Comments on European Debt Crisis

Posted by rpicon on Jun 16, 2010 in Market News | Comments Off

Comments on Recent Events (6-8-2010)

The European debt crisis is important because it is symptomatic of the global debt problem faced by most industrial nations. European banks may have to go through a period of restructuring debt and recapitalization similar to that of the U.S banks recap during the past two years.  U.S. banks are now well capitalized, but debt levels in the public and private sectors of industrial countries remain near record levels as a percentage of GDP as well as in absolute terms.

The way out of the debt problem is through private sector economic growth over an extended period of time while controlling government expenditures.  Such growth requires capital formation that comes from savings, rising productivity and growing credit availability.  With economies still deleveraging from overextended debt levels and banks unable to expand credit to accommodate needed growth, central banks in the U.S. and in Europe have begun to create new money (monetize debt). Such “quantitative easing” should encourage growth and buy time for deleveraging to work its way through global economies.

Investment implications:

Printing large quantities of new money may eventually lead to inflation after global economic recovery from recession, but maintaining liquidity in the banking system to avoiding deflation and fund economic growth is a much more pressing mandate at this time.

Newly created money will go into increased economic activity or financial assets (i.e. bonds, stocks, precious metals) and other so called “hard assets”.

Investor psychology may favor currencies of creditor nations, gold as an alternate currency and other “hard assets,” (i.e. real estate, energy, metals and mining).

The risk of mistakes (political or financial) remains high, as governments of debtor countries work through necessary deleveraging.  Even though there is reason to believe that the highly focused attention of both politicians and financial authorities will enable them to successfully maintain a functioning global financial system; it is clear that economic growth in Europe (and the U. S.) will be slow and unemployment will remain high.  The high level of fear among investors will make stock prices vulnerable to future shocks which are likely in a period of instability.  It is a time for caution.  TO SEE IF YOUR PORTFOLIO IS PROPERLY ALLOCATED, PLEASE CALL (703 683 8488 – ex 102) or e-mail (blong@aribaasset.com).