Speaker #0Hello everyone and welcome back to Think Macro. It's just me for this episode but it's summer and in these fairly quiet markets is the perfect opportunity to take a step back and look at the major economic balances from a broader perspective. In this episode we will reflect on Europe. its apparent stability, its underlying vulnerabilities, and above all how it can mobilize its capital to return to innovation and growth. So let's get started with a bit of history. 15 years ago Europe was on the brink of collapse. Today the region is economically sound, exports are strong, inflation is under control, and unemployment is relatively low. The euro offers stability to southern countries and through its relative discount competitiveness to northern countries. Debt that was a serious issue back then is now firmly held by local institutions and its mutualization has begun. So it's fair to say that it can no longer really be attacked. How can this rapid transformation be explained? This desire for stability and security is not just the result of the crisis. It also reflects European culture and the wishes of its voters. However, it's not a stable state of affairs. Why? Well, because the economy is growing less than elsewhere at just 1%. over the past 15 years and even less in the last five. Competitiveness is declining leading to dependence and ultimately insecurity. The Covid crisis has revealed Europe's dependence on health care with masks and gels coming from China and a vaccine that was discovered in the US. The war in Ukraine has revealed its military dependence on the United States and its energy dependence on Russia. with gas prices that were multiplied by 10. The recent change in US policy and its subsequent imbalanced trade agreement is now revealing the continent's commercial dependence. Without growth, it's just not possible to finance independence in healthcare, defence or trade. Without growth, the continent is at the mercy of its partners and their strategic choices. Without growth, It's the security of the region that is, at some point, at risk. So what is hindering this growth? Well, stagnating productivity. And behind, a real lack of innovation. Since the creation of the euro in 1999, productivity has grown at half the rate it did before the single currency and three times slower. than in the United States where it has actually accelerated and without productivity there can be no growth. At the time Europe accounted for more than a third of global patents. Today its share has halved. It has been overtaken by China, the United States and even Japan. Mario Draghi's plan for Europe released last year makes this clear. It is essential to boost productivity to avoid, I quote, a slow economic and political decline. And to do this, investment must be revived on a massive scale. So, invest okay, but with what money? What capital? The good news is that Europe has no shortage of capital. Under pressure from the debt crisis and, to be fair, the frugality of northern countries, the EU is, on average, less indebted than elsewhere. The monetary stability achieved over the last 15 years would allow for more borrowing at low interest rates, which is becoming increasingly difficult in the United States, for example. Savings, also, are high, twice those of the United States for decades. The problem is that this considerable reserve of private capital remains frozen in risk-free investments or goes abroad. In 10 years, nearly $3 trillion will be lost. euros has flowed out of Europe to the United States. This is the equivalent of 15 years of growth gone to finance the competition. So why this reluctance to invest in Europe? First there's a cultural reason. Europeans are cautious. They prefer to invest in cash or bonds rather than equities. They fear. in general, capitalism, and prefer the security of a steady return to the prospect of a higher, but more speculative gains of equities. The dot-com bubble certainly didn't help, causing savers caught up in the euphoria of the late 90s to lose significant sums of money. A weak economic culture also plays an important role, because it gives rise to investment reflexes that are often inappropriate. and lead to losses and frustration. A culture conducive to investment must be created. Then there's a financial reason. To be sure, investing in Europe yields lower returns and is often riskier and more volatile. It is difficult not to prefer the American or Chinese alternative. And finally there's a regulatory reason. In seeking to protect itself, Europe has slowed down productive investment by heavily restricting long-term risk-taking. This was for a good cause, and the system is now solid, but it is rigid and does not help the economy to progress. In short, European companies are starved of capital for investment and innovation. They are condemned to pay more for capital. through higher dividends or self-finance which is much slower and a lot less efficient than the leverage offered by the capital markets. The automotive sector perfectly illustrates this dynamic. 25 years ago, European manufacturers dominated the global market. When it came time to invest in the transition to electric vehicles, they were unable to keep pace. Why? Well... While investors demanded dividends of 7-8% from Renault or Volkswagen, Tesla never paid a penny. While European manufacturers had to finance their research from their reserves and profits, Tesla's market capitalization reached $1 trillion, five times that of its European competitors combined, despite sales that are 10 times lower. The leverage effect is considerable. It allows it to invest and innovate much faster than its competitors. It took Tesla 10 years to make its first profits, but it did not have to wait that long to invest much more than its European competitors, thanks to the capital markets. Last, where Europe is imposing the transition through regulation and constraints, in China and in the United States, subsidies and incentives encourage investment by savers. Regulation even reaches the point of absurdity when European manufacturers are fined billions for failing to meet the carbon quotas imposed by the EU. Fines that are then paid to their American and Chinese competitors. Self-financing, even on a large scale, is powerless against the market multiplier when it comes to technological disruption. It's too weak, too slow. The media, the telecoms revolution and more recently the Covid vaccine are further proofs of this. We must assume that it will also be the case for AI if Europe continues to regulate before innovating. It is therefore essential to mobilize capital in order to participate in the race for innovation and make up for lost productivity. That is already the case at the state level. It seems that recent crises have raised awareness of the issues at stake. Europe is taking action, and faster than usual. In the wake of the Covid crisis, the next generation EU plan, worth 1.5 trillion euros, is financing infrastructure, energy independence, education in southern and eastern countries, in exchange for structural reforms, and rigorous management of public accounts. This is the first truly European investment plan. It is jointly financed by the entire Union on a given time. take basis which encourages the countries concerned to invest in the interests of the Union. Through its structural reforms and alignment of interests, it is very positive for growth in the region. This year, Germany amended its constitution to invest in infrastructure and double its defense budget. Europe is following suit with the Re-arm Europe plan that gives budget flexibility and incentives for cooperation. on military projects. More than 1% of GDP in investment per year in Europe. 