Europe

The grim future of Europe

Europe is in long term decline. Massive structural problems are being compounded by poor policies. The Greek debt saga is a reminder of the deep-seated problems throughout the European Union. In fact Greece is the first of many dominoes that will fall. We should expect frequent financial crises and political turmoil in Europe for decades to come. It’s sad to say, but Europe has a grim future ahead of it.

For a long time now Europe has been seen as a relatively low risk sort of place, especially Western Europe. But it’s now in the early stages of long term decline, which means a lot more uncertainty and upheaval.

The biggest problem in Europe – and one that is rarely talked about in public – is a huge and unstoppable trend. It’s the “demographic shift” caused by increasing life expectancy, on the one hand, and falling birth rates, on the other hand.

The European Union’s own official projection across the 28 EU countries is that the number of working age people to retirees is set to halve by 2050 from 4-to-1 to 2-to-1. This simple statistic represents a challenge of epic proportions.

Half as many productive, tax-paying workers will be around to fund the pension and healthcare needs of each old person – let alone everything else that governments spend money on.

…there simply won’t be enough in the state coffers to go around.

Where will that money come from? My bet is that there simply won’t be enough in the state coffers to go around.

Politicians have a range of choices to deal with this. They can substantially raise taxes, slash public services or allow mass immigration of workers from, say, Africa and the Middle East.

To say the least, none of these would improve an incumbent government’s chances of re-election. So the hard decisions are put off. They are left for someone else to deal with. Until there is no choice left.

The result will be economic stagnation and decline across much of Europe. Financial crises will be more frequent. Standards of living will fall steadily. The middle class will be hollowed out. The ground will be fertile for ever more populist politics.

Nationalists will rally under their countries’ flags and blame foreigners for their troubles. Hard core socialists will rally under their own banners and soak the rich and big business. The increasingly extreme policies of neither will be good for the economy or for European unity.

Let’s not forget that the last time “nationalist” and “socialist” both found prominence in European political thinking the outcome was a humanitarian and economic catastrophe.

We’re still a long way from that happening again. But it’s worth remembering that already around a quarter of members of the European parliament represent eurosceptic parties.

A few years ago no one would have predicted such a resurgence in nationalist tendencies. It’s reopening old wounds and reminding people of deep seated grudges between countries. Efforts by the powers at the centre to prevent fragmentation are likely to worsen the ultimate outcomes.

For the 28 countries in the European Union the average debt-to-GDP ratio is 87%.

Compounding the demographic problem is that much of Europe is already in a weak financial position. Government debts are high in relation to economic output. For the 28 countries in the European Union the average debt-to-GDP ratio is 87%.

This kind of debt level is previously unheard of during peacetime. There’s no leeway for massive public borrowing and bailouts the next time a big crisis strikes. And strike it most certainly will.

Of course there’s a big range of individual country debt burdens within that European average. Norway, which is the richest country in the world, has massive net government assets due to its sovereign wealth fund, which is money saved from its oil and gas business. At the other end of the scale – and of the continent – sits Greece. It’s in the hole for debts that are 172% of GDP, and set to climb to 200% in the next couple of years according to IMF projections.

Greece is a microcosm of where much of Europe is heading in the coming years and decades. Across the continent, government debts will keep climbing faster than the economies than underpin them. Politicians will continue to overspend to meet voter expectations. Eventually a breaking point will be reached.

Greece is already at that breaking point. The Greek people have had enough of the deep depression that their country is suffering. And who can blame them? Earlier this year they elected a new, hard line socialist government to reject austerity and fight their corner. In theory at least.

Just recently that government organised a referendum where the Greek people firmly rejected the latest bailout proposals from Europe and the IMF, and the attached conditions. Shortly after that – and with a strong mandate from the people to do precisely the opposite – the same Greek government completely surrendered to German led demands and signed up to an even worse deal for Greece.

The mind boggles. But then this is politics after all. However it gives us a perfect illustration of the kind of political uncertainty that is likely to plague Europe for years and decades to come. And where there’s political uncertainty then there’s additional risk for investors.

That said, Europe should not be written off just yet as an investment destination. There are bound to be many great opportunities over coming years and decades. But ever more caution is required.

When it comes to Greece, I don’t think, for one second, that the crisis is over. Even if the latest proposals get the necessary parliamentary approvals in Athens, and other European capitals, nothing has been solved. I suspect lots of European politicians and bureaucrats also understand this reality, but they just don’t want to admit in on their own watch.

Let’s be (really) optimistic and say that Greece finds a path where it can grow at 4% a year over the long run – even if it keeps the euro. That’s 2% for inflation and 2% “real”, above inflation growth.

And let’s say that the Greek government can run a balanced budget over time, including interest costs on the debt. That means there is no new public borrowing.

Under those unlikely assumptions it would still take over 30 years to get Greek debt down to a sustainable level of around 50% of GDP. The reality is probably twice as long.

Could there be a whole generation of budget discipline and no juicy handouts to voters, no matter what government is elected? And no more financial crises in the meantime? Does that sound likely? Of course not.

Much more likely is weak growth, continued government budget deficits, the emergence of new radical political parties, and perma-crisis.

Of course there is a way out for Greece, but even the majority of Greeks don’t seem to have worked it out yet. And certainly the powers in Brussels and Berlin wouldn’t want it to happen on their watch.

Greece could simply default on its debt and devalue its currency by exiting the euro. This is the time tested strategy of bankrupt countries throughout history. Of course this would upset its creditors in Europe and at the IMF. And all sorts of doom mongers claim it would impoverish the Greek people.

For every employable person under 25 with a job there is another with nothing to do. That’s a huge waste of human capital.

But guess what – ordinary Greeks have already been impoverished by current policies. The country is saddled with huge debts and is living through a massive depression. Unemployment is 26% and youth unemployment is twice as high. For every employable person under 25 with a job there is another with nothing to do. That’s a huge waste of human capital.

In fact any additional pain from a “Grexit” could be extremely short lived. Renowned market strategist Albert Edwards, of French bank Societe Generale, recently pointed this out. When Argentina broke the currency peg between its peso and the US dollar in 2002, which resulted in a huge devaluation, it suffered just one quarter of recession. This was followed by fast growth due to newly competitive pricing of Argentine products in world markets.

Greece could do the same. After all, tourism alone is 17% of its economy. With a devalued currency, holidays to Greece would be much cheaper, drawing in the pasty, sun-seeking, northern European crowds and giving the country a boost.

Of course this partly explains why other Mediterranean countries – Portugal, Spain and Italy – are so keen to keep Greece in the euro. They don’t want the competition from cheaper Greek beaches. It’s not just the Germans that want to maintain the status quo.

The Greek situation is far from resolved. And due to the deep structural problems across Europe it shows where much of the continent is heading in future. More debt, more crises, more dodgy politics.

We’re witnessing a time of profound uncertainty in Europe. It’s a drawn-out, relentless process that will most likely last for decades. Greece reminds us that the European dominoes are starting to fall. The future of Europe is grim.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com

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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.