Opinion

Hugo Dixon

Euro crisis is race against time

By Hugo Dixon
October 1, 2012

Solving the euro crisis is a race against time. Can peripheral economies reform before the people buckle under the pressure of austerity and pull the rug from their politicians? After two months of optimism triggered by the European Central Bank’s plans to buy government bonds, investors got a touch of jitters last week.

The best current fear gauge is the Spanish 10-year government bond yield. After peaking at 7.64 percent in late July, it fell to 5.65 percent in early September. It then poked its head above 6 percent in the middle of last week because there were large demonstrations against austerity; because Mariano Rajoy’s government was dragging its heels over asking for help from the ECB; and because the prime minister of Catalonia, one of Spain’s largest and richest regions, said he would call a referendum on independence.

But by the end of the week, the yield was just below 6 percent again. That’s mainly because Rajoy came up with a new budget which contains further doses of austerity. The move prepares the way for Madrid to ask for the ECB to buy its bonds and so drive down its borrowing costs.

Rajoy didn’t want to be seen to be told to do anything by his euro partners. Hence, this elaborate dance – where he has now done what he knew he would have been told to do but can claim it was his choice. It’s hard to believe that anybody is fooled by this subterfuge; indeed, from investors’ perspective, it looks childish. But, at least the show is on the road again: the government has had the guts to press ahead with reform despite the immense unpopularity of the measures.

The question is whether Madrid and other governments in Lisbon, Dublin, Rome and Athens can keep up the reforms long enough to restore their economies to health. That, in turn, depends on three factors: how much farther they have to travel; how unruly their people are going to get; and how much help they will receive from their partners.

Economic health requires both that fiscal deficits are eliminated and that competitiveness is restored. The peripheral economies have made some progress on both fronts. But shrinking economies makes it hard to balance their budgets while fiscal squeezes undermine growth. The austerity vicious spiral is still whirring away.

That’s why Spain is unlikely to hit its target of cutting its deficit to 4.5 percent of GDP next year. It can get there only on the optimistic assumption that the economy will shrink by just 0.5 percent in 2013. The same could be said of France, not yet a full member of the periphery, whose budget unveiled last Friday calls for a deficit of 3 percent of GDP next year. Paris is assuming 0.8 percent growth. The French prime minister describes the projection as “realistic and ambitious”. Just ambitious would have been a more accurate description.

Meanwhile, restoring competitiveness is painful because it involves cutting people’s pay. Ireland and Spain have made good progress, covering respectively 80 percent and 50 percent of what they needed to achieve by the end of last year, according to a report last week by Open Europe, a British think-tank. Portugal and Greece have done less well.

Current account deficits paint a similar picture. Spain’s had shrunk to 3.5 percent of GDP last year while Ireland actually had a small surplus. Portugal, though, had a deficit of 6.4 percent of GDP and Greece was struggling with one of 9.8 percent.

Big falls in pay are forecast for the deficit countries over the next two years by Eurostat. It sees unit labour costs dropping 4.7 percent in Spain between end-2011 and end-2013; 3.8 percent in Portugal; and 9.5 percent in Greece. If that happens, competitiveness could be restored. Citigroup forecasts that Spain and Portugal will have current account surpluses next year while Greece’s deficit will have shrunk to 2.8 percent.

The snag is that such pay cuts – especially when combined with higher taxes and rising unemployment – provoke howls of outrage from the population. Short of leaving the single currency and devaluing, the only other medicine for improving competitiveness is so-called fiscal devaluation. This involves cutting the social security contributions paid by employers and, in return, putting up other taxes.

Germany succeeded in pushing through such a fiscal devaluation in 2007. But that just made it more competitive vis-a-vis the weaker euro zone economies. More recently, Spain did a mini fiscal devaluation. But the most ambitious attempt, by Portugal, provoked such a massive backlash earlier this month that the government backed down.

