Overview
Still deep in recession / depression, it is possible and perhaps even likely that the US economy will be dealt a sledgehammer blow over the coming months. The full price for the European crisis might be paid in American jobs, with four categories of job losses imperiling the US economy and threatening the standards of living for millions of people. If you are employed in the US, UK, Canada, or Australia (among other nations), don't pity the continental Europeans, because it may be a European that ends up taking your job.
The next stage of the sovereign debt crisis has arrived, and we are seeing how the differential recognition of national problems can rapidly redistribute the real wealth of nations as well as individuals. In this article we'll discuss how some Europeans will be forced (kicking and screaming) into a state of "Accidental Virtue", and how this may protect them from the worst of the damage that will occur in nations with stronger currencies.
Sharp Currency Changes & Market Share
Not everyone in Europe is upset about the fall of the euro. As Daimler Chief Executive Officer Dieter Zetsche stated in a Bloomberg interview, "Because of massive growth in markets like the US and China... The fall of the euro is a benefit."
According to Airbus Chief Operating Officer John Leahy, each ten cent drop in the euro adds 1 billion euros to operating profits at Airbus.
The relationship that turns a plunge in the euro from disaster into an occasion to pop the champagne, comes down to each company's cost and revenue structure. If most of your costs are in euros that are falling in value, but a big chunk of your revenues are in dollars that are rising in value, then a rapidly falling euro will redistribute wealth to you on a pleasantly rapid basis.
There is a particular benefit that goes to companies where a large portion of their expense structure is paying their employees. It just got significantly cheaper to pay European workers to make products relative to US workers - and the differential could grow with further euro troubles. This relationship of the competitive advantage dramatically shifting to Europe applies to all nations where the euro is suddenly much weaker compared to their own currency, including such countries as the UK, Canada and Australia.
While the financial media focuses on the effects on near-term corporate profits, let me suggest that the much more important fallout from a fundamental change in the valuation of the euro is market share, employment, and national economies. In the very short-term, yes, a plunging euro means companies that employ European workers are going to gain a powerful profit advantage. When we move to the medium and long term however, (assuming the euro stays down compared to the dollar), then the companies can gain something even more important from an economic perspective -- increased market share.
Companies that employ European workers, generally speaking, have just gained a 13% advantage over US companies this year. This means they can lower their prices by 13%, relative to companies employing American workers, and grab great big chunks of market share. Indeed, they can lower prices by 8% in dollar terms, and have the dual advantage of both grabbing a bigger share of the market, and having each dollar in that market of sales be more profitable than it was before the euro fell. (For ease of illustration, these examples assume 100% of costs are labor. If 50% of cost were labor, then the advantages would be 6.5% and 4%, roughly speaking.)
As the crisis in the euro continues to develop, some are calling for parity between the dollar and euro by next spring. (That and worse could happen a whole lot faster than that, of course.) This would be about a 30% plunge in the value of the euro compared to where it started in January. Thus, companies that employ European workers gain a extraordinary advantage over companies that employ US workers (and Canadian, Australian and UK workers, if their currencies move with the US dollar rather than the euro). An advantage that would of course lead to increased profits for those companies, but much more importantly, could lead to dramatic changes in market share - with sales rising fast at companies that employ European workers, while sales plummet at companies that employ US workers.
You may have wondered about my using the somewhat awkward phrasing of talking about companies that employ European workers, and companies that employ the American workers, rather than the shorthand of European companies and American companies. The distinction is far from minor, and understanding the difference is essential. Indeed, if you want to understand the makeup of the world economy over the next several years, if this situation persists with a very weak euro and strong dollar, it is this distinction between the location of companies versus the location of their workers that will be one of the most important influences on the national economies of both the United States and Europe.
A Powerful Blow To A Reeling Economy
A nation's workforce taking on a 13% cost disadvantage would be painful for a healthy economy - but manageable. That's the normal course with currencies over time, there are significant fluctuations. A potential 30% differential is a different story, however, and could fundamentally change economies and countries - but doesn't by itself destroy a healthy economy. A more accurate assessment might be that a 30% differential could severely stress a healthy economy.
Unfortunately, the US economy is anything but healthy.
