Sound The Alarm For Tech Vendors: The European Titanic Has Already Hit The Iceberg

Neither The Economist magazine nor the Organization for Economic Cooperation and Development (OECD) is known for being alarmist. So one pays attention when The Economist in the lead item ("Is this really the end?"; see also "The euro: Beware of falling masonry") in its November 26 issue stated: "The chances of the euro zone being smashed apart have risen alarmingly, thanks to financial panic, a rapidly weakening economic outlook and pigheaded brinkmanship." The OECD had similar strong words of concern in its press release ("OECD calls for urgent action to boost ailing global economy") announcing its latest "Economic Outlook": "Decisive policies must be urgently put in place to stop the euro area sovereign debt crisis from spreading and to put weakening global activity back on track."

For me, the economies of the European Union (EU) have disturbing similarities to the ocean liner RMS Titanic as it steamed across the Atlantic on that fateful trip in 1912. From the start when Greek debt crisis surfaced in early 2010, the leaders of the EU have consistently done too little, too late to keep the problem contained and manageable. The steps that could have been taken to change course were not taken. Instead, the EU ocean liner stayed on its course, right into the path of an iceberg of financial panic.

Like the iceberg that scraped holes below the waterline in the hull of the Titanic, the financial panic facing Europe will damage the real economy of jobs and business activity. That panic — manifested most obviously by the failure of a German bond auction last week — means not only that European governments like Italy and Spain are having to pay unsustainably higher rates on their bonds. It also means, as The Economist pointed out, that European banks have lost their access to wholesale funding, businesses and individuals are starting to pull deposits from weaker countries, and banks as a result are cutting back lending to consumers and businesses. European lending to Turkey, the Middle East, and Asia, which helps support European exports to those regions, are also contracting. As the normal lending that fuels growth disappears, so too will growth itself disappear.

Unlike the Titanic, Europe itself won’t sink. But the great experiment of the euro could. So the questions now are how much damage has already been done, and what will the European leaders and institutions — Germany and the European Central Bank (ECB), in particular — do to contain the damage and keep it from spreading?

Sadly, it now appears that an economic recession in Europe is almost unavoidable, unless the EU and ECB take immediate and decisive actions that are both unprecedented and unlikely. At best, the European economies will experience a moderate recession in 2012, with real GDP declining by 1% to 2%. That assumes that the European Central Bank does become more aggressive before the end of 2011 in acting as a lender of last resort, and that the EU by early 2012 begins issuing some European-wide Eurobonds that can be exchanged for at least some portion of the bonds of Italy, Spain, Portugal, Ireland, and Greece. These actions would probably be enough to hold the eurozone countries together long enough for a combination of debt and economic restructuring in the heavily indebted countries and a better system of fiscal controls and transfers to be put in place. But absent these steps, there is a high risk that one or more European countries would be forced to leave the euro, creating even worse financial strains and economic problems. If that happened, the European economies could experience declines in real GDP of 5% to 8%, or more.

For tech vendors, the hope which I have shared that European economies would muddle through 2011 and 2012 with weak but still positive growth must be put aside. Already, our index of European revenues of 45 leading tech vendors showed growth in euros of just 2% in Q2 2011, 1% in Q3 2011, and forecasts of 2% in Q4 2011. Communications equipment vendors have been experiencing declines in their euro-denominated revenues since Q1 2011. Those small increases occurred when European real GDP on a year-over-year basis grew by 1.8% in Q2 and 1.5% or so in Q3. With real GDP declines of at least 1% to 2% in prospect, vendors should expect their euro-denominated revenues in 2012 will fall by 3% to 5%, depending on which European countries they earn revenues in. If the euro breaks up and a deep recession hits, declines in euro revenues in Europe of 10% or more are possible. Even the advanced tech markets of the Nordics, the UK, and Switzerland — who have used the flexibility of their own currency to avoid the sluggish of the eurozone economies — and the large and healthy markets of Germany (and to a lesser extent France) will suffer as intra-Europe exports dry up.

For US vendors, the only silver lining will be a likely weakening of the Euro against the dollar, which means that in dollar terms European revenues may still post positive growth. But European vendors don’t have this recourse.