How much time does the euro have left? That question was put on its edge last week when the Swiss National Bank decided it was no longer going to anchor the Swiss franc to the iceberg-bound euro ship. It was a wise decision for a number of reasons, the most compelling one being that the euro faces insurmountable challenges in the years ahead.
In fact, the Swiss decision was de facto a death spell for Europe’s currency union. More specifically, I noted that the euro…
survived the Greek depression of 2012 by a razor-thin margin. Now it faces three very serious threats to its own survival. The first is the upcoming Greek elections, where anti-austerity, anti-euro, pro-Hugo Chavez Syriza looks like winners. Should they emerge victorious they could very well initiate a Greek exit from the currency union. The euro would survive that, and the German government has a contingency plan in place to stabilize the euro. But then there is the Greek government debt… Syriza has openly declared that they want “debt forgiveness” for governments throughout Europe. If the drachma is reintroduced, it will very likely plummet vs. the euro, making it exceptionally difficult for Syriza to repay its loans to the EU and the ECB. A default is within the realm of the probable; remember the Greek “debt write down” three years ago.
If all the problems for the euro were tied to Greece, the currency would indeed have a future. But there are so many other challenges ahead for the common currency that nothing short of a miracle – or unprecedented political manipulation – can keep it alive through the next three years.
The biggest short-term problem – Greece aside – is the pending announcement by the ECB of its own Quantitative Easing program. Reuters reports:
The European Central Bank will announce a 600 billion euro sovereign bond buying program this week, money market traders polled by Reuters say, but they also believe this will not be enough to bring inflation up to target. In the past two months traders have consistently predicted that the ECB would undertake quantitative easing, considered the bank’s final weapon against deflation. Eighteen of 20 in Monday’s poll said the bank would announce QE on Thursday.
This highly anticipated European QE program must be viewed in its proper macroeconomic context. It is going to be very different from the American QE program. For starters, the balance between liquidity supply and liquidity demand was very different in the U.S. economy than it is in the euro zone today. After its initial plunge into the Great Recession the American economy slowly but relentlessly worked its way back to growth again. Since climbing back to growth in 2010 the U.S. GDP has grown at a rate slightly above two percent per year. This is not something to throw a party over, but it has allowed the economy to absorb much of the liquidity that the Federal Reserve has pumped into the economy.
By being able to absorb liquidity, the U.S. economy has avoided getting caught in the liquidity trap. Growth rates have been good enough to motivate businesses to increase investment-driven credit demand; households have gotten back to buying homes and automobiles (car and truck sales in 2014 were almost as good as in pre-recession 2006).
The European economy does not absorb liquidity. It is stagnant, and has been so for three years now. The ECB has pushed its bank deposit rate to -0.2 percent, in other words it is punishing banks for not lending enough money to its customers. Despite this ample supply of credit there are no signs of a recovery in the euro zone, with GDP growth having reached the one-percent rate once in three years.
In other words, the positive outlook on the future that motivates American entrepreneurs and households to absorb liquidity through credit is notably absent in the European economy. When the ECB now evidently plans to pump even more liquidity out in the economy, it appears to not understand how significant this difference is between the euro zone and the United States.
Or, to be fair, with all its highly educated economists onboard, the ECB most certainly understands what role liquidity demand plays in an economy. Its pending decision to launch a QE program appears instead to be based in open ignorance of the lack of liquidity demand.
Which leads us to ask why they would ignore it.
The answer to this question is in the declared purpose of the QE program. If it is aimed at buying treasury bonds, then the QE program clearly is not designed to re-ignite the economy, an argument otherwise used. If QE is supposed to monetize government deficits, then its purpose is really to secure the continued existence of the European welfare state. If that is the purpose, then the only safe prediction is that there will be no end to QE before the welfare state ends.
That, in turn, means the ECB would be stuck monetizing deficits for the rest of the life of the euro. Which, under such circumstances, would be a relatively short period of time…
More on this on Thursday, when the ECB is expected to announce its QE program. Stay tuned.
Three years have passed since Greece simply nullified part of its debt. In the last quarter of 2011 the Greek government owed its creditors 356 billion euros; in the first quarter of 2012 that debt had been reduced to 281 billion euros, a reduction of 75 billion euros, or 21 percent. The banks that owned Greek treasury bonds were strong-armed by the EU and the ECB into accepting the debt write-down; ironically, that only added insult to injury as banks in, e.g., Cyprus started having serious problems as a result of precisely that same write-down.
As some of you may recall, a bit over a year after the Greek government unilaterally decided to keep some of the property lenders had allowed them to use – in other words wrote down their own debt – banks in Cyprus began having problems. Having invested heavily in Greek treasury bonds they had to take a disproportionately impactful loss on their lending to Athens. As a direct result the EU-ECB-IMF troika began twisting another arm: that of the Cypriot government. They wanted the government in Nicosia to order the banks in Cyprus to replenish their balance sheets with – yes – money confiscated from their customers.
