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Judging by the increasingly upbeat statements of European policymakers and the currently buoyant market pricing of eurozone sovereign bonds, one could be forgiven for thinking that the euro crisis is now finally behind us. However, to do so would be to ignore a whole slew of underlying economic and political indicators that would suggest a very different story. Those indicators would suggest that at best we are in the phony-war stage of the crisis and that it is only a matter of time before that crisis returns with greater virulence than before.
Among the more basic indicators to which the market is paying scant attention is the fact that eurozone public debt levels remain extraordinarily high and are yet to show any clear signs of declining. The public sector sovereign debt to GDP level is now as high as 175% in Greece, 133% in Italy, and around 125% in Ireland and Portugal. Making these debt levels all the more troubling is the fact that all of these countries are now showing the clearest signs of austerity fatigue and the lack of political willingness to generate primary budget surpluses of a size sufficient to place those debt ratios on a declining path.
“Markets are paying little attention to clear indications that the eurozone’s feeble economic recovery is already running out of steam.” – Desmond Lachman
More surprising yet, markets are paying little attention to clear indications that the eurozone’s feeble economic recovery is already running out of steam. Generally after an economic recession as long and as deep as that which Europe recently experienced, one would have expected a sharp rebound in economic activity to bring the economy quickly back to trend. However, this is clearly not happening as Europe perseveres with budget austerity, its dysfunctional banking system continues to restrict credit, and an overly strong currency undermines export performance. Indeed, the dismal first quarter of 2014 eurozone GDP numbers suggest that, excluding Germany from the mix, the rest of the eurozone’s economy essentially stagnated.
Of equal concern as renewed economic stagnation is the fact that the eurozone as a whole is now experiencing very low and declining inflation, while as many as six eurozone countries are now experiencing outright price and wage deflation. Absent economic growth at a sufficiently fast pace to reduce Europe’s near record high unemployment rate, one has to expect that those deflationary trends will only intensify. Were that to happen, it is very difficult to see how the countries in the European periphery can restore public debt sustainability without significantly restructuring their public debts.
Not surprisingly, Europe’s poor economic performance over the past three years has taken a heavy toll on its politics. Years of extraordinarily high unemployment have undermined popular support for European governments and given a major boost to populist parties. Bepe Grillo’s Five-Star movement in Italy, Marine Le Pen’s National Front in France, and Alexis Tsipras’ Syriza Party in Greece, are all now coming from nowhere to pose serious challenges to those countries’ governments. These disturbing political trends are all too likely to be on full display at this weekend’s European parliamentary elections where anti-European parties are expected to garner as much as 30% of the vote.
A fundamental question that markets are choosing to ignore is that if over the past three years high unemployment and disappointing growth has led to political fragmentation in Europe, why will the persistence of those conditions not lead to more of the same in the future? And if there is further loss of political willingness, can we really expect those countries to persevere with budget austerity and economic structural reform so necessary to put those countries on a better growth path?
“Sadly, there are good reasons to question whether the ECB will be able to avert a renewed Euro crisis in a pre-emptive manner.” – Desmond Lachman In apparently ignoring the eurozone’s many economic and political weaknesses, markets are seemingly relying on the European Central Bank (ECB) to come to the rescue again in one of two ways. The first is by substantially easing monetary policy through unorthodox measures including through quantitative easing. The second is by bailing out countries in the European periphery as needed through the ECB’s Outright Monetary Transaction program.
Sadly, there are good reasons to question whether the ECB will be able to avert a renewed Euro crisis in a pre-emptive manner. Indeed, there is very strong resistance to quantitative easing in Germany, the ECB’s main shareholder. This is likely to keep the ECB on a “too little too late” policy path now in much the same way as it has done over the past three years. Similarly, one has good reason for doubting that the ECB is able to pre-emptively rescue peripheral eurozone countries for to do so it would require that those countries had some sort of IMF-style program in place. And, with those countries now exiting those sort of programs, it would seem that they would only revert to IMF tutelage in the throes of a full blown crisis.
If the euro crisis indeed does return despite the present complacency in markets and policymaking circles, it will not be the first time that this will have happened. Indeed, on the very eve of the outbreak of the eurozone crisis in early 2010, both markets and policymakers were caught napping as they extolled Europe’s future economic and political prospects.
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