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July 29, 2013

(Updated August 8, 2013)

“Europe is getting better.” 

I keep hearing this on TV and just shake my head. I often wonder whether or not the person speaking those words has

actually traveled there to see what’s really going on. I believe it’s quite safe to say that many of them have not. 

The photo below is a prime example. On July 25th, CNBC was discussing this very subject and used the graphic below as

evidence that Europe is “bottoming”. 

Just a few days ago we did see better than expected PMI data for the Eurozone, but let’s take a look at each point

quickly:

“UK GDP is up 0.6%” – Excuse my cynicism, but since when has 0.6% been considered a good number? Everything is

relative I suppose, and this is their best number since early 2011. However, as this chart from the London Telegraph 

shows, GDP has been in gradual decline for nearly a decade.

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“German and Dutch Confidence is higher” – Again, this may be cynical, but this data is dependent on the “emotions” of 

people and not necessarily based on any hard data. Maybe the weather was nice that day and everyone was happy?

One can see from the chart below that confidence is, in fact, quite high in Germany, but it’s been there all year so why is

now any different? It seems to me that CNBC is cherry picking what little “positive” data there is. 

But wait. Perhaps you noticed what just happened there. Consumer confidence was not the data point that was released

today. It was German Ifo Business confidence.

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As you can see from Ifo’s own data, this data has been trending down for the last few years as well.

CNBC actually proves my point because their final two data points aren’t “green shoots” at all. Yes Spanish jobless claims

fell, but it fell to 26.20% from 27.16% in the previous quarter. Any improvement is good, but let’s cobble together morethan one month before we start calling for a change in trend. Anyone that pays attention to employment data points

knows that there is a myriad of ways to manipulate the data. The media is so desperate to put a good face on what’s

happening that they often intentionally misrepresent data to make it sound better than it is.

France is not only a problem, but it very well may be the “pale horse” of the continent. I’ve stated for months now that

people are wildly underestimating the problems that will come from France. Now we see that French jobless claims are

hitting record levels. Almost 3.3 million French are out of work and this is indicative of the vast majority of Europe. I’ll

circle back around to France in a bit.

To be sure, there are some pockets in and around Europe that aren’t doing poorly, but like any puzzle, we must step

back to see the full picture. What strikes me as interesting is how any piece of data that is “less bad” is immediatelyheralded as the sign of a bottom or nascent recovery. Just because something is declining at a slower rate doesn’t mean

there is improvement. It likely means that it’s difficult for things to get much worse without some exogenous event.

Based on the data I’m about to present, I believe that things in Europe are actually worse than they’ve ever be en.

Beginning with the PIIGS, Greek GDP is expected to contract by 7% by year’s end. Industrial output is down 4.6% year-

over-year and the little manufacturing they have was also down 1.8%. Lending to business continues to fall, deposits are

still leaving banks, and unemployment is a stifling 27.6% up almost 1% from last month (under 25, it’s over 55%). Almost

1.4 million Greeks are out of work.

The IMF has handed down a -1.8% forecast for Italian GDP, which is now down ~10% since 2007. PMI’s are still in

contraction - Manufacturing in June ticked higher, but services fell and both are below 50, unemployment is over 12%

(great compared to the rest of the periphery), Its debt has ballooned to 130% of GDP in the last year (up 650bps from

2012), the YTD deficit is now 7.3% from just 2.9% in 2012, and S&P downgraded their sovereigns to one notch above

 junk saying that Italy needs to run a surplus equal to 5% of GDP just to stabilize the debt ratio.

Are you seeing a recovery yet? I’m not either, even though consumer confidence for Jul came in at 97.3 better than the

expected 95.5 and 95.8 from June and their July manufacturing PMI came in at 50.4 from 49.1 in June. Q2 GDP just came

in at -0.2% QoQ and -2.2% YoY.

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Let’s keep going.

