March marked the beginning of an interesting political season for the European Union. Unlike Brexit last year, the elections in the Netherlands in March, France in May (first round in April), Germany in September and Italy sometime in 2018 might have much more momentous consequences for Europe’s political future, its common market and how it will affect the world economy. If one or more of the larger economies decided to pull out it’s dubious that the Union could survive, at least as we know it.
To understand why Brexit did not have the same potential for turmoil the first thing to keep in mind is that the UK was never part of the Monetary Union: by not giving up monetary sovereignty it never got to the same level of integration attained by the other European Countries, for better or for worse.
The second consideration follows and is more political in nature: the UK was not bound by a whole set of laws and regulation that other countries had to follow, allowing its elected officials to retain more control and room for maneuvering.
The common theme of most anti EU movements is fear of economic integration and in most cases of immigration. An exception to the latter is the Five Stars Movement in Italy that is committedly antiestablishment but can hardly be considered nationalist or belonging to the right of the political spectrum. All these movements identify the EU as the cause of everything wrong in their respective Countries. Are they right? At the end of the day that is the question.
While a complete analysis is way beyond the scope of this note, it’s worth thinking about a few points and examples. For starters we should all remember that every economic decision will benefit somebody and penalize somebody else. That is why economists always talk about tradeoffs.
If France decides to close its borders to German imports it might protect French companies and their workers from competition on the domestic market, but chances are that Germany will retaliate and the French exporters and their workers will suffer the consequences. Both countries will end up with fewer choices and higher prices.
Investors always demanded a significant risk premium to hold Italian debt, because of its size in comparison to GDP and political uncertainty, but also because of loose monetary policy. The Stability Pact and the commitment to fight inflation first of the European Central Bank allowed to greatly reduce the yield on Italian bonds and allowed the Italian government to borrow at rates much closer to Germany’s.
Speaking of Germany, a common motif is that they had to deal with all these undisciplined neighbors and carry the weight for everyone. A closer look might tell a different story. By participating in the Euro as the strongest economy and more stable country, Germany had a deciding role in shaping the European Central Bank that closely resembles the Bundesbank and the way it used to manage monetary policy. Being part of the Euro however prevented the Deutsche Mark from continuing to appreciate against the other currencies, preventing German exports from becoming more expensive.
How about the workers? This might be a more complex question to answer because competition from foreigners is only a piece of the puzzle, possibly not the more important. Automation and widening skills gap between the more and the least educated weight dramatically on the whole picture. It should be considered however that often times recent immigrants do not get the same jobs nationals do, but rather fill gaps in the labor market. In Italy for example a lot of the caretaking jobs (elderlies, disabled assistance, etc) go to recent eastern European immigrants but there is nothing preventing Italians from taking them. Some will say that the foreigners keep the salary low otherwise the nationals would take the jobs but that argument neglects substitution effects and opportunity cost. For most goods if the price goes up the demand goes down. In an extreme case where the cost is too high people might decide to quit their job and provide care themselves, which has income and long term growth consequences (this problem is not uncommon with children day care). The opportunity cost is simply the alternative: people don’t take these jobs because they have something better or because they don’t need them (family money, welfare, illicit income, etc.).
The Netherlands elections rejected the nationalist candidate that gained some seats but not nearly as many as feared by some and the mainstream candidate in France seems to be gaining ground. These are good tests for the survival of the EU, whose foundations are still fragile. All the anti EU movements are however the expression of conflicts and malaise that should not be overlooked by European Governments. We said that every economic decision determines winners and losers, but nobody likes to be on the losing end. Trying to identify solutions is the Politicians ‘job but is hard to believe that breaking the Union, the single currency and market could be the solution. Not likely to be well received by the markets either
Monetary policy seems like a done deal at this point: the FED increased rates in March and probably will do it again in June. Now all eyes are on the Trump Administration whose statements of purpose are still to be translated into concrete policies and initiatives, that will have to get through Congress first. The consequences will be far reaching, well beyond the US borders.
RISK DISCLAIMER: Trading in futures products entails significant risks of loss which must be understood prior to trading and may not be appropriate for all investors. Past performance of actual trades or strategies cited herein is not necessarily indicative of future performance. The information contained herein is provided to you for information only and believed to be drawn from reliable sources but cannot be guaranteed; Phillip Capital Inc. assumes no responsibility for errors or omissions. The views and opinions expressed in this letter are those of the author and do not reflect the views of Phillip Capital Inc. or its staff.