Despite the fact that financial markets were calmed on Friday, the debt crisis now threatening Europe figures to get worse going forward.
That’s why I prefer to fade the euro rally. Looking at specific levels, there’s initial resistance near $1.3350. A move above there would likely be checked in the $1.3400 and then $1.3450 area. On the downside now, a move back to $1.3250 is possible on any disappointment. Over the medium term, the issues outlined here, within the context of an expanding US economy (estimated to be between 3% and 4% in 2010) will likely push the euro back below $1.30 with a move toward the mid-$1.20s a reasonable target.
The root of this debt crisis, as usual, was that interest rates were kept too low for a borrower who was determined to borrow and spend as much as it could in order to maintain a veneer of prosperity because as an EU member, Greece had access to lower borrowing costs than it otherwise would have. For years, Europe’s Central Bank actually facilitated profligate spending by allowing the commercial banks, which buy the debt, to deposit it at the ECB as collateral for newly printed money.
The bailout money that Greece will receive over the next year from the EU and IMF at relatively low (5%) rates, which amounts to about 18% of GDP or 4000 euros per person, is only a short-term ‘solution’ that actually does nothing to resolve many of the longer term problems that exist. With its total debt at 114% of GDP, nearly twice that of Argentina when it went into default, Greece is economically on the verge of bankruptcy after years of refinancing its interest payments by issuing new debt on the assumption that economic growth would continue.
The point has now been reached where financial markets are refusing to buy into this Ponzi scheme as evidenced by the recent dramatic rise in the cost of borrowing that’s actually a judgment not on Greece alone, but rather on the entire EU-ECB bailout system.
Next on the radar will be Portugal, which also spent too much over the last several years, building its debt up to 78% of GDP at the end of 2009. By 2012, Portugal’s debt-to-GDP ratio should reach 108% even if the country meets its planned budget deficit targets (which are questionable to say the least). And because EU money will be there for anyone who wants it, Portuguese politicians are likely to do basically nothing while they wait for their bail-out package which will again be financed by the ECB’s printing press.
The inevitable result will be Germany, which as the world’s 3rd largest exporter has a vested interest in seeing the euro decline, growing tired of bailing out weaker European countries. The longer this system continues, the more debt will be built up and the more dangerous the situation will get.
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