On the surface, it would seem that the euro crisis has calmed. Markets have rallied since the summer and, to borrow a phrase from Herbert Hoover, “prosperity is just around the corner.” But outward appearances in Europe are like a Potemkin village. Behind the well-scrubbed facades, Southern Europe is in a death spiral. Anyone convinced that the European monetary union has come through the crisis stronger is a victim of the slickest PR campaign in history.
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Let’s be very clear here: this is what the euro has wrought. This destruction of the non-German industrial bases has taken place with the active complicity of the European technocrats. They did not even realize that France, the EMU’s second largest economy, for example was becoming hopelessly uncompetitive.
Let's go one step further. According to the official GDP statistics the French economy since the beginning of the euro experiment has done as well as the German economy:
But note that if we use the ratio of the two industrial production indices, then we see that the French economy has “underperformed” the German economy by 20%.
The loss of industrial capacity in France, Italy and Spain has taken place in the private sector part of the economy. The implication is thus that the share of the private sector in the economy must have been going down in Italy and France, and up in Germany. To compensate for demise of the private sector, the "solution" in good Keynesian logic is of course to grow the public sector.
The red line in the chart below depicts reality; the blue line the Keynesian fairy tale. French debt went through the roof, to pay for a massive increase in government spending as a percentage of GDP.
Needless to say, the same thing has happened in Greece, Spain, Italy, Portugal, etc., where the collapse of the private sector has been offset by a rise in government spending financed by an even bigger rise in new debt. Where does that leave us? Well, we have a bunch of countries deindustrializing fast, issuing tons of "riskless assets" to mask the fact that they are in a very serious depression.
This is very visible in the next chart (see below). The euroland industrial production index is FLAT since 1998, with Germany’s index up 30%, the French one down -10% and the Italian and Spanish ones down- 20% each.
This is a zero sum game if there ever was one, with Germany being the main winner and the other three economies massive losers. Instead of leading to convergence in euroland economies, the euro project has led to massive divergences, with the strong getting stronger, and the weak getting weaker.
For these trends to change, we would need radical change. We are not talking about retirement age being nudged up a year in one country, or a rules for firing people liberalized an iota in another. We would need to see bloated states firing 20% to 40% of civil servants, and the government spending share of GDP to plunge; the cost of labor to fall by at least –20% relative to the cost in Germany; the return on invested capital in Europe’s South to move above the ROIC not just in Germany but also in Eastern Europe. There is zero chance of these types of reforms taking place.
Which means the logical end of the euro experiment is thus to have all the European factories in Germany or its office bases in the East and none in the South of Europe where the costs are too high and will remain too high under almost any scenario. We have already part of this journey, which I fully expected when I wrote in 2000 that the euro was going to lead to "too many houses in Spain, too may civil servants in France and too many factories in Germany."
The dire truth is that one cannot maintain a fixed exchange rate among countries which have different underlying productivity growth rates, different social systems and different political arrangements. Nothing will ever change this reality.
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Conclusion
The ECB has thrown enough money at the market to, for now, reduce borrowing costs and allow equity prices to rise (unfortunately so is the euro, threatening exports). This buys time—but these actions are not enough to solve the structural problems created by the euro. The private sector has shriveled in Southern Europe, as government spending and debt has soared. If we have France, Italy and Spain together enter a debt deflation/debt trap, the crisis will be far too big for Germany to handle: and if this happens before German federal elections are held (no later than October) we could see the European political crisis revive in full force. Do not trust the Potemkin façade of the euro. I would not own fixed income in any country in euro land, especially with the euro being so strong. Only equities in the freest parts of the economy should be considered
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