A Tale of Two Europes

We have two Europes. One in which I have lived and invest in, with diversity of language and culture comprising a varied economic platform for 27 member states at the cost of surrendering individual economic sovereignty. And the European Union, a political construct held together by a single currency which is in essence the Deutschmark (see article ‘Is the Euro the Deutschmark).

The Federalist vision of the latter is an extension of the Bismarck Plan of the 1880s with an ambition to cede political sovereignty from self-governing members states to a Federal State Government.

The single currency is the glue. However, without a treasury an exchequer and central fiscal policy which Germany will not allow, they are unable to create debt or credit on which fiscal money supply and an economy is sustained. The argument for the EU has never been an economic one. It has and will always be political, which is why so much misinformation was given by both sides of the argument, during the campaigning leading to the Brexit vote in 2016.

The German 10-year Bund is the benchmark for European credit and the only safe paper in which to invest in Europe. There is a simple reason for this. Germany has little debt relative to GDP and low unemployment with a sustained level of GDP growth higher than all the other European economies. It has been the benefactor of the single currency, ECB monetary policy and historic low interest rates. German exports are 50% of GDP.

The same so called ‘debt trap diplomacy’ with which China is engaging across Asia and Europe with ‘One Belt Road ‘ (see past Newsletter) is reflected also by the EU investing soft Euros and Sterling into economic ‘waste lands’ like the coal mining valleys of Wales in the UK. The long-term goal is to force more not less integration and dependency on the EU. Greece is the classic example. In their Hubris they did not see Brexit coming however will turn this to their advantage by demanding ever closer economic fiscal and political union.

Compare the fortunes of national bankruptcy between Iceland, now a thriving economy and independent self-governing nation and member of the 4 non-EU countries in the European free trade association, and Greece still run from Brussels by the Troika unable to set its own interest rates or make fiscal policy. The EU and the Single Currency are unsustainable in their present construct. If you look at world trade by capitalization of companies (source Morgan Stanley World Index) the US is some 33% Europe 17% UK 9% (France and Germany approx. 3% each) Exports are 13% of US GDP with Germany 50% and China 35%.

The next decade game changer is the harnessing of Artificial Intelligence, robotics and evolving battery power. The German model of precision engineering and high-quality manufacturing through small to mid-sized family business succession will not be sustainable in coming decades as AI and robotics challenge their economic model. Economists do not know how to model the behavioural changes in the society and workplace and the ensuing unintended consequences.

Should the UK leave the EU with a negotiated settlement or none, it is unlikely that she will be a net contributor to the EU budget. The lion’s share will in the immediate term be underwritten by Germany. It is interesting that throughout the Brexit negotiations the EU have not made any attempt to scale back their budget for 2019 or 2020. This from a political construct which has failed to close and sign off an audit for the last 11 years!

If the UK contribution were to cease then given the UKs trading capacity, the monetary loss will, I think, negatively affect the credibility of the Euro to foreign investors. The euro is still a major player in the loan leg of the carry trade as some currencies like the Swiss Franc have a negative yield. Sterling on the other hand has been heavily discounted by institutions who favour a close relationship with Europe and can only gain ground when a settlement is finally reached. Sterling was overvalued against the USD going into the referendum and will find its level against the USD when all uncertainty has been removed. UK exports of goods and services have during the last 3 years received a windfall profit against a strong USD providing a stimulus for the UK economy and labour market. As the two Europes battle for political control, Shakespeare’s “This royal throne of kings, this scepter’d isle”. “This fortress built by Nature for herself Against infection and the hand of war” is proving to be just that.

Jeremy Blatch TEP
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