Europe's Recovery Is Stuck In The Mud

by: Acting Man

Weak Economic Performance

It was reported last week that the recovery in euro-land remains more hope than reality. It is worth noting that the sovereign debt crisis has not produced much by way of spending cuts on the part of governments. By and large, the debtberg has just kept growing as if nothing of importance had happened. While the gap between government revenue and spending has narrowed somewhat - due to a combination of tax increases and a slowing in the contraction in the economies most severely affected by the bust - total spending has continued to grow, if at a somewhat slower pace than before:

Public spending and revenue in the EU and the euro area

So there has been a modest improvement relative to the worst deficits seen at the height of the economic downturn in 2009, but deficits remain very large relative to the pre-crisis era. There is of course no sign whatsoever that the size of governments will shrink.

Concurrently, the ECB's interventions have produced a sizable rebound in money supply growth since the 2011 low (it is no coincidence that the peak of the crisis coincided with a low in year-on-year money supply growth), but the growth rate has been declining fairly sharply of late. The current level of year-on-year money supply growth is still high relative to the lows seen in 2008 and 2011 shortly before the respective crisis situations became acute, but it is not higher than the level recorded in 2000, which presaged a considerable asset price bust and concomitant slowdown in economic activity as well.

Euro area money supply and its annual growth rate (blue line)

It is a good bet that if the recent slowdown in money supply growth persists, it will once again be reflected in declining asset prices and a slowdown in economic activity (note here that the activities that are negatively affected by a slowdown in money supply growth are as a rule of the wealth-consuming sort anyway).

Meanwhile, the total public debt load of 14 of the 18 euro area member nations remains above the 'threshold' imposed by the so-called 'fiscal compact' (formerly known as the Maastricht treaty limit):

European debt-to-GDP ratios, 2012 vs. 2013. Public debt in the euro area as a whole remains more than 50% above the limit (at 92% instead of the 60% threshold level)

Germany, Austria, Estonia and Latvia are the only euro area countries in which the government debt-to-GDP ratio has ever so slightly improved. The latter two are well below the threshold level anyway, two of only four member states which can boast of this feat (the other two are Finland and Slovakia). Every other government essentially became a tad more bankrupt.

France's Economy 'Lags'

It is probably not a big surprise that France has once again underwhelmed in terms of its economic performance. The country continues to be bedeviled by the fact that socialistic policies were imposed at a time when the exact opposite would have been urgently needed. Even worse though was the economic performance of the Netherlands, where a collapsing housing bubble keeps taking its toll. No harsh winter weather was needed to keep European economic performance tepid. According to to the AP:

"Europe's economy failed to gain any momentum in the first quarter, reinforcing expectations that the European Central Bank will soon deploy fresh stimulus measures to shore up the tepid recovery.

The economy of the 18 countries that share the euro saw output grow by only 0.2 percent in the first quarter from the previous three-month period, the EU statistics office said Thursday. That marked the fourth straight quarter of expansion. But the rise was below economists' expectations for 0.4 percent. […]

A large chunk of the blame can be placed on a flat performance in France, Europe's second largest economy behind Germany. Between them, the two make up roughly half of the eurozone economy. France has lagged in reducing worker protections and cutting labor costs for business - steps that have benefited other eurozone economies.

A dismal 1.4 percent contraction in the Netherlands and a 0.1 percent decline in Italy did not help, either. Elsewhere, Portugal's economy slipped even as the country prepares to leave its bailout aid program on May 17. Greece, its economy ravaged by excess debt and brutal austerity, saw its output decline in annual terms by 1.1 percent. Greece doesn't provide quarter figures but the annual rate of contraction has been diminishing for a year now. There are hopes now that the country at the forefront of Europe's debt crisis will soon be recording some growth.

Without a stellar 0.8 percent rise in Germany and a solid 0.4 percent improvement in Spain, there may not even have been any growth in the eurozone.

Tom Rogers, senior economic adviser to the EY eurozone forecast, said the numbers "should act as a wake-up call for any eurozone policy makers tempted towards complacency about the road to recovery."

