EU breakup

Worrisome Signs in EU Economy

October 27th, 2016 by

EU breakupPerhaps even more so than its major counterparts in North America and the Asia-Pacific region, the European Union (EU) has been unable to escape from its years-long economic conundrum.

This is obviously due in part to the fact that the world economy is facing its own universal crises. Yet, the particularly tough climb toward recovery for the eurozone can also be attributed to the structure of the EU itself.

Inflation Woes

Typically, when it comes to inflation, policymakers are most worried when it is too high. This robs the public of its purchasing power as prices rise too fast and the value of the currency in use erodes. However, the opposite situation has been the problem in Europe (and, indeed, in much of the world). Rather than runaway inflation, the EU has been saddled with disinflation—stubbornly low inflation—for years.

There is, of course, the tumbling euro. The single currency that unites the member countries of the eurozone is a convenient avatar for the entire Pan-European movement that created the precursor to the EU, the European Communities. If the currency fails, so does the entire union along with it in all likelihood.

By User: Mattes (Own work) [ECB decisions ECB/2003/4 and ECB/2003/5 or Public domain], via Wikimedia Commons

By User: Mattes (Own work) [ECB decisions ECB/2003/4 and ECB/2003/5 or Public domain] via Wikimedia Commons

Partly because of the ambitious stimulus program undertaken by the European Central Bank (ECB), the euro has been progressively falling in value against the dollar. The EUR/USD is currently below $1.10, and has recently traded at levels not seen since the beginning of 2003. In the seven years prior to 2015, the euro consistently traded above $1.30 and touched as high as $1.60. However, over the last two years, it’s lost more than 10% against the USD. It’s fallen 3% relative to the dollar in the last month alone.

ECB Struggles

The ECB has been dealing not just with low inflation but also a number of debt crises (think: Greece’s bailout) that threaten the stability of European banking. This, and the models of quantitative easing created by Japan and the United States, led to the stimulus “bazooka” pursued by the ECB. The central bank stood pat at its last policy meeting, merely reiterating that it will continue its asset purchases as planned but will not target still-lower interest rates.

Nonetheless, there are still warning signs for the European economy. ECB President Mario Draghi acknowledged that negative interest rates are hurting European banks, and suggested he would like to reverse some of these emergency policies as soon as the central bank sees no further need for such stimulus support.

The legal confusion and anti-establishment sentiment of the Brexit vote aren’t helping Draghi’s cause. Even a seemingly benign trade deal between the EU and Canada known as CETA recently fell through because of opposition from one influential part of Belgium, the French-speaking region of Wallonia. Brexit is also emboldening other separatist movements around the continent from groups that are disillusioned with globalization and continental integration.

italeaveIn Italy, an upcoming national referendum that is seen as an up-or-down vote for Prime Minister Renzi, as well as a possible banking crisis, could lead to an “Italian Brexit” situation. (Exitaly? Italeave?) One troubling sign is that capital outflows from Italy’s biggest banks have been accelerating.

If the economic problems of the EU inexorably deepen and the euro fails, there is no telling how severely global trade will be negatively impacted. However, a complete collapse may well be the only step toward fixing the European economy’s many ailments. A wholesale restructuring of how Europe’s money and economy function might avoid the cardinal mistake underlying the euro area: All of the countries share one currency, which is centrally managed by the ECB in Brussels, but there is no accompanying coordination of fiscal policy.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.