Eurozone Quakes

by The Financial Guru 1 Jan 2012

Currency has been a hot topic of late and it is no wonder given what has been happening in the Eurozone, which is making waves worldwide no matter how far removed you are as a nation from the epicenter of the current financial quakes.

It might be easy to think that in Asia, where we are seeing a relative boom compared to the rest of the global economies, that it does not matter. But you would be wrong to think that, and here is why.

You see, the conventional wisdoms of investing in bonds have, essentially, been turned on their head thanks to the current sovereign debt crisis.

Ordinarily, bond funds will invest in the countries that are the biggest issuers of bonds, the likes of the traditional, old economies such as Italy, France, the UK and Germany. Yet there is an irony to this method – these countries are the most indebted nations, by definition, so are consequently the most likely nations to default when it comes to paying their debts.

Bonds are essentially an IOU from a nation – or company, if we are talking about corporate bonds – where the entity in question agrees to pay you a set amount of interest for an agreed period of time, and at the end of that term you will get your investment back. Relatively simple really, and it is a good way of allowing you to plan for events in the future, for example a retirement income.

However, where it becomes complicated is where the country – or company – is not in a position to pay your money back because they no longer have enough in assets to repay it. Then it would default, and would be considered bankrupt unless a renegotiation of the debt, or some refinancing, can be arranged.

Now, that is what is going on in Europe right now, the EU nations are working hard to try and prop up those that have effectively overspent on the assets they have, and can no longer afford to pay their debts.

They are struggling to refinance, because the amount they have to pay to encourage new countries or bond funds to buy their bonds is so high that there is real concern they will not be able to repay any more money that is made available to them.

They are faced with the prospect of decreasing their currency valuation, or defaulting – neither of which is particularly appealing to their populations who have savings and assets that would also be devalued.

Italy, Greece, Portugal, Ireland, Spain and now France and Belgium are all either having to make significant cuts to their spending to try and balance the books, or are being caught with the contagion that those countries who have already needed bailouts – Portugal, Ireland and Greece – have precipitated across the region.

Italy and Greece now have unelected technocrats running their parliaments, as they are in dire need of tough economic decisions being made, not popular political decisions. The future of the euro itself is now being openly questioned, with Jacques Delors, one of the main architects of the euro, admitting it was flawed from the very beginning.

So what we are seeing is a situation where the traditionally strong, old economies are becoming too risky to invest in, despite their increasing interest payments. In contrast, you have relatively new economies, such as China, which has a strong foreign currency reserve – the only country to hold more dollars than China is America itself – and strong growth prospects going forward.

Yet because it is not regarded as a traditionally ‘strong’ economy, China is still paying high rates for its borrowing, despite there being less chance of it actually defaulting on its debt. This is not the only country in this position either, bonds from Qatar, Singapore, Abu Dhabi, Dubai and Russia are also of interest, for the same reasons.

So if there is one thing the ‘New World Order’ – at least financially – is telling us, it is that you should not discount funds that invest in what are often considered to be more risky economies. As things stand, it could be a question of the Far East and Middle East taking a greater lead in global finance than ever before in the years to come.

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