10 February 1999 - Ecce Euro

As we all know, the first stop on our round-the-world odyssey was Iceland, where we encountered our first adventure.

On our circumnavigation of the island we ran into a blizzard and had to turn back to civilization. On our way we ran into one of the official Icelandic rescue squads, out to save us from our recklessness. A day or two later, after the storm cleared, we set out again, this time with the rescue squad at our side, as Icelanders are too friendly to allow travelers to put themselves at risk in their country. Ironically, however, it was we who had to rescue the rescue squad when their four-wheeler ran off the road and became stuck in a snow bank.

The hybrid car we’ve driving-a cross between a convertible and a sports-utility vehicle-is performing well. As we suspected, it’s gathering crowds wherever we go, a bit too many, in fact. While it’s good that it starts a lot of conversations, I worry that some envious lout will make trouble.

So far on this trip e-mail has been a godsend. My understanding is that in the States 4-trillion e-mails are sent a year, a vast market, many times more than the 100-billion pieces of first-class mail. This trip has shown us a major untapped market for some smart entrepreneur. To jack into the Net, I often have to make a long-distance call to my Internet Service Provider back in the States, as it’s too much trouble to find an internet provider as we travel. With all the world-wide traveling done these days, I can’t understand why some bright phone company hasn’t set up a world-wide ISP to service such people.

Here in Europe we’re obtaining a first-hand flavor of Europeans’ attitudes toward the newly formed euro, which seem uniformly positive. Prices are often presented to us in both the local currency and in euros, even though euro bills or coins don’t yet exist and won’t exist for three more years. As a consumer, you are only able to use euros with a check or a credit card. So you can pay your Macy’s credit-card bill in euros, but you can’t use a euro to buy a pint at an Irish pub or a sandwich at a Paris bistro. Bills and coins are supposed to arrive on June 30th, 2002, but Europeans’ response to the euro’s formation has been so enthusiastic that there’s talk of cranking up the printing presses early. It’s often noted that 30% of the world’s trade will be denominated in euros. No matter what the degree of enthusiasm, it’s going to take months and years to adjust vending machines and telephone coin slots and gas pumps to take the new notes and coins.

My contrary nature has been aroused to full alert by all this enthusiasm. Very few enterprises this popular ever fail to trip over their own feet. That is, such ideas might or might not work at inception, but such enthusiasm encourages the sponsors to overplay their hand, inviting disasters. In particular, the euro managers haven’t built into their organizational structures any sound means of handling the nationalistic impulses caused by economic problems and financial disruptions. For example, will the Germans pay for Spain’s banking mistakes? I don’t think so. I expect if a Spanish bank fails the Spanish government will force a merger or nationalize the bank, but here’s nothing that says this is how the crisis will be resolved. Even so, the concept of the euro seems to be sinking in on Europeans and makes me think the euro will sustain itself for awhile. Still, there’s a long way to go. As a trivial example of the continued fragmentation of Europe, even today you can’t rent a car in Dublin and drop it off in London, about the distance from New York to Boston.

It’s important not to forget the larger picture, and I’m concerned that those in power in Europe may be doing just that. Europe’s leaders are ignoring the region’s deep-seated structural problems. Some background is important here. It was 15 conservative governments in 1992 that conceived and planned the euro. The European Union set strict criteria for entry and last year judged 14 nations had met them. Of course the EU had to allow the fabric of many nations’ finances to be stretched to fit the criteria-various countries’ finance ministers cooked the books and the judges turned a blind eye but in the end all but Greece managed to cover their warts and even conceal a missing limb or two. Despite all the Euro-hoopla and Euro-jingoism, Sweden, the United Kingdom, and Denmark opted out.

Today, however, most of the euro-zone countries are run by left-leaning governments, whereas the originators of the euro-plan were right-leaning governments. That is, those who planned the euro were interested in sound money first and jobs and growth second–the only way to insure a country’s long-term growth and stability-while those in power now are more interested in jobs and growth first, with a sound currency second, the usual left politician’s means of obtaining the votes he needs to stay in power over the short run.

When economic trouble hits a region in the United States, such as New England, several adjustments automatically happen here that won’t occur in Europe. Workers speaking the same language in New England as 1,500 miles away in the Southeast-will leave and look for jobs in one of several other regions. Within income down, federal income taxes will drop. Investment capital will come into buy assets cheaply, providing a boost to the region. The state and Feds will start stimulus programs. In Europe none of these mechanisms is in place.

