Stock Markets Finally Catch On to Europe’s Game of Government Musical Chairs

Changing Governments in Italy and Greece Will Not Solve all the Problems

Those of us who follow stock markets have been amazed for the last six months at the gullibility of investors with respect to the financial crisis current descending upon Europe.  The problem, to summarize as best that can be done is that Greece, Portugal, and Ireland have run up such large debts that they cannot pay their national debt and they cannot borrow any more from banks and other institutions because who exactly wants to loan money to countries that cannot pay pack their debts.

Italy is a different case.  The Italians have been plagued (and yes that is the correct word) by having a Prime Minister who is both arrogant and incompetent and charged with all sorts of misconduct, so much so that he spends more time in court and taking care of his legal problems than in governing. He also remains active in running his businesses, which cuts into his governing time.   Italy runs a relatively small deficit, but has built up huge debts, several trillion dollars worth. 

The Europeans have gone from plan to plan to try to solve the problem, and each time they say that have arrived at a solution the markets reward them with positive movements.  The latest change has been a change in government in Greece and Italy, with coalition governments taking over in both countries.  But it appears investors, dumb as they are, are no longer being fooled.

The changes of government were intended in part to demonstrate to investors that embattled euro zone nations were serious about solving their problems. While European stocks rallied in early trading, the euphoria was short-lived. . . .

In Europe, the Euro Stoxx 50 index, a barometer of euro zone blue chips, fell 1.6 percent, while the FTSE 100 index in London was down 0.5 percent.

The cause of the gloom is that while Italy can still borrow, it is doing so an increasing rates.

The market’s skepticism was reflected in the outcome of the Italian bond auction. The Italian Treasury on Monday sold 3 billion euros, or $4.1 billion, of five-year bonds priced to yield 6.3 percent — up nearly a full percentage point from the yield it paid at a similar auction last month, and the most Italy has had to pay to move such securities since June 1997, according to Bloomberg News.

And while this can continue in the short run, long term these rates will drive up Italian deficits and create even more need to borrow.

Another reason why investors and observers are getting more rather than less nervous is that they may finally be realizing that economic austerity policy produces economic austerity, and the when growth slows and goes negative countries are less rather than more able to pay their debts.  Here is Spain.

The sharp move upward in the Spanish yield might be a sign of things to come, analysts said. The Spanish economy may be contracting in the current quarter, worsening Spain’s budget deficit and the position of its banks.

The country holds elections on Sunday, but whoever takes over power will have little choice but to introduce more austerity measures, analysts said.

So Spain’s austerity program so far is producing the wrong results.  And what type of program did Italy just enact?  Austerity?  Yes, and what do you suppose that will produce?

Gosh, are investors finally getting smart?  Maybe.  Smart enough to force a change in policy to pro-growth?  Not Yet.