Let me tell you a story about the “haves” ……
We all know them. Love them or hate them, please give a warm welcome to: The Haves and The Have-Nots. Boy, doesn’t that conjure up feelings? It’s like the purple Schwinn 10-speed bike you hoped Santa would bring you for Christmas, that your cousin got from Santa two years before you had to pay for your own Western Flyer 10-speed bike from Western Auto; or, why do your friends get to have all the fun and watch TV on school nights, and you have to hear about it in bits and pieces the next morning from your friends? The Haves generally earned what they had through hard work, inheritance, or maybe just being in the right place at the right time. The Have-Nots, who maybe lacked the genes, education, and/or work ethic, inherited it and spent it all, or were in the wrong place at the wrong time.
The Eurozone Crisis is an amalgamation of a lot of mini-crises that has put the Eurozone countries into a precarious spot. Europe’s vision for a single currency dates back to World War II. The Eurozone is an economic and monetary union (EMU) of 17 European Union (EU) member states that have adopted the euro (€) as its common currency. The euro officially began trading on January 1, 1999. To become a member of the Eurozone, a country had to pass a series of tests over a number of years, very similar to the way an apprentice becomes a journeyman. In essence, each member had to show that it could “run with the big dogs.” With minimal exception, the requirements for joining the Eurozone were: the country’s inflation rate could be no more than 1.5% higher than the average of the three best performing (lowest inflation) member states; its government debt couldn’t exceed GDP by more than 60%; its government deficit couldn’t be more than 3% of GDP; and interest rates on long-term debt couldn’t be more than 2% higher than the average of the three best performing (lowest inflation) member states. The monetary policy for the zone was maintained by the European Central Bank (ECB), but the sovereignty to tax, spend, and borrow remained with each member country. With a single currency came more transparency; economies of scale were expected to create more competition and efficiencies; and, with fewer barriers, capital was expected to flow more easily and yield a lower cost of funds.
The roles of The Haves and The Have-Nots are played by France and Greece, respectively. Germany, The Have-Lots, is in another category altogether. Germany is the backbone of the Eurozone and without its participation there probably wouldn’t be a zone. It has by far the largest GDP in the zone and competes very well on a global basis. Its balance sheet is rock-solid, which doesn’t go unnoticed by the other members, particularly those that are very close to collapse. France is one of the stronger countries in the zone but still is a distant second to Germany. Its balance sheet is deteriorating, yet its leaders are still finding ways to increase benefits to the populace. France’s current leadership believes they can increase taxes beyond already high levels and still expect growth. They probably would like to be like the Have-Lots but don’t have the desire to have to work for it. They continue to push for more government involvement. Greece is a story unto itself — the weakest of all the members because it is burdened by government, fraud, inefficiencies, and heavy regulation, with corruption the likes not seen in any other developed country. Greece has borrowed like there is no tomorrow, with debt now exceeding its GDP by more than 200%.
The discussions about bailing out Greece have been very heated. Greece already received relief on some of its debt that called for a 50% reduction of the face amount of the bonds in exchange for a bond with a longer maturity and a lower interest rate. This relief only applied to bonds held by private investors (i.e., banks), which had bought the bonds as capital. When the bonds were marked down, it caused investing banks to be undercapitalized and thus in need of additional capital. However, this reduction/exchange wasn’t applied to debt in the hands of official creditors like the IMF and the ECB. Further, if members were allowed to fail or leave the Eurozone, it would create uncertainty among investors that may bring on higher interest rates or cost of capital. Greece has shown no restraint in its spending and borrowing, so it is understandable that Germany feels the way it does, especially since it has no control over Greece’s fiscal policy. It is a major weakness that a country is not required to give up some sovereignty as a member of the Eurozone.
Amidst all of this turmoil with no end in sight, why would anyone invest in companies domiciled in the Eurozone? With 2008 still fresh on investors’ minds, many are, understandably, extremely sensitive to investment risk; thus high volatility will likely remain. In a recent commentary on European stocks, Joe Davis, Vanguard’s chief economist, said:
Ten years from now, if analysts were to ask, “What were the greatest investments of the past decade?” it wouldn’t surprise me if European stocks were among the top-performing regions of the world. Regardless, equity investors must have a long-term orientation and “look through” the current negative and troubling headlines. It’s in highly volatile periods such as this that long-term investors could be compensated for bearing such equity risk.