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Snowden: 11th hour QE can save Europe
by Stephen Snowden on Dec 09, 2011 at 12:05
I fear that 2012 will deliver more of the same – weak and volatile markets. The problems the western world now faces are obvious; too much debt and too little economic growth. While I don’t want to re-hash a now well known history, a small reminder of the last two years needs to be considered.
Markets have lurched from fear of too much debt to the euphoria that a solution has been found. Recently, however, the cycle has been one of fear followed by more fear. Sovereign woes kicked off in December 2009 when Dubai’s solvency was first questioned. The markets then took a closer look at Greece in February 2010, and it wasn’t until May 2010 that the sovereign solvency question fell upon other European countries. An alphabet spaghetti of solutions have appeared, which in turn have had to be modified and enhanced pretty quickly afterwards.
The third quarter of 2011 has seen a material turn for the worse as the third largest bond market in the world, Italy, was finally fully engulfed. Two years is a long time for markets to endure the same problem, particularly one that gets worse every time we encounter it. Politicians are very important people. They are fully entitled, for example, to let the markets get on with it while they enjoy their summer hiking trips. But as important as they think they are, they regrettably choose to finance broad government spending in excess of tax receipts by borrowing from the bond markets.
This inconvenience matters. Silvio Berlusconi was ejected from power when the markets showed a vote of no confidence, and not the Italian parliament. The market has simply been the bridesmaid too many times now. The current ‘alphabet spaghetti’ solution is simply unworkable. Worse still, my main fear is that a belated marriage proposal is now simply too late – the love has gone. Market participants are no longer fresh faced.
Once, a Eurobond was seen as a neat solution; Eurobonds would allow the markets to view Europe as a whole with a lower debt to GDP ratio than that of the US or the UK. Now, the markets are tired and grumpy and will view Germany’s 81% debt to GDP ratio as simply not strong enough to prop up the sick men of Europe.
In my view, quantitative easing (QE) now appears our only hope. But as has been pointed out to me by a continental gentleman, “that is Anglo-Saxon thinking”. While QE is embraced in the UK and US, it is an alien concept in northern Europe. If it happens, and I hope it does, how far do asset prices have to fall first?
Does it require bank runs on several nation champions in different countries for the warning signs finally to cement the need to do the unpalatable? It is not outwith the wit of man to solve the problems we are in - but they come at a political cost. There is always an opposition politician ready to offer voters an easier way. Unfortunately, the inconvenience of having to borrow that from the bond market is sadly under-appreciated by voters as a whole.
As gloomy as my scenario is, there is hope. I do believe QE will eventually happen in Europe. No doubt it will be at the 11th hour to prevent complete collapse. And credit markets have already suffered one of the worst sell-offs in history. But in keeping with my view of things having to get worse before we get the final policy solution of QE, we are running a conservative portfolio in the Kames Investment Grade Global Bond fund.
European banks are clearly vulnerable, particularly those in the troubled countries. If a country can’t borrow with extraordinary intervention by the European Central Bank, I fail to see how a bank in that country could - a sovereign default will almost certainly cause the default of many of that nation’s banks.
To that end, we have no exposure to either banks or insurance companies in Portugal, Ireland, Italy, Greece or Spain. And given the substantial cross border exposure that French financial institutions have, we are also avoiding them. We are materially underweight the banking sector as a whole.
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