The European Union – Is the economic euphoria justified? by Harris Samaras

October 2017

The European Union â&#x20AC;&#x201C; Is the economic euphoria justified?

By Harris A. Samaras

www.pytheas.net

About the Author – Harris A. Samaras An Economist and presently the Chairman & CEO of Pytheas, an international investment banking organization, Harris has also worked with the Bank of America Group, Thomson Financial BankWatch, and Moody’s Investors Service. His expertise lies primarily in the areas of investment and corporate banking, private equity and finance, corporate restructuring, risk management and business development, strategic advisory and thought leadership. His research and extensive publications in these areas range across practice rather than theory, economic and business thought, entrepreneurship and geopolitics. He has been an adviser to various governments, central banks, financial institutions, and other corporates and has been a member of the board of directors of multinational organizations.

07 October 2017

While the UK voted to exit the EU, Eurosceptic and populist voices are getting stronger. Whilst the threat of the unsolved refugee crisis from the East is being downplayed (in the midst of echoes of daily provocations from a bullying Turkey), terror attacks in Europe are on the rise. As the Union has not yet convinced that the Eurozone can efficiently function without threatening the EU’s own existence, totalitarian and undemocratic austerity policies do not only suffocate the EU’s economic growth but tear the European society apart, nurturing discord instead of solidarity, and disintegration. As the more-integration-no-matter-what-theconsequences-doctrine continues, the European Union seems to only act after an agreement to solve a conflict or after a crisis has already been adopted by the conflicting parties. All of these and more while the President of the European Commission announces that the Union is on the right path. But is it? The 2008 Global Financial Crisis may be over but the wounds it left on the global (and European) economy remain unhealed. In essence, European and other governments have bailed out banks and the corporate private sector. These bailouts (or bail-ins in at least one case) and subsequent stimuli, swelled global government debt, which jumped 75%, to about EUR 50 trillion in 2014 from EUR 28 trillion in 2013. Today, global government debt is about EUR 55 trillion whereas in the Euro Area it is about EUR 10 trillion (was about EUR 4 trillion in 2007). Oddly, exploding government debt should have brought higher interest rates… But as central banks bought the bonds of their respective governments and corporations, interest rates have been driven down corresponding to about 25% of global government debt – “paying” negative interest… Deflation Negative and near-zero interest rates show central banks’ desperation to naturally avoid deflation (Deflation, a contraction in the total supply of money and credit, is an economic issue that if not harnessed can exacerbate a crisis and turn a recession into a full-blown depression). Low and negative interest rates were supposed to reduce savings and stimulate spending. In practice, the opposite has happened: The savings rate has gone up! Table 1. Interest Rates EU-28 Daily (%) 2017

2017

2016

Austria Belgium Bulgaria Croatia Cyprus Czech Republic Denmark

0.00 0.00 0.00 2.50 0.00 0.25 -0.65

2016 0.00 0.00 0.00 2.50 0.00 0.25 -0.65

Italy Latvia Lithuania Luxembourg Malta Netherlands Poland

0.00 0.00 0.00 0.00 0.00 0.00 1.50

Estonia Finland France Germany Greece Hungary Ireland

0.00 0.00 0.00 0.00 0.00 0.90 0.00

Portugal Romania Slovakia Slovenia Spain Sweden United Kingdom

0.00 1.75 0.00 0.00 0.00 -0.50 0.25

Source: Eurostat Note: Year 2017= As at Sep 2017

The falling inflation in the Euro Area over the past seven years despite the marginally positive changes of the last few months remains a serious risk that constantly needs to be harnessed!

