There really is only one story capturing attention in the market at present – what is the future for the euro?
If the behaviour of shares is to be believed, the future looks bleak. Core to current perceptions is the possibility – likelihood even – of Greece leaving the single-currency zone, with all the implications this may have. It does no harm to examine likely consequences of this happening and the alternatives.
Markets do not like uncertainty, which is why shares are in retreat at present. Uncertainty lies at the core of what a break-up – even a partial one – of the eurozone might mean. Perhaps the biggest fear is that Greece’s departure might force other leavers. After all, the single-currency zone was conceived as set in concrete.
If it turns out to be membership of a club that is optional, then why should the leavers just be the smallest and weakest?
If such a concept took hold, then who could blame investors from eschewing those nations likely to exercise their rights to exit, preferring the core nations with stronger balance sheets? Such a scenario would accelerate the flow of money from the embattled Southern European states to the stronger Northern countries such as Germany and Finland.
To some extent, this is already happening. Last week, Kent County Council withdrew its short-term deposits from Santander’s UK operations to reduce risk of exposure to default. But then, it had been a victim of the Icelandic banking collapse.
Whether or not its concerns are justified, we all know that at times of financial stress, people will opt for the perceived safety-first policy.
Witness the low level of government bond yields here in the UK and in the US for that matter. Now, there is a nation with extravagant debts – one which has even had its credit rating downgraded. No one expects it to default, though.
So, allowing Greece to leave the single currency could well increase the level of concern rather than defuse it. And if a domino effect becomes apparent, then who might be the greatest losers? Why, the Germans, of course. Aside from the fact that the German economy is strong, helped by a currency held back by worry over its future, the Bundesbank owns staggering amounts of debt from the very nations that might try to engineer a devaluation.
But the alternatives involve stepping back from the severe austerity packages presently being imposed upon those countries in receipt of bailout cash. German taxpayers may not be keen on this. But then, do they fully appreciate the cost to them as taxpayers if vast tracts of the eurozone effectively devalue? And what happens to their competitive position if faced with a de facto reimposition of the Deutschmark?
The problem for Europe’s leaders is that their electorate do not see things the way they do. The number of political casualties as a consequence of this particular debacle is high and rising.
Francois Hollande came to power in France on the basis that austerity was not the only answer. The next Greek government will almost certainly take an even more entrenched view along the same lines. Democracy means that the final outcome cannot be predicted.
For investors, all this adds up to a difficult time when betting against the crowd could prove very damaging in the short term. It could be, though, that this represents more of an opportunity than a threat.
Even the hardest-nosed Northern European leader must recognise by now that allowing the euro to fail will threaten growth for years to come. The price could be inflation, of course. We will have to wait and see but if consensus is achieved we may not see these market levels again.
Brian Tora is an associate with investment managers JM Finn & Co