Afterlife of a Greek tale

The EU has set its face against debt restructuring because it thinks that it would be rewarding speculators who have taken positions on Greek debt default. There is a justifiable feeling that many speculators, with not-so-inconsiderable help from credit rating agencies, have been pushing the case for restructuring not out of concern for Greece or for the future of the euro, but for their short-term gains. That is why Bare Talk does not disapprove of the measures that the German government took last week.

That said, given the absence of growth drivers for a structurally uncompetitive economy such as Greece, fiscal austerity could be the stranglehold that chokes the economic revival. Whereas, debt restructuring accompanied by a temporary exit from the euro zone might work better than severe austerity that reinforces structural growth headwinds. Further, EU leaders must remember that speculators delivered the members of the Exchange Rate Mechanism (ERM) in the 1990s out of their misery when they were locked into unsustainable monetary and exchange rate policies with Germany that was dealing with the inflationary aftermath of reunification with higher interest rates. Speculators broke up the ERM in effect and that restored the much-needed exchange rate flexibility to other European nations.

For better or worse, EU leaders think that any inch given to speculators might eventually lead to the whole house being taken over by them. So, one hears that the European Central Bank had requested many Asian central banks to buy Greek and other beleaguered European debt. Obviously, this rules out any debt restructuring. That would be a diplomatic disaster. Nonetheless, austerity imposed on a Europe that is ageing and struggling to grow brings back painful memories of the inter-war period of the 20th century. European leaders might be throwing the baby (debt restructuring) out with the bathwater (speculators).

This means that the avenues for growth in the euro zone would be a super-loose monetary policy and a super-undervalued euro. A super-loose monetary policy raises inflation risks for Germany, while a weak euro risks creating an eventual trade war with the US, the UK and China. The two Anglo-Saxon countries are bound to feel the need for further currency weakness at some stage. In fact, the day is not far off when quantitative easing (printing money) is revived by the central banks of these two countries.

The investment implication of this prospect is straightforward and Bare Talk has talked often enough about it—the need to have exposure to physical gold in investment portfolios and to hold a diversified basket of currencies that includes the Canadian dollar, the Norwegian krone, the Swiss franc and the Singapore dollar.

Beyond that, what should investors do? The problem with reading loose monetary policies as an invitation for loading up on financial assets is that loose monetary policy has exhausted its potential to cause asset inflation in the structurally damaged West. Throwing money at problems worked as long as there was economic growth and there was no concern about government budgets, ageing societies and resource constraints. That was then. Now, throwing money brings currency debasement followed by inflation.

In the developing world, where some of this money finds its way, economies are neither big nor mature enough to avoid an increase in the cost of living that follows close on the heels of asset bubbles. In fact, the euro zone crisis has bailed out many Asian central banks, at least for a while, from the need to tighten monetary policies. Decline in the prices of crude oil and industrial metals is a boon for them.

Investors should be in safe and liquid assets, load up on real assets (e.g., real estate) opportunistically, and dabble in financial assets through long-option strategies where the downside is known from day one.

Investors should do well to remember that capital markets have been characterized by increasing opaqueness and over-the-counter products and arrangements (credit default swaps and dark pools, for example). What we do not know can hurt.

The old financial world order ended in 2007. A new one is yet to emerge to take its place. It is a multi-year work in progress. It might conclude by 2012 or by 2015. Until then, it is better to be safe and prudent with investments.

V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at baretalk@livemint.com

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