Which country is a bigger threat; Greece or Russia?
In 1998, the IMF and World Bank formulated a rescue package for Russia after the country’s economic woes forced Moscow to devalue the rouble and default on domestic debt. Investors were reminded how Russia’s financial torment shook global financial markets 17 years ago when the country careered towards a similar catastrophe last month. On December 16, the rouble dived more than 20% after plunging oil prices, the bite of sanctions blocking debt renewal and a loss of faith in the Central Bank of Russia blasted their confidence in holding the country’s securities.
In Greece a day later, the centre-right coalition headed by Prime Minister Antonis Samaras of the New Democracy Party failed to secure the votes needed to win the first round of the parliamentary election for its nominee for president. Sure enough, the government had two more failed attempts to secure the votes needed to appoint Stavros Dimos as Ceremonial Head of State and a General Election was triggered a year ahead of schedule. The poll scheduled for January 25 could see the anti-austerity, pro-debt-renegotiating, left-wing novice Syriza party led by Alexis Tsipras gain office, if opinion polls hold. The political tension in Athens during the parliamentary votes and ahead of the general election has reminded investors how Greece is just as big a threat to the Eurozone as it was for the three years from 2009 when the revelation that Greece’s government had lied about its finances sparked the region’s financial crisis.
Many are warning that the woes of Greece and Russia could trigger a new phase of the global financial crisis (and perhaps wider conflict in Ukraine). For Russia, the financial doom would include a massive default, a banking collapse, a crushed economy leading to political instability and perhaps a more aggressive approach to Ukraine in response. For Greece, with its unemployment at 26%, it could be another default on sovereign debt or a departure, somehow, from the Euro that allows no exit. Which is the bigger threat to a continent with record unemployment and largely in depression? Time will tell, although, of the two, Greece probably is. Russia and the EU can at least take steps to have the sanctions blocking debt renewals removed by soothing concerns over Ukraine, whereas the mess that is Greece where government debt is an unsustainable 167% of GDP requires a drastic solution of some sort before too long.
What both countries serve to highlight is the political risk that Europe must navigate just to get through 2015. Apart from the geopolitical tensions over Ukraine ensnaring Russia’s economy and Greece’s future in the Euro, investors must watch the outcomes of scheduled elections in Spain, Portugal and the UK, as well as Greece. All four polls could see anti-establishment populist fringe parties of the left and right do well enough to destabilise financial markets. (Populists are expected to do well in scheduled parliamentary elections in Denmark, Estonia, Finland and Poland but these polls are not expected to cause any strife for global investors.)
To be sure, citizens exercising their democratic rights are not the problem. The issue is that voters will crystallise the political disquiet triggered by Europe’s unemployment crisis. Even if populist politicians are leading opinion polls now, they could gaffe their way to oblivion before elections are held. In power, these populists may prove as conservative and as pro-Euro as the politicians they displace. It’s true, too, that there are always political risks. Maybe todays are exaggerated. After all, Sweden in December managed to quell the political crisis triggered when the balance-of-power-holding neo-Nazi Sweden Democrats took the unprecedented step of blocking the coalition’s first budget because the government wouldn’t agree to slash immigration by 90%, the party’s signature policy. Sweden’s two-month-old left-of-centre coalition avoided a sudden poll by forming a so-called grand coalition with the centre-right opposition, in what is essentially a political deal between the country’s six mainstream parties designed to snuff out the influence of the Sweden Democrats. (A grand coalition in Australia would be if the Liberal-Nationals teamed up with the ALP to thwart minor parties.) At least no polls are due this year in France, Germany and Italy that could destabilise investor confidence – the anti-Euro Marine Le Pen must wait until 2017 to test her poll-leading position to become the next French President.
The elections in Europe scheduled for this year, however, serve to warn of the existentialist danger that voters pose for the Eurozone. The anti-elite, anti-Euro and anti-EU sentiment swirling in Europe, whether grounded in nationalism, socialism, the politics of identity or simply a backlash against economic failure and the corruption scandals engulfing the political class, will buffet investment markets for a while yet. The rise of populism highlights how the political union needed to ensure the survival of a currency union is becoming more distant, if not a dream.
Poll watch
Last year carried a rehearsal of how easily an election in Europe could unnerve investors. The Scottish referendum showed that decisions by enough voters could unleash panic in a world that has little ability to absorb fresh shocks. London had no plan if the voters in the September poll opted to end the union formed in 1707. A vote for independence would have heralded vast friction over negotiating Scotland’s exit from the UK, as clashes were certain over the use of the pound and the sharing of the UK’s national debt and assets. Analysts warned that a yes would lead to a pound in freefall, for starters. As it turned out, only 45% voted for independence (not that far off 50% plus one, really), so the worrying was for nothing. Hopefully, the elections sprinkled throughout Europe over 2015 will prove as innocuous.
The first poll test, to be held on January 25 in Greece, could prove troubling though. Syriza’s policy to default on debt and rebuke austerity is placing the party at the top of the polls. If a Syriza-led Greece is allowed by the country’s creditors to default on some debt then speculation will rise that other debtor countries such as Italy, Spain and Portugal will seek similar favourable treatment. Such talk could reignite a continent-wide financial crisis. Possibly a more dangerous scenario might be if Greece’s creditors were to refuse to let the country renegotiate its debt repayments and Tsipras opts to pull Greece off the Euro to effect a default.
