EUROZONE PROBLEMS “BUBBLING” UNDER THE SURFACE

Dirk Steinhoff, Chief Investment Officer of BFI Wealth Management, regularly writes for the World Money Analyst (WMA). He recently shared his views on the latest developments and trends in Europe in an interesting interview with Kevin Brekke of WMA.

World Money Analyst: With me today is Dirk Steinhoff. Dirk is a contributing editor at World Money Analyst and covers the European and Scandinavian markets. Great to have you with us.

Dirk: Thank you very much for having me.

WMA: Seeing that you’re in Zurich and I’m in Fribourg, let’s start with a look at developments in our own backyard. The Swiss are known for their system of direct democracy via use of the referendum. The recent success of a referendum that will restrict immigration into Switzerland made global headlines. What’s your position on the immigration issue and the consequences of this vote?

Dirk: First of all, I should mention that I was born and raised in Berlin and moved with my family to Switzerland in 2007. One of the main reasons why I decided to leave Germany and come to Switzerland, next to the great Swiss landscape, was the strong centralized developments in the European Union, which reminds me painfully of the political system in the former DDR [Communist East Germany].

European politicians live a life that is completely detached from those that don’t belong to this elitist political class. Their decisions are based on distorted experience and lobbyist influence, not on real life experience and independent judgment.

The strong, centralized power of Brussels, in combination with the desire to regulate everything in life, increasingly limits personal freedom, limits the development of entrepreneurship (and therefore the creation of nongovernment related workplaces), and eliminates local, regional, or national characteristics. The state is much less dominant in Switzerland, mainly due to its federalist and decentralized political system, which limits the power of the federal government.

Due to my own background and my own moral conviction, I personally believe that every human being should be able to live and work wherever he or she wants, as long as they are selfreliant, willing to integrate, and intent on not becoming a burden to the community they recently entered.

My interpretation of the referendum is that the Swiss people basically decided that they want to control immigration themselves and do not want to give up this control to the centralized administration in Brussels. I think that this is a clear signal to the Swiss government, that the Swiss people don’t want to give up more sovereignty and that they would like to see more decentralization in the future.

It is also interesting to note, that most of the media in Europe (even Swiss media) were shocked by the outcome. In sharp contrast, different polls across different European countries actually show that most citizens would have voted similarly to the Swiss, and some by an even higher margin than the outcome of the Swiss vote. I think that in the long run more and more of the European people would prefer the Swiss model of democracy.

Although the rhetoric used by politicians in Europe might change to the negative in the shortterm, I do not think that the referendum will have a longterm negative effect on the relations between Switzerland and Brussels. I believe that Brussels has to come to terms with our form of democracy and has to respect our sovereignty, even if they might disagree with some of our decisions.

WMA: The immigration debate is not unique to Switzerland, of course, and is a divisive issue across Europe. This seems to be part of a trend where we’ve seen a rise in popularity of nationalist and anti-euro parties? What’s your view?

Dirk: You are right. The severe criticism of Switzerland because of the outcome of the referendum has eclipsed the fact that there are many European countries that face the same issue. People are not only unhappy with the immigration politics within in the EU, there are becoming more EU skeptical in general.

The political parties critical of the European Union—like the UK independence party in Great Britain, the Finns Party (formerly the True Finns) in Finland, the Lega Nord in Italy, the FPÖ in Austria, the AfD in Germany, the French Front Nationale, the Golden Dawn in Greece, and the Party of Freedom in the Netherlands—are gaining popularity. Of course, the reasons for and the scope of their EU criticism varies a lot.

I think that this trend can be summed up as follows: The people want to have a voice and to be able to decide their own fate! Pretty much everybody in the EU is unhappy about one issue or another. The southern European countries are unable to cope with the austerity measures, and on the other hand you have a large part of the German population who is simply unwilling to continue financing the complete EU.

I believe that this trend will gain momentum, and it will bring some surprises in the elections to the European Parliament in May 2014.

Europe has so many different cultures that centralization just doesn’t work, because there isn’t a onesizefits all answer to most issues. The Euro is a perfect example of this!

WMA: That’s an important point on the Euro. With the continued rise of anti-euro sentiment, what is your outlook for the currency? Will the Euro survive?

Dirk: I don’t know. There are different scenarios for the Euro that I can imagine. Strong countries leaving the Eurozone unwilling to pay for a bottomless pit of EU debt, weak countries leaving the Eurozone in order to be able to devalue their currency and regain competiveness. Or a split in a strong Northern Euro and a weaker southern Euro. Or some combination of these.

As you can see, there are many possibilities, but what we will see depends on the economic and political developments in the European countries over the next years. In my view, something will happen and we won’t have the same Euro in five years time as we have today.

WMA: The adoption of the common currency has limited how individual countries can respond to fiscal stresses. News about the Euro debt crisis has been very quiet lately. What is the situation?

