The Eurozone’s recovery is now blazing forward into practically uncharted territory. Just today we learned that Eurozone business activity in March, as measured by the Composite PMI, which includes manufacturing and services, showed moderate growth that hit a 46-month high. It was fueled by new orders. Even the French PMI showed signs of expansion!
The report clarified the timing, though: “the ECB’s quantitative easing has been started at a time when the Eurozone’s economic upturn is already starting to gain traction.”
There were other signs of traction. The Eurozone trade surplus with the rest of the world has been setting new records, powered by strong exports, particularly from Germany. This trend kicked off before the euro started tanking a year ago.
So on Monday, ECB President Mario Draghi took the opportunity to slap himself and his colleagues on the back for their heroic and bold action, as these things are called, and offered an upbeat assessment of the Eurozone economy. He proclaimed “that growth is gaining momentum.” And he totally nailed it with three out of the four reasons he gave for that growth:
This is due to in particular the fall in oil prices, the gradual firming of external demand, easy financing conditions driven by our accommodative monetary policy, and the depreciation of the euro.
We might quibble with his reason number 2 – “gradual firming of external demand.” But the other three he totally nailed: the plunge in oil prices, an absurd monetary policy that is spreading negative yields across the Eurozone and beyond, and the brutal devaluation of the euro that has triggered a vicious currency war with neighboring currencies, and that over the last 12 months has eaten up 21% of the wealth of those pour souls holding euro-denominated assets. In fact, the euro has been so crummy that it lost 13% year-to-date against the ruble!
And now, economists are busy expecting more growth.
But just when we’re about to begin jubilating that the Eurozone is finally crawling out of its economic quagmire to bask in the German sun, if any, we get some very unwelcome clarity from investment bank Natixis, a subsidiary of Groupe BPCE, France’s second largest megabank:
But the important point is that this improvement in the Eurozone’s economic situation has been “stolen” from the rest of the world and does not stem from developments inside the Eurozone.
What a party-pooper report! It’s titled, “All the euro zone is capable of doing is “stealing” its growth from others.”
It then proceeds to list the three ways in which the Eurozone was “stealing” growth from other economies, which turn out to be the three very reasons that Draghi had totally nailed, and for which he was slapping himself on the back.
The depreciation of the euro. It has boosted already strong Eurozone exports, and inflated the Eurozone trade surplus further, “but at the expense of the Eurozone’s competitors,” including the US, emerging countries, and others.
The plunge in the price of oil. It has “sharply reduced the cost of the Eurozone’s energy imports,” which have been dropping from over 5% of nominal GDP in 2012 toward 3% now. But this comes “obviously at the expense of oil-exporting countries (OPEC countries, Russia).”
The trade surplus with the rest of the world, particularly Germany’s trade surplus with the rest of the world.
Historically, Germany had a larger trade surplus with the rest of the Eurozone than with the rest of the world. But when the debt crisis erupted, German exporters, realizing growth wouldn’t come from the Eurozone, redoubled their efforts in China, the US, Russia, Brazil, and other countries. Exports to them began soaring, while exports to Eurozone countries were declining due to the debt crisis. In 2011, exports to the rest of the world for the first time outpaced those to the Eurozone. Now German exports to the Eurozone have dropped to around 2% of Germany’s nominal GDP while they have ballooned to 6% for the rest of the world.
Germany’s trade surplus with the rest of the world adds to growth in Germany and therefore the Eurozone. But this surplus, Natixis writes, “has obviously been obtained at the expense of Germany’s non-European trading partners.
These three factors – depreciation of the euro, plunge in the price of oil, and trade surpluses – are responsible for the Eurozone recovery. They all come at the expense of other countries. But the report says poignantly:
“Nothing is happening inside the Eurozone that favors growth.”
Corporate investment is “stagnant.” R&D spending in the US has been hovering at 2.8% of GDP, in Japan at 3.4%. But in the Eurozone, it’s at 2.2%. And investment in IT is lagging way behind: in the US over the last four years, IT spending has been running between 3.3% and 3.5% of GDP; in the Eurozone between 1.6% and 1.7%.
Productivity gains are weak, ranging from 0% to 1% over the past four years. This comes largely as a result of corporate underinvestment.
The employment rate is low. As defined by the OECD, the employment rate in the US in 2014 was 68.1% (down from 71.9% in 2002); in Japan, it was 72.7% (up from 68.3% in 2002); but in the Eurozone it was a measly 63.8% though that was an improvement over 2002 (62.3%), when Germany was still the Sick Man of Europe, dogged by high unemployment.
Those are Draghi’s big accomplishments: beggar-thy-neighbor policies, a currency war, and a 21% cut in wealth of the people in the Eurozone. But concerned countries have already begun to react, and are going to react further against his machinations. And in the end, their impact on the Eurozone economy is not sustainable and may reverse direction.
The Eurozone, which doesn’t produce a lot of oil, benefits from the oil price plunge, the factor Draghi mentioned as his number 1 item. But these low oil prices may not last forever. When they rise again, the people of the Eurozone will have to pay for their imported hydrocarbon energy products with their demolished euros. That double whammy will certainly be well-received, and will become a nasty drag on the economy.
So we admire Draghi’s elegant upside-down construct while it lasts, and we’re dazzled by the absurdities it has produced, such as negative yields for bondholders, negative interest rates for depositors, and insanely valued stock markets, and we continue to be dazzled until something in that fragile construct breaks.
But investors are getting nervous. “The Bond Bubble becomes more extreme” and stocks are “overvalued,” said 11,000 financial professionals though they’re not quite ready yet to hit the sell button. Read… The “Insanity Trade:” Where Does It Go From Here?