Global Agenda: Don’t wait until it’s too late

Investors and savers have every right to feel frightened and confused, After all, here we are in mid-April, barely three months after the most recent, most expensive and most comprehensive attempt to resolve the financial and economic crisis gripping Europe, and yet that crisis is already back in full force. The result is weakness across the financial markets, with most – and in some cases all and more – of the strong gains recorded in the first quarter of the year having been erased.

But the paper gains and losses are not the main cause of the fear and confusion that have so swiftly re-emerged.

They stem, rather, from the very real threat facing many of the largest European financial institutions – banks, insurance companies and investment firms. Not to be concerned about one’s savings and investments held in and/or managed by these institutions would be strange and irrational behavior by any standards.

In short, we are back to a situation in which return OF capital is once again the paramount consideration in the minds of savers and investors, while return ON capital is a distant second. Justifying this approach does not resolve the greater question of what its practical implications are; indeed, it actually sharpens the question.

The first and most critical requirement is to understand and internalize that the European crisis is unresolvable within the framework of the status quo. In simple terms, that means the European Monetary Union is unworkable, so that both it and the euro are doomed. The attempt to resolve the crisis of the euro by advancing to a fiscal and economic union, although theoretically possible, cannot work in light of the huge differences – in everything from economic structure to cultural ethos – among the various European countries; especially between Germany and its neighbors on the one hand, and the Mediterranean countries on the other.

The immediate problem facing the latter group, and spooking the markets, is that they are trapped between the need to impose austerity for fiscal reasons (i.e., to reduce spending and thereby tame their deficits) and the need to boost growth in their economies. These two requirements are contradictory, and the response of the markets is to punish whatever it regards as too much austerity, as well as too little. This reflects the deeper malaise: that the markets have lost confidence in the leadership of the EU and, in most cases, of the individual countries.

The markets understand, on the basis of fundamental financial analysis, that the European countries (with the possible exception of Germany) have promised far more to their citizens than they can possibly deliver. But the implications of this statement are far more sociopolitical than they are financial and economic. True, lenders to most European countries will not see all their money back, at least in anything approaching its real value. But for the younger generation of Europeans, the truly devastating implication is that its future has been largely mortgaged, stolen or otherwise expropriated and that there is very little they can do about it. They can, however, vent their anger and frustration, at the least via the ballot box and perhaps even via the barricades. That is why the upcoming elections in France and Greece, and the Irish referendum, are so important.

These brutal facts about the bleak reality facing Europe mean that the risks entailed in holding European financial (and real) assets are very high. These risks include not merely market risk (prices might fall), but serious political risk as well (governments might fall or be overthrown and contracts and/or obligations be voided or canceled).

Indeed, even before the political upheavals get under way, the Greek crisis has already resulted in the Greek government reneging on its obligations to private investors (foreign banks in which ordinary people hold their money), while exempting “privileged” lenders, such as the European Central Bank and the national central banks of the European countries. This milestone event has, in the opinion of many analysts, unleashed a chain reaction on the part of investors (and savers) that will speed up the process of European financial disintegration that is already under way.

The rational response, therefore, is to seek to preserve one’s capital. This requires exiting the euro and euro-denominated assets – but also non-euro European currencies, including sterling, the Swiss franc and the Scandinavians, because they are so deeply and inextricably bound together with the euro. The same is true, to a greater or lesser extent, for financial institutions in non-euro countries – especially where, as in the UK, these institutions have significant exposure to problematic countries such as Spain, or are actually owned by Spanish banks.

These are not vague potential threats, but rather trends that are already under way and rapidly escalating. Runs on individual banks, on entire banking systems and on sovereign states tend to become mechanisms of disaster that feed on themselves. Precisely for that reason, the prudent response to these phenomena – and, in practical terms, to the developing situation in Europe – is not to wait and see, but first to get out of the danger zone and then to observe developments from the sidelines.

landaup@netvision.net.il