The markets last week responded by pushing up the mark as a safe haven from Euro-chaos. Then at the weekend, in response to these forecasts, there were a clutch of political speeches, some asserting that the single currency must go ahead on schedule, others that it could be delayed without damage.
Yesterday the scene shifted to Brussels, the first ministerial meeting since the deterioration of German and French public finances became evident. There it was the turn of Malcolm Rifkind to stir the pot by saying in public what he had previously said in private: that Britain reckoned that the present timetable for EMU had "a serious credibility problem", a comment not designed to endear him to the Brussels bureaucrats.
Now from the perspective of most Britons it is tempting to see this as all good clean fun: nice to see the pompous Euro-enthusiasts squirming for a change. But quite aside from being a bit childish, that sort of reaction has to be set against the reality that EMU may well still happen.
If Germany and France do wish to establish a single currency in 1999, it is technically perfectly possible for them to do so. It would just be a question of changing the Maastricht rules. In any case, even if France and Germany missed the conditions in 1997, at some stage in the next three or four years they would be able to scramble back within them. The present war of words between various politicians around the EU is about delay, not about junking the thing.
A much more sensible approach is to step back from the politics and focus on the range of market implications. There are two ways into this. The first is to construct a flow-chart, which might run on these lines.
First, you have to decide the odds on any countries going ahead in 1999. Next, there is the extent to which the criteria are eased, bent, or broken to allow these to do so. Obviously the wider the group, the greater the flexibility of the criteria. Finally, depending on which countries had been excluded, you would make some guesses as to when the outsiders might be admitted, if they wanted to.
On the other hand, if the 1999 date were not met, you would make a separate set of judgements: how long the delay might be, whether delay would scupper the project, and perhaps the runners and riders for start dates of, say, 2002 and 2005.
There is nothing wrong with that approach, and it is useful because even if you give quite a low probability to the start date of 1999, you tend to find that the chance of there being some sort of EMU by 2005 is quite large. People considering buying 10-year or longer-dated German bonds needs to be aware that they will probably be repaid in another currency. Indeed if investors are really determined to be repaid in the same currency as they are lending, they really should stick to dollars or yen.
Even buyers of gilts are not certain to be repaid in sterling, though amusingly there were some suggestions yesterday that gilts were becoming a safe haven amidst the turmoil of European currencies. That shows that things have really come to a pretty pass.
This points to another way of looking at the whole business. It is to say something like this. Let's forget about the details of the EMU debate, because we simply cannot add anything sensible to it. What happens and when will be a political decision over which we have no control. Instead we should adopt a practical, fact-based approach to all investment decisions, and see where that leads.
That sort of approach heads in this direction. First, look at global inflation trends. These are clearly down and have been down since the early 1980s. There is no sign of any reversal of the secular trend, though obviously there will be cyclical swings.
Anyone investing money in bonds maturing in 20 years' time is making a grand decision about global inflation, besides which the performance of individual currencies is less important. If world inflation comes down, so will inflation in the various European currencies, though by somewhat different amounts.
But we still have to make a choice of the relative attractiveness of different lenders, so what are the guides there? The age-old laws of supply and demand hold good, but since we can have little idea of the demand for bonds in the second decade of the next century, let's focus on supply.
The graph (below left) shows what has been happening to the supply of government bonds in the three big economic zones, showing that the supply is most restricted at the moment in the US, has increased rapidly in Japan, and is continuous and considerable in Europe. On this very simplistic basis, dollar-denominated bonds ought, on the face of it, to be attractive compared with Japanese and European ones.
One should also look at the stock as well as the flow, at the size of the European public sector debt in relation to gross domestic product compared with Japan and the US, and at the different levels within Europe. Allow for the different age structure of Japan and the US and the debt levels are not vastly different.
Most European countries, on the other hand, either have very high debt levels (Belgium, Italy), or they have rapidly ageing populations (France, Germany, Italy again). Since economic textbooks point out that the ability to service a country's debt depends on the tax-gathering powers of a government, age structure is very important to the ability of country to honour its debts.
In so far as sterling ought to be a safe haven, it is not because the pound seems likely to exclude itself from the "Euro" game: it is because, for the next 20 years, the UK has a significantly less unfavourable age structure than the other larger European nations.
Look at those big issues, those that determine creditworthiness, rather than current fashions in economic or political thinking. The right-hand graph shows just how volatile the crucial relationship between French and German interest rates has been over the last three years: whenever the franc is weak, the French authorities have to jack up interest rates. But the reality of the relationship between the two currencies has hardly changed.
I think there is a moral here. We do not know what will happen to EMU. But if investors are risk-averse, they steer clear of the whole thing and invest in good old dollars.Reuse content