Portugal’s GDP forecast is -3%, their deficits continue to widen and total debt to GDP sits at a staggering 370%. Public

debt is nearing 130%, up 1500bps year over year. There is no coming back from numbers like that. This makes no

mention of the fact that Portugal also has to raise 23% of GDP is new funding for this year, and 22% for next year. From

where will that money come?

Spain still faces near record unemployment at 26.2% as of the last report, with youth unemployment double that. Publicdebt is expected to surpass 100% of GDP in 2014. Housing transactions were down 3.7% in May year-over-year and

mortgages were even worse down 29% year-over-year. Perhaps the most frightening is that a massive corruption

scandal has recently exploded in the highest ranks of political office adding unneeded fuel to the social uprising fire.

Even Ireland is now struggling again after showing signs of life. GDP is down in four of the last five quarters, the budget

deficit for 2014 has exploded to exceed 7% of GDP, and unemployment is still in the low teens.

According to EuroStat, Euro area (EA17) sovereign debt as of Q1 2013 is now an astounding 92.2% of GDP. That figure is

up 400bps year-over-year, nearly 5%. There is not once single economy in the continent I can find that is growing at that

rate. The IMF is forecasting a second consecutive annual contraction of 0.6% for the Eurozone in 2013. Is it not obvious

by now that contrary to Keynesian thought debt is a burdensome obstacle preventing these countries from even

attempting a recovery? In their latest quarterly report, Lacy Hunt and Van Hoisington make this very point:

“ Astronomical sums of money have been expended by both monetary and fiscal authorities

since the crisis. With the benefit of hindsight it is clear their efforts have not aided economic growth,

but rather the balance of their actions has been counterproductive. The Fed has maintained the Fed 

Funds rate at near-zero levels, and it has tried to lower longer term rates through a series of 

quantitative easings. The effect of each of the quantitative easings was the opposite of the Fed’s

intentions.”  

That comment was specifically directed toward interest rates, but it all serves the same purpose as the Fed implemented

these policies to stimulate aggregate spending and create a favorable environment for companies to hire new people.

All that has happened with these policies, both in the US and in Europe, is that equity markets have caught fire enriching

a portion of the population but widening the wealth gap more than anything. Hunt and Hoisington say that the

“recovery” has passed most people by: 

Based on the standard of living, as measured by the real median household income, this entire

recovery has bypassed the consumer sector. The standard of living has contracted regularly in

recessions, but this is the first time deep into an expansion that it has continued to erode. The

current standard of living is unchanged from 1995 (Chart 5).

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Granted this is supposed to be about Europe and not the USA, but if this is what is happening here, what in the world do

you think is happening there?

Germany continues to be the glue that holds the continent together, but recently we’ve seen weakness in their data as

well. In early July, German factory orders for June fell 1.3% month-over-month and 2.0% year-over-year versus

expectations of an increase of 1.2% and 0.1% respectively. Data was negative for May as well. A few days later we

learned that experts fell 2.4% when expectations were for an increase of 0.1% and +1.7% in the prior month. Granted,

Manufacturing PMI for July was a bit higher along with Factory Orders, but Services PMI was down again. The good news

is that inflation is almost non-existent. That is good  news isn’t it? Overall, one habit people must break themselves of is

extrapolating German data to the rest of the EuroZone. Clearly, Germany is not indicative of the EuroZone.

Getting back to France, attitudes are at their worst levels in years.

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I do believe that many observers make the mistake of believing that weak banks are the primary cause limiting growth in

Europe. While that makes sense from an economic textbook point of view, it is putting the cart before the horse.

Excessive government regulation and rampant corruption continent wide are the real culprits and only with a sea

change of ideology will Europe have a chance at survival. This is the core problem that most financial observers simply

cannot grasp. 

I understand that may be a tough comment to accept, but having recently spent a few weeks in Europe (my family is

there so I go almost every year and have been going since a young child) I’d like to share my personal point of view. I

spent a week in Rome and saw nearly the entire city while I was there. I thought it to be in rather poor condition, with

many parts of the city looking run down (as opposed to just old, which of course, Rome is). Apartments looked like

ghettos, replete with graffiti and trash. Cafés were empty, as were tour buses, which was odd because the Vatican and

Coliseum were both packed with people. It’s as if many there had specific reasons to be there and sight-seeing was more

a function of free time than the primary objective. Prices for everything were outrageous as many items were easily

double what we would find here in America (except their amazing gelato).

