What would a benign dictator do with the euro?

July 16, 2012

The idea of a “benign dictator” may well be an oxymoron but as a thought exercise it goes a way to explaining why giant global fund manager Blackrock thinks the chances of a euro zone collapse remains less than 20 percent.  When push comes to shove, in other words, Europe can sort this mess out. Speaking at an event showcasing the latest investment outlook from Blackrock Investment Institute, the strategy hub of the investment firm with a staggering $3.7 trillion of assets under management,  Richard Urwin said the problem in trying to second-guess the outcome of the euro crisis was the extent to which domestic political priorities were working against a resolution of the three-year old crisis.

“The thing is if you could imagine a benign dictator, then the problems are all solvable and could be fixed in a matter of weeks,” said Urwin, who is Head of Investments at Blackrock’s Fiduciary Mandate Investment Team.  Playing with the idea, Urwin said parts of a workable plan may involve debt rescheduling or restructuring for the existing bailout countries Greece, Portugal and Ireland; a buildup of a sufficiently large liquidity fund to help the larger countries such as Spain and Italy; a euro banking union with deposit guarantees and single supervisor to ring-fence and close insolvent banks that will never function properly; the creation of a central finance ministry and the issuance of jointly-guaranteed euro bonds etc etc.

Urwin’s point of course was not to advocate a dictator for the euro zone — although he acknowledged the euro was not exactly a child of European electorates to begin with–  rather that euro members have the ability if not the willingness yet to solve the crisis and that global investors looking for signposts in the saga needed to watch closely the runes of political cooperation and leadership instead of the economics and debt dynamics alone.  Where exactly that turns is hard to guess, but but it may well be that the process that has to wait until the German elections next year, he added.

Far from thinking these plans are some fanciful wishlist, Blackrock managers stressed that a lot of what has been done in the euro bloc over the past couple of the years — in terms of cross-border bailouts and funds, fiscal integration and central bank activism — would also have been thought unthinkable as recently as 2009.  And the past month of European Union moves  — recapitalisation of the Spanish banking system,  opening up the new European Stability Mechanism to directly fund banks and not just sovereigns, and moves toward a European banking union — all marked another big, if still insufficient, step to restore system-wide confidence.

“My view is that there has been a great deal of progress in the past 60 days in Europe,” said Peter Fisher, Head of Blackrock’s Fixed Income Portfolio Management Group. “But we’ve yet to see whether the political leadership in Europe will tie themselves to the mast of reforms needed to hold the euro together. They’ve made some progress but we still don’t see them having done enough to make it credible yet for us.”

“If Hollande and Merkel started showing the sort of political leadership Kohl and Mitterand showed in committing themselves to the future of Europe, markets would sit up and take notice and it would take a lot of the uncertainty premium out,” Fisher said.

And it’s the uncertainty of political and central bank behaviour in reaction to the dead weight of western deleveraging that’s creating so much visibility problems for investors, they said — not just  in Europe but also on how a new U.S. President and Congress deal with the worrying “fiscal cliff” of pre-scheduled budget tightening there next year and how China and other emerging markets cushion their steadily slowing economies.

“To the question ‘what do I do with my money?’, the answers can be summed up in three words — policy, policy, policy,” said Ewen Carmeron Watt, Chief Investment Strategist at the Blackrock Investment Institute. Apart from defensive equity plays hinging on dividends and income, it was best to focus on companies with strong cash flows and Cameron Watt said he liked direct exposure to emerging markets equity and bonds rather than through proxies such as multi-nationals. High-yield bonds and mortgage securities, due to their relative scarity, were also tipped by the managers — as was long-term exposure to supply-affected oil and copper, though via resource company equity and not physical holdings due to relative valuations.

“Focus on extremely short-term opportunities and five-year investment themes, and avoid the dangerous three-to-six-month investment horizon,” Cameron Watt said.


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