EU warns euro may disappear as political, economic risks rise
on December 4, 2015

Schengen Dec15a

The excellent new Spielberg movie, Bridge of Spies, vividly captures the building of the Berlin Wall in 1952.  It also reminds us of the excitement when the Wall fell, and European borders reopened after 47 years.

Now, Europe’s borders are closing again, pressured by vast Syrian refugee movements and terrorist massacres. France, Germany, Austria and Sweden have all “temporarily” reimposed border controls within the Schengen passport-free travel zone, whilst Hungary’s fences, as the photo shows, even resemble those of the old Iron Curtain.

Even more worrying is that the European Union will today discuss suspending the Schengen zone for 2 years – essentially confirming the return of national borders between major countries such as Austria and Germany.  In addition, it will increase the pressure on Greece to leave Schengen – whose financially crippled administration has been swamped by the arrival of 700k refugees and migrants this year.

It is only 3 months since I was interviewed by the BBC on the threat posed to business by a Schengen breakdown. Since then, the threat has become even more serious, with the President of the European Commission warning:

“A single currency does not exist if the Schengen fails.

The problem is Europe’s failure to agree a centrally-organised mechanism to enforce its border.  This parallels its failure to implement a centrally-organised system of banking supervision, which is at the heart of the ongoing Eurozone debt crisis:

  • National governments will not work together to establish both mechanisms as quickly as possible
  • Thus the problems get worse, and allow euro-sceptic parties across the EU to claim exit is the only solution

Of course, Europe is not alone in trying to avoid tackling difficult issues.  One of its problems is that these twin crises are taking place at a moment when the cracks are showing in key parts of the global financial system – Emerging Market debt, and the high-yield Western “junk bond” market.

As Carl Icahn warned recently, the central banks’ policy of low interest rates forced investors to take on more risk –  but also meant investors became involved in markets they didn’t understand

  • They all wanted to believe in the concept of the Commodity SuperCycle: but now commodity exporters in a wide arc from Brazil through S Africa, Australia, Asia, Middle East and Russia are suffering as this myth is exposed
  • The Institute of International Finance has warned their $27tn of debt means companies “in many emerging markets will face difficulties in servicing their debts and in incurring new debts to support economic growth.  It is another headwind adding to the slowdown in growth that emerging markets face.
  • A similar problem is affecting US energy investors: they bet $1.2tn on the idea that oil prices would always stay at $100/bbl, but now defaults are becoming common
  • High yield, triple-C rated debt has fallen 6% so far this year, whilst double-B debt now yields 8% – its price has fallen by around a half in the past 2 years (bond prices move inversely to yields)

Of course, one could argue that these investors simply got what they deserved, and simply illustrate the principle that “a fool and his money are soon parted”.  But the big money is being lost by pension funds and other major investors.

Thus the problems in debt markets add to the social and economic problems created by the Eurozone debt and refugee crises.  Unless these are quickly resolved, they threaten to overwhelm the progress made since the fall of the Berlin Wall.  It could be a very difficult 2016, if policymakers continue to duck discussion of the key issues.

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