07 October 2017

Euro Area member states, with limited tools in hand – as they have a shared currency and cannot use the nominal exchange rate as an instrument to reduce external imbalances between the member states – need to make necessary adjustments via differential growth in nominal wages and prices. The problem though is that nominal wage increases are very low throughout the Euro Area, thus a country can only achieve a reduction in its relative wage level via falling nominal wages. Important to note that nominal wage reductions tend only to be possible in very depressed economic conditions, e.g. Greece and Spain. If for example, Greece, Portugal, Spain, Ireland and Italy, continue to experience periods of falling prices, and if those are combined together with sharply lower commodity prices, will unmistakably push inflation further down for the whole Euro Area. Very low inflation makes fiscal consolidation more politically difficult, i.e., freezing nominal expenditure as a way of achieving real spending cuts via inflation. Such actions though yield only budgetary gains in a low inflation environment. Table 2. Inflation Rates EU-28 Monthly (%) 2017

2017

2016

Austria Belgium

2.10 2.01

2016 2.00 1.90

Italy Latvia

1.10 3.10

1.20 2.60

Bulgaria Croatia Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Ireland

1.40 1.00 -0.40 2.70 1.50 3.70 0.70 1.00 1.80 0.90 2.60 0.40

1.30 0.80 -0,20 2.50 1.50 3.90 0.50 0.90 1.80 1.00 2.10 -0.20

Lithuania Luxembourg Malta Netherlands Poland Portugal Romania Slovakia Slovenia Spain Sweden United Kingdom

4.40 1.76 1.20 1.50 1.10 1.10 1.20 1.50 1.40 1.80 2.10 2.90

3.90 2.00 1.20 1.40 0.90 0.90 1.40 1.40 1.20 1.60 2.20 2.60

Source: Eurostat Note: Year 2017= As at Sep 2017

In theory, expansionary monetary policy should cause higher economic growth and lower unemployment. It will also cause a higher rate of inflation. However, as we have seen in the recent crisis, cutting interest rates isn’t guaranteed to cause a strong economic recovery. If confidence is low, despite the lower interest rates, markets simply do not want to invest and/or are hesitant to spend. Over and above, even after the ECB cut base rates, it has been difficult to be granted financing from a bank. One of the reasons, banks standard variable rate did not fall as much as the base rate. Moreover, strong fall in exports outweighed the improvement in consumer spending. The points that are made here? (1) Expansionary monetary policy is actually deflationary, and (2) terrible things happen to growth when debt crosses 90% of GDP. It is to a great extent “tormenting” to comprehend the EU Commission’s euphoric rhetoric! Especially with its insistence on austerity policies and measures at the absence of appropriate reforms in the structure of the Eurozone – the current structure leads to divergence, and creates current account deficit and crises, prohibiting economic growth, and increasing divisiveness within and between member states. At the same time, it gives rise to unpleasant political and social dynamics, disillusion and extremism. It threatens the EU’s existence!

