Tuesday, November 25, 2014

Early Retirement for the Eurozone?

NEW YORK – Whether the eurozone is viable or not remains an open question. But what if a breakup can only be postponed, not avoided? If so, delaying the inevitable would merely make the endgame worse – much worse.

Germany increasingly recognizes that if the adjustment needed to restore growth, competitiveness, and debt sustainability in the eurozone’s periphery comes through austerity and internal devaluation rather than debt restructuring and exit (leading to the reintroduction of sharply depreciated national currencies), the cost will most likely be trillions of euros. Indeed, sufficient official financing will be needed to allow cross-border and even domestic investors to exit. As investors reduce their exposure to the eurozone periphery’s sovereigns, banks, and corporations, both flow and stock imbalances will need to be financed. The adjustment process will take many years, and, until policy credibility is fully restored, capital flight will continue, requiring massive amounts of official finance.

Until recently, such official finance came from fiscal authorities (the European Financial Stability Facility, soon to be the European Stability Mechanism) and the International Monetary Fund. But, increasingly, official financing is coming from the European Central Bank – first with bond purchases, and then with liquidity support to banks and the resulting buildup of balances within the eurozone’s Target2 payment system. With political constraints in Germany and elsewhere preventing further strengthening of fiscally-based firewalls, the ECB now plans to provide another round of large-scale financing to Spain and Italy (with more bond purchases).

Thus, Germany and the eurozone core have increasingly outsourced official financing of the eurozone’s distressed members to the ECB. If Italy and Spain are illiquid but solvent, and large-scale financing provides enough time for austerity and economic reforms to restore debt sustainability, competitiveness, and growth, the current strategy will work and the eurozone will survive.

In the process, some form of fiscal and banking union may also emerge, together with some progress on political integration. But, however important the fiscal and banking union elements of this process may be, the key is whether large-scale financing and gradual adjustments can restore sustainable growth in time. This will require considerable patience from governments and publics in the core and periphery alike – in the former to maintain large-scale financing, and in the latter to avoid a social and political backlash against years of painful contraction and loss of welfare.

Is this scenario plausible? Just consider what must be overcome: economic divergence and deepening recessions; irreversible balkanization of the banking system and financial markets; unsustainable debt burdens for public and private agents; daunting growth and balance-sheet costs in countries that pursue internal devaluation and deflation to restore competitiveness; asymmetrical adjustment, with moral-hazard risks in the core and insufficient financing in the periphery fueling incompatible political dynamics; fickle and impatient markets and investors; austerity fatigue in the periphery and bailout fatigue in the core; the absence of conditions for an optimal currency area; and serious difficulties in achieving full fiscal, banking, economic, and political union.

If a gradual process of disintegration eventually makes a eurozone breakup unavoidable, the path chosen by Germany and the ECB – large-scale financing for the eurozone periphery – would destroy the core central banks’ balance sheets. Worse still, massive losses resulting from the materialization of credit risk might jeopardize core eurozone economies’ debt sustainability, placing the survival of the European Union itself in question. In that case, surely an “orderly divorce” now is preferable to a messy split down the line.

Of course, a breakup now would be very costly, requiring an international debt conference to restructure the periphery’s debts and the core’s claims. But breaking up earlier could allow the survival of the single market and of the EU. A futile attempt to avoid a breakup for a year or two – after wasting trillions of euros in additional official financing by the core – would mean a disorderly end, including the destruction of the single market, owing to the introduction of protectionist policies on a massive scale. So, if a breakup is unavoidable, delaying it implies much higher costs.

But politics in the eurozone does not permit consideration of an early breakup. Germany and the ECB are relying on large-scale liquidity to buy time to allow the adjustments necessary to restore growth and debt sustainability. And, despite the huge risk implied if a breakup eventually occurs, this remains the strategy to which most of the players in the eurozone are committed. Only time will tell whether betting the house to save the garage was the right move.

