Euro area: Bottom fishing, anyone?

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A powerful policy mix -- consisting of easy credit conditions, a moderately relaxed fiscal stance and bold structural reforms -- is driving the euro area's improving growth prospects.

An extraordinary monetary expansion is the most widely recognized – but not correctly understood – part of that winning combination.

Strangely, the prevailing opinion in financial markets is that the ECB -- like the Fed, the Bank of Japan and the People's Bank of China – has lost its way; its policies are allegedly ineffective and policymakers have no instruments to deal with world's slowing demand, output and employment.

That this view is not based on any plausible empirical evidence does not seem to matter much.

The fact is lost that the Fed single-handedly brought the U.S. economy up from a Great Recession to near full-employment and an average growth rate that is an entire percentage point above its non-inflationary growth potential.

(It is not entirely the Fed's fault that the U.S. growth potential is now down to 1.6 percent from a 1.9 percent average over the last 25 years. Inadequate structural and fiscal policies are mainly responsible for our dismal 0.4 percent growth of labor productivity over the last three years.)

The ECB's job is much more difficult, because it is guiding the economy and a monetary union of politically diverging nation states.

Great Frankfurt bankers

Indeed, despite Germany's constant opposition, the ECB has managed to bring up the euro area's growth rate to 1.6 percent in the third quarter of last year.

That is exactly double the pace of advance in the same quarter of 2014, and almost twice the area's estimated growth potential of 0.9 percent.

The good news is that the ECB will now get substantial help from more reasonable and growth-oriented fiscal policies in an environment where governments' declining borrowing requirements will continue to reduce pressures on euro area's credit markets.

Germans may not like it, but this is mainly the result of the ECB's smart policy actions.

And here are the numbers: Declining credit costs, increasing growth (i.e., rising government revenues) and stronger employment creation have led to last year's estimated euro area budget deficit of 1.9 percent of GDP, down from 2.6 percent in 2014.

Lower interest rates have also reduced the area's public debt service charges to about 2 percent of GDP, from a 2.4 percent average over the last three years, despite the fact that the gross debt/GDP ratio rose from 93.5 percent in 2009 to more than 111 percent estimated for 2015.

Structural policies have also made a contribution to euro area growth, although they were mainly limited to a fairly radical dismantling of protective labor market regulations of another era.

Spain, for example, has gone very far in that direction, creating, in the process, an apparently big segment of informal employment opportunities.

Critics say that this has led to large cohorts of the working poor, but it has also reduced charity lines and slashed the unemployment rate by 2.5 percentage points to 21.3 percent in the year to last November.

French employers still want more freedom to manage the labor force, despite the fact that most of the new labor contracts are for part-time employment.

In a recent letter to the government, they wanted a further decline in non-wage labor costs, and a free hand in getting rid of their permanent staff. It is not clear how far that initiative will go in the run-up to an election year, partly because business leaders offered no commitment for job creation as a counterpart for significant tax and regulatory concessions they were asking for.

Italy's organized labor and political establishment are still hanging on to some extravagant labor market privileges, but that is also being gradually eroded by the country's socialist government.

"Angstrepublik Deutschland"

The growth dynamics in France, Italy and Spain – about one-half of the euro area economy -- improved markedly in the course of last year.

The stage is now set for further gains in demand, output and employment in the months ahead.

The beleaguered socialist government in France will lead initiatives to strengthen growth and job creation in a last-ditch effort to prop up its low approval ratings.

Several election-focused programs are under way to do that.

By contrast, Italy is in a surprisingly confident mood.

Defying Brussels and Berlin, Rome has recently approved an expansionary budget for this year, where the stimulus measures amount to 30 billion euros, ranging from the abolition of a controversial tax on primary residences to investment incentives and strengthened security provisions.

Spain is still struggling to form a government in the wake of last December's elections.

In spite of that, it seems that the current inter-regnum is unlikely to derail the country's buoyant economic activity.

It is even possible that additional stimulus measures may follow in case of a probable government coalition led by the center-left party PSOE and left-wing upstart Podemos.

It is ironic that these three erstwhile problem countries now look like pillars of stability compared with the crisis-ridden Germany.

A self-confident country is now portrayed in the German media as an anxious nation, where citizen vigilantes are patrolling the streets and a virtually collapsing government coalition has no idea how to fix the mismanaged refugee debacle.

One thing is clear, though.

Germany's public spending will be soaring in the months ahead.

That could be good for the rest of the world, because it might generate more growth from domestic demand (and stimulate imports), instead of drawing strength from export sales to trade partners.

It is estimated, for example, that providing shelter and basic public services to more than a million of its new settlers will cost Germany up to 20 billion euros this year alone.

On top of that, Germany's budget for this year includes an increase in military spending of 34 billion euros.

Investment thoughts

Economic growth in Germany, France, Italy and Spain – about 80 percent of the euro area – is picking up.

Demand, output and employment are driven by cheap and amply available liquidity, growth-oriented fiscal policies and structural reforms that could facilitate job creation.

If you are ready to take with equanimity the euro area's unwieldy politics, its grossly oversold stock markets and smartly recovering economies are offering a broad array of solid asset values.

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