Europe

What does Europe’s future look like? Last night I finished reading Douglas Murray’s fascinating, brilliant, beautifully argued and deeply disturbing book, The Strange Death of Europe. Murray writes of Europe’s “suicide,” a decision made not by voters choosing this in democratic elections but very largely by elites acting without broad consent. Murray, a British intellectual and journalist whose writing is always worth attention, explains that two factors have combined to produce the danger that European culture and civilization as it has been known for centuries will not survive. The first is “the mass movement of peoples into Europe” at a time when Europe is quite literally not reproducing itself—not having enough children to keep population levels steady, much less to grow. The second is what he calls “the fact that…at the same time Europe lost faith in its beliefs, traditions, and legitimacy.” He continues: Europeans sometimes fall into terrible doubts about our own creation. More than any other continent or culture in the world today, Europe is now deeply weighed down with guilt for its past….there is also the problem in Europe of an existential tiredness and a feeling that perhaps for Europe the story has run out and a new story must be allowed to begin. Mass immigration…is one way in which this new story has been imagined…. This very brief description does not do justice to the detail, nuance, and honesty of Murray’s thinking about Europe’s situation. I suppose he will be called names for his writing, but there is not an ounce of prejudice here; just candor. Some of what Murray writes is reporting from his visits and conversations all over the continent, and some is analysis or speculation. Much is an effort to state the facts as clearly as possible, an effort European governments too often evade. A look at birth rates in Europe shows that something is going wrong: a society that does not reproduce itself begs us to ask why. George Weigel called this “demographic suicide” and Niall Ferguson called it “the greatest sustained reduction in European population since the Black Death in the fourteenth century.” It has recently been pointed out that Europe is now also led by people without children, including May, Merkel, and Macron, and the Italian, Dutch, and Swedish prime ministers, and more. These are very different people and the causes of childlessness will also be different, and as Weigel notes in some cases this will be experienced with sorrow. But this is surely the first time that Europe, and Europe’s elites, have so clearly turned away from producing the next generation. And at the same time, the mass immigration brings a new population, a development that in any place and at any time would present real challenges. How is Europe meeting them; is it even acknowledging them; what might be done; is it too late? These are among the questions Murray asks, and in lucid prose he tries to find the answers. Worth reading, for sure.      

Italy is making real progress now. But completing the recapitalization of Monte and the restructuring of the two Veneto banks may not be quite enough.

History suggests that Europe’s current wave of terror can be ameliorated, if not entirely stopped.

Emmanuel Macron received a strong endorsement from French voters in yesterday’s second round election, winning around 66 percent of the vote.  While abstentions were up from the last election (an estimated 26 percent), early returns suggest broad-based support for Macron and his centrist, pro-European message. Attention now turns to the June 11th and 18th parliamentary elections, where President Macron and his newly formed political movement En Marche! face uncertain prospects in their effort to gain a workable parliamentary majority. The result was expected, and consequently the market response was muted though positive.  Clearly a major tail risk that would have rattled investors has been avoided, and markets view favorably Macron's economic program centered on business, labor and fiscal reform. European leaders were visibly relieved, and rightly so, as a Le Pen win would have presented a deep and immediate challenge to the future of the European Union. But I am less sure that the obverse is true, that a Macron win represents the zenith of the populist threat. As I mentioned after the first round, a common refrain during the recent IMF Meetings was the idea that, with the electoral challenge from radical populists in the Netherlands and France defeated, and assuming continuity in German elections this fall, Europe would be ready to make a strong push towards greater European integration, most importantly on economic issues. It also is assumed that Macron will take a strongly pro-EU line in the Brexit negotiations, though there again it isn’t until late this year or 2018 that the significant decisions will be made on the terms of the Britain-EU divorce, as well as what follows. I am more convinced by the argument that the nationalism and populism that has spread across western industrial countries will remain a potent force in Europe, even as the immediate threat as been pushed back, until Europe’s leaders, policies, and institutions can deliver a more optimistic economic future (with more broad-based, inclusive growth and a more integrated Europe that is better able to respond to shocks) to more of its citizens. While immigration and security top polls now as the central concern of Europeans, a decade of economic growth has left many Europeans pessimistic about their long-term economic future.  In this scenario, these pressures are likely to fester, and potentially constrain even European-mined politicians to adopt more nationalistic policies. While a France-led Macron may become a leading voice for more Europe, forming a consensus across Europe (including, most importantly, those countries with the fiscal capacity to finance greater integration) on pro-growth, pro-Europe policies seems increasingly challenging.  European populism appears, as nicely put elsewhere, to have entered the awkward adolescence years: “able to borrow the car but not own it, have an influence on the household but be too young to run it.” The election could have one immediate impact on international economic relations, as there are reports that Macron could look to IMF managing director Christine Lagarde, Managing Director of the IMF, as his prime minister. That would be good choice for France, but would confront world leaders with tough questions about the future direction the IMF.  Legarde had appeared to be building good relations with the new U.S. administration, and while the convention of European leadership of the IMF has held until now, a succession discussion could provide an early test of the organization’s relationship with a new U.S. administration that has entered office suspicious of multilateralism.

