A safe haven in the middle of a crisis-bound Europe

The coronavirus crisis poses an enormous challenge for humanity as well as for policymakers and central banks. This particularly applies to the Eurozone, where COVID-19 has brought the fragility of the euro and the economic imbalances within the monetary union back to light once more. A prime example is the debate surrounding “coronabonds” and a mutualization of European sovereign debt. Today it is already foreseeable that wealthier northern countries like Germany, for example, will be asked to pay up in some form or other in the future. A deeper political and societal polarization could turn out to be another adverse side effect of the pandemic. The contrast with independent, prosperous Liechtenstein is starker than ever in the current crisis. The tiny country in the heart of Europe combines the best of two worlds and is once again proving to be a safe haven in times of elevated uncertainty.

 

The coronavirus is likely to keep us preoccupied for quite some time yet…

The coronavirus crisis poses a tremendous challenge for humanity as well as for policymakers and central banks. In the days and weeks ahead, the nations of Europe will embark on an initial attempt to inch their way back to normalcy, an exercise that won’t proceed smoothly and seamlessly, but is more likely to be marked by intermittent setbacks. Because until there is an effective vaccine against the novel coronavirus, “carrying on as before” is unrealistic from a medical standpoint.

There will be no return to the “pre-corona era” for the world and the Eurozone member states, neither from an economic nor political perspective. Quite the contrary, in fact, the impending recession and governments’ fiscal measures to mitigate the pandemic’s economic impact look destined to cause sovereign debt in the Eurozone countries to balloon in the years ahead. As debt levels surge, the existing economic imbalances between poorer southern Europe and wealthier northern Europe will widen even further. The International Monetary Fund (IMF) projects that sovereign debt in Italy, for example, will increase from 135% of annual gross domestic product at present to 160% by the end of 2021. A sharp rise in sovereign debt is also being forecast for Germany, the main economic heavyweight in the Eurozone. But after years of conservative budget management, Germany can actually afford to raise government spending for a while.

 

Costly economic stimulus packages
Government debt in the Eurozone countries looks set to explode

Sovereign debt in relation to gross domestic product

Source: IMF, Kaiser Partner Privatbank

 

…and exposes the weaknesses of the Eurozone

The public health crisis, though, won’t just lead to ballooning debt and economic pain – it also threatens to severely rupture European Union (EU) unity. At their virtual summit meeting on April 23, the EU heads of state and government approved an aid package worth up to EUR 540 billion in the form of loans from the European Investment Bank (EIB) and the European Stability Mechanism (ESM). On paper, the summit participants also agreed to set up a new joint European recovery fund to provide targeted economic assistance specifically to the regions and sectors hit hardest by the crisis. But it’s one thing to agree that more money is needed, and quite another to actually reach an agreement on precisely how much money is required and, above all, where it is to come from. And this harder part is exactly where EU unity doesn’t live up to its billing. The southern countries want economic aid to be disbursed to EU member states in the form of grants, not loans. The government of Italy has particularly been advocating for the EU to collectively guarantee debt, for example by issuing “coronabonds”.

Germany is under the spotlight…

This kind of risk-sharing is out of the question for the countries of northern Europe, not least due to fears that it would lead to a resumption of lax budget discipline on the part of the southern European countries. The past weeks have thus seen frequent bickering at the highest political level between the EU member states, as well as a renewed flare-up of speculation about the EU’s viability. In the midst of the current crisis, Germany in particular is standing more than ever at the center of discussion and attention. Labeled “the sick man of Europe” back in the mid-2000s, Germany has since enjoyed a more than 10-year economic expansion that has massively extended its growth and prosperity lead over southern Europe. Much of that owes to the weak euro, which has fueled Germany’s export-driven growth model.

 

Widening gap
Germany is outpacing the south

Per capita economic output, indexed

Source: Bloomberg, Kaiser Partner Privatbank

 

…and will probably be asked to pony up cash

Without the European monetary and economic union, Germany would be considerably less well off today, and German policymakers know that. To keep the European project afloat and the euro from imploding, and ultimately to safeguard its own prosperity, financially sound Germany is likely to reach deeper into its coffers and make certain transfer payments to the south in the future, albeit not necessarily in a form that’s readily visible at first glance.

