Via Mark J. Grant, Author of Out of the Box,
“Two roads diverged in a woods…”
-Robert Frost
I have said, for months now, that Europe and the United States were heading in two different directions. That became quite clear today as the manufacturing numbers for Europe were dismal while unemployment for the entire Eurozone reached 10.9% which is up 9.1% from last year. The entire Continent is in a recession, with the exception of Germany, and I think their next release, in mid May, will show that they have joined the rest of their brethern. Austerity has its costs and two of them are increased unemployment and a decline in demand for goods and services which is then exacerbated by the drop in the number of people that are working. All of this will get played out in a number of ways including a drop in the value of the Euro against the Dollar, ever widening spreads for European assets versus corresponding American assets and increasing costs for the refinancing of European bank and sovereign debt. As the effects of the LTRO wane and as it becomes apparent that there will be no new easing by the ECB; the problems mount. Liquidity wins in the short term but the issues of solvency and structural deficiencies remain and, being unsolved, they continue to weigh upon various credits and worsen their financials as investors take note and shed European assets. In the months ahead, for both political and economic reasons, I think we will see a flight back to American assets as the picture in Europe becomes both clearer and obviously worse.
The Denominator
Europe has made a colossal mistake in how they have done things. They have erred in that they have forgotten what is really important which is not the size of the debt and not the size of the GDP but that the critical issue is the size of the relationship of the debt to the economy. In focusing so much on austerity they have increased uncemployment and reduced demand which decreased the size of the national economies. Brussels/Berlin has created, in fact, a death spiral which can only be broken by growth or Inflation and, with neither present, the downward spin continues and worsens. It is always the Denominator, the relationship of debt to GDP, which is critical and in losing focus; they are losing the war. This is becoming evident in ever larger European protests that could easily become violent at some point and, short of that, in national governments that are being voted out of power in one country after another. A France under the guidance of Hollande is going to be a very different place and then when the general elections for Parliament come in June we will all see members from the far right and left that will also influence how France is governed. In Greece the splinter parties may rule the day on Sunday and how that country is going to be governed is anyone’s guess at present. What I do believe however is that Greece will exit the EU the moment that funding is cut off for them and hang the EU/ECB/IMF in the process. It will be an amusing moment, no doubt, as the curtain closes and as the ticket owners are forced to pay the costs of closing the show.
Understanding Unemployment
The Eurozone now has the highest unemployment since its inception at 10.9%. The affects of unemployment are a squared number. In the first place the costs of social services increases as people receive the largesse of the government’s programs and in the second place demand decreases as people can no longer afford to buy many goods and services. The year-over-year variance is 9.1% which equates, broadly, to an 18.2% differentiation between increased costs and lessened demand. This is a rather simplistic equation of course but it demonstrates what is now taking place in Europe and the variance is large enough to be quite significant for the European economies which is one reason why I see the recession in Europe to be much more severe than is spoken of in the Press. The sovereign debt increases, the economy declines and the result is a formula for disaster. All of this, of course, will affect American corporations and our banks so that expectations should be lowered in coming quarters for American earnings and profits. As “no man is an island,” no region of the world will be exempt from the European recession just as Europe was not exempt from our financial crisis.
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