07 October 2017

Table 3. Government Debt to GDP (%) 2016

2015

2014

2010

2007

Greece Italy Portugal Cyprus

179.0 132.6 130.4 107.8

177.4 132.0 129.0 107.5

179.7 99.8 130.6 107.1

146.2 115.4 96.2 55.8

103.1 131.8 68.4 53.5

Belgium Spain France United Kingdom Euro Area European Union

105.9 99.4 96.0 89.3 89.2 83.5

106.0 99.8 95.6 89.0 90.3 84.9

106.7 100.4 94.9 88.1 92.0 86.7

99.7 60.1 81.6 76.0 83.9 78.4

87.0 35.6 64.3 42.0 65.0 57.6

Source: Eurostat, Pytheas Market Research

If monetary policy efforts fail due to greater than anticipated weakness in the economy (target interest rates remain zero or close to zero, unable to spur sufficient demand and economic growth), and with austerity programs curbing spending and growth further, Mr. Juncker’s recent euphoric statements, are aimed only to create a market perception that is false… and a false perception is something that the European economy cannot afford to be centered on nowadays! EU’s problems cannot be managed by just pointing to the marginal growth of some of its member-states as evidence of “returning back to normalcy”! Well, if the European (and global) economy were doing great, interest rates would not be where they are today! Closing this headline, although the measures and commitment of the ECB to avoid a prolonged period of low inflation have helped, the impact of low inflation within the Euro Area remains negative and serious. The deflationary spiral scenario remains a threat and it is scary. Austerity Introductory textbook macroeconomics dictate that cutting spending in a depressed economy, with no room to offset these cuts by reducing interest rates (that were already and still are near zero), will trigger a downward growth spiral and indeed deepen the crash. The priority for governments in recession should be to keep money flowing to generate growth, ultimately needed to pay off debt. But EU policymakers and their advisors or to be more precise, Germany, had a different point of view… while they were very much aware that austerity will definitely drive weak economies into a deeper recession… The austerity policies that have been pursued and are still pursued by the EU have had perverse effects. Coordinated fiscal consolidation has not only had substantially larger negative impacts on growth than expected (and advertised), but has actually had the effect of raising rather than lowering Debt-to-GDP ratios. Not only would growth had been higher if such policies had not been pursued, but debt-to-GDP ratios would have been lower. As if the plan of Brussels was and is to asphyxiate the European economy… It is absurd to insist that austerity is the only alternative. If Brussels (Berlin to be more precise) had agreed at the start of the crisis to mutualize high-risk-countries debt, the crisis could have been eradicated in months… Debt Mutualization was the only alternative then and it is the only alternative now!

07 October 2017

Austerity during an economic recession is not just counterproductive, it is idiotic! It is also a hideous crime that concurrently destroys the fabric of the European society. It attacks the poor, it attacks European democracy, enhances divergence and encourages extreme elements within a society to manipulate. Back to our subject: There can be no economic euphoria while austerity is on the table! Brexit What if the leadership in the EU and the UK had done more to avoid the outcome which they almost all opposed? An outcome that indisputably will reshape the future of the EU. But they didn’t… Now, those EU officials (and their naive followers) who believe that the secession of the second largest economy in Europe can be managed by reasonable and mutual accommodation, well they must be totally off, as if living in a “Dreamworld”. Those EU officials, that quite understandably, have taken a hard line, believing that they must be unrelenting in the punishment of the UK, (and should offer little more than what the UK is guaranteed under normal global agreements), basically promote that the EU will be held together by threats and fear, fear of what would happen if a country dares to secede… Misled but also deceived by opportunists, political party (narrow-minded) power-games, bigotry, and populism, the vulnerable UK citizen – however polarized or disillusioned (like the rest of the European public is) – felt that she/he has had enough – consequences of increased economic insecurity, stagnant wages, reduced job protection, and the constant threat of government cuts to the social safety net upon which so many depend as a last resort made them feel even more vulnerable. Spice this with a bit of nationalism and here we are… The dysfunction of the Eurozone, the “annihilation” of sovereignty in the EU countries under severe crisis, has made the EU a Union that seems less and less attractive – especially as Germany “seems” to dominate in an autocratic way (that is offensive to many). The failure of EU policies along with the arrogance and unforgiving way with which they have been implemented has only made things worse. Consequently, politicians in the UK have manipulated this to more than an extent, blaming the EU for any wrongdoing. The oxymoron? While the British did not suffer directly from the democratic deficit so evident in the European Financial Crisis, it played directly into their perceptions of the EU itself. Whatever the outcome of the Brexit “exercise” – whether a hardline EU will refuse to grant the UK any special status, or if the UK is “forgiven” exiting with a “top” deal, or if Brexit is even reversed – the only certainty is that the future of the EU has become even more uncertain. Unless the European Union is convincingly and tangibly willing to fundamentally restructure into an efficient Union that is not divergent (and conflicting); with mechanisms in place that counteract stagnation and enhance stability, reflecting the interests of not only its corporates but also its citizens as a whole, its existence is uncertain! The Banking Union The EU is in need of a well-designed Pan-European banking system which should entail more than just banking supervision – with a Pan-European deposit insurance fund and an appropriate regulatory framework. It is the only sound way for the EU as a whole to promote stability, and ensure that all the member-states have a fair chance to perform well.

