While conventional wisdom would discourage investors from investing in the EU, in light of the billions the EU is spending in bailouts, it is important to consider the differences between current and potential bailout countries. The average public-sector deficit to GDP ratio in the EU is actually lower than that of the US and Japan, but there are several countries that could be in trouble. See the following article from Money Morning for more on this.
The $100 billion-plus bailout of Ireland, which followed the $100 billion-plus bailout of Greece, seems at first to validate the standard U.S. view of Europe – that it’s a bunch of backward, socialist countries that will be washed away by the tide of history.
According to this view, one European country after another will succumb to the “Greek disease,” until the continent ultimately runs out of bailout money.
The conventional wisdom is that U.S. investors should just avoid the European Union (EU) in its entirety.
But U.S. investors who embrace this view – and ignore the economic muscle that exists in key European market economies – will end up leaving an awful lot of money on the table.
Ireland and Greece: A Tale of Two Divergent Economies
The average public-sector deficit in the 15 countries that use the European euro currency will be 6.5% of gross domestic product (GDP) this year, The Economist magazine’s team of forecasters concluded recently.
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That’s lower than the 9% ratio for the United States, the 10.1% ratio for Great Britain, or even the 7.5% ratio for Japan.
So why would an investor who was worried about public-sector finances run away from the EU?
The reality is that as you go through the 27 countries of the EU – from worst to first – the concerns about public-sector finances are concentrated in less than a third of the European continent.
Greece is a basket case – no question about it.
Ireland, on the other hand, has merely been foolish about its banking and housing policies – and can actually boast an overall national economic policy that was put together in a highly intelligent manner.
Ireland’s low corporate tax rate of 12.5% has generated strong inbound investments. That has developed Ireland’s economy and its national skill set – while admittedly also fostering the formation of a sector of dodgy aircraft-leasing companies.
It will be very unjust if Ireland is forced to jettison that excellent national economic policy to get a bailout from the EU – but tough choices must sometimes be made.
The bottom line: Greece and Ireland are on divergent paths. In the long run, I expect Ireland to recover nicely; Greece – not so much. The difficulty now is that with the markets having generated $100 billion rescue packages for each country, they’ll next be hunting for new victims.
The Next Phase of the EU Contagion
In this hunt for potential EU victims, it certainly appears to be a “target-rich” environment. In my opinion, there are six economies to watch. They are:
- Portugal: It has a sensible banking system and had only a moderate housing-price bubble (for some reason the Algarve stayed more selective than Benidorm or Marbella). Unfortunately, it has a dozy Socialist government that engineered a “stimulus” in 2009 and that resorted to such ill-advised, onetime deficit-reduction strategies as stealing the telecom company’s pension fund – instead of employing such proper strategies as spending cutbacks. Portugal’s deficit for the first 10 months of 2010 was higher than in 2009. Spending was up 2.8%, in spite of a modest economic recovery and very low inflation. So Portugal is almost certain to get a bailout, and is fairly unlikely to recover.
- Spain: This country had a real-estate the size of Ireland or England, has a Socialist government as dozy as Portugal’s, and a huge 2010 fiscal deficit of 9.7% of GDP. While the top end of its banking system (Banco Santander SA (NYSE ADR: STD), for example) is admirable, there’s a lot of dreck lower down. So at some point, I’d expect Spain to demand a bailout, too. The problem is, Spain is bigger than Portugal, Ireland and Greece put together. A bailout of around 50% of GDP, roughly the size handed out to Ireland and Greece, would total $730 billion – and drain the bailout fund of the remainder of its cash.
- Spain’s plight is unfortunate, because we should also worry about Italy: Bigger than Spain, and with a government that is tottering on the brink (at which point it will be replaced by yet another dozy Socialist operation), Italy is a country whose banks are so sleepy that they’ve been able to avoid trouble. It’s real estate market stayed within bounds and its fiscal deficit is only half of Spain’s. But its public debt is far in excess of 100% of GDP. If the speculators succeed in knocking off Portugal and Spain, they will think they are on a roll and have a go at Italy – which is probably too big to bail out.
- There are two countries that pundits talk little about – Hungary (not an EU member) and Slovakia (got lucky and elected a competent government last summer). And there’s a final one nobody talks about – Belgium: A mirror image of Italy, with about the same budget deficit and even more public debt, Belgium has the worst debt/GDP ratio outside Japan. What’s more, it has great difficulty forming governments and may someday split in two. Its big advantage is that it happens to be where all the Eurocrats live and work, so like the District of Columbia, it will get bailed out somehow.
This article has been republished from Money Morning. You can also view this article at Money Morning, an investment news and analysis site.