The Dow Jones Industrial Average lost as much as 500 points in late morning trading today as investors ran for shelter from bad news out of Europe and here at home. European financial industry stocks plummeted overnight on speculation that the global economy is grinding to a halt. Gold simultaneously posted a new all-time high of $1829 per ounce as the flight from securities has again bolstered buying of the safe haven metal.
The benchmark Stoxx Europe 600 index is lower by more than 5.3%, showing the largest single day selloff of European securities since 2008. The index has lost more than 22% from this year’s peak.
There are two main areas of concern which are driving this selloff in stocks. The first is that European central bankers will not be able to contain the expanding debt crisis. Spain and Italy are the next giants in line to fall, and it looks increasingly unlikely they will receive any meaningful bailout package from the EU. This is dragging down US financial institutions as well, who hold more than 35 billion in debt from the two fledgling EU members.
Though American banks’ total direct exposure to failing European bonds is relatively manageable, the unknown factor is the massive credit default swap market which is entirely unregulated and undocumented. These insurance like instruments (which fueled the fire of the 2008 real estate meltdown here at home) represent an extraordinary level of interconnectedness between financial institutions on both sides of the Atlantic. Some estimate these default swaps on European banks and bonds to be valued in the trillions of dollars. If EU banks and sovereign governments fail, you can bet that US institutions will be left holding the bag to one extent or another. The problem is that with the unregulated derivative market, no one has any idea how big the losses could be.
Another round of negative financial news here at home has also helped prompt the selloff. Simultaneous increases in cost of living and producer prices were met by unexpected drops in home sales and consumer confidence paints a grim picture. The fear is simply that the US and Europe are simultaneously sinking into a second recession, which may have already arrived. What make that worse are the inflationary signs that are popping up on the sidelines. A second recession, combined with increased prices and cost of living could pose a death blow to the American economy much worse than that seen in the 2008 crash.
Through all of this, there are only two assets that have fared well throughout the last month of trading, those being US treasury bills and gold. Of course with the growing US debt concerns, it’s anyone’s guess when the dollar’s party will come to an end. Though the short term appeal of the dollar as a safe haven play is still strong, it’s unlikely to hold as a long term strategy. For that, investors will have to turn to gold, which they are sure to continue doing.