Dealing with a crisis requires three things, according to Jack Welch, General Electric’s former CEO. Define your reality – not as you would like it to be, but as it is. Do something about it. Then, third, acknowledge that the crisis wasn’t half as difficult as you thought it was. Germany is the key player in Europe’s crisis today, and it is still struggling to accurately define its reality.
The crisis in Europe was the focus of two presentations at last week’s Strategic Investment Conference in San Diego, hosted by Altegris Investments and John Mauldin. Lack of a common vision and inability to coordinate effectively are undermining progress in Europe, according to Mohamed El-Erian, PIMCO’s chief executive officer and co-chief investment officer. David McWilliams, one of Ireland’s leading economic commentators, echoed El-Erian’s sentiments and highlighted Germany’s role in determining the Eurozone’s future.
McWilliams, who served as Welch’s master-of-ceremonies during Welch’s 2001 Straight from the Gut book tour, used the former GE executive’s framework to illustrate how events in Europe are likely to unfold.
“Germany is the key to everything,” McWilliams said, “and the key for Europe is to understand how Germany is going to deal with the crisis over the next couple of years.”
Germany’s pivotal role
Germany wants the EU to remain intact to support its export-driven economy, McWilliams said, and the question is how much the Germans are willing to pay for that benefit.
Europe faces a big problem with its middle class, which is suffering from losses in the value of their assets – specifically land and houses. Uncertainty about the future is causing middle-class Europeans to save more and spend less, he said, and retailers are cutting prices. But demand is continuing to fall. For example, new car sales are down 30% in Italy, McWilliams said. Banks are refusing to lend because their balance sheets are too weak and “the economy is seizing up.”
Unemployment is rising everywhere but in Germany, and the continent is heading into recession. El-Erian called Germany the “good house in a bad neighborhood.”
Throughout Europe, the initial response to the crisis was denial, according to El-Erian. The reality that Germany still refuses to accept, McWilliams said, is its co-dependence with the weaker European countries. Germany (and other surplus countries, like Austria, Holland and Finland) grew by selling its exports, like Mercedes, to the European periphery, like Ireland, which financed those purchases with debt its governments can no longer service.
The weaker and less competitive parts of Europe are saddled with too much debt, El-Erian said.
“At the moment, the policy is to load us up with more and more debt to pay for debt that we couldn't pay for in the first place,” McWilliams said. “So we are borrowing from tomorrow to pay for yesterday, not even today. And this, of course, is causing the economies to contract.”
Borrowers and lenders need to share responsibility for the crisis – perhaps lenders more so, since it is their capital that is at risk, McWilliams said. “What has happened in Europe is we have too much debt, too little growth, not enough political leadership, and a lack of political legitimacy,” McWilliams said.
