Does the Ukraine war herald the end of Europe’s economic foundations?

By Marc El-Lazidi, Chief Investment Officer at Jesmond Mizzi Financial Advisors

As winter sets in, Europe finds itself amid an unprecedented energy crisis that could push the bloc into a prolonged period of recession. Jesmond Mizzi Financial Advisors’ chief investment officer Marc El-Lazidi discusses the risks facing Europe and how they can be addressed. 

Q: What is your assessment on Europe’s economic situation?

A: Europe’s biggest concern ahead of winter was a potential shortage of gas given that the supply from Russia has been cut. Most countries appear to have filled their reserves, and the cold season hasn’t started just yet, so in the short term, things aren’t too bad.

Even if Europe does make it through the winter relatively unscathed, questions will remain about the bloc’s long-term strategy. Europe needs a robust plan to make it more energy independent if it hopes to build an economy for the future. Beautiful as it was, the European model of using cheap Russian gas to fund the continent’s industry is coming to an end.

Europe is like the driver of a vintage car who has been driving along the same road for many years. The car has remained the same, but the road has changed over the years. What was once a smooth and easy path has become bumpy and rough, and Europe must now think of what type of car it wants for the future.

Q: Is there any other alternative to an economy based on Russian gas and oil?

A: There is, but it will require a long-term plan and serious investment. One possibility is the use of liquified natural gas (LNG) which can be more broadly sourced than natural gas, but which would require significant investment in new LNG terminals across Europe.

Another alternative, which I feel Europe does not take seriously enough, is nuclear energy – the only energy source that could really give the European economy more independence.

Renewable sources of energy are similar in that they can be used to generate electricity without dependence on external suppliers, but they cannot provide enough energy to meet Europe’s demand.

In this respect, I think European policymakers are placing too much of an emphasis on growing green and not giving enough attention to how demand for energy is set to change in the coming years.

Q: This year Germany registered its first monthly trade deficit since reunification; what does this tell us about the country’s economy?

A: The outlook for Germany isn’t looking great, just like for the rest of Europe.

A major concern the German economy is that it is still very reliant on traditional industries like car-making, machinery and chemicals. They are all energy intensive industries that leave the economy vulnerable to shifts in global energy markets.

They are also ageing industries that were established after World War II and are today under increasing pressure to modernise. There is, however, a reluctance to change, simply because so much has been built around them over the years.

Another concern is with Germany’s Mittelstand – small and medium enterprises – that together make up the country’s major industries.

They are particularly vulnerable to the present economic climate and could trigger a domino effect across the economy if things get worse. Besides being hit with more expensive energy, Germany is also having to contend with a fall in demand from major markets like China, dealing a double blow to its economy.

At the same time, contrary to what one would expect, the country is not in the global tech sector which is quickly reshaping the modern economy.

Q: So can we expect to start seeing fewer German cars on the roads?

A: I don’t think we’re there just yet, but the German car-making industry has been seriously challenged by electric car start-ups in both China and the US.

The industry is ripe for disruption by big tech companies, which have recognised that the future lies in smart cars and shared services.

Over the next 10 years, the car industry will see more players competing in a shrinking market and, yes, this is likely to be problematic for Germany.

Ultimately, Germany has a very industrialised economy unlike, say, the UK, which after a very long and painful process of deindustrialisation today finds itself on the opposite end of the spectrum with a focus on services.

Q: Speaking of the UK, what’s your analysis of the current political situation?

A: The politics is problematic and the market reaction we saw to Liz Truss’ mini budget highlights the risks to economic stability of populist political decisions.

The government announced fiscal stimulus that was directly opposed to the country’s monetary policy, forcing the Bank of England to intervene in order to prevent a threat to pension funds which could have triggered widespread instability.

On a structural level, however, the UK’s economy is more dynamic. There are strong incentives for start-ups and the UK knows how to foster an innovation ecosystem, like it’s done with fintech.

This isn’t to say that Europe should be looking to the UK for inspiration. For this I think we need to look towards Scandinavia. Countries like Norway and Sweden have diverse, prosperous and resilient economies while also providing citizens with high living standards.

Q: Was the market reaction to the UK budget rooted in fears that something similar could happen elsewhere in Europe?

A: It was definitely a factor because similarly populist measures could be announced by other European countries. The difference is that if something similar were to happen in an EU member state, it is unlikely that the European

Central Bank would intervene in the same way the Bank of England did. Having one central bank dictating policy to 27 economies, each at different stages of development, remains a major problem for Europe and one that will hold it back from recovery.

At the moment you have half of the EU in the north whose priority is to bring down inflation at all costs with the south unable to implement such measures without bringing down their entire economy.

So you have a central bank that is unable to intervene to the extent that it needs to be effective. I understand how this has come to be, but as an investor I am looking for stability, which the ECB is seemingly structurally unable to provide.

If we take a look at policy rates, it is clear that Europe has a long way to go before it can really start to bring inflation under control, and is likely to grapple with it well into 2024. This isn’t cause for much optimism from an investment perspective, and I would much rather put my money in an economy like

Norway’s, because it is much more resilient, and its central bank is nearing the end of its cycle.

Q: Do you see the possibility of a soft landing for Europe?

A: I think the possibility of a soft landing here in Europe is very small. Maybe it will be the case in the US given its distance from the war and the fact that it has a stronger economy.

The extent and speed of any recovery will be dependent on how agile and flexible economies are at meeting new challenges.

Europe definitely has its work cut out for itself because its economy is in need of significant structural changes that won’t be easy to make but which are necessary for it to be in a position to bring about lasting economic prosperity.

Like I said earlier, Europe should be looking to countries like Norway – like we at Jesmond Mizzi Financial Advisors are doing – where both civil society and the corporate world have decided to seriously invest in sustainability and circularity, while embracing tech and the new economy.

Such countries have a diverse economy, strong entrepreneurial spirit, and above all, effective monetary policy which can offer investors stability and value in the medium to long-term.

This interview does not intend to give investment advice and the contents therein should not be construed as such. The company is licensed to conduct investment services by the MFSA under the Investment Services Act and is a member of the Malta Stock Exchange and a member of the Atlas Group. For further information, contact Jesmond Mizzi Financial Advisors Ltd of 67, Level 3, South Street, Valletta, on Tel. 2122 4410, or e-mail [email protected].