"Tough decision-making is never easy, and wishful thinking and trying to postpone the day of reckoning is always tempting."
(Jeremy Grantham: Children at play, August 2011)

Too much debt

- the era of recourse to credit and debt to finance increasingly artificial growth seems to have ended. A large part of the global economy is currently facing a situation of excessive debt. The necessary deleveraging will hamper economic growth, making it even more difficult to service the debt. A vicious circle is thus in danger of setting in;

- from an economic viewpoint, the stimulus measures taken by the authorities in recent years were poorly designed. They are doing nothing to enhance the growth potential of their economies and have only added high public to high private debt;

- the problem with high public debt is that the interest paid on the debt absorbs an ever-larger part of the resources that could otherwise be used to create jobs and increase the standard of living;

- the current situation is more critical than that of three years ago given that interest rates are lower and that the degree of government debt is higher than in 2008. The authorities have very few resources to deal with the crisis;

- the current crisis is aggravated by a severe lack of leadership on both sides of the Atlantic;

Europe: No solution in sight

- in Europe, the economic and financial problems have been amplified by the fact that the eurozone is not fulfilling the necessary criteria for a single currency: there is very limited coordination between the economic policies of the member states, labor mobility is weak, and fiscal transfers not existent;

- since the introduction of the euro, the economic fundamentals of the eurozone have never been so divergent;

- quite simply, there is no realistic scenario in which certain European countries could avoid restructuring their debt. The measures taken to remedy the problems in the peripheral countries are doing nothing to kick-start growth in these countries. To the contrary in fact, since the fiscal austerity that has been imposed will reduce economic activity even more, leading to further deterioration in the public finances – as we saw last Friday with the Greek government’s announcement that the objectives of reducing the public deficit to 7.4% in 2011 could not be sustained due to a bigger-than-expected contraction in Gross Domestic Product;

- in the event of restructuring the government debt of some countries, the majority of listed European banks would be in danger of facing a problem of solvency. This puts the stock price falls of the financials into some sort of perspective;

EURO STOXX banks index

- in a recent paper entitled ‘Budget Cuts and Social Unrest in Europe, 1919 - 2009', the CEPR noted that there is a positive correlation between budgetary austerity and social instability. Demographic trends will result in social programmes becoming an unsustainable burden on young people;

What future for the euro?

- it will be difficult to solve the problem of competitiveness of certain countries in the eurozone without adjusting their currency. And without such an adjustment, these countries will only be able to become competitive again by reducing salaries and opening up their labour market at a time when unemployment rates (especially among young people) are already very high;

- the idea that the euro has more disadvantages than advantages is currently gaining ground in some countries. At the same time, the current political class continues to stick to the notion that more European integration is always better. This is creating a rift between the leaders and the people.

BL-Global Flexible's investment strategy in this environment