Greek Fire, Part 2

I've been warning about the next big correction in the stock market, and it finally seems to be here.  January was a miserable month, and February's not looking much better.

Stocks tumbled Monday as financials and commodities sold off amid jitters about the global recovery.

The Dow Jones Industrial Average dropped 103.84, or 1 percent, to close at 9,908.39, the first time its closed below 10,000 since November. The S&P 500 shed 0.9 percent and the Nasdaq lost 0.7 percent.

Worries about debt problems in Greece, Portugal and Spain have dragged on markets across the globe for the past week as many worry that these are the next shoes to drop. European finance ministers tried to reassure Group of Seven leaders that the debt situation there is under control but it hasn't been as easy convincing investors, who are backing away from riskier bets.

In addition to battling debt, Greece is faced with an assault on another front: Organized labor. Unions are threatening more strikes if the Socialist government goes through with a tough cost-cutting plan. 

The Greek Fire is spreading.  The EU refuses to throw dirt on it.  Everyone's looking at each other, waiting for somebody else to make the move to bail out Greece.  But nobody's going to pull the trigger.  Least of all, Germany.

(More after the jump...)

Ambrose Evans-Pritchard once again sounds the alarm.

Both the City and Brussels seem certain that Europe will conjure a rescue, crossing the Rubicon towards fiscal federalism and a debt union. The emergency aid clause of Article 122 is on everybody's lips. Insiders talk of a "Eurobond".

On balance, such a rescue is likely. Yet leaving aside whether North Europe can afford to guarantee Club Med debt – or whether a bail-out pollutes more countries, as HBOS polluted Lloyds – there is one overwhelming fact missing from the debate: Germany has not endorsed any such rescue.

Jurgen Stark, Germany's champion at the European Central Bank, said markets are "deluding themselves" if they think others will pay to save Greece. He shot down Article 122, saying Athens was responsible for its own mess.

Bundesbank chief Axel Weber said it would be "politically impossible" to ask taxpayers to bail out a profligate state. Both the finance and economy ministers have forsworn a rescue. Die Welt has called for Greek withdrawal from the euro.

I cannot judge how much is brinkmanship, pressure to make Club Med sweat. But I remember vividly lunching with the British prime minister's economic adviser in August 1992 and being told that Germany would soon rescue sterling in the Exchange Rate Mechanism by cutting rates. Such was the self-deception of the British elite. Anybody following German politics – such as George Soros– knew it was nonsense.

Germany is harder to read today. The euro is a giant step beyond the ERM. Yet there are powerful counter-currents. Germany's constitutional court issued a crushing put-down of EU pretensions last June, ruling that the sovereign states are "Masters of the Treaties" and that EU bodies lack democratic legitimacy.

So if you are betting that Germany must forever more efface itself for the European Project, be careful. Berlin hawks might prefer to lance the Club Med boil sooner rather than later. 

And when that boil goes, it's going to take the Euro with it.  That in turn will wreak havoc on the dollar carry trade and put a .50 caliber bullet in the Dow dirigible.  Yves Smith:

We do have a factor here that could get the reluctant Europeans, meaning the Germans in particular, to act, namely, that Eurobanks are still wobbly and are not doubt exposed directly and indirectly to a European sovereign debt crisis. There is no way to avoid rescue operations of some sort, it’s merely a matter of picking which poison. Do they want to face the ugly bailout of countries they see as profligate, or wait till it morphs into a crisis and have to put their banks on emergency life support? The problem is the latter is politically more palatable, even though ultimately more destructive, since a lot of collateral damage will occur in the wave that hits the banks.

Nobody wants to take the initial hit while everyone else gets to play clean up.  Everyone expects the Germans to do it.  And the Germans are not that stupid.  So the Greek Fire will spread because nobody wants to kick in the door and face the backdraft.  They'd rather wait until the house burns down.  Safer for the economic firefighters, you see.