U.S. Animal Spirits Since ’07 Proves Superior to EU SlumpSimon Kennedy and Rich Miller
America’s aggressive strategy for tackling its financial and economic ills is working better than Europe’s go-slow approach -- and investors are taking notice.
Even amid the weakest recovery in modern history, the U.S. economy is outperforming the euro area and soon may break higher. More than a year after U.S. gross domestic product returned to its pre-crisis level, Europe still has to make up lost ground and is back in recession. While America’s unemployment, at 7.5 percent, is 2.5 percentage points higher than at the start of the recession, it’s below the 12.1 percent rate of the euro zone -- and the gap is the most since 2000. Manufacturing is shrinking in the 17-nation bloc; U.S production is expanding.
“The U.S. is in a transition from the intensive-care unit to out of the hospital,” said Mohamed El-Erian, the chief executive officer at Pacific Investment Management Co. in Newport Beach, California. “Europe is out of the ICU, but in a ward close by.”
The source of America’s relative economic success may lie in the decisions of policy makers. While the U.S. quickly addressed bank solvency, Europe battled over how to deal with its sovereign-debt turmoil and still is struggling to craft a comprehensive banking plan. The Federal Reserve eased monetary policy faster than the European Central Bank, and governments in Europe put their faith in austerity over the U.S. preference for fiscal stimulus.
Investors are beginning to tune in. The 15 percent gain in the Standard & Poor’s 500 Index since the start of the year is more than twice the advance of the Euro Stoxx 50 Index. A Morgan Stanley gauge of 50 companies that generate almost all their sales from within the U.S. is up 18 percent this year, compared with an 12 percent rise in a measure of 49 companies that get 60 percent of their sales from abroad.
The dollar also stands to benefit. Deutsche Bank AG, Citigroup Inc. and Barclays Plc are among banks predicting the currency will gain this year against the euro as U.S. growth accelerates.
Since financial turmoil first began in 2007 and then accelerated with the collapse of Lehman Brothers Holdings Inc. in 2008, the U.S. has set up a $700 billion bank-bailout fund, enacted a fiscal-stimulus program of about $800 billion and embarked on a loosening of monetary policy that has injected more than $2 trillion into the economy so far.
Even though the U.S. was “the source of the crisis, we moved quickly to clean things up,” said David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York. “And we haven’t had the aftershocks that unfolded inside the euro zone as people began to question the very foundations of that structure.”
In the EU, while nations have provided 1.7 trillion euros ($2.2 trillion) of support to their banking systems since October 2008, they put off calls for sweeping recapitalizations, even as the debt crisis festered beyond Greece. The latest bailout of Cyprus even included a tax on uninsured bank deposits as countries again tried to ring-fence turmoil rather than find a continent-wide solution.
Policy makers still are clashing over a banking union aimed at breaking the cycle of contagion between governments and lenders so troubled institutions don’t paralyze economies. Disputes include how far to go in building a central authority to handle failing banks and whether national deposit-guarantee programs should be linked up.
Europe also ran into criticism for failing to replicate the success of U.S. bank stress tests by being too soft and failing to expose weaknesses. In 2010, for example, the now-defunct Committee of European Banking Supervisors said seven EU banks needed only 3.5 billion euros more capital, a 10th of the lowest analyst estimate.
Now the ECB is left propping up the system through unlimited long-term loans to financial institutions, justifying this approach by noting that banks account for 80 percent of European financing compared with 20 percent in the U.S.
“The natural adjustment has been impeded by counter-cyclical policies to prevent deleveraging,” said Stephen Jen, managing partner at hedge fund SLJ Macro Partners LLP in London.
To Mike Howell, founding managing director of London-based CrossBorder Capital Ltd., Europe’s banking system is similar to Japan’s in the 1990s, which plagued the Asian nation’s economy for two decades. As much as 15 percent of European bank loans may be bad, the same share as in Japan, he estimates. Attracting new deposits will be hard, because institutions are paying interest rates below comparable government-debt yields and their credit ratings have fallen, he said.
“Banking is a bad business in Europe,” Howell said. “They have to recapitalize the banks, and then you might get lending. The U.S. outlook looks pretty good because the banking system is coming back to normality.”
The divergence is reflected in how easily nonfinancial companies can tap credit. While U.S. banks eased conditions in every quarter but one since the end of 2009, European lenders have tightened for 23 consecutive quarters since 2007, according to UBS AG. Europe’s small and new businesses particularly have been hit.
The different approaches are influencing economic performance as the U.S. and Europe decouple, breaking what Lucrezia Reichlin of Now-Casting Economics Ltd. in London says is a traditionally high level of synchronization. Kevin Loane, an economist at Fathom Consulting in London, says America’s economic output will be 8 percent above its pre-recession peak by the end of next year, while the euro area will still be 2.4 percent below.
