A year ago, German growth was buoyant and the Eurozone (EZ) seemed firmly on the path to economic recovery from the 2008 recession. One economist at the ING group in Brussels announced triumphantly “Superman is wearing black, red and gold this year, Germany’s national colours”. [1] That has now totally changed. According to last week’s forecasts by the European Commission, German GDP growth, which was expected to be 1.9% in 2012 is now put at only 0.8% while French growth, previously predicted to be 2%, has been revised downward to 0.6%.
The outlook for Italy is even worse. Earlier, the Commission had estimated that Italy would grow by 1.3% in 2012; now it is suggesting that it will barely grow at 0.1% next year – making it more difficult for it come out of the economic slump and lower its debt/GDP ratio. Moreover unemployment for the Eurozone as a whole is expected to be around the 10% mark.[2]
Should you need further evidence of an imminent slump, you need merely look at the bond markets where the yield curve is inverting. (In normal times, because the long-term future is less certain than the short-term, 30-year bonds are considered riskier than 3-month bonds and so command a higher yield; when bond purchasers fear recession, though, even short-term borrowing can become very expensive.)
In the past month, Spain has seen the rate on its three-month bills double to nearly 6%. Italy saw yields of all its bonds from two- to eight-years rise above its benchmark 10-year note, and unlike a fortnight ago, intervention by the ECB did not undo this inversion. As I write, the euro is sliding because a German auction of 10-year bunds has failed—about one-third were left unsold. [3] One Wall Street Journal piece is entitled ‘Europe’s broken bond market’—and the total value of European sovereign bonds is about €6tr. [4]
In truth, as has been apparent for some weeks, European bond markets are failing and banks are growing ever warier of lending. Europe (Britain included) is in a slow-motion credit crunch, and will soon be returning to recession. Why?
The seizing-up of the EZ sovereign bond market was predictable enough given two critical flaws in the original Maastricht architecture. First, the ECB was prevented from acting as lender-of the last resort (LOLR). This fact, combined with making each member state individually dependent on the bond market, meant that sooner or later the weaker countries would be attacked since the only upper limit on sovereign yields was national bankruptcy. Threatened with one possible national bankruptcy, fear gripped the markets and contagion spread to other countries. (I shall not deal with the trade-imbalance argument here which I — and many others—have set out elsewhere.)[5]
There are various short-to-medium-term remedies for this state of affairs such as serious quantitative easing by the ECB, some form of ECB sovereign bond guarantee, a common Eurobond scheme (most likely the Bruegel ‘blue bond’) and so forth. Faced with a frozen bond market, one or more imminent national defaults and EZ recession, Ms Merkel will eventually blink and agree to more substantive intervention in the short term and ‘EZ economic governance’ in the medium-to-long term. Indeed, the plans are already being drawn up in Brussels.[6]
But here is the rub. The sort of governance the Germans have in mind is that all countries should be good Germans and balance their budget—a proposition also supported by the deeply conservative UK Chancellor. Austerity is thought to be the solution. It is not. The EZ crisis can only be overcome if aggregate demand is boosted domestically, enabling the required new technology to be adopted in the periphery via new investment which will boost productivity. Issuing blue-bonds and all the rest ultimately will fail unless the EZ abandons the absurd notion that frugality can bring recovery.
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[2] See http://www.egovmonitor.com/node/44606/print
[3] See http://www.guardian.co.uk/business/blog/2011/nov/23/eurozone-crisis-eurobonds-recession-fears
[4] See http://blogs.wsj.com/overheard/2011/11/09/euro-zones-broken-bond-market/
[5] See an excellent recent paper by Jan Kregel; http://www.levyinstitute.org/publications/?docid=1431
[6]See http://www.msnbc.msn.com/id/39435196#.Ts0FZlaCixU; also http://www.ft.com/cms/s/0/356c252e-152c-11e1-855a-00144feabdc0.html#axzz1eWvQIlsr
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Imho speaking of the Euro crisis is misleading. As I see it, there are several quite seperate problems which are loosely related with each other. And many of them can be observed in other nations outside of Europe, too, most prominently the US. To only see this as a European problem prevents finding good solutions.
Firstly, while a majority of people calls this a debt crisis, this is actually much more of a banking crisis. It's the financial sector which is the core of the desease, and that's where the solutions have to start. Quite obviously, the proper consequences from the 2008 haven't been drawn yet. It were the new "creative" financial products which triggered this mess and those haven't been prohibited yet. The inventors deliberately ruined any transparency that may have been left in international investments, and it's that lack of transparency which fuels the fears about a domino effect now, even among the most intelligent and knowledgeable experts. It's high time all politcal leaders admit that the banks created several monsters which can't be controlled by regulation because their complexity overwhelms human capacity.
There is no other way to make this crisis manageable again than to consequently force the financial sector to limit itself to the boringly simple kind of banking of the pre-deregulation years. Speculation, irresponisble risk taking and increasing interconnection between banks has to be fought tooth and nail. It's not enough to cut the heads of that hydra off, we all have seen she simply grows new ones faster than the regulating knights can swing their swords! The body of the monster has to be put in an iron corset that prevents all proliferations. Translated into our real world, this means all financial instruments that haven't been specifically approved by the regulating agency have to be declared illegal! And all investment providers have to be put under mandatory regulation, there shouldn't be any loopholes for hedge funds and other junk businesses anymore. Only with the increased transparency of that simplified financial sector will there be any chance to successfully engage the core of the sprawling crisis.
To come back to the topic: As I see it, Merkel is the oneyed among the blind. Under the impression of even the most merited experts being unable to predict the consequences of totally unproven "solutions", she rightly refuses to support any experiments. She's fighting a defensive battle against the vast majority of panicking heads of state, economists, and the bankers (whcih she'll probably lose in the long run), but at least she gives all of us more time to think about the real issues behind the crisis. And hopefully that will lead to a widespread public outrage that enforces the systemic changes the global economy desperately needs now. The Occupy movement gaining traction all around the world is an encouraging sign. Maybe it's not too late to engage the monster before it swallows our civilisations!
Gray: I don't disagree with you that we have a banking crisis resulting larely from deregulation in the past two generations. But while fixing the banking sector may ne a necessary condition for recovery, it is not sufficient. We have an economic crisis—the OECD countries are going back into recession—and insufficient aggregate demand to reverse this state of affairs.
Who's supposed to pay for such a Keynesian boost in the Eurpean heartlands ? The Chinese, the Russians, the Saudis ??? Inflation ? Probably the last. So your diagnosis may not be wrong, but your therapy is deadly.
Pffft. Inflation, the great bogeyman. Venezuela's had high inflation for a decade. In that time Venezuela has also had good economic growth, cut both poverty and extreme poverty more than in half, lowered unemployment greatly, improved health care and education, markedly increased agricultural production (important for a country overly dependent on food imports) . . .
If only Venezuela were responsible like the EU, making sure that no inflation can rear its ugly head and making with the austerity, they too could have a collapsing bond market and deep recession with massive unemployment in half the members.
Wow – what a great example ! Let's save the Eurozone with oil, inflation and Chavez.
wizofaus, I uasully try to write so that the post makes sense without following the links. On this occasion that wasn’t possible without the length exploding to unacceptable proportions.Thanks for the compliment, though.