Evercore Pan Asset

The Euro and its troubles have dominated markets and media for many weeks. When people are in a panic about the condition of state finances and EU banks, they sell any risk assets to protect themselves. Asian shares have been falling as well as European shares, though not so much, despite being far away from the crisis. When people occasionally cheer up about the prospects for the Euro, they like risk around the world.

These positions are a bit extreme in both directions. Whilst it is true that a collapse in Euroland would cut export demand for Asian goods, China is currently embarked on a policy of selling more items to itself. A bad banking crash in the EU would have a bad effect on US banks, but the further from Europe’s shores you go the less dramatic the impact would be. There can be world growth even after a Euro disaster. Euroland is only around a fifth of the world economy, and much of its economic output and income will survive even a bad crisis.

The bears are right, however, to worry about the gathering storm in Euroland. The latest “fix” proposed by Germany and France is worryingly thin. They say they need a Treaty change to strengthen the controls the EU can impose on Euro member governments. Member states will have to conform with EU rules on how much they spend, tax and borrow. The truth is they are meant to already. Most of the Euro countries have been breaking the rules for years. The new device they want is the power to enforce fines on states who misbehave. As the countries concerned will be borrowing all their extra spending, it means the EU’s answer to a state borrowing too much is to require them to borrow more to pay the fine. A Treaty change usually takes considerable time to agree amongst all 27 states, and longer where some member states need to get the approval of their electorates through a referendum. Some worry that states like Greece are now in a vicious downward spiral. Cutting more public spending, sacking more state employees, lowers demand more and cuts tax revenues further.

The markets are waiting for more money printing. The US and UK have got used to the idea that their economies are given artificial stimulus through the creation of large sums of electronic money to buy government bonds. These two economies benefit from low official interest rates as a result. The US is now urging the European authorities to do the same in Euroland. The Germans are very reluctant, fearing it will be inflationary. They argue that printing more money to buy up the bonds of profligate states takes away the pressure on those countries to sort out their deficit problems. Other members of the EU are probably more sympathetic to the US lobbying, and would love to see their bond rates come down for whatever reason.

On the day that the German and French leaders announced their plan to save the Euro, S&P came out with a warning that most Euroland states are now on negative watch. The rating agency is actively considering downgrading various European government bonds, as it is not satisfied they are making sufficient progress to get their finances in order. Printing more Euros should lead to a sharp rally in markets, but does little to solve the underlying problems. Many Euro states are spending too much. Germany is super competitive within the zone and is enjoying large surpluses. There is no easy way of recycling these surpluses to allow the other countries to keep buying the German goods. Restoring competitiveness without creating new currencies and allowing devaluation is going to be a long and painful process, necessitating large pay cuts.

The general gloom has made shares around the world look cheap. We still prefer the faster growing East, which has more scope to advance. It is important to remember there will be life after the Euro crisis. It is also wise to realise that no-one has yet come up with a long term solution to the Euro’s manifest failings.

As published in Investment Week