Investor Pessimism

Lately, I have been reading a lot about investors, banks and nations preparing for the worst case scenario. It seems that the definition for "worst case scenario" differs from time to time: a Greek exit, a Euro collapse, a banking collapse, a Eurozone collapse and so on. Obviously one has to prepare for such events. What I always thought to be weird is that people always prepare for "worst case scenarios" only after recessions or severe economic blows occur. One should never be worried by pessimism or optimism in the markets. Although they may last long in many cases, they are always alternating. They are both outcomes of human nature, a sort of behaviour that was the same throughout the years.

All of the great investors throughout history understood this. People are always prone to good or bad feelings. A bear market (e.g. a falling index in the stock exchange) occurs when people feel overly pessimistic about the present and the future and a bull market (the exact opposite, a rising index) occurs when people feel overly optimistic about it.

A great example of this is the banking situation nowadays. Banking institutions after expanding rapidly in the last decade (overly optimistic) are now contracting their business operations to operating only at the local level (overly pessimistic). Cross-border lending is steadily declining in the EU reaching 2007 levels in last June. Otmar Issing, a former ECB chief economist states: "Over the long term, the monetary union can't be maintained without private investors,because it would only be artificially kept alive." While this is true and many feel that getting rid of their assets in euros and buying gold or real estate is a great idea, others have gone even further by removing themselves from the monetary zone. 

Many investors are even betting against the euro surviving. John Paulson, who made billions shorting (i.e. selling something now - e.g. a stock or a currency - in hope of buying it later at a lower price and thus profiting with the difference) during the sub-prime lending crisis in the US and the now retired George Soros stated that they are betting against the common currency. 

As for me, I wouldn't worry about bank contraction. Both economies and firms contract and expand as they react to the general feelings of threat or hope for the future. A crisis is a good opportunity for people, firms, economies and states to learn from their mistakes. What I hope is that politicians and policymakers will realize the need for action. Even late action is better than no action, however too late would mean the end of the euro as many investors prophesied.

Two-Speed Euro aka the Moses Plan

It has been proposed before and it seems that it's back in vogue: Make a 2-speed euro. The idea is that richer countries like Germany, Finland, Luxemburg, Austria and others, should have an "expensive" euro, whilst Greece, Spain, Italy and others which face problems should be better off with a "cheaper" euro. I like to call this the Moses solution (think of what he did to the Red Sea). The rationale is that now, the Euro is too cheap for rich countries (whatever that may mean!), while it is too expensive for the poorer ones.

It is not the first time something like this has been proposed. The main problem in the Eurozone is non-integration and what is the brilliant solution of some economists? An idea that divides the EU even more. Remember what I said about economists and real life?

The idea is simply absurd: First of all what does it mean that a currency is too cheap for a rich country? I don't think that the Germans are having trouble sleeping because their exports have boomed, due to a falling euro. The same holds for all other "rich" countries. Second, what defines what a rich country is? Ireland was a rich country before 2008 but I don't believe that anyone would consider letting them in the "rich" country ghetto now.

As in the case of Ireland, a nation may be rich one year and in the next, faced with an unprecedented disaster (of any kind not just economic) may fall into the "poor" class of countries. What would happen then? Just change to the low currency and if the country gets back on its feet change back to the expensive one again? I do not think that the public would really much appreciate this, having to change their hard money every time the economy takes a downturn. The future is unpredictable and uncertain. No country can guarantee that it will be solvent and trustworthy in the future.

Another important consequence is that there will be a "rich country ghetto" in the Union. To be accepted into the rich currency you will have to be accepted by the already existing countries, which would breed political disputes. The same problems would occur when a country should be exited from the rich country union as nations would be reluctant to dismiss a country like Germany, even if it has sever financial problems.

What economists with no real-life experience fail to see is the infeasibility of a Moses plan and the disastrous consequences that it may have if it is applied. Now is the time for more union and more integration. Dividing the EU would be a step towards breaking it up. I do not think that if the South US states had a problem, Bernacke would divide the dollar into two. Why should we?