Down with the Eurozone
By Nouriel Roubini
The opinions expressed are his own.
The eurozone crisis seems to be reaching its climax, with Greece on the verge of default and an inglorious exit from the monetary union, and now Italy on the verge of losing market access. But the eurozone’s problems are much deeper. They are structural, and they severely affect at least four other economies: Ireland, Portugal, Cyprus, and Spain.
For the last decade, the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) were the eurozone’s consumers of first and last resort, spending more than their income and running ever-larger current-account deficits. Meanwhile, the eurozone core (Germany, the Netherlands, Austria, and France) comprised the producers of first and last resort, spending below their incomes and running ever-larger current-account surpluses.
These external imbalances were also driven by the euro’s strength since 2002, and by the divergence in real exchange rates and competitiveness within the eurozone. Unit labor costs fell in Germany and other parts of the core (as wage growth lagged that of productivity), leading to a real depreciation and rising current-account surpluses, while the reverse occurred in the PIIGS (and Cyprus), leading to real appreciation and widening current-account deficits. In Ireland and Spain, private savings collapsed, and a housing bubble fueled excessive consumption, while in Greece, Portugal, Cyprus, and Italy, it was excessive fiscal deficits that exacerbated external imbalances.
The resulting build-up of private and public debt in over-spending countries became unmanageable when housing bubbles burst (Ireland and Spain) and current-account deficits, fiscal gaps, or both became unsustainable throughout the eurozone’s periphery. Moreover, the peripheral countries’ large current-account deficits, fueled as they were by excessive consumption, were accompanied by economic stagnation and loss of competitiveness.
So, now what?
Symmetrical reflation is the best option for restoring growth and competitiveness on the eurozone’s periphery while undertaking necessary austerity measures and structural reforms. This implies significant easing of monetary policy by the European Central Bank; provision of unlimited lender-of-last-resort support to illiquid but potentially solvent economies; a sharp depreciation of the euro, which would turn current-account deficits into surpluses; and fiscal stimulus in the core if the periphery is forced into austerity.
Unfortunately, Germany and the ECB oppose this option, owing to the prospect of a temporary dose of modestly higher inflation in the core relative to the periphery.
The bitter medicine that Germany and the ECB want to impose on the periphery – the second option – is recessionary deflation: fiscal austerity, structural reforms to boost productivity growth and reduce unit labor costs, and real depreciation via price adjustment, as opposed to nominal exchange-rate adjustment.
The problems with this option are many. Fiscal austerity, while necessary, means a deeper recession in the short term. Even structural reform reduces output in the short run, because it requires firing workers, shutting down money-losing firms, and gradually reallocating labor and capital to emerging new industries. So, to prevent a spiral of ever-deepening recession, the periphery needs real depreciation to improve its external deficit. But even if prices and wages were to fall by 30% over the next few years (which would most likely be socially and politically unsustainable), the real value of debt would increase sharply, worsening the insolvency of governments and private debtors.
In short, the eurozone’s periphery is now subject to the paradox of thrift: increasing savings too much, too fast leads to renewed recession and makes debts even more unsustainable. And that paradox is now affecting even the core.
If the peripheral countries remain mired in a deflationary trap of high debt, falling output, weak competitiveness, and structural external deficits, eventually they will be tempted by a third option: default and exit from the eurozone. This would enable them to revive economic growth and competitiveness through a depreciation of new national currencies.
Of course, such a disorderly eurozone break-up would be as severe a shock as the collapse of Lehman Brothers in 2008, if not worse. Avoiding it would compel the eurozone’s core economies to embrace the fourth and final option: bribing the periphery to remain in a low-growth uncompetitive state. This would require accepting massive losses on public and private debt, as well as enormous transfer payments that boost the periphery’s income while its output stagnates.
Italy has done something similar for decades, with its northern regions subsidizing the poorer Mezzogiorno. But such permanent fiscal transfers are politically impossible in the eurozone, where Germans are Germans and Greeks are Greeks.
