Opinion

James Saft

Europe needs a weak euro: James Saft

November 6, 2012

Nov 6 (Reuters) – While the world is transfixed by the
outcome of the U.S. elections, the euro zone is busily imploding
economically.

And this time the difficulty isn’t so much being driven by
the troubles in Greece, Spain and elsewhere but is reflecting a
stark underlying weakness which will complicate already thorny
structural problems. Recent data on bank lending – still central
to the European economy – shows an old-fashioned, flat-out
recession deepening, with banks and borrowers both backing away
from credit as quickly as their little legs will carry them.

The situation cries out for action to weaken the euro from
the European Central Bank, which is widely expected to do
exactly nothing at its policy meeting this Thursday. Perhaps the
only good news is that the markets, recognizing the issues, are
trading the value of the euro lower, making some slight
difference in competitiveness and external demand.

Data released last week shows euro zone manufacturing
shrinking for the 16th month in a row, but the real horror show
last week was in an ECB survey of bank loan officers. Compared
to the second quarter, loan conditions were 15 percent tighter
in July-August, with banks charging more, demanding more
collateral and being especially tough on riskier loans.

While banks mostly blamed the dismal outlook for their
signal unwillingness to lend, lending conditions were also made
worse by how expensive bank capital has become. Few want to
commit capital to banks, but bank regulators are demanding more
capital. This is probably wise, but the upshot is a real credit
crunch. And the outlook, bankers say, is for more of the same
between now and the end of the year.

We are probably hearing less about this than we otherwise
would because companies themselves are not keen to borrow,
seeing less profit in making new investment and being wary of
extending themselves going into what may be a multi-year
recession. A separate survey of small and medium-sized companies
showed they are finding it increasingly difficult to get loans,
with 18 percent calling access to financing their main problem.

Compared to the year before, the amount of loans made to the
private sector in September shrank by 1.3 percent, with loans to
corporations shrinking at double the rate in that month compared
to August.

ECB ACTION NEEDED

It is hard to overstate just how bad these numbers are. The
euro zone economy relies heavily on bank loans, but its banking
system is both unwilling and largely unable to provide finance.

Even if financing were cheap and easy, businesses have
little motivation to take it up.

In pledging in late July to provide whatever was needed to
support the euro, ECB chief Mario Draghi vastly reduced the risk
of break-up, but didn’t do enough, in reality, to improve
conditions on the ground. In actuality, Draghi’s pledge helped
to underwrite a sharp rise in the value of the euro, the last
thing the economy of the currency zone needs. Even after recent
falls, the euro is still about 6.5 percent stronger against the
dollar than its July lows. Further falls would be
welcome, but the ECB may prove reluctant to jawbone its currency
lower, fearing that it looks weak and overly pliant in the
process.

The problem for the ECB is that, having stepped rather far
out on a limb in supporting the euro project, it could easily
find itself waiting too long for institutional solutions to
fast-moving economic deterioration. Just this week we will have
two key votes in Greece on austerity measures, and it is already
manifest that Greece will need some combination of extra time,
money and reduced debt. At the same time, the central bank faces
questions, most recently raised in German media, over how
rigorously it is applying its own rules over collateral
presented to it by Spanish banks for loans. All of this may make
it difficult for the ECB to feel it can safely take extra steps
to support growth.

Almost throughout the crisis the ECB has erred in being too
hawkish, fighting the phantom of inflation while structural and
debt problems sent waves of deflation through the euro zone
economy and out into the world. And to be sure, on the currency
front the ECB’s job has been made more difficult by the fact
that both the Federal Reserve and Bank of Japan have moved in
recent months to expand or extend bond-buying programs.

If the ECB takes this Thursday’s press conference as an
opportunity to spell out when and how it will implement its new
bond purchase program, a perverse impact could actually be to
drive the euro higher even while it lowers financing costs for
euro zone sovereigns.

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