The Continent may need a new economic model, says David Jane.
In financial markets, we often focus on certain numbers, such as GDP, interest rates, leading indicators, and so on. In doing so, we often forget that the real economy is actually a collection of people and their business activities. The measurements matter, of course, but what drives them arises from the real world.
We raise this in the context of interest rate policy in Europe, where negative interest rates have failed to prevent an ongoing slowdown, and further easing is planned.
The issue is that the difficulties faced by the eurozone economies are partly caused by the policy of ultra-low rates and partly structural. In neither case will more free money help.
The products that have been the core of Europe’s production and exports are rapidly becoming redundant. Demand for diesel-powered passenger vehicles is falling. Diesel was sponsored as a more environmentally friendly fuel source, largely for protectionist reasons, by European governments. Unfortunately, this proved not to be the case and as a consequence, demand is declining rapidly. Two factors exacerbate this trend, China’s move towards domestic brands and the potential of Brexit.
Capital goods exports to China have also been weak, reflecting China’s move towards domestic suppliers, as well as its shift towards a more consumer-focused economy.
As a result of these trends, Europe’s big drivers of past growth are now behind them and a new economic model may be needed. Interest rate policy has prevented the normal process of creative destruction. Resources are not being recycled effectively into the industries of the future and away from those of the past.
Europe thinks that it needs a new model and we can already see how that might look. For some time, there has been talk of fiscal policy to complement the zero-interest policy. Europe has a long history of industrial policy, giving government support, both financial and non-financial, to gain an advantage in certain industries albeit with mixed success. It seems clear that the ground is being laid for some form of European deal in which investment into the new energy sector is further accelerated.
We have little exposure to Europe’s struggling economies, our European equities being focused on growth areas, such as new energy and healthcare.
We are, however, quite vigilant as to the implications of a change away from monetary to fiscal policy as this might have material effects well beyond the immediate impact on near-term growth, on bond yields and currencies.
David Jane is manager of Miton’s multi-asset fund range.