That also means that Germany and the ECB have less power than they seem to believe. Unless they abandon asymmetric adjustment (recessionary deflation), which concentrates all of the pain in the periphery, in favor of a more symmetrical approach (austerity and structural reforms on the periphery, combined with eurozone-wide reflation), the monetary union’s slow-developing train wreck will accelerate as peripheral countries default and exit.
The recent chaos in Greece and Italy may be the first step in this process. Clearly, the eurozone’s muddle-through approach no longer works. Unless the eurozone moves toward greater economic, fiscal, and political integration (on a path consistent with short-term restoration of growth, competitiveness, and debt sustainability, which are needed to resolve unsustainable debt and reduce chronic fiscal and external deficits), recessionary deflation will certainly lead to a disorderly break-up.
With Italy too big to fail, too big to save, and now at the point of no return, the endgame for the eurozone has begun. Sequential, coercive restructurings of debt will come first, and then exits from the monetary union that will eventually lead to the eurozone’s disintegration.
This piece comes form Project Syndicate.
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As Wilhelm Hankel and I argue in BRAVE NEW WORLD ECONOMY (Wiley, 2011),
the disintegration of the existing Eurozone system is inevitable, which Roubini
confirms. However, by returning to the European Exchange Rate Mechanism
which preceded the Euro, the Euro nations could return to their own currencies within a managed band of exchange rates, providing flexibility for devaluations in the periphery nations and overall stability in the European Union. At the same time, however, there needs to be more financial regulation at the G-20 level to enable the IMF to have the financial resources to become the lender of last resort, eventually replacing the role of the overstretched dollar with a more rebust SDR system along the lines of Keynes’s proposed ‘bancor’. It is clearly in the interest of Germany to initiate such a transformation. And for the U.S. to share the burden of global reserve currency status with other key economies.
Perhaps there’s a fifth option –
“It is entirely in the hands of Germany. Angela Merkel’s attitude has changed. She recognizes that the euro is in mortal danger and she is willing to risk her political future to save it. I think she recognizes that Germany has caused the crisis to get out of control, and she is now determined to correct that.”
http://blogs.reuters.com/chrystia-freela nd/2011/11/11/george-soros-advice-for-th e-euro-zone/
You listed a number of peripheral countries mired in high debt, falling output, weak competitiveness, and structural external deficits.
There was no mention of the fakelaki-factor of corruption, wilful deceit at the sovereign level, money laundering instead of a genuine tax/revenue system.
Those factors require a significant dose of common-sense rather than abstractions drawn across graphs.
It can also be argued that living within your means may seem austere, but that is only in comparison with your neighbour. For example, Montenegro is outside your concept of the periphery and the EU, but its currency is the euro, along with Kosovo. Sure, you could point to deficiencies and lack of luxuries in comparison with the well-to-do oligarchs in Greece. But don’t write them off because they live in the periphery of your mental maps.
Links for those who like links:
http://www.charlestannock.com/pressartic le_lf.asp?ID=2060
ec.europa.eu/economy_finance/internation al/enlargement/pre-accession_prog/pep/20 11-pep-montenegro_en.pdf
More a case of finding common-sense solutions, than the magician’s graph.
The eurozone crisis is the result of excessive liquidity, created from “recycled” debt instruments, and thus only as good as the basic “real value” of the original asset.
The problem with this approach is that “recycled debt” (i.e. its flip-side credit) is NOT money on its own terms.
Thus, it has a multiplier effect when the economy is expanding, but when the economy contracts it exacerbates the economic problems.
Thus, feeding more “recycled debt” into the eurozone crisis will only exacerbate the crisis.
