Part 1: Europe
The world markets are volatile, the United States Congress broken, and Europe on the edge of a proverbial financial knife blade. The media loves those soundbites. The current market crisis does not have any new elements just new perceptions facilitated by the media and politicians. The world economy is not at a precipice and improvements have been ignored by investors' panic.
Current market turmoil is certainly blown out of proportion but however illogical the turmoil is it will have an effect on the economic and political structures of nations. The significance of market turmoil is subject to existing and established structural weakness in various world economies. This article will focus on how volatility will interact with the European zone of economic collaboration. The debt crisis in Europe has been evolving since the fall of Lehman Brothers and the focus of the new market upheaval has been directed towards the contagion of debt problems in countries such as Italy and Spain. Although Italy and Spain's debt problems should not be taken lightly there have been several developments towards a solution. In addition the specter of a new mortgage crisis in Central Europe has been entirely ignored by most market participants.
When market participants are infected with fear they will traditionally dump the riskier assets and flock to "safe" assets such as government paper or bank certificates of deposit. However, fixed income products are yielding almost nothing. Investors searching for safety have been storing their wealth by direct purchases of currency or indirectly through Electronically Traded Funds (ETF's). In Europe investors have flocked to the Swiss Franc and subsequently driven the currency much higher than the European Euro.
The Swiss banking system has long been held in high regards and Central European nations, namely Poland and Hungary, have taken home mortgages denominated by the Swiss-Franc. These mortgages have much lower rates and were very attractive to borrowers in the old Soviet-Bloc. Currently, 53 percent of mortgages in Poland and 60 percent of those in Hungary are denominated in Swiss-Francs. If the Franc continues to rise in value compared to the neighboring Euro the effect is essentially the same as a sharp interest increase of debts in Poland and Hungary. Because Poland and Hungary are part of the Euro-Zone they are at the mercy of how markets will value the Euro in relation to the Franc.
The Swiss Banking system has been buying Euro debt in an effort to stop the sharp increase in the value of its currency but it has had little effect on stopping the upward trend. On August 11th, the Swiss national bank made an announcement that they were considering a directive to peg the the Franc to the Euro. Shortly after the announcement the Franc fell 600 blips compared to the Euro but quickly regained most of that loss by the end of Friday. The Swiss find themselves in a difficult spot, if the Euro-zone continues to struggle with the debt crisis than Switzerland can not afford to attach its independent currency to a sinking ship. On the other hand, if it does not find a way to decrease its currency than its banks will surely suffer large losses due to waves of mortgage defaults in Central Europe.
The underlying issue is that the Euro-zone is at a debt crossroads but a solution has been signed that has escaped the markets. On July 24th the German Government agreed to sign as the underwriter for the newly reformed European Financial Security Facility (EFSF). The purpose of the EFSF was to provide loans to the indebted Mediterranean nations as a form of refinance. The issue the EFTF immediately faced was that the organization relied on funds from the northern and wealthier members of the Euro-zone to donate funds. Germany has the assets but giving money directly to the EFSF is politically unpalatable to German politicians who do not want to be viewed as bailing out member nations. Instead, the Germans have signed in a fashion that allows the organization to raise funds through the sale of bonds on Germany's credit rating.
This has accomplished two objectives. First, the EFSF can raise unlimited amounts of money to lend to the peripheral Euro-Zone nations at a rate far lower and on longer terms than could be issued otherwise. Second, The German population has not seen this move as a direct bailout, although that could change in the future. The catch to this whole EFSF deal is that Germany and Germany alone has the right to decide who can tap the EFSF for money. The EFSF has in effect created a central financial monetary leader and the leader of the Euro is the German State. Member nations do no have to gain permission from the European Central Bank to tap into the capital of the EFSF but member nations will have to understand that the Germans now hold the purse strings.
In all reality Germany is the only nation with the resources to save the Euro-Zone and Germany owes its economic success to the creation of the Euro-Zone. Germany decided to take responsibility and become the economic leader of Europe. The question becomes, is Europe ready to rally around Germany as it's leader?