In the first of a new series for Investment Week, we ask industry experts....
Will the euro collapse? Will peripheral countries leave the currency?
Trevor Greetham, manager of Fidelity’s Multi-Asset Strategic fund
While the reluctance of stronger eurozone economies such as Germany to prop up their southern neighbours is understandable, I find it hard to believe monetary union will survive over the long term without large fiscal transfers from one country to another and a much greater degree of political integration.
“The recovery is fragile and the strait-jacket of the single currency means policy makers in countries like Greece or Spain can’t offset government spending cuts with currency devaluation or additional monetary stimulus as would be possible in the UK outside EMU.
“Successful monetary unions like that between the 50 US states ease the problem of shared monetary policy by transferring tax revenues from more affluent regions to pay benefits in less fortunate areas. These transfers can be large but they are all but invisible and attract little political or media interest. Everyone feels entitled to the same benefits should their circumstances change for the worse, no matter where in the US they happen to live.
“The furore surrounding loans to weaker countries shows us we are still a long way away from the necessary degree of political union in Europe. The recent bail-out package eases near-term financial strains but offers no extra stimulus for peripheral economies. The risk is spending cuts trigger a double dip recession as asset prices drop and banks rein in their lending in an unpredictable way. Falling prices and lower wages in the troubled countries will see the one-size-fits-all interest rate tighten in inflation-adjusted terms, further accentuating the downturn.
“I hope that sustained economic growth will start to refill government coffers but there are signs that activity may be about to slow down and I worry that the markets will continue to go after weak players until it is clear this is nothing more than a moderation in the pace of recovery. If the crisis in the eurozone gets sufficiently bad, things could end in one of two ways: a break-up of monetary union as it currently stands or a move to deeper political integration. We may be witnessing the birth pangs of a federal Europe.”
Mike Turner, head of global strategy and asset allocation, Aberdeen
“It is important to put the current situation into context. Remember that only six months ago all the talk was of the dollar’s impending loss of reserve currency status, as central banks around the world were supposed to continue diversifying their dollar exposure. Also markets have tended to underestimate the political commitment behind the single currency.
“However, the survival of the single currency is driven by more than the sum of the collective political efforts invested so far. The dangers of any eurozone nation either defaulting or exiting completely go beyond the relative strength of the currency itself and the financial future of the country in question.
“The euro has enabled a certain amount of financial glue between the region’s banks and a default or exit is likely to result in huge and lasting damage to lenders far and wide. In this context the collective €750bn package looks like money well spent.
“There is of course a silver lining. Many of the region’s key exporters are for the first time in almost a decade becoming price competitive on the world stage thanks to a weak euro and years of wage moderation. While southern European states badly need a deflated currency to give them any chance of reflating their own economies.
“The success of governments reducing their debt levels, imposing a prudent fiscal orthodoxy and a sustainable economic recovery are likely to determine the euro’s longer term future rather than short-term currency market fluctuations.”
Julian Chillingworth, chief investment officer, Rathbone Unit Trust Management
“The writing is on the wall; it is now a matter of how and when. Much depends on an acceptance by political egos that the euro experiment has failed, so expect this to be a painfully protracted process.
“The escalating fiscal crisis means that over the next two years, the financing requirements of the region’s most troubled economies (the amount needed to cover maturing and new loans) will amount to over 30% of GDP in each case.
“This represents a massive economic contraction. Add to this the realisation that measures to avert default are short term and not enough to stem the deflation trap or further contagion, and the peripherals could be shown the door.
“This downleg in the euro does not compare with previous ones because the contagion risk is wider. Banks and governments in the PIIGS owe each other billions of euros, but they owe larger debts to the UK, France and Germany. The troubles also weaken the export strength of stronger nations, as domestic demand falls off.
“We believe the core countries will, therefore, resort to a form of collective preservation, creating a tighter trading block, and thus securing the euro’s future in the medium term.
“They will not escape the impact of course, once peripheral countries reintroduce local currencies as borrowing costs rise in sympathy. So while fears persist over sovereigns, a potential contraction in the banking sector and thus economic growth, expect a tumultuous ride. To rebuild investors’ confidence, something akin to a Herculean sweep of the stables of Augeus is now required.”
Tom Becket, CIO, PSigma Investment Management
“Although I have little doubt the best thing for Europe and the peripheral countries in Europe would be for the PIIGS to start afresh, there is little chance of it happening.
