By the time you read this, the most important development in global finance in 50 years will have taken place. At vast expense to private sector banks and non-financial institutions – who have borne almost the entire burden of a task made unnecessarily difficult by the long-evident inability of Europe’s governments to act pragnatically or in concert – the euro has been created. Sceptics are still concerned that the costs will far outweigh the benefits. But the apparent altruism of the private sector should tell them something.
The private sector has taken on this mammoth project with only muted mutterings of complaint about the costs, the effort and the risks because it expects to make a great deal of money out of the euro. In no sector is this more true than in banking especially in fixed income and equities, where volumes and values should increase enormously.
In the short run, this looks true. American investors have got used to looking for performance abroad. Asia and Latin America, two previous favourites, no longer look safe. Europe at least offers some growth and, supposedly, German-style fiscal rectitude. Substantial capital may also flow into the euro from foreign investors that never bothered with the smaller national currency markets.
The arguments for believing in a European equity boom are well known: a flow of money within Europe out of government bond markets, where supply and yields have fallen as governments have striven to meet the Maastricht criteria, into equities; this inflow to increase because of the inadequacy of state pension provision and to be met on the issuer side by lean, competitive, restructuring corporate tigers, driven by a new generation of European managers committed to delivering value to their shareholders.
Perhaps. But let’s not get too carried away. Many European companies are taking a halfway approach to adopting shareholder value. And there are worrying economic strains within Europe. Oddly, when Europe’s new centre-left politicians began urging central banks to cut interest rates in November, many economists sided for once with the interfering politicians. Normally monetarist scribblers even began favouring – over the short-term of course – some form of Keynesian boost.
CSFB is forecasting just 1.5% GDP growth in Germany in 1999 and, more worrying, suggests consumption will provide 1.3%, with investment and exports contributing almost nothing. How Europe will fare in a slowing world is yet as unclear as how the ECB itself will operate and respond.
The ECB’s decision to set an M3 reference zone around 4.5%, rather than a strict target, may appear woolly, but could in fact be wise. After all the Federal Reserve now all but ignores the measure. And a reference zone may make it easier for the ECB to cut interest rate next year assuming the new left wing governments do not step in first with their Keynesian boost. As one economist points out, it may be well for policy makers who have no more idea of what’s going on in the economy than anyone else – but have to look as if they do – not to explain what they are doing in too much detail.
If Europe’s economy lurches down, all those new holders of equity had better watch out. Many retail buyers have taken exposure through principal-guaranteed products, structured by the wholesale giants and distributed by national retail bank networks. The trouble is that on more and more of these the principal isn’t really guaranteed. If those investors are seriously burnt, they may abandon equities and not return for a very long time.
