Deconstructing the Eurozone

Deconstructing the Eurozone
June 18, 2012
David R. Kotok and Bill Witherell



This weekend, leaders of 20 of the world’s largest economies headed to Mexico for a G-20 meeting, at which the outcome of the elections in Greece and the implications for Europe and global financial markets are a central topic, along with the future course of actions by the countries of the eurozone to address the current crisis.  The major central banks have indicated they are prepared to meet any liquidity pressures in the banking system, and the IMF is hoping to secure agreement for a major increase in the Funds resources, to deal with any further shocks to the global economy.

The Greek election results are in. The pro-bailout New Democracy party won, but did not get an absolute majority. It will, therefore, seek to form a coalition government, most likely with the pro-bailout Pasok (Socialist) party. It is a positive result for Europe, signaling there will be no early exit of Greece from the euro. Greece and the euro system have avoided a train wreck. But difficult days lay ahead as the likely weak coalition government, in the face of strong opposition, struggles to proceed with the austerity program, perhaps obtaining some unavoidable concessions from Europe with regard to timing.

In France today there was another parliamentary election, whose results will also be viewed as positive for Europe. The Socialists won an absolute majority. This means there will be no need to form a coalition with parties further to the left, which would have made it even more difficult than it still will be to make progress on controlling the government budget deficit.

Global markets should react positively to the above developments. However, attention will likely move quickly away from Greece to the results of the G-20 meeting, the Federal Open Market Committee meeting on Tuesday and Wednesday (and possible coordinated liquidity boosting action by other central banks), and the meeting of Europe’s leaders on the 28th.

The eurozone has been in a sovereign debt crisis for several years.  The size of the balance sheet of the European Central Bank has expanded greatly (see as the monetary authority of the eurozone has introduced new program after new program in order to stopgap liquidity constraints.  Various funding methods have been designed and implemented to bail out countries and their banking systems.

The members of the eurozone continue to be divided between the better-behaved northern countries, whose budgets are more balanced, conservatively aligned, and less debt-dependent, and the southern (peripheral) countries, whose budget deficits have become unwieldy and whose economies are now suffering.

Damage in the eurozone is spreading through a slow-motion contagion.  Many economies in the eurozone are contracting.  Austerity policies that raise taxes and costs on shrinking economies are failed policies.  They make the shrinkage worse; they accelerate the pace of shrinkage to the downside.  Unless eurozone country leaders cut on the social-spending side and advise their constituencies that they cannot honor the social-payment commitments they have made, unless they balance down the spending side and also cut the tax/cost imposition side; unless they make this policy adjustment, they will continue to implement failed austerity programs.

There are seventeen countries in the eurozone.  Each has a national central bank.  Some of those national central banks monitor their banking systems and policies rigidly and with enforced disciplines.  Those banking systems are attracting euro-denominated bank deposits, which are leaving the other countries as depositors seek safety.  The eurozone countries losing deposits are collaborating with their domestic national central banks in order to survive.

Some national central banks are being drained for liquidity.  Their collateral values that secure loans are falling.  Liquidity constraints render the banks ineffective.  Capital infusions are needed.  Some eurozone governments now pay high yields to borrow money (  That makes the governments’ financial situation impossible to balance.  When benchmark, high-credit countries in a single-currency zone pay interest rates on their ten-year debt of close to 1%, while other, larger economies in the same currency zone pay interest rates of 5 to 10%; when that happens, the gap between the “haves” and the “have-nots” is too wide to reconcile.


Europe’s economies continue to spiral downward.  Its politicians are involved in endless sequential meetings and collaborative discussions.  Europe’s finance ministers hold conference calls.  The European Commission debates and discusses changes that are needed to its banking system.  Then, everyone looks to Germany to bail out the entire system.  Why should German workers pay more to subsidize the financial profligacy of people in places like Greece?  Where are these countries headed?  What is the outlook for each of them?

In the following comments, Cumberland’s Chief Global Economist, Bill Witherell, will summarize the condition of the seventeen countries in the eurozone.  The eurozone countries range in size from the smallest ones, like Malta and Cyprus, to the largest,  Germany.  Bill has just returned from a fact-finding trip to Europe.  He has written the following concise single-paragraph summaries of key points about each of the countries.

