The Ukraine conflict is taking a toll on the Euro-zone and it could result in finally pushing it over the edge. Everything flowing from Russia's incursion poses a big negative for the region which is already struggling. When you couple soaring energy prices with stagnate growth and a growing trade balance with China you have the recipe for disaster. This is also apparent on the inflation front.
According to Reuters, the Euro-zone inflation rate surged to yet another record high in
May. Inflation accelerated
to 8.1% in May from 7.4% in April. A big part of the problem is that it is no longer just
energy pulling up the headline figure. Looking past the headline figure, we find excluding food
and energy prices, inflation rose to 4.4%
year-on-year from 3.9%. This puts pressure on the European Central Bank to increase rates further. The timing of such a move is horrible in that Europe's dust-up with Russia has brought to the forefront just how weak Europe is.
Lurking in the background is the strong possibility that the Ukraine conflict will drag on and Russia could completely cut off gas to Europe. Currently, it appears Russia intends to keep Europe from filling storage, this will substantially increase Russia’s
leverage in the winter months. Already talks of gas rationing are being floated if we see further cuts to Russian gas supplies. In
the past three months, Russia cut off supply to several European
countries that refused to pay for gas in rubles and has also
substantially reduced the flow through the Nord Stream. This has cut off supplies to France and reduced flows to Germany by some 60
percent.
With inflation running at 4 times the ECB's 2%
target, ECB policymakers are facing the toxic mix of raising rates at the same time the economy is shifting into reverse. The choice between galloping inflation, and political instability due to economic misery, is difficult. Hoping to tame inflation and thread the needle, ECB President Christine Lagarde
is moving to raise rates. Some
policymakers and economists doubt small moves will be enough, especially
since underlying inflation is showing no signs of abating.
Due to supply chain problems
following the pandemic, then as a result of Russia's war in Ukraine, prices have been soaring across Europe. This suggests that a
new era of rapidly rising prices is now sweeping away a decade of ultra-low
inflation. What many economists tried to blow off as a transitory
jump in prices is now becoming embedded into the economy. The
fear is that once high energy prices flow into the economy, inflation
will get entrenched and eventually perpetuate a
price-wage spiral. A jump in negotiated wages to broadening
core inflation remains a growing risk.
Data from the European Union's statistics agency,
Eurostat, is only adding to the euro-zone's woes. It shows the euro zone's trade balance swung to a record deficit in January
from a surplus a year earlier as the cost of imported energy increased
sharply. The euro-zone's trade deficit in
goods, the difference between exports and imports, was 27.2 billion
euros ($30.17 billion) in January, compared with a EUR10.7 billion
surplus the same month a year earlier.
The Euro-zone has already endured a lot of problems what it does not need is another refugee crisis this time caused by food insecurity across
North Africa or the emergence of an energy-scarce winter as 2022 comes to a close. The EU abandoned all structural reforms in 2014
when the ECB started its quantitative easing program (QE) and expanded
the balance sheet to record levels. Considering the above, it is difficult to remain optimistic that The European Union is on the right track.
Volkswagen CEO Herbert Diess told the FT in a recent interview that a prolonged war in Ukraine would be "very
risky" for the European and German economies. According to the FT, Diess
said the economic damage from the war could be "very much worse" than
the pandemic. A slowing economy combined with inflation produces stagflation. If the economy crashes, it will crush savings and cause European corporates to default.
A big factor I fear many economists are not honing in on is that the Euro-zone region simply isn't competitive. The EU lacks technological and intellectual property and
is falling further behind the U.S. and China. Germany, the
regions manufacturing powerhouse continues to skirt along narrowly
escaping recession while France, Spain,
and Italy face years of large unemployment levels. The ugliness is exacerbated by the fact that roughly 80% of the Euro-Zone's real economy is financed by a banking
sector that
carries more than 600 billion euros in non-performing loans.