In their race for votes Europe’s leftish politicians will ignore the coming pressures their jobs-first policies must bring on their peoples. First they’ll paper over the problems with monetary Band-Aids; and when this ceases to work they’ll point their fingers at others, outsiders, particularly those in Brussels, the headquarters of the European Union. Europe’s leaders today have no answer to what will happen when Portugal’s needs are different from Finland’s or Austria’s, how they will resolve the regional pressures that must arise as the union reaches its toddler years. They’re ignoring the demographics of their continent, as with its historical low birth rate, there will scarcely be any Italians in 50 years. In contrast, most of Ireland’s population-in the midst of the greatest boom in Celtic history-is under 30, as no one now emigrates from Ireland.

What you can feel in Ireland, and in much of that part of Europe that is prosperous, is the excitement that prosperity brings, the strong shots of entrepreneurial adrenaline, the excited talk, the feverish pace. Traffic in Dublin was a nightmare, as the infrastructure hasn’t kept up with the boom, reminding me of London 20 years back and New York 40 years ago. What used to be dowdy, weather-beaten pubs are now varnished fern bars sporting perky waitresses brandishing perky menus.

However, in Germany and the United Kingdom prosperity is starting to curdle. Profits are slowing, and the manufacturing indexes are turning down. Contrarian that I am, I can’t help but wonder if in a slowdown the Maastricht Treaty can hold together, untested as it is. The treaty calls for every country to meet its criteria for inclusion or to pay to EU headquarters in Brussels a large fine. In the midst of a crippling recession, is Italy actually going to send a large fine to Brussels? The last time I checked, the European Central Bank had no tanks. Just how will the ECB enforce its rules?

Moreover, the old currencies, such as German marks and French francs, are still being traded in quantity, and according to the Chicago Merc, will be traded as long as there is a demand. In an international liquidity crunch traders will be buying marks and selling lira, possibly both against the euro, putting yet more strains on the ECB.

The members of the current European Central Bank were all chosen by prior conservative governments for their staunch views on the importance of sound money. However, sooner or later the leftish politicians now in power will have the chance to replace these members, and replace them they will with members who will do as they’re told and be only too happy to print money in the vain hope that more jobs and prosperity will ensue.

What will actually ensue will be a vast economic system under large strains. On the bright side, the euro zone today has a positive balance of payments and huge reserves, which will make it a likely refuge for world-weary flight capital. On the negative side, its industries will slow down, unemployment will continue to rise, its population will age, and bitter internal conflict will rise, intractable political squabbles that will threaten the existence of the European Union and the euro itself.

Like that of any new baby, the arrival of the euro has its parents and relatives excited by the new off-spring’s potential. There’s relief that the baby has ten fingers and ten toes, that it breathes well and seems robust. At its birth the euro has achieved the momentum of life and seems as if it will survive over the short run in better shape than the pessimists expected. While there’s a chance that the euro will become the super-currency the dollar has been for decades and the pound sterling was for decades before that, this won’t happen for a while, as belief takes time to build and various wrinkles will need to be ironed out.

Indeed, in the time frame measured by years instead of months, the euro might come to resemble the U.S. dollar in the 40s and 50s when the dollar was the world’s strongest currency-back when we had a large positive balance of payments and were a creditor nation-and not weaken and collapse suddenly.

However, I can’t help but wonder if when Italy goes into a recession it’s actually going to pay fines to EU headquarters in Brussels for not meeting its budget and debt requirements. Is it possible to have a Euro-union without Euro-discipline?

What the left-leaning governments of Europe won’t face are their devastating structural problems brought on by their attempts to give their voters not only a free lunch but also a free petite dejeauner and dinner, too. While their problems may seem many and varied, these many solutions can almost all be gathered under a single rubric: deregulation.

Agriculture is an example. Across Europe farmers live not off their crops but off government subsidies. That is, the farmers don’t raise tomatoes and sell them to make their living; they sell the tomatoes below what it costs them to raise and receive a government subsidy that makes up the difference and gives them a profit. Indeed, they can’t sell a tomato without owning a government quota to do so, and this is true for every important agricultural product.

Another reason for the laggard European economy is its high unemployment, which is of course subsidized by the governments’ generous unemployment insurance. While it’s hard in this day and age not to agree that a safety net is needed within the large industrial democracies, it’s also true that unemployment insurance is a moral hazard that encourages unemployment and goldbricking. In the U.S., our relatively more stingy unemployment insurance and welfare-to-work programs contribute to keep job growth robust and our unemployment to about 4.3%. In most European countries job growth scarcely exists and unemployment is not only in the double digits but has been there for years and years. European employers are doubly, triply, cautious about hiring a new worker because it may cost a year’s wages to fire him. Imagine what a damper such a policy does to trying out a new hire or bringing out a new product line.

Naturally to pay for all this farmer welfare, unemployment welfare, worker welfare, and other cradle-to-grave social services European governments have punishingly high tax rates, which further contribute to the drag on the growth of the economy.

