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Europe's Economic Woes

Is This the Fate of the U.S.?

Written by Geoffrey Pike
Posted August 29, 2014

The European economy continues to struggle, making the U.S. economy look strong by comparison.

Investors are now guessing whether the European Central Bank (ECB) is going to take further action to supposedly stimulate the economy. Many investors hope for a U.S.-style quantitative easing program.

In simpler terms, they hope for more monetary inflation.

With speculation on what the ECB will do, the euro recently hit a 13-month low. Meanwhile, the yield on the German 10-year bond is setting record lows. It recently went below 1% for the first time before falling further to below 0.9%.

This means someone lending money to the German government for 10 years will earn interest of less than 1% per year over the next 10 years. This is almost nothing.

The 10-year yield in the U.S. is just under 2.5%. While this is higher than Germany's yield, it is still extremely low. If you account for inflation, even using the government’s numbers, you are coming out about even. Inflation is cancelling out your return.

Meanwhile, you have to pay taxes on the interest you earn, unless it is being deferred in a retirement account.

Incredibly, Germany does not have the lowest yield amongst major countries of the world. The 10-year yield on Japanese government debt is just 0.5%. The country's debt-to-GDP ratio is well over 200%, yet bonds are only paying a half of a percent.

The German Economy

The European countries have basically been in one big recession for many years now. Of course, each country is different, but there are a lot of similarities between most of them.

Switzerland and a few of the really tiny countries are usually better off than the rest, but they are the exceptions.

Aside from Russia, Germany is the largest country in Europe, and it is supposed to be the economic powerhouse of the European Union. We know Greece is a disaster, and we know some other major countries such as Italy and Spain have had major problems. But Germany was supposed to be strong.

Now, its economic growth is stagnating.

Everything is relative. Germany is a paradise compared to Greece these days. But that doesn’t mean its economy is sound. What will the European Union and the European Central Bank do if Germany gets further into trouble? Who will bail out Germany?

With the 10-year yield below 1%, all signs are pointing to a recession in Germany, which means the rest of Europe is really in trouble. Will the ECB fire up the monetary printing presses to combat this?

A Welfare State

I consider Europe to be one giant welfare state. Greece is a far bigger welfare state than Germany, but Germany is a far bigger welfare state than the United States. Even the United States today is a far bigger welfare state than it was in the year 1900.

These policies catch up with society. They sometimes appear to work at first, depending on productivity and prior savings. Capital and savings are built up over long periods of time. Growth can still outpace the welfare state up to a certain point.

But there is a tipping point when the welfare state consumes more than the country creates.

This has already happened in Greece. The results are real. If you go outside of a tourist area in Greece, the situation is really bad. There is extreme poverty reminiscent of a third-world country.

People there demand that the government help them, but there is almost nothing left for the government to help them with. And the true entrepreneurs and producers have mostly left or gone into hiding.

In Greece, you could say Atlas has shrugged.

I don’t expect Germany to end up like Greece, but that doesn’t mean the German people won't experience some really hard times. The nation has not only had to support its own welfare state, but it has also helped prop up other European countries.


The ECB Will Step In

I fully expect that the ECB will eventually start inflating the euro at a great pace.

It already took the unprecedented step of imposing a negative interest rate on bank reserves. There will be too much screaming and wailing for Mario Draghi and the ECB to sit on their hands and do nothing.

In our Keynesian economic world of today, the answer almost always ends up being that we need to print more money. Of course, central banks don’t actually print the money — but they do the equivalent in creating digital money out of thin air with a computer.

This will not be done without consequences. Monetary inflation doesn’t just cause prices to increase; it also redistributes wealth. It also misallocates resources. Wealth is diverted from producing things that consumers want into producing things that are politically favorable.

So whether it is the ECB, the Fed, or any other central bank, creating new money out of thin air will cause distortions in the economy. If it is bad enough, it can eventually lead to negative growth.

Monetary inflation will sometimes appear to be working at first as certain sectors are propped up. But these are artificial bubbles that eventually get exposed as bad investments. We eventually get a bust.

Real growth happens through production, which is a result of capital investment and savings. Real growth means resources are being allocated to goods and services that consumers desire.

In a free economy, if entrepreneurs divert resources to goods and services that aren’t in high demand, they will soon be forced to change tactics as a result of their lack of profits or even outright losses.

Watching Europe as a Sign

Europe is different than the U.S., although the differences are fewer now with the presence of the European Union.

However, I do expect the EU to break up one day, especially as people continue to struggle. There are greater cultural and language differences between countries compared to what you would see from state to state in the U.S.

But despite the differences, I still like to watch other places — Europe and Japan in particular — for indications of what may be coming our way. While China is interesting to watch, the economic system there is still young and a great deal different.

Germany has over 80 million people. If a major recession hits, it is going to affect everyone. Will the productive class in Germany be able to overcome the welfare class? If things get really bad, will they turn to some form of socialism or fascism, or will they turn to the free market?

Either way, Americans don’t have to follow the same fate. But there is likely some major economic trouble ahead in the U.S., and we don’t know how people will react.

The Fed has created huge amounts of money out of thin air over the last six years, while interest rates have remained extremely low. The national debt continues to rise at an astounding rate, and the major entitlement programs of Social Security and Medicare have massive unfunded liabilities. Promises will be broken, and many people will see their dream of a nice retirement shattered.

People will look for answers — let’s hope they don’t look to the government.

Let’s hope they realize it was dependence on government that caused the problems in the first place.

Until next time,

Geoffrey Pike for Wealth Daily

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