America’s aggressive strategy for tackling its financial and economic ills is working better than Europe’s go-slow approach -- and investors are taking notice.
Even amid the weakest recovery in modern history, the U.S. economy is outperforming the euro area and soon may break higher. More than a year after U.S. gross domestic product returned to its pre-crisis level, Europe still has to make up lost ground and is back in recession. While America’s unemployment, at 7.5 percent, is 2.5 percentage points higher than at the start of the recession, it’s below the 12.1 percent rate of the euro zone -- and the gap is the most since 2000. Manufacturing is shrinking in the 17-nation bloc; U.S production is expanding.
“The U.S. is in a transition from the intensive-care unit to out of the hospital,” said Mohamed El-Erian, the chief executive officer at Pacific Investment Management Co. in Newport Beach, California. “Europe is out of the ICU, but in a ward close by.”
The source of America’s relative economic success may lie in the decisions of policy makers. While the U.S. quickly addressed bank solvency, Europe battled over how to deal with its sovereign-debt turmoil and still is struggling to craft a comprehensive banking plan. The Federal Reserve eased monetary policy faster than the European Central Bank, and governments in Europe put their faith in austerity over the U.S. preference for fiscal stimulus.
S&P’s Gain
Investors are beginning to tune in. The 15 percent gain in the Standard & Poor’s 500 Index since the start of the year is more than twice the advance of the Euro Stoxx 50 Index. A Morgan Stanley gauge of 50 companies that generate almost all their sales from within the U.S. is up 18 percent this year, compared with an 12 percent rise in a measure of 49 companies that get 60 percent of their sales from abroad.
The dollar also stands to benefit. Deutsche Bank AG, Citigroup Inc. and Barclays Plc are among banks predicting the currency will gain this year against the euro as U.S. growth accelerates.
Since financial turmoil first began in 2007 and then accelerated with the collapse of Lehman Brothers Holdings Inc. in 2008, the U.S. has set up a $700 billion bank-bailout fund, enacted a fiscal-stimulus program of about $800 billion and embarked on a loosening of monetary policy that has injected more than $2 trillion into the economy so far.
Crisis Source
Even though the U.S. was “the source of the crisis, we moved quickly to clean things up,” said David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York. “And we haven’t had the aftershocks that unfolded inside the euro zone as people began to question the very foundations of that structure.”
In the EU, while nations have provided 1.7 trillion euros ($2.2 trillion) of support to their banking systems since October 2008, they put off calls for sweeping recapitalizations, even as the debt crisis festered beyond Greece. The latest bailout of Cyprus even included a tax on uninsured bank deposits as countries again tried to ring-fence turmoil rather than find a continent-wide solution.
Policy makers still are clashing over a banking union aimed at breaking the cycle of contagion between governments and lenders so troubled institutions don’t paralyze economies. Disputes include how far to go in building a central authority to handle failing banks and whether national deposit-guarantee programs should be linked up.
Expose Weakness
Europe also ran into criticism for failing to replicate the success of U.S. bank stress tests by being too soft and failing to expose weaknesses. In 2010, for example, the now-defunct Committee of European Banking Supervisors said seven EU banks needed only 3.5 billion euros more capital, a 10th of the lowest analyst estimate.
Now the ECB is left propping up the system through unlimited long-term loans to financial institutions, justifying this approach by noting that banks account for 80 percent of European financing compared with 20 percent in the U.S.
“The natural adjustment has been impeded by counter- cyclical policies to prevent deleveraging,” said Stephen Jen, managing partner at hedge fund SLJ Macro Partners LLP in London.
To Mike Howell, founding managing director of London-based CrossBorder Capital Ltd., Europe’s banking system is similar to Japan’s in the 1990s, which plagued the Asian nation’s economy for two decades. As much as 15 percent of European bank loans may be bad, the same share as in Japan, he estimates. Attracting new deposits will be hard, because institutions are paying interest rates below comparable government-debt yields and their credit ratings have fallen, he said.
‘Bad Business’
“Banking is a bad business in Europe,” Howell said. “They have to recapitalize the banks, and then you might get lending. The U.S. outlook looks pretty good because the banking system is coming back to normality.”
The divergence is reflected in how easily nonfinancial companies can tap credit. While U.S. banks eased conditions in every quarter but one since the end of 2009, European lenders have tightened for 23 consecutive quarters since 2007, according to UBS AG. Europe’s small and new businesses particularly have been hit.
The different approaches are influencing economic performance as the U.S. and Europe decouple, breaking what Lucrezia Reichlin of Now-Casting Economics Ltd. in London says is a traditionally high level of synchronization. Kevin Loane, an economist at Fathom Consulting in London, says America’s economic output will be 8 percent above its pre-recession peak by the end of next year, while the euro area will still be 2.4 percent below.
Root Causes
“Policy makers in the U.S. addressed the root causes of the crisis more quickly,” Loane said. “That is why the U.S. is doing better.”
The world’s five biggest businesses are American for the first time in nine years, and automakers General Motors Co., Ford Motor Co. and Chrysler Group LLC all gained U.S. market share in the first quarter for the first time in 20 years.
“We wouldn’t be hiring if we didn’t think it was going to last,” Joe Hinrichs, Ford’s president of the Americas, said in a May 2 telephone interview after the company announced plans to add workers at its F-150 truck plant in Claycomo, Missouri.
Global policy makers have recognized the gap. International Monetary Fund Managing Director Christine Lagarde divides advanced economies between those “on the mend,” like the U.S., and those “that still have some distance to travel, such as the euro area.”
Next page: 'Breaking Out'
