Clouds Gathering Over Europe
After more than a decade of being constantly on the verge of a full-blown crisis - political, economic, monetary, or all of them at once - today, the European Union appears to be closer to that edge of the cliff than ever before. With a war on its doorstep, an economy in disarray and an energy crisis that will potentially cost lives this winter, it is becoming increasingly difficult to imagine any scenario that doesn’t involve severe financial pain for most households and dangerous socio-political tensions flaring up.
"Clouds Gathering Over Europe” appeared in the 2022 Q3 Digger, a quarterly newsletter created by BFI Bullion AG. You can read the entire Digger by visiting the following website: https://www.bfibullion.ch/digger. All invested clients and partners of BFI Bullion get the Digger automatically, but you can subscribe to receive them every quarter and learn more in general about BFI Bullion by visiting the website.
Since the start of the year, inflation has been relentlessly on the rise, climbing from one record high to the next, and doing so with no sign of abating. And while many political excuses have been deployed by ECB figures and by politicians throughout the bloc, any diligent observer of monetary policy over the last decade most likely knows better.
Since the onset of the 2008 recession, the European Central Bank has implemented persistently aggressive and reckless policies to artificially prop up the Eurozone’s economy and its ailing currency. Mario Draghi, with his (in)famous “whatever it takes” stance, normalized the once absurd concept of negative interest rates, while overzealous money printing became the order of the day. And indeed, even after the 2011 Eurozone crisis, the currency did survive and all these efforts were widely celebrated, as was the man behind them. But not many investors or analysts ever stopped to think: at what cost?
The same “playbook” was followed during the covid crisis. In order to deal with the incalculable damage that the lockdowns and the forced business shutdowns inflicted upon the bloc’s economy, the ECB, this time under the leadership of Christine Lagarde, again turned to the printing press in search of a panacea. Once more, after the worst of the pandemic was behind us, the central bank was widely praised for its role in saving the economy. Again, very few took a moment to ask: at what cost?
The answer to that question is now plain for everyone to see. After gathering a lot of compound interest for all these years, the bill has finally arrived in the form of an inflation rate of 10%. And while the ECB leadership tried with all its might to deny it for almost a year, by insisting that inflation would return by itself to the 2% target, the fact remains that the basic laws of economics still apply, and wishful thinking does not suffice to suspend them. Too much of anything in circulation diminishes its value and money is no different.
As for the steps taken to counter the problem, “too little, too late” is a gross understatement. For months after inflation established a clear upwards trajectory, the ECB insisted on maintaining its negative rates policy. Even after the Federal Reserve and the Bank of England reversed course and embarked on a series of rate hikes, Eurozone policy makers still very resolutely stuck to their “wait and see” approach. It was only on July 21, 2022, that the bank finally decided to act. For the first time in 11 years, it announced a 50-point increase of its key interest rates, which brought the official rate to zero and on September 8th, another hike followed.
As for the very root of today’s problems, President Lagarde still unapologetically stands her ground. While the purchases under the bank’s regular Asset Purchasing Program (APP) and the pandemic emergency purchase program (PEPP) may have come to an end, reinvestment of these bonds (that stood at 3.436 trillion euros at the end of August) will continue when they reach maturity. As she told the European Parliament at the end of September, “When we have completed our monetary policy normalization, using the most appropriate, efficient and effective tool, that are the interest rates, then we will ask ourselves: how, when, at which rhythm, at which pace, we use the other monetary tools that we have available, including quantitative easing”.
Record inflation has been making daily headlines in many Eurozone nations and, more often than not, there has been one common denominator that one can easily spot in the coverage: The focus is persistently, overwhelmingly on energy prices. Of course, there is nothing wrong with that, per se. Fuel costs exploded in Europe and energy is indeed one of the main drivers of the CPI’s skyward trajectory. Households and businesses are facing increases up to 750% in electricity bills since the beginning of the year and the impact on the real economy is already devastating. As the New York Times recently reported, “high energy prices are lashing European industry, forcing factories to cut production quickly and put tens of thousands of employees on furlough. The cutbacks, though expected to be temporary, are raising the risks of a painful recession in Europe. Industrial production in the euro area fell 2.3 percent in July from a year earlier, the biggest drop in more than two years.” And this, unfortunately, is only the beginning, with winter fast approaching and fuel demand expected to sharply rise.
