The 2011 Hayman Leadership Retreat was truly ground breaking. By bringing experts from Europe, the US, China, Japan, India, Indonesia, the Middle East and other regions together with Australian business, investment and political leaders, suddenly you could see a road map for the global future.

It is a road map that has many boulders along the way and there are sections of the road where we could fall off the cliff. But longer-term, more optimistic scenarios emerged that will require different business and investment strategies.

Speaking under the Chatham House rule (which applied to all speakers) Treasurer Wayne Swan gave an address that contained no politics but showed he was on top of the world developments that unfolded during our time at Hayman. Given the current turmoil in Canberra this was very reassuring.

I returned to the mainland with a strange mixture of fear and hope because there is no doubt that in Europe and the US we face some bad news. Our immediate fate will in part be determined by how China handles what’s ahead for Europe and the US.

Usually in commentaries of this sort you start with the conclusions and then go from there. But what happened at Hayman 2011 was too important to be treated that way so I invite you to join me over the next few days as I set out the road map. And just when you may think we have reached the end of the journey, I will stun you with what is ahead by way of medicine, which was also explained at Hayman.

I am going to start with the worst of the news ahead. Long-term students of the euro explained that those who devised the euro as a common currency for diverse countries knew it would not work in the long term. Eventually there would be a crisis and that crisis would force the European countries to unify their governments and their finances and move closer to being a United States of Europe.

We now know the form of that crisis — European banks have made huge loans to European countries that have no hope of paying in full. A series of European banks now face the grim reality that their shareholders’ funds would be wiped out if they valued at market their loans to the countries in trouble.

The European banks have now become very wary of lending to each other and unless there is a resolution, this will paralyse Europe. So far, Band-Aids have been tried and have not worked. It is possible more Band-Aids will defer the crisis but the market speculators at Hayman believe that in time markets will force Europe to face its demons.

At Hayman there were three solutions on the table. First, that the bonds would be guaranteed jointly and severally by all the European countries, but a condition of those guarantees would be political and monetary integration; second, that the euro breaks up, possibly with Germany and perhaps France leaving. And the third option is a deep depression.

As the reality of the third alternative sinks in, one of the first two solutions will be selected. The amalgamation of Europe will be much less painful than the European break up via Germany leaving because the euro would slump, requiring massive aid for most European banks.

These are not easy scenarios but the message from Hayman is that in the next 12 months a solution is likely — and assuming one of the first two solutions are selected, then the world will make the required adjustment. Later I will explain what could happen in the post-adjustment period.

In the US, while Bank of America is under pressure, the banking system is for the most part in much better shape than Europe’s. Moreover, its companies have made themselves much more productive and many have lifted earnings strongly and have strong cash balances.

The US problem is that American companies have transferred much of their employment offshore or have been hit by the fact that the normal driver of the US economy, its consumers and home-building industry, are moribund. About 30% of American families have negative equity in their homes and there are extensive problem loans and foreclosures. Those foreclosures are in a legal minefield.

Americans in Hayman said that there was a 50% chance the US would go into recession and privately they conceded that the US could even be in recession now. That recession will cause a crisis in the US, albeit not as big as the European crisis.

What happens next and how that plays out in China will be the subject of tomorrow’s commentary.

*This first appeared on Business Spectator.

Peter Fray

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