That little episode of assault on private property is also known as the Cyprus Bank Heist.
Both these events, which exemplify reckless disrespect for private property and business contracts, make Bernie Madoff look like a Sunday school prankster. Unlike Madoff, government is established to protect life, liberty and property. But in both Greece and Cyprus government has voided property rights simply because it is the most convenient way at the time for government to fund its operations.
In other words, to protect the welfare state at any cost.
There were many of us who thought that Europe’s governments had learned a lesson from the massive protests against both the Greek debt write-down and the Cyprus Bank Heist. Sadly, that is not the case. Benjamin Fox, one of the best writers at EU Observer, has the story:
With fewer than three weeks to go until elections which seem ever more likely to see the left-wing Syriza party form the next Greek government, the debt debate has returned to the centre of European politics. Syriza’s promises to call an end to the Brussels-mandated budgetary austerity policies … are not new … But what is potentially groundbreaking is Syriza’s proposal to convene a European Debt Conference, modelled on the London Agreement on German External Debts in 1953 which wrote off around 60 percent of West Germany’s debts following the Second World War
Apparently, Syriza does not think twice about the actual consequences of their proposal. If it was carried out, it would have the same kind of effects on Europe’s banks as the last debt write-down. While there are no immediately reliable sources on how much of the Greek government debt is owned by financial corporations, we can get an indirect image from other euro-zone countries in a similar situation. In Spain, e.g., banks owned 54.3 percent of all government debt in 2013; in Italy the share was 55.6 percent while 41.2 percent of the French government were in the hands of financial corporations.
Adding up actual debt for these three countries, both total and the share owned by banks, gives us a financial-corporation share of almost exactly 50 percent. Using this number as a proxy for Greece, we can assume that banks own 160 billion of 320 billion euros worth of Greek government debt.
A Greek debt write-down according to the Syriza proposal would, if it cut evenly across the total debt, force banks to lose 86 billion euros. And this is under the assumption that, unlike the last write-down, banks are treated on the same footing as everyone else. Back then banks had to assume a bigger shock than other creditors.
The 2012 write-down was worth a total of 75 billion euros.
Has Syriza even taken into account that families, saving up for retirement, own treasury bonds? In Italy they own as much as ten percent of all government debt, a share that would equal 32 billion euros in Greece. But even if that number is five percent – 16bn euros – and you ask them to give up 60 percent of it, the impact on remaining private wealth in Greece would be devastating.
To make matters worse, Syriza does not confine their confiscatory dreams to their own tentative jurisdiction. Benjamin Fox explains that Syriza hopes that a write-down in Greece…
would lead to a huge write-down of government debt for … other southern European countries. The idea was initially mooted by Syriza leader Alexis Tsipras in 2012 when the left-wing coalition finished second in the last Greek elections. Roundly dismissed as fantasy for almost all the two years since then, the proposal is at the heart of the party’s campaign manifesto and Syriza insists it won’t back down if it wins the election.
In the three countries mentioned earlier, Italy, Spain and Greece, banks own a total of 2.47 trillion euros worth of debt. A 60-percent write-down of that equals 1.58 trillion euros. Compare that, again, to the total Greek write-down of three years ago of 75 billion euros.
In Italy alone households own 215 billion euros in government debt. Is the socialist cadre leading Syriza ready to rob them of 89 billion euros just to improve their government’s balance sheets? That would be 1,500 euros for every man, woman and child in Italy. Obviously, all of them do not own government debt, but the more concentrated the ownership is the bigger the impact will be on their economic decisions.
This is, for all it is worth, an idea of galaxy-class irresponsibility. If it ever became the law of the land in Europe it would set off a financial earthquake far beyond what the continent experienced in 2009. And I keep repeating this: all of this is under the assumption that banks will not be discriminated against – an assumption that is not likely to survive all the way to a deal of this kind. Europe’s socialists have a tendency to despise banks and consider them unfair, even illegitimate institutions. It is possible that Syriza, at least as far as Greece is concerned, would force banks to eat the entire write-down loss.
But is this really worth all the drama? After all, the Greek election is three weeks out. Benjamin Fox notes that “Syriza is so close to taking power that the proposal deserves to be taken seriously.”
This debt write-down is part of a broader plan that Syriza has put in place for the entire European Union. To work at the EU level the plan would have to be more complex and involve a series of transactions involving the European Central Bank that, frankly, amount to little more than macro-financial accounting trickery. At the end of the day, those who have lent money to Europe’s governments would make losses worth trillions of euros.
As things look today it is not very possible that Syriza would have it their way across the EU. But it is almost certain that they will go ahead and do it in Greece. What the ramifications would be for the Greek economy is difficult to predict at this point – suffice it to say that the storm waves on the financial ocean that is the euro zone will rise again, and rise high, if Syriza wins on January 25.
