When a crisis rears its ugly head, eurozone politicians have had a long history of failing to act quickly enough. That may be changing.
And regardless of your political views, if you’re an investor, you need to pay attention because it could make you a lot of money...
Why the fate of the eurozone matters so much for investors
I’ll start by asking you to forgive me for repeating myself, but I want to discuss again why Europe and the eurozone are so important for investors to keep an eye on right now.
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Since the global financial crisis, the biggest fear for markets has been deflation. That’s understandable. We are always fighting the last war in our minds, so that we don’t get caught out again. (The problem, of course, is that the next war is rarely the same as the last one, mainly because we spend so much time worrying about the last one. But we’ll get to that later.)
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The basic problem during the 2008 crisis is that the global financial system turned into a black hole – the banks were bankrupt. So you pumped money in and it was just swallowed up. The US dealt with that first. It fixed its banks relatively quickly. The UK got there more slowly, but it got there. The eurozone didn’t.
Why? It helps to understand that fundamentally, a central bank is just an arm of the government. The US and the UK used their central banks and their power to print money to prop up their sovereign balance sheets, which in turn enabled their governments to stand behind their banks.
Europe struggled to do that because the European Central Bank (ECB) is answerable to lots of individual governments, and none of them were keen to throw their weight behind other countries’ banking systems. (As well as domestic politics, there was an element of hubris at an international political level, whereby this was deemed a crisis of the “Anglo-Saxon” model. Clearly no one had bothered to take a look at what all the German banks had been buying...)
Anyway. We then had the Greek debt crisis, which threatened to be another Lehman Brothers moment, just a couple of years after the original one. That took ages to sort out and it cast a deflationary shadow for much longer than that.
Ever since Mario Draghi’s “whatever it takes” speech, the eurozone has been clawing its way back from the brink, with Draghi patching together an ECB policy using toilet rolls and double-sided sellotape that roughly approximated a typical national central bank.
But there was always the risk that all of that would fall apart once Draghi stepped down. And it did look as though everyone was heading for another confrontation after Christine Lagarde took over.
Perhaps ironically, it’s only during the coronavirus crisis that convincing moves to underwrite the eurozone for the longer term (I won’t say permanently – nothing is permanent) and prevent the breakup of the euro have been made.
And this is why I keep talking about it. The eurozone’s situation has been a persistent threat hanging over the “big picture”. If you were worried about deflation you just needed to point to the eurozone and its ongoing stagnation. As long as that potential breakup is hanging over markets, there’s always a desire to price in a risk of it happening.
Most of the scariest moments of the last decade or so when it comes to deflation can largely be traced to concerns over the eurozone going pear-shaped again. 2016 and the Brexit vote was an obvious one – that was when we saw the first incredible peak in negative-yielding debt. More recently, when Draghi was coming to the end of his term and populism was kicking off in Italy and various other parts of the eurozone, we also saw creeping concern with bond yields sliding hard again.
So plugging that hole matters a lot to markets. And increasingly it looks as though they might achieve it.
Why money printing is leading to a stronger euro
Yesterday, the ECB increased the scope of its Pandemic Emergency Purchase Programme by €600bn, which was more than expected.
But perhaps more importantly, Germany has also announced a big stimulus (worth €130bn) for its businesses and consumers, aimed at – as finance minister Olaf Scholz put it – bringing Germany out of the crisis “with a ka-boom”. It includes a one-off bonus for households of €300 per child.
Why does this matter? Because it means Germany is serious about splashing the cash. Germany has always had a lot more fiscal rectitude than any other European country, for a wide variety of reasons. But this marks a departure from that, and indicates that Germany is also serious in its support for a pan-European Union support fund.
This, by the way, is why people keep going on about a “Hamiltonian” moment for the eurozone. I honestly don’t know much about Alexander Hamilton – there are way too many gaps in my knowledge of UK history for me to worry about starting on the US – but he was America’s first treasury secretary, and he played a key role in having the US states collectivise their debt. The idea is that we’re seeing something similar in the eurozone now.
But whether it goes that far or not doesn’t matter too much for markets. The fact is that the eurozone is moving in a market-friendly direction, and that’s what investors should be aware of.
To be clear, none of what I’m saying here is meant to be an indication of whether I think it's a good idea or not. All I’m pointing out is this: until now, a breakup of the euro has been a scenario that has continued to concern investors. That is now changing.
How do we know that? Because the euro is getting stronger against the dollar. You’d normally expect money printing to do the opposite, but in this particular case, it’s seen as shoring up the case for the euro staying together. In effect, the “breakup discount” is diminishing as a result of the money printing.
In turn, that’s also good for risk appetite. A stronger dollar effectively means tighter global monetary policy. If markets are to continue to rise – if we’re to get the melt-up that we’re all secretly hoping for – then the US dollar needs to get weaker.
Now, don’t get me wrong. Markets have come a long way in a short while and maybe they need a correction or a breather. But unless you’re a short-term trader (and if you are, I can’t help you much), then it doesn’t matter.
What’s more important is that this is another big step away from the deflationary scenario and towards the inflationary one.
That will bring its own problems of course. In fact, I’ll be writing about those for the next issue of MoneyWeek, coming up next Friday. If you’re not already a subscriber, snap up that six free issues deal now.
