The next phase of the banking and debt crisis
May 25th, 2010
As we feared, we are now well into the next phase of the sovereign debt and banking crisis.
Strong market recovery last year took place worldwide on the back of easy money and the transfer of risks from banks and the private sector to governments. Governments printed and borrowed what it took to recapitalise banks and assume responsibility for many of their doubtful debts. Governments also decided to borrow more to reflate their recession ridden economies. Now we are reaching the days of reckoning.
The worst tensions over public debt are in the Eurozone for one simple reason. A number of countries in the Euro are borrowing too much for comfort. The individual country does not have the power to print more Euros to guarantee repayment of their debts. They depend on the actions of the European Central Bank and the goodwill of other Eurozone members. Markets doubt that the German led zone will pump in enough extra cash to the impecunious south to keep them going easily, and doubts the ECB’s intentions to print enough currency to lower the exchange rate enough to allow easier repayment to foreign holders.
So now the Eurozone is in danger of derailing the recovery by its own structural problems. Weaker government debt in the zone is marked down in the markets. That raises the price of borrowing for countries like Greece, making it even more difficult for their budget sums to add up, further undermining confidence.
The disappointing response to the $1 trillion package of support and guarantees alarmed us, and confirmed our view that we should reduce holdings in Euro based sovereign debt. We do not hold segregated European equities in any discretionary portfolio. There will be more worries about Euroland banks and about the credit worthiness of various Euroland states. Meanwhile the Euro is falling. This will help with the necessary adjustment of the Euroland economy, and will devalue the external cost of repaying Euro sovereign debt.
