The european rescue plan and greece bailout - how does it impact you?
At Newport Partners, our perspective is always the same – how does an issue affect the personal and business affairs of our entrepreneur clients and their families?
It was very evident last week that investors were looking past Greece’s debt woes to the much larger fiscal problems in Europe. Bold measures were needed to calm the waters ...and fast! The authorities sent a forceful message to the market – “we will do what has to be done”.
Quickly, here is a summary of what happened:
- The European Union (EU) and the International Monetary Fund (IMF) combined to make credit available of 750 billion Euros to EU member countries;
- This new plan was in addition to the loan to Greece of 110 billion Euros to Greece to allow it to meet upcoming debt payments and avoid bankruptcy;
- This is the first bailout by the EU since it was established in 1999;
These steps will only be successful over the long term if the culprits are brave enough to follow through with tax increases, reduced wage and spending cuts.
So, the panic is over …for the moment. But let’s look out a little further and discuss what the longer term implications might be.
Problems of this nature mostly affect the cost of money and the currency.
The Euro, now at US 1.265, is at its lowest level in a year. Six months ago, it was US$1.50. How things change. Only 12 months ago, we were all wondering how low the US dollar would go! Now, the USD is regaining its status as the “safe haven” currency.
There has been a similar flight to quality in terms of the cost of money. We have all been expecting interest rates to rise, especially short term rates. Yet, 10 year US bond yields have fallen from 4% to 3.59% in the last six weeks. The European turmoil has contributed to this trend, both in Canada and the U.S. Our bond rates fell 0.15% last week which inspired local lenders to reduce mortgage rates by a similar amount.
It is easy to forget that we have faced these situations in the past. – the Mexican peso crisis of 1994, the economic meltdown in Asia in 1997 and the Russian financial crisis of 1998. In each case, there were financial rescues, devalued currencies and a “flight to safety” by international investors.
But we did learn that the flight to safety is somewhat short-lived. As the clouds clear, the more important factors start to drive the markets. In a few months, the markets will be focused on what is more important – earnings in the case of stocks and inflation in the case of interest rates.
So how does the Greece turmoil affect you? We identified three possible items of consequence to you:
Cost of Borrowing Money – The troubles might slow the inevitable climb in interest rates. But, we believe that it will only be temporary. The general trend is up as the authorities move away from the emergency levels and put short term interest rates into “neutral”.
Currencies – Do you do business in Euros? If so, we believe there are long term consequences here. About 25% of US corporate revenues are derived from Europe. Certainly, these economies are going to be weakened by the events of the last week. And do not expect the Euro to recover. The troubles in the EU have reversed the momentum that carried the Euro to US1.50.
European Economy – Does your portfolio include European investments? If so, make sure that they are global companies as domestic companies will be facing a very sluggish economy. The austerity measures to be implemented in Greece, Spain and Portugal (and others) are going to have a material impact on economic growth.
