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Monday, February 18, 2013

Celebrating the end of the eurozone affair ignores the heart of the matter

In today's Telegraph, Mats Persson seeks to answer this simple - and yet brutally complex - question: is the eurozone crisis over?

'We are in the middle of the beginning of the end. The crisis has really hit its peak”, former French economy minister and current IMF chief Christine Lagarde told a broadcaster when asked about the eurozone crisis. The only problem: that was in July 2010. Time and again, EU leaders have declared the crisis over – and been proven wrong. So with markets remaining cautiously optimistic about the euro, is the worst finally behind us?

There are well-rehearsed reasons to be cheerful. Borrowing costs are down for all crisis-stricken countries, exports are picking up in some and EU leaders have actually agreed on a forward-looking measure by turning the ECB into a single supervisor for eurozone banks. Just as eurozone leaders have celebrated prematurely, Anglo-Saxon analysts have consistently tended to overstate the immediate risk of a eurozone break-up. Famously, one major US bank last year assigned an 80pc-90pc risk of Greece leaving the euro – an assessment that Open Europe cautioned strongly against. In Europe, the safest money is always on another fudge. Germany and the ECB were likely to take a political decision to keep Greece inside the eurozone for now, given the fragile situation elsewhere.

But the news last week that the eurozone economy shrunk by 0.6pc in the last quarter of 2012 illustrated what was always the bloc’s greatest challenge: reversing chronic economic malaise. Most fundamentally, reconciling a supranational currency with 17 national democracies remains a challenge. The eurozone’s basic austerity-for-cash prescription continues to fuel tension within individual countries and between the hawkish north and the austerity-fatigued south, testing voters’ patience. The forthcoming Italian elections are turning into a bit of a referendum on EU-mandated austerity, just like the Greek elections last year. Five of the seven main political parties – together polling at around 50pc – have vowed to end cuts. Two parties, Lega Nord and the Five Star Movement, the latter led by comedian-cum-politician Beppe Grillo, even want a referendum on whether the country should remain in the eurozone. The everlasting Silvio Berlusconi is making last-minute gains, in part thanks to a promise to kill what he calls “austerity imposed by Europe”. Against all known principles of common sense, the man still could win. Thankfully, a broadly pro-reform, centre-left coalition led by Pier Luigi Bersani is the most likely outcome, but even then the hope of sweeping economic reforms will be tempered, not least due to those parties’ strong links to the unions.

The Italian elections show how the north and Club Med in many ways are locked into a Catch-22: one wants cash (“solidarity”) first, supervision or discipline second, the other the exact opposite. That dynamic is again evident in the ongoing difficulties in agreeing a bail-out for Cyprus: Germany is unwilling to put in cash for fear of rewarding the bloated Cypriot financial sector. Cyprus resists far-reaching privatisations or significant write-downs of its banking or sovereign debt. This north-south stalemate could become further entrenched if French president Francois Hollande continues to slide towards the Mediterranean bloc, both in terms of political temperament and growth rates (France registered zero growth in 2012). This would weaken the Franco-German axis.

And beyond politics, has the eurozone’s triple crisis – fiscal, banking and competitiveness – really been addressed in any fundamental way? Many eurozone countries are on the path to running a primary surplus – meaning income exceeds outgoings, excluding the cost of servicing a country’s debt. But the eurozone’s overall debt still stands at 90pc of GDP, compared to 70pc in early 2010. Greece, Italy, Portugal and soon probably Cyprus, have debt levels exceeding 120pc of GDP – double what is meant to be allowed under eurozone rules.

The banking sector, too, remains fragile. Thankfully, ECB action helped avoid a massive bank funding crisis last year, but there is a price: eurozone banks have become alarmingly reliant on artificial life support. Liquidity from the ECB to banks now tops €1 trillion (£860bn) – up €140bn on 2009. Even though some banks have started to pay back the cash they owed the ECB early, the eurozone is a long way off a back-stop to allow for wind-downs of bust banks or disentangling of bank and government debt. Overnight interbank lending – a key indicator of banks confidence in the system – remains only half of what it was in 2009 and a third of its peak in 2007. If the crisis were solved, this would surely not be the case.

Finally, by almost every indicator, the single currency is absolutely riddled with economic imbalances, but with no fiscal facility to compensate for them. Encouragingly, Spain, Portugal and in particular Ireland have cut unit labour costs relative to Germany – a key measure of competitiveness - but Italy and France are actually becoming less competitive in relative terms. And imbalances go far beyond labour cost. This year, Greece is expected to contract by over 4pc, Spain by 1.5pc and Cyprus by almost 2pc – while Germany, Finland and others are set for growth. Then there is unemployment. Shockingly, Greek unemployment hit 27pc towards the end of last year, with youth unemployment close to 62pc. Spain is not much better at 26pc and 55pc respectively – and all the scheduled reforms and cuts haven’t even been implemented yet. In Germany, meanwhile, unemployment is at record lows.

In a best-case scenario, the Mediterranean countries will follow the Irish example and continue to squeeze wages and cut costs at home. But in light of domestic political resistance, these imbalances could well continue to test the eurozone’s one-size-fits-all model for a very long time.

So, we have an election fought over EU austerity, political stalemate, a bail-out which no one wants to pay for, abysmal growth forecasts and massive unemployment. There may come a day when the eurozone bounces back and puts us all to shame. But to celebrate now the “end of the crisis” seems to be setting the bar exceptionally low.


Jesper said...

Again I'll be talking about the meaning of words....

A crisis is temporary in nature, a bad situation can be had for a long time. When is a crisis no longer a crisis but instead a bad situation?

