|Summary: The global financial crisis has ended, but widespread problems across Europe are a warning sign for all investors to stay alert. Soaring energy prices, high debt levels, a weaker euro, industrial relations chaos and still-sluggish growth are just some of the factors pointing to a fresh European crisis.|
|Key take-out: Europe’s parlous economic state translates into low demand for Australian raw commodities over the medium term, and that’s bad news for our mining and energy exporters.|
|Key beneficiaries: General investors. Category: Economics and investment strategy.|
Apart from its magnetic appeal as a tourist destination, there is not much positive to be said about Europe. Still the sick man of the global economy, Europe is a growing threat to investors everywhere, even as far away as Australia.
Despite the benefit of super-low interest rates and direct central bank support, European economic growth remains anaemic, with France sliding towards a financial and political crisis that has the potential to engulf the region.
It might be overstating the situation to say that Europe could trigger a re-run of the 2008 global financial crisis, but it is possible to see continued recession in the world’s third-biggest economy acting as a dead-weight on global demand for manufactured goods – and that means slow growth for Australian resources.
China and other fast-growing Asian countries will dominate demand for Australian exports, but if European demand stalls and US growth fails to pick up as forecast after a negative March quarter, then it is hard to see commodity prices doing much more than marking time for at least the next 12 months.
Supply surprises, such as Indonesia’s ban on nickel and bauxite exports and labour unrest in South Africa, will help with prices. But the underlying trend is for sub-par demand growth at a time when heavy capital investment in new mines has boosted output.
For the past three weeks I’ve been in Europe, taking a close look at its potential to help or hinder investors. And while there are parts of the region performing strongly, there is a definite bias towards low growth, and perhaps no growth, as well the potential for a political crisis that would trigger an economic crisis.
A series of recent developments, and impending events, have shifted Europe back to centre-stage of the world economy, including:
- Soaring energy costs, which are reducing the region’s capacity to compete, especially with its manufacturing rival, the US. There is the threat of worse to come should Russia restrict gas supplies to Europe, intentionally or unintentionally, as it argues with Ukraine over unpaid bills for gas.
- Strikes in France, which have crippled the country’s rail system and threaten to cripple air traffic movements and retailing.
- A failure of cheap money created by European central banks to actually make it into the private sector because of commercial bank concern about the weak trading of many business customers and the risk they represent.
- A fresh push by German business leaders for their country to exit the common currency, the euro, and return to the Deutschmark.
- Increasing political success of Euro-sceptic political parties, which were once a uniquely British trait but which have now claimed a foothold in other members of the European Union.
- Scotland’s referendum in September on the question of whether to quit the United Kingdom, an unlikely outcome but a possibility that could trigger the UK’s exit from Europe, and
- Booming property prices in London, which are showing the hallmarks of an unsustainable bubble that could be pricked by political or financial developments, including a forecast from the Governor of the Bank of England, Mark Carney, that interest rates could rise sooner rather than later.
Leaving the politics of Europe aside, however interesting they might be, it is important to focus on the single-biggest problem confronting the region – the price of power.
Quite simply, heavy manufacturing in Europe is being killed by electricity and gas prices that are more than double those in the US. Big German companies are paying US21c per kilowatt hour of electricity compared with US5.5c in the oil rich US state of Louisiana.
That dramatic difference is partly explained by the US embracing new oil and gas drilling and extraction technologies and the push by Europe into environmentally friendly (but more expensive) green-power projects such as wind farms and solar arrays.
The story of the power-price difference is best told by Germany’s big car maker, BMW. It is investing $US1 billion to expand its manufacturing plant in South Carolina, making it the biggest single producer of BMW vehicles anywhere in the world, and by the US chemicals maker, Huntsman, which is closing European factories and expanding in the US where the cost of running a similar plant is estimated to be $US125 million a year cheaper.
The power situation in Europe is not a crisis yet, but it will become one as Russia squeezes the region over gas supplies, and as France moves to cut its production of electricity from nuclear power plants. Despite nuclear being the source of more than 70% of the country’s electricity, a decision has been taken to invest in alternative sources of power such as wind and solar.
Bank lending, which ought to be benefiting from near-zero interest rates, is not expanding because too few customers can pass bank lending standards.
In Greece today, after a seemingly perpetual rescue effort, it is estimated that 30% of all outstanding bank loans to private customers are classified as non-performing, up from a non-performing measure of 7% in 2009, at the height of the GFC.
In Italy, 15% of all bank loans are non-performing, while 11% are non-performing in Portugal.
In other words, the cash might have been created by governments and central banks, and interest rates are the lowest in history, but commercial banks are not prepared to make loans because of concern that they will not be repaid.
In France, a different problem is emerging in the form of an industrial relations crisis that threatens to swamp a weak government, and spill over into neighbouring countries. Striking French train drivers are being joined by air-traffic controllers, taxi drivers and shop assistants, who object to a proposed new law that would permit shops to open on Sundays.
How the grand experiment in trying to create a unified Europe ends is anybody’s guess. It might, or it might not, work.
The more important point is that from an investment perspective the politics of Europe effectively ensures that it will be a no-growth zone for years to come. That means around 20% of the global economy will be sidelined, at best, and the potential source of a future global crisis, at worst.
Currency values, perhaps the best way of testing how investors see the future of a country or region, are starting to reflect the problems in Europe. The euro is down by 3% against the British pound over the past three months, and down by 1% against the US dollar.
Any move up in US or British interest rates over the next six to 12 months will increase pressure on the euro, and while that might help European exporters the widening power-price gap will minimise potential gains.
There is not much new in seeing Europe as the weakest of the major global economies. What is new is a realisation that it is likely to stay that way for a long time, and that cannot be good for raw material prices. That’s bad news for Australia’s mining and oil exporters.