A look at the EU and real assets

The new political reality

The coalition of the left-wing Syriza party with the right-wing Independent Greeks should surprise no one, whatever the shock to the Euro-elite in Brussels. Over the past five years alone, Greece has lost more than a quarter of a million companies, suffered a 50 per cent drop in family spending, and currently has adult unemployment of 25 per cent and youth unemployment of 50 per cent, while its education, social and health services have been all but destroyed. Both parties are determined to change the wrong-headed policies of the Troika.

Deflation within the eurozone has been brought about by the policies of the EU. Or perhaps lack of policy is the more appropriate term. Although it is difficult to coordinate the activities of 28 different – and differing – countries, nevertheless the paucity of imagination displayed by European national leaders after the banking crisis of 2008 is remarkable. But the worst failing has been that of Germany, which, having achieved its century-old desire to be the European hegemon has no idea of what leadership entails.

Keynes identified that persistent creditor countries constituted an equal danger to world equilibrium as debtors and, although American policy makers did not accept his arguments at the 1944 Bretton Woods conference that set up the post-war financial structure, they did in 1947 with the very practical and generous Marshall Plan. This relieved European economies of the dollar [liquidity] shortage, and was the foundation stone of European economic recovery. Then, in 1953, the London Conference resolved the problem of German indebtedness by writing off the greater part of it.

The German economic miracle

Not surprisingly the Germans of that generation liked to think that their economic success was entirely due to their own efforts. Actually it was due to the generosity of their allies – and the Cold War – and this is what Germans now need to recall in their turn with the Mediterranean members of the EU.

Germany is an exporting country that needs Europe as a free trade partner, probably more than Europe needs Germany as a supplier; either Germany must rebalance its economy away from exporting 50 per cent of its GDP – as China is trying to do – or it must find a way of recycling its surpluses. Either Germans must consume and import more, or invest and lend more overseas. This needs to be done more intelligently than shown by their banks both in their lending to American property bonds before the financial crisis, or to Greece.

Clientelism and corruption

Greek problems are unique to Greece – as are those of all EU members, such as Italy, Spain and France – but the design of the eurozone allows no room for complexity. The post-war anti-Nazi resistance in Greece soon became a victim of the looming Cold War, and a venomous struggle between right and left, which ended with the Colonels’ coup d’état in 1967.

For the forty years since the fall of the Colonels, and in an attempt to heal social wounds, both conservative and socialist parties used patronage to create state jobs for their supporters, so blurring the distinction between state and party. This is known as ‘clientelism’, and is so embedded in the Greek state that the risk is that Syriza, rather than its promised reform, will simply copy the ‘clientelism’ of the defeated parties. As much as anything else, it was this ‘clientelist’ structure that prevented either party from ‘shrinking the state’ under Troika rules.

The new coalition claims it wants to finish this system of patronage, and free the entrepreneurial spirits of the Greeks. This does not necessarily entail a writing off of various debts, originally accrued by greedy and stupid banks and then taken over by EU states embarrassed by the bankruptcy of these self-same banks, but something at which Brussels is very good: an extension of maturities, reduction of rates payable and an “extend and pretend” policy that will give the Greek as well as the European economy a chance to grow.

But the real answer, which might come from Syriza’s suggested debt conference [based on the 1953 London model] is writing off of not just Greek but many other EU debts. The level of state and bank indebtedness throughout Europe is a weight on both economic expectations and hope, and must be recognised if Europe’s deflationary spiral is to be halted.

What course for investors?

This European economic disaster has taken place despite the evidence of the now 20-year old Japanese deflation, and despite the founding purpose of the EU – together we are stronger and richer – as expressed in its anthem ‘the ode to joy’. The new QE policy, which, under German pressure, insists that each country is responsible for its own debts, shows the hollowness of that promise.

Unless German political leaders can find the leadership required to persuade not only the German public, but also most of the other Northern European nations, that Greece needs help to restart its economy, then the existing deflation will continue. QE will not help; as already proved by US experience, all it does is to inflate asset values. The so-called ‘trickle down’ theory of economic growth does not work when the world lacks demand, and technological change is making the rich richer and the poor poorer.

But there is another lesson for investors from German history. The roller-coaster ride of the 1920s wiped out most German private wealth, except for those brave enough to invest in real assets. These could have been gold and diamonds, or even property, but have only worked over the very long term. In uncertain financial times, such valuables lack liquidity, and liquidity is what is needed when cash is required.

So the only real assets in such times are those that produce a regular and reasonably certain income – that is, for most of us, an equity share in a quoted business.

Most of us wait too long, hoping to avoid such decisions, fearful of selling government bonds or giving up cash. But US investors who bought AT&T, or GE in 1932, despite yet another slide in prices the following year, ended up very rich at end of the war.

And likewise German shareholders in such buttresses of the German war machine as Siemens, Mercedes and Deutsche Bank also did very well, despite horrendous wartime destruction; their fellow citizens, who hung on to their bonds, ended up with nothing.

The problem, of course, is identifying which businesses will survive in such chaotic political and economic conditions. It is not sufficient to buy a fund with a particular index as its benchmark: who knows which index or market will do well, and most funds in recent years have struggled to match their chosen benchmark.

What investors need are survival values. These are mostly found in investment trusts, with corporate structures that enabled them to survive the far-from-tranquil 20th century.

No European investor should assume that these problems will be easily or quickly resolved, nor that economic growth will return before the decade is out. Investment must be brave and bold, but practical, and how to square that circle will be the subject of next month’s Investment Spotlight.