The time has come.
It's what investors, bankers, traders and asset managers have been waiting for, and it has the potential to redefine the next decade for the European economy.
The European Commission announced it's "Next Generation EU" plan this week, which includes a €750bn recovery fund made up of €500bn in grants (yes - free money), €250bn in loans.
Add this to the expected €1.1 trillion EU budget for 2021-27 as well as the €540bn in spending already agreed in April and you have a total of over €2 trillion in spending by the European Union to safeguard it's economy as well as fuel growth for the rest of this decade and likely beyond.
European Commission President Ursula von der Leyen called it "Europe's Moment", and boy do we agree. The question was always - and still is - whether all 27 member states can agree on the package. But executed properly, this has the potential to take the European economy to the next level and compete with Chinese and American counterparts over the long run.
Where will all the money come from?
Up to now, the European COVID response has been largely driven by individual governments borrowing money from the capital markets to support their faltering economies.
While rich Northern European countries have been able to patch up their economies in this way, the problem here is that it's harder for countries in the most urgent need (i.e. Spain, Italy) to borrow large sums of money from capital markets given they are already quite heavily indebted. To illustrate this point, European economies have so far already spent over €2 trillion collectively in response to COVID-19, but over 40% of that has been spent by Germany alone.
So the solution proposed by the European Commission - and backed by Germany & France - addresses the issue by borrowing on behalf of the entire EU - which has a strong credit rating and can borrow at very low interest rates - and distributing the funds to where they are most urgently needed.
The proposed recovery fund is great for struggling Southern European economies who will receive a disproportionately large amount of the €500bn in grants on offer. On the other hand, "frugal" states such as Austria, Denmark, the Netherlands and Sweden currently oppose such a large sum of money being handed out to poorer European states.
The details of who gets what and how that is distributed still remain up for debate and negotiation and in true European Union style, the end result is likely to be complicated. But the staggering numbers being talked about here are definitely worth paying attention to.
Strings Attached
The money being dished out here will come with strings attached. These "strings" will undoubtedly be tweaked in the final agreement, but as it stands the general principles are as follows:
Companies which struggled anyway prior to COVID-19 won't be rescued
All firms who receive bailout money must pay it back
The largest beneficiaries of bailout funds will not be allowed to pay dividends or bonuses until their debt to the European Union has been repaid
There will also be green and digital strings attached
25% of all recovery fund financing must be set aside to power green and digital transitions. We may look back on this condition alone in 2030 as the watershed moment which fast-tracked Europe's transition to a sustainable future - here's to hoping.
Why is this exciting?
From an economic perspective, the EU's existing rules which forbid state aid for companies go out the window - for now.
This means European companies could well receive the support needed to compete effectively against Chinese and American counterparts - who have at times been accused of benefiting from subsidies and favourable policies in their own home markets.
In other words, the fund is not just about survival in the COVID-era but about thriving in the coming decade.
This has the potential to level the playing field by enabling the creation of European industrial champions, and it could happen by allowing mergers between national champions to create European behemoths which are in turn able to compete on the same scale as their Chinese and American counterparts.
All this is exciting, but also a potential hazard if European industrial giants eliminate competition across the EU - it's something the European competition commission will have to grapple with over the next few years in order to ensure the outcomes are best for individual consumers.
Don't forget about the ECB
All this fiscal policy looks like just what the doctor ordered for the European economy, but Ursula von der Leyen isn't the only one in the spotlight right now.
ECB President Christine Lagarde has additional monetary policy tools at her disposal to support the European recovery. European inflation is at it's lowest level in 4 years, giving the ECB the room needed to expand it's monetary stimulus programme. Investors and market participants now expect an additional €500bn of emergency asset purchases to be announced next week, taking the central bank's support so far this year to €1.6 trillion in total.
What does it mean for you, the investor?
All of this is clearly positive news for the European economy, while stock market valuations in the US look punchy already - the S&P500 is only 5% lower in 2020 while the NASDAQ is 5% up on the year.
It may therefore be time to shift your investment focus towards European stock markets, which are still between 10% - 30% lower year-to-date. The move higher has already started with some European stock indices gaining more than 5% this past week.
Picking out individual winners and losers is difficult at this stage with much of the European recovery fund still up for debate, but this week might just have been the starting gun on European stock market recovery.
As always, we'll be watching. 🍿🥤
Please know, the value of investments can go up as well as down and you may receive back less than your original investment, meaning, when investing your capital is at risk.
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