Euro zone should beware the “F” word

By Hugo Dixon
April 2, 2012

Beware the “F” word. The European Central Bank and, to a lesser extent, the zone’s political leaders have bought the time needed to resolve the euro crisis. But there are signs of fatigue. A renewed sense of danger may be needed to spur politicians to address underlying problems. It would be far better if they got ahead of the curve.

The big time-buying exercise was the ECB’s injection of 1 trillion euros of super-cheap three-year money into the region’s banks. A smaller breathing space was won last week when governments agreed to expand the ceiling on the region’s bailout funds from 500 to 700 billion euros.

These moves have taken the heat out of the crisis – both by easing fears that banks could go bust and by making it easier for troubled governments, especially Italy’s and Spain’s, to fund themselves. Data from the ECB last week shows how much of the easy money has been recycled from banks into government bonds. In February, Italian lenders increased their purchases of euro zone government bonds by a record 23 billion euros. Spanish banks, meanwhile, increased their purchases by 15.7 billion euros following a record 23 billion euro spending spree in January.

The risk is that, as the short-term funding pressure comes off, governments’ determination to push through unpopular reforms will flag. If that happens, the time that has been bought will be wasted – and, when crisis rears its ugly head again, the authorities won’t have the tools to fight it.

Early signs of such fatigue are emerging. One is the tendency of politicians – most recently, Italian Prime Minister Mario Monti – to say that the worst of the crisis is over. They may wish to take credit for their crisis-fighting skills or relax. But it is too early to declare victory.

Italy is a case in point. Monti should have pushed through crucial reforms to the labour market earlier, while his popularity was high and the electorate was afraid that Italy would be engulfed by the crisis. He did not. And although he has now come up with a good package, his honeymoon period as the unassailable technocratic prime minister is nearing its end. His popularity fell to 44 percent from 62 percent in early March, according to a poll published last week by ISPO. Two-thirds of Italians oppose his labour reforms.

It’s a similar story in Spain. Mariano Rajoy, the incoming prime minister, should have cracked on earlier with a budget to bring the government’s finances into balance. To be fair, his administration did publish plans last Friday to curb its deficit – though it won’t be possible to judge how credible these are until Madrid explains how the health and education spending of Spain’s free-wheeling regional governments is to be reined in. Meanwhile, Rajoy’s honeymoon is also over. Last week, he failed to win the regional election in Andalucia and faced his first general strike.

Both Monti and Rajoy are still in strong positions. Although Italy’s political parties could theoretically kick Monti out, they are even less popular than him. Meanwhile, the Spanish prime minister has a sound majority in parliament. But as each month passes, it will get harder to push through reforms. Both men must hold their nerve and implement their full programmes while they can, without compromise.

Further afield, the appetite for austerity is also flagging – sometimes in unexpected places. The Dutch government, one of the high priests of fiscal rectitude, is finding it difficult to cut its own deficit. The ruling coalition may even collapse under the strain.

There is also increasing unhappiness about the fiscal discipline treaty Germany rammed through in December. Francois Hollande, the French socialist who is the front-runner to be France’s next president, wants to add a growth component to it. So do Germany’s social democrats, whose support is needed to ratify the treaty even though they are in opposition.

A fudge will probably be found that adds a protocol to the treaty which emphasises the importance of growth as well as discipline. Indeed, that would be no bad thing: too much austerity can be self-defeating as severe budget squeezes can crush an economy and make it even harder to raise taxes and cut deficits.

However, governments can’t ease up on short-term austerity and do nothing. What is needed is a vigorous programme of long-term structural reforms such as freeing up labour markets and introducing more competition into services industries. This could ultimately boost GDP by about 15 percent in large euro countries such as France, Italy and Spain, according to the Organisation for Economic Cooperation and Development. Even Germany, whose services markets are sclerotic, could benefit by about 13 percent of GDP.

Such a programme would make the euro zone’s economies fit enough to stand on their own feet when the anaesthetic of cheap money fades. But do governments have the will to make these changes given that the cheap money is lulling them and their people into believing the worst of the crisis is over?

A prod from the markets may be what is required. There are indications that this is beginning to happen. Spanish 10-year bond yields briefly reached 5.5 percent last week. The art, though, will be in the calibration. If markets move too little the politicians will be complacent. If there is too much, the euro zone will slip back into full-blown crisis.

8 comments

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Are you serious?

You state “What is needed is a vigorous programme of long-term structural reforms such as freeing up labour markets and introducing more competition into services industries.”

For one thing the markets don’t operate on a “long-term” basis, so this won’t work right up front. Second, “structural reforms” have hardly begun and that is why people are rioting in protest.

Thus, it should be obvious that there is no time to make any long-term changes under the present circumstances.

The eurozone needs to face reality and begin on a plan for the most amicable “divorce” possible before it becomes impossible to do so.

