19 december 2011
MARK BURGESS: PAY IT OFF OR WRITE IT OFF

Mark Burgess, Chief Investment Officer at Threadneedle Investments, comments on the European debt crisis:

For very obvious reasons, for most of this year the investment backdrop has been dominated by the issues surrounding the euro and the Eurozone. Investors have come to question the ability of sovereigns to fund themselves, and have aggressively pushed up interest rates in countries with unsustainably large budget deficits. Much of the focus has been on whether the euro will survive, and in what form and constituents. The authorities appear to lurch from one crisis to the next, setting out policy measure after policy measure in an effort to appease the markets and buy themselves some breathing space. The latest policy measure finally appears to be facing up to reality in as much as the authorities are proposing significant fiscal integration, and a series of yet to be defined punishments for miscreant countries. I have significant reservations about the politicians ability to deliver their voters on this issue, but more of this later.

For me, this euro focus and debate misses the point; the simple and most significant issue is that Europe, and indeed most of the developed world, has too much debt, and on the current growth trajectory, no real means of paying it off. As net debt to GDP approaches 100% in many countries, then the relationship between interest rates and growth rates takes on real significance, as, if the former is greater than the latter, net debt inexorably rises. Debt is simply tomorrows consumption brought forward to today, and someone has to pay. Countries can either choose to pay it off, lowering long term GDP growth in the process, or write it off, undermining, potentially fatally the financial system. There is the third option of inflating your way out of the problem, where ultimately savers pay, and this indeed appears to be the path opted by the UK. There is in Europe, almost no debate around this growth problem. Indeed the austerity policy measures demanded by Germany are if anything reducing growth for the region as large swathes of spending are taken out of the system. If one accompanies this with the very significant deleveraging currently being undertaken by the Eurozone banks, it is difficult to be anything other than very pessimistic for growth in Europe next year, Germany included. One has to hope that this looming recession (in reality we are probably already in it) eventually acts as a catalyst for the introduction of QE as the situation is likely to progressively deteriorate until it is.

Coming back to fiscal integration, I do wonder whether the population of Europe have truly taken on board what this means? Effectively handing over large swathes of national budgets for sanction and sign off to an unelected body. I fear that as the full implications of this begin to sink in, an increasing number of euro constituents will feel the need to hold referendums on the issue. This will place further tensions on the system as faced with this undemocratic construct, it will be voted down. I remain of the view that the Euro will ultimately be constituted by a much smaller group of countries than it does today.