Greece is the first to fall and it most certainly will not be the last. Today in FT, Niall Ferguson went so far as to say contagion, somewhere down the road, inevitably points to America. Citing that "there is no Keynesian free lunch," Prof. Ferguson aptly points out that deficit spending in the West has become an untamable epidemic that will require some serious structural adjustments moving forward.
He's right. And while the US is not completely immune to the looming Eurozone contagion, it does still have the luxury of being a safe haven (the dollar as a shock absorber) and with a total public debt to GDP ratio (55 percent) that is sadly enviable to many in Europe (the Euro area debt, for example, is 69 percent of GDP and projected to grow to 100 percent by 2014), the US is safe, for now. To put it another way, America is not exactly the weakest gazelle in pack.
Unfortunately, the same can't be said for many in the Eurozone. While budget shocks in the region can certainly be attributed to the aggressive fiscal pump-priming that occurred in the wake of 2008-09 crisis, significant structural cracks had been in place long before. And unless growth picks up, more specifically to the extent that it exceeds current forecasts (which are almost always wrong), Europe could be in for a tailspin sooner rather than later.
CDS Spreads (in basis points)
In addition, the IMF points out in its most recent Global Financial Stability Report that the forecasted growth of public debt issuances during the next two to three years could crowd out private sector credit growth, and hence stunt the prospects of a real, sustainable recovery. In a Europe that is currently struggling to find a viable 'bailout' for Greece, and perhaps also for others down the road, the IMF's debt assessment becomes even more pronounced and worrisome. Coupled with the European Commission's own recent public finance risk assessment for the region, one is sure to encounter a made-to-order recipe for disaster.
The EC report notes that only Bulgaria, Denmark, Estonia, Finland and Sweden have strong budgetary positions - that's 5 out of the 27 Eurozone countries. Notably, the report also shows that those facing the highest risk (in addition to Greece) are the UK, Ireland, Spain, Slovenia, Czech Republic, Cyprus, Latvia, Lithuania, Malta, the Netherlands, Romania and Slovakia - that's 13 of the 27 Eurozone countries. The chart above, which shows the Sustainability Gaps in the region is perhaps most telling. It shows that almost all countries fall under the unfavorable long-term camp.
So what does all this mean?
1) In the short-term, look for a weakening Euro.
2) For the medium to long-term, a weak Europe makes emerging markets, particularly commodity exporters (i.e. Brazil and Russia), even more attractive investments due to their higher growth potential. On the back of y-o-y commodity price increases and recovering global demand (esp. China, India and US), EM commodities could tread upward and recover from recent decline.
Disclosure: No Positions