Mario Draghi, the President of the European Central Bank (ECB), remarked at his most recent press conference that markets should be careful about discounting a European recovery: “the shoots are still very, very green”. Aside from the fact that the newest of shoots might not be very green at all, his point was well made. Europe’s economic recovery has a very long way to go.
One area where economists have become a little excited has been the recovery in euro-zone PMIs. Recent data from the PMI surveys has shown manufacturing, in many European states, has returned to expansionary territory. But it’s not clear the surveys reflect reality. The following chart shows the PMI survey result and industrial production: that is a measure of what surveyed companies say, and what companies actually produce. The data is stark, while there may be a lag (it’s close to 24 months), companies are expanding but production, in total, is not, it’s still declining. Production remains 12% below its 2007 peak, and 3.5% below its 2011 peak.
So what’s happening?
It’s not that companies aren’t telling the truth. They are. Their production probably is expanding. More likely it’s that so much production has been cut that there’s a survivor bias to the surveys. Indeed, many firms may be doing alright within the euro-zone because so much production capacity has been cut. Capacity utilisation within the European Commission area is starting to rise. For instance, Italy has reported that 9,000 firms in operation for more than 50 years have closed their doors in the last four years.
The true European recovery
The real European recovery is occurring in asset markets. It’s something I’ve missed. Effectively, I believe, the ECB is pursuing a strategy of asset price appreciation. It’s not a particularly novel strategy, nor is it particularly sensible, but nonetheless it’s all the ECB seems to have.
I believe ECB policy is designed to lower interest rates that will feed through to higher asset prices, which in turn will effectively shore up bank balance sheets. Not entirely, but enough to remove some of the obligation of European governments for re-capitalisations. It’s not the stupidest policy in the world, assets in Europe are fundamentally valuable and were under-valued. But it isn’t without risk. With the decline in competition and the inherent value of land in an asset rich and still heavily populated economy, owning capital makes a lot of sense.
The problem for the ECB is transforming rising asset prices into jobs and economic activity. Better capitalised banks would help lending. But the example of the US is salutary. Strong asset price growth has not driven strong employment outcomes and the euro-zone recession has been worse.
I believe the capital growth part of the strategy will work, it’s always worked in the short-term, but in the medium term I still worry about the political consequences of high unemployment.