The whole European mess could be righted by killing most of its regulations. Even though this would make the European continent an economic powerhouse, I’ve never said this would be easy or even possible, for the yowls of the affected parties will make a coward of almost every European politician, left and right. The Europeans would be much better off-as is true for everybody everywhere-if they would concentrate on doing what they do best and let other nations engage in the economic pursuits for which they are best suited. There’s no reason for France and Germany to raise food; food should be imported from those countries best suited for it: the U.S., Canada, Australia, and Argentina.

Is Europe a place for Americans to invest? Yes, but we have to be aware of certain tendencies in Europe. Anglo-Americans have come to accept, even be enthusiastic about, the financing of businesses through raising equity. This hasn’t been true in Europe, where businesses turn to banks for their financial needs and citizens keep their savings in bank deposits, not mutual funds. The value of our public equity market is 130% of our GDP, whereas the value of the European public markets is only 40%. Suddenly, however, equity fever is striking Europe, although it has years if not decades to go before it reaches the level of popular investing in the United States.

Indeed, investing in Europe is somewhat safer than in the U.S., as when the inevitable bear market finally arrives, Europe’s stock market won’t have as far to fall because it will not have been as overblown, as popular with the general public as ours has been with us. Indeed, companies in Europe are finally splitting stock, an event that makes Americans yawn. However, in Europe stock prices routinely rise to $500, $600, even $1,000. If a stock is held only by institutions, who cares to what height it rises? Besides, isn’t there something shady and immoral about splitting stock, Europeans ask, if not illegal? But if you want to sell stock to the public, you have to break it up into retail bites. Now in Europe it’s not uncommon to see stocks being split 10-to-1, making up for lost time.

What I can see is that if despite all the problems the euro works, it has to replace the dollar as the world’s most important currency. That is, if the euro works it will become the world’s chief reserve currency and the world’s chief medium of exchange. What this means is that the world’s central banks, which until December 31st, the day before the launch of the euro, held nearly 60% of their foreign-currency reserves in dollars, will over the next five years, say, sell off many of these dollars and buy euros. Our enormous balance-of-trade deficit has never been addressed by our government, but more and more investors are seeing the big picture, that the dollar cannot keep its value forever with these awful pressures against it, not the least of which is the enormous Japanese trade surplus and largest foreign-currency reserves in the world. Indeed, the dollar has already fallen dramatically over the last few months; I can’t help but believe this is the beginning a long, long secular fall.

The fall of the dollar will mean higher-priced imports for us, as well as higher interest rates, for who will want to own such a hollow currency unless he’s paid more to do so. All this will be a drag on our general prosperity, and I can’t see how under these pressures our stock market can continue to defy the iron laws of gravity.

Now that we’re in a real monetary race, with a real competitor to the dollar-a competitor who is a real threat to our immense influence in the world-what could our leaders, if they had foresight and were really leaders, do?

The policies that would enable the United States to run the race at our best would be: one, cut capital gains and corporate taxes to low, low rates or nothing; two, eliminate taxes on our savings of all kinds; and three, give up our phony national accounting, arrange for a true surplus instead of the phony surplus we now report, and actually pay down our national debt. The coming decline in the dollar will do a lot to eat away at our balance-of-payments problem, as import prices will skyrocket and Americans not be able to afford to buy so many European cars, French wines, and Asian electronic gadgets.

Worth’s readers will want to know how they might benefit from this somewhat gloomy news. Indeed there is a way to benefit from either occurrence, the failure or the success of the euro.

If the euro survives and prospers, obviously euro-denominated bonds and stocks should do well. I believe that the best bets now in Europe are its smaller banks and smaller defense companies. With Europe becoming one, small banks must be bought up by the continents’ big banks, who will be looking to expand their businesses in the easiest way possible, and Europe’s defense industry-under pressure from our defense industry’s consolidations–must consolidate or be plowed under by their U.S. competitors. The purchase of such European bank and defense stocks should give an investor a double whammy, a currency rise and a chance to benefit from a merger.

If the euro should fail, however, then the 11 nations who belong to the European Union will have to reissue their currencies-put back in place the marks, lira, francs, punts they just abandoned. The reflex action in that case will be for investors to rush into German marks, formerly the hardest and best-performing currency in Europe, and to flee those of Italy, Portugal, and Spain. A far better bet, I think, will be the currently vigorous economies of the Netherlands, Ireland, Finland, and Luxembourg. Buying banks in such countries and what defense companies you can find in them might well give an investor a profit no matter what happens to the euro.

We’re off eastward, and I expect the next discussion will depict what we find on the ground in Romania, Bulgaria, Hungary, Turkey, Czechoslovakia, and Poland.