29 December 2016
The euro will celebrate its 15th anniversary in a few days time. The first coins and banknotes were issued to the public and exchanged on 1 January 2002. Strictly speaking, the European single currency celebrated this anniversary three years ago, as the euro was introduced as book money at the beginning of 1999. However, there is no doubt that the more emotive event was the physical launch of the new currency, making this an appropriate point for some reflection and anticipation.
The 15-year wedding anniversary is referred to as the crystal anniversary. Many investors may consider this to be an apt analogy since the euro currently appears to be extremely fragile. Very few market participants expect the euro to be celebrating its silver anniversary in ten years’ time.
A political decision…
It is generally not appreciated that the introduction of the euro was almost as much a political decision as it was a purely economic one from the very beginning. The eurozone is, of course, far from being the ideal landscape to host a single currency; the individual national economies are too heterogeneous, the economic cycles too asymmetrical and the factor mobility too low. Admittedly, this means that it is questionable whether the economic benefits will outweigh the drawbacks at any time. Nevertheless, the origins of the euro can be traced right back to the concept of European integration and the creation of a European market at the beginning of the seventies. The public acceptance of the single-currency project in some countries was very low (e.g. below 40 percent in Germany, where the former Federal Chancellor Helmut Kohl exclaimed that he was acting like a dictator in this respect). However, tolerance gradually increased in subsequent years and remains high, despite some prominent public protests.
An economic convergence of countries within the eurozone is essential for the long-term survival of the euro. The stability and growth pact of Maastricht is clearly insufficient to achieve this objective. In fact, it can be argued, at least in recent years, that the Maastricht criteria has contributed to the eurozone crisis rather than constrained it. Consequently, it is logical that the “no-bailout” clause was effectively dropped with the introduction of the European Stability Mechanism and the implementation of the Eurozone equivalent of quantitative easing. Other important amendments have also been made: Through the banking union, approved in 2014, the supervision of banks (‘Single Supervisory Mechanism’) and the bank liquidation process (‘Single Resolution Mechanism’) have been standardised (but unfortunately not the deposit insurance guidelines) across the eurozone.
More anniversaries to come…
The political risks in relation to the presidential elections in France must not be underestimated, especially if political forces openly opposed to continued Eurozone membership gain power in the coming year. However, the example of Greece demonstrates that the election of a euro-sceptic party does not automatically lead to a eurozone exit. This reflects an understanding that any defection by a member state would make its economic situation significantly worse not better, at least in the short term. Consequently, we can assume that the euro will have many more anniversaries to celebrate.
What does this mean for the investor? The euro is considerably undervalued when measured in terms of purchasing power parity. Aside from the increasing interest rate differential with the US and the still unresolved issue of bad loans on the balance sheets of major European banks, anticipated political risks are also responsible for this development. Given the fact that some of the negative developments are already priced in and the constant support afforded by a significantly positive current account, the likelihood of a recovery in the exchange rate is comparable to that of a further slump. A neutral position therefore seems appropriate at present.
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The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.