Markets around the world had a bad start to the week.
The FTSE 100 slid 2% to below 5,300. The S&P 500 shed 1%. Copper hit a ten-month low. Both oil and gold closed lower.
What’s all this about? There are plenty of things to fret over. In commodities markets particularly, traders are worried about whether or not China can manage a ‘soft’ landing.
But the biggest problem – surprise, surprise – is still the eurozone. Investors are starting to grasp that this story isn’t going to have a happy ending.
So what does that mean for your investments?
US politicians just don’t understand Europe
Europe’s woes just keep growing. As if Greece wasn’t enough, this morning credit rating agency Standard & Poor’s downgraded Italy’s credit rating by a notch. It can’t have been unexpected, but it hardly put a spring in the step of Asian investors.
The idea of Greece leaving the euro is, by some estimates, too awful to contemplate (as my colleague Merryn Somerset Webb discusses here: Why the cost of letting Greece go is just too high).
But the notion of Europe clubbing together to underwrite the debts of a nation that shows no real sign of being able to change its ways is also pretty far-fetched. For that to be palatable to Germany and other northern European countries, you’d basically need German tax collectors to impose their rules on Greek citizens. Which would in turn require a massive step towards a federal Europe.
What’s wrong with that idea? The Americans certainly seem to like it. “There must be a reduction in the financial autonomy of member states if the common currency is to survive”, proclaims former US Treasury Secretary Lawrence Summers in the Financial Times.
In the process, he sums up why US politicians just don’t get it when it comes to Europe. Because Greece isn’t California. And Germany isn’t Texas.
What do I mean? Texans and Californians are all Americans when push comes to shove. Germans and Greeks are Europeans in name only. That warm patriotic glow extends only to their national borders, not to the west coast of Portugal.
As Gideon Rachman notes in this morning’s FT, this is the fundamental problem with the euro. People put their national identity ahead of any notion of a European identity. Which is perfectly understandable, not to mention blindingly obvious.
So when national interests conflict with European interests (ie when Germans are told they need to act as open-ended guarantor for the Greeks), there’s no contest.
There is no sneaky way to prevent a Greek default
However, where Rachman really hits the nail on the head is when he describes the European political process. “I have always believed that steps towards deeper European unity work best when they are technical-sounding, hard to understand, and not subject to the approval of voters.”
In other words, any route out of this crisis has to be a sneaky one. Trouble is, Europe has reached the point where there are no sneaky options left. A eurozone-wide bond would need approval and a new treaty. Meanwhile, any attempt by the European Central Bank to print money and embark on an open-ended buying spree of Greek, Spanish and Portuguese bonds is bound to come up against resistance from Germany.
I know it’s old-fashioned to talk about ‘moral hazard’, but this is yet another situation that sums up why it’s such an important factor to consider when you’re trying to get a handle on the big picture in economics.
Europe’s politicians have never really had to make the case for a united Europe. Because if the electorate disagreed with them, they pushed it through anyway. So they always took the easy way out of any uncomfortable situations.
But now there is no easy way out. Say they’d fought their corner honestly in the first place. Say they had actually persuaded voters of the benefits of euro membership. Their citizens would now feel that they had some responsibility for this situation, and might be more inclined to back steps to hold the whole project together.
As it is, trying to make the case for a united Europe at a time when the euro seems more like a millstone than something to defend, is almost impossible.
Sure, Greece leaving the euro might be unthinkable. Up until summer 2007, a run on a British bank was unthinkable – but it happened. Up until September 2008, the idea that the global financial system might disintegrate overnight was unthinkable – but it happened.
Greece has enough money to last until mid-October. And it may well get the next tranche of bail-out funding that it needs. But in the long run, it can’t repay its debts. And no one else wants to pay for them. What do you get when an unstoppable force meets an immovable object? I suspect the answer is: a big explosion and a terrible mess.
So what does this mean for you?
The good news is that some European stocks are looking very cheap as a result of all this. An implosion in the euro of course, would mean they get even cheaper. But Paul Hill has looked at a few promising candidates for the next issue of MoneyWeek magazine, out on Friday. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
The dollar is doing well out of all this. We talk about how to profit from currency upheaval and the return of the dollar in particular in the current issue of MoneyWeek. And if you want to try your hand at currency trading – bearing in mind that it’s a risky business – check out our free MoneyWeek Trader email.
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