The US economy is currently in the worst shape that it has been since the 1930s. The economy has been shrinking for at least two years, and if we accept official government statistics and then adjust them for the different measurement methodology we use compared to the 1970s and before -- then some current estimates for the real rate of US unemployment range between 17% and 22%. For what holds it down to the official total of about 10% is simply that when people are unemployed for too long the government decides they are no longer part of the labor force. So technically, the "long-term discouraged" are no longer unemployed, they merely cease to exist for the statistics that are reported by the government to the media.
The economy is reeling, employment has not been growing, and unemployment claims were rising again even before the euro's plummet began. Yet, the so-called recovery remains a prediction of many economists and government officials, almost all of whom would've assured you two or three years ago that the current situation was impossible.
The US economy was already knocked down to the floor and in the worst shape in more than 70 years, even before it received the current kick to the stomach. Currencies are not weight-lifting competitions, being strongest is not necessarily the best, and ironically, a strong dollar can potentially pummel US employment in four distinct ways.
One. Companies that employ US workers just likely lost substantial international market share to companies that employ European workers, not only in Europe but around the rest of the globe. It may take six months or a year before the full damage occurs and makes it through official reporting channels, but the effects are already likely beginning to occur today in terms of contracts and purchases that are still being negotiated - or are being suddenly renegotiated. This substantial loss in market share of course translates to large numbers of US jobs being lost.
Two. Companies that employ US workers to make products for the domestic US market are likely to lose substantial market share to cheaper European imports over the coming year. With globalized trade, a major change in the competitiveness of your workforce necessarily can hit your domestic market every bit as hard as international markets. Again, this substantial loss in market share translates to large numbers of US jobs being lost.
Three. The strong dollar leading to decreased competitiveness for US workers (through no fault of their own) means that "job flight" is likely to return with a vengeance. Companies that employ American workers, whether they are US companies or foreign-owned companies, are not going to passively accept a major, perhaps even bankruptcy-inducing loss in market share. Naturally, they are going to aggressively do everything they can to try to protect their market share in markets around the world. That will likely mean a rapid shift in jobs inside of multinational corporations, as plants and offices employing US workers are closed down, with the jobs shifted to new or existing subsidiaries and suppliers abroad, particularly in Europe. If the euro plunges further versus the dollar, this migration of jobs within companies could happen fast and hard, dealing a third blow to American workers.
Four. All of this is taking place in the midst of a global financial and economic crisis that means economies outside of Asia are in many cases shrinking rather than growing. When the sales "pie" to be split is shrinking - so is employment. If American workers are being underbid by European workers for shares of a shrinking pie, this is a devastating one-two combination for total US employment. This also creates a feedback loop as falling US employment lowers US sales, which leads to further job losses. US workers then attempt to secure employment at lower wage levels, which would usually put a floor under the fall.
However, in this case, an artificially high dollar means that wages must fall further than would otherwise be needed, to overcome the cost advantage enjoyed by Europeans. This means that the jobs aren't created, or that they are at such low wages that discretionary spending is near non-existent. Each of which then leads to lower sales, which lead to further job losses. Effectively, the currency driven decline in the price of employing Europeans at least partially jams the self-correcting mechanism within the US labor market that would usually kick in.
Thus we have a recipe for national economic disaster. Indeed, with a further plunge in the euro from today's levels, there is potential for real US unemployment to reach levels last seen in the 1930s, unless aggressive action is taken by the US government to bring down the value of the dollar.
The Perils Of Differential Problem Recognition
What makes this situation quite ironic is that the reason the dollar has soared versus the euro is not because the US economy is fundamentally sounder, but rather that Europe has been forced to recognize its problems, while the US continues to refuse to deal with its own equally powerful economic problems. The dollar is soaring because Europe has a "sovereign debt" crisis (which is just the current catch phrase for saying governments have made more promises than they can pay for). But when it comes to unfunded government promises - the US has no equal, with approximately $100 trillion in unfunded obligations for Social security, Medicare and pensions.
So even while the dollar "wins" versus the euro in the headlines, what is going on is a fundamental weakening of the US economy, which brings forward the day when the US experiences problems that are every bit as severe as the problems in the eurozone.
