How European Contagion Could Bring Down the US Treasury Market
Someday, perhaps within a matter of months but more likely in a year or two, the US Treasury market will fall apart as certainly as Greece's did. Here's how that might happen.
At my firm we like to track things from the outside in, as the initial movements at the periphery tend to give us an early warning of when things might go wrong at the center. It is always the marginal country, weakest stock in a sector, or fringe population that gives us the early warning that trouble is afoot. For example, rising food stamp utilization and poverty levels in the US indicate that economic hardship is progressing from the lower socioeconomic levels up toward the center -- that is, from the outside in.
That exact pattern is now playing out in Europe, although arguably the earliest trouble was detected with the severe weakness seen in the eastern European countries nearly two years ago.
Because of this tendency for trouble to begin at the periphery before spreading to the center, we try to spend a disproportionate amount of our time watching junk bonds instead of Treasurys, looking at weak sectors instead of strong ones, and generally trying to scout out where there are early signs of trouble that can give us a sense of what's coming next. In this report, we explore the idea that Europe is the canary in the coal mine that tells us it is time to begin preparing for how the world might change if the contagion spreads all the way to US Treasurys (which is mathematically inevitable, in our view).Why the US Should Care About Europe
At the very core of the global nuclear money reactor are US Treasurys and the dollar. If the dollar's role as the world's reserve currency wanes or even collapses, then the scope and pace of the likely disruptions will be enormous. Of course, we'll be glad to have as much forewarning as possible.
Accordingly, it is my belief that if the contagion spreads from Greece to Portugal (or Italy or Spain), and then to the big banks of France and Germany in such a way that they fail, then rather than strengthening the dollar's role (as nearly everyone expects), we should reserve some concern for the idea that the contagion will instead jump the pond and chew its way through the US financial superstructure.
While I am expecting an initial strengthening of the dollar in response to a euro decline, I believe this will only be a temporary condition.
The predicament is that the fiscal condition of the US is just as bad as anywhere, and we'd do well to ignore the idea, widely promulgated in the popular press, that the US is in relatively better shape than some other countries. 'Relatively' is a funny word. In this case, it's kind of meaningless, as all the contestants in this horse race are likely destined for the glue factory, no matter how well they place.
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