Tuesday, September 3, 2019

Euro-zone Woes Continue With No End In Sight

German Business Confidence (click to enlarge)
Recently we saw the euro's slump deepen after German business confidence extended its decline. The euro fell to its weakest level in almost seven years as weakening manufacturing put Europe’s largest economy on the brink of recession. The German GDP contracted in the second quarter and it could shrink again in the third, sending the economy into its first technical recession in years. It does not help that as Germany’s export-centered economy is struggling global trade tensions are worsening. With talk of the trade war back with a vengeance following Jackson Hole the German government has signaled it’s open to fiscal stimulus if the current downturn turns into a more severe crisis.

On top of this bad news, it appears the European Union is finally moving towards crunch time with the UK. Boris Johnson, the new Prime Minister of the United Kingdom, has taken the stand the UK will exit the union, deal or no deal, on October 31. The failure of the EU to negotiate in a fair way has led to this scenario and the negative implications of such a split may reverberate throughout the economy for years. This all leaves those of us watching Europe's combined economies wondering where they might get a spark that will ignite growth. Sadly, the answer has not revealed itself and it appears it could be all downhill from here.

This leaves much of the EU fate resting on the new incoming head of the ECB, former IMF chief Christine Lagarde and the hope she can pull a rabbit out of her hat and find a way to set things right. Lagarde's announced appointment is reviving praise as an experienced financial firefighter with a steady hand. Her greatest challenge is that she is replacing a man credited with saving the Euro-zone by means that will no longer work. If she departs from Draghi’s script, she will face fierce criticism but if she does not, the Euro-zone’s never-ending crisis is expected to spin out of the ECB’s control. Draghi attempted to save the Euro-zone by printing trillions of euros which funded bankrupt banks and allowed Italy, Spain and other stressed states to roll over their debts but has failed.

Low-interest rates and easy money have not cured Europe's problems and the area continues to face growing anti-EU sentiment. Looming before the region is the problem of envisioning exactly from where its next economic renaissance might flow. The source certainly won't be from a well-tuned and responsive political system or because of its growing ability to produce goods for a fraction of the cost of competing nations. Unfortunately for the Euro-zone, much of its problem can be viewed as one of "stagnation." Figures show that as of 2017 not a single European company ranked among the top fifteen technology companies in the world. It was mainly North American and Chinese companies that are driving the world forward. Still, more troubling is that of the top 50 global technology companies, only four are European and even those are slowing losing their edge.

Italy A European Debt Bomb Waiting To Explode
The truth is that in all reality Italy went bankrupt in summer 2011. Back then we saw interest rates on the national debt spike going out of control and Italy lost access to the financial markets. At that time the ECB and political authorities in Europe agreed to create around the country’s finances an artificial market to give the impression of stability and the appearance that Italy could work its way through its problems.

Italy is now forced to stay on this artificial support until the economic conditions improve and confidence is restored to where the country will have again access to real and normal credit markets. This most likely will never happen because not only is Italy mired in debt but it is also a mess politically. Not only the size of debt but the quality of the debt meaning the ability to repay it is an important issue. Because of the sheer dimensions of Italy as an economy and as a debtor, it dwarfs the problems posed by other countries that make up what has been referred to as the Euro-zone PIGS. All countries are not equal in size and the reason for their woes vary, however, propping up an economy is not a long term fix. The ECB loaning money to banks to have them purchase government-issued bonds is a scheme and instrument that allowed international investors to exit Italy in an orderly fashion but resolves little.

Not attempting to load onto the list of problems it still must be pointed out that on May 16th of this year when Bloomberg declared the EU migrant crisis over they may have been premature. This has proven to be a case of hope being placed in front of reality. The good news is the 150,000 migrants seeking to enter Europe illegally last year represents a 92% drop since 2015. Also, the article stated the number of people seeking asylum in 2018 was 646,000, less than half of what it was three years ago. Still, the issue remains politically divisive as ever. It is clear the EU’s member states do not share a common long-term perspective on migration from the Middle East and Northern Africa to Europe.

Who Should We Blame? (click to enlarge)
In the later part of July, French president, Emmanuel Macron, said European countries have made progress on plans to redistribute refugees rescued in the Mediterranean. Still, Italy's Salvini, who closed ports to NGO rescue boats, said the agreement underscored a demand that Italy continues to be the refugee camp of Europe. Salvini said Italy “does not take orders and is not a partner. If Macron wants to discuss migrants, come to Rome.” The fact is things are still up in the air as to what to do with the thousands of refugees still attempting to reach Europe.

Each day more attempt to cross the Mediterranean with Italy and a few other countries forced to bear the brunt of the problem. Salvini has accused the NGOs of running a “taxi service” for migrants and has demanded other European countries open their ports to the boats. This has resulted in NGO boats being forced into time-consuming negotiations between EU member states as they try to find a country willing to admit them each time they rescue migrants and refugees. Charities have criticized what they describe as Europe’s “campaign of criminalization” towards their rescue boats. This has led to a joint statement from the heads of the UN refugee agency UNHCR and the International Organization for Migration, it said: “The crucial role played by NGOs must be acknowledged. They should not be criminalized nor stigmatized for saving lives at sea.”

When all is said and done we in America have been shielded from a great deal of the bad news and migrant problem flowing out of Europe. In general, we hear little of the continuing yellow vest protest in France or no-go zones where police and delivery divers fear to tread. Instead, our media is focused on Trump's latest tweets. It seems we have enough of our own problems both economically and politically to keep us busy. Like many of the issues confronting America, the woes facing the Euro-zone economies are deep-seated and structural. Trying to avoid confronting them will not make them disappear but will simply result in more pain down the road. In time, much of this pain may come to the people of Europe in the way of a falling euro that strips them of their wealth.

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