"Stagnating output in Italy and France, two of the four largest economies, is in large part a result of deteriorating cost-competitiveness, while Germany and Spain continue to reap rewards from reform implemented either well before the crisis, or more recently," he added.

(emphasis added)

In Italy, the Renzi government has recently announced that it plans to rescind some of the worst tax increases of Mario Monti's reign, so there is still a smidgen of hope there. However, both Italy and France need to urgently free up their sclerotic labor markets. They have some of the most growth-inhibiting labor market regulations this side of communism.

Naturally, everybody keeps going on about the alleged need for the ECB to resume monetary pumping by a panoply of means:

"The ECB could cut its benchmark interest rate from what is already a record low of 0.25 percent. It could also impose a negative interest rate for money banks deposit at the central bank, a step aimed at increasing loans to households and businesses. The ECB could also purchase government or corporate bonds on financial markets to add to the supply of money in the economy.

All those steps could help increase an inflation rate of 0.7 percent, which is well below the ECB's goal of just under 2 percent. Low inflation makes it harder for indebted governments to reduce their burdens. It has also raised fears that the eurozone may fall into outright deflation, a crippling downward price spiral that kills growth and business investment."

(emphasis added)

Yes, the central bank can 'add to the supply of money in the economy', but this is not going to add a scintilla to existing wealth - it will merely redistribute more of it in the direction of the early receivers, with governments the chief beneficiaries. It also runs the risk of reigniting the boom and producing yet another big crisis down the road. It is certainly true enough that 'higher inflation' will reduce the debt burden of governments and other debtors (to the detriment of everybody else in the economy). However, much of this debt is unsound to begin with. If one looks e.g. at Greece with its near 180% debt-to-GDP ratio, one wonders what point there is in continuing the pretense that this is actually sustainable.

As for 'deflation producing a crippling spiral', etc., it is tiresome to see this nonsense continually parroted in print as though it were an unassailable, self-evident truth. We have discussed on several recent occasions why this idea must be rejected both on theoretical and empirical grounds. Not to mention that there actually is no 'deflation' anyway, as the euro area's money supply growth rate remains close to 6%.

Peripheral Stock Markets - Canaries in the Coal Mine?

European stock markets have put in a mixed performance lately. One of the strongest performers in the past two years was the battered Greek stock market, mainly because it had fallen so much (at one point it was down almost 95% from its 2007 peak) that even the slightest sign of economic improvement was sufficient to produce a significant rebound. The Athens General index (AGT) has in the process been transformed from a downside leader to an upside leader after putting in its low in mid 2012. However, it has turned into a downside leader again in recent weeks, performing significantly worse than other European stock markets:

The Athens General index is beginning to look a tad wobbly. It has by now declined well over 20% from its mid March peak. Two more months of this and it is going to look like the chart of YELP

Another peripheral stock market that has performed very well hitherto and has lately come under considerable pressure is Portugal's. To be sure, it is technically still in somewhat better shape than the AGT, but the recent decline still exhibited a great deal of momentum:

The PSI 20 in Lisbon has stepped on a banana peel too. Suspicion is no longer as fast asleep as it used to be

The divergences among European markets are a bit reminiscent of the intra- and intermarket divergences within and between various U.S. indexes, where the stocks and indexes that previously had the biggest upside momentum have also borne the brunt of the recent selling. It is of course unknowable if the weakness in peripheral stock markets will eventually translate into a more broad-based sell-off, but it is certainly not a possibility we would dismiss out of hand.

Note here that faith in the economic recovery is closely tied to the performance of stock markets (even though stock prices are hardly a reliable sign of how the underlying economy is actually doing in this age of prices distorted by central bank policies).


Europe is still in trouble, in spite of a few months during which more encouraging data points emerged. These days one finds economies in trouble or performing well below expectations almost regardless of where in the world one looks. And yet, almost every government has followed the Keynesian / monetarist cocktail of prescriptions to a T (i.e., a mixture of deficit spending and ultra-loose monetary policy. Hopefully the data shown above have dispelled any lingering 'austerity' myths). Unfortunately it has still not dawned on those responsible that it is the prescriptions that are actually the root cause of the problem.