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    1. CommentedJohn Smith

      Professor Roubini has an undeserved reputation as a doom-monger. In reality, he is hopelessly optimistic, as in his wishful, wistful opinion that "breaking up earlier could allow the survival of the single market and of the EU".
      In the years leading up to the eruption of the crisis in 2007, exponentially-increasing aggregate debt in Europe & N America, combined with costcutting via massive and accelerating outsourcing of production and services to low-wage countries, succeeded in staving off dreaded recession. The famous can has been kicked along a very long road! Debt-financed consumption and cost-cutting/profit-boosting outsourcing were therapies that have now become pathologies: debt has prostrated the financial system and outsourcing has piled up vast, destabilising 'imbalances'. Transfixed by these side-effects, the economists forget the underlying disease of overproduction and stagnating profit that prompted recourse to these ultimately futile measures, and for which there are now no available remedies but trade wars and shooting wars. 'All roads lead into the crisis', as I argued in this paper: http://www.mediafire.com/view/?nianqs71hvd6vic

    2. CommentedNicusor Stanciu

      I don't understand why nobody want to see the truth.
      And that is this :
      - even the socialist theory (created by Marx and Engels) stipulate that the socialist facilities will exist in the MOST DEVELOPED CAPITALIST SOCIETY so the socialism will be the next stage of an economic society development, after the last stage of the capitalist ( estate monopolist ). But in practice the socialist facilities was trying to be used in the countries which have not arrived at that level of economic development, starting with the ..... feudalism Rusia and ending with all European countries (except UK) where the socialist parties have had the power many years after the second world war. So is normal that all this countries, who are trying to jump some real capitalist stages to can arrive at that supreme economic level which offer the power to sustain the socialist facilities, arrived at the moment when they have to accept the truth that they don't had and still not have yet that economic power to sustain such socialist facilities. From my point of view all the socialist politicians are like a mathematics teachers who learn their "children mind" electors that 1+1 = 3 because this is the best simple why in which they can obtain the vote from the mass. And if the end of this sovereign debts will be the money print from ECB, nobody will have a reason to work more efficient, to create more or at least to spend just how much they produce because it will be a proof that is possible to have a nice life also ..... in another way than to work or to create something for the society from which you ask that nice life. And actually that's the socialist dream.

    3. CommentedManuel Caraballo Callero

      The article is interesting and is considering making what many economists do right now: whether the Eurozone eventually survive or not.
      The question is very difficult to guess and economy science usually guess very bad.

      Therefore, we only have the ways Nouriel Roubini posed in this article.
      But I must point out that I have very clear that Germany would be that the ECB which is highly liquid dowry to periphery countries, if we look at the statements of this week by the German government and the Bundesbank in particular. Moreover, my opinion is rather the opposite: it is the German government who wants to lead the economic policy of the EU.

      Regarding the consequences of a disorderly break right now, I think Roubini has described perfectly. And none of them is attractive. Moreover, could result in breakage of the European Union dramatically.

      Finally, Roubini does not give too many solutions to the problem: a civilized divorce and negotiated now or a dramatic break in the future? The issue certainly is complex.

    4. CommentedPaolo Magrassi

      I love Dr. Doom! A media darling, he's been long «predicting» the collapse of the Eurozone: one day he'll prove right, as much as you would've, had you «predicted» the collapse of the Roman Empire in 10 B.C. Never, ever heard anything constructive from Dr. Doom: what consulting engagements does he get, other than ominous hoodoo speeches? LOL!

      PS: FYI, «to predict» an economic event means to specify its date and magnitude with sufficient accuracy so as to justify the cost of the response.

        CommentedPaolo Magrassi

        Jan, I do not want him to «go away». I think we need Roubini around like we need any other smart individual. I also clearly see and recognize the problems he describes. But the «predictions» and the surrounding media hype is crap. Furthermore, please be aware that biz school types are less inclined to scientific research than to business or political engagements.

        CommentedJan Smith

        Paolo, do you think your insults will make him go away, and you will be able to live in your bubble forever and ever?

