Geopolitics: Why its so important

Morris Segall      Capital Markets, Emerging markets economic growth, European debt crisis, Global financial and banking systems, International economic growth, U.S economic growth, Worldwide recession

Since the spring of 2010 events outside the U.S. have been dominating our financial news and influencing our economy and capital markets. That spring the European debt difficulties moved to crisis stage with the imminent debt default of Greece. The financial crisis that began that spring has continued virtually unabated with a series of financial “band aids” that have staved off world financial disaster but done nothing to provide a permanent solution to Europe’s financial distress. In the meantime, the ratings agencies have downgraded both sovereign and bank credit through much of Europe and the ill advised austerity programs (See our website articles of March 15, 2011 and December 17, 2010), adopted by the members of the European Union have “choked off” economic growth in much of the continent, threatening the region with existing and imminent recession. During this period, world financial markets have been in turmoil and capital markets have been depressed.

Without a firm solution to the spreading sovereign debt woes, panic spread to the continent’s banking system that forced world central banks to add liquidity to the European banking system. This new calamity necessitated a summit of European leaders to fashion a long awaited permanent solution to Europe’s debt crisis. The summit was held last week and as we expected, failed to produce a bona fide solution to the debt crisis. Once again, a summit of European political and financial leaders was long on rhetoric and short on tangible solutions. After a reflex rally in the world capital markets last Friday on the news of increased unity and collaboration of EU members, the absence of substance in the summit became evident on examination over last weekend and the capital markets reacted accordingly on Monday.

We have been pessimistic about the future of the European union since its financial woes became unmanageable in 2010 and the sequence of events since then have only borne out our concerns. The fact is there is no machinery within the European Union framework that will accomplish what is needed to alleviate Europe’s financial distress and satisfy world financial markets that Europe is creditworthy. The principal entity that should be able to provide a conduit for Europe’s sovereign debt financing and shore up its banking system, the European Central Bank, is not empowered nor does it have the resources to do both. Therefore, the members of the EU face totally revamping their union with new treaties, subordinating their sovereignty to the European Commission, or creating some ersatz organ to provide the financial resources to do so. Again, there is not enough consensus among EU members to do what is necessary and not enough resources within the European Community to fully engineer a financial solution to both the sovereign debt and under-capitalized banking system. So the angst over Europe’s financial future continues as does the continuing threat of credit downgrades by the credit rating agencies, exacerbating an already tense situation. At this point, the austerity programs have created a negative economic situation for Europe, both Western and Eastern, that is threatening world economic growth for 2012-13. Europe represents approximately 20% of world trade and is a major market for U.S. and emerging market exports. Its economic stagnation has negative implications for GDP growth here and abroad. If Europe’s financial woes degenerate into a world financial crisis threatening the banking systems globally, it could precipitate a worldwide recession. This is the principal reason why forecasting world economic growth for the next 2-3 years has become so difficult.

That difficulty has been compounded by the current significant economic growth slowdown in the emerging market leaders in Asia and Latin America, notably China, India and Brazil. Emerging markets have been the locomotive of world economic growth before the recession and have led the world economic recovery since the recession ended. Economic deceleration in this key segment of the world economy coupled with economic stagnation in Europe cannot help but depress prospects for economic growth in the U.S. The impact of overseas events on our economy, our financial system and capital markets has never been greater and is unprecedented in the post war era. Unfortunately it is part of a secular change in the world economic order where global interdependence has replaced economic independence and where global economic growth leadership has passed to the newly industrialized economies of Asia and Latin America.

Morris R. Segall