The European Union Has Changed Its Focus

Richard Croft
May 13, 2013
11 minutes read

Since the European Union (EU) bailout programs began there has been an austerity pre-condition. Mostly the result of German strong arm tactics designed to get member States to restructure social programs so as to level the playing field in a way that supports a single eurozone currency.

The challenge is how does one deal with the extreme conditions in which have not states (Cyprus, Greece, Ireland, Portugal and possibly Spain and God forbid Italy) are trying to manage through the crisis with unsustainable unemployment rates against the political views inherent in the stronger states that further bailouts will simply result in a vicious circle of throwing good money after bad?

Recently that has begun to change!

There is a move afoot among EU politicians that austerity is simply not working. Couple that with clear evidence that the US economy is gaining momentum – albeit ever so slowly – plus more academic literature challenging the austerity approach and politicians are beginning to lean towards a growth oriented strategy.

To that end, the European Commission adopted a reprogramming plan that will help promote growth in Cyprus and strengthen the impact of EU regional funds there. According to the EU press release “the decision to redirect €21 million worth of Regional Funds is intended to help the country deal with the current socio-economic crisis and ensure a quicker delivery of available investments particularly when it comes to supporting small and medium sized business and the employment of young people. This revision was requested by Cyprus earlier this year and has been given added political momentum in the last few weeks The decision will see funds from lesser performing regional policy areas being redirected to where the funds are likely to have more impact for growth and jobs in the shorter term.”

The European Commission also proposed measures to ensure “the better application of EU law on people’s right to work in another Member State and so make it easier for people to exercise their rights in practice. Currently there is a persistent problem with public and private employers’ lack of awareness of EU rules, regardless of whether the national legislation is compliant or not. This lack of awareness or understanding of the rules is a major source of discrimination based on nationality. People also consider that they do not know where to turn to in the host Member State when faced with problems concerning their rights to free movement. The proposal aims to overcome these obstacles and to help prevent discrimination against workers on the basis of nationality by proposing practical solutions.”

According to László Andor, Commissioner for Employment, Social Affairs and Inclusion “The free movement of workers is a key principle of the EU’s Single Market. With much higher levels of unemployment in some Member States it is all the more important to make it easier for those that want to work in another EU country to be able to do so. Labour mobility is a win—win – it benefits both Member States’ economies and the individual workers concerned.”

Of course, structural reforms are one thing. To make this work, there has to be increased efforts by central banks to provide much needed liquidity within the bounds of international agreements.

On that front, I noted reports from Reuters covering the G-7 meetings last week that British finance minister George Osborne “is keen for his peers to focus on what more central banks can do to help growth at a time when most governments are trying to cut bloated debts.”

According to Mr. Osborne, this is “an opportunity to consider what more monetary activism can do to support the recovery, while ensuring medium-term inflation expectations remain anchored.”

The Chicken and egg problem with this approach, as echoed at the G-7 meetings, was the need to focus on bank regulation to re-structure many of the failed banks. The emergency rescue of Cyprus in March acted as a reminder of the need to finish an overhaul of the banking sector, five years after the world financial crisis began.

That too is a political hot potato, as Germany may come under pressure to give more support to a banking union in the euro zone. The plan could help strengthen the single currency area, but according to Reuters, Berlin worries it may pay too much for future bank bailouts if it signs up to a scheme to wind up failing banks. A position that caused grief at last month’s IMF meeting.

While no formal decisions will come out of this meeting, it will lay the foundation for talks at the G-20 leaders’ summit which will take place in Russia in September.

That goes hand in hand with the heated political debate about the need for governments to ease up on austerity, something Germany, Britain and Canada view as a mistake but Washington, Paris and Rome are in favour of.

US Treasury Secretary Jack Lew weighed in during an exclusive interview with CNBC where he opined that “a global recovery cannot be led by the United States alone… There are countries in Europe that have more fiscal space to create a bit more economic demand.”

All of this is a major change in the EU’s approach and must still be adopted by legislatures. And while nothing is guaranteed – note: Germany faces elections this year – it is seen as a step in the right direction, especially in light of Germany’s strong economy reflected in the DAX index which now rests at all time highs, making it the only stock market in the EU that has fully recovered from the crisis.

With this change in focus, there is hope that the EU has finally turned the corner a sentiment echoed at the G-7 meetings in London this past week. In fact, the main focus of the G-7 Finance Ministers seemed to be on Japan and its domestic strategy.

Currency Wars

The Bank of Japan (BOJ) has embarked on a liquidity program that dwarfs efforts currently underway by the US Federal Reserve (FED). In an attempt to stimulate the Japanese economy with its heavy dependence on exports and to kick start inflation the BOJ is printing money at a pace that has other Finance Ministers concerned that the Japanese are effectively manipulating their currency. In fact one of the best trades of 2013 has been to short the Yen against world currencies. Noteworthy is the fact that the yen hit a four-year low against the US dollar on Friday, beyond the psychologically important 100-yen mark. It also trades at a three-year low against the euro.

US Treasury Secretary Jack Lew, while recognizing that Japan has growth issues that need to be dealt with, warned that the world has limits on the degree to which it will allow Japan to stimulate its economy, saying that “Japan had to stay within the bounds of international agreements to avoid competitive devaluations.”

Still the general consensus was that a weakened yen was not a hot topic at the G-7 meeting despite ongoing rhetoric about a global currency war. And while that may be true, the G-7 was concerned that Japan’s attempts to engineer an export-led recovery could hinder other regions’ ability to grow.

But writes Reuters, “having urged Tokyo for years to do something to revive its economy, other world powers are not in a strong position to complain now that it is doing so.” Let’s face it, any attempts to rein in Japan at a time when other central banks are doing the same thing seems a bit like crying wolf.


Could it be that financial markets are surging to new highs in recognition that these changes were inevitable? One could argue in light of a changing focus within the EU and the growth oriented strategies being employed by Japan will be a lynchpin of global growth that will allow economies to catch up with the market.

But even with that, one cannot escape the inexorable fact that markets are priced for perfection. And while one should never fight the largesse of central banks we must be mindful that growth can create an inflationary bubble.

Note to Japan… be careful what you wish for!

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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