Saturday, November 22, 2014

Europe’s Short Vacation

NEW YORK – Since last November, the European Central Bank, under its new president, Mario Draghi, has reduced its policy rates and undertaken two injections of more than €1 trillion of liquidity into the eurozone banking system. This led to a temporary reduction in the financial strains confronting the debt endangered countries on the eurozone’s periphery (Greece, Spain, Portugal, Italy, and Ireland), sharply lowered the risk of a liquidity run in the eurozone banking system, and cut financing costs for Italy and Spain from their unsustainable levels of last fall.

At the same time, a technical default by Greece was avoided, and the country implemented a successful – if coercive – restructuring of its public debt. A new fiscal compact – and new governments in Greece, Italy, and Spain – spurred hope of credible commitment to austerity and structural reform. And the decision to combine the eurozone’s new bailout fund (the European Stability Mechanism) with the old one (the European Financial Stability Facility) significantly increased the size of the eurozone’s firewall.

But the ensuing honeymoon with the markets turned out to be brief. Interest-rate spreads for Italy and Spain are widening again, while borrowing costs for Portugal and Greece remained high all along. And, inevitably, the recession on the eurozone’s periphery is deepening and moving to the core, namely France and Germany. Indeed, the recession will worsen throughout this year, for many reasons.

First, front-loaded fiscal austerity – however necessary – is accelerating the contraction, as higher taxes and lower government spending and transfer payments reduce disposable income and aggregate demand. Moreover, as the recession deepens, resulting in even wider fiscal deficits, another round of austerity will be needed. And now, thanks to the fiscal compact, even the eurozone’s core will be forced into front-loaded recessionary austerity.

Moreover, while über-competitive Germany can withstand a euro at – or even stronger than – $1.30, for the eurozone’s periphery, where unit labor costs rose 30-40% during the last decade, the value of the exchange rate would have to fall to parity with the US dollar to restore competitiveness and external balance. After all, with painful deleveraging – spending less and saving more to reduce debts – depressing domestic private and public demand, the only hope of restoring growth is an improvement in the trade balance, which requires a much weaker euro.

Meanwhile, the credit crunch in the eurozone periphery is intensifying: thanks to the ECB long-term cheap loans, banks there don’t have a liquidity problem now, but they do have a massive capital shortage. Faced with the difficulty of meeting their 9% capital-ratio requirement, they will achieve the target by selling assets and contracting credit – not exactly an ideal scenario for economic recovery.

To make matters worse, the eurozone depends on oil imports even more than the United States does, and oil prices are rising, even as the political and policy environment is deteriorating. France may elect a president who opposes the fiscal compact and whose policies may scare the bond markets. Elections in Greece – where the recession is turning into a depression – may give 40-50% of the popular vote to parties that favor immediate default and exit from the eurozone. Irish voters may reject the fiscal compact in a referendum. And there are signs of austerity and reform fatigue both in Spain and Italy, where demonstrations, strikes, and popular resentment against painful austerity are mounting.

Even structural reforms that will eventually increase productivity growth can be recessionary in the short run. Increasing labor-market flexibility by reducing the costs of shedding workers will lead – in the short run – to more layoffs in the public and private sector, exacerbating the fall in incomes and demand.

Finally, after a good start, the ECB has now placed on hold the additional monetary stimulus that the eurozone needs. Indeed, ECB officials are starting to worry aloud about the rise in inflation due to the oil shock.

The trouble is that the eurozone has an austerity strategy but no growth strategy. And, without that, all it has is a recession strategy that makes austerity and reform self-defeating, because, if output continues to contract, deficit and debt ratios will continue to rise to unsustainable levels. Moreover, the social and political backlash eventually will become overwhelming.

That is why interest-rate spreads in the eurozone periphery are widening again now. The peripheral countries suffer from severe stock and flow imbalances. The stock imbalances include large and rising public and private debt as a share of GDP. The flow imbalances include a deepening recession, massive loss of external competitiveness, and the large external deficits that markets are now unwilling to finance.

Without a much easier monetary policy and a less front-loaded mode of fiscal austerity, the euro will not weaken, external competitiveness will not be restored, and the recession will deepen. And, without resumption of growth – not years down the line, but in 2012 – the stock and flow imbalances will become even more unsustainable. More eurozone countries will be forced to restructure their debts, and eventually some will decide to exit the monetary union.

