The outcome of the General Election here in the UK was widely expected to have major ramifications for the UK markets. In reality, it was completely overshadowed, for the time being at least, by the widening sovereign debt problems in southern Europe. The Greek debt crisis has served to highlight a number of burning issues that just won’t go away.

The issues:

1. There is the question of “Moral Hazard”. If governments know that there will always be a bailout, where is the incentive to behave responsibly?

2. Will the indebted countries take their medicine? The so called PIGS (Portugal, Italy, Greece & Spain) need to tighten fiscal policy significantly; with interest-rate cuts and devaluation ruled out by euro membership, that implies wage cuts and massive unemployment.

3. Will Germany be able to pass the legislation to permit such bailouts? For how long will their responsible populace be prepared to write a blank cheque?

4. Are the bailouts affordable anyway? All the AAA-rated nations in Europe already have public debt-to-GDP ratios of 70%-80%. So we cannot be confident that countries will be able to raise the amount required.

Is it just a giant sticking plaster?

The most recent €750bn initiative by the EU and IMF to provide loans or guarantees to individual Eurozone governments is in reality just a ‘giant sticking plaster’ rather than a solution to the sovereign debt crisis. It may provide some comfort to the lenders that there is some guarantee from France and Germany behind their IOUs however bad debt just doesn’t disappear. Most of the PIGS cannot afford to service their debt let alone pay it back. Europe’s leaders have merely passed the debt along to a broader audience. Now, the ghost of Greek, Portuguese, and Spanish debt haunts the whole continent.

What all of this really serves to do is highlight the yawn engulfing competitiveness between northern and southern Europe and the problems and contradictions within the Eurozone that were easy to ignore during the boom times. Greece and the others have been “keeping up with the Jones’s” and the problem is that they have become used to the lifestyle.

These problems are being reflected throughout European stock markets and on the Euro, and we expect to see this continue through the summer.