For an excellent article on the concept of what is money, how the concept has changed to include debt, and how the excess credit based on this debt has created this crisis see http://www.atimes.com/atimes/Global_Econ omy/MK01Dj01.html
Money and the eurozone crisis
Commentary and weekly watch by Doug Noland
Does the Mezzogiorno even dream of secession, which probably would be ecouraged by northern Italy? Obviously not. And likewise, most of the PIIGS submit to partial surrender of sovereignty to stay inside the Eurozone. Other than the reflationary/recessionary choice it might be that core-Europe (which also includes Finland) prefers a more psychological approach: whip them in line and be sure everybody knows who is calling the shots and does as told. First things first.
Nouriel Roubini, my hat is off to you! This very sound analysis of the European Debt Crisis! And, what you suggest as solutions is pure excellence! I am totally in the camp of advocating that the weaker nations also known as the PIIGS, to break away from the European Union and restarting their sovereign currencies. This would be the best thing for these nations in order to rejump-start economic growth and restructure their debts on their own terms. It would be painful for the rest of Europe, but these weaker nations at least would have a chance of having economic growth again in the future, as opposed to be dragged through a very long recessionary economic environoment. These weaker nations will inevitably default on their debts on the current course they are on. Sadly, given the political and economic situation in Europe there is simply no financial solution as long as these nations remain in the European Union, in fact they will suffer a depression eventually, Ireland, Spain and Greece are already on this collision course. If and when they do break away, it would be most advantageous for these nations to create state-owned central banks to claim full command over their monetary system. This way these nations can save billions of dollars in interest that they would have to pay if they were under privately owned central banks. I pray you understand what I mean. If you don’t you need to read more history of international banking.
Europe is certainly playing with fire. I still think the northern European leaders are deliberately trying to hold the feet of the leaders of PIIGS countries to the fire, so as to get them to make necessary reforms, and secure political support for further (necessary) fiscal integration. It’s playing with fire, but it might still work…
“At the late stage of the boom, a hugely distorted marketplace saw trillions of risky subprime mortgages sliced and diced into mostly “AAA” “money”-like credit instruments.”
http://www.atimes.com/atimes/Global_Econ omy/MK01Dj01.html
Let P equal the US population. Current estimate: P = 312,596,174 (http://www.census.gov/main/www/popclock .html).
Let M equal the maximum number of subprime mortgages ever issued. Liberally estimate M as equal to P/2.
Let T equal one trillion. Conservatively, assume that “trillions” refers to two trillion (2T).
Compare 2T to M = P/2 as a ratio:
2T/M = 2T/(P/2)= 4T/P = 12,796 (in significant figures).
Notes –
Let D equal an estimate of the current amount (in USD) of all mortgage debt in the US. Rounded up, D = 13.6 T USD at present (http://www.usdebtclock.org/). Thus,
D/M = D/(P/2) = 2D/P = 43,507 USD,
which is an estimate of the average outstanding debt per mortgage in the USA. There are surely fewer than P/2 mortgages, so this figure must be an underestimate, but cannot be in error by more than an order of magnitude unless the number of mortgages is actually P/20 or fewer.
One million = 1,000,000 = 1,000,000,000,000/1,000,000.
One trillion = 1,000,000,000,000 = 1,000,000*1,000,000.
Nouriel is right. For anyone who wants to know what’s going to happen next in the Eurozone crisis, with solutions, this other guy has been right all along…led the bandwagon everyone is now jumping on… A MUST READ.
http://jackworthington.wordpress.com/201 1/11/09/reality-hits-the-eurozone-finall y/
Spoken like a true economist, which is not a compliment. The Eurozone’s problem is not its symptom about which you speak. The Eurozone’s disease is that of the EU. The EU’s problem is one of politics. The euro was a political creation and I never understood who profited from it (please don’t bring up the moronic “it’s easier for tourists to understand.” You don’t change an entire monetary system for tourists’ convenience nor for that of the bookkeepers.