    5. Commenteddonna jorgo

      perfect ..NR is exacte what you say..i think EUZ is like one ''animal''is bit very agly and trying to survive with soul and heart BUT ...the end.....
      i think too this leader EUZ did not read your article ?
      SHOULD DO ..because there needed one strong and right mind with out intres politice to find resolution ..IF they waiting for ''miracle''
      NOT COME ....work ....change mechanisme..not political intresess ..maybe maybe..can help ..(for me not)is too late... THANK YOU NICE ARTICLE

    6. CommentedDaniel Gomes

      The solution is simple, Germany must abide by the agreements it signed and stop interfering in th ECB and stop sabotaging the democratic process tat rules the ECB.

      Then once they take their claws off the ECB, it should announce that it will purchase as much sovereign debt as necessary at pre-crisis prices until speculators and panicky investors stop behaving irrationally.

      This could be done by printing money which would:
      1. Help to lower the currency value which is too overvalued! Despite most people's believes it still higher against most other currencies (including Asian and U.S) when compared to a decade ago!!!
      2. Raise inflation to healthy levels and erode European debt which is high is almost ALL EZ countries, not just in the so called PIIGS)
      3 As a consequence of the two aforementioned events, boost Europe's competitiveness.

      After all the same QE has prevented UK's broken economy from being cut off from the credit markets and even restarted the U.S. economy!

      And please don't bother me with debt mutualisation moral hazard.

      That should have been considered back in 2008 and 2009 when te ECB and Fed shoveled money into the financial system, in particular the German one which was greatly exposed to the U.S sub-prime unlike southern Europe.

    7. Portrait of Christopher T. Mahoney

      CommentedChristopher T. Mahoney

      No eurozone strategy can work in an environment of 1% nominal and 0% real growth. 5-6% nominal growth would allow real growth, an increase in government revenues, a balancing of government budgets, and a reduction in debt ratios as NGDP grows, and debt remains stable. The cost of such an exercise would be borne by existing bondholders (especially in the north), but they will have to suffer either way. NGDP growth can occur without any new treaties or pacts, if the Bundesbank would go along. Of course they won't, but in the end something will have to give. As NR says, the austerity/debt plan will only make the endgame that much worse.

    8. CommentedRoman Bleifer

      Europe has major problems. But that is no reason for apocalyptic scenarios. If we start from the problem of sovereign debt, the situation in Europe is worse than that of the U.S.. Without a doubt, the EU should deepen, go for some limitation of state sovereignty in favor of international regulatory institutions. The ideal would be to have some form of confederation. In spite of strong resistance, Europe will come to that. World crisis to force Europe to come to this.
      But the basis of no problems in finance and not in sovereign debt. They are only a manifestation of the global crisis that is systemic ( http://crisismir.com/analiticheskie-materialy/ekonomika/13-mirovoj-ekonomicheskij-krizis-prichiny-i-posledstviya-quo-vadis.html ). These are the problems and challenges of a very different, much more fundamental. This is a development issue. And these challenges will have to find an answer, regardless of the store or the collapse in the eurozone.

    9. CommentedMark Pitts

      The only options are

      (1) Painful and highly unpopular austerity in the South, or
      (2) Endless subsidies from the North, or
      (3) Breakup.

      I bet on (3) .

    10. CommentedLeo Zanakis

      Roubini doesn't understand Eurozone

        Portrait of Christopher T. Mahoney

        CommentedChristopher T. Mahoney

        I have been told for six years that "euroskeptics don't understand Europe" or "euroskeptics don't understand the eurozone". So far, everything predicted by the euroskeptics has happened, and nothing predicted by the eurozone's cheerleaders has proven accurate. Clearly, NR understands the eurozone better than the Juncker/Rehn/Barroso gang do.

    11. CommentedAndré Rebentisch

      No need for doom mongering! The North could at any time solve the issues via Eurobonds. Obviously they won't agree at this stage, and they won't let the Club Med off the hook unless their demands of financial order and discipline are met, not 'met' in the traditional ways, but multiple implementations of institutional concrete with sanctions and all. It is a vabanque game that the North cannot lose.