As of 2017, not a single
European company ranked among the top fifteen technology companies in
the world and only four of the top 50
global technology
companies are European. This is why skeptics are concerned that if the
politically directed
"Green New Deal" agenda doesn't boost growth or reduce debt the
Euro-Zone will remain economically stagnate. At the beginning of last year, to
generate the impression of hope, the EU's leaders in Brussels tried to pull a rabbit out of the hat by strengthening ties with China.
The EU-China comprehensive investment agreement
clearly signifies a significant shift in EU policy towards Asia. The
proposed deal dovetailed with Beijing's "One Belt, One Road" (OBOR)
initiative and follows the signing of an agreement made with Italy which
is viewed by many as bankrupt. Last year, in
what was considered a bold move the Italian Prime Minister signed
a historic memorandum of understanding with Chinese President
Xi Jinping in Rome. The agreement made Italy the first
founding EU member, and the first G-7 nation, to officially sign on to
OBOR in hopes it would shore up its weak prospects.
The
ramifications flowing from Italy's deal with China may, in the end,
prove to be a deal with the devil. The key motivation behind
China working to reach a deal with poor, weak, but lovable Italy was its
desire to exploit Italy and use
it as a backdoor into the broader Euro-Zone market. The deal China and
Italy inked contained development deals
covering
everything from port management, science and technology, e-commerce,
and
even soccer. The fact that China now has control of entry
points into the European Union that can be lawfully expanded upon does not bode well for the region.
According
to data from Eurostat, the EU has for years enjoyed a trade
surplus with the U.S.
(meaning it exported more to the U.S. than it imported) in 2019. The
problem the European Union faces is that it imports
far more from China than it imports. Imports from China to the EU surged by more than a fifth last year to
472 billion euros ($522 billion) compared to 2020. This widened the bloc's trade deficit with China to 249 billion
euros. The deficit with China is not
an outlier but highlights a trend that has been growing. Expect the
surplus with America to drop in the future and the deficit with China
to grow.
It could be argued Brussels
is leading the EU into an ambush, Europe cannot hold its own against
China. Both the United States and the European Union have
a long history of complaining that China wants free trade without playing fair. To think
China is a tiger that has suddenly changed its stripes borders on
insanity. The EU is likely to find this is not the first time that China signs such an
agreement without respecting it. Europe which has seen its manufacturing sector debased by cheap
knockoffs from China and other low-wage countries will gain nothing by bringing more of these goods into their market. China exploits its trading partners by exporting goods at slightly below cost in order to
draw manufacturing jobs
from other countries. This has the potential to hasten the demise of Europe.
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The ECB’s Balance Sheet Grew From €1.0 Trillion In 2005 To €8.7 trillion. |
Still, the Euro-zone's biggest problem remains its massively flawed currency and banking system. Because many countries and economies share the same currency when a country fails to keep its budget in line or falls on hard times, they become a burden the others are forced to carry. The EU abandoned all structural reforms in 2014
when the ECB started its quantitative easing program (QE) and expanded
the balance sheet to record levels. Making matters worse, the ECB has come up with several schemes over the years to kick the can down the road by adding liquidity to this insolvent system.
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European Households Tend To Hold More Of Total Assets In Currency And Deposits
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In short, when you look at the situation, not only are many of the people living in the Euro-zone politically opposed to Brussels exerting more power, on top of that, the banks are up to
their eyeballs with bad debts and holding worthless paper. Simply put,
the whole system is rotten to the core. Circling back to soaring
inflation, the ECB has little choice but to raise rates in lockstep with
other central banks. The Fed rate hikes are toxic to both the euro and
the yen. The people of both Europe and Japan face losing a great deal of
their wealth if the euro and yen continue to fall.
| Below are two links to other articles relating to China and the situations contained above.
https://brucewilds.blogspot.com/2019/11/chinas-state-driven-business-model.html
https://brucewilds.blogspot.com/2019/03/italy-picked-off-by-china-folly-of-it.html Republishing this article is welcomed with reference to Bruce Wilds/AdvancingTime Blog |