Read any major newspaper and you’ll find a plethora of worrisome stories: European bond yields hitting new highs as banks and others sell off their Greek, Portuguese, Dutch, Spanish and Italian bonds; the decline of the value of the Euro against other currencies; and stocks tumbling on either side of the Atlantic. You could be driven to the conclusion that global finance is due to tumble into a bottomless abyss.
For now, the European bank and national debt crisis looks like a game of whack-a-mole. Bash any one problem into place and another pops up. Yet after all the tragedies play out, there will still be currencies that measure prices, there will still be land supporting crops and rents, and there will still be manufacturers turning out things for which people are willing to pay.
The problems of the Euro are structural, for in creating the currency and the European Central Bank to manage monetary policy, the European Union (EU) devised an abnormal regional economy. No country since ancient times — the Roman empire is a good example — has run without some sort of tax policy. The policies may have been predatory, corrupt, badly administered or even the foundations for revolution, but they served the needs of the state at the moment.
States want money to pay their bills. And the EU has no tax policy worthy of the name. It has no way to pay its bills as a regional entity. So the Euro is supported by a central bank with a single mandate to fight inflation — not even to manage stimulus programs — and a nonexistent regional tax authority. This is more than odd, more than a diversion from history. It is nuts.
The Euro in jeopardy
Europe faces the loss of its currency if Greece pulls out and Germany declines to pay the rising costs of keeping Spain, Portugal and maybe Italy in the currency group.
Without the Euro, the smaller economies of Europe would have a hard time floating their bonds at maybe even single digit interest rates. Their currencies would depreciate against those of Germany and France, perhaps the Netherlands and, of course, the United Kingdom which is part of the EU but not a Euro-user.
Without the Euro, the peripheral states would find it far more costly to sell bonds to finance national debt. If it’s tough now, it would be far harder to work global bond markets post-Euro. Companies with the scale and heft to be able to sell bonds in non-Euro countries would find their borrowing rates up and the costs of selling stocks even higher. Without the ease of trade that a single currency makes possible, companies in countries that go off the Euro would have to pay a good deal more interest.
There are alternatives to the dissolution of the Euro. A country, say Italy, could peg its currency, call it the New Lira, to the British pound or the new German Mark. The country could set a value and lock in terms of trade with the country whose currency is the anchor for the peg. That would make it a snap for wine merchants in London to price Italian chiantis and a cinch to pay for them. But outside of trade with the U.K., the problem of variable pricing would be as bad as with no Euro at all.
If the single peg did not work well, as it would not for a nation like France that sells large parts of its mainly agricultural products in many nations, then trade could be priced in a basket of currencies — perhaps rubles and pounds, American dollars and Japanese yen. For daily trade and international shipping, it would be tough, though spot prices would be generated and doubtless available on the web every day. But how about pricing an insurance contract? Would today’s currency mix reflect the cost of university education for an insured’s children a decade or two after his death? Banks could add currency insurance to their prices and would doubtless love to do so. That would drive up the cost of trade, of insurance, and even the cost of a bushel of wheat to be delivered to another country.
Another solution: satisfy creditors by selling them national assets. Land, for example, could be priced and sold to a creditor. A think tank in Athens, the Institute for Strategic and Development Studies, has offered the opinion that the national government of Greece could sell up to $280 billion worth of land and buildings (that’s in Canadian dollars). There is precedent for such a move, notes a recent edition of The Economist, the British financial weekly. One of the most famous was the U.S. purchase of the Louisiana Territory from France in 1803 for $15 million ($312 million in 2011 dollars). That chunk, 2.14 million square kilometres, includes most of the central United States.
Selling off Greek Islands that would become German or Chinese would probably doom the government that tried it. But selling not sovereignty, just title, might do. And private parties that cannot buy sovereignty but would be happy to have title to their own little islands might go for it. The result in balance of payments cash transfers and debt alleviation would be the same.
The costs of abandoning the simple idea of a single currency are so large, the alternatives so peculiar and the costs of replacement so large, that the wise minds of European finance are bound to find a solution to their difficulties. The only remaining question is how long it will take.
The road to stabilization
The European debt crisis will find a stability point when Germany and France, with the potential assistance of China, inject enough money into afflicted national economies to stabilize them. What governments may not do, individual investors could do. After all, if it’s possible to buy, say, a Greek shipping line for a fraction of its real worth, you can bet it will happen. Even long term conditions of instability breed the foundations of return to stability.
The process of a return to stabilized interest rates will take months, perhaps the better part of a year. In the meantime, there will be deleveraging of industrial economies as output falls in the face of higher financing costs. Inflation will decline. We may see lower energy prices as the world economy contracts. Food prices could soften or even decline. Those forces will set the stage for a return to normalcy in bonds. That will bring down interest rates.
Good deals and security
Is it time to start buying Spanish and Italian state bonds at seven per cent yields? That’s worth a look. How about senior bonds from giant American investment banks at similar rates? Greek bonds at yields of 120 per cent? Probably not, for the problems apparent may worsen before they get better. But some bonds still offer good deals and security.
Canadian corporate bonds from major regulated utilities in the single A to BBB+ ratings range offer returns of three to five percent for 10 years. That is a good return with a predictable return of principal. Bond repayments and recognition of return can be timed to the day. There is no currency risk in a Canadian corporate bond payable in loonies. Finally, provincial regulation of issuing utilities ensures that the companies will be able to pay their dividends.
Canadian corporate bonds have largely been ignored by the rest of the world, but they are relatively safe, easy to buy, easy to trade, and easy to follow. That’s a pretty good security blanket in a period of global bond turmoil. †