Can the euro survive democracy?

ING IM’s Ad van Tiggelen believes 2011 may turn out to be ‘the year of truth’ for the eurozone.


Policy makers appear determined to keep the euro family together, and this is understandable from a financial risk/return perspective. An uncontrolled default of Greece could have grave repercussions for the eurozone as a whole. Policy makers are aware of this, but the mind gap between them and their voters is growing.

Most major countries have parliamentary elections in 2012 and 2013. So in the end, the future of the eurozone will be largely determined by its voters. And in an increasingly complex financial world, where voters have little knowledge about issues like ‘short selling’, ‘cross-country exposure’ or ‘credit default swaps’, one has to wonder: can the euro survive democracy?
If Greece is allowed to (partially) default now, the risk of a confidence crisis and contagion is substantial. The debt of other weak eurozone countries may fall victim to speculators and the market for credit default swaps (insurance against defaults) could experience difficulties again, as was the case after the Lehman collapse in 2008. In this scenario, banks, insurers and pension funds in all eurozone countries could face heavy write-offs.
Regretfully, this is not a scenario which is sufficiently communicated to, or understood by, most eurozone voters. In the north there is growing popular aversion against ‘subsidising’ the south, and in the south there is growing popular aversion against implementing austerity packages. Sentiment overrules rationality.

The Greek people who now protest against necessary austerity measures do not realize that Greece could become a third world country if it has to revert to the drachma. The painful truth is that we all live in an ageing society which has become part of a competitive globalised world. Cold Darwinism is increasingly casting its shadow over our cosy post-war welfare society.

Fiscal union?

Of course, the real tragedy in the eurozone is that on the area-wide level there is no acute fiscal problem at all! The EMU wide budget deficit last year came out at 6%, which is much lower than in the US and the UK. Also the eurozone debt to GDP ratio is ‘only’ 85%, not overly worrisome in comparison to other developed nations. The problem is that the fiscal capacity is not being shared efficiently across member states. This will have to be corrected in the coming years, if the eurozone is to survive in its current form.
In this respect, 2011 may become the year of truth, as voters will have to be somehow convinced about the long term rationality of the current actions by the EU, ECB and IMF. If they do not (want to) get that message, they may take matters in their own hand by voting for anti-euro and anti-austerity politicians in the coming years.

Politicians are now buying time to communicate this message and to push for massive Greek asset sales. They are also buying time to ensure that a potential debt-restructuring or even a possible default happens as much as possible in a risk-controlled fashion.
All of this means that the euro crisis will remain a risk factor for investors for some time to come. This is a pity, because European equities have a lot going for them, certainly in comparison to the low but safe 3% yield on German Bunds.

Equities are quite cheap, pay attractive dividends and the companies have healthy balance sheets. Having said this, the uncertainty surrounding the euro crisis justifies to some extent the lower than usual valuation, especially for the more domestically oriented companies.



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