Terrified & Bored

by Kris_Tuttle on September 26, 2011

Paul Krug­man applied this per­fect label to the cur­rent sit­u­a­tion in Europe about the econ­omy, soci­ety, and the Euro cur­rency. He points out some of the tired but scary obser­va­tions about how coun­tries account­ing for about 1/3 of the Euro­pean econ­omy are tee­ter­ing on edge of ruin and default. The richer coun­tries like France and Ger­many have been pro­vid­ing sup­port while insist­ing on aus­ter­ity and reforms. But, the bills seem to get big­ger and the “rich economies” of France and Ger­many are low or no growth. That’s the big prob­lem that is lead­ing some to pre­dict the Euro will cease to exist. The best rebut­tal to the this argu­ment is the UBS Euro Note Sept 2011 pre­dicts that the Euro will be sup­ported with a slow and very painful inte­gra­tion of fis­cal pol­icy over time. It’s worth read­ing the whole note, but the sit­u­a­tion might best be described as “damned if they do, damned if they don’t.” This is due mostly to the fact that the costs for exit­ing the Euro by choice or force are massive.

Back in 2004 I was attend­ing a small group event in Paris focused on the global econ­omy and the Euro. Trichet came to speak with us “off the record” and made it clear that the reforms required for the Euro to suc­ceed were far beyond what the peo­ple of Europe would ever accept. The strat­egy up to that point was to empha­size the ben­e­fits of a more uni­fied Europe and a sin­gle cur­rency while avoid­ing all dis­cus­sion about other con­se­quences. For exam­ple, one might talk about how much eas­ier it would be for peo­ple in one coun­try to send their kids to school in another or even move there to take a new job — the promise of more mobil­ity. But, the fact that fund­ing for schools might be severely reduced isn’t mentioned.

For the next few weeks, the world will be won­der­ing what sort of “grand plan” the “author­i­ties” in Europe will craft to unveil at the G20 meet­ing on Novem­ber 4th. The cur­rent Euro­pean Finan­cial Sta­bil­ity Facil­ity (EFSF) has a $600B check­book  which is prob­a­bly enough for Greece. How­ever, if Spain and Italy are at risk, the esti­mate for what will be needed jumps to about $3T. It’s only one let­ter so we should all pause and read that fig­ure as “three tril­lion dol­lars” which is a lot of money. The final pro­posal is likely to be com­pli­cated, but the thrust of it is to lever­age resources by appor­tion­ing the losses from defaults and use the assets of the rich coun­tries to absorb only a por­tion, say 20 or 30% of each loss. I’m not smart enough to under­stand why this would actu­ally work but per­haps global mar­kets will see the value of this approach.

That part describes the “ter­ri­fied” aspect of the Euro­zone cri­sis. The num­bers are big, and nobody can be sure if it will work. The “bored” aspect has to do with the struc­tural lack of growth in the rich coun­tries. With­out sig­nif­i­cant growth, the coun­tries in Europe are forced to play a grim zero-sum game. The rich give to the poor and then are forced to cut ben­e­fits and reduce their own qual­ity of liv­ing. No won­der ten­sions are mount­ing. Growth fixes the prob­lem because liv­ing stan­dards can rise for the rich coun­tries and give them more resources to share with their poorer cousins.

So how could Europe solve their prob­lem if growth is the only way to do it and they are sad­dled with tons of debt? There’s only one way but it doesn’t seem likely. It’s an often-dreaded four-letter word called WORK. But, this isn’t just work in the con­ven­tional sense of “there I came in and did some­thing” but the kind of HARD WORK that gen­er­ates a step­wise improve­ment in results. Even worse the mea­sure of this sit­u­a­tion sug­gests we are really talk­ing about LONG HARD WORK.  Peo­ple famil­iar with Europe tend to respond with “Wow! That’s NEVER going to happen!”

It could hap­pen though. One sim­ple solu­tion would be to rein­sti­tute the draft. This would imme­di­ately solve two big prob­lems in France. #1 the mas­sive unem­ploy­ment of young adults would go down, and they would receive train­ing and expe­ri­ence to obtain jobs after their ser­vice period and #2 dif­fer­ent ele­ments of soci­ety would again be inte­grated under a com­mon cause and belief sys­tem. France has also gone some dis­tance in mak­ing it far eas­ier to become a free­lancer or start a small busi­ness. But putting these and more things with bold mea­sures and lead­er­ship is out of reach based on most edu­cated guesses.

Back in June of this year I attended the “eG8 Sum­mit” in Paris and came away with a sense that the gov­ern­ments of Europe, par­tic­u­larly France, would have a hard time not over­play­ing their hand of gov­ern­ment inter­ven­tion. (See the full doc­u­ment in PDF here: eG8 Meet­ing Sum­mary June 10 2011.) France wants to orches­trate suc­cess­ful growth instead of cre­ate a sus­tain­able sys­tem that can drive itself. Almost every aspect of growth depends on some gov­ern­ment pro­gram, hand­out, or tax break. There are a few brave souls who have built impor­tant busi­nesses in France from scratch, some even on the Inter­net, but they are rare enough to be on dis­play at the eG8 meet­ing as if they were exotic animals.

The most recent events have not given much rea­son to hope for bet­ter lead­er­ship. In August Sarkozy and Merkel put their heads together and came up with lit­tle to noth­ing of sub­stance. After vis­i­bly agree­ing on how nice the weather was the two dis­cussed meet­ing more often and rais­ing taxes on finan­cial trans­ac­tions. It all elicited a groan from any­one with a pass­ing knowl­edge of growth, wealth cre­at­ing, eco­nom­ics and cap­i­tal markets.

So what does it all mean? Only one thing in the medium term that is to avoid Euro­pean assets and regional invest­ments in favor of global and multi­na­tional equi­ties. Many are sport­ing high earn­ings yields, rich div­i­dend pay­ments, and excel­lent cov­er­age ratios. Own the best qual­ity free cash flow rel­a­tive to equity. They may all remain under pres­sure for a while as global growth slows, but they are the only attrac­tive long-term invest­ment play right now except tech­nol­ogy and startups.

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