2 to 3% for Germany. This is significant and while the effects may be limited in the short run, these investments will, like the next generation plan, have a major impact on long-term growth both because of their volume and because they respond to real needs. The impact of all these plans is estimated at half a percentage point of additional growth over the next 10 years. But the state cannot do everything. It is effective when it comes to strategic investments and public services like healthcare, education, defense, energy, but much less so when it comes to innovation and boosting productivity. To achieve this, savings must be mobilized. How? Well... It cannot be forced. It must be encouraged and convinced. With no prospects for return in Europe, private savings will always favour the security of bonds or the performance of US equities. For 30 years, European private capital has earned 2-3% less per year than in the United States. This may not seem like much, but over the course of a career, it means 3 times less savings. Improving the return on European savings by just 1.5% would double the accumulated pension. So the stakes are therefore high for the economy, which is stagnating without active capital, but also for savers who need to earn more on their savings to finance their retirement. It is this virtuous circle of savings and investment that enables the United States to finance business creation and innovation. while providing solid returns on pensions. It is this form of capitalism that has enabled the United States to create the champions that dominate the technological sphere and impose a competitor in the electric vehicle market from scratch. Savings must provide more funding for businesses, which, being more productive, will in turn be able to offer better returns. Here, too, things are changing. Europe is now giving itself the means to have its own form of capitalism with the necessary framework. As with state financing, progress is recent but real. There have been an acceleration this year under pressure from the change in US policy. But first we need a solid foundation, robust and harmonized capital markets. After 15 years of banking consolidation we're almost there. the sector. is well capitalized, twice as much as 15 years ago. Harmonization is beginning with the first major cross-border between Italy's Unicredit and Germany's Commerzbank. Regulation is being relaxed this year to encourage the financing of projects on a European scale. Unified supervision, simplified control procedures, incentives for securitization. There's still work to be done. but the European financing toolbox is starting to look well equipped and can now provide effective support for continental projects. Savers must be encouraged to shift their capital to the productive part of the economy. The opportunity must be real, incentives must be provided and explanations must be given. And this is precisely what the new German plan proposes. Fewer barriers to investing in risky assets, tax incentives and the development of pension funds. Businesses also are participating through the WIN plan. The goal is to restore confidence and inspire others to follow suit. The cultural aspect also is being taken seriously. See, the government will set up an investment account for every young citizen from the age of 8. which they will have to put to work in equity markets, and monitor and comment on. This is not anecdotal. The assets without understanding them can be disastrous, as the internet bubble showed. This financial education, started early, must bring about profound changes in behaviour and in. The plan is ambitious and comprehensive. We know Germany's driving force, so we must bet that other countries will follow suit. And there's one last potential source of capital, the 3 trillion euros that Europeans have sent. to the united states over the past 10 years it's difficult to blame them for a long time this allocation was justified u.s equities have significantly outperformed and the dollar has reinforced this trend not only did it appreciate but it did so every time equities corrected cushioning the shocks more performance for less risk the perfect investment but things are changing US policy is becoming more uncertain, the political climate is unstable and the dollar is weakening. Worse still, the dollar is now moving in the same direction as the equity markets, which increases risk rather than offsetting it. In April, for example, this new correlation exacerbated losses. As a result, investors are starting to repatriate some of their capital. Investing in the United States is becoming riskier and therefore less attractive for Europeans. European authorities are not mistaken. In its May report, the ECB highlighted the growing risks of investing in the United States. High valuations. high concentration and lack of diversification. Mrs Lagarde and von der Leyen have both called for rebalancing of portfolios and a move away from all-dollar investment. This is a new and very clear message aimed as much as warning of the new US risk as at attracting capital back to Europe. All these measures are just the beginning. Much remains to be done and their effects will not necessarily be immediate but because they cover all the dimensions necessary for private investment whether financial tools, simplification, incentives, remuneration or education they will encourage savers to redirect their capital towards the productive part of the economy, reduce its costs and facilitate access for businesses enabling them to rejoin the race for innovation. This is good for returns and good for innovation. Combined with government investment, the mobilization of savings should make it possible to make up for a quarter of a century of lost productivity and sustainably improve growth in the eurozone. The German initiative and the acceleration observed this year give cause for optimism that results will start to be seen this year with the zone showing good resilience to the inevitable US slowdown before Perhaps picking up speed next year, given the significant discount of European assets, investors looking for alternatives to the dollar should find something to soothe them. Thank you all for listening to Think Macro. We will see you very soon for the next episode.
