European stocks offer value amid crisis
When one contemplates the effect of the Greek crisis on financial markets, it is tempting to recall the words of Neville Chamberlain.
“How horrible, fantastic, incredible it is that we should be digging trenches and trying on gas masks here because of a quarrel in a far-away country between people of whom we know nothing,” the UK prime minister said, during the UK’s failed attempt to prevent a second world war breaking out in continental Europe.
Greece is a very small economy, only roughly 2 per cent of euro area economic output. As Jim O’Neill, chairman of Goldman Sachs Asset Management, is fond of saying, China creates economic growth the size of Greek GDP several times a year. But when David Zervos, strategist at investment bank Jefferies, visited Beijing recently, he found that 80 per cent of his time was devoted to answering questions about the impact of a Greek exit from the euro.
The European stockmarket looks a lot less vulnerable than it did in 2008.
The panic may relate to the events of 2007 and 2008, when the financial crisis started. Investors were told that the subprime mortgage crisis would have a very limited impact and regulators assumed that the market could cope with the collapse of Lehman Brothers because it was very well prepared.
Both assessments turned out to be entirely wrong. Subprime debt had been sliced and diced so efficiently that no one knew how exposed banks were to the problem, so they played it safe and avoided all banks. Lehman’s collapse made the problem seem even worse.
The worry this time is that a Greek exit from the euro will destroy the belief that the currency is permanent. Greek depositors will find their bank accounts redenominated in drachma, losing perhaps 50 per cent of their value.
Portuguese and (worse) Spanish depositors may fear that the same thing will happen to them. They may choose to move their money to French and German banks to avoid the same fate.
Similarly, international investors may follow the same reasoning. At a recent Economist conference Olivier Sarkozy, the former French president’s brother and head of global financial services at private equity group Carlyle, outlined the worries about buying a European company – you might invest in euros but get paid back in a devalued currency.
We are already seeing a credit crunch – loans to Portuguese non-financial companies fell 5 per cent between the first quarters of 2011 and 2012.
What about the effect on Greece? Currency devaluation is not always a terrible thing. Those countries that were first to leave the gold standard in the 1930s saw their economies recover quickest. Britain’s departure from the Exchange Rate Mechanism in 1992 proved a blessing in disguise. A devaluation is like taking a wage cut in order to keep your job. It is a fall in your standard of living but it might be the only option.
A country’s exports become more attractive to foreigners but its import bill rises. Oil will still be priced in dollars and the Greeks will be paying in devalued drachmas. Workers may respond to these higher prices by demanding higher wages, and all the competitive gain can quickly be inflated away.