Will the Euro Survive?

When the European economic block created the common currency the Euro, everybody was a winner. Weaker currencies like Italy’s Lira and Greece’s Drachma benefitted from lower interest rates and reduced cost of borrowing. An Italian who bought a car with a loan had to pay much higher interest rates when the country used the Lira than he did when he bought a car using the Euro. Stronger economies like France and Germany benefitted by tying their economies to weaker economies like Spain, Portugal, Italy, Ireland and Greece as it helped to put a cap on the value of their currencies, which helped Germany in particular to export more Mercedes and BMWs using a weaker currency.  If Germany retained the Deutsch Mark, it would likely be the strongest currency in the world today, which would make German exports much more expensive. Everybody was happy. That is until it started to go wrong.  Today, I believe that the Euro is now is serious trouble as a currency and is unlikely to survive in the long term.

So what is the problem with the Euro? The cornerstone of my argument is based on the fact that I firmly believe the fundamentals of the Euro are seriously flawed, and on its current path, I believe the Euro is a sinking ship and is going to go down like the titanic.

So what is the meat of my argument? Member states in Europe have very different levels of skill and productivity. Greece will never be able to compete against Germany in making automobiles, as an example. It neither has the engineering skills or discipline to do so; it is not in the Greek DNA. And Greece is a hot country and Greek’s like their siesta to escape the midday heat, so their productivity is also much lower than Germany. 

My favourite question to any statement is, so what? Let’s wind back to the days when European member states had there own currencies. Historically, if Greece was unable to compete with Germany, it had the ability to devalue its currency to make the exports of its products and services cheaper. At some point, those products and services would reach a sufficient discount to equivalent products and services from Germany and people would start buying them. So even if they were not fundamentally competitive with countries like Germany, they could still generate sufficient economic activity and provide employment and income for Greek nationals.  

Fast forward to the today’s monetary union. Greece is still uncompetitive against Germany. The problem is, because it no longer has the Drachma as a separate currency and is now using the Euro, it cannot devalue its currency to make its’ products and services cheaper. When I was growing up, Greece was the place that everybody went to for a cheap holiday in the sunshine. Today, it is no cheaper in Greece than anywhere else in Europe as everything is priced in Euro’s. So far fewer people go there and tourism is one of Greece’s main sources of economic activity and income. And if you are uncompetitive and have no means in your control to make yourself competitive, you go broke. Which is pretty much where most of the Mediterranean countries including Greece, Spain, Portugal etc are at today.

So how do we know that this is actually the case today? When countries become uncompetitive, their companies that are the commercial entities driving economic activity start to go bankrupt. They then cannot repay the loans that they have taken from the banks to fund their businesses. 

So what is the state of the banking systems in these countries? Greece currently has 34% non-performing loans. Ireland has 19%. Italy has 18%. Portugal has 12%. In our fractional reserve banking system, banks only have approximately 10% of their capital in real money. If you put $100 in the bank as a deposit, the bank can print $900 out of thin air and lend that money out to you and I. So depending on the capital reserve ratio set by the central banks, once the non-performing loan level exceeds the amount of real money that the bank has taken in deposits, it is effectively bankrupt. That percentage is typically around 10%. Which means the banking systems in Greece, Ireland, Italy and Portugal are effectively bankrupt.  

We have seen this play out over the last few years in Grexit and bank bailouts by the EU. But these bailouts are only addressing the symptoms of the problem, and basically just kicking the can down the road. It does not address the fundamental issue that Greece cannot compete with Germany, and that it no longer has an independent currency to devalue its products and services to make it competitive.  It just makes the problem worse by loading more debt on a country that will not be in a position to repay that debt because it cannot generate sufficient wealth from its economic activities, because it is not competitive.

And the inability to devalue your countries products and services to make them competitive is not even the biggest problem of the Euro. The idea that you can have monetary union without having common leadership, if the principles that I learned at business school are correct, is also fundamentally flawed. India has a common currency but it has a democratically elected Federal government that can balance the different levels of productivity in its member states. The same is true in the US. The idea that you can have separate economic entities using a common currency without common leadership is comparable to the idea that you have many separately run companies operating off the same balance sheet without a common CEO and Board. If anybody thinks this is a good idea, please contact the author and I would be very happy to run my company off your balance sheet. 

And it gets worse. The final nail in the European Monetary Union coffin will come as a result of demographics and an aging population. At the moment, Germany is the economic engine behind the stability of Europe. Germany is very happy with the European Monetary Union. They have the most skilled and productive workforce in Europe, they get access to other markets with very few entry barriers, and nobody can compete with German companies so the Germans make out like bandits.  This can be measured in Germany’s export trade surplus, which is enviable. Problem is, Germany is also about to fall off a cliff.