A crisis calls for quick and decisive actions.
Resolving a bad situation allows for more time to find the best solution.

I'd say that the crisis is over and now we're slowly dealing with a bad situation. Structural unemployment, opaque back-room dealings between bankers and politicians (previously also including property developers), tax-evasion and so on. Except for increasing transparency there is no quick fixes and the benefits of transparency will take time to notice.

& for the ones asking for fiscal transfers (supporters of the optimal currency area theory): What has years of fiscal transfers within Italy (north to south) achieved? Better governance, less corruption or?

Rik said...

Until things have bottomed out (or when it is clear when they will bottom out) nothing is solved.

1. Looks like especially the stockmarket is close for a correction. QE have driven a lot of money to especially the asset market we are now probably 10 to 20% higher than on fundamentals. Basically roughly at the point at which big players start to leave the building (carefully not to disturb the rest).
There are some people who think it will keep going on like that, but difficult to see how when half or so will be selling iso buying. You would need (much) more QE to continue the party. Furthermore QE looked to be priced in. Meaning that if somewhere lateron the CBs leave the 15% or so manipulated pricerise will be reversed. This stil will have to be priced in. Who will keep shares if they are rising in value as the bubble as let out? Muppets and there are not enough of them. Markets have been clearly pricing QE in, but the fact that somewhere it will be reversed means that the price will be back to normal is not priced in.
Basically leaving a market at the top of the band that is only good for short term trading not longer term investing.

2. I always wonder why people pay so much attention to what these people say. First of all except Draghi they simply havenot got a clue what they are talking about. Hollande just ran his country's economy aground in 1/2 year, but still we should be interested according to the media in his economic views. We should only be interested in their political views (what they do). Economic assessments are only relevant as far as these influence political decisionmaking. The assessments itself are of less value than what you got in the average pub. At least overthere they are not liars.

3. What do you expect them to say when they think we are short for collapse: 'Everything is going well'. And what if everything is going well: well the same. What they say is only interesting when they say something new (give an idea of future policies) or something we not expect. So 'the economy is bad worst yet to come' is news, 'crisis is over' no news.

Anyway still a lot of steps to take before things have bottomed out (without major calamities). And each step has its risks. Political, will politicians in all relevant countries go with it; are elections insight? And economical, how will markets react you can have some indication thereof but at the end of the day it will be determined by the whole picture at the time it happens which is very diffuicult to oversee. And social all those nice protests for instance. In a nuthshell nobody knows if all obstacles can be cleared. My calculated guess is there simply still too many to come, simple stats say if there are a lot of them likley somewhere something will go wrong. When and where we donot know. It is mainly political my guess is somewhere in the South the voters crumbling under the constant austerity pressure.

Rik said...

On Italy.
Very likely Monti is by far the best person the get Italy through the crisis technically. However he needs politicl support to do so. there the probelms start:
-he is as charismatic as Van Rompuy;
-he has no own major political party he is leader of;
-people (a lot of them) are stil buying alot of rubbish from guys like Berlusconi.
Monti not making it would be a real problem (probably polls indicate he gets some sort of support but not completely. Leaving Monti with a somewhat eroded powerbase.

Berlusconi not very likley seen the polls but these have been proven to be very unreliable all over the place in the US and Europe. Subsequently what would he do if elected. If he is out for refenge he can do a lot of harm. If he get Draghi in dicted (as should happen in a normal criminal justice system) the ECB has a huge problem. Or even worse take Italy out of the Euro. Or goes for a kamikaze strategy towards Germany (that these will not buy as political capital has nearly been burned up).

In general how good are things under control. Merkel assumes 2 months ago no new problems before electiontime. We likely see Cyprus, Spain and Greece I donot see them making it till the election so requiring a 3.0. Portugal needs an new larger package. All in one time didnot work either.

christina speight said...

It's unbelievable that anyone should even pose such a batty question.

The intro here says with charming understatement - "reconciling a supranational currency with 17 national democracies remains a challenge"

The intro above nods vaguely in the direction of mounting recession but merely as an obversation . The cobscene level of unemployment is ignored.

The plain fact is that there is NO hope of "reconciling a supranational currency with 17 national democracies" because it cannot be done. Until the dreamers and fanatical believers across europe recognise that Europwe is doomed to decline or even worse - collapse and even revolution.

The mind boggles at such crass human stupidity!

jon livesey said...

To ask if the crisis is over is really the wrong question, because the monetary, fiscal or debt crisis is just a symptom of a deeper economic problem.

The euro is a single currency shared by countries such as Germany that have historically had low inflation expectations and low nominal wage settlements, and peripheral countries that traditionally had high inflation expectations and high nominal wage settlements.

If a country in a common currency allows high nominal wage settlements, it will inevitably lose competitiveness versus Greater Germany. That's how we got the current crisis, and if that doesn't change, it's how we will get the next crisis.

It is tempting to say "No worries, since austerity will keep a cap on wage settlements by causing elevated unemployment".

But then there are two serious problems. High youth and long-term unemployment rates do a lot of damage to societies, and we saw in the Thirties where that damage can lead.

Secondly, unlike a devaluation of a national currency, which falls on all segments of society and reduces the value of debt as well as incomes, internal deflation falls mostly on wage-earners, and reduces wages without reducing the real value of debt.

So the problem never goes away. It just reappears in a new form. If you fix the debt problem via austerity, the underlying disparities in competitiveness either re-appear, or show up as social damage and even violence.

We know this, since we have performed the experiment before, and the results were not encouraging.