Searching for Tranquility Amidst Troubled Waters

Presentation Prepared for the FMRS 2015

John E. Charalambakis

Near Term Troubles• Ramifications of a Greek

default or Grexit are not “contained”

• Exposure has merely shifted from private to public sectors

• EFSF, ELA, and TARGET 2

• Other peripheral nations will be tested by the market

• Recapitalizing all EU central banks

Near Term Troubles• Limits of what monetary policy can accomplish

• QE may boost assets and depreciate Euro but will not provide economic adjustments on the ground• Capital Markets are shallow compared to US

• Logistical limitations• ECB could be forced to buy non-sovereign debt

Near Term Troubles• ECBs efforts are and will continue to distort markets

• German yield curve negative 7 years out

• Dividends paying more than bonds

Structural Dysfunction• Europe as a whole has not seen deleveraging that U.S. has

• Poor growth a partial explanation

• Debt overhang will limit growth prospects going forward

• Not Secular Stagnation

Structural Dysfunction• Poor status of European banks will be a future shoe to drop• Texas Ratio of EU banks shows huge problems

Structural Dysfunction• Problem is different from country to country

• Public debt in Greece versus Private Debt in Spain

• Requires significant out-of –the-box reforms

• No evidence Europe’s leaders can craft this

Structural Dysfunction• Institutional makeup of Eurozone, as currently constructed, is

schizophrenic

• Public Policy, Economic Policy, stuck between identity of Eurozone versus Nation-State• Monetary Union without Fiscal Union

• Leads to asymmetries in markets, regulations, and politics; contributed to crisis• Markets treated all debt as equal up to crisis despite fundamentals

Structural Dysfunction• Current Account Imbalances up to crisis distorted asset and credit

markets

• Still not resolved. Requires adjustment from creditor nations too• Reemphasizes problem of national policies vs Eurozone policies

Structural Dysfunction• Absence of true a Banking Union as well as of a Fiscal Union

weakens the Euro as a currency and potential for growth

• Weakens market signals, capital allocation and investment prospects

Structural Dysfunction• Productivity Growth is nowhere close to levels of 10 years ago

• Substantial Deterioration past three years• Areas of Improvement: Greece and U.K., which is not a

member of Eurozone

Structural Dysfunction• Regulatory costs are a major burden to European Union members

• Recent battles with companies like Uber, Facebook, and Google give impression of hostility

Structural Dysfunction• Environment in EU is not

conducive to businesses

• Lack of uniform business climate

• Spain, Germany rank poorly on starting a business relative to European average per World Bank

Structural Dysfunction• Major European economies

score poorly on Investor Protection

• Germany, Greece, France Spain trail Italy, U.K. Regional Average

Structural Dysfunction• Small businesses, which account for majority of employment

in E.U., far behind 2008 levels

Structural Dysfunction• Small businesses employment slower to recover to pre-Crisis

levels than the U.S.

• Stifles innovation and productivity

• New markets not discovered. Lack of competition

Structural Dysfunction• Father Time is undefeated• Ageing of Europe poses significant challenges to productivity,

growth, ability to service liabilities, and public finances

Structural Dysfunction• Problem will only become more pronounced going

forward• Requires reforms in labor market, public liabilities and

immigration

Structural Dysfunction• Political situation is untenable and perpetuates divisions

at the Eurozone and national level• Gives rise and credence to nationalist parties who promote

populist positions• Reforms become much more difficult. Endangers long-term

growth prospects

• EU may need to return to the basic elements of free trade, free movement of capital, and free enterprise liberated from gov’t regulations

What Can Be Done?• Eurozone cannot stay in middle ground between a collection of

independent states and one supranational body

• Must choose one or the other. Integrate or Devolve• Mutualize debts, fiscal policies, etc. or revert to system of

national economies with open trade and capital flows where immigration flows are encouaged

• Requires visionary leadership• Thus, not likely anytime soon

• Entrepreneurs