Contagion from Greece Having Global Impact

As the situation in Greece deteriorates further, Moody’s announced today that it intended to downgrade 114 European financial institutions and 17 global banks. Hopes that China will buy up EU sovereign debt to help prop up the faltering eurozone may wind up costing the U.S. more than it does China.

The hostility between Greece and the EU/IMF/ECB bailout troika is palpable. Nevertheless, there are claims that a deal should be reached by Monday. Whether the severe budget cuts demanded will actually be implemented is another story. Greece’s GDP is shrinking 7% this year and additional budget cuts will only make the situation worse. Athens is already riot torn and elections in April (assuming a democratic government still exists) are not likely to produce a government favorable to the bailout terms. The market remains increasingly skeptical of Greece’s near-term future with one-year government bond yields reaching 528% today.

While all attention is focused on Greece, the European debt crisis permeates the continent. Banks have lent too much money to not just Greece, but to Portugal, Spain, Italy and Eastern European countries as well. There is a still a hangover of pre-Credit Crisis debt that wasn’t resolved in 2008, but merely papered over with newly printed money. Moody’s just announced it was planning on downgrading 114 European financial entities including 7 in Germany, 9 in Great Britain, 10 in France and over 20 each in Spain and Italy. Global banks Nomura and Bank of America are in line for a one-notch downgrade, while Barclays, BNP Paribas, Credit Agricole, Deutsche Bank, HSBC Holdings and Goldman Sachs could have their ratings lowered two notches. UBS, Credit Suisse and Morgan Stanley could be reduced three notches.

China with its vast foreign reserve holdings has been considered the potential savior of the eurozone. If this does occur, it won’t be only China that is paying however; the U.S. will be sacrificing as well. China has previously announced it wants to diversify its reserve holdings. Since a disproportionate amount of these are in U.S. treasuries, the obvious implication is that it will be funding less U.S. debt as it funds more EU debt. The most recent figures for November 2011 indicate that China decreased its U.S. debt security holdings by almost 3%.

The EU debt crisis is likely to be us for some time to come. The situation with Greece is not stable and at some point it will have to leave the eurozone. Attention will increasingly focus to the other debt-ridden countries and the weak banking system. Just as the crisis spread from Greece throughout Europe, it will then spread from Europe to the rest of the world. We are already seeing this happen.

Daryl Montgomery
Author: “Inflation Investing – A Guide for the 2010s”
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.