United States looks like the best bet for 2011 as eurozone gets set for big battle
Published 19/12/2010 | 05:00
AFTER taking the worst battering in its 12-year history in 2010, the eurozone will be tested to destruction and possibly beyond in 2011.
With the Chinese economy also showing signs of over-heating, the US still looks like the best bet for investors in the New Year.
It was the year in which all of the doubts expressed by the sceptics in the run-up to the formation of the euro at the beginning of 1999 suddenly seemed to be justified. The risks of establishing a single currency, combining the monetary policies of 16 disparate economies, without first establishing a single treasury, thus bringing together their fiscal policies, became blindingly obvious in 2010.
Having scented blood in 2010 the markets won't let go in 2011. With Greece and Ireland having already been forced to seek bailouts, Portugal will be forced to do the same early in 2011. As soon as this happens the pressure will mount on Spain. With an economy over twice the combined size of Greece, Ireland and Portugal, can the EU and IMF afford to bail out Spain? That's almost certainly a question which will be answered in 2011.
However, it's not just the problems on the north-western and southern peripheries of the eurozone that should have investors worried. While, with the exception of Slovakia and Slovenia, most of the Central European countries that joined the EU in 2004 aren't members of the eurozone, that doesn't mean they are of no concern to the single currency area.
While most of these countries have retained their own currencies, they all have pegs to the euro. This has meant that local borrowers have tended to borrow in euro rather than in much higher-interest local currency. This represents a further huge exposure for Europe's banks, particularly German, Italian and Austrian lenders.
Between them, the European banks have lent just over $1.3 trillion (€1 trillion) to Portugal, Ireland, Greece and Spain, the so-called PIGS. Most of this money has been lent by German, British and French banks. This of course explains why the ECB was so determined to prevent "haircuts" being imposed on the senior bondholders of the Irish banks during last month's bailout negotiations. To have done so could very quickly have transformed a purely Irish banking crisis into a pan-European one.
But that isn't even the half of it. European banks have lent a further $1.5tn (€1.15tn) to the former Soviet bloc (including Russia). If the European banks' lending to the PIGS is starting to look ropey, what can one say about their eastern and central European loan books?
Austrian banks alone have an exposure of $230bn (€175bn) to these countries.
What all of this means is that the problems currently afflicting the banks of the peripheral eurozone countries, particularly those of Ireland, are sooner rather than later likely to spread to the centre. Faced with a domestic financial crisis, would the Bundesbank adhere so rigidly to the sado-monetarism it currently deems appropriate for the PIGS?
'Having scented blood in 2010, the markets won't let go in 2011 . . .'
While certainly not beyond the bounds of possibility, a far more likely outcome is that, confronted by such an appalling vista, Germany would let the printing presses rip, whether it stays inside the eurozone or not. This combination of a likely banking crisis and the seeming inability of European leaders to get ahead of events rather than merely reacting to them, makes both the euro and eurozone stocks look like bad investments.
China is also starting to look suspiciously like a bubble. With construction now representing more than half of all economic activity, one has to ask who is going to occupy all of those new apartments, factories and roads, assuming of course that they could afford them in the first place?
If the fears of China bears such as Jim Chanos, who predicted the implosion of Enron a decade ago, are correct, then, far from being the engine that pulls the global economy out of recession, the Middle Kingdom could unleash a second, more serious phase of the Great Recession. A Chinese property bust is also likely to be accompanied by the mother-and-father of all banking crises as the downside of more than two decades of politically-directed lending become apparent.
The notion that China represents a good investment opportunity strikes me as fanciful. For an example of what can happen when a Far Eastern property bubble bursts one has only to look across the Yellow Sea to Japan, where the Nikkei stock index is still at just one-third of its level of two decades ago.
All of which by a process of elimination leaves us with the US and the much-maligned dollar. The US economy has bottomed out and its financial system is in much better shape than anyone would have dreamed possible after the collapse of investment bank Lehman Brothers in September 2008.
When the scale of the problems facing China and the eurozone are taken into account, Uncle Sam starts looking like a haven of tranquillity. In an age of uncertainty, the United States and the dollar look an awful lot less uncertain than any of the main alternatives.