A Five-Step Guide to Contagion
Why European debt matters to the United States.
Times are tough and those struggling to make ends meet have focused their efforts close to home.
That's a natural instinct but it doesn't change the fact that problems on the other side of the world affect us all. To fully understand the depth and complexity of our current conundrum, we must appreciate how we got here.
It is widely accepted that grieving arrives in five stages: denial, anger, bargaining, sadness, and acceptance. If we apply that psychological continuum to the financial market construct, it offers a valuable lens with which to view this evolving crisis.
In April 2007, policymakers assured an unsuspecting public that housing and sub-prime mortgage concerns were "well contained." Minyanville took the other side of that trade and argued that the nascent contagion extended all the way around the world. (Read more in Well Contained?)
In August 2007, as the Dow Jones Industrial Average traded near an all-time high, Canadian officials told investors it would "provide liquidity to support the stability of the Canadian financial system and the continued functioning of the financial markets" before systemic contagion ensued. (See also The Credit Card)
In March 2008, Alan Schwartz, CEO of Bear Stearns appeared on CNBC to assuage concerns that his firm was facing a liquidity crisis. "Some people could speculate that Bear Stearns might have some problems since we're a significant player in the mortgage business," he said, "None of those speculations are true."
On January 28 of this year, Greek Prime Minister George Papandreou offered that Greece was being victimized by rumors in the financial markets and denied seeking aid from European partners to finance the country's budget deficit, according to Bloomberg. As we know, European issues are now staking claim as the next phase of the financial crisis.
Two of my Ten Themes for 2010 are relevant to this discussion. The first is the "tricky trifecta," or the migration from societal acrimony to social unrest to geopolitical conflict. Populist uprising, the rejection of wealth, and an emerging class war are symptomatic of this dynamic, as is the unfortunate fact economic hardship traditionally serves as a precursor to war.
The other theme is the notion of "European Disunion," as I wrote in early January:
The European Union is committed to the regional and economic integration of 27 member states, with sixteen countries sharing a common currency. That was a fine idea when it was first founded but the economic fallout of the financial crisis will put loyalties to the test.
Look for the Union to adopt more stringent guidelines in the coming year, including but not limited to distancing itself from the weaker links such as Greece and Ireland. Sovereign defaults, as a whole, should jockey for mind-share. This could conceivably spark a rally in the US Dollar, which could have ominous implications for the crowded carry trade.
European discontent continues to simmer with labor strikes and social strife as efforts are made to map an amenable plan before €20 billion ($28 billion) in Greek debt comes due in April and May. While that amount is far smaller than what financial firms faced in September 2008, the dynamic is earily reminiscent. (Read also Pirate's Booty)
By the time it was evident sub-prime mortgage woes weren't contained, the damage already occurred. Our government reactively responded to the crisis by consuming the cancer in an attempt to stave off a car crash. (See also Shock & Awe)
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