Long Trudge for the West But Emerging Economies Will Eventually Save the Day

How to resolve the European Problem... Well Sort Of

The situation in Europe is grave. It's exactly the situation in Asia in 1997 - 98. The PIIGS' fiscal deficits are so huge that the bond vigilantes are attacking their bonds. Yields for Greek debt reached 70% at some stage for 3 year bonds. While the coupons have been decided before the yields rose, this means Greece certainly cannot issue new debt. The problem is Greece needs to issue bigger and bigger amounts of new debts. The situation is spreading to the other European countries too. The reason that it resembles the Asian Financial Crisis was that like the Korea, Malaysia, Indonesia, Thailand which could not service their debt denominated in USD, the European countries could not print the EUR currencies.

The solution back in 1997 was to get a haircut for the Asian debt in exchange for opening up their economies to the rest of the world. It taught the Asian countries a lesson about borrowing money to spend which they cannot repay.

Now even if the PIIGS can balance their books immediately, they will still be in peril because the bond yields may rise to levels that cannot be repaid. It will be like loan shark rates of 10 - 30% per annum. The solution should be to get the ECB to print money and buy up all the bonds that the PIIGS wish to issue. That may mean the EUR crashing and further more, who wish to have a balance sheet full of bonds that will be worthless in future? The biggest countries, such as Germany and France will obviously suffer because they probably contributed the most to ECB.

Can the Greeks reasonably pay off all the debts without defaulting, if ECB buys off all their debt? It could ask for a hair cut from the private sector so that ECB doesn't need to buy so much of the debt and threaten the EUR. This is precisely what's happening. A 60% haircut is talked about and this will kill the European banks and any other bank that held or sold insurance protecting against default of Greek debt.

So the solution is a hotch potch of sacrifice of the private sector and the EUR. I expect EUR to come down to 1.45 against SGD by 2013/14 and gold to shoot up beyond USD2500/oz in the same period. I also expect inflation to rise to 3-4% in Eurozone.

What the PIIGS Must Do On Their Part

Any country wallowing in debt must do the obvious: increase taxes and cut spending. But the paradox is when you cut government spending, you may slow down the economy so much that tax collections fall. So the obvious solution is to reform the economy like the Asian countries did. EU must dismantle the social welfare system, liberalise its labour law and allow wealthy non-EU citizens and corporations to invest without hinderance.

Does the EU have the policial will to do so? We already witnessed riots on the streets in Greece. We could see more riots if the austerity measures set in for other European countries as well. We could see turbulent times ahead. But it is very unfair that the world gathers round to save the socialist Europeans when they just lectured and demanded Asians to reform back in 1997.

There is good debt and bad debt. Good debt is when you borrow to invest in infrastructure, education, housing, basically, things that will yield long-term returns in future. A country that invests in good road networks, rail roads and airports will enable more tourists to visit the country, facilitate transportation of people to and from work more easily, raise the real estate prices. A country that invests in education will cultivate a workforce that will be more productive, be able to invent more things in future.

Bad debt is when you borrow to pay welfare benefits, to provide free healthcare that results in wastages, to expand the civil service sector so that masked unemployment occurs.

The west has put too much good money after bad situations... They don't have the fiscal option to stimulate the economy out of a recession. They don't have the political will to weane their electorates out of the welfare system. I do not think the EU as a region can emerge out of a recession in 2012, or indeed in 2013. Even if they did, recovery will be very weak and a bit like Japan's. The best case scenario is where Greece defaults and most major banks recapitalised by the EU and perhaps by the US (I suspect many American banks sold insurances for Greek debt).


QE Cannot Save the World

I am doubtful if QE3 can prevent a global recession. The western world is deleveraging and wages are not growing. A massive QE may not stimulate lending because they is no demand. EU certainly won't import more from the US. The ROW is not ready to take up this slack, not for the next 2 - 3 years. I expect global economy to increase by 0.9% in 2012 and 1.9% in 2013. It will be quite similar to growth in 2008. We may see the world's stock indices start to pick up by the mid 2012 to late 2012.

But Emerging Countries Will...

The EM 10 group comprising BRIC, Indonesia, Turkey, Mexico, Taiwan and Saudi will surpass the EU as the biggest economy in the world in 2012. They will form 26% of the world's economy by 2013 and reach 30% by 2016. They will grow between 2 - 3% between 2012 - 13. By 2014 - 15, EM 10 will start to grow by between 3 - 6% per annum. EU and the US, which comprised 49% of the world's GDP in 2011, will see their share fall to 43% in 2013. By 2020, EM 10 will surpass EU and US in importance. It will be a transition period for the next 5 years but we will reach the Super-Cycle soon. I've even factored in a hard landing in China where a financial crisis occurs.