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Tuesday 12 April 2011
Telegraph.co.uk Home News Sport Finance Comment Culture Travel Lifestyle Fashion Technology Jobs Dating Offers Companies Comment Personal Finance Economics Markets Your Business Olympics Business Fund Game Business Club Blogs Ambrose Evans-Pritchard Jeff Randall Damian Reece Jeremy Warner Richard Fletcher Kamal Ahmed Alistair Osborne James QuinnRoger Bootle
Eurozone ship is on the course that was set for it: heading for the rocks Two events last week saw the crisis in the eurozone deepen - the Portuguese bail-out and the ECB's interest rate increase. But much more is brewing. The medicine being dished out to the afflicted eurozone countries is a dose of German austerity. Photo: Bloomberg News By Roger Bootle 5:36PM BST 10 Apr 2011Comments
Everyone is now focused on government debt as the nub of the problem. And the numbers are shocking.
The debt to GDP ratio is over 140pc in Greece. Indeed, it is all but impossible for Greece to adjust through fiscal austerity. It is caught in a debt trap from which the only escapes are inflation (which is impossible if you are still in the euro), default, or being bailed out.
As with most things "euro", the bail-outs provided to Greece and Ireland – and now on offer to Portugal – aren't quite what they seem. They are high interest loans. If this is any sort of remedy, it is for a different malady.
The peripheral countries' fundamental problem is not illiquidity but insolvency. At some point, Greece will have to default on its debts or be the beneficiary of an outright gift from its creditors – or leave the euro.
And the debt problem is pretty serious elsewhere too. In Italy, the debt to GDP ratio is about 120pc. Italy has not really featured in the crisis so far, partly because its government debt is largely held by Italians. Yet if confidence in the Italian government's ability to service its debt were to crumble, then its people and institutions would not sit there passively out of a sense of public duty.
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09 Apr 2011Debt is one facet of the euro's crisis. There are three others.
The first is competitiveness. Since the formation of the euro, German unit labour costs have barely risen, but in the peripheral countries they have surged ahead – by about 30pc in Greece, Spain and Portugal. The result is that the peripheral countries are uncompetitive both inside and outside the eurozone, thereby shutting off strong exports as a route to recovery.
The second factor is the property market. In Ireland and Spain, house prices were driven up in a major property bubble. Although prices have since fallen a long way, the prospect is for further large drops.
The third factor is the weakness of the banks. Interestingly, some of the most serious problems lurk in that paragon of financial orthodoxy, Germany, where the state-owned regional banks have taken on oodles of dodgy assets.
The euro is supposedly cemented by unshakeable political will. Yet not only has the eurozone failed to establish workable union-wide political institutions, but the political situation in member countries has turned ugly.
Portugal and Belgium are without governments. Opposition to austerity is building in Greece and Ireland. President Sarkozy of France faces an uphill battle to be re-elected, not least against a revived, and euro-sceptic, National Front. In Germany, after recent electoral losses, Angela Merkel is in a weak position.
Even so, the medicine being dished out to the afflicted countries is a dose of German austerity. The idea is that fiscal deficits can be reduced by expenditure cuts and tax rises while competitiveness can be restored through reducing costs and prices.
But given the multi-faceted nature of the euro's problems, this mixture of depression and deflation is extremely dangerous. Because it reduces aggregate demand, fiscal austerity will intensify the downward pressures on house prices and undermine the quality of banks' assets.
Admittedly, if costs and prices fall, then competitiveness can gradually be regained. But falling prices increase the real value of debt – both public and private – and make the debt crisis worse. Most of this mess was envisaged by the critics of monetary union when the single currency was established but the euro-elite just ploughed on.
The single currency was going to bring convergence between member countries. In fact, several members have diverged.
It was going to lead to an upsurge of growth. In fact, there has been no improvement in underlying economic performance and the eurozone has been clobbered by the global financial crisis.
The private sector was assumed to be well behaved and the banks sober and responsible. In fact, the euro led to a mega-property boom which has left an already shaky banking system distinctly vulnerable.
What the eurozone needs now is sustained, strong economic growth. Yet this is a realistic prospect only for Germany and its immediate satellites. By contrast, the peripheral countries face years of depression.
Predictably, the remedy offered by the politicians is an alphabet soup of support mechanisms, all beginning with the magical letter E, and more of the balm that supposedly overcomes all ills, namely political will.
In other words: don't panic; it will be all right on the night.
It won't. The eurozone is heading for the rocks.
Roger Bootle is managing director of Capital Economics and economic adviser to Deloitte.
roger.bootle@capitaleconomics.com
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