Investors have been captivated by the European debt crisis. Just as in 2011, first-quarter gains in stock prices have given way to losses fueled by Europe’s springtime uprisings and political acrimony.
In the 1990s, faced with the prospect of economic decline, European leaders were able to prolong their untenable government largesse by linking arms and unifying around a common currency. The euro enabled Germany to price its goods and services by some estimates 30 percent below what they would have been had the deutschmark continued to exist.
Meanwhile, southern European customers, suddenly holding a respected currency, found themselves with purchasing power. This economic symbiosis enabled the region to neglect economic reality.
Now that the countries’ capacity to take on debt has reached its upper limit, Europe is weighed down by the reversal and by a rapidly aging population.
Based on market activity, investors mistakenly think that Europe’s malaise will be contagious. Although there is an eerie parallel between debt burdens, the U.S. is somewhat insulated from Europe’s predicament. In many respects Europe’s loss is America’s gain.
Take manufacturing, for example. The recent surge in U.S. activity is the direct result of several trading advantages. After almost a decade of stagnant blue-collar wages, U.S. unit labor costs have become substantially cheaper than those in other developed markets, thanks in large part to gains in productivity and years of decline in the dollar. The cost of hiring an American manufacturing worker is 5 percent cheaper today than it was in 2000. Average European manufacturing wages rose 13 percent in dollar terms. In Spain and Italy they rose 27 percent and 33 percent, respectively. Now the table is tilted toward the U.S.
Recent news that General Electric Co., the Boeing Co. and Ford Motor Co. will shift manufacturing capacity to the U.S. should come as no surprise. If GE has determined that making appliances is more cost competitive in Kentucky than in China or Mexico, what does that say about the edge the U.S. has over European countries?
Consider, next, the natural gas revolution. In just a few years, the entire energy price structure in the U.S. has been turned on its head. Thanks to hydraulic fracturing technology, North America suddenly has abundant natural gas selling for about $2 per million BTU, while Europe is forced to pay $9. (In Asia, the price is $18 per million BTU.)
The U.S. appears to be turning the corner on housing as well. Confidence among homebuilders spurted more than expected in May, reaching a five-year high. My team at Harris Private Bank estimates that national home prices, gauged against the broad economy, are slightly below fair value. This calculation is based on the observation that, for more than a year, new home construction has been trailing labor force gains, which is a crucial indicator of household formations. By the same measure, U.S. housing was 22 percent overvalued in the third quarter of 2006.
In certain European markets, home prices have similarly adjusted; Ireland’s have been cut in half, and collapses in Spain and the U.K. are well known. Yet several countries haven’t seen a slump. In France, notably, home prices have just kept marching upward as if the global recession never happened. The typical French home is, amazingly, 10 percent more expensive now than six years ago. At the margin, international cities like Miami should benefit from a surge of foreign real estate buyers using cheap dollars to buy discounted homes.
France appears to have bubbly prices for most things. A few weeks back, my colleagues and I conducted an unscientific study of worldwide elite hotel rates by logging onto the Four Seasons’ web site for quotes on a four-night stay this coming New Year’s Eve. Not surprisingly, the cheapest rooms were in Bangkok and Shanghai, where thanks to relatively undervalued currencies the nightly rate was $285. In Las Vegas it was $374, in Beverly Hills $425 and in New York $855 (that price is tied to Times Square’s special status on the big night). What really jumped out was that the room in Paris, despite all of Europe’s economic woes, came to a whopping $1,210, hinting at excesses in Parisian real estate prices and in the euro.
The European experience looks a lot like what happened in Japan, as the world’s manufacturing powerhouse and second-largest economy became the aged third-largest economy. The difference in Japan is its enormous debt load has been able to grow because most of it was self-funded. Despite its two-decade bear market, the Nikkei 225 index of Japanese stocks has exerted little gravitational pull on other bourses. From the Nikkei’s top in 1989, the index has generated a devastating minus-76 percent total return. Meanwhile, investors in the S&P 500 have multiplied their money fivefold. The dirty little secret was that Japan never took money-printing to the same level as Western central banks have today. A generational deflationary funk is thus much less probable in the U.S. of 2012 than in Japan of 1990.
Europe and the U.S. have decoupled on several important fronts. Trade will certainly be a drag, but U.S. exports to the region represent only about 2 percent of gross domestic product -- not enough to derail growth. There is no doubt that headlines about European sovereign debt may prophesize what’s in store for the U.S. if its fiscal and monetary imbalances are not rectified. Yet the U.S. has several advantages on this front, too. Thanks to immigration, it has a more dynamic workforce. And while federal debt levels are dauntingly high, U.S. monetary policy is not beholden to conflicts among multiple countries.
I’m not denying that the U.S. faces challenges ahead, but these can be managed over the course of years, not weeks. The U.S. has an enormous edge on the rest of the developed world. As investors reach that conclusion, U.S. equity markets will continue to decouple from and outperform those in other developed economies.
(Jack Ablin is the chief investment officer of Harris Private Bank in Chicago. The opinions expressed are his own.)
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