The future of the euro

03 August 2018 | Webinars


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Alexis Gray, senior economist, speaks to Leo Schulz, investment writer, about future options for the euro. Does survival of short-term crises imply long-term strength, or will flaws in the initial design ultimately undermine Europe’s shared currency?

Leo Schulz: The fate of the euro. The euro area is seeing a phase of economic growth at a level to rival the UK and indeed the US – a distinct turnaround on the currency union’s troubled recent history. I have with me Alexis Gray, senior economist at Vanguard’s Investment Strategy Group.

Alexis, some of us are old enough to remember the sovereign debt crisis, and the recent troubled history of the euro area. I guess what we’d like to talk about with you today and to get a sense of if you don’t mind is, is the change in the euro area that you’re seeing. Is it something that’s abiding, that has some depth and some substance to is, or is it really just a promise that may or may not work out?

And I think what we want to get to as a conclusion to our discussion is some of the key issues that should form investment decisions over the medium to the longer term, if we can just bring up a map of the euro area.

And just before we start, Alexis, if I can just help our listeners. If anyone is having any trouble with the quality of the audio there should be a window on your screen now giving instructions on how to dial in directly on your phone and this should help to give you a nice clear sound. For our live listeners, you should see a box in which you can type questions, we have a fairly large audience today, so if we don’t get to your particular question we will definitely follow up.

The call will last about thirty minutes, the webinar earns participants a half hour’s worth of CPD points, you will need to request your certificates by contacting your usual Vanguard representative or writing to

The agenda for the discussion is as follows: we’ll have a definition of the euro area, we’ll talk about post-crisis era for the euro area, the sovereign debt crisis, we’ll talk a little bit about euro scepticism in the euro area at the current time, we will ask Alexis her ideas about what would be the best programme of reform for the euro area and then we’ll look at the revival in the economic prospects of the region.

So, Alexis, I think you were on Today, you were on the Today programme this morning talking about the UK, which I think listeners can access on iPlayer, and a very interesting discussion around the UK economy it was, but let’s plunge into the euro area. So just talk us through the map, Alexis, just so that we can be really clear about just what it is we’re talking about.

Alexis Gray:  Good afternoon, Leo, so, a little bit of background and history on the euro and the European Union, and I think often people confuse the two of them because they’re closely related, so the European Union is of course this big economic union of which the UK is a member.

The name European Union only came about in the 1990s but the predecessors of the European Union have actually existed since the end of World War II. There was a commitment in Europe after World War II to sort of heal the rifts, heal old wounds, and to work together more closely, and in effect what happened was the leaders created what is now the world’s largest free-trade zone.

Some years later, European policy makers decided that in order to strengthen this union it would be valuable to operate under one single currency, it makes it a lot easier to make transactions if every country has the same currency.

So, there was an agreement that all countries would adopt the euro, initially only a subset, roughly eleven joined the euro, but there was a commitment from all the other countries to eventually jump on.

So, on the map what you can see here is all the countries that are members of the European Union, however we have shaded countries that use the euro in dark blue, so the ones that people tend to know best are Germany, France, Italy, Spain, Greece and so on and so forth.

In fact, in the early days when the euro was conceived the UK actually opted out of joining the single currency, so they never made a commitment to actually join the currency union, and obviously now, you know, as fate would have it, the UK has now opted out of the European Union as well.

Leo Schulz:  So it is interesting actually just looking at the map and just going, the UK I think is the only large economy in the European Union that is not part of the euro, but when you look at that map, you are struck by the difference in size and economic development of different members of the euro, so Greece or the Baltic states on the one hand, and then obviously such sort of economic powerhouses as Germany or the Netherlands on the other hand. That’s been the sort of problem with it really, hasn’t it?

Alexis Gray: Yes, and I think when the UK opted out of the euro, one of the concerns they cited was that the UK had a very different business cycle and was made up of different industries from some of the other members of the euro, and so those economies are not very synchronised and they were worried that that would cause problems down the line.