The seventeen members of the eurozone, all using the euro as their currency, are the following, in order of their share of the eurozone’s total economy: Germany, France, Italy, Spain, Netherlands, Belgium, Austria, Greece, Finland, Portugal, Ireland, Slovakia, Luxemburg, Slovenia, Cypress, Estonia, and Malta. In the case of Portugal and the final six countries in this list, there are presently no country-specific ETFs available on the US market. Their economies are very small. The largest of these seven, Portugal, has an economy that is less than 2% of the eurozone’s; all of the other six have economies that are less than 1%. Some are doing relatively well – Luxemburg, Estonia, Slovenia, and Slovakia. Others – Portugal and Cyprus – are suffering. The equity markets of all seven are too small to be of interest to global investors.  Below, we discuss the ten countries for which individual-country ETFs are currently listed on the US market. In view of the considerable divergence in the performance this year of the respective equity markets of these ten countries, investor discrimination among these markets is important.

Germany has the largest and strongest economy in the eurozone, accounting for 26.7% of the eurozone total.  While not completely escaping the negative effects of the recession in much of the eurozone, Germany’s GDP managed to rebound in the first half of this year, continuing to outstrip the eurozone average.  Germany’s highly competitive export industries have been able to take advantage of the weakening euro, and the manufacturing sector’s performance is strong.  Germany’s equity market rose sharply in the first quarter, up by some 20.5%. In the second quarter, as investor concerns about the eurozone (ex-Germany) increased, Germany joined the retreat in global markets, wiping out the first-quarter gains, so that the year-to-date performance is a 2% loss, which compares with a 7.8% loss for the eurozone as a whole.  We expect the German economy and its equity market to continue to outperform the rest of the eurozone over the remainder of 2012 and into 2013.  Accordingly, Germany is currently the only eurozone position in Cumberland Advisors’ International and Global Multi-Asset Class ETF Portfolios. There are four Germany ETFs available (EWG, EWGS, FGM, and GERJ). However, only BlackRock’s iShares Germany, EWG, has the liquidity we consider necessary.

France has the second-largest economy, accounting for 21.3% of the eurozone total. Its equity market capitalization is slightly larger than that of Germany, and together these two equity markets account for some 60% of total eurozone market capitalization.  The French economy is considerably behind that of Germany in enacting market-friendly reforms. While more dynamic than much of the eurozone, France’s industries are hampered by an inflexible labor market and high social charges. The prospect of needed economic reforms has been greatly diminished by the recent election of the Socialist President, Hollande. The French economy avoided a decline in the final quarter of last year, unlike the German economy, which did decline. In the first quarter, the French economy was flat. Industrial production declined in March but then rose in April. President Hollande has stressed his intention to push for growth, which suggests increased government investment programs. This will be difficult to square with his pledge to reduce the excessively large budget deficit. France’s equity market is down 6.1% year-to-date but has been doing better than Germany’s in recent weeks. There is only one available ETF for France, BlackRock’s iShares France, EWQ.

Italy’s economy ranks third in the eurozone, at 17% of the eurozone total. Its equity market capitalization is only 7.9% of the eurozone total. However, its bond market is the third-largest in the world.  Italian sovereign bonds have come under stress, with the 10-year yield rising to 6.34% Thursday before moving back somewhat to 5.96% Friday.  Investors worry about the country’s ability to get its fiscal house in order and continue to finance its very heavy debt burden while its economy is in a recession that appears to be worsening. Mario Monti’s technocratic government has enacted some needed economic reforms, but much more is needed. Monti, in his efforts to put Italy back on a path of sustainable growth, faces great political resistance to further needed reforms, as austerity programs are having painful effects. Italy’s competitiveness has declined. Yet it must be added that Italy is in a better overall economic position than Spain; in particular, its banks have not suffered from a collapsing housing market. Italy’s equity market is down 15% year-to-date. The one available ETF for Italy is BlackRock’s iShares Italy, EWI.

Spain has the fourth-largest economy in the eurozone, 11.7% of the eurozone total, and the third-largest equity market, with a market capitalization equal to 10.2% of that of the eurozone.  Spain’s economy includes a number of internationally competitive companies, and its top international banks are relatively sound. But the overall economy is hampered by many rigidities, including its labor market, and its second-tier banks are in serious trouble. The economy is reeling from the bursting of a massive bubble in the housing and construction sector.  The government has undertaken a number of difficult reforms and austerity measures, but hesitated until a week ago to admit that it needed assistance to address the growing problems in the banking sector. European governments have responded impressively to help Spain in this regard. Nevertheless, the Spanish economy is in a recession, which looks likely to continue into 2013, and its 10-year bond yield is hovering near the dangerous level of 7%.  Spanish equities have often performed better than would be implied by the country’s macroeconomic performance. That is not currently the case, as Spanish equities are down 23.7% year-to-date.  The one available ETF for Spain is BlackRock’s iShares Spain, EWP.