Another way of looking at this is differential problem recognition. For a long time now - because these pressures have been building for a very long time - the US and Europe have both had fundamental economic and demographic problems coming at them like a freight train, which the markets have by and large ignored. Now the markets are recognizing the problems in Europe, while ignoring similar and equally massive problems in the United States. While the headlines may sound very negative for Europe - and Europe is indeed in crisis mode - it's worth noting that a couple of the side effects are that European investors can now command a higher return on their investments, all else being equal, because the prices of those investments have fallen even while European competitiveness has increased on a global basis. So lower prices for better economic performance relative to what would otherwise be the case with a higher value on the euro. Economic growth may still be negative, but less negative than would otherwise be the case.
On the other hand, the US dollar status as a reserve currency means that US investments become relatively more expensive for US and global investors to buy even as economic prospects for the US economy grow steadily worse. This translates to higher prices for lower fundamental economic strength. Which then operates to increase the differential between current prices and future value, and therefore increases the size and pain associated with the eventual convergence between market prices and economic fundamentals.
Crisis Economics & Accidental Virtue
Stefan Hofrichter, chief economist at Allianz Global Investors RCM unit, made a statement with wide-ranging implications when he said, "My concern is that the (falling euro) benefits will at most compensate for the headwind stemming from fiscal tightening, a more restrictive Chinese monetary policy and weakening growth momentum."
His point, of course, is that a greater market share- in a market that has been shrunk by the economic chaos accompanying the global financial crisis - may work out to be about the equivalent of breaking even for some European companies. If this works out to be true for Allianz, it means that they will likely be doing much better than many other companies in the world.
A falling euro is not all sunshine for European workers and consumers. Everything Europeans import from abroad just became substantially more expensive. This includes the oil from Saudi Arabia and the natural gas from Russia, as well is the other raw materials that must be imported from around the world. European manufacturers with cost structures that are heavily tilted to the acquisition of raw materials may be badly hurt, with accompanying job losses.
Indeed for the more efficient economic producers in Europe, the main side effect of the fall in the value of the euro may be to be pushed into a reluctant state of what I will call "Accidental Virtue". By the time all is said and done, there's a good chance that consumption will fall across European countries and that the standard of day-to-day living may fall for many or most Europeans. Every finished product imported from the US and Asia just grew more expensive. Even as every raw material and commodity imported from the rest of the world grew more expensive. This drop in consumption lowers the standard of living, even while jobs associated with exports grow rapidly.
This could lead many of the citizens of Europe to become more like the citizens of China and Japan, as they become much more competitive producers of real goods and services, even while their consumption of foreign goods and materials drops. In at least some nations, this may lead to the Accidental Virtue of being a nation of savers with strong jobs but lowered consumption. The word "Accidental" is important, because those involved may be quite reluctant, indeed they are likely to be dragged to this state of virtue kicking and screaming - but once they are there, they may be substantially better positioned for the coming decades than those in the US.
They will need every bit of "virtue" - and the jobs which come from that "virtue" - that they can get, because we have to remember that the fall of the euro is not the problem, but a symptom. The problem is the fundamental economic and societal crisis of a continent that has entered into promises with its own population that it will be unable to honor. The breaking of these promises, which must occur in substance, even if not in legal form (meaning inflation), will be painful - and that price will be very real. There will be turmoil, popular government safety nets will not have the funding that has been promised, and investment markets will be devastated. As always in times of major economic and monetary crisis, the workers will likely find a way to adapt (so long as the jobs are there), but the heaviest pain is likely to fall on the retirees.
While reduced consumption in combination with austerity programs and broken pensioner promises is not likely to be politically popular, even with a relatively stronger global economic position, it is nonetheless an enviable state compared to the alternatives.
What will hurt even more is if you have just as many or more government promises to be broken, but instead of having a resurging real economy - your real economy is imploding. This may be the fate that awaits the US, particularly if it continues to ignore this emergency and does not take the urgent action required.
Do keep in mind that this article is an extrapolation of current events in the news, and not a prophecy of unavoidable doom. If the US were to go a step further than Europe in recognizing its problems, and deal with its real issues, then it would be the US real economy that would be at the competitive advantage. The short-term turmoil would appear catastrophic to markets, politicians and the banking system - but you have to keep in mind that markets and banks aren't what determines standards of livings for a nation as a whole. It's the real economy that does that, and a strategy that attempts to mask real pain with short term manipulations - which has the result of increasing the damage to the real economy of workers, jobs and production - goes directly against the national interest.