07 October 2017

But I am afraid that Germany for one is going to create obstacles for its content and implementation. You see, without a Pan-European deposit insurance fund, money will always flow from the banking system of weaker countries to the banks of stronger ones, weakening further the already weak ones… European security The idea of spending more on defence and other security capabilities is politically unappealing at a time when the EU is still healing from the Crisis, and social welfare spending is under pressure. However, European Security is paramount for Europeans to protect their way of life. And if the UK will exit, the EU will be further weakened through the loss of one of its most powerful military members. The European Defence Action Plan (which is not just an expense as it will also foster a lucrative industrial base) and the European Defence Fund are steps toward the right direction. So is the recently revived prospect for EU-NATO cooperation; although NATO has as a member Turkey, a consciously destabilizing force and a threat to peace. The European Border and Coast Guard Agency (Frontex) and EUNAVFOR MED are two other steps towards the right direction and so are the other related EU initiatives. But all of these have to be translated into strong policy outcomes that have as a weapon not only the EU’s 28-member-states sizable-market-force but also a deterring and significant military one. The EU cannot afford any longer to only act after the fact. Foremost, it has to take a stance and tangibly behave as an entity that protects the rights of all its member-states and citizens. Not an easy task, as own member-states geopolitical and economic agendas but also agendas of private industrial and other lobbies’ may be disrupted. Additionally, the need for compliance with fundamental rights, democratic values and ethical standards increases the complexity of the issue, but let’s not allow again the perfect to become the enemy of the good. In Europe more than anywhere else, we have to admit, we tend to increasingly adopt a conceptual approach to a problem that is strongly solution-driven and tend to neglect the variety and complexity of social economic, technical and political factors that have caused the problem in the first place up until the moment (years later) we hit dead-end. Let’s “ignore” the problem if we know the solution and let’s… reduce red tape! Epilogue We also know what the solutions are for a clearly better functioning Eurozone. The recent financial crisis is not the first the world had lived through and it will not be the last. The solutions are there. So are the dos and the don’ts. Mr. Schäuble knows for instance, as a sophomore economics student does, that austerity and recession do not mix. Mrs. Merkel and Mr. Macron also know that we cannot have a Banking Union without a welldesigned Pan-European deposit insurance fund. Mr. Draghi knows that deflation still is a serious threat to the European economy, as Mr. Shinzō Abe knows that it is a threat to the Japanese economy.

07 October 2017

Mrs. Mogherini knows that European security can only be achieved if a proactive foreign policy is adopted and significant military force is established, as do the European Union Cypriot citizens that face daily Turkey’s bullying and threats. And Mr. Juncker very well knows, that this is no time for economic euphoria, but costly, I am afraid, bold and capable leadership. We all know, that the challenges that the EU is facing today as a whole are fundamental and existential. They are not just… problems. And if our European leaders have not identified them as so, then they cannot feel the pulse of their own citizens. They cannot be our leaders. I respectfully remind our leaders, that crises and revolutions – political and social but also armed ones – even collapses of civilizations, do not primarily occur because of a country’s or a region’s economic fallout, but because the societies of those countries/regions encounter fundamental challenges. Fundamental challenges to which institutional structures and the psychological outlook of the people have rendered them unable to adapt themselves in the time available. The main reason for the sequence of fragmentation and breakdown processes that follows is mainly caused because leaders have forgotten what humanity and dignity are all about (and no, I am not naive!). This idea, that we all want to be proud of, the European Union, cannot subsist if its leaders have as common tactic the use of polarization to meet their own political ends. Mainly because of the practice of such tactic, in each and very EU member-state, voters, dissatisfied with “mainstream” parties are willing to give a chance to those proposing extreme and radical alternatives. A sign that something is fundamentally wrong, a demand for change! And ignoring demands for change would ultimately deepen popular hostility toward the Union. One is of course aware, that the multitude of rules that govern economic life in the Union are much more difficult to amend than are alike domestic provisions, and that the European Parliament has limited “visibility” as major decisions are primarily negotiated between national governments. Furthermore, the selfish view of human nature “cannot be” eradicated, although true leaders should be able to control it and transform it somehow into cooperation; that is easier possible if they themselves do not deliberately practice selective justice. The recent financial crisis is the defining collective economic and social event of most of our lifetimes, a major challenge of our time, and a major challenge and test for the European Union as a whole; an event that forced both its strengths and flaws to surface. Let’s not let this last financial crisis go to waste! We should ask ourselves: Is this really the best we can do?

