JUNE 2012                                                                                                               

Europe Needs an African Lifeline.


As Southern Europe begins to resemble and take on the tell-tale signs of emerging markets of yesteryear, perhaps it is time to harken back to old fashioned remedies. One such nugget comes from the African continent. The dual-currency policy that South Africa ran from 1961 to 1995 provides a potential but overlooked possibility to the Euro predicament.

Germany’s wish list for Europe is logical:

  1. Southern Europe must become more competitive;

  2. A currency revaluation is needed without any member state exiting the Euro; and

  3. The payment mechanism of the Euro should remain intact.

Germany does not want to open its cheque book and start recapitalising the European banking system, as this would represent an endless risk with an unknown cost.

The current options being discussed by A-list economists in the financial press range from the re-introduction of the drachma, to massive printing of money, to, finally, (mein Gott!) Germany themselves withdrawing and returning to the Deutschmark; the printing press is the preferred option.

However, an obscure financial edifice from Africa may provide an answer to German prayers. 

A Bid / Offer spread

South Africa, from most of the time between 1961 to 1995 ran two classes of Rand, the financial Rand and the commercial Rand. This mechanism, simply stated, was a very wide bid-offer spread which rewarded foreign investment into South Africa and discouraged outflow; the currency ran at two distinct rates. By way of an example at March 1993 the financial Rand was at $1=R4.50 while the commercial Rand rate was $1=R3.15. This meant that there was an in-built devaluation for South Africans wishing to take their Rand out of the country of approximately 40%. On the other hand, there was a massive incentive for foreigners to invest. Over time the two rates converged and the Rand became the currency we know today.

Greuro not Grexit

If we take Greece as an example, why could we not have an internal and devalued Greek Euro and a standard European Euro? The internal Greek Euro would trade at a substantial discount and therefore immediately make Greek assets look more attractive. Furthermore there would be greater margin for Greek goods and Greece would become much more competitive; importantly the Euro payment system would remain intact.  As Greece returned to health, over a period of time, there would be no reason why the Greuro’s discount to the Euro would not narrow and eventually disappear.

Such a mechanism could be used to deal with the entire European periphery as they struggle with their debt levels and recession-bound economies.

The Immoveable Object?

If we remain with Greece - what would be the outcome for their financial system? Most clearly, Greek banks would become completely localised; their balance sheets would shrink, as would their profits (or the potential to make them again). They would, in effect, return to being more like utility companies rather than highly leveraged risk-takers.

However, such a solution represents the feared Achilles heel of global financial services - capital controls. These have been applied with great skill by emerging economies, such as China, but are considered an anathema by developed countries, their financial institutions and the majority of economists, all of whom pray at the altar of mobile capital.

End Game

So we are left with three choices:

  1. Revert to local currencies with all the unknowns;

  2. Print Euros, with all the consequences; or

  3. Introduce short-term capital controls.

Africa does provide a model for a potential Euro solution that does not require any new printed capital or taxpayer monies. It also highlights that the chief tension in Europe may lie not between member states but, actually, between national governments and their financial institutions.

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