Economic Crisis

Why the European depression continues

The economic crisis in Europe started a full seven years ago, initially triggered by the financial meltdown in the USA, which quickly spread to European banks. After years of stagnation, there is no sign of a return to decent growth. Most large European banks are still shrinking their balance sheets, which is deflationary. Unemployment rates remain at elevated levels, especially for the young. The worst part is that low growth could be here to stay for the long term.

It’s not often described this way, but the European Union is an empire. It started life in 1950 as the European Coal and Steel Community, with the simple aim to create a common market for coal and steel between its six participating countries.

In other words it started out life as a modest trading bloc, with the aim of progressively building economic ties between countries. Europe had just suffered two gigantic wars that started only 25 years apart, and those were only the latest conflagrations after centuries of conflict. The noble idea was that with more economic interdependency European countries would be less likely to go to war with each other. Europeans had endured enough of senseless slaughter and destruction.

But fast forward 64 years and things have changed dramatically. We now have the “European Union”, which counts 28 member states. Far from being merely a trading partnership this is now a closer and closer political union, headquartered in Brussels, Belgium.

The eurocrats have a clear agenda to centralise more and more power, with the inconvenient problem that this is done in a more-or-less undemocratic way. For example, no individual citizen gets to vote for the European president, a role currently held by the slightly non-descript Herman Van Rompuy. (Although a recent photo compared him unkindly with the character Gollum from the Lord of the Rings films.)

“Politicians talk about grand ideas like spreading their “civilised values” and other guff, but really this is about opening new markets and expanding the presence of NATO…”

Part of the EU’s agenda has been expansion. Ten countries in Eastern Europe have been added since 2004. And the recent coup d’etat in Ukraine took place with EU (and US) endorsement, with an eye on further expansion. Politicians talk about grand ideas like spreading their “civilised values” and other guff, but really this is about opening new markets and expanding the presence of NATO, the military alliance between North America and Europe.

At the centre of the political project has been the creation of a common currency, known as the euro, which was introduced in 1999. This common coin is shared across 18 of the 28 EU countries.

Some of the countries are rich and some are relatively poor. For example, according to International Monetary Fund (IMF) figures, Germany had GDP per capita of US$45,000 in 2013 and France US$43,000. At the other end of the scale Latvia had GDP per capita of US$15,000, Slovakia US$18,000 and Estonia US$19,000.

In other words some of the bigger euro countries are three times richer than some of the smaller ones. They must have different monetary and economic policy needs, and yet the euro treats them all the same. It makes no sense at all.

The other 10 EU countries have sensibly stayed away from this one-size-fits-all approach to a vast and diverse region. (I’ve written before about the problems in Greece.)

The overall idea is that if countries share monetary policy then sooner or later they will have to have common fiscal policies too. So more and more taxation and government spending will be controlled at the centre, which in turn means giving up national power and independence at the country level. Although, of course, it isn’t presented to the voters in that way, who tend to value their distinct cultures and borders. There really is little similarity between the Netherlands and Greece, or between France and Slovakia. To get around this the EU empire grows and consolidates itself by sleight of hand and stealth.

Part of the problem since the financial crisis is that certain countries desperately need a devaluation to get themselves back to growth, such as Greece, Spain, Portugal and Italy.

But a more powerful group, led by Germany, is so worried about high inflation coming to their own stronger economies that it hasn’t let this happen. In fact the euro is only 2% lower against the US dollar than it was in March 2007, around the time when the financial crisis got started (although there have been some swings along the way).

“The economic situation in Europe today is poor to say the least.”

The economic situation in Europe today is poor to say the least. Across the EU the official unemployment rate was 10.2% at the end of June, and 11.5% in the euro zone. Unemployment in certain countries can only be described as being at depression levels, led by Greece at 27% and Spain at 25%.

Youth unemployment is pretty dire across the board, and tragically high in certain countries. For those under the age of 30 unemployment rates are 49% in Greece, 42% in Spain, 30% in Italy, 29% in Portugal….the list goes on. Even the supposedly recovering UK has youth unemployment at 15%.


Credit continues to shrink as well. I took a look at the balance sheets of 15 of the biggest banks across Europe and found that their loan books shrank over 3% during 2013.

