Evercore Pan Asset

Earlier this year some thought I was writing and speaking too much about the problems of the Euro. After all, the currency remained quite stable, Germany was growing well and each successive worry about a peripheral country caused only minor blips. I was always worried that the politicians on the continent were unwilling or unable to solve the underlying tensions and troubles. One day it was likely to explode.
 
I am afraid that happened last week. After months of arguing over how to control the debt and deficits of the wayward members, after various meetings to construct packages of loans and cash to prop up the problem countries, after more debates about how the centre needed to take more power to provide some central discipline, after endless austerity measures in the weaker countries, the markets lost patience. The crisis I most feared spurted from slow play to fast forward.
 
The 2007-8 crisis in the west was a crisis brought on by excessive bank borrowing to buy properties, to consume and to spend by the private sector. Banks realised late in the day they had lent too much and would not get it all back. Bank credit dried up, weak banks were left without access to market money, and the world economy plunged into recession. The governments of the world, late in the day, shifted from a tough monetary stance to propping up the banks and stimulating demand with loads of borrowed money that they borrowed  on their own account. 
 
The government’s solution to 2007-8 has now set up the sovereign debt crash of 2011. The markets have taken a long hard look at how much governments have been borrowing, and in some cases have said it cannot be repaid. The debt mountain has to be brought down. This has proved especially tough for the Eurozone. High borrowing countries in it cannot devalue or print extra money to see themselves through the disaster. First Greece, then Ireland, then Portugal, next  Cyprus faced the reality that they could not borrow enough at affordable rates. They were thrown back on asking for subsidised credit from the rest of the EU or the IMF. 
 
The solution to 2008 created a vicious circle for 2011. Weak banks raised new capital privately or from governments. They were told by the Regulators to keep a lot of it in the form of “safe” loans or bonds to governments. Now some of those loans have fallen sharply in value. The banks have lost money at current market rates. The markets are losing confidence in those banks again. The banks  need to borrow more money from governments, but governments themselves are finding it difficult to borrow more. 
 
It looks as if we are in for a period of slowing growth at best. This makes the numbers worse. Deficit reduction is so much easier to achieve with faster growth bringing in more tax revenue from more activity and higher incomes. The outlook for most western assets has just got a lot worse, as the markets fall. Many government bonds have been damaged. So far German, UK and US government bonds have ridden the crisis out well, but these too are vulnerable to changing perceptions of their credit status, speed of deficit reduction  and ability to repay. In Germany’s case the worries will be about how many of the bills for the rest of Euroland Germany has to meet. The deathly embrace of public bonds and banking capital does not bode well for immediate prospects.
 
It is a time for pension funds to be cautious. It is also a time to redefine caution. Buying government bonds in any country with a large deficit and without a convincing plan to bring it down quickly is unlikely to prove a safe thing to do. This government debt crisis is far from over. Who lends to the lender of last resort? Bank deposits with safe banks, short term high grade corporate bonds, and longer term equity assets well away from the damaged areas are the best for the time being. The big imbalances between west and east are still being worked out. It looks as if living standards and returns in much of the west have further to fall.

As published in Investment Week