And as you mentioned we’ve got these really diverse set of countries, I think for smaller countries there is a benefit in joining the currency union with very large countries, because it adds credibility to the currency and allows them to share resources with you know, a larger zone and a larger central bank.

There’s also a benefit for a large country like Germany to join a currency union with smaller countries, which is, you know, helps put downward pressure on the currency and make their exports more attractive, so, there are benefits from different sides to joining a currency union.

Leo Schulz:  Germany of course I think has probably done well out of the euro, hasn’t it, but if we, not to spend too much time on this, but if we think of the United States as being a currency union, there’s a lot of diversity within the United States as well, isn’t there?

Alexis Gray:  That’s an interesting parallel, I mean the interesting point about the euro is that it’s such a large zone of countries, you know, and people’s concern was that each of these different countries had very different business cycles, very different make-up, you know, different languages, different ethnicities, but every country has its own currency.

So, for example the United States, the United Kingdom, Australia, which is made up of many different regions, who also have different characteristics, I mean, yes, they have one nationality and one language, but there are many differences, some states for example in the United States are heavily focused on car manufacturing, some are more in finance or government services, so it’s that similar sort of you know, yeah, similar sort of patchwork sharing.

Leo Schulz:  Diversity, large states and small states, rural states and urban states and so on, services and manufacturing, yeah.

Alexis Gray:  Exactly, but the interesting thing is that you never wake up in the morning worrying if you know, California is going to leave the US dollar, but you do worry about Greece leaving the euro, now why should that be any different? Well, the eurozone is not run by one overall government, it’s a whole set of different countries and there’s something about national identity as well, which I think plays into this.

Leo Schulz:  Well, we’ll come back to some reform ideas in a moment, which I think will be very interesting, just let’s stick with the history just for the moment, and so this is 2008-2017, post-crisis economic performance, so, what are we learning from this chart, Alexis?

Alexis Gray:  So, in this chart we’re comparing GDP growth per capita over the post-crisis period, and we’re ranking them by countries, so, some of these countries are members of the eurozone and some are not.

What you can see, and in fact what we’ve done is we’ve shaded euro area countries in dark blue and countries such as the United States and the UK in the softer blue. Now what’s tended to happen over the past decade since the global financial crisis, is that eurozone countries have had pretty poor economic performance, I mean recessions, very high unemployment, and they’ve tended to perform poorly compared to the United Kingdom, United States and other non-eurozone countries, and so for this reason I think that economists, some economists have argued that the eurozone has been a failure.

Leo Schulz:  Again, we see that divergence, even if we take out the non-euro countries, obviously the US or the UK or Sweden, all of which are positive, but there’s still a lot of divergence within the euro, isn’t there, with Germany on one side and Greece and Italy on the other side?

Alexis Gray:  I think that for that reason many people have argued that Germany has benefited more than say some of these poorer Mediterranean countries. It is important to remember though that before the financial crisis, Germany went through a whole lot of reforms and had pretty bad economic performance in the early 2000s, so, some of this was also about catch-up.

But you know, we’ve had very severe recessions and high unemployment, particularly in the periphery and in Greece where you know, government debts have sort of gone through the roof and at one point it really looked like Greece was going to leave the euro altogether.

Leo Schulz:  So there’s still a lot of euro scepticism in the euro area, I just wonder actually, sorry just before we go onto this, and just think about the post-crisis era effect, if we just go back to the previous slide, just one more question around that. We’ve looked at the divergence, but what were some of the reasons for the fact that the recessionary economy in the euro area was so prolonged, much more prolonged than it was in the US or the UK, what were some of the policies that caused that?

Alexis Gray:  Certainly, after the financial crisis I think that there was a very different approach from governments and from the central bank in the eurozone compared to other places. The term austerity has been thrown around a lot, but basically what that means is that instead of the government trying to stimulate the economy when it was quite depressed, they were much more worried about having too much debt.