The stagnant European economy does not need more bad news. Unfortunately, there is more coming. Business Insider reports:
The amazing collapse in German bond yields is continuing. Today, five-year bonds (or bunds) have a negative nominal return for the first time ever. That means that investors buying a 5-year bond on the market today will effectively be paying the German government for the privilege of owning some of its debt. This has been happening for some time now. In 2012, people were amazed when 6-month bund yields went into negative territory. In August, the two-year yield went negative too. Less than a month ago, the same thing happened with the country’s four-year bunds.
While there is a downward trend in bond yields in most euro-zone countries, there is a clear discrepancy between first-tier and second-tier euro states. Ten-year treasury bond yields, other than Germany:
- Austria, 0.71 percent, trending firmly downward; France, 0.83 percent, trending firmly downward; Netherlands, 0.68 percent, trending firmly downward; Italy, 1.87 percent, trending firmly downward.
A couple of second-tier examples:
- Ireland, 1.24 percent, trending weakly downward; Portugal, 2.69 percent, trending weakly downward.
Greece is the real outlier at 9.59 percent and an upward yield trend. But Greece is also a reason why Germany’s bond yields are turning negative. Although the Greek economy is no longer plunging into the dungeon of depression, it is not recovering. Basically, it is in a state of stagnation. Its very high unemployment and weak growth is coupled with an ongoing austerity program, imposed by the EU, the ECB and the IMF.
Add to that the political instability which, in late January, will probably lead to a new, radically leftist government. Syriza’s ideological point of gravity is the Chavista socialism that has been practiced in Venezuela over the past 10-15 years. They are also vocal opponents to the EU-imposed austerity programs, an opposition they would have to deliver on in case they want to stay relevant in Greek politics.
If Greece unilaterally ends its austerity program, it de facto means the beginning of their secession from the euro. That in turn would raise the possibility of other secessions, such as France, where a President Le Pen would begin her term in 2017 with a plan to reintroduce the franc. When that happens, the euro is history.
There is no history of anything similar happening in modern history, which makes it very difficult for anyone, economist or not, to predict what will happen. Europe’s political leaders will, of course, want to make the transition as smooth and predictable, but without experience to draw on there is a considerable risk that the process will be neither smooth nor politically controllable. Add to that the inability of econometricians to forecast the transition; based on the numerous examples of forecasting errors from the past couple of years, there is going to be little reliable support from the forecasting community for a rollback of the euro.
That is not to say the process cannot be a success. But the window of uncertainty is so large that it alone explains the investor flight to German treasury bonds.
This uncertainty is also throwing a wet blanket over almost the entire European economy, an economy that desperately needs growth and new jobs. Since 2010 the EU-28 economy has added 800,000 new jobs, an increase of 0.37 percent. For comparison, during the same time the American economy has added eleven million jobs, an increase of a healthy 8.5 percent.
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While this year is promising for many, especially Americans who have a steadily improving job market to search for new opportunities, the outlook on the new year is hardly better in Europe today than it was a year ago. As far as Europe is concerned, 2014 went down in history as the year of squandered hopes for a recovery. I have lost track of all the forecasts that predicted “the” recovery take-off during last year, though it would be valuable for future reference to collect all the “squandered hopes” forecasts. There is a lot to be learned from the serial failures of econometrics-based forecasting during 2014.
The reason why Europe is nowhere near a recovery is that its political leadership is doing absolutely nothing to address the fundamental structural problem of their economy. The welfare state is still in place and its austerity policies have been driven by an urge to save the welfare state – make it slimmer and more affordable – so that it can fit inside a smaller economy with high unemployment and weak tax revenues. But it is precisely these efforts that have escalated the current crisis to a level where – as I explain in my book – it has now become a permanent state of economic affairs.
So long as Europe’s leaders refuse to acknowledge the nature of the economic crisis, they will continue to inject the patient with the medicine that perpetuates the illness.
There are some lights in the tunnel, for sure. The Greek economy has, of late, shown signs of transitioning from an almost unreal ratcheting down into an economic depression to a state that is at least a little bit promising. Its vital macroeconomic signs indicate stagnation rather than decline, which is hardly something to write home about, but good news for people who on average have lost 25 percent of their income, their jobs, and their standard of living since the beginning of the Great Recession.
Sadly, just as the Greeks were being given an opportunity to catch their breath, their elected officials went ahead and caused an early parliamentary election to be held in late January. If current opinion polls are correct, the next prime minister will be Mr. Tsirpas of the Syriza party – a radical socialist group that considers deceased Venezuelan president Hugo Chavez and his authoritarian government a good role model.
Greece does not need an economic model that has caused high unemployment, eradicated property rights and brought about 63 percent inflation. Greece needs major free-market reforms, thoughtfully executed and coupled with growth-generating tax cuts.
