There is overwhelming evidence supporting the view that European policymakers have lost control of their debt crisis. While LTRO altered the short-term market liquidity backdrop, a strong case can be made that it actually worsened the debt situation. “Periphery,” certainly now including Spain and Italy, banking systems today have much greater exposure to sovereign debt. Indeed, the sovereign and banking system nexus has become only more toxic. And with the ECB today highly exposed to Greece and Portugal, there are myriad issues that will have the European Central Bank treading cautiously when it comes to accumulating Spanish and Italian debt. The Europeans will have to use the “firewall” they had hoped was fashioned only for show.
It’s clear that policymaking has hit a wall in Greece. There will now be a second round of elections on June 17th, which has the potential to lead again to inconclusive results. Mr. Tsipras, head of Syriza, or “The Coalition of the Radical Left,” has in the limelight become only more radical and nationalistic. He is content to play hardball with the EU (and Germany, in particular) and dare them to cut off aid. European policymakers haven’t to this point had to deal with a character like Tsipras, and it would be seen as a bad precedent to let him win this game of chicken. The hope is that a majority of Greek voters will look for an alternative to Syriza’s obstinate approach. I was not comforted by today’s New York Times article (Rachel Donadio), “With Little to Lose, Many Greeks Shrug Off Dire Warnings.” The fear is that the “we have no fear. We have nothing to lose” view quoted in the article is becoming deeply entrenched in Greek society.
This week was replete with troubling talk of bank runs in Greece and Spain - and finance more generally on the move. There will be a lot of work to do to ensure a functioning Greek banking system. Bank runs, even the contemporary electronic version, are destabilizing. It is also clear that worries have engulfed Spanish and Italian banks, with very real concern that the uncertainty associated with a Greek exit from the euro could unleash enormous deposit flight. And it was leaked today that the EU is hard at work with an emergency plan for Greece’s exit from the euro system. Such extraordinary uncertainty beckons for “risk off.”
If the European debt fiasco wasn’t enough, it is increasingly clear that China is faltering. Recent economic data confirm the Chinese economy has commenced a meaningful downturn. Housing markets continue to weaken, and there has been increased focus on rising inventories of apartments, automobiles, steel, raw materials, commodities, etc. Shanghai News this week reported that China’s four largest banks essentially had zero net loan growth in the first two weeks of May, confirming that April’s sharp lending slowdown gained momentum. It is also apparent that, despite recent reductions in bank reserve requirements, finance has tightened throughout important markets for non-bank finance (including securitizations and corporate bonds). I don’t see China’s economic and financial systems responding well to an abrupt Credit slowdown.
Importantly, global markets have begun to question the widely-held assumption that Chinese policymakers have their economy and financial system under control. A counter-argument would be that the massive post-2008 Chinese stimulus package pushed China’s system to unwieldy Bubble status. There is ample support for the view of a historic Chinese Bubble replete with massive leverage, financial engineering, fraud and epic economic maladjustment. This is important because such a Bubble dynamic connotes acute fragility. And such latent fragility takes on much greater significance with Europe rapidly deteriorating and global finance now convulsing.
Working at my desk today was somewhat surreal. Global risk markets were closing out a dreadful week. Newswires were full of disconcerting articles – J.P. Morgan, Greece, Spain, Italy, China, etc. Meanwhile, CNBC was in the midst of blanket coverage of Facebook's initial public offering. Mark Zuckerberg rang the bell to open Nasdaq trading, while helicopters provided live video of the employee gathering at Facebook’s Menlo Park headquarters. Insiders are now worth billions, the “average” employee millions. Even U2’s Bono pocketed $1.2bn (with a “B”). I noted above how I see J.P. Morgan’s current predicament as a microcosm of global financial woes. Well, it is difficult for me today not to see Facebook as emblematic of the incredible transfer of wealth associated with Credit Bubbles. It’s almost as if this historic Bubble has been waiting to end with just such an exclamation point.