the country may not be able to use its own bonds as collateral at the ECB when the central bank returns to its pre-crisis requirement of an “A” rating or better. This too would make it very hard for Greece to borrow money.
The good news is that, according to Haver Analytics, Greece makes up just 2.7% of the Euro-Zone Nominal Gross Domestic Products. By comparison, Portugal is 1.8%, Italy is 17.3%, Ireland is 1.9% and Spain makes up 11.9%. Taken together, the PIGI’S are responsible for 35.6% of the Euro-Zone
The way the rest of the world could control the outrageous spending in DC is through US treasuries-like just quit buying the overrated junk debt. Congress can raise the debt limit all they want but it means nothing if they cannot finance the debt. I wonder if the Federal Reserve(central bank) has come to the conclusion that they can only buy so many treasuries before the buck becomes nothing but butt wiping paper. What really gets me is the outrageous bonus of the investment banks-this is not productive in the sense of the productivity of a factory unless this money is going back into business world as capital investment which I seriously doubt-actually it just creates more inflation(maybe not if they are putting in overseas bank accounts never to be seen again or into gold). How close is China and others that hold massive amount of treasuries telling our government what to do-apparently they are not there yet because we are still fighting stupid foreign wars and wasting money on ineffective social programs instead of investing in the creation of cheap energy which would solve many problems. The situation we have is no better than the PIGIs.