But Greece is not the only EU member state that is struggling. France is going nowhere, and going there fast. The socialists in charge in Paris stick to their tax-to-the-max policies, which is part of the reason why the country is going into 2015 with record-high unemployment. Economic forecasters, perhaps burned by last year’s irresponsibly positive predictions, now expect a 0.4-percent increase in real GDP for 2015. That is much more realistic.
Overall, when predicting Europe’s future, one should not ask “when is the economy going to recover?” but “what reasons do the European economy have to start growing again?”.
Again, there is not much positive to look forward to for our European friends. However, it is better to talk about things the way they are, and then find a solution to the problems thus identified, than to pretend that everything is really not what it really is.
Europe has a lot of potential. It could join us here in America and restore prosperity, hope and opportunity for the entire industrialized world. If Europe chooses to do so, we have a future to look forward to that is almost unimaginably positive.
If, on the other hand, Europe’s political leaders stick to their statist guns, their continent will continue on its current path to becoming the next Latin America. It will no longer be even close to comparison with the United States, whose economy will continue its ho-hum economic recovery through 2015 and 2016. Beyond that, it depends entirely on who is elected president next year. If it is a Republican friendly to Capitalism, like Rand Paul or Mitt Romney, we will know for certain that there will be good, growth-promoting tax and spending reforms. A more mainstream-oriented Jeb Bush or Chris Christie would also be good, but not only second-tier good.
Even a fiscally conservative Democrat would be preferable to the kind of leadership they have in Europe.
Hopefully, there can be some libertarian-inspired change for the better in Britain thanks to the seemingly unstoppable UKIP. Maybe – just maybe – that could inspire a surge of support for libertarian ideas elsewhere in Europe.
I spent some time traveling Eastern Europe before the Berlin Wall came down. I have many vivid memories of my trips, such as the very low-tech cars they all were so proud of. But I was also impressed with some things, like the breakfast on the overnight train through East Germany – a gourmet experience you could not even get in first-class intercontinental flights at that time. Or the beauty of Prag and Budapest, two of Europe’s most prominent, historic cities.
Perhaps the most painful experience was the sense of perennial economic stagnation. It was almost as though they all lived in a 1950s time capsule, from the enormous, inefficient and highly polluting industrial “combinates” to the design and quality of furniture and home electronics (to the extent it even existed).
Children grew up to the same standard of living that their parents experienced. And their children had nothing more optimistic to look forward to.
Fast forward a quarter century. The Great Recession is hurricaning its way through the European economy. Panic-driven tax increases, combined with spending cuts designed not to shrink government, but to preserve the welfare state, add insult to injury in country after country. The entire continent falls into the dungeon of economic stagnation.
Year after year go by without any discernible improvement on the horizon. All of a sudden, half-a-billion people have no reason to believe in a better tomorrow.
To me, and to anyone who had the opportunity to see first hand what life was like in Communist Europe, this is a painful deja-vu experience. One generation after the fall of the Berlin Wall and the opening of unlimited opportunities to hundreds of millions of people from Saxony to Sakhalin, new skies have descended over the former Soviet empire. The part of it that remained under the Russian sphere now struggle with political instability and an economy that seems to be moving backwards.
The countries that chose the European Union for their future are not in much better shape. They are now part of a bigger economy that may have elevated them to a higher standard of living, but is now keeping them from further growth. If anything, people all over Europe now have to worry that their children and grandchildren will not be able to lead a more prosperous life than they have.
A new era – the same stagnation.
Industrial poverty, for short.
The insights of this long-term trend are slowly spreading. While 2014 has been the year of dashed hopes for a recovery, it looks like 2015 might be the year of painful insights. Those are coming little by little, slowly spreading from writer to writer, from analyst to analyst. A good example of someone who seems to be joining the ranks of the frustrated yet insightful is Peter Kohli, who writes for NASDAQ about Greece:
On November 13th, I wrote an article on this website on how to take advantage of a possible turnaround in the Greek economy, because of certain positive reports I had read. However, it seems that things have changed rather quickly and that the Presidential elections there have been moved up to next week, beginning on December 17th.
The lack of steady economic recovery is taking a political toll on the country. This is not surprising – the channels between politics and the economy are strong in Europe’s welfare states, where government is promising to cater to almost every need people may have. During the fall from relative prosperity in 2007 to the dark, frustrating dungeons of economic depression in 2012, Greek voters expressed their very deeply felt dissatisfaction with their government by voting for two radical and fundamentally anti-democratic parties: Syriza with its Hugo Chavez-style bolivarian socialist platform, and Golden Dawn, the first openly Nazi party to take seats in a European parliament since the 1930s.
Earlier this year it looked like there might be a recovery under way in Greece. However, as more data came online, it quickly became clear that this was merely a transition from depression to stagnation, an insight that very likely has made its way into the hallways of Greek political power. Alas, the election concerns that Kohli writes about. Back to his article:
Ordinarily this would not be a problem, except that there are no candidates for the post yet. In Greece, the election of a president is done by the legislators, who need a supermajority – which they don’t have. If after three successive elections they fail to install a candidate, a general election will be called, and here is where the real problem lies. Currently, the far left anti-austerity party, Syriza, is way ahead in the polls and they are promising to basically roll back nearly all the plans to put the country back on the path of prosperity instituted by the current government.