People have been theorizing on the root of Greece’s problems for years now, yet in my opinion, not one single

prognosticator has correctly identified the cause. So far, the blame has been thrown at poor education, overly simplistic

economic theory, or Germany (or the EU in general), among other excuses. Take this quote as a great example:

“I admit there are structural problems in Greece,” says Theodoros Ampatzoglou, governor of the Greek 

Manpower Employment Organization, the government agency in charge of tackling unemployment. “But 

the basic problem isn’t matching labor supply and labor demand. The problem is that there’s very little

d emand.”  

This is so misguided I would laugh if I weren’t crying for the impoverished generations of this country and theother peripheral nations.

The real problem in Greece (and likely Portugal, Spain, Italy) is twofold: 1) Government so corrupt you’d think it

was a 3rd world country ravaged by war and fought over by various tribes/war lords like Afghanistan or some

embattled African nation. 2) The people themselves. The second reason is likely to ruffle some feathers.

Government is easy to tackle, especially coming from someone with libertarian leanings. But, what occurs in

Greece goes beyond a simple Laissez Faire argument. Most people may not realize, but Greece has been left (I

would say radically left) and dominated by socialist and communist ideology for at least the last 70 years. (To

give readers some perspective, the New Democracy party in Greece is often called the “conservative” party. I

would compare it to our Democrat party here in the US. Excluding the fanatical Golden, every other party is

meaningfully to the left of New Democracy. There is no true voice for conservative or libertarian principles as

we know them.) Because of this focus of ideology, government has long been a central factor in people’s lives

from socialized medicine to employing 1/3 of the adult workforce. The corruption has been epic and due to the

power wielded by government officials, law enforcement has effectively been neutered and thrown Greece into

a semi-anarchistic state.

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Traffic and parking is the easiest example to offer proof. The simplest explanation I can offer is “anything goes”.

If you can fit your car there, you can park there. Take a look at the photo below and see where that truck

parked. That’s the bus lane, by the way.

Double parking is as common there as seeing someone walking outside, as is parking in the curvature of a turn.

These things have come to just be “accepted practice”. Above this, criminals are treated as victims and victims

as criminals. Last year in a neighborhood near my parents, a small group of armed burglars (firearms are

generally prohibited in Greece – especially handguns) had been terrorizing residents. One particular house was

getting robbed for a second time. This time, however, the homeowner shot and killed one of the criminals with a

legal shotgun (remember, this criminal was also armed). The homeowner was arrested and imprisoned for

defending his family and his home. The same ideology applies to anything there, especially business. The state is

flat out hostile to private businesses be they corporations or individual small businesses. In the last year or two,

both Hellenic Bottling (the Greek base for Coca-Cola) and Fage, the country’s premier dairy/yogurt producer, left

the country due to the punitive tax structure levied by the then-in-charge socialist Pasok party. To this day, the

leadership in Greece cannot grasp economic theory that has worked in many other nations. Their “go to” idea

for raising money is new taxes. The Value Added Tax (VAT) was raised twice within a three month span in 2010

to 23% from 19%. Who can afford that on top of every other tax they have to pay? It’s stifling. Did I mention that

Greeks pay the most for gasoline in all of Europe? On average, gas is ~€1.75 per LITRE which at the current

$1.32 exchange rate is $8.74 per gallon. It’s amazing that Greece has any economy to speak of with taxes and

gasoline at these levels. I haven’t even touched on the massive corruption within the government where officials

have literally stolen billions of Euros for themselves at the expense of the people of Greece and those of 

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Germany and other creditor nations. The defense minister was caught red-handed stealing. Recently, a

pharmacist was caught illegally selling prescription medication. He had a powerful government friend intervene

on his behalf and stopped the investigation cold. (I will say this particular story has a good ending as the brand

new health minister fired the pharmacist anyway.) Another pharmacist was caught telling elderly patients their

medication wasn’t covered by their insurance and forcing them to pay cash so she could reap payment twice.

