Appreciation of depreciation
Those familiar with macro-thematic investors will know they seek to identify major themes and interpret their impact on markets.
From the standpoint of such an investor, however, momentous recent economic and political developments should not in themselves constitute new themes. Instead, they serve as pointers to the evolution of existing themes.
For most people in this country, the latest UK inflation and GDP statistics felt more relevant than the economic and political news from mainland Europe. But in reality, the collapse of the Dutch government, the dramatic developments within the French general election campaign and the tragic unemployment data from Spain are hugely more important. They suggest to us that the demise of the eurozone has drawn much closer.
There was never electoral approval of either austerity or the sustained transfer of wealth from richer to poorer eurozone states – only grudging tolerance. Now even tolerance has vanished. At the heart of Spain’s predicament lies the politically unpalatable truth that neither austerity nor a transfer of wealth – nor even the purchase of Spain’s entire sovereign debt by the European Central Bank (ECB) – would render Spain’s labour force globally competitive.
Furthermore, even if Spain possessed appropriate economic structures and labour force skills, the adjustment in wages required would involve untenable levels of social and political stress. It seems to us that exit from the eurozone and the re-establishment of a national currency at an exchange rate set by the free market represent, ultimately, the only plausibly sustainable solution.
In the short term, such an exit would severely damage sentiment among investors. However, if one assumes the ECB would act effectively to protect the European financial system from collapse (possibly by reactivating its long-term refinancing operation and securities markets programme without limit), it is not obvious to us why longer term global investors should be disadvantaged.
There are many well capitalised banks outside the eurozone that can provide international commercial banking services. Multinational corporations have long since taken the necessary actions to minimise their exposure to a break up of the eurozone. Write-downs of manufacturing facilities in countries whose currencies devalued would, over the longer term, be offset by cheaper exports that are priced more attractively in the devalued currency.
Meanwhile, in a globalised and openly competitive world, although some industries may enjoy advantages in terms of pricing by dint of their rare skills and/or resources, the cost of production will, over the long term, trend roughly towards parity, adjusted for the relevant range of risks.