The two-year-old euro crisis is ultimately an identity crisis that threatens to jeopardize Europe’s geopolitical relevance in the 21st century. In the current issue of “Perspectives”, Burkhard P. Varnholt, Chief Investment Officer of Bank Sarasin & Co. Ltd, examines the historical and economic development of Europe and draws conclusions from the ongoing euro crisis from the standpoint of the economy as well as investors. He sees a medium-term transformation from a confederation of states into a liberal constitutional federal state as being the only solution for Europe. For that to happen, the currency union must survive intact and there must be greater willingness on the part of the traditional surplus countries to run deficits.
European economic and monetary union was originally pursued with peacekeeping and reconstruction in mind, but today those issues no longer play a central role for most Europeans. Instead, Europe now has to address a new challenge: either it will resolve to forge a much stronger political integration that will transform Europe from a confederation of free states into a constitutional federal state, or it will have to accept fading into geopolitical irrelevance. The latter option would hamper Europe’s access to core resources such as energy, food and water, and it would significantly increase funding and capital costs. Faced with these prospects, Europe will have to take decisive steps over the next 12 months.
Greater willingness to run deficits is called for
The popular opinion that the “irresponsible” deficit-wracked Mediterranean countries should be forced to undertake drastic policy reforms is wrong, for one reason because the fragile economic policy situation has been caused not just by soaring sovereign debt, but in many cases also by rising private debt. Moreover, the euro-zone countries cannot all pursue austerity policies at the same time without triggering a recession. This means that a policy of austerity in the deficit countries can only be successful if it is cushioned by a heightened willingness on the part of the traditional surplus countries to run deficits.
Burkhard P. Varnholt, Chief Investment Officer of Bank Sarasin & Co. Ltd
“It’s a popular misconception that creditors and debtors have separate economic fates. If I lend someone a million euros and that borrower goes bankrupt, that’s the latest point at which his problem starts to become mine as well. So the fates of the European deficit and surplus countries are actually two sides of the same coin.”
The currency union must survive
In order to enable European politicians to address the necessary task of plotting a longer-term course forward for the euro zone, it is first and foremost crucial that the currency union survive intact. But the problem facing the European Monetary Union lies precisely in the fact that its 17 member states no longer have recourse to their own central banks to obtain stabilizing backing of their debt. This is the key reason why a country like Spain, which has less sovereign debt and a smaller deficit than the UK, pays much higher interest on borrowings than the UK does. The simple difference lies in the fact that the UK has its own central bank, whereas Spain no longer does.
Long-term consequences for investors
There will still be some anxious moments to overcome on the road toward a federal European state. These considerations give rise to three long-term consequences for investors. First, hyper-nervous politicians are one of the few “quasi-sureties” that investors will be able to count on in the years ahead. This simple reason alone means that “risk-free” interest rates in the euro zone will probably continue to drift toward zero for much longer than most yield-seeking investors would like. Second, the valuation gap between stocks and government bonds is likely to close in the years ahead – and this will probably already trigger a strong rally on the stock markets during the next twelve months. And third, sustainability-oriented asset management will become an increasingly important determinant of the risk-adjusted performance of fixed-income and equity portfolios. In the final analysis, this trend traces back to the crucial importance of sustainable development to the rise and fall of nations and thus the economy. At the same time, the megatrend toward sustainable asset management will also help to push principles of corporate governance in this direction, especially at publicly traded companies.