European debt resulting in different speeds of economic recovery

Wherever I go at the moment I hear cautious optimism regarding the European economy and the prospects for business in 2010. Nevertheless there seems to be something troubling people, a sense of unease despite the positive sentiments. A couple of weeks ago someone went as far as suggesting they were seeing a multi-speed recovery in Europe; some markets picking up - others remaining severely challenged.

Today, I thought I’d take the bull by the horns, go one step further and openly talk about the enormous elephant in the room – DEBT.

OK, so I’ve said it – what now?

Well firstly, it is actually something of a relief to have been quite so open about it. Whilst it is positive to see clients and business partners facing 2010 with a positive mindset, we should remain mindful of the economic realities that are faced.

Before I start on the subject of debt, I feel compelled to highlight a linked trend and an important feature of business over the next few years; political intervention. One prediction we can make with certainty is the increased involvement of politicians in markets and business.

When things are going well politicians are usually happy to adopt a laissez-faire approach and in more difficult times the opposite is true. With the very real possibility of sovereign defaults within Europe and the large number of political elections taking place across Europe in 2010 we are set to see a continuation of closer ties between politics and business for the foreseeable future.

Ironically, as consumers show signs of deleveraging and reducing personal debt, so governments around the world have been borrowing at an astonishing rate. Since the collapse of Lehman Brothers G20 countries have spent more than $2 trillion in efforts to stimulate growth. Much of this money has been borrowed and many of those borrowing were already in debt before the crisis hit.

We hear daily of the problems facing the PIIGS nations (Portugal, Ireland, Italy, Greece, Spain). Greece is the poster child for debt but Greece is a mere 2.6% of eurozone GDP. From a purely financial point of view the Greek problem should be trivial. From a political point of view it is an entirely different matter. Spain on the other hand represents a much larger slice of eurozone GDP and is not far behind Greece in the deficit stakes. Spain, and many argue Italy, represents much more serious threats to eurozone stability.

Looking outside of the single currency area for just a moment and the picture is hardly better. The UK government’s finances look similarly precarious to those of Greece and the UK situation is exacerbated by personal debt levels of the UK population. With some European countries running double digit budget deficits relative to GDP it is helpful to remind ourselves that the eurozone’s own rules limit this to 3%. Even France, with a deficit running at 8% of GDP, is well outside of what has, until recently, been considered acceptable. However, in the new financial world France appears positively prudent in comparison to many of its neighbours.

Talk of a eurozone currency crisis is commonplace. In certain sections of the media the only debate appears to be whether sterling or the euro will nosedive first.

Government debt, like all debt needs to be financed. The debt issue becomes pressing when it needs to be rolled over (refinanced). When the time comes governments will compete for money with the private sector. Central bank interest rates no longer reflect the cost of money. All borrowers are already paying much higher rates and this trend seems set to continue. As governments issue bonds to finance their debts so the spectre of inflation and downgraded credit ratings only increase the returns demanded for taking on this risk. Personally, I do not see inflation as a major concern despite recent rises in some markets, but that is a topic for another day.

So what does all this mean for our industry? Well for one thing the cost of money is going to increase. This in turn will have a direct impact on the cost of leasing and financing. Even cost reduction exercises under the guise of MPS engagements are going to suffer adversely from more expensive credit.

Arguably of more importance is that an increased cost of capital stifles business investment. Without this investment it seems wise to question where the economic growth levels necessary for governments to collect enough taxation to repay debts will come from. Many governments do not yet appear to be advocating a cessation of spending, instead they continue to add to their borrowing whilst spare capacity remains in the economy. Once a government has started on a path of intervention it is difficult to stop – it is truly a vicious circle, a real catch 22.

The challenges faced are global in nature and not limited solely to our continent. However, Japan should serve as a timely reminder that it is entirely possible for a government to spend money but for the economy to still suffer twenty years of falling in and out of recession.

The document industry mantra of ‘business as usual’, so prevalent for so long, describes a business world that looks very different to the markets we can expect to see in the coming months and years. The ‘business as usual’ we will come to acknowledge in the future is going to look rather different to the years prior to 2007. As our industry is exposed to customers across all sectors of the economy, our business is directly impacted by the prevailing economic mood in the markets in which we operate. Consequently, I would argue that, on balance, we are a cyclical industry, moving with the market.

On an exchange rate level during the course of 2010 we can expect both sterling and the euro to come under severe pressure whilst the world’s reserve currency, the US dollar, looks set to rally further. The euro was trading at an all time high against the dollar as late as December. The German export engine was complaining about a lack of competitiveness but just two months later the euro has fallen significantly and the very future of the single currency is being openly questioned in some quarters. It is reasonable to expect exchange rate fluctuations to have an impact on market prices during the course of 2010.

What all of this most likely means is that we are almost certain to see differing speeds within the European economies during 2010. Ironically, in markets where government continue to spend, whether debt financed or otherwise, opportunities in public sector accounts will remain. It is human nature for people who know future budget cuts are inevitable to be more inclined to spend today. We should also expect to see greater divergence between European markets. Cultural differences are a daily challenge for those working in central European functions and EMEA HQs but the economic divergence between the financially secure nations and those heavily indebted is likely to make country level differences more pronounced.

Given this backdrop, the rapid traction gained by MPS engagements is not surprising. To survive in the economy of the next decade those that accept and adapt to the new ‘business as usual’ the fastest will likely fair better than those expecting (or hoping) for a return to 2007 style business.

Due to the breadth of customers that our industry serves, the opportunities in more austere times continue to be enormous. Crafting an offering that resonates with customers does however require an understanding of the economic backdrop that we all are presented with.

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1. InfoTrends InfoBlog » Markets force European sovereign debt issue – ‘Show me the money!’ — May 6, 2010 @ 3:33 pm

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