In spite of the eurozone mess, U.S. markets appeared to have forgotten about the severity of the chaos in Europe, instead focusing on a good jobs report and domestic renewal. January began with a bang, with the NASDAQ up close to five percent before some selling surfaced last Friday driven by the eurozone financial mess. But I did warn my readers in past articles that the eurozone problems weren’t going away anytime soon.
Don’t be fooled by the recent upswing in the markets. It’s true the economic situation continues to improve across America, but there is still $15.0 trillion in U.S. debt along with a mounting deficit, not only in the country, but also across many states. And, in this election year, there is increasing evidence that there could be political gridlock for at least the first quarter, as the two parties haggle for their policies, neither willing to give in.
But the risk is far greater. Standard & Poor’s downgraded the debt of France and suggested there were additional eurozone countries on the watch list ready for a credit downgrade. The downgrade of France is significant, as the country is one of the two strongest countries in the eurozone, the other being Germany. But data out of Germany suggest that the country has fallen back into a recession, albeit a mild one.
The situation could worsen, especially in the much weaker PIIGS eurozone countries; that is, Portugal, Italy, Ireland, Greece and Spain. I still feel that there could be more shocks ahead for Europe in 2012 due to the debt and growth issues.
Greece is in the midst of a complex debt swap program that is aimed at preventing a debt default in the country, but the plan is facing some obstacles that could derail the eurozone debt resolution. Greece warned of “catastrophic” results if the debt swap is not completed soon. A major sticking point is the interest rate Greece will pay. Creditors taking on the Greek debt want higher rates and avoid to major losses. On the other hand, Greece wants lower rates, which is expected. A failed deal would mean heavy losses for creditors and default for Greece. A compromise is in the best interest of both parties, so a deal must be salvaged.
And even if this deal is done, Greece will likely need the funds to continue flowing from the European Union and International Monetary Fund. Then there are also the other weak eurozone countries.
But what I view as a major problem is the impact of eurozone on the rest of the world, especially China, which is experiencing a higher risk of deeper slowing due to the reduced demand from Europe. China is pumping over $540 million into its banking system for new loans, as inflation is steadily on the decline. The country’s consumer price index (CPI) fell to 4.1% in December, down from 6.5% in July, representing five straight months of monthly declines in inflation. And, should China falter, the impact on the world could be devastating.
If you missed it, read what I said about 2012 and where stock markets may be heading in My Market View: A Risky Start to 2012.