The European Crisis Is The "New Normal"

Philip Aldrick Daily Telegraph November 19, 2011

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By Philip Aldrick Economics Last updated: November 18th, 2011

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Euro crisis: this could persist deep into 2013 (Photo: Alamy)

There are two main schools of thought when it comes to fixing the eurozone debt crisis at the moment. The first is that matters will come to a head around Spring and a solution will be found. The second is that matters will come to a head around Spring and the euro will implode, pitching the world into another great recession. As the second scenario is so unpalatable "“ and as we have repeatedly been told that it is entirely within the wit of Europe's leaders to prevent it "“ hope quietly prevails.

That was certainly the message I got from John Cridland, directior general of the CBI, yesterday. "I think the least likely outcome is paralysis," he said. "I don't think the eurozone crisis can rumble on forever. Europe's politicians are edging towards a statisfactory resolution." The CBI's bleak UK growth forecasts, he said, are based on the assumption there is a solution of sorts by the Spring.

Cridland is not alone. IMF head Christine Lagarde has repeatedly said "there is a path to recovery" albeit "narrower than three years ago", George Osborne this week claimed "the eurozone has the financial capacity to restore stability", US Treasury Secretary Tim Geithner has argued "when France and Germany agree on a plan together and decide to act, big things are possible". All clearly believe there is a way out.

But there is a third scenario. That the current stalemate persists throughout the year and deep into 2013, when the permanent European rescue mechanism is finally launched (that's the ESM for lovers of acronyms). Stalemate would mean permanently elevated bond yields across the eurozone, with the sole exception of Germany. It would mean very weak growth across Europe, if any at all. It would mean markets in a constant state of anxiety, pitching back and forth on the whims of confidence.

If recent history has anything to teach us, it's that the third scenario is the most likely "“ and Europe will revert to "kicking the can down the road". Consider the recent past. The crisis flared up again earlier this year with Greece. Bond markets panicked and the panic spread to Spain. After some prevaricating, a deal was struck on July 21 for a second Greek bail-out and to beef up the bail-out fund.

The respite was short-lived. By September, Greece was back in the spotlight and the markets were turning on Italy. In Washington, George Osborne gave Europe "six weeks to save the euro". Another much larger rescue package was devised for Greece and bigger euro bail-out fund agreed in principle, but not in practice. Six weeks passed and the euro was not saved. Worse, it had begun to spread to the euro's core – with France under attack. As Cridland conceded: "Every time they've built a firewall, it hasn't been big enough and the fire has jumped it."

The focus now is on what the new technocratic governments in Greece and Italy can achieve, while the European Central Bank (ECB) appears to do be tinkering in the bond markets to keep government borrowing costs around the "unsustainable" 7pc mark. If anything, the current status looks like the new normal.

That, at least, is the opinion of one former senior minister who reckons the CBI is completely wrong. Stalemate is by far the most likely outcome. Short of the crisis actually bringing down a major German lender, such as Deutsche Bank, Chancellor Merkel will refuse to let her taxpayers' money be used to bail-out the region "“ either directly or through the ECB. If she won't step in, the international community certainly won't "“ they made that much clear in Cannes at the G20 summit.

Reflecting on Sir Mervyn King's comments at the Bank of England's Inflation Report this week, it struck me that the former minister is not alone.

"I'm all in favour of sticking plaster, it's just it's not a substitute for having proper medical treatment," he said. "The question which I think markets are looking at is "“ what is the plan to eliminate that loss of competitiveness in order to reduce the deficit and put the resulting debts on a sustainable basis?

"Until those questions are answered, then simply finding another temporary solution to a so-called liquidity problem will merely result in the problem being deferred, but not answered."

The implication is clear "“ until there is an answer to the core problems of competitiveness within the euro, the markets will not settle and the crisis will rumble on. Even if a "sticking plaster" bail-out is agreed. And just how likely is Europe to come up with that "sticking plaster"? Sir Mervyn is not hopeful.

"The whole issue is "“ do they wish to make transfers within the euro area or not?" he said. So far, the answer "“ from the only nation that can really do it, Germany "“ has been an emphatic "?no'.

For Britain, it's not a pretty picture. The CBI's downgraded forecasts "“ based on a euro resolution "“ are for growth next year of 1.2pc and 2.2pc in 2013. If Europe now drifts into a year or more of stalemate, UK banks will be unable to fund affordably and the economy will be starved of credit. Export growth will slump. The UK will be dragged even further down. There really is little to be hopeful about.

Tags: CBI, Christine Lagarde, debt crisis, euro, Europe, European Central Bank, European rescue mechanism, George Osborne, greece, italy, sir mervyn king, spain, Tim Geithner

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