Unemployment rate for ages 15-29 years 2013


It’s no surprise then that Europe is experiencing deflation. In the month of July prices fell in the EU at a 0.5% annual rate. This deflation took in some of the larger economies such as Italy (-2.1% annualised rate), Spain (-1.5%) and France (-0.4%). Price falls are being driven by collapsing prices of industrial goods, which fell at a 3.7% annualised rate in July.

“In 2013 the real (inflation adjusted) GDP growth of the whole EU was just 0.1%. That’s so close to a rounding error that it could easily have continued the recession of 2012…”

With high unemployment, shrinking credit and falling prices it’s also no surprise that economic growth is weak. In 2013 the real (inflation adjusted) GDP growth of the whole EU was just 0.1%. That’s so close to a rounding error that it could easily have continued the recession of 2012, when GDP fell 0.4%. For the 18 countries in the euro zone real GDP shrank by 0.4% in 2013 following a 0.7% fall in 2012.

Several countries have been shrinking for years. Using Eurostat data I calculate that Greece’s economy is now almost a quarter smaller than it was in 2007. The economies of Spain, Italy and Portugal are also all 7% to 9% smaller than before the crisis.

“The policy makers appear to be fighting against reason due to their dogmatic insistence on preserving the euro at all costs.”

Many governments have continued to run budget deficits to keep things going. This has led government debt-to-GDP ratios to explode to levels previously unheard of in peacetime. The EU project may have prevented wars, for now, but it hasn’t prevented war-like debt levels. The policy makers appear to be fighting against reason due to their dogmatic insistence on preserving the euro at all costs.

According to the IMF, five countries have debt-to-GDP levels over 100% and a further five are over 80%, which is still a high level. Greece tops the list at 159%, followed by Italy at 127%. But even the UK, which until the crisis prided itself on the “golden rule” of keeping government debt below 40% of GDP, is now up at 90%. The UK may in theory now be growing, but it has come at a steep price.

It’s no surprise, with all this bad news, that expectations are building for the European Central Bank to start money printing on a massive scale, using the method known as “quantitative easing” (QE). It’s increasingly possible to spot panic in the eyes of the eurocrats, as their great project flounders around in the mud of stagnation and despair.

But Europe, along with much of the developed world, has a much bigger, long-term, structural problem which no amount of money printing can solve. This is the so called “demographic shift”, where the population is both ageing and growing more slowly. Birth rates are lower as women marry later due to professional careers, and life expectancy is progressively longer. Between them these factors make for an unstoppable trend. (If you want to learn more about this population shifts read chapter 1 of the Wealth Workout Report )

For example, Eurostat reckons that between the years 2009 and 2050 the working age population, defined as those aged 15 to 64, will fall by 48 million. At the same time the population aged above 65 will increase by 58 million people.

This is a big deal. The clear implication is that there will be fewer productive and tax paying workers to fund the pensions and healthcare of ever more retirees. We can see this by looking at the age dependency ratio, which is the ratio of those over 65 to those aged 15 to 64.

In 2008, according to agency Europop, this was 0.25, meaning there were four (potential) workers to every retiree. By 2050 this is expected to change to 0.5, meaning just two workers for every pensioner. That’s a massive shift. It will make it seriously hard for already bankrupt governments to dig themselves out of their already huge debt holes. Higher taxes, especially on the wealthy and on companies, seem inevitable. And Europeans will need to save and invest more than ever (and spend less!) as government pensions and other services come under pressure.

Given all of this I find it seriously hard to get excited about European shares as an investment destination. Where is all the earnings growth going to come from in countries full of low income retirees, where workers and companies pay higher and higher taxes to fund the state?

It’s especially unconvincing when you consider the current levels that markets trade at. The MSCI Europe index already looks fully valued, with a P/E of 17.2 at the end of July. That’s not crazy, but it’s certainly not cheap.

Of course, QE could pump stock prices higher for a short while, and there are bound to be plenty of individual stock opportunities buried within the overall market morass. But at a high level European stocks look unappealing from either a long term growth potential or short term value perspective. So I suggest you mostly steer clear and look for better opportunities around the world.

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.