The immediate response of the markets last week was quite muted. They assumed that with Germany in charge of the Euro and Merkel in charge of Germany, the austerity programmes will continue to the bitter end. Simpletons.
Faced with changes in France and another election in Greece, people then started falling over themselves talking about growth. Voters have also spoken in Germany where Merkel’s hard line approach seems to be losing touch. Merkel herself has to go to the polls next year. In Spain a large banking bailout will be required to accommodate all the duff mortgages and construction loans.
People are now openly talking about two things which are contradictory – Greece leaving the Euro and growth pacts. If Greece leaves the Euro, there will be such a flight of money from all Club Med countries that the Euro will find it difficult to work at all. There will be no growth. Investors have already had a ‘haircut’ with the Greek debt and won’t want to go there again. Don’t imagine it will be a civilised divorce, whatever the contractual obligations and treaties.
Apart from the inevitable poverty and chaos that will happen in Greece, the real big losers will be France and Germany, which have invested most in Greece and other Club Med countries. Companies have already started putting money in ‘safe havens’ overnight. There is no guarantee that the money will come back. Remember what happened with Lehman Bros?
If Greece does exit – or is evicted – then while physical Euros currently in Greece will be OK, accounts will be empty because the other banks will not lend to Greek banks at all. Contagion will occur in the other indebted countries. The abyss.
While Greece must bear some responsibility, the banks which lent them money are also at fault. Some of this debt was actually to fund exports to Greece – of military hardware! Both Germany and France are the main suppliers of such goods and have, to some extent, been competing with each other. Presumably these exports were ‘guaranteed’ by the respective governments so if Greece does default it will be German and French taxpayers that will take the largest hit.
Forseeing this possibility, the Euro has weakened and stock markets round the world have taken a trip south. Unless the principles I outlined last week are adopted and the European Central Bank starts behaving like a proper central bank – with all its implications not the least for the redundant national banks – the market will start to view the Euro as not as a stateless currency but a currency working under diverse and incoherent jurisdictions, which it is. Expect then more than a few countries, Euro-denominated bonds and instruments to lose their credit ratings.
It is against this background that Francois Hollande is being baptised in Berlin. He will be aware of the consequences of failing to persuade Germany that its best interests lie in growth and renegotiation. So let’s assume that he succeeds.
Hollande succeeds …
The immediate effect is that the Euro will lose a little more value but if as a result the Eurozone economy picks up, that will be good news all round. Changes will have to be subtle not seismic but a move from austerity to growth will bode well for the Eurozone internally. Investors will be more realistic and accept that to get out of the mess that the Euro finds itself, they will have to be rather more patient.
It will need considerable time and, for fiscal union, political agreement which will need a new Agreement post Lisbon and not be easy. Most importantly, something must be offered now to the innocent people while this re-orientation is going on. There has to be hope.
As far as the consumer is concerned, it will be carry on as before. Some countries may have painful re-orientation, property prices in Spain and Ireland will remain low and a Eurobond with the ECB as banker of last resort will drastically cut the interest payments for all. Maybe not honey and cream but at least some jam.
… or fails
On the other hand, if there is no progress, all hell will break loose. It is likely that social unrest in southern Europe will become a major issue; none of the countries has a passive history. Of course, it may be that a passive and broken population of southern Europe will bow down and accept their fate but it is also possible that pigs will fly. When people are driven to the wall with five years of constant cuts while others walk away with millions, don’t expect acquiesence.
Many people in Greece are already starving and it may soon come to Spain, Portugal and Italy. The only one of the PIIGS which is likely to escape is Ireland because their problems were not in tax collection or overspend but in an overheated property market. It is Club Med that will suffer I’m afraid. Get out now while you can – there may be investment opportunities once everything has settled down but that could be years away.
There will have to be a lots more haircuts. Investors stand to loose many billions or even trillions of Euros which will depress the world economy affecting not only Europe but also the US and China. Therefore it behoves these countries not to rock the boat. Europe needs some re-alignment for sure because the world does not owe it a living. But it has many good things, not only culture but also innovation, science and a certain civilisation that has been exported all over the world.
The UK will suffer. If our major trading partner is not purchasing, our economy will nose-dive as well and it will be impossible to square Osborne’s fiscal circle. There is no room for schadenfreude here.
So what for the rest of the world? Pretty dire for the next 10 years or so. While there are havens and not all countries will be affected, severe recession in Europe will take many years to recover and depress the world economy by many points.
It is in all our interests therefore that Hollande succeeds.