Where to from here, Europe? Some experts share their views.
Summary: Slowly Europe’s crisis evolves. Although the outcome remains invisible (the endgame lies ahead), they have started to make choices. It’s a process that cannot be halted, leading to either unification or division. Here we see some experts’ explainations of current events. Read carefully, so as to understand the crisis that lies ahead for America.
What we need now is really bold leadership from European politicians and the ECB. Also peace, love, brotherhood, and a pony for everyone, which seem about equally likely.
— Paul Krugman, New York Times, 7 November 2011 (source here)
- Two summaries of Europe’s economics
- Why recent events have changed the game
- Kenneth Rogoff explains why the Euro should fall in value
- Nouriel Roubini explains why Europe’s current policies will fail
- An afterword, putting current events in a larger context
- For more information about Europe’s crisis
(1) Two summaries of Europe’s economics
(a) How sick is Europe?
It’s not sick, just poorly organized, as explained in this Special Report by Bank Credit Analyst, 11 August 2011:
The Euro area is a paradox. If it were one nation with the ability to raise taxes and issue bonds as a union, it would look better than the U.S., Japan or the U.K. on some of the key financial metrics that matter to investors: government debt and deficits, the consumer debt overhang, and the trade balance, to name a few.
(b) Europe needs growth, but gets recession
Europe’s rescue plans require growth. In theory, austerity will reduce the PIIGS’s deficits. In practice it slows their economies, reducing tax revenue and increasing government expenditures. As the resulting recession spreads from the weaker south to the core (note recent grim data from Germany), it will likely disrupt the fragile political coalitions supporting the rescue plans.
This is almost inevitable, as explained in this excerpt from a report by Paul Schulte, CCB International (formerly China Construction Bank), 4 November 2011:
The bottom line is that when your economy is REleveraging, politicians can do nothing wrong. When your economy is DEleveraging, politicans can do nothing right. Politicians almost never volunteer to force deleveraging since it is political suicide. They wait for the market to do it and then find scapegoats.
(2) Why recent events have changed the game
“The game Changer – Ongoing debate offers hope”, Carsten Brzeski (Senior Economist), ING, 4 November 2011 — Excerpt:
A referendum that never became a referendum and a threat that was just a bluff. Developments over the last few days were, in our view, a crucial game changer in the Eurozone sovereign debt crisis. All of a sudden there is an increasing awareness that there is more to crisis management than either German willingness to put tax payers’ money on the table or Franco-German agreements. The success of bailout packages depends on the receiving countries’ willingness to implement austerity measures and structural reforms.
Papandreou’s gambit has set a precedent and shows that there could be an alternative to bailout packages, which could include disorderly defaults and Eurozone exits.
… An important conclusion of the last days is that peripheral countries are not as powerless as it sometimes seems. As long as a country cannot be kicked out of the Eurozone, Papandreou’s gambit shows that there could be an alternative to bailout packages. Other governments could follow, trying to balance the risks of opting for the shock therapy of disorderly default within the Eurozone and the loss of national sovereignty as part of a bailout. Merkel’s and Sarkozy’s threat this week could quickly turn out to be a bluff.
(3) Why the Euro probably will fall in value
“A Gravity Test for the Euro“, Kenneth Rogoff (Prof Economics at Harvard, former Chief Economist of the IMF), Project Syndicate, 3 November 2011 — Excerpt:
Although I appreciate that exchange rates are never easy to explain or understand, I find today’s relatively robust value for the euro somewhat mysterious. Do the gnomes of currency markets seriously believe that the eurozone governments’ latest “comprehensive package” to save the euro will hold up for more than a few months?
The new plan relies on a questionable mix of dubious financial-engineering gimmicks and vague promises of modest Asian funding. Even the best part of the plan, the proposed (but not really agreed) 50% haircut for private-sector holders of Greek sovereign debt, is not sufficient to stabilize that country’s profound debt and growth problems.
So how is it that the euro is trading at a 40% premium to the US dollar, even as investors continue to view southern European government debt with great skepticism? I can think of one very good reason why the euro needs to fall, and six not-so-convincing reasons why it should remain stable or appreciate. Let’s begin with why the euro needs to fall.
Absent a clear path to a much tighter fiscal and political union, which can lead only through constitutional change, the current halfway house of the euro system appears increasingly untenable. It seems clear that the European Central Bank will be forced to buy far greater quantities of eurozone sovereign (junk) bonds. That may work in the short term, but if sovereign default risks materialize – as my research with Carmen Reinhart suggests is likely – the ECB will in turn have to be recapitalized. And, if the stronger northern eurozone countries are unwilling to digest this transfer – and political resistance runs high – the ECB may be forced to recapitalize itself through money creation. Either way, the threat of a profound financial crisis is high.