When it comes to the "sovereign debt" crisis, the earlier a nation steps forward to accept what is inevitably coming - the better the real economy of that nation performs relative to how it otherwise would have, and the less the long term damage from the breaking of promises.
Euro Collapse Could Be Catastrophic For US & World
In order to explore the vital issues covered in this article, an assumption had to be made that the euro would be deeply wounded, but that it wouldn't collapse. That is, whether we're talking about the current 13% drop in the value of the euro versus the dollar, or the potential for a 20%, 30% or 40% total decline, these all assume that the euro and European Monetary Union remain intact and functional. It is these assumptions that lead to our hypothetical future state of "Accidental Virtue" in Europe with a reduced average standard of living for employed families, but with greater employment levels.
In the real world we have no such assurance. The situation is grave, a monetary union among sovereign nations with different objectives and situations is inherently fragile, and a collapse in the euro remains a strong possibility. While there will be winners, and lucrative windfall profits will be realized in the event of a monetary collapse (as covered in my article linked below), for the average citizen, living through a monetary collapse has always been - and will be - a nightmare scenario.
http://danielamerman.com/articles/Windfall.htm
Savings are wiped out across the continent. Pension plans become meaningless. During the peak of monetary crisis it is difficult for an economy to function at all, and unemployment becomes massive. These times of monetary crisis also can bring radical political change in a very short period of time that the average person would have said was impossible just two or three years beforehand. It is this political change that makes the process so unstable and unpredictable, as parties previously on the fringe may end up taking control. Politics and even culture can become quite pliable during crisis, and the characteristics of the Europe that would emerge on the other side of crisis can almost be considered a roll of the dice.
As this article has demonstrated, this is not just a European problem. And what needs to be clearly understood is that in a globalized world, if the euro collapses then the problems described in this article become much larger, much faster. The European market for US exports collapses - taking the associated US jobs with it. Meanwhile, the cost advantages of using highly educated and trained European workers over their American counterparts just grew much greater than that which we've been discussing.
This means that unless trade barriers are erected, US workers will be at a terrible disadvantage, and likely face a declining standard of living. However if political pressure leads to rapid erection of trade barriers, then the US inability to pay for its own standard of living unless it has cheap foreign imports, immediately comes to the fore. The US could face a 28% decline in discretionary income, as well as a series of rapid exogenous inflationary supply shocks, as covered in two videos / articles in my "Crisis & Globalization" series:
http://danielamerman.com/Video/PSL.htm
http://danielamerman.com/Video/Shock.htm
The Sharp And Unfair Redistribution Of Wealth
The first step in dealing with any problem is to accept that it is real, and that wishing, hoping and ignoring won't make it go away.
Impossible promises get broken by definition. One way or another. If the real economic resources are not there to cover the retirement standard of living than had been promised to an entire nation, then the average retiree is going to have a lower standard of living than what was promised. No amount of legislation can overcome that simple reality.
If the retirement plan for a nation is to invest with the assumption that we already know the future, and it is one of never-ending economic growth -- but that growth does not occur -- then the investment implications are grim for the average retirement investor who has been following conventional financial planning techniques.
But here's the key, as we are seeing with Europe: bad news has an uneven distribution. Not everyone is affected equally, far from it. What economic crisis does is rapidly redistribute wealth. The unfortunate likelihood is that tens of millions of people who have lived good responsible lives, are going to see their lifestyles crushed, through no fault of their own. Other tens of millions of people will experience substantial but manageable declines in their standard of living. There will be another group, and the Europeans are particularly well-positioned at this time, where they will more or less break even.
There will be a smaller group that will position themselves so that the rapid redistribution of wealth will radically increase their net worth. These individuals will be found in every nation, but their numbers will be relatively few.
To position yourself to have a fighting chance of keeping what you've built, and maybe even increasing it substantially - there is simply no substitute for understanding how wealth is rapidly redistributed by economic crisis. If you don't understand how the redistributions work and you keep the same investments and strategies that everyone else has, then you will just be impoverished along with everyone else. To protect your financial capital, to protect what you have for you and your family, the very best step you can take is to build your intellectual capital.
Seek to acquire an uncommon education in the redistribution of wealth during crisis.
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