Prepare your portfolio for eurozone money printing

published 12 January 2012

Even Germany is feeling the eurozone's pain now.

Initial estimates suggest that the German economy probably shrank in the fourth quarter of 2011. If it shrinks again this quarter, then that'd be a technical recession.

It shouldn't really come as a surprise. You can't sit in the middle of all that chaos and panic and expect to get away unscathed. And with global demand for exports weakening, Germany's main growth driver is suffering too.

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The bad news is that this will all have a nasty knock-on effect to the rest of the world. The good news if there is any is that it might just lead to the eurozone crisis being resolved more rapidly

Europe isn't listening to newspaper columnists

You could be forgiven for being bored with the European crisis by now. The papers are still full of what Europe "should" or "shouldn't" do. Every other FT columnist seems to have their own personal cure for the crisis that would solve things if only Europe's leaders were clever enough to listen to them.

For example, this morning there's an editorial in the paper explaining how Europe should resolve the issue of private sector involvement in the Greek crisis (ie just how much private holders of Greek debt should lose).

There's a whole game plan outlined, involving recapitalising the banks through takeovers and debt-for-equity swaps. Oh, and it has to be clear that this is a one-off, so that no one worries it'll happen elsewhere. "A decisive amputation is now better than death by a thousand cuts," concludes the piece.

Problem solved, eh? Except that no one in Europe gives a hoot what the FT, or any other newspaper columnist, thinks they should do about their crisis.

I can write a whole list of "should" and "shouldn'ts" for the eurozone. I'm sure you can too.

They shouldn't have set the euro up in the first place. Having set it up, they shouldn't have let Greece in. Having let Greece in, they should have been stricter about forcing countries to meet the rules. Having failed the strictness test, they should have kicked Greece out or clubbed together to buy all its bonds the minute the crisis first broke out.

But none of that tells you how to make money from this crisis, or how to avoid being badly burned by it. For that, you need to try to think about what's likely to happen, rather than what would happen in an ideal world.

What's likely to happen in the eurozone?

The key problem with the eurozone is that everyone has different aims. The Greek situation sums it up. No one really wants to pay the price for bailing out Greece. But no one really wants to suffer the consequences of Greece crashing out of the euro either.

So the various eurozone countries have been unable to decide on a concrete plan of action. The root problem is that Germany doesn't want to end up on the hook every time an economy like Greece spends too much money. They are (quite rightly) worried about 'moral hazard'. If they do it once, they'll only end up having to do it again.

Trouble is, the current, drawn-out, painful process is just making things worse. That increases the chances of the whole thing unravelling in a very messy way. That's what has markets so scared.

The one good thing about the recession spreading across the eurozone is that it might help to focus everyone's minds a little. As James Ferguson pointed out in our New Year predictions issue (if you're not already a subscriber, subscribe to MoneyWeek magazine), the nastier things become, the more likely it is that the European Central Bank (ECB) will end up printing money.

That's no solution in the long run. While it should buy time to find a long-term solution, the reality is that everyone will feed off the free money as much as they can and will try to avoid changing their ways. You just need to look at the Western banking sector's resistance to change to realise that.

The euro isn't weak enough yet

But whether it's the 'right' thing to do or not, the most likely outcome is that the ECB is forced to act. It might even happen as a result of Greece storming out of the euro, which would be extremely disruptive.

What does this all mean in investment terms? Arguably the euro still isn't weak enough against the dollar to account for this. And European stocks while getting cheap could get cheaper still as the crunch point approaches. So while I'd be starting to look at stocks to buy in the region, I would also hang on to a large chunk of cash, to be ready to buy in at the most promising time.

And stick with gold as insurance. It is not cheap, as we've noted already. But a stronger dollar is not part of Ben Bernanke's plan. The US currency looks a good place to be at the moment, but with the country pinning its hopes on a manufacturing recovery, there's a lot of pressure to do more quantitative easing. That pressure will only increase if Europe does some QE of its own. Gold is a good defence against that.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.