Help from abroad is the main way of easing the pain of adjustment. The ECB’s promised bond-buying plan is the most dramatic example. But solidarity has its limits. There has been a backlash in the German media over the central bank’s plan. Meanwhile, Berlin has been trying to persuade Madrid not to ask for help. The German finance minister also clubbed together with his Dutch and Finnish counterparts last week, proposing rules that will make it harder for Spain to shift the cost of bailing out its banks onto the euro zone.

The consequences of a breakup of the euro zone would be so ghastly for both the periphery and the core that they will probably pull through what looks like it is going to be at least another year of hell. But the risks have certainly not vanished.

Comments
11 comments so far | RSS Comments RSS

If the ECB end up bailing out Spain they MUST send the Troika in to Madrid to go through the books. There is no way that we are being given the true numbers and before any cash is committed we must know the truth. THAT is why Rajoy is prevaricating.

Posted by paulos | Report as abusive
 

Ruining the whole of Europe to satisfy, some bad cooked plans, from self-appointed politicians.

Do those politicians sleep well at night? Or do they really don’t give a …

Posted by Willvp | Report as abusive
 

And let us not forget that those same politicians where PART and PARCEL of this mess during their political time in their own country, before they were dumped at the EU, to earn hugh end-of-carriere remuneration and a big lifetime pension. (did they put austerity on their own pensions/wages? Oh no, they forgot)

Posted by Willvp | Report as abusive
 

@Willvp,

“Ruining the whole of Europe to satisfy, some bad cooked plans, from self-appointed politicians.” English is not your “first language, is it?

The existing socialist society you apparently wish to preserve is finally, as Margaret Thatcher predicted, “…running out of other people’s money” and even their own. Europeans must revise personal expectations of government to what their collective productivity can sustain, as elsewhere. Your “paradise” is that of an immature self-centered fool.

There are no “self-appointed politicians”. They are elected, even where elections are among poor choices or the outcome is “rigged”. Perfection is a wonderful goal, but yet to be achieved anywhere.

Posted by OneOfTheSheep | Report as abusive
 

This is an excellent analysis of the present state of the Eurocrisis, and Mr. Dixon even forecasts that the eurozone will probably pull through another bad year.

I am not so sanguine about Europe’s prospects. German electioneering has begun with Peer Steinbrueck being elected to lead the Social Democrats against Merkel’s conservative coalition. German elections will take place in just about one year, which coincidentally is how long the eurozone is predicted to keep lurching along.

A distinct pattern has developed during the crisis. Governments have fallen at a rapid clip. The Dutch elections last month were the first time that a government in power survived since the onset of the crisis in 2009.

What the politicians in every country are trying to do is remain in power. This is the Merkel’s plan, too, and it is no coincidence that current measures appear to keep the lid on things for another year or so.

This is where we reach the limits of analysis. Any commentator on the Eurocrisis must realize that the eurozone has become critically unstable, just like a snow packed mountain before an avalanche.

When I read about how avalanches were like market crashes, it was stated more succinctly, but let me give it a shot. Imagine a mountain covered in snow. There is another snowstorm and another. Pretty soon, the snow pack on the mountain reaches a critical point. One more snowflake will trigger the avalanche, but we cannot blame this last snowflake.

Several snowfalls have contributed to this disaster. The last snowflake just came along at the wrong place at the wrong time. Of course, maybe we just experienced the last snowfall of the season and the summer melt removes the danger of the avalanche. It is not inevitable that our hypothetical snowflake falls.

The Eurocrisis has now reached a critical stage. The next snowflake could trigger a disaster, but right now it appears that it will not snow.

This is a dangerous view. As with many complex systems wrought by man, the eurozone is to complex for us to understand. As Rumsfeld would say, there are things that we don’t know we don’t know. Look at two surprises from the last few months. Did anyone predict a resurgence of either Catalan separatism or Greek fascism?

The question is what other nasty surprises are lurking beneath the exteriors of these countries. Any one of these could trigger the avalanche. Perhaps, a TBTF bank will be caught lying about its true market condition creating a panic. Maybe a government will be caught in a similar lie. There could be a political crisis, like a coup.