A long time ago I confessed that I like to read the IMF’s World Economic Outlook (WEO) from back to front. OK, I sometimes skip a few chapters. But I take particular interest in the IMF’s data tables (the World Economic Outlook electronic data set is also very well done, though sadly a bit lacking in balance of payments data).* And the data tables show the combined current account surplus of Europe and the manufacturing heavy parts of Asia—a surplus that reflects Asia's excess savings and Europe's relatively weak investment—remained quite big in 2016. China's surplus dropped a bit in 2016, but that didn't really bring down the total surplus of the major Asian manufacturing exporters. Much of the fall in China’s surplus was offset by a rise in Japan’s surplus. The WEO data tables suggest that net exports accounted for about half of Japan's 1 percent 2016 growth—Japan isn't yet growing primarily on the basis of an expansion of internal demand. And the combined surplus of Korea, Taiwan, Singapore and Hong Kong remains far larger than it was before the global financial crisis in 2008. The Asian NIEs (South Korea, Taiwan, Hong Kong, and Singapore) collectively now run a bigger surplus than China. As a result, in dollar terms—and also relative to the GDP of Asia’s trading partners—"manufacturing" Asia's combined surplus hasn’t come down that much over the last ten years. The size of the combined surplus of Europe and “manufacturing” Asia necessarily means that other large parts of the global economy need to run large deficits in manufactured goods. To be sure, barring an energy revolution, the big oil and gas exporters will necessarily trade oil for manufactured goods (and holidays), and parts of Asia and Europe equally will need to trade manufactures for energy. But the big Asian and European manufacturing exporters could not maintain surpluses of their current scale in the absence of a U.S. trade deficit in manufacturing that is as large as it was back in 2005 or 2006. There are only so many ways the global balance of payments can add up. While the surplus of key parts of the global economy haven't moved much, the nature of the financial outflows that channel the current account surplus of Europe and Asia (their savings surplus so speak) to the rest of the world has certainly changed. Setting a few countries (Switzerland, and perhaps Singapore***) aside, governments aren’t directly channeling funds abroad through the build-up of their reserves and the assets of their sovereign funds. Here is a plot of the growth in Asia’s official assets. My measure of official asset growth is mostly reported reserve growth, but is has been adjusted to include changes in countries' disclosed forward position and China's "other foreign assets." I also added in the rise in the non-reserve portfolio holdings held by the public sector (and I assumed China's portfolio outflows are from government institutions). This is a way of capturing sovereign wealth fund and public pension fund outflows. I did not add in the external lending of China's state banks. To be honest these adjustments are primarily for my own satisfaction (they all come from the balance of payments data—I am trying to avoid valuation adjustment these days). Looking only at reserves (adjusted for forwards and China's other foreign assets) would not materially change the picture. And here is the similar plot for Europe looking only at reserves (I didn’t include Norway—too much of an oil-exporter—so I didn’t really need to adjust for official non-reserve assets). And here is a chart adding the reserve growth of the major oil exporting regions to Asian official asset growth.*** It clearly shows that the growth in official assets was correlated with the big run-up in their combined surplus prior to the crisis (for much more, see Joe Gagnon's 2013 working paper, and his forthcoming book with Fred Bergsten) and that the countries that historically have accounted for most of the reserve build-up are now running down their stock of assets. Broadly speaking, over the last ten years, Asia's surplus hasn't changed much while Europe has replaced the oil exporters as the second main driver of global payments imbalances. And private outflows rather than official outflows have become the financial counterpart to the world's big current account surpluses. That in turn matters for the composition of inflows into the United States: the world is buying fewer Treasuries and far more U.S. corporate bonds—though Asia also seems to have regained confidence in Freddie and Fannie. Taiwanese life insurers, Korean pension funds, and Japanese banks have more risk tolerance than traditional central bank reserve managers. The same is true of German insurers, Dutch pension funds, and for that matter Switzerland's reserve managers—who have more freedom than most of their counterparts to buy equities and corporate bonds alongside traditional reserve assets. Such changes in the composition of inflows to the U.S. could help explain why the IMF found that relative to fundamentals, U.S. corporate spreads seem a bit tight… One last point: The U.S. Treasury suspects that this fall off in reserve growth is largely a function of the dollar's strength, and has expressed concern that it may not be durable in its most recent foreign exchange report. I generally agree: the world's central banks historically have intervened far more when the dollar is weak than when the dollar is strong. The major surplus countries in a sense only need to step up and the use their government balance sheets when the market doesn't want to fund the U.S. external deficit. But I also suspect the world's big surplus countries are also now a bit more skilled than in the past at disguising their intervention—sovereign wealth funds can keep foreign assets off the books of the central bank, government pension funds often do some of the heavy lifting, and, in China's case, the growth in the overseas lending of China's state banks is likely to have structurally reduced the pace of reserve growth in good times. When intervention returns, it may not be primarily through the use of central bank balance sheets. *The long-standing joke that the IMF stands for “It is mostly fiscal” applies to the WEO data set. Tons of fiscal numbers. And for the balance of payments, only the current account (at least for individual countries). Sad! ** The overall U.S. external deficit is of course smaller, thanks mostly to a large fall in the oil deficit. The rise in the offshore income of U.S. multinationals also helped, as did the fall in the rate the U.S. paid on its external borrowing. *** I was lazy and did not try to adjust for the buildup of sovereign wealth fund assets in the Middle East. I have another technical complaint here. The IMF used to provide an estimate of official outflows from the Middle East and North Africa, which was a good proxy for the activity of the region's sovereign wealth funds—it was one of the bits of the WEO data tables that I found most useful. With the shift to the new IMF balance of payments standard (BPM 6) the IMF now only reports aggregated portfolio outflows. The old breakdown was in some ways more useful. The IMF could help to address this by insisting that more countries report the disaggregated data on portfolio outflows—even when this shows that the public sector accounts for the bulk of outflows. **** Singapore's headline reserves aren’t moving, but Singapore’s forward book is now rising and government deposits abroad have soared—call me suspicious.