It might look rather odd. I am not feeling very positive about the Euro, to be frank, but I just topped up another $2,000 into my portfolio. The main reason has to do with this so-called contagion effect and the fallout. Do I think that Europe is headed for more trouble, yes, unfortunately I do. But will Asia markets and high yield bonds come out of this well when the dust settles over there in Europe? Yes they would.
Firstly, let’s touch on Europe. Despite committing over 1 trillion US dollars to support the Euro, it is still coming under attack and has slid back to the levels before the 1 trillion dollar measures were announced. And it will continue to come under attack. The EC had two very stark choices before they announced the 1 billion dollar measures when the Euro came under pressure, would they stand together with Greece and the Euro, or would they go their separate ways, let the Euro fall apart and cut Greece loose. They choose the former, to stand together, and support Greece (and by default the Euro).
The problem with that, is that the market knows that such a choice is going to be a really tough road. And so, currency speculators, hedge funds will all continue to attack the Euro at every sign of weakness. Why is it so tough? Because while its easy to announce big measures, throw money at a problem, if the root of the problem is not solved, it will just get bigger and bigger.
Is it really so terrible for a country to go bankrupt? It’s not. Many countries have defaulted on their debts, had to go to the IMF for money, and forced to swallow bitter pills to turn themselves around. Some of the Asian countries had to go through this during the Asian financial crisis back in 1997/98. But while some had to go to the IMF, others didn’t, and since there wasn’t an “Asian Commission” to bail out any Asian country, whatever bitter pills that had to be taken, were taken. The more affected countries saw their currencies crash, but as a result it made their exports much cheaper, and the combination of the financial discipline plus their cheaper currencies caused most Asian countries to bounce back in a big way in the corresponding recovery. Most significantly, while the entire Asia was sold down, (even Singapore then), the bounce back was sharp and fast, particularly for countries which had strong reserves and whose currencies was never really in serious trouble (like the Singapore dollar).
But in Europe, we have over 20 countries of different backgrounds, politics and finances linked together by one single currency – the Euro. Its worked for the last ten years, but now the cracks are obvious. By refusing to cut Greece loose, and standing together, the EC has effectively made the Euro vulnerable to future attacks linked to any weakness in the weakest of their countries. If Greece shows any weakness in overcoming whatever tough financial measures it needs to take to address its huge debt, the Euro will come under attack as a result, and other countries like Portugal, Spain will all come under increasing scrutiny.
Trying to support a currency without addressing the underlying weakness has always been a futile problem. 1 trillion might be a lot of money, but hedge funds collectively could probably match that and more if they smelt blood (or weakness in this case). Even big countries like UK have learnt the hard way that if they try and prop up a currency against the rest of the market, you would probably need more money than you could cough up even if you are a central bank of a big rich country.
I sometimes wonder, if the EU had bitten the bullet, cut Greece loose from the Euro, what would have happened? There’s a difference between cutting a country from the Euro versus kicking it out of the EU. By cutting Greece loose, the EU would have shown that the Euro club is not for everyone, and even if you are part of the EU, if you don’t have the financial discipline to qualify, you are out. This would have immediately stopped the contagion then and there. The Euro would have been safe from further attacks because people knew that if countries didn’t make the cut, they would be kicked out. Greece could then be allowed to devalue their original currency and whether they manage to get their house in order sooner or later, at least the contagion would not spread.
Now unfortunately, by standing together, we have traded short term stability for long term weakness. The Euro is now only as strong as its weakest link. There will be a lot more pain going forward for the countries in the EU, and it remains to be seen if they have the political will to truly stand together. The bill has not truly been paid. When the richer member countries like Germany, France get the bill for what they have to come up with to save Greece, and the Euro, will their citizens balk? Honestly, I wouldn’t want to be holding EU country debt or much Euro now with all this uncertainty in the horizon.
So, why am I topping up more? Because even if I run through some of the worst case scenarios, I still arrive at the conclusion that Asia would come out of it alright, if not stronger. In particular ,if we are talking about currencies, its all relative. For the Euro to fall, it has to fall against something, be it the US dollar, the Yen, or other Asian currencies. Let’s not be afraid to look at extreme scenarios. Even if the Euro falls apart, would that immediately plunge Asia into a recession? It would not. There would be chaos in Europe as member countries have to go back to their original home currencies, but does it mean even Europe itself would fall into recession, much less Asia? The answer would be no.
Right now, there is weakness because the Euro is linking them all together. In an extreme scenario, if the Euro currency was dissolved, the EU would be seen as a grouping of countries each with their own strengths and weaknesses. The stronger member countries like France, Germany would not be placed in the same light as the likes of Greece in terms of financial strength. The initial chaos would be painful of course, but when the dust has settled, I do not see stronger countries like France, Germany weakening just because the Euro was dissolved. In fact, the Franc, the German mark would become more popular because they are seen as the stronger currencies in the region. Asia, itself would continue to export to Europe, and its currencies might actually rise against many European currencies. While some export markets might be affected, it would not be the entire region.
During the Asian financial crisis, while Asia countries were grappling with currency attacks, recession, the rest of the world continued to grow. The western countries hardly experienced much of a blip in their economies. I believe the same would happen even if the Euro could not be sustained and it fell apart. The Euro definitely does not have the status which the US dollar has. The world at this point can’t do without the USD, but it for sure can survive without the Euro, which didn’t even exist more than 10 years ago.
At this point though, I am glad I have switched out of financials, into Technology. There is too much ongoing potential problems at this stage and possible contagion effect to take a lot of risk with the financial sector, even though I do believe that Asian financials will come out alright. In contrast, the Tech sector will continue to see growth and recovery this year. The iphones, ipads, TVs flying off the shelves are proof of that.
I would also be more comfortable putting money into high yield bonds rather than a global bond fund which would likely have G7 and developed market bonds. But this blog entry has become longer than I originally though, so I will save my thoughts on why I actually think high yield bonds are safer than a global bond fund or developed country sovereign debt at this point in time for a future blog entry. Till next time.
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