(4) Why Europe’s current policies will fail
“Four Options to Address the Eurozone’s Stock and Flow Imbalances: The Rising Risk of a Disorderly Break-Up“, Nouriel Roubini, Roubini Global Economics, 1 November 2011 — Subscription only. Excerpt:
The latest eurozone (EZ) rescue package starts to deal with some but not all of the stock imbalances (large and potentially unsustainable debt levels in the public and private sectors) between the core and periphery of the bloc, but does not address the serious flow imbalances (lack of growth and competitiveness and large current account and fiscal deficits in the periphery) and, as such, will not resolve the monetary union’s fundamental problems.
The package fails to recognize that the restoration of growth and competitiveness are the key to success as they make stocks of liabilities more sustainable and reduce flow imbalances (such as current account and fiscal deficits); in fact, the proposals heighten the risk of a deeper and longer recession. Thus, financial engineering alone is bound to fail, as markets started to recognize soon after the new plan was announced.
… The international experience of “internal devaluations” is mostly one of failure.
… Some EZ periphery members — notably Ireland — are undergoing a degree of internal devaluation, but it is too slow and small to rapidly restore competitiveness: A fall in public wages may, in due course, push down private wages in traded sectors and eventually reduce unit labor costs.
Finally, the deflation route to real depreciation — even if it were politically feasible — makes the private and debt unsustainability problem more severe: After prices and wages have fallen 30% after a painful deflation, the real value of private and public debts would be 30% higher, making the case for a sharp reduction in unsustainable debts even more compelling.
Some EZ countries — notably Ireland — may have a better chance of restoring their competitiveness via internal devaluation than others — Portugal, Greece, Cyprus. Ireland has a large and productive manufacturing base — as two-thirds of its manufacturing industry is owned by multinational firms — many in tech or high-value-added sectors — that made a lot of FDI in Ireland in the past two decades to create an industrial base — in a low corporate tax economy — for their European and international production activities. So, Ireland, with some difficulty, could regain its competitiveness in due time if the fiscal adjustment more rapidly leads to a change in the relative prices of traded to nontraded goods.
But, in the case of Greece, Portugal and Spain, the problems of competitiveness are much more chronic and un-resolvable without a nominal currency depreciation: They have permanently lost export market shares in labor intensive and low-value-added sectors — textile, apparel, leather products, light labor intensive manufacturing — to EMs with much lower unit labor costs (Asia, Turkey, Eastern Europe) and they don’t have the high-value-added tech industries of Ireland, for example. Also, in these periphery countries (unlike in Ireland), productivity growth was mediocre even in the years of positive economic growth and restoring comparative advantage without a sharp and rapid real depreciation looks less likely to be achievable.
(5) An afterword, putting current events in a larger context
Eric Kraus, Truth and Beauty, 6 October 2011:
What is unfortunate is that much of the commentary about Europe is now focused upon what should have been done a decade ago, as well as upon the moral rights and wrongs of fiscal transfers and burden-sharing – fit subjects for theologians and future historians, but totally irrelevant when faced with a clear and present danger of financial Armageddon. The interesting question is not what should have been done but rather, what now needs to be done!
(6) For more information about Europe’s crisis
- “Europe’s Plan To End the Debt Crisis – Putting The “Con” in “Confidence”, by Satyajit Das, Naked Capitalism — Part 1 and Part 2
Other articles on the FM website about Europe’s crisis:
- The post-WWII geopolitical regime is dying. Chapter One , 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
- Can the European Monetary Union survive the next recession?, 11 July 2008
- The periphery of Europe – a flashpoint to the global economy, 8 February 2010
- A great speech by the PM of Greece. How soon until an American President says similar words?, 3 March 2010
- Governments cannot go bankrupt, 2 April 2010
- Our government’s finances are broken. How do we compare with our peers?, 8 April 2010
- The EU does Kabuki for Greece. Is it the next domino to fall?, 14 April 2010
- About the Euro crisis: the experts are wrong; the German people are right., 7 May 2010
- Former Central Bank Head Karl Otto Pöhl says bailout plan is all about ‘rescuing banks and rich Greeks’, 20 May 2010
- The Fate of Europe, nearing the point of decision, 13 September 2011
- Europe drifts towards the brink of a cataclysm, 26 September 2011
- Delusions about easy fixes for Europe, dreaming during the calm before the storm, 30 September 2011
- Every day the new world emerges, yet we see it not. Like today, as Europe begs China for loans, 15 September 2011
- Is Europe primed for chaos, as it was in July 1914?, 7 October 2011
- We see the outlines of the next cure for Europe. Will it work?, 14 October 2011
- Today Europe’s leaders took another step towards the edge of the cliff, 27 October 2011