Sense on Cents

Does the world have the political will to impose the necessary disciplines in drafting and implementing meaningful fiscal and monetary policies? Anybody? Each and every country in the world is certainly not in the dire straits of some nations within the EU, but plenty are.

David Roche, president and global strategist at Independent Strategy, addresses this very topic in a recent commentary in the Financial Times, This Is Not the Way to Solve the Euro-zone Debt Crisis:

The aim of the emergency European Union financial stabilisation package was to create “shock and awe” in financial markets. It is designed to convince markets that they cannot win in forcing any eurozone state into defaulting on its debt.

The shock of this package will eventually give way to less awe. As all the AAA-rated nations in Europe have 70-80 per cent of gross domestic product public debt ratios already – not far behind the “junk bond” states (and worse than Spain), we reckon the market will soon wake up to the fact that this deal is a form of contagion by official action.

As we explained in our book, Sovereign DisCredit! *, the world is facing a sovereign debt crisis that will squeeze economic growth and possibly deliver a series of debt default events down the road. Sovereign debt issuance is sucking up 25 per cent of available world savings and that will squeeze the ability of the private sector to invest in productive opportunities. And there is a wide body of empirical research from the IMF, the BIS and the work of Carmen Reinhart and Ken Rogoff that suggests when sovereign debt hits these sorts of levels in so many large countries, it curbs long-term economic growth well below trend and could lead to debt defaults.

The EMU crisis is a harbinger for the future elsewhere. Average sovereign debt in the eurozone will be about 85 per cent this year and the eurozone will run an average budget deficit of about 6.5 per cent in 2010. That’s bad enough. But it is lower than in the UK, the US and Japan. UK sovereign debt to GDP will surpass that of the eurozone average by 2011, as will the US, while Japan’s is more than double. The US and UK budget deficits will be in double digits this year and probably next.

What investors must focus on is the conditionality of the loans and guarantees. If the profligate and high-debt governments of Greece, Portugal, Spain, Ireland (and perhaps even Italy and Belgium down the road) can get away with soft conditions for getting EMU financing, the euro will suffer for some time. So will all sovereign debt in the eurozone.

The real worry is that the eurozone debt crisis may seem like a tea party if the contagion spreads to the US, the UK and Japan. The UK has no effective government in prospect that can start to deal with its fiscal crisis, while the Japanese and US governments are in denial about the extent of their debt burden. Tighten your seat belts.

Denial? How about ignorance on behalf of both the politicians and the public at large? I do not view the spreading of the currency crisis to be a question of if, but rather a question of when. Timing is everything in terms of markets and investing.

Do the political crowds within the EU, in London, Washington, and Tokyo have the understanding, the determination, and the discipline necessary to address our collective massive debts? Or will they remain in ignorant denial and put our nation at peril in the process?

LD

This entry was posted on Wednesday, May 12th, 2010 at 10:22 AM and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.