A brilliant and provocative but pessimistic analysis by Albert Edwards of Société Générale: “To cut or not to cut? Actually it doesn’t really matter. We’re stuffed anyway!”, 12 February 2010. With links to even better analysis by Richard Koo. Must-reading for anyone seeking to understand this crisis. Excerpt:
My own view of developments, for what it is worth, is that any help given to Greece merely delays the inevitable break-up of the eurozone. But, for me, the problem is not the size of the government deficit and the solvency or otherwise of the governments in the PIGS (Portugal, Ireland, Greece and Spain we deliberately exclude Italy).
The problem for the PIGS is that years of inappropriately low interest rates resulted in overheating and rapid inflation, even though interest rates might well have been appropriate for the eurozone as a whole. Rapid inflation has led to overvalued bilateral real exchange rates (they do still notionally exist) for the PIGS and in most cases yawning double-digit current account deficits. With most trade done with other eurozone countries, the root problem for the PIGS is lack of competitiveness within the eurozone – an inevitable consequence of the one size fits all interest rate policy. Even if the PIGS governments could slash their fiscal deficits, as Ireland is attempting, to maintain credibility with the markets in the short term, the lack of competitiveness within the eurozone needs years of relative (and probably given the outlook elsewhere, absolute) deflation. Hence the PIGS public sector deficit will inevitably remain large as a direct consequence of this weak growth outlook.
In my opinion this will not be tolerated by the electorates in these countries. Unlike Japan or the US, Europe has an unfortunate tendency towards civil unrest when subjected to extreme economic pain. Consigning the PIGS to a prolonged period of deflation is most likely to impose too severe a test on these nations. And the political consensus within the PIGS to remain in the eurozone could falter in the face of another of Europe’s unfortunate tendencies: the emergence of small extreme parties to take advantage of any unrest. My own view is that there is little help that can be offered by the other eurozone nations other than temporary confidence-giving sticking plasters before the ultimate denouement: the break-up of the eurozone.
About the economic crisis of the developed nations
Note: A copy of this graphic appears in this report (earlier, by different author but same firm).
I am persuaded though by Richard Koo’s book about the lessons from Japan’s balance sheet recession. The crux of his analysis is that governments have no option but to stimulate aggressively all the while the private sector is de-leveraging. ANY attempt at fiscal cuts simply results in renewed recession and a further loss of confidence, thus making it even harder and more costly to sustain any subsequent recovery and hence the budget deficit ends up bigger than before.
For a deeper understanding of these events, I recommend reading Richard Koo
Richard C. Koo is Chief Economist of the Nomura Research Institute, Tokyo.
- “‘Plan B’ for the Global Financial Crisis“, presentation at the Center for Strategic and International Studies, 22 October 2008 — Here is a PDF of his slides.
- Interview of Koo by Kate Welling, Welling @ Weeden, 11 September 2009
- The Holy Grail of Macroeconomics, Revised Edition: Lessons from Japans Great Recession (2009)
For more information from the FM site
To read other articles about these things, see the FM reference page on the right side menu bar, including About the FM website page. Of esp relevance to this topic:
Posts about forecasts and warnings :
- We have been warned. Death of the post-WWII geopolitical regime, 28 November 2007 — A long list of the warnings we have ignored, from individual experts and major financial institutions.
- Geopolitical implications of the current economic downturn, 24 January 2008 – How will this recession end? With re-balancing of the global economy — and a decline of the US dollar so that the US goods and services are again competitive. No more trade deficit, and we can pay our debts.
- Consequences of a long, deep recession – part I, 18 June 2008
- Consequences of a serious US recession – part II, 19 June 2008
- Consequences of a long, deep recession – part III, 20 June 2008
- The most important news of the month. Perhaps the year., 29 September 2008 — Warnings from our foreign creditors.
- Forecasting the results of this financial crisis – part I, about politics, 13 October 2008
- Forecasting the results of this financial crisis – part II, a new economy for America, 14 October 2008
- A look at out future, 2009 – 2010 … and beyond, 9 November 2008
- America on its way from superpower to banana republic, 28 March 2009
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