A winter of discontent

Financial markets have been decidedly unsettled in recent months. World share markets reached their high point for the year to date towards the end of February, and have since fallen by around 7 per cent. Locally, our market is around 10 per cent off its 2011 peak.

The causes of what might be described as “a winter of discontent” are many, and often interrelated.

One of the major causes emanates from Europe where policymakers continue to struggle with the fiscal crisis facing Greece and other nations on the European periphery.

Negotiations have continued for some time over whether to pay Greece the latest installment (12 billion Euros) of the rescue package put in place last year. The absence of that payment will inevitably trigger a default by the Greek Government.

One potential stumbling block to the rescue package appears to have gone, now that the now reshuffled Greek Government has successfully steered legislation through Parliament to implement new austerity measures.

What needs to happen next is getting the European Union membership to agree on just how much of a ‘voluntary’ haircut, if any, private sector bondholders will be required to take.

While a failure to make the 12 billion Euro payment seems unthinkable, the reality is that some kind of debt restructuring or default is inevitable in Greece, and perhaps also in Ireland and Portugal.

The austerity measures implemented to date have simply made matters worse – deepening the recession, and causing a further deterioration in the Greek Government’s already perilous finances. Public and political pressure against further austerity is building.

  In a democracy, there are limits to how much financial pain can be inflicted on the populace in the name of appeasing international bond investors. At least some of these investors, particularly some of the hedge funds that have opportunistically bought into peripheral European debt markets, should be big enough and ugly enough to fend for themselves. Others however, most notably major banks in Germany, France, Belgium and elsewhere, maybe should have known better, but now that it is clear that they did not, are in danger of requiring a major capital injection - preferably, but perhaps not solely from the markets. Without such an injection of capital, there remains a real danger that a Greek default could quickly be followed by defaults in Ireland and Portugal, which could trigger a full-blown European banking crisis. While to us default appears inevitable, the Europeans do have an option to face reality and ensure that such an event is orderly - a disorderly default is surely in no one’s interest. Are we being alarmist in saying that default is inevitable? Our views are hardly controversial: we are not saying anything that many other commentators are saying, and indeed bond market pricing has shown for some time that market participants are placing a very high probability that some kind of debt restructuring taking place. The history of such fiscal crises shows that some kind of default is inevitably part of the solution. Brian Parker CFA is investment strategist for MLC Investment Management.