Why the European crisis could lead business to put the shutters up: Benjamin

The next few weeks are likely to bite a huge hole in consumer sentiment and an even bigger dent in business confidence. Analysts are predicting a global rush back to gold as high as $2,000, and the US Federal Reserve is looking to find ways to pump out another tranche of funds by trading in short- and long-term bonds.

The hundreds of billions being poured into Spanish banks will trigger clashes across Southern Europe as Greece goes back to the polls and the gnomes of Zurich lose confidence in fiscal solutions to their crises. Of more concern is the contagion into Latin America as the chickens come home to roost in Brazil.

The back up of banks in Spain may well lead to a new global credit squeeze that may exacerbate an economic slowdown in Brazil, Portugal, Italy and France. Their banks are up to their gills in corporate debt to companies from the BRIC economies.

With one in four Spaniards looking for work, whole regions are in recession in Spain. We are likely to see a repeat of the American collapse in property prices as interest rate increases and corporate liquidity goes in proportion to the gold price.

Spanish corporate debt is already higher than the country’s GDP and the banks will now be forced to limit lending to firms from Latin America that have been financed for an acquisition spree. Spanish household debt is also among the highest in Europe at more than a 100% of disposable income.

This heavy borrowing means Spanish banks will be given six months to crank up credit restrictions. Companies have so far ignored Bank of Spain warnings to cut borrowing or risk lower profits on higher debt financing costs. Bad debts have been rising at the rate of billions of dollars a month for the last couple of years, while bank managers have been covering their eyes with bandanas rather than more loans.

Until now, Brazil, like Australia, managed to weather the international financial crisis reasonably well, despite been initially severely hit. Brazil felt the financial crisis most strongly at the end of 2008 and industry was particularly affected by the slow recovery in the US.

The result was that the reduction of interest rates had to be interrupted when the basic interest rate was, as in Australia, still quite high. The fiscal and public credit expansion, the timing of which, had much more to do with electoral considerations than fighting the recession, contributed significantly to the higher rate of inflation.

When the Lehman Brothers bank failed in September 2008, there was a rapid and very severe international credit crunch that led to a huge devaluation of the BRL. Economic policy reactions involved a moderate amount of monetary easing, together with abundant fiscal and para-fiscal expansion engineered by the expansion of credit from government-owned banks.

Member of Barron’s Roundtable for more than 20 years, legendary Swiss investor Felix Zulauf paints a gloomy picture in his recent interview with Barron’s. Besides his usual bearish calls on China and Europe, he says the US will perform relatively better than others and recommends holding US dollars and shorting emerging markets.

“As for the euro, it is a misconstruction. As I said in January, I expect the disintegration to begin in the second half of this year. That should lead the world into financial and economic chaos. My two major themes into 2013 are euro disintegration and China weakness, due to the bursting of a real estate boom.”

Zulauf compounds the gloom scenarios saying, “The global economy is weakening cyclically, on top of a highly fragile credit system. It is an explosive cocktail. The tower of debt is compounded by the gigantic over-the-counter derivatives market. In the past 10 years the notional value of derivatives worldwide has grown from $100 trillion to almost $800 trillion. The numbers are mind-boggling. If something goes wrong in the real economy, it could shake the whole credit system dramatically. It is a dangerous situation.”

The last thing the global economy needs now is for the other European sovereign basket cases to demand the same “non-bailouts” for their financial systems if the Greek populace pulls out of the Euro. Leading companies around the world are likely to reverse their order books, cut their staff and put the shutters up until after the first Tuesday in November. That seems a prudent path right now.