A chilly wind from across the pond

By Robert Smith The Daily Record Newswire Most of you already know I feel about the economy. The recent stock market rally notwithstanding, we are in a rolling depression and not a recession. The "recovery" was an artifice, bought and paid for by historically unprecedented government borrowing and spending. Without the stimulus, no new growth occurred in the private sector. This is why the recent uptick in economic activity may ultimately prove so disappointing to investors. Despite the U.S. Bureau of Economic Analysis' recent downward revision of third-quarter GDP growth, the short-term economic outlook is beginning to tick up. Mortgage delinquencies are down, foreclosures are slowing and consumer spending is up. Strong results from black Friday and cyber Monday also support increasing consumer confidence. However, the big question is: Can it last? Will this activity ultimately translate into new job growth and signal a return to some semblance of normalcy? Or is it just a break in the clouds? Unfortunately, with the European sovereign debt issue spiraling out of control, odds are it will be the latter. Let's step back and look at this dispassionately. In so doing, we may better understand why a recession/depression is inevitable in Europe and why that chilly wind must be felt here. After asking European banks to take a 75 percent cut on their sovereign debt, Greece is already in default. With this in mind, the likelihood of other countries defaulting "is no longer negligible." French and German banks hold a disproportionate amount of debt. This means the European banking community is much less capitalized than most people think. Therefore, one of two things must happen: European banks either get more money from somewhere else to improve their capital ratios or they change their business model. Well, the continent is tapped out. There is little or no private capital available to the banking system. Quite the contrary, money is fleeing European stock and bond markets as fast as it can toward places such as Asia or the U.S. This is why the Europeans were forced to go hat in hand to the Chinese recently, begging for money. Not surprisingly, the Chinese turned them down flat. This leaves us with plan B -- changing the business model. To raise more capital, banks will simply lend less. As happened here, credit conditions will tighten and economic activity will slow. Decreased spending by consumers and businesses will negatively impact the American economy, which already exports one-fifth of its manufactured goods to the European Union. This will be exacerbated by the dollar rally that occurs in the wake of the euro's meltdown. Our goods will become more expensive and fewer will be sold. Sadly, this is the best-case scenario -- a European recession that tips the scales against an American economic recovery. If multiple defaults occur and cause weak member states to leave the EU, we could easily see it fragment into recession and depression along a north/south line. Unemployment in places like Spain already exceeds 20 percent (50 percent among youth). If countries like this are no longer able to leverage up on the creditworthiness of their northern neighbors, we could easily see their economies shrink by as much as 50 percent. Europe represents about one-fifth of the global economy. The ripple out from such a recession/depression is bound to be felt here. Because things can still so easily spin out of control, I counsel investors to get real. Keep dollars at home and keep them producing as much cash flow as possible. Income is real and it is immediate. As such, it is less vulnerable to the unknown. The current financial environment is more uncertain than at any time in the recent past. Until the situation changes, money is not likely to come out of hiding. ---------- Robert Smith is president of Peregrine Private Capital Corp. Contact him at 503-241-4949 or at www.peregrineprivatecapital.com. Published: Thu, Dec 15, 2011