At present, there are only two people in the world to whom equity investors are paying attention: the German Chancellor and the Chairman of the Board of Governors.
Greece needs to be on an eternal and unlimited IV drip from “Europe” which means Germany. The chancellor is under enormous pressure from Sarkozy and Trichet for Germany to become Europe’s unending sugar-daddy. But Europe’s problem is German demography: the WW2 generation is dead, and their descendents see the Federal Republic not only as a normal country, but also as a very responsible country, with nothing to apologize for. “We are Europeans in good standing, and we are no longer suckers for guilt-games.”
The German taxpayer is unwilling to take his credit card and hand it to Greek cigarette-smoking marxists lounging at their grandfather’s ouzo cafe. Greece represents everything that Germans hate about Europe and the eurozone. The eurozone was the price that Germany had to pay for reunification, a bad bargain. (And one they can now revoke.)
So, if the CDU/CSU/FDP coalition is to survive, at some point Merkel will have to pull the plug on Greece, or on the euro. Sarko won’t like it, but it isn’t his money. And if Germany becomes the guarantor of the eurozone’s debt, it won’t keep its AAA, which is something that no German could ever accept. So whatever happens to be going on in Berlin at the moment (i.e., Juergen Stark resigning from the ECB), is market information, as opposed to Obama's daily speech.
Why does the S&P 500 care about Greece? Because an unravelling of the eurozone would be (a) uncontrolled; (b) deflationary; (c) bad for global growth and trade; and (d) calling into question European financial and political stability. In other words, a reduction in global demand.
The other focus of the stock market’s attention is the FOMC, chaired by Ben Bernanke. Will there or won’t there be QE3? If the answer is no, very bad for stocks (and Obama). If the answer is yes, the reverse. Hence Rick Perry’s schoolyard threats to Bernanke about "playing politics" with monetary policy. Gov Perry thinks that Bernanke should continue to keep 15 million people out of work, in order to help the GOP. Their wives and kids? Who cares?
The GOP opposes QE3, because (a) it is as economically ignorant as Obama/Pelosi; and (b) it would help Obama by reducing unemployment and causing more of the horrendous “hyperinflation” we have recently been experiencing. (Can anyone remember 1980?). This kind of politics is cheap, cruel, and unpatriotic, and bad politics in the long-run. The GOP should want the economy to prosper no matter who is president. A nation of state dependents is a nation of Democrats. Hello Belarus.
Here is my prediction: Greece can’t comply with the austerity package, Germany and the ECB pull the plug, game over for Greece. Greece will have to go cold turkey and implode upon itself. That means redrachmaization, hunger and social unrest. (Greece has no exports, bulk shipping rates are in the tank, and strikes and riots don’t help tourism.)
After Greek default, contagion spreads ( it’s spreading now), but Greece is arguably a special case, and Europe may (may) be able to erect a firewall around it. Ireland, Spain and Portugal are not basket cases. Italy still has a short window in which to demonstrate that it is not the rich man’s Greece. Mario Draghi should be PM instead of the unserious Berlusconi. It will come to that, and hopefully soon. If Italy defaults, Houston we have a problem.
Any such dire European scenario would inevitably mean that the US will need to have as many QEs as we need to prevent deflation and to sustain nominal demand. If Perry is elected, intimidates the Fed, and causes deflation and negative nominal growth, he will be a one-term president, and maybe our last president.
But isn’t it curious how, when hard money guys (e.g.,Nixon) become president, they become inflationists overnight. I promise you that President Perry will have a revelation from God that nominal growth is holy and sacred, and will play golf weekly with Bernanke.