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Ruffer: the right question to ask

The estimable and splendidly ideosyncratic private client fund manager Jonathan Ruffer, whom I profiled a couple of years ago in The Spectator, has some thoughtful points on the prospects for Europe in his most recent monthly investment review. Here is a short extract, in which he points to the underlying frailty of the European project, about whose future he is not optimistic:

The Treaty of Rome in 1957 was a great moment for the peacemakers, but now its architects are dead, as are pretty much all those who felt the visceral despair in the darkness of the late 1940s. That hope has been replaced with a sort of Communism: power divorced from economics. Just as Russia could not keep control when the figures didn’t add up, nor can Europe. It is only a question of time. So, when does it all end? I think it is a mistake to try and guess. Observers of 1980s Russia fell into two categories: those who thought things would continue as they were forever, and those who could see the pressure, the inconsistencies, and imagined that the crisis would strike a week on Thursday. Nevertheless, it is striking on my return to find how far the status quo has shifted in Europe since March. It’s the same tune, to be sure, but the violins have been replaced by cellos.

So when will it happen? Perhaps a better question is, ‘in what way will it happen?’, because it elicits the obvious answer that it ends when people have had enough and express their intolerance in extreme ways. Imbalances in a national balance sheet do not end a regime, but when the regime stops paying civil servants, the police, the doctors, and the army, the end comes, and comes suddenly. When looking for its signs it is worth keeping an eye on two separate things: are depositors taking their money out of the banks, and are the taxpayers paying their taxes? Once an inflection point is reached, both these bad dynamics unravel quickly and it has to be said that in certain countries these things have already happened. The tax take in Athens is already down by 20%, and in those countries where taxes are always to an extent voluntary, the inflection point will come sooner rather than it otherwise would.

In Spain, the first five months of the year (arguably before the crisis had set in), bank withdrawals turned out to be frighteningly higher than expected: just short of €100 billion. The sinister thing about these figures is that they were largely represented by corporate withdrawals, not domestic individuals. The reason for this is, of course, that companies have the sophistication and the contacts to be able to move their money internationally. The peasant in Toledo is as beady as the CFO of a Spanish trading company – probably more so – but he does not yet have the access to the escape hatch. If he has the desire and the will to stab the Spanish economy, it will not be long before he finds the knife.

The analogy with the former Soviet Union is an apt one in many ways, I fear, even if some may find it provocative. One reading of market movements in the few weeks since Mr Ruffer wrote his comment is that investors have become more confident that the latest Eurozone rescue plan, with the European Central Bank actively involved, now has a better chance of working.

That may of course be right, although the habit of imputing grand conclusions to short term market movements flies in the face of everything we know about the essentially random nature of markets over such limited periods of time. A more prosaic explanation is that equity markets were oversold when Mr Draghi, the ECB’s president,  made his “euro will be saved” declaration and are beginning to look overbought now, while the reverse is true of eg gilt and bund yields after their panicky swoon in June.

In any event I am still to be convinced.  Mr Ruffer’s warning is borne out by history: when ambitious but flawed projects like the euro collapse, they often do so suddenly and without warning (at which point their demise is deemed to have been inevitable all along). The truth is that Mrs Merkel and co still have a mountain to climb if they are to keep the Eurozone intact in its present shape, and with the political battle lines being drawn ever more sharply ahead of some critical events in September, you would be wise not to bet against at least one more phase of serious market nervousness before the issue is more clearly resolved.

Written by Jonathan Davis

August 20, 2012 at 4:39 PM