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Where Will Euro-Dominoes Stop?

Posted by Larry Doyle on April 28, 2010 8:34 AM |

While many eyes, including mine, were fixated yesterday on the Senate hearings grilling the Goldman Sachs’ executives, the fact is much more serious issues are playing out across the pond. Greece is literally on the precipice of default. Is Portugal far behind? Will Ireland be next? Will the financial train wreck in Europe be contained? Is that a pipe dream in a world interconnected via a massive credit derivatives market?

Who has a great pulse on the Euro-zone? Simon Johnson, former chief economist of the IMF, co-author with James Kwak (my BlogTalkRadio guest on April 11th) of 13 Bankers, and blogger at Baseline Scenario. Johnson sheds timely insights on moves within the European bond markets and potential for another wave of global financial crisis in writing, Wake the President:

Most days we can coast along, confident that tomorrow will be much like yesterday. On a very few days we need to look hard at the news headlines, click through to read the whole story, and then completely change a large chunk of how we thought the world worked. Today is such a day.

Everything you knew or thought you believed about the European economy – and the eurozone, which lies at its heart – was just ripped up by financial markets and thrown out of the proverbial window.

While you slept, there was a fundamental repricing of risk in financial markets around Europe – we’ll see shortly about the rest of the world. You may see this called a “panic” and the term conveys the emotions involved, but do not be misled – this is not a flash in a pan; financial markets have taken a long hard view at the fiscal and banking realities in Europe. They have also looked long and hard into the eyes – and, they think, the souls – of politicians and policymakers, including in Washington this weekend.

The conclusion: large parts of Europe are no longer “investment grade” – they are more like “emerging markets”, meaning higher yield, more risky, and in the descriptive if overly evocative term: “junk”.

This is not now about Greece (with 2 year yields reported around 20 percent today) or Portugal (up 7 basis points) or even Spain (2 year yields up 27 basis points; wake up please) or even Italy (up 6 basis points). This is no longer about an IMF package for Greece or even ring fencing other weaker eurozone economies.

This is about the fundamental structure of the eurozone, about the ability and willingness of the international community to restructure government debt in an orderly manner, about the need for currency depreciation within (or across) the eurozone. It is presumably also about shared fiscal authority within the eurozone – i.e., who will support whom and on what basis?

It is also, crucially, about stabilizing the macroeconomic situation without resorting to more unconditional bailouts. Bankers are pounding tables all across Europe, demanding that governments buy out their position – or bring in the IMF to do the same. We again find ourselves approaching the point when the financial sector will scream: rescue us all or face global economic collapse.

The White House did not see this coming – and the Treasury’s attention was elsewhere. The idea that we can leave this to the Europeans to sort out is an idea of yesterday. Today is very different and much more scary.

President Obama is wide awake and working hard. Someone please tell him what is really going on.

I commend Simon Johnson for not being bashful in laying out the risks, both financial and political, staring us right in the face. We ignore them at our peril. Navigate accordingly.


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