Fund selector: Euro’s plots and twists

We had emerging market inflation, the Arab Spring, the Japanese earthquake, ECB policy errors, the Portuguese bailout, Greece’s second bailout, the US debt ceiling fiasco and subsequent downgrading, flights to safe haven assets, further rounds of quantitative easing, soaring Italian and Spanish bond yields and the demise of incumbent European governments.

Possibly the most striking thing about 2011 was the realisation for investors that political risks are not limited to developing countries. The downgrading of the US credit rating from triple-A by S&P brought this fact into focus.

France is now firmly in the spotlight, with its cherished triple-A status in tatters. Where next? Germany or the UK?

Given the eurozone’s monopolistic grasp over media and Germany’s central role, it is interesting to compare the eurozone crisis to the grammatical construction of a German sentence. It is often said that it is almost impossible to interrupt a German. This is because you never know what they are going to say until the end of the sentence, as only then do they reveal the critical action verb. As the world waited with bated breath for Angela Merkel to finally finish her sentence at the December 9 summit, as before, she failed to deliver the required action. It was David Cameron who took the headlines – from a UK perspective, at least.

One thing that struck me when looking back over the year was the relentless, negative nature of the rhetoric on Europe’s response to the crisis.

Policymakers (read Angela Merkel) have been endlessly criticised for providing a piecemeal solution. Phrases like ‘too little, too late’ or ones involving ‘cans’, ‘roads’ and ‘kicking’ spring to mind.

Yet few have stopped to consider that Germany’s actions are entirely rational. Of course we all understand that Angela Merkel is walking a political tightrope, balancing the fortunes of Europe on one hand against those of her German electorate on the other. However, many have still accused her of inaction and ‘being caught in the headlights’. This underestimates her shrewdness.

One might argue she is playing a delicate, albeit extremely high stakes, game with her fellow eurozone members, her voting public and the markets. Playing her hand strategically, she is mindful not to simply write a blank cheque and underwrite the more profligate eurozone members.

Instead she demands the sensible German traits of fiscal orthodoxy and financial conservatism to be written into struggling members’ constitutions, before guaranteeing the currency bloc’s future via effective fiscal union – whichever form that takes. Should she navigate a successful path, she will extract the best possible solution for Germany while also saving the euro. That is her rational game plan.

Another factor to consider is that a healthy, functioning or merely existent eurozone is of global strategic interests. With a population of approximately 400m, Europe’s global importance speaks for itself. As an export market it offers vast opportunities and therefore US and Chinese support for the region via International Monetary Fund funding is not an unreasonable request from flailing European politicians.