When a system is this unstable, it can come crashing down in an instant, and no one will see it coming. The best that we can do with analysis is recognize when the system is unstable, not predict when it will die.

dareconomics.wordpress.com

Posted by dareconomics | Report as abusive
 

@OneOfTheSheep:

You explain to me, slowly because English is NOT my mother tongue, on HOW and by WHOM for instance Van Rompuy and Barosso and Rehn and Monti were elected.

Always good to know that I am/was wrong but I will decide on that AFTER your learned assistance.

Posted by Willvp | Report as abusive
 

@Willvp,

My apologies for any offense.

I speak as an American from the inherent limitations of purely American experience. There seems considerable difference between the “typical perspective” of Europeans and Americans as to respective working hours, social benefits and the “bottom line” of productivity.

Given that there are few places in the world that English is not commonly spoken, most Americans are not sufficiently fascinated with other languages to learn another, or with individual countries or their politics/politicians within the Euro zone other than as which may be in economic difficulty.

Accordingly, I freely confess my inability to answer your question. I merely expressed my present understanding that European countries today function generally in a democratic manner, in form if not in function.

If that’s not so, please enlighten?

Posted by OneOfTheSheep | Report as abusive
 

Well put Willvp, and nicely apologised OneOfTheSheep; if only all on-line disputes were so graciously resolved.

Looking at it from Australia, the Euro economic model is interesting, in that it does not allow for heavy-handed Keynesian-style stimulus of the economy. Yet it would appear that, if each country plays the game and keeps its budget in balance over the medium term, it could still prove to be a workable system.

The Euro model means that when things get tough, government expenditure has to be cut, including pensions and wages. It would be nice if plutocrats led the field in this by cutting their pensions and pay, even though the main benefit of this would be in the example set (there are not enough plutocrats to really affect the bottom line).

The austerity model actually make sense; it is the household budget on a grand scale: reduce expenditure when there is not enough income, rather than borrowing against the future.

However, the austerity model will continue to be under attack until it starts to deliver an end to the crisis in one of the countries currently suffering badly. Perhaps this will be in Spain or Italy.

Two things are clear from this great distance; a government cannot spend more cash than it can get its hands on; and rioting will not help to restore the economy.

Posted by GrahamLovell | Report as abusive
 

(quote) “Europeans must revise personal expectations of government to what their collective productivity can sustain, as elsewhere. Your “paradise” is that of an immature self-centered fool.”

… no sooner read, then forgotten

like Linux OS, the European Union requires considerable user input and self-education

Another analogy is to grasp at least three european languages and cultures

You don’t have to, but don’t cry if you can’t track the cultural and political landscape. Understanding the European Union requires more than eating fat-free fries.

Posted by scythe | Report as abusive
 

@OneOfTheSheep:

If there ever is a democratic election in Europe to elect the top echelon of the EU, ECB etc…then I will gladly inform you.

The top is still “appointed” by…nobody knows actually, by themselves I guess, possibly with the help of an American financial institution, if you check where those elected, were either trained, or worked before.

And maybe, one day, their budget will be approved by the member states, as apparantly that never happened in the life of this political institution….Amazing that the media don’t jump on those undemocratic issues.

Posted by Willvp | Report as abusive
 

If they are bankrupt they should declare bankruptcy and tell the creditors it is end of the line if they cannot pay without killing people it is the end of the line. They will have take some banks to make business loans the rest will go under. They then have to build export industries to pay for imports. If other nations cry foal, they could offer with glee to extradite their ex-politicians and bankers who got into the mess to any nation who try to put them in jail for fraud or whatever.

You cannot bleed a dry rock. If they cannot pay the creditors lose unless they can sell the debt to some sucker. That the first rule of finance. Even in days of slavery if someone owed more than the sum of what his labor would be worth and what had the creditors lost.

No one is talking about growing export industries by taking form thew other industries.

Posted by Samrch | Report as abusive
 

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