We’ve seen this movie before.

Europe moves towards greater unity. Economic tensions develop. Speculators challenge the weaker countries. Markets are volatile. The call goes out for the strong countries to support the weak. The Germans resist, a crisis ensues, and eventually, a new structure is enacted.

The year is 1998; the structure is the ERM, or exchange-rate-mechanism. European currencies traded within narrow bands, supported by their central banks. Inevitably traders would test support for the “soft” currencies like the Lira or Drachma, and the call would go out for Germany to defeat them by buying unlimited quantities of Lira. The Germans resisted, on the grounds that the new Deutschmarks would eventually find their way back and stoke inflation.

Eventually, they developed the Euro. Now all the countries had the same currency, which would stop the attacks. And it did for a while—until speculators discovered that they could raid the “soft” countries’ debt instead of their currency. Once again Germany is being called upon for support. Month-after-month they are being asked to provide funding for the European Financial Stability Fund. But this support cannot be unlimited.

This explains the growing excitement over Eurobonds. Replacing eurozone national debt with obligations recognized by all euro-governments is a replica of the Euro-currency. This would cost each country control over its credit—which explains why the AAA countries are nervous. The concessions necessary to get them to participate will be enormous. People don’t easily relinquish their wallets—but that’s what it will take.

Douglas R. Tengdin, CFA
Chief Investment Officer
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