Submitted by Mark Hanna
Courtesy of MarketMontage. View original post here.
Barron’s Annual Roundtable is out and worth the read for a host of differing views. I would generally highlight Mr. Zulauf for the ‘economic big picture’ – although probably ‘worst case’ in some of his comments, and Marc Faber for more actionable investing ideas (although he is a trader type, so 6 months from now the view could be different).
Head over to Barron’s for the read.
To a one, these leading lights of Wall Street agreed that the world is a lot more dangerous than it was 10 or 20 or 30 years ago, when investors worried more about return on their capital than return of it.
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Zulauf: Europe is going to be key this year for the markets and the economy. China is slowing; the emerging world is slowing, and the U.S. is barely above water, constrained by its structural problems. I have called the euro a misconstruction since its birth. The problem is a difference in competitiveness among European countries, and you can’t solve it by lending money to the less competitive countries. You have to deflate wages and prices in the south, and inflate the north. But given Germany’s history, it will never inflate.
The members of the euro zone agreed in December that each country could have a structural deficit of no more than half a percent of GDP. If a deficit goes above 3% of GDP, the country will be sanctioned. This agreement now has to be ratified in all countries. But when you agree to such a prescription and you are uncompetitive, your currency is overvalued by 30%, you can’t devalue, and your nominal interest rates are too high, that is a recipe for a depression. It is a death sentence. Several countries won’t ratify the contract, and the next day their markets will be repriced accordingly. They will exit the euro, and the turmoil will go to the next level. Greece is bust in either case. If you can devalue your currency by 40% or 50% in that situation, at least you will have the chance to see the sun again and recover.
What happens at the next level of turmoil?
Zulauf: The banking system goes bust. Assume Greece won’t repay anything, or at most 10% of its total debt. It is not just the government but the private sector that is bust. That means banks in other countries will be in trouble, which means they will be nationalized. Governments won’t have the money to pay for this, so they will assume even more debt. That is the chain of events I expect in 2012, and if you believe it won’t affect the U.S. you are dreaming. The estimated notional value of the over-the-counter fixed-income-derivatives market in Europe is estimated to be about 60 trillion euros. There are many links to the U.S. banking system, although we don’t yet know who is positioned how. If one country exits the euro, all hell will break loose.
Gabelli: How bad is bad, and how long will it take to recover? Felix, what happens 18 months from now?
Zulauf: Fiscal stimulation is out of the question. That will come at the depths of the crisis, not before. Central bankers are more at ease with the problems and will continue to print money, but if the ECB overdoes it, Germany will say it isn’t participating in the game.
Hickey: Aren’t they overdoing it already? The ECB’s balance sheet has gone to $3.5 trillion.
Zulauf: So far, the expansion is passive. The banks are requesting help to refinance their operations because they can’t refinance in the interbank-loan market and are losing deposits. Now the Bank for International Settlements is demanding higher capital ratios. That means European banks will shrink their balance sheets and weaker countries with balance-of-payment deficits will have a harder time funding their deficits, which leads to economic contraction. The European crisis has a global dimension.
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