EMU PMIs Continue to Unwind and the EU Unravels

The EMU region has continued to expand in October, but the composite PMI reading has logged its weakest reading since September 2016 with both manufacturing and services on lows that are their worst on about that same timeline. However, those comparisons pit the current flash reading against historic flash readings. When compared against actual (since revised) readings, this is the weakest composite since January 2015. Whichever comparison you prefer, this is the weakest PMI value in some time and it continues a streak of weakness that is not abating.

The EMU composite PMI peaked in January 2018; the manufacturing sector peaked in December 2017; services peaked in January 2018. In the last seven months, the composite PMI has fallen by 4.7 points. In the previous seven months, it had risen by 2.5 points. The PMI is falling at nearly twice the pace of its previous advance. Over the last eight months, counting from its peak, the manufacturing PMI has fallen by 7.4 points, nearly twice the pace of its previous eight-month climb. The service sector rise and fall has been relatively rapid by its own standards, but it is falling at a relatively more measured pace than is manufacturing (by 3.3 points over seven months compared to having risen by 2.5 points over the previous seven months). Despite the measured pace, the services sector is eroding faster than it had made gains over the past seven months as it ran up to its peak.

It's all about...timing?
The European Central Bank is planning to unwind its stimulus program. In the U.S., the Federal Reserve is well into unwinding; it is shrinking its balance sheet and hiking rates. The IMF, the German Chamber of Commerce, and a pool of economists surveyed by Reuters all have cut various outlooks for growth for the coming year or so. Is this a good time to tighten policy?

The world is awash in geopolitical conflicts without much of a consensus on how to deal with them and in fact with Post War alliances now strained in a way we have never before seen. In addition, the European 'experiment' is straining its Petri dish as the U.K. has finally opted out of the EU and the EU is having hard time deciding how to deal with the rejection. In truth, that has a lot to do with the dissent that the EU itself knows is only partly masked by the suppression of discord within the EU itself by employing hard-nosed policies meant to keep all the animals in their cages. The bureaucrats (unelected bureaucrats) are in charge of the asylum. Italy is now a rogue state having affirmed that it will not modify its budget and having had its budget rejected by the EU Commission. Do rules really trump results?

Rules, the Golden Calf of the European Union
Italy has 'played nice' with the EU Commission over the last decade in the wake of financial crisis. In return, it has a level of GDP that is smaller than it was nearly ten years ago. Why would Italy want to continue to play this game? When does the EU say 'enough,' time for “Plan B?” Never? The hard money Northern and Western European portion of the euro area have a way of operating that works for them. It has never occurred to them that the economics in South might work differently or that methods that are successful in traditional hard currency areas don't work as well in traditional 'soft currency' areas. Modern economics has suppressed the role of sociology in economics and is consumed by math and statistical models (genuflect here). It is easy to pool Italian with Finnish or German data if you only put them in the same currency units, something that the formation of the EMU did.

The fallacy of 'one'
But there is no such thing as a single Europe. You can add up GDP or pool IP or consolidate employment or unemployment numbers. It's still oil and water. Tight labor markets in Germany will not dive up wages in Spain.

Countries maintain their languages. Indeed, with the U.K. leaving the EU, one of the first proposals mooted was to remove English as the first use language in the EU! Countries guard and maintain cultural differences and they jealously guard their precious fiscal resources. The Finns (seemingly) eagerly tax one another in pursuit of their societal objectives, but they have no interest whatsoever in a joint European fiscal operation. None of the hard money countries wants a united Europe badly enough to share wealth (or income) with the South.

All they want to do is to impose the same harsh medicine for noncompliance on them to whip them into shape. After all, Eastern Germans and Italians are not the same and East Germans are not Spanish or Greeks. The clear and never taught lesson of the euro area is that you take care of your own and throw only some crumbs to the needy. West Germans drained resources to unite with eastern Germany. For the rest of the Europe, there is very little support and an extra helping of distain.

Some are more equal than others...
Early in the EMU, France and Germany were the first two countries to violate the Maastricht (Mass-Trick?) criteria and they used their clout to escape any discipline. Greece, Spain, Portugal, and Italy have not been 'so lucky' and certainly not powerful enough to flex their muscle.

Austerity has brought inflation rates more into alignment but not growth. Spain's unemployment rate is still prodigious as is Greece's rate. Italy's GDP is unable to grow. And Italian banks have not been fixed and need an infusion of funds that Italy cannot provide –and one that is probably no longer allowable since France and Germany were allowed to fix their own banking systems, including buying up their Greek assets before the Greek crisis, then they changed the rules governing help for banks for the Cyprus affair to mandate bail-ins.

There is nothing about the EMU that is fair or that really makes full-blown economic sense. Without fiscal union, a good share of Europe is being left behind or left to limp ahead as best it can. Meanwhile, Germany purses fiscal surpluses and runs the highest ratio of current account to GDP in the world and does so with impunity despite it being in violation of EMU principles on running persistent surpluses. You see it's not the rule you break; it's who you are when you break the rule.

Germany's economy is finally suffering. The degradation in its 'neighborhood' is finally taking a toll. Its PMI standings are below their medians over the past four and one half years. The German composite PMI has been weaker on this period only 5% of the time. Even the richest best positioned EMU economies are having a hard time prospering in the Euro-Zone-of Horrors.

Italy wants a chance to regrow its economy. Its debt levels already are high, but even doctors know that putting an obese period on too draconian a diet is not healthy. Northern Europe needs to develop compassion and to cultivate some insight on how the rest of the community works if it wants to stay together. What is being done now is just putting salt in open wounds. The rules over migrants also push most of the migrant problem onto the economies in the South where migrants are camped en mass before being absorbed if at all. And this is a burden that patently not shared equally and is unfair.

Europe's problems run deeper than those on display in Italy. And its solutions clearly have tended to favor the elite and the powerful. Italy may be a rogue state by the rules. But what would YOU have Italy do after a decade of stunted growth? Is there any evidence that anybody in the EU or EMU views the Community's policies as having failed (as they clearly have) or is it their view still that the members are failing? Washing your hands of a problem is no way of solving it.

Bend or break
When the EMU was formed, it was widely recognized that there was no fiscal sharing and that the members did not conform to the parameters of a currency union as laid out by academics. All EMU members are to blame for taking countries with such disparate views and putting them in one region, with one currency without discussion what needed to be changed or enforcement of its basic rules. Enforcing them after the fact is no virtue. They did nothing to harmonize. Each went its separate ways bound by some loose rules until things blew up in their faces. For a while, each type of member got what it wanted. The Germans got a big single currency free trade zone and a united Germany to boot. The Greeks and Italians gained access to cheaper bond yields...at least for a while. But the euro area had not been made stable or sustainable. If it were an Alfred Hitchcock movie, we would have been seeing cut away shots to ticking bomb in the various capitals and at the central bank over this whole period. And today the euro area still isn't stable. Those 'bombs' are still ticking. And pretending or taking a tougher line on existing rules is not what is going to make it last...is it? I believe it has come to the impasse of 'bend or break.' Yelling louder or enforcing rules more stringently will not be the answer.