September 23, 2010
Munich, Germany
Despite being governed and regulated by federal policies, local economies within a single nation or monetary union typical vary wildly. In the United States, for example, Texas is having an easier time than, say, Florida. Oklahoma City isn’t suffering as much as Detroit. Etc.
The same holds true within the European Union… big time. In fact, the whole of the continent is being split into the ‘haves’ and the ‘have nots’, at least, relatively speaking.
Germany is an example of a ‘have’ nation. The Germans have their own pension and social entitlement issues, but they still manage to run a reasonably sound economy. Moreover, Germany doesn’t have the same debt or unemployment problems as many of its neighbors.
Austria, Belgium, Luxembourg, the Netherlands, Poland, and even France could also be considered the ‘have’ nations… effectively, these are the net creditors who will be forced to make a decision whether to bail out the ‘have nots’.
The PIIGS nations, plus others like Hungary, Romania, and Latvia, are the ‘have nots,’ the ones who are in serious need of a bail out and whose economies need to undergo massive restructuring.
The net result has been significant pressure on the euro for all of 2010. Faced with a loss of confidence by institutional investors, the single currency reached a low of $1.18 earlier this year, though it has rebounded about 10% since then.
Investors’ chief concern is that the ‘have’ nations will need to turn on an endless flow of cash for the ‘have not’ nations… meaning one of two things: either (a) wealthier countries will have to undergo nationwide austerity and higher taxes, or (b) the eurozone will inflate its currency away.
In either case, the net result to the euro is negative; and as these sovereign problems are not going away any time soon, there should still be plenty of pressure against the euro for the medium term.
The nice thing about this is that it affords us the opportunity to buy ‘have’ nation assets at a ‘have not’ discount. Look at a company like Deutsche Telekom for an example.
DT (you may know them as T-mobile) is one of the largest telcom companies in the world. Headquartered in Bonn, Germany, DT represents a high quality German asset trading at a Greek discount– with over a 7% dividend yield, it’s currently trading at book value.
To be clear, I’m not suggest that you rush out and buy DT shares right this second– I’m considering the company for my own portfolio, but I mostly wanted to paint a picture of this ‘have not’ discount.
I am convinced that these sovereign disparities will eventually cause a euro breakup. It absolutely has to happen– the ‘have’ nations are not going to keep bailing out Greeks who march in the streets protesting an increase to their retirement age… or Hungarians, whose prime minister tells the ECB to take their advice and shove it.
The only question is, what will happen after the split?
My estimation is that the PIIGS will simply drop out, one-by-one. Italy will go back to its own lira, Greece will go back to its Drachma, and the remaining eurozone will be comprised of the continent’s strongest economies.
Another possibility, though more extreme, is that the entire monetary union falls apart, and each nation goes back to its own currency– the French to their franc, and the Germans to their mark.
In either case, the net result will be the same. Assets that had been purchased in the ‘have’ nations will immediately go up in value– no more ‘have not’ discount. And you could expect significant currency appreciation as well.
This, I believe, is one of the many, many macro opportunities that we will see in the Age of Turmoil.
