Global Equities Research: Who Is Europe's Troubled Child?

 

I started my career in Paris in the early 90s in an airless office, a tired ventilator blowing the stale air (you could smoke in French offices back then and my boss smoked 60 cigarettes a day) from one part of the room to the other.  A few large coffee stains on the floor, the odd unfixed hole in the wall and 36 centigrade outside, complete the stifling picture. My first job was as a credit analyst assessing loan requests from French subsidiaries of UK groups. We didn’t take kindly to people asking us for money. Yes, I worked for a bank and lending money was our job, but the whole concept of banking had not filtered through to the credit department. We were there to be a pain to the front office and keep them in check. They oddly wanted to hand out loans to any client daring enough to cross our threshold. We took a much dimmer view. Mind you, as I soon found out, this was not unique to my employer. France, three or so decades ago, had a very conservative take on the whole concept of borrowing money. If you ever dreamed of going overdrawn without informing your bank, you were threatened with an interdit bancaire. Simply put, you would be barred from actually having a bank account if you didn’t know how to use it responsibly. They had not even discovered the joys of credit cards back then, a whole new world I discovered to my cost when I came back to the UK five years later.

How things have changed. For France has a legitimate claim to Italy’s crown as the troubled child of Europe. The total debt of the country (government + corporate debt + household debt) is considerably higher than its transalpine cousin.

Source: Bloomberg

But more worrying still is the parting of debt ways between the heart and soul of the European project.  If Germany is the heart of the EU and France its soul, then the pathway of debt between these two does not spell happy times ahead. A soul parting from its body is not usually a healthy sign.

Source: Bloomberg

The frugal householders of the Mitterand years are now long gone.

Source: Bloomberg

… but  the greatest difference comes in the levels of corporate debt which French companies have managed to pile on over the last two decades.

Source: Bloomberg

So cumbersome has the debt become, that they are only just pipped to the post by China in the G20,  thus missing out on the crown of the nation with the most heavily indebted corporates.

Source: Bloomberg

You’ll notice that the debt gap between Germany and France only really took off after the crisis.  The European sovereign debt crisis of 2011 to 2012 and the European Central Bank’s (ECB’s) ensuing monetary pyrotechnics have kept the euro well tethered, allowing a competitive, export-focused German economy to thrive.       

Source: Bloomberg

How long can this last? In normal times a rapid rise in debt is followed by a banking crisis. But these are not normal times.  Since the global financial crisis, the leading central banks of the world have always set off the monetary sprinklers at the first hint of smoke. In Europe, the ballooning balance sheet and pancake shaped profile of interest is typical of other leading central banks.

Source: Bloomberg

The difference comes in the governance structure of the ECB. Its capital is owned by all the member states of the EU and its decisions are chaired by its President, six executive board members and all 19 governors of the central banks in the Eurozone. There are many cooks in this kitchen. The more often poorer members get help through quantitative easing (QE) and low rates, the greater the domestic opposition in prosperous states becomes. Pressure grows for those in a position to help the weak gain greater control. The latest shape this has taken is a greater push to complete the “Banking Union”. In exchange for common deposit insurance, the ability of weaker states such as Italy to cajole their domestic banks into buying their own debt will be curtailed. Italy is currently digging its heels in and refusing to countenance such an idea.

This latest episode is symptomatic of an on-going battle; a battle which goes a long way towards explaining the rise of populism across the continent. As long as the strong don’t want to pay for the weak, as long as the weak don’t want to lose control of their affairs, the Eurozone will act as a green-house for the growth of populism.

Now the litmus test of strength or weakness is debt and France has lots of it. That is an existential threat to the future of the euro. The media focus over the last few years has been almost exclusively focused on the Mediterranean “fringe”, with Italy causing the greatest concern given its size. In no way can France be called a “fringe” member of the Eurozone. The whole of the EU project has been built on the foundations of post-war Franco-German reconciliation.

Many a commentator has confidently called time on the euro, and just as often been proved wrong. But there is a fact you can’t avoid. The balance sheets of the two most important founding members of the EU have never been so far apart. That is a problem – a problem which is not going away but is growing. In the absence of a political union which would channel the wealth of the richer parts of a currency union to the poorer parts as happens largely un-noticed in any country, this cannot be sustained.

The next question is what “cannot be sustained” mean? Does it mean a spectacular finale to the Eurozone as dramatic as the fireworks set off every year at the London Eye to call time on one year and usher in a new one? That seems highly unlikely. A more likely pathway is a single currency “in name only”, with growing capital controls and the growth of covert parallel currencies.

These concerns are reflected in Canada Life Investments’ Global Equity weightings. A significant stepping stone to the end of Brexit uncertainty was taken in the December 2019 elections. As a result, our European exposure favours the UK with the funds having a lower exposure to continental European stocks than our benchmark.

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CLI01557 Expiry 31/01/2020

Daniel White

Daniel White

Senior Research and Strategy Manager

LF Canlife Global Equity Fund

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