When the euro was created on Jan. 1, 1999, few could have predicted what the next decade would bring. At the time, the creation of a common currency was seen as a way to ease trade among member states and boost their presence in global markets. Today, of course, the euro’s troubles have the world wondering if its days are numbered.
“I would never have dreamed it would come to what it’s come to,” says Stephen Smith, managing director and portfolio manager with Brandywine Global Investment Management, LLC.
Smith joined the Legg Mason organization (Brandywine Global is a wholly owned subsidiary of Legg Mason) in 1991, where his role was to diversify the firm’s investment strategies and launch its global fixed income product. But the arrival of the euro caused significant change in Europe.
In the first half of this century, countries such as Sweden, Italy, Portugal and Spain were yielding strong bond returns of around 12% and 14%. Germany, however, was struggling to integrate East Germany while still maintaining a rigorous financial discipline, with bond yields at 5% or 6%. The introduction of a unified European currency would only carry this instability to other countries.
Smith and his colleagues were concerned that the euro would lead to a convergence trade, with spreads trading closer to the weak German bond yields. “Monetary policy was set for Germany, not the countries that were rocking and rolling,” he explains. “Germany was the ‘sick man’ of Europe. When Canada and the U.S. were raising interest rates in 2002, Europeans were lowering rates because of Germany. And the unfortunate thing that happened to countries such as Portugal, Spain—and particularly Ireland—is that they were taken along for the ride. Their economies were so strong that they should have been raising interest rates; instead, they were lowering interest rates because of Germany.”
Today, it seems the very advantages that brought the euro to life—such as integrated financial markets—are contributing to its demise. Countries that are less financially secure are relying on their more productive sister states, draining all members of the eurozone, says Smith.
“The end game for the Germans is a fiscal union to complement the monetary union,” he explains. “The ongoing process to achieve this goal has been filled with tension, frustration and negotiation fatigue.”
“We believe the process is in the final stage, because we now have a slow-motion run on the European banks. And, in the end, self-preservation will dominate—because the alternative is more destructive.”
As for the euro’s future, Smith says the complexities make it difficult to predict. “The problem the Europeans have with dismantling the euro is that the banking systems are so intertwined. There’s no exit strategy once you’re in the euro.”
Tammy Burns is associate editor of BenefitsCanada.com. tammy.burns@rci.rogers.com
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