Bill Jamieson: Will America break the eurozone deadlock?

FEAR, uncertainty, paralysis – the eurozone crisis is freezing up the economy and markets. For investors, the deepening stand-off in the eurozone and the worsening outlook at home has brought a sense of entrapment.

Sovereign debt strains are moving from the periphery to the core. There is a clear sense that this crisis is now coming to a head, with an outcome that could see world stock markets plunging to their lows of March 2009 and below.

How do we get out of this? The desperate hope in markets is that German chancellor Angela Merkel and the European Central Bank (ECB) will relent and agree to stand behind debt-stricken eurozone members through a massive quantitative easing programme. Should this happen, stock markets in Europe and around the world would bounce very sharply upwards, mocking the growing number of those who have sold out in recent months. If it doesn’t happen, we could be in for the mother of all market collapses.

This is increasingly affecting financial markets beyond the eurozone and multiplying the risks we now face. But it may also be the source of salvation.

There are formidable obstacles to the view that a German capitulation will miraculously lift the black clouds now gathering over markets. First, bail-outs by the ECB are outlawed by European Union treaty.

Second, such a volte face could be political suicide for Merkel, who is accountable to a German electorate already apprehensive over the consequences of opening the monetary sluice gates. It is not just the haunting historical fear of hyperinflation that accounts for German reluctance to go down this route; the country’s post-war economic success has been largely founded on monetary stability. A nation throws this away at its peril.

Third, it would be seen to be letting high-spend, high-debt countries off the hook, enabling them to carry on as before in the knowledge that they would always be bailed out.

And fourth, there is no guarantee any such easing – surrounded as it would be by conditions giving Germany effective oversight and control over national budgets – would be acceptable to voters. They would resent such oversight, fuelling political divisions and undermining the very integration Merkel advances as a solution.

This is the paralysing deadlock we have now reached. Its immediate result is a deepening economic contraction across Europe. However, exposure by no means stops there. According to ratings agency Fitch, America’s five biggest banks have $188 billion (about £119bn) of gross exposure to France alone, including $114bn of exposure to French banks, equivalent to a quarter of their Tier One capital.

JPMorgan Chase and Goldman Sachs, two of the biggest traders of credit derivatives, have sold protection on more than $5 trillion of debt – much of it on the debt of eurozone countries. Hence the ominous signs of another freezing of interbank lending.

So if the ECB is reluctant to step up as lender of last resort, who might? Veteran market commentator Ed Yardeni suggests the US Federal Reserve will spearhead the formation of a Global Liquidity Facility (GLF) to avert a global financial meltdown.

He says: “Fed chairman Ben Bernanke demonstrated he is a master at putting together such emergency measures back in 2008. In effect, it would act as the world’s central bank. Bernanke is clearly very worried about the prospect that the European sovereign debt crisis is a contagion that could spread to the US.

“The GLF would receive deposits from the Fed and other participating central banks, including the ECB. The funds would be used to buy the bonds of debt-challenged governments that would be required to accept strict supervision of their fiscal and regulatory policies by the IMF.”

This would be immediately credible in markets, acceptable to voters in debt-stricken countries and would move the world back from the brink. It would be a humiliation for the eurozone political elite. But I suspect their protestations would be drowned out by a world-wide sigh of relief.

Venturing capital

Last week’s “Where to From Here” investment evening organised by The Scotsman was a huge success, with more than 200 attendees at the Hilton Grosvenor, Edinburgh. All five speakers rose to the occasion, with Robin Angus of Personal Assets Trust providing the most memorable quip of the evening – “Eurozone finance ministers like sweating contestants in The Apprentice waiting to be fired by Alan Sugar” – which lit up the audience.

As is often the case, the best questions are never asked until afterwards. With so much emphasis being placed by speakers on index-linked bonds, gold, and defensive equities such as Vodafone, Tesco and Centrica, one attendee questioned me afterwards on how much investors would put into venture capital start-ups given the urgent need to encourage – and finance – the creation of new businesses.

It is a moot point: in the rush to capital protection we may be starving capitalism of the means of its survival – fresh risk capital. For those interested, the Association of Investment Companies has an excellent guide to venture capital trusts and the tax reliefs available at www.theaic.co.uk