Payback Time: Europe to Export a Recession to America

It’s payback time…

In 2008, the now infamous bust of the U.S. housing market placed extreme pressure on U.S. banks and it created a credit crisis in America. A homegrown U.S. recession was then quickly exported to Europe.

Now it’s Europe’s turn to return the favor.

The debt crisis in the eurozone is causing European banks to quickly lose confidence in each another. Should one eurozone bank need to be restructured (or, dare I say, even go bankrupt), the repercussions would be felt by large U.S. banks, as U.S. banks hold many shares, derivatives and sovereign bonds from across the pond. (See: There Once Was a Bank.)

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Take a Lehman moment. Remember how that went down?

Of concern today…there is one indicator flashing red…saying that the situation is extreme with eurozone banks. Let me tell you about it.

Banks perform a common operation amongst each other of overnight lending and deposits. If one eurozone bank has requests for withdrawals by its clients along with other short-term obligations for cash, they traditionally borrow the money from other eurozone banks for 24 hours and promise to pay it back. (It’s like asking a family member for money for pressing bills that are due, with the promise to pay him/her back upon receiving your next paycheck.)

When the system functions normally, eurozone banks do lots business with one another, with only a few overnight operations taking place at the European Central Bank (ECB). The ECB is equivalent to the Fed here in the U.S. It is the backstop for the banking system in Europe.

To put some perspective on this, throughout most of the first half of 2011, the ECB received between €30 billion and €100 billion in overnight deposits from eurozone banks. In August of 2011, as the eurozone crisis worsened, banks erred on the side of caution and funneled more of their overnight operations through to the ECB.

The overnight money deposits at the ECB jumped to €150 billion in August, and continued to soar to €340 billion in December. The overnight money deposited with the ECB by eurozone banks has now reached a record €482 billion and counting.

Not even during the crisis of 2008 did eurozone banks feel the need to deposit this much money with the ECB. What this means, dear reader, is that the European crisis is turning into a eurozone banking crisis. The banks don’t trust each other to be around the next day and so they are parking their money with the sure thing, the ECB, instead of lending the money out.

Here in the U.S., the Fed recapitalized—or should I say pumped money into—the U.S. banks to prevent them from collapsing during the credit crisis of 2008. That has not happened with the eurozone banks because of Germany’s unwillingness to let the eurozone print money (i.e. expand the money supply).

If a single eurozone bank fails, and I believe one will, the repercussions will be felt here in the U.S. just like our credit crisis of 2008 impacted the European stock and bond markets and the European banking system. Payback time. (See also: Break-up of Eurozone a Foregone Conclusion?)

Michael’s Personal Notes:

Ominous signs about the economy have started early in 2012…

A high-end retail sector company that weathered the 2008 and 2009 financial crisis quite well is now buckling under the pressure of a slowing economy in both Europe and the U.S.

Tiffany & Co. (NYSE/TIF), the world’s second-largest luxury jewelry retailer and a major player in the U.S. retail sector, has already cut its earnings and sales forecast for 2012, citing a pull-back in consumer spending on the part of its well-heeled customers, as demand for fine jewelry in both its U.S. and European outlets fell short of expectations during the holiday season.

The news sent the Tiffany retail sector shares down just over 10% Tuesday. The company’s stock price has fallen from $80.00 in late October 2011 to under $60.00 yesterday. Ouch.

We all know that if the U.S. economy is going to deliver a meaningful rebound, the U.S. consumer (especially within the high-end retail sector) is going to have to pick up the pace of spending. Remember, consumer spending in the U.S. accounts for 70% of GDP!

I’ve been saying that 2012 is going to be a difficult year (many thanks to imported woes from Europe). Tiffany’s warning on its retail sector profit and revenue this year is just the first of many signs I believe we will get that the U.S. economy is slowing.

The wealthier consumers continued to spend in 2010 and for the better part of 2011 at the retail sector level. Something has changed, however, which has them reining in their spending. Confidence is everything in the retail sector. Tiffany’s early warning shows that even the wealthy don’t feel confident about their situations and the direction the economies in both the U.S. and Europe are headed.

Granted, this is only a small sign coming from the retail sector, but it further highlights my argument that the U.S. economy cannot grow with the problems in Europe gaining momentum. Retail sector company Tiffany noted in its report that Asian shoppers also pulled back on purchases during the holiday season, as their economies are cooling.

Introduce a slowing Chinese economy into the equation and it is almost impossible to see the U.S. escaping the slow economic grind it will face, as economic growth in both Europe and China erode.

Back to those high-end retail sector stocks…I liked them for most of 2010 and 2011. For 2012, I’m not sure I want to be in them.

Where the Market Stands; Where it’s Headed:

Not much for investors to complain about. Less than two weeks into the New Year and the Dow Jones Industrial Average is up two percent for 2012. The bear market rally that started in March of 2009 continues along its merry way.

Dear reader, we know better: a huge top is being put into place for the major market indices.

What He Said:

“Any way you look at it, the U.S. housing market is in for a real beating. As I have written before, in the late 1920s, the real estate market crashed first, the stock market second and the economy third. This is the exact sequence of events I believe we are witnessing 80 years later.” Michael Lombardi in PROFIT CONFIDENTIAL, August 27, 2007. A dire prediction that came true.