Steve Collins · @TradeDesk_Steve
27th Jun 2012 from Twitlonger
Debt crisis: the benefits of selective eurozone default
There is a consensus in the corridors of power that if any eurozone member defaults or leaves, contagion and collapse are assured. This is a fairy tale designed to frighten voters into submission to bizarre government policies. It also ignores two historical lessons.
One is that sovereign default is normal, especially after major banking crises. Only 13 of the G20 countries (the world's wealthiest nations) existed a century ago.
Of these, only two have not defaulted. Many have repeatedly reneged. The other is that default can be beneficial. Markets already expect several EU countries to 'restructure', hence Greek and Portuguese 10-year government bonds are now worth 16pc and 65pc of their face value; but discussion remains a political heresy because the eurozone has some aspects of a religious cult. The result is an absence of analysis on how to manage the cyclical inevitability of default, or to reap the benefits.
It is also worth noting that for many countries default is their normal condition. Spain is the winner, officially defaulting 18 times since 1550. Greece has done so five times since its re-creation in the 1820s, and has been barred international borrowing for 110 years out of the last 190.
The architects of the euro created an interdependent economic area so that never again could there be a war across Europe. They knew a single currency before political union carried risks so built in financial controls. The breakdown occurred when France and Germany waived the budget deficit rules in 2003 fearing the electoral consequences. From then on, a crisis was inevitable.
Elections across Europe now show an anti-EU trend because of its new association with financial pain: previously voters signed up for the money - low interest rates, unimaginably easy credit, rising income and house prices. The Poles and Czechs never conceived they would be asked to pay in; the Mediterranean periphery never expected to repay overseas donations. The risk/reward for these nations has tilted towards leaving, the more so given the potential benefits.
The economies of all five 'PIIGS' [Portugal, Italy, Ireland, Greece and Spain] are contracting. The longer they remain within the eurozone, the more local deposits, foreign investors and industry will flee. Soaring unemployment, mass emigration, deflation and social unrest are guaranteed. Recovery post-default is always driven by a reversal of previous capital flows: deposits return into the system; foreign businesses see the opportunity of cheap wages and a weak currency; governments are keen to smooth their path so regulations are waived. Investors suddenly become interested in building factories and buying assets. Tourists find the exchange rate compelling and arrive in droves. Service companies (which can be based anywhere) find the case for relocation compelling.
Currently the PIIGS are aid junkies. The cure for addiction is not to increase the dose as it prevents necessary structural changes. Default will be painful yet this should be brief as it allows reform to take place. The precedents are good, one suffices. 2012 marks the 15th anniversary of Asia's bone-jarring economic collapse; most countries bordering the Pacific underwent some form of default, even China at the provincial level. The problems were artificially high exchange rates and excessive debt. In 1997, it was inconceivable that within 15 years Asia would account for four-fifths of the world's foreign exchange reserves, or 60pc of commodity imports. Rightly so as it only took ten - because there was simultaneous reform. In contrast, Argentina has defaulted three times since 1982 but has never restructured because of its strange Peronist legacy. The world's sixth richest country on a per capita basis in 1914, today its fails to make the top 50.
There are major opportunities in crises and defaults, such as the collapse of the Berlin Wall in 1989 which effectively doubled the number of global consumers overnight and resulted in a fifteen-year equity bull market and high growth in real income. Asia's financial crash in 1997 proved another. Today Greece's entire stock market is capitalised at $20bn, less than 5pc the value and 0.5pc of a single day's turnover in Apple. Italian opportunities are potentially greater. It is premature to place bets on the PIIGS today because of the EU's amazing record of dither and delay. Yet decision making has already passed to voters; the priority for national politicians is re-election so rapid changes are imminent. The result should be long overdue reform and economic renaissance, provided the dead hands of government incompetence are temporarily severed.
Jonathan Compton, Managing Director, Bedlam Asset Management.