Bad Policies Unleash the Bears

08/05/2011 11:06 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Insistence on austerity in Europe and the US is sabotaging the economic recovery, writes senior editor Igor Greenwald.

I realize I’m not supposed to feel this way. This is a very tough time for most investors, and a loss is a loss is a loss. It’s never right to enjoy someone’s misery.

And yet when I first glanced at the action in the European stocks this morning, and saw that wrecked Milan and ruined Madrid were up—while Frankfurt was still down big—I felt more than a little schadenfreude.

Through Thursday, the German DAX was down an unlucky 13% in just seven trading sessions, and while that’s not good, it does seem just. Germany bears the primary responsibility for turning Greece’s blowup into an epidemic of continental credit contagion.

The austerity advocated from Bonn and Frankfurt not only denied the heavily indebted nations the chance to grow out of their debt, but has in fact plunged them into recession (Italy, Spain, and Portugal) or depression (Ireland and Greece).

In fairness, the euro hasn’t helped. Greek government and Irish property developers borrowing freely at near-German rates has proven a terrible idea.

But sentencing countries to penury and servitude without end on behalf of equally irresponsible creditors made a bad situation infinitely worse, and now the consequences have finally boomeranged.

Germany didn’t bungle this alone, of course. It’s been abetted by an arrogant and dishonest European Central Bank, raising interest rates to please its German masters while simultaneously underwriting the insolvent banks on the periphery that desperately need to be restructured.

France and Italy and Spain and just about every other European government have complained bitterly about the lack of appreciation for their policies in the markets, blaming speculators for their troubles when they should have been looking in the mirror.

But it was German Chancellor Angela Merkel who refused to explain to her citizens how their prosperity and Greek misery were inextricably linked—were, in many ways, two sides of the same coin.

Germany has benefited tremendously as the single currency gradually priced its less efficient European competitors out of export markets.

And it has benefited even more by selling all those Mercedes sedans to those same partners on credit at a low, low introductory rate. Now, like a subprime mortgage, all those loans have been repriced...but Germany still wants its money back.

The recent selling in Frankfurt marks a realization that this money isn’t coming back, and that collection efforts are now spooking even the creditworthy customers.

The policies of “extend and pretend” have worked out better for their intended beneficiaries, the German and French banks. Deutsche Bank, for example, was given the time it needed to sell almost all of the $11.5 billion of the Italian government bonds on its books at the beginning of the year.

The same has been true of Greek debt: most of the main European banks have already unloaded their holdings. One reason Germany has played hardball in debt restructuring talks for Greece is that so much of the debt is now mostly held by hedge funds and other speculators, many of whom bought it below face value.

But this stance has now panicked holders of Italian and Spanish bonds as well. And most of Italy’s bonds are in the hands not of hedge funds, but Italy’s rapidly aging populace. So irresponsible Deutsche Bank has been helped, while responsible Italian savers have been hurt.

Almost as troubling, the misplaced priorities have left European makers badly out of touch with the action in the markets, which is the arena where Italy and Spain must borrow money.

Markets are at a loss as to how these countries will ever grow again when the policy response to economic weakness is to keep cutting. Markets are selling off because policies in Europe and the US remain dysfunctional, and politicians are unwilling to either restructure old debts or to stimulate the sort of growth that it would take to get them honored.

Until that changes, blips like today’s less awful than expected employment report remain invitations to sell into market pops.

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