The Netherlands is generally perceived as a solid core eurozone country, almost as good as Germany itself. Attention to these two countries will come back this week as there are elections in the Netherlands on the same day that the German Constitutional Court will deliver its verdict on whether the permanent European rescue fund, the ESM is compatible with the German constitution.
At the minimum, the Dutch elections could make forming a stable government pretty difficult and there is an off-chance that one of the left-wing or right-wing fringe party will be necessary to form a government. Both the left-wing socialist party (SP) and the right-wing freedom party (the PVV of Geert Wilders) have a rather strong anti-euro stance. The PVV actually wants the Netherlands leaving the euro.
Both parties are strongly against domestic austerity for the sake of meeting abstract budgetary targets imposed by the new fiscal compact and the older Stability Pact (that is, 'Brussels,' the EU capital). But there are other worrying facts about the Netherlands. One can really question whether its economic and financial position is as solid as many seem to assume.
A particular danger sign is the high mortgage debt in the Netherlands. It stands at 111% of GDP, the highest in the eurozone. Combine that with a recession and declining house prices and you potentially have the same recipe for serious trouble that got the likes of Ireland and Spain in deep trouble.
The Dutch housing market has been shaped by highly interventionist public policies spanning over several decades. Direct and indirect government intervention in the housing market through spatial planning and land policy, regulation and supervision of housing associations, rent policy and financial guarantees, generous mortgage interest deductibility and other explicit or implicit subsidies have led progressively to entrenched structural problems, which have negative consequences for the economy as a whole
Low taxation of home ownership and the very generous mortgage interest deductibility artificially raise housing prices, disproportionately favour high-income taxpayers and have ambiguous effects on housing tenure.
To some degree, this is the result of lack of space. The Netherlands is one of the most densely populated countries in the world and most of the population is concentrated in the so called 'Randstad,' the part in the west around the four main cities (Amsterdam, Rotterdam, The Hague and Utrecht).
Getting planning permissions for construction is a rather complex process (to put it mildly), hence construction, never really exuberant in the first place, is progressing at a snails pace. Here is the authoritative Rabobank quarterly overview of the housing market (August 2012):
In the second quarter of 2012 second-hand house prices fell further. Compared to the first quarter, prices dropped by 1.8%. This further decline does not come as a surprise. We have seen the number of houses for sale continue to rise, while disposable income is still dropping. Besides having less money to spend, potential buyers are faced with uncertainty about their jobs, their pensions and the question of mortgage interest relief. Nor do we expect this picture to change materially during the coming quarters. Uncertainty about the future of mortgage interest relief still prevails now that the debate about the housing market has been postponed until after the September elections.
The Rabobank expects house prices to fall 5% this year and another 4% next year. Construction has slowed markedly however, so the bottom will probably not fall out of the market altogether, as there is a lot of pent-up demand.
On the other hand, it is possible that the interest deduction of mortgage debt, one of the pillars of the large house price rises of the past couple of decades will be scaled down or even phased out. There was a modest proposal by the previous government to limit the deduction to mortgages that are actually being paid off in full during the time to maturity.
While the interest deduction on mortgages is rather generous and largely amounts to a tax on the poor to the better off, the uncertainty created by the discussion comes at an unhelpful time. With the housing market already in trouble, the country can do without the added uncertainty.
Yet for all the economic troubles the Netherlands finds itself in, there are a few strengths that are worth mentioning as well.
- While the mortgage debt might be the eurozone's highest, the value of houses, at 1.4 trillion euros (according to the Central Bureau of Statistics, the CBS) is twice the amount of mortgage debt (at 670 billion euros).
- The Netherlands has a large amount of other savings. Household savings and deposits amount to 332 billion euro, half the value of outstanding mortgage debt.
- The Dutch pension system, despite repeated alarm within the country itself the last five years or so, is still the best in Europe by some considerable margin. Dutch households had 1140 billion euros of pension reserves build up at the end of 2011. That's the highest per GDP in Europe (see table below).
Chart: Pension reserves as a percentage of GDP in Europe
This level savings is also manifest in the large current account surplus of the Netherlands.
At nearly 10% of GDP, this is a whopping surplus. It is actually considerably larger than the current account surplus of Germany:
(click to enlarge)
If these eurozone countries, with current account surpluses ranging from 5-10% of GDP, would embark on mildly expansionary policy it would help solve the eurocrisis. At present, all the adjustment burden falls on the deficit countries in the periphery, creating a terrible deflationary bias in the whole eurozone.
In fact, it is worse as even the surplus countries are embarking on deflationary policies. Little wonder that much of the eurozone is in a deep economic funk. A funk which actually makes the fiscal consolidation and the re-balancing of competitiveness within the eurozone more difficult.
Here is how the Dutch AEX index has been faring the last 5 years. In green is the German DAX index, which has done considerably better over the same time period.
This isn't really much of a surprise. Apart from Shell (RDS.A) the AEX is dominated by big banks like ING (ING) and insurance companies like AEGON (GM:AEGOF). The DAX has much more manufacturing in the index, and German manufacturing has done rather well.
There is an ETF for Dutch shares, the iShares MSCI Netherlands Index ETF (EWN). At almost 21%, by far the largest holding is Unilever (UN), a defensive consumer staples play that has actually performed quite well.
It hasn't made much of a difference in the performance of EWN versus the AEX index though, although Unilever has done much better than both the past two years (in red):
With Unilever very much a defensive stock (and the company performing very well), this isn't much of a surprise either. As it happens, this defensive stock just got a whole lot more defensive, considering the following headline from The Telegraph:
Unilever sees 'return to poverty' in Europe
In the article (from late last month), CEO Jan Zijderveld argues:
"Poverty is returning to Europe," Jan Zijderveld, the head of Unilever's European business told the Financial Times Deutschland in an interview. "If a consumer in Spain only spends €17 when they go shopping, then I'm not going to be able to sell them washing powder for half of their budget" "In Indonesia, we sell individual packs of shampoo 2 to 3 cents and still make decent money," said Mr Zijderveld. "We know how to do that, but in Europe we have forgotten in the years before the crisis."
Having mastered marketing in countries with lots of poor people in the third world, Unilever is perhaps uniquely positioned to profit from this unfortunate trend. The shares, at 19 times this year's earnings aren't cheap, certainly if you consider that analysts expect earnings to be flat next year.
Unilever's third world marketing acumen brings us back to the eurozone crisis and the burden of adjustment falling entirely on the deficit countries. Surely there must be a better way than embarking on policies that force companies like Unilever to adapt to third world marketing strategies for the new poor in Europe.