Well, that path is not exactly a path. It is more of a picture on the wall. But that is a minor point here. Let’s listen to Kohli’s conclusion:
This sent shivers down the spines of many investors, causing the ATHEX Composite Index (GD) to plummet 12.78% on December 9th, another 1% the following day, and then down a further 7.35% the next. Subsequently, the only single-country Greece ETF (GREK), has been hit hard and is down a whopping 39.28% YTD. After making some significant positive steps, I thought the Greeks were on their way back, but this is another Greek tragedy in the making.
It is indeed. If the Greeks do elect Syriza, there is a not-insignificant risk of two major crises forming a perfect storm:
- The attempt to roll back austerity will lead to the only thing worse than those policies, namely reckless tax hikes; an abandonment of EU-imposed austerity could also lead to a Greek euro exit, with currency free-fall and massive inflation as a result; the economy would be hurled back into depression; and
- The Nazis in Golden Dawn will not tolerate a government they would consider to be downright Communist; with their penchant for “creative” extra-parliamentary politics, and their deep support among the armed forces and the police, this would pose a direct threat to Greek democracy.
Europe needs to choose between the welfare state and prosperity. Irrefutable evidence shows they cannot get both. The question is: what will it take for them to realize the terms of the choice? The Greek situation may be extreme, but it is extreme in quantity, not in quality. The architecture for a similar development is present in several other European countries: Spain, Portugal, France…
In a few articles recently I have pointed to some evidence of an emerging economic recovery in Spain and Greece. This is not a return to anything like normal macroeconomic conditions, but more a stagnation at a depressed level of economic activity. To call it a “recovery” is a stretch, but given the desperate circumstances of the past few years, an end to the depression is almost like a recovery.
The transition from a depression with plunging GDP, vanishing jobs and overall an economy in tailspin, to stagnation where nothing gets neither better nor worse, is in fact a verification of my long-standing theory. Europe has entered a new era of permanent stagnation – an era best described as industrial poverty – and is slowly but steadily becoming a second-tier economy on the global stage. The path into that dull future is paved with decisions made by political leaders, both at the EU level and in national governments. While they do have the power to actually return Europe to global prosperity leadership, they choose not to use that power. Instead, their economic policies continue to destroy the opportunities for growth, prosperity and full employment.
In fact, Europe’s leaders have the opportunity on a daily basis to choose which way to go. The difference is made in their responses to the economic situation in individual EU member states. Let us look at two examples.
First out is an article from Euractiv a month ago:
Greece is “highly unlikely” to end its eurozone bailout programme without some new form of assistance that will require it to meet targets, a senior EU official said on Monday (3 November). “A completely clean exit is highly unlikely,” the official told reporters, on condition of anonymity. “We will have to explore what other options there are. Whatever options we may be adopting, it will be a contractual relationship between the euro area institutions and the Greek authorities,” the official said.
How will the EU, the European Central Bank and the International Monetary Fund respond to this? Will they continue to impose the same austerity mandates that they began forcing upon Greece four years ago? Back to Euractiv:
The eurozone and IMF bailout support of €240 billion began in May 2010. Greece is in negotiation with EU institutions and the International Monetary Fund ahead of the expiry of its bailout package with the European Union on 31 December. Athens has said it wants its bailout to finish when EU funding stops, though the IMF is scheduled to stay through to early 2016. The EU official said he expected eurozone ministers and Greece to decide on how best to help Athens at a meeting of finance ministers in Brussels on 8 December.
If the EU decides to continue with the same type of bailout program, thus continuing to demand government spending cuts and tax hikes, then their response to this particular situation will continue the economic policies that keep Europe on its current path into perpetual industrial poverty.
The second example, France, also presents Europe’s political leadership with a fork-in-the-road kind of choice. From the EU Observer:
France’s finance minister cut the country’s deficit forecast for 2015 on Wednesday (3 November) adding that Paris will be well within the EU’s 3 percent limit by 2017. Michel Sapin told a press conference that he had revised France’s expected deficit down to 4.1 percent from the 4.3 percent previously forecast, as a consequence of extra savings worth €3.6 billion announced by Sapin in October.
That sounds good, but what is the reason for this improved forecast – and, as always with optimistic outlooks in Europe, can we trust it?
The extra money does not come from additional spending cuts but instead from lower interest expenses from servicing France’s debts, a reduction in its contributions to the EU budget, and extra tax revenues from a clampdown on tax evasion and a new tax on second homes. “We have revised the 2015 deficit … without touching the fundamentals of French economic policy,” Sapin told reporters.