07 October 2017

Sources (Alphabetically) ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ►

Angela Dewan, “Brexit: EU chief Juncker warns UK will regret it”, CNN, 2017 Anna Isaac, “Trillions of pounds at risk without Brexit deal on derivatives, warns Bank of England”, The Telegraph, 2017 Barry Eichengreen, “The Euro’s narrow path”, Social Europe, 2017 Ben S. Bernacke, Thomas Laubach, Frederic S. Mishkin and Adam S. Posen, Inflation Targeting – Lessons from the international experience”, Princeton University Press, 1999 Benjamin Dodman, “The debt write-off behind Germany’s economic miracle”, France24, 2015 Benjamin J. Cohen, “How stable is the Global Financial System?”, Project Syndicate, 2017 Buttonwood, “The next financial crisis may be triggered by central banks”, The Economist, 2017 Böll Lunch Debates, “What are the main challenges facing the European Union in 2017?”, The Heinrich Böll Stiftung European Union, 2017 Carl Bildt, “The six issues that will shape the EU in 2017”, World Economic Forum, 2017 Carmen Reinhart, “Is the deflation cycle over?”, Social Europe, 2017 Chris Jones, “The ongoing march of the EU’s security-industrial complex”, Open Democracy, 2017 Christian Odendahl, “Quantitative easing alone will not ward deflation”, Centre for European Reform, 2017 Christopher House, Christian Proebsting and Linda Tesar, “Austerity in the aftermath of the Great Recession”, VOX, 2017 Dawn Holland and Jonathan Porfes, “Self-defeating austerity?”, VOX, 2012 DebtClocks.eu, “Debt clocks of the EU Member States”, DebtClocks.eu, 2017 European Commission, “Eurostatistics – Data for short-term economic analysis (09/2017)”, Eurostat 2017 Eurostat, “Unemployment statistics”, Eurostat, 2017 Eurostat News Release, “Provision of deficit and debt data for 2016”, Eurostat Press Office, 2017 Ferdinando Giugliano and Christian Odendahl, “Europe’s make-or-break country: What is wrong with Italy’s economy?”, Centre for European Reform, 2016 Francesco Guarascio, “EU tries revamp of banking plan, as skeptical Schaeuble leaves”, Reuters, 2017 George Friedman and Jacob L. Shapiro, “Three issues that will lead to trouble in Europe in 2017”, Business Insider, 2017 Gernot Jeller and Jan Strupczewski, “EU, Germany head for clash over deposit insurance plan”, Reuters, 2017 Hans-Werner Sinn, “Jean-Claude Juncker’s roadmap for European disaster”, Project Syndicate, 2017 Harris A. Samaras, “Could the Greek Financial Crisis be the end of the EU as we know it?”, Pytheas Market Focus, 2011 Harris A. Samaras, “Cyprus facts and European Union totalitarianism and horror”, Pytheas Market Focus, 2013 Harris A. Samaras, “More than ten facts and one question about Greece and the EU Financial Crisis”, Pytheas Market Focus, 2015 Harris A. Samaras, “The failure of the Greek State engendered a disillusioned society”, Pytheas Social & Political Review, 2012 Harry S. Dent, Jr., “The demographic cliff”, Penguin Group, 2014 James K. Galbraith, “Welcome to the poisoned chalice: The destruction of Greece and the future of Europe”, Yale University Press, 2016 James Grant, “The forgotten depression”, Simon & Schuster, 2014 James Rickards, “The new case for gold”, Portfolio Penguin, 2016 Jeet Heer, “An utter failure: Joseph Stiglitz on the Euro and Europe’s uncertain future”, New Republic, 2016 Jeffrey Frankel, “Why financial markets underestimate risk”, Project Syndicate, 2017 John Palmer, “Is Wolfgang Schäuble as dangerous to the EU as Donald Trump?”, Social Europe, 2017 Jonathan Sterns, “Juncker tells EU to seize window of opportunity after Brexit”, Bloomberg Politics, 2017 Jonathan Sterns, “With crisis fading EU chief Juncker projects renewed confidence”, Bloomberg Businessweek, 2017 Joschka Fischer, “Brexit to Nowhere?”, Project Syndicate, 2017 Joseph Stiglitz, “The Euro and its threat to the future of Europe”, Allen Lane, 2016 Nick Gutteridge and Monika Pallenberg, “Largest peace project in history of mankind: Merkel gushes at Germany’s bond with EU”, Express, 2017 Larry Elliot, “OECD in Brexit warning U-turn as it revises growth forecast for UK”, The Guardian, 2017 Laurens Cerulus, “Sigmar Gabriel: Merkel’s austerity is driving EU to brink of collapse”, Politico, 2017 Maria Vokshi, “Europe reacts to Juncker’s State of the European Union speech”, Open Europe, 2017 Mohamed El-Rian, “How healthy is the global financial system?”, The Guardian, 2017 Niall Ferguson and Nouriel Roubini, “This time, Europe really is on the brink”, Spiegel Online, 2012

