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2016-11-25

How's the EU economy doing (part 2)

Europe's not doing so great. Eastern Europe is 10x poorer than the US, Bulgaria is even poorer than China by nominal GDP per capita. Even rich countries in Europe are poor compared to the US, with just 70% of the nominal GDP per capita.

Wait, what? Didn't you just write yesterday that everything is fine, don't worry? Welcome to the land of currency exchange rates. The US dollar is valued at levels unseen since the early 2000s, so suddenly everyone else gets thrown into the poorhouse. A few years earlier, the dollar was valued a third lower, so the story was that EU was an economic juggernaut, eclipsing the US economy. Now the USD/EUR exchange rate is nearly even, and the story is that the US is an unstoppable economic powerhouse, and the EU's economic policy is one of total and utter failure.

What's going on then? Exchange rate fluctuations? One day you're rich, the next you're poor, the day after tomorrow you're rich again.

There are a couple historical analogies to this situation. Both helpfully involving the US as one of the economies involved. First time around, there was the Soviet Union. A serious economic competitor to the US. The USSR had a population 20% larger than the US, but it was culturally fragmented and started off significantly poorer, so it never really reached the total economic bulk of the US before it got sideswiped by Japan into the third place in the late 1980s. Japan was clocking massive annual growth rates at that point and overtook the Soviet Union, despite having only half the population. And Japan kept on growing. At the peak of the Japanese bubble, Japan's GDP per capita was higher than the US one and there was all sorts of crazy talk of the Japanese buying up the entire United States and becoming the largest economy in the world by 2005. Then the bubble burst and Japan was pushed to the third place by the new-born European Monetary Union.

So, is this history repeating itself? Is the EU in a valuation bubble, which burst during the euro crisis, and now the Union is going to disintegrate and disappear from the world stage, much like USSR and Japan? While the situation is a bit similar to the one with the Soviet Union, as both the EU and the USSR are culturally and politically fragmented economies that started off poorer than the US, there are some crucial differences. First off, the population of the EU is about 50% larger than the US, making it harder to overtake without veering into bubble territory. Second, a significant chunk of the EU is made up of historically rich countries, who should know how to manage an economy. Third, the EU GDP per capita has never exceeded that of the US, so it's less likely that we're experiencing a wild valuation bubble bursting. The euro crisis did have a valuation bubble involved in it, but it was confined to the newly-rich fast-growing South Europe and Ireland.

Taken together, these points make it less likely that we're witnessing a USSR / Japan -style situation where the other economy crashes, the US recovers from a slump, and returns to being the biggest economy. In fact, it feels a bit like the Japanese situation, but with the US in Japan's position. You've got a tightly integrated economy with a smaller population overtaking a more loosely-bound economy with a significantly larger population.

At the same time, China has passed both the US and EU to become the largest economy by GDP PPP (and a nominal number one in a few years). At 3x the population size of the EU and a faster-growing economy, China's going to be number one with a comfortable margin for a good while.

With that in mind, you could also think of this as a larger-scale re-enactment of the 1990s. In that scenario, the US would pass the EU in GDP to retake the number two position after China. The resulting shock would cause the EU to disintegrate USSR-style while the US surfs an asset bubble. In a few years, some "let's create a counterweight to China" economic union comes online, overtakes the US and the US asset bubble bursts.

So you've got a weird situation. On one hand, the US and EU are nominally the number 1 and 2 economies in the world, waiting to be passed by China. On the other, they're numbers 3 and 2 by PPP. This is playing out in both empires crumbling in various ways, instead of the more usual "number 3 disintegrates as number 1 and 2 turn on it." Brexit pulling the UK out of the EU, Canada-EU trade deal pulling Canada towards Europe, US talk about breaking up NAFTA, SE Asia pivoting away from the US, EU neighbors dropping plans to join the Union, California fringe movements lobbying for Calexit, and a Eurasian pivot towards China.


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