The Key to Pandora's Box.

September 19, 2011

Stocks jumped off the mats last week. Investors were encouraged by central banks vowing to pump dollars into the European banking system to avert a liquidity crisis. This week, the focus remains on the determination of European leaders to complete the job.
Concern grew on Friday regarding Greek debt and the eurozone's financial stability. European finance ministers and U.S. Treasury Secretary Timothy Geithner met in Wroclaw, Poland, to discuss solutions for the crisis. As of yet, no progress has been announced.
Do not underestimate the power of central bankers to achieve anything to which they set their minds. These are powerful people with vast resources. When they unite in any effort, odds are on their side.
And yet the problems with which they grapple are even more powerful. More insidious. Do prey that these bankers keep the lid shut on Pandora's Box, lest its contents escape and global debt contagion ensues.
From whence came the contents of this scary, problematic box? Like modern finance, rugby and the Bubonic Plague, it originated in Europe, alongside the birth of the monetary union, circa 1993.
Not everyone was for the establishment of the EU, yet that is another day's story. Today, we'll focus on how the EU's birth led to the current debt monster straining to burst from its cage...
Europe has always consisted of four distinct quadrants: The east, west, north and south. Each quadrant as distinct as their cultures are unique. From those distinctions arose today's issues. The very idea behind the EU was conceived in Northern Europe. Which, in many cultural regards, is a lot further away from Southern Europe than the distance itself.
All of the world's energy and intellect cannot obscure the fact that Greece, Italy, Spain and Portugal differ in their economic ambitions compared to those of their northern neighbors. The hyper-efficient, industrial nature of the Germans will never perfectly align with the relaxed attitudes of their Mediterranean peers.
Yet, France and Germany pushed, prodded and cajoled the southern countries into a currency union ill-suited to their ambitions. And the fact that the union was unable to tax or issue bonds made the situation even more untenable during those inevitable periods of difficutly.
As the EU took shape, the global economy prospered. The northern industrialists, realizing what was best for the mediterranean cousins, prodded the southern members into issuing more debt than they could afford. Debt that contributed greatly to the salaries and bonuses of German and French bankers.
When the global economy slowed, and the southern members had difficulty repaying the debt, the northerners expressed shock and dismay. And of course it was French and German banks expressing the most shock and dismay.
Alas, one can easily light a fire. Putting it out is the trick.
Granted, the Greeks are not without guilt. Their fiscal irresponsibility is troubling. Yet, when a banker unlocks the vault, hands you a suitcase and leads you inside, one cannot absolve the banker just because he then decides to recast you as a ne'er-do-well.
How does the situation affect you? Considers the potential chain of events should Greece (or any of the Mediterranean nations) default. German, French, British and Dutch banks will spasm as mounds of Mediterranean debt are vaporized. European governments, rushing to aid their large commercial banks, will shovel capital atop the flames in an attempt to snuff them out. Debt agencies will watch closely, trigger-ready to downgrade any commercial or sovereign institutions that cross the line of fiscal probity. American banks, holding European debt, will get indirectly kicked in the teeth as the debt and equity of our European partners go into seizures.
The situation is manageable. But, it involves a stroll across a tight rope stretched between two very tall buildings. In the rain. With howling winds.
Remember, these nations are attempting to reign in their budgets at a time of global economic contraction. While the credit crunch gains strength, governments are demanding more austerity measures. Populations, already feeling the downturn, are taking to the streets. Protesting. Rioting. Adding to a vicious Catch-22.
Bottom line? Central bankers learned a lot during the U.S. credit crisis in 2008. They have all of the tools and wherewithal at their disposal to get ahead of this. To prevent it from becoming a full-scale global credit meltdown. We are not pretending that's not possible. As Nassim Nicholas Taleb taught in his book, The Black Swan, anything can happen. Regardless of how improbable.
Yet, if corporate credit markets remain firm, as they have, and global leaders, bankers and markets can keep the lid down, then Pandora's Box need not be opened. In which case, we will likely look back on this period as an opportunity, as opposed to a catastrophe. Stay tuned.

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