This week we will be presenting excerpts from the latest President’s Letter. If you missed it, catch up with yesterday’s post on the dismal month of May. Roger Hewins comments on the latest job numbers and proposes a few reasons to stay calm through the downswing. Today’s post from the President’s Letter concerns another sign of the times: The Euro zone crisis.
As we have discussed in the past, the situation in Europe is a very big challenge. Some terrible mistakes were made, and the price for those mistakes is going to be large. Will the “solid Europeans,” most especially Germany, pick up the tab for the deadbeats who borrowed and spent all that money? And exactly why did the Germans lend such people all that money?
Before we answer that, let’s pause a moment to stroll down memory lane. It seems like only yesterday when we were looking at the debt ceiling debacle and the credit downgrade for the good old US of A. We pointed out the obvious, that the downgrade was largely symbolic, and that US Government interest rates might well fall, not rise, the opposite of what is supposed to happen after a downgrade. But the bottom line is that US treasuries represent safety in an unsafe world, and scaring people causes them to buy treasuries, not sell them. And so they did.
That was back when the 10-year treasury yield hovered around 2%. This past Friday the 10-year yield dropped below 1.50%, a new record. The funny part is, that puts us 11th on the list of low 10-year yields. Interest rates are down in a lot of countries. Look at this table of 10-year bond yields (courtesy of Barry Ritholtz at The Big Picture1):
No signs of inflation despite promiscuous printing of money, especially by the US. The money is “printed,” and then it sits. Corporate cash balances in the US are well over $2 trillion, another record. Seems we are setting a lot of records lately.
Needless to say, none of the PIIGS2 made the top ten. Their yields were at record spreads over German yields (in the Euro era) as people became very nervous about them. The euro is dropping sharply against the dollar, and European equities are now negative for the year in dollar terms. Fear is ruling at the moment, as Greece and Spain are in the spotlight. Both have been the subjects of our letters in the recent past, for obvious reasons, and here we go again.
Will Germany backstop the rest of Europe? Will Greece fall out of the Euro zone, and if so, who will be next? Spain? Do we have dead countries, or just a second tier, a “junior Euro zone?” How does any of that work, and what will be the effect on the rest of us? Will it affect China and Brazil? Answer: we really don’t know yet.
But enough of the good news. In the US, as we head for the fall election we are also headed for what is widely called the Fiscal Cliff. At year-end, tax rates will go sharply higher if no action is taken, and we have seen this play before. Congress plus President Obama seems to equal stalemate. So, will they allow tax rates to go sharply higher as the economy slows down and our structural unemployment remains historically high? Or will Dudley Do-Right once more rescue poor Nell from the train tracks just in the nick of time? Stay tuned…