“Policy makers in the U.S. addressed the root causes of the crisis more quickly,” Loane said. “That is why the U.S. is doing better.”
The world’s five biggest businesses are American for the first time in nine years, and automakers General Motors Co., Ford Motor Co. and Chrysler Group LLC all gained U.S. market share in the first quarter for the first time in 20 years.
“We wouldn’t be hiring if we didn’t think it was going to last,” Joe Hinrichs, Ford’s president of the Americas, said in a May 2 telephone interview after the company announced plans to add workers at its F-150 truck plant in Claycomo, Missouri.
Global policy makers have recognized the gap. International Monetary Fund Managing Director Christine Lagarde divides advanced economies between those “on the mend,” like the U.S., and those “that still have some distance to travel, such as the euro area.”
Bank of Canada Governor Mark Carney said April 18 that America “is breaking out” of the pack of crisis economies, and U.S. Treasury Secretary Jacob J. Lew said May 7 that growth may accelerate to a rate of 3-plus percent by early next year.
While the U.S. is repeating a pattern of the past three years in suffering a soft patch now, Aneta Markowska, chief U.S. economist in New York at Societe Generale SA, predicts it soon will start expanding at an average 3.5 percent pace. This will continue during the next five years, eclipsing long-run trend growth of about 2.5 percent, she added.
Consumers, whose spending represents 70 percent of the economy, have come through five years of deleveraging, and the prices of homes will rise 30 percent in the next five years, Markowska said, citing fiscal tightening as the only outstanding drag. Employers took on an additional 165,000 workers in April, more than forecast.
To be sure, the U.S. isn’t firing on all cylinders. GDP grew an annualized 1.6 percent in the second quarter after advancing 2.5 percent in the prior three months, as federal spending cuts and tax increases hit, according to the median estimate of economists surveyed by Bloomberg News. Recent reports showed auto sales and manufacturing cooled in April, while unemployment is still a percentage point above the 6.5 percent rate to which the Fed has tied its stimulus.
“We’re moving through a phase of pretty intense fiscal tightening,” said JPMorgan’s Hensley.
Still, Europe’s woes are greater more than three years after its sovereign-debt crisis began and as Cyprus became the fifth nation to negotiate a rescue. A recession that started in the final quarter of 2011 now will extend through the third quarter of this year, according to a Bloomberg survey of economists.
The jobless rate reached a record 12.1 percent in March, manufacturing and services contracted for a 15th month in April and inflation weakened to the slowest since 2010. The pain has spread from the periphery -- with France struggling to avoid a third recession in four years -- although data have improved recently in Germany.
“The economy is basically not going anywhere at all,” said Marchel Alexandrovich, senior European economist at Jefferies International Ltd. in London.
The divergent performance of the U.S. and euro area also may reflect different monetary strategies. The Fed cut its benchmark rate to a record near-zero low in December 2008 and has held it there ever since. It’s conducted three rounds of quantitative easing, boosting its balance sheet to $3.3 trillion.
The ECB has been more conservative. It often has throttled back its monetary expansion, and its 2.6 trillion-euro balance sheet is 16 percent below the peak of last June. It raised its benchmark in 2008 and 2011, cutting it to a record low of 0.5 percent only this month, more than four years after the Fed’s action. Complicating its task: Strained banks in the periphery have resisted passing on the cheaper borrowing costs.
European governments, under the whip hand of Germany, also embarked on austerity in an effort to regain fiscal control. The euro-area’s average budget deficit will fall to 2.9 percent of GDP this year from 6.4 percent in 2009, according to the European Commission.
In the U.S., President Barack Obama resisted Republican efforts to tighten the budget, arguing the economy wasn’t strong enough to take the hit. The resulting stand-offs, especially over a debt-ceiling increase in 2011, disrupted financial markets while putting off the brunt of the budget squeeze until this year, when the economy is better able to withstand it.
European authorities may be shifting, signaled by the ECB’s rate cut this month and President Mario Draghi saying it’s “ready to act again.” Officials also are studying how to revive credit markets by using collateralized loans.
The ardor for austerity also is fading. Countries are being given more time to satisfy the euro’s budget limits, and voters in nations including Italy are backing parties willing to reconsider cost-cutting.
Even so, Europe will remain the laggard. American growth will accelerate to 2.8 percent in 2014 and 3.2 percent in 2015 from 1.8 percent this year, said Nariman Behravesh, chief economist at IHS Inc. in Lexington, Massachusetts. He projects euro-area GDP will rise 0.4 percent next year and 1.2 percent in 2015, after contracting by 0.7 percent in 2013.
“The U.S. has a lot of things going for it: better policies, quicker adjustment,” Behravesh said. It’s “in much better shape than the European economy.”