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Matthew Lynn's London Eye Archives | Email alerts
Dec. 7, 2011, 9:32 a.m. EST
By Matthew Lynn
LONDON (MarketWatch) "” Plans to save the euro are a bit like very cheap Christmas toys. There's a lot of anticipation, a brief flurry of excitement, but they are usually broken by lunchtime, and completely forgotten about by the next morning.
This week's plan, likely to be pushed through at the latest summit, is for a German-led "?fiskalunion', as it is known in that country. A full-fledged budgetary policy for the single currency, with central control of tax and spending decisions, will be created.
Investors could be forgiven for not paying very much attention. We've seen so many plans by now, and they have lasted so little time, it is hard to keep taking them seriously.
This one is not as flimsy as some of the earlier attempts, however. In fact, it looks like it might go ahead "” and could even keep the whole show on the road for another two or three years. If so, how should investors respond? By getting ready for a short-term bounce, backing the German DAX /quotes/zigman/2380246 DX:DAX -0.57% , supporting the peripheral nation's banks, and going short on all of the southern European stock markets.
The latest deal is a "grand bargain" between German Chancellor Angela Merkel and the other 16 nations in the euro zone. Some of the finer details still have to be worked out "” and bear in mind that euro-zone deals have a tendency to fall apart as soon as anyone gets into the fine print "” but the plan would see all the members of the single currency submit to centralized control of tax and spending policies, in return for which Germany will keep on supporting the bailouts of the weaker members, and allow the European Central Bank to turn on the printing presses.
The threat of a collective downgrade of the euro-zone's credit dampened the enthusiasm that greeted the announcement by France and Germany of plans for a radical solution to the debt crisis. Dow Jones's Geoffrey Smith discusses the fallout.
It won't work in the long term, or probably even the medium term. Why not? Because it will do nothing to address the fundamental gap in competitiveness between northern and southern Europe.
It will impose crushing austerity on the periphery, which will stop their economies growing for just about ever. Italians have already been through a lost decade of zero growth, and have another couple of them to live through under the plans being cooked up in Berlin. And the lack of democratic control will eventually lead to popular uprisings. National parliaments will have little say in tax and spending decisions, and if they try to interfere, they can expect a technocrat to be helicoptered in from Brussels to put them back in their place.
No taxation without representation has been a good rallying cry for insurrectionists for a few hundred years: it will work as well in Greece, Spain and Portugal, and indeed France, as it has done everywhere else.
But, and this is the important point for investors, it may work in the short term "” say between now and 2015. So, if it goes ahead, what does that mean for investors?
They are four big trends to watch for.
If the plan shows any signs of working "” indeed if it shows any signs of lasting beyond the usual 36 hours before someone presses the auto-destruct button "” there will be a visible mood of relief. Avoiding an apocalypse is always good news. True, the medium-term outlook will be just as bad, and perhaps even worse than ever. But the stock market doesn't worry about the medium term. If everything looks like it will be OK until Christmas, sentiment will improve.
The big German exporters have been the only real winners from the euro. An artificially low exchange rate has kept their goods a lot cheaper on the world's markets than they otherwise would be. There are a lot of BMWs in China precisely because of that. At the same time, southern Europe hasn't been able to devalue against Germany they way it always used to "” and the way it needs to again to get its economy back in balance. The result has been that German manufacturers have flooded the world with their exports.
The German trade balance has gone from zero, when the euro was launched, to more than 8% of gross domestic product. A fiskalunion will be the continuation of the same polices, except on steroids. More exports for Germany, and more austerity for everyone else. It isn't going to be much fun for the rest of the world, but so long as that can be sustained, the big German companies that make up the DAX will do well.
No sector of the stock market is more bombed out than Greek, Italian or Spanish banks. Shares in the huge Italian bank UniCredit /quotes/zigman/172005 IT:UCG -2.42% , for example, are down from 2 euros in February to less than a euro today. But under the fiskalunion the banks will start to recover. The bond markets will never believe the euro zone is permanent: once the prospect of countries quitting is raised, it won't be forgotten. So real interest rates in all those countries will be very high, but the banks will get low-cost funding from the European Central Bank. That is bad news if you happen to be a small business looking to borrow money to expand your business. But it's great for the banks. The margins on loans will be sky high. Profits will recover and so will share prices.
All the peripheral countries will have grinding austerity packages imposed on them. The German take on the crisis is that it was created by irresponsible government borrowing in the peripheral countries "” even though Spain ran a surplus, and the Italian debt was run up before it joined the euro. If countries have to be stuck in permanent recession, that is the way it will be. It will be very tough for any companies operating in those markets "” and their share prices can be expected to suffer.
The fiskalunion will be inherently unstable "” but it may stagger through two or three more years. It will be the world's largest economic bloc, and impossible for investors to ignore. Played right, there will be money to made from it "” so long as you get out before the inevitable implosion.
Matthew Lynn is a financial journalist based in London. He is the author of "Bust: Greece, the Euro and the Sovereign Debt Crisis," and he writes adventure thrillers under the name Matt Lynn.
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