The next disconcerting election will take place on May 7 when a General Election is held in the non-Euro-using UK. At stake is the UK’s membership in the EU. Opinion polls show that voters could propel the anti-EU and anti-immigration UK Independence Party into a position where it can force conservative Prime Minister David Cameron to persist with an in-out referendum on the UK’s EU membership. Chances are that UK voters would choose to quit the EU even though their economy is about the best performing in Europe. Cameron is trying to repel Nigel Farage’s UKIP, which topped last year’s European Parliamentary elections and won two by-elections in 2014 to enter Westminster for the first time, by promising to negotiate the UK’s relationship with the EU. But such steps only create fresh tension across Europe. The French, for one, have ruled out such changes because President François Hollande fears such demands would force a referendum on France’s EU membership and enhance the popularity of Le Pen’s right-wing National Front. A UK withdrawal from the EU could rock the foundations of Europe’s post-war political settlement.
Portugal’s poll in September or October appears harmless in comparison for it will probably result in a victory by the pro-euro and mainstream Socialist party. A long-term threat, however, is that the left-wing party is promising to overturn Angela Merkel’s austerity policy for southern Europe. While such calls would be no direct threat to the Euro, any fiscal laxness for bailed-out Europe would inflame the rising anti-Euro Alternative for Germany party that, with its ability to outflank Merkel’s coalition to the right, would put Merkel under more pressure to be tough with bailed-out Europe.
Spain’s poll, which is due by year end, promises to be problematic, for unlike Portugal, an insurgent party is soaring. Conservative Prime Minister Mariano Rajoy is facing the sudden appearance of the anti-establishment Podemos party at a time when the province of Catalonia has held a non-recognised vote for independence. Rajoy of the corruption-riddled, centre-right People’s Party is refusing to negotiate with Catalonian separatists who defied Madrid and Spain’s Constitutional Court to hold a successful referendum in November. To further inflame tensions between Madrid and Barcelona, Catalonia’s Regional President Artur Mas is threating to call an early poll for Spain’s richest region to gain a mandate for independence. If re-elected, Mas’ secessionists plan to hold a final referendum after 18 months.
Podemos, Spanish for “we can”, is Europe’s political success story of 2014. At the start of the year the radical left-wing party didn’t exist. By year end, it was leading the opinion polls. Like Portugal’s Socialists, Podemos is anti-austerity. Like Greece’s Syriza, Podemos want to renegotiate Spain’s public debt that reaches 102% of GDP. Investors should understand that debt negotiations are disguised defaults.
Unlike the past
The question begs as to what investors can do about political risk. The answer might be to largely ignore it, if the recent past is any guide. Over the past 30 years or so, investors have easily brushed aside political events such as the terrorist attacks on the US in 2001 and the US invasion of Iraq in 2003 and other wars in the Middle East. These episodes only tended to cause sudden, but temporary, shifts into haven assets. Investors typically quickly regained their optimism because they determined that these confrontations would do little lasting damage to economies.
The trouble for investors is that the benign political backdrop of the recent past may no longer apply. In recent decades, political events have either been too contained to trouble the global economy or, more to the point, they have worked in favour of investors. There is no better example of an investment-friendly political shock than the so-called peace dividend from the unexpected collapse of the Berlin Wall in 1989. Another investment-friendly political experience was the rise of the reformist Deng Xiaoping, who led China from 1981 to 1987 (though unofficially held power largely until his death in 1997). The integration that goes by the name of globalisation and the associated belief in the inevitable rise of liberal democracy created complacency that countries were too intertwined to fight wars, forgetting that Britain and Germany were each other’s biggest trading partners in 1914. The widening of the EU and the creation of the Eurozone in 1999 were other endeavours that made politics appear irrelevant to investing.
Go back further than a few decades, though, and it’s clear that political risk acted against investors. World War 1 and World War 11 were the ultimate political events. Even the damaging oil price shocks of the 1970s were driven by politics. The first shock of 1973-74 was triggered when Opec nations cut production and banned oil sales to the US and other Israel supporters in retaliation for helping Israel during the Yom Kippur war of 1973. The rule of Mao Zedong in China from 1949 to his death in 1976 was one endless political risk. It encompassed the world’s worst-ever famine under the misnamed Great Leap Forward of 1959 to 1961 and a purge of society during the equally misnamed Cultural Revolution from 1966 to 1976.
It’s more likely that the nationalist and populist politics in Europe will limit prospects for investors in coming years. The liberal democratic political system won acceptance within Europe over the past 50 years as countries such as Greece, Spain and Portugal overthrew dictatorships and Central and Eastern Europe shooed off communism because it promised prosperity. The system’s legitimacy is fading now. The poor see hardship and widening inequality. The middle class see that their children are worse off. The economic depression across the Eurozone has created hordes of dispossessed voters. Voters appear willing to torment the political elite whom they blame for such social and economic ructions, especially when they are shown to be corrupt. Investors will need to protect themselves against European political risks during 2015 and beyond.
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