Will the U.S. Stock Market React to Spain’s Troubles?

The increased flow of negative news coming out of the eurozone is intensifying and Spain is at the forefront of it. The eurozone’s debt crisis is very critical to the U.S.’s economic future.

The current situation is that the eurozone countries want Spain to implement severe austerity measures and to cut its spending—but the Spanish government has been failing to impress them. Spain desperately needs a financial bailout from its neighbors.

The Spanish government is planning to implement policies that would restrict people from taking early retirement. (Source: Wall Street Journal, September 26, 2012.) The Spanish government does not plan to reduce the pension, but has not decided whether the pension should be frozen. These austerity measures are not welcomed by the people of Spain and protests have turned violent in Madrid. (Source: Reuters, September 26, 2012.)

The yield on the Spanish government bond is increasing and the cost of borrowing is too high. There’s no doubt about it; Spain needs money—be it from eurozone countries or the markets—to stop the debt crisis from becoming fatal.

Chances are that the Spanish government will borrow money from eurozone peers, because there are no other available options for it unless China steps in.

The issues at stake are how much money the Spanish government will need to recapitalize its banks and whether it will be able to go through with its austerity measures. Eurozone countries will be careful this time around, after witnessing Greece‘s struggle. Spain has already used 100 billion euros from the eurozone rescue fund in June; money that failed to put even a dent in Spain’s big-picture economic problems.

How does this all affect the U.S. economy and, ultimately, the U.S. stock markets?

If the Spanish government fails to implement the measures the eurozone countries are expecting, there will be much deeper consequences: the debt crisis will become more troublesome. The Spanish banks are wounded after the collapse in the housing market, and not getting quick treatment will create another downward spiral.

Spain is already in a deep, dark recession, and sadly it’s one of the major contributors among the eurozone economies. And any further slowdown in the eurozone economy will send even bigger spillover effects into the global economy. Spain needs to recapitalize its banks.

If the debt crisis deepens in Spain, the after-effects will spill over to other eurozone countries and it won’t take long for those severe economic issues to hit the shores of America.

There is already enough evidence of big U.S. companies witnessing their sales decreasing and profit growth declining due to the eurozone debt crisis. It won’t take much more turbulence from the eurozone to create havoc within the 40% of S&P 500 companies that have exposure to the eurozone economy.

Where the Market Stands; Where it’s Headed:

According to a report being circulated by Goldman Sachs, the Federal Reserve’s recently announced third round of quantitative easing (QE3) could result in $2.0 trillion of new money being created. Add this to the $2.3 trillion the Fed has previously created with QE1 and QE2 and the $6.0 trillion increase in the official U.S. national debt since President Obama took office and, presto, we have over $10.0 trillion in new money and debt created in about four years’ time.

The U.S. has never printed and borrowed so much money, ever, in such a short time period. What will be the end result? We are living through it. The stock market has rallied since March 2009 on all of this magically created money. But the next step is inflation. And when American companies can’t raise prices (to offset their increased costs) because consumers can’t afford higher prices, the whole house of cards will come crashing down.

What He Said:

“We will wish Greenspan had never brought rates down so low as to entice so many consumers to have such big mortgages.” Michael Lombardi in Profit Confidential, April 27, 2004. Michael first started warning about the negative repercussions of Greenspan’s low-interest-rate policy when the Fed first dropped interest rates to one percent in 2004.