So, the idea was well let’s tighten our belts now to save us from having too much debt in the future and in hindsight I think that happened far too early, so, you know, the government was not providing perhaps the same amount of welfare and benefits and so forth and not promoting jobs to the extent that say, you know, the US and the UK were doing, so that I think prolonged the recovery and made it that much harder.

In addition to that, if you look at the response from the European Central Bank (ECB), it was in stark contrast to the Federal Reserve in the US, and the Bank of England here in the UK where yes, interest rates were cut to zero, but we didn’t have a quantitative easing programme, which became quite fashionable.

Leo Schulz:  In the euro area we didn’t have that?

Alexis Gray:  No, we didn’t have one, it took many years for the ECB to ultimately adopt QE, and I think for a long time it was felt that that would never happen, it was actually illegal under the rules of the eurozone for them, for the ECB to do quantitative easing and they had to go to the German courts to get approval, so, it was a long, arduous process.

So really all of that support and stimulus that was happening in developed countries just wasn’t taking place, and I think that’s a big part of the reason why you had this really depressed environment for all these years, I mean policy makers weren’t really helping to dig the economy out of trouble.

Leo Schulz:  When was the Mario Draghi, when the famous speech of “anything it takes”, when was that?

Alexis Gray:  That’s right, “whatever it takes”, so that was in 2012 where, to be honest, I think it came to a point where the eurozone may very well have broken up, you know, for one of the world’s largest currencies to collapse would have been just disastrous, so there was a real pressure for the central bank regardless of its rules, to do something to sort of commit and try and hold the current together.

Leo Schulz:  But that speech was the beginning, wasn’t it, and as you say there was a lot of resistance, as you implied, there was a lot of resistance wasn’t there, particularly from the Bundesbank and the German representation?

Alexis Gray:  This is the difficulty with forming a currency union because when other countries are in trouble, you have to help them out, but it’s sort of like having a marriage, all right, and maybe in this case not always a great marriage. But you know, in the depths of the crisis countries needed to be there to support each other and this idea of you know, buying assets from other countries was sort of seen as bailing them out in some sense, even though it wasn’t a permanent loan, so there was a lot of resistance and in the end, I think, you know, the risk of a break up was so bad that it just had to be done.

Leo Schulz:  Reality finally came to call.

Alexis Gray:  Exactly, exactly,

Leo Schulz:  So if we go back to the next slide, go back to the next slide, go back to the future, although the conditions have improved quite considerably, and that’s something we really want to talk about in just a moment, but before we get to that, the troubles aren’t completely over are they? I think this slide is  showing the popularity of euro membership within the euro area, so what are we finding out, what are we learning when we’re looking at this chart, Alexis?

Alexis Gray:  Well this is a survey that was carried out and actually carried out on a regular basis by the European Commission asking, surveying people across Europe about how they feel about being in the euro, so, is the euro a good thing for your country?

And as you can see, looking across countries, a different percentage of people is happy or believes that the euro is a good thing for their country, on the top you see Ireland for example where there’s a huge amount of support for the euro, Luxembourg, Germany, Finland, and then at the bottom of that list you’ve got countries like Italy, Cyprus, and Greece, and that’s probably not surprising giving economic performance.

Leo Schulz:  Now let’s just touch on two of those countries if you don’t mind, Alexis, the two I-countries, so Italy and Ireland, because both countries have gone through some significant difficulties as a result of their membership of the euro area, but one is very happy with it, in fact, the happiest of all the happy countries, and the other is very nearly the least happy with it, so, I just wonder if you might just be able to give a little compare and contrast of those experiences?

Alexis Gray:  I think it’s partly tied to the performance of the economy, Ireland’s actually had several really fantastic years while Italy’s recovery has been much slower, unemployment is still very high. You’ve also had a big migrant crisis in Europe where a lot of the migrants have ended up at Italian shores, and so recently we had Italian elections where in fact two of the most popular parties were populist, non-mainstream parties.