What you talk about is the zone. Initially it was created to facilitate the flow of goods and people and that was accomplished by the mid-eighties. Then the politicians decided it would be beneficial (to them) to bring in as many countries as possible. The books were cooked and everyone knew it. But the bigger the EU, the bigger the potential corruption and the more power the politicians at the top had. Immediately on accession to the Euro, prices rose by about 20% (although the politicians said the contrary.)The cost of living in Greece, Portugal, Spain, Greece, etc. which had been inexpensive and drew tourists like flies, became comparable to costs in the PIIGS countries. The public suffered in those countries, but the corruption thrived. The 1% got richer. The 99% got poorer – BECAUSE they were told they could spend beyond their means – which they did and those who governed did on a national level for which everyone is now paying.
The Politicians got filthy rich out of the EU and in no real case did that happen to the general public which just put it on their newly found credit cards. The United States of Europe’ downfall is just as tragic as the United States of America’s diminishing. They have both collapsed because their leadership has collapsed!!!
But the symptoms did not cause the cancer!
If the ECB is going to take on a role like the FED’s, it is worthwhile to compare the two institutions and the environments in which they operate.
1.The FED operates in a system with a federal republic and a central treasury and a single currency. The ECB operates in a monetary union with a single currency that is composed of individual sovereign nations and has no central treasury.
2.The central government in the US has the legislative authority to tax and to apportion funds. There is no such corresponding authority above the individual sovereigns within Europe.
3.The Fed loans to the US Treasury unconditionally. By “unconditionally,” I mean that it is the Treasury that decides how to apportion and account for the funds, not the Fed.
4.The Fed operates in a system which issues bonds at its own level – the national level. There are no such equivalent bonds in Europe at the supranational level of the ECB.
Obviously, these are critically important differences. When the Fed was established, institutions were firmly in place to arbitrate fiscal policy at the national level. National bonds were in place so that the Fed supports the sovereign on its own level, as opposed to from a level above it. The immense danger in having the ECB take on the role of the Fed derives from the fact that none of these institutions or instruments exist in Europe at the ECB’s level. Hence, the ECB would not operate at the level of the countries it lends to, it would operate from a higher level, a supranational level. While the Fed’s role as lender of last resort may be purely that, the ECB would have a critical vacuum to fill in a similar role. It would the ECB’s decision as to who it lent to and, most critically, under what conditions. In the absence of a central fiscal authority at the European level, the ECB would be the institution to dictate conditions for receiving its funds. Those conditions could include debt/GDP targets, deficit reduction targets, enforced austerity measures, labor market measures, etc. In fact, such demands have already been made, the latest occasion being a letter from Trichet to Italy in late September demanding certain actions. Given the lack of a supranational Eurobond, the ECB would also have the power to decide whose bonds it would purchase and whose it would sell. In short, the ECB would become the central government of Europe, and an unelected and opaque one at that.
The take away point: The Fed is a monetary authority, while the ECB as LOLR to sovereigns would be both a fiscal and a monetary one. While the Fed may be the USA’s lender of last resort, the ECB would be Europe’s paymaster/treasurer.
Whether the elected leaders of European nations will allow their citizenry to be subjugated to such a powerful unelected bureaucracy, and whether the citizens will stand for it, remains to be seen….
“Give me control of a nation’s money and I care not who makes it’s laws”
-Mayer Amschel Bauer Rothschild
“Whoever controls the volume of money in any country is absolute master of all industry and commerce.”
-James A. Garfield, President of the United States
You say “For the last decade, Portugal, Ireland, Italy, Greece, and Spain were running ever-larger current-account deficits; Germany, the Netherlands, Austria, and France were running ever-larger current-account surpluses.”
Really? The current account figures of the last decade show that France is not part of what you call the “eurozone core” group. At best, its part of a “close periphery” group with Belgium and some others.
Among the 17, the ones running ever-larger current-account surpluses are Germany, the Netherlands, Austria, Finland and Luxembourg. Only 5.
Tony B Liar – and his ilk + Basel II = mass corruption. An opportunity grabbed with both hands by a very small band of opportunists who engineered their own opportunity.
His children’s generation will have to pay, possibly in blood, for their greed.