The European Union has agreed a deal. I’m not sure that it’ll inspire any hit musicals 200 years from now (although now that you mention it, “Whatever it takes” is quite a promising song title). But it does remove another potential roadblock to the ongoing rally.
Here’s what happened, and why it matters.
It’s not an amazing deal, but it is a deal
The European Union has been trying to agree a deal to raise funds to help the countries worst-hit by coronavirus. It’s spent the last four days hammering it out. And now it’s agreed on a deal.
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As usual, the issue was that the countries that put the most in need to make sure that their voters don’t feel they’re being ripped off. And the countries that take the most out need to make sure that their voters don’t feel that, as a result, they’re handing over too much sovereignty (over and above what they already gave up by losing their national currencies).
So one side doesn’t want to give handouts without having tough conditions attached. This side was embodied on this occasion by the Frugal Five ( (they were the Frugal Four – Austria, the Netherlands, Denmark and Sweden – but then Finland joined on tambourine). The other side – best represented by Italy – wants handouts without any conditions.
The total deal is worth €750bn. Originally, €500bn was to be grants, and €250bn loans. The compromise is that it's now €390bn grants, with the rest in loans.
Meanwhile, the “Frugals” also get bigger budget rebates. France had hoped to scrap these altogether in the wake of Brexit. But it turns out that they should in fact be grateful for Margaret Thatcher’s legacy, as the rebate mechanism gives the Frugals a handy bone to toss to their voters, which in turn enabled the whole deal in the first place.
So it’s a deal, but it’s no better than markets had expected. And it’s frankly not a lot of money either. And it all needs to be approved by national parliaments. But it’s enough to do what it needed to do.
What really matters here is that the deal allows the European Commission itself to borrow a significant sum of money and hand it out to member states. In other words, whether you give it that name or not, you’re looking at collectively-issued debt. There might not be much of it, but once you’ve done it once, you can do it again.
And that’s significant to investors for one reason.
Why this matters to investors
Park the politics for a minute. I don’t care if you voted Leave or Remain. I don’t care if you think the EU is the best thing since sliced bread, a monstrous anti-democratic Trojan horse precision-designed to enable corporatism/socialist takeover, or a reasonably sensible free trade zone spoiled by overweening ambitions of federalism.
There’s only one reason why this matters for us as investors. As I’ve been saying for months, this kicks the most dangerous global financial tail risk – a deflationary eurozone breakup – into the long, long grass.
Ultimately, politicians – actually, scratch that, people in general – will always take the path of least resistance. That’s why a central bank that can print money at will to avoid difficult political decisions will always be leaned on to do so.
Look at this deal – how do the Frugal Five justify this to their electorates? Like I said, they get to talk up their big rebates. And how do the countries that spend more get to justify the deal? Well, they basically got what they wanted.
And how do you pay for all this in the long run? The biggest obstacle during the Greek crisis was the fact that the European Central Bank (ECB) couldn’t just print money to make it go away.
We are long past that now. In future negotiations, the ECB is hanging about at the back, ready to print the money needed. You can keep everyone just about happy enough (or at least, not quite discontented enough) so that the whole thing stays on the road for a good while longer.
In the longer run, you get a shift whereby the eurozone specifically swings in the direction of the “southern” countries (by which I mean the likes of Italy and the countries that want more spending – France is arguably one too). It’s harder for any “exit” movements to arise in those countries if they’re mostly getting what they want.
In the end, that means that the people who’ll most likely leave are the wealthier nations – Germany maybe, or the Frugals. But then again, from their point of view, who wants to be the next Britain? Especially if you’re in the eurozone. Who wants to take on the slings and arrows of being the horrible country who broke up the club?
So that’s all you really need to take from this as an investor. Clearly the unexpected can and does happen. But compared to even a year ago, and certainly five years ago, the risk of a disorderly eurozone collapse is now parked for quite some time. It’s a long way down the worry list.
Of course, the market is increasingly pricing this in, in any case. This is just confirmation of what markets expected.
It’s possible however, that European stocks might start to catch-up a bit with the US, now that the break-up premium is shrinking, and the US dollar is getting weaker. I’d take a look at your exposure to the region and consider whether you want to increase it or not.
We’ll have more on all this in the next issue of MoneyWeek magazine, out on Friday. If you haven’t already subscribed, get your first six issues free here.
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