Europe's Crisis Is Secular Not Cyclical

by: Panic of 1901

Today, leading commentators speak of the European Union’s sovereign risk crisis in cyclical terms.

For instance, at Bloomberg’s recent Hedge Fund and Investing Summit, Alice Schroeder facilitated a rich discussion on the Eurozone with Pierre LaGrange, a co-founder of GLG Partners; Guy Wyser-Pratte, a legendary risk arb now pursuing activism on the Continent; and, Arun Motianey, director of fixed-income strategy for Roubini Global Economics.

  • All repeated now familiar mantras. Europe needs to rein in public sector spending, reverse consumer dis-saving, and de-lever.
  • Indeed, this is reasonable. As many note, Greece, Ireland (NYSE:IRL), the UK (NYSEARCA:EWU), and Spain (NYSEARCA:EWP) each have combined current account and national deficits exceeding 13% of their GDP. In 2008, the UK, Spain, France, and Italy (NYSEARCA:EWI) each had a debt-to-GDP ratio exceeding 300%. The U.K. led the pack with 475%, 200% of which comes from its financial sector.
  • A bullish LaGrange contends that the fiscal position of the Euro is better than the Dollar in terms of structural deficits and net debt; that Germany and Holland could afford bigger deficits; that Euro deterioration would stimulate European exports; and, that market participants have forgotten that Greece’s bailout package is only 4% of GDP.
  • A more skeptical Wyser-Pratte thinks the crisis highlights the growing economic attractiveness of Eastern Europe; the inherent problems of monetary without political union for fiscal discipline and bailout; and, the need for European businesses to increase capital expenditures if they wish to remain competitive.
  • He advised anyone owning European corporate equity (VGK, DBX) or debt to consider shorting the Euro (NYSEARCA:EUO) while being aware of unanticipated dollar parity risk in the earnings of individual names.
  • Motianey makes the excellent point that an underappreciated, black ball risk in the current crisis is rejection of current and future European bailout packages by the German Constitutional Court. (For now, we appear safe.)

Such discussion is fascinating yet misses the more important story. Western’s Europe’s real economic heartache is still to come this decade. Its true crisis will be secular not cyclical. Before investors too eagerly celebrate the Euro’s recent rally (NYSEARCA:FXE), they should consider that millions of European jobs are yet to be lost.

A decade ago, Lester Thurow warned that – when it came to picking economic winners in the 21st century – sociology would dominate technology. As he wrote, there otherwise seems no better starting position than Europe. No other contiguous landmass in the world has nearly a billion people with a higher, cross-population endowment in education; scientific research; cultural achievement; infrastructure; and well-tended environmental resources.

Yet Europe woefully underperformed after World War II­­. In one example, Thurow cites: America created 11 million jobs in the first 7 years of the 1990s while the EU created only 71,000, none of which were in the private sector. The issue is not simply about European wage-labor laws or structural government deficits. More fundamental are ponderous barriers European society and institutions impose on would-be entrepreneurs. Silicon Fen is as appropriately named as a “fun size” candy bar, for there is no Silicon Valley across the pond. In fifty years, Europe has hardly forged a single, new industry within its borders.

Commentators as diverse as Peter Thiel, Noam Scheiber, and Ron Bloom imply that, after 1970, American businesses increasingly stopped building things and started refinancing them. (Perhaps partly explaining the so-called marginal labor productivity declines that concerned U.S. economists since the Reagan era.)

But, even if that accusation is true, it would be multitudes more so in Europe. So, before looking at European struggles with entrepreneurship, it is helpful to consider the role of its financial sector and the forces which drive it, especially in the UK. That is the next section.

Disclosure: No positions