While the energy crisis indeed presents a very serious challenge, it is important to note that extreme price increases have been a much wider problem. As we already outlined in our last issue of the Digger, countless households have been under pressure since the beginning of the year. Europeans are finding it increasingly difficult to cope with the relentless food price inflation, forcing many to make a choice they never thought they would have to face: “eat or heat”. According to the Financial Times, “butter prices in the EU have surged 80 per cent in the year to July, with milk powder up more than 50 per cent and beef 28 per cent higher”. Furthermore, the price increases can vary greatly between countries. For example, Hungarians, among the hardest hit by food inflation, are paying 66% more for bread and 49.5% more for cheese, compared to last year.
CPI explosion in Eurozone
To make matters worse, there aren’t too many reasons to hope that the steps being taken by governments to ameliorate the inflationary pressures will have any significant effect. In fact, given the nature of most of these policies, one can only hope they will not actually exacerbate the crisis. This is because this “patchwork” of solutions is geared towards throwing more money at a problem that was largely created by having thrown too much money at a previous problem. The Italian government sent out a €200 “cost of living bonus” to certain groups of workers, the unemployed, and pensioners. Germany is spending over €65 billion to combat high energy crisis, a package that included a €300 one-off payment for workers. France, Denmark, Poland and Greece have also adopted their own “fuel cheque” policies.
The role of the Ukraine war in Europe’s cost-of-living crisis can certainly be debated ad nauseam. There is no doubt that Russia’s move to massively cut gas supplies to Europe had a direct effect on prices and it is obvious that trade and logistics disruptions have caused price spikes in commodities like grain and impacted food costs. Nevertheless, it is also essential to bear in mind that inflation in the Euro area had already reached worrying levels months before the war broke out. Even more importantly, if we are to use political arguments to defect the blame from monetary and fiscal mistakes, a practice that most political and institutional leaders in Europe eagerly engage in, then we would be remiss if we didn’t mention the EU’s energy policy over the last years. Having fully embraced a “green agenda” and embarked on a premature energy transition away from fossil and nuclear sources, Brussels all but guaranteed the bloc’s absolute dependence on imports.
As is the case with virtually every economic crisis in- history, financial uncertainty and fear breed social and political frictions. The public looks for someone to blame and most of the time voters are justified to blame whoever is in charge, but the alternatives they gravitate towards are not always better replacements. We frequently see sudden shifts of support to the extremes of the political spectrum and to populists of all stripes who promise easy and painless fixes to very complicated problems.
Recent national election results of right-wing parties in Europe
We saw this after the 2011 Eurozone crisis and we’re starting to see it again now. Voters sent a clear message to President Macron who lost his majority in the last legislative elections in France. In Sweden’s election in mid-September, the far-right Sweden Democrats recorded their best result ever, with 20.5% of the vote. The latest nation to follow suit was Italy, where Giorgia Meloni, leader of the “Brothers of Italy” party, is now the country’s first female prime minister, heading the most right-wing government since WWII.
Overall, a lot of old arguments and debates are resurfacing in Europe. Immigration is once again becoming a hot button issue, which is quite predictable when most citizens are struggling to make ends meet and feel “there’s not enough to go around”. Extreme public pressure for governments to “do more” to provide financial help is also growing. Demanding minimum wage hikes or the expansion of various welfare programs and subsidies, workers have moved on from demonstrations to full blown, industry-wide strikes.
Airlines, airports, and railways have seen the most extensive disruptions, however, unions from other industries are also using strikes as leverage. In France, various labor and trade unions got together to organize a national general strike to protest the loss of purchasing power and a similar action is planned in Belgium, triggered by the exact same grievance.
It is quite clear that although the “return of the right” has been the focal point thus far of most mainstream political analyses, given the nature of the current public demands and the leverage that unions have over an already fragile economy, we are more than likely to see a resurgence of the extreme left as well. And as the opposite ends of the political spectrum garner more and more support, social friction and unrest become increasingly likely scenarios.
Given the present challenges, clearly the outlook for Europe, and for the Eurozone in particular, is rather bleak and an extended Ukraine-Russia conflict will not help. Even if a resolution were to be reached tomorrow, the bloc’s economic, and by extension political, woes would most likely persist. Taming inflation after it has already reached its present levels is virtually impossible without serious policy changes that could plunge the economy into a deep and prolonged recession. Clearly, either scenario spells trouble for the euro.
It is important to highlight, however, that while our outlook for the Eurozone as a whole might be far from positive, this doesn’t mean aren’t any interesting investments out there. On the contrary, diligent and patient investors are bound to find very attractive opportunities at cheap valuations amid the overall market turmoil, especially if their risk appetite is somewhat higher.
But for those who are focused on the long-term preservation of their wealth and on protecting what is rightfully theirs against both economic and political threats, it is by now self-evident that physical precious metals are still amongst one of the safest bets.