The Russian Sanctions Still Burden Europe’s Weak Economy And Society

The Eurozone is in a technical recession, with first quarter GDP at -0.1%. It could be worse.

The Russian war in Ukraine has packed a wallop on Europe with food prices rising and energy scarcity leading to closed factories and steel mills. But the worst-case scenarios for markets never played out precisely as the bear case presumed.

Inflation is coming down, but still high. Energy prices are coming down due to slowing demand, but higher than pre-Covid. For investors, the German DAX
DAX
index and the French CAC are both up 13% and 9.7%, respectively, while the Dow is up only 1% year-to-date ending June 7. Investors had their chance.

“Investors missed the market on the indexes running as they did,” says Albert Marko, a partner in Mavarinas Management Group, a Florida-based hedge fund. “European markets caught tailwinds of a falling dollar, beneficial weather keeping natural gas prices away from hyper-inflating and excellent revenue from luxury goods. Just look at the stock charts of luxury brands and you will see how much that sector rallied European markets.”

The consumer price inflation in France declined to 5.1% year-on-year in May 2023, down from 5.9% in April and better than the 5.5% consensus. Germany’s inflation is now 6.1%, its lowest level in 12 months. And UK inflation is in decline but still high at 7.8% as of April.

Europe: Out of the Woods Yet?

Europe’s inflation rates are all higher than that of Brazil, China, India and Saudi Arabia. Electricity prices are falling in France and Germany but are higher than they were pre-Covid by a factor of three to four, causing the drag on Eurozone GDP.

And that GDP is stagnant.

In number terms, European Union GDP is producing less value than it did in 2021. Its unemployment rate is worse than the U.S. In some countries, it is nearly double that of the U.S. rate.

Germany and Belgium’s unemployment rate is around 5.6%. France is 7.1%. Portugal is 7.2%. Spain is now an emerging market. It’s unemployment rate is worse than Latin American countries at 13% as of the end of the first quarter.

The U.S. unemployment rate was 3.7% in May. Colombia has 10% unemployment.

In a recently published report, the World Bank said there is now a “cost of living” crisis in Europe. The Guardian led with this in its headline today about the negative growth rate in the eurozone.

The war in Ukraine has significantly contributed to the crisis with refugee floods in poor states like Romania, the end of cheap gas, and the loss of Russian markets.

European countries responded to this crisis with social assistance and subsidies, which involved moratoriums on energy price increases, reduced public transport fees, and caps on electricity and natural gas prices for households and businesses. Poorer EU members like Slovakia, Slovenia have had it tougher, with higher inflation leading to higher costs of living for the working class there, the report said.

EU member Poland’s inflation is over 13% as of May, and unemployment is around 5%. It has been one of the country’s hardest hit by the inflow of Ukrainian migrants fleeing the war, according to the International Rescue Committee. Some 12 million refugees crossed into the Polish border since February 24, 2022 to spread throughout Europe, and 1.5 million remain in Poland.

“In terms of Europe’s outlook, I don’t see much good coming from there,” says Vlad Signorelli, head of Bretton Woods Research. “The European Central Bank is still going to raise rates. Regarding the NATO lockstep, I can’t think of any EU member country other than Hungary saying, ‘let’s stop sanctions and get this war over with’,” Signorelli says. Hungary’s leadership has been calling for this since July 2022. “Russian sanctions are not working as advertised,” Signorelli says.

Still, the EU is considering its 11^th round of sanctions against Russia. Greece has supposedly thrown in its lot with Hungary and is currently opposing new sanctions, Politico Europe reported on May 26.

German philosopher Oswald Spengler, writing in his classic takedown of Europe’s leaders titled “The Decline of the West” during World War I, said if Europe fails to build its own policy based on its citizen’s shared prosperity and economic security, risks of wars and civil unrest will ensue. Ukraine isn’t exactly in the EU, but it is part of Europe and on the EU’s doorstep. It is exacting a high price on Europe, surely more than what the war’s main cheerleader outside of Moscow – the United States – has had to pay.

Since the Covid crisis, Europe has gone into high gear in reinventing itself. Brussels is rebuilding four sectors of the EU-wide economy by promoting policies focused on climate change. This has led to high energy costs, negatively affected the production of food and traditional energy, and is rapidly changing the mighty auto industry. In April, the EU was the first to approve a carbon tax on imports to compensate for fossil fuel use in manufactured goods. The European consumers will foot the bill.

Then there is the EU’s Sustainable Corporate Governance initiative, which would force European companies to ensure that EU social and human rights standards apply throughout their supply chain. In Germany, this now applies to 150 companies, but the number is set to rise to 15,000. Many European companies are pushing back against the measures, saying they make it harder for them to compete with foreign manufacturers who do not have similar regulatory burdens.

