Sunday, January 4, 2015

Euro-zone Doomed By Lack Of Action

Debt Is Growing As Growth Stalls
When will the Euro-zone finally gets it's act together? It appears the answer may be on the 12th of never. More and more it looks like the Euro-zone is doomed by its inability to act. In March of 2013 I penned an article titled "The Euro has problems, big problems" and little has changed.  The two main reason the euro holds together is fear of financial and economic chaos on an unprecedented scale if it is allowed to fail, and the other is to defend the decades long investment in the project.  Today we see the parties involved say they remain committed to propping up nations such as Greece. Germany's chancellor Angela Merkel has even gone so far as to state its departure would be "catastrophic" yet, she is not ready to take the action needed to save the euro once and for all.

This means the currency and the European Union remains vulnerable to new shocks. Currently the Euro-zone is engaged in an unending "talkathon" with nothing being done whenever the fear of an immediate collapse is off the table. The members of the Euro-zone much like their counterparts in America just talk about solutions without any action. For us in America news from across the pond dribbles out in small doses often with injections of hope from a media that glazes over the problems and issue promises that better days of growth are just around the corner. It is only when Greece again starts talking about default and politicians begin bantering around anti-austerity solutions they say will create a painless path to put all this ugliness behind us that the situation again garners our attention.

Recent elections in Greece have again put the country front and center with talk and speculation as to the euro's future as a currency. Markets still worry about the risk of sovereign defaults, unsustainable deficit spending and of a partial or total collapse of the euro. It is possible that the euro is built on such an unstable foundation and so flawed that it can't continue. Common sense suggests that leaders might make better use of their time thinking about how to manage a break-up. Some may be doing so, but having described a split as bringing economic Armageddon, leaders dare not be seen planning for it. Greece is not alone, several countries with austerity wracked economy's are expected to muddle forward, but economists remain skeptical that growth will pick up in 2015 as had been forecast.

Muddying the water is the fact some people see what is happening in Greece as the answer and say scaremongering campaigns on the part of German and European officials make no sense. These people see the leftist Syriza party not as a threat to Europe but a breakthrough. Syriza's program advocates a substantial write-off and renegotiation of the bail-out agreements, accompanied with what is called a "development clause". Leaning towards a Keynesian, rather than a monetarist approach, Syriza opts for balanced rather than surplus budgets, and advocates a return to the minimum wage and a relief program for all affected by the crisis in order to stem the humanitarian fall-out. It also advocates a fair taxation system and ending corruption. All well said but it should be noted we have not yet seen a concrete reform program concerning institutional renewal and how the nightmarish state machine of Greece would be reorganized and put right.

Without the fear of an acute crisis that might endanger the euro it appears Germany has little leverage to move reform along. In the past, countries desperate for Germany’s financial backing quickly agreed to treaty changes to  satisfy Angela Merkel and fill her need to placate her constituents. Germany has pushed the idea that countries should sign binding contracts with European institutions concerning promised reforms in exchange for additional economic help. Northern hawks  like the Netherlands and Finland continue to be adamantly opposed to additional transfers, fearing they might become permanent. Southern doves rejected the idea of yet more control and over-site of reforms imposed from Brussels, especially if only small amounts of money and aid come with them. The result is a “negative coalition” of the rival camps who opposed the German idea for completely different reasons.

Another problem is that when it comes to reforms the concept of austerity has been skewed and painted as evil. Governments have found it easier to cut deficits by raising taxes than reducing spending or address the rigidities in the labor and product markets that retard growth. The best two explanations for reform-aversion are; structural reforms run into organized opposition from groups that enjoy benefits, while raising taxes causes only generalized grumbling. Second, European rules focus primarily on controlling debt and deficits and not the underlying workings of the economy. Countries that have been forced to seek bailouts have already enacted major reforms, in truth these contracts are really aimed at vulnerable countries like Italy and France that have not come under official programs. Enrico Letta, the former Italian prime minister took the line that “the time was not right”. France has gone so far as to say the commission should not “dictate” the shape of reforms.

Problems in the Euro-zone ultimately stem from the loss of competitiveness in the countries of the periphery where wages have outrun productivity. Germany wants structural reforms to labor and product markets to have more growth. Voluntary initiatives, starting with the Lisbon Agenda seeking to make Europe more competitive and dynamic have achieved little. The Euro Plus Pact of early 2010, where countries made voluntary pledges that were to be reviewed yearly by peers has produced little fruit. The commission’s “country-specific recommendations” have been generally ignored. Today many leaders fear the unpopularity of such moves will feed the rise of anti-establishment, anti-EU and anti-immigrant parties. The idea of these contracts have been repeatedly pushed off since autumn of 2012. Merkel will now begin a waiting game, only when they need Germany to commit more money to stabilize the Euro-zone will she be able to push her contract agenda through, but remember getting someone to sign a contract and meeting its terms are two totally different issues.

At some point we must circle back around to the issue of the long awaited Banking Union, the absence of a permanent burden sharing agreement to end the doom-loop between weak sovereigns and weak banks remains elusive and progress towards the necessary institutional framework is not the same thing as completion. A banking union is no panacea for the euro zone’s ills, but it would ensure that taxpayers of individual countries are not called upon to save the banks. Currently, there is agreement on a bail-in scheme for banks that will involve creditors if a bank fails, but still there is no pan-European deposit insurance or resolution scheme with a single Euro-zone deposit-guarantee system similar to America’s FDIC. What has been agreed to would transfer to European authorities the supervision of Euro-zone banks and the power to handle their liquidation if necessary yet fails to address key issues. Even the IMF has warned that such a piecemeal banking union would fail and leave the most troubled countries vulnerable to bank runs. 

Unfortunately, without a crisis little gets done, it appears the Euro-zone and the world has been lulled into complacency by all their constant talk coupled by central banks printing and promising easy money for the foreseeable future. It seems many people have already forgotten the lessons of the 2008 financial crisis that debt does matter. All this has set the stage for more problems in the near future. If the government's of the Euro-zone do not come up with solutions that the people can accept and buy into we should be prepared to continue seeing unrest play out on the streets of that troubled region of the world. The problems are many and the economic obstacles facing the Euro-zone are massive, the other thing that is certain, is that they are not going away. Instead the issue of how to make economies more sustainable will soon be visiting even more countries across the globe.

   Footnote;  As always comments are welcome and encouraged. This article goes hand in hand with several others on the Euro-zone, the article below looks at how currency trading is about to get very wild.

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