3 Paths for Europe - Analyst Blog
15 Décembre 2011 - 4:27PM
Zacks
The underlying cause of the Euro crisis is the massive internal
European Trade imbalances, not fiscal irresponsibility on the part
of the weaker “Club Med” countries leading up to the 2008 Financial
meltdown (with the exception of Greece, which had both big fiscal
and trade deficits).
Indeed, if you had looked at just the budget deficits of the
countries in Europe in 2007, you would have predicted that Spain
and Ireland would be the areas of strength and Germany would be one
of the countries in trouble. Looking at the trade deficits would
have given you the right list of weak versus strong countries.
Germany (and countries like the Netherlands and Finland, but for
simplicity sake I will just refer to all of the strong countries as
Germany) is FAR more competitive than the “Club Med” countries
(Which for simplicity I will simply call Italy). As a result, it
exports far more goods and services to a country like Italy than it
imports from them.
If there were no Euro, this would be an easy problem to solve, and
would take place naturally through the free market. The Lira would
fall relative to the Mark. Presto-chango, Italian goods
become cheap in Germany, and German goods become expensive in
Italy. With a common currency, no such devaluation is possible.
Thus there are only three ways that the relative competitiveness
balance can be restored.
- Italy could institute structural reforms to its labor markets
and other policies. Cutting the red tape needed to start a new
business would also help a great deal (and there is far more red
tape in Italy than Germany, and Germany still has much more than
the US). Germany did this several years ago, and the efforts have
paid off. The problem is that is a long-term solution, and the
process will take years to have a noticeable impact. The financial
markets are not going to wait years. At best, we are hoping they
will wait weeks.
- Germany could accept a higher rate of inflation than Italy,
perhaps by instituting a big fiscal stimulus. The German response
to this idea has Frau Merkel channeling her inner Herman Cain:
"Nein, Nein, Nein." For historical reasons (The Weimar Republic),
Germany has an absolute phobia about inflation.
- Prices could fall in Italy. That means deflation, and deflation
means years of negative or at best very weak economic growth and
very high levels of unemployment. It means tough austerity measures
with taxes going up and services going down. It also means that the
ratio of debt to GDP is not going to fall very fast, as the
denominator is working against them.
The fiscal and banking problems plaguing the continent are a
symptom, not the underlying disease. Without a doubt, they are a
serious symptom and need to be addressed, but alleviating them will
not cure the disease. The pact reached a few weeks ago that got
everyone all excited did make some progress on moving towards a
common fiscal policy, towards the creation of a real “United States
of Europe.” That does help address the “original sin” of the Euro:
a common monetary policy but not a common fiscal policy. However,
it does nothing to address the trade imbalance problem.
Is It Workable?
There are also major issues of if it is workable or not. Countries
that have budget deficits of more than 3% of GDP would face
automatic penalties. But if you take today’s situation, how exactly
would imposing a large fine on Italy help improve its current
fiscal situation not make it worse? It wouldn’t.
The ECB could help out by backstopping Italian debt and effectively
printing Euros. That would help lubricate the adjustment problem by
raising the overall level of inflation in Europe. If a 5%
differential in inflation is needed over several years to bring
Germany and Italy back into competitive balance, 6% inflation in
Germany with 1% inflation in Italy would be MUCH less painful than
1% inflation in Germany and 4% deflation in Italy.
Any central banker worth his salt knows that deflation should be
avoided at all costs. Common debt, in the form of Eurobonds would
be a big step forward in having a common fiscal policy and could
greatly ease the overall problem. Once again, though, Germany
stands in the way.
Unfortunately, it looks like we are mostly seeing option number
three (with a little bit of option one, but that is much too slow a
process to make a difference). This means that Southern Europe is
going to be hurting for a very long time. They are losing a great
deal of their sovereignty as their budgets will have to be reviewed
and approved by Brussels (in reality Berlin).
Merkel has played her cards brilliantly with her obstructionism.
She will effectively be forming German domination of all of Europe,
without German taxpayers being on the hook for the common debt. The
cost will all be borne by Italy and the rest of Club Med. Those
costs will be very heavy and will probably result in substantial
social instability. Italy will no longer be a rich country in a few
years.
All in all, it would have probably been best if the Euro were never
created. However, we cannot go back in time to change history. At
this point, any country that left the Euro would face massive bank
runs, and that would spread to even the healthy countries. The
continent would be instantly be plunged into a downturn rivaling
the Great Depression. That experience in Europe did not end well,
to say the least.
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