For an in-depth analysis, see Bloomberg’s article today, “Euro Was Flawed at Birth and Should Break Apart Now”.

http://www.bloomberg.com/news/2012-04-01  /euro-was-flawed-at-birth-and-should-br eak-apart-now.html

Posted by PseudoTurtle | Report as abusive

No, what Europe needs is to bring back manufacturing by imposing a protective tariff.

The young people in Europe have no jobs. And if you walk into any supermarket there, it’s easy to see why.

All the goods in the supermarket are made in China!

Europe needs to wake up. Their survival is at stake. The doctrine of “free trade” has benefited multinational corporations immensely, but has murdered, destroyed the European middle class.

Europe needs an immediate 25% tariff on all imported goods from outside Europe, manufactured or agricultural. The tariff must be a clean and simple 25% so that it can’t be corrupted away in the shadows.

If such a tariff were imposed, jobs for European youth would spring up like new grass after a rain. And the huge proceeds of the tariff could be used to balance the budget.

Tariffs work. And they are the easiest of all taxes to administer, and the least susceptible to corruption. Tariffs are good for citizens but multinational corporations hate them.

Posted by AdamSmith | Report as abusive

I thought the “F” word was going to be “Fed”

Posted by Hinch | Report as abusive

Adam Smith: In Italy, I see more things coming from Germany than from China. If I go to Sardegna, I use Moby Lines (German). When I go to Auchan (French), I buy food like “biscotti” and “mozzarella” from Germany (very good and cheaper than the Italian option, even though I live in Italy ?!) My local macellaio (butcher) carries pretty much German beef. Again, cheaper than the Italian comparative. This also applies to clothing, shoes, cooking utensils, light fixtures, plumbing supplies….. Germany is Europe’s China.

Posted by piaf | Report as abusive

Yeah right – anyone is going to listen to commentators from the self-righteous criminally and socially bankrupt Anglo Saxon countries?

Posted by topmutt | Report as abusive

The main problem stemming from the formation of the Eurozone is that it requires the wages of the poorer economies to perennially move downwards to match their eternally lower productivity year on year decade on decade.

However it is well known that wages are sticky even in a recession see http://cowles.econ.yale.edu/news/bewley/ tfb_00-02_wages.htm
Hence there is no practical mechanism having the same effect as devaluing individual currencies to cater for country’s lower growth rates once a common currency is formed.

The only get-out would be a full fiscal union where the rich regions eternally give largesse to the poor regions to keep their heads above water. Try selling that concept to the German public.

Posted by skeptic | Report as abusive

Here in the US the middle class faces the same fate. The virtual elimination of our manufacturing base has decimated not only the solid paying jobs and benefits they bring. It’s also destroying something I believe to be of even greater importance to our once great Republic. Belief. Belief that the people we elect to represent us in the halls of Congress would never sell their countrymen out for 30 pieces of silver. Belief in the general decency of their brethren who own these companies they work for, small and large, that they would never become our Judas, choosing larger profit margins over their own country. A belief, that is at the heart and soul of anything good America has ever represented. The belief that even with all of our flaws and shameful missteps, that when it really matters most, our brothers in the positions of power would stand on the side of the righteous and never yield. That belief, is everything in America. Without it, all of the bloodshed by our Founding Fathers and countrymen to gain our rightful independence from tyranny, will have been for naught. Our Constitution, amongst the most divinely inspired and just words mankind has ever put to parchment, betrayed by those who swore a sacred oath to uphold and defend her. Sold out to global banksters and corporate elites in bed with our Executive, Legislative and Judicial representatives, here and abroad. Men devoid of conscience. Sociopath puppet masters who actually believe it is their destiny and right to rule us serfs under a New World Order. The deconstruction of freewill principles and the wealth of nations has been decades in the making. The acceleration of their move to one world government is so palpable, that even those who lack the detailed knowledge or education in such matters can sense that we are all but done for as a free people. Without those beliefs secured in their hearts and minds, America is all but guaranteed to become a part of the totalitarian state we’re being sold to. A job is just that, a job. The reason for America’s stunning success in gaining our Independence from England, was their/our belief. Having a truly just cause worthy of sacrificing your life for if necessary. The British were the greatest military force the world had ever known, defeated by a group of educated rebels and a rag tag army of outgunned, outnumbered, farmers and expats with little to no training or combat experience in comparison. The Brits served a tyrant, a King who owned them as if chattel. The American Patriot’s they faced had tasted the notion of true freedom, after having suffered under the boot heel of a tyrant King and his henchmen. This is why England was defeated. These Patriot’s believed in a just, noble cause and sacrificed dearly for it. What were the Brits fighting for? Promotion in rank? Titles? Land? Fear of angering their King? What they had was just a job, no belief that was just or noble. I see the change in my country destroying the faith in our beliefs, our own elected leaders speaking as if Patriot’s while governing as tyrants. Jobs and industry are important for all nations, but we’ve got much deeper problems the world over than a high unemployment rate……We’re losing our freedom.

Posted by Mastafing | Report as abusive

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