Standard Life Investments

Published Article

Citywire - Global Strategy


It is a truism to state that there is an intense degree of uncertainty about the prospects for the global economy and financial markets. Conversations with many clients and investors in recent weeks show a desire for discussion and contemplation completely at odds with a willingness to make an investment decision. Perhaps a philosophical approach can be combined with that of a market practitioner to work through some of the issues. The triad of thesis, antithesis and synthesis may be a way forward. Let me demonstrate.

The thesis is an intellectual proposition – for example that Greece must default and leave EMU. After all, as is now well known, the country suffers from a debt/GDP ratio well north of 100%, the IMF is forecasting a recession of 5% in 2011, on the back of the fiscal austerity programmes, while the patience of its fellow Eurozone members is running short. A number of newspaper commentators and politicians say enough is enough, we must make an example of Greece, it must leave.

The antithesis is the negation of the thesis, a reaction to the proposition. It is all well and good to say on paper that Greece must default. Let us examine some of the practicalities. For example, a recent report by UBS indicated that – aggregating the various costs such as privatising a bankrupt banking system, the disruption to overseas trade, and so forth – the cost for an economy leaving EMU could be of the order of 20-25% of GDP. To put this into context, the fall in Iceland’s GDP during the recent crisis was only about 10%.

What about the synthesis? In philosophical terms this solves the conflict between the thesis and antithesis by reconciling their common truths, and forming a new proposition. What are the common truths in relation to Greece? I would suggest that these include: markets will push politicians until eventfully they react; politicians want EMU to survive, as the cost of failure is too high; the ECB will be forced to do what the politicians want, to make EMU survive. No surprise therefore that in recent months, after recent crises, the ECB has if belatedly, agreed to expand its programmes to purchase sovereign debt, to provide short term loans to European banks and undertaken a joint currency swap with other major central banks.

This is far from saying that the synthesis rests solely on the ECB. The EFSF will eventually play a part, a capital fund which can be used to support individual governments or even banks when they need finance. Although there is considerable concern about Eurobonds from Germany, Holland and Finland we expect them eventually to form part of the necessary package. Political concerns are understandable that such bonds remove the need for peripheral countries to reform their economies and that the debt servicing costs of the AAA members would be higher. Progress on conditionality (Maastricht 2) is understandably proceeding slowly. However, the introduction of such bonds, at least up to 60% of Eurozone GDP as some are proposing, would help reassure investors. A market crisis may be needed though to bring such a synthesis about.

We can use this approach in other ways too. It is becoming increasingly clear that more countries suffer from debt problems: China has municipal debt concerns which affect the banking sector and local government finances. The UK is struggling with a slow growth economy against the backdrop of a historically high large private and public sector debt burden The US can cope with its debt burden for the time being – helped by its reserve currency status - but the clock is ticking loudly. After the elections in 2012, the government needs to make some serious decisions about growth, debt and spending priorities or it faces a crowding out effect which could seriously damage long term growth prospects.

Thesis, antithesis, synthesis. Economies face a serious debt problem. Politicians find action increasingly difficult. The onus will fall on central banks to act. As the MPC minutes stated “the weaknesses and stresses of the past month had significantly strengthened the case for an immediate resumption of asset purchases”. QE3 approaches, and it may be rather different to QE1 or 2.

Andrew Milligan, Head of Global Strategy, Standard Life Investments

First Published 29th September 2011 In Citywire Wealth Manager