Netherland’s economy is ranked fifth in the eurozone, accounting for 6.4% of the eurozone total. Its equity market capitalization is 9.4% of the eurozone market.  Netherlands, along with Germany, Finland, Austria, and France, is one of the eurozone’s “good guys”. It has maintained its Aaa credit rating, and its 10-year bond rate of 1.94% is lower than those of all eurozone countries except Germany and Finland.  Its economy is closely linked to that of Germany, and it shares many of Germany’s positive features.  Unlike Germany, though, Netherlands is in recession, suffering more than Germany from the depressed state of much of the eurozone. While positive growth is likely to return in the second half, the annual growth figure for 2012 is projected at -1%.  Netherland’s equity market is off 6.9% for the year to date, similar to that of France. The one available ETF for the Netherlands is BlackRock’s iShares Netherlands, EWN.

Belgium, another one of the “good guys”,  is ranked 6th, accounting for 3.8% of the eurozone economy.  It is closely linked to Netherlands and Germany, but it shares some of the inflexibilities of the French economy. Politically, the country is divided along language lines – French versus Walloon – making action on economic reforms difficult to achieve. Positive growth was achieved in the first quarter, following a slight decline in the final quarter of 2011. The economy is expected to advance further in the second half and in 2013. Belgium’s equity market has been the top performer in the eurozone this year, up an amazing 8.4% year-to-date, during a period when the world’s markets achieved only a 1.1% advance.  The one available ETF for Belgium is BlackRock’s iShares Belgium, EWK, which has rather limited liquidity (net assets of $25.4 million).

Austria has the seventh largest economy, accounting for 3.1% of the eurozone. Austria is another “good guy” of Northern Europe, with an Aaa credit rating. It shares many of the attributes of Germany, its main trading partner, except the size of its domestic market. Austria also does considerable business with the countries of Central and Eastern Europe.  Austria’s small equity market accounts for only 0.9% of the market capitalization of the Eurozone.  The Austrian market is down 7.9% year-to-date.  The one available ETF for Austria is BlackRock’s iShares Austria, EWO, which also has limited liquidity (net assets of $53 million).

Greece has the eighth largest economy in the eurozone, with a rapidly declining share of the eurozone’s economy of less than 2%. There is no need here to repeat the very depressed state of Greece’s economy or its astronomical interest rates. Its equity market is very small, less than 0.3% of the capitalization of the eurozone equity market.  There is an ETF for Greece, Global X’s FTSE Greece 20, GREK, which has very limited liquidity (net assets of only $2.4 million).

Finland has a small economy, ranking ninth and accounting for 1.9% of the eurozone. However, it is a very-well-run economy, one of the “good guys,” with an Aaa credit rating and a 10-year bond yield only 33 basis points above that of Germany. Its debt/GDP ratio is only 48.4%, compared with 83.4% for Germany, 82.4% for France, and 119.1% for Italy. Finland’s equity market is large relative to the size of its economy, accounting for 3.1% of the eurozone’s market capitalization. Finland’s market has not performed well in 2012, down 16.1% year-to-date, much worse than its non-eurozone Nordic neighbors, Sweden (-3.9%), Norway (-5.6%), and Denmark (+7.4%). The one available ETF for Finland is BlackRock’s iShares Finland, EFNL, which has very limited liquidity (net assets of only $2.2 million).  A better-performing and somewhat more liquid ETF (net assets of $15.9 million) is Global X’s FTSE Nordic Region, GXF, in which the country weights are 12.7 for Finland, 46.1 for Sweden, 20.6 for Norway, and 20.5 for Denmark.

Ireland has the eleventh-largest economy, accounting for just 1.8% of the eurozone total. (Portugal, ranked tenth, has no available US-listed ETF.) Ireland suffered a severe banking crisis, related to a burst housing bubble, requiring a bailout from its European partners.  Ireland is rightly praised for its strong response to its crisis, and has made substantial progress in regaining competitiveness and reducing its fiscal deficits. Its economy is recovering, doing well relative to the rest of the eurozone. It is expected to grow somewhat faster than other eurozone countries in the second half of 2012 and in 2013.  Ireland’s small equity market (accounting for only 1% of the market capitalization of the Eurozone) is down 4.4% year-to-date. The one ETF available for Ireland is BlackRock’s iShares Ireland, EIRL, also has very limited liquidity (net assets of $7.9 million).



David R. Kotok, Chairman and Chief Investment Officer, and Bill Witherell, Chief Global Economist

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