Wednesday, October 12, 2011

Euro crisis: still sliding toward the cliff

I haven't blogged that much the last couple of weeks about the European Union crisis that is more specifically a euro crisis at the moment. Not because it's going away, or getting better, or just treading water. On the contrary. European leaders seem locked into a cycle of bad policy choices not unlike the proverbial deer in the headlights.

Martin Wolf in First aid is not a cure Financial Times 11/11/2011 explains the unpleasant state of things:

At least, nobody now sees the eurozone crisis as a little local difficulty. It has become the epicentre of an aftershock of the global financial crisis that could prove even more destructive than the initial earthquake. Potentially, it is a triple shock: a financial crisis; a crisis of sovereigns, including Italy, the world's third largest sovereign debtor; and a crisis of the European project with unknowable political consequences. It is no wonder people are frightened. They ought to be.
The "European project" means the European Union. One of the severe failures of EU leadership in the past several years, especially in Germany and France, has been to focus on the EU as though it were mainly an economic undertaking. But until recently, the economic union including the common currency were economic measures taken to promote the larger political ends: the development of common democratic political institutions and policies and the prevention of war in Europe. It may sound formulaic, but the collapse of the EU would be a serious setback for democracy and peace, first of all in Europe but in the larger world, as well.

Wolf discusses what needs to be done in the short term:

The broad consensus of the world's policymakers and commentators is that the eurozone must now do the following: divide countries in difficulties into the insolvent and the illiquid; restructure the debts of the former and provide unlimited, but temporary, support for the latter; and recapitalise banks, after stress tests that allow for losses on sovereign debt, either from national treasuries or from the European financial stability facility, in accordance with the flexibility given by the decisions taken in July 2011.
It's not in itself a sign of the value of the ideas that there is a "broad consensus of the world's policymakers and commentators" around it. The Very Serious People are often very seriously wrong (as we're probably going to see once again in their reaction to the alleged Iranian terror plot just busted in the US).

But in this case, it's my impression as well that pretty much everyone familiar with the situation knows that something like what Wolf describes has to be done, and the sooner the better. That's what makes the current EU political paralysis so remarkable. Pick your metaphor: deer in headlights, heading toward the cliff, Titanic and the iceberg, train heading toward the washed-out bridge, whatever. But from what I can see, the EU leaders know they are on a disastrous course with consequences that will be seriously bad. But they just keep heading in the same direction.

Wolf gets wonkier here:

As I have long argued, at bottom this is far more a balance of payments crisis rooted in financial sector misbehaviour and cumulative divergence in competitiveness, than a fiscal crisis. The architects of the eurozone thought that balance of payments crises were impossible in a currency union. They were wrong. In the absence of automatic cross-border financing, an unfinanceable external deficit will emerge as a domestic credit crisis. Then, even currency risk will return if the union is among largely sovereign states.

It is not the case that the countries in difficulties had irresponsible fiscal policy before the crisis. Greece did. Arguably, Italy did, given its huge debt overhang. But Ireland and Spain had fiscal surpluses and negligible net public debt: Ireland's net public debt was 12 per cent of gross domestic product in 2006, while Spain's was 31 per cent, far below France's 60 per cent and Germany's 53 per cent. Even Portugal's net debt was 59 per cent of GDP.
I hope the European leaders will surprise us by flushing their mad faith in austerity economics and start pursuing more sensible policies. But my hope has been fading lately.

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