Contrary to what Ben Bernanke would have us believe, the current state of the world economy — and in particular stock and metal markets — is not the sole fault of those dithering Europeans. The metals markets have been seriously worried about the prospect and extent of a slowing Chinese market, the US is barely staying in positive growth territory and inflation is beginning to be a worry not just in China, but in Europe as well.
However, there is no getting away from the fact that Europe’s banks are horribly exposed to debts in peripheral EU states, and it is the fear of possible default by banks in those states and even the states themselves that has frozen the interbank market in Europe and is impacting investor confidence. It is no surprise that bank and mining stocks are leading the falls, with the first exposed to the largely European debt crisis and the second the slowing world economy and hence metals demand. Just as Europeans dismissed early fears among US investment banks as a problem for those on the other side of the pond, many in the US see the European debt crisis as a largely European problem.
That is a mistake.
The global economy is so interlinked, we only have to look at the daily fluctuations in New York or Shanghai stock markets to every piece of news out of Europe to realize this is everyone’s problem, and some finance minister’s decision in Greece or Italy can have a direct impact on the cost of tomorrow’s copper buy or aluminum scrap sale.
As the New York Times rightly points out, European debt problems are showing signs of turning into a far deeper challenge: Europe’s second recession in three years. Greece, Ireland, Portugal and Spain are already in downturns or fighting to avoid them, as high unemployment and austerity belt-tightening take their toll. Italy has just had its credit rating slashed not one but three levels by Moody’s from A2 to AA2. Of all Eurozone members, only Germany seems relatively confident it will avoid recession with analysts predicting a slowing yet still marginally positive 2012 for the largest economy in Europe.
Greece is almost certainly going to default on its debts. Portugal is next in line and has to find an additional Ã¢â€šÂ¬1 billion in austerity savings which will only push the economy deeper into recession, already estimated to contract 1.8 percent this year and 2.3 percent next year. Next-door Spain is supposed to be in growth, predicting 1.8 percent this year, falling to 0.8 percent next year, but with 20-percent unemployment and a similarly severe austerity plan yet to really impact the economy, one has to ask if that’s possible.
The failure this week of Franco-Belgian Drexia bank is symptomatic of the problem facing many European banks. CDS insurance on Drexia debt has soared this year as buyers have become concerned about the bank’s exposure to Greek and Italian debt. With a market cap currently of just Ã¢â€šÂ¬1.9 billion, Dexia’s holdings of Greek, Italian and other Eurozone nations’ sovereign debt amounts to about Ã¢â€šÂ¬21 billion. According to a Telegraph article, analysts at UBS reckon the “at-risk” sovereign debt held by the bank now amounts to more than 80 percent of Dexia’s common equity, while its loan-to-deposit ratio is in excess of 250pc. As with many other European banks, Dexia has not been able to access public debt markets or interbank lending since May. The rush by France and Belgium to assure the markets that the state will support Dexia underlines the fear this is the first domino of European banks to fall. Shorting bank shares is not as easy in Europe as in the UK or US, otherwise you can be sure more would follow within weeks if not days.
Lay this against a backdrop of cooling Asia growth and lackluster (although recently more encouraging) numbers from the US and you have to conclude even for those markets that avoid recession and remain in growth mode, the growth will collectively be meager as most of them are currently heading in the wrong direction and Europe will be a drag on all.
As irritated as the US authorities are with Europe’s problems, they have to accept there is no quick fix and live with the fallout — 2012 is unlikely to see the vigorous bounceback we had been hoping for.