Friday, November 21, 2014

Europe in Depression?

MILAN – Charles P. Kindleberger, the great economic historian, once noted that the Great Depression was so deep and so long because of “British inability and American unwillingness” to stabilize the system. Among the functions that the great powers failed to perform, a few should ring a bell to European leaders today. Kindleberger singled out their failure to “maintain a market for distress goods” – that is, to keep their domestic markets open to imports from crisis-stricken economies.

Surely history is not repeating itself – at least not in the literal sense. European creditor countries today are not tempted by anything like America’s Smoot-Hawley Tariff Act, which crippled world trade in 1930. Germany, the Netherlands, Austria, and Finland remain committed to the European Union’s single market for goods and services (though their national regulators hinder intra-European capital flows).

Still, one cannot help but notice similarities with the 1930’s. At the time of the Great Crash, the United States and France were piling up gold as fast as the Weimar Republic was piling up unemployment. Today’s northern European countries are running up record current-account surpluses, just as some southern European countries are experiencing Weimar-level unemployment. For Italy, Europe’s fourth-largest economy, the current slump is proving to be deeper than the one 80 years ago. Meanwhile, huge savings and potential demand for consumer and capital goods remain locked up next door.

How did this happen? As Kemal Derviş has pointed out, the cumulated current-account surplus of the Scandinavian countries, the Netherlands, Austria, Switzerland, and Germany is now around $500 billion. This dwarfs China’s surplus at its mercantilist peak of the mid-2000’s, when the G-7 (including Germany) regularly scolded the Chinese for fueling global imbalances.

More striking still, in the now-rebalancing eurozone, many countries’ current accounts are trending toward balance (and Ireland has recently moved from deficit to a small surplus). One exception is Germany, whose external position strengthened over the last year, with the surplus rising from 6.2% to 7% of GDP – all the more remarkable in the context of a European recession and a slowing domestic economy.

Indeed, Germany’s GDP grew by just 0.9% last year, and is forecast to slow further this year, to 0.6%. Slackening growth, declining private and public debt, and super-low interest rates would suggest loosening up a bit and supporting aggregate demand. Instead, a distorted view of what competitiveness really is (mis)leads politicians to consider large external surpluses an unqualified good and a testament to virtue, whatever the consequences abroad.

The second exception is France. Over the last year, France’s external deficit deteriorated further, from a 2.4% to 3.5% of GDP. France now faces zero or negative growth in 2013, and seems to have reached the point at which it must reverse course on competitiveness or risk more trouble ahead.

Unfortunately, this, too, is reminiscent of the 1930’s. To paraphrase Kindleberger, French inability and German unwillingness to stabilize the system are contributing to an ever more intractable European crisis.

In this respect, the debate in Brussels concerning the “right” amount of austerity misses the mark; in the same vein, southern European leaders’ strategy of blaming German Chancellor Angela Merkel for their own tax increases looks increasingly futile. It is not Germany’s fault that Italy and Spain had to tighten their budgets last year. As research by Ray Dalio shows, any country with an average cost of debt far above its nominal GDP growth has little choice but to resort to belt-tightening.

For example, in November 2011, interest rates on Italian sovereign bonds were around 8% all along the curve, even as the government faced refinancing needs totaling nearly 30% of GDP over the following year. Because debt monetization was not an option, austerity had to ensue at that point, regardless of what Merkel – or anyone else – had to say.

This suggests a collective failure by European leaders to frame the response to the crisis properly. Southern European leaders have wasted time and energy asking Merkel for weaker fiscal medicine. Merkel and her allies have invested just as much political capital in resisting such pressure. And the European Council has become a theater for tired repetition of the same old show, performed mostly for domestic audiences, with little attention devoted to the opportunity – once Italy’s political stalemate has ended and Germany’s upcoming election is over – to re-write the script.

Southern countries, still largely in denial, should accept the need for deeper, competiveness-enhancing reforms. Germany and its allies, for their part, should accept that running high external surpluses is damaging the eurozone and themselves, and that it is time for them to put part of their huge excess savings to work to support growth. The failure of leaders in France, Italy, and Spain to raise this issue more effectively has been a clear shortcoming so far.

