The unfolding covid-19 pandemic could resolve a contradiction which is deeply imbedded within the eurozone – for, in times of stress, a currency union does not compare favourably with nation state. A country is based on a covenant through which a single currency is shared to the benefit of all not the few. In a country, a shared currency is to the benefit of the strong, in effect stopping the ability of the weak to regain competitiveness through devaluing “their” currency. The stronger parts of the country get mightier but agree to compensate the poorer parts through transfers of wealth from rich to poor. This unity does not just stop at the sharing of wealth. When a crisis hits, the response to that crisis is done in common with mutual sharing of resources and efforts in combating the common threat.
Historically, common currencies not backed by a form of government held in common are rare and have been short lived. This is simply because this “covenant” between the strong and the weak exists only in a very diluted form.
This difference between a country and currency area has been shown in the response to this rapidly growing pandemic. All important decisions on how to combat this illness have been taken by each nation state, with little thought about the impact on bordering neighbours. Countries across the eurozone have shut borders and banned the export of medical supplies and equipment to each other. As the pandemic took hold in France, the largely unaffected central parts of the country did not shut their borders to Paris and other more heavily impacted areas of the country. It did not hoard ventilators and ban the export of face masks beyond the “Macif Central”. But that is exactly what has happened in the rest of the eurozone, with Italy reliant on shipments of medical aid from China and Russia rather than the countries with which it shares a currency.
The fact that the eurozone is not a deep mutual commitment between countries resembling a covenant has been painfully laid bare by this dis-jointed reaction to covid-19. But this should also be put into the context of the decade long evidence that the eurozone is not working for its weakest members. The same process of the strong getting stronger in the middle of a single currency has been painfully evident in the ever falling size of the Italian manufacturing base compared to its larger northern neighbour beyond the Alps. What has been lacking has been a common tax base to help redistribute the wealth of those who win from a single currency to those who do not.
A global pandemic will always be tragic, and as we can see it unfolding also economically devastating. There is never a “good” time for it to emerge and spread. But over a decade on from the global financial crisis, almost all European states still can show deep scars on their balance sheets from the efforts to survive that seismic event in financial markets. Therefore, the timing of this outbreak is particularly bad. Some commentators are starting to make a stab at how expensive this latest crisis will be for different states. We have seen figures ranging from 15% to 50% of GDP. If Italy, in particular, gets anywhere close to the upper end of these estimates, then Italian finances become the new Greece. A decade of austerity has contributed in large part to the rise of populism in Italy. If there is a need to impose ever harsher austerity when this pandemic dies down, in line with an even larger debt pile, it is hard to imagine that an already rebellious Italian electorate would accept it.
There are loud calls for what was meant to be a covenant when the euro was launched, this currency acting as a sign of deep mutual commitment, to become one in reality. At the very least, a sign of this commitment should take the form of “corona-bonds”, or debt held in common by the eurozone. But there are calls for more. Some form of debt monetisation, by which the European Central Bank directly finances government expenditure through this crisis.
This latter idea is both inflationary and rubs up against a profound German phobia brought about by the hyper-inflation experienced in the Weimar republic in the early 1920s. Hyper-inflation brought about exactly by such money printing to finance state spending. But whatever shape debt relief comes, for Italy, the Eurozone has shaped up to be not so much a covenant of mutual obligation as a commercial contract signed on very bad terms. There is only so long the temptation to break the clauses of an onerous contract can be resisted.
These concerns are reflected in the equity weightings in our global equity portfolios, with an underweight in Continental European equities versus other parts of the world. As we look at these rapid pull-backs in markets, the length of time of this crisis is yet unknown. But pass it will and so we continue to look for the opportunities such a dramatic event can bring. However, in looking at potential investments, we remain mindful of the strains such an event could bring to our Continental European holdings and so maintain our underweight.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate. Currency fluctuations can also affect performance.
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CLI01592 Expiry 31/03/2021