Dirk: Yes, there has hardly been any news regarding the problems in the EU recently, which does not mean that the problems are solved. It is still bubbling under the surface.

With the current papering over and continuation of indebtedness, the need to address the problems with its adherent negative consequences for most people has been postponed. Because of that, right now most of the harsh protest has faded and turned away from the streets and is canalized into the Euroskeptic political parties. And if there have been noteworthy protests, like last November in French Brittany, media coverage was excluded.

What has changed in the last year? Absolutely nothing fundamentally! So the euro crisis will at some point reappear with all its inevitable consequences.

WMA: You mention France, so let’s continue down that path. So far, the small and midsize Eurozone countries as measured by GDP—like Spain, Portugal, Italy, and Greece—are essentially bankrupt and in receivership by Brussels. Today, there is growing speculation that France is headed for trouble soon as well. What do you think?

Dirk: I totally agree! They have too much debt, a radical socialist government, and absurd business unfriendly regulations. I have several friends who are business owners in France and they are all contemplating leaving the country and moving their businesses abroad. The quantity of regulation they have to comply with can simply not be handled by a normal business and the labor laws are so strict that no business owner in their right mind wants to take on the risk of employing someone.

Taking the unhealthy debt levels they have, the unsustainable social programs they offer, and the complete lack of any growth impulses into consideration, leaves me to believe that they are indeed headed for trouble soon. And, as the second largest economy in the EU, France matters. If France stumbles, the EU is at risk.

WMA: Drawing on your comments about strict labor laws, the unemployment numbers in many EU countries are mindboggling. You discussed this situation in your recent article for World Money Analyst. Can you talk about this for a minute?

Dirk: As we have seen since 2008, the trillions of newly created fiatmoney have been fuelling asset bubbles. However, the real economy has not profited because this money has not been lent to private industry. We are still facing 30% lower money velocity than before 2008 and means that more than 30% of credit in circulation has disappeared. This is also why the real economy is still going down the drain.

Most jobs have been created within the government or governmentrelated entities, and as we all know, these jobs are paid by the taxpayers and are not a source of production. Therefore, I personally believe the situation in the labor market will further deteriorate, especially the young generation below 25; they are going to suffer the most. The current youth unemployment rates in Spain and Italy are just shocking: 57.7% and 41.6%, respectively. We are losing a whole generation and we cannot predict how strong the damage we are causing to them will play out in the future.

WMA: High and sustained rates of joblessness can lead to frustration and anger by the unemployed that turns to civil unrest and protests. We’ve seen riots in several EU countries like France, Greece, and Bosnia. Is that also a real danger for the strong European countries?

Dirk: Yes, this is a real danger. As soon as the deterioration of people’s personal economic situation reaches a certain level they will be on the streets, and that includes the streets of the stronger countries. At the moment, most people still believe that all the debt and all the rescue programs come for free.

WMA: What does this all mean for the outlook for European stocks and bonds?

Dirk: That you have to watch closely what the ECB and governments do. It’s a tricky situation; you don’t want to miss any upside rallies in equities and bonds induced by loose monetary policies. Yet, on the other side, you know the party could end at any time. Risk management is essential. The day of reckoning can be postponed by governments and central banks much further, as we know from the US and Japan, than common sense would allow for.

WMA: In your opinion, what European countries have the best economic outlook?

Dirk: The countries that has been strong in the past, with competitive industries, with sound current account and budget balances. Countries like Germany, Austria, Denmark, Sweden, and Norway. And Switzerland.

WMA: As you mentioned above, in May 2014 there will be the election for EU parliament? Will that change anything?

Dirk: The potential increase of parliamentarians that are critical of Europe in the EU parliament (maybe later seen as an irony of history) I mentioned before could intensify the tensions within the EU and complicate the functioning of the EU system. But I don’t expect a quick change.

WMA: We must talk about the unloved Swiss franc. Since Switzerland began intervention in the currency markets to halt the rise of the franc against the euro, the mainstream consensus has it that the franc is doomed. But the performance of the franc against other currencies, in particular the US dollar, has been very strong.

What’s your take on the Swiss franc going forward?

Dirk: It’s hard to say. In a Euro crisis I would expect the Swiss National Bank [the central bank] to remove the floor to the Euro. In such a situation the power of the SNB should be simply too small to be able to keep the floor. There are also attempts in Switzerland to again back the Swiss franc constitutionally by gold. We have to see.

The Swiss Franc for me still belongs to the upper class of paper currencies.

WMA: Do you have any last thoughts for our readers?

Dirk: We have globally entered a time where substantial corrections of past misadventures are likely to occur. It’s not the end of the world, but it’s worth being prepared.

WMA: I really appreciate your insights on the European markets. Thank you for taking the time to speak with us today.

Dirk: The pleasure was on my side.

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