After a few months of decent equity market performance, liquidity injections and improving investor sentiment, should we feel more positive about the future of global markets? “No way,” said Christian Menegatti, Head of global research with Roubini Economics. “Far from it,” he explained during his keynote address at the 2012 Global Investment Conference in Kelowna, B.C. Rather, investors need to understand the key difference between the financial crisis we’ve come through and what we’re facing for the next few years – a balance sheet recession.
“Liquidity will not take care of a balance sheet recession,” Menegatti said. “What is needed is balance sheet repair.” And that, he warns, will slow down economic growth for years to come. While policymakers have bought time through monetary policy choices, countries still need to figure out how to deleverage and ease themselves out of the “debt super cycles” which threaten growth.
So far Menegatti believes the U.S. has been doing a better job than Europe when it comes to dealing with the debt super cycle. The policy approach the U.S. has taken has been more successful in helping to pull that country through the balance sheet recession it faces. In contrast, Menegatti said austerity measures in the Euro zone have lead to higher savings rates and they have kept money out of the economy. All that has been a growth killer. In not choosing the austerity route, the US is in a better position today although he cautioned that there are still tough times ahead.
For now, however, solid policy in the U.S. will help that country avoid a Japan style scenario. Europe, on the other hand, might not be so lucky as policymakers push for continued austerity measures that will keep growth at bay for years.
In the coming months and years, Menegatti said the Euro zone faces huge challenges, not the least of which is Italy, the world’s third largest bond market. If that market has to be restructured and if the face value of bonds is reduced, he believes that this will lead to a crisis that makes Lehman Brothers look like a “walk in the park.” How likely is this scenario? “It’s not the baseline scenario,” he told the delegates, adding that Italy’s Prime Minister Mario Monti is committed to keeping politics out of the country’s finances at it seeks the best route to restructuring its debt.
However, Menegatti warned, political risk is huge right now and investors should not underestimate its potential to derail fragile financial markets.