So, you know, there’s still a lot of scepticism and you know, concerns that really the public in Italy would want a referendum on euro membership, similar to the vote that was held in the UK, but not just on the European Union, but on the currency itself, so, you know, still plenty of people unhappy, which I think is quite tied to performance of the economy.

Leo Schulz:  And it is interesting, the politics of Italy at the moment, isn’t it, because if I think of the Northern League and the Five-Star Movement, they’re quite, they’re poles apart – one is definitely on the right side of the spectrum, the other is on the left side of the spectrum, one is calling for significant tax cuts, the other one wants I think universal benefits if I’m not sort of over-simplifying, and I sometimes think it’s almost as though Russell Brand had become the prime minister of Britain, it’s, you know, is that going to work?

Alexis Gray:  Yeah well that’s interesting when you have any coalition government, especially with two parties at the extremes, how does that work? They have some things in common, they’re both calling for an end to austerity, they just believe in doing it in a different way, one obviously through increased spending and one through cutting taxes.

They are also both pushing for some limits on migration or on extra help to support all of those migrants who are arriving, so, there are some areas where you may get more movement because they have some agreement, but Italian governments tend to turn over more quickly than in other countries, so you know, how long will this coalition last, who knows – perhaps not for years and years.

Leo Schulz:  But they’re much more used to coalitions than we are, aren’t they, they’re not such an unusual feature of Italian politics as they are of the UK, sorry, I did promise just to confine you to two countries to make your task a little bit easy, but I can’t help but look at Spain actually because Spain feels to me quite comparable to Italy in terms of its great difficulties with employment, particularly with youth unemployment, but Spain is kind of reasonably happy with the situation at least by going on your chart.

Alexis Gray:  So, Spain has gone about implementing reforms, which is something that Italy has not done to the same extent, so, we’ve actually seen the economy roar ahead of Italy, and I think that’s partly why you see them scoring more highly on the happiness scale here.

One thing that I think the European governments have asked Italy to do is to reform their labour market to become more competitive, make it easier to hire and fire workers, you know, modernise in many ways, which is something that people are not happy with, whereas Spain has done those types of reforms and has benefited as a result.

Leo Schulz:  So it’s a little bit sort of bear the pain to get the gain.

Alexis Gray:  Short-term pain, long-term gain.

Leo Schulz:  That’s it, you know you’ve said that before, haven’t you? Shall we just move to the next slide, and I think this is really interesting because this is what reforms might improve the euro area, and I think this is, I did the colouring in, but the ranking is yours and I think we’re looking at the ones, which are probably the most important at the top and possibly were to have the greatest impact would be at the top, and those which were the most crucial at the top, and those which would be of less impact at the bottom, but what I’d really be interested in if you could do for us Alexis, if you could just pick out a couple of those, which are the ones, which are A, the most important, and B, the most likely to actually happen?

Alexis Gray:  If I could pull out two, I would say would be the rescue plan, which is at the top of the list in red, and secondly a banking union, there’s already work happening on both of those fronts, there was recently a summit in Europe to discuss these issues. Emmanuel Macron, the French president, in particular has been a huge supporter of European reform and has been working with the German Chancellor, Angela Merkel, to get these two policies in particular done.

The idea being that after the financial crisis there wasn’t enough support to keep the economy running when it was in recession we went to austerity very quickly, and so some sort of rescue plan needs to be derived, and that’s the purpose of that, and that may mean having some sort of budget that’s pulled together from various countries and spent when a recession does hit.

Leo Schulz:  Have Merkel and Macron come to see eye to eye on that, is there an agreement there?

Alexis Gray:  I think they’re definitely inching closer, there’s always been some difference of opinion between France and Germany, however, I think if there was ever a moment for something to happen it is now where we’ve got two leaders who are somewhat more on the same page.

Leo Schulz:  And the differences there, is that personal to Macron and Merkel or is that sort of deeper routed in France and Germany, if you can see what I mean?