As Europe’s biggest manufacturing country, Germany has taken a heavy toll from the destruction of the Nord Stream pipeline in September 2022, but also due to its own decision to stop using nearby gas and oil from Russia. Now with the green push they are taking on, Germany’s auto parts industry will go the way of the dinosaur as electric cars require fewer parts. (But Mercedes Benz in India will still make cars with internal combustible engines, as if India is on a different planet.) Moreover, the U.S. is providing subsidies to BMWs and Mercedes Benz EVs if they are made and sold in the U.S.

“In Europe, there is still concern that a new global economic architecture designed in Washington will inevitably favor U.S. producers and workers,” wrote Gideon Rachman in an FT editorial on June 5.

George Friedman, a geopolitical forecaster and founder of Geopolitical Futures, an online publication that analyzes the course of global events, thinks it is an exaggeration to say Europe is shooting itself in the foot.

“Stubbing their toe and pretending agony is more like it,” he says. “Aside from the fact that many economic predictions have proven wrong or were overstated, obsession with the economy leaves a nation distracted from the fact that a major war is being waged near them and they are part of it. And in war shooting yourself in the foot is a minor wound,” he says, adding that the European economy was heavily involved in the war.

Europe: Shifting Allegiances, War Wary Public?

German Chancellor Olaf Scholz was booed by constituents recently, called a “war monger” as he grew increasingly angry, shaking fists and raised voice and all. He looked like a mad leader in a World War II documentary.

“Something like food or energy security is very hard to change your opinion on because the safety of your society depends on them,” Ivan Kłyszcz, an analyst of Russian foreign policy at The International Center for Defense and Security in Estonia said in an article about Ukraine war fatigue in Euronews back in March.

On Feb. 10, the Progressive Alliance of Democrats in the European Parliament held an event called “Feeding Europe in Times of Crisis” where they blamed the EU’s Green Deal strategy called “From Farm to Fork” for putting pressure on food production, and causing a spike in food prices. Some of the goals of that program include making 25% of EU agriculture organic and reducing nitrogen-based fertilizers by 20% by 2030. Incentives and a huge propaganda campaign would be needed to get people to lower animal protein consumption by at least 20% and reduce dairy consumption by around 10%. For Brazil and the U.S. soy farmers – no more soybean imports to Europe if this policy has any legs.

European businesses are increasing against these climate change policies. Last year, Italy was ordered to pay UK-based oil and gas company Rockhopper more than €190 million for the Italian government’s refusal to grant an offshore oil concession in order to fight climate change.

The European Union was created mainly to serve the economic growth of the member states. It actually got its beginnings from the “European Coal and Steel Community” established in 1951. The prioritizing of economic growth allowed Europe to achieve phenomenal wealth just a few years after a massive war. This ultimately led to the creation of the EU in its current form.

But now the EU is more of an extension of the policy platforms put forth by the likes of Davos Man each year at the World Economic Forum. Is Europe a growth story anymore? Few would say so, despite the DAX and CAC run.

The EU has been in a constant state of crisis and disarray since the 2009 PIIGS (Portugal, Italy, Ireland, Greece, Spain) crisis that centered on Greece possibly leaving the EU; then the UK actually going ahead with it and leaving in “Brexit”; then came China-style Covid restrictions and requirements; and now the Ukraine war.

It is true that perception is often greater than reality, but the reality here also suggests a populous turning against the status quo.

A rise of Euro-skeptic parties and nationalist right-wing parties in France, Hungary and Italy make Brussels-led policy cohesion incredibly difficult. The Alternativa fur Deutschland (AFD) Party now garners nearly 30% in polls after years of being dubbed nothing but right-wing fanatics due to its Neo-Nazi wing.

As the war in Ukraine continues, more countries outside of Europe are calling for an end to it. This will pressure Brussels, even if their policies are hand in hand with Washington.

Some recent headlines here should be seen as a signal of greater “war fatigue”.

The New York Times
NYT
wrote about the Azov fighting force of Ukraine being a Nazi unit, wearing Nazi insignia on their uniforms. The Washington Post published an article speculating that a Ukrainian group blew up Germany’s Nord Stream pipeline (German companies Wintershall and Uniper owned it with Russia’s Gazprom). And CIA Director William Burns in January reportedly inquired about lost U.S. aid money in Ukraine. Any day now, more voices from Europe will join those from China, Brazil and Indonesia to get Russia and Ukraine diplomats to stop the war.

For sure, an end to the war in Ukraine will be great for Europe. It is unclear if the markets are pricing that in already, given how far ahead the DAX is to the Dow. Even the FTSE Europe was up on Thursday morning despite the poor GDP news.

“Subsidies, rationing and other methods of economic suppression have allowed Europe to survive an energy crunch and inflation,” says Marko about the EU economy and stock market. “This is not sustainable.”