Political risk and monetary policy are affecting investors, says AGI’s Neil Dwane
As governments across Europe implement austerity measures and contemplate necessary structural reforms in their respective countries, political risk is weighing heavily on markets and affecting investors through greater volatility, says Neil Dwane, CIO Europe at Allianz Global Investors
Politics is a predictably important theme for 2012. The extent of austerity measures varies depending on the country, but all politicians need to balance what is necessary with what is politically acceptable – in particular where elections are looming.
The positive benefits of austerity measures and, even harder to achieve, structural reforms will take time to achieve. In the meantime, as the spectre of austerity takes hold we are starting to see emerging signs of an EU-wide recession, which is impacting markets.
When thinking about austerity, it is important to consider that it has taken between 13 and 20 years of EU convergence for Greece or Ireland or Italy or Spain to get itself into the problems that we now see on our screens and in our newspapers. It therefore could take more than 10 to 15 years to get out of those problems. This is not a quick fix.
We have seen austerity lead to default. Greece has recently defaulted on half its government debt. Markets believe it will default again on quite a lot of the remainder of its debt. Thus, the jury is very much out as to whether austerity will work. You cannot have everybody including the government, the private sector and the financial sector saving at the same time. Greece’s economy has fallen 17% in the last three years and there is no sign yet that it will actually start growing in the next two or three years. So we have some serious economic issues around austerity that investors, politicians and society in general needs to consider.
With various elections to look forward to and speculate about, 2012 and 2013 are going to be very exciting from the political perspective. We can expect both bond and equity markets to have moments of volatility and nervousness as we look through the uncertainty of who is going to win these elections and what type of policy they are going to be able to enforce.
On the other side of the coin from the politicians, we have the central bankers. We have what I describe as the Fantastic Four – the Federal Reserve, the Bank of Japan, the European Central Bank (ECB) and the Chinese Central Bank – have so far ridden to the rescue of the global economy in the last three or four years. They have done so by collectively putting somewhere between $8 trillion and $10 trillion into the global economy. That is the equivalent of monetising the entire one year output of the US GDP. This monetary policy has so far stopped a global recession and has actually allowed the banking system to start to heal and for world trade and other activities to recommence.
However, monetary policy – particularly on this scale – is ultimately inflationary and creates tremendous volatility in currencies. Aggressive monetary policy has led to concerns about the rising gold price and rising commodities as the providers of those commodities have seen the commodities rise in real terms relative to the US dollar because there are now a lot more US dollars around. Investors and savers must realise that this type of policy has consequences.