“The dogmatic and obsessive defence of the eurozone has been remarkable in recent months, as the European leaders have completely failed to appreciate that Europe in its current form cannot realistically survive.
“In particular, while there has been belated action to try to cure the liquidity problem that Europe was facing, nothing has really been done to solve the long term solvency issues that many parts of Europe face. The only thing that can really cure the structural long-term deficits is higher economic growth and less spending. The first of these is unlikely and the second unpalatable.
“After living beyond their means for too long, the Europeans are going to have to start swallowing some tough medicine and I would urge against venturing near the Piraeus on a hot day this summer!
“Furthermore, it might get quite edgy in Germany, should the Germans get hacked off over paying their hard saved money to bail out their Greek cousins. At least if the euro continues to plummet it will foster growth in the powerhouse exporters.
“While there is a good chance of a European country winning the World Cup, (for the record, my money is on Holland as dark horses), I think there is considerably less chance of a happy few quarters ahead for Europe or the euro.”
Andrew Milligan, head of global strategy, Standard Life Investments
“The brief answers are we expect the euro currency to be rather weak while the probability of any country leaving the EMU is low. These are highly complex issues, however.
“The largest questions, whether a country defaults or leaves the eurozone, are binary issues and hence very difficult to price correctly. Portfolios can be positioned, however, to take account of some of the likely secondary outcomes, such as the depreciation of the euro currency itself.
“The house view has been prepared for euro weakness and we would not be surprised to see it test parity with, for example, the dollar before the current crisis phase has ended.
“Will any members leave or the whole system collapse? It is important to remember that EMU is first and foremost a political construction; hence both peripheral and core governments will take considerable efforts for some time to stay within the European club, as the recent €750bn support package, the ECB’s agreement to undertake QE, and austerity measures from individual countries all demonstrate.
“However, there has been some disagreement between EMU governments and it would be helpful to firmer evidence that they co-ordinate their policies to be more certain in our views. All in all, we assess the probability as low of such a major event as any country leaving EMU; however, it is not negligible and therefore investors need to position their portfolios for the possibility of a major shock. The house view is tactically light in European assets.”
Gary Reynolds, CIO, Courtiers Investment Services
Most common currencies fail, and the euro is about to join their ranks. It will either break up entirely, or fragment, leaving Germany and the Benelux countries as the only survivors. The only question is when, and it may be a lot quicker than people realise. Italy, Greece, Spain and Portugal may all soon decide that they are better off outside of the euro.
There has been political will to stay in until now but the Greek problems have raised the question of whether failing countries will be bailed out and the answer seems to be “not necessarily so”. This means that countries are being forced to adopt austere fiscal and monetary policies whilst seeing interest rates rise. Will the transient Mediterranean politicians be able to carry their populations (“voters”) with them just to stay in the EMU? I think not. So expect euro problems and when they happen you are better long German bunds and short Italian BTPs.
By Dr John Tsoukalas, lecturer, faculty of social sciences, the Nottingham School of Economics and Dr Michael Arghyrou, lecturer, Cardiff Business School
The euro’s recent slide reflects doubts about the currency’s long-term prospects.
Markets have seen unsustainable and highly contagious national macro-imbalances, the no-bail-out clause abolished, the ECB’s independence compromised and intra-EMU disagreements about future policy.
What they haven’t seen is a credible end-game plan for resolving the crisis, which is why they fear that either the EMU will finance deficits by printing money or the union will collapse.
Reversing the situation is possible under two preconditions: structural reforms to address micro-imbalances in periphery countries and the creation of a European Monetary Fund that will monitor national budgets and provide emergency cash under strict conditions. But there is an important risk: periphery societies won’t bear a substantial fall in living standards.
We recently detailed a plan to deal with this eventuality. It involves a temporary split of the euro into two currencies, both run by the ECB: the “strong euro” for core countries and the “weak euro” for periphery countries.
We propose a one-off devaluation of the weak versus the strong, alongside the introduction of far-reaching reforms and rapid fiscal consolidation. Enhanced market credibility means the plan has a realistic chance of success, maintaining European monetary integration and leaving the door open to periphery countries for a return to the strong euro.
It may be an option of last resort, but it is one with something good to offer to all interested parties. Above all, it would preserve a project whose long-term economic and political benefits are plain.
