Stocks Will Rise or Fall On Confidence Levels

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A worldwide sigh of relief was evident this week when European governments and banks were able to fashion another temporary rescue of the failing Greek economy.  Without the continuing rescue efforts, Greece was prepared to default on obligations coming due in two weeks.

The consortium of governments and banks determined once again that they could not afford to accept the reality that Greece is insolvent, not merely suffering from a liquidity squeeze.  The decision-makers faced the dilemma of either bailing out the Greek economy again or bailing out their own banks and the European Central Bank itself, which hold the toxic Greek paper.

Violent demonstrations erupted immediately in the streets of Greece, as many Greeks expressed disdain for the austerity measures to be enforced as the quid pro quo for the new bailout money.  If the taxpayers in northern Europe fully understood the implications of the bailout, we might well have seen demonstrations on the streets of Germany and France as well.  These taxpayers will be the primary source of the bailout funds that will keep the Greek government alive for a while longer.  We in the United States have the privilege of contributing as well.  As the largest funding source for the International Monetary Fund, we also get to wear an “I bailed out Greece’ button, with whatever degree of pride that entails.

The unfortunate reality, however, is that the Greek debt has not disappeared.  The bond restructuring has merely deferred the ultimate due date.  This is another blatant example of the “extend and pretend” practice that we and many others across the globe have exercised with respect to real estate loans.  Deferment doesn’t change the underlying reality.  It simply buys time, giving both debtors and creditors hope that circumstances may sufficiently change to enable repayment.  In Greece’s case, that hope is a pipe dream.

Greece is but the most open sore on the life-threatening wound that is excessive worldwide indebtedness.  But for government rescue, the entire financial system was on the verge of collapse less than three years ago. The pledge of a seemingly endless stream of money boosted investor confidence and has led to a two-and-a-half-year stock market rally.  This week’s powerful price advance is further testimony to the continuing ability of central planners to rev up investors’ animal spirits.

Unfortunately the long history of governmental attempts to rescue economies in crisis is not rife with examples of pain-free success.  The normal path is marked by lengthy periods of economic tribulation.  When investor confidence is high, stock prices can soar, but they can’t ultimately break the bonds of struggling economic fundamentals.  In the United States, we are still faced with an unprecedented level of foreclosures and the worst unemployment situation since the Great Depression of the 1930’s.  Even under the most optimistic of scenarios, we will be experiencing deficits and growing debt as far as the eye can see.  When the fundamental safety net is unsound, any event threatening confidence levels can lead to dramatic price declines.