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Eurozone: in crisis « Previous | |Next »
January 14, 2011

Paul Krugman has a long and interesting article on the Eurozone in the New York Times magazine that questions the viability of the Euro project. Europe is in deep crisis — because its proudest achievement, the single currency adopted by most European nations, is now in danger.

Krugman's argument is that Europe lacks the institutions needed to make a common currency workable. He says:

when the single European currency was first proposed, an obvious question was whether it would work as well as the dollar does here in America. And the answer, clearly, was no — for exactly the reasons the Ireland-Nevada comparison illustrates. Europe isn’t fiscally integrated: German taxpayers don’t automatically pick up part of the tab for Greek pensions or Irish bank bailouts. And while Europeans have the legal right to move freely in search of jobs, in practice imperfect cultural integration — above all, the lack of a common language — makes workers less geographically mobile than their American counterparts.

As in the US the bubble burst in 2008.The peripheral economies of Europe---Greece, Ireland, Portugal --- had borrowed much more than they could really afford to pay back. First Greece, then Ireland, became caught up in a vicious financial circle: as potential lenders lost confidence, the interest rates that they had to pay on the debt rose, undermining future prospects, leading to a further loss of confidence and even higher interest rates.

Krugman says:

it’s the euro itself that makes Spain and Ireland so vulnerable. For membership in the euro means that these countries have to deflate their way back to competitiveness, with all the pain that implies.The trouble with deflation isn’t just the coordination problem Milton Friedman highlighted, in which it’s hard to get wages and prices down when everyone wants someone else to move first. Even when countries successfully drive down wages, which is now happening in all the euro-crisis countries, they run into another problem: incomes are falling, but debt is not... so debtors have to meet the same obligations with a smaller income; to do this, they have to cut spending even more, further depressing the economy.

The policy solution has not been one of Greece or Ireland leaving the Eurozone and returning to their own currencies. It has been one of harsh fiscal austerity in an effort to regain the market’s confidence, backed in Greece and Ireland by official loans intended to buy time until private lenders regain confidence.

The markets don’t expect Greece and Ireland to pay their debts in full. They are expecting some kind of debt restructuring, that could bring the vicious circle of falling confidence and rising interest costs to an end, potentially making internal devaluation a workable if brutal strategy. The austerity strategy demanded by the Germans is for Greece, Ireland, Portugal and Spain to tough it out:

Governments that can’t borrow on the private market will receive loans from the rest of Europe — but only on stiff terms: people talk about Ireland getting a “bailout,” but it has to pay almost 6 percent interest on that emergency loan. There will be no E-bonds; there will be no transfer union...it will be an ugly process, leaving much of Europe deeply depressed for years to come. There will be political repercussions too, as the European public sees the continent’s institutions as being — depending on where they sit — either in the business of bailing out deadbeats or acting as agents of heartless bill collectors.

Krugman's judgement is that the odds are that the current tough-it-out strategy won’t work even in the narrow sense of avoiding default and devaluation — and the fact that it won’t work will become obvious sooner rather than later.

At that point, Europe’s stronger nations---France and Germany--- will have to make a choice: saving the Euro-project or allowing Greece, Ireland, Portugal and Spain to default on their debts and the French and German banks take a haircut.

| Posted by Gary Sauer-Thompson at 8:32 AM | | Comments (5)
Comments

Comments

Ha, ha, hoist on their own petards.
Isn't the definition of a camel as an animal designed by a committee so true, when its appled to Europe?
But nice to know Australia is not the only part of the world that operates on the two speed economy priciple?
Camerons are coming, hurrah, hurrah!

paul,
fairs fair. The creation of the euro was supposed to be part of the generations-long effort to bring peace, democracy and shared prosperity to a once and frequently war-torn continent. The point of integration under the European project is to deliver a series of economic integration plans that do double duty: they’re economically productive, but they also create “de facto solidarity”, moving Europe closer to political union.

As Krugman observes in his article:

The Europeans have shown us that peace and unity can be brought to a region with a history of violence, and in the process they have created perhaps the most decent societies in human history, combining democracy and human rights with a level of individual economic security that America comes nowhere close to matching. These achievements are now in the process of being tarnished, as the European dream turns into a nightmare for all too many people.

The envisioned end point is a “European federation” — which is necessary because of the continent’s history of war.

However, it does seem that restructuring or defaults by several deeply indebted peripheral European sovereigns may be unavoidable.

I'd rather, as GST says concluding, see the
big end "take a haircut".
Since 2007 with the US, then Britain and now the rest of Europe, the big end has, in each instance, wriggle out of its responsibilities for the current problems at the expense of those who weren't responsible and did not create the Fin meltdown mess.
Unfortunately, the neoliberal system with entrenched "weak" government was already there to protect the Goldman Sachs types in each location, after the heist was pulled off.

The expectation is for another serious crisis to break out in early 2011. This projected crisis is tied to the rollover funding needs of weaker eurozone governments, i.e., debts falling due in March through May.

The crisis will take the form of a run on a nation’s currency and capital starts flowing out of the country as banks refuse to start rolling over the lending that they’ve done to these governments, or more commonly (’cause it isn’t always going to governments) the lending they’ve done to banks in those countries

Whether it’s a bank or whether it’s a government, they borrow for a certain period, and then they have to pay off that debt–not only the interest on it but the principal on it. They then try to secure another loan in order to keep going. And insofar as things are ticking over, they’re provided with that loan. When there’s a fear that they will not be able to secure the same rates as they secured before, or that the bank won’t be able to pay or the government won’t be able to pay, then those debts aren’t rolled over.

The Europeans will save themselves because there will be no other way to avoid wasting 60 years of political unification.

Though European leaders see markets as the cause of their problems the unsustainable debt remains the heart of the problem. This is what Satyajit Das argues in Debt trap in Europe in The Age.

He says that what the troubled countries--Greece, Ireland, Portugal, Spain, Italy and Belgium--- have in common is that the rising cost of borrowing increasingly makes high levels of debt unsustainable because of the cost of interest payments. Eventually, countries lose access to commercial funding sources, which is what has happened to Greece and Ireland.

Greek debt is trading at about 12 per cent. Ireland trades at about 9.5 per cent. Portugal trades at about 7 per cent. Spanish debt now trades at 6 per cent while Italy is trading close to 5 per cent.

The heavily indebted European sovereign states face $2.85 trillion of maturing debt in the period to 2013. Portugal, Italy, Ireland, Greece and Spain have bond maturities of $502 billion this year. The financing needs of Greece, Ireland, Portugal and Spain over the last quarter of 2010 and 2011 are €320 billion, rising to €712 billion if Italy is included.

If the support measures--from the European Central Bank--- do not work then increasingly Portugal and Spain, find themselves under siege from the market. As market access closes, they too will need bailouts---from the EU and IMF---straining existing arrangements, necessitating new measures.

If the EU does not agree to fiscal union or continuing support, then pressure on Portugal, Spain, Italy and Belgium may reach a tipping point, making default on debt or restructuring (IMF style) the likely endgame.

It doesn't look good.