07 October 2017

► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ► ►

Noam Gidron and Bart Bonikowski, “Varieties of Populism: Literature review and research agenda”, WCFIA Harvard University, 2013 Paul De Grauwe, “Catalonia and Brexit: The same Nationalism”, Social Europe, 2017 Paul Krugman, “Austerity arithmetic”, The New York Times, 2015 Paul Krugman, “The austerity delusion”, The Guardian, 2015 Pentti Hakkarainen, “The challenges and future of banking in the EU”, European Central Bank, 2017 Peter Praet, “Maintaining price stability with unconventional monetary policy measures”. European Central Bank, 2017 Phillip Inman, “UK growth will trail Italy, France and Germany next year, says OECD”, The Guardian, 2017 Robert Hackwill, “Austerity obsession is pushing EU into crisis warns Stiglitz”, Euronews, 2016 Robin Niblett, “Fragility in Europe is on the rise, and we’re not doing enough to respond”, World Economic Forum, 2017 Samuel Osborne, “Turkey threatens ending EU refugee deal amid diplomatic crisis with Germany and the Netherlands”, Independent, 2017 Scott Eric Kaufman, “Thomas Piketty attacks hypocritical Germans for insisting on Greek austerity: They are a huge joke”, Salon, 2015 Simon Tilford, “Is the Eurozone really out of the woods?”, Centre for European Reform, 2017 Sunny Oh, “Four charts show why U.S. investors should watch Draghi at Jackson Hole” MarketWatch, 2017 The Sound of Economics, “How will Europe’s banking system respond to future challenges?”, Bruegel, 2017 Thomas Jansen, “Reflection on European identity”, European Commission – Forward Studies Unit, 1999 Timothy W. Guinnane, “The 1953 London Debt Agreement”, Yale University – Economic Growth Center, 2015 Tony Barber, “Jean-Claude Juncker’s vision for Europe”, Financial Times, 2017 Torsten Bell, “We let the 2007 financial crisis go to waste”, The Guardian, 2017 Trading Economics, “ECB Policymakers reveal concern over Euro strength”, Trading Economics, 2017 Trading Economics, “Euro Area Unemployment Rate – 1995-2017, Trading Economics, 2017 Trading Economics, “Euro Area Money Supply M2 – 1980-2017”, Trading Economics, 2017 Vicky Dendrinou and Ian Wishart, “These are the most pressing challenges for Europe’s leaders”, Bloomberg Politics, 2017 Vitaly Katsenelson, “The world is becoming desperate about deflation”, MarketWatch, 2017 Vladimir Mau and Irina Starodubrovskaia, “The challenge of revolution”, Oxford Scholarship Online, 2003 World Bank Group and PwC, “Paying Taxes 2017”, PwC, 2017

Disclaimer The above notes have been compiled to assist you; however, actions taken as a result of this document are at the discretion of the reader and not of Harris A. Samaras or Pytheas. All rights reserved. The material in this publication may not be copied, stored or transmitted without the prior permission of the publishers. Short extracts may be quoted, provided the source is fully acknowledged.

07 October 2017