Feature: Dominos Poised

Lot's of talk about dominos in European banks and economies if Greece defaults, while from across the Atlantic, a growing realisation the US economy is approaching stall speed, as the Fed's punchbowl is being closed off.

No one wants to left holding the last domino, but who that will be nobody has any idea.

The US economy is slowing, week by week; the Fed's fiscal easing ends in less than a fortnight and the US debt ceiling deadline is around August 2, and some economists wonder what will be reached first: Greek default or saving, US default or a new debt deal, or a further slide in the economy towards stall speed.

So it's no wonder this week has seen an acceleration of fear and loathing in markets from the already high levels we have been writing about for the past six weeks.

And the euro has turned tail and fallen, making the suspect US dollar look strong in comparison.

In fact some commentators say that Europe is approaching its "Lehman moment" with Greece, a reference to September 2008 when the US authorities let Lehman Brothers fail, which then triggered a knock on effect across markets and economies around the world.

The dilemma is, should Greece be saved, and save the rest of Europe and the world from the damage default would cause, or should default be allowed to happen and the world face a possible second GFC in three years?

Up till Wednesday night the Standard and Poor's 500 index had fallen 7% from its highs of April.

Oil fell to $US95 a barrel in New York, down $US15 a barrel in the past six weeks and it hit a 4 month low during trading.

Gold edged higher, copper was also weak.

Yields on US 10 year bonds fell 0.13%, one of the biggest falls recorded for years, to end around 2.97% or less in nervy trading.

The Australian market is now on the verge of reaching correction territory: it has lost 9.8% since its most recent high in April of 4970 for the ASX 200 (and is down 4.5% so far in June to a 9 month low yesterday).

Asian markets fell with Shanghai down 1.2%, Hong Kong off 2%, Tokyo down 1.7% and South Korea off 1.9%.

Australia, Hong Kong and Shanghai hit new 2011 lows yesterday.

European markets sold off as well, but the US markets steadied Thursday night because of a fall in job benefit applicants and a small rise in new home starts.

Greece is entering the final stage of either rescue or ruin: either way the eurozone and the rest of Europe are going to be hurt by the outcome.

The people of Greece don't want any more austerity, as they showed on Wednesday and nearly brought the government down.

A day of protests, at times violent from opponents of a 38 billion package of austerity cuts and privatisations, brought the offer from the Prime Minister.

It was rejected, so he said in a recorded speech that he would reshuffle his cabinet and present his government for a vote of no confidence within the next day or so.

The estrangement between Germany, which wants private bondholders to contribute something of the cost of the second bailout, either by taking losses on existing loans and or rolling over those loans and extending more credit, or opposition to that from the European Central Bank and France, with strong support from Belgium and Spain (two of the next three in the market's sights).

The only way any agreement will happen if Germany, France and the ECB take heed of the way markets in Europe and the US were frightened into on Wednesday into a flight towards the safety of bolt holes, including the US dollar and Government bonds, even though America continues to stagger towards the spectre of default around August 2.

But the International Monetary Fund said Greece would be supported, meaning a 11.2 billion euro payment under the 2010 bailout could be made early, perhaps before the end of June, instead of in July, which would ease immediate fears the country would default because it had run out of money.

This was supported by the EU, but the Greek parliament has to pass the sweeping austerity package. Failure to do so will see the crisis feeling of Wednesday return.

That has allowed the eurozone to pout off any finalisation of a Greek package until July 11, allowing more time for Germany and the ECB/France to argue out their differences.

But yields on two year Greek bonds hit an all time high of more than 28% in the markets: that's a fictitious rate in that there's very little volume and the buyer would be a vulture fund punting on a big killing from buying cheaply if Greece manages to stay afloat.

Adding to the fears was a warning by ratings agency Moody's that it would be reviewing the ratings of three major French banks, BHP Paribas, Credit Agricole and Society Generale because of their exposure to Greek debt and ownership of banks in the troubled country.

If Greece defaults, the country's bank would be damaged and would probably collapse unless supported by their parents or the ECB, which has been doing just that for over a year (and would suffer big losses itself).

French banks are among Greece's biggest creditors, with $US53 billion in overall net exposure to Greek private and public debt, according to the latest figures from the Bank for International Settlements. German banks are also exposed with $US34 billion, including loans made through KfW, a state-controlled industry bank.

Ireland didn't help by reviving a demand that some bondholders be forced to take losses to share in the multi-billion euro cost of rescuing the country's imprudent banks that forced the country to ask for an 85 billion euro bailout last year from the IMF and the EU.

In doing so the comments from Finance Minister, Michael Noonan, indicated the country was throwing itself behind Germany's push for private bondholders to Greece to take similar "punishment". Irish revenge or realism?

Greece had 340 billion euros of debts all up, a default would see an estimated 50% or more of that lost, which is why the country's credit rating was cut on Monday by Standard & Poor's to triple C, which indicates there's a very good chance of default happening.

That move, like Moody's warning on the three French banks hasn't helped sentiment.

The rating downgrades were once again late and a bit of backside covering by the agencies.

Australian banks have no exposure to Greece, but we are exposed to the US where the flow of weak economic data continues to worry markets.

The New York Fed's Empire State survey of manufacturing in the New York area went negative last month, in a surprise, instead of the expected positive reading.

On Thursday night a similar survey for the Philadelphia Fed went negative as well instead of remaining positive. But investors preferred to focus on the drop in weekly unemployment benefits and the rise in new home starts.

Its the first time in over two years that these two surveys have both gone negative at the same time.

US manufacturing is turning down and that's important because it has led the tentative recovery in the past nine months.

After weak producer price inflation data for May was released on Tuesday, consumer inflation figures the next day, showed a bigger than expected rise, with growth driven by increased food prices, not energy.

The Labor Department's consumer price index rose 0.2% in May. Economists were expecting a rise of just 0.1%, down from the 0.4% rise in the previous month.

The news brought some economists to predict the US faces months of "stagflation" a 1970's concept of low growth and high price growth.

While others more accurately suggested that while the economy was not dipping into negative growth territory yet, it was approaching what they called its 'stall speed', which is where growth slows to around 1% annual, or a bit.

That in turn has forced many to focus on the employment market and the weekly and monthly figures will not be watched even more closely for signs of a rapid rise in jobless numbers.

Some economists claim a rise of 0.5% in the unemployment rate over the next few months could signal a new recession lies ahead for the US.

That will increase pressure on the Fed and the Obama Administration for more stimulus, at a time when their capacity to do any more is very limited.

The Fed's June 30 deadline approaches when its current easing ends, as does the August 2 deadline for the US to approach default on its debt, if it can't borrow any more money.