This also means they have done their debt revision without seeing a change for the better in “the fundamentals” of the French economy. In other words, no stronger growth outlook, no sustainable improvement in business investments or job creation. As a matter of fact, a closer look at the measures that Mr. Sapin refers to reveals a frail, temporary improvement that will not put France on the right side in any meaningful macroeconomic category:
- A lower interest rate on French government debt is almost entirely the work of the European Central Bank and its irresponsible money-printing; the French are paying lower interest rates on ten-year treasury bonds than we do here in the United States, but that will last only for as long as investors remain confident in the ECB’s version of Quantitative Easing; interest rates will quickly start rising again once that confidence is shattered – and it will be shattered as soon as investors realize that, unlike in the United States, the European economy will not start growing again;
- Reduced French EU contributions come at the expense of other countries and likely won’t last very long; as soon as other countries have grown impatient with the French, they will force Paris to increase its contributions again; besides, this “reduced EU contributions” thing is basically just an accounting trick – effectively it means that the EU has reduced their demands on how much France needs to cut its deficit to be “compliant”;
- A new second-home tax is a tax increase to which taxpayers will make the necessary adjustments; they will move from owning a home to renting one or to extended-stay vacations at luxury hotels; once that adjustment reaches a critical point the French government will have lost the new revenue and their hopes of being “compliant” with the EU deficit requirement will fade away.
If the French government spent all the political and legislative efforts that went into these measures, on structural reforms to the French government, then France would be en route to a major improvement in growth, jobs creation, business investments and the standard of living of their citizens. But that is not going to happen. All they do is try to comply with the same old statist rules that have forced them to balance their budget – and save their welfare state – instead of promoting the prosperity of their people.
There is a painful shortsightedness in European fiscal policy, one that almost entirely prevents the political leadership of that continent to look beyond the next fiscal year. It is time for them to stop, raise their eyes to the horizon and think about where they want their continent to be ten years from now.
If they don’t, I can surely say where they are going to be: in an era of industrial poverty, colored by three shades of grey, where children are destined to – at best – live a life no better than what their parents could accomplish. Think Argentina since the decline and fall of their 15 years of global economic fame.
Think Eastern Europe under Soviet rule.
It is very easy to establish that Europe’s economy is stuck in a state of deep, solid stagnation. As I have explained recently, you have to look carefully to find any exceptions to that rule. However, those exceptions exist in the form of Greece and Spain. So far neither country has reached a state of real recovery – so far their economies have elevated themselves out of the deepest part of a depression, but their economies have so far only risen to the same state of stagnation that has slowly but steadily spread to the entire continent.
That is not to say Spain and Greece can’t do better. They can. To find out more about their economies I decided to review the value-added side of their economies. For those of you who are not macroeconomic nerds, there are three ways to calculate GDP: the income approach, the expenditure approach and the value added approach. The third is the least commonly used one, mostly because it does not say very much about the two major forms of activity in an economy such as the European: private consumption and government spending. However, value added can tell us a great deal about what industries are flourishing and which ones are doing poorly.
The following four industries represent almost 40 percent of the Greek economy:
Correction: the industry labeled “Tourism etc” should really be “Wholesale trade, tourism etc”.
This is unfortunately not the image of an economy in steady recovery. Manufacturing, which is only responsible for nine percent of the added value in the Greek economy, is definitely in a state of stagnation; if all the talk about an exports renaissance in Europe were true, Greek manufacturing would be surging.
Instead, it is “Wholesale trade, tourism, etc” that is on a clear trajectory to recovery. Producing 22 percent of the value added, this industry is labor intensive and close to consumers. The sustained improvement in activity is encouraging and has a potential for spreading its upturn to other sectors. First and foremost, it could mean that the young in Greece, whose chances of finding a job – any job – is the worst in the industrialized world, might regain some sort of faith in the future. That would be good for the long-term stability of both the economy and the Greek democracy.
That said, the figure of the Greek economy also shows that the other major industries are still in decline – or at least were in decline through the second quarter of this year. Greece needs a lot more to regain some of its status as an industrialized economy with a future.
Things look a bit different in Spain:
Together, these four industries are responsible for 46 percent of the total value produced in the Spanish economy. The three recovering industries represent 38 percent of total value added, a share big enough to positively affect the rest of the economy.
Adding to the cautious optimism about the Spanish economy is the fact that the growth rate of value added in two of the three recovering industries is actually accelerating. Manufacturing saw accelerating growth in five consecutive quarters:
|Wholesale, Tourism etc||-2.45%||-0.64%||1.07%||1.35%||1.69%||2.83%|
It deserves to be repeated that in total, the Spanish economy is still very much in recession mode. Austerity is still a real fiscal-policy threat, and the declining euro-zone interest rates pose a threat in terms of renewed financial speculation. However, the sectorial recovery has enough momentum that if it is allowed to continue, it will give the Spanish economy a reasonable shield against moderate negative shocks.
