The Weakest Link: Terrifying Economic Conditions in the US and Europe

US economic conditions are “terrifying,” Mohamed El-Erian said yesterday. El-Erian, as you may know, is Bill Gross’ right-hand man at Pimco, the world’s largest bond fund. He gives the US a 50/50 chance at a renewed recession.

“What’s most terrifying?” El-Erian asked rhetorically in a Bloomberg TV interview. “We are having this discussion about the risk of recession at a time when unemployment is already too high, at a time when a quarter of homeowners are underwater on their mortgages, at a time then the fiscal deficit is at 9% and at a time when interest rates are at zero.

“The big concern is the US getting tipped over by Europe. Things in Europe are getting worse, not better.”

Indeed, they are. A plan to bail out the French-Belgian banking mongrel known as Dexia is falling apart, according to a Belgian newspaper.

That’s fueled talk of France having to dig deeper into its bailout fund… which, in turn, prompted Fitch to say it might have to revisit France’s AAA-rating.

That’s the headline news from Europe. Beneath the surface is this scary little ditty: A German bond auction failed today.

The German government hoped to sell €6 billion of 10-year bunds. It could attract bids for only €3.644 billion.

Conventional wisdom is writing this off: “The auction reflects the deep mistrust [of the] euro project, rather than a mistrust to German government bonds,” an analyst from Danske Bank tries to reassure The Wall Street Journal.

Conventional wisdom might wish to consult the respected German newsweekly Der Spiegel… “It is debatable how much longer Germany can be seen as a refuge of stability and security,” reads an article that came out yesterday.

“Germany’s budget management is not nearly as exemplary as it would have people believe, and the national debt is way over the EU’s limit. In some respects, Italy’s finances are in much better shape.”

The Federal Reserve plans to carry out a new round of “stress tests” on 31 major US banks — the third time since Lehman and everything else hit the fan three years ago. This round will, purportedly, assess domestic banks’ ability to withstand a sudden escalation of the eurozone crisis.

We’ll save you the drama: We expect a result similar to the two previous tests — a limited release of data carefully designed to paper over thin capitalization of every major bank.

“When are we going to wake up?” asks David Stockman, who served last century as budget director under Ronald Reagan.

Stockman’s beef? With the failure of the “supercommittee,” talk in Washington, D.C., is switching to an extension of this year’s Social Security tax cut into next year ($110 billion), plus, a continuation of unemployment benefits beyond the standard 26 weeks ($200 billion).

“I don’t know what Washington thinks,” says Mr. Stockman, “that we can just continue to go out into the market and borrow $100 billion every month, and nothing is ever going to go wrong, the Fed can just keep printing the money. That’s what the Europeans thought. Look where they are today.”

Another downgrade of US sovereign debt is a “certainty,” he adds. “It’s only a matter of when.”

Addison Wiggin
for The Daily Reckoning