Europe to Enter Double Dip Recession that Hurts U.S. Investors

It’s been my opinion lately that economic recovery in the U.S. is very much in the hands of foreign governments. The basic theory goes like this: the recovery so far has been the result of cheap money and government assistance. When that assistance ends, economies will be left to stand on their own. And that may not be such a good thing.
At the recent G-20 meeting over the weekend of November 7 and 8, central banks around the world pledged that they would keep stimulative monetary policies in place. Investors loved that news and launched the Dow Industrials firmly above 10,000 on Monday, November 9.
But now, barely two weeks later, the European Union is already backtracking on that G-20 statement.
*****At a conference in Frankfurt, European Union central bank president Jean-Claude Trichet said:
“Not all our liquidity measures will be needed to the same extent as in the past…Any non-standard measure whose continuation would pose a threat to the achievement of price stability must be undone promptly and unequivocally.”
Apparently, the European central bank is part of a growing number of countries who feel that inflation is a threat. Of course, at some point, inflation does become a threat. But as we saw clearly in the recent CPI and PPI numbers, there’s no sign of inflation yet.
What’s more, GDP growth in the EU is much weaker than it is here. The EU grew just 0.4% in the third quarter, led by Germany and Italy. GDP in Spain, Greece and most eastern European countries is still negative. England’s economy also contracted in the third quarter.
*****I fear that if Europe reverses some stimulus policies in the near future, which seems likely, what little growth there is will be choked off. The threat of a double-dip recession for Europe is very high. And that will not be good for the U.S. economy, or stock markets.
The U.S. dollar is already moving higher on the news from Europe. And if Europe does indeed enter a second round of recession, the dollar will move even higher. That will certainly send stock prices lower.
*****Here in the U.S., it’s clear that the housing market is still hurting. Mortgage delinquencies continue to rise and new mortgage applications for residential construction are still falling.
Interest rates must stay low to encourage buyers. But the bigger problem may still be mortgage-backed securities, the so-called toxic assets, that remain on bank balance sheets.
You’ll recall that Treasury Secretary Timothy Geithner had an opportunity to force banks to get rid of these toxic assets when he was conducting his now infamous Stress Tests. I was very vocal this was a great opportunity for Geithner to force banks to clean up their balance sheets.
Unfortunately, Geithner took the easy way out. First, he allowed accounting rules to be re-written so banks appeared more stable than they were. Then, he required them to raise more cash to offset the toxic assets on their books. His trick worked. The accounting rule changes suddenly made banks look healthy, investors bought in and drove the stocks higher and the banks were able to sell stock and raise cash.
But the basic problem remained – banks still hold those toxic assets. And if stimulus policies can’t revive the housing market, banks could easily become insolvent again and we’re right back where we were a year ago, with investors and taxpayers left holding the bag, again.

*****In a way, I applaud Trichet’s efforts. He is very vocal that European banks must be able to stand on their own. Ultimately, that’s how it should be. But starting with Hank Paulson and continuing with Geithner, the U.S. chose to handle the banks with kid gloves. And that may prove to have been a big mistake.

Published by Wyatt Investment Research at