Today I met with the Markets

Today I met a group of German investment portfolio managers to talk about the current economic situation in Euroland and what both sides expected from each other. This is what I learnt: 1. Investors are interested in a predictable investment climate. The most predictable climate would be a stronger Eurozone, a political signal that this is going to happen and a clear timetable for how to get there. And this is exactly what is missing now, there is no clear signal, no timetable and hence no predictability for investments. Because of that investors, even conservative investors, are making speculative investments. Some speculate that Merkel&Co will get their act together and the Eurozone will survive strenghend. Others speculate that Greece and other countries will leave the Euro, so they start pulling their investments out of these countries or delay any possible investments there. Quite rational. And as most of these investment portfolios are pension funds, future pensioners are expecting that fund managers are taking rational investment decisions. After Lehmann Broth, they have enough of creative investment of pension money. 2. The political signal and timetable must consist of the right balance of short term and long term measures. Long term means full economic integration with some sort of joint borrowing mechanism. Short term means empowering the ECB to act as a credible lender of last resort. 3. Fiscal discipline is good and preferable, but it is not enough to get Europe back on track. More important is a new Marshall (Growth) Plan for Southern Europe. You can call it European solidarity or enlightened self interest. Investors know that a fiscal union will not be possible without internal transfers and that is ok. 4. To have principles is a virtue, especially fiscal principles are important for investment predictability. But when the principles contribute to a situation where the whole basis of the investment is eroded, one should at least review them, even if this is uncomfortable. 5. The market knows very well what a fiscal union means, and they know that the Merkozy plan is not it. With good will it can be interpreted as a useful step in the right direction. But the market will only consider this as such, when the other, more fundamental steps will follow suit. 6. The market will like Eurobonds, not as a quick fix now but as part of a well thought through fiscal union. Eurobonds now will overstretch Germany. 7. After two years of bad crisis management international investors have lost their basic trust in the Eurozone. They got used to the idea that the Eurozone is not too big to fail and have started to price in the possible failure of the Euro in their investment decisions. 8. Currently they estimate the chance that the Eurozone will still exist in 5 years above 50%. However, if the Eurozone survives, it will be a different Eurozone either in composition and/or in organisation. 9. Saving the Eurozone will be expensive, but it will be much cheaper than cleaning up the mess of a breakup, let alone the political cost. 10. The problem of public debt is larger than the Eurozone and concerns almost all Western democracies. It can become a systemic risk for the future of Western liberal democracy. 11. Intervention of the ECB as lender of last resort can increase the level of inflation, say up to 5%. Even this is disputed as there are also deflationary trends. But even inflation of 5% is no catastrophe and is much preferable to a messy breakup of the Euro with its unpredictable economic and political consequences. 12. German Angst of inflation is not just a historic paranoia. It has a structural reason. Germans put a much higher percentage of their money into deposits(Sparbuch, Staatsanleihen) than other Europeans and have relatively little ownership of shares and property. Deposits will be the big losers during inflation. 13. Germany is a rich country not only because people there work hard but because it draws a huge benefits from the interdependence of the European economy. If this interdependence is damaged, Germany will become poorer, however hard the Germans will work. 14. In the current volatile situation it is difficult for any investor to make money. The market is not winning in this crisis. Paradoxically the only one who seems to be winning these days is Germany because it can borrow at an interest rate (2%) which is below the inflation rate (3%). My conclusion: The markets are indeed the most active Europeans. They want a clear political signal that the EU is making a big leap forward towards a fiscal, economic and political union and a timetable for getting there. They know this is not happening tomorrow but a believable political commitment will provide a predictable investment climate. And this is exactly what is missing now, there is no clear signal, no timetable and hence no predictability for investments. That is why they hedge against a breakup of the Euro in order to protect their investment portfolios and so put more pressure on the Eurozone. It looks like the markets have not made their case strong enough.