Conventional wisdom held that the COVID crisis would see Europe outperform the US.  The European ‘big government’ interventionist socioeconomic model was judged better able to handle large-scale crises such as the coronavirus pandemic, resulting in better health outcomes and a smaller economic contraction.  It was even argued that the EU reforms engendered by the crisis could potentially set the scene for the euro to displace the US dollar at the heart of the international financial system.  So, what’s going wrong?


We are standing at a fork in the road: will this virus permanently divide us into rich and poor?  Into the haves and the have-nots?  Or will we become a stronger continent, a player to be reckoned with in this world?

Ursula von der Leyen, EU Commission President, March 2020

Among major currencies, the dollar depreciated by over 4 ½ percent in real terms between April and late September…during the same period the euro appreciated by close to 4 percent on improving economic prospects and slower increases in COVID-19 cases. (emphasis added)

World Economic Outlook, October 2020, IMF

Second dip of the recession will be immeasurably harder for Eurozone than first one.  We spent our political capital on a recovery fund that is already delayed.  Need for a real Eurobond is still there.

Wolfgang Munchau, German financial journalist, October 23, 2020 (via Twitter)

Politicians love to make international comparisons when it comes to COVID-19.  Whether it’s Trump claiming that the US has the ‘lowest fatality rate in the world’, or just about every opposition politician incredulous at the fact that their country has more cases than New Zealand (a remote island nation whose largest city has a population of about one and a half million), these comparisons, rightly or wrongly, have become the lens through which the COVID crisis is scrutinized. 

In addition to political observers, the comparison between Europe and the US has been of particular interest to FX market participants.  With the US dollar bull market looking a little long in the tooth (see chart I), the COVID crisis was identified as a likely catalyst to reverse the trend.  The reasoning is relatively straightforward.  The pandemic, which precipitated the worst economic contraction since the Great Depression, is seen as the type of economic catastrophe that market forces alone simply cannot fix.  When dealing with a natural disaster on this scale, the European ‘statist’ model, with its high taxes and better quality public services, should outperform the US.

Chart I: EURUSD 2008 – 2020
Source: Bloomberg

For a while, it did look like this would be the case.  In August, the pro-Europe think-tank, Centre for European Reform, wrote: “At the time of writing, US claims for unemployment benefit are rising again, after a second surge in the number of COVID-19 infections.  In Europe, by contrast, economic activity is picking up, and the pandemic is largely under control.”

Chart II: 7 day rolling average of new COVID cases
Source: John Hopkins University / Statista

In July (chart II) the US was seeing alarming growth in COVID cases, while Europe seemed to have the virus more or less under control.  It’s not a coincidence that EURUSD began July at 1.12 and ended it at 1.18.  However, since the beginning of October, the European case numbers have increased rapidly, to a point where it is hard to argue that Europe is containing the virus any better than the US.  So far, however, this has not resulted in much of a correction lower for the euro.

Similarly, from an economic standpoint, it is hard to see much in the way of European outperformance, despite the EU’s enhanced social safety net and state involvement in the economy.  Yes, the US has experienced a greater increase in unemployment, but a lot of this is illusory (at least so far) as many workers are counted as unemployed when they are actually temporarily furloughed.

More importantly, in terms of the broader economy, the US is performing much better than Europe. According to the IMF, the US economy is expected to contract by 4.3% in 2020.  This is much better than the 8% contraction estimated back in June.  In Europe, the economy is expected to contract by 8.3%, almost twice as much as the US.  (It is also worth mentioning that the UK is looking particularly vulnerable, with the IMF predicting a 9.8% contraction this year).

So, why are we failing to see this expected European outperformance?  In terms of health outcomes, it is very difficult to ascertain why some countries perform better. For example, while Europe may have a better health care system (in general), it is also about three times more densely populated, and its population is about six years older on average. 

However, when it comes to the economics, one factor does stand out.  Somewhat counterintuitively, the size of the US fiscal response (estimated at about 13% of GDP) vastly outweighs that of the supposedly interventionist Europeans, which is less than 5% of GDP (although this does not include the impact of the state aid temporary framework announced in May).  While the US government has stepped up to directly (and permanently) replace lost private sector income with public spending, Europe has relied much more heavily on responses designed to provide temporary liquidity (e.g. tax deferrals, credit support). 

For all the plaudits the EU received when their EUR 750 billion COVID response fund (Next Generation EU) was announced in July, the shortcomings of the EU’s response are quickly becoming clear. In fact, many countries, like Portugal and Spain, have announced they will be forgoing the lending element of the plan, and only taking the grants (which amount to about 50% of the total programme size).  This makes the headline figure of EUR 750 billion more than a little misleading.   As the Spanish newspaper El Pais noted last week: “it seems obvious that the European funding program, known pompously as Next Generation EU, could end up a victim of its own success”. 

The European debt crisis, triggered by the Global Financial Crisis in 2008/9, resulted in an economic contraction of about 5%.  Following Europe’s underwhelming response to this crisis, the French economist Jean Pisani-Ferry noted: “Europe’s mistakes in economic policy will be studied in the history books”.  COVID will hit the European economy much harder than this previous crisis, and for all the early talk of Europe’s ‘Hamiltonian moment’, it is clear that while the European socio-economic model is set up to provide a high level of risk-sharing within countries, it has not yet shown it can do so between countries.  If it continues to fail this test, it is hard to see how the European economy can truly rival the US, and that talk of the euro displacing the US dollar as a reserve currency is premature at best.

Author: Kevin Lester