Much of the Western world has been conditioned to a “return to the mean” paradigm for the past 60 years. Yes, there are recessions, but they are temporary lulls in a prevailing growth dynamic. The growth trend has been more or less inexorable. And we have become accustomed to it. Mainstream economic thought and forecasting are based upon the “past performance” that economic growth will resume. But lately that has not been the case. Economic growth after the credit crisis has been decidedly lackluster.
That return to the mean has gone missing of late. The reason is that we are coming to the end of the debt supercycle. Debt-fueled growth in the “developed” world is coming to an end as the cost of debt rises and the bond markets abandon one country after another, seemingly overnight. One minute debt is easy, the next it is hard to get.
Europe is coming to the make-or-break point rather rapidly. As noted last week, the recent summit did not solve the real problems. The distraction of the British veto served for a while to obscure the lack of any significant solutions. My friend Mohamed El-Erian, who is the CEO and co-chief investment officer of PIMCO, wrote rather alarmingly in this week’s Foreign Policy ( http://www.foreignpolicy.com/articles/2011/12/15/downward_spiral) about the choices facing Europe. Remember, this is one of the most thoughtful and influential investors in the world. He knows he is sitting on the world’s largest pile of bonds. He is not given to rash analysis (as is so often the case with your humble analyst, who sits on next to nothing). The following is raising eyebrows all over the world (emphasis mine!):
“It is critical for the welfare of billions around the world that Europe get its act together now. The continent faces an increasing probability of having to navigate a fourth potential morphing in the next few months. Should it materialize, this would take one of two forms:
“… either a disorderly and highly disruptive fragmentation of the eurozone, or the establishment of a smaller and less imperfect eurozone that has a different relationship with the rest of the EU.
“Both possibilities involve yet another set of immediate disruptions for Europe and the global economy. As such, the temptation among politicians will be to avoid making any active choices. But that would constitute a huge mistake. It would further reduce their future degrees of freedom due to an even narrower set of possibilities and, with that, erode their ability to influence outcomes.
“As time passes, the option of a smaller and less imperfect eurozone is becoming the only way to ‘refound’ a union that would have the chance to stand the test of time and, thus, constitute a key component of medium-term efforts to restore global financial stability, meaningful economic growth, and plentiful jobs. It is not an absolute best, and it would be a messy process involving the risk of collateral damage and unintended consequences. Yet, when judged in terms of feasibility and desirability, it sure dominates the alternative of a full fragmentation.”