Friday, May 18, 2012

European Crisis Has Global Consequences

What has been clear to me for quite some time is that Greece is going to exit the eurozone, either willingly or unwillingly. The nation is in a full-on depression and there is no way for it to ever repay its debts.

The Greek unemployment rate was last measured at 21.7 percent in February, a new record. More than half of young people (15-24) are without a job, a recipe for social disaster. In a population of 10.7 million, 1.1 million are jobless and only 3.87 million are employed, a decline of 8 percent, year-over-year.

Even the nation's population is in decline, which will thwart any lingering hope of long term economic growth. Absent a growth in population, energy supplies and credit, there can be no economic growth.

As it stands, the Greek economy is projected to contract by about 20 percent from 2008 to 2012. That's just brutal.

There has been a wave of corporate closures and bankruptcies across Greece. Tax collections, already poorly enforced prior to the economic meltdown, have collapsed.

Under these conditions, there is no way for Greece to grow its economy and service its debts.

Fearing a banking collapse, Greek depositors withdrew €700 million ($890 million) from the nation’s banks on Monday. This is creating a self-fulfilling prophecy and putting enormous strain on the Greek banking system, which will need even more funding from the European Central Bank.

The ECB is just one of the entities to which Greece is heavily indebted and will likely be unable to repay. At a minimum, given its plight, Greece may simply refuse repayment since this payment scheme will keep it permanently indebted.

At its heart, a debt crisis is really a crisis of confidence. In Greece, and elsewhere in Europe, there is no confidence whatsoever.

The failure of Greek party leaders to reach an agreement to form a unity government is raising fears that Greece could soon be ousted from the euro zone. It may even choose to leave voluntarily. Such a possibility is rattling global financial markets. There is no legal mechanism for a nation to leave the euro zone and that is a vexing problem. Apparently, the architects of the euro zone never imagined such a scenario.

Any sign that Greece is preparing to exit the euro zone would trigger contagion in the more vulnerable euro zone bond markets, such as Spain and even Italy. The trouble in Europe is expanding and worsening. Leaders have been delaying some rather ugly outcomes for years, but they are now running out of time. They can no longer kick the can down the road because they have finally run out of road.

This week, Moody's downgraded the ratings of 26 Italian banks. But that's only half the story.

Moody's also downgraded 16 Spanish banks in what was the latest blow for a country already facing economic recession, surging unemployment and a property bust. There is a legitimate fear that the run on Greek banks will shift to Spain next.

The contagion in Europe has been continually spreading, from Greece, to Ireland, to Portugal, to Spain and even Italy. The yields on Spanish and Italian government debt are again rising to unsustainable levels. If unchecked, that could raise the crisis to an entirely new magnitude. Italy and Spain are the third and fourth largest economies in the euro zone.

As it is, there are now debt and/or bank problems in countries that have been traditionally viewed as safe and stable: Holland, Austria, Switzerland and Sweden, for example.

The continent's recession will have global consequences. It will dampen demand and hurt exporters that rely on the European market, such as the U.S.

The European sovereign debt crisis and slowing global economy have driven the dollar to its longest rally since 1985, as investors seek to reduce risk. The strength of the dollar is weighing on dollar-priced commodities such as gold and oil, making them more expensive for holders of other currencies.

In essence, the purchasing power of the dollar is rising, making commodities cheaper. So, commodities aren't really going down in value; the dollar is going up in value.

On the one hand, this is good for the U.S. and American consumers. Lower pump prices would be a welcome outcome. However, while oil/gas prices are dropping here, they are rising elsewhere in the world. That will hurt other economies, and this is ultimately a global issue.

Furthermore, the strength of the dollar will make U.S. goods more expensive overseas, ultimately hurting American exporters. That's not good for the country's whopping trade deficit, or the economy in general. So the rising dollar can be viewed as a tradeoff, or a mixed blessing.

The global economy is just creeping along, reacting to one crisis after another. Even the giant Chinese economy is slowing. That's bad news. The world needs robust economies to spur trade and growth.

Ultimately, the nations of the world are grappling with unsustainable debts. And the whole world needs economic growth to service all those cumbersome debts. The trouble is, there can be no growth without debt. Growth equals debt. In order to grow, the world's economies will have to incur even more debt. But that's like adding more disease to an already sick patient.

Furthermore, there can be no economic growth without an abundant supply of oil, particularly cheap oil. Neither exists.

The global economy is inextricably linked due to trade, finance and the competition for finite resources, such as oil. That's why the pain in Europe will be felt worldwide.

Not every nation can be a net exporter, meaning that huge trade imbalances will not only continue, but will worsen. This is simply unsustainable.

As credit risk rises, lenders will become increasingly scarce and the cost of borrowing will reach unmanageable levels, as is already the case in parts of Europe.

When the price of oil drops, that means the world economy is slowing or stagnating. That's a bad tradeoff. And, as previously stated, if oil prices are dropping only in the U.S. due to a rising dollar, that has an opposite effect to the rest of the world, which must buy oil in dollars.

We are witnessing a slow motion train wreck, or even collapse. Europe's leaders, as well as the central bankers around the world, are attempting to hold back the tide.

How this ends is open to speculation, but one thing is certain; it won't end well.

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