Panic over. For now.
The markets ended last week little changed, or slightly higher than where they started. But in between we saw 400-point moves in the Dow Jones every day.
The papers have been full of pundits trying to work out exactly what kicked it all off. Doubtless a number of worries are whacking the market all at once, from fears over US recession to concerns about the recent downgrade.
But of all the worries, Europe is the most potent. And the bad news is that this week is fraught with chances for more nasty surprises from the continent.
Europe has three choices – none of them good
German chancellor Angela Merkel and French president Nicolas Sarkozy are meeting up on Tuesday to discuss the sticky problem of Europe.
Ambrose Evans-Pritchard, writing in The Telegraph, outlines the three options they face: they can go ahead with issuing debt jointly, which would involve ‘a constitutional revolution’, or they can force the European Central Bank (ECB) to print money, Federal Reserve-style, to buy bonds issued by the problem countries.
This might help out the likes of Greece and Italy, assuming it drove up inflation and helped their economies to stop shrinking. But it might not suit Germany, which understandably has historical concerns about money-printing.
The third option? “They can try to muddle through with their usual mix of half-measures and bluster. This will lead to a rapid disintegration of monetary union and a banking collapse.”
Given the consequences, you might think that option three would be a last resort. But of course, it’ll almost certainly be the first. This is the problem you have when the economy backs itself into a corner like this.
The difficulty is that there is no good choice here. Full European union is a drastic step. It would be unpopular with many voters in even the most euro-friendly countries. And it’s also unfair. A piece by Ostmar Issing – formerly of the ECB – spelt the problem out in the Financial Times last week.
His point was that any attempt to create bonds issued jointly by Europe basically would let the likes of Greece off the hook and dump the German taxpayer with the costs. “It is a move on a slippery road to a regime of fiscal indiscipline drowning hitherto solid countries in the morass of over-indebtedness.”
As far as Issing’s concerned, that’s no way to push forward European integration, because in the end, voters will rebel against such unfairness. Why should German voters have to pay for Greek political and economic policies over which they have no control? “In the past, cries of ‘No taxation without representation’ have brought war,” warns Issing.
Regardless of your stance on Europe, you have to admit that Issing’s got a point. Look at the pressure our own little monetary union here in Britain is under. Post-Scottish devolution, the West Lothian question (which ponders why Scots politicians have influence over purely English policy matters, while the reverse is not true) has become ever more problematic. Particularly now that the UK’s money is running out.
France remains vulnerable
So what about the quantitative easing option? Money-printing appears less drastic on the surface. But again it’s effectively forcing the German taxpayer to suffer to ease the pain in the periphery.
It’s the same problem you see in both Britain and the US: money printing is a tax on savers, with the aim of bailing out those who took on unwise amounts of debt. At least the European bond solution is a more transparent form of larceny. In any case, this option is also politically fraught. It would involve destroying ECB independence.
When faced with two politically difficult options, the politicians will always opt for the fudge instead. This might involve more chatter about expanding the European Financial Stability Facility (EFSF). But they don’t have the luxury of time.
It may seem like stock markets fluctuate randomly. But last week was incredibly volatile for a reason. The French banking sector tumbled last week because – through the fog of rumour-mongering and market chatter – there’s a genuine underlying reason for investors to be worried. If France’s credit rating gets written down, then the French banks would likely follow.
And the thing that immediately threatens France’s credit rating, is the risk that it will have to shoulder ever-increasing amounts of the burden for bailing out the rest of Europe.
In short, if nothing comes out of this meeting on Tuesday, expect more panic in the markets.
Political risk is everywhere
To be fair, this isn’t just a problem in Europe. All across the Western world, politicians face tough choices. Whichever route they take, they are going to cause pain, and will therefore be unpopular. That leaves a wide-open goal for anyone in opposition to propose alternatives which sound attractive on the surface, but would just make things worse in the long run.
With all these potential sources of turmoil in the markets, where can investors turn? We got a team of experts into our latest MoneyWeek magazine roundtable and they’ll be giving their views on where to invest now in the next issue of MoneyWeek, out on Friday. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
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