The rescue package for Greece can at best delay a reckoning for the entire universe of indebted developed countries. If it is not seen as a success by global investors, it could trigger a risk aversion that will prompt outflows from Asian and emerging stock and bond markets, warns Kirby Daley, senior strategist at Newedge Group in Hong Kong.
The strategy of Western governments (and Japan) to deal with the problems of indebtedness has been to borrow more, in the hope that they can buy enough time to grow their way out of their problems.
"It is trite to say you can't solve the debt problem with more debt, but there is no truer statement," Daley says.
The package announced by the European Union finance ministers over the weekend is in line with similar efforts at monetary and fiscal stimulus taken around the world last year. EU governments agreed to expand a balance-of-payments facility, on top of a €750 billion rescue package announced last Friday by the EU and the International Monetary Fund.
These efforts will only saddle Greece with more debt. They will delay any default for the time being but Daley expects it will not suffice, given the level of Greek indebtedness is now around 118% of its GDP - a figure that under the rescue package is meant to grow to 149% over the next three years, assuming creditors take no haircuts.
The European Central Bank is under pressure to follow the US Federal Reserve's lead and engage in quantitative easing and inflate its balance sheet by buying its own bonds without sterilisation, although the ECB's president, Jean-Claude Trichet, continues to oppose such a move.
Daley expects Trichet will bow to such pressure, however, because the ECB will run out of options. The only possible strategy for indebted governments that can't or won't make very hard choices is to extend the current system for as long as possible.
"The issues facing Western governments, especially the US when unfunded liabilities are taken into account, is that there is no viable solution," Daley says.
Buying time means hoping that, somewhere, somehow, economies return to enough growth to pay down or inflate away debt. Although the US, Japan and Britain may have time to put their houses in order, Daley says matters are accelerating, and the likelihood of governments taking necessary tough measures is low.
"What was once seen to be a problem for our grandchildren has now become a problem for the current generation," he says.
The alternative would have been accepting an immediate restructuring, rather than trying to drag things out, as governments were initially forced to deal with subprime mortgages and other private-sector debts.
Daley acknowledges the shock may well have led to a great depression, so it's not so much a question of criticising government actions since 2008, but of accepting that many of these indebted countries are ultimately going to default, or suffer hyperinflation. Investors should therefore look for ways to protect themselves.
Although China now represents the best long-term growth story, Daley believes that it and the rest of Asia are probably so dependent upon exports to the West that they will face constraints. Chinese stimulus in 2009 has so obscured supply and demand that it's impossible to tell just how strong domestic consumer demand really is, in China or in the rest of Asia.
Chinese stimulus has the advantage that it can probably be sustained for longer than the Western house of cards, but it too has a limit.
In the meantime, as investors turn risk-averse once more, Daley says this will lead them to cash out of Asia and emerging markets. Liquidity may suffer as a result.
Daley believes credit and equities in the US, Europe and Japan are overvalued. Commodities hold obvious appeal but are subject to shifts in value between different sub-sets of the asset class. It is difficult to know what is a sensible entry level for hard assets, from gold to real estate. Daley says investors need to be accumulating these gradually, and de-risk.
US government bonds will remain a safe haven as well, despite Uncle Sam's growing pile of IOUs. The collapse of the euro's credibility as a reserve currency leaves the dollar and the yen as the final 'flight-to-quality' destinations with sufficient liquidity. The dollar's role as the world's reserve currency gives the US enormous flexibility in this regard, and Daley predicts the yen will at some point lose its favoured status as its debt burden reveals itself.
But it's a double-edged sword for America, which won't be able to use a cheap dollar to export its way back to growth. And, at some point, barring an unlikely recovery in global growth, bond markets will eventually focus on US debt, much as they are lasering in on Greek debt today.