In 1945, the Second World War ended. Between 1946 and 1961, there was a huge explosion of baby births. This generation is commonly known as the baby boomers. This generation has generated a huge amount of wealth and economic growth in the 1980s, 90’s and early 2000’s when they reached their peak earnings.  Those baby boomers started retiring in 2011. The math is easy, 1946 plus 65 years which is the standard retirement age. They will retire in droves through to about 2022. And because Germany was at the centre of the Second World War, its demographics are much worse than over developed countries and is currently in the process of falling off a very steep demographic cliff.

When people get older, they naturally cut down on their spending to start saving for retirement years. When you get past the magic number of 50, your mind turns to how you are going to survive when you are no longer pulling in a fancy salary. So you start squirreling away money.  This effects economic growth of a country that has an aging population, which is largely why the west in currently in an economic malaise. Japan has been in demographic driven economic malaise since 1990. The problem really comes home to roost when the population starts retiring in droves.

When your oldest most skilled workers, and highest earners start retiring, a number of things happen. Governments lose the tax income that they used to pay, which hits tax collections.  High earners also draw high pensions. So as well as losing tax income, retirees convert from being an asset on the balance sheet to a liability. So there is a double whammy. They no longer pay taxes, and they start drawing fancy pensions. Germany is currently in the thick of this process where a significant chunk of its highest taxpayers and highest skilled workers are leaving the workforce and starting to retire and draw pensions. And the process will continue until about 2022. I predict that this is going to have a significant impact on the German economy. Germany’s demographic profile is worse than Japan’s in the late 80’s and 90’s. So I would expect them to suffer a similar fate as Japan over the last 20 years. And if the shine comes off the German economy that is the economic engine of Europe, who is going to pay to bailout the uncompetitive failing bankrupt economies like Greece, Italy, Portugal and Ireland?

Germany is correctly trying to address this demographics issue by allowing large amounts of immigrants into the country from war torn countries. But it will be a long time before a Syrian refugee has the skills and experience to replace a 65-year-old German engineer. And refugees are typically an economic burden in the short term before they become trained and productive members of the workforce. So as well as funding bail outs for unproductive European countries, and funding significantly increased pension liabilities with reduced tax income of German workers, they will also have to fund the liability of refugees. Where will this money come from?  

So in summary, the Euro makes member countries with lower productivity uncompetitive, and ultimately bankrupt. It has no democratically elected common leadership that can effectively deal with the problem. Germany, the economic engine of Europe, has a demographic issue that could very well take the country from being a booming economy to possibly pushing it into a recession, or maybe even a depression, depending no how you measure it. So as I stated in my opening paragraph, I think that the Euro is a sinking ship.  

So how do we see the cracks starting to appear?  The Netherlands has recently had a general election.  The PVV Freedom Party set up by the far right extremist Geert Wilder won 20 out of 150 seats in the Netherlands Parliament and was the second largest elected party. The party manifesto was to exit the Euro. There is a similar political dynamic in France.  The far right party The National Front led by Marie Le Pen, has just come second against the centrist candidate Emmanuel Macron who was elected as the President of France. Marie Le Pen is anti the Euro and campaigned on a manifesto of exiting the Euro. The fact that her party polled 35% of the national vote or 11 million votes, and came second place in the polls gives an indication to the feelings about the Euro in the greater population of France.  Croatia who have recently joined the European Economic block have correctly decided not to adopt the Euro and retain their own currency the Croatian Kuna. 

GREXIT and BREXIT are also considered to be surrogate indicators as to the problem of Euro. Greece voted not to leave the Euro, but is so indebted to the Eurozone that it is financially impossible for them to exit unless they are thrown out. And whilst the UK was never part of the Euro currency, their exit from the European Union has been viewed as one of the early nails in the Euro coffin because of the contagion affect. 

The only way that the Euro can survive is by Europe agreeing to integrate fully, and electing a Federal European government making Europe one country with common leadership similar to the US and India. This basically means that Europe will be ruled by Germany. With far right parties like the National Front in France and PVV Freedom Party in Netherlands gaining every increasing support from the masses, my reading of it is that is highly unlikely to ever happen. And if that does not happen, for the reasons stated above, I think that the Euro in the long term is doomed to die.  Whether that happens by the current slow painful death or European governments decide to recognise that they have made a major error in introducing the common currency without common leadership is up to individual European governments to decide.