That said, should austerity again come to define fiscal policy at the levels it saw in 2012, there is a substantial risk that the recovering industries will fall back into recession mode. They will then pull the entire economy back down into the hole of depression.
Bottom line: Greece is far from out of its depression, farther than a cursory analysis would show. Spain on the other hand is worth watching closely.
In a couple of articles recently I have noted that Greece and Spain seem to be breaking the ranks of economic stagnation in Europe. While we wait for Eurostat to release third-quarter GDP data, let us take a look at what has happened on the job front in those two countries.
Let us, first of all, make one thing clear: a recovery as traditionally defined in the macroeconomics literature is not necessarily a recovery from a crisis of the kind Europe is now stuck in. This crisis is structural – permanent by default – and it will take a permanent change in the structure that perpetuates the crisis in order to end it. We may see an improvement in economic activity without such changes, but that improvement will not be strong enough to actually recover these economies.
A real recovery means a permanent elevation of economic activity above the two-percent growth threshold. Greece and Spain are far away from that threshold – even if they occasionally hit it in one quarter, it does not mean that they have recovered.
That said, there is one area where the Greek and Spanish economies are at least showing some resiliency: the job market. Analyzing Eurostat employment data we find quite a few interesting factoids.
Both Greece and Spain saw stronger job growth in Q2 2014 than the euro zone as a whole. In Greece the total number of employed persons grew by 1.58 percent over the previous quarter; in Spain the increase was 2.37 percent. For the 18-country euro area as a whole, job growth was a modest 1.21 percent.
In Q1 2014 total Greek employment increased by 0.11 percent, while Spain saw a 1.07-percent decline. Both numbers beat the euro zone where total employment fell by 1.57 percent over the previous quarter, Q4 2013.
Annually, the improvement is not quite as impressive. The Greek economy only grew total employment by 0.1 percent in Q2 2014 over Q2 2013. For Spain, the number was better at 1.1 percent, clearly beating the euro zone’s 0.3 percent. But both Greece and Spain lost jobs in the first quarter over same quarter previous year: employment was down 0.6 percent in Greece and 0.5 percent in Spain, while euro-zone employment expanded by 0.2 percent.
Nevertheless, looking back, the Greek economy has clearly been moving in the “right” direction for some time. Their annual quarter-over-quarter employment numbers have been improving for five quarters in a row now. This means four quarters of smaller and smaller decline, and again one quarter with an improvement year-to-year. The Spanish economy has seen a similar trend, though not quite as pronounced as in Greece.
The euro zone, by contrast, is not exhibiting any clear job-creation trend. Year to year, its quarterly employment numbers vary within a narrow band: from a decline of one percent to 0.4 percent growth. This verifies that the Greek and Spanish economies are bucking the trend, and this in turn calls for a deeper analysis of why that is happening. Furthermore, it means finding out whether or not it is realistic to expect the improvement trend to continue.
There is more good news for Greece and Spain: both countries have been able to turn around, or almost turn around, the employment situation for their young. In the age group 15-24, Greece has again seen five straight quarters of improving numbers: three quarters of a slowdown in job losses and two straight quarters, Q1 and Q1 2014, of actual growth in youth employment. For Spain, the trend is again not as pronounced – young Spaniards are still losing jobs – but at least situation is not worsening nearly as fast now as it did in 2012. For Q1 2014 Spanish youth employment fell by 4.7 percent; for Q2 2014 it fell by 1.2 percent. By contrast, the first two quarters of 2013 the decline was 14.7 and 12.4 percent, respectively.
In this area the euro zone is still very much in trouble. Consider these changes, quarterly year-over-year, to youth employment in the 18 euro-zone countries:
|Euro-18 youth employment change||-3.94%||-3.05%||-2.88%||-2.71%||-3.01%||-2.75%|
As soon as third-quarter GDP data is out we will take a close look at them. Then we will get a good opportunity to asks whether or not Greece and Spain are indeed recovering, or if their job improvement numbers are merely a reflection of the end of the harshest austerity measures known to free men (outside Sweden) since the 1930s.
European third-quarter GDP growth data is beginning to make its way out in the public. What we have seen so far is just more of the same new normal – the same new stagnated way of life in industrial poverty.
Starting from the aggregate level, Eurostat’s third-quarter growth report says that the EU-28 grew at 1.3 percent per year in Q3 of 2014 over the same quarter 2013. The euro zone’s growth rate was half-a-percentage point lower at 0.8. This difference is the same as over the past few years: the last quarter where the euro zone grew faster than the entire EU was in Q1 of 2011. It shows that austerity is still taking a tougher toll on Europe’s core countries than its non-euro members on the outer rim.
Or, to make the same argument from the other side: if you are a European welfare state, it pays to keep your own currency.
