Eurozone Economy Could Be Chilled To The Core

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Includes: DEZU, FEUZ, FXE, HDEZ
by: Joseph Shupac

Summary

The Eurozone's economic slowdown may be creeping inward, from the periphery of the region into central economies like Germany, Belgium, northern Italy, and the Netherlands.

In the past, in contrast, it occurred mainly on the fringes of the Eurozone, in Greece, Cyprus, Spain, Portugal, southern Italy, and Finland.

Going forward, the fate of Eurozone expansion (or contraction, or even dissolution) may rest with the Czech Republic.

Since 2001, when Greece adopted the euro as its currency, seven countries have joined the eurozone. Slovenia began using the euro in 2007, Cyprus and Malta in 2008, Slovakia in 2009, Estonia in 2011, Latvia in 2014, and Lithuania in 2015. These countries are small. Together, they are home to around 14.5 million people, just 4 percent of the eurozone's total population

This is not surprising: from 2001 to 2008 European countries were more focused on expanding the European Union and NATO than expanding the eurozone, while since 2008 the economic slowdown in Europe has limited the ambition of European institutions to expand in a meaningful way. Key economies in the region, like Britain, Poland, Sweden, Norway, and Switzerland, not to mention Russia or Turkey, do not appear likely to join the eurozone any time soon, if ever.

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Still, the admittance of these seven small states has altered somewhat the geography of the eurozone. Slovakia is the only state among the "ex-satellites" of the former Soviet Union (the others being Poland, Romania, Hungary, the Czech Republic, and Bulgaria) to adopt the Euro, and it is the only eurozone country to border Ukraine.

Slovenia is the first among the states of the former Yugoslavia to formally join the eurozone, and its membership gives Austria and Germany a eurozone-only route to the Mediterranean that bypasses Italy. The Baltics are the only former Soviet Union republics to adopt the Euro, and their inclusion also means that Finland is no longer the extreme geographic outlier of the eurozone that it was between 1999 (when it and all ten of the other eurozone countries apart from Greece joined) and 2011, when Estonia joined.

Similarly, the Cyprus and Malta additions mean that Greece is no longer an outlier in the eurozone. Even before they joined, though, Greece was still only 100 km from Italy - whereas Finland had been more than 800 km from any fellow eurozone economies before the Baltics joined.

Among the eurozone members that joined the group prior to 2007, the economies on the outer edges of the eurozone - Portugal, Spain, Ireland, southern France, southern Italy, Greece, and Finland - have struggled the most during Europe's nearly decade-long economic downturn. The inner countries of the eurozone, on the other hand, as well as most of the non-Eurozone countries in the region, have not fared so poorly.

As the graph below shows, Germany and Austria may have been the only two pre-2007 eurozone members to have experienced per capita income growth from 2008-2013, and Germany in particular (which accounts for an estimated 29 percent of eurozone GDP) has been a veritable island of low unemployment within the eurozone.

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Even among the newcomer eurozone states, which apart from crisis-ravaged Cyprus have not done too poorly, it has been the more centrally located countries of Slovakia (the capital of which, Bratislava, is just 50 km from Vienna) and Lithuania (the westernmost Baltic) that have experienced the most growth. Slovakia and Lithuania are both thought to have had per capita income growth of 5.2 percent during the period 2008-2013, whereas Estonia, Latvia, and Malta had growth of just 1.6-2.7 percent, and Cyprus's income shrank by 20.6 percent.

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Within Spain, Italy, and Belgium, the European countries with the largest internal regional divisions in their employment rates, their southern regions have higher unemployment in each case than their northern regions

Now, however, the economic slowdown may be moving towards the inner sanctuary of the eurozone, in and around Germany, even as it has also lately been afflicting the outer regions of non-Eurozone Europe (Russia, Norway, Turkey, Scotland, etc.), which had performed relatively well in the wake of the 2008 financial crisis. Economies like Germany, northern Italy, and the Netherlands have increasingly appeared to be under threat of recession, while at the same time some of the eurozone outsider "PIIGS", like Spain and especially Ireland, are finally thought to be in recovery. Europe may be looking a bit topsy-turvy these days.

Much of this perception is simply anecdotal (which is not to say incorrect, necessarily), an adding-up of the Volkswagen emissions scandal, the Syrian migration crisis, Deutsche Bank's falling stock price, terrorist attacks in Paris and Brussels, the "looming threat of Brexit", and so forth.

There have also, however, been larger shifts. Falling resource prices have helped southern Europe far more than northern Europe. Slow growth both in East Asia, emerging markets, and Europe threatens export-oriented economies like Germany and the Netherlands. People in countries like Germany are getting old. The global shipping industry crash has hit parts of the Belgian, Dutch, and Danish economies. And there is a growing fear that Italy's financial system may not be too far from collapsing.

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Now, it may be that these fears are overwrought, and that the centre of Europe will not undergo a reversal of fortune. But perception can often influence reality where economics are concerned, and the perception of countries like Italy, France, and even Germany has undeniably changed for the worse of late. It was less than a year ago that Germany was still popularly viewed as an unassailable economic and political stronghold of Europe, and less than two years ago that Spain, rather than Italy, was seen as the likeliest trigger for a euro crisis (apart from Greece, of course).

When it comes to the "future of the euro project", the inward creeping of economic troubles from the eurozone periphery to the eurozone core should raise the question of whether or not the Czech Republic will join the eurozone too.

The Czech, as well as most of the other Eastern Europe nations, were officially supposed to adopt the Euro, but many guess that this will not happen anymore given the current atmosphere in Europe. Nowadays, a "Czexit" from the European Union seems more likely, arguably, than a Czentrance into the eurozone. The Czech Republic has the biggest GDP in Eastern Europe apart from Poland, more than double Slovakia's. It is a "core" state: Prague is actually located closer to Frankfurt than Berlin is, and closer to Berlin than Vienna is.

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If the Czech Republic does join, Poland would then be surrounded by eurozone states on all its EU land borders. The Czech Republic's key trade partners, Slovakia, Austria, and Germany, have all joined now - and both the Czech and the Slovaks are arguably among the world's five most trade-dependent nations. The Czech Republic also sits in the main route between Germany and Slovakia, both of which are in the eurozone. Along with the financial fastness of Switzerland, worldly London, and the half-in, half-out (but mostly out) ERMII monetary system of Denmark, Prague is now the only place within the core of the European Union not to have joined the eurozone.

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Whether or not the Czech Republic joins could impact the future shape of the monetary union: its expansion, contraction, or dissolution. Yet for now the eurozone seems focused on keeping the economies in its own centre intact, rather than expanding toward new peripheries in Eastern Europe.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.