When Fear Dominates

Today’s twin pieces of news out of Germany – that the ECB’s most prominent German, Juergen Stark, is resigning, and the unconfirmed report that the German government is preparing a contingency plan to support its banks in the event of a Greek default – had the effect of fanning the flames of fear running through world financial markets. How should we interpret this?

I’m not sure about how sensible it was, but I’m quite sure that today’s reaction was completely unsurprising. Because market participants are afraid right now, and so any news has to be viewed through the lens of that uncertainty and fear.

The Stark Resignation

Europe has a couple of major problems right now. As we all know, there’s the seemingly never-ending concern that Greece (and possibly other countries) may be insolvent and have to default on its government debt. But an equally serious problem, I think, is the widespread perception that there is no convincing leadership in Europe. European leaders just can’t seem to agree on the big decisions that would have to be taken to firmly resolve the crisis one way or another, and so the policy responses have been seen to be nothing more than a series of delaying tactics. When you then get news about members of the ECB leadership resigning (note that Stark was the second to do so in recent months), the policy disarray looks even worse.

Stark was the most prominent German in the ECB’s leadership, and probably also one of the most hawkish of them. The Germans, and Stark in particular, were quite unhappy with the ECB’s decision to start buying the government bonds from Italy and Spain. They simply do not want to put the German taxpayers on the hook for any of that debt, even indirectly.

But the question now is what to make of this news, because you can really have two completely opposite interpretations about what this will mean for ECB policy going forward. Since the ECB leadership is losing one of the fiercest opponents of assistance to the weaker euro countries, maybe this means that the ECB will now actually provide more of it. On the other hand, it’s equally possible to think that German cooperation with the ECB’s policies has now been pushed to the limit, so this will mean the end of support for the eurozone periphery.

The point is that no one really knows… and when fear is the dominant emotion, people just imagine the worst, even if they don’t know quite what that is.

It reminds me a little of Kremlin-watching back during the Cold War, when people were trying to figure out what Soviet policy was going to be based on who appeared in the photos. It’s just that this time the Kremlin is in Frankfurt.

The German Contingency Plan

The other news today was that the German government may be preparing to recapitalize their banks in the event of a Greek debt default. I’ve argued before that there are numerous signs that people are losing confidence in the European banking system, and this news strikes right at the heart of that concern.

For months and months European governments have been working hard to reassure people that the European banking system is sound. And then comes this news that Germany is already working on figuring out how to strengthen their banks. Once again, you can read that two completely different ways.

You could take heart from this news, and take it as a sign that the German government has a plan, and will step in if things go wrong to make sure that their banks are safe. It was only two weeks ago that Christine Lagarde, head of the IMF, was urging Europe to take concrete action to strengthen the European banking sytem. Maybe this simply means that the Germans were listening, and are being prudent. If so, it’s entirely reasonable to read this as good news.

But on the other hand, you could hear this news and think that maybe it means that the German government knows something we don’t know. Maybe it suggests that the German government thinks that Greece really is about to default. Or worse: maybe it suggests that the German government believes that the European banking system really is weak and vulnerable. In that case, this could be a very, very bad sign.

Given today’s climate of fear in the financial markets, and given that no one really knows what’s going on behind the scenes, it shouldn’t come as a shock that lots of people are going to jump to the scariest possible interpretation of the news. When fear dominates, the worst case scenario suddenly becomes the one everyone thinks about.

Disclaimer: This page contains affiliate links. If you choose to make a purchase after clicking a link, we may receive a commission at no additional cost to you. Thank you for your support!

About Kash Mansori 46 Articles

Who is this guy, anyway? And is Kash his real name?

Yes, Kash Mansori is my real name, and I've been writing online about economics since 2003, with a few breaks here and there. After receiving my PhD in economics in the late 1990s, I did a tour of duty as an economics professor at a small liberal arts college in northern New England. The charm of 6-month long winters eventually wore off, however, and I left the academic world in order to move south to warmer climes. I now live in North Carolina and make my living providing economic consulting services, primarily to US and European companies in the manufacturing, high-tech, and finance industries. I have a couple of kids, I enjoy cooking, and I have maps hanging all over the walls of my house.

Visit: MINA Economics

1 Comment on When Fear Dominates

  1. Some comments to your story:
    1) Greece will never be able to pay its debt. No economist that is telling the truth will assert otherwise. Default or no default is all a question of who bears the burden of that fact.
    2) European banks are extremely weak, no economist will assert otherwise, unless he has a selfish interest in distorting things for the non-economists. Everybody knows and this is in the news (you will be well served by reviewing 1 year old or more news on the European crisis, when people were not so scared of triggering panic they were more honest), their stress tests didn’t consider a single sovereign default. If Germany thinks that their banks (the strongest in Europe, and the most conservative ones) are at risk, imagine where the Spanish and Italian Banks are, and I don’t need to mention the Irish (Bank of Ireland share price was less than 8 cents), Portuguese and Greek Banks, do I?
    3) The impact on the USA of a European sovereign failure is unknown, but suffice it to say that the CEO of JP Morgan in a CNBC interview a few weeks ago, when asked that explicit question on the impact of a Euro failure on JP Morgan, his answer was that, that situation is unthinkable and would not occur. Denial, has never helped anybody, has it?
    4) The EU has only one solution, as Nobel Friedman foretold us, FISCAL UNITY.
    5) Fiscal unity is not physically doable in time to contain the crisis, it will take years of political posturing to create it, and to my knowledge the EU has never been able to do anything fast.
    Conclussion: They should plan an exit to the current situation that is orderly, anything orderly will beat trying to maintain a situation that is unsustainable in the short term and that will inevitably lead to a disorderly exit.
    Note: Never forget that the rats are the ones that leave the ship first when it is sinking!

Leave a Reply

Your email address will not be published.


This site uses Akismet to reduce spam. Learn how your comment data is processed.