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How to get “Asian-sized” returns in Europe

Free-market US conservatives like to talk about  “old Europe.” They tell stories about the sclerotic EU bureaucracy, the intransigent French unions, and the rigid German banking system.

Problem is, they ignore the really interesting Europe. The Europe that is growing rapidly. The Europe with soaring productivity, low inflation, small public sectors, an excellent education system, and high foreign investment in factories that quickly learn to undercut their neighbors in Western European. This new Europe - centered around Poland, the Czech Republic, Slovakia and Hungary - is difficult for the average US investor to buy. But there are still some inbound pathways with solid profit potential. Let me explain…

The productive key to growth
As my readers in the Money Map Report know, productivity growth is the key to long-term gains. The United States manages productivity growth of just over 2% a year, Western Europe a little less, and Latin America an abysmally low 1% per annum. At the opposite end of the spectrum, wealthy Asian countries like South Korea and Taiwan enjoy productivity growth of more than 4% a year. This makes their companies more competitive year by year against their Western counterparts.

Poland, Hungary, the Czech Republic and Slovakia are all quite wealthy - much wealthier than their neighbors further east. Yet each of their productivity growth rates over the last five years are almost up to Asian standards: Poland (3.1%); the Czech Republic (3.3%); Hungary (3.4%); and Slovakia (4.9%). Real economic growth was also good in 2006, clocking in at 6.1% in Poland, 6.4% in the Czech Republic, and 8.3% in Slovakia.

Only Hungary (3.9%) was a little slower. Inflation, budgets, and balance of payments are all in balance or, at worst, are in a modest deficit. The lower growth in Hungary illustrates the one remaining political problem in the region. Electorates in former Communist countries like to throw their governments out every few years. (I guess it’s partly the thrill of being able to do so after so many years under Communism.)

However, throwing one government out means putting another one in, and in all these countries, until now, the Socialists have been the replacement party. The Socialists are generally opposed to the free market, corrupt and full of survivors from the Communist regime. That slows down economic progress, as it has in Hungary, where the Socialists have been back in power since 2002. In Slovakia, the bad guys were in power until 1998, but were then succeeded by a wonderful reformist government under Mikulas Dzurinda that introduced a 19% flat tax and brought rapid economic growth.

Alas, after the World Bank praised the Dzurinda government as the  “best reformist government in the world,” the Slovakian prime minister lost the 2006 election. So the country’s stellar growth in 2006 is likely to be the last such performance for some time to come. Poland, at last, found a way around this progress blockade. In Sunday’s election, the ruling  “social-conservative” Law-and-Justice government was thrown out - but wasn’t replaced by the Socialists, who got only 13% of the vote. Instead, they were replaced by the  “economic-conservative” Civic Platform.

Since Law and Justice were themselves pretty competent economically, the Polish electorate can now enjoy the pleasure of throwing out its governments, while replacing them only with other governments equally committed to the free market and economic growth. This is wonderful news for investors in Poland. And since these four countries tend to copy each other, it is likely to be wonderful news in the long run for investors in the other three countries, as well.

How to play emerging Europe
Since few stocks or American Depository Receipts (ADRs) are traded on the US exchanges, the best bet for emerging Europe is the Spider Standard & Poor’s Emerging Europe (GUR) exchange-traded fund (ETF). It invests in the share indexes of the Czech Republic, Hungary, Poland, Russia and Turkey. However this ETF was only founded in March, and currently has a market capitalization of only $39 million.

That’s up from $29 million a month ago. Of the five countries I just listed, Turkey’s also a good bet (though it may hiccup from the Iraqi-Kurdistan problem). I would only be nervous of Russia. There is also a closed-end fund, the $180 million Morgan Stanley Eastern Europe Fund (RNE), which trades at around net asset value. However, it has a high expense ratio of 1.6%, and invests mainly in Russia.

Mutual funds are usually for the risk averse. But in the case of the San Antonio, Texas-based US Global Investors Inc. (GROW), mutual funds are worth a look by conservative and aggressive investors alike. The reason: US Global’s funds are almost always top performers. Their US Global Accolade Eastern Europe Fund (EUROX) is no exception. You can invest in it with confidence. (Original & Related stories)