The growth numbers for the EU and the euro zone are poor in and by themselves. By not even coming close to two percent per year, Europe is not even able to reproduce its own standard of living. But even worse is the fact that the U.S. economy grew by more than two percent annually for the second quarter in a row: 2.3 percent in Q3 of 2014, compared to 2.6 percent in Q2 of 2014. This growth disparity is slowly becoming a self-reinforcing phenomenon: when global investors see that the U.S. economy is growing while the Europeans are standing still, they choose to reallocate their investments to the United States. That way investments and new jobs go to where investments and new jobs are already going.
But does not that mean that the U.S. economy will run into inflation problems that, in turn, will even out the differences between the United States and Europe? No, not necessarily. In fact, that is a very unlikely scenario. We are now rising to become the global leader in producing energy, with costs far below those of European countries. Right-to-work states offer a union-free manufacturing environment, something that, e.g., Volkswagen successfully took advantage of when they opened their new plant in Tennessee. The large US-only Passat they build there is a runaway sales success, $7,000 cheaper and selling ten times more (100K units per year) than its German-built predecessor.
Long-term, it looks like manufacturing is making its way back to the United States. This does not bode well for Europe, whose exporting manufacturing industry has, basically, been the only part of the economy that has not sunken into the three shades of gray that is industrial poverty. That European manufacturing is in trouble is well proven by the Eurostat report, according to which Germany has seen a decline in growth for two quarters in a row: now down to 1.2 percent on an annual basis.
Another supposedly big manufacturing economy, France, barely finished the third quarter with growth at all: 0.4 percent over Q3 of 2013. Austria’s growth is also dwindling, with 0.3 percent this quarter compared to 0.5 in Q2 and 0.9 in Q1.
The only real positive news is that the Greek economy showed annual growth for the second quarter in a row – at 1.4 percent this quarter – with growth numbers improving steadily for a year now. Spain also shows positive growth, 1.6 percent, with a similar upward long-term trend.
Neither the Greek nor the Spanish number is anything to write home about, but it looks like the two countries are slowly recovering from the bad austerity beating they took in 2012 and 2013. It is an extremely hard journey back for both of them, though, especially for Greece which lost one quarter of its economy to destructive austerity policies. The welfare states of both Spain and Greece have now been recalibrated, so that government budgets paying for the welfare states will balance at a much lower employment level than before. This means, effectively, that government will begin to net-tax the economy and thereby cool off a growth trend long before full employment is restored.
This structural problem is entirely unknown to Europe’s lawmakers – and, frankly, to almost every economist on the planet. I defined the problem in my book Industrial Poverty; if unsolved, this problem will guarantee permanent economic stagnation in Europe for, well, ever.
That said, I don’t want to spoil the fun for Greek and Spanish families who are now seeing the first glimpse of daylight after a long, horrible nightmare. Let them celebrate today; tomorrow they will still be living in industrial poverty.
Retail trade is one of the better indicators of how an economy is doing. It is an immediate “gauge” of both confidence and private finances of consumers. Therefore, given the overall stagnant nature of the European economy, the latest report on retail trade from Eurostat has some valuable information in it:
The 1.3% decrease in the volume of retail trade in the euro area in September 2014, compared with August 2014, is due to falls of 2.2% for the non-food sector and 0.1% for “Food, drinks and tobacco”, while automotive fuel rose by 0.9%. In the EU28, the 1.2% decrease in retail trade is due to a fall of 2.1% for the non-food sector, while “Food, drinks and tobacco” remained stable and automotive fuel increased by 0.4%. The highest increases in total retail trade were registered in Malta (+1.0%), Luxembourg (+0.9%), Hungary and Slovakia (both +0.7%), and the largest decreases in Germany (-3.2%), Portugal (-2.5%) and Poland (-2.4%).
Month-to-month changes are not that important. The one detail here to note, though, is the big contraction in Germany. It is a small but noteworthy sign that the German economy, as this blog has reported before, is leaving a period of exports-driven growth and returning to the new European normal, namely stagnation.
The Eurostat memo also reported annual data:
The 0.6% increase in the volume of retail trade in the euro area in September 2014, compared with September 2013, is due to rises of 0.9% for “Food, drinks and tobacco”, of 0.6% for the non-food sector and of 0.5% for automotive fuel. In the EU28, the 1.0% increase in retail trade is due to rises of 1.5% for the non-food sector and 1.2% for “Food, drinks and tobacco”, while automotive fuel fell by 0.2%. The highest increases in total retail trade were observed in Luxembourg (+12.3%), Estonia (+9.1%) and Bulgaria (+5.6%), while decreases were recorded in Finland (-3.2%), Poland (-1.8%), Denmark and Germany (both -0.8%).
Again Germany shows up on the negative side, reinforcing the impression that the largest economy in Europe is no longer its locomotive.
On the upside, there is one interesting detail worth noting. Greece has experienced three months in a row of annual, inflation-adjusted retail sales increases: four percent in June, 4.6 percent in July and 7.4 percent in August.
Is this an early sign that the Greek depression is coming to an end? Let’s hope so.