        CommentedDaniel Gomes

        I'm sorry, but what about the trillions of Euros and Dollars shoveled by the ECB (e.g Greeks, Portuguese, Spanish) and Fed to rescue the German financial system back in 2008 and 2009 after banks like Deutsche Bank ganged up with ratings agencies like that of Mr. Christopher T. Mahoney to destroy the world's financial system and subsequently the economy?

        Back then the southern European financial system was quite healthy and no southern European country rejected that ECB helped Netherlands, Germany, Belgium by socialising their debt and toxic assets!

        Had the ECB not socialised German debt the debt of those countries, high chances now the scenario would be the reverse of what we have today!

        I still find it hard to believe that I hear people saying the rubbish you say after such bailout to Germany in 2008 and 2009 which dwarfed any other known bailout in Europe!

        And do remember, despite your silly beliefs, Spain' debt is lower than Germany and so was Portugal until the onset of this crisis!

        So the question is, why can the ECB and FED secretely flood Germany with cash, but then the arrogant virgin prostitutes claim that we cannot allow such moral hazzard for the states of the south?

        And by the way, so far the only country to unilaterally default on its debt was Iceland, a very nordic country!

        And UK is in terrible financial mess and I don't think it's part of the so called club med!

        So please drop that northern supremacy rubbish, the facts are simple, ECB rescued Germany and the Benelux with tonnes of easy cheap money and now is denying any such help to southern europe!

        Portrait of Christopher T. Mahoney

        CommentedChristopher T. Mahoney

        Eurobonds compound the eurozone's over-indebtedness, thus spreading the disease northward. Eurobonds look BBB to me.

    12. CommentedAlexandros Liakopoulos

      Excellent work Mr Roubini, and I am not talking on the article, I am talking on your appointment as former Greece's PM George Papandreou' s Economic Adviser! You managed to destroy the Eurozone and the whole of the European Union, with a clear strategy that seeks to serve the American Deep State' s interests, which are in clear contradiction with American People' s interest. Through Greece and the European Peripheral debt, with your own well-payed advices, the world banking system - which created the current world economic mess under a framework of neoliberal expansion through ongoing shocks (see N. Klein in the Shock Doctrine) - seeks to buy its own merit of World Power, transferring to European constituents the cost of their own scams of the past. And while you serve them to do exactly that, afterwards you appear giving speeches and advices as an "independent thinker"! Well now... it would be much more ethical from your side (what am I talking about, huh?) if you would just state your purpose and your causes, while posting your "independent thoughts", Mr Roubini. Cause, as a Greek citizen who pays your "advices" and "forecasts" with his own wealth, health and life, I believe I have all the rights to ask about your incentives while publishing a view and/or article, which is in place to create in its own some market allocations of multimillion worth and also, "European and world political readjustments" that seem to be in the agenda of the World Banksters and their alliance with Rightwing Bush-ism and its definition of the American Interest, predominantly defined by the World Corporations' involvement in it...
      So, as a Greek and a European, as an international politics researcher and as a young person without sustainable future, thanks again for your advices and your ongoing commitment in destroying the world as we know it! I am sure some of the readers may not understand what I am talking about, but in the same time I am double sure that you do! Well done, we owe to you and some of your friends our own extinction... celebrate it, you did well!

