During the past two decades, investors focused more and more on the United States and paid less attention to Europe. Besides the lack of European tech companies and the relatively weak depth of Europe’s capital markets compared to the United States, a key reason is that investors deem Europe more vulnerable to financial and economic crises. Therefore, they are more cautious about investing in European markets and prefer the perceived stability of the United States, which has contributed to a significant undervaluation of European stocks compared to American ones.
Nevertheless, there are different reasons to believe that Europe is more resilient to financial and economic crises than is widely assumed. This is a sign of the hidden strength of the European Union.
When it comes to Europe’s resilience to a financial crisis, the way in which European countries have agreed to become liable for each other’s debt has gone somewhat unnoticed. In reaction to the COVID-19 pandemic, the EU issued so-called “Eurobonds” for the first time. In a recent analysis, writer and investment strategist Joachim Klement argues that “thanks to the introduction of Eurobonds in 2020, the fiscal headroom for the Eurozone is about three to four once-in-a-century pandemics or ten to twenty global financial crises”. In other words, because of the introduction of Eurobonds, Europe’s debt problem is relatively small compared to the debt problem of the United States (which we highlighted in a previous Dasym Horizons) or of the United Kingdom. Perhaps more importantly, Klement argues that when a future financial crisis presents itself, the European Central Bank is likely to intervene aggressively to limit the negative impact (as it did in 2012) – just like the Federal Reserve does in the United States.
Even if Klement is wrong, it is important to note that the European Union has repeatedly proven to be capable of limiting the negative impact of a crisis. A recent example is Brexit. The EU negotiated with the United Kingdom for several years to limit the negative economic impact of losing one of its biggest member states. These negotiations were a sign of a key strength of the European Union, which is to “muddle through” a crisis. In the 2018 book The Grand Strategy of the Habsburg Empire, the author A. Wess Mitchell suggested that the European Union resembles the late Habsburg Empire (1740-1918), as both use the bureaucracy of fragmented member states to their advantage by delaying, talking and negotiating their way through a crisis to limit its negative impact. Indeed, besides Brexit, this is what the EU did to avert a debt crisis in 2012, as well as to limit the significant pressure of the US government under president Trump.
The unique way in which the EU can muddle through a crisis is not the only empire-like strength it has. The key feature of an empire is its ability and willingness to conquer new territory (often for economic benefits). As such - although it may sound strange - the European Union is the only empire in the world, as argued by Jan Zielonka in his 2006 book Europe As Empire. Put simply, no country still has the ability to expand its territory legally, but the EU does. It can do so because it uses carrots (like trade, investment and access to the Common Market) rather than sticks (as Russia has repeatedly tried and failed to do). Indeed, all of this is unfolding in Ukraine: whereas Russia is using force to conquer Ukrainian territory, it now seems more likely that Ukraine will join the European Union. Another example of Europe’s potential to expand is the 2022 establishment of the European Political Community, in which the EU is making plans for the future of Europe together with not only Ukraine, but also the United Kingdom (in which the majority of the population now wants to return to the EU) and Turkey (which still wants to become a member).
All of this points to a key insight for investors. In light of the common view that Europe is more vulnerable to a crisis than the United States, the relatively strong capacity of the European Union to manage crises means that investors should reconsider the way they look at European markets. Going forward, investors should monitor in particular Europe’s project for “strategic autonomy”, which is a synonym for more self-sufficiency in supply chains like energy, metals, semiconductors and batteries. After all, these projects, which increasingly gain support in the EU, will continue to reshape European markets in the years ahead.