I realise I am tempting fate in writing about Europe. As the situation changes daily or even hourly, there could be utter calamity or temporary respite by the time you read this. What does not change is the constant reminder that monetary union without proper fiscal union is bound to lead to problems and the pro-euro voice in the UK has become quiet indeed as the mistakes made by European politicians come home to roost.
Creditor nations, notably Germany, are as much to blame for the problems as the debtors such as Greece. Creditors have responsibilities, too. It seems insane that Greece was allowed to join the euro in the first place and even more senseless that it was lent vast sums of money at cheap rates. Yet Greece is tiny, representing about 1 per cent of eurozone GDP, and, in theory, easy to contain if the political will is there. The problems really start when you get to the bigger nations of Spain or Italy. There is not enough money to bail out these countries, whichever way you look at it.
The solution European politicians keep coming back to is austerity. But progressively pushing through more cutbacks is not going to work, particularly at a time when banks are being recapitalised. True, the banks have too much bad debt on their books, so this clearly needs to happen at some point. The trouble is that money is effectively taken out of circulation in the process, draining the supply and causing a deeper slowdown. The time to increase banks’ capital provisions is when the economy is booming rather than struggling – and I see little chance of banks increasing their lending as politicians would like.
The Europeans are likely to make the situation much worse if they insist on going ahead with an immediate bank recapitalisation. Unfortunately, regulators around the world are desperately trying to close the stable door after the horse has bolted and disappeared over the horizon. To counteract this deflationary effect, what Europe really needs to do is to follow the US and the UK into quantitative easing. Printing new money would allow more of it to circulate out in the real economy.
The stumbling block here is Germany, where it is believed that QE will lead to inflation. Those who have studied German history will understand the hyperinflation of the Weimar Republic in the 1920s still haunts German society today. Unfortunately, I cannot see any way round the problem without resorting to money printing and I do not necessarily see it as inflationary at a time when banks are pulling in the levers of credit. At some point, Germany is going to have to accept this as the solution.
We still await the tipping point, or ERM moment, when a real decision to get to grips with the problem is made – or the market forces it. When the UK was pushed out of the exchange-rate mechanism in 1992, the equity markets took the news badly but subsequently recovered strongly. Something similar could happen with this European crisis.
Until then, markets will remain nervous and, as European politicians lurch from one disaster to the next, it is not surprising UK investors are withdrawing from European equities. Recent IMA figures show big redemptions. I can see their logic and things might get worse before they get better but given the levels valuations have reached already, it could be a mistake. According to our own research, European equities are now two standard deviations below what we consider to be fair value. This is not to say they will not go lower but given a five-year view, it is tempting to phase some money into good-quality funds in the sector such as Henderson European special situations, Jupiter European and Cazenove European.
Mark Dampier is head of research at Hargreaves Lansdown