After vehemently denying that it needed outside help, Ireland did what the market had expected: It applied for a three-year loan of up to 90 billion euro (the equivalent of about $122 billion) from the EU and IMF to shore up its bank problems. Exact details of the bailout loan package will be finalized in the upcoming days. Confidence in Ireland eroded in recent weeks as fear that the country’s cash-strapped banks could cause a domino effect through its economy sent Irish government bond yields skyrocketing, making it even harder for Ireland to raise capital in debt markets.
The lack of concrete details in the Ireland bailout plan has further sparked uncertainty in markets while concerns linger that Portugal and Spain are next on the bailout list. Yields for Portuguese and Spanish government bonds have similarly risen sharply lately. Leaders from both countries have publicly stated that the bailout will keep Ireland’s financial problems contained and stabilize the eurozone, but as we have seen in Ireland’s case, public words of assurance don’t carry much credibility. There is also Portugal and Spain, in which investors don’t have much confidence (rightly so), making more international intervention likely and even necessary.
Europe’s debt problems aren’t going to be fixed easily, and will time and again thrust its ugly head into the spotlight. We expect the euro currency to eventually go the way of the dinosaur, but for now, despite terrible government balance sheets, a catastrophic government default in the near future appears unlikely. The euro has retreated on the Ireland news. Although the dollar isn’t exactly on firm footing either, we expect ongoing uncertainty in Europe to be a headwind for the common European currency.
Exacerbating the markets’ worries, North Korea is back in the news. The reclusive communist country launched artillery fire on South Korea in a border region, killing two South Korean soldiers, wounding several other soldiers and civilians, and setting houses ablaze. South Korea returned fire. The attack comes after North Korea flexed its muscles to the world by showing off a new uranium enrichment facility over the weekend. The latest events are escalating fears that a large scale conflict could break out in the tense region, potentially dragging other nations into the conflict. The Korean Peninsula remains a ticking time bomb and bears watching. Should a larger conflict erupt, it would likely put more downward pressure on stocks worldwide.
China’s monetary tightening measures, of course, also remain on investor minds. Late last week, China raised its bank reserve ratio requirement by 50 basis points (half a percentage point), the fifth hike this year, and hinted at further increases in the future. In recent weeks, China has also increased interest rates, and sold off raw materials from stockpiles, while enforcing price controls on certain products, namely food.
The concern is that the Chinese government’s tightening grip on the economy could derail the economy and slam the brakes on growth, but having shown strength again and again, the Chinese economy is unlikely to lapse into a recession. The tightening of the reins in China could actually help other countries around the world by temporarily cooling the growth of commodity prices. Fast-rising input costs increase business costs and are eventually passed down to consumers, acting as an effective tax and potentially hurting the economy—recall the first half of 2008. Controlling inflation should lead to more sustainable growth for the long run for China and relax some raw material price pressures on the developed world, which does not have the growth to tolerate increasingly expensive commodities.
（Dr. Stephen Leeb's e-mail）