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    1. CommentedPrasanna Srinivasan

      EU can look towards regaining competitiveness by taking cuts in wages and looking for overseas business (non-EU) based on this. A large part of the deficits run up by govts have essentially been propping up standards of living/real income in these countries without corresponding productivity increases to boost incomes - something Germany has successfully done. In the medium to long term, many EU countries will have to readjust their expectations of the relatively luxurious standards of living they enjoy if they are to generate incomes based on competition from elsewhere or create high value propositions that also employ large numbers (difficult to do).

    2. CommentedJonathan Lam

      gamesmith94134 08:07 06 Oct 11

      Gamesmith94134: Catching up is so very hard to do 67

      Justlistenall said well, ”how about “nations of higher living standards” in lieu of “rich nations”, except for those who really qualify as such?” It was not the yuan or GDP that make China the emerging nation; and the fact is the affordability that gives impetus to growth and not the higher living standard.

      If the rich nations must catch up the up-ward growth spiral, they must cut their living standard to make its people live to grow, instead of, strive to survive. The rich nations are only think of their people are rich but they are not; not afford to consume make its economies anemic. If they want to catch up, they must make it affordable for their people.

      Even if the troika can get 2 trillion to cover the PIIGS, the onward slow or anemic growth is not getting to the level of the proportion on the normalcy. In addition, the solution is short of the fiscal and tax equation among its EU members. Then, the 2 trillion would be spent in vain if the present higher living standard does not meet its affordability level, then, there is no demand to consume. It is still no growth if the durables or oil do not go down enough to provide the cash flow that will change the marginal affordability level and ready to consume.

      The bank or central bank may free of the old debts with the fresh new debts like the 2 trillion with longer term bonds with low interest, however, the low rate will halt lending to commercial based on the non-profitable, eventually, it will die or go bankrupt itself unless banking cut its own size like BOA or JPM. Such condition will turn into another tourniquet to the commercial needs if the bonds are not restructured by 2013 with the short-term basis. Depression will become inevitable even the BRICS can help to restructure the loans.

      Inflation and deflation is much as virus in fever and cold to one body as it is to an economy; it is understandable that disease works with one’s body to create its anti-biotic to fight diseases. Now, what our economist is facing the anemic economy with too much of sterilization with sub-prime and long-term interest rate that the body or the economy will not respond till the inflation or deflation can take its effects to make the economy change.

      In order to face reality, EU and US must settle on the coming depression, deflation helps in cutting the cost of living in a down turn spiral till the private industries can use human capitals in a lower valuation in wages. If the affordability allows more consumption; then, production will rise. Eventually, growth comes only after there is demand of it.

      If there is no systematic cut the valuation of the present, and the lowest interest of today only make the financial industry suffers. Let the nature take its course to adjust. Any attitude like no on my watch can only make it-- Japanification.

      If the economy is immune to inflation or deflation, then, valuation on price is not valid. I was not surprise if gold can fall 6% in a day; and how about you, Soros? What is you gold standard of monetization if immunization stands?
      Anything else is just excuses, isn’t it?

      May the Buddha bless you?

    3. CommentedAntoine Songeur

      Mr Roubini fails to note the following:
      -The balance of paiements of Europe is roughly balanced with huge excedent in Germany, Netherland... and huge deficits in France, etc... The problem is not Eurozone versus rest of the world but internal to the Eurozone
      - A massive devaluation of the Euro to 1 Euro for 1 Dollar would increase Europe's competitiveness and create huge problems for the US, the UK and other developped economies with a balance of paiements deficit
      - The real problem is Eurozone internal imbalances linked to divergent policies over the past 10-15 years: Germany having gone through "structural reform" (basically building a competitive advantage based on 20% of the workforce making less than 800€/months), the South European countries having been less "virtuous" and being uncompetitive versus Germany

      The necessary rebalancing (as South Europe deficits are unsustainable let alone because the markets will not accept it) can happen through 2 ways:
      - Rebalancing of internal competitiveness through higher salaries and consumption in Germany and lower salaries and consumption in Southern Europe, the overall impact being neutral
      - Break up of the euro

      This, of course, only looks at the specific European problem and does not address the global crisis linked to the massive misallocation of workforce and capital brought by a globalisation whose main unbalancing characteristics are the increase of inequalities, the arbitration of the cost of labour and the massive tax evasion/optimisation which have led to low growth and massive governement endebtness

    4. CommentedRoman Bleifer

      Economic policy, which is now carried out, similar to drug use. After their adoption, it seems that the problem disappeared. But they are not long and require a new dose of drugs. Then comes the effect of habituation. Required to increase the dose, and its validity is reduced. In the economy as a "drug" are used trillions in no way secured the money that are thrown into the financial system. In the real economy, they do not fall, no one system does not solve the problem. The amount of "improvement" from a throw-oh, is becoming shorter and shorter.
      "Vacation" is really short. But it will be short of, not only for Europe but for the U.S. economy and the global economy ( ). Prolema sovereign debt linked to the global crisis, but it deteriorated as its consequence, and not as a reason. The policy of austerity does not solve all problems. At a time when resources are scarce, Europe more than ever necessary to develop a strategy for economic development. It should be based on an adequate understanding of the processes of the global crisis, and its basis should be used ahead of principle.

