Many Market participants are clearly not understanding the current situation in Greece and the contagion it can cause. It's not Greece alone, its the real systemic contagion risk and potential collapse of The European Central Bank (ECB) along with many globally interconnected institutions who have been joining in the fray. The ECB cannot carry nations alone because the EUR/USD is not the reserve currency like the USD, and the U.S. Fed only helps to carry one nation, The United States, not multiple nations like The ECB Markets have become dependent on Central bank interventions around the globe, which allow for "easy money" leverage/borrowing. USA Markets clearly do not understand its own leverage situation caused by years of QE buying and a zero percent Fed Fund Rate. Failure to raise these rates makes the eventual correction a potentially catastrophic global financial collapse in and of itself.
- Greece is small potatoes in and of itself
However, its current failings unmask the real structural issues our globe faces - living beyond its means on borrowed money. The ECB cannot continue to buy junk debt of Spain and Italy and artificially keep bond yields low there without risking insolvency themselves as they do not print the world's reserve currency and face a real risk of insolvency at some point. Knowing this, the ECB has help in the form of global institutions also stepping in and buying the bonds/debt of these 2 countries which have little chance of real growth with youth unemployment skyrocketing.
This is why the no vote won in Greece, primarily from the youth voters under 25 who face 50% unemployment in Greece, and about the same in Spain and Italy: "Spain and Greece now share the same youth unemployment figure of 50.1%, while Italy has reversed its recent improving trend, and is now at 43.1% and rising."
These are the young voters who feel hopeless and these same voters voted "no" to allow Greece to accept more Austerity. The youth voters in Spain and Italy are in the same 'boat' so to speak. Italy and Spain are not Greece! If any one or both of those nations default - "Houston, we have a Godzilla sized problem!" These 2 bond markets combined is where all the leverage is, and more so in Italy. By leverage, I mean the credit default swap (CDS) insurance being sold by many globally interconnected institutions ((tutes)). Germany cannot carry these nations by themselves nor can the ECB. This sets up a potential devastating scenario because the tutes that have been buying these bonds that have large spreads are only doing so because they are being sold CDS, which is a very liquid market. The 2 primary sellers of CDS in Europe have been Deutsche Bank (XETRA:DBKGn) and PIMCO Total Return Active Exchange-Traded (NYSE:BOND) with some of the leverage ratios being said to be as high as 400 to 1. I have to wonder if Pimco's risk taking in selling a good deal of the CDS in Europe is what led to Bill Gross stepping down last year? Austerity could work if politicians agreed to real structural reforms across Europe, but they do not and will not as these measures are largely unpopular with the youth vote. If there is one thing politicians are consistent in, it's saving their own jobs first and foremost! Greece will not budge on any reforms, Tsipras has made this very clear, which is why he called for, and encouraged his nation to vote "no" on the referendum to accept more austerity.
The EU Zone finance ministers have nothing more to offer, because there is frankly nothing to offer but a potential haircut (debt forgiveness) with strings attached -- more austerity which Greece will once again reject, even if put to another referendum vote. Here is specifically what the EU financiers will offer; "we want you (Greece) to raise taxes, increase work weeks, cut pensions which equates to austerity, Tsipras has soundly rejected this and certainly will not budge in the face of the recent overwhelming "no" vote in Greece on this very issue.
- Potential effect on U.S. and Global Markets
Because we are a globally connected financial world. the risk is systemic. If CDS kicks in under the scenario mentioned here, it cannot be paid out and likely settled with for pennies on dollar with some, while others go belly-up like which happened in 2008, except Italian and Spanish Bond markets are Lehman brothers and AIG x 200 in size -- banks could fail globally under this scenario. In order to raise the necessary funds to pay off a settlement on CDS, like 2008, these tutes will scramble to sell equities and short into themselves until the supposed money dries up, which is a capital liquidity dry up. Under this scenario, The Federal Reserve will come back in with more Quantitative Easing (QE), but only after the dominoes have fallen. Remember, the FED is a private bank with a private balance sheet. if you think they will accept and keep that risk, you really fail to understand what the Federal Reserve is and what it truly does.
- There is a way out of the potential Euro Zone collapse
Break up the Euro Zone into 2 currency unions, North and South. The PIIG nations, Greece, Italy, Spain, Portugal, and Ireland remain on the EURO Dollar, while Germany and the stronger Northern countries adopt the former German Deutsche Mark. This would allow the PIIG nations to remain afloat and give them a chance to potentially come together in a conglomerate to pool their resources on equal ground, giving some hope that eventually they can grow together and face a better future. Meanwhile, the strong nations like Germany, Switzerland, and others can enjoy a stronger dollar from which is can consume and build on.
- Complacent risk ignorant and one-sided markets cause deep market corrections and have historically caused market crashes.
USA market participants and many institutions in the USA fail to understand what it means to de-lever. Because of this, financial froth is boiling in our markets. Many of these the money managers were hired after the crash of 2008, so they only know a market that relies on Fed QE -- they only know one sided thinking which is to lever up and buy, which is very dangerous.
However, the Fed will raise rates, and likely in December if not earlier. They have to else they risk their balance sheet turning toxic. They know they have to "unwind QE." Failure for the FED to raise rates puts the very United States Dollar (USD) in danger of losing in part its enjoyed reserve currency status. The FED is a private bank, but it seems market participants have morphed into Pavlov's Dog, and dogs are known to be very stupid, if not consistent animals. Ring the dinner bell, they come drooling for their meal, on cue, willing and ready to devour it -- the constant programming becomes a natural reflex response.
Remember, it's over bullishness, over leverage, over margined, and a disregard for risk that starts market crashes, not bearish short players. Shorts actually help markets go higher as we have seen over the last few years. Over leverage, and a refusal to responsibility de-lever in the face of real systemic risk is potentially catastrophic. The negative result of this can wipe people out dry, but no one here is saying to sell everything you have and run in panic. What is being said here is to know, understand, and accept the risks equity markets are currently facing, and to act responsibly -- this is why market corrections are indicative of a healthy market. However, I fear that the markets no longer assess and understand risk correctly and have become addicted to a one-sided natural reaction of #BTFD, which is potentially devastating and has always been the cause of major market crashes.