Blain’s Morning Porridge Dec 4^th 2024: What is the problem in Europe – and is there a solution?

“Oh, you don’t need to fight them – you just need to convince the pitchfork people that the torch people want to take away their pitchforks.”

 Europe is getting “interesting” in the Chinese sense of the word. The market to watch will be European Bonds – French OATs may just be the first to wobble. As the crisis unfolds (and it will) there may be opportunities to arbitrage the actions of the ECB to stem any crisis – watch this space.

Let’s talk about Yoorp

The French are revolting – quell surprise. Later today the French Government will likely fall. Michel Barnier’s brief spell as Prime Minister was caught betwixt Left and Right. The Centre cannot hold … indeed. And its’ not just France. Across Europe there is a void emerging.

I suggest readers familiarise themselves with Irish poet WB Yeats’ classic The Second Coming. It may be a metaphor of the coming times:

“Things fall apart; the centre cannot hold;

Mere anarchy is loosed upon the world,

The blood-dimmed tide is loosed, and everywhere   

The ceremony of innocence is drowned;

The best lack all conviction, while the worst   

Are full of passionate intensity.

Surely some revelation is at hand;”

Butler’s poem seems rather prescient. Written over a 100 years ago, he seems to capture the pressures tearing apart long-term consensus, how populist political opportunists have taken advantage of crisis, (and the lacklustre dull politicians in office), as the rise of fake news and disinformation destabilises process and democracy. There is increasing certainty a crisis is at hand..

It is a spooky and somewhat scary take on what might be to come..

Cheer up; Barnier lasted longer than she-who-should-not-be-named in the UK… the lettuce woman analogue.

How much worse can the headlines get? If it’s not Paris, its Mutti’s Memoirs in Berlin. The market’s unwavering faith in Vorsprungdurchtecnik (as the Germans no longer think) has been shattered in the collapse of the Olaf Scholf’ coalition of the squeezed middle vs a classic Mittle-Europe pitchfork waving mob. France is caught between Left and Right. The rest of Europe sits uneasy – riven by threats of populism, perceived immigrant tides, Russian disinformation, and the threat of a renewed energy crisis and inflation as winter sets in. Perversely, the strongest growth economy in Europe is the Greeks, who’ve got on with the business of making their nation work.

The general market consensus is France spells a crisis for European bonds, and thus the European economy – dump bonds, dump stocks and dump the Euro. There are reasons to be concerned – Europe’s bond markets are…. unlike other bond markets as I will explain below. It raises existential risks for the Euro.

Macron will attempt to rule France without a government, but the problems and instability will multiply. Le Pen will calling for revolution from the Tennis Court (that’s a reference to 1789 and a previous period of French administrative unpleasantness). As the French debt spread vs Bunds widens it will raise memories of 2012 all over again… a full blown European debt crisis might, or might not be in the offing. Now, that would be an awfully big adventure… again. How well I remember the last one.

Ask any investor, trader or analyst and they will point to multiple reasons European economies are in crisis. They will sadly shake their heads explaining how Europe’s ailing economies exhibit all the multiple co-morbidities associated with terminal economic decline: low to zero growth, a dearth of productivity gains, bureaucratisation, stubborn inflation, stagnant wages, populist politics driven by a lack of trust in the perceived “elites”, aging demographics, the state crowding out private enterprise, decay and receding hope.

Layer in high energy costs, ailing production and declining markets, plus a rising sense of crisis over burgeoning sovereign debt, and it’s no surprise European markets massively underperform the vibrancy of the US exchanges. (US stocks trade at record multiples to Europe, and account for over 70% of global stock market value, while Europe is barely a speed bump on the chart! Or maybe US stocks are a bubble?)

Three particular problems stand out:

• Europe does not produce much of anything at a competitive advantage. That’s best illustrated by its biggest industry – cars, where it’s been comprehensively trounced by the Chinese, and left flollopping in the wake of Tesla inspired electric revolution. Luxury goods are a small market. Airbus is leader of the global airliner duopoly, and the Chinese COMAC is at least an aircraft generation behind – but don’t believe it won’t catch up.
• Confidence is low: there is a dearth of ambition across the continent, crushed by reality. Young people caught in low paying jobs, forced to remain living at home (creating a demographic family formation timebomb) while their parents struggle to pay mortgages, taxes and the consequences of inflation. European companies seem to struggle to reach critical scale – here in the UK we know promising start ups coming through the still excellent university systems are hunted down and harvested early by US venture capitalists and predatory firms.
• Entrepreneurship and business growth is stifled by the embedded bureaucracy of individual nations, but also by the overarching demands and consequences of the single market and Europe – represented in the now resented Brusselsification and Regulatoriat of the European Economy. The idea of a single strong European market, including a strong internal capital market, has proved largely theoretical – the reality is an unfinished still broken project that’s been buried by political headwinds. Forget fiscal and political union in the near future, meaning Europe will struggle on with the incomplete monetary union of the Euro.

Why does Europe’s economic outlook look so bad….?

Spend any time travelling in Europe and it’s not a bad place. It’s tremendously rich in history, creativity and human wealth. Each nation, in fact each region, of Europe has its own distinct characteristics – making each unique, and although all are welcoming, they are also intensely proud of that uniqueness.

Perhaps the mistake of Europe has been the length of time it’s taken the European project to sputter out in the current surge of populism and nationalism. The aim of creating a single United Europe, and internalised market, a single currency, unified codified laws and a single European identify – the Jean Monnet Europe dream – as effectively as it exists across the USA has become the wrong path. It remains the Europe the centralised EU and ECB seem still determined to take us down, despite the increasing conflict with the individual nations.

Careful. I begin to sound like a Brexiteer here. (I am cured of that madness.) A unified Europe of diverse, independent, competitive nation states with common ambitions and shared security – which I hope incorporates the UK – seems a much better option. However, dreaming about a better, sustainable, European unity will not solve the looming crisis in European bonds.

The problem is Europe’s nations are not financially sovereign. Under the Euro, they don’t control their own currencies. In periods of crisis a financially sovereign nation can simply fire up the printing presses to repay debt – using monetary magic to unburden its debt load. European states don’t own their own currency – they share the Euro: a currency by committee. They can’t just walk away from the trap the Euro has become.

The ECB, run by a politician rather than a central banker, is responsible for the stability of the Euro and inflation, but has only marginal control over the debt quantum of European nations – even the Bundesbank is talking about funding German infrastructure rebuild by borrowing in the common currency. If Germany can do it – why not everyone? That’s when crisis gets hot.

Over the past decade – since Mario Draghi solved the last Euro Debt Crisis by promising “to do whatever it takes”, there has been much papering over the cracks of Euro-sovereign debt compromises. The ECB has tried to centralise debt under its own banner – but it can’t “federalise” Europe’s debt without full political and fiscal unity – which looks politically unlikely.

The reality is the very different nations of Europe do not offer a single solution when it comes to debt, and debt-mutualisation is not an answer – German and Swedish workers will not accept paying Italian and French pensions. They are all using a currency they don’t control. That’s a problem which means we’re likely to see the ECB forced to act – probably with some kind of “whatever it takes” bailout – meaning a potential capital arbitrage for investors smart enough to spot the moment.

Europe is going to get … interesting.

Out of time and back to the day job..

Bill Blain

Author of the Morning Porridge, and CEO Windshift Capital

billblain@morningporridge.com

www.morningporridge.com

www.windshift.capital