Do BRICs (and Germans) Eat PIGS?

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This post is a guest contribution by Niels Jensen*, chief executive partner of London-based Absolute Return Partners.

When the euro was introduced about ten years ago, the pessimists didn’t give it much chance of reaching its tenth anniversary. The euro, or so the argument went, was doomed from the outset because of the disparity in economic performance amongst the member countries. In this respect not much has changed. At one end of the scale you still have the highly disciplined, but also slow growing, economies of Germany and the Netherlands; at the other end you find faster growing but ill disciplined countries such as Spain and Greece. As icing on the cake, you also have countries that lack in both departments, such as Italy, making it difficult for the union to ‘gel’ – well, according to sceptics.

There is admittedly an embedded weakness in the way the European currency union is structured. In the United States, arguably the largest currency union in the world, fiscal transfers between member states allow for the federal government to adjust for variances in economic performance. There is no such mechanism within the eurozone, which explains why the member states are subject to a number of rules1. These rules require strict fiscal discipline. The problem is that few countries play by the rules.

The best example of this is the huge spread in the rise of unit labour costs over the past few years. Unit labour costs measure labour (wage) costs adjusted for changes in productivity. It is probably the best measure that exists in terms of tracking the changes in competitiveness between nations. The currency union is governed by the so-called Stability and Growth Pact. There is no mention of unit labour costs in the pact which, with the benefit of hindsight, is a major mistake. Even Jean-Claude Trichet, the Head of the European Central Bank, who rarely admits mistakes, has publicly stated that if he could design the currency union all over again, he would push for a unit labour cost stability pact.

Back to the early sceptics. What they failed to realise was that Europe, together with the rest of the world, was about to enter a period of unprecedented prosperity. The good times would not only gloss over
the deeper problems, but the euro would actually go from strength to strength to a point where it now threatens to unseat the US dollar as the premier reserve currency of the world. It will be a mystery to some of you, then, why one should question the longer term viability of the euro. That is nevertheless what I intend to do.

Click here for the full letter.

* Niels Jensen has 24 years of investment banking, private banking and asset management experience. He founded Absolute Return Partners LLP and is its chief executive partner.

 

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