As the IIF continues to believe it is negotiating with Greece on voluntary haircuts and Ireland follows the Greek playbook by threatening referenda and asking for bailout term adjustments, is it any wonder that the words of a supposedly united Europe ring hollow in the ears of investors who seem to expect a Euro breakup sooner rather than later. Deutsche Bank's credit team see two noteworthy similarities between the world today and where it was in the 1930s. First, they view the Euro today as creating the same problems for Europe as the Gold Standard did in the 1930s and secondly, the austerity now is perhaps equivalent to the tightening of fiscal and monetary conditions in the US in 1937.
Is the Euro today the Gold Standard of the 1930s for European Economies?
The 1930s in Europe was a slow moving game of falling dominoes with countries one by one leaving the narrow confines of the Gold Standard after chronic growth problems that a fixed currency system intensified. There was a definite trend in the 1930s that saw those countries that left the Gold Standard seeing a much quicker recovery from the Depression than those that stayed on for a number of years into the latter half of the decade. Figure 12 shows a case study of six countries currencies relative to Gold in the 1930s. We’ve rebased them to 100 at the start of the series. In order of leaving the Gold Standard, we had the UK (left September 1931), Sweden (also left September 1931), US (April 1933), Belgium (March 1935), France (September 1936) and Italy (October 1936).
Interestingly, by the middle of 1937 all had devalued by at least 40% to Gold except Belgium who had devalued by around 30% in 1935. France, which held on until September 1936, then saw its currency collapse by nearly 70% in the three years up to WWII. Figure 13 then shows the same six countries nominal (left) and real (right) GDP performance over the same period.
The UK and Sweden, which left the Gold Standard earliest (September 1931) in this sample, saw a ‘relatively’ mild negative growth shock compared to the other four. In contrast, France which stuck to Gold until late 1936 saw growth notably under-perform until they left the standard. Interestingly as discussed above, France later saw a dramatic 3 year 70% devaluation to Gold which helped restore nominal GDP close to that of the UK and Sweden by the end of the 1930s. However, in real terms they were still the laggard at this point. The worst slump of all was that seen in the US between 1929 and 1932 where they lost nearly half the value of their economy in nominal terms and nearly 30% in real terms. However, the bottom pretty much corresponded to the end of the Dollar’s gold convertibility and subsequent devaluation. From this point on, the recovery was fairly dramatic until the 1937 recession we’ll discuss below. Overall, Figure 13 does indicate some fairly strong evidence that growth did seem to respond to currency debasement and that countries which left this later ended up with weaker economies for longer and also, in France’s case, a more dramatic end devaluation.
Obviously this led to a deep recession after the fragile post-Depression recovery and given the current central bankers' tendencies outside of Europe, the inevitable (and so much more easy to achieve now) print-fest solution to the necessary deflation.
The differences between now and the 1930s – "We're printing gold"
In real terms, we are not too different in many countries to the outcome seen in the Depression. However, the overall price level in the economy has held up much better than it did in the 1930s leaving nominal GDP above its 2007/2008 peak in Austria (106.5 relative to a rebased 100 peak), Belgium (106.4), US (105.3), UK (104.7), Germany (103.7), France (103.3), Finland (102.9) and the Netherlands (101.3). Much of this has been because of QE and other dramatic interventions preventing the collapse of much systemically crucial debt (particularly banks) that would otherwise have defaulted and led to deflation.
However, all the peripheral five are below their nominal peak still with Portugal, Italy and Spain just below their peak but with Greece (92.8) and Ireland (82.4) well below. When using Ireland as a positive case study for what others can achieve, it is worth being aware that they have seen a near 20% fall in their economy on a nominal basis. This has allowed them to dramatically improve their competitiveness. Unless others are prepared to make the same hard decisions and can be funded in the meantime, we think they are unlikely to be able to repeat Ireland’s competitive gains.