Employees basically cannot be fired and those that do are given six months of employer paid benefits. How

many employers can afford this?

I could tell these stories all day long…and they wonder why things aren’t getting better?

Being confronted with common sense has done little to change how the people think. Strikes are common place.

One never knows when busses or trains will stop running, whether or not the trash will be picked up (trash was

8ft high in many places right before I left Athens), one year strikers managed to close the airport. In an economy

largely dependent on tourism, the Greek people are slitting their own throats with this behavior. It’s no wonder

that tourism this year may likely be the worst they’ve have in the last decade or longer. 

This allows me to segue into reason number two, the people. In my opinion, the people of Greece are as much

to blame for their situation as anyone. Forget the easy argument like continuing to vote for the same corruptpoliticians over and over again. Forget that the media is totally in the pocket of the far left and almost no

dissenting opinion is allowed (and if it is, those people are excoriated live on the air, while the other side gets a

pass). Wait…that’s starting to sound familiar, but I digress. The Greek people for too long have depended on

government for everything. No one has any retirement savings because they had a government pension. Now

those pensions have been slashed because there is no money. They want their healthcare for free even though

someone is working to provide that care, they want medicine for free even though someone has to research,

study, and develop those products at great expense, for many years the people received “bonus checks” around

the holidays (!!), they want a month off for vacation (ok, who doesn’t want that?) and on top of it all, they don’t

want to pay their taxes. How convenient for them.

Greece is the living embodiment of the late Lady Thatcher’s well known quote: “The problem with socialism is

that eventually you run out of other people’s money.” I would also quote Winston Churchill here as saying, “We

contend that a country trying to tax itself into prosperity is like a man standing in a bucket and trying to lift

himself up by the handle.” 

For many years now I have stated simply, “There is no out for Greece.” They have no recourse, there is no

solution, and there is nothing for Greece until the people change how they think about life and government’s

role in their lives. Excessive government has destroyed the country, but the people wanted it and now they have

to deal with it. Without a sea change in ideology to one of self-reliance, the rule of law, and limited government,the depression in place now will continue on for a very long time. One can’t get out of debt by adding more debt

all the while running a negative balance of payments. This is something every American should pay close and

careful attention to because we are following their insidious example to the letter.

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My advice to Greece begins here:

1)  Leave the Euro and return to the Drachma. This is will painful as there will be a meaningful devaluation

in the country, but you are not competitive with the Euro at 1.32. You need to be cheap to encourage

tourism and exporting of food goods like honey and olives.

2)  Strongly consider defaulting on your debt and start over. People do this all of the time and come back to

be successful. No one said this was going to be easy. At this stage of the game, there are only “difficult”

and “more difficult” decisions. 

3)  Overhaul your tax system. This, too, will not be easy since most people are self-employed and there is

almost always a cash price and a “receipt” price for services. Figuring a way to accurately measure gross

proceeds is a problem to which I do not have a solution. That said, a flat tax could help compress

“pricing” spread and begin to normalize things, remove the VAT tax, and lower gas taxes. Stop taxing

people based on the size of the engine in their car or if they have a swimming pool or not. How

ridiculous.

4)  Continue to reduce the size of government. In a country with ~12 million people, 4 million of them

cannot work for the government. The math just doesn’t work.  

5)  Encourage business in the country. Profit is not a bad thing. Without profit how do people develop

discretionary income to spend in shops, cafés, and car dealerships? Business, profit, and spending are

what create demand which in turn creates jobs.

6)  The people must begin to take responsibility for their own country, for their political leaders, for their

legal system, for everything. For years now, they have let problems festers while their kept their heads

down and kept moving. It’s time to take your country back. 

Leo Isaak

Axios Capital Advisors, LLC

@axiosadvisors