- The Washington Times - Friday, February 12, 2010

World financial markets have been whipsawed in recent days by the European debt crisis, with stock and bond investors thousands of miles from Greece feeling the effects of that nation’s budget woes.

After losing from 5 percent to 10 percent last week on speculation among investors that Greece’s problems eventually might imperil the entire European Union, damage its currency and thwart world growth, U.S. stock indexes posted a major relief rally after European authorities signaled early this week that a bailout package was being considered.

But turmoil could erupt anew if other nations such as Portugal and Spain start to exhibit signs of not being able to cope with their huge debt burdens.

Meanwhile, the pullback in stocks last week had caused a rush of investors into safe-haven U.S. Treasury securities, helping to draw U.S. 30-year mortgage rates, which are linked to 10-year Treasury bond yields, down toward record lows of less than 5 percent. But the benefits for the Treasury and the U.S. dollar abruptly reversed on Wednesday as investors rushed back into global stock markets.

The seesawing market reaction to Greece’s troubles was the latest example of how financial markets - which arguably are the most globalized part of the world economy - transmit events happening in far corners of the world in ways that affect the U.S. economy and pocketbooks of ordinary Americans.

David Starkey, a trader at Custom House, a Canadian foreign exchange firm, said even unfounded speculation in the markets can have a powerful effect and force major economic events. For example, rampant speculation against the European currency, the euro, earlier this week raised the specter of a currency crisis and likely helped to prompt action by European authorities to rescue Greece.

“As Greece’s ability to pay back its debt came into question during the last few weeks, concerns of a contagion effect on [Portugal, Spain, Ireland and Italy] arose,” he said. “This has triggered speculation regarding the strength of all European countries and the stability of the European common currency itself.”

Although the European Council, the executive of the European Union, met Thursday to formulate a response to the possibility of a Greek default, it came up with only a vague statement pledging help if asked.

The leaders of Europe hesitated to bail out Greece for the same reason the U.S. government has found it distasteful and unpopular to bail out failing banks and automakers at taxpayer expense.

Authorities in Germany, which would bear the brunt of European bailouts, warned that Greece’s loan package will include “strict conditions” requiring Greece to quickly bring down its budget deficits - likely prolonging a deep recession in that country.

But European leaders were forced into action by the markets not only to help Greece but to preserve increasingly shaky unity in Europe, Mr. Starkey said.

“The precedence for such national bailouts” raised worries, he said, but “the risks associated with doing nothing are far too grave to be ignored.”

European leaders were forced into action to “fend off speculation” against the euro, said Aroop Chatterjee, an analyst with Barclays Capital, but the tribulations of the European currency haven’t ended.

“While the announcement of an assistance package could further stabilize the markets in the short term,” he said, it also will spawn increasing speculation about whether other countries, such as Portugal, will get in line for assistance.

Many traders also are likely to doubt that European leaders will enforce demands for stringent budget cuts because the EU in the past has been lenient toward countries that exceeded budget deficit targets, he said.

In the zero-sum logic of global financial markets, what’s bad for Europe and the euro has been good for the U.S., its currency and its debts in recent weeks. But as the European crisis eased and investors scurried back into stocks, the U.S. was forced to pay a price.

A scheduled Treasury auction of $16 billion in 30-year bonds on Thursday went poorly. A shortage of buyers forced the Treasury to pay higher rates to sell the securities. The same thing happened Wednesday when Treasury tried to sell $25 billion in 10-year bonds.

Mike Larson, an analyst at Weiss Research, said the incident shows how the “explosion in debt and deficits” to address last year’s global financial crisis eventually will come home to roost in the United States, as it has in Europe.

“The government debt crisis will not stay bottled up in Europe,” he said. “It will spread to the U.K. and the U.S., because the same underlying problems hammering countries like Greece are at work here, too.”

Jeffrey Kleintop, chief market strategist at LPL Financial, said the European debt crisis most likely was a passing phase for the U.S. stock market and bond markets. After gaining some lost ground this week, the Standard & Poor’s 500 and other major U.S. stock indexes have sustained losses of 8 percent, compared with losses averaging more than 10 percent in other global stock indexes.

The same “bond vigilantes” that have started to punish countries with big debts, like Greece, also have exhibited concerns about burgeoning U.S. deficits, but the cost of financing U.S. debt remains low by world standards, he said.

The European debt troubles are “aftershocks” from last year’s global financial crisis, which prompted the U.S. and European governments to pour money into their economies through government spending and tax cuts to avert deep recession.

“Concerns that the troubles in peripheral Europe could lead the rest of the world economy to another crisis will fade,” he said. “We expect there will be more aftershocks, but they are unlikely to undermine the global economic recovery.”

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