Without a pro-growth, pro-reform deal, southern Europe’s attempts at deleveraging may result in a politically destabilizing depression. As Mark Twain famously observed, “History doesn’t repeat itself. At best, it sometimes rhymes.” In Europe’s case, the poetry could be very dark.

  • Contact us to secure rights


  • Hide Comments Hide Comments Read Comments (5)

    Please login or register to post a comment

    1. CommentedPatrick Lietz

      Why is it so difficult for economists to understand that growth is unattainable without cheap energy? Energy is getting more expensive by the day. The Energy return on energy invested (EROI) has been dropping precariously, regardless of the type, such as unconventional oil, shale oil, oil shale et al.

      The global energy pie is shrinking and that is what is driving Europe into depression. Have a look at gas consumption charts for European or US consumers. The yoy drop is frightening in its scale and pace.

      We need cheap energy and we need it now, otherwise we will see revolutions like in Egypt and very few rich people among large masses of the destitute and starving.

    2. CommentedMarco Cattaneo

      "Because debt monetization was not an option, austerity had to ensue": this is tantamount to say that the euro does not work as countries have to recover their monetary autonomy to avoid falling in a liquidity trap. This CAN actually be achieved WITHOUT breaking the euro up.

    3. CommentedErnest Dautovic

      it's utopic to speak about enhancing competitiveness in Spain and Italy when these countries have been uncompetitive wrt Germany since the XIX century. Competitiveness is not matter of mere nominal downward rigidities in wages, but a coherent industrial policy that takes decades to realize. Instead, restoring an effective backstop for the lender of last resort role the ECB must have is a priority to refrain the imbalances.

    4. CommentedC. Jayant Praharaj

      Mr. Fubini does not state clearly if he wants Germany to do anything or what he wants Germany to do on the current account surplus front. The demand and supply forces that determine German current account surpluses or northern European current account surpluses and the corresponding capital accounts have been far steadier than the forces determining southern European current account numbers or capital account numbers. Inflation has been steady throughout the eurozone, the ECB has begun LTROs etc in the troubled eurozone economies ( one can argue about the pros and cons of the specific measures, but that would be another topic ). The troubled countries themselves have begun addressing their public finance problems. Does Mr. Fubini want northern European economies to do something specific regarding their current account numbers in order to affect the recessionary trends in several eurozone countries and the overall slowdown in the eurozone ? Clearly, the German policy makers cannot make Germany's economic agents change their demand levels for products from specific countries to any meaningful extent over months or few years or the demand for German products from non-German economic agents.

      What specific measures is Mr. Fubini refering to when he talks about " supporting aggregate demand " ? Would these run counter to what Mr. Fubini wants to happen on the current account front ? Mr. Fubini needs to address these questions in some detail.

    5. CommentedZsolt Hermann

      I think the following sentence from the article explains the whole, very deep problem:
      "...Charles P. Kindleberger, the great economic historian, once noted that the Great Depression was so deep and so long because of “British inability and American unwillingness” to stabilize the system..."
      We are not in a depression but we are at an evolutionary jump in our development.
      We are in a natural process but we try to ignore it.
      Humanity decided evolution changed, and we achieved our perfect developmental state and we have to do everything we can to "stabilize" and maintain it as it is.
      In our mind the present socio-economic system, the constant, infinite quantitative growth is perfect and we need to keep pushing it without any doubts.
      We ignore all the available data, growing daily, that this system is unsustainable and it is collapsing regardless of what we are doing.
      Thus there is nothing to stabilize, instead we have to let go, we have to sense and embrace the next level of our evolutionary path and in a proactive way we have to prepare and sweeten the transition to the new, global, mutual, natural system.
      A new plant always grows out of a rotting seed, every previously collapsing civilization gave way to a more evolved newer one, but for the first time we could make this transition consciously, gradually, instead of going through explosions.