Morgan Stanley’s Graham Secker has an excellent note out titled: How We Think About The European Sovereign Debt Crisis.
In it, he lays out 5 key ideas that form a framework of his thinking.
- Weak GDP growth is a key impediment to any reform/austerity plans working. Morgan Stanley forecasts just 1.2% GDP growth for the eurozone in 2012, presenting a major problem.
- Policy initiatives will fail unless a country’s nominal GDP can get above its cost of capital (yields on 10-year debt, being a typical benchmark for this). In the US, for example, nominal GDP is above 3%, while yields on the 10-year is sub-3%, so everything is kosher for now. In Europe, that’s not the case (see chart below).
- This is a big one: Anything less than a comprehensive solution, investors should sell.
- The focus on achieving a primary surplus (a government budget surplus before the cost of servicing debt) may be misplaced, since unless the country can grow robustly in this scenario, it won’t do any good.
- Financials. In the end, they’re the one sector that really takes it on the chin in this mess.
Here’s a look at the failure of European nominal GDP growth to stay above the cost of capital. Bear in mind of course, that on a country by country-by-country basis, things swing wildly.