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By Jeremy Glaser | 08-19-2011 09:50 AM

Younes: Europe Taking Easy Medicine First

Europe is currently trying quick fixes, but the continent will need to make major structural reforms in order to solve the sovereign debt crisis, says Artio's Rudolph-Riad Younes.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Global markets continued to be rocked by fears of slowing European growth and the ongoing European sovereign debt crisis. I'm here today with Rudolph-Riad Younes. He is a portfolio manager at Artio, and he will provide an update on the situation.

Riad, thank you so much for joining me.

Rudolph-Riad Younes: Thank you, Jeremy. Thank you for having me.

Glaser: So, my first question is, do you really see Europe careening toward recession or do you think that there's going to be a some more resilience there?

Younes: Definitely, we feel during the next five to 10 years, Europe as well as the United States will be in a very low-growth environment, much lower than they had in the past.

Glaser: Is that the same across, the entire continent? I mean, there was some the hope that maybe strength in Germany would be able carry some of the slower-growth countries, but we're seeing at least the gross domestic product numbers indicating slowing growth in Germany. Is that something that concerns you?

Younes: So far, Germany has been able to offset a lot of the weaknesses of its weaker partners in the eurozone, but ultimately it will affect them.

Glaser: So, let's turn our sights to the eurozone then. There is lot of talk about if it can remain stable, or if it will be able to continue in its current form. Do you think, there'll need to be major structural changes to the eurozone or to the European Union in order to secure growth in Europe or will they be able to muddle through with their current system?

Younes: Definitely, the eurozone needs a serious reengineering. The current status quo is not an equilibrium, and that's what the financial market is telling the policymakers. That's also how the policymakers, little by little, are acknowledging the problem, but the solutions are not easy. Therefore, there is this resistance, and it is difficult to tell what kind of outcome it's going to be. But definitely, the current situation is unsustainable.

Glaser: Do you think they are moving fast enough to make these structural changes? Or is there a chance that the government won't be able to act quickly enough to kind of stave off an even slower-growth or negative-growth scenario?

Younes: I mean, the situation is very dynamic. Definitely, the market is moving too fast. The market was to slow, and now the market is too fast. And there is this dynamism between the market and fundamentals because even if market prices do not reflect fundamentals, they affect them anyway. So, there is a dynamic relationship between pricing and the situation. If you look at the current situation today, the eurozone is kind of like a currency board in reality but you have a zero fluctuation in currency. Instead of a currency band, what you really have is an interest rate brand. And like any currency board system, for it to work you need very little deviation. For the eurozone to work you need the sovereign spread versus Germany to be, on average, within 50 basis points.

If we get to that, then we know the eurozone is working. If we don't get there, which we are far away from that, then we know that the system is not working, and little by little, the fundamentals are getting worse for all the weak members.

Glaser: So we look at the European banks, obviously they are very exposed to both growth in Europe and also just some of the sovereign debt problems. Do you think the banks are appropriately capitalized; will they be able to ride out any storm in Europe? Or are you worried about those institutions?

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