Last year, we viewed the European problem (with the exception of Greece) primarily as a banking problem. Last December, the European Central Bank (ECB) launched its Long-Term-Refinancing-Operation (LTRO) which essentially provided interest-free 3-year loans to banks. For awhile, it looked like the crisis was averted, because European leaders “would surely” devise a long-term resolution within those three years. The market reacted strongly, and we enjoyed a nice bull run during the first quarter, as Euro-fatigue subsided.
Then, it became more clear that Europe also has a government debt problem, not a mere banking problem. As usual, the market over-reacted, and the bears took over The Street during the second quarter, as Euro-fatigue increased again.
Last Thursday, Mario Draghi, who is head of the ECB, practically guaranteed he would “save” the Euro and dared the world markets to test him. The Dow promptly rallied over 200 points. The next day, there was several rumors that the ECB now had a strategic alliance with the two other large rescue funds (the EFSF and the ESF) to stop any bond vigilantes from successfully attacking the bonds of any European nation. The Dow promptly rallied another 200 points, as Euro-fatigue suddenly dropped.
So, are we in for another bull run like we enjoyed in the first quarter or another bear attack like we suffered in the second quarter?
We’ll enjoy a short bull run . . . until the market remembers that a central bank like the ECB can save banks with monetary policy, but it cannot save a nation, since it does not control fiscal policy. Until the individual governments of Europe surrender enough control over their budgets (both spending and taxing), there can be no long-term solution to Europe. This is tantamount to surrendering their sovereignty to the barely-existent central government of Europe. While they wouldn’t do that for Hitler . . . they may now be forced to surrender . . . by the bond vigilantes. Instead of “your money or your life,” Europeans will hear “your sovereignty or economic collapse.”
Enjoy the bull run for awhile, but remember — it is like a “sugar high” which pumps you up right now . . . before letting you down later.