    5. CommentedZsolt Hermann

      This tends to happen when the problem is only treated symptomatically but the root problems are not addressed.
      Europe's problems are twofold.
      1. They have tried to achieve some fiscal union in between independent countries, all of them based on self calculations only interested in their own progress and profit. In other words they tried building a house without foundations. This kind of structure only works to a certain degree until everything goes well, growth is constant and the in flowing income can cover the imperfections, but today this is not the case any longer.
      2. And it is not the case because the constant growth, profit oriented system exhausted itself, we are not in a recession or crisis, but in a system failure. The writer says: "The trouble is that the eurozone has an austerity strategy but no growth strategy." But today nobody has growth strategy, every country in the world is surviving on cosmetic measures, adjustments including the strongest nations. The principle conditions constant growth was based on evaporated.
      The solution given the above, and the closed, global, integral nature of our human system is increasing, mutual supra-national integration, and a totally new economic system based on necessities and resources which of course requires a fundamental attitude and thinking change from all of us.

    6. CommentedPaul A. Myers

      If you want growth, then you have to go to equity. A very large institutional capability to take European debt--both existing and that still to be issued--and convert it into equity and invest this equity to get growth going again where growth is needed should be the overall solution architecture.

      A shift to a more balanced solution would encourage optimism about future growth. To continue to issue debt is to continue to enslave the future to the sins of the past.

    7. CommentedKeevan Morgan

      both the inflationists and the austerityites are right to fear each other, because in the present situtation following either of those two paths is likely to have the horrible consequences predicted by the opposite parties.
      if europe were merely sick, then depending on the particulars and the psychology of whatever moment was at hand, either more deficit spending or pulling in the governmental belt could work. that is because economic graphs aside, when the elites and the people are confident, they will force the graphs the right way towards increased productivity and prosperity despite even the best analysis of the economic number crunchers that an economy will surely go this way or that. therefore, for a sick economy, it is the effect of the governmental policy on the psychology of the nation that counts most, and the words of the great song must be remembered "musta been the right move, musta been the wrong time" or vice versa.

      but, today, the european economies are not generally sick; they are generally dead. therefore, treating illness won't work; rather, you have to bury the dead and start over.

      an economy either makes money or it doesn't, just like a business, but we just call it expansion and wealth production instead of a profit. the dead european economies cannot do so any more.
      in business when this happens, the company is declared dead and its assets are sold to bottom feeders to reassemble a new business or to attach to old ones, but in either case to make the same assets produce a surplus instead of continuing to flail away at the impossible task of making a profit under conditions where a profit is impossible. when this happens, creditors and equity are wiped out.

      the time has come for a european default--or at least greece and spain. this will cause great pain, but for a lot less time than stretching out the propping up of the dead. the european countries have to just tell their creditors: "we are not paying you anything on your old debt. your old debt is repudiated. now, if you ever want to recover a penny, buy more of our new bonds, which we will issue and have every intention of honoring."

      that takes care of the creditors, who will cry how outraged they are and nobody will EVER give those (()&*^((*& governments credit again--not noway, not nohow, not EVER, OK!!!!

      but the creditors won't really mean it, because in the end, if there is a chance for a profit tomorrow, they will take it. nothing gets you over an old girlfriend or boyfriend like a new one.

      "equity" in the case of a country is the taxpayers. the taxpayers have to be told: "benefits are now reduced to only those that are necessary to prevent starvation, disease, and we will provide emergency medical care. we will also reduce taxes, but not as much as we will reduce spending--at least until we're in the black again."

      in a few years, all the countries in trouble will have large budget surpluses--profits. investors will return more and more as time goes on and the people will see their governments.2 are in the black.

      confidence will be restored and the enterprises, both private and the governments themselves, will begin to hum and nobody will remember the deadbeat governments.1 any more than they do the financial distress of the hapsburgs or bourbons, because they will be so in love with profitable governments.2.

      nothing in the foregoing should be construed that under normal circumstances i think governmental defaults are desirable. however, lazurian feats of resurrection are rare, and when the patient passes away the reality needs to be accepted by the still living and the mourning period short so that the work of the day can begin anew for those still concerned with such things.

      keevan d. morgan, esq., chicago