Global markets ebbed and flowed based on rumors relating to China’s willingness to hold on to hold on to European assets. The markets tumbled on Wednesday when this rumor hit the markets, only to rebound tremendously when the Chinese FX Authority denied the rumors on Thursday. For the week, the S&P 500 was up one, closing at 1089. The Month of May was the worst performing May for the Dow Jones Industrial Average since 1940.
The European debt crisis will have far-reaching political and economic consequences. The politics contemplated here is not about partisanship but rather the balance of power between the state, business, and labor. Over the years, European citizens have increased the basket of goods and services they receive from the state. These concessions mean that the state was subsidizing the true cost of labor and this generally bought social peace. The financial crisis is bringing to an end that which was unsustainable in the first place. Given slow growth even in the best of times and demographic considerations, that basket of goods and services is no longer affordable. The basket of goods that citizens will get going forward from the European states will be less. Exactly how much less will be a function of the distribution of power within each country. If the state is not going to be subsidizing labor as much, the distribution of productivity gains may be more fiercely fought over. The divergence between the return to capital in the form of profits and rents on one hand and the returns to labor in the form of wages and benefits on the other may re-emerge as a powerful political and social force. This will likely take place at the same time as businesses realign themselves with new regulations and slower economic growth. On Friday, Fitch downgraded Spain to AA+ from AAA and inexplicably with a stable outlook. Spain should be downgraded multiple notches. This comes a few weeks after S&P downgraded Spain one notch to AA from AA+ and kept a negative outlook. Spain so far has gotten off relatively easy. Moody’s still has Spain as a triple-A credit. Indeed, Spain is the 800-pound gorilla in the room. Greece and Portugal are small countries, but Spain is about five times their size concerning GDP. European banks are being forced to pay more for short-term dollar borrowings than banks in the U.S. and Asia, suggesting that lenders worldwide are increasingly nervous about the risks ahead for European banks as financial pain cascades across the continent. The London interbank offered rate, or Libor the rate at which banks lend money to each other, and thus a vital sign of their mutual trust, rose to its highest level for the three-month dollar rate since last July. While the current Libor, at just above 0.5%, is far below the sky-high levels of 4.81875% reached at the height of the financial crisis in 2008, it is still a significant jump from 0.25% as recently as March. Corporate spreads are also backing up making it harder for business to operate efficiently.
Analysis provided by Exto Capital