Continental flu!

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Recently, my business partner, Paul Gambles, was on Money Channel talking about Europe. Paul started by saying, “If we look at what’s happening in Europe right now, we’re starting to see that the lack of activity in the real economy, in the high-street as it were, is actually now starting to clash with the liquidity that has been driven into risk assets, and Greece is probably the perfect example of that.

“There are a million people in Greece below the poverty line; they’re starving; they’re out on the streets protesting; they’re not happy about the fact that the Greek have agreed to all these austerity measures that are going to make their lives even worse for the next few months and years, and we have an election coming up in Greece. It may well be that as a result of that, the technocrat Prime Minster in Greece, who was really appointed by the German government and the ECB, may well lose his mandate; we may get somebody in charge of Greece who doesn’t accept these austerity measures going forwards, who tries to back out of this deal.”

The Greeks are suffering but not helping themselves either. On one Greek island, 600 people were claiming disability benefits but an investigation found that there were only 50 who actually did have a disability. If this is happening on one island then it is going on all over the country.

We are now getting to the stage where the tensions between the real economy and what is really happening on Main Street and the financial economy and what happens in places like Wall Street are close to snapping. This is because they are so disconnected, they now both have different aims. Every time more liquidity gets produced, Wall Street wants it because it wants asset prices to rise, but the people on the street who are starving see all this liquidity being produced, and they do not see why they should have to give in to austerity measures. This is not just a Greek phenomenon – it is true all the way across Europe.

Greece is the starting point because it is probably in the worst state of all the European economies. It was probably the least developed and least competitive economy. Then Greece borrowed all this money and transferred all this debt into the country to allow it to buy all these manufactured goods that came from competitive countries like Germany. Greece was really the place where the wheels came off, but the problem is that all the other places in Europe are not much better.

So we are expecting there to be a problem with Greece this year. We have been saying that for some time. We have been talking about Greece defaulting and leaving the Euro. A couple of years ago, everybody said that was crazy. Last year, people said well maybe Greece will find a way of defaulting that will allow it to stay in the Euro. Now, people have pretty much come round to accepting that Greece will, at some point, almost certainly have to leave the Euro. When that happens, it will put a huge amount of pressure on Portugal, which is probably the next domino that would have to fall. At that point, we get Spain and Italy; then Belgium starts to get the contagion, and this contagion would ripple all the way through Europe.

Recently, we have seen ratings agencies talking about downgrading. Indeed, France has been downgraded, but no one is really talking about downgrading Germany and yet it is at the end of this chain. If Greece falls over, then Portugal falls over; if Portugal falls over, then Italy and Spain; if Italy and Spain go, then Belgium goes. Ultimately we get to France. The French banking system is so exposed to the domino effect that France cannot survive it and, at the point when France falls over, then Germany has got a horrendous problem. Germany is not a AAA jurisdiction by any means; it is not a safe haven. Germany is probably the last domino that will fall – all the others will fall first, but like in Asia in 1997, once the first domino goes, once one economy devalues its currency and everyone else has to follow, it sets off a chain reaction that will probably be much quicker and much more inevitable than the markets seem to be allowing for right now.

Liquidity will get sucked out again, and then all the reasons why asset prices have been as high as they have for the last few months and all the reasons why they have recovered so dramatically since 2008 will suddenly get drawn out of the market. Then we will not have liquidity anymore, and we will have to look at what is actually underneath and that could be pretty ugly.

It is not just Europe. This also applies to the United States. In the US, we have an economy that is not functioning properly. We are not getting people back to work. We are not getting GDP levels anywhere near where it should be at this point after a recession. The announced 2.8% growth in the US last year is getting close to stall speed. If it falls below that, it is almost impossible to pick it back up again. Historically, once GDP growth falls below 2% a year, it is pretty much impossible to prevent a recession at that stage.

One of the things that helped the recovery following 2008 was the idea that the government sponsored a lot of incentives, a lot of stimulus, a lot of back-to-work schemes and infrastructure schemes. Well, the US government cannot afford to do that anymore because it is already running a $1.5 trillion deficit each year, so it cannot afford to go and spend money on discretionary items like building more bridges or more roads. It has actually sucked that money back out of the Federal budget and it is not spending that, and this is one of the reasons which has contributed to the slowdown in the States last year. Growth is slowing and getting slower and slower.

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]