Greece, EuroCrisis and Deleveraging

As the IMF demands Austerity, growth in Europe is scarce, budget cuts have already put Europe in a recession and the misguided Austerity push will make that worse. But rebellion runs on an empty stomach, and Europe now faces a break up or a severe devaluation of the Euro to around 80cUSD.

Economist Shayne Heffernan takes a look at what will happen next in Europe.

Only now are we seeing a growing political opposition to austerity measures, that forced Italy to delay its goal of balancing the budget by one year to 2014, joining Spain in missing fiscal targets amid a worsening recession. French President Nicolas Sarkozy may be toppled in a May 6 vote and the Netherlands will hold elections in September after the cabinet resigned over spending cuts and tax increases.

The Washington-based International Monetary Fund said in an April 17 report that the world economy will expand 3.5 percent this year, down from 3.9 percent in 2011, as growth in Europe shrinks 0.3 percent.

The default in Greece was one of the worst moments since the 2008 financial crisis, part of the European Union defaulted on their debt and with the help of the ECB, World Bank and IMF strong armed bond holders in to accepting massive write offs.

Italian and Spanish bonds led losses among Europe's higher-yielding government securities on speculation European authorities will struggle to stop the region's debt crisis from spreading.

As I warned at the time, this type of action supported by the ECB, World Bank and IMF clearly values Europe's sovereign debt at cents on the dollar and institutions holding or invested in that debt should be writing down the valuations.

The International Monetary Fund warned Wednesday that European banks are under pressure to preserve capital and could cut back sharply on lending over the next two years, slowing the region's growth.

The predicted credit crunch is a major reason why Europe's economy is expected to suffer a mild recession this year and barely grow in 2013, the IMF said in a report on the global financial system released Wednesday.

The 17 countries that use the euro will see their economies shrink by 0.3 percent this year, and expand by only 0.9 percent in 2013, the IMF has forecast.

The International Monetary Fund fanned those fears, saying Spain was facing severe challenges. It insisted that last week's strict budget must be put into practice to cut its deficit.

Clearly the challenges Spain is facing are severe. Market sentiment remains volatile, said IMF spokesman Gerry Rice.

Large banks based in the European Union may reduce their balance sheets - which include outstanding loans, securities and other assets - by as much as $2.6 trillion through the end of 2013, the IMF said. That's about 7 percent of their total assets.

About one-quarter of that reduction will come from reduced lending and could shrink the amount available for credit by 1.7 percent.

Some reduction in credit, or deleveraging, is necessary, the IMF said. Banks aren't able to borrow as freely as in the past and governments are requiring them to hold more capital.

Deleveraging simply means banks will sell assets, stocks, real estate and businesses adding to the pressure on already fragile European markets and also impacting their USA holdings.

Why Greece Might Become a Black Swan

On the eve of the Greek default I wrote regarding the possibility of the Greece action becoming a Black Swan, now it is clear that Europe is on the edge of a Black Swan Event.

As deleveraging pressures grew towards the end of 2011, European banks offered for sale a significant volume of assets, notably those with high risk weights or market prices close to holding values.

Offerings with high risk weights included low-rated securitised assets, distressed bonds and commercial property and other risky loans. Although some such transactions were completed, others did not go through because the offered prices were below banks' holding values.

Strong deleveraging pressures during the final quarter of 2011 were also associated with weak or negative growth in the volume of credit extended by many European banks. Credit extended by financial institutions in the euro area, for example, turned down during this period, with credit to non-bank private sector borrowers in the area falling by around 0.5%, while assets vis-àvis non-euro area residents declined by almost 4%. Outstanding loans to euro area non-financial corporations grew by just over 1% and loans to households for house purchases by around 2%, while consumer credit declined by just over 2%.

European banks also cut lending to emerging markets. Their consolidated foreign claims on emerging Europe, Latin America and Asia had already started to fall in the third quarter of 2011.

New syndicated and large bilateral loans from EU banking groups to emerging market borrowers then fell in the final quarter of the year. This was in contrast to lending to western Europe and other developed countries, which was essentially unchanged . At the same time, banks tightened terms on new loans to corporations and households in emerging markets. The more pervasive tightening in emerging Europe than elsewhere may have reflected the widespread ownership of banks in the region by EU banking groups. Reduced lending to emerging Europe may also reflect lower demand, however, as the region's economic growth forecasts fell by more than those for any other during the final quarter of 2011.

Spain is in extreme difficulty, Prime Minister Mariano Rajoy said April 4, raising the possibility of a bailout for the second time this week. The government has widened its budget deficit target to 5.3 per cent of gross domestic product from 4.4 per cent and warned on April 3 that public debt will surge to a record 79.8 per cent of GDP this year.

Spain sold 2.6 billion euros of bonds, near the minimum target for the sale on April 4. Borrowing costs rose in its first auction since the country said public debt will jump to a record this year. The Treasury had set a range of 2.5 billion euros to 3.5 billion euros for the sale.

In the US, the Federal Reserve is holding off on increasing monetary accommodation unless US economic growth falters or prices rise at a rate slower than its 2 per cent target, minutes released from a March 13 policy meeting showed on April 3.

The European Central Bank left its benchmark interest rate unchanged at a record low of 1 per cent on April 4. The euro-area's economic outlook remains subject to downside risks, President Mario Draghi said at a press conference later that day in Frankfurt.

The remaining tensions in euro area sovereign-debt markets are expected to dampen economic momentum, he said.

Euro-area services and manufacturing output contracted for a second month in March. A composite index based on a survey of purchasing managers in both industries dropped to 49.1 from 49.3 in February, London-based Markit Economics said on April 4. That's above an initial estimate of 48.7 on March 22. A reading below 50 indicates contraction.

How Global Debt Looks Now

This list of countries by estimated future gross government debt based on data released in September 2011 by the International Monetary Fund is the stark reality of the value of physical money and cash assets. The figures are in percentage of national GDP.

Cash is no longer king and the value of most currencies is being eroded which means everyone must rethink their investment strategy and adjust their portfolio holdings.

While many think that if they live in the USA and earn in USD nothing will change, I can assure you that those days are over, growing world wide demand for food, energy, goods and services has an impact at all retail outlets in the USA.

Every investor, institutional or individual must now balance their portfolio based on currency exposure.

The IMF's John Lipsky has warned that the average public debt ratio of advanced countries will exceed 100 percent of their GDP for the first time since the war by the end of this year, and that this debt is unsustainable, risking a new fiscal crisis for some.

The massive sovereign debt problems of the US and Eurozone also clearly run the risk of sharply increasing future inflation as their currency wars export inflationary pressure around the world.

This will result in real investment losses in long-term fixed interest bonds (as well as in cash), since debt that cannot be repaid from taxes will need to be printed by means of ever larger rounds of quantitative easing (money printing) measures.

All this simply implies an accelerating erosion of the value and purchasing power of money.

Investors can protect themselves from rising inflationary risks by investing in or gaining exposure to real scarcity, traditional safe haven assets like gold, as well as other commodities, I would include things like agricultural land and soft commodities as well.

Shayne Heffernan

Shayne Heffernan oversees the management of funds for institutions and high net worth individuals.

Shayne Heffernan holds a Ph.D. in Economics and brings with him over 25 years of trading experience in Asia and hands on experience in Venture Capital, he has been involved in several start ups that have seen market capitalization over $500m and 1 that reached a peak market cap of $15b. He has managed and overseen start ups in Mining, Shipping, Technology and Financial Services.Read the Terms of Service