I was recently asked whether I still hold the view that the eurozone will fragment, or whether I have moved from that position. Simply put, I am sticking with my position. I think that eventually one or more smaller countries will defect from the eurozone. Cyprus came close to it, and I think Greece may still exit.
There are three main drivers pointing to a possible break-up of the eurozone. On one hand, we have the risk of austerity fatigue. The longer the peripheral countries like Greece, Spain, Portugal and Ireland remain in recession due to austerity, the more we see rising unemployment and dissatisfaction among consumers and voters. Eventually these voters will elect an extreme government, either of the right or of the left. We came close to that in Greece and in the French presidential election last summer, and we saw it in Italy in February, so this is becoming more common. At some point, one of those extreme parties is going to be elected, and then the orthodox politicians will lose control of the process, because one of the extremist leaders will say, “Enough is enough. We are going to quit.”
On the other side, we have the risk of bailout fatigue. The Germans, the Finns or the Dutch may say, “Enough of these bailouts. We are not going to provide any more loans.”
The other risk, which nobody can control, is the possibility of bank runs. We saw that last summer in Greece, Spain and Portugal, and we saw it recently with Cyprus.
It is basically a struggle at the moment between the elite of the eurozone, who want to keep the system together, and the people at large, who are fed up with the cost of preserving it in terms of unemployment, continued recession, and so on. The prolonged economic stagnation is increasing the stresses, and I think ultimately, we should expect somebody to break the link with the euro.
Of course, the next question is whether the exit of one or more peripheral countries would jeopardize the entire concept of the euro and the eurozone. It would not necessarily, although it may require capital controls by the economy in crisis (as happened in Cyprus), and possibly by one or two others who feel threatened.
The fundamental proposition is this: The eurozone remains a flawed concept. It is a monetary union without a fiscal union, and although they are putting in place a banking union and the rescue fund (the ESM or European Stability Mechanism), neither of those two things is a really satisfactory substitute for a federal eurozone treasury that could raise taxes, control expenditures and issue bonds across Europe. In the absence of moving to that full solution, these crises will continue to erupt from time to time.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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