The recovering Eurozone meme, which details improvements in the Eurocrisis and draws a hypothesis that the worst is over, has been around for about two months. The first article I noticed fitting the meme was published on November 16. Since then, these articles have abounded in the mainstream media.
Five elements comprise the meme, though each may not be present in every article:
- Positive market moves
- Improving economic fundamentals omitting amplitudes
- Anecdotes from financial industry professionals
- Giving short shrift to the data that matters
- An outside actor that ensures that this time will be different
The objective of the mainstream media is to generate interest in its content so that it can profit from it. People prefer news that supports their worldview. Financial news outlets cater to investors who wish to believe that economic conditions will increase the value of their investments. Rather than unbiased facts, we receive articles that conform to a certain narrative.
In light of the elements above, we can analyze this article and thoroughly debunk its premise.
Positive Market Moves
Investors respond to incentives. The ECB has issued a policy promising to print money in unlimited quantities to purchase distressed sovereign debt. With a new price guarantee, it is no wonder that PIIGS debt has increased in value exemplified by decreasing sovereign debt yields. This is not evidence of a recovering Eurozone but of the existence of a printing press in the ECB’s headquarters.
Moreover, the improving $/€ exchange rate is used to support the meme when it is actually a contra-indicator. Distressed periphery countries must reduce their current account balances by increasing exports, and the high value of the euro is making this adjustment more difficult.
Improving Economic Fundamentals Omitting Amplitudes
The article points to improving current account balances in the periphery but ignores the role of the budget balance in national accounting and the degree of change. For example, Spain has exhibited a steadily improving current account, but its budget deficit has barely budged. Its combined deficit has decreased from 16.2% in 2010 to 14.2% in 2011 to 12.9% in 2012.
That’s an average of about 10% a year. At that rate, Spain will require foreign financing of its national deficit for over ten more years, a lost decade indeed. While the current account has improved, it is not improving at a fast enough rate to counteract the large budget deficit. A similar pattern may be observed in the other PIIGS.
Anecdotes From Financial Industry Professionals
No less than four times, the article uses happy talk from pros who have recently opened positions in PIIGS securities. Since they have a skin in the game, their comments are not objective.
This is how Wall Street works. If you are an asset manager, you will not get fired for following the herd into a risky investment. On the other hand, you will lose your job if you ignore the herd and your firm loses money.
Each of the anecdotes reveals this incentive. To an extent, the asset manager herd has moved back into the periphery, so members are free to invest their firms’ and clients’ money there without risking their livelihoods. In fact, if they do not take advantage of those higher returns, their firms and clients may forego profits during the next quarter, and they will have some explaining to do.
Giving Short Shrift to the Data That Matters
The three charts above show the only data that matters in the Eurozone. The article mentions poor fundamental data, too, specifically, German 4th quarter GDP shrinking 2% and industrial production in the Eurozone decreasing 3.7%.
While these facts are merely presented as the other side of the story, the mainstream media fails to see that they are the story. Europe needs to grow its economy to pay its bills, and it is failing to do so. As long as the recession and weak growth persist, the Eurocrisis will continue.
An Outside Actor Ensures That This Time is Different
Whenever a country enters crisis mode, the endgame is an inexorable conclusion. No country has ever entered a debt crisis and extracted itself from it without a default or restructuring. As I have written before, if you wish to understand the Eurocrisis, you should read Endgame by Mauldin and Tepper and This Time Is Different by Reinhart and Rogoff.
Despite all we know about debt crises, people will invariable point to government action and claim that it will arrest and reverse the crises. In the case of the Eurocrisis, the “Draghi put” on sovereign debt is given a lot of credit for the recent improvement in market conditions. There has been an improvement, but it will prove to be temporary because the imbalances that caused the crisis continue and will for the foreseeable future.
In addition to the Draghi put, another outside actor that will supposedly fix the crisis is the EU. Recent steps towards closer integration are used in this article and others to show that they have the will to solve the problems. But do they?
I believe that all 17 eurozone countries deciding to become joint and severally liable for their government and financial system debts in combination with dramatic economic reforms that liberalize trade and labor markets would do the trick. However, we are no closer to these goals than we were seven months ago when they were promised after the June summit.
The rich countries will not pay for the debts of the periphery through either a fiscal union or a banking union with depository insurance and resolution authority. Mainstream media articles point to bureaucratic progress, which amounts to issued reports, leaked documents and paper shuffling, as real progress.
Until you see huge transfers of euros from the rich countries to the periphery coupled with economic reforms, this time will not be different.
These five elements are the tell-tale signs of an Eurozone recovery meme in progress. Now that you are armed with the proper knowledge, you will be able to spot these on your own and treat them accordingly.
Despite this temporary abatement in conditions, the Eurocrisis is here to stay and with it depressed economic growth and the ever-present specter of default and breakup risk. Invest carefully.