The enormous coronavirus stimulus package enacted by Germany’s federal government and stepped-up funding for the European Union are bound to cost an awful lot of money. Although the economic emergency leaves little room for it right now, sooner rather than later discussions will emerge about who has to pay for all of the spending. In any event, today there is already reason to expect that the Germans will soon want to revert to customary budget discipline. Today’s expenses will undoubtedly increase the debt burden on future generations, but already in the nearer term, there will probably be mounting pressure to raise taxes on the wealthier part of society.

 

The contrast between Liechtenstein and the troubled European Monetary Union could hardly be starker in the current crisis.

 

 

Assailable wealth

We see a number of more or less realistically conceivable ways in which coronavirus debt could be paid down:

Higher taxes and wealth confiscation: Imposing a higher tax burden on part of the population would be easy to execute and easy to communicate, at least to a certain section of the political spectrum. Calls for such a move have already been raised lately by the hardline Left and Social Democrats. The German Institute for Economic Research also recently put forth two proposals on how to remedy the damage caused by the pandemic. One of its suggestions is a coronavirus solidarity tax surcharge that would add an extra 7.5% per annum to the regular income tax bills for the richest tenth of taxpayers. The other is a one-time wealth tax under which a certain percentage of assets above a certain level would have to be ceded to the state in a lump-sum payment or installments. From today’s perspective, the second proposal in particular still looks like just a leftist thought experiment. But the possibility of it coming true can’t be dismissed entirely because the coronavirus crisis is bound to sharpen the divide between social classes, even within the rich countries of northern Europe. So, a political pivot to the left in the years ahead cannot be ruled out.

Higher inflation: The recession expected this year looks destined to involve much deeper growth contractions than the ones during the 2008/2009 financial crisis. It will definitely have a deflationary effect in the near term. The longer-term prospects for inflation, though, aren’t necessarily clear-cut. The implemented fiscal and monetary policy actions are unprecedented in their nature and magnitude. Meanwhile, central banks around the world are engaged in a race to print money. A big chunk of the sovereign debt in the years ahead looks set to end up on central banks’ balance sheets. It cannot be ruled out that all of this will lead to rising inflation rates at some point, also due to dwindling confidence in paper money. Furthermore, the public health crisis will likely turn back the clock a bit on the last few decades of globalization. This, too, would tend to have an inflationary impact.

Weak euro: Although a weak currency isn’t a direct means of financing sovereign debt, it nonetheless is a form a wealth erosion for globally oriented citizens. The common currency called the euro looks destined to come out of the public health crisis weakened, at least compared to a fundamentally sound currency like the Swiss franc, which has once again proven itself as a bastion of security in recent months. Low government debt, economic agility, a large current-account surplus, legal security and an independent monetary policy – all of these virtues should keep the franc on a long-term uptrend against the euro in the future.

 

Bastion of security
The Swiss franc is the stronger currency

EUR/CHF exchange rate

Source: Bloomberg, Kaiser Partner Privatbank

 

The contrast: Safe-haven Liechtenstein

The social and political climate appears set to tend to take a turn for the worse in the aftermath of the coronavirus crisis. Pressure on “the higher-ups of society” is bound to intensify. If economic well-being and entrepreneurship become imperiled, it is more justified and necessary than ever to look for alternatives.

Liechtenstein presents one such alternative. The contrast between Liechtenstein and the troubled European Monetary Union could hardly be starker in the current crisis. The tiny country in the heart of Europe is an epitome of political continuity and stability. The principality boasts a triple-A sovereign credit rating and is debt-free. Moreover, it combines the best of two worlds: Liechtenstein is tied to Switzerland through a customs and monetary union and has direct access to both the European Economic Area (EEA) and the EU. This unique combination facilitates attractive growth prospects in areas including the financial services industry. A liberal economic policy and moderate corporate taxes make Liechtenstein a great place to base business operations. Throughout its history, the principality of Liechtenstein has always stood for innovation, liberty and entrepreneurship.

Due to the extraordinary geographical and political situation, banks in Liechtenstein like Kaiser Partner Privatbank have always been dependent on thinking and operating across borders. Founded in 1977 in the Liechtenstein capital Vaduz, Kaiser Partner Privatbank has a solid equity capital base. Decades of experience in investments with a focus on capital preservation distinguish the family-owned private bank.

Learn more about our services here or feel free to contact our Private Banking Team.

 

Roman Pfranger
Head Private Banking
Oliver Hackel, CFA Macro and Investment Strategy, Behavioral Finance and Technical Analysis

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