Thursday, September 15, 2011

Greece isn't a match about to light a fire. It is a symptom - a plume of smoke. The PIGS are only part of what is smoking. The fire has been burning larger inside the building every year since the developed world began piling on debt in the mid 80s.

Real growth in the developed world was disingenuous over much of this period of time because it was enabled by very low inflation for extended periods of time. This was the result of large-scale outsourcing of both manufacturing and services. Now everything that can be outsourced has, and natural inflation is occurring again. We are seeing lower real growth rates as a result, which has put additional focus on sovereign debt.

Debt is simply at a tipping point for the worlds biggest economies and there are only two paths: inflate out of it or exercise extreme fiscal discipline. Either path has devastating consequences. The economic theory is strong in describing either scenario. At the same time we are tremendously strengthening banking regulations and capital requirements. Although this reduces the risk of "outlier" events, it guarantees slower growth. The combination of debt burden and financial regulation has created a difficult situation.

There is a horrendously painful recession coming and it could be much worse than that. It will be global and last for years. It could take a few months to happen, or a year, or a few years.

Regarding Europe...separate currencies are needed to allow economically weak countries to become competitive. The mechanism by which this occurs is a weakened currency. Either weak states such as PIGS will default on their debt, stop using the euro, and then inflate a local currency...or strong states (Germany) will adopt a local currency and collapse the value of the euro. The euro as a true common currency in Europe is dead.

European political leadership (*cough* Merkel *cough*) is waging a PR war to convince investors that this will not happen because a massive amount of capital will be lost when it does. In my opinion it is inevitable and simply a matter of when. All politics is local and when the heat comes politicians will either do what voters tell them to do, or new politicians will be anointed for this purpose. Stronger nation members of the EU will not accept the economic burden of supporting debt-burdened states.

Monday, May 09, 2011

This one is for Aidan.