Alexis Gray:  No, I think it’s probably more a longstanding difference between the two countries, Germany is quite a fiscally conservative country and plays by the rules and generally has a budget surplus and has been quite reluctant to overspend or bail out other countries, and you know, generally been viewed as the responsible sort of older sister, and that’s sort of the line that Germany has taken. It’s been quite reluctant to share risks and share finances with other countries, whereas France has been more willing to sort of form a fiscal union.

Leo Schulz:  Although the fiscal surplus that Germany runs is, not everyone would think that’s a responsible older sister type of action.

Alexis Gray:  Yes, I mean when we talk about the eurozone needing more money and not going to austerity in recent years, and you said well, where would that money come from, who could spend more money and help sort of bail out the loan? It’s probably Germany who has the largest sort of treasure chest, the largest tax revenues, and also one of the lowest levels of debt, so there’s been a lot of burden placed on Germany’s shoulders.

Leo Schulz:  And is this because Germany doesn’t see itself as being sort of politically shoulder to shoulder, or politically united with the rest of the union? What’s holding it back?

Alexis Gray:  If you ask people on the street I would say there’s some who might argue that other countries have been irresponsible and wasted money and that they shouldn’t have to pay for it, I mean in the simplest terms, whether or not that’s the right characterisation, remains to be seen but there’s a feeling that Germany is sort of bailing out countries who didn’t do reforms as they did, very painful reforms, and who perhaps wasted money or even fudged books.

Leo Schulz:  And the banking union, on a scale of one to five, what’s the likelihood of that coming off?

Alexis Gray:  So, some work has already been happening in that area so I would say that’s highly likely. One of the other big problems, and Ireland knows about this too, is that when some of the banks collapsed after the financial crisis, the governments were generally the ones who bailed them out, which you know, citizens saw as very unfair because at the end of the day that sort of fell on taxpayers.

If your government bails out a bank, you have to pay for it with higher taxes, so, to cut that sort of feedback loop, because really is it citizens’ fault? – not necessarily – is now going to be sort of a push for oversight for all banks, one to stop them from making mistakes and going bankrupt, and two for finding some sort of more fair way to bail out banks across the globe.

Leo Schulz:  And it was to some extent banks from France and Germany who were the ones who were lending to Greece and Italy and Spain, so, I mean it wasn’t all sort of innocent on one side and guilty on the other.

Alexis Gray:  Yes, and what you often hear people argue is that during the sort of the boom years in the 2000s, that some banks in the north were lending money to the south without doing a lot of due diligence, and not really assessing credit risk appropriately and making the assumption that they would be paid back. There was a period of time where it was assumed that you know, governments in the south were equally credit-worthy as those in the north, and the same with banks, which turned out very much not to be the case, so I think the level of due diligence has definitely improved since 2008.

Leo Schulz:  The single currency was taken to imply a single and harmonious…

Alexis Gray:  Exactly and all countries were sort of equal and represented an equal risk and you know…

Leo Schulz:  Indeed, which turned out not to be exactly the case.

Alexis Gray:  Very, very wrong.

Leo Schulz:  Shall we go on to the cheerful part of the presentation, which is the current situation, the current prospects for the euro area? That is a pretty startling graphic that you’ve got there, Alexis, if I’m reading that correctly, so, what is that telling us?

Alexis Gray:  So, what we’re doing here is comparing economic growth across the UK, the USA and the euro area over two separate timeframes, and the first is 2009-2013, which is really the heart of the crisis

Leo Schulz:  And that’s the one on the left, the kind of dark green or the sort of teal coloured bar.

Alexis Gray:  Exactly, and then on the right-hand side is 2014-2017, so now moving into the recovery. Now quite clearly across all the regions the economy has performed better the further away we are from the crisis, but in particular the eurozone was just stuck in recession for so many years and now has finally bloomed and is actually growing in a more synchronised fashion with the rest of the world. Even since the UK’s referendum on EU membership, the eurozone has actually outperformed the UK, which has been an interesting turn of events.

