Morningstar Advisor - February/March 2012 - (Page 52)

Morningstar Conversation What economic policy inadvertently is doing is turning Europe into kind of an economic zone, which is likely to be characterized by rising unemployment, weak or no growth, and occasional economic slumps, one of which looms during the coming 12 months. George Magnus Senior economic advisor, UBS ized by rising unemployment, weak or no growth, and occasional economic slumps, one of which looms during the coming 12 months. Chancellor: Think of Spain, a country that [European Central Bank chief Mario] Draghi is now pointing out, without there being immense ill consequences for your own economy. has around 23% unemployment and is still running a current account deficit, which suggests pretty strongly that it’s uncompetitive. It has a very enormous amount of private sector debt relative to GDP. Its nominal GDP has not contracted, unlike Ireland’s, which has gone through this deflationary bust over the last couple of years. Now, if Spain loses any sort of capacity to run a countercyclical fiscal policy, it is then set for a deflationary adjustment, while having a private sector debt/GDP ratio of around 400%. When I wake up in a very depressed mood about the eurozone, the way the crisis is working out reminds me of the Gold Standard in the 1930s, when you had the Credit-Anstalt Crisis of May 1931, and that was followed by bank runs and runs on various currencies across Europe. The Gold Standard forced countries into reducing their deficits at a time when their banks were experiencing runs, and there was a severe deflation. If you look at the history books, that was not a good thing to do to the European economies. But today’s crisis is even worse, because the great thing about the Gold Standard is that any country could decide, as Britain did in 1931, that it had had enough and leave with very little ill effect—in fact, with immediate recovery. But you can’t leave the eurozone, as The Competitiveness Problem Johnson: One of the main motives for leaving the common currency would be to inflate away the value of one’s debt. But as we’ve seen, that is just a near-term and not a long-term solution. A long-term solution is to regain competitiveness. Isn’t it one of the more elemental issues that the eurozone is facing? Certain peripheral members have just fundamentally lost their competitiveness. Chancellor: I think that some of the data is a bit confusing because people often choose 2000 as a starting point to compare unit labor costs with Germany. They then point out how Italy’s unit labor costs have risen relative to Germany’s. But in fact, the starting point was probably a period in which the German unit labor costs were relatively high, compared with the periphery’s. We’ve been doing a lot of work on Italy, and Italian exports actually have been very strong over the last year. In fact, they’re only just about 1 percentage point behind Germany’s. So, it doesn’t look to me, in terms of export growth, that Italy has a particular problem. Ireland has deflated its unit labor costs by a great chunk over the last few years and is now back to around a current account surplus. Spain, I think, is the most worrying on the competitive front. But perhaps George has a different view. Magnus: Not necessarily. There are obviously quite a few horses for courses already that we’ve seen since the crisis began, Ireland being the case in point, and other smaller economies like Latvia and Estonia. I agree that Italy’s competitiveness problem is not quite as blatant as Spain’s and Portugal’s, from the pure point of view of labor costs—although I think most countries in Europe did suffer to some degree, compared with Germany, over the last several years. But the competitiveness problem can also be couched in terms of the inability of countries like Italy and Portugal to really grow. A little anecdote concerning Italy: Since 1999, when the monetary union started, Italy’s fixed-asset investment grew by half as much again as Germany’s, but it only got about half as much GDP as was recorded in Germany. In other words, Germany’s return on investment is substantially higher, maybe twice as high, than Italy’s. And one of the reasons that people have suggested for this can be found in the World Governance Indicators, which is published annually by the World Bank. Over the last 10, 11 years, Italy has slid down the rankings very rapidly in terms of things like operation of the rule of law, effectiveness of government, and spread of corruption. These kinds of things are not easily fixable. So, the problem is—from the point of view of sovereign solvency, which is the immediate issue, even though we could present all sorts of math that shows that Italy could fund itself reasonably for a little while longer even 52 Morningstar Advisor February/March 2012

Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2012

Morningstar Advisor - February/March 2012
Contents
Contributors
Letter From the Editor
Make a Difference Stories, Not Debates
How Concerned Are You About Europe?
Analytical and Independent
What to Ask When a Fund Manager Leaves
Past, Present, Future
Have Financials Gotten Cheap Enough?
Four Picks for the Present
Investment Briefs
Tactical Funds Miss Their Chance
Specialty Retail: Ad Hoc Opportunity
How Europe Is Making Its Crisis Worse
Impact on U.S. Economy Will Be Minimal
European Banks: Bargains or Value Traps?
Don’t Count the Euro Out Yet
Europe on the Brink
GoodHaven Realizes Its Vision
How Index Trading Increases Market Vulnerability
Nonlisted REITS: Handle With Care
Safety Picks for the Many Moods of Mr. Market
On the Prowl for Large- Blend Index-Beaters
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
The Math That Matters

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