    13. CommentedPieter Keesen

      The question mark in the title is correct. This article is below par and full of assumptions the author fails to argue in a coherent and cogent fashion. Mr. Roubini enumerates all the imbalances and challenges the EMU faces since the onset of the present economic decline. Yet how do all the different parts that comprise the Euro crisis interact with one and other, what are the options politicians have at their disposal, what is exactly the most principle dilemma? What are the parameters of the present conundrum.
      It would be so much more interesting to read about historical precedents to the present problem, I would be be interested to read how personal decisions shape European politics today, what the game is people play, and what the stakes exactly are. The euro crisis is an abstraction. Abstractions can die without consequence. What is of real consequence, is life, our way of life. If there is a crisis, I hope for the learned to act like a doctor, and diagnose the patient. Who is the patient, what is his condition, identify the ailment suffered, calculate the risks, and devise a treatment. The dignity of a learned man prescribes for him not to declare the patient death even before the crisis has ran it's course, just because it might prevent future suffering. The point of the crisis is after all for it to be a decisive moment. This decision is luckily not left to a New York professor.

    14. CommentedPaul A. Myers

      "Economic divergence" may well be the lever the cracks the eurozone apart. As the world economy recovers, the divergence in unit labor costs between the Euro Zone and the Advancing Economies will put huge pressures on Europe.

      A simple question: are there examples in past history where "endless" monetary policy has prevailed over structural deficiency?

      Maybe monetary policy never was a Big Bazooka. Maybe tough structural reform was the Long March to future prosperity.

    15. CommentedZsolt Hermann

      This solution would work only if there was truly a regional, cultural problem in the Eurozone, and not a general much deeper disease affecting all participants without any difference. And this is not even a European problem but a global one, Europe is just on of the symptoms.
      At this stage we still continue pointing fingers and we prepare cutting the ballast to let the other parts fly, but this is a very costly misunderstanding because the disease is general, and it is spreading.
      Using a medical example we can cut the rotten foot to save the body but if we did not correct the disease that made the foot rotten we have to keep cutting until nothing remains.
      Today even Germany started rotting according to the latest figures, not to mention other developing and fast growing countries in other parts of the global world.
      We should stop and think what did go wrong, what is ailing all of us?
      We try to mend the problems with the same methods, mentality and framework that has caused the problem in the first place.
      Even Einstein famously quoted that this was not a good idea.

    16. Commentedwarren matthei

      The analogy works, but the players are using a different type of "house money".
      Policymakers have come to rely upon the "Greenspan put", so that unlimited debt issuance is "on the house". EZ policymakers will clearly rely upon the ECB to print their way out of each succeeding crisis until full integration is attained. The strategy defies logic, history, laws of economics and common sense, but they believe they have no other option and in reality they probably do not.
      If the EZ dissolves every government will fall, and political instability could become a serious problem. Students of European history between the Fall of Rome and 1989 are perhaps those most wishful about survival of the EZ.

      I hope the EZ will reach its goal of political and fiscal integration. However, most economists agree that the currency union never made sense as a stand-alone project since it was not an OCA; so if the integration project cannot be completed within a reasonable time frame, the EZ will certainly fall apart. However, the probability of a completion of the integration project any time soon seems almost remote.
      Roubini's work on the EZ crisis has been exhaustingly thorough, timely and balanced. It seems that he has established an authoritative franchise on the subject.

    17. CommentedFrank O'Callaghan

      Excellent article. But it might have been wise to look at the fundamentals of the crisis. Germany's strength is both intrinsic and extrinsic. The extrinsic part is a consequence of being able to export without currency appreciation. This is a consequence of the less industrially competitive components of the eurozone. It has allowed Germany and some others to increase their intrinsic strengths.

      It is therefore fair to say that German unemployment is in Greece and Spain and burdens the exchequer of each of these 'peripherals'. An intelligent and fully integrated system would have balanced this better. Perhaps the example of Italy with it's 'Germanic' north and 'Greek' south is an unwelcome one.

      If the euro is too break up, there is no bright future for Germany as the core of a northern fortress. That is the road to decline.

      The current situation is not so much betting the house to save the garage as it is a case of reckless miners who have failed to shore up their mineshaft. Calling the strongest neighbour to hold up the roof while the ones who caused the problem exit is morally wrong and practically foolish. That is the current situation as the risky bonds are being transferred to the public account while paying the full value to private investors who have made bad bets. This process began with Ireland's casino and has now spread through the zone.