Leo Schulz:  So, what is, well there’s two questions I think, one is why is that happening, what’s driving it, but also is it kind of balanced across the region or is it really sort of focused in on the already successful economies?

Alexis Gray:  Why it’s happened I think is because, largely because austerity has ended, I think really the fact that policy makers weren’t doing enough to stimulate growth was sort of choking off the recovery, it just couldn’t get going. So once all of that austerity ended, the eurozone just took off, and that’s why you see a stark contrast between the eurozone and other countries.

And then on your second question…

Leo Schulz:  Is it balanced, regionally balanced?

Alexis Gray:  It is broadly balanced, let’s say there’s almost every country is growing reasonably quickly again. I mean, I would say Greece is the exception where there’s just very high levels of debt and a whole host of problems there that haven’t been fixed, but all the other countries are growing, and are pretty much growing above trend as well, so have been in a real hotspot for the last couple of years.

Leo Schulz:  Is it trade related, is it a domestic economy, is it services, is it manufacturing, where sort of within the economy are you seeing the stimulus coming from?

Alexis Gray:  I think we’re seeing green shoots really across all of those different areas. I mean trade definitely has improved although recently the euro has been very strong and that sort of depressed trade a little bit, but we’re starting to see consumers spending again, they’re going back to the bank and borrowing again. Not in an excessive way like they did before, companies are investing, you know, they’re exporting to China, the world has been through a much stronger period as well.

So, when your trade partners are buying from you that also stimulates growth, so to be honest it’s been all round as it should have been, it’s unfortunate that it took this long.

Leo Schulz:  I just wonder, and this is a broader question, but in the UK at any rate, and I think this does work more generally in other developed economies, although we have these good figures, we see that employment is actually pretty good by recent historical standards, certainly growth is positive even if it’s not huge, and yet interest rates are low so you would think all the elements, almost of the Goldilocks economy are there, but people aren’t feeling very wonderful about it, or they don’t seem to be, what’s your impression there?

Alexis Gray:  No, I mean I do think sentiment’s improved, in fact it’s a funny thing when we look at the sort of euro scepticism, I mean it’s true that some countries are unhappy, but across the board, in fact the popularity of the euro is at an all-time high, I mean who would have thought?

So, unemployment rates are falling, they typically are higher in Europe, but a lot of people now who want a job have a job, the labour market’s tightening, it’s just not at a point yet where we’re seeing a lot of wage pressure, wages are still relatively depressed, and so you know the central bank is still reluctant to start raising interest rates and normalising just yet.

Alexis Gray:  I think the euro area cycle is lagging the United States by several years so that whole recovery of monetary policy is going to happen, but at a lag of three to four years.

Leo Schulz:  So, much brighter prospects for the eurozone, and very pleasing to see that it is finally coming out of the slough, which as Alexis explained, lasted much longer than perhaps it needed to. So really interesting decisions for investors to be making around the eurozone in the coming months and years, obviously a very significant economic area in the world, so one which all investors I think need to understand and keep in touch with.

This will be our last webinar for the summer, we will be taking a break and giving our listeners a well-earned holiday for August. We will be back though on the third Tuesday of the month, at 2pm on Tuesday 18 September, and our guest will be Cynthia Pagliaro, and Cynthia is part of our Centre for Investor Research at Vanguard.

And Cynthia and her colleagues at the CIR have been doing some really interesting research into deaccumulation, I know that deaccumulation is a word that’s very popular with a lot of people, but I think that it’s a concept really, which I think people have really struggled with and particularly in the UK since the end of compulsory annuatisation. So I really would urge listeners to dial in for that, there’s some really interesting analysis, which has come out of our research and Cynthia is the perfect person to be sharing that with you.

If I could just remind you about the CPD points, if you have listened to the entire webinar, you’re entitled to half an hour, you can either email, contact your usual Vanguard representative, or you can call 0800 9175508, I’ll just repeat that for you slowly, 0800 9175